ITEM 1. BUSINESS
GENERAL
The Company is the leading provider in North America of outsourced food and facilities management services to businesses, health care facilities, colleges and universities, primary and secondary schools and other clients. Food services include food and beverage procurement, preparation and menu planning, as well as the operation and maintenance of food service and catering facilities, generally on a client's premises. Facilities management services include plant operations and maintenance, energy management, grounds keeping, and housekeeping and custodial services.
The Company was formerly named Marriott International, Inc. Upon consummation of the Distribution, Acquisition, and Refinancing (the "Transactions"), which occurred on March 27, 1998 (the last day of the first quarter of 1998), Marriott International, Inc. was renamed Sodexho Marriott Services, Inc. As of March 27, 1998, the principal business of the Company changed from lodging and contract services to food and facilities management services. This change was the result of the Distribution and the Acquisition. In connection with the Distribution and Acquisition, the Company refinanced its debt. The Transactions are explained in more detail below and in the Company's Notes 1 through 5 of the Consolidated Financial Statements included in this report. Due to the extensive changes in the Company's business that resulted from the Transactions, the Company is providing for informational purposes the following description of its business.
INDUSTRY AND MARKETPLACE
The food and facilities management services industry is rapidly changing. Major industry dynamics are:
o Continued growth in the outsourcing of food service and facilities management as a result of: focus by customers on core competencies and outsourcing of their non-core services, general economic growth, and increasing cost pressures. o Increasing market penetration by large, well-capitalized participants due to their ability to provide more cost-effective services as a result of economies of scale, a broader range of services than local and regional participants, and national and international coverage to large clients. o An increase in the retail orientation of contract catering due to the proliferation of alternative retail outlets, including quick serve restaurants. o Strong industry dynamics towards a "one-stop shopping" alternative for all outsourcing needs, including food service and facilities management. o Minimal capital requirements due to several factors, including low capital expenditures because operations are generally conducted at client sites using client equipment; low fixed costs, permitting rapid response to market conditions; and predictable cash flow from client payments, reducing or eliminating working capital needs. o Stable industry revenues from an existing client base.
MARKET POSITION
The Company has its origins in two well-established food service providers, MMS and Sodexho North America. The Company is the market leader in the North American contract food services industry, which the Company's management believes is generally underpenetrated by large contractors. Market leadership makes the Company well positioned to grow faster than the overall market. The Company has a unique opportunity to leverage its position as the market leader in food service by cross-selling its facilities management services to existing food-service-only clients. Management of the Company believes that the facilities management industry remains even more underpenetrated by large contractors than the contract food services industry.
ITEM 1. BUSINESS, CONTINUED
The Company operates primarily in four business segments as discussed below (also see Note 14 to the Consolidated Financial Statements):
CORPORATE SERVICES. Although the market for food service in business and industry is relatively highly penetrated, customers are responding favorably to the growth in retail orientation by food service contractors. The market for multi-service national providers (food and facilities) is growing as large corporations are moving toward outsourcing all of their non-core services on a multi-site and multi-service basis. This represents an opportunity to leverage from food contracting to the less developed facilities management market. The government market is expected to increase as federal departments and agencies implement large-scale outsourcing of non-core functions. The Corporate Services segment represents approximately 31% of the Company's current revenues.
HEALTH CARE. The health care industry continues its transformation from a fee-for-service to a managed care and capitated rate environment. This market dynamic has shifted the risk and burden of cost control from insurance providers to the health care institutions themselves, forcing them to focus not only on the cost component of clinical care, but also on the cost of all services including food and facilities management. These cost pressures are driving the trend toward consolidation of health care institutions and guaranteed cost contracts for hospital services, and have contributed to several institutional bankruptcies. While management of the Company recognizes the challenges of these trends, it also believes that there are opportunities for growth, as the health care market remains significantly underpenetrated. The Health Care segment represents approximately 29% of the Company's current revenues.
EDUCATION. The campus dining marketplace, principally in colleges and universities, continues to shift from residential board plans to more retail-oriented operations driven by (i) the growing proportion of non-resident day and evening students on campuses, (ii) the taste and service preferences of today's young consumers and (iii) colleges' and universities' desire to provide their students with greater flexibility. Traditional straight-line cafeterias are being replaced by scatter systems and food courts. These trends, coupled with cost pressures, are causing public and private institutions to consider outsourcing as a viable choice. The Education segment represents approximately 27% of the Company's current revenues.
SCHOOLS. The current fiscal climate is forcing school districts (kindergarten through Grade 12) to minimize costs while improving the performance of non-instructional areas. Over the last several years, 150-200 school systems per year have decided to begin outsourcing their food services. Also, new federal regulations require that school meals meet more stringent food specifications and production techniques to comply with "Nutrient Standards" guidelines. Some school districts may turn to contractors to help comply with these guidelines. The Schools segment represents approximately 8% of the Company's current revenues.
The Company also operates two additional segments-- Canada and Laundry Services. These two segments collectively represent approximately 5% of the Company's current revenues.
COMPETITION
The food and facilities management services business in North America is comprised of a large number of local, regional and national service providers. The Company's strongest competition comes from larger, well-capitalized participants due to their ability to provide (i) cost-effective services as a result of economies of scale, (ii) a broader range of services than local and regional participants and (iii) national coverage to large clients.
Many educational institutions, health care providers and businesses consider cost to be an important factor when selecting companies to provide food and facilities management services. The Company expects to continue being a successful low-cost services provider due to its (i) significant purchasing economies of scale for food service and facilities management supplies, (ii) sophisticated site labor management controls, (iii) low administrative overhead, and (iv) strong information and accounting systems which allow clients to monitor costs more closely in tandem with the Company's management team.
Clients also consider the quality of food and facilities management services to be an important factor in addition to price. Accordingly, the Company's ability to maintain a level of quality in keeping with client expectations will continue to be an important competitive factor.
ITEM 1. BUSINESS, CONTINUED
THE TRANSACTIONS
DISTRIBUTED OPERATIONS. On March 27, 1998, the Company distributed to its shareholders, on a pro rata basis, all outstanding shares of New Marriott MI, Inc., a wholly owned subsidiary of the Company, in a tax-free distribution (the "Distribution"). New Marriott MI, Inc., subsequently renamed Marriott International, Inc. (together with subsidiaries, "MI") conducts business in the lodging segment and in two of the three lines of business previously in the Company's contract services segment - MSLS and MDS. The lodging, MSLS and MDS business are collectively referred to as the Distributed Operations. The third line of business in the contract services segment, MMS, is now the principal business of the Company.
ACQUISITION. Immediately after the Distribution, on March 27, 1998, Sodexho transferred to the Company the operations of Sodexho North America having a fair market value of approximately $278 million, and simultaneously made a cash payment of $304 million in exchange for 29.9 million shares of the Company's common stock, after giving effect to the one-for-four reverse stock split, as detailed in Note 9 to the Consolidated Financial Statements. The purchase price included approximately $3 million in transaction costs. As a result of the issuance of new shares of the Company's common stock to Sodexho in connection with the Acquisition, the shareholders who owned 100 percent of the Company immediately prior to the Distribution owned approximately 51% immediately thereafter.
The Acquisition was accounted for using the purchase method of accounting. The purchase price was allocated to the fair market value of assets acquired and liabilities assumed as follows:
Immediately after the Acquisition, the Company refinanced the $73 million of debt assumed, as detailed in Note 3 to the Consolidated Financial Statements.
REFINANCING. On March 27, 1998, the Company borrowed $615 million and $620 million under the Secured Facility and Guaranteed Facility, respectively, both of which are described below. The proceeds were used to repurchase $713 million of the Company's publicly held debt, as discussed in the following paragraph, and to repay its $950 million outstanding obligations under the Company's existing $1.5 billion credit facility, which was cancelled immediately after such repayment. Also, the Company repaid debt of $73 million assumed in the Acquisition. The $304 million received from Sodexho (see Note 3 to the Consolidated Financial Statements) was used together with the proceeds of the new debt to fund the debt repayments. The Company also received letters of credit for $13 million under the Secured Facility on March 27, 1998.
ITEM 1. BUSINESS, CONTINUED
The Secured Facility consists of a $235 million revolving credit facility and a $500 million six year term loan facility. It bears interest at rates based on a bank prime rate, the Federal funds rate, or the London interbank offered rate for Eurodollar deposits ("LIBOR"), payable in arrears quarterly. The Company is currently paying interest at an aggregate 6.88%. Of the revolving credit facility, up to $100 million may be used to cover letters of credit. As of September 3, 1999, the Company had letters of credit outstanding of $33 million. The facility is collateralized by liens on the inventory, accounts receivable, and stock of the principal subsidiaries of Sodexho Marriott Operations, Inc. As of September 3, 1999, $150 million of borrowing capacity was available under this facility.
The Guaranteed Facility is a $620 million seven-year term loan. It bears interest at rates based on a bank prime rate, the Federal funds rate, or LIBOR, payable in arrears quarterly. The Company is currently paying interest at 6.85%, after adjusting for the impact of hedging activities and miscellaneous fees associated with this facility, which includes a 0.5% annual fee ($3 million) based on the Guaranteed Facility balance that the Company pays Sodexho to serve as guarantor of the loan.
In connection with the Distribution, the Company tendered for $720 million principal amount of its outstanding publicly held debt, $600 million related to the Series A through D Senior Notes and $120 million related to the Renaissance Hotel Group (RHG) Financing. Approximately $593 million of the Series A through D Senior Notes were tendered at a premium of $45 million (pretax). The untendered Series A through D Senior Notes remain a liability of the Company.
Approximately $117 million of the $120 million in RHG Finance outstanding Guaranteed Notes were tendered at a premium of $20 million (pretax). The Company paid an additional $3.5 million in cash to MI representing the untendered RHG debt that became a liability of MI. The debt extinguishment was financed through the Secured Facility and the Guaranteed Facility discussed above, as well as the $304 million received from Sodexho in connection with the Acquisition.
As part of the Distribution, the Company and MI agreed that total indebtedness retained by the Company after the Distribution would equal $1.444 billion. Because the Company's indebtedness totaled $1.698 billion after effecting the Distribution, MI paid the Company the difference of $254 million, which the Company used to repay debt as detailed above.
As a result of the foregoing, the Company incurred an extraordinary charge for costs associated with the early extinguishment of debt of $71 million, $44 million after-tax, or $0.85 per diluted share for the 34-week period ended August 28, 1998.
The Company's borrowing agreements contain various covenants, which, among other things, require the Company to meet certain financial ratios and tests. Each of the borrowing agreements is described generally in pages 121 through 123 of the Proxy Statement for the Special Meeting of Stockholders of Marriott International, Inc. dated March 17, 1998, which is incorporated by reference into this report and is included as an exhibit to this report.
ITEM 1. BUSINESS, CONTINUED
INTEGRATION AND RESTRUCTURING
Integration and restructuring actions, such as those taken in the past two years and which may be taken in future years, reflect the Company's efforts to change in anticipation of marketplace trends. These actions are intended to integrate and realign resources for more effective and efficient execution of operating strategies. The integration costs recorded in the Transition Period and in Fiscal Year 1999 include, among other items, training and relocating employees, incremental overhead during the integration phase, systems modifications, and other one-time costs related to the integration of MMS and Sodexho North America. Integration costs totaling $16 million pretax were included in the results of operations for Fiscal Year 1999 and $24 million pretax were reflected in the results of operations for the Transition Period.
Restructuring actions totaling approximately $37 million were recorded in the first quarter of the 1998 Transition Period, $7 million of which was recorded as a charge to operations related to termination benefits for approximately 50 employees and office closure costs related to MMS. Restructuring costs represent costs, such as employee termination benefits and office closure costs, that are incurred to terminate certain duplicate activities. This reserve totaled $5 million at August 28, 1998 and $2 million at September 3, 1999. The gross acquisition reserve detailed in Note 3 to the Consolidated Financial Statements principally represents costs associated with termination benefits for approximately 350 employees and office closure costs related to the former Sodexho North America operations. This reserve totaled $24 million at March 27, 1998, and was reduced to $17 million and $8 million at August 28, 1998 and September 3, 1999, respectively, due to net payments made during these periods.
These actions have generated approximately one-third of the anticipated annual cost savings of approximately $60 million pretax. The remaining two-thirds of these anticipated savings relate to greater purchasing economies. Management believes it will achieve these synergies by the end of fiscal year 2001. The synergies from both purchasing and administrative actions are estimated to be $25 million in the current year. Anticipated incremental synergies generated in fiscal year 2000 are expected to be reinvested during fiscal year 2000. The reinvestments, which are targeted primarily for additional sales and management personnel, have already begun. See Item 7.--Liquidity and Capital Resources.
ARRANGEMENTS BETWEEN THE COMPANY AND MI
Pursuant to the Distribution agreement, the Company and New Marriott MI, Inc. ("New Marriott", subsequently renamed Marriott International, Inc.) agreed upon the allocation of assets and liabilities related to the MMS business and the New Marriott business. In this regard, the Company agreed generally to indemnify New Marriott against liabilities that relate to the MMS business, and New Marriott agreed generally to indemnify the Company against liabilities that relate to the New Marriott business. The Company and New Marriott also entered into a number of agreements governing their relationship after March 27, 1998. These agreements include (i) a tax-sharing agreement, (ii) an employee benefits allocation agreement, (iii) a trademark license agreement, (iv) a noncompetition agreement, (v) a LYONs allocation agreement, as well as other additional agreements between the companies. Each of these agreements is described generally in pages 43 through 48 of the Proxy Statement for the Special Meeting of Stockholders of Marriott International, Inc. dated March 17, 1998, which is incorporated by reference into this report, and is included as an exhibit to this report.
ARRANGEMENTS BETWEEN THE COMPANY AND SODEXHO
The Company has entered into various agreements with Sodexho that govern its relationship with that entity. These agreements include (i) a royalty agreement, (ii) an assistance agreement, (iii) a stockholder agreement, as well as other additional agreements between the companies including guarantees of certain liabilities of the Company by Sodexho. Each of these agreements is described generally in pages 48 through 50 of the Proxy Statement for the Special Meeting of Stockholders of Marriott International, Inc. dated March 17, 1998, which is incorporated by reference into this report, and is included as an exhibit to this report.
ITEM 1. BUSINESS, CONTINUED
GOVERNMENT REGULATION
The Company is subject to various governmental regulations relating to its operations, including, but not limited to, employment, health, safety and environmental regulations as well as regulations applicable to bidding for and performing federal, state and local government contracts. The Company has installed various controls and procedures designed to ensure compliance with these regulations.
EMPLOYEES
The Company has approximately 103,000 employees on its payroll in the U.S. and Canada, and manages approximately 60,000 people on its clients' payrolls. An estimated 12,000 non-management employees are represented by organized labor unions for collective bargaining purposes. The Company believes its relations with its employees are positive.
INFLATION
The Company's expenses are impacted by inflation. While price increases generally can be instituted as inflation occurs, many contracts require certain approvals before prices can be increased, which may temporarily have an adverse impact on profit margins. Management believes that over time, however, the Company will be able to raise prices, as appropriate, and sustain profit margins.
ACCOUNTING PERIOD
On April 15, 1998, the Company's Board of Directors approved a change in the Company's fiscal year from the Friday closest to the end of December to the Friday closest to the end of August, effective immediately. This change resulted in a 34-week Transition Period from the end of fiscal 1997 to August 28, 1998. In addition, Fiscal Year 1999 had 53 weeks and ended on September 3, 1999. The Company's 1997 historical fiscal year ended on the Friday nearest the end of December and contained 52 weeks, while the 1996 historical fiscal year contained 53 weeks.
ITEM 2.
ITEM 2. PROPERTIES
In June 1998, the Company entered into a 10 year lease, ending in December 2008, with 2 renewable periods of 5 years each, for approximately 80,000 square feet of space at 9801 Washingtonian Boulevard, Gaithersburg, Maryland. Also in June 1998, the Company entered an amended agreement with MI to vacate the Bethesda headquarters office space no later than December 31, 1998. By December 1998, the Company had moved all of its 250 headquarters employees to the Gaithersburg Headquarters. Since that time, an additional 100 employees have been hired or moved from other locations to the Gaithersburg Headquarters.
In addition, all of the Company's operating divisions lease their respective headquarters office space as follows: Avon, Connecticut (Health Care); Altamonte Springs, Florida (Education); and Downers Grove, Illinois (Schools). The headquarters for the Corporate Services division is located with the Company's headquarters in Gaithersburg, Maryland. These operating division leases generally run for initial terms of three to five years with renewal options. The Company also has a long-term lease for its office facility in Buffalo, New York, where all of the centralized accounting and processing activities for North America take place. The Company owns three laundry facilities (Walla Walla, Washington; Tucson, Arizona; and Phoenix, Arizona) and leases three additional laundry facilities (Birmingham, Alabama; Gilroy, California; and Compton, California).
As a result of the Acquisition, the Company also occupied approximately 25,000 square feet of office and warehouse space in Trumbull, Connecticut; approximately 15,000 square feet of office space in Mobile, Alabama; approximately 20,000 square feet of building space in Sunnyvale, California; and approximately 15,000 square feet of building space in Allston, Massachusetts. The Company also owns a 30,000 square foot office building in Montreal, Canada.
In October 1998, the Company sold an 80,000 square foot office facility in Waltham, Massachusetts, obtained in the Acquisition. The sale of the Waltham office facility did not have any adverse impact on the Company's financial condition or results of operations. To provide space for the operations that formerly occupied one-half of the Waltham office facility, the Company entered into an agreement in December 1998 to lease approximately 25,000 square feet of office space in Lexington, Massachusetts, for a seven year period, with a five year renewal option.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
There are no material legal proceedings pending against the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders of the Company during the fourth quarter of Fiscal Year 1999.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
COMMON STOCK. The comparability of stock prices in the table below is affected by the Transactions which occurred on March 27, 1998. The range of the Company's common stock prices and dividends declared per share for Fiscal Year 1999, the Transition Period and the past two fiscal years are as follows (restated to reflect the one-for-four reverse stock split):
At September 3, 1999, there were 62.3 million shares of common stock outstanding held by approximately 42,000 shareholders of record. The Company's common stock is traded on the New York Stock Exchange, Chicago Stock Exchange, Pacific Stock Exchange and Philadelphia Stock Exchange.
DIVIDEND POLICY. Prior to the Transactions, the Company had paid regular quarterly dividends. On October 13, 1999, the Board of Directors declared an $0.08 per common share dividend for Fiscal Year 1999, payable on December 10, 1999 to shareholders of record on November 22, 1999--see Item 7.--Liquidity and Capital Resources. The Company may pay dividends in the future, subject to the restrictive covenants contained in the Company's credit facility agreements related to the Refinancing and other relevant considerations. In general, the restrictive covenants do not permit the Company to pay dividends to shareholders in an amount greater than 40 percent of the Company's net income, or 45 percent when the ratio of the Company's consolidated debt to Earnings Before Interest, Taxes, Depreciation and Amortization ratio ("EBITDA", as defined in the documentation for the credit facility agreements) is less than 4 but not less than 3. This restriction will no longer apply when such ratio is less than 3. The payment and amount of cash dividends on the Company's common stock will be subject to the sole discretion of the Company's Board, which will review the Company's dividend policy at such times as may be deemed appropriate. The Board will closely monitor the results of the Company's operations, capital requirements, and other considerations to determine the extent to which a dividend may be declared in future periods.
ITEM 6.
ITEM 6. SELECTED HISTORICAL FINANCIAL DATA
The following table presents summary selected historical financial data for the Company derived from its financial statements as of the fiscal year ended September 3, 1999, the 34-week period ending August 28, 1998, and for the four fiscal years ended January 2, 1998. As the result of the Transactions, 1998's results are not comparable to the other years presented. Specifically, the results of Sodexho North America are only included in the Stub Period ended August 28, 1998. Conversely, the results of MDS and MSLS are included in the historical financial continuing operations prior to the Transaction. In addition, operating results in 1997 include a loss before income taxes of $22 million ($14 million after-tax, or $0.40 per share) on the sale of MMS- UK to Sodexho.
The historical information set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and notes thereto, each contained herein.
ITEM 6. SELECTED HISTORICAL FINANCIAL DATA, CONTINUED
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
As described in Part I, Items 1 & 2, "Business and Properties," on March 27, 1998, the Company completed the Distribution, Acquisition, and Refinancing. As a result, the assets, liabilities, and business operations of the Company as of September 3, 1999 and for the year then ended have changed substantially compared to prior periods presented.
In particular, the most significant differences relate to the following:
o The 1997 and 1996 Consolidated Statement of Income included revenues, as well as operating costs and expenses, related to the Distributed Operations. In the Consolidated Statement of Income, the operations of the Lodging segment have been combined and included as "Discontinued Operations, Net of Income Taxes." The MDS and MSLS segments of Contract Services were also part of the Distribution to shareholders, but remained part of continuing operations in the historical financial statements. See Note 1 to the Consolidated Financial Statements. o As described in Notes 1 through 5 to the Consolidated Financial Statements, the Company acquired the North American operations of Sodexho Alliance, S.A. on March 27, 1998. The historical data in 1997 and prior years does not include the revenue and expenses of the acquired business. o On March 27, 1998, the Company obtained over $1.3 billion in new debt through secured and guaranteed credit facilities, with the proceeds used to repay of over $1.6 billion of existing debt. o On April 15, 1998, the Company's Board of Directors changed the fiscal year from the Friday closest to the end of December to the Friday closest to the end of August, thereby creating a 34-week Transition Period. See Note 1 to the Consolidated Financial Statements.
Due to these substantial differences in the comparability of the Company's historical operating results for fiscal year 1999, the Transition Period and prior fiscal years, management believes that it is meaningful and relevant in understanding the present and ongoing Company operations to compare the Company's pro forma operating results for fiscal years 1999, 1998 and 1997, presented in the "Introduction" section of this report. These pro forma statements were prepared as if the Distribution, Acquisition, Refinancing and the implementation of the various related agreements entered into with Marriott International, Inc. and Sodexho occurred at the beginning of each period. The pro formas exclude, among other items, certain non-recurring costs such as (i) costs of the Distribution of $17 million (net-of-tax) in 1998, (ii) an extraordinary loss related to the early extinguishment of debt of $44 million, after-tax, and (iii) integration and restructuring charges totaling $16 million in 1999 and $31 million for 1998. See Notes 1 through 4 to the Consolidated Financial Statements.
Management's Discussion and Analysis of Financial Condition and Results of Operations of the Company, which analyzes the major elements of the Company's consolidated statements of operations and financial condition, should be read in conjunction with the detailed information and consolidated financial statements, and related Notes to Consolidated Financial Statements, included in this report.
SEASONAL NATURE OF THE COMPANY'S BUSINESS
The food service and facilities management business has been characterized historically by seasonal fluctuations in overall demand for services, particularly in the Education and Schools divisions where sales are stronger during the fall and spring.
LIMITED GEOGRAPHIC FOCUS
The Company is not currently expected to expand its international presence beyond Canada. The Trademark License Agreement entered into by the Company and Marriott International, Inc. gives the Company the right to use the Marriott name in the U.S. and Canada (and elsewhere only in extremely limited circumstances). Likewise, the Company entered into a Royalty Agreement with Sodexho pursuant to which Sodexho licenses the right to use the "Sodexho" name in the U.S. and Canada. As a practical matter, since the Company will only be allowed to use its corporate name in the U.S. and Canada, and since Sodexho controls or has a significant interest in companies operating in other countries in the food and facilities management industries, it is unlikely that the Company will engage in significant operations outside the U.S. and Canada. As a result, the Company will be more susceptible to a downturn in the U.S. and Canadian economies than a company that is actively engaged in various other markets.
BUSINESS STRATEGY
The Company's key financial objective is to generate higher revenues and increase cash flow from operations through new contract sales, the retention of existing contracts, and improved efficiencies in the Company's operations. This financial objective is designed to build on the performance strengths of the Company, which include expanding relationships with existing clients, attracting new business, identifying under-penetrated and rapidly growing segments of the food and facilities management industry, and seeking selective strategic acquisition candidates compatible with this objective.
In 1999, the Company substantially completed the integration of the number one and number four market leaders in the U.S. food and facilities management services industry. The focus during the year has been setting common goals and the merging of best practices and business strategies. The Company successfully aligned its management team, consolidated its systems and processes for improved operations, and developed integrated business strategies.
The Company is positioned to capitalize on the current trend for outsourcing services. As increasing cost pressures force organizations to focus on their core business, the demand for outsourcing services is growing. The total market is estimated at $113 billion in North America, with 75% of potential food and facilities management outsourcing business still self-operated. The Company is focusing on building the organization where resources are closest to the units, facilitating the local managers ability to adapt to the clients needs. Additionally, the Company wants to focus on the markets and sub-markets that have the most growth potential and that match up well with the Company's core services. During the past year, the Company made significant progress in segmenting all of its markets in terms of size, penetration, needs, growth and profitability. The results of this process provide the basis for choosing the steps the Company will take to strengthen its leadership position and to target specific high potential markets.
An integral part of the Company's business strategy has been the design and implementation of the Company-wide incentive program, which is predominately based on the achievement of predetermined financial targets and operational performance objectives. During the Transition Period, the Board of Directors granted 1.8 million shares in the form of incentive stock options to the managing employees of the Company. These grants have extended further down in the management structure than previous grants issued prior to the Transactions--see Note 9 to Consolidated Financial Statements. In addition, the Company expects to issue approximately 2.5 million new stock option awards in the first half of fiscal year 2000, which are anticipated to include one-time grants for eligible unit general managers of the Company.
In fiscal year 1999, efficiencies in the procurement and distribution processes, when combined with the administrative savings, resulted in an estimated $25 million in aggregate savings for the year. The Company expects that the procurement and distribution process savings will account for approximately two-thirds of the estimated $60 million in annual synergies which the Company expects to realize by the year 2001. While no assurance can be given that this objective will be met, management believes it is attainable as seen in the results for fiscal year 1999. Anticipated incremental synergies generated in fiscal year 2000 are expected to be reinvested during fiscal year 2000. The reinvestments, which are targeted primarily for additional sales and management personnel, have already begun. In addition, the Company has undertaken an information systems strategy study to evaluate the current state of its information systems, and consider information technology options. Among the options under consideration is the adoption of certain elements of the technology platform adopted by Sodexho Alliance. This evaluation will require additional time to study and review alternatives and their impact on capital investments, earnings, shareholder value and the provisions of the Company's debt agreements. Strategic developments in this area are expected to be finalized during Fiscal Year 2000. See Item 7.--Liquidity and Capital Resources.
RESULTS OF OPERATIONS
The following discussion presents an analysis of results of operations of the Company for the 53-week period ended September 3, 1999 ("Fiscal Year 1999") as compared with the 34-week period ended August 28, 1998 (the "Transition Period") presented in the Selected Consolidated Financial Highlights above. The discussion below also presents an analysis of fiscal years ended January 2, 1998 (52 weeks) and January 3, 1997 (53 weeks). As detailed above, due to the substantial differences in the comparability of the Company's historical operating results for Fiscal Year 1999, the Transition Period and prior fiscal years, management believes that it is more meaningful and relevant, in understanding the present and ongoing operations of the Company, to review the Company's pro forma operating results for fiscal years 1999, 1998, and 1997, presented in the "Introduction" section of this report.
HISTORICAL 53 WEEKS ENDED SEPTEMBER 3, 1999 COMPARED WITH THE 34 WEEKS ENDED AUGUST 28, 1998.
Total sales for Fiscal Year 1999 were $4.5 billion, an increase of $1.7 billion, or 59.2% compared with $2.8 billion for the Transition Period. The significant increase between the periods was due to the 19 additional weeks reported in Fiscal Year 1999, partially offset by the first 12 weeks of the Transition Period including sales from the Marriott Distribution Services ("MDS") and Marriott Senior Living Services ("MSLS") divisions that were distributed to shareholders on March 27, 1998 (as detailed in Notes 1 through 4 to Consolidated Financial Statements). Excluding the MDS and MSLS divisions, total sales increased $2 billion, or 79.6%. Solid sales growth in comparable accounts was partially offset by a lower retention rate for the Transition Period. Retention rates, particularly in the Health Care and Education divisions, improved in Fiscal Year 1999, which will favorably impact fiscal year 2000's sales growth.
Operating profit before corporate items totaled $304 million for Fiscal Year 1999, more than double the $119 million for the 1998 Transition Period. Excluding $2 million and $10 million in integration and restructuring costs in Fiscal Year 1999 and the Transition Period, respectively, operating profit would have totaled $306 million for Fiscal Year 1999 and $129 million for the Transition Period. This increase was the result of the 19 week difference between the periods as well as increased margins, largely due to purchasing and administrative synergies between the periods. These increases were partially offset by challenges in the health care industry, which resulted in charges totaling $3 million to operating profit for Fiscal Year 1999 to record additional bad debt reserves due to three client bankruptcies during the year.
Corporate items totaled $212 million, an increase of $61 million, or 40%, when compared to $151 million for the Transition Period. Excluding integration expenses totaling $14 million for Fiscal Year 1999 and integration and restructuring expenses of $21 million for the Transition Period, adjusted corporate items totaled $198 million and $130 million, an increase of $68 million, or 52%. This increase reflects the over 50% increase in the number of operating weeks between the periods. In addition, the benefits from the elimination of certain positions after the Transactions along with other administrative synergies were more than offset in the current fiscal year by a one-time, $3.4 million pretax charge related to the resignation of the former Chief Executive Officer and $5 million pretax of Year 2000 related costs (see "Year 2000"). Fiscal Year 1999 also included the favorable impact from the sale of the Company's Bright Horizons Family Solutions ("BFAM") investment, resulting in a cumulative pretax gain of $8.3 million, or $4.6 million after-tax ($0.07 per diluted common share).
Excluding the Year 2000 costs, integration expenses and the one-time resignation charge, total operating costs, corporate expenses and amortization of intangible assets represented, in the aggregate, 95.7% of total sales for Fiscal Year 1999 compared with the Transition Period's comparable period ratio of 98.1%. The Company anticipates this margin will continue to improve in the periods ahead, as the Company continues to realize purchasing synergies. Together with the synergies from administrative actions, these savings are anticipated to reach $60 million annually by fiscal year 2001. Synergies from both purchasing and administrative actions are estimated to be $25 million in the current year. Anticipated incremental synergies generated in fiscal year 2000 are expected to be reinvested during fiscal year 2000. The reinvestments, which are targeted primarily for additional sales and management personnel, have already begun. In addition, the Company has undertaken an information systems strategy study to evaluate the current state of its information systems, and consider information technology options. Among the options under consideration is the adoption of certain elements of the technology platform adopted by Sodexho Alliance. This evaluation will require additional time to study and review alternatives and their impact on capital investments, earnings, shareholder value and the provisions of the Company's debt agreements. See "Liquidity and Capital Resources."
RESULTS OF OPERATIONS, CONTINUED
HISTORICAL 53 WEEKS ENDED SEPTEMBER 3, 1999 COMPARED WITH THE 34 WEEKS ENDED AUGUST 28, 1998, CONTINUED.
Total income from continuing operations before taxes was $108 million, excluding $16 million of integration charges, versus a comparable $1 million loss from continuing operations for the Transition Period. This significant increase was due to the 19 additional weeks of operations in the current year, in addition to increased operating margins as well as administrative and purchasing synergies. The Transition period included Discontinued Operations, net of income taxes, totaling $77 million, reflecting the results of the lodging segment prior to the Transactions. The Transition Period also included a loss from an extraordinary item totaling $44 million, or $0.85 per share, from the redemption and defeasance of debt (see Note 1 to Consolidated Financial Statements).
HISTORICAL 34 WEEKS ENDED AUGUST 28, 1998 COMPARED WITH THE 52 WEEKS ENDED JANUARY 2, 1998.
Total sales for the Transition Period were $2.8 billion, a decrease of $2.2 billion, or 43.7% compared with $5.0 billion for Fiscal Year 1997. The significant decrease between the periods was due to the 35% decrease in the number of weeks reported, in addition to the $1.45 billion decrease from the Marriott Distribution Services ("MDS") and Marriott Senior Living Services ("MSLS") divisions that were distributed to shareholders on March 27, 1998 (as detailed in Notes 1 through 3 to Consolidated Financial Statements). Excluding the MDS and MSLS divisions, and with no adjustment for the difference in the number of weeks reported, total sales decreased $750 million, or 23.0%.
Operating profit before corporate items totaled $119 million for the Transition Period, a decrease of $38 million, or 24.2%, compared with the $157 million for Fiscal Year 1997. Excluding $10 million in integration costs in the Transition Period and a $22 million pretax loss from the sale of MMS- UK in Fiscal Year 1997 operating profit would have totaled $129 million for the Transition Period and $179 million for Fiscal Year 1997, a decrease of $50 million, or 27.9%. This decrease was the result of the 18 week difference between the periods and the $14 million decrease in operating profit from the MDS and MSLS divisions, which were partially offset by increased margins between the periods, especially in the Corporate Services division from the continued success of the Crossroads Cuisines marketing strategy.
Corporate items totaled $151 million, a decrease of $21 million, or 12%, when compared to $172 million for Fiscal Year 1997. Excluding integration and restructuring expenses of $21 million for the Transition Period, adjusted corporate items totaled $130 million for the Transition Period, an adjusted decrease of $42 million, or 24%. This decrease reflects the 35% decrease in the number of operating weeks between the periods, though the Transition Period includes the Stub Period expenses of Sodexho North America's operations.
Excluding integration and restructuring expenses, total operating costs, corporate expenses and amortization of intangible assets represented, in the aggregate, 98.1% of total sales for the Transition Period compared with Fiscal Year 1997's comparable period ratio of 98.7%. The Company anticipates this margin will continue to improve in the periods ahead, as the Company continues to realize purchasing synergies. Together with the synergies from administrative actions, these savings are anticipated to reach $60 million annually by fiscal year 2001. Synergies from both purchasing and administrative actions are estimated to be $25 million in the current year. Anticipated incremental synergies generated in fiscal year 2000 are expected to be reinvested during fiscal year 2000. The reinvestments, which are targeted primarily for additional sales and management personnel, have already begun. In addition, the Company is evaluating participation in the development of Sodexho Alliance's information technology platform. This evaluation will require additional time to study and review alternatives and their impact to earnings, shareholder value and the provisions of the Company's debt agreements. See "Liquidity and Capital Resources."
Total loss from continuing operations before taxes was $1 million, excluding $31 million of integration and restructuring charges, for the Transition Period. This compares with income from continuing operations before taxes of $7 million for Fiscal Year 1997, excluding the $22 million pretax loss from the sale of MMS- UK operations. This decrease is the result of the decrease of 18 weeks of operations in the current period, most of which include strong operational weeks for the Education and Schools divisions. The Transition period included Discontinued Operations, net of income taxes, totaling $77 million, reflecting the results of the lodging segment prior to the Transactions. Fiscal Year 1997 included Discontinued Operations, net of income taxes, totaling $335 million, reflecting a full year of the lodging segment. The Transition Period also included a loss from an extraordinary item totaling $44 million, or $0.85 per share, from the redemption and defeasance of debt (see Note 1 to Consolidated Financial Statements).
RESULTS OF OPERATIONS, CONTINUED
HISTORICAL 52 WEEKS ENDED JANUARY 2, 1998 COMPARED WITH 53 WEEKS ENDED JANUARY 3, 1997.
The Company reported a 1% increase in operating profit from continuing operations on 16% higher sales in fiscal 1997, before the $22 million loss on the sale of the MMS- UK operations to Sodexho. Profit comparisons between years were affected by sales to investors during 1996 and 1997 of 43 senior living communities, which were part of the Company's MSLS division that was distributed to shareholders on March 27, 1998. Before the impact of the Distribution and sale of the MMS- UK operations, operating profits from continuing operations increased 11% over fiscal 1996. Operating profit was also adversely affected by start-up losses for new distribution centers and distribution accounts from the MDS division.
Before the loss on the sale of the MMS- UK operations, operating profits, excluding MDS and MSLS, were 14% higher on a sales increase of 3% percent in fiscal 1997. Sales and profits increased due to new contracts, expanded service to ongoing accounts and continued cost reductions in several areas. The Corporate Services, Health Care, Education and Schools divisions were the main contributors to the profit growth.
MSLS, which was part of the Distribution on March 27, 1998, reported a sales increase of 28% in fiscal 1997 over 1996, primarily due to the opening of 17 communities during 1997 and a two percentage point increase in occupancy, to 95%, for comparable properties. The Company sold 43 senior living properties to investors since the beginning of 1996, retaining long-term operating agreements. Operating profits declined as "ownership profits" from these properties were replaced with "managed operating profits." This reduction in operating profit was offset by a corresponding reduction in interest expense.
MDS, which was also part of the Distribution on March 27, 1998, had sales move up sharply in fiscal 1997 as a result of the addition of several major restaurant customers and the net addition of two new distribution centers. Profits, however, were lower in fiscal 1997 due to start-up costs associated with the new centers, as well as costs involved in integrating the new business into existing distribution centers.
Corporate expenses rose 19% in 1997, due to noncash items associated with investments generating significant income tax benefits, as well as modest staff increases to accommodate growth and new business development. Interest expense increased 29% over fiscal 1996 despite lower effective interest rates. The average debt balance increased due to the acquisition of RHG, partially offset by proceeds from sales of hotels and senior living communities.
Discontinued Operations, comprising the lodging division, had an operating profit increase of 26% on 20% higher sales, benefiting from favorable conditions in the U.S. lodging market, and contributions from new properties. The revenue increase resulted from average growth across all brands of eight percent. This revenue growth resulted in higher base management and franchise fees. Revenue growth also contributed to higher house profits, which resulted in higher incentive management fees.
The Company's net effective income tax rate for continuing and discontinued operations increased to 39.5% in 1997, compared to 39% in 1996, reflecting approximately a one percentage point increase due to the RHG acquisition and the Company's ongoing participation in jobs and affordable housing tax credit programs.
Net income increased nine percent to $335 million in fiscal 1997, on a sales increase of 18% to $12 billion when including the sales from discontinued operations, driven by contributions from new unit expansion and strong profit growth for the Discontinued segment, partially offset by the loss on the sale of the MMS- UK operations to Sodexho and the impact of the Renaissance Hotel Group (RHG) acquisition. Diluted earnings per share increased 16% to $10.53, reflecting higher net income. Before the loss on sale of the MMS- UK operations and the impact of the RHG acquisition, net income and diluted earnings per share increased 20%.
LIQUIDITY AND CAPITAL RESOURCES
The Company continues to capitalize on its combined market presence as well as focusing on attracting new accounts and enhancing services to sustain growth. The Company is highly leveraged and anticipates that it would have long-term unsecured debt ratings, if obtained, below investment grade based on its pro forma financial statements. The debt resulting from the Refinancing contains restrictive covenants and requires grants of security and guarantees by subsidiaries of the Company, which limit the Company's ability to incur additional debt and engage in certain other activities. Additionally, these debt covenants limit the Company's ability to pay dividends.
Capital requirements are funded from a combination of existing cash balances and operating cash flow. Additionally, the Company anticipates achieving annual cost savings of approximately $60 million pretax by the end of fiscal year 2001, resulting from purchasing actions and administrative synergies. The anticipated cost savings, which the Company estimates were approximately $25 million in Fiscal Year 1999, will be available to pay down debt and reinvest in the Company to fund activities to enhance its competitive position. Anticipated incremental synergies generated in fiscal year 2000 are expected to be reinvested during fiscal year 2000. These reinvestments, which are targeted primarily for additional sales and management personnel, have already begun. In addition, the Company has undertaken an information systems strategy study to evaluate the current state of its information systems, and consider information technology options. Among the options under consideration is the adoption of certain elements of the technology platform adopted by Sodexho Alliance. This evaluation will require additional time to study and review alternatives and their impact on capital investments, earnings, shareholder value and the provisions of the Company's debt agreements. Strategic developments in this area are expected to be finalized during Fiscal Year 2000. See Item 1.--Integration and Restructuring and Item 7.--Liquidity and Capital Resources. Subject to the foregoing, the Company believes that current cash flow generated from operations and cash balances will be adequate to finance ongoing capital needs, meet debt service requirements and fund the Company's planned growth initiatives.
As of September 3, 1999, the Company had a $235 million revolving credit facility available at an interest rate of 7.55% to provide funds for liquidity, seasonal borrowing needs and other general corporate purposes. At September 3, 1999, $52 million of this facility was outstanding, while an additional $33 million of this revolving credit facility was utilized by letters of credit outstanding, principally related to insurance programs.
Prior to the Transactions, the Company paid regular quarterly dividends. On October 13, 1999, the Board of Directors declared an $0.08 per common share dividend for Fiscal Year 1999, payable on December 10, 1999 to shareholders of record on November 22, 1999. The Company may pay dividends in the future, subject to the restrictive covenants contained in the Company's credit facility agreements and other relevant considerations. In general, the restrictive covenants do not permit the Company to pay dividends to shareholders in an amount greater than 40 percent of the Company's net income, or 45 percent when the ratio of the Company's consolidated debt to Earnings Before Interest, Taxes, Depreciation and Amortization ratio ("EBITDA", as defined in the documentation for the credit facility agreements) is less than 4 but not less than 3. This restriction will no longer apply when such ratio is less than 3. The payment and amount of cash dividends on the Company's common stock will be subject to the sole discretion of the Company's Board, which will review the Company's dividend policy at such times as may be deemed appropriate. The Board will continue to closely monitor the results of the Company's operations, capital requirements, and other considerations to determine the extent to which a dividend may be declared in future periods.
The Company is required to make quarterly cash interest payments on its term and guaranteed facilities, as well as scheduled principal repayments on its Senior Secured Credit Facility (as detailed in Note 8 to Consolidated Financial Statements). Annual interest expense was $88 million for the 53-week period ended September 3, 1999 ($87 million on an annualized basis). Principal repayments totaled $70 million in fiscal year 1999; with scheduled repayments of approximately $80 million in 2000; $80 million in 2001; $90 million in 2002; $115 million in 2003 and $65 million in 2004.
On October 7, 1999, Marriott International notified all holders of the LYONs, that Marriott International had elected to redeem all of the LYONs at a price of $619.65 for each $1,000 principal amount at maturity of the LYONs, with a redemption date of November 8, 1999. Conversion is available at any time until the close of business on the redemption date. The maximum amount of funds that the Company would be obligated to pay to Marriott International if all the LYONs were redeemed for cash is approximately $30 million. This amount would be paid to Marriott International in the first quarter of fiscal year 2000--See Note 8 to Consolidated Financial Statements.
NEW ACCOUNTING STANDARDS
SFAS No. 133-- "Accounting for Derivative Instruments and Hedging Activities," was issued in June 1998 and will require the Company to record derivative instruments, such as interest-rate agreements, on the Consolidated Balance Sheet as assets or liabilities, measured at fair value. Currently, the Company treats such instruments as off-balance-sheet items. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the specific use of each derivative instrument and whether it qualifies for hedge accounting treatment as stated in the standard. In June 1999, the Financial Accounting Standards Board approved the deferral of the effective date for SFAS No. 133 to all fiscal quarters of all fiscal years beginning after June 15, 2000. Therefore, SFAS No. 133 will be effective for the Company on September 2, 2000, the beginning of fiscal year 2001. The impact to the Company's financial position of implementing SFAS No. 133 is not anticipated to be material.
YEAR 2000
GENERAL. The Company is actively addressing potential issues arising from the historical computer programming practice of using two digits rather than four digits to signify dates (e.g. "00" instead of "2000"). This practice could cause the Company's owned and operated computer-based technology to process dates incorrectly because of an inability to distinguish properly between 1900 and 2000, and could result in computer systems failures or miscalculations. These potential issues are collectively referred to as the Year 2000 issue. The Year 2000 issue could arise at any point in the Company's purchasing, supply, processing, distribution and financial chains. Incomplete or untimely resolution of the Year 2000 issue by the Company, its key suppliers, clients and other parties could have a material adverse effect on the Company's business, results of operations, financial condition and cash flow.
YEAR 2000 READINESS DISCLOSURE. The Company began the process of understanding the Year 2000 issue in 1996. The Company's Board of Directors and senior management are committed to minimizing the impact of the Year 2000 issue on the Company's operations.
The Company established a Year 2000 project (the "Project") to address the Year 2000 issue. The Project's Steering Committee consists of members of the Company's senior management, including representatives from each of the Company's divisions and most corporate functions. This Steering Committee oversees and regularly reviews the status of each of the following areas of concentration for the Project:
o Internally developed software o Third party software o Infrastructure (mainframe, personal computers, etc.) o Facilities systems o Other external systems (supply chain and other outside relationships)
Internally developed software, third party software and infrastructure hardware are all information technology ("IT") systems. Facilities and other external systems are non-IT systems.
The Steering Committee is also tasked with estimating and controlling the associated costs of the Project. Additionally, the Company established a Year 2000 Project team, led by an experienced project manager, that is responsible for the day-to-day oversight and coordination of the Company's Year 2000 efforts. The Company's methodology involves eight phases for the Project: (1) awareness, (2) inventory, (3) assessment, (4) remediation, (5) testing and validation, (6) implementation, (7) contingency planning and (8) crisis management/business continuity.
INFORMATION TECHNOLOGY SYSTEMS The inventory and assessment phases for the IT systems began in 1996. For internally developed mainframe software, the Company not only has completed these two phases, but also has completed testing, third party validation, and implementation of compliant versions of the software.
With respect to other internally developed software, third party software and personal computers, which are used at most of the Company's operating locations to support unit level financial and operating systems, the Company has completed the inventory and assessment of these items. The Company also completed testing and third party validation of its internally developed software and has acquired compliant versions of all of its third party software. The Company is working with clients and other external entities to validate the compliance status of their systems.
YEAR 2000, CONTINUED
The rollout of compliant versions of all software and of personal computers to replace those the Company owns and the removal of non compliant systems are on schedule to be substantially complete by October 31, 1999. Considering the large number and geographic diversity of the Company's operating locations, systems considered most critical to ongoing operations and those that could have a material adverse effect on the Company's business results of operations, financial condition and cash flow are being given the highest priority.
NON-INFORMATION TECHNOLOGY SYSTEMS The Company has also surveyed and assessed facilities systems, which include food service refrigeration and food preparation systems that the Company manages for its clients. The Company also manages elevators, heating, ventilation and air conditioning systems, and other equipment for its clients pursuant to plant operations and maintenance agreements. In some Health Care division accounts the Company provides, either directly or through subcontractors, certain maintenance services related to biomedical equipment. Because these facilities systems reside at client sites, they are generally not under the Company's control, and responsibility for these systems generally rests with the client. The assessment of these systems has involved close cooperation between the Company and its clients. With respect to plant operations and maintenance clients, the Company is providing certain services to assist its clients in achieving their Year 2000 objectives relative to their facilities systems.
Finally, the Company continues to obtain up-to-date compliance information regarding its vendors and suppliers and is monitoring the compliance status of other external systems that support the different facets of its business, such as utilities, government entities and other service providers. These systems are not under the Company's control. At this time, the Company anticipates sporadic outages of limited duration, however the Company believes its contingency plans in place are sufficient to address this degree of potential disruption.
RISKS. There are many risks associated with the Year 2000 issue. Because the Company's Year 2000 compliance depends upon numerous third parties also being Year 2000 compliant on a timely basis, there can be no guarantee that the Company's efforts will prevent a material adverse impact on its business, results of operations, financial condition and cash flow. The possible consequences to the Company of its business partners or the general infrastructure (including transportation, government, utilities, and communications) not being fully Year 2000 compliant include temporary facilities closings, delays in the delivery of products, delays in the receipt of key food products, equipment and packaging supplies, invoice and collection delays and errors, and inventory and supply shortages. These consequences could have a material adverse impact on the Company's business, results of operations, financial condition and cash flow if the Company is unable to conduct its business in the ordinary course.
To manage potential points of failure, the Company has developed contingency plans designed to mitigate the potential disruptions that may result from the Year 2000 issue. In general, because the Company has had much experience with power outages, equipment failures, etc., in its normal course of business, the Company believes it is prepared for potential Year 2000 disruptions. Contingency plans and associated cost estimates are generally complete, and will be continually refined as additional information becomes available. The Company believes that its business continuity planning should significantly reduce the adverse effects any disruptions may have.
COSTS. The Company had originally estimated that the pretax costs to be borne by it to address the Year 2000 issue would be approximately $5-8 million principally for modification, testing, validation, project management and contingency and business continuity planning. These costs are being expensed as incurred and funded from operating cash flow. Through Fiscal Year 1999, approximately $5.5 million had been incurred and expensed, and the Company now anticipates spending a total of approximately $8 million for this Project. Thus, approximately $2.5 million will be incurred and expensed for this Project in Fiscal Year 2000. The Company does not separately identify certain internal costs incurred for the Project, most of which are related to the Company's internal IT-personnel costs.
The actual costs to be incurred by the Company will depend on a number of factors which cannot be accurately predicted, including the extent and difficulty of the remediation and other work remaining to be done, the clients' expectations of the Company's responsibility to help remediate the clients' facilities systems, the availability and cost of consultants, the extent of testing required to demonstrate Year 2000 compliance, the portion of such costs that may be borne by the Company's clients pursuant to existing contractual agreements and the Company's ability to timely collect all payments due to it under existing contracts and the severity and duration of the impact of Year 2000 on the Company's business.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's earnings are not materially affected by changes in interest rates, due to the relatively low balances of borrowings at floating interest rates (after adjusting for hedge positions outstanding) as well as notes receivable which earn a variable rate of interest (see Note 8 to the Consolidated Financial Statements). However, changes in interest rates also impact the fair value of the Company's debt, totaling $1.1 billion at September 3, 1999. If interest rates increased by 100 basis points, the fair value of the Company's debt would have decreased by approximately $21 million, while a 100 basis point decrease in rates would have increased the fair value of the Company's debt by approximately $22 million, based on balances at September 3, 1999.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial information is included on the pages indicated:
PAGE(S) -------
Management's Report 31 Reports of Independent Public Accountants 32-33 Consolidated Statement of Income 34 Consolidated Balance Sheet 35 Consolidated Statement of Cash Flow 36 Consolidated Statement of Stockholders' Equity 37 Notes to Consolidated Financial Statements 38-58 Supplementary Data 59
MANAGEMENT'S REPORT
Management is responsible for the integrity and objectivity of the consolidated financial statements and other financial information presented in this report. In meeting this responsibility, the Company maintains a highly developed system of internal controls, policies and procedures, including an internal auditing function that continually evaluates the adequacy and effectiveness of its control system. Management believes this system provides reasonable assurance that transactions are properly authorized and recorded to adequately safeguard the Company's assets and to permit preparation of the financial statements in accordance with generally accepted accounting principles.
The financial statements presented herein were prepared on a historical basis for Fiscal Year 1999, the Transition Period of January 3, 1998 to August 28, 1998, and for the calendar years 1997 and 1996, as described in Note 1 to the Consolidated Financial Statements. In addition, pro forma fiscal years 1997 through 1999 are presented in the Introduction section of this report. Management believes that this presentation is the most meaningful to shareholders and other users of these financial statements. The pro forma results were prepared by applying certain pro forma adjustments to the audited historical results of Marriott International, Inc. and the acquired North American operations of Sodexho Alliance, S.A.
The historical consolidated financial statements for Fiscal Year 1999 and for the Transition Period in 1998 have been audited by PricewaterhouseCoopers LLP, independent public accountants. The historical consolidated financial statements for 1997 and 1996 have been audited by Arthur Andersen LLP, independent public accountants. Their reports, included in this report, express an informed judgment as to whether management's historical consolidated financial statements present fairly the Company's financial position and results of operation in conformity with generally accepted accounting principles. The pro forma financial statements included herein do not represent actual historical results of the Company and as such are not audited.
The Board of Directors fulfills its responsibility for the financial statements through its Audit Committee, composed of three directors not otherwise employed by the Company. The committee meets a minimum of two times during the year with the independent public accountants, representatives of management and the internal auditors to review the scope and results of the internal and external audits, the accounting principles applied in financial reporting, and financial and operational controls. The independent public accountants and internal auditors have unrestricted access to the Audit Committee with and without the presence of management.
/s/ MICHEL LANDEL /s/ LAWRENCE E. HYATT /s/ LOTA S. ZOTH
Michel Landel Lawrence E. Hyatt Lota S. Zoth President and Senior Vice President and Vice President, Chief Executive Officer Chief Financial Officer Corporate Controller and Chief Accounting Officer
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of Sodexho Marriott Services, Inc.
In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of income and stockholders' equity and of cash flow present fairly, in all material respects, the financial position of Sodexho Marriott Services, Inc. and its subsidiaries at September 3, 1999 and August 28, 1998 and the results of their operations and their cash flow for the fifty-three weeks and thirty-four weeks then ended, respectively, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for the opinion expressed above.
/s/ PRICEWATERHOUSECOOPERS LLP
Washington, D.C. October 8, 1999
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of Sodexho Marriott Services, Inc.:
We have audited the accompanying consolidated balance sheet of Sodexho Marriott Services, Inc. (formerly "Marriott International, Inc.") as of January 2, 1998, and the related consolidated statements of income, cash flow, and stockholders' equity for each of the two fiscal years in the period ended January 2, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sodexho Marriott Services, Inc. as of January 2, 1998, and the results of its operations and its cash flow for each of the two fiscal years in the period ended January 2, 1998, in conformity with generally accepted accounting principles.
/s/ ARTHUR ANDERSEN LLP
Vienna, VA February 3, 1998 (except with respect to the matters discussed in Notes 2 and 14, as to which the date is October 7, 1998)
See Notes to Consolidated Financial Statements.
See Notes to Consolidated Financial Statements.
See Notes to Consolidated Financial Statements.
See Notes to Consolidated Financial Statements.
SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
Sodexho Marriott Services, Inc. (the "Company") is the leading provider in North America of outsourced food and facilities management services to businesses, health care facilities, colleges and universities, and primary and secondary schools. Food services include food and beverage procurement, preparation and menu planning, as well as the operation and maintenance of food service and catering facilities, generally on a client's premises. Facilities management services include plant maintenance, energy management, grounds keeping, and housekeeping and custodial services.
The Company was formerly named Marriott International, Inc. ("MI"). Upon consummation of the Distribution, Acquisition and Refinancing (collectively, the "Transactions"), which occurred on March 27, 1998, the last day of the first quarter of 1998, Marriott International, Inc. was renamed Sodexho Marriott Services, Inc. As of March 27, 1998, the principal business of the Company changed from lodging and contract services to food and facilities management services. In connection with the Distribution and Acquisition, the Company began a restructuring and refinanced its debt. The Transactions are explained in detail in Notes 2, 3, and 4.
All material intercompany transactions and balances between Sodexho Marriott Services, Inc., and its consolidated subsidiaries have been eliminated. Certain amounts previously presented have been reclassified to conform to the current presentation. Additionally, related to the Distribution on March 27, 1998, the Company has combined the results of operations, cash flow and balance sheet items of the lodging segment as "Discontinued Operations" for all periods presented (see "Distribution" below and Note 2).
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements, and the reported amounts of sales and expenses during the reporting period. Accordingly, ultimate results could differ from those estimates.
DISTRIBUTION
On March 27, 1998, the Company completed the Distribution to its shareholders, on a pro rata basis, of all outstanding shares of New Marriott MI, Inc. ("New Marriott"), a wholly owned subsidiary of the Company, in a tax-free distribution (the "Distribution"). New Marriott conducts the lodging (including timeshare resort development and operation), senior living services and distribution service businesses previously conducted by the Company and changed its name to Marriott International, Inc. The food service and facilities management business will continue to be conducted by the Company. Immediately after the Distribution, the Company acquired the North American food service and facilities management operations of Sodexho Alliance, S.A. (Sodexho) in exchange for stock of the Company, with the Company operating the combined food service and facilities management businesses under the name - Sodexho Marriott Services, Inc. As a result of the issuance of new shares of the Company's common stock to Sodexho in connection with the Acquisition, the shareholders who owned 100% of the Company immediately prior to the Distribution owned approximately 51% of the Company thereafter. At the same time, the Company obtained financing arranged by Sodexho, to refinance certain existing indebtedness of the Company.
For the purposes of governing certain of the ongoing relationships between MI and the Company after the Distribution and to provide for an orderly transition, MI and the Company entered into various agreements including the Employee Benefits and Other Employment Matters Allocation Agreement, Liquid Yield Option(TM) Notes (LYONs) Allocation Agreement (see Note 8), Tax Sharing Agreement, Trademark and Trade Name License Agreement, Noncompetition Agreement, Employee Benefit Services Agreement, Procurement Services Agreement, Distribution Services Agreement and other transitional services agreements. Effective March 27, 1998, these agreements provided, among other things, that MI assumed administration of certain of the Company's employee benefit plans and insurance programs as well as succeed to the Company's liability to LYONs holders under the LYONs Indenture, a portion of which was assumed by the Company. In connection with the Distribution, on October 31, 1997, the Company sold the MMS- UK operations to Sodexho for $50 million in cash. The sale resulted in a pretax loss of $22 million ($14 million after tax, or $0.40 per share) for the year ended January 2, 1998.
SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
REVERSE STOCK SPLIT
The Company also combined every four shares of its common stock into one share of the Company's common stock pursuant to a reverse stock split on March 27, 1998. All share and per share data has been adjusted to reflect a one-for-four reverse stock split effective March 27, 1998.
FISCAL YEAR
On April 15, 1998, the Company's Board of Directors approved a change in the Company's fiscal year from the Friday closest to the end of December to the Friday closest to the end of August, effective immediately. This change resulted in a 34-week transition period (the "Transition Period") from the end of fiscal 1997 to the end of the new fiscal year on August 28, 1998. The new fiscal 1999 year had 53 weeks and ended on September 3, 1999.
Prior to the 1998 Transition Period, the Company's fiscal year ended on the Friday nearest to December 31. The 1997 fiscal year included 52 weeks and ended on January 2, 1998 ("Fiscal 1997" or "1997"). The 1996 fiscal year included 53 weeks and ended on January 3, 1997 ("Fiscal 1996" or "1996").
REVENUE RECOGNITION AND ACCOUNTS AND NOTES RECEIVABLE
Revenues are recognized at the time services are rendered or products are delivered. Revenues include reimbursements for food and payroll costs incurred on behalf of customers under contracts in which the Company manages food service programs for a fee. Losses, if any, are provided for at the time management determines the cost will ultimately exceed contract revenue for the duration of the contract.
The allowance for doubtful accounts for continuing operations was $21 million, $17 million, and $12 million as of September 3, 1999, August 28, 1998, and January 2, 1998, respectively. Concentration of credit risk within accounts receivable is limited because a large number of customers make up the Company's customer base, thus spreading risk associated with trade credit. In addition, the Company closely monitors its accounts receivable. The Company generally does not require collateral and maintains reserves for potential uncollectible amounts, which, in the aggregate, have not exceeded management's expectations.
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the sum of undiscounted expected future cash flow is less than the carrying amount of long-lived assets, the Company recognizes an impairment loss based on the amount by which the carrying amount of the asset exceeds the fair value of the asset.
INTEREST-RATE AGREEMENTS
The Company's policies prohibit the use of derivative instruments for trading purposes and procedures are in place to monitor and control their use. The use of derivative instruments is limited to interest-rate agreements for the purpose of reducing the variability of the Company's debt costs. The majority of these agreements were entered into in conjunction with the issuance of the debt they were intended to modify.
The notional balances of these agreements represent a balance used to calculate the exchange of cash flows and are not assets or liabilities of the Company, in addition to not representing an exposure to credit loss. The notional amount and interest payment of these agreements match the cash flows of the related debt. Accordingly, any market risk or opportunity associated with these agreements is offset by the opposite market impact on the related debt. The Company's credit risk related to interest-rate agreements is considered low because they are entered into only with strong creditworthy counterparties and are generally settled on a net basis. The difference paid or received on interest-rate agreements is recognized as an adjustment to interest expense. See Note 8 for the notional amounts, related interest rates, maturities, and fair values of these interest-rate agreements.
SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
INCOME TAXES
The Company recognizes deferred tax assets and liabilities based upon the expected future tax consequences of existing differences between the financial reporting and tax reporting bases of assets and liabilities and operating loss and tax credit carryforwards.
EXTRAORDINARY ITEM
On March 27, 1998, the Company recognized an extraordinary charge of $71 million ($44 million after the related income tax benefit of $27 million) in connection with the redemption and defeasance of the Secured Debt. This loss was comprised of premiums totaling $67 million paid for the redemptions and $4 million of financing costs.
EARNINGS PER SHARE
The Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share," in fiscal 1997. Under SFAS No. 128, basic earnings per share is computed by dividing net income by the weighted-average number of outstanding common shares. Diluted earnings per share is computed by dividing net income by the diluted weighted-average number of outstanding common shares. In addition, on March 27, 1998, the Company's common stock underwent a one-for-four reverse stock split. Earnings per share computations have been restated to reflect this reverse stock split.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of three months or less at date of purchase to be cash equivalents. The Company uses drafts in its cash management system. At September 3, 1999, the Company had $83 million of outstanding drafts included in accounts payable, compared with outstanding draft totals of $34 million and $193 million at August 28, 1998 and January 2, 1998, respectively.
INVENTORIES
Inventories consist of food items and supplies, which are stated at the lower of average cost or market, generally using the first-in, first-out method.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, generally ranging from 3 to 40 years. Replacements and improvements are capitalized. Leasehold improvements, net of estimated residual value, are amortized over the shorter of the useful life of the asset or the lease term.
INTANGIBLE ASSETS
Intangible assets consist of goodwill and customer relationships. Intangible assets are amortized on a straight-line basis over periods generally ranging from 30 to 40 years for goodwill and 10 to 20 years for customer relationships. Amortization expense for continuing operations totaled $38 million in fiscal year 1999, $26 million for the Transition Period ended August 28, 1998, $25 million in fiscal year 1997, and $26 million in fiscal year 1996. Amortization expense for discontinued operations totaled $8 million for the Transition Period ended August 28, 1998, $42 million in fiscal year 1997 and $8 million in fiscal year 1996.
OTHER ASSETS
Included in other assets are client investments, which represent amounts provided by the Company to clients at contract inception for the purchase of property and equipment pertaining to the contract. These amounts are amortized over the life of the related contract. When a contract terminates prior to its scheduled termination date, the client generally must repay any unamortized client investment balance to the Company.
SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
INSURANCE
Except for the period of October 1, 1997 to March 27, 1998, the Company is partially self-insured for certain levels of workers' compensation, general liability, employment practices and employee medical coverage. Self-insurance levels are the result of the Company using certain insurance programs that include higher deductibles for the Company, resulting in the Company being "self-insured" for claims below the deductible levels. Estimated costs for these self-insurance programs are accrued at the present value (discounted at a rate of 5% at fiscal year end 1999) of projected settlements for known and anticipated claims. Self-insurance liabilities of the Company amounted to $89 million at September 3, 1999 and $87 million at August 28, 1998. The Company was fully insured for most claims occurring during the period of October 1, 1997 to March 27, 1998, as the Company placed certain insurance programs with third-party providers during the period.
ACCUMULATED OTHER COMPREHENSIVE INCOME
In June 1997, SFAS No. 130--"Reporting Comprehensive Income" was issued, requiring that certain financial activity typically disclosed in stockholders' equity be reported in the financial statements as an adjustment to net income in determining comprehensive income. Items applicable to the Company include activity in foreign exchange translation adjustments and securities available for sale under SFAS No. 115. Items identified as comprehensive income are reported in the Consolidated Balance Sheet and the Consolidated Statement of Stockholders' Equity, under separate captions.
Results for the Canada division are translated to U.S. dollars using the average exchange rates during the period. Assets and liabilities are translated using the exchange rate in effect at the applicable balance sheet date, and resulting translation adjustments are reflected in stockholders' (deficit)/equity as accumulated other comprehensive income.
Total accumulated other comprehensive income included $3.1 million of gross foreign exchange translations gains, net of taxes totaling $1.4 million, at September 3, 1999. At August 28, 1998, total accumulated other comprehensive income was comprised of $10.1 million of gross unrealized securities gain adjustments under SFAS No. 115, net of taxes totaling $4.0 million and gross foreign exchange translation gains totaling $1.1 million, net of taxes totaling $0.4 million. At January 2, 1998, total accumulated other comprehensive income was comprised of $28.2 million of gross unrealized securities loss adjustments, net of taxes totaling $11.0 million, partially offset by gross foreign exchange translation gains totaling $8.9 million, net of taxes totaling $3.5 million.
During fiscal year 1999, total comprehensive income was comprised of $51 million in net income and $1.9 million of gross foreign exchange translation gains, net of taxes totaling $0.9 million, partially offset by the reclassification of the realized gain on the sale of investment totaling $8.3 million pretax, net of taxes totaling $3.7 million. Total comprehensive income for the 34 weeks ended August 28, 1998, included $14 million in net income and $1.2 million in gross securities gain adjustments, net of taxes totaling $0.5 million, partially offset by $10.7 million of gross foreign exchange translation losses, net of taxes totaling $4.3 million. For fiscal 1997, total comprehensive income was comprised of $335 million in net income and $8.9 million of gross securities gain adjustments, net of taxes totaling $3.5 million, partially offset by $26.6 million of gross foreign exchange translation losses, net of taxes totaling $10.4 million.
SEGMENT REPORTING
In June 1997, SFAS No. 131--"Disclosures about Segments of an Enterprise and Related Information" was issued requiring the reporting of selected segmented information in quarterly and annual reports. Information from operating segments is derived from methods used by the Company's management to allocate resources and measure performance. The Company is required to disclose profit/loss, revenues and assets for each segment identified, including reconciliations of these items to consolidated totals. The Company is also required to disclose the basis for identifying the segments and the types of products and services within each segment. SFAS No. 131 was effective for the Company for the Transition Period ended August 28, 1998 (see Note 14), and quarterly in fiscal 1999, including the restatement of prior periods reported consistent with this pronouncement, if practicable.
SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
NEW ACCOUNTING STANDARDS
SFAS No. 133-- "Accounting for Derivative Instruments and Hedging Activities," was issued in June 1998 and will require the Company to record derivative instruments, such as interest-rate agreements, on the Consolidated Balance Sheet as assets or liabilities, measured at fair value. Currently, the Company treats such instruments as off-balance-sheet items. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the specific use of each derivative instrument and whether it qualifies for hedge accounting treatment as stated in the standard. In June 1999, the Financial Accounting Standards Board approved the deferral of the effective date for SFAS No. 133 to all fiscal quarters of all fiscal years beginning after June 15, 2000. Therefore, SFAS No. 133 will be effective for the Company on September 2, 2000, the beginning of fiscal year 2001. The impact to the Company's financial position of implementing SFAS No. 133 is not anticipated to be material.
(2) THE DISTRIBUTION AND DISCONTINUED OPERATIONS
THE DISTRIBUTION
On March 27, 1998, the Company distributed to its shareholders, on a pro rata basis, all outstanding shares of New Marriott MI, Inc., a wholly owned subsidiary of the Company, in a tax-free distribution (the "Distribution"). New Marriott MI, Inc., subsequently renamed Marriott International, Inc. (together with subsidiaries, "MI") conducts business in the lodging segment and two of the three lines of business in the contract services segment - Marriott Senior Living Services ("MSLS") and Marriott Distribution Services ("MDS"). The lodging, MSLS and MDS businesses are collectively referred to as Distributed Operations. The third line of business in the contract services segment, Marriott Management Services ("MMS"), has become the principal business of the Company.
DISCONTINUED OPERATIONS
As a result of the Distribution, the Consolidated Financial Statements and Notes thereto have been restated to present the lodging segment distributed to shareholders as Discontinued Operations. The MDS, MSLS and MMS business make up the Contract Services segment in the historical financial statements of the Company. Thus, the distributed operations of MSLS and MDS are presented as continuing operations prior to the date of distribution, March 27, 1998.
Discontinued Operations, Net of Income Taxes, is comprised of the following:
Results of discontinued operations in 1998 include a pretax charge of $28 million relating to the Distribution detailed above, and was comprised of legal, administrative and accounting costs to consummate the Distribution. Net identifiable assets of the Lodging segment totaled $2.90 billion and $1.62 billion as of the end of fiscal years ended 1997 and 1996, respectively (see Note 14).
SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(3) ACQUISITION
On March 27, 1998, Sodexho transferred to the Company the operations of Sodexho North America having a fair market value of $278 million, combined with a cash payment of $304 million, in exchange for 29.9 million shares of the Company's common stock, after giving effect to the one-for-four reverse stock split (see Notes 1 through 4). The purchase price included approximately $3 million in transaction costs. As a result of the issuance of new shares to the Company's common stock to Sodexho in connection with the Acquisition, the shareholders who owned 100% of the Company immediately prior to the Distribution owned approximately 51% immediately thereafter.
The Acquisition has been accounted for using the purchase method of accounting. The purchase price has been allocated to the fair market value of assets acquired and liabilities assumed as follows:
Pro forma results of the Company, assuming the Acquisition had been made at the beginning of the periods presented are shown below:
PRO FORMA UNAUDITED RESULTS OF OPERATIONS ($ in millions, except per share amounts)
Pro forma sales include the combined actual sales of the food and facilities management services business of MMS and Sodexho North America. Pro forma operating profit before corporate expenses and interest reflects the pro rata amount of approximately $15.9 million of annual amortization expense for the intangible assets related to the Acquisition. Pro forma corporate expenses include the combined corporate overhead of both businesses. No synergies are assumed and integration and restructuring costs totaling $31 million have been excluded from the 34 weeks ended August 28, 1998 results. However, an estimate of $6.4 million in annual costs were included on a pro rata basis in all periods presented until the date of the Transactions, representing the incremental costs to operate as a separate public entity.
SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(3) ACQUISITION, CONTINUED
For the 52 weeks ended January 2, 1998, the loss from the sale and operations of the MMS- UK operations sold to Sodexho in October 1997 have been excluded from the results presented. Pro forma interest expense, net, represents the estimated costs as if the Refinancing and the interest-rate agreements had been in place on the first day of both periods presented. An effective income tax rate of 48% and 49% were used for current and prior period, respectively. Pro forma results do not include the extraordinary item related to the Refinancing. Pro forma basic earnings per share were calculated on a share base of 61.9 million for both periods presented, which represents the number of shares outstanding on August 28, 1998. Pro forma diluted earnings per share were calculated on a share base of 62.6 million for both periods presented. The dilutive shares are due to stock option plans, deferred stock incentive plans, and convertible debt outstanding.
(4) INTEGRATION AND RESTRUCTURING
Integration and restructuring actions taken in fiscal year 1999 and the Transition Period ended August 28, 1998 reflect the undertaking by the Company to integrate and realign resources for more effective and efficient execution of operating strategies. Integration costs totaled $16 million during fiscal year 1999 and $24 million during the Transition Period. The integration costs include, among other items, training and relocating of former MMS employees, incremental overhead during the integration phase, systems modifications, and other one-time costs.
Restructuring costs represent employee termination benefits, office closure expenditures, and other costs related to a restructuring plan initiated from the Transactions. The acquisition reserve, which totaled $8 million at September 3, 1999, generally represents the estimated cost of termination benefits for approximately 350 former Sodexho North America employees as well as the estimated cost for the closure of certain Sodexho North America offices.
Acquisition reserve activity, reflecting certain adjustments made to the preliminary allocation of the purchase price to the fair market value of assets acquired (see Note 3), is detailed below:
In addition, integration expenses recorded in the Consolidated Statement of Income during fiscal year 1999 and the Transition Period are detailed below. No restructuring expenses were recorded in the Consolidated Statement of Income during fiscal year 1999.
SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(5) RELATIONSHIP WITH MARRIOTT INTERNATIONAL AND SODEXHO ALLIANCE, S.A.
RELATIONSHIP WITH MARRIOTT INTERNATIONAL ("MI")
Pursuant to the Distribution agreement (see Note 2), the Company and MI agreed upon the allocation of assets and liabilities related to the MMS business and MI business. The Company and MI also agreed to enter into a number of agreements governing their relationship after March 27, 1998, as described below.
TAX SHARING AGREEMENT. The Tax Sharing Agreement by and among the Company, MI and Sodexho Alliance, S.A. ("Sodexho") provides that MI is liable for all taxes of the Company (other than sales, use and property taxes, which are borne by the entities filing such returns) for all periods up to and including March 27, 1998. In addition, the parties have agreed for certain specified periods after the Distribution not to take specific actions that could cause the Distribution not to have Tax-Free Status.
EMPLOYEE BENEFITS ALLOCATION AGREEMENT. On September 30, 1997, the Company and MI entered into an Employee Benefits and Other Employment Matters Allocation Agreement providing for the allocation of employees of the Company and obligations and responsibilities regarding compensation, benefits and labor matters.
MEDICAL AND OTHER WELFARE BENEFITS PLANS. MI assumed the administration of the Company's medical, dental, short-term disability, vacation and group term life insurance plans incurred before March 27, 1998 by MI employees, the Company's employees and former employees. The Company established and maintains a separate medical, dental, short-term disability, vacation and group term life insurance plans for its employees after the Distribution.
TRADEMARK LICENSE AGREEMENT. As part of the contribution of assets to MI, the Company transferred and assigned to MI all of the Company's right, title and interest in certain trademarks, including the trademarks "Marriott," "Courtyard," "Residence Inns by Marriott" and "Fairfield Inns by Marriott." Pursuant to the terms of the agreement MI generally granted to the Company a limited nonexclusive right to use the "Marriott" name solely in connection with the Company's business as defined in the agreement. For four years after March 27, 1998, the Company is permitted to use the "Marriott" name as part of its corporate name and the names of its principal business divisions. During the term of the license, the Company pays MI a license fee of $1 million per year, payable quarterly in advance. MI may terminate the Trademark License Agreement prior to the expiration of its term under certain conditions. In addition, the Company may terminate this agreement upon 180 days' prior written notice to MI.
NONCOMPETITION AGREEMENT. The Company and MI entered into a Noncompetition Agreement generally prohibiting MI from competing in the core business of MMS (as defined) in the United States, Canada and the United Kingdom for a period of four years. However, per the agreement, MI may enter into certain negligible investments (as defined) in businesses that compete with the Company through direct investment or acquisitions.
LYONS ALLOCATION AGREEMENT AND SUPPLEMENTAL INDENTURE. The Company had issued $540 million face amount of Liquid Yield Option(TM) Notes ("LYONs"), with an accreted value as of January 2, 1998 of approximately $310 million. Pursuant to the LYONs Allocation Agreement and a supplemental indenture to the LYONs Indenture, MI assumed responsibility for all of the debt obligations evidenced by the LYONs by becoming a successor to the Company in accordance with the terms of the LYONs Indenture. The Company assumed responsibility for a portion of the LYONs equal to its pro rata share based on the relative equity values of the Company and MI, although MI will remain liable for any payments that the Company fails to make on its allocable portion. Subsequent to the end of fiscal year 1999, on October 7, 1999, Marriott International notified all holders of the LYONs, that Marriott International had elected to redeem all of the LYONs at a price of $619.65 for each $1,000 principal amount at maturity of the LYONs, with a redemption date of November 8, 1999--See Note 8.
ADDITIONAL AGREEMENTS BETWEEN THE COMPANY AND MI. In connection with the Distribution agreement, the Company and MI (or a subsidiary of MI) have entered into a number of additional agreements providing for the delivery of certain transitional and other services between the companies. The terms and conditions of these agreements were negotiated by the parties bargaining at arm's length. Absent the Transactions, the Company believes that it may have been able to negotiate more favorable terms with outside parties on certain of these agreements. However, the Company further believes the terms of these agreements are within the range of the prevailing markets for such services.
SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(5) RELATIONSHIP WITH MARRIOTT INTERNATIONAL AND SODEXHO ALLIANCE, S.A., CONTINUED
Such additional agreements include agreements regarding payroll processing, benefits administration, procurement, distribution, information technology, and office space and related facilities management in the MI corporate headquarters (see Note 2).
Billings from MI to the Company and from the Company to MI associated with the performance of these agreements (excluding pass-through product costs) were approximately $65 million and approximately $4 million, respectively, for fiscal year 1999. Billings from MI for the 1998 22-week Stub Period totaled approximately $25 million, with total billings to MI of $2 million during the same period.
As part of the Transactions, the Company entered into an agreement with MI that established a reasonable amount of adjusted net tangible assets (as defined in the agreement) for the operations that were not part of the Distribution immediately prior to the consummation of the Transactions. This agreement provided that the Company would pay MI the amount by which the adjusted net tangible assets total is greater than $103 million, estimated at March 27, 1998 to be $29 million payable to MI. This amount was arbitrated and paid in fiscal year 1999 for a reduced amount totaling $19 million, mostly the result of adjustments related to deferred taxes.
RELATIONSHIP WITH SODEXHO ALLIANCE, S.A. ("SODEXHO")
ROYALTY AGREEMENT AND ASSISTANCE AGREEMENT. The Company and Sodexho entered into a Royalty Agreement and an Assistance Agreement effective March 27, 1998. Pursuant to these agreements, the Company has the right to use the name "Sodexho" in connection with its operations in the United States and Canada for a period of 10 years, for a royalty payment equal to 0.05% of the annual gross revenues of the Company during the first three years of the Royalty Agreement. Thereafter, Sodexho and the Company will negotiate in good faith to determine the royalty fee, based on fair market value. The Royalty Agreement may be terminated by the Company at any time after Sodexho owns less than 10% of the outstanding Common Stock of the Company. Sodexho may terminate the Royalty Agreement prior to the expiration of its term under certain circumstances. Payments made to Sodexho under this agreement in Fiscal Year 1999 totaled $2.25 million.
The Assistance Agreement sets forth certain services provided by Sodexho to the Company, including services related to purchasing activities, catering and site support services, marketing, management and administration, legal and financial matters, human relations, communications and cash management. In exchange for these services, the Company pays to Sodexho a fee equal to a percentage of the annual gross revenues of the Company and its subsidiaries. Pursuant to the terms of the Assistance Agreement, no fee was owed during the 22-week Stub Period ended August 31, 1998. Payments from the Company to Sodexho associated with the performance of services was approximately $2.25 million for fiscal year 1999. Payments made to Sodexho for the 1998 22-week Stub Period totaled approximately $1 million. Payments in fiscal year 2000 are expected to increase to approximately $5 million under this agreement.
OTHER ARRANGEMENTS. Sodexho has agreed to guarantee the following: (i) the payment when due of certain deferred compensation amounts payable by the Company to the Company's employees, (ii) the obligations of the Company under the LYONs allocation agreement and the LYONs indenture, (iii) obligations with respect to certain insurance costs that are set forth in the Distribution agreement, and (iv) Senior Credit Guarantee Facility (see Note 8) where Sodexho has guaranteed the Company's obligation under a $620 million credit facility in exchange for a guarantee fee equal to 0.50% per annum of the outstanding principal amount of indebtedness. In addition, the Company and Sodexho entered into a stockholder agreement covering certain corporate governance matters and that grants Sodexho certain registration rights with respect to stock of the Company held by Sodexho as well as certain rights to nominate members of the Company's Board of Directors.
As part of the Acquisition, the Company entered into an agreement with Sodexho that established a reasonable amount of adjusted net tangible assets (as defined in the agreement) of the acquired operations immediately prior to the consummation of the Acquisition. This agreement provided that the Company would pay Sodexho the amount by which the adjusted net tangible assets total is less than a negative $35 million, estimated on March 27, 1998 to be $20 million payable to Sodexho. As a result of negotiations between Sodexho and the Company, this amount was paid in fiscal year 1999 for a reduced amount totaling $17 million.
SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(6) PROPERTY AND EQUIPMENT
Property and equipment is recorded at cost, including interest, rent and real estate taxes incurred during development and construction. Interest capitalized for continuing operations was not material for all periods presented. Interest capitalized for discontinued operations totaled $16 million in 1997 and $9 million in 1996. Replacements and improvements that extend the useful life of property and equipment are capitalized. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the shorter of the asset life or lease term. As a result of the Distribution, approximately $1.09 billion of the Company's property and equipment was restated as Discontinued Operations as of the fiscal year ended 1997 (see Notes 1 and 2).
(7) INTANGIBLE ASSETS
Amortization expense for continuing operations totaled $38 million for fiscal year 1999, $26 million for the 34 weeks ended August 28, 1998, $25 million in 1997 and $26 million in 1996. As a result of the Distribution, approximately $1.29 billion of the Company's intangible assets were restated as Discontinued Operations as of the fiscal year ended 1997 (see Notes 1 and 2). Amortization expense for discontinued operations totaled $8 million for the 34 weeks ended August 28, 1998, $42 million in 1997 and $8 million in 1996.
SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(8) DEBT
Senior Secured Credit Facility-- the senior secured credit facility consists of $235 million of revolving credit and an additional $500 million, six-year term loan facility. Interest is based on a bank prime rate, an amount over the Federal funds rate, or an amount over the London interbank offered rate for Eurodollar deposits ("LIBOR"), payable in arrears quarterly. At September 3, 1999, the Company is paying a rate of 6.80% on the term loan facility, adjusted for fee amortization and hedging costs. The senior secured credit facility is secured predominantly by inventory and accounts receivable of the Company. Up to $100 million of the $235 million revolving credit may be used to collateralize letters of credit, which totaled $33 million at September 3, 1999 and $26 million at August 28, 1998. At September 3, 1999, $150 million of this facility was not used and was available to the Company, compared with $184 million at August 28, 1998.
Senior Guaranteed Credit Facility-- the senior guaranteed credit facility consists of a $620 million seven-year term loan. Interest is based on a bank prime rate, an amount over the Federal funds rate, or an amount over LIBOR, payable in arrears quarterly. At September 3, 1999, the Company is paying a rate of 6.85% on this facility, adjusted for fee amortization and hedging costs and including an annual guarantee fee of 0.5% ($3 million pretax) paid to Sodexho for this facility (see Note 5).
Debt totaling $17 million was presented as Discontinued Operations at January 2, 1998 (see Notes 1 and 2).
Aggregate debt maturities, excluding capital lease obligations, are: 2000 - $80 million; 2001 - $80 million; 2002 - $90 million; 2003 - $115 million and $692 million thereafter.
The Company's debt agreements require the maintenance of certain financial ratios and stockholders' equity balances, and also include, among other things, limitations on additional indebtedness, certain acquisitions, dividend payments, pledging of assets, and other restrictions on operations related to cash flow. The Company met the financial covenants of the debt agreements as of September 3, 1999 and the year then ended, as well as August 28, 1998 and for the 22 weeks then ended.
SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(8) DEBT, CONTINUED
CONVERTIBLE SUBORDINATED DEBT
On March 25, 1996, the Company issued $540 million (principal amount at maturity) of zero coupon convertible subordinated debt in the form of Liquid Yield Option(TM) Notes ("LYONs") due 2011. Each $1,000 LYON is convertible at any time, at the option of the holder, into 8.76 shares of the Company's Common Stock. The LYONs were issued at a discount representing a yield to maturity of 4.25 percent. The Company recorded the LYONs at the discounted amount at issuance. Accretion is recorded as interest expense and an increase to the carrying value. Gross proceeds from the LYONs issuance were $288 million.
Upon consummation of the Distribution, each LYON was convertible into 2.19 shares of the Company's common stock (after giving effect to a one-for-four reverse stock split), as well as 17.52 shares of MI's Common Stock. The LYONs were assumed by MI, and the Company assumed responsibility for a portion of the LYONs equal to its pro rata share of the relative equity values of the Company and MI as determined in good faith by the Company prior to the Distribution, although MI remains liable to the holders of the LYONs for any payments that the Company fails to make on its allocable portion. The Company's allocated portion of the LYONs totaled $30 million at September 3, 1999 and $29 million at August 28, 1998.
On October 7, 1999, MI notified all holders of the LYONs, that MI had elected to redeem all of the LYONs at a price of $619.65 for each $1,000 principal amount at maturity of the LYONs, with a redemption date of November 8, 1999. Conversion is available at any time until the close of business on the redemption date. The maximum amount of funds that the Company would be obligated to pay to MI if all the LYONs were redeemed for cash is approximately $30 million. This amount would be paid to MI in the first quarter of fiscal year 2000.
INTEREST-RATE AGREEMENTS
At September 3, 1999, the majority of the Company's debt was payable at variable rates of interest. As part of the Refinancing of the Company's debt, the Company entered into several interest-rate agreements on May 29, 1998 totaling $900 million in notional principal balances to hedge a portion of its variable rate debt. These agreements guarantee a fixed rate of interest over the life of the agreements. The Company is paying a fixed rate ranging between 5.70% and 5.90%, plus a residual margin that is not hedged relating to the underlying variable-rate debt.
In March 1999, the Company entered two new interest-rate agreements to guarantee a fixed rate of interest payments for a portion of its unhedged floating interest rate debt. These agreements were effective on March 30, 1999 and April 1, 1999, with notional principal amounts of $80 million and $70 million, respectively, and paid a fixed rate of 5.02% and 5.05%, respectively, while receiving interest based on three-month LIBOR. These agreements matured in fiscal year 1999. The weighted-average rate for the total debt portfolio, including the effect of the interest-rate agreements, was 6.87% at September 3, 1999. These agreements expire between August 2001 and February 2005.
Details of these interest rate agreements as of September 3, 1999 are as follows:
At September 3, 1999, the Company did not have any material accrued interest receivable or payable to its counterparties and did not have any unamortized fees or premiums under these agreements. All of the Company's interest-rate agreements are for purposes other than trading.
SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(9) STOCKHOLDERS' (DEFICIT)/EQUITY
STOCKHOLDERS' (DEFICIT)/EQUITY
The Company is authorized to issue three hundred million shares of the Company's common stock, with a par value of $1 per share. One million shares of preferred stock, without par value, are authorized, with none issued. At the Distribution, each shareholder received one share of the Company's stock and one share of New Marriott, Inc. stock (renamed Marriott International, Inc.). In addition, the Company's stock underwent a one-for-four reverse stock split on March 27, 1998. Prior to the Distribution, the Company's charter authorized the issuance of seventy-five million shares of the Company's common stock, with a par value of $1 per share, with one million shares of preferred stock, without par value, authorized, with none issued.
In addition, on March 27, 1998, the Company issued to Sodexho Alliance, S.A., approximately 48% of its shares of common stock, representing 29.9 million shares (after the effect of the reverse stock split), in exchange for $304 million in cash and the operations of Sodexho North America (see Note 3). At September 3, 1999, the Company had 62,251,459 shares outstanding.
On July 23, 1993, the Company's Board of Directors adopted a shareholder rights plan under which one preferred stock purchase right was distributed for each share of Company common stock. Each right entitles the holder to buy 1/1000th of a share of a newly issued series of junior participating preferred stock of the Company at an exercise price of $150. The rights will be exercisable ten days after a person or group acquires beneficial ownership of 20 percent or more of the Company's common stock, or begins a tender or exchange offer for 30 percent or more of the Company's common stock. Shares owned by a person or group on September 30, 1993 and held continuously thereafter are exempt for purposes of determining beneficial ownership under the rights plan. The rights are nonvoting and will expire on the tenth anniversary of the adoption of the Company's shareholder rights plan, unless exercised or previously redeemed by the Company for $.01 each. If the Company is involved in a merger or certain other business combinations not approved by the Board of Directors, each right entitles its holder, other than the acquiring person or group, to purchase common stock of either the Company or the acquirer having a value of twice the exercise price of the right. The shareholder rights plan continued in effect after the Distribution and was amended to exempt shares acquired by Sodexho and its affiliates.
A program to repurchase the Company's common stock, up to 5.1 million shares, was terminated with the consummation of the Transactions.
On October 13, 1999, the Board of Directors declared an $0.08 per common share dividend for Fiscal Year 1999, payable on December 10, 1999, to shareholders of record on November 22, 1999. The payment and amount of cash dividends on the Company's common stock will continue to be subject to the sole discretion of the Company's Board, which will review the Company's dividend policy at such times as may be deemed appropriate. The Board will continue to closely monitor the results of the Company's operations, capital requirements, and other considerations to determine the extent to which a dividend may be declared in future periods.
SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(9) STOCKHOLDERS' (DEFICIT)/EQUITY, CONTINUED
EARNINGS PER SHARE
In 1997, the Company adopted SFAS No. 128 (see Note 1), thus 1996 earnings per share computations have been restated in conformity with SFAS No. 128. The following table details earnings and number of shares used in the basic and diluted earnings per share calculations.
Certain employee and deferred stock options to purchase shares of common stock were outstanding but were not included in the computation of diluted earnings per share because the exercise prices of the options were greater than the average market price of the common shares as follows:
SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(10) INCOME TAXES
The (provision) benefit for income taxes on continuing operations was comprised of the following:
A reconciliation of the Federal statutory tax rate to the Company's effective income tax rate follows:
The tax effect of significant temporary differences is as follows:
Total deferred tax assets and liabilities as of September 3, 1999, August 28, 1998 and January 2, 1998, were as follows:
SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(10) INCOME TAXES, CONTINUED
The Company has not established a valuation allowance for deferred tax assets. In assessing the realizability of deferred tax assets, management considers the Company's ability to generate sufficient future taxable income during periods in which temporary differences reverse. The amount of net deferred tax assets considered realizable could be reduced if estimated future taxable income cannot be achieved. Management believes it is more likely than not the Company will realize the benefits of its net deferred tax assets.
As part of the Distribution and Acquisition, the Company, MI and Sodexho entered into tax sharing agreements which reflect each party's rights and obligations with respect to deficiencies and refunds, if any, of federal, state or other taxes relating to the business of the Company, MI and Sodexho prior to the Transactions (see Note 5).
While the Company has changed its accounting period from a fiscal year ended on the Friday closest to the end of December to the Friday closest to the end of August, its tax year has not changed. The Company has applied to the Internal Revenue Service for a change in its tax year in 1999 to the Friday closest to the end of August.
(11) COMMITMENTS AND CONTINGENCIES
The Company issues bid and performance bonds for its client-related contracts in the normal course of business. These guarantees are limited, in the aggregate, to $56 million at September 3, 1999 and August 28, 1998, with expected funding of zero. Letters of credit outstanding on the Company's behalf at September 3, 1999 and August 28, 1998 totaled $33 million and $26 million, respectively, related to the Company's insurance programs. Upon consummation of the Distribution, MI replaced the Company as guarantor or obligor under previous guarantees and commitments related primarily to the lodging segment distributed on March 27, 1998.
Summarized below are the Company's future obligations under leases at September 3, 1999:
The Company generally leases office space and equipment under noncancellable agreements, primarily to support its administrative operations. Most leases have initial terms of one to 20 years, and contain one or more renewal options, generally for five or 10-year periods. The leases provide for minimum rentals, and additional rentals, which are based on the operations of the leased property. Total rent expense for continuing operations for fiscal year 1999 totaled $26 million, the 34 weeks ended August 28, 1998 totaled $13.8 million, fiscal year 1997 totaled $90 million, and fiscal year 1996 totaled $81 million. Total rent expense for discontinued operations for the 34 weeks ended August 28, 1998 totaled $41 million, and $177 million and $179 million for the fiscal years ended 1997 and 1996, respectively.
The nature of the business of the Company causes it to be involved in routine legal proceedings from time to time. Management of the Company believes that there are no pending or threatened legal proceedings that upon resolution would have a material adverse impact to the Company.
SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(12) EMPLOYEE BENEFIT AND INCENTIVE PLANS
DEFERRED COMPENSATION PLANS
Employees meeting certain eligibility requirements can participate in the Company's deferred compensation and savings plans. As part of the Distribution, the Company elected to continue the deferred compensation plan and has established a new savings plan for the Company separate from the MI profit sharing plan. The Company assumed the obligations and liabilities of the undistributed portion of the deferred compensation plan in relationship to the employees retained by the Company after the Distribution. The Company currently contributes generally 50% of the participants' contributions to these plans, limited to 6% of compensation, with certain exceptions. For the fiscal year ended September 3, 1999, the Company contributed approximately $10.2 million for these plans, with contributions totaling $9.5 million for the 34-week period ended August 28, 1998.
STOCK OPTION PLANS
The Company has two stock-based incentive plans-- the Sodexho Marriott Services, Inc. 1993 and 1998 Comprehensive Stock Incentive Plans (the "1993 Plan" or the "1998 Plan"). The purpose of these plans is to promote and enhance the long-term growth of the Company by aligning the interests of the employees with the interests of the Company's shareholders. The 1993 Plan administers converted stock options prior to the Distribution, with no new awards made under this plan. The 1998 Plan governs the issuance and administration of conversion awards and is also available for the issuance of new awards. These stock plans are administered by the Compensation Policy Committee as authorized by the Board of Directors. As part of the Distribution and the amendment of these plans, and in relationship to the changes in the capital structure of the Company after the Distribution, the Board of Directors has approved up to 10 million shares of common stock to be available under the 1998 Plan for converted options as well as new awards. At the Distribution date, approximately 3.3 million options were exchanged as conversion options of prior grants under both the 1993 and 1998 Plans, with an additional 0.4 million options issued to employees of Sodexho North America as part of the conversion of stock options held by those employees prior to the Acquisition. Also, 3.3 million shares were terminated related to the options of former MI employees from the Distribution.
Employee stock options may be granted to officers and key employees at exercise prices not less than the market price of the Company's stock on the date of grant. Most options under the stock option plans are exercisable in cumulative installments of one-fourth at the end of each of the first four years following the date of grant. In June 1998, the Company issued 1.8 million new stock option awards. The Company expects to issue approximately 2.5 million new stock option awards in the first half of fiscal year 2000.
A summary of the Company's stock option activity during fiscal 1999, the 34 weeks ended August 28, 1998 and fiscal 1997 is presented below (adjusting for the one-for-four reverse stock split on March 27, 1998):
SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(12) EMPLOYEE BENEFIT AND INCENTIVE PLANS, CONTINUED
Stock options under the 1993 and 1998 Plans that were outstanding at September 3, 1999 are summarized as follows:
Pro forma compensation cost for the Stock Option Plans, the Deferred Compensation Plan, the Supplemental Executive Stock Option awards and employee purchases, recognized in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation," would reduce the Company's net income as follows:
The aggregate weighted-average fair value for each option granted during fiscal year 1999, the 34 weeks ended August 28, 1998, fiscal 1997 and fiscal 1996 was $11, $12, $88 and $76, respectively. Since the pro forma compensation cost is recognized over the vesting period, the foregoing pro forma reductions in the Company's net income are not representative of anticipated amounts in future years.
For purposes of the following disclosures required by SFAS No. 123, the fair value of each option granted has been estimated on the date of grant using the Black-Scholes option-pricing model, with the following assumptions:
SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(13) FAIR VALUE OF FINANCIAL INSTRUMENTS
For current assets, current liabilities and notes and other receivables, management believes the carrying amounts are reasonable estimates of their fair values. The fair values of noncurrent financial liabilities are shown below.
The difference between carrying amounts and fair values for notes and other receivables for continuing operations are not material as of September 3, 1999, August 28, 1998 and January 2, 1998. However, net noncurrent assets of discontinued operations include notes and other receivables with a carrying amount of $647 million at fiscal year end 1997, with a market value based on the expected future cash flows discounted at risk adjusted rates of $660 million. Valuations for long-term debt, convertible subordinated debt and other long-term liabilities are determined based on quoted market prices or expected future payments discounted at risk adjusted rates. The fair value of commercial paper borrowings is equal to the carrying value.
SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(14) BUSINESS SEGMENTS
The Company is the leading provider in North America of outsourced food and facilities management services to businesses, health care facilities, colleges and universities, primary and secondary schools and other clients. The Company has identified six new business segments within these markets: Corporate Services, Health Care, Education, Schools, Canada, and Laundries/Other. Prior to the Distribution, the Company was a diversified hospitality company with operations in two business segments: Lodging, which includes development, ownership, operation and franchising of lodging properties under 10 brand names and development and operation of vacation timesharing resorts; and Contract Services, consisting of the Company's principal business operations after the Distribution, in addition to the senior living communities business and the wholesale food distribution business ("Other Contract Services").
In June 1997, SFAS No. 131 was issued--"Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 requires the reporting of selected-segmented information in quarterly and annual reports. As required in SFAS No. 131, information from operating segments presented has been derived consistent with the Company's methodology in allocating resources and measuring performance after the Distribution (see Note 1).
SALES AND OPERATING PROFIT BY BUSINESS SEGMENT:
SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(14) BUSINESS SEGMENTS, CONTINUED
The Company does not have any material activity outside of the United States and does not presently analyze it operations by geographic regions. In addition, the Company offers a wide array of food and facilities products within its operations, customized to individual client's requirements, and thus the Company's management has not found it practical to track results by individual products or services in relationship to the financial statements presented in this report. At September 3, 1999, the Company had a diverse client base and does not have any individual clients that are material to its overall operations.
IDENTIFIABLE ASSETS, CAPITAL EXPENDITURES AND DEPRECIATION AND AMORTIZATION BY BUSINESS SEGMENT:
SODEXHO MARRIOTT SERVICES, INC. SUPPLEMENTARY DATA
HISTORICAL QUARTERLY FINANCIAL DATA - UNAUDITED ($ in millions, except per share amounts)
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEMS 10, 11, 12 AND 13.
As described below, certain information appearing in the Company's Proxy Statement to be furnished to shareholders in connection with the 2000 Annual Meeting, is incorporated by reference in this Form 10-K Annual Report.
ITEM 10.
ITEM 10. This information is incorporated by reference to the "Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" sections of the Company's Proxy Statement to be furnished to shareholders in connection with the 2000 Annual Meeting. Information regarding executive officers is included below.
ITEM 11.
ITEM 11. This information is incorporated by reference to the "Executive Compensation" section of the Company's Proxy Statement to be furnished to shareholders in connection with the 2000 Annual Meeting.
ITEM 12.
ITEM 12. This information is incorporated by reference to the "Security Ownership of Certain Beneficial Owners and Management" section of the Company's Proxy Statement to be furnished to shareholders in connection with the 2000 Annual Meeting.
ITEM 13.
ITEM 13. This information is incorporated by reference to the "Certain Transactions" section of the Company's Proxy Statement to be furnished to shareholders in connection with the 2000 Annual Meeting.
EXECUTIVE OFFICERS
The 12 persons identified below are the executive officers of the Company.
EXECUTIVE OFFICERS, CONTINUED
EXECUTIVE OFFICERS, CONTINUED
EXECUTIVE OFFICERS, CONTINUED
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT
(1) Financial Statements
The response to this portion of Item 14. is submitted under Item 8. of this Report on Form 10-K.
(2) Financial Statement Schedules
All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.
(3) Exhibits
Any shareholder who desires a copy of the following Exhibits may obtain a copy upon request from the Company at a charge that reflects the reproduction cost of such Exhibits. Requests should be made to the Secretary, Sodexho Marriott Services, Inc., 9801 Washingtonian Boulevard, Gaithersburg, Maryland, 20878.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K, CONTINUED
(A) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT, CONTINUED
(3) Exhibits, Continued
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K, CONTINUED
(A) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT, CONTINUED
(3) Exhibits, Continued
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K, CONTINUED
(A) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT, CONTINUED
(3) Exhibits, Continued
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K, CONTINUED
(A) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT, CONTINUED
(3) Exhibits, Continued
(B) REPORTS ON FORM 8-K
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, on this 29th day of October, 1999.
SODEXHO MARRIOTT SERVICES, INC.
By: /S/ ROBERT A. STERN ------------------------- Robert A. Stern Senior Vice President and General Counsel
Pursuant to the requirements of the Securities Act of 1934, as amended, this report has been signed by the following persons in the capacities and on the dates indicated.
*By: /S/ ROBERT A. STERN ----------------------- Robert A. Stern Attorney- in- fact