-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, UQPRW/j9HskdPlEJrBJmg+bpMUnKc9ku8hR8rl7QYEhDIJol8r7HLljvd560b25y FUUwfC1fIsFpw6JzT77Z0g== 0000905036-99-000012.txt : 19991101 0000905036-99-000012.hdr.sgml : 19991101 ACCESSION NUMBER: 0000905036-99-000012 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19990903 FILED AS OF DATE: 19991029 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SODEXHO MARRIOTT SERVICES INC CENTRAL INDEX KEY: 0000905036 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-EATING PLACES [5812] IRS NUMBER: 520936594 STATE OF INCORPORATION: DE FISCAL YEAR END: 0828 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-12188 FILM NUMBER: 99736669 BUSINESS ADDRESS: STREET 1: 9801 WASHINGTONIAN BOULEVARD CITY: GAITHERSBURG STATE: MD ZIP: 20878 BUSINESS PHONE: 3019874431 MAIL ADDRESS: STREET 1: 9801 WASHINGTONIAN BOULEVARD CITY: GAITHERBURG STATE: MD ZIP: 20878 FORMER COMPANY: FORMER CONFORMED NAME: MARRIOTT INTERNATIONAL INC DATE OF NAME CHANGE: 19930517 10-K 1 FOR THE FISCAL YEAR ENDED SEPTEMBER 3, 1999 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED SEPTEMBER 3, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File No. 1-12188 SODEXHO MARRIOTT SERVICES, INC. ------------------------------------------------------ (Exact name of registrant as specified in its charter) DELAWARE 52-0936594 ------------------------ --------------------------------------- (State of Incorporation) (I.R.S. Employer Identification Number) 9801 WASHINGTONIAN BOULEVARD, GAITHERSBURG, MARYLAND 20878 ---------------------------------------------------- ------- (Address of principal executive offices) (Zip Code) (301) 987-4431 ---------------------------------------------------- (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED ----------------------------- ----------------------------------------- Common Stock, $1.00 par value New York Stock Exchange Chicago Stock Exchange Pacific Stock Exchange Philadelphia Stock Exchange Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] Indicate by check mark if disclosure by delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of October 26, 1999, the number of shares of common stock outstanding was 62,339,533. The aggregate market value of shares of common stock held by non-affiliates at October 26, 1999 was $430,400,000. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's definitive annual proxy statement to be filed within 120 days of the Registrant's fiscal year ended September 3, 1999 are incorporated by reference into Part III of this report. Index to Exhibits is located on pages 63 through 67 of this report. SODEXHO MARRIOTT SERVICES, INC. ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED SEPTEMBER 3, 1999 TABLE OF CONTENTS PAGE ---- INTRODUCTION Overview and Glossary of Terms 2 Forward-Looking Statements 4 Pro Forma Unaudited Financial Information 5 PART I Item 1. Business 13 Item 2. Properties 19 Item 3. Legal Proceedings 19 Item 4. Submission of Matters to a Vote of Security Holders 19 PART II Item 5. Market for the Company's Common Stock and Related Shareholder Matters 20 Item 6. Selected Historical Financial Data 20 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 22 Item 8. Financial Statements and Supplementary Data 30 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 60 PART III Item 10. Directors and Executive Officers of the Registrant 60 Item 11. Executive Compensation 60 Item 12. Security Ownership of Certain Beneficial Owners and Management 60 Item 13. Certain Relationships and Related Transactions 60 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 63 -1- INTRODUCTION OVERVIEW AND GLOSSARY OF TERMS 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. Upon the consummation of the distribution of its lodging, senior living and distribution services businesses to existing shareholders (see "Distributed Operations" below), which occurred on March 27, 1998 (the last day of the first quarter of 1998), the Company then acquired the North American operations of Sodexho Alliance, S.A., and the combined operations were renamed Sodexho Marriott Services, Inc. The subsidiaries listed below represent the current direct subsidiaries of the Company. Each of these direct subsidiaries, in turn, has one or more subsidiaries. o Sodexho Marriott Operations, Inc., with two main operating subsidiaries: Sodexho Marriott Management, Inc. (formerly Marriott Management Services Corp.) and its subsidiaries, and International Catering Corporation and its subsidiaries; o Sodexho Financiere du Canada, Inc. (acquired in the Transactions described in Note 1 to the Consolidated Financial Statements); and o Sodexho MS Canada, Ltd. (formerly Marriott Corporation of Canada, Ltd.). Sodexho Financiere du Canada, Inc. and subsidiaries and International Catering Corporation and subsidiaries are collectively referred to as "Sodexho North America." Similarly, the former Marriott Corporation of Canada, Ltd. and subsidiaries and the former Marriott Management Services Corp. and subsidiaries are collectively referred to as "MMS." THE TRANSACTIONS As of March 27, 1998, the assets, liabilities and business operations of the Company changed substantially due to the Distribution to shareholders, the Acquisition of Sodexho North America and the Refinancing of debt (the "Transactions"). Below is an overview of the Transactions. DISTRIBUTED OPERATIONS. On March 27, 1998, the Company distributed to its shareholders 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 the Distributed Operations. The third line of business in the contract services segment, MMS, has become the principal business of the Company. The lodging segment distributed to shareholders is presented as Discontinued Operations in the historical financial statements 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, 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 a one-for-four reverse stock split. 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 REFINANCING. On March 27, 1998, the Company borrowed $615 million and $620 million under the Secured SMS Facility and Guaranteed SMS Facility, respectively (see Note 8 to the Consolidated Financial Statements). The proceeds were used to reduce the Company's previously existing debt outstanding. Also, the Company repaid debt of $73 million assumed in the Acquisition. -2- Due to the extensive changes in the Company's business that resulted from the Transactions, the Company is providing the following glossary of significant terms used in this report for informational purposes. In certain places in this document, where deemed meaningful for the reader's understanding, these definitions may be repeated. THE ACQUISITION. On March 27, 1998, the Company acquired Sodexho North America, and Sodexho paid the Company $304 million, in exchange for approximately 48% of the shares of the Company's common stock that were issued and outstanding immediately after the Transactions. ADJUSTED NET TANGIBLE ASSETS. The amount by which stockholders' equity exceeds intangible assets with certain adjustments. THE COMPANY. Sodexho Marriott Services, Inc. (together with its consolidated subsidiaries), formerly Marriott International, Inc. DISCONTINUED OPERATIONS. The Company's lodging business segment. DISTRIBUTED OPERATIONS. The lodging, senior living services, and distribution services businesses taken collectively. THE DISTRIBUTION. On March 27, 1998, the Company distributed the stock of New Marriott MI, Inc., which contained all of the assets and liabilities of the Company's lodging, senior living services, and distribution services businesses, to its shareholders in a tax-free transaction. FISCAL YEAR 1999. The 53-week period ended September 3, 1999. FISCAL YEAR 1997. The 52-week period ended January 2, 1998. FISCAL YEAR 1996. The 53-week period ended January 3, 1997. ICC. International Catering Corporation, and subsidiaries, combined with Sodexho Financiere du Canada, Inc. and subsidiaries, collectively referred to as Sodexho North America. I&R COSTS. Integration and Restructuring costs related to the Transactions. MI. New Marriott MI, Inc. (together with its subsidiaries) was subsequently renamed Marriott International, Inc. MDS. Marriott Distribution Services, the Company's distribution services business. MMS. Marriott Management Services Corp., the remaining line of business in the contract services segment, consisting of food service and facilities management, which has become the principal business of the Company. MMS- UK OPERATION. Marriott Management Services Corp.'s United Kingdom operations sold in October 1997 to a subsidiary of Sodexho Alliance, S.A. in anticipation of the Transactions. MSLS. Marriott Senior Living Services, the Company's senior living services business. NEW MARRIOTT MI, INC. Subsequently renamed Marriott International, Inc. ("MI"), conducts business in the lodging segment, MDS and MSLS. OTHER CONTRACT SERVICES. MDS and MSLS, which for the first quarter of the 1998 Transition Period and prior fiscal years were part of the Company's continuing operations. PRO FORMA FISCAL YEAR 1999. The pro forma 53-week period ending September 3, 1999. PRO FORMA FISCAL YEAR 1998. The pro forma 52-week period ended August 28, 1998. PRO FORMA FISCAL YEAR 1997. The pro forma 52-week period ended August 29, 1997. -3- THE REFINANCING. On March 27, 1998, the Company and its indirect subsidiary, RHG Finance Corporation, tendered for a total of $720 million principal amount of their respective outstanding publicly held debt. In addition, the Company refinanced its commercial paper and indebtedness outstanding under its revolving credit facility, which totaled $950 million on March 27, 1998. RETAINED BUSINESS. All operations not distributed. REVERSE STOCK SPLIT. On March 27, 1998, the Company's common stock underwent a one-for-four reverse stock split. SODEXHO. Sodexho Alliance, S.A., a worldwide food and management services organization headquartered in France and a 48% shareholder of the Company. SODEXHO NORTH AMERICA. Sodexho Financiere du Canada and subsidiaries, and International Catering Corporation and subsidiaries (also known as Sodexho USA) taken collectively. STUB PERIOD. The 22-week period beginning March 27, 1998, the date of the Transactions, and ending on August 28, 1998. THE TRANSACTIONS. The Distribution, Acquisition, and Refinancing taken collectively. TRANSITION PERIOD. On April 15, 1998, the Board of Directors of the Company approved the change of the fiscal year of the Company to the Friday nearest to August 31 of each year. Prior to this change in fiscal year, the Company's fiscal year ended on the Friday nearest to December 31 of each year. Thus, the 1998 fiscal year, which began on January 3, 1998, ended on August 28, 1998, and is considered the Transition Period. The 1999 fiscal year, which began on August 29, 1998 and ended on September 3, 1999, was a 53-week period. TRANSITION REPORT. The Company's Transition Report on Form 10-K for the 34-week period ended August 28, 1998. FORWARD-LOOKING STATEMENTS This report by the Company contains forward-looking statements within the meaning of the federal securities laws. These statements are based on the Company's current expectations and relate to anticipated future events that are not historical facts, such as the Company's business strategies and their intended results. The forward-looking statements included in this report are subject to numerous risks and uncertainties that could cause the Company's future activities and results of operations to differ materially from those expressed or implied in the forward-looking statements. These risks and uncertainties, which are further discussed in Management's Discussion and Analysis of Financial Condition and Results of Operations and other parts of this report, include: (i) the ability of the Company to adapt to various changes, including changes in its structure, senior management and in its relationship with its largest shareholder--Sodexho Alliance, (ii) the potential adverse impact of the Company's substantial indebtedness, (iii) the ability of the Company to attract, hire, train and retain competent management personnel, (iv) competition in the food services and facilities management industries, (v) the effects of general economic conditions, (vi) the ability of the Company to retain clients and obtain new clients on satisfactory terms, (vii) the ability of the Company to remedy any computer-related issues that may result from the advent of the Year 2000, and other factors described from time to time in the Company's filings with the Securities and Exchange Commission including those set forth in Exhibit 99 filed herein. As a result of these risks and uncertainties, readers are cautioned not to place undue reliance on the forward-looking statements included in this report or that may be made elsewhere from time to time by, or on behalf of, the Company. The Company assumes no obligation to update any forward-looking statements. -4- PRO FORMA UNAUDITED FINANCIAL INFORMATION As of March 27, 1998, the assets, liabilities and business operations of the Company changed substantially due to the Transactions described fully in Notes 1 through 5 to the Consolidated Financial Statements. As a result of these changes, there are substantial differences in the comparability of the Company's historical operating results prior to March 27, 1998, presented in Parts I and II of this document and the Company's ensuing and ongoing operations. To assist readers in understanding the present operations of the Company, management believes it is meaningful and relevant to set forth in this report not only the results for the fiscal year ended September 3, 1999 compared with the historical results of operations for the thirty-four weeks ended August 28, 1998 and the historical fiscal years 1997 and 1996 (presented in Item 8 of this report), but also the pro forma operating results and pro forma cash flow for the full fiscal years ended September 3, 1999, August 28, 1998 and August 29, 1997, as well as the condensed balance sheet as of September 3, 1999 and August 28, 1998. The pro forma operating results and cash flow information were prepared as if the Transactions occurred at the beginning of each period and only include the Company's Retained Business and the acquired operations of Sodexho North America. Prior to March 27, 1998, pro forma sales and managed volume include the combined actual activity of the food and facilities management services business of MMS and Sodexho North America. Managed Volume represents the Company's measurement of gross revenues associated with all services the Company manages on behalf of its clients. Similarly, pro forma corporate expenses include the combined corporate overhead of both businesses. No synergies are assumed for periods presented prior to March 27, 1998. Management estimates that approximately $25 million in synergies were realized in pro forma fiscal year 1999. Integration and restructuring charges of $15.6 million and $31.1 million were excluded for pro forma fiscal years 1999 and 1998, respectively. However, an estimate of $6.4 million in annual costs were included on a pro rata basis in all periods presented prior to March 27, 1998, representing incremental costs to operate the Company as a separate public entity. Pro forma net income reflects approximately $15.9 million of amortization expense for each year for the intangible assets related to the Acquisition. Pro forma interest expense, net, represents the estimated costs as if the Refinancing and the interest rate agreements had been in place on the first day of all periods presented. Effective income tax rates of 44.8%, 48% and 54% were used for pro forma fiscal years 1999, 1998 and 1997, respectively. Pro forma results do not include any extraordinary charges related to the Refinancing, the loss in 1997 from the sale of MMS- UK operations to Sodexho or any operating results from the MMS- UK operations prior to its sale. Pro forma basic earnings per share was calculated with total weighted-average shares outstanding of 62.1 million for pro forma fiscal 1999. For pro forma fiscal years 1998 and 1997, a base of 61.9 million shares was included in pro forma basic earning per share, which represents the number of shares outstanding at August 28, 1998. Pro forma diluted earnings per share were calculated on a base of 63.9 million shares for pro forma fiscal 1999 and 62.5 million shares for fiscal 1998 and 1997. The dilutive shares are the result of the Company's convertible debt, stock option plans and deferred stock incentive plans. -5- PRO FORMA UNAUDITED CONDENSED STATEMENT OF INCOME BY SEGMENT FOR FISCAL YEARS ENDED SEPTEMBER 3, 1999, AUGUST 28, 1998 AND AUGUST 29, 1997 ($ IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
1999 1998 1997 ------------------ ------------------- ------------------ (53 WEEKS) (52 WEEKS) (52 WEEKS) SALES Corporate Services $1,380 $1,336 $1,243 Health Care 1,323 1,277 1,249 Education 1,221 1,150 1,083 Schools 358 333 302 Canada 143 145 153 Laundries/Other 77 65 59 ------------------ ------------------- ------------------ TOTAL SALES 4,502 4,306 4,089 OPERATING COSTS AND EXPENSES Corporate Services 1,289 1,253 1,169 Health Care 1,214 1,182 1,156 Education 1,148 1,093 1,034 Schools 337 317 288 Canada 136 140 149 Laundries/Other 72 61 56 ------------------ ------------------- ------------------ TOTAL OPERATING COSTS AND EXPENSES 4,196 4,046 3,852 ------------------ ------------------- ------------------ OPERATING PROFIT BEFORE CORPORATE ITEMS Corporate Services 91 83 74 Health Care 109 95 93 Education 73 57 49 Schools 21 16 14 Canada 7 5 4 Laundries/Other 5 4 3 ------------------ ------------------- ------------------ TOTAL OPERATING PROFIT 306 260 237 ------------------ ------------------- ------------------ CORPORATE ITEMS: Amortization of Intangible Assets (38) (37) (38) Corporate Expenses (81) (73) (74) Interest Expense, Net (87) (87) (87) Gain on Sale of Investment 8 -- -- ------------------ ------------------- ------------------ INCOME BEFORE INCOME TAXES 108 63 38 Provision for Income Taxes (48) (30) (20) ------------------ ------------------- ------------------ PRO FORMA NET INCOME $ 60 $ 33 $ 18 ================== =================== ================== PRO FORMA BASIC EARNINGS PER SHARE $ 0.96 $ 0.53 $ 0.28 ================== =================== ================== PRO FORMA DILUTED EARNINGS PER SHARE $ 0.94 $ 0.52 $ 0.28 ================== =================== ==================
-6- PRO FORMA UNAUDITED SUPPLEMENTAL INFORMATION ON MANAGED VOLUME* FOR FISCAL YEARS ENDED SEPTEMBER 3, 1999 AND AUGUST 28, 1998 ($ IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
FISCAL FIRST SECOND THIRD FOURTH YEAR QUARTER QUARTER QUARTER QUARTER ENDED % INC./ SEGMENT NOV-98 FEB-99 MAY-99 SEP-99 SEP-99 (DEC.) ----------------------------------------------------------------------------------------- (13 weeks) (13 weeks) (13 weeks) (14 weeks) (53 weeks) Corporate Services $ 335 $ 323 $ 350 $ 372 $1,380 3 % Health Care 699 705 708 758 2,870 9 Education 421 320 343 239 1,323 6 Schools 194 174 195 84 647 8 Canada 63 56 59 57 235 (1) Laundries/Other 33 33 35 38 139 20 -------------------------------------------------------------------------- Total $1,745 $1,611 $1,690 $1,548 $6,594 7 % ========================================================================== FISCAL FIRST SECOND THIRD FOURTH YEAR QUARTER QUARTER QUARTER QUARTER ENDED SEGMENT NOV-97 FEB-98 MAY-98 AUG-98 AUG-98 -------------------------------------------------------------------------- (13 weeks) (13 weeks) (13 weeks) (13 weeks) (52 weeks) Corporate Services $ 329 $ 320 $ 344 $ 346 $1,339 Health Care 650 650 657 671 2,628 Education 399 307 337 203 1,246 Schools 180 165 182 75 602 Canada 67 59 60 51 237 Laundries/Other N/A N/A N/A N/A 116 -------------------------------------------------------------------------- Total $1,625 $1,501 $1,580 $1,346 $6,168 ========================================================================== * Managed Volume represents the Company's measurement of gross revenues associated with all services the Company manages on behalf of its clients.
-7- DISCUSSION OF PRO FORMA FISCAL YEAR 1999 COMPARED WITH PRO FORMA FISCAL YEAR 1998 RESULTS OF OPERATIONS Total sales for pro forma fiscal year 1999 ("1999") were $4.5 billion, an increase of $196 million, or 4.6%, over $4.3 billion for pro forma fiscal year 1998 ("1998"). Excluding the estimated $76 million impact of the extra week in fiscal year 1999, sales increased $120 million, or 2.8%. This growth was mostly attributable to solid performance in the Education and Schools divisions that was the result of sales growth at existing clients partially offset by an overall lower retention rate for the Company in 1998. The Corporate Services division had lower growth in sales for 1999, resulting from strong competition in this mature market, the overall impact of corporate restructurings and a lower retention rate going into 1999 from 1998. Growth in the Health Care division was impacted by the challenging environment for the health care industry in 1999, including decreased government reimbursements, consolidation in the industry and several bankruptcies of health care institutions. Despite these challenges, the Health Care division has grown sales at existing clients and sold new business to largely offset a lower retention rate going into 1999 from 1998. As with other divisions, retention in Health Care improved in 1999, which will favorably impact next year's sales growth. Management believes that these challenges present an opportunity to gain new business, as the Company works with new and existing clients to seek cost-effective outsourcing solutions. The Company believes managed volume is the more complete measure of its overall level of business activity. Managed volume is the Company's measurement of gross revenues associated with all services the Company manages on behalf of its clients. Pro forma managed volume for fiscal year 1999 was $6.6 billion, up 7% over pro forma fiscal 1998. Pro forma sales were up 5% to $4.5 billion, from $4.3 billion a year ago. Excluding the estimated effect of the 53rd week in fiscal 1999, pro forma managed volume and sales increased 5% and 3%, respectively, over fiscal 1998. Pro forma operating profit before corporate items (corporate administrative expenses, interest expense, fees to Marriott International and Sodexho Alliance, and amortization of intangible assets) totaled $306 million for 1999, an increase of $46 million, or 17.7%, over $260 million in operating profit for 1998. This increase was driven by improved operating margins, particularly in the Education and Schools divisions, the result of efficiencies achieved in the procurement of food-related products and administrative synergies gained during the year. Operating profit for the Health Care division was unfavorably impacted by several bankruptcies at hospital clients in 1999, as this industry continues to experience consolidation and restructuring issues. Excluding $3 million in charges related to bankruptcies in 1999, Health Care's operating profit would have totaled $112 million, or a 16.7% increase over a comparably adjusted 1998 operating profit of $96 million. Operating profit in the Canada and Laundries/Other divisions collectively totaled $12 million in 1999, an increase of $3 million or 33% over 1998. This double-digit increase was driven by improved margins in the both divisions. The 53rd week did not have a material impact of the Company's operating profit for the current year. Corporate expenses and amortization of intangible assets in pro forma fiscal 1999 totaled $119 million, an increase of $9 million, or 8%, compared with pro forma fiscal 1998. Included in corporate expenses are a one-time, $3.4 million charge ($1.9 million after-tax, or $0.03 per diluted share) related to the resignation of the former Chief Executive Officer and $5 million of Year 2000 related costs (see "Year 2000"). Excluding the one-time resignation charge and the Year 2000 costs, total corporate expenses were level with Pro Forma Fiscal 1998. Administrative synergies were achieved as planned during 1999, but were partially offset by consulting expenses and other reinvestments in the Company's corporate infrastructure. Pro Forma Fiscal 1999 included the favorable impact from the sale of the Company's Bright Horizons Family Solutions ("BFAM") investment, resulting in a gain of $8.3 million ($4.6 million after-tax, or $0.07 per diluted share). Excluding the Year 2000 costs 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 Pro Forma Fiscal Year 1999 compared with Pro Forma Fiscal Year 1998's comparable period ratio of 96.5%. 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. -8- DISCUSSION OF PRO FORMA FISCAL YEAR 1999 COMPARED WITH PRO FORMA FISCAL YEAR 1998 RESULTS OF OPERATIONS, CONTINUED 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. The growth in operating profit increased pretax income to $108 million, a 71% or $45 million increase when compared with $63 million for 1998. The effective tax rate for 1999 was 44.8%, a decrease from 48% for 1998, mostly due to the proportion of nondeductible intangible amortization expense in relation to total operating profit between the years. Net income almost doubled in 1999 to $60 million, or $0.94 per diluted share, compared with $33 million, or $0.52 per diluted share for 1998. Excluding the one-time resignation charge and the BFAM gain, pro forma earnings per diluted share would have been approximately $0.90. DISCUSSION OF PRO FORMA 1998 COMPARED WITH PRO FORMA 1997 RESULTS OF OPERATIONS Total sales for Pro Forma Fiscal 1998 were $4.3 billion, an increase of $217 million, or 5.3%, over $4.1 billion for 1997. This growth was mostly attributable to solid performance in the Corporate Services and Education divisions. Increases in the Corporate Services and Education divisions were the result of high retention of existing clients (approximately 95% for 1998), and strong new sales growth. Corporate Services division's sales were also favorably impacted by the continued implementation of the Crossroads Cuisines retail strategy. Lower growth in the Health Care division in 1998 was mostly the result of the challenging environment for the health care industry in 1998, including decreased government reimbursements, consolidation in the industry and several bankruptcies of health care institutions. Despite these challenges, the Health Care division increased sales by $28 million, or 2.2%, over the prior year. Management believes that these challenges present an opportunity for the Company to gain new business, as client organizations are likely to seek cost-effective outsourcing solutions. The Schools, Canada and Laundries/Other divisions' sales collectively totaled $543 million for 1998, an increase of $29 million, or 5.6%, over the $514 million in aggregate sales for 1997. Operating profit before corporate items (corporate expenses, interest expense, and amortization of intangible assets) totaled $260 million for 1998, an increase of $23 million, or 9.7%, over the $237 million in operating profit for 1997. This increase was driven by solid sales growth in the Corporate Services and Education divisions in 1998. Operating margins, particularly in the Education division, improved as the result of efficiencies in labor costs and increased efficiencies in the procurement of food-related products gained during the year. Operating profit in the Schools, Canada and Laundries/Other divisions collectively totaled $25 million in 1998, an increase of $4 million or 19% over 1997. This double-digit increase was driven by strong growth in new business in the Schools division. Corporate expenses in 1998 were about even with the prior year, reflecting the elimination of certain positions after the Transactions and the timing of filling certain employee positions. Had the Company fully completed the consolidation of the MMS and Sodexho North America processing systems and related hiring of certain personnel, additional costs of approximately $5 million pretax would have been incurred during the 22 week Stub Period. Total operating costs, corporate expenses and amortization of intangible assets represent, in the aggregate, 96.5% of total sales for the year, compared with 1997's ratio of 96.9%. The Company anticipates this margin will continue to improve in the periods ahead, as the Company continues the integration of the MMS and Sodexho North America operations resulting in savings realized from purchasing and administrative actions. These savings are anticipated to reach $60 million annually by fiscal year 2001. The growth in operating profit combined with relatively flat corporate items contributed to an increase in pretax income of $25 million, or 66%, to $63 million for 1998. The effective tax rate for 1998 was 48%, a decrease from 54% for 1997, mostly due to the proportion of nondeductible intangible amortization expense in relation to total operating profit between the years. Net income almost doubled in 1998 to $33 million, or $0.52 per diluted share, compared with $18 million, or $0.28 per diluted share for 1997. -9- DISCUSSION OF 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 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 Liquid Yield Option(TM) Notes ("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 $30 million. This amount would be paid to Marriott International in the first quarter of fiscal year 2000--See Note 8 to Consolidated Financial Statements. -10- CONSOLIDATED CONDENSED BALANCE SHEET SEPTEMBER 3, 1999 AND AUGUST 28, 1998 ($ IN MILLIONS)
SEPTEMBER 3, AUGUST 28, 1999 1998 ------------------ ------------------ ASSETS Current assets Cash and equivalents $ 48 $ 79 Accounts and notes receivable 445 374 Inventories 60 54 Other 89 98 ------------------ ------------------ Total current assets 642 605 ------------------ ------------------ Property and equipment, net 85 82 Intangible assets 535 569 Other 85 85 ------------------ ------------------ $ 1,347 $ 1,341 ================== ================== LIABILITIES AND STOCKHOLDERS' DEFICIT Current liabilities Current portion of long-term debt $ 133 $ 96 Accounts payable 238 222 Other current liabilities 347 377 ------------------ ------------------ Total current liabilities 718 695 Long-term debt 980 1,062 Other long-term liabilities 113 110 Convertible subordinated debt 30 29 Stockholders' deficit Preferred stock, no par value, 1 million shares authorized; no shares issued - - Common stock, $1 par value; 300 million shares authorized, 62 million shares issued and outstanding 62 62 Additional paid-in capital 1,326 1,322 Accumulated deficit (1,884) (1,946) Accumulated other comprehensive income 2 7 ------------------ ------------------ Total stockholders' deficit (494) (555) ------------------ ------------------ Total liabilities and stockholders' deficit $ 1,347 $ 1,341 ================== ==================
-11- DISCUSSION OF PRO FORMA CASH FLOW CASH FLOW FROM OPERATING ACTIVITIES The Company's cash flow from operations is affected by a predictable seasonal pattern. Cash flow from operations is strongest during the fall and spring, as the demand for services fluctuates in the Education and Schools divisions. Cash flow from operations, before the impact of changes in working capital, was $145 million in 1999, $115 million in 1998, and $102 million in 1997. The increase in the adjusted operating cash flow in pro forma fiscal years 1999 and 1998 was mostly the result of higher net income in both years. Working capital, defined as the net of current assets and current liabilities, is favorable to the Company when current liabilities exceed current assets. This negative working capital position is primarily the result of the timing of cash payments in relationship to the timing of cash received. Higher accounts and notes receivable in 1999 reflect the impact of the 53rd week and a lengthening of the average billing cycle compared to last year. The Company anticipates it will improve its negative working capital position in future periods. CASH FLOW FROM INVESTING ACTIVITIES The Company invests cash primarily for capital expenditures related to new or existing client relationships. Total capital expenditures were $72 million, $60 million and $57 million for 1999, 1998 and 1997, respectively. The Company anticipates expending approximately $70 to $75 million for capital investments for fiscal year 2000. In addition, the Company intends to make, from time to time, investments for business acquisitions. CASH FLOW FROM FINANCING ACTIVITIES The Company's financing activities reflects the Company's management of its debt and other long-term liabilities, in addition to the Company's receipt of funds from stock sales, as part of the Company's overall management of its cost of capital. Pro forma cash flow from financing activities represents cash flow as if the Refinancing had been in place on the first day of all periods presented. In 1999, net cash used in financing activities totaled $40 million, mostly due to the $70 million repayment of long-term debt, partially offset by increases in short-term debt and other liabilities. Net cash provided by financing activities in 1998 totaled $49 million. Other cash provided by financing activities totaled $106 million, reflecting the transfer of insurance-related liabilities from MI, and was partially offset by repayments of long-term debt totaling $57 million in 1998. Net cash provided by financing activity was unchanged for 1997. PRO FORMA UNAUDITED CONDENSED CASH FLOW FOR THE FISCAL YEARS ENDED 1999, 1998 AND 1997 ($ IN MILLIONS)
YEAR ENDED YEAR ENDED YEAR ENDED SEPTEMBER 3, AUGUST 28, AUGUST 29, 1999 1998 1997 ------------------- ------------------ ------------------ (53 WEEKS) (52 WEEKS) (52 WEEKS) CASH PROVIDED BY OPERATING ACTIVITIES - ------------------------------------- Net income $ 60 $ 33 $ 18 Adjust to reconcile net income to net cash: Depreciation expense 47 45 46 Amortization of intangible assets 38 37 38 Net changes in certain working capital items (40) (39) (12) ------------------- ------------------ ------------------ NET CASH PROVIDED BY OPERATING ACTIVITIES 105 76 90 ------------------- ------------------ ------------------ CASH FLOW FROM INVESTING ACTIVITIES - ----------------------------------- Capital expenditures (72) (60) (57) Other (24) (27) (30) ------------------- ------------------ ------------------ NET CASH USED IN INVESTING ACTIVITIES (96) (87) (87) ------------------- ------------------ ------------------ CASH FLOW FROM FINANCING ACTIVITIES - ----------------------------------- Repayments of long-term debt (70) (57) - Other 30 106 - ------------------- ------------------ ------------------ NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (40) 49 - ------------------- ------------------ ------------------ NET (DECREASE) INCREASE IN CASH & CASH EQUIVALENTS $(31) $ 38 $ 3 =================== ================== ==================
-12- PART I 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. -13- 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. -14- 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 $3 million in transaction costs. As a result of the issuance of new shares of the Company's common stock to Sodexho in connection with the Acquisition, the shareholders who owned 100 percent of the Company immediately prior to the Distribution owned approximately 51% immediately thereafter. The Acquisition was accounted for using the purchase method of accounting. The purchase price was allocated to the fair market value of assets acquired and liabilities assumed as follows:
($ in millions) ----------------- Current assets $ 142 Other assets 56 Customer relationships 122 Current liabilities (137) Payable to Sodexho for excess net tangible assets (17) Other liabilities (46) Debt (73) Deferred taxes, net (8) Goodwill 239 ----------------- Subtotal 278 Cash contributed to the Company 304 ----------------- Total purchase price $ 582 =================
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. -15- 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 $45 million (pretax). The untendered Series A through D Senior Notes remain a liability of the Company.
Face Amount Prior to Untendered Debt at Untendered Debt at Tender March 27, 1998 March 27, 1998 September 3, 1999 ------------------------- ------------------------- ------------------------ ($ in millions) Series A $ 150 $ 2 $ 2 Series B 200 1 1 Series C 150 3 2 Series D 100 1 1 ------------------------- ------------------------- ------------------------ $ 600 $ 7 $ 6 ========================= ========================= ========================
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. -16- 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. -17- 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. -18- 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. LEGAL PROCEEDINGS There are no material legal proceedings pending against the Company. 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. -19- PART II 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):
DIVIDENDS DECLARED PER HIGH LOW SHARE ---------------- --------------- ---------------- FISCAL YEAR 1999 First Quarter $ 33 3/8 $ 24 5/8 $ - Second Quarter 29 1/4 22 - Third Quarter 25 1/8 18 7/8 - Fourth Quarter 23 1/4 13 3/4 - TRANSITION PERIOD 1998 Quarter ended March 27, 1998 330 1/2 243 3/4 .36 Nine weeks ended May 29, 1998 31 3/8 24 5/16 - Quarter ended August 28, 1998 33 1/16 25 3/4 - FISCAL YEAR 1997 First Quarter 229 198 1/2 .32 Second Quarter 256 1/2 198 1/2 .36 Third Quarter 287 240 .36 Fourth Quarter 307 260 1/2 .36 FISCAL YEAR 1996 First Quarter 210 1/2 149 .32 Second Quarter 200 177 .32 Third Quarter 229 1/2 193 1/2 .32 Fourth Quarter 239 1/2 205 1/2 .32
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. 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 $0.40 per share) on the sale of MMS- UK to Sodexho. The historical information set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and notes thereto, each contained herein. -20- ITEM 6. SELECTED HISTORICAL FINANCIAL DATA, CONTINUED
SELECTED CONSOLIDATED FINANCIAL HIGHLIGHTS 34 FISCAL WEEKS YEAR AUGUST FISCAL YEAR ----------------------------------------- 1999(1) 1998(1) 1997(2) 1996(3) 1995 1994 ----------- ---------- --------- ---------- --------- ---------- ($ in millions, except per share data) INCOME STATEMENT DATA: Sales $4,502 $2,828 $5,026 $4,318 $3,634 $3,466 Operating Profit Before Corporate Expenses and Interest 304 119 157 177 130 111 Total Corporate Expenses and Interest(4) (212) (151) (172) (127) (78) (71) ----------- ---------- --------- ---------- --------- ---------- Income (Loss) From Continuing Operations, Before Taxes and Extraordinary Item 92 (32) (15) 50 52 40 (Provision) Benefit for Income Taxes from Continuing Operations (41) 13 15 (17) (20) (17) ----------- ---------- --------- ---------- --------- ---------- Income (Loss) From Continuing Operations, Before Discontinued Operations and Extraordinary Item 51 (19) -- 33 32 23 Discontinued Operations, Net of Income Taxes(5) -- 77 335 273 215 177 ----------- ---------- --------- ---------- --------- ---------- Income Before Extraordinary Item 51 58 335 306 247 200 Loss from Extraordinary Item, Net of Income Taxes(6) -- (44) -- -- -- -- ----------- ---------- --------- ---------- --------- ---------- Net Income $ 51 $ 14 $ 335 $ 306 $ 247 $ 200 =========== ========== ========= ========== ========= ========== PER SHARE DATA(7): Diluted Earnings Per Share: Continuing Operations $ 0.81 $(0.36) $ -- $ 0.97 $ 0.97 $ 0.69 Discontinued Operations(5) -- 1.48 10.53 8.08 6.51 5.35 ----------- ---------- --------- ---------- --------- ---------- Diluted Earnings Per Share before Extraordinary Item 0.81 1.12 10.53 9.05 7.48 6.04 Extraordinary Item(6) -- (0.85) -- -- -- -- ----------- ---------- --------- ---------- --------- ---------- Diluted Earnings Per Share $ 0.81 $ 0.27 $10.53 $ 9.05 $ 7.48 $ 6.04 =========== ========== ========= ========== ========= ========== Cash Dividends Declared(8) $ -- $ 0.36 $ 1.40 $ 1.28 $ 1.12 $ 1.12 Diluted Weighted - Average Shares 63.9 52.0 31.8 33.8 33.0 33.1 BALANCE SHEET DATA (AT END OF YEAR): Total Assets $1,347 $1,341 $5,009 $4,180 $3,221 $2,529 Long-Term and Convertible Subordinated Debt 1,010 1,091 1,829 1,300 795 488 Stockholders' (Deficit)/Equity (494) (555) 1,463 1,260 1,054 767 - ----------- 1 - 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. On March 27, 1998, the Company acquired Sodexho North America. In addition, fiscal year 1999 had 53 weeks and ended on September 3, 1999. The historical data for fiscal year 1997 and prior years does not include the revenue and expenses of the acquired business, see Notes 1 through 3 to the Consolidated Financial Statements. 2 - Operating results in fiscal year 1997 include a loss before income taxes of $22 million ($14 million after tax, or $0.40 per share) on the sale of the MMS- UK operations to Sodexho in connection with the Transactions. 3 - Fiscal year 1996 includes 53 weeks, all fiscal years prior to the Transactions include 52 weeks. 4 - Total corporate expenses include the amortization of intangible assets. For fiscal year 1999 and the 34 weeks ended August 28, 1998, $16 million and $31 million pretax, respectively, of integration and restructuring charges were recognized, see Note 4 to the Consolidated Financial Statements. 5 - On March 27, 1998, the Company distributed to its shareholders the Lodging, MSLS and MDS divisions as part of the Transactions. For reporting purposes, the Lodging segment is considered Discontinued Operations prior to March 27, 1998. MSLS and MDS are considered part of continuing operations for the same periods (see Note 1 to the Consolidated Financial Statements). 6 - On March 27, 1998, the Company refinanced its debt as part of the Transactions (see Note 1 and Note 8 to the Consolidated Financial Statements), resulting in a $71 million pretax charge from the early extinguishment of debt ($44 million after-tax). 7 - Earnings per share data have been restated to reflect the adoption in 1997 of Statement of Financial Accounting Standards No. 128, "Earnings Per Share." All per share data has been adjusted to reflect a one-for-four reverse stock split effective March 27, 1998. 8 - Subsequent to the end of fiscal year 1999, the Board of Directors declared on October 13, 1999, 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 Note 9 to the Consolidated Financial Statements.
-21- 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. -22- 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. -23- 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." -24- 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). -25- 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%. -26- 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. -27- 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. -28- 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. -29- 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. 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 -30- 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 -31- 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 -32- 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) -33-
SODEXHO MARRIOTT SERVICES, INC. CONSOLIDATED STATEMENT OF INCOME FOR THE FISCAL YEAR ENDED SEPTEMBER 3, 1999, THE THIRTY-FOUR WEEKS ENDED AUGUST 28, 1998 AND FOR FISCAL YEARS ENDED JANUARY 2, 1998 AND JANUARY 3, 1997 ($ IN MILLIONS, EXCEPT PER SHARE AMOUNTS) JANUARY 3 TO AUGUST 28, 1999 1998 1997 1996 -------------------- ------------------- -------------------- ------------------ (53 WEEKS) (34 WEEKS) (52 WEEKS) (53 WEEKS) SALES $4,502 $2,828 $5,026 $4,318 OPERATING COSTS AND EXPENSES Operating expenses 4,198 2,709 4,847 4,141 Loss on sale of MMS- UK operations - - 22 - -------------------- ------------------- -------------------- ------------------ 4,198 2,709 4,869 4,141 -------------------- ------------------- -------------------- ------------------ OPERATING PROFIT BEFORE CORPORATE EXPENSES AND INTEREST 304 119 157 177 Corporate expenses, including amortization of intangible assets (133) (97) (94) (79) Interest expense (88) (65) (110) (85) Interest income 1 11 32 37 Gain on sale of investment 8 - - - -------------------- ------------------- -------------------- ------------------ INCOME (LOSS) FROM CONTINUING OPERATIONS, BEFORE TAXES AND EXTRAORDINARY ITEM 92 (32) (15) 50 (Provision) Benefit for Income Taxes from Continuing Operations (41) 13 15 (17) -------------------- ------------------- -------------------- ------------------ Income (Loss) From Continuing Operations, Before Discontinued Operations and Extraordinary Item 51 (19) - 33 Discontinued Operations, Net of Income Taxes - 77 335 273 -------------------- ------------------- -------------------- ------------------ Income Before Extraordinary Item 51 58 335 306 Loss from Extraordinary Item, Net of Income Taxes - (44) - - -------------------- ------------------- -------------------- ------------------ NET INCOME $ 51 $ 14 $ 335 $ 306 ==================== =================== ==================== ================== BASIC EARNINGS (LOSS) PER SHARE: Continuing Operations $ 0.82 $(0.36) $ - $ 1.03 Discontinued Operations - 1.48 10.53 8.56 -------------------- ------------------- -------------------- ------------------ 0.82 1.12 10.53 9.59 Extraordinary Item - (0.85) - - -------------------- ------------------- -------------------- ------------------ BASIC EARNINGS PER SHARE $ 0.82 $ 0.27 $10.53 $ 9.59 ==================== =================== ==================== ================== DILUTED EARNINGS (LOSS) PER SHARE: Continuing Operations $ 0.81 $(0.36) $ - $ 0.97 Discontinued Operations - 1.48 10.53 8.08 -------------------- ------------------- -------------------- ------------------ 0.81 1.12 10.53 9.05 Extraordinary Item - (0.85) - - -------------------- ------------------- -------------------- ------------------ DILUTED EARNINGS PER SHARE $ 0.81 $ 0.27 $10.53 $ 9.05 ==================== =================== ==================== ==================
See Notes to Consolidated Financial Statements. -34-
SODEXHO MARRIOTT SERVICES, INC. CONSOLIDATED BALANCE SHEET SEPTEMBER 3, 1999, AUGUST 28, 1998 AND JANUARY 2, 1998 ($ IN MILLIONS) SEPTEMBER 3, AUGUST 28, JANUARY 2, 1999 1998 1998 ----------------- ----------------- ------------------- ASSETS Current Assets Cash and equivalents $ 48 $ 79 $ 139 Accounts and notes receivable, net 445 374 487 Inventories 60 54 116 Other 89 98 77 Net current assets from discontinued operations - - 95 ----------------- ----------------- ------------------- Total current assets 642 605 914 ----------------- ----------------- ------------------- Property and equipment, net 85 82 505 Intangible assets, net 535 569 388 Investments in affiliates 7 5 197 Other 78 80 198 Net noncurrent assets of discontinued operations - - 2,807 ----------------- ----------------- ------------------- $1,347 $1,341 $5,009 ================= ================= =================== LIABILITIES AND STOCKHOLDERS' (DEFICIT)/EQUITY Current Liabilities Current portion of long-term debt $ 133 $ 96 $ 23 Accounts payable 238 222 548 Accrued payroll and benefits 327 301 358 Other current liabilities 20 27 220 Payable to affiliates for excess net tangible assets - 49 - ----------------- ----------------- ------------------- Total current liabilities 718 695 1,149 ----------------- ----------------- ------------------- Long-term debt 980 1,062 1,519 Other long-term liabilities 113 110 568 Convertible subordinated debt 30 29 310 Commitments and Contingencies (Note 11) Stockholders' (deficit)/equity Preferred stock, no par value, 1 million shares Authorized; no shares issued - - - Common stock, $1 par value; 300 million, 75 million and 75 million authorized; 62.3 million, 61.9 million and 31.5 million shares issued and outstanding 62 62 32 Additional paid-in capital 1,326 1,322 805 (Accumulated deficit)/Retained earnings (1,884) (1,946) 822 Accumulated other comprehensive income (expense) 2 7 (12) Treasury stock, at cost - - (184) ----------------- ----------------- ------------------- Total stockholders' (deficit)/equity (494) (555) 1,463 ----------------- ----------------- ------------------- Total liabilities and stockholders' (deficit)/equity $1,347 $1,341 $5,009 ================= ================= ===================
See Notes to Consolidated Financial Statements. -35-
SODEXHO MARRIOTT SERVICES, INC. CONSOLIDATED STATEMENT OF CASH FLOW FOR FISCAL YEAR 1999, THE THIRTY-FOUR WEEKS ENDED AUGUST 28, 1998 AND FISCAL YEARS ENDED JANUARY 2, 1998 AND JANUARY 3, 1997 ($ IN MILLIONS) JANUARY 3 TO AUGUST 28, 1999 1998 1997 1996 ------------------ ------------------ ------------------- ----------------- (53 WEEKS) (34 WEEKS) (52 WEEKS) (53 WEEKS) CASH PROVIDED BY OPERATING ACTIVITIES - ------------------------------------- Net income $ 51 $ 14 $ 335 $ 306 Adjust to reconcile net income to cash and equivalents: Income from discontinued operations - (77) (335) (273) Extraordinary item - extinguishment of debt - 44 - - Gain on sale of investment (8) - - - Depreciation and amortization expense 85 57 99 101 (Benefit) provision for deferred taxes (5) 6 (2) (2) Changes in working capital (18) 128 67 57 Changes in discontinued operations - 131 271 397 Other - (2) 142 6 ------------------ ------------------ ------------------- ----------------- NET CASH PROVIDED BY CONTINUING OPERATING ACTIVITIES 105 301 577 592 ------------------ ------------------ ------------------- ----------------- CASH FLOW FROM INVESTING ACTIVITIES - ----------------------------------- Capital expenditures (72) (86) (282) (170) Net cash - acquisitions - 24 - (331) Dispositions 26 29 441 60 Net decrease in loans to affiliates - - 4 44 Cash from distributed operations - (305) - - Net investment in discontinued operations - (113) (1,118) (99) Other (50) (160) (86) (53) ------------------ ------------------ ------------------- ----------------- NET CASH USED IN INVESTING ACTIVITIES (96) (611) (1,041) (549) ------------------ ------------------ ------------------- ----------------- CASH FLOW FROM FINANCING ACTIVITIES - ----------------------------------- Proceeds from the issuance of long-term debt - 1,820 687 - Repayments of long-term debt (70) (1,900) (18) (137) Proceeds from issuance of convertible subordinated debt - - - 288 Proceeds from issuance of common stock for Acquisition - 304 - - Common stock issued - ESOP & other 4 72 40 43 Purchases of treasury stock - (35) (191) (158) Dividends paid - common - (11) (43) (40) Other 26 - - - ------------------ ------------------ ------------------- ----------------- NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (40) 250 475 (4) ------------------ ------------------ ------------------- ----------------- NET (DECREASE) INCREASE IN CASH AND EQUIVALENTS $ (31) $ (60) $ 11 $ 39 CASH & CASH EQUIVALENTS BEGINNING OF PERIOD 79 139 128 89 ------------------ ------------------ ------------------- ----------------- CASH & CASH EQUIVALENTS END OF PERIOD $ 48 $ 79 $ 139 $ 128 ================== ================== =================== ================= SUPPLEMENTAL: Interest paid - continuing operations $ 87 $ 64 $ 96 $ 57 Income tax payments - continuing operations 37 23 19 35 NONCASH INVESTING AND FINANCING ACTIVITIES: Issuance of common stock for Acquisition $ - $ 275 $ - $ -
See Notes to Consolidated Financial Statements. -36-
SODEXHO MARRIOTT SERVICES, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY FOR THE YEAR ENDED SEPTEMBER 3, 1999, THIRTY-FOUR WEEKS ENDED AUGUST 28, 1998 AND FISCAL YEARS ENDED JANUARY 2, 1998 AND JANUARY 3, 1997 (IN MILLIONS, EXCEPT PER SHARE AMOUNTS) ACCUMULATED (ACCUMULATED OTHER COMMON ADDITIONAL DEFICIT)/ COMPREHENSIVE TREASURY SHARES COMMON PAID-IN RETAINED INCOME STOCK, OUTSTANDING STOCK CAPITAL EARNINGS (EXPENSE) AT COST TOTAL - ---------------- ------------------------------- ----------- ------------- ----------------- ---------------- ------------ --------- 31.4 Balance, December 29, 1995 $32 $ 716 $ 395 $(2) $ (87) $ 1,054 - Net income - - 306 - - 306 - Foreign exchange translation - - - 1 - 1 ----------- ------------- ----------------- ---------------- ------------ --------- - TOTAL COMPREHENSIVE INCOME - - 306 1 - 307 ----------- ------------- ----------------- ---------------- ------------ --------- Employee stock plan 0.9 issuance and other - 35 (32) - 100 103 - Dividends ($1.28 per share) - - (41) - - (41) (0.8) Purchases of treasury stock - - - - (163) (163) - ---------------- ------------------------------- ----------- ------------- ----------------- ---------------- ------------ --------- 31.5 Balance, January 3, 1997 32 751 628 (1) (150) 1,260 - Net income - - 335 - - 335 - Unrealized gain on securities - - - 5 - 5 - Foreign exchange translation - - - (16) - (16) ----------- ------------- ----------------- ---------------- ------------ --------- - TOTAL COMPREHENSIVE INCOME - - 335 (11) - 324 ----------- ------------- ----------------- ---------------- ------------ --------- Employee stock plan 0.8 issuance and other - 54 (97) - 173 130 - Dividends ($1.40 per share) - - (44) - - (44) (0.8) Purchases of treasury stock - - - - (207) (207) - ---------------- ------------------------------- ----------- ------------- ----------------- ---------------- ------------ --------- 31.5 Balance, January 2, 1998 32 805 822 (12) (184) 1,463 - Net income - - 14 - - 14 - Unrealized gain on securities - - - 1 - 1 - Foreign exchange translation - - - (6) - (6) ----------- ------------- ----------------- ---------------- ------------ --------- - TOTAL COMPREHENSIVE INCOME - - 14 (5) - 9 ----------- ------------- ----------------- ---------------- ------------ --------- - Distribution to shareholders - - (2,715) 24 - (2,691) Shares issued to Sodexho-- 29.9 related to the Acquisition 30 549 - - - 579 Employee stock plan 0.6 issuance and other - (32) (56) - 160 72 - Dividends ($0.36 per share) - - (11) - - (11) (0.1) Purchases of treasury stock - - - - (35) (35) - Cancellation of treasury stock - - - - 59 59 - ---------------- ------------------------------- ----------- ------------- ----------------- ---------------- ------------ --------- 61.9 Balance, August 28, 1998 62 1,322 (1,946) 7 - (555) - Net income - - 51 - - 51 Reclassification of gain - realized in net income, net - - - (5) - (5) - Foreign exchange translation - - - 1 - 1 - Other - - - (1) - (1) ----------- ------------- ----------------- ---------------- ------------ --------- - TOTAL COMPREHENSIVE INCOME - - 51 (5) - 46 ----------- ------------- ----------------- ---------------- ------------ --------- Adjustment of distribution to - shareholders - - 11 - - 11 Employee stock plan 0.4 issuance and other - 4 - - - 4 - ---------------- ------------------------------- ----------- ------------- ----------------- ---------------- ------------ --------- 62.3 Balance, September 3, 1999 $62 $1,326 $(1,884) $ 2 $ - $ (494) ================ =============================== =========== ============= ================= ================ ============ =========
See Notes to Consolidated Financial Statements. -37- 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. -38- 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. -39- 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. -40- 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. -41- 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:
34 WEEKS ENDED AUGUST 28, 1998 1997 1996 ------------------- ------------------ ------------------- ($ in millions, except per share amounts) Sales $1,774 $7,008 $5,854 Income Before Income Taxes $ 158 $ 569 $ 452 Income Taxes (64) (234) (179) ------------------- ------------------ ------------------- Income -Discontinued Operations $ 94 $ 335 $ 273 Costs Associated with Effecting the Distribution $ (28) $ - $ - Income Taxes 11 - - ------------------- ------------------ ------------------- Net Costs Associated with Effecting the Distribution $ (17) $ - $ - ------------------- ------------------ ------------------- Discontinued Operations, Net of Income Taxes $ 77 $ 335 $ 273 =================== ================== =================== Basic Earnings Per Share $ 1.48 $10.53 $ 8.56 Diluted Earnings Per Share $ 1.48 $10.53 $ 8.08
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). -42- 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 $3 million in transaction costs. As a result of the issuance of new shares to the Company's common stock to Sodexho in connection with the Acquisition, the shareholders who owned 100% of the Company immediately prior to the Distribution owned approximately 51% immediately thereafter. The Acquisition has been accounted for using the purchase method of accounting. The purchase price has been allocated to the fair market value of assets acquired and liabilities assumed as follows:
($ in millions) ----------------- Current assets $ 142 Other assets 56 Customer relationships 122 Current liabilities (137) Payable to Sodexho for excess net tangible assets (17) Other liabilities (46) Debt (73) Deferred taxes, net (8) Goodwill 239 ----------------- Subtotal 278 Cash contributed to the Company 304 ----------------- Total purchase price $ 582 =================
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)
34 WEEKS ENDED 52 WEEKS ENDED AUGUST 28, 1998 JANUARY 2, 1998 -------------------- -------------------- ($ in millions, except per share amounts) SALES $2,716 $4,163 OPERATING COSTS AND EXPENSES 2,574 3,908 -------------------- -------------------- OPERATING PROFIT BEFORE CORPORATE ITEMS 142 255 Corporate expenses and amortization of intangible assets (68) (116) Interest expense, net (57) (87) -------------------- -------------------- INCOME BEFORE INCOME TAXES 17 52 Provision for income taxes (8) (25) -------------------- -------------------- PRO FORMA NET INCOME $ 9 $ 27 ==================== ==================== PRO FORMA EARNINGS PER SHARE: BASIC $ 0.14 $ 0.43 ==================== ==================== DILUTED $ 0.14 $ 0.43 ==================== ====================
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. -43- 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 $8 million at September 3, 1999, generally represents the estimated cost of termination benefits for approximately 350 former Sodexho North America employees as well as the estimated cost for the closure of certain Sodexho North America offices. Acquisition reserve activity, reflecting certain adjustments made to the preliminary allocation of the purchase price to the fair market value of assets acquired (see Note 3), is detailed below:
BALANCE AS OF BALANCE AS OF AUGUST 28, 1998 ADJUSTMENTS PAYMENTS SEPTEMBER 3, 1999 -------------------- -- ----------------- - ------------- -- ---------------------- ($ in millions) Employee Terminations $10.3 $ 0.3 $ (8.2) $2.4 Relocation of Sodexho Facilities 2.6 (0.8) (1.1) 0.7 Closures 3.1 1.2 (2.4) 1.9 Other Restructuring 1.3 1.3 -- 2.6 -------------------- ----------------- ------------- ---------------------- Total $17.3 $ 2.0 $(11.7) $7.6 ==================== ================= ============= ======================
In addition, integration expenses recorded in the Consolidated Statement of Income during fiscal year 1999 and the Transition Period are detailed below. No restructuring expenses were recorded in the Consolidated Statement of Income during fiscal year 1999.
FISCAL YEAR 34 WEEKS ENDED 1999 AUGUST 28, 1998 ---------------------- --------------------- ($ in millions) Integration: Duplicate Overhead $ 7.2 $ 9.4 MMS Relocation 0.3 1.7 Training Systems 1.1 1.3 Other 7.0 12.0 Restructuring: Employee Terminations -- 2.2 Closures -- 2.1 Other -- 2.4 ---------------------- --------------------- Total $15.6 $31.1 ====================== =====================
-44- 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. -45- 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 $17 million. -46- SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (6) PROPERTY AND EQUIPMENT
1999 AUGUST 28, 1998 1997 ------------------ ------------------ ------------------ ($ in millions) Land $ 1 $ 9 $ 89 Buildings and leasehold improvements 14 20 242 Furniture and equipment 233 217 303 Construction in progress 9 3 129 ------------------ ------------------ ------------------ 257 249 763 Accumulated depreciation and amortization (172) (167) (258) ------------------ ------------------ ------------------ $ 85 $ 82 $505 ================== ================== ==================
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 $1.09 billion of the Company's property and equipment was restated as Discontinued Operations as of the fiscal year ended 1997 (see Notes 1 and 2). (7) INTANGIBLE ASSETS
1999 AUGUST 28, 1998 1997 ------------------ ------------------ ------------------ ($ in millions) Customer relationships $461 $477 $389 Goodwill 375 413 269 Other 23 24 10 ------------------ ------------------ ------------------ 859 914 668 Accumulated amortization (324) (345) (280) ------------------ ------------------ ------------------ $535 $569 $388 ================== ================== ==================
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 $8 million in 1996. -47- SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (8) DEBT
SEPTEMBER 3, 1999 AUGUST 28, 1998 JANUARY 2, 1998 --------------------- --------------------- --------------------- ($ in millions) SHORT-TERM DEBT: Current Portion of Long-Term Debt $ 80 $ 70 $ 23 Senior Secured Revolving Credit Facility 52 25 - Other 1 1 - --------------------- --------------------- --------------------- Total $ 133 $ 96 $ 23 ===================== ===================== ===================== LONG-TERM DEBT: Senior Secured Credit Facility, maturing 2004 averaging 7.13% in 1999 $ 430 $ 500 $ - Senior Guaranteed Credit Facility, due 2005 averaging 6.92% in 1999 620 620 - Unsecured debt: Senior Debt, maturing through 2009 averaging 7.07% in 1999 6 6 725 Commercial Paper, 5.82% in 1997 - - 692 Endowment Deposits (non-interest bearing) - - 91 Other 1 2 24 Capital Lease Obligations 3 4 10 --------------------- --------------------- --------------------- Total $1,060 $1,132 $1,542 Amount Reclassified to Short-Term Debt (80) (70) (23) --------------------- --------------------- --------------------- $ 980 $1,062 $1,519 ===================== ===================== =====================
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. -48- 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 $70 million, respectively, and paid a fixed rate of 5.02% and 5.05%, respectively, while receiving interest based on three-month LIBOR. These agreements matured in fiscal year 1999. The weighted-average rate for the total debt portfolio, including the effect of the interest-rate agreements, was 6.87% at September 3, 1999. These agreements expire between August 2001 and February 2005. Details of these interest rate agreements as of September 3, 1999 are as follows:
YEAR-TO-DATE NOTIONAL WEIGHTED-AVERAGE NET IMPACT PRINCIPAL FAIR INTEREST RATE TO EARNINGS- TERMS BALANCE VALUE* PAID RECEIVED FY 1999 - ------------------------------------------------- ------------- ------------- ------------- ------------- ----------------- ($ in millions) Receive Variable, Pay Fixed, Maturing 5/--8/01 $400 $ 3 5.71% 5.49% $(2) Receive Variable, Pay Fixed, Maturing 8/02 300 4 5.84% 5.49% (2) Receive Variable, Pay Fixed, Maturing 8/05 200 6 5.90% 5.49% (1) ------------- ------------- ------------- ------------- ----------------- $900 $13 5.80% 5.49% $(5) ============= ============= ============= ============= ================= *-- based on the termination cost for these agreements obtained from third party market quotes.
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. -49- 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. -50- 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.
34 WEEKS ENDED AUGUST 28, 1999 1998 1997 1996 --------------- -------------- --------------- --------------- (in millions, except per share amounts) COMPUTATION OF BASIC EARNINGS PER SHARE: Net Income (Loss) from Continuing Operations $ 51 $ (19) $ -- $ 33 Net Income from Discontinued Operations -- 77 335 273 Net Loss from Extraordinary Item -- (44) -- -- --------------- -------------- --------------- --------------- Net Income $ 51 $ 14 $ 335 $ 306 =============== ============== =============== =============== Weighted Average Shares Outstanding 62.1 52.0 31.8 31.9 =============== ============== =============== =============== Basic Earnings Per Share: Continuing Operations $0.82 $(0.36) $ -- $1.03 Discontinued Operations -- 1.48 10.53 8.56 Extraordinary Item -- (0.85) -- -- --------------- -------------- --------------- --------------- BASIC EARNINGS PER SHARE $0.82 $ 0.27 $10.53 $9.59 =============== ============== =============== =============== COMPUTATION OF DILUTED EARNINGS PER SHARE: Diluted Net Income (Loss) from Continuing Operations $ 51 $ (19) $ -- $ 33 Diluted Net Income from Discontinued Operations -- 77 335 273 Diluted Net Loss from Extraordinary Item -- (44) -- -- After-tax Interest Expense on Convertible Subordinated Debt 1 * * * --------------- -------------- --------------- --------------- Diluted Net Income $ 52 $ 14 $ 335 $ 306 =============== ============== =============== =============== Weighted Average Shares Outstanding 62.1 52.0 31.8 31.9 Effect of Dilutive Securities: Employee Stock Option Plan 0.5 * * 1.1 Deferred Stock Incentive Plan 0.1 * * 0.8 Convertible Subordinated Debt 1.2 * * * --------------- -------------- --------------- --------------- Diluted Weighted Average Shares Outstanding 63.9 52.0 31.8 33.8 =============== ============== =============== =============== Diluted Earnings Per Share: Continuing Operations $0.81 $(0.36) $ -- $0.97 Discontinued Operations -- 1.48 10.53 8.08 Extraordinary Item -- (0.85) -- -- --------------- -------------- --------------- --------------- DILUTED EARNINGS PER SHARE $0.81 $ 0.27 $10.53 $9.05 =============== ============== =============== =============== *--The effect of dilutive securities is computed using the treasury stock method and average market prices during the periods. The if-converted method is used for convertible subordinated debt ("debt securities"). For the 34 weeks ended August 28, 1998 and for fiscal 1997, dilutive securities under the employee stock option plan (of 0.6 million and 1.1 million, respectively), the deferred stock incentive plan (of 0.1 million and 0.7 million, respectively) and the debt securities (of 1.2 million for both periods) was excluded due to the loss from continuing operations. Also, debt securities were excluded in fiscal 1996 (of 0.9 million) as they were antidilutive.
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:
34 WEEKS ENDED AUGUST 28, 1999 1998 1997 1996 ------------- ------------- ------------- ------------- Weighted average number of shares (in millions) 1.8 0.6 0.6 0.5 Weighted average exercise price $29 $29 $272 $220 Weighted average remaining life (in years) 9 10 15 15
-51- SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (10) INCOME TAXES The (provision) benefit for income taxes on continuing operations was comprised of the following:
34 WEEKS ENDED AUGUST 28, 1999 1998 1997 1996 ---------------- ----------------- ----------------- ---------------- ($ in millions) Current: - Federal $(36) $19 $12 $(13) - Other (10) -- 1 (6) ---------------- ----------------- ----------------- ---------------- (46) 19 13 (19) ================ ================= ================= ================ Deferred: - Federal 5 (6) 2 2 - Other -- -- -- -- ---------------- ----------------- ----------------- ---------------- 5 (6) 2 2 ---------------- ----------------- ----------------- ---------------- $(41) $13 $15 $(17) ================ ================= ================= ================
A reconciliation of the Federal statutory tax rate to the Company's effective income tax rate follows:
34 WEEKS ENDED AUGUST 28, 1999 1998 1997 1996 ---------------- ----------------- ----------------- ---------------- Federal statutory tax rate (35.0)% 35.0 % 35.0 % (35.0)% State income taxes, net of Federal tax benefit (6.3) (1.3) 6.8 (2.8) Tax credits 1.5 13.7 90.5 8.1 Goodwill amortization (3.9) (6.9) (24.7) (7.6) Other, net (1.1) 0.1 (8.7) 4.1 ---------------- ----------------- ----------------- ---------------- Effective income tax rate (44.8)% 40.6 % 98.9 % (33.2)% ================ ================= ================= ================
The tax effect of significant temporary differences is as follows:
AUGUST 28, 1999 1998 1997 --------------------- --------------------- --------------------- ($ in millions) Self-insurance $ 38 $ 38 $ 37 Employee benefits 28 25 30 Other liabilities 15 26 14 Property and equipment 6 2 3 Intangible assets (54) (63) (29) Other, net 8 4 (7) --------------------- --------------------- --------------------- Net deferred tax assets $ 41 $ 32 $ 48 ===================== ===================== =====================
Total deferred tax assets and liabilities as of September 3, 1999, August 28, 1998 and January 2, 1998, were as follows:
SEPTEMBER 3, 1999 AUGUST 28, 1998 1997 --------------------- --------------------- --------------------- ($ in millions) Deferred tax assets $ 110 $ 104 $ 81 Deferred tax liabilities (69) (72) (33) --------------------- --------------------- --------------------- Net deferred taxes $ 41 $ 32 $ 48 ===================== ===================== =====================
-52- 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 $26 million, respectively, related to the Company's insurance programs. Upon consummation of the Distribution, MI replaced the Company as guarantor or obligor under previous guarantees and commitments related primarily to the lodging segment distributed on March 27, 1998. Summarized below are the Company's future obligations under leases at September 3, 1999:
CAPITAL OPERATING LEASES LEASES ------------------------- -------------------------- ($ in millions) FISCAL YEAR 2000 $0.7 $12.0 2001 0.7 10.2 2002 0.8 8.0 2003 0.8 5.5 2004 0.8 4.5 Thereafter 0.9 10.5 ------------------------- -------------------------- Total minimum lease payments 4.7 $50.7 ========================== Less amount representing interest (1.1) ------------------------- Present value of minimum lease payments $3.6 =========================
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. -53- 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):
34 WEEKS ENDED 1999 AUGUST 28, 1998 1997 ---------------------------- ---------------------------- ---------------------------- WEIGHTED WEIGHTED NUMBER OF WEIGHTED NUMBER OF AVERAGE NUMBER OF AVERAGE OPTIONS AVERAGE OPTIONS EXERCISE OPTIONS EXERCISE (IN EXERCISE (IN MILLIONS) PRICE (IN MILLIONS) PRICE MILLIONS) PRICE -------------- ------------- -------------- ------------- ------------- -------------- Outstanding at beginning of year 5.0 $ 20 3.6 $140 3.5 $112 Granted during the year 0.1 26 1.9 28 0.6 268 Conversion options-Distribution -- -- 3.3 * -- -- Conversion options-Acquisition -- -- 0.4 6 -- -- Terminations-Distribution -- -- (3.3) * -- -- Exercised during the year (0.4) 8 -- -- (0.5) 84 Forfeited during the year (0.1) 24 (0.9) 17 -- -- -------------- ------------- -------------- ------------- ------------- -------------- Outstanding at end of year 4.6 $ 21 5.0 $ 20 3.6 $140 ============== ============= ============== ============= ============= ============== Options exercisable at end of year 1.4 $ 14 0.5 $ 11 2.3 $ 96 ============== ============= ============== ============= ============= ============== *-- exercise price for shares outstanding prior to the Transactions were repriced to reflect the change in the Company's capital structure (including the one-for-four reverse stock split) as well as preserve the financial value of the options to the option holders as of March 27, 1998.
-54- 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:
OUTSTANDING EXERCISABLE --------------------------------------------------------- -------------------------------------- WEIGHTED WEIGHTED WEIGHTED RANGE OF NUMBER OF AVERAGE AVERAGE NUMBER OF AVERAGE EXERCISE OPTIONS REMAINING LIFE EXERCISE OPTIONS EXERCISE PRICES (IN MILLIONS) (IN YEARS) PRICE (IN MILLIONS) PRICE - ------------------------ ------------------- ------------------ ------------------ ------------------ ------------------- $ 2.3 to 10.0 0.5 5 $ 8 0.5 $ 8 10.1 to 15.0 0.5 6 12 0.3 12 15.1 to 20.0 0.9 7 18 0.3 18 20.1 to 25.0 1.0 8 22 0.3 22 25.1 to 31.4 1.7 9 29 -- -- - ------------------------ ------------------- ------------------ ------------------ ------------------ ------------------- $ 2.3 to 31.4 4.6 7 $21 1.4 $14 ======================== =================== ================== ================== ================== ===================
Pro forma compensation cost for the Stock Option Plans, the Deferred Compensation Plan, the Supplemental Executive Stock Option awards and employee purchases, recognized in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation," would reduce the Company's net income as follows:
34 WEEKS ENDED SEPTEMBER 3, 1999 AUGUST 28, 1998 1997 1996 --------------------- --------------------- ------------------ ------------------ ($ in millions, except per share amounts) Net income as reported $51 $14 $335 $306 Pro forma net income $46 $13 $317 $295 Diluted earnings per share as reported $0.81 $0.27 $10.53 $9.05 Pro forma diluted earnings per share $0.72 $0.25 $9.97 $8.73
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:
34 WEEKS ENDED 1999 AUGUST 28, 1998 1997 1996 --------------------- --------------------- -------------------- --------------------- Annual dividends $-- $-- $1.40 $1.28 Expected volatility 44% 40% 24% 25% Estimated forfeitures 35% 35% 13% 13% Risk-free interest rate 6.2% 5.5% 6.2% 6.1% Expected life (in years) 10 10 7 7
-55- SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (13) FAIR VALUE OF FINANCIAL INSTRUMENTS For current assets, current liabilities and notes and other receivables, management believes the carrying amounts are reasonable estimates of their fair values. The fair values of noncurrent financial liabilities are shown below.
1999 AUGUST 28, 1998 1997 --------------------------- --------------------------- --------------------------- CARRYING FAIR CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE AMOUNT VALUE ------------- ------------- ------------- ------------- ------------- ------------- ($ in millions) Long-term debt, convertible subordinated debt and other long-term liabilities $1,010 $981 $1,091 $1,073 $1,908 $1,944
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 $660 million. Valuations for long-term debt, convertible subordinated debt and other long-term liabilities are determined based on quoted market prices or expected future payments discounted at risk adjusted rates. The fair value of commercial paper borrowings is equal to the carrying value. -56- SODEXHO MARRIOTT SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (14) BUSINESS SEGMENTS The Company is the leading provider in North America of outsourced food and facilities management services to businesses, health care facilities, colleges and universities, primary and secondary schools and other clients. The Company has identified six new business segments within these markets: Corporate Services, Health Care, Education, Schools, Canada, and Laundries/Other. Prior to the Distribution, the Company was a diversified hospitality company with operations in two business segments: Lodging, which includes development, ownership, operation and franchising of lodging properties under 10 brand names and development and operation of vacation timesharing resorts; and Contract Services, consisting of the Company's principal business operations after the Distribution, in addition to the senior living communities business and the wholesale food distribution business ("Other Contract Services"). In June 1997, SFAS No. 131 was issued--"Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 requires the reporting of selected-segmented information in quarterly and annual reports. As required in SFAS No. 131, information from operating segments presented has been derived consistent with the Company's methodology in allocating resources and measuring performance after the Distribution (see Note 1). SALES AND OPERATING PROFIT BY BUSINESS SEGMENT:
34 WEEKS ENDED AUGUST 28, 1999 1998 1997 1996 ----------------- ----------------- ---------------- ----------------- ($ in millions) GROSS SALES Corporate Services $1,380 $ 803 $ 930 $ 901 Health Care 1,323 784 1,039 1,027 Education 1,221 598 824 805 Schools 358 199 303 275 Canada 143 80 106 111 Laundries/Other 77 43 55 56 Other Contract Services -- 321 1,769 1,143 ----------------- ----------------- ---------------- ----------------- Contract Services 4,502 2,828 5,026 4,318 Discontinued Operations -- 1,774 7,008 5,854 ----------------- ----------------- ---------------- ----------------- Total Gross Sales $4,502 $4,602 $12,034 $10,172 ----------------- ----------------- ---------------- ----------------- GROSS OPERATING PROFIT Corporate Services $ 91 $ 49 $ 35 $ 30 Health Care 109 49 60 54 Education 73 5 27 24 Schools 20 8 11 8 Canada 6 1 3 2 Laundries/Other 5 2 2 3 Other Contract Services -- 5 19 56 ----------------- ----------------- ---------------- ----------------- Contract Services 304 119 157 177 Discontinued Operations -- 158 569 452 ----------------- ----------------- ---------------- ----------------- Total Gross Operating Profit $ 304 $ 277 $ 726 $ 629 ----------------- ----------------- ---------------- ----------------- Total Net Operating Profit from Continuing Operations (Contract Services) $ 304 $ 119 $ 157 $ 177 Corporate Items, Gain on Investment and Net Interest Expense 212 151 172 127 ----------------- ----------------- ---------------- ----------------- Income (Loss) From Continuing Operations, Before Taxes and Extraordinary Item $ 92 $ (32) $ (15) $ 50 ================= ================= ================ =================
-57- 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:
AUGUST 28, 1999 1998 1997 1996 ----------------- ---------------- ----------------- ---------------- ($ in millions) IDENTIFIABLE ASSETS Corporate Services $ 160 $ * $ * $ * Health Care 193 * * * Education 169 * * * Schools 44 * * * Canada 37 * * * Laundries/Other 23 * * * Corporate 721 * * * ----------------- ---------------- ----------------- ---------------- Contract Services 1,347 1,341 1,669 2,108 Discontinued Operations, Net -- -- 2,902 1,624 Other -- -- 438 448 ----------------- ---------------- ----------------- ---------------- $1,347 $1,341 $5,009 $4,180 ================= ================ ================= ================ CAPITAL EXPENDITURES Corporate Services $ 15 $ * $ * $ * Health Care 11 * * * Education 26 * * * Schools 3 * * * Canada 2 * * * Laundries/Other 2 * * * Corporate 13 * * * ----------------- ---------------- ----------------- ---------------- Contract Services 72 86 264 154 Discontinued Operations -- 58 271 158 Other -- -- 18 14 ----------------- ---------------- ----------------- ---------------- $ 72 $ 144 $ 553 $ 326 ================= ================ ================= ================ DEPRECIATION AND AMORTIZATION Corporate Services $ 11 $ * $ * $ * Health Care 9 * * * Education 18 * * * Schools 2 * * * Canada 2 * * * Laundries/Other 1 * * * Corporate 42 * * * ----------------- ---------------- ----------------- ---------------- Contract Services 85 57 87 91 Discontinued Operations -- 21 89 55 Other -- -- 12 10 ----------------- ---------------- ----------------- ---------------- $ 85 $ 78 $ 188 $ 156 ================= ================ ================= ================ * -- Management has determined that available financial information related to periods prior to March 27, 1998 does not allow for a practical or meaningful presentation of identifiable assets, capital expenditures or depreciation and amortization for its current business segments for the Transition Period and Fiscal Years 1997 and 1996.
-58- SODEXHO MARRIOTT SERVICES, INC. SUPPLEMENTARY DATA HISTORICAL QUARTERLY FINANCIAL DATA - UNAUDITED ($ in millions, except per share amounts)
1999(1) ------------- ------------- ------------- ------------- ------------- FIRST SECOND THIRD FOURTH FISCAL QUARTER QUARTER QUARTER QUARTER YEAR ------------- ------------- ------------- ------------- ------------- (13 WEEKS) (13 WEEKS) (13 WEEKS) (14 WEEKS) (53 WEEKS) Sales $1,209 $1,090 $1,163 $1,040 $4,502 Operating profit before corporate items 101 74 83 46 304 Income (Loss) from continuing operations 29 11 15 (4) 51 Net income $ 29 $ 11 $ 15 $ (4) $ 51 Diluted earnings per share(6) $ 0.45 $ 0.18 $ 0.24 $(0.07) $ 0.81 1998(1) ------------- ------------- ------------- ------------- FIRST 9 WEEKS 13 WEEKS 34 WEEKS QUARTER 5/29/98(2) 8/28/98(2) 8/28/98 ------------- ------------- ------------- ------------- Sales $1,111 $ 752 $ 965 $2,828 Operating profit before corporate items 39 50 30 119 (Loss) Income from continuing operations(3) (11) 9 (17) (19) Discontinued operations, net of income taxes(3) 77 -- -- 77 Extraordinary item, net of income taxes(4) (43) (1) -- (44) Net income $ 23 $ 8 $ (17) $ 14 Diluted earnings per share(6) $ 0.73 $ 0.12 $(0.27) $ 0.27 1997(1) ------------- ------------- ------------- ------------- ------------- FIRST SECOND THIRD FOURTH FISCAL QUARTER QUARTER QUARTER QUARTER(3) YEAR ------------- ------------- ------------- ------------- ------------- (12 WEEKS) (12 WEEKS) (12 WEEKS) (16 WEEKS) (52 WEEKS) Sales $1,154 $1,164 $1,072 $1,636 $5,026 Operating profit before corporate items 41 44 18 54 157 Income (Loss) from continuing operations(3) -- -- -- -- -- Discontinued operations, net of income taxes(3) 77 83 67 108 335 Net income(5) $ 77 $ 83 $ 67 $ 108 $ 335 Diluted earnings per share(6) $ 2.50 $ 2.62 $ 2.12 $ 3.29 $10.53 1 - 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 August 31, thereby creating a 34-week Transition Period. On March 27, 1998, the Company acquired Sodexho North America. The historical data for fiscal year 1997 and prior years does not include the revenue and expenses of the acquired business, see Notes 1 and 3 to the Consolidated Financial Statements. 2 - Combined actual results of MMS and the acquired Sodexho North America after March 27, 1998. 3 - On March 27, 1998, the Company distributed to its shareholders the Lodging, MSLS and MDS divisions as part of the Transactions. For reporting purposes, the Lodging segment is considered Discontinued Operations prior to March 27, 1998. MSLS and MDS are considered part of continuing operations (see Note 1 to the Consolidated Financial Statements). 4 - On March 27, 1998, the Company refinanced its debt as part of the Transactions (see Notes 1 and 8 to the Consolidated Financial Statements), resulting in a $71 million pretax charge from the early extinguishment of debt ($44 million after-tax). 5 - Operating results in the fourth quarter of 1997 include a loss before tax of $22 million ($14 million after tax, or $0.40 per share) on the sale of MMS- UK to Sodexho in connection with the Transactions. 6 - Earnings per share data have been restated to reflect the adoption in 1997 of Statement of Financial Accounting Standards No. 128, "Earnings Per Share." All per share data has been adjusted to reflect a one-for-four reverse stock split effective March 27, 1998.
-59- 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. 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. 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. 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. 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.
NAME AND TITLE AGE BUSINESS EXPERIENCE -------------- --- ------------------- Michel Landel 48 Michel Landel was named President and Chief Executive Officer of President and the Company on May 3, 1999. Upon consummation of the Chief Executive Officer Transactions, Mr. Landel was appointed as the Company's Executive Vice President on June 16, 1998 and was named President, Corporate Services division. Prior to the Transactions, Mr. Landel was appointed President and Chief Executive Officer of Sodexho North America in 1994. Mr. Landel joined Sodexho in 1984 as a Regional Manager of Sodexho Africa. In 1986, he was named President of Sodexho Africa, a position he held until 1989, when he became President and Chief Executive Officer of Sodexho's United States operations. Prior to joining Sodexho, Mr. Landel held positions with Groupe Poliet (Plan General Manager, 1980-1984) and The Chase Manhattan Bank (Financial Analyst and Assistant Treasurer, 1976-1980).
-60- EXECUTIVE OFFICERS, CONTINUED
NAME AND TITLE AGE BUSINESS EXPERIENCE -------------- --- ------------------- Anthony F. Alibrio 55 Anthony F. Alibrio was appointed President, Health Care Services Executive Vice President effective with the Transactions and was also appointed an President, Health Care Services Executive Vice President as of May 3, 1999. Prior to the Transactions, Mr. Alibrio served as President of Health Care Services for the Marriott Management Services division of Marriott International, Inc. since 1990. His career has been focused on serving the health care industry for the past 28 years of his 33-year tenure with Marriott. In the past he has held various operations, sales, and marketing responsibilities including Division Vice President and National Vice President of Sales and Marketing at Marriott. A member of the Healthcare Research and Development Institute and the American Academy of Medical Administrators, Mr. Alibrio also serves as a member of the Board of Directors for the National Committee for Quality Health Care and Health Insights Foundation. William W. Hamman 57 William W. Hamman was appointed President, Education Services Executive Vice President effective with the Transactions and was also appointed an President, Education Services Executive Vice President as of May 3, 1999. Prior to the Transactions, Mr. Hamman served as President of the Marriott Education Services division of Marriott International, Inc. since 1990. He has supported the higher education community for 36 years, holding positions in Marriott Education Services that included Regional Vice President, Area Vice President and Division Vice President. Mr. Hamman is active in the National Association of College and University Business Officers (NACUBO) and Council of Independent Colleges (CIC). He also serves on the Western Illinois University Foundation Board of Trustees. Thomas M. Mulligan 48 Thomas M. Mulligan was appointed to his current position President, Corporate Services effective May 28, 1999. Mr. Mulligan joined Sodexho Services, Inc., a subsidiary of Sodexho Alliance, in 1974 and has served in the Sodexho Education, Corporate Services and Healthcare divisions. Prior to his current appointment, Mr. Mulligan served as head of the New England Corporate Services operations of the Company. Mr. Mulligan supports hunger relief efforts through the Pine Street Inn in Boston and has worked with the Toys for Tots program. James A. Seaton 50 James A. Seaton was appointed to his current position effective President, School Services September 3, 1998. Prior to his current position, Mr. Seaton served as Senior Vice President in the Corporate Services division of the Company. Mr. Seaton joined Marriott International, Inc. in 1972 as a management trainee and advanced through several positions in the Education Services division, serving as a manager of district operations, Regional Vice President and Vice President of Operations. Mr. Seaton also served as Vice President of Grandy's and as Senior Vice President for the Corporate Services division of Marriott Management Services prior to the Transactions.
-61- EXECUTIVE OFFICERS, CONTINUED
NAME AND TITLE AGE BUSINESS EXPERIENCE -------------- --- ------------------- Stephen J. Brady 55 Stephen J. Brady was appointed to his current position effective Senior Vice President, Corporate with the Transactions. Mr. Brady joined Sodexho USA, a division Communications of Sodexho Alliance, in 1989 after a 15-year career in the retail industry. His positions with Sodexho USA were Vice President of Strategic Developments, Vice President of Health Care Operations and Regional Vice President of Education Operations. Most recently he has served as Vice President of Marketing and Communications for Sodexho USA. Mr. Brady serves on the board of FoodChain, the national food rescue network. Randall C. Harris 48 Randall C. Harris was appointed to his current position effective Senior Vice President and Chief Human with the Transactions. Mr. Harris joined Marriott International, Resources Officer Inc. in 1997. Before joining Marriott, Mr. Harris was with Cognizant Corporation, which was formed as a result of the restructuring of Dunn & Bradstreet Corporation. His previous experience includes senior human resources and general management positions with American Express (and the subsequent initial public offering of First Data Corporation) and Sprint Corporation. Lawrence E. Hyatt 45 Lawrence E. Hyatt was appointed to his current position effective Senior Vice President and Chief with the Transactions. Mr. Hyatt served as Senior Vice President Financial Officer of Finance and Planning for the Marriott Management Services division of Marriott International, Inc. since 1988. He joined Marriott Corporation in 1981 and has been Staff Auditor for Corporate Internal Audit, Manager of Financial Analysis for Roy Rogers Restaurants, Director of Finance for Marriott Services Group and Vice President, Operations Planning and Control for the Company. Previously, Mr. Hyatt was an associate in ICF Incorporated and a financial analyst for the US Department of Energy. David R. Smail 60 David R. Smail was appointed to his current position effective Senior Vice President and Chief with the Transactions. Previously, Mr. Smail served as Senior Information Officer Vice President and Chief Information Officer for the Marriott Management Services division of Marriott International, Inc. since 1993. He joined Marriott Corporation in 1981 as Vice President in the Marriott Information Systems Department. From 1985 to 1992, he served as Vice President, Corporate Systems Services, Marriott Corporation. Prior to joining Marriott Corporation, Mr. Smail worked as an Assistant Vice President in the Operations Group, AMTRAK, and spent 14 years at Andersen Consulting. Robert A. Stern 41 Robert A. Stern was appointed to his current position effective Senior Vice President and General Counsel with the Transactions. Previously, Mr. Stern served as Associate General Counsel for Marriott International, Inc. providing legal support to Marriott Management Services. Prior to his appointment to Associate General Counsel, Mr. Stern provided legal support to Marriott Corporation's Restaurant and Travel Plaza businesses. Mr. Stern joined Marriott Corporation in 1985 from the Washington D.C., office of Skadden Arps Slate Meagher & Flom.
-62- EXECUTIVE OFFICERS, CONTINUED
NAME AND TITLE AGE BUSINESS EXPERIENCE -------------- --- ------------------- Philippe Taillet 40 Philippe Taillet was appointed to his current position effective Senior Vice President, August 10, 1999. Prior to his appointment, Mr. Taillet served as Facilities Management Senior Vice President, Strategic Planning for the Company. Prior to the Transactions, Mr. Taillet served as Vice President, Corporate Strategy for Sodexho Alliance since 1995. From 1991 to 1995, he was Director of Facilities Management at Disneyland Paris and from 1986 to 1991 he was a consultant for Bain & Company in Paris and Boston. Mr. Taillet began his career as a software engineer for Schlumberger Oil Field Services in Paris. Anthony J. Wilson 47 Anthony J. Wilson was appointed to his current position effective Senior Vice President, with the Transactions. Previously, Mr. Wilson served as Senior Marketing and Procurement Vice President, Marketing and Product Development for the Marriott Management Services division of Marriott International, Inc. since November 1996. Prior to joining Marriott, Mr. Wilson was Vice President and General Manager in the Global Food Service division of Campbell Soup Company. He also spent 13 years at ARAMARK, where he served as Senior Vice President ARASERVE and President of ARAMARK's Marketing Services Group.
PART IV 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.
EXHIBIT DESCRIPTION INCORPORATION BY REFERENCE (WHERE A REPORT OR ------- ----------- --------------------------------------------- NO. REGISTRATION STATEMENT IS INDICATED BELOW, THAT --- ----------------------------------------------- DOCUMENT HAS BEEN PREVIOUSLY FILED BY THE ----------------------------------------- COMPANY AND THE APPLICABLE EXHIBIT IS ------------------------------------- INCORPORATED BY REFERENCE THERETO) ---------------------------------- 3.1 Amended and Restated Certificate of Exhibit No. 3 (a) to Form 8-K dated April 3, 1998. Incorporation. 3.2 Amended and Restated Bylaws. Exhibit No. 3 (b) to Form 8-K dated April 3, 1998.
-63- 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
EXHIBIT DESCRIPTION INCORPORATION BY REFERENCE (WHERE A REPORT OR ------- ----------- --------------------------------------------- NO. REGISTRATION STATEMENT IS INDICATED BELOW, THAT --- ----------------------------------------------- DOCUMENT HAS BEEN PREVIOUSLY FILED BY THE ----------------------------------------- COMPANY AND THE APPLICABLE EXHIBIT IS ------------------------------------- INCORPORATED BY REFERENCE THERETO) ---------------------------------- 4.1 Certificate of Designation, Preferences and Exhibit No. 4.1 to Form 8-K dated October 25, 1993. Rights of Series A Junior Participating Preferred Stock. 4.2 Rights Agreement with The Bank of New York, as (a) Exhibit No. 4.2 to Form 8-K dated October 25, Rights Agent, as amended. 1993, (b) Exhibit 1 to Form 8--A/A filed on October 15, 1997 (Amendment No. 1) and (c) Amendment No. 2 to Rights Agreement dated as of March 27, 1998 filed by amendment to Form 8-A. 4.3 Indenture with Chemical Bank, as Trustee, as (a) Exhibit Nos. 4(i) and 4(ii) to Form 8-K dated supplemented. December 9, 1993 (original Indenture and First Supplemental Indenture); (b) Exhibit No. 4 (ii) to Form 8-K dated April 19, 1995 (Second Supplemental Indenture); (c) Exhibit No. 4.2 to From 8-K dated June 7, 1995 (Third Supplemental Indenture); (d) Exhibit No. 4.2 to Form 8-K dated December 11, 1995 (Fourth Supplemental Indenture); (e) Exhibit No. 4(a) to Form 8-K/A dated April 27, 1998 (Fifth Supplemental Indenture); (f) Exhibit No. 4(b) to Form 8-K/A dated April 27, 1998 (Sixth Supplemental Indenture); Exhibit No. 4(c) to Form 8-K/A dated April 27, 1998 (Seventh Supplemental Indenture); and Exhibit No. 4(d) to Form 8-K/A dated April 27, 1998 (Eighth Supplemental Indenture). 4.4 Indenture with The Bank of New York, as Trustee, (a) Exhibit No. 4.1 Form 8-K dated March 25, 1996; relating to Liquid Yield Option(TM) Notes, as and (b) Exhibit No. 4.2 to Form 8-K dated March 25, supplemented. 1996 (First Supplemental Indenture). 4.5 Indenture among RHG Finance Corporation, as (a) Exhibit No. 2.02 to Renaissance Hotel Group issuer, Renaissance Hotel Group N.V. and the N.V. Annual Report on Form 20-F for the fiscal year Company, as guarantors, and The First National ended June 30, 1996; and (b) Exhibit No. 4 to Form Bank of Chicago as Trustee, as supplemented. 10-Q for the fiscal quarter ended June 20, 1997 (First and Second Supplemental Indenture). 4.6 Sodexho Marriott Services, Inc. 1993 Exhibit 4(a) to Form 8-K dated April 15, 1998. Comprehensive Stock Incentive Plan. 4.7 Sodexho Marriott Services, Inc. 1998 Exhibit 4(a) to Form 8-K dated April 15, 1998. Comprehensive Stock Incentive Plan. 4.8 Sodexho Savings Plus Plan. Exhibit 4.3 to Form S-8 dated September 17, 1998. 4.9 Sodexho Marriott Services, Inc. 401(k) Employee Exhibit 4.3 to Form S-8 dated September 17, 1998. Retirement Savings Plan.
-64- 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
EXHIBIT DESCRIPTION INCORPORATION BY REFERENCE (WHERE A REPORT OR ------- ----------- --------------------------------------------- NO. REGISTRATION STATEMENT IS INDICATED BELOW, THAT --- ----------------------------------------------- DOCUMENT HAS BEEN PREVIOUSLY FILED BY THE ----------------------------------------- COMPANY AND THE APPLICABLE EXHIBIT IS ------------------------------------- INCORPORATED BY REFERENCE THERETO) ---------------------------------- 4.10 Trust Agreement with Bankers Trust Company, Exhibit 99.1 to Form S-8 dated September 17, 1998. Trustee for the Sodexho Marriott Services, Inc. 401(k) Employee Retirement Savings Plan. 10.1 $1.5 billion Credit Agreement with Citibank, (a) Exhibit No. 10 to Form 10-Q for the fiscal N.A., as Administrative Agent, and certain banks, quarter ended March 28, 1997 (original agreement); as Banks, as amended. (b) Exhibit No. 10.2 to Form 10-K for the fiscal year ended December 29, 1995 (first Amendment); and (c) Exhibit No. 10-1 to Form 10-Q for the fiscal quarter ended September 12, 1997 (Second Amendment). 10.2 Distribution Agreement with Host Marriott, as (a) Exhibit No. 10.3 to Form 8-K dated October 25, amended. 1993; (b) Exhibit No. 10.2 to Form 10-K for the fiscal year ended December 29, 1995 (First Amendment); and (c) Exhibit No. 10.1 to Form 10- Q for the fiscal quarter ended September 12, 1997 (Second Amendment). 10.3 Non Competition Agreement with Host Marriott and (a) Exhibit No. 10.7 to Form 8-K dated October 25, Host Marriott Services Corporation, as amended. 1993; and (b) Exhibit No. 10.4 to Form 10-K for the fiscal year ended December 29, 1995 (Amendment No. 1). 10.4 Employee Benefits and Other Employment Matters Exhibit No. 10.6 to Form 8-K dated October 25, 1993. Allocation Agreement with Host Marriott. 10.5 Agreement and Plan of Merger by and among Exhibit No. (c) (1) to Schedule 14d-1 dated Marriott International, Inc., FGI Acquisition February 23, 1996. Corp. and Forum Group, Inc. 10.6 Acquisition Agreement, dated as of February 17, Exhibit No. 10.1 to Form 8-K dated February 19, 1997, by and between the Company and Renaissance 1997. Hotel Group N.V. 10.7 Shareholder Agreement, dated as of February 17, Exhibit No. 10.2 to Form 8-K dated February 19, 1997, by and between Marriott International, Inc. 1997. and Diamant Hotel Investments N.V. 10.8 Stock Purchase Agreement, dated as of June 21, Exhibit No. 10.2 to Form 10-Q for the fiscal quarter 1997, by and between Host Marriott Corporation ended September 12, 1997. and Marriott Senior Living Services, Inc. 10.9 Distribution Agreement dated as of September 30, Appendix A to Definitive Proxy Statement for a 1997 between the Company and New Marriott MI, Special Meeting of Shareholders commenced on March Inc. 17, 1998 and adjourned on March 20, 1998.
-65- 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
EXHIBIT DESCRIPTION INCORPORATION BY REFERENCE (WHERE A REPORT OR ------- ----------- --------------------------------------------- NO. REGISTRATION STATEMENT IS INDICATED BELOW, THAT --- ----------------------------------------------- DOCUMENT HAS BEEN PREVIOUSLY FILED BY THE ----------------------------------------- COMPANY AND THE APPLICABLE EXHIBIT IS ------------------------------------- INCORPORATED BY REFERENCE THERETO) ---------------------------------- 10.10 Agreement and Plan of Merger dated as of Appendix B to Definitive Proxy Statement for a September 30, 1997 by and among the Company, Special Meeting of Shareholders commenced on March Marriott - ICC Merger Corp., New Marriott MI, 17, 1998 and adjourned on March 20, 1998. Inc., Sodexho Alliance, S.A., and International Catering Corporation. 10.11 Omnibus Restructuring Agreement dated as of Appendix C to Definitive Proxy Statement for a September 30, 1997 by and among the Company, Special Meeting of Shareholders commenced on Marriott - ICC Merger Corp., New Marriott MI, March 17, 1998 and adjourned on March 20, 1998. Inc., Sodexho Alliance, S.A., and International Catering Corporation. 10.12 Amendment Agreement, dated as of January 28, Appendix D to Definitive Proxy Statement for a 1998, by and among the Company, Marriott-ICC Special Meeting of Shareholders commenced on Merger Corp., New Marriott MI, Inc., Sodexho March 17, 1998 and adjourned on March 20, 1998. Alliance, S.A., and International Catering Corporation. 10.13 Employee Benefits and Other Employment Exhibit No. 10.1 to Form 10 of New Marriott MI, Matters Allocation Agreement, dated as of Inc. filed on February 1, 1998. September 30, 1997, by and between the Company and New Marriott MI, Inc. Computation of Ratio of Earnings to Fixed Charges. Subsidiaries of Marriott International, Inc. Consent of Arthur Andersen LLP. Forward-Looking Statements. 10.14 Trademark and Trade Name License Agreement Exhibit No. 10.18 to Form 10-K/A filed on April 15, dated as of March 27, 1998 among the Company, 1998. New Marriott and Marriott Worldwide Corporation. 10.15 Royalty Agreement dated as of March 27, 1998 Exhibit No. 10.19 to Form 10-K/A filed on April between Sodexho Alliance, S.A. and the Company. 15, 1998. 10.16 $620 million Credit Agreement dated as of (a) Exhibit No. 10(a) to Form 8-K/A dated April 27, January 30, 1998 with the Company, as Borrower, 1998; and (b) Exhibit No. 10(c) to Form 8-K/A certain initial lenders, as Initial Lenders, dated April 27, 1998 (Amendment No. 1). Societe Generale and J.P. Morgan Securities Inc. ("J.P. Morgan"), as Arrangers, Societe Generale, as Administrative Agent, and Morgan Guaranty Trust Company of New York ("Morgan"), as Documentation Agent, as amended.
-66- 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
EXHIBIT DESCRIPTION INCORPORATION BY REFERENCE (WHERE A REPORT OR ------- ----------- --------------------------------------------- NO. REGISTRATION STATEMENT IS INDICATED BELOW, THAT --- ----------------------------------------------- DOCUMENT HAS BEEN PREVIOUSLY FILED BY THE ----------------------------------------- COMPANY AND THE APPLICABLE EXHIBIT IS ------------------------------------- INCORPORATED BY REFERENCE THERETO) ---------------------------------- 10.17 $735 million Credit Agreement dated as of (a) Exhibit No. 10(b) to Form 8-K/A dated April 27, January 30, 1998 with Sodexho Marriott 1998 and (b) Exhibit No. 10(d) to Form 8-K/A dated Operations, Inc., as Borrower, the Company, as April 27, 1998 (Amendment No. 1). Parent Guarantor, certain initial lenders, as Initial Lenders, Societe Generale and Morgan, as Initial Issuing Banks, Morgan, as Documentation Agent and Administrative Agent, and Societe Generale and J.P. Morgan, as Arrangers, as amended. 10.18 Stockholder Agreement dated as of March 27, 1998 Exhibit No. 10.22 to Form 10-K/A filed on April 15, with Sodexho Alliance, S.A. 1998. 10.19 Severance agreement with Charles D. O'Dell, Filed herewith. dated as of May 3, 1999. 12 Schedule of Ratio of Earnings to Fixed Charges. Filed herewith. 21 Subsidiaries of Sodexho Marriott Services, Inc. Filed herewith. 23.1 Consent of PricewaterhouseCoopers LLP, Filed herewith. Independent Public Accountants. 23.2 Consent of Arthur Andersen LLP, Filed herewith. Independent Public Accountants. 24 Power of Attorney. Filed herewith. 99 Forward-Looking Statements. Filed herewith.
(B) REPORTS ON FORM 8-K
DATE ITEM REPORTED ---- ------------- September 17, 1998 Announcement of the 1999 Annual Meeting of Stockholders. May 3, 1999 Announcement of the Company's Board of Directors had named Michel Landel as President and Chief Executive Officer and a member of the Board of Directors of the Company. July 29, 1999 Announcement relating to the Company's investor conference held in New York, New York.
-67- 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.
SIGNATURE TITLE DATE - --------- ----- ---- * President and Chief Executive Officer October 29, 1999 - --------------------------- and Director (Principal Michel Landel Executive Officer) /S/ LAWRENCE E. HYATT Senior Vice President and Chief Financial October 29, 1999 - --------------------------- Officer (Principal Financial Officer) Lawrence E. Hyatt /S/ LOTA S. ZOTH Vice President, Corporate Controller and October 29, 1999 - --------------------------- Chief Accounting Officer (Principal Lota S. Zoth Accounting Officer) * Chairman and Director October 29, 1999 - --------------------------- William J. Shaw * Director October 29, 1999 - --------------------------- Daniel J. Altobello * Director October 29, 1999 - --------------------------- Pierre Bellon
-68-
SIGNATURE TITLE DATE - --------- ----- ---- * Director October 29, 1999 - --------------------------- Bernard Carton * Director October 29, 1999 - --------------------------- Doctor R. Crants * Director October 29, 1999 - --------------------------- John W. Marriott III * Director October 29, 1999 - --------------------------- Edouard de Royere
*By: /S/ ROBERT A. STERN ----------------------- Robert A. Stern Attorney- in- fact -69- EX-10.19 2 SEVERANCE AGREEMENT WITH CHARLES D. O'DELL EXHIBIT 10.19 SODEXHO MARRIOTT SERVICES, INC. SEVERANCE AGREEMENT WITH CHARLES D. O'DELL SEVERANCE AGREEMENT This SEVERANCE AGREEMENT (this "Agreement"), dated as of May 3, 1999, is between SODEXHO MARRIOTT SERVICES, INC., a Delaware corporation (the "Company") and CHARLES D. O'DELL ("O'Dell"). WHEREAS, the Company was formed on March 27, 1998 as a result of a series of transactions (the "Transaction") in which the company that was previously known as Marriott International, Inc. ("Old Marriott") completed a distribution of its lodging and other related businesses to its shareholders and the remaining food and facilities management businesses of Old Marriott were combined with the North American operations of Sodexho Alliance, S.A. to form the Company. WHEREAS, in connection with the Transaction, the Company and O'Dell entered into an Employment Agreement dated March 30, 1998 (the "Employment Agreement") under which O'Dell became the President and Chief Executive Officer of the Company. WHEREAS, O'Dell holds 60,922 shares of the Company's common stock, par value $1.00 per share (the "Common Stock") that are subject to Deferred Stock Agreements between O'Dell and the Company (which were initially entered into by Old Marriott or its predecessor, Marriott Corporation), dated as of April 26, 1985, February 6, 1986 and November 2, 1995 (the "Deferred Stock Agreements"). WHEREAS, O'Dell holds 15,231 shares of Common Stock pursuant to the Restricted Stock Agreement between O'Dell and the Company dated October 14, 1993 (the "Restricted Stock Agreement"). WHEREAS, O'Dell holds options to purchase up to an aggregate of 217,778 shares of Common Stock pursuant to the stock option agreements identified on Schedule A hereto (the "Stock Option Agreements"). WHEREAS, O'Dell holds an option to purchase up to 152,266 shares of Common Stock granted pursuant to the "Supplemental Long-Term Incentive Plan" referenced in the March 20, 1997 memorandum from J.W. Marriott, Jr. to O'Dell (the "Supplemental Option"). WHEREAS, in his capacity as President and Chief Executive Officer of the Company, O'Dell is entitled to participate in certain other employee benefit plans and receives certain perquisites and benefits provided by the Company. WHEREAS, O'Dell and the Company jointly and amicably agree that O'Dell shall resign as President and Chief Executive Officer and therefore terminate his employment and service with the Company and its subsidiaries. WHEREAS, O'Dell and the Company desire to set forth the terms and conditions of their joint and amicable agreements regarding the resignation of O'Dell, the termination of O'Dell's employment and service with the Company and its subsidiaries, the terms of their relationship after O'Dell's resignation and the effect of such resignation and termination on the Employment Agreement, the Deferred Stock Agreements, the Restricted Stock Agreement, the Options and the Supplemental Option. NOW, THEREFORE, in consideration of the mutual covenants and obligations hereinafter set forth, the parties hereto agree as follows: 1. Resignation From and Termination of Employment. (a) The Company and O'Dell agree that O'Dell's last day of employment with the Company under the Employment Agreement shall be June 3, 1999 (the "Termination Date"), however, the Company shall retain O'Dell on its payroll for the sole purpose of implementing this Severance Agreement in accordance with the terms hereof. O'Dell resigns immediately from all of his offices and positions with the Company and its subsidiaries including, without limitation, his position as a member of the Board of Directors, President and Chief Executive Officer of the Company. O'Dell shall take no official action in the name and on behalf of the Company or any of its subsidiaries nor have any authority to bind the Company or any of its subsidiaries after the date hereof. O'Dell agrees to execute and deliver to the Company and its subsidiaries such documents concerning such resignation and termination as may be reasonably requested by the Company or any of its subsidiaries from time to time. (b) O'Dell and the Company agree that, notwithstanding anything in the Employment Agreement or any other agreement, oral or written, express or implied, to the contrary, the payments and provisions set forth in this Agreement accurately reflect all of the compensation, benefits and perquisites payable or otherwise to be provided to, or for services of, O'Dell by the Company before, at or after the Termination Date and that O'Dell is not entitled to any compensation, benefits, payments or perquisites from the Company except as set forth in this Agreement. -1- 2. Further Assistance. O'Dell agrees to make himself reasonably available to the Company relating to his prior services as an employee of the Company under the Employment Agreement including, but not limited to, assisting the Company and acting as a witness in connection with any pending or threatened litigation or other legal proceeding with respect to which the Company reasonably determines his participation to be necessary and responding to questions and inquiries with respect to such prior services. Such assistance will be without compensation to O'Dell except for compensation provided herein. However, O'Dell will be reimbursed for any out-of-pocket expenses he incurs in providing such assistance. 3. Payments on Termination. The Company shall continue to retain O'Dell on its payroll for a period of twenty-four (24) months after the Termination Date (the "Benefits Period") for purposes of making certain of the payments and providing certain of the benefits required to be made or provided pursuant to this Agreement. (a) Accrued Salary and Expenses. The Company shall pay to O'Dell his base salary, and shall reimburse his business expenses incurred on behalf of the Company, through the date hereof, in the same manner as the Company has previously made such payments. (b) Base Salary. The Company shall continue to pay to O'Dell his current base salary, less ordinary payroll deductions, from the date hereof through the Benefits Period. (c) Bonus Compensation. Promptly after the Termination Date, the Company shall pay to O'Dell a pro-rata portion his target bonus for 1999, which amount shall be equal to $365,750 multiplied by a fraction, the numerator of which shall be the number of calendar days constituting the period from the first day of the Company's fiscal year 1999 through the day prior to the Termination Date, inclusive, and the denominator of which shall be 371 (representing the number of calendar days in such fiscal year). (d) Vacation and Sick Days. Promptly after the Termination Date, the Company shall pay to O'Dell (1) a pro rata portion of his current base salary for any accrued and unused, and vested vacation days through the Termination Date and (2) in lieu of payment for sick and personal days, O'Dell's current base salary for ten work days. (e) Severance Payments. The Company shall pay to O'Dell an aggregate cash amount of $1,000,000, less any applicable payroll deductions, in two installments of $500,000 each on the first and second anniversaries of the Termination Date. 4. Effect on Employment Agreement. Except as otherwise provided in this paragraph, the Employment Agreement shall be terminated as of the date hereof and shall be of no further force or effect. (a) The Company and O'Dell each hereby waive the provisions of Section 3(d) of the Employment Agreement. (b) Sections 5(a), 5(d), 5(g), 5(h), 5(i), 5(j), 5(k) and 5(l) of the Employment Agreement shall remain in full force and effect until the expiration of the Benefits Period and are incorporated herein by reference. (c) Section 5(e) of the Employment Agreement shall remain in full force and effect until the expiration of the Benefits Period and is incorporated herein by reference, except that the second sentence thereof is hereby amended to read in its entirety as follows: "Competition with the business of SMS shall include (i) any business which provides competitive products or services or (ii) which provides internal services within their organization which substitute for, replace or otherwise compete with the services or products supplied by SMS, provided that O'Dell is involved in the provision of such internal services, but shall not include (a) any retail restaurant business or any business involving the sale of food and/or food supplies which retail restaurant or food and/or food supply business does not have as a significant portion of its business the provision of products or services to health care, educational, governmental, corporate, or other similar facilities or institutional accounts; (b) financial services businesses, benefits administration businesses, or employment services businesses (such as Manpower); or (c) food or supply manufacturers or wholesalers (without regard to who their customers are), provided that the amount of business that such manufacturer or wholesaler does with health care, educational, governmental, corporate or other similar institutional food service accounts is not significant." (d) Section 5(f) of the Employment Agreement shall remain in full force and effect until the expiration of the Benefits Period and is incorporated herein by reference, except that the second sentence thereof is hereby amended to read in its entirety as follows: "Therefore, prior to the expiration of the Benefits Period (as such term is defined in the Severance Agreement between the Executive and SMS dated as of May 3, 1999), Executive agrees not to directly or indirectly, either for himself or for any other person, firm or corporation, knowingly call on or solicit, or attempt to call on or solicit, any of SMS's customers for the purpose of offering or providing any product or service that would be deemed to compete with or to be similar to SMS's products or services under the standards set forth in Section 5(e) of this Agreement." -2- 5. Effect on Options. (a) The Supplemental Option and all rights and benefits of O'Dell thereunder shall be terminated and canceled as of the Termination Date and thereafter shall be of no further force or effect. (b) The Stock Option Agreements and all rights and benefits of O'Dell thereunder shall remain in full force and effect, and the options granted thereby (the "Options") shall continue to vest in accordance with the terms of the Stock Option Agreements, until the expiration of the Benefits Period as if O'Dell's employment by the Company had not terminated. All Options that are vested as of the last day of the Benefits Period shall continue to be exercisable through the original term of the applicable Stock Option Agreement, as if O'Dell's employment by the Company had not terminated. Options that are not vested as of the last day of the Benefits Period shall be canceled and shall be of no further force or effect as of such date. (c) Upon O'Dell's request from time to time, the Company will make all reasonable efforts to permit O'Dell to exercise his Options through broker-assisted cashless exercises. To effect a cashless exercise, the written notice of exercise shall direct that the Common Stock certificate or certificates for the shares for which the Option is exercised be delivered to a specified licensed broker acceptable to the Company, as O'Dell's agent, and, at the time the Common Stock certificate or certificates are delivered, the broker tenders to the Company cash (or cash equivalents acceptable to the Company) equal to the exercise price of the Option plus the amounts, if any, of federal and/or other taxes which the Company may be required to withhold with respect to the exercise of the Option, which may be satisfied as provided in Section 9 of this Agreement. 6. Effect on Deferred Stock Agreements. The parties hereby agree as follows, and the Deferred Stock Agreements shall be deemed amended to the extent necessary to reflect such agreement: (a) The Deferred Stock Agreements and all rights and benefits of O'Dell thereunder shall remain in full force and effect, and the stock awards granted thereunder shall continue to vest in accordance with the terms of the Deferred Stock Agreements as if O'Dell's employment had not been terminated, until the expiration of the Benefits Period. (b) All shares of Common Stock that are vested under the Deferred Stock Agreements on the last day of the Benefits Period shall be distributed to O'Dell on such date. All shares of Common Stock that have not vested as of the last day of the Benefits Period shall be forfeited. Upon the expiration of the Benefits Period and distribution of the Common Stock as provided in the first sentence of this section, the Deferred Stock Agreements shall be of no further force or effect. 7. Effect on Restricted Stock Agreement. The parties hereby agree as follows, and the Restricted Stock Agreement shall be deemed amended to the extent necessary to reflect such agreement: (a) The Restricted Stock Agreement and all rights and benefits of O'Dell thereunder shall remain in full force and effect, and installments of shares shall continue to be released thereunder in accordance with the terms of the Restricted Stock Agreement as if O'Dell's employment had not been terminated and as if all performance objectives had been satisfied, until the expiration of the Benefits Period. (b) All Shares of Common Stock that are vested under the Restricted Stock Agreement on the last day of the Benefits Period shall be delivered to O'Dell on such date. All shares of Common Stock that have not vested as of the last day of the Benefits Period shall be forfeited, and thereafter the Restricted Stock Agreement shall be of no further force or effect. 8. Host Marriott Corporation Deferred Stock Agreement(s) and Deferred Stock Bonus Plan. The parties agree to request in good faith that Host Marriott Corporation ("HMC") distribute to O'Dell immediately upon expiration of the Benefits Period (a) all securities that are vested under the Deferred Stock Agreement(s) between HMC and O'Dell as of the last day of the Benefits Period and (b) all securities to which O'Dell is then entitled under the HMC Deferred Stock Bonus Plan, as, for both (a) and (b) above, a retiree with twenty (20) years of service. 9. Tax Withholding. The Company may deduct or withhold, or require O'Dell to remit to the Company, the amount necessary to satisfy the Company's obligation to withhold federal, state or other taxes incurred upon O'Dell's exercise of an Option or upon the distribution or delivery to O'Dell of shares of Common Stock under the Deferred Stock Agreements or the Restricted Stock Agreement. The Company shall be entitled to withhold such amounts from any compensation or other payments then or thereafter payable to O'Dell. In addition, O'Dell may elect to satisfy the tax withholding requirement, in whole or in part, by having the Company withhold shares of Common Stock otherwise issuable to him having a fair market value on the date the tax is to be determined equal to the minimum statutory total tax which could be imposed in connection with the transaction. For this purpose, the Common Stock shall be deemed to have a fair market value per share equal to the closing price of the Common Stock on the New York Stock Exchange or such other primary market in which the Common Stock is then traded, as of the date on which the tax is to be determined. -3- 10. Termination-Related Expenses. (a) The Company will pay for or reimburse O'Dell for the following termination-related expenses to the extent that such expenses are (i) incurred prior to the earlier of 18 months following execution of this Agreement and the commencement of O'Dell's employment as an executive by another employer and (ii) evidenced by appropriate invoices or receipts: (i) fees and expenses of an outplacement service; (ii) reasonable costs of travel to job interviews, or travel otherwise reasonably related to pursuit of employment; and (iii) cost of reasonable and customary office supplies. (b) During the period referred to in Section 10(a) hereof, the Company will provide O'Dell with a reasonably furnished office in a shared executive suite or similar arrangement, with commensurate secretarial and switchboard support, or pay for the cost of O'Dell's use of such office space and support. (c) Four months after the date of this Agreement, O'Dell and the Company will discuss in good faith fixing a monthly amount to be paid in lieu of actual cost reimbursements for the items in Sections 10(a)(i), 10(a)(iii) and 10(b). (d) The Company will pay the reasonable attorneys' fees and expenses incurred by O'Dell in connection with the negotiation and execution of this Agreement upon receipt of an invoice therefor. 11. Certain Employee Benefit Plans and Agreements. (a) Until the expiration of the Benefits Period (or, if earlier, until O'Dell becomes employed by another employer), O'Dell shall be entitled to participate fully in the Company's 401(k) Plan in accordance with its terms and shall be eligible for matching contributions by the Company in accordance with the provisions of the Plan, to the same extent as other executives of the Company. (b) Vested amounts accrued to O'Dell's account under deferred compensation plans of the Company shall be distributed to O'Dell following the expiration of the Benefits Period, in accordance with O'Dell's elections and in accordance with the terms of such plans. (c) Until the expiration of the Benefits Period, the Company shall continue to make available to O'Dell coverage under the Company's health and dental insurance plans on the same terms as such benefits are made available to other executives of the Company. (d) After the expiration of the Benefits Period, O'Dell shall have the option to convert and continue his health and dental insurance coverage, at his sole expense and at then current rates for a period not to exceed 24 months after the expiration of the Benefits Period in accordance with the rules and procedures of the Consolidated Omnibus Budget Reconciliation Act of 1985 ("COBRA"). (e) Any coverage under disability or accidental death and dismemberment insurance plans currently provided to O'Dell by the Company shall discontinue on the Termination Date. 12. Certain Perquisites. (a) The Company shall pay O'Dell $7,500 on the Termination Date and $7,500 on the first anniversary of the Termination Date in lieu of the current $7,500 executive allowance program. (b) Any coverage under business travel life insurance plans currently provided to O'Dell by the Company shall discontinue on the Termination Date. (c) The Company shall reimburse O'Dell for costs incurred by O'Dell in connection with travel to one board meeting of the National Restaurant Association and one board meeting of Second Harvest, provided in each case that such meeting occurs in May 1999. The Company shall reimburse O'Dell for costs incurred by O'Dell or his spouse in connection with his spouse's travel to one of these meetings. (d) O'Dell's car allowance shall continue until the expiration of the Benefits Period on the same terms that are in effect at the time of this Agreement. (e) The Company shall, prior to, on or promptly after the Termination Date, transfer to O'Dell ownership and possession of O'Dell's office computer. (f) O'Dell shall remain eligible to participate in the Marriott/Sodexho Marriott umbrella plan for cellular phones to the same extent and on the same terms as other executives of the Company. -4- 13. Releases. (a) O'Dell, on behalf of himself and his heirs, executors, administrators, successors and assigns, forever releases and discharges the Company, Marriott International, Inc., Host Marriott Corporation and Sodexho Alliance, S.A., and their respective agents, officers, employees, directors, stockholders and affiliates, and the respective successors and assigns of each of the foregoing persons and entities, from and against any and all claims, damages, lawsuits, actions, causes of action, and liabilities whatsoever, whether known or unknown, absolute or contingent, accrued or unaccrued, including but not limited to, all claims arising from or in any way connected with O'Dell's employment by the Company and the termination of O'Dell's employment with the Company, but excluding any claims, damages or liabilities associated with any breach by any of the foregoing parties after the date hereof of the terms of this Agreement or any agreement referred to herein to the extent that such agreement remains in effect after the date hereof. This release includes, but is not limited to, rights or claims arising under Title VII of the Civil Rights Act of 1964, as amended, the Employee Retirement Income Security Act of 1974, as amended, the Americans with Disabilities Act and any other federal, state or local statutes or common-law rights of action prohibiting employment discrimination based on sex, race, color, national origin, religion, handicap or veteran status or otherwise concerning O'Dell's employment. O'Dell also agrees not to sue or otherwise institute or cause to be instituted or in any way voluntarily participate in the prosecution of any complaints or charges against any person or entity released herein in any federal, state, District of Columbia or other court, administrative agency or other forum concerning any claims released herein. Notwithstanding anything to the contrary contained in this Agreement, if O'Dell is a party or is added or joined as a party to any suit or proceeding, whether civil, criminal, administrative or investigative by reason of any acts or omission prior to the date of this Agreement, or by reason of the fact that he was a director, officer, employee, or agent of the Company at any time prior to the date of this Agreement, the indemnification and insurance provisions contained in the Company's By-Laws (as such By-Laws consist as of the Termination Date) shall continue to apply to O'Dell, and O'Dell does not release any claims with respect to such indemnification. If O'Dell is sued or made a party to a suit or proceeding by a bona fide third party by reason of any acts or omission related to the Company prior to the date of this Agreement, or by reason of the fact that he was a director, officer, employee, or agent of the Company at any time prior to the date of this Agreement, then notwithstanding the provisions of this paragraph, O'Dell will not be prevented from taking any action in connection with such suit or proceeding with respect to any person otherwise released. O'Dell's release contained in this Section as to Sodexho Alliance, S.A., Marriott International, Inc., and Host Marriott Corporation shall be conditional upon O'Dell's receipt of a release, respectively, from each of those companies in a form consistent with Section 13(c) of this Agreement. (b) O'Dell acknowledges that he has carefully read this Agreement which includes the release set forth in Section 13(a) (the "Release of Claims") and fully understands all of its terms. O'Dell is signing this Agreement voluntarily and with full knowledge of its significance and acknowledges that he has not relied upon any representation or statement, written or oral, not set forth in this Agreement. (c) The Company, on behalf itself and its subsidiaries and their respective successors and assigns, forever releases and discharges O'Dell from and against any and all claims, damages, lawsuits, actions, causes of action, and liabilities whatsoever, whether known or unknown, absolute or contingent, accrued or unaccrued, including but not limited to all claims arising from or in any way connected with O'Dell's employment by the Company and any subsidiary of the Company and the termination of O'Dell's employment with the Company, but excluding any claims, damages or liabilities associated with any breach by O'Dell after the date hereof of the terms of this Agreement or any agreement referred to herein to the extent that such agreement remains in effect after the date hereof. The Company also agrees not to sue or otherwise institute or cause to be instituted or in any way voluntarily participate in the prosecution of any complaints or charges against O'Dell in any federal, state, District of Columbia or other court, administrative agency or other forum concerning any claims released herein. 14. Injunctive Relief. O'Dell acknowledges and agrees that the compensation, benefits and other entitlements provided to him under this Agreement are adequate consideration for Section 4. O'Dell acknowledges and warrants that he will be fully able to earn an adequate livelihood for himself and his dependents if Section 4 should be specifically enforced against him. O'Dell also acknowledges that the restrictions contained in Section 4 are reasonable and necessary to protect the business and interests of the Company, the Company has relied and is relying upon the enforceability of such restrictions in entering into this Agreement, and any violation of these restrictions will cause substantial irreparable injury to the Company. Therefore, O'Dell agrees that the Company is entitled, in addition to other remedies, to preliminary and permanent injunctive relief to secure specific performance, and to prevent a breach or contemplated breach, of Section 4. The restrictions set forth in Section 4 shall be construed as independent covenants, and the existence of any claim or cause of action against the Company, whether predicated upon this Agreement or otherwise, shall not constitute a defense to the enforcement by the Company of the restrictions contained in Section 4. O'Dell hereby consents to the jurisdiction over his person of any courts within the State of Maryland with respect to any proceedings in law or in equity arising out of this Agreement. If any court of competent jurisdiction shall hold that the restrictions contained in Section 4 are unreasonable as to time or geographical area, said restrictions shall be deemed to be reduced to the extent necessary in the opinion of such court to make them reasonable. -5- 15. No Disparagement. O'Dell agrees not to disparage the reputation of the Company or Sodexho Alliance, S.A., any subsidiary or affiliate of either entity, or any and all of the officers, directors, employees, agents or affiliates of any of the foregoing, and will take no steps and make no statements detrimental to the reputation or interests of any such person or entity, or those associated with any such person or entity; provided, however, that O'Dell may make any statements about the foregoing that he is required to make by law. The Company agrees not to disparage the reputation of O'Dell, and not to take any steps or make any statements detrimental to the reputation or interests of O'Dell; provided, however, that the Company may make any statements about O'Dell that it may be required to make by law. 16. Nondisclosure of this Agreement. The parties hereto agree that they will keep the terms, amounts and facts of this Agreement completely confidential, and will not hereafter disclose any information concerning this Agreement to anyone except their respective attorneys or accountants, including, but not limited to, any past, present, or prospective employees of the Company or any of its parent, subsidiary or related companies or entities, except, in each case, as may be required by law or as permitted in writing by the Company and O'Dell or as may be necessary in furtherance of the agreements hereunder. O'Dell will not, directly or indirectly, discuss the circumstances of his termination with any client or customer of the Company, any securities analyst, securities broker, or any agent or representative of any of the foregoing, and will direct all inquiries to the investor relations staff of the Company. 17. Cooperation With Legal Process. O'Dell agrees that if he receives a subpoena or is otherwise required by law to provide information to a governmental entity or other person concerning the activities of the Company or his activities in connection with the Company's business, he will immediately notify the General Counsel of the Company of such subpoena or requirement and deliver to the General Counsel of the Company a copy of such subpoena or other notice, unless such disclosure would in the opinion of a recognized legal expert on such matters, be prohibited by law. 18. Payments and Stock Distributions in the Event of Death. In the event of O'Dell's death, any payments or stock distributions otherwise payable to him under this Agreement shall be paid to the legal representative(s) of his estate. 19. No Assignments. This Agreement is personal to each of the parties hereto. Neither party may assign or delegate any rights or obligations hereunder (other than by operation of law) without first obtaining the written consent of the other party hereto. However, in the event of the death of O'Dell all rights to receive payments hereunder shall become rights of O'Dell's estate. 20. Amendment; Modification; Waiver. No amendments or additions to this Agreement shall be binding unless in writing and signed by both of the parties hereto. No delay or failure at any time on the part of the Company or O'Dell in exercising any right, power or privilege under this Agreement, or in enforcing any provision of this Agreement, shall impair any such right, power, or privilege, or be construed as a waiver of any default or as any acquiescence therein, or shall affect the right of such party thereafter to enforce each and every provision of this Agreement in accordance with its terms. 21. Section Headings. The section headings used in this Agreement are included solely for convenience and shall not affect, or be used in connection with, the interpretation of this Agreement. 22. Severability. The provisions of this Agreement shall be deemed severable, and the invalidity or unenforceability of any provision shall not affect the validity or enforceability of the other provisions hereof. 23. Notices. For purposes of this Agreement, notices and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when hand delivered, sent by overnight courier, or mailed by first-class, registered or certified mail, return receipt requested, postage prepaid, or transmitted by telegram, telecopy or telex, addressed as follows: If to the Company: Sodexho Marriott Services, Inc. 9801 Washingtonian Boulevard Gaithersburg, Maryland 20878 Telecopy No.: (301) 987-4499 Attention: General Counsel If to O'Dell: Charles D. O'Dell 10803 Cripplegate Road Potomac, Maryland 20854 Telecopy No.: (301) 983-1296 -6- with a copy (which shall not constitute notice) to: Bruce S. Mendelsohn, Esq. Akin, Gump, Strauss, Hauer & Feld, L.L.P. 1333 New Hampshire Avenue, N.W., Suite 400 Washington, District of Columbia 20036 or to such other address as either party may have furnished to the other in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt. 24. Entire Agreement. This Agreement constitutes the entire agreement between the parties hereto, and supersedes all prior oral or written agreements, commitments or understandings, including the Employment Agreement, with respect to the matters provided for herein, except as otherwise specifically provided herein. 25. Further Assurance. Each party hereto agrees that, at any time, and from time to time, such party shall execute and deliver such further documents as the other party hereto may reasonably request to effect fully the purposes of this Agreement. 26. Consent to Jurisdiction. All judicial proceedings brought against the Company arising out of or relating to this Agreement must be brought in a state or federal court of competent jurisdiction in the State of Maryland. By execution and delivery of this Agreement the parties accept for themselves, respectively, and in connection with their properties, generally and unconditionally, the exclusive jurisdiction of the aforesaid courts and waive any defense of forum non conveniens and irrevocably agree to be bound by any judgment rendered thereby in connection with this Agreement, in each respect to the maximum extent permitted by law. 27. Enforceability Representation. Each party to this Agreement represents that this Agreement constitutes the legally valid and binding obligation of such party, enforceable against such party in accordance with its terms, except as may be limited by bankruptcy, insolvency, reorganization, moratorium or similar laws relating to or affecting creditors' rights generally (including, without limitation, fraudulent conveyance laws) and by general principles of equity, including without limitation, concepts of materiality, reasonableness, good faith and fair dealing and the possible unavailability of specific performance or injunctive relief, regardless of whether considered in a proceeding in equity or at law. 28. Consents. Each of the parties further represents that it is not required to submit any notice, report or other filing to or obtain any consent or approval from any governmental authority or third party under any agreement to which the party is a party or under any law to which it is subject in order to execute, deliver and perform this Agreement as contemplated hereby. 29. Attorney's Fees. In the event of any action by any party arising under or out of, in connection with or in respect of this Agreement, including any participation in bankruptcy proceedings to enforce against a party a right or claim in such proceedings, the prevailing party shall be entitled to reasonable costs, expenses and attorneys' fees incurred in such action. Attorneys' fees incurred in enforcing any judgment in respect of this Agreement are recoverable as a separate item. The parties intend that the preceding sentence be severable from the other provisions of this Agreement, survive any judgment and, to the maximum extent permitted by law, not be deemed merged into such judgment. 30. Interpretation. Each party hereto hereby acknowledges that: (a) it or he was represented by counsel and had an opportunity to participate equally in the drafting and negotiations of this Agreement; (b) such negotiations were extensive and have been conducted on an arm's length basis; (c) O'Dell is sophisticated and has substantial experience in business, financial and legal matters; and (d) there are no circumstances surrounding the drafting or negotiations of this Agreement and no other reason that would or should require a court construing this Agreement to construe it more strictly or stringently against one party than against the other party. 31. Governing Law. This Agreement shall be governed by the laws of the State of Maryland, excluding the choice of law rules thereof. 32. Counterparts. This Agreement may be executed in counterparts, each of which shall be deemed to be an original, but each of which taken together shall constitute one and the same instrument. -7- IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed and delivered in their names and on their behalf as of the date first above written. SODEXHO MARRIOTT SERVICES, INC. By: /S/ ROBERT A. STERN ------------------------------------------- Name: ROBERT A. STERN ------------------------------------------- Title: SENIOR VICE PRESIDENT--GEN. COUNSEl ------------------------------------------- Date of Execution: May 3, 1999 /S/ CHARLES D. O'DELL ------------------------------------------------- CHARLES D. O'DELL Date of Execution: May 3, 1999 -8- SCHEDULE A DATE OF OPTION AGREEMENT NUMBER OF SHARES SUBJECT TO OPTION AT MAY 3, 1999 - ------------------------ ------------------------------------------------- June 8, 1998 85,000 November 6,1997 46,583 November 7, 1996 34,265 November 2, 1995 31,066 November 3, 1994 20,864 -9- EX-12 3 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES EXHIBIT 12
SODEXHO MARRIOTT SERVICES, INC. COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES ($ in millions) FISCAL YEAR 34 WEEKS FISCAL YEAR ENDED ----------------------------------------- 1999 AUGUST 28, 1998 1997 1996 1995 1994 -------------- ------------------- --------- ---------- --------- ---------- Income Before Extraordinary Item $ 51 $ 58 $335 $306 $247 $200 Add / (Deduct): Tax and Extraordinary Item 41 42 219 196 165 142 Fixed Charges 88 65 179 142 107 84 Interest Capitalized as Property and Equipment -- -- (16) (9) (8) (4) (Income) / Loss Related to certain 50%-or-Less- Owned-Affiliates -- -- -- 1 -- (2) -------------- ------------------- --------- ---------- --------- ---------- Earnings Available For Fixed Charges $180 $165 $717 $636 $511 $420 ============== =================== ========= ========== ========= ========== Fixed Charges: Interest Including Amounts Capitalized as Property and Equipment $ 88 $ 65 $126 $ 94 $ 61 $ 36 Portion of Rental Expense Representative of Interest -- -- 53 48 45 45 Share of Interest Expense of certain 50%-or-Less- Owned-Affiliates -- -- -- -- 1 3 -------------- ------------------- --------- ---------- --------- ---------- Total Fixed Charges $ 88 $ 65 $179 $142 $107 $ 84 ============== =================== ========= ========== ========= ========== Ratio of Earnings to Fixed Charges 2.0 2.5 4.0 4.5 4.8 5.0 ============== =================== ========= ========== ========= ========== For the purpose of computing the ratio of earnings to fixed charges as prescribed by the rules and regulations of the Commission, earnings represent income before cumulative effect of a change in accounting principle and extraordinary item, plus, when applicable, (a) taxes on such income, (b) fixed charges, and (c) the Company's equity interest in losses of certain 50%-or-less-owned-affiliates; less (x) undistributed earnings of 50%-or-less-owned-affiliates, and (y) interest capitalized. Fixed charges represent interest (including amounts capitalized), representative of interest, and when applicable, the Company's share of the interest expense of certain 50%-or-less-owned-affiliates.
EX-21 4 SUBSIDIARIES OF REGISTRANT EXHIBIT 21 9/3/1999 SODEXHO MARRIOTT SERVICES, INC. PAGE NUMBER : 1 DOMESTIC SUBSIDIARIES STATE INCORPORATION 10-K REPORT State: Alabama Marcorp, Inc. State: California Sodexho Management Corp. Saga Health Care Dietary Management Services, Inc. Saga Education Food Services, Inc. LunchStop, Inc. Servo Foods, Inc. State: Connecticut Sodexho Services, Inc. State: Delaware Sodexho Marriott Services, Inc. Sodexho Marriott Operations, Inc. Sodexho Marriott Laundry Services, Inc. Sodexho Marriott Education Services, Inc. SMS Services of California, Inc. SMO Finance Corp. International Catering Corporation Gardner Merchant Holdings, Inc. Corporate Food Services, Inc. Sodexho Marriott Services of Indiana Limited Partnership SDH I, Inc. SDH II, Inc. SDH III, Inc. SDH IV, Inc. State: Massachusetts Sodexho USA, Inc. International Catering Corp. of Massachusetts State: New Jersey SMS Electrical, Inc. dba SMS Electrical and Plumbing State: New York Sodexho Marriott Management, Inc. Service Systems Corporation State: Texas Premier Hospitality, Inc. Premier Hospitality Club, Inc. Sodexho Marriott Services of Texas Limited Partnership State: Vermont Sodexho Vermont, Inc. 9/3/1999 SODEXHO MARRIOTT SERVICES, INC. PAGE NUMBER : 2 FOREIGN SUBSIDIARIES CORPS. WITHIN COUNTRY 10-K LIST Country: Canada, Ontario Sodexho MS Canada, Ltd. dba Sodexho Marriott Services Canada Ontrak Services, Inc. Country: Canada, Quebec Sodexho Marriott Quebec Ltee Sodexho Financiere du Canada, Inc. Sodexho Canada, Inc. dba Sodexho Services Canada Luc, Inc. EX-23.1 5 CONSENT OF INDEPENDENT ACCOUNTANTS Exhibit 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 333-63863, No. 333-63861, No. 33-66624, No. 33-85420 and No. 333-00404) of Sodexho Marriott Services, Inc. of our report dated October 8, 1999 relating to the financial statements, which appears on page 32 of this Annual Report on Form 10-K. /s/PRICEWATERHOUSECOOPERS LLP Washington, D.C. October 27, 1999 EX-23.2 6 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS Exhibit 23.2 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report, dated February 3, 1998 (except with respect to the matters discussed in Notes 2 and 14 of the Company's financial statements, as to which the date is October 7, 1998), included in this Form 10-K, into the Company's previously filed Registration Statements Files No. 33-66624, No. 33-85420, No. 333-00404, No. 333-63863,and No. 333-63861. /s/ARTHUR ANDERSEN LLP Vienna, VA October 27, 1999 EX-24 7 POWER OF ATTORNEY Exhibit 24 POWER OF ATTORNEY We the undersigned directors of Sodexho Marriott Services, Inc. (the "Corporation"), do hereby constitute and appoint Robert A. Stern and Joan Rector McGlockton, or either or both of them, with full power of substitution, our true and lawful attorneys-in-fact and agents, to do any and all acts and things in our names and our behalf in our capacities as directors for the purpose of executing and filing on behalf of the Corporation, a Form 10-K for the fiscal year ended September 3, 1999, including any exhibits thereto and any and all amendments thereto; and we hereby ratify and confirm all that said attorneys and agents shall do or cause to be one by virtue thereof. IN WITNESS WHEREOF, each of the undersigned has executed and delivered this Power of Attorney on and as of October 13, 1999. /s/ WILLIAM J. SHAW /s/ PIERRE BELLON - ------------------------------------------------ ----------------------------------------------- William J. Shaw, Director Pierre Bellon, Director /s/ BERNARD CARTON /s/ EDOUARD DE ROYERE - ------------------------------------------------ ----------------------------------------------- Bernard Carton, Director Edouard de Royere, Director /s/ JOHN W. MARRIOTT, III /s/ DOCTOR R. CRANTS - ------------------------------------------------ ----------------------------------------------- John W. Marriott, III, Director Doctor R. Crants, Director /s/ DANIEL J. ALTOBELLO /s/ MICHEL LANDEL - ------------------------------------------------ ----------------------------------------------- Daniel J. Altobello, Director Michel Landel, Director
EX-27 8 FINANCIAL DATA SCHEDULE
5 FINANCIAL DATA SCHEDULE FOR SODEXHO MARRIOTT SERVICES, INC. THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE COMPANY'S FISCAL YEAR ENDED SEPTEMBER 3, 1999 CONSOLIDATED STATEMENT OF INCOME AND THE CONSOLIDATED BALANCE SHEET AS OF SEPTEMBER 3, 1999 FROM THE COMPANY'S FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000,000 YEAR OTHER YEAR SEP-03-1999 AUG-28-1998 JAN-02-1998 AUG-29-1999 JAN-03-1998 JAN-04-1997 SEP-03-1999 AUG-28-1998 JAN-02-1998 48 79 139 0 10 9 445 374 487 21 17 12 60 54 116 642 605 914 257 249 763 172 167 258 1,347 1,341 5,009 718 695 1,149 1,010 1,091 1,829 0 0 0 0 0 0 62 62 32 (556) (617) 1,431 1,347 1,341 5,009 4,502 2,828 5,026 4,502 2,828 5,026 4,198 2,709 4,847 4,198 2,709 4,869 133 97 94 0 0 0 88 65 110 92 (32) (15) 41 13 15 51 (19) 0 0 77 335 0 (44) 0 0 0 0 51 14 335 0.82 0.27 10.53 0.81 0.27 10.53 On April 15, 1998, the Board of Directors of the Company approved the change of the fiscal year of the Company to the Friday nearest to August 31 of each year. Prior to this change in fiscal year, the Company's fiscal year ended on the Friday nearest to December 31 of each year. Thus, the 1998 fiscal year, which began on January 3, 1998, ended on August 28, 1998, and the 1999 fiscal year began on August 29, 1998 and ended on September 3, 1999 and was a 53-week period.
EX-99 9 FORWARD-LOOKING STATEMENTS EXHIBIT 99 SODEXHO MARRIOTT SERVICES, INC. FORWARD-LOOKING STATEMENTS SUMMARY OF IMPORTANT FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS As indicated previously, this report contains forward-looking statements that are subject to a number of risks and uncertainties. Sodexho Marriott Services, Inc. (the "Company") cautions readers that the following important factors, among others, in some cases have affected, and in the future could affect, the Company's actual results of operations. The factors set forth below do not constitute all factors which investors should consider prior to making an investment decision with respect to the Company's securities. Further, investors should not assume that the information contained below is complete or accurate in all respects following the date of this filing. The Company assumes no obligation to update any forward-looking statements or any of the factors discussed below. CHANGES IN OPERATIONS. On March 27, 1998, the Company, formerly named Marriott International, Inc. (as formerly named, "Old Marriott"), consummated a series of transactions (the "Transactions") that, among other things, resulted in: (i) a spin-off to Old Marriott's stockholders of all businesses of Old Marriott other than its food service and facilities management business through a special dividend of stock in a new company which now uses the name "Marriott International, Inc." ("New Marriott"); (ii) the acquisition through a merger of the North American operations of Sodexho Alliance, S.A. ("Sodexho"); and (iii) the refinancing of certain outstanding indebtedness. Following the Transactions, the Company was renamed Sodexho Marriott Services, Inc. As a result of the Transactions, the Company's operations were significantly changed. The distribution of the lodging business narrowed the Company's operations to its food service and facilities management business (as expanded by the addition of the North American operations of Sodexho), and caused the Company's debt obligations, as a percentage of its assets, to increase significantly. The Company's business strategy is based on the belief that it will be able to expand its business, and reduce its debt over a reasonable period of time, and be able to attract, hire, train and retain competent employees. There can no assurance, however, that the Company's efforts to execute all elements of this strategy will be successful, or that a failure to do so will not have a material adverse effect on the Company's business, results of operations, and financial condition. In addition, because the Company is less diversified than it was prior to the Transactions, the results of operations of the Company will be more susceptible to competitive and market factors specific to its core businesses. LIMITED HISTORY AS AN INDEPENDENT FOOD SERVICE AND FACILITIES MANAGEMENT COMPANY. The Company has been operating less than two years as an independent, publicly owned, food service and facilities management company. The Company's management has limited experience in operating and managing a public company with indebtedness that exceeds its assets, or in integrating an acquisition the size of Sodexho North America. The Company also must take steps to assure that certain corporate services now being provided to the Company for limited periods of time by New Marriott eventually will be adequately performed by the Company or third-party contractors. Any or all of these factors could have a material adverse effect on the Company's business, results of operations, and financial condition. SUBSTANTIAL INDEBTEDNESS. The Company's indebtedness under its credit facility agreements is currently $1.1 billion and bears interest at rates that float with certain indices. The size of the Company's indebtedness and the restrictive covenants, events of default and other restrictions on the Company's activities contained in its credit facility agreements may limit the Company's ability to respond to market conditions, satisfy capital expenditure requirements, meet contractual or financial obligations, incur additional debt, invest in information technology infrastructure or engage in other activities. As a result, significant losses by the Company or certain activities by it could cause the Company to violate the terms of its credit facility agreements and thereby impair the Company's liquidity and limit its ability to raise additional capital. Moreover, a failure by the Company to make required debt payments could result in an acceleration of the Company's indebtedness, in which case the lenders thereunder would be entitled to exercise their remedies, including foreclosing on collateral. In view of the Company's substantial leverage, any new financings and refinancings by the Company of the Company's indebtedness, if available at all, may be at higher interest rates and may contain terms significantly less advantageous than would have been available to the Company absent the Transactions. In addition, a rise in interest rates would cause the Company's payment obligations to increase, even though the Company has hedged a significant portion of its interest rate risk. The occurrence of any of these events could restrict the Company's ability to finance its future operations, meet capital needs or engage in other business activities that may be in the interest of the Company. There can be no assurance that the Company will be able to obtain additional capital, if needed, on acceptable terms, or that the occurrence of any of the foregoing events would not have a material adverse effect on the Company's business, results of operations and financial condition. CONTRACTUAL ARRANGEMENTS. The Company's ability to continue the growth of its food service and facilities management business depends on whether it can continue to obtain new contracts, or renewals of existing contracts, on satisfactory terms. The majority of the food service and facilities management contracts of the Company are either based on fixed-price terms or terminable by clients on short notice (generally from 30 to 120 days), or both. Therefore, the Company's results of operations are dependent to a significant extent on its ability to estimate and control costs associated with the provision of services under these contracts. The Company's costs are subject to increases as a result of rising labor and supply costs, many of which are outside its control. In addition, the terms of the Company's operating contracts, distribution agreements, franchise agreements and leases are influenced by contract terms offered by the Company's competitors, general economic conditions, and other factors. There can be no assurance that some or all of these factors will not adversely affect the Company's operating margins or its ability to enter into satisfactory future contracts, or that these factors would not have a material adverse effect on the Company's business, results of operations, and financial condition. COMPETITION. The food service and facilities management industries are highly competitive. The Company competes in these industries with numerous other vendors of varying sizes, many of which have significant financial resources. The continued success of the Company will be dependent, in large part, upon its ability to compete in such areas as the quality of food and facilities management services, the nature and scope of specialized services, and upon the Company's ability to contain costs. ECONOMIC CONDITIONS. A decline in international, national or regional economic conditions could result in reduced demand for the outsourcing of food and facilities management services and create pressure on the Company to enter into contractual arrangements less favorable than those currently in effect or under consideration. Accordingly, such a decline could have a material adverse effect on the Company's business, results of operations, and financial condition. LIMITED GEOGRAPHIC FOCUS. The Company is not currently expected to expand its international presence beyond Canada. The Company's licensing arrangements with New Marriott and Sodexho to use the names "Marriott" and "Sodexho" cover only the U.S. and Canada. As a practical matter, since the Company will be allowed to use its corporate name only in the U.S. and Canada, and since Sodexho controls or has significant interests in companies competing in other countries in the food service and facilities management sector, 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. RELATIONSHIP WITH SODEXHO. As part of the Transactions, the Company and Sodexho entered into certain arrangements under which Sodexho provides the Company with a variety of consulting and advisory services and other assistance and has guaranteed a portion of the Company's indebtedness. Sodexho also has licensed to the Company the use of the name "Sodexho." These arrangements may have the effect of causing the Company to be reliant to a substantial degree on its relationship with Sodexho. Each of these arrangements has a finite term, and the failure to renew any such arrangements on comparable terms could have a material adverse effect on the Company's business, results of operations, and financial condition. This relationship may also require the Company's management to focus on issues arising from cultural and geographic differences, rather than on the strategic initiatives specifically designated for the North American marketplace. Effects might also result in the event Sodexho were to encounter financial or other difficulties that could prevent it from providing such services or assistance to the Company. 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 sector where sales are stronger during the academic year. There can be no assurance that these fluctuations will not have a material adverse effect on the Company's business, results of operations, and financial condition. CERTAIN ANTI-TAKEOVER EFFECTS. As of September 3, 1999, Sodexho, the Company's largest stockholder, beneficially owned approximately 48% of the outstanding shares of the Company's common stock. Sodexho has agreed pursuant to a tax sharing and indemnification agreement entered into among the Company, New Marriott and Sodexho not to acquire 50% or more of the Company's common stock for three years after the Transactions or through March 27, 2001. The certificate of incorporation of the Company generally provides that no person may acquire 50% or more of the Company's common stock until the end of such period. Consequently, no change in control of the Company is expected to occur before March 27, 2001. In addition, because Sodexho owns a large percentage of the Company's common stock it may be able to exercise significant influence over many matters requiring stockholder approval. Pursuant to a stockholder agreement with the Company, Sodexho also has the right to nominate three members of the Company's Board. As a result, Sodexho's relationship with the Company may have the effect of, among other things, preventing a change in control of the Company at any time without the agreement of Sodexho. USE OF TRADENAMES. New Marriott has licensed the "Marriott" name to the Company in certain limited respects for a period of four years after the Transactions, or through March 27, 2002. The Company will not have the right to use the "Marriott" name after the expiration of the four-year period. In addition, Sodexho has licensed the "Sodexho" name to the Company under a royalty agreement having a ten-year term. The "Sodexho" name, which has been used in the food service and facilities management business in North America for the four years prior to the Transactions, is not as well known in that market as the "Marriott" name. The Company may have to make additional expenditures to position its new name in the marketplace and cannot predict with certainty the extent to which the substitution of a new name may adversely affect its retention and acquisition of clients. Further, to the extent that the Company fails to perform its obligations under its license agreements with New Marriott or Sodexho, each of New Marriott and Sodexho could successfully prevent the Company from using their respective names, which could adversely affect the Company's retention and acquisition of clients and its financial performance. DIVIDEND POLICY. Prior to the Transactions, the Company paid regular quarterly dividends. On October 13, 1999, the Company's Board of Directors declared a dividend for fiscal year 1999 of $0.08 per common share for Fiscal Year 1999, payable on December 10, 1999 to shareholders of record on November 22, 1999. In the future, the Company may pay dividends, 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 stockholders 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 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. Payment of dividends on the Company's common stock will depend upon the Company's financial position, capital requirements, profitability and such other factors as the Company's Board deems relevant. YEAR 2000 READINESS. 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. 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. FLUCTUATING PRICES OF THE COMPANY'S COMMON STOCK. The Company's common stock is listed and traded on the New York Stock Exchange and certain other U.S. exchanges. Prices at which the Company's common stock trades fluctuate significantly and could be influenced by many factors, including, among others, the continuing depth and liquidity of the market for the Company's common stock, investor perception of the Company, the Company's dividend policy and general economic and market conditions. -----END PRIVACY-ENHANCED MESSAGE-----