Annual Report (Form 10-K), fiscal year 1994

Item 1. Business
The Company
This annual report on Form 10-K is filed by ServiceMaster Limited Partnership (hereinafter sometimes called the "Registrant"). The Registrant and its immediate subsidiary, The ServiceMaster Company Limited Partnership, were formed in December 1986 as limited partnerships under the laws of the State of Delaware to succeed to the business and assets of ServiceMaster Industries Inc. The Registrant and The ServiceMaster Company, together with all other entities affiliated with these two limited partnerships and the Registrant's predecessor organization, are hereinafter referred to as "ServiceMaster" or the "Company" or the "ServiceMaster enterprise".
The Registrant is a holding company whose limited partner shares are listed on the New York Stock Exchange and whose principal asset consists of all of the common limited partner interest in The ServiceMaster Company. Until January 31, 1992, the Registrant had both individual general partners and one corporate general partner. In January 1992, the shareholders of the Registrant approved an amendment of the Registrant's agreement of limited partnership under which the structure of the Registrant was changed by the withdrawal of the three individual general partners and the admission of ServiceMaster Corporation as a special general partner. These changes are described further under the caption "The 1992 Reorganization".
The two principal operating groups of the ServiceMaster business are Consumer Services and Management Services, each of which is organized as a separate limited partnership. ServiceMaster Consumer Services Limited Partnership was formed in the summer of 1990, and ServiceMaster Management Services Limited Partnership was formed in December 1991.
All subsidiaries of The ServiceMaster Company (which for purposes of this paragraph are limited to first-tier subsidiaries) are wholly owned except for the following: ServiceMaster Consumer Services L. P., as to which a subsidiary of WMX Technologies, Inc. owns a 27.8% common equity interest; ServiceMaster Management Services L.P., as to which senior management owns a 10% equity interest (determined after giving effect to intercompany debt), and LTCS Investment L.P. (the immediate parent of ServiceMaster Diversified Health Services), as to which management of ServiceMaster Diversified Health Services owns an 11% equity interest.
All subsidiaries of ServiceMaster Consumer Services L.P. are now wholly owned. However, throughout the year 1994 senior management of TruGreen Limited Partnership owned a 15% interest in that partnership. This 15% interest was acquired by the Registrant in January 1995. See Note I, page 14, for further information regarding this transaction.
All subsidiaries of ServiceMaster Management Services L.P. are wholly owned.
The 1992 Reorganization
On January 13, 1992, the shareholders approved a "Reorganization Package" consisting of a comprehensive amendment and restatement of its partnership agreement and a merger by which the Registrant can convert back into corporate form. The expected time of such conversion is the end of December 1997.
As a result of the approval of the Reorganization Package, ServiceMaster Corporation was admitted as a Special General Partner of the Registrant to serve as a vehicle through which institutional investors could be offered opportunities to invest in ServiceMaster through the acquisition of a corporate security. If shares of stock were to be issued by ServiceMaster Corporation ("Corporate Shares"), the Corporate Shares would indirectly represent the same percentage interest in the Registrant as was then represented by each limited partner share in ServiceMaster. At the present time there are no plans to issue stock of ServiceMaster Corporation.
The merger agreement which was approved as part of the Reorganization Package provides for the merger by which ServiceMaster expects to return to corporate form (the "Reincorporating Merger"). ServiceMaster Incorporated of Delaware has been organized to become the successor entity through which the public will invest in ServiceMaster after the Reincorporating Merger. The limited partner shares of the Registrant together with any Corporate Shares which may be issued prior to the Reincorporating Merger will be converted on a one- for-one basis into new shares of common stock to be issued by ServiceMaster Incorporated. As a result of these conversions, ServiceMaster Incorporated will be entirely owned by the persons who, collectively, owned all of the limited partner shares of the Registrant and all of the Corporate Shares of ServiceMaster Corporation (if any) immediately prior to the Reincorporating Merger.
The Reorganization Package included certain changes in the identity of and the capital contribution requirements for the general partners of the Registrant. These changes were effected on January 31, 1992. On that date, ServiceMaster Management Corporation became the sole general partner of the Registrant and
of The ServiceMaster Company with sole management authority with respect to these partnerships and the amount of independent capital required to be maintained by ServiceMaster Management Corporation was reduced to $15 million.
For further information concerning the changes effected by the 1992 Reorganization, see the discussion captioned "Description of the Structure of the ServiceMaster Enterprise" beginning on page 14.
Principal Business Groups
ServiceMaster is functionally divided into four operating groups: Consumer Services,Management Services, Diversified Health Services and International and New Business Development. Consumer Services and Management Services are the two principal operating groups. Reference is made to the information under the caption "Business Unit Reporting" on page 29 of the ServiceMaster Annual Report to Shareholders for 1994 (the "1994 Annual Report") for detailed financial information on these two groups.
Trademarks and Service Marks; Franchises
The Company's trademarks and service marks are important for all elements of the Company's business, although such marks are particularly important in the advertising and franchising activities conducted by the operating subsidiaries of ServiceMaster Consumer Services L.P. Such marks are registered and are renewed at each registration expiration date.
Within ServiceMaster Consumer Services, franchises are important for the TruGreen-ChemLawn, Terminix, ServiceMaster Residential/Commercial, and Merry Maids businesses. Nevertheless, revenues and profits derived from franchise-related activities constitute less than 10% of the revenue and profits of the consolidated ServiceMaster enterprise. Franchise agreements made in the course of these businesses are generally for a term of five years. ServiceMaster's renewal history is that most of the franchise agreements which expire in any given year are renewed.
Consumer Services
ServiceMaster Consumer Services provides specialty services to homeowners and commercial facilities through five companies: TruGreen L.P. ("TruGreen-ChemLawn"); The Terminix International Company L.P. ("Terminix"); ServiceMaster Residential/Commercial Services L.P. ("Res/Com"); Merry Maids L.P. ("Merry Maids"); and American Home Shield Corporation ("American Home Shield" or "AHS"). The services provided by these companies include: lawn care, tree and shrub services under the "TruGreen" and "ChemLawn" service marks; termite and pest control and radon testing
services under the "Terminix" service mark; residential and commercial cleaning and disaster restoration services under the "ServiceMaster" service mark; domestic housekeeping services under the "Merry Maids" service mark; and home systems and appliance warranty contracts under the "American Home Shield" service mark.
The services provided by the five Consumer Services companies are part of the ServiceMaster "Quality Service Network" and are accessed by calling a single toll-free telephone number: 1-800-WE SERVE. ServiceMaster focuses on establishing relationships to provide one or more of these services on a repetitive basis to customers. Since 1986, the number of customers served by ServiceMaster Consumer Services has increased from fewer than one million customers to more than 6.4 million customers (including international operations).
The International and New Business Development Group is responsible for overseeing the Consumer Services which are provided in foreign markets.
TruGreen-ChemLawn. Until January 1, 1995, TruGreen-ChemLawn was an 85% owned subsidiary of ServiceMaster Consumer Services Limited Partnership with senior management of TruGreen-ChemLawn holding the remaining 15% interest. However, effective January 1, 1995, all of the holders of the 15% minority interest contributed their interests to the Registrant in exchange for shares of the Registrant. See Note I, page 21 for further information regarding this transaction. With 2.3 million residential and commercial customers, TruGreen-ChemLawn is the leading provider of lawn care services in the United States. As of December 31, 1994, TruGreen-ChemLawn had 173 company-owned branches and 73 franchised branches. TruGreen-ChemLawn also provides lawn care services in Saudi Arabia through a licensing arrangement. The TruGreen-ChemLawn business is seasonal in nature.
Terminix. Terminix is a wholly owned subsidiary of ServiceMaster Consumer Services L.P. With approximately 2.0 million residential and commercial customers, Terminix, through its company-owned branches and through franchisees, is the leading provider of termite, pest control and radon testing services in the United States. As of December 1994, Terminix was providing these services through 314 company-owned branches in 40 states and Mexico and through 225 franchised branches in 22 states and Mexico. Terminix also provides termite and pest control services in Japan, Taiwan, Lebanon, Saudi Arabia, Oman, the Bahamas, Dominican Republic, Jamaica, and Puerto Rico through licensing arrangements with local partners. It provides the same services through subsidiaries in Belgium, the Netherlands, Norway, Sweden, the United Kingdom, and Mexico. The Terminix business is seasonal in nature.
Res/Com. Res/Com is a wholly owned subsidiary of ServiceMaster Consumer Services L.P. ServiceMaster, through Res/Com, is the leading franchisor in the residential and commercial cleaning field. Res/Com provides carpet and upholstery cleaning and janitorial services, disaster restoration services and window cleaning services to over 1.3 million residential and commercial customers worldwide through a network of over 4,300 independent franchisees. Res/Com provides its services through subsidiaries in Germany and the United Kingdom, through an affiliate in Canada, and through licensees in Australia, New Zealand, Austria, Belgium, Finland, Spain, Turkey, Saudi Arabia, Korea, Japan, Brazil, and Canada.
Merry Maids. Merry Maids is a wholly owned subsidiary of ServiceMaster Consumer Services Limited Partnership. (A minority interest held by senior management of Merry Maids at the end of 1993 was acquired by Merry Maids in 1994). Merry Maids is the organization through which ServiceMaster provides domestic house cleaning services. With nearly 200,000 customers, Merry Maids is the leading provider of domestic house cleaning services in the United States. As of December 31, 1994, these services were provided through 4 company-owned branches in four states and through 774 licensees operating in 49 states. Merry Maids also provides domestic housecleaning services in Canada through an affiliate and in Japan, the United Kingdom, Saudi Arabia, Denmark and Australia through licensing arrangements with local service providers.
American Home Shield. AHS is a wholly owned subsidiary of SVM Holding Corp., a holding company in which ServiceMaster Consumer Services L.P. owns 100% of the equity. (An 8% interest held by senior management of AHS at the end of 1993 was acquired by SVM Holding Corp. in 1994). AHS is a leading provider of home service warranty contracts in the United States, providing homeowners with contracts covering the repair or replacement of built-in appliances, hot water heaters and electrical, plumbing, central heating, and central air conditioning systems which malfunction by reason of normal use. Service contracts are presently sold principally through participating real estate brokerage offices in conjunction with resales of single-family residences to homeowners. AHS also sells service warranty contracts directly to non-moving homeowners through various other distribution channels which are currently being expanded. As of December 31, 1994, AHS was providing services to approximately 328,000 homes through approximately 6,000 independent repair maintenance contractors in 47 states and the District of Columbia, with operations in California, Texas and Arizona accounting for 30%, 21% and 9%, respectively, of AHS' gross contracts written. AHS also provides home service warranty contracts in Japan and Saudi Arabia through licensing arrangements with local service providers.
Management Services
ServiceMaster pioneered the providing of supportive management services to health care facilities by instituting housekeeping management services in 1962. Since then, ServiceMaster has expanded its management services business such that it now provides a variety of supportive management services to health care, education and commercial customers (including the management of housekeeping, plant operations and maintenance, laundry and linen, grounds and landscaping, clinical equipment maintenance, energy management services and food service). ServiceMaster's general programs and systems free the customer to focus on its core business activity with confidence that the support services are being managed and performed in an efficient manner.
For many years, Management Services was organized in geographic companies, with each of these companies providing the full range of ServiceMaster's supportive management services. In October 1994, Management Services was reorganized into three discrete operating units each providing a separate functional service on a nationwide basis. These units are: Healthcare Management Services; Education Management Services; and Business and Industry Management Services.
As of December 31, 1994, ServiceMaster was providing supportive management services to approximately 2,200 health care, educational and commercial facilities. These services were being provided in all 50 states and the District of Columbia and in 15 foreign countries. Outside of the United States, ServiceMaster was providing management services through subsidiaries in Japan, through affiliated companies in Canada, Japan, Italy, Mexico, and the United Kingdom, and through licensees in Korea, Australia, New Zealand, Singapore, Taiwan, Hong Kong, Czech Republic, Slovakia, Chile, Japan and throughout the Middle East. The International and New Business Development Group is responsible for overseeing the management services which are provided in foreign markets.
In February 1995, Management Services formed a joint venture with DAKA International in which the latter, in effect, acquired 80% of Management Services'education food service management business. At the time of its formation, the DAKA-ServiceMaster Management Services joint venture was serving approximately 100 customers.
Diversified Health Services
The Diversified Health Services Group was organized in 1993. It consists of the ServiceMaster Diversified Health Services companies and ServiceMaster Home Health Care Services. The Diversified Health Services companies were acquired by
ServiceMaster in August 1993, at which time they were known as VHA Long Term Care.
ServiceMaster Diversified Health Services. ServiceMaster Diversified Health Services, Inc., ServiceMaster Diversified Health Services L.P. and their respective subsidiaries (collectively, the "ServiceMaster Diversified Health Services Companies") form a comprehensive health services organization which provides: management services to freestanding, hospital based, and government owned nursing homes and assisted living facilities; design, development, refurbishing and construction consulting services to long-term care facilities; hospice services; and various medical supplies. The companies are the exclusive licensee to promote the provision of long-term care services to the hospitals in the Voluntary Hospitals of America alliance. As of December 31, 1994, the ServiceMaster Diversified Health Services Companies were providing management services to approximately 14,800 beds in 28 states in a total of 103 facilities.
Home Health Care Services. ServiceMaster Home Health Care Services Inc. provides management services to hospital-based home health care agencies and operates freestanding home health care agencies. As of December 31, 1994, this organization was serving 46 home health care agencies, four of which are wholly-owned.
International and New Business Development
The International and New Business Development Group consists of International Services and companies which are in a formative stage of development.
International Services. The International Services component of the International and New Business Development Group oversees the performance of supportive management services and consumer services in international markets either through the arrangements described above or through ownership of foreign operating companies acquired by ServiceMaster.
In the Spring of 1994, ServiceMaster made a strategic decision to expand its pest control business into Europe through the acquisition of existing pest control companies. Thereafter, in August 1994, International Services organized TMX-Europe B.V., a Netherlands limited company ("TMX-Europe") as a subsidiary of The ServiceMaster Company to serve as a holding company for acquisitions of pest control businesses in the United Kingdom and Europe. At the end of August 1994, TMX-Europe acquired Peter Cox plc, a leading pest control company in the United Kingdom; in early September 1994, TMX-Europe acquired Protekta B.V. and Riwa B.V., each a pest control company in the Netherlands; and at the end of December 1994, TMX-Europe acquired Anticimex Development
AB, a holding company for pest control and related businesses in Sweden.
Child Care Services. ServiceMaster Child Care Services, Inc., a part of the New Business Development component of the International and New Business Development Group, operates employer or developer sponsored child care centers under the "GreenTree" service mark. As of December 31, 1994, GreenTree had 17 child care centers in operation, all of which were in the greater Chicago area and in Milwaukee, Wisconsin.
Other Activities
Supporting Departments. ServiceMaster has various departments responsible for technical, engineering, management information, planning and market services, and product and process development activities. Various administrative support departments provide personnel, public relations, administrative, education, accounting, financial and legal services.
Manufacturing Division. ServiceMaster has a manufacturing division which manufactures and distributes supplies, products and equipment that are used internally in providing management services to customers and which are sold to licensees for use in the operation of their businesses. ServiceMaster has an insignificant share of the market for the manufacture and distribution of cleaning equipment, chemicals and supplies.
Industry Position, Competition and Customers
The following information is based solely upon estimates made by the management of ServiceMaster and cannot be verified. In considering ServiceMaster's industry and competitive positions, it should be recognized that ServiceMaster competes with many other companies in the sale of its services, franchises and products and that some of these competitors are larger or have greater financial and marketing strength than ServiceMaster.
The principal methods of competition employed by ServiceMaster in the Consumer Services business are name recognition, assurance of customer satisfaction and history of providing quality services to homeowners. The principal methods of competition employed by ServiceMaster in each of the operating units in the Management Services business are price, quality of service and history of providing management services. The principal methods of competition employed by ServiceMaster in the Diversified Health Services business are name recognition, price, quality of services and history of providing management services.
Consumer Services
Consumer Services subsidiaries provide a variety of residential and commercial services under their respective names on the basis of their and ServiceMaster's reputation, the strength of their service marks, their size and financial capability, training and technical support services. The markets served by Terminix and TruGreen/ChemLawn are seasonal in nature.
Lawn Care Services. TruGreen-ChemLawn, both directly and through franchisees, provides lawn care services to residential and commercial customers. Competition within the lawn care market is strong, coming mainly from regional and local, independently owned firms and from homeowners who elect to care for their lawns through their own personal efforts. TruGreen- ChemLawn is the leading national lawn care company within this market.
Lawn care services are regulated by law in most of the states in which TruGreen-ChemLawn provides such services. These laws require licensing which is conditional on a showing of technical competence and adequate bonding and insurance. The lawn care industry is regulated at the federal level under the Federal Insecticide, Fungicide and Rodenticide Act, and lawn care companies (such as TruGreen-ChemLawn) which apply herbicides and pesticides are regulated under the Federal Environmental Pesticide Control Act of 1972. Such laws, together with a variety of state and local laws and regulations, may limit or prohibit the use of certain herbicides and pesticides, and such restrictions may adversely affect the business of TruGreen- ChemLawn.
Termite, Pest Control and Radon Testing Services. The market for termite, pest control and radon testing services to commercial and residential customers includes several large competitors and many small competitors. Terminix is the leading national termite and pest control company within this market and has a significant share of the market. Competition within the termite and pest control market is strong, coming mainly from regional and local, independently owned firms throughout the United States and from one other company which operates on a national basis.
Termite and pest control services are regulated by law in most of the states in which Terminix provides such services. These laws require licensing which is conditional on a showing of technical competence and adequate bonding and insurance. The extermination industry is regulated at the federal level under the Federal Insecticide, Fungicide and Rodenticide Act, and pesticide applicators (such as Terminix) are regulated under the Federal Environmental Pesticide Control Act of 1972. Such laws, together with a variety of state and local laws and regulations,
may limit or prohibit the use of certain pesticides, and such restrictions may adversely affect the business of Terminix.
House Cleaning Services. The market for domestic house cleaning services is highly competitive. In urban areas the market involves numerous local companies and a few national companies. ServiceMaster believes that its share of the total potential market for such services is small and that there is a significant potential for further expansion of its housecleaning business through continued internal expansion and greater penetration of the housecleaning market. Through its franchisees, ServiceMaster has a small share of the market for the cleaning of residential and commercial buildings.
Home Systems and Appliance Warranty Contracts. The market for home systems and appliance warranty contracts is relatively new. ServiceMaster believes that AHS maintains a favorable position in its industry due to the system developed and used by AHS for accepting, dispatching and fulfilling service calls from homeowners through a nationwide network of independent contractors. AHS also has a computerized information system developed and owned by AHS, and an electronic digital voice communication system through which AHS handled more than 5.1 million calls in 1994.
Management Services
Health Care. Within the market consisting of general health care facilities having 50 or more beds, ServiceMaster is the leading supplier of plant operations and maintenance, housekeeping, clinical equipment maintenance, and laundry and linen management services. As of December 31, 1994, ServiceMaster was serving in approximately 1,300 health care facilities. The majority of health care facilities within this market not currently served by ServiceMaster assume direct responsibility for managing their own non-medical support functions.
ServiceMaster believes that its management services for health care facilities may expand by the addition of facilities not presently served, by initiating additional services at facilities which use only a portion of the services now offered, by the development of new services and by growth in the size of facilities served. At the same time, changes in use and methods of health care delivery and payment for services continue to affect the health care environment.
Education. ServiceMaster is a leading provider of maintenance, custodial, and grounds services and through the DAKA/ServiceMaster joint venture, food management services, to the education market. The facilities which comprise the education market served by ServiceMaster include primary schools,
secondary schools and school districts, private specialty schools and colleges and universities. As of December 31, 1994, ServiceMaster was serving in approximately 500 educational facilities. ServiceMaster believes there is significant potential for expansion in the education market due to its current relatively low penetration of that market and the trend of educational facilities to consider outsourcing more of their service requirements. However, a majority of the educational facilities continue to assume direct responsibility for managing their support functions.
Business and Industry. ServiceMaster believes it is a leading provider of plant operations and maintenance, custodial and grounds management services to business and industrial customers. During the period 1991 - 1994, this market has been adversely affected by periods of weak economic conditions and corporate downsizing, but ServiceMaster continues to believe that there is potential for expansion in the business and industrial markets due to ServiceMaster's low current penetration of that market and the trend of business to consider outsourcing more of their service requirements and the trend of governmental units to privatize parts of their operations. As of December 31, 1994, ServiceMaster was serving in 141 business or industrial facilities.
Diversified Health Services
Long-Term Care Management Services. The ServiceMaster Diversified Health Services Companies constitute the nation's ninth largest long term care company based on the number of beds served and the largest company that is primarily a management services company (as distinguished from a real estate operator). It is also a major provider of planning and design services for long term care facilities and for acute care hospitals.
Home Health Care Services. ServiceMaster Home Health Care Services is a leading provider of management services to hospital-affiliated home health care agencies. The number of free-standing home health care agencies operated by ServiceMaster Home Health Care Services represents a very small proportion of home health care agencies in the United States.
International and New Business Development
International Services. The pest control companies acquired by ServiceMaster through International Services are each leaders in the pest control business in the countries in which they respectively operate. ServiceMaster believes that there is potential for expansion of these businesses in both the United Kingdom and elsewhere on the European continent.
Child Care Services. ServiceMaster Child Care Services, Inc. is the sixth largest manager of employer-based child care facilities in the United States. ServiceMaster believes that there is a significant potential for expansion of its child care services, particularly in the market consisting of employer-based child care.
Major Customers.
ServiceMaster has no single customer which accounts for more than 10% of its total revenues. No part of the Company's business is dependent on a single customer or a few customers the loss of which would have a material adverse effect on that part. Revenues from governmental sources are not material.
Employees
On December 31, 1994, ServiceMaster had a total of approximately 34,000 employees.
ServiceMaster provides its employees with annual vacation, medical, hospital and life insurance benefits and the right to participate in additional benefit plans which are described in the Notes to Financial Statements included in the 1994 Annual Report.
STRUCTURE OF SERVICEMASTER
This chart shows the entities which collectively make up the ServiceMaster enterprise. The public shareholders are shown at the top of the chart, below which are listed ServiceMaster Limited Partnership, The ServiceMaster Company, the four business units and their respective significant subsidiaries, in that order.
DESCRIPTION OF THE STRUCTURE OF THE SERVICEMASTER ENTERPRISE
Organization and Structure of the Parent Companies
Until December 30, 1986, the ServiceMaster business was conducted by ServiceMaster Industries Inc. On December 30, 1986, ServiceMaster was reorganized into a limited partnership with the following results, among others: ServiceMaster Limited Partnership became the parent unit in the ServiceMaster enterprise, with one limited partnership share in ServiceMaster Limited Partnership being issued to replace every then outstanding share of common stock issued by ServiceMaster Industries Inc., and The ServiceMaster Company Limited Partnership was established as the principal operating subsidiary of ServiceMaster Limited Partnership.
Until January 31, 1992, the general partners in ServiceMaster Limited Partnership and The ServiceMaster Company were ServiceMaster Management Corporation, which served as the managing general partner, and three individual general partners. On January 31, 1992, the three individual general partners withdrew and became stockholders of ServiceMaster Management Corporation, leaving ServiceMaster Management Corporation as the sole general partner having management authority in the two principal partnerships and, as further discussed below, the sole general partner having an interest in the 1% carried interest reserved to the general partners of the two partnerships.
Since January 1, 1987, the general partners have collectively held a 1% interest in all profits and losses of ServiceMaster Limited Partnership and of The ServiceMaster Company, in each case limited to profits and losses generated since that date. Following the withdrawal of the individual general partners on January 31, 1992, the entire 1% interest in the profits and losses of each of ServiceMaster Limited Partnership and The ServiceMaster Company has been held by ServiceMaster Management Corporation. These separate interests constitute an aggregate interest of approximately 2% of the consolidated income and losses of the ServiceMaster business (determined after allowing for minority interests in subsidiaries, where applicable).
The Board of Directors of ServiceMaster Management Corporation has the ultimate power to govern the ServiceMaster business. A majority of the positions on the Board are reserved for independent directors. Although the stock of ServiceMaster Management Corporation is owned by members of ServiceMaster management, the stockholders have entered into voting trust arrangements under which the incumbent members of the Board have the right to determine the persons who will be elected to the Board each year. These arrangements were not altered by the 1992 Reorganization.
Although the owners of the outstanding limited partner shares issued by ServiceMaster Limited Partnership do not have the right to vote directly for the directors of ServiceMaster Management Corporation, they do have the right to replace ServiceMaster Management Corporation as the managing general partner by voting the percentages of their shares prescribed in the Partnership Agreement in favor of such replacement (provided, however, that certain opinions of counsel are obtained). The holders of the outstanding shares of ServiceMaster Limited Partnership accordingly retain the ultimate right to select the ServiceMaster management.
The 1992 Reorganization (ServiceMaster Corporation)
Reference is made to the discussion on page 1 for the background of the 1992 Reorganization. As a result of the approval of the Reorganization Package on January 13, 1992, ServiceMaster Corporation was admitted as a Special General Partner of the Registrant on January 31, 1992. As of March 20, 1995, no shares of stock of ServiceMaster Corporation had been issued and the corporation remains dormant.
Organization and Structure of Consumer Services
ServiceMaster Consumer Services Limited Partnership ("SMCS") provides a separate identity for the Consumer Services business. SMCS is a holding company for all of the operating groups which comprise such business, i.e., TruGreen-ChemLawn, Terminix, ServiceMaster Residential/Commercial Services, Merry Maids, and American Home Shield.
SMCS has two general partners, ServiceMaster Consumer Services, Inc. and The ServiceMaster Company, and two limited partners, The ServiceMaster Company and a subsidiary of WMX Technologies, Inc. (which holds a 27.8% interest in SMCS). The controlling interest in ServiceMaster Consumer Services, Inc., is held by ServiceMaster Management Corporation.
Organization and Structure of Management Services
ServiceMaster Management Services Limited Partnership ("SMMS") provides a separate identity for the Management Services business. This business is primarily carried out through three divisions of SMMS, with a small amount of specialized business conducted through a wholly owned subsidiary.
SMMS has two general partners, ServiceMaster Management Services, Inc., and The ServiceMaster Company and 44 limited partners in two classes: Class A and Class B. The general
partners together hold a 1% interest in SMMS. The Class A limited partners, all of whom are senior members of SMMS management, collectively own 10% of the equity of SMMS (with equity determined for this purpose after allowing for $505.6 million of intercompany debt to The ServiceMaster Company). The Class B limited partner is The ServiceMaster Company, which holds the remaining equity interest in SMMS.
Organization and Structure of Diversified Health Services
The ServiceMaster Company holds the controlling interests in the following organizations which, together, comprise the ServiceMaster Diversified Health Services group: the ServiceMaster Diversified Health Services Companies and ServiceMaster Home Health Care Services Inc.
The ServiceMaster Diversified Health Services Companies consist of a limited partnership and its general partner and their respective subsidiaries. The ServiceMaster Company owns 89% of the equity of the ServiceMaster Diversified Health Services Companies, with members of senior management owning the remaining 11% of such equity.
ServiceMaster Home Health Care Services Inc. is wholly owned by The ServiceMaster Company.
Organization and Structure of International and New Business Development
International operations of the Company are carried out through subsidiaries, licensing or joint venture arrangements all of which are coordinated and supervised by the International Services component of International and New Business Development. As previously noted, in 1994, the Company, through its Netherlands subsidiary, TMX-Europe B.V., acquired pest control businesses in the United Kingdom, the Netherlands and Sweden.
The ServiceMaster Company owns all of the equity in ServiceMaster Child Care Services, Inc. as part of its New Business Development group.
Notes to Organizational Structure Chart
The following Notes are intended to be read in conjunction with the organizational structure chart on page 13.
Note A--Public Investors
The public investors in the Registrant collectively hold a 99% interest in the profits, losses and distributions of the
Registrant through their ownership of the limited partner interests in the Registrant ("Partnership Shares"). (If ServiceMaster Corporation were to issue any shares of its common stock, this 99% interest would be divided among the owners of the Partnership Shares and the owners of the Corporate Shares in accordance with their respective interests). The Partnership Shares are listed on the New York Stock Exchange under the symbol "SVM". For the reasons indicated in Note D below, the public investors' 99% interest in the Registrant entitles the public investors to an approximately 98% interest in the consolidated profits, losses and distributions of ServiceMaster.
Note B--ServiceMaster Limited Partnership
The Registrant (ServiceMaster Limited Partnership) serves as the holding company for the ServiceMaster business. It does not conduct any significant business operations or own any significant property except for its 99% common equity interest in the profits, losses and distributions of The ServiceMaster Company Limited Partnership. ServiceMaster Corporation became a special general partner of the Registrant following the approval of and in accordance with the 1992 Reorganization, but ServiceMaster Corporation has not been activated through the issuance of any of its stock. Reference is made to the Proxy Statement/Prospectus of ServiceMaster Limited Partnership dated December 11, 1991 for a complete discussion of the background and arrangements regarding ServiceMaster Corporation.
Note C--The ServiceMaster Company Limited Partnership
The ServiceMaster Company Limited Partnership conducts all of the operations of the International and New Business Development Group and serves as a holding company for the Consumer Services, Management Services, and Diversified Health Services groups. All of its common limited partner interests are held by the Registrant. An individual held a preferred limited partner interest in The ServiceMaster Company which was redeemed by The ServiceMaster Company in May 1994 - see Note S. On January 1, 1993, the ServiceMaster SGP Trust became a special general partner of The ServiceMaster Company and has remained a special general partner of The ServiceMaster Company since that date - see Note T.
Note D--ServiceMaster Management Corporation (Managing General Partner)
ServiceMaster Management Corporation is the managing general partner of ServiceMaster Limited Partnership and The ServiceMaster Company Limited Partnership (collectively referred to in this Note D as the "Partnerships"). ServiceMaster
Management Corporation has the ultimate authority to control each entity in the ServiceMaster enterprise.
The certificate of incorporation of ServiceMaster Management Corporation requires that a majority of the positions on its board of directors must be comprised of independent directors. The certificate of incorporation further provides that this requirement may not be amended without the consent of the holders of a majority of the outstanding shares of ServiceMaster Limited Partnership. During the year 1994, the stock of ServiceMaster Management Corporation was owned by persons who were past or present senior members of the ServiceMaster management. The stockholders of this corporation have deposited their stock in a voting trust of which the directors themselves are trustees with discretionary power to vote the stock. These arrangements enable the incumbent members of the Board of Directors to choose the persons elected to the Board each year.
On January 31, 1992, as contemplated by the 1992 Reorganization, all individuals who were then serving as general partners of the Partnership withdrew as general partners and became stockholders of ServiceMaster Management Corporation with stock interests therein which indirectly represented their former general partner carried interests. Their general partner carried interests were transferred to ServiceMaster Management Corporation as part of these adjustments.
ServiceMaster Management Corporation does not employ any significant number of persons or own any office space or other equipment used to conduct the day-to-day management of ServiceMaster; rather, the employees and assets necessary to manage the ServiceMaster business are based within the operating entities.
The applicable partnership agreements as adopted in 1986 and as amended since then provide that the general partners of the Partnerships are entitled to a 1% interest in each of the two Partnerships. Since January 31, 1992, the sole holder of the 1% interest in each of the two Partnerships has been ServiceMaster Management Corporation. These interests are "carried interests" which means that ServiceMaster Management Corporation is not required to contribute to the capital of the Partnerships except as may be necessary to pay liabilities for which provision cannot otherwise be made. These carried interests will remain at a constant 1% in each of the two Partnerships at all times regardless of the extent to which additional investments in the Partnerships are made by others and regardless of the extent to which the Partnerships redeem other interests. These 1% interests provide ServiceMaster Management Corporation with approximately 1.99% of the profits and losses of the entire ServiceMaster enterprise, that is, ServiceMaster Management Corporation is entitled to 1% of the profits of The ServiceMaster
Company Limited Partnership and, because that partnership is 99% owned by ServiceMaster Limited Partnership, it is entitled to an additional 1% of the 99% of The ServiceMaster Company Limited Partnership's profits which are allocated to ServiceMaster Limited Partnership.
For the year 1994, each of the Partnerships made cash distributions equal to 1% of its net income to ServiceMaster Management Corporation. The total of the distributions made with respect to the year 1994 was $3,041,268. From that amount the corporation paid state corporate taxes and, on behalf of its stockholders but subject to reimbursement by them, the letter of credit fees charged with respect to the promissory notes described in the next paragraph. The balance, $2,895,062, was distributed by ServiceMaster Management Corporation to those past and present officers of ServiceMaster who constituted the stockholders of ServiceMaster Management Corporation. At December 31, 1994, such persons included Messrs. Cantu, Erickson, Mooney, Keith, and Squires, whose participations within the 1.99% total carried interest of ServiceMaster Management Corporation at the end of 1994 were, respectively, 11.44%, 11.44%, 2.53%, 3.04%, and 3.04%.
The stock of ServiceMaster Management Corporation is presently owned by 35 ServiceMaster executives, each of whom has signed a promissory note payable to the corporation in the amount of the purchase price of his or her stock. Such notes total approximately $15,000,000 in the aggregate and are payable upon demand. The payment of each such note is secured by a letter of credit from the Bank of America (Illinois). The fees for such letters of credit are borne entirely by the makers of the notes and not by ServiceMaster.
Note E--ServiceMaster Consumer Services Limited Partnership and ServiceMaster Consumer Services, Inc.
ServiceMaster Consumer Services Limited Partnership ("SMCS") is the holding company for the Consumer Services business. ServiceMaster Consumer Services, Inc. is one of the two general partners of SMCS. The second general partner is The ServiceMaster Company. The ServiceMaster Company, through its direct and indirect ownership of the 1% interest held by the general partners and as one of two limited partners, holds in total a 72.2% equity interest in SMCS. The other limited partner is WMI Urban Services, Inc. ("WMUS"), a wholly owned subsidiary of WMX Technologies, Inc., which owned 27.8% of the common equity of SMCS at the end of 1994. Beginning on January 1, 1998, WMUS has a right to convert its equity interest in SMCS into common stock of the ServiceMaster parent entity based on relative fair market values at the date of conversion. However, the parent
entity has the unilateral option to substitute cash for the parent shares which would otherwise be issued.
Note F--ServiceMaster Management Services Limited Partnership and ServiceMaster Management Services, Inc.
ServiceMaster Management Services Limited Partnership ("SMMS") is the holding company for the Management Services business. ServiceMaster Management Services, Inc. is one of the two general partners of SMMS. The second general partner is The ServiceMaster Company. The general partners collectively hold a 1% interest in SMMS, and The ServiceMaster Company, as the Class B limited partner, and members of senior management of Management Services, as Class A limited partners, hold the remaining 99% interest.
In January 1994, members of senior SMMS management purchased a 10% interest in SMMS as Class A limited partners. The equity of SMMS is determined, for purposes of such 10% interest, after allowing for intercompany debt to The ServiceMaster Company. Such intercompany debt is offset and eliminated in preparing the consolidated financial statements of the Registrant. SMMS has the right (the "call right") to purchase this minority interest and each Class A limited partner has the right (the "put right") to require SMMS to purchase his or her interest at any time after the end of the year 1997. The purchase price for all transactions involving the purchase of a Class A limited partner interest is the then current fair market value of the interest as confirmed by an independent appraisal.
Note G--ServiceMaster Diversified Health Services
ServiceMaster Diversified Health Services is a division of The ServiceMaster Company. It is comprised of the ServiceMaster Diversified Health Services Companies ("DHS") and ServiceMaster Home Health Care Services. The former is 89% owned by The ServiceMaster Company (see Note N) while the latter is 100% owned by The ServiceMaster Company but the latter's earnings are included as part of the earnings of DHS for purposes of the minority interest in DHS. The ServiceMaster Diversified Health Services Companies include a parent limited partnership and its general partner, and a number of subsidiary companies.
Note H--International and New Business Development
International and New Business Development is a division of The ServiceMaster Company. It consists of International Services and New Business Development. The International Services component oversees and provides administrative support for
ServiceMaster's international operations. The New Business Development component oversees and provides administrative support for businesses which are in their formative stages (e.g., ServiceMaster Child Care Services).
Note I--TruGreen Limited Partnership
TruGreen Limited Partnership ("TruGreen") has two general partners: TruGreen, Inc., which is the managing general partner, and TSSGP. Until January 1, 1995, members of TruGreen management owned a 15% minority interest in TruGreen. Effective January 1, 1995, all of the holders of the minority interest contributed their limited partner units in TruGreen to the Registrant in exchange for 2,824,062 shares of the Registrant and a contingent right to receive an additional payment in 1997 depending upon the magnitude of TruGreen's earnings and the performance of the Registrant's shares in 1995 and 1996. As a result of this transaction, the Registrant and Consumer Services together became the owners of 100% of the equity interests in TruGreen.
Note J--The Terminix International Company Limited Partnership
The Terminix International Company Limited Partnership ("Terminix") has two general partners: Terminix International, Inc., the managing general partner, and TSSGP Limited Partnership ("TSSGP"). Terminix is a wholly owned subsidiary of SMCS.
Note K--Res/Com Limited Partnership
ServiceMaster Residential/Commercial Services Limited Partnership ("Res/Com") has two general partners: ServiceMaster Residential/Commercial Services Management Corporation, which is the managing general partner, and TSSGP. Res/Com is a wholly owned subsidiary of SMCS.
Note L--Merry Maids Limited Partnership
Merry Maids Limited Partnership ("Merry Maids") has two general partners: Merry Maids, Inc., which is the managing general partner, and TSSGP. Merry Maids is a wholly owned subsidiary of SMCS. (The minority interest in Merry Maids held by members of senior management of Merry Maids was acquired by Merry Maids in 1994).
Note M--American Home Shield Corporation
American Home Shield Corporation ("AHS") is a wholly-owned subsidiary of SVM Holding Corp. ("Holding"). Holding is a wholly owned subsidiary of SMCS. (The 8% interest in Holding held by members of senior management of AHS was acquired by Holding in 1994.)
Note N--ServiceMaster Diversified Health Services Companies
The ServiceMaster Diversified Health Services Companies (formerly VHA Long Term Care) are wholly owned subsidiaries of LTCS Investment L.P. ("LTCS"). LTCS is 89% owned by The ServiceMaster Company and 11% by members of senior management of the ServiceMaster Diversified Health Services Companies. LTCS has the right (the "call right") to purchase this 11% minority interest, and each person who holds a part of the minority interest has the right (the "put right") to require LTCS to purchase his or her minority interest in LTCS. The call right and the put right may be exercised at any time during the period beginning on January 1, 1999, and ending on January 31, 2004. The purchase price for all transactions involving a minority interest purchase is the then current fair market value as confirmed by an independent appraisal.
Note O--Home Health Care Services
ServiceMaster Home Health Care Services Inc. is a wholly owned subsidiary of The ServiceMaster Company and is a part of the ServiceMaster Diversified Health Services group.
Note P--Child Care Services
ServiceMaster Child Care Services, Inc., is a wholly owned subsidiary of The ServiceMaster Company and is a part of the New Business Development group. Its operations have been described above (page 8).
Note Q--International Services
The International Services component of the International and New Business Development group is a division of The ServiceMaster Company. Its operations have been described above (page 7). It owns all of the shares of TMX-Europe B.V., the Netherlands holding company for all pest control businesses acquired in Europe.
Note R--Other Subsidiaries
Other subsidiaries include CMI Group, Inc., a subsidiary of ServiceMaster Management Services L.P.; miscellaneous operating and name protection entities; and ServiceMaster Operations, AG, a Swiss corporation which, in turn, operates through separate subsidiaries organized in the United Kingdom and Germany. Reference is made to Exhibit 21 for a complete list of the subsidiaries of the Registrant.
Note S--Norrell Corporation
On February 11, 1994, ServiceMaster sold to Norrell Corporation ("Norrell") all of the common equity interest in Norrell held by ServiceMaster for $29.3 million, an amount which exceeded its carrying value. On March 31, 1994, ServiceMaster redeemed the preferred interest in The ServiceMaster Company which was issued in 1991 to, and thereafter held by, Norrell's principal stockholder. Payment of the redemption price was made on May 31, 1994 in the form of cash in the amount of $14.6 million and 372,950 shares of the Registrant.
Note T--ServiceMaster SGP Trust
On January 1, 1993, the limited partnership agreement of The ServiceMaster Company was amended to admit a trust as a Special General Partner of The ServiceMaster Company (the "SGP Trust"). The beneficiaries of the SGP Trust are the limited partners of the Registrant as constituted from time to time and ServiceMaster Corporation (but the latter is a beneficiary only if shares of its common stock are outstanding, which is not now the case). The SGP Trust receives each year an allocation of taxable income equal to the amount by which the aggregate taxable income of The ServiceMaster Company exceeds the cash distributions made by the Registrant directly to its limited partners (and to ServiceMaster Corporation, if and when ServiceMaster Corporation is activated). As a result of this allocation of taxable income, the cash distributions made by the Registrant directly to its limited partners and to ServiceMaster Corporation will equal or exceed the taxable income of the Registrant which is directly allocated to its limited partners and to ServiceMaster Corporation. The ServiceMaster Company makes cash distributions to the SGP Trust in the amounts required by the trust for the payment of its federal and state income tax liabilities. This arrangement prevents taxable income as allocated to the public shareholders from exceeding their cash distributions from the Registrant and thereby solves the "crossover problem" as described in earlier annual reports and in the Registrant's Proxy Statement dated December 11, 1991.
Item 2.



Item 2. Properties
The headquarters facility of ServiceMaster, which also serves as headquarters for the ServiceMaster Management Services and International and New Business Development groups, is owned by The ServiceMaster Company and is located on a ten-acre tract at One ServiceMaster Way, Downers Grove, Illinois. The initial structure was built in 1963, and two additions were completed in 1968 and 1976. In early 1988, ServiceMaster completed construction of a two-story 15,000 square foot addition for office space, food service demonstrations and dining facilities. The building contains approximately 118,900 square feet of air conditioned office space and 2,100 square feet of laboratory space. In the Spring of 1992, ServiceMaster completed the conversion of approximately 30,000 square feet of space formerly used as a warehouse to offices for Management Services and for The Kenneth and Norma Wessner Training Center.
ServiceMaster owns a seven acre, improved tract at 2500 Warrenville Road, Downers Grove, Illinois, which is adjacent to its headquarters facility. In 1993, ServiceMaster substantially remodeled the building and thereafter leased approximately half the space (50,000 square feet) to a commercial tenant. The balance of the space is utilized by ServiceMaster personnel.
ServiceMaster leases a 50,000 square foot facility near Aurora, Illinois which is used by ServiceMaster as a warehouse/distribution center.
ServiceMaster believes that the facilities described in the preceding three paragraphs will satisfy the Company's needs for administrative and warehouse space in the Chicago area for the immediate future.
ServiceMaster owns four properties in Cairo, Illinois, consisting of a 36,000 square foot, three-story building used for manufacturing and warehousing equipment, supplies and products used in the business; a warehouse and package facility comprising 30,000 square feet; a three-story warehouse and manufacturing building consisting of 43,000 square feet; and a 2,500 square foot building used for a machine shop. ServiceMaster leases a 44,000 square foot manufacturing facility in Lancaster, Pennsylvania, which is used to provide products and equipment primarily to customers of Management Services in the eastern part of the United States. Management believes that the foregoing manufacturing and warehouse facilities are adequate to support the current needs of ServiceMaster.
The headquarters for ServiceMaster Consumer Services L.P. are located in leased premises at 860 Ridge Lake Boulevard, Memphis, Tennessee. Until January 1995, Consumer Services was headquartered at 855 Ridge Lake Boulevard, Memphis, Tennessee.
The 860 Ridge Lake Boulevard facility also serves as the headquarters for TruGreen-ChemLawn, Terminix, Res/Com, and American Home Shield and, in mid-1995, will become the headquarters for Merry Maids. Consumer Services maintains some functions at the 855 Ridge Lake Boulevard facility, including computer and telecommunication services.
TruGreen-ChemLawn owns 5 buildings which are used as branch sites for lawn care services. These facilities are located in Texas (2 properties), Colorado (1 property), Ohio (1 property), and Georgia (1 property).
Terminix owns 16 buildings which are used as branch sites for termite and pest control services. These properties are all one-story buildings that contain both office and storage space. These properties are located in New Jersey (2 properties), California (2 properties), Florida (8 properties), and Texas (4 properties).
The headquarters facility for Merry Maids is presently located in leased premises at 11117 Mill Valley Road, Omaha, Nebraska, but as stated above, the Merry Maids headquarters will be relocated to Memphis, Tennessee in mid-1995.
American Home Shield moved all of its administration operations to Memphis, Tennessee during the year 1994, but the company retained some leased space in the building at 90 South E Street, Santa Rosa, California for administrative and sales operations. American Home Shield's service and data processing departments are located in premises owned by the company in Carroll, Iowa. This facility consists of a 43,000 square foot building on a seven-acre site.
American Home Shield owns approximately 98 acres of land in Santa Rosa, California. This land is held for investment purposes and has been and will continue to be offered for sale, with the timing of sales being affected by, among other things, market demand, zoning regulations, and the availability of financing to purchasers.
The headquarters for the ServiceMaster Diversified Health Services Companies ("DHS") is located in leased premises at 5050 Poplar Avenue, Memphis, Tennessee. DHS leases other administrative facilities in Plymouth Meeting, Pennsylvania; Dallas, Texas; and Atlanta, Georgia. As of December 31, 1994, DHS had an ownership interest in three nursing home facilities through joint venture arrangements in which DHS has a 50% interest.
Item 3.

Item 3. Legal Proceedings
In the ordinary course of conducting its business activities, ServiceMaster becomes involved in judicial and administrative proceedings which involve both private parties and governmental authorities. As of March 20, 1995, these proceedings included a number of general liability actions and a very small number of environmental proceedings.
General Liability Matters. Terminix is a party to litigation in Tennessee involving an alleged misapplication of the chemical Aldrin. This matter has been settled as to the compensatory element of the case for an amount within Terminix's insurance coverage. The punitive damages element of the case will be the subject of a new trial. Terminix expects that punitive damages, if any, will not be material in amount.
Environmental Matters. Terminix is one of several defendants named in a suit filed by the United States Environmental Protection Agency (the "EPA") on November 3, 1986 in the United States District Court for the Western District of Tennessee, to recover the costs of remediation at two sites in Tennessee which have been designated by the EPA as "Superfund sites" under the Comprehensive Environmental Response Compensation and Liability Act ("CERCLA"). Terminix has agreed, on an interim basis, to a ten percent cost share with respect to one site and has not entered a cost sharing agreement with respect to the other. In October 1991, Terminix was notified by a letter from the EPA, along with many other parties, as a "potentially responsible party" under CERCLA at a site in Wichita, Kansas; there have not been any developments in this matter since that date. Terminix was named in a Superfund site in Michigan but Terminix's connection to this matter is through an acquisition in which the seller retained responsibility for environmental matters; Terminix considers its exposure in this case to be not material. Terminix's actual participation in the total volume of hazardous waste at these sites is less than five percent. The CERCLA law is written to impose joint and several liability for the cleanup costs at any particular site on every contributor to that site, and accordingly every contributor's potential liability at every site is large. However, based on practical experience with prior CERCLA situations and the circumstances of the cases in which it is now involved, Terminix expects that its actual liability at these sites will not be material.
ServiceMaster believes the outcome of the proceedings referred to above will not be, individually or in the aggregate, material to its business, financial condition or results of operations.
Item 4.

Item 4. Submission of Matters to a Vote of Security Holders
None
PART II
Item 5.

Item 5. Market for Registrant's Partnership Shares and Related Shareholder Matters
Except for the information set forth in the second and third sentences of this Item 5, the portions of the ServiceMaster Annual Report to Shareholders for 1994 under the captions "Shareholders' Equity" (pages 32-33) and "Cash Distributions Per Share" and "Price Per Share" in the Quarterly Operating Results table (page 34) supply the information required by this item and such portions are hereby incorporated herein by reference. The Registrant's shares are listed and traded on the New York Stock Exchange. At March 20, 1995, the Registrant's shares were held of record by approximately 65,000 persons.
Item 6.

Item 6. Selected Financial Data
The portion of the ServiceMaster Annual Report to Shareholders for 1994 in the Financial Statements and Management Discussion section ("FSMD Section") under the caption "Eleven Year Financial Summary" (pages 22-23) supplies the information required by this item and such portion is hereby incorporated herein by reference.
Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Management's Discussion and Analysis of Financial Condition and Results of Operations for the three years ended December 31, 1994, is contained in the FSMD Section of the ServiceMaster Annual Report to Shareholders for 1994 on pages 17-21 and is hereby incorporated herein by reference.
Item 8.


Item 8. Financial Statements and Supplementary Data
The consolidated statements of financial position of ServiceMaster as of December 31, 1994 and 1993, and the consolidated statements of income, cash flows and shareholders' equity for the years ended December 31, 1994, 1993 and 1992 and notes to the consolidated financial statements are contained in the FSMD Section of the ServiceMaster Annual Report to Shareholders for 1994 on pages 24 - 34 and are incorporated herein by reference. The report of Arthur Andersen LLP thereon dated January 24, 1995, and the summary of significant accounting
policies are contained in the FSMD Section of the ServiceMaster Annual Report to Shareholders for 1994 on page 24 and are hereby incorporated herein by reference.
Item 9.

Item 9. Disagreements on Accounting and Financial Disclosure None.
PART III
Item 10.



Item 10. Directors and Executive Officers of the Corporate General Partner of Registrant and The ServiceMaster Company
The following section of this Item 10 shows: (i) the names and ages (as of March 17, 1995) of the present directors of ServiceMaster Management Corporation (the managing general partner of ServiceMaster Limited Partnership and The ServiceMaster Company); (ii) all positions and offices with ServiceMaster held by each such director; and (iii) the term of each such person as a director and all period(s) during which each director has served. There are no arrangements or understandings between any director and any other person pursuant to which the director was or is to be selected as a director or nominee. All committee memberships to which reference is made means membership on a committee of the Board of Directors of ServiceMaster Management Corporation.
1995 Class
Henry O. Boswell, age 65, has been a director since 1985. He is a member of the Executive Committee, the Consumer Services and International and New Business Development Committee, the Finance Committee, the Nominating Committee and the Compensation Committee. From 1983 until his retirement in October 1987, Mr. Boswell was President of Amoco Production Company. During the same time period, he was Chairman of the Board of Amoco Canada and a director of Amoco Corporation. Mr. Boswell is a director of Rowan Companies, Inc., Houston, Texas, and Cabot Oil & Gas Corp. in Houston, Texas.
James D. McLennan, age 58, has been a director since May 1986. He is a member of the Management Services and Diversified Health Services Committee and the Audit Committee. Mr. McLennan joined McLennan Company, a full service real estate company, in 1958. He was named partner in 1968 and became President in 1981. He is the Chairman of the Board of the Lutheran General Medical Center Foundation. Mr. McLennan is also a director of NBD Bank of Park Ridge, Park Ridge, Illinois, a director of Potomac
Corporation in Wheeling, Illinois, a laminator of paper products and a director of The Loewen Group Inc., a provider of funeral services, Burnaby, B.C., Canada.
Burton E. Sorensen, age 65, has been a director since May 1984. He is a member of the Executive Committee, the Finance Committee and the Compensation Committee. He is the Chairman and Chief Executive Officer of Lord Securities Corporation. He served as President and Chief Executive Officer of the corporation from December 1984 to December 1992. Mr. Sorensen is also a director of Provident Life and Casualty Insurance Company of America, Chattanooga, Tennessee.
Charles W. Stair, age 54, has been a director since December 1986. He previously served as a director from 1976 to 1983. On December 10, 1994 he was elected Vice Chairman of the Board of Directors. He is a member of the Management Services and Diversified Health Services Committee. Mr. Stair is a member of the Profit Sharing, Savings and Retirement Plan Administrative Committee. He served as the President and Chief Executive Officer of ServiceMaster Management Services from May 1991 to December 31, 1994, as President and Chief Operating Officer, Management Services, from June 1990 to April 1991, and as Executive Vice President and Chief Operating Officer, Management Services, from October 1, 1988 to May 1990. He is Chairman of the board of directors of Greater Europe Mission, Monument, Colorado, and Executive Chairman of Tyndale House Publishers, Inc., Wheaton, Illinois.
David K. Wessner, age 43, has been a director since March 1987. He is a member of the Executive Committee, the Management Services and Diversified Health Services Committee and the Compensation Committee. Mr. Wessner is Executive Vice President, HealthSystem Minnesota. Previously, he was Senior Vice President, Program and Process Improvement, Geisinger Health System, from November 1992 to August 1994. He was Senior Vice President and Administrative Director from 1982 to November 1992.
1996 Class
Sidney E. Harris, age 45, has been a director since December 10, 1994. He is a member of the Management Services and Diversified Health Services Committee. He has been the Dean of the Peter F. Drucker Graduate Management Center at the Claremont Graduate School, Claremont, California since 1991. He is a co- founder of the Institute for the Study of U.S./Japan Relations in the World Economy. Dr. Harris is a director of Family Savings Bank, Los Angeles, California, and Property Secured Investments, Inc., Los Angeles, California, a real estate investment trust.
He is also a member of the Board of Governors of the Peter F. Drucker Non-Profit Foundation, New York, and a trustee of Menlo College, Atherton, California.
Herbert P. Hess, age 58, has been a director since 1981. He is a member of the Executive Committee, the Consumer Services and International and New Business Development Committee, the Finance Committee, the Nominating Committee, the Compensation Committee and the Share Option Committee. Mr. Hess is a Managing Director of Berents & Hess Capital Management, Inc., an investment management firm. He is the past President and Chief Executive Officer of State Street Research & Management Company, an investment management firm. Mr. Hess was Chairman of MetLife- State Street Investment Services, Inc. from 1988 to April 1, 1990.
Kay A. Orr, age 56, has been a director since January 1, 1994. She is a member of the Consumer Services and International and New Business Development Committee. Mrs. Orr was Governor of Nebraska from 1987 to 1991 and served as the State Treasurer of Nebraska from 1981 to 1986. From 1979 to 1981, she served as Chief of Staff to the Governor of Nebraska. Mrs. Orr is a director of The Williams Companies, Tulsa, Oklahoma, a director of VanCom Incorporated, Oak Brook Terrace, Illinois, a transportation company, a trustee of Hastings (Nebraska) College, and a trustee of the Peoples City Mission Foundation.
Phillip B. Rooney, age 50, has been a director since January 1, 1994. He is a member of the Executive Committee, the Consumer Services and International and New Business Development Committee and the Compensation Committee. Mr. Rooney is a director and the President and Chief Operating Officer of WMX Technologies, Inc., Oak Brook, Illinois and the Chairman and Chief Executive Officer of its Waste Management, Inc. subsidiary, Oak Brook, Illinois, the Chairman of the Board and Chief Executive Officer of Wheelabrator Technologies Inc., Hampton, New Hampshire, Chairman of the Board of Rust International Inc., Birmingham, Alabama, and a director of Waste Management International, plc, London, England. He is also a director of Illinois Tool Works, Inc., Caremark International, Inc. and Urban Shopping Centers, Inc.
1997 Class
Carlos H. Cantu, age 61, has been a director since 1988. He is a member of the Consumer Services and International and New Business Development Committee, the Management Services and Diversified Health Services Committee, the Finance Committee and the Nominating Committee. On January 1, 1994, Mr. Cantu became the President and Chief Executive Officer of ServiceMaster. He
served as the President and Chief Executive Officer of ServiceMaster Consumer Services from May 1991 to August 1994, as Executive Vice President and Chief Operating Officer, Consumer Services, from October 1988 to May 1990 and as President and Chief Operating Officer of ServiceMaster Consumer Services from June 1, 1990 to May 1991. He served as President and Chief Executive Officer of The Terminix International Company Limited Partnership from December 18, 1986 to December 31, 1992. He has been a director of Midland Financial Group, Inc., an insurance company in Memphis, Tennessee, since September 1992 and of Haggar Corporation, a clothing company in Dallas, Texas, since February 9, 1995.
Lord Brian Griffiths of Fforestfach, age 53, has been a director since August 1992. He is a member of the Executive Committee, the Nominating Committee and the Compensation Committee. He is an international advisor to Goldman, Sachs & Co. concerned with strategic issues related to their United Kingdom and European operations and business development activities worldwide. During the period 1985 to 1990, he served at No. 10 Downing Street as Head of the Prime Minister's Policy Unit. He was made a life peer at the conclusion of his service to the Prime Minister. Lord Griffiths is a director of THORN EMI plc, Times Newspapers Holding Ltd., Herman Miller, Inc., Zeeland, Michigan, and Telewest, London, England.
Gunther H. Knoedler, age 65, has been a director since 1979. He is a member of the Executive Committee, the Management Services and Diversified Health Services Committee, the Audit Committee (of which he is the Chairman), the Compensation Committee and the Share Option Committee. Mr. Knoedler is a retired Executive Vice President and Director Emeritus of Bell Federal Savings & Loan Association, Chicago, Illinois. He is a member of the Board of Trustees of Wheaton College, Wheaton, Illinois, and a member of the Board of Directors of Tyndale House Publishers, Inc.
Vincent C. Nelson, age 53, has been a director since 1978. Mr. Nelson is a member of the Executive Committee, the Consumer Services and International and New Business Development Committee, the Nominating Committee, the Compensation Committee, the Audit Committee, the Employee Share Purchase Plan Administrative Committee and the Share Option Committee. Mr. Nelson is a business investor and is a trustee of Westmont College, Santa Barbara, California.
C. William Pollard, age 56, has been a director since December 1977. Since May 1990, he has been the Chairman of the Board of Directors and Chairman of the Executive Committee of the Board of Directors. He is a member of the Consumer Services and International and New Business Development Committee, the Management Services and Diversified Health Services Committee,
the Finance Committee and the Nominating Committee. From May 1983 to December 31, 1993, Mr. Pollard served as the Chief Executive Officer of ServiceMaster. He served as President of ServiceMaster from 1981 to May 1990. Mr. Pollard is a director of Herman Miller, Inc., Zeeland, Michigan, an office furniture manufacturer; a director of Provident Life and Casualty Insurance Company of America, Chattanooga, Tennessee; and advisory director of Trammell Crow Company, Dallas, Texas, a real estate management company. He is the Chairman of the Board of Trustees of Wheaton College, Wheaton, Illinois.
Senior Management Advisers
The Bylaws of ServiceMaster Management Corporation provide that the Board of Directors may appoint officers of ServiceMaster and other persons having a special relationship to ServiceMaster to serve as Senior Management Advisers. Senior Management Advisers attend the meetings of the Board and advise the Board but do not have the power to vote. The Board has determined that providing a greater number of officers the opportunity to advise and interact with the Board is in the best interest of ServiceMaster as well as the individual officers. The Senior Management Advisers receive no special compensation for their services in this capacity.
The Board of Directors has appointed the persons listed below as Senior Management Advisers effective as of the 1994 annual meeting of shareholders to serve in such capacity until the annual meeting of shareholders in 1995 or until otherwise determined by the Board of Directors.
Robert D. Erickson, age 51, was a director from May 1987 to May 1993. He previously served as a director from May 1981 through May 1984. He is a non-director member of the Consumer Services and International and New Business Development Committee. Mr. Erickson also is a member of the Profit Sharing, Savings and Retirement Plan Administrative Committee, the Employee Share Purchase Plan Administrative Committee, and the Employee Benefits Plan Committee. He is President and Chief Operating Officer, International and New Business Development. He served as Executive Vice President and Chief Operating Officer of this division from November 1992 to October 1993. He served as Executive Vice President and Chief Operating Officer, People Services, from January 1990 to October 1992 and as Executive Vice President and Chief Financial Officer of ServiceMaster from January 1986 through December 1989. Mr. Erickson is a director and Vice Chairman of Moody Bible Institute, Chicago, Illinois, an educational institution, and he is a director of VanCom Incorporated, Oak Brook Terrace, Illinois, a transportation company.
Brian D. Oxley, age 44, is President and Chief Operating Officer of ServiceMaster Management Services. From November 1992 to December 31, 1993, he served as the President and Chief Executive Officer of the International and New Business Development Group. He served as Executive Vice President, New Business Development from January 1991 to November 11, 1992 and as President of International Services from January 1, 1988 to November 11, 1992. Mr. Oxley is a director of Kawakita Hospital, Tokyo, Japan. He is a non-director member of the Management Services and Diversified Health Services Committee.
Dallen W. Peterson, age 58, served as the Chairman of Merry Maids, Inc. until the acquisition of that company's assets by Merry Maids Limited Partnership in July 1988. He is presently the Chairman of Merry Maids Limited Partnership. He is a non- director member of the Consumer Services and International and New Business Development Committee.
Donald K. Karnes, age 44, is President of TruGreen-ChemLawn. He has served as President and Chief Operating Officer of TruGreen-ChemLawn since January 1, 1992; from January 1, 1990 to December 31, 1991, he was Senior Vice President, TruGreen Limited Partnership. During the year 1989, Mr. Karnes was a Regional Vice President for Waste Management Urban Services, Inc. He is a non-director member of the Consumer Services and International and New Business Development Committee.
Robert F. Keith, age 38, was elected President and Chief Operating Officer of ServiceMaster Consumer Services, Inc., effective August 1, 1994. He served as Group President, ServiceMaster Consumer Services, from November 1992 to July 1994. He had been Vice President, Treasurer and Chief Financial Officer from November 1989 to October 1992. He is a non-director member of the Consumer Services and International and New Business Development Committee.
Executive Officers of ServiceMaster
The following table shows: (i) the names and ages (as of March 20, 1995) of the present executive officers of the Registrant, The ServiceMaster Company and ServiceMaster Management Corporation; (ii) all positions presently held by each officer; and (iii) the year each person became an officer. Each person named has served as an officer of the Registrant continuously since the year shown, except for Jerry D. Mooney, who has served as an officer of the Registrant's subsidiaries, ServiceMaster Diversified Health Services, Inc. and ServiceMaster Diversified Health Services L.P. since August 31, 1993 and as an executive officer of the Registrant since March 1995. There are no arrangements or understandings between any executive officer
and any other person pursuant to which the officer was or is to be selected as an officer.
Messrs. Pollard, Stair and Cantu are also Directors of ServiceMaster Management Corporation. Messrs. Erickson, Oxley and Keith are Senior Management Advisers. See pages 20-23 for biographical information with respect to these executive officers.
Jerry D. Mooney, age 41, is the President and Chief Executive Officer of ServiceMaster Diversified Health Services, Inc. and ServiceMaster Diversified Health Services L.P. He has held these positions since the acquisition of these companies by the Registrant in August 1993. He is a non-director member of the Management Services and Diversified Health Services Committee of the Board of Directors. He is also a director, chairman of the audit committee and member of the compensation committee of Concord EFS, Inc., a company headquartered in Memphis, Tennessee, involved primarily in the electronic processing of debit and credit card transactions.
Vernon T. Squires, age 60, was elected Senior Vice President and General Counsel effective January 1, 1988. He served as Vice President and General Counsel from April 1, 1987 until December 31, 1987. He served as an associate and partner with the law firm of Wilson & McIlvaine in Chicago, specializing in corporate and tax law, from 1960 to April 1, 1987. He is presently Of Counsel to that firm. He is a director of the Suburban Bus Division of the Regional Transportation Authority and a member of the Advisory Board to The Private Bank, Wilmette, Illinois.
Ernest J. Mrozek, age 41, was elected Senior Vice President and Chief Financial Officer effective January 1, 1995. He served as Vice President and Chief Financial Officer from May 1, 1994 to December 9, 1994, as Vice President, Treasurer and Chief Financial Officer from November 1, 1992 to April 30, 1994, as Vice President and Chief Accounting Officer, from January 1, 1990 to October 31, 1992 and as Vice President, Accounting, from December 1987 to December 1989. He practiced public accounting as a manager with Arthur Andersen & Co. from 1981 to December 1987.
Eric R. Zarnikow, age 35, was elected Vice President and Treasurer effective May 1, 1994. From August 1991 to April 1994, he served as Vice President and Treasurer of Gaylord Container Corporation. He was Treasurer of Gaylord Container Corporation from June 1987 to July 1991.
Deborah A. O'Connor, age 32, was elected Vice President and Controller effective January 1, 1993. From July 1991 to December 1992, she was Manager of Financial Projects. She previously had practiced public accounting with Arthur Andersen and Co. since 1984. She is a member of the Profit Sharing, Savings and Retirement Plan Administrative Committee.
Compliance With Section 16(a) of The Exchange Act of 1934
Section 16(a) of the Securities Exchange Act of 1934 requires ServiceMaster's officers and directors, and persons who own more than ten percent of ServiceMaster's shares, to file reports of ownership and changes in ownership with the Securities and Exchange Commission (the "Commission") and the New York Stock Exchange. The Commission's regulations require certain officers, directors and greater-than-ten-percent shareholders to furnish to ServiceMaster copies of all Section 16(a) forms that they file. During 1994, ServiceMaster received Section 16(a) forms from such officers and directors. ServiceMaster has no shareholders with an interest greater than ten percent.
Based solely on a review of the copies of Section 16(a) forms received by ServiceMaster or on written representations from certain reporting persons that no Forms 5 were required for those persons, ServiceMaster believes that during 1994, its officers and directors complied with applicable filing requirements except that two reports, covering an aggregate of two transactions, were filed late by Messrs. Wessner and Stair.
Item 11.

Item 11. Executive Compensation
The following table sets forth all compensation awarded to, earned by, or paid to the Chief Executive Officer of ServiceMaster and ServiceMaster's four most highly compensated executive officers other than the Chief Executive Officer of ServiceMaster during or in respect of the year 1994. Each of the listed persons was holding the office indicated in the table on the last day of December 1994.
(A) The table does not include the cash distributions made to ServiceMaster Management Corporation, as the managing general partner of the Registrant and The ServiceMaster Company, and the redistribution of such amounts to the stockholders of ServiceMaster Management Corporation (who include the persons listed in the above table). See Note D, page 12. The foregoing amounts represent the stockholders' share of profits in return for their equity risk.
(B) With respect to the year 1994, see Note (A) to the Option/SAR Grants Table. The figures shown for earlier years are the number of the underlying shares for grants of options under the ServiceMaster 10 Plus Option Plan.
(C) Mr. Mooney was not employed within the Registrant's organization in 1992 and for most of 1993 and he was not an executive officer of the Registrant during either of these two years.
The following table summarizes the number and terms of the stock options (if any) granted during the year 1994 to the named executive officers.
(A) ServiceMaster 10 Plus Option grants were approved for each of the named executive officers in October 1993. In each case, acceptance of the option and payment by the grantee of the price for the option itself ($1.50 per option share) was not required until early 1994. These grants were not shown in the Options/SAR Grants Table in the Registrant's Form 10-K for 1993 but are reported in the above table.
(B) ServiceMaster 10 Plus Option grants were approved for each of the named executive officers in December 1994. In each case, acceptance of the option and payment of the price for the option itself ($1.50 per option share) was not required until early 1995. These grants will be shown in the Option/SAR Grants Table in ServiceMaster's Form 10-K for 1995.
(C) The fair market value of the Registrant's shares at the time when the grants of the options were made (October 1993) was $25.75. Each grantee was required to pay $1.50 per option share as a condition to receiving the option (which sum was, in each case, paid in February 1994). Column (d) combines the exercise price and the option price.
(D) C. William Pollard was a named executive officer in the Option/SAR Grant Table in the Registrant's Form 10-K for 1993. He was granted an option in 1993 which was not accepted until early 1994. In accordance with Note (B) to the 1993 Option/SAR Table, the following details for such option are set forth in this Form 10-K for 1994. Number of option shares granted: 75,000; percent of total options granted in 1993: 7.16%; exercise or base price: $27.25/option share; expiration date: 9-30-2003; potential realizable value at 5% and 10% assumed annual rates of stock price appreciation for the option term: $1,102,053 and $2,965,415.
The following table summarizes the exercises of stock options during the year 1994 by the named executive officers and the number of, and the spread on, unexercised options held by such officers at December 31, 1994.
(A) The Options shown in the Options/SAR Grants Table on the preceding page were not in-the-money at December 31, 1994. Accordingly, such options are not included in column (e).
As shown in the following table, no long-term incentive awards were granted to any of the named executive officers during the year 1994.
Compensation of Directors
During the year 1994, directors of ServiceMaster Management Corporation who were not officers received $3,000 for each meeting of the Board of Directors and each meeting of the Executive Committee which they attended. In addition, directors who were not officers and who were not members of the Executive Committee received an annual stipend of $5,000; and directors who were not officers and who were members of the Executive Committee received an annual stipend of $10,000. Directors who were members of the Audit Committee (which committee does not include any officers) received an annual stipend of $8,000, except that the annual stipend for the Chairman of the Audit Committee was $10,000. In 1995, the annual stipend for outside directors will be $12,000.
During the year 1994, a director of a subsidiary company who was not an officer of that company or any ServiceMaster company which is a parent of the subsidiary received $3,000 for each meeting of the subsidiary board of directors which he or she attended. If such a person was not a director of ServiceMaster Management Corporation, he or she also received an annual stipend of $5,000. The practice of having independent directors on the board of directors of subsidiary entities was discontinued effective January 1, 1995 and no compensation will be paid thereafter in respect of directorships on such boards.
Each director of ServiceMaster Management Corporation or of a subsidiary board of directors may enter into a deferred fee agreement with the company on whose board he or she is serving whereby part or all of the fees payable to him or her as a director are deferred and will either earn interest based on the five-year borrowing rate for ServiceMaster or be used to purchase shares of ServiceMaster Limited Partnership in a number determined by the fair market value of such shares on the date of purchase. Upon termination of a director's services as a director or attainment of age 70, whichever occurs first, a director will receive the amount for his or her deferred fee account in a lump sum or in installments or in shares of ServiceMaster Limited Partnership, depending on which deferral plan the director has elected.
In July 1994, the Board of Directors adopted the ServiceMaster 1994 Non-Employee Directors Share Option Plan (the "Directors Option Plan") and authorized a total of 250,000 shares of the Registrant to be issued pursuant to the exercise of options granted under such plan. The Directors Option Plan provides that options to purchase shares of the Registrant may be granted from time to time by the Board of Directors to those members of the Board who are not employees of any ServiceMaster entity. The exercise price of such options is the fair market value of the shares at the time of the grant. The Directors
Option Plan contemplates that the options themselves will be purchased at a price which reflects the value of the option at the time of the grant. Thereafter, a total of nine options for 5,000 shares each were granted at a price of $1.50 per option share.
Employment Contracts and Termination of Employment
ServiceMaster enters into employment contracts with each of its executive officers in December of each year to cover the officer's employment during the subsequent calendar year. Each contract provides for the amount of such officer's base salary for the calendar year covered by the contract. Either party may cancel the contract on two weeks' notice to the other party. If an executive officer's employment terminates, he or she is prohibited from entering into certain activities which are competitive with any of the ServiceMaster businesses. These contracts do not provide for any bonuses or other form of compensation beyond the base salary stated in the contract.
The amounts paid under the employment contracts with each of the persons listed in the Summary Compensation Table are included in Column (c) of the table.
Change-in-Control Arrangements
The ServiceMaster Plan for Continuity of Employment (the "Plan") was adopted by the Board of Directors of ServiceMaster Industries Inc. on July 19, 1986 and assumed by ServiceMaster Limited Partnership and its subsidiaries at the time the ServiceMaster reorganization became effective on December 30, 1986. The purpose of the Plan is to provide protection to a broad range of ServiceMaster employees from damage to their careers which could result if ServiceMaster were taken over by another organization.
The Plan provides that if during the period following a takeover to which the Plan applies any covered employee is fired or leaves after being demoted, then ServiceMaster will be obligated to pay that employee an amount equal to either (i) the amount of the employee's relevant annual compensation (if the employee has between two and five years of credited service with ServiceMaster) or (ii) 2.5 times the employee's relevant annual compensation (if the employee has more than five years of credited service). The amount of an employee's relevant annual compensation will be the amount of the cash compensation received by the employee during the calendar years preceding the year in which the Plan becomes activated with respect to the takeover involved, provided that in no event will an employee be entitled to receive under the Plan more than twice the amount of the compensation (including both cash compensation and benefits with a monetary value received in a form other than cash) received by
the employee during the calendar year preceding the termination of his or her employment.
The Plan is not limited to management employees but rather covers every ServiceMaster employee who has at least two years of credited service at the time his or her employment terminates.
The Plan provides that a takeover will be deemed to have occurred for purposes of the Plan when (i) any organization or group (other than ServiceMaster employees or plans established for the benefit of ServiceMaster employees) acquires ownership of at least 20% of ServiceMaster outstanding shares, or (ii) a majority of the positions on the Board of Directors of ServiceMaster Management Corporation (the "ServiceMaster Board") come to be occupied by "Takeover Directors" (as defined in the Plan).
The Plan provides that it will automatically become activated with respect to any particular takeover ten days after the ServiceMaster Chief Executive Officer becomes aware that the takeover has occurred except that the ServiceMaster Board has the right to accelerate or postpone the date upon which the Plan will become activated with respect to any particular takeover. The ServiceMaster Board has the right at any time before the Plan becomes activated to modify the terms of the Plan and to exempt any particular takeover from operation of the Plan or to terminate the Plan, but no such notification exemption or termination can be made after activation.
Employees are entitled to compensation under the Plan in connection with any takeover to which the Plan applies only if their employment terminates within the "Shakeout Period" beginning at the time such takeover occurs and ending on the second anniversary of the date on which the Plan is activated with respect to that particular takeover.
The Plan is expressly intended to be a severance pay plan for purposes of the Employee Retirement Income Security Act of 1974 ("ERISA") and ServiceMaster employees are expressly entitled to the protection afforded by ERISA to participants in a severance pay plan.
The Plan is designed to put any organization which may at any time consider taking over ServiceMaster on notice in advance that it may be required to compensate individuals who have made significant career investments in ServiceMaster if those individuals are disadvantaged by the takeover. At the same time, the Plan is intended to serve the best interests of those who invest in ServiceMaster for the long term by (i) improving the ability of the ServiceMaster enterprise to recruit and retain employees, (ii) increasing the willingness of employees to risk working for long-term rewards rather than seeking to maximize
their immediate salary, and (iii) providing insurance to employees against any unfavorable outcome, and thereby encouraging employees to remain with ServiceMaster while the outcome of a takeover attempt is in doubt.
Compensation Committee Interlocks and Insider Participation
The persons who served as members of the Compensation Committee of the Registrant's board of directors during 1994 are listed in the next section. The Compensation Committee consists solely of independent members of the board of directors. There are no interlocking arrangements involving service by any executive officer of the Registrant on the Compensation Committee of another entity and an executive officer of such other entity serving on the ServiceMaster Compensation Committee.
Board Compensation Committee Report on Executive Compensation
The following report of the Compensation Committee of the Board of Directors of ServiceMaster Management Corporation was delivered to the Board of Directors on March 17, 1995. The Compensation Committee consists of the members of the Executive Committee other than the Chairman of the Company. (The Executive Committee consists of independent directors and the Chairman.) As used in the report, the term "salary year" means the calendar year.
"REPORT OF THE COMPENSATION COMMITTEE"
To: The Board of Directors:
The Executive Committee as constituted in December 1994, in its capacity as the Compensation Committee for the year 1994, hereby submits its report to the Board of Directors for the year 1994.
In December of each year, the Compensation Committee reviews the compensation levels of senior members of management, evaluates the performance of management and recommends a base salary for each member of senior management for the next salary year. This review and recommendation process includes a review of additional compensation (if any) payable under the Company's Incentive Reward Compensation Plan. At the end of each salary year, the Compensation Committee determines whether adjustments should be made in the compensation of an executive as established by his or her base salary and the Incentive Reward Compensation Plan. The Compensation Committee does not constitute the administering committee under any of the Company's stock option plans, but the Compensation Committee does take option grants to
senior members of management into account in the reviews and recommendations described above.
Summary of Compensation Policies. The compensation policies applicable to all executive officers are as follows: (1) a base level of compensation is established by reference to the standards described below; (2) bonuses are paid in accordance with the Company's Incentive Reward Compensation Plan, under which bonuses are determined by the extent to which the actual performance of the Company (or the relevant division thereof) achieved budget objectives; and (3) such year-end adjustments as the Compensation Committee may consider to be warranted.
The standards for determining the base compensation in any given year for the Chief Executive Officer (and for all other officers whose salaries are subject to Compensation Committee approval) are: performance by the officer in the discharge of his or her responsibilities, financial performance of the Company for the immediately preceding year, and the base salary levels of comparable officers in comparable companies.
Five Highest Paid Officers. The base compensation of each of the highest paid officers for 1994 (including the Chief Executive Officer) was in the amount recommended by the Compensation Committee in December 1993 and approved by the Board of Directors in the same month. This base compensation was further reviewed at the end of 1994. The Compensation Committee unanimously agrees that these base levels were reasonable at the time established and reasonable in the context of the performance of the Company in 1994 and the contribution of such persons to the Company's performance.
Chief Executive Officer. The base compensation of Carlos H. Cantu, President and Chief Executive Officer, for the year 1995 was set at $380,000 at the commencement of the year. This amount reflects an increase of $30,000 in his base compensation for the year 1994. This increase in the base compensation for the Chief Executive Officer for the year 1995 was warranted in the light of both the Company's and his performance in the year 1994. (Reference is made to the Management Discussion and Analysis section of the Company's 1994 Annual Report to Shareholders for a discussion of the Company's performance in 1994 and a summary of the Company's growth in 1994 relative to 1993). The Committee also approved a modification of the formula in the Company's Incentive Reward Compensation Plan so that, with respect to the year 1994, the Chief Executive Officer was awarded incentive compensation in the amount of 175% of his 1994 base compensation.
The Compensation Committee notes that the Chief Executive Officer was granted an option for 75,000 shares in December 1994, subject to acceptance by him and payment of the price for the
option itself of $1.50 per option share. This grant was accepted and the required payment was made in March 1995.
No member of the Compensation Committee is a former or current officer or employee of the Company or any of its subsidiaries.
Respectfully submitted, Dated: March 17, 1995 Henry O. Boswell Lord Brian Griffiths Herbert P. Hess Gunther H. Knoedler Vincent C. Nelson Phillip B. Rooney Burton E. Sorensen David K. Wessner
(Compensation Committee)
Performance Graph
The following graph compares the five-year cumulative total return to shareholders of the Registrant with the five year cumulative return as determined under the Standard & Poor's 500 Index and under the Dow Jones Consumer and Household Services Index.
See Graphics Appendix
Item 12.

Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth as of March 20, 1995, the beneficial ownership of the Partnership Shares with respect to ServiceMaster's directors and senior management advisers, those executive officers named in the Summary Compensation Table (page 26), and the Registrant's directors and officers as a group. The Registrant does not know of any person who is the beneficial owner of more than five percent of its shares.
(1) The shares owned by each person and by all directors and officers as a group, and the shares included in the total number of shares, have been adjusted, and the percentage ownership figures have been computed, in accordance with Rule 13d-3(d)(1)(i).
(2) Shares in column (3) are owned by spouse as to which beneficial ownership is disclaimed.
(3) Shares in column (3) include shares held by spouse and/or other family members.
(4) Shares in column (2) include shares which may be acquired within sixty days under options granted under the ServiceMaster Share Option Plan, under the ServiceMaster 10- Plus Option Plan and/or the Directors Option Plan.
(5) Shares in column (3) include shares held in one or more investment partnerships in which the listed person is a partner with shared voting power and investment power.
(6) Shares in column (2) include shares held in trust for the benefit of self and/or family members.
(7) Shares in column (3) include 28,792 shares owned by spouse or held in trust for the benefit of family members as to which beneficial ownership is disclaimed.
(8) Shares in column (3) include shares held in trust for benefit of self and/or family members.
(9) Shares in column (2) include 13,717 shares in trust for the benefit of family members as to which beneficial ownership is disclaimed. Shares in column (3) include 4,365 shares held in trust for the benefit of family members as to which beneficial ownership is disclaimed.
(10) Shares in column (3) include 51,725 shares owned by a charitable trust of which Vincent C. Nelson is a trustee. Mr. Nelson disclaims beneficial ownership of such shares.
(11) Shares in column (3) include 18,000 shares owned by a charitable foundation of which C. William Pollard is a director. Mr. Pollard disclaims beneficial ownership of such shares. Shares in column (3) also include 10,201 shares in trust for the benefit of family members.
(12) Shares in column (3) include 3,500 shares owned by a charitable foundation of which Carlos H. Cantu is an
officer. Mr. Cantu disclaims beneficial ownership of such shares.
(13) Shares in column (3) include 20,700 shares owned by a charitable foundation of which Charles W. Stair is a director. Mr. Stair disclaims beneficial ownership of such shares.
(14) Shares in column (3) include 450,000 shares owned by a charitable foundation of which David K. Wessner is a director. Mr. Wessner disclaims beneficial ownership of such shares.
(15) Shares in column (3) include 206,110 shares held by an investment company of which David K. Wessner is a shareholder and one of four directors.
(16) Shares in column (3) are owned by a corporation in which Mr. Mooney owns no stock but of which he is the president. Mr. Mooney disclaims beneficial ownership of such shares.
(17) Includes 2,640,395 shares which certain officers of ServiceMaster, through the exercise of their respective rights, may acquire within 60 days under share purchase agreements, options granted under the ServiceMaster Share Option Plan and options granted under the ServiceMaster 10- Plus Option Plan. This figure includes shares purchasable by the persons identified in Item 11 as follows: Mr. Cantu - 150,000 shares; Mr. Erickson - 95,000 shares; Mr. Mooney - 50,000 shares; Mr. Keith - 119,500 shares; Mr. Squires - 70,000 shares; and all executive officers as a group - 792,000 shares.
Item 13.

Item 13. Certain Relationships and Related Miscellaneous Transactions
ServiceMaster Limited Partnership and The ServiceMaster Company made distributions to ServiceMaster Management Corporation (the managing general partner of these two partnerships) with respect to the year 1994 based on the managing general partner's 1.99% carried interest in the profits and losses of these two partnerships. (See Note D, page 17).
Indebtedness of Management
The following executive officers were indebted to The ServiceMaster Company in excess of $60,000 at some point during the year 1994. Their indebtedness was incurred by reason of tax loans made in connection with one or more share grants ("Share Grants") made to the person before 1994 under the ServiceMaster
Share Grant Award Plan and/or by reason of a full recourse loan made to assist the person in connection with a portion of his acquisition of an equity interest in certain subsidiaries of the Registrant. The figure set opposite the person's name below is the largest amount of indebtedness outstanding during the year 1994; the figure in parentheses is the amount of indebtedness outstanding on March 20, 1995: Charles W. Stair - $500,000 ($500,000); Brian D. Oxley - $523,925 ($306,342); Jerry D. Mooney - $363,000 ($363,000); Robert F. Keith - $118,656 ($97,409); Ernest J. Mrozek - $106,685 ($90,399); and Vernon T. Squires - $123,895 ($57,945). Interest on each of the foregoing loans is charged to the borrower at a rate between 6% and 10% per annum and is charged quarterly.
PART IV
Item 14.

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) Financial Statements, Schedules and Exhibits
1. Financial Statements
The documents shown below are contained in the Financial Statements and Management Discussion section of the ServiceMaster Annual Report to Shareholders for 1994, on pages 17 - 34 and are incorporated herein by reference:
Summary of Significant Accounting Policies
Report of Independent Public Accountants
Consolidated Statements of Income for the three years ended December 31, 1994, 1993 and 1992
Consolidated Statements of Financial Position as of December 31, 1994 and 1993
Consolidated Statements of Cash Flows for the three years ended December 31, 1994, 1993 and 1992
Consolidated Statements of Shareholders' Equity for the three years ended December 31, 1994, 1993 and 1992
Notes to the Consolidated Financial Statements
2. Financial Statements Schedules
Schedule IV--Amounts Receivable from Related Parties and Underwriters, Promoters, and Employees other than Related Parties. The items required by this Schedule are incorporated into the information relating to Share Grants on page 36.
Included in Part IV of this Report:
Schedule VIII--Valuation and Qualifying Accounts
Report of Independent Public Accountants on Schedules
Exhibit 11 -- Exhibit Regarding Detail of Income Per Share Computation
Exhibit 23 -- Consent of Independent Public Accountants
Other schedules are omitted because of the absence of conditions under which they are required or because the required information is given in the financial statements or notes thereto.
Separate financial statements and supplemental schedules of the Registrant are omitted because prior to 1987 the Registrant was primarily an operating company. Its subsidiaries, included in the consolidated financial statements being filed, did not have a minority equity interest or indebtedness to any person other than the Registrant in an amount in excess of five percent of the total assets as shown by the consolidated financial statements as filed herein.
3. Exhibits
The exhibits filed with this report are listed on pages 94-100 herein (the "Exhibits Index").
The following entries in the Exhibits Index are management contracts or compensatory plans in which a director or any of the named executive officers of the Registrant does or may participate. Reference is made to the Exhibits Index for the filing with the Commission which contains such contract or plan.
(b) Reports on Form 8-K
None in the last quarter of the period covered by this Report on Form 10-K.
Certain Undertakings With Respect To Registration Statements on Form S-8
For the purposes of complying with the amendments to the rules governing Form S-8 (effective July 13, 1990) under the Securities Act of 1933, the Registrant hereby undertakes as follows which undertaking shall be incorporated by reference into each of the Registrant's Registration Statements on Form S-8, including No. 33-19763 and No. 2-75851:
Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.
FEDERAL INCOME TAX CONSIDERATIONS
The following discussion of Federal income tax matters describes the material consequences to the non-corporate U.S. shareholders of ServiceMaster Limited Partnership (the "Public Partnership") and to the Public Partnership as sole common limited partner of The ServiceMaster Company Limited Partnership (the "Principal Subsidiary Partnership"). (These two partnerships are together referred to as the "Principal Partnerships".) This discussion does not consider state, local and foreign tax issues, nor does it separately describe (except where noted) the consequences to shareholders who received their shares as a form of compensation (or in exchange for ServiceMaster stock issued in prior years as compensation), or which are corporations, tax-exempt entities, or non-resident alien individuals.
THIS DISCUSSION MAY NOT BE DIRECTLY APPLICABLE TO ANY PARTICULAR SHAREHOLDER, DEPENDING ON THAT SHAREHOLDER'S UNIQUE CIRCUMSTANCES. SHAREHOLDERS ARE URGED TO CONSULT THEIR OWN TAX ADVISORS TO DETERMINE THE FEDERAL INCOME TAX TREATMENT IN THEIR SPECIFIC TAX SITUATIONS, INCLUDING THE APPLICATION AND EFFECT OF THE STATE, LOCAL AND FOREIGN LAWS WHICH MIGHT APPLY TO A SPECIFIC SHAREHOLDER.
The following discussion is based on provisions of the Internal Revenue Code of 1986 (the "Code"), as amended, existing and proposed regulations promulgated thereunder, judicial deci- sions, legislative history, and current administrative rulings and practices. For a number of Code sections the Internal Revenue Service (the "IRS") has been directed or authorized by statute to issue regulations that may materially affect the tax consequences of holding an interest in ServiceMaster. As of the date hereof, certain of these regulations have not yet been promulgated. Moreover, any of the statutes, regulations, rulings, practices, or judicial precedents upon which this discussion is based could be changed, perhaps retroactively, with adverse tax consequences.
The Federal income tax treatment of shareholders, as described below, depends in some instances on interpretation by ServiceMaster Management Corporation (the "Managing General Partner") of complex provisions of the Federal income tax law for which no clear precedent or authority may be available. In determining basis adjustments, allocations, asset valuations and taxable income of the Principal Partnerships, the Managing General Partner must make determinations that will affect a shareholder in various ways depending on such factors as the date a shareholder purchased shares of the Public Partnership.
Possible Legislative Changes. Congress is considering the possible enactment of proposals to revise in certain respects the
federal income taxation of widely held partnerships (such as the Public Partnership). These proposals would, among other changes, simplify the rules under which the partners report their share of partnership income or loss and change the rules relating to the auditing of, and the collection of deficiencies with respect to, such partnerships.
Tax Status of the Principal Partnerships
Significance of "Partnership" Status. Except as otherwise provided by Code Section 7704, a partnership incurs no Federal income tax liability unless the partnership is classified as an association taxable as a corporation. Instead, each partner in a partnership is required to take into account in computing his or her Federal income tax liability his or her allocable share of the income, gains, losses, deductions and credits of the partnership. The Federal income tax treatment contemplated for shareholders of the Public Partnership will be available only if the Public Partnership is not classified as an association taxable as a corporation.
If either of the Principal Partnerships were classified as an association taxable as a corporation in any year, such partnership's income, gains, losses, deductions and credits would be reflected on its own tax return, rather than being passed through to shareholders, and its net income would be taxed at corporate rates (with the maximum rate for regular tax currently equal to 35%, and the rate for alternative minimum tax equal to 20%). In addition, distributions made to shareholders would be treated as (a) taxable dividend income (to the extent of such partnership's current and accumulated earnings and profits) or, to the extent distributions exceed the partnership's earnings and profits, (b) a non-taxable return of capital (to the extent of a shareholder's basis for his or her shares) or (c) taxable capital gain. In sum, classification of either of the Principal Partner- ships as an association taxable as a corporation would result in a material reduction in the anticipated cash flow and after-tax return to shareholders from holding Public Partnership shares.
Classification of the Principal Partnerships. The Principal Partnerships received an opinion of counsel that, as of their formation in December, 1986, the Principal Partnerships would be classified as partnerships for Federal income tax purposes. The Principal Partnerships believe that, since that date, nothing has occurred which changes the conclusion that each of these entities is to be classified as a partnership for Federal income tax purposes. This conclusion is based upon the following factors, among other things:
(a) ServiceMaster Management Corporation has acted as a general partner in each of the Principal Partnerships and has maintained and will continue to maintain a net worth, on
a fair market value basis, of at least $15.0 million (apart from direct or indirect interests in either of the Principal Partnerships or in any subsidiaries of the Principal Partnerships) in the form of (i) cash or cash equivalents; (ii) marketable obligations issued or guaranteed by the United States government or any agency or political subdivision thereof or issued by any state of the United States or any agency or political subdivision thereof; (iii) commercial paper; (iv) certificates of deposit; (v) bankers' acceptances; (vi) securities regularly traded on an established market; and/or (vii) notes receivable secured by bank letters of credit;
(b) Each of the Principal Partnerships has operated at all times in accordance with applicable provisions of the Delaware Revised Uniform Limited Partnership Act, the terms and conditions of their respective partnership agreements, and the statements and representations made in ServiceMaster's December 11, 1991, proxy statement/prospectus;
(c) Except as required by Section 704(c) of the Code or as the result of a temporary allocation required under Section 704(b) of the Code (for example, a qualified income offset or a minimum gain chargeback), the aggregate interest of the Managing General Partner in each material item of gain, loss, deduction or credit of each of the Principal Partnerships has always been equal to at least 1% of each such item;
(d) The partnership agreement governing each of the Principal Partnerships has provided, and continues to provide, in accordance with IRS Revenue Procedure 89-12, that upon dissolution of the respective partnerships the general partners of that partnership will contribute to the partnership an amount equal to the deficit balance, if any, in their capital accounts; and
(e) The general partners of each of the Principal Partnerships have always held their respective interests in each of the Principal Partnerships for their own accounts and, in managing each of the Principal Partnerships, have not acted under the direction of or as agents for the limited partners of the Public Partnership.
If the Managing General Partner were to withdraw as a partner at a time when there is no successor managing general partner, or if the successor managing general partner could not satisfy the applicable net worth requirement and other restric- tions, then the IRS might attempt to classify one or both of the Principal Partnerships as associations taxable as corporations.
The Managing General Partner and the Principal Partnerships intend to contest any material adverse determination by the IRS classifying either of the Principal Partnerships as an associ- ation taxable as a corporation. Shareholders should be aware that the Principal Partnerships, and hence indirectly the shareholders, may incur substantial legal expenses in the event of such a contest, and there can be no assurance that such a contest would be successful. At the same time, however, such an adverse determination is not expected to occur.
Publicly Traded Partnerships Treated as Corporations. Section 7704 of the Code provides that a publicly traded partnership (i.e., any partnership if interests in the partnership are traded on an established securities market or are readily tradeable on a secondary market or the substantial equivalent thereof) will generally be treated as a corporation for Federal income tax purposes with respect to taxable years beginning after 1987. However, Section 7704 also provides that a partnership whose interests were publicly traded on December 17, 1987 will not be treated as a corporation under Section 7704 until the partnership's first taxable year beginning after 1997. This "grandfather status" is lost, however, if the partnership adds a substantial new line of business after December 17, 1987; in that event, the partnership may be treated as a corporation as of the day after the date on which such substantial new line of business is added. The Public Partnership is a publicly traded partnership for purposes of Section 7704 but ServiceMaster currently intends to operate its businesses in a manner so as to continue to qualify under this exception to the general rule of Section 7704 and to thereby retain its partnership tax status for Federal income tax purposes for all tax years beginning before 1998.
In accordance with shareholder approval granted on January 13, 1992, ServiceMaster currently intends to engage in a reincorporating merger on December 31, 1997, immediately prior to the time when Code Section 7704 would otherwise automatically treat the Public Partnership as a corporation for Federal income tax purposes. The reincorporating merger should provide certain benefits which might not be available if ServiceMaster remained in partnership form subject to the application of Code Section 7704. As discussed more fully in ServiceMaster's December 11, 1991 proxy statement/prospectus, no Federal income tax will be imposed on shareholders in the Public Partnership by reason of the reincorporating merger, assuming that Federal income tax laws remain as now constituted.
The board of directors of the Managing General Partner may accelerate the effective date of the reincorporating merger to a date earlier than December 31, 1997 if either changes in tax laws or other developments cause more than 51% of ServiceMaster's income to be subject to corporate income tax prior to 1998 or the
board of directors, in its sole discretion, determines that the advantages of such acceleration to ServiceMaster and the holders of a majority of its outstanding shares outweigh the disadvantages. It is possible that an acceleration of the effective date of the reincorporating merger could adversely impact some shareholders in the Public Partnership.
THE DISCUSSION THAT FOLLOWS IS BASED ON THE ASSUMPTION THAT THE PRINCIPAL PARTNERSHIPS ARE NOT CLASSIFIED FOR FEDERAL INCOME TAX PURPOSES AS ASSOCIATIONS TAXABLE AS CORPORATIONS, AND THAT THE PUBLIC PARTNERSHIP IS NOT TREATED AS A CORPORATION PURSUANT TO CODE SECTION 7704.
Tax Consequences of Partnership Share Ownership
General. The Public Partnership is not subject to Federal income tax as an entity. Rather, subject to the limitations prescribed in Code Section 469, each partner is required to report on his or her Federal and state income tax returns his or her allocable share of the income, gains, losses, deductions and credits (and, for alternative minimum tax purposes, tax preference items) of the Public Partnership for the taxable year of the Public Partnership ending with or within his or her taxable year and will be taxable directly on his or her allocable share of the Public Partnership's taxable income. The Public Partnership's taxable income includes its allocable share of the income, gains, losses, deductions and credits (and, for alternative minimum tax purposes, tax preference items) of the Principal Subsidiary Partnership which, in turn, includes its allocable share of such items of subsidiary partnerships. The beneficial owners of Partnership Shares are treated as partners of the Public Partnership for Federal income tax purposes. Thus, if Partnership Shares are held by a nominee, the beneficial owner of the Partnership Shares will be taxed on income and loss of the Public Partnership. Subject to the discussion set forth in the next five paragraphs, because shareholders are required to include Public Partnership income in their income for tax purposes without regard to whether they receive cash distributions of that income, shareholders may be liable for Federal income taxes with respect to Public Partnership income even though they have not received cash distributions from the Public Partnership sufficient to pay such taxes. However, throughout the period from January 1, 1987 to December 31, 1994, the Public Partnership's cash distributions to its shareholders have been substantially in excess of the taxes payable in respect of the taxable income allocated to such shareholders. The Public Partnership has no reason to expect that this situation will not continue through the end of the year 1997.
ServiceMaster SGP Trust. In recognition of the fact that in 1993 (for the first time in the Public Partnership's history) taxable income was likely to exceed cash distributions to many
shareholders of the Public Partnership, the Principal Subsidiary Partnership admitted the ServiceMaster T Trust as a special general partner of the Principal Subsidiary Partnership effective January 1, 1993. On September 30, 1993, the ServiceMaster T Trust was replaced by the ServiceMaster A Trust. Each of these trusts is hereinafter referred to as the "SGP Trust". The interest held by the SGP Trust is denominated in the Principal Subsidiary Partnership's partnership agreement as a Class T Partnership Interest. (See Note T, page 16). As stated in Note T, the beneficiaries of the SGP Trust are the limited partners of the Public Partnership as constituted from time to time. On the date on which ServiceMaster converts back to corporate form pursuant to the Reincorporating Merger approved on January 16, 1992, the SGP Trust will be assimilated into ServiceMaster Incorporated of Delaware, the successor corporate holding company for the ServiceMaster enterprise.
The beneficial interests held by the beneficiaries of the SGP Trust are not assignable or transferable separately, but only by and in connection with the transfer of shares in the Public Partnership Every assignment, sale or transfer of any interest in shares in the Public Partnership prior to the date on which the SGP Trust terminates will include a proportional undivided beneficial interest in the SGP Trust.
Since January 1, 1993 the SGP Trust has been allocated that amount of the taxable income (determined without regard to section 743(b) adjustments) of the Principal Subsidiary Partnership which exceeds the aggregate cash distributions made by the Public Partnership to its limited partners. The effect of this arrangement is that the cash distributions made by the Public Partnership to its limited partners will always equal or exceed the taxable income of the Public Partnership which is directly allocated to its limited partners. With respect to the additional taxable income which is allocated to the SGP Trust, the Principal Subsidiary Partnership makes cash distributions to the SGP Trust from time to time in the amounts required by the SGP Trust to discharge its federal and state income tax liabilities. The SGP Trust does not receive any other allocations of income or cash distributions.
The formation of the SGP Trust was not a taxable event to the Principal Partnerships or the shareholders, and the creation of the Class T Partnership Interest was not a taxable event to either the SGP Trust or the Principal Subsidiary Partnership or to the Public Partnership. The distribution of funds to the SGP Trust by the Principal Subsidiary Partnership is not be a taxable event to either party. The SGP Trust includes in its taxable income its allocable share of the income of the Principal Subsidiary Partnership.
If the SGP Trust were to distribute its income to its beneficiaries, such distributions would be taxable to the beneficiaries. However, because it is not anticipated that the SGP Trust will make any distributions to its beneficiaries, the shareholders of the Public Partnership will not recognize any taxable income on account of the establishment of, and the allocations to, the SGP Trust.
Accounting Method and Tax Information. The Public Partnership uses the accrual method of accounting in reporting income and computes income on the basis of a taxable year ending on December 31. The Public Partnership will prepare and furnish to each shareholder of record during any taxable year the information necessary for the preparation of the shareholder's Federal, state and other tax returns required as a result of the operations of the Public Partnership for that year.
Tax Basis of Partnership Shares. The tax basis of a share- holder in his or her Partnership Shares is significant because (i) basis is used in measuring the gain or loss recognized for tax purposes either upon the receipt of cash distributions from the Public Partnership or upon a partial or complete disposition of Partnership Shares by the shareholder and (ii) a shareholder may deduct his or her allocable share of Public Partnership losses only to the extent of his or her tax basis in his or her shares. See "Tax Consequences of Partnership Share Ownership -- Taxation of Partners on Public Partnership Distributions" and "Sale or Other Disposition of Shares."
Taxation of Partners on Public Partnership Distributions. If the cash distributions to a shareholder by the Public Partner- ship in any year exceed his or her allocable share of the Public Partnership's taxable income for that year, the excess will constitute a return of capital to the shareholder to the extent of the shareholder's basis in his or her Partnership Shares. This situation is expected to occur for shareholders whose taxable income is determined by reference to the Section 754 election (see "Section 754 Election", page 50). A return of capital will not be reportable as taxable income by a shareholder for Federal income tax purposes, but will reduce the tax basis of his or her Partnership Shares. If a shareholder's tax basis were reduced to zero, then any further cash distribution to the shareholder for any year in excess of his or her allocable share of the Public Partnership's taxable income for that year would be taxable to him or her as though it were gain on the sale or exchange of his or her Partnership Shares. All or a portion of such excess cash distribution could be treated as ordinary income as the result of the application of the recapture provisions of the Code. See "Sale or Other Disposition of Shares."
Limitation on Losses. No investor should invest in the Public Partnership with the expectation that an investment in the
Public Partnership will result in tax losses that may be applied to offset an investor's income from other sources. To the extent that the Principal Partnerships' operations result in losses for tax purposes in any calendar year, a shareholder generally will be entitled to use his or her allocable share of such losses to the extent of his or her tax basis in his or her Partnership Shares at the end of the year, subject to the limitations prescribed in Code Section 469.
Code Section 469 limits a taxpayer's ability to use losses or credits generated by limited partnerships and other business activities in which such taxpayer does not materially participate ("passive activities"). In general, losses from passive activities will not offset earned income (salary and bonus) or portfolio income (interest, dividends and royalties). Such losses will generally only offset income from other passive activities. Similarly, tax credits from passive activities will only reduce income tax attributable to income from passive activities. Losses and credits from a passive activity which cannot be used in a given year are generally carried forward. These deferred losses and credits, if not usable sooner, will generally be allowed in full when the taxpayer disposes of his or her entire interest in the activity.
Section 469 applies separately to each publicly traded partnership. Thus, passive activity losses and credits attribut- able to a limited partner's interest in a publicly traded partnership (such as the Public Partnership) cannot be applied against the limited partner's other income, even if such income is treated as passive under Section 469. Such losses and credits are suspended and carried forward for applications against income from the publicly traded partnership in future years. Upon a complete disposition of the limited partner's interest in the publicly traded partnership in a fully taxable transaction, any of the limited partner's remaining suspended losses generally may be applied against other income. Income attributable to a limited partner's interest in a publicly traded partnership (such as the Public Partnership) cannot be offset by losses or credits from the limited partner's other passive activities.
Substantially all of any losses or credits generated by the Public Partnership will likely be subject to the limitations prescribed in Section 469. The limitations prescribed in Section 469 generally apply to individuals, estates, trusts, personal service corporations and, with certain modifications, closely- held corporations.
Under current law, a partner who is subject to the "at-risk" limitations of Code Section 465 may not deduct his or her allocable share of partnership losses for a taxable year to the extent they exceed the aggregate amount for which he or she is considered to be "at-risk" with respect to the partnership
activities giving rise to those losses as of the end of its taxable year in which the losses occur. Because it is not anticipated that the Principal Partnerships will incur losses that exceed either the shareholders' aggregate basis in their Partnership Shares or amounts "at-risk" with respect to the Principal Partnerships' activities, the "at-risk" limitations under current law should generally not affect shareholders adversely.
Federal Income Tax Allocations
General. In general, items of income, gain, loss, deduction and credit for the Principal Partnerships are allocated for both accounting and Federal income tax purposes in accordance with the percentage interests of the general and limited partners. However, as discussed in greater detail below, the Managing General Partner is empowered by the limited partnership agreements for the Principal Partnerships (the "Principal Partnership Agreements") to specially allocate various Principal Partnership tax items other than in accordance with percentage interests when, in the judgment of the Managing General Partner, such special allocations are necessary to comply with applicable provisions of the Code and the regulations or, to the extent permissible under the Code and the regulations, to preserve the uniformity of the shares in the Public Partnership, i.e., to ensure that all Partnership Shares will have identical attributes. These allocation provisions will be recognized for Federal income tax purposes if they are considered to have "substantial economic effect" within the meaning of Code Section 704(b). If any allocation fails to satisfy the "substantial economic effect" requirement, the allocated items will be reallocated among the shareholders based on their respective "interests in the partnership," determined on the basis of all of the relevant facts and circumstances.
Pursuant to regulations issued under Section 704(b), a partnership allocation will be considered to have "substantial economic effect" if it is determined that the allocation has "economic effect" and the economic effect is "substantial." An allocation to partners (other than an allocation of loss, deduction or certain other items attributable to nonrecourse liabilities ("nonrecourse deductions")) will be considered to have "economic effect" if (i) the partnership maintains capital accounts in accordance with specific rules set forth in the regulations and the allocation is reflected through an increase or decrease in the partners' capital accounts, (ii) liquidating distributions are required to be made in accordance with the partners' respective positive capital account balances by the end of the taxable year (or, if later, within 90 days after the date of liquidation), and (iii) any partner with a deficit in his or her capital account following the distribution of liquidation proceeds would be unconditionally required to restore the amount
of such deficit to the partnership. If the first two of these requirements are met but the partner to whom an allocation is made is not obligated to restore the full amount of any deficit balance in his or her capital account, the allocation still will be considered to have "economic effect" to the extent the allocation does not cause or increase a deficit balance in the partner's capital account (determined after reducing that account for certain "expected" adjustments, allocations, and distributions specified by the regulations) if the partnership agreement contains a "qualified income offset" provision. A qualified income offset requires that in the event of any unexpected distribution (or specified adjustments or allocations) to a partner that results in a deficit balance in such partner's capital account, there must be an allocation of income or gain to the distributee that eliminates the resulting capital account deficit as quickly as possible.
In order for the "economic effect" of an allocation to be considered "substantial," the regulations require that the allocation must have a "reasonable possibility" of "substantially" affecting the dollar amounts to be received by the partners, independent of tax consequences. The regulations provide that the "economic effect" of an allocation will be presumed to be insubstantial if it merely shifts tax consequences within a partnership taxable year or is transitory, i.e., likely to be offset by other allocations in subsequent taxable years. The regulations state, however, that adjustments to the tax basis in property will be presumed to be matched by corresponding changes in the fair market value of the property. Thus, the regulations conclude that there will not be a strong likelihood that an allocation of deductions attributable to depreciation will be transitory due to a provision for a subsequent corresponding allocation of gain attributable to the disposition of that property.
In addition to the regulations described above, the Treasury has issued regulations which address the effect of nonrecourse liabilities upon partnership allocations. Under the regulations, if (i) the partnership maintains capital accounts in accordance with specific rules set forth in the regulations and allocations are reflected through an increase or decrease in partners' capital accounts and (ii) liquidating distributions are required to be made in accordance with partners' respective positive capital account balances by the end of the taxable year (or, if later, within 90 days after the date of liquidation), then a partner may be allocated nonrecourse deductions that cause his or her capital account to fall below zero, provided (among other requirements) that the deficit produced by the allocation is not in excess of the minimum gain that would be allocated to the partner in the event the partnership property securing the nonrecourse liability were disposed of in a taxable transaction in full satisfaction of such liability. The regulations further
provide that in the event there is a decrease in such partnership's minimum gain for a partnership taxable year, the partners must be allocated items of partnership income and gain for such year (and, if necessary, for subsequent years) in proportion to, and to the extent of, an amount equal to such partner's share of the net decrease in partnership minimum gain during such year.
The Principal Partnership Agreements provide that a capital account is to be maintained for each partner, that the capital accounts are to be maintained in accordance with applicable principles set forth in the regulations, and that all allocations to a partner are to be reflected in the partner's capital account. In addition, distributions upon liquidation of the Principal Partnerships are to be made in accordance with respective capital account balances. The Principal Partnership Agreements do not require the limited partners to restore any deficit balance in their capital accounts upon liquidation of the Principal Partnerships. However, the Principal Partnership Agreements contain a "minimum gain" allocation for nonrecourse deductions and a "qualified income offset" provision. Pursuant to the Principal Partnership Agreements, tax income and gain will be allocated in a manner consistent with the book income and gain allocations associated with the minimum gain and qualified income offset provisions.
The manner of allocation of items of income, gain, loss, deduction and credit for both book and Federal income tax purposes is set forth in the Principal Partnership Agreements. In general, the Principal Partnerships' income, gains, losses, deductions and credits are allocated pursuant to the Principal Partnership Agreements among the partners pro rata in accordance with their percentage interests, except that the allocation of taxable income of the Principal Subsidiary Partnership to the ServiceMaster SGP Trust is determined in the manner described above and in Note T, page [16]. The Principal Partnership Agreements contain special allocations of book income and gain for the qualified income offset and minimum gain provisions (discussed above) and special allocations of income and deduction to preserve the uniformity of shares. The Principal Partnership Agreements further provide exceptions to the pro rata allocations for Federal income tax purposes of (i) income, gain, loss and deductions attributable to properties contributed to the Principal Partnerships in exchange for shares ("Contributed Property"), (ii) income, gain, loss and deductions attributable to the Principal Partnerships' properties where the Principal Partnerships have adjusted the book value of such properties upon the Public Partnership's issuance of additional shares to reflect unrealized appreciation or depreciation in value from the later of the Principal Partnerships' acquisition date for such properties or the latest date of a prior issuance of shares ("Adjusted Property"), (iii) curative allocations of gross income
and deductions to preserve the uniformity of shares issued or sold from time to time, (iv) recapture income resulting from the sale or disposition of Principal Subsidiary Partnership assets ("Recapture Income"), (v) income and gain in a manner consistent with the allocation of book income and gain pursuant to a qualified income offset, and (vi) income and gain attributable to nonrecourse debt in a manner consistent with the allocation of book income and gain under a minimum gain provision.
With respect to property contributed by a shareholder to the Principal Partnerships, the Principal Partnership Agreements provide that, for Federal income tax purposes, partnership income, gain, loss and deductions shall first be allocated among the partners in a manner consistent with Code Section 704(c). In addition, the Principal Partnership Agreements provide that partnership income, gain, loss and deductions attributable to Adjusted Property shall be allocated for Federal income tax purposes in accordance with Section 704(c) principles. Pursuant to Section 704(c), items of partnership income, gain, loss and deduction with respect to Contributed Property are to be shared among the partners pursuant to regulations so as to take account of the differences between the Principal Subsidiary Partnership's basis for the property and the fair market value of the property at the time of the contribution (i.e., a Book-Tax Disparity).
The IRS has issued final regulations under Section 704(c) which provide that these allocations of partnership income, gain, loss and deduction to account for the Book-Tax Disparity can be made by any reasonable method. The final regulations set forth three non-exclusive allocation methods which are generally considered to be reasonable. The Principal Subsidiary Partnership makes every effort to comply with these regulations.
As discussed below, the Code Section 754 election permits an adjustment in the basis in the assets of the Principal Subsidiary Partnership and subsidiary partnerships pursuant to Code Section 743(b) to reflect the price at which Partnership Shares are purchased from a shareholder as if such purchaser had acquired a direct interest in such assets. See "Section 754 Election." Such Section 743(b) adjustment is attributed solely to such purchaser of shares and is not added to the bases of the assets of the Principal Subsidiary Partnership and subsidiary partnerships associated with all of the shareholders ("common bases"). With respect to Section 743(b) adjustments, proposed regulations relating to ACRS depreciation appear to require the acquiring partner to use a depreciation method and useful life for the increase in basis which is different from the method and useful life generally used to depreciate the Public Partnership's common bases in the assets of the Principal Subsidiary Partnerships and subsidiary partnerships.
The Managing General Partner has the authority under the Principal Partnership Agreements to specially allocate items of income and deductions in a manner that will preserve the uniformity among all shares, so long as such allocations are consistent with and supportable under the principles of Code Section 704. The Managing General Partner may use a "depreciation convention method" or any other convention to preserve the uniformity of shares. If no allowable or workable convention is available to preserve the uniformity of Partnership Shares or the Managing General Partner in its discretion so elects, the Partnership Shares may be separately identified as distinct classes to reflect differences in tax consequences. The Managing General Partner has adopted conventions and allocations to achieve uniformity among all Partnership Shares.
The Principal Partnership Agreements also require that gain from the sale of Principal Subsidiary Partnership properties, to the extent characterized as Recapture Income, be allocated (to the extent such allocation does not alter the allocation of gain otherwise provided for in the Principal Partnership Agreements) among the partners (or their successors) in the same manner in which such partners were allocated the deductions giving rise to such Recapture Income.
The Section 704(b) regulations and Sections 1.1245-1(e) and 1.1250-1(f) of the regulations tend to support a special allocation of Recapture Income. However, such regulations do not specifically address a special allocation based on the allocation of the deductions giving rise to such Recapture Income as stated in the Principal Partnership Agreements. Therefore, it is not clear that the allocation of Recapture Income will be given effect for Federal income tax purposes. If it is not, such Recapture Income will be allocated to all shareholders and the general partners.
Transferor/Transferee Allocations. The Principal Partnerships will allocate their taxable income and losses among the shareholders of record in proportion to the number of Partnership Shares owned by them based on the number of months during the year for which each shareholder was record owner of the shares. The Principal Partnerships' taxable income and loss allocable to each month will be determined by allocating such income or loss pro rata to each month in the year. With respect to any Partnership Share that is transferred during any calendar month, the Principal Partnerships will treat a shareholder who becomes the record owner of such share on or before the close of business on the fifteenth day of the month as having been the owner of such share for the entire month if he or she holds such share for the remainder of such month. Conversely, a shareholder who becomes the record owner of a Partnership Share during such month but after the fifteenth day of a calendar month will be allocated the taxable income and losses attributable to the
second half of such month if he or she holds such share for the remainder of such month.
Depreciation; Amortization; Recapture
General. The Principal Partnerships claim depreciation, cost recovery and amortization deductions with respect to the purchase price (or other tax basis) of the various properties of the Principal Partnerships and subsidiary partnerships and related improvements to the extent permitted by the applicable Code provisions. Land is not subject to depreciation, cost recovery or amortization deductions.
Until the enactment of Code section 197 in 1993, the general rule was that if an intangible asset has a determinable useful life, then the cost of the asset may be amortized over that useful life using a straight-line method. If, however, the useful life of an intangible asset is not determinable, then the cost of the intangible asset may not be amortized or deducted.
In 1993, Congress enacted Code Section 197. This section allows for the amortization of certain intangibles over a 15-year period. This 15-year amortization period must be used even if the intangible asset has a useful life of less than 15 years. The types of intangible assets covered by Code Section 197 include goodwill, going concern value, work force in place, licenses, permits, covenants not to compete, franchises, trademarks, trade names, customer-based intangible assets (e.g.,favorable sale contracts) and supplier-based intangible assets (e.g., favorable supply contracts). Interests in partnerships are specifically excluded from Code Section 197, among other types of intangible assets. Code Section 197 applies to intangible assets acquired after August 10, 1993 unless an election is made to apply Code Section 197 retroactively starting after July 25, 1991.
The Principal Partnerships elected to have the provisions of Code Section 197 apply retroactively to an increase in basis for property acquired by the Principal Partnerships after that date. This election can be expected to increase the amount of intangible amortization of the Principal Partnerships.
Various components of the Principal Partnerships' properties fall into each of the categories discussed in the preceding paragraphs. A portion of the cost of certain Principal Partnership properties is allocable to (i) nondepreciable, nonamortizable land, (ii) tangible property, some of which is real property (i.e., buildings and structural components) or tangible personal property that may qualify for depreciation deductions, and (iii) intangible property that may or may not qualify for amortization.
For shareholders who purchased shares in the Public Partnership after August 18, 1993, the amortization on the intangible assets acquired by the Principal Partnerships before July 26, 1991 allowed by Section 197 will apply only to the increase in basis resulting from the Code Section 754 election. In other words, no amortization under Code Section 197 will be allowed on the Principal Partnerships' original basis in intangible assets, unless those assets were acquired by the Principal Partnerships after July 25, 1991.
Deductions for depreciation, cost recovery and amortization claimed by the Principal Partnerships with respect to assets of the Principal Partnerships and subsidiary partnerships reduce the partnerships' adjusted basis for the properties, thereby increasing the potential gain (or decreasing the potential loss) to the Principal Partnerships upon the ultimate disposition of the properties. These deductions also have the effect of reducing the shareholders' adjusted basis for their Partnership Shares (by reducing taxable income or increasing tax losses), thereby affecting the potential gain or loss to be realized upon a subsequent sale of the shares. See "Sale or Other Disposition of Shares."
Sale or Other Disposition of Shares
General. In the event of a sale or disposition of Partnership Shares, a shareholder will recognize gain or loss, as the case may be, on the disposition in an amount equal to the difference between the amount realized by the shareholder on the disposition and his adjusted tax basis for his Partnership Shares. See "Tax Consequences of Partnership Share Ownership" -- "Tax Basis of Partnership Shares." For these purposes, a shareholder's share (as determined for purposes of Code Section 752) of any Principal Partnership indebtedness attributable to the transferred Partnership Shares will be included in the amount realized on the disposition.
Generally, under current law, gain recognized by a shareholder on the sale or exchange of shares that have been held for more than twelve months will be taxable as long-term capital gain, taxable at a maximum rate of 28% in the case of taxpayers other than corporations. However, that portion of the gain attributable to "substantially appreciated inventory items" and "unrealized receivables" of the Principal Partnerships, as those terms are defined in the Code, will be treated as ordinary income. Ordinary income attributable to unrealized receivables and inventory items may exceed the net taxable gain realized upon the sale and may be recognized even if there is a net tax loss realized upon the sale. "Unrealized receivables" include, among other things, the shareholder's proportionate share of the amounts that would be recaptured as ordinary income if the Principal Partnerships were to have sold their assets at fair
market value at the time the shareholder transferred his shares. See "Depreciation; ACRS; Amortization; Recapture" -- "Recapture." Any loss recognized upon the sale of shares generally will be treated as a capital loss.
A shareholder will not ordinarily recognize any gain or loss upon making a gift of Partnership Shares. However, a shareholder making a gift of Partnership Shares more likely than not will include as an amount realized the share (as determined for purposes of Code Section 752) of any of the Partnerships' indebtedness allocable to the transferred Partnership Shares. See "Tax Consequences of Partnership Share Ownership" -- "Tax Basis of Partnership Shares," such shareholder would therefore recognize gain (but not loss) on making a gift of Partnership Shares if the shareholder's basis had declined so that it were less than such amount deemed realized. In the case of a deductible gift to a charitable organization the donor's basis is apportioned between the value deemed contributed and the deemed sale price. Any gain recognized more likely than not would be subject to the same rules (described above) which apply to gain recognized on a sale of a Partnership Share, so that some portion could be treated as ordinary income.
The IRS has ruled that a partner must maintain an aggregate adjusted tax basis in his entire partnership interest (consisting of all interests in a given partnership acquired in separate transactions). Upon the sale of a portion of such aggregate interest, such partner would be required to allocate his aggregate tax basis between the portion of the interest sold and the portion of the interest retained according to some equitable apportionment method. (The IRS ruling requires that the apportionment be based on the relative fair market values of such interests on the date of sale.) This requirement, if applicable to the Public Partnership, effectively would preclude a shareholder owning shares that were purchased at different prices on different dates from controlling the timing of the recognition of the inherent gain or loss in his shares by selecting the specific shares that he will sell. However, the application of this ruling in the context of a publicly traded limited partnership such as the Public Partnership is not clear. The ruling does not address whether this aggregation requirement, if applicable, results in the tacking of the holding period of older shares onto the holding period of more recently acquired shares.
Transferor/Transferee Allocations. The manner in which the Principal Partnerships intend to allocate their taxable income and losses between transferors and transferees of shares is described above under "Federal Income Tax Allocations" -- "Transferor/Transferee Allocations." Shareholders contemplating a transfer of shares should note that cash distributions to which they are entitled may not correspond to the Principal
Partnerships' taxable income and loss which shall be allocated between the transferor and transferee of such shares.
Information Return Filing Requirements. The Public Partnership is required to notify the IRS of any sale or exchange (of which the Public Partnership has notice) of a share and to report to the IRS the name, address, and taxpayer identification number of the transferee and the transferor who were parties to such transaction and of the Public Partnership, the date of the transaction and any additional information required by the applicable information return or its instructions. The Public Partnership also must provide this information to the transferor and the transferee. If the Public Partnership fails to furnish the required information to the IRS, the Public Partnership may be subject to a penalty of up to $50 per failure, up to an annual maximum penalty of $250,000, unless the failure is due to an intentional disregard of the requirement, in which case a penalty of $100 per failure or if greater, 5% of the amount required to be reported, would apply, without limit. Penalties could also be asserted against the Public Partnership if it fails to furnish the required information to the transferor and the transferee.
Any person who directly or indirectly holds an interest in the Public Partnership as a nominee on behalf of another person during a Public Partnership taxable year must furnish the Public Partnership with a written statement for such taxable year identifying the name, address and taxpayer identification number of the nominee and such other person and providing information regarding acquisitions and transfers of Partnership Shares (including information regarding acquisition cost and net sale proceeds) made by the nominee on behalf of such other person during such taxable year.
Section 754 Election
Effect of the Election. The Principal Partnerships have made and expect to continue to make the election permitted by Section 754 of the Code which allows adjustments to the basis of partnership property under Section 743 of the Code upon certain transfers of a partnership interest. Such election, once made, is irrevocable absent the consent of the IRS. The general effect of such an election upon a transfer of shares is to permit the purchaser of such shares to adjust the basis of the Principal Partnerships' properties for purposes of his tax return to reflect the price at which his shares are purchased, as if such purchaser had acquired a direct interest in the Principal Partnerships' assets.
Effect of the Interplay Between the Section 754 Election, Section 197 and the SGP Trust. As discussed on page 43, the existence of the SGP Trust means that the taxable income of ServiceMaster Limited Partnership as allocated to each of its
shareholders will not be greater than the cash distributions made to that shareholder. For many shareholders, however, taxable income will be less than their cash distributions due to the effect of the Section 754 election. The principal effect of the Section 754 election is to cause the calculation of a partner's share of taxable income to reflect amortization and depreciation deductions which are determined by using a higher basis (reflecting the partner's purchase price) in the underlying assets than the partnership's own internal, historical basis for those assets. In this connection, the provision in the Revenue Reconciliation Act of 1993 which permits the amortization of intangible assets over a 15-year period has important consequences to those persons who purchased ServiceMaster shares on August 10, 1993 or thereafter. If their purchase price for such shares is at least $22 per share ($33 per share before the June 7, 1993 3-for-2 share split), their proportionate interest in the assets of ServiceMaster, including goodwill and other intangible assets on which amortization is now being taken over a 15-year period, will cause the calculation of their share of ServiceMaster's taxable income to include deductions which are expected to leave such persons with an allocation of no taxable income on such ServiceMaster shares or with negative taxable income on those shares. (If a limited partner is allocated negative taxable income on his or her ServiceMaster shares, it can be used to offset a like amount of positive taxable income on other ServiceMaster shares or gain upon the sale of ServiceMaster shares; however, it can not be used to offset taxable income from other sources). Under these circumstances, cash distributions on such shares will decrease the tax basis of those shares by the amount of cash distributed and without an offset increase in basis attributable to the allocation of taxable income to those shares. Accordingly, the amount of gain realized upon a taxable disposition of the shares will be greater than would be the case if the Section 754 election had not been made.
Tax exempt organization such as pension plans, profit sharing plans, IRAs, Keoghs, private foundations and other charitable organizations will benefit from the interplay among the Section 754 election, the SGP Trust and the amortization of intangibles in another way. Such entities are subject to the unrelated business income tax on their share of the taxable income of a publicly traded partnership (such as ServiceMaster). However, since their ServiceMaster taxable income is expected to be zero or less (for the reasons discussed above), such entities should not be subject to any unrelated business income tax liability.
Other Section 754-Related Matters. If a shareholder's adjusted basis in his or her Partnership Shares is less than his or her proportionate share of adjusted basis of the Principal Partnerships' property at the time of acquisition of such Partnership Shares, such shareholder's share of adjusted basis of
the Principal Partnerships' property must be reduced to equal his or her basis in the Partnership Shares, resulting in adverse consequences to such shareholder.
A proper allocation of the adjustment among the various assets deemed purchased for purposes of Section 743(b) requires a determination of the relative value of the Principal Partnerships' assets at such time. The IRS may challenge any such allocations.
Should the IRS require a different basis adjustment to be made, and should, in the Corporate General Partner's opinion, the expense of compliance exceed the benefit of the election, the Corporate General Partner may seek permission from the IRS to revoke the Section 754 elections for the Principal Partnerships. If such permission is granted, a purchaser of Partnership Shares probably will incur increased tax liability.
Termination of the Principal Partnerships for Tax Purposes
Code Section 708 provides that if 50% or more of the capital and profits interests in a partnership are sold or exchanged within a single 12-month period, the partnership will be considered to have terminated for tax purposes. Because of the structure of the Principal Partnerships, it is likely that a Code Section 708 termination of the Public Partnership would result in a Code Section 708 termination of the Principal Subsidiary Partnership as well. In view of the fact that Partnership Shares will be publicly traded, it is possible that shares representing 50% or more of the Public Partnership's capital and profits interests might be sold or exchanged within a single 12-month period. However, a share that changes hands several times during a 12-month period would only be counted once for purposes of determining whether a termination has occurred. If the Principal Partnerships should terminate for tax purposes, they would be deemed to have distributed their assets to their partners, who would then be deemed to have contributed the assets to new partnerships. The Principal Partnerships would have a new basis in their non-cash assets equal to the aggregate basis of the shareholders in their Partnership Shares prior to the termination plus any gain recognized by the shareholders in the termination, less any cash deemed distributed to the shareholders in connection with the termination. Accordingly, if the basis of the shareholders in their Partnership Shares is more or less than the Principal Partnerships' aggregate basis in their assets immediately prior to the termination, the Principal Partnerships' basis in their non-cash assets following the termination might have to be reallocated among those assets to reflect the relative fair market values of those assets at the time of termination. Such a reallocation may be favorable or unfavorable, depending on the circumstances.
Generally, a shareholder would not recognize any taxable gain or loss as a result of the deemed pro rata distribution of Principal Partnership assets incident to a termination of the Principal Partnerships. A shareholder, however, would recognize gain to the extent, if any, that the shareholder's pro rata share of the Principal Partnerships' cash (and the reduction, if any in the shareholder's share of the Principal Partnerships' indebtedness as determined for purposes of Code Section 752) at the date of termination exceeded the adjusted tax basis of his Partnership Shares. Also, the Principal Partnerships' taxable years would terminate. If the shareholder's taxable year were other than the calendar year, the inclusion of more than one year of the Principal Partnerships' income in a single taxable year of the shareholder could result. Also, new tax elections would be required to be made by the reconstituted partnerships. Finally a termination of the Principal Partnerships may cause the Principal Partnerships or their assets to become subject to unfavorable statutory or regulatory changes enacted prior to the termination but previously not applicable to the Principal Partnerships or their assets because of protective "transitional" rules. However, a constructive termination under Code Section 708 should not cause the Partnership to lose the benefits of the up-to-10- year grace period during which the application of new Code Section 7704 is postponed. See "Tax Status of the Partnerships" - "Publicly Traded Partnerships Treated as Corporations."
In order to preserve maximum liquidity for the Partnership Shares, the Public Partnership has not adopted procedures designed to prevent a deemed termination of the Principal Partnerships from occurring.
An actual dissolution of the Principal Partnerships will result in the distribution to the shareholders of record of any assets remaining after payment of, or provision for, the Principal Partnerships' debts and liabilities. To the extent that a shareholder is deemed to receive money (including any reduction in his share of Principal Partnership liabilities as determined for purposes of Code Section 752) in excess of the basis of his Partnership Shares, such excess generally will be taxed as a capital gain, except to the extent of any unrealized receivables or substantially appreciated inventory items, as described above. See "Sale or Other Disposition of Shares." A shareholder will recognize a loss upon dissolution only if the liquidating distribution consists solely of cash, or of cash and unrealized receivables and appreciated inventory items, and then only to the extent that the adjusted basis of his Partnership Shares exceeds the amount of money received and his basis in such unrealized receivables and inventory items.
Minimum Tax on Tax Preference Items
The Code provides for an alternative minimum tax on the excess of alternative minimum taxable income over an exemption amount. Although these rules are applicable to the shareholders of the Public Partnership, in fact the Public Partnership has had no preference items since inception and does not anticipate generating any preference items in the future.
Investment Interest
Each individual shareholder's distributive share of the Public Partnership's portfolio income (i.e., income from interest, dividends, annuities and royalties not derived in the ordinary course of a trade or business) will be treated as investment income under Code Section 163(d) and may be offset by the shareholder's investment interest expense. Code section 163(d) has been amended to exclude capital gains on the disposition of investment property from the computation of investment income unless a shareholder elects to include such gains in his or her taxable income at ordinary rates. A portion of the interest incurred by a shareholder to finance the acquisition of Partnership Shares will generally be treated as investment interest expense if the Principal Partnerships hold investment property.
The IRS has announced that forthcoming Regulations will also treat an individual shareholder's net passive income from a publicly traded partnership (such as the Public Partnership) as investment income under Code Section 163(d). Accordingly, the amount of an individual shareholder's net passive income if any from the Public Partnership will be treated as investment income for purposes of Code Section 163(d). For this purpose, the computation of the amount of a shareholder's net passive income from the Public Partnership will take into account any passive activity deductions attributable to expenses of the shareholder that are incurred outside the Public Partnership and are properly allocable to the interest in passive activities that the shareholder holds through Partnership Shares. Thus, the amount of a shareholder's net passive income, if any, from the Public Partnership generally will be reduced on account of a portion of any interest incurred by the shareholder to finance the acquisition of Partnership Shares.
Noncorporate shareholders are urged to consult their tax advisors with regard to the specific effect that limitations on the deduction of investment interest would have on their investment in the Public Partnership.
Tax-Exempt Entities, Individual Retirement Accounts and Regulated Investment Companies
Unrelated Business Taxable Income. Tax-exempt entities (including IRAs and trusts that hold assets of employee benefit
or retirement plans) are subject to tax on certain income derived from a business regularly carried on by the entity that is unrelated to its exempt activities (i.e., "unrelated business taxable income" ("UBTI")). It is anticipated that nearly all of any tax-exempt entity's share (whether or not distributed) of the Principal Partnerships' gross income will be treated as gross income from an unrelated business, and the tax-exempt entity's share of nearly all of the Principal Partnerships' deductions will be allowed in computing the tax-exempt entity's UBTI.
Tax-exempt shareholders other than those who benefit from the interplay between the Section 754 Election, Section 197 and the SGP Trust as described on pages 50 and 51 would be subject to tax on any UBTI to the extent that the sum of such UBTI (i.e., gross income net of deductions), if any, from their Partnership Shares and from other sources were to exceed $1,000 in any particular year. Moreover, even if their UBTI does not exceed $1,000 so that tax-exempt shareholders do not incur a Federal income tax liability, they nevertheless will be required to file income tax returns if their gross income included in computing such UBTI is $1,000 or more for any tax year.
Investment Company Income. For purposes of determining whether a shareholder is a regulated investment copany (within the meaning of Code Section 851), the shareholder's income derived from the Principal Partnerships will be treated as income from dividends, interest and gains from the sale or other disposition of securities only to the extent the shareholder's income is attributable to such dividends, interest and gains realized by the Principal Partnerships.
Administrative Matters
Information to Shareholders and Assignees. In addition to the required Schedule K1 to be furnished by the Public Partnership to holders of Partnership Shares during a particular taxable year, the Public Partnership intends to furnish detailed instructions and explanations advising recipients of the Schedule K1 as to how to fill out their own income tax returns. The information will be provided within 90 days after the end of the Public Partnership's taxable year.
Partnership Tax Returns and Possible Audit. Although a partnership is not required to pay any Federal income tax, tax audits are conducted, and the tax treatment of partnership income, loss, deduction and credit is determined, at the partnership level in a unified proceeding.
In audits of partnerships, the IRS ordinarily will provide notice of the commencement of administrative proceedings and final adjustment only to each partner with an interest in profits of 1% or more. The Corporate General Partner is designated the
"tax matters partner" ("TMP") to receive notice on behalf of and to provide notice to those shareholders with interests of less than 1% in the Public Partnership ("non-notice shareholders"). The TMP may extend the statutory period of limitations for assessment of adjustments attributable to "partnership items" for all shareholders and may enter into a binding settlement on behalf of non-notice shareholders, except for any group of such shareholders with an aggregate interest of 5% or more in Public Partnership profits that elects to form a separate notice group or shareholders who otherwise properly notify the IRS that the TMP is not authorized to act on their behalf. If the IRS and the TMP fail to settle an audit proceeding, then the TMP may choose to litigate the matter. In that event, the TMP would select the court in which such litigation would occur (including, perhaps, a court where prepayment of the tax may be required). All shareholders would have the right to participate in such litigation and, regardless of participation, would be bound by the outcome of the litigation. Because shareholders will be affected by the outcome of any administrative or court proceedings with respect to both the Public Partnership and the Principal Subsidiary Partnership, the Corporate General Partner intends to provide shareholders with appropriate notices of Federal income tax proceedings with respect to both Principal Partnerships.
Shareholders will be required to treat Public Partnership items on their individual returns in a manner consistent with the treatment of those items on the Public Partnership's return, unless the shareholders file with the IRS a statement identifying the inconsistency. Examination of the Principal Partnerships' tax returns could result in an adjustment to the tax liability of a shareholder without any examination of the shareholder's tax return. In addition, any such audit could result in an audit of a shareholder's entire tax return and in adjustments to non- partnership related items on that return.
Tax Shelter Registration. The Code requires a tax shelter organizer to register a "tax shelter" with the IRS by the first date on which interests in the tax shelter are offered for sale. Such registration does not indicate approval by the IRS and could result in an audit. The registration provisions require the tax shelter organizer to maintain a list containing information on each investor, would require the shareholders to report the Public Partnership's tax registration number on their separate Federal income tax returns, and would require the Public Partnership to maintain a list of each person to whom it transfers an interest in a "tax shelter." Penalties may be imposed if registration is required and not made. A "tax shelter" for purposes of the registration requirement is one in which a person could reasonably infer, from the representations made in connection with any offer for sale of any interest in the investment, that the "tax shelter ratio" for any investor may be
greater than two to one as of the close of any of the first five years ending after the date on which the investment is offered for sale. The term "tax shelter ratio" is the ratio that the aggregate amount of gross deductions plus 350% of the credits that are potentially allowable to an investor bears to the partner's investment base for the year.
The Public Partnership has not been registered as a "tax shelter" because it expects that no shareholder's tax shelter ratio will exceed two to one.
Accuracy-Related Penalties. The Code provides for a penalty to be assessed in the event of a tax underpayment attributable to a substantial overstatement of the value or adjusted basis of property claimed on a tax return. This penalty will apply if (i) the claimed value or adjusted basis of the property equals or exceeds 200% of the correct value or adjusted basis, and (ii) the amount of the tax underpayment for the taxable year attributable to substantial valuation overstatements exceeds $5,000 ($10,000 in the case of a corporation other than an S corporation or a personal holding company). The amount of the penalty generally is 20% of the tax underpayment attributable to substantial valuation overstatements where the claimed value or adjusted basis is less than 400% of the correct value of adjusted basis, and 40% of the tax underpayment attributable to substantial valuation overstatements where the claimed value or adjusted basis equals or exceeds 400% of the correct value or adjusted basis. The penalty will likely be potentially applicable to partners in cases where the partnership has made a substantial valuation overstatement. The penalty generally will not apply with respect to any portion of a tax underpayment attributable to a substantial valuation overstatement (with respect to property other than charitable deduction property) if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion.
The Code provides for a penalty in the amount of 20% of any underpayment of tax attributable to a "substantial understatement of income tax." A "substantial understatement of income tax" is the amount of the understatement of tax on a taxpayer's return for a particular taxable year that exceeds the greater of $5,000 ($10,000 if the taxpayer is a corporation other than an S corporation or a personal holding company) or 10% of the tax required to be shown on the return for the year. As a general rule, the penalty will not be imposed with respect to underpayments attributable to items for which (i)there is or was substantial authority for the tax treatment afforded such items by the taxpayer, or (ii)the relevant facts affecting the treatment of such items are adequately disclosed in the taxpayer's return or in a statement attached to the return and there was a reasonable basis for the position. The penalty will not apply with respect to any portion of a tax underpayment
attributable to a substantial understatement of income tax if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion. There can be no assurance that a shareholder will not have a substantial understatement of income tax as a result of the treatment of items of income, gain, loss, deduction and credit resulting from his investment in the Public Partnership or that the IRS will not contend that there is not substantial authority for the treatment on the shareholder's return of certain items of income, gain, loss, deduction and credit. If the IRS should challenge the treatment by the Principal Partnerships for tax purposes of the various items of income, gain, loss, deduction and credit, and if a shareholder should fail to meet the substantial authority and adequate disclosure tests, a shareholder could incur a penalty for a substantial underpayment of taxes resulting from his investment in the Public Partnership.
Interest on Deficiencies. The Code provides that interest accrues on all tax deficiencies at a rate based on the Federal short-term rate plus 3 percentage points (5 percentage points in certain cases involving underpayment by a Ccorporation of tax amounting to more than $100,000) and compounded daily. This interest applies to penalties as well as tax deficiencies.
Backup Withholding. Distributions to shareholders whose Partnership Shares are held on their behalf by a broker may constitute reportable payments subject to backup withholding. Backup withholding, however, would apply only if the shareholder (i) failed to furnish his Social Security number or other taxpayer identification number to the person subject to the backup withholding requirement (e.g., the broker) or (ii)furnished an incorrect Social Security number or taxpayer identification number. If backup withholding were applicable to a shareholder, the person subject to the backup withholding requirement would be required to withhold 31% of each distribution to such shareholder and to pay such amount to the IRS on behalf of such shareholder. Amounts withheld under the backup withholding provisions are allowable as a refundable credit against a taxpayer's Federal income tax.
Tax Considerations for Foreign Investors
General. A nonresident alien or foreign corporation, trust or estate ("foreign person") which is a partner in a partnership which is engaged in a business in the United States will be considered to be engaged in such business, even though the foreign person is only a limited partner. The activities of the Principal Partnerships will constitute a United States business for this purpose, and such activities likely will be deemed to be conducted through a permanent establishment within the meaning of the Code and applicable tax treaties. Therefore, a foreign
person who becomes a shareholder in the Public Partnership will be required to file a United States tax return on which he must report his distributive share of the Principal Partnerships' items of income, gain, loss, deduction and credit, and to pay United States taxes at regular United States rates on his share of any of the Principal Partnerships' net income, whether ordinary income or capital gains.
Code Section 1446 generally requires partnerships which have taxable income effectively connected with a trade or business in the United States to withhold tax with respect to the portion of such income allocable to foreign partners. This withholding tax generally is imposed at the rate of 39.6% with respect to effectively connected income (as computed for purposes of Section 1446) allocable to foreign individuals, and 35% with respect to effectively connected income (as computed for purposes of Section 1446) allocable to foreign corporations and withholding may be required under Section 1446 even if no actual distribution has been made to partners. However, pursuant to an IRS Revenue Procedure, in the case of a publicly traded partnership (such as the Public Partnership) the Code Section 1446 withholding tax will be imposed in an alternative manner unless the publicly traded partnership elects not to have such alternative treatment apply. Under this alternative approach, the Code Section 1446 withholding tax is imposed on distributions made to individual or corporate foreign partners. The Treasury is authorized to issue such regulations applying Section 1446 to publicly traded partnerships as may be necessary to carry out the purposes of Section 1446, but such regulations have not yet been issued. Although foreign shareholders would be entitled to a United States tax credit for amounts withheld by Principal Partnerships under Section 1446, either Section 1446 or the regulations (not yet issued) applying Section 1446 to publicly traded partnerships could under some circumstances adversely affect the Principal Partnerships and the foreign shareholders.
Branch Profits Tax. Code Section 884 imposes a branch profits tax at the rate of 30 percent (or lower to the extent provided by any applicable income tax treaty) on the earnings and profits (after certain adjustments) of a U.S. branch of a foreign corporation, if such earnings and profits are attributable to income effectively connected with a U.S. trade or business. The legislative history of Code Section 884 indicates that the branch prose tax is intended to apply to foreign corporations that are partners in partnerships which have a U.S. trade or business. Thus, foreign corporations which own shares in the Public Partnership may be subject to the branch profits tax on earnings and profits attributable to the Principal Partnerships' income as well as federal income tax on their share of Partnership income. The earnings and profits (which are subject to branch profits tax) attributable to Partnership Shares held by a foreign corporation will, of course, reflect a reduction for Federal
income taxes paid by the foreign corporate shareholder on its share of Partnership income.
FIRPTA. The Foreign Investment in Real Property Tax Act of 1980 ("FIRPTA"), as amended by subsequent legislation, provides that gain or loss on the disposition of a United States Real Property Interest ("USRPI") is taxable in the United States as if effectively connected with a U.S. business and imposes withholding requirements on such sales and on distributions of USRPIs by partnerships to foreign persons. USRPIs include (i) United States real estate and (ii) interest in certain entities (including publicly traded partnerships) holding United States real estate. The shares will not be USRPIs unless the value of the Principal Partnerships' United States real estate equals or exceeds 50% of the value of all its business assets. Furthermore, the FIRPTA rules generally do not apply to any foreign person which owns 5% or less of the publicly traded Partnership Shares. FIRPTA also imposes certain withholding obligations with respect to dispositions of USRPIs by a partnership that are includable in a foreign person's share of partnership income.
Foreign Taxes. A foreign person may be subject to tax on his share of the Principal Partnerships' income and gain in his country of nationality or residence, or elsewhere. The method of taxation in such jurisdictions, if any, may differ considerably from the United States tax system described previously, and may be affected by the United States characterization of the Principal Partnerships and their income. Prospective investors who are foreign persons should consult their own tax advisors with respect to the potential tax effects of these and other items related to an investment in the Public Partnership.
State and Local Income Taxes
In addition to the Federal income tax consequences described above, prospective investors should consider state and local tax consequences of an investment in the Public Partnership. A shareholder's share of the taxable income or loss of the Principal Partnerships generally will be required to be included in determining his reportable income for state or local tax purposes. If the Public Partnership is treated as a corporation under Code Section 7704, as described above under "Tax Status of the Partnerships" -- "Publicly Traded Partnerships Treated as Corporations," the Public Partnership may also be treated as a corporation for state tax purposes in those states which base state income taxes on Federal income tax laws.
Management has been successful in filing a composite return on behalf of its individual shareholders in all states where the Principal Partnerships do business. The Public Partnership will provide information each year to the shareholders as to the share
of income and taxes paid on their behalf in each state. For those entities not included in the composite state return (corpo- rations, partnerships and certain other entities), the Public Partnership will provide the applicable state information.
Certain tax benefits which are available to shareholders for Federal income tax purposes may not be available to shareholders for state or local tax purposes and, in this regard, investors are urged to consult their own tax advisors. The Public Partnership intends to supply shareholders with information regarding their income, if any, derived from various jurisdictions in which the Principal Subsidiary Partnership operates.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of ServiceMaster Limited Partnership:
We have audited in accordance with generally accepted auditing standards, the financial statements included in ServiceMaster Limited Partnership's annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 24, 1995. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedules included in Part IV in the Form 10-K are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These supporting schedules have been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
Arthur Andersen LLP Chicago, Illinois January 24, 1995
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
SERVICEMASTER LIMITED PARTNERSHIP Registrant
By: ServiceMaster Management Corporation (General Partner)
Date: March 17, 1995 By: /s/ C. WILLIAM POLLARD ---------------------- C. William Pollard Chairman
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in their capacities and on the date indicated.