It's been a rough couple of trading days for investors in ServiceMaster (NYSE:SVM), ever since the company reported earnings last Thursday morning. So far, the Motley Fool Income Investor pick's stock has sunk 4% on news that it met, but did not beat, earnings expectations of $0.25 per share. And it can't be denied that the company behind such well-known brands as Terminix, TruGreen ChemLawn, and American Home Shield didn't give investors a whole lot to be excited about.
Revenues grew by a steady but unexciting 8%. The same goes for earnings per share, which grew just a bit faster at 9%. The bad news -- as it has been for the past few quarters -- was that the company's previously disclosed $131 million tax settlement with the IRS made ServiceMaster's cash flow situation look just plain abominable. In comparison with the $241 million that the company generated in cash from operations over the first nine months of 2004, ServiceMaster generated just $112 million this year.
Worse than the numbers, though, was that the company added insult to its own financial injury (not to mention insulting its investors' intelligence) in asserting that "excluding the impact of the IRS settlement, we expect cash from operating activities to increase and to again substantially exceed net income." That's a bogus argument. After all, the cash settlement was for taxes that ServiceMaster owed to the IRS. A company shouldn't be allowed to boast about massive cash flow that it generated by underpaying its taxes in one year and then, in a later year, dismiss as irrelevant the massive decline in cash flow it gets hit with when the tax man comes knocking.
So to set the record straight, this is how ServiceMaster actually looks in cash from operating activities-to-net income terms: From 2000 to the end of fiscal 2004, ServiceMaster generated $1.836 billion in cash from operations, against reported net income (under generally accepted accounting principles) of $533.6 million. Even after you subtract out $250.4 million in capital expenditures, there's no denying that ServiceMaster is massively more profitable from a real cash profits perspective (free cash flow or "FCF") than it appears to be under GAAP. Its FCF over the past five years was $1.586 billion -- nearly three times its GAAP profits. That's great. That's admirable. That's a large part of the reason we recommended the company to our Income Investor subscribers.
But it doesn't change ServiceMaster's year-to-date generation of just $77.2 million in FCF, much less than its GAAP net income of $172 million. Fair's fair, guys. You have to take the bad with the good.
For further Foolish views on ServiceMaster, read these columns by fellow Fools W.D. Crotty and Tim Beyers:
- ServiceMaster Serves Earnings: Fool by Numbers
- ServiceMaster Does the Job
- Serving the Master
- ServiceMaster Serves Cash
Fool contributor Rich Smith owns no shares in any of the companies mentioned in this article.
