American Home Shield 2004 Annual Report Download - page 23

2004 annual report ServiceMaster 21
Diluted earnings per share from continuing operations were
$1.08 in 2004 compared with a loss of ($.75) in 2003. As more
fully discussed below, the diluted earnings per share from
continuing operations for 2004 include a $.49 per share ($150
million) non-cash reduction in the tax provision and the 2003
amount includes a non-cash goodwill and intangible assets
impairment charge of $1.30 per share ($481 million pre-tax,
$383 million after-tax). Operating income for 2004 was $337
million, compared with a loss of ($166) million in 2003. The 2003
results include the $481 million non-cash impairment charge.
Management believes that the cost controls and focus on
improved efficiencies that were evident throughout the enter-
prise during the second half of 2003 remained firmly in place in
2004, and that these were instrumental in helping the Company
overcome approximately $35 million, or $.07 per diluted share, of
incremental variable compensation and fuel costs. The Company
expects the growth in incentive compensation to return to more
normal levels in 2005 and in subsequent years. The increase in
operating income in 2004 reflects the impact of the 2003 impair-
ment charge, strong profit growth at American Home Shield
and TruGreen’s ChemLawn operations, a reduced level of oper-
ating loss in TruGreen’s landscaping operations and improved
profits at ServiceMaster Clean and Terminix, as well as a $4 million
gain that TruGreen ChemLawn realized in the third quarter of
2004 from the sale of a support facility. These increases were
partially offset by a reduced level of profits at ARS.
Tax Agreement
In January 2005, the Company reached a comprehensive agree-
ment with the Internal Revenue Service (IRS) regarding its
examination of the Company’s federal income taxes through the
year 2002. As previously disclosed, the Company had not been
audited by the IRS during the period in which it operated as a
master limited partnership (1987 through 1997) or in subsequent
years. Consequently, the examination covered numerous matters,
including the tax consequences resulting from the Company’s
reincorporation in 1997, and the sale of its large Management
Services segment in November 2001. The principal terms of the
agreement were as follows:
1. The agreement affirmed the previously identified step-up in
the tax basis of the Company’s assets which occurred upon
reincorporation. For income tax reporting purposes, this
step-up is generally being amortized and deducted over the
15 year period ending December 31, 2012.
2. The agreement increased taxes and interest due on the 2001
sale of the Company’s Management Services business. This
occurred primarily as a result of changes in the timing of
certain items which were previously netted against the gain
and will now be amortized as additional deductions over the
15 year period ending December 31, 2016.
3. The agreement resolved all other matters in the years under
review.
For 2004, the IRS agreement resulted in a $25 million favorable
timing difference in fourth quarter 2004 tax payments. Pursuant
to the agreement, the Company paid taxes and interest (primarily
in February 2005) to the IRS and various states in the amount of
$133 million ($113 million of increased taxes and $20 million of
interest). Existing financial resources were utilized to fund the
payment and the Company does not believe that the payment
significantly impaired its financial flexibility. Also related to the
agreement, the Company will realize an approximate $45 million
reduction in the 2005 estimated tax payments that would otherwise
have been paid in the second half of 2005. Finally, the agreement
resulted in incremental future tax benefits of approximately $57
million, which will be recovered on the Company’s tax returns
over the 11 year period ending in 2016.
Certain deferred tax assets which had previously not been
recorded due to uncertainties associated with the complexity
of the matters under review and the extended period of time
effectively covered by the examination were recorded. This
resulted in a non-cash reduction in the Company’s 2004 income
tax provision, thereby increasing 2004 consolidated net income
by approximately $159 million ($150 million, or $.49 per diluted
share, related to continuing operations and $9 million, or $.03
per diluted share, related to discontinued operations).
2003 Impairment Charge
In the third quarter of 2003, the Company recorded a non-cash
impairment charge associated with the goodwill and intangible
assets at its ARS, AMS and TruGreen LandCare business units.
This charge, which totaled $481 million pre-tax, $383 million
after-tax, and $1.30 per share, reduced the carrying value of the
assets to their estimated fair value of $56 million. In accordance
with SFAS 142, “Goodwill and Other Intangible Assets”, goodwill
and intangible assets that are not amortized are subject to assess-
ment for impairment by applying a fair-value based test on an
annual basis or more frequently if circumstances indicate a
potential impairment. The Company’s annual assessment date
is October 1.