American Home Shield 2004 Annual Report Download - page 24

22 ServiceMaster 2004 annual report
Operating and Non-Operating Expenses
Cost of services rendered and products sold increased four percent
compared to the prior year and decreased as a percentage of
revenue to 67.2 percent in 2004 from 68.1 percent in 2003. This
decrease reflects a change in the mix of business as TruGreen
ChemLawn, Terminix, and American Home Shield increased
in size in relationship to the overall business of the Company.
These businesses generally operate at higher gross margin levels
than the rest of the business, but also incur relatively higher selling
and administrative expenses. Selling and administrative expenses
increased nine percent and increased as a percentage of revenue
to 23.7 percent from 22.9 percent in 2003. The increase in selling
and administrative expenses primarily reflects the change in
business mix described above, as well as an increased level of
variable incentive compensation expense at the headquarters
level and increased investments in the sales force, particularly at
Terminix and American Home Shield.
Net interest expense decreased $5 million from 2003, primarily
reflecting the favorable impact of interest rate swap agreements
entered into at the end of 2003 and early 2004, and a slightly
higher level of investment income from securities in the American
Home Shield investment portfolio. It is important to note that
investment gains are an integral part of the business model at
American Home Shield, and there will always be some market-
based variability in the timing and amount of investment gains
realized from year to year.
The comparison of the effective tax rate is impacted by the 2004
reduction in the tax provision related to the Company’s agree-
ment with the IRS, as well as the impairment charge recorded in
2003. The effective tax rate of continuing operations reflects a
benefit of 14 percent in 2004 and a benefit of one percent in
2003. As previously discussed, the agreement with the IRS
resulted in a $150 million non-cash reduction in the 2004
income tax provision for continuing operations. The impair-
ment charge recorded in 2003 included a portion of goodwill
that was not deductible for tax purposes, resulting in a tax
benefit of $98 million, or only approximately 20 percent of the
pre-tax impairment charge of $481 million. Excluding the
impact of the 2004 IRS agreement and the 2003 impairment
charge, the effective tax rates for continuing operations were 38
percent in 2004 and 37 percent in 2003. The Company expects
that its effective tax rate for 2005 will approximate 39 percent.
Segment Review (2004 vs. 2003)
Key Performance Indicators
As of December 31, 2004 2003
TruGreen ChemLawn -
Growth in Full Program Contracts 8% 4%
Customer Retention Rate 62.2% 59.5%
Terminix -
Growth in Pest Control Customers 7% 2%
Pest Control Customer Retention Rate 78.1% 77.1%
Growth in Termite Customers 0% -2%
Termite Customer Retention Rate 87.9% 88.1%
American Home Shield -
Growth in Warranty Contracts 5% 5%
Customer Retention Rate 55.2% 55.1%
TruGreen Segment
The TruGreen segment includes lawn care services performed
under the TruGreen ChemLawn brand name and landscape
maintenance services provided under the TruGreen LandCare
brand name. The TruGreen segment reported revenue of $1.4
billion in 2004, five percent above the prior year. The segment
reported operating income of $171 million in 2004 compared to
an operating loss of ($34) million in 2003. During the third quarter
of 2003, the Company recorded a non-cash impairment charge of
$189 million pre-tax, relating to goodwill and intangible assets
of its TruGreen LandCare operations. For a further discussion
of the impairment charge see the “Goodwill and Intangible
Assets” section in the Notes to Consolidated Financial Statements.
The increase in segment operating income reflects the impact of
the 2003 impairment charge as well as a strong increase in
profits in the lawn care operations, a $4 million gain from the
sale of a support facility, and a reduced level of operating losses
in the landscaping operations.
Revenue in the lawn care operations increased eight percent
over 2003. The growth in revenue was supported by an eight
percent increase in customer counts, with five percent of that
growth from organic sources and three percent from acquisi-
tions. The organic customer count growth reflected continued
significant improvement in customer retention, partially offset
by a modest decline in new sales. The customer retention
improvement of 270 basis points in 2004 was geographically
broad-based, resulting from programs implemented to improve
customer communications and problem resolution, initiatives
to produce more visible results, focused incentive compensation
structures at all levels, and more favorable weather conditions.
Over the last three years, the retention rate has improved by
450 basis points, reflecting management’s concerted focus on
customer satisfaction.
management discussion and analysis of financial condition and results of operations