American Home Shield 2004 Annual Report Download - page 28

26 ServiceMaster 2004 annual report
Revenue for 2003 was $3.6 billion, two percent above 2002.
The Company reported a net loss from continuing operations in
2003 of ($222) million and a loss from discontinued operations
of ($3) million. The net loss of ($225) million in 2003 compared
with net income of $157 million in 2002. Diluted earnings per
share were a ($.76) loss in 2003 and $.51 in 2002.
Diluted earnings per share from continuing operations were a
loss of ($.75) in 2003 compared with $.51 in 2002. The diluted
earnings per share for 2003 include the non-cash goodwill and
intangible assets impairment charge that is discussed below.
This charge totaled $1.30 per diluted share, $481 million pre-tax,
and $383 million after-tax. Operating income for 2003 was a
loss of ($166) million, compared with income of $335 million in
2002. The 2003 results include the $481 million non-cash
impairment charge. The net change in operating income reflects
strong growth at American Home Shield and ServiceMaster
Clean and increased profits in TruGreen’s lawn care operations
and Terminix, offset by the impact of the impairment charge,
reduced profitability in TruGreen’s landscaping operations
as well as at AMS. There was also increased spending at the
headquarters level.
In the third quarter of 2003, the Company recorded a non-cash
impairment charge associated with the goodwill and intangible
assets of its ARS, AMS and TruGreen LandCare business units
of $481 million pre-tax, $383 million net of tax, or $1.30 per
diluted share. The pre-tax charge consisted of $224 million at
American Residential Services, $68 million at American
Mechanical Services and $189 million at TruGreen LandCare.
The impairment charge 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
charge amount.
Throughout the first half of 2003, management believed that
the significant declines in the operating results of these businesses
were due to temporary conditions and that the operations, with
an anticipated good summer season, would show ongoing
improvement which would support the amount of goodwill and
intangible assets on the balance sheet. The Company had
discussed such events, trends and expectations in its press
releases and periodic filings with the Securities and Exchange
Commission. In the third quarter of 2003, the results did not
improve. In addition, the Company identified certain branch
closures at ARS and announced the sale of its utility line clearing
operations at TruGreen LandCare. The lack of a good 2003
summer season, combined with declining profitability in the
base businesses, led management to conclude that the businesses
were unlikely to meet the previous projections which had
supported the carrying value. A valuation was performed during
the third quarter of 2003 which incorporated third quarter
2003 performance. The fair value of the reporting units was
determined primarily by utilizing a discounted cash flow
methodology. The Company used an independent valuation
firm to confirm the Company’s assessment of the fair value of its
reporting units. Based on the evaluation, it was determined that
the fair values of the ARS, AMS, and TruGreen LandCare
reporting units were less than their carrying values. As a result,
in the third quarter of 2003, the Company recorded a non-cash
impairment charge of $481 million pre-tax, $383 million net of
tax, to reduce the carrying value of the intangible assets to $56
million, their estimated fair value.
During the fourth quarter of 2003, the Company recorded a
reduction in revenue and operating income as a result of a
correction in its historical method of recognizing renewal revenue
from certain Terminix and American Home Shield customers
who have prepaid. The effects of the adjustment were not material
to years prior to 2003. This adjustment reduced operating and
pre-tax income by $12 million, or $.02 per diluted share in the
fourth quarter of 2003. The Company also recorded a favorable
adjustment as a result of positive trending in termite damage
claim costs related to the portion of the customer base that had
been acquired from Sears several years ago. This resulted in a
pre-tax reduction in expense of $7 million in the fourth quarter of
2003 and a total of $13 million, or $.03 per diluted share, for
the full year 2003. Combined, these items reduced revenue
for the fourth quarter of 2003 by $14 million and reduced oper-
ating and pre-tax income in the fourth quarter by approximately
$5 million.
Operating and Non-Operating Expenses
Cost of services rendered and products sold increased one percent
compared to 2002 and decreased as a percentage of revenue to
68.1 percent in 2003 from 68.5 percent in 2002. This decrease
reflects a change in the mix of business as TruGreen Chem-
Lawn, 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 somewhat higher selling
and administrative expenses as a percentage of revenue. Selling
and administrative expenses increased seven percent and
increased as a percentage of revenue to 22.9 percent in 2003
from 21.7 percent in 2002. The increase in selling and adminis-
trative expenses primarily reflects the change in business mix
described above, as well as increased expenditures for sales and
marketing and higher technology and compliance costs at the
headquarters level.
Net interest expense decreased $35 million from 2002, reflecting
the payment in 2002 of a $15 million premium to repurchase
public bonds, lower interest expense from reduced debt balances,
as well as higher investment income from securities gains in the
American Home Shield investment portfolio.
management discussion and analysis of financial condition and results of operations