American Home Shield 2004 Annual Report Download - page 31

2004 annual report ServiceMaster 29
Those operations had $35 million in revenue in 2002 and $20
million prior to their closure in 2003. Operating profits at ARS
Service Express declined due to the third-quarter impairment
charge as well as a decrease of $.7 million from operations. These
results, however, include incremental shutdown costs and
operating losses prior to disposition of approximately $1.8 million.
AMS’ revenue decreased nine percent in 2003, reflecting
reduced levels of project work due to depressed conditions in the
commercial construction industry. The project backlog increased
substantially by the end of 2003, but bid pricing was very
competitive and there were longer lead-times for projects to start.
Capital employed in the ARS/AMS segment declined, reflecting
the impact of the impairment charge.
Other Operations Segment
The Other Operations segment reported a two percent increase
in revenue to $152 million in 2003 compared with $149 million
in 2002. The combined ServiceMaster Clean and Merry Maids
franchise operations reported revenue growth of eight percent in
2003, driven primarily by continued excellent results in disaster
restoration services. The impact of the franchise operations
revenue growth was partially offset by $6 million of licensing
fees recorded in the third quarter of 2002 related to the Company’s
former Terminix United Kingdom operations.
The segment reported an operating loss of ($40) million in 2003
compared with a loss of ($23) million in 2002. Continued strong
growth in operating income of ServiceMaster Clean was more
than offset by higher costs at the headquarters level related to
insurance, marketing and compliance, and the effect of $6 million
of non-recurring licensing fee income earned in 2002, as well
as the compensation expense related to a deferred compensa-
tion trust. Accounting standards require that appreciation on
investments in a deferred compensation trust be reflected as
compensation expense in computing operating income, with a
corresponding amount of investment income included in non-
operating income/expense.
Total initial and recurring franchise fees (excluding trade name
license agreements) represented 2.6 percent of consolidated
revenue in both 2003 and 2002, respectively, and direct franchise
operating expenses were 1.6 percent and 1.7 percent of consoli-
dated operating expenses in 2003 and 2002, respectively. Total
franchise fee profits (excluding the aforementioned trade name
license agreements) comprised 10.5 percent and 9.4 percent of
consolidated operating income (without the impairment charge
for 2003) before headquarter overheads in 2003 and 2002,
respectively. The portion of total franchise fee profits related to
initial fees received from the sales of franchises was not material to
the Company’s consolidated financial statements for all periods.
2004 Financial Position and Liquidity
Cash Flows from Operating Activities
Net cash provided from operating activities was $376 million in
2004, $92 million more than 2003. The improvement reflects
reduced working capital usage of $45 million, a $25 million
favorable timing difference in tax payments resulting from the
agreement with the IRS, and an increased level of profits. The
improvement in working capital reflects a lower rate of cash
outflows in early 2004 relating to incentive compensation
earned in 2003, combined with an increased level of non-cash
accruals for 2004 incentives, reflecting a return to more normal
incentive rates. Net cash provided from operating activities has
historically exceeded net income. In 2005, the Company
expects this trend to continue. However, the rate of growth in
cash flows from operating activities is anticipated to temporarily
subside due to the aforementioned tax and incentive items.
Three factors contribute to the Company’s strength in its annual
cash provided from operating activities: a solid earnings base,
businesses that need relatively little working capital to fund
growth in their operations, and significant annual deferred taxes.
The Company receives a significant annual cash tax benefit due
to a large base of amortizable intangible assets which exist for
income tax reporting purposes, but not for book purposes. A
significant portion of these assets arose in connection with the
1997 conversion from a limited partnership to a corporation. The
2004 agreement with the IRS affirmed the previously identified
step-up in the tax basis of the Company’s assets which occurred
upon reincorporation. This basis will continue to be amortized
and deducted over the 15 year period ending December 31,
2012. This amortization has resulted in $50 million of annual
cash tax benefits.
The 2004 IRS agreement also increased taxes and interest due
on the 2001 sale of the Company’s large Management Services
segment. This occurred primarily as a result of changes in the
timing of certain items which were previously netted against the
gain and now will be amortized for tax purposes as additional
deductions over the 15 year period ending December 31, 2016.
The Company will now realize an incremental $7 million of
annual cash tax benefit.
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