American Home Shield 2005 Annual Report Download - page 23

P. 2 1 SERVICEMASTER 2005 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 62.6 percent in 2004 from 63.5
percent in 2003. Selling and administrative expenses
increased nine percent and increased as a percentage of
revenue to 26.7 percent from 26.0 percent in 2003. The
increase in selling and administrative expenses primarily
reflects an increased level of variable incentive compensa-
tion 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 returns 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 returns 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 agreement with the IRS, as well as the impair-
ment charge recorded in 2003. The effective tax rate for
continuing operations reflects a benefit of 17 percent in
2004 and a 105 percent tax expense 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 impairment charge reported
in continuing operations for 2003 included a portion of
goodwill that was not deductible for tax purposes, resulting
in a tax benefit of $33 million, or only approximately 17 percent
of the pre-tax impairment charge of $189 million.
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 ChemLawn Segment
The TruGreen ChemLawn segment reported revenue of
$981 million in 2004, eight percent above 2003. Operating
income was $176 million in 2004 compared to $162 million
in 2003. Included in the 2004 results was a $4 million pre-tax
gain from the sale of a support facility.
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 acqui-
sitions. 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 communica-
tions and problem resolution, initiatives to produce more
visible results, focused incentive compensation structures
at all levels, and more favorable weather conditions. Since
2001, the retention rate has improved by 450 basis points,
reflecting management’s concerted focus on customer
satisfaction.
Management is encouraged with the progress TruGreen
ChemLawn has made in diversifying its marketing model,
further reducing its reliance on telemarketing. Overall, new
sales in 2004 were down less than two percent, reflecting a
decline in telemarketing sales as a result of new restrictions,
including implementation of the National Do Not Call registry,
offset by a substantial increase in sales from new channels
such as neighborhood sales efforts and direct mail. In April
2004, TruGreen ChemLawn acquired the assets of
Greenspace Services Limited (“Greenspace”), Canada’s
largest professional lawn care service company.
Operating income increased nine percent, with approxi-
mately three percent of the increase related to the $4 million
gain realized from the sale of a support facility in the third
quarter. Operating income margins improved slightly,
reflecting the impact of the support facility gain, partially
offset by increased fuel and chemical costs as well as
increased variable incentive compensation costs.
Capital employed increased two percent, reflecting acquisi-
tions, offset in part by improved working capital management.
Management Discussion and Analysis of Financial Condition and Results of Operations