American Home Shield 2005 Annual Report Download - page 28

SERVICEMASTER 2005 ANNUAL REPORT P.26
The Company has minority investors in Terminix. This
minority ownership reflects an interest issued to the former
owners of the Allied Bruce Terminix Companies in connection
with the acquisition of that entity. At any time, the former
owners may convert this equity security into eight million
ServiceMaster common shares. The ServiceMaster shares
are included in the shares used for the calculation of diluted
earnings per share whenever their inclusion has a dilutive
impact. Subsequent to December 31, 2005, ServiceMaster
has the ability to require conversion of the security into
ServiceMaster common shares, provided the closing share
price of ServiceMaster’s common stock averages at least
$15 per share for 40 consecutive trading days.
Total shareholders’ equity was $1.1 billion and $992 million
at December 31, 2005 and 2004, respectively. The increase
primarily reflects operating profits in the business offset in
part by cash dividend payments and share repurchases.
Under federal tax rules, dividends are considered taxable
only when paid out of current or accumulated earnings and
profits as defined under federal tax laws. As a result of its
December 1997 reincorporation, the Company only began
generating corporate earnings and profits for tax purposes
in 1998. Since 1998, earnings and profits for tax purposes
have been reduced by dividend payments, amortization of
intangible assets for tax reporting, deductions relating to
business closures and the timing of certain other tax-related
items. The Company currently expects that approximately
60 percent of its 2006 dividends on common stock will be
taxable as dividend income for federal income tax purposes.
This is lower than the previously disclosed taxability
percentage for 2005 dividends of 87 percent, primarily due
to one-time effects of the pending dispositions. The 2006
estimate is subject to change, based on the outcome of
future events. Any portion of the dividend that is not taxable
would be treated as a return of capital and would generally
be applied to reduce the cost basis of the shares. The
Company expects that the taxable portion of its dividend
will rebound sharply in 2007, and grow to be fully taxable
over the succeeding few years.
Financial Position – Businesses Held Pending Sale and
Discontinued Operations
The assets and liabilities related to businesses held pending
sale and discontinued businesses have been classified in a
separate caption on the Consolidated Statements of
Financial Position. Assets from the businesses held pending
sale and discontinued operations have increased, reflecting
growth in receivables at the American Residential Services
(ARS) and American Mechanical Services (AMS) businesses.
The increase in liabilities from businesses held pending sale
and discontinued operations represents increases in
payables and other current liabilities at the ARS and AMS
businesses, partially offset by reductions associated with
the favorable conclusion of certain obligations related to the
previously sold international pest control operations. The
remaining liabilities primarily represent payables and other
current liabilities at the businesses held pending sale and
obligations related to long-term self-insurance claims.
Critical Accounting Policies and Estimates
The preparation of the financial statements requires man-
agement to make certain estimates and assumptions
required under generally accepted accounting principles
which may differ from actual results. The more significant
areas requiring the use of management estimates relate to
the allowance for receivables, accruals for self-insured retention
limits related to medical, workers’ compensation, auto and
general liability insurance claims, accruals for home warranty
claims, the possible outcomes of outstanding litigation,
accruals for income tax liabilities as well as deferred tax
accounts, the deferral and amortization of customer acquisition
costs, useful lives for depreciation and amortization expense
and the valuation of tangible and intangible assets.
The allowance for receivables is developed based on several
factors including overall customer credit quality, historical
write-off experience and specific account analyses that
project the ultimate collectibility of the outstanding balance.
As such, these factors may change over time causing the
reserve level to vary.
The Company carries insurance policies on insurable risks
at levels which it believes to be appropriate, including workers’
compensation, auto and general liability risks. The
Company has self-insured retention limits and insured layers
of excess insurance coverage above those limits. Accruals
for self-insurance losses and warranty claims in the
American Home Shield business are made based on the
Company’s claims experience and actuarial projections.
Current activity could differ causing a change in estimates.
The Company has certain liabilities with respect to existing
or potential claims, lawsuits, and other proceedings. The
Company accrues for these liabilities when it is probable
that future costs will be incurred and such costs can be
reasonably estimated. Any resulting adjustments, which
could be material, are recorded in the period identified.
The Company records deferred income tax balances
based on the net tax effects of temporary differences
between the carrying value of assets and liabilities for financial
reporting purposes and income tax purposes. There are
significant amortizable intangible assets for tax reporting
purposes (not for financial reporting purposes) which arose
as a result of the Company’s reincorporation from partner-
ship to corporate form in 1997. The Company records its
deferred tax items based on the estimated value of the tax
basis. The Company adjusts tax estimates when required
to reflect changes based on factors such as changes in tax
laws, results of tax authority reviews and statutory limitations.
Management Discussion and Analysis of Financial Condition and Results of Operations