American Home Shield 2003 Annual Report Download - page 25

ServiceMaster    23
In the third quarter of 2003, the Company recorded a non-
cash impairment charge associated with the goodwill and
intangible assets at its ARS, AMS and TruGreen LandCare
business units of $481 million pre-tax, which is $383 million
after-tax or $1.30 per share. In accordance with SFAS 142,
“Goodwill and Other Intangible Assets”,goodwill and intan-
gible assets that are not amortized are subject to assessment
for impairment by applying a fair-value based test on an
annual basis or more frequently if circumstances indicate a
potential impairment. The Company’s annual assessment
date is October 1.
Based on events and underlying trends in its HVAC,plumbing
and commercial landscape business, the Company determined
that these businesses were unlikely to generate the necessary
cash flows to support the recorded value of goodwill and
intangible assets. There were several factors leading up to the
resulting impairment charge. Throughout the first half of
the year, management believed that the significant declines in
operating results in 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 and trends 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 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. As a result, the Company recorded a non-
cash impairment charge to reduce the carrying value of the
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
revenues from certain Terminix and American Home Shield
customers who have prepaid. The effects of the adjustment
were not material to prior years. This adjustment reduced
operating and pre-tax income by $12 million,or $.02 per share
in the fourth quarter of 2003. The Company also recorded a
favorable adjustment as a result of positive trending in
certain termite damage claim costs. This resulted in a pre-tax
reduction in expense of $7 million in the fourth quarter and
$13 million, or $.03 per share, for the full year. Combined,
these items reduced revenues for the fourth quarter by $14
million and reduced operating and pre-tax income in the
fourth quarter by approximately $5 million. In addition, the
Company incurred severance and shut down costs primarily
associated with branch closures and had lower incentive
compensation expense than the prior year; the net effect of
these latter two other items was immaterial.
Cost of services rendered and products sold increased one
percent compared to the prior year and decreased as a per-
centage 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 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 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 from 21.7 percent in 2002. The
increase in selling and administrative 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 invest-
ment portfolio.
Comparability of the effective tax rate is impacted by the
impairment charge recorded in the third quarter of 2003 and
the use of prior year net operating losses in 2002.The effective
tax rate of continuing operations reflects a one percent benefit
in 2003 and a 35 percent provision in 2002. The impairment
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 approximately 20 percent of the pre-tax
impairment charge of $481 million. Excluding the impair-
ment charge the tax rate was 37 percent. The 2002 rate
included a one-time benefit from utilizing the prior year net
operating losses of the ServiceMaster Home Service Center
operations, which resulted in a reduction in the tax provision.
The Company anticipates the effective tax rate of continuing
operations to increase slightly in 2004 to a more normalized
rate of approximately 39 percent.
Management Discussion and Analysis of
Financial Condition and Results of Operations