American Home Shield 2006 Annual Report Download - page 18

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Item 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Results of Operations
Consolidated Review of 2005 and Outlook for 2006
2005 was an encouraging year for ServiceMaster (the "Company") as it reported revenue and earnings per share in line with
management's expectations. It was also a year where every one of the Company's business segments achieved growth in revenue
and two of the Company's core businesses, Terminix and TruGreen ChemLawn, each surpassed $1 billion in revenue for the first
time. In 2005, the Company overcame significant challenges including record high fuel prices, steadily rising interest rates, unusual
weather aberrations, including the hurricanes, and continued expansion in telemarketing restrictions. The Company overcame these
obstacles by focusing on what it could control, like safety, customer satisfaction, and sales force and geographic expansion.
In 2006, the Company will be implementing three significant changes to its business portfolio. (1) The Company intends to sell
American Residential Services (ARS) and American Mechanical Services (AMS). These are businesses, in large markets, with
strong management teams. These companies are making good progress on key initiatives that will make them even better in the
future. But there were two fundamental issues that led the Company to the difficult decision to sell these operations. First, is the
Company's need to have fewer priorities, so that it can pursue them with greater intensity. Second, the Company concluded that
ARS and AMS businesses are not compatible with the Company's overall business model. ARS and AMS are not built around the
kind of repeat business experienced in the Company's other operations, and hence the ARS and AMS operations are more cyclical
and weather dependent. These two businesses also operate at much lower margins, and they would require meaningful time and
capital to establish widely recognized national brands such as those the Company enjoys in each of its other businesses.
(2) In February 2006, the Company announced an agreement to acquire InStar Services Group, Inc. InStar is a leading direct
provider of commercial disaster response and reconstruction services in the United States with 2005 revenues of approximately
$130 million. InStar provides a continuum of services, from planning prior to an event, to emergency response following the event
and ultimately including cleaning, recovery and reconstruction. InStar has been growing rapidly and is expected to grow at a much
faster rate than the businesses held pending sale. InStar has solid profit margins and operates in an extremely large market with a
tremendous opportunity to gain a larger share. The Company believes there is a great strategic fit in combining the capabilities of
InStar with the Company's existing disaster restoration business within ServiceMaster Clean. ServiceMaster Clean's disaster
restoration business already totals over $500 million in customer level revenue through its franchisee network and has been growing
at double digit rates for more than five years. The Company expects the InStar acquisition, after interest and amortization costs, to
be accretive in the $.01 per share range for the period in 2006 following the acquisition.
(3) The Company has launched Project Accelerate, an internal, multi-phase reengineering project designed to improve the
effectiveness and efficiency of all functional support areas. Upon completion, Project Accelerate will result in an organization that
is better aligned to respond faster to the marketplace, its customers, and provide better day-to-day support for front line associates
who are in the homes and businesses of customers every day. This project is consistent with the Company's goal of becoming
systematically stronger and is expected to have a positive financial impact on the enterprise. The reduction in direct support costs,
combined with more effective purchasing of outside services and other cost reductions, is targeted to produce annualized gross
savings in the range of $50 to $75 million, and net savings of $25 million to $35 million after reinvestments into the business and
the impact of factor cost increases. Those savings should begin to be realized in 2006, and reach end state (on an annualized run
rate basis) in 2007. Excluding the effects of one-time severance and implementation costs, the amounts of which the Company will
be determining over the course of the first quarter 2006, the Company estimates the 2006 savings from Project Accelerate in the
$0.02 per share range, helping the Company to offset rising factor costs and contribute to continued strong bottom-line growth.
Going forward, the Company will be comprised of leading service brands that collectively have strong cash flow, solid revenue
growth potential, greater operating margins and stronger returns on invested capital. The Company believes that its improved
portfolio, combined with solid execution of its business strategies, will enable it to deliver mid to high-single digit revenue growth
and low double-digit earnings growth in 2006. From a base of earnings from continuing operations of $0.61, the Company's
earnings per share target for 2006 is $0.69. Based on the actions the Company is taking in 2006, the Company's target is to achieve
high single digit revenue growth and earnings per share growth in the mid-teen level during 2007 and beyond, with cash from
operations growing and continuing to substantially exceed net income.
2005 Compared with 2004
Revenue from continuing operations for 2005 was $3.2 billion, a six percent increase over 2004. Most of the revenue growth was
organic, with every business segment achieving increases over 2004 levels.
The Company reported income from continuing operations in 2005 of $181 million and income from businesses held pending sale
and discontinued operations of $18 million. Total net income was $199 million in 2005 compared with $331 million in 2004. The
2004 total included a $159 million nonrecurring reduction in the tax provision and corresponding increase in net income resulting
from the agreement with the IRS. Diluted earnings per share were $.67 in 2005 compared with $1.11 in 2004.
Diluted earnings per share from continuing operations were $.61 in 2005 compared with $1.06 in 2004. As more fully discussed
below, the diluted earnings per share from continuing operations for 2004 include a $.49 per share ($150 million) non-cash
reduction in the tax provision resulting from the Company's agreement with the IRS.
11