American Home Shield 2004 Annual Report Download - page 26

24 ServiceMaster 2004 annual report
Termite renewal revenues experienced strong growth, supported
by improved pricing. Pest control revenue increased modestly as
high single-digit growth in customer counts, attributable in part
to a 100 basis point improvement in retention, was partially offset
by the unfavorable impact to revenues from the increased
number of customers receiving quarterly service visits versus
monthly service visits. The Company believes this shift has
had a positive impact on improving customer satisfaction and
has already caused and should continue to lead to improved
labor efficiencies.
Operating income grew modestly as the projected termite mix
shift did have a negative effect on first year gross profit. Operating
income was also adversely impacted by higher insurance, fuel,
and bad debt costs, as well as the costs associated with a procedural
change in the branches to ensure that termite renewal reinspections
occur before the actual renewal payments are due. In 2004, the
Company recorded a final adjustment to reflect positive trending
in damage claim costs associated with the Sears termite customer
base acquired several years ago. This resulted in an $8 million
reduction in expense in 2004, compared with a $13 million
reduction in 2003. In the fourth quarter of 2003, Terminix
corrected its method of recognizing renewal revenue from certain
customers who have prepaid. A cumulative adjustment was
recorded reducing fourth quarter 2003 revenue by $9 million
and operating income by $7 million.
Capital employed in the Terminix segment increased six percent,
primarily reflecting acquisitions.
American Home Shield Segment
The American Home Shield segment, which provides home
warranties to consumers that cover HVAC, plumbing and other
systems and appliances, reported an eight percent increase in
revenue to $487 million from $450 million in 2003, and operating
income growth of 24 percent to $72 million compared to $58
million in 2003.
Renewal sales, which are American Home Shield’s largest
source of revenue, experienced solid growth, reflecting manage-
ment’s specific programs to improve satisfaction and retention.
Real estate sales, which are the second-largest channel, had slight
growth with volume negatively impacted by strong declines in
home listings in high warranty usage states like California and
Texas. And consumer sales, which are the smallest but fastest-
growing channel, experienced very strong double-digit growth,
reflecting an increased level of direct-mail solicitations. American
Home Shield’s total new contract sales in the fourth quarter
increased three percent, a rate less than the full year growth rate
due in part to the relative timing of direct mail solicitations.
Operating income increased, reflecting the effects of revenue
growth and continued very strong controls over claim costs.
Partially offsetting these factors were continuing investments to
increase market penetration and customer retention. In 2005,
American Home Shield is planning to continue its efforts to
expand sales in less established real estate markets by expanding
its sales force, improving training, and reducing the span of
control of sales force supervisors. These efforts are intended to
drive a replication of the results of high performing account
executives. Management is also focusing on continuing to
improve customer satisfaction and retention through enhanced
customer communications.
In the third quarter of 2004, American Home Shield recorded
a cumulative, non-cash negative adjustment to revenue and
operating income of approximately $5.5 million related to the
conversion from a historically manual deferred revenue calculation
to an automated computation. In the fourth quarter of 2003,
American Home Shield recorded a cumulative adjustment of a
comparable amount related to a correction in its method of
recognizing revenue from customers who have prepaid.
Capital employed increased 25 percent reflecting a higher level
of investments due to the growth in the business and improved
market performance. The calculation of capital employed for
the American Home Shield segment includes approximately
$258 million and $221 million of cash, short-term and long-term
securities at December 31, 2004 and 2003, respectively. The
interest and realized gains/losses on these investments are
reported as non-operating income/expense.
ARS/AMS Segment
The ARS/AMS segment primarily provides HVAC and plumbing
installation and repair services under the brand names of ARS
Service Express, Rescue Rooter, (collectively “ARS Service
Express”) and American Mechanical Services (AMS) for large
commercial accounts. The segment reported revenue of $691
million, an increase of three percent compared to $674 million in
2003. Excluding the effects of branch closures in 2003, revenue
increased six percent. The segment reported operating income
of $6 million compared with an operating loss of ($282) million
in 2003. During the third quarter of 2003, the Company recorded
a pre-tax non-cash impairment charge of $292 million relating
to goodwill and intangible assets of this segment. For a further
discussion on the impairment charge see the “Goodwill and
Intangible Assets” section in the Notes to Consolidated Financial
Statements. The increase in segment operating income reflects
the impact of the 2003 impairment charge and modest profit
growth at AMS, partially offset by decreased profitability in the
ARS Service Express operations.
management discussion and analysis of financial condition and results of operations