American Home Shield 2005 Annual Report Download - page 25

P. 2 3 SERVICEMASTER 2005 ANNUAL REPORT
American Home Shield Segment
The American Home Shield segment 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
management’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 of six percent 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 cash and marketable securities 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.
Other Operations Segment
The Other Operations segment reported an eight percent
increase in revenue to $164 million in 2004 compared with
$152 million in 2003. On a combined basis, the
ServiceMaster Clean and Merry Maids franchise opera-
tions reported revenue growth of 10 percent and a solid
increase in operating income. ServiceMaster Clean continued
to experience strong growth in disaster restoration services.
At Merry Maids, a better economy and improved sales
processes have driven steady increases in internal revenue
growth in both the branch and franchise operations. The
segment’s operating loss increased over the prior year,
primarily reflecting a higher level of variable incentive
compensation expense at the headquarters level, partially
offset by increased profits in the franchise operations.
Total initial and recurring franchise fees represented 3.3
percent and 3.2 percent of consolidated revenue in 2004
and 2003, respectively and direct franchise operating
expenses were 2.1 percent and 2.0 percent of consolidated
operating expenses in 2004 and 2003, respectively. Total
franchise fee profits comprised 10.3 percent and 10.9
percent of consolidated operating income (excluding the
impairment charge in 2003) before headquarter overhead
in 2004 and 2003, respectively. The portion of total fran-
chise fee profits related to initial fees received from the sales
of franchises was not material to the Company’s consoli-
dated financial statements for all periods.
Capital employed in the Other Operations segment
increased primarily reflecting the deferred tax assets
recorded at the conclusion of the IRS review.
2005 Financial Position and Liquidity
Cash Flows from Operating Activities
Net cash provided from operating activities was $243
million in 2005, compared to $370 million in 2004. This
decrease primarily reflects the tax payment impacts resulting
from the IRS agreement. Related to this agreement, the
Company realized tax savings of $25 million in 2004, made
tax payments in early 2005 totaling $131 million and realized
a $45 million reduction in estimated tax payments in the
third and fourth quarters of 2005. Additionally, this agree-
ment resulted in a deferred tax annuity totaling $57 million
that will be realized through 2016. Excluding the impact of
the IRS agreement, cash provided by operating activities
totaled $329 million in 2005, approximately 80 percent
higher than net income from continuing operations, and
$345 million in 2004. This 2004 amount was favorably
impacted by a non-sustainable reduction in payments of
incentive compensation in 2004 related to the 2003 year
totaling approximately $20 million.
Management Discussion and Analysis of Financial Condition and Results of Operations