American Home Shield 2003 Annual Report Download - page 27

ServiceMaster    25
consolidate branch locations. In 2004, the Company expects
improvement in operating income from the landscaping
operations resulting from adding management depth and
industry experience, improving pricing and cost disciplines,
consolidating sub-scale branches, and expanding its safety
professionals and programs.
Capital employed in the TruGreen segment decreased 16
percent, primarily reflecting the impact of the impairment
charge, partially offset by tuck-in acquisitions. Capital
employed is a non-U.S. GAAP measure that is defined as the
segment’s total assets less liabilities, exclusive of debt balances.
The Company believes this information is useful to investors in
helping them compute return on capital measures and there-
fore better understand the performance of the Company’s
business segments.
Terminix Segment
The Terminix segment, which includes termite and pest
control services, reported a two percent increase in revenue
to $945 million from $924 million in 2002 and operating
income of $131 million compared to $127 million in the prior
year, a three percent increase. The growth in revenue reflects
higher revenue in both termite renewals and pest control.
Cooler temperatures earlier in the year that impacted many
regions of the country significantly impeded the develop-
ment of the termite swarm. This resulted in fewer sales of
new termite contracts and also had a dampening effect on
renewals.Operating performance improved in the second half
of the year as termite revenue stabilized, customer retention
rates improved and strong cost controls were implemented.
Renewal revenues increased,resulting from favorable mix and
pricing. Pest control volume increased, driven by improved
customer retention and stronger commercial sales.
Operating income margins improved slightly compared to
the prior year, reflecting lower than expected damage claims
in the acquired Sears termite customer base, partially offset
by incremental costs associated with the unit’s new branch
operating system. The roll-out of this system to all of the
Terminix branches is expected to be completed in the spring
of 2004. In the fourth quarter of 2003, Terminix corrected
its method of recognizing renewal revenue from certain cus-
tomers who have prepaid. A cumulative adjustment was
recorded reducing fourth quarter revenue by $9 million and
operating income by $7 million.The Company also continued
to experience positive trending in damage claim costs associated
with its acquired Sears termite customer base, resulting in a
$7 million reduction in expense in the fourth quarter and
$13 million for the full year.
The Company will be entering 2004 with an enhanced
segmented termite offering for consumers. With the
improved efficacy of liquid termite treatments, the Company
is providing consumers with the choice of receiving termite
services through baiting stations or liquid treatments. The
Company believes that providing consumers a choice in
services will increase the number of sales leads closed and
result in improved price realization. The Company estimates
the mix of its new termite sales to move from 80 percent bait
and 20 percent liquid at the end of 2003 to 35 percent bait
and 65 percent liquid in 2004. The Company’s analyses
indicate that lifetime values of its liquid and bait termite
customers are comparable; however, the earnings cycles are
different with liquid customers having less first year prof-
itability and more profitability in subsequent years. The
Company anticipates that increased termite volume from a
more normal swarm in 2004 and improved pricing will help
offset the first year effect of this change in mix.
Capital employed in the Terminix segment was comparable
to the level in 2002.
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 a six percent increase
in revenue to $450 million, from $424 million in 2002, and
operating income growth of 21 percent, to $58 million
compared to $48 million in 2002. Contract sales increased
eight percent, driven by strong growth in renewal activity,
reflecting both a larger base of renewable customers and
improved customer loyalty, as well as the impact of price
increases. Retention rates improved 10 basis points despite
increased cancellations from mortgage refinancings. Sales
from the direct-to-consumer channel increased modestly,
with the timing of sales coming later in the year as third-party
direct mail solicitations were delayed. Real estate sales
increased slightly for the year as a whole, but were adversely
impacted later in the year by a decline in home listings,
particularly in California and Texas, which are two of the
Company’s largest warranty usage states.
In the fourth quarter of 2003, AHS corrected its method of
recognizing revenue from customers who have prepaid. A $5
million cumulative adjustment was recorded, reducing
fourth quarter revenue and operating income by that
amount. Operating margins improved 40 basis points due to
a reduction in the current year claims incidence rate and
favorable trending of prior year claims. The claims incidence
rate is expected to increase slightly in 2004. AHS has been
successful in implementing programs to reduce low cost
claims, control the prices paid to its contractor network,
and utilize technology to improve both productivity and
customer convenience.
Management Discussion and Analysis of
Financial Condition and Results of Operations