American Home Shield 2006 Annual Report Download - page 23

Terminix Segment
The Terminix segment, which includes termite and pest control services, achieved a milestone in 2005 by surpassing $1 billion in
revenue. Revenue increased six percent to $1.1 billion from $997 million in 2004 while operating income increased 10 percent to
$146 million compared to $133 million in 2004.
Strong growth in revenue from initial termite applications ("termite completions") resulted from a solid increase in renewable unit
sales. The unit growth was achieved despite a relatively weak termite swarm season, and reflected benefits derived from
investments to increase market penetration, which included 25 branch splits, and the expansion of the sales force in under-
penetrated territories. The mix of termite completion sales moved from approximately 45 percent bait and 55 percent liquid at the
end of 2004 to approximately 30 percent bait and 70 percent liquid at the end of 2005. A relatively modest additional shift is
expected to occur in 2006. The Company was encouraged by its ability to maintain pricing of both liquid and bait services, despite
the introduction in 2005 of a new, lower cost liquid perimeter treatment technique.
Solid growth in termite renewal revenues reflected the impact of improved pricing, offset in part by a slight decline in customer
retention. Solid growth in pest control revenue primarily reflected the impact of acquisitions, offset in part by a modest decline in
retention.
Two positive developments meaningfully impacted Terminix's 2005 results. In March, the Company introduced a new bait option
which utilizes an active termiticide from day one, and provides meaningful labor and material cost advantages over the prior bait
offering. Labor efficiencies were also realized in the liquid option as a result of the new "perimeter treatment" technique. These
efficiencies, along with solid revenue growth, enabled operating income to grow 10 percent, despite higher factor costs and the
effects of adjustments to prior year damage claim reserves. In 2005, Terminix recorded a $10 million unfavorable correction in
estimating prior years' termite damage claim reserves. New termite damage claims continue to trend favorably. In addition, as
previously disclosed, Terminix recorded an unrelated $8 million favorable but non recurring adjustment in 2004.
Capital employed in the Terminix segment increased three percent, primarily reflecting the impact of 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 $529 million from $487 million in 2004, and operating
income of $71 million compared to $72 million in 2004, a decrease of one percent.
New warranty contract sales, which are reported as earned revenue over the subsequent twelve-month contract period, increased
seven percent in 2005. A solid increase in customer renewals, which are American Home Shield's largest source of revenue, was
supported by a larger base of renewable customers and an overall improved customer retention rate. The improvement in retention
reflects a favorable mix in customers renewing as well as a reduced level of non-renewal contracts due to mortgage refinancings.
American Home Shield's second largest channel, real estate sales, showed some improvement in the second half of the year, but
were adversely impacted throughout the year by weaker home re-sales. Consumer sales, American Home Shield's fastest growing
channel, experienced strong double-digit growth driven by expanded and more successful targeted direct mail programs.
Operating income declined modestly as incremental profits from increased revenue levels were more than offset by higher claim
costs associated with summer weather that was much hotter than the generally mild conditions that prevailed in 2004. This led to a
three percent increase in the rate of service requests, as well as a higher cost per claim, which had a combined adverse impact on
operating income of approximately $15 million. In addition, the Company made planned investments in initiatives to increase
market penetration and further improve customer retention, both of which should enhance long-term growth. The operating income
comparison to last year was positively impacted by a $5.5 million cumulative negative adjustment to deferred revenue and
operating income that was reported in the third quarter of 2004.
Capital employed increased 24 percent primarily reflecting a higher level of cash and marketable securities due to growth in the
business and improved market performance. Capital employed at American Home Shield which totaled $208 million and $168
million at December 31, 2005 and 2004, respectively, includes approximately $283 million and $258 million of cash, short-term
and long-term securities at those dates. The investment income and realized gains/losses on these assets are reported as non-
operating income/expense.
Other Operations Segment
The Other Operations segment includes the Company's ServiceMaster Clean and Merry Maids operations as well as its
headquarters functions. Revenue in this segment increased eight percent to $177 million in 2005 compared with $164 million in
2004. On a combined basis, the ServiceMaster Clean and Merry Maids franchise operations reported revenue growth of eight
percent and a strong increase in operating income. ServiceMaster Clean reported continued strong growth in disaster restoration
services along with improved momentum in commercial cleaning. Merry Maids continued to experience strong internal revenue
growth in its branch operations, along with improving branch profit margins. The overall segment operating loss for 2005 was ($53)
million compared with ($52) million in 2004. Favorable trending of prior year insurance claims, as well as a strong increase in
profits from the franchise businesses, were offset by increases in costs of certain strategic investments.
Total initial and recurring franchise fees represented 3.4 percent and 3.3 percent of consolidated revenue in 2005 and 2004,
respectively and direct franchise operating expenses were 2.1 percent in both 2005 and 2004. Total franchise fee profits comprised
10.5 percent and 10.3 percent of consolidated operating income before headquarter overhead in 2005 and 2004, respectively. The