American Home Shield 2007 Annual Report Download - page 28

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Capital employed in the Terminix segment increased seven 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 a seven percent increase in revenue to $565 million from $529 million in 2005, and operating
income of $63 million compared to $71 million in 2005, a decrease of 12 percent.
Warranty contract sales and renewals, which are reported as earned revenue over the subsequent twelve-month contract period,
increased six percent in 2006. Warranty contract renewals, which represent approximately 60 percent of total annual contracts
written, increased ten percent, supported by a larger base of renewable customers and continued improvements in retention. This
growth was partially offset by declines in new sales from both the real estate and direct to consumer channels.
Unit sales in the real estate channel, which represents approximately 25 percent of total annual contracts written, were down nine
percent, due to a pervasive weakening in the home resale market. In the third quarter of 2006, the Company signed an agreement
with Realogy, which includes the Coldwell Banker, Century 21 and ERA brands. This agreement is strategically very important and
is expected to help generate strong growth in real estate sales in 2007. In the first full year of the contract, the Company expects
incremental sales to exceed 100,000 units, or approximately $40 million, while initial costs of the agreement will result in a net
minimal impact to operating income in the first year, but an increasingly positive profit impact in subsequent years. The annual
level of incremental sales is expected to double over the five year contract term, as the Company expands penetration of the
franchised outlets of these brands and increases contract renewals.
The direct-to-consumer channel, which represents approximately 15 percent of total annual contracts written, experienced a six
percent decline in unit sales due to lower response rates on certain direct mail programs.
The decline in operating income primarily resulted from increases in the average cost per service claim. Heating and air
conditioning related costs were at relatively higher levels than last year due to the required conversion to more efficient "13 SEER"
units as a result of legislation that became effective early in 2006. Claim costs in other areas, such as appliance and plumbing, were
also higher as a result of inflationary pressures. Additionally, the Company incurred marketing fees related to the Realogy
agreement; and the Company increased its volume of direct mailing in the second half of 2006, supporting an expected
improvement in direct-to-consumer unit sales growth in 2007.
Capital employed increased 21 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 $251 million and $208
million at December 31, 2006 and 2005, respectively, includes approximately $323 million and $283 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 and Headquarters Segment
The Other Operations and Headquarters segment includes the operations of ServiceMaster Clean, InStar and Merry Maids, as well
as the Company's headquarters functions. Revenue in this segment increased to $292 million in 2006 compared with $177 million
in 2005. Revenue from InStar (which was acquired on February 28, 2006) was $96 million with operating income, net of
acquisition-related amortization costs, of $2 million. InStar's results were negatively impacted by reduced hurricane activity in 2006
and operating profits were reduced by increased reserves for certain receivables associated with prior year hurricanes. The
ServiceMaster Clean and Merry Maids franchise operations reported a combined growth in revenue of 12 percent, driven by
continued strong increases in disaster restoration and solid internal revenue growth in residential maid service. The overall segment
operating loss for 2006 was ($45.7) million compared with ($52.5) million in 2005. Included in the 2006 operating loss are
restructuring charges totaling $21.6 million. The segment's operating loss improved by $7 million, despite the inclusion of the
restructuring charges, primarily reflecting continued favorable trending of prior year insurance claims, lower overhead support costs
and incentive compensation expense, and increased profits from the combined franchise operations, offset in part by the
aforementioned restructuring charges.
Total initial and recurring franchise fees represented 3.5 percent and 3.4 percent of consolidated revenue in 2006 and 2005,
respectively and direct franchise operating expenses were 2.2 in 2006 and 2.1 percent in 2005. Total franchise fee profits comprised
11.3 percent and 10.5 percent of consolidated operating income before headquarter overhead and restructuring charges in 2006 and
2005, respectively. The portion of total franchise fee profits related to initial fees received from the sales of franchises was not
material to the Company's consolidated financial statements for all periods.
Capital employed in the Other Operations and Headquarters segment decreased, primarily reflecting the realization of the annual
tax benefit associated with the amortization of tax intangible assets that will continue through 2012.
Discontinued Operations
In the third quarter of 2006, the Company completed the sales of American Residential Services (ARS) and American Mechanical
Services (AMS) generating gross cash proceeds of approximately $115 million, which was used to reduce outstanding debt
balances. The results of the ARS/AMS operations, which provide heating, ventilation, air conditioning (HVAC), plumbing and
electrical installation and repair, have been reported within the financial statement caption "discontinued operations" for all periods.
During the first quarter of 2006, the Company recorded a $25 million after-tax ($42 million pretax) impairment charge for expected
losses on the disposition of certain ARS/AMS properties held pending sale. The Company recorded an after-tax net loss of ($0.5)
million related to the sales of the ARS and AMS businesses in the third quarter of 2006.