Management’s Discussion and Analysis

Results of Operations

Brink’s Home Security

Executive Overview

Brink’s Home Security has reported strong growth in revenues and earnings over the last few years. Key factors in this performance are continuing to attract and retain customers through quality service and the reputation of the brand while operating as efficiently as possible consistent with the desired level of service.

In order to achieve higher efficiency and effectiveness, BHS focuses on controlling initial marketing and installation costs by matching sales representative staffing with the number of sales opportunities and the size of the technician workforce with the available installation volume. BHS then strives to keep customer service and monitoring costs as low as possible without disturbing its high quality service levels.

The Company believes customer retention is driven by customer selection and high customer service levels. In order to obtain customers who are less likely to disconnect, the Company seeks to attract customers with solid credit scores and the willingness to pay reasonable up-front fees. Once there is agreement to install an alarm system, the Company strives to provide a high quality installation followed up with continuing high quality customer service and alarm monitoring. BHS believes its disconnect rate is helped by consistently following the above policy.

The Company believes that the level of economic activity in the U.S. may affect the performance of BHS. However, this effect is not as significant as it is for industries with close ties to economic performance. In addition, there is some seasonality in performance since disconnect expenses can impact operating earnings. Since more household moves take place during the second and third quarters of each year, the disconnect rate and related expenses are typically higher in those quarters than in the first and fourth quarters.

               
  Years Ended December 31,   % change
(In millions)   2004 2003 2002   2004 2003
Revenues $ 345.6 310.4 282.4   11 10
Operating Profit
Recurring services (a)   147.8 125.9 109.5   17 15
Investment in new subscribers (b)   (67.0) (54.7) (48.6)   (22) (13)
  $ 80.8 71.2 60.9   13 17
Monthly recurring revenues (c) $ 26.1 23.3 21.1   12 10
Cash Flow Information
Depreciation and amortization (d) $ 51.5 47.9 43.9   8 9
Impairment charges from subscriber
disconnects   38.4 34.3 32.3   12 6
Amortization of deferred revenue (e)   (26.1) (25.0) (23.9)   4 5
Deferred subscriber acquisition costs
(current year payments)   (19.5) (18.4) (17.7)   6 4
Deferred revenue from new subscribers
(current year receipts)   34.6 28.2 27.1   23 4
Capital expenditures   117.6 98.0 86.9   20 13
(a)
Reflects operating profit generated from the existing subscriber base including the amortization of deferred revenues.
(b)
Primarily marketing and selling expenses, net of the deferral of direct selling expenses (primarily a portion of sales commissions), incurred in the acquisition of new subscribers.
(c)
This measure is reconciled below under the caption “Reconciliation of Non-GAAP Measures.”
(d)
Includes amortization of deferred subscriber acquisition costs.
(e)
Includes amortization of deferred revenue related to active subscriber accounts as well as acceleration of amortization of deferred revenue related to subscriber disconnects.

Overview

Operating profit comprises recurring services minus the cost of the investment in new subscribers. Recurring services reflects the monthly monitoring and service earnings generated from the existing subscriber base, including the amortization of deferred revenues. Impairment charges from subscriber disconnects and depreciation and amortization expenses, including the amortization of previously deferred direct costs from installations, are also charged to recurring services. Recurring services is affected by the size of the subscriber base, the amount of operational costs including depreciation, the level of subscriber disconnect activity and changes in the average monitoring fee per subscriber.

Investment in new subscribers is the net expense (primarily marketing and selling expenses) incurred in adding to the subscriber base every year. The amount of the investment in new subscribers charged to income may be influenced by several factors, including the growth rate of new subscriber installations and the level of costs incurred in attracting new subscribers. As a result, increases in the rate of investment (the addition of new subscribers) may have a negative effect on current segment operating profit but a positive impact on long-term operating profit, cash flow and economic value.

Capital expenditures are primarily the equipment, labor and related overhead costs associated with system installations for new subscribers.

Subscriber Activity

             
  Years Ended December 31,   % change
(Subscriber data in thousands) 2004 2003 2002   2004 2003
Number of subscribers:
Beginning of period 833.5 766.7 713.5  
Installations 146.0 121.9 105.8   20 15
Disconnects (58.1) (55.1) (52.6)   (5) (5)
End of period 921.4 833.5 766.7   11 9
Average number of subscribers 875.5 797.5 739.0   10 8
Disconnect rate (a) 6.6% 6.9% 7.1%  
(a)
The disconnect rate is a ratio, the numerator of which is the gross number of customer cancellations during the period and the denominator of which is the average number of customer subscribers for the period. The gross number of customer cancellations is reduced for customers who cancel service at one location but continue service at a new location, customer accounts acquired from dealers that cancel during a specified contractual term that allows the account to be charged back to the dealers, and inactive sites that return to active service during the period.

Installations increased 20% for 2004 and 15% for 2003 as compared to the prior-year periods primarily as a result of growth in Company-owned branches as well as the growing dealer network. BHS believes its 2004 and 2003 disconnect rates improved over the respective prior-year periods largely due to the cumulative effect of having improved its subscriber selection and retention processes in recent years and its high quality customer service. Since a certain number of disconnects cannot be prevented, including, for example, disconnects that occur because customers move, the disconnect rate may not materially improve in the future.

2004

Revenues increased 11% in 2004 primarily due to a 10% larger average subscriber base, as well as higher average monitoring rates, higher revenues from home builders and higher service revenues. The slight increase in average monitoring rates was primarily due to new customers initiating service at higher average monitoring rates than the average rates being paid by existing customers. These factors also contributed to a 12% increase in monthly recurring revenues as measured at year end.

Operating profit for 2004 increased 13% as higher profit from recurring services was partially offset by an increased investment in new subscribers. Higher profit from recurring services was primarily due to increased monitoring and service revenues resulting from a larger average subscriber base and to a lesser extent from improved service margins. These increases were partially offset by increased depreciation and other costs associated with the larger subscriber base. Investment in new subscribers increased 22% on 20% higher installations during 2004, reflecting an investment in additional sales and branch infrastructure to support expansion of installation services offered across most lines of business, partially offset by more cost-effective marketing efforts.

BHS intends to expand its presence in commercial alarm installation and monitoring. As a result, the investment in new subscribers may continue to grow faster than installations as BHS develops the resources needed to achieve its objectives. BHS intends to add a second monitoring center which may slow the growth in profit from recurring services in the near term. Both of these initiatives are expected to have a positive impact on future growth and productivity.

2003

The increase in BHS’s revenues for 2003 versus 2002 was primarily due to an 8% larger average subscriber base, as well as a higher average monitoring rate, higher revenue from home builders and higher service revenues. The slight increase in average monitoring rates was primarily due to higher average monitoring rates for new customers initiating service compared to the average rate being paid by existing customers. The above factors also contributed to a 10% increase in monthly recurring revenues as measured at year end.

Operating profit increased 17% in 2003 from 2002 as higher profit from recurring services was partially offset by an increased investment in new subscribers. Higher profit from recurring services was primarily due to increased monitoring revenues from the larger average subscriber base as well as improved service margins, partially offset by higher depreciation and other costs associated with the larger subscriber base. Investment in new subscribers increased 13% on 15% higher installations during 2003 reflecting more effective marketing and installation efforts partially offset by an investment in additional sales infrastructure to support expansion of installation services offered to home builders.

Other

Police departments in several U.S. cities are not required to respond to calls from alarm companies unless an emergency has been visually verified. If more police departments in the future refuse to automatically respond to calls from alarm companies without visual verification, this could have an adverse effect on future results of operations for BHS. In cities that have stopped providing police response to burglar alarms, BHS has offered its customers the option of receiving private guard response from guard companies who in most cases have contracted with BHS.

Reconciliation of Non-GAAP Measures – Monthly Recurring Revenues

The purpose of this table is to reconcile monthly recurring revenues, a non-GAAP measure, to its closest GAAP counterpart, BHS’ total revenues.

         
  Years Ended December 31,
(In millions)   2004 2003 2002
Monthly recurring revenues (“MRR”) (a) $ 26.1 23.3 21.1
Amounts excluded from MRR:
Amortization of deferred revenue   2.1 2.0 2.0
Other revenues (b)   1.8 2.4 1.2
Revenues on a GAAP basis:
December   30.0 27.7 24.3
January – November   315.6 282.7 258.1
January – December $ 345.6 310.4 282.4
(a)
MRR is calculated based on the number of subscribers at period end multiplied by the average fee per subscriber received in the last month of the period for contracted monitoring and maintenance services.
(b)
Revenues that are not pursuant to monthly contractual billings.

The Company believes the presentation of MRR is useful to investors because the measure is widely used in the industry to assess the amount of recurring revenues from subscriber fees that a security business produces.