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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-6402-1
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SERVICE CORPORATION INTERNATIONAL
(Exact name of registrant as specified in its charter)
TEXAS 74-1488375
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
1929 ALLEN PARKWAY
HOUSTON, TEXAS 77019
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: 713/522-5141
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
Common Stock ($1 par value) New York Stock Exchange
Preferred Share Purchase Rights New York Stock Exchange
6 3/4% Convertible Subordinated Notes Due 2008 New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in the Securities Exchange Act of 1934 Rule 12b-2). Yes [X] No [ ]
The aggregate market value of the common stock held by non-affiliates of the
registrant (assuming that the registrant's only affiliates are its officers and
directors) was $1,142,008,087 based upon a closing market price of $3.87 on June
30, 2003 of a share of common stock as reported on the New York Stock Exchange
- -- Composite Transactions Tape.
The number of shares outstanding of the registrant's common stock as of
February 27, 2004 was 303,571,052 (net of treasury shares).
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Proxy Statement in connection with its 2004 Annual
Meeting of Shareholders (Part III)
1
SERVICE CORPORATION INTERNATIONAL
INDEX
Page
Part I
Item 1. Business..................................................................... 3
Item 2. Properties .................................................................. 6
Item 3. Legal Proceedings............................................................ 6
Item 4. Submission of Matters to a Vote of Security Holders.......................... 6
Part II
Item 5. Market for the Company's Common Equity, Related Stockholder
Matters and Issuer Purchase of Equity Securities........................... 9
Item 6. Selected Financial Data...................................................... 9
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations...................................................... 10
Item 7A. Quantitative and Qualitative Disclosures about Market Risk................... 40
Item 8. Financial Statements and Supplementary Data.................................. 41
Item 9. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosures...................................................... 84
Item 9A. Controls and Procedures...................................................... 84
Part III
Item 10. Directors and Executive Officers of the Company............................. 85
Item 11. Executive Compensation...................................................... 85
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters........................................... 85
Item 13. Certain Relationships and Related Transactions.............................. 85
Item 14. Principal Accountant Fees and Services...................................... 85
Part IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K............. 87
Signatures............................................................................. 88
Exhibit Index.......................................................................... 89
2
PART I
ITEM 1. BUSINESS.
We restated our previously issued financial statements for the fiscal years
ended December 31, 2000, 2001 and 2002, the interim quarters of 2000, 2001, 2002
and the first three quarters of 2003. All applicable amounts relating to these
restatements have been reflected in this Form 10-K. See Item 7 Management's
Discussion and Analysis of Financial Condition and Results of Operations and
notes two and twenty-one to the consolidated financial statements in Item 8 of
this Form 10-K for details of the restatement.
GENERAL
Service Corporation International (SCI or the Company) is the world's
largest provider of funeral and cemetery services. At December 31, 2003, we
operated 2,225 funeral service locations, 417 cemeteries and 183 crematoria
located in eight countries. We also had a minority interest equity investment in
funeral and cemetery operations in the United Kingdom and Australia. In the
fourth quarter of 2003, we sold our minority interest equity investment in our
Australia operations. We expect to sell our minority interest equity investment
in the United Kingdom in the second quarter of 2004, pending a successful public
offering transaction. On March 11, 2004, we sold our funeral operations in
France (hereafter referred to as "joint ventured") and then purchased a 25%
equity interest in the acquiring entity. The French operations consisted of 963
funeral service locations and 39 crematoria at December 31, 2003. For additional
information regarding this transaction, see note twenty to the consolidated
financial statements in Item 8 of this Form 10-K.
Our funeral service and cemetery operations consist of funeral service
locations, cemeteries, crematoria and related businesses. Personnel at the
funeral service locations provide all professional services relating to
funerals, including the use of funeral facilities, motor vehicles, and
preparation and embalming services. Funeral related merchandise (including
caskets, coffins, burial vaults, cremation receptacles, flowers and other
ancillary products and services) is sold at funeral service locations. Certain
funeral service locations contain crematoria. We sell prearranged funeral
services whereby a customer contractually agrees to the terms of a funeral to be
performed in the future. Our cemeteries provide cemetery property interment
rights (including mausoleum spaces, lots and lawn crypts) and sell cemetery
related merchandise (including stone and bronze memorials, burial vaults, casket
and cremation memorialization products) and services (primarily merchandise
installation fees and burial opening and closing fees). Cemetery items are sold
on an atneed or preneed basis. Personnel at cemeteries perform interment
services and provide management and maintenance of cemetery grounds. Certain
cemeteries operate crematoria and certain cemeteries contain gardens
specifically for the purpose of cremation memorialization. There are 185
combination locations that contain a funeral service location within or adjacent
to an SCI owned cemetery.
SCI was incorporated in Texas in July of 1962. Our principal corporate
offices are located at 1929 Allen Parkway, Houston, Texas 77019 and our
telephone number is (713) 522-5141. Our website is http://www.sci-corp.com. We
make available free of charge, on or through our website, our annual, quarterly
and current reports and any amendments to those reports, as soon as reasonably
practicable after electronically filing such reports with the Securities and
Exchange Commission. Information contained on our website is not part of this
report.
FUNERAL AND CEMETERY OPERATIONS
General
The funeral and cemetery operations consist of our funeral service
locations, cemeteries, crematoria and related businesses. As of December 31,
2003, our operations were organized into a North America division, which
represents the United States and Canada, a European division primarily
consisting of operations in France and an Other Foreign division relating to
operations managed in South America and Singapore. In March 2004, we joint
ventured our funeral operations in France. (For additional information regarding
this transaction, see note twenty to the consolidated financial statements in
Item 8 of this Form 10-K.)
During the fourth quarter of 2003, we realigned our funeral and cemetery
operations in North America to better meet the needs of different market types.
As a result, the funeral and cemetery operations in North America are organized
into 32 major markets and 44 middle markets. Each market is led by a market
director with responsibility for funeral and cemetery operations as well as
preneed sales. Within each market, the operational facilities realize
efficiencies by sharing common resources such as personnel, preparation services
and vehicles. There are three market support centers in North America to assist
market directors with financial, administrative and human resource needs.
3
These support centers, commonly referred to as "hubs", are located in Houston,
New York and Los Angeles. The primary functions of the market support centers
are to help facilitate the execution of corporate strategies, coordinate
communication between the field and corporate offices and serve as liaisons for
implementation of policies and procedures.
The death care industry in North America is characterized by a large number
of locally owned, independent operations. In order to be successful, we believe
our funeral service locations and cemeteries must maintain good reputations and
high professional standards in the industry, as well as offer attractive
products and services at competitive prices. We believe we have an unparalleled
network of funeral service locations and cemeteries that offer high quality
products and services at prices that are competitive with local competing
funeral homes, cemeteries and retail locations.
We have multiple funeral service locations and cemeteries in a number of
metropolitan areas. Within individual metropolitan areas, the funeral service
locations and cemeteries operate under various names because most operations
were acquired as existing businesses. Some of our international funeral service
locations operate under certain brand names specific for a general area or
country. We have branded our funeral operations in North America under the name
Dignity Memorial(R). A national brand name is unique to the death care industry
in North America and we believe this gives us a strategic advantage in the
industry. While this branding process is intended to emphasize our seamless
national network of funeral service locations and cemeteries, the original names
associated with acquired operations, and their inherent goodwill and heritage,
will generally remain the same. For example, Geo. H. Lewis & Sons Funeral
Directors is now Geo. H. Lewis & Sons Funeral Directors, a Dignity Memorial(R)
provider.
In the death care industry, there has been a growing trend in the number of
cremations performed in North America as an alternative to traditional funeral
service dispositions. The west coast of the United States, Florida and Arizona
have the highest concentration of cremation consumers in North America.
Cremations usually result in lower revenue and gross profit dollars than
traditional funeral services. In North America during 2003, 39.0% of all funeral
services we performed were cremation cases, compared to 37.9% performed in 2002.
We have expanded our cremation memorialization products and services in several
North America markets, which has resulted in higher average sales for cremation
cases compared to historical levels. During 2003, we continued to expand our
nationally branded cremation service locations called National Cremation(R)
Service (NCS). At December 31, 2003, NCS operated in eighteen states and Canada.
NCS plans to expand its presence in existing states by adding locations where
there is a business need.
Historically, we focused on the acquisition and consolidation of independent
funeral homes and cemeteries in the fragmented death care industry in North
America. During the 1990's, we also expanded our operations through acquisitions
in Europe, Australia, South America and the Pacific Rim. At one time, our
network consisted of more than 4,500 businesses in 20 countries on 5 continents.
During the mid to late 1990's, the acquisition market became extremely
competitive resulting in increased prices for acquisitions and substantially
reduced returns on invested capital. In 1999, we significantly reduced the level
of acquisition activity and focused on identifying and addressing non-strategic
or underperforming businesses. This focus resulted in the divestiture of several
North America and international operations. During 2002 and 2001, we completed
joint ventures of operations in Australia, United Kingdom, Spain and Portugal;
and divested of operations in the Netherlands, Norway, Italy and Belgium. In
2003, we sold our equity investment in our operations in Australia, Spain and
Portugal. During the first quarter of 2004, we completed a joint venture of our
funeral operations in France. We expect to sell our minority interest equity
investment in the United Kingdom in the second quarter of 2004, pending a
successful public offering transaction. We will pursue discussions with various
third parties concerning the sale or joint venture of our remaining
international operations (primarily in South America) as we intend to focus our
efforts on operating a core business of high quality funeral service locations
and cemeteries in North America.
Funeral Service Locations
Our 2,225 funeral service locations provide all professional services
relating to funerals, including the use of funeral facilities, motor vehicles,
and preparation and embalming services. Funeral service locations sell caskets,
coffins, burial vaults, cremation receptacles, flowers, burial garments, and
other ancillary products and services. Our funeral service locations generally
experience a greater demand for services in the winter months primarily related
to higher incidents of deaths from pneumonia and influenza.
In addition to selling products and services to client families at the time
of need, we also sell prearranged funeral services in most of our service
markets. Funeral prearrangement is a means through which a customer
contractually agrees to the terms of a funeral to be performed in the future.
All or a portion of the funds collected from prearranged funeral contracts are
placed into trust accounts, pursuant to applicable law. Alternatively, where
allowed, customers may choose to purchase a life insurance or annuity policy
from third party insurance companies to fund their prearranged funeral. In
certain situations and pursuant to applicable laws, we will post
4
a surety bond as financial assurance for a certain amount of the preneed funeral
contract in lieu of placing certain funds in trust accounts. See the Financial
Assurances section included in Financial Condition, Liquidity and Capital
Resources in Item 7 of this Form 10-K for further details on our practice of
posting such surety bonds. At December 31, 2003, our Deferred prearranged
funeral contract revenues amounted to approximately $5,117.4 million of which
$3,595.6 million related to North America. For additional information regarding
prearranged funeral activities, see the Prearranged Funeral and Cemetery
Activities section in Financial Condition, Liquidity and Capital Resources in
Item 7 and notes three, four and five to the consolidated financial statements
in Item 8 of this Form 10-K.
Cemeteries
Our cemeteries sell interment rights associated with cemetery property such
as mausoleum spaces, lots and lawn crypts, and sell cemetery merchandise such as
stone and bronze memorials, burial vaults, caskets and cremation memorialization
products. Our cemeteries perform interment services and provide management and
maintenance of cemetery grounds. Certain cemeteries operate crematoria and
certain cemeteries contain gardens specifically for the purpose of cremation
memorialization.
Cemetery sales are often made on a preneed basis pursuant to installment
contracts providing for monthly payments. A portion of the proceeds from
cemetery contracts is generally required by law to be paid into perpetual care
trust funds. Earnings from perpetual care trust funds are used to defray the
maintenance costs of cemeteries. Additionally, all or a portion of the proceeds
from the sale of preneed cemetery merchandise and services may be required by
various state laws to be paid into merchandise and services trusts until the
merchandise is delivered or the service is provided. In certain situations and
pursuant to applicable laws, we will post a surety bond as financial assurance
for a certain amount of the preneed cemetery contract in lieu of placing certain
funds into trust accounts. See the Financial Assurances section included in
Financial Condition, Liquidity and Capital Resources in Item 7 of this Form 10-K
for further details on the practice of posting such surety bonds. At December
31, 2003, our Deferred cemetery contract revenue amounted to approximately
$1,575.4 million of which $1,574.2 million related to North America. For
additional information regarding cemetery preneed activities, see the
Prearranged Funeral and Cemetery Activities section in Financial Condition,
Liquidity and Capital Resources in Item 7 of this Form 10-K and notes three,
four and six to the consolidated financial statements in Item 8 of this Form
10-K.
Combined Funeral Service Locations and Cemeteries
We currently own 185 funeral service/cemetery combination locations in which
a funeral service location is physically located within or adjoining an SCI
owned cemetery. Combination locations allow certain facility, personnel and
equipment costs to be shared between the funeral service location and cemetery
and typically have a higher gross margin than if the funeral and cemetery
operations were operated separately. Combination locations also create synergies
between funeral and cemetery sales force personnel and give consumers added
convenience to purchase both funeral and cemetery products and services at a
single location.
EMPLOYEES
At December 31, 2003, we employed 20,471 (13,461 in North America)
individuals on a full time basis and 7,342 (6,788 in North America) individuals
on a part time basis. Of the full time employees, 19,949 were employed in the
funeral and cemetery operations and 522 were employed in corporate or other
overhead activities and services. All eligible employees in the United States
who so elect are covered by SCI's group health and life insurance plans.
Eligible employees in the United States are participants in retirement plans of
SCI or various subsidiaries, while international employees are covered by other
SCI (or SCI subsidiary) defined or government mandated benefit plans.
Approximately 3% of our employees in North America are represented by unions.
Although labor disputes are experienced from time to time, relations with
employees are generally considered favorable.
REGULATION
Our operations are subject to regulations, supervision and licensing under
numerous foreign, federal, state and local laws, ordinances and regulations,
including extensive regulations concerning trust funds, preneed sales of funeral
and cemetery products and services and various other aspects of our business. We
comply in all material respects with the provisions of such laws, ordinances and
regulations. Since 1984, we have operated in the United States under the Federal
Trade Commission (FTC) comprehensive trade regulation rule for the funeral
industry. The rule contains requirements for funeral industry practices,
including extensive price and other affirmative disclosures and imposes
mandatory itemization of funeral goods and services. From time to time in
connection with our former strategy of growth through acquisitions, we entered
into consent orders with the FTC that required us to dispose of certain
operations in order to proceed with such acquisitions, or limited our ability to
make acquisitions in specified areas. The trade regulation rule and the various
consent orders have not had a material adverse effect on our operations.
5
As previously mentioned, we sold our funeral operations in France to a joint
venture in March 2004. The French funeral services industry has undergone
significant regulatory change in recent years. Historically, the French funeral
services industry had been controlled, as provided by national legislation,
either (i) directly by municipalities through municipality-operated funeral
establishments (Municipal Monopoly), or (ii) indirectly by the remaining
municipalities that have contracted for funeral service activities with third
party providers, such as our French funeral operations (Exclusive Municipal
Authority). Legislation was passed that has generally ended municipal control of
the French funeral service business and has allowed free competition among
funeral service providers. Under such legislation, the Exclusive Municipal
Authority was abolished in January 1996, and the Municipal Monopoly was
eliminated in January 1998. Cemeteries in France are currently controlled by
municipalities and religious organizations. We previously sold cemetery
merchandise such as markers and monuments to consumers for use in these
cemeteries.
ITEM 2. PROPERTIES.
Our corporate headquarters are located at 1929 Allen Parkway, Houston, Texas
77019. A wholly-owned subsidiary of SCI owns an undivided one-half interest in
the building and parking garage. The other undivided one-half interest is owned
by an unrelated third party. We plan to acquire the other one-half interest in
the building at the end of the lease in July 2005 for $2 million. The property
consists of approximately 127,000 square feet of office space and 185,000 square
feet of parking space. We lease all of the office space in the building for $59
thousand per month and pay all operating expenses. One half of the rent is paid
to the wholly-owned subsidiary and the other half is paid to the owners of the
remaining undivided one-half interest. We own and utilize two additional
buildings located in Houston, Texas for corporate activities containing a total
of approximately 207,000 square feet of office space.
At December 31, 2003, we owned approximately 68% of the real estate and
buildings used by our 2,225 funeral service locations, 417 cemeteries and 183
crematoria, and 32% of such facilities are leased. In addition, we leased two
aircraft pursuant to cancelable operating leases. At December 31, 2003, we
operated 10,032 vehicles, of which 29% were owned and 71% were leased. For
additional information regarding leases, see the Contractual, Commercial and
Contingent Commitments section in Financial Condition, Liquidity and Capital
Resources in Item 7 and note twelve to the consolidated financial statements in
Item 8 of this Form 10-K.
At December 31, 2003, our 417 cemeteries contained a total of approximately
28,254 acres, of which approximately 57% was developed.
The specialized nature of our businesses requires that our facilities be
well-maintained and kept in good condition and we believe that these standards
are being met.
ITEM 3. LEGAL PROCEEDINGS.
Information regarding legal proceedings is set forth in note twelve to the
consolidated financial statements in Item 8 of this Form 10-K.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
6
EXECUTIVE OFFICERS OF THE COMPANY
Pursuant to General Instruction G to Form 10-K, the information regarding
executive officers of the Company called for by Item 401 of Regulation S-K is
hereby included in Part I of this report.
The following table sets forth as of March 15, 2004 the name and age of each
executive officer of the Company, the office held, and the date first elected an
officer.
YEAR FIRST
BECAME
OFFICER NAME AGE POSITION OFFICER(1)
------------ --- -------- ----------
R. L. Waltrip.......... 73 Chairman of the Board and Chief Executive Officer 1962
B. D. Hunter........... 74 Vice Chairman of the Board 1986
Thomas L. Ryan......... 38 President and Chief Operating Officer 1999
Michael R. Webb........ 45 Executive Vice President 1998
Jeffrey E. Curtiss..... 55 Senior Vice President Chief Financial Officer 2000
and Treasurer
Stephen M. Mack........ 52 Senior Vice President Middle Market Operations 1998
James M. Shelger....... 54 Senior Vice President General Counsel and 1987
Secretary
J. Daniel Garrison..... 52 Vice President Operations Services 1998
W. Cardon Gerner....... 49 Vice President Accounting 1999
Eric D. Tanzberger..... 35 Vice President and Corporate Controller 2000
Stephen J. Uthoff...... 52 Vice President Chief Information Officer 2000
Sumner J. Waring, III.. 35 Vice President Major Market Operations 2002
- ----------
(1) Indicates the year a person was first elected as an officer although there
were subsequent periods when certain persons ceased being officers of the
Company.
Unless otherwise indicated below, the persons listed above have been
executive officers or employees for more than five years.
Mr. Waltrip is the founder, Chairman and Chief Executive Officer of the
Company and a licensed funeral director. He grew up in his family's funeral
business and assumed management of the firm in the 1950s after earning a
Bachelor's degree in Business Administration from the University of Houston. He
began buying additional funeral homes in the 1960s, achieving cost efficiencies
by pooling their resources. At the end of 2003, the network he began had grown
to include more than 2,800 funeral service locations, cemeteries and crematoria
in eight countries. Mr. Waltrip took the Company public in 1969. He has provided
leadership to the Company for over 40 years.
Mr. Hunter was appointed Vice Chairman of the Board in January 2000. For
more than five years, prior to February 2002, Mr. Hunter had been the Chairman
of Huntco, Inc., an intermediate steel processor, and was also its Chief
Executive Officer prior to May 2000. In February 2002, Huntco, Inc., filed a
petition for bankruptcy under Chapter 11 of the United States Bankruptcy Code
during a severe downturn in the steel industry. Mr. Hunter has been a director
since 1986 and also served as Vice Chairman of the Board from September 1986 to
May 1989. He is a graduate of Truman State University, formerly known as
Northeast Missouri State University, in Kirksville, Missouri.
Mr. Ryan joined the Company in June 1996 and has served in a variety of
financial management roles within the Company. In February 1999, Mr. Ryan was
promoted to Vice President International Finance. In November 2000, he was
promoted to Chief Executive Officer of European Operations based in Paris,
France. In July 2002, Mr. Ryan was appointed President and Chief Operating
Officer. Prior to joining the Company, Mr. Ryan was a certified public
accountant with Coopers & Lybrand L.L.P. for more than five years. Mr. Ryan
holds a Bachelor of Business Administration degree from the University of
Texas-Austin.
Mr. Webb joined the Company in 1991 when it acquired Arlington Corporation,
a regional funeral and cemetery consolidator, where he was then Chief Financial
Officer. Prior to joining Arlington Corporation, Mr. Webb held various executive
financial and development roles at Days Inns of America and Telemundo Group,
Inc. In 1993, Mr. Webb joined the Company's corporate development group, which
he later led on a global basis before accepting operational responsibility for
the Company's Australian and Hispanic businesses. Most recently, Mr. Webb has
led the efforts to reduce overhead costs and improve business and financial
processes. Mr. Webb was named Executive Vice President in July 2002. He is a
graduate of the University of Georgia, where he earned a Bachelor of Business
Administration degree.
7
Mr. Curtiss joined the Company as Senior Vice President and Chief Financial
Officer in January 2000. In August 2002, Mr. Curtiss' responsibilities changed
to include the responsibilities of Treasurer of the Company. From January 1992
until July 1999, Mr. Curtiss served as Senior Vice President and Chief Financial
Officer of Browning-Ferris Industries, a waste services company. Mr. Curtiss
attended the University of Nebraska, Lincoln, where he earned Bachelor of
Science in Business Administration and Doctor of Jurisprudence degrees. He also
holds a Master of Legal Letters degree in taxation from Washington University in
St. Louis, Missouri.
Mr. Mack joined the Company in 1973 as a resident director after graduating
from Farmingdale State University of New York. He became Vice President of the
Eastern Region in 1987 and Regional President in 1992. Mr. Mack was appointed
Corporate Vice President in 1998 and then promoted to Senior Vice President in
2002. Mr. Mack was promoted to Senior Vice President Eastern Operations in
August 2002 and assumed the office of Senior Vice President Middle Market
Operations in November 2003.
Mr. Shelger joined the Company in 1981 when it acquired IFS Industries, a
regional funeral and cemetery consolidator, where he was then General Counsel.
Mr. Shelger subsequently served as counsel for the Cemetery Division until 1991,
when he was appointed General Counsel. Mr. Shelger earned a Bachelor of Science
degree in business administration from the University of Southern California in
Los Angeles and a Juris Doctor from the California Western School of Law in San
Diego.
Mr. Garrison joined the Company in 1978 and worked in a series of management
positions until he was promoted to President of the Southeastern Region in 1992.
In 1998, Mr. Garrison was promoted to Corporate Vice President in charge of
operations outside North America. In 2000, Mr. Garrison was promoted to Vice
President North American Cemetery Operations. He served in this position until
assuming his current position as Vice President Operations Services in August
2002. Mr. Garrison is an Administrative Management graduate of Clemson
University.
Mr. Gerner joined the Company in January 1999 in connection with the
acquisition of Equity Corporation International (ECI) and in March 1999 was
promoted to Vice President Corporate Controller. In August 2002, Mr. Gerner's
responsibilities and position changed to Vice President Accounting. Before the
acquisition, Mr. Gerner had been Senior Vice President and Chief Financial
Officer of ECI since March 1995. Prior thereto, Mr. Gerner was a partner with
Ernst & Young LLP. Mr. Gerner graduated with honors from the University of
Texas-Austin, with a Bachelor of Business Administration in Accounting.
Mr. Tanzberger joined the Company in August 1996 as Manager of Budgets &
Financial Analysis. Since then, Mr. Tanzberger has served as Vice President of
Operations/Western Division, Director of Investor Relations and Assistant
Corporate Controller. Mr. Tanzberger was promoted to Vice President Investor
Relations and Assistant Corporate Controller in January 2000, and to Corporate
Controller in August 2002. Prior to joining the Company, Mr. Tanzberger was
Assistant Corporate Controller at Kirby Marine Transportation Corporation, an
inland waterway barge and tanker company, from January through August 1996.
Prior thereto, he was a certified public accountant with Coopers & Lybrand
L.L.P. for more than five years. Mr. Tanzberger is a graduate of the University
of Notre Dame, where he earned a Bachelor of Business Administration degree.
Mr. Uthoff joined the Company as Vice President Chief Information Officer in
January 2000. From June 1994 through July 1999, Mr. Uthoff served as Vice
President - Planning & Analysis of Browning-Ferris Industries, a waste services
company. Mr. Uthoff attended Oklahoma State University, where he earned a
Bachelor of Science degree in Engineering and a Master of Science degree in
Accounting.
Mr. Waring, a licensed funeral director, joined the Company as an Area Vice
President in 1996 when the Company merged with his family's funeral business.
Mr. Waring was appointed Regional President of the Northeast Region in 1999 and
was promoted to Regional President of the Pacific Region in September 2001. Mr.
Waring was promoted to Vice President Western Operations in August 2002 and
assumed the office of Vice President Major Market Operations in November 2003.
Mr. Waring holds a Bachelor's degree in Business Administration from Stetson
University in Deland, Florida, a degree in Mortuary Science from Mt. Ida College
and a Masters of Business Administration degree from the University of
Massachusetts Dartmouth.
Each officer of the Company is elected by the Board of Directors and holds
his office until his successor is elected and qualified or until his earlier
death, resignation or removal in the manner prescribed in the Bylaws of the
Company. Each officer of a subsidiary of the Company is elected by the
subsidiary's board of directors and holds his office until his successor is
elected and qualified or until his earlier death, resignation or removal in the
manner prescribed in the bylaws of the subsidiary.
8
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES.
The Company's common stock has been traded on the New York Stock Exchange
since May 14, 1974. On December 31, 2003, there were 6,609 holders of record of
the Company's common stock.
In October 1999, the Company suspended payment of regular quarterly cash
dividends on its outstanding common stock in order to focus on improving cash
flow and reducing existing debt. Under the Company's bank credit agreement, the
Company is restricted from paying dividends and making other distributions.
The table below shows the Company's quarterly high and low common stock
prices for the two years ended December 31, 2003:
2003 2002
---------------- -----------------
HIGH LOW HIGH LOW
-------- ------- -------- -------
First quarter.................................. $ 3.82 $ 2.78 $ 5.50 $ 4.55
Second quarter................................. 4.24 2.67 5.15 3.60
Third quarter.................................. 4.95 3.75 4.64 2.25
Fourth quarter................................. 5.58 4.45 3.71 2.42
SRV is the New York Stock Exchange ticker symbol for the common stock of the
Company. Options in the Company's common stock are traded on the Philadelphia
Stock Exchange under the symbol SRV.
For equity compensation plan information, see Part III of this report on
page 86.
ITEM 6. SELECTED FINANCIAL DATA.
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
The following selected consolidated financial data for the years ended
December 31, 1999 through December 31, 2003 is derived from our audited
consolidated financial statements as restated. The operating results data
includes reclassifications to conform to current period presentations with no
impact on net income. The data set forth should be read in conjunction with the
Company's consolidated financial statements and accompanying notes to the
consolidated financial statements included in Item 8 of this Form 10-K. The
historical information is not necessarily indicative of the results to be
expected in the future.
We restated our previously issued financial statements for the fiscal years
ended December 31, 2000, 2001 and 2002, the interim quarters of 2000, 2001,
2002, and the first three quarters of 2003. All applicable amounts relating to
these restatements have been reflected in the following selected financial data.
See Item 7 Management's Discussion and Analysis of Financial Condition and
Results of Operations and notes two and twenty-one to the consolidated financial
statements in Item 8 of this Form 10-K for details of the restatement.
In the first quarter of 2003, we adopted Statement of Financial Accounting
Standards (SFAS) No. 145, "Recission of FASB Statements No. 4, 44 and 64,
Amendment of FASB Statement No. 13, and Technical Corrections," (SFAS 145) as it
relates to the classification of extinguishments of debt to be aggregated and
classified as extraordinary items as well as certain other items. Gains and
losses on early extinguishments of debt are included in income (loss) from
continuing operations before cumulative effects of accounting changes for all
periods presented.
In 2002, we adopted Statement of Financial Accounting Standards (SFAS) No.
142, "Goodwill and Other Intangible Assets". (SFAS 142). SFAS 142 addresses
accounting for goodwill and other intangible assets and redefines useful lives,
amortization periods and impairment of goodwill. Under the pronouncement,
goodwill is no longer amortized, but is tested for impairment annually by
assessing the fair value of reporting units, generally one level below
reportable segments. As a result of the adoption of SFAS 142, we recognized a
non-cash charge in 2002 reflected as a cumulative effect of accounting change of
$135.6 million, net of applicable taxes, related to the impairment of goodwill
in our North America cemetery reporting unit. For more information regarding
goodwill, see note seven to the consolidated financial statements in Item 8 of
this Form 10-K.
9
In 2000, we implemented Staff Accounting Bulletin No. 101, "Revenue Recognition
in Financial Statements" (SAB 101). As a result of this implementation, we
changed certain of our accounting policies regarding prearranged sales
activities. We recorded a non-cash charge reflected as a cumulative effect of
accounting change of $866.1 million (as restated), net of applicable taxes, as
of January 1, 2000.
The selected consolidated statement of operations data presented below is
reported on a pro forma basis to reflect the application of SFAS 142 and SAB 101
to the financial data for the three years ended December 31, 2001 and the year
ended December 31, 1999, respectively. Further, results of operations have been
reclassified for all periods presented to separately reflect results of
discontinued operations. See note nineteen to the consolidated financial
statements of Item 8 of this Form 10-K for further discussion of discontinued
operations.
SELECTED CONSOLIDATED FINANCIAL DATA
AS REPORTED PRO FORMA
------------ ----------- --------------------------------------
2003 2002 2001 2000 1999
- -----------------------------------------------------------------------------------------------------------------------------------
(RESTATED) (RESTATED) (RESTATED)
SELECTED CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenue................................................. $ 2,341.6 $ 2,323.6 $ 2,518.3 $ 2,599.0 $ 2,759.2
Income (loss) from continuing operations before
cumulative effects of accounting changes.............. $ 85.1 $ (96.9) $ (570.1) $ (344.8) $ (155.3)
Net income (loss)....................................... 85.1 (232.5) (576.0) (1,240.8) (137.7)
Earnings per share:
Income (loss) from continuing operations before
cumulativeeffects of accounting changes
Basic.......................................... $ .28 $ (.33) $ (2.00) $ (1.27) $ (.57)
Diluted........................................ .28 (.33) (2.00) (1.27) (.57)
Net income (loss)
Basic.......................................... $ .28 $ (.79) $ (2.02) $ (4.56) $ (.51)
Diluted........................................ .28 (.79) (2.02) (4.56) (.51)
SELECTED CONSOLIDATED BALANCE SHEET DATA (AS REPORTED):
Total assets............................................ $ 11,202.7 $ 10,718.0 $11,565.4 $ 12,853.4 $12,978.2
Long-term debt, less current maturities................. 1,528.9 1,884.5 2,314.0 3,091.3 3,636.1
Stockholders' equity.................................... 1,527.0 1,326.7 1,456.4 2,025.0 3,495.3
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
(DOLLARS IN MILLIONS, EXCEPT AVERAGE SALES PRICES AND PER SHARE DATA)
RESTATEMENT OF HISTORICAL FINANCIAL STATEMENTS
We restated our previously issued financial statements for the fiscal years
ended December 31, 2000, 2001 and 2002, the interim quarters of 2000, 2001 and
2002, and the first three quarters of 2003, primarily related to adjustments to
Deferred preneed cemetery contract revenues. All applicable amounts relating to
these restatements have been reflected in the consolidated financial statements
and notes to the consolidated financial statements.
Effective January 1, 2000, we adopted the Securities and Exchange
Commission's Staff Accounting Bulletin No. 101, "Revenue Recognition in
Financial Statements" (SAB 101), and recorded a liability for Deferred preneed
cemetery contract revenues of approximately $1.8 billion. This deferred revenue
represented presold cemetery merchandise and services that had not been
delivered or had not been performed.
As a result of the adoption of SAB 101, we significantly changed our accounting
procedures and controls to comply with the new revenue recognition accounting
policies under SAB 101. Beginning in the latter part of 2000 and continuing
through 2001 and 2002, we improved our procedures and controls for reporting the
delivery of cemetery merchandise and performance of services. These improvements
identified approximately $110 million of preneed cemetery contract items that
had been delivered or performed, but for which no revenues had been recognized.
Previously, we recorded revenues associated with these preneed cemetery contract
items as changes in estimates in the period identified in our accounting system.
The amounts (per quarter), where material, have been previously disclosed as
changes in estimates under our previous interpretation of the accounting rules
in our annual reports on Form 10-K for the years 2001 and 2002. These amounts,
where material, were also disclosed in our earnings press releases and quarterly
reports on Form 10-Q. We have now determined to report the recognition of
revenues for these items in the periods in which the cemetery merchandise and
services were delivered or performed. Additionally, we also concluded that
10
previously reported deferred revenues included approximately $41 million of
items for which delivery or performance occurred, but revenue recognition had
not occurred. Therefore, the restatement includes adjustments related to these
two items affecting the cumulative effect of the adoption of SAB 101, revenues
and deferred revenues from 2000 through 2003 to report cemetery merchandise and
service revenues in the period these items were delivered or performed.
We have also reviewed our accounting policy for amortizing prearranged
funeral deferred selling costs and have changed the methodology for amortizing
these costs from a straight line basis to a method more in proportion to when
the associated revenues are recognized. We have included this change in
amortization in our restated results.
The effect of the restatement of our previously reported consolidated
statement of operations and consolidated balance sheet for the periods described
above is as follows:
(Dollars in thousands, except YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31,
per share data) --------------------------- --------------------------- -------------------------
2002 2001 2000
--------------------------- --------------------------- -------------------------
AS REPORTED AS RESTATED AS REPORTED AS RESTATED AS REPORTED AS RESTATED
----------- ----------- ----------- ----------- ----------- -----------
Selected consolidated statement of
operations data:
Revenues...................... $ 2,333,429 $ 2,323,619 $ 2,567,437 $ 2,518,294 $ 2,579,238 $ 2,599,021
Costs and expenses............ $(1,969,514) $(1,960,694) $(2,208,051) $(2,200,789) $(2,251,596) $(2,261,738)
Gross profits................. $ 363,915 $ 362,925 $ 359,386 $ 317,505 $ 327,642 $ 337,283
Operating income (loss)....... $ 1,510 $ 520 $ (338,846) $ (380,727) $ (252,885) $ (243,244)
Loss from continuing
operations before income
taxes and cumulative
effects of accounting
changes.................... $ (133,180) $ (134,170) $ (527,673) $ (569,554) $ (482,375) $ (472,734)
Benefit (provision) for
income taxes............... $ 36,860 $ 37,244 $ (64,223) $ (47,986) $ 78,825 $ 75,087
Cumulative effects of
accounting changes (net
of income taxes)........... $ (135,560) $ (135,560) $ (7,601) $ (7,601) $ (909,315) $ (866,084)
Net loss...................... $ (231,880) $ (232,486) $ (597,796) $ (623,440) $(1,343,251) $(1,294,117)
Basic and diluted earnings
per share:
Loss from continuing
operations before
cumulative effects of
accounting changes........ $ (.33) $ (.33) $ (2.08) $ (2.17) $ (1.48) $ (1.46)
Net loss................... $ (.79) $ (.79) $ (2.10) $ (2.19) $ (4.93) $ (4.75)
AS OF DECEMBER 31, 2002
-----------------------------------
AS REPORTED AS RESTATED
------------ ------------
Selected consolidated balance sheet data:
Inventories..................................... $ 135,529 $ 136,932
Total current assets............................ $ 617,521 $ 618,924
Deferred charges and other assets............... $ 718,567 $ 711,417
Total assets.................................... $ 10,723,785 $ 10,718,038
Deferred cemetery contract revenues, net........ $ 1,672,661 $ 1,629,540
Deferred income taxes........................... $ 429,868 $ 444,358
Accumulated deficit............................. $ (1,046,029) $ (1,023,145)
Total stockholders' equity...................... $ 1,303,771 $ 1,326,655
Total liabilities and stockholders' equity...... $ 10,723,785 $ 10,718,038
See note twenty-one to the consolidated financial statements for the effect
of the restatement upon quarterly unaudited financial data.
OVERVIEW
Service Corporation International (SCI), headquartered in Houston, Texas, is
the world's largest funeral and cemetery company. At December 31, 2003, we
operated 2,225 funeral service locations, 417 cemeteries, and 183 crematoria in
eight countries. North America operations represented 56% of funeral service
locations, 97% of cemeteries and 77% of crematoria owned at December 31, 2003,
and approximately 73% of consolidated revenues and 77% of consolidated gross
profits.
North America Operations
To meet the needs of different markets, the funeral and cemetery operations
in North America are organized into 32 major markets and 44 middle markets. Each
market is led by a market director with responsibility for both funeral and
cemetery operations as well as preneed sales in their particular market.
11
Within each market, the businesses realize efficiencies by sharing common
resources such as personnel, preparation services, and vehicles. To assist
market directors with financial and administrative needs as well as human
resource issues, there are three market support centers in North America. These
support centers, commonly referred to as "hubs" are located in Houston, New York
and Los Angeles. The market support centers help to facilitate the execution of
corporate strategies, coordinate the communication between corporate office and
the field, and act as liaisons for implementation of policies and procedures.
International Operations
On March 11, 2004, we sold our funeral operations in France and then
purchased a 25% equity interest in the acquiring company. We also have a
minority interest equity investment in the United Kingdom. Remaining
international operations outside of North America consist of funeral businesses
in Singapore and primarily cemetery businesses in Argentina, Chile and Uruguay.
It is our intention to exit these remaining international businesses when market
values and economic conditions are conducive to a sale or joint venture. At this
time, we believe our focus is best spent in North America where significant
opportunities for growth exist.
STRENGTHS AND CHALLENGES
SCI is the dominant industry leader in North America. While there are three
other publicly-traded companies that operate in our industry, we have more
physical locations and serve more consumers than the rest of the public peer
group combined. With that said, the industry remains highly fragmented with
these three public companies and SCI combined representing approximately 20% of
the total industry, and the other 80% of the industry is represented by
independent funeral and cemetery operators. In 2000, we launched the first
national branding strategy in the funeral service industry in North America
under the name Dignity Memorial(R). While this branding process is intended to
emphasize our seamless national network of funeral service locations and
cemeteries, the original names associated with acquired locations generally
remain the same. For example, Geo. H. Lewis & Sons Funeral Directors is now Geo.
H. Lewis & Sons Funeral Directors, a Dignity Memorial(R) provider. We believe
SCI is the only company in our industry to successfully implement a national
brand. We believe that a national brand gives us a competitive advantage and is
discussed further in our strategies for growth described below.
Our core business can be characterized as stable, reflective of favorable
demographics and relatively predictable revenue and cash flow streams that are
further enhanced by more than $5,100 million of deferred revenues associated
with North America preneed funeral and cemetery sales. This backlog of future
revenues is primarily supported by investments in trust funds or third party
insurance companies.
We and others in the industry face certain challenges in growing revenues.
The primary external factors impacting revenue growth are a lack of near-term
growth in the number of deaths and an increasing trend toward cremation.
Although the United States Census Bureau projects that the numbers of deaths
will grow between 0.7% and 0.8% annually through 2010, modern advances in
medicine and healthier lifestyles could reduce the numbers of deaths during this
time. Our comparable (same store) funeral services performed declined 1.6% in
2003 which we believe is consistent with, or in certain instances less than, the
declines experienced by other companies in the funeral service and casket
manufacturing industries as well as mortality data reported by the Centers for
Disease Control and Prevention (CDC). Preliminary mortality statistics reported
by the CDC reflect a decline in the number of deaths in the United States of
more than 2.0% in 2003 versus 2002.
In North America, social trends, religious changes, environmental issues and
cultural preferences are driving an increasing preference for cremation. SCI is
the largest provider of cremation services in North America where approximately
39% of the total funeral services we perform are cremation services as compared
to the national average of approximately 30%. Our cremation mix is greater due
to the high concentration of properties we own along the west coast of the
United States, Florida, and Arizona where cremation rates exceed 45%. The rate
of cremation in North America has been increasing approximately 100 to 150 basis
points each year and we expect this trend to continue in the near term. A
cremation service historically has generated less revenues and gross profit
dollars than a traditional funeral service. Additionally, the cremation consumer
may choose not to purchase cemetery property or merchandise. We believe we are
well positioned to address this growing trend and have experienced initial
success through the use of contemporary marketing strategies and unique product
and service offerings that specifically appeal to cremation consumers. See
further information regarding initiatives to address cremation as part of our
overall revenue growth strategy described below.
12
THE PATH TO GROWTH
With the significant progress made in reducing debt and increasing cash flow
since 1999, we believe our current capital structure affords us improved
financial flexibility. Our primary focus has shifted to initiatives that will
grow revenues and earnings. In the near term, we believe that cost reduction
efforts will be the main means to improving earnings. We believe strategies
centered on our national brand, Dignity Memorial(R), and other revenue growth
initiatives will provide the framework that will drive sustainable growth over
the longer term.
IMPROVING THE INFRASTRUCTURE
We have historically had an infrastructure that did not fully realize the
inherent efficiencies in our large organization. As a result, we did not fully
capitalize on the benefits of standardization, technology, process improvement
and outsourcing programs. Some of the key actions taken to improve the
infrastructure while reducing costs include redesigning our sales organization,
improving business and financial processes, implementing new information
systems, and changing the management structure.
In late 2002 and early 2003, we made significant changes to the structure
and processes of the sales organization. These changes included eliminating
certain lead generation programs, incentive travel programs and other
inefficient sales activities and shifting to a sales model based on personal
referrals and standardized professional certification, redesigning sales
management compensation programs to profit-based measures from revenue-based
measures and reducing sales management positions. We are also in the final
stages of shifting to a compensation model for sales counselors that is variable
and directly related to the production of new business. Historically, sales
counselors' compensation was based solely on commissions. These changes made to
the sales organization were a significant driver of improved cemetery margins in
2003.
In 2003, we began to focus on improving business and financial processes and
systems that support our North America funeral and cemetery operations. The
information systems used by us in the field were proprietary systems developed
by us internally. There were three separate systems (funeral, cemetery and trust
administration) and the systems operated independent of each other. These
systems were costly to maintain. In 2003, we began to implement a new
information system in the field that would replace the three separate contract
entry systems and integrate these functions into one system. In addition,
process improvement reviews resulted in our decision to outsource certain
accounting functions, including accounts payable and payroll, and to change
outsourcers for trust administration.
Having simplified our sales approach and redesigned our financial, technical
and administrative infrastructure, we were able to make significant changes to
the field management structure in late 2003. The old management structure
consisted of multiple layers and two organizations (sales and operations). The
new management structure is based on a major market and middle market concept
with the understanding that our markets and businesses are not all the same and
can benefit from different management approaches. We eliminated the dual
management organizations and now have one person responsible for each market who
has the ability to lead in a multi-segment environment, who is focused on
growing our business and who is committed to the Dignity Memorial(R) standards
and brand. This single line management structure is expected to increase
accountability and execution, improve communication and reduce overhead costs.
To assist market directors with financial and administrative needs as well as
human resource issues, there are three market support centers, commonly referred
to as "hubs". The market support centers help facilitate the execution of
corporate strategies, coordinate the communication between the corporate office
and our operating locations, and act as liaisons for implementation of policies
and procedures, including monitoring and enhancing our internal control policies
and procedures.
BUILDING THE BRAND
SCI has implemented the first national brand in the funeral service industry
called Dignity Memorial(R). Internally, we are focused on ensuring that we have
consistency in service standards and processes across our network of businesses.
We want every customer interaction to be the standard "Dignity" interaction,
which is based upon values of integrity, respect, enduring relationships and
service excellence. All of our employees who interact with consumers must
complete a Dignity certification process. Additionally, we are developing a
comprehensive training program under the name "Dignity University" that
incorporates required specific curriculum for each job type within SCI using a
combination of traditional classroom, web-based courses, virtual classroom and
on-the-job training for the more than 20,000 individuals that we employ in North
America.
Externally, we continue to enhance signage and local advertising efforts
using the Dignity(R) name and logo. Through our national brand we are the
sponsor of several nationally recognized community programs including Dignity
Memorial Escape School(R) (www.escapeschool.com), which provides parents and
their children with critical abduction prevention and escape techniques,
13
Dignity Memorial Smart and Safe Seniors(R) (www.smartandsafe.com), which
educates seniors about consumer fraud, cons and scams, home break-ins, travel
safety and other topics, and The Vietnam Wall Experience
(www.vietnamwallexperience.com), which is a traveling, three-quarter-scale
replica of the Vietnam Veterans Memorial in Washington, D.C. We are also
currently testing new television, radio and print advertising, which if
successful, will be launched on a national basis. This new media advertising
focuses on the unique products and services exclusive to Dignity Memorial(R)
providers.
It is our belief that today's funeral consumers' preferences are changing.
The focus in this industry historically has been on selling caskets, flowers and
interment rights. Based on our market studies, we believe customers are less
interested in buying products and more interested in creating a meaningful
experience and receiving professional help to deal with the aspects of what
occurs when a loved one dies. Through our Dignity(R) brand we are developing
more contemporary and comprehensive products and services that we believe will
help the consumer through the entire experience. Some of the exclusive items
offered through Dignity providers include grief counseling services through a
24-hour Compassion Helpline, legal services membership, internet memorial
archive capabilities through Making Everlasting Memories (www.mem.com) and the
Aftercare(R) Planner - a comprehensive organizing system that helps families
manage the many business details that arise after a death occurs. Dignity
benefits also include the Bereavement Travel Program, a unique feature through
which customers can obtain special rates on airfare, car rentals and hotel
accommodations for family and friends who must travel from out of town to attend
memorial services. Depending on the number of visitors and the cities from which
their travel originates, the cumulative savings in connection with one funeral
can be in the hundreds - even thousands - of dollars. Importantly, these
products and services appeal to both burial and cremation consumers. We are also
focusing on programs that offer consumers new ways to personalize funeral
services and create meaning in the experience.
GROWING OUR REVENUES
As described earlier, we believe improvements in our cost structure will
drive near term earnings growth; however, we realize to achieve sustainable
long-term growth that we must grow our revenues. We believe we can be successful
in this regard by developing the Dignity brand, listening to our consumers and
developing an approach that takes our Company to new levels.
Enhancing Sales Opportunities
We believe we can grow core revenues by utilizing technology and
contemporary marketing strategies to enhance our sales opportunities and
strengthen the competitive advantage of our national brand, Dignity Memorial(R).
In this regard, particular focus is being placed on selling Dignity Memorial(R)
packaged funeral and cremation plans, developing product differentiation within
our cemeteries, and enhancing our cremation strategies.
Our national brand name, Dignity Memorial(R), also represents a unique set
of packaged funeral and cremation plans offered exclusively through our network
on an atneed and preneed basis. These packages are designed to simplify customer
decision-making and include the unique value-added products and services
described earlier which have traditionally been unavailable through funeral
service locations. Our customer satisfaction index, as measured by independent
surveys completed by consumers three weeks following a funeral, continues to
reach record levels which we believe is largely attributable to the value and
savings consumers receive when they select a Dignity package. When Dignity
packages are sold, it results in significant incremental revenue and gross
profit margin per funeral service compared to non-Dignity sales due to the
comprehensive product and service offerings they provide. On a burial funeral,
Dignity packaged sales generate on average approximately $2,800 more than
non-Dignity sales. On a cremation service, Dignity packaged sales generate
approximately $1,700 more than non-Dignity sales. In 2003, approximately 16% of
the total funeral consumers we served selected a Dignity package. On a preneed
basis, approximately 20% of funeral prearrangement contracts sold were Dignity
plans. A key initiative to help drive increases in the selection rate of Dignity
packaged plans is through improved merchandising techniques. In a limited number
of test locations, modifications are being made to casket selection rooms that
will place less emphasis on traditional funeral merchandise and more focus on
the comprehensive product and service offerings unique to Dignity Memorial
providers. These new displays and other presentation models also offer a special
emphasis on personalization options. We will continue to enhance and make
modifications to these new displays in the test locations in early 2004. As we
finalize a model of what works best, these new modifications will be launched
nationally in late 2004 and 2005.
We are also beginning to use more contemporary marketing strategies within
our cemetery segment. Initiatives are underway to employ a tiered-product
strategy that emphasizes a wide range of product offerings versus only grave
spaces. Special emphasis is being placed on the development of high-end cemetery
property projects such as private family estates. As of December 31, 2003, this
tiered-product strategy had been implemented in less than 15% of the more than
400 cemeteries that we own and we believe this initiative will be a key driver
of cemetery revenue growth in 2004 and 2005.
14
To grow core revenues and profits, we believe we must address the growing
trend toward cremation. We believe a successful cremation strategy is built on
product differentiation, personalization and simplicity. The sale of Dignity
Memorial(R) cremation plans can have a meaningful impact in the near term as
these sales on average result in more than $1,700 of incremental revenue per
service to us compared to non-Dignity cremation sales. We are also developing
new displays to be used in the arrangement process that clearly explain the
products and services available to cremation consumers. Within the cemetery
segment, we are promoting cremation gardens, which are separate sections located
within certain of our cemeteries where cremated remains can be permanently
placed and that contain other unique memorialization products. We continue to
develop and expand our national brand, National Cremation(R), which targets the
direct cremation consumer. And finally, comprehensive training programs are
being developed to support and drive these key initiatives, as well as to focus
on creating a personal and meaningful experience for the cremation consumer.
Increasing Market Share
We believe that SCI has unique opportunities to grow market share due to its
size and geographic diversity. We believe that a national brand will provide us
access to new customers over the long term due to an increasingly mobile society
in North America. We think consumers today are less likely to know a funeral
director personally or live in the same area as past generations who may have
used funeral home services before. A favorable experience with Dignity
Memorial(R) through one of our community outreach programs, attending a funeral
service at a Dignity location, or through previous use of a Dignity provider may
influence a consumer to choose one of our funeral homes. Our centralized
marketing effort will utilize information from our broad customer databases to
determine geographic, demographic and lifestyle information about our consumers
in order to promote awareness of the Dignity Memorial(R) brand name, our local
names, and our provider network in the most efficient and effective manner. In
addition, we will continue to capitalize on our nationwide network of providers
to develop affinity relationships with large groups of individuals to whom we
could market our products and services including employers, social organizations
and insurance companies. Our most strategic affinity partnership today is with
the Veterans of Foreign Wars and Ladies Auxiliary whose membership exceeds two
million. Over the longer term, we believe these types of groups can be key
influencers in the funeral home selection process.
In addition to reducing costs, our new management structure is intended to
have our strongest business leaders driving results in each of our markets.
Under the new structure, many of the administrative and financial functions are
now handled by support centers and the geographical scope of responsibility and
accountability for business leaders has been narrowed. We believe this allows
our market leaders to have a greater focus on developing people, growing market
share and improving profitability in their respective markets. In addition, we
continue to use market action plans as a measurement tool to drive
accountability and improved results. Market leaders identify the strengths,
weaknesses, opportunities and threats of their local area and develop supporting
action plans in response that include measurable objectives, necessary resources
and a timetable for completion.
We are also targeting expansion through acquisition or construction in the
top 150 markets in North America where probable investment returns will exceed
our cost of capital. We will focus future growth capital deployment in the major
metropolitan markets where there are large population bases and where multiple
businesses are more conducive to clustering and contemporary marketing
strategies and it is easier to attract quality management. Over the longer term,
the potential for a franchise opportunity exists for further expansion in the
smaller markets. In a franchise relationship we could recruit independent
funeral providers to join the Dignity Memorial(R) network and earn fees for a
comprehensive range of services that we could provide to the franchisee - all at
very little or no capital cost to us.
OUTLOOK FOR FISCAL 2004
Our outlook for 2004 demonstrates continued strength in cash flows and
further improvements to the capital structure. We expect growth in operating
margins in 2004 largely as a result of infrastructure improvements and cost
reduction programs that began in 2003. As discussed earlier in this section,
initiatives centered on our Dignity Memorial(R) brand are being further
developed to increase revenues and profits while addressing the consumers'
increasing preference for value-added products and services that assist them
through the entire experience when a death occurs. In 2004, we anticipate
increases in the selection rate of Dignity Memorial packaged funeral and
cremation plans. We are continuing to focus on the development of strategic
high-end cemetery inventory and implementation of a tiered-product approach and
standard pricing model in each of our cemeteries.
The outlook below provides ranges for certain operating measures on the
income statement that could be used to calculate a broad range of expected
diluted earnings per share; however, we believe it is more appropriate to use
the range of expected diluted earnings per share provided because of the
uncertainty of developments described below.
15
HIGHLIGHTS OF FISCAL 2004 OUTLOOK
(In millions)
OPERATING MEASURES
North America Comparable Operations
Funeral Revenues $1,120 - $1,170
Funeral Gross Margin Percentage 20% - 24%
Cemetery Revenues $ 500 - $ 550
Cemetery Gross Margin Percentage 13% - 17%
General and Administrative Expense $ 65 - $ 70
Interest Expense $ 127 - $ 130
Annual Consolidated Effective Tax Rate 15% - 18%
Diluted Earnings Per Share $ .42 - $ .50
CASH FLOW AND OTHER MEASURES
Cash Flows from Operating Activities $ 270 - $ 310
Capital Expenditures $ 100 - $ 120
Depreciation and Amortization $ 125 - $ 135
Diluted earnings per share guidance and all other outlook provided above
specifically exclude the following:
o Any impact from the implementation of Financial Accounting Standards
Board (FASB) Interpretation No. 46, "Consolidation of Variable
Interest Entities, an Interpretation of Accounting Research Bulletin
(ARB) 51". This standard was originally required to be implemented in
the third quarter of 2003. In December 2003, the FASB issued a
revision (FIN 46R) which allows companies to defer implementation. We
will implement FIN 46R as of March 31, 2004. For a complete discussion
of the effect that the implementation of FIN 46R could have on our
financial statements, see Critical Accounting Policies, New Accounting
Pronouncements and Accounting Changes within this Management's
Discussion and Analysis of Financial Condition and Results of
Operations and note three to the consolidated financial statements in
Item 8 of this Form 10-K.
o The recognition of a charge of approximately $55 million (pretax) for
the cumulative effect of an accounting change associated with pension
plan accounting. Effective January 1, 2004, we changed the accounting
for gains and losses on our pension plan assets and obligations to
recognize these gains and losses as they occur. In our outlook for
2004, we anticipate this change will reduce pension expenses in 2004
compared to 2003; however, because gains and losses will be recognized
currently, market conditions could cause an adverse effect on
results of operations as these gains and losses will be recognized
currently. See note four to the consolidated financial statements in
Item 8 of this Form 10-K.
o Any impact from potential changes to our accounting for insurance
funded prearranged funeral contracts and other accounting changes.
o The recognition of costs associated with settlements of litigation and
the recognition of receivables for insurance recoveries associated
with litigation.
o The possibility of gains or losses associated with early
extinguishments of debt.
o The possibility of gains or losses associated with asset dispositions
or joint ventures.
o The possibility of changes in the capital structure, including new
debt issuances and a new credit facility.
o The possibility of the recognition of a cumulative effect of an
accounting change under generally accepted accounting principles
(other than FIN 46R and the change in pension accounting described
above).
Please refer to the discussion of risks related to our business and to the death
care industry that could also affect this outlook in the Cautionary Statement on
Forward-Looking Statements section in Item 7 of this Form 10-K.
The following commentary describes our assumptions, estimates and beliefs
supporting our 2004 outlook:
Operating Measures
o Comparable financial information as used in our 2004 outlook is
intended to be reflective of "same store" results and excludes the
effects of acquisition or construction as well as divestitures or joint
ventures.
16
o The outlook for North America comparable funeral revenues assumes the
number of funeral services performed will be flat to slightly down with
an increase in cremation services performed offset by a 1% to 3%
increase in the overall average revenue per funeral service compared to
2003 levels.
o North America comparable cemetery revenues are expected to be lower
than 2003 levels due to a decline in cemetery construction revenues to
more normalized levels. Revenues associated with cemetery property
development projects in 2003 were approximately $60 million. Normalized
levels of construction revenues in 2004 are expected to be $25 to $30
million. Offsetting this decline in revenues are anticipated increases
in preneed sales as our sales structure becomes more stabilized
following the significant changes that occurred in late 2002 and 2003.
o North America funeral and cemetery gross margin percentages are
expected to improve in 2004 compared to 2003 primarily due to the
recent business process and operating management structure changes and
expected reductions in pension plan expenses.
o General and administrative expenses in 2003 were $178.1 million and
included $95.2 million of net costs associated with various
litigation-related matters. Also included in 2003 were accelerated
systems amortization costs of $13.8 million that ceased in the third
quarter of 2003. Excluding these litigation expenses and accelerated
system amortization costs, general and administrative expenses in 2003
would have been $69.1 million. For 2004, we are estimating general and
administrative expenses to be $65 to $70 million (excluding the
possibility of the recognition of costs associated with settlements of
litigation or receivables for insurance recoveries). Reductions in
system costs will be somewhat offset by increased expenses associated
with Sarbanes-Oxley compliance and compensation programs.
o Interest expense is expected to decrease $13 to $16 million in 2004
compared to 2003 as a result of retiring debt that is scheduled to
mature in 2004. Interest expense expected in 2004 of $127 to $130
million includes approximately $10 million associated with amortization
of deferred loan costs. The outlook for interest expense does not take
into consideration any additional debt reduction that could occur with
proceeds from asset sales or joint ventures or from cash flows from
operating activities.
o The consolidated effective tax rate is expected to be 15% to 18% in
2004 compared to 25.6% in 2003. These unusually low rates are
attributable to tax benefits received from certain international
transactions. The 2004 expected effective tax rate on an annual basis
for 2004 includes approximately $30 million of tax benefits associated
with the joint venture of our France operations which will be realized
in the first quarter of 2004. The consolidated effective tax rate in
the remaining quarterly periods is expected to be 32% to 35%.
o The range for expected diluted earnings per share assumes dilution from
shares associated with the 6.75% convertible notes due 2008.
International Operations
o On March 11, 2004, we completed the joint venture of our funeral
operations in France. In addition to maintaining a 25% share of the
total equity capital of the newly formed entity, we received net cash
proceeds of approximately $300 million and a note receivable in the
amount of 10 million euros. As a result of the transaction, we expect
to recognize a pretax gain on the sale of approximately $10 to $20
million in the first quarter of 2004. We also anticipate receiving tax
benefits of approximately $30 million in 2004 related to the
transaction. Our consolidated reported results for the year 2003
included $584.6 million in revenues and $68.3 million in gross profits
that were associated with France.
o Remaining international operations consist primarily of cemetery
businesses in South America, where we anticipate modest improvement,
net of currency fluctuations.
o We own a 20% minority equity investment in funeral and cemetery
operations in the United Kingdom. Pending a successful public offering
transaction, we expect to receive proceeds of approximately $50 to $60
million in the second quarter of 2004 associated with the sale of our
holdings in stock and notes in these operations.
Cash Flow and Other Measures
o Cash flows from operating activities in 2003 were $374.1 million and
included a tax refund of $94.5 million and payments of $27.1 million,
net of insurance recoveries, made during 2003 to resolve certain
litigation matters. Had we not received the tax refund or incurred
these net litigation payments, cash flows from operating activities in
2003 would have been $306.7 million. Cash flows from operating
activities in 2004 are expected to be $270 to $310 million. This amount
includes our ownership of France through March 11, 2004, and excludes
the $100 million payment related to the proposed settlement of certain
Florida litigation and any possible payments that could be made
associated with other litigation matters. It also excludes any receipts
from insurance recoveries related to litigation matters and the cash
contribution to our frozen pension plan as discussed below.
Anticipated improvements in North America funeral and cemetery margins
and reduced interest expense are expected to offset the loss of cash
flows from operating activities in 2004 due to the joint venture of
France, the discontinued use of surety bonding in Florida as discussed
below.
o Excluded from our 2004 outlook for cash flows from operating activities
are payments made related to litigation matters. In February 2004, we
paid $100 million into escrow to settle certain litigation matters in
Florida. We expect this payment to be partially offset by the receipt
of $25 million in recoveries under the first layer of our insurance
coverage in 2004.
17
o On March 11, 2004, we completed the joint venture of our funeral
operations in France. In 2003, cash flows from operating activities
were approximately $33 million associated with these businesses in
France.
o In the first quarter of 2004, we made a voluntary cash contribution of
$20 million to our frozen pension plan to increase the fair value of
the plan assets. This contribution is excluded from our 2004 outlook
for cash flows from operating activities.
o In February 2004, we discontinued the use of surety bonding as a means
to provide financial assurance to customers for the prospective sale of
preneed contracts in Florida. Beginning with contracts written in early
2004, we have elected to deposit customer receipts from the sale of
preneed contracts into trust funds in accordance with state
requirements. As a result of this change, our cash flows from operating
activities will decline by $15 to $20 million, net of prospective trust
receipts, in 2004 over 2003 levels. In subsequent periods, the impact
to cash flows is expected to be immaterial. Not included in the outlook
for 2004 are other potential changes regarding the use of surety
bonding. We are currently evaluating our surety bonding program and may
elect to discontinue the use of bonding in other states or cancel
certain outstanding bonds and replace with funds in trusts in
accordance with state regulations.
o Payments on restructuring charges are expected to increase by
approximately $7 million in 2004 compared to 2003 primarily due to
severance costs associated with the reorganization of our operating
management structure in the fourth quarter of 2003.
o Similar to 2003, we do not expect to pay U.S. federal income taxes in
2004 due to significant tax loss carry-forwards. Because of these tax
loss carry-forwards, we believe we will not pay cash taxes until 2006.
In 2004, we expect to pay approximately $5 million for various state
and Canadian province taxes.
o Capital expenditures in 2004 are expected to be $100 to $120 million
compared to $116 million in 2003. Increases in North America capital
spending will be offset by reductions related to the joint venture of
France. In 2003, $34.3 million of our total capital expenditures were
associated with operations in France. Of the total projected capital
expenditures in 2004, we expect to spend approximately $65 to $70
million on capital improvements that we believe are necessary to
maintain our existing facilities in a condition consistent with company
standards and extend their useful lives. This includes approximately $5
million related to our partial year ownership of France in 2004.
Growth-oriented capital spending in North America is expected to
increase due to investments in new funeral service facilities,
Dignity(R)product displays in our funeral homes, and in developing
strategic high-end cemetery property inventory.
o Depreciation and amortization expense is expected to decline in 2004
compared to 2003 primarily due to the elimination of accelerated
systems amortization costs and a reduction in cemetery deferred selling
amortization costs due to expected lower levels of preneed revenues in
2004.
CRITICAL ACCOUNTING POLICIES, NEW ACCOUNTING PRONOUNCEMENTS AND ACCOUNTING
CHANGES
Our consolidated financial statements are impacted by the accounting
policies used and the estimates and assumptions made by management during their
preparation. The following is a discussion of our critical accounting policies
pertaining to revenue recognition, the impairment or disposal of long-lived
assets, and the use of estimates.
Revenue Recognition
Funeral revenue is recognized when funeral services are performed. Our trade
receivables primarily consist of amounts due for funeral services already
performed. We sell price guaranteed prearranged funeral contracts through
various programs providing for future funeral services at prices prevailing when
the agreements are signed. Revenues associated with sales of prearranged funeral
contracts, which include accumulated trust earnings and increasing insurance
benefits, are deferred until such time that the funeral services are performed
(see notes three and five to the consolidated financial statements in Item 8 of
this Form 10-K).
Revenue associated with cemetery merchandise and services is recognized when
the service is performed or merchandise is delivered. Revenue associated with
preneed cemetery property interment rights is recognized in accordance with the
retail land sales provision of SFAS No. 66, "Accounting for the Sales of Real
Estate" (SFAS 66). Under SFAS 66, revenue from constructed cemetery property is
not recognized until a minimum percentage (10%) of the sales price has been
collected. Revenue related to the preneed sale of unconstructed cemetery
property is deferred until it is constructed and 10% of the sales price is
collected. Revenue associated with sales of preneed merchandise and services is
not recognized until the merchandise is delivered or the services are performed
(see notes three and six to the consolidated financial statements in Item 8 of
this Form 10-K).
18
Impairment or Disposal of Long-Lived Assets
We review our goodwill annually for impairment in accordance with SFAS No.
142, "Goodwill and Other Intangible Assets" (SFAS 142), by assessing the fair
values of each of our reporting units compared to our reported carrying amounts.
We determine the fair value of the reporting units based on several valuation
methodologies (discounted future cash flows and multiples of revenue) in order
to assess impairment. If the fair value is less than our carrying amounts, the
deficiency is charged to expense.
We review our deferred selling costs for impairment in accordance with SFAS
No. 60, "Accounting and Reporting by Insurance Enterprises" (SFAS 60). We incur
deferred selling costs associated with our deferred revenue from (1) prearranged
funeral contracts which will be funded by trusts and (2) preneed cemetery
contracts. When circumstances indicate our deferred selling costs are not
recoverable compared to the associated portfolio of deferred revenue, the
deficiency is charged to expense.
We review our remaining long-lived assets for impairment when changes in
circumstances indicate that the carrying amount of the asset may not be
recoverable, in accordance with SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" (SFAS 144). SFAS 144 requires that long-lived
assets to be held and used be reported at the lower of their carrying amount or
fair value. Assets to be disposed of and assets not expected to provide any
future service potential to us are recorded at the lower of their carrying
amount or fair value less estimated cost to sell.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires
management to make certain estimates and assumptions. These estimates and
assumptions affect the carrying values of assets and liabilities and disclosures
of contingent assets and liabilities at the balance sheet date. Actual results
could differ from such estimates due to uncertainties associated with the
methods and assumptions underlying our critical accounting measurements. Key
estimates used by management, among others, include:
Allowances - We provide various allowances and/or cancellation reserves for our
funeral and cemetery preneed and atneed receivables, our prearranged funeral and
preneed cemetery deferred revenues, as well as for our funeral and cemetery
deferred selling costs. These allowances are based on an analysis of historical
trends and include, where applicable, collection and cancellation activity.
These estimates are impacted by a number of factors, including changes in
economy, relocation, and demographic or competitive changes in our areas of
operation.
Depreciation of long-lived assets - We depreciate our long-lived assets over
their estimated useful lives. These estimates of useful lives may be affected by
such factors as changing market conditions or changes in regulatory
requirements. In 2002, we changed the estimated useful life of our existing
information technology systems as a result of the decision to implement a new
North America point of sale system and an upgraded general ledger system. We
recognized approximately $13.8 and $13.5 million of additional amortization
expense related to this change in estimate in 2003 and 2002, respectively.
Amortization of deferred selling costs - Deferred selling costs, which relate to
our deferred revenues associated with prearranged funeral contracts (which will
be funded by trusts) and preneed cemetery contracts, are expensed in proportion
to the applicable revenue when recognized in the consolidated statement of
operations.
Taxes - Our ability to realize the benefit of deferred tax assets requires us to
achieve certain future earnings levels. We have established a valuation
allowance against a portion of deferred tax assets and could be required to
further adjust that valuation allowance if market conditions change materially
and future earnings are, or are projected to be, significantly different from
its current estimates. We intend to permanently reinvest the unremitted earnings
of certain of our foreign subsidiaries in those businesses outside the United
States and, therefore, have not provided for deferred federal income taxes on
such unremitted foreign earnings.
Pension cost - Our pension costs and liabilities are actuarially determined
based on certain assumptions, including expected long-term rates of return on
plan assets and the discount rate used to compute future benefit obligations. It
is our policy to use a discount rate comparable to rates of return on
high-quality fixed income investments available and expected to be available
during the period to maturity of the Company's pension benefits. In 2003 and in
prior years, actuarial gains and losses resulting from changes in the
assumptions, or experience differences from those assumptions, are amortized
over the remaining service period of active employees expected to receive
benefits under the plans.
19
Since 2002, we have used a 9.0% assumed rate of return on plan assets as a
result of a high allocation of equity securities within the plan assets. At
December 31, 2003, 74% of the plan assets were equity securities with the
remaining 26% of plan assets being represented by fixed income securities.
As of December 31, 2003, the equity securities were invested approximately
40% in U.S. "Large Cap" investments, 15% in international equities, 10% in
U.S. "Small Cap" investments and 9% in the Company's stock. Our actuaries
estimate the expected performance over a ten year period of each class of
security. The 9.0% rate of return on plan assets was determined by
allocating these expected long-term returns to the different components of
the assets.
Pursuant to the previously mentioned $20 million infusion of funds into the
plan in early 2004, we expect to rebalance the plan assets to have a lower
percentage invested in traditional equity securities and fixed income
securities and instead incorporate investments in hedge funds. We believe
that this reallocation will reduce the volatility with limited reduction of
returns.
Furthermore, we are changing our method of accounting for gains and losses
on pension assets and obligations in 2004 to recognize such gains and
losses during the year in which they occur. In addition to the change in
our investment strategy described above, we expect to record net pension
expense reflecting estimated returns on plan assets and obligations for our
interim financial statements. Under the new accounting policy, upon
completion of our annual remeasurement during the fourth quarter, we will
recognize actual gains and losses on plan assets and obligations.
Therefore, pension expense during the fourth quarter could be different
than amounts recorded in interim periods. Additionally, the rate of return
on pension plan assets could be lower in 2004 due to the accounting change
to immediately recognize gains and losses and due to the reallocation of
plan assets as discussed above. See accounting changes and note four to the
consolidated financial statements in Item 8 of this Form 10-K for details
of this accounting change.
Insurance loss reserves - We purchase comprehensive general liability,
morticians and cemetery professional liability, automobile liability and
workers compensation insurance coverages structured with high deductibles.
This high deductible insurance program results in the Company being
primarily self-insured for claims and associated costs and losses covered
by these policies. Historical insurance industry experience indicates a
high degree of inherent variability in assessing the ultimate amount of
losses associated with casualty insurance claims. This is especially true
with respect to liability and workers compensation exposures due to the
extended period of time that transpires between when the claim might occur
and the full settlement of such claim, often many years. We continually
evaluate loss estimates associated with claims and losses related to these
insurance coverages and falling within the deductible of each coverage
through the use of qualified and independent actuaries. A variety of
actuarial methodologies are applied to the underlying loss data by the
actuary in arriving at an estimate of the "reasonably possible" loss range.
Assumptions based on factors such as claim settlement patterns, claim
development trends, claim frequency and severity patterns, inflationary
trends and data reasonableness will generally effect the analysis and
determination of the "best estimate" of the projected ultimate claim
losses. The results of these actuarial evaluations are used to both analyze
and adjust our insurance loss reserves.
New Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities, an
Interpretation of Accounting Research Bulletin (ARB) No. 51". This
interpretation clarifies the application of ARB 51, "Consolidated Financial
Statements", to certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient
equity and risk for the entity to finance its activities without additional
subordinated financial support from other parties. In December 2003, the FASB
revised FASB Interpretation No. 46 (FIN 46R) which allows companies with certain
types of variable interest entities to defer implementation until March 31,
2004.
We are currently in discussions with the Staff of the Securities and
Exchange Commission related to our implementation of FIN 46R. The discussion
relates to (i) the consolidation under FIN 46R of our prearranged funeral and
preneed cemetery merchandise and service trusts; (ii) the potential
consolidation of our cemetery perpetual care trust funds; and (iii) the policies
of recognition of the associated investment earnings of the trust funds.
We believe, at this time, that we will consolidate the prearranged funeral
and preneed cemetery merchandise and service trust funds upon implementation of
FIN 46R. Upon consolidation, the large majority of the trust assets will be
recorded at fair value. We are unclear at this time whether we will consolidate
the cemetery perpetual care trust funds upon implementation of FIN 46R.
Currently, the perpetual care trust funds are not recognized on our consolidated
balance sheet. If the cemetery perpetual care trust funds are consolidated, we
believe we will recognize an asset and a corresponding liability in our
consolidated balance sheet of approximately $650 million. The large majority of
the assets of cemetery perpetual care trust funds will be recorded at fair
value.
20
Currently, we defer investment earnings associated with prearranged funeral
and preneed cemetery merchandise and service trust funds until the corresponding
merchandise is delivered or the service is performed. It is unclear at this time
whether this revenue recognition policy will continue upon implementation of FIN
46R, or if we will have to recognize these trust fund earnings in a revised
manner, such as at the time the trusts funds themselves earn such investment
earnings.
Realized investment earnings from cemetery perpetual care trust funds
recognized in current cemetery revenues as they are intended to defray cemetery
maintenance costs. We expect to continue recognizing these investment earnings
under this new accounting policy.
We believe the consolidation of the prearranged funeral and preneed cemetery
merchandise and service trust funds (and possibly the cemetery perpetual care
trust funds) will have an effect on certain components within our consolidated
statement of cash flows. Upon such consolidation, proceeds from sales of trust
fund investments and disbursements for purchases of trust fund investments will
be shown as separate components of cash flows from investing activities.
Currently, the cash flows described above are reported within cash flows from
operations as they are receivables collected from third parties.
In addition to potentially consolidating our trust funds, we also believe we
will consolidate certain cemeteries managed by us upon implementation of FIN
46R. We expect to recognize a charge of approximately $10 to $20 million,
representing the cumulative effect of an accounting change, as a result of
consolidating these cemeteries as of March 31, 2004. The results of operations
and cash flows of these cemeteries will be included in our consolidated
financial statements upon implementation of FIN 46R, although no material impact
is anticipated.
We are also discussing our accounting policies for insurance funded
prearranged funeral contracts (see note five to the consolidated financial
statements) with the Staff of the Securities and Exchange Commission. The
discussion relates to whether amounts recorded in Prearranged funeral contracts,
net and Deferred prearranged funeral contract revenues, net associated with such
contracts represent assets and liabilities of the Company as defined in
Statement of Financial Accounting Concepts No. 6, "Elements in Financial
Statements". If it is concluded that these amounts are not assets and
liabilities as defined, we will remove from our consolidated balance sheet,
amounts relating to insurance funded prearranged funeral contracts recorded in
Prearranged funeral contracts, net and Deferred prearranged funeral contract
revenues, net which, as of December 31, 2003, were approximately $4 billion and
$4 billion, respectively. Such a change in accounting would have no impact on
our consolidated stockholders' equity, results of operations or cash flows.
Effective January 1, 2004, we changed the accounting for gains and losses on
our pension plan assets and liabilities. We will recognize such gains and losses
in our consolidated statement of operations as such gains and losses are
incurred under pension accounting. Prior to January 1, 2004, we amortized the
difference between actual and expected investment returns and actuarial gains
and losses over seven years (except to the extent that settlements with
employees required earlier recognition). We believe the change is preferable as
the new method of accounting better reflects the economic nature of our pension
plan and recognizes gains and losses on the pension plan assets and liabilities
in the year the gains and losses occur. As a result of this accounting change,
we expect to recognize a charge for the cumulative effect of an accounting
change of approximately $55 million (on a pretax basis) as of January 1, 2004.
This amount represents accumulated unrecognized net losses related to the
pension plan assets and liabilities.
RESULTS OF OPERATIONS
Our results for the fiscal years ended 2002 and 2001 and the first three
quarter of 2003 have been restated. The financial data below reflects the
effects of the restatement for all periods affected. For details relating to
this restatement, see notes two and twenty-one to the consolidated financial
statements in Item 8 of this Form 10-K.
Additionally, we have reclassified certain prior year amounts to conform to
the current period financial presentation with no effect on previously reported
net income, financial condition or cash flows.
Total consolidated revenues were $2,341.7 million in 2003 compared to
$2,323.6 million in 2002 and $2,518.3 million in 2001. The growth in revenues in
2003 over 2002 is largely attributable to increases in our funeral operations in
France and driven by positive currency fluctuations. The decrease in revenues in
2002 compared to 2001 is primarily the result of the sale of our funeral and
cemetery operations in the United Kingdom, which previously generated annual
revenues of approximately $165 million, and various businesses in North America.
Although revenues have declined from 2001 levels, gross profits improved to
$365.8 million in 2003 compared to $362.9 million in 2002, which in turn was
14.3% higher than 2001. The gross profit margin was flat at 15.6% in 2003 and
2002 and substantially above 12.6% in 2001 largely as a result of successful
ongoing cost reduction initiatives.
21
Net income in 2003 totaled $85.1 million compared to net losses in 2002 and
2001 of $232.5 million and $623.4 million, respectively. Net income in 2003
included a pretax gain on the sale of our equity investment in Australia and the
collection of an associated note receivable of $45.7 million. Net income in 2003
was negatively impacted by litigation related expenses, net of estimated
insurance recoveries, of $95.2 million. Included in these net litigation
expenses was the recognition of a $25 million receivable during the fourth
quarter of 2003 for expected insurance recoveries under the first layer of our
insurance coverage related to the previously announced $100 million proposed
settlement of certain Florida litigation. Net losses reported in 2002 and 2001
were impacted by impairment losses on dispositions, expenses related to market
value adjustments of certain options associated with our 6.3% notes due in 2003,
severance costs of former employees and expenses related to the termination of
certain consulting and non-compete contractual obligations.
DETAILED COMPARABLE OPERATING RESULTS FOR 2003, 2002 AND 2001
Results in all periods presented below are representative of comparable
results, which excludes operations that were acquired or constructed after
January 1, 2001 and divested by prior to December 31, 2003. Comparable financial
results are meant to be reflective of "same store" results of operations. In
2002, we ceased amortization of goodwill as required by SFAS 142; changed the
allocation methodology of overhead costs in North America to be based on funeral
and cemetery reporting unit revenues; began recognizing revenues associated with
delivered caskets previously prearranged on cemetery contracts as part of
funeral operations instead of cemetery operations; and ceased depreciation of
operating assets held for sale during 2002. In 2002, we determined transactions
to sell or joint venture certain assets would be delayed until after 2002. As a
result, we resumed normal depreciation of those assets held in France and Chile
in the third quarter of 2002. In January 2003, we once again ceased depreciation
of France operating assets held for sale. For purposes of the following
discussion, we have presented the financial information for 2001 on a pro forma
basis as if these changes had been implemented as of January 1, 2001. The
following is a discussion of results of comparable operations by geographic
segment:
COMPARABLE
(Dollars in thousands) YEAR ENDED DECEMBER 31, 2003
---------------------------------------------------------------------------------------------
North % of % of Other % of % of
America Revenue Europe Revenue Foreign Revenue Total Revenue
------------ ---------- ----------- ---------- ----------- ----------- ----------- ----------
(Restated) (Restated)
Revenues:
Funeral.................... $1,132,782 67.0% $591,704 100.0% $ 7,262 16.7% $1,731,748 74.5%
Cemetery................... 556,976 33.0% - -% 36,271 83.3% 593,247 25.5%
------------ ---------- ----------- ---------- ----------- ----------- ----------- ----------
$1,689,758 100.0% $591,704 100.0% $ 43,533 100.0% $2,324,995 100.0%
============ ========== =========== ========== =========== =========== =========== ==========
Gross profit and margin percentage:
Funeral.................... $ 214,395 18.9% $ 69,249 11.7% $ 2,602 35.8% $ 286,246 16.5%
Cemetery................... 75,267 13.5% - -% 8,976 24.7% 84,243 14.2%
------------ ---------- ----------- ---------- ----------- ----------- ----------- ----------
$ 289,662 17.1% $ 69,249 11.7% $ 11,578 26.6% $ 370,489 15.9%
============ ========== =========== ========== =========== =========== =========== ==========
COMPARABLE
YEAR ENDED DECEMBER 31, 2002
---------------------------------------------------------------------------------------------
North % of % of Other % of % of
America Revenue Europe Revenue Foreign Revenue Total Revenue
------------ ---------- ----------- ---------- ----------- ----------- ----------- ----------
(Restated) (Restated)
Revenues:
Funeral.................... $1,138,984 65.8% $479,935 100.0% $ 6,862 19.8% $1,625,781 72.4%
Cemetery................... 592,287 34.2% - -% 27,770 80.2% 620,057 27.6%
------------ ---------- ----------- ---------- ----------- ----------- ----------- ----------
$1,731,271 100.0% $479,935 100.0% $ 34,632 100.0% $2,245,838 100.0%
============ ========== =========== ========== =========== =========== =========== ==========
Gross profit and margin percentage:
Funeral.................... $232,632 20.4% $ 47,407 9.9% $ 2,815 41.0% $ 282,854 17.4%
Cemetery................... 70,358 11.9% - -% 4,737 17.1% 75,095 12.1%
------------ ---------- ----------- ---------- ----------- ----------- ----------- ----------
$302,990 17.5% $ 47,407 9.9% $ 7,552 21.8% $ 357,949 15.9%
============ ========== =========== ========== =========== =========== =========== ==========
22
COMPARABLE PRO FORMA
(Dollars in thousands) YEAR ENDED DECEMBER 31, 2001
---------------------------------------------------------------------------------------------
North % of % of Other % of % of
America Revenue Europe Revenue Foreign Revenue Total Revenue
------------ ---------- ----------- ---------- ----------- ----------- ----------- ----------
(Restated) (Restated)
Revenues:
Funeral.................... $1,114,686 67.4% $431,297 100.0% $11,350 18.5% $1,557,333 72.5%
Cemetery................... 539,617 32.6% - -% 49,873 81.5% 589,490 27.5%
------------ ---------- ----------- ---------- ----------- ----------- ----------- ----------
$1,654,303 100.0% $431,297 100.0% $61,223 100.0% $2,146,823 100.0%
============ ========== =========== ========== =========== =========== =========== ==========
Gross profit and margin percentage:
Funeral.................... $ 238,818 21.4% $ 43,730 10.1% $2,695 23.7% $ 285,243 18.3%
Cemetery................... 49,211 9.1% - -% 12,420 24.9% 61,631 10.5%
------------ ---------- ----------- ---------- ----------- ----------- ----------- ----------
$ 288,029 17.4% $ 43,730 10.1% $15,115 24.7% $ 346,874 16.2%
============ ========== =========== ========== =========== =========== =========== ==========
COMPARABLE
FUNERAL SERVICES PERFORMED
--------------------------------------------
NORTH OTHER
AMERICA EUROPE FOREIGN TOTAL
-------- ------ ------- -----
December 31:
2003....................................... 263,952 140,864 4,236 409,052
2002....................................... 268,326 137,668 4,069 410,063
2001....................................... 268,197 138,475 4,104 410,776
Comparable Funeral Segment Analysis
Comparable North America funeral revenues in 2003 were $1,132.8 million and
on the upper end of our guidance range of $1,090 million to $1,150 million.
Comparable North America funeral revenues decreased slightly in 2003 over 2002.
A decline of 1.6% in the number of funeral services performed and lower levels
of general agency revenues associated with the sale of insurance funded
prearranged funeral contracts were partially offset by an increase of 2.1% in
the average revenue per funeral service. We believe the declines in funeral
services performed are consistent with, and in certain instances less than, the
declines reported by others in the funeral service and casket manufacturing
industries. We also track weekly mortality data published by the Centers for
Disease Control (CDC). We believe that the decline in our funeral services
performed in 2003 is less than the decline in the number of deaths reported by
the CDC. General agency revenues declined in 2003 versus 2002 due to the
anticipated decrease in s