SCI

Business Context and Reporting Period

Company: Service Corporation International (SCI)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2008
Business Overview: SCI is North America's leading provider of deathcare products and services, operating 1,302 funeral service locations and 369 cemeteries across 43 U.S. states, eight Canadian provinces, and Germany. The company operates under the Dignity Memorial brand and maintains a preneed backlog of $6.2 billion as of year-end 2008.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Consolidated revenue decreased 5.7% to $2,155.6 million, driven by approximately $100 million in lost revenue from divestitures in 2007 and a $13.0 million decline in preneed cemetery property sales due to the economic downturn.
• Profitability Drop: Net income fell 61% to $97.1 million. This was significantly impacted by a $36.1 million net pre-tax loss on asset divestitures and impairments, a $3.1 million net expense from Hurricane Ike, and reduced trust fund income.
• Trust Fund Performance: Adverse financial market conditions caused significant investment losses. Preneed funeral and cemetery merchandise trust funds realized aggregate net losses of $67.6 million in 2008, compared to gains in prior years. Net unrealized losses in these trusts totaled $488.9 million at year-end.
• Segment Performance:
  • Funeral: Comparable funeral services decreased 2.7%, but average revenue per service increased 3.4%, resulting in modest profit growth for the segment.
  • Cemetery: Revenue declined 11.4% due to a 5.4% drop in property sales and a 9.4% drop in preneed service/merchandise production.

Guidance, Outlook, and Risks

• Outlook: Management expects lower earnings and cash flow in 2009 due to the decline in trust investment values. The company anticipates that until market values recover, distributable earnings from trusts will be reduced.
• Capital Allocation: SCI plans to invest $80 to $90 million in capital improvements in 2009. The company maintains a share repurchase program with $123.4 million remaining authorized and intends to continue paying quarterly dividends, subject to debt covenants.
• Key Risks:
  • Trust Fund Shortfalls: If trust fund values do not recover, the company may be required to replenish funds, impacting cash flow. As of Dec 31, 2008, unrealized losses in certain states requiring replenishment were $19.8 million.
  • Goodwill Impairment: While no impairment was recorded in 2008, the cemetery segment (goodwill of $54.8 million) is sensitive to market conditions. Further economic deterioration could trigger future impairment charges.
  • Surety Bonds: If surety companies cancel bonds, SCI may be required to fund approximately $232.8 million into state-mandated trust accounts.
  • Internal Controls: The company identified a material weakness in internal controls related to the accounting for income taxes, which resulted in audit adjustments in 2008.

Investor Verification Checklist

• Trust Fund Recovery: Monitor the recovery of the $488.9 million in net unrealized losses in preneed trusts and the impact on future distributable earnings.
• Debt Covenants: Verify continued compliance with leverage (3.53 actual vs. 4.75 max) and interest coverage (3.79 actual vs. 2.50 min) ratios, noting that covenants become more restrictive in 2009.
• Internal Control Remediation: Track the implementation of remediation steps for the material weakness in income tax accounting to ensure future financial statement reliability.
• Divestiture Proceeds: Confirm the timing and amount of proceeds from assets held for sale, which totaled $98.8 million in assets at year-end.
• Cremation Trends: Assess the impact of the rising cremation rate (41.9% in 2008) on average revenue per service and the effectiveness of memorialization product strategies.