SCI

Service Corporation International: Q1 2003 Filing Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2003. Service Corporation International (SCI) is the world's largest provider of funeral and cemetery services, operating 2,266 funeral service locations, 436 cemeteries, and 189 crematoria across eight countries. As of March 31, 2003, North America operations represented approximately 75% of consolidated revenues.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Revenues decreased 3.5% year-over-year, primarily due to divestitures of non-core operations and a 5.3% decline in the number of funeral services performed in North America. This was partially offset by a strengthening Euro and higher average revenue per funeral service.
• Profitability Improvement: Net income turned positive ($42.3M) compared to a significant loss ($88.7M) in Q1 2002. The prior year loss was heavily impacted by a one-time cumulative effect of an accounting change ($135.6M charge). Excluding this, income before the accounting change was $42.3M in 2003 vs. $46.8M in 2002.
• Debt Reduction: Total debt decreased by $240.5 million ($12.1%) due to strong operating cash flows and the receipt of a $94.5 million tax refund. The company repaid $76.3 million of notes due in 2003 and purchased other notes in the open market, recognizing a $2.3 million gain.
• Cash Flow Surge: Operating cash flow increased 121.4% to $183.3 million, driven largely by the $94.5 million tax refund and improved working capital management (decreased receivables).

Outlook, Risks, and Management Commentary

• Strategic Initiatives: Management is focusing on cost rationalization, restructuring the sales organization to improve productivity, and increasing the adoption of "Dignity Memorial" branded packages which command higher average revenues. The company aims to achieve a "BB" credit rating from S&P and "Ba2" from Moody's.
• Industry Trends: The company notes a growing trend toward cremation, which typically yields lower revenue per service than traditional funerals, though the company is expanding high-margin cremation memorialization products.
• Legal Contingencies: SCI faces significant litigation risks, including a consolidated securities class action regarding the 1999 merger with Equity Corporation International (ECI) and multiple lawsuits in Florida regarding cemetery operations at Menorah Gardens. The company states it cannot quantify potential liabilities but intends to aggressively defend these actions.
• Accounting Changes: The company adopted SFAS No. 145, reclassifying gains on debt extinguishment from extraordinary items to "Other income." It is also assessing the impact of FIN No. 46 regarding the consolidation of variable interest entities (trust assets).

Investor Verification Checklist

• Debt Maturities: Verify the company's ability to service near-term debt obligations, specifically the $111.2 million due in April 2004 and $50.8 million due in December 2004, given the current cash balance of $152.9 million.
• Florida Litigation Impact: Monitor the outcome of the Florida Attorney General lawsuit and related consumer class actions regarding Menorah Gardens, as an adverse ruling could require a receiver or significant remediation costs.
• Prearrangement Funding Shift: Assess the cash flow impact of the impending expiration of Florida's surety bond law in 2004, which may force a shift to trust funding, potentially reducing annual pre-tax cash flow by $20-$25 million starting in 2005.
• Divestiture Proceeds: Track the realization of the projected $300-$400 million in proceeds from future asset divestitures and joint ventures, which management cites as critical for debt reduction.
• FIN 46 Application: Confirm the final determination on whether funeral and cemetery trust assets must be consolidated under FIN No. 46, which could materially alter the balance sheet.