SCI

Business Context and Reporting Period

Company: Service Corporation International (SCI)
Reporting Period: Fiscal year ended December 31, 2004
Operations: SCI operates 1,216 funeral service locations and 400 cemeteries, primarily in North America (90.8% of revenue). The company also owns Kenyon International Emergency Services. In 2004, SCI sold its funeral operations in France (retaining a 25% equity interest) and sold its minority interest in the United Kingdom. Operations in Argentina and Uruguay were classified as discontinued operations and sold in early 2005.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Consolidated revenue decreased 20.1% to $1.86 billion, primarily due to the sale of French operations (which contributed $584.6 million in 2003) and a decline in Kenyon International Emergency Services revenue.
• Profitability Improvement: Despite lower revenue, Net Income increased 33.6% to $113.7 million. This was driven by a $53.6 million net gain on dispositions, reduced overhead costs, and a change in pension accounting that recognized gains/losses immediately rather than amortizing them.
• Debt Reduction: Total debt decreased by approximately $448 million (26.3%) to $1.25 billion through successful tender offers and debt extinguishments.
• Cash Flow Volatility: Operating cash flow dropped significantly to $107.8 million from $374.1 million in 2003. This decline was largely due to a $131.1 million payment for litigation settlements, a $20.0 million voluntary pension contribution, and a $19.2 million extra bi-weekly payroll payment.

Guidance, Outlook, and Risks

• Internal Control Weaknesses: Management and auditors identified material weaknesses in internal controls over financial reporting. These included failures in revenue recognition for preneed cemetery contracts, reconciliations of trust assets, and lease accounting. These weaknesses led to the restatement of the first three quarters of 2004.
• Strategic Focus: Management is focusing on cost management, the "Dignity Memorial" national brand, and expanding cremation services (which accounted for 40% of North American funerals in 2004). The company plans to divest remaining international operations outside North America.
• Capital Allocation: SCI initiated a quarterly cash dividend of $0.025 per share in February 2005. The company also authorized a $300 million share repurchase program, having repurchased approximately $213.8 million worth of shares by March 31, 2005.
• Risks: Key risks include the increasing trend toward cremation (which generates lower revenue per service than traditional burials), regulatory changes regarding preneed sales and surety bonding, and the potential for significant litigation costs.

Investor Verification Checklist

• Restatement Impact: Verify the full extent of the financial restatements for Q1-Q3 2004 related to cemetery revenue recognition and trust reconciliations.
• Internal Control Remediation: Review the progress of the remediation plan for the nine identified material weaknesses in internal controls, specifically regarding revenue recognition and cash handling at funeral home locations.
• Discontinued Operations: Confirm the final proceeds and tax implications from the sale of Argentina and Uruguay operations completed in early 2005.
• Cremation Mix: Monitor the growth rate of cremation services and the company's ability to maintain margins as the mix shifts away from higher-margin traditional burial services.
• Debt Maturities: Assess the company's ability to service debt with approximately $75 million maturing in 2005 and $164 million in 2006, given the recent reduction in operating cash flow.