SCI

Business Context and Reporting Period

Company: Service Corporation International (SCI)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2005
Business Overview: SCI owns and operates funeral service locations and cemeteries worldwide, primarily in North America. The company also holds a minority interest in French funeral operations and owns Kenyon International Emergency Services. The reporting period includes significant restatements of prior period financial data due to accounting errors and changes in accounting principles.

Key Financial Metrics

Material Changes vs. Prior Period

• Restatements: The company restated financial statements for the three and nine months ended September 30, 2004, and the balance sheet as of December 31, 2004. Restatements corrected errors related to preneed trust income recognition, point-of-sale system errors, and asset disposition gains/losses.
• Accounting Change: Effective January 1, 2005, SCI changed its method of accounting for direct selling costs related to preneed contracts from capitalization to expensing as incurred. This resulted in a cumulative effect charge of $187.5 million (net of tax) in the nine months ended September 30, 2005.
• Revenue Trends:
  • Three Months: Revenues increased 2.3% to $406.4 million compared to $397.2 million in 2004. North America funeral revenue decreased slightly, offset by increased revenue from Kenyon International Emergency Services.
  • Nine Months: Revenues decreased 8.5% to $1,285.5 million compared to $1,404.6 million in 2004, primarily due to the sale of French operations in March 2004.
• Profitability: Net loss for the nine months ended September 30, 2005, was $150.9 million, compared to net income of $87.0 million in the same period of 2004. The loss was driven by the $187.5 million accounting change charge, net losses on dispositions ($28.7 million), and a loss on early extinguishment of debt ($14.3 million).
• Dispositions: The company recorded net losses on dispositions of $27.4 million for the quarter and $28.7 million for the nine months, primarily associated with underperforming North American businesses and impairment losses on assets held for sale.

Guidance, Outlook, Risks, and Unusual Items

• Outlook: Management expects to generate cash flows above operating and financing needs. The company plans to continue its share repurchase program (approximately $85.2 million remaining as of October 31, 2005) and pay regular quarterly dividends ($0.025 per share).
• Unusual Items:
  • Accounting Change Charge: $187.5 million cumulative effect of changing accounting for preneed selling costs.
  • Debt Extinguishment: Loss of $14.3 million on early extinguishment of debt in the nine months ended September 30, 2005.
  • Discontinued Operations: Income of $3.8 million from discontinued operations (Argentina, Uruguay, Chile) for the nine months ended September 30, 2005.
• Risks and Contingencies:
  • Legal Proceedings: Significant litigation includes the "Hijar Lawsuit" (Texas class action regarding markup disclosures), the "2003 Securities Lawsuit" (alleged unlawful treatment of human remains), and various antitrust lawsuits regarding casket sales. Outcomes are uncertain and could have a material adverse effect.
  • Internal Controls: Management identified multiple material weaknesses in internal control over financial reporting as of December 31, 2004, including controls over revenue recognition, trust reconciliations, and lease accounting. While remediation efforts are underway, these weaknesses continue to exist as of September 30, 2005.
  • Market Risks: Exposure to foreign currency fluctuations (less than 6% of net assets) and interest rate changes (substantially all debt is fixed rate).

Important Facts for Investor Verification

• Restatement Impact: Verify the specific adjustments made to prior period financial statements (2002-2004) regarding preneed trust income and asset dispositions.
• Accounting Change Effect: Confirm the $187.5 million charge related to the change in accounting for preneed selling costs and its impact on reported net income.
• Legal Exposure: Assess the potential financial impact of the Hijar Lawsuit, the 2003 Securities Lawsuit, and ongoing antitrust litigation.
• Internal Control Remediation: Monitor the progress of remediation efforts for the identified material weaknesses in internal controls, particularly regarding revenue recognition and trust reconciliations.
• Cash Flow Strength: Note the strong operating cash flow of $258.4 million for the nine months ended September 30, 2005, despite the reported net loss.
• Share Repurchases: Track the company's ongoing share repurchase program and dividend payments.