SCI

Service Corporation International: Q2 2003 10-Q Summary

Business Context and Reporting Period

This report covers the quarterly period ended June 30, 2003. Service Corporation International (SCI) is the world's largest provider of funeral and cemetery services, operating 2,259 funeral service locations, 431 cemeteries, and 188 crematoria across eight countries. The company is currently executing a strategy focused on debt reduction, asset divestitures, and operational cost restructuring.

Key Financial Metrics

Material Changes vs. Prior Period

• Turnaround in Profitability: The company returned to profitability in Q2 2003 ($14.4M net income) compared to a significant loss in Q2 2002 ($143.0M). The 2002 loss was heavily impacted by a $187.7 million impairment charge on assets held for sale and $40.8 million in other operating expenses related to contract terminations.
• Debt Reduction: Total debt decreased by approximately $249 million from year-end 2002 to June 30, 2003, driven by strong operating cash flows and asset sales.
• Arbitration Charge: General and administrative expenses increased significantly in Q2 2003 due to a $15.0 million charge related to an arbitration award (James P. Hunter, III). This charge was recognized because an insurance carrier covering the liability was insolvent.
• Volume Trends: North American comparable funeral volume declined 3.5% in the first six months of 2003, attributed to a decrease in the number of deaths and a rising trend toward cremation (39.3% of services in Q2 2003).

Guidance, Outlook, and Risks

• Strategic Goals: Management aims to achieve a "BB" credit rating from S&P and "Ba2" from Moody's. The focus remains on deleveraging, completing asset divestitures (targeting $300-$400 million in proceeds), and improving cash flows.
• Accounting Changes (FIN 46): The company expects to consolidate prearranged funeral and cemetery trust funds and certain managed cemeteries effective July 1, 2003. This is projected to add approximately $630 million in assets and liabilities and result in a pretax charge of $20-$30 million in Q3 2003.
• Legal Contingencies:
  • Florida Litigation: The company settled a lawsuit with the Florida Attorney General for $6 million. Criminal charges were filed in May 2003 regarding misconduct at a Florida cemetery; the company intends to vigorously defend these charges.
  • Securities Litigation: A consolidated class action lawsuit regarding the 1999 merger with Equity Corporation International remains pending, with a motion to dismiss currently before the court.
• Market Risks: Risks include declining death rates, increasing cremation rates (which lower average revenue per service), and potential changes in surety bonding regulations in Florida expiring in 2004.

Investor Verification Checklist

• Arbitration Impact: Verify the finality of the $15.0 million Hunter arbitration charge and the status of the insolvent insurance carrier.
• FIN 46 Consolidation: Monitor the Q3 2003 financials for the anticipated $20-$30 million pretax charge and the $630 million balance sheet expansion due to trust fund consolidation.
• Florida Criminal Charges: Track the progress of the criminal charges filed in May 2003 regarding the Menorah Gardens cemetery, as an adverse outcome could materially affect financial condition.
• Debt Maturities: Review the schedule for $111.2 million in senior notes due in April 2004 and the company's plan to refinance or repay this obligation.
• Cremation Trends: Assess the long-term impact of the rising cremation rate (nearly 40%) on average revenue per service and gross margins.