SCI

Service Corporation International (SCI) - 2003 Annual Report Summary

Business Context and Reporting Period

This Form 10-K covers the fiscal year ended December 31, 2003. SCI is the world's largest provider of funeral and cemetery services, operating 2,225 funeral service locations, 417 cemeteries, and 183 crematoria across eight countries. The company is actively restructuring its portfolio, focusing on its core North American business while divesting international operations. Notably, in March 2004 (subsequent to the reporting period), SCI completed a joint venture of its French funeral operations, retaining a 25% equity interest. The company also sold its Australian equity investment in late 2003 and expects to sell its UK holdings in mid-2004.

Important Note: The company restated its financial statements for fiscal years 2000, 2001, and 2002, as well as the first three quarters of 2003, primarily due to adjustments in revenue recognition for preneed cemetery contracts and changes in the amortization of deferred selling costs.

Key Financial Metrics (2003)

Material Changes vs. Prior Period

• Return to Profitability: SCI returned to net income in 2003 ($85.1 million) after reporting significant net losses in 2002 ($232.5 million) and 2001 ($623.4 million). This turnaround was driven by cost reduction initiatives, gains on asset dispositions, and improved operating margins.
• Revenue Growth: Consolidated revenue increased slightly by 0.8% to $2,341.7 million. Growth was largely attributable to increased funeral operations in France and favorable currency fluctuations, offsetting declines in North America.
• Debt Reduction: Total debt decreased by $273.2 million (13.8%) from 2002 levels, reflecting a continued focus on deleveraging. Net debt (total debt less cash) reached $1,472.2 million, the lowest level since 1994.
• Asset Dispositions: The company recognized a net pretax gain of $50.4 million on dispositions, primarily from the sale of equity investments in Australia ($45.7 million gain) and Spain ($8.1 million gain).
• Legal Expenses: General and administrative expenses increased significantly to $178.1 million (from $89.8 million in 2002), primarily due to $95.2 million in litigation-related expenses (net of insurance recoveries) associated with Florida cemetery operations.

Guidance, Outlook, and Risks

2004 Outlook: Management expects growth in operating margins driven by infrastructure improvements and cost reductions. Key guidance ranges for 2004 include:

• Diluted EPS: $0.42 to $0.50 (excluding specific accounting changes and litigation impacts).
• Operating Cash Flow: $270 million to $310 million.
• Capital Expenditures: $100 million to $120 million.
• Effective Tax Rate: 15% to 18% (benefited by international transactions).

Strategic Initiatives: The company is focusing on the "Dignity Memorial" national brand to increase average revenue per service, particularly through packaged funeral and cremation plans. They are also addressing the industry trend toward cremation by expanding memorialization products.

Risks and Contingencies:

• Florida Litigation: SCI entered into an agreement in principle to settle class action lawsuits regarding Florida cemetery operations for approximately $100 million. A $25 million insurance recovery receivable was recognized in 2003. The settlement requires court approval.
• Accounting Changes: Implementation of FIN 46R (consolidation of variable interest entities) in March 2004 may require consolidating trust funds, potentially impacting the balance sheet. A change in pension accounting effective Jan 1, 2004, is expected to result in a $55 million pretax charge.
• Regulatory Environment: Changes in state laws regarding surety bonding for preneed contracts (specifically in Florida) are expected to reduce operating cash flows by $15-$20 million in 2004 as the company shifts to trust funding.

Investor Verification Checklist

• Restatement Impact: Verify the specific adjustments made to 2000-2003 financials regarding preneed cemetery revenue recognition and deferred selling costs.
• Florida Litigation Status: Monitor the court approval process for the $100 million settlement and the realization of the $25 million insurance recovery.
• FIN 46R Implementation: Assess the impact of consolidating prearranged funeral and cemetery trust funds on the balance sheet and cash flow classification in Q1 2004.
• International Divestitures: Track the completion of the UK equity sale and the performance of the retained 25% interest in the French joint venture.
• Cash Flow Sustainability: Confirm that operating cash flows remain sufficient to service debt and fund capital expenditures, particularly given the shift from surety bonding to trust funding in Florida.