FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
or
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
---------- ----------
COMMISSION FILE NUMBER 1-6402-1
--------------------
SERVICE CORPORATION INTERNATIONAL
(Exact name of registrant as specified in charter)
TEXAS 74-1488375
(State or other jurisdiction of (I. R. S. employer
incorporation or organization) identification number)
1929 ALLEN PARKWAY, HOUSTON, TEXAS 77019
(Address of principal executive offices) (Zip code)
713-522-5141
(Registrant's telephone number, including area code)
--------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months and (2) has been subject to the filing
requirements for the past 90 days.
YES X NO
---------- -----------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in the Securities Exchange Act of 1934 Rule 12b-2).
YES X NO
---------- -----------
The number of shares outstanding of the registrant's common stock as of November
3, 2003 was 301,356,436 (net of treasury shares).
1
SERVICE CORPORATION INTERNATIONAL
INDEX
Page
----
Part I. Financial Information
Item 1. Financial Statements
Consolidated Statement of Operations -
Three and Nine Months Ended September 30, 2003 and 2002 3
Consolidated Balance Sheet -
September 30, 2003 and December 31, 2002 4
Consolidated Statement of Cash Flows -
Nine Months Ended September 30, 2003 and 2002 5
Consolidated Statement of Stockholders' Equity -
Nine Months Ended September 30, 2003 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Introduction 21
Goals and Challenges 21
Strategic Initiatives 22
Critical Accounting Policies, Accounting Changes and New Accounting Pronouncements 24
Results of Operations 24
Financial Condition, Liquidity and Capital Resources 30
Prearranged Funeral and Preneed Cemetery Activities 32
Cautionary Statement on Forward-Looking Statements 35
Item 3. Quantitative and Qualitative Disclosures about Market Risk 36
Item 4. Controls and Procedures 36
Part II. Other Information
Item 1. Legal Proceedings 36
Item 6. Exhibits and Reports on Form 8-K 36
Signature 38
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SERVICE CORPORATION INTERNATIONAL
CONSOLIDATED STATEMENT OF OPERATIONS
<Table>
<Caption>
Three months ended Nine months ended
September 30, September 30,
---------------------------- ----------------------------
(In thousands, except per share amounts) 2003 2002 2003 2002
- ---------------------------------------------------------------- ----------- ----------- ----------- -----------
Revenues ....................................................... $ 571,100 $ 560,646 $ 1,737,435 $ 1,745,335
Costs and expenses ............................................. 502,473 485,237 1,461,835 1,459,489
----------- ----------- ----------- -----------
Gross profits .................................................. 68,627 75,409 275,600 285,846
General and administrative expenses ............................ (52,771) (22,492) (110,450) (57,815)
Gains and impairment (losses) on dispositions, net ............. (1,423) 408 6,392 (190,213)
Other operating expenses ....................................... -- (25,621) (1,724) (66,428)
----------- ----------- ----------- -----------
Operating income (loss) ........................................ 14,433 27,704 169,818 (28,610)
Interest expense ............................................... (34,998) (38,221) (108,515) (123,013)
Other income, net .............................................. 11,236 17,103 17,646 23,303
----------- ----------- ----------- -----------
(23,762) (21,118) (90,869) (99,710)
----------- ----------- ----------- -----------
(Loss) income before income taxes and cumulative effect
of accounting change ...................................... (9,329) 6,586 78,949 (128,320)
(Benefit) provision for income taxes ........................... (3,753) 2,525 27,877 (36,215)
----------- ----------- ----------- -----------
(Loss) income before cumulative effect of accounting
change .................................................... (5,576) 4,061 51,072 (92,105)
Cumulative effect of accounting change (net of income
tax benefit of $11,234) ................................... -- -- -- (135,560)
----------- ----------- ----------- -----------
Net (loss) income .................................... $ (5,576) $ 4,061 $ 51,072 $ (227,665)
=========== =========== =========== ===========
Basic (loss) earnings per share:
(Loss) income before cumulative effect of
accounting change ........................... $ (.02) $ .01 $ .17 $ (.31)
Cumulative effect of accounting change ................ -- -- -- (.46)
----------- ----------- ----------- -----------
Net (loss) income ........................... $ (.02) $ .01 $ .17 $ (.77)
=========== =========== =========== ===========
Diluted (loss) earnings per share:
(Loss) income before cumulative effect of
accounting change ........................... $ (.02) $ .01 $ .17 $ (.31)
Cumulative effect of accounting change ................ -- -- -- (.46)
----------- ----------- ----------- -----------
Net (loss) income ........................... $ (.02) $ .01 $ .17 $ (.77)
=========== =========== =========== ===========
Basic weighted average number of shares ........................ 300,507 295,151 299,221 293,892
=========== =========== =========== ===========
Diluted weighted average number of shares ...................... 300,507 295,593 299,842 293,892
=========== =========== =========== ===========
</Table>
(See notes to consolidated financial statements)
3
SERVICE CORPORATION INTERNATIONAL
CONSOLIDATED BALANCE SHEET
September 30, December 31,
(In thousands, except share and per share amounts) 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents...................................................... $ 163,920 $ 200,625
Receivables, net of allowances................................................. 277,510 291,765
Inventories.................................................................... 131,882 135,529
Other ......................................................................... 53,493 126,980
-------------- -------------
Total current assets...................................................... 626,805 754,899
-------------- -------------
Prearranged funeral contracts ...................................................... 4,553,158 4,273,790
Long-term receivables, net of allowances ........................................... 1,081,599 1,156,458
Cemetery property, at cost.......................................................... 1,527,926 1,567,584
Property, plant and equipment, at cost (net)........................................ 1,214,898 1,188,340
Deferred charges and other assets................................................... 633,814 598,536
Goodwill ......................................................................... 1,197,055 1,184,178
-------------- -------------
$ 10,835,255 $ 10,723,785
============== =============
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities....................................... $ 370,139 $ 361,910
Current maturities of long-term debt........................................... 131,971 100,330
Income taxes .................................................................. 17,393 2,043
-------------- -------------
Total current liabilities................................................. 519,503 464,283
-------------- -------------
Long-term debt...................................................................... 1,585,127 1,884,508
Deferred prearranged funeral contract revenues ..................................... 4,947,406 4,659,994
Deferred preneed cemetery contract revenues......................................... 1,630,301 1,672,661
Deferred income taxes............................................................... 505,037 522,453
Other liabilities .................................................................. 216,995 216,115
Commitments and contingencies (note 6)
Stockholders' equity:
Common stock, $1 per share par value, 500,000,000 shares authorized,
301,054,918 and 297,010,237, issued and outstanding
(net of 2,469,445 and 2,516,396 treasury shares, at par)................ 301,055 297,010
Capital in excess of par value................................................. 2,270,051 2,259,936
Accumulated deficit............................................................ (994,957) (1,046,029)
Accumulated other comprehensive loss........................................... (145,263) (207,146)
-------------- -------------
Total stockholders' equity................................................ 1,430,886 1,303,771
-------------- -------------
$ 10,835,255 $ 10,723,785
============== =============
(See notes to consolidated financial statements)
4
SERVICE CORPORATION INTERNATIONAL
CONSOLIDATED STATEMENT OF CASH FLOWS
Nine months ended
September 30,
--------------------------
(In thousands) 2003 2002
- --------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) .......................................................................... $ 51,072 $(227,665)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Cumulative effect of accounting change, net of tax .................................... -- 135,560
Depreciation and amortization ......................................................... 126,632 136,966
Provision (benefit) for deferred income taxes ......................................... 7,956 (43,097)
(Gains) and impairment losses on dispositions, net .................................... (6,392) 190,213
Other operating expenses .............................................................. 1,724 66,428
Payments on restructuring charges ..................................................... (10,515) (8,032)
Gains on early extinguishments of debt, net ........................................... (2,078) (4,133)
Changes in assets and liabilities, net of effects from acquisitions and dispositions:
Decrease in receivables ............................................................. 53,195 23,334
Decrease (increase) in other assets ................................................. 30,753 (16,990)
Increase (decrease) in payables and other liabilities ............................... 44,791 (5,837)
Other ............................................................................... 5,161 (5,890)
Net effect of prearranged funeral production and maturities ........................... 1,289 11,356
--------- ---------
Net cash provided by operating activities .................................................. 303,588 252,213
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures .................................................................. (80,237) (62,064)
Proceeds from divestitures and sales of property and equipment ........................ 52,186 51,045
Proceeds and distributions from joint ventures and equity investments,
net of cash retained ............................................................... 30,802 266,704
Net (deposits) receipts of restricted funds ........................................... (56,230) 2,565
Other ................................................................................. -- 848
--------- ---------
Net cash (used in) provided by investing activities ........................................ (53,479) 259,098
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in borrowings under credit agreements .................................... -- (29,061)
Payments of debt ...................................................................... (86,604) (70,712)
Early extinguishments of debt ......................................................... (194,019) (273,638)
Bank overdrafts and other ............................................................. (10,349) (22,106)
--------- ---------
Net cash used in financing activities ...................................................... (290,972) (395,517)
Effect of foreign currency ................................................................. 4,158 (4,041)
--------- ---------
Net (decrease) increase in cash and cash equivalents ....................................... (36,705) 111,753
Cash and cash equivalents at beginning of period ........................................... 200,625 29,292
--------- ---------
Cash and cash equivalents at end of period ................................................. $ 163,920 $ 141,045
========= =========
(See notes to consolidated financial statements)
5
SERVICE CORPORATION INTERNATIONAL
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
<Table>
<Caption>
Accumulated
Capital in other
Common excess of Accumulated comprehensive
(In thousands) Stock par value deficit income (loss) Total
- ------------------------------------------ -------- ---------- ----------- ------------- ----------
Balance at December 31, 2002.............. $297,010 $2,259,936 $(1,046,029) $ (207,146) $1,303,771
Comprehensive income:
Net income............................ 51,072 51,072
Foreign currency translation.......... 61,883 61,883
----------
Comprehensive income.................. 112,955
Common stock issued:
Contribution to employee 401(k) plan.. 3,839 9,959 13,798
Other................................. 206 156 362
-------- ---------- ----------- ----------- ----------
Balance at September 30, 2003............. $301,055 $2,270,051 $ (994,957) $ (145,263) $1,430,886
======== ========== =========== =========== ==========
</Table>
(See notes to consolidated financial statements)
6
SERVICE CORPORATION INTERNATIONAL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. NATURE OF OPERATIONS
Service Corporation International (SCI or the Company) is the largest provider
of funeral and cemetery services in the world through its funeral service and
cemetery operations. At September 30, 2003, the Company operated 2,236 funeral
service locations, 429 cemeteries and 190 crematoria located in eight countries.
The Company also has minority interest equity investments in funeral and
cemetery operations in Australia and the United Kingdom.
The funeral service and cemetery operations consist of the Company's funeral
service locations, cemeteries, crematoria and related businesses. Company
personnel at the funeral service locations provide all professional services
relating to funerals, including the use of funeral facilities and motor
vehicles. Funeral related merchandise is sold at funeral service locations and
certain funeral service locations contain crematoria. The Company sells
prearranged funeral services whereby a customer contractually agrees to the
terms of a funeral to be performed in the future. The Company's cemeteries
provide cemetery property interment rights (including mausoleum spaces, lots and
lawn crypts) and sell cemetery related merchandise. Cemetery items are sold on
an atneed or preneed basis. Company personnel at cemeteries perform interment
services and provide management and maintenance of cemetery grounds. Certain
cemeteries also operate crematoria. There are 187 combination locations that
contain a funeral service location within a Company owned cemetery.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The consolidated financial statements for the three
and nine months ended September 30, 2003 and 2002 include the accounts of the
Company and all majority-owned subsidiaries and are unaudited but include all
adjustments, consisting of normal recurring accruals and any other adjustments
which management considers necessary for a fair presentation of the results for
these periods. These consolidated financial statements have been prepared in a
manner consistent with the accounting policies described in the annual report on
Form 10-K filed with the U. S. Securities and Exchange Commission for the year
ended December 31, 2002, unless otherwise disclosed herein, and should be read
in conjunction therewith. The accompanying year-end consolidated balance sheet
was derived from the audited consolidated financial statements but does not
include all disclosures required by accounting principles generally accepted in
the United States of America. Operating results for interim periods are not
necessarily indicative of the results that may be expected for the full year
period.
The Company has reclassified certain prior year amounts to conform to the
current period financial presentation with no effect on previously reported
results of operations, financial condition or cash flows.
Use of Estimates in the Preparation of Financial Statements: The preparation of
the consolidated financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that may affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenues and
expenses during the reporting periods. As a result, actual results could differ
from these estimates.
During the second quarter of 2002, the Company decided to implement new
information technology systems, including a new North America point of sale
system and an upgraded general ledger system. As a result of this decision, the
Company accelerated amortization of its existing capitalized systems costs
beginning in the second quarter of 2002 in order to reflect the estimated
remaining useful lives of these systems. The Company recognized amortization
related to this change in estimate of approximately $4,600 during the third
quarter of 2003 and 2002 and $13,800 and $9,200 during the nine months ended
September 30, 2003 compared to the same period of 2002.
7
3. ACCOUNTING CHANGES AND NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No.
143, "Accounting for Asset Retirement Obligations." SFAS No. 143 addresses
obligations associated with the retirement of tangible long-lived assets and
associated asset retirement costs. Under the provisions of SFAS No. 143, the
fair value of a liability for an asset retirement obligation should be
recognized in the period in which it is incurred, if a reasonable estimate can
be made. The associated costs are capitalized as part of the carrying amount of
the long-lived asset and are allocated to expense over the useful life of the
asset. The Company adopted SFAS No. 143 during the first quarter of 2003 with no
effect on its results of operations, financial condition or cash flows.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." The Company adopted SFAS No. 145 during the first quarter of 2003
as it relates to the classification of extinguishments of debt for all periods
presented. SFAS No. 145 eliminates the requirement that gains and losses from
the extinguishment of debt be aggregated and classified as extraordinary items
as well as certain other items. Gains and losses from early extinguishments of
debt are included in Other income, net in the consolidated statement of
operations for all periods presented. The Company recorded $2,078 as gains from
the early extinguishment of debt in Other income, net for the nine months ended
September 30, 2003 and has reclassified $4,133 related to the prior year period
to Other income, net which was previously reported as an extraordinary gain. The
other provisions of SFAS No. 145 were generally effective for transactions
occurring after May 15, 2002.
In November 2002, the FASB issued FASB Interpretation No. 45 (FIN No. 45),
"Guarantor's Accounting Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others, an Interpretation of FASB
Statements No. 5, 57 and 107 and Rescission of FASB Interpretation No. 34." FIN
No. 45 clarifies the disclosures required by a guarantor about its obligations
and it requires guarantors to recognize a liability at fair value at the time of
issuance. The provisions for initial recognition and measurement are applicable
on a prospective basis to guarantees issued or modified after December 31, 2002.
The disclosure requirements were effective for financial statements for periods
that end after December 15, 2002. There have been no material changes in the
guarantees related to FIN No. 45 since December 31, 2002.
In January 2003, the FASB issued FASB Interpretation No. 46 (FIN No. 46),
"Consolidation of Variable Interest Entities, an Interpretation of Accounting
Research Bulletin (ARB) No. 51." FIN No. 46 clarifies the application of ARB No.
51, Consolidated Financial Statements, to certain entities in which equity
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. FIN No. 46
defines the terms related to variable interest entities and clarifies if such
entities should be consolidated. FIN No. 46 was originally required to be
implemented in the third quarter of 2003; however, the FASB subsequently allowed
companies to defer the implementation. The Company has decided to implement FIN
No. 46 as of December 31, 2003 in order to give the Company sufficient time to
compile the financial information necessary to complete the implementation. Now
as amended, the provisions of FIN No. 46 are effective immediately for all
enterprises with variable interests in variable interest entities created after
January 31, 2003.
Upon implementation of FIN No. 46, the Company may be required to
consolidate, as of December 31, 2003, its prearranged funeral, cemetery
merchandise and services and perpetual care trust funds, as well as certain
cemeteries managed, but not owned, by the Company. If the perpetual care trust
funds are consolidated, the Company may recognize an asset and corresponding
obligation in its Consolidated Balance Sheet of approximately $650 million.
Additionally, the Company's trust funds may be recorded at fair value. If the
trust funds are consolidated, changes in fair value may be recorded as
adjustments to the prearranged funeral, cemetery merchandise and service and
cemetery perpetual care trust fund investments with corresponding changes
recorded in prearranged funeral and preneed cemetery deferred revenue and
cemetery perpetual care balances.
8
The Company expects to recognize a pretax charge of approximately $20 to
$30 million, representing the cumulative effect of an accounting change as of
December 31, 2003, as a result of consolidating certain cemeteries managed, but
not owned by the Company. The results of operations and cash flows of these
cemeteries may be included in the consolidated financial statements although no
material impact is anticipated. If the trust fund investments are consolidated,
the Consolidated Statement of Cash Flows may include proceeds from sales of
trust fund investments and disbursements from purchases of trust fund
investments shown separately as components of cash flows from investing
activities. Proceeds related to the distribution of trust fund earnings to the
Company may be recognized as cash flows from investing activities. Currently,
these cash flows are reported as operating cash flows as they are collections of
third party trust receivables.
4. DEBT
<Table>
<Caption>
September 30, 2003 December 31, 2002
------------------ -----------------
6.3% notes due 2003........................................................... $ -- $ 84,801
7.375% notes due April 2004................................................... 111,190 111,190
8.375% notes due December 2004................................................ 50,797 50,797
6.0% notes due 2005........................................................... 272,451 387,241
7.2% notes due 2006........................................................... 150,000 150,000
6.875% notes due 2007......................................................... 143,475 150,000
6.5% notes due 2008........................................................... 195,000 200,000
6.75% convertible subordinated notes due 2008, conversion price of
$6.92 per share............................................................ 312,694 328,005
7.7% notes due 2009........................................................... 358,266 371,183
6.95% amortizing notes due 2010............................................... 10,006 42,106
7.875% debentures due 2013.................................................... 55,627 55,627
Convertible debentures, maturities through 2013, fixed interest rates
from 4.75% to 5.5%, conversion prices from $13.02 to $50.00 per share...... 39,171 39,531
Mortgage notes and other debt, maturities through 2050........................ 70,328 76,758
Deferred charges.............................................................. (51,907) (62,401)
-------------- --------------
Total debt............................................................... 1,717,098 1,984,838
Less current maturities.................................................. (131,971) (100,330)
-------------- --------------
Total long-term debt.............................................. $ 1,585,127 $ 1,884,508
============== ==============
</Table>
Bank Credit Agreements
The Company's bank credit agreement matures in July 2005 and provides a total
commitment of $185,000, including a sublimit of $125,000 for letters of credit.
The credit facility is secured by the stock, inventory and receivables of
certain of the Company's domestic subsidiaries and these domestic subsidiaries
have guaranteed the Company's debt obligation associated with this facility. The
bank credit agreement contains certain financial covenants, including a minimum
interest coverage ratio, a maximum leverage ratio and limits on capital
expenditures. Additionally, the Company is restricted from paying dividends and
making other distributions. The Company had no borrowings under the bank credit
agreement at either September 30, 2003 or December 31, 2002; however, the
Company used the credit agreement sublimit to issue letters of credit, in the
amounts of $67,365 and $85,845, at September 30, 2003 and December 31, 2002,
respectively. Interest rates for outstanding borrowings are based on various
indices as determined by the Company. The Company also pays a quarterly fee on
the unused commitment, ranging from 0.50% to 0.75%, which is based on the
percentage of the facility used and was 0.625% at September 30, 2003 and at
December 31, 2002.
9
Debt Settlements and Extinguishments
During the nine months ended September 30, 2003, the Company purchased the
following notes in the open market: $8,528 of the 6.3% notes due 2003; $114,790
of the 6.0% notes due 2005; $6,525 of the 6.875% notes due 2007; $5,000 of the
6.5% notes due 2008; $15,311 of the 6.75% convertible subordinated notes due
2008; $12,917 of the 7.7% notes due 2009; $31,284 of the 6.95% amortizing notes
due 2010; and the remaining $25 of the 7.0% notes due 2015. As a result of these
transactions, the Company recognized a net gain for the first nine months of
2003 of $2,078 recorded in Other income in the consolidated statement of
operations.
In March 2003, as required by the terms of the agreement, the Company
repaid the remaining $76,273 due on the 6.30% notes due in 2003.
Additional Debt Disclosures
The Company's consolidated debt had a weighted average interest rate of 6.95% at
September 30, 2003 compared to 6.87% at December 31, 2002. Approximately 99% of
the Company's total outstanding debt had a fixed interest rate at September 30,
2003 and December 31, 2002.
At September 30, 2003 and December 31, 2002, the Company had deposited
$79,822 and $23,592, respectively, in restricted interest-bearing accounts, held
as collateral for various credit instruments, which is included in Deferred
charges and other assets in the consolidated balance sheet.
5. SEGMENT REPORTING
The Company's operations are both product and geographically based, and the
reportable operating segments presented below include funeral and cemetery
operations. The Company's geographic segments include North America, Europe and
Other Foreign. The Company conducts funeral and cemetery operations in its North
America and Other Foreign segments and conducts funeral operations in its
European segment. In the first quarter of 2002, the Company completed a joint
venture with respect to its United Kingdom operations which conducted both
funeral and cemetery operations in its European segment.
The Company has reclassified certain prior year amounts to conform to the
current period presentation with no effect on previously reported results of
operations, financial condition or cash flows.
The Company's reportable segment information is as follows:
<Table>
<Caption>
Reportable
Funeral Cemetery Segments
- -------------------------------------------------------------------------------------------------------------
Revenues from external customers:
Three months ended September 30,
2003................................................. $ 422,715 $ 148,385 $ 571,100
2002................................................. $ 396,106 $ 164,540 $ 560,646
Nine months ended September 30,
2003................................................. $1,289,569 $ 447,866 $ 1,737,435
2002................................................. $1,251,253 $ 494,082 $ 1,745,335
- -------------------------------------------------------------------------------------------------------------
Gross profits:
Three months ended September 30,
2003................................................. $ 53,608 $ 15,019 $ 68,627
2002................................................. $ 55,406 $ 20,003 $ 75,409
Nine months ended September 30,
2003................................................. $ 208,433 $ 67,167 $ 275,600
2002................................................. $ 221,953 $ 63,893 $ 285,846
- -------------------------------------------------------------------------------------------------------------
</Table>
10
The following table reconciles gross profits from reportable segments to
the Company's consolidated (loss) income before income taxes and cumulative
effect of accounting change:
<Table>
<Caption>
Three months ended Nine months ended
September 30, September 30,
------------------------- -------------------------
2003 2002 2003 2002
------------------------- -------------------------
Gross profits from reportable segments ........................ $ 68,627 $ 75,409 $ 275,600 $ 285,846
General and administrative expenses ..................... (52,771) (22,492) (110,450) (57,815)
Gains and impairment (losses) on dispositions, net ...... (1,423) 408 6,392 (190,213)
Other operating expenses ................................ -- (25,621) (1,724) (66,428)
------------------------- -------------------------
Operating income (loss) ....................................... 14,433 27,704 169,818 (28,610)
Interest expense ........................................ (34,998) (38,221) (108,515) (123,013)
Other income, net ....................................... 11,236 17,103 17,646 23,303
------------------------- -------------------------
(Loss) income before income taxes and cumulative effect of
accounting change ........................................ $ (9,329) $ 6,586 $ 78,949 $ (128,320)
========================= =========================
</Table>
11
The Company's geographic segment information is as follows:
<Table>
<Caption>
North Other
America Europe Foreign Total
- ----------------------------------------------------------------------------------------------------------------------------
Revenues from external customers:
Three months ended September 30,
2003 ................................................. $ 409,280 $ 149,952 $ 11,868 $ 571,100
2002 ................................................. $ 437,512 $ 116,162 $ 6,972 $ 560,646
Nine months ended September 30,
2003 ................................................. $ 1,276,877 $ 429,245 $ 31,313 $ 1,737,435
2002 ................................................. $ 1,360,100 $ 359,337 $ 25,898 $ 1,745,335
- ----------------------------------------------------------------------------------------------------------------------------
Gains and impairment (losses) on dispositions, net:
Three months ended September 30,
2003 ................................................. $ (2,929) $ 1,476 $ 30 $ (1,423)
2002 ................................................. $ 1,300 $ (892) $ -- $ 408
Nine months ended September 30,
2003 ................................................. $ 7,262 $ (900) $ 30 $ 6,392
2002 ................................................. $ (173,335) $ (641) $ (16,237) $ (190,213)
- ----------------------------------------------------------------------------------------------------------------------------
Other operating expenses:
Three months ended September 30,
2003 ................................................. $ -- $ -- $ -- $ --
2002 ................................................. $ (25,621) $ -- $ -- $ (25,621)
Nine months ended September 30,
2003 ................................................. $ (1,724) $ -- $ -- $ (1,724)
2002 ................................................. $ (66,428) $ -- $ -- $ (66,428)
- ----------------------------------------------------------------------------------------------------------------------------
Operating (loss) income:
Three months ended September 30,
2003 ................................................. $ (6,966) $ 17,828 $ 3,571 $ 14,433
2002 ................................................. $ 14,966 $ 12,364 $ 374 $ 27,704
Nine months ended September 30,
2003 ................................................. $ 109,453 $ 51,774 $ 8,591 $ 169,818
2002 ................................................. $ (59,935) $ 42,435 $ (11,110) $ (28,610)
- ----------------------------------------------------------------------------------------------------------------------------
Depreciation and amortization:
Three months ended September 30,
2003 ................................................. $ 42,210 $ -- $ 65 $ 42,275
2002 ................................................. $ 44,631 $ 4,630 $ 252 $ 49,513
Nine months ended September 30,
2003 ................................................. $ 126,321 $ -- $ 311 $ 126,632
2002 ................................................. $ 132,084 $ 4,630 $ 252 $ 136,966
- ----------------------------------------------------------------------------------------------------------------------------
Operating locations at September 30,:
2003 ................................................. 1,814 1,018 23 2,855
2002 ................................................. 1,882 1,149 24 3,055
- ----------------------------------------------------------------------------------------------------------------------------
</Table>
12
Included in the North America figures above are the following United States
amounts:
<Table>
<Caption>
Three months ended Nine months ended
September 30, September 30,
------------------------ -------------------------
2003 2002 2003 2002
------------------------ -------------------------
Revenues from external customers....................... $ 388,852 $ 416,619 $1,218,269 $ 1,301,696
Operating (loss) income................................ $ (9,103) $ 11,070 $ 97,448 $ (71,203)
Depreciation and amortization.......................... $ 40,773 $ 42,604 $ 122,194 $ 127,609
Operating locations at September 30,................... 1,659 1,734
- ---------------------------------------------------------------------------------------------------------------------
</Table>
Included in the European figures above are the following French amounts:
<Table>
<Caption>
Three months ended Nine months ended
September 30, September 30,
------------------------ -------------------------
2003 2002 2003 2002
------------------------ -------------------------
Revenues from external customers........................ $ 148,412 $ 114,398 $ 424,060 $ 338,050
Operating income........................................ $ 17,578 $ 11,846 $ 51,081 $ 39,493
Depreciation and amortization........................... $ -- $ 4,624 $ -- $ 4,624
Operating locations at September 30,.................... 1,002 1,131
- ---------------------------------------------------------------------------------------------------------------------
</Table>
During the nine months ended September 30, 2003 and throughout 2002, the
Company divested certain North America and international funeral service
locations and cemeteries not considered part of its core operations. These
divested operations do not qualify as discontinued operations under SFAS No.
144, "Accounting for the Impairment or Disposal of Long Lived Assets," because
they do not meet the criteria for discontinued operations as defined in SFAS No.
144. Revenue and gross profit information of the Company's divested operations
for the three and nine months ended September 30, 2003 and 2002 are as follows:
<Table>
<Caption>
North America Europe
----------------------------------------------- ---------------------------------------------
Three months ended Nine months ended Three months ended Nine months ended
September 30, September 30, September 30, September 30,
--------------------- --------------------- --------------------- --------------------
2003 2002 2003 2002 2003 2002 2003 2002
-------- -------- -------- -------- -------- -------- -------- --------
Revenues:
Funeral ..................... $ 1,510 $ 7,074 $ 8,324 $ 31,766 $ -- $ -- $ -- $ 14,284
Cemetery .................... 527 3,230 1,425 13,571 -- -- -- 2,190
-------- -------- -------- -------- -------- -------- -------- --------
$ 2,037 $ 10,304 $ 9,749 $ 45,337 $ -- $ -- $ -- $ 16,474
======== ======== ======== ======== ======== ======== ======== ========
Gross Profits:
Funeral ..................... $ (557) $ (235) $ (2,134) $ (852) $ -- $ -- $ -- $ 3,358
Cemetery .................... (56) 476 (1,425) 2,584 -- -- -- 740
-------- -------- -------- -------- -------- -------- -------- --------
$ (613) $ 241 $ (3,559) $ 1,732 $ -- $ -- $ -- $ 4,098
======== ======== ======== ======== ======== ======== ======== ========
</Table>
13
<Table>
<Caption>
Other Foreign Total
-------------------------------------------- -----------------------------------------------
Three months ended Nine months ended Three months ended Nine months ended
September 30, September 30, September 30, September 30,
-------------------- -------------------- --------------------- ---------------------
2003 2002 2003 2002 2003 2002 2003 2002
-------- -------- -------- -------- -------- -------- -------- --------
Revenues:
Funeral ................ $ -- $ -- $ -- $ -- $ 1,510 $ 7,074 $ 8,324 $ 46,050
Cemetery ............... -- -- -- -- 527 3,230 1,425 15,761
-------- -------- -------- -------- -------- -------- -------- --------
$ -- $ -- $ -- $ -- $ 2,037 $ 10,304 $ 9,749 $ 61,811
======== ======== ======== ======== ======== ======== ======== ========
Gross Profits:
Funeral ................ $ -- $ -- $ -- $ -- $ (557) $ (235) $ (2,134) $ 2,506
Cemetery ............... -- -- -- -- (56) 476 (1,425) 3,324
-------- -------- -------- -------- -------- -------- -------- --------
$ -- $ -- $ -- $ -- $ (613) $ 241 $ (3,559) $ 5,830
======== ======== ======== ======== ======== ======== ======== ========
</Table>
6. COMMITMENTS AND CONTINGENCIES
The Company is a party to various litigation matters, investigations and
proceedings. For each of its outstanding legal matters, the Company evaluates
the merits of the case, its exposure to the matter, possible legal or settlement
strategies and the likelihood of an unfavorable outcome. If the Company
determines that an unfavorable outcome is probable and can be estimated, it
establishes the necessary accruals. Certain insurance policies held by the
Company may reduce cash outflows with respect to an adverse outcome of these
litigation matters. The Company accrues such insurance recoveries when they
become likely to be paid and can be reasonably estimated. The following
discussion describes certain litigation and proceedings as of November 3, 2003.
In Re Service Corporation International; Cause No. H-99-0280; In the United
States District Court for the Southern District of Texas, Houston Division (the
Consolidated Lawsuit). The Consolidated Lawsuit was filed in January 1999 and
includes numerous separate lawsuits that were filed in various United States
District Courts in Texas. The Consolidated Lawsuit has been certified as a class
action and names as defendants the Company and three of the Company's current or
former executive officers or directors (the Individual Defendants).
The Consolidated Lawsuit has been brought on behalf of all persons and
entities who (i) acquired shares of Company common stock in the merger of a
wholly-owned subsidiary of the Company into Equity Corporation International
(ECI); (ii) purchased shares of Company common stock in the open market during
the period from July 17, 1998 through January 26, 1999 (the Class Period); (iii)
purchased Company call options in the open market during the Class Period; (iv)
sold Company put options in the open market during the Class Period; (v) held
employee stock options in ECI that became options to purchase Company common
stock pursuant to the merger; and (vi) held Company employee stock options to
purchase Company common stock under a stock plan during the Class Period.
Excluded from the class definition categories are the Individual Defendants, the
members of their immediate families and all other persons who were directors or
executive officers of the Company or its affiliated entities at any time during
the Class Period.
The plaintiffs in the Consolidated Lawsuit allege that defendants violated
federal securities laws by making materially false and misleading statements and
failing to disclose material information concerning the Company's prearranged
funeral business. The Consolidated Lawsuit seeks to recover an unspecified
amount of monetary damages. A Motion to Dismiss the Consolidated Lawsuit filed
by the Company and the Individual Defendants is pending before the Court. The
Company intends to aggressively defend this lawsuit.
On November 5, 2002, James P. Hunter, III and the James P. Hunter, III
Family Trust filed a demand for arbitration styled Case No. 70 Y 168 00717 02;
James P. Hunter, III and the James P. Hunter, III Family Trust v. Service
Corporation International, Robert L. Waltrip, L. William Heiligbrodt, and George
R. Champagne; before the American Arbitration Association in Houston, Texas. Mr.
Hunter was the Chairman, President and Chief Executive Officer of ECI at the
time of its merger with a wholly-owned subsidiary of the Company. The Hunter
plaintiffs asserted claims against the Company and the Individual Defendants
with respect to the Company's merger with ECI in 1999. Hunter also individually
asserted claims that he was instructed to resign as an officer of the Company
several months after the merger and suffered lost income as a result. The
arbitration was held in June 2003. On August 6, 2003, the Company received the
decision of the arbitration panel in the Hunter arbitration. The amount of the
award made under Texas securities laws was approximately $27.8 million
comprising amounts relating to ECI stock and ECI stock options held by
claimants, and attorney fees. The arbitration panel made no finding that the
Company knew or should have known of facts that should have been disclosed to
claimants. The Company has paid the amount set forth in the arbitration award,
and the matter has been settled.
14
During the third quarter of 2003, the Company received $12.8 million from
certain of its insurance companies for partial reimbursement of payment of the
arbitration award.
Several other lawsuits have been filed against the Company, the Individual
Defendants and other defendants, including, in the first and second lawsuits
listed below, the Company's independent accountants, PricewaterhouseCoopers LLP,
in Texas state courts by former ECI shareholders, officers and directors. These
lawsuits include the following matters:
No. 33701-01-01; Jack D. Rottman v. Service Corporation International,
et al.; In the District Court of Angelina County, Texas, filed December 28,
2000 (Rottman matter); and
No. 2000-63917; Jack T. Hammer v. Service Corporation International, et
al.; In the 165th Judicial District Court of Harris County, Texas, filed
December 15, 2000 (Hammer matter);
No. 31820-99-2; Charles Fredrick, Individually, and as a Representative
of the Class v. Service Corp. International; In the District Court of
Angelina County, Texas, filed February 16, 1999 (Frederick matter).
These lawsuits allege, among other things, violations of Texas securities law
and statutory and common law fraud, and seek unspecified compensatory and
exemplary damages. The Company has recently settled the Rottman matter. With
regard to the Hammer and Fredrick matters, the Company intends to aggressively
defend these lawsuits.
Thomas G. Conway et al v. Service Corporation International, et al; Cause
No. CV-02-2818; In the United States District Court for the Eastern District of
New York, filed May 10, 2002 and Demand for Arbitration, No. 13 168 02061 02,
before the American Arbitration Association (AAA) (Conway action). The Conway
action was filed against the Company and two former officers of the Company who
were also former officers of ECI, James P. Hunter III (Hunter) and Jack D.
Rottman (Rottman). On August 28, 2002, the Conway plaintiffs filed a Demand for
Arbitration and Statement of Claim against the Company, ECI and SCI Delaware
Funeral Services, Inc., a subsidiary of the Company (SCI Delaware), in New York
City. The American Arbitration Association ruled that the arbitration would be
conducted in Houston, Texas. The Conway plaintiffs have indicated that they will
refuse to recognize the transfer on the grounds that they contend it is improper
to conduct the arbitration in Houston, Texas. The Company, ECI and SCI Delaware
have initiated an action in the United States District Court for the Southern
District of Texas to compel the Conway plaintiffs to arbitrate their claims in
Houston, Texas.
The plaintiffs in the Conway action owned funeral homes in Queens County and
Suffolk County, New York, which were sold and merged into a subsidiary of ECI in
July 1998. The plaintiffs are also included in the definition of class members
in the Consolidated Lawsuit described above. In the Conway action, plaintiffs
assert that ECI failed to disclose that ECI was negotiating the merger with the
Company in breach of covenants in the agreements between ECI and the plaintiffs.
ECI purchased the plaintiffs' funeral homes with ECI stock and cash, and the
Plaintiffs' ECI stock was exchanged for stock in the Company in the merger of
January 1999. Plaintiffs allege damages from the loss in value of the Company's
stock from 1999 to the present. The plaintiffs seek to recover compensatory
damages alleged at a minimum of $8 million and punitive damages alleged at a
minimum of $14 million. The plaintiffs allege that SCI and SCI Delaware are
liable as the alleged "successor" entities to ECI. The Company and its
subsidiaries believe that the allegations in the Conway action do not provide a
basis for recovery of damages on several legal grounds. The Company and its
subsidiaries intend to aggressively defend this lawsuit.
15
Shareholder Derivative Demand; The Company received a letter dated January
14, 2002, addressed to the Board of Directors, from a law firm stating that it
represented a shareholder of the Company. The letter asserts a shareholder
derivative demand that the Company take legal action against its directors and
officers based upon alleged conduct that is the subject of:
(1) a putative class action lawsuit filed on December 19, 2001, in
Broward County, Florida against the Company and one of its subsidiaries;
(2) a lawsuit filed against the Company by former employees of the
Company in Atlanta, Georgia; and
(3) certain events described in newspaper articles referred to in the
plaintiffs' consolidated complaint in the Consolidated Lawsuit (described
above).
The Board of Directors responded to the letter by forming a committee of
certain independent directors to conduct an inquiry into the allegations in the
letter. The committee retained independent counsel to assist it in its inquiry.
The letter does not seek a specified amount of legal damages. Based on its
investigation, the Committee determined that a lawsuit or derivative proceeding
against the directors or officers of SCI is not in the best interest of SCI. The
Committee reported its decision to the Executive Committee of the Board of
Directors on September 11, 2002.
Maurice Levie, Derivatively on behalf of Nominal Defendant, Service
Corporation International v. R. L. Waltrip, et al and Service Corporation
International; No. 2002-42417; In the 164th Judicial District Court of Harris
County, Texas, filed August 20, 2002 (Levie action). The Levie action was filed
against the Company and the members of its Board of Directors individually as a
result of the Shareholder Derivative Demand of January 14, 2002, described
above. In response to the filing of the lawsuit before the conclusion of the
Committee's investigation, the Company and the individual directors filed an
answer denying the allegations in the lawsuit and a motion to dismiss based on
the results of the investigation and determination of the Committee in response
to the shareholder demand letter. This motion is currently pending before the
trial court. The Company and the individual directors intend to aggressively
defend this lawsuit.
Joan Light, Shirley Eisenbert and Carol Prisco v. SCI Funeral Services of
Florida, Inc. d/b/a Menorah Gardens & Funeral Chapels, and Service Corporation
International; Case No. 01-21376 CA 08; In the Circuit Court of the 17th
Judicial Circuit in and for Broward County, Florida, General Jurisdiction
Division (Consumer Lawsuit). The Consumer Lawsuit was filed December 19, 2001
and names the Company, a subsidiary and other related entities as defendants. On
August 19, 2003, the Court certified a class comprising all persons with burial
plots or family members buried at Menorah Gardens & Funeral Chapels in Florida.
Excluded from the class definition are persons whose claims have been reduced to
judgment or have been settled as of the date of class certification. The
defendants are appealing the trial court's order regarding class certification.
The plaintiffs allege that defendants have failed to exercise reasonable
care in handling remains by secretly: (i) dumping remains in a wooded area; (ii)
burying remains in locations other than the ones purchased; (iii) crushing
vaults to make room for other vaults; (iv) burying remains on top of the other
or head to foot rather than side-by-side; (v) moving remains; and (vi)
co-mingling remains.
The plaintiffs in the Consumer Lawsuit allege that the above conduct
constitutes negligence, tortious interference with the handling of dead bodies,
infliction of emotional distress, and violation of industry specific state
statutes, as well as the state's Deceptive and Unfair Trade Practices Act. The
plaintiffs seek an unspecified amount of compensatory and punitive damages. The
Court has granted plaintiffs' motion for leave to amend their complaint to
include punitive damages. Plaintiffs also seek equitable/injunctive relief in
the form of a permanent injunction requiring defendants to fund a court
supervised program that provides for monitoring and studying of the cemetery and
any disturbed remains to insure their proper disposition.
Counsel for plaintiffs in the Consumer Lawsuit also represent individuals
who have filed eight separate lawsuits setting forth individual claims similar
to those in the Consumer Lawsuit as well as two additional lawsuits. These
lawsuits include Sheldon Cohen, surviving son of Hymen Cohen, deceased v. SCI
Funeral Services of Florida, Inc., d/b/a Menorah Gardens & Funeral Chapels and
Service Corporation International; Case No. 02014679; In the Circuit Court of
the 17th Judicial Circuit in and for Broward County, Florida, and Marian Novins,
surviving daughter of Harold Wells deceased v. SCI Funeral Services of Florida,
Inc. d/b/a/ Menorah Gardens & Funeral Chapels, and Service Corporation
International; Case No. 0307886; In the Circuit Court of the 17th Judicial
Circuit, in and for Broward County, Florida, General Jurisdiction Division. With
regard to the Sheldon Cohen lawsuit, a trial date has been scheduled for the
court's docket beginning December 3, 2003.
On April 21, 2002, additional plaintiffs filed a lawsuit styled Sol
Guralnick, Linda Weinr, Joan Nix, Gilda Schwartz, Paul Schwartz, Ann Ferrante,
Steve Schwartz, Nancy Backlund, Jamie Osit, Corey King, Marc King, Barbara
Feinberg Clark v. SCI Funeral Services of Florida, Inc. d/b/a Menorah Gardens
and Funeral Chapels and Service Corporation International; In the Circuit Court
in the 15th Judicial Circuit, Palm Beach County, Florida; Case number CA024815AE
(Guralnick Lawsuit), making essentially
16
the same allegations as the Consumer Lawsuit with the exception that it does not
contain class allegations.
The Company intends to continue its investigation and to aggressively defend
itself in the Consumer Lawsuit, the related individual claims, and the Guralnick
Lawsuit, as well as continue to cooperate with state officials in resolving the
issues presented.
In addition, on May 21, 2003, the Special Assistant State Attorney for Palm
Beach County, Florida, filed criminal charges against the Company, a Florida
subsidiary and certain individuals. The criminal charges involve allegations of
misconduct by the Company and its Florida subsidiary, including allegations
similar to those in the Consumer Lawsuit. The Company intends to vigorously
defend its interests in this matter.
As of September 30, 2003, the Company had approximately $32 million accrued
for the outstanding litigation related matters described in this note 6. The
Company has substantial face amount of insurance coverage, which it believes is
applicable to these litigation related matters, although there are various
unresolved coverage issues relative to such insurance. For that reason, the
Company has not accrued an estimated receivable for insurance recoveries. Such
receivables are recorded when they are likely to be paid and can be reasonably
estimated.
No assurance can be given regarding the ultimate outcome of these
proceedings. Certain insurance policies held by the Company may reduce cash
outflows with respect to an adverse outcome of these litigation related matters.
If an adverse decision in these matters exceeds the insurance coverage or if the
insurance coverage is deemed not to apply to these matters or if an insurance
carrier is unable to pay, an adverse decision could have a material adverse
effect on the Company, its financial condition, results of operations and cash
flows.
Copies of certain pleadings in these cases are filed as exhibits to this Form
10-Q.
17
7. EARNINGS PER SHARE
A reconciliation of the numerators and denominators of the basic and diluted
earnings per share computations is presented below:
<Table>
<Caption>
Three months ended Nine months ended
September 30, September 30,
----------------------------- ----------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
(Loss) income before cumulative effect of accounting
change (numerator):
(Loss) income before cumulative effect of accounting
change - basic and diluted ........................... $ (5,576) $ 4,061 $ 51,072 $ (92,105)
Net (loss) income (numerator):
Net (loss) income - basic and diluted .................... $ (5,576) $ 4,061 $ 51,072 $ (227,665)
---------------------------------------------------------------
Shares (denominator):
Shares - basic ........................................... 300,507 295,151 299,221 293,892
Stock options ....................................... -- 442 621 --
Convertible debt .................................... -- -- -- --
----------- ----------- ----------- -----------
Shares - diluted ......................................... 300,507 295,593 299,842 293,892
---------------------------------------------------------------
(Loss) income per share before cumulative effect of
accounting change:
Basic .................................................... $ (.02) $ .01 $ .17 $ (.31)
Diluted .................................................. $ (.02) $ .01 $ .17 $ (.31)
---------------------------------------------------------------
Net (loss) income per share:
Basic .................................................... $ (.02) $ .01 $ .17 $ (.77)
Diluted .................................................. $ (.02) $ .01 $ .17 $ (.77)
---------------------------------------------------------------
</Table>
The computation of diluted earnings per share excludes outstanding stock
options and convertible debt in certain periods in which the inclusion of such
options and debt would be antidilutive in the periods presented. Total options
and convertible debt that could impact dilutive earnings per share are as
follows:
<Table>
<Caption>
Three months ended Nine months ended
September 30, September 30,
------------------------ ------------------------
2003 2002 2003 2002
------ ------ ------ ------
Antidilutive options....................................... 20,151 30,059 24,067 23,551
Antidilutive convertible debt.............................. 46,702 50,426 47,276 51,598
------ ------ ------ ------
Total common stock equivalents excluded from
computation...................................... 66,853 80,485 71,343 75,149
====== ====== ====== ======
</Table>
8. STOCKHOLDERS' EQUITY
Stock Options
The Company accounts for employee stock-based compensation expense under the
intrinsic value method. Under this method no compensation expense is recognized
on stock options if the grant price equals the market value on the date of
grant.
18
If the Company had elected to recognize compensation expense for its options
plans based on the fair value method, net (loss) income and per share amounts
would have changed to the pro forma amounts indicated below.
<Table>
<Caption>
Three months ended Nine months ended
September 30, September 30,
----------------------------- -----------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Net (loss) income ............................................ $ (5,576) $ 4,061 $ 51,072 $ (227,665)
Deduct: Total additional stock-based employee
compensation expense determined under fair value based
method for all awards, net of related tax expense ....... (2,230) (3,492) (6,730) (10,475)
----------- ----------- ----------- -----------
Pro forma net (loss) income .................................. $ (7,806) $ 569 $ 44,342 $ (238,140)
=========== =========== =========== ===========
Basic (loss) earnings per share:
Net (loss) income ............................................ $ (.02) $ .01 $ .17 $ (.77)
Deduct: Total additional stock-based employee
compensation expense determined under fair value based
method for all awards, net of related tax expense ....... (.01) (.01) (.02) (.04)
----------- ----------- ----------- -----------
Pro forma basic (loss) earnings per share .................... $ (.03) $ .00 $ .15 $ (.81)
=========== =========== =========== ===========
Diluted (loss) earnings per share:
Net (loss) income ............................................ $ (.02) $ .01 $ .17 $ (.77)
Deduct: Total additional stock-based employee
compensation expense determined under fair value based
method for all awards, net of related tax expense ....... (.01) (.01) (.02) (.04)
----------- ----------- ----------- -----------
Pro forma diluted (loss) earnings per share .................. $ (.03) $ .00 $ .15 $ (.81)
=========== =========== =========== ===========
</Table>
The fair value of the Company's stock options used to compute the pro forma
net income and per share disclosures is determined by calculating the estimated
fair value at grant date using the Black-Scholes option-pricing model.
Accumulated Other Comprehensive Loss
The components of Accumulated other comprehensive loss are as follows:
<Table>
<Caption>
Foreign Minimum Accumulated
Currency Pension Other
Translation Liability Comprehensive
Adjustment Adjustment Income (Loss)
----------- ----------- -------------
Balance at December 31, 2002 ....................................... $ (170,591) $ (36,555) $ (207,146)
Activity in 2003 .............................................. 61,883 -- 61,883
----------- ----------- -----------
Balance at September 30, 2003 ...................................... $ (108,708) $ (36,555) $ (145,263)
=========== =========== ===========
Balance at December 31, 2001 ....................................... $ (261,846) $ (29,353) $ (291,199)
Activity in 2002 .............................................. 17,594 -- 17,594
Reclassification adjustment for sold businesses ............... 47,479 -- 47,479
----------- ----------- -----------
Balance at September 30, 2002 ...................................... $ (196,773) $ (29,353) $ (226,126)
=========== =========== ===========
</Table>
The components of Comprehensive income (loss) are as follows:
<Table>
<Caption>
Three months ended Nine months ended
September 30, September 30,
-------------------------- -------------------------
2003 2002 2003 2002
-------- -------- --------- ----------
Comprehensive income (loss):
Net (loss) income........................ $ (5,576) $ 4,061 $ 51,072 $ (227,665)
Foreign currency translation adjustment.. 16,321 4,440 61,883 65,073
-------- -------- --------- ----------
Comprehensive income (loss)........... $ 10,745 $ 8,501 $ 112,955 $ (162,592)
======== ======== ========= ==========
</Table>
19
9. GAINS AND IMPAIRMENT LOSSES ON DISPOSITIONS AND OTHER OPERATING EXPENSES
Nine Months Ended September 30, 2003 and 2002
As dispositions occur in the normal course of business, gains or losses on the
sale of such businesses are recognized in the income statement line item Gains
and impairment (losses) on dispositions, net. Additionally, as dispositions
occur related to the Company's ongoing asset sale programs, adjustments are made
through this income statement line item to reflect the difference between actual
proceeds received from the sale compared to the original estimates.
Gains on dispositions for the nine months ended September 30, 2003 and 2002
were $20,899 and $7,869, respectively. Impairment losses related to assets held
for sale for the nine months ended September 30, 2003 and 2002 were $27,993 and
$162,893, respectively. Changes to previously estimated impairment losses were a
net reduction to such losses of $13,486 in the first nine months of 2003 and an
additional net loss of $35,189 in the first nine months of 2002. As described
above, the sum of these three components are recognized in the income statement
line item Gains and impairment (losses) on dispositions, net, and amounted to a
net gain of $6,392 and a net loss of $190,213 in the nine months ended 2003 and
2002, respectively. The $190,213 net loss reported in 2002 primarily related to
an impairment charge for several funeral and cemetery operations held for sale
in North America.
Other operating expenses of $66,428, for the nine months ended September
30, 2002, primarily related to the termination of certain consulting and
covenants-not-to-compete contractual obligations and market value adjustments of
certain options associated with the Company's 6.3% notes due 2003.
Previous Years' Charges
Included in the Company's charge amounts in 2002, 2001, 2000 and 1999 are
severance costs related to cost rationalization programs and terminated
contractual relationships of former employees and executive officers, planned
divestitures of certain North America and international funeral service and
cemetery businesses, reductions in carrying values of equity investments, market
value adjustments for certain options associated with the Company's senior notes
and relieving certain individuals from their consulting and/or
covenant-not-to-compete contractual obligations.
The majority of the remaining balance at September 30, 2003 of these
original charge amounts related to severance costs and terminated consulting
and/or covenant-not-to-compete contractual obligations, which will be paid by
2012. Of the $49,148 remaining liability at September 30, 2003, $17,120 is
included in Accounts payable and accrued liabilities and $32,028 is included in
Other liabilities in the consolidated balance sheet based on the expected timing
of payments. The Company continues to adjust the estimates of certain items
included in the original charge amounts as better estimates become available or
actual divestitures occur.
20
The activity related to these original charge amounts for the nine months
ended September 30, 2003 is detailed below. The adjustments made during the
first nine months of 2003 to the original charge amounts were recognized in the
income statement line item Gains and impairment (losses) on dispositions, net,
as described above.
<Table>
<Caption>
Utilization for nine months
ended September 30, 2003
-----------------------------
Original Balance at Balance at
charge December 31, September 30,
amount 2002 Cash Non-cash 2003
---------- ---------- -------- --------- -------------
First Quarter 1999 Charge......... $ 89,884 $ 564 $ 434 $ (122) $ 252
Fourth Quarter 1999 Charge........ 272,544 48,254 5,708 21,706 20,840
Fourth Quarter 2000 Charge........ 434,415 -- -- -- --
2001 Charges...................... 663,548 3,385 309 (161) 3,237
2002 Charges...................... 292,979 27,990 4,064 (893) 24,819
---------- ---------- -------- --------- ----------
Total........................ $1,753,370 $ 80,193 $ 10,515 $ 20,530 $ 49,148
========== ========== ======== ========= ==========
</Table>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
The Company is the largest provider of funeral and cemetery services in the
world. As of September 30, 2003, the Company operated 2,236 funeral service
locations, 429 cemeteries and 190 crematoria located in 8 countries. The Company
also has minority interest equity investments in funeral and cemetery operations
in Australia and the United Kingdom. As of September 30, 2003, the Company's
North America operations represented approximately 73.5% of the Company's
consolidated revenues, 78.3% of consolidated gross profits and 63.5% of the
Company's total operating locations.
The Company's funeral and cemetery operations are organized into a North
America division covering the United States and Canada, a European division
primarily responsible for the Company's French operations and an Other Foreign
division relating to operations in the Pacific Rim and South America. The
Company's operations in its North America division are separated into Eastern
and Western operations. The Eastern and Western operations in North America are
managed by separate operational, sales and financial management teams. Within
these Eastern and Western operations in North America, the majority of the
Company's funeral service locations and cemeteries are managed in groups called
clusters. These clusters are geographical groups of funeral service locations
and cemeteries that can share common resources such as operating personnel,
preparation services, clerical and accounting staff, limousines, hearses and
preneed sales personnel.
GOALS AND CHALLENGES
The Company is seeking to redirect its focus from international markets to North
America, where significant opportunities for growth exist. As a result, the
Company is targeting to sell or joint venture its French operations, which is
its largest business outside of North America. The Company's operational goals
are to grow its North America base of funeral and cemetery revenues while
diligently managing its cash expenses. In addition to reducing debt, the Company
will also continue to examine investment opportunities to grow its funeral and
cemetery operations where appropriate investment returns can be reasonably
expected using its cash flows from operations and significant cash on hand.
These potential growth opportunities could include acquisitions of funeral
service locations and cemeteries in large or strategic North America markets,
additional construction of funeral service locations on Company-owned cemeteries
and the development of high-end cemetery property inventory.
The Company's financial objectives in 2003 focus on generating strong cash
flows, completing asset divestitures and reducing debt to further improve the
capital structure. The Company is targeting a "BB" credit rating from Standard &
Poor's and a "Ba2" credit rating from Moody's Investors Service, with general
access to the capital markets. The Company's current ratings with these agencies
are "BB-" and "B1", respectively.
The Company and the death care industry face certain challenges in growing
funeral and cemetery revenues. The primary challenges include a lack of
near-term growth in the number of deaths and an increasing trend toward
cremation. Although the United States Census Bureau projects that the numbers of
deaths will grow up to 1% annually through 2010, modern advances in medicine and
healthier lifestyles could reduce the numbers of deaths during this time. In
2003, the industry has experienced a meaningful reduction in the numbers of
deaths. In the first nine months of 2003, the Company's North American
comparable funeral volume declined 2.7%. The Company believes this trend is
consistent with trends experienced by other companies in the funeral service and
casket manufacturing industries and also with mortality data reported by the
Centers for Disease Control and Prevention.
In North America today, various factors including social trends, religious
changes, environmental issues and cultural preferences are driving an increasing
preference for cremation. The Company is the largest provider of cremation
services in North America where approximately 39% of its total funeral services
performed are cremation services. A cremation service typically generates less
revenue and gross profit dollars than a traditional funeral service.
Additionally, the cremation consumer may choose not to purchase cemetery
property or merchandise. Management believes the Company is well positioned to
address this growing trend through the use of contemporary marketing strategies
and unique product and service offerings that specifically appeal to cremation
consumers -- in a cost-effective manner that utilizes its existing
infrastructure of businesses. See further information regarding the Company's
initiatives to address cremation as part of its overall growth strategy
described below.
21
STRATEGIC INITIATIVES
The Company's growth strategy begins with developing the appropriate
organizational structure and cultural environment that promotes teamwork,
accountability and execution. In this regard, the Company is working to redesign
all compensation programs with clear, specific and definable goals that are
aligned with shareholder objectives. In the near-term there are a number of
tactical actions that the Company believes will improve the infrastructure of
the organization while at the same time drive improvements in earnings and cash
flow. To generate sustainable growth over the longer term, the Company is
focused on leveraging the power of its branded network of businesses and its
strong cash flows.
Near Term Focus
The Company believes the following tactical initiatives will solidify the
foundation on which to build and grow its funeral service and cemetery
operations in the future while also improving results in the near-term.
o Improving the cost structure through redesigning the sales organization
and improving business and financial processes.
o Increasing the impact of the Company's Dignity Memorial(R) branded
funeral and cremation packages.
o Driving accountability and improved results through local market action
plans.
The Company has recently implemented significant changes to the structure
and processes of its sales organization designed to reduce costs and improve
cash flows in 2003 while improving the quality of its sales efforts. Examples of
these changes include eliminating ineffective lead procurement programs,
incentive travel programs and other inefficient sales activities and shifting to
a sales model based on personal referrals and standardized professional
certification, redesigning sales management compensation programs to
profit-based measures from revenue-based measures and reducing sales management
positions. The Company is also shifting to a compensation model for its sales
counselors that is variable and directly related to the production of new
business, but not solely based on commissions.
The Company is currently in the process of improving business and financial
processes and systems that support its North America funeral and cemetery
operations with a focus on improving efficiency and eliminating unnecessary
costs and expenses. Examples of these improvements include replacing three
separate contract entry systems with one system for funeral home, cemetery and
trust administration; outsourcing certain accounting functions including
accounts payable, payroll and trust administration to third-party providers; and
streamlining and standardizing management financial reports to focus on key
performance measures that are aligned with shareholder objectives. These
initiatives are expected to meaningfully reduce overhead costs beginning in
2004.
The Company's national brand name for its operations in North America,
Dignity Memorial(R), also represents a unique set of packaged funeral and
cremation plans offered exclusively through the Company's network on an atneed
and preneed basis. The Dignity Memorial(R) funeral and cremation packages are
designed to simplify customer decision-making and include products and services
which have traditionally been unavailable through funeral service locations.
These products appeal to both cremation and burial consumers and include grief
counseling services through a 24-Hour Compassion Helpline, legal services
membership, bereavement travel discounts which are significantly lower than
traditional discounts offered by airlines, internet memorial archive
capabilities through Making Everlasting Memories (www.mem.com) and the
Aftercare(R) Planner - an exclusive, comprehensive organizing system that helps
families manage the many business details that arise after a death occurs. The
Company's goal in 2003 is to continue to increase the sales of Dignity
Memorial(R) packaged plans, which on average result in significant incremental
revenue per funeral service compared to non-Dignity Memorial(R) sales. On a
burial funeral, Dignity Memorial(R) packaged sales generate on average
approximately $2,700 more than non-Dignity sales. On a cremation service,
Dignity Memorial(R) packaged sales generate approximately $1,700 more than
non-Dignity sales.
Other near term initiatives include the development and implementation of
local market action plans designed to grow funeral and cemetery revenues and
profits. In every funeral and cemetery operation, each local manager has
identified the strengths, weaknesses, opportunities and threats of their local
market and developed supporting action plans that include measurable objectives,
necessary resources, and a timetable for completion. These local market action
plans provide an important measurement tool and further drive accountability
within the organization.
22
Framework for Long-term Growth
In addition to the Company's tactical initiatives described above to improve its
North America funeral and cemetery operations in the near-term, the Company is
currently developing a framework for its long-term strategic plan with an
emphasis on three key concepts that will drive future growth in shareholder
value:
o Growing core revenues and profits from existing businesses.
o Expanding in large or strategic markets in North America through capital
investment.
o Investing in the Company's human capital.
The Company believes it must attract new customers to its existing
businesses in order to grow core funeral and cemetery profits over the
long-term. Actions by the Company to attract new customers over the long-term
include developing a more contemporary marketing model that leverages the power
of the Company's Dignity Memorial(R) national brand in North America and its
size as a national company. The Company's centralized marketing effort will
utilize information from the more than nine million consumers in its collective
databases to determine geographic, demographic and lifestyle information about
its consumers in order to promote awareness of the Dignity Memorial(R) brand and
network in the most efficient and effective manner. The Company is currently
testing new television, radio and print advertising that, if successful, will be
launched on a nationwide basis. These new media ads focus on the unique benefits
being offered by Dignity Memorial(R) providers. In addition, the Company will
continue to capitalize on its nationwide network of providers and develop
affinity relationships with organizations containing large groups of individuals
to whom the Company could exclusively market its products and services.
To grow its existing businesses, the Company is also focused on enhancing
its sales opportunities through improved and contemporary merchandising
techniques. Testing is being performed in the Company's funeral service
locations to consider potential modifications to its casket selection rooms that
will place less emphasis on the casket and more focus on the comprehensive
product and service offerings unique to Dignity Memorial(R) providers. Within
the Company's cemetery segment, initiatives are underway to employ a
tiered-product marketing strategy that emphasizes a wide range of product
offerings with particular emphasis on building strategic high-end property
development projects such as private family estates.
To grow its core revenues and profits, the Company is also refining its
strategies to address the growing trend toward cremation. To enhance its
cremation revenues and profits, the Company is focused on utilizing better
marketing and merchandising methods to increase sales of products and services
aimed specifically at cremation consumers. In the near term, sales of Dignity
Memorial(R) cremation plans can have a meaningful impact as these sales on
average result in more than $1,700 of incremental revenue per service to the
Company compared to non-Dignity Memorial(R) cremation sales. The Company is also
currently developing new displays to be used in the arrangement process that
will clearly explain the products and services available to cremation consumers.
Within its cemetery segment, the Company is promoting its cremation gardens,
which are separate sections located within certain of the Company's cemeteries
where cremated ashes can be permanently placed. Comprehensive training programs
are being developed to support and drive these key initiatives, as well as to
focus on creating a personal and meaningful experience for the cremation
consumer.
The Company's long-term growth strategy also addresses plans to expand its
funeral and cemetery network in North America where investment returns in excess
of capital costs can be reasonably expected. The Company will focus future
growth capital deployment through acquisition and/or construction in the top 150
markets in the United States. These large markets offer several
23
advantages: more than 70% of the U.S. population resides in these markets, the
markets have a tendency to be less dependent on local heritage, they are more
conducive to clustering and contemporary marketing strategies and it is easier
to attract quality management. In smaller markets, the Company will consider
recruiting independent funeral providers to join the Dignity Memorial(R) network
in a franchise relationship where the Company receives an annual fee and earns
cash for Dignity Memorial(R) services and products sold and affinity services
performed, but does not have its capital at risk. At the end of September 2003,
the Company had approximately 170 franchised providers. When combined with the
Company's network capabilities, the Dignity Memorial(R) network has the ability
to provide services to approximately 74% of the U.S. population.
The Company also believes it must invest in its human capital and resources.
Attracting, hiring, developing and retaining high quality management and
employees is critical to the success of the long-term strategic plan. In the
near term, the Company is focusing its efforts on leadership and management
development. Over the longer term, the Company is developing a comprehensive
training program under the name "Dignity University" that incorporates required
specific curriculum for each job type within the Company using a combination of
traditional classroom, web-based courses, virtual classroom and on-the-job
training for the more than 20,000 individuals that the Company employs in North
America.
CRITICAL ACCOUNTING POLICIES, ACCOUNTING CHANGES AND NEW ACCOUNTING
PRONOUNCEMENTS
The Company's consolidated financial statements are impacted by the accounting
policies used and the estimates and assumptions made by management during their
preparation. These critical accounting policies should be read in conjunction
with the annual report filed with the U.S. Securities and Exchange Commission on
Form 10-K, for the year ended December 31, 2002.
USE OF ESTIMATES
In the second quarter of 2002, the Company decided to implement new information
technology systems including a new North America point of sale system and an
upgraded general ledger system. As a result of this decision, the Company
accelerated amortization of its existing capitalized systems costs beginning in
the second quarter of 2002 to reflect the remaining estimated useful lives of
these systems. The Company recognized amortization of $13.8 million and $9.2
million related to this change in estimate during the nine months ended
September 30, 2003 compared to the same period of 2002.
ACCOUNTING CHANGES AND NEW ACCOUNTING PRONOUNCEMENTS
New Accounting Pronouncements
See Note 3 to the consolidated financial statements of the Company, which
information is hereby incorporated by reference.
RESULTS OF OPERATIONS
The following table highlights the consolidated results of operations for the
three months ended September 30, 2003 and 2002.
<Table>
<Caption>
Three months ended
(In millions, except per share amounts) September 30,
---------------------------------
2003 2002
- ------------------------------------------------------------------------------ ---------------
Total revenues............................................. $ 571.1 $ 560.6
Total gross profits........................................ 68.6 75.4
Net (loss) / income........................................ (5.6) 4.1
Diluted (loss) / earnings per share........................ $ (.02) $ .01
</Table>
Due to litigation related expenses recognized during the quarter, the
Company reported a net loss of $5.6 million or $.02 per diluted share. The
Company recognized general and administrative expenses of $52.8 million of which
$32.0 million ($20.3 million after tax or $.07 per diluted share) was associated
with various outstanding litigation matters.
24
Revenues increased $10.5 million or 1.9% in the third quarter of 2003
compared to the third quarter of 2002 led by a significant increase in the
French funeral operations. Excluding favorable currency effects, France's
funeral revenues increased more than $15 million as a result of the increase in
deaths during the quarter related to the heat wave in France. These results from
France and favorable currency effects more than offset the expected reduction in
cemetery revenues in North America due to fewer cemetery development projects
completed and less cemetery merchandise deliveries. North America funeral
revenues remained relatively flat during the quarter.
Gross profits for the third quarter of 2003 declined $6.8 million or 9.0%
due to lower funeral volumes and expected lower levels of cemetery revenues in
North America.
Detailed Comparable Operating Results - Three Months Ended September 30, 2003
and 2002
The following table and segment analysis summarizes the Company's comparable
results for the three months ended September 30, 2003 and 2002. Comparable
financial information excludes operations that have been acquired or constructed
after January 1, 2002 and operations that have been divested or joint ventured
prior to September 30, 2003. Comparable financial results are meant to be
reflective of "same store" results of operations.
(In millions) Three months ended September 30, 2003
------------------------------------------------------------------------------------------------------------
Comparable
------------------------------------------------------------------------------------------------------------
North % of % of Other % of % of
America revenue Europe revenue Foreign revenue Total revenue
------------------------------------------------------------------------------------------------------------
Revenues:
Funeral.......... $ 269.4 66.2% $ 150.0 100.0% $ 1.8 15.1% $ 421.2 74.0%
Cemetery......... 137.8 33.8% - - 10.1 84.9% 147.9 26.0%
------------------------------------------------------------------------------------------------------------
$ 407.2 100.0% $ 150.0 100.0% $ 11.9 100.0% $ 569.1 100.0%
============================================================================================================
Gross profit and
margin percentage:
Funeral.......... $ 37.1 13.8% $ 16.3 10.9% $ 0.7 38.9% $ 54.1 12.8%
Cemetery......... 12.2 8.9% - - 2.9 28.7% 15.1 10.2%
------------------------------------------------------------------------------------------------------------
$ 49.3 12.1% $ 16.3 10.9% $ 3.6 30.3% $ 69.2 12.2%
============================================================================================================
Three months ended September 30, 2002
------------------------------------------------------------------------------------------------------------
Comparable
------------------------------------------------------------------------------------------------------------
North % of % of Other % of % of
America revenue Europe revenue Foreign revenue Total revenue
------------------------------------------------------------------------------------------------------------
Revenues:
Funeral.......... $ 271.1 63.5% $ 116.2 100% $ 1.7 24.6% $ 389.0 70.7%
Cemetery......... 156.1 36.6% - - 5.2 75.4% 161.3 29.3%
------------------------------------------------------------------------------------------------------------
$ 427.2 100.0% $ 116.2 100% $ 6.9 100.0% $ 550.3 100.0%
============ ============== ============= ============= ============== ============ ============ ===========
Gross profit and
margin percentage:
Funeral.......... $ 43.4 16.0% $ 11.6 10.0% $ 0.7 41.2% $ 55.7 14.3%
Cemetery......... 19.8 12.7% - - (0.3) (5.8)% 19.5 12.1%
------------------------------------------------------------------------------------------------------------
$ 63.2 14.8% $ 11.6 10.0% $ 0.4 5.8% $ 75.2 13.7%
============================================================================================================
25
Comparable Funeral Segment Analysis
Comparable funeral services performed
--------------------------------------------------------
North Other
Three months ended September 30, America Europe Foreign Total
--------- -------- -------- -------
2003.................................... 62,104 36,645 1,074 99,823
2002.................................... 62,868 31,111 1,276 95,255
North America funeral revenues remained relatively flat quarter over
quarter. An increase of 2.2% in the average revenue per funeral service helped
to offset a 1.2% decline in funeral services performed and lower levels of
general agency revenue associated with insurance funded prearranged funeral
sales. The Dignity Memorial(R) packaged funeral and cremation plan sales
initiative continued to be successful in driving growth in the average revenue
per funeral service. Dignity Memorial(R) burial and cremation packaged plans
generate significant incremental revenue per funeral service compared to
non-Dignity sales. On a burial funeral, Dignity Memorial(R) packaged sales
generate on average approximately $2,700 more than non-Dignity sales. On a
cremation service, Dignity Memorial(R) packaged sales generate approximately
$1,700 more than non-Dignity sales. The 2.2% increase in average was achieved
despite an increase in cremation services during the quarter, which typically
has a lower average revenue. Of the total funeral services performed in North
America during the quarter, 39.2% were cremation services compared to 38.2% in
the prior year quarter. The Company believes the decline in the number of
funeral services performed during the quarter is primarily attributable to
declines in the number of deaths in North America as evidenced by similar trends
experienced by other companies in the funeral service and casket industries, as
well as mortality data reported by the Centers for Disease Control and
Prevention.
The North America funeral gross margin percentage was 13.8% versus 16.0% in
the prior year quarter. The gross margin decline was primarily a result of fewer
than expected funeral services performed on a predominantly fixed cost
structure, and increases in personnel costs (particularly pension and health
insurance costs).
In North America, the percentage of funeral services performed that were
previously prearranged was approximately 32% in both periods. The average
revenue associated with the performance of these funeral services was flat in
the third quarter of 2003 compared to 2002.
Revenues and gross profits from funeral operations in France were $148.4
million and $16.1 million in the third quarter of 2003 compared to $114.4
million and $11.1 million in 2002. Included in 2002 results is $4.6 million of
depreciation expense. There was no depreciation expense included in 2003 as a
result of the Company actively pursuing a joint venture with respect to these
funeral operations. Included in 2003 results are positive effects of foreign
currency translation of $18.8 million in revenues and $2.0 million in gross
profits compared to 2002. Excluding the favorable currency effect, France's
funeral revenues increased by $15.2 million or 13.3%. The Company's French
operations responded with professionalism to the increase in deaths that
occurred during the quarter as a result of the well-publicized heat wave. Being
the largest provider of funeral services in France, the Company was extensively
involved during this difficult time providing assistance through additional
resources, facilities, vehicles and equipment. Although revenues increased
substantially during this period, the gross profit comparison was negatively
impacted by changes in legal reserves, regulatory issues and predominantly due
to the significant additional costs incurred by the Company working with the
public authorities to deal with this large-scale crisis.
Comparable Cemetery Segment Analysis
The trend in North America cemetery revenues during the quarter was consistent
with expectations for 2003. North America cemetery revenues decreased $18.3
million or 11.7% compared to the prior year quarter. The decline in revenues
during the quarter is primarily attributable to fewer cemetery property
development projects completed in the third quarter of 2003 compared to the
third quarter of 2002. During 2002, the Company completed construction on an
unusually high amount of cemetery development projects, particularly in the
third quarter. Revenues and profits from development projects are deferred until
construction is complete and until 10% has been collected from the customer. In
addition, cemetery merchandise deliveries were down during the quarter primarily
as a result of a decline in the numbers of deaths. Revenues and profits
associated with the sales of merchandise are not recognized until the
merchandise is delivered and installed.
26
The North America cemetery gross margin percentage was 8.9% compared to
12.7% in the prior year quarter. The gross margin decline was impacted by lower
levels of revenues associated with cemetery property development projects and
was partially offset by a reduction in selling costs. The cemetery gross margin
was also impacted by increases in personnel costs (primarily pension and health
insurance costs) and maintenance expenses to bring certain cemeteries in line
with Company standards.
Revenues and gross profits from cemetery operations in South America were
$10.1 million and $2.9 million in the third quarter of 2003 compared to $5.2
million and a loss of $(0.3) million in 2002. Included in 2003 results are
positive effects of foreign currency translation of $0.8 million in revenues and
$0.1 million in gross profits compared to 2002. Excluding the favorable currency
effect, South America's cemetery revenues grew by $4.1 million or 78.8% and the
gross margin percentage improved to 30.1% versus (5.8)% in the prior year
quarter. These increased results are due to improved economic conditions in
South America. In addition, revenues and gross profits in the third quarter of
2002 were negatively impacted by a $1.5 million increase in the allowance for
doubtful accounts.
Other Income and Expenses
The Company recognized a net expense of $1.4 million during the third quarter of
2003 in Gains and impairment (losses) on dispositions, net. As dispositions
occur in the normal course of business, gains or losses on the sales of such
businesses are recognized in this income statement line item. Additionally, as
dispositions occur related to the Company's ongoing asset sale programs,
adjustments are made through this income statement line item to reflect the
difference between actual proceeds received from the sale compared to the
original estimates.
Other operating expenses recognized in the three month period ending
September 30, 2002 related to market value adjustments of certain options
associated with the Company's 6.3% notes due 2003, and severance costs of former
employees. These options were subsequently terminated in the fourth quarter of
2002 when an additional charge of $22.0 million was recognized.
Reducing overhead remains a key focus for the Company. In North America,
there are three components of overhead costs: general and administrative
expenses, home office overhead and field overhead. Home office and field
overhead costs are allocated to funeral and cemetery operations in North America
while general and administrative expenses are disclosed in a separate line item
on the Consolidated Statement of Operations. Home office and field overhead
costs totaled $37.8 million in the third quarter of 2003 compared to $40.9
million in the same period of 2002 representing a decrease of $3.1 million or
7.6%. Reductions in preneed sales overhead costs helped to offset initial start
up costs associated with various outsourcing programs. These outsourcing
programs are expected to meaningfully reduce overhead costs beginning in 2004.
In the third quarter of 2003, general and administrative expenses were
$52.8 million compared to $22.5 million in 2002. The increase was due to the
recognition of $32.0 million of expense during the third quarter for outstanding
litigation related matters. Excluding these litigation related expenses, general
and administrative expenses declined $1.7 million or 7.6%. This decline is
primarily due to decreases in maintenance and development costs associated with
the Company's existing point of sale systems, which are being replaced with a
new system.
The Company recognized $11.2 million of Other income during the third
quarter of 2003 compared to $17.1 million in the prior year quarter. This
variance was primarily related to a decline in gains on early extinguishments of
debt of $7.4 million.
The average total debt balance declined $359.8 million from the third
quarter of 2002 to the third quarter of 2003. As a result, interest expense
decreased $3.2 million or 8.4% in the third quarter of 2003 compared to the
prior year quarter.
Detailed Comparable Operating Results - Nine Months Ended September 30, 2003
and 2002
The following table and segment analysis summarizes the Company's comparable
results for the first nine months of 2003 and 2002. Comparable financial
information excludes operations that have been acquired or constructed after
January 1, 2002 and operations that have been divested or joint ventured prior
to September 30, 2003. Comparable financial results are meant to be reflective
of "same store" results of operations.
27
<Table>
<Caption>
(In millions) Nine months ended September 30, 2003
----------------------------------------------------------------------------------------------------------
Comparable
----------------------------------------------------------------------------------------------------------
North % of % of Other % of % of
America revenue Europe revenue Foreign revenue Total revenue
----------------------------------------------------------------------------------------------------------
Revenues:
Funeral.......... $ 846.4 66.8% $ 429.3 100.0% $ 5.5 17.6% $1,281.2 74.2%
Cemetery......... 420.7 33.2% - - 25.8 82.4% 446.5 25.8%
----------------------------------------------------------------------------------------------------------
$1,267.1 100.0% $ 429.3 100.0% $ 31.3 100.0% $1,727.7 100.0%
==========================================================================================================
Gross profit and
margin percentage:
Funeral.......... $ 157.2 18.6% $ 51.3 11.9% $ 2.1 38.2% $ 210.6 16.4%
Cemetery......... 62.1 14.8% - - 6.5 25.2% 68.6 15.4%
----------------------------------------------------------------------------------------------------------
$ 219.3 17.3% $ 51.3 11.9% $ 8.6 27.5% $ 279.2 16.2%
==========================================================================================================
Nine months ended September 30, 2002
----------------------------------------------------------------------------------------------------------
Comparable
----------------------------------------------------------------------------------------------------------
North % of % of Other % of % of
America revenue Europe revenue Foreign revenue Total revenue
----------------------------------------------------------------------------------------------------------
Revenues:
Funeral.......... $ 857.0 65.2% $ 342.9 100.0% $ 5.3 20.5% $1,205.2 71.6%
Cemetery......... 457.7 34.8% - - 20.6 79.5% 478.3 28.4%
----------------------------------------------------------------------------------------------------------
$1,314.7 100.0% $ 342.9 100.0% $ 25.9 100.0% $1,683.5 100.0%
==========================================================================================================
Gross profit and
margin percentage:
Funeral.......... $ 178.1 20.8% $ 39.2 11.4% $ 2.1 39.6% $ 219.4 18.2%
Cemetery......... 57.6 12.6% - - 3.0 14.6% 60.6 12.7%
----------------------------------------------------------------------------------------------------------
$ 235.7 17.9% $ 39.2 11.4% $ 5.1 19.7% $ 280.0 16.6%
==========================================================================================================
Comparable Funeral Segment Analysis
Comparable funeral services performed
--------------------------------------------------------------
North Other
Nine months ended September 30, America Europe Foreign Total
--------- -------- --------- ---------
2003.................................... 196,457 106,517 3,222 306,196
2002.................................... 201,939 102,583 3,064 307,586
</Table>
Comparable North America funeral revenues decreased $10.6 million or 1.2%
in the nine months ended 2003 compared to 2002 primarily as a result of a
decrease in the number of funeral services performed. Funeral services performed
decreased 2.7% in the nine months ended 2003 compared to 2002. Management
believes the decline in funeral services performed is primarily attributable to
declines in the number of deaths in North America as evidenced by similar trends
experienced by other companies in the funeral service and casket industries, as
well as mortality data reported by the Centers for Disease Control and
Prevention. This decline was partially offset by an increase in the average
revenue per funeral service of 2.4% during the period. The increase was
primarily a result of selling more Dignity Memorial(R) packaged funeral plans,
which offer consumers a broad array of unique products and services. Also
impacting 2003 revenue performance was a decline in general agency revenue
associated with the expected decline in insurance funded prearranged sales due
to significant changes made to the Company's preneed sales structure and
processes.
28
The North America funeral gross margin was 18.6% versus 20.8% in the prior
year. The gross margin decline was primarily a result of fewer than expected
funeral services performed on a predominantly fixed cost structure, particularly
as it relates to personnel costs. The impact of fewer funeral services performed
was partially offset by reductions in costs resulting from strategic changes in
the Company's prearranged funeral sales activities.
North America funeral locations had an average cremation rate of 39.1%
compared to 37.7% in the prior period. The average revenue per cremation service
increased 2.6% over the prior period, led by increased sales of Dignity
Memorial(R) packaged cremation plans.
In North America, 31.7% of funeral services performed were previously
prearranged compared to 31.6% in the prior period. The average revenue
associated with the performance of these funerals was $4,022 in the nine months
ended September 30, 2003 compared to $3,976 in 2002.
Revenues and gross profits from funeral operations in France were $424.1
million and $50.6 million in the first nine months of 2003 compared to $338.1
million and $38.7 million in 2002. Included in 2002 results is $4.6 million of
depreciation expense. There was no depreciation expense included in 2003 as a
result of the Company actively pursuing a joint venture with respect to these
funeral operations. Included in 2003 results are positive effects of foreign
currency translation of $70.5 million in revenues and $8.4 million in gross
profits compared to 2002. Excluding the favorable currency effect, France's
funeral revenues increased $15.5 million or 4.6%. An increase in the average
revenue per funeral service and an increase in the number of funeral services
performed helped to offset declines in monument sales during the quarter. The
increase in funeral services performed is a result of an increase in the number
of deaths related to the heat wave in France during the third quarter of 2003.
The Company was extensively involved in working with the public authorities and
incurred significant costs to provide resources, vehicles, facilities and
equipment during this difficult time. These additional costs, along with changes
in legal reserves and regulatory issues, negatively impacted the gross profit
comparison in the three and nine month period ended September 30, 2003.
Comparable Cemetery Segment Analysis
North American cemetery revenues decreased by $37.0 million or 8.1% compared to
the prior period primarily due to fewer cemetery property development projects
completed in 2003 compared to 2002. The decline in cemetery revenues was also
impacted by lower levels of cemetery property sales and cemetery merchandise
delivered during the period which the Company expected in 2003. Although
cemetery revenues declined, the North America cemetery gross margin improved to
14.8% compared to 12.6% in the prior period, benefited by the reduction in
selling costs as a result of the strategic changes to the Company's preneed
sales structure and processes.
Revenues and gross profits from cemetery operations in South America were
$25.8 million and $6.5 million in the nine months ended September 2003 compared
to $20.6 million and $3.0 million in 2002. Included in 2003 results are negative
effects of foreign currency translation of $0.9 million in revenues and $0.2
million in gross profits compared to 2002. Excluding the unfavorable currency
effect, South America's cemetery revenues grew by $6.1 million or 29.6% and the
gross margin percentage improved to 25.1% versus 14.6% in the prior period.
These increased results are primarily due to improved economic conditions in
South America. In addition, revenues and gross profits in 2002 were negatively
impacted by a $1.5 million increase in the allowance for doubtful accounts.
Other Income and Expenses
The Company recognized a net gain of $6.4 million during the nine months ended
2003 in Gains and impairment (losses) on dispositions, net, compared to a net
loss of $190.2 million in 2002. As dispositions occur in the normal course of
business, gains or losses on the sales of such businesses are recognized in this
income statement line item. Additionally, as dispositions occur related to the
Company's ongoing North America asset sale programs, adjustments are made
through this line item to reflect the difference between actual proceeds
received from the sale compared to the original estimates. The $190.2 million
net loss reported in 2002 primarily related to an impairment charge for several
funeral and cemetery operations held for sale in North America. In addition,
during the nine months ended 2002, the Company reported Other operating expenses
of $66.4 million related to the termination of certain consulting and
non-compete contractual obligations, market value adjustments of certain options
associated with the Company's 6.3% notes due 2003 and severance costs of former
employees.
29
The Company has three components of overhead costs in North America:
general and administrative expenses, home office overhead and field overhead.
Home office and field overhead costs are allocated to funeral and cemetery
operations in North America while general and administrative expenses are
disclosed in a separate line item on the Consolidated Statement of Operations.
Home office and field overhead costs totaled $114.7 million in the nine months
ended 2003 compared to $120.4 million in the same period of 2002, representing a
$5.7 million or 4.7% decline. Reductions in costs as a result of changes to the
compensation structure and processes of the Company's preneed sales efforts
helped to offset initial start up costs associated with various outsourcing
programs. These outsourcing programs are expected to meaningfully reduce
overhead costs beginning in 2004.
In the nine months ended September 30, 2003, general and administrative
expenses were $110.5 million compared to $57.8 million in 2002. The increase in
general and administrative expenses resulted from $47.0 million recognized
during the period for outstanding litigation related matters. Included in the
$47.0 million were $32.0 million recognized in the third quarter of 2003 and
$15.0 million recognized in the second quarter of 2003. The $15.0 million was
related to a decision in an arbitration matter and was necessary because one of
the Company's insurance carriers that would have covered a portion of this
decision was insolvent.
General and administrative expenses were also impacted by the Company's
decision in 2002 to implement new information systems. As a result of this
decision, the Company accelerated the amortization of existing capitalized
system costs and recorded $4.6 million of additional costs in the first nine
months of 2003 compared to 2002. Excluding these litigation expenses in 2003 and
accelerated amortization costs in both periods, general and administrative
expenses increased $1.1 million during the period impacted by costs of $2.7
million to expense the Company's new long term incentive program. Beginning in
2003, the Company switched its long-term incentive compensation plan from stock
options, which historically were not expensed, to a plan that is expensed. This
new plan consists of performance units with a cash payout that is based upon the
Company's total shareholder return compared to the total shareholder return of a
defined group of peer companies.
The Company recognized $17.6 million in Other income during the first nine
months of 2003 compared to $23.3 million in 2002. This variance is primarily a
result of lower levels of interest income earned from various investments,
reduced cash overrides received from the Company's former North American
insurance company and reduced gains on early extinguishments of debt.
Interest expense decreased $14.5 million or 11.8% in the first nine months
of 2003 compared to the prior period as a result of the significant debt
reductions by the Company. The average total debt balance declined $417.7
million in the nine month period of 2003 compared to the nine month period of
2002.
The Company's effective tax rate was 35.3% during the first nine months of
2003 compared to 28.2% in the first nine months of 2002. The increase in the
effective tax rate is due to the utilization in the previous year of net
operating loss carry-forwards related to its French operations. The Company is
under audit by the Internal Revenue Service (IRS) for the tax years 2002, 2001,
2000 and 1999. At the present time, the IRS has not proposed any significant tax
adjustments.
In the nine months ended September 30, 2002, the Company recognized an
after tax charge of $135.6 million as a result of the adoption of Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
(SFAS No. 142). This standard required goodwill to no longer be amortized, but
instead tested for impairment annually.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
The Company's financial objectives in 2003 focus on the continued improvement of
the capital structure by further reducing debt, generating strong cash flows and
completing asset divestitures. The Company's goal is to obtain a "BB" credit
rating from Standard and Poor's and a "Ba2" credit rating from Moody's Investors
Service, with general access to the capital markets. The Company's current
ratings with these agencies are "BB-" and "B1", respectively.
<Table>
<Caption>
September 30, 2003 December 31, 2002
-------------------- -------------------
Cash and cash equivalents $ 163.9 $ 200.6
Total debt $1,717.1 $1,984.8
</Table>
30
Management believes it currently has significant liquidity. As of September
30, 2003, the Company had a cash balance of $163.9 million. The Company's total
debt less cash and cash equivalents decreased by $231.0 million or 12.9% during
the nine months ended 2003 reflecting strong cash flows provided by operating
activities and the receipt of an unusual tax refund in the first quarter of 2003
of $94.5 million. In addition, at September 30, 2003, the Company had $117.6
million of availability under its $185 million bank credit facility. There were
no cash borrowings under this credit facility, but $67.4 million of letters of
credit had been issued under the facility.
At September 30, 2003, current maturities of long-term debt were $132.0
million and primarily related to senior notes due in April 2004 of $111.2
million. The maturity schedule for outstanding senior public notes due in the
near and intermediate term was as follows:
<Table>
<Caption>
Outstanding at
(In millions) September 30, 2003
----------------------
7.375% senior notes due April 2004................... $111.2
8.375% senior notes due December 2004................ $ 50.8
6.0% senior notes due December 2005.................. $272.5
</Table>
Based upon the Company's current cash balance and credit availability, along
with expectations of future cash flows from operating activities and from the
sale or joint venture of certain businesses, management believes there are
adequate means to meet the near and intermediate term debt obligations of the
Company as well as its operating needs. The Company anticipates future asset
divestiture and/or joint venture proceeds of $300 to $400 million, predominantly
related to the joint venture of the Company's French funeral operations.
Sources and Uses of Cash
Net cash provided by operating activities was $303.6 million for the nine months
ended September 30, 2003 compared to $252.2 million for the same period of 2002.
The increase in operating cash flow was primarily due to reductions in cash
interest, an increase in unusual tax refunds and working capital improvements
resulting from the strategic changes made to the Company's preneed sales
structure and processes. Unusual cash tax refunds were $94.5 million in 2003
compared to $57.1 million in 2002. Cash interest payments were $82.9 million in
the nine months ended September 30, 2003 compared to $105.1 million in the same
period of 2002.
Net cash used by investing activities was $53.5 million for the nine months
ended September 30, 2003 compared to $259.1 million of net cash provided by
investing activities in the same period of 2002. The decrease principally
related to a reduction in proceeds from joint ventures and sales of equity
investments, increases in capital expenditures and additional deposits to
restricted cash. During the first quarter of 2002, the Company completed the
joint venture of its United Kingdom operations, which resulted in $266.7 million
in pretax cash proceeds. During the second quarter of 2003, the Company sold its
remaining equity investment in its operations in Spain for pretax cash proceeds
of $26.0 million. The Company's capital expenditures increased $18.2 million in
the nine months ended September 30, 2003 compared to the same period of 2002 due
to a greater emphasis on maintenance capital spending in the Company's existing
operations. Restricted deposits increased in 2003 as a result of the Company's
decision to replace certain letters of credit with cash collateral.
Net cash used in financing activities was $291.0 million for the nine
months ended September 30, 2003 compared to $395.5 million for the same period
of 2002. The net cash used in financing activities in both periods was related
to the Company's continued debt reduction initiatives.
Financial Assurances
In support of operations, the Company has entered into arrangements with certain
high quality surety companies whereby such companies agree to issue surety bonds
on behalf of the Company as financial assurance and/or as required by existing
state and local regulations. The surety bonds are used for various business
purposes; however, the majority of the surety bonds issued and outstanding have
been used to support the Company's prearranged funeral and preneed cemetery
sales activities. The underlying obligations these surety bonds assure are
recorded on the Company's consolidated balance sheet as Deferred prearranged
funeral
31
contract revenues and Deferred preneed cemetery contract revenues. The breakdown
of surety bonds between funeral and cemetery prearrangements, as well as surety
bonds for other activities, is as follows:
<Table>
<Caption>
September 30, December 31,
2003 2002
------------ -------------
Prearranged funeral........................................................... $ 119.3 $ 108.3
Preneed cemetery:
Merchandise and services................................................. 179.0 172.8
Preconstruction.......................................................... 20.0 22.6
------------ ------------
Bonds supporting prearranged funeral and cemetery obligations........ 318.3 303.7
------------ ------------
Bonds supporting prearranged business permits................................. 4.9 4.9
Other bonds................................................................... 4.7 6.1
------------ ------------
Total surety bonds outstanding........................................... $ 327.9 $ 314.7
============ ============
</Table>
As the Company sells prearranged funeral contracts and preneed cemetery
contracts, the Company posts surety bonds in certain instances where allowed by
applicable law. In these instances, the Company posts these surety bonds in lieu
of trusting a certain amount of funds received from the customer. Generally, the
amount of the bond posted is determined by the total amount of the prearranged
contract that would otherwise be required to be trusted, in accordance with
applicable state law. For the nine months ended September 30, 2003 and 2002, the
Company had $70.2 million and $72.7 million, respectively, of cash receipts
attributable to bonded sales. These amounts do not consider reductions
associated with taxes, obtaining costs, or other costs.
Surety bond premiums are paid annually and are automatically renewable,
unless prior notice of cancellation, until maturity of the underlying
prearranged contracts. Except for cemetery preconstruction bonds (which are
irrevocable), the surety companies generally have the right to cancel the surety
bonds at any time with appropriate notice. In the event a surety company were to
cancel a surety bond, the Company would be required to obtain replacement surety
assurance or fund a trust for an amount generally less than the posted bond
amount, unless the customer's prearranged contract has been paid in full. The
Company does not currently believe it will be required to fund material future
amounts related to these surety bonds.
The Company is reconsidering its strategy of using surety bonds to provide
financial assurance to consumers related to the Company's prearranged funeral
and preneed cemetery sales activities. The economics of this activity has
recently changed as surety bonding programs have increased in cost. As the
Company's financial condition and liquidity have improved, it is also more
difficult for the Company to purchase its outstanding debt securities at a
discount. Furthermore, the applicable Florida law that allows posting of surety
bonds for prearranged contracts will expire December 31, 2004. Prearranged
contracts entered into prior to December 31, 2004 where the Company posts surety
bonds will be allowed to continue to be bonded for the remaining life of those
contracts. Of the total bonding proceeds received by the Company for the nine
months ended September 30, 2003 and 2002, approximately $52.8 million and $52.9
million, respectively, were attributable to the state of Florida. For
prearranged contracts sold by the Company's Florida operations subsequent to
2003, the Company is considering trusting instead of surety bonding. When the
Company implements this change, the Company estimates a negative impact to its
cash flow from operations of approximately $15 to $20 million in the first
annual period. In subsequent periods, the impact to cash flows from operations
is expected to not be material.
PREARRANGED FUNERAL AND PRENEED CEMETERY ACTIVITIES
The Company believes an active funeral and cemetery prearrangement program,
which complements the Company's framework for long term growth, can increase
future market share in markets in which the Company operates.
For purposes of discussion in this section, the use of the term
"prearranged" or "prearrangement" refers to funeral programs specifically or
funeral and cemetery programs generally. The use of the term "preneed" refers to
cemetery programs specifically. Prearrangement is a means through which a
customer contractually agrees to the terms of a funeral service, cremation
service and/or cemetery burial to be performed or provided in the future.
32
Revenues associated with prearranged contracts are deferred until such time
that the funeral or cemetery services are performed or merchandise is delivered.
Preneed sales of cemetery interment rights (cemetery burial property) are not
recognized until a minimum of 10% of the sales price has been collected and the
property has been constructed.
Compensation costs that vary with and are directly related to the
production of new trust funded prearranged funeral contracts are deferred as
selling costs and amortized over 12 years, a period representing the estimated
life of the prearranged funeral contracts. Compensation costs that vary with and
are directly related to the production of new cemetery contracts are deferred as
selling costs at the time of sale and are amortized into expense when the
corresponding revenues are recognized. Other costs associated with the sales and
marketing of prearranged contracts - lead procurement costs, brochures and
marketing materials, advertising and administrative costs - are expensed as
incurred.
When prearranged funeral services and merchandise are funded through
insurance policies purchased by customers from third party life insurance
companies, the Company earns a commission on the sale of such policies for
acting as an agent in selling such insurance contracts. Such general agency (GA)
revenues are based on a percentage per contract sold and are recognized when the
insurance purchase transaction between the customer and the third party
insurance provider has been completed. Prior to January 1, 2003, the Company
recognized GA revenues as reductions to direct expenses. In the first quarter of
2003, the Company began recognizing these amounts as revenues. The Company has
reclassified the prior year amounts to conform to the current period
presentation with no effect on previously reported results of operations,
financial condition or cash flows. GA revenues recognized in the nine months
ended September 30, 2003 and 2002 were $24.2 million and $38.6 million,
respectively. Compensation costs that vary with and are directly related to the
production of new insurance funded prearranged funeral contracts are expensed as
incurred and amounted to $16.0 million and $25.2 million for the nine months
ended September 30, 2003 and 2002, respectively. Additionally, the Company may
receive cash overrides related to life insurance policies sold as a result of
marketing agreements entered into in connection with the sale of an insurance
subsidiary in 2000. These cash overrides are recorded in Other income in the
consolidated statement of operations.
The table below details North America funeral and cemetery prearranged
production for the nine months ended September 30, 2003 and 2002, and the
related deferred selling costs incurred to procure the prearrangements.
Additionally, the table reflects North America revenues recognized and
previously deferred North America selling costs recognized in the consolidated
statement of operations associated with previously prearranged production for
the nine months ended September 30, 2003 and 2002.
<Table>
<Caption>
North America
-----------------------------------------------------------
(In millions) Funeral Cemetery
-------------------------- -------------------------
2003 2002 2003 2002
---------- ---------- ---------- ---------
Origination:
Prearranged production......................... $ 265.3 $ 348.5 $ 171.2 $ 241.5
========== ========== ========== =========
Deferred selling costs, net.................... $ 10.3 $ 13.5 $ 33.6 $ 35.5
========== ========== ========== =========
Maturities:
Previously prearranged production
included in current period revenues....... $ 253.4 $ 261.7 $ 166.8 $ 213.2
========== ========== ========== =========
Amortization of deferred selling costs
in current period......................... $ 10.1 $ 10.9 $ 27.3 $ 32.6
========== ========== ========== =========
</Table>
33
Generally, all or a certain portion of the funds collected for prearranged
funeral or preneed cemetery contracts funded through trusts are required to be
placed into trust accounts, pursuant to applicable law. Funds not required to be
placed into trust accounts are retained by the Company and used for working
capital purposes, generally to help alleviate the current cost of those
prearrangement programs. Realized investment earnings on funds placed into trust
accounts are generally accumulated and deferred until the maturity of each
prearranged contract. However, in certain states the Company is allowed to
distribute a portion of the realized investment earnings before the prearranged
contract matures. Until maturity, any unrealized or realized investment earnings
are attributed to the individual prearranged funeral contract or individual
preneed cemetery contract item. Upon maturity, these attributed investment
earnings, unrealized and realized, are recognized in the Company's results of
operations. Recognition of the investment earnings is independent of the timing
of the receipt of the related cash flows. When a prearranged trust contract
matures, the Company receives the principal and previously undistributed trust
fund income and any remaining receivable due from the customer. In certain
situations, the Company can post a surety bond as financial assurance pursuant
to applicable law in an amount that would otherwise be required to be trusted.
Funds collected on prearranged contracts where the Company has posted a surety
bond may be retained by the Company creating a source of working capital cash
flow generated from operating activities before the prearranged contract
matures. When the prearranged contract matures, the Company receives any
remaining receivable due from the customer. Finally, funds collected from
prearranged funeral contracts can be used to pay premiums on life insurance or
annuity contracts. Increasing death benefits associated with life insurance
contracts are accumulated and deferred until the maturity of each prearranged
contract. When a prearranged insurance contract matures, the Company receives
the proceeds from the third party insurance companies consisting of the original
contract amount and any increasing death benefits.
As previously stated, deferred prearranged funeral or cemetery contract
revenue is recognized in the consolidated statement of operations at the time
the contract matures. For trust or bonded contracts, the revenue recognized is
generally greater than the cash received by the Company at the time a
prearranged contract matures, and creates a negative effect on working capital
cash flow generated from operating activities at the time of contract maturity.
The cash flow activity from originating funeral production until the
maturity of a prearranged funeral contract is captured in the line item Net
effect of prearranged funeral production and maturities in the consolidated
statement of cash flows. Cash flow is provided by the amount retained from funds
collected from the customer and distributed trust fund earnings. This is reduced
by the payment of deferred selling costs and the use of funds to service matured
contracts.
The cash flow activity from originating the preneed cemetery contract
until recognition of the deferred revenue is reflected through Changes in
receivables and Changes in other assets in the consolidated statement of cash
flows. Changes in receivables is affected by cash flows provided by the amount
retained from funds collected from the customer and distributed trust earnings,
reduced by use of funds to service preneed cemetery contracts. Changes in other
assets is affected by the cash use associated with the payment of deferred
selling costs when the preneed cemetery contracts are originated.
The following table reflects the total North American backlog of deferred
prearranged contract revenues and the prearranged receivables associated with
the contracts. The difference between the amounts of Deferred prearranged
contract revenues and the prearranged receivables associated with such contracts
represents future revenues to be recognized in which the associated cash has
already been collected by the Company.
<Table>
<Caption>
North America
----------------------------------------------------------------------------------------------------
(In millions) Funeral Cemetery Total
------------------------------- -------------------------------- ------------------------------
September 30, December 31, September 30, December 31, September 30, December 31,
2003 2002 2003 2002 2003 2002
------------- ------------ ------------- ------------ ------------- -------------
Deferred prearranged
contract revenues, net.... $ 3,620.6 $ 3,638.3 $ 1,629.3 $ 1,671.6 $ 5,249.9 $ 5,309.9
Deferred selling cost, net.. $ 89.1 $ 90.1 $ 210.3 $ 210.3 $ 299.4 $ 300.4
Prearranged
receivables, net:
Trust related
receivables............ $ 978.6 $ 983.4 $ 809.3 $ 859.3 $ 1,787.9 $ 1,842.7
Third party insurance
related receivables.... $ 2,177.1 $ 2,175.5 $ - $ - $ 2,177.1 $ 2,175.5
</Table>
34
The deferred prearranged contract revenue associated with prearranged
funeral contracts and preneed cemetery contracts (net of an estimated allowance
for cancellation) are reflected separately in the consolidated balance sheet.
Both funeral and cemetery deferred selling costs (net of an estimated allowance
for cancellation) are included as a component of Deferred charges and other
assets. Prearranged assets associated with prearranged funeral contracts, which
consist of amounts due from trusts, customer receivables or third party
insurance receivables (net of an estimated allowance for cancellations), are
reflected as Prearranged funeral contracts separately in the consolidated
balance sheet. Prearranged assets associated with preneed cemetery contracts,
which consist of amounts due from trusts and customer receivables (net of an
estimated allowance for cancellation), are reflected in Current and Long term
receivables in the consolidated balance sheet.
CAUTIONARY STATEMENT ON FORWARD-LOOKING STATEMENTS
The statements in this Form 10-Q that are not historical facts are
forward-looking statements made in reliance on the "safe harbor" protections
provided under the Private Securities Litigation Reform Act of 1995. These
statements may be accompanied by words such as "believe," "estimate," "project,"
"expect," "may," "anticipate," "forecast," or "predict" and words of similar
meaning that convey the uncertainty of future events or outcomes. These
statements are based on assumptions that the Company believes are reasonable;
however, many important factors could cause the Company's actual results in the
future to differ materially from the forward-looking statements made herein and
in any other documents or oral presentations made by, or on behalf of, the
Company. Important factors which could cause actual results of the Company to
differ materially from those in forward-looking statements include, among
others, the following:
1) Changes in general economic conditions, both domestically and
internationally, impacting financial markets (e.g., marketable security
values, as well as currency and interest rate fluctuations) that could
negatively affect the Company, particularly, but not limited to, levels of
trust fund income, interest expense and negative currency translation
effects.
2) The outcomes of pending lawsuits and proceedings against the Company
involving alleged violations of securities laws, including the possibility
of an adverse decision in these matters exceeding the Company's insurance
coverage or if the insurance coverage is deemed not to apply to these
matters or if an insurance carrier is unable to pay any covered amounts to
the Company.
3) The outcomes of pending lawsuits in Florida involving certain cemetery
locations, including criminal charges or other civil claims being filed
against the Company, its subsidiaries or its employees, including the
possibility of an adverse decision in these matters exceeding the Company's
insurance coverage or if the insurance coverage is deemed not to apply to
these matters or if an insurance carrier is unable to pay any covered
amounts to the Company.
4) Amounts payable by the Company with respect to its outstanding legal
matters may exceed reserves established by the Company.
5) The Company's ability to successfully implement its strategic plan related
to producing operating improvements, strong cash flows and further
deleveraging as discussed herein and in the Company's Form 10-K for the
year ended December 31, 2002.
6) The Company's ability to successfully implement its plan to reduce costs
and increase cash flows associated with significant changes being made to
the Company's organization structure, process and quality of its sales
efforts.
7) Changes in consumer demand and/or pricing for the Company's products and
services due to several factors, such as changes in local number of deaths,
cremation rates, competitive pressures and local economic conditions.
8) Changes in domestic and international political and/or regulatory
environments in which the Company operates, including potential changes in
tax, accounting and trusting policies.
9) Changes in credit relationships impacting the availability of credit and
the general availability of credit in the marketplace.
10) The Company's ability to successfully complete its ongoing process
improvement and system implementation projects, including the Company's
replacement of its North America point-of-sale information technology
systems.
11) The Company's ability to successfully access surety and insurance markets
at a reasonable cost.
12) The Company's ability to successfully exploit its substantial purchasing
power with certain of the Company's vendors.
35
For further information on these and other risks and uncertainties, see the
Company's 2002 Annual Report on Form 10-K. The Company assumes no obligation to
publicly update or revise any forward-looking statements made herein or any
other forward-looking statements made by the Company, whether as a result of new
information, future events or otherwise.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For information regarding the Company's exposure to certain market risks, see
Item 7A. Quantitative and Qualitative Disclosures about Market Risk in the
Company's Form 10-K for the year ended December 31, 2002. As a result of market
performance the Company's prearranged funeral and cemetery merchandise and
service trust funds increased from approximately 94% of cost as of December 31,
2002 to approximately 102% of cost as of September 30, 2003. There have been no
other material changes to the disclosure on this matter made in such Form 10-K.
ITEM 4. CONTROLS AND PROCEDURES
As required by Rules 13a-15 and 15d-15 under the Securities Act of 1934, as
amended (the "Exchange Act"), Robert L. Waltrip, the Company's Chief Executive
Officer, and Jeffrey E. Curtiss, the Company's Chief Financial Officer, have
evaluated the effectiveness of the Company's disclosure controls and procedures
(as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange
Act) as of the end of the Company's third fiscal quarter of 2003 (the
"Evaluation Date"). Based on such evaluation, such officers have concluded that,
as of the Evaluation Date, the Company's disclosure controls and procedures are
effective in alerting them on a timely basis to material information relating to
the Company (including its consolidated subsidiaries) required to be included in
the Company's periodic filings under the Exchange Act.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Information regarding legal proceedings is set forth in note six to the
consolidated financial statements in Item 1 of Part I of this Form 10-Q, which
information is hereby incorporated by reference herein.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
12.1 Ratio of earnings to fixed charges for the nine months ended
September 30, 2003 and 2002.
31.1 Certification of Robert L. Waltrip as Chief Executive Officer
in satisfaction of Section 302 of the Sarbanes-Oxley Act of
2002.
31.2 Certification of Jeffrey E. Curtiss as Principal Financial
Officer in satisfaction of Section 302 of the Sarbanes-Oxley
Act of 2002.
32.1 Certification of Periodic Financial Reports by Robert L.
Waltrip as Chief Executive Officer in satisfaction of Section
906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Periodic Financial Reports by Jeffrey E.
Curtiss as Principal Financial Officer in satisfaction of
Section 906 of the Sarbanes-Oxley Act of 2002.
99.1 Consolidated Class Action Complaint filed September 3, 1999 in
Civil Action No. H-99-280, In re Service Corporation
International. (Incorporated by reference to Exhibit 99.1 to
Form 10-Q for the fiscal quarter ended September 30, 1999).
99.2 Defendants' Answer to the Consolidated Class Action Complaint
filed September 17, 1999 in Civil Action No. H-99-280, In re
Service Corporation International. (Incorporated by reference
to Exhibit 99.2 to Form 10-Q for the fiscal quarter ended
September 30, 1999).
36
99.3 Defendants' motion to Dismiss the Consolidated Class Action
Complaint filed October 8, 1999 in Civil Action No. H-99-280,
In re Service Corporation International. (Incorporated by
reference to Exhibit 99.3 to Form 10-Q for the fiscal quarter
ended September 30, 1999).
99.4 Plaintiffs' Opposition to Defendants' Motion to Dismiss the
Consolidated Class Action Complaint filed November 5, 1999 in
Civil Action No. H-99-280, In re Service Corporation
International. (Incorporated by reference to Exhibit 99.4 to
Form 10-Q for the fiscal quarter ended September 30, 1999).
99.5 Defendant's Reply to Plaintiffs' Opposition to Defendants'
Motion to Dismiss the Consolidated Class Action Complaint
filed November 24, 1999 in Civil Action No. H-99-280, In re
Service Corporation International. (Incorporated by reference
to Exhibit 99.12 to Form 10-K for the fiscal year ended
December 31, 1999).
99.6 Plaintiff's Original Petition filed December 15, 2000, in
Cause No. 2000-63917, Jack T. Hammer v. Service Corporation
International, Robert L. Waltrip, L. William Heiligbrodt,
George R. Champagne, W. Blair Waltrip, James M. Shelger,
Wesley T. McRae and PricewaterhouseCoopers LLP; in the 165th
Judicial District Court of Harris County, Texas. (Incorporated
by reference to Exhibit 99.18 to Form 10-K for the fiscal year
ended December 31, 2000).
99.7 Defendants' Original Answer to the Original Petition referred
to in Exhibit 99.6. (Incorporated by reference to Exhibit
99.19 to Form 10-K for the fiscal year ended December 31,
2000).
99.8 Amendment No. 2 dated as of September 29, 2003 to the Credit
Agreement dated as of July 24, 2002, as amended by Amendment
No. 1 dated as of December 6, 2002, among the Company, as
Borrower, the financial institutions party thereto, JPMorgan
Chase Bank, as Administrative Agent, Bank of America, N.A., as
Syndication Agent, and Credit Lyonnais New York Branch, Lehman
Commercial Paper Inc. and Merrill Lynch Capital Corporation,
as Co-Documentation Agents.
(b) Reports on Form 8-K
During the quarter ended September 30, 2003, the Company furnished a report
on Form 8-K dated August 6 and filed August 7, 2003 reporting (i) under
"Item 7. Financial Statements and Exhibits" that attached as an exhibit was
a press release dated August 6, 2003, and (ii) under "Item 12. Results of
Operations and Financial Condition" that the Company issued the press
release which disclosed financial results for the second quarter of 2003.
37
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
November 5, 2003 SERVICE CORPORATION INTERNATIONAL
By: /s/ Jeffrey E. Curtiss
----------------------------------------
Jeffrey E. Curtiss
Senior Vice President
Chief Financial Officer and Treasurer
(Principal Financial Officer)
38
INDEX TO EXHIBITS
12.1 Ratio of earnings to fixed charges for the nine months ended
September 30, 2003 and 2002.
31.1 Certification of Robert L. Waltrip as Chief Executive Officer
in satisfaction of Section 302 of the Sarbanes-Oxley Act of
2002.
31.2 Certification of Jeffrey E. Curtiss as Principal Financial
Officer in satisfaction of Section 302 of the Sarbanes-Oxley
Act of 2002.
32.1 Certification of Periodic Financial Reports by Robert L.
Waltrip as Chief Executive Officer in satisfaction of Section
906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Periodic Financial Reports by Jeffrey E.
Curtiss as Principal Financial Officer in satisfaction of
Section 906 of the Sarbanes-Oxley Act of 2002.
99.1 Consolidated Class Action Complaint filed September 3, 1999 in
Civil Action No. H-99-280, In re Service Corporation
International. (Incorporated by reference to Exhibit 99.1 to
Form 10-Q for the fiscal quarter ended September 30, 1999).
99.2 Defendants' Answer to the Consolidated Class Action Complaint
filed September 17, 1999 in Civil Action No. H-99-280, In re
Service Corporation International. (Incorporated by reference
to Exhibit 99.2 to Form 10-Q for the fiscal quarter ended
September 30, 1999).
99.3 Defendants' motion to Dismiss the Consolidated Class Action
Complaint filed October 8, 1999 in Civil Action No. H-99-280,
In re Service Corporation International. (Incorporated by
reference to Exhibit 99.3 to Form 10-Q for the fiscal quarter
ended September 30, 1999).
99.4 Plaintiffs' Opposition to Defendants' Motion to Dismiss the
Consolidated Class Action Complaint filed November 5, 1999 in
Civil Action No. H-99-280, In re Service Corporation
International. (Incorporated by reference to Exhibit 99.4 to
Form 10-Q for the fiscal quarter ended September 30, 1999).
99.5 Defendant's Reply to Plaintiffs' Opposition to Defendants'
Motion to Dismiss the Consolidated Class Action Complaint
filed November 24, 1999 in Civil Action No. H-99-280, In re
Service Corporation International. (Incorporated by reference
to Exhibit 99.12 to Form 10-K for the fiscal year ended
December 31, 1999).
99.6 Plaintiff's Original Petition filed December 15, 2000, in
Cause No. 2000-63917, Jack T. Hammer v. Service Corporation
International, Robert L. Waltrip, L. William Heiligbrodt,
George R. Champagne, W. Blair Waltrip, James M. Shelger,
Wesley T. McRae and PricewaterhouseCoopers LLP; in the 165th
Judicial District Court of Harris County, Texas. (Incorporated
by reference to Exhibit 99.18 to Form 10-K for the fiscal year
ended December 31, 2000).
99.7 Defendants' Original Answer to the Original Petition referred
to in Exhibit 99.6. (Incorporated by reference to Exhibit
99.19 to Form 10-K for the fiscal year ended December 31,
2000).
99.8 Amendment No. 2 dated as of September 29, 2003 to the Credit
Agreement dated as of July 24, 2002, as amended by Amendment
No. 1 dated as of December 6, 2002, among the Company, as
Borrower, the financial institutions party thereto, JPMorgan
Chase Bank, as Administrative Agent, Bank of America, N.A., as
Syndication Agent, and Credit Lyonnais New York Branch, Lehman
Commercial Paper Inc. and Merrill Lynch Capital Corporation,
as Co-Documentation Agents.