SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 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
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SERVICE CORPORATION INTERNATIONAL
(Exact name of registrant as specified in its charter)
TEXAS 74-1488375
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
1929 ALLEN PARKWAY
HOUSTON, TEXAS 77019
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: 713/522-5141
---------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
Common Stock ($1 par value) New York Stock Exchange
Preferred Share Purchase Rights New York Stock Exchange
6 3/4% Convertible Subordinated Notes Due 2008 New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE
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 (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
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 aggregate market value of the common stock held by non-affiliates of the
registrant (assuming that the registrant's only affiliates are its officers and
directors) was $1,142,008,087 based upon a closing market price of $3.87 on June
30, 2003 of a share of common stock as reported on the New York Stock Exchange
- -- Composite Transactions Tape.
The number of shares outstanding of the registrant's common stock as of
February 27, 2004 was 303,571,052 (net of treasury shares).
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Proxy Statement in connection with its 2004 Annual
Meeting of Shareholders (Part III)
1
SERVICE CORPORATION INTERNATIONAL
INDEX
Page
Part I
Item 1. Business..................................................................... 3
Item 2. Properties .................................................................. 6
Item 3. Legal Proceedings............................................................ 6
Item 4. Submission of Matters to a Vote of Security Holders.......................... 6
Part II
Item 5. Market for the Company's Common Equity, Related Stockholder
Matters and Issuer Purchase of Equity Securities........................... 9
Item 6. Selected Financial Data...................................................... 9
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations...................................................... 10
Item 7A. Quantitative and Qualitative Disclosures about Market Risk................... 40
Item 8. Financial Statements and Supplementary Data.................................. 41
Item 9. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosures...................................................... 84
Item 9A. Controls and Procedures...................................................... 84
Part III
Item 10. Directors and Executive Officers of the Company............................. 85
Item 11. Executive Compensation...................................................... 85
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters........................................... 85
Item 13. Certain Relationships and Related Transactions.............................. 85
Item 14. Principal Accountant Fees and Services...................................... 85
Part IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K............. 87
Signatures............................................................................. 88
Exhibit Index.......................................................................... 89
2
PART I
ITEM 1. BUSINESS.
We restated our previously issued financial statements for the fiscal years
ended December 31, 2000, 2001 and 2002, the interim quarters of 2000, 2001, 2002
and the first three quarters of 2003. All applicable amounts relating to these
restatements have been reflected in this Form 10-K. See Item 7 Management's
Discussion and Analysis of Financial Condition and Results of Operations and
notes two and twenty-one to the consolidated financial statements in Item 8 of
this Form 10-K for details of the restatement.
GENERAL
Service Corporation International (SCI or the Company) is the world's
largest provider of funeral and cemetery services. At December 31, 2003, we
operated 2,225 funeral service locations, 417 cemeteries and 183 crematoria
located in eight countries. We also had a minority interest equity investment in
funeral and cemetery operations in the United Kingdom and Australia. In the
fourth quarter of 2003, we sold our minority interest equity investment in our
Australia operations. We expect to sell our minority interest equity investment
in the United Kingdom in the second quarter of 2004, pending a successful public
offering transaction. On March 11, 2004, we sold our funeral operations in
France (hereafter referred to as "joint ventured") and then purchased a 25%
equity interest in the acquiring entity. The French operations consisted of 963
funeral service locations and 39 crematoria at December 31, 2003. For additional
information regarding this transaction, see note twenty to the consolidated
financial statements in Item 8 of this Form 10-K.
Our funeral service and cemetery operations consist of funeral service
locations, cemeteries, crematoria and related businesses. Personnel at the
funeral service locations provide all professional services relating to
funerals, including the use of funeral facilities, motor vehicles, and
preparation and embalming services. Funeral related merchandise (including
caskets, coffins, burial vaults, cremation receptacles, flowers and other
ancillary products and services) is sold at funeral service locations. Certain
funeral service locations contain crematoria. We sell prearranged funeral
services whereby a customer contractually agrees to the terms of a funeral to be
performed in the future. Our cemeteries provide cemetery property interment
rights (including mausoleum spaces, lots and lawn crypts) and sell cemetery
related merchandise (including stone and bronze memorials, burial vaults, casket
and cremation memorialization products) and services (primarily merchandise
installation fees and burial opening and closing fees). Cemetery items are sold
on an atneed or preneed basis. Personnel at cemeteries perform interment
services and provide management and maintenance of cemetery grounds. Certain
cemeteries operate crematoria and certain cemeteries contain gardens
specifically for the purpose of cremation memorialization. There are 185
combination locations that contain a funeral service location within or adjacent
to an SCI owned cemetery.
SCI was incorporated in Texas in July of 1962. Our principal corporate
offices are located at 1929 Allen Parkway, Houston, Texas 77019 and our
telephone number is (713) 522-5141. Our website is http://www.sci-corp.com. We
make available free of charge, on or through our website, our annual, quarterly
and current reports and any amendments to those reports, as soon as reasonably
practicable after electronically filing such reports with the Securities and
Exchange Commission. Information contained on our website is not part of this
report.
FUNERAL AND CEMETERY OPERATIONS
General
The funeral and cemetery operations consist of our funeral service
locations, cemeteries, crematoria and related businesses. As of December 31,
2003, our operations were organized into a North America division, which
represents the United States and Canada, a European division primarily
consisting of operations in France and an Other Foreign division relating to
operations managed in South America and Singapore. In March 2004, we joint
ventured our funeral operations in France. (For additional information regarding
this transaction, see note twenty to the consolidated financial statements in
Item 8 of this Form 10-K.)
During the fourth quarter of 2003, we realigned our funeral and cemetery
operations in North America to better meet the needs of different market types.
As a result, the funeral and cemetery operations in North America are organized
into 32 major markets and 44 middle markets. Each market is led by a market
director with responsibility for funeral and cemetery operations as well as
preneed sales. Within each market, the operational facilities realize
efficiencies by sharing common resources such as personnel, preparation services
and vehicles. There are three market support centers in North America to assist
market directors with financial, administrative and human resource needs.
3
These support centers, commonly referred to as "hubs", are located in Houston,
New York and Los Angeles. The primary functions of the market support centers
are to help facilitate the execution of corporate strategies, coordinate
communication between the field and corporate offices and serve as liaisons for
implementation of policies and procedures.
The death care industry in North America is characterized by a large number
of locally owned, independent operations. In order to be successful, we believe
our funeral service locations and cemeteries must maintain good reputations and
high professional standards in the industry, as well as offer attractive
products and services at competitive prices. We believe we have an unparalleled
network of funeral service locations and cemeteries that offer high quality
products and services at prices that are competitive with local competing
funeral homes, cemeteries and retail locations.
We have multiple funeral service locations and cemeteries in a number of
metropolitan areas. Within individual metropolitan areas, the funeral service
locations and cemeteries operate under various names because most operations
were acquired as existing businesses. Some of our international funeral service
locations operate under certain brand names specific for a general area or
country. We have branded our funeral operations in North America under the name
Dignity Memorial(R). A national brand name is unique to the death care industry
in North America and we believe this gives us a strategic advantage in the
industry. While this branding process is intended to emphasize our seamless
national network of funeral service locations and cemeteries, the original names
associated with acquired operations, and their inherent goodwill and heritage,
will generally remain the same. For example, Geo. H. Lewis & Sons Funeral
Directors is now Geo. H. Lewis & Sons Funeral Directors, a Dignity Memorial(R)
provider.
In the death care industry, there has been a growing trend in the number of
cremations performed in North America as an alternative to traditional funeral
service dispositions. The west coast of the United States, Florida and Arizona
have the highest concentration of cremation consumers in North America.
Cremations usually result in lower revenue and gross profit dollars than
traditional funeral services. In North America during 2003, 39.0% of all funeral
services we performed were cremation cases, compared to 37.9% performed in 2002.
We have expanded our cremation memorialization products and services in several
North America markets, which has resulted in higher average sales for cremation
cases compared to historical levels. During 2003, we continued to expand our
nationally branded cremation service locations called National Cremation(R)
Service (NCS). At December 31, 2003, NCS operated in eighteen states and Canada.
NCS plans to expand its presence in existing states by adding locations where
there is a business need.
Historically, we focused on the acquisition and consolidation of independent
funeral homes and cemeteries in the fragmented death care industry in North
America. During the 1990's, we also expanded our operations through acquisitions
in Europe, Australia, South America and the Pacific Rim. At one time, our
network consisted of more than 4,500 businesses in 20 countries on 5 continents.
During the mid to late 1990's, the acquisition market became extremely
competitive resulting in increased prices for acquisitions and substantially
reduced returns on invested capital. In 1999, we significantly reduced the level
of acquisition activity and focused on identifying and addressing non-strategic
or underperforming businesses. This focus resulted in the divestiture of several
North America and international operations. During 2002 and 2001, we completed
joint ventures of operations in Australia, United Kingdom, Spain and Portugal;
and divested of operations in the Netherlands, Norway, Italy and Belgium. In
2003, we sold our equity investment in our operations in Australia, Spain and
Portugal. During the first quarter of 2004, we completed a joint venture of our
funeral operations in France. We expect to sell our minority interest equity
investment in the United Kingdom in the second quarter of 2004, pending a
successful public offering transaction. We will pursue discussions with various
third parties concerning the sale or joint venture of our remaining
international operations (primarily in South America) as we intend to focus our
efforts on operating a core business of high quality funeral service locations
and cemeteries in North America.
Funeral Service Locations
Our 2,225 funeral service locations provide all professional services
relating to funerals, including the use of funeral facilities, motor vehicles,
and preparation and embalming services. Funeral service locations sell caskets,
coffins, burial vaults, cremation receptacles, flowers, burial garments, and
other ancillary products and services. Our funeral service locations generally
experience a greater demand for services in the winter months primarily related
to higher incidents of deaths from pneumonia and influenza.
In addition to selling products and services to client families at the time
of need, we also sell prearranged funeral services in most of our service
markets. Funeral prearrangement is a means through which a customer
contractually agrees to the terms of a funeral to be performed in the future.
All or a portion of the funds collected from prearranged funeral contracts are
placed into trust accounts, pursuant to applicable law. Alternatively, where
allowed, customers may choose to purchase a life insurance or annuity policy
from third party insurance companies to fund their prearranged funeral. In
certain situations and pursuant to applicable laws, we will post
4
a surety bond as financial assurance for a certain amount of the preneed funeral
contract in lieu of placing certain funds in trust accounts. See the Financial
Assurances section included in Financial Condition, Liquidity and Capital
Resources in Item 7 of this Form 10-K for further details on our practice of
posting such surety bonds. At December 31, 2003, our Deferred prearranged
funeral contract revenues amounted to approximately $5,117.4 million of which
$3,595.6 million related to North America. For additional information regarding
prearranged funeral activities, see the Prearranged Funeral and Cemetery
Activities section in Financial Condition, Liquidity and Capital Resources in
Item 7 and notes three, four and five to the consolidated financial statements
in Item 8 of this Form 10-K.
Cemeteries
Our cemeteries sell interment rights associated with cemetery property such
as mausoleum spaces, lots and lawn crypts, and sell cemetery merchandise such as
stone and bronze memorials, burial vaults, caskets and cremation memorialization
products. Our cemeteries perform interment services and provide management and
maintenance of cemetery grounds. Certain cemeteries operate crematoria and
certain cemeteries contain gardens specifically for the purpose of cremation
memorialization.
Cemetery sales are often made on a preneed basis pursuant to installment
contracts providing for monthly payments. A portion of the proceeds from
cemetery contracts is generally required by law to be paid into perpetual care
trust funds. Earnings from perpetual care trust funds are used to defray the
maintenance costs of cemeteries. Additionally, all or a portion of the proceeds
from the sale of preneed cemetery merchandise and services may be required by
various state laws to be paid into merchandise and services trusts until the
merchandise is delivered or the service is provided. In certain situations and
pursuant to applicable laws, we will post a surety bond as financial assurance
for a certain amount of the preneed cemetery contract in lieu of placing certain
funds into trust accounts. See the Financial Assurances section included in
Financial Condition, Liquidity and Capital Resources in Item 7 of this Form 10-K
for further details on the practice of posting such surety bonds. At December
31, 2003, our Deferred cemetery contract revenue amounted to approximately
$1,575.4 million of which $1,574.2 million related to North America. For
additional information regarding cemetery preneed activities, see the
Prearranged Funeral and Cemetery Activities section in Financial Condition,
Liquidity and Capital Resources in Item 7 of this Form 10-K and notes three,
four and six to the consolidated financial statements in Item 8 of this Form
10-K.
Combined Funeral Service Locations and Cemeteries
We currently own 185 funeral service/cemetery combination locations in which
a funeral service location is physically located within or adjoining an SCI
owned cemetery. Combination locations allow certain facility, personnel and
equipment costs to be shared between the funeral service location and cemetery
and typically have a higher gross margin than if the funeral and cemetery
operations were operated separately. Combination locations also create synergies
between funeral and cemetery sales force personnel and give consumers added
convenience to purchase both funeral and cemetery products and services at a
single location.
EMPLOYEES
At December 31, 2003, we employed 20,471 (13,461 in North America)
individuals on a full time basis and 7,342 (6,788 in North America) individuals
on a part time basis. Of the full time employees, 19,949 were employed in the
funeral and cemetery operations and 522 were employed in corporate or other
overhead activities and services. All eligible employees in the United States
who so elect are covered by SCI's group health and life insurance plans.
Eligible employees in the United States are participants in retirement plans of
SCI or various subsidiaries, while international employees are covered by other
SCI (or SCI subsidiary) defined or government mandated benefit plans.
Approximately 3% of our employees in North America are represented by unions.
Although labor disputes are experienced from time to time, relations with
employees are generally considered favorable.
REGULATION
Our operations are subject to regulations, supervision and licensing under
numerous foreign, federal, state and local laws, ordinances and regulations,
including extensive regulations concerning trust funds, preneed sales of funeral
and cemetery products and services and various other aspects of our business. We
comply in all material respects with the provisions of such laws, ordinances and
regulations. Since 1984, we have operated in the United States under the Federal
Trade Commission (FTC) comprehensive trade regulation rule for the funeral
industry. The rule contains requirements for funeral industry practices,
including extensive price and other affirmative disclosures and imposes
mandatory itemization of funeral goods and services. From time to time in
connection with our former strategy of growth through acquisitions, we entered
into consent orders with the FTC that required us to dispose of certain
operations in order to proceed with such acquisitions, or limited our ability to
make acquisitions in specified areas. The trade regulation rule and the various
consent orders have not had a material adverse effect on our operations.
5
As previously mentioned, we sold our funeral operations in France to a joint
venture in March 2004. The French funeral services industry has undergone
significant regulatory change in recent years. Historically, the French funeral
services industry had been controlled, as provided by national legislation,
either (i) directly by municipalities through municipality-operated funeral
establishments (Municipal Monopoly), or (ii) indirectly by the remaining
municipalities that have contracted for funeral service activities with third
party providers, such as our French funeral operations (Exclusive Municipal
Authority). Legislation was passed that has generally ended municipal control of
the French funeral service business and has allowed free competition among
funeral service providers. Under such legislation, the Exclusive Municipal
Authority was abolished in January 1996, and the Municipal Monopoly was
eliminated in January 1998. Cemeteries in France are currently controlled by
municipalities and religious organizations. We previously sold cemetery
merchandise such as markers and monuments to consumers for use in these
cemeteries.
ITEM 2. PROPERTIES.
Our corporate headquarters are located at 1929 Allen Parkway, Houston, Texas
77019. A wholly-owned subsidiary of SCI owns an undivided one-half interest in
the building and parking garage. The other undivided one-half interest is owned
by an unrelated third party. We plan to acquire the other one-half interest in
the building at the end of the lease in July 2005 for $2 million. The property
consists of approximately 127,000 square feet of office space and 185,000 square
feet of parking space. We lease all of the office space in the building for $59
thousand per month and pay all operating expenses. One half of the rent is paid
to the wholly-owned subsidiary and the other half is paid to the owners of the
remaining undivided one-half interest. We own and utilize two additional
buildings located in Houston, Texas for corporate activities containing a total
of approximately 207,000 square feet of office space.
At December 31, 2003, we owned approximately 68% of the real estate and
buildings used by our 2,225 funeral service locations, 417 cemeteries and 183
crematoria, and 32% of such facilities are leased. In addition, we leased two
aircraft pursuant to cancelable operating leases. At December 31, 2003, we
operated 10,032 vehicles, of which 29% were owned and 71% were leased. For
additional information regarding leases, see the Contractual, Commercial and
Contingent Commitments section in Financial Condition, Liquidity and Capital
Resources in Item 7 and note twelve to the consolidated financial statements in
Item 8 of this Form 10-K.
At December 31, 2003, our 417 cemeteries contained a total of approximately
28,254 acres, of which approximately 57% was developed.
The specialized nature of our businesses requires that our facilities be
well-maintained and kept in good condition and we believe that these standards
are being met.
ITEM 3. LEGAL PROCEEDINGS.
Information regarding legal proceedings is set forth in note twelve to the
consolidated financial statements in Item 8 of this Form 10-K.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
6
EXECUTIVE OFFICERS OF THE COMPANY
Pursuant to General Instruction G to Form 10-K, the information regarding
executive officers of the Company called for by Item 401 of Regulation S-K is
hereby included in Part I of this report.
The following table sets forth as of March 15, 2004 the name and age of each
executive officer of the Company, the office held, and the date first elected an
officer.
YEAR FIRST
BECAME
OFFICER NAME AGE POSITION OFFICER(1)
------------ --- -------- ----------
R. L. Waltrip.......... 73 Chairman of the Board and Chief Executive Officer 1962
B. D. Hunter........... 74 Vice Chairman of the Board 1986
Thomas L. Ryan......... 38 President and Chief Operating Officer 1999
Michael R. Webb........ 45 Executive Vice President 1998
Jeffrey E. Curtiss..... 55 Senior Vice President Chief Financial Officer 2000
and Treasurer
Stephen M. Mack........ 52 Senior Vice President Middle Market Operations 1998
James M. Shelger....... 54 Senior Vice President General Counsel and 1987
Secretary
J. Daniel Garrison..... 52 Vice President Operations Services 1998
W. Cardon Gerner....... 49 Vice President Accounting 1999
Eric D. Tanzberger..... 35 Vice President and Corporate Controller 2000
Stephen J. Uthoff...... 52 Vice President Chief Information Officer 2000
Sumner J. Waring, III.. 35 Vice President Major Market Operations 2002
- ----------
(1) Indicates the year a person was first elected as an officer although there
were subsequent periods when certain persons ceased being officers of the
Company.
Unless otherwise indicated below, the persons listed above have been
executive officers or employees for more than five years.
Mr. Waltrip is the founder, Chairman and Chief Executive Officer of the
Company and a licensed funeral director. He grew up in his family's funeral
business and assumed management of the firm in the 1950s after earning a
Bachelor's degree in Business Administration from the University of Houston. He
began buying additional funeral homes in the 1960s, achieving cost efficiencies
by pooling their resources. At the end of 2003, the network he began had grown
to include more than 2,800 funeral service locations, cemeteries and crematoria
in eight countries. Mr. Waltrip took the Company public in 1969. He has provided
leadership to the Company for over 40 years.
Mr. Hunter was appointed Vice Chairman of the Board in January 2000. For
more than five years, prior to February 2002, Mr. Hunter had been the Chairman
of Huntco, Inc., an intermediate steel processor, and was also its Chief
Executive Officer prior to May 2000. In February 2002, Huntco, Inc., filed a
petition for bankruptcy under Chapter 11 of the United States Bankruptcy Code
during a severe downturn in the steel industry. Mr. Hunter has been a director
since 1986 and also served as Vice Chairman of the Board from September 1986 to
May 1989. He is a graduate of Truman State University, formerly known as
Northeast Missouri State University, in Kirksville, Missouri.
Mr. Ryan joined the Company in June 1996 and has served in a variety of
financial management roles within the Company. In February 1999, Mr. Ryan was
promoted to Vice President International Finance. In November 2000, he was
promoted to Chief Executive Officer of European Operations based in Paris,
France. In July 2002, Mr. Ryan was appointed President and Chief Operating
Officer. Prior to joining the Company, Mr. Ryan was a certified public
accountant with Coopers & Lybrand L.L.P. for more than five years. Mr. Ryan
holds a Bachelor of Business Administration degree from the University of
Texas-Austin.
Mr. Webb joined the Company in 1991 when it acquired Arlington Corporation,
a regional funeral and cemetery consolidator, where he was then Chief Financial
Officer. Prior to joining Arlington Corporation, Mr. Webb held various executive
financial and development roles at Days Inns of America and Telemundo Group,
Inc. In 1993, Mr. Webb joined the Company's corporate development group, which
he later led on a global basis before accepting operational responsibility for
the Company's Australian and Hispanic businesses. Most recently, Mr. Webb has
led the efforts to reduce overhead costs and improve business and financial
processes. Mr. Webb was named Executive Vice President in July 2002. He is a
graduate of the University of Georgia, where he earned a Bachelor of Business
Administration degree.
7
Mr. Curtiss joined the Company as Senior Vice President and Chief Financial
Officer in January 2000. In August 2002, Mr. Curtiss' responsibilities changed
to include the responsibilities of Treasurer of the Company. From January 1992
until July 1999, Mr. Curtiss served as Senior Vice President and Chief Financial
Officer of Browning-Ferris Industries, a waste services company. Mr. Curtiss
attended the University of Nebraska, Lincoln, where he earned Bachelor of
Science in Business Administration and Doctor of Jurisprudence degrees. He also
holds a Master of Legal Letters degree in taxation from Washington University in
St. Louis, Missouri.
Mr. Mack joined the Company in 1973 as a resident director after graduating
from Farmingdale State University of New York. He became Vice President of the
Eastern Region in 1987 and Regional President in 1992. Mr. Mack was appointed
Corporate Vice President in 1998 and then promoted to Senior Vice President in
2002. Mr. Mack was promoted to Senior Vice President Eastern Operations in
August 2002 and assumed the office of Senior Vice President Middle Market
Operations in November 2003.
Mr. Shelger joined the Company in 1981 when it acquired IFS Industries, a
regional funeral and cemetery consolidator, where he was then General Counsel.
Mr. Shelger subsequently served as counsel for the Cemetery Division until 1991,
when he was appointed General Counsel. Mr. Shelger earned a Bachelor of Science
degree in business administration from the University of Southern California in
Los Angeles and a Juris Doctor from the California Western School of Law in San
Diego.
Mr. Garrison joined the Company in 1978 and worked in a series of management
positions until he was promoted to President of the Southeastern Region in 1992.
In 1998, Mr. Garrison was promoted to Corporate Vice President in charge of
operations outside North America. In 2000, Mr. Garrison was promoted to Vice
President North American Cemetery Operations. He served in this position until
assuming his current position as Vice President Operations Services in August
2002. Mr. Garrison is an Administrative Management graduate of Clemson
University.
Mr. Gerner joined the Company in January 1999 in connection with the
acquisition of Equity Corporation International (ECI) and in March 1999 was
promoted to Vice President Corporate Controller. In August 2002, Mr. Gerner's
responsibilities and position changed to Vice President Accounting. Before the
acquisition, Mr. Gerner had been Senior Vice President and Chief Financial
Officer of ECI since March 1995. Prior thereto, Mr. Gerner was a partner with
Ernst & Young LLP. Mr. Gerner graduated with honors from the University of
Texas-Austin, with a Bachelor of Business Administration in Accounting.
Mr. Tanzberger joined the Company in August 1996 as Manager of Budgets &
Financial Analysis. Since then, Mr. Tanzberger has served as Vice President of
Operations/Western Division, Director of Investor Relations and Assistant
Corporate Controller. Mr. Tanzberger was promoted to Vice President Investor
Relations and Assistant Corporate Controller in January 2000, and to Corporate
Controller in August 2002. Prior to joining the Company, Mr. Tanzberger was
Assistant Corporate Controller at Kirby Marine Transportation Corporation, an
inland waterway barge and tanker company, from January through August 1996.
Prior thereto, he was a certified public accountant with Coopers & Lybrand
L.L.P. for more than five years. Mr. Tanzberger is a graduate of the University
of Notre Dame, where he earned a Bachelor of Business Administration degree.
Mr. Uthoff joined the Company as Vice President Chief Information Officer in
January 2000. From June 1994 through July 1999, Mr. Uthoff served as Vice
President - Planning & Analysis of Browning-Ferris Industries, a waste services
company. Mr. Uthoff attended Oklahoma State University, where he earned a
Bachelor of Science degree in Engineering and a Master of Science degree in
Accounting.
Mr. Waring, a licensed funeral director, joined the Company as an Area Vice
President in 1996 when the Company merged with his family's funeral business.
Mr. Waring was appointed Regional President of the Northeast Region in 1999 and
was promoted to Regional President of the Pacific Region in September 2001. Mr.
Waring was promoted to Vice President Western Operations in August 2002 and
assumed the office of Vice President Major Market Operations in November 2003.
Mr. Waring holds a Bachelor's degree in Business Administration from Stetson
University in Deland, Florida, a degree in Mortuary Science from Mt. Ida College
and a Masters of Business Administration degree from the University of
Massachusetts Dartmouth.
Each officer of the Company is elected by the Board of Directors and holds
his office until his successor is elected and qualified or until his earlier
death, resignation or removal in the manner prescribed in the Bylaws of the
Company. Each officer of a subsidiary of the Company is elected by the
subsidiary's board of directors and holds his office until his successor is
elected and qualified or until his earlier death, resignation or removal in the
manner prescribed in the bylaws of the subsidiary.
8
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES.
The Company's common stock has been traded on the New York Stock Exchange
since May 14, 1974. On December 31, 2003, there were 6,609 holders of record of
the Company's common stock.
In October 1999, the Company suspended payment of regular quarterly cash
dividends on its outstanding common stock in order to focus on improving cash
flow and reducing existing debt. Under the Company's bank credit agreement, the
Company is restricted from paying dividends and making other distributions.
The table below shows the Company's quarterly high and low common stock
prices for the two years ended December 31, 2003:
<Table>
<Caption>
2003 2002
---------------- -----------------
HIGH LOW HIGH LOW
-------- ------- -------- -------
First quarter.................................. $ 3.82 $ 2.78 $ 5.50 $ 4.55
Second quarter................................. 4.24 2.67 5.15 3.60
Third quarter.................................. 4.95 3.75 4.64 2.25
Fourth quarter................................. 5.58 4.45 3.71 2.42
</Table>
SRV is the New York Stock Exchange ticker symbol for the common stock of the
Company. Options in the Company's common stock are traded on the Philadelphia
Stock Exchange under the symbol SRV.
For equity compensation plan information, see Part III of this report on
page 86.
ITEM 6. SELECTED FINANCIAL DATA.
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
The following selected consolidated financial data for the years ended
December 31, 1999 through December 31, 2003 is derived from our audited
consolidated financial statements as restated. The operating results data
includes reclassifications to conform to current period presentations with no
impact on net income. The data set forth should be read in conjunction with the
Company's consolidated financial statements and accompanying notes to the
consolidated financial statements included in Item 8 of this Form 10-K. The
historical information is not necessarily indicative of the results to be
expected in the future.
We restated our previously issued financial statements for the fiscal years
ended December 31, 2000, 2001 and 2002, the interim quarters of 2000, 2001,
2002, and the first three quarters of 2003. All applicable amounts relating to
these restatements have been reflected in the following selected financial data.
See Item 7 Management's Discussion and Analysis of Financial Condition and
Results of Operations and notes two and twenty-one to the consolidated financial
statements in Item 8 of this Form 10-K for details of the restatement.
In the first quarter of 2003, we adopted Statement of Financial Accounting
Standards (SFAS) No. 145, "Recission of FASB Statements No. 4, 44 and 64,
Amendment of FASB Statement No. 13, and Technical Corrections," (SFAS 145) as it
relates to the classification of extinguishments of debt to be aggregated and
classified as extraordinary items as well as certain other items. Gains and
losses on early extinguishments of debt are included in income (loss) from
continuing operations before cumulative effects of accounting changes for all
periods presented.
In 2002, we adopted Statement of Financial Accounting Standards (SFAS) No.
142, "Goodwill and Other Intangible Assets". (SFAS 142). SFAS 142 addresses
accounting for goodwill and other intangible assets and redefines useful lives,
amortization periods and impairment of goodwill. Under the pronouncement,
goodwill is no longer amortized, but is tested for impairment annually by
assessing the fair value of reporting units, generally one level below
reportable segments. As a result of the adoption of SFAS 142, we recognized a
non-cash charge in 2002 reflected as a cumulative effect of accounting change of
$135.6 million, net of applicable taxes, related to the impairment of goodwill
in our North America cemetery reporting unit. For more information regarding
goodwill, see note seven to the consolidated financial statements in Item 8 of
this Form 10-K.
9
In 2000, we implemented Staff Accounting Bulletin No. 101, "Revenue Recognition
in Financial Statements" (SAB 101). As a result of this implementation, we
changed certain of our accounting policies regarding prearranged sales
activities. We recorded a non-cash charge reflected as a cumulative effect of
accounting change of $866.1 million (as restated), net of applicable taxes, as
of January 1, 2000.
The selected consolidated statement of operations data presented below is
reported on a pro forma basis to reflect the application of SFAS 142 and SAB 101
to the financial data for the three years ended December 31, 2001 and the year
ended December 31, 1999, respectively. Further, results of operations have been
reclassified for all periods presented to separately reflect results of
discontinued operations. See note nineteen to the consolidated financial
statements of Item 8 of this Form 10-K for further discussion of discontinued
operations.
SELECTED CONSOLIDATED FINANCIAL DATA
AS REPORTED PRO FORMA
------------ ----------- --------------------------------------
2003 2002 2001 2000 1999
- -----------------------------------------------------------------------------------------------------------------------------------
(RESTATED) (RESTATED) (RESTATED)
SELECTED CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenue................................................. $ 2,341.6 $ 2,323.6 $ 2,518.3 $ 2,599.0 $ 2,759.2
Income (loss) from continuing operations before
cumulative effects of accounting changes.............. $ 85.1 $ (96.9) $ (570.1) $ (344.8) $ (155.3)
Net income (loss)....................................... 85.1 (232.5) (576.0) (1,240.8) (137.7)
Earnings per share:
Income (loss) from continuing operations before
cumulativeeffects of accounting changes
Basic.......................................... $ .28 $ (.33) $ (2.00) $ (1.27) $ (.57)
Diluted........................................ .28 (.33) (2.00) (1.27) (.57)
Net income (loss)
Basic.......................................... $ .28 $ (.79) $ (2.02) $ (4.56) $ (.51)
Diluted........................................ .28 (.79) (2.02) (4.56) (.51)
SELECTED CONSOLIDATED BALANCE SHEET DATA (AS REPORTED):
Total assets............................................ $ 11,202.7 $ 10,718.0 $11,565.4 $ 12,853.4 $12,978.2
Long-term debt, less current maturities................. 1,528.9 1,884.5 2,314.0 3,091.3 3,636.1
Stockholders' equity.................................... 1,527.0 1,326.7 1,456.4 2,025.0 3,495.3
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
(DOLLARS IN MILLIONS, EXCEPT AVERAGE SALES PRICES AND PER SHARE DATA)
RESTATEMENT OF HISTORICAL FINANCIAL STATEMENTS
We restated our previously issued financial statements for the fiscal years
ended December 31, 2000, 2001 and 2002, the interim quarters of 2000, 2001 and
2002, and the first three quarters of 2003, primarily related to adjustments to
Deferred preneed cemetery contract revenues. All applicable amounts relating to
these restatements have been reflected in the consolidated financial statements
and notes to the consolidated financial statements.
Effective January 1, 2000, we adopted the Securities and Exchange
Commission's Staff Accounting Bulletin No. 101, "Revenue Recognition in
Financial Statements" (SAB 101), and recorded a liability for Deferred preneed
cemetery contract revenues of approximately $1.8 billion. This deferred revenue
represented presold cemetery merchandise and services that had not been
delivered or had not been performed.
As a result of the adoption of SAB 101, we significantly changed our accounting
procedures and controls to comply with the new revenue recognition accounting
policies under SAB 101. Beginning in the latter part of 2000 and continuing
through 2001 and 2002, we improved our procedures and controls for reporting the
delivery of cemetery merchandise and performance of services. These improvements
identified approximately $110 million of preneed cemetery contract items that
had been delivered or performed, but for which no revenues had been recognized.
Previously, we recorded revenues associated with these preneed cemetery contract
items as changes in estimates in the period identified in our accounting system.
The amounts (per quarter), where material, have been previously disclosed as
changes in estimates under our previous interpretation of the accounting rules
in our annual reports on Form 10-K for the years 2001 and 2002. These amounts,
where material, were also disclosed in our earnings press releases and quarterly
reports on Form 10-Q. We have now determined to report the recognition of
revenues for these items in the periods in which the cemetery merchandise and
services were delivered or performed. Additionally, we also concluded that
10
previously reported deferred revenues included approximately $41 million of
items for which delivery or performance occurred, but revenue recognition had
not occurred. Therefore, the restatement includes adjustments related to these
two items affecting the cumulative effect of the adoption of SAB 101, revenues
and deferred revenues from 2000 through 2003 to report cemetery merchandise and
service revenues in the period these items were delivered or performed.
We have also reviewed our accounting policy for amortizing prearranged
funeral deferred selling costs and have changed the methodology for amortizing
these costs from a straight line basis to a method more in proportion to when
the associated revenues are recognized. We have included this change in
amortization in our restated results.
The effect of the restatement of our previously reported consolidated
statement of operations and consolidated balance sheet for the periods described
above is as follows:
(Dollars in thousands, except YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31,
per share data) --------------------------- --------------------------- -------------------------
2002 2001 2000
--------------------------- --------------------------- -------------------------
AS REPORTED AS RESTATED AS REPORTED AS RESTATED AS REPORTED AS RESTATED
----------- ----------- ----------- ----------- ----------- -----------
Selected consolidated statement of
operations data:
Revenues...................... $ 2,333,429 $ 2,323,619 $ 2,567,437 $ 2,518,294 $ 2,579,238 $ 2,599,021
Costs and expenses............ $(1,969,514) $(1,960,694) $(2,208,051) $(2,200,789) $(2,251,596) $(2,261,738)
Gross profits................. $ 363,915 $ 362,925 $ 359,386 $ 317,505 $ 327,642 $ 337,283
Operating income (loss)....... $ 1,510 $ 520 $ (338,846) $ (380,727) $ (252,885) $ (243,244)
Loss from continuing
operations before income
taxes and cumulative
effects of accounting
changes.................... $ (133,180) $ (134,170) $ (527,673) $ (569,554) $ (482,375) $ (472,734)
Benefit (provision) for
income taxes............... $ 36,860 $ 37,244 $ (64,223) $ (47,986) $ 78,825 $ 75,087
Cumulative effects of
accounting changes (net
of income taxes)........... $ (135,560) $ (135,560) $ (7,601) $ (7,601) $ (909,315) $ (866,084)
Net loss...................... $ (231,880) $ (232,486) $ (597,796) $ (623,440) $(1,343,251) $(1,294,117)
Basic and diluted earnings
per share:
Loss from continuing
operations before
cumulative effects of
accounting changes........ $ (.33) $ (.33) $ (2.08) $ (2.17) $ (1.48) $ (1.46)
Net loss................... $ (.79) $ (.79) $ (2.10) $ (2.19) $ (4.93) $ (4.75)
AS OF DECEMBER 31, 2002
-----------------------------------
AS REPORTED AS RESTATED
------------ ------------
Selected consolidated balance sheet data:
Inventories..................................... $ 135,529 $ 136,932
Total current assets............................ $ 617,521 $ 618,924
Deferred charges and other assets............... $ 718,567 $ 711,417
Total assets.................................... $ 10,723,785 $ 10,718,038
Deferred cemetery contract revenues, net........ $ 1,672,661 $ 1,629,540
Deferred income taxes........................... $ 429,868 $ 444,358
Accumulated deficit............................. $ (1,046,029) $ (1,023,145)
Total stockholders' equity...................... $ 1,303,771 $ 1,326,655
Total liabilities and stockholders' equity...... $ 10,723,785 $ 10,718,038
See note twenty-one to the consolidated financial statements for the effect
of the restatement upon quarterly unaudited financial data.
OVERVIEW
Service Corporation International (SCI), headquartered in Houston, Texas, is
the world's largest funeral and cemetery company. At December 31, 2003, we
operated 2,225 funeral service locations, 417 cemeteries, and 183 crematoria in
eight countries. North America operations represented 56% of funeral service
locations, 97% of cemeteries and 77% of crematoria owned at December 31, 2003,
and approximately 73% of consolidated revenues and 77% of consolidated gross
profits.
North America Operations
To meet the needs of different markets, the funeral and cemetery operations
in North America are organized into 32 major markets and 44 middle markets. Each
market is led by a market director with responsibility for both funeral and
cemetery operations as well as preneed sales in their particular market.
11
Within each market, the businesses realize efficiencies by sharing common
resources such as personnel, preparation services, and vehicles. To assist
market directors with financial and administrative needs as well as human
resource issues, there are three market support centers in North America. These
support centers, commonly referred to as "hubs" are located in Houston, New York
and Los Angeles. The market support centers help to facilitate the execution of
corporate strategies, coordinate the communication between corporate office and
the field, and act as liaisons for implementation of policies and procedures.
International Operations
On March 11, 2004, we sold our funeral operations in France and then
purchased a 25% equity interest in the acquiring company. We also have a
minority interest equity investment in the United Kingdom. Remaining
international operations outside of North America consist of funeral businesses
in Singapore and primarily cemetery businesses in Argentina, Chile and Uruguay.
It is our intention to exit these remaining international businesses when market
values and economic conditions are conducive to a sale or joint venture. At this
time, we believe our focus is best spent in North America where significant
opportunities for growth exist.
STRENGTHS AND CHALLENGES
SCI is the dominant industry leader in North America. While there are three
other publicly-traded companies that operate in our industry, we have more
physical locations and serve more consumers than the rest of the public peer
group combined. With that said, the industry remains highly fragmented with
these three public companies and SCI combined representing approximately 20% of
the total industry, and the other 80% of the industry is represented by
independent funeral and cemetery operators. In 2000, we launched the first
national branding strategy in the funeral service industry in North America
under the name Dignity Memorial(R). While this branding process is intended to
emphasize our seamless national network of funeral service locations and
cemeteries, the original names associated with acquired locations generally
remain the same. For example, Geo. H. Lewis & Sons Funeral Directors is now Geo.
H. Lewis & Sons Funeral Directors, a Dignity Memorial(R) provider. We believe
SCI is the only company in our industry to successfully implement a national
brand. We believe that a national brand gives us a competitive advantage and is
discussed further in our strategies for growth described below.
Our core business can be characterized as stable, reflective of favorable
demographics and relatively predictable revenue and cash flow streams that are
further enhanced by more than $5,100 million of deferred revenues associated
with North America preneed funeral and cemetery sales. This backlog of future
revenues is primarily supported by investments in trust funds or third party
insurance companies.
We and others in the industry face certain challenges in growing revenues.
The primary external factors impacting revenue growth are 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 between 0.7% and 0.8% annually through 2010, modern advances in
medicine and healthier lifestyles could reduce the numbers of deaths during this
time. Our comparable (same store) funeral services performed declined 1.6% in
2003 which we believe is consistent with, or in certain instances less than, the
declines experienced by other companies in the funeral service and casket
manufacturing industries as well as mortality data reported by the Centers for
Disease Control and Prevention (CDC). Preliminary mortality statistics reported
by the CDC reflect a decline in the number of deaths in the United States of
more than 2.0% in 2003 versus 2002.
In North America, social trends, religious changes, environmental issues and
cultural preferences are driving an increasing preference for cremation. SCI is
the largest provider of cremation services in North America where approximately
39% of the total funeral services we perform are cremation services as compared
to the national average of approximately 30%. Our cremation mix is greater due
to the high concentration of properties we own along the west coast of the
United States, Florida, and Arizona where cremation rates exceed 45%. The rate
of cremation in North America has been increasing approximately 100 to 150 basis
points each year and we expect this trend to continue in the near term. A
cremation service historically has generated less revenues and gross profit
dollars than a traditional funeral service. Additionally, the cremation consumer
may choose not to purchase cemetery property or merchandise. We believe we are
well positioned to address this growing trend and have experienced initial
success through the use of contemporary marketing strategies and unique product
and service offerings that specifically appeal to cremation consumers. See
further information regarding initiatives to address cremation as part of our
overall revenue growth strategy described below.
12
THE PATH TO GROWTH
With the significant progress made in reducing debt and increasing cash flow
since 1999, we believe our current capital structure affords us improved
financial flexibility. Our primary focus has shifted to initiatives that will
grow revenues and earnings. In the near term, we believe that cost reduction
efforts will be the main means to improving earnings. We believe strategies
centered on our national brand, Dignity Memorial(R), and other revenue growth
initiatives will provide the framework that will drive sustainable growth over
the longer term.
IMPROVING THE INFRASTRUCTURE
We have historically had an infrastructure that did not fully realize the
inherent efficiencies in our large organization. As a result, we did not fully
capitalize on the benefits of standardization, technology, process improvement
and outsourcing programs. Some of the key actions taken to improve the
infrastructure while reducing costs include redesigning our sales organization,
improving business and financial processes, implementing new information
systems, and changing the management structure.
In late 2002 and early 2003, we made significant changes to the structure
and processes of the sales organization. These changes included eliminating
certain lead generation 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. We are also in the final
stages of shifting to a compensation model for sales counselors that is variable
and directly related to the production of new business. Historically, sales
counselors' compensation was based solely on commissions. These changes made to
the sales organization were a significant driver of improved cemetery margins in
2003.
In 2003, we began to focus on improving business and financial processes and
systems that support our North America funeral and cemetery operations. The
information systems used by us in the field were proprietary systems developed
by us internally. There were three separate systems (funeral, cemetery and trust
administration) and the systems operated independent of each other. These
systems were costly to maintain. In 2003, we began to implement a new
information system in the field that would replace the three separate contract
entry systems and integrate these functions into one system. In addition,
process improvement reviews resulted in our decision to outsource certain
accounting functions, including accounts payable and payroll, and to change
outsourcers for trust administration.
Having simplified our sales approach and redesigned our financial, technical
and administrative infrastructure, we were able to make significant changes to
the field management structure in late 2003. The old management structure
consisted of multiple layers and two organizations (sales and operations). The
new management structure is based on a major market and middle market concept
with the understanding that our markets and businesses are not all the same and
can benefit from different management approaches. We eliminated the dual
management organizations and now have one person responsible for each market who
has the ability to lead in a multi-segment environment, who is focused on
growing our business and who is committed to the Dignity Memorial(R) standards
and brand. This single line management structure is expected to increase
accountability and execution, improve communication and reduce overhead costs.
To assist market directors with financial and administrative needs as well as
human resource issues, there are three market support centers, commonly referred
to as "hubs". The market support centers help facilitate the execution of
corporate strategies, coordinate the communication between the corporate office
and our operating locations, and act as liaisons for implementation of policies
and procedures, including monitoring and enhancing our internal control policies
and procedures.
BUILDING THE BRAND
SCI has implemented the first national brand in the funeral service industry
called Dignity Memorial(R). Internally, we are focused on ensuring that we have
consistency in service standards and processes across our network of businesses.
We want every customer interaction to be the standard "Dignity" interaction,
which is based upon values of integrity, respect, enduring relationships and
service excellence. All of our employees who interact with consumers must
complete a Dignity certification process. Additionally, we are developing a
comprehensive training program under the name "Dignity University" that
incorporates required specific curriculum for each job type within SCI using a
combination of traditional classroom, web-based courses, virtual classroom and
on-the-job training for the more than 20,000 individuals that we employ in North
America.
Externally, we continue to enhance signage and local advertising efforts
using the Dignity(R) name and logo. Through our national brand we are the
sponsor of several nationally recognized community programs including Dignity
Memorial Escape School(R) (www.escapeschool.com), which provides parents and
their children with critical abduction prevention and escape techniques,
13
Dignity Memorial Smart and Safe Seniors(R) (www.smartandsafe.com), which
educates seniors about consumer fraud, cons and scams, home break-ins, travel
safety and other topics, and The Vietnam Wall Experience
(www.vietnamwallexperience.com), which is a traveling, three-quarter-scale
replica of the Vietnam Veterans Memorial in Washington, D.C. We are also
currently testing new television, radio and print advertising, which if
successful, will be launched on a national basis. This new media advertising
focuses on the unique products and services exclusive to Dignity Memorial(R)
providers.
It is our belief that today's funeral consumers' preferences are changing.
The focus in this industry historically has been on selling caskets, flowers and
interment rights. Based on our market studies, we believe customers are less
interested in buying products and more interested in creating a meaningful
experience and receiving professional help to deal with the aspects of what
occurs when a loved one dies. Through our Dignity(R) brand we are developing
more contemporary and comprehensive products and services that we believe will
help the consumer through the entire experience. Some of the exclusive items
offered through Dignity providers include grief counseling services through a
24-hour Compassion Helpline, legal services membership, internet memorial
archive capabilities through Making Everlasting Memories (www.mem.com) and the
Aftercare(R) Planner - a comprehensive organizing system that helps families
manage the many business details that arise after a death occurs. Dignity
benefits also include the Bereavement Travel Program, a unique feature through
which customers can obtain special rates on airfare, car rentals and hotel
accommodations for family and friends who must travel from out of town to attend
memorial services. Depending on the number of visitors and the cities from which
their travel originates, the cumulative savings in connection with one funeral
can be in the hundreds - even thousands - of dollars. Importantly, these
products and services appeal to both burial and cremation consumers. We are also
focusing on programs that offer consumers new ways to personalize funeral
services and create meaning in the experience.
GROWING OUR REVENUES
As described earlier, we believe improvements in our cost structure will
drive near term earnings growth; however, we realize to achieve sustainable
long-term growth that we must grow our revenues. We believe we can be successful
in this regard by developing the Dignity brand, listening to our consumers and
developing an approach that takes our Company to new levels.
Enhancing Sales Opportunities
We believe we can grow core revenues by utilizing technology and
contemporary marketing strategies to enhance our sales opportunities and
strengthen the competitive advantage of our national brand, Dignity Memorial(R).
In this regard, particular focus is being placed on selling Dignity Memorial(R)
packaged funeral and cremation plans, developing product differentiation within
our cemeteries, and enhancing our cremation strategies.
Our national brand name, Dignity Memorial(R), also represents a unique set
of packaged funeral and cremation plans offered exclusively through our network
on an atneed and preneed basis. These packages are designed to simplify customer
decision-making and include the unique value-added products and services
described earlier which have traditionally been unavailable through funeral
service locations. Our customer satisfaction index, as measured by independent
surveys completed by consumers three weeks following a funeral, continues to
reach record levels which we believe is largely attributable to the value and
savings consumers receive when they select a Dignity package. When Dignity
packages are sold, it results in significant incremental revenue and gross
profit margin per funeral service compared to non-Dignity sales due to the
comprehensive product and service offerings they provide. On a burial funeral,
Dignity packaged sales generate on average approximately $2,800 more than
non-Dignity sales. On a cremation service, Dignity packaged sales generate
approximately $1,700 more than non-Dignity sales. In 2003, approximately 16% of
the total funeral consumers we served selected a Dignity package. On a preneed
basis, approximately 20% of funeral prearrangement contracts sold were Dignity
plans. A key initiative to help drive increases in the selection rate of Dignity
packaged plans is through improved merchandising techniques. In a limited number
of test locations, modifications are being made to casket selection rooms that
will place less emphasis on traditional funeral merchandise and more focus on
the comprehensive product and service offerings unique to Dignity Memorial
providers. These new displays and other presentation models also offer a special
emphasis on personalization options. We will continue to enhance and make
modifications to these new displays in the test locations in early 2004. As we
finalize a model of what works best, these new modifications will be launched
nationally in late 2004 and 2005.
We are also beginning to use more contemporary marketing strategies within
our cemetery segment. Initiatives are underway to employ a tiered-product
strategy that emphasizes a wide range of product offerings versus only grave
spaces. Special emphasis is being placed on the development of high-end cemetery
property projects such as private family estates. As of December 31, 2003, this
tiered-product strategy had been implemented in less than 15% of the more than
400 cemeteries that we own and we believe this initiative will be a key driver
of cemetery revenue growth in 2004 and 2005.
14
To grow core revenues and profits, we believe we must address the growing
trend toward cremation. We believe a successful cremation strategy is built on
product differentiation, personalization and simplicity. The sale of Dignity
Memorial(R) cremation plans can have a meaningful impact in the near term as
these sales on average result in more than $1,700 of incremental revenue per
service to us compared to non-Dignity cremation sales. We are also developing
new displays to be used in the arrangement process that clearly explain the
products and services available to cremation consumers. Within the cemetery
segment, we are promoting cremation gardens, which are separate sections located
within certain of our cemeteries where cremated remains can be permanently
placed and that contain other unique memorialization products. We continue to
develop and expand our national brand, National Cremation(R), which targets the
direct cremation consumer. And finally, 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.
Increasing Market Share
We believe that SCI has unique opportunities to grow market share due to its
size and geographic diversity. We believe that a national brand will provide us
access to new customers over the long term due to an increasingly mobile society
in North America. We think consumers today are less likely to know a funeral
director personally or live in the same area as past generations who may have
used funeral home services before. A favorable experience with Dignity
Memorial(R) through one of our community outreach programs, attending a funeral
service at a Dignity location, or through previous use of a Dignity provider may
influence a consumer to choose one of our funeral homes. Our centralized
marketing effort will utilize information from our broad customer databases to
determine geographic, demographic and lifestyle information about our consumers
in order to promote awareness of the Dignity Memorial(R) brand name, our local
names, and our provider network in the most efficient and effective manner. In
addition, we will continue to capitalize on our nationwide network of providers
to develop affinity relationships with large groups of individuals to whom we
could market our products and services including employers, social organizations
and insurance companies. Our most strategic affinity partnership today is with
the Veterans of Foreign Wars and Ladies Auxiliary whose membership exceeds two
million. Over the longer term, we believe these types of groups can be key
influencers in the funeral home selection process.
In addition to reducing costs, our new management structure is intended to
have our strongest business leaders driving results in each of our markets.
Under the new structure, many of the administrative and financial functions are
now handled by support centers and the geographical scope of responsibility and
accountability for business leaders has been narrowed. We believe this allows
our market leaders to have a greater focus on developing people, growing market
share and improving profitability in their respective markets. In addition, we
continue to use market action plans as a measurement tool to drive
accountability and improved results. Market leaders identify the strengths,
weaknesses, opportunities and threats of their local area and develop supporting
action plans in response that include measurable objectives, necessary resources
and a timetable for completion.
We are also targeting expansion through acquisition or construction in the
top 150 markets in North America where probable investment returns will exceed
our cost of capital. We will focus future growth capital deployment in the major
metropolitan markets where there are large population bases and where multiple
businesses are more conducive to clustering and contemporary marketing
strategies and it is easier to attract quality management. Over the longer term,
the potential for a franchise opportunity exists for further expansion in the
smaller markets. In a franchise relationship we could recruit independent
funeral providers to join the Dignity Memorial(R) network and earn fees for a
comprehensive range of services that we could provide to the franchisee - all at
very little or no capital cost to us.
OUTLOOK FOR FISCAL 2004
Our outlook for 2004 demonstrates continued strength in cash flows and
further improvements to the capital structure. We expect growth in operating
margins in 2004 largely as a result of infrastructure improvements and cost
reduction programs that began in 2003. As discussed earlier in this section,
initiatives centered on our Dignity Memorial(R) brand are being further
developed to increase revenues and profits while addressing the consumers'
increasing preference for value-added products and services that assist them
through the entire experience when a death occurs. In 2004, we anticipate
increases in the selection rate of Dignity Memorial packaged funeral and
cremation plans. We are continuing to focus on the development of strategic
high-end cemetery inventory and implementation of a tiered-product approach and
standard pricing model in each of our cemeteries.
The outlook below provides ranges for certain operating measures on the
income statement that could be used to calculate a broad range of expected
diluted earnings per share; however, we believe it is more appropriate to use
the range of expected diluted earnings per share provided because of the
uncertainty of developments described below.
15
HIGHLIGHTS OF FISCAL 2004 OUTLOOK
(In millions)
OPERATING MEASURES
North America Comparable Operations
Funeral Revenues $1,120 - $1,170
Funeral Gross Margin Percentage 20% - 24%
Cemetery Revenues $ 500 - $ 550
Cemetery Gross Margin Percentage 13% - 17%
General and Administrative Expense $ 65 - $ 70
Interest Expense $ 127 - $ 130
Annual Consolidated Effective Tax Rate 15% - 18%
Diluted Earnings Per Share $ .42 - $ .50
CASH FLOW AND OTHER MEASURES
Cash Flows from Operating Activities $ 270 - $ 310
Capital Expenditures $ 100 - $ 120
Depreciation and Amortization $ 125 - $ 135
Diluted earnings per share guidance and all other outlook provided above
specifically exclude the following:
o Any impact from the implementation of Financial Accounting Standards
Board (FASB) Interpretation No. 46, "Consolidation of Variable
Interest Entities, an Interpretation of Accounting Research Bulletin
(ARB) 51". This standard was originally required to be implemented in
the third quarter of 2003. In December 2003, the FASB issued a
revision (FIN 46R) which allows companies to defer implementation. We
will implement FIN 46R as of March 31, 2004. For a complete discussion
of the effect that the implementation of FIN 46R could have on our
financial statements, see Critical Accounting Policies, New Accounting
Pronouncements and Accounting Changes within this Management's
Discussion and Analysis of Financial Condition and Results of
Operations and note three to the consolidated financial statements in
Item 8 of this Form 10-K.
o The recognition of a charge of approximately $55 million (pretax) for
the cumulative effect of an accounting change associated with pension
plan accounting. Effective January 1, 2004, we changed the accounting
for gains and losses on our pension plan assets and obligations to
recognize these gains and losses as they occur. In our outlook for
2004, we anticipate this change will reduce pension expenses in 2004
compared to 2003; however, because gains and losses will be recognized
currently, market conditions could cause an adverse effect on
results of operations as these gains and losses will be recognized
currently. See note four to the consolidated financial statements in
Item 8 of this Form 10-K.
o Any impact from potential changes to our accounting for insurance
funded prearranged funeral contracts and other accounting changes.
o The recognition of costs associated with settlements of litigation and
the recognition of receivables for insurance recoveries associated
with litigation.
o The possibility of gains or losses associated with early
extinguishments of debt.
o The possibility of gains or losses associated with asset dispositions
or joint ventures.
o The possibility of changes in the capital structure, including new
debt issuances and a new credit facility.
o The possibility of the recognition of a cumulative effect of an
accounting change under generally accepted accounting principles
(other than FIN 46R and the change in pension accounting described
above).
Please refer to the discussion of risks related to our business and to the death
care industry that could also affect this outlook in the Cautionary Statement on
Forward-Looking Statements section in Item 7 of this Form 10-K.
The following commentary describes our assumptions, estimates and beliefs
supporting our 2004 outlook:
Operating Measures
o Comparable financial information as used in our 2004 outlook is
intended to be reflective of "same store" results and excludes the
effects of acquisition or construction as well as divestitures or joint
ventures.
16
o The outlook for North America comparable funeral revenues assumes the
number of funeral services performed will be flat to slightly down with
an increase in cremation services performed offset by a 1% to 3%
increase in the overall average revenue per funeral service compared to
2003 levels.
o North America comparable cemetery revenues are expected to be lower
than 2003 levels due to a decline in cemetery construction revenues to
more normalized levels. Revenues associated with cemetery property
development projects in 2003 were approximately $60 million. Normalized
levels of construction revenues in 2004 are expected to be $25 to $30
million. Offsetting this decline in revenues are anticipated increases
in preneed sales as our sales structure becomes more stabilized
following the significant changes that occurred in late 2002 and 2003.
o North America funeral and cemetery gross margin percentages are
expected to improve in 2004 compared to 2003 primarily due to the
recent business process and operating management structure changes and
expected reductions in pension plan expenses.
o General and administrative expenses in 2003 were $178.1 million and
included $95.2 million of net costs associated with various
litigation-related matters. Also included in 2003 were accelerated
systems amortization costs of $13.8 million that ceased in the third
quarter of 2003. Excluding these litigation expenses and accelerated
system amortization costs, general and administrative expenses in 2003
would have been $69.1 million. For 2004, we are estimating general and
administrative expenses to be $65 to $70 million (excluding the
possibility of the recognition of costs associated with settlements of
litigation or receivables for insurance recoveries). Reductions in
system costs will be somewhat offset by increased expenses associated
with Sarbanes-Oxley compliance and compensation programs.
o Interest expense is expected to decrease $13 to $16 million in 2004
compared to 2003 as a result of retiring debt that is scheduled to
mature in 2004. Interest expense expected in 2004 of $127 to $130
million includes approximately $10 million associated with amortization
of deferred loan costs. The outlook for interest expense does not take
into consideration any additional debt reduction that could occur with
proceeds from asset sales or joint ventures or from cash flows from
operating activities.
o The consolidated effective tax rate is expected to be 15% to 18% in
2004 compared to 25.6% in 2003. These unusually low rates are
attributable to tax benefits received from certain international
transactions. The 2004 expected effective tax rate on an annual basis
for 2004 includes approximately $30 million of tax benefits associated
with the joint venture of our France operations which will be realized
in the first quarter of 2004. The consolidated effective tax rate in
the remaining quarterly periods is expected to be 32% to 35%.
o The range for expected diluted earnings per share assumes dilution from
shares associated with the 6.75% convertible notes due 2008.
International Operations
o On March 11, 2004, we completed the joint venture of our funeral
operations in France. In addition to maintaining a 25% share of the
total equity capital of the newly formed entity, we received net cash
proceeds of approximately $300 million and a note receivable in the
amount of 10 million euros. As a result of the transaction, we expect
to recognize a pretax gain on the sale of approximately $10 to $20
million in the first quarter of 2004. We also anticipate receiving tax
benefits of approximately $30 million in 2004 related to the
transaction. Our consolidated reported results for the year 2003
included $584.6 million in revenues and $68.3 million in gross profits
that were associated with France.
o Remaining international operations consist primarily of cemetery
businesses in South America, where we anticipate modest improvement,
net of currency fluctuations.
o We own a 20% minority equity investment in funeral and cemetery
operations in the United Kingdom. Pending a successful public offering
transaction, we expect to receive proceeds of approximately $50 to $60
million in the second quarter of 2004 associated with the sale of our
holdings in stock and notes in these operations.
Cash Flow and Other Measures
o Cash flows from operating activities in 2003 were $374.1 million and
included a tax refund of $94.5 million and payments of $27.1 million,
net of insurance recoveries, made during 2003 to resolve certain
litigation matters. Had we not received the tax refund or incurred
these net litigation payments, cash flows from operating activities in
2003 would have been $306.7 million. Cash flows from operating
activities in 2004 are expected to be $270 to $310 million. This amount
includes our ownership of France through March 11, 2004, and excludes
the $100 million payment related to the proposed settlement of certain
Florida litigation and any possible payments that could be made
associated with other litigation matters. It also excludes any receipts
from insurance recoveries related to litigation matters and the cash
contribution to our frozen pension plan as discussed below.
Anticipated improvements in North America funeral and cemetery margins
and reduced interest expense are expected to offset the loss of cash
flows from operating activities in 2004 due to the joint venture of
France, the discontinued use of surety bonding in Florida as discussed
below.
o Excluded from our 2004 outlook for cash flows from operating activities
are payments made related to litigation matters. In February 2004, we
paid $100 million into escrow to settle certain litigation matters in
Florida. We expect this payment to be partially offset by the receipt
of $25 million in recoveries under the first layer of our insurance
coverage in 2004.
17
o On March 11, 2004, we completed the joint venture of our funeral
operations in France. In 2003, cash flows from operating activities
were approximately $33 million associated with these businesses in
France.
o In the first quarter of 2004, we made a voluntary cash contribution of
$20 million to our frozen pension plan to increase the fair value of
the plan assets. This contribution is excluded from our 2004 outlook
for cash flows from operating activities.
o In February 2004, we discontinued the use of surety bonding as a means
to provide financial assurance to customers for the prospective sale of
preneed contracts in Florida. Beginning with contracts written in early
2004, we have elected to deposit customer receipts from the sale of
preneed contracts into trust funds in accordance with state
requirements. As a result of this change, our cash flows from operating
activities will decline by $15 to $20 million, net of prospective trust
receipts, in 2004 over 2003 levels. In subsequent periods, the impact
to cash flows is expected to be immaterial. Not included in the outlook
for 2004 are other potential changes regarding the use of surety
bonding. We are currently evaluating our surety bonding program and may
elect to discontinue the use of bonding in other states or cancel
certain outstanding bonds and replace with funds in trusts in
accordance with state regulations.
o Payments on restructuring charges are expected to increase by
approximately $7 million in 2004 compared to 2003 primarily due to
severance costs associated with the reorganization of our operating
management structure in the fourth quarter of 2003.
o Similar to 2003, we do not expect to pay U.S. federal income taxes in
2004 due to significant tax loss carry-forwards. Because of these tax
loss carry-forwards, we believe we will not pay cash taxes until 2006.
In 2004, we expect to pay approximately $5 million for various state
and Canadian province taxes.
o Capital expenditures in 2004 are expected to be $100 to $120 million
compared to $116 million in 2003. Increases in North America capital
spending will be offset by reductions related to the joint venture of
France. In 2003, $34.3 million of our total capital expenditures were
associated with operations in France. Of the total projected capital
expenditures in 2004, we expect to spend approximately $65 to $70
million on capital improvements that we believe are necessary to
maintain our existing facilities in a condition consistent with company
standards and extend their useful lives. This includes approximately $5
million related to our partial year ownership of France in 2004.
Growth-oriented capital spending in North America is expected to
increase due to investments in new funeral service facilities,
Dignity(R)product displays in our funeral homes, and in developing
strategic high-end cemetery property inventory.
o Depreciation and amortization expense is expected to decline in 2004
compared to 2003 primarily due to the elimination of accelerated
systems amortization costs and a reduction in cemetery deferred selling
amortization costs due to expected lower levels of preneed revenues in
2004.
CRITICAL ACCOUNTING POLICIES, NEW ACCOUNTING PRONOUNCEMENTS AND ACCOUNTING
CHANGES
Our consolidated financial statements are impacted by the accounting
policies used and the estimates and assumptions made by management during their
preparation. The following is a discussion of our critical accounting policies
pertaining to revenue recognition, the impairment or disposal of long-lived
assets, and the use of estimates.
Revenue Recognition
Funeral revenue is recognized when funeral services are performed. Our trade
receivables primarily consist of amounts due for funeral services already
performed. We sell price guaranteed prearranged funeral contracts through
various programs providing for future funeral services at prices prevailing when
the agreements are signed. Revenues associated with sales of prearranged funeral
contracts, which include accumulated trust earnings and increasing insurance
benefits, are deferred until such time that the funeral services are performed
(see notes three and five to the consolidated financial statements in Item 8 of
this Form 10-K).
Revenue associated with cemetery merchandise and services is recognized when
the service is performed or merchandise is delivered. Revenue associated with
preneed cemetery property interment rights is recognized in accordance with the
retail land sales provision of SFAS No. 66, "Accounting for the Sales of Real
Estate" (SFAS 66). Under SFAS 66, revenue from constructed cemetery property is
not recognized until a minimum percentage (10%) of the sales price has been
collected. Revenue related to the preneed sale of unconstructed cemetery
property is deferred until it is constructed and 10% of the sales price is
collected. Revenue associated with sales of preneed merchandise and services is
not recognized until the merchandise is delivered or the services are performed
(see notes three and six to the consolidated financial statements in Item 8 of
this Form 10-K).
18
Impairment or Disposal of Long-Lived Assets
We review our goodwill annually for impairment in accordance with SFAS No.
142, "Goodwill and Other Intangible Assets" (SFAS 142), by assessing the fair
values of each of our reporting units compared to our reported carrying amounts.
We determine the fair value of the reporting units based on several valuation
methodologies (discounted future cash flows and multiples of revenue) in order
to assess impairment. If the fair value is less than our carrying amounts, the
deficiency is charged to expense.
We review our deferred selling costs for impairment in accordance with SFAS
No. 60, "Accounting and Reporting by Insurance Enterprises" (SFAS 60). We incur
deferred selling costs associated with our deferred revenue from (1) prearranged
funeral contracts which will be funded by trusts and (2) preneed cemetery
contracts. When circumstances indicate our deferred selling costs are not
recoverable compared to the associated portfolio of deferred revenue, the
deficiency is charged to expense.
We review our remaining long-lived assets for impairment when changes in
circumstances indicate that the carrying amount of the asset may not be
recoverable, in accordance with SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" (SFAS 144). SFAS 144 requires that long-lived
assets to be held and used be reported at the lower of their carrying amount or
fair value. Assets to be disposed of and assets not expected to provide any
future service potential to us are recorded at the lower of their carrying
amount or fair value less estimated cost to sell.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires
management to make certain estimates and assumptions. These estimates and
assumptions affect the carrying values of assets and liabilities and disclosures
of contingent assets and liabilities at the balance sheet date. Actual results
could differ from such estimates due to uncertainties associated with the
methods and assumptions underlying our critical accounting measurements. Key
estimates used by management, among others, include:
Allowances - We provide various allowances and/or cancellation reserves for our
funeral and cemetery preneed and atneed receivables, our prearranged funeral and
preneed cemetery deferred revenues, as well as for our funeral and cemetery
deferred selling costs. These allowances are based on an analysis of historical
trends and include, where applicable, collection and cancellation activity.
These estimates are impacted by a number of factors, including changes in
economy, relocation, and demographic or competitive changes in our areas of
operation.
Depreciation of long-lived assets - We depreciate our long-lived assets over
their estimated useful lives. These estimates of useful lives may be affected by
such factors as changing market conditions or changes in regulatory
requirements. In 2002, we changed the estimated useful life of our existing
information technology systems as a result of the decision to implement a new
North America point of sale system and an upgraded general ledger system. We
recognized approximately $13.8 and $13.5 million of additional amortization
expense related to this change in estimate in 2003 and 2002, respectively.
Amortization of deferred selling costs - Deferred selling costs, which relate to
our deferred revenues associated with prearranged funeral contracts (which will
be funded by trusts) and preneed cemetery contracts, are expensed in proportion
to the applicable revenue when recognized in the consolidated statement of
operations.
Taxes - Our ability to realize the benefit of deferred tax assets requires us to
achieve certain future earnings levels. We have established a valuation
allowance against a portion of deferred tax assets and could be required to
further adjust that valuation allowance if market conditions change materially
and future earnings are, or are projected to be, significantly different from
its current estimates. We intend to permanently reinvest the unremitted earnings
of certain of our foreign subsidiaries in those businesses outside the United
States and, therefore, have not provided for deferred federal income taxes on
such unremitted foreign earnings.
Pension cost - Our pension costs and liabilities are actuarially determined
based on certain assumptions, including expected long-term rates of return on
plan assets and the discount rate used to compute future benefit obligations. It
is our policy to use a discount rate comparable to rates of return on
high-quality fixed income investments available and expected to be available
during the period to maturity of the Company's pension benefits. In 2003 and in
prior years, actuarial gains and losses resulting from changes in the
assumptions, or experience differences from those assumptions, are amortized
over the remaining service period of active employees expected to receive
benefits under the plans.
19
Since 2002, we have used a 9.0% assumed rate of return on plan assets as a
result of a high allocation of equity securities within the plan assets. At
December 31, 2003, 74% of the plan assets were equity securities with the
remaining 26% of plan assets being represented by fixed income securities.
As of December 31, 2003, the equity securities were invested approximately
40% in U.S. "Large Cap" investments, 15% in international equities, 10% in
U.S. "Small Cap" investments and 9% in the Company's stock. Our actuaries
estimate the expected performance over a ten year period of each class of
security. The 9.0% rate of return on plan assets was determined by
allocating these expected long-term returns to the different components of
the assets.
Pursuant to the previously mentioned $20 million infusion of funds into the
plan in early 2004, we expect to rebalance the plan assets to have a lower
percentage invested in traditional equity securities and fixed income
securities and instead incorporate investments in hedge funds. We believe
that this reallocation will reduce the volatility with limited reduction of
returns.
Furthermore, we are changing our method of accounting for gains and losses
on pension assets and obligations in 2004 to recognize such gains and
losses during the year in which they occur. In addition to the change in
our investment strategy described above, we expect to record net pension
expense reflecting estimated returns on plan assets and obligations for our
interim financial statements. Under the new accounting policy, upon
completion of our annual remeasurement during the fourth quarter, we will
recognize actual gains and losses on plan assets and obligations.
Therefore, pension expense during the fourth quarter could be different
than amounts recorded in interim periods. Additionally, the rate of return
on pension plan assets could be lower in 2004 due to the accounting change
to immediately recognize gains and losses and due to the reallocation of
plan assets as discussed above. See accounting changes and note four to the
consolidated financial statements in Item 8 of this Form 10-K for details
of this accounting change.
Insurance loss reserves - We purchase comprehensive general liability,
morticians and cemetery professional liability, automobile liability and
workers compensation insurance coverages structured with high deductibles.
This high deductible insurance program results in the Company being
primarily self-insured for claims and associated costs and losses covered
by these policies. Historical insurance industry experience indicates a
high degree of inherent variability in assessing the ultimate amount of
losses associated with casualty insurance claims. This is especially true
with respect to liability and workers compensation exposures due to the
extended period of time that transpires between when the claim might occur
and the full settlement of such claim, often many years. We continually
evaluate loss estimates associated with claims and losses related to these
insurance coverages and falling within the deductible of each coverage
through the use of qualified and independent actuaries. A variety of
actuarial methodologies are applied to the underlying loss data by the
actuary in arriving at an estimate of the "reasonably possible" loss range.
Assumptions based on factors such as claim settlement patterns, claim
development trends, claim frequency and severity patterns, inflationary
trends and data reasonableness will generally effect the analysis and
determination of the "best estimate" of the projected ultimate claim
losses. The results of these actuarial evaluations are used to both analyze
and adjust our insurance loss reserves.
New Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities, an
Interpretation of Accounting Research Bulletin (ARB) No. 51". This
interpretation clarifies the application of ARB 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 and risk for the entity to finance its activities without additional
subordinated financial support from other parties. In December 2003, the FASB
revised FASB Interpretation No. 46 (FIN 46R) which allows companies with certain
types of variable interest entities to defer implementation until March 31,
2004.
We are currently in discussions with the Staff of the Securities and
Exchange Commission related to our implementation of FIN 46R. The discussion
relates to (i) the consolidation under FIN 46R of our prearranged funeral and
preneed cemetery merchandise and service trusts; (ii) the potential
consolidation of our cemetery perpetual care trust funds; and (iii) the policies
of recognition of the associated investment earnings of the trust funds.
We believe, at this time, that we will consolidate the prearranged funeral
and preneed cemetery merchandise and service trust funds upon implementation of
FIN 46R. Upon consolidation, the large majority of the trust assets will be
recorded at fair value. We are unclear at this time whether we will consolidate
the cemetery perpetual care trust funds upon implementation of FIN 46R.
Currently, the perpetual care trust funds are not recognized on our consolidated
balance sheet. If the cemetery perpetual care trust funds are consolidated, we
believe we will recognize an asset and a corresponding liability in our
consolidated balance sheet of approximately $650 million. The large majority of
the assets of cemetery perpetual care trust funds will be recorded at fair
value.
20
Currently, we defer investment earnings associated with prearranged funeral
and preneed cemetery merchandise and service trust funds until the corresponding
merchandise is delivered or the service is performed. It is unclear at this time
whether this revenue recognition policy will continue upon implementation of FIN
46R, or if we will have to recognize these trust fund earnings in a revised
manner, such as at the time the trusts funds themselves earn such investment
earnings.
Realized investment earnings from cemetery perpetual care trust funds
recognized in current cemetery revenues as they are intended to defray cemetery
maintenance costs. We expect to continue recognizing these investment earnings
under this new accounting policy.
We believe the consolidation of the prearranged funeral and preneed cemetery
merchandise and service trust funds (and possibly the cemetery perpetual care
trust funds) will have an effect on certain components within our consolidated
statement of cash flows. Upon such consolidation, proceeds from sales of trust
fund investments and disbursements for purchases of trust fund investments will
be shown as separate components of cash flows from investing activities.
Currently, the cash flows described above are reported within cash flows from
operations as they are receivables collected from third parties.
In addition to potentially consolidating our trust funds, we also believe we
will consolidate certain cemeteries managed by us upon implementation of FIN
46R. We expect to recognize a charge of approximately $10 to $20 million,
representing the cumulative effect of an accounting change, as a result of
consolidating these cemeteries as of March 31, 2004. The results of operations
and cash flows of these cemeteries will be included in our consolidated
financial statements upon implementation of FIN 46R, although no material impact
is anticipated.
We are also discussing our accounting policies for insurance funded
prearranged funeral contracts (see note five to the consolidated financial
statements) with the Staff of the Securities and Exchange Commission. The
discussion relates to whether amounts recorded in Prearranged funeral contracts,
net and Deferred prearranged funeral contract revenues, net associated with such
contracts represent assets and liabilities of the Company as defined in
Statement of Financial Accounting Concepts No. 6, "Elements in Financial
Statements". If it is concluded that these amounts are not assets and
liabilities as defined, we will remove from our consolidated balance sheet,
amounts relating to insurance funded prearranged funeral contracts recorded in
Prearranged funeral contracts, net and Deferred prearranged funeral contract
revenues, net which, as of December 31, 2003, were approximately $4 billion and
$4 billion, respectively. Such a change in accounting would have no impact on
our consolidated stockholders' equity, results of operations or cash flows.
Effective January 1, 2004, we changed the accounting for gains and losses on
our pension plan assets and liabilities. We will recognize such gains and losses
in our consolidated statement of operations as such gains and losses are
incurred under pension accounting. Prior to January 1, 2004, we amortized the
difference between actual and expected investment returns and actuarial gains
and losses over seven years (except to the extent that settlements with
employees required earlier recognition). We believe the change is preferable as
the new method of accounting better reflects the economic nature of our pension
plan and recognizes gains and losses on the pension plan assets and liabilities
in the year the gains and losses occur. As a result of this accounting change,
we expect to recognize a charge for the cumulative effect of an accounting
change of approximately $55 million (on a pretax basis) as of January 1, 2004.
This amount represents accumulated unrecognized net losses related to the
pension plan assets and liabilities.
RESULTS OF OPERATIONS
Our results for the fiscal years ended 2002 and 2001 and the first three
quarter of 2003 have been restated. The financial data below reflects the
effects of the restatement for all periods affected. For details relating to
this restatement, see notes two and twenty-one to the consolidated financial
statements in Item 8 of this Form 10-K.
Additionally, we have reclassified certain prior year amounts to conform to
the current period financial presentation with no effect on previously reported
net income, financial condition or cash flows.
Total consolidated revenues were $2,341.7 million in 2003 compared to
$2,323.6 million in 2002 and $2,518.3 million in 2001. The growth in revenues in
2003 over 2002 is largely attributable to increases in our funeral operations in
France and driven by positive currency fluctuations. The decrease in revenues in
2002 compared to 2001 is primarily the result of the sale of our funeral and
cemetery operations in the United Kingdom, which previously generated annual
revenues of approximately $165 million, and various businesses in North America.
Although revenues have declined from 2001 levels, gross profits improved to
$365.8 million in 2003 compared to $362.9 million in 2002, which in turn was
14.3% higher than 2001. The gross profit margin was flat at 15.6% in 2003 and
2002 and substantially above 12.6% in 2001 largely as a result of successful
ongoing cost reduction initiatives.
21
Net income in 2003 totaled $85.1 million compared to net losses in 2002 and
2001 of $232.5 million and $623.4 million, respectively. Net income in 2003
included a pretax gain on the sale of our equity investment in Australia and the
collection of an associated note receivable of $45.7 million. Net income in 2003
was negatively impacted by litigation related expenses, net of estimated
insurance recoveries, of $95.2 million. Included in these net litigation
expenses was the recognition of a $25 million receivable during the fourth
quarter of 2003 for expected insurance recoveries under the first layer of our
insurance coverage related to the previously announced $100 million proposed
settlement of certain Florida litigation. Net losses reported in 2002 and 2001
were impacted by impairment losses on dispositions, expenses related to market
value adjustments of certain options associated with our 6.3% notes due in 2003,
severance costs of former employees and expenses related to the termination of
certain consulting and non-compete contractual obligations.
DETAILED COMPARABLE OPERATING RESULTS FOR 2003, 2002 AND 2001
Results in all periods presented below are representative of comparable
results, which excludes operations that were acquired or constructed after
January 1, 2001 and divested by prior to December 31, 2003. Comparable financial
results are meant to be reflective of "same store" results of operations. In
2002, we ceased amortization of goodwill as required by SFAS 142; changed the
allocation methodology of overhead costs in North America to be based on funeral
and cemetery reporting unit revenues; began recognizing revenues associated with
delivered caskets previously prearranged on cemetery contracts as part of
funeral operations instead of cemetery operations; and ceased depreciation of
operating assets held for sale during 2002. In 2002, we determined transactions
to sell or joint venture certain assets would be delayed until after 2002. As a
result, we resumed normal depreciation of those assets held in France and Chile
in the third quarter of 2002. In January 2003, we once again ceased depreciation
of France operating assets held for sale. For purposes of the following
discussion, we have presented the financial information for 2001 on a pro forma
basis as if these changes had been implemented as of January 1, 2001. The
following is a discussion of results of comparable operations by geographic
segment:
COMPARABLE
(Dollars in thousands) YEAR ENDED DECEMBER 31, 2003
---------------------------------------------------------------------------------------------
North % of % of Other % of % of
America Revenue Europe Revenue Foreign Revenue Total Revenue
------------ ---------- ----------- ---------- ----------- ----------- ----------- ----------
(Restated) (Restated)
Revenues:
Funeral.................... $1,132,782 67.0% $591,704 100.0% $ 7,262 16.7% $1,731,748 74.5%
Cemetery................... 556,976 33.0% - -% 36,271 83.3% 593,247 25.5%
------------ ---------- ----------- ---------- ----------- ----------- ----------- ----------
$1,689,758 100.0% $591,704 100.0% $ 43,533 100.0% $2,324,995 100.0%
============ ========== =========== ========== =========== =========== =========== ==========
Gross profit and margin percentage:
Funeral.................... $ 214,395 18.9% $ 69,249 11.7% $ 2,602 35.8% $ 286,246 16.5%
Cemetery................... 75,267 13.5% - -% 8,976 24.7% 84,243 14.2%
------------ ---------- ----------- ---------- ----------- ----------- ----------- ----------
$ 289,662 17.1% $ 69,249 11.7% $ 11,578 26.6% $ 370,489 15.9%
============ ========== =========== ========== =========== =========== =========== ==========
COMPARABLE
YEAR ENDED DECEMBER 31, 2002
---------------------------------------------------------------------------------------------
North % of % of Other % of % of
America Revenue Europe Revenue Foreign Revenue Total Revenue
------------ ---------- ----------- ---------- ----------- ----------- ----------- ----------
(Restated) (Restated)
Revenues:
Funeral.................... $1,138,984 65.8% $479,935 100.0% $ 6,862 19.8% $1,625,781 72.4%
Cemetery................... 592,287 34.2% - -% 27,770 80.2% 620,057 27.6%
------------ ---------- ----------- ---------- ----------- ----------- ----------- ----------
$1,731,271 100.0% $479,935 100.0% $ 34,632 100.0% $2,245,838 100.0%
============ ========== =========== ========== =========== =========== =========== ==========
Gross profit and margin percentage:
Funeral.................... $232,632 20.4% $ 47,407 9.9% $ 2,815 41.0% $ 282,854 17.4%
Cemetery................... 70,358 11.9% - -% 4,737 17.1% 75,095 12.1%
------------ ---------- ----------- ---------- ----------- ----------- ----------- ----------
$302,990 17.5% $ 47,407 9.9% $ 7,552 21.8% $ 357,949 15.9%
============ ========== =========== ========== =========== =========== =========== ==========
22
COMPARABLE PRO FORMA
(Dollars in thousands) YEAR ENDED DECEMBER 31, 2001
---------------------------------------------------------------------------------------------
North % of % of Other % of % of
America Revenue Europe Revenue Foreign Revenue Total Revenue
------------ ---------- ----------- ---------- ----------- ----------- ----------- ----------
(Restated) (Restated)
Revenues:
Funeral.................... $1,114,686 67.4% $431,297 100.0% $11,350 18.5% $1,557,333 72.5%
Cemetery................... 539,617 32.6% - -% 49,873 81.5% 589,490 27.5%
------------ ---------- ----------- ---------- ----------- ----------- ----------- ----------
$1,654,303 100.0% $431,297 100.0% $61,223 100.0% $2,146,823 100.0%
============ ========== =========== ========== =========== =========== =========== ==========
Gross profit and margin percentage:
Funeral.................... $ 238,818 21.4% $ 43,730 10.1% $2,695 23.7% $ 285,243 18.3%
Cemetery................... 49,211 9.1% - -% 12,420 24.9% 61,631 10.5%
------------ ---------- ----------- ---------- ----------- ----------- ----------- ----------
$ 288,029 17.4% $ 43,730 10.1% $15,115 24.7% $ 346,874 16.2%
============ ========== =========== ========== =========== =========== =========== ==========
COMPARABLE
FUNERAL SERVICES PERFORMED
--------------------------------------------
NORTH OTHER
AMERICA EUROPE FOREIGN TOTAL
-------- ------ ------- -----
December 31:
2003....................................... 263,952 140,864 4,236 409,052
2002....................................... 268,326 137,668 4,069 410,063
2001....................................... 268,197 138,475 4,104 410,776
Comparable Funeral Segment Analysis
Comparable North America funeral revenues in 2003 were $1,132.8 million and
on the upper end of our guidance range of $1,090 million to $1,150 million.
Comparable North America funeral revenues decreased slightly in 2003 over 2002.
A decline of 1.6% in the number of funeral services performed and lower levels
of general agency revenues associated with the sale of insurance funded
prearranged funeral contracts were partially offset by an increase of 2.1% in
the average revenue per funeral service. We believe the declines in funeral
services performed are consistent with, and in certain instances less than, the
declines reported by others in the funeral service and casket manufacturing
industries. We also track weekly mortality data published by the Centers for
Disease Control (CDC). We believe that the decline in our funeral services
performed in 2003 is less than the decline in the number of deaths reported by
the CDC. General agency revenues declined in 2003 versus 2002 due to the
anticipated decrease in sales of insurance funded prearranged funeral contracts
as a result of the significant changes made to the sales organization.
Comparable North America funeral revenues increased 2.2% in 2002 compared to
2001 led by a slight increase in comparable funeral services performed and a
1.9% increase in the average revenue per funeral service.
The average revenue per funeral service increased 2.1% in 2003 over 2002 and
increased 1.9% in 2002 over 2001. The fourth quarter of 2003 represents the
fourteenth consecutive quarter in which we have increased our average revenue
per funeral service. This consistent growth in average revenue is largely a
result of the success of the nationally branded Dignity Memorial(R) packaged
funeral and cremation plan initiative. Dignity Memorial packaged plans are
designed to simplify the customer decision-making process, provide savings and
enhance the value to consumers through unique products and services which have
traditionally been unavailable through funeral service locations. In addition to
improving customer satisfaction levels as measured by independent surveys,
Dignity Memorial burial and cremation packaged plans generate significant
incremental revenue per funeral service compared to non-Dignity sales due to the
comprehensive product and service offerings they provide. On a burial funeral,
Dignity Memorial packaged sales generate on average approximately $2,800 more
than non-Dignity sales. On a cremation service, Dignity Memorial packaged sales
generate approximately $1,700 more than non-Dignity sales. During 2003,
approximately 16% of the total funeral consumers served selected a Dignity
packaged plan compared to approximately 14% in 2002 and approximately 7% in
2001. On a preneed basis, approximately 20% of funeral prearrangement contracts
sold in 2003 were Dignity plans compared to approximately 18% in 2002 and
approximately 7% in 2001.
We achieved increases in average revenue during 2001 through 2003 despite an
increase in cremation services. In the death care industry, there has been a
growing trend in the number of cremations performed in North America as an
alternative to traditional funeral service dispositions. While cremations
performed by us in North America typically have higher gross profit margins than
traditional funeral services, cremations usually result in lower revenue and
gross profit dollars compared to traditional burial funeral services. Of the
total comparable funeral services performed in North America during 2003, 39.0%
were cremation services compared to 37.9% in 2002 and 36.7% in 2001. Our ability
to offer the cremation consumer a broad array of products and services through
Dignity packaged plans resulted in increases in the average revenue per
cremation service in 2003 compared to 2002.
23
The North America funeral gross margin percentage for the twelve months
ended December 31, 2003 was 18.9% and on the lower end of our targeted range of
18% to 22%. The North America funeral gross profit and gross margin percentage
declined in 2003 compared to 2002 and 2001 primarily due to volume declines
experienced by us and others in the industry and increased employee benefit
costs and insurance costs. These increases in employee benefit and insurance
costs were somewhat offset by reductions in selling and other overhead costs.
Comparable international funeral revenues and gross profits, which
predominantly are associated with our businesses in France, increased in 2003
compared to 2002 and 2001. Subsequent to December 31, 2003, these businesses
were sold in a joint venture transaction on March 11, 2004 and we retained a 25%
minority equity interest. In 2003, France's reported revenues and gross profits
were $584.6 million and $68.3 million, respectively. Included in 2003 results
are positive effects of foreign currency translation of $93.2 million in
revenues and $9.2 million in gross profits compared to 2002. Excluding favorable
currency effects, France's revenues grew 3.1% and the gross margin percentage
improved to 11.7% compared to 9.9%. These improved results were driven by a 2.6%
increase in funeral services performed and a 4.5% increase in the average
revenue per funeral service. Also, 2002 results included $8.9 million of
depreciation expense that was not included in 2003 under accounting rules once
we began to actively pursue a joint venture with respect to these funeral
operations. Revenues and gross profits for France also improved in 2002 over
2001 despite a 0.5% decline in funeral services. The effect of foreign currency
translations positively benefited 2002 revenues by $24.9 million and gross
profits by $2.5 million. Included in results for 2001 is approximately $10
million more of depreciation expense as discussed above. Excluding favorable
currency effects and the impact of depreciation expense, France's revenues grew
by 5.5% and gross profits improved by approximately $10 million. These improved
results were due to a 4.3% increase in the average revenue per funeral and
increases in burial monument sales, along with successful cost reduction
initiatives.
Comparable Cemetery Segment Analysis
Comparable North America cemetery revenues for the twelve months ended
December 31, 2003 were $557.0 million. Comparable North America cemetery
revenues decreased in 2003 compared to 2002 associated with the anticipated
decrease in preneed revenues due to significant changes in the sales
organization and lower levels of revenues associated with completed cemetery
property development projects. As a result of redesigning sales compensation
programs, eliminating certain lead generation programs, incentive travel
programs and other sales activities and shifting to a sales model based on
personal referrals, we expected revenues in 2003 to be negatively impacted. We
also expected, and realized, higher gross margins as a result of these strategic
changes. Comparable North America cemetery revenues increased in 2002 compared
to 2001 as a result of increases in completed cemetery property development
projects and increases in the amount of cash receipts and down payments received
from preneed property sales. Preneed cemetery property revenues are recognized
when development of the property is completed and customer payments are at least
10% of the total contract amount.
The cemetery gross margin percentage for the twelve months ended December
31, 2003 was 13.5%, which exceeded the 2002 gross margin percentage of 11.9%. A
significant decline in preneed selling costs as described above helped to
overcome increased employee benefit and insurance costs and increased
maintenance expenses to bring certain cemeteries in line with Company standards.
Comparable North America cemetery gross profit and margin percentage increased
in 2002 compared to 2001 primarily as a result of increases in completed
cemetery property development projects.
International cemetery operations are associated with our businesses in
South America. For the full year 2003, South America generated cemetery revenues
and gross profits of $36.3 million and $9.0 million, respectively. Included in
2003 are positive effects of foreign currency translation of $0.8 million in
revenues and $0.6 million in gross profits compared to 2002. Excluding favorable
currency effects, South America's cemetery revenues grew 27.7% and the gross
margin percentage improved to 24.8% from 17.1%, reflective of improvement in
economic conditions in the region. Revenues and gross profits declined in 2002
compared to 2001 primarily as a result of unfavorable currency effects and a
$1.5 million increase in the allowance for doubtful accounts recorded in 2002.
General and Administrative Expenses
General and administrative expenses in 2003 were $178.1 million compared to
$89.8 million in 2002. This increase of $88.3 million is primarily a result of
an increase in litigation expenses of $85.2 million. We recognized expenses, net
of estimated insurance recoveries, of $95.2 million in 2003 compared to $10
million in 2002. These expenses were primarily associated with litigation
matters in Florida. Excluding these litigation related expenses in 2003 and
2002, general and administrative expenses increased $3.1 million. Decreases in
technology and other overhead costs were offset by $6.0 million of accrued
expenses associated with our long-term incentive compensation program. This new
plan is based upon our total shareholder return (share price appreciation
including
24
reinvested dividends) during the period 2003 to 2005 relative to a peer group of
companies. This new compensation plan is expensed currently in contrast to our
historical stock option plan in 2002 that was not expensed. Amounts accrued in
2003 related to this compensation plan are not expected to be paid until 2006
and only if earned.
General and administrative expenses increased $19.4 million in 2002 compared
to 2001. Included in 2002 is $10 million of expenses associated with litigation
related matters and $13.5 million of accelerated non-cash amortization expense
related to our decision to implement new information systems that was not
included in 2001. In 2002, we made the decision to implement new information
systems and, therefore, accelerated the existing systems amortization costs
which ceased in the third quarter of 2003.
In addition to general and administrative expenses, there are two other
components of overhead costs in North America: home office overhead and field
overhead. These overhead costs are allocated to funeral and cemetery operations
in North America. Home office and field overhead costs totaled $152.7 million in
2003 compared to $162.9 million in 2002 representing a decline of more than $10
million or 6.3%. This decline is primarily attributable to reductions in preneed
sales overhead costs as a result of significant changes made to our sales
organization in late 2002 and early 2003.
Other Income and Expenses
In 2003, we recognized a net pretax gain of $50.4 million in gains and
impairment (losses) on dispositions, net, primarily related to the sale of
certain equity investments during the year. In December 2003, we sold our equity
investment in Australia and collected an associated note receivable that
generated a gain and net cash proceeds of $45.7 million. During the second
quarter of 2003, we sold our equity investment in Spain for net cash proceeds of
$26.0 million and recognized a gain of $8.1 million. These gains helped to
offset net losses related to sales of various North America businesses. In 2002,
we recognized a net loss of $177.7 million primarily related to an impairment
charge for several funeral and cemetery operations held for sale in North
America. In 2001, we recognized a net loss of $627.0 million primarily related
to the loss on joint venturing our Australian operations, losses from the
disposition of operations in the Netherlands, Norway and Belgium and the
impairment of certain international operations held for sale.
Other operating expenses of $9.0 million recognized in 2003 are largely due
to severance costs associated with the reorganization of our operating
management structure in the fourth quarter of 2003. In November 2003, we moved
to a major market and middle market concept with the understanding that our
markets and businesses are not all the same and require different management
approaches. We eliminated the dual management organizations of sales and
operations and now have one leader responsible for each market that has the
ability to lead in a multi-segment environment, who is focused on growing our
business and who is committed to the Dignity Memorial(R) standards and brand.
Other operating expenses recognized in 2002 of $94.9 million related to market
value adjustments of certain options associated with our 6.3% notes due 2003,
severance costs of former employees, and expenses related to the termination of
certain consulting and non-compete contractual obligations.
Interest expense decreased to $143.4 million in 2003 compared to $161.5
million and $211.6 million in 2002 and 2001, respectively. The decrease in
interest expense reflects the success we have had in reducing outstanding debt.
Other income, net was $28.7 million in 2003 compared to $26.8 million in
2002 and $22.8 million in 2001. Other income, net primarily consists of income
from various notes receivable and cash investments, gains from early
extinguishments of debt, equity earnings of investments in certain companies and
cash overrides associated with prearranged funeral sales with third party
insurance companies. Other income, net increased in 2003 over 2002 and 2001
primarily associated with increases in interest income and transactional foreign
currency exchange gains which helped to offset declines in gains from early
extinguishments of debt and lower levels of cash overrides received from third
party insurance companies associated with the sale of prearranged funeral
contracts.
In the twelve months ended December 31, 2002, we 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". This
standard required goodwill to no longer be amortized, but instead tested for
impairment annually. This charge related to impairment of goodwill in our North
America cemetery segment.
The effective tax rate was 25.6% in 2003 compared to 27.8% in 2002. The
decline in the effective tax rate is due primarily to income tax benefits
associated with certain international transactions. We expect the annual
effective tax rate in 2004 to be 15% to 18% due to income tax benefits of
approximately $30 million related to our joint venture of France which will be
realized in the first quarter of 2004.
25
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Our primary financial objectives are to continue to improve our financial
flexibility by generating strong cash flows, completing remaining asset sales or
joint ventures, and further reducing debt. We have a goal of achieving specific
ratings with the credit rating agencies. At December 31, 2003, our long-term
debt was rated "BB-" by Standard and Poor's and "B1" by Moody's Investors
Service. Our targeted rating from Standard and Poor's is "BB" and from Moody's
Investors Service a "Ba2". Our balance sheet continues to improve. We have made
significant progress in reducing debt since 2001.
December 31,
-----------------------------------------------------------------------
2003 2002 2001
----------------------- -------------------- --------------------
Cash and cash equivalents........... $ 239.4 $ 200.6 $ 29.3
Total debt.......................... 1,711.6 1,984.8 2,534.6
-------- -------- --------
Net debt (total debt less cash)..... $1,472.2 $1,784.2 $2,505.3
======== ======== ========
Cash and cash equivalents were $239.4 million at the end of 2003 as compared
with $200.6 million at the end of 2002 and $29.3 million at the end of 2001.
Total debt less cash and cash equivalents at December 31, 2003, was $1,472.2
million, representing the lowest levels in our company since 1994. Total debt
has been reduced by $823 million or 32.5% since December 31, 2001. This
reduction since December 31, 2001, is a result of strong cash flows from
operating activities including the receipt of tax refunds of approximately $152
million and a successful asset divestiture and joint venture program that
produced more than $500 million of net cash proceeds.
Cash Flow
We believe our ability to generate cash from operations to reinvest in our
business is one of our fundamental financial strengths. Cash flows from
operating activities were $374.1 million in 2003 included payments of $27.1
million, net of insurance recoveries, to resolve certain litigation matters.
Excluding these litigation payments, cash flows from operating activities were
$401.2 million, ahead of our guidance range of $350 to $400 million (our target
range specifically excluded any potential impact from litigation matters). Also
included in our actual and projected 2003 amounts and our 2003 guidance range
was the receipt of a $94.5 million tax refund. Cash flows from operating
activities in 2002 were $352.2 million and included a $57.1 million tax refund
and a $10.1 million escrow receipt from the sale of our French insurance
company. Had we not incurred these net litigation payments or received the tax
refunds and escrow receipt, cash flows from operating activities in 2003 would
have been $306.7 million compared to $285.0 million in 2002, representing an
increase of $21.7 million or 7.6%. The increase is primarily attributable to
reductions in cash interest paid. We also had improvements in working capital in
North America associated with reduced preneed selling costs which helped to
offset reduced operating cash flows from our French operations.
Our investing activities resulted in a net cash outflow of $37.4 million in
2003 compared to a net cash inflow of $326.9 million in 2002. The change is
primarily due to a reduction in proceeds from asset sales and joint ventures,
increases in capital expenditures and additional deposits to restricted cash as
we decided to replace certain letters of credit with cash collateral.
Net cash used in financing activities was $300.1 million in 2003 compared to
$505.5 million in 2002. The net cash used in both periods is primarily due to
our continued focus on debt reduction. Repayments of long term debt were $291.3
million in 2003 and $383.1 million in 2002. Included in 2002 was a use of cash
of $57 million related to the final settlement of certain options associated
with our 6.3% notes due 2003.
Cash flows from operating activities in 2004 are expected to be $270 to $310
million, excluding the $100 million payment related to the proposed settlement
of certain Florida litigation matters in February 2004 and the possibility of
payments that could be made associated with other litigation related matters. It
also excludes any receipts from insurance recoveries related to litigation
matters and the cash contribution to our frozen pension plan. Anticipated
improvements in North America funeral and cemetery margins and reduced interest
expense are expected to offset the loss of cash flows from operating activities
in 2004 as a result of the joint venture of France and the discontinued use of
surety bonding in Florida prospectively.
Capital Expenditures
For 2003, capital expenditures totaled $116 million compared to $100 million
in 2002 and $74 million in 2001. Of the total capital expenditures in 2003,
$34.3 million was associated with our funeral operations in France, which was
divested in a joint venture on March 11, 2004. Capital spending for items that
we believe are necessary to maintain our existing facilities in a condition
consistent with Company standards and extend their useful lives amounted to
$87.2 million in 2003 as compared to $72.9 million in 2002 and $74.0 million
26
in 2001. The increase in capital improvement spending at our existing facilities
in 2003 was planned as we continue to focus on the quality of our facilities to
ensure that they are consistent with standards that we have established related
to our national branding strategy and that we are competitive in our respective
markets. Capital spending associated with new growth initiatives was $29.2
million in 2003 compared to $27.1 million in 2002. Included in these amounts are
approximately $10 million in 2003 and 2002 associated with our operations in
France. These expenditures are intended to grow revenues and profits and are
primarily related to the construction of cemetery property inventory and the
construction of funeral home facilities on SCI-owned cemeteries.
Total capital expenditures in 2004 are expected to be $100 million to $120
million. Of the total projected capital expenditures in 2004, we expect to spend
approximately $65 to $70 million on capital improvements to maintain our
existing facilities. Growth-oriented capital spending in North America is
expected to increase due to investments in new funeral home facilities,
Dignity(R) product displays in our funeral homes, and in developing strategic
high-end cemetery property.
Liquidity
We believe we have sufficient liquidity and that our financial position is
sound. As of December 31, 2003, we had a cash balance of approximately $240
million plus approximately $115 million of availability under a $185 million
bank credit facility. We have no cash borrowings under this credit facility, but
we have issued approximately $70 million of letters of credit under the
facility. In February 2004, we paid $100 million into escrow to settle certain
litigation matters in Florida. We expect this payment to be partially offset by
the receipt of $25 million from recoveries under the first layer of our
insurance coverage in 2004. On March 11, 2004, we successfully completed a joint
venture of our funeral operations in France and received approximately $300
million in net cash proceeds while retaining a 25% minority interest in the
acquiring company. In the first quarter of 2004, we made a voluntary cash
contribution of $20 million to our frozen pension plan to increase the fair
value of plan assets. For further details regarding this pension plan, see note
fourteen to the consolidated financial statements in Item 8 of this Form 10-K.
Beginning in early 2004, we discontinued the use of surety bonding for the
prospective sale of preneed cemetery contracts in the state of Florida and have
elected to deposit customer receipts from the sale of preneed contracts into
trust funds. As a result of this change, we expect our cash flows from
operations to decline by $15 to $20 million in 2004. Pending a successful public
offering transaction, we expect to receive proceeds of approximately $50 to $60
million in the second quarter of 2004 associated with the sale of our holdings
in stock and notes in operations in the United Kingdom.
At December 31, 2003, the maturity schedule for outstanding public notes due
in the near and intermediate term was as follows:
<Table>
<Caption>
OUTSTANDING AT
DECEMBER 31, 2003
-----------------
7.375% notes due April 2004......................................... $111.2
8.375% notes due December 2004...................................... $ 50.8
6.0% notes due December 2005........................................ $272.5
7.2% notes due June 2006............................................ $150.0
</Table>
Based on our cash balance and credit availability, expectations of future
cash flows from operating activities and asset sales, and proceeds received from
the joint venture of France, we believe that we have adequate means to meet the
near and intermediate term debt obligations as well as our operating needs.
Contractual, Commercial and Contingent Commitments
We have assumed various financial obligations and commitments in the
ordinary course of conducting our business. We have contractual obligations
requiring future cash payments under existing contractual arrangements, such as
management, consulting and non-competition agreements. We also have commercial
and contingent obligations which result in cash payments only if certain
contingent events occur requiring our performance pursuant to a funding
commitment.
27
The following table details our known future cash payments (on an
undiscounted basis) related to various contractual obligations as of December
31, 2003.
PAYMENTS DUE BY PERIOD
----------------------- -------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS 2004 2005 - 2006 2007 - 2008 THEREAFTER TOTAL
----------------------- ----------- ----------- ----------- ---------- ------------
Current maturities of long-term debt(1)............. $ 182,682 $ - $ - $ - $ 182,682
Long-term debt (1).................................. - 479,475 675,854 423,148 1,578,477
Casket purchase agreement (2)....................... 100,000 187,000 - - 287,000
Operating lease agreements (3)...................... 50,138 65,978 29,873 27,986 173,975
Contingent purchase obligation (4).................. - 53,000 - - 53,000
Management, consulting and non-competition
agreements (5)...................................... 50,177 44,023 13,731 7,695 115,626
----------- ----------- ----------- ---------- ------------
TOTAL CONTRACTUAL OBLIGATIONS.................. $ 382,997 829,476 719,458 458,829 2,390,760
========== =========== =========== ========== ============
- ----------
(1) Our outstanding indebtedness contains standard provisions, such as payment
delinquency default clauses and change of control clauses. In addition, our
bank credit agreement contains a maximum leverage ratio and a minimum
interest coverage ratio. Our outstanding indebtedness includes $25.4
million principal balance of capital lease obligations of which $24.2
million was associated with capital leases of our French operations. For
further information see note nine to the consolidated financial statements
in Item 8 of this Form 10-K.
(2) We have executed a purchase agreement with a major casket manufacturer for
our North America operations with an original minimum commitment of $750
million, covering a six-year period, which will expire in 2004. The
agreement contains provisions for annual price adjustments and provides for
a one-year extension to December 31, 2005 in which we are allowed to
satisfy any remaining commitment that exists at the end of the original
term. At December 31, 2003, our remaining maximum commitment under the
purchase agreement was $287 million. Based on our historical purchases, we
expect to exercise our option to extend the terms of the agreement for one
year and expect to fulfill our commitment without any economic loss.
(3) The majority of our operating leases contain options to (i) purchase the
property at fair value on the exercise date, (ii) purchase the property for
a value determined at the inception of the leases, or (iii) renew for the
fair rental value at the end of the primary lease term. Our operating
leases primarily relate to funeral service locations, automobiles,
limousines, hearses, cemetery operating and maintenance equipment and two
aircraft. Approximately $28 million of our operating leases are associated
with facilities in our France operations. We have residual value exposures
related to certain operating leases of approximately $7.6 million. We
believe it is unlikely that we will have to make future cash payments
related to these residual value exposures.
(4) In connection with certain acquisitions related to our South America
operations, we entered into contingent purchase obligations with certain
former owners of those businesses, which require us to pay additional
consideration in any one year between 2003 and 2005, at the option of the
former owners, based on the results of operations, as defined. The
additional consideration may be partially paid in common stock at the
discretion of the former owners. Presently, we expect the former owners to
request the additional consideration in 2005 and estimate it to be a $53
million liability, which is recorded in Other liabilities in the
consolidated balance sheet.
(5) We have entered into management employment, consulting and non-competition
agreements which contractually require us to make cash payments over the
contractual period. The agreements have been primarily entered into with
certain officers and employees of the Company and former owners of
businesses acquired. The contractual obligation amounts pertain to the
total commitment outstanding under these agreements and may not be
indicative of future expenses to be incurred related to these agreements
due to cost rationalization programs completed by the Company.
We have not included amounts in this table for payments of pension
contributions and payments for various postretirement welfare plans and
postemployment benefit plans, as such amounts have not been determined beyond
2004. Furthermore, we have not presented the amounts associated with these
obligations for 2004 since we are not required to make any payments to the
plans. Still, as previously disclosed, we have voluntarily elected to contribute
$20 million to our frozen pension plans in the first quarter of 2004.
28
The following table details our known potential or possible future cash
payments (on an undiscounted basis) related to various commercial and contingent
obligations as of December 31, 2003.
EXPIRATION BY PERIOD
------------------------------------- -------------------------------------------------------------------------
COMMERCIAL AND CONTINGENT OBLIGATIONS 2004 2005 - 2006 2007 - 2008 THEREAFTER TOTAL
------------------------------------- ---------- ----------- ----------- ---------- ------------
Surety obligations (1)............................. $ 241,856 $ - $ - $ - $ 241,856
Letters of credit (2).............................. 69,815 - - - 69,815
Representations and warranties (3)................. 7,194 13,543 - 18,386 39,123
---------- ----------- ----------- ---------- ------------
TOTAL COMMERCIAL AND CONTINGENT OBLIGATIONS... $ 318,865 13,543 - 18,386 350,794
========== ========== =========== ========== ============
- ----------
(1) To support our operations, we have engaged certain surety companies to
issue surety bonds on behalf of the Company for customer financial
assurance or as required by state and local regulations. The surety bonds
are primarily obtained to provide assurance for our prearranged funeral and
preneed cemetery obligations, which are appropriately presented as
liabilities in the consolidated balance sheet as Deferred prearranged
funeral contract revenues and Deferred cemetery contract revenues.
The total outstanding surety bonds at December 31, 2003, were $333 million.
Of this amount, $310 million was related to prearranged funeral and preneed
cemetery obligations. When we obtain surety bonds, we are required to
obtain 100% of our liability amount to perform the services. When we
deposit funds into state-mandated trust funds, however, we are often not
required to deposit 100% of the liability amount. Therefore, in the event
all of the surety companies canceled or did not renew our outstanding
surety bonds, which are generally renewed for twelve-month periods, we
would be required to either obtain replacement assurance or fund
approximately $242 million, as of December 31, 2003, primarily into
state-mandated trust accounts. At this time, we do not believe we will be
required to fund material future amounts related to these surety bonds. We
are currently evaluating our surety bonding program and may elect to
discontinue the use of bonding in other states or cancel certain
outstanding bonds and replace with funds in trusts in accordance with state
regulations.
(2) We are occasionally required to post letters of credit, issued by a
financial institution, to secure certain insurance programs or other
obligations. Letters of credit generally authorize the financial
institution to make a payment to the beneficiary upon the satisfaction of a
certain event or the failure to satisfy an obligation. The letters of
credit are generally posted for 1-year terms and are usually automatically
renewed upon maturity until such time as we have satisfied the commitment
secured by the letter of credit. We are obligated to reimburse the issuer
only if the beneficiary collects on the letter of credit. We believe that
it is unlikely we will be required to fund a claim under our outstanding
letters of credit. In 2003, the full amount of the letters of credit were
supported by our credit facility which expires July 2005.
(3) In addition to the letters of credit described above, we currently have
contingent obligations of $39.1 million related to our asset sale and joint
venture transactions. We have agreed to guarantee certain representations
and warranties associated with such disposition transactions with letters
of credit or interest bearing cash investments. We have interest bearing
cash investments of $13.8 million included in Deferred charges and other
assets pledged as collateral for certain of these contingent obligations.
We do not believe we will ultimately be required to fund to third parties
any claims against these representations and warranties.
Subsequent to December 31, 2003, we agreed to certain representations and
warranties associated with the disposition of our investment in France. The
undiscounted amount of the representations and warranties associated with
the sale is approximately $36 million and includes indemnifications related
to taxes and other obligations. This amount will be recorded in Other
liabilities in our consolidated balance sheet.
Prearranged Funeral and Cemetery Activities
In addition to selling our products and services to client families at the
time of need, we believe an active funeral and cemetery prearrangement program,
which complements our framework for long-term growth, can increase future market
share in our service markets. Prearrangement is a means through which a customer
contractually agrees to the terms of a funeral service, cremation service,
and/or cemetery burial interment right, merchandise or cemetery service to be
performed or provided in the future (that is, in advance of when needed or
"preneed"). Within our business, we traditionally apply the term "prearranged"
to funeral activities and the term "preneed" to cemetery activities. Both refer
to situations where the customer has made contractual arrangements in advance of
when the services or merchandise are needed.
29
Prearranged Funeral Activities
When customers contractually prearrange their funeral services, we record
an asset, Prearranged funeral contracts, net, and a corresponding liability,
Deferred prearranged funeral contract revenues, net in our consolidated balance
sheet for the contract price. The funeral revenues are deferred and will not be
recognized in the consolidated statement of operations until the funeral
services are performed or the merchandise is delivered. While some customers may
pay for their contract in a single payment, most prearranged funerals are sold
on an installment basis over a period of one to seven years. On these
installment contracts, we receive on average a down payment at the time of sale
of approximately 11%. Historically, the majority of our prearranged funeral
trust contracts have not included a finance charge. Because the services or
merchandise will not be provided until some time in the future, most states and
provinces require that all or a portion of the funds collected from customers on
prearranged funeral contracts be protected for the benefit of the customer
pursuant to applicable law. Some or all of the funds may be required to be
placed into trust accounts, or a surety bond may be posted in lieu of trusting
(collectively "trust funded prearranged funeral contracts"). Alternatively,
where allowed, customers may choose to purchase a life insurance or annuity
policy from third party insurance companies to fund their prearranged funeral
("insurance funded prearranged funeral contract"). Only certain of these
customer funding options may be applicable in any given market we serve.
Trust Funded Prearranged Funeral Contracts: Where the applicable law
requires that all or a portion of the funds collected from prearranged funeral
contracts be placed in trust accounts, the funds deposited into trust are
invested by the independent trustees in accordance with the investment
guidelines established by statute or, where the prudent investor rule is
applicable, the guidelines established by our Investment Committee. The trustees
utilize professional investment advisors to select and monitor the money
managers that make the individual investment decisions in accordance with the
guidelines. We retain any funds above the amounts required to be deposited into
trust accounts and use them for working capital purposes, generally to offset
the selling and administrative costs of the prearrangement programs. Applicable
law governs the timing of the required deposits into the trust accounts, which
generally ranges from five to 45 days after receipt of the funds from the
customer.
The trust investments are expected to generate earnings sufficient to
offset the inflationary costs of providing the prearranged funeral services and
merchandise in the future for the prices that were guaranteed at the time of
sale. We believe the market value of the prearranged funeral trust investments
at December 31, 2003 exceeds the expected cost of meeting our obligations to
provide funeral services and merchandise for the unperformed prearranged funeral
contracts. Investment earnings on funds placed into trust accounts are generally
accumulated and deferred until each prearranged contract is either utilized upon
the death of, or canceled by, the customer. However, in certain states, the
trusts are allowed to distribute a portion of the investment earnings to us
prior to that date. Until the prearranged contract is utilized or canceled, any
investment earnings are attributed to the individual prearranged funeral
contract. These attributed investment earnings (whether distributed or
undistributed) are recognized in our consolidated statement of operations when
the merchandise is delivered and the services are performed following the death
of the customer or when the contract is canceled and we are entitled to retain
these earnings. Recognition of the investment earnings is independent of the
timing of the receipt of the related cash flows.
Direct selling costs incurred pursuant to the sales of trust funded
prearranged funeral contracts are deferred and included in Deferred charges and
other assets in the consolidated balance sheet. The deferred selling costs are
expensed in proportion to the corresponding trust funded prearranged funeral
contract revenues when recognized. Other selling costs associated with the sales
and marketing of preneed cemetery contracts (e.g., lead procurements costs,
brochures and marketing materials, advertising and administrative costs) are
expensed as incurred. An allowance for cancellation is recorded for trust funded
prearranged funeral contract deferred selling costs based on historical contract
cancellation experience.
If a customer cancels the trust funded prearranged funeral contract,
applicable law determines the amount of the refund owed to the customer,
including in certain situations the amount of the attributed investment
earnings. Upon cancellation, we receive the amount of principal deposited to
trust and previously undistributed net investment earnings and pay the customer
the required refund. We retain any excess funds and recognize the attributed
investment earnings (net of any investment earnings payable to the customer) in
our consolidated statement of operations. In certain jurisdictions, we may be
obligated to fund any shortfall if the amounts deposited by the customer exceed
the funds in trust. As a result, when realized or unrealized losses of a trust
result in trust funded prearranged funeral contracts being under-funded, we will
assess those contracts to determine whether a loss provision should be recorded.
We have not been required to recognize any loss amounts.
The cash flow activity over the life of a trust funded prearranged funeral
contract from the date of sale to its death maturity or cancellation is captured
in the line item Net effect of prearranged funeral production and maturities in
the consolidated statement of cash flows. While the contract is outstanding,
cash flow is provided by the amount retained from funds collected from the
customer and any distributed investment earnings. This is reduced by the payment
30
of trust funded prearranged funeral deferred selling costs. The effect of
amortizing trust funded prearranged funeral deferred selling costs is reflected
in Depreciation and amortization in the consolidated statement of cash flows. At
the time of death maturity, we receive the principal and undistributed
investment earnings from the trust and any remaining receivable due from the
customer. This cash flow at the time of service is generally less than the
revenue recognized, thus creating a negative effect on working capital cash flow
from operating activities.
In certain situations pursuant to applicable laws, we can post a surety
bond as financial assurance for an amount that would otherwise be required to be
deposited in trust accounts for trust funded prearranged funeral contracts. See
the Financial Assurances section within this Financial Condition, Liquidity and
Capital Resources section for further details on our practice of posting such
surety bonds. We believe the deferred revenues associated with prearranged
funeral bonded contracts exceed the expected cost of meeting our obligations to
provide funeral services and merchandise for the outstanding prearranged funeral
bonded contracts, and our future operating cash flows will be sufficient to
fulfill these contracts without use of the surety bonds.
If a customer cancels the trust funded prearranged funeral contract that
has been bonded prior to death maturity, applicable law determines the amount of
the refund owed to the customer. Because the funds have not been held in trust,
there are no earnings to be refunded to the customer or us. We pay the customer
refund out of our operating funds, which reduces working capital cash flow from
operating activities.
The cash flow activity over the life of a trust funded prearranged funeral
contract that has been bonded from the date of sale to its death maturity or
cancellation is captured in the line item Net effect of prearranged funeral
production and maturities in the consolidated statement of cash flows. The
payments received from our customers for their trust funded prearranged funeral
contracts that have been bonded are a source of working capital cash flow from
operating activities until the contracts mature. This is reduced by the payment
of deferred selling costs, the premiums to the surety companies for the bond
coverage, and refunds on customer cancellations of contracts. When a trust
funded prearranged funeral contract that has been bonded matures upon the death
of the beneficiary, there is no additional cash flow to us unless the customer
owed an outstanding balance.
Insurance Funded Prearranged Funeral Contracts: Where permitted, customers
prearrange their funeral contract by purchasing a life insurance or annuity
policy from third party insurance companies, for which we earn a commission for
being the general agent for the insurance company. The policy amount of the
insurance contract between the customer and the third party insurance company
equals the amount of the prearranged funeral contract. The third party insurance
company collects funds related to the insurance contract directly from the
customer. The customer/policy holder assigns the policy benefits to our funeral
home to pay for the prearranged funeral contract at the time of need.
Approximately 68% of our 2003 North America prearranged funeral production was
insurance funded prearranged funeral contracts.
The life insurance contracts include increasing death benefit provisions,
which are expected to offset the inflationary costs of providing the prearranged
funeral services and merchandise in the future for the prices that were
guaranteed at the time of sale. The increasing death benefits are accumulated
and deferred until the death maturity of each prearranged contract. We record
the increase in the Prearranged funeral contracts, net, and the Deferred
prearranged funeral contract revenues, net, in the consolidated balance sheet
based on updates from the insurance company. We believe the value of the
insurance funded prearranged funeral contracts at December 31, 2003 exceeds the
expected cost of meeting our obligations to provide funeral services and
merchandise for the unperformed contracts.
The commission we earn for being the general agent on behalf of the third
party insurance companies is based on a percentage per contract sold. These
general agency (GA) revenues are recognized when the insurance purchase
transaction between the customer and third party insurance provider is
completed. Prior to January 1, 2003, we recognized these GA revenues as
reductions to selling expenses in the consolidated statement of operations. In
2003, we began recognizing these amounts as funeral revenues. We have
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. Direct selling costs incurred pursuant to
the sale of insurance funded prearranged funeral contracts are expensed as
incurred. GA revenues recognized by us totaled approximately $27.7 million,
$47.1 million and $43.3 million, and direct selling costs expensed by us totaled
approximately $23.9 million, $34.1 million and $37.3 million for the years ended
December 31, 2003, 2002 and 2001, respectively, in connection with sales of
insurance funded prearranged funeral contracts.
Additionally, we may receive cash overrides based on achieving certain
dollar volume targets of life insurance policies sold as a result of marketing
agreements entered into in connection with the sale of our insurance
subsidiaries in 2000. These overrides are recorded in Other income, net, in the
consolidated statement of operations.
31
If a customer cancels the insurance funded prearranged funeral contract
prior to death maturity, the insurance company pays the cash surrender value
under the insurance policy directly to the customer. The insurance company
informs us of the cancellation and we reduce the Prearranged funeral contracts,
net, and Deferred prearranged funeral contract revenues, net, in our
consolidated balance sheet. If the contract was outstanding for less than one
year, the insurance company charges back the GA revenues and overrides we
received on the contract. An allowance for these chargebacks is included in the
consolidated balance sheet based on our historical chargeback experience.
The cash flow activity over the life of an insurance funded prearranged
funeral contract from the date of sale to its death maturity or cancellation is
captured in the consolidated statement of operations within our funeral segment.
The cash flow activity associated with these contracts generally occurs at the
time of sale, where the GA revenues received net of the direct selling costs
provide a net source of cash flow, and at death maturity, where the insurance
proceeds (including increasing death benefit) less the funds used to provide the
funeral goods and services provide a net source of cash flow. If the
cancellation occurs within the one year following the date of sale, our cash
flow is reduced by the charge-back of GA revenues and overrides.
An allowance for cancellation, based on historical experience, is provided
in Prearranged funeral contracts, net, and Deferred prearranged funeral contract
revenues, net, in the consolidated balance sheet.
The table below details the North America results of trust and insurance
funded prearranged funeral production for the years ended December 31, 2003 and
2002 and the related deferred selling costs incurred to obtain the trust funded
prearrangements (see discussion above for the revenue recognized and selling
cost incurred to obtain the insurance funded prearrangements). Additionally, the
table reflects revenues and previously deferred trust funded prearranged funeral
contract selling costs recognized in the consolidated statement of operations
associated with death maturities of prearranged funeral contracts for the years
ended December 31, 2003 and 2002.
NORTH AMERICA
---------------------------
(IN MILLIONS) FUNERAL
---------------------------
2003 2002
---------- -----------
(RESTATED)
ORIGINATION:
Prearranged production ...................................................................... $ 337.4 436.6
========== ===========
Trust funded prearranged funeral deferred selling costs...................................... $ 13.4 $ 17.0
========== ===========
DEATH MATURITY:
Previously prearranged production included in current period revenues........................ $ 339.5 $ 350.2
========== ===========
Amortization/recognition of trust funded prearranged funeral deferred selling
costs in current period.................................................................. $ 9.2 $ 9.4
========== ===========
The following table reflects the total North America backlog of deferred
prearranged funeral contract revenues and the associated prearranged funeral
assets included in our consolidated balance sheet at December 31, 2003 and 2002.
The difference between the amounts of Deferred prearranged contract revenues and
the associated prearranged funeral assets represents future revenues to be
recognized for which we have already collected the associated cash.
32
NORTH AMERICA
-------------------------------
(IN MILLIONS) FUNERAL
-------------------------------
2003 2002
------------- -------------
(RESTATED)
Deferred prearranged funeral contract revenues, net............................ $ 3,595.6 $ 3,638.3
=========== ===========
Deferred selling costs, net.................................................... $ 95.4 $ 91.1
=========== ===========
Prearranged funeral receivables, net:
Trust funded prearranged funeral contracts.................................. $ 1,029.3 $ 1,087.4
Insurance funded prearranged funeral contracts.............................. 2,204.8 2,175.5
----------- -----------
$ 3,234.1 $ 3,262.9
=========== ===========
The Deferred prearranged funeral contract revenues, net, are reflected
separately in the consolidated balance sheet. The prearranged funeral deferred
selling costs (net of an estimated allowance for cancellation) are included with
preneed cemetery deferred selling costs as a component of Deferred charges and
other assets. Prearranged funeral receivables, which consist of amounts due from
trusts, customer receivables or third party insurance receivables (net of an
estimated allowance for cancellation), are reflected as Prearranged funeral
contracts, net, in the consolidated balance sheet.
Preneed Cemetery Activities
When purchasing cemetery property interment rights, merchandise, and
services on a preneed basis, approximately 30% of our consumers choose to pay
100% of the contract at the time of sale. The remaining customers choose to pay
for their contracts on an installment basis generally over a period of one to
seven years. On these installment contracts, we receive an average down payment
at the time of sale of approximately 14%. Historically, the installment
contracts have included a finance charge ranging from 3.5% to 15.7% depending on
the date sold, the payment period selected, state laws and the payment method
(i.e., monthly statement billing or automated bank draft). Unlike prearranged
funeral contracts, where the entire purchase price is deferred and the revenue
is recognized as one event at the time of death maturity, the revenues
associated with a preneed cemetery contract can be recognized as different
contract events occur. Preneed sales of cemetery interment rights (cemetery
burial property) are recognized when a minimum of 10% of the sales price has
been collected and the property has been constructed. With the customer's
direction, which is generally obtained at the time of sale, we can choose to
order, store, and transfer title to the customer of their personalized marker
merchandise. Upon the earlier of vendor storage of these items or delivery in
our cemetery, we recognize the associated revenues and record the cost of sale.
For services, personalized marker merchandise where the customer chooses not to
elect vendor storage or early delivery to our cemetery, and non-personalized
merchandise (such as vaults), we defer the revenues until the services are
performed and the merchandise is delivered.
Because the services or merchandise will not be provided until some time in
the future, all or a portion of the proceeds from the sale of preneed cemetery
merchandise and services may be required by law to be paid into merchandise and
services trusts until the merchandise is delivered or the service is provided.
As with trust funded prearranged funeral contracts, the funds deposited into
trust are invested by the independent trustees in accordance with the investment
guidelines established by statute or, where the prudent investor rule is
applicable, the guidelines as established by our Investment Committee. The
trustees utilize professional investment advisors to select and monitor the
money managers that make the investment decisions in accordance with the
guidelines. We retain any funds above the amounts required to be deposited into
trust accounts and use them for working capital purposes, generally to defray
the selling costs of obtaining the contracts. Applicable law governs the timing
of the required deposits into the trust accounts, which generally ranges from
five to 45 days after receipt of the funds from the customer. In certain
situations pursuant to applicable laws, we post a surety bond as financial
assurance for a certain amount of the preneed cemetery contract in lieu of
placing funds into trust accounts. See the Financial Assurances section within
this Financial Condition, Liquidity and Capital Resources section for further
details on our practice of posting such surety bonds.
The trust investments are expected to generate earnings sufficient to
offset the inflationary costs of providing the preneed cemetery services and
merchandise in the future for the prices that were guaranteed at the time of
sale. We believe the current market value of the preneed cemetery trust
investments at December 31, 2003 exceeds the expected cost of meeting our
obligations to provide the cemetery services and merchandise for the outstanding
preneed cemetery contracts. Investment earnings on funds placed into trust
accounts are generally accumulated and deferred until the delivery of each
preneed contract item. However, in certain states, the trustees are allowed
33
to distribute a portion of the investment earnings to us before the preneed
cemetery service or merchandise item is delivered ("distributable states").
Until delivered, any investment earnings are attributed to the individual
contract items. Upon delivery, these attributed investment earnings (whether
distributed or undistributed) are recognized in our consolidated statement of
operations along with the revenues associated with the related contract item.
Recognition of the net investment earnings is independent of the timing of the
receipt of the related cash flows, but generally will be the same in states that
are not distributable states.
We are generally required by law to deposit a portion of the proceeds from
the sale of cemetery property interment rights (burial property) into perpetual
care trust funds. Earnings, and in some cases realized capital gains, from these
perpetual care trust funds are used to defray the maintenance costs of our
cemeteries.
Direct selling costs incurred pursuant to the sales of preneed cemetery
contracts are deferred and included in Deferred charges and other assets in the
consolidated balance sheet. The deferred selling costs are expensed in
proportion to the corresponding revenues when recognized. Other selling costs
associated with the sales and marketing of preneed cemetery contracts (e.g.,
lead procurements costs, brochures and marketing materials, advertising and
administrative costs) are expensed as incurred. An allowance for cancellation is
recorded for cemetery deferred selling costs based on historical contract
cancellation experience.
If a preneed cemetery contract is canceled prior to delivery, applicable
law determines the amount of the refund owed to the customer, if any, including
the amount of the attributed investment earnings. Upon cancellation, we receive
the amount of principal deposited to trust and previously undistributed
investment earnings and, where required, issue a refund to the customer. We
retain any excess funds and recognize the attributed investment earnings (net of
any investment earnings payable to the customer) in our consolidated statement
of operations. Based on our historical experience, we have included an allowance
for cancellation for preneed cemetery contracts in Preneed cemetery contracts,
net, and Deferred cemetery contract revenues, net, in our consolidated balance
sheet.
As the preneed cemetery contract merchandise and service items for which we
were required to deposit funds to trust are delivered and recognized as
revenues, we receive the principal and previously undistributed investment
earnings from the trust. There is generally no remaining receivable due from the
customer, as our policy is to deliver preneed cemetery merchandise and service
items only upon payment of the contract balance in full. This cash flow at
delivery is generally less than the revenue recognized, thus creating a negative
effect on working capital cash flow from operating activities, especially if we
posted a surety bond in lieu of trusting for the preneed cemetery contract
merchandise and service items, as there are no funds in trust available for
withdrawal.
The cash flow activity from the date of sale of a preneed cemetery contract
(origination) to the date of the recognition of the deferred revenue upon its
delivery or cancellation (maturity) is reported in the Net effect of preneed
cemetery production and deliveries line item in the consolidated statement of
cash flows. Net effect of preneed cemetery production and deliveries is affected
by cash flows provided by the amount retained from funds collected from the
customer and distributed trust earnings, reduced by the use of funds for the
payment of deferred selling costs when the preneed cemetery contracts are
originated. The amortization of the cemetery deferred selling costs is included
in Depreciation and amortization in the consolidated statement of cash flows.
The table below details the North America results of cemetery production
which has been deferred for the years ended December 31, 2003 and 2002 and the
related deferred selling costs incurred to obtain the contract items.
Additionally, the table reflects previously deferred revenues and previously
deferred selling costs recognized in the consolidated statements of operations
associated with deliveries of cemetery contract items for the years ended
December 31, 2003 and 2002.
34
NORTH AMERICA
-------------------------
(IN MILLIONS) CEMETERY
-------------------------
2003 2002
---------- -----------
(RESTATED)
ORIGINATION:
Revenue which has been deferred.............................................. $ 215.7 $ 303.2
======== ========
Deferred selling costs, net.................................................. $ 42.0 $ 44.2
======== ========
RECOGNITION:
Previously deferred revenue
included in current period revenues........................................ $ 217.8 $ 288.8
======== ========
Amortization/recognition of deferred selling costs in current period......... $ 35.9 $ 42.2
======== ========
The following table reflects the total North America backlog of deferred
cemetery contract revenues and the related preneed cemetery contract assets
included in our consolidated balance sheet at December 31, 2003. Deferred
cemetery contract revenues are greater than the related preneed cemetery
contract assets primarily due to cash collections allowed to be retained by us
in accordance with applicable laws, partially offset by contract amounts where
the revenue can be recognized at the date of sale (contracts which include
constructed cemetery interment rights where we receive at least 10% of the sale
price.)
NORTH AMERICA
-------------------------
(IN MILLIONS) CEMETERY
-------------------------
2003 2002
---------- -----------
(RESTATED)
Deferred cemetery contract revenues, net.................................... $1,574.2 $1,628.5
======== ========
Deferred selling costs, net................................................. $ 204.9 $ 197.7
======== ========
Preneed cemetery contracts, net............................................. $1,059.2 $1,129.4
======== ========
Deferred cemetery contract revenues, net, and Preneed cemetery contracts,
net (which consist of amounts due from trusts and customer receivables, net),
are reflected separately in the consolidated balance sheet. The preneed cemetery
deferred selling costs (net of an estimated allowance for cancellation) are
included with prearranged funeral deferred selling costs as a component of
Deferred charges and other assets.
Financial Assurances
In support of operations, we have entered into arrangements with certain
surety companies whereby such companies agree to issue surety bonds on our
behalf 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 our prearranged funeral and preneed cemetery sales activities. The
underlying obligations these surety bonds assure are recorded on the
consolidated balance sheet as Deferred prearranged funeral contract revenues,
net and Deferred preneed cemetery contract revenues, net (see notes five and six
to the consolidated financial statements in Item 8 and Prearranged Funeral and
Cemetery Activities within Financial Condition, Liquidity and Capital Resources
of this Form 10-K for further details regarding our prearranged funeral and
preneed cemetery activities). The breakdown of bonds between funeral and
cemetery prearrangements, as well as surety bonds for other activities, is as
follows:
(In millions) DECEMBER 31, 2003
------------------
Prearranged funeral............................................................ $ 125.6
Preneed cemetery:
Merchandise and services.................................................. 179.6
Preconstruction........................................................... 18.1
------------------
Bonds supporting prearranged funeral
and cemetery obligations........................................... 323.3
Bonds supporting prearranged business permits.................................. 4.8
Other bonds.................................................................... 4.7
------------------
Total bonds outstanding.............................................. $ 332.8
===================
35
When selling prearranged funeral contract and preneed cemetery contracts, we
intend to post surety bonds where allowed by applicable law, except as noted
below for Florida. We post the surety bonds in lieu of trusting a certain amount
of funds received from the customer. 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. During 2003 and 2002, we
recorded $90.8 million and $95.5 million, respectively, in cash receipts
attributable to bonded sales. These amounts do not consider reductions
associated with taxes, selling costs or other costs.
Surety bond premiums are paid annually and are automatically renewable until
maturity of the underlying prearranged contracts, unless we are given prior
notice of cancellation. 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 was to
cancel the surety bond, we are required to obtain replacement assurance from
another surety company or fund a trust for an amount generally less than the
posted bond amount. A quantitative detail of this subject is discussed in the
Contractual, Commercial and Contingent Commitments section included within
Financial Condition, Liquidity and Capital Resources. We do not believe we will
be required to fund any material future amounts related to these surety bonds.
The applicable Florida law that allows posting of surety bonds for
prearranged contracts expires December 31, 2004; however, it allows for
prearranged contracts entered into prior to December 31, 2004 to continue to be
bonded for the remaining life of those contracts. Thus, we are required to
change from bonding to either trust or insurance funding for new prearranged
funeral and cemetery contracts in Florida by December 31, 2004. We have elected
to change to trust funding as of February 1, 2004. Of the total bonding contract
proceeds we received from customers for 2003 and 2002, approximately $67.1
million and $70.3 million, respectively, were attributable to Florida contracts.
Assuming our prearranged funeral and cemetery sales in Florida in 2004 is
consistent with production for the full year of 2003, we forecast a negative
impact on our cash flow from operations of approximately $15 to $20 million, net
of trust receipts in 2004.
CAUTIONARY STATEMENT ON FORWARD-LOOKING STATEMENTS
The statements in this Form 10-K 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", "anticipate", or "predict" that indicate the uncertainty of future
events or outcomes. These statements are based on assumptions that we believe
are reasonable: however, many important factors could cause our actual
consolidated 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. These factors are discussed below. We assume 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.
Our ability to execute our strategic plan depends on many factors, many of which
are beyond our control.
Our strategic plan is focused on reducing overhead costs, increasing cash
flow, asset redeployment, and reducing debt while at the same time developing
key revenue initiatives designed to generate future internal growth in our core
funeral and cemetery operations without the outlay of significant additional
capital. Many of the factors necessary for the execution of our strategic plan
are beyond our control. We cannot give assurance that we will be able to execute
any or all of our strategic plan. Failure to execute any or all of the strategic
plan could have a material adverse effect on us, our financial condition,
results of operations, or cash flows.
Our indebtedness limits funds available for our operations.
As of December 31, 2003, we had approximately $1.7 billion in indebtedness.
Our indebtedness may limit our ability to obtain additional financing and
require the dedication of more cash flow to service our debt than we desire.
Furthermore, it may require sale of assets or limit our flexibility in planning
for, or reacting to, changes in our markets. Our ability to satisfy our
indebtedness in a timely manner will be dependent on the successful execution of
our long-term strategic plan and the resulting improvements in our operating
performance.
36
Our existing credit agreements and indentures contain covenants that may prevent
us from engaging in certain transactions.
Our existing credit agreements and indentures contain, among other things,
various affirmative and negative covenants that may prevent us from engaging in
certain transactions that might otherwise be considered beneficial to us. These
covenants limit, among other things, our and our subsidiaries' ability to:
o Borrow money;
o Pay dividends or make distributions;
o Purchase or redeem stock;
o Make investments;
o Engage in transactions with affiliates;
o Engage in sale-leaseback transactions; and
o Consummate certain liens on assets.
The credit agreement also requires us to maintain certain financial ratios
and satisfy other financial condition tests. Although the maturity of our bank
credit agreement brings an end to the restrictions created by it, any future
credit agreements or indentures may contain terms and conditions that are more
or less restrictive than those of the existing bank credit agreement and
indentures.
If we lost the ability to use surety bonding to support our prearranged funeral
and preneed cemetery activities, we could have to make material cash payments to
fund certain trust funds.
We have entered into arrangements with certain surety companies whereby such
companies agree to issue surety bonds on our behalf, as financial assurance
and/or as required by existing state and local regulations. The surety bonds are
used for various business purpose; however, the majority of the surety bonds
issued and outstanding have been issued to support our prearranged funeral and
preneed cemetery activities. The applicable Florida law that allows posting of
surety bonds for prearranged contracts will expire December 31, 2004. Thus, we
are required to change from bonding to either trust or insurance funding for new
prearranged funeral and cemetery contracts in Florida by December 31, 2004. We
have elected to change to trust funding as of February 1, 2004. Of the total
bonding contract proceeds we received from customers for 2003 and 2002,
approximately $67.1 million and $70.3 million, respectively, were attributable
to Florida contracts. Assuming our prearranged funeral and cemetery sales in
Florida in 2004 is consistent with production for the full year of 2003, we
forecast a negative impact on our cash flow from operations of approximately $15
to $20 million, net of prospective trust receipts in 2004. In subsequent years,
we do not expect the impact on cash flows from operations to be material.
Furthermore, our future cash flows could be materially affected if we lost
access to using surety bonds for financial assurance in our normal course of
business. We are currently evaluating our surety bonding program and may elect
to discontinue the use of bonding in other states or cancel certain outstanding
bonds and replace with funds in trusts in accordance with state regulations.
The funeral home and cemetery industry is becoming increasingly competitive.
In North America and most international markets in which we operate, the
funeral and cemetery industry is characterized by a large number of locally
owned, independent operations. To compete successfully, our funeral service
locations and cemeteries must maintain good reputations and high professional
standards in the industry, as well as offer attractive products and services at
competitive prices. In addition, we must market our company in such a manner as
to distinguish us from our competitors. If we are unable to successfully
compete, our company, our financial condition, results of operations and cash
flows could be materially adversely affected.
Our affiliated funeral and cemetery trust funds own investments in equity
securities and mutual funds, which are affected by financial market conditions
that are beyond our control.
In connection with our prearranged funeral operations and preneed cemetery
merchandise and service sales, affiliated funeral and cemetery trust funds own
investments in equity securities and mutual funds. Our earnings and investment
gains and losses on these equity securities and mutual funds are affected by
financial market conditions that are beyond our control. If our earnings from
our trust funds decline, we would likely experience a decline in future
revenues. In addition, if the trust funds experienced significant investment
losses, there would likely be insufficient funds in the trusts to cover the
costs of delivering services and merchandise or maintaining cemeteries in the
future. We would have to cover any such shortfall with cash flows, which could
have a material adverse effect on us, our financial condition, results of
operations, or cash flows.
37
As of December 31, 2003, net unrealized appreciation in the prearranged
funeral and cemetery merchandise and services trust funds amounted to $18.8
million and $48.7 million, respectively. The perpetual care trust funds had net
unrealized appreciation of $24.8 million as of December 31, 2003. The following
table summarizes the investment returns excluding fees on our trust funds for
the last three years.
2003 2002 2001
------------- ------------ ------------
Prearranged funeral trust funds...................... 17.9% (7.6)% 1.7%
Cemetery merchandise services trust funds............ 17.1% (5.5)% 1.0%
Perpetual care trust funds........................... 12.6% 5.3% 4.3%
Increasing insurance benefits related to prearranged funeral contracts funded
through life insurance or annuity contracts may not cover future increases in
the cost of providing a price guaranteed funeral service.
We sell price guaranteed prearranged funeral contracts through various
programs providing for future funeral services at prices prevailing when the
agreements are signed. For prearranged funeral contracts funded through life
insurance or annuity contracts, we receive in cash a general agency commission
of approximately 14% of the total sale from the third party insurance company.
Additionally, we accrue an increasing insurance benefit associated with the
contract of approximately 1% per year to be received in cash by us at the time
the funeral is performed. There is no guarantee that the increasing insurance
benefit will cover future increases in the cost of providing a price guaranteed
funeral service, which could materially adversely affect our future cash flows,
revenues and profit margins.
We may not be able to joint venture or sell our international operations on
acceptable terms or at all.
Our long-term strategic plan includes the joint venture or sale of our
remaining international operations outside of North America in order to create
cash proceeds to reduce debt. On March 11, 2004, we completed the joint venture
of our funeral operations in France having received approximately $300 million
in net cash proceeds. However, if we are unable to joint venture or sell our
South America or other international operations on acceptable terms or
otherwise, it could adversely affect our ability to achieve our strategic plan.
Our foreign operations and investments involve special risks.
Our activities in areas outside the United States are subject to risks
inherent in foreign operations, including the following:
o Loss of revenue, property and equipment as a result of hazards such as
expropriation, nationalization, wars, insurrection and other political
risks;
o The effects of currency fluctuations and exchange controls, such as
devaluation of foreign currencies and other economic problems; and
o Changes in laws, regulations, and policies of foreign governments,
including those associated with changes in the governing parties.
We are the subject of lawsuits in Florida that, if not settled in accordance
with the agreement in principle with respect thereto, could have a negative
effect on our financial condition, results of operations and cash flows and we
may be subject to additional class action or other significant lawsuits in the
future.
On December 2, 2003, we announced that we entered into an agreement in
principle to settle the class action lawsuit and all individual related lawsuits
pending against us involving Florida's Menorah Gardens and Funeral Chapels (the
"Florida litigation"), with the exception of two lawsuits pending in Palm Beach
County, Florida. All claims under the Florida litigation would be dismissed if
final court approval of the settlement is obtained.
The terms of the proposed settlement call for us to make payments totaling
approximately $100 million in settlement of these claims. As of December 31,
2003, we have recorded reserves of $100 million related to the Florida
litigation. In the fourth quarter of 2003, we recognized a receivable of $25
million for expected recoveries under one primary layer of the Company's
insurance coverage related to this litigation. We have a substantial face amount
of insurance coverage remaining, although there are various unresolved insurance
coverage disputes in litigation.
38
If the settlement is not approved by the court, the proceedings and
litigation will continue. We cannot assure you that the results of any such
continued proceedings and litigation would be on terms as favorable as those of
the current settlement agreement.
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 Florida litigation. In February 2004, the Company
negotiated a plea arrangement with the Special Assistant State Attorney for Palm
Beach County to resolve the criminal charges; however, the court rejected the
plea arrangement.
In addition, we are involved in other litigation proceedings in the ordinary
course of business. There is a risk that one of the lawsuits that we do not view
as significant at the moment, or an additional lawsuit brought in the future,
could have a material adverse effect on us, our financial condition, results of
operations, or cash flows.
We are the subject of securities fraud class action lawsuits that, if decided
against us, could have a negative effect on our financial condition, results of
operations and cash flows.
In January 1999, numerous putative class-action lawsuits were filed in the
United States District Courts for the Southern and Eastern Districts of Texas,
on behalf of persons and entities who (1) acquired shares of our common stock in
the merger with Equity Corporation International (ECI); (2) purchased shares of
our common stock in the open market during the period from July 17, 1998 through
January 1999 (referred herein as the class period); (3) purchased call options
in the open market during the class period; (4) sold put options in the open
market during the class period; (5) held employee stock options in ECI that
became options to acquire our stock pursuant to the ECI merger; and (6) held
employee stock options to purchase our common stock under a plan during the
class period. These actions have been consolidated into one lawsuit in the
federal court in Houston, Texas. The consolidated complaint alleges that we and
three of our current or former executive officers and directors violated federal
securities laws by making false and misleading statements and failing to
disclose material information concerning our prearranged funeral business and
other financial matters, including in connection with the ECI merger. Plaintiffs
allege damages based on the market loss, during the class period, of the
outstanding shares, including those exchanged in the ECI merger. In October
1999, we filed a motion to dismiss the consolidated complaint that has not been
ruled on by the court. The parties have met on at least two occasions to discuss
a possible resolution of this case, but no progress has been made. We anticipate
that another meeting will be held in mid-April 2004 to discuss a possible
resolution of this matter.
The ultimate outcome of the stockholder class-action cannot be determined at
this time. The class-action lawsuit seeks to recover an unspecified amount of
monetary damages. Certain insurance policies held by us may limit our cash
outflows in the event of a decision adverse to us in these matters. If the legal
costs or the damages awarded against us exceed the insurance coverage, if the
insurance coverage is determined not to apply to these amounts, or if an
insurance carrier is unable to pay, we would have to pay them out of our own
funds, which could have a material adverse effect on us, our financial
condition, results of operations or cash flows.
If the number of deaths in our markets declines, our cash flows and revenues may
decrease.
The United States Bureau of the Census estimates that the number of deaths
in the United States will increase up to one percent per year from 2000 to 2010.
However, longer life spans could reduce the number of deaths. If the number of
deaths declines, the number of funeral services and interments performed by us
will decrease and our financial condition, results of operations and cash flows
may be materially adversely effected.
The growing trend in the number of cremations performed in North America could
result in lower revenue and gross profit dollars.
In the death care industry, there has been a growing trend in the number of
cremations performed in North America as an alternative to traditional funeral
service dispositions. In North America during 2003, 39.0% of the comparable
funeral services performed by us were cremation cases compared to 37.9% and
36.7% performed in 2002 and 2001, respectively. In recent years we have
continued to expand our cremation memorialization products and services which
has resulted in higher average sales for cremation services. If we are unable to
successfully expand our cremation memorialization products and services, we, our
financial condition, results of operations, and cash flows could be materially
adversely affected.
39
The funeral home and cemetery businesses are high fixed-cost businesses.
The majority of our operations throughout the world are managed in groups
called "markets". Markets are geographical groups of funeral service locations
and cemeteries that share common resources such as operating personnel,
preparation services, clerical staff, motor vehicles and preneed sales
personnel. Personnel costs, the largest of the operating expenses for the
company, are the cost components most beneficially affected by this grouping. We
must incur many of these costs regardless of the number of funeral services or
interments performed. Because we cannot necessarily decrease these costs when we
experience lower sales volumes, the sales decline may cause margins, profits and
cash flows to decline at a greater rate than the decline in revenues.
The funeral home and cemetery industry is highly regulated.
Our operations are subject to regulation, supervision, and licensing under
numerous foreign, federal, state and local laws, ordinances and regulations,
including extensive regulations concerning trust funds, preneed sales of funeral
and cemetery products and services, and various other aspects of our business.
The impact of such regulations varies depending on the location of our funeral
and cemetery operations. Violations of applicable laws could result in fines or
their sanctions to us.
In addition, from time to time, governments and agencies propose to amend or
add regulations, which would increase costs and decrease cash flows. For
example, foreign, federal, state, local and other regulatory agencies have
considered and may enact additional legislation or regulations that could affect
the death care industry. Some states and regulatory agencies have considered or
are considering regulations that could require more liberal refund and
cancellation policies for preneed sales of products and services, limit or
eliminate our ability to use surety bonding, increase trust requirements and
prohibit the common ownership of funeral homes and cemeteries in the same
market. If adopted by the regulatory authorities of the jurisdictions in which
we operate, these and other possible proposals could have a material adverse
effect on us, our financial condition, results of operations and cash flows.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information presented below should be read in conjunction with notes
eight and nine to the consolidated financial statements in Item 8 of this Form
10-K.
We have historically used derivatives primarily in the form of interest rate
swaps, cross-currency interest rate swaps, and forward exchange contracts in
combination with local currency borrowings in order to manage our mix of fixed
and floating rate debt and to hedge our net investment in foreign assets. We
generally do not participate in derivative transactions that are leveraged or
considered speculative in nature. We were not a party to any derivative
transactions at December 31, 2003. Subsequent to December 31, 2003, we executed
certain forward exchange contracts to hedge our net foreign investment in our
France operations.
At December 31, 2003 and 2002, 99% of our total debt consisted of fixed rate
debt at a weighted average rate of 6.95% and 6.87%, respectively.
Approximately 13% of our net investment and 55% of our operating income,
excluding Gains and impairment (losses) on dispositions, net, and other
operating expenses, are denominated in foreign currencies, primarily the euro,
at December 31, 2003. At December 31, 2002, approximately 8% of our net
investment and 27% of our operating income excluding Gains and impairment
(losses) on dispositions, net, and Other operating expenses were denominated in
foreign currencies. We do not have a significant investment in foreign
operations that are in highly inflationary economies.
Marketable Equity and Debt Securities -- Price Risk
In connection with our prearranged funeral operations and preneed cemetery
merchandise and service sales, the related funeral and cemetery trust funds own
investments in equity securities and mutual funds, which are sensitive to
current market prices. Cost and market values as of December 31, 2003 and 2002
are presented in notes five and six to the consolidated financial statements in
Item 8 of this Form 10-K.
Market-Rate Sensitive Instruments -- Interest Rate and Currency Risk
We perform a sensitivity analysis to assess the impact of interest rate and
exchange rate risks on earnings. This analysis determines the effect of a
hypothetical 10% adverse change in market rates. In actuality, market rate
volatility is dependent on many factors that are impossible to forecast.
40
Therefore, the adverse changes described below could differ substantially from
the hypothetical 10% change.
A sensitivity analysis of debt instruments with variable interest rate
components was modeled to assess the impact that changing interest rates could
have on pretax earnings. The sensitivity analysis assumes an instantaneous 10%
adverse change to the then prevailing interest rates with all other variables
held constant. Given this model, our pretax earnings, on an annual basis, would
not change at either December 31, 2003 or 2002.
A similar model was used to assess the impact of changes in exchange rates
for foreign currencies on interest expense. At December 31, 2003 and 2002, our
debt exposure was primarily associated with the euro. A 10% adverse change in
the strength of the U.S. dollar would have negatively affected our interest
expense, on an annual basis, by approximately $0.2 million on December 31, 2003
and 2002, respectively.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEX TO FINANCIAL STATEMENTS AND RELATED SCHEDULE
PAGE
--------
Financial Statements:
Report of Independent Auditors................................. 42
Consolidated Statement of Operations for the years ended
December 31, 2003, 2002 and 2001............................ 43
Consolidated Balance Sheet as of December 31, 2003 and 2002.... 44
Consolidated Statement of Cash Flows for the years
ended December 31, 2003, 2002 and 2001...................... 45
Consolidated Statement of Stockholders' Equity for the three
years ended December 31, 2003............................... 46
Notes to Consolidated Financial Statements..................... 47-83
Financial Statement Schedule:
II-- Valuation and Qualifying Accounts........................ 84
All other schedules have been omitted because the required information is
not applicable or is not present in amounts sufficient to require submission or
because the information required is included in the consolidated financial
statements or the related notes thereto.
41
REPORT OF INDEPENDENT AUDITORS
To the Stockholders and Board of Directors of
Service Corporation International
In our opinion, the consolidated financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of
Service Corporation International and its subsidiaries at December 31, 2003 and
December 31, 2002, and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 2003 in conformity with
accounting principles generally accepted in the United States of America. In
addition, in our opinion, the financial statement schedule listed in the
accompanying index presents fairly, in all material respects, the information
set forth therein when read in conjunction with the related consolidated
financial statements. These financial statements and financial statement
schedule are the responsibility of the Company's management; our responsibility
is to express an opinion on these financial statements and financial statement
schedule based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
As discussed in note four to the consolidated financial statements, the Company
changed its method of accounting for goodwill on January 1, 2002, and changed
its method of accounting for derivative financial instruments and hedging
activities on January 1, 2001.
As discussed in note two to the consolidated financial statements, the Company
restated its previously issued consolidated financial statements for the
years ended December 31, 2002 and 2001.
PricewaterhouseCoopers LLP
Houston, Texas
March 15, 2004
42
SERVICE CORPORATION INTERNATIONAL
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31,
----------------------------------------------
2003 2002 2001
----------- ----------- -----------
(RESTATED) (RESTATED)
Revenues.................................... $ 2,341,651 $ 2,323,619 $ 2,518,294
Costs and expenses.......................... (1,975,853) (1,960,694) (2,200,789)
----------- ----------- -----------
Gross profits............................. 365,798 362,925 317,505
General and administrative expenses......... (178,101) (89,752) (70,309)
Gains and impairment (losses) on
dispositions, net......................... 50,350 (177,743) (626,992)
Other operating expenses.................... (9,004) (94,910) (931)
----------- ----------- -----------
Operating income (loss)................... 229,043 520 (380,727)
Interest expense............................ (143,426) (161,494) (211,626)
Other income, net........................... 28,716 26,804 22,799
----------- ----------- -----------
Income (loss) from continuing operations
before income taxes and cumulative
effects of accounting changes........... 114,333 (134,170) (569,554)
(Provision) benefit for income taxes........ (29,251) 37,244 (47,986)
----------- ----------- -----------
Income (loss) from continuing operations
before cumulative effects of accounting
changes................................... 85,082 (96,926) (617,540)
Income from discontinued operations
(net of income tax expense of $936)....... - - 1,701
Cumulative effects of accounting changes
(net of income tax benefit of $11,234
and $5,318, respectively)................. - (135,560) (7,601)
----------- ----------- -----------
Net income (loss)................. $ 85,082 $ (232,486) $ (623,440)
=========== =========== ===========
Basic earnings (loss) per share:
Income (loss) from continuing
operations before cumulative effects of
accounting changes....................... $ .28 $ (.33) $ (2.17)
Income from discontinued operations....... - - .01
Cumulative effects of accounting
changes................................. - (.46) (.03)
----------- ----------- -----------
Net income (loss)................. $ .28 $ (.79) $ (2.19)
=========== =========== ===========
Basic weighted average shares outstanding... 299,801 294,533 285,127
=========== =========== ===========
Diluted earnings (loss) per share:
Income (loss) from continuing
operations before cumulative
effects of accounting changes........... $ .28 $ (.33) $ (2.17)
Income from discontinued operations....... - - .01
Cumulative effects of accounting changes.. - (.46) (.03)
----------- ----------- -----------
Net income (loss)................. $ .28 $ (.79) $ (2.19)
=========== =========== ===========
Diluted weighted average shares outstanding. 300,790 294,533 285,127
=========== =========== ===========
(See notes to consolidated financial statements)
43
SERVICE CORPORATION INTERNATIONAL
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
DECEMBER 31,
----------------------------
2003 2002
------------ -----------
ASSETS (RESTATED)
Current assets:
Cash and cash equivalents.................................................... $ 239,431 $ 200,625
Receivables, net............................................................. 233,935 154,387
Inventories.................................................................. 137,121 136,932
Other........................................................................ 62,837 126,980
----------- -----------
Total current assets.................................................. 673,324 618,924
----------- -----------
Prearranged funeral contracts, net.............................................. 4,734,859 4,281,773
Preneed cemetery contracts, net................................................. 1,084,636 1,165,822
Cemetery property, at cost...................................................... 1,524,545 1,567,584
Property, plant and equipment, at cost, net..................................... 1,250,632 1,188,340
Deferred charges and other assets............................................... 739,250 711,417
Goodwill........................................................................ 1,195,423 1,184,178
----------- -----------
$11,202,669 $10,718,038
=========== ===========
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities.................................... $ 456,523 $ 361,910
Current maturities of long-term debt........................................ 182,682 100,330
Income taxes................................................................ 29,742 2,043
----------- -----------
Total current liabilities............................................. 668,947 464,283
----------- -----------
Long-term debt.................................................................. 1,528,883 1,884,508
Deferred prearranged funeral contract revenues, net............................. 5,117,442 4,659,994
Deferred cemetery contract revenues, net........................................ 1,575,352 1,629,540
Deferred income taxes........................................................... 431,401 444,358
Other liabilities............................................................... 353,686 308,700
Commitments and contingencies (note 12)
Stockholders' equity:
Common stock, $1 per share par value, 500,000,000 shares
authorized, 302,039,871 and 297,010,237 issued and
outstanding (net of 2,469,445 and 2,516,396 treasury
shares at par) ............................................................ 302,040 297,010
Capital in excess of par value............................................... 2,274,664 2,259,936
Accumulated deficit.......................................................... (938,063) (1,023,145)
Accumulated other comprehensive loss......................................... (111,683) (207,146)
----------- -----------
Total stockholders' equity............................................ 1,526,958 1,326,655
----------- -----------
$11,202,669 $10,718,038
=========== ===========
(See notes to consolidated financial statements)
44
SERVICE CORPORATION INTERNATIONAL
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
----------------------------------------------
2003 2002 2001
----------- ----------- -----------
(RESTATED) (RESTATED)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)............................................ $ 85,082 $ (232,486) $ (623,440)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Income from discontinued operations, net of tax........... - - (1,701)
Gains on early extinguishments of debt.................... (1,315) (7,783) (7,755)
Cumulative effects of accounting changes, net of tax...... - 135,560 7,601
Depreciation and amortization............................. 161,058 179,733 241,640
Provision for deferred income taxes....................... 4,692 106,841 59,482
(Gains) and impairment losses on dispositions, net........ (50,350) 177,743 626,992
Other operating expenses.................................. 9,004 94,910 931
Payments on restructuring charges......................... (14,155) (12,806) (22,794)
Change in assets and liabilities, net of effects from
acquisitions and dispositions:
(Increase) decrease in receivables................... (52,106) 3,597 33,642
Decrease (increase) in other assets.................. 66,505 (31,101) 87,839
Increase (decrease) in payables and other
liabilities........................................ 164,250 (83,549) (106,409)
Net effect of prearranged funeral production and
maturities......................................... 4,061 26,721 48,329
Net effect of cemetery production and deliveries..... 667 (7,827) 21,223
Other................................................ (3,285) 2,619 17,755
----------- ----------- -----------
Net cash provided by operating activities...................... 374,108 352,172 383,335
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures......................................... (116,000) (100,045) (74,164)
Proceeds from divestitures and sales of property and
equipment.................................................. 76,577 291,795 285,688
Proceeds and distributions from joint ventures and equity
investments, net of cash retained.......................... 73,940 76,292 126,792
Net (deposits) withdrawals of restricted funds and other..... (71,939) 58,883 (12,906)
----------- ----------- -----------
Net cash (used in) provided by investing activities............ (37,422) 326,925 325,410
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in borrowings under credit agreements........... - (29,061) (734,186)
Payments of debt............................................. (90,980) (75,857) (166,262)
Proceeds from long-term debt issued.......................... - - 345,000
Early extinguishments of debt................................ (200,349) (307,232) (155,545)
Settlement of debt-related options........................... - (57,000) -
Bank overdrafts and other.................................... (8,820) (36,332) (16,445)
----------- ----------- -----------
Net cash used in financing activities.......................... (300,149) (505,482) (727,438)
Effect of foreign currency..................................... 2,269 (2,282) 76
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents........... 38,806 171,333 (18,617)
Cash and cash equivalents at beginning of period............... 200,625 29,292 47,909
----------- ----------- -----------
Cash and cash equivalents at end of period..................... $ 239,431 $ 200,625 $ 29,292
=========== =========== ===========
(See notes to consolidated financial statements)
45
SERVICE CORPORATION INTERNATIONAL
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
ACCUMULATED
CAPITAL IN OTHER
COMMON EXCESS OF ACCUMULATED COMPREHENSIVE
STOCK PAR VALUE DEFICIT INCOME (LOSS) TOTAL
----------- ---------- ----------- ------------- ----------
(RESTATED) (RESTATED)
Balance at December 31, 2000, as
previously reported.................... $ 272,507 $2,156,824 $ (216,353) $ (237,157) $1,975,821
Restatement (note 2)..................... -- -- 49,134 -- 49,134
----------- ---------- ----------- ----------- ----------
Balance at December 31, 2000,
as restated............................ 272,507 2,156,824 (167,219) (237,157) 2,024,955
Comprehensive loss:
Net loss............................... (623,440) (623,440)
Other comprehensive loss:
Foreign currency translation........ (76,403) (76,403)
Minimum pension liability
adjustment, net................... (16,629) (16,629)
Reclassification adjustment for
realized loss on foreign
currency translation............... 38,990 38,990
----------
Total other comprehensive loss... (54,042)
----------
Total comprehensive loss......... (677,482)
Common Stock issued:
Stock option exercises and stock
grants................................ 627 2,367 2,994
Contributions to employee 401(k) and
cash balance plan..................... 3,576 15,559 19,135
Debenture conversions.................. 244 5,284 5,528
Debenture extinguished using common
stock................................ 15,200 66,021 81,221
----------- ---------- ----------- ----------- ----------
Balance at December 31, 2001........... 292,154 2,246,055 (790,659) (291,199) 1,456,351
Comprehensive loss:
Net loss............................... (232,486) (232,486)
Other comprehensive income:
Foreign currency translation........ 43,776 43,776
Minimum pension liability
adjustment, net................... (7,202) (7,202)
Reclassification adjustment for
realized loss on foreign
currency translation.............. 47,479 47,479
----------
Total other comprehensive income 84,053
----------
Total comprehensive loss........ (148,433)
Common Stock issued:
Stock option exercises and stock
grants............................... 173 414 587
Contributions to employee 401(k)....... 4,683 13,467 18,150
----------- ---------- ----------- ----------- ----------
Balance at December 31, 2002............. 297,010 2,259,936 (1,023,145) (207,146) 1,326,655
Comprehensive income:
Net income............................. 85,082 85,082
Other comprehensive income:
Foreign currency translation........ 92,507 92,507
Minimum pension liability
adjustment, net................... 2,956 2,956
----------
Total other comprehensive income. 95,463
----------
Total comprehensive income....... 180,545
Common stock issued:
Stock option exercises and other....... 471 1,909 2,380
Contributions to employee 401(k)....... 4,559 12,819 17,378
----------- ---------- ----------- ----------- ----------
Balance at December 31, 2003............. $ 302,040 $2,274,664 $ (938,063) $ (111,683) $ 1,526,958
=========== =========== =========== =========== ==========
(See notes to consolidated financial statements)
46
SERVICE CORPORATION INTERNATIONAL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NOTE ONE
NATURE OF OPERATIONS
Service Corporation International (SCI or the Company) is the world's
largest provider of funeral and cemetery services. At December 31, 2003, we
operated 2,225 funeral service locations, 417 cemeteries and 183 crematoria
located in eight countries. We also had minority interest equity investments in
funeral and cemetery operations in the United Kingdom and Australia. In the
fourth quarter of 2003, we sold our minority interest equity investment in
Australia. Subsequent to December 31, 2003, we sold our funeral operations in
France to a joint venture on March 11, 2004. The French operations consisted of
963 funeral service locations and 39 crematoria at December 31, 2003.
The funeral service and cemetery operations consist of funeral service
locations, cemeteries, crematoria and related businesses. Personnel at the
funeral service locations provide all professional services relating to
funerals, including the use of funeral facilities and motor vehicles, and
preparation and embalming services. Funeral related merchandise (including
caskets, coffins, burial vaults, cremation receptacles, flowers and other
ancillary products and services) is sold at funeral service locations. Certain
funeral service locations contain crematoria. We sell prearranged funeral
services whereby a customer contractually agrees to the terms of a funeral to be
performed in the future. Our cemeteries provide cemetery property interment
rights (including mausoleum spaces, lots and lawn crypts) and sell cemetery
related merchandise (including stone and bronze memorials, burial vaults, casket
and cremation memorialization products) and services (primarily merchandise
installation fees and burial opening and closing fees). Cemetery items are sold
on an atneed or preneed basis. Personnel at cemeteries perform interment
services and provide management and maintenance of cemetery grounds. Certain
cemeteries operate crematoria, and certain cemeteries contain gardens
specifically for the purpose of cremation memorialization. There are 185
combination locations that contain a funeral service location within a Company
owned cemetery.
NOTE TWO
RESTATEMENT OF FINANCIAL STATEMENTS
The Company restated its previously issued financial statements for the
fiscal years ended December 31, 2000, 2001 and 2002, the interim quarters of
2000, 2001 and 2002, and the first three quarters of 2003, primarily related to
adjustments to Deferred preneed cemetery contract revenues. All applicable
amounts relating to these restatements have been reflected in the consolidated
financial statements and notes to the consolidated financial statements.
Effective January 1, 2000, the Company adopted the Securities and Exchange
Commission's Staff Accounting Bulletin No. 101, "Revenue Recognition in
Financial Statements" (SAB 101), and recorded a liability for Deferred preneed
cemetery contract revenues of approximately $1.8 billion. This deferred revenue
represented presold cemetery merchandise and services that had not been
delivered or had not been performed.
During 2000 through 2003, the Company identified approximately $110 million
of preneed cemetery contract items that had been already delivered or performed,
but for which no revenues had been recognized. Previously, the Company recorded
revenues associated with these preneed cemetery contract items as changes in
estimates in the periods identified in the Company's accounting system. The
Company has now determined to report the recognition of revenues for these items
in the periods in which the cemetery merchandise and services were delivered or
performed. Secondly, the Company also concluded that previously reported
deferred revenues included approximately $41 million of items for which delivery
or performance occurred, but revenue recognition had not occurred. Therefore,
the restatement includes adjustments related to these two items affecting the
cumulative effect of the adoption of SAB 101, revenues and deferred revenues
from 2000 through 2003 to report cemetery merchandise and service revenues in
the period these items were delivered or performed.
The Company has also reviewed its accounting policy for amortizing
prearranged funeral deferred selling costs and has changed the methodology for
amortizing these costs from a straight line basis to a method more in proportion
to when the associated revenues are recognized. The Company has included this
change in amortization in its restated results.
47
The effect of the restatement on the Company's previously reported
consolidated statement of operations and consolidated balance sheet for the
periods described above is as follows:
(Dollars in thousands, YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31,
except per share data) 2002 2001 2000
--------------------------- --------------------------- --------------------------
AS REPORTED AS RESTATED AS REPORTED AS RESTATED AS REPORTED AS RESTATED
----------- ----------- ----------- ----------- ----------- -----------
Selected consolidated statement of
operations data:
Revenues...................... $ 2,333,429 $ 2,323,619 $ 2,567,437 $ 2,518,294 $ 2,579,238 $ 2,599,021
Costs and expenses............ $(1,969,514) $(1,960,694) $(2,208,051) $(2,200,789) $(2,251,596) $(2,261,738)
Gross profits................. $ 363,915 $ 362,925 $ 359,386 $ 317,505 $ 327,642 $ 337,283
Operating income (loss)....... $ 1,510 $ 520 $ (338,846) $ (380,727) $ (252,885) $ (243,244)
Loss from continuing
operations before income
taxes and cumulative effects
of accounting changes....... $ (133,180) $ (134,170) $ (527,673) $ (569,554) $ (482,375) $ (472,734)
Benefit (provision) for
income taxes................ $ 36,860 $ 37,244 $ (64,223) $ (47,986) $ 78,825 $ 75,087
Cumulative effects of
accounting changes (net
of income taxes)............ $ (135,560) $ (135,560) $ (7,601) $ (7,601) $ (909,315) $ (866,084)
Net loss...................... $ (231,880) $ (232,486) $ (597,796) $ (623,440) $(1,343,251) $(1,294,117)
Basic and diluted earnings
per share:
Loss from continuing
operations before
cumulative effects
of accounting changes..... $ (.33) $ (.33) $ (2.08) $ (2.17) $ (1.48) $ (1.46)
Net loss................... $ (.79) $ (.79) $ (2.10) $ (2.19) $ (4.93) (4.75)
AS OF DECEMBER 31, 2002
----------------------------
AS REPORTED AS RESTATED
----------- -----------
Selected consolidated balance sheet data:
Inventories..................................... $ 135,529 $ 136,932
Total current assets............................ $ 617,521 $ 618,924
Deferred charges and other assets............... $ 718,567 $ 711,417
Total assets.................................... $10,723,785 $10,718,038
Deferred cemetery contract revenues, net........ $ 1,672,661 $ 1,629,540
Deferred income taxes........................... $ 429,868 $ 444,358
Accumulated deficit............................. $(1,046,029) $(1,023,145)
Total stockholders' equity...................... $ 1,303,771 $ 1,326,655
Total liabilities and stockholders' equity...... $10,723,785 $10,718,038
See note twenty-one to the consolidated financial statements for the effect
of the restatement upon quarterly unaudited financial data.
NOTE THREE
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of SCI and all
majority-owned subsidiaries. Intercompany balances and transactions have been
eliminated in consolidation.
The Company has classified gains and losses associated with early
extinguishments of debt as Other income, net in the consolidated statement of
operations. Previously, these gains and losses were classified as extraordinary
items. Additionally, the Company has classified gains from dispositions within
Gains and impairment (losses) on dispositions, net in the consolidated statement
of operations. Previously, gains from dispositions were presented separately
after Operating income in the consolidated statement of operations. The
reclassifications have been made for all years presented in accordance with
Statement of Financial Accounting Standards (SFAS) No. 145, "Revision of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections".
48
The Company has reported general agency (GA) revenues as funeral revenues
for all periods presented. Previously, the Company reported these GA revenues as
a reduction to selling expense in the consolidated statement of operations. See
note five to the consolidated financial statements for further discussion of GA
revenues. Additionally, certain other reclassifications have been made to prior
years to conform to current period presentation with no effect on the Company's
consolidated financial position, results of operations 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 expenses during the reporting period. As a result, actual
results could differ from these estimates.
In 2002, the Company changed its allocation methodology of overhead costs in
North America to be based on funeral and cemetery reporting unit revenues. The
change in overhead allocation has not impacted the Company's reported results of
operations, financial position or cash flows.
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 to reflect the remaining estimated
useful lives of these systems. The Company recognized additional amortization
related to this change in estimate of approximately $13,800 and $13,500 in the
years ended December 31, 2003 and 2002, respectively. This change in estimate
impacted net income by approximately $8,694, or diluted income per share of $.03
in 2003 and impacted net loss by approximately $8,500, or diluted loss per share
$.03 in 2002.
Cash Equivalents
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents.
Inventories and Cemetery Property
Funeral merchandise and cemetery burial property and merchandise are stated
at the lower of average cost or market.
Property, Plant and Equipment, net
Property, plant and equipment, net are recorded at cost. Maintenance and
repairs are charged to expense whereas renewals and major replacements that
extend the assets useful lives are capitalized. Depreciation is provided using
the straight line method over the estimated useful lives of the various classes
of assets. Property and plant are depreciated over a period ranging from seven
to forty years, equipment is depreciated over a period from three to eight years
and leasehold improvements are depreciated over the shorter of the lease term or
ten years. When property is sold or retired, the cost and related accumulated
depreciation are removed from the consolidated balance sheet; resulting gains
and losses are included in the consolidated statement of operations.
Goodwill
The excess of purchase price over the fair value of identifiable net assets
acquired in business combinations accounted for as purchases is recorded as
Goodwill. Prior to 2002, goodwill was amortized over its estimated life. Since
then, goodwill is no longer amortized but is tested annually for impairment by
assessing the fair value of each of the Company's reporting units (which is
generally one level below the Company's reportable segments). As of December 31,
2003, the Company's funeral segment reporting units are North America, France,
Germany, Singapore and Argentina. The Company's cemetery segment reporting units
are North America, Argentina, Chile and Uruguay. The Company determines the fair
value of its reporting units based on a combination of present value of expected
future cash flows and multiples of revenue in order to assess impairment of
goodwill.
Deferred Selling Costs
The Company defers selling costs that vary with and are primarily related to
the production of deferred revenues associated with (1) prearranged funeral
contracts (trust funded only) and (2) preneed cemetery contracts. These costs
are expensed in proportion to the corresponding revenue when recognized.
The Company reviews its deferred selling costs for impairment consistent
with the provision of SFAS 60, "Accounting and Reporting by Insurance
Enterprises" (SFAS 60). When circumstances indicate the deferred selling costs
are not recoverable compared to the associated portfolio of deferred revenue,
the amount deemed unrecoverable is recorded in earnings.
49
An allowance is provided against the deferred selling costs associated with
contract cancellations, with a corresponding charge to the consolidated
statement of operations. The allowance is determined from historical experience
and is based on the amount of unrecoverable deferred selling costs in relation
to the associated deferred revenue.
Impairment or Disposal of Long-Lived Assets
Except as noted for Goodwill and deferred selling costs, the Company reviews
its long-lived assets for impairment when changes in circumstances indicate that
the carrying amount of the asset may not be recoverable in accordance with
Statement of Financial Accounting Standards (SFAS) No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" (SFAS 144). SFAS 144 requires that
long-lived assets to be held and used be reported at the lower of carrying
amount or fair value. Assets to be disposed of and assets not expected to
provide any future service potential to the Company are recorded at the lower of
carrying amount or fair value less estimated cost to sell.
In January 2002, the Company ceased depreciation of certain operating assets
held for sale (which primarily included France and Chile). The Company later
determined transactions to sell or joint venture these assets would be delayed.
As a result, the Company resumed normal depreciation of those assets held in
France and Chile in the third quarter of 2002. In January 2003, the Company once
again classified the France operating assets held for sale and ceased
depreciation. In March 2004, the Company sold 75% of its funeral operations in
France.
Stock Options
The Company accounts for employee stock-based compensation expense under the
intrinsic value method. Under the intrinsic value method, no compensation
expense is recognized on stock options if the grant price equals the market
value on the date of grant. All of the Company stock option grants have been at
market value on the dates of each grant.
If the Company had elected to recognize compensation expense for its stock
option plans, based on the fair value of awards at their grant dates, net income
(loss) and earnings (loss) per share would have changed for the years ended
December 31 to the following pro forma amounts:
2003 2002 2001
--------- --------- ----------
(RESTATED) (RESTATED)
Net income (loss)................................. $ 85,082 $(232,486) $ (623,440)
Deduct: Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related
tax expense..................................... (6,720) (13,537) (17,680)
--------- --------- ----------
Pro forma net income (loss)....................... $ 78,362 $(246,023) $ (641,120)
======== ========= ==========
Basic and diluted net earnings (loss) per share... $ .28 $ (.79) $ (2.19)
Deduct: Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax
expense......................................... (.02) (.04) (0.06)
-------- --------- ----------
Pro forma basic and diluted net earnings (loss)
per share....................................... $ .26 $ (.83) $ (2.25)
======== ========= ==========
</Table>
The fair values of the Company's stock options used to calculate the pro
forma net income (loss) and earnings (loss) per share disclosures are calculated
as of the grant date using the Black-Scholes option-pricing model with the
following weighted average assumptions:
<Table>
<Caption>
ASSUMPTIONS 2003 2002 2001
------------------------------------------ ----------- ----------- -----------
Dividend yield........................... n/a 0.0 % 0.0%
Expected volatility...................... n/a 66.3% 62.0%
Risk-free interest rate.................. n/a 3.6% 5.1%
Expected holding period.................. n/a 6.1 years 7.1 years
Weighted average fair value.............. n/a $2.90 $2.68
The assumptions are not applicable for 2003, since the Company did not issue
stock options during the year.
The Black-Scholes option-pricing model is generally intended for use in
estimating the fair value of traded options, which have no vesting restrictions
and are fully transferable. Furthermore, option-pricing models require highly
subjective variable assumptions, such as the expected stock price volatility.
Therefore, the fair values of the Company's stock options presented in the pro
forma calculations are not necessarily representations of the actual fair values
of those stock options since the granted options have characteristics
significantly different from those of traded options, and the variables used,
under alternative assumptions, could cause the calculations to vary from those
presented.
Foreign Currency Translation
All assets and liabilities of the Company's foreign subsidiaries are
translated into U.S. dollars at exchange rates in effect as of the end of the
reporting period. Revenue and expense items are translated at the average
exchange rates for the reporting period. The resulting translation adjustments
are included in stockholders' equity as a component of Accumulated other
comprehensive income (loss) in the consolidated statement of stockholders'
equity.
50
The transactional currency gains and losses that arise from transactions
denominated in currencies other than the functional currencies of our operations
are recorded in Other income, net in the consolidated statement of operations.
Funeral Operations
Revenue is recognized when the funeral services are performed. The Company's
funeral trade receivables consist of amounts due for services already performed.
An allowance for doubtful accounts has been provided based on historical
experience. The Company sells price guaranteed prearranged funeral contracts
through various programs providing for future funeral services at prices
prevailing when the agreements are signed. Revenues associated with sales of
prearranged funeral contracts, which include accumulated trust earnings and
increasing insurance benefits, are deferred until such time that the funeral
services are performed. Allowances for customer cancellations are based upon
historical experience. See note five to the consolidated financial statements
regarding prearranged funeral activities.
Cemetery Operations
Revenue associated with sales of cemetery merchandise and services is
recognized when the service is performed or merchandise is delivered. The
Company's cemetery trade receivables consist of amounts due for services already
performed and merchandise already delivered. An allowance for doubtful accounts
has been provided based on historical experience. Revenue associated with sales
of preneed cemetery interment rights is recognized in accordance with the retail
land sales provisions of SFAS No. 66, "Accounting for the Sales of Real Estate"
(SFAS 66). Under SFAS 66, revenue from constructed cemetery property is not
recognized until a minimum percentage (10%) of the sales price has been
collected. Revenue related to the preneed sale of unconstructed cemetery
property is deferred until it is constructed and 10% of the sales price is
collected. Revenue associated with sales of preneed merchandise and services is
not recognized until the merchandise is delivered or the services are performed.
Allowances for customer cancellations for preneed cemetery contracts are based
upon historical experience.
Costs related to the sales of property interment rights include the property
and development costs specifically identified by project. At the completion of
the project, costs are charged to operations as revenue is recognized. Costs
related to sales of merchandise and services are based on actual costs incurred.
Pursuant to state or provincial law, all or a portion of the proceeds from
cemetery merchandise or services sold on a preneed basis may be required to be
paid into trust funds. The Company defers investment earnings related to these
merchandise and services trusts until the associated merchandise is delivered or
services are performed.
A portion of the proceeds from the sale of cemetery property interment
rights is required by state or provincial law to be paid into perpetual care
trust funds. Investment earnings from these trusts are distributed regularly,
are recognized in current cemetery revenues and are intended to defray cemetery
maintenance costs, which are expensed as incurred. The principal of such
perpetual care trust funds generally cannot be withdrawn by the Company and
therefore is not included in the consolidated balance sheet.
See note six to the consolidated financial statements regarding preneed
cemetery activities.
Derivatives
Derivative instruments are recognized in the consolidated balance sheet at
their fair values. For derivatives that qualify and are designated as hedges of
future cash flows or net foreign investments, the changes in fair values are
recorded in Other comprehensive income (loss) in the consolidated statement of
stockholders' equity. For derivatives that qualify and are designated as fair
value hedges, the changes in fair values are recorded in earnings, offset by the
recognition of the changes in fair values of the underlying hedged asset or
liability. The changes in fair values of derivatives that do not qualify for
hedge accounting and the ineffective portion of derivatives that do qualify for
hedge accounting are recorded in earnings.
Income Taxes
The Company calculates taxes on a consolidated basis. Deferred income taxes
are computed using the liability method and are provided on all temporary
differences between the financial basis and the tax basis of assets and
liabilities. The Company records a valuation allowance to reduce its deferred
tax assets when uncertainty regarding their realization exists. The Company
intends to permanently reinvest the unremitted earnings of certain of its
foreign subsidiaries in those businesses outside the United States and,
51
therefore, has not provided for deferred federal income taxes on such unremitted
foreign earnings. See note eight to the consolidated financial statements.
Equity Investments
The Company maintains certain equity interests in international operations
as a result of our strategy to dispose of all or a majority interest of all our
international operations outside of North America. At December 31, 2003, the
Company had a minority interest equity investment in operations in the United
Kingdom and at December 31, 2002 had minority interest equity investments in
operations in the United Kingdom, Australia and Spain. The Company accounts for
these investments in accordance with Accounting Principles Board Opinion No. 18,
"The Equity Method of Accounting for Investments in Common Stock." The Company
has not presented summarized financial information of the investees as they are
not material to the Company's financial position or results of operations or
cash flow.
NOTE FOUR
NEW ACCOUNTING PRONOUNCEMENTS AND ACCOUNTING CHANGES
In April 2003, the Financial Accounting Standards Board (FASB) issued SFAS
No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities" (SFAS 149). This statement amends and clarifies financial accounting
and reporting for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
derivatives) and for hedging activities under SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities" (SFAS 133). This statement is
effective for contracts entered into or modified after June 30, 2003 and for
hedging relationships designated after June 30, 2003. In addition, all
provisions of this statement should be applied prospectively. The provisions of
this statement that relate to SFAS 133 implementation issues that have been
effective for fiscal quarters that began prior to June 15, 2003, should continue
to be applied in accordance with their respective effective dates. The adoption
of SFAS No. 149 had no impact on the Company's financial condition, results of
operations or cash flows.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity" (SFAS
150). This statement establishes standards for the classification and
measurement of certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances). Many of those instruments were previously classified as equity.
This statement is effective for financial instruments entered into or modified
after May 31, 2003 and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003. These effective dates are not
applicable to the provisions of paragraphs 9 and 10 of SFAS 150 as they apply to
mandatorily redeemable noncontrolling interests, as the FASB has delayed these
provisions indefinitely. The adoption of SFAS 150 had no impact on the Company's
financial condition, results of operations or cash flows.
In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets"
(SFAS 142), the Company, effective January 1, 2002, recognized a charge
reflected as a cumulative effect of an accounting change of $135,560 (net of
applicable taxes) or $.46 per diluted share related to the impairment of
goodwill in its North America cemetery reporting unit.
In accordance with the accounting proscribed by SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities", and SFAS No. 138,
"Accounting for Certain Derivative Transactions and Certain Hedging Activities,
an amendment to FASB Statement No. 133", the Company, effective January 1, 2001,
recognized a charge reflected as a cumulative effect of an accounting change of
$7,601 (net of applicable taxes) or $0.03 per diluted share.
In December 2003, the FASB revised SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits" (SFAS 132). The revised SFAS
132 requires additional disclosures about the assets, obligations, cash flows
and net periodic benefit cost of defined benefit pension plans and other defined
benefit postretirement plans, of which certain disclosures are not required
until 2004. The Company has adopted the disclosure requirements that were
effective for 2003.
In January 2003, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities, an
Interpretation of Accounting Research Bulletin (ARB) No. 51". This
interpretation 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. In December 2003, the FASB
revised FASB Interpretation No. 46 (FIN 46R) which allowed companies with
certain types of variable interest entities to defer implementation until March
31, 2004.
The Company is in discussions with the Staff of the Securities and Exchange
Commission related to the implementation of FIN 46R. The discussion relates to
(i) the consolidation under FIN 46R of our prearranged funeral and preneed
cemetery merchandise and service trusts; (ii) the potential consolidation of our
cemetery perpetual care trust funds; and (iii) the policies of recognition of
the associated investment earnings of the trust funds.
The Company believes, at this time, that it will consolidate the prearranged
funeral and preneed cemetery merchandise and service trust funds upon
implementation of FIN 46R. Upon consolidation, the large majority of the trust
assets will be recorded at fair value. It is unclear at this time whether the
Company will consolidate the cemetery perpetual care trust funds upon
52
implementation of FIN 46R. Currently, the cemetery perpetual care trust funds
are not recognized on the Company's consolidated balance sheet. If the cemetery
perpetual care trust funds are consolidated, the Company believes it will
recognize an asset and a corresponding liability in its consolidated balance
sheet of approximately $650,000. The large majority of the assets of cemetery
perpetual care trust funds will be recorded at fair value.
Currently, the Company defers investment earnings associated with
prearranged funeral and preneed cemetery merchandise and service trust funds
until the corresponding merchandise is delivered or the service is performed. It
is unclear at this time whether this revenue recognition policy will continue
upon implementation of FIN 46R, or if the Company will have to recognize these
trust fund earnings in a revised manner, such as at the time the trust funds
themselves earn such investment earnings.
Realized investment earnings from cemetery perpetual care trust funds are
recognized in current cemetery revenues as they are intended to defray cemetery
maintenance costs. The Company expects to continue recognizing these investment
earnings under this new accounting policy.
The Company believes the consolidation of the prearranged funeral and
preneed cemetery merchandise and service trust funds (and possibly the cemetery
perpetual care trust funds) will have an effect on certain components within its
consolidated statement of cash flows. Upon such consolidation, proceeds from
sales of trust fund investments and disbursements for purchases of trust fund
investments will be shown as separate components of cash flows from investing
activities. Currently, the cash flows described above are reported within cash
flows from operations as they are receivables collected from third parties.
In addition to potentially consolidating these trust funds, the Company also
believes it will consolidate certain cemeteries managed by the Company, upon
implementation of FIN 46R. The Company expects to recognize a charge of
approximately $10,000 to $20,000, representing the cumulative effect of an
accounting change, as a result of consolidating these cemeteries managed by the
Company as of March 31, 2004. The results of operations and cash flows of these
cemeteries will be included in the Company's consolidated financial statements
upon implementation of FIN 46R, although no material impact is anticipated.
The Company is also discussing its accounting policies for insurance funded
prearranged funeral contracts (see note five to the consolidated financial
statements) with the Staff of the Securities and Exchange Commission. The
discussion relates to whether amounts recorded in Prearranged funeral contracts,
net and Deferred prearranged funeral contract revenues, net associated with such
contracts represent assets and liabilities of the Company as defined in
Statement of Financial Accounting Concepts No. 6, "Elements in Financial
Statements". If it is concluded that these amounts are not assets and
liabilities as defined, the Company will remove from our consolidated balance
sheet, amounts relating to insurance funded prearranged funeral contracts
recorded in Prearranged funeral contracts, net and Deferred prearranged funeral
contract revenues, net which, as of December 31, 2003, were approximately $4
billion and $4 billion, respectively. Such a change in accounting would have no
impact on the Company's consolidated stockholders' equity, results of operations
or cash flows.
In July 2003, the Emerging Issues Task Force of the FASB issued Issue No.
00-21, "Revenue Arrangements with Multiple Deliverables" (Issue 00-21). Issue
00-21 addresses certain aspects of the accounting by a vendor for arrangements
under which it will perform multiple revenue generating activities. The
provisions of Issue 00-21 were effective July 1, 2003 and have been applied
prospectively by the Company. Issue 00-21 did not have an impact on the
Company's results of operations, financial position or cash flows, as the
Company's revenue recognition policy is consistent with the provisions of Issue
00-21.
Effective January 1, 2004, the Company changed the accounting for gains and
losses on its pension plan assets and liabilities. The Company will recognize
such gains and losses in its consolidated statement of operations as such gains
and losses are incurred under pension accounting. Prior to January 1, 2004, the
Company amortized the difference between actual and expected investment returns
and actuarial gains and losses over seven years (except to the extent that
settlements with employees required earlier recognition). The Company believes
the change is preferable as the new method of accounting better reflects the
economic nature of the Company's pension plans and recognizes gains and losses
on the pension plan assets and liabilities in the year the gains or losses
occur. As a result of this accounting change, the Company expects to recognize a
charge for the cumulative effect of an accounting charge of approximately
$55,000 (on a pretax basis) as of January 1, 2004. This amount represents
accumulated unrecognized net losses related to the pension plan assets and
liabilities.
53
NOTE FIVE
PREARRANGED FUNERAL ACTIVITIES
The Company sells price-guaranteed prearranged funeral contracts through
various programs. Because the services or merchandise will not be provided until
the future, most states and provinces require that all or a portion of the
customer payments under these contracts be protected for the benefit of the
customers pursuant to applicable law. Some or all of the funds may be required
to be placed into trust accounts, or a surety bond may be posted in lieu of
trusting (collectively "trust funded prearranged funeral contracts").
Alternatively, where allowed, customers purchase a life insurance or annuity
policy from third party insurance companies to fund their prearranged funeral
("insurance funded prearranged funeral contracts"). The insurance policy
proceeds will be used to pay for the funeral goods and services selected at the
time of prearrangement. Under either customer funding option, the Company enters
into a prearranged funeral contract with the customer to provide funeral
services in the future at prices prevailing when the contract is signed. When
the prearranged funeral contract is consummated, the Company records an asset
(included in Prearranged funeral contracts, net) and corresponding liability
(included in Deferred prearranged funeral contract revenues, net) for the
contract price.
Funeral revenues are recognized in the consolidated statement of operations
on prearranged funeral contracts at the time the funeral service is performed.
Trust investment earnings, net of taxes and certain other expenses paid by the
trust, and increasing insurance benefits are accrued and deferred until the
services are performed, at which time these funds are also recognized in funeral
revenues. These amounts are intended to cover future increases in the cost of
providing a price-guaranteed funeral service.
Direct selling costs incurred pursuant to the sales of trust funded
prearranged funeral contracts are deferred and included in Deferred charges and
other assets in the consolidated balance sheet. The deferred selling costs are
expensed in proportion to the corresponding trust funded prearranged funeral
contract revenue when recognized. Deferred selling costs associated with trust
funded prearranged funeral contracts were $113,920 and $105,057 at December 31,
2003 and 2002, respectively. Direct selling costs incurred pursuant to the sales
of insurance funded prearranged funeral contracts are expensed as incurred. In
connection with insurance funded prearranged funeral contract sales, the
customer purchases a life insurance policy and the Company earns a commission as
the agent in the transaction between the customer and the third party insurance
company. Such general agency (GA) revenues are based on a percentage per
insurance policy sold and are recognized when the insurance purchase transaction
between the customer and the third party insurance company is complete. GA
revenues recognized by the Company totaled $27,700, $47,100 and $43,300, and
direct selling costs expensed by the Company totaled $23,900, $34,100, and
$37,300 for the years ended December 31, 2003, 2002 and 2001, respectively, in
connection with sales of insurance funded prearranged funeral contracts.
Prearranged Funeral Contracts, Net
Prearranged funeral contracts, net of allowance for cancellation, represents
amounts due from trust funds, customer receivables and third party insurance
companies related to unperformed, price-guaranteed prearranged funeral
contracts. The components of prearranged funeral contracts, net in the
consolidated balance sheet at December 31 are as follows:
2003 2002
----------- ----------
Trust funded prearranged funeral contracts:
Receivables due from trust assets.................... $ 965,296 $ 983,357
Receivables from customers........................... 188,817 228,524
----------- ----------
Trust funded prearranged funeral contracts......... 1,154,113 1,211,881
Insurance funded prearranged funeral contracts......... 3,958,881 3,442,170
---------- ----------
5,112,994 4,654,051
Allowance for cancellation......................... (378,135) (372,278)
---------- ----------
Prearranged funeral contracts, net..................... $4,734,859 $4,281,773
========== ==========
Upon cancellation of a trust funded prearranged funeral contract, a customer
is generally entitled to receive a refund of the funds held in trust. In many
jurisdictions, the Company may be obligated to fund any shortfall if the amounts
deposited by the customer exceeds the funds in trust. As a result, when realized
or unrealized losses of a trust result in trust funded prearranged funeral
contracts being under-funded, the Company assesses those contracts to determine
whether a loss provision should be recorded. No loss amounts have been required
to be recognized as of December 31, 2003.
54
Accumulated investment earnings from trust funds and increasing insurance
benefits of third party insurance companies have been included to the extent
that they have been accrued through December 31, 2003 and 2002, respectively.
The trust-related assets above have been reduced by the trust investment
earnings the Company has been allowed to withdraw prior to death maturity and
amounts received from customers that were not required to be deposited into
trust pursuant to various state laws.
The activity in prearranged funeral contracts, net for the years ended
December 31 is as follows:
2003 2002
----------- -----------
Beginning balance - Prearranged funeral contracts,
net............................................. $4,281,773 $4,109,195
Net sales, net of receipts on bonded contracts
and amounts retained by the Company on trust
funded contracts.............................. 610,326 601,816
Dispositions of businesses...................... (81,281) (293,888)
Net undistributed investment earnings and
increasing insurance benefits................. 17,554 43,217
Maturities and distributed earnings............. (414,947) (370,336)
Change in cancellation allowance................ (5,857) (4,778)
Effect of foreign currency ..................... 286,321 136,692
Other........................................... 40,970 59,855
---------- ----------
Ending balance - Prearranged funeral contracts, net $4,734,859 $4,281,773
========== ==========
The cost and market value of the assets held in the trust funds underlying
the Company's trust funded prearranged funeral contracts at December 31 are
detailed below. The Company believes the unrealized losses related to certain of
the assets held in trust funds are temporary in nature.
2003 2002
----------------------------- ----------------------------
COST MARKET COST MARKET
------------- ------------ ------------ ------------
Cash and cash equivalents................... $ 65,354 $ 65,354 $ 78,010 $ 78,010
Fixed income securities:
U.S. Treasury........................... 226,098 224,316 88,017 91,979
Foreign government...................... 74,340 74,016 54,954 56,000
Corporate............................... 6,483 6,456 11,763 12,401
Mortgage-backed......................... 91,438 87,767 103,793 105,024
Asset-backed............................ 9,042 8,782 2,722 2,820
Municipal and other..................... 32,096 32,014 452 458
Equity securities:
Common stock............................ 315,725 345,807 473,257 413,488
Mutual funds:
Equity.................................. 54,046 59,358 59,487 50,172
Fixed income............................ 46,021 47,116 54,639 56,155
Private equity and other.................... 44,653 33,064 56,263 48,106
--------- --------- --------- ---------
Receivables due from trust assets........... $ 965,296 $ 984,050 $ 983,357 $ 914,613
========= ========= ========= =========
Market value as of a percentage of cost..... 101.9% 93.0%
========= =========
Deferred Prearranged Funeral Contract Revenues, Net
Deferred prearranged funeral contract revenues, net of allowance for
cancellation, represent the original contract price plus the net trust
investment earnings and increasing insurance benefits associated with
unperformed prearranged funeral contracts. The following table summarizes the
activity in deferred prearranged funeral contract revenues, net for the years
ended December 31:
2003 2002
----------- -----------
Beginning balance - Deferred prearranged funeral contract
revenues, net.............................................. $ 4,659,994 $ 4,596,116
Net sales.................................................. 644,463 647,119
Dispositions of businesses................................. (85,418) (361,005)
Net investment earnings and increasing insurance benefits.. 17,785 43,307
Maturities................................................. (438,303) (387,144)
Change in cancellation allowance........................... (5,857) (4,778)
Effect of foreign currency................................. 286,789 134,892
Other...................................................... 37,989 (8,513)
----------- -----------
Ending balance - Deferred prearranged funeral contract
revenues, net.............................................. $ 5,117,442 $ 4,659,994
=========== ===========
55
NOTE SIX
PRENEED CEMETERY ACTIVITIES
The Company sells price-guaranteed preneed cemetery contracts providing for
future property interment rights, merchandise or services at prices prevailing
when the agreements are signed. Some or all of the funds received under these
contracts for merchandise or services may be required to be placed into trust
accounts, or a surety bond may be posted in lieu of trusting, pursuant to
applicable law.
Direct selling costs incurred pursuant to the sales of preneed cemetery
contracts are deferred and included in Deferred charges and other assets in the
consolidated balance sheet. The deferred selling costs are expensed in
proportion to the corresponding revenue when recognized. Deferred selling costs
related to preneed cemetery contracts were $205,123 and $200,478 as of December
31, 2003 and 2002, respectively.
Preneed Cemetery Contracts, Net
Preneed cemetery contracts, net of allowance for cancellation, represents
amounts due from trust funds and customer receivables (net of unearned finance
charges) for contracts sold in advance of when the property interment rights,
merchandise or services are needed. The components of Preneed cemetery
contracts, net in the consolidated balance sheet at December 31 are as follows:
2003 2002
---------- ----------
Receivables due from trust assets............................. $ 862,265 $ 859,338
Receivables due from customers................................ 523,680 620,731
Unearned finance charges...................................... (75,785) (102,394)
---------- ----------
1,310,160 1,377,675
Allowance for cancellation.................................... (225,524) (211,853)
--------- ----------
$1,084,636 $1,165,822
========== ==========
Interest rates on cemetery contracts range from 3.5% to 15.7%. The average
term of a financed preneed cemetery contract is approximately 4.6 years.
The activity in preneed cemetery contracts, net for the years ended December
31 is as follows:
2003 2002
---------- ----------
Beginning balance - Preneed cemetery contracts, net........... $1,165,822 $1,294,102
Net sales including deferred and recognized revenues....... 364,149 443,889
Dispositions of businesses................................. (10,806) (18,194)
Net undistributed investment earnings (losses)............. 5,468 (30,799)
Cash receipts from customers, net of refunds............... (455,043) (496,165)
Deposits to trust.......................................... 127,249 145,003
Maturities, deliveries and associated earnings............. (117,605) (142,805)
Change in cancellation allowance........................... (17,466) (2,380)
Effect of foreign currency................................. 10,353 (12,049)
Other...................................................... 12,515 (14,780)
---------- ----------
Ending balance - Preneed cemetery contracts, net.............. $1,084,636 $1,165,822
========== ==========
The change in cancellation allowance includes amounts related to receivables
due from customer for recognized revenues, as well as deferred revenues.
56
Merchandise and Services Trusts
Amounts paid into cemetery merchandise and services trusts are included in
Preneed cemetery contracts, net, at cost, in the consolidated balance sheet. The
cost and market values associated with the assets held in the cemetery
merchandise and services trust funds underlying these receivables at December 31
are detailed below. The Company believes the unrealized losses related to
certain of the assets held in trust funds are temporary in nature.
2003 2002
-------------------------- -------------------------
COST MARKET COST MARKET
---------- --------- --------- ---------
Cash and cash equivalents.......................... $ 65,737 $ 65,737 $ 85,526 $ 85,526
Fixed income securities:
U.S. Treasury.................................. 115,208 116,763 120,140 131,133
Foreign government............................. 14,671 15,200 11,096 11,096
Corporate...................................... 6,135 6,374 4,464 4,867
Mortgage-backed................................ 202,096 205,010 150,007 156,891
Asset-backed................................... 12,731 13,306 1,549 1,657
Municipal and other............................ 2,121 2,321 4,188 4,340
Equity securities:
Common stock................................... 298,830 337,351 320,116 273,937
Mutual funds:
Equity......................................... 79,370 90,655 88,609 70,794
Fixed income................................... 32,450 33,125 41,807 42,273
Private equity and other........................... 32,916 25,125 31,836 26,702
---------- --------- --------- ---------
Receivables due from trust assets.................. $ 862,265 $ 910,967 $ 859,338 $ 809,216
========== ========== ========== ==========
Market value as a percentage of cost............... 105.6% 94.2%
========== ==========
All investment earnings related to these cemetery merchandise and services
trust funds are deferred until the associated merchandise is delivered or
service is performed. The investment earnings recognized in the consolidated
statement of operations related to these cemetery merchandise and services trust
funds were $9,094, $8,165, and $8,379, for the years ended December 31, 2003,
2002, and 2001, respectively.
Deferred Cemetery Contract Revenues, Net
Deferred cemetery contract revenues, net of allowance for
cancellation, represent the original contract price for the preneed cemetery
items deferred plus net investment earnings associated with the deferred items.
The following table summarizes the activity in Deferred preneed cemetery
contract revenues, net for the years ended December 31 is as follows:
2003 2002
----------- ------------
(RESTATED)
Beginning balance - Deferred cemetery contract revenues, net.......... $1,629,540 $1,703,110
Net sales......................................................... 215,660 302,691
Dispositions of businesses........................................ (43,106) (45,312)
Net investment earnings (losses).................................. 14,688 (28,364)
Maturities, deliveries and associated earnings.................... (220,119) (289,326)
Change in cancellation allowance.................................. (18,718) 3,149
Effect of foreign currency........................................ 5,904 3,032
Other............................................................. (8,497) (19,440)
---------- -----------
Ending balance - Deferred cemetery contract revenues, net............. $1,575,352 $1,629,540
========== ==========
57
Perpetual Care Trusts
The Company is required by state or provincial law to pay into perpetual
care trust funds a portion of the proceeds from the sale of cemetery property
interment rights. The principal of such perpetual care trust funds generally
cannot be withdrawn by the Company and therefore is not included in the
consolidated balance sheet. The cost and market values associated with the
assets held in perpetual care trust funds at December 31 are detailed below.
2003 2002
--------------------------- --------------------------
COST MARKET COST MARKET
---------- --------- --------- ----------
Cash and cash equivalents............ $ 54,292 $ 54,292 $ 63,932 $ 63,932
Fixed income securities:
U.S. Treasury.................... 18,201 18,871 64,473 67,226
Foreign government............... 27,774 28,765 20,978 21,726
Corporate........................ 78,667 82,463 57,488 60,470
Mortgage-backed.................. 94,995 94,926 94,996 98,359
Asset-backed..................... 61,456 60,787 18,052 19,588
Municipal and other.............. 13,942 14,505 2,731 3,295
Equity securities:
Preferred stock.................. 15,486 15,857 13,906 12,632
Common stock..................... 76,033 81,265 25,428 23,717
Mutual funds:
Equity........................... 32,734 36,741 29,311 28,470
Fixed income..................... 121,426 128,621 142,086 136,281
Private equity and other............. 33,040 35,707 30,896 35,563
---------- --------- --------- ----------
Perpetual care trust assets.......... $ 628,046 $ 652,800 $ 564,277 $ 571,259
========== ========== ========== ==========
Market value as a percentage of cost. 103.9% 101.2%
========== ==========
Investment earnings from these perpetual care trust funds are distributed
regularly, are recognized in current cemetery revenues and are used to defray
cemetery maintenance costs, which are expensed as incurred. The investment
earnings related to these perpetual care trust funds were $31,018, $26,611, and
$29,926 for the years ended December 31, 2003, 2002, and 2001, respectively.
NOTE SEVEN
GOODWILL
The changes in the carrying amounts of goodwill for the Company's two
segments are as follows:
FUNERAL CEMETERY
SEGMENT SEGMENT TOTAL
------------ ---------- ----------
Balance as of December 31, 2001................................ $ 1,246,273 $ 163,036 $1,409,309
Impairment loss recorded upon adoption of SFAS No. 142...... - (146,794) (146,794)
Goodwill reduction related to disposition programs.......... (68,078) (14,220) (82,298)
Effect of foreign currency and other........................ 4,076 (115) 3,961
------------ ---------- ----------
Balance as of December 31, 2002................................ 1,182,271 1,907 1,184,178
Goodwill reduction related to disposition programs.......... (11,663) - (11,663)
Effect of foreign currency and other........................ 22,531 377 22,908
------------ ---------- ----------
Balance as of December 31, 2003................................ $ 1,193,139 $ 2,284 $1,195,423
============ ========== ==========
In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets"
(SFAS 142), the Company, effective January 1, 2002, recognized a charge
reflected as a cumulative effect of an accounting change of $135,560 (net of
applicable taxes) or $.46 per diluted share related to the impairment of
goodwill in its North America cemetery reporting unit.
58
The following table shows the 2001 historical results compared to unaudited
pro forma effects of SFAS 142 had goodwill not been amortized during that
period.
2001
----------
(RESTATED)
Loss from continuing operations before cumulative effects of
accounting changes............................................. $ (617,540)
Add back: Goodwill amortization, net of taxes.................... 47,455
----------
Pro forma loss from continuing operations before cumulative
effects of accounting changes.................................. $ (570,085)
==========
Net loss.......................................................... $ (623,440)
Add back: Goodwill amortization, net of taxes.................... 47,455
----------
Pro forma net loss................................................ $ (575,985)
==========
Basic and diluted earnings (loss) per share from continuing
operations before cumulative effects of accounting changes..... $ (2.17)
Add back: Goodwill amortization, net of taxes.................... .17
----------
Pro forma basic and diluted loss per share from continuing
operations before cumulative effects of accounting changes..... $ (2.00)
==========
Basic and diluted net loss per share.............................. $ (2.19)
Add back: Goodwill amortization, net of taxes.................... .17
----------
Pro forma basic and diluted net loss per share.................... $ (2.02)
==========
NOTE EIGHT
INCOME TAXES
The provision or benefit for income taxes includes United States federal
income taxes, determined on a consolidated return basis, foreign, state and
local income taxes.
Income (loss) from continuing operations before income taxes and cumulative
effects of accounting changes for the years ended December 31 is as follows:
2003 2002 2001
--------- ---------- ----------
(RESTATED) (RESTATED)
United States.................... $ 5,765 $ (192,157) $ (604,150)
Foreign.......................... 108,568 57,987 34,596
--------- ---------- ----------
$ 114,333 $ (134,170) $ (569,554)
========= ========== ==========
59
Income tax provision (benefit) for the years ended December 31 consisted of
the following:
2003 2002 2001
--------------- -------------- --------------
(RESTATED) (RESTATED)
Current:
United States................. $ 2,050 $ (127,426) $ (25,432)
Foreign....................... 18,203 (15,161) 9,935
State and local............... 4,306 (1,498) 4,001
--------- ---------- ---------
$ 24,559 $ (144,085) $ (11,496)
Deferred:
United States................. $ 1,237 $ 86,576 $ 55,054
Foreign....................... 8,505 22,207 2,856
State and local............... (5,050) (1,942) 1,572
--------- ---------- ---------
$ 4,692 $ 106,841 $ 59,482
--------- ---------- ---------
$ 29,251 $ (37,244) $ 47,986
========= ========== =========
The Company made income tax payments on continuing operations of
approximately $14,462, $8,920 and $22,423 excluding income tax refunds of
$97,724, $63,547 and $122,522 for the years ended December 31, 2003, 2002 and
2001, respectively. Net tax refunds of $83,262, $54,627 and $100,099 include one
time refunds of approximately $950, $21,962 and $116,300 related to losses on
sales of investments and one time refunds of approximately $93,569, 35,306 and
$0 related to approval of a change in tax accounting method for years 2003, 2002
and 2001, respectively.
The differences between the U.S. federal statutory income tax rate and the
Company's effective tax rate for the years ended December 31 were as follows:
2003 2002 2001
-------- --------- ----------
(RESTATED) (RESTATED)
Computed tax provision (benefit) at the applicable federal
statutory income tax rate....................................... $ 40,017 $ (46,960) $ (199,344)
State and local taxes, net of federal income tax benefits.......... (484) (2,236) 3,623
Dividends received deduction and tax exempt interest............... (471) (638) (1,668)
Amortization of goodwill........................................... - - 9,619
Foreign jurisdiction tax rate difference........................... (5,893) (8,333) (16,173)
Foreign net operating loss utilization............................. (531) (9,895) -
Write down of assets and other losses with no tax benefit.......... 119 28,554 111,984
Tax benefit associated with dispositions........................... (3,350) - -
Accounting for asset impairment.................................... - 5,683 143,646
Other.............................................................. (156) (3,419) (3,701)
-------- --------- ----------
Provision (benefit) for income taxes............................ $ 29,251 $ (37,244) $ 47,986
======== ========= ========
Total effective tax rate........................................ 25.6% 27.8% (8.4)%
======== ========= ========
60
Deferred taxes are determined based on differences between the financial
reporting and tax bases of assets and liabilities and are measured using the
enacted marginal tax rates. The tax effects of temporary differences and
carry-forwards that give rise to significant portions of deferred tax assets and
liabilities as of December 31 consisted of the following:
2003 2002
---------- ----------
(RESTATED)
Inventories and cemetery property, principally due to purchase
accounting adjustments............................................. $ 436,209 $ 452,545
Property, plant and equipment, principally due to depreciation and
to purchase accounting adjustments................................. 97,135 152,934
Other................................................................. 100,019 102,408
---------- ----------
Deferred tax liabilities.............................................. 633,363 707,887
---------- ----------
Receivables, principally due to sales of cemetery interment rights
and related products............................................... (5,357) (51,382)
Deferred revenue on prearranged funeral and cemetery contracts,
principally due to earnings from trust funds....................... (108,702) (13,682)
Accrued liabilities................................................... (58,231) (91,097)
Loss and tax credit carry-forwards.................................... (100,593) (282,896)
---------- ----------
Deferred tax assets................................................... (272,883) (439,057)
---------- ----------
Valuation allowance................................................... 37,168 158,001
---------- ----------
Net deferred income taxes............................................. $ 397,648 $ 426,831
========== ==========
Current refundable income taxes and current deferred tax assets are included
in Other current assets, while long-term deferred tax assets are included in
Deferred charges and other assets in the consolidated balance sheet. Current
taxes payable and current deferred tax liabilities are reflected as Income taxes
in the consolidated balance sheet and long-term tax liabilities are included in
Other liabilities in the consolidated balance sheet. The Company had a tax
receivable of $92,445 at December 31, 2002, which was subsequently received in
February 2003. The Company joint ventured its French subsidiary in March 2004.
The current tax liability of the French subsidiary is $17,376 at December 31,
2003.
During 2003, as a result of the restructuring of debt and equity of certain
foreign subsidiaries, the Company incurred $1,619 of foreign withholding taxes
and provided $9,009 of additional United States income taxes. At December 31,
2003 and 2002, United States income taxes had not been provided on $147,720 and
$73,852, respectively, of the remaining undistributed earnings of foreign
subsidiaries since it is the Company's intent not to remit these earnings. The
Company intends to permanently reinvest these undistributed foreign earnings in
those businesses outside the United States and, therefore, has not provided for
U.S. income taxes on such earnings. The unremitted earnings of the Company's
French subsidiary at December 31, 2003 was $102,864.
The Company maintains accruals for tax liabilities which relate to uncertain
tax matters. If these tax matters are unfavorably resolved, the Company will
make any required payments to tax authorities. If these tax matters are
favorably resolved, the accruals maintained by the Company will no longer be
required and these amounts will be reversed through the tax provision at the
time of resolution.
Amounts related to the prior year's writedown of assets held for sale,
categorized as U.S. Capital loss carry-forwards and reduced by a full valuation
allowance, have been reclassified to Other deferred tax liabilities in the
current period with no change to Net deferred income taxes. This
reclassification is a result of changes to the expected tax effect of
disposition of these assets.
Various subsidiaries have international, federal and state carry-forwards of
$794,820 with expiration dates through 2022. The Company believes that some
uncertainty exists with respect to future realization of certain state and
international carry-forwards, therefore a valuation allowance has been
established for those carry-forwards where uncertainty exists. The valuation
allowance is primarily attributable to state net operating losses and is due to
complexities of the various state laws restricting state net operating loss
utilization.
61
The loss carry-forwards will expire as follows:
<Table>
<Caption>
2004................................................ $ 18,318
2005................................................ 24,491
2006................................................ 28,043
2007................................................ 16,975
2008................................................ 1,613
Thereafter.......................................... 705,380
----------------
Total............................................ $ 794,820
================
</Table>
NOTE NINE
DEBT
Debt as of December 31 was as follows:
2003 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............................................... 3,557 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...... 38,368 39,531
Mortgage notes and other debt, maturities through 2050........................ 69,734 76,758
Deferred charges.............................................................. (49,594) (62,401)
----------- ------------
Total debt............................................................... 1,711,565 1,984,838
Less current maturities.................................................. (182,682) (100,330)
----------- ------------
Total long-term debt.............................................. $ 1,528,883 $ 1,884,508
============== ==============
The aggregate maturities of debt for the five years subsequent to December
31, 2003, are as follows:
<Table>
2004................................................................................ $ 182,682
2005................................................................................ 301,043
2006................................................................................ 178,432
2007................................................................................ 155,469
2008................................................................................ 520,385
2009 and thereafter................................................................. 423,148
----------
Total.............................................................................. $1,761,159
==========
</Table>
62
Bank Credit Agreements
The Company's bank credit agreement, which matures in July 2005, provides a
total lending 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 December 31, 2003 or December 31,
2002; however, the Company used the credit agreement sublimit to issue letters
of credit, in the amounts of $69,815 and $85,845 at December 31, 2003, and
December 31, 2002, respectively. Interest rates for the outstanding borrowings
are based on various indices as determined by the Company. The Company also pays
a quarterly fee on the unused commitment, which ranges from 0.50% to 0.75% based
on the percentage of the facility used, and was 0.625% at December 31, 2003 and
December 31, 2002.
Debt Issuances and Exchanges
In September 2002, the Company issued $172,183 of unregistered 7.70% notes
due 2009 in connection with an exchange offer to holders of an equivalent
principal amount of its existing 6.00% notes due 2005. Upon settlement of the
exchange offer, the Company paid approximately $11,480 in closing fees,
incentive payments and accrued interest. In January 2003, the Company exchanged
substantially all of the unregistered notes issued in September 2002 for an
equivalent principal amount of registered 7.70% notes due 2009 with
substantially identical terms.
Debt Settlements and Extinguishments
During the year ended December 31, 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; $37,213 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 year ended December 31,
2003, of $1,315, recorded in Other income, net, in the consolidated statement of
operations.
On March 15, 2003, as required by the terms of the agreement, the Company
repaid the remaining $76,273 due on the 6.3% notes due 2003.
Aside from the $172,183 of 6.00% notes due 2005 that were extinguished in
the previously mentioned exchange offer, the Company also purchased the
following notes in the open market during the year ending December 31, 2002:
$2,850 of the 7.00% notes due 2015 (putable 2002); $166,483 of the 6.30% notes
due 2003; $116,810 of the 7.375% notes due April 2004; $1,043 of the 8.375%
notes due December 2004; $22,126 of the 6.00% notes due 2005; $16,995 of the
notes due 2008; $1,000 of the 7.70% notes due 2009; and $15,618 of mortgage
notes and other debt. As a result of these transactions, the Company recognized
gains on early extinguishments of debt totaling $7,783, recorded in Other
income, net, in the consolidated statement of operations.
In May 2002, the Company's French subsidiary satisfied $113,500 of debt
associated with the financial restructuring of the Company's French subsidiary
with non-cash French financial assets. On June 1, 2002, substantially all of the
holders of the 7.00% notes due 2015 (putable 2002) presented the notes for
payment pursuant to the terms of the embedded put options. The Company paid the
holders in accordance with the terms of the agreement.
Additional Debt Disclosures
The Company's consolidated debt had a weighted average interest rate of
6.95% at December 31, 2003, compared to 6.87% at December 31, 2002.
Approximately 99% of the total debt had a fixed interest rate at December 31,
2003 and 2002.
Cash interest payments for the three years ended December 31, 2003, were as
follows:
<Table>
2003..................................................................... $136,691
2002..................................................................... 158,585
2001..................................................................... 218,429
</Table>
63
At December 31, 2003 and 2002, respectively, the Company had deposited
$95,325 and $23,592 in restricted interest-bearing accounts that were held as
security for various credit instruments, which were included in Deferred charges
and other assets in the consolidated balance sheet. In addition, the Company had
assets of approximately $35,205 and $40,845 pledged as collateral for the
mortgage notes and other debt at December 31, 2003 and 2002, respectively.
Included in mortgage notes and other debt, the Company had capital lease
obligations totaling $25,438 and $26,822 at December 31, 2003, and 2002.
Approximately $24,194 of the capital lease obligations reported at December 31,
2003, was related to vehicles in the Company's France operations.
NOTE TEN
DERIVATIVES
The Company occasionally participates in hedging activities using a variety
of derivative instruments, including interest rate swap agreements,
cross-currency swap agreements, and forward exchange contracts. These
instruments are used to hedge exposure to risk in the interest rate and foreign
exchange rate markets. The Company has documented policies and procedures to
monitor and control the use of derivative instruments and executes transactions
with a limited group of creditworthy financial institutions. The Company
generally does not engage in derivative transactions for speculative or trading
purposes, nor is it a party to leveraged derivatives.
The Company was not a party to any derivative transactions during the year
ended December 31, 2003. Subsequent to December 31, 2003, the Company executed
certain forward exchange contracts to hedge its net foreign investment in
France. The derivative transactions have an aggregate notional value of
EUR 240,000 with a corresponding aggregate notional value of $301,719.
During the year ended December 31, 2002, in connection with the purchase of
the 6.30% notes due 2020 (putable 2003), the Company terminated options embedded
in the extinguished securities by exchanging them for new options with
economically equivalent terms. The initial liability of $16,213 was recorded
with the early extinguishment of debt in Accounts payable and accrued
liabilities in the consolidated balance sheet and subsequently the Company
recognized a charge of $40,787 in Other operating expenses in the consolidated
statement of operations. In October 2002, the Company paid $57,000 in full
settlement of the options associated with the 6.30% notes due 2020 (putable
2003), thereafter presented as the 6.30% notes due 2003.
During 2002, the Company hedged a portion of its net foreign investments in
the United Kingdom and Europe by engaging in certain forward exchange contracts,
having aggregate notional values of GBP 70,000 and EUR 100,000 and a
corresponding aggregate notional value of $188,662. These forward exchange
contracts were settled during 2002 at a loss of $11,836, which was recorded in
the Other comprehensive income (loss) in the consolidated statement of
stockholders' equity.
In accordance with the accounting proscribed by SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities", and SFAS No. 138,
"Accounting for Certain Derivative Transactions and Certain Hedging Activities,
an amendment to FASB Statement No. 133", the Company, effective January 1, 2001,
recognized a charge reflected as a cumulative effect of an accounting change of
$7,601 (net of applicable taxes) or $0.03 per diluted share.
NOTE ELEVEN
CREDIT RISK AND FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair Value Estimates
The fair value estimates of the following financial instruments have been
determined using available market information and appropriate valuation
methodologies. The carrying values of cash and cash equivalents, trade
receivables and trade payables accurately represent the fair values of those
instruments due to the short-term nature of the instruments. The fair values of
receivables on prearranged funeral contracts and cemetery contracts, excluding
prearranged funeral trust funds and cemetery merchandise and services trust
funds (see notes five and six to the consolidated financial statements,
respectively) are impracticable to estimate because of the lack of a trading
market and the diverse number of individual contracts with varying terms. The
carrying value of other notes receivable approximates the fair value, as the
Company regularly reviews the loans for impairment. At December 31, 2003 and
2002, other notes receivable, net, included in Other current assets and Deferred
charges and other assets in the consolidated balance sheet, totaled $50,546 and
$79,724, respectively. In addition, the Company had $0 and $9,615 in outstanding
undrawn commitments at December 31, 2003 and 2002, respectively.
64
The fair values of the Company's debt at December 31 were as follows:
2003 2002
--------- ---------
6.3% notes due 2003................................................. $ - $ 83,953
7.375% notes due April 2004......................................... 112,858 110,773
8.375% notes due December 2004...................................... 52,194 50,797
6.0% notes due 2005................................................. 277,900 364,007
7.2% notes due 2006................................................. 157,125 142,500
6.875% notes due 2007............................................... 149,573 137,250
6.5% notes due 2008................................................. 202,800 179,000
6.75% convertible subordinated notes due 2008,
conversion price of $6.92......................................... 329,892 302,995
7.7% notes due 2009................................................. 387,823 348,912
6.95% amortizing notes due 2010..................................... 3,577 39,087
7.875% debentures due 2013.......................................... 57,157 49,578
Convertible debentures, maturities through 2013, fixed interest
rates from 4.75% to 5.5%, conversion prices from $13.02 to
$50.00 per share.................................................. 38,176 34,728
Mortgage notes and other debt, maturities through 2050.............. 69,734 76,756
---------- ----------
Total fair value of debt.................................. $1,838,809 $1,920,336
========== ==========
The fair values of the Company's long-term, fixed rate and convertible debt
securities were estimated using market conditions for those securities or for
other securities having similar terms and maturities. Mortgage notes and other
debt have been reported at face value because of the diverse terms and
conditions and non-trading nature of these notes.
Credit Risk Exposure
The Company's cash deposits, some of which exceed insured limits, were
distributed among various regional and national banks in the jurisdictions in
which the Company operates. In addition, the Company regularly invests excess
cash in financial instruments, which are not insured, such as money-market funds
and Eurodollar time deposits that are offered by a variety of reputable
financial institutions and commercial paper that is offered by corporations with
high quality credit ratings. The Company believes that the credit risk
associated with such instruments is minimal.
The Company grants credit in the normal course of business. The credit risk
associated with funeral, cemetery and prearranged funeral and preneed cemetery
receivables due from customers is generally considered minimal because of the
diversification of the customers served. Furthermore, bad debts have not been
significant relative to the volume of deferred revenues. Customer payments on
prearranged funeral or preneed cemetery contracts that are either placed into
state regulated trusts or used to pay premiums on life insurance contracts
generally do not subject the Company to collection risk. Insurance funded
contracts are subject to supervision by state insurance departments and are
protected in the majority of states by insurance guaranty acts.
NOTE TWELVE
COMMITMENTS AND CONTINGENCIES
Leases
The Company's leases principally relate to funeral home facilities,
transportation equipment and two aircraft. The majority of the Company's
operating leases contain options to (i) purchase the property at fair value on
the exercise date, (ii) purchase the property for a value determined at the
inception of the leases, or (iii) renew for the fair rental value at the end of
the primary lease term. Rental expense for these leases was $77,133, $89,291,
and $92,895 for the years ended December 31, 2003, 2002, and 2001, respectively.
In 2002, the Company entered into certain capital leases primarily related to
vehicles in its France operations, which constituted approximately $27,748 of
the Company's future minimum lease payments for capital lease obligations at
December 31, 2003. The Company also has future minimum lease payments related to
operating leases in its France operations of approximately $28,248. As of
December 31, 2003, future minimum lease payments for operating and capital
leases exceeding one year are as follows:
65
OPERATING CAPITAL
---------- ----------
2004............................................... $ 50,138 $ 7,429
2005............................................... 38,932 8,348
2006............................................... 27,046 5,462
2007............................................... 18,575 2,611
2008............................................... 11,298 2,195
2009 and thereafter................................ 27,986 3,011
---------- ----------
Subtotal..................................... 173,975 29,056
Less: Subleases................................. (3,287) -
---------- ----------
Total........................................ $ 170,688 29,056
========== ----------
Less: interest on capital leases................
(3,618)
----------
Total principal payable on capital leases.......... $ 25,438
==========
Purchase Commitments
The Company has a purchase agreement for its North America operations with a
major casket manufacturer, having an original minimum commitment of $750,000 for
a six-year period expiring at the end of 2004. The agreement contains provisions
for annual price adjustments and provides for a one-year extension period to
December 31, 2005 in which the Company is allowed to satisfy any remaining
commitment that exists at the end of the original term. During 2003, the Company
made minimum purchases of approximately $95,000 under this purchase agreement,
and at December 31, 2003, the remaining commitment was for $287,000.
Management, Consulting and Non-Competition Agreements
The Company has entered into management, employment, consulting and
non-competition agreements, generally for five to ten years, with certain
officers and employees of the Company and former owners of businesses acquired.
The Company has modified several of the above agreements as part of cost
rationalization programs (see note eighteen to the consolidated financial
statements). During the years ended December 2003, 2002, and 2001, the Company
recognized expense of $45,766, $56,878, and $70,758, respectively, related to
these agreements. At December 31, 2003, the maximum estimated future cash
commitment under agreements with remaining commitment terms was as follows:
<Table>
2004....................................................................... $ 50,177
2005....................................................................... 25,467
2006....................................................................... 18,556
2007....................................................................... 9,845
2008....................................................................... 3,886
2009 and thereafter........................................................ 7,695
--------
Total................................................................ $115,626
========
</Table>
Contingent Purchase Obligations
In connection with certain acquisitions made by the Company's South America
operations, the Company entered into contingent purchase obligations with
certain former owners of those businesses. According to the agreements, the
Company is required to pay additional consideration between 2003 and 2005, based
on the results of operations, as defined. The additional consideration may be
paid partially in the Company's common stock at the discretion of the former
owners and is currently estimated to be $53,000, recorded in Other liabilities
in the consolidated balance sheet. The Company currently expects to pay amounts
related to this contingency in 2005.
Representations and Warranties
The Company has contingent obligations of $39,123 resulting from the
Company's international asset sales and joint venture transactions. In some
cases, the Company has agreed to guarantee certain representations and
warranties with such disposition transactions with letters of credit or interest
bearing cash investments. The Company has interest bearing cash investments of
$13,830 included in Deferred charges and other assets collateralizing these
contingent obligations. The Company does not believe it will ultimately be
required to fund to third parties any claims against these representations and
warranties.
Subsequent to December 31, 2003, the Company agreed to certain
representations and warranties associated with the disposition of its investment
in France. The undiscounted amount of the representations and warranties
associated with the sale is approximately
66
$36 million and includes indemnifications related to taxes and other
obligations.
The Company also has entered into other representations and warranties
associated with North America asset sales that it does not believe are material
in nature.
Litigation
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 probable of being paid and can be reasonably estimated. The following
discussion describes certain litigation and proceedings as of March 12, 2004.
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 and other financial matters, including in connection with the
ECI merger. 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 parties
have met on at least two occasions to discuss a possible resolution of this
case, but no progress was made. The Company anticipates that another meeting
will be held in mid-April 2004 to discuss a possible resolution of this matter.
The ultimate outcome of the Consolidated Lawsuit cannot be determined at this
time and the Company cannot predict the outcome of any efforts to resolve the
case. To the extent the Consolidated Lawsuit is not settled, the Company intends
to aggressively defend this lawsuit.
Several other lawsuits have been filed against the Company, the Individual
Defendants and other defendants, including, in the first lawsuit listed below,
the Company's independent auditors, PricewaterhouseCoopers LLP, in Texas state
courts by former ECI shareholders, officers and directors. These lawsuits
include the following matters:
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 (Fredrick 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 Hammer matter has been ordered to arbitration; however,
the Company is engaged in negotiations to resolve this matter. To the extent
these lawsuits are not settled, the Company intends to aggressively defend these
lawsuits.
67
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 (the District Court) to compel the Conway plaintiffs to
arbitrate their claims in Houston, Texas. The District Court recently entered an
order compelling 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.
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, 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 named 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 were persons whose claims had been reduced to
judgment or had been settled as of the date of class certification. The
defendants appealed the trial court's order regarding class certification.
68
The plaintiffs alleged that defendants had 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 alleged that the above conduct
constituted 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 sought an unspecified amount of compensatory and punitive damages.
The Court granted plaintiffs' motion for leave to amend their complaint to
include punitive damages. Plaintiffs also sought 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 represented individuals
who filed numerous separate lawsuits setting forth individual claims similar to
those in the Consumer Lawsuit. 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.
Based on consultation with legal counsel, as of September 30, 2003, the
Company had accrued approximately $23 million related to these claims. In
December 2003, based on developments in the Consumer Lawsuit after the filing of
our Form 10-Q for the third quarter of 2003, the Company entered into an
agreement in principle to settle the Consumer Lawsuit and the above individual
related lawsuits. A settlement agreement pertaining specifically to the Consumer
Lawsuit was filed with the court on March 2, 2004 and a motion for preliminary
court approval of the settlement agreement was filed on March 3, 2004. A court
hearing on this motion is scheduled for March 17, 2004. All claims under the
Consumer Lawsuit will be dismissed if final court approval of the settlement is
obtained. The terms of the proposed settlement call for the Company to make
payments totaling approximately $100 million in settlement of these claims. As
of December 31, 2003, the Company had recorded reserves of $100 million relating
to this matter. In the fourth quarter of 2003, the Company recognized a
receivable of $25 million for expected recoveries under one primary layer of the
Company's insurance coverage related to the litigation.
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 the same allegations as the Consumer
Lawsuit with the exception that it does not contain class allegations. In
addition to the Guralnick Lawsuit, counsel filed a lawsuit containing cemetery
mismanagement allegations styled Diane Wolff, Arlene Benowitz, Michael Wolff,
Randee Wolff Blumstein, and Martha Freedberg v. SCI, Funeral Services of
Florida, Inc. a Florida corporation d/b/a Menorah Gardens & Funeral Chapels,
Service Corporation International, a Texas Corporation, Menorah Partnership, a
Florida General Partnership, and Sharon Gardens Limited Partnership, a Florida
Limited Partnership; In the Circuit Court in the Fifteenth Judicial Circuit in
and for Palm Beach County, Florida, Case No. 2003CA013025 (Wolff Lawsuit).
The Company intends to continue its investigation and to aggressively defend
itself in the Guralnick and Wolff Lawsuits, 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 Florida litigation. In February 2004, the Company
negotiated a plea arrangement with the Special Assistant State Attorney for Palm
Beach County to resolve the criminal charges; however, the court rejected the
plea arrangement. The Company intends to continue to seek a resolution to this
matter and, to the extent it is not settled, the Company will vigorously defend
its interests in this matter.
Edgar Neufeld v. Service Corporation International, et.al,; Cause No.
CV-S-03-1561-HDM-PAL; In the United States District Court for the District of
Nevada, filed December 12, 2003; and Rujira Srisythemp v. Service Corporation
International, et. al.; Cause No. CV-S-03-1392-LDG-LRL; In the United States
District for the District of Nevada, filed November 10, 2003, (collectively, the
Nevada actions). The Nevada actions were filed in connection with the
circumstances surrounding the Consumer Lawsuit. The plaintiffs in the Nevada
actions allege that the Company failed to disclose, or falsely stated, material
information relating to the circumstances surrounding the Consumer Lawsuit.
Since the Nevada actions are in their preliminary stages, no discovery has
69
occurred, and the Company cannot quantify its ultimate liability, if any, for
the payment of damages. The Company intends to aggressively defend itself in the
Nevada actions.
Joshua Ackerman v. Service Corporation International, et. al.; Cause No.
04-CV-20114; In the United States District Court for the Southern District of
Florida court, filed January 15, 2004 (Miami action). The Miami action was filed
in connection with the circumstances surrounding the Consumer Lawsuit and is
similar to the Nevada actions. The plaintiffs in the Miami action allege that
the Company failed to disclose, or falsely stated, material information relating
to the circumstances surrounding the Consumer Lawsuit. Since the Miami action is
in its preliminary stages, no discovery has occurred, and the Company cannot
quantify its ultimate liability, if any, for the payment of damages. The Company
intends to aggressively defend itself in the Miami action.
The Company has substantial face amount of insurance coverage which it
believes is applicable to these litigation related matters. There are various
unresolved coverage issues relative to such insurance, and the Company is
currently involved in litigation with certain of its insurance carriers
regarding these matters. For that reason, the Company has not accrued an
estimated receivable for insurance recoveries other than the $25 million
receivable recorded in the fourth quarter of 2003 as described above. Such
receivables are recorded when they are probable of being 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.
NOTE THIRTEEN
STOCKHOLDERS' EQUITY
Share Authorization
The Company is authorized to issue 1,000,000 shares of preferred stock, $1
per share par value. No preferred shares were issued as of December 31, 2003 and
2002. At December 31, 2003 and 2002, respectively, 500,000,000 common shares of
$1 par value were authorized. The Company had 302,039,871 and 297,010,237 shares
issued and outstanding, net of 2,469,445 and 2,516,396 shares held in treasury
at par.
Share Purchase Rights Plan
The Board of Directors has adopted a preferred share purchase rights plan
and has declared a dividend of one preferred share purchase right for each share
of common stock outstanding. The rights are exercisable in the event certain
investors attempt to acquire 20% or more of the common stock of the Company and
entitle the rights holders to purchase certain securities of the Company or the
acquiring company. The rights, which are redeemable by the Company for $.01 per
right, expire in July 2008 unless extended.
Stock Benefit Plans
The Company has benefit plans whereby shares of the Company's common stock
may be issued pursuant to the exercise of stock options granted to officers and
key employees. The Company's Amended 1996 Incentive Plan reserves 24,000,000
shares of common stock for outstanding and future awards of stock options,
restricted stock and other stock based awards to officers and key employees of
the Company. The Company's 1996 Non-qualified Incentive Plan reserves 8,700,000
shares of common stock for outstanding and future awards of nonqualified stock
options to employees who are not officers of the Company.
The benefit plans allow for options to be granted as either non-qualified or
incentive stock options. The options are granted with an exercise price equal to
the then current market price of the Company's common stock. The options are
generally exercisable at a rate of 33 1/3% each year unless alternative vesting
methods are approved by the Company's Compensation Committee of the Board of
Directors.
At December 31, 2003 and 2002, respectively, 4,434,123 and 5,005,623 options
were outstanding with alternative vesting methods. Under the alternative vesting
methods, partial or full accelerated vesting will occur when the price of
Company common stock reaches pre-determined prices. If the pre-determined stock
prices are not met in the required time period, the options will fully
70
vest in periods ranging from eight to ten years from grant date. At December 31,
2003 and 2002, 7,407,502 and 6,168,833, respectively, were reserved for future
option grants under all stock option plans.
The following tables set forth certain stock option information:
WEIGHTED
AVERAGE
EXERCISE
OPTIONS PRICE
---------- ----------
Outstanding at December 31, 2000 25,293,793 $ 17.92
Granted...................... 9,083,100 3.98
Exercised.................... (136,414) 4.32
Canceled..................... (4,291,215) 21.94
---------- ----------
Outstanding at December 31, 2001 29,949,264 13.18
Granted...................... 5,699,100 4.32
Exercised.................... (42,633) 4.38
Canceled..................... (5,604,481) 12.51
---------- ----------
Outstanding at December 31, 2002 30,001,250 11.63
Granted...................... 0 0
Exercised.................... (382,295) 3.70
Canceled..................... (1,303,735) 25.67
---------- ----------
Outstanding at December 31, 2003 28,315,220 $ 10.77
========== ==========
Exercisable at December 31, 2001 12,824,879 $ 18.72
========== ==========
Exercisable at December 31, 2002 16,194,767 $ 14.81
========== ==========
Exercisable at December 31, 2003 20,845,928 $ 10.76
========== ==========
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------------------- ------------------------------------
NUMBER WEIGHTED-AVERAGE NUMBER
RANGE OF OUTSTANDING AT REMAINING WEIGHTED-AVERAGE EXERCISABLE AT WEIGHTED-AVERAGE
EXERCISE PRICE DECEMBER 31, 2003 CONTRACTUAL LIFE EXERCISE PRICE DECEMBER 31, 2003 EXERCISE PRICE
-------------- ----------------- ---------------- -------------- ----------------- ---------------
$0.00 -- 4.00 8,190,329 4.8 $ 3.35 5,449,359 $ 3.34
4.00 -- 5.00 3,937,347 2.2 4.40 3,072,331 4.39
5.00 -- 10.00 5,765,400 5.1 5.79 3,716,594 6.19
10.00 -- 20.00 6,513,447 2.9 16.07 6,483,947 16.07
20.00 -- 38.00 3,908,697 1.9 31.24 2,123,697 30.84
- --------------- --------- --------- --------- --------- -------
$0.00 -- 38.00 28,315,220 3.7 $ 10.77 20,845,928 $ 10.76
=============== ========== ========= ========= ========== =======
Since all of the Company's option grants have been at market value on the
dates of each grant, the Company has not recognized compensation expense on
stock options under its accounting policy using the intrinsic value method.
Under the Company's 2001 Stock Plan for Non-Employee Directors, non-employee
directors may elect to receive an award of restricted stock annually through the
year 2005. The annual award cannot exceed 15,000 shares of common stock per
director and vests after one year of service. No shares were issued under this
stock plan in 2003. In 2002 and 2001, each non-employee director was awarded
10,000 shares of common stock.
The Company's Director Fee Plan allows for compensation to non-employee
directors to be partially paid in common stock. In 2003, 2002, and 2001,
respectively, 155,560; 45,108; and 36,784 shares of common stock were granted
under the Director Fee Plan. Certain directors, as permitted in the plan
agreement, have elected to defer the issuance of stock granted under this plan.
In 2003, 2002, and 2001, respectively, 60,614; 21,724; and 6,688 shares were
reserved for future issuance under this plan.
71
Accumulated Other Comprehensive Income (Loss)
The Company's components of accumulated other comprehensive income (loss) at
December 31 are as follows:
FOREIGN MINIMUM ACCUMULATED
CURRENCY PENSION OTHER
TRANSLATION LIABILITY COMPREHENSIVE
ADJUSTMENT ADJUSTMENT INCOME (LOSS)
------------- ------------ -------------
Balance at December 31, 2000.............. $ (224,433) $ (12,724) $ (237,157)
Activity in 2001....................... (76,403) (16,629) (93,032)
Reclassification adjustment for
realized loss on foreign currency
translation.......................... 38,990 -- 38,990
------------- ------------ -------------
Balance at December 31, 2001.............. (261,846) (29,353) (291,199)
Activity in 2002....................... 43,776 (7,202) 36,574
Reclassification adjustment for
realized loss on foreign currency
translation.......................... 47,479 -- 47,479
------------- ------------ -------------
Balance at December 31, 2002.............. $ (170,591) $ (36,555) $ (207,146)
Activity in 2003....................... 92,507 2,956 95,463
------------- ------------ -------------
Balance at December 31, 2003.............. $ (78,084) $ (33,599) $ (111,683)
============= ============ =============
Included in Foreign currency translation adjustment are net gains of
$59,877 and an associated deferred tax asset of $59,662 related to the
Company's France operations that were held for sale at December 31, 2003.
The minimum pension liability adjustment of $33,599 at December 31, 2003 is
net of deferred taxes of $21,274.
NOTE FOURTEEN
RETIREMENT PLANS
The Company has a non-contributory, defined benefit pension plan covering
approximately 40% of United States employees (US Pension Plan), a supplemental
retirement plan for certain current and former key employees (SERP), a
supplemental retirement plan for officers and certain key employees (Senior
SERP), and a retirement plan for certain non-employee directors (Directors'
Plan). The Company also has established a 401(k) employee savings plan.
Effective January 1, 2001, the Company curtailed its US Pension Plan, SERP,
Senior SERP and Directors' Plan and recognized a curtailment loss of $3,572 in
2001. As these plans have been frozen, the participants do not earn additional
benefit from additional years of service and the Company does not incur new
service cost subsequent to 2000.
Retirement benefits for the US Pension Plan are generally based on years of
service and compensation. This contribution is an actuarially determined amount
consistent with the funding requirements of the Employee Retirement Income
Security Act of 1974. Assets of the pension plan consist primarily of fixed
income investments and marketable equity securities.
Retirement benefits under the SERP are based on years of service and average
monthly compensation, reduced by benefits under the pension plan and Social
Security. The Senior SERP provides retirement benefits based on years of service
and position. The Directors' Plan provides for an annual benefit to directors
following their retirement, based on a vesting schedule.
Most foreign employees are covered by their respective foreign government
mandated or defined contribution plans which are adequately funded and are not
considered significant to the financial condition or results of operations of
the Company. The plans' liabilities and their related costs are computed in
accordance with the laws of the individual countries and appropriate actuarial
practices.
72
The components of net periodic benefit cost for the years ended December 31
were as follows:
2003 2002 2001
---------- ---------- -------
Service cost--benefits earned during the
period.......................................... $ -- $ -- $ 5,081
Interest cost on projected benefit obligation... 9,897 9,824 14,474
Return on plan assets........................... (6,808) (8,539) (13,569)
Settlement/curtailment charge................... 352 -- 3,572
Amortization of unrecognized transition asset... -- -- (418)
Amortization of prior service cost.............. 183 197 114
Recognized net loss............................. 7,586 4,834 2,826
--------- -------- -------
$ 11,210 $ 6,316 $12,080
========= ======== =======
The plans' funded status at December 31 were as follows (based on valuations
as of September 30):
2003 2002
-------- --------
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation at beginning of year.................. $142,842 $193,325
Interest cost............................................. 9,897 9,824
Settlement charge......................................... (16,145) (13,325)
Actuarial loss............................................ 14,796 3,642
Benefits paid............................................. (6,977) (6,683)
Effects of dispositions................................... - (43,941)
-------- --------
Benefit obligation at end of year......................... $144,413 $142,842
======== ========
CHANGE IN PLAN ASSETS:
Fair value of plan assets at beginning of year............ $ 77,461 $147,075
Actual return on plan assets.............................. 13,263 (10,528)
Employer contributions.................................... 6,989 3,214
Settlement charge......................................... (12,692) (13,325)
Benefits paid............................................. (10,712) (7,299)
Effects of dispositions................................... - (41,676)
-------- --------
Fair value of plan assets at end of year.................. $ 74,309 $ 77,461
======== ========
Funded status of plan..................................... $(70,105) $(65,381)
Unrecognized actuarial loss............................... 54,873 59,701
Unrecognized prior service cost........................... 1,173 1,357
-------- --------
Net amount recognized..................................... $(14,059) $ (4,323)
======== ========
FUNDING SUMMARY:
Projected benefit obligation.............................. $144,413 $142,842
Accumulated benefit obligation............................ 144,413 142,842
Fair value of plan assets................................. 74,309 77,461
AMOUNTS RECOGNIZED IN THE CONSOLIDATED BALANCE SHEET:
Prepaid benefit cost...................................... $ - $ -
Accrued benefit liability................................. (70,105) (65,381)
Intangible asset.......................................... 1,173 1,357
Accumulated other comprehensive loss...................... 54,873 59,701
-------- --------
Net amount recognized..................................... $(14,059) $ (4,323)
======== ========
The retirement benefits under the SERP, Senior SERP and Directors' Plan are
unfunded obligations of the Company. As of December 31, 2003, the benefit
obligation of the SERP, Senior SERP and Director's Plan is $33,764; however, the
Company purchased various life insurance policies on the participants in the
Senior SERP with the intent to use the proceeds or any cash value buildup from
such policies to assist in meeting, at least to the extent of such assets, the
plan's funding requirements. The cash surrender value of these insurance
policies is $21,952 as of December 31, 2003.
The change in minimum liability included in Accumulated other comprehensive
loss was a decrease of $4,828 in 2003, and an increase of $11,762 in 2002.
The plans' weighted-average assumptions used to determine the benefit
obligation and net benefit cost were as follows. Due to the curtailment of the
plans, the assumed rate of compensation increase is zero.
2003 2002
-------- --------
Discount rate used to determine obligations................ 6.25% 7.00%
Assumed rate of return on plan assets...................... 9.00% 9.00%
73
The plans weighted-average asset allocations at December 31 by asset
category are as follows:
2003 2002
-------- --------
Fixed income investments................................... 26% 23%
Equity securities.......................................... 74% 77%
-------- --------
Total 100% 100%
Equity securities include shares of Company common stock in the amounts of
$7,138 (9 percent of plan assets) and $4,394 (6 percent of plan assets) at
December 31, 2003 and 2002, respectively. The 9.0% assumed rate of return on
plan assets is a result of a high allocation of equity securities within the
plan assets.
The primary investment objective of the plan is to achieve a rate of
investment return over time that will allow the plan to achieve a fully funded
status, while maintaining prudent investment return volatility levels. The
investment manager of the Company recommends an asset allocation strategy of 65%
equity and 35% fixed income. Allocations within the equity asset class are
divided among large capitalization domestic equity (value and growth styles),
small capitalization domestic equity (value and growth styles) and international
equity. The large capitalization domestic equity may be further diversified
between active and passive (index) management styles. The fixed income
allocation is divided between cash and an intermediate-term investment grade
bond portfolio. The investment strategy is managed within ranges that are
centered at specific allocation targets. The specific allocations within the
strategy, as well as the individual asset class ranges are as follows:
RANGES
---------------
Large cap equity (value and growth)................ 35% - 45%
Small gap growth................................... 5% - 15%
International equity............................... 10% - 20%
Fixed income
Core bond..................................... 20% - 40%
High yield.................................... 0% - 10%
SCI stock.......................................... 0% - 10%
Money market....................................... 0% - 5%
Benefit payments are expected to be paid by the plan as follows:
2004............................................... $ 4,120
2005............................................... 4,405
2006............................................... 4,700
2007............................................... 5,108
2008............................................... 5,569
Years 2009 thru 2013............................... $33,709
The 2001 balances included a defined benefit pension plan for the Company's
United Kingdom operations (UK Plan). In 2002, the Company joint ventured the
United Kingdom operations and as such, retirement plans included in 2002 are for
U.S. employees only. Discount rates for the U.S. plans were 6.25% and 7.00% in
2003 and 2002, respectively. All plans subject to this disclosure were curtailed
effective January 1, 2001.
Effective January 1, 2004, the Company changed the accounting for gains and
losses on its pension plan assets and obligations. The Company will recognize
such gains and losses in our consolidated statement of operations in the year
such gains and losses are incurred. Prior to January 1, 2004, the Company
amortized the difference between actual and expected investment returns and
actuarial gains and losses over seven years (except to the extent that
settlements with employees required earlier recognition). The Company believes
this change in accounting is preferable as the new method of accounting better
reflects the economic nature of the Company's pension plans and recognizes gains
and losses on the pension plan assets and obligations in the year the gains and
losses occur. As a result of this accounting change, the Company expects to
recognize a charge for the cumulative effect of an accounting change of
approximately $55,000 (on a pretax basis) as of January 1, 2004. This amount
represents accumulated unrecognized net losses related to the pension plan
assets and obligations.
Pursuant to this accounting change and the infusion of approximately $20,000
to the U.S. pension plan in 2004, the Company intends to rebalance the assets of
the plan to reduce the percent invested in equity and fixed income securities
and incorporate investments in hedge funds.
74
The Company has an employee savings plan that qualifies under section 401(k)
of the Internal Revenue Code for the exclusive benefit of its United States
employees. Under the plan, participating employees may contribute a portion of
their pretax and/or after tax income in accordance with specified guidelines up
to a maximum of 50%. The Company then matches a percentage of the employee
contributions through contributions of the Company's common stock. For 2003 and
2002, the Company match was based upon the following:
YEARS OF VESTING SERVICE PERCENTAGE OF DEFERRED COMPENSATION
--------------------------------- --------------------------------------------
0 - 5 years..................... 75% of the first 6% of deferred compensation
6 - 10 years.................... 110% of the first 6% of deferred compensation
11 or more years................ 135% of the first 6% of deferred compensation
The amount of Company matched common stock contributions in 2003, 2002 and
2001 was $17,378, $18,150 and $12,635, respectively.
NOTE FIFTEEN
SEGMENT REPORTING
The Company's operations are product based 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 of its United Kingdom operations, which conducted both funeral and
cemetery operations in this European segment.
In 2002, the Company changed its allocation methodology of overhead costs in
North America to be based on funeral and cemetery reporting unit revenues. The
change in overhead allocation has not impacted the Company's consolidated
results of operations, financial position or cash flows.
The Company's reportable segment information is as follows:
REPORTABLE
FUNERAL CEMETERY SEGMENTS
------------- ----------- -------------
2003
Revenues from external customers..................... $ 1,743,983 $ 597,668 $ 2,341,651
Depreciation and amortization........................ 84,292 64,879 149,171
Gross profit......................................... 282,561 83,237 365,798
Total assets......................................... 7,379,001 3,453,958 10,832,959
Capital expenditures................................. $ 69,622 $ 44,401 $ 114,023
Operating locations at year end (unaudited).......... 2,356 469 2,825
(RESTATED)
------------------------------------------------------
2002
Revenues from external customers..................... $ 1,682,506 $ 641,113 $ 2,323,619
Depreciation and amortization........................ 70,644 74,377 145,021
Gross profit......................................... 284,669 78,256 362,925
Total assets......................................... 6,985,601 3,340,081 10,325,682
Capital expenditures................................. $ 69,940 $ 44,271 $ 114,211
Operating locations at year end (unaudited).......... 2,526 507 3,033
(RESTATED)
------------------------------------------------------
2001
Revenues from external customers..................... $ 1,864,797 $ 653,497 $ 2,518,294
Depreciation and amortization........................ 142,888 79,326 222,214
Gross profit......................................... 263,299 54,206 317,505
Total assets......................................... 7,121,991 3,994,939 11,116,930
Capital expenditures................................. $ 56,824 $ 26,596 $ 83,420
Operating locations at year end (unaudited).......... 3,210 541 3,751
75
The following table reconciles certain reportable segment amounts to the
Company's corresponding consolidated amounts:
REPORTABLE
SEGMENTS CORPORATE CONSOLIDATED
------------- ---------- -------------
2003
Revenue from external customers..................... $ 2,341,651 $ - $ 2,341,651
Depreciation and amortization....................... 149,171 11,887 161,058
Total assets........................................ 10,832,959 369,710 11,202,669
Capital expenditures (1)............................ 114,023 1,977 116,000
(RESTATED)
-----------------------------------------------------
2002
Revenue from external customers..................... $ 2,323,619 $ - $ 2,323,619
Depreciation and amortization....................... 145,021 34,712 179,733
Total assets........................................ 10,325,682 392,356 10,718,038
Capital expenditures (1)............................ 114,211 12,924 127,135
(RESTATED)
-----------------------------------------------------
2001
Revenue from external customers..................... $ 2,518,294 $ - $ 2,518,294
Depreciation and amortization....................... 222,214 19,426 241,640
Total assets........................................ 11,116,930 448,440 11,565,370
Capital expenditures (1)............................ 83,420 2,574 85,994
- ------------
(1) Consolidated capital expenditures include $0, $27,090 and $11,830 for the
years ended December 31, 2003, 2002, and 2001, respectively, for capital
leases and purchases of property, plant and equipment, cemetery property,
and goodwill of acquired businesses. The 2001 amount relates to assets
previously held by the Company's lending subsidiary exchanged for collateral
in bankruptcy proceedings. Excluding these capital expenditures related to
acquired businesses the Company had consolidated capital expenditures of
$116,000, $100,045 and $74,164 for the years ended December 31, 2003, 2002,
and 2001, respectively.
The following table reconciles gross profits from reportable segments shown
above to the Company's consolidated income (loss) before income taxes and
cumulative effects of accounting changes:
2003 2002 2001
----------- ------------ ----------
(RESTATED) (RESTATED)
Gross profit from reportable segments.......................... $ 365,798 $ 362,925 $ 317,505
General and administrative expenses....................... (178,101) (89,752) (70,309)
Gains and impairment (losses) on dispositions, net........ 50,350 (177,743) (626,992)
Other operating expenses.................................. (9,004) (94,910) (931)
----------- ------------ ----------
Operating income (loss)........................................ 229,043 520 (380,727)
Interest expense.......................................... (143,426) (161,494) (211,626)
Other income.............................................. 28,716 26,804 22,799
----------- ------------ ----------
Income (loss) from continuing operations before income
taxes and cumulative effects of accounting changes.......... $ 114,333 $ (134,170) $ (569,554)
=========== ============ ==========
76
The Company's geographic segment information was as follows:
NORTH OTHER
AMERICA EUROPE FOREIGN TOTAL
----------- --------- ---------- ----------
2003
Revenues from external customers..................... $ 1,706,413 $ 591,704 $ 43,534 $2,341,651
Depreciation and amortization........................ 160,358 170 530 161,058
Operating income (loss).............................. 147,569 69,858 11,616 229,043
Gains and impairment (losses) on dispositions, net... 51,050 (734) 34 50,350
Other operating expenses............................. (9,004) - - (9,004)
Long-lived assets.................................... 4,278,981 367,405 63,461 4,709,847
Operating locations at year end (unaudited).......... 1,786 1,016 23 2,825
(RESTATED) (RESTATED)
----------- ----------
2002
Revenues from external customers..................... $ 1,792,578 $ 496,409 $ 34,632 $2,323,619
Depreciation and amortization........................ 170,247 8,943 543 179,733
Operating income (loss).............................. (43,424) 52,206 (8,262) 520
Gains and impairment (losses) on dispositions, net... (162,870) 941 (15,814) (177,743)
Other operating expenses............................. (94,910) - - (94,910)
Long-lived assets.................................... 4,351,458 255,096 44,965 4,651,519
Operating locations at year end (unaudited).......... 1,866 1,143 24 3,033
(RESTATED) (RESTATED)
----------- ----------
2001
Revenues from external customers..................... $ 1,789,110 $ 647,714 $ 81,470 $2,518,294
Depreciation and amortization........................ 192,284 40,614 8,742 241,640
Operating income (loss).............................. 179,289 (317,856) (242,160) (380,727)
Gains and impairment (losses) on dispositions, net... (4,805) (370,775) (251,412) (626,992)
Other operating expenses............................. (931) - - (931)
Long-lived assets.................................... 5,034,613 718,405 52,076 5,805,094
Operating locations at year end (unaudited).......... 1,999 1,726 26 3,751
Included in the North American figures above are the following United
States amounts:
2003 2002 2001
------------ ----------- -----------
(RESTATED) (RESTATED)
Revenues from external customers................... $ 1,623,437 $ 1,716,264 $ 1,709,501
Operating income (loss) (1)........................ 130,325 (56,986) 157,508
Long-lived assets.................................. 4,120,455 4,232,672 4,911,741
Operating locations at year end (unaudited)........ 1,632 1,714 1,842
</Table>
Included in the European figures above are the following French amounts:
2003 2002 2001
------------ ----------- -----------
Revenues from external customers................... $ 584,636 $ 473,643 $ 425,129
Operating income (loss) (1)........................ 68,884 49,207 (100,580)
Long-lived assets.................................. 364,570 265,415 317,190
Operating locations at year end (unaudited)........ 1,002 1,125 1,139
(1) Operating income (loss) includes $41,036, ($257,907) and ($15,049) in Gains
and impairment (losses) on dispositions, net and other operating expenses
in the United States and ($734), $2,347 and ($124,844) in France for the
years ended December 31, 2003, 2002, and 2001, respectively.
77
In March 2004, the Company completed a joint venture transaction of its
funeral operations in France and retained a 25% minority interest equity
investment in the acquiring entity. The Company will account for its 25%
ownership of France using the equity method of accounting in 2004.
During 2003 and 2002, the Company divested of 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 144 because either the divested operations were held for
sale in accordance with previous accounting pronouncements related to
dispositions or they do not meet the criteria as defined in SFAS 144. Summary
operating results of the Company's divested operations are as follows.
NORTH AMERICA EUROPE
----------------------------- -------------------------------
2003 2002 2003 2002
------------ ------------- ------------- --------------
(RESTATED)
Revenues:
Funeral............................................. $ 12,234 $ 42,441 $ - $ 14,284
Cemetery............................................ 4,421 18,867 - 2,190
---------- --------- -------- ----------
$ 16,655 $ 61,308 $ - $ 16,474
========== ========= ======== ==========
Gross profits (loss):
Funeral............................................. $ (3,686) $ (1,544) $ - $ 3,358
Cemetery............................................ (1,005) 2,422 - 740
---------- --------- -------- ----------
$ (4,691) $ 878 $ - $ 4,098
========== ========= ======== ==========
TOTAL
---------------------------
2003 2002
---------- ---------
(RESTATED)
Revenues:
Funeral............................................. $ 12,234 $ 56,725
Cemetery............................................ 4,421 21,057
---------- ---------
$ 16,655 $ 77,782
========== =========
Gross profits (loss):
Funeral............................................. $ (3,686) $ 1,814
Cemetery............................................ (1,005) 3,162
---------- ---------
$ (4,691) $ 4,976
========== =========
NOTE SIXTEEN
SUPPLEMENTARY INFORMATION
The detail of certain balance sheet accounts was as follows:
DECEMBER 31,
-------------------------
2003 2002
--------- ----------
Cash and cash equivalents:
Cash......................................... $ 41,153 $ 35,338
Commercial paper and temporary investments... 198,278 165,287
--------- ----------
$ 239,431 $ 200,625
========= ==========
Other current assets:
Deferred tax asset and income tax receivable. $ 37,600 $ 113,981
Prepaid insurance............................ 16,274 7,796
Other........................................ 8,963 5,203
--------- ----------
$ 62,837 $ 126,980
========= ==========
78
DECEMBER 31,
---------------------------
2003 2002
----------- ----------
(Restated)
Inventories:
Caskets, vaults, urns, markers and bases.... $ 95,766 $ 93,635
Developed land, lawn crypts and mausoleums.. 41,355 43,297
----------- ----------
$ 137,121 $ 136,932
=========== ==========
Cemetery property:
Undeveloped land............................ $ 1,277,481 $1,308,182
Developed land, lawn crypts and mausoleums.. 247,064 259,402
----------- ----------
$ 1,524,545 $1,567,584
=========== ==========
Property, plant and equipment:
Land........................................ $ 278,424 $ 252,769
Buildings and improvements.................. 1,167,988 1,170,342
Operating equipment......................... 398,648 373,294
Leasehold improvements...................... 21,296 23,412
----------- ----------
1,866,356 1,819,817
Less: accumulated depreciation.............. (615,724) (631,477)
----------- ----------
$ 1,250,632 $1,188,340
=========== ==========
Deferred charges and other assets:
Covenants-not-to-compete, net............... $ 81,173 83,241
Cemetery deferred selling expense, net...... 205,123 200,478
Funeral deferred selling expense, net....... 113,920 105,057
Investments, net............................ 21,872 17,226
Restricted cash............................. 95,325 23,592
Notes receivable, net....................... 50,546 79,724
Other....................................... 171,291 202,099
----------- ----------
$ 739,250 $ 711,417
=========== ==========
Included in receivables, net is our funeral and cemetery at-need allowances
for doubtful accounts of approximately $15,348 and $22,697 at December 31, 2003
and 2002 respectively.
Included in Notes receivable, net in the consolidated balance sheet is $0
and $3,977 of notes with officers and directors of the Company, and $179 and
$1,189 of notes with employees, former officers of the Company, and other
related parties at December 31, 2003 and 2002, respectively. Interest rates on
notes receivable range from 5% to 15% as of December 31, 2003 and 2002.
DECEMBER 31,
---------------------------
2003 2002
----------- ----------
Accounts payable and accrued liabilities:
Accounts payable.......................... $ 118,607 $ 130,222
Accrued payroll........................... 63,763 91,836
Special litigation matters................ 103,150 10,000
Restructuring liability................... 16,298 28,179
Other accrued liabilities................. 154,705 101,673
----------- ----------
$ 456,523 $ 361,910
----------- ----------
NON-CASH TRANSACTIONS
YEARS ENDED DECEMBER 31,
--------------------------------------------
2003 2002 2001
------------- ------------ ------------
Minimum liability under retirement plans........ $ (2,956) $ (7,202) $ (16,629)
Debenture conversions to common stock........... -- -- 5,528
Debt extinguished using common stock............ -- -- 81,221
Common stock contributions to employee 401(k)... 17,378 18,150 12,635
Common stock contributions to cash balance plan. -- -- 6,500
NOTE SEVENTEEN
EARNINGS PER SHARE
Basic earnings (loss) per common share (EPS) excludes dilution and is
computed by dividing net income (loss) by the weighted average number of common
shares outstanding for the period. Diluted EPS reflects the potential dilution
that could occur if securities or other obligations to issue common stock were
exercised or converted into common stock or resulted in the issuance of common
stock that then shared in our earnings (losses). Because we reported net loses
in 2002 and 2001, all potentially dilutive securities were antidilutive and
basic and diluted weighted average number of common shares outstanding were the
same in those years.
79
A reconciliation of the numerators and denominators of the basic and diluted
EPS for the three years ended December 31 is presented below:
2003 2002 2001
--------- --------- ----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(Restated) (Restated)
Income (loss) (numerator):
Income (loss) from continuing operations before cumulative
effects of accounting changes - basic and diluted.......... $ 85,082 $ (96,926) $ (617,540)
Net income (loss) - basic and diluted........................ $ 85,082 $(232,486) $ (623,440)
- --------------------------------------------------------------------------------------------- --------------
Shares (denominator):
Shares - basic............................................... 299,801 294,533 285,127
Stock options........................................... 989 - -
---------- --------- ----------
Shares - diluted............................................. 300,790 294,533 285,127
- ------------------------------------------------------------------------------------------------------------
Income (loss) per share from continuing operations before
cumulative effects of
accounting changes:
Basic........................................................ $ .28 $ (.33) $ (2.17)
Diluted...................................................... .28 (.33) (2.17)
- -----------------------------------------------------------------------------------------------------------
Net income (loss) per share:
Basic........................................................ $ .28 $ (.79) $ (2.19)
Diluted...................................................... .28 (.79) (2.19)
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 debentures that could impact dilutive earnings per share are as
follows:
2003 2002 2001
------------ ----------- -----------
Antidilutive options.............................................. 22,097 30,001 29,949
Antidilutive convertible debentures............................... 47,096 51,408 51,763
------------ ----------- -----------
Total common stock equivalents excluded from computation...... 69,193 81,409 81,712
============ =========== ===========
NOTE EIGHTEEN
GAINS AND IMPAIRMENT (LOSSES) ON DISPOSITIONS, NET AND OTHER OPERATING EXPENSES
The Company has incurred various charges related to impairment losses and
other operating expenses from 1999 through 2002. Charges included in Gains and
impairment (losses) on dispositions, net consists of losses associated with
planned divestitures of certain North America and international funeral service
and cemetery businesses and reductions in the carrying values of equity
investments. As dispositions occur in the normal course of business, gains or
losses on the sale of such businesses are recognized in this line item.
Additionally, as dispositions occur related to the Company's ongoing 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.
Gains and impairments (losses) on dispositions, net consists of the
following for the years ended December 31:
2003 2002 2001
----------- ------------ --------------
Gains on dispositions....................................... $ 73,770 $ 16,401 $ 52,865
Impairment losses for assets held for sale.................. (38,447) (198,069) (662,617)
Changes to previously estimated impairment losses........... 15,027 3,925 (17,240)
----------- ------------ ------------
$ 50,350 $ (177,743) $ (626,992)
=========== ============ ============
The most significant items in 2003 related to the Company selling its equity
investments in Australia and Spain for gains of $45,776 and $8,090,
respectively. The $177,743 net loss reported in 2002 primarily related to an
impairment charge for several funeral and cemetery operations held for sale in
North America. The $626,992 net loss reported in 2001 primarily related to
foreign impairment charges associated with international businesses held for
sale.
Charges included in Other operating expenses consists of severance costs
related to cost rationalization programs and terminated contractual
relationships of former employees and executive officers, market value
adjustments for certain options associated with the Company's debt and relieving
certain individuals from their consulting and/or covenants-not-to-compete
contractual obligations.
80
For the year ended December 31, 2003, the Company recorded Other operating
expenses of $9,004, primarily consisting of $6,859 of severance costs for former
employees. The charges related to 350 employees involuntarily terminated in
North America were in accordance with the Company's post employment severance
policies. Any amounts remaining to be paid at December 31, 2003 will be paid in
2004. For the year ended December 31, 2002, the Company recorded $94,910 of
Other operating expenses, 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. For the year ended December 31, 2001, Other operating expenses of $931
related primarily to the termination of certain covenants-not-to-compete
contractual obligations.
The reserve activity for the years ended December 31, 2003 and 2002 related
to the original charge amounts generating the impairment losses and other
operating expenses are as follows:
2003 Activity
Utilization for twelve months
ended December 31, 2003
-----------------------------
Original Balance at Balance at
charge amount December 31, 2002 Cash Non-cash December 31, 2003
------------- ----------------- ---- -------- -----------------
First Quarter 1999 Charge........ $ 89,884 $ 564 $ 434 $ 130 $ -
Fourth Quarter 1999 Charge....... 272,544 48,254 7,606 22,366 18,282
2000 Charges..................... 434,415 - - - -
2001 Charges..................... 663,548 3,385 392 (109) 3,102
2002 Charges..................... 292,979 27,990 5,723 (2,128) 24,395
---------- ---------- -------- -------- ----------
$1,753,370 $ 80,193 $ 14,155 $ 20,259 $ 45,779
========== ========== ======== ======== ==========
2002 Activity
Utilization for twelve months
ended December 31, 2002
-----------------------------
Original Balance at Balance at
charge amount December 31, 2001 Cash Non-cash December 31, 2002
------------- ----------------- ---- -------- -----------------
First Quarter 1999 Charge........ $ 89,884 $ 2,743 $ 1,326 $ 853 $ 564
Fourth Quarter 1999 Charge....... 272,544 67,517 7,308 11,955 48,254
2000 Charges..................... 434,415 19,011 175 18,836 -
2001 Charges..................... 663,548 15,959 1,682 10,892 3,385
2002 Charges..................... 292,979 - 2,315 262,674 27,990
---------- ---------- -------- -------- ----------
$1,753,370 $ 105,230 $ 12,806 $305,210 $ 80,193
========== ========== ======== ======== ==========
The majority of the remaining balance at December 31, 2003 of these original
charge amounts related to actions already taken by the Company associated with
severance costs and terminated consulting and/or covenant-not-to-compete
contractual obligations, which will be paid by 2012. Of the $45,779 remaining
liability at December 31, 2003, $16,298 is included in Accounts payable and
accrued liabilities and $29,481 is included in Other liabilities in the
consolidated balance sheet based on the expected timing of payments.
81
NOTE NINETEEN
DISCONTINUED OPERATIONS
In the fourth quarter of 2001, the Company recognized in income from
discounted operations the partial release of a contingent liability associated
with the 2000 sale of its insurance operations.
Summary operating results of discontinued operations:
TWELVE MONTHS ENDED
DECEMBER 31,
------------------
2001
------------------
Revenues...................................................... $ -
Cost and expenses............................................. 2,637
------------------
Income from discontinued operations before income taxes....... 2,637
Provision for income taxes.................................... (936)
------------------
Income from discontinued operations........................... $ 1,701
==================
NOTE TWENTY
SUBSEQUENT EVENT
Subsequent to December 31, 2003, the Company completed a joint venture
transaction of its funeral operations in France. The joint venture transaction
was consummated with an enterprise value of the French business of EUR 300
million. In addition to maintaining a 25% share of the total equity capital of
the newly formed entity, the Company received net cash proceeds of EUR 243
million, prior to transaction costs, and a note receivable in the amount of EUR
10 million.
At December 31, 2003, the net assets of France were as follows:
Current assets................................................ $ 170,348
Non-current assets............................................ 1,890,260
------------
Total assets............................................. 2,060,608
------------
Total current liabilities..................................... 137,317
Long term liabilities......................................... 1,607,365
------------
Total liabilities........................................ 1,744,682
------------
Net assets.................................................... $ 315,926
============
NOTE TWENTY-ONE
QUARTERLY FINANCIAL DATA (UNAUDITED)
The Company restated its previously issued financial statements for the
fiscal years ended December 31, 2000, 2001 and 2002, the interim quarters of
2000, 2001 and 2002, and the first three quarters of 2003. All applicable
amounts relating to these restatements have been reflected in the consolidated
financial statements and these notes to the consolidated financial statements.
See note two to the consolidated financial statements for further information
relating to the restatements.
82
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER
--------------------- --------------------- --------------------- ---------------------
AS AS AS AS AS AS AS AS
REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
2003
Revenues................. $580,093 $581,509 $586,242 $587,598 $571,100 $570,204 $602,340
Costs and expenses....... 467,538 465,986 491,824 491,663 502,473 500,199 518,005
Gross profits............ 112,555 115,523 94,418 95,935 68,627 70,005 84,335
Operating income (loss).. 100,478 103,446 54,907 56,424 14,433 15,811 53,362
Income (loss) from
continuing operations
before income taxes and
cumulative effects of
accounting changes..... 67,094 70,062 21,184 22,701 (9,329) (7,951) 29,521
Provision (benefit) for
income taxes........... 24,825 25,976 6,805 7,393 (3,753) (3,219) (899)
Net income (loss)........ 42,269 44,086 14,379 15,308 (5,576) (4,732) 30,420
Earning per share:
Basic - EPS........... .14 .15 .05 .05 (.02) (.02) .10
Diluted - EPS......... .13 .14 .05 .05 (.02) (.02) .10
- --------------------------------------------------------------------------------------------------------------------------------
2002
Revenues................. $601,265 $600,394 $583,423 $583,094 $560,646 $553,744 $588,095 $586,387
Costs and expenses....... 482,101 479,536 492,150 490,279 485,237 482,384 510,026 508,495
Gross profits............ 119,164 120,858 91,273 92,815 75,409 71,360 78,069 77,892
Operating income (loss).. 100,521 102,215 (156,835) (155,293) 27,704 23,655 30,120 29,943
Income (loss) from
continuing operations
before income taxes and
cumulative effects of
accounting changes..... 65,319 67,013 (200,225) (198,683) 6,586 2,537 (4,860) (5,037)
Provision (benefit) for
income taxes........... 18,470 19,127 (57,210) (56,612) 2,525 955 (645) (714)
Net (loss) income........ (88,711) (87,674) (143,015) (142,071) 4,061 1,582 (4,215) (4,323)
Earning per share:
Basic - EPS........... (.30) (.30) (.49) (.48) .01 .01 (.01) (.01)
Diluted - EPS......... (.25) (.24) (.49) (.48) .01 .01 (.01) (.01)
- --------------------------------------------------------------------------------------------------------------------------------
2001
Revenues................. $681,360 $675,236 $622,404 $614,582 $586,260 $559,515 $677,413 $668,961
Costs and expenses....... 570,472 569,280 535,834 534,151 519,241 514,938 582,504 582,420
Gross profits............ 110,888 105,956 86,570 80,431 67,019 44,577 94,909 86,541
Operating income (loss).. 67,377 62,445 48,433 42,294 49,328 26,886 (503,984) (512,352)
Income (loss) from
continuing operations
before income taxes and
cumulative effects of
accounting changes..... 17,488 12,556 (1,385) (7,524) 5,025 (17,417) (548,801) (557,169)
Provision (benefit) for
income taxes........... 9,622 7,710 9,200 6,820 744 (7,957) 44,647 41,413
Net income (loss)........ 265 (2,755) (10,585) (14,344) 4,281 (9,460) (591,757) (596,881)
Earning per share:
Basic - EPS........... .00 (.01) (.04) (.05) .01 (.03) (2.03) (2.05)
Diluted - EPS......... .00 (.01) (.04) (.05) .01 (.03) (2.03) (2.05)
- --------------------------------------------------------------------------------------------------------------------------------
2000
Revenues................. $687,488 $695,559 $640,471 $645,551 $619,067 $624,693 $632,212 $633,218
Costs and expenses....... 570,423 573,004 568,403 570,841 547,205 549,899 565,565 567,994
Gross profits............ 117,065 122,555 72,068 74,710 71,862 74,794 66,647 65,224
Operating income (loss).. 96,952 102,442 39,053 41,695 51,818 54,750 (440,708) (422,131)
Income (loss) from
continuing operations
before income taxes and
cumulative effects of
accounting changes..... 41,579 47,069 (2,632) 10 (15,370) (12,438) (505,952) (507,375)
Provision (benefit) for
income taxes........... 14,057 16,186 (1,577) (553) (4,524) (3,387) (86,781) (87,333)
Cumulative effect of (909,315) (866,084) - - - - - -
accounting change......
Net (loss) income........ (876,641) (830,049) 4,556 6,174 (49,626) (47,831) (421,540) (422,411)
Earning per share:
Basic - EPS........... (3.22) (3.05) .02 .02 (.18) (.18) (1.55) (1.55)
Diluted - EPS......... (3.21) (3.03) .02 .02 (.18) (.18) (1.55) (1.55)
83
SERVICE CORPORATION INTERNATIONAL
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
THREE YEARS ENDED DECEMBER 31, 2003
CHARGED CHARGED
(CREDITED) (CREDITED)
BALANCE AT TO TO BALANCE
BEGINNING COSTS AND OTHER AT END OF
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS(2) WRITE OFFS(1) PERIOD
----------- ---------- ----------- ----------- ------------- ---------
Current Provision:
Allowance for doubtful accounts:
Year ended December 31, 2003 $ 22,697 $ 7,627 $ (719) $ (14,256) $ 15,349
Year ended December 31, 2002 42,439 2,710 (2,179) (20,273) 22,697
Year ended December 31, 2001 66,591 (7,931) 2,774 (18,995) 42,439
Due After One Year:
Allowance for contract cancellation
doubtful accounts:
Year ended December 31, 2003 $ 29,030 $ 1,813 $ 24,675 $ (489) $ 55,029
Year ended December 31, 2002 (21,984) 45,901 7,311 (2,198) 29,030
Year ended December 31, 2001 (45,573) 16,584 9,509 (2,504) (21,984)
Prearranged Funeral and Preneed Cemetery Asset:
Allowance for contract cancellation and
doubtful accounts:
Year ended December 31, 2003 $594,255 $ (2,673) $ 24,141 $ - $ 615,723
Year ended December 31, 2002 629,329 (36,253) 1,179 - 594,255
Year ended December 31, 2001 629,122 (1,884) 2,091 - 629,329
Deferred Prearranged Funeral and Cemetery Revenue:
Allowance for contract cancellations
Year ended December 31, 2003 $(557,680) $ - $ (25,153) $ - $ (582,833)
Year ended December 31, 2002 (as restated) (556,501) - (1,179) - (557,680)
Year ended December 31, 2001 (as restated) (549,616) - (6,885) - (556,501)
Deferred Tax Valuation Allowance:
Year ended December 31, 2003 $ 158,001 $ 2,646 $(123,479) $ - $ 37,168
Year ended December 31, 2002 168,528 (10,527) - - 158,001
Year ended December 31, 2001 69,199 99,329 - - 168,528
- ----------
(1) Uncollected receivables written off, net of recoveries.
(2) Primarily cumulative effect of accounting change and acquisitions and
dispositions of operations. 2003 deferred tax valuation allowance was
reclassified to other deferred tax liabilities with no change to net
deferred income taxes.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE 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 fourth 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.
Management has determined that as of December 31, 2003, there was a
deficiency in the Company's internal controls and procedures. This deficiency
related to revenue recognition transactions specifically associated with the
timely recording of the delivery and performance of cemetery goods and services
sold on a preneed basis. The Company has improved its controls and procedures
with respect to these matters since the adoption of SAB 101 effective January 1,
2000, and will continue to enhance these controls and procedures.
84
CHANGE IN INTERNAL CONTROLS
There were no changes in the Company's internal controls over financial
reporting during the quarter ended December 31, 2003 that have materially
affected, or are reasonably likely to materially affect its internal controls
over financial reporting.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information called for by PART III (Items 10, 11, 12, 13 and 14) has been
omitted as the Company intends to file with the Commission not later than 120
days after the close of its fiscal year a definitive Proxy Statement pursuant to
Regulation 14A. Such information is set forth in such Proxy Statement (i) with
respect to Item 10 under the captions "Election of Directors" and "Other Matters
- - Section 16(a) Beneficial Ownership Reporting Compliance," (ii) with respect to
Items 11 and 13 under the captions "Certain Information with Respect to Officers
and Directors," "Compensation Committee Interlocks and Insider Participation"
and "Certain Transactions" and (iii) with respect to Item 12 under the caption
"Voting Securities and Principal Holders", and (iv) with respect of Item 14
under the caption "Proposal to Approve the Selection of Independent Accountants
- - Audit Fees and All Other Fees". The information as specified in the preceding
sentence is incorporated herein by reference; provided however, notwithstanding
anything set forth in this Form 10-K, the information under the captions
"Compensation Committee Report on Executive Compensation" and "Performance
Graph" in such Proxy Statement, and the information in the paragraphs under the
caption "Report of the Audit Committee" in such Proxy Statement, are not
incorporated by reference into this Form 10-K.
The information regarding the Company's executive officers called for by
Item 401 of Regulation S-K has been included in PART I of this report.
The information regarding the Company's equity compensation plan information
called for by Item 201(d) of Regulation S-K is set forth below.
85
Equity Compensation Plan Information at December 31, 2003:
NUMBER OF SECURITIES REMAINING
NUMBER OF SECURITIES TO BE WEIGHTED-AVERAGE AVAILABLE FOR FUTURE ISSUANCE
ISSUED UPON EXERCISE OF EXERCISE PRICE OF UNDER EQUITY COMPENSATION PLANS
OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, (EXCLUDING SECURITIES REFLECTED
WARRANTS AND RIGHTS WARRANTS AND RIGHTS IN COLUMN (A))
PLAN CATEGORY (A) (B) (C)
---------------------------- ----------------------------- ------------------------- -------------------------------
Equity compensation
plans approved by
security holders........ 21,697,873 $12.08 5,581,351
Equity compensation
plans not approved
by security holders (1). 6,617,347 6.48 4,569,906(2)
---------------------------- ----------------------------- ------------------------- -------------------------------
Total...................... 28,315,220 $10.77 10,151,257
============================= ========================= ===============================
- ---------------------
(1) Includes options outstanding under the Equity Corporation International
1994 Long-Term Incentive Plan which became exercisable to acquire
Company common stock when the Company acquired Equity Corporation
International in January 1999. The outstanding options cover an
aggregate of 327,650 shares at a weighted-average exercise price of
$22.41 per share. No shares of Company common stock are available for
any future grants under this plan.
Also includes options outstanding under the 1996 Nonqualified Incentive
Plan under which nonqualified stock options may be granted to employees
who are not officers or directors. The exercise price of an option may
not be less than the fair market value of the underlying stock on the
date of grant and no option may have a term of more than ten years. The
terms of the options, including vesting, are set by a committee
appointed by the Board of Directors. The Board of Directors may amend,
terminate or suspend the plan in its discretion. The Company has
6,289,697 total options outstanding under the 1996 Non-qualified
Incentive Plan. The Company has options available for future issuance
under the 1996 Nonqualified Incentive Plan of 1,826,151. See note
thirteen to the consolidated financial statements in Item 8 of this Form
10-K for a further description of 1996 Nonqualified Incentive Plan.
These plans have not been submitted for shareholder approval.
(2) Includes an estimated 2,743,755 shares available under the Employee
Stock Purchase Plan. Under such plan, a dollar value of shares (not an
amount of shares) are registered. The above estimate was determined by
dividing (i) the remaining unissued dollar value of registered shares at
December 31, 2003, which was $14,788,841, by (ii) the closing price of
$5.39 per share of common stock at December 31, 2003.
The Employee Stock Purchase Plan enables Company employees in North America
to invest via payroll deductions up to $500 (or $600 Canadian) per month in
Company common stock. Contributions are utilized to purchase the stock in the
open market. With respect to Canadian employees who meet certain requirements,
the Company will provide annually a match equal to 25% of the amount of the
employee's contribution subject to a maximum contribution per participant of
$1,800 Canadian. This plan has not been submitted for shareholder approval.
86
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1)-(2) Financial Statements and Schedule:
The financial statements and schedule are listed in the accompanying Index
to Financial Statements and Related Schedule on page 41 of this report.
(3) Exhibits:
The exhibits listed on the accompanying Exhibit Index on pages 89-93 are
filed as part of this report.
(b) Reports on Form 8-K
During the quarter ended December 31, 2003, the Company furnished a report
on Form 8-K dated November 5, 2003 reporting (i) under "Item 7. Financial
Statements and Exhibits" that attached as an exhibit was a press release
dated November 5, 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 third quarter of 2003. The Company
furnished a report on Form 8-K dated December 2, 2003 reporting (i) under
"Item 7. Financial Statements and Exhibits" that attached as exhibits were
a press release dated December 2, 2003 and Merrill Lynch Health Services
Conference presentation slides, dated December 3, 2003, and (ii) under
"Item 9. Regulation FD Disclosure" that the Company issued the press
release which disclosed its intention to participate in the Merrill Lynch
Health Services Equity Conference on December 3, 2003. In addition, the
Company furnished a report on Form 8-K dated December 8, 2003 reporting (i)
under "Item 7. Financial Statements and Exhibits" that attached as an
exhibit was a press release dated December 2, 2003, and (ii) under "Item 9.
Regulation FD Disclosure" that the Company issued the press release which
announced the Company had entered into an agreement in principle to settle
the class action lawsuit and related lawsuits against the Company involving
two cemeteries owned in Florida.
(c) Included in (a) above.
(d) Included in (a) above.
87
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant, Service Corporation International, has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
SERVICE CORPORATION INTERNATIONAL
By: /s/ JAMES M. SHELGER
------------------------------------
(James M. Shelger,
Senior Vice President, General
Counsel and Secretary)
Dated: March 15, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the date indicated.
SIGNATURE TITLE DATE
- --------- ----- ----
R. L. WALTRIP* Chairman of the Board and Chief March 15, 2004
- -------------------------------- Executive Officer (Principal
(R. L. Waltrip) Executive Officer)
JEFFREY E. CURTISS* Senior Vice President Chief March 15, 2004
- -------------------------------- Financial Officer and Treasurer
(Jeffrey E. Curtiss) (Principal Financial Officer)
ERIC D. TANZBERGER* Vice President and Corporate March 15, 2004
- -------------------------------- Controller
(Eric D. Tanzberger)
ALAN R. BUCKWALTER, III* Director March 15, 2004
- --------------------------------
(Alan R. Buckwalter, III)
ANTHONY L. COELHO* Director March 15, 2004
- --------------------------------
(Anthony L. Coelho)
JACK FINKELSTEIN* Director March 15, 2004
- --------------------------------
(Jack Finkelstein)
A. J. FOYT, JR.* Director March 15, 2004
- --------------------------------
(A. J. Foyt, Jr.)
JAMES H. GREER* Director March 15, 2004
- --------------------------------
(James H. Greer)
B. D. HUNTER* Director March 15, 2004
- --------------------------------
(B. D. Hunter)
VICTOR L. LUND* Director March 15, 2004
- --------------------------------
(Victor L. Lund)
JOHN W. MECOM, JR.* Director March 15, 2004
- --------------------------------
(John W. Mecom, Jr.)
CLIFTON H. MORRIS, JR.* Director March 15, 2004
- --------------------------------
(Clifton H. Morris, Jr.)
W. BLAIR WALTRIP* Director March 15, 2004
- --------------------------------
(W. Blair Waltrip)
EDWARD E. WILLIAMS* Director March 15, 2004
- --------------------------------
(Edward E. Williams)
*By /s/ JAMES M. SHELGER
- --------------------------------
(James M. Shelger, as Attorney-In-Fact
For each of the Persons indicated)
88
EXHIBIT INDEX
PURSUANT TO ITEM 601 OF REG. S-K
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------------------------------------------------------
3.1 -- Restated Articles of Incorporation. (Incorporated by
reference to Exhibit 3.1 to Registration Statement No.
333-10867 on Form S-3).
3.2 -- Articles of Amendment to Restated Articles of Incorporation.
(Incorporated by reference to Exhibit 3.1 to Form 10-Q for
the fiscal quarter ended September 30, 1996).
3.3 -- Statement of Resolution Establishing Series of Shares of
Series D Junior Participating Preferred Stock, dated July
27, 1998. (Incorporated by reference to Exhibit 3.2 to Form
10-Q for the fiscal quarter ended June 30, 1998).
3.4 -- Bylaws, as amended. (Incorporated by reference to Exhibit
3.1 to Form 10-Q for the fiscal quarter ended September 30,
1999).
4.1 -- Rights Agreement dated as of May 14, 1998 between the
Company and Harris Trust and Savings Bank. (Incorporated by
reference to Exhibit 99.1 to Form 8-K dated May 14, 1998).
4.2 -- Agreement Appointing a Successor Rights Agent Under Rights
Agreement, dated June 1, 1999, by the Company, Harris Trust
and Savings Bank and The Bank of New York. (Incorporated by
reference to Exhibit 4.1 to Form 10-Q for the fiscal quarter
ended June 30, 1999).
10.1 -- Retirement Plan For Non-Employee Directors. (Incorporated by
reference to Exhibit 10.1 to Form 10-K for the fiscal year
ended December 31, 1991).
10.2 -- First Amendment to Retirement Plan For Non-Employee
Directors. (Incorporated by reference to Exhibit 10.2 to
Form 10-K for the fiscal year ended December 31, 2000).
10.3 -- Agreement dated May 14, 1992 between the Company, R.L.
Waltrip and related parties relating to life insurance.
(Incorporated by reference to Exhibit 10.4 to Form 10-K for
the fiscal year ended December 31, 1992).
10.4 -- Employment Agreement, dated January 1, 1998, between SCI
Executive Services, Inc. and R.L. Waltrip. (Incorporated by
reference to Exhibit 10.3 to Form 10-K for the fiscal year
ended December 31, 1998).
10.5 -- First Amendment to Employment Agreement, dated February 25,
2003, between SCI Executive Services, Inc. and R. L.
Waltrip. (Incorporated by reference to Exhibit 10.5 to Form
10-K for the fiscal year ended December 31, 2002).
10.6 -- Non-Competition Agreement and Amendment to Employment
Agreement, dated November 11, 1991, among the Company, R.L.
Waltrip and Claire Waltrip. (Incorporated by reference to
Exhibit 10.9 to Form 10-K for the fiscal year ended December
31, 1992).
10.7 -- Separation and Release Agreement, dated January 18, 2000,
among the Company, SCI Executive Services, Inc. and W. Blair
Waltrip. (Incorporated by reference to Exhibit 10.6 to Form
10-K for the fiscal year ended December 31, 1999).
10.8 -- Employment and Noncompetition Agreement, dated January 1,
2004, between SCI Executive Services, Inc. and B.D. Hunter.
89
10.9 -- Employment and Noncompetition Agreement, dated January 1,
2004, between SCI Executive Services, Inc. and Thomas L.
Ryan.
10.10 -- Employment and Noncompetition Agreement, dated January 1,
2004, between SCI Executive Services, Inc. and Michael R.
Webb.
10.11 -- Employment and Noncompetition Agreement, dated January 1,
2004, between SCI Executive Services, Inc. and Jeffrey E.
Curtiss.
10.12 -- Form of Employment and Noncompetition Agreement pertaining
to non-senior officers.
10.13 -- 1993 Long-Term Incentive Stock Option Plan. (Incorporated by
reference to Exhibit 4.12 to Registration Statement No.
333-00179 on Form S-8).
10.14 -- Amendment to 1993 Long-Term Incentive Stock Option Plan,
dated February 12, 1997. (Incorporated by reference to
Exhibit 10.15 to Form 10-K for the fiscal year ended
December 31, 1996).
10.15 -- Amendment to 1993 Long-Term Incentive Stock Option Plan,
dated November 13, 1997. (Incorporated by reference to
Exhibit 10.17 to Form 10-K for the fiscal year ended
December 31, 1997).
10.16 -- 1995 Incentive Equity Plan. (Incorporated by reference to
Annex B to Proxy Statement dated April 17, 1995).
10.17 -- Amendment to 1995 Incentive Equity Plan, dated February 12,
1997. (Incorporated by reference to Exhibit 10.18 to form
10-K for the fiscal year ended December 31, 1996).
10.18 -- Amendment to 1995 Incentive Equity Plan, dated November 13,
1997. (Incorporated by reference to Exhibit 10.21 to Form
10-K for the fiscal year ended December 31, 1997).
10.19 -- Amended 1996 Incentive Plan. (Incorporated by reference to
Annex A to Proxy Statement dated April 13, 1999).
10.20 -- Split Dollar Life Insurance Plan. (Incorporated by reference
to Exhibit 10.36 to Form 10-K for the fiscal year ended
December 31, 1995).
10.21 -- Supplemental Executive Retirement Plan for Senior Officers
(as Amended and Restated Effective as of January 1, 1998).
(Incorporated by reference to Exhibit 10.28 to Form 10-K for
the fiscal year ended December 31, 1998).
10.22 -- First Amendment to Supplemental Executive Retirement Plan
for Senior Officers. (Incorporated by reference to Exhibit
10.28 to Form 10-K for the fiscal year ended December 31,
2000).
10.23 -- SCI 401(k) Retirement Savings Plan. (Incorporated by
reference to Exhibit 4.7 to Form S-8 filed as of June 1,
2000, Registration Statement No. 333-38310).
10.24 -- First Amendment to SCI 401(k) Retirement Savings Plan.
(Incorporated by reference to Exhibit 10.31 to Form 10-K for
the fiscal year ended December 31, 2000).
10.25 -- SCI 401(k) Retirement Savings Plan as Amended and Restated.
(Incorporated by reference to Exhibit 4.9 to Registration
Statement No. 333-91046).
10.26 -- 2001 Stock Plan for Non-Employee Directors. (Incorporated by
reference to Annex A to Proxy Statement dated April 13,
2001).
10.27 -- First Amendment to 2001 Stock Plan for Non-Employee
Directors dated May 8, 2003. (Incorporated by reference to
Exhibit 10.1 to Form 10-Q for the quarterly period ended
June 30, 2003).
10.28 -- Director Fee Plan. (Incorporated by reference to Annex B to
Proxy Statement dated April 13, 2001).
90
10.29 -- First Amendment, dated November 13, 2002, to Director Fee
Plan. (Incorporated by reference to Exhibit 10.33 to form
10-K for the fiscal year ended December 31, 2002).
10.30 -- Second Amendment to Director Fee Plan dated May 8, 2003.
(Incorporated by reference to Exhibit 10.1 to Form 10-Q for
the quarterly period ended June 30, 2003).
10.31 -- 1996 Nonqualified Incentive Plan. (Incorporated by reference
to Exhibit 99.1 to Registration Statement No. 333-33101).
10.32 -- Amendment to 1996 Nonqualified Incentive Plan dated November
13, 1997. (Incorporated by reference to Exhibit 99.2 to
Registration Statement No. 333-50084).
10.33 -- Amendment to 1996 Nonqualified Incentive Plan dated November
11, 1999. (Incorporated by reference to Exhibit 99.3 to
Registration Statement No. 333-50084).
10.34 -- Amendment to 1996 Nonqualified Incentive Plan dated February
14, 2001. (Incorporated by reference to Exhibit 99.4 to
Registration Statement No. 333-67800).
10.35 -- Employee Stock Purchase Plan. (Incorporated by reference to
Exhibit 1.1 to Registration Statement No. 2-62484 on Form
S-8).
10.36 -- Amendment No. 1 to the Employee Stock Purchase Plan.
(Incorporated by reference to Exhibit 15.1 to Registration
Statement No. 2-62484 on Form S-8).
10.37 -- Amendment No. 2 to the Employee Stock Purchase Plan.
(Incorporated by reference to Exhibit 28.3 to Registration
Statement No. 33-25061 on Form S-8).
10.38 -- Amendment No. 3 to the Employee Stock Purchase Plan.
(Incorporated by reference to Exhibit 28.4 to Registration
Statement No. 33-35708 on Form S-8).
10.39 -- Amendment No. 4 to the Employee Stock Purchase Plan.
(Incorporated by reference to Exhibit 4.1 to Current Report
on Form 8-K dated December 21, 1993).
10.40 -- Amendment No. 5 to the Employee Stock Purchase Plan.
(Incorporated by reference to Exhibit 10.31 to Form 10-K for
the fiscal year ended December 31, 1999).
10.41 -- Amendment No. 6 to the Employee Stock Purchase Plan.
(Incorporated by reference to Exhibit 10.44 to Form 10-K for
the fiscal year ended December 31, 2002).
10.42 -- Amendment No. 7 to the Employee Stock Purchase Plan.
(Incorporated by reference to Exhibit 10.45 to Form 10-K for
the fiscal year ended December 31, 2002).
10.43 -- Agreement between Merrill Lynch Canada Inc. and Service
Corporation International. (Incorporated by reference to
Exhibit 28.5 to Post- Effective Amendment No. 1 to
Registration Statement No. 33-8907 on Form S-8).
10.44 -- First Amendment to Agreement between Merrill Lynch Canada
Inc. and Service Corporation International. (Incorporated by
reference to Exhibit 4.2 to Current Report on Form 8-K dated
December 21, 1993).
10.45 -- Employee Stock Purchase Plan Administration Agreement dated
July 25, 2001 between Service Corporation International
(Canada) Limited and Fastrak Systems Inc. (Incorporated by
reference to Exhibit 10.48 to Form 10-K for the fiscal year
ended December 31, 2002).
12.1 -- Ratio of Earnings to Fixed Charges.
21.1 -- Subsidiaries of the Company.
23.1 -- Consent of Independent Accountants (PricewaterhouseCoopers
LLP).
91
24.1 -- Powers of Attorney.
31.1 -- Certification of R. 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 R. 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 -- Defendants' 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, L.L.P.; 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 -- Credit Agreement dated as of July 24, 2002 among the
Company, as Borrower, the Lenders Party thereto, JPMorgan
Chase Bank, as Administrative Agent, Bank of America, N.A.,
as Syndicated Agent, and Credit Lyonnais, Lehman Commercial
Paper Inc. and Merrill Lynch Capital Corporation, as
Co-Documentation Agents, J.P. Morgan Securities Inc., and
Banc of America Securities LLC, as Joint Bookrunners and
Joint Lead Arrangers. (Incorporated by reference to Exhibit
99.2 to Form 8-K dated July 25, 2002).
92
99.9 -- Amendment No. 1 dated as of December 6, 2002 to the Credit
Agreement referred to in Exhibit 99.8. (Incorporated by
reference to Exhibit 99.14 to Form 10-K for the fiscal year
ended December 31, 2002).
99.10 -- Amendment No. 2 dated as of September 29, 2003 to the Credit
Agreement referred to in Exhibit 8. (Incorporated by
reference to Exhibit 99.8 to Form 10-Q for the quarterly
period ended September 30, 2003).
In the above list, the management contracts or compensatory plans or
arrangements are set forth in Exhibits 10.1 through 10.45.
Pursuant to Item 601(b)(4) of Regulation S-K, there are not filed as exhibits to
this report certain instruments with respect to long-term debt under which the
total amount of securities authorized thereunder does not exceed 10 percent of
the total assets of Registrant and its subsidiaries on a consolidated basis.
Registrant agrees to furnish a copy of any such instrument to the Commission
upon request.
93
CORPORATE INFORMATION
CORPORATE OFFICES
Service Corporation International maintains corporate offices located
at 1929 Allen Parkway, Houston, Texas 77019. The telephone number is
713/522-5141. Additional information can be found at our web site:
http://www.sci-corp.com.
REQUESTS
Written requests for financial information, including the Annual Report
on Form 10-K as filed with the Securities and Exchange Commission, should be
directed to Investor Relations, P.O. Box 130548, Houston, Texas 77219-0548.
TRANSFER AGENT AND REGISTRAR
THE BANK OF NEW YORK
1-800-524-4458
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ADDRESS SHAREHOLDER INQUIRIES TO: SEND CERTIFICATES FOR TRANSFER AND ADDRESS CHANGES TO:
The Bank of New York
Shareholder Relations Department Receive and Deliver Department
P.O. Box 11258 P.O. Box 11002
Church Street Station Church Street Station
New York, NY 10286 New York, NY 10286
The Bank of New York's Stock Transfer Website:
http://www.stockbny.com
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