FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1999 or ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 1-6402-1 -------------------- SERVICE CORPORATION INTERNATIONAL (Exact name of registrant as specified in charter) Texas 74-1488375 (State or other jurisdiction of (I. R. S. employer identification incorporation or organization) number) 1929 Allen Parkway, Houston, Texas 77019 (Address of principal executive offices) (Zip code) (713) 522-5141 (Registrant's telephone number, including area code) -------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to the filing requirements for the past 90 days. YES X NO The number of shares outstanding of the registrant's common stock as of May 10, 1999 was 271,980,963 (excluding treasury shares).
SERVICE CORPORATION INTERNATIONAL INDEX <TABLE> <CAPTION> <S> <C> <C> Page Part I. Financial Information Consolidated Statement of Income (Unaudited) - Three Months Ended March 31, 1999 and 1998 3 Consolidated Balance Sheet - March 31, 1999 (Unaudited) and December 31, 1998 4 Consolidated Statement of Cash Flows (Unaudited) - Three Months Ended March 31, 1999 and 1998 5 Consolidated Statement of Stockholders' Equity (Unaudited) - Three Months Ended March 31, 1999 6 Notes to Consolidated Financial Statements (Unaudited) 7 - 13 Management's Discussion and Analysis of Financial Condition and Results of Operations 14 - 23 Part II. Other Information 24 Signature 24 </TABLE>
SERVICE CORPORATION INTERNATIONAL CONSOLIDATED STATEMENT OF INCOME (Unaudited) <TABLE> <CAPTION> Three months ended March 31, (In thousands, except per share amounts) 1999 1998 - -------------------------------------------------------------------------------- <S> <C> <C> Revenues........................................ $ 904,056 $ 698,844 Costs and expenses.............................. (685,185) (482,716) --------- --------- Gross profit.................................... 218,871 216,128 General and administrative expenses............. (19,710) (17,008) Restructuring charge............................ (89,884) - --------- --------- Income from operations.......................... 109,277 199,120 Interest expense................................ (57,448) (37,710) Other income.................................... 14,588 6,651 --------- --------- (42,860) (31,059) --------- --------- Income before income taxes and extraordinary gain............................ 66,417 168,061 Provision for income taxes...................... (24,534) (59,275) --------- --------- Income before extraordinary gain................ 41,883 108,786 Extraordinary gain on early extinguishments of debt (net of income taxes of $1,071)....... 1,885 - --------- --------- Net income $ 43,768 $ 108,786 ========= ========= Earnings per share: Basic: Income before extraordinary gain............. $ .15 $ .43 Extraordinary gain on early extinguishments of debt..................................... .01 - --------- --------- Net income................................... $ .16 $ .43 ========= ========= Diluted: Income before extraordinary gain............. $ .15 $ .42 Extraordinary gain on early extinguishments of debt..................................... .01 - --------- --------- Net income................................... $ .16 $ .42 ========= ========= Dividends per share............................. $ .09 $ .09 ========= ========= Basic weighted average number of shares......... 272,990 254,635 ========= ========= Diluted weighted average number of shares....... 275,442 261,768 ========= ========= (See notes to consolidated financial statements) </TABLE>
SERVICE CORPORATION INTERNATIONAL CONSOLIDATED BALANCE SHEET <TABLE> <CAPTION> March 31, 1999 December 31, (Dollars in thousands, except share amounts) (Unaudited) 1998 _______________________________________________________________________________ <S> <C> <C> Assets Current assets: Cash and cash equivalents...................... $ 181,684 $ 358,210 Receivables, net of allowances................. 605,314 565,552 Inventories.................................... 207,242 189,070 Other ......................................... 89,458 96,248 ----------- ---------- Total current assets....................... 1,083,698 1,209,080 ----------- ---------- Investments - insurance subsidiaries.............. 1,273,154 1,234,678 Prearranged funeral contracts .................... 3,020,594 2,588,806 Long-term receivables, net of allowances ......... 1,543,440 1,408,076 Cemetery property, at cost........................ 2,165,787 2,035,897 Property, plant and equipment, at cost (net)...... 1,964,615 1,824,979 Deferred charges and other assets................. 1,231,651 1,151,430 Names and reputations (net)....................... 2,453,578 1,813,212 ----------- ---------- $14,736,517 $13,266,158 =========== =========== Liabilities & Stockholders' Equity Current liabilities: Accounts payable and accrued liabilities..... $ 616,341 $ 452,354 Current maturities of long-term debt......... 93,750 96,067 Income taxes ................................ 83,818 81,904 ----------- ----------- Total current liabilities.................. 793,909 630,325 ----------- ----------- Long-term debt.................................... 4,049,215 3,764,590 Reserves and annuity benefits - insurance subsidiaries........................... 1,191,699 1,207,169 Deferred prearranged funeral contract revenues .. 3,255,373 2,819,794 Deferred income taxes............................. 842,841 797,086 Other liabilities ................................ 919,508 893,092 Stockholders' equity: Common stock, $1 per share par value, 500,000,000 shares authorized, 271,968,548 and 259,201,104, issued and outstanding (net of 2,856,658 and 68,373 treasury shares). 271,969 259,201 Capital in excess of par value................ 2,154,928 1,646,765 Retained earnings............................. 1,252,046 1,232,758 Accumulated other comprehensive income........ 5,029 15,378 ----------- ----------- Total stockholders' equity.................. 3,683,972 3,154,102 ----------- ----------- $14,736,517 $13,266,158 =========== =========== </TABLE> (See notes to consolidated financial statements)
SERVICE CORPORATION INTERNATIONAL CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited) <TABLE> <CAPTION> Three months ended March 31, (Dollars in thousands) 1999 1998 _______________________________________________________________________________ <S> <C> <C> Cash flows from operating activities: Net income......................................... $ 43,768 $ 108,786 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization................. 55,904 42,853 Provision for deferred income taxes........... 6,802 10,708 Restructuring charge.......................... 89,884 - Extraordinary gain on early extinguishments of debt, net of income taxes................. (1,885) - Gains from dispositions (net)................. (10,641) (2,117) Realized gains on sale of investments......... (1,728) - Change in assets and liabilities, net of effects from acquisitions: Increase in receivables..................... (86,940) (64,812) Decrease (increase) in other assets........ 26,021 (14,912) Increase in payables and other liabilities . 45,068 57,906 Other....................................... (889) 1,219 --------- --------- Net cash provided by operating activities ......... 165,364 139,631 --------- --------- Cash flows from investing activities: Capital expenditures.......................... (57,718) (56,465) Net affect of prearranged funeral production and maturities............................... (28,074) 16,718 Purchases of securities - insurance subsidiaries....................... (676,287) (245,244) Sales of securities - insurance subsidiaries.. 570,969 244,687 Proceeds from sales of property and equipment. 16,282 5,135 Acquisitions, net of cash acquired............ (24,344) (55,608) Loans issued by lending subsidiary............ (23,125) (23,837) Principal payments received on loans issued by lending subsidiary........................ 5,807 4,296 Other......................................... (1,298) 5,516 --------- --------- Net cash used in investing activities.............. (217,788) (104,802) --------- --------- Cash flows from financing activities: Increase (decrease) in borrowings under revolving credit agreements.................. 489,337 (284,031) Proceeds from issuance of long-term debt...... - 500,000 Payments of long-term debt.................... (186,160) (27,021) Early extinguishments of long-term debt....... (365,936) - Repurchase of common stock.................... (45,669) - Dividends paid................................ (23,331) (18,795) Bank overdrafts and other..................... 7,657 (10,272) --------- --------- Net cash (used in) provided by financing activities (124,102) 159,881 --------- --------- Net (decrease) increase in cash and cash equivalents.................................. (176,526) 194,710 Cash and cash equivalents at beginning of period... 358,210 46,877 --------- --------- Cash and cash equivalents at March 31, 1999 and 1998........................... $ 181,684 $ 241,587 ========= ========= </TABLE> (See notes to consolidated financial statements)
SERVICE CORPORATION INTERNATIONAL CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (Unaudited) <TABLE> <CAPTION> Accumulated Capital in other Common excess Retained comprehensive stock of par value earnings income Total ________________________________________________________________________________ (Dollars in thousands) <S> <C> <C> <C> <C> <C> Balance at December 31, 1998....$259,201 $1,646,765 $1,232,758 $15,378 $3,154,102 Comprehensive income: Net income.......... 43,768 43,768 Other comprehensive income (loss): Foreign currency translation....... 337 Unrealized loss on securities..... (10,686) ---------- Total other comprehensive income (loss)....... (10,349) (10,349) ---------- Comprehensive income. 33,419 Common stock issued: Acquisitions......... 15,505 550,325 565,830 Stock option exercises and stock grants.............. 104 415 519 Debenture conversions 16 235 251 Repurchase of common stock............... (2,857) (42,812) (45,669) Dividends on common stock........ (24,480) (24,480) -------- ---------- ---------- -------- ---------- Balance at March 31, 1999.......$271,969 $2,154,928 $1,252,046 $ 5,029 $3,683,972 ======== ========== ========== ======== ========== </TABLE> (See notes to consolidated financial statements)
SERVICE CORPORATION INTERNATIONAL NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share amounts) (Unaudited) 1. Nature of Operations The Company is the largest provider of death care services in the world. At March 31, 1999, the Company operated 3,812 funeral service locations, 515 cemeteries and 199 crematoria located in 20 countries on five continents. The funeral service locations and cemetery operations consist of the Company's funeral homes, cemeteries, crematoria and related businesses. Company personnel at the funeral service locations provide all professional services relating to funerals, including the use of funeral facilities and motor vehicles. Funeral related merchandise is sold at funeral service locations and certain funeral service locations contain crematoria. The Company sells prearranged funeral services whereby a customer contractually agrees to the terms of a funeral to be performed in the future. The Company's cemeteries provide cemetery interment rights (including mausoleum spaces and lawn crypts) and certain merchandise including stone and bronze memorials and burial vaults. These items are sold on an at need or preneed basis. Company personnel at cemeteries perform interment services and provide management and maintenance of cemetery grounds. Certain cemeteries contain crematoria. There are 167 combination locations that contain a funeral service location within a Company owned cemetery. The financial services division represents a combination of the Company's prearranged funeral and cemetery trust administration, investment management, life insurance operations, and the lending activities of Provident Services, Inc. ("Provident"), which provides capital financing for independent funeral home and cemetery operations. 2. Summary of Significant Accounting Policies Basis of Presentation: The consolidated financial statements for the three months ended March 31, 1999 and 1998 include the accounts of Service Corporation International and all majority-owned subsidiaries (the "Company") and are unaudited but include all adjustments, consisting of normal recurring accruals and any other adjustments which management considers necessary for a fair presentation of the results for these periods. These consolidated financial statements have been prepared consistent with the accounting policies described in the annual report on Form 10-K filed with the Securities and Exchange Commission (the "Commission") for the year ended December 31, 1998 and should be read in conjunction therewith. Operating results for interim periods are not necessarily indicative of the results that may be expected for the year. Certain reclassifications have been made to the prior period to conform to the current period presentation with no effect on previously reported net income, financial condition or cash flows. Use of Estimates in the Preparation of Financial Statements: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. As a result, actual results could differ from these estimates.
3. Acquisitions In January 1999, a wholly owned subsidiary of the Company merged with Equity Corporation International ("ECI") in a stock-for-stock transaction in which ECI shareholders received 15,500,824 shares of Company common stock valued at approximately $557,000 and approximately 1,200,000 options to purchase Company common stock valued at approximately $8,628. At the time of the merger, ECI owned 359 funeral service locations and 80 cemeteries in North America. Exclusive of the merger with ECI, the Company acquired 29 funeral service locations, 6 cemeteries and 2 crematoria during the three months ended March 31, 1999 for an aggregate purchase price of approximately $49,400 (The Company acquired 45 funeral service locations and 7 cemeteries during the three months ended March 31, 1998 for an aggregate purchase price of approximately $68,600). The consideration for these acquisitions consisted of combinations of cash, common stock of the Company and issued debt. All acquisitions have been accounted for under the purchase method of accounting, therefore, the operating results of all of these acquisitions have been included since their respective dates of acquisitions. The effect of acquisitions, net of cash acquired, on the consolidated balance sheet at March 31, was as follows: <TABLE> <CAPTION> 1999 1998 ________________________________________________________________________________ <S> <C> <C> Current assets................................... $ 94,030 $ (3,622) Prearranged funeral contracts.................... 307,468 (216) Long-term receivables............................ 42,810 5,083 Cemetery property................................ 136,763 33,499 Property, plant and equipment.................... 147,600 10,679 Deferred charges and other assets................ 28,749 2,945 Names and reputations............................ 662,629 34,098 Current liabilities.............................. (93,950) 205 Long-term debt................................... (346,729) (13,258) Deferred prearranged funeral contract revenues... (315,536) (7,536) Deferred income taxes and other liabilities...... (73,660) 230 Stockholders' equity............................. (565,830) (6,499) --------- -------- Cash used for acquisitions..................... $ 24,344 $ 55,608 ========= ======== </TABLE> 4. Prearranged Funeral Activities The Company sells price guaranteed prearranged funeral contracts through various programs providing for future funeral services at prices prevailing when the agreements are signed. Payments under these contracts are placed in trust accounts (pursuant to applicable law) or are used to pay premiums on life insurance policies. Unperformed price guaranteed prearranged funeral contracts not funded through Company owned insurance subsidiaries are included in the consolidated balance sheet as "Prearranged funeral contracts." This balance represents amounts due from trust funds, customer receivables, or third party insurance companies. A corresponding credit is recorded to "Deferred prearranged funeral contract revenues." Amounts paid by a customer under a prearranged funeral contract are recognized in funeral revenue at the time the funeral service is performed. Trust earnings and increasing insurance benefits are accrued and deferred until the services are performed, at which time these funds are also recognized in funeral revenues and are intended to cover future increases in the cost of providing a price guaranteed funeral service. Net obtaining costs incurred pursuant to the sales of trust funded and third party insurance funded prearrangements are included in "Deferred charges and other assets". These obtaining costs include sales commissions and certain other direct costs which are deferred and amortized over a period representing the actuarially determined life of the prearranged contracts.
Prearranged funeral contracts may also be funded by insurance policies written by the Company's wholly-owned insurance subsidiaries. These insurance subsidiaries follow generally accepted accounting principles for life insurance companies. Policy acquisition costs are deferred as "Deferred charges and other assets" and amortized as prescribed by generally accepted accounting principles for life insurance companies. The total value of unperformed prearranged funeral revenues includes prearranged funeral contracts that are trust funded or to be funded by third party insurance companies ("Deferred prearranged funeral contract revenues") or by the Company's insurance subsidiaries. The total value represents the original contract values plus any accumulated trust fund earnings or increasing insurance benefits. The amount funded through the Company's insurance subsidiaries is the original contract amount plus increasing insurance benefits. This amount differs from the "Reserves and annuity benefits - insurance subsidiaries" amount in the accompanying consolidated balance sheet in that "Reserves and annuity benefits - insurance subsidiaries" is an actuarially determined amount relating to SCI and non-SCI business. As of March 31, 1999 and December 31, 1998, unperformed prearranged funeral contracts are composed of the following: <TABLE> <CAPTION> March 31, 1999 December 31, 1998 -------------- ----------------- <S> <C> <C> Deferred prearranged funeral contract revenues $3,255,373 $2,819,794 Contracts funded by Company insurance subsidiaries 939,907 932,056 ---------- ---------- Total value of unperformed funeral contracts $4,195,280 $3,751,850 ========== ========== </TABLE> The majority of the increase from December 31, 1998 relates to acquisitions (see note 3). 5. Debt Debt at March 31, 1999 and December 31, 1998, was as follows: <TABLE> <CAPTION> March 31, December 31, 1999 1998 ----------- ------------ <S> <C> <C> Bank revolving credit agreements and commercial paper.......................... $1,064,296 $ 650,596 6.375% notes due in 2000................... 150,000 150,000 6.75% notes due in 2001.................... 150,000 150,000 8.72% amortizing notes due in 2002......... 99,950 114,259 8.375% notes due in 2004................... 51,840 51,840 7.375% notes due in 2004................... 250,000 250,000 6.0% notes due in 2005..................... 600,000 600,000 7.2% notes due in 2006..................... 150,000 150,000 6.875% notes due in 2007................... 150,000 150,000 6.5% notes due in 2008..................... 200,000 200,000 7.7% notes due in 2009..................... 200,000 200,000 6.95% amortizing notes due in 2010......... 54,926 55,691 Floating rate notes due in 2011 (putable in 1999)......................... - 200,000 7.875% debentures due in 2013.............. 55,627 55,627 7.0% notes due in 2015 (putable in 2002)... 300,000 300,000 6.3% notes due in 2020 (putable in 2003)... 300,000 300,000 Medium term notes, maturities through 2019, fixed average interest rate of 9.32%...... 35,720 35,720 Convertible debentures, interest rates range from 4.75% - 5.5%, due through 2008, conversion price ranges from $11.25 - $50.00........................... 50,975 49,979 Mortgage notes and other notes payable - maturities through 2015 .................. 303,892 216,833 Deferred loan costs........................ (24,261) (19,888) ---------- ---------- Total debt................................. 4,142,965 3,860,657 Less current maturities................... (93,750) (96,067) ---------- ---------- Total long-term debt....................... $4,049,215 $3,764,590 ========== ========== </TABLE>
The Company's primary revolving credit agreements provide for borrowings up to $1,800,000 and consist of three committed tranches - two 364-day facilities and a 5-year, multi-currency tranche. These facilities are primarily used to support commercial paper issuance and for general corporate needs, including the Company's ongoing acquisition program. One 364-day tranche allows for borrowings up to $300,000. This facility expires June 25, 1999, but has provisions to be extended for additional 364-day terms. At the end of any term, the outstanding balance may be converted into a two-year term loan at the Company's option. Interest rates are based on various indices as determined by the Company. In addition, a facility fee of 0.08% is paid quarterly on the total commitment amount. A second 364-day tranche allows for borrowings up to $800,000 and expires November 2, 1999. A facility fee of 0.09% is paid quarterly on the total commitment amount. Interest rates on this facility are based on various indices as determined by the Company. The 5-year tranche allows for borrowings up to $700,000, including $500,000 in various foreign currencies. This facility expires June 27, 2002. Interest rates on this facility are based on various indices as determined by the Company. In addition, a facility fee is paid quarterly on the total commitment amount. The facility fee, which ranges from 0.07 to 0.15%, is based on the Company's senior debt ratings and is currently set at 0.08%. At March 31, 1999, approximately $245,479 of revolving borrowings was outstanding under this facility with a weighted average interest rate of 5.02% ($217,345 at December 31, 1998 with a weighted average interest rate of 5.65%). As of March 31, 1999, $818,817 of commercial paper was outstanding, backed by the above facilities, with a weighted average interest rate of 5.33% ($433,251 at December 31, 1998 with a weighted average interest rate of 6.68%). The credit facilities described above have financial compliance provisions that contain certain restrictions on levels of net worth, debt, liens, and guarantees. The commercial paper borrowings and revolving notes generally have maturities ranging from 1 to 180 days. Since it is the Company's intent to refinance borrowings under these facilities with long-term debt or equity, the Company has classified such borrowings as long-term debt. In March 1999, the Company repurchased two issues of debt. On March 26, the Company repurchased the $200,000 floating-rate notes, which were originally due April 2011. These notes were to be remarketed in April 1999 as fixed-rate notes. The Company chose to refinance with commercial paper to maintain floating-rate exposure. The purchase price was $200,000 and a premium of approximately $22,186, plus accrued interest, resulted in an extraordinary after tax loss of $14,148. On March 31, the Company repurchased the $143,750 ECI convertible debentures, which were originally due December 2004. This repurchase was effected by a change-of-control clause allowing the holders to put the bonds back to the Company as a result of the merger with ECI. The purchase price was $143,750 plus accrued interest and resulted in an extraordinary gain of $25,141 ($16,033 net of tax) relating to the unamortized premium reflecting the market valuation of the debentures at the date ECI merged with the Company. These debentures were also refinanced with commercial paper. 6. Derivatives The Company enters into derivative transactions primarily in the form of interest rate swaps and cross-currency interest rate swaps in combination with local currency borrowings to manage its mix of fixed and floating rate debt and to substantially hedge the Company's net investments in foreign assets. The Company has procedures in place to monitor and control the use of derivatives and only enters into transactions with a limited group of creditworthy financial institutions. The Company does not engage in derivative transactions for speculative or trading purposes, nor is it a party to leveraged derivatives. At March 31, 1999, the Company's consolidated debt totaled $4,142,965 ($3,860,657 at December 31, 1998) at a weighted average rate of 6.46% (6.77% at December 31, 1998), excluding $228,962 of Provident debt. After giving consideration to the interest rate and cross-currency interest rate swaps, the weighted average rate of debt was 5.87%, (6.16% at December 31, 1998), excluding Provident debt.
Together, the Company's debt and derivative instruments consisted of approximately 71% of fixed interest rate debt at a weighted average rate of 6.17% and approximately 29% of floating interest rate debt at a weighted average rate of 5.14%. Approximately $1,980,056 of the Company's indebtedness was foreign-denominated after inclusion of the derivative instruments. The net fair value of the Company's various swap agreements at March 31, 1999, was an asset of $123,893 ($97,944 at December 31, 1998). Fair values were obtained from the counterparties to the agreements and represent their estimate of the amount the Company would pay or receive to terminate the swap agreements based upon the existing terms and current market conditions. 7. Ratio of Earnings to Fixed Charges <TABLE> <CAPTION> Three months ended March 31, 1999 1998 --------------------- <S> <C> 1.95 4.69 </TABLE> For purposes of computing the ratio of earnings to fixed charges, earnings consist of income before income taxes and extraordinary gain; (1) less undistributed income of equity investees which are less than 50% owned, (2) plus the minority interest of majority-owned subsidiaries with fixed charges and (3) plus fixed charges (excluding capitalized interest). Fixed charges consist of interest expense, whether capitalized or expensed, amortization of debt costs, and one-third of rental expense which the Company considers representative of the interest factor in the rentals. The decrease in the Company's ratio of earnings to fixed charges in 1999 is primarily due to the $89,884 pre-tax restructuring charge recorded during the first quarter of 1999 (see note 10). 8. Segment Reporting The Company's operations are service based and geographically based. The Company's primary reportable operating segments presented below are based on services and include funeral, cemetery, and insurance operations. The Company's geographic segments include North America, France, other Europe and other Foreign. The Company conducts funeral operations in all geographical regions, cemetery operations in all regions except France, and financial services operations in North America and France. The Company's reportable segment information was as follows: <TABLE> <CAPTION> Reportable Three months ended March 31, Funeral Cemetery Insurance Segments - -------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Revenues from external customers: 1999..............................$574,641 $251,858 $ 71,796 $ 898,295 1998.............................. 469,962 205,941 18,326 694,229 - -------------------------------------------------------------------------------- Income from operations: 1999..............................$131,020 $ 77,800 $ 7,301 $ 216,121 1998.............................. 130,526 81,253 2,166 213,945 - -------------------------------------------------------------------------------- </TABLE>
The following table reconciles reportable segment income from operations shown above to the Company's consolidated income before income taxes and extraordinary gain: <TABLE> <CAPTION> Three months ended March 31, 1999 1998 - -------------------------------------------------------------------------------- <S> <C> <C> Income from operations: Reportable segments................................. $ 216,121 $ 213,945 Provident income from operations.................... 2,750 2,183 General and administrative expenses................. (19,710) (17,008) Restructuring charge................................ (89,884) - --------- --------- Income from operations................................ 109,277 199,120 Interest expense.................................... (57,448) (37,710) Other income........................................ 14,588 6,651 --------- --------- Income before income taxes and extraordinary gain..... $ 66,417 $ 168,061 ========= ========= </TABLE> The Company's geographic segment information was as follows: <TABLE> <CAPTION> Three months North Other Other ended March 31, America France Europe Foreign Total - -------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> Revenues from external customers: 1999................ $612,178 $168,578 $88,872 $34,428 $904,056 1998................ 473,659 139,088 63,714 22,383 698,844 - -------------------------------------------------------------------------------- Income from operations before restructuring charge: 1999................ $152,937 $ 20,747 $18,906 $ 6,571 $199,161 1998................ 168,485 12,456 13,762 4,417 199,120 - -------------------------------------------------------------------------------- Income from operations: 1999................ $102,719 $ (63) $ 4,011 $ 2,610 $109,277 1998................ 168,485 12,456 13,762 4,417 199,120 - -------------------------------------------------------------------------------- Operating locations at March 31: 1999................ 2,293 1,220 838 175 4,526 1998................ 1,732 1,118 731 149 3,730 - -------------------------------------------------------------------------------- </TABLE> Included in the North America figures above are the following United States amounts: <TABLE> <CAPTION> Three months ended March 31, 1999 1998 - -------------------------------------------------------------------------------- <S> <C> <C> Revenues from external customers........................ $590,150 $452,646 Income from operations before restructuring charge...... 146,380 162,114 Income from operations.................................. 96,318 162,114 Operating locations at March 31......................... 2,136 1,584 - -------------------------------------------------------------------------------- </TABLE>
9. Earnings Per Share A reconciliation of the numerators and denominators of the basic and diluted earnings per share computations are presented below: <TABLE> <CAPTION> Three months ended March 31, 1999 1998 - -------------------------------------------------------------------------------- <S> <C> <C> Income (numerator): Income before extraordinary gain - basic........... $41,883 $108,786 After tax interest on convertible debentures....... 132 371 ------- -------- Income before extraordinary gain - diluted......... $42,015 $109,157 - -------------------------------------------------------------------------------- Shares (denominator): Shares - basic..................................... 272,990 254,635 Stock options and warrants........................ 1,299 4,992 Convertible debentures............................ 1,153 2,141 ------- ------- Shares - dilute...d................................ 275,442 261,768 - -------------------------------------------------------------------------------- Earnings per share before extraordinary gain: Basic.............................................. $ .15 $ .43 Diluted......................................... $ .15 $ .42 - -------------------------------------------------------------------------------- </TABLE> 10. Restructuring Charge During the first quarter of 1999, the Company recorded a pre-tax restructuring charge of $89,884, related to a cost rationalization program initiated in 1999. The $89,884 charge relates to the following: (1) severance costs of $56,757; (2) a charge of $19,123 for terminated projects representing costs associated with certain construction projects that have been cancelled ($2,153) and costs associated with acquisition due-diligence which will no longer be pursued ($16,970); (3) a $7,245 charge for business and facility closures, primarily in the Company's European operations; and (4) a remaining charge of $6,759 consisting of various other cost initiatives. The $56,757 for severance costs is related to the termination of five executive contractual relationships and the involuntary termination of approximately 100 employees in North America (of which approximately 20 were located in the corporate office), 600 employees in France, 85 employees in other European operations and 10 employees in other foreign operations. The positions terminated were both operational and administrative in nature and the severance costs are expected to be paid out over the next 12 to 18 months. The severance costs related to the executive contractual relationships will be paid out according to the terms of the respective agreements and will extend through 2005. At March 31, 1999 approximately $37,105 remained in accrued liabilities, of which $34,286 related to severance costs and $2,819 related to cancellation fees and remaining non cancellable payments on operating leases.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Dollars in thousands, except average sales prices) Overview: The majority of the Company's funeral service locations and cemeteries are managed in groups called clusters. Clusters are established primarily in metropolitan areas to take advantage of operational efficiencies, particularly the sharing of operating expenses such as service personnel, vehicles, preparation services, clerical staff and certain building facility costs. Personnel costs, the largest operating expense for the Company, is the cost component most beneficially affected by clustering. The sharing of employees, as well as the other costs mentioned, allow the Company to more efficiently utilize its operating facilities. The Company conducts funeral, cemetery and financial services operations in 20 countries. The Company's largest markets are North America and France, which when combined, represent approximately 78% of the Company's total operating locations, and approximately 86% of the Company's consolidated revenue. Three months ended March 31, 1999 Compared to Three months ended March 31, 1998 Results of Operations: During the quarter ended March 31, 1999 the Company recorded non-recurring items relating to the Company's cost rationalization program and early extinguishments of debt. The cost rationalization program resulted in a pre-tax restructuring charge of $89,884, while early extinguishments of debt resulted in an extraordinary gain of $1,885, net of tax. For the quarter ended March 31, 1999, the Company reported revenues of $904,056, representing a 29.4% increase in revenues compared to revenues of $698,844 from the first quarter of 1998. Gross profits for the first quarter of 1999 increased 1.3% to $218,871 compared to $216,128 in the first quarter of 1998. In the first quarter of 1999, income from operations of $199,161 before the effect of non-recurring charges, remained relatively flat compared to $199,120 in the first quarter of 1998. Before non-recurring items relating to the Company's cost rationalization program and early extinguishments of debt, the Company reported earnings of $98,564 and diluted earnings per share of $.36 ($.36 basic) for the first quarter of 1999. This represents a 9.4% and 14.3% decrease in earnings and diluted earnings per share before non-recurring items, respectively, when compared to the first quarter of 1998. After giving effect to the non-recurring items, the Company reported net income of $43,768 or $.16 diluted earnings per share ($.16 basic) for the first quarter of 1999 compared to $108,786 or $.42 diluted earnings per share ($.43 basic) in the first quarter of 1998. The results from the first quarter of 1999 contain no significant benefits from the Company's 1999 cost rationalization program.
Information for the Company's three lines of business was as follows: <TABLE> <CAPTION> Percentage Three months ended March 31, Increase Increase 1999 1998 (Decrease) (Decrease) ------------------------------------------------------------ <S> <C> <C> <C> <C> <C> <C> Revenues: Funeral............ $574,641 $469,962 $104,679 22.3% Cemetery........... 251,858 205,941 45,917 22.3 Financial services. 77,557 22,941 54,616 238.1 -------- -------- -------- $904,056 $698,844 $205,212 29.4% ======== ======== ======== Gross profit and margin percentage: Funeral............ $131,020 22.8% $130,526 27.8% $ 494 0.4% Cemetery........... 77,800 30.9 81,253 39.5 (3,453) (4.2) Financial services. 10,051 13.0 4,349 19.0 5,702 131.1 -------- -------- -------- $218,871 24.2% $216,128 30.9% $ 2,743 1.3% ======== ======== ======== </TABLE> FUNERAL Funeral revenues were as follows: <TABLE> <CAPTION> Three months ended March 31, 1999 1998 Increase % Increase -------------------------------------------------------- <S> <C> <C> <C> <C> North America........... $333,058 $278,058 $ 55,000 19.8% France.................. 147,064 120,762 26,302 21.8 Other European.......... 79,019 57,773 21,246 36.8 Other foreign........... 15,500 13,369 2,131 15.9 -------- -------- -------- Total funeral revenues.. $574,641 $469,962 $104,679 22.3% ======== ======== ======== </TABLE> The $55,000 increase in North American funeral revenue was the result of a $401 increase in revenues from comparable locations (representing locations acquired before January 1, 1998), a $56,634 increase in revenues from new locations (operating locations acquired subsequent to January 1, 1998), partially offset by a $2,035 decrease in revenues related to operations which have been disposed. The increase in revenues from comparable locations was due to increases in the number of funeral services performed (70,970 in 1999 compared to 70,929 in 1998) and increases in the average sales prices ($3,838 in 1999 compared to $3,832 in 1998). The increase in revenues from new locations is primarily due to the January 1999 merger with Equity Corporation International ("ECI"). The $26,302 increase in French funeral revenue was the result of a $19,092 increase, or 16.1%, in revenues from comparable locations and a $7,210 increase in revenues from new locations. The number of funeral services performed at comparable locations in 1999 increased 3.1% (39,984 in 1999 compared to 38,787 in 1998), while the average sales price increased 9.3% ($2,124 in 1999, compared to $1,944 in 1998). The average French franc to US dollar exchange rate strengthened 4.2% during the first quarter in 1999 as compared to the first quarter in 1998. The $21,246 increase in other European funeral revenue was the result of a $6,163 increase, or 10.4%, in revenues from comparable locations and a $15,083 increase in revenues from new locations. The increase in revenues from comparable locations was primarily due to 12.4% increase in the number of funeral services performed at these locations in 1999 (30,364 in 1999 compared to 27,014 in 1998).
Funeral gross margin was as follows: <TABLE> <CAPTION> Three months ended March 31, % of % of Increase % Increase 1999 Revenue 1998 Revenue (decrease) (decrease) ---------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> North America........ $ 96,400 28.9% $106,289 38.2% $ (9,889) (9.3)% France............... 17,613 12.0 10,290 8.5 7,323 71.2 Other European....... 14,749 18.7 11,708 20.3 3,041 26.0 Other foreign........ 2,258 14.6 2,239 16.7 19 0.8 -------- -------- -------- Total funeral gross margin........ $131,020 22.8% $130,526 27.8% $ 494 0.4% ======== ======== ======== </TABLE> The decrease in North American funeral margin dollars and percentage was primarily the result of increases in merchandise, personnel and facility costs at comparable locations. The decline in comparable funeral margins dollars was partially offset by increased margin dollars contributed by new locations. The increase in French funeral margin dollars and percentage was primarily the result of increased funeral services performed which produced incremental profits over the base fixed cost structure. Additionally, funeral margin dollars were impacted by the average French franc to US dollar exchange rate strengthening 4.2% in 1999. The increase in other European funeral margin dollars was primarily the result of increased funeral services performed and associated revenues discussed above. The decrease in other European funeral margin percentage was primarily the result of strategic pricing changes in certain markets. CEMETERY Cemetery revenues were as follows: <TABLE> <CAPTION> Three months ended March 31, 1999 1998 Increase % Increase ------------------------------------------------------- <S> <C> <C> <C> <C> North America.............$ 223,077 $ 190,986 $ 32,091 16.8% Other European............ 9,853 5,941 3,912 65.8 Other foreign............. 18,928 9,014 9,914 110.0 --------- --------- -------- Total cemetery revenues..$ 251,858 $ 205,941 $ 45,917 22.3% ========= ========= ======== </TABLE> The $32,091 increase in North American cemetery revenue was primarily the result of a $17,819 increase, or 11.2%, in revenues from comparable locations and a $22,507 increase in revenues from new locations. Of the increases, $15,572 and $14,936 related to increases in the sales of preneed cemetery products and services at comparable and new locations, respectively. Partially offsetting these increases was a $11,017 reduction in realized gains and income from cemetery merchandise trust funds, which is consistent with the decrease in equity returns experienced by the Company's investment portfolio and certain other broad equity indices, and declines in interest rates over the comparable periods. The $9,914 increase in other foreign cemetery revenue was primarily the result of revenue increases from the Company's recently acquired South American operations.
Cemetery gross margin was as follows: <TABLE> <CAPTION> Three months ended March 31, % of % of Increase %Increase 1999 Revenue 1998 Revenue (decrease) (decrease) ---------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> North America..........$ 69,330 31.1% $ 77,021 40.3% $ (7,691) (10.0)% Other European.. ...... 4,157 42.2 2,054 34.6 2,103 102.4 Other foreign.......... 4,313 22.8 2,178 24.2 2,135 98.0 -------- -------- -------- Total cemetery gross margin..........$ 77,800 30.9% $ 81,253 39.5% $ (3,453) (4.2)% ======== ======== ======== </TABLE> The decrease in North American cemetery margin dollars and percentage was primarily the result of increased merchandise and selling costs due to changes in product mix, and reduced realized gains and income from cemetery merchandise trust funds discussed above. The $2,135 increase in other foreign cemetery margin dollars was primarily the result of increases in margin dollars from the Company's recently acquired South American operations. The decrease in margin percentage from the Company's other foreign operations is primarily due to the expected dilutive effect of lower margins in the cemetery operations in South America. FINANCIAL SERVICES Financial services represents a combination of the Company's lending subsidiary, Provident Services, Inc. ("Provident"), and the Company's two insurance subsidiaries. Financial services revenues were as follows: <TABLE> <CAPTION> Three months ended March 31, 1999 1998 Increase % Increase ----------------------------------------------------- <S> <C> <C> <C> <C> North America............. $ 50,282 $ - $ 50,282 France.................... 21,514 18,326 3,188 17.4% -------- --------- -------- Total insurance............. 71,796 18,326 53,470 291.8 Provident................. 5,761 4,615 1,146 24.8 -------- --------- -------- Total financial services revenues................. $ 77,557 $ 22,941 $ 54,616 238.1% ======== ========= ======== </TABLE> Financial services gross margin was as follows: <TABLE> <CAPTION> Three months ended March 31, % of % of 1999 Revenue 1998 Revenue Increase %Increase - -------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Insurance: North America......... $ 4,167 8.3% $ - $ 4,167 France .............. 3,134 14.6 2,166 11.8% 968 44.7% -------- ------- ------- 44.7% Total insurance....... 7,301 10.2 2,166 11.8 5,135 237.1 Provident............... 2,750 47.7 2,183 47.3 567 26.0 -------- ------- ------- Total financial services gross margin........... $ 10,051 13.0% $ 4,349 19.0% $ 5,702 131.1% ======== ======= ======= </TABLE> The increase in North American revenue and gross margin is due to the acquisition of American Memorial Life Insurance Co. effective July 1998. Provident reported a gross margin of $2,750 for the three months ended March 31, 1999, compared to $2,183 for the same period in 1998. Provident's average outstanding loan portfolio during the current period increased to $286,885 compared to $205,955 in 1998, while the average interest rate spread decreased to 2.86%, compared to 3.07% in 1998.
OTHER INCOME AND EXPENSES General and administrative expenses increased $2,702 to $19,710, compared to $17,008 in the first quarter of 1998. Expressed as a percentage of revenues, general and administrative expenses decreased to 2.2% for the three months ended March 31, 1999, compared to 2.4% for the comparable period in 1998. Interest expense, which excludes the amount incurred by Provident, increased $19,738 or 52.3% period to period. The increased interest expense primarily reflects the Company's funding of acquisitions with debt. The provision for income taxes reflected a 36.9% effective tax rate for the three months ended March 31, 1999, compared to a 35.3% effective tax rate for the comparable period in 1998. The increase in the effective tax rate is due primarily to higher tax rates for the Company's recently acquired ECI operations. During the first quarter of 1999, the Company recorded a pre-tax restructuring charge of $89,884, related to a cost rationalization program initiated in 1999. The $89,884 charge relates to the following: (1) severance costs of $56,757 related to approximately 800 employees worldwide; (2) a charge of $19,123 for terminated projects representing costs associated with certain construction projects that have been cancelled ($2,153) and costs associated with acquisition due-diligence which will no longer be pursued ($16,970); (3) a $7,245 charge for business and facility closures, primarily in the Company's European operations; and (4) a remaining charge of $6,759 consisting of various other cost initiatives. At March 31, 1999 approximately $37,105 remained in accrued liabilities, of which $34,286 related to severance costs and $2,819 related to cancellation fees and remaining non cancellable payments on operating leases. Payments of these accrued liabilities will occur through 2005. The Company does not expect these payments will have a significant effect on its liquidity or financial position. The effect of the above cost rationalization program, coupled with other cost reduction initiatives, is expected to produce future annualized cost savings of at least $60,000, on a pre-tax basis, primarily from the reduction of personnel and facility costs.
Financial Condition and Liquidity at March 31, 1999: General Historically, the Company has funded its working capital needs and capital expenditures primarily through cash provided by operating activities and borrowings under bank revolving credit agreements and commercial paper. Funding required for the Company's acquisition program has been generated through public and private offerings of debt and the issuance of equity securities supplemented by the Company's revolving credit agreements and additional securities registered with the Securities and Exchange Commission (the "Commission"). The Company believes cash from operations, additional funds available under its revolving credit agreements, and proceeds from public and private offerings of securities will be sufficient to continue its anticipated acquisition program and operating policies. Excluding the ECI transaction, for the three-month period ended March 31, 1999, the Company acquired 29 funeral service locations, 6 cemeteries and 2 crematoria for an aggregate purchase price of approximately $49,400. As of April 21, 1999, the Company has received signed letters of intent to acquire an additional 51 funeral service locations, 8 cemeteries and 2 crematoria for an aggregate purchase price of approximately $56,786. Combined, these businesses are expected to produce approximately $56,000 in annualized revenues, including $26,200 in North American operations and $29,800 from operations outside North America. In addition, the Company merged with ECI in a stock-for-stock transaction in which ECI shareholders received 15,500,824 shares of Company common stock valued at approximately $557,000 and approximately 1,200,000 options to purchase Company common stock valued at approximately $8,628. The ECI merger added 359 funeral homes and 80 cemeteries. At March 31, 1999, the Company had net working capital of $289,789 and a current ratio of 1.37:1, compared to working capital of $578,755 and a current ratio of 1.92:1 at December 31, 1998. Sources and Uses of Cash Cash flows from operating activities: Net cash provided by operating activities was $165,364 for the three months ended March 31, 1999, compared to $139,631 for the same period in 1998, an increase of $25,733. Significant components of cash flow provided by operating activities included: (1) net income adjusted for non-cash items, (2) the original $89,884 pre-tax restructuring provision (of which $37,105 remains at March 31, 1999 and the decrease is reflected through the change in payables and other liabilities), partially offset by (3) an increase in receivables of $86,940 primarily attributed to a 27.8% increase in the sales of preneed cemetery products and services which are usually financed on an installment basis in excess of 12 months.
Cash flows from investing activities: Net cash used in investing activities was $217,788 for the three months ended March 31, 1999, compared to $104,802 for the same period in 1998, an increase in the use of cash of $112,986. Significant components of the increase in cash used are the net of purchases over sales of securities at the Company's insurance subsidiaries. One of the subsidiaries had a significant cash position at December 31, 1998 and the excess cash was used to purchase securities. Additionally, cash provided by the net effect of prearranged funeral production and maturities in the first quarter of 1998 was primarily attributed to a $27,000 cash distribution of previously undistributed trust fund income pursuant to applicable state laws. The increase in cash used was partially offset by the decrease in cash used in connection with acquisitions, which is consistent with the Company's new benchmark criteria for pursuing prospective acquisition candidates. Cash flows from financing activities: Net cash used in financing activities was $124,102 for the three months ended March 31, 1999, compared to net cash provided by financing activities of $159,881 for the same period in 1998, an increase in the use of cash of $283,983. The three months ended March 31, 1999 included a use of cash of $365,936 for the early extinguishment of certain floating rate debt and debt assumed in connection with the ECI merger. As of March 31, 1999, the Company's debt to capitalization ratio was 52.9% compared to 55.0% at December 31, 1998. The interest rate coverage ratio for the three months ended March 31, 1999 was 3.53:1 (excluding 1999 restructuring charge of $89,884), compared to 5.20:1 for the same period in 1998. Though the level of acquisition activity is expected to slow from the 1998 level, the Company still believes that the acquisition of funeral, cemetery and financial services operations funded with debt or Company common stock is a prudent business strategy given the stable cash flow generated and the low failure rate exhibited by these types of businesses. The Company believes these acquired firms are capable of servicing the additional debt and providing a sufficient return on the Company's investment.
The Company expects adequate sources of funds to be available to finance its future operations and acquisitions through internally generated funds, borrowings under credit facilities and the issuance of securities. As of March 31, 1999, the Company had approximately $736,000 of available borrowings under various revolving credit facilities and lines of credit. As of March 31, 1999, the Company also had the ability to issue $900,000 in securities registered with the Commission under a shelf registration. In addition, 12,870,000 shares of common stock and a total of $187,000 of guaranteed promissory notes and convertible debentures are registered with the Commission under a separate shelf registration to be used exclusively for future acquisitions. Prearranged Funeral Services The Company sells prearranged funeral contracts and the funds collected are generally held in trust or are used to purchase life insurance or annuity contracts. The amounts paid into trust funds or premiums paid on insurance contracts on such prearranged funeral contracts will be received in cash by a Company funeral service location at the time the funeral is performed. Earnings on trust funds and increasing benefits under insurance and annuity funded contracts also increase the amount of cash to be received upon performance of the funeral. The total value of unperformed prearranged funeral revenues includes prearranged funeral contracts that are trust funded or to be funded by third party insurance companies or the Company's insurance subsidiaries. The total value represents the original contract values plus any accumulated trust fund earnings or increasing insurance benefits. At March 31, 1999, the total value of unperformed prearranged funeral revenues expected to be recognized in future periods was $4,195,280 ($3,751,850 at December 31, 1998). The Company's investment program targets a real return in excess of the amount necessary to cover future increases in the cost of providing a price guaranteed funeral service as well as any selling costs. This is accomplished by allocating the portfolio mix to the appropriate investments that more accurately match the anticipated maturity of the contracts. The Company anticipates an asset allocation of approximately 65% equity and 35% fixed income. Prearranged funeral service sales afford the Company the opportunity to both protect current market share and mix as well as expand market share in certain markets. The Company believes this will stimulate future revenue growth. Prearranged funeral services fulfilled as a percent of the total North American funerals performed was 27% for the three months ended March 31, 1999 (26% for the three months ended March 31, 1998) and is expected to grow, thereby making the total number of funerals performed more predictable. Other Matters: Year 2000 Issue The Year 2000 issue, also known as "Y2K," refers to the inability of some computer programs and computer-based microprocessors to correctly interpret the century from a date in which the year is represented by only two digits (e.g., 98). As a result, on or before January 1, 2000, computer systems used by companies throughout the world may experience operating difficulties unless they are modified or upgraded to properly process date related information. The Y2K issue can arise at any point in a company's supply, manufacturing, processing, distribution, or financial chains.
The Company has established Y2K Program Offices at its corporate offices in Houston, Texas and Birmingham, England. These program offices, under the direction of senior management, are responsible for advising and monitoring the numerous facets of the Company's Y2K preparations. The Company engaged an external consulting firm to assist in oversight of the Company's Y2K preparations and various assessment activities associated with discovering the seriousness of the Y2K issue in the Pacific Rim and South America. Additionally, the Company is utilizing internal personnel, contract project managers, programmers and testers, as well as vendors, to identify Y2K issues, test and implement the chosen solutions. In order to adequately address the Y2K issue, efforts have been directed to the following categories: production systems, networks, desktops, user developed applications, vendor supplied software, facilities and telecommunications, and the Company's supply chain. The following phases are common to all of these categories: inventory and determination of criticality, discovery to determine Y2K problems, analysis to determine corrective action, correction, testing, and implementation. In addition to these activities, promotion of Y2K awareness and development of contingency plans are part of the Company's Y2K preparation effort. State Of Readiness: The majority of the Company's internal Y2K exposure exists at the corporate office locations where the accounting and processing of the Company's business transactions takes place. Individual operating locations (primarily funeral homes and cemeteries) are substantially technology independent and thus face few Y2K risks from internal systems. Production systems: In 1998, in order to improve access to business information through a common, integrated computing system across the company, the Company began a worldwide computer systems replacement project utilizing systems from Oracle Corporation. While this project has begun at the Company's Australian and European headquarters, global implementation will not be achieved prior to the turn of the century. Therefore, all computer programs expected to be replaced by Oracle are being made Y2K ready. The only exception to this is in the United Kingdom where the implementation of Oracle is proceeding in order to achieve Y2K readiness. In general, the Company's production systems have progressed through the inventory, discovery, and analysis phases and are in various stages of correction and testing. Production systems make up the majority of the Company's "mission critical systems" and are expected to be Y2K ready by mid-1999, with deployment completed by late-1999. In most cases, deployment of the Y2K ready production systems to the Company's many operating locations in North America will require new desktop computers. As noted in the Company's previous Y2K disclosures, it is the short time available for deployment, and not the need for corrective action, that poses the largest risk to the Company. See the section on Risks for more details. Networks: Inventory, discovery and analysis of critical networks have been completed at all of the Company's headquarter and regional locations and these networks are in various stages of correction and testing. Accomplishing Y2K readiness in this category has been complicated by Microsoft's recent change in its position on the Y2K readiness of Windows NT 4.0, requiring customers to install another software update to be considered fully Y2K compliant. Some non-critical networks exist at individual operating locations and will be assessed and made Y2K ready as time allows. Expectations are that all critical networks will be Y2K ready mid- to late-1999.
Desktops: Testing has been conducted to determine the extent to which the Y2K problem associated with desktops will affect the Company's ability to conduct business. As none of the Company's critical computer systems directly access date information from the desktop's real time clock, it has been determined that very few desktops will pose a Y2K issue. Coincidentally, as part of ongoing technology refresh programs and new production systems' deployment, desktops are being upgraded, as needed, to better meet the Company's business needs. As part of contingency planning, personnel will be instructed on how to verify each desktop's date, and reset if necessary, after January 1, 2000. User developed applications: Inventory and discovery for items in this category have been achieved. Very few critical applications were found to have date dependencies. Those that do are being remediated and tested to ensure no problems arise because of Y2K issues. Readiness should be achieved by mid-1999. Vendor supplied software: It is the policy of the Company to query each manufacturer of critical "off-the-shelf" software to ascertain the vendor's statement regarding the Y2K readiness of their products. Once the vendor's statement is obtained, upgrades, replacements and testing will be implemented to minimize the risk of Y2K issues arising from the software. Accomplishing Y2K readiness in this category is becoming increasingly challenging as vendors are modifying previously stated positions on existing software, requiring customers to install patches or upgrades to achieve full Y2K readiness. This has occurred with at least three critical vendor supplied software packages the Company currently uses. Given the moving target posed by the vendor's changing statements, the Company has changed its expectations for critical items in this category and plans to be using the latest vendor supplied patches and upgrades by late-1999. Facilities and telecommunications: The Company recognizes the potential for Y2K issues to arise from embedded technology systems which may be in use at its numerous facilities. Inventory, discovery and analysis are complete at the Company's headquarters and most international operating locations. North American operating locations are expected to complete these phases by mid-1999. Telecommunications equipment has proven the most vulnerable, and plans are in place to upgrade and/or replace equipment as necessary. Planning has begun to obtain inventories from the remaining operating locations. All critical facilities and telecommunication systems are expected to be Y2K ready by late-1999. Supply chain: Due to the Company's disparate locations and methods of operation, assessing the Y2K readiness of the Company's supply chain must occur at both the corporate level (for core supply chain relationships) and the local level (for those relationships unique to a location). Inventory and discovery have been completed at a number of operating locations and is ongoing at the Company's headquarters. In general, responses to the Company's inquiries have been less than informative, with many companies failing to respond. Activities have begun to assign criticality to both corporate and local supply relationships and additional efforts will be expended to ascertain the Y2K readiness of critical suppliers. Contingency plans for critical suppliers are expected to be in place by late-1999.
Costs: The aggregate costs for the Company to achieve Y2K readiness are not expected to exceed $20,000 of which $4,800 represents lease payments which will be incurred from 2000-2002. All costs associated with Y2K readiness will be funded from operating cash flows. The Company's actual costs incurred associated with Y2K readiness through March 31, 1999 are estimated at $8,500. In an effort to report material costs related to the Company's Y2K effort, the Company has adopted a policy of capturing all contractor expenses and internal costs for dedicated resources (those working exclusively on Y2K issues). As such the Company acknowledges that there are many internal resources working part-time on Y2K-related issues for which no payroll or overhead costs are being reported. Risks: The majority of the Company's internal Y2K exposure exists at its corporate offices where the Company's production systems operate. The failure to correct a material Y2K problem at these locations could result in an interruption of certain normal corporate business activities. Such a failure would not, however, render the Company's various operating locations unable to deliver goods and services. The Company believes that the greatest risks continue to arise from the uncertainty of the Y2K readiness of critical third party suppliers, both private businesses and government entities, especially in the Company's international markets. The possible consequences of critical third party suppliers not being Y2K ready by January 1, 2000 could include temporary location closings, delays in the delivery of goods and services, delays in the receipt of goods and invoice and collection errors. Continued efforts by the Company to ascertain the Y2K status of critical third party suppliers is expected to significantly reduce the Company's level of uncertainty as the year 2000 approaches and, through the use of contingency planning, the possibility of significant interruptions in normal operations should be reduced. At this time, the Company has no substantiated reason to believe that one or more key third party suppliers will not be able to meet their obligations to the Company after January 1, 2000; therefore, the Company believes that the "most reasonably likely worst case scenario" would occur if deployment of the Company's newly remediated proprietary funeral home financial system to all North American locations was not completed by December 31, 1999. The Company's approach to deploying this new system calls for implementation in those clusters which have the highest transaction volumes first. Using such a plan, should deployment to all locations not be achieved by December 31, 1999, such an occurrence would not be materially disruptive to the Company. Locations not receiving the new system by the end of the year would forward transaction information to a location with input capability. Contingency Plans: Because of the many uncertainties that exist, it is part of the Company's Y2K preparation methodology that contingency plans be established for critical systems in each of the categories outlined above. Contingency planning is progressing at different stages at the Company's various locations. Contingency plans for all critical production systems and plans for all individual operating locations are expected to be in place by late-1999.
Cautionary Statement on Forward-looking Statements The statements contained in this filing on Form 10-Q that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements may be accompanied by words such as believe, estimate, expect, anticipate, or predict, that convey the uncertainty of future events or outcomes. These statements are based on assumptions that the Company believes are reasonable; however many important factors could cause the Company's actual results in the future to differ materially from the forward-looking statements made herein and in any other documents or oral presentations made by, or on behalf of, the Company. Important factors which could cause actual results to differ materially from those in forward-looking statements include, among others, the following: 1) Changes in general economic conditions both domestically and internationally impacting financial markets (e.g. marketable security values as well as currency and interest rate fluctuations). 2) Changes in domestic and international political and/or regulatory environments in which the Company operates, including tax and accounting policies. Changes in regulations may impact the Company's ability to enter or expand new markets. 3) Changes in consumer demand for the Company's services caused by several factors such as changes in local death rates, cremation rates, competitive pressures and local economic conditions. 4) The Company's ability to identify and complete additional acquisitions on terms that are favorable to the Company, to successfully integrate acquisitions into the Company's business and to realize expected cost savings in connection with such acquisitions. The Company's future results may be materially impacted by changes in the level of acquisition activity. 5) The ability of the Company, or its critical third-party suppliers, to adequately complete Y2K preparation efforts. The Company assumes no obligation to publicly update or revise any forward-looking statements made herein or any other forward-looking statements made by the Company.
SERVICE CORPORATION INTERNATIONAL PART II, OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.1 Employment Agreement, dated March 10, 1999, between SCI Executive Services, Inc. and George R. Champagne. 10.2 Employment Agreement, dated January 1, 1999, between SCI Executive Services, Inc. and W. Blair Waltrip. 12.1 Ratio of earnings to fixed charges for the three months ended March 31, 1999 and 1998. 27.1 Financial data schedule. (b) Reports on Form 8-K During the quarter ended March 31, 1999, the Company filed four reports on Form 8-K. The Form 8-K dated January 20, 1999 reported (i) under "Item 2. Acquisition or Disposition of Assets" the merger of Equity Corporation International ("ECI") with a wholly-owned subsidiary of the Company, (ii) under "Item 5. Other Events" the execution of a supplemental indenture under which the Company became co-obligor with respect to certain debentures of ECI, and (iii) under "Item 7. Financial Statements and Exhibits" the exhibits comprised of the merger agreement with ECI and the first amendment thereto, the first amendment to the aforementioned supplemental indenture and a joint press release dated January 19, 1999 issued by the Company and ECI. The Form 8-K dated January 26, 1999 reported (i) under "Item 5. Other Events" the Company's announcements that (x) its diluted earnings per share for the fourth quarter of 1998 and for the year ended December 31, 1998 would be lower than analyst expectations and (y) it had expanded its share repurchase program, and (ii) under "Item 7. Financial Statements and Exhibits" the exhibits comprised of two Company press releases dated January 26, 1999. The Form 8-K dated February 9, 1999 reported (i) under "Item 5. Other Events" the Company's results for the fourth quarter of 1998 and for the year ended December 31, 1998, as well as the commencement of class action lawsuits against the Company and certain of its officers and directors, and (ii) under "Item 7. Financial Statements and Exhibits" the exhibit comprised of the Company's press release dated February 9, 1999. The Form 8-K dated February 11, 1999 reported (i) under "Item 5. Other Events" the resignation of L. William Heiligbrodt as President and Chief Operating Officer, and (ii) under "Item 7. Exhibits" the exhibit comprised of the Company's press release dated February 11, 1999. SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. May 17, 1999 SERVICE CORPORATION INTERNATIONAL By: /s/ George R. Champagne --------------------------- George R. Champagne Executive Vice President Chief Financial Officer (Principal Financial Officer)