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During fiscal year 2001, the Company focused on restructuring and reducing its debt, pursuing the sale of its foreign operations, improving cash flow and operating its core businesses.
On June 29, 2001, the Company completed the refinancing of substantially all of its long-term debt. The refinancing extended the Company’s long-term debt maturities four to seven years but increased its cost of debt by approximately 300 basis points. The refinancing also resulted in an extraordinary charge to earnings for the early extinguishment of debt of $5.5 million, after taxes. The refinancing is described in more detail in Note 14 to the Company’s consolidated financial statements.
In addition, during fiscal year 2001, the Company decided to sell its foreign operations and certain domestic assets, primarily excess cemetery property and funeral home real estate, and wrote down the value of these assets to their estimated fair value. Primarily as a result of these actions, the Company incurred an aggregate after-tax noncash charge to earnings of $205.1 million, of which $187.3 million related to foreign operations. Because the Company has already reduced equity for the cumulative foreign translation adjustment incurred in each period that it has owned its foreign businesses, the total related charge to shareholders’ equity for the loss on its foreign operations is estimated to ultimately be $85.6 million. For additional information, see Note 13 to the Company’s consolidated financial statements.
The Company has made substantial progress with its plan to sell its foreign operations, and as of October 31, 2001, the Company had completed the sale of all of its foreign operations other than those in Southern Europe (France, Spain and Portugal), Canada and Argentina. The Company also sold domestic assets, primarily excess cemetery property and funeral home real estate. The Company used the proceeds from these transactions, along with free cash flow, to reduce debt from $950.5 million at the end of fiscal year 2000 to $690.9 million, excluding debt associated with assets held for sale as of October 31, 2001. Subsequent to October 31, 2001, the Company signed a binding contract for the sale of its operations in Southern Europe and will use the net proceeds from the sale to reduce its debt.
Also during fiscal year 2001, the Company implemented SAB No. 101 which changed the way the Company records preneed sales. The cumulative effect of this accounting change resulted in an after-tax charge to earnings of $250.0 million. The impact of SAB No. 101 is discussed in more detail below and in Note 3 to the consolidated financial statements.
Although not required to implement SFAS No. 142, “Goodwill and Other Intangible Assets,” until the first quarter of fiscal year 2003, the Company intends to implement it in the first quarter of fiscal year 2002. SFAS No. 142 establishes a new method of testing goodwill for impairment by requiring that goodwill be separately tested for impairment at the “reporting unit” level using a fair value approach rather than an undiscounted cash flow approach. If the fair value of a reporting unit is less than its book value, an impairment loss will be recognized and treated as a change in accounting principle. Without clear guidance as to the constitution of a reporting unit, the Company’s initial understanding was that a reporting unit could range from an individual facility level to a regional level. Consequently, the Company preliminarily estimated that it would incur a pre-tax noncash impairment charge of between $100.0 million to $300.0 million for its domestic operations. Since the Company’s initial analysis, there has been clarification and guidance on the application of this pronouncement, including guidance related to the determination of a reporting unit. This clarification has resulted in the Company’s evaluation of goodwill at the funeral and cemetery segment level, which it believes constitutes the Company’s reporting unit. Accordingly, the Company believes that the adoption of SFAS No. 142 in the first quarter of 2002 will not result in a material impairment charge. Upon the implementation of SFAS No. 142, goodwill will no longer be amortized. The Company’s foreign operations will not be affected as they have been previously marked to fair value. The Company’s amortization of goodwill amounted to $19.3 million ($14.4 million related to domestic operations) in fiscal year 2001.
During fiscal year 2002, the Company plans to continue to focus on debt reduction and to position itself for business expansion in 2003.
The Company sells cemetery property and funeral and cemetery products and services both at the time of need and on a preneed basis. The Company’s revenues in each period consist primarily of at-need sales, preneed sales delivered out of the Company’s backlog during the period, preneed cemetery property sales and other items such as perpetual care earnings and finance charges.
The Company considers maintaining its preneed backlog through preneed marketing and sales to be an integral part of its long-term business strategy. The Company’s primary objective is to produce preneed sales levels sufficient to balance its cash investment with its goal of maintaining a sustainable and predictable level of growth in its preneed backlog. The Company’s current goal is to make four preneed funeral sales for every three it delivers.
The Company estimates that as of October 31, 2001 the future value of its domestic preneed backlog represented $2.2 billion to $2.3 billion of revenue to be recognized in the future as these prepaid products and services are delivered. This represents the face value of the backlog plus the earnings that are projected on the funds held in trust, assuming an average yield of about 8.5 percent and a build-up in the face value of insurance contracts. It assumes no future sales and assumes maturities of the existing contracts over a weighted average life of approximately 10 to 15 years, which is consistent with the Company’s experience. While the investment yield over the past five years has been in this range, there is no guarantee that future yields will be at this level. As of October 31, 2001, the value of the preneed backlog, excluding any future earnings on the funds held in trust and any build-up in the face value of insurance contracts, but including earnings realized to date on the funds held in trust, was approximately $1.6 billion.
Preneed property, products and services are typically sold on an installment basis with terms of approximately three to five years. In fiscal year 2000, the Company changed the terms and conditions of its preneed sales contracts and commissions, and moderated its preneed sales activities, in order to enhance its cash flow. These changes are described in more detail under the heading, “Results of Operations — Year Ended October 31, 2001 Compared to Year Ended October 31, 2000 — Cemetery Segment” below.
With respect to the sale of cemetery property, whether preneed or at-need, the Company is generally required by state law to place into a perpetual care trust, a portion, usually 10 percent, of the proceeds it receives in order to fund maintenance of the cemetery grounds. As payments are received, the Company generally funds the perpetual care trust in the same proportion as the payment bears to the contract amount; for example, if the Company receives 20 percent of the contract price, it places in trust 20 percent of the total amount to be placed in trust for that contract. The Company withdraws realized earnings, including net realized capital gains in some jurisdictions, on these funds to use towards the maintenance of its cemeteries, but principal must generally be held in the trust in perpetuity.
With respect to the preneed sale of cemetery and funeral products and services, state laws generally require either (1) a portion of the installment payments received be placed into a trust fund or (2) the use of an insurance policy underwritten by an insurance company to provide funds to cover the costs of delivering funeral products and services in the future. With respect to the preneed sale of cemetery merchandise, the Company is generally required to place in trust 30 to 50 percent of each installment received. With respect to the preneed sale of funeral and cemetery services, the Company is generally required to place in trust 70 to 90 percent of each installment received. The sale of caskets is treated in some jurisdictions in the same manner as the sale of cemetery merchandise and in some jurisdictions in the same manner as the sale of funeral services for these purposes. When insurance is used, the Company applies customer payments to pay premiums on the insurance policies. The Company typically acts as agent for the insurance company and earns a commission. Generally, the Company can withdraw the principal of and earnings on the funds placed in trust only at the time that the related products and services are delivered.
If a preneed funeral product or service contract is cancelled, the Company generally returns to the customer the related principal that was placed in trust and retains the portion not placed in trust. In many jurisdictions, the Company can withdraw and retain all related earnings in the trust, but in other jurisdictions these earnings must be returned to the customer. If a preneed cemetery property, product or service contract is cancelled, the Company generally is not required to return any funds to the customer.
The impact of preneed sales on near-term cash flow depends primarily on the commissions paid on the sale, the portion of the sale required to be placed into trust and the terms of the particular contract (such as the size of the down payment required and the length of the contract). The Company generally pays commissions to its preneed sales counselors based on a percentage of the total preneed contract price, but only to the extent cash is paid by the customer. If the initial cash installment paid by the customer is not sufficient to cover the entire commission, the remaining commission is paid from subsequent customer installments. However, because the Company is required to place a portion of each cash installment paid by the customer into trust, it may be required to use its own cash to cover a portion of the commission due on the installment from the customer. Accordingly, preneed sales are generally cash flow negative initially but become cash flow positive at varying times over the life of the contract, depending upon the trusting requirements and the terms of the particular contract.
Cash expended for preneed funeral and cemetery merchandise and service sales, principally sales commissions, is capitalized in deferred charges on the balance sheet and amortized and expensed as cost of sales as the contracts are delivered.
Effective November 1, 2000, the Company implemented Staff Accounting Bulletin No. 101 (“SAB No. 101”) “Revenue Recognition in Financial Statements,” which resulted in changing its methods of accounting for preneed sales activities. The effect of the change in accounting principles is described in Note 3 to the consolidated financial statements. A description of the Company’s current accounting for preneed sales and trust and escrow account earnings after implementation of SAB No. 101 follows.
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