Financial Report of Loewen Group Inc. Essay Example

of the revenue recognition
practices used by L.G.I..

The Funeral Services Industry
According to a paper issued in August 1995, by Statistics Canada's Services,
Science and technology Division Final Purchase, Growing Demand: The Canadian
Funeral Services Industry, the funeral services industry, in comparison to other
industries, has historically been considered a low risk industry. The Funeral
service industry is not significantly affected by economic cycles. The
stability of the industry is increased by future demographic trends.

Individuals from the "baby boomer" generation are now entering their fifties and
the death rate is growing slowly at 1.5% per year, compounded, as demonstrated
in Appendix A: Deaths, Actual and Projected. The industry is characterised by
above-average profitability and revenue growth.

Public Health issues and consumer protection issues are primarily regulated at
the provincial level of government. These regulations are implemented to
protect the dignity of the deceased as well as his or her estate. These
regulations are described in detail in the revenue recognition section.

Loewen Group Inc. Strategies
The Provident America Corporation lawsuit was settled in February, 1995 for US
$19 million. On November 2nd, 1995, a jury in Jackson, Mississippi, awarded US
$500 million in Breach-of-contract lawsuit brought by Gulf National. This amount
is almost twenty-six times high than what was originally asked for. In order to
appeal, Loewen was required to post a US $625 million bond, which was later
reduced to US $125 million with the condition that there would be no significant
change in assets or increases in dividends without prior notification to the
court and the other party. No provision on was made on the financial statement
at this point since the result was hard to predict on the appeal. On January
29th, 1996, Loewen settled the lawsuit for US $175 million and recorded US $135
million, present value

of $175 million.

Loewen decided to settle because of two reasons: the first is that the
appeal would have a financial impact on the company's income and the second
reason is that prolonging the lawsuits would create uncertainty and speculation
amongst the company's shareholders.

S.C.I. Take-over Attempt
On September 17, 1996 Service Corporation International (S.C.I.), the largest
Funeral Service Company in the world, placed a $ 2.5. billion take-over bid for
Loewen Group Inc. The bid's share value is equivalent to US $ 43 each. Houston
based S.C.I.'s bid was considered to be fair by many analysts like Todd Richter
of Dean Witter Reynolds Inc. (New York) and Ivar Leipens of Moss, Lawson ; Co.

(Toronto). Another analyst, Dean Martin of TD securities Inc. (Toronto), stated
that the bid was too low and that the a bid of US $ 50 would be fair. He noted
that Chairman Ray Loewen and his management team retain 20 % (15 % + 5 %
respectively) of the company's stock. Canadian institutional holders of the
company's stock would be more likely to support the company because they must
follow constraints such as a cap of 20 % on foreign holdings in regards to
Canadian Pension funds. Therefore S.C.I. will has had a difficult time gaining
the support of 75 % of Loewen Group Inc. shareholders needed as per the Canadian
securities law.

In the week following the announcement of the take-over bid, the fourth
largest company in the industry, Equity Corp. International, based in Lufkin,
Texas had contacted the Federal Trade Commission in regards to how to become
eligible to bid for divested properties if the take-over took place. Equity
Corp. International is 40 % owned by Service Corp. International. Another
company, Continua LLC, offered Loewen Group Inc. $ 500 million in exchange

for
some of Loewen's southern US holdings. On September 27, 1996 the State of
Florida launched an antitrust probe into the take-over bid. The state was
worried about the impact it would have on Medicare issues, pricing and other
areas.

S.C.I. would raise the bid to US $ 45 per share before Loewen rejected
the bid on October 10, 1996, while at the same time launching an antitrust
lawsuit against S.C.I. and Equity Corp. International. The lawsuit accused the
two companies of conspiring to eliminate L.G.I. from the industry.

All companies in the Funeral Service Industry are continuing to
reposition themselves as the industry continues to expand. If successful, S.C.I.

would be able to monopolise the North American market. S.C.I.'s take-over
proposal is intended to eliminate the competition in North America. S.C.I.

wanted to buy cheap after the one time event with the jury. By taking over
Loewen, S.C.I. would become the preferred buyer in the industry. Loewen rejected
their offer because of the following reasons:
1) inadequate proposal which has a potential anti-competition effect in
the commonwealth of the industry.

2) Although both companies encourage the integration of new acquisitions
in their structures, Loewen felt that its structure would not be preserved.

3) Loewen is considered as the preferred acquirer in the industry after
the acquisition of two of its key assets: Prime Succession, and Ross Hill
Memorial Park, two major cemeteries in the United States of America.

Loewen decided that it is best to continue implementing the company's long term
business plan as an independent company. Loewen has created a good corporate
culture and has a record for caring for its employees, customers, and
communities it serves.

Annual Report Analysis
The Loewen Group Incorporated 1995 Annual Report covers the period
beginning January 1, 1994 and ending December 31st, 1995. This analysis will
cover

the following items: the report to the company's shareholders, the
"Striking a Balance" section of the report and the operational highlights. The
operational highlights analysis will include Management's Statement of
Responsibility, the Auditor's report to the Shareholders, a ratio analysis of
the financial statements disclosed in the report as well as the pertinence of
the notes regarding the financial statements.

The annual report stresses the company's belief in its Eagle Principle. In the
report to the company's shareholders, The chairman and chief executive officer,
Ray Loewen stresses that the company showed 'outstanding growth' despite the
inflicting costs associated with the two major lawsuits it dealt with. He
thanked the shareholders for their support, then stated promising figures that
were overshadowed by the above for mentioned events. He continued with the
aspect of growth by discussing the company's acquisitions. Mr. Loewen concluded
by promising to continue to uphold the company's standards in 1996.

The "Striking a Balance" section of the annual report's purpose is to
provide answers from management and executive members about questions
shareholders might have about the Loewen Group Inc. beliefs, operations and
structure. The topics ranged from the effect of the Gulf National lawsuit to
how the services provided by Loewen benefit the communities it serves. This
section does not disclose monetary figures, its responsibility lies in creating
or restoring the trust of its potential shareholders and current shareholders
before they analyse the financial statements in the following section of the
annual report, by demonstrating the personal accountability of its staff .

Operational Highlights
The management's statement of responsibility states that management has
presented fairly the financial position of the company while respecting the
generally accepted accounting principles in Canada. Management also states that
it maintains its control systems to assure that also transactions are completed
and recorded properly. The letter

conclusion indicates that the auditors
selected are independent.

The auditor's report to the shareholders notes that the audits made by
KPMG Peat Marwick Thorne (independent auditors) were based on the generally
accepted auditing standards and summarises its criterion: finding evidence of
amounts and disclosure policies and the manner in which the company adopted the
generally accepted accounting principles. The auditors concluded upon the
completion of the audits that the information provided in the consolidated
financial statements to be presented fairly because the company applied
generally accepted accounting principles consistently.

Ratio Analysis of Financial Statements
All ratios presented show 1995 in the first column and 1994 in the second column.

As shown with the return on equity ratio. The dollar figures in the annual
report are in American currency.

Performance Ratios
19951994
Return on equity(76684)/614682 = (0.125)38494/411139 = 0.094
Return on equity based on the Scott formula (Please refer to Appendix E: for
complete figures)
ROE=SR*AT+ ROA-IN *D/E 1995
(0.125) = (0.011) * 0.265+(0.003) - 0.043 * 2.682
19940.094= 0.146* 0.315+0.046- 0.025 * 2.226
In 1995, $50 million of cash and 1.5 million Common shares are paid off to Gulf
National. The settlement decreases Loewen's 1995 net income and retained
earnings while increasing their owner's equity. Therefore the shareholders lost
12.5 % on their initial investment, compared to a gain of 9.4 % in 1994. Return
on equity, calculated without the lawsuit settlement, shows a smaller decrease
of 7.8 % from the previous year. This is primarily due to the increase in share
capital of $210 million made by the company to cover the debts incurred through
the litigation proceedings. Based on the Scott formula results, the decrease on
the return on equity ratio was caused by a loss on overall operating return
before interest cost and a high leverage return. Return on assets
(72949)/2262980 = (0.032)95113/1326275 =

0.0717
Total assets increased by 70.6 % however, the costs associated with the legal
settlements ($165 million) resulted in a net loss. These occurrences resulted
in a negative return on assets. The negative return on assets normally indicates
trouble in ability to pay interests. Only $53 million of $165 million was paid
in cash and the remainder was recorded as a long term liability without interest.

We can also relate these figures to the decrease in credit ratings of Loewen
Group Inc. by the following credit facilities: Duff & Phelps Credit Rating,
Standard & Poor's Rating Group and Moody's Investor Services as stated in the
'Current Credit Facilities and Credit Ratings' section of the 1995 annual report.

Sales return(76684)/599939 = (0.128)38494/417328 = 0.092 In 1994,
9.2 % of all revenues ended up as profit, while in 1995, 12.8 % of all revenues
were recorded as a loss. 0.080 If the company would not have had to incur the
costs relating to the lawsuit, 8 % of its revenues would have been profit. The
costs relating to funeral homes and cemeteries expenditures exceeded the
revenues they generated, because their revenues were not considered revenues of
L.G.I. until the acquisitions were completed.

Gross margin599939-373131/599939 = 0.378417328-258474/417328 = 0.381
Average interest rate50913/1648298 = 0.03134203/91536 = 0.037
The gross margin and the average interest rate both remained steady.

Cash flow to total assets39454/2262980 = 0.01711649/1326275 = 0.009
Cash flow to total assets ratio shows an increase, because the new acquisitions
generated more revenues. The majority of the costs related to the Gulf National
lawsuit were not included in the ratio, since a large percentage of the costs
were recorded as long term liabilities. These liabilities did not involve a
cash transaction.

Earnings per share(1.690)0.970 Book value per share
614682000/48167765 = $12.761 per share411139000/41015447 = $10.024 per

share
Price-earning ratio34.380/(1.690) = (20.343)36.750/0.970 = 37.887
Dividend payout ratio0.050/(1.69) = (0.030)0.070/0.970 = 0.072
Earnings per share shows a large decrease in percentage, since the company
issued US $ 210 million dollars worth of new shares. Therefore the dividends
were distributed to a larger number of shares. The value of shareholders equity
per share increased from US $ 10.02 in 1994 to US $ 12.76 in 1995. The dividend
payout ratio decreased because earnings per share decreased. The price earning
ratio lowered due to the decrease in earnings per share, as well as the current
market price per share. Activity Ratios
Total asset turnover599939/2262980 = 0.265417328/1326275 = 0.315
The total asset turnover remained steady because of the new acquisitions off
balanced the legal settlements and litigation cost. One American dollar of total
assets generated US $ 0.27 in 1995, whereas in 1994, it generated US $ 0.32.

Inventory turnover373131/27489+19673/2= 15.800
210471/19673+15952/2= 11.820 Collection ratio
115953/599939/365 = 70.50070547/417328/365 = 61.700
The inventory turnover was 15.8 times in 1995, an increase from 11.8 times in
1994. In 1995, it took 70.5 days to collect accounts receivables compared to
61.7 days in 1994. This has a negative impact on the company's liquidity.

Financing Ratios
Debt-equity ratio1648298/614682 = 2.682915136/411139 = 2.200 Long-
term debt-equity934509/614682 = 1.520516654/411139 = 1.260 Debt to
assets ratio1648298/2262980 = 0.728915136/1326275 = 0.690
The company's reliance on debt increased because the costs it had to incur
relating to the Gulf National lawsuit as well as the insurance liabilities
incurred created by the two insurance companies it received during the
acquisition of S.I. Acquisitions Associates, L.P.

Liquidity and Solvency Warning Ratio
Working capital ratio191081/241275 = 0.790109868/97665 = 1.125
The working capital ratio lowered to 0.790 from 1.125 in 1994. This means that
their current liabilities increased at a faster rate than their current assets
in 1995. This is cause

for concern because ideally this ratio should be at $ 2
of assets to $ 1 of liabilities. Acid test ratio39454+115953/241275 =
0.64415349+70547/97665 = 0.880 Interest coverage ratio72949-
47178/50913 = 0.50624029+19738/34203 = 1.280
Both the acid test ratio and the interest coverage ratio both fell from last
year. The acid test ratio decrease was caused by larger increase in liabilities
than assets. The interest coverage ratio decreased below to 0.506 which is
below the ideal target of 1. The company is not generating sufficient income to
cover its obligations as they become due.

Revenue Recognition
This analysis of the revenue recognition practices by Loewen Group Inc.

is divided into two sections. The first section will concentrate on revenue
recognition practices relating to funeral services and the second section will
develop those relating to the cemetery operations of this company. We have
included three Appendixes, Appendix B: Average Funeral Costs, Appendix C:
Revenue by Source in the Funeral Service Industry and Appendix D: Total Revenue
of the Funeral Service Industry by Sector for additional references .

Funeral homes offer services, which include everything from the actual
service and registration of the death of an individual to the sale of a casket.

These services can be purchased "at-need", which is considered as a purchase at
the time of death, or "pre-need", which is a prearranged contract established
while the deceased is still living.

Provincial regulations in Ontario protect the consumer with respect to
pre-need funeral and cemetery services. In general, the regulations require a
specific percentage of pre-paid funds to be deposited in trust. Ontario
requires 100% deposits in trust on the sale of pre-arranged funeral services.

This is required in order to protect the consumer from service non-delivery due
to the closure or failure of the firm where they purchased the funeral services.

Firms

within the province of Ontario can not take the fullest financial
advantage of pre-need services due to regulatory restrictions on the funds in
question. However the firms still benefit, in that they are gaining control of
future market share, and can be certain of future revenue flows.

"Payments made for pre-need contracts are either placed in
trust by the company or are used on behalf of the purchaser of the pre-need
contract to pay premiums on life insurance policies under which the company is
the designated beneficiary. At the date of performance of a pre-arranged
service, the company records as a funeral revenue the amount originally trusted
or the insurance contract amount, together with all related insurance contract
amount, together with all related accrued trust earnings and increased insurance
benefits"2
Pre-arranged funeral services are included in other assets and amortised
over a period of ten years approximating the period the benefits are expected to
be realised.

The regulations regarding cemeteries focus on public health aspects and
the care and maintenance of cemetery grounds. Funeral home companies are
required to deposit a certain percentage from the proceeds of sales of interment
rights (ie: the lot, crypt or riches for the final disposition of the remains).

These perpetual care funds are held in perpetuity and is not considered an asset
to the firm. The firm does however have the right to the interest earned on the
funds in order to provide the care and maintenance of their cemeteries.The
percentage required to be deposited into the perpetual care fund varies from 5%
to 40%, depending on the area. In the event that the firm suspends its
operation these funds can be made available through the province or municipality.

"The pre-need sale of interment rights and other related
products is recorded as revenue when customer

contracts are signed and,
concurrently, related costs are recorded and an allowance is established for
customers cancellations and refunds based on management's estimated of expected
cancellations."3
1995, was a controversial year for The Loewen Group Inc. The company
showed its desire to expand within the funeral industry by acquiring funeral
homes and cemeteries from Osiris Holding Corp., MHI Group as well as other
companies. The speed in which they attempted to acquire new holdings made the
company vulnerable to lawsuits. The company stated in its annual report that it
has become more aware of this issue after the Gulf National incident. Although
the company was severely affected financially by the settlement as demonstrated
by the financing and liquidity ratios, the company showed its potential to
maintain its position in the industry, as shown by the relative unchanged gross
margin.

The company now finds itself highly leveraged (as demonstrated by the
Scott Formula calculations) and therefore has the potential for big earnings
for shareholders. This has also made the company vulnerable to outsiders, as
demonstrated by the Service Corporation International's attempt to take-over the
company. If Loewen Group Incorporated is able to stop the take-over attempt, it
will prove its stability.

REFERENCES
1. Loewen Group Incorporated, "The Loewen Group Inc. 1995 Annual Report", H.

MacDonald Printing.,1996, 1. 2. Loewen Group International Inc., online
Available @ http://www.sec.gov/archives/edgar/data/845577/0000950109/09-96-
003953.txt. 3. Ibid.

BIBLIOGRAPHY
Freiedman, Jack P., Dictionary of Business Terms, New York, Barron's Educational
Series Inc., 1994.

Gibbins, Michael, Financial Accounting: An Integrated Approach, 2nd Edition,
Scarborough, Nelson Canada, 1995.

Heimbecker, John, Final Purchase, Growing Demand, The Canadian Funeral Services
Industry, Ottawa, Statistics Canada, 1995.

The Loewen Group Inc., The Loewen Group Inc. 1995 Annual Report, Burnaby B.C.: H.

MacDonald Printing, 1996. The Loewen Group International Inc., online
Available @ http://www.sec.gov/archives/edgar/data/845577/0000950109/09-96-
003953.txt. Milner, Brian. "Loewen board rejects SCI takeover bid", The Globe
and Mail, 11

October 1996, B13. Milner, Brian. "Rivals target Loewen assets",
The Globe and Mail, 23 Sepetember 1996, B1, B10. Schreiner, John. "Loewen won't
concede defeat without exacting a high price" The Financial Post 19 September
1996: 1-2. Schreiner, John. "U.S. giant bids for Loewen" The Financial Post 18
September 1996: 1-2.

APPENDIX A: Death, Actual and Projected
Source: p.18 of Final Purchase, Growing Demand The Canadian Funeral Services
Industry. APPENDIX B: Average Funeral Costs
Source: p.13 of Final Purchase, Growing Demand The Canadian Funeral Services
Industry. APPENDIX C: Revenue by Source in the Funeral Services Industry
Source: p.6 of Final Purchase, Growing Demand The Canadian Funeral Services
Industry. APPENDIX D: Total Revenue of the Funeral Services Industry by Sector
Source: p.4 of Final Purchase, Growing Demand The Canadian Funeral Services
Industry.

APPENDIX E: The Scott Formula
(Expressed in thousands of U.S. Dollars)
19951994Symbols
Total assets2262980 1326275 A
Total liabilities 1648298 915136 L
Total equity614682 411139 E
Total revenue599939 417328 REV
Net income(76684) 38494NI
Interest expense 5091334203INT
Income tax rate (38.1) % 33.9 % TR
After-tax interest expense 50913 * 1.381 = 70311 34203 * .661 = 22608 ATI =
INT (1 - TR)
ROE (return on equity) (76684) / 614682 =
(0.125) 38494 / 411139 = 0.094 NI / E
SR (sales return before interest) (76684) + 70311 / 599939 = (0.011) 38494 +
22608 / 417328 = 0.146 NI + ATI / REV
AT (asset turnover) 599939 / 2262980 = 0.265417328 / 1326275 = 0.315
REV / A
ROA (return on assets) (76684) + 70311 / 2262980 = (0.003) 38494 + 22608 /
1326275 = 0.046 NI + ATI / A
IN (average interest rate after tax) 70311 / 1648298 = 0.043 22608 / 915136 =
0.025 ATI / L
D / E (debt-equity ratio) 1648298 / 614682 = 2.682915136 / 411139 = 2.226 L
/ E