Service Corporation International — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. SCI operates funeral homes, cemeteries and related deathcare businesses across the United States and Canada. Unless otherwise noted, financial amounts below are in millions of dollars.
Financial results and liquidity
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $796.1 | $773.2 | $1,590.6 | $1,551.0 |
| Operating income | $162.0 | $143.9 | $325.6 | $283.8 |
| Net income attributable to common stockholders | $103.2 | $68.5 | $185.2 | $243.2 |
| Diluted EPS | $0.55 | $0.36 | $0.98 | $1.26 |
| Operating margin | 20.3% | 18.6% | 20.5% | 18.3% |
Q2 revenue increased 3.0%, while operating income increased 12.5%. For the first half, revenue rose 2.6% and operating income rose 14.7%, but reported net income and diluted EPS fell because the prior-year period included a substantial income tax benefit. The effective tax rate was 13.4% in Q2 2018 versus 32.5% in Q2 2017; for the first half it was 19.3% in 2018 versus a 21.6% tax benefit in 2017. Results are also affected by the 2018 adoption of new revenue-recognition guidance: management estimated that it reduced first-half net income by $10.4 million, or diluted EPS by $0.06, relative to prior guidance.
Q2 funeral revenue was $468.6 million and cemetery revenue was $327.4 million. Comparable funeral services performed declined 0.7% in Q2, and the cremation rate rose to 54.6% from 53.4%; comparable funeral operating profit declined 3.4%. Comparable cemetery revenue and operating profit increased, with cemetery operating margin up 70 basis points to 30.0%. For the first half, funeral services performed increased 1.6%; comparable cemetery operating margin rose 210 basis points to 28.5%.
First-half operating cash flow was $315.4 million, versus $222.5 million a year earlier. Investing activities used $272.8 million, including $167.6 million for acquisitions and $102.9 million of capital expenditures; financing activities used $210.1 million, including $228.9 million of share repurchases and $62.2 million of dividends. Cash and cash equivalents were $164.5 million at June 30, 2018, compared with $330.0 million at year-end.
Total debt was $3.589 billion, up from $3.473 billion at December 31, 2017; weighted-average interest rate was 4.88%. SCI had $596.7 million of available bank-facility capacity and reported compliance with debt covenants. Its actual leverage ratio was 3.85 against a 4.50 maximum; interest coverage was 5.32 against a 3.00 minimum. Management said available cash, expected operating cash flows and credit capacity provide adequate liquidity. Preneed backlog was approximately $11.1 billion, including insurance-funded contracts that are not recorded as balance-sheet assets or liabilities.
Material changes and notable items
- SCI adopted revenue-from-contracts guidance on January 1, 2018. It recorded a $172.2 million increase to retained earnings at adoption, principally reflecting deferred selling costs, and changed presentation of certain customer amounts. Comparisons with 2017 are therefore not fully like-for-like.
- Q2 general and administrative expense decreased $9.2 million year over year; the prior-year quarter included a $1.1 million pension settlement and higher legal costs. First-half 2018 also included a $10.1 million loss on early extinguishment of debt. SCI redeemed $250 million of 7.625% notes due October 2018.
- SCI acquired 15 funeral homes and seven cemeteries in June for $82.2 million in cash and paid $49.8 million of acquired debt. Purchase accounting was preliminary. The company repurchased 6.1 million shares for $228.9 million during the first half; it repurchased a further 869,229 shares for $32.2 million after quarter-end.
- SCI recorded $1.9 million of net hurricane expenses in Q2. For the first half, it reported $4.2 million in hurricane damages offset by $4.5 million of insurance proceeds.
Outlook, risks and contingencies
The filing provides no specific quantitative earnings or revenue guidance. Management highlighted acquisition and new-build investment, dividends and share repurchases as capital-allocation priorities, subject to returns, market conditions, board decisions and debt covenants. It cited the approximately $11.1 billion preneed backlog as a source of future revenue, while noting that most related revenue is deferred until merchandise or services are delivered.
Key operating risks include rising cremation mix, which can reduce average revenue per service; wage and other cost pressures; competition, regulation and changing customer preferences; and fluctuations in death rates. Additional risks include trust-investment market declines or funding requirements, reliance on third-party insurers and surety bonds, leverage and interest-rate exposure, and possible adverse litigation outcomes. SCI reported multiple wage-and-hour and operational claims, as well as an unclaimed-property matter; it said it could not reasonably estimate potential losses for these matters. Self-insurance reserves were $76.5 million at June 30. Management reported disclosure controls were effective and no material change in internal control during the quarter.
Important facts for investors to verify
- Separate underlying operating performance from the effects of tax items and the revenue-recognition transition when comparing earnings periods.
- Monitor funeral volume, cremation mix, average revenue per service, cemetery margins and the durability of recent cost increases.
- Assess debt growth, interest expense, covenant headroom and the effect of continued buybacks, dividends and acquisitions on liquidity.
- Review trust-asset performance, preneed backlog funding, insurance and surety arrangements, and any material developments in litigation or unclaimed-property claims.