Service Corporation International — Q2 2016 Form 10-Q
Business and period: North American funeral and cemetery operator; this unaudited filing covers the three and six months ended June 30, 2016, compared with the corresponding 2015 periods. At quarter-end, SCI operated 1,525 funeral locations and 469 cemeteries. Management reported a $9.6 billion preneed backlog of future revenue.
Key financial results
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $751.7 million | $754.4 million | $1,501.0 million | $1,502.5 million |
| Gross profit | $161.4 million | $166.3 million | $322.9 million | $343.7 million |
| Gross margin | 21.5% | 22.0% | 21.5% | 22.9% |
| Operating income | $94.5 million | $127.6 million | $218.1 million | $268.7 million |
| Net income attributable to common stockholders | $15.6 million | $52.6 million | $63.1 million | $114.0 million |
| Diluted EPS | $0.08 | $0.25 | $0.32 | $0.55 |
| Operating cash flow | Not separately stated | Not separately stated | $225.5 million | $282.5 million |
Financial position and liquidity
- June 30 cash and cash equivalents were $171.8 million; management estimated approximately $115 million was unencumbered. Current assets were $332.6 million and current liabilities $501.7 million.
- Total debt was $3.203 billion, including $90.1 million of current maturities. Weighted-average debt interest rate was 4.6%; approximately 65% of debt was fixed-rate.
- SCI reported $416.7 million of available borrowing capacity under its March 2021 credit facility and compliance with debt covenants. Actual leverage ratio was 3.86 against a 4.25 maximum; interest coverage was 4.81 against a 3.00 minimum.
- For the first half, investing activities used $119.5 million, including $83.2 million of capital expenditures and $52.8 million of acquisitions. Financing activities used $74.3 million, including $81.5 million of share repurchases and $48.5 million of dividends.
Changes and operating trends
- Q2 revenue was nearly flat year over year, but common-stockholder income fell to $15.6 million from $52.6 million. First-half revenue was also nearly flat while common-stockholder income declined to $63.1 million from $114.0 million.
- Funeral performance weakened: comparable funeral services performed fell 2.7% in Q2 and 4.3% in the first half. Management attributed the first-half comparison partly to an unusually strong flu season in 2015 versus a mild season in 2016. Higher cremation mix also pressured average revenue; comparable cremation rate reached 52.4% in Q2.
- Cemetery revenue and gross profit improved, supported by recognized preneed and atneed revenue and higher preneed property production. First-half cemetery revenue rose 3.5% and gross profit 4.4%.
- First-half operating cash flow decreased $57.0 million year over year. Management said the decline excluding specified items was $41.1 million, primarily from $22.0 million of higher cash taxes and lower funeral cash receipts.
- Cash dividend declared was $0.13 per share in Q2, versus $0.10 a year earlier. Shares outstanding declined, reflecting repurchases.
Outlook, unusual items and risks
- No specific earnings or revenue guidance was provided. Management said liquidity, expected operating cash flow and credit availability should support short- and long-term needs; capital priorities include acquisitions and new builds, dividends, share repurchases, and debt repurchases. Future dividends and buybacks remain subject to board decisions, market conditions and debt covenants.
- Q2 included a $31.2 million impairment charge tied to planned divestiture of Los Angeles funeral homes, a $21.9 million debt-extinguishment loss, and $4.9 million of system-transition costs. First-half results also included $5.5 million of previously improperly capitalized acquisition costs recorded as an out-of-period expense, which SCI described as immaterial to current and prior periods.
- SCI refinanced debt, including its 7.0% 2017 notes; management expected approximately $9 million of cash interest savings in 2016. The transaction generated a first-half $22.5 million debt-extinguishment loss.
- On July 27, 2016, after quarter-end, SCI agreed to settle litigation over six mortuary ground leases by selling substantially all related operating assets to the Archdiocese of Los Angeles. SCI expects $24 million at closing and three additional annual payments based on future revenue, each between $0.8 million and $1.0 million; closing was expected November 30, 2016. The planned sale prompted the impairment charge.
- Other risks include trust-investment market volatility and possible funding requirements, cremation trends and death-volume fluctuations, competition, insurance-company and surety-bond reliance, indebtedness and covenant limits, tax examinations, self-insured claims, and litigation. Unrecognized tax benefits were $179.8 million, with $54.3 million of accrued interest; audit outcomes and timing remain uncertain.
Important facts to verify
- Whether funeral volume, cremation mix and trust investment income continue to pressure funeral margins, and whether cemetery growth offsets the weakness.
- Cash generation and liquidity quality, including the distinction between reported cash and management’s approximately $115 million estimate of unencumbered cash, and the availability of credit subject to covenants.
- Debt refinancing benefits versus the one-time extinguishment charge, and debt maturity, interest-rate and leverage exposure.
- Final terms, closing and proceeds from the Los Angeles mortuary sale and settlement, including any continuing operational or legal effects.
- Potential outcomes of tax audits, litigation, insurance claims and trust funding obligations; the filing does not quantify certain ultimate exposures.
- How much of the $9.6 billion preneed backlog converts to revenue and cash over time; a substantial portion is future, and insurance-funded contracts are not recorded as balance-sheet assets or liabilities before fulfillment.