Business context and reporting period
Service Corporation International (SCI) filed this Form 10-K for the fiscal year ended December 31, 2010; it is an annual report, not a standalone fourth-quarter filing. SCI is North America’s largest deathcare provider, operating funeral homes, cemeteries and related businesses, with sales at need and through preneed contracts. In March 2010, SCI acquired Keystone North America for approximately $288.9 million, including refinancing of Keystone debt. SCI also operated 12 funeral locations in Germany and said it intended to exit that business when conditions permitted.
Financial performance and position
| Metric | 2010 | 2009 |
|---|---|---|
| Revenue | $2,190.6 million | $2,053.5 million |
| Gross profit | $449.2 million | $421.4 million |
| Operating income | $354.0 million | $323.9 million |
| Net income attributable to common stockholders | $126.4 million | $123.1 million |
| Diluted EPS | $0.50 | $0.49 |
| Cash from operating activities | $354.4 million | $372.1 million |
| Total debt | $1,854.9 million | $1,890.5 million |
| Cash and cash equivalents | $170.8 million | $179.7 million |
Gross margin was approximately 20.5% in both years; operating margin was approximately 16.2% versus 15.8%. The effective tax rate rose to 42.1% from 38.3%. Total assets were $9.19 billion and equity was $1.48 billion at year-end 2010. SCI reported $357.9 million of available borrowing capacity under its bank facility, which matures in November 2013; it had no significant long-term debt maturities until October 2014. The company was in compliance with its debt covenants at year-end.
Material changes versus the prior comparable period
- Revenue increased 6.7%, reflecting acquisitions and higher comparable funeral and cemetery revenue. Keystone contributed $83.7 million of revenue and $16.7 million of net income from its acquisition date through year-end.
- Comparable funeral services performed fell 1.9%, while comparable average revenue per service rose 2.5% to $5,274. Comparable funeral gross margin declined to 21.3% from 22.3%, amid higher preneed selling costs and other expenses.
- Comparable cemetery revenue rose 4.9%; comparable cemetery gross margin increased to 19.0% from 17.7%, supported by property sales and trust income.
- Operating cash flow fell $17.7 million, as higher compensation and vendor payments more than offset increased customer receipts. Investing outflows rose to $279.7 million, principally due to acquisitions, including Keystone.
- SCI issued $250 million of 7.0% senior notes due May 2019, repaid bank-facility borrowings and made other debt repayments. Total debt declined modestly.
- SCI repurchased approximately 13.9 million shares for $116.2 million and paid $40.0 million in dividends. The board authorized an additional $171.5 million for repurchases in November.
Outlook, commentary, risks and unusual items
Management emphasized preneed sales, operating discipline, technology, selective acquisitions and capital returns as strategic priorities. SCI forecast 2011 capital improvements and cemetery development spending of $85 million to $95 million. The board approved a quarterly dividend increase to $0.05 per share in February 2011; future dividends and repurchases remain subject to board approval, debt covenants and market conditions. Management said cash, expected operating cash flow and available facility capacity should meet obligations over the following 12 months.
- Preneed backlog was $6.8 billion at December 31, 2010, versus $6.4 billion a year earlier. Approximately 78% of North American preneed funeral production was insurance-funded; related unfulfilled contracts are not recorded on SCI’s balance sheet.
- Trust investment returns improved in 2010, but investment losses could require trust replenishment or leave SCI funding future service costs. The filing reported $10.2 million of unrealized losses in certain trusts and said no loss-contract charge was required at year-end.
- If surety bonds were cancelled and SCI could not obtain replacements, it estimated potential trust-funding needs of approximately $216.5 million. Total surety bonds outstanding were $265.6 million.
- Other principal risks include competition, declining death counts, rising cremation rates, high fixed operating costs, regulation of preneed trusts and sales, third-party insurer creditworthiness, foreign exchange, covenant restrictions and potential goodwill impairment. Cremation represented 41.6% of comparable North American funeral services in 2010.
- SCI faced litigation involving alleged burial practices, wage-and-hour matters and other claims. A casket antitrust case was dismissed in September 2010, but plaintiffs appealed. Management could not quantify potential liability for several pending cases; adverse outcomes could materially affect results or cash flows.
- Unusual 2010 items included a $9.4 million pretax loss on early debt extinguishment, a $8.5 million net pretax gain on divestitures and impairments, and acquisition-related expenses. The effective tax rate also reflected acquisition integration and other tax effects. Approved tax accounting method changes reduced taxable income and were expected to support a $7.1 million federal tax refund in 2011.
The independent auditor issued an unqualified opinion on the financial statements and concluded that internal control over financial reporting was effective as of December 31, 2010.
Important facts for investors to verify
- Keystone’s final purchase-price allocation and realization of projected acquisition synergies; SCI said its fair-value assessment was not yet complete.
- Whether preneed production, backlog maturities and related trust assets support expected future margins and cash generation, particularly under weaker investment markets.
- Debt covenant headroom, refinancing needs and the capacity to sustain dividends, repurchases and planned capital spending.
- Developments in burial-practice, wage-and-hour and appealed antitrust litigation, as well as tax audits and uncertain tax positions.
- Progress on Germany’s intended exit and SCI’s response to higher cremation rates and lower comparable service volumes.