Service Corporation International — Q3 2016 Form 10-Q
Business context and period. SCI is a North American funeral and cemetery operator, reporting for the three and nine months ended September 30, 2016, compared with the same periods in 2015. At quarter-end it operated 1,531 funeral locations and 471 cemeteries. Management reported approximately $10.0 billion of preneed backlog, including trust-funded and insurance-funded contracts.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $721.5 million | $714.5 million | $2,222.1 million | $2,216.8 million |
| Gross profit | $140.7 million | $141.7 million | $465.7 million | $486.8 million |
| Operating income | $114.4 million | $124.5 million | $332.6 million | $393.2 million |
| Net income attributable to common stockholders | $47.7 million | $47.4 million | $110.8 million | $161.4 million |
| Diluted EPS | $0.24 | $0.23 | $0.56 | $0.78 |
| Operating cash flow | Not presented for quarter | Not presented for quarter | $358.5 million | $396.6 million |
- Revenue increased about 1.0% in Q3 and 0.2% year to date. Approximate gross margin was 19.5% versus 19.8% in Q3, and 21.0% versus 22.0% year to date.
- Year-to-date operating income declined about 15% and attributable net income about 31%. Results included a $30.4 million net loss on divestitures and impairments and a $22.5 million debt-extinguishment loss.
- Q3 funeral revenue fell to $445.5 million from $449.3 million; cemetery revenue rose to $276.0 million from $265.2 million. For the first nine months, funeral gross profit fell to $273.9 million from $299.8 million, while cemetery gross profit rose to $191.7 million from $187.0 million.
- Year-to-date operating cash flow decreased $38.1 million. Capital expenditures were $131.2 million versus $104.7 million; acquisitions used $66.1 million versus $41.4 million. Operating cash flow less capital expenditures was approximately $227.3 million, compared with $291.9 million.
- At September 30, cash was $177.6 million; total debt was $3.27 billion, including $89.5 million of current maturities. Current assets were $344.9 million and current liabilities $537.8 million. The new credit agreement had $342 million of borrowing capacity available. Management said the company was compliant with debt covenants; actual leverage was 3.92 against a 4.25 maximum, and interest coverage was 4.85 against a 3.00 minimum.
- SCI declared dividends of $0.13 per share in Q3 and $0.38 per share year to date. It repurchased 7.54 million shares for $193.0 million during the first nine months; approximately $88 million remained authorized at quarter-end.
Changes, outlook, and significant items
- Management attributed weaker year-to-date funeral results chiefly to a 3.5% decline in comparable services performed, partly reflecting an unusually strong flu season in the first half of 2015. Cremation mix continued to rise: comparable cremation rates were 52.1% in Q3 and 51.9% year to date. Higher cemetery revenue reflected preneed growth and increased recognized revenue.
- SCI refinanced debt during 2016, including replacing its 2018 bank facility and term loan with a $1.4 billion agreement maturing in March 2021, and refinancing $295 million of 7.0% notes due 2017. The company reported a $22.5 million year-to-date extinguishment loss and expected approximately $9 million in 2016 cash interest savings from the refinancing.
- A settlement with the Archdiocese of Los Angeles provides for SCI to sell substantially all assets of six mortuaries and terminate related leases. SCI expects $24 million at closing plus three annual payments tied to future revenue, each expected to be $0.8 million to $1.0 million. Closing was expected November 30, 2016. The planned divestiture led to a $31.2 million noncash impairment charge; net assets held for sale were $31.9 million at quarter-end.
- General and administrative expenses included $11.2 million in year-to-date system-transition costs and $5.5 million in acquisition costs. A new financial management system was deployed July 5, 2016; management reported effective disclosure controls.
- No formal revenue or earnings guidance is provided in the filing. Management said liquidity from cash, future operating cash flow, and credit availability should meet short- and long-term obligations, while noting that some cash is encumbered. Capital allocation priorities include acquisitions and new builds, dividends, share repurchases, and opportunistic debt reduction.
- Key risks include market volatility in trust investments, possible trust-funding requirements, dependence on surety bonds, debt and covenant constraints, litigation, competition, changing consumer preferences and rising cremation rates, death-volume changes, insurance-provider condition, regulation, self-insurance exposure, tax audits, and Canadian currency and operating risks.
Investor verification priorities
- Track comparable funeral service volume, cremation mix, average revenue per service, and whether cemetery growth offsets funeral weakness.
- Assess the sustainability and cash conversion of earnings, including trust-related revenue, operating cash flow, capital spending, and working-capital effects.
- Review debt maturities, floating-rate exposure, covenant headroom, available revolver capacity, and the effect of continuing dividends and repurchases on leverage.
- Confirm completion and final economics of the Los Angeles mortuary sale and any further effects on reported results.
- Monitor tax uncertainty: unrecognized tax benefits were $178.3 million and accrued interest was $55.8 million at September 30, 2016; audit outcomes and timing were uncertain.
- Review litigation and insurance exposure, including wage-and-hour claims, self-insurance reserves of $78.3 million, and any material developments in the Archdiocese settlement.