Service Corporation International — Q2 2012 Form 10-Q
Business context and reporting period. This unaudited report covers the three and six months ended June 30, 2012, compared with the corresponding 2011 periods. SCI operates funeral homes, cemeteries, crematoria, and related deathcare businesses, primarily in the United States and Canada. At quarter-end it operated 1,425 funeral locations and 373 cemeteries in North America, plus 12 funeral homes in Germany, which it intended to exit when conditions supported a sale.
Financial performance
Amounts below are in millions of dollars except per-share data, percentages, and share counts.
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Revenue | $597.4 | $576.8 | $1,199.9 | $1,156.5 |
| Gross profit | $128.2 | $115.0 | $255.8 | $241.5 |
| Gross margin | 21.5% | 19.9% | 21.3% | 20.9% |
| Operating income | $99.7 | $80.5 | $200.8 | $177.7 |
| Net income attributable to common stockholders | $37.1 | $26.1 | $85.1 | $64.9 |
| Diluted EPS | $0.17 | $0.11 | $0.39 | $0.27 |
- Revenue rose 3.6% in Q2 and 3.8% year to date; common-stockholder net income increased 42% and 31%, respectively. The 2011 comparisons included net divestiture and impairment losses ($9.8 million in Q2 and $10.3 million year to date), while 2012 recorded small net gains.
- Q2 funeral gross profit increased 8.4% to $81.7 million; cemetery gross profit rose 17.4% to $46.5 million. Management attributed improvement to preneed funeral volume and cemetery property sales, alongside cost management. For the first half, funeral and cemetery gross profit increased 4.0% and 10.9%, respectively.
- Same-store Q2 funeral revenue declined, mainly due to fewer services, while comparable average revenue per service increased 2.5%. Same-store cemetery revenue grew 6.4%, supported by preneed sales and recognition of previously sold property and completed construction projects. Comparable gross margins improved in both segments.
- Q2 G&A increased to $29.6 million from $24.7 million. SCI cited higher incentive compensation, $2.2 million of system and outsourcing transition costs, and a $3.1 million prior-year reimbursement of legal settlements.
Cash flow, debt, and liquidity
- First-half operating cash flow was $158.4 million, down from $175.5 million. Investing used $60.0 million, versus $108.7 million in 2011; financing used $122.5 million, versus $106.5 million. Cash ended at $105.3 million, down from $128.6 million at year-end 2011.
- First-half capital expenditures were $52.1 million. SCI repurchased 9.2 million shares for $102.8 million (cash-flow statement reports $104.7 million of total common-stock purchases) and paid $22.0 million in dividends.
- Total debt was $1.900 billion, including $30.5 million current maturities; cash was $105.3 million. The weighted-average debt rate was 6.59%, and approximately 88% of debt had fixed rates. No significant long-term debt maturities were expected before October 2014.
- The $500 million revolver had $72.0 million drawn and $32.4 million of letters of credit outstanding, leaving $395.6 million available. SCI reported compliance with covenants: leverage ratio 3.15 against a 4.00 maximum; interest coverage 4.55 against a 3.00 minimum. Management said cash, expected operating cash flow, and available credit should cover obligations over the next 12 months.
Outlook, risks, and unusual items
- No quantified earnings or revenue guidance was provided. Management said it would prioritize profitable growth, including cemetery and funeral-home construction and acquisitions meeting return criteria, while intending to continue quarterly dividends subject to board approval and debt restrictions.
- SCI reported a $7.1 billion preneed backlog at June 30, 2012. First-half cemetery sales production was $383.4 million, up from $354.7 million. Funeral preneed production growth included Neptune, acquired in 2011; its direct-cremation business has lower average revenue per contract.
- Cash taxes included a $6.6 million partial IRS settlement payment. SCI estimated approximately $25 million of additional payments during the remainder of 2012. At June 30, gross unrecognized tax benefits were $146.9 million and accrued interest was $40.0 million; outcomes and timing of other tax examinations remain uncertain.
- Material contingencies include cemetery burial-practices lawsuits, including class certification in the Eden Memorial Park case and a case scheduled for October 2012, as well as wage-and-hour matters. The filing says ultimate liability cannot be quantified; an adverse outcome could materially affect results and cash flows. The company also carried $52.2 million of self-insurance reserves.
- Key risks include market fluctuations in funeral and cemetery trust investments, possible trust-funding requirements, loss or cancellation of surety capacity, competition, increasing cremation rates, death-volume changes, regulation, litigation, and tax uncertainty. The trusts’ assets are held for customers or cemetery care and should not be treated as unrestricted corporate liquidity.
Investor verification points
- Reconcile share repurchases reported in the cash-flow statement with the stated repurchase cost and share-count reduction, and assess their contribution to EPS growth.
- Review comparable funeral-service volumes, average revenue per service, cremation trends, and the sustainability of cemetery preneed production and margin improvements.
- Track the estimated $25 million remaining 2012 IRS payments, the outstanding tax exposures, and developments in the burial-practices and wage-and-hour cases.
- Confirm cash conversion, access to revolver capacity, covenant headroom, and the effects of continued dividends, buybacks, and capital-lease obligations.
- Assess trust investment performance, valuation assumptions for illiquid Level 3 assets, and the potential for funding or surety-bond requirements.