SERVICE CORP INTERNATIONAL quarterly report, Q1 FY2014

Service Corporation International — Q1 2014 Form 10-Q

Reporting period: Three months ended March 31, 2014. SCI provides funeral, cemetery, cremation, and related services, principally in North America. Results include Stewart Enterprises, acquired in December 2013; consequently, reported year-over-year comparisons are not fully comparable.

Financial performance

Metric	Q1 2014	Q1 2013
Revenue	$747.1 million	$652.4 million
Gross profit / margin	$166.4 million / 22.3%	$159.7 million / 24.5%
Operating income / margin	$107.6 million / 14.4%	$127.8 million / 19.6%
Net income attributable to common stockholders	$41.1 million	$57.6 million
Diluted EPS	$0.19	$0.27
Operating cash flow	$127.9 million	$151.1 million

• Revenue rose 14.5%, largely reflecting Stewart. Comparable revenue was $628.2 million versus $650.0 million; comparable gross profit was $134.8 million versus $159.7 million.
• Reported net income attributable to common stockholders fell 28.7%. Higher general and administrative expense and interest expense contributed to the decline.
• Cash and cash equivalents were $148.6 million at quarter-end. Capital expenditures were $25.2 million; investing cash use was $35.6 million and financing cash use was $86.6 million.
• Total debt was $3.24 billion, down from $3.30 billion at year-end 2013; long-term debt was $3.13 billion and current maturities were $105.7 million. The weighted-average interest rate was 5.38%.
• The $500 million credit facility had $140.0 million drawn, $31.6 million of letters of credit, and $328.4 million of available borrowing capacity. SCI reported compliance with covenants; actual leverage ratio was 3.95 against a 5.00 maximum, and interest coverage was 5.69 against a 3.00 minimum.

Material changes and management commentary

• Stewart contributed $117.7 million of revenue and $31.2 million of gross profit in the quarter. Management cited added scale, cost-saving opportunities, and a larger preneed backlog as acquisition rationales, while noting integration risks.
• Comparable funeral services performed declined 7.2%, which management attributed largely to the unusually strong 2013 flu season not recurring. Comparable funeral average revenue per service rose 1.2%; the comparable cremation rate increased to 51.3% from 49.3%.
• Comparable funeral gross profit declined 18.4%, and its margin fell to 22.4% from 26.1%. Comparable cemetery gross profit declined 7.1%, with margin down to 19.2% from 20.8%. Acquired operations lifted reported segment results.
• General and administrative expense increased $25.1 million to $56.0 million. Q1 2014 included $16.0 million of Stewart acquisition and transition costs, $11.1 million of legal settlements and defense fees, and $2.9 million of system and process transition costs. Interest expense rose $12.2 million to $45.0 million.
• Operating cash flow fell $23.2 million year over year; management said it increased $8.8 million excluding specified acquisition costs, share-based tax benefits, transition costs, and legal-defense fees. Cash receipts grew, but vendor, compensation, interest, and tax payments also increased.
• The quarterly dividend increased to $0.08 per share from $0.06; $17.1 million was paid. No purchases were made under the public share-repurchase program, which had approximately $190.1 million remaining authorization.

Outlook, risks, and unusual items

• No specific earnings or revenue guidance was provided. Management expects to prioritize investment in the core business and preneed backlog, pursue suitable acquisitions, and consider repurchases and dividends subject to cash generation, market conditions, and debt covenants.
• SCI reported a $9.1 billion preneed backlog of future revenue. This includes insurance-funded contracts not recorded as balance-sheet assets; backlog is not equivalent to immediately available cash.
• A preliminary settlement in the Eden Memorial Park burial-practices class action provides for a $35.25 million fund, with insurers contributing $25.25 million and SCI the balance, plus up to $0.25 million in claims-administration costs. Final court approval was pending, and SCI retained a right to cancel under specified opt-out conditions.
• Other litigation includes wage-and-hour claims and a lawsuit concerning the Stewart acquisition; outcomes and potential liabilities were not quantifiable. SCI warned that adverse litigation outcomes could materially affect results and cash flows.
• Properties identified for divestiture under an FTC consent order were classified as held for sale. Net assets held for sale were $291.5 million at March 31, 2014.
• Other risks include trust-investment market volatility, possible trust-funding requirements, loss of surety-bond capacity, competition, cremation trends, changing death rates and consumer preferences, tax audits, and high debt. Gross unrecognized tax benefits were $136.9 million, with $45.3 million of accrued interest.
• SCI recorded $2.8 million of net divestiture losses and impairment charges. Q1 2014 also included $10.1 million of after-tax Stewart acquisition and transition costs and $7.1 million of after-tax legal-defense and labor-matter expenses in management’s reconciliation of notable items.

Investor verification priorities

1. Track Stewart integration, realized synergies, and the financial and timing impact of required FTC divestitures.
2. Confirm final approval and terms of the Eden settlement, and monitor other litigation and the associated cash exposure.
3. Assess whether comparable funeral volumes and segment margins stabilize, particularly as cremation rates rise.
4. Review debt maturities, covenant headroom, refinancing needs, and cash available after operating requirements and dividends.
5. Distinguish trust assets and preneed backlog from unrestricted corporate liquidity; monitor trust investment performance and any funding obligations.