Service Corporation International — Q2 2017 Form 10-Q
Business context and period. SCI is a North American funeral and cemetery operator. This unaudited report covers the quarter and six months ended June 30, 2017, compared with the same 2016 periods. At quarter-end, SCI operated 1,502 funeral locations and 475 cemeteries. Management reported approximately $10.3 billion of preneed backlog.
Financial performance
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Revenue | $773.2 million, up 2.9% from $751.4 million | $1,551.0 million, up 3.4% from $1,500.6 million |
| Operating income | $143.6 million, versus $94.5 million | $283.2 million, versus $218.2 million |
| Net income attributable to common stockholders | $68.5 million; diluted EPS $0.36, versus $15.6 million and $0.08 | $243.2 million; diluted EPS $1.26, versus $63.1 million and $0.32 |
| Operating profit by reportable segment | Funeral $92.1 million; cemetery $91.4 million | Funeral $204.7 million; cemetery $155.9 million |
| Operating cash flow | $224.2 million for the six months, versus $225.5 million |
Q2 comparable funeral revenue fell 1.0% to $451.7 million; comparable services performed rose 0.4%, while average revenue per service declined 0.6% to $5,261. The comparable cremation rate increased to 53.5% from 52.3%. Comparable cemetery revenue rose to $313.0 million from $284.3 million, principally from higher cemetery property revenue recognition and merchandise deliveries. For the six-month period, comparable funeral revenue increased to $943.3 million and comparable cemetery revenue to $590.9 million.
Comparable funeral operating profit rose 3.8% in Q2 to $91.9 million, with margin up 90 basis points to 20.3%. Comparable cemetery operating profit rose to $91.5 million, with margin up 360 basis points to 29.2%. For the first half, comparable funeral and cemetery operating profit increased 4.8% and 21.4%, respectively. Growth was led by cemetery results and effective cost management.
Balance sheet, liquidity and capital allocation
- At June 30, 2017, cash was $224.9 million; total debt was $3.36 billion, including $70.7 million of current maturities. Long-term debt was $3.29 billion. Debt increased from $3.29 billion at December 31, 2016.
- Weighted-average debt interest rate was 4.80%; approximately 62% of debt had fixed rates. The $250 million 7.625% senior notes mature in October 2018.
- SCI had $205.7 million of borrowing capacity under its bank facility and was compliant with covenants. Actual leverage was 3.71x against a 4.25x maximum; interest coverage was 5.43x against a 3.00x minimum.
- Six-month investing cash use was $101.8 million, including $85.3 million of capital expenditures and $24.0 million for acquisitions. Financing cash use was $96.6 million.
- SCI repurchased 4.0 million shares for $120.1 million in the first half, paid $52.5 million in dividends, and declared $0.28 per share in dividends. Approximately $248.2 million remained authorized for repurchases at June 30.
Material changes and unusual items
- First-half reported earnings benefited substantially from tax items. SCI recorded a $43.3 million income tax benefit versus $49.1 million of tax expense in the first half of 2016; the 2017 effective tax rate was a benefit of 21.6%. The IRS settlement covering tax years 1999–2005 reduced unrecognized tax benefits by $143.0 million, including a $102.5 million income tax benefit and $40.5 million added to taxes payable. SCI paid $34.2 million in settlement and related interest in June.
- Q2 net divestiture and impairment results were a $0.8 million gain, versus a $30.6 million loss in Q2 2016. First-half results were a $5.7 million gain, versus a $31.0 million loss. The comparison also reflects the absence of 2016 debt-extinguishment losses ($21.9 million in Q2; $22.5 million in the first half).
- First-half 2017 general and administrative expense included a $12.8 million pension termination settlement. Prior-year expense included acquisition and system-transition costs. Interest expense increased in Q2, primarily due to higher bank-facility borrowings and floating rates.
- Operating cash flow was nearly unchanged year over year. SCI cited higher customer receipts, offset in part by the $34.2 million IRS payment, higher ordinary cash taxes, employee and vendor costs, and pension settlement payments.
Outlook, risks and contingencies
The filing provides no quantified earnings or revenue guidance. Management said it believes cash on hand, future operating cash flow, and available credit provide adequate liquidity for short- and long-term needs. Its capital priorities are acquisitions and new builds, dividends, share repurchases, and opportunistic debt repurchases. Dividends and buybacks remain subject to board decisions, market conditions, and debt covenants.
Management highlighted cremation growth as a potential pressure on average funeral revenue and profitability; cremation services historically generate about half the average revenue of traditional burials. Other risks include trust-investment market volatility and potential trust-funding requirements, surety-bond availability, preneed insurance-provider credit, competition, regulation, litigation, self-insured claims, cybersecurity and IT disruption, and the possible application of unclaimed-property laws to preneed contracts.
Contingencies include wage-and-hour cases, a Telephone Consumer Protection Act class action, and an unclaimed-property inquiry involving 36 states; SCI said ultimate exposure could not be quantified. A California arbitration award in July rejected the Samborsky plaintiffs’ claims, while a court denied SCI’s summary-judgment motion in the Allard matter. SCI also disclosed $80.9 million in self-insurance reserves. The company adopted stock-compensation accounting changes in 2017 and is still assessing the impact of the revenue-recognition standard scheduled to take effect January 1, 2018, particularly for certain upfront fees and contract-acquisition costs.
Key facts for investors to verify
- How much of first-half EPS growth is attributable to the IRS settlement and other tax benefits, versus recurring operating improvement.
- Whether cemetery revenue and profit growth, including property revenue recognition, can be sustained and converted into cash.
- Trends in funeral volume, sales averages, cremation mix, and preneed insurance production.
- Debt, refinancing needs, covenant headroom, and continued capacity for dividends and share repurchases.
- Potential exposure from unclaimed-property matters, litigation, self-insurance claims, trust funding, and surety-bond availability.
- The eventual effects of the 2018 revenue-recognition standard on reported revenue, expenses, and balance-sheet presentation.