Service Corporation International — 2014 Form 10-K
Business context and reporting period
SCI is North America’s largest deathcare provider, operating funeral homes, cemeteries and related businesses in the United States and Canada. This filing reports the fiscal year ended December 31, 2014; it is an annual report, not a standalone fourth-quarter filing. Results include the first full year of operations following the December 2013 Stewart Enterprises acquisition. At year-end, SCI operated 1,559 funeral service locations and 466 cemeteries. Preneed funeral and cemetery backlog was approximately $9.3 billion, versus $9.2 billion in 2013.
Key financial results
| Metric | 2014 | 2013 |
|---|---|---|
| Revenue | $2,994.0 million | $2,550.5 million |
| Gross profit | $675.8 million | $549.0 million |
| Operating income | $607.5 million | $387.7 million |
| Net income attributable to common stockholders | $172.5 million | $147.3 million |
| Diluted EPS | $0.81 | $0.68 |
| Cash from operating activities | $317.4 million | $384.7 million |
| Capital expenditures | $144.5 million | $112.9 million |
Revenue rose 17.4%, largely reflecting Stewart’s contribution. Gross margin was approximately 22.6%, up from 21.5%. Reported operating margin increased to approximately 20.3% from 15.2%, but 2014 operating income included a $116.6 million net gain on divestitures and impairment charges, primarily from FTC-required Stewart-related asset sales. Net income was also affected by a 56.1% effective tax rate, compared with 37.9% in 2013. Operating cash flow declined year over year; management said it increased excluding specified acquisition, transition, debt-refinancing, divestiture-tax, legal and other items.
Total debt was $3.05 billion at year-end, compared with $3.30 billion in 2013; long-term debt excluding current maturities was $2.96 billion. Cash was $177.3 million, with $233.4 million of available borrowing capacity under the bank facility. SCI reported compliance with its debt covenants; actual leverage was 3.69 against a 4.75 maximum, and interest coverage was 4.66 against a 3.00 minimum. Quarterly dividends paid totaled $71.5 million, and the company repurchased $241.7 million of shares during 2014.
Changes versus the prior comparable period
- Funeral revenue increased to $1.92 billion from $1.70 billion, primarily from Stewart. Comparable funeral revenue was nearly flat at $1.636 billion versus $1.635 billion; comparable services performed fell 1.8%, while comparable average revenue per service rose 1.1%.
- Cemetery revenue increased to $1.07 billion from $852.0 million, reflecting Stewart, stronger comparable preneed sales and trust income. Comparable cemetery revenue increased 8.0%, and comparable gross margin rose to 26.4% from 23.7%.
- Cremation represented 51.6% of comparable services, up from 50.1% in 2013. SCI noted that cremation cases generally generate lower average revenue than traditional burials.
- Operating cash flow decreased by $67.4 million, while investing cash flow shifted to a $257.3 million source from a $1.16 billion use in 2013, when SCI funded the Stewart acquisition. 2014 investing cash flow benefited from $424.4 million of divestiture and property-sale proceeds.
Outlook, commentary, risks and unusual items
- SCI provided no specific numerical earnings or revenue guidance. Its stated priorities are revenue growth, leveraging its scale, and capital deployment, with acquisitions and new funeral-home construction prioritized ahead of dividends, share repurchases and debt repurchases. Management expects to develop sales-force productivity and continue preneed initiatives.
- Management cited demographic aging and the $9.3 billion preneed backlog as supports for future business, while noting sensitivity to death volumes, consumer preferences, pricing, cremation trends and economic conditions.
- 2014 included $116.6 million of net divestiture gains; $29.2 million of losses on early debt extinguishments; and substantial Stewart acquisition and transition, legal, system-transition and tax-related costs. A new trust legal structure also generated about $15.0 million of perpetual-care trust income in the fourth quarter.
- Trust investment performance and market exposure are significant: combined SCI trust assets increased 4.1% in 2014, below the S&P 500’s 13.7% gain. Market declines could lead to trust replenishment requirements or losses on guaranteed preneed contracts. The company reported $14.6 million of unrealized losses in trusts subject to potential replenishment requirements.
- SCI disclosed an adverse internal-control-over-financial-reporting conclusion: a material weakness concerned preparation and review of the tax-basis balance sheet. Prior-year financial statements were revised for tax-related misstatements, though management said they did not materially misstate those prior-period statements. The auditor’s financial-statement opinion was unqualified, but its report also identified the material weakness.
- Other risks include significant indebtedness and restrictive covenants, competition, litigation and burial-practice claims, regulatory changes, Canadian-dollar exposure, and reliance on surety bonds. If surety coverage were not renewed or replaced, SCI estimated it could need to fund approximately $184.7 million into state-mandated trusts. Uncertain tax positions and related interest and penalties totaled $239.3 million.
Most important facts for investors to verify
- How much of reported operating-income growth reflects recurring operations versus the $116.6 million divestiture gain and other acquisition-related items.
- Whether comparable funeral volumes, preneed sales and cemetery margins remain resilient as cremation penetration rises.
- Progress in remediating and independently testing the tax-basis balance-sheet control weakness, and the effects of the prior-period revisions.
- Debt repayment capacity, covenant headroom, refinancing needs and the sustainability of dividends and share repurchases.
- Potential cash requirements from trust-market losses, surety-bond replacement, tax audits and pending litigation.