Business context and reporting period
Service Corporation International (SCI), a North American deathcare provider, filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2011. It operated 1,427 funeral locations and 374 cemeteries in North America, plus 12 funeral homes in Germany, which it intended to exit when conditions permitted. Management reported a $6.8 billion preneed backlog of future revenues.
Financial performance
Amounts below are in millions of dollars except per-share data. Comparisons are with the corresponding 2010 period.
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $573.0 | $533.2 | $1,729.5 | $1,619.3 |
| Gross profit | $107.1 | $102.6 | $348.5 | $324.3 |
| Gross margin | 18.7% | 19.2% | 20.2% | 20.0% |
| Operating income | $78.2 | $68.5 | $255.9 | $250.0 |
| Net income attributable to common stockholders | $35.5 | $18.8 | $100.4 | $90.0 |
| Diluted EPS | $0.15 | $0.08 | $0.42 | $0.36 |
- Q3 funeral gross profit was essentially flat; cemetery gross profit rose $4.4 million, or 13.1%. For the first nine months, funeral gross profit increased $12.6 million, or 5.4%, and cemetery gross profit increased $11.6 million, or 12.5%.
- Operating cash flow for the first nine months was $291.3 million, up from $266.1 million. Investing used $167.2 million, including $85.9 million of capital expenditures and $97.5 million for acquisitions. Financing used $166.2 million, including $146.6 million for share repurchases and $33.4 million in dividends.
- Cash and equivalents were $127.0 million at September 30, versus $170.8 million at December 31, 2010. Total debt was $1.888 billion, including $23.7 million of current maturities; the weighted-average interest rate was 6.67%.
- The $500 million bank facility had $65.0 million drawn, $33.3 million in letters of credit, and $401.7 million of reported borrowing capacity. SCI reported compliance with debt covenants; actual leverage was 3.16 against a 4.00 maximum, and interest coverage was 4.34 against a 3.00 minimum.
Material changes versus the prior comparable period
- Q3 revenue grew 7.5%; nine-month revenue grew 6.8%. Acquisitions contributed to reported growth, while comparable operations also improved. Q3 comparable funeral revenue increased, but comparable funeral services performed declined 2.4%; comparable cemetery revenue benefited from higher preneed property sales.
- Q3 net income increased partly because of lower losses on early debt extinguishment and a lower effective tax rate. The 2011 tax rate benefited from the sale of SCI’s Puerto Rican subsidiary; management said the tax loss on that sale exceeded the book loss and was permanent.
- Nine-month debt increased from $1.855 billion at year-end 2010. SCI amended and extended its credit facility in Q1, and drew $65 million by September 30. It repurchased 14.6 million shares for approximately $145 million during the period; weighted-average diluted shares fell to 239.5 million from 252.5 million.
- SCI acquired 70% of The Neptune Society for $44 million in June, expanding its direct-cremation business. The purchase-price allocation was still under review at filing.
Outlook, management commentary, risks and unusual items
- SCI gave no specific earnings or revenue guidance. Management said cash on hand, expected operating cash flows, and available credit should meet obligations over the next 12 months. It intended to invest in growth, consider suitable acquisitions, pay regular quarterly dividends subject to board approval and debt limits, and make share repurchases subject to market conditions and covenants.
- SCI recorded a $5.0 million Q3 pretax net loss on divestitures and impairment charges; the nine-month loss was $15.3 million, compared with a $5.8 million gain in 2010. Nine-month early debt-extinguishment losses were $3.5 million.
- Trust investment impairments rose materially: Q3 charges were $42.4 million across funeral and cemetery merchandise/service trusts, versus $2.7 million in Q3 2010; nine-month charges were $47.2 million versus $12.2 million. SCI stated these trust-related results were offset through corresponding trust liabilities or corpus reclassifications. Trust market losses and investment income remain exposed to financial-market movements.
- Key risks include changes in economic and market conditions, cremation trends and consumer demand, cost inflation, acquisition execution, trust funding requirements, surety availability, and litigation and tax-audit outcomes. SCI disclosed burial-practice claims, wage-and-hour matters, and an antitrust case whose class certification was denied and dismissal appealed. It said ultimate liability in specified cases could not be quantified and that an adverse outcome could materially affect results or cash flows.
- SCI reported $265.1 million of outstanding surety bonds. Management did not expect material future funding needs from cancellations or surety-company nonperformance. It also reported self-insurance reserves of $51.9 million.
Important facts for investors to verify
- How much reported revenue and profit growth came from acquisitions versus comparable operations, and whether comparable funeral volume and margins stabilize.
- Whether operating cash flow remains sufficient to support capital spending, dividends, acquisitions, and continued buybacks while debt is elevated.
- The performance, valuation assumptions, and potential funding obligations of preneed and perpetual-care trust investments, including the effect of further market declines.
- Progress and potential exposure in burial-practice, wage-and-hour, antitrust, and tax matters; several outcomes and liabilities were not quantifiable in the filing.
- The final purchase-price allocation and operating contribution of Neptune, and whether SCI’s stated liquidity and covenant headroom remain adequate.