Business Context and Reporting Period
Company: Service Corporation International (SCI)
Filing Type: Form 10-Q (Unaudited)
Period Ended: June 30, 2007
Business Overview: SCI is North America's leading provider of deathcare products and services, operating funeral homes and cemeteries primarily in the United States and Canada. The reporting period includes the full impact of the November 2006 acquisition of Alderwoods Group, Inc., which significantly expanded the company's footprint. The company is also in the process of divesting certain properties mandated by the FTC and its French operations.
Key Financial Metrics
| Metric (in thousands) | Three Months Ended June 30, 2007 |
Three Months Ended June 30, 2006 |
Six Months Ended June 30, 2007 |
Six Months Ended June 30, 2006 |
|---|---|---|---|---|
| Revenues | $565,492 | $431,400 | $1,173,047 | $873,401 |
| Gross Profit | $103,361 | $84,188 | $244,515 | $172,882 |
| Operating Income | $82,823 | $60,385 | $180,898 | $122,562 |
| Net Income | $15,118 | $25,450 | $52,760 | $52,376 |
| Diluted EPS | $0.05 | $0.09 | $0.18 | $0.18 |
| Cash from Operating Activities | N/A | N/A | $191,555 | $151,603 |
| Total Debt (Long-term + Current) | $1,941,155 | N/A | N/A | N/A |
| Cash and Cash Equivalents | $222,785 | N/A | N/A | N/A |
Note: Gross margin for the three months ended June 30, 2007 was 18.3% (down from 19.5% in 2006). For the six months, gross margin was 20.8% (up from 19.8% in 2006).
Material Changes vs. Prior Period
- Revenue Growth: Consolidated revenues increased 31.1% for the quarter and 34.3% for the six-month period compared to the prior year, primarily driven by the inclusion of Alderwoods operations.
- Net Income Decline (Q2): Net income for the quarter dropped 40.6% to $15.1 million. This decrease was driven by one-time costs including a $12.1 million loss on the early extinguishment of debt, $9.7 million in net after-tax losses on asset sales, and $2.8 million in transition expenses related to the Alderwoods acquisition.
- Debt Restructuring: The company issued $400 million in new senior notes in April 2007 to fund tender offers for older debt. This resulted in a $12.1 million loss on early extinguishment in Q2 and a total of $14.5 million for the six-month period.
- Effective Tax Rate: The effective tax rate for the six months ended June 30, 2007, was 52.4%, significantly higher than the 37.3% in the prior year. This was due to permanent differences on asset dispositions, FIN 48 interest and penalties, and state tax law changes.
- Divestitures: Proceeds from divestitures of properties (including FTC-mandated sales) totaled $193.7 million in the first half of 2007.
Guidance, Outlook, and Risks
- Strategic Pricing: Management continues to implement a strategic pricing initiative, shifting focus from product sales to service offerings. This has led to a decline in low-margin cremation services but an increase in average revenue per funeral (up 2.0% in Q2 and 2.8% for the six months).
- Divestiture Plans: The company expects to divest the remaining five FTC-mandated properties in Q3 2007. Additionally, a contract to sell the 25% equity interest in French operations is expected to close in the second half of 2007, with anticipated proceeds of approximately $170 million.
- Capital Allocation: The company maintains a share repurchase program. As of June 30, 2007, $97.1 million remained authorized. In August 2007, the Board approved an additional $200 million authorization.
- Legal Risks: Significant litigation risks include the "2003 Securities Lawsuit" regarding improper treatment of remains in Florida, various "Burial Practices Claims," and antitrust class actions regarding casket sales. The company states it cannot quantify ultimate liability for these matters.
- Integration Risks: Forward-looking statements highlight risks regarding the successful integration of Alderwoods and the realization of anticipated synergies.
Investor Verification Checklist
- Debt Covenants: Verify compliance with the new $450 million credit facility covenants, specifically the minimum interest coverage and maximum leverage ratios.
- Preneed Backlog: Review the $6.5 billion backlog of future revenues to assess the stability of future cash flows, noting the distinction between trust-funded and insurance-funded contracts.
- Legal Reserves: Monitor the status of the Florida burial practices lawsuits and the Texas "Hijar" class action regarding markup disclosures, as adverse outcomes could be material.
- Divestiture Proceeds: Confirm the timing and final proceeds of the French operations sale and the remaining FTC-mandated property sales.
- Tax Position: Assess the impact of the FIN 48 adoption on future tax provisions and the potential resolution of the IRS audit for tax years 1999-2002.