Business Context and Reporting Period
Company: Service Corporation International (SCI)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2006
Business Overview: SCI is a leading provider of deathcare products and services in North America, operating funeral homes, cemeteries, and combination locations. The company also holds a 25% equity interest in a French funeral entity and owns Kenyon International Emergency Services. As of September 30, 2006, SCI operated 827 funeral homes and 144 cemeteries across 41 U.S. states and seven Canadian provinces.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2006 | Nine Months Ended Sep 30, 2006 |
|---|---|---|
| Total Revenues | $400.3 million | $1,273.5 million |
| Gross Profit | $72.0 million | $242.8 million |
| Operating Income | $20.3 million | $140.7 million |
| Net Income (Loss) | $3.4 million | $55.7 million |
| Diluted EPS | $0.01 | $0.19 |
| Cash and Cash Equivalents | $636.6 million | $636.6 million (Balance Sheet) |
| Long-Term Debt | $1,265.2 million | $1,265.2 million (Balance Sheet) |
| Cash Flow from Operations | N/A | $265.3 million |
Material Changes vs. Prior Period
- Revenue: Total revenues decreased slightly in the three months ended September 30, 2006 ($400.3M) compared to the same period in 2005 ($406.4M). For the nine months, revenues were $1,273.5M versus $1,285.7M in 2005.
- Profitability: Net income improved significantly to $3.4 million in Q3 2006 from a net loss of $9.7 million in Q3 2005. For the nine-month period, net income was $55.7 million compared to a net loss of $150.7 million in 2005. The 2005 loss was heavily impacted by a cumulative effect of an accounting change ($187.5 million) and losses on early extinguishment of debt.
- Gross Margins: Combined gross margin percentage improved to 18.0% in Q3 2006 from 14.5% in Q3 2005. For the nine months, margins improved to 19.1% from 17.7%.
- Dispositions and Impairments: The company recorded net losses on dispositions and impairment charges of $30.8 million in Q3 2006 and $38.1 million for the nine months, compared to $27.4 million and $28.7 million in the respective 2005 periods.
- Interest Expense: Interest expense increased 27.1% in Q3 2006 to $33.3 million (from $26.2 million in 2005), primarily due to $6.4 million in bridge financing costs related to the Alderwoods acquisition.
Guidance, Outlook, and Risks
- Alderwoods Acquisition: SCI entered a definitive agreement to acquire Alderwoods Group, Inc. for approximately $1.22 billion. The transaction is expected to close by the end of 2006, subject to antitrust clearance. Financing includes new debt issuances and a new $450 million credit facility.
- Strategic Initiatives: Management is focusing on customer segmentation, exiting unprofitable business relationships, and increasing average revenue per funeral service. This strategy has led to a decline in funeral case volume (down 5.9% in Q3) but a significant increase in average revenue per service (up 12.3% in Q3).
- Divestitures: The company continues to divest non-strategic locations and international operations. Subsequent to September 30, 2006, SCI sold its Singapore funeral businesses for approximately $11.6 million.
- Risks and Contingencies:
- Legal Proceedings: SCI is involved in various litigation matters, including the "Hijar Lawsuit" regarding funeral service markups in Texas and antitrust cases regarding casket sales. Outcomes are uncertain and could have a material adverse effect.
- Acquisition Risks: Failure to complete the Alderwoods acquisition or inability to realize anticipated synergies could negatively impact the stock price and operations.
- Regulatory: The SEC Staff has issued comment letters regarding the reporting of trust-related cash flow activities, which remains unresolved.
Investor Verification Checklist
- Alderwoods Closing: Verify the status of antitrust clearance and the expected closing date for the $1.22 billion Alderwoods acquisition.
- Debt Covenants: Review the terms of the new credit facility and privately placed debt securities, specifically covenants that may restrict future share repurchases or dividends.
- Legal Exposure: Monitor developments in the Hijar Lawsuit and antitrust cases to assess potential liability and impact on future cash flows.
- Volume vs. Margin Trade-off: Assess the sustainability of the strategy to reduce funeral case volume in exchange for higher average revenue and gross margins.
- SEC Comment Resolution: Confirm the resolution of the SEC Staff's comments regarding the presentation of trust-related cash flows in the Statement of Cash Flows.