Service Corporation International — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015; comparison is with the corresponding 2014 periods. SCI operates funeral homes and cemeteries across the United States and Canada, selling services, merchandise, and preneed contracts. At quarter-end it operated 1,540 funeral locations and 469 cemeteries. Figures below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Financial performance and position
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $714.5 | $718.3 | $2,217.0 | $2,210.6 |
| Gross profit | $141.9 | $148.3 | $486.6 | $470.4 |
| Operating income | $124.6 | $135.1 | $393.2 | $387.3 |
| Net income attributable to common stockholders | $47.4 | $17.7 | $161.4 | $84.7 |
| Diluted EPS | $0.23 | $0.08 | $0.78 | $0.39 |
| Operating cash flow | Not separately stated | Not separately stated | $396.6 | $256.2 |
- Q3 gross margin was approximately 19.9%, versus 20.6%; nine-month gross margin was approximately 21.9%, versus 21.3%. Q3 operating margin was approximately 17.4%, versus 18.8%; nine-month operating margin was approximately 17.7%, versus 17.5%.
- Q3 funeral revenue fell to $449.2 million from $458.9 million; cemetery revenue increased to $265.3 million from $259.4 million. Nine-month funeral revenue declined to $1,428.4 million from $1,447.5 million, while cemetery revenue rose to $788.6 million from $763.0 million.
- Cash and cash equivalents were $142.0 million at September 30, down from $177.3 million at year-end 2014. Current assets were $320.7 million and current liabilities $546.6 million.
- Total debt was $3.14 billion, including $95.0 million of current maturities; debt was $3.05 billion at December 31, 2014. Weighted-average interest rate was 5.15%; approximately 76% of debt was fixed-rate.
- SCI generated $396.6 million of operating cash flow in the first nine months, spent $125.8 million on investing activities, and used $298.4 million in financing activities. Capital expenditures were $104.7 million; acquisitions were $41.4 million.
Material changes and business drivers
- Revenue was nearly flat year over year: down 0.5% in Q3 and up 0.3% for the first nine months. Q3 net income rose substantially, while Q3 gross profit declined.
- Management attributed Q3 comparable funeral gross-profit decline of $11.5 million (12.9%) to lower comparable revenue and inflation in fixed costs. Comparable funeral services performed fell 1.3%, and average revenue per service declined 1.2%; cremations were 51.7% of comparable services versus 50.9% a year earlier.
- Q3 comparable cemetery gross profit increased $6.1 million (10.5%), driven mainly by preneed property sales; comparable cemetery gross margin rose to 24.4% from 22.9%.
- For the nine months, comparable funeral gross profit increased $6.7 million (2.3%), and comparable cemetery gross profit increased $31.7 million (20.5%). Cemetery performance benefited from preneed property sales and higher trust-fund income.
- Q3 general and administrative expense declined $11.6 million year over year, largely because 2014 included Stewart acquisition/transition and systems costs. Nine-month expense declined $45.1 million, with 2014 also including acquisition, legal, and integration costs.
- Operating cash flow increased $140.4 million year over year for the nine months. Management cited lower acquisition and transition costs, lower debt-extinguishment premiums and certain other payments, as well as increased customer receipts; cash tax payments increased.
Outlook, capital allocation, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management emphasized preneed sales, acquisitions and new builds when returns are attractive, dividends, share repurchases, and opportunistic debt reduction. It described cash on hand, operating cash flows, and available credit as adequate for short-term needs.
- Preneed backlog was approximately $9.4 billion at September 30, 2015, including insurance-funded contracts. Insurance-funded backlog is not recorded as an SCI asset or liability until the contract is fulfilled. Preneed trusts and perpetual-care assets are subject to legal restrictions and should not be treated as freely available corporate cash.
- SCI repurchased 11.0 million shares for $305.5 million during the first nine months, at an average $27.75 per share. The quarterly dividend was $0.12 per share. The board increased the repurchase authorization to $400 million; approximately $321.6 million remained at quarter-end.
- In August, SCI issued $300 million of 5.375% notes due 2024, using proceeds to redeem its 6.75% notes due 2016 and repay $100 million of bank-facility borrowings. It recorded a $6.9 million loss on early debt extinguishment. Nine-month interest expense was $129.8 million.
- SCI reported compliance with debt covenants: actual leverage ratio 3.74 against a 4.50 maximum and interest coverage 4.96 against a 3.00 minimum. The $500 million revolving facility had $225 million drawn, $33.3 million of letters of credit, and $241.7 million available borrowing capacity.
- Trust investment performance and market exposure are significant: combined SCI trusts declined 3.1% in the first nine months, while the S&P 500 declined 5.3% and the Barclays Aggregate Index rose 1.1%. Trust investments include market-sensitive securities and illiquid alternatives. Management reported remaining unrealized losses as temporary; nine-month trust impairment charges were $8.3 million, compared with $109.5 million in 2014.
- Key risks include death-rate and cremation trends, competition, high fixed costs, trust investment losses or funding requirements, loss of surety-bond capacity, third-party insurer performance, Canadian currency exposure, leverage and covenant limits, regulation, litigation, tax audits, and information-security risks.
- Contingencies include wage-and-hour litigation and disputes involving leases at six California properties acquired through Stewart. SCI said ultimate outcomes could not be determined and that adverse decisions could materially affect results, financial condition, or cash flows. Self-insurance reserves were $76.8 million.
- Unrecognized tax benefits were $191.7 million, with $50.4 million accrued interest; several federal, state, and foreign tax matters remained under review or audit, and the company could not estimate the possible changes over the next year.
- Management stated disclosure controls were effective and that the previously reported material weakness in income-tax internal controls had been remediated as of September 30, 2015.
Important facts for investors to verify
- Whether funeral volume, average revenue per service, and funeral margins recover, particularly given the rising cremation mix and Q3 fixed-cost pressure.
- How much of reported earnings and cash-flow improvement reflects sustainable operations versus prior-year acquisition costs, divestiture gains, tax effects, and debt-refinancing items.
- Whether preneed cemetery production and the $9.4 billion backlog convert to future revenue and cash as expected, including cancellation assumptions and trust-funding obligations.
- Debt, covenant headroom, refinancing needs, and the balance between substantial repurchases and leverage; confirm the availability and terms of revolving credit.
- Trust portfolio valuations, market losses, alternative-investment liquidity, and any requirement to replenish trusts or replace surety bonds.
- Developments in the tax audits and litigation, and continued effectiveness of the remediated income-tax controls.