Service Corporation International — Q3 2014 Form 10-Q
Business context and period: Unaudited results for the three and nine months ended September 30, 2014, compared with the corresponding 2013 periods. SCI operates funeral homes, cemeteries, crematoria, and related businesses in the United States and Canada. The 2014 results include Stewart Enterprises, acquired in December 2013; Germany operations sold in July 2014 are reported as discontinued operations.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $718.3 million | $608.6 million | $2,210.6 million | $1,883.2 million |
| Gross profit | $148.3 million | $115.8 million | $470.4 million | $401.1 million |
| Operating income | $135.1 million | $83.0 million | $387.3 million | $299.5 million |
| Net income attributable to common stockholders | $17.7 million | $26.8 million | $84.7 million | $118.0 million |
| Diluted EPS | $0.08 | $0.12 | $0.39 | $0.55 |
| Interest expense | $43.4 million | $38.1 million | $134.7 million | $103.6 million |
- Q3 gross margin was approximately 20.7%, versus 19.0% a year earlier; nine-month gross margin was approximately 21.3%, essentially unchanged. Q3 operating income included a $26.6 million net gain on divestitures and impairment charges.
- Q3 funeral revenue was $458.9 million and cemetery revenue $259.4 million. Funeral gross profit rose 31.9% and cemetery gross profit rose 22.9%, with Stewart contributing to both increases.
- Comparable Q3 funeral services performed increased 0.3%; comparable average revenue per service rose 1.5% to $5,309. The comparable cremation rate was 51.9%, up from 50.9%. Comparable cemetery revenue increased 5.2%.
- For the first nine months, comparable funeral services performed declined 3.0%, which management attributed largely to the prior year’s strong flu season not recurring. Comparable average revenue per funeral service increased 1.4%.
- Cash from operating activities was $256.2 million for nine months, down from $326.4 million. Continuing-operations operating cash flow was $257.2 million, versus $325.7 million.
- Investing activities provided $284.1 million, largely reflecting $397.3 million of divestiture and property-sale proceeds. Financing activities used $416.4 million. Capital expenditures were $95.2 million.
- At September 30, cash was $266.3 million and total debt was $3.068 billion, down from $3.302 billion at year-end 2013. The weighted-average debt rate was 5.19%. The $500 million credit facility had $235.0 million drawn, $31.7 million in letters of credit, and $233.3 million of borrowing capacity.
- SCI reported compliance with debt covenants: leverage ratio 3.68 against a maximum of 5.00; interest coverage 4.76 against a minimum of 3.00. It declared dividends of $0.09 per share in Q3 and repurchased 6.28 million shares for $129.1 million during the nine months.
Material changes and unusual items
- Revenue growth reflects the Stewart acquisition as well as comparable cemetery growth; it should not be read as entirely organic. Q3 comparable revenue was $614.7 million, versus consolidated revenue of $718.3 million.
- Despite higher revenue and operating income, common-stockholder net income and diluted EPS fell year over year. The effective tax rate rose to 81.7% in Q3 from 40.3%, and to 60.0% for nine months from 38.5%. SCI cited nondeductible goodwill associated with required Stewart divestitures and state taxes as primary factors.
- Nine-month results included a $29.2 million loss on early extinguishment of debt. SCI issued $550 million of 5.375% senior notes due 2024 and used proceeds, along with facility borrowing, to refinance higher-coupon notes; it also repaid other debt.
- Q3 trust investment impairment charges totaled $108.6 million across funeral, cemetery, and perpetual-care trusts; nine-month charges were $109.5 million. SCI said these were recorded in anticipation of a post-quarter strategic change in trust asset management that required liquidation of most U.S. trust assets. The charges were offset through trust-related accounting entries; the filing reports no net effect on consolidated other expense from these trust items.
- Management reported a $9.4 billion preneed backlog of future revenues at September 30, including trust-funded and insurance-funded arrangements. Trust assets and related obligations are subject to investment performance, regulation, and contract maturities.
Outlook, commentary, and risks
- No specific revenue, earnings, or cash-flow forecast is provided. Management said it expects to prioritize reinvestment in the core business, acquisitions when terms are favorable, share repurchases when appropriate, dividends commensurate with free-cash-flow growth, and opportunistic debt repurchases.
- Management described operating cash flow as relatively consistent and resistant to economic cycles, and said cash, expected operating cash flow, and available credit should meet short-term needs. Future dividends and repurchases remain subject to board decisions, market conditions, and debt-covenant restrictions.
- Key disclosed risks include trust-portfolio market losses or funding requirements; loss or cancellation of surety capacity; competition and increasing cremation rates; lower death volumes or changing consumer preferences; execution and integration risks from Stewart; indebtedness and covenant limits; insurance-company financial strength; and litigation, regulatory, and tax uncertainty.
- Notable contingencies include a California wage-and-hour class action for which SCI could not quantify ultimate liability, and a dispute over six cemetery-related ground leases in Los Angeles County that could affect operations and preneed backlog. SCI stated that adverse outcomes in litigation could materially affect financial condition, results, or cash flows.
- SCI disclosed $135.4 million of gross unrecognized tax benefits and $46.9 million of accrued interest; the timing and outcome of tax audits remain uncertain. The filing also reported $76.2 million in self-insurance reserves.
Important facts for investors to verify
- How much of revenue and profit growth is attributable to Stewart and divestitures versus comparable-location performance, including ongoing integration costs and expected synergies.
- Whether the elevated tax rate and acquisition-related costs persist, and how they affect reported earnings and cash conversion.
- The post-quarter trust-asset restructuring, the realized impact of the recorded impairments, and the performance and liquidity of trust investments.
- Debt reduction plans, refinancing costs, covenant headroom, and the capacity to fund dividends and repurchases while maintaining liquidity.
- Developments in the Archdiocese lease dispute, wage-and-hour claims, and tax audits, including any change in estimated exposure.
- Whether preneed production and the reported $9.4 billion backlog convert to future revenue and cash flow as expected, considering cancellations, maturities, surety arrangements, and insurance funding.