Service Corporation International — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014. SCI is a North American funeral and cemetery operator; reported results include the acquired Stewart Enterprises businesses. Amounts below are in U.S. dollars.
Financial performance
| Metric | Q2 2014 | Q2 2013 | First half 2014 | First half 2013 |
|---|---|---|---|---|
| Revenue | $746.7m | $624.2m | $1,492.3m | $1,274.6m |
| Gross profit | $155.9m | $126.0m | $322.1m | $285.3m |
| Operating income | $144.7m | $89.1m | $252.1m | $216.5m |
| Net income attributable to common stockholders | $25.9m | $33.6m | $67.0m | $91.2m |
| Diluted EPS | $0.12 | $0.16 | $0.31 | $0.42 |
| Operating cash flow | Not separately provided for the quarter | $170.8m | $226.9m |
- Gross margin was approximately 20.9% in Q2 2014 versus 20.2% in Q2 2013; first-half gross margin was approximately 21.6% versus 22.4%.
- Cash and cash equivalents were $140.5m at June 30, 2014. Total debt was $3.152bn, including $3.050bn long-term debt and $101.4m current maturities. Debt was $3.302bn at year-end 2013.
- Current assets were $355.7m and current liabilities were $564.9m. The company also had $233.4m of available borrowing capacity under its $500m credit facility.
Material changes and operating trends
- Revenue growth primarily reflected Stewart, acquired in December 2013. Q2 funeral revenue rose to $479.5m from $414.5m and cemetery revenue to $267.2m from $209.7m. In the first half, reported revenue increased in both segments, while comparable funeral revenue declined and comparable cemetery revenue increased.
- Q2 funeral and cemetery gross profit increased $17.6m and $12.3m, respectively, with substantial contributions from Stewart locations. First-half comparable funeral gross profit fell $20.9m (10.6%), and comparable funeral gross margin declined to 20.9% from 22.9%; management cited lower comparable service volume and the segment’s fixed-cost structure. Comparable cemetery gross profit rose modestly in the first half.
- Comparable funeral services performed fell 1.3% in Q2 and 4.4% for the first half. Comparable cremation rates increased to 51.7% for Q2 and 51.5% for the first half. Comparable average revenue per funeral service rose 1.4% in Q2 and 1.3% in the first half.
- Operating income benefited from a $35.0m Q2 net gain on divestitures and impairment charges, versus a $5.5m loss a year earlier. First-half gain was $32.2m versus a $6.5m loss.
- Net income declined despite higher revenue and gross profit. Key items included higher interest expense, a $29.2m pretax loss on early debt extinguishment, higher acquisition and transition costs, and elevated effective tax rates. Q2 effective tax rate was 53.9%; first-half rate was 45.1%.
Cash, debt, capital allocation and outlook
- First-half operating cash flow was $170.8m, down $56.1m year over year. Management attributed the decline partly to Stewart-related acquisition costs, debt-refinancing premiums, legal defense fees and other items; excluding specified items, management said cash from operations increased $33.4m.
- First-half investing activities provided $77.4m, mainly reflecting divestiture and asset-sale proceeds. Financing activities used $250.2m, including debt repayments and early extinguishments, share repurchases and dividends.
- In May, SCI issued $550m of 5.375% senior notes due 2024 and used proceeds, together with a credit-facility draw, to refinance several notes. The refinancing contributed to the $29.2m early-extinguishment loss. SCI reported compliance with debt covenants; actual leverage and interest coverage ratios were 3.81 and 5.31, respectively.
- SCI repurchased 3.08m shares for $59.4m in the first half and declared dividends of $0.16 per share. Approximately $130.8m remained authorized for repurchases at June 30. Management stated it intends to grow dividends in line with free cash flow, subject to board approval and debt-covenant limits.
- Management expected remaining FTC-required Stewart divestitures to generate $215m–$240m in after-tax proceeds in the second half of 2014, with $80m expected to repay the term loan and remaining proceeds allocated under its capital-deployment approach. These proceeds were estimates, not assured results. The divestiture properties generated approximately $47m in annual gross profit while still owned.
- Management cited a $9.3bn preneed backlog as a source of future revenue and cash-flow stability. No formal earnings guidance is provided in the filing.
Risks, contingencies and unusual items
- SCI completed the $35.3m Eden Memorial Park burial-practices settlement in May 2014; insurers contributed $25.3m and SCI funded the balance, with up to $0.3m additional claims-administration costs. Other burial-practices and wage-and-hour matters remain, and the company said potential liability in certain cases could not be quantified.
- Gross unrecognized tax benefits were $135.4m, with $46.1m accrued interest. Tax audits and appeals remain unresolved; management said the amount of possible changes over the next 12 months could not be estimated.
- Trust investments are exposed to equity and fixed-income market movements. Certain private equity and alternative trust investments are illiquid and valued using estimates. Trust assets are associated with preneed customers or cemetery-care obligations and should not be treated as unrestricted corporate liquidity.
- Other stated risks include increased cremation rates and their effect on revenue, competition, high fixed costs, trust funding requirements, reliance on surety bonds, insurance-company strength, regulation, litigation, and the ability to realize Stewart acquisition synergies.
- After quarter-end, SCI sold its German operations on July 8, 2014 for approximately $5m; these operations are presented as discontinued operations. The filing also notes that the December 2013 current-debt classification was revised by $30m, without material misstatement of previously issued statements.
Important facts for investors to verify
- How much of reported growth and divestiture gains is attributable to Stewart, acquisitions, or asset sales, versus underlying comparable operations.
- Whether the forecast $215m–$240m after-tax proceeds from remaining FTC divestitures are realized, and the resulting impact on debt and foregone gross profit.
- Whether first-half comparable funeral volume and margin weakness persists, particularly as cremation rates rise.
- Debt covenant headroom, refinancing costs, interest expense, and the company’s capacity to sustain repurchases and dividend growth.
- Developments in unresolved litigation and tax matters, including any changes to estimated exposure or cash requirements.