Service Corporation International — Q3 2010 Form 10-Q
Reporting period: Three and nine months ended September 30, 2010; unaudited. SCI provides funeral and cemetery services and products in North America, with funeral operations in Germany. In March 2010, SCI acquired Keystone North America.
Financial performance
Amounts below are in millions, except per-share data and ratios.
| Metric | Q3 2010 | Q3 2009 | 9M 2010 | 9M 2009 |
|---|---|---|---|---|
| Revenue | $533.2 | $497.2 | $1,619.3 | $1,521.8 |
| Gross profit | $102.6 | $101.2 | $324.3 | $303.1 |
| Operating income | $68.5 | $78.0 | $250.0 | $232.6 |
| Net income attributable to common stockholders | $18.8 | $31.2 | $90.0 | $88.8 |
| Diluted EPS | $0.08 | $0.12 | $0.36 | $0.35 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $266.1 | $305.3 |
- Revenue increased 7.2% in Q3 and 6.4% for the first nine months. Keystone and other acquisitions contributed to growth; nine-month revenue also benefited from higher general agency revenue and funeral volumes.
- Gross margin was approximately 19.3% in Q3 2010 versus 20.3% a year earlier; for the first nine months it was approximately 20.0% versus 19.9%. Operating margin was approximately 12.8% versus 15.7% in Q3, and 15.4% versus 15.3% for nine months.
- Q3 net income attributable to common stockholders fell about 40%, while nine-month net income rose about 1%. Q3 results included an after-tax debt-extinguishment loss of $5.3 million, an after-tax asset-sale loss of $8.5 million, and $1.8 million of after-tax Keystone acquisition and integration costs. Nine-month figures included corresponding items of $5.5 million, $3.2 million, and $6.4 million.
- Nine-month operating cash flow declined $39.2 million year over year, primarily due to higher incentive compensation and trade-payable payments and prior-year proceeds from life-insurance asset liquidations; improved atneed collections partly offset the decline.
Balance sheet, liquidity and capital
- At September 30, cash was $135.8 million, total debt $1.821 billion, and long-term debt $1.799 billion. Total debt was $1.890 billion at December 31, 2009. Cash declined from $179.7 million at year-end.
- The bank facility had $215 million outstanding, $44.1 million of letters of credit, and $140.9 million of remaining borrowing capacity. SCI reported compliance with its covenants: actual leverage ratio 3.30 against a 4.00 maximum, and interest coverage 4.03 against a 3.00 minimum.
- SCI reported $266.1 million in operating cash flow, $239.9 million in investing cash outflow and $73.3 million in financing cash outflow for the first nine months. Acquisitions used $281.8 million; capital expenditures were $67.4 million. SCI repurchased $86.9 million of stock and paid $30.2 million in dividends.
- Current assets were $344.5 million and current liabilities $343.6 million. Much of the reported balance sheet includes trust assets and corresponding liabilities for preneed customers and cemetery care; these funds are restricted by their purpose and applicable requirements.
- SCI declared dividends of $0.04 per share in Q3 and reported $0.12 per share for the first nine months. It repurchased 10.3 million shares for $86.2 million during the period, at an average $8.39 per share.
Material changes and management commentary
- Keystone was acquired for a reported purchase price of $288.9 million, including refinancing of Keystone debt. From acquisition through September 30, it contributed $56.9 million of revenue and $10.6 million of net income. Purchase-price allocation remained subject to finalization.
- Q3 consolidated funeral services performed rose 6.9%, primarily reflecting acquisitions, while comparable funeral services declined 1.6%. For nine months, comparable funeral services declined 2.4%, which management attributed mainly to soft demand and lower deaths in relevant markets. Comparable average revenue per funeral service increased 1.8% in Q3 and 2.8% for nine months.
- Nine-month cemetery gross profit increased 17.6%, with management citing higher preneed property and merchandise sales, trust income, and benefits from maintenance-cost initiatives. Q3 comparable funeral gross profit was pressured by higher selling and field overhead costs and the prior-year benefit from lower insurance reserves.
- SCI cited a $6.6 billion preneed backlog of future revenues at September 30. It stated that cash on hand, operating cash flow, and facility availability should meet liquidity needs, and that it had no significant debt maturities before November 2013. No specific earnings or revenue guidance was provided.
Risks, contingencies and unusual items
- Key risks include market volatility in trust investments, changing death and cremation trends, economic and currency movements, cost inflation, integration and synergy delivery at Keystone, access to capital and surety markets, and potential changes in regulation.
- Trust portfolios recorded impairment charges on certain equity securities in 2010, including $7.3 million for funeral merchandise and service trusts and $4.9 million for cemetery merchandise and service trusts for the first nine months. Management characterized remaining unrealized losses as temporary; alternative investments involve valuation judgment and limited liquidity.
- SCI disclosed burial-practices, wage-and-hour, and antitrust litigation. It said ultimate outcomes could not be determined for several matters and that an adverse decision could materially affect financial condition, results, or cash flows. A securities lawsuit was dismissed and terminated; a funeral-industry antitrust case was dismissed, with plaintiffs appealing.
- Tax examinations and disputes remain pending; SCI said potential changes in unrecognized tax benefits could be significant, but it could not estimate the range of changes in the next 12 months. The filing also reported $55.2 million of self-insurance reserves and $267.5 million of surety bonds outstanding.
- Immaterial prior-period error corrections reduced nine-month 2010 pretax income by $1.3 million and net income by $1.0 million. Disclosure controls were assessed as effective, with no material quarterly change in internal control reported.
Important facts for investors to verify
- How much of reported revenue and profit growth reflects Keystone and other acquisitions versus comparable-location performance.
- Whether comparable funeral volumes and funeral gross margins stabilize, and whether cemetery sales and margins remain strong.
- Keystone integration, final purchase accounting, and realization of expected cost savings and synergies.
- Debt covenant headroom, refinancing access, and cash available after acquisition spending, debt service, dividends, and repurchases.
- Developments in material litigation, tax audits, trust investment valuations, and any additional impairment or funding requirements.