Service Corporation International — Q3 2018 Form 10-Q
Business context and period. SCI is a North American funeral and cemetery operator, with operations in the United States and Canada. This unaudited quarterly report covers the three and nine months ended September 30, 2018; balance-sheet comparisons are with December 31, 2017. At quarter-end SCI operated 1,478 funeral locations and 481 cemeteries. Management cited an approximately $11.3 billion preneed revenue backlog.
Financial performance and position
| Metric | Q3 2018 | First nine months 2018 |
|---|---|---|
| Revenue | $778.8 million, up 6.5% | $2,369.4 million, up 3.8% |
| Operating income | $132.3 million, versus $109.4 million | $457.9 million, versus $393.1 million |
| Net income attributable to common stockholders | $68.9 million; diluted EPS $0.37 | $254.2 million; diluted EPS $1.36 |
| Cash from operating activities | Not provided for the quarter | $452.3 million, versus $389.5 million |
| Capital spending | Not provided for the quarter | $165.9 million |
Q3 revenue growth reflected stronger cemetery results and acquired businesses; funeral revenue also rose, although comparable funeral operating profit declined. In the first nine months, cemetery operating profit increased 15.0% to $271.0 million; funeral operating profit increased 1.5% to $279.0 million. Q3 comparable funeral operating margin declined 100 basis points to 15.4%, while comparable cemetery operating margin rose 280 basis points to 29.9%. Comparable funeral cremation mix increased to 55.0% in Q3 and 54.6% for the nine-month period.
For the nine months, net income fell from $299.3 million to $254.2 million, despite higher operating income. The prior-year period included a tax benefit, while 2018 included a $10.1 million debt-extinguishment loss and higher interest expense. Diluted EPS also reflected a lower share count following repurchases.
At September 30, cash and cash equivalents were $158.3 million, total debt was $3.61 billion, and total equity was $1.49 billion. Debt was up from $3.47 billion at year-end 2017; current debt maturities were $68.8 million. The company reported $571.7 million of available credit capacity and compliance with debt covenants. Actual leverage was 3.86 against a maximum of 4.50; interest coverage was 5.23 against a minimum of 3.00. The weighted-average debt interest rate was 4.93%.
Material changes and unusual items
- Revenue from contracts with customers was adopted January 1, 2018. Adoption increased opening retained earnings by $172.2 million and changed balance-sheet presentation of certain preneed amounts. For the first nine months, management reported adoption reduced net income by $10.5 million, or $0.06 per diluted share, versus results without the new guidance.
- SCI repurchased 7.30 million shares for $275.7 million in the first nine months and paid $93.0 million in dividends. Dividends declared were $0.51 per share for the period.
- Investing cash outflow was $346.8 million, including $187.6 million for acquisitions. A June acquisition included 15 funeral homes and seven cemeteries; purchase accounting remained preliminary. The acquired businesses contributed $10.4 million of revenue and $1.1 million of net income from June 8 through September 30.
- The nine-month effective tax rate was 19.4%, compared with a tax benefit rate of 12.3% in 2017. SCI recorded a $16.3 million adjustment to provisional Tax Act estimates; related accounting remained incomplete.
Outlook, commentary, and risks
SCI provided no specific numerical earnings or revenue guidance in the supplied filing. Management described liquidity as adequate and prioritized acquisitions and new builds, dividends, share repurchases, and opportunistic debt repurchases. It expects preneed sales to support future revenue and cash-flow stability, while noting the ongoing rise in cremation and its lower average revenue relative to traditional burial. Management also expects adoption of the lease standard in 2019 to significantly increase reported assets and liabilities for operating leases; the amount was not yet determined.
Risks include market fluctuations in trust investments and potential trust-funding requirements; high fixed operating costs; competition and changing consumer preferences; dependence on third-party insurers and surety bonding for preneed business; debt and covenant constraints; regulatory, tax, and unclaimed-property matters; and litigation. SCI disclosed multiple wage-and-hour and operational lawsuits for which it could not reasonably estimate possible losses. In October 2018, after quarter-end, Illinois’ Comptroller alleged $13.6 million in withdrawals from perpetual-care trusts were improper; SCI said it believed the withdrawals were proper and intended to defend them. Hurricane-related costs and insurance recoveries also affected results.
Important facts for investors to verify
- Assess comparability of 2017 and 2018 results given the revenue-recognition change and prior-year tax and settlement items.
- Review the composition, investment risk, legal restrictions, and availability of preneed and perpetual-care trust assets; these are not equivalent to unrestricted corporate cash.
- Track debt, floating-rate exposure, covenant headroom, and the cash impact of acquisitions, repurchases, and dividends.
- Follow the Illinois trust-withdrawal claim, wage-and-hour and other litigation, and unrecognized tax benefits; potential losses are not clearly quantifiable in the filing.
- Confirm the final purchase accounting for the 2018 acquisition and the balance-sheet impact of lease-standard adoption.