Service Corporation International — FY2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. This is an annual filing; fourth-quarter figures below are unaudited.
Business context
SCI is North America’s largest deathcare provider, operating 1,481 funeral locations and 481 cemeteries across the United States and Canada. Its funeral and cemetery businesses sell services and merchandise at need and in advance. Preneed backlog was $11.1 billion at year-end, versus $10.7 billion in 2017.
Financial performance and liquidity
| Metric | FY2018 | FY2017 |
|---|---|---|
| Revenue | $3.190 billion | $3.095 billion |
| Operating income | $630.7 million | $571.1 million |
| Net income attributable to common stockholders | $447.2 million | $546.7 million |
| Diluted EPS | $2.39 | $2.84 |
| Operating cash flow | $615.8 million | $503.4 million |
| Cash and cash equivalents at year-end | $198.9 million | $330.0 million |
| Total debt, including current maturities | $3.602 billion | $3.473 billion |
Revenue rose 3.1% and operating income rose 10.4%; net income declined 18.2%, chiefly because 2017 included substantially larger tax benefits. Operating margin was approximately 19.8%, compared with 18.4% in 2017. Capital expenditures were $235.5 million; operating cash flow less capital expenditures was approximately $380.3 million.
Funeral revenue was $1.898 billion, up 1.6%; comparable funeral operating profit fell to $369.3 million from $375.6 million, with comparable margin down 50 basis points to 19.9%. Comparable services performed rose 0.5%, while average revenue per service declined 0.2%; cremations reached 54.9% of comparable services, versus 53.5% in 2017. Cemetery revenue increased 5.3% to $1.292 billion and operating profit increased 11.3% to $390.7 million; comparable cemetery margin improved 170 basis points to 30.4%.
Cash and cash equivalents fell by year-end, while debt increased. SCI reported $572.1 million of available borrowing capacity and was in compliance with debt covenants. Its leverage ratio was 3.86 against a maximum of 4.50, and interest coverage was 5.05 against a minimum of 3.00. About 66% of debt was fixed-rate; the weighted average interest rate was 4.99%. Current maturities of long-term debt were $69.9 million.
Changes and notable items
- The 2018 effective tax rate was a 1.3% benefit, compared with a 36.6% benefit in 2017. Expiration of statutes of limitations on uncertain tax positions was a major 2018 factor; the 2017 result included the Tax Act and IRS audit settlement benefits.
- SCI adopted the new revenue recognition standard in 2018. It increased opening retained earnings by $172.2 million. For 2018, adoption reduced net income by $10.7 million, or $0.06 per diluted share, versus results without the standard.
- Trust investment returns were negative in 2018: funeral merchandise and service trusts returned -4.9%, cemetery merchandise and service trusts -5.2%, and perpetual-care trusts -3.0%. SCI reported a combined trust performance decline of 4.4%.
- SCI repurchased 7.35 million shares for $277.6 million and paid $123.8 million in dividends. The annual dividend declared was $0.68 per share, up from $0.58.
- Acquisitions, net of cash acquired, used $194.8 million. In June, SCI acquired 15 funeral homes and seven cemeteries; the acquired businesses contributed $17.9 million of revenue and $1.7 million of net income from acquisition through year-end.
- Fourth-quarter 2018 revenue was $820.8 million and net income attributable to common stockholders was $193.0 million, or $1.04 diluted EPS; fourth-quarter 2017 figures were $812.7 million, $247.3 million, and $1.29, respectively.
- A change in estimated useful lives reduced 2018 depreciation expense by $4.3 million, or $0.02 per share. SCI recorded $2.4 million of tradename impairment and a $10.1 million loss on early debt extinguishment.
Outlook, risks and contingencies
SCI gave no quantified earnings or revenue guidance in the provided filing text. Management’s strategy is to grow revenue and preneed sales, leverage scale, and deploy capital through acquisitions, new funeral homes, dividends, share repurchases, and debt management. Management expects to benefit over time from an aging population and is investing in cremation-related offerings, sales systems, and customer-facing technology. It also cautions that cremation’s growing share can pressure revenue and profit because cremation cases generate lower average revenue than traditional burials.
- Trust market losses could reduce funds available for future services and cemetery upkeep or require SCI to replenish trusts. Unrealized losses in trusts subject to potential replenishment requirements were $31.2 million at year-end.
- If surety bonds supporting preneed activities were not renewed and replacement coverage were unavailable, SCI estimated it could need to fund approximately $161.9 million into mandated trusts.
- SCI faces litigation and regulatory matters, including burial-practice and wage-and-hour claims. Potential losses for certain matters could not be reasonably estimated. Illinois authorities disputed $13.6 million of perpetual-care trust withdrawals; SCI says the withdrawals were proper and intends to defend them.
- State unclaimed-property authorities have raised potential escheatment claims related to certain preneed contracts; audits had not commenced, and the possible loss was not estimable.
- Other risks include high fixed costs, competition, changing consumer preferences, labor and compliance costs, cybersecurity and IT disruption, Canadian-dollar exposure, interest rates, insurance-company funding risk, and debt covenants. The CEO and CFO reported effective disclosure controls and internal control over financial reporting; the independent auditor concurred.
Important facts for investors to verify
- How much of the 2018 earnings decline reflects underlying operations versus the unusually large 2017 tax benefit, and how sustainable the low 2018 tax rate is.
- Whether cemetery growth and margins can continue, and whether funeral pricing and product mix can offset the continuing shift toward cremation.
- The effects of trust-market performance on trust assets, future obligations, and possible replenishment requirements.
- Debt repayment capacity, covenant headroom, interest-rate exposure, and the balance between acquisitions, dividends, and repurchases.
- Developments in the Illinois trust dispute, unclaimed-property matters, and other litigation, including any resulting cash or earnings impact.
- The balance-sheet effect of adopting lease accounting in 2019; management expected a significant balance-sheet impact but no material effect on results or cash flows.