SERVICE CORP INTERNATIONAL quarterly report, Q3 FY2017

Service Corporation International — Q3 2017 Form 10-Q

Reporting period: Three and nine months ended September 30, 2017. SCI operates funeral and cemetery businesses in the U.S. and Canada. This summary compares results with the corresponding 2016 periods; financial figures are in U.S. dollars.

Key financial metrics

Metric	Q3 2017	Q3 2016	Nine months 2017	Nine months 2016
Revenue	$731.3 million	$721.5 million	$2,282.3 million	$2,222.1 million
Operating income	$109.1 million	$114.4 million	$392.3 million	$332.6 million
Net income attributable to common stockholders	$56.2 million	$47.7 million	$299.3 million	$110.8 million
Diluted EPS	$0.29	$0.24	$1.56	$0.56
Operating cash flow	Not separately reported	Not separately reported	$389.6 million	$358.5 million

Q3 revenue grew 1.4%, while operating income fell 4.7%. Nine-month revenue increased 2.7% and operating income increased 18.0%.
Q3 operating margin was approximately 14.9%, versus 15.9% a year earlier. Comparable funeral margin was 16.3%, down 0.6 percentage points; comparable cemetery margin was 27.1%, up 3.0 points.
Nine-month cash used in investing was $178.6 million, including $141.7 million of capital expenditures and $49.6 million of acquisitions. Cash used in financing was $147.5 million. Cash and cash equivalents ended the period at $268.0 million.
At September 30, total debt was $3.369 billion, including $76.3 million of current maturities; cash was $268.0 million. The weighted-average debt interest rate was 4.80%, and approximately 62% of debt had fixed rates.
Current assets were $404.9 million versus current liabilities of $579.7 million. The company reported $196.6 million of available borrowing capacity under its bank facility and compliance with debt covenants; actual leverage and interest-coverage ratios were 3.62 and 5.39, respectively.
SCI reported approximately $10.54 billion of preneed backlog at fair value, including trust-funded and insurance-funded contracts. Insurance-funded backlog is not recorded as an asset or liability on the balance sheet.

Operating performance and changes

Q3 funeral revenue declined to $437.5 million from $445.5 million, while funeral operating profit fell to $70.1 million from $74.5 million. Comparable services performed were essentially flat; the comparable cremation rate rose to 53.5% from 52.7%. Management cited lower average revenue per service, reduced general agency revenue, and hurricane-related interruptions.
Q3 cemetery revenue rose 6.4% to $293.8 million and operating profit increased 20.2% to $79.6 million. Growth reflected cemetery property sales and recognition, merchandise deliveries, and high-margin comparable revenue.
For the first nine months, cemetery revenue grew 8.5% to $887.1 million and operating profit rose 21.1% to $235.5 million. Funeral operating profit increased 1.3% to $274.8 million, despite lower consolidated funeral revenue, as comparable results and cost management improved.
Q3 general and administrative expense increased $12.3 million to $39.2 million, including an $11.5 million legal settlement. Nine-month G&A also included a $12.8 million pension termination settlement. Higher cemetery earnings, fewer shares outstanding, and tax benefits supported reported earnings.

Liquidity, outlook, risks, and unusual items

The nine-month effective tax rate was a benefit of 12.3%, compared with tax expense of 40.8% in 2016. A 2017 IRS settlement reduced unrecognized tax benefits by $143.0 million and generated a $102.5 million income tax benefit; the filing also reports $34.2 million of settlement payments and associated interest. The unusually high year-over-year earnings increase therefore does not solely reflect operating performance.
Hurricanes Harvey and Irma caused damage and business interruptions. Q3 cleanup and repair costs of $5.8 million were partly offset by $4.5 million of insurance proceeds, for a $1.3 million net expense. Management estimated another $5.0 million of repair and cleanup costs in Q4 and approximately $10.0 million of capital costs to replace damaged assets, with additional insurance proceeds expected to partially offset costs. The impact of Hurricane Maria was still being assessed; management did not expect it to be material.
Management gave no specific full-year earnings or revenue guidance in the provided filing text. It described capital priorities as acquisitions and new construction, dividends, and share repurchases, subject to returns, market conditions, and debt covenants. The stated dividend payout-ratio target is 35%–45%.
SCI repurchased 4.8 million shares for $148.8 million in the first nine months and paid $80.7 million in dividends. It repurchased a further 390,063 shares for $13.4 million after quarter-end through the date disclosed in the filing.
Key exposures include trust-investment market volatility and possible trust-funding requirements, variable-rate debt costs, high fixed operating costs, rising cremation mix, competition, insurance-company performance, litigation, regulation, and the potential application of unclaimed-property laws to preneed contracts. An audit inquiry involving 36 states had not yet resulted in actual audits; possible liability was not quantifiable.
SCI disclosed wage-and-hour litigation and other legal matters. A Telephone Consumer Protection Act class-action settlement called for a $15.0 million payment, of which $3.5 million was expected from insurance, subject to court approval. The filing states that the ultimate outcomes of the described matters could not be determined.
The company expected to adopt the new revenue-recognition standard on January 1, 2018 using the modified retrospective method. It had identified changes involving nonrefundable upfront fees, deferred selling costs, and presentation of certain preneed customer balances, but had not determined the full financial impact.
Disclosure controls were assessed as effective as of September 30, 2017, with no material changes in internal control over financial reporting reported during the quarter.

Important facts for investors to verify

How much of nine-month net income growth is attributable to the IRS tax settlement and other discrete tax benefits, versus recurring operating performance.
Whether hurricane repair, replacement, and insurance-recovery estimates change, and how much of the expected capital spending is incremental.
The eventual financial and cash-flow impact of revenue-recognition adoption, including deferred selling costs and balance-sheet reclassifications.
Developments in the multi-state unclaimed-property inquiry, wage-and-hour claims, and the TCPA settlement approval and payment.
Trust investment returns, possible funding requirements, and the company’s ability to manage debt, interest costs, and shareholder distributions while maintaining covenant compliance.