Service Corporation International — Q1 2013 Form 10-Q
Business context and period. This unaudited report covers the three months ended March 31, 2013, compared with Q1 2012. SCI operates funeral homes, cemeteries and related businesses across North America, with 12 funeral homes in Germany that it intends to exit when conditions permit. At quarter-end it operated 1,437 funeral locations and 374 cemeteries. Management reported a $7.5 billion preneed backlog of future revenues.
Financial performance
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Revenue | $652.4 million | $602.5 million | +8.3% |
| Gross profit | $159.6 million | $127.6 million | +25.1% |
| Operating income | $127.8 million | $101.1 million | +26.3% |
| Net income attributable to common stockholders | $57.6 million | $48.0 million | +20.0% |
| Diluted EPS | $0.27 | $0.22 | +$0.05 |
| Operating cash flow | $151.1 million | $95.8 million | +$55.3 million |
- Gross margin was approximately 24.5%, versus 21.2%; operating margin was approximately 19.6%, versus 16.8%.
- Funeral revenue rose to $462.0 million from $424.3 million; funeral gross profit was $120.1 million versus $100.0 million. Funeral services performed increased 6.8%, while comparable average revenue per service rose 1.6% to $5,224. The comparable cremation rate increased to 48.9% from 48.3%.
- Cemetery revenue increased to $190.3 million from $178.2 million; cemetery gross profit rose to $39.5 million from $27.5 million. Management cited higher preneed property sales, trust income and $1.9 million of insurance claim settlements.
- Cash and cash equivalents were $188.5 million at March 31, 2013, up from $92.7 million at year-end 2012. Capital expenditures were $22.6 million; financing activities used $34.3 million, including dividends and the purchase of an additional Neptune Society interest.
- Total debt was $1.951 billion, including $37.3 million current maturities; long-term debt was $1.913 billion. Approximate debt less cash was $1.762 billion. The weighted-average debt rate was 6.27%, and 87% of debt was fixed-rate.
- The $500 million credit facility had $86.6 million drawn, $31.7 million of letters of credit and $381.7 million of available borrowing capacity. SCI said it was covenant-compliant; actual leverage was 2.82 against a 4.00 maximum, and interest coverage was 4.88 against a 3.00 minimum.
- Current assets of $374.7 million were below current liabilities of $425.5 million. The balance sheet includes substantial preneed and care-trust assets and related liabilities; these should not be treated as freely available corporate liquidity.
Changes and management commentary
- Revenue and profit growth reflected higher funeral volumes and average revenue, more cemetery preneed sales, trust income and prior-year acquisitions. Funeral comparable gross margin increased to 26.2% from 23.9%; cemetery comparable gross margin increased to 21.0% from 15.4%.
- Operating cash flow increased primarily with higher customer receipts and net trust withdrawals, partly offset by higher vendor, payroll and tax payments. Financing cash use fell from $89.1 million to $34.3 million, mainly because share repurchases were much lower than in Q1 2012.
- Q1 2013 declared dividends were $0.06 per share, up from $0.05. The board had authorized approximately $190.1 million of remaining repurchases, though no purchases under the public program occurred during the quarter.
- Preneeds: trust-funded funeral production was $46.3 million versus $37.7 million; insurance-funded funeral production was $137.9 million versus $134.4 million. Cemetery production was $196.5 million versus $183.9 million. Total funeral backlog was $5.43 billion and deferred cemetery backlog was $2.08 billion at quarter-end.
- No specific earnings or revenue guidance was provided. Management said it expected to continue investing in the core business and preneed backlog, consider acquisitions at favorable terms, and use repurchases and dividends subject to market conditions, debt covenants and board decisions. It stated that cash, operating cash flow and credit availability were expected to meet liquidity needs.
Risks, contingencies and unusual items
- Reported results included $0.6 million after-tax of asset-sale losses, $0.7 million of system and process transition costs, $0.8 million of legal defense fees and $0.9 million from changes in certain tax reserves and other items. In Q1 2012, tax-reserve and other items benefited results by $3.3 million, including a $3.1 million tax-expense reduction associated with an IRS settlement. The effective tax rate was 37.5% versus 32.4%.
- General and administrative expense increased $4.9 million to $30.9 million, chiefly from higher long-term incentive compensation and legal fees. Other expense was $1.0 million, versus $3.9 million of other income in Q1 2012, when foreign-currency liability settlements were favorable.
- SCI disclosed cemetery burial-practices and wage-and-hour litigation. A California cemetery class-action trial was scheduled for July 2013; the company said potential liability could not be quantified and an adverse outcome could materially affect results, financial condition or cash flows. Other matters included a dismissed Florida case and pending individual and class-related wage claims.
- Gross unrecognized tax benefits were $133.1 million and accrued interest was $42.0 million. Several tax years remained under review or audit; SCI said the amount of possible changes over the next 12 months could not be estimated.
- Risks include investment-market declines in affiliated trusts, possible trust-funding requirements, loss of surety-bond capacity, competition, rising cremation rates, pricing and cost pressures, regulatory requirements, third-party insurer financial condition, litigation and changes in death rates. SCI reported $240.4 million of surety bonds outstanding and said it did not expect material future funding due to surety capacity or nonperformance.
- Trust investments include illiquid Level 3 private-equity and alternative assets valued using estimates; these trusts had unfunded investment commitments. Investment performance and valuations remain market-sensitive. Management recorded impairment charges of $0.6 million across the preneed trusts in Q1 2013 and considered remaining unrealized losses temporary.
Important facts for investors to verify
- Whether the strong year-over-year margin and cash-flow gains persist, and how much reflects recurring operations versus trust income, insurance settlements, acquisitions and other items.
- Funeral volumes, cremation mix, average revenue per service, cemetery preneed production and the conversion of the reported backlog into realized revenue and cash.
- Debt covenant headroom, refinancing needs beginning in April 2015, credit-facility renewal assumptions and the availability of cash after considering trust restrictions.
- Developments in cemetery burial-practices and wage-and-hour litigation, IRS and other tax matters, and related cash exposure.
- Trust portfolio market performance, Level 3 valuation assumptions, unfunded commitments, and any future obligations to replenish trusts or replace surety bonds.