Carriage Services, Inc. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; the filing also reports unaudited fourth-quarter results. Amounts are in U.S. dollars.
Business context
Carriage provides funeral and cemetery services and merchandise across the United States. At year-end it operated 182 funeral homes in 29 states and 29 cemeteries in 11 states. Funeral operations generated about 80% of revenue and cemetery operations about 20%. The company acquired four funeral-home businesses during 2018.
Key financial metrics
| Metric | 2017 | 2018 |
|---|---|---|
| Revenue | $258.1 million | $268.0 million |
| Gross profit | $76.8 million | $75.9 million |
| Operating income | $48.9 million | $43.3 million |
| Income before taxes | $32.8 million | $18.3 million |
| Net income | $37.2 million | $11.6 million |
| Diluted EPS | $2.09 | $0.63 |
| Operating cash flow | $45.2 million | $49.0 million |
| Capital expenditures | $16.4 million | $13.5 million |
Revenue increased 3.8%, while gross profit declined 1.1%. Gross margin fell to 28.3% from 29.8%; operating margin declined to 16.2% from 19.0%. Net margin fell to 4.3% from 14.4%. The 2017 net income included a $17.5 million discrete tax benefit from tax reform; 2018 also incurred $8.2 million more interest expense, mainly associated with the new Senior Notes. Management’s non-GAAP adjusted net income was $21.6 million in 2018 versus $24.7 million in 2017.
Fourth quarter: 2018 revenue was $66.5 million, gross profit $17.8 million, and net loss $2.7 million, compared with 2017 revenue of $65.1 million, gross profit of $19.6 million, and net income of $22.7 million. The 2017 fourth-quarter comparison benefited from tax reform’s discrete tax benefit.
Segments and operating indicators: Funeral revenue rose to $210.7 million from $200.9 million; cemetery revenue was essentially flat at $57.3 million. Funeral same-store operating profit decreased $3.4 million to $59.0 million, with margin down 180 basis points to 36.8%, primarily due to lower same-store revenue and higher salaries and benefits. Total funeral contracts increased 5.5%, while average revenue per contract decreased 0.5%. Cemetery same-store operating revenue improved on higher preneed property sales and average prices; cemetery trust earnings declined amid late-year market weakness. Company-defined segment operating profit, a non-GAAP measure, was $82.2 million for funeral and $22.2 million for cemetery.
Liquidity and debt: Year-end cash was $0.6 million and current assets were $29.3 million versus current liabilities of $35.0 million. The company reported $367.4 million of debt excluding debt issuance costs, discounts and capital leases: $325.0 million Senior Notes due 2026, $27.1 million drawn on its revolving facility, $6.3 million principal of Convertible Notes due 2021, and $8.9 million acquisition debt. Revolver availability was $120.9 million after letters of credit. The Senior Notes carry a 6.625% coupon; the $150 million revolving facility matures in 2023. The company was compliant with its credit covenants at year-end, reporting leverage of 5.10x against a 5.50x maximum and fixed-charge coverage of 1.84x against a 1.20x minimum. Dividends paid were $5.5 million; share repurchases totaled $17.7 million.
Material changes versus the prior period
- Revenue growth was supported by acquisitions and increased funeral contract volume, but lower funeral same-store performance and higher field costs reduced gross profit and operating income.
- Interest expense rose to $21.1 million from $12.9 million. The company issued $325 million of 6.625% Senior Notes, repaid its former credit facility, exchanged about $115 million principal of convertible debt for cash and shares, then repurchased a further $22.4 million principal of convertible notes.
- Net income fell from the unusually elevated 2017 result, which included the $17.5 million tax benefit; the 2018 income-tax provision was $6.6 million.
- Operating cash flow increased $3.8 million, mainly from favorable working-capital changes. Investing cash outflow increased to $51.5 million, including $38.0 million for acquisitions.
- Under ASC 606, adopted January 1, 2018, the company capitalized certain preneed sales commissions. Adoption increased opening retained earnings by $2.1 million; management said the standard did not materially affect revenue recognition overall.
Outlook, commentary, risks and unusual items
- No numerical earnings or revenue guidance is provided. Management said it expected liquidity to be sufficient for foreseeable needs and described a High Performance and Value Creation Trends Restoration Program intended to restore positive performance trends beginning in first-quarter 2019 and continuing through 2023.
- Management cited rising cremation rates and changing customer preferences as ongoing challenges. Cremation represented 52.2% of the company’s funeral services in 2018; management noted average cremation revenue is substantially below traditional burial revenue and emphasized selling complementary services and merchandise.
- Material risks include retaining local leaders and sales personnel, executing the operating and acquisition strategies, competition and pricing pressure, mortality and cremation trends, preneed sales and trust-fund returns, interest rates, debt service and covenant restrictions, regulation, environmental liabilities, and potential asset impairments.
- Trust investment returns were negative in 2018: funeral preneed trusts −6.5%, cemetery preneed trusts −8.4%, and perpetual-care trusts −8.0%. The filing said none of these trust portfolios was underfunded at year-end, but sustained declines could create future funding or earnings pressure.
- Unusual expenses included a $3.3 million write-off following cancellation of performance award agreements, an $0.8 million goodwill impairment and a $0.2 million impairment of property held for sale. Three cemetery operations ceased after a Florida municipal management agreement expired. A California wage-and-hour class action settlement was agreed in principle and a $650,000 accrual was recorded; court approval remained pending.
- The IRS examination of amended 2013–2015 federal returns was ongoing. Requested tax accounting-method changes required IRS approval; management expected approval and anticipated favorable cash-tax effects in 2019, but timing was uncertain. The 2019 lease-accounting adoption was expected to add $15–$17 million of right-of-use assets and lease liabilities, with no material effect on results, cash flows or covenant measures expected.
Important facts for investors to verify
- Whether the 2019–2023 restoration program improves same-store revenue, margins and operating performance, especially in funeral operations.
- Debt-service capacity and covenant headroom, given $325 million of 6.625% Senior Notes, variable-rate revolver borrowings and low year-end cash.
- Whether unfavorable trust-market returns persist and affect trust funding, future revenue or obligations to deliver guaranteed preneed services.
- Final court approval and total cost of the California class settlement, and the outcome of the IRS examination and requested accounting-method changes.
- How much reported earnings depend on tax items and other adjustments; compare GAAP net income with management’s non-GAAP adjusted net income and review the underlying reconciliations.
The independent auditor issued an unqualified opinion on the financial statements and internal control over financial reporting; management also reported effective disclosure controls.