Business context and reporting period
Service Corporation International (SCI), North America’s largest deathcare provider, filed this unaudited Form 10-Q for the three months ended March 31, 2017, compared with the three months ended March 31, 2016. It operated 1,500 funeral service locations and 475 cemeteries across the U.S. and Canada. SCI sells funeral and cemetery goods and services both at need and through preneed contracts.
Financial results and key metrics
Unless otherwise noted, amounts are in millions of dollars.
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Revenue | $777.7 | $749.2 |
| Operating profit | $177.2 | $162.9 |
| Operating income | $139.6 | $123.7 |
| Interest expense | $40.6 | $43.1 |
| Income before income taxes | $98.5 | $79.8 |
| Income tax benefit (expense) | $76.2 benefit | $(32.3) expense |
| Net income attributable to common stockholders | $174.7 | $47.4 |
| Diluted EPS | $0.91 | $0.24 |
| Operating cash flow | $188.4 | $184.8 |
| Capital expenditures | $40.2 | $41.7 |
Revenue grew 3.8%. Operating income margin was approximately 18.0%, compared with 16.5%; reported net income was strongly affected by tax benefits, so the year-over-year earnings comparison is not representative of underlying operating growth. Operating cash flow less capital expenditures was approximately $148.2 million, versus $143.1 million.
Funeral revenue was $498.8 million, up from $492.2 million; funeral operating profit was $112.6 million, up 5.0%. Comparable services performed rose 1.7% and comparable average revenue per service rose 0.8%; the comparable cremation rate increased to 53.4% from 52.2%. Cemetery revenue was $278.9 million, up 8.5%, and cemetery operating profit was $64.6 million, up 16.0%; comparable cemetery operating margin increased 140 basis points to 23.1%.
At March 31, 2017, cash and cash equivalents were $238.3 million. Current assets were $390.8 million and current liabilities were $613.0 million. Total debt, including capital leases, was $3.288 billion, comprising $63.6 million current and $3.225 billion long-term. The weighted-average debt interest rate was 4.75%; approximately 63% of debt had fixed rates. The company had $282.3 million of available borrowing capacity and was in compliance with its debt covenants. Trust assets are subject to preneed and perpetual-care obligations and should not be treated as freely available corporate liquidity.
SCI’s preneed backlog was approximately $10.2 billion at quarter end. This included $7.49 billion of funeral backlog, including $5.41 billion of insurance-funded contracts, and $2.67 billion of cemetery backlog.
Material changes versus the prior comparable period
- Net income rose to $174.7 million from $47.4 million, principally reflecting a large income tax benefit rather than operating results alone.
- The effective tax rate was a 77.4% benefit, versus a 40.5% expense in Q1 2016. An IRS settlement concerning tax years 1999–2005 reduced unrecognized tax benefits by $143.0 million; $102.5 million was recognized as an income tax benefit, while taxes payable increased $40.5 million. Share-based award tax benefits also reduced the quarter’s tax provision.
- Operating profit increased in both funeral and cemetery segments. Cemetery growth reflected higher preneed property sales and merchandise deliveries; Q1 2016 included $7.2 million of perpetual-care trust capital-gain distributions that did not recur.
- Interest expense declined $2.4 million, which management attributed to prior debt refinancing and a greater proportion of lower-rate variable debt.
- Cash from operations increased $3.6 million. Investing cash outflow increased to $56.3 million, primarily due to $19.3 million spent on acquisitions. Financing cash outflow was $89.6 million, including $83.5 million of share repurchases and $24.4 million of dividends.
- SCI repurchased 2.8 million shares at an average $29.67 per share during the quarter. The quarterly dividend declared was $0.13 per share, versus $0.12 a year earlier.
Outlook, commentary, risks, and unusual items
No specific numerical earnings or revenue guidance is provided in the filing. Management describes preneed sales and the resulting backlog as supporting revenue and cash-flow stability, and says it expects to maintain liquidity through operating cash flow, cash on hand, and available credit. Its stated capital priorities are acquisitions and new builds, dividends, share repurchases, and opportunistic debt repurchases. The company targets a dividend payout ratio of 35%–45%, subject to board approval and debt covenants.
Unusual items include the $102.5 million tax benefit from the IRS settlement, a $6.4 million tax benefit from share-based award settlements under newly adopted accounting guidance, and an $11.6 million pension termination settlement expense. Net gains on divestitures and impairment charges were $4.9 million, including $16.8 million of divestiture gains and $11.8 million of impairment losses.
Key risks include market volatility in trust investments; possible trust-funding needs; reliance on surety bonding for preneed business; competition and the shift toward cremation, which generally generates lower average revenue than traditional burial; high fixed costs; debt and covenant constraints; litigation and regulatory matters; unclaimed-property claims involving preneed contracts; insurance-company performance; and potential adverse tax outcomes. SCI reported $78.6 million in self-insurance reserves. It could not quantify potential liability for several litigation matters or the unclaimed-property audit inquiry involving 36 states; the filing warns an adverse outcome could materially affect liquidity, cash flows, or results.
Management reported effective disclosure controls and procedures as of March 31, 2017, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of Q1’s reported earnings improvement is attributable to the one-time IRS settlement and share-based award tax benefits, and what earnings measure best reflects ongoing performance?
- Whether the $10.2 billion preneed backlog converts to revenue and cash flow as expected, including the performance and funding of insurance-backed contracts.
- The potential cash and financial-statement exposure from the unclaimed-property inquiry, wage-and-hour claims, and other disclosed litigation.
- Debt maturity, variable-rate exposure, covenant headroom, and continued access to the $282.3 million of reported borrowing capacity.
- Whether trust investment returns, cemetery sales growth, and rising cremation mix affect future revenue, margins, or required trust contributions.