Service Corporation International — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; comparisons are with Q1 2015 unless noted. SCI is a North American funeral and cemetery operator, with 1,522 funeral locations and 468 cemeteries at quarter-end. Amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q1 2016 | Q1 2015 / prior date |
|---|---|---|
| Revenue | $749.3 million | $748.1 million |
| Gross profit / margin | $161.5 million / 21.5% | $177.4 million / 23.7% |
| Operating income / margin | $123.6 million / 16.5% | $141.1 million / 18.9% |
| Net income attributable to common stockholders | $47.4 million | $61.4 million |
| Diluted EPS | $0.24 | $0.30 |
| Operating cash flow | $184.8 million | $188.8 million |
| Capital expenditures | $41.7 million | $28.3 million |
| Cash and cash equivalents | $213.5 million | $134.6 million at Dec. 31, 2015 |
| Total debt | $3.13 billion | $3.12 billion at Dec. 31, 2015 |
Net income fell 22.7%, while revenue was nearly flat. Interest expense was $43.1 million. The effective tax rate rose to 40.5% from 37.4%. Cash increased by $78.9 million during the quarter. SCI reported $639.2 million of available borrowing capacity and said approximately $160 million of cash was unencumbered. Trust assets and related balances include funds held for preneed customers and should not be treated as unrestricted corporate liquidity.
Material changes and operating trends
- Funeral revenue declined to $492.1 million from $507.7 million; funeral gross profit fell to $107.0 million from $126.9 million. Comparable services performed decreased 5.8%, which management attributed largely to a milder flu season versus a strong flu season in Q1 2015. Comparable average revenue per service was essentially unchanged at $5,219.
- The comparable cremation rate rose to 52.1% from 51.1%. SCI noted that cremation services generally generate lower average revenue than traditional burials.
- Cemetery revenue increased 7.0% to $257.2 million and gross profit rose to $54.5 million from $50.5 million. Higher preneed property revenue and increased distributions of perpetual-care trust capital gains contributed to the revenue increase.
- General and administrative expense increased to $37.5 million from $34.6 million. The quarter included $4.1 million of system-transition costs and a $5.5 million out-of-period expense for acquisition costs previously improperly capitalized. Management said the latter was immaterial to current and prior-period financial statements.
- SCI recorded a $0.6 million loss on early extinguishment of debt in Q1. In March, it replaced prior 2018 bank facilities with a $1.4 billion credit agreement maturing in March 2021, including a $700 million revolving facility and a $700 million term loan.
Liquidity, capital allocation and outlook
SCI reported compliance with debt covenants at March 31, 2016: actual leverage ratio 3.75 versus a maximum of 4.25, and interest coverage ratio 4.80 versus a minimum of 3.00. Approximately 75% of debt had fixed interest rates; the weighted-average rate was 5.1%.
Management stated that cash on hand, expected operating cash flows and available credit should provide adequate liquidity for short- and long-term obligations. Its stated capital priorities are acquisitions and new construction, dividends, share repurchases and opportunistic debt repurchases. The quarterly dividend declared was $0.12 per share, up from $0.10 a year earlier. SCI repurchased 2.3 million shares for $54.6 million during the quarter.
SCI reported a $9.6 billion preneed backlog, including trust-funded and insurance-funded future revenue. Trust-funded funeral production increased to $71.9 million from $65.1 million; cemetery sales production rose to $262.4 million from $239.7 million. The filing provides no quantified full-year earnings or revenue guidance. Management highlighted demographic trends, pricing, cost control, preneed sales and adaptation to cremation demand as important business drivers.
Subsequent event: In April 2016, SCI borrowed $320 million under the new facilities to repay its $295 million 7.0% notes due June 2017 and related costs, recognizing a $21.7 million early-extinguishment loss.
Risks, contingencies and unusual items
- Key risks include trust-portfolio market volatility, possible trust-funding requirements, reliance on surety bonding, indebtedness and covenant limits, competition, cremation trends, changing death volumes, regulation, insurance-provider credit, Canadian currency exposure and litigation.
- Surety bonds outstanding totaled $285.2 million. Management did not expect material future funding needs from lack of surety capacity or surety-company nonperformance, but cancellation could require replacement assurance or trust funding.
- Self-insurance reserves were $77.1 million. The filing describes wage-and-hour claims and other litigation; ultimate outcomes and potential liabilities could not be quantified. In a lease dispute involving six California locations, a February 2016 ruling adopted the Archdiocese’s interpretation of its termination rights; further proceedings and appeals remained pending.
- Unrecognized tax benefits were $179.8 million, with $52.7 million of accrued interest. Several federal, state and foreign tax matters remained under review or audit; outcomes and timing were uncertain.
- Management identified $41.1 million, $42.7 million and $44.9 million of unfunded private-equity commitments in funeral, cemetery and perpetual-care trusts, respectively; any calls would be funded from trust assets.
Important facts for investors to verify
- Whether funeral volumes and gross profit recover after the flu-season-related decline, and how cremation mix affects average revenue and margins.
- How much of cemetery growth is recurring, particularly the contribution from preneed property sales and trust capital-gain distributions.
- The effect of the April refinancing, including the $21.7 million loss, on reported and recurring earnings, interest costs and debt maturity exposure.
- The composition and convertibility of reported cash and borrowing capacity, distinguishing corporate liquidity from legally restricted trust assets.
- Progress and potential exposure in the California lease litigation, wage-and-hour claims, tax audits and surety-bond arrangements.
- Whether preneed backlog converts to future revenue and cash as expected, considering cancellations, investment returns, contract costs and insurance-company performance.