Business Context and Reporting Period
Company: Service Corporation International (SCI)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2006
Industry: Deathcare (Funeral homes and cemeteries)
SCI is North America's leading provider of deathcare products and services. As of December 31, 2006, the company operated 1,613 funeral service locations and 452 cemeteries across 45 U.S. states, eight Canadian provinces, the District of Columbia, Puerto Rico, and Germany. The reporting period was significantly impacted by the acquisition of Alderwoods Group, Inc. on November 28, 2006, for approximately $1.2 billion. This transaction added 578 funeral service locations and 70 cemeteries to SCI's portfolio. The company also divested its Singapore operations and an insurance business acquired from Alderwoods, which are reported as discontinued operations.
Key Financial Metrics
| Metric | 2006 | 2005 | 2004 |
|---|---|---|---|
| Total Revenue | $1,747.3 million | $1,711.0 million | $1,825.7 million |
| Gross Profit | $344.7 million | $297.0 million | $328.3 million |
| Gross Margin | 19.7% | 17.4% | 18.0% |
| Net Income (Loss) | $56.5 million | $(127.9) million | $110.7 million |
| Diluted EPS | $0.19 | $(0.42) | $0.34 |
| Operating Cash Flow | $324.2 million | $312.9 million | $94.2 million |
| Total Assets | $9,729.4 million | $7,544.8 million | $8,227.2 million |
| Long-Term Debt | $1,912.7 million | $1,186.5 million | $1,200.4 million |
| Stockholders' Equity | $1,594.8 million | $1,581.6 million | $1,843.0 million |
Note: 2005 results included a $187.5 million after-tax charge for a change in accounting for direct selling costs. 2006 results include $50.9 million in revenue and $5.4 million in net income from the Alderwoods acquisition.
Material Changes vs. Prior Period
- Revenue Growth: Consolidated revenue increased 2.1% to $1,747.3 million, driven by the Alderwoods acquisition and a 9.0% increase in comparable average revenue per funeral service in North America.
- Profitability Improvement: Net income turned from a loss of $127.9 million in 2005 to a profit of $56.5 million in 2006. This reversal was primarily due to the absence of the 2005 accounting change charge and improved gross margins (19.7% vs. 17.4%).
- Debt Increase: Long-term debt increased by approximately $726 million to $1.91 billion to finance the Alderwoods acquisition. The company issued $500 million in senior notes, $200 million in private placement notes, and a $150 million term loan.
- Volume Decline: Despite revenue growth, comparable funeral services performed in North America declined 5.8% due to a decrease in the number of deaths in served markets and strategic exits from unprofitable business relationships.
- Impairment Charges: The company recognized a $58.7 million net pretax impairment loss in 2006, primarily associated with the disposition of underperforming businesses and assets held for sale related to FTC-mandated divestitures.
Guidance, Outlook, and Risks
Management Commentary & Outlook: Management expects operating cash flow in 2007 to range from $306 million to $346 million. The company anticipates achieving annual pretax cost savings and revenue enhancements of $90 million to $100 million from the Alderwoods integration within 18 months of closing. SCI plans to continue exiting unprofitable business relationships to focus on higher-margin customer segments.
Key Risks and Contingencies:
- Integration Risk: Failure to realize anticipated synergies or cost savings from the Alderwoods acquisition could adversely affect financial results.
- Regulatory & Litigation: The company faces significant litigation, including class actions regarding funeral rule disclosures (e.g., Hijar and Baudino lawsuits) and antitrust investigations. Unfavorable outcomes could result in material damages.
- Trust Fund Performance: Earnings are sensitive to financial market conditions affecting preneed funeral and cemetery trust funds. Significant investment losses could require the company to fund shortfalls.
- Surety Bonding: If surety companies cancel bonds supporting preneed activities, SCI would be required to fund approximately $278.6 million into state-mandated trust accounts.
- Debt Covenants: New credit agreements contain restrictive covenants limiting share repurchases, dividends, and additional indebtedness.
Investor Verification Checklist
- Alderwoods Integration: Verify the realization of projected $90-$100 million in annual synergies and cost savings.
- Debt Servicing: Monitor compliance with new leverage and interest coverage ratios given the significant increase in debt load.
- Legal Exposure: Track the status of the Hijar and Baudino class action lawsuits and antitrust investigations, as outcomes could be material.
- Preneed Backlog: Confirm the stability of the $6.5 billion preneed backlog and the performance of trust fund investments.
- Divestitures: Monitor the execution of FTC-mandated divestitures and the sale of non-strategic assets to generate liquidity.