SERVICE CORPORATION INTERNATIONAL The Company We areNorth America's largest provider of deathcare products and services, with a network of funeral service locations and cemeteries unequaled in geographic scale and reach. AtDecember 31, 2019 , we operated 1,471 funeral service locations and 482 cemeteries (including 290 funeral service/cemetery combination locations), which are geographically diversified across 44 states, eight Canadian provinces, theDistrict of Columbia , andPuerto Rico . Our funeral and cemetery operations consist of funeral service locations, cemeteries, funeral service/cemetery combination locations, crematoria, and other related businesses, which enable us to serve a wide array of customer needs. We sell cemetery property and funeral and cemetery merchandise and services at the time of need and on a preneed basis. Our financial position is enhanced by our$12.0 billion backlog of future revenue from both trust and insurance-funded preneed sales atDecember 31, 2019 . Preneed selling provides us with a strategic opportunity to gain future market share. We also believe it adds to the stability and predictability of our revenue and cash flows. While revenue on the majority of preneed merchandise and service sales is deferred until the time of need, sales of preneed cemetery property provide opportunities for full current revenue recognition to the extent that the property is developed and available for use. We have adequate liquidity and a favorable debt maturity profile, which allow us to return capital to shareholders through share repurchases and dividends. Factors affecting our operating results include: demographic trends in terms of population growth and average age, which impact death rates and number of deaths; establishing and maintaining leading market share positions supported by strong local heritage and relationships; effectively responding to increasing cremation trends by selling complementary services and merchandise; controlling salary and merchandise costs; and exercising pricing leverage related to our atneed revenue. The average revenue per funeral contract is influenced by the mix of traditional and cremation services because our average revenue for cremations is lower than that for traditional burials. To further enhance revenue opportunities, we continue to focus on our cremation customer's preferences and remaining relevant by developing additional memorialization merchandise and services that specifically appeal to cremation customers. We believe the presentation of these additional merchandise and services through our customer-facing technology enhances our customer's experience by reducing administrative burdens and allowing them to visualize the product offerings and services, which will help drive increases in the average revenue for a cremation in future periods. For further discussion of our key operating metrics, see our "Cash Flow" and "Results of Operations" sections below. For a discussion of our results of operations and liquidity and capital resources for the fiscal year endedDecember 31, 2017 , see Management's Discussion and Analysis of Financial Condition, Liquidity and Capital Resources and Results of Operations in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2018 , filed with theSecurities and Exchange Commission onFebruary 20, 2019 . Financial Condition, Liquidity, and Capital Resources Capital Allocation Considerations We rely on cash flow from operations as a significant source of liquidity. Our cash flow from operating activities provided$628.8 million in 2019. In addition, as ofDecember 31, 2019 , we have$671.0 million in excess borrowing capacity under our Bank Credit Facility. As ofDecember 31, 2019 , we have$69.8 million in long-term debt current maturities, which primarily consist of current amounts due on the term loan and finance leases. Our Bank Credit Facility requires us to maintain certain leverage and interest coverage ratios. As ofDecember 31, 2019 , we were in compliance with all of our debt covenants. Our financial covenant requirements and actual ratios as ofDecember 31, 2019 are as follows: Per Credit Agreement Actual Leverage ratio 4.75 (Max) 3.78 Interest coverage ratio 3.00 (Min) 5.03
We believe we have the financial strength and flexibility to reward shareholders through share repurchases and dividends while maintaining a prudent capital structure and pursuing new opportunities for profitable growth.
24Service Corporation International --------------------------------------------------------------------------------
PART II
We believe that our unencumbered cash on hand, future operating cash flows, and the available capacity under our bank credit agreement will give us adequate liquidity to meet our short-term needs as well as our long-term financial obligations. Due to cash balances residing inCanada and minimum operating cash requirements, a portion of our cash on hand is encumbered. We consistently evaluate the best uses of our cash flow that will yield the highest value and return on capital. Our capital deployment strategy is prioritized as follows: Investing in Acquisitions andBuilding New Funeral Service Locations . We manage our footprint by focusing on strategic acquisitions and building new funeral service locations where the expected returns are attractive and exceed our weighted average cost of capital by a meaningful margin. We target businesses with favorable customer dynamics and/or where we can achieve additional economies of scale. We continue to pursue strategic acquisitions and build new funeral service locations in areas that provide us with the potential for scale. In 2019, we increased our growth capital spend on new funeral service locations and expansions of existing locations to expand our footprint into desirable markets and to remain relevant with our customers. For our cemetery businesses, we plan to pursue strategic acquisitions to create more opportunities to serve Baby Boomers through our tiered cemetery options. During 2019, we acquired land that will be developed for future cemetery use in some of our largest markets to remain relevant with our customer. This investment in our future will allow us to continue to create cemetery offerings that appeal to varying preferences in those markets for many years to come. Paying Dividends. Our quarterly dividend rate has steadily grown from$0.025 per common share in 2005 to$0.18 per common share at the end of 2019. We target a payout ratio of 30% to 40% of after tax earnings excluding special items and intend to grow our cash dividend commensurate with the growth in our business. While we intend to pay regular quarterly cash dividends for the foreseeable future, all future dividends are subject to limitations in our debt covenants and final determination by our Board of Directors each quarter upon review of our financial performance. Repurchasing Shares. Absent opportunities for strategic acquisitions, we expect to continue to repurchase shares of our common stock in the open market or through privately negotiated transactions, subject to market conditions, debt covenants, and normal trading restrictions. The volume and timing of our purchases is determined as we evaluate the opportunity to capture value for our shareholders. Since 2010, we have reduced the number of shares outstanding by 25%. InAugust 2019 , our Board of Directors increased our repurchase authorization to$400.0 million . The remaining dollar value of shares authorized to be purchased under the share repurchase program was$312.0 million atDecember 31, 2019 . Subsequent toDecember 31, 2019 , we repurchased 475,476 shares for$22.2 million at an average cost per share of$46.69 . Managing Debt. We continue to focus on maintaining optimal levels of liquidity and financial flexibility. Our flexible capital strategy allows us to make open market debt repurchases when it is opportunistic to do so to manage our debt maturity profile. During 2019, we had an opportunity to reduce our debt by repurchasing$46.5 million of certain senior notes through open market repurchases. We viewed these transactions as strategic and attractive from a valuation perspective. Cash Flow We believe our ability to generate strong operating cash flow is one of our fundamental financial strengths and provides us with substantial flexibility in meeting operating and investing needs. Operating Activities Net cash provided by operating activities was$628.8 million , and$615.8 million for the years endedDecember 31, 2019 , and 2018, respectively. Included in operating cash flows are the following: Years EndedDecember 31, 2019 2018
Legal settlement, net of insurance recoveries
$ - $ 5.6 (1) See discussion regarding the
Item 8. Financial Statements.
Excluding the above items, cash flow from operations increased
• a$15.4 million increase inGeneral Agency (GA) and other receipts; partially offset by FORM 10-K 25
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PART II
• a
• a
• a
• a
• a
Investing Activities Cash flows from investing activities used$278.5 million , and$414.6 million , in 2019, and 2018, respectively. The$136.1 million decrease from 2019 over 2018 is primarily due to the following: • a$120.6 million decrease in cash spent on business acquisitions,
• a
• a
• a
net of proceeds, partially offset by
• a
cemetery development,
• a
construction of new funeral homes, and
• a
Financing Activities Financing activities used$319.1 million in 2019 compared to using$329.2 million in 2018. The$10.1 million decrease from 2019 over 2018 is primarily due to: • a$162.3 million increase in debt payments, net of proceeds, and
• a
• a
• a
• a
Off-Balance Sheet Arrangements, Contractual Obligations, and Commercial and Contingent Commitments We have assumed various financial obligations and commitments in the ordinary course of conducting our business. We have contractual obligations requiring future cash payments under existing contractual arrangements, such as debt maturities, interest on long-term debt, operating lease agreements, and employment, consulting, and non-competition agreements. We also have commercial and contingent obligations that result in cash payments only if certain events occur requiring our performance pursuant to a funding commitment. 26Service Corporation International --------------------------------------------------------------------------------
PART II
The following table details our known future cash payments (on an undiscounted
basis) related to various contractual obligations as of
Payments Due by Period
Contractual Obligations 2020 2021-2022 2023-2024 Thereafter Total
(In millions)
Debt maturities (including
finance leases)(1) (2) (3) $ 73.9 $ 305.3 $ 1,729.0 $ 1,504.4 $ 3,612.6
Interest obligation on
long-term debt(4) 169.5 320.9 262.4 274.8 1,027.6
Operating lease agreements(5) 11.1 19.0 11.8 40.3 82.2
Employment and management,
consulting, and non-competition
agreements(6) 8.2 10.4 4.8 4.8 28.2
Benefit cost obligation(7) 2.7 4.7 4.0 8.4 19.8
Firm purchase agreement(8) 7.0 1.2 - - 8.2
Total contractual obligations $ 272.4 $ 661.5 $ 2,012.0 $ 1,832.7 $ 4,778.6 (1) Our outstanding indebtedness contains standard provisions, such as payment
delinquency default clauses and change of control clauses. In addition, our
Bank Credit Facility contains a maximum leverage ratio and a minimum
interest coverage ratio. See "Capital Allocation Considerations" and Note 6
in Part II, Item 8. Financial Statements and Supplementary Data, for
additional details related to our long-term debt.
(2) Excludes non-cash net premiums and original issuance discounts recorded on
the debt. The unamortized balance of the net premiums and original issuance
discounts at
(3) Excludes non-cash debt issuance costs on the debt. The unamortized balance
of debt issuance costs at
(4) Approximately 69% of our total debt is fixed rate debt for which the
interest obligation was calculated at the stated rate. Future interest
obligations on our floating rate debt are based on the current forward rate
curve of the underlying index. See Note 6 in Part II, Item 8. Financial
Statements and Supplementary Data for additional information related to our
future interest obligations.
(5) Our operating leases primarily include funeral service real estate and
office equipment for funeral service locations, cemetery locations, andadministrative offices. See Note 8 in Part II, Item 8. Financial Statements
and Supplementary Data for additional details related to our leases.
(6) We have entered into employment and management, consulting, and
non-competition agreements that require us to make cash payments over the
contractual period. The agreements have been primarily entered into with
certain officers and associates and former owners of businesses acquired.
Agreements with contractual periods less than one year are excluded. See
Note 9 in Part II, Item 8. Financial Statements and Supplementary Data for
additional details related to these agreements.
(7) See Note 12 in Part II, Item 8. Financial Statements and Supplementary Data
for discussion of our pension plans.
(8) We have entered into a purchase commitment for certain merchandise for
resale. The agreement is through 2021 and includes annual minimum volume
purchase commitments.
The following table details our known potential or possible future cash payments
(on an undiscounted basis) related to various commercial and contingent
obligations as of
Expiration by Period
Commercial and Contingent
Obligations 2020 2021-2022 2023-2024 Thereafter Total
(In millions)
Surety obligations(1)$ 153.8 $ - $ - $ -$ 153.8 Long-term obligations related to uncertain tax positions(2) 2.0 - - - 2.0 Letters of credit(3) 34.0 - - - 34.0 Total commercial and contingent obligations$ 189.8 $ - $
- $ -
(1) Represents the aggregate funding obligation associated with our surety bond
arrangements assuming our surety partners did not renew any of our surety
obligations and we could not find replacement surety assurance. See the
section titled "Financial Assurances" following this table in this Form 10-K
for more information related to our surety bonds.
(2) We have recorded a liability for unrecognized tax benefits and related
interest and penalties of
in Part II, Item 8. Financial Statements and Supplementary Data for
additional information related to our uncertain tax positions.
FORM 10-K 27
--------------------------------------------------------------------------------PART II
(3) We are occasionally required to post letters of credit, issued by a
financial institution, to secure certain insurance programs or other
obligations. Letters of credit generally authorize the financial institution
to make a payment to the beneficiary upon the satisfaction of a certain
event or the failure to satisfy an obligation. The letters of credit are
generally posted for one-year terms and are usually automatically renewed
upon maturity until such time as we have satisfied the commitment secured by
the letter of credit. We are obligated to reimburse the issuer only if the
beneficiary collects on the letter of credit. We believe it is unlikely we
will be required to fund a claim under our outstanding letters of credit. As
of
by our Bank Credit Facility, which expires in
Not included in the above table are potential funding obligations related to our merchandise and service trusts. In certain states and provinces, we have withdrawn allowable distributable earnings including unrealized gains prior to the maturity or cancellation of the related contract. Additionally, some states have laws that either require replenishment of investment losses under certain circumstances or impose various restrictions when trust fund values drop below certain prescribed amounts. In the event that our trust investments do not recover from market declines, we may be required to deposit portions or all of these amounts into the respective trusts in some future period. As ofDecember 31, 2019 , we had unrealized losses of$12.0 million in the various trusts within these states. Financial Assurances In support of our operations, we have entered into arrangements with certain surety companies whereby such companies agree to issue surety bonds on our behalf as financial assurance and/or as required by existing state and local regulations. The surety bonds are used for various business purposes; however, the majority of the surety bonds issued and outstanding have been used to support our preneed sales activities. The obligations underlying these surety bonds are recorded on our Consolidated Balance Sheet as Deferred revenue, net. The breakdown of surety bonds between funeral and cemetery preneed arrangements, as well as surety bonds for other activities, is described below. Years Ended December 31, 2019 2018 (In millions) Preneed funeral$ 94.6 $ 106.9 Preneed cemetery: Merchandise and services 147.6 137.9 Pre-construction 20.3 15.4
Bonds supporting preneed funeral and cemetery obligations 262.5
260.2
Bonds supporting preneed business permits 5.5
4.2
Other bonds 19.7
18.9
Total surety bonds outstanding$ 287.7
When selling preneed contracts, we may post surety bonds where allowed by state law. We post the surety bonds in lieu of trusting a certain amount of funds received from the customer. The$262.5 million in bonds supporting preneed funeral and cemetery obligations differs from the$153.8 million potential funding obligation disclosed in our "Commercial and Contingent Obligations" table above because the amount of the bond posted is generally determined by the total amount of the preneed contract that would otherwise be required to be trusted, in accordance with applicable state law, at the time we enter into the contract. We would only be required to fund the trust for the portion of the preneed contract for which we have received payment from the customer, less any applicable retainage, in accordance with state law. For the years endedDecember 31, 2019 , 2018, and 2017, we had$24.2 million ,$23.4 million , and$22.6 million , respectively, of cash receipts from sales attributable to bonded contracts. These amounts do not consider reductions associated with taxes, obtaining costs, or other costs. Surety bond premiums are paid annually and the bonds are automatically renewable until maturity of the underlying preneed contracts, unless we are given prior notice of cancellation. Except for cemetery pre-construction bonds (which are irrevocable), the surety companies generally have the right to cancel the surety bonds at any time with appropriate notice. In the event a surety company were to cancel the surety bond, we are required to obtain replacement surety assurance from another surety company or fund a trust for an amount generally less than the posted bond amount. Management does not expect that we will be required to fund material future amounts related to these surety bonds due to a lack of surety capacity or surety company non-performance. 28Service Corporation International --------------------------------------------------------------------------------
PART II
Preneed Activities and Backlog of Contracts
In addition to selling our products and services to client families at the time
of need, we enter into price-guaranteed preneed contracts, which provide for
future funeral or cemetery merchandise and services. Because preneed funeral and
cemetery merchandise or services will generally not be provided until sometime
in the future, most states and provinces require that all or a portion of the
funds collected from customers on preneed contracts be deposited into
merchandise and service trusts until the merchandise is delivered or the service
is performed. In certain situations, as described above, where permitted by
state or provincial laws, we may post a surety bond as financial assurance for a
certain amount of the preneed contract in lieu of placing funds into trust
accounts. Alternatively, we may sell a life insurance or annuity policy from
third-party insurance companies.
Insurance-Funded Preneed Contracts: Where permitted by state or provincial law,
we may sell a life insurance or annuity policy from third-party insurance
companies, for which we earn a commission as general sales agent for the
insurance company. These general agency commissions (GA revenue) are based on a
percentage per contract sold and are recognized as funeral revenue when the
insurance purchase transaction between the preneed purchaser and third-party
insurance provider is completed. All selling costs incurred pursuant to the sale
of insurance-funded preneed contracts are expensed as incurred. We do not
reflect the unfulfilled insurance-funded preneed contract amounts in our
Consolidated Balance Sheet. The proceeds of the life insurance policies or
annuity contracts will be reflected in funeral revenue as we perform these
funerals.
The table below details our results of insurance-funded preneed production and
maturities.
Years Ended December 31,
2019 2018
(Dollars in millions)
Preneed insurance-funded:
Sales production(1) $ 568.8 $ 538.9
Sales production (number of contracts) (1) 99,310 92,858
General agency revenue $ 139.7 $ 134.1
Maturities $ 347.5 $ 342.5
Maturities (number of contracts) 58,773 58,232
(1) Amounts are not included in our Consolidated Balance Sheet
Trust-Funded Preneed Contracts: The funds collected from customers and required
by state or provincial law are deposited into trusts. We retain any funds above
the amounts required to be deposited into trust accounts and use them for
working capital purposes, generally to offset the selling and administrative
costs of our preneed programs. Although this represents cash flow to us, the
associated revenues are deferred until the merchandise is delivered or services
are performed (typically at maturity). The funds in trust are then invested by
professional money managers with oversight by independent trustees in accordance
with state and provincial laws.
FORM 10-K 29
--------------------------------------------------------------------------------PART II
The tables below detail our results of preneed production and maturities,
excluding insurance contracts, for years ended
Years Ended December 31,
2019 2018
(Dollars in millions)
Funeral:
Preneed trust-funded (including bonded): Sales production$ 379.7 $
354.6
Sales production (number of contracts) 102,176
95,768
Maturities$ 289.2 $
288.4
Maturities (number of contracts) 72,523 71,617 Cemetery: Sales production: Preneed$ 908.9 $ 892.0 Atneed 327.0 322.0 Total sales production$ 1,235.9 $ 1,214.0 Sales production deferred to backlog: Preneed$ 397.8 $
421.1
Atneed 241.4
238.1
Total sales production deferred to backlog$ 639.2 $
659.2
Revenue recognized from backlog: Preneed$ 310.2 $
338.8
Atneed 237.6
236.7
Total revenue recognized from backlog$ 547.8 $
575.5
Backlog of Preneed Contracts: The following table reflects our backlog of trust-funded deferred preneed contract revenue, including amounts related to Deferred receipts held in trust atDecember 31, 2019 and 2018. Additionally, the table reflects our backlog of unfulfilled insurance-funded contracts (which are not included in our Consolidated Balance Sheet) atDecember 31, 2019 and 2018. The backlog amounts presented include amounts due from customers for undelivered performance obligations on cancelable preneed contracts to arrive at our total backlog of deferred revenue. The table does not include the backlog associated with businesses that are held for sale. 30Service Corporation International --------------------------------------------------------------------------------
PART II
The table also reflects our preneed receivables and trust investments associated
with the backlog of deferred preneed contract revenue including the amounts due
from customers for undelivered performance obligations on cancelable preneed
contracts. We believe that the table below is meaningful because it sets forth
the aggregate amount of future revenue we expect to recognize as a result of
preneed sales, as well as the amount of funds associated with this revenue.
Because the future revenue exceeds the assets, future revenue will exceed the
cash distributions actually received from the associated trusts and future
collections from the customer.
December 31, 2019 December 31, 2018
Fair Value Cost Fair Value Cost
(In billions)
Deferred revenue, net $ 1.47 $ 1.47 $ 1.42 $ 1.42
Amounts due from customers for unfulfilled
performance obligations on cancelable preneed
contracts (1) 0.58 0.58 0.57 0.57
Deferred receipts held in trust 3.84 3.54 3.37 3.47
Allowance for cancellation on trust investments (0.27 ) (0.25 ) (0.24 ) (0.25 )
Backlog of trust-funded deferred revenue, net of
estimated allowance for cancellation 5.62 5.34 5.12 5.21
Backlog of insurance-funded revenue (1) 6.37 6.37 5.97 5.97
Total backlog of deferred revenue $ 11.99 $ 11.71
Preneed receivables, net and trust investments
$ 4.27 $ 4.37 Amounts due from customers for unfulfilled performance obligations on cancelable preneed contracts (1) 0.58 0.58 0.57 0.57 Allowance for cancellation on trust investments (0.27 ) (0.25 ) (0.24 ) (0.25 ) Assets associated with backlog of trust-funded deferred revenue, net of estimated allowance for cancellation 5.10 4.82
4.60 4.69 Insurance policies associated with insurance-funded deferred revenue (2)
6.37 6.37 5.97 5.97
Total assets associated with backlog of preneed
revenue $ 11.47 $ 11.19
(1) Prior to adoption of "Revenue from Contracts with Customers" on
2018, amounts due from customers for unfulfilled performance obligations on
cancelable preneed contracts were included in Preneed receivables, net and
trust investments.
(2) Amounts are not included in our Consolidated Balance Sheet.
The fair value of our trust investments was based on a combination of quoted market prices, observable inputs such as interest rates or yield curves and appraisals. As ofDecember 31, 2019 , the difference between the backlog and asset market amounts represents$0.23 billion related to contracts for which we have posted surety bonds as financial assurance in lieu of trusting,$0.07 billion collected from customers that were not required to be deposited into trusts, and$0.22 billion in allowable cash distributions from trust assets. As ofDecember 31, 2019 , the fair value of the total backlog comprised$3.17 billion related to cemetery contracts and$8.82 billion related to funeral contracts. As ofDecember 31, 2019 , the fair value of the assets associated with the backlog of trust-funded deferred revenue comprised$2.93 billion related to cemetery contracts and$2.17 billion related to funeral contracts. Trust Investments In addition to selling our products and services to client families at the time of need, we enter into price-guaranteed preneed funeral and cemetery contracts, which provide for future funeral or cemetery merchandise and services. Since preneed funeral and cemetery merchandise or services will generally not be provided until sometime in the future, most states and provinces require that all or a portion of the funds collected from customers on preneed funeral and cemetery contracts be paid into trusts and/or escrow accounts until the merchandise is delivered or the service is performed. Investment earnings associated with the trust investments are expected to mitigate the inflationary costs of providing the preneed funeral and cemetery merchandise and services in the future at the prices that were guaranteed at the time of sale.Also, we are required by state and provincial law to pay a portion of the proceeds from the preneed or atneed sale of cemetery property interment rights into perpetual care trusts. For these investments, the original corpus generally remains in the trust in perpetuity and the earnings or elected distributions are withdrawn as allowed to defray the expense to maintain the cemetery property. While many states require that net capital gains or losses be retained and added to the corpus, certain states allow the net realized capital gains and losses to be included in the earnings that are distributed. Additionally, some states allow a total return distribution that may contain elements of income, capital appreciation, and principal. FORM 10-K 31 --------------------------------------------------------------------------------
PART II
Independent trustees manage and invest the majority of the funds deposited into the funeral and cemetery merchandise and services trusts as well as the cemetery perpetual care trusts. The majority of the trustees are selected based on their respective geographic footprint and qualifications per state and provincial regulations. Most of the trustees engage the same independent investment managers. These trustees, with input from SCI's wholly-owned registered investment advisor, establish an investment policy that serves as an operating document to guide the investment activities of the trusts including asset allocation and manager selection. The investments are also governed by state and provincial guidelines. All of the trusts seek to control risk and volatility through a combination of asset classes, investment styles, and a diverse mix of investment managers. Asset allocation is based on the liability structure of each funeral, cemetery, and perpetual care trust. Based on the various criteria set forth in the investment policy, the investment advisor recommends investment managers to the trustees. The primary investment objectives for the funeral and cemetery merchandise and service trusts include 1) preserving capital within acceptable levels of volatility and risk and 2) achieving growth of principal over time sufficient to preserve and increase the purchasing power of the assets. Preneed funeral and cemetery contracts generally take several years to mature; therefore, the funds associated with these contracts are often invested through several market cycles. Historically, the cemetery perpetual care trusts' investment objectives, in accordance with state and provincial regulations, have emphasized providing a steady stream of current investment income with some capital appreciation in order to provide for the maintenance and beautification of cemetery properties. However, during 2016, SCI worked with several state legislatures to adjust laws and regulations to allow for a fixed distribution rate from cemetery perpetual care trusts' assets regardless of the level of ordinary income, similar to university endowments. As a result, beginning in 2017, a significant portion of our cemetery perpetual care trust assets were liquidated and reinvested in a more growth-oriented asset allocation with investment objectives similar to the funeral and cemetery merchandise and service trusts. As ofDecember 31, 2019 , the asset allocation is almost evenly split between income and growth orientations. We expect this asset allocation shift to enhance asset growth and provide further protection to our customers. Additionally, we expect more states to adopt total return distribution legislation in the coming years. As ofDecember 31, 2019 approximately 88% of our trusts were under the control and custody of three large financial institutions. TheU.S. trustees primarily use four managed limited liability companies (LLCs), one for each merchandise and service trust type and two for the cemetery perpetual care trust type, each with an independent trustee as custodian. Each financial institution acting as trustee manages its allocation of trust assets in accordance with the investment policy through the purchase of the appropriate LLCs' units. For those accounts not eligible for participation in the LLCs or where a particular state's regulations contain other investment restrictions, the trustee utilizes institutional mutual funds that comply with our investment policy or with such state restrictions. TheU.S. trusts include a modest allocation to alternative investments. These alternative investments are held in vehicles structured as LLCs and are managed by certain trustees. The trusts that are eligible to allocate a portion of their investments to alternative investments purchase units of the respective alternative investment LLCs. Investment Structures Each financial institution, acting as trustee, manages its allocation of trust assets in compliance with the investment policy primarily through the purchase of one of four managed LLCs, matched to their trust type and each with a different, independent trustee acting as custodian. The managed LLCs use the following structures for investments: Commingled Funds. These funds allow the trusts to access, at a reduced cost, some of the same investment managers and strategies used elsewhere in the portfolios. Mutual Funds. The trust funds employ institutional share class mutual funds where operationally or economically efficient. These mutual funds are utilized to invest in various asset classes includingU.S. equities, non-U.S. equities, corporate bonds, government bonds, high yield bonds, and commodities, all of which are governed by guidelines outlined in their individual prospectuses. Separately Managed Accounts. To reduce the costs to the investment portfolios, the trusts utilize separately managed accounts where appropriate. Asset Classes Fixed income investments are intended to preserve principal, provide a source of current income, and reduce overall portfolio volatility. The majority of the fixed income allocation for the trusts is invested in institutional share class mutual funds. Where the trusts have direct investments in individual fixed income securities, these are primarily in government and corporate instruments. 32Service Corporation International --------------------------------------------------------------------------------
PART II
Canadian government fixed income securities are investments in Canadian federal and provincial government instruments. In many cases, regulatory restrictions mandate that the funds from the sales of preneed funeral and cemetery contracts sold in certain Canadian jurisdictions must be invested in these instruments. Equity investments have historically provided long-term capital appreciation in excess of inflation. The trusts have direct investments in individual equity securities primarily in domestic equity portfolios that include large, mid, and small capitalization companies of different investment styles (i.e., growth and value). The majority of the equity allocation is managed by institutional investment managers that specialize in an objective-specific area of expertise. Our equity securities are exposed to market risk; however, we believe these securities are well-diversified. As ofDecember 31, 2019 , the largest single equity position represented less than 1% of the total securities portfolio. Private equity fund investments serve to provide high rates of return with reduced volatility and lower correlation. These investments are typically long term in duration. These investments are diversified by strategy, sector, manager, and vintage year. The investments consist of numerous limited partnerships, including but not limited to private equity, real estate, energy, infrastructure, transportation, distressed debt, and mezzanine financing. The trustees that have oversight of their respective alternative LLCs work closely with the investment advisor in making all investment decisions. Trust Performance During the year endedDecember 31, 2019 , the Standard and Poor's 500 Index increased 31.5% and the Barclay's Aggregate Index increased 8.7%. This compares to the SCI trusts that increased 19.2% during the same year-end period, which have a diversified allocation of approximately 55% equities, 30% fixed income securities, 10% alternative and other investments with remaining 5% available in cash. SCI, the trustees, and the investment advisor monitor the capital markets and the trusts on an on-going basis. The trustees, with input from the investment advisor, take prudent action as needed to achieve the investment goals and objectives of the trusts. Results of Operations - Years EndedDecember 31, 2019 and 2018 Management Summary In 2019, we reported consolidated net income attributable to common stockholders of$369.6 million ($1.99 per diluted share) compared to net income attributable to common stockholders in 2018 of$447.2 million ($2.39 per diluted share). These results were impacted by certain significant items including: Years EndedDecember 31, 2019 2018 (In millions)
Pre-tax gains on divestitures and impairment charges, net
$ 15.9 Pre-tax losses on early extinguishment of debt, net$ (16.6 ) $ (10.1 ) Pre-tax legal settlements$ (6.4 ) $ - Tax effect from special items$ (4.1 ) $ (1.6 ) Change in uncertain tax reserves and other (1)$ 10.9
(1) See Note 5 in Part II, Item 8. Financial Statements and Supplementary Data,
for additional information related to change in uncertain tax reserves and
other.
FORM 10-K 33--------------------------------------------------------------------------------
PART II
In addition to the above items, the 2019 growth can be attributed to higher
expenses in the prior year for our long-term incentive compensation plan that is
tied to increases in total shareholder return. Increased interest expense
related to refinancing activities were offset by the favorable impact from a
lower share count in 2019. We also had a favorable tax rate compared to the
prior year.
Funeral Results
Years Ended December 31,
2019 2018
(Dollars inmillions, except average revenue
per service)
Consolidated funeral revenue$ 1,923.9 $ 1,898.0 Less: revenue associated with acquisitions/new construction 42.1 16.3 Less: revenue associated with divestitures 4.6 12.1 Comparable(1) funeral revenue 1,877.2 1,869.6 Less: comparable recognized preneed revenue 137.0 124.3 Less: comparable general agency and other revenue 128.1 123.6 Adjusted comparable funeral revenue$ 1,612.1 $ 1,621.7 Comparable services performed 307,702 307,865 Comparable average revenue per service(2) $ 5,239
Consolidated funeral gross profit $ 372.6
3.3 -
Less: gross losses associated with divestitures (1.9 ) (3.4 )
Comparable(1) funeral gross profit $ 371.2 (1) We define comparable (or same store) operations as those funeral locations
owned by us for the entire period beginning January 1, 2018 and ending
December 31, 2019 .
(2) We calculate comparable average revenue per service by dividing comparable
funeral revenue, excluding general agency revenue, recognized preneed
revenue, and other revenue to avoid distorting our average of normal funeral
services revenue, by the comparable number of services performed during the
period. Recognized preneed revenue is preneed sales of merchandise that are
delivered at the time of sale, including memorial merchandise and travel
protection, net, and excluded from our calculation of comparable average
revenue per service because the associated service has not yet been
performed.
Funeral Revenue Consolidated revenue from funeral operations was$1,923.9 million for the year endedDecember 31, 2019 , compared to$1,898.0 million for the same period in 2018. This increase is primarily attributable to the$25.8 million increase in revenue contributed by acquired and newly constructed properties and the$7.6 million increase in comparable revenue as described below, partially offset by the loss of$7.5 million in revenue contributed by properties that have been subsequently divested. Comparable revenue from funeral operations was$1,877.2 million for the year endedDecember 31, 2019 compared to$1,869.6 million for the same period in 2018. This increase was primarily attributable to the$12.7 million increase in recognized preneed revenue and a$4.8 million increase in comparable general agency revenue. These increases helped mitigate against flat comparable services performed and a slight decline in the average revenue per funeral service compared to the prior year. Average revenue per funeral service decreased 0.6% for the year endedDecember 31, 2019 compared to the same period in 2018. Organic growth at the customer level of 1.6% was largely offset by the increase in our cremation mix. Our total comparable cremation rate increased to 56.8% in 2019 from 55.1% in 2018 as a result of an increase in both direct cremations and cremations with service. 34Service Corporation International --------------------------------------------------------------------------------
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Funeral Gross Profit
Consolidated funeral gross profit increased $3.0 million , or 0.8%, in 2019
compared to 2018. This increase is primarily attributable to a $3.3 million
increase in gross profit contributed by acquired and newly constructed
properties and a $1.5 million increase in gross profit contributed by properties
that have been subsequently divested, partially offset by a decrease in
comparable funeral gross profit of $1.8 million . Comparable funeral gross profit
decreased $1.8 million to $371.2 million and the gross profit percentage
decreased 20 basis points to 19.8% primarily as a result of the revenue
increases described above that were more than offset by investments in our
preneed sales program in support of growing our backlog to secure future
revenue.
Cemetery Results
Years Ended December 31,
2019 2018
(In millions)
Consolidated cemetery revenue $ 1,306.9 $ 1,292.2
Less: revenue associated with acquisitions 20.5
11.2
Less: revenue associated with divestitures 1.4
2.3
Comparable(1) cemetery revenue$ 1,285.0 $
1,278.7
Consolidated cemetery gross profit$ 387.9 $
390.7
Less: gross profit associated with acquisitions 1.8
2.5
Less: gross profit associated with divestitures 0.3
0.2
Comparable(1) cemetery gross profit$ 385.8 $
388.0
(1) We define comparable (or same store) operations as those cemetery locations
owned by us for the entire period beginning
Cemetery Revenue Consolidated revenue from our cemetery operations increased$14.7 million , or 1.1%, in 2019 compared to 2018 primarily attributable to the$9.3 million in revenue contributed by acquired properties and$6.3 million increase in comparable revenue. The comparable revenue growth over the prior year is due to increased recognized preneed property revenue from sales into existing developed cemetery property projects and higher other revenue (primarily endowment care trust fund income) partially offset by lower recognized preneed merchandise revenue. Cemetery Gross Profit Consolidated cemetery gross profit decreased$2.8 million , or 0.7%, in 2019 compared to 2018 which is primarily attributable to the decrease in comparable gross profit of$2.2 million , or 0.6%. Comparable cemetery gross profit decreased$2.2 million to$385.8 million and the gross profit percentage decreased 30 basis points to 30.0% driven by the increase in revenue described above more than offset by expected increases in our maintenance and field administrative expenses. Other Financial Statement Items Corporate General and Administrative Expenses Corporate General and administrative expenses were$126.9 million in 2019 compared to$145.6 million in 2018. Excluding a$6.4 million legal settlement in 2019, corporate general and administrative expenses, decreased$25.1 million in 2019 compared to 2018 due to lower pension termination costs, long-term incentive compensation, and self-insurance reserves. Gains (Losses) on Divestitures and Impairment Charges, Net We recognized a$32.9 million and a$15.9 million net pre-tax gain on asset divestitures and impairments in 2019 and 2018, respectively, primarily as the result of asset divestitures associated with non-strategic funeral and cemetery locations inthe United States andCanada , partially offset by impairment losses. FORM 10-K 35 --------------------------------------------------------------------------------
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Interest Expense Interest expense increased$4.2 million to$185.8 million in 2019 compared to$181.6 million in 2018 due to interest on the new 2029 notes partially offset by the payoff of 2020 and 2022, purchases of our 2027 senior notes, and lower balances on the credit facility. Losses on Early Extinguishment of Debt,Net During 2019, we made aggregate debt payments of$1.2 billion for scheduled and early extinguishment payments. During 2018, we made aggregate debt payments of$293.7 million for scheduled and early extinguishment payments. Certain of these transactions resulted in the recognition of losses of$16,6 million and$10.1 million in 2019 and 2018, respectively, recorded in Losses on early extinguishment of debt, net in our Consolidated Statement of Operations. Provision for Income Taxes The 2019 consolidated effective tax rate was a tax expense of 20.4%, compared to a tax benefit of 1.3% in 2018. The effective tax rate for the twelve months endedDecember 31, 2019 was lower than the federal statutory tax rate of 21% primarily due to the reduction in tax liability as a result of the expiration of statute of limitations and higher excess tax benefits on the increased exercises of stock options, The effective tax rate for the twelve months endedDecember 31, 2018 was lower than the federal statutory tax rate of 21% primarily due to the reduction in uncertain tax positions as a result of the expiration of statutes of limitations. For further information on the impacts of the Tax Act, see Note 5 in Part II, Item 8. Financial Statements and Supplementary Data. Weighted Average Shares The diluted weighted average number of shares outstanding was 185.5 million in 2019, compared to 187.0 million in 2018, The decrease in all years primarily reflects the impact of shares repurchased under our share repurchase program. Critical Accounting Policies, Recent Accounting Pronouncements, and Accounting Changes Our consolidated financial statements are impacted by the accounting policies used and the estimates and assumptions made by management during their preparation. See Note 2 in Part II, Item 8. Financial Statements and Supplementary Data, for more information. Estimates and assumptions affect the carrying values of assets and liabilities and disclosures of contingent assets and liabilities at the balance sheet date. Actual results could differ from such estimates due to uncertainties associated with the methods and assumptions underlying our critical accounting measurements. The following is a discussion of our critical accounting policies pertaining to revenue recognition, valuation of goodwill, valuation of intangible assets, fair value measurements, and the use of estimates. Revenue Recognition Revenue is recognized when control of the merchandise or services is transferred to the customer. Our performance obligations include the delivery of funeral and cemetery merchandise and services and cemetery property interment rights. Control transfers when merchandise is delivered or services are performed. For cemetery property interment rights, control transfers to the customer when the property is developed and the interment right has been sold and can no longer be marketed or sold to another customer. On our atneed contracts, we generally deliver the merchandise and perform the services at the time of need. Personalized marker merchandise and marker installation services sold on atneed contracts are recognized when control is transferred to the customer, generally when the marker is delivered and installed in the cemetery. We also sell price-guaranteed preneed contracts through various programs providing for future merchandise and services at prices prevailing when the agreements are signed. Revenue associated with sales of preneed contracts is deferred until control of the merchandise or the services is transferred to the customer, which is upon delivery of the merchandise or as services are performed, generally at the time of need. On certain preneed contracts, we sell memorialization merchandise, which consists of urns and urn-related products, that we deliver to the customer at the time of sale. Revenue is recognized at the time of delivery when control of the memorialization merchandise is transferred. For personalized marker merchandise sold on a preneed contract, we will: • purchase the merchandise from vendors,
• personalize such merchandise in accordance with the customer's specific
written instructions, 36Service Corporation International --------------------------------------------------------------------------------
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• either store the merchandise at a third-party bonded storage facility or
install the merchandise, based on the customer's instructions, and
• transfer title to the customer.
We recognize revenue and record the cost of sales when control is transferred for the merchandise, which occurs upon delivery to the third-party storage facility or installation of the merchandise at the cemetery. Pursuant to state or provincial law, all or a portion of the proceeds from funeral and cemetery merchandise or services sold on a preneed basis may be required to be paid into trust funds. We defer investment earnings related to these merchandise and service trusts until the associated merchandise is delivered or services are performed. Fees charged by our wholly-owned registered investment advisor are also included in revenue in the period in which they are earned. A portion of the proceeds from the sale of cemetery property interment rights is required by state or provincial law to be paid by us into perpetual care trust funds to maintain the cemetery. This portion of the proceeds is not recognized as revenue. Investment earnings from these trusts are distributed to us regularly and recognized in current cemetery revenue. For more information related to revenue, see Notes 2, 3, and 12 in Part II, Item 8. Financial Statements and Supplementary Data. Valuation ofGoodwill We record the excess of purchase price over the fair value of identifiable net assets acquired in business combinations as goodwill.Goodwill is tested annually during the fourth quarter for impairment by assessing the fair value of each of our reporting units. Our goodwill impairment test involves certain estimates and management judgment. In the first step of our goodwill impairment test, we compare the fair value of a reporting unit to its carrying amount, including goodwill. We determine fair value of each reporting unit using both a market and income approach. The income approach, which is a discounted cash flow method, uses projections of future cash flows and includes assumptions concerning future operating performance and economic conditions that may differ from actual future cash flows. We do not record an impairment of goodwill in instances where the fair value of a reporting unit exceeds its carrying amount. If the aggregate fair value is less than the related carrying amount for a reporting unit, we compare the implied fair value of goodwill to the carrying amount of goodwill. If the carrying amount of reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. For more information related to goodwill, see Notes 2 and 4 in Part II, Item 8. Financial Statements and Supplementary Data. Valuation of Intangible Assets Our intangible assets include covenants-not-to-compete, customer relationships, trademarks and tradenames, and other intangible assets primarily resulting from acquisitions. Certain of our trademark and tradenames and other intangible assets are considered to have an indefinite life and are not subject to amortization. We test for impairment of intangible assets annually during the fourth quarter. Our intangible asset impairment tests involve estimates and management judgment. For trademark and tradenames, our test uses the relief from royalty method whereby we determine the fair value of the assets by discounting the cash flows that represent a savings over having to pay a royalty fee for use of the trademark and tradenames. The discounted cash flow valuation uses projections of future cash flows and includes assumptions concerning future operating performance and economic conditions that may differ from actual future cash flows. For more information related to intangible assets, see Notes 2 and 4 in Part II, Item 8. Financial Statements and Supplementary Data. Fair Value Measurements We measure the securities held by our funeral merchandise and service, cemetery merchandise and service, and cemetery perpetual care trusts at fair value on a recurring basis. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We utilize a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows: • Where quoted prices are available in an active market, securities held by the trusts are classified as Level 1 investments. FORM 10-K 37 --------------------------------------------------------------------------------
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• Where quoted market prices are not available for the specific security, fair
values are estimated by using either quoted prices of securities with similar
characteristics or an income approach fair value model with observable inputs
that include a combination of interest rates, yield curves, credit risks,
prepayment speeds, ratings, and tax-exempt status. These securities are
classified as Level 2 investments.
• The valuation of other investments requires management judgment due to the
absence of quoted market prices, inherent lack of liquidity, and the long-term
nature of such assets. These securities are classified as Level 3 investments.
An asset's or liability's categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Certain available-for-sale securities held by our funeral merchandise and service, cemetery merchandise and service, and cemetery perpetual care trusts have been classified as Level 3 of the hierarchy due to the significant management judgment required as a result of the absence of quoted market prices, inherent lack of liquidity, or the long-term nature of the securities. For more information related to our fair value measurements, see Notes 2, 3, and 7 in Part II, Item 8. Financial Statements and Supplementary Data. Use of Estimates The preparation of financial statements in conformity with Generally Accepted Accounting Principles inthe United States (GAAP) requires management to make certain estimates and assumptions. These estimates and assumptions affect the carrying values of assets and liabilities and disclosures of contingent assets and liabilities at the balance sheet date. Actual results could differ from such estimates due to uncertainties associated with the methods and assumptions underlying our critical accounting measurements. Key estimates used by management include: Allowances. We provide various allowances and/or cancellation reserves for our receivables. These allowances are based on an analysis of historical trends and include, where applicable, collection and cancellation activity. We also record an estimate of general agency revenue that may be canceled in its first year and revenue would be charged back by the insurance company. These estimates are impacted by a number of factors, including changes in economy, relocation, and demographic or competitive changes in our areas of operation. Valuation of trust investments. The trust investments include marketable securities that are classified as available-for-sale. When available, we use quoted market prices for specific securities. When quoted market prices are not available for the specific security, fair values are estimated by using either quoted market prices for securities with similar characteristics or a fair value model with observable inputs that include a combination of interest rates, yield curves, credit risks, prepayment terms, rating, and tax exempt status. The valuation of certain investments requires significant management judgment due to the absence of quoted market prices, inherent lack of liquidity, and the long-term nature of such assets. Legal liability reserves. Contingent liabilities, principally for legal matters, are recorded when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Liabilities accrued for legal matters require judgments regarding projected outcomes and a range of loss based on historical experience and recommendations of legal counsel. However, litigation is inherently unpredictable and excessive verdicts do occur. As disclosed in Note 8 in Part II, Item 8. Financial Statements and Supplementary Data, our legal exposures and the ultimate outcome of these legal proceedings could be material to operating results or cash flows in any given quarter or year. Depreciation of long-lived assets. We depreciate our long-lived assets ratably over their estimated useful lives. These estimates of useful lives may be affected by such factors as changing market conditions, changes in our expected use, or changes in regulatory requirements. Amortization of certain intangible assets. We amortize certain intangible assets ratably over their estimated useful lives. These estimates of useful lives may be affected by such factors as contractual terms, changing market conditions, or changes in regulatory requirements. Valuation of assets acquired and liabilities assumed. Tangible and intangible assets acquired and liabilities assumed are recorded at their fair value and goodwill is recognized for any difference between the price of acquisition and our fair value determination. We have customarily estimated our purchase costs and other related transactions known to us at closing of the acquisition. To the extent that information not available to us at the closing date subsequently became available during the measurement period, we have adjusted our goodwill, assets, or liabilities associated with the acquisition. Income taxes. We compute income taxes using the liability method. Our ability to realize the benefit of our deferred tax assets requires us to achieve certain future earnings levels. We have established a valuation allowance against a portion of our deferred tax assets, and we could be required to further adjust that valuation allowance in the near term if market conditions change materially and future earnings are, or are projected to be, significantly different than our current estimates. An increase in the valuation allowance would result in additional income tax expense in such period. 38Service Corporation International --------------------------------------------------------------------------------
PART II
As ofDecember 31, 2019 , foreign withholding taxes have not been provided on the estimated$259.8 million of undistributed earnings and profits ("E&P") of our foreign subsidiaries as we intend to permanently reinvest these foreign E&P in those businesses outside theU.S. However, if we were to repatriate such foreign E&P, the foreign withholding tax liability is estimated to be$13.4 million . We file income tax returns, including tax returns for our subsidiaries, with federal, state, local, and foreign jurisdictions. We considerthe United States to be our most significant jurisdiction; however, all tax returns are subject to routine compliance review by the taxing authorities in the jurisdictions in which we file tax returns in the ordinary course of business. InMarch 2017 , we received from theIRS Office of Appeals the fully executed Form 870-AD for the years 1999-2005, which effectively settled the issues under audit for those years. The federal statutes of limitations have expired for all tax years prior to 2016 and we are not currently under audit by theIRS . Various state jurisdictions are auditing years 2013 through 2017. There are currently no federal or provincial audits inCanada ; however years subsequent to 2014 remain open and could be subject to examination. It is reasonably possible that the amount of unrecognized tax benefits may change within the next twelve months. However, given the number of years that remain subject to examination and the number of matters being examined, an estimate of the range of the possible increase or decrease cannot be made. Retirement plans. Certain retirement plans are frozen with no benefits accruing to participants except interest. Benefit costs and liabilities are actuarially determined based on certain assumptions, including the discount rate used to compute future benefit obligations. Weighted-average discount rates used to determine net periodic benefit cost were 4.15% and 3.26% as ofDecember 31, 2019 and 2018, respectively. We verify the reasonableness of the discount rate by comparing our rate to the rate earned on high-quality fixed income investments, such as the Moody's Aa index. See Note 12 in Part II, Item 8. Financial Statements and Supplementary Data for more information. Insurance loss reserves. We purchase comprehensive general liability, morticians and cemetery professional liability, automobile liability, and workers' compensation insurance coverages structured with high deductibles. This high-deductible insurance program means we are primarily self-insured for claims and associated costs and losses covered by these policies. Historical insurance industry experience indicates a high degree of inherent variability in assessing the ultimate amount of losses associated with casualty insurance claims. This is especially true with respect to liability and workers' compensation exposures due to the extended period of time that transpires between when the claim might occur and the full settlement of such claim, which is often many years. We continually evaluate loss estimates associated with claims and losses related to these insurance coverages falling within the deductible of each coverage. Assumptions based on factors such as claim settlement patterns, claim development trends, claim frequency and severity patterns, inflationary trends, and data reasonableness will generally affect the analysis and determination of the "best estimate" of the projected ultimate claim losses. The results of these evaluations are used to both analyze and adjust our insurance loss reserves. As ofDecember 31, 2019 reported losses for workers' compensation, general liability, and auto liability incurred during the periodMay 1, 1991 throughDecember 31, 2019 were approximately$609.8 million over 28.7 years. The selected fully developed ultimate settlement value estimated was$674.3 million for the same period. Paid losses were$590.0 million indicating a reserve requirement of$84.3 million . Recent Accounting Pronouncements and Accounting Changes For discussion of recent accounting pronouncements and accounting changes, see Note 2 in Part II, Item 8. Financial Statements and Supplementary Data. FORM 10-K 39 --------------------------------------------------------------------------------
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