Service Corp International (SCI) Q2 2021 Earnings Call Transcript

Good morning, and welcome to the SCI Second Quarter 2021 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to SCI management. Please go ahead.

Thank you, and good morning. This is Debbie Young. Welcome today to our company's review of business results for the second quarter of 2021. I hope everyone has had a chance to review our press release issued yesterday. Before the prepared remarks from Tom and Eric, let me remind you that we will be making some forward-looking statements today.

Thanks, Debbie, and hello, everyone, and thank you for joining us on the call today. I apologize in advance for my voice. Eric promises me I look worse than I sound. This morning, I'm going to begin my remarks with a high-level overview of the quarter, followed by a more detailed analysis of our funeral and cemetery results, and finally comment on our guidance and outlook for the year. But before I begin, I want to give special thanks again to my SCI family. You work so hard to deliver the impressive operating results reported this quarter. But more importantly, you continue to stay relentlessly focused on what we do best, helping our client families and the communities that we serve, gain closure and healing the process of grieving, remembrance, and celebration. During these difficult times, I just can't say enough about how you continue to rise to the occasion. You truly are my heroes, and you have my heartfelt appreciation. So let's get right to the highlights. For the second quarter, we generated adjusted earnings per share of $0.92, a 59% increase over the prior year. The primary driver of the earnings per share growth was our 34% increase in cemetery revenues for the quarter, which was generated by our continued strength in printed cemetery property sales production, at-need cemetery revenue growth, and highly profitable increase in recognized preneed merchandise and service revenue. The funeral segment delivered strong funeral sales average growth, which more than offset expected decline in funeral volumes when compared against the quarter, severely impacted by COVID-19 and the commercial restrictions imposed at the time. The preneed funeral sales production came roaring back with a 57% increase in the prior year quarter.

Thanks, Tom, and good morning, everybody. First, we hope you, your friends, and your family are remaining safe and healthy during these really trying times. I want to first and most importantly, echo Tom's comments that our positive quarterly results discussed today are a testament to the dedication and hard work of all of our team members here at SCI, who are putting our client families first in one of their most dire times of need. We appreciate each and every one of you. So this morning, I'd like to begin by walking you through our cash flow results and capital deployment for the quarter, and then briefly touch upon our revised full-year cash flow guidance and financial position. So let's start with cash flow. We generated adjusted operating cash flow of $192 million in the current quarter, compared to $184 million in the prior year, which exceeded our expectations, primarily due to the strong preneed cemetery sales production that you saw yesterday in our release, and Tom just walked you through. In addition to strong operating cash flow results, which again resulted from EBITDA growth of over $60 million, we also benefited from a decrease in cash interest payments of about $25 million, primarily resulting from the timing of our recent debt refinancing transactions. I want to go ahead and highlight the transaction that we completed after our last earnings call. In light of the continued historic low interest rates, we took the opportunity to issue new 10-year, $800 million senior notes at a 4% rate.

We will now begin the question-and-answer session. The first question is from Joanna Gajuk from Bank of America. Please go ahead.

Good morning. Thanks so much for taking the question here. So I guess I appreciate all the commentary about the second half growth rates and what it implies for the year. And can you just flesh out a little bit more, the dynamics around the cemetery pre-sales strength? I mean, clearly, you said that it surprised you. So any ideas in terms of what's driving that and what gives you confidence that we will continue in the second half? Are those pull-forward sales as it like just people obviously are thinking more about their own mortality and whatnot, so kind of making these decisions faster than in the prior year? So kind of flesh out those dynamics for us. Thank you.

Sure, Joanna. First of all, I would say, obviously, we believe that COVID deaths have had an impact on our ability to generate leads and generate production. So some of this is, for lack of a better term, pull forward. But I guess the preneed cemetery sales side with so many potential customers, it's not like it’s really an opportunity to capture it. We still think a significant portion of this relates to, I think, people's realization and focus on what we do. And I think as long as COVID is around, and maybe for a while after that, I think their aperture for what we do is going to continue to be available. The last piece that I think is just true, and I think Jerry here runs our sales force would agree with this comment, we have found a better way to manage and we're managing with less travel, leveraging technology, and focusing on leads, what we do with those leads, and success. So you heard me reference the lead-to-sale percentages at 17%, and it used to be at 14%. So we're getting better leads. We're following up better. We're utilizing our tools, Salesforce, customer relationship management Beacon. And so I think there's an element of continuation. The other thing that gives me confidence on the cemetery side— and we referenced this a little bit— we've been selling a lot of merchandise and services. Remember, those get deferred and put into trust. If you look at our numbers this time, those were up pretty significantly. Why is that? We've sold a lot of preneed customers. And those funds can be invested in trust. There are some cumulative trust earnings in there that roll out as we deliver merchandise and services. So that, again, will be something that ought to benefit the back half of the year 2022 going forward for all those reasons. So hopefully, Joanna, that helps answer your question.

Right, no that's good color, and I guess to your point, similar dynamics, the preneed funeral sales production also up very nicely, right? So I guess it’s kind of similar dynamics as in just like you have obviously mentioned the salespeople being more efficient, but just the whole point of them being out there, right, and more kind of able to do those events in person, right, that's driving the specific bucket, right?

Exactly. And I think what's slightly different about funeral, that's made it a better comparison in growth and probably will be as you think about the back half of the year, funeral leads— a lot of them were dependent upon seminars. If you remember, the seminars effectively shut down last year. The other thing about funeral is we do follow-up events with the family. So once we've had a funeral, we'll follow up, and that typically generates leads. Well, last year, we weren't allowed into their homes to follow up. So I think the dynamics of markets opening up again, people feel more comfortable, and that tends to give a boost back to funeral, maybe more relatively than even in the cemetery. In the cemetery, we can do it outside. You're generally showing people through the cemetery. So there's just a different dynamic. But we feel very positive about the momentum in both channels. And I just think funeral has got an easier comparison as you think about the second half of the year versus cemetery. The cemetery will continue to be very strong.

Yeah. I appreciate that. If I can squeeze a follow-up to something you said before in terms of the funeral average sales essentially slightly above 2019 levels. So things really came back really nice there. But are there still some markets essentially closed for activities, or are you pretty much open? Thank you.

It's pretty much open. The last one, Canada, was pretty shut. California has gone back in certain pockets to mask inside. But as of right now, we're seeing people, as you can see in the numbers, choosing to celebrate, memorialize, and gather. We think that's such a positive thing. I mean, you probably noticed in here the cremation rates have been flat for the last couple of quarters. I don't expect that to continue. But I do think people are focusing on what's important in their lives and the people who are important, and that aligns well with what we do. So we're happy to be of service to our families.

The next question is from Scott Schneeberger from Oppenheimer. Please go ahead.

Good morning. Hi. It's Daniel on for Scott. Could you guys elaborate a little bit on the expectations for semitranfuneral margins, please, in the back half? And also discuss the efficiencies you guys have gained and could be sustained with some perspective on how margins should expand a little bit longer-term as well, please? Thank you.

Sure. Eric, do you have some margin stuff you want to talk to you about?

Yeah. The margins essentially for the— as you know, we had a little bit of pressure relative to the incremental revenues that Tom has already described in a lot of detail. The question is, for the back half of the year, what will that look like? And what will it look like as it relates to the revenues in the back half because of the volume declines that will potentially occur during the quarters? And that's hard for us to predict as it relates to Q3 and Q4 volumes. I mean, Tom did mention that we do not have a crystal ball, but we do use the IHME statistics from the University of Washington. There’s no doubt that things appear to be picking up from a COVID perspective in the back half of the year. I do think some of the things that put pressure on the margins during this quarter, such as part-time and overtime, to some extent, have now been ramped up. I think there could be some pressure as a comparison in the back half of this year because of 2020. But there are other cases where ICP, for example, our incentive comp plan, I think we have set up in a place where we're very comfortable based on our projections through the second quarter. The punchline is I don't really expect it to be too much pressure related to the back half of the year, but really from those fixed costs that we just described. Ultimately, it's going to be a question of throughput. What you saw in the second quarter is that the model we have in terms of incremental margins based on more volume clearly worked and dropped to the bottom line. Then we had some fixed cost pressure. If the fixed costs relieve themselves according to what the margins are going to do, it’s going to be a function of what we think the volume is going to be in Q3, Q4, so that’s a little out of our control. Ultimately, I think we could see a little bit of headwinds related to it, but it's going to be somewhere in the ballpark of the very high teens, and maybe with some volume help we can get into where we kind of were in the second quarter as well.

Got it. Thank you.

I'm sorry, the second part of the question you asked about what are some of the sustainable things from the model. In that regard, what we're finding is from a selling cost perspective, both from lead management cost per sale and cost per lead, and looking at travel and entertainment and utilizing technology to leverage more, those are tools that are allowing us to reduce the cost of sales. If you think about selling, the other thing is by utilizing a lot more technology, if you look at our staffing metrics, just to give you an example, our full-time staff, as you think about a quarter, probably runs about 7,100, 7,200 FTEs in the funeral segment. That’s pretty consistent whether you go back to 2019, 2020, or 2021. The difference is the way we utilize the part-time metric. Pre-pandemic we were about 2,100 on average in a quarter for personnel; during the pandemic, we dropped to 1,400— so pretty significant. That was because we didn't have elaborate funerals. We had a simpler structure because we couldn't operate at full tilt. Now we've moved that back to about 1,700 or 1,800 in this quarter, where we did a lot more funerals than we did in 2019. So I think the way to think about this is we found a staffing metric model that's more efficient, more effective in how we service clients even in a full-service mode that we're in today. A lot of little things like that have allowed us to learn to manage more effectively when you think about the cost side of the equation.

Got it. Very helpful color. Thank you. Just a quick one on cremation. Not changing so much on a year-over-year basis recently, I understand the comps are a factor there as well. But could you speak to where you see the cremation mix going near-term? And what kind of trends you've seen in the quarter?

Yeah. So what we saw was effectively flat this quarter, last quarter. Historically, that range has been about 100 to 150 basis points per year. There are a lot of different opinions on this, and I trust our Chief Operating Officer very much on this. What he sees, and from the feedback, I think we would expect that maybe the 150 basis point move is over for a while. A lot of people are seeing value and memorialization value in cemeteries— you're seeing it in the cemetery sales production. So we don't know, but our expectation is that it will slowly begin to grow again, maybe not to the historical levels we've seen.

Got it. Thank you very much. Good luck.

The next question is from A.J. Rice from Credit Suisse. Please go ahead.

Hi, everybody. Just maybe quickly to follow up on that last discussion around the cremation rate. Do you think much of what you're seeing there was just that cremation was elevated a year ago because of the inability to have normal services, or do you think that's really not part of it?

I think there's a little bit of that, A.J., for sure. But I think we even saw it in the first quarter where you were comparing back to as much. And so again, I agree with you. I think the flatness of this has a little bit of what happened last year. Just from talking to people that are in the field— and I think it's a sentimental thing where people are saying, life's too short, and I'm going to celebrate the people I love, and it's important to me. So again, I just provide that feedback. I don't know where it will normalize out. Again, we do anticipate it to begin to grow, maybe just not at the levels we saw. But you're right, there's surely in the second quarter, there's a comparison issue.

Okay. When you think about the funeral averages and the strength you saw there, is there any way to discuss what you're seeing in terms of the averages coming out of the backlog from pre-need to at-need versus the walk-in at-need? And does that give you any gauge on how far you bounce back, and how far you may still have to go as we return to normal?

Yeah. I think if you look at, for instance, for the quarter, I believe, our at-need walk-in average was about $5,800 in the core part of our business. So I’m going to talk not SCI Direct for a minute. Our preneed going at-need was about $6,400. That's about a $600 delta; that's what's coming out of the backlog. And so when you think about the robust nature of that backlog and our ability to continue to grow it, what we're putting into the backlog today is just over $6,000 on the core side. So again, I think what that tells us is that customers are paying up for premium. They want remembrance, they want celebration, they want to be able to grieve, they want to do a lot of the traditional things. So we view it as two things: One, there's probably room on the at-need side for increases, and we like what's coming out of our backlog, and more and more will come out of our backlog as we think about how this rolls out in the future.

Okay. And then maybe finally on capital deployment. You're expressing confidence, or Eric is, on the acquisition pipeline. Does that mean that there are deals that are pretty far along? You haven't done much; you’re still saying you could think you could do $50 million to $100 million. And then on the buyback, I know in this quarter, you did about $81 million— that seems a little above average, for sure. What are there any updated thoughts on the quarterly run rate to contemplate for that?

A.J., I will take share repurchase first. The $81 million is pretty much in line with what you've seen in the first quarter. I think we did $106 million. Last year, we deployed over $500 million to shares. The answer to your question is we're going to deploy capital to the highest relative return opportunity. Ultimately, we believe shares are a good value where they are, and we've been purchasing through 10b5-1 all during this period, and we'll continue, once we get out of this period, to open market repurchases. But in terms of the level of those repurchases, that’s going to depend on the relative valuation with other opportunities— excuse me, the relative opportunity with how we feel about the perfect value of the company. But I'm trying to tell you very clearly is, we will continue— our expectations are to continue to deploy capital towards our share repurchase program at these levels. So I hear that very clearly, subject to what I've already described. In terms of the acquisition pipeline, I think things ebb and flow, and with COVID there are always some timing issues and things being delayed. What we're trying to communicate to you is that there is a pipeline out there that we are involved in and we are active in, and that gives us optimism and confidence that we will continue down that path. I don't really want to say any more than that at this point in time, but it's a good pipeline.

Okay. Great. Thanks a lot.

The next question is from John Ransom from Raymond James. Please go ahead.

Good morning. I was just remembering that your stock used to be $1 a share back in the late '90s. I think about that take that basis. The question I have, Eric, is I like your 25,000 fewer funerals and here's our earnings compared to 2019. Could you just help me understand how much of that is just structurally better cost structure? How much of that is higher preneed? And how much of that is anything else you want to help us with?

Well, I think, John, as you think out to 2022, the capital structure loan is probably $0.45, $0.50, and I'm doing this from memory, so forgive me if I'm off a little bit. I would think the cost side of it is again probably another $15 million in the high-teens sense. I think there's real upside. Clearly, we're going to make less money on the funeral side, right? We did 25,000 fewer funerals and cemeteries because of the levels that we operate in today, and the effectiveness of our model in leads is going to be significantly higher. We think about— you heard me reference last time; take a 2019 level, and we believe we can grow cemetery sales 7% compounded. If you believe that is the right way to think about it, you can come up with a number that says, now I know of excess 2020 and 2021 sales. But there's nothing we believe that should stop us from compounding at seven, and a lot of our models now run higher than that when you think about what type of levels preneed cemetery should be in a given year, 2022, 2023. That allows you some pretty spectacular numbers on that lower share count, more effective operating platform. You get to these numbers, like what we're saying for 2023 at $3.25. If I told you in 2019, we’d grow EPS 10% a year, I think it's like $268, $270, is that right? Now I’m telling you, okay, we got through this pandemic, and now we're at $3.25. That tells you— that's really cemetery, both property production and merchandise and service revenues that will deliver combined with, again, the better operating structure, better capital. We're still— and now we've got a really good trend for funeral, right? Because funeral is going to be challenged. But the good news is that that pull forward is going to wane, and so year-over-year comparisons are going to get tailwinded. So I feel really good about, as we think about moving out to 2025, what type of growth you can see within SCI.

And Tom, did you just turn a tailwind into a verb? I like that. I like what you said. Okay. Sorry. No more. I'll just be serious. No more comment yet.

Oh, come on.

The other question I had was the surprising thing last year to us was how much cemetery preneed related to stronger funeral volumes. So as you go down the other side of that slope, is there a rough rule of thumb, say, for every 100 points of funeral volume decline, that equals x dollars or maybe pressure on some material preneed, or is it not that easy to think about it that way?

I don't think it's too easy to think about it that way. Jerry, is there— would you have any comment on that? So I don't think so. Every time you have a case, there's an opportunity to follow up, which leads to a way to generate a lead. The one thing that's slightly different today about our model, and a lot of this is with our new Chief Marketing Officer, Jamie Pierce, is that she's really turned up the capabilities as it relates to digital leads, and that actually feeds into direct mail. We don’t think about direct mail and digital, but there's a lot of science behind the technology that we have. A much lower cost of direct mail and a much more effective piece. That has taken what used to be marketing leads in the 10% to 15% of our lead process, now with the 25% to 30%. And those are much more effective workable leads. When you think about that, that really isn’t driven off a customer walking in. I think we're less leveraged to the funeral volume as we think about our ability to drive cemetery sales production going forward than the pre-COVID SCI is the way to think about it. That’s why I think we're pretty confident about our continued performance. And one nice thing about the cemetery is it really is a heritage sale. When you get in, there’s an opportunity to get Tom's brother, Tom's sister, everybody loves you, Tom. And John, I know you're part of that group that would make you a potential customer.

Thanks; everybody loves Raymond. So it reminds me, Beacon and cemetery got a lot of discussion a couple of years ago. Part of that was, say, we can simplify our product offerings, not that 87 turns that we're selling. Where are you in that process? Is there still more upside? And what the shopper are you kind of through that process?

We've kind of got it in most of our 90% of the network. It’s hard to understand what the impact is, but here's what I know for sure— it's a much more robust, efficient sale. When you think about our ability— and you keep hearing this reference velocity, the number of contracts, our sales counselors can do a lot more in a day than they used to get to. The other thing that we’re finding is because you have the ability to kind of control the price tests and everything else, we’re seeing less discounting. So higher average sales with more throughput through the system. That's a big function of Beacon contributing to that. I also would tell you that I think our customer relationship management system, which we've had for a while—we were good at it. But now when you couldn’t travel, it was your lifeline. I think it's become the lifeline for our sales organization with all the potential that was wrapped up in that. We’re making— it’s so useful now, we’re trying to make adjustments to it to make it even more useful for people to embrace it. So while it was always embraced, I think it’s embraced throughout the entire sales organization now. Those two things are very big reasons why we're confident about the future.

That’s it for me. Thank you.

Thanks, John.

This concludes our question-and-answer session. I would like to turn the conference back over to SCI management for any closing remarks.

I want to thank everybody for being on the call. Stay safe out there, and we look forward to talking to you again in October. Have a great week.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.