Service Corp International (SCI) Q3 2022 Earnings Call Transcript

Good morning and welcome to the SCI Third Quarter 2022 Earnings Conference Call. All participants will be in a 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. Today, we will be providing an overview of our business results for the third quarter, as well as some thoughts about our outlook for the fourth quarter and for next year as well. As usual, let me quickly go over our Safe Harbor language before we begin with prepared remarks. Any comments made by our management team that state our plans, beliefs, expectations, or projections for the future are forward-looking statements. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated in such statements. These risks and uncertainties include, but are not limited to, those factors identified in our earnings release and in our filings with the SEC that are available on our website. Today we'll also discuss certain non-GAAP financial measures and a reconciliation of these measures to the appropriate GAAP measures can be found in the tables at the end of our earnings release and also on our website under the Investors, Webcast and Events session. With that out of the way, I will hand it over to Tom Ryan, Chairman and CEO for opening remarks.

Hello everyone and thank you for joining us on the call today. First of all, I want to express my heartfelt thanks to our entire SCI team. Your continued commitment, dedication, and execution have positioned us for the results we posted this quarter. You have remained focused on helping our client families find closure and healing through the grieving process, as well as assisting our preneed clients in securing their final arrangements. This morning, I will start with a high-level overview of the quarter, followed by insights into our business performance, including details regarding our solid funeral and cemetery results. I will also share observations from 2022 that will inform our preliminary thoughts about 2023. For the third quarter, we generated adjusted earnings per share of $0.68, which exceeded both our internal forecast and analyst expectations, although it was lower compared to $1.16 in the prior year quarter, which had a significant pandemic influence. The anticipated decline in earnings is mostly due to lower operating results from a diminished impact from COVID and decreased trust fund income attributable to declines in global equity and fixed income markets. Rising inflationary fixed costs also affected this quarter's performance. On a positive note, the reduction in share count helped mitigate the effects of higher interest expenses and a slightly increased tax rate. To better understand this quarter's performance, we achieved earnings per share growth of 84% compared to the pre-pandemic third quarter of 2019, reflecting an impressive compounded annual growth rate of 22% in earnings per share over three years. Although down from the previous year, funeral results exceeded our expectations, maintaining elevated levels of services. Cemetery profits were consistent with our expectations, and preneed sales production was strong, surpassing our forecasts, though tempered by lower recognition rates and diminished trust fund income. Now, let’s take a closer look at the funeral results for the quarter. As expected, total comparable funeral revenues decreased compared to a prior year quarter that benefitted from significant pandemic effects. This decline of $48 million, or about 8%, includes a $41 million decrease in comparable core funeral revenues. Though comparable core funeral volume fell about 10% compared to the prior year quarter, the volume for the third quarter of 2022 remains over 15% higher than the pre-COVID third quarter of 2019, indicating a compounded annual growth rate of 5% over the three years. We continue to serve elevated levels of client families beyond COVID-related deaths, aligning with our previous comments during our Investor Day presentation in May. Our core average revenue per service increased by 1.8% over the prior year quarter, and organic growth for the quarter was 4.7%. However, this was negatively impacted by a 190 basis point rise in the core cremation rate, a decline in trust fund income, and to a lesser extent, currency translation in our Canadian operations. From a profit standpoint, funeral gross profit dropped $67 million, and the gross profit percentage fell to 19% from 29% in the prior year quarter. The revenue decline due to lower volumes compared to 2021 accounted for most of the profit decrease. We also observed historically high increases in employee-related costs, utilities, and fuel due to current inflationary pressures compared to the previous year. Additionally, we experienced slight increases in technology costs, including depreciation and maintenance of our impactful sales and marketing systems developed over recent years. Preneed funeral sales production rose over $6 million, or 2%, compared to the third quarter of 2021, with our SCI direct production increasing by almost 10% over the prior year quarter. Increased contract velocity came from leads generated through new targeting strategies for our direct mail and community seminar programs, along with a greater emphasis on digital initiatives. Turning to the cemetery, as predicted, cemetery revenue also fell compared to the COVID-affected prior year quarter; however, preneed sales production exceeded our expectations. Comparable cemetery revenue declined by $21 million, or about 5%, in the third quarter. Core revenues were down by $17 million compared to the previous year, with at-need revenues contributing $15 million to this decline and recognized preneed accounting for $2 million. Recognized preneed revenue was actually $6 million higher prior to accounting for an $8 million drop in merchandise and service trust income. Other revenue fell by about $3 million year-over-year as endowment care trust fund income was negatively affected by shifts in capital gains and losses. Preneed cemetery sales production grew a solid $16 million, or 5%, in the third quarter, and we are now 67% ahead of the third quarter of 2019, leading to a 19% compounded annual growth rate over the three years. As we noted in our Investor Day presentation, we believe we have improved our sales and marketing productivity in cemetery sales based on lessons learned during the pandemic. Sales velocity did see a slight decrease that was more than offset by inflationary increases in core sales averages. Large sales continued to be strong, growing by $10 million over the prior year quarter. However, cemetery gross profits declined by about $41 million, with the gross profit percentage dropping to 31% from 38% in the prior year quarter. This revenue-related profit decline was further impacted by a $12 million loss in trust income, which directly affects the bottom line. Inflationary pressures have resulted in substantial increases in employee and cemetery maintenance costs, along with higher technology costs from systems amortization and maintenance. As indicated in our earnings release, we adjusted our 2022 earnings per share range upward by $0.20 to $3.60 to $3.80, with a midpoint of $3.70. This suggests a range of $0.73 to $0.93 for the fourth quarter compared to the COVID-impacted fourth quarter of 2021, which was $1.17. Our previously stable business model faced upheaval starting in 2020 due to COVID-related uncertainties, lockdowns, and shifts in consumer behavior and sentiment. At our Investor Day in May, we shared our insights on our operating platform and the expected impacts of COVID, providing guidance on future expectations. We identified a new earnings per share baseline that arose from accelerated learning and actions taken during the pandemic, initially set at $3.18 per share for 2022, with an anticipated additional non-recurring COVID impact of $0.32, leading to a total guidance midpoint of $3.50 for 2022. Our base assumptions reflected a significant decline in funeral volumes and at-need cemetery revenues compared to 2021, especially in the second half of 2022, with projections for normalization towards 2019 levels. We expected relatively stable preneed cemetery sales compared to 2021 levels and anticipated aggressive rate hikes from the Federal Reserve, increasing variable rate debt interest expenses. Having assessed the last five to six months of 2022, we now believe that the actual levels of non-COVID funeral services and at-need cemetery revenues will move our original baseline assumption of $3.18 closer to $3.50. We believe these additional services may be permanent due to an aging demographic and changing health trends, alongside market share gains in certain areas. Preneed cemetery sales remained strong, aligning with our projections from May. Unfortunately, we did not foresee the significant declines in both equity and fixed income markets that will lower trust fund income for 2022 by about $0.20 per share. This leads us to an earnings per share baseline of $3.30 for 2022. Adding the non-recurring COVID impact, which increased to $0.40 from the originally discussed $0.32 in May, results in a revised midpoint of $3.70 for 2022. For our preliminary guidance for 2023, we are using the $3.30 earnings per share baseline, along with our historical growth assumptions, including slightly higher interest expenses and lower trust fund income, leading us to an estimated 2023 earnings per share range of $3.45 to $3.75. I want to extend my gratitude to all my more than 24,000 teammates for your dedication and efforts every day for our families. You are what makes this company exceptional. With that, I will now turn the call over to Eric Tanzberger, our Chief Financial Officer.

Thanks, Tom. Good morning, everybody. Thanks for joining us again. Kind of how Tom just left it off, before I really address the quarter, I first want to say thank you to all of our 24,000 plus funeral homes, cemetery, crematory personal care center associates. Now these are the associates who make this company go and continue to work tirelessly to take care of what's most important, our client families and our communities. In turn, these are the people that have produced these impressive financial results. We truly appreciate all of your hard work and efforts. Please hear that very clearly. So with that said, let's get into the business at hand, kicking off my comments this morning. I'm going to discuss our cash flow results and capital investments for the quarter and the financial market effects on our trust funds. I will then provide some comments on our increased cash flow outlook for the balance of this year 2022, and also give you some preliminary thoughts for 2023 in terms of cash flows. Starting with the quarter, we generated adjusted operating cash flow of $183 million in the third quarter. This was higher than our expectations, but it was about $49 million lower than the prior year, which as we've discussed was heavily impacted positively by pandemic activity. The declining cash flow quarter-over-quarter aligns with the $107 million decline in operating income, which excludes gains on divestitures and was somewhat offset by $22 million of lower cash taxes as a result of the lower earnings as well as about $41 million of favorable working capital in the quarter. This net source of working capital is first related to the timing of preneed cemetery cash receipts from strong sales production during the quarter as compared to the correspondent revenue recognition. Secondly, working capital was favorably impacted by the payment of roughly $21 million in the third quarter of the prior year of deferred payroll taxes as allowed under the CARES Act. So, just to refresh your memory, remember that we're able to defer quarterly payroll taxes under this CARES Act totaling approximately $42 million for the full year of 2020. Then we repaid the first half of this amount, the $21 million, in the third quarter of last year, and we'll be paying the second remaining $21 million next quarter, the fourth quarter of this year 2022. Finally, cash interest payments were on target, increasing an expected $5 million due to increases in the balance and interest rate of our floating rate debt. So, now shifting to our trust funds. I made some comments about our trust funds last quarter, but I think it bears repeating to make sure everyone understands the impact of the financial markets on our near-term and longer-term cash flows. As we've discussed in the past, the volatility of financial markets influences the market value of our trust funds, but again has a muted effect on our near-term earnings and cash flows. Given the 10 to 14-year average life of the underlying customer contracts, only about 8% of those contracts to the trust backlog really mature in any given year. Therefore, the effect of the reduction in trust fund market value allocated to each individual contract is reflected in our earnings and cash flows over a 12-year period or about 8% per year. So, with that said, let's talk about the balances. We began the year with about $6.5 billion in total trust assets, and currently today, that balance is about $5.6 billion, slightly higher than the $5.3 billion at the end of this quarter that we reported to you. The deposits on the new sales and withdrawals from maturities generally have offset each other during the first nine months of this year. Thus, the $900 million change is primarily associated with the change in market value of those trust assets. This reflects the 17.5% decline in trust performance year-to-date, which has been impacted by historical inflation, the speed of the Central Bank tightening, and uncertainty in the geopolitical space. This has led to somewhat of what we call a black swan event, where we have seen 15% to 20% declines in both the equity and fixed income markets, which is something we have not seen in at least the last 30 years. This decline in our trust finance balances is expected to result in about a $35 million to $40 million cash flow headwind for the full year of 2022, all of which is considered in our increase in our 2022 earnings and cash flow guidance that we talked about this morning and in the press release. So, with that, next, I'd like to shift gears and touch on corporate G&A expenses, which were $42 million in the current quarter and slightly higher than our expectations due to inflationary salary and wage pressures as well as some workers' compensation and general liability insurance cost increases. Looking forward to 2023, we expect corporate G&A to trend a little bit higher due to these inflationary labor pressures and be in the ballpark of $38 million to $40 million per quarter. So, now I'd like to touch upon our capital investment activity. During the quarter, we invested $382 million into our funerals, our cemeteries, new build opportunities, and accretive acquisitions, and we also returned capital to shareholders. Let's talk about the breakdown. First, as it relates to these investments in our businesses. We had $59 million of maintenance capital, which was higher than both our expectations and prior year. During the third quarter, we accelerated our investments in our funeral home and cemetery technology infrastructure, and this really prepares our locations for the utilization of both customer and non-customer facing technology that is currently being developed to create a more contemporary experience for all involved. These costs were also higher due to inflationary cost pressures and supply chain constraints with the associated hardware being installed at all of these locations. Additionally, we invested $34 million into cemetery development projects during the quarter. This is higher than the prior year, primarily due to the pandemic-related delays experienced last year, and has also trended slightly above our expectations as we continue to replenish inventory to meet the consumer demand following elevated preneed selling activity as well as future customer opportunities. Considering increased investments in technology infrastructure and cemetery development we just discussed, I believe our recurring CapEx will be about $10 million higher for 2022, which was reflected in the updated guidance range that we gave you in the press release. So, now shifting to growth capital. We invested $12 million towards the purchase of real estate, construction of new facilities, and expansion of existing funeral homes and cemeteries across our footprint. On the acquisition front, we closed two funeral home transactions on the East and West Coast totaling about $12 million. Subsequent to the quarter, we purchased multiple funeral home and cemetery locations on the West Coast for about $40 million. So, our year-to-date spend for acquisitions, including these recently closed transactions, is about $55 million, all of which were done at our usual targeted IRRs. We again remain optimistic about the acquisition pipeline and believe we'll end the year well into our range of $75 million to $125 million. Finally, we continue returning capital to shareholders with nearly $265 million returned this quarter, which is comprised of about $40 million of dividends and about $225 million towards share repurchases. Year-to-date, we have invested close to $590 million. These opportunistic investments demonstrate our confidence that we have in this business and our strategy and our commitment to returning value to shareholders. So, shifting quickly to our financial position. We continue to have a strong balance sheet with a favorable debt maturity profile, and robust liquidity of approximately $720 million, which was at the end of the quarter, consisting of $170 million of cash on hand, plus almost $550 million available on our long-term bank credit facility. Our leverage at the end of the quarter was just above three times net debt to EBITDA. We will continue over the coming quarters to invest capital in high return opportunities such as acquisitions, new builds, and the share repurchase program. In addition, our EBITDA is currently normalizing from the prior year that was impacted by the pandemic activity. We expect our leverage ratio at the end of 2022 to be at the low end of our targeted leverage range of 3.5 to four times, and we expect to enter that low end of that range in 2023. So, now let's shift to an outlook and talk about the remainder of 2022 and into 2023. In our press release, we increased our guidance for adjusted operating cash flow for the full year by $40 million to a range of $795 million to $835 million, or the midpoint of $815 million. This implies a range of $140 million to $180 million in the fourth quarter. We also anticipate continued pressure from rising interest costs on our floating rate debt, which could be a $10 million to $12 million cash flow headwind in the fourth quarter, which has also been considered in this updated cash flow guidance. So, looking ahead to 2023. We are currently working through our cash flow, our cash taxes, and our working capital models and we'll give you better guidance more specifically in February, which is what we normally do. I did want to mention a few items this morning to give some direction as it relates to this 2023 cash flow expectations. So, first, when we think about the adjusted EPS guidance of 2023, which was $3.60 at the midpoint of the range that Tom just mentioned, this $0.10 difference from 2022 levels is expected to result in about a $20 million net decrease in cash flows for 2023. Included in this $20 million net change is higher EBITDA expected from growth in our cemetery operations that will be more than offset by about $50 million of higher interest costs associated with higher interest rates on our floating rate debt. Additionally, we expect to have a couple of working capital items that could pressure 2023 cash flow, really related to strong incentive compensation cash payments as well as the timing of preneed cemetery cash receipts as compared to the correspondent revenue recognition year-over-year. But remember, these working capital items should be considered temporary for 2023 and would not be expected to affect cash flows in 2024 and beyond at a more normalized level. So, in closing, thanks for joining us this morning. We're proud of this performance year-to-date. Our expectations are to now finish 2022 with a very strong fourth quarter. And with that, operator, that concludes Tom and my prepared remarks, and I'll shift it back to you and open the call up to questions.

We will now begin the question-and-answer session. The first question comes from A.J. Rice of Credit Suisse. Please go ahead.

Hi, everyone. I have a couple of questions following your final comments. You mentioned some items like incentive compensation and others affecting cash flow, and I understand you want to refine those further in working capital. Could you provide us with some insight into the order of magnitude? Additionally, why do you consider these to be one-time occurrences and reference them again in 2024? What is unique about them in 2023?

It's a good question, A.J. We'll need to refine the models to provide exact numbers in February as we usually do. However, we had strong performance in 2022, which will lead to significant cash outflows for incentive compensation payments across the company in February, likely close to twice our targeted ranges. For working capital, we expect to accumulate expenses during 2023 on the income statement while making a considerably large payment in February. This will create a working capital drag for that month, which could normalize in 2024 depending on our performance in 2023 and the differences between accruals on the income statement and actual cash flow payments in February. Additionally, this year, we experienced about $40 million in positive working capital, with $20 million from the CARES Act related to payroll. The other $20 million is connected to preneed cemetery services, driven by efforts from our teams to boost sales at the entry-level price point. This involved customer incentives and lowering down payments; without at least a 10% down payment, we cannot recognize that revenue immediately. Therefore, we are receiving cash in the latter half of this year, with revenue recognition expected next year. This creates a timing difference where we will have a source of working capital at the end of this year, which will turn into a use of working capital when the revenue gets recognized. I anticipate that the bonus could lead to cash flow as high as $30 million to $40 million, and the working capital shift might be around $10 million to $20 million. Overall, I am indicating that we could see approximately $50 million in working capital that should return in 2024 and should be regarded as temporary.

Okay. Great. Also just maybe I'll ask, Tom, you had mentioned this excess death issue, and you don't think it's related to COVID anymore. We're obviously looking at a period where the baby-boomers start to hit 80 in 2026. I'm assuming that the step up in deaths will be a bell curve. It won't be all in one year. There's a big stair step. Is that what you think you're seeing? Is there something else going on? Is it maybe we just haven't fully normalized? Do you think this is a normalized rate that we can sort of see normal at-need growth from here?

Yeah. A.J., there are three things that I kind of identified in my comments. The first one was exactly what you said, call it, the baby-boomers. I do believe we're beginning to see lift as it relates to that demographic, that is a component of what's happening. And you're right, I think it's more like a bell curve and we would anticipate that to kind of continue to steadily climb. The second one is probably the trickiest of all. I mentioned it, I think I called it, and I get a lot of pushback on the way we describe this, but I'm going to call it lifestyle. What I mean by that is we're seeing people being impacted in almost every category of death. We're seeing more deaths from car accidents, more drug overdoses, more suicides, more murders, more cancer deaths. I guess, I would say it was the pandemic disruption. When does that go away? It's my belief that at some point, society heals itself and we get better. I don't think that's going to happen for some time. I think when people are impacted by their mental health or physical health, these trends are hard to reverse quickly. So, I think we're seeing some of that. But to your point, I hope three, four, five years from now, it will subside a bit, but I don't think it's any time soon. The last piece that I mentioned that impacts us, we believe, is market share. Again, we try to track that. It's not perfect, but we're seeing in a variety of markets and probably particularly where we've got big combo facilities an increase in our share as we measure it over time. Three things impacting that I don't think go away over the next couple of years. The only one that at some point, I think, diminishes is that unhealthy America comment that I've talked about.

Okay. Maybe one final question. Obviously, your cemetery production, preneed production rebounded nicely after a somewhat sluggish second quarter. In the second quarter, you were somewhat cautious about the macro backdrop, maybe affecting some purchasing decisions. Can you say whether that dynamic is still there? Was the increase in production more a function of plots sold? Or was it the average price on the plots? Any color on that would be interesting as well.

Sure, A.J. So, as it relates to that, the one area that really was robust and hasn't changed is, let's call it, the large sale. So, large sales were up $10 million year-over-year against a pretty impacted by the pandemic last quarter. That tells us at the high end of the consumer spectrum, it's continuing to shine even with the markets down, which is a little surprising. But again, as you go back to time, I would say high-end sales probably correlate better with housing prices. Although we've seen some slowdown, I don't think we're seeing that backtrack yet. The thing we were concerned about was for our other customers, what would happen with selling price and what would happen with velocity. Eric touched upon this. Our sales leadership team, Steve and Jerry sat down and said our impression from getting feedback was that we have a consumer that when you think about a fixed-income consumer that's going to have to pay over time, what can we do to not have a resistance point as it relates to closing these deals. They came up with some things about lowering some down payments, some interest price points and then also identifying inventory that may be a more reasonable transaction for that consumer. By doing that, what we saw is almost flat, it was only slightly down, velocity for the third quarter. In the second quarter, we had seen some more concerning trends. Our belief is that worked really well. What we try to do is tie those sales to things like getting automatic payments and things like that to assure us that we shouldn't see a big dip in cancellations or anything like that. This isn't the first time we've done it. It's just something that I think worked at a moment in time. We saw the third quarter, and I’d say we continue to see it working in the fourth quarter so far.

The next question comes from Tobey Sommer of Truist. Please go ahead.

Thank you. If you could dig into the higher than expected funeral sales and events in the quarter a little bit more? And what is the math, if you could refresh us as we get questions about the ongoing, but lower level of direct COVID deaths? And then, the other sort of related factors and maybe offshoots of the pandemic that actually drive death higher in other categories? Thanks.

Sure, Tobey. It kind of builds upon A.J.'s question, but let me put it in some longer-term perspective. If you go back in this industry and particularly with SCI, year-to-year, you would see the number of deaths probably in one year, you may be down 1% or 2% in the next year, you're up 1% or 2%, which you could predict with pretty good accuracy over a year and over a big footprint like ours. It was impacted by seasonal flu. In a heavy flu season with many deaths, you might be up and then you've got a tough comparable for the following year and you might be down slightly. We lived that way forever as an industry. 2020 comes along, COVID was a game-changer. We happened to do at one point probably 20% more funerals, which is unheard of in a year versus a year or two before. What we're trying to identify is we know what is COVID and we can carve that out, and we believe that's diminished now and should continue to diminish. What we would have expected is, why wouldn't we go back towards, let's say, a 2019 level, maybe you get 1% or so growth over 2019, I would expect that. That's a reasonable level that we think would stabilize. That’s kind of what we anticipated. The third quarter this year, we did 15% more calls than we did in the third quarter of 2019. That is not what anybody would have anticipated, and that has just a very minimal amount of COVID deaths. Is that sustainable? I don't think 15%. What I'm telling you is, I don't think we're going back to 2019. The reason for that is, there's more baby-boomers dying. There's an impact from this, call it, unhealthy America concept, which really is, the best way to say it is probably we lack access to help. That would be from mental health issues as well as physical health issues. Going to doctor screenings, diabetes, many things are dragging. I would love to believe that we're all going to get up and go work out tomorrow and be healthy, but it takes time, and these are long-term issues. That is having an impact. Through this pandemic, the way our company reacted gained favor with our local communities. We made contact with a lot of people. What we've been doing on the preneed side is leveraging our digital communications with consumers. We're on a higher profile, and that's allowed us to gain share, particularly in certain geographic markets. What I'm saying is, going back to those 2019 levels, we're not going there. We're going to be significantly higher, I think trending out from here, and that's the big realization that I don't think we anticipated.

Perfect. Thanks. Could you kind of double-click on that geographic market share gain? Where is that concentrated? Is there some sustainable momentum behind that in your opinion?

Well, again, I’ll generalize, Tobey, because I think we gained market share in a lot of different places and a lot of different markets. More noticeable areas, probably more pronounced in the west, particularly where we have combo facilities. Some of that has to do with the fact that when you think about COVID, people didn't want to go inside again, we were inviting people to our cemeteries to have a service, and they got to see our beautiful grounds. A lot of consumers got a glimpse of that. I believe that triggered some recognition of, boy, that was beautiful. I like that places. Our people were able to pivot and serve client families in unique ways to develop relationships. Many more people were impacted by death over the last two years. In regions of the country, both California and New York, we were so inundated with client families needing help that we shipped people from across the country. Extraordinary things like that build your reputation and brand that allowed us in certain markets. I’d say we saw it in places like Arizona, Nevada, California, Texas where you have great weather and outdoor facilities. We feel very good about our position regarding market share.

Thank you. If I could sneak in a third question. How big is the high end within preneed cemetery sales? And could you expand upon that correlation with housing prices? Historically, when you look at that, is it leading, lagging, or coincident with changes in prices?

I think it's probably lagging is what we've seen before. If you go back to 2008, 2009, we saw in the third quarter of 2008, our comparable sales go down, and it concerned us. Then in the first quarter of 2009, they stayed down and it concerned us. In April of 2009, our sales were up 10%. Now they weren't large sales. They were customers taking care of business. Our consumer is impacted by the economy, but we’re one of the first things people turn back on. They don't buy the big-screen TV, but they take care of their family, insurance, and these types of deals. What took a longer bit of time back then was large sales really struggled, I think, in 2009 and even into 2010 because that again correlated with my feeling of wealth. If I'm at the high end, I’m going to spend more than $80,000, boy, the stock market going down 20% doesn't make me feel good. The bigger correlation is, are people buying high-end houses? Because if they’re buying high-end houses, they’re probably buying high-end cemetery inventory, and that could be regional, it could be national. That’s the way I’d correlate it, and I think it's slightly lagging. That could happen, we’ll manage through it. Large sales have become a significant component of our sales.

Our next question comes from Scott Schneeberger of Oppenheimer. Please go ahead.

Thanks very much. Good morning. I just want to stay on the topic of cemetery preneed sales growth. A strong third quarter after a second quarter that wasn't as strong. You all just touched on A.J.'s question a bit on what you did with the sales force to invigorate in the third quarter? It sounds like you believe that can persist in the fourth. Could you delve into that a bit more? Is this something that can persist in the fourth quarter and through next year? Or are these just measures that you're taking that are really more short-term in effect? Thanks.

Yeah. Scott, great question. I do think we view these as more of a temporary assist for the consumer. We're just looking out there and getting feedback from the people that are interacting with families. What we found is there was a growing portion of families that said, I'm interested, but this is a big ask right now. Gasoline prices are going up. My utility is going up. I don't know that I can afford it yet. I think this is a response to say let's find a way to get you what you want. That's our approach. As economic conditions improve, these are types of things that we won't need to do, and we will pull back and go back to more traditional measures. You have to anticipate as you lower some of these entry points, you're going to have a slightly higher cancellation rate, and that's going to happen. We have modeled that; we don't think it's going to be significant. We want a satisfied family that gets what they wanted. We're talking about sales that are less than $15,000, maybe paid over 48 months or 36 months but finding a way to accommodate a price point that they feel comfortable with. That's the endgame. As the economy improves, those are probably things that we would turn back.

Okay. Thanks. Along those lines, on cemetery preneed sales growth production, you would anticipate slightly positive for the full year. By my math, you're trending up mid-single digits, which, I guess, is there any change to that outlook with this final quarter to go? It looks like you should achieve your guidance easily if you are down say mid-single digits. Is that what we should be expecting in the fourth quarter with maybe some drop-off in large value sales and some more drop-off in velocity? Just how should we think about that as we end the year? And any commentary you can share about 2023 along the lines of that question. Thanks.

I don’t like the optimistic way you think, Scott. Yeah, you’re probably right. We want to get a little further before we declare victory at the end of 2022. If trends continue, it could be a little higher than what you anticipate. We just don’t know. As we think about 2023, we believe that we will go back to the kind of growth rates you'd anticipate off this new base. The only quarter that might be tough to compare against is the first quarter of last year, which was heavily impacted by COVID, and could generate more leads. You're probably not going to have that same level of lead generation. I think the first quarter is a tough comp. We think we're at a plateau, and we will grow off that. Very pleased with our sales and ops teams and what they've done for our families and for SCI.

Thanks. I appreciate that. One more I'm going to sneak in here. M&A, sounds like you're pretty active here in the fourth quarter. It sounds like you're not at your annual target to spend, but think you'll get there. Eric, maybe just some thoughts, comments. Are there some very right things in the pipeline? If not here in the fourth quarter, will 2023 be perhaps a higher than expected year for M&A? Thank you.

Yeah. I think we feel good about it, Scott. It's the same thing I said last quarter. I mentioned a deal that closed for about $40 million that was just after year-end. Timings can accelerate or push by weeks, and that's fine. It’s important for us to work with the sellers as best we can in those situations. The answer to your question is, we still think it's a robust pipeline. We still believe in the guidance that we've given you out there that $75 million to $125 million, and we feel that we’ll end the year in it. I’m clearly telegraphing to you a good fourth quarter.

Thanks. Anything policy-wise or regulation-wise that would make 2023 different than 2022 on the buy and sell-side approach to M&A? Thank you.

No. Nothing that we know about from a policy perspective.

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

So, Tom, what you're saying is you haven't looked at a workout media since 1982.

Yes. I guess, I got caught. You know why? Because I make my own video.

I might subscribe and pay money. $8 a month.

I might subscribe and pay money. $8 a month with неизвестно.

No, you're not. Yeah, I know you're not ready to give full guidance on 2023 the range. But could you help us with kind of the low end versus the high end assumptions? And then, just what's the trust income swing factor you're contemplating for the full year 2022 versus 2023? Thanks.

Sure. So, I'll start with the assumptions. As you think through the volumes of next year, we expect to see volumes down, I'd say, probably low to mid-single digits compared to 2022. That's predominantly going to happen again in the first quarter, maybe even some into the second quarter where you still have a little bit of that, call it, COVID impacted numbers. Overall, slightly down. But again, back to that 2019 comparison, well above 2019 trends. On the sales side, we feel really good. We think we're back to normal growth levels, which would be, what call it, mid-single-digit type of growth that you would expect us to do year-over-year. The other thing to think about is clearly as every company I know of is seeing some wage inflation. We've seen it this year. The way we've tried to manage that is, we'll call it, locally managed and assisted by us. If we have wage pressures, let's fix those, get our people right, and then let's find a way to get it back in pricing. We're a service business, and if our services cost more, then we will be able to pass those along to our consumers. We've been very pleased with our ability to do that. The headwinds that Eric has already identified, we have some variable rate debt. It's not a significant component, but variable rates have gone up pretty aggressively. We got to factor that in. What’s unique about this is if you look back in history, we've seen 20% declines in equity markets before, but never combined with a 20% decline in fixed income markets. It's a very, very unique dip down. Trust income getting whacked down, if you will. If you look at any other cycle, we would expect that, at some point, it may be 2023 or maybe 2024, 2025, we accelerate and get some of that back. I don’t think we want to guess on the timing. We do expect 2023 to be a favorable year for our trust returns. That’s the way we’ll think about 2023 guidance.

So, what was your estimate best guess for trust fund drag this year and for the full year?

I think this year it impacted us by about $0.20 to $0.25 in terms of decline compared to last year. For those who may not have been with us for a long time, trust income is a challenging concept because it represents the cumulative income from that contract over a period of 10 years. We are continuously generating trust income, but it’s at a reduced level due to market conditions. What should we expect for 2023? I’m starting from that lower baseline. I might experience some challenges in the latter part of 2023 because my earlier contracts from 2022 weren't affected by the market changes in the second or third quarters. You’ll see that unfavorable impact come into play. So, you might consider an additional $0.06 or $0.07 rolling into 2023, which could be a slight headwind for us.

The next question comes from Joanna Gajuk of Bank of America. Please go ahead.

Thank you. Thanks for taking the question here. So, I guess, one follow-up actually on the last topic in terms of the lower trust fund returns. Is there any way to think about the headwind to the sales average? Like this quarter same-store average was up only 0.6% for the Funeral segment. Is there a way to quantify the headwind there?

Yeah. Thank you, Joanna. In my remarks, I’m doing a little bit of this by estimation, so forgive me. We reported a 1.8% in our funeral average. Our actual year-over-year increase was 4.7%, a pretty robust, big beat. What happens is you have a 190 basis point decline in burial funerals, the cremation rate mix change. So that puts 100 or so or 150 bps of pressure on you. The decline in trust income will flow through that line item. Last, we also have Canadian operations. When you translate what's happened with the strength of the U.S. dollar, it puts another $50-$80 pressure on the average when you translate it back in. We had three things that knocked 47 down to 18. I don’t think anything's changed. We still think that 100 to 120 basis points a year is a good way to think about the cremation mix change.

Okay. Thank you. Because that was my second follow-up in terms of the cremation. You view it more as a year-over-year kind of dynamic versus just a change in the market dynamics in terms of people choosing cremation over burials?

Exactly. It really kind of ebbs and flows. It was unusual. If you looked at really 2020 and 2021, the cremation, we had a couple of quarters where it went the other way. An unusually high cremation rate change. But you know what happened during the last 100 years of pandemic disruption of tradition.

Sure. Yeah. Thank you. If I might just squeeze a different topic here. So, on the FCC front, they issued this advanced notice of proposed rulemaking, where they are seeking additional comments on how to modify the funeral rule. There were no specific proposals included there, just a long list of questions, but what is your sense? Does it change anything? Or did the public session they hosted change your views around what they might consider, including the changes they might be considering and including here? Any sense of the timing of when we might hear back from them on the specific proposal?

I'll take that, Joanna. Just to refresh everybody's memory, because there are a lot of new people on the call as well. The initial submission was done two years ago back in June and that's public information, and you can go look at what we submitted in terms of some of those questions on whether the funeral rule should continue or not. We believe it's working, and we believe it should continue. As part of that, what's important to know is we submitted independent J.D. Power customer comments and feedback. We submitted five years of 100,000 per year each. We submitted 500,000 individual customers responding to J.D. Powers on these topics. About 91% of the customers ranked nine out of ten or higher in clarity of pricing. Our submission in June was transparency in pricing exists. Seconds, the high point was probably 75% of the customers believe our prices met were lower than expectations. Fast forward to October, they have issued the advanced notice of proposed rulemaking. They want to keep the FTC funeral rule in place, which makes sense. That as part of that ANPR and proposed rulemaking, they've asked the 40 questions. It was published this morning. The 60-day comment period starts today and ends January 3rd. You can see what the questions are, but they’re very similar. They’re really going; should GPLs, the price list, be online and what format should they be in online and such. The one thing that we would say that's disappointing is that to change the rule and regulate it under the codification, you think that you need to have something damaging to consumers. It appears that our data tells a different story than where they’re going. We just simply don’t believe that it’s a one-size-fits-all commodity. In fact, we think it's the opposite. The funeral business is highly customized. Celebrations of life are getting even more customized and that's where the trend is going and such. Does this solve any problem? It doesn't appear that it does, but we'll respond accordingly like we have before with data. In terms of the effect on SCI, I think we have just our thoughts haven’t changed to what we said before. We do different things online. We tier our customers. Many of our funeral homes are tiered in terms of spending. We have over 450-plus of our funeral homes online that have starting price types. We have premium experiences for our more high-end tiers as well. We have almost 300 to 400 GPLs online ourselves. We’re already going down this path. The most critical thing for us is to give clarity and transparency to our consumers and meet with them to help customize their celebrations of life. The punchline is, we haven’t seen any type of effect that we consider material. If this ANPR went into effect and went down that path, I think we've been consistent for a couple of years. We continue to believe that we just don't think that is materially affecting our business going forward from an EPS, cash flow, or market share perspective.

No. Appreciate the comments and thanks for taking the questions.

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

I want to thank everybody for being here today. Have a great end of the year. Be careful out there. We look forward to seeing you next year in February to talk about our full year 2022 and fourth quarter results. Thanks.

The conference has now concluded, and thank you for attending today’s presentation. You may now disconnect.