Service Corp International (SCI) Q3 2023 Earnings Call Transcript

Good morning, and welcome to the SCI Third Quarter 2023 Earnings Conference Call. Please note that the 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, and we welcome you today to our third quarter earnings call. We'll have prepared remarks from Tom and Eric in just a moment. But before that, let me quickly go over the safe harbor language. Any comments made by our management team that state our beliefs, plans, 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 also in our filings with the SEC that are available on our website. Today, we will also discuss certain non-GAAP financial measures, and a reconciliation of these measures can be found in the tables at the end of our earnings release as well as on our website. I'd now like to turn the call over to Tom Ryan, Chairman and CEO.

Thank you, Debbie. Hello, everyone, and thank you for joining us on the call today. This morning, I'm going to begin my remarks with some high-level color on our business performance for the quarter and provide some greater detail around our solid funeral and cemetery results. I will then close with some thoughts on the rest of 2023 and some preliminary thoughts on 2024. For the third quarter, we generated adjusted earnings per share of $0.78 compared to $0.68 in the prior year. This impressive 15% growth in earnings per share over the prior year is primarily related to improved cemetery profitability driven by higher cemetery revenue from completed construction projects, along with lower fixed costs in both the cemetery and funeral segments, resulting in higher gross profit and margin expansion. Below the line, the 425 basis point rise in interest rates on our variable-rate debt increased our interest expense, reducing earnings per share by $0.09. This increased interest rate expense was predominantly offset by lower general and administrative expenses and the favorable impact of a lower share count. We have accelerated the pace of our share buyback, given our recent stock price, repurchasing $65 million of stock during September and $99 million during the month of October. Now let's take a deeper look at the funeral results for the quarter. Total comparable funeral revenues declined by $7 million or about 1% over the prior year quarter, primarily due to an expected decrease in core funeral volume. Although core funeral volume declined by 6% compared to the prior year quarter, we believe due to the COVID pull-forward effects, volumes were in line with what we had anticipated. Notably, funeral volumes are about 11% higher than third-quarter 2019 levels. Our core average revenue per service grew over the prior year by an impressive 4% even after absorbing the negative effects of a 120 basis point increase in the cremation mix. From a profit perspective, funeral gross profit increased by $6 million, while the gross profit percentage grew by 130 basis points to about 20%. Lower fixed costs and reduced incentive compensation costs over the prior year quarter more than offset the slight revenue decline. Preneed funeral sales production grew an impressive $15 million or about 5% over the third quarter of 2022. Both the core and the SCI Direct channels experienced strong sales production growth during the quarter. Now shifting to cemetery. Comparable cemetery revenue increased by $22 million or just over 5% compared to the prior year third quarter. Core revenue accounted for the preponderance of the increase as recognized preneed revenue increased by $21 million or 7%. This growth is primarily due to the expected completion of construction projects during the third quarter, which drove an increase in the revenue recognition rate by capturing sales from both the current and previous quarter's sales production. Additionally, we saw increased merchandise and service trust fund income generated from higher returns over an average 5-year period as compared to the prior year quarter. Preneed cemetery sales production declined by $20 million or 6% in the third quarter. While we continue to see significant growth in our large sales activities, core production or sales contracts below $80,000 declined by $29 million. We believe some of this decline is attributable directly and indirectly to the COVID pull-forward effect. We also continue to see our discretionary consumer impacted by diminished savings rates and lower real incomes, acutely affected by inflation. History tells us that similar economic trends have stabilized in the past. Our products and services have experienced a relatively early recovery in the discretionary purchase cycle. We had the advantage of selling a product that appreciates versus depreciating value. And we believe our cemetery sales production is deferred, not lost. This affords us the ability to recover quickly as the consumer economic cycle turns. Notably, preneed cemetery sales production is 58% higher than the third quarter of 2019. While large sales are an impressive 2.5 times higher than 2019. The preponderance of the sales production growth is from core sales, which grew by 48% over 2019, and were at a compounded annual growth rate over the 4-year period. Cemetery gross profits in the quarter increased by $15 million, and the gross profit percentage grew by 190 basis points to over 32% as the increase in cemetery revenue was further enhanced by lower incentive compensation costs in the third quarter as compared to the prior quarter. Now let's shift to a discussion about our outlook for the remainder of 2023, where we are maintaining our annual guidance. In the funeral segment, we would expect to see low to mid-single-digit declines in funeral volume as the impact of the COVID pull-forward slightly outpaces increasing volume trends. On the positive side, we would expect healthy low to mid-single-digit growth in our funeral average, both at the at-need customer level as well as the funerals maturing from the preneed backlogs. On the cemetery side, we would expect preneed cemetery sales production to range from flat to low single-digit percentage growth in the fourth quarter, while we anticipate a healthy favorable impact from newly completed construction projects during the fourth quarter. The comparison against the prior year quarter will be unfavorable as the 2022 fourth quarter new construction impact was the highest in many years. Favorable impact from a lower share count and lower general and administrative costs, for the most part, will offset higher interest expense. Therefore, we would expect earnings per share to be at or slightly above last year's fourth quarter results. Now as we look at 2024, on the funeral side, we would expect fewer COVID and excess deaths as well as a moderating impact from the pull-forward effect, resulting in slightly lower comparable funeral volumes as compared to 2023 levels, still an improvement from mid-single-digit decline in 2023. We would anticipate achieving inflationary increases in funeral average pricing, slightly offset by the effect of the cremation mix change. In the cemetery segment, absent a material change in discretionary consumer behavior, we would expect a normalized pre-COVID growth trajectory, slightly impacted by the lead source decline from lower funeral volumes. This anticipated low single-digit percentage sales growth, when combined with a favorable comparative impact from newly completed construction projects, should result in cemetery revenue growth in the low to mid-single-digit percentages. Below the line, we anticipate higher interest expense due to higher credit facility balances and a slightly higher comparable interest rate, at least during the first half of the year. This higher interest expense, for the most part, will be offset by a lower share count when impacting 2024 earnings per share. Typically, we will provide a preliminary earnings per share range of about $0.30 when we set any guidance for the coming year. Today, we maintain variable-rate debt of approximately $1.5 billion, having recently experienced significant Fed rate hikes during 2023. Keep in mind that a 100 basis point move has an annual effect of $0.09 on 2024 earnings per share. Due to the lack of visibility on interest rates, and the uncertainty surrounding the economic condition of the consumer, we are widening the range of our guidance to $0.50. Therefore, our preliminary guidance range for 2024 earnings per share is $3.40 to $3.90. We will provide formal guidance in our February earnings release and investor call. So I want to point you back quickly to Investor Day, May '22, because we gave you a presentation and talked about a new base that we were growing off of, and we gave you some preliminary thoughts around 2023, '24, and '25. If you go back to Page 35, we referenced this $0.65 higher base that we believe we're operating off of, and 75% of that was coming from sales productivity, 15% from accelerated buybacks, and 10% from cost effectiveness. So if you go to that Page 34, we were using a 10% earnings per share growth to grow off the new base. We had projected 2023 to be $3.50 and 2024 to be $3.85. So we'd ask ourselves, and I'm sure you ask yourselves, how are we doing versus that? So let's reconcile to that 2024 number. If you start with the idea that our range is $3.40 to $3.90, the midpoint we tell you, I guess, with math, $3.65. So $3.65 compares to $3.85, how are we doing? Well, remember, at the time we were in May '22, our variable rate on our debt was 2%, and when we were modeling out 2024, we assumed the Fed would raise rates, and we had an average rate of 3.5% for our variable rate debt in 2024. Today, we sit projecting that to be 7.5%. So there's about a 400 basis point increase versus our assumption that was in that model back on Page 34. So if you put that 400 basis point increase against $1.6 billion in variable-rate debt, which is where we'll finish the year most likely, that's about $64 million of additional interest expense that's flowing into 2024 when you compare back to our Investor Day. It's about $0.30 per share. So if you add $0.30 per share to the $3.65 midpoint, that would tell you our midpoint is $3.95 compared to the model at Investor Day, which was $3.85. So the truth of the matter is, and looking back, we're performing at a level at or actually above what we told you we would do on Investor Day. And the one variable that we didn't take into consideration was the Fed raising rates as aggressively as they did. And so we sit here today, I think, with an operating model that's working very well. We've got a higher interest rate environment we're navigating through. But we're very pleased with where we are as a company and excited about seeing a lot of positive trends as we think about year-over-year comparisons. So finally, I'd like to thank the entire SCI team for all that you continue to do every day for our customers, our communities, and each other, and you guys are what make our company great. So with that, operator, I'm going to turn the call over to Eric.

Thanks, Tom, and good morning, everyone. I want to express our gratitude to our 25,000 associates across the U.S., Canada, and Puerto Rico for your dedication to providing peace of mind and exceptional service to our client families during their most challenging times. Without your hard work and commitment, these impressive financial results wouldn't be attainable. Now, let’s discuss our operating cash flow results and our capital investments this quarter. I will also provide an update on our financial position and cash flow outlook for the fourth quarter, along with some preliminary insights for 2024, which we will discuss in detail in February. During this quarter, we generated strong adjusted operating cash flow of just under $230 million, exceeding our internal expectations and growing by over $45 million compared to the previous year. This significant quarter-over-quarter improvement can be attributed to three main factors. First, the increase in cash flow was driven by higher earnings growth, as Tom detailed earlier. Lower cash tax payments, expected to be about $40 million lower due to changes in tax accounting treatment, also contributed, as this change defers cash tax payments into future years when installment payments for cemetery properties are received. This reduction in cash taxes more than offset approximately $18 million in higher interest payments caused primarily by increased interest rates on our floating rate debt. We made exciting investments with that cash flow this quarter. We allocated a total of $148 million toward current locations, new growth opportunities, accretive acquisitions, and real estate. Specifically, just over $80 million was reinvested in our existing businesses, including $41 million for cemetery development, $28 million on maintenance for existing facilities, and $13 million targeting digital systems and initiatives. Regarding maintenance CapEx, we project a total of $290 million to $310 million for the entire year of 2023, and while we anticipate some moderation in the fourth quarter, we believe we will finish at the higher end of that range. We infused almost $9 million in growth capital mainly for expanding existing funeral homes and cemeteries in locations such as Texas, Ohio, and California, as well as constructing new facilities in Virginia and Florida. In terms of acquisitions, we invested over $30 million this quarter, bringing our year-to-date acquisition spending to $73 million, close to the lower end of our target investment range of $75 million to $125 million for 2023. Lastly, we invested $24 million in real estate purchases, mainly in a significant Western U.S. market for future cemetery expansion. In addition to these investments, we returned nearly $132 million to shareholders during the quarter, with $44 million in dividends and $88 million in share repurchases. Following the quarter's end, we repurchased an additional $99 million, resulting in total capital returns to shareholders of approximately $565 million year-to-date. Our corporate G&A expenses were $33 million for the quarter, below our expected range of $38 million to $40 million, primarily due to lower incentive compensation tied to total shareholder returns relative to our peer group. Regarding our financial position, our favorable debt maturity profile and liquidity of just under $1 billion at the quarter's end enable us to effectively invest capital. Our liquidity consisted of around $170 million in cash plus approximately $800 million available from our long-term bank credit facility. With stronger operating results, our leverage decreased slightly to about 3.5x net debt-to-EBITDA from 3.6x last quarter. We aim to maintain our leverage ratio near the lower end of our targeted range of 3.5 to 4x in the near term. As for our outlook, our adjusted operating cash flow guidance for 2023 has a midpoint of $855 million, and we expect to grow off this base in 2024, with official cash flow guidance provided after the year ends in February. Preliminary insights suggest that cash flow in 2024 will benefit from expected earnings growth, including anticipated increases in interest expenses. Cash taxes are projected to be $40 million to $60 million lower in 2024 for the reasons mentioned earlier. Additionally, we expect net working capital uses from our preneed program to be offset by reduced ICP payments occurring early in 2024. As we look ahead, you can expect more of the same from our company, particularly in 2024, with strong and consistent cash flow, a solid balance sheet, and significant liquidity that will enable continued capital investment to maximize shareholder value. I would like to conclude by thanking the entire SCI team for their outstanding contributions and dedication. This concludes our prepared remarks. I will now turn the call back over to the operator to open it up for questions.

The first question comes from Joanna Gajuk with Bank of America.

So I guess, first, you talked about 2024 initial outlook here. Thanks for that color, and I guess the bridge to how you were thinking were the initial, I guess, obvious you expressed in May 2022. So that's helpful in terms of the interest expense. In terms of the cemetery segments, specifically, so two questions there. So first, you talk about expectations for cemetery revenues actually grew low single digits year-over-year. But I guess for this year, for '23, production will be down. So I guess, what's driving the revenue actually growing into next year?

Yes, Joanna. So thanks for the question. Yes, I think the way to think about cemetery, especially if you correlate it with preneed funeral, what we saw through COVID was a real spike in cemetery sales much higher than funeral. The discretionary consumer on the cemetery side was more likely to purchase. That probably was because they're very focused on that issue. Secondly, I think on the funeral side, you're very reliant upon seminars, direct mail, digital leads. So meeting in person was pretty difficult to do. If you look at both sales trajectories over the entire period, the compounded probably the same. The difference is cemetery really spiked up and now has to come down the mountain a little bit, whereas funeral did not spike as much and is now continuing to eked out the growth. But the trajectories are pretty much the same. The cemetery business relies upon traffic to come through the places. As you think about the impact on COVID because funeral volumes are down 6%, that has an impact on our lead source skewing towards cemetery. There's less traffic, there's less people to sell to. So again, I think as the funeral volumes stabilize, that’s when year-over-year we think we begin to go back to be able to grow cemetery sales. We're predicting that right now for 2024, that our funeral volumes will be slightly down because of, again, excess deaths and COVID trending slightly down. But we feel confident about our ability, from a lead source perspective and a traffic perspective, to get back to that low to mid-single-digit growth that you expect to see from our core cemetery business.

Because that was my second question in terms of how you think about, I guess it supports 2 parts, right, how you think about the cemetery growth after 2024, which you just answered, but also on the preneed cemetery sales production. Remind me, I don't know whether you said it for next year or afterwards.

Next year, we believe preneed cemetery sales can grow in the range of 3% to 6%, depending on various factors. We feel confident about returning to this trajectory. However, it's important to note that funeral volumes may decline slightly, which could impact our lead source but likely not more than a percentage point. Therefore, you can expect preneed cemetery sales growth to be around 2% to 5%. Keep in mind that cemetery purchases are discretionary. This morning, I heard Brian Cornell from Target discussing how they've seen consumer discretionary volumes decline for seven consecutive quarters. Considering the diminishing excess savings, ongoing inflation, and higher interest rates affecting consumer spending, there are several challenges facing discretionary spending. I'm proud of our sales team for their achievements in this environment, which I find impressive. I remain optimistic unless something significantly negative occurs regarding consumers' discretionary spending capacity. At the higher end, we continue to observe positive trends, which I believe are more closely linked to the stock market and housing prices since inflation and interest rates do not seem to affect this consumer segment as much. So, for next year, anticipate slightly lower than usual growth, but by 2025, I expect we’ll return to the 3% to 6% same-store growth that you are familiar with.

No, that's very helpful. And I guess, if I may just squeeze one more for Eric in terms of the G&A commentary. How should you think about this number going forward into next year? Is there going to be a reversal of this accrual that's going to impact next year when it comes to numbers?

Yes, there probably is. The annual guidance, since you're talking annually, and I was talking quarterly before, is generally to have G&A expense in the $150 million to $160 million range for the full year. I think we'll end at the low end of that, if not slightly below that low end of that range. I believe next year in 2024 will end up probably in the heart of that range. So if you put us in the $145 million to $150 million for '23, you're looking at a little bit of a headwind getting back up to the middle of that $155 million.

All right. So would you say, I guess, as a follow-up to that on the comp accrual, the magnitude of things? Was it like $5 million, a little bit more than that, it sounds like?

Yes. I think in the quarter, you're comparing against a very strong accrual that was really bringing a lot of the ICP accruals up to kind of their max last year. So it's probably a tailwind during the quarter of I don't have it in front of me, but I'd probably say $0.03 to $0.04 in that ballpark for the specific quarter. Of course, we’ve got to get some of that back next year depending on how we accrue it. But everything I just said in terms of my assumptions for G&A assumes kind of a middle of the road target percentage for 2024, not a max percentage that we saw in 2022 if that helps you.

Our next question comes from Scott Schneeberger with Oppenheimer.

It's Daniel filling in for Scott. Can we discuss the expectations for funeral volume next year? What range do you anticipate, and how are you considering the effects of pull forwards at this stage in the cycle? Do you view 2024 as the final transition year before things normalize in 2025?

No. I think Eric has probably got a much better number statistics, but I'd say philosophically, the way we're thinking about this, that pull-forward effect diminishes each year. So we do think there's a pull-forward effect in '24. We think it's going to be in '25 and '26, but it becomes pretty negligible as you get further out. So in that regard, year-over-year, it's actually an improvement when you think about 2024. Having said that, in 2023, we continue to see some COVID deaths; we continue to experience some excess deaths. So as we think about those trends, those are beginning to go away as you get into '24 to '25. So, the net effect is slightly negative. That's what we're trying to point you towards is we think there's still a bit of a drag on 2024. Probably in the call it, 1% to 2% range as you think the year-over-year decline versus what we're seeing this year, about a 5% decline. Then as you get out to '24 and '25, our assumption would be that you begin to climb back up and see favorable year-over-year trends getting back to kind of that, call it, 1% growth in the numbers of deaths and then our competition for market share.

Got it. Switching gears to margin. Could you please speak to margin expectations for next year across both segments? I know I think a pretty good cost performance on the funeral side this quarter. In the past, you talked about the efficiency you gained during the pandemic. So if you please can get an update on how you think about the segment margins looking into next year.

For the year, we expect overall segment margins to be positive, with a stronger projection for the cemetery side compared to the funeral side when considering year-over-year comparisons. However, I want to highlight that the first quarter of this year may be a challenging comparison due to sales production and funeral volume. As we look ahead to 2024, we believe it's reasonable to anticipate margins to remain flat or experience slight growth.

Our next question comes from John Ransom with Raymond James.

Looking at the midpoint of your guidance next year, the $3.65, how do we think about the cemetery recognition rate, which was certainly elevated this year? Where does that go relative to this year, I'd say, last year?

No. I think last year, when you look at what's in the press release, the recognition rates were probably in the low 90s, John. I think they're probably going to be in the mid-90s is kind of where we're going to end this year. I would probably say that 2024 will probably be in that ballpark. So think of it as we’re starting to get back and completing the construction projects, recognizing the revenues. You saw that in the quarter that we were on plan and what we expected to do. I think you'll see more of the same in '24. So think of '24 being kind of a mid-90% type recognition rate similar to how '23 will end.

Okay. So that's higher than what you mentioned. Is that the new standard, or are we still seeing a decline from the major construction projects?

No. I think there's more to come beyond that. But I think that for right now, what we have on our radar and visibility for the next 18 to 24 months, I think that's a good metric to use.

Okay. Using the midpoint of your guidance, how are you considering the share count for next year given your increased repurchase activity so far this year?

Yes. I mean, it depends on what happens and what the price is because as you've seen us, we kind of throttle up and throttle back based on what we think the value is in that. We've already purchased, as we gave you the numbers through October already. We're already in the 6.5 million share range as what we repurchased back. I think there's potentially more of that to come during the fourth quarter as we've already described to you. So it just depends on going forward. Right now, that 6.5 million has brought our basic shares outstanding, let's just talk about that, as opposed to getting a dilutive calculation to about 148 million to 149 million shares outstanding. I think we're very happy to finally pierce through that 150 million, and I think we'll go from there. But will it moderate in '24? There's a lot of assumptions to that in terms of what are there other opportunities with a higher return to deploy the capital to and what the share price is.

You're kind of into that buy-low thing? Is that what you're telling me?

We kind of are.

I hope this is the last time I ask this question because I know it was tedious, but can you provide an update on putting your prices online, FTC competitor behavior, and whether you're experiencing any fallout from that? What are your thoughts for next year in that area?

Yes, it's pretty much consistent with what we've discussed previously. In early September, there was a public workshop attended by many industry participants and some external attendees along with the FTC, where we were present. After that, we sent a letter reiterating our points from the workshop, which aligns with our previous statements; this was sent in early October. Regarding our online pricing strategy, we have not altered our position. Currently, out of our 1,500 funeral homes, about 1,000 to 1,100 have their pricing posted online. We offer various pricing options, from basic to premium experiences, allowing detailed exploration of services and menus for celebrations, among other features. Our approach will continue to evolve as we gather insights. We're pleased with our engagement with consumers through our Dignity Memorial website and will keep investing in our digital presence. From the FTC's standpoint, regardless of their decisions, I believe we are ahead of the game, and I don't anticipate any significant impact on our business moving forward.

So just to put a fine point on this in the markets where you've done this, you're not seeing any knock-on effect from the online pricing?

We're not seeing any negative effects, and we're actually seeing, in some markets, some positive effects as it relates to preneed leads and preneed consumers. So we're going to keep going. We're going to keep testing. We're going to find the right variables to figure out. That's what a lot of the people doing this, our management team is good at.

I'm sorry, I just want to continue with this because we receive a lot of questions. In your markets, if a competitor does not post their prices online, how do you find out what the local situation is? Do you rely on mystery shopping or other methods?

Yes. I would say our market management is very, very plugged in with their competition, both online and what's happening at their competition is pretty much each and every week and each and every day.

You meet the demographics.

Yes, I keep getting the flyers from Dignity. I don't know what you guys are telling me that last checkup was fine. I got a little ways.

We have a follow-up question from Joanna Cajuk.

I guess on this last topic. So I understand the workshop took place, and it sounds like FTC was still collecting some information. So there’s any update on the timing when we might hear from the FTC?

Yes. We really don't, Joanna. I mean, this has been going on for several years at this point in time. I think there is a little bit of a change in flavor that we picked up on at the FTC that maybe this is sooner rather than later. I wouldn't have said that last quarter before the September 7 meetings that all of the industry had an opportunity to go to. But I'm hoping it's sooner rather than later, but my predictions with the FTC and the government have not been on compared to the timing, as you know.

All right. So I guess we just sit and wait. But actually, my other follow-up, when you were talking about the presales production on the cemetery side. So can you give us maybe some comparison to how things were in Q2 large sales versus the lower end of mid-tier? I guess you talked about large sales around or above $50 million in Q2. So I guess where it was in Q3? And on the lower end, I guess, you continue to offer financing options to the customers because it sounds like that's what you were trying to do to bring back some of these customers to you?

Yes. To fact that the first one was large sales, and we continue to see a lot of success there. I mentioned that from 2019 levels, this third quarter was 2.5 times higher. I think in the second quarter, we were about equivalent at about $50 million and $49 million, so about the same pace on that piece. As it relates to the consumer incentives, we have rolled those out. I guess I would describe that as a mixed bag. In certain markets, it's been effective; in other markets, maybe not as much. But it's a tool in the toolkit of our sales teams that they're utilizing and to varying degrees of success. We just want to make sure if there’s a customer that has a need and has a want, that we've got a plan for them to fix it. I don't think we've seen anything dramatic yet, Joanna, but we're continuing to utilize that as a tool.

Okay. And I guess do you still offer like a 0% financing? Or I guess that's off the table?

Again, it's kind of a toolbox item for different markets, right? So they have different things that they can utilize if they see that consumer base and what may drive behavior. We try to give them a variety of things that they can utilize to help the consumer get on board, including 0%.

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