Service Corp International (SCI) Q1 2024 Earnings Call Transcript

Good day, and welcome to the SCI First Quarter 2024 Earnings Conference Call. Please note this event is being recorded. I would now like to turn the conference over to SCI management. Please go ahead.

We're going to have some prepared remarks about the quarter 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 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 also in our filings with the SEC that are available on our website. Today, we might also discuss certain non-GAAP financial measures, a reconciliation of these measures can be found in the tables at the end of our earnings release and also on our website. With that out of the way, I will now turn it 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 our outlook for the rest of 2024. For the first quarter, we generated adjusted earnings per share of $0.89, which compared to $0.93 in the prior year or a decline of $0.04 per share. We had anticipated a decline in earnings per share from operations for the quarter due to lower funeral volumes, lower non-funeral home revenues, and lower cemetery revenues recognized from completed construction projects. While these trended as we had anticipated, stronger-than-expected preneed cemetery sales in a slightly better funeral sales average allowed us to reduce the operating shortfall, resulting in a better-than-expected $0.06 per share decline in operating earnings per share over the prior year quarter. Below that of a lower share count and a lower income tax rate, more than offset the impact of higher interest expense, producing a net favorable increase in earnings per share of $0.02, resulting in a combined net $0.04 decrease in earnings per share for the quarter. Now let's take a deeper look into the funeral results for the quarter. Total comparable funeral revenues declined $9 million or about 1% over the prior year quarter, and an increase of $4 million in core funeral revenue was more than offset by an expected $12 million decrease in non-funeral home preneed sales revenue. Although core funeral volume declined 3% compared to the prior year quarter, we believe due to the COVID pull-forward effects, volumes were in line with what we had anticipated. Our core average revenue per service grew over the prior year by an impressive 4%, even after absorbing the negative effects of a modest 70 basis point increase in the cremation mix. SCI Direct non-funeral home preneed sales revenue decreased by $12 million, primarily due to operational changes in our California market with respect to the timing of merchandise delivery. We would anticipate the quarter-over-quarter net revenue decline to diminish over the coming quarters as compared to the first quarter of 2024. It is our intention over the next several quarters to implement this and other operational changes across the remaining non-funeral home market as we begin offering an insurance-funded product for SCI Direct service and merchandise sales, as well as shifting certain travel protection sales to an insurance-funded product where it makes sense. While these changes will defer recognition of these revenue streams until the at-need cremation services performed, it will also generate significant general agency revenue upon the sale of the preneed contracts, which we expect to mitigate the effect of the revenue decline from these operational changes. Over the coming years, we would expect to grow General Agency revenues at very healthy and sustainable growth rates. And when combined with organic growth in the number of contracts maturing from the preneed backlog for SCI Direct should result in very impressive revenue and profit growth rates for SCI Direct. From a profit perspective, funeral gross profit declined $18 million, while the gross profit percentage declined by 270 basis points to about 22%. This decrease is primarily due to the decline in revenue and an increase in annual incentive compensation costs over the prior year quarter. Preneed funeral sales production decreased by $8 million or about 2% over the first quarter of 2023. This was primarily due to a decline in our core sales production as non-funeral home sales production was relatively flat over the prior year quarter. Now shifting to cemetery. Comparable cemetery revenue increased by an impressive $21 million or about 5% compared to the prior year first quarter. Recognized preneed revenue accounted for the preponderance of the increase, growing by $20 million or 7%. Growth in preneed cemetery sales production of $24 million or almost 8% over the prior year quarter delivered $8 million of the $20 million recognized revenue increase, as the preponderance of our sales production increase was deferred and will be recognized in subsequent quarters. Preneed merchandise and service revenue delivered $12 million of the recognized revenue increase as robust increases in contract averages, favorably impacted by increased merchandise and service trust income, combined with a slightly higher delivered units, produced 14% growth compared to the prior year quarter. $17 million of the $24 million increase in preneed cemetery sales production was generated from a 6% growth in core cemetery sales over the prior year quarter. Bard sales accounted for the other $7 million of the increase, which was a 19% increase over the prior year total. Cemetery gross profits in the quarter increased by $3 million from increased revenues, and the gross profit percentage declined by 100 basis points, still generating margins over 32%. This decline in gross profit percentage was primarily due to an increase in annual incentive compensation costs as compared to the prior year quarter. Now let's shift to a discussion about our outlook for 2024. As you saw in our earnings release, we're confirming our normalized earnings per share guidance range of $3.50 to $3.80 for 2024, or a midpoint of $3.65. Remember, the first quarter was the most challenging year-over-year comparison because we anticipated the most difficult comparisons to occur in the quarter in both revenue recognized from cemetery completed construction projects and non-funeral home preneed sales revenue. We also knew our most challenging comparison of variable interest rates on our floating debt would occur in the first quarter. As we think about comparing the rest of 2024 earnings per share expectations against our last 9 months of 2023 normalized earnings per share, we expect year-over-year growth in earnings per share in each of the subsequent quarters, driven by increased profitability in both the funeral and cemetery segments. We expect low single-digit increases in funeral revenues, and we anticipate increased sales production and increased revenue recognized from completed construction projects combined to drive mid-single-digit increases in cemetery revenue over the coming 9 months. In conclusion, 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. You are what makes our company great. With that operator, I'll now turn the call over to Eric.

Good morning. And again, a warm welcome to everybody joining today's earnings call and similar to the way Tom just ended his remarks. Before I get into my prepared remarks, I want to take a moment, as I customarily do, to extend my sincere appreciation to our dedicated team of over 25,000 associates at SCI. Your constant commitment to serving each and every one of our client families with empathy and unwavering excellence is truly remarkable. We take immense pride in the fact that our associates embody our fundamental values of respect, integrity, service excellence, and fostering enduring relationships. So thank you. Now let's go ahead and shift to my remarks for the quarter. I'm going to first discuss our cash flow results before moving to capital investments during the quarter. I'll end with providing some forward-looking commentary on our outlook, and also finish with talking about our current financial position. So in the first quarter, we generated an impressive adjusted cash flow from operations of $220 million. This is flat compared to the prior year and was in line with our expectations. Lower operating income and higher cash interest payments were more than offset by slightly lower cash taxes and favorable working capital. So let me give you a little more color on those items. Operating income declined by about $13 million quarter-over-quarter due to an expected decline in earnings that Tom just walked us through. Additionally, we saw $14 million of higher cash interest payments during the period as anticipated and as a result of higher weighted average interest rates and balances on our floating rate debt during the quarter. Cash taxes in the quarter were slightly lower than the prior year by about $4 million. Now while federal cash tax payments are generally not made in the first quarter, I want to reiterate from my previous comments that we expect our 2024 cash taxes to range between $25 million to $35 million. 2024 is being impacted from a temporary benefit of about $150 million of reduced cash tax payments as a result of the tax accounting method change that I've now discussed over the last several quarters. And as we look to 2025 and beyond, we expect cash taxes to revert toward a more normalized trend that, again, would not include this $150 million benefit beginning in 2025. And finally, working capital provided a net $23 million source of cash during the period, primarily driven by favorable impacts associated with lower 2023 incentive comp cash payments that were actually paid this quarter in 2024. So I'll now touch upon our capital investments in the first quarter. We invested a total of $103 million into improvements of our existing funeral homes and cemeteries, new growth opportunities, and real estate for future expansion. We invested $70 million of maintenance capital back into our current businesses, with $39 million for cemetery development, $25 million into improvements to our various funeral and cemetery locations, and $7 million into our digital strategy and other corporate investments. The cemetery development spend increased on a year-over-year basis as we continue to execute on opportunities to invest in high-returning cemetery construction projects. These projects generate high-quality cemetery property for our customers, helping to drive the strong preneed cemetery results we've seen this quarter and in recent quarters. We also invested $16 million of growth capital in the quarter towards the purchase of real estate, the construction of new funeral homes, and the expansion of existing funeral homes and cemeteries. Finally, we made several accretive acquisitions in the quarter, closing on $16 million in total. We remain optimistic about the activity we're seeing in the second quarter and the pipeline through the remainder of the year. With that, we now believe we'll be at the high end of our $75 million to $125 million acquisition investment target for 2024. In addition to the investments into our business and the acquisitions, we returned $93 million of capital to shareholders in the quarter through $44 million of dividends and just under $50 million of share repurchases. We purchased about 700,000 shares at an average price of about $70 during the quarter, and this ended the quarter with just over 146 million shares outstanding. Now subsequent to the quarter, we continue to be active on the repurchase of shares, acquiring about another $700,000 of shares for just under a $50 million investment. In the press release, while we've confirmed our 2024 adjusted operating cash flow guidance of a range of $900 million to $960 million, with a midpoint of $930 million, we deem this again as appropriate. When we deduct $325 million of expected maintenance capital, this results in an impressive adjusted free cash flow of just over $600 million or over $4 adjusted free cash flow per share for 2024. In addition to the strong cash flow foundation, we also have a very favorable debt maturity profile and liquidity of just over $900 million at the end of the quarter, which consists of a cash balance just over $200 million, as well as approximately $700 million available on our long-term bank credit facility. Our leverage at the end of the quarter remained close to the year-end number at 3.59x net debt to EBITDA, and again, we maintain our near-term bias towards the lower end of our targeted leverage range of 3.5x to 4x until we have a little bit more clarity as to where interest rates will go from here for the rest of the year. So in closing, I'd like to reiterate that our solid balance sheet, our ample liquidity, and our predictable cash flows will continue to fortify our capital investment strategy of investing to the highest and best use in order to maximize shareholder value. So before we open the call out to questions, I have one more topic I'd just like to mention very briefly. And I'd like to compliment and recognize Debbie Young, who most of you on the call know very well. Some of you on the call, as I look at these questions with A.J. and perhaps Ransom, have been around for the last many, many years, where Debbie has led over 37 years at our company. She has led Investor Relations for over 25 years, or as I like to say, over 100 quarters. She's led our Investor Relations program here and has done a remarkable job. Debbie has decided to retire at the end of this quarter and ultimately will spend more time with her husband Scott and her son Matthew. Please join us in wishing Debbie the best of luck. And from a personal perspective, what makes a job great is when you're able to work with great people that become your friends over the last several years. Debbie, you made a lot of tough times here early on 25 years ago a lot easier, and you make the good times a lot better. So for that, I thank you, and we all thank you.

Our first question comes from A.J. Rice of UBS.

Best wishes to you, Debbie. I'm glad Eric didn't try to guesstimate how long John Ransom and I have been doing this. A couple of questions, if I could. First of all, there was an announcement from the Attorney General out of California reaching a settlement regarding some cremation practices. I wonder if you could just give us your perspective on that? Does it change anything going forward? Your perspective on it would be helpful.

Sure, A.J. Thanks for the question. After about 8 years of back and forth, we reached a settlement with the California Attorney General that includes the cost reimbursement and civil penalties of $23 million, which you probably saw in the press release, and provides certain pre-need contract customers with the right to receive refunds. There's no admission of any wrongdoing or fault by the company or the officers of the Board. We believe that our fourth quarter 2022 accrual that we made in relation to this is adequate to cover the $23 million civil penalty and reimbursement, as well as any estimated cancellations from the customer contract. A little history here: The lawsuit was brought by the state. It was primarily based on the interpretation of the Short Act, which is under California law, very specific to California. While we don't agree with California's interpretation, we've agreed to certain operational changes that allowed us to remedy the dispute. A.J., you mentioned any changes. As I stated, in California, we had stopped delivering merchandise, and that's one of the reasons the non-funeral home revenues have been down. We've been looking at the model, and while this is very specific to California, we believe in compliance with every law. We saw an opportunity to streamline the SCI Direct model. As I mentioned over time here, we're going to transition SCI Direct from delivering merchandise in advance and delivering TRPP to shift that product to an insurance product. We believe this will streamline the model and provide protection for our customers who pay over time. This will allow us to leverage the value of our insurance sales production stream and will generate general agency revenues, which will offset the effects of not delivering the merchandise. We are excited about this transition. We believe that we settled a dispute with the AG, and we're happy about that. Hopefully, that covers the questions you may have around that topic.

Yes, no, that's great. And I know you commented on acquisitions in the prepared remarks a little bit. But I wondered, obviously, you've got the expiration of the standstill arrangement related to steward, and that would open up some new market opportunities that haven't been available to you for a while. Would those not be some of the more accretive deals that you can do because you already have some facilities in those locations?

Yes, A.J., you're exactly right. The markets that will open up are the ones we really like since we already have a presence in them. Eric mentioned that we feel really good about the rest of the year. That means we've got a number of deals that are under a letter of intent and others that are in the final stages of negotiation. Businesses come for sale when the seller is ready to sell. What we've found is that over the last 10 years, there has been a time for businesses to come up that we would have loved to participate in, but it precluded us from participating due to negotiations needing to wait for approval from the Federal Trade Commission. Now that we don't have to go to the FTC for transactions under $120 million, I think it's going to be good. But I would say that today, absent that, we still feel very good about the pipeline of acquisitions.

Our next question comes from Parker Snure of Raymond James.

You have Parker on for John Ransom. Maybe just talk about the cemetery preneed production. It was up almost 8%. Anything notable to call out there? Was there any bounce back in the Qingming sales that maybe you lost last year? Anything notable in terms of geography and then maybe the high-end versus the low-end?

Sure. The Qingming, again, as you know, kind of crosses quarters. We have an impact that typically happens in the last couple of weeks of March and probably will have a few weeks in April. We're very pleased with Qingming this year, and I think that reflects in the first quarter results as well. We feel great. The nice thing about the first quarter is not only do we have great large sales that grew 19%, but our core products grew by 6%. So we're hitting on all cylinders in a lot of different markets and feel good about the direction and momentum that our sales team has. But I want to caution you that a big lead source for preneed cemetery sales is funeral volume and therefore, burial volume. We still have a little bit of a hangover, as you think about the pull-forward effect, which can put slight pressure on that lead source. The good news is that our sales teams are overcoming that with increased digital leads, better follow-ups, and great products in our cemeteries available to sell. We feel great about the momentum. It's still early in the year, so we don't want to spike the ball on the 40, but I'm confident about where we're headed for the rest of 2024, and even more confident about 2025 and 2026.

And then just any updated thoughts on the FTC funeral rule? Any updated thoughts on timing and when we might see that?

Parker, it's Eric. No, we really don't have any updated thoughts. We have been very consistent, saying we continue to have a very good relationship with the staff of the FTC and are helpful in working through it. We've submitted all the way back in October of 2023, and I think the whole industry is waiting for finalization. The important thing to remember is we don't believe there's anything coming out of this rule that will have a material effect on our company one way or the other. We think, ultimately, it's a good rule for the industry, but nothing that's going to materially impact our financial projections.

All right. Great. Congrats, Debbie.

Our next question comes from Joanna Gajuk of Bank of America.

I have a couple of follow-ups. Not the last topic, but the one before, around the cemetery pre-sales production. It sounds like it's actually the large sales, but also core was up. So did I hear that core was up mostly on pricing? What gives you the ability to drive pricing while inflation and interest rates are still high? Can you talk about the consumer perception and demand in both core and large sales?

Sure, Joanna. The large sales continue to grow significantly compared to where they were just 5 to 6 years ago. A lot of that success is due to the product we can offer and our sales force's ability to close. If you consider the high-end sale—varying by seasonality— the second quarter is probably stronger than the fourth quarter. We anticipate doing about $40 million to $50 million a quarter in that segment. It is contingent on where the economy and stock market are because those buyers are typically not borrowing money. On the other end, we experienced good activities, although activity for the quarter was relatively flat from a unit perspective. However, we're约10% to 11% higher than pre-pandemic levels. Most of the increase in core is related to average. Some of that reflects inflationary pricing, but a significant portion is due to customers trading up to enhanced products. We continue to invest in our inventory at levels of $100 million to $130 million a year to keep bringing in new inventory property.

Thank you for the clarification on the 10% to 11% increase because looking at the preneed sales production dollars, it’s like a 9% CAGR versus the first quarter of '19. It sounds like there's definitely demand and people willing to spend money, which is good for the business. A couple of other follow-ups. Your comments around deal spending for the year seem to indicate your confidence is increasing. Does this signify anything meaningful for your guidance in terms of accretion from these deals?

Yes, Joanna, you're right. While we're excited about it, it's not going to have a material impact on our guidance. Obviously, it gives us a little more confidence in achieving the range, and as is typical for the first quarter of the year, I think as we get through the first half, we'll have a better idea of that pipeline. Three months does not make a year.

Can you also give us a sense of the assets acquired in the quarter—what's in the pipeline?

Eric mentioned that the assets we acquired in the first quarter were predominantly funeral homes and cremation facilities. In terms of the pipeline, I always hesitate to provide specifics until they're closed, but we do have a few deals under letter of intent and others are very close to getting one. It’s a combination of both funeral homes and some cemetery investments that we hope will be coming online soon. We're optimistic about the level of activity, and as Eric said, we feel confident in achieving the high end of the range.

And regarding your confidence in deal spending, is that why you did not buy as much stock in the quarter? The $50 million was the lowest since 2019.

Yes, I’d respond in two ways: We maintain a history of ramping up and down based on value perception. So you'll see some quarterly volatility. We still strongly believe in the share repurchase program. We don’t want you to interpret this differently, including what we did in the quarter and what I mentioned we already accomplished this quarter. Last quarter, we took on debt for share buybacks and acquisitions, and this quarter, we focused on paying down debt. It’s about a $100 million swing. We paid down debt, and it's not a change in strategy. Three months don't make a year, as Tom mentioned. But we also had a bias towards the lower end of our leverage range of 3.5x to 4x. We anticipate some floating rate relief in the latter part of the year. That said, I'm confident in the share repurchase program in the beginning of this quarter.

Joanna, just to add, there’s a technical reason. During quiet periods, we cannot make day-to-day decisions and must follow a formulaic approach. The first quarter has the longest duration where we have limited discretion, so that likely contributed to the lower activity.

Got it. That makes sense. Just to clarify further on projections into 2025. After you stated that you saw good momentum this year, should I interpret that in a similar way to the comments made less than 3 months ago regarding an 8% to 12% EPS growth and strong returns in 2025?

Yes, I feel we have increasingly positive indicators for 2025. Our expectations and trends for the first quarter are positive, and getting the AG matter resolved should allow us to transition to a new SCI Direct strategy. This strategy will ultimately generate general agency revenues and contribute to a robust growth platform. Our digital leads continue to grow, our sales teams are productive, and I’m very optimistic about our trajectory for the rest of 2024 and beyond.

Our next question comes from Scott Schneeberger of Oppenheimer.

Congratulations to Debbie on achieving a century mark—100 quarters is quite a milestone! I'd like to start out with a high-level question for you, Tom. From the pandemic pull-forward, we've been going through this reversion period. Where are we in that? What inning would you say we're in regarding that reversion? When do you expect to see normalization and maybe some improvement in funeral volume?

Yes, Scott. We feel like 2024 is likely the last year we experience the net true hangover. As you consider the remainder of 2025, we expect flat to positive growth. The impact of COVID will lessen. As you near the back half of the decade, demographic changes will be beneficial. We believe that our growth in preneed will continue to capture market share reflected in funeral volumes moving forward.

Yes, what's our perspective on interest rates? Currently, we're around 7.4% on floating debt. The first half of the year has tough comparisons as it was already elevated last year. nLooking forward, whereas we initially anticipated 3 or 4 rate cuts, that has likely shifted to about 2 by the end of the year. However, this won’t be materially impactful. Our variable debt constitutes about 30% of total debt, and a 25 basis point cut wouldn't significantly affect our results. This small move won't change any guidance.

Appreciate that. A last quick question regarding cremation mix. It's a bit lighter year-over-year than historical trends. Is this just from year-over-year comps, or is there anything else we should consider?

Scott, what I believe is that trends will likely revert to the mean. We've seen variations over the years. It can ebb and flow, and we generally expect a 100 to 150 basis point change per year. We've observed it in our numbers, and we're optimistic about our outlook.

The next question comes from Tobey Sommer of Truist.

Debbie, reaching a century mark seems like an apropos milestone. Could you comment on your expense inflation, particularly regarding labor and merchandise for 2024 versus last year?

On merchandise, we have long-term agreements with inflationary caps, so I have confidence in our forecast, which has been lower than general inflation. We're maintaining merchandise costs through these contracts. On the wage front, we experienced wage inflation over 4% in recent years but are beginning to see it normalize to the high 3s. Wage inflation is still elevated compared to the past, but we expect to see it stabilize as we head further into 2024.

Looking at your customer base and sales experience, can you tell us how revenue trends appear across low, mid, and high-end customer bases in both cemetery and funeral?

It's less of an issue on funeral and probably more of an issue on cemetery sales. Buying preneed cemetery property tends to be less emotional than at-need decisions. In periods of high-interest rates, consumers may be more price-sensitive. We see high demand at the high end and continued interest in the mid level, but we notice consumer sensitivity to price in the low-end segment. This is partly due to inflation affecting their everyday lives. We offer plans and strategies to help them engage, whether through terms or rates. We’ve done a good job of keeping them active.

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

We want to thank everybody for being here today. I want to reiterate the exceptional contributions of Debbie Young. We will miss her dearly, but we're excited for her next chapter. Thank you, everybody.

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