Service Corp International (SCI) Q2 2024 Earnings Call Transcript

Good day, and welcome to the SCI Second 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.

Good morning. This is Allie O'Connor, AVP of Investor Relations of financial reporting. Welcome to our second-quarter earnings call. We will have prepared remarks about the quarter from Tom and Eric shortly. 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 in our filings with the SEC that are available on our website. Today, we may 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 on our website. With that out of the way, I will now turn it over to Tom Ryan, Chairman and CEO.

Hello, everyone, and thank you for joining the call. To kick things off, I will begin my remarks with some high-level insights into our business performance for the quarter and provide some greater detail around our funeral and cemetery results. I will close with some thoughts regarding our earnings expectations for the rest of 2024. For the second quarter, we generated adjusted earnings per share of $0.79, which compared to $0.83 in the prior year. The decline of $0.04 from the prior year was attributed to an anticipated decline in services performed. This decline was slightly offset by an increase in cemetery profits and better-than-expected results from recent acquisitions. The favorable impact of a lower share count was offset by the negative impact of higher interest expense and a higher tax rate. Let's take a deeper look into the financial results for the quarter. Total comparable funeral revenues declined by $5 million or about 1% over the prior year quarter. The comparable core funeral revenues accounted for this shortfall as it declined almost $7 million. Funeral volume declined by 2.7% versus our expectation of flat to slightly higher volumes. Funeral volumes tracked our expectations during the first four months of the year, and we saw an unexpected decline in May and June. We believe the COVID pull-forward effect combined with lower excess deaths across our markets contributed to the decline in services for the quarter. However, we are seeing more positive funeral volume trends in the month of July with comparable case volume trending positively versus the prior year and our modeling expectations. Our core average revenue per service grew over the prior year quarter by 1.3% after absorbing the negative effect of a 60 basis point increase in the cremation mix. Preneed non-fuel revenue decreased by $7 million, primarily due to operational changes in our California market regarding the timing of merchandise deliveries, which we discussed with you on the first quarter call. This was offset by a $7 million increase in core general agency commissions and other ancillary revenues, generated by the favorable impact from higher insurance-funded sales production and higher general agency commission rates. From a profit perspective, funeral gross profit declined by $16 million as the gross profit percentage declined from about 21% to about 18%. This decrease is primarily due to the decline in revenue, increased annual incentive compensation, and operational costs, reflecting the timing of incentive compensation accrual adjustments over the prior year quarter. Preneed funeral sales production increased by $7 million or about 2% for the second quarter of 2023, led by a $10 million or 4% increase in core preneed funeral sales production. Now shifting to Signature. Comparable cemetery revenue increased by $12 million or about 3% compared to the prior year's second quarter. The increase was due to a $7 million increase in core revenue and a $5 million increase in other revenue. The $7 million quarter revenue increase was primarily the result of a CAD10 million or 11% increase in recognized preneed merchandise and service room. Robust increases in contract averages were mainly supported by favorable cumulative trust earnings. The other revenue increase was predominantly the result of a $4 million increase in endowment care fund income. Comparable preneed cemetery sales production decreased by $7 million or 2%, which was less than our flat to slightly above expectation. While we saw a $4 million increase in core sales production, we had an offset of an $11 million decline related to large sales. We believe this is purely timing as we continue to see long-term strength in our preneed cemetery inventory and sales production. On a positive note, year-to-date, preneed cemetery sales production is up $17 million or about 3%. Cemetery gross profits in the quarter increased by $5 million, and the gross profit percentage increased by 30 basis points, generating an operating margin percentage of 33%. The profit from higher revenues was slightly offset by higher maintenance costs and an increase in annual incentive compensation costs, again reflecting the timing of incentive accrual adjustments 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 now believe our full-year results will be at the lower end of our adjusted earnings per share guidance range of $3.50 to $3.80 for 2024. For the back half of 2024, we would expect growth in revenues and margins for both the funeral and cemetery segments, resulting in impressive earnings per share growth compared to the prior year's six-month period. As well as compared to sequentially to the first six months of 2024. We anticipate a more challenging funeral volume comparison and lower revenue recognized from completed cemetery construction projects in the third quarter versus the prior year, and therefore expect the majority of the earnings per share growth to occur in the fourth quarter. As we consider 2025, we expect to return to earnings per share growth towards the higher end of our historical annual guidance range of 8% to 12% as the negative effects of comparably higher interest rates and SCI Direct operational changes subside, and the positive impact of our new Global Atlantic preneed funeral insurance agreement takes effect. Beyond that, I am genuinely excited about our vast North American network featuring market-leading brands and businesses, a world-class workforce, and a robust preneed backlog. We are poised to capture incremental value for our shareholders as demographic trends positively impact our interests. In conclusion, I want to acknowledge and thank the entire SCI team for their daily commitment to our customers, our communities, and one another. Your dedication is the foundation of our success. Thank you for making a difference every day. With that, operator, I'll now turn the call over.

Thank you, Tom, and good morning, everybody on the call. I guess I'll start off in the same way. I want to express my appreciation for your comments, Tom, and really just start by thanking all of our 25,000 associates here at SCI for their dedication to the communities and the client families, especially those client families during their greatest times of need. Again, your inspiring commitment and exceptional efforts do not go unnoticed. Most importantly, I want to thank you for everything that you do for our company. With that important note mentioned, today, I'm going to first discuss our cash flow results before moving to capital investments during the quarter. I'll end with some commentary on our outlook, similar to what Tom just provided, and I'll also talk a little bit about our financial position. Our cash flow remained resilient in the quarter despite lower than anticipated funeral services performed, as we've mentioned this morning and yesterday, and was primarily aided by strong cash receipts from not only preneed installment sales but our underlying funeral and cemetery operations. For the second quarter, we reported adjusted operating cash flow of $220 million, which is an increase of $62 million over the prior year. The primary contributor to that increase was lower cash tax payments of about $60 million. That's due to the tax accounting method change related to the timing of recognition of cemetery property revenue for tax purposes. As a reminder, this tax accounting method change will resolve in the deferral of cash taxes in future years as the installment payments for cemetery property are received. We have discussed that now for several quarters. As we look forward to 2025 and perhaps beyond, we expect cash taxes to revert toward a more normalized trend that you would expect from us with an anticipated increase of $150 million in cash tax payments going forward compared to 2024 levels. In terms of cash flow, cash flow was generally flat to the prior year, with net favorable working capital, primarily associated with premium installment sales, more than offsetting the operating income decline that we've discussed and slightly higher cash interest payments. While we're on the topic of cash interest, assuming the rates remain at the current levels, we continue to expect an increase in cash interest in the second half of this year of about $5 to $10 million. And that relates to higher floating rate debt balances compared to the prior year. Now shifting to capital investment activity. During the quarter, we invested just over $300 million of capital to grow our business and return value to our shareholders. Looking at the components, we invested $40 million into high-return cemetery inventory development projects in order to benefit future preneed sales, $29 million of maintenance capital into our facilities, and $18 million into digital systems and initiatives. We also invested about $9 million in growth capital towards the construction of new funeral homes and the expansion of some existing funeral homes and cemeteries. From an M&A perspective, we successfully closed three transactions—one in Illinois, one in Kentucky, and one in Western Canada for a total spend of about $23 million. This brings our first half acquisition spend to about $38 million. As I alluded to last quarter, we continue to remain very optimistic about our momentum here and the investment opportunities we see. We are expected to end the year above our targeted range of $75 to $125 million of capital invested and mergers and acquisitions. In addition to acquiring businesses, we also spent $15 million purchasing real estate, including $8 million for expansionary cemetery land in the Western United States. Finally, in terms of capital returned to shareholders, we returned nearly $170 million of capital to our shareholders in the quarter through $43 million of dividends and just under $130 million in share repurchases. Year-to-date, we have purchased about 2.7 million shares, resulting in just over 144 million shares outstanding as of June 30th. Now moving on to our cash flow outlook for the full year, even with lower than anticipated volumes that impacted our earnings during this quarter, our cash flows have proven resilient due to the continued support of cash receipts on both premium and installment sales, as well as underlying cash receipts from our funeral and cemetery at-need business. Accordingly, as reflected in our press release yesterday, I want to emphasize that we are reiterating our adjusted cash flow from operations guidance range of $900 million to $960 million with a midpoint of $930 million. In closing our prepared remarks, I would like to highlight our solid financial position. We continue to have a favorable debt maturity profile and liquidity of just under $800 million at the end of the quarter. This consists of $185 million of cash on hand, plus just over $600 million available on our long-term bank credit facility. Our leverage at the end of the quarter increased slightly to about 3.7 times on a net debt to EBITDA basis. Cash flow continues to be our strength, and together with our solid balance sheet position, we are well positioned to continue delivering value to our shareholders. Once again, I want to express my gratitude to our entire SCI team for their invaluable contributions each and every day to the communities and client families we serve. That concludes our prepared remarks, and with that, operator, I'd now like to turn the call over to questions.

We'll now begin the question and answer session. The first question comes from Joanna Gajuk from Bank of America.

So I guess some color on your comment, if I may have our next year outlook. It sounds like you think this June weakness in the funeral segment was sort of a temporary drop, as you alluded to July tracking better. So just to confirm, any expectations for the second half of this year and your growth rate?

They're predominantly the same genre of belief. We do believe, and again, you never know with volume. It's very difficult to predict. We did say July is trending positively. But we have many factors to execute the back half of the year and into 2025.

Okay, great. That leads me to my next question regarding your outlook for next year. You mentioned Q2 was viewed as a temporary issue, and you expect growth again at the higher end of the typical range. Can you share what gives you that confidence?

Yes. As I mentioned before, when considering the 2024 numbers, two things stand out. We have an unfavorable interest rate comparison that we believe will subside in 2025. Additionally, you might remember we discussed some operational changes we made with SCI Direct that we believe are very favorable for the long-term business but caused some temporary pain in the first half of the year. We recorded about $20 million of revenue that were not captured due to these changes. With these factors changing in the back half of the year, we get positive tailwinds into 2025. Our core business is strong, and while we anticipate some challenges in funeral volumes, we feel good about our cemetery prospects as we look out into 2025. Furthermore, with inflation subsiding, we expect expenses to stabilize as well.

If I may follow up on the new contract with Global Atlantic and the insurance commissions. When you negotiated that, did you adjust the predetermined returns that you expect to see from the contract as well?

The predominant enhancement comes from the commissions structure. The new agreement allows us a better ability to write for our customers in terms of guaranteed insurance products, making underwriting easier. This should allow for higher commissions, thus better service for our customers and better returns for the company.

On the quarter itself, can you elaborate on the funeral segment's gross margin in this past quarter?

Sure. Looking at the bigger picture, over the six-month period, our funeral margins were 19.9%, which is about 280 basis points below last year. When analyzing gross margin percentages, we anticipated and forecasted SCI Direct changes caused us to miss about $20 million in merchandise deliveries. If we were to offset that, we could expect a significant improvement in our margin percentages. We had a bit of cost creep, but we believe our efforts will stabilize our margins going into the back half of the year.

Thank you. The next question comes from Farquhar Murray with Raymond James. Please go ahead.

Good morning. Parker on for John Ransom. Can you talk about the preneed cemetery sales? I know you mentioned lower high-end sales, but the core actually improved. This seems different from what you’ve noted in recent quarters, so could you explain that trend?

You hit the nail on the head. We feel very good about the core. We saw growth in the core, which has been a reversal, as the high-end sales dipped down. However, we have active conversations with high-end clients that didn't close by the end of June, so we expect to see positive developments there as well.

Could you talk about managing preneed cemetery sales in a lower-volume funeral environment and what strategies you have?

We are increasingly utilizing digital leads and seminars to generate more leads outside of our traditional channels. Our funeral business, which accounts for approximately 55% of our volume, remains a significant source of leads for preneed cemetery sales.

Your next question comes from Tobey Sommer with Truist Securities. Please go ahead.

I wanted to ask about managing the sales force in the current demand environment. A couple of years ago, you shared impressive productivity gains despite a lower headcount. Have you seen any pullback in productivity of the sales force?

Yes. To give everyone a brief refresher, we have improved our productivity significantly despite the reduction in our sales force. With better technology and lead management, we've become much more efficient, improving our overall productivity.

Thank you. Could you clarify the negative headwind you indicated earlier concerning the SCI Direct changes?

The negative comparison should begin to flatten in 2025. We anticipate it will have no material effect on margins in 2025 compared to 2024.

Next question comes from A.J. Rice with UBS. Please go ahead.

Could you clarify your expectations regarding cemetery production and your outlook for the third quarter?

Our sales production will be fine but revenue recognition from completed contracts will be less favorable compared to last year. We believe our sales will remain strong moving into the fourth quarter.

Regarding high-end properties, could you comment on whether the softness is due to timing of projects or consumer behavior?

The softness reflects both timing and consumer behavior, but we expect to see improvement moving forward without any significant pushback from consumers.

On funeral side, could you elaborate on the core funeral revenue growth rate in this past quarter?

While the core revenues grew by 1.3%, challenges from changes in the cremation rate affected the overall growth. We still see solid increases at the customer level.

Could you speak to your acquisition pipeline and the motivations behind the increased activity?

We believe several factors are contributing to the increased activity. The rise in interest rates has negatively impacted competitors, creating opportunities for us. Our financial stability has positioned us well in the current market, allowing us to pursue these opportunities.

Good morning. I wanted to revisit the funeral segment's profit underperformance. Can you break out the drivers and clarify the significant margin drop in light of stable revenues?

Sometimes quarterly performance can be misleading due to adjustments and estimations. If we step back to examine the six-month data, it indicates underlying health despite temporary noise in quarter comparisons. We're seeing better management of our cost structure and tighter controls moving forward.

On the new insurance partner, when do you expect to see the full effect of that relationship?

We expect to see some of the benefits in the second half, but the most noticeable impact will likely be seen in 2025 as we transition to a higher volume of underwritten products.

Concerning lower-priced tiers, how has consumer behavior changed in that segment?

Consumers in lower-priced segments have faced challenges, similar to other retail experiences currently impacted by inflation. We have implemented better financing terms to assist these customers. As for the FTC Funeral Rule updates, we are in continuous communication and expect nothing that will cause significant changes for us. We are well-prepared for compliance.

I just want to clarify on the cemetery preneed sales production commentary. Do you still expect to grow low single digits for the year and has anything changed in your outlook?

Yes, we do expect to end the year with low single-digit growth and feel better about future years returning to low to mid-single-digit growth due to stabilization in funeral volumes.

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

Thanks, everybody, and thank you for joining us. We will see you again at the end of October. Thank you, everyone.

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