Service Corp International (SCI) Q3 2024 Earnings Call Transcript

Good day and welcome to SCI's Third Quarter 2024 Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to SCI management. Please go ahead.

Good morning, this is Allie O'Connor, AVP of Investor Relations and Financial Reporting. Welcome to our third quarter earnings call. We will have 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 risk 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 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 on our website. With that out of the way, I will now turn it over to Tom Ryan, Chairman and CEO.

Thanks, Allie. 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, then provide some greater detail around our funeral and cemetery results. I will then close with some thoughts regarding our earnings expectations for the rest of 2024 and preliminary thoughts about 2025. For the third quarter, we generated adjusted earnings per share of $0.79, compared to $0.78 in the prior year. Gross profit from both the funeral and cemetery segments was relatively stable. Below the line, the favorable impact of a lower share count and a lower tax rate was nearly offset by increased corporate, general, and administrative expense caused by changes in our total shareholder return and its corresponding effect on our long-term incentive compensation plan, as well as increased interest expense, resulting in a net $0.01 increase in earnings per share. We also had a very active quarter on the business acquisition front. We invested $123 million during the quarter into top tier businesses in growing major metropolitan markets, adding 10 funeral homes and two cemeteries. We are excited to welcome our new teammates into the SCI family. We also invested an additional $31 million in real estate transactions for the expansion of our footprint of funeral homes and cemeteries in our existing markets. Now, let's take a deeper look into the funeral results for the quarter. Total comparable funeral revenues increased $7 million, or about 1% over the prior year quarter. Comparable core funeral revenue attributed $4 million of the revenue increase, with core averages growing by 2%, absorbing a 30 basis point increase in the core cremation rate. This growth was attained even with the core funeral volume decline of 1%, which was better than we had expected for the quarter. SCI Direct non-funeral home pre-need sales revenue decreased by $5 million primarily due to a decline in sales production as we transitioned from trust to insurance-funded contracts, coupled with operational changes in certain markets regarding the timing of merchandise deliveries. Core general agency and other revenue grew by $8 million, primarily from an increase in general agency revenue driven by higher average commission rates resulting from our new pre-need insurance marketing agreement, as well as the effect of selling a heavier mix of underwritten insurance products, which carry higher commission rates versus flex or non-underwritten products. Funeral gross profit declined slightly by about $2 million, while the gross profit percentage declined 50 basis points to just over 19%. This decrease was in line with our expectations as inflationary increases in our fixed costs slightly outpaced our 1% revenue growth. Pre-need funeral sales production decreased by $22 million or about 7% over the third quarter of 2023. Core pre-need funeral sales production decreased by $14 million or 6%, primarily due to the transition to our new pre-need insurance provider during the quarter. We anticipate comparable core pre-need sales production to normalize over the coming months. Non-funeral home pre-need sales production decreased $8 million or 10% as SCI Direct transitions from trust to insurance-funded contracts. This transition required many of our sales counselors to obtain insurance licenses, which caused a temporary slowdown in sales, but this too should stabilize and grow again in the coming quarters. Now shifting to cemeteries. Comparable cemetery revenue was flat compared to the prior year quarter as a $5 million increase in other revenue was offset by a $5 million decrease in core revenue. The $5 million decline in core revenue was primarily the result of a $4 million decline in at-need revenue combined with a $1 million decline in total recognized pre-need revenue. Breaking the components of recognized pre-need revenue apart, recognized pre-need merchandise and service revenue growth of $10 million from higher quality contract sales averages being delivered out of a backlog was offset by a decline of $11 million in recognized pre-need property revenues. Other revenue grew by $5 million compared to the prior year quarter, primarily from an increase in endowment care trust fund income, as we continued to expand our total return investment strategy through successful industry and legislative efforts. Comparable pre-need sales production decreased by $8 million, or about 3%, primarily due to a decline in large sales, while our core production was relatively flat. For each of the last three quarters, we've generated around $40 million in large sales. Prior to 2023, we had only achieved this milestone once in our history. Last year, we averaged about $48 million per quarter in the second, third, and fourth quarters. In the face of these very challenging comparisons, our sales results remain very strong. At our largest location, Rose Hills, customer access to some of our new premium sections has been limited this year due to ongoing development activities. We anticipate returning to low to mid-single-digit growth in 2025 as we continue to see long-term strength in our premium cemetery inventory and sales production. Cemetery gross profits in the quarter increased by $1 million, and the gross profit percentage increased by 10 basis points, generating an operating margin of 32%. While revenues were flat, growth in higher margin trust fund income and managing our fixed cost expense growth below 3% allowed us to grow gross profits modestly. Now let's shift to discussion about our outlook for the remainder of 2024. Our current outlook for the fourth quarter of 2024 for adjusted earnings per share is $1 to $1.10, representing expected growth of 8% to 18% compared to $0.93 of adjusted earnings per share in the fourth quarter of 2023. We expect to grow both comparable funeral and cemetery margins in the fourth quarter, primarily from the impact of higher general agency revenues from our new pre-need marketing agreement on the funeral side, and on the cemetery segment, from the favorable impact stemming from the servicing of our merchandise and service pre-need backlog, coupled with endowment care fund trust income. Increased profits from recent acquisitions and lower corporate general and administrative costs will be somewhat offset by a higher tax rate. As we think about 2025, we are optimistic that we can return to earnings per share growth towards the higher end of our historical annual guidance of 8% to 12%. We anticipate funeral volumes to stabilize compared to 2024 levels, and pre-need cemetery sales production to return to low to mid-single-digit percentage growth. We are highly confident we can grow general agency revenues impressively with our new pre-need insurance marketing agreement. The negative effects of comparably higher interest rates and lower SCI Direct profits from operational changes in 2024 should turn positive in 2025. Finally, the contributions from the fantastic class of acquisitions of 2024 should provide another positive trend for 2025. Beyond that is where I truly get excited. With our vast North American network containing market-leading brands and businesses, a world-class workforce, and a robust $16 billion pre-need backlog, we are poised to capture incremental value for our shareholders as future demographic trends have a very positive impact on our industry. 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 to Eric.

Thanks, Tom. Good morning, everyone. I'm going to kind of start the way Tom just ended. So before we get too much into the financial prepared remarks, I want to address all of our associates tuning in this morning and express my sincere gratitude to you and your unwavering dedication to our communities as well as the client families that you serve, especially during their most challenging times. What you are doing is truly amazing. Whether you're on that family-facing front line or in a home office support role, your commitment and hard work truly make a difference and are deeply appreciated by all of us in senior management. So, thank you for everything that you do. So with that, I'm going to start the prepared remarks by discussing our cash flow results and then move into capital investments during the quarter. I'll then make a few comments on corporate G&A expense and our current financial position before concluding with some updates on guidance specifically related to cash flow. So, during the quarter, our adjusted cash flow remained strong as we reported adjusted operating cash flow of $269 million. This exceeded our expectations internally and is an increase of more than $41 million or 18% over the prior year. The primary drivers for the strong cash flow growth were favorable working capital sources of $54 million in the quarter, which continued to benefit from higher customer cash receipts derived mainly from previous pre-need cemetery installment sales. Over the last couple of years, we've seen a significant increase in our pre-need cemetery sales, particularly during COVID. We generally financed these sales over a four to five-year period and continued to see the benefits of the strong installment cash receipts as a result. These higher working capital sources were partially offset by our lower adjusted operating income of about $12 million during the quarter and higher cash interest of about $6 million, which is primarily related to higher debt balances. Cash taxes in the quarter were flat year-over-year, and as we've discussed several times now over the past several quarters, this year has benefited from a tax accounting method change related to the timing of recognition of cemetery property revenue. Looking forward beyond 2024, we expect cash taxes to revert toward a more normalized level, which will result in an anticipated increase of about $150 million in annual cash tax payments in 2025 compared to 2024, and then we'll continue at that more normalized level in the years beyond that. Now let's talk about the capital investment during the quarter. We're very excited about the investments we made during this particular quarter. We invested a combined $320 million of capital, which was allocated back into our existing businesses, purchased or constructed new businesses, and returned capital to our shareholders. This is the highest quarterly investment rate for 2024 and $40 million higher than our prior year quarter. Specifically, we invested $88 million into maintenance capital in the quarter, slightly higher than our expectations due to the timing of some projects. So let's break that down a little further. We deployed $44 million to high-yielding cemetery inventory development projects, supporting future pre-need cemetery sales growth. We allocated $37 million of maintenance capital to maintain our current best-in-class facilities, and $7 million into digital investments and corporate initiatives. Additionally, we also invested $13 million in growth capital to expand some of our existing funeral homes and construct some new funeral homes as well. Now let's talk about the acquisitions, which were a particular highlight for us during the quarter. As Tom has already mentioned, we successfully closed on several significant businesses in major markets for a total of $123 million of spend. This brings our 2024 investment on acquisitions to $162 million, which significantly exceeds our typical range of $75 million to $125 million on an annual basis. We are happy to welcome all these new associates from these acquisitions to the SCI family. In addition to acquiring these businesses, we also spent $31 million purchasing real estate in California, Florida, and Texas, some of our largest states for future development of cemeteries and funeral homes. Lastly, in terms of capital return to shareholders, we returned nearly $65 million of capital to shareholders in the quarter through $44 million of dividends and $21 million of share repurchases. Let's talk about those repurchases for a second. Year to date, we've purchased about 2.7 million shares at an average price of just around $71, resulting in just under 145 million shares outstanding as of the end of the quarter. Subsequent to the quarter, we've also repurchased another $25 million in shares, bringing the total year-to-date capital returned to shareholders to $353 million, about a little over $130 million in dividends and a little over $220 million in share repurchases. So, now let's shift to corporate G&A, where we incurred $44 million in the quarter, which is a little bit higher than our expected $38 million to $40 million range for 2024. The increase was primarily due to higher long-term incentive compensation on plans supported by growth in total shareholder return, or TSR, during the quarter. We remain comfortable with the fourth quarter range in ‘24 of $38 million to $40 million for normal corporate G&A expense. So I'd like to share a few updates on our solid financial position. In September, we issued an eight-year, $800 million note at a 5.75% rate, which we used to repay about $780 million of our long-term bank credit facility. This transaction was immediately accretive as we effectively swapped 7.4% debt for 5.75% debt, which calculates to about an $11 million to $12 million savings on an annual basis. Additionally, this transaction also meaningfully increased our liquidity because it freed up availability on this long-term bank credit facility. At the end of the quarter, we had liquidity of about $1.5 billion, made up of $185 million of cash on hand, plus about $1.3 billion now available on this long-term bank credit facility. Our leverage at the end of the quarter increased slightly to 3.78 times on a net debt to EBITDA basis, putting us near the midpoint of our targeted range of 3.5 to 4 times. Now let's shift a little to going forward in cash flow guidance. Cash flow has remained strong driven by better-than-expected cash flows from pre-need cemetery installment receipts, as well as somewhat lower cash taxes. As a result, we are raising the midpoint of our 2024 adjusted cash flow from operations guidance range from $930 million to $950 million. This resulted in a 2024 range of $940 million to $960 million and specifically a range of $230 million to $250 million for the fourth quarter. Also, our expectation for total maintenance CapEx guidance remains unchanged for the full year of ‘24 at about $325 million. Looking beyond ‘24, I'd now like to give you some high-level color on our 2025 cash flow expectations. To neutralize cash taxes for a second and talk before cash taxes, our cash flow in 2025 should be positively impacted by our expected earnings growth that Tom just discussed, as well as expected continued strength in these pre-need installment cash receipts. From a CapEx perspective, while we're initially expecting the capital to maintain our field locations and cemetery development spend to be slightly higher than ‘24 levels, we expect continued moderation in our digital and corporate initiatives heading into next year, which means our overall maintenance capital will generally stay flat compared to ‘24 levels. In closing, our cash flow remains a key strength for our company and combined with our strong balance sheet, should allow us to maintain the financial flexibility to keep providing value to our shareholders. I want to once again thank our entire SCI team for their invaluable contributions each and every day. So with that, operator, this wraps up our prepared remarks, and now we'll pass it back to you and open the floor up to questions.

And the first question comes from Scott Schneeberger with Oppenheimer. Please go ahead.

Thanks. Good morning, everyone. I'd like to start out discussing cemetery pre-need sales. I just want to get a sense for maybe recognized revenue here into the end of the year and into 2025, and more so in 2025. Thinking about where, based on what you're seeing ending ‘24, what type of levels you think would be reasonable with any commentary about large sales appreciated as well. Thanks.

Scott, so as you think about the fourth quarter, again, we've got a really tough comparison, particularly when you think about large sales. I think it was around $48 million. So that's a big one to overcome when you think about production. On the recognition front, last year we had a pretty big influx, which is typically seasonal, in the fourth quarter of recognized projects that get completed. I think this year will be slightly below last year, but in line with that. So a lot bigger than the third quarter, but when you compare it back to the fourth quarter, it's pretty comparable, slightly below. As you think about ‘25, I think from a sales production and recognition basis, we feel pretty confident again that we can get back to traditional growth levels, typically in the low to mid-single-digit percentage range. I do think we know that the COVID epidemic had an impact on funeral volumes. Funeral volumes are lead sources for cemeteries, and so we feel that ‘25 is the year that volume stabilizes, allowing pre-need sales to return to traditional growth levels.

And, Tom, just on large sales, I heard you mention Rose Hills has some ongoing construction that may prohibit timing on that. Does that play into what we saw in the quarters, or was it purely just year-over-year comps being so challenging?

Yeah, if you look at Rose Hills, traditionally large sales last year probably ran $9 million or $10 million a quarter. They're running $5 million a quarter right now. That's a pretty big delta, and it's solely based upon the fact that we're not finished with a section and don’t have the ability to take customers up there and see it. But that section will be open in 2025, as an example. So I'd expect Rose Hills to be a growth opportunity when you think about large sales for next year.

Thanks. Appreciate that. And then just on the funeral side, what gives confidence for flattish volume growth in ‘25 as perhaps another year of reversion post the pandemic pull-forward? Just want to get a sense of what you're seeing there, as funeral pre-need was a little weaker than we expected in the quarter. Just some thoughts on what the kind of run rate should be on that going forward or the status quo. Thanks so much.

Sure. On funeral volumes, we've created models that indicate there may still be pull-forward effects, but we think the markets are growing. We expect to see increases in deaths due to the demographics of the population. Although it could slightly vary, we're confident it will flatten out in 2025 and then get into slight growth thereafter. There are just so many changes going on with both core sales and SCI Direct sales. We’re transitioning to a new contract and provider. We've also been addressing the concern of selling a lot of flex products that didn’t protect our customers during the payment cycle. We've spent much time with our new partner to onboard more clients onto underwritten insurance products, which provide necessary protection. This has caused some hiccups currently, but we expect things to stabilize and grow in the latter half of 2025.

Thanks for the color, Tom.

Thanks. I was thinking you could dig into this new insurance relationship and maybe, given some of the changes in selling and products and organization, could you talk about the lower efficiency that you might have had here near-term and what kind of delta you could have in the sales force as you go into next year when things are a bit more settled, so to speak?

Yeah, I think if you look back historically, cemetery sales grow in the low to mid-single digits. Core funeral sales should ideally return to that range. When you look at SCI Direct, traditionally, it's achieved mid-single to potentially high single-digit growth. However, I expect SCI Direct to take a little longer to stabilize due to licensing complications. Although we face sales losses now, we're setting ourselves up for tremendous growth. Notably, with large sales, the contracts from SCI Direct's backlog can increase revenues significantly.

Thanks. The acquisitions were pretty sizable in the quarter. Does the pipeline remain strong? And are you, in this post-COVID period, seeing mom-and-pop operators more willing to sell? Do you have an expectation for this trend to continue?

Yeah, Tobey, this is Eric. We continue to be excited about the pipeline in the industry. Each seller's decision differs, and I wouldn't generalize it solely based on COVID. There is a healthy pipeline for independence and acquisition opportunities, particularly in major metropolitan areas and larger combination facilities. Those deals were in the pipeline for a while, and we're very glad to have closed them, but there are more opportunities to come. Our official guidance returns to the $75 million to $125 million range next year, but we hope to be at the high end or exceed that like we did this year.

Hi, good morning. Thanks so much for taking the question. So maybe first, just clarification on the comment on the funeral loans next year to be flattish. That's organic, isn't it?

Yes, that's the same-store organic.

Okay, right, exactly, because we're just talking about all these acquisitions. So I just want to clarify that. I guess two other questions. When you talk about switching to cemetery, you mention these large pre-need sales. Can you talk about these large pre-need sales compared to 2019? I understand last year was very active. Also, when thinking about these large sales, are those delayed? Are there any indications that these clients might come back in Q4?

If you go back to ‘19, I remember we were probably running around $100 million annually in large sale production. Now we're closer to a rate of $160 million to $170 million. While we are down year-over-year, we're operating at a high level. We've expanded high-end gardens and estates into different parts of the country. Rose Hills accounts for about 25% of our high-end production each year. Therefore, any declines here are hard to overcome, but we're excited for continued potential in future growth.

Okay, that's good color. Thank you. I guess on funeral margins, I noticed the improvement from Q2, and 19% in this quarter is much better than the 16% in 2019 in the third quarter. Should we view this as a new runway? Is this benefiting from the new insurance contract? How should we think about full-year funeral margins considering the benefits of this new contract?

The improvements you've noted in 2019 relate mainly to the core business and SCI Direct, and it really has nothing to do with the federal agency. We're experiencing a bit of that benefit now, but we expect it to become more significant in 2025. I think anticipating our margins to grow is a reasonable expectation, potentially by 150 basis points if we execute well.

Great, thank you. If I may squeeze one last question on funeral, the cremation shift, where it was only 40 basis points, that's the fourth consecutive quarter of that shift being below what you had been describing previously as a trend of 100 to 150. So is that enough to call it a new trend? Are we in a new paradigm where maybe the shift headwind is smaller now? Thank you.

We debate that internally all the time. I think my personal opinion is it does ebb and flow. I still believe that maybe 150 basis points is not likely to be the reality moving forward. However, I think it could still be around 100 basis points a year. Some of that shift comes from the substantial base of business we have, and it takes a lot to move the needle.

Hi, everybody. A couple of questions if I could. So the anticipation that volumes might begin to trend a little more positively. We've been through this kind of flat to down period regarding at-need volumes. Can you talk about what underpins your thought that we'll start to see a positive turn?

It's a combination of factors, AJ. Most importantly, the effects of pull-forward diminish every year as we model that out. Additionally, the population has grown, and demographics are shifting in that direction. We believe that we’re competing aggressively in our markets, supported by a great pre-need backlog. So these factors together bolster our confidence.

Just to think about, I haven't asked you about this in a while, but with the volatility and volumes this year, have you changed your views on the pull-forward dynamic and the lingering effects of COVID on the demand for pre-need cemetery property sales or the at-need funeral side? What is the update of your thoughts versus what you laid out at your Investor Day a couple of years ago?

No, our outlook remains largely unchanged. Less volume on the funeral side correlates to fewer leads for core funeral sales. Historically, this has been around a 53% or 54% correlation for the past decade. Thus, if we say volume stabilizes, we feel better about cemetery sales production as it relates to leads from at-need business. The growth target will include acquisitions. Spending well above $160 million, not sure what we might close before the end of the year, will yield a great accretive effect for shareholders. You can assume these are in major markets, and there are some cost synergies we can apply. However, we are acquiring high-quality businesses without needing to change much in terms of top-line dynamics as many owners continue to be engaged and involved post-acquisition.

Great, thank you! Lastly, we don't often hear about this, but inter-quarter there was an announcement regarding some management changes. Can you provide any perspective on what you’re doing in that area?

Yeah, AJ, we've taken the board's succession planning seriously, given that transitions inevitably happen. With Steve wanting to take a step back as he approaches retirement, it spurred several decisions. However, it was straightforward since we had a succession plan in place. We're excited about the heightened responsibilities for the executives we announced and believe it preserves significant value.

Hey, good morning. This is Parker on for John Ransom. Sorry if I missed the beginning of the call. Regarding pre-need cemetery selling, I know you noted the lower-end consumer is holding in flat year-over-year. Have you changed payment terms or introduced notable incentives to help stabilize the lower-end segment? What would you attribute this stability to?

There hasn't been any loosening of payment terms or unusual incentives that would compress margins. Some pull-forward effects exist, and we will continue to push for more volume to serve as the primary lead source. As we've shared, volume may improve as we foresee a range of flattish next year, which will help our sales counselors.

Okay. And then late in the third quarter, early fourth quarter, there were significant hurricanes in Florida. Did you notice any impacts recently on funeral volumes or pre-need selling activity?

Funeral volumes might experience delays. Something that was intended for one week could be pushed to the next. We saw about a week or 10 days of shutdown linked to these specific markets, but we bounced back. Perhaps there was a minimal headwind of around $0.01 or $0.02 for the quarter, but overall, the business is resilient. As management, we're more concerned about our associates, their homes, and personal situations, and I am pleased we managed through it effectively.

Okay, if I can just get one last question, regarding acquisitions. When acquiring smaller regional operators, what types of integrations occur? How do you achieve synergies, and how should we view the multiples involved?

For multiples, they haven’t changed. We're paying fair multiples, typically between 8 to 10 times EBITDA pre-synergies. But we gain nearly a turn quickly due to our scale, both locally in important markets and nationally. Additional synergy opportunities come from new revenue streams that maybe an independent lacked or through CRM processes and other technological improvements made post-COVID. Many of the former owners remain with us, which enhances the integration process and positively contributes long-term value for our shareholders.

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

Thank you, everybody, for being on the call today. Happy Halloween, and we will speak to you at our fourth quarter earnings call in February. Thanks so much.

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