Carriage Services, Inc. (NYSE:CSV) Q3 2023 Earnings Call Transcript

Carriage Services, Inc. (NYSE:CSV) Q3 2023 Earnings Call Transcript November 9, 2023

Operator: Good day, and thank you for standing by. Welcome to the Carriage Services Third Quarter 2023 Earnings Conference Call. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Steve Metzger, President. Please go ahead, sir.

Steven Metzger: Good morning, everyone, and thank you for joining us to discuss our third quarter results. In addition to myself, on the call this morning from management are Carlos Quezada, Chief Executive Officer and Vice Chairman of the Board of Directors; and Kian Granmayeh, Executive Vice President and Chief Financial Officer. On the Carriage Services website, you can find our earnings press release, which was issued yesterday after the market closed. Our press release is intended to supplement our remarks this morning and include supplemental financial information, including the reconciliation of differences between GAAP and non-GAAP financial measures. Today’s call will begin with formal remarks from Carlos and Kian and will be followed by a question-and-answer period.

Before we begin, I’d like to remind everyone that during this call, we’ll make forward-looking statements, including comments about our business, projections and plans as well as 2023 guidance. Forward-looking statements inherently involve risks and uncertainties and only reflect our view as of today. These risks and uncertainties include, but are not limited to, factors identified in our earnings release as well as in our SEC filings, all of which can be found on our website. Thank you all for joining us this morning. And now I’d like to turn the call over to Carlos.

Carlos Quezada: Good morning, everyone. We are pleased to share our third quarter financial performance with all of you. For today’s call, I will start by giving you some color on our impressive third quarter operational results in addition to providing you with a few updates. Following my prepared remarks, Kian will share our financial performance and our views for the remainder of 2023 and an early look at 2024. But before doing so, we would like to thank every Carriage employee for all the hard work and passion in pursuing our Being The Best mission. These results reflect your unwavering commitment to service excellence and a best-in-class customer experience for all the families that we serve. Now on to the results. For the third quarter, our Cemetery portfolio delivered impressive growth of 15.5% of total cemetery operating revenue compared to last year’s third quarter.

Our preneed sales team did an outstanding job delivering growth of 27.2% in total preneed property production and an increase of 8.4% of our same-store portfolio. Total cemetery field EBITDA grew to $9 million or 14.4% over the prior year. These results are primarily driven by the execution of our high-performance cemetery sales plan through increased activity, marketing lead generation efforts and the optimization of Sales Edge, our in-house customer relationship management platform. Our high-performance health organization is still in the interesting stage and we expect to continue to grow consistently in the low double digits on an annual basis. As it relates to our funeral home portfolio, while we have seen a 5% decline in at-need volume as a consequence of the expected COVID-19 pull-forward effect on our same-store portfolio, our acquisition portfolio and increase in sales average more than made up for it, resulting in total funeral operating revenue of $59.4 million which is $478,000 more than the same period last year.

Our total field EBITDA for the quarter was $22 million, an increase of $318,000 or 1.5%, leading to a combined funeral and cemetery field EBITDA including financial income of $36.1 million, an increase of 2.5% over the same quarter last year and despite inflationary cost pressures and macroeconomic headwinds, we successfully maintained a 39.9% total field EBITDA margin, one of the highest in the industry. These results demonstrate our successful navigation of cost pressures and our ability to grow revenue against a lower death rate. PVC data in the states where we already showed a 9% decline in deaths compared to last year. However, our volume only declined 5% during the third quarter. Moreover, our internal data shows that we continue to gain market share broadly throughout our portfolio.

Our adjusted consolidated EBITDA was $24 million for the quarter, an increase of $1.4 million or 6.1% over last year, and our adjusted consolidated EBITDA margin of 26.8% was an increase of 70 basis points over the prior year quarter. This performance is a result of the hard work of our managing partners and their teams and all they do to serve families while managing their cost structure in this inflationary economic environment. We thank you all for the great work. These strong operating results translated into robust free cash flow, generating $21.4 million for the quarter, allowing us to reduce our variable rate credit facility by $16.7 million. However, despite this paydown, we experienced an increase of $2.6 million in interest expense compared to last year’s quarter, significantly impacting our adjusted earnings per share, which ended at $0.33 against $0.45 last year.

After accounting for approximately $0.12 increase in interest expense, our adjusted diluted earnings per share are flat compared to the prior year. We will continue to execute our capital allocation strategy with a primary focus on accelerated debt repayment and reducing interest expense. Now let me provide 3 additional updates. The first is related to our preneed funeral sales strategy, which is in full swing. Our partnership with the National Guardian Life Insurance Company and Pricoa preneed has been deployed and fully integrated throughout Western region. We are in the final stages of integrating the central region and the Eastern region is scheduled to be completed by January 2024. While we are still in the early innings of the integration process, we have already started to see the benefits of this strategy with GA revenue growth of 31.9% over the prior year.

We expect these results to continue as we complete integration and grow exponentially over time, allowing families to plan their final wishes while our businesses are able to secure future market share. We are very excited about this performance and look forward to reporting continued progress in future calls. The second update is our digital transformation journey, known as Trinity. We have completed the data collection and the gap analysis, and we’re in full-time programming mode with a pilot set to be launched at the end of first quarter of next year. Once deployed, Trinity will increase efficiency and insights related to finance, accounting, data analytics, pricing and other operational functions. Moreover, the automation of processes will transform how we engage with families and radically improve the customer experience.

Lastly, we continue our review of our strategic alternatives, and will provide additional details once the Board has completed its review. Until that time, we will have no further comment on the process. In closing, after 3 quarters of strong operational performance, we are very excited about where we are as a company. And while we have some headwinds due to the current macroeconomic environment, inflationary cost, variable interest rates and the death rate normalization as a pull forward effect of COVID-19 continues to impact volume, we believe we are well positioned to navigate the current environment while continuing to build on the areas we have highlighted throughout the year. We are very encouraged by the progress that has been made in 2023 and our ability to execute our strategy and create shareholder value over time.

Thank you, and I will now pass it on to Kian.

Kian Granmayeh: Thank you, Carlos, and good morning, everyone. Carlos already touched on most of the principal financial metrics and highlighted the company’s key performance indicators for this quarter when compared to the same quarter last year. But I will dig into a few additional financial highlights with respect to this quarter, provide context on our updated full year 2023 guidance and offer some broad thoughts as we start to think about 2024 and providing more detailed color on our February call. First, I will start off with corporate overhead. This quarter, when adjusting out special items related to our ongoing review of strategic alternatives, our overhead costs totaled less than $12 million or approximately 13% of revenue which is a positive indication as we are targeting the same levels by year-end 2024 on an annualized basis.

The general decrease in overhead expense this year is primarily a result of lower incentive compensation relative to prior quarters, but also our focus throughout the year on optimizing and reducing overhead costs. Second, I would like to discuss our cash flow from operations which increased to $22.7 million this quarter, up from $19.9 million in the same quarter last year despite net income decreasing $1.2 million during the same period. With our capital discipline, we spent nearly $1.5 million less in maintenance CapEx during the quarter, resulting in a robust adjusted free cash flow of $21.4 million after adding back special items. This strong free cash flow generation, along with our well-defined capital allocation strategy brings me to my third highlight, the reduction in outstanding borrowings under our variable rate credit facility.

This quarter, as Carlos mentioned earlier, we were able to pay down $16.7 million on our credit facility, reducing the outstanding borrowings to $187.3 million by quarter end. Using our bank covenant compliance ratio as defined by our credit agreement, we have steadily decreased our leverage, ending the third quarter with 5.28x net debt to EBITDA. Despite the pay down, interest rates continued to increase in the quarter, with a weighted average interest rate of 9% for the quarter on our credit facility as compared to 4.3% in the same quarter last year. Considering this new reality in interest rates, we will continue to be laser-focused on capital allocation and paying down the variable interest debt. Fortunately, the credit facility only accounts for a little over 30% of our financial borrowings.

The remaining $400 million has been locked in at 4.25% through May 2029 via our senior notes. As we continue to pay down outstanding borrowings on the credit facility, this should vastly improve our credit profile and reduce our interest rate burden. Now turning to our update on full year 2023 guidance. Over the last 2 quarters, we have prudently reaffirmed our annual guidance as we waited for more data and clarity on the macro headwinds that Carlos mentioned earlier and how these challenges would ultimately impact our business. After the third quarter and now partially into the fourth quarter, where we stand today on this call, we have updated our full year 2023 guidance to the following: First, we have tightened our guidance range for total revenue to $375 million to $380 million to reflect the decrease in contract volume as a result of the COVID pull-forward effect, which has been partially offset by our increase in average revenue per contract.

Second, we have updated guidance for adjusted consolidated EBITDA to $105 million to $110 million to reflect the general inflationary cost environment we have continued to experience across both the funeral home and cemetery businesses. Third, we have updated guidance for adjusted diluted earnings per share to $1.90 to $2. When comparing to our original forecast at the beginning of the year, cost inflation has translated into a $0.32 loss in diluted earnings per share and higher interest rates have accounted for an additional $0.15. Lastly, we reaffirm our strong free cash flow generation, which remains resilient as we navigate the macroeconomic headwinds of $50 million to $60 million for the year. With the clear visibility into the current macroeconomic environment and its effect on our business, we have updated our view on 2024.

The current headwinds of a moderate decrease in volume as a result of a COVID pull forward, continued cost inflationary pressures and higher interest rates will require us to review our 2024 forecast, which we will update fully on our February call. However, we are well positioned to successfully navigate and grow our financial metrics during this period with our discipline around capital allocation, further offsetting cost inflation by increasing price where it makes sense, and to use our free cash flow to continue paying down our variable interest debt. At the point the macroeconomic conditions improve, whether that is in 2024 or later, we are primed for growth as we continue executing on our strategic efforts around preneed cemetery, preneed funeral sales, Project Trinity and more.

And with that, we will open it to questions.

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Q&A Session

Operator: [Operator Instructions]. And we’ll take our first question from Alex Paris with Barrington Research.

Alex Paris: I had some technical issues on prior conference calls, so I’m glad I’m getting through. So I got a few questions for you, and I’ll start where you left off, Kian. Updated 2023 guidance suggests flat fourth quarter revenue and lower adjusted EBITDA margins. Does this reflect anything we know about the month of October?

Carlos Quezada: I’d be happy to respond to that, Alex. So it’s not just a reflection of what we have seen as significant drop in our case, 5% in at-need volume, and we believe that’s coming from the pull-forward effect from COVID-19, but also the high impact on income — I’m sorry, in interest expense that we have experienced through different hikes, as you know, throughout the year, ramping up through Q3 and now continue because we don’t believe that’s going to decline anytime soon. And so taking all of that into consideration, the interest expense is significantly greater than we expected. And with the debt that we have, as you know, it does make a significant impact in our financial performance.

Alex Paris: Got you. And just to be clear, because I missed that at the early part of the call, you said at-need funeral volume was down 5% in the third quarter.

Carlos Quezada: That is correct.

Alex Paris: Okay. Good. Given your expectations for the fourth quarter, and Kian’s comments about next year growing financial metrics. Do you — just to be more clear, do you expect to return to revenue growth and margin expansion in 2024. At this point, I realize we have to wait until February for full guidance, but just wondering, from 50,000 feet, can revenue grow next year, year-over-year, can margins expand?

Carlos Quezada: The way we’re looking at this, Alex, is if you look at the first quarter of 2023, the decline on volume year-over-year from an at-need basis was 8%, and that’s trending down now in the third quarter to 5%. We believe it’s going to take probably another full year for the full — or maybe even 2 for the full effect of the pull-forward impact to wash off and to come back to a normalized level. However, we do expect a more seasonalized year in 2024. We have some seasonality now back in 2023, which is something we haven’t experienced over the last 3 years since COVID started. But with the seasonality coming back and with an expected decline, we do believe revenue growth is going to be achieved, but not on a same-store basis.

It will be because of the accretive acquisitions we have done over the past few years. And the work that all of the managing partners are doing to increase sales average and to add services and merchandises to the families that they’re serving. So yes, we do believe there will be growth on a year-over-year basis. But we will be making that up from acquisitions and sales average perspective.

Alex Paris: Good. That’s very helpful. And then speaking of acquisitions, I was wondering if we can get an acquisition integration update. On the second call, you said it was — on the second quarter call, you said it was going well. And I’m speaking of Greenlawn, Heritage and Funeraria, San Juan.

Carlos Quezada: Yes. So heritage is going really, really well. And as you remember, with Heritage, we have Heritage funeral homes, we also have Forest Lawn East Cemetery. And in both ends, the integration of those businesses into the Carriage centralized model is going as expected with the performance picking up especially on the cemetery side to Preneed sales. Our Preneed is ramping up at a very fast rate in that market and funeral home continued to be the leader provider of funeral services in the market. And so we’re very excited with that integration, how that’s going with that acquisition and the performance of the team so far. San Juan, I mean, it’s a small business. When you think about it from the point of view of the square footage of the business, but from a core volume perspective, is very, very large.

We acquired that business when it was doing around 800 cases and that continues to grow consistently. That team is doing an incredible job, continue to captivate the market share, specifically on the Hispanic demographic in the Orlando area. And because of the integration and the support that we can provide to that business, the EBITDA has grown, and we’ll continue to do that over the foreseeable future.

Alex Paris: Great. And then I guess, last one for me right now. And again, it’s a follow-up. With regard to debt reduction, it was great to see you reduced your credit facility by $16.7 million in the quarter. I’m curious on how fast you think you will reduce it barring anything that comes out of strategic alternatives. In December of 2022, I believe you said that you would reduce that from the $212 million peak in Q1 to somewhere in the range of $110 million to $120 million by the end of 2024, taking the leverage ratio down from roughly 5.5x to closer to 4x. Is that still the expectation?

Kian Granmayeh: Good. Yes. So I’ll take the first crack of that and Carlos will supplement. Those forecasts were done before I got here. But in terms of what we’re tracking, we continue to target a goal — our goal is to hit that target at the end of 2024. But in that assumption and in that forecast was included some divestitures, which would help accelerate that deleveraging. So we’ve kind of put that on pause during this review of strategic alternatives. But it is something that, depending on where we go forward, that is an option we have to accelerate our deleveraging profile.

Carlos Quezada: Yes. I’ll add a couple of comments to that, if you don’t mind, Alex. And when we — when Mel put that out in December 12 of last year, the high-performance grade profile restoration plan, it included a set of items that would allow us to accelerate debt repayment that was the focus and continues to be the focus. When we announced the strategic review, we had to stop a few things within that plan because it is what it is. It deserves in terms of attention. As we continue to evaluate our review and at some point, we’ll close that in, we will come back and accelerate those points, including potential asset sales that was announced back in December ’22, we prepared for that through the first half of 2023, and we’re ready to execute once we are ready to do that if that’s what we’ll continue to do.

Alex Paris: And then in terms of asset sales, is my last follow-on question, the asset sales. You have over 170 funeral homes at this point. What are the criteria for divestment? Is it the smaller locations or the locations that have had lower growth due perhaps to size of market or demographic? How many — just to get sort of an idea, how many funeral homes might be under consideration without identifying them, obviously?

Steven Metzger: Yes. Alex, this is Steve. So when we look at potential divestitures, we’re really focused on those assets that we don’t really consider core when we look at our strategy moving forward. So if you look at the acquisitions that we’ve completed over the past 4 years, it’s a pretty specific profile, bigger businesses, larger markets, growing markets, more cemeteries. And that’s where our focus is as we look at growth in the future. So the assets that don’t really fit that vision moving forward, they’re smaller assets. They’re in what we think are either low growth or no growth markets. But really one of the bigger drivers is we get a lot of outreach from folks. And if ultimately, the multiple is of a premium that is attractive to us, then we’ll consider it if — again, it’s not a high-growth market for us.