Service Corporation International (NYSE:SCI) Q4 2022 Earnings Call Transcript

Service Corporation International (NYSE:SCI) Q4 2022 Earnings Call Transcript February 15, 2023

Operator: Good morning, and welcome to the SCI Fourth Quarter 2022 Earnings Conference Call. All participants will be in a 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.

Debbie Young: Thank you. I appreciate that. Good morning. This is Debbie Young. I’m the Director of Investor Relations. Today, we are going to be providing an overview of business results for our fourth quarter, as well as some thoughts about our outlook for 2023. But first, as usual, 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.

During this call, we’ll also discuss certain non-GAAP financial measures. A reconciliation of these measures to the appropriate GAAP measures can be found in the tables at the end of our earnings release and also on our website under the Investors, Webcast & Events session. With that, let me now turn it over to Tom Ryan, our Chairman and CEO, for opening remarks.

Thomas Ryan: Thanks, Debbie. Hello, everyone, and thank you for joining us on the call today. Before I begin, I want to express my sincere appreciation to our entire SCI family. Your dedication and commitment to helping our client families’ gain closure and healing through the process of breathing, remembrance and celebration are what makes our company great. And to our preneed teams, your efforts to provide peace of mind for families, securing file arrangements has never been more important than at times like these. Thank you. This morning, I’m going to begin my remarks with some color on our business performance for the year and for the quarter, with some detail around our funeral and cemetery results. I’ll then provide some thoughts about our 2023 financial outlook.

First, in terms of the full-year 2022 results. We are proud to report adjusted earnings per share of $3.80, which was at the high end of our most recent guidance range. While this is below our prior year, that was meaningfully impacted by COVID-19, it’s an incredible 26% earnings per share compounded annual growth rate from a pre-COVID 2019 base year of $1.90. This accelerated growth was achieved by a combination of the incremental COVID learnings and efficiencies we highlighted at our Investor Day last May by increased volumes driven by excess deaths and the net positive impact from COVID-19. In the Funeral segment, volume was down 4.6% for the year, but well exceeded our expectations and represents a 5% compounded annual growth rate from 2019 levels.

We continue to be impacted by excess deaths, which we have consistently defined pre and post-COVID as deaths above an approximate 0.5% to 1.5% annual compounded growth. These excess deaths are identified officially as COVID, heart disease and diabetes among other causes. Some percentage of these deaths could be the early impact of baby boomers, SCI-specific market share gains or temporary fluctuations caused directly by COVID or the ripple effects on health from the pandemic lockdown. Funeral sales averages remained strong for the year, and we experienced some inflationary cost increases associated with labor and energy. In the Cemetery segment, revenues were down slightly by $39 million or 2% versus the prior year. Preneed recognized revenues grew primarily due to a 2.4% increase in preneed cemetery sales production, which we had anticipated based upon our incremental COVID learnings around sales and marketing, which we touched upon at Investor Day.

Our preneed cemetery sales production has grown by an impressive 14.5% compounded annual growth rate from 2019. This preneed growth was offset by a 7% decline in atneed revenues as well as the $31 million decline in merchandise and service and endowment care trust fund income. Timely, meaningful action in our share repurchase program of over $660 million throughout the year more than offset higher interest expense and a slightly higher tax rate. Just as importantly, we delivered these results while at the same time, making strategic investments in our facilities, our cemetery inventory, our digital platforms, our customer experience and engagement, and most importantly, our people. For the fourth quarter, we generated adjusted earnings per share of $0.92, which was ahead of our expectations, but down from prior year, which benefited from a significant pandemic impact.

Most of this decline in earnings could be attributable to lower operating results on a reduced impact from COVID, some increased inflationary costs as well as a decrease in trust fund income. Below the line, the favorable impact of lower share count offset higher interest expense and a slightly higher tax rate. Now let’s take a deeper look into the funeral results for the quarter. Total comparable funeral revenues declined $30 million or about 5% over the prior year quarter, primarily due to a decline in comparable core funeral revenues. Although comparable core funeral volume declined over 6% during the quarter, volumes were higher than we anticipated and about 12% higher than fourth quarter 2019 levels. Our core average revenue per service grew over the prior year by about 1%.

However, that does not reflect the true success in enhanced value being delivered to our customers. The negative effects of currency translation, trust fund income and cremation mix almost equally diluted the 4.6% organic growth rate into the reported 1%. From a profit perspective, funeral gross profit decreased about $35 million while the gross profit percentage declined to about 23%. The revenue decline due to the lower volume versus 2021 accounted for the preponderance of the profit decline. We also experienced increased inflationary growth rates in our employee and energy-related costs. Preneed funeral sales production grew over $13 million or more than 5% over the fourth quarter of 2021. Both the core and the SCI Direct channels showed an impressive growth in contract velocity and increased sales averages.

Now shifting to cemetery. Comparable cemetery revenue was essentially flat in the fourth quarter. In terms of breakdown, core revenues increased $3 million compared to the prior year as recognized preneed revenue growth of about $18 million, which absorbed the $6 million merchandise and service trust fund income decline. It was partially offset by a $15 million decline in atneed cemetery revenue. Other revenue consisting primarily of endowment care trust fund income decreased by about $4 million over the prior year quarter due to lower capital gains. Preneed cemetery sales production declined by $9 million or 3% in the fourth quarter. This was in line with our expectations for the quarter as the comparison quarter was a very strong one more acutely impacted by COVID-19.

To better understand the level at which our sales teams are operating, our fourth quarter preneed sales production was about 28% above our 2019 fourth quarter, representing an 8.6% CAGR over the three-year period. Cemetery gross profits in the quarter declined by about $18 million and the gross profit percentage dropped to 33% from 37% in the prior year quarter. While revenues were essentially flat, the $11 million decline in high margin trust fund income from both merchandise and service and endowment care trust had a more pronounced effect on profits. Inflationary increases in merchandise, labor and maintenance expenses also put some downward pressure on the gross profit line. Now let’s shift to the discussion about our outlook for 2023. As you saw in our earnings release, we confirmed our 2023 guidance that we introduced to you last quarter of an adjusted earnings per share range of $3.45 to $3.75 or a midpoint of $3.60.

I think the easiest way to understand what we are assuming for 2023 is to compare the $3.60 projected midpoint for 2023 to the $3.80 earnings per share result from 2022. While the impact from COVID is not an exact science, we do our best to quantify it for you. We believe there is $0.45 per share attributable to COVID in the 2022 earnings per share, about $0.30 in funeral and call it, $0.15 in cemetery. That results in an adjusted 2022 base of $3.35 per share. It is our belief that in 2023, we can grow off that adjusted base at the high end of our historical earnings per share growth range of 12%. We expect higher recognized preneed cemetery property revenue from completed inventory projects in 2023, and a lower share count from accelerated share repurchases made in 2022 will more than offset the declining impact from COVID and other excess deaths projected in 2023.

This $0.40 per share growth results in a $3.75 per share base for 2023. Finally, increased interest expense is projected to have a $0.25 negative impact on 2023 earnings per share. While we would typically assume interest expense to grow accordingly with increased debt levels of the company growth, we attribute approximately $0.15 of this increase as a unique year-over-year headwind associated with the aggressive Fed hikes impacting our variable rate debt. Removing this $0.15 from the $3.75, we arrived at our $3.60 midpoint. This $3.60 midpoint is a 17% compounded annual growth rate from a pre-pandemic 2019 base of $1.90. As you think about the cadence of the earnings for the year, we expect a meaningful decline in the first quarter as early last year was still being impacted acutely by COVID.

However, this decline is anticipated to be mostly offset by year-over-year growth in each of the remaining quarters. Now as you think about some of the segment assumptions for this year, in our Funeral segment, we are anticipating a comparable volume decrease in the mid-single-digit percentage range. This reflects the waning effect from COVID and other excess deaths, which should be more pronounced in the first quarter comparison. Meanwhile, we expect the average revenue per case to continue to compare favorably, growing in the low single-digit percentage range. We expect to see inflationary pressures lessen, but still be above our recent historical trends in the 3% to 4% range, resulting in funeral margins of around 20%. Finally, we are forecasting preneed funeral sales production growth in the 3% to 5% range for the year.

Photo by Mayron Oliveira on Unsplash

On the cemetery side of the business, cemetery atneed revenues should correlate somewhat with funeral volumes, and we expect them to be down in the mid- to high-single-digit percentage range. For preneed cemetery, given our success in 2022, creating a new higher base and expected lack of COVID-lead activity in 2023, we expect preneed cemetery sales production to grow a little less than historical trends, but still grow in the low single-digit percentage range. We have enjoyed tremendous success during 2022 and selling into unconstructed inventory projects, which should continue into early 2023. As these projects are completed throughout the year, this should result in favorable preneed property revenue when compared to 2022. We expect inflationary pressures to lessen around labor and maintenance, but still exceeds recent historical trends and anticipate margins in the low to mid-30% range.

As we look to 2024, we would expect to return to normalized earnings per share growth off of this 2023 base. Finally, I’d like to thank the entire SCI team for all that you do every day for our families, our communities and each other. You are what makes this company great. With that, operator, I’ll now turn the call over to Eric Tanzberger.

Eric Tanzberger: Thanks, Tom. Good morning, everybody. Kind of as Tom ended his remarks, before I address the quarter, I think it’s most appropriate to first just say thank you to all of our 25,000-plus field and home office associates. This continued hard work and efforts have produced our impressive financial results that we are talking today. The compassion, dedication you always provide to our client families and our communities is second to none in this industry, and we truly appreciate all that you do. So with that, in my comments today, I will discuss our cash flow results and capital investments for the quarter and for the full-year and provide some brief commentary on our trust funds as well as our corporate G&A expenses.

I’ll then provide some color on our cash flow and capital investment outlook for 2023 as we move forward, and I’ll end the call with some comments about our financial position. So during the quarter, we generated adjusted operating cash flow of $170 million, which is at the high end of our guidance range we talked about last quarter by $20 million lower than the prior year. This decline was driven by a year-over-year $52 million decline in operating income. And again, that’s normalized for gains on divestitures and the impact of estimated legal charges as the prior year was impacted by more pronounced COVID activity. Additionally, we had a headwind of $21 million of payroll tax payments in the current quarter related to the deferral of about $42 million of payroll taxes under the CARES Act for the full-year of 2020.

And we’ve talked about this for a couple of quarters, but with this payment, we have repaid all deferred amounts at this time. Cash interest payments were also higher by about $10 million with higher rates driving the predominance of that, driving about $9 million of the increase and the remainder due to anticipated higher debt balances. Somewhat offsetting these headwinds were $60 million of lower cash taxes primarily due to the lower earnings that we just mentioned. So as we sit back and look at the full-year of 2022, we generated $826 million in adjusted operating cash flow, which is almost $200 million or 30% higher than our 2019 pre-COVID results. This enabled us to invest capital to grow our company as well as to enhance shareholder value.

So speaking of capital investment activity. During the quarter, we invested $330 million into our current businesses first, the newbuild opportunities and accretive acquisitions, in addition to continuing to return capital to our shareholders. Specifically during the quarter, we invested $117 million in total capital expenditures, which is $9 million lower than the prior year. The timing of growth projects drove an $8 million decline in growth capital, while our maintenance CapEx was generally flat at about $109 million. For the full-year 2022, as it relates to our maintenance CapEx, we invested about $75 million more in 2022 compared to 2021. The breakdown of the $75 million consists of three components: first, $25 million of the increase is driven in large part by increased technology infrastructure spend as well as capital improvements to maintain our best-in-class locations.

This technology infrastructure spend relates to upgrading the hardware, wireless and network capabilities at all of our funeral homes and cemeteries to accommodate current as well as planned digital enhancements. The bulk of this spend now is now complete, which I’ll speak to in a moment when I discuss our 2023 outlook. Second, $30 million of the increase relates to our cemetery development spend as we continue to replenish our cemetery property inventory that our sales team sold during the COVID pandemic. Finally, the remaining $20 million of the increase relates to our digital investments and corporate spend. And we’ve really been discussing the spin for several years now and have now broken it out separately from field maintenance capital expenditures to really just give better visibility.

This spend relates to ongoing support for and enhancements of existing systems like Salesforce, HMIS Plus, Beacon and our 2,000-plus websites, which continue to enable sales growth in our preneed and atneed sales areas as well as new digital initiatives to improve our future customer experiences and field operations. From a growth capital perspective, we deployed $16 million during the quarter towards the purchase of real estate, construction on new facilities and expansion of existing funeral homes and cemeteries across our footprint. This brings the total 2022 spend on newbuilds and real estate to about $52 million, which will also help drive additional earnings and cash flow growth for the company with low double-digit to mid-teen IRR. On the acquisition front, we are excited today to report that we had a very active fourth quarter, invested almost $90 million in acquiring three combination operations and 11 standalone funeral homes and four separate transactions, bringing our full-year spend to just under $105 million.

These businesses acquired during the quarter are located in California, Pennsylvania and Ontario, Canada. We are excited to welcome all of our new associates to the SCI family. Finally, we continue returning capital to shareholders with nearly $116 million to be returned this quarter alone through $42 million of dividends and $74 million toward share repurchases. For the full-year, we returned an impressive $821 million to shareholders. So let’s shift here and talk about our trust funds a little bit. We saw some improvements to the value of our trust assets in the fourth quarter, but again, year-to-date, they declined about $800 million to $5.7 billion in total at year-end. Deposits on the new sales that go into the trust funds and withdrawals from maturities generally offset each other during 2022.

So the decline is primarily associated with the change in market value of our trust assets really reflected 11.5% decline in trust performance that we’ve disclosed year-to-date. As of today, our trust assets have increased by just over $250 million in 2023. Keep in mind, this market volatility has a muted effect on our near-term earnings as well as our cash flows. And again, I’d also like to reiterate, we have an accounting white paper and a one-page summary on preneed in the Investors section of our website, which I think will really help illustrate the cash flows associated with these trust funds. So let’s talk about corporate G&A. After adjusted for the $64 million pretax estimated charge for certain legal matters, Corporate G&A of $43 million in the current quarter was about $2 million higher than the prior year and slightly higher than our expectation, primarily due to workers’ compensation and general liability insurance costs that were a little bit higher than what we expected.

As I mentioned on our last call, as we look forward in 2023, we continue to expect corporate G&A to be lower than we experienced in 2022 at approximately $38 million to $40 million per quarter as incentive compensation is expected to be lower than our COVID impact 2022. The actual results within this quarterly range will depend on company performance during the year, which will affect our incentive compensation plans. Now let’s move to a few comments about our cash flow outlook about 2023. In our press release, our guidance for adjusted operating cash flow for full-year of 2023 is a range of $740 million to $800 million with a midpoint of $770 million. As Tom just mentioned, while we are expecting some nice normalized growth in our businesses in 2023, the headwind from lower expected COVID volumes generally offset this growth and leads to modest growth in 2023 EBITDA.

There are a couple of items that I’d like to highlight, though, when thinking about our adjusted cash flow in 2023. First, as we’ve said previously, we’ll have higher interest costs on our floating rate debt. Last quarter, we mentioned it could be a headwind of about $50 million, but I now think it’ll be closer to about $55 million, primarily on higher expected rates and somewhat higher balances. Cash tax payments in 2023 are anticipated to be about $165 million at the midpoint of our guidance or $15 million lower than 2022 on the lower earnings. And by the way, from an effective tax rate standpoint, we continue to model in the range of 24% to 25% for 2023. From a working capital perspective, we are expecting $20 million to $25 million incremental use of working capital as usage from strong preneed cemetery sales and strong incentive compensation cash payments are partially offset having the no CARES Act payments in 2023 that I mentioned before is now behind us.

So to look about invested capital in 2023, our first investments will be, as usual, back into our businesses. We expect maintenance CapEx will drop from $335 million to $300 million, which is primarily due to the declines in technology infrastructure spend at our field locations that I already mentioned. At the midpoint, investments in our locations make up about $120 million. Cemetery development CapEx comprises about $130 million and the remaining $50 million is being deployed towards digital investments and corporate. In addition to this maintenance CapEx that I just described, we expect to deploy $75 million to $125 million towards acquisitions and roughly $45 million in new funeral home construction and real estate opportunities, which together will drive low to mid-teen after-tax IRRs, which again is well in excess of our cost of capital.

We feel we have the financial flexibility and liquidity to continue much of the same successful capital investment strategy in 2023, as you’ve seen us do over the past few years. We will continue to follow a disciplined and balanced approach investing to the highest relative value for our shareholders. And of course, this strategy is predicated on our stable free cash flow, our strong liquidity as well as our favorable debt maturity profile. So in closing, I’d like to provide some commentary on exactly that, our liquidity and financial position. I’d first like to highlight that in January of this year, we entered into a new $2.175 billion bank credit agreement, which consists of a $675 million term loan and a $1.5 billion revolving credit facility, both maturing now in January 2028.

This transaction increased our liquidity by over $600 million. So today, that stands at about $1.2 billion in liquidity, and it also improved our debt maturity profile substantially. Finally, our leverage at the end of the quarter was about 3.25% net debt-to-EBITDA. Our EBITDA continues to normalize as COVID activity wanes, and we expect to enter our targeted leverage range of 3.5x to 4x by the end of this year. So in conclusion, 2022 was a really great year for us. We began this year with a very strong financial position. Most importantly, I echo Tom’s comments that none of this would have been possible without the hard work and compassionate carrying of all of our dedicated frontline associates. We appreciate all of your efforts and again, say, thank you.

So with that, operator, we’ll now conclude our prepared remarks, and we’ll now open it back to you for questions.

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Q&A Session

Operator: Thank you. We will now begin our question-and-answer session. And the first question will be from Joanna Gajuk from Bank of America. Please go ahead.

Joanna Gajuk: Good morning. Thanks for taking the question. So I guess first, maybe clarify the comments you made on 2024. Did I hear right, you say you expect to grow at a normalized rate off of the earnings base? I don’t know, did you mean from of the $3.60 midpoint or there was another number?

Thomas Ryan: Yes, Joanna, what I was referencing to is, we think this $3.60 is kind of a level off year for €“ with all the COVID impacts and the like. And so based on what we know today, I know 2024 still ways off. We would expect to get back to that growth range of 8% to 12% growing off that $3.60 base. Obviously, we’ll update you as the year goes on and be in a better position to talk about that a year from now.

Joanna Gajuk: Okay. That makes sense. I just want to clarify that. And I guess on the quarter and I guess as it relates to 2023 guidance, so clearly Q4 was stronger and you said funeral services were €“ was the area that came in much stronger. So can you €“ is there a way to think about how big were this excess death number in Q4? And also what do you assume in your guidance for 2023? And did anything change how you think about 2023 from that angle versus how you were thinking about things three months ago?

Thomas Ryan: Yes. I think three months ago, Joanna, if you really look at what’s happened, we’ve been able to maintain our guidance and when you compare back to 2022. And I’d say the big upside surprises, the Funeral segment is performing more funeral cases than we would have anticipated, that’s somewhat being offset by a couple of things like trust fund income, interest expense that’s going up. So being able to absorb those things a year-ago, we wouldn’t have anticipated it being so impactful. So really positive about our funeral volumes and our ability to service those. I think on the excess deaths, I mentioned that what we can do is we can go to the death certificate and see why somebody’s been deceased. And normally, we’d expect, let’s say, a 1% compounded under growth, but we’re at 5%.

So you begin to say what’s causing that? And I think some of it could be the beginning of the baby boomers. Some of it could be our market share. And I think I believe most of it is either COVID-related and a lot less of that and more of this concept of excess deaths. Remember, the concept of excess death is really around as a society are we less healthy, mentally and physically than we were going into the COVID and the ramifications of that, lack of access to healthcare for some period of time. So it’s our belief and I think there’s other data supporting this that those trends will continue, albeit to lessen. So as we think about these excess deaths, they’ll continue into 2023, they’ll be less comparatively as you think about 2022 is the way we’re thinking about it.

But again, not an exact science, just our belief.

Joanna Gajuk: So would you say it’s like 1%, 2% funeral services being above where they would have been otherwise?