Welcome to the second quarter 2015 Service Corporation International earnings conference call. My name is Joe, and I will be the operator for your call today. At this time, all participants are in a listen-only mode, and later we will be conducting a question and answer session. Please note that this conference is also being recorded. I would now like to turn the call over to SCI management. You may begin.
Good morning, everyone. This is Debbie Young from investor relations at SCI. We hope everyone's doing well today, and we appreciate you taking the time to join us as we discuss our results for the second quarter. Let me begin by covering the customary safe harbor language. The comments made by our management team today will include statements that are not historical and are forward-looking. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, those factors identified in our press release and in our filings with the SEC that are available on our website. Today, we may also refer to certain non-GAAP measurements such as normalized EPS, adjusted operating cash flow, and free cash flow.
Reconciliation of these measurements to the appropriate measures calculated in accordance with GAAP is provided on our website and in our press release and 8-K that were filed yesterday. With that behind us, let's begin with comments from Tom Ryan, SCI's President and CEO.
Thank you, Debbie, and good morning, everyone, and thank you for joining us on the call today. I'm going to begin my comments by giving you the highlights of the quarter, then a deeper dive into both funeral and cemetery operations, and finally, I'll give you some color on our outlook for the back half of 2015. Beginning with an overview of the quarter, we're very pleased to report normalized earnings per share of $0.28, which is a $0.05 or 22% growth over the prior year period that slightly exceeded our internal expectations. This growth is even more impressive when you consider that we lost a little more than $0.03 per share from the FTC-ordered Stewart divested businesses that we owned in 2014, but we do not have the benefit of this year.
This impressive earnings growth was primarily driven by strong pre-need cemetery sales production, the impact of our share repurchase program, lower interest expense, and a slightly lower tax rate. I want to thank each and every one of my 24,000 teammates for all that they do every day, not only to generate these results, but most importantly, in helping our client families plan and assisting them on their most difficult days. While we are proud of our operating performance in the first half of 2015, we also never forget it is our responsibility to deploy your precious capital wisely. During the first half of 2015, we've invested $53 million in new acquisitions and have three transactions under a letter of intent, which should close in the third quarter.
We've also returned over $40 million to you through our dividends and have increased your effective ownership level by repurchasing approximately $152 million of our outstanding common stock. Now for an overview of funeral operations. The results of our comparable funeral segment were better than we expected, primarily on higher-than-anticipated volume. When compared to the prior year, our second quarter funeral revenues increased by nearly $10 million or 2.2%. This funeral revenue growth was primarily driven by a $6.9 million increase in general agency commissions generated from our pre-need funeral sales. We are experiencing higher commission rates from our new contract terms with AMLIC, as well as selling a higher value customer mix in our sales activity. Additionally, we saw a $4.2 million or 20% increase in recognized pre-need revenue.
The general agency and recognized pre-need revenue growth was partially offset by a $1.2 million reduction in our core funeral revenue. Funeral volumes were essentially flat in the quarter, while average revenue per case was down $13 or 0.2%. Excluding the negative currency impact, the funeral sales average grew 0.8% during the quarter, driven by an increase in our at-need sales average that was partially offset by a lower matured pre-need sales average. Our at-need sales average actually grew about 3% as pricing and packaging had the anticipated positive effect, which was slightly offset by an increase in the cremation rate. However, our matured pre-need sales average was lower as a larger number of our maturing contracts are coming from the SCI Direct backlog.
With a $9.9 million increase in funeral revenues, we only put $1.7 million into profit. So what gives? Think of funeral profitability as coming from three buckets. First, general agency revenue growth should have about a 30% margin after you reduce it for selling expenses. So a $6.9 million in revenue increase generates $2 million in profits. Second, SCI Direct revenue growth of $4.2 million should generate about a 20% margin or $800,000 of profit. And finally, with core revenues down $1.2 million at a 60% margin, the negative effect on profit should be about $700,000. Altogether, that would be about a $2 million profit increase, which is in line with our $1.7 million number.
To summarize, increases in lower margin businesses were partially offset by a decline in high margin core revenue. As it relates to pre-need, comparable funeral sales production, excluding terminally imminent situations in both periods, grew 3.4%. Year-to-date, through the first six months, our pre-need funeral sales production growth was about 4% and in line with our low- to mid-single-digit percentage growth expectations. Let's turn to cemetery operations. Our cemetery segment had an impressive second quarter performance and came in well above our expectations. Comparable cemetery revenue increased more than $26 million, or more than 10%, over the prior year quarter, led by strong pre-need sales and higher trust fund income. The largest component of the $26 million revenue increase was $18.7 million from recognized pre-need cemetery revenue. While this 12.7% increase is impressive, our actual pre-need sales production grew by $31.6 million, or almost 17%.
The net $13 million we did not recognize in the second quarter will get recognized in a future period when the revenue recognition trigger is completed, via construction, delivery, or a 10% down payment occurs. These successes are being driven by higher productivity as our sales velocity or volume increased approximately 10% during the quarter. Baby Boomer demographics continue to fuel more sales opportunities, which our sales teams are able to capitalize on by further leveraging our investments in tools like our new customer relationship management platform. We continue to train and manage the right sales behaviors, which results in improved outcomes. In addition to increased velocity, we saw more than a 7% increase in average spend per contract as our tiered inventory strategy continues to expand and enhance the value of our product and service offering.
Trust fund income growth of $5 million for the quarter was elevated due to capital gain distributions from our perpetual care trusts that were anticipated. Our success in pre-need cemetery sales production is a real testament to the talents of our sales organization and the support from the rest of our team. Through the first six months of the year, total cemetery pre-need production was up a remarkable 17.2%. This strong performance, we would anticipate the comps to moderate somewhat in the back half of 2015, but still leading to a low double-digit percentage growth for the full year. Comparable cemetery profits increased $18.4 million in the quarter, and margin percentage grew 450 basis points to 26.6%. Like funeral, let's think of cemetery profits in three buckets. First, we had a $21 million revenue increase from core operations, which are at-need and pre-need recognized cemetery production.
This should have about a 65% margin, or call it $13.6 million increase in our profits. Second, we had a $5 million increase in trust income, which essentially has 100% margin. Finally, we backlogged $13 million in cemetery sales, for which we incurred and recognized the selling expense during the period. At an approximate 20% cost, this had a negative $2.6 million effect on profitability of cemetery. The net effect of these three items results in a $16 million projected increase in cemetery profits, which approximates our reported increase of $18.4 million. To wrap it up, we are very pleased about our performance thus far in the year. For the first six months, our same-store funeral profits are up nearly $16 million, and funeral margins have increased by 90 basis points.
In the same period, comparable cemetery profits have grown $27.6 million, and margins have improved 350 basis points. We've sold more than $750 million in combined pre-need funeral and cemetery sales, representing a growth of just over $70 million or more than 10%. This all has resulted in a year-to-date normalized earnings per share growth of $0.08, or nearly 16%, to $0.59 per share. Keep in mind, all of this was accomplished against the backdrop of losing the contribution from the FTC-ordered Stewart divestitures. On the heel of this strong year-to-date performance, we feel comfortable that we're trending towards the high end of our full year 2015 guidance range for normalized earnings per share that we have previously provided. Our current expectation is that normalized earnings per share will range between $1.22 and $1.28, versus our previous expectation of $1.16 to $1.28.
This brings the midpoint of our guidance up by $0.03. As we begin the second half of the year, we feel good about our ability to continue delivering solid performance and deploying capital for the benefit of our shareholders to enhance the long-term value of the company. With that, I'll turn the call over to Eric.
Thank you. Good morning, everybody. I first want to echo Tom's comments about how pleased we are with the performance in the quarter as well as the first six months of the year. As usual, today I'm going to start by commenting on our cash flow results for the second quarter, I'd like to talk a little bit about our cash flow outlook for the remainder of 2015. I also want to touch on how we deployed our capital this quarter to continue to enhance shareholder value. As you saw in our press release that we issued yesterday, our adjusted operating cash flow grew $4 million in the second quarter to a total of $102 million year to date, which exceeded our expectations, primarily due to the higher than anticipated, very strong cemetery pre-need sales production. A little bit more color on this.
Similar to what we said last quarter, this growth in cash flow from operations was accomplished despite contributions from FTC-divested properties in 2014 that did not benefit us in 2015. This was a headwind of about $12 million when you talk about cash flow from operations. Higher cash receipts, primarily on the strong pre-need cemetery sales production and higher trust withdrawals, helped to offset higher payroll payments. A little bit of color here as well. The higher payroll funding is simply a timing issue due to the way the July 4th holiday fell this year, and we will see that timing benefit us next quarter.
During the second quarter, we paid about $15 million more in cash taxes, which was expected, and it was partially offset by a decline of $9 million in cash interest payments due to our accretive refinancing that we completed in the prior year quarter. Maintenance and cemetery development CapEx for the quarter came in at approximately $36 million, which was about $8 million higher than the prior year and a little higher than our expectations. We do believe this is only related to the timing of this capital deployment and does not change our opinion or affect our full year 2015 CapEx expectations. When you deduct these recurring CapEx items, we calculate our free cash flow for the second quarter to be $66 million. A little bit lower than the prior year due to the higher CapEx timing I just noted above, but above our internal expectations.
At the end of the day, it was a really good quarter for us in terms of cash flow. Mid-year through 2015 year to date, adjusted cash flow from operations has grown $38 million or 14% to $300 million, resulting from the earnings growth that Tom has just highlighted, as well as improved collections on our pre-need sales. Based on our first half strong results, we feel comfortable that we are trending toward the high end of our original 2015 guidance range with our current expectations for adjusted cash flow from operations now between $475 million-$500 million. This was previously $450 million-$500 million. Our cash tax estimate for 2015, based on the midpoints of our models, remains unchanged at approximately $125 million for the full year of 2015.
Our guidance for capital spending in 2015 for maintenance and cemetery development CapEx also remains unchanged at $130 million-$140 million, as I just mentioned, gave you a little color on that. Deducting these recurring CapEx items from our 2015 adjusted cash flow from operation expectations will result in free cash flow in 2015 ranging from $335 million-$370 million, which equates to $1.72 of free cash flow per share at the midpoint of this guidance, using a fully diluted weighted average share count of about 205 million shares. This is only $0.04 less than the $1.76 free cash flow per share we reported on an adjusted basis in 2014, which is pretty impressive when you consider the expected $80 million increase in cash taxes year-over-year and the headwind from the loss of cash flows from the Stewart FTC divestiture properties that I just previously mentioned.
Now let's talk about how we deployed this free cash flow in our capital in general during the quarter. To begin with, we finished the quarter with healthy liquidity of a little more than $400 million, consisting of about $200 million of cash on hand and $200 million of availability on our credit facility. This liquidity positions us well to strategically execute our capital deployment plans. During the quarter, we acquired a funeral cemetery combination facility in South Texas for a total investment of approximately $6 million. Our leverage, which is calculated as net debt to EBITDA in accordance with our credit facility, was 3.55 at the end of the quarter.
This is at the lower end of our current targeted leverage range, as defined, of 3.5-3.7, which we continue to believe is the appropriate range for our company and positions us well as we move forward in 2015. For what we gave back to our shareholders. We returned an impressive $100 million of value to our shareholders during the quarter. In addition to $20 million in dividend payments in the quarter, we also repurchased about $80 million, or 2.8 million shares, during this quarter. Subsequent to the end of the quarter, we have also repurchased just over 1.4 million additional shares for a total investment of approximately $42 million. When you look at what we have done so far in 2015, we have repurchased about 7.2 million shares through today for a total investment of over $190 million.
Currently, we have just over 200 million shares outstanding and about $46 million of remaining share repurchase authorization from our board of directors. In conclusion, we are proud of our performance in the first half of the year. As we look forward, we continue to be excited about the remainder of 2015. We've been on the road quite a bit this year with our investor day, as well as meeting with investors. A common theme we continue to hear is that SCI is somewhat of a boring story, but a great cash flow generator that deploys this cash flow back to its shareholders. By the way, we love being that boring cash flow generator.
I think that appropriately sums up the SCI story right now, and be assured that our management team will continue to work hard to increase the value of your investment in our company. Operator, that concludes our prepared remarks. At this time, we'd like to go ahead and turn it over to you to take questions.
Thank you. We will now begin the question and answer session. If you do have a question, please press star and then one on your telephone keypad. If you'd like to remove your question from the queue, please press the pound sign or the hash key. If you're using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, if you do have a question, please press star and then one on your telephone keypad now. Standing by for questions. First question here comes from Mr. Chris Rigg from Susquehanna Financial. Please go ahead.
Good morning, guys. On volumes, I think your annual guidance initially was down 1% to 2%. Obviously, at this point, you're tracking quite a bit better through mid-year. Can you give us a sense of how you're thinking about volumes in the back half of the year and for the year overall? Thanks.
Yeah, Chris, this is Tom. I think we're very pleased with the comfortable volume statistics on the first six months of the year. I think I'd say it this way. I think we feel pretty good about the year ending on a positive note. Having said that, in most years where you see an advanced flu season like we have this year, you tend to see some fall off on the back half of the year. The only other thing I would add in there is that since we created SCI Direct, the volume statistics on that business are different than I'd say the national trend. Because they're so pre-need oriented as a company, we are in that segment. We're driving higher volume through the backlog. As an example, I think in the first half of the year, SCI Direct's up almost 10%.
That type of trend I would expect that could continue at those types of levels on the back half. I'd expect the core part of the business to retract somewhat. Again, I think at this point, because of what we've seen the first half of the year, it's a positive year for volume.
Okay, great. Just on the acquisitions, can you just clarify a little bit? I got a little confused. You spent just under $37 million through the first six months, but you've done some stuff after the quarter closed. Can you just help me better understand exactly what the moving pieces are at this point? Thanks.
Sure. We actually, I think Eric talked to this in the first quarter, we closed on some businesses in California, and the actual purchase price, we had some 1031. It was closer to a, I think, $45 or $1 million purchase price. In the second quarter, as Eric mentioned, we purchased a business in South Texas, businesses around $6 million. We actually had three under letter of intent. I actually believe we closed one last night that was in South Carolina. What we've reported so far to date are the California and the Texas pieces. We expect, again, more to come. The pipeline looks, as we've said before, pretty good. We're excited about continuing to grow with businesses that fit our footprint and really some great people and some great businesses coming into the company.
Got it. Then just one last one, not directly related to the quarter. When we were out on the road a few weeks back, the concept of having a white paper with regard to pre-need accounting came up. Can you give us a sense for where that stands and when we might see something? Thanks a lot.
Sure, Chris. As you know, the accounting is somewhat straightforward on the at-need side, but there's some challenges in terms of its complexity on the pre-need side. We have taken our disclosures that are in all of our filings and just taken that same information, no new additional information, but taken that same information and just tried to simplify some things in tabular formats and used some examples, and et cetera. We have been working on that, Chris, after that request, and I anticipate that getting out onto our investor tab of our website shortly. When I say that, I'm going to say in the next few weeks. Everyone should look for that, and hopefully that's a document that would clarify some things, but most importantly, simplify some things as well for our shareholders and investors.
Perfect. Thanks a lot.
Sure.
Oh, sorry.
Yes?
Oh, yes. I'm sorry. Please continue.
No, I'm sorry. We'll take the next question.
No problem. Our next question here comes from A.J. Rice from UBS. Please go ahead.
Hello, everybody. Maybe just to follow up on the acquisition question, maybe stepping back a little bit further. A, is there any change in what you're seeing pricing-wise, competition for deals, and B, it seems like there may be a little bit of a pickup in activity. Is that right, or would you characterize this sort of steady state?
Sure, A.J. I'd say that we're really not seeing any real changes. I think where these deals are crossing the line are pretty much consistent. We have seen a lot more activity. If you think about it, with us and Stewart talking, obviously, we were out of the market for acquisitions for a little bit. You get a lot of the divestitures that were going to come out, so a lot of our smaller competitors were raising money in order to buy those. I think there was a pent-up number of deals that probably we're experiencing now.
Having said that, I also think demographics play into everything, and we're just noticing it kind of as an industry, these generational businesses seem to be turning over more with this generation than the previous one. We're not seeing as many kids wanting to go into the business, and so there's probably more deals that are beginning to come out just because of the simple demographics. That's a bit of speculation, but we're pleased with the number of businesses that are coming available, and we're excited about continuing to grow.
Okay. Maybe switching over to the cremation. It sounds like the above-average growth is happening on the Neptune side, and then maybe your legacy cremation business, pre-Neptune, is more tracking what you saw with the at-need business side. A, is that right? Maybe second, is the Neptune growth being driven by new market entrants or sales incentives, or what's behind that, would you say?
I think it's two things, A.J. We studied this quite a bit when we entered the business and purchased Neptune Society back when we did. We really saw these two businesses as two separate consumers that we're trying to drive penetration with. Remember, we said that what Neptune Society was doing was aggressively pre-need selling a consumer that was primarily driven by price.
Right.
I think that consumer is very likely to pre-need. That consumer wasn't likely to come to one of our funeral homes before. I think you're exactly right. We're seeing more growth on that side of the business, partially because of the way we approach that consumer. I think on the SCI Direct side, probably 20%-25% of our business is at-need walk-in, and 75%-80% is pre-need going at-need. You can almost reverse that for the core business. It's probably 60%-65% walk-in and 35% pre-need going at-need. That's the reason for seeing, I'd say, more market share pickup within that segment on SCI Direct. I'd say your hypothesis is correct as far as I'm concerned, A.J.
My last one, for the last year, a lot of things have been going on, the last 18 months in the organization, obviously integrating Stewart Enterprises, Inc. You had the initiative last fall around your restructuring some of the pre-need sales commissions. It seems like a lot of that is now in place. Is this just the time to sort of block and tackle and run the business, or are there some other initiatives looking out 12-18 months, 12-24 months, that it'll be worth highlighting?
I think it's a constant challenge to wake up every morning and drive. If you think about it, A.J., I'd say the biggest things on our plate right now really won't change. The tools we use may be different. One is relevance to the consumer. We've got to remain relevant. We've got to provide products and services that people find value in. Life Well Celebrated is a campaign that we've rolled out and continue to emphasize the changing consumer wants and needs, making sure we're adapting to those. The big part of our strategy has always been pre-need. We think pre-need differentiates us from our competitors. We think it's a real strategic advantage for us.
We invest a lot of money and time, and attention on continuing to grow pre-need cemetery, as well as pre-need funeral, which we know will enhance our market share in the future as the baby boomers begin to impact the funeral segment. Really, our strategies haven't changed. We may have new tools that we're introducing. We're laser-focused on the customer, and laser-focused on both the at-need customer and on the pre-need customer.
Okay, great. Thanks a lot.
Thank you. Our next question here comes from Robert Willoughby from Bank of America. Please go ahead, sir.
Thank you. Eric, did you mention what the expected divested Stewart facility hit might be in the third quarter?
No, we didn't. In terms of cash flow, it was about $24 million year to date. If you think of an earnings per share perspective, then it was about $0.035 first quarter, $0.035 second quarter, and I think it's like another $0.01 in the back half. It really moderates-
Okay
in the back half of the year, Robert.
Okay. Just thinking about the balance between the share repurchases and the deals. Given where the stock is there a level in your mind where the deals will take greater precedence here? You've obviously stepped them up, could we see the deal flow pick up more meaningfully and share repos come down a bit at some point here?
Well, I think the deals outrank the share repurchases today. The IRRs that we've been doing, as we've disclosed, have been anywhere from 12%-22%, and that's a tremendous value to our shareholders to deploy capital with that type of return. Frankly, growing the business as well, on top of that capital deployment, is a strong desire for ours that frankly has been outranking it. It's the time where you have to have the deals come to us in a meaningful way that we've described before. Ultimately, when you shift then to deployment towards share repurchases, it's a function of various metrics informing an opinion internally on what we think the intrinsic value of the company is. There's plenty of different ways that we do that, whether it's DCF calculations or other various quantitative means.
At the end of the day, we are comfortable at these levels continuing to repurchase our shares and deploy capital back to our shareholders.
Okay. Maybe lastly, just in terms of focusing on the deals and the returns that they can generate, have there been any renewed thoughts about looking overseas again?
We did a deeper dive on that a while back, Robert, I think concluded that the best thing we can do right now, there's more than ample opportunity in the markets that we already are in here in the U.S. and Canada. That remains our near-term focus to grow the business. We'll constantly look at things from a valuation and a risk reward, and I'd say our best risk reward is right here in the U.S. and Canada.
Perfect. Thank you.
Yeah.
Thank you. Our next question comes from John Ransom from Raymond James. Please go ahead.
Hi. Good morning. Did you guys say you were boring? I think that's bad. I don't believe that.
John, you told us we were boring, if you remember.
Well, I embody the boring ethos. Let's talk a little bit, if you don't mind, about Canada. I think that market is maybe a little less known than the U.S. Could you talk about how I know you talked about your market share in U.S. plus Canada, but what's the Canadian opportunity? How many big lumpy assets are there? How does pricing compare? How do the fundamentals compare to the U.S., and how do you rank the attractiveness other than, obviously, it's one-tenth the size of the U.S. in terms of number of people?
Yeah, I guess, John, I'd say this. I don't have the specific market share of Canada, but I'd say it pretty well reflects, it's probably about the same or slightly above the U.S., our market share.
Right.
We love Canada.
Let's not get carried away.
Well, I did. I love Canada. Rush is from Canada. There's a lot of great bands from there. We'll continue to look at those markets, and we're having conversations all the time in the Canadian markets. I think the pricing is relatively similar. We're excited about the ability to grow in Canada, and particularly in Toronto and Vancouver, and places where we've really got good infrastructure and can continue to grow in those markets.
Are there proportionally more sizable assets there than there are left in the U.S. since you've done a pretty good job mopping up some of the opportunities in the U.S.?
We've done a pretty good job there, too. I don't see it as any different. Again, we look at those opportunities through the same lens, I'd say they look about the same. We've seen a decent amount of activity and discussion in Canada, we're excited about it.
Okay. I'd remind you that Justin Bieber is also from Canada, temper your enthusiasm. All right. Thank you.
You know what? He's not boring.
Here it appears we have no further questions. I would now like to turn the call back over to SCI.
We want to thank everybody for participating in the call today. We look forward to seeing you again for our third quarter release, which I believe, Eric, will be in late October.
End of October.
Thanks again. Appreciate it.
Thank you, ladies and gentlemen. This does conclude today's conference. Thank you for participating, and you may now disconnect.