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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Welcome to the second quarter 2018 Service Corporation International earnings conference call. My name is Hilda and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. During the question and answer session, if you have a question, please press star then one on your touchtone phone. Please note that this conference is being recorded.
I would now like to turn the call over to SCI management.
Hi, good morning. This is Debbie Young, Director of Investor Relations. As usual, today I’ll quickly go over our Safe Harbor language before we begin the prepared remarks from Tom and Eric.
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.
Also today we may refer to certain non-GAAP measurements such as adjusted EPS, adjusted operating cash flow, and free cash flow. A reconciliation of these measurements to the appropriate measures calculated in accordance with GAAP is provided on our website and also in our press release and 8-K that were filed yesterday.
With that, I’ll turn the call over to Tom Ryan, SCI’s Chairman and CEO.
Thank you, Debbie. Hello everyone and thank you for joining us on the call this morning. As usual, I’m going to begin my remarks with an overview of the quarter followed by a more detailed analysis of our funeral and cemetery operations, and finally I’ll comment on our outlook for the remainder of the year. Let’s begin with an overview of the quarter.
As you saw in our press release yesterday, adjusted earnings per share grew $0.09 or 26% to $0.44 per share, which was generally in line with our expectations. This $0.09 of growth quarter over quarter is comprised of three components. First and most importantly, operating income contributed about $0.03 of growth as a revenue increase of more than $18 million from both segments and lower general and administrative expenses were partially offset by increased wage and benefits cost as well as marketing costs that were included in segment operating expenses. Next, earnings per share benefited by $0.02 from the impact of the new revenue recognition standard requiring us to defer certain selling costs until the time of delivery or performance. This impact was in line with our expectations. Finally, a lower tax rate, a reduced share count and slightly higher interest expense combined to benefit our earnings per share by an additional $0.04.
Turning to cash flow, adjusted operating cash flow in the quarter grew $29 million to $104 million. This was primarily due to a reduction in cash taxes related to tax reform coupled with the effect of tax planning initiatives. Last but certainly not least, we continued our commitment to deploy our free cash flow to the highest and best use. During the second quarter, we returned $141 million to our shareholders in the form of share repurchases and dividends paid, bringing the year-to-date total for the six months to $291 million. Additionally during the quarter, we deployed about $140 million of capital towards acquisitions and the construction of new funeral home locations. One unusually sizeable transaction completed in the quarter consisted of 15 funeral homes and seven cemeteries, four or which are combos across four states: Indiana, Ohio, Florida and Washington. Annually, these businesses perform approximately 4,500 funeral cases and over 3,500 cemetery interments.
We typically guide to an acquisition and growth capital spend of $75 million to $100 million on an annual basis. Through the first six months of this year, we’ve already outpaced that estimate as we are now at $180 million year-to-date. The pipeline continues to be robust with a number of deals under letters of intent and active discussions with other parties.
Now let’s talk about how funeral operations performed for the quarter. Yesterday we reported that comparable funeral revenue grew by nearly $7 million or 1.5% compared to the same period last year. Revenues from our core and non-funeral home businesses were relatively flat in the quarter as slight increases in the average revenue were offset by a slight decrease in volume. I must admit I was sad to see our streak of five consecutive quarters of case volume increases come to an end, but we anticipated this based on the strong impact of the flu on the first quarter.
Recognized preneed revenues grew $3.5 million or 11.6% during the quarter. Recall these are the products sold on a preneed contract which are delivered at the time of sale, primarily representing cremation related merchandise and travel protection membership plans sold by our non-funeral home network.
Finally on the revenue front, other funeral revenues increased $4 million compared to the prior year. Included in this amount is an increase of approximately $6 million in general agency revenue on higher insurance-funded preneed sales production of over $14 million or 11.6% compared to the prior year. This increase was slightly offset by a $2 million decrease in SCI direct processing fees, which under our new policy are deferred into service revenue. You should expect to see a similar variance in the next two quarters until we lap the change in the first quarter of 2019.
From a profit perspective, comparable funeral operating profits declined about $3 million and operating margins decreased 100 basis points from 20.6% to 19.6%. Typically on a $7 million increase in revenue, we would expect to generate a $6 million gross profit, but the impact of such a small revenue increase is almost entirely offset by a $5 million increase in fixed costs, assuming a 2% growth rate, we would expect an increase in operating profit of $1 million versus our $3 million decrease we reported. Our fixed costs grew at 3.7% this quarter versus a 2% expectation, or approximately $4 million more than expected.
Three items contributed equally to this cost increase. First, we purposefully increased wages to almost 60% of our employee base, investing in key personnel with particular emphasis on customer service. Second, higher healthcare costs from our self-insured program was impacted by the timing of a few large claims. Finally on the cost front, we saw increased marketing and sales lead development costs which we believe are helping drive improved market share and growth in our preneed funeral sales production.
Total preneed funeral sales production, which gets deferred into our backlog, was a real bright spot for the quarter as it grew a very impressive $24 million or 11%. This consisted of a 9% growth in contracts sold and a 2% increase in the average revenue per contract. Both our core funeral home channel and non-funeral home channel delivered double digit growth. I want to commend the entire sales organization for this extraordinary performance, particularly as we are rolling out Beacon, our new customer-facing technology in a number of regions. We are seeing a significant bump in productivity in markets where we have had Beacon up and running. Through the first six months of the year, overall preneed funeral sales production has grown 7%, setting us up nicely to beat our expectations of 3 to 5% for the full year.
As we step back and look at the funeral segment for the six-month year-to-date period, we have seen funeral volumes up 1.6%, a relatively flat funeral average, mid-single digit revenue growth in our non-funeral home revenues, all resulting in a $4 million increase in funeral margin dollars while maintaining our funeral margin percentage. This performance is absorbing the investment in our workforce as well as incremental marketing spend in preneed funeral growth of 7%.
Now turning to cemetery operations, total comparable cemetery revenue grew $11.4 million or 3.6% in the second quarter. This was primarily driven by a $7.3 million increase in recognized preneed property revenue as well as higher perpetual care trust fund income of about $5 million. The $7.3 million of recognized preneed property growth over the prior year quarter is due to an almost $6 million or 4% increase in preneed property sales production and an increase in recognition rights as we sold a higher percentage into completed projects. We are happy to report that overall preneed sales production, which includes property, merchandise and services, grew almost $8.5 million or 3.6%. We were especially pleased with this performance as the 2017 quarter included a particularly large single sale of $6 million. If you exclude the impact of that particular sales, our preneed sales production would have grown at 6.3%.
As we communicated to you back in the first quarter, the tough comparable for cemetery sales production was in the first half of the year. We believe we can achieve mid to high single digit growth in the back half of 2018.
From a profit perspective, comparable cemetery profits grew $5.6 million and operating margins increased 70 basis points from 29.3% to 30% for the quarter. The new accounting standard related to the deferral of preneed selling expense benefited operating profits by $4.7 million. Based on the revenue increase of $11 million, you would expect to generate about an $8 million gross profit in the cemetery segment offset by about a $2.5 million increase in fixed cost, again assuming a 2% growth rate. Including the change in accounting, we would expect an increase in operating profits of about $10 million versus our reported increase of $5.6 million. Similar to funeral, the approximate $4 million in increased fixed costs above our expectation was due to higher labor costs, including increased wages for certain of our customer-facing employees, and higher healthcare costs coupled with increased marketing spend.
Again as we step back and look at the cemetery segment for the six-month year-to-date period against an incredibly difficult 2017 comparison, we saw a $12 million or 2% revenue growth with less than 1% preneed sales production growth. This generated almost $16 million in increased operating profit, expanding margins to 210 basis points to 28.5%. Over half of our profit growth and margin expansion was due to the anticipated change in accounting for selling costs, but even if you exclude that, we expanded profits over $7 million or 60 basis points as we head into the back half of the year with a much easier sales comparison.
To wrap it up, in the first half of 2018 our company delivered solid performance. We grew earnings per share by almost 25% against a very solid 2017 operating performance, given over half of the increases year-to-date were driven by accounting changes and the impact of tax reform. Having said that, we had as solid contribution from our operations and are now for the first time in a long time growing preneed funeral sales production at 7%. I want to thank our entire team for their hard work and dedication, and particularly our sales team for contributing to the success of our long-term preneed growth strategy.
As we look to the back half of the year, we would expect earnings per share growth to normalize into our long-term guidance range of 8 to 12% as the effect of both the change in accounting and the impact of tax reform normalize and therefore should not have a material effect. This is based on the seasonality of the selling and construction process as well as some favorable tax rates in the back half of 2017 driven by the impact of large stock option exercises last year, therefore we believe our earnings per share growth will primarily be driven by healthy increases in preneed cemetery sales in the back half of 2018.
For now, we’re maintaining our earnings per share guidance although we believe we should be in the upper half of the range by year-end, and we’re increasing the midpoint of our adjusted operating cash flow targets for the full year 2018 by $25 million related to reduced cash taxes, which Eric is going to discuss in more detail. In the meantime, we’ll continue to pursue our three core strategies of growing our revenues, leveraging our scale, and deploying capital in a disciplined manner towards the highest and best use for the long term benefit of our company and our shareholders.
With that, I’ll turn the call over to Eric.
Thanks Tom, and good morning everybody on the call. I’d like to give you some color on our cash flow results, as I usually do, and specifically talk about the quarter, and then I’m going to touch on our outlook and financial position for the remainder of the year.
First, I’d like to address the tremendous results of our capital deployment programs that you’ve just seen during the quarter. As we’ve mentioned in the past, we follow a very disciplined approach to deploying capital focusing on opportunities that yield the highest relative returns for our company. As you’ve just heard, during the quarter we have delivered on this commitment as we have invested an impressive $282 million towards acquisitions, new location builds, dividends, as well as share repurchases.
To give you some perspective on these amounts, during the second quarter of last year we deployed only $82 million, so we more than tripled the amount of capital deployed over the prior year quarter. Let me cover where we specifically deployed this capital.
As Tom just mentioned, we’re extremely happy to have completed about $141 million of acquisitions and new builds during the quarter, which includes the purchase of several premier funeral homes and cemeteries across multiple states As we have noted in the past, acquisitions continues to be our highest and best use of capital as they have generally resulted in after-tax cash IRRs that meaningfully exceed our cost of capital. Year-to-date, we have invested approximately $180 million on these growth opportunities, significantly exceeding our original guidance of about $75 million to $100 million. We’re proud of these purchases and welcome all these new associates from these acquisitions into the SCI and Dignity Memorial family. Looking forward, we remain positive about the acquisition pipeline and hope to be able to add to an already exciting year of acquisitions as we finish 2018.
Further, dividend payments in the second quarter totaled $31 million, which was an increase of 11% over the prior year amount of $28 million, which really reflects the $0.02 per share dividend increase announced in February of this year. Finally, we returned an impressive $110 million of capital to investors during the quarter in the form of share repurchases, acquiring approximately 3 million shares at an average cost of $37.05 per share. When you step back and look at what we have done for the full year, share repurchases have totaled just under a quarter of a billion dollars, or to be specific, about $230 million resulting in the reduction and number of shares outstanding by 6.1 million shares, or about 3%. At quarter end, our outstanding shares have been reduced to just over 181 million shares.
Subsequent to the end of this quarter, we have continued our repurchase program, reducing our outstanding share count by an additional 900,000 shares for a total investment of about $32 million at an average cost similar to what I just described - about $35.03 per share. In total for the year, we have deployed an impressive amount of capital of over $470 million towards $180 million of acquisitions and growth capital, with the remaining $290 million being returned to shareholders in the form of share buybacks and dividends, as I just described.
Now let’s talk about the cash flow and talk about specifically the quarter. Moving on to really what has allowed us to deliver on this capital deployment strategy, let’s talk about the cash flow. As you saw in yesterday’s press release, we are very pleased to report adjusted operating cash flow of $104 million, which was $29 million or almost a 40% increase compared to the prior year quarter of $75 million. The significant increase in cash flow is primarily due to lower cash tax payments of $36 million. There was growth in our cash earnings during the quarter, but it was tempered by negative working capital partially associated with an increase in the revenue recognition of preneed cemetery property related to completed construction projects during the quarter, but as the cash was received on much of these sales or made later on an installment basis.
Shifting back to cash taxes for a second, of the $36 million decline in cash taxes, about $10 million is related to the recently enacted tax reform, and this puts us on track to realize the full-year benefit of $20 million that we had guided you to earlier in the year. The remaining amount of cash tax savings relates almost entirely to effective tax planning which we have been able to execute on through the implementation of successful tax accounting method changes. As a result of the recognition of these tax planning benefits, we are reducing our full year cash tax estimate for 2018 by $25 million to about $90 million from our previously disclosed guidance range midpoint of $115 million. As a point of reference, during the first half of this year, we have already paid just about a third, or $31 million of the $90 million we expect to spend for the full year.
Looking at capex and maintenance and cemetery development capex, [indiscernible] the two components that we define as capex in our free cash flow calculation, this is approximately $50 million for the quarter, which is about $9 million higher than the prior year, but this is roughly in line with our planned spending for the quarter. With some of the extra $25 million of cash flow due to these lower cash taxes, we are planning to increase our guidance for capital spending in 2018 for maintenance and cemetery development from $185 million to $195 million for the full year. The $10 million increase reflects ongoing renovations to certain of our funeral homes to really match our facilities to our customers’ desired memorialization experiences, as we’ve highlighted in our investor day, as well as some investments in our websites and other sales production growth initiatives.
As we think about outlook for the remainder of the year, we are confident in our ability to continue generating strong cash flow. Midyear through 2018, adjusted cash flow from operations has grown $47 million from $263 million in the prior year to $310 million, and is ahead of our original expectations. We are increasing our 2018 guidance for adjusted cash flow from operations by the $25 million, and again this is just reflected in the reduction in anticipated cash tax payments for the year, so now our new range is $575 million to $615 million of adjusted cash flow, or a midpoint of $595 million.
On a free cash flow basis when you deduct our updated guidance of $195 million of recurring capex items from this adjusted cash flow from operation, we calculated our free cash flow guidance range for the full year of $380 million to $420 million, which is the midpoint of $400 million.
In closing, let me provide a high level view of our financial position as we finish the quarter. As a foundation to this capital deployment strategy, we finished the quarter with robust liquidity. After taking into account that generally about $100 million of our cash is encumbered primarily due to balances residing in Canada as well as expected minimum operating cash floors, we had about $65 million of unencumbered cash at the end of the quarter. Adding this unencumbered cash to about $600 million of availability on our long term credit facility, we calculate our unencumbered liquidity to be a strong $665 million at June 30. This liquidity positions us well to strategically execute our capital deployment plans for the remainder of this year and beyond.
Our leverage, which is calculated as net debt to EBITDA in accordance with our updated credit facility, was 3.85 times as of June 30, which really reflects the recent large acquisition we completed but again keeps us in line with our targeted leverage rang of 3.5 to 4 times.
In closing, we’re very proud of our performance in the first half of the year, and as we look forward, we’re also very excited about the remainder of 2018.
With that, Operator, that concludes our prepared remarks, and I’d like now to pass it back over to you and we’ll open it up for questions.
[Operator instructions]
Operator, this is SCI management. I just want to make clear that we can’t hear anything at this point in time.
My apologies. I will read the instructions one more time. Perhaps I was muted. My apologies.
[Operator instructions]
We have a question from AJ Rice from Credit Suisse.
Thanks. Hi everybody. I had a few questions, if I might ask. On the large acquisition, I just wondered whether that--is there overlap with some of your existing facilities? Is there an opportunity for synergies? How should we think about that, and any comment that you can give us on valuation, how that compares with other recent deals?
Sure, AJ. This is Tom, hope you’re doing well. As it relates to that acquisition, for the most part, like I said, it’s multiple markets. They are at or around some of our existing locations, so we do have synergy opportunities within the markets. We’re very, very excited about it, its great people, great management team, and they’re integrating well as we speak. From a valuation perspective, it was well within the range that we’ve disclosed to you guys for the better deals. Generally, we’re going to see deals done in the 7 to 9 times EBITDA range, internal rates of return just below the teens or getting into double digits. Again, this was that type of transaction, and from a revenue perspective, this delivered about, call it $45 million of revenue as it relates to this single transaction.
Okay. On acquisitions, you’ve had a couple years now where you’ve been sort of at the high end of your targets, and now this year you’ll be well above. Is the underlying availability of properties on an upswing, or how would you explain what you’re seeing and what is the pipeline look for continuing deals? Are you on hold for the rest of the year because of this big one, or are you still out there looking at additional deals if they come to fruition?
No AJ, we are open for business, and like I said in my comments, we’ve got a couple of deals under LOI. We’re having discussions with other parties. We are seeing more activity. You hate to predict too far out in the future because the pipeline discussion time is generally going to be in the 12 to 18-month category, so I don’t want to get ahead of myself, but my personal opinion about this, and it’s not worth much, but again I think as you get back to the baby boomers, if you look at the people that are running these businesses, they’re probably getting to a point in their lives generally where there’s more of these that are saying, I’m working really hard, I’ve developed a great business, it’s time for me to begin to enjoy the fruits of my labor. So I just think there’s a natural point we’re reaching where maybe we’re seeing a lot more transactions come available because of that dynamic. I don’t know how long it lasts - I’m sure it will ebb and flow, but as we look today, we’ve got obviously a great six months behind us and as we look forward, we’re excited about the pipeline. I think we continue to see it active and we’re able to deploy capital into great businesses and great people.
Okay. Maybe switching gears, on the preneed funeral side, 11.2% growth - that seems well above--I think mid single digits is sort of how you’re described your target long term. Anything to call out there? I know preneed funeral sales can be a positive or a negative depending on whether it’s insurance driven and you get agency fees, or whether it’s trust fund and you end up having a little commission drag upfront. Did the fact that you had such robust preneed funerals hurt you or help you in the quarter in terms of the bottom line?
Well, I think it was probably fairly neutral this quarter, because remember this also - as you think about--when you think about insurance sales, and the good news this quarter is insurance sales were up even more than the overall average, on the insurance sales we’re going to make a little bit of margin from a raw dollar perspective because the G&A revenues are higher. Now, the calculated margin percentage may have a little bit of turbulence because it’s not a big margin relative to the rest of funeral, but it’s a positive contributor.
On the trust fund side of things, remember with this accounting change, the negative headwind kind of went away from a GAAP perspective because we’re no longer recognizing the trust commission currently. That’s getting deferred into the backlog and it’s going to be allocated against the contract when it goes that need, so overall I would tell you that it was probably helpful to gross dollar percentage.
The success I would attribute, one, to great field leadership and sales leadership in getting this going, but one thing that we’re very excited about, and again we’re rolling it out but we saw a differentiation in the market, is remember we talked about Beacon. Beacon is our customer-facing technology that we’re utilizing in the field, so our sales force can sit it down in front of a customer and do a very nice, robust, professional presentation, and then secondarily a lot of the administrative work that used to have to be done with multiple contracts and signatures is now being done on that platform, so our sales people can be much more efficient in their presentation and utilizing their time in front of customers. In markets where we’ve rolled out, this is a year-to-date number, we’re seeing a pretty big differential in markets that are using Beacon and the markets that haven’t rolled out Beacon yet. I think the difference is like, call it a 9% production increase versus a 2% on a year-to-date - I don’t have quarter numbers in front of me.
We’re very excited about rolling out Beacon to the rest of the network - that should be done by the end of the year. The next big, exciting moment is Beacon is not on cemetery sales yet, so next it’ll go there. Not sure how that’s going to roll out, but I do believe it’s going to help our sales people be much more effective in the presentation and to utilize their time much more efficiently as it relates to more time in front of customers, less time with paperwork.
Okay, great. I’ve got two more here. One is pretty technical. You’ve got something called--you attribute higher non-funeral home sales production in the recognized preneed, it’s about $3.5 million. I’m just curious what that is that ended up flowing through.
Yes AJ, if you remember, we pull out in that sheet on the press release now, that is when we sell effectively on our non-funeral network, so we are selling on a contract urns on a preneed basis and we’re selling away from home protection, and those two products, because they are delivered to the customer, get revenue recognition when we sell them and the rest of the contract is the service component that gets deferred and put into a trust fund. To the extent we can sell more urns and away from home protection, that’s going to drive current revenues and profits, and that’s what that category represents.
Okay. Then this last question being more a theoretical question, I appreciate the comments about being at the upper half of your guidance range. You still have a range of $0.18 halfway through the year, and it looks like to me you’re ahead on buybacks, you’re ahead on acquisitions, you’ve been modestly ahead overall in the first half of the year at least relative to us, and I think you said relative at least in the second quarter, and then you’ve got easier comps. Anything in the back half that’s sort of a headwind that is keeping you from even looking at it a little more, either narrowing the range or even moving the range up slightly?
Really not, AJ. We probably could have narrowed it a little bit. I gave you the color that we think we’re more likely to land in the upper half versus the lower half. Really, nothing that we’re concerned about. I think again, remember the accounting change should be relatively nothing in the back half of the year, and the tax differential shouldn’t be very much, although the one weird thing about taxes you’ve got to remember is, and this was a GAAP change that happened in 2017, when we exercise stock options and that can be a lumpy thing that occurs, last year there was a lot of exercise of options in the third quarter which now reduces the tax rate. It’s an unusual thing but that compensation charge used to flow through, I think equity through the retained earnings statement, and now it flows through tax rate. It’s difficult sometimes to predict what that tax rate is going to be because we don’t know exactly when people exercise options, so that’s probably one minor detail that it’s harder to predict, and that could move a few pennies on the earnings per share.
But we feel good about the back half of the year from an operational perspective. We feel good about our cemetery sales. We feel like we’re making real headway from a market share perspective and competing more effectively for funeral calls, and our preneed funeral we believe will continue to shine, so I feel good. I just think with six months behind us, we’ll know a lot more in the third quarter and give you a better update then.
All right, sounds good. Thanks a lot.
Thank you, AJ.
We have a question from Joanna Gajuk from Bank of America.
Good morning. Thanks so much for taking the questions here. In terms of the performance in the quarter and how you look for the year, I appreciate the comment that pre-funeral sales production was quite impressive, and you’re not willing to change that outlook for the year, so can you just flesh out what drove that 11% production growth in Q2?
Yes, I think in Q2, Joanna, a lot of the success--number one, remember we’ve been working on this for a while. We’ve not been pleased with our preneed funeral production over the last few years. There’s been a variety of reasons, from changing comp plans to onboarding people, new initiatives and new technology, so we’ve been telling you we thought this day was coming, and I guess I’m telling you now we’re excited it’s here.
I’d say the biggest single impact that we can point to for our success in the second quarter again goes back to the rollout of Beacon and that customer-facing technology. We’ve got that in quite markets, I’d say Steve, are we 40% rolled out, is that a fair number? So I think we really saw a ramp-up in the second quarter of higher productivity in markets that Beacon has been in place for, so that’s probably the number one thing I could point you to, and therefore I would tell you that I feel really good about the back half of the year because we’re going to continue to see that in those markets where we’ll finish rolling it out the rest of the year. So we feel very good about our ability to continue to generate good returns - I think we’re up 7% in the first half of the year. I see no reason why we couldn’t repeat that performance in the back half of the year, and then we’re excited, like I said, on the cemetery front to getting to better comparable periods of production that I think will allow us to put some numbers up that will impress you.
Right, because on the cemetery side, right, definitely comps are getting easier, and did I get it right, you said that you still expect--I guess you said second half, you expect high single digits or mid to high single digits gross, so that should imply sort of the mid single digits for the full year you were talking about before. Is that correct?
Yes, so if we can get to that mid to high single digits, that probably pulls the year up to that mid single digit, so we still feel comfortable about that number. I wish we could do the first quarter again, but that’s behind us and we’re very pleased about the second quarter production. Again, if you take out that $6 million sale, we grew second quarter at almost 6.5%, and that’s a level that we feel comfortable with.
Great. Coming back to your comment earlier about investments you’re making into Beacon and rolling that out, you also flag in the press release and in your commentary increased spending on marketing. Can you just give us maybe some examples on exactly where you are putting your money in, and also is there anything to be said around your preparations or anticipation of any changes to the funeral rule? Is that influencing what you are doing around your marketing efforts in terms of the internet marketing type products? Thank you.
Sure Joanna, glad to talk about that. First of all, I’ll go backwards. As far as the funeral rule is concerned, it’s going to be what it’s going to be. Our marketing decisions and internet presence are really driven off trying to drive customers to our great people, so I wouldn’t say that that concerns us. I think this points us in a direction where we’re more prepared for something if that were to come around.
But as you think about this year, I’m going to say two things. The quarter is unusually higher than you should expect on an annualized basis. Let me say that a different way - we’ve budgeted to spend up in marketing this year, so that was already in play. Within the quarter, there’s a little bit of drag as it relates to we transitioned from a vendor, an advertising vendor last year, and in that transition, sometimes because these bills show up in different quarters, I’d say this quarter was more acutely impacted by the lack of marketing spend last year. As you get to the back half of the year, this is going to normalize better, but having said that, we are purposefully spending more on this category.
The term we have utilized internally is really trying to win digital, is the way that we’re describing this, and as you think about the categories, first we’ve got increased what we call broadcast spend, and what this is, is really development of what you’d think of as something like a--something that could be used in a TV commercial, but really more of it is about videos that we are generating for our website. Remember, we rolled out our new websites earlier this year and the video content within there is a spend that we’ve spent more on.
The second thing with digital spend, we’re working on things around reputation management. We’ve always had JD Power as a resource internally, but as you think about externally and your reputation management in today’s world, you’re faced with Google, Yahoo. Those are things that I’d say before we weren’t paying much attention to, but customers are paying attention to that, so we’re working on investing in developing our reputation management.
Then finally as part of that also is our search engine optimization and search engine marketing, and so there again, remember you’ve got paid search, search engine marketing which you pay to be at the top of that, and then secondarily on search engine optimization, when somebody puts a word in, your ability to show up in the top three categories is driven by algorithms and certain things that are out there. Investing and understanding that, investing in the things that allow us to again try to win in digital, so all these things I think are important as a part of our future.
I think we’re just ramping up to a level that’s going to be pretty consistent, so I don’t expect this to be a big spend increase as you think about the future. It’s just a timing mechanism in the second quarter. You might see a little bit spill over in the back half of the year, but we feel very good about this. We think it’s effective, we think it’s going to drive volume both on an as-needs basis and on a preneeds basis.
Great, that’s extremely helpful color, thanks. That definitely makes sense, putting the money where the customers are searching for information, so thank you for that color.
You bet, Joanna. Thank you.
We have a question from Scott Schneeberger from Oppenheimer.
Thanks, good morning. I’d like to focus a little bit more on the cemetery preneed. Could you speak about what you saw in the second quarter, kind of the dynamic of the transition from first quarter to second quarter, and then the follow-up part of this is what gives you the confidence of the strength in the back half? Are you rolling out Beacon in cemetery preneed sales as well, or is that not coming yet, is it something else? Thanks.
Hey Scott. Yes as it relates to the second half of this year, really what gives me the confidence about that is the comparison to last year. Last half of last year was not very strong for us. Some of that, as you recall, relates to hurricanes. If you remember in September, the markets in Florida, the markets in Houston particularly were impacted by that for a number of weeks, so I think you’re going to see some nice gains in those markets as you think about it. That’s probably what gives me the most confidence.
As it relates to Beacon and cemetery, that’s really going to be in 2019, so as I think about exciting news for cemetery, I’d say back half comparison ’18, I like that . We’ve got a great sales team focused, we’ve probably got the most robust leadership at the sales manager level we’ve had in the history of the company now, the right people in the right seats, and we feel like we can really drive the back half. Then if you add Beacon to the mix in 2019, we feel very, very good about our ability to drive that.
Keep in mind too that we just made a pretty significant acquisition that has 3,500 burials a year. There’s a lot of cemetery customers in these new businesses that we’ve acquired, so now I’m getting you excited, Scott, about ’19 - I’m sorry. But ’18 is probably more of a function of we just think it’s an easier comp that allows us to grow at a higher level.
Great, thanks. I think you had said you are trending at 6.3% if you exclude the one-time big sale in second quarter ’17. Is that right?
That is correct, yes.
Okay, same pattern. Could you discuss please cemetery and funeral margin expectations in the back half, just anything that we should be on the watch out for there? Thanks.
Really nothing. As I think about funeral, remember third quarter seasonally is the worst quarter for funeral. You’re going to see a lot less volume, the margins are going to shrink down, they’re not going to be up around the 20%--off the top of my head, I want to say call it 16% is probably a typically third quarter margin, and then the fourth quarter tends to trend back.
As it relates to cost, the only thing I would tell you is remember we adjusted the pay of, again, a lot of our field personnel, customer-facing personnel, and we did this because we believe in them. We believe how important it is to interact with these consumers when we announced it, so again for ’18, that’s going to continue to be a little bit of a headwind as you think about year-over-year.
As it relates to the other categories, marketing spend is going to continue at the level that it is now, but the comparisons in the back half of the year aren’t going to look as negative, so as I think about the margins going forward, maybe a little bit in our face as it relates to salaries and wages that we’ll have to manage, but nothing significant, and on the cemetery side a similar thing - we’re going to have some customer-facing salaries, but we feel good about the cemetery side, one, because of our ability to sell against that last year, and two, completed construction. Remember, cemetery margins tend to rise in the back half of the year because construction projects get completed, so you’ll begin to see more recognized GAAP revenue versus what we sell, whereas in the first half of the year it’s like squirrels storing nuts for the winter. We’re adding to backlog and then we’re going to build it in the back half of the year, so look for strong cemetery margins, look for seasonality on the funeral side, and slight increases in salaries and wages related to people that are very important to us.
Great, thanks. Congratulations on your sizeable acquisition. It sounds like the pipeline is very active. Could you give us a feel for when the big acquisition closed in second quarter, just a sense of how maybe that contributed to second quarter and how we should think about modeling that? I did catch the $45 million revenue contribution, but anything else you can help on some of that impact on the P&L.
Scott, I think we closed that acquisition the second week of June, so there’s not much to say about the second quarter, but it will obviously be full impact beginning in the third quarter and moving forward.
All right, thanks. Good work.
Thanks Scott.
The next question comes from Duncan Brown from Wells Fargo.
Hey, good morning. Just going back to that large acquisition, I think you said it’s in the typical range of 7 to 9 times EBITDA. Is that an LTM EBITDA or is that adjusted for expected synergies, that range?
That generally--because a lot of times, Duncan, because there were private businesses, the way they report is a little different than ours, so that’s really kind of a Year 1 pro forma for us, based on our accounting, based upon the immediate adjustments out of the gate. But generally, it would not include revenue enhancements, it’s more about how the business looks in our hands Day 1.
Okay, that’s fair. Appreciate that. Then if I heard you right, the cemetery perpetual care trust income was up, I think $5 million year-over-year. Is that because of interest rates? I know at the investor day, you guys had talked about moving some of those dollars from fixed income to equity, and I was just curious where you were on that path.
I think we’re making good progress, as we said. There’s some states that are delayed, as we mentioned to you, I think on investor day, like California, which will be a couple years from now, or next year. But ultimately, I think we’re just seeing some traction and it’s that easily 30 to 40% of the assets now are incorporated into the total return methodology, and that asset allocation, Duncan, is much more similar to the other merchandise and service trust funds. It has a good amount of equities, a smaller amount of fixed income - much smaller, and then some alternatives and some cash. But the point is I think we’re starting to see a little bit of traction related to total return, which has helped us during this quarter.
More to come, can’t really predict it because we’re not in the business of predicting the equity markets, but a good quarter for us.
Great. Just last one, you have a little bit of floating rate debt. Can you just remind us is any of that swapped? Any plans on fixing any of that?
We really have done a lot of analysis and like to stay in the range of, I’d call it 70% fixed, 30% floating. We’re not too far off of that now as we have a little over $3 billion in total debt and about a billion in floating. We have no plans, although we’ve looked at it, but we have nothing specifically to announce related to any type of hedge or anything like that, so we do not have a hedge on it.
Just to give you a feel for it, I think that floating rate debt is about LIBOR plus 1.75. It consists of the term loan and the revolver, and that’s 98% of our floating rate debt. I think we began the year--just to make it easy for us, I think we began the year about 3.3%, and now we’re up to about 3.85%, so we’ve had about 50 basis points movement in that. A full 100 basis points would equate to about, I’m going to call it $12 million to $14 million, or $0.04 to $0.05 a share in terms of the headwind, so this would be half that; but of course, that assumes the full 12-month period, so it’ll be a little bit less than that because it’s not like January 1, it went up those 50 basis points. It’s kind of trickled up during the year, so that’s kind of how I’d describe it, Duncan.
Great, thanks a lot.
Thank you. We have no further questions. I would like to turn the call over to SCI management.
Thank you everyone for being on the call today. We look forward to speaking to you again towards the end of October. Have a great week.
Thank you. Ladies and gentlemen, this concludes today’s conference. Thank you for participating. You may now disconnect.