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…

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…

[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…

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.