Welcome to the third quarter 2018 Service Corporation International earnings conference call. My name is Hilda and I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session [Operator Instructions]. Please note that this conference is being recorded. I will now like to turn the call over to SCI management.

Good morning and thanks everyone for joining our call today. I'm Debbie Young, Director of Investor Relations. I'll quickly go over our Safe Harbor language before we begin the prepared remarks about the quarter 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. We may also 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. I'll turn the call over to Tom Ryan, SCI's Chairman and CEO.

Thank you, Debbie and hello everyone and thank you for joining us on the call this morning. Today, I'm going to begin my remarks with a high level overview of the third quarter, followed by a more detailed analysis of our funeral and cemetery operations, then I'll comment on our outlook for the fourth quarter, as well as take a little deeper dive with you regarding the rollout and impact of Beacon, our new customer-facing technology that we've been referring to over the last few quarters. So let's begin with an overview of the quarter. As you saw in our press release yesterday, adjusted earnings per share grew $0.02 or 6% to $0.35 per share compared to the same period last year. From a revenue and operating profit perspective, this was a very strong quarter, growing revenues over 6% and operating profit at 11%. Comparable operations contributed about $0.06 of earnings-per-share growth as strong cemetery revenue growth was partially offset by higher-than-inflationary fixed cost increases in both the funeral and cemetery segments. These increases were associated with higher wage and benefit costs as well as an increase in marketing spend. In addition, our recent acquisitions contributed an additional $0.01 to growth for the quarter. This robust operational improvement of $0.07 was somewhat offset by a $0.05 increase in general and administrative expense for the quarter. $0.04 of this general and administrative increase was generated by higher long-term incentive compensation expense associated with three separate years of a performance unit plan whose value is tied to total shareholder return. We experienced this significant increase as SCI's stock price appreciated over 23% for the quarter, which was more than three times the percentage growth of the S&P 500, moving our relative ranking quite significantly in all three plans. Additionally, higher interest expense…

Thanks, Tom; and good morning, everybody. Today, as usual, I'm going to provide some color on our cash flow results during the quarter, and I'm going to touch on our outlook for both cash flow and capital deployment, and then end with discussing our financial position for the remainder of 2018. But first, I'd like to start with our continued progress on the capital deployment front. And as a reminder, our capital deployment philosophy focuses on opportunities that will yield the highest relative returns for our Company. We're already off to an outstanding start in terms of delivering value to our shareholders and the third quarter results have further enhanced this progress. So during the quarter we invested nearly 108 million toward acquisitions, new location builds, dividends and share repurchases. This is an impressive 20% increase to capital deployment over the prior year's quarter's investment of roughly 90 million. So let's talk about the breakdown of this deployment. We were able to deploy 30 million of capital toward acquisitions and new builds during the quarter. About 20 million of this was for two notable acquisitions: one in the Mid-Atlantic area for a combination funeral and cemetery operation; and another was here in Texas for a funeral home. Remember that acquisitions are our highest and best use of capital as they generally result in after-tax cash IRRs that meaningfully exceed our cost of capital. We are proud of these acquisitions; and most importantly, we welcome all of these new associates into the Dignity Memorial and SCI family. In addition, we are delivering on our strategy of building new funeral homes, and we spent nearly $10 million during the quarter. This spend is going to develop our footprint in important markets, for example, such as Texas, Florida, California and other states through…

Thank you. We will now begin the question-and-answer session. [Operator Instructions] We have a question from Joanna Gajuk from Bank of America.

Good morning. Thanks so much for taking the questions here. So first on the quarter and I guess the outlook, just to, I guess, to reframe what you just said in terms of G&A, because you've kind of talked about the 2019 commentary. But should we assume that for Q4 this year the G&A will come back to, call it, $30 million range for quarter that we've seen in earlier - or first half of the year?

Yeah, we do think that, Joanna. I think this is more of a onetime event that occurred during the quarter as it relates to the performance unit plans, and of course are disclosed out there in the proxy, which really resulted from, as Tom mentioned, the differential run in our stock price during the third quarter, which is about three times the S&P performance. So consider that kind of a onetime event, and I think you should consider us going back to kind of the normalized levels which are kind of about 30 million to 33 million right now in general agency, G&A expense I should say, per quarter. So kind of around that rate for the fourth quarter will be good.

Great, that makes sense. And on the - on the point of guidance, so I understand for EPS, you narrowed the range, but still there is a band. So can you flesh to us maybe what are the key drivers to get to the higher end versus the lower end?

I think the - Joanna, this is Tom. I think the key driver - the number one key drivers is going to be cemetery sales production and particularly around the property portion of that and we feel very confident. As we look to the fourth quarter, we believe we got the right momentum to deliver on that. The things that are going to be a little bit in our face are we know based upon the timing of construction contracts that we're going to be a little bit backwards compared to prior years as it relates to recognition of constructed projects. But we believe we're going to overcome that and then some with our cemetery sales production. So I think that's the key number that pushes you toward a top, or in the event of not doing well, pushes you back toward the bottom.

Thank you and if I might squeeze a last one, a quick one I guess. On the endowment trust fund strategy changes that benefited this quarter, can you flesh out I guess where you are on that shift or is there a goal in terms of how many of the states will be willing to do that because I know when you introduced this concept at the Investor Day, you talked about some states might take really long time, so kind of are you on track, is there more opportunity to shift more of these I guess, trust funds to that strategy? Thank you.

Well we're always trying. We, continue to lobby. We think it is a benefit for our company, but most importantly we think it's a benefit for the consumers that will benefit for the long-term maintenance that the trust funds will produce through perpetuity, so that makes it a win-win situation and that's how states are receptive to change in the laws. We've done a significant amount of movement with those states to move it to allow the total return asset allocation. I would characterize it as kind of about half the states are there in terms of the dollars in our trust funds. We did have a major movement in California this year in a positive direction towards that which was approved, but that's not effective Joanna until the 2020 year under the law that they passed. So I would think of it as kind of 60% to two thirds having the total return opportunity as you get to 2020, which bodes well. For us, we think that's a higher return opportunity to us as you saw in this quarter where we had a good amount of movement, half of which was probably related to the total return on asset allocation.

Great, thank you. I'll go back to the queue. Thanks, so much.

Sure.

The next question comes from Scott Schneeberger from Oppenheimer.

Thanks, very much. Good morning. So to start out asking on funeral preneed sales growth that was a significant second quarter in a row, very large and accelerating, could you discuss kind of compare and contrast how much of that is Beacon versus how much of maybe some of your other initiatives? And then the previous expectation for the year was low-to-mid single-digit growth rate, you clearly have surpassed that. How should we think about that growth rate going forward? Thanks.

Hey, Scott, this is Tom. Thanks for the question. I think and again it's always hard to measure, but based upon the markets where we're rolled out, it's our belief that about half - we have 40% growth in the quarter, about half of that was driven off Beacon markets, which we're going to attribute them to Beacon's impact, which is pretty huge, particularly since we're only at 60% of the markets with the target to be at 95% by year end, so that is a big driver and a lot of that I think is - what it does in front of the customer, it also really increases the efficiency of our sales force. They're allowed to spend more time in front of families and less time with administrative tasks and burdens, and I think you're seeing a real shift of emphasis if you will to the pre-arranged product because it's easier to do. I can meet my quotas and objectives as it relates to funeral side of the business quite possibly to the detriment of cemetery, I mean in certain markets. So we're excited about that. As you think about next year, and again, we haven't put out any formal guidance, and I don't want to put any pressure with Gerry sitting in the room across from me, but I do think we should particularly on the first half of the year have a really nice comparable which then should, in my opinion, settle into that kind of mid-single digit growth. So next year again could be mid-to-high with an emphasis on, I think, real execution in the first half of the year as you think about the rollout of Beacon. The most exciting point, Scott, for me is, we're going to roll it out to cemetery next year. And it could begin at some point to impact our results as you think about sales production growth on the cemetery side of equation, which is exciting and particularly exciting to earnings, because again when we sell preneed cemetery property, we're generally going to be able to recognize those earnings. We don't get that benefit on the funeral side today. Having said that, what's important to us is our client families, what's important to us is the long-term future of SCI. And having Beacon in our funeral production tool kit is a huge advantage, and we see continue to benefit into 2019.

Thanks, a few more from me, if I could. Acquisitions has been very elevated this year versus your evergreen model. How should we think in fourth quarter and perhaps looking out to next year, how active is the pipeline? Clearly it has been. Is there more to go and any margin implications in the fourth quarter or things to think about from all that you've done this year? Thanks.

Yeah. Thanks, Scott. First on the ones that we've done, we did highlight as you know we got $0.01 in the quarter from the effect of acquisitions. And again, that's because of the size and the number of acquisitions we've been able to close. So as you think of the fourth quarter, we believe it'll have an effect at least that much as you think about the impact on Q4. And obviously, that's going to lop over into 2019. So that's a real opportunity for us, we believe, to deliver. As you think about the pipeline today and talking to John Faulk about this, we're still seeing an active pipeline and feel good about the fourth quarter. Like we said before, your visibility only goes so far, but right now we're continuing to see a pretty robust activity. The difference is probably going to be in the size, the number of deals we probably are seeing, but we had a very unusually large transaction this year. I don't know if that's repeatable. Having said that, I think the activity is good, I think the price discussions are good, and so we feel pretty good about putting a significant amount of money to work as it relates to both acquisitions, as well as growth opportunities to construct new funeral homes either on cemeteries or another market. So we're excited.

All right. Thanks. I'm going to throw one more and turn it over. But it looks like the - on the EPS guidance, it looks like most of the reduction of the high-end was affiliated with the incentive comp or related to SCI stock price. And then also you're talking about probably paying less cash taxes this year, yet you maintained cash from ops guidance and obviously the incentive comp is non-cash. So is it working capital or conservative, help us think why - understand why the - why that guidance did not increase for the year? Thanks.

Yeah, let me - I want to address two things. I want to make sure everybody understands the incentive comp piece too. So first of all, I think the real difference this time is think about the level of the way we delivered the earnings this time absent the composition which I'll touch upon a little more, Scott, if you let me. And that is, we're doing it through preneed cemetery revenue recognition. So there's two components. One is the preneed sale which Eric touched upon earlier and said, when we sell cemetery, we get all the revenue, but we don't get all the cash. We get cash over a longer period of time. And the same thing on the construction; we may have received a lot of the cash earlier that we are now recognizing with no cash associated with it. So there's a lot of - there's a real mismatch between in timing on cash and earnings as it relates to cemetery. So anytime you see that move expected to look one way or the other. As an example, if our preneed cemetery sales were to ever go down, we would look like we're cash collectors, really good which isn't necessarily a healthy thing, right, we'd rather have the sales. So that's probably the biggest driver of the cash change. And then Eric touched upon a little bit, we have higher interest rates and those are cash interest rates, because of the variable rate nature of our debt. The one thing I just want to clarify, Scott, on these plans, just to give people a little more color, because I know they're not as apparent as they are to us. So this is a performance unit plan, it's based upon our total shareholder return related to a competing…

Okay, thanks. I'll turn it over.

Thank you. The next question comes from AJ Rice from Credit Suisse.

Hi, everybody. First of all, I just wanted to go back to the guidance and what it implies for the rest of the year. I think, when you - on second quarter conference call, the comment was, we think we'll be toward the upper half of the guidance range that was in place. You've narrowed the range and, I guess, kept the midpoint at about $1.81 and you've also now picked up this $0.04, sounds like that's included in guidance but it's sort of unusual. I guess how should we think about that comment in the second quarter relative today? Do you still feel like you're probably in the upper half of your guidance range that you've offered now or is it - in light of the $0.04 is that not as likely?

Yeah, I think - AJ the way that works is - you're right, and when we did the second quarter call the stock hasn't moved yet. So our opinion was we thought highly likely being at the top end of that range, so let's call it is the middle range of the $1.81 and we had $0.04, we didn't know differential that's going to happen. So maybe another way to say it is, we believe we're on pace in that map to get to $1.85. We now have this - we now are aware of the $0.04, we don't know what's going to happen, we're not changing any opinion about our fourth quarter and so hopefully that guide –again the midpoint is still in $1.81 and for lack of a better term you can feel a lot more sense more as to what - so our expectation really hasn't changed. We still feel good about the fourth quarter. And again I think I try to point out on what we're talking about, when I think about '19, '18 if it is like it is today, it's probably going to have a higher incentive compensation accrual than what we're going to accrue in '19. So as I think about modeling '19 I might take that if you believe the midpoint to $1.81, I might add a few pennies to say I know I'm going to get back a little bit of that unusual accrual. So maybe my starting base is $1.83, 4 or 5. And now, I could say, can I grow it so percent, check the box and what are the factors do I need to think about as you model 2019.

Okay, alight, that's helpful. And I know you talked a little bit about Beacon already. But I guess, I'd love to hear you flesh out a little more. Obviously, it's accelerated the growth in the cemetery side. What would be - I mean, is it reasonable to think that you - I mean, on the accelerated growth from the funeral side, now as you move to cemetery, which obviously has sort of near-term earnings implications. Do you think some of the dynamics that led to accelerated growth on the funeral side apply on the cemetery side? I know it's a different business in some ways. Is there any way to flesh out what it might mean in terms of accelerating the pace of growth in the cemetery business?

Sure, AJ. First of all, we have seen a significant lift on the funeral side. And as I think about cemetery, and again, let's - they may shoot me later, so I'll Tom's opinion, but Gerry is in the room here and Bryan Bentley, the person responsible for rolling out Beacon. I would think of it this way. First of all, I'll give you the positive. We believe, it's going to have a favorable impact as we go forward on cemetery for sure. The slight differences I would explain it this way. The funeral is a much more homogeneous product, it's easier to roll out, there's not as much differentiation as you think about walking through the options. Cemetery is unique in the variety of options that are out there and how you can weigh that value of different types of cemetery property in different locations which are uniquely priced and they are different, but they're little more complicated. However, as you work through that, I think it's, at least, my belief that as it comes to large sales, it's probably harder to see where you get as much of an impact because the large sale has a lot of activity around which is still going to happen. But as you think about the sales that are not large sales, but more traditional type sales that are going to look a little more like a funeral, I don't know why you wouldn't have a similar impact as you think about that channel, because we're going to become much more efficient and effective at presenting to the client families, it's going to be easier to process these. Again, I go back to the time it takes for a counselor to sit down and present and have a contract and haven't funded and haven't collected is dramatically reduced to what the old paperwork system used to work. So it's my belief we'll be much more productive and it will have an impact particularly on the non-large sales cemetery side.

Okay and that makes a lot of sense. And then just a last question, we've started to get questions obviously with the market volatility of the last month or so, about how to think about that relative to your performance and results over time given the exposure of the trust funds. I know you're moving the perpetual care trust fund to sort of a total return and that may be a - help you offset it. But just, can you give us a little perspective on how we should think about - and how you would think about budgeting given the volatility that seems to be coming back to the market little bit?

Sure. I mean, what would obviously affect and you're exactly right, A.J., you made a good point, which is ECF is going to be a little bit isolated because of the total return scenario, which is generally under these laws allows you to take out 3% to 4%. Now, over a period of time, if those returns are not there, then ECF could get affected as well. But what really happens, you're exactly right, on the MST trusts, which are the merchandise and service trusts that support the funeral and the cemetery backlog in those specific contracts for the monies invested in those trust funds. Ultimately, it's a muted effect that we've said many times before, because ultimately, the life of the contracts is about 10 years. And so any time you have a drop in the market, it doesn't immediately come through your EBITDA or your cash flow strength. Think of it as it comes through over a 10-year period, so therefore about one-tenth of it may come through in year one. And that's the muted effect that we've tried to walk people through many times, which was indicative of what happened in the '08, '09 scenario. As a very, very general rule, all else being equal, and this is dangerous sometimes to use this metric, but as the trust funds come off at a 1% clip from where it's been - where the trajectory has been over a long period of time, any 1% movement off of that trajectory generally turns out to be $1 million to $1.5 million of EBITDA loss. There's a lot of assumptions in that, a lot of things outside of that has to be equal for that to hold up. But generally that gives you a quantitative feel for the muted effect as markets change and the trust portfolio changes.

Okay, great. Thanks a lot.

Welcome.

The next question comes from John ransom from Raymond James.

Good morning. A.J. stole my questions, so I got to go to a clearly inferior question, which is, on your floating rate debt, Eric, what's the good rule of thumb, every 100 bps of short-term rates, how much of an effect is that?

Generally, there's about - we have about $650 million on the terms loans, we have $400 million on the revolvers, so call that $1 billion. You have about $200 million more in operating leases that are floating. So think of about, I call it, about a-third of our debt is floating. So a movement can be significant in terms of that. Most of that debt is LIBOR plus 175. It's already moved 20 basis points in the third quarter as you know; it's about 3.8%, now it's about 4%, so 1% movement in that will have -

10 million.

$10 million or so of effect. And you've kind of seen that this year already as 2017 ended the year about $170 million. And if you do the math and trend it out where we are, '18 is going to end in kind of $180 million, $182 million somewhere in that interest expense area. So that ratio we just talked about holds true.

So there's no - in this 30-day LIBOR, there's no fancy caps or swaps or anything like that?

That is correct.

Good, that's easy for me. The other question I had is –I know most of the - is the Beac - are the Beacon sales the same kind of mix of 70/30 third party funded versus trust funded preneed sales?

No, I think a lot of the Beacon sales are tending probably a little more insurance in the rating [ph] right now, some of that the function of where you put it, but some of that, I think, a function of simplifying the insurance process.

So you're getting some margin, right, you get the commission payment less what you pay yourselves guys, so there's a little bit of margin that you capture upfront?

There is John, you're exactly right. Probably 1.5 million bucks in this quarter and that's something you probably could think about going forward as well.

I'm sorry, is that revenue or is that EBITDA?

That's the net. So I think we're up $5.3 million in G& A revenue. And if you look at - it's hard to measure the associated sales, because of the change in the accounting for selling. But I would put it closer to $4 million is the real difference. So probably making a little over $1 million in the quarter as you think about the way you're putting it.

Sure. And if you're - and on the cemetery side, I know you can recognize the plot of land and some of the stuff you deliver, so if you grew your cemetery preneed $100 next year because of Beacon, approximately how much of that would fall to the bottom-line?

Again, it probably depends on your - if it's property. But if it's property, it's probably somewhere around $650 to $700 of that $1,000.

Okay, so yeah, there is an EBITDA effect and hopefully that kind of offsets some of the interest expense comparison, so okay. Alright that's all I had. Thank you.

Thank you, John.

Thank you. The next question comes from Duncan Brown from Wells Fargo.

Hey, good morning, just wanted to go back to the change in the perpetual trust allocation. Obviously, there's not a lot of time on the sort of more standard the muted impact of 1% move on the broader trust fund. Is that how should we think about the potential impact for the change in perpetual trust is, it sounds like it was a nice impact, positive impact this quarter, the markets stays week. How should we think about that going forward?

Well, this quarter was really a function of incremental total return portfolios versus prior year coupled with some capital gains that occurred, which is really kind of outside our control, Duncan, because that's really the professional institution or money managers that we outsource those funds to, but they happen to rebalance some things, create some capital gains and then at some stage that gets distributed to us. So first of all, that's what occurred this particular quarter. ECF, each one of the laws in the internal care funds is a little bit different. But generally, in the total return area, we can pull out that 3% to 4%. And I think, that will essentially continue to move in the positive direction. Ultimately, if you have a string in the market that's declining and there's not positive income therefore a positive return, if you will, to take out, ultimately after a period of time maybe one year, maybe two years, maybe three years, which depends on the state law, you would have to seize pulling that out and let it settle for a while until it comes back positive, and that would have an effect on us. We don't have the crystal ball to try to predict that or try to quantify it, but certainly that is a possibility under the state laws.

Okay. So maybe to try and simplify, at least, for me, so if the market stays weak in Q4, you would still be able to pull out the 3% to 4%, it just wouldn't - it would only become an issue over a longer period of time and would vary by state. Is that the right way to think about it?

That's correct.

And then just lastly - and I should know the answer to this, but on Beacon, can you remind us - this is something you all designed, right, this is not like a sales force that a competitor could go out and also implement it, is that correct?

That is correct.

And to your knowledge is there anything similar to that or any competitors trying to do anything like it or is it unique?

I think it's unique and obviously somebody could try to create something like it. I think what's hard for people to do in order to get bang for your buck, it's going to cost multimillion dollars put in place and I think with our scale it's a great return on investment. A lot of our competitors because of their lack of scale this would be a significant capital outlay for them and so I think that's going to prevent, I'd say, the level of it that we've instituted.

And then I guess just following on maybe on markets where you're not currently at or have any plans to be at, is that something you would consider licensing out or selling or is that not in the plans?

Truly not in the plans today, never say never, but I think this is something we want to - it's really about taking care of our client families, enhancing the productivity and the careers of our fellow associates. So that's where we're getting bang for the buck today. One day it may be worth looking to something like that, but not on the plan as we speak.

Great, thank you.

Thanks, Duncan.

Thank you. We have no further questions. I would like to turn the call over to SCI management.

Thank you everybody for being on the call today. We appreciate you being here. We look forward to talking to you on our fourth quarter earnings call, which I believe is going to be in early February. Thank you so much.

Thank you. Ladies and gentlemen this concludes today's conference. We thank you for participating. You may now disconnect.