Service Corporation International - Q2 2024

Transcript

Operator (participant)

Good day and welcome to the SCI Q2 2024 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation there will be an opportunity to ask questions. To ask a question you may press star and one on your telephone keypad. To withdraw your questions, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to SCI Management. Please go ahead.

Alanna O'Connor (Assistant VP | Financial Reporting | Investor Relations)

Good morning, this is Allie O'Connor, AVP of Investor Relations and Financial Reporting. Welcome to our Q2 earnings call. We will have prepared remarks about the quarter from Tom and Eric in just a moment, but before that let me quickly go over the safe harbor language. Any comments made by our management team that state our plans, beliefs, expectations or projections for the future are forward-looking statements. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated in such statements.

These risks and uncertainties include, but are not limited to, those factors identified in our earnings release and in our filings with the SEC that are available on our website today. We might also discuss certain non-GAAP financial measures. A reconciliation of these measures can be found in the tables at the end of our earnings release and on our website. With that out of the way, I will now turn it over to Tom Ryan, Chairman and CEO.

Thomas Ryan (Chairman of the Board and CEO)

Thanks, Allie. Hello, everyone, and thank you for joining us on the call today. This morning I'm going to begin my remarks with some high-level color on our business performance for the quarter and provide some greater detail around our funeral and cemetery results. I will then close with some thoughts regarding our earnings expectations for the rest of 2024. For the Q2, we generated adjusted earnings per share of $0.79, which compared to $0.83 in the prior year. The decline of $0.04 from the prior year was attributable to lower funeral profits from a larger-than-anticipated decline in services performed. This decline was slightly offset by an increase in cemetery profits and better-than-expected results from recent acquisitions. Below the line.

The favorable impact of a lower share count was offset by the negative impact of higher interest expense and a higher tax rate. Now let's take a deeper look into the funeral results for the quarter. Total comparable funeral revenues declined $5 million or about 1% over the prior year. Quarter comparable core funeral revenues accounted for this shortfall as it declined almost $7 million. Core funeral volume declined 2.7% versus our expectation of flat to slightly higher volume. Funeral volumes tracked our expectations during the first four months of the year and we saw an unexpected decline in May and June. We believe the COVID pull forward effect combined with lower excess deaths across our markets contributed to the decline in services for the quarter.

However, we are seeing a more positive funeral volume trend in the month of July with comparable case volume trending positively versus the prior year and our modeling expectations. Our core average revenue per service grew over the prior year quarter by 1.3% after absorbing the negative effects of a 60 basis point increase in the cremation mix. SCI Direct non-funeral home preneed sales revenue decreased by $7 million primarily due to operational changes in our California market with respect to the timing of merchandise deliveries which we discussed with you on the Q1 call. This was offset by a $7 million increase in core general agency commissions and other ancillary revenues that were generated by the favorable impact from higher insurance funded sales production and higher general agency commission rates.

From a profit perspective, funeral gross profit declined by $16 million while the gross profit percentage declined from about 21% to about 18%. This decrease is primarily due to the decline in revenue and an increase in annual incentive compensation costs reflecting the timing of incentive compensation accrual adjustments over the prior year. Quarter pre-need funeral sales production increased by $7 million or about 2% over the Q2 of 2023, led by a $10 million or 4% increase in core pre-need funeral sales production.

Now shifting to cemetery, comparable cemetery revenue increased $12 million or about 3% compared to the prior year. In the Q2, the increase was due to a $7 million increase in core revenue and a $5 million increase in other revenue. The $7 million core revenue increase was primarily the result of a $10 million or 11% increase in recognized pre-need merchandise and service revenue. Robust increases in contract averages being delivered out of the backlog, favorably impacted by cumulative trust earnings, were responsible for the impressive year-over-year increase. The other revenue increase was predominantly the result of a $4 million increase in endowment care fund income. Comparable pre-need cemetery sales production decreased by $7 million or 2%, which was less than our flat to slightly up expectation.

While we saw a $4 million increase in core sales production, we had an offset of an $11 million decline related to large sales. We believe this is purely timing as we continue to see long-term strength in our premium cemetery inventory and sales production on a positive note. Year-to-date, preneed cemetery sales production is up $17 million or about 3%. Cemetery gross profits in the quarter increased by $5 million and the gross profit percentage increased by 30 basis points, generating an operating margin percentage of 33%. The profit from higher revenues was slightly offset by higher maintenance costs and an increase in annual incentive compensation costs, again reflecting the timing of incentive accrual adjustment as compared to the prior year quarter. Now let's shift to discussion about our outlook for 2024.

As you saw in our earnings release, we now believe our full year results will be in the lower end of our adjusted earnings per share guidance range of $3.50-$3.80 for 2024. For the back half of 2024, we would expect growth in revenues and margins for both the funeral and cemetery segments resulting in impressive earnings per share growth versus the prior year six month period as well as compared to sequentially to the first six months of 2024. We would anticipate a more challenging funeral volume comparison and lower revenue recognized from completed cemetery construction projects in the Q3 as compared to the prior year and therefore would expect the preponderance of the earnings per share growth to occur in the Q4.

As we think about 2025, we would expect to return to earnings per share growth towards the higher end of our historical annual guidance range of 8%-12% as the negative effects of comparably higher interest rates and SCI Direct operational changes subside and the positive impact of our new Global Atlantic preneed funeral insurance agreement takes effect. Beyond that is where I truly get excited.

With our vast North American network containing market leading brands and businesses, a world class workforce and a robust pre-need backlog, we are poised to capture incremental value for our shareholders as the demographic trends impact our industry. In conclusion, I want to acknowledge and thank the entire SCI team for their daily commitment to our customers, our communities and one another. Your dedication is the foundation of our success. Thank you for making a difference every day with that operator. I'll now turn the call over to Eric.

Eric Tanzberger (SVP and CFO)

Thank you, Tom, and good morning, everybody, on the call. I guess I'll start off the same way. You just ended your comments, Tom, and really just start by thanking all of our 25,000 associates here at SCI for the dedication to the communities, the client families, especially those client families during their greatest times of need. Again, your inspiring commitment and exceptional efforts do not go unnoticed, and most importantly, we say thank you for everything that you do for our company. So with that important thing mentioned today, I'm going to first discuss our cash flow results before moving to capital investments during the quarter. I'll end with providing some commentary on our outlook similar to what Tom just did. And I'll also talk a little bit about our financial position.

Our cash flow remained resilient in the quarter despite lower than anticipated funeral services performed that we've mentioned this quarter morning and yesterday and was primarily aided by strong cash receipts from not only pre-need installment sales, but our underlying funeral and cemetery at-need operations. Specifically for the Q2, we reported adjusted operating cash flow of $220 million, which is an increase of $62 million over the prior year. Let's talk about that. The primary contributor of that increase was expected in the form of lower cash tax payments of about $60 million. That's due to the tax accounting method change related to the timing of recognition of cemetery property revenue for tax purposes. As a reminder, this tax accounting method change will result in the deferral of cash taxes into future years when these installment payments for the cemetery property are received.

We've talked about that now for several quarters. But as we look forward to 2025 and perhaps beyond 2025, we expect cash taxes to revert toward a more normalized trend that you'd expect from us with an anticipated increase of $150 million in cash tax payments going forward compared to 2024 levels. So if you get outside of these cash taxes, though, in terms of cash flow, cash flow is generally flat to the prior year with net favorable working capital.

And that was primarily associated with premium installment sales that were more than offsetting the operating income decline that we talked about and slightly higher cash interest payments. And while we're on the topic of cash interest, assuming the rates remain at the current levels, we continue to expect an increase in cash interest in the second half of this year of about $5 million-$10 million.

That really relates to higher floating rate debt balances compared to prior year. That's really not new, but I just want to remind you of that. Shifting now to capital investment activity. During the quarter we invested just over $300 million of capital to grow our business and return value to our shareholders. Let's look at the components. First, let's start with our maintenance capital. We invested $40 million into high-returning new cemetery inventory development projects.

Again to benefit future preneed sales growth. $29 million of maintenance capital into our facilities and $18 million into digital systems and initiatives. We also invested about $9 million in growth capital towards the construction of new funeral homes and expansion of some existing funeral homes and cemeteries. From an M&A perspective, we were successful in closing 3 transactions. One was in Illinois, one was in Kentucky.

One was in Western Canada for a total spend of about $23 million. That brings our first half acquisition spend to about $38 million and that's kind of how I alluded to last quarter. We continue to remain very optimistic about our momentum here and investment opportunities and are expecting to end the year above our targeted range of $75 million-$125 million of capital invested in mergers and acquisitions. In addition to acquiring businesses, we also spent $15 million purchasing real estate, including $8 million for expansionary cemetery land in the Western United States. Finally, in terms of capital invested or deployed to shareholders, we returned nearly $170 million of capital to our shareholders in the quarter through $43 million of dividends and just under $130 million of share repurchases.

So speaking of that year, to date we have purchased about 2.4 million shares at an average price of about $70. This resulted in just over 144 million shares outstanding for our company as of June 30th. Now moving on to our cash flow outlook for the full year. Even with the lower than anticipated volumes impacted our earnings during this quarter, our cash flows have proven resilient. As I've already mentioned, due to the continued support of cash receipts on both preneed and installment sales and the underlying cash receipts from our funeral and cemetery at need business. Accordingly, as reflected in our press release yesterday, it is important to note that we are reiterating today our adjusted cash flow from operations guidance range of $900 million-$960 million with a midpoint of $930 million.

So in closing our prepared remarks, I'd like to just do a couple more items and highlight about our solid financial position. We continue to have a favorable debt maturity profile and liquidity of just under $800 million at the end of the quarter. This consists of $185 million of cash on hand plus just over $600 million available on our long term bank credit facility. Our leverage at the end of the quarter increased slightly to about 3.7 times and again that's on a net debt to EBITDA basis and cash flow continues to be our strength and together with our solid balance sheet position, we are well positioned to continue delivering value to our shareholders.

Once again, I want to express my gratitude to our entire SCI team for their invaluable contributions each and every day to the communities and the client families we are so lucky to serve. With that, this concludes our prepared remarks and with that, operator, I'd now like to turn this call over to questions.

Operator (participant)

We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the key. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. At this time, we'll pause momentarily to assemble a roster. The first question comes from Joanna Gajuk from Bank of America. Please go ahead.

Joanna Gajuk (Equity Research Analyst)

So much for taking the question here. So, I guess on your comment, if I may, around next year outlook. So, sounds like you think this June weakness in the funeral was sort of temporary drop because you alluded to July tracking better. So, just to confirm, I guess first you're reducing your guidance essentially for the Q2 results. Right? And your expectations for second half of this year aren't changed, right?

Thomas Ryan (Chairman of the Board and CEO)

Yeah, they're predominantly the same, Joanna, we do believe. And again, you never know with volume. It's very difficult to predict. We did say July is a positive trend, but again, you know, we've got many things we can do to execute in the back half of the year and as we get into 2025, so we'll be ready both, you know, delivering the revenue and managing expenses back half.

Joanna Gajuk (Equity Research Analyst)

Okay, great. And then. Yeah, that leads me to the question, original question I was thinking about for next year comment that you just made. So if Q2 was, you know, sort of viewed as a temporary issue, so to speak, and you expect to grow right at the higher end of a typical range. So I guess, yeah. What gives you confidence in ability to grow towards, you know, 12%, I guess, off of maybe somewhat depressed 2024 number?

Thomas Ryan (Chairman of the Board and CEO)

Yes. So as you think about, as I mentioned before, when you think about the 2024 number, two things stand out as it's going away. One is we have an unfavorable interest rate comparison as you think about 2023 to 2024, we believe that will subside in 2025. The other thing is, Joanna, you'll remember in the Q1 we talked about some operational changes we made to SCI Direct, that we thought these were very favorable for the long term business, but were going to cause some temporary pain. And the first half of the year we had essentially $20 million of revenue that were not recorded because of changes in the way we deliver merchandise on the SCI Direct side and some changes that relate to selling away from home insurance.

So those two negative effects kind of go away in the back half of the year and also go away in 2025. So out of the gate, you have two negative trends that kind of disappear. The other positive thing, and there's been an announcement we switched partners as it relates to our general agency agreement, the insurance company that funds our premium insurance. And with this new agreement and some of the terms that are in it, we believe we can generate higher general agency commissions.

So we would anticipate the positive effects of that to lift us up in 2025. And then having said that, the core business itself, we feel, again, very good about. We feel like, you know, volume should stabilize in 2025 from the funeral side, we feel good about our cemetery prospects as we look out into 2025.

And again, I think as you see inflation subsiding, you'll begin to see our expenses. We have a lot of people. We have a lot of great people. We need to pay them appropriately. And we have. But I think we're seeing wage inflation subside a bit and all the other people pieces that go into it. So we're excited about 2025 and think it could be a really exciting year for the company.

Joanna Gajuk (Equity Research Analyst)

So if I may follow up on this new contract with the Global Atlantic. So you said commissions will be higher, but when you negotiated this, did you also adjust your sort of, you know, the predetermined returns that you expect to get on these contracts because it's largely kind of reflective and the commissions being higher?

Thomas Ryan (Chairman of the Board and CEO)

Well, it's predominantly going to be in the commissions, and then it's also in the product mix. You get real technical in some of these terms. But to give you an example, we'll have a better ability to write for our customers guaranteed insurance product the way we had to do it under our old agreement. It was more difficult to get people underwritten and therefore give more protection to our customer, which also happens to generate a higher commission for us.

And we worked really well with Global Atlantic in finding ways to onboard more people. And we'll get into all the technical aspects of that. So we really think we'll have a higher percentage of underwritten product as you think about our customer base, which is better for them, better for our commissions, better for Global Atlantic, quite honestly.

It's allowed us to kind of think through a better way to serve our customers, which also should, again, if we execute correctly, generate higher commission rates.

Joanna Gajuk (Equity Research Analyst)

Great, thank you. If I may, a very last one on the quarter itself because clearly the funeral segment gross margin there was very low. So sounds like the revenue essentially was surprised to you, right? So it sounds like you kind of were heading into the quarter with different kind of cost structure. And then things surprised you in June. Right. So there was sort of, you know, cost mismatch between the cost and revenue. That's hard to think about this quarter and funeral. Thank you.

Thomas Ryan (Chairman of the Board and CEO)

Yeah, I think, you know sometimes Joanna. I think if you. Because quarters are such short periods of time and you have adjustments to accrual and things that can happen, maybe a better way to look at funeral is step back and look at the six months. For the six month period our funeral margins were 19.9% which are I think about 280 basis points below last year.

When you think about gross margin percentages, one thing to keep in mind is that anticipated and forecasted SCI Direct change, we're missing about $20 million of not delivering merchandise, predominantly on the SCI Direct side. So if you add back $20 million and the profits associated with it, it takes that 19.9 back up to around. I think it's 20.7, 20.8. So I think your explanation of margin throughput is about 200 basis points and 150 would explain it.

We've got a little bit of, I'd say cost creep associated with a couple of categories but nothing material. So it's kind of where we thought it would be. Not to say we can't do a better job of managing expenses. We will. But as I think about the funeral margins in the back half of the year, I would expect them to be higher. So we feel better about getting our arms around that. We're going to lose the negative comparison on SCI Direct. So that's going to help us. And again I feel a lot more positive about the funeral margins as I think about the back half of 2024.

Joanna Gajuk (Equity Research Analyst)

Thank you so much.

Thomas Ryan (Chairman of the Board and CEO)

Thank you.

Operator (participant)

The next question comes from Parker Snure with Raymond James. Please go ahead.

Parker Snure (Associate Analyst)

Hey, good morning. This is Parker on for John Ransom. Maybe just talk about the pre-need cemetery sales. I know you mentioned lower high end sales, but the core actually improved. That seems to be a divergence from what you guys have noted in recent quarters. So maybe just kind of pull on that thread a little bit.

Are there any common themes that you're seeing that's driving that trend or is it purely just kind of timing related or some one off in certain markets? And then generally how are you thinking about the lower end consumer? Has that changed at all? And then also maybe just remind us the percent of your pre-need cemetery. Sales that comes from the kind of core consumer versus that high end consumer.

Thomas Ryan (Chairman of the Board and CEO)

Sure, Parker. So first of all I think you know you hit the nail on the head. It is a reversal. We feel very good about the core. We saw growth in the core and that's different. It's been a while since we've seen, you know, the high end sales dip down. But you know, as I think we've tried to explain over and over, the high end sales are just very hard to predict when they fall. I would tell you that we were having a lot of conversations with people at the high end that probably didn't close at the end of June. We feel like there's still a lot of interest, a lot of ability to execute in the back half of the year. So I wouldn't get to. We're not worried about that. We're going to continue to work hard.

If you step back and look at the whole year, actually high end sales are about flat. And so I think you got to again, as you move out in periods of time, it probably normalizes. So we feel very good about the back half of the year. And I think the remainder is that from a pre-need cemetery perspective, high end sales generate I believe 15%-20%. Is that probably right? It's probably 13 to 15 in that ballpark. But again, I think that's the piece that's always going to be a little more volatile as you try to predict quarter to quarter.

Parker Snure (Associate Analyst)

Okay. And then if maybe I can just do one more just kind of higher level. As you just talk about just managing the pre-need selling cemetery in an environment where you have maybe tougher funeral volumes, which is typically a lead source for the pre-need cemetery selling. Maybe just talk about some of the tools that you have in your kit for kind of driving more pre-need cemetery in an environment where you're kind of having to maybe work a little bit harder.

Thomas Ryan (Chairman of the Board and CEO)

Yeah, I think a lot of the tools that we've talked about before, a lot more of our leads now are coming from outside the location. So from a digital perspective, when you think about seminars that we put on, when you think about digital leads that we'll generate through the website and other means. So those are where we're seeing a lot more leads, Parker. And so we're executing on those very differently. But you correctly say, I mean if you look at our core volume, we generally write, you know, 55% of our funeral volume is the percentage that you can almost predict within a band of, you know, between 53%-57%. That's the number of contracts core that we'll write in any given. So it shows you that there's still a high correlation of people that are coming through.

Our funeral homes are a tremendous lead source for preneed cemetery. I do think that over time will trend more towards other sources. And that's where we're working really hard at. How can we do better at identifying people that are ready to purchase cemetery? And again, from a digital perspective, there's a lot of data out there that we're mining and understanding and getting in front of those customers. So feel very good about the trends in that business. But you can't. You know, it's still such a core reason for cemetery sales. Funeral volume still has a material impact on our ability to generate those leads and then turn them into sales. All right, great.

Parker Snure (Associate Analyst)

Thank you so much.

Operator (participant)

The next question comes from Toby Sommer with Truist Securities. Please go ahead.

Speaker 8

Hey, good morning, guys. This is [Uncertain] Jess for BofA for Toby. I wanted to ask, are you managing the sales force in the current demand environment? I think at the investor day two years ago, you showed how you've been able to drive pretty impressive productivity gains even with lower headcount. So curious if you've seen those productivity levels hold up this year. Salesforce.

Thomas Ryan (Chairman of the Board and CEO)

Well, what we were doing now is that just to refresh everybody's memory, as you asked, when you look back four or five years and again, you referenced the May 2022 Investor Day. So I did this by memory, but we had about 4,300 to 4,400 counselors to produce total pre-need sales of somewhere around $1.7-$1.8 billion at the time. Now that's funeral and cemetery. When I say that. Okay, so that's the entire pre-need sales function today. Fast forward now. Now you're looking at 2.7 to 2.8 ish area in terms of billion for the pre-need sales force. And we're doing that with 3,700 counselors as opposed to the 4,300 counselors. Not to get repetitive, but it's kind of what Tom had already answered during the call today.

You're talking about better technology in terms of what we're using in terms of in front of the customer that's helping us be more efficient. Tom already mentioned the quantity and quality of the leads. That's not just digital leads, although that's a big piece to that improvement. But it's also how we're handling direct mail and seminars differently than before.

We're getting a lot more effective and productive in terms of utilizing the CRM system and which is helping us reduce turnover, which we can all talk about, you know, has a huge benefit and less distraction on recruiting and such. And then let's don't forget that we're continuing to invest capital into our cemeteries. I mean if you do use the same time frame back to 2018, you know, you're not spending $165 million of capital to build inventory. It would be much, much less than that.

It'd probably be $80 million-$100 million if I remember correctly. So we are going in there with the tiering strategy that we have led the industry in doing and putting our money where our mouth is and spending the capital and which has wonderful returns to those capitals for those high-end projects all the way down to the mid-tier projects all the way down to that, you know, beginning entry-level type price points in these cemeteries. So it's not one magic bullet kind of all of the above that we talked about back in 2022 which continues to come to fruition, you know, as we speak today.

Speaker 8

Thanks. I think earlier you mentioned 150 basis point headwind this year on the SCI Direct changes for first half funeral gross margin. And that's going to help you next year. Is the right way to think about that as being let's say like 70-80 basis points funeral gross margin tailwind for 2025 versus 2024.

Thomas Ryan (Chairman of the Board and CEO)

I think. No, I think your negative comparison should begin to flatten out in 2025. So I wouldn't anticipate it to have any kind of material effect on margins in 2025. Just 2024.

Speaker 8

Okay, understood. Thanks.

Operator (participant)

The next question comes from A.J. Rice with UBS. Please go ahead.

A.J. Rice (Managing Director, Equity Research)

Hi everybody. Just a couple of things maybe I think you're saying you expect a little more challenging comparison in the Q3 and the pre-need cemetery related to lower revenue recognized from completed cemetery construction projects in Q3 versus prior year. Their overall comments seem to be for more at least flat in the second half. I just want to make sure we walk away with the right assumption about what you're thinking of for the pre-need cemetery production in the Q3.

Thomas Ryan (Chairman of the Board and CEO)

I think my comment was more about not production but about completed contracts. Remember I think our sales production will be fine in the Q3 and good in the Q4 and not a lot of big differentiation. What I was referencing more too is the timing of completed construction projects that have already been sold into and last year we had a pretty decent sized number in the Q3.

And I think what we're trying to highlight a little bit that it could be as big as let's say a $20 million difference of revenue recognized from completing those contracts think of a mausoleum. So it has nothing to do with production, but more about when the revenue gets recognized. And that comparison is much more favorable when you think about the four. So just think about cemetery revenue recognized for the Q3.

You're going to have a little bit of a hill to climb just because of that. We still feel very good about production for the Q3.

A.J. Rice (Managing Director, Equity Research)

Okay. And on the larger, higher end properties, I know sometimes it can be just when the construction's completed and then you can recognize it. And sometimes there's consumer behavior. Are you saying the softness a little bit in the high end that you saw in the Q2 is more about projects and when they got completed? Are you actually saying that you've seen a little softness in the consumer behavior in the high end?

Thomas Ryan (Chairman of the Board and CEO)

Yeah, when we talk about production, that's just consumer behavior. So yeah, we saw less contracts close in the Q2 as it relates to last year's Q2. But again, I'd kind of highlight you too. The Q1 was a really nice upside surprise. We had a very strong high end sale. So again, looking at the six months, it's kind of flat.

I think as we think of the back half of the year, we see no reason we can't generate high end sales. We're not seeing pushback from consumers or anything like that. Sometimes, as you know, A.J. it's just getting in front of people, somebody deciding they want to pull the trigger, not pull the trigger. So we still feel very positive about our ability to sell the high end inventory. Large sales in both the back half of the year and then again in 2025.

A.J. Rice (Managing Director, Equity Research)

Okay. Then on the funeral side, I know the core funeral rate per service was up about 1.3% in a quarter where you didn't have very much growth in cremation rates, which can put some pressure on that. Anything as you drill down there, it just seemed like that might have been a little stronger in a normal environment. Anything you see, really not.

Thomas Ryan (Chairman of the Board and CEO)

I think at the level it was closer to 3% from a contractual year-over-year. Remember, you got the, the cremation mix change, which negates some of that. And then lastly, I think it was more of a tougher comparison as it relates to the pre-need backlog comparison versus the at need walk in. And so again, that's going to vary from time to time depending when those contracts come in. So at the customer level, we're still seeing kind of 3% increases, which may not be 4, but some of that 1.3 is because of the mix and because of trust income from the contracts that are coming out of the backlog.

A.J. Rice (Managing Director, Equity Research)

Okay, and then just the last question on the deal pipeline. I know you said in the prepared remarks you'd be above the high end of your target, normal target range. Do you think you're just seeing more properties? Is it the competitive landscape has gotten better? Some of the smaller competitors are having their own financial issues. Is it the consent decree going away or are there deals in those markets? Is that what we're seeing? Give us a little more on that. And is there anything new about the economics of the deals you're seeing?

Thomas Ryan (Chairman of the Board and CEO)

Sure, I think first of all, probably all the above. But the predominant reason I think we feel is interest rates spiking up. And again I'm just using history as a gauge. A lot of our competitors had variable rate debt structures and we've got a little bit of that but very little. I think back to Eric's point, our financial stability, our cost of borrowing is very different. So I think if those went up, those competitors really had to pull back. And I think it's allowed us to to more deals to flow directly to us and not be as in the competitive stage. I think I don't see a drastic difference in pricing. No, I mean I think it's pretty much the same.

It's just we're the choice and we've got a lot of stuff working in the pipeline and like Eric said, I think we feel highly confident. You never want to declare something until it's signed and done. But there's enough out there and sizable deals that we're really excited about. So great opportunities to deploy some capital and create some future profitability and growth for SCI.

A.J. Rice (Managing Director, Equity Research)

Okay, thanks a lot. Thank you.

Operator (participant)

The next question comes from Scott Schneeberger with Oppenheimer. Please go ahead.

Scott Schneeberger (Managing Director)

Thank you. Good morning. Just going back on the funeral segment. Profit underperformance in the quarter. Tom, could you kind of break out what the drivers are there and in magnitude and maybe mix because the revenue. I know there was maybe some timing in the quarter and this was discussed on an earlier question but it was not much of a difference on revenue year-over-year yet this significant drop. And you had mentioned in that prior answer some cost creep. So I heard some SCI Direct incentive comp, just the leverage and then this cost creep and I think that maybe has people concerned. Is that something that's going to persist in the back half even though you did talk about some stabilization? So if you could break that out a little bit more, it'd be appreciated, thanks.

Thomas Ryan (Chairman of the Board and CEO)

Sure. What I was trying to say is in the quarter sometimes, and you guys know how these things work, you adjust estimates and accruals. So I'll give you an example. If you had an AR reserve in one period and you decided, hey, I'm over reserved or under reserved, going to hit that accrual in the Q2 and it may or may not have, you know, begin to show its head in the first.

So it's really hard, you know, sometimes you got a credit going one way and a debit going another way. And that's why I say a quarter can have noise. And if you step back and look at the six months, you know, we went from 19.9%, we're at 19.9% funeral margin for the six months versus 22.7% in the six months of last year. That's 280 basis points.

If you do the volume throughput, it would tell you that I would have expected based upon your volumes to go down 150 basis points. That's just pure volume calculation on the core. Then you take SCI Direct and say, okay, I knew that I was going to stop delivering merchandise and a couple of other items, that's $20 million, which would have dropped say $14 million to the bottom line. So now I've explained another 150 and now explained another 80. So 230 basis points of my 270, whatever it is difference is explained by SCI Direct and the throughput and the 4% is higher expenses. And again, I think you can take away some of the quarter-to-quarter noise if you do it that way.

And I look at those numbers and say, okay, I've got slightly higher incentive comp because again, back to timing of when you adjusted those incentive comp accruals which recall are not just based on EPS, they're based on production, they're based on cash flows. So we don't think there's any big boogeyman in the cost. I guess what I'm saying. Having said that, there are things we can do.

We clearly have had wage inflation for the last couple of years, rightfully so. We're seeing that subside in some of those trends as I think about 2025, we'll have less wage inflation, we'll be more efficient in how we are running the operations and we don't have the drag of SCI Direct. On top of that we've got a better general agency agreement which should generate higher commissions which are going to enhance the funeral margins.

When you think about 2025. So that's why I feel better is we're going to manage this tighter. We've got a good G&A revenue story coming in 2025 and we don't have the drag of SCI Direct operational changes on a year-over-year basis. And remember the thing that should get exciting about SCI Direct, we're deferring a lot of revenue that we're still selling. And one day that money is going to come out of trust and the margins on SCI Direct operational business are going to go way up. This is a timing thing and the business itself is very healthy. The consumer is very healthy. And so long term, I love our trends. Short term, we're having to stomach a little bit of earnings indigestion.

Scott Schneeberger (Managing Director)

Thanks, Tom. Just on the new partner, the new insurance company partner, you allude to 25, so it sounds like you think that maybe you get some better fee flow by that time. Could it come as early as the second half or is it going to take a few quarters before it's discernible?

Thomas Ryan (Chairman of the Board and CEO)

We will get some in the second half for sure. I think the full effects are going to come in 2025 because again, remember, there's a lot of operational change here as it relates to what type of products we're selling. The most robust commission rates get around underwritten insurance. And we believe we now have the right type of products to put in front of our customers. Some of it is getting people insurance licenses. So as you transition to this new agreement and the real opportunities in insurance, we have to make sure that our salespeople have an insurance license. These sound simple, they're not. And we need to get more people licensed. We need to get people understanding the product mix.

Like I said, what I'm excited about is we're going to have more of our customers that are protected by underwritten insurance than we ever historically have. It's a better product for the consumer. Our counselors can feel really good about providing that protection. If we do it right, we're going to generate higher commissions.

Scott Schneeberger (Managing Director)

Thanks. I just have two more and they're separate, but I'll ask them both up front. We can wrap. Thank you. One is consumer behavior in the lower price tiers. If you could just delve into that a little bit. Are you seeing inflection better? Is it inflecting a little worse? Just curious about the contract velocity volume. So that's question number one, just that trend and how you think about that. And number two is the funeral rule update FTC. Anything on that? Thanks so much.

Thomas Ryan (Chairman of the Board and CEO)

I'm going to let Eric talk about the funeral rule, but as it relates to the consumer, I think I would say this. We saw a while back that I think the lower end consumers were being challenged. And again I think it correlates with a lot of other retailers that are out there with inflation impacting other pieces of their lives. It's harder at the lower end. And we made some adjustments through our sales leadership to say let's get people on board by having better financing terms for them to be able to get that first down payment and get them started. And so we saw a little bit of positive reaction to that and I think we continue to. So we've not really seen any further deterioration.

I do believe that consumer is still challenged mainly because of what I see in other ailing retailers as opposed to ours. We want to do what we can to make sure we can accommodate them. If that means stretching out terms a little bit, making the payments a little easier, we're going to try to do that to accommodate that consumer.

Eric Tanzberger (SVP and CFO)

Scott, on the FTC, I guess the short answer is there's really no update to give to you. So I'll just remind everybody where we are. You know, we continue to work with the staff. We have a very good relationship with the staff of the FTC. We're ready to go at any point in time to adopt anything that we have. We're not expecting anything to surprise us and ultimately we don't think anything that's coming down the pipe that we know about, such as pricing online. We do not expect that to have any material effect to our company. And as you know, we have a tremendous amount of our funeral homes already that have pricing online in different forms and fashions.

Whether it's starting at prices or just complete full premium pricing experiences digitally where you can really dive deep into that particular funeral home's offering and kind of everywhere in between. Ultimately, we think we will continue to go down that path. We'll continue to test, we'll continue most importantly to optimize the websites according to the tier of customer spend that we are dealing with at one particular funeral home and one particular market. We will go from there.

Scott Schneeberger (Managing Director)

Great, thanks. Thank you both.

Thomas Ryan (Chairman of the Board and CEO)

Thanks Gab.

Operator (participant)

The next question comes from Joanna Gajuk with Bank of America. Please go ahead, please.

Joanna Gajuk (Equity Research Analyst)

Hi, thanks for the follow up. I just want to clarify on the cemetery pre-need sales production commentary. So do you still expect to grow low single digits for the year, and then has anything changed in your kind of long term view of growth for the pre-need cemetery sales production. Thank you.

Thomas Ryan (Chairman of the Board and CEO)

Yes, Joanna, we do expect to end the year in the low-single-digits. And again, as we think about the outer years 2025, 2026, I think we feel better about getting back to that low- to mid-single-digit because again, with the stabilization of funeral volume, anticipated stabilization of funeral volume, we expect to be able to get there.

Joanna Gajuk (Equity Research Analyst)

Great. Thank you.

Thomas Ryan (Chairman of the Board and CEO)

Thank you.

Operator (participant)

This concludes our question and answer session. I would like to turn the conference back over to SCI management for any closing remarks.

Thomas Ryan (Chairman of the Board and CEO)

Thanks everybody. Thank you for joining us and we will see you again at the end of October. Thanks everybody.

Operator (participant)

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.