Carriage Services Inc (CSV) 2007 Q1 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Carriage Services first quarter earnings conference call. [Operator Instructions]

I would now like to turn the conference over to Lisa Elliott, Senior Vice President of DRG&E. Please go ahead, ma'am.

Thank you, and good morning, everyone. We appreciate you joining us today for Carriage Services' conference call to review first quarter 2007 financial results.

Before I turn the call over to management, I have some normal housekeeping items to run through. If you'd like to be on the email distribution or fax list for future Carriage Services news releases, or if you had any technical problems and didn't receive your copy yesterday afternoon, please call our offices at DRG&E and we'll be glad to help you with that. That phone number is 713-529-6600.

Also, if you'd like to listen to a replay of today's call, it will be available via webcast by going to Carriage Services' website at www.CarriageServices.com. Additionally, in a few hours, there will be a telephonic instant replay feature that will be available for the next week. The replay access number and code are in yesterday's release.

Please note that information reported on this call speaks only as of today, May 10, 2007, and therefore you are advised that time sensitive information may no longer be accurate at the time of any replay listening.

Also, as you know, certain statements made today in the conference call or elsewhere by or on behalf of the company that are not historical facts are intended to be forward-looking statements within the meaning of Section 27A of the Securities Act of 1913 as amended and Section 21E in the Securities Act of 1934 as amended.

These statements are based on assumptions that the company believes are reasonable. However, many factors that are discussed under forward-looking statements and cautionary statements in the company's Annual Report on 10K for the year ended December 31, 2006, and in subsequent SEC filings, could cause the company's results in the future to differ materially from forward-looking statements made today or other documents or oral presentations made by or on behalf of the company.

A copy of the company's Form 10K and Form 10Q and other information and news releases are available on Carriage's website or by going to the Securities and Exchange Commission website at www.SEC.gov.

With me today are Mel Payne, Carriage Services' Chairman and Chief Executive Officer, and Joe Saporito, Carriage's Financial -- Chief Financial Officer. Now I'd like to turn the call over to Mel.

Thank you, Lisa. It's a real pleasure to be here today and to report on our company.

I've been trying to think of a good analogy to let those of you on this call know how I personally feel about this first quarter report. The best I can come up with is what I call a cocoon analogy. When we moved from a budget and control funeral operating model in 2003 to a standards model in 2004, we were an okay but not very broadly good operating company. But even when we went down this path, unknowingly had entered into a transformative cocoon process involving great innovation and change.

The process of change was often in fits and starts until the last half of 2006, when, as I wrote in the annual report, we went into a warp speed model of change, especially as to the organizational structure and the operating leadership. It was simply time to emerge from our cocoon.

I'm sure that some of you who've been following us, and I can't blame you, thought we would emerge as an ugly moth. But I believe, and I speak for our corporate, regional, and importantly, our managing partners of each business, that we have emerged as a beautiful butterfly. We've got wings, and we're going to fly our company someplace special over the next few years.

Now that we are able to fly, it's all about executing our journey wisely and well. In order for you to properly understand the transformation into our becoming a consistent and predictable operating company, and to gauge how well we are executing our journey, we also transformed, starting with this report, our public reporting, to align more closely with how we report and communicate internally with both our funeral and cemetery standards operating models.

In essence, much like we abandoned budgets, we have taken off our Wall Street and GAAP accounting clothes and put on a transparent operational performance bikini, no gender bias intended, I can assure you. We weren't ready until now to show off what we've accomplished. But whether you like it or not, you will no longer doubt where we've been, where we are, and where we're going with our company. We worked out hard in the gym, and we think the bikini is the way to go.

The main driver of success in our business is the number of client families served -- we call that market share -- reflected by funeral contracts and interments. We will refer to funeral contracts, interments, often as volumes. And we don't mean that to be insensitive. It is the volumes over a long period of time that really count in our industry, because that means you're serving more customers at the time of need.

At the local level, this is a very reputational and heritage business where customer loyalty in general still remains strong. Our same store funeral reporting will now focus on long-term performance trends, [applied] family contracts, revenues, which are simply the volumes times the revenue average per case, and the local controllable profit margins, which we define as field EBITDA margin.

These three funeral metrics are also standards in our funeral standards operating model. These three standards alone represent 50% of the total standards, with 30% of the standards related to same store funeral contracts. For the first time, we can communicate with you publicly about how this model actually works and the results it will drive over time.

For example, we've shown four full years of funeral contracts on the same store basis. We also have shown the most recent four quarters. At each individual business, their standard on funeral contracts for 2007 is the three-year average of the last three full years.

So if we have a business that wants to achieve a lot of their standards in '07, which they are incentivized to do, they must hit their average number of families served over '04, '05, and '06, in '07. That takes out normalized death rates and means you have to be doing the right things to grow your business. This is not complicated.

Our cemetery standards were modified and simplified to start 2007. Our managing partners are heavily weighted on achieving a sustainable operating profit margin, which does not include financial revenues, because they have no control over our trust fund operations. They also are joined at the hip with our sales managers on pre-need property sales, with pre-need property sales representing a standard of 20% weighting.

On the sales manager side it's just the reverse -- 60% weighting on pre-need property sales, and 20% weighting on operating profit margin that is sustainable, because they need to be selling their products and services at the right markups and in the right way.

We will report our long-term performance by using the annual trend report, which includes the recent four full years compared to the most recent trailing four quarters, which will show how what we are achieving currently is changing the long-term trends.

For the first time, we are reporting field EBITDA, just as we report, monitor, and incentivize at the individual business level, without any overhead or accounting allocations, which are required in our SEC filings.

Most importantly, our local leadership and their teams can see publicly how their individual performance is impacting the performance of Carriage as a whole. I cannot understate the importance of this point.

We are hiring A players, and the A players want to make a difference, and they take ownership in what they do. And it is very important to the future of our company.

But let me make another point. Field EBITDA is not a result. It is a result. It is a result, not a driver. It is not an activity that creates value. So our models are designed to drive the right kind of activity by the right people under the right leadership at every business, so that continuous improvement in our people and the value of their work leads to growth in the business that is sustainable within a range of profitability that is also sustainable. We have all of this defined, and we consider it proprietary.

We don't work on EBITDA. We work on leadership, people, and operational and service and sales strategies. We simply report field EBITDA as a result to show our progress.

Because of seasonality, death rate variations, cremation mix shifts, etcetera, our business performance on a quarterly basis can see somewhat unpredictable. But when viewed over a period of years, for example, our same store field operations are not only highly predictable, they are stable and highly profitable. And we are recently getting better at an increasing rate, especially as our central region has improved dramatically over the last two quarters.

As an example of how our trend report clearly defines performance, our same store funeral field EBITDA was $37.6 -- one second. I've got a bad number. Our same store funeral field EBITDA was $37.6 million, and our same store funeral field EBITDA margin was 34.6% in 2004, our first year under our standards operating model.

Our same store funeral financial performance increased in both 2005 and 2006, as revenues rose modestly, while field EBITDA margin rose also, so that field EBITDA dollars rose more rapidly. The total field EBITDA margin increased by 230 basis points over two years.

Even with our central region underperforming for the first nine months of 2006, our same store funeral portfolio revenue increased $2.4 million in 2006 over 2005, and our same store field EBITDA increased $2.4 million in 2006, meaning that we converted 100% of incremental revenues into controllable profit, as we had more businesses approach their sustainable earning power range as defined by a 400 basis point standards range of field EBITDA margin at every business, depending on size and mix.

Just as our same store funeral field EBITDA margins have increased since 2004, we see 2006 as the bottom for our same store cemetery field EBITDA margins, and believe that we'll look back in a couple of years and see a very nice and gradual improvement in our revenues, field EBITDA, and field EBITDA margin. We are simply two years behind in our cemetery operations compared to our funeral operations on execution, but to say that we are highly focused on it now would be an understatement.

I'd like to spend a few minutes on what we call our strategic portfolio optimization model. If you are a shareholder, you've received our annual report, in which my letter elaborates on six strategic ranking criteria. They are size of the business, size of the market, competitive standing in the market, the demographics in the market, strength of the brand in the market, and the barriers to entry.

There has been some confusion, not just outside our company, but within our company, about this ranking system and the strategic ranking criteria. For each of these criteria, we have specifically defined what an A, B, or C will be as far as rank, plus or minus. Then we weight each criteria to come up with an overall ranking for every business that we currently own, and for every acquisition candidate that we would consider.

These rankings are not related to whether a business is a good business or not. We have some great C businesses. The ranking is very much determined by the size of the business, the size of the market, and the demographics. That's not to say that we will not keep our C businesses, or we won't sell a B business. We sold a B business in Indiana last year that was a good business, but it wasn't in a big market, and it wasn't strategic, so we exited Indiana.

We want A, B, and C businesses in our portfolio, but we want them to make sense and we want them to grow and prosper over time.

We are using these criteria on acquisition candidates, and they are working great. The good news is that having closed two acquisitions so far in 2007, and having had a fairly active candidate assessment process in the last seven or eight months, the strategic ranking criteria create an acquisition strategy discipline that with effective execution should add substantial shareholder value over time. You cannot snooker this system.

You will be able to follow our progress with our acquisition strategy as we report the new and growing portfolio separately from our 1990 same store portfolio.

Our five-year goal is to have a much larger contribution to our total results from the newer portfolio, which on average should be larger individual operations in larger markets, with good demographics, so that we achieve the goal of positioning our portfolio for organic growth, especially as the baby boomer generation increasingly begins to use our services.

With that, I'd like to turn it over to Joe for a discussion of overhead and our outlook.

Good morning, everyone. I want to make some brief comments about our overhead and consolidation platform, our cash flow, and our rolling four quarter outlook and long-term outlook.

We now report our corporate and regional overhead and all incentive compensation payments, which include field operations in three categories, two of which are mostly fixed, and one of which is variable and consists of the incentive comp. Between 2003 and 2006, our corporate fixed overhead increased approximately $1.9 million because of two significant and opposite trends.

First, we reorganized and streamlined our operations organization over this period by ultimately combining our funeral and cemetery sales and operations into three geographic regions, with a common regional structure, and eliminated the heads of funeral and cemetery operations. This has allowed us to effectively use a single operations support group rather than maintaining a separate corporate support organization for funeral and cemetery operations.

We estimate that the new operations organizational structure has resulted in an approximate $1.2 million decrease in our corporate fixed overhead from 2003 to 2006.

Second, during this period, we significantly upgraded our corporate support infrastructure by implementing key IT systems, developing a fully staffed internal audit department, upgraded our human resources function, and brought our legal function in house under a new general counsel, and reorganized our pre-need trust and investment activities.

As a result, costs of our corporate support departments increased approximately $3.1 million during this period, which resulted in a net increase in corporate fixed overhead of $1.9 million.

However, these costs and investments were necessary additions to our support infrastructure, which are allowing us to more effectively execute the standards operating model while maintaining a flat regional operations organization.

In addition, we are now positioned to execute our mission of being the best by supporting our newly acquired businesses to improve their operations, people, market share, and financial results.

We believe that our regional and corporate fixed overhead costs will increase no more than compensation increases and inflation over time, and will not grow as a fixed percentage of revenue as we acquire new businesses.

Field EBITDA from acquired businesses should substantially fall to consolidated EBITDA and pre-tax free cash flow, and be accretive to EPS, as well.

We achieved a consolidated -- we've achieved a consolidated EBITDA margin of 27.2% in the first quarter of 2007, compared to 25.1% in the first quarter of 2006. As we leverage our new growth over our mostly fixed cost platform, we expect our consolidated EBITDA margin to increase to within our annual sustainable earning power range of 24% to 26%.

Turning to cash flow, our free cash flow from the first quarter of 2007 was break even, which is revised from the $3.8 million deficit we reported in the release yesterday. The first quarter free cash flow was impacted by the semi-annual interest payments of $5.1 million on our senior notes, and payment of annual incentive bonuses.

In addition, we made the final payment of $1.4 million related to a long-term incentive arrangement with one of our directors, who is also the former owner of a significant group of businesses we acquired in 1997.

Cash used for capital expenditures was approximately $1 million higher year over year, but we continue to expect our maintenance CapEx to be approximately $6.5 million for the entire year.

Now as we had previously announced, we will provide a rolling outlook for the next four quarters. As we close acquisitions during the year, we will update the outlook for expected operating results for those acquisitions.

The outlook that we presented in the press release covers the period ending March 31, 2008, and is unchanged from what we reported last quarter, because we closed the announced acquisitions in Corpus Christi and Ventura County, California, and the expected operating results had been previously included in the rolling forecast. No significant additional divestitures were identified as of March 31, 2006.

Our long-term outlook expresses our financial goals based on the successful execution of our standards operating model and strategic portfolio optimization model. The trend reporting will show our progress towards our financial goals. Over the next five years, we expect revenue growth of 7% to 9% annually, and this includes acquisitions, consolidated EBITDA growth of 9% to 11%, including acquisitions, our consolidated EBITDA margin to range between 24% and 26%, and we should grow based on internally generated funds without new debt or equity.

Finally, we will file our Form 10Q later today with our traditional GAAP financial statements. We have made some modifications to the format of our income statement to make it somewhat compatible with the new trend reports. However, by year end, we intend to recast our GAAP income statement to align it more closely with the trend reports. Mel?

Thank you, Joe. Looking back, it's clear that our company went through an eight-year down cycle, from a public company valuation point of view. We were okay with that. We never got personally down about it inside our company. We just became more determined than ever to become a good operating company, and took the opportunity of the environment of low expectations to continuously change and improve our ability to support our field operations to grow their businesses by serving the needs of their client families and communities.

I want to personally thank the critical input that I and the other leaders of Carriage got over the years to get to this point, from our best and our brightest in our field operations. We couldn't have done it without them.

Looking forward, we believe our company is the right size with the right leadership and the right culture and the right operating strategies to be an attractive succession planning solution to the best [independents] and the best long-term markets.

For that reason, we are well positioned for what we believe will be a long up cycle in the death care industry. For those of you who have been shareholders or bond holders for a while, including holders of our TIDES convertible securities, we appreciate your patience. For those of you who are new, we welcome you and encourage you to get comfortable with our company and your position by getting more knowledgeable about our company. Enjoy the journey.

With that, I'd like to open it up for questions.

Thank you, sir. [Operator Instructions] And our first question comes from Jamie Clement with Sidoti & Company. Please go ahead.

Good morning, Mel. Good morning, Joe.

Hi, Jamie.

Hey. Just a couple of questions. And I'm actually going to take it back a couple of years, and hopefully understand the new data that you're making available. What exactly is variable overhead? And noticing the four-year trend going back, that number is up an awful lot. And it's sort of -- I guess the trailing four quarters compared to '06, it looks like it's trending back down again. What exactly drives that? What are those costs?

That's a good question, Jamie. And what we have done, and this is very different than what we've -- the way we've reported in the past, is that we've isolated all the overhead above the field. So in other words, all of our overhead above our field operations is now isolated in that overhead section, and as you said, we've classified into variable and fixed.

The variable represents primarily incentive compensation. There are other items in there that vary -- could vary according to experience, but the predominant items in there are incentive compensation. And what you're seeing in the yearly trend between 2005 and 2006 is the effect of that incentive arrangement that I referred to in my cash flow discussion.

We had a long-term incentive arrangement with one of our former owners. We made the terminal payout of that incentive arrangement in 2006, and there was a significant amount of expense, about $1.4 million, to provide for the long-term incentive payment. And that's the blip that's showing up in 2006.

As we go forward, we would expect that obviously not to recur. And our incentive comp will come down somewhat, although as -- it will vary, and it will go up as our operations improve. And many of our incentive are tied to EBITDA, so as our EBITDA goes up, that will go up.

But let me put a little more color on that, Jamie, for the year '06, because this was very interesting for me, as well. What happened beneath the covers in '06 was fascinating. I'm sure when you looked at the same store funeral operations, you were a little surprised to see that we were actually better.

The reason for that is twofold. But a big reason was our Northern California funeral operations. The Northern California funeral operations were assembled by the director who got this payment. And the ten-year arrangement for him, which was an excess of EBITDA arrangement over the underwriting, was because that portfolio, as 2006 unfolded, was doing a whole lot better than what we ever thought it would do.

In fact, it was doing so well, it really offset -- more than offset what the central was down. So we didn't know it was going to do that well during the year. And during the -- but we did have some accrual on that payout. What happened in the third quarter was we had to add to the accrual, because it was clear by the end of the year that the western funeral operations were going to have just a breakout, great year.

And so it made it -- it made it look --

Right.

-- like we weren't doing very well, especially in the third quarter.

But in fact you don't mind paying that money out.

That was the best money we ever paid out.

Okay.

I wish we had had more people -- we did have other people under those arrangements. This is the only one that had a payout like that.

But it sounds to me like -- and correct me if I'm wrong, but it's sort of going forward, a - you would have sort of a $3 million annual number that I guess grows with the EBITDA growth or something like that? Is that -- I know that's sort of circular, but --

Yes. I think this year, in our outlook, we're talking about a roughly $3.9 million component.

Okay.

So yes. It'll be somewhere in that range.

Okay. And then --

Depending on operations.

That's assuming that we do really well operationally, and we pay out a lot of field bonuses, and we pay out a lot of regional bonuses. We want people -- we have really opened up the bonus program at the location level.

Right. Right. But you want to be paying out those.

We want to be paying it, and they've got to make it because they are able to grow the business.

Right.

[Inaudible].

Mel, another line of questions for you, and I know that you've talked about how you sort of strategically rank your businesses and look at acquisitions and that kind of thing. One thing that I don't exactly understand in light of how you -- in light of how you've broken out the numbers here is that I understand why the demographics of the market are critical, but if you think about size of the market and size of the business, if you've got an acquisition potentially, okay, and it's a C business that you can buy for a good valuation, but it's not necessarily a large business, then why wouldn't you take a look at that business, if it exceeds your cost of capital based on the price that you could get?

Well, we've got a limited capital. And we would rather buy in markets that are bigger, that are growing, get an A or two, get some good Bs, get some Cs. Because what we've found is that when you really go into a bigger market and affiliate with the very best, you get some -- you get some reputation and you get some notice. And so the other good operators are going to be looking to join your team.

If you get into a smaller market where there's really no opportunity to build area reputation and a track record, and there's no other opportunity, you've got a standalone deal that sometimes can work. But I would say that would be the exception.

And final question, and then I'll get back in the queue. What are you seeing out there in terms of competition for A deals?

Well, we're seeing some competition.

Because I've sort of heard that there's maybe some private money that's sort of re-entering your industry. I don't know how accurate that is.

Well, what we find, and this may sound -- I don't know how it will sound, but it's just the truth. When I co-founded Carriage 16 years ago now, and even in the early years, and even after it went public, we were still the new kid on the block, and we weren't known. We didn't have a track record. We really didn't have a reputation. I mean, we did, but it wasn't broad or deep.

And there was new money back then. Well, and we were the -- we were part of the new money. So I think unless you go through what we've gone through over the last seven or eight years, and you build the infrastructure, you build the systems, you treat the former owners a certain way, they're happy, your employees spread the word that we're a good company to work for.

I mean, there was a lot of people who started companies in the '90s, and they did it to sell, and there were people who got misled. And there's a lot of sour grapes out there. I think this time around, the best operators are going to be very careful who they get in bed with.

Okay. That's a good point. Thanks very much for your time.

They spend a lifetime or multiple lifetimes building reputation and heritage, and it -- to get another 5% or 10%, I don't know if you're going to find many takers.

Okay. All right. Thanks very much.

Thank you. [Operator Instructions] I show no further questions at this time. I would like turn the call over to Mr. Payne for closing remarks.

Jamie, do you have any more questions? Jamie? All right, ladies and gentlemen. We appreciate you calling in, and we look forward to reporting our progress.

Ladies and gentlemen, this concludes the Carriage Services first quarter earnings conference call. [Operator Instructions] 11