Carriage Services Inc (CSV) 2007 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Thank you so much for standing by and welcome to the Carriage Services third-quarter earnings conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded today, Friday, the 2nd of November, 2007. I would now like to turn the conference over to Mr. Ken Dennard of DRG&E. Please go ahead.

Thank you, Michael, and good morning, everyone. We appreciate you joining us for our Carriage Services conference call to review yesterday afternoon's earnings release. Before I turn the call over to management, I have the normal housekeeping details to run through. If you would like to be on the e-mail distribution or fax list for future Carriage Services' news releases or if you have any technical problems and didn't receive your copy of the news release yesterday afternoon, please call our offices at DRG&E and we will be glad to help you out. That number is 713-529-6600. Also, if you'd like to listen to a replay of today's call, one will be available via webcast by going to Carriage's website at www.CarriageServices.com. Additionally, in a few hours, there will be a telephonic instant replay available and that will be available for the next seven days. The replay access number and code are in the press release so you can get that information there.

Also, please note that information reported on this call speaks only as of today, November 2nd, 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, they are intended to be forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E in the Securities Act of 1934, as amended. These statements are based on upon 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 10-K for the year ended December 31st, 2006 and in subsequent SEC filings could cause the Company's results in the future to differ materially from the forward-looking statements made today and other documents or oral presentations made by or on behalf of the Company.

A copy of the Company's Form 10-K or 10-Q and other information and news releases are available for free on the Carriage website.

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

Thanks, Ken. Our third-quarter performance reflected good operating execution in a very difficult industry environment, as death rates were down significantly in July and August compared to 2006, especially in our Eastern and western regions. Nevertheless, as we point out in our press release, consistent with our theme this year of no excuses, we were solidly profitable during our seasonally weak third quarter, at $0.04 per share, which could have easily been double that under more stable industry conditions. We were especially appreciative of the good work being done in our cemetery operations, as we are achieving a much broader contribution across our portfolio than in the past, with the Central Region in particular making a large contribution to our third-quarter performance. And Rolling Hills, as we promised a year ago, is continuing its dramatic turnaround under strong new leadership.

I hope by now, everyone on this call and in our investor audience is warming up to our trend reports, as they really do tell the story of a continuously improving performance over time because of continuously improving leadership in all parts of our Company. We have also, this year, been adding great new, what we call "Being the Best" death care franchises to our portfolio in markets where we expect to be able to continuously grow at a sustainable rate of profit, additional market share and financial performance over time. With that, I'd like to turn it over to Joe.

Thank you, Mel, and good morning, everyone. Before I start, I would like to remind you that you can go to our investor homepage on our Corporate website for a link to the press release that includes the properly formatted annual and quarterly trend letters.

The highlights of our results of continuing operations for the third quarter of 2007 were as follows -- we reported revenues of $40.6 million compared to revenues of $35 million for the third quarter of 2006. Consolidated EBITDA margin was 20% compared to consolidated EBITDA margin of 18.1% for the third quarter of 2006. Our consolidated EBITDA was $8.1 million compared to consolidated EBITDA of $6.3 million for the third quarter of 2006 and our diluted earnings per share from continuing operations was $0.04 compared to a loss per share from continuing operations of $0.03 for the third quarter of 2006.

Our third-quarter financial performance was solidly profitable compared to last year's loss, notwithstanding the weaker death rates this year versus last and an increase in our overhead. Our same-store cemetery operations had a good third quarter, primarily attributable to the continuing improvement at Rolling Hills Memorial Park and a broader performance in our Central Region cemetery operations.

Same Store Funeral services decreased 3.79 during the quarter, which was attributable to unusually weak death rates in our Eastern and Western regions. The five acquisitions during the first nine months of 2007 proved to be substantially accretive to earnings in the third quarter. As a result of 130 basis points increase of our total field EBITDA margin, our relatively fixed consolidation platform overhead structure and our attractive low-cost fixed capital structure, we were able to operationally and financially leverage a 16% increase in revenue during the third quarter into a 28% increase in consolidated EBITDA and a 7% increase in diluted EPS.

Now along the comments that Mel made about our trend reports, I would like to spend a little more time on this call actually going through and highlighting certain trends from our annual and quarterly reports. First off, I'll turn to our annual trend report.

Between 2003 and 2006, our total revenue from continuing operations increased with a compounded annual rate of 2.4%. For the trailing four quarters ended 9/30/07, revenues increased 7.7% compared to 2006 because of a contribution of $9.4 million of revenue from our acquired businesses this year, and a 2.3% increase in same-store revenue.

Between 2003 and 2006, our field EBITDA margin from continuing operations increased 80 basis points from 34.4% to 35.2%. For the trailing four quarters ended September 30, 2007, the field EBITDA margin increased 150 basis points to 36.9%, largely because of better execution in both our funeral and cemetery operations.

Between 2003 and 2006, our consolidated EBITDA increased $1.1 million or a compounded annual rate of 1.1%. For the trailing four quarters ended September 30, 2007, consolidated EBITDA increased $4.8 million or 14.7% compared to 2006. The consolidated EBITDA margin increased 140 basis points to 23.6% and this compares favorably to our long-term outlook range of 24 to 26%.

And lastly, diluted earnings per share for the trailing four quarters ended 9/30/2007 has increased 85% to $0.37 per share compared to $0.20 per share for 2006.

Now turning to our quarterly trends, I'd like to just review a few of the more significant ones. Same-store field EBITDA margin decreased 140 basis points to 33.7% compared to the third quarter of 2006 because our net preneed contribution increased by $250,000. Excluding the preneed contribution, same-store funeral EBITDA margin decreased 60 basis points to 34.2%. We consider this a solid performance for our operators in light of the 3.7% decrease in same-store volume and only a nominal increase in the Same Store Funeral revenues. Same Store Cemetery field EBITDA increased $1.1 million or 56% and margin increased 790 basis points to 32.6%. Now I want to remind you that this comparison excludes the charge that we took last year in Rolling Hills of $700,000 for some environmental remediation, so this is looking at really the operation on a comparable basis. This excellent performance was attributable to the improved execution of Rolling Hills and our Central Region cemeteries.

The acquisition field EBITDA margin improved to 36.5% for the quarter. We would expect the margin of our acquired businesses to continue to improve as we progress in the operational integration. In time, we expect the margin of the acquired businesses to consistently exceed our same-store margin, which represents the average of our portfolio because the acquired businesses have higher strategic rankings and higher earning power than the average business in our existing portfolio.

Total overhead increased $528,000 or 10.5% when compared to the third quarter of 2006. Variable overhead included approximately $200,000 in additional legal fees related to uninsured claims and approximately $100,000 of additional incentive compensation.

Corporate fixed overhead included approximately $200,000 of additional costs related to support personnel added as a result of upgrading our human resources and legal [rooms] in 2007. As a result of the improved same-store operating performance and the addition of accretive acquisitions, our consolidated EBITDA margin increased 190 basis points to 20% compared to 18.1% in the third quarter of 2006.

Turning to other matters, we reported negative free cash flow from continuing operations of $3.6 million in the third quarter of 2007 compared to negative free cash flow of $2.6 million in the third quarter of 2006. In addition to being the seasonally weakest quarter of the year, we paid $6.7 million in cash interest in the third quarter for a semiannual interest payment on our senior notes and the quarterly distribution payment on our convertible preferred stock.

Capital expenditures for the third quarter were $2.8 million, and in addition, funeral and cemetery preneed activities used $1.8 million of working capital in the third quarter. We ended the quarter with $12.2 million of cash and investments.

Free cash flow from continuing operations totaled $1.1 million for the nine months ended September 30, 2007 compared to $4.2 million for the first nine months of 2006. Year to date, we have used cash flow for $3.3 million of growth capital expenditures.

In addition, we settled a long-term incentive payment to a former director and former owner of a business we acquired in 1997 and have made relocation and other working capital advances, which, in the aggregate, all totaled $2.6 million. Excluding these items which were not considered in our outlook for 2007, our year-to-date free cash flow from continuing operations would have been $7 million.

For the third quarter of 2007, 10.7% of our total revenues and 11.6% of our total field EBITDA was from businesses acquired since the fourth quarter of 2005. These businesses contributed $0.04 per diluted share to our third-quarter earnings before considering any allocation of overhead or interest.

In October 2007, we signed an agreement to acquire the Evans Brown Mortuary Group in southern California, consisting of four funeral homes located in Southeast Los Angeles and rapidly growing Riverside County, which, together performed approximately 1200 funeral services annually.

The Evans Brown acquisition, scheduled to close in the fourth quarter, was expected to materially add to our new acquisition portfolio performance during the fourth-quarter outlook period ended September 30, 2008. So we have increased our 12-month outlook performance accordingly.

The key assumptions for our 12-month outlook are summarized in our press release. And for the four quarters ending September 30, 2008, we expect revenues to range from 174 to $178 million and consolidated EBITDA to range from 42 to $44 million, diluted earnings per share to range from $0.46 to $0.50, and free cash flow to range between 14 and $16 million.

In summary, we have had four consecutive quarters of considerably improving sustainable profitability, which we believe validates our [three] models when executed broadly and effectively as we have been doing over the past year. Our reporting format provides a clear picture of our long and short-term operating financial trends, which, in turn, show a healthy portfolio of businesses and a consolidation platform well positioned to leverage our revenue growth into attractive long-term growth rates of consolidated EBITDA, consolidated EBITDA margin, earnings per share, and free cash flow. Mel?

Thank you, Joe. Well, what a difference a year makes. At this point, Carriage is well positioned for a strong finish to 2007 and an even stronger start to 2008 compared to prior years. We will have grown substantially during 2007 by acquisition, and while we do expect to make two to four quality acquisitions in 2008, which are not in our outlook, our focus will be on operations, integration, and the leadership talent required to continue what we call the financial dynamic of leveraging relatively small revenue increases in the higher and sustainable rates of earnings growth over time. I will report to you our progress with that theme as we go along. With that I would like to open it up for questions.

(OPERATOR INSTRUCTIONS). Jamie Clement, Sidoti & Co.

Good morning, gentlemen. A couple of questions in no particular order. First, the Evans Brown acquisition, can you give us a little additional color, was this a well-shopped property or did they come to you? Can you share any more information on that?

I can share some information on that. This was not a shopped property at all. In fact, the owner and his sons are building this business rapidly in a very rapidly growing market in what is called the Inland Empire of the Eastern L.A. market. So he was not really a seller, although he is -- he was attracted to what we were doing. What got his attention was the Conejo Mountain acquisition in L.A. that we went into in the second quarter. And then, to find out more about our Company, we talked to him about what we were doing and our vision of growth in certain markets, including the Inland Empire, and the fact that we wanted to have a platform that would be a special platform with great leadership to get us started in the Inland Empire. And I think the more we talked, the more he got excited, the more I got excited, and Carriage got excited, so we figured we would get married. It's that kind of deal.

I think it will be a win-win marriage with a lot of opportunity in the future and this is the kind of -- these are the kinds of acquisitions, really partnerships that we want to put in place.

Very good.

This business has grown from like 600 calls over the last five years to double that.

Got it. Moving on a little bit, Mel, obviously, the middle two quarters of last year were certainly challenging and arguably sort of a trough in some of your operations. Cemetery EBITDA margin at the field level up substantially year over year, kind of continuing that trend. How much of that improvement is related to Rolling Hills versus improvements that you are seeing throughout your operation?

Rolling Hills is a big piece, no doubt, but it's -- as opposed to the past where we had two cemeteries that dominated our financial performance, we are seeing more and more contribution from other larger cemeteries and some medium-sized cemeteries and combinations that are making the performance much more predictable and much broader and deeper. And we expect that to continue. You haven't seen the best yet!

Okay, so it's fair to say that some of the initiatives from an operating perspective that you brought to your cemetery business, it seems like you are already starting to see some progress there?

Well, here's the deal on the cemetery business -- and I will have to admit, having been more of a funeral guy for 15 years, that in the last year, I have gone to school on the cemetery business along with a lot of other great people in our Company.

And what we're finding is that this is one good business, but you've got to have the right talent in charge of it and you have to do master planning of your land, demographics, then build the product according to the demographics of the future, not just the past and build a sales organization that can sell that product because you are selling future heritage.

And we are in the very early innings of that much longer-term process with our cemetery group. This is one of the reasons we have been buying combinations. We see the beauty of it, the convenience of it, and upside of it over time, compared to the funeral industry, which is pretty much an at-need in terms of revenue recognition. I think the upside in our cemetery portfolio will unfold over the next few years. And the earning power, just in what is in the portfolio already, is much higher than what you are seeing currently. But it will take a few years to gradually get there.

And that's why I asked the question because the way you had been describing this over the last couple of quarters was that the cemetery business was a -- this was like a -- it was a multi-year strategy in play here.

You're seeing the low-hanging fruit (multiple speakers) being picked.

Okay. Very good. And you know, with your trend reporting, you opened this up so I'm going to have to start asking a couple of questions about this. And Joe, feel free to jump in here. Your variable overhead and your regional fixed overhead were up a little bit sequentially. Your rolling 12-month guidance, I think for those two line items, is about $3.9 million and $3.1 million, respectively, which would suggest that the numbers you just reported this quarter would have to come down. What is driving that? Was there anything slightly unusual that was flowing through the income statement in the third quarter? Can I get a little bit more color on that?

Yes, Jamie, I can. First of all, in the outlook, I think we have an estimate for the next 12 months in the aggregate of $22 million of overhead. And quite frankly, I think we were -- we've been still building our support organization this year, particularly in two areas or three areas, actually -- human resources; our legal group -- we brought our legal functions in-house; and then something we used to call corporate development, we now call strategic development, which has a much broader purview than in the past. We're actually -- the individuals in that group will be, for example, assisting our cemetery operators with the long-term planning and master planning. So some of those things have impacted us this year as well as a couple of things that I cited in my remarks.

We had some legal fees this year related to uninsured claims that have kicked up the numbers. And our incentive compensation is up, as you would expect, since we have had a much better year or performance this year. So those are some of the factors that are driving the overhead. We think that going into next year, it should stabilize, but the variable overhead is just that. We are always going to have fluctuations there that -- up or down. But our goal is to stabilize or bring down our fixed costs in the future.

Right. Let me comment on that too, Jamie. We probably were about a year early declaring our consolidation platform overhead fixed. And the reason I say that is we had this concept of breaking this thing down and making it a whole lot more transparent. But we've never shied away from our mission of being the best and we've been constantly and continuously redefining what that means. And a year ago, about today, we hired someone in-house as general counsel, who also was head of HR. And then he hired what we call an A player to really hit HR.

Since then, a lot of changes have come about in the Company to let us execute what we call being the best people strategy because one of our standards in every business as you know is right quality of staff and continuous upgrading. We have also been focused on this leadership for [e-model] and we didn't have the plumbing right and the infrastructure right in HR and legal to actually get that right, faster and faster and better and better. And so we've been adding to the plumbing and the infrastructure so that I think by the end of this year, and including training, including training, by the end of this year, we're going to be there.

Now, that doesn't mean that overhead won't go up on the variable side because of things that are variable and some of the things that hit us in the third quarter were incentive comp and some of this litigation expense that wasn't covered by insurance. But that's a net.

I think what you are looking at here is a consolidation platform and a company that can truly live up to our mission, if a business is acquired and joins us, even a good one, we need to bring value by making them better at what they do. Information, training, leadership, people -- that's where we are. And that's what we are seeing. We are not buying any businesses that have been auctioned. They are coming to us, and that's why they are coming to us.

(OPERATOR INSTRUCTIONS). Mitch Almy, McAdams Wright Ragen.

I have probably what's going to be the dumbest question that's ever been asked on here.

We like -- there are no dumb questions in this Company.

When we talked about a drop-off in the death rate, would I be fair to assume that if there hasn't been a material drop-off in the birth rate, that at some point we're going to see a catch-up? Or how should I look at that?

Okay, here's the deal. In the '30s and early '40s, depression and World War II, the birthrate went way down, of course. Number one. And that -- and we're moving through those -- the ramifications of that on death rate.

People are living longer, number two. No doubt about it. I read about in the paper every day, especially in Houston with MD Anderson, we read about it every day. Cancer, heart, people are living longer. That's a good thing. I'm really happy about that!

And third, cremation rates are increasing as more and more people pick cremation as a final disposition choice. So the industry, whether you're independent or consolidator, has been somewhat revenue challenged. We don't view any of that as an excuse not to perform up to what we put out as far as outlook and future growth. We do view that as an opportunity at some point, and there will be catch-up. And when that catch-up comes, we want to be positioned in all the better markets where demographically you are going to have growth in deaths because you are in the right places doing the right things.

And when that happens, I'm not counting on that in the next year or two or three or four or five, when that does happen, it will be doubly better than it is today as far as our performance.

Okay.

Or triple it. Whatever, I can't even think about it!

Okay. Thank you very much.

(OPERATOR INSTRUCTIONS). Mike Scarangella, Merrill Lynch.

The acquisition market really seems to be heating up for you guys, which is great. I know you've been waiting for a couple of years to see these opportunities. I'm just trying to understand if you can identify any macro driver that A, is causing more properties to come up for sale and B, that it sounds like the multiples are in line with your expectations for the first time in a while and I'm wondering what's making the stars align in your view.

This is Mel, Mike. I have said this before and I've heard from some of the other players in the industry that the economics of the prices are still too high to be economic.

What we find is if someone has a true motivation for a change in ownership, then the price, if it's a really good business and in our criteria, guide us there, it's not any great mystery at this point. We have made it public what our criteria are and the multiple differences between and A, B and C business, that's strategic. If the motivations are age, health, or some family issue or a partnership issue, then the price tends to be right because they really do need to do something. And the better businesses are going to want to do it with someone they feel will pay a fair price, win-win, take care of their business after they sell it, and they are still proud to be affiliated with it in the community. That's what we are seeing. And we don't need a lot of those to achieve our goals.

If we were much bigger, we probably couldn't be saying that. But at this point, we were doing it out of cash flow, free cash flow, and it's working. We have no shortage of candidates and we are turning down a lot of candidates.

Are these candidates coming from relationships that you have made in the past? Are you getting calls from people that you've not spoken with before who are aware of what you are doing?

I'm thinking here. Most of this is relatively new, although they have heard of our Company, they are not that familiar with it primarily because we've been under the radar and we don't get a lot of bad press. So what they have heard is generally good and if we come into a market with a large quality acquisition, others start to call us and say I want to get on that train. If you are going to be dealing with only the best businesses, I consider myself one of those. I want to join the team. That's kind of how this is working.

Okay. That's interesting. The follow-up to that is given that you are doing more acquisitions, I know you mentioned infrastructure before, but do you feel like you have enough infrastructure to execute and integrate these acquisitions or do you need more kind of full-time development people?

No, we don't need any more development people because we're not out, unlike the '90s, turning over rocks seeing what's for sale. We are pretty much -- we know who the players are in the markets that we pick. We're not looking at new markets right now. We like the markets we are in, the Western markets and some of the Eastern markets. We haven't even ventured to some really attractive new markets like a Charlotte or down the East Coast because we don't really see a need to. We have plenty of infrastructure in place, systems, HR; I think we are there. I don't really see that growing that much.

The infrastructure is really in place, Mike, if you are talking about basic infrastructure like systems and accounting and finance and HR and things like that.

I guess just also when an opportunity comes in, is it just you and Mel go check it out and then if you like it you bring in some of your ops and your finance people? Or are there dedicated people that go look at acquisition opportunities?

We have a dedicated group, that's two people at this point, but we call it strategic development. And their primary charge is to evaluate the business opportunities, whether that be internal or external.

Yes, that -- but it's two people and they probably will grow by 50% by adding a third. That's the only additional infrastructure I can think of.

And when we are looking at these bigger acquisitions, like Evans Brown, I mean I go and Kevin Musico, who heads strategic development, we personally go and meet these owners and employees. This is too important to our Company to just treat it in a cavalier manner.

Okay, thanks. And Joe, just the last one, just quickly looking at the sequential margins, you are down a little bit second and third quarter. I know third quarter is seasonally the weakest for you, but it looks like it's down a little bit more than it has been historically second or third. Is that some of the increased overhead that you discussed in the prior question or is there something else going on there?

Which margin are you talking about, Mike?

EBITDA margin.

Consolidated EBITDA margin?

Yes.

Yes.

23.6%.

It's basically 20% per quarter. And it was 23% in the second quarter. I know I would say that's --

That's not down.

That's pretty normal. I don't think there is anything unusual there.

Well, we were at 20% versus 18.1% a year ago.

Right.

Yes, I'm just looking -- I mean you can't really look at '06 because that was very unusual. '05 you were down more like --

Now remember in '06, we factored out -- the 18.1% factors out the unusual stuff.

It's operating. That's apples to apples.

Right, right.

Okay. All right, guys. Thanks a lot.

Jamie Clement.

Mel, have you generally been pleased with your managers' willingness to help other managers? And I know that with the standards model, there's some ranking that's going on. Is there more of a sharing of best practices that's going on at CSV than there was maybe 18 months ago?

Absolutely. The standards-based model allows us to publish leak tables every month. And we update those leak tables on a quarterly basis as to right quality of staff and continuous upgrading.

We also have in this model, standards councils for each region that are populated by the very best, most highly respected operators in each region.

So that group increasingly has become a sounding board for best practices to talk to other managing partners about what they are doing and what the best operators are doing to achieve more and more of their standards over time, whether it's market share standards, whether it's a gross margin standard, whether its S&B, average revenue per funeral, whether it's cemetery operating margin, which is a major standard on our cemetery side. More and more best practices are being shared by the operators.

Okay, and I would assume that your --

In each region.

And I would assume you are already starting to see some benefits from that.

Yes, we are. What's interesting is we've had a lot of changes in the managing partner population, especially in the central. When you hire these A players, they don't wait. They want to get it in gear and do something, and they are looking for support and ideas. You don't have to go feed it -- force feed it to them. You have to support them to be successful.

And that's really our key strategy here. It's first who, then what. If you get the who right, supporting them to achieve these standards and how they do it, best practices, is the easy part. The hard part is getting the who right.

The standards model has made it abundantly clear and transparent who the who, when the who isn't right. That's why we've moved so fast in the Central. We've done the same in the West over the last six months. And a lot of new leadership will be in the West over the next year, already happening, just as it was in the Central. So this is an exciting time for us.

And the reason I asked the question was that some people that have looked at your industry in the past have said you can destroy a business in a day, but it takes years to actually show progress in your industry, and it sort of seems like you are actually proving otherwise.

I think we are proving otherwise. We used to be very timid and tenuous about making changes in the management because we were afraid of losing market share because of relationships.

And I'll never forget this. We had someone in charge of a business in the Northeast, and we kind of agonized over it and finally said let's do it. This was two or three years ago. And come to find out, the guy we had running our business not only didn't hurt us, he couldn't even get a job with a competitor. So we just said swallow hard, make those calls, faster and faster, hire their A players, support them, and that's what we're doing.

And we have -- the good news for us is that the word is getting out and the better talent is coming our way. And it's not that hard to find them anymore. It's still a process that has to be managed, and we are very patient on making sure that we get the managing partner process right. We turn down a lot of candidates, just like we do on the acquisitions.

Okay. Mel, Joe, thanks a lot for taking all the time for my questions this morning. I appreciate it.

Thank you. Management, there are no further questions at this time. Please continue with any closing comments.

That's it. We will report our full year sometime late January I think and we look forward to it, or maybe early February.

Thank you, ladies and gentlemen. This does conclude the Carriage Services third-quarter earnings conference call. If you would like to listen to a replay of today's conference, please do so by dialing 303-590-3000 and put the access code 11100075. Again, 303-590-3000, the access code 11100075. AZT would like to thank you very much for your participation today. You may now disconnect. Have a very pleasant rest of your day and a wonderful weekend too.