Service Corporation International (SCI) 2013 Q2 法說會逐字稿

Welcome to the second quarter 2013 Service Corporation International Earnings Conference Call. My name is Chris, and I will be your operator for today's call. At this time all participants are in a listen-only mode. Later, we will conduct a question and answer session. Please note that this conference is being recorded. I would now like to turn the call over to SCI management. You may begin.

Good morning. This is Debbie Young, Director of Investor Relations at SCI. Thanks for joining us today as we discuss our second quarter results.

Before I turn the call over to Tom, let me remind you that the comments made by our management today will include statements that are not historical and are forward-looking. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections.

These risks and uncertainties include, but are not limited to, those factors identified in our press release and in our filings with the SEC that are available on our website. Today's comments may also include certain non-GAAP measurements, such as normalized EPS, adjusted operating cash flow and free cash flow.

Reconciliation of these measurements to the appropriate measures calculated in accordance with GAAP is provided on the website and in our press release and 8-Ks that were filed yesterday. With that out of the way, I would like to now turn the call over to Tom Ryan, SCI's President and CEO.

Thank you, Debbie. And good morning everyone, and thanks for joining us, today. We are pleased to report our second quarter earnings and cash flow results that exceeded our internal expectations and the prior year quarter.

Normalized earnings per share in the second quarter grew to $0.19, which was a penny ahead of the prior year. Based on these results for the quarter, and for the first half of the year, we are raising our earnings per share and cash flow guidance for 2013. Before I get into more details about the quarter, I wanted to give you a brief update on our Stuart transaction.

Before I do that, I want to recognize the fact that we lost one of our great ones this week. Jim McGilley was from Kansas City and was 85 years old, and our thoughts and prayers are with Mark McGilley and his family, today. Jim joined us in 1987 and was truly an inspiration to us all, and really left his mark on our Kansas City marketplace and team. He will be missed.

Now, back to Stewart. As you know, in late May, we announced our expected acquisition of Stewart Enterprises. The early stages of planning for the integration process are underway, and we have been pleased with the progress, so far. We remain confident in the value that this creates for us, including our Synergy [customers]. The transaction closing is primarily pending two items.

One, approval by Stewart's Class A shareholders, for which the shareholder meeting is scheduled for are August 13th. And secondly, the Federal Trade Commission review, which is ongoing. As noted in our press release last week, we did receive an expected second request from the FTC, and we still anticipate closing in December of this year or early 2014. Now, for an overview of funeral operations.

Comparable funeral revenues increased nearly $13 million or 3.3%. This revenue increase was ahead of our expectations, primarily on higher than anticipated funeral volumes. The average sale per funeral continued to grow at 2.6% for the quarter. Isolating the currency and trust fun impacts, the average grew at 2%. This was accomplished despite 160 basis point increase in the mix of cremation, which carries a substantially lower average.,

Partially offsetting the average growth, same-store funeral volumes were down slightly 0.6% for the second quarter, which continues to be better than our expectations. When combined with the large volume increase in the first quarter due to the strong flu season, same-store volume, year-to-date, through the first six months is up 1.9%.

We believe that comparison will get more difficult in the back half of the year, particularly, in the fourth quarter where we reported volume up 1.5% last year. We now are expecting our volume for the full year will be down in the low, call it, 1% range. Funeral recognized preneed revenues grew by $3 million or 21% to about $17 million in the quarter.

This represents preneed sales of items that are delivered at time of sale, primarily URN kits and travel protection insurance. Lastly, on the revenue front, General Agency revenues grew by $2.4 million on increased insurance funded preneed funeral productionDuring the quarter, we grew total premium funeral sales production an impressive 11%.

On a year-to-date basis, preneed funeral sales production is up 8%. Again, we would anticipate the comps for premium funeral sales production to get a little more difficult as we enter the back half of 2013. With a full year, we now anticipate an increase in the mid-single digit percentage range, up from previous guidance of low to mid single-digit range.

On a $13 million revenue increase that we experienced in the quarter, we would have expected to grow profits in the $6 million to $7 million range. However, comparable funeral profits declined by $2.5 million and the margins dropped 130 basis points during the quarter. This decrease can be attributed to a few specific items.

First, as expected, in connection with the increase of preneed funeral sales production, we saw an increase in preneed selling costs that pressured margins. Remember, the revenues get deferred, but we recognize the selling expense as a period cost, now. This impacted profits some $4.5 million.

Secondly, we had an increase in expenses, quarter over quarter, related to Worker's Comp claims and higher incentive compensation for both field and home office operations. As it relates to higher Worker's Comp claims, we do not believe that this is a trend or an issue to be concerned with going forward. Additionally, in our results, we are beginning to see the investments we are making in our sales force and related support infrastructure to drive future growth into preneed funeral and cemetery sales productions.

This primarily includes additional sales managers, sales counselors and recruiters to support preneed sales production. As a matter of fact, as of June 30th, our head count in our sales organization was up 170 people over June of last year. So, we went from about 3600 in our sales force to about 3770.

We told you that we would be making these investments, and we are pleased with the production increases that we continue to see. Keep in mind, that this investment will be ongoing with the expectation that you will see a corresponding growth in preneed sales production. We remain confident that the investment we are making in our sales strategies that are impacting margins today will pay dividends in the future.

We still anticipate funeral margins for the full year to be in the low 20% range. Now, for an overview of cemetery operations. Comparable cemetery revenue increased $8.7 million or 4.4% in the quarter.

This increase was primarily due to preneed cemetery sales production growth of 5.4% in the quarter, which we view as particularly good against a high hurdle rate set in the prior year quarter up at 14%. Through the first six months of the year, total cemetery preneed production was up 6%. We are anticipating continued strong results in the second half of the year, leading to an increase in the mid to high single digit percentage range, year-over-year, as we originally guided to.

During the quarter, we also recognized higher trust fund income. If I do my simple back of the napkin math, we would have expected about a 60% margin on the incremental operating revenue. This would equate to some where around $6 million of operating profit growth. However, comparable cemetery profits declined a $1 million for the quarter, and the margins dropped 140 basis points.

In the quarter, we had a higher amount of cemetery property production that was deferred. If you recall, under GAAP accounting rules, property revenues are not recognized until a project is constructed and until we receive at least 10% from the customer. The good news is that these revenues will get recognized primarily in the third quarter, as we either construct the cemetery property or collect the more than 10% of the sales price from the customer.

However, we have recognized the associated selling expenses in the current quarter, which put some downward pressure on our margins to the tune of about $2 million in this quarter. Additionally, similar to what happened in the funeral segment, we had a higher expense associated with increase in Worker's Comp claims and additional incentive compensation [quotas].

As we mentioned earlier, we are beginning to experience an increase in selling costs associated with the sales force and infrastructure investments we are making for the future. We still anticipate cemetery margins for the full year to also be in the low 20% range. So, in conclusion, I want to reiterate that we are excited about our performance thus far this year.

For the first six months, our same-store funeral profits were up $15 million, and funeral margins have increased 60 basis points. In the same period, cemetery profits have grown $11 million and margins have improved 170 basis points. And finally, year-to-date normalized earnings per share have increased $0.10 or 26% to $0.48 for the first six months period this year.

On the heels of this strong year-to-date performance, and after exceeding our internal expectations for the first two quarters, we are increasing our full year 2013 guidance for normalized earnings per share to a range of $0.87 to $0.93. The mid point of this new range represents a 12.5% increase from 2012 normalized earnings per share.

As we begin the second half of the year, we feel good about our ability to continue to deliver solid performance in our core business, and are excited about 2014, as we expect to realize the benefits of adding the valuable Stuart businesses and talented people to our organization. With that, I will turn the call over to Eric.

Thank you. Good morning to everybody. To echo Tom's comments, I want to say we are excited to have exceeded our internal expectations again this quarter.

This morning I'm going to walk you through the details of our cash flow for the quarter, like I usually do, and I'm also going to discuss our 2013 cash flow expectations for the remainder of the year. Then I will provide you an update on the financing for our expected Stewart acquisition. So let's start with cash flow this morning.

As you saw on yesterday's press release, adjusted operating cash flow in the quarter grew $8.6 million over the prior year to $78.2 million, and this exceeded our internal expectations. So this growth was predominantly related to the timing of cash receipts associated with preneed sales of cemetery property that were deferred as Tom just explained, so we expect most of the sales to be recognized into revenue during the third quarter of this year.

Additionally, we had better collections this quarter, which was primarily driven by the hard work of our field folks that created a decrease in our days sales outstanding. Some what offset by the timing of cash outflows related to vendor payments, but this is inline with our expectations. Maintenance CapEx and cemetery development CapEx, and again, these are the two components that we consider our recurring CapEx, for the quarter it came in at approximately $26 million.

And this was also in line with our expectations. When you do the math and deduct in these recurring capital spending items from our adjusted cash flow from ops, we calculate our free cash flow for the second quarter to be $53 million, which isapproximately $11 million higher than the prior year and above our internal expectations.

So mid-year, through 2013, our adjusted cash flow from operations has grown $67 million, or about 40%, to $232 million, which is slightly higher than where we expected to be mid-year. Based on this strong mid-year results, we feel comfortable raising our 2013 guidance for adjusted cash flow from operations to a new range of $410 million to $435 million for the full year of 2013.

This increase primarily correlates with our increase in normalized earning guidance that Tom just mentioned, but it also takes into account that we now believe our cash tax payments will be around $30 million for the full year of 2013. This is slightly lower than what we have communicated in the past due to further refinement of our ongoing tax planning initiatives positively affecting our cash taxes for 2013.

Our new guidance range for adjusted cash flow from operations at the midpoint equates to an 11% increase over 2012, and at today's trading levels it represents about an 8% free cash flow yield. So let's talk about deployment of these great free cash flow results. And as you might expect in light of our potential Stuart acquisition, our cash flow deployment during the quarter was limited.

We did make two funeral home acquisitions, but it was for a total investment of about $3.6 million. And aside from that, we have generally been building our cash balance in anticipation of the Stewart acquisition. Our cash balance at June 30th, as you saw in the press release, grew to just over $220 million.

Subsequent to the end of the quarter, we did pay off the balance on our existing bank credit facility of roughly $87 million. So, I would characterize the current cash balance as now some where around $150 million. For the remainder of the year look for us to continue to build cash with the Stewart acquisition, and for other possible tuck-in acquisitions like you saw this quarter as well as we will pay our regular cash dividend.

Then lastly, as I said, I want to talk about the financing for the Stewart acquisition. You saw a lot of press releases earlier this month and this financing is largely now in place. In early July we completed our offering of $425 million of 5 and 3/8% senior notes, and the proceeds were deposited into escrow. We did this because we wanted to take advantage of the historically low interest rate environment at this time, and we decided, after a lengthy analysis, to lock in the rate now versus closer to the closing date.

I also want to point out to you that we expect to incur approximately $12 million of interest expense in the latter half of 2013 related to the bond in escrow that I just mentioned, but there will be no cash interest paid until until January 2014. So, until the Stewart transaction closes the associated earnings impact of this incremental interest expense is currently not included in our new earnings guidance range.

Also in July, early July, we completed a new $1.1 billion credit agreement, which now matures in 2018. This new bank credit facility consists of a $600 million term loan and a new $500 million revolving credit facility, which replaces the previous credit facility. So in total the blended interest rate on the acquisition incremental debt is expected to be around 4%.

This consists of the newly issued senior notes, and our anticipated term loan and revolver drawings along with Stewart's 6.5%, $200 million senior notes. We expect this to add, annually, about cash interest of about $55 million upon completion wherethere are actual drawings of the new note -- of the new revolver and the term loan.

So lastly, to reiterate what Tom mentioned earlier, we are gaining traction related to the planning processes related to the Stewart acquisition. We believe we are right on track with where we need to be at this stage of the process, and we continue to expect a closing in late this year or early in 2014. So, we appreciate you joining us this morning, and operator, we will now open it up for your questions.

(Operator Instructions). Our first question from A.J. Rice. A.J., your line is open.

Thanks. Hi, everybody. A couple can of questions if I could ask. First of all, just to clarify what you were just going over there, Eric, the $55 million, does that include the Stewart assumed debt, or is that -- not include that?

That does include that, because we anticipate absorbing those notes and leaving them outstanding for a period of time.

Right. Okay. Obviously, the one thing operationally that jumped off this quarter was the pickup, particularly in the preneed funeral sales production, while representing one of the best numbers you had in quite awhile. Is that the underlying risk activity of customers that is driving that or is that -- I know you have some ability to drive by just directing resources and incentives and so forth. Could you just give us a flavor for what is behind that, and is that with the investment and the new -- the incremental sales people? Is that sort of the new -- do you think the new normal is going to be something closer to high single digits, low double digits on the funeral side for a while?

This is Tom. And, yes, we are very, very pleased with funeral production as you mentioned. I would tell you that the investments in the sales infrastructure people really hasn't begun to pay off yet. We -- as you well remember when we talked about this, we have seen growth over the last three or four years, predominantly from increased production amongst productivity within our sales force. Our counselors are getting better. Our managers are getting better, and this was really an attempt to say, "Let's begin to bring more people under the tent and grow this against the aging demographic that we can sell to."

We really haven't experienced that yet. I would chalk this up to, again, just great performance by our sales organization. We are more effective at following up on leads from what we can tell. And that is what it's resulted in. We are guiding in the mid to high single digitsI think that's what I would expect over kind of longer periods of time. You may have a quarter where you jump up and grab low double digits like we did here, but a lot of that is going to be a function of which quarter you are comparing back to.

Okay.

So that's -- the way I think about it is kind of mid to high single digits. We believe we can do that over longer periods of time.

Okay. And then maybe just to talk for a minute about Neptune and the cremation rate, overall. First of all, the 160 basis points, year-to-year, jump in the cremation rate is that include the Neptune? Is that being impacted by what's going on in Neptune, and in Neptune, specifically, seems like you are seeing very good growth there, 22% revenue growth and 10% revenue per contract. What -- any interesting things to call out there?

Yes. I think, first of all, Neptune is in both numbers. So, you are seeing that in the cremation rate, and so because it is now comparable, you notice that our cremation rate kind of went up for both periods over the last couple of quarters. That's because it includes Neptune.

Okay.

160 basis points. Again, we think it is kind of a -- over three months you got to look at it as an anomaly. If you look at it over a year it could be bigger, but we had some quarters that are almost flat. So I don't think we read much into that. With regard to Neptune and success we are very, very pleased. It is a function of better performance at the operations. We have also opened new offices. We opened six new offices this year.

The second half of the year we have got another two that are coming online. And that -- at that point we will be at 59 locations. We believe we are on pace for probably close to 60,000 preneed sales contracts in 2013. So very, very excited about that. And I tell you, again, this is one of those that where you talk about two great companies come together and you learn from one another. And this is a perfect example. One of the things that happened with Neptune is that we took our NCS businesses and put them under Neptune's management, and in doing so we learned from them a bit about preneed marketing.

We weren't selling travel protection plans at the same velocity as they were, and so and those old NCS businesses, Neptune taught us how to sell travel protection and that increased the average sale as it relates to those NCS businesses. From the flip side, we have added some management talent to Neptune by bringing somebody in at SCI and that person was responsible in getting a team together and looking at the way Neptune sells.

And when we sell in the home, as you can imagine, discounting was one of the techniques that we utilized quite a bit. And I think our recognition that, "Hey, we can sell more of a value and less about the discounts," and what we have seen is the discounts coming down over time, which resulted in a higher average sale because of the quality of what we are selling. So both sides have probably come together, you know, under Marco's leadership and we he have seen, again, average revenue growth that approaches 10% like you recognized.

Okay. All right. Great. Thanks.

Our next question comes from Chris Rigg. Chris, your line is open.

Good morning. Thanks for taking my question. Just wanted to come back to the selling cost commentary to make sure I fully understand the message. Clearly, you are onboarding new representatives but is the sort of the same store or same representative cost going up, as well? Are you paying the people more for the same service than you were last quarter or last year?

Okay. The way to think about it, Chris, is -- is a great question. The answer really is no, the short answer. There is a little bit of mix, and we didn't get into this on the call as much, but particularly on the cemetery side. One of the things that occurs is the funeral's probably about the same and you really wouldn't notice anything. On the cemetery side of the business there is two factors that would impact it. What you are selling and who sells it. We have -- if we sell property, property has a higher cost of sale than merchandise or service. So as our mix of property goes up, your percentage of selling costs should go up. And that is a bit of a factor in the quarter. Not a big one, but that is one of the reason why cemetery costs are up.

The other thing is who sells it. We have what you guys would refer to as inside sales and outside sales. If an inside seller sells it, generally that is an easier sale and the cost associated with it is lower. If more of the production goes to outside sales, and again I'm using this as a generic analogy, the cost of sale tends to be higher. And so what we have seen is within our outside sales force is a higher productivity, relative to the overall sale. So you do get a little bit of a mix shift. It is not that you are paying more, necessarily, by inflationary terms. It's really how the business comes into the company.

Okay. And then on the cemetery margins, more generally, I mean sometimes the profits are delayed because of the timing of development when things are completed. It looks like you are alluding to that a little bit in the commentary. Definitely in the press release. It there anything that would suggest that maybe we would, see you, know a decent sequential change in the profits in the business?

Yes. I think what you've always seen it is kind of a weird thing, Chris, because you are hitting on something that is probably the most confusing part of what we do. If you look at this quarter, two things happen. One is in the second quarter of 2012, we constructed a lot of stuff, and when we did that we recognized the profits. So there is $5 million more profits last year for construction that's in this year's quarter -- then is in this year's quarter. The second thing that is weird is this 10% down thing. We sold almost $4 million more of stuff with less than 10% down. So again, we have got the selling costs in this year, and we haven't recognized the revenue yet, so two things kind of converged on the quarter to make it dampen a bit.

On the cash flow side, this is where it gets even trickier. When you construct something, you get the prophets, but the cash probably has already been collected. So when you look at the cash flow stream, like look that the quarter. Profits were relatively flat, but cash is up. Cash is up because we didn't have earnings that weren't attached to cash like we did last quarter. So that it's going to ebb and flow, and so, logically, you would say next year -- next quarter ought to be a little more profitable on the cemetery side, but it may not, you know, result in more cash if that makes any sense.

It does. Thanks a lot.

Okay.

And our next question comes from Robert Willoughby. Robert, line is open.

Are -- answer two quick ones. Eric, have you mentioned or broken out as what part of the funding of the Stewart deal will actually be cash? Is there any ranges you could throw out there?

We really haven't talked about it throwing a range out there, Robert. I'll try to help you. It really depends on in terms of how much cash we will be absorbing in this Stewart deal from their cash accounts, obviously. You know, roughly, that could be somewhere around $100 million or so. And then it just really depends on how much cash we have versus what the liquidity profile that we want to keep. So we look at a liquidity profile with the capacity we have on the new revolver, which is a full $500 million at this point. It's brand new and we paid it off; paid the $87 million off versus our cash balance. We may be able to use another $100 million, as well. When I said a $600 million term loan and a $500 million revolver, I certainly wasn't trying to say in the comments that we would fully draw up on this.

Right.

You know, it is probably a couple hundred million dollars less than that, and that is how I calculated the extra $55 million of cash interest on an annual basis at the end of the day.

Perfect. Perfect. And do you have an estimate? Should the kind of Stewart related deal costs this quarter be around the same as what we just saw in the second quarter?

You know, I think I would say that it would be somewhat equal. I mean this quarter we had a lot of legal fees that were more front ended, although we have a lot of legal costs related to what we are going through with the FTC. But what will ramp up are more of some transition costs, as we have started in June having access to working with the really high quality folks that are over in New Orleans in the Stewart corporate office. So, we will see some cost there. But, yes I mean, generally, it's going to be somewhere in the ballpark.

Okay. That's great. Thank you.

Our next question comes from Nicholas Jansen. Nicholas, your line is open.

Hi, guys. Two for me. How has the dialogue been thus far with the FTC, and kind of any changed expectations relative to the May call regarding potential for divestitures at this stage of the game?

No change in assumptions, Nick, at all. I think it has gone -- progressed well as we would anticipate. Good conversations but really early in the process still. But we -- so we still anticipate, basically, the guidance we had given you before hadn't changed.

Okay. Then maybe looking at the year-over-year improvement in the capital markets, how has that contributed to EBITDA this year and kind of your expectations for the back half of the year? Thanks.

I mean I think the capital markets, obviously, performed well, a little above expectations, but as you know, Nick, the way our trust funds work and revenue recognition is only about 10% of the impact from the trust funds reverts to us and any given year, so not the material impact but favorable, nonetheless.

And generally, Nick, you know, the trust fund as you saw are up just under 5%. And to answer your question specifically for the back half of the year, we pretty much assumed flat performance so we stay up where we are right now through June 30. So if you are specifically asking a model question that's how we modeled it.

And then maybe just lastly in terms of given the better financing costs that you got from the Stewart deal relative to our expectation, maybe your thoughts surrounding when you could maybe, perhaps, return to the buybacks longer term? Is that more of a 2015 dynamic, or how should we think about the deleveraging post transaction?

We filed the credit agreement, that I just described to you, in early July, and so there is some -- obviously, some limitations above four times leverage as defined in the agreement. You can go look at that. You are [precluded] from doing it below that. You could start doing it, and it really depends on when the transaction closes when you're talking the calendar, and when the divestitures occur. But you know, generally I don't think it's that late as you've mentioned. I would hope it would be somewhere in maybe the back half of 2014, somewhere in that area. But again, there is a lot of variables in that timing in terms of when the divestiture proceeds come in.

Thanks, guys. Great quarter.

Thanks, Nick.

Our next question comes from Duncan Brown. Duncan, your line is open.

Hey, good morning. Maybe going back to the cemetery preneed. Did I hear you right that you said you sold $4 million more of cemetery preneed, but that had less than the necessary 10% down payment to recognize it as revenue?

That is correct, Duncan.

Are there -- is it -- sorry, I didn't mean to interrupt you there. I guess my question is can you give us some comfort regarding maybe cancellation rates or something like that the quality of those sales and your comfort regarding that you are going to get the payments going forward?

We are very comfortable with it. We monitor it every month and every quarter. And I would characterize our cancellations rates to be right around where we expected, and there's no material movement one way or another as it relates to our cancellation rates, Duncan

Has there been a -- thank you for that. Has there been a change in terms of what you all are offering in terms of offering lower initial down payments or different financing terms?

I would say you know a lot of that is driven regionally and by market, Duncan. We have had campaigns that, again, as you radiate outside of the cemeteries and begin to get to people that probably weren't thinking about that at the moment and haven't saved up for it and didn't have the money yet those are the type of business that we are writing. But I think, again, you will find historically because of the sensitivity of what we sell, people are very loyal about -- you know, this is a decision they don't take very lightly, and so our experience has been that collection rates remain in this general area.

And we have seen quarters like this before, and we generally collect them and they are good customers. So again we are comfortable. I think you are going to see more of that as we have more success, because, again, if you think about the cemetery and a radius around it, as you expand that radius you are going to begin to get customers that one, weren't thinking about it, and two, might not have come into your cemetery. And that's going to probably require a little more financing, but, again, I can't think of a better sale because we own the property and it is pretty easy to repossess if somebody doesn't pay.

Sure, that's fair enough. Last went for me, and maybe not something you care to address, but anything you can comment on regarding the situation in Illinois and that Teamsters' Union?

Well, again, I think I'd say, number one, we are open for business and we continue to serve client families. You mentioned that in Chicago we've got 16 locations that are affected by this out of our total of 1800. There's about 60 employees and we have adequate staffing in place to continue to serve our families to the levels of service and professionalism that they would expect.

Again, we don't like these types of things. These are employees we care about and we want them back to work. There's -- we think we have offered some very fair increases over the coming years, and we are really concerned about this underfunded pension plan that we have been paying into. And we think it is very important, again, to resolve these issues and we look forward to welcoming them back at the appropriate time.

Great. Thanks for taking the questions.

(Inaudible).

(Operator Instructions). Now, I would like to turn the call back over to SCI management.

I want to thank everybody for participating in the call today. We look forward to talking to you again. I guess that would be in late October for our third quarter earnings call. Have a great week.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.