Service Corporation International (SCI) 2014 Q2 法說會逐字稿

Welcome to the Q2 2014 Service Corporation International earnings conference call. My name is Adrian and I will be your operator for today's call.

(Operator Instructions).

Please note this conference is being recorded. I will now turn the call over to SCI management. SCI management you may begin.

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

Before I turn the call over to Tom let me remind you that the comments made by our management team today will include statements that are not historical and are forward-looking. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, those factors identified in our press release and in our filings with the SEC that are available on our website.

In today's comments we may also refer to 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 our website and in our press release and 8-K that were filed yesterday.

With that out of the way I like to now turn the call over to Tom Ryan SCI's President and CEO.

Thank you Debbie and good morning everyone. Thanks for joining us on the call today.

I'm going to begin my comments by giving you the highlights of the quarter. Then I'll provide some details on the Stewart integration and synergies, including for the first time our estimate of potential revenue synergies, which we have previously not quantified. These revenue synergies will be in addition to the $80 million of cost and purchasing synergies we have already discussed.

Finally I will close by giving some color on our outlook for the back half of 2014. Beginning with an overview of the quarter we were very pleased to report normalized earnings per share of $0.23, which is an impressive 21% growth over the prior year and in line with internal expectations. Adjusted operating cash flow also grew a solid 27% to approximately $98 million.

Our comparable SCI businesses, particularly on the cemetery side had a strong performance during the quarter. Additionally, we benefited from the contribution of the Stewart acquisition, which you will recall we closed at the end of 2013. Also during the quarter with our leverage back to below 4 times we were extremely pleased to report that we returned to our share repurchase program returning more than $59 million to repurchase approximately 3.1 million shares.

As it relates to the Federal Trade Commission divestiture process we are on track to close the majority of the divestitures over the next couple of months. We closed on a deal that generated more than $150 million of gross proceeds in the second quarter.

And finally during the quarter we closed on a large cemetery acquisition in New Castle, Delaware and therefore we want to welcome Lee Hagenbach, his team in Delaware, our 44th State, we now do business in, to the SCI family.

Now for an overview of the funeral operations in the quarter. Overall our comparable funeral segment which excludes Stewart, performed very well and ended the quarterly slightly ahead of our expectations. When compared to the prior year, second quarter funeral revenues grew by $2.4 million.

This increase in revenue was related to an 11% growth in recognized pre-need revenue from our SCI Direct businesses. Remember this represents pre-need sales of products primarily earned kits and travel protection insurance that we are recognizing at the time of sale upon delivery.

Core funeral revenue excluding SCI Direct was flat as a 1.4% increase in the sales average helped to offset a 1.3% decline in funeral volume. From a profitability standpoint comparable funeral gross profit and the gross margin percentage grew slightly over the prior year quarter. In addition to the contribution from SCI Direct that I just mentioned we continue to do a good job of managing our fixed costs.

On a pre-need basis funeral sales production was relatively flat in the quarter and lower than our internal model. Recall last quarter we expected to have some temporary challenges as we integrated our Stewart businesses into our compensation plan and our point-of-sale system.

Funeral production, however rebounded slower than cemetery production. But in the month of June they hit stride with a 13.3% increase over June 2013 production. With the majority of the heavy lifting of the pre-need sales integration behind us our expectation is to have high single-digit percentage growth and comparable pre-need funeral sales production in the second half of 2014.

Now let's talk about cemetery operations. Our cemetery segment had an impressive performance in the quarter and came in above our expectations. Comparable cemetery GAAP revenues, excluding Stewart, increased more than $13 million or 6.4% over the prior year quarter. Pre-need cemetery sales production outperformed the prior year quarter by even more, some 11.8%. I was very proud of our team for achieving this growth in the midst of a complicated integration of the sales organizations, processes and systems.

In the first six months of the year total cemetery pre-need production was up 4.6%. As I just mentioned, we believe most of the major integration milestones of our pre-need sales program are behind us. Consequently we expect the momentum we experienced, particularly in June in the pre-need sales area, to continue into the second half of the year and expect to end the full year with high single digit percentage growth over 2013.

Comparable cemetery profits increased $4 million in the quarter and the margin percentage grew 50 basis points to 22.2%. While recognized revenue growth was impressive we still increased sales in the backlog some $7 million.

Keep in mind we're required under GAAP to recognize the selling cost in the current period putting pressure on second-quarter margins. However these circumstances bode well for us as we expect the $7 million to be recognized as revenues in the back half of 2014. As we complete construction of the cemetery property and collect on the deferred contracts, with no corresponding selling costs incurred in the period.

Now let's shift to Stewart. We're very pleased with the Stewart's business' performance, as they generated just under $105 million of revenues in the second quarter. I would say the margins and sales averages are generally in line with our expectations.

Additionally, you may have already seen in the earnings release that we're very pleased to have identified and developed a plan for the attainment of revenue synergies. Recall that we estimated our cost in purchasing synergy from the Stewart acquisition to be approximately $80 million.

We believe in addition to these costs related synergies that we can achieve incremental revenue synergies, which equates to approximately $20 million of additional EBITDA. We believe we can generate incremental revenues and profits as we add new products and services to the legacy Stewart funeral offering such as catering and reception initiatives.

Second our average pre-need cemetery sales production in our SCI locations is higher than Stewart's. We believe we can close the gap over time through expanded property offerings, strategic pricing and sales training. We expect to see some of the additional revenue synergies beginning to ramp up over the back half of 2014.

However, we believe the majority of the synergies will be recognized in 2015. With the additional revenue synergies this now brings our total estimated synergies from the Stewart acquisition to approximately $100 million of EBITDA. This is a 66% increase over our original expectations at the time we announced the acquisition.

Further it comes close to doubling historical EBITDA of Stewart and highlights the incredible leverage we can achieve in a transaction of this magnitude. This acquisition has been a big win for us and we're extremely proud to deliver this value to our shareholders.

Now to the outlook for the remainder of 2014. We're excited about our performance thus far in the year with year-to-date normalized earnings per share growth of 8.5% to $0.51 per share. On the heels of this solid year-to-date performance, the timing of the Stewart cost synergies impacting the back half of the year and the additional revenue synergies identified we're increasing our full-year 2014 guidance for normalized earnings per share to a range of $1.08 to $1.12. The midpoint of this new range represents a 20% increase from 2013 normalized earnings per share.

So to wrap it up and summarize, despite the anticipated interruptions we had in the first half related to integration, we believe the major milestones of the sales integration are now behind us. This, coupled with the current momentum of our sales force going into the back half of the year, will allow us to generate impressive topline cemetery growth. Additionally we continue to be enthusiastic about the profitable growth that the Stewart acquisition will contribute to 2014 and again in 2015 as the full weight of the synergies are realized, which are now estimated at approximately $100 million of EBITDA.

And finally we expect to continue to generate strong cash flow, which Eric is going to update you on shortly. This cash flow along with anticipated divestiture proceeds expected in 2014 will allow us to be focused on capital deployment strategies designed to enhance shareholder value.

This concludes my prepared comments, and I now will turn the call over to Eric.

Good morning everybody. I'm going to start this morning by commenting on our cash flow results for the quarter and our outlook for the remainder of 2014, and I'm going to touch on how we deployed our capital to enhanced shareholder value during the quarter.

So let's start with our cash flow. Our adjusted operating cash flow, and just to remind you that exclude Stewart transition and other costs as we defined in our press release, this adjusted operating cash flow grew an impressive $21 million or 27% in the second quarter to $98 million, benefiting from incremental cash flows related to the addition of Stewart. These results were ahead of our internal expectations primarily due to higher cemetery comparable pre-need sales production. Adjusted operating cash flow was able to continue to grow even in the face of higher anticipated payments for both cash interest and cash taxes, which collectively grew $19 million over the prior-year quarter.

Cash interest payments increased $11 million. This was related to the incremental debt associated with the Stewart acquisition. And cash tax payments increased $8 million, and again, both of these figures are in line with our internal expectations. Maintenance and cemetery development CapEx for the quarter came in at approximately $28 million. This was slightly lower than what we anticipated. When you deduct these recurring CapEx items we calculate our free cash flow for the quarter to be $71 million or $19 million higher than the prior year and above our internal expectations.

So now I want to shift to the outlook as it relates to cash flow for the remainder of 2014. At the midyear point adjusted cash flow from operations has grown $30 million or 13% totaling $262 million, resulting from the earnings growth that Tom has just highlighted as well as improved collections on our pre-need sales.

Now looking at cash taxes I want to first mention what I said last quarter about our cash tax range. I said further positive refinement of our cash tax assumptions from the Stewart acquisition would push us toward the lower end of our cash tax range while stronger-than-expected operating performance would create higher taxable income and could push us to the high end of our cash tax range.

So now as an update today, we continued during this quarter working through more of the details associated with the Stewart acquisition, which has generated positive refinements to our assumptions. So, we are now expecting our 2014 cash tax payments to decrease to a range of $40 million to $50 million from the $50 million to $60 million I mentioned last quarter. We will continue to work hard to identify additional ongoing tax savings opportunities.

So based on these strong first-half results and the reduction in our cash tax outlook I just mentioned, we feel comfortable raising our 2014 guidance for adjusted cash flow from operations to a range of $475 million to $500 million. Our new guidance range for adjusted cash flow at the midpoint equates to an 11% increase over 2013.

As a result of lower capital spending to date our recurring CapEx range is being reduced to $125 million to $135 million. Both of these changes result in an updated 2014 free cash flow guidance range of $340 million to $375 million. On a per-share basis our free cash flow guidance range equates to $1.60 to $1.75 per share, using a fully diluted weighted average share count of around 216 million shares. We believe this represents a favorable high single digit free cash flow yield.

Now I'd like to shift a little bit to the capital deployment, as well as our financial position. As I mentioned on our April call we intended to take a balanced approach in 2014 to deploying our capital. I'm happy to say we have resumed our strategy of returning value to shareholders through share repurchases. And as Tom mentioned in the second quarter, we purchased about 3.1 million shares for a total investment of just under $60 million for an average price of just under $19.30. We currently have about $130 million of board repurchased authorization remaining. Our leverage, which is calculated as net debt-to-EBITDA in accordance with our credit facility dropped from 3.95 at March 31 to 3.81 at June 30.

With this we have flexibility in making balanced capital allocation decisions in the back half of this year which includes our ability to continue these share repurchases. During the quarter we also returned $17 million to shareholders through dividends, which reflects the February increase of 14% in the dividend rate, which is $0.08 per share, per quarter.

As Tom noted earlier our SEC divestiture process continues to go well. During the quarter we received approximately $120 million of net after-tax proceeds from divestitures associated with the Stewart acquisition, and recall that the first $200 million of after-tax proceeds are required to reduce our term loan as stipulated by our bank credit agreement. Therefore the estimated after-tax proceeds of $120 million were used to pay down the term loan during the quarter.

This leaves only $80 million of required term loan payments, which we expect to complete during the third quarter. I'm also happy to say that due to further refinement of Stewart's location specific tax information we are increasing the total estimated after-tax proceeds to be received in 2014 to $335 million to $360 million range, which was previously $315 million to $340 million expectation that we communicated on the April call.

We also made a required amortization payment of $7.5 million in the second quarter on the term loan. So all in all this leaves our term loan with a balance of $465 million down from the original $600 million balance.

Additionally during the quarter we took advantage of the current historic low interest rate environment and we managed our near-term debt maturity profile by refinancing our 2015 and 2019 notes along with the legacy Stewart 2019 notes through the issuance of a $550 million note due 2024 and a $95 million revolver draw. This transaction not only reduces our cash interest by $8 million annually but also pushes our next significant debt maturity to April 2016 giving us a favorable debt maturity profile.

We also continue to have very robust liquidity of about $373 million at June 30, which consists of $140 million of cash on hand and $233 million of availability on our long-term credit facility. So in conclusion we're proud of our first half of the year and looking forward we are excited about the remainder of 2014 as we move forward with robust liquidity a favorable debt maturity profile and strong cash flow coupled with the expected divestiture proceeds, which allows us to be able to deploy our capital in a way that will create long-term value for our shareholders. Our number one priority though continues to remain to ensure that we at effectively and efficiently complete the integration of the Stewart acquisition and achieve our new robust synergy targets.

So with that operator, that concludes my remarks and Tom's remarks, and would like to now turn the call over for questions.

Thank you.

(Operator Instructions)

A.J. Rice, UBS

Thanks. Hi everybody. Maybe a few questions if I can ask first of all just to try to make sure I understand the comments about obviously the good performance in the cemetery and particularly in the pre-need production area. Is at 11.8% is that legacy SCI or is that the entire business?

A.J. that is legacy SCI pre-need production so keep in mind there's a component of pre-need and then there's an at-need production for cemetery. So it will grow more like funeral revenue at kind of slightly flat or slightly up or down. So that 11.8% is pre-need comparable business.

Okay. And to think about that as on the Stewart side I'm assuming that there's probably not much growth right now as you're going through the integration process but you made some comments about the back half of the year. Do you think that the pre-need production side on the Stewart -- legacy Stewart side you'll start to be able to grow that in the back half of the year?

We do A.J. and I think-- I don't have the numbers in front of me. My memory is the first quarter was down for sales for Stewart and we actually saw some cemetery production growth in the Stewart business in the second quarter.

I attribute a lot of that to just change management, all the integration, learning new processes, systems products so I really think we already have momentum to grow the back half of the year on Stewart. The incremental piece that we're talking about gets to availability of a breadth of product in cemetery associated with the appropriate tiered pricing which again is our strategic pricing model and then our ability to sell that. That kind of incremental growth that is beyond what I think we could do is probably more of a 2015 issue but we may (technical difficulty) regionally in the back half of the year.

Okay. I know there was a number of one-time items that I know you are singling out and obviously should. Are we pretty much done with the Stewart integration costs, the systems integration costs, the deal cost or is there some residual cash outlay in the third quarter that the Company will have to make around these things?

On the deal cost I think we are pretty much done. We've refinanced the converts and have the capital structure done. But in terms of the integration costs no. There will be more looking forward.

And as the synergies rise remember they have risen now from $60 million to $100 million it costs money for integration standpoint cash outflows to achieve those synergies, so no. I don't think we're done and I think we have more to go. Not at the levels that you have seen for the first half of the year, but maybe more like 25% to 55% -- 50% quarter to half of the levels that you have seen so far year-to-date.

Okay. And then obviously it's interesting that in the midst of all this you were able to pull off an acquisition in Delaware. Is the Company actively out there looking for a family of opportunities -- smaller opportunities and what does the pipeline look like?

I would say right now the pipeline looks really good. I rarely see John Faulk anymore he's traveling all the time out there beating the bushes.

I would tell you from feedback from John that we're seeing a lot of activity and, again, it may be pent-up activity because of us and Stewart being out of the market for the last year and a half. So we're excited about that. I don't know how long it will last but we're actually talking to quite a few folks and looking at quite a few sets of numbers.

And the pricing is consistent with some of your other recent smaller deals?

I think that is safe to say, yes.

Okay. Thanks a lot.

Bob Willoughby Bank of America Merrill Lynch

You touched on just about everything here it seems like you're hitting all cylinders frankly. But just how much upside stemmed from holding onto some of those divested assets maybe bit longer what exactly falls out of the model sequentially from a revenue and EBITDA standpoint?

Well I don't have revenue in front of me but I think EBITDA Bob is probably close to $4 million from an EBITDA perspective. That was with all of them in there. So you compare that back up against your lost use of those funds.

It is accretive to hold them longer that is not our intention. We would like to ?- again, because I think these businesses are better in the hands of the long-term owners than they are of temporary owners. So we are moving as quickly as we can but to your point it's not hurting us from a financial perspective.

Okay. And you mentioned there is a lower CapEx number out there. What anecdotally is it being invested in what drove that?

It's really we had some numbers in their in terms of maintenance CapEx for the Stewart facilities, those continue. But our original guidance is probably a little bit on the conservative side based on the quality of assets that Stewart has during the acquisition.

I think that was primarily kind of the change. It's not much of a change. 135-ish down to 125-ish, so we're still going to spend the capital to get into the Dignity Memorial standards but the locations are in pretty good shape; as we've said all along the Stewart assets are just great assets.

Excellent. You did surprise me with the share repurchase in the second quarter. $59 million, it is a big number. What is a share repo run rate going forward for you?

We will have to valuate that in terms of the free cash flow yield in our different metrics but generally what you saw us do in the second quarter is kind of our opinion. And we have the liquidity; we have the favorable debt maturity profile. And so you'll probably see us stay on that same path during the back half of the year Bob.

Okay. Great. Thank you.

John Ransom, Raymond James

Everybody got to ask all the good questions so I am reduced to just thinking about your overall ASP it's a little bit complicated blending the Stewart into the Service Corp. and then thinking about the backlog but if we were to think about the 2 year to 3 year trend in ASP how would you help us think about that particularly on the funeral side? Thanks

You're talking about the walk in average or the pre-need backlog?

I'm talking about blending pre-need and at-need your overall realized revenue for funeral including what you pull out of your backlog.

I think the way we think about is this. On the at-need side we believe every year ties back into what is going on in inflation. But we feel pretty confident that we can experience somewhere in the neighborhood of 2% to 3% increases in average sale. Now what ends up happening is you get a cremation mix change that's going knock that down to probably somewhere between 1.5% and 2% on a blended basis is the way we think about modeling forward.

The nice surprise to me is that I think is changing now, and this would exclude obviously SCI Direct, but if you take the non ? call it the core backlog, the core backlog for the first time this year I believe the pre-need coming out of the backlog is actually higher than the at-need. It's taking a while to catch up for a variety of reasons but our expectation is that pre-need backlog growth will actually grow at a higher clip and again we've already got the mix baked into it, right? So that will actually be a little more of a tailwind for us as we think about two to three to five years out.

And then you add on top of that a one-time $20 million reset for Stewart? Or is $20 million just getting started? Is there more to do down the road other than the $20 million?

Remember the $20 million is EBITDA and remember the $20 million is a mix between funeral and cemetery. So as we think about the impact of the two we actually believe the cemetery side will be more impactful on EBITDA growth, the opportunities there than the funeral side.

You said it though John the average Stewart location wasn't as high an average as us. Now some of that is geographic but again we think some of that is product mix. We sell a higher breadth of products and services and options which again can be done through packaging; it can be done through sales training. So we do believe that we'll begin to close that gap predominantly related to additional products and services.

And then my other question is I know you are a metric driven guy how real-time do you think you get market share information by market? And how would you look at your market share gains or losses? And I know you focus more on the top call it 60% to 70% of the market but how do you think your market share has progressed and do you think will -- what do you think the trends look like going out?

Okay John we don't think I guess first of all we don't get perfect market share data; it doesn't exist. We have CDC data that's really not very timely.

So in a local market basis everybody that runs a market has their version of market share. And they report to us and I realize when you self-report it isn't always the same. It isn't always objective.

I would tell you again and this is Tom's opinion so there will be people that may differ in this. In 2004 or 2005 I think it was more in 2005 we went -- I guess it was 2005 -- we switched from putting more emphasis on service and recognizing that in our pricing strategies versus product. And again this was done based upon a strategic analysis that we did.

We lost some market share I would say in the lower price points. So we've been more competitive as it relates to like you said a customer that's willing to spend for services and products that we're really good at delivering at.

So we clearly lost some market share back then but again I'd say it wasn't the most profitable part of our business. Then as we began to look at strategically why can't we compete more effectively again at that lower price point that's when we decided to eventually go with the Neptune acquisition. And we competed more aggressively in that price-sensitive consumer but through the pre-need model not so much through the at-need model.

So I would argue that we may still lose a slight bit of market share of customers that are going down in certain markets and again this is the geographic mix, so sometimes we're up, sometimes we're down. And we're actually more price competitive in the arena that I would call the price-sensitive to major consumer. I think over time we're going to gain share because we're the best pre-need seller in that segment.

The other thing I would argue is too, we're the best pre-need seller in all segments and I think we're growing backlog by what were putting in the pre-need bucket there and I also believe the demographics will begin to move our way. As we look at the Harvard study how we evaluate markets we know that our consumers have access to healthcare, quality healthcare, and probably have more of an extension on life than some of the other markets some of these segments that we aren't as pronounced in.

So that again is a deferral and at some point it's going to turn. We have a lot of belief that our market share should begin to move the other way not aggressively but an acknowledgement that maybe in years past we've lost a slight bit of share in certain markets.

Okay. And then lastly any update worth talking about in terms of your tax mitigation/efforts to look at those efforts. I'm not asking the question very well. You have looked at the [reed] idea you have looked at a number of things is there anything worse reporting on that front?

Really not in a position yet John to report on that. It continues to be under study and I just remind everybody the lens we will evaluate these options through.

One, reputation in our communities and with our families is incredibly important to us particularly in a business as emotional as ours. I will remind you that anything we do will be first and foremost in our client families minds lined up with what's right for that business.

Also our ability to execute our operational growth strategies. We're excited about what we think we can achieve over the next few years so any strategy would have to give us some assurance that we continue to be able to execute and do that.

And finally it's really about value creation for our long-term shareholders who will be with us post transaction. And that's the way -- the lens we're going to look at everything we do. Also we have got to evaluate things like breakup fees and taxable events that got very low basis assets.

So there's a lot of things to look at and consider. We're still in the midst of that. We're a lot further along than we were last time we talked to you but really nothing new to report other than that.

Okay. Thank you very much.

Duncan Brown, Wells Fargo

Good morning. Just want to go back to what someone said earlier, in connection with the EBITDA associated with assets to be divested. Did that $4 million number, is that -- does that represent assets that there was a $4 million of EBITDA contribution in the current quarter?

Yes, it's $4 million a month in this current quarter. Now remember, that gets smaller and smaller as we sell things off. So probably what's left, Duncan, maybe the run rate of the assets that are left is more like $2.5 million, and probably 40% of it. But that is, you are correct in the way you are thinking about it.

Got you. Thanks. And then on the synergy front, the original or the second reversion, the $80 million of cost synergies, how much is in the current run rate?

We expect, Duncan, this is Eric, we expect to have about half of that hit 2014. And the reality of it is, the first chunk of it really didn't come until during this quarter around May, when we really made some significant milestones associated with the integration. So not very much, is the answer to your question.

Great. That's fair. And then, just lastly for me, maybe going back to pre-need funeral sales production. Is the right way to think about it, that sort of the slow down there, is in your view entirely related to integration issues, or is there anything else worth mentioning there?

It is probably related to integration issues. Again, I would remind you that average pre-need funeral customer is in their early 70s, and so you really haven't seen the baby boomer impact from that business like you would in cemetery.

But additionally, Duncan, I'm glad you mentioned it. Funeral probably has a few more distracting issues then cemetery side, and it is related to the new products and the training around them. We also had some changes to our insurance sales policies, and when we recognize commissions, and how we deal with imminent death type of situations with that.

And also, if you recall, Stewart used Forethought as their insurance provider, and we use Assurant. And we currently are using both those products, and it is on a geographic mix. So I think that created a little bit of I would say of a slowdown or confusion.

So those things are done now. They are integrated, and so we feel like the back half of the year, we ought to be getting back to a level that we can all be excited about.

Great. Thanks very much.

Chris Rigg, Susquehanna

This is Frank Lee on for Chris. Thanks for taking my question.

Would you be able to provide any color on the pace of earnings in the last two quarters of the year? And is the revenue and cost synergies that will hit in 2014, will those be balanced across the last half of the year, or will those predominantly fall in the fourth quarter? Thanks.

I think on the synergy front, obviously the year goes further the more. So you are going to get a bigger pop in the fourth quarter, but I would also say the third quarter will be meaningful. But I think again, like you were pointing out, it would be weighted to that fourth-quarter as far as synergies go.

And Frank, just to be clear, what Tom was just referring to correctly, is on the cost synergy side. Because you actually mentioned revenues as well. Revenues are stuff that we just now are starting to identify, so not much of that probably built into the models in 2014. That is really more of a 2015 situation, as we go to achieve the full $100 million run rate.

Okay. Thanks. That's helpful.

And I will now turn the call back over to SCI management.

Okay. Thank you, everybody, for being on the call today. We appreciate the time and the questions, and we look forward to talking to you again in October.

Take care. Thank you.

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