Service Corporation International (SCI) Q4 2013 Earnings Report, Transcript and Summary

Welcome to the Fourth Quarter 2013 Service Corporation International Earnings Conference Call. My name is Christine and I will be the 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 will now turn the call over to SCI management. You may begin.

Hi and good morning. This is Debbie Young, Director of Investor Relations at SCI. Welcome to our call today. As we discussed our fourth quarter and year-end results as well as our outlook for 2014. 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. Reconciliations 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’d like to now turn the call over to Tom Ryan, SCI’s President and CEO.

Thanks, Debbie, and good morning everybody. I’m going to begin my comments today by giving you an update on our Stewart acquisition and some high level perspective on the 2013 year then I’ll get into the details of the quarter and give you some color on our outlook for 2014. Now for an update on Stewart. First and foremost, we’re very pleased to report that we closed the Stewart transaction on December 23rd and we’re in the midst of a successful integration. We couldn’t be any more tried it. The Stewart acquisition generated the meaningful internal rate of return on capital deployed for our shareholders. Through this transaction we’re expanding our footprint with premier properties to complement our existing network as well as welcoming very talented and committed people from Stewart into our SCI family. As part of the federal trade commission approval the level of required divestitures was a little more than we anticipated. While we’re disappointed to leave these businesses, we do not believe it will meaningfully affect our internal rates of return based on the anticipated sales proceeds. However, it will have a slightly negative effect to earnings per share compared to our previous expectations. Speaking of the divestiture process is going very well and we’re on track to complete all sales we believe by mid 2014. We like to remind you that we’re divesting of businesses that we’re both legacy SCI and Stewart facilities. These businesses generated EBITDA of approximately 25% of the historical field level EBITDA of Stewart on a standalone basis. Shifting to integration, the back office and systems integration processes are progressing and we’re confident we can deliver our initial cost synergy estimate. As we begin our operational and sales integration, we believe this could lead to identification of additional synergies. Now let…

Good morning, everybody. I am going to start this morning with my comments described in our cash flow results for the full year 2013 and then I'm going to talk a little bit about the fourth quarter as well. Then after this I'd like to discuss some forward-looking comments related to our cash flow outlook for 2014, our current financial position. And then I'm going to end with some of our thoughts on our capital deployment plans as we look forward in 2014. So, as you've seen, we finished 2013 on a really high [hope], delivering strong earnings and cash flow results, which exceeded our expectations. For the full year, free cash flow generated in 2013 grew $65 million to $236 million and exceeded the high-end of our guidance range for normalized free cash flow, which was $305 million to $320 million. This represents a tremendous growth of 24% over 2012 levels, despite a $10 million increase in cash taxes year-over-year. This increase is primarily the result of higher earnings associated with increased cemetery profits and higher cash receipts associated with preneed funeral and cemetery sets. So on the fourth quarter, our operating cash flow grew 15% to $106 million compared to $92 million in the prior year quarter and exceeded the high-end of our guidance range given to you in October, which was $80 million to $95 million. Similar to the full year story, the increase in operating cash flow in the fourth quarter is predominantly associated with higher than anticipated earnings driven by our cemetery segment results and higher preneed cash receipt on the very strong preneed sales production numbers that Tom just highlighted. Additionally, we benefited by about $5 million with lower cash interest payments in the quarter as we refinanced our 7.375% debt with 4.5% debt…

Thank you. We will now begin the question-and-answer session. (Operator Instructions). Our first question comes from A.J. Rice from UBS. Please go ahead.

Hi this is [Brandon Bager] for A.J. Just maybe a little more color on the acceleration versus last couple of quarters seems kind of double-digit growth in the preneed funeral side. What's been driving that, is there any sort of internal sales force changes or just the market growth getting better? And then also, as you think about it, sort of big picture here at the backlog, helps you or doesn’t to help your earnings that much in the current quarter on the funeral side, when you think you get to point where some of the success you’ve got a last decade growing that backlog, maybe that starts to more than offset what we would see in a current quarter and on a given quarter, what you get you put in to the preneed backlog if you will?

Okay. First part of your question Bran I think is as it relate to our success, again I think it’s the primary reason that I would put on the most recent acceleration has to do with what I was talking about before. We have seen productivity enhancements over the last few years to drive sales and what you are seeing for the first time in the last four, five years is an expanded sales force. We grew the sales force by an additional 7%, we've never done that. And we are putting people on that are very productive. So I think probably the primary differential over previous quarters is that we really have more people out there interacting with baby boomers, which is driving production. The second question, I wish I could answer for you unfortunately, if I knew that I would tell you. So it’s very, very hard to predict. What I would tell you is we've experienced kind of accelerated preneed production now for four years. And so my gut would tell me that within the next two to three to four to five years, we should begin to at least see some of that falling into your revenue, but again very, very hard to predict within the accuracy. So we’ll continue to monitor it, but I can’t give anymore guidance than that.

Got you. Thank you.

Thank you. Our next question comes from Chris Rigg from Susquehanna. Please go ahead.

Good morning guys. And I got in a couple of minutes late here, so I apologize if you comment on this. But with regard to the guidance, is your synergy target unchanged at this point?

Yes. The synergy target that we have is unchanged. I think what I said Chris if you missed it was we feel like there could be more we’re not in a position yet to quantify what that might be. But that has not unchanged and I kind of gave three factors that we’re kind of negatively impacting our ability to execute ‘14 and then three that overcome it which gets us back to maintaining our range.

Okay, okay. And then when I look at the direct selling prices, the average revenue per contract sold, it looks like that pricing firmed quite a bit relative to other recent periods, is there anything notable there?

I think a lot of it has to do with smaller discounting that we’re doing a better job of explaining. You’re talking about within direct cremation sales…

Yes, when I look at the average it looks like it was up 11% to 12% and have been sort of mid to upper single-digits prior to this quarter?

Yes. I think we’ve used a lot of kind of discounting and coupon strategically and we’ve done some testing to see if people found value without that and we realized some success in utilizing some of those techniques and that’s been probably the biggest driver of the increase year-over-year is just less discounting as they percentage their products and services.

Okay, okay. And then one of the headwinds that you talked about was the way you allocated the purchase price. I am assuming that’s falling into amortization somehow. Can you give us a sense for how much of that -- what’s the incremental headwind that wasn’t in your initial 2014 guidance?

What I’d Chris is it wasn’t a reallocation, it was just a fact that when we gave October guidance, we hadn’t close the transaction, we were still in the middle of really pulling together what we thought the anticipated purchase price allocation and now obviously is more refined as we closed in and as of December 31st that you will see in our 10-K. But the answer of your question is in terms of the original $1.05 to today it was probably about $0.02 to $0.03 differential that it put pressure on EPS. Didn’t necessarily pressure on cash, which means you are correct in your assumption that it’s more of non-cash amortization type item that put that pressure on.

Okay, great. Thanks a lot.

Thank you. Our next comes from John Ransom from Raymond James. Please go ahead.

Hey good morning. Three things; in your funeral backlog is the mix of dignity still higher that had need and is that have an effect on your ASP as the dignity matures?

Yes, we are seeing a higher mix of selling packages into the backlog and the things that are rolling out are going to have that impact, exactly John. I don’t have the numbers in front of me, but that’s the general trend that we are experiencing and that we would project overtime. We feel better about the preneed going at need average that should continue to grow overtime because of the type of business we are putting in the backlog.

Tom, do you have an approximate number for the maturing preneed compared to your overall ASP, what’s the difference there? So, in other words if you are generating $500,000 on average for dignity’s maturity as the backlog is maturing at $7,000 or something like that?

I think it’s about a $200 differential amount, John. So, it’s something to that affect. And keep in mind, probably that backlog has a higher instance of cremation as it relates to. So, you are dealing with the higher mix and still generating the type of revenues that we are.

Okay. Secondly, I know you do a lot of work I mean early days to minimize the cash flow track from selling preneed because you pick the cash in the short time; you have to pay your sales person. Could you remind us kind of currently how that stands when you sell funeral preneed into the truck into the third party interest. What the kind of first year cash flow looks like from that activity?

Yes I think, I mean at synergy if you just look to the selling cost and G&A, if we sell an insurance funded product, call it a -- we are going to get a 20% of base value just around the purposes that’s the G&A revenue and cash that will get upfront. We will pay about 15% or 16% in selling cost in order to obtain that. The difference if we sold all insurance, it be actually slightly cash flow positive. The differences in certain states and in certain instances we sold trust. When we sell trust, we mainly get retainage of 10% and our selling costs continue to be 16. So, when you blend the two, essentially the G&A revenues and retention are going to offset the selling cost. And so, one of the things we keep talking about is the margin percentage is negatively impacted. It’s not really a cash flow drag in a pure sense, it just brings down the percentage margin because you are grossing up the revenues and then you’re turning around and giving away all the profit below. Cemetery side, I'm sorry.

Go ahead, I'm sorry.

What I was going to say on the cemetery side, the trusting loss are less punitive, we don't sell insurance to start with, but generally we're not having to trust nearly the amount we do on the funeral side. So, as we grow cemetery generally the cash flow is going to more than offset again depending on how much you collect down payment. But regardless of that, it's very cash flow beneficial and as you know to the extent we sell property, the profit gets recognized upon sales as long as it's been constructed. So, very cash flow positive on the cemetery side. But there is a day prior 10, 15 years ago where our selling cost that I'm telling you now 16, 18 on the cemetery side, it's pretty closer to 20, we're in the 30% range. And so, there is a time when preneed was very cash flow negative and now what I'd tell you is that on the funeral side it's cash flow neutral and on the cemetery side it's cash flow positive.

Right. And as you have [blended] next now that you are accounting for the divestitures in the Stewart deal, do you still think you'll be on the funeral side in that 2 to 1 range of insurance funded versus trust funded preneed on the funeral side?

Yes, I don't see no reason why we wouldn't continue with the trend we're at.

Okay. And then finally could you just remind us as you do cremation funeral versus a casket funeral, just to be approximate gross profit dollars difference in those two transactions?

I mean, I'd be approximating John, because I don't have anything in front of me. But probably the way you think about it is you're going to spend on average about $4,000 less. So, revenue would be impacted by that much. I would tell you that more than likely on a profit side it's probably closer to 2, because you're not going to have the cost of a casket, you're not going to have some other ancillary costs, so I’d say on a gross dollar percentage, it’s probably around two and I would tell you on a gross margin percentage, not gross dollar that actually, it would be higher on a incremental basis.

Right. Okay, thanks a lot. Great job.

Thanks.

Thank you. Our next question comes from Duncan Brown from Wells Fargo. Please go ahead.

Hey, good morning. I think going back to the last call, asked about your guidance thoughts for legacy SCI and Stewart and you made basically similar assumptions for both volume and pricing for both legacy assets but that you thought there might be some more opportunity on the Stewart side, particularly on the funeral portion; any update on that?

You are talking specifically about sales, Duncan?

That's right, sorry.

Yes. I think again, it’s really too early to tell. We’re just integrating the Stewart businesses; we got some great people, some great properties. We are little bit difficult to transition completely because of systems that needed to be integrated. We would anticipate by the end of May that we would all be on similar systems and therefore to go to similar sales structure and sales payment type programs, which I think should generate some accelerated growth particularly in the back half of the year. But I’d say we are still in a position of analyzing and trying to understand exactly what we think we can do. But we feel very good about the businesses and the people. And so, I’d look for our ability to grow those very similarly to what we grow SCI business.

Okay. That's fair; I appreciate it, still early stages. I guess for the assets you need to sell, is there anything that you can tell us about them, are they -- I think in the press release you said, there was 91 locations, are most of them combos, is it heavily weighted to funerals or cemeteries anything you can parse out there?

Well I think on a location basis, you’re going to see more funeral homes, but I think on an EBITDA basis, a lot of it’s driven on a cemetery side. There is some really profitable cemeteries that unfortunately we’re going to have to divest of. But the good news is a lot of people are interested in them and they’re going to command good prices. So, I would say the mix of profits more tilted towards cemetery and the mix of actual numbers of 91 is going to be probably 65% on the funeral. That’s -- I am speaking without anything in front of me, so forgive me if I’m a little off.

No that’s fair, I appreciate. And maybe if I could, one numbers question. In press release you highlighted $25.7 million of cost related to Stewart and G&A line. How should we think about that, is all of that one-time in connection with the transaction or some of that ongoing?

That’s a one-time cost in terms of what we’re calling out and added back in non-recurring. That all relates to fees and such related to the closing of the transaction in the fourth quarter.

Great, thanks a lot.

Thank you.

Thank you. We have time for one more caller. Our caller is Bob Willoughby from Bank of America. Please go ahead.

Hey, Tom and Eric. I apologize I jumped on late, if you mentioned this already. But can you give us any comments on the performance of Stewart since their last financial report, we haven’t seen much from them of late, is there anything anecdotal about their experience?

I think that again just to reiterate what Tom mentioned about not only the quality of the assets, is the quality of the people and those people that are running the funeral homes and cemeteries for the Stewart and they are going to be integrated into our network are doing a great job. And we really haven’t seen a lot of degradation in their performance and in their properties. We are very pleased again with the assets and we are very pleased with the management and the people that are just doing a tremendous job and we look forward to integrating them into our company.

Were the pre-lease efforts in line with the view…

Yes, I think Bob we probably saw a little bit of and I think it’s just hesitation in trying to understand where you are going. Funeral volumes are going to be down a little bit like we experienced because you had a tough. And I would say on the selling side, it was tough to drive sales in that interim period. But I think what Eric is trying to point out is we think that was a temporary blip and we believe now that within our systems and within our structure, they are great people, great properties; we are going to get them back. But you are right, I mean I think waiting for the Federal Trade Commission over seven months period, it’s hard to drive sales if you are Stewart management in that time period. So it was down a bit but nothing shocking by any stretch.

Okay. And did you offer any update Tom, just the timing of the divestiture program, can you get it done in the first half that quickly?

We do. I said in the comments Bob that we believe as of right now that it will all get done by mid-year. So we feel pretty good about that. And again on the integration side, everything is going really well and we are very confident about our ability to deliver synergies.

That’s perfect. Thank you very much.

Thanks Bob.

Thank you. I will now turn the call back to SCI management for closing remarks.

We want to thank everybody for participating today and we look forward to talking to you at our first quarter earnings call which will be sometime in late April. So until then, have a great 2014.