Welcome to the First Quarter 2017 Service Corporation International Earnings Conference Call. My name is Eric and I’ll 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. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to SCI Management. Please go ahead.

Hi, good morning. This is Debbie. I'm the Director of Investor Relations at SCI. Before we begin today with prepared remarks about the quarter from Tom and Eric, let me just quickly go over the customary Safe Harbor language. 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. Today we may also refer to certain non-GAAP measurements such as adjusted EPS, adjusted operating cash flow and free cash flow. A 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 behind us, I will now turn the call over to, Tom Ryan, SCI's Chairman and CEO.

Thank you, Debbie, and good morning, everyone, and thanks for joining us on the call today. Today I’ve planned to give an overview of the quarter, followed by a more detailed analysis of our funeral and cemetery operation, and finally comment on our outlook for 2017. Let's begin with an overview of the quarter. This was one of the special quarters where a lot of things just went our way. Having said that, success is where opportunity meets preparation and our team was prepared. Excluding the significant special items, like the IRS settlement which had a significantly positive impact on earnings per share, we reported adjusted earnings per share of $0.38 for the quarter which was $0.10 increase over the prior year quarter. While we expected to have easier comparisons in the first half of 2017, you may recall, we were facing a couple of headwinds in the first quarter related to the loss financial contribution from the LA Archdiocese property and a perpetual care capital gain distribution which collectively contributed $0.03 in the prior year quarter. Offsetting these two headwinds in the quarter was a $0.03 non-cash benefit in our tax provision related to revised accounting standard for share-based compensation. So at a high level, I would summarize, the $0.10 increase in a quarter like this, higher operating profits in our comparable businesses led by a double-digit percentage increase in our preneed cemetery sales production and an increase in the funeral services performed contributed $0.07 of growth in adjusted earnings per share. The remaining $0.03 of growth was attributed to lower interest expense, a lower adjusted tax rate from tax planning strategy and fewer shares outstanding. We also reported strong operating cash flows of $188 million, which was relatively flat as compared to the prior year. We accomplished this…

Thanks, Tom, and good morning, everybody. Today, as usual, I'm going to begin by giving you a few thoughts on our cash flow results and capital deployment both during the quarter before touching upon on some comments on our full-year guidance. Let's start with the details of the cash flow during the quarter. And as you’ve seen and we’ve noted earlier, we generated a healthy $188 million of adjusted operating cash flow during the quarter, which was as we anticipated slightly downed from the prior year quarter, while quarterly cash earnings grew impressively over prior year, this growth was offset by few items. First, and again as expected, cash tax payments increased nearly $12 million as a result of our transition to becoming a full cash taxpayer. We paid about $19 million during the quarter versus $7 million in the prior year quarter in terms of cash tax. Second, cash interest payments increased about $4 million, which is more of a timing issue among quarter and was also in line with our expectation. We paid about $20 million in cash interest during the quarter versus about $16 million in the prior year quarter. Third, cash flow during the quarter was impacted by the $7.2 million associated with cemetery perpetual care distribution that occurred in last year and did not reoccur this year as well as the loss of a couple million dollars related contribution from certain businesses divested in the prior year. And lastly, keep in mind that the excess tax benefit from the accounting change related to share based compensation benefited our adjusted EPS by about $0.03 per share or about $6.4 million. However, this accounting change had no impact as on our adjusted operating cash flow as we define. Our current capital expenditures during the quarter, which again…

Thank you. We will now being the question and answer session. [Operator Instructions] And our first question comes from A.J. Rice from UBS. A.J., your line is now open. And your next question comes from Ryan Halsted from Wells Fargo. Ryan, your line is now open.

Thanks. Good morning.

Good morning, Ryan.

So I wanted to touch on the cemetery preneed sales production, which was a really strong quarter. I wanted to better understand the property growth that you called out, the 14%, with half of that coming from the large prices, can you just may be give a little more color on – is that – is some of that related to some of that development that had been in process that you were selling in advance and booking once completed or is that something else?

Yes, so the 14%, Ryan, is referring to production, so you’d have nothing to be recognition of what are we selling and what we define as a large sale is a sale above $40,000, typically that’s going to be an inventory product came back to our tired pricing where we develop something very special. We completed some project up in Vancouver that we had a lot of sales activity in the first quarter related Qingming and that was a big driver of our success when you think about that high end property. But to just give you a little bit of flavor, if you think about the units that we sell above $40,000, we probably sold them – a little bit from memory – about 330 or 340 units above that in the first quarter and that compares to, I think, it’s about a 90 unit increase over last year. So the velocity in that category is up about 40% and I think the 20. So what you are really seeing is a lot more people going to that price point for what they view and we view as significant value in the type of property that we are able to develop.

Okay. That's helpful. And then, I mean, are there other cemetery development projects ongoing right now that you are currently selling into, but not recognizing any of the revenues or cash flows until it's completed? If you could just help us think about how to may be capture that over the course of this year.

Yeah, I mean, we are on work constantly because, again, I think, this is a type of product that we're seeing the customer really want. So we're always developing somewhere generally moving around the country in different section. And the way you think about it, we had an unusual, I’d say, Vancouver was pretty big project that we completed in fourth quarter, but you're always going to see the effect. You are going to see the first quarter you projection is going to be higher than your recognition rate and that’s probably going to continue into the back half of the year and then generally in the – for sure in the fourth quarter and some of the third quarter, you will being to see a lot of that pent up sale that it’s going to get recognized associated with the completion of the construction of project. We pointed out to you today we built about $18 million of sale that didn't get recognized in the first quarter. That number is going to go up in the second quarter and then being to get recognized as you approach the back half of the year.

Okay. That's very helpful. I appreciate that. And then maybe moving on to the funeral segment, obviously, some great margin expansion there. I understand there were some easier comps and still some good volume sort of above and beyond that. So I guess what I was wondering my sort of, I guess, general rule of thumb has been that 1% to 2% same store funeral revenue growth is typically what you look for to maintain your margins, but you had some nice margin expansion. Was there any one aspect of your funeral revenue performance in the quarter that really drove that margin expansion?

Well, I think, one of thing that’s helpful is that it’s big, but if you look at the revenue recognition from preneed sales, we grew that about, I think, it was $3.3 million as you think about that category. That’s growing at, I’m recalling about a 15% cliff. That's an exciting part of what we're doing. And that again gets into SCI Direct and their success at selling a product that relates to that customer base. The other thing is if you look at the core revenues, we're able to grown them I believe at around 2.3%. So back to you 1% to 2%, what that says is, if we get 1% and some change, we ought to be able to hold our margins constant. If we get above 2%, then we are probably should be growing our margins. We saw it grow 70 basis points in the first quarter. They really kind of came in, Ryan, as we expected the model. That isn't always the case. There could be some lumpiness in some of the cost some times. But if it performs as we would have expected seeing the revenues coming like they did.

Okay. And then maybe my last question. Looks like there has been some nice production on the non-funeral home side. I’d be curious just to hear your thoughts on where we are, I guess, in terms of cremation – the penetration or the sales cycle of preneed cremation contracts, is there just kind of a – sort of a catching up happening now in that sales cycle with the at-need customer profile or are we seeing sort of a higher incidence rate of preneed customers choosing cremation plans?

I think we're seeing a slightly higher – there's definitely a growth in that market. Because if you think about SCI Direct and what we think about it, a lot of the growth is organic. Some of it is opening new place and we will continue to be able to expand into new markets as it relates to our varieties of brands under SCI Direct. But having said that, it’s going to – it’s meets the law of bigger scale every time. So if we open three stores and then you have 50, that’s one growth rate, if you open three stores and you have 100, it’s different growth rate. At some point, this double-digit growth we expect to being to move more towards maybe a high-single-digit, mid-single-digit, but what we are really excited about is our management team, SCI Direct has done a tremendous job of driving growth really beyond our expectations. And so we are excited about their continued ability to grow that and it will continue to be something that we will call out because it’s going to grow at higher rates than our core business.

Great. Thanks for taking my questions.

Thank you, Ryan.

And you next question comes from Joanna Gajuk from Bank of America. Joanna, your line is now open.

Thank you. Thanks for taking the question. So, if I just may quickly on the guidance, you said that in general you did not attend your guidance range after Q1, so this time you said you expect to be at the upper end on the adjusted EPS, but at the same time, you said, you kept the cash flow outlook unchanged, your range unchanged, so is it because kind of view the guidance somewhat conservative, but also reflecting the accounting change impact on EPS while it does not affect the cash flow outlook, is that how we should be thinking about it?

Yeah, I think there is two factors, Joanna, and you just hit on one. The share based compensation accounting change which obviously isn’t specific to SPI, it’s for every company had an effect on the EPS, but the way we define adjusted operating cash flow, that was never in our number, so it didn’t have a cash effect based on what the guidance was built on in the first place. That’s the – that’s really the first effect. The other thing is we have a substantial movement on our cash flow stream related to cash taxes and there is some even more noise around IRS audit, but independent of putting all that aside, our normalized cash taxes have – become a full cash tax there means that our cash tax rate is getting pretty close to – will get pretty close to the rate in our provision in our income statement. And that boggier [ph] difference is about $40 million to $45 million compared to 2016. And that $40 million to $45 million is going to ebb and flow during the year, but that’s a big bogey for us to overcome and it’s kind of a little bit of a moving target. And for that reason we felt more comfortable just reiterating the cash flow guidance at this point in time coupled with kind of the policy that we just described and you mentioned earlier is that three months doesn’t make it a year and it’s a little early to make any material changes in annual guidance.

All right. That’s helpful. And then on outlook, I guess, so to speak so you still expect the $180 million of the recurring CapEx and you still kind of referring the – their commentary on the acquisition, so is that number when you talk about acquisition, that includes the 25 on the funeral home development, is that how you kind of combine?

No, it does not. The $180 million is maintenance CapEx, which is probably about 100 of it roughly and cemetery development CapEx, so about $80 million. And that $80 million is exactly what Tom was just talking about in terms of building the inventory that sales force then has to sell during the year. The amount that we will spend above and beyond that in terms of the growth CapEx, which relates to greenfield opportunities and such as you just mentioned is about $25 million and again that is over and above that $180 million.

Okay, great. And then – but then when you talk about acquisition that's sort of – you kind of view it as a same kind of range for the year or is there more traction on the deal front?

Well, first of all, we are very excited about the pipeline related to the acquisition opportunities and I think we were consistent now with what we said in February on that front. But to answer your question we expect to spend probably about – deploy capital is the better way to say it, $75 million to $100 million during the year and yes, the $25 million that you just described would be part of that basket that I just mentioned.

Great. And I may just may one follow-up on the preferred commentary when you talk about cemetery margins which were very strong, but then you are also mentioned something about higher cost there. So can you just flash it out a little bit more? Thank you.

Yeah, I think when we mentioned the higher cost, it was slightly above inflationary levels for our fixed cost. And the two we call that one was maintenance and again some of the timing with cemetery maintenance and the other piece was incentive compensation. So as you can expect when you have good results like this, we’ve got to improve bonus for the company’s bonus plan, and so right now those are pointing out pretty nicely. So it just showed up a little more as we allocate that cost to funeral and cemetery. So, again, that’s probably more of a timing issue, but something that’s a little higher than our 2% inflationary expectation.

Great. Thank you so much.

Thank you.

Thanks, Joanna.

And our next question comes from Scott Schneeberger from Oppenheimer. Scott, your line is now open.

Good morning. This is Donnie [ph] on for Scott. Congratulations on a good quarter. Can you guys give us an update on your cost savings initiatives, how impactful that might have been in the quarter and what you expect for the next couple of quarters?

I think in general as Tom just mentioned, we really want to hold our fixed cost structure to grow in the year 1% to 2% and a large amount of our cost structure of course is personnel and what comes with that is benefit and we all know the pressures on benefit cost in our country right now. So there is other savings and synergies that we have to find to maintain that fixed cost structure and we are pretty good at doing that. Generally, it’s just making ourselves more efficient around process, people, technology front. And a little bit more specific in that, for example, we implemented a F&A ERP last year, it was Oracle and from that we expect to change process and create some synergies from that perspective. So it’s more – I would consider it more from a support function perspective in terms of that synergies and that support function is not just Huston though, it’s spread throughout our markets as well where we’ve been doing a really good job especially in our operational leadership in terms of creating those synergies for us and always make us more efficient, but at the same time supporting the customer service satisfaction that faces our customer, which again is the most important spend that we could have.

Okay. Got it. Great. On funeral volumes and average revenue per service, can you guys help us think about the cadence there if we look out to couple of quarters?

Yeah, I mean, I think the way to think about it, clearly, it’s a – funeral is a very seasonal thing, so we are going to see our highest volumes in the first quarter and then the fourth quarter will be your second highest volumes. And those are going to be driven more likely than not in what’s happening with flu in a quarter-over-quarter basis. While we didn’t see a big flu season this year, last year was an incredibly meek one, so the comparison looks good. As we think about the rest of the year, we guide people to say we think it’s going to be flat to slightly down on an annual basis. Our expectations for the back half of the year, hopefully hold on to a flat year, if we can do that, or slightly below that, that would mean more than likely we are going to see a slight decline in the back half. Now having said that we don’t know, I that’s just one of those things that unfortunately or fortunately we don’t have the ability to predict. But again when you think about the capacity and our ability to flex costs, we are going to nimble in how we deal with whatever the volume that comes to us, the next quarters have it.

Got it. Thank you very much.

Thank you.

And our next question comes from A.J. Rice from UBS. A.J., your line is open.

Thanks. I will try again. Hello, everybody. First of all, we’ve been in a fairly robust financial markets for some time, I’m wondering if that has gotten to the point where it’s starting to impact the relative attractiveness of the cases coming out of the preneed backlog versus your at-need, can you just comment on how those might compare to these days, preneed maturing contract, it’s been in your book for a while versus just an at-need on a relative profitability and relative revenue per case?

Well, as you saw in the press release, the preneed average that’s coming out was pretty strong as you saw that and it’s stronger than the at-need average as well A.J. from our core operation. You see that the at-need was up just over 0.3%, but the preneed turned at-need is up about 3%. Now I will tell you that there is some noise in there because the situation that we changed last year that you’ve heard us talk about before related to customers that were deemed to be in our internal language terminal in nature where before those calls we’re including in an at-need versus writing the contract on a preneed basis. When you adjust that noise out A.J., you still have a couple of hundred basis points increase in terms of year-over-year growth in the matured preneed average versus just walk-in average year-over-year. I think some of that has to do though with the incredible job that our prearranged funeral sales force has done, utilizing packages and utilizing the customer facing techniques to continue to drive that average of what’s going into our backlog. And that I would say is the largest component of what we are starting to enjoy as it comes out. Now you do have a good point though, the market has been affecting it and I do think we are enjoying 6% to 7%, maybe 5% to 6% nominal growth in the trust funds, but we are enjoying probably 2% to 3% real return growth in the trust fund and that’s going to have an effect. So a lot of that 2% growth of matured preneed, maybe that’s 30, 40 basis points of it. Does it help? Yes. But is it the majority of it? It’s really not. It really has to do with again giving credit to our sales leadership and what we are able to do in terms of selling and giving the customer what they want that’s going into the backlog on a prearranged basis.

Okay. That’s great. And I know the initiative is to roll in, I guess, the HMIS system and then the sales force system more recently. Where are you at with that? Is that still sort of transition holding your back a little bit on the sales effort or is – or should we start to see a acceleration there pretty soon?

A.J., we mentioned a couple of different ones and I will mention three. So sales force is really the customer relationship management tool, it is fully implemented, but I think the power of that, it’s one of those things that over time as you being to utilize it and it becomes part of core of what you do, you being to see the real benefits payout. I will tell you that we are starting to see that, I think, there is still a lot of runway as to what we can do with that product. You mentioned HMIS as plus, HMIS plus is our customer facing tool that we are utilizing in our funeral homes to make arrangements, generate the contract, but it takes people through I’d say a much more robust and consistent presentation of items offered. That is pretty much rolled out in its entirety, like everything some places take to it very well, some places we go back and do retraining, so we are in that process. The last piece that you mentioned is we are taking basically the customer facing opportunity of HMIS plus and putting into what we call sales enablement. And sales enablement is going to allow our sales force take that same power of what we do in the funeral home on that road. And that is going to be launched in the back half of this year. And so again the productivity from that when we did test markets was pretty significant. So we feel highly confident that that sales enablement tool should really enhance maybe fourth quarter of 2017, but probably more appropriately 2018 and 2019 as you roll this thing throughout the country.

Okay. That’s great. And then a final question. Some reference to doing some transactions was a 1031 exchange, can you just remind us what typically drives you doing it that way and are the economics materially different on those transactions than traditional ones?

What it is that we go through periodic process where we are divesting of excess cemetery land or business that’s dull and when we do that the tax laws will allow you to put those funds into essentially trust account over a period of time and you can utilize those funds to purchase or part of purchase of the next acquisition. And what that allows you to do is really shield you from a capital gain situation. And so it’s a tax efficient mechanism of doing it is the reason why we do it A.J.

Okay.

Does it have a material effect on the IRR? Not really.

Okay. All right. That’s great. Thanks a lot.

And our next question comes from John Ransom from Raymond James. John, your line is now open.

Hi, good morning. At the higher end of your guidance, how should we think about preneed growth in cemetery for the rest of the year? I know you mentioned you’ve sold some stuff that you are going to realize later, but also having a hard time translating that relative to your kind of ongoing 6% to 8% goal?

Yeah, John, I think, it was a real upside first quarter in productivity. I think the way we think about it is if we had an idea of what we thought we can do on preneed cemetery sales, that’s always going to be in the mid to high single digit growth rates. We did 13% in the first quarter. I think when we think about the rest of the year, we still think that rest of the year can still achieve that 6% to 7%, it isn’t like – I don’t think it’s our opinion that we are going to give back that trajectory but also would caution 13% is pretty high step. So that’s probably not going to be sustainable [ph]. But I don’t think of it as something that we pull forward into the first quarter and we are going to give back in the back half of the year.

Right. Are you seeing any – I mean, I know this is softer sale, but are you seeing any uptick in what, I’d call, consumer confidence or just willingness to spend more just correlating to other stuff?

Definitely, I think it’s at the high-end we are seeing that and particularly in certain markets again and the correlation, John, lot of times you can see in housing price. I mean the markets that have the vroom, vroom going on in the real estate markets generally are markets where we see high-end inventory that’s moving. So it’s is correlating to consumer confidence. I would say across the board not so recognizable year.

Okay.

But from business perspective you hear a lot of confidence in the market right now.

So the sales guys are wearing their mega hats [ph], I guess, they are all in. The last thing I was just wanting to understand a little better, I know you’ve done a good job in the funeral sector of managing the cash flows using the insurance product, if your preneed cemetery sales grow, say, 10%, is that a short-term working capital burn or are you managing your preneed cemetery to a cash neutral basis no matter what the growth is?

It’s a working capita burn because I think the average is in the, call it, 35% to 40% range on cemetery. Now, [indiscernible] having, if you do it long enough, you are beginning to layer in that collect space. And so as an example, this quarter did, I think, was somewhat surprising to Eric and I as we are looking at the numbers is with these sales, we said, wow, you got a big use of capital, but the surprising thing was the collections that we are getting on in the last few years, you also see that somewhat offset that working capital. So, yeah, it’s a temporary cash flow use, but it kind of quickly makes up for itself.

So, again, let’s assume, I mean, just for argument, like a $5,000 cemetery sale, how much of that do you collect in year – is it typically a four year installment sales and you collect 25% in year one, I mean, just what’s the kind of year one cash in, cash out versus [indiscernible] and how long are those contracts certainly?

First of all, if you purchase cemetery property, it probably be $100,000, but I will do your $5,000. I think…

[indiscernible] I live small.

So you can afford…

I work for a humble regional firm, I live small here.

So, anyway, John, it varies. So what I was saying before, I think, on average, we get 35%. Some people pay in full, some people are going to put, I’d say, let’s say, 10% down, maybe 20% down and they’re going to pay over three to five year period on average. But again it’s really across the board. You see different thing in different regions and the like.

So collect 75 and you got to pay the sales guy 20% or something?

Yes. All-in across the board about that.

Okay. So there is a point, so your cash flow positive on average in year one just might take a few months to get?

Yes, pretty close because you’re exactly right. To think about it, we don’t have – you’re selling something and there is no cash outlay, [indiscernible] widget.

Yes.

So that recognition has no cash other than selling cost associated with the property.

Sorry to keep drilling down but off that, let’s assume you collect 35% of the cash, how much you would generally recognize? I know the accounting rules about revenue recognition of [indiscernible] and cemetery but how does that compare to the revenue you recognize in year one, is it 35%, is it a different number?

What happened since – once you get the 10% down which again as Tom said predominately happens on day one. But once you build the mausoleum in that example is when you get to recognize it which is going to occur in the fourth quarter which you saw our last quarter to make it lumping up. So when you take that, I know we’re talking about a single contract, John, but when you take it across the entire network over an entire 12 month, think of it this way. About 90% to 92% of the amount that you sold actually goes through the income statement in the same year. I think that’s a new rule of thumb for you to use when you’re modeling.

Okay.

John, the other thing is that we’re talking about property sales. We think about a typical customer buyback property, merchandise and services I’m going to make it a rounded example 60% of my spend is on property which will be recognized when I sell it generally and the other 20% are merchandise and service, those are just like – they’re going to put into a trust fund, they’re going to get deferred and they get recognized when we delivered the product [indiscernible].

And then my last question and going to the funeral side, what you’re selling today end of the backlog? How does that ASP compare to what’s your average ASP is that you realize this quarter? In other words, is there a big premium or are selling stuff [indiscernible] price today or is it kind of – I know that there is lift from stuff coming out of the backlog. I’m just going to figure out what that [indiscernible] future ASP?

[indiscernible] is good. So we are selling it a few hundred dollars above what’s coming out today. So that’s a great thing. The one thing to keep in mind as you look at some of those disclosures, when we sell an SCI Direct, remember SCI Direct is growing at a pretty rapid rate. So when you blend it sometimes it may look like it’s coming down, so we view that as a different channel. If you look at SCI Direct, it’s growing the average price per contract as well as our core businesses going the average bunch of contract. So we say, in the core business, what’s coming in is hundreds of dollars higher than what’s coming out today.

And in SCI Direct, it’s about 2,100, 2,200 something like that?

I think its 2,300 now.

Yes, 2,300.

Okay, great. Thanks. That’s all from me.

Thanks, John.

Thank you, John.

We have no additional questions at this time.

Okay. We want to thank everybody for being on the call with us today. We look forward to speaking to you after our second quarter results in the last week of July. Have a great day.

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