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Stewart Enterprises, Inc. (NASDAQ:STEI)

F1Q09 Earnings Call

March 12, 2009 11:00 am ET

Executives

Leslie Loyet – Financial Relations Board

Thomas Crawford – President and Chief Executive Officer

Thomas Kitchen – Senior Executive Vice President, Chief Financial Officer

Analysts

Henry Reukauf – Deutsche Bank

Robert Willoughby – Banc of America

Jamie Clement – Sidoti & Company

Operator

Welcome to today’s Stewart Enterprises, Inc. first quarter 2009 earnings conference call. (Operator Instructions) I would now like to turn the call over to Ms. Leslie Loyet of the Financial Relations Board.

Leslie Loyet

Good morning and thank you all for joining us. On behalf of Stewart Enterprises I’d like to welcome everyone. By now you should have all received a copy of the press release that was issued this morning. If not, please call Liz Dolezal at 312-640-6771 and she will send you a copy immediately, or visit Stewart’s website at www.stewartenterprises.com for a copy. Management will provide an overview of the first quarter and then we’ll open the call up to your questions.

Before I turn the call over to management, please be advised that the information contained in this call is current only as time of the call and the company assumes no obligation to update any statements, including forward-looking statements made during this call.

Statements made by the company that are not historical facts are forward-looking statements. Examples of forward-looking statements include projections of revenues, earnings, growth rates, free cash flow, debt levels, tax benefits and other financial items, statements regarding plans and objectives of the company or its management, statements regarding industry trends, competitive trends and their effect on future performance and assumptions underlying the forward-looking statements regarding the company and its business.

The company’s actual results could differ materially from any forward-looking statements due to several important factors which are described in the company’s Form 10K for the year ended October 31, 2008.

The company uses EBITDA and free cash flow as financial measures. These financial measures are not in accordance with accounting principals generally accepted in the United States of America or GAAP and are intended to supplement rather than replace or supersede any information presented in accordance with GAAP.

Reconciliation to the most directly comparable GAAP financial measures can be found on the company’s website, again at www.stewartenterprises.com under Investor Information, Reconciliation of non-GAAP financial measures and can also be found in the company’s press release dated March 12, 2009.

Joining us today from management of Stewart Enterprises we have Thomas Crawford, President and Chief Executive Officer, and Thomas Kitchen, Senior Executive Vice President and Chief Financial Officer.

At this point I’d like to turn the call over to Thomas Crawford.

Thomas Crawford

Thank you Leslie. Good morning and welcome to everyone. Before we begin I have one housekeeping item I’d like to take care of at this time. Just to let you know, Mr. Kitchen is one sick man. Not only that he doesn’t feel well. All kidding aside, Tom is not feeling well today and we appreciate his willingness to take one for the team to try and spur primary demand but we need him around. I just want you to know Tom is not his usual chipper self because he has been fighting a terrible cold and we appreciate him fighting through that.

By now you should have received the press release with the filing and all the relative detailed financial and operating data on the performance for the quarter. The structure of today’s call I would like to be as follows: First of all I will review a few of the key operating measures for the quarter and provide management’s assessment on some of the effects the current economic conditions are having on the company.

Second, Tom will provide a more detailed look at our trust portfolios, how we account for them and the implications for the future given the current economy. Now it became clear to us from conversations with some of our investors throughout the last three months that there is some confusion around the trust portfolios. Where we thought we gave adequate information in the fourth quarter call, we realized that confusion exists and that we need to take time to more fully explain the situation. That will be one of the key points of our call today.

After Tom’s review I will summarize our direction for the future and our actions to improve shareholder value in a turbulent and unsettled economy.

As you read from the press release our results for the first quarter are as follows: We generated net earnings of $5.7 million compared to $8.9 million for the first quarter of last year. This translates into earnings of $0.06 per share compared to $0.09 for a reduction of 33% from the previous quarter of last year.

After adjusting for the current tax valuation allowance and Tom will discuss that later in the call, we earned $6 million compared to $8.9 million and that in turn generates earnings per share of $0.07 compared to $0.09 for a reduction in our earnings per share of 22% on an adjusted basis.

There are two main factors contributing to the decline in net earnings and earnings per share in the quarter. The first was a decline in trusts related to earnings of $2.2 million which was in line with our expectations and which we communicated during that fourth quarter call. If there is a piece of good news in the earnings decline in the trust funds it was that the decline was less than we had anticipated.

The second major factor was the decline in cemetery property sales which decreased by $7.2 million or 27.9% over the prior period. We will discuss both issues in the course of the call today.

We are very pleased with the cash that was generated for the quarter as our operating cash flow was $7.3 million which is an increase of $3.2 million or a growth of about 78%. Even after you make an adjustment for the fact there was a decrease in tax payments made in 2009 compared to 2008 cash still increased over the previous period by about $800,000 for a growth of approximately $0.11.

It is also interesting to note that for the quarter not only did we grow cash over the previous year but we also generated more cash than earnings. Now the only point I’m trying to make here is that we do pay attention to cash and evaluate every decision we make for cash generation capability in addition to earnings potential.

Our liquidity position remains strong. At the end of the quarter we had $71.5 million in cash on hand. In relation to obligations to our lenders we have no significant near-term debt maturities and no amounts drawn on our $125 million revolving credit facility which matures in November 2009.

In today’s economy the strength of our liquidity position is a significant fact that cannot be overlooked. Now let’s take a closer look at the performance of both the cemetery and funeral operations.

First of all, in the funeral operations segment our revenues did decline by 3.3% compared to the previous quarter which resulted from lower services events flowing through our facilities and also lower trust earnings. However, even with the decline in funeral revenue we were able to grow gross margin dollars by 1.7% and increase our margin yield by 100 basis points to 25.5 up from the 24.5% of last year. These gains were made despite the additional headwinds of funeral trust earnings decline of $900,000.

Now we are pleased with our organization’s ability to better manage costs and scale our locations to meet market conditions. We are also pleased we were able to increase revenue per event on the funeral side by 6% as we saw positive increases in both traditional and cremation services. We believe this demonstrates our ability to positively communicate the value of our offerings to consumers and that consumers will select according to their needs and values despite low consumer confidence measures in the economy and the negativity that is being bombarded to the public on a daily basis by the media.

Now we are disappointed our calls are down by 6.3%. We fully expected the calls to be down as we tracked death data, probed suppliers and listened to other operators but not by 6.3%. While traditional calls are down which is expected given the growth in cremation, we believe the vast majority of the above expected decline in our calls was the result of low end cremations. During the quarter we actually saw a positive growth in terms of price and volume in our mid and upper end cremation price points which indicates to us our field personnel are doing a much, much better job in explaining value and options to families selecting cremation. We are very pleased with those two measures.

However, we also experienced a high percentage decline in the number of low end cremation cases. Our low end cremation average prices are well above the prices of the low cost, direct cremation operators that are out there today. We charge more because the family gets more than the low price provider. However, because of the large decline in our low end cremation business we concluded from our analysis that those families in that segment are more sensitive to the economic conditions and have opted to pursue a lower cost alternative.

Now we can understand the movement to low cost alternatives by families that are closer to the margin and more troubled by the current economic conditions. However, our low end cremations generate positive margins and help cover fixed costs and we are not happy with the loss of volume and share. We are evaluating our options to better appeal to those types of customers and bring them back to our facilities.

After we normalize for the reduction in low end cremation volume loss our overall volume decline does come back in line with what the overall market conditions are today.

Our cemetery segment has felt the largest impact from a weak economy. As we experienced a decline in cemetery property sales of approximately 28% for the quarter. Additionally, our cemetery performance was negatively affected by a reduction in trust income of $1.3 million. Given the fact that approximately 80% of our property sales are made well in advance of death and given the effects of the economy and the incredible drop in consumer confidence from a year ago it is not terribly surprising that cemetery property sales have declined. It could also be argued when compared to other consumer businesses that it would be surprising that the decline was not greater.

The decision to purchase cemetery property on a premium basis is one that can be postponed. While the ability to postpone purchases in the short-term, we continue to believe that it remains a benefit to us over the long-term. When the economy begins to recover or consumer confidence increases we believe consumers who are more likely and who have been more likely to postpone the decision to buy premium property will return to their past purchase behaviors simply because the historical reasons making it desirable to purchase cemetery property pre-need such as availability of desired spaces, planning in advance, less stress in an already difficult time, locking in price where demand continues to out pace supply have not diminished or gone away.

To a younger consumer that might not be an issue but to those of us that are approaching that point those issues still exist. They haven’t diminished and we feel that will continue to go forward. On the other hand if the economy lingers in the current state for an extended period the need for premium property doesn’t disappear. It just shifts from pre-need to at-need. You can delay the purchase but eventually that time will come. There will be a transition period before the pre-need to at-need starts to balance out.

With that in mind and with the long-term in mind we took actions during fiscal 2008 to strengthen our cemetery sales organization by improving the length and quality of our training and improving the caliber of new sales professionals joining our organization. As I stated earlier we don’t like to report declines in our financial performance but given our marketplace conditions we believe we performed relatively well for the quarter.

With that I’ll turn it over to Tom Kitchen to go through our trust portfolios and financials.

Thomas Kitchen

Thanks Tom. Good morning to everyone. On this morning’s call I’d like to discuss several items impacting the results which are covered in more detail in our form 10Q and to give you the context within which we view these items. In line with this I will spend a majority of our time giving you some additional insight on our trust investments and the actual effects the recent decline in the stock market has had on our company.

To better explain the impact of the trusts on our financial statement, you need to review the trusts in two different types. First, pre-need and cemetery merchandising services trust. For ease of discussion I will refer to these trusts as premium trusts throughout the call. Secondly, perpetual care trusts.

Our pre-need trusts are primarily related to pre-need customer contracts. These contracts are sold in advance of when the merchandise and services will need to be delivered. In many cases it could be ten or more years in advance. We place in trust a percentage of the revenue received from the pre-need contract. This amount will vary in each jurisdiction but generally averages between 70-90% of the sales price of services and 30-50% of the sales price for merchandise. In addition to the principle placed in the trust any earnings will also be used to fund delivery of the merchandise and services.

Our premium trusts realized and unrealized losses had no immediate impact on our income statement. We allocate all realized earnings including capital gains and losses to the underlying customer contracts and recognize those earnings as funeral or cemetery revenue in the period the contract is ultimately delivered.

The investment performance of the premium trust is mirrored to the overall declines in the financial markets. Cumulatively the unrealized loss position for these trusts at January 31, 2009 totaled approximately $278 million. In light of this, investors may wonder if there is a current funding obligation relative to the market performance for these premium trusts. The answer to this is no. While the cumulative loss is important it is only one piece of the puzzle. It is equally important to note the company has approximately $228 million in earnings that have been realized and allocated to our premium contracts but not yet recognized in the company’s financial performance to date.

This deferred income will be recognized in future periods when the underlying contracts are performed. In a sense, much of the unrealized loss relates to the appreciation of what was realized over the last several years. What is important then is to determine if we expect the premium contracts to be profitable when they mature or go as need at some point in the future. Based on our analysis in the first quarter these contracts continue to be profitable.

Other factors that are important to consider in reaching this conclusion include the following: The cost of delivering the premium contract is not as high as the consolidated margins suggest. This is due to factors such as the acquisition of sales expenses recognized at the point of sale, not at the delivery of the premium contract and also the inherent fixed cost nature of the business is significantly higher than the variable costs and therefore the incremental cost to deliver the premium contract is significantly lower. Further, in assessing the impact of these premium contracts on the company’s overall business it is significant to note that approximately 2/3 of our funeral services performed in any period are at-need services. Those at-need services cover most, if not all, of our fixed costs.

So while there may be some reduction in revenues in the future to be recognized when the premium contracts deliver it relates to only 1/3 of the services that are performed. This is important because for the at-need funerals there is no trusting related to the sale and therefore there is no financial impact from our trust portfolio. Similarly, the cemetery revenue that is dependent on the company’s premium trust is slightly more than 20% which means almost 80% of our cemetery revenue is not impacted by the financial markets.

Therefore, on a consolidated basis more than 70% of the company’s revenues are unaffected by the investment performance for the trust portfolio. On a quarterly basis we perform a rigorous impairment review which consequences of this review determine that we no longer have the intent to hold certain premium trust securities for our forecasted recovery period. As a result we impaired unrealized losses of $11.3 million in our premium trust during the first quarter. Again, it is important to note this impairment did not result in any financial impact on our first quarter’s net income.

Other trusts relates to our perpetual care funds. The purpose of these funds is to set aside a portion of the revenue from cemetery property sales to generate income which is used to defray the costs of maintaining our cemeteries. While perpetual care funds the original principle of the investment is to be maintained at all times. In effect, these funds act as an endowment fund. Since the principle is not to be touched and because we can only withdraw the income we have no funding obligation for the unrealized loss unless we sell the securities or the securities are rendered worthless because of some action such as a bankruptcy. This was the basis for the funding obligation of $13.3 million we recorded during our fourth quarter of FY08 and the additional obligation recognized during the first quarter of 2009 just $100,000.

During the first quarter of 2009 we did fund approximately $1 million of this obligation. Notwithstanding, the balance was classified as a current liability, we plan to manage the remaining funding obligation over an extended period of time if possible. You can see that with the perpetual care fund there is more of a [bright] line criterion in determining any funding obligations. Securities that have an unrealized loss do not trigger funding obligation unless they have sold or become part of some bankruptcy. They may be lower income to be recognized but this will be a future period event.

With regard to our current funding obligation, it is interesting to note that the company has adequate liquidity to satisfy the payment and we are generating positive cash flow from these funds that can be used to satisfy the obligation. It is also interesting to note that if we used existing liquidity one could view this as a reallocation from a current aspect, cash, to a long-term investment in our perpetual care funds. Even if this occurred we would still report the asset on our balance sheet, invest the funds and realize the economic benefit in the future from the investment income in our financial statements.

It would, of course, be restricted from use as a principle for other corporate purposes.

As we reported during our fourth quarter of FY08 we recorded a tax valuation allowance of $7.4 million related to some of the losses realized in certain of our premium trusts because some additional losses realized in these trusts were recorded in additional $300,000 loans in the first quarter of FY09. This brings the total tax valuation of accounts to $7.7 million for the capital loss carry forward.

All of the company’s pre-need cemetery trust and some of the funeral trusts are grantor trusts where the company is the grantor. This is significant because the company retains the income tax characteristics, dividends and capital gains and losses in these trusts. Since capital losses can only be offset against capital gains and have demonstrated an ability to realize the benefit of the loss carry forward in the future, a tax valuation reserve is required. Does this mean the company has a near-term or current $7.7 million tax liability to repay? The answer to this question is no.

What it does mean is to the extent the company is unable to generate significant capital gains in the future the amount of taxes paid in cash will be higher than the gap tax expense for those premium contracts to which the capital losses were allocated in those contracts that delivered. To the extent we are able to generate capital gains we will be able to reduce this tax valuation account and recognize this benefit in that future period.

Currently the loss carry forward period is five years and so we have at least this long to address this. In our last call we estimated the expected overall decline in revenue from trust earnings in 2009 to be approximately $10 million. As of January 31, 2009 and based on current market conditions we believe the approximately $10 million annual decline is still a reasonable assumption. With that said, for the first quarter of fiscal year 2009 we experienced a $2.2 million or $0.02 per diluted share decline in our trust related revenue which negatively impacted our first quarter results.

This decrease includes a $100,000 or $0.01 per diluted share in our funeral segment and $1.3 million or $0.01 per diluted share in our cemetery segment. Overall we are not pleased with the trust portfolio performance. However, we don’t believe anyone was forecasting a recession and credit market impact as severe as we have experienced. We stopped investing in equities about half way through fiscal year 2008 and have been building our cash balances in our trust which now approximate $78 million. When appropriate we will look to deploy these funds in higher yielding securities that produce a reasonable return with a significantly lower risk profile.

We are also evaluating other asset allocations that are less dependent on equities and consequently have less risk but produce a reasonable overall return. We don’t, however, believe that any significant shift in our present asset allocation makes much sense at this point of the market cycle. While we do not anticipate a significant shift in asset allocation in the near-term we are selectively identifying strategies and investment opportunities that will help to improve the current yield of the portfolio and implementing them as those opportunities arise.

Market studies consistently show that when the financial markets turn positive it happens in a very significant way. We also don’t believe there are alternative investment choices that currently exist with reasonable returns to compensate you for the risk you take. Near term, market conditions are evolving and changing and will continue to do so before we see the type of stability we want. Therefore, any new allocation will require a period of time to transition to.

Shifting from the company’s trust performance, I would like to give you some additional insight on the company’s liquidity and cash flow following the first quarter. Our cash position remains strong with $71.5 million in cash on hand as of January 31. No amounts have been drawn on our $125 million revolving credit facility and no near-term significant debt maturities exist. We are well in compliance with our debt covenants. We also paid some $2.3 million or $0.025 per share in dividends in the first quarter of fiscal year 2009.

For the quarter we generated cash from operations of $7.3 million compared to $4.1 million for the same period of last year. This approximately $3.2 million increase in operating cash flow is due in part to a decrease in net tax payments made in the first quarter of fiscal year 2009. In the first quarter of fiscal 2008 we paid $3.3 million in net tax payments compared to $900,000 in net tax payments in the first quarter of fiscal 2009.

I would like to point out that our cash flow is not generated evenly throughout the year. The timing of our insurance payments, property taxes and other payments made on or around year-end. Historically we have had negative to slightly positive cash flow in the first quarter while generating greater amounts of cash in later quarters. We are working with our bank on the renewal or the replacement of our existing revolving credit facility which matures in November 2009. While we earlier placed a self-imposed time table of completing this by March 2009 we expect to have this completed in the near future.

Since we have the time we wanted to make sure we negotiated an agreement that was the right agreement for the company that enabled us to execute our business strategy with the appropriate amount of flexibility. Lastly, I would also like to discuss our quarter end tax rate. For the first quarter our effective tax rate was 40.4% compared to 37.5% for the same period in 2008. The change in 2009 tax rate from the 2008 tax rate was primarily due to a $300,000 tax expense attributable to an increase in our valuation allowance discussed earlier.

The effective tax rate for 2009 exclusive of the valuation allowance would have been 37% which is more comparable to the 2008 tax rate.

To conclude, if you look at our results taking into account our current economic environment we believe our company’s operations performed well. We hope we have given you the context of how to view our portfolio and its relationship to the company’s current and future operations.

Now I’ll turn it back to Tom.

Thomas Crawford

Tom thank you for that review. There is no question that this is an unprecedented time and that we are all in a tough economic environment. Even our [inaudible] veterans tell me they have never seen these kind of conditions before which simply lets me know we can’t predict with any kind of certainty how families will behave in the future.

With that said, I have stated to our employees that it is in these kinds of conditions that we are tested and we will come to find out how good we really are. I don’t mean that from an uncertain standpoint of not knowing how good we might be, but that we can come to understand more fully that we are capable and that we will have as a byproduct more confidence in our abilities now and in the future.

We believe the fundamentals of the company remain intact to weather the storm. We also believe that times like these gives us opportunities of looking at the business in new ways to find new possibilities that would have been overlooked in less challenging times. Some months after my coming aboard at Stewart Enterprises our senior management group laid out a strategic framework around three major thrusts.

The first was the implementation and optimization of the best in class initiative. This initiative focused on the creation of the Stewart cultural values and the development of performance metrics and systems to monitor key measures that matter most and to capture the creativity and innovation of the star performers at the local level with the intent of injecting that creativity and performance into the rest of the organization. The desired outcome is to significantly increase performance, profits, cash flow and increase our return on assets and our equity base.

The second thrust was identified as the pursuit of simply entitled “New Invention.” The intent was to develop and generate new growth opportunities tangential to or springing from the base business. Internally with our organization we have positioned this throughout to capitalize on the 11-22 million people that set foot on our properties every year.

The third component was simply to use our capital resources in the best and highest use possible. To invest in opportunities in the base business as they arise and make sense or to invest in infrastructure to support and grow new invention opportunities as they develop. Or if the strength in our capital base were opportunities to justify the investment.

Last week we announced an organizational change to help us further achieve those objectives. To further capture the intent and benefits of best in class we eliminated our division management structure. I have been thinking about this change for some time. The division structure made sense historically as the company was a de-centralized company with each division in a sense competing with one another.

However, with the best in class mindset to capture the best our company has to offer and apply it to the rest we needed to eliminate divisional barriers, reduce management layers and speed the flow in information. Our past investments in processing infrastructure also allowed us to accomplish this objective. Right now all of our field operations report to one Senior Vice President of Operations and this individual was instrumental in building our best in class dashboard tools and systems.

We also intend to get more focused on our sales efforts by reporting our sales organization through one key executive, our Senior Vice President of Sales reporting to me instead of splitting the responsibilities across divisional boundaries as it was in our divisional structure. We have changed the responsibilities of our Senior Vice President of Marketing and Sales to focus on traditional marketing responsibilities and more importantly to devote energy and creativity to developing and commercializing new invention opportunities. Our intent is to find ways to capitalize on assets we currently have but have not realized as assets simply because we have not been asking the questions differently than we have in the past.

We are trying to find ways to inject a little bit faster growth into a low growth industry. While it is too early to discuss anything at this point in time, we do have ideas circling that are stimulating, exciting and get me quite energized. Only time will tell if we can commercialize any of our ideas but we intend to step up to the plate and swing the bat. Additionally, with the organizational changes we have realigned our corporate activities into a more natural grouping to better facilitate work flows and capitalize on investments made in improving our systems and processes.

It is important to note that this organizational change while producing the savings of approximately $1 million per year was not intended to reduce costs. It was implemented to provide greater focus on maximizing the intended benefits of best in class and to reallocate those resources to create and commercialize new market opportunities that if successful will produce greater growth for the company in the future. In reality we are reallocating our resources and in fact may be adding new resources to the business and marketing initiatives to move them ahead at a faster pace.

In summary, while no one likes a decline in performance we certainly don’t, we believe relative to the market we performed probably relatively well. We believe the underlying company fundamentals are sound and will get stronger with full maximization of best in class. While we don’t like the conditions of the financial markets we believe our balance sheet is strong and we like our strong cash position. I trust Tom’s review of the investment portfolio helped you to better understand those points. We have altered our organization to help us achieve stronger base business growth and to apply resources to develop and commercialize new business opportunities. While the business conditions are tough, that is a given, I feel very good about our team and feel excited about what we have on the drawing board.

We will continue to use our cash wisely where we can get the best and highest long-term returns for our shareholders. We will continue to pay dividends. We will evaluate the benefits of repurchasing debt as well as repurchasing stock. We will pursue acquisitions in the base business where they make sense or we will acquire infrastructure to support new development activities as they arise and warrant that investment.

With that we are now ready to take your calls.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Henry Reukauf – Deutsche Bank.

Henry Reukauf – Deutsche Bank

Just a clarification question for me. On the receivables you have on your balance sheet am I correct that most of the receivables are for at-need, I guess all of them? Two, you really don’t extend terms on them. It is pretty much pay upon delivery of service?

Thomas Kitchen

No, it is mostly related to property sales. We do extend terms in the premium property sales. At-need is generally you pay at the time of service. There are some at-need receivables but the majority of receivables are related to property sales.

Henry Reukauf – Deutsche Bank

So it is property sales from deposits that you received? How long is the usual contract for the property sale?

Thomas Kitchen

It varies. Typical range average would be about five years.

Henry Reukauf – Deutsche Bank

Have you seen any increase in sort of defaults or not following through with the property sale?

Thomas Kitchen

Not dramatic. When people buy the property once it gets into paying they generally complete the sale. It is really the ones that don’t have as much skin in the game that are probably the highest risk. We are seeing some trends in the first quarter but not of a dramatic nature.

Henry Reukauf – Deutsche Bank

Just a break down on the cemetery sales, I guess pre-need and the trust was part of the reduction in cemetery sales year-over-year. For the quarter what percentage of the overall sales, sales of still sort of pre-need sales that have come through that meet the criterion for revenue recognition?

Thomas Kitchen

Property sales, the general criterion would be that if you sell a product or service that is delivered immediately or at the time of the sale the right to use it is transferred to the party then we will recognize the revenue associated with it. For our pre-need funeral to be delivered services in the future or merchandise such as a memorial that we would be delivering in the future then that would be deferred until that time. Now what we have said in the past is that of our property sales approximately 80% relates to pre-need but that just simply means that the individual is buying in advance of the need. It is pre-planning. 20% approximately is at-need and happens as death occurs. The family would come in and purchase the property. A little confusing possibly in terminology because even though you sell the property on a pre-need basis if you transfer the interment rights to the person upon the sale and meet the criteria to recognize the sale we would recognize it immediately so there would be no trust as a consequence of that sale.

So principally in the case of cemetery most of the sales that require some trust and go through the delivery of some merchandise that is going to happen in the future many times it is going to be a vault or a memorial of some sort. So I think the answer to your question is it is not just a case of what is pre-need and at-need in the case of cemetery as much as it is how much is going to be sold to date for immediate delivery versus how much have we sold today for our future delivery.

Thomas Crawford

Let me just put one more point on this and you may not be asking for this, but on our cemetery side Tom mentioned the premium percentage. We actually require more down payment on that property today than we did years ago. You can imagine in today’s environment there is some pressure to reduce that but we haven’t done that because we feel that as Tom said the more skin on the table then people will stay less down. All we have to do is look at the environment today and what happened in the housing business and you can see the impact of that. We have not succumbed to lowering that percentage. We believe, again from a receivables standpoint and the quality of our earnings that we continue to hold our standard on that.

Henry Reukauf – Deutsche Bank

That down payment is how much?

Thomas Crawford

For recognized it is about…

Henry Reukauf – Deutsche Bank

Or just that you are requiring.

Thomas Crawford

Well we require at least a 5% down payment. Traditionally in the case of property sales when we analyze the sales people tend to put down as a down payment a significant amount of the price of the sale. So it is not just a 5% or 10% across the board. Many people will come in and purchase it and pay cash for it or put a substantial amount of the price down as a down payment.

Henry Reukauf – Deutsche Bank

I really was trying to get, you described it earlier, the percentage of the cemetery that is pre-need that qualifies for recognition in the current period.

Thomas Kitchen

Of the property sales that occur in a current period approximately 80% is pre-need and about 20% is at-need.

Henry Reukauf – Deutsche Bank

Of that pre-need how much is pre-need sold in the quarter that because of recognition requirements you were able to recognize it because of the percentage of completion?

Thomas Kitchen

First of all, as a backlog of work like that you have to do some construction and that amount has remained relatively constant over the years. At this point I would tell you that you have some coming into the revenue stream that were sold and deferred in prior periods and you get some that are going into the deferrals that basically offset each other.

Henry Reukauf – Deutsche Bank

So is there a percentage that you break out that is pre-need that was sold this quarter that is kind of being recognized now? Is that what really the decrease was? Because the pre-need sold years ago is going to have to occur whether…

Thomas Crawford

No, we have not identified that.

Henry Reukauf – Deutsche Bank

Is it a significant portion or is it a minor portion of that pre-need?

Thomas Crawford

I’m not sure. In terms of the pre-need cemetery that is deferred and going to delivery in the future? If that is the case as a foot note in the financial statement that really addresses that.

Operator

The next question comes from Robert Willoughby – Banc of America.

Robert Willoughby – Banc of America

I think in our conference last year around this time you had referenced a number just in terms of operating cost efficiencies, best practices, etc. what you hope to get at. It was in the $30 million range if I remember correctly. I see in the initiative you just announced a couple of weeks ago I think you broke out about $1 million of annualized savings here. What is left to achieve on that front? How much cost savings opportunities are still out there?

Thomas Crawford

Well it wasn’t just cost savings. There were component parts to that of revenue increases both on the funeral side, both in traditional and in cremation and then also on the labor side in eking out the efficiencies we have. We are making progress on that and we have more progress to make. So the $30 million was all-in, everything adds up and we are not going to get that. I think an indicator we are making good progress you have it on two fronts. One is the average revenue per event that continues to go up and we said what we need to do there is that is where the best in class comes in. So we look at all of our arrangers, across the board and within facilities, so we can look at the deltas and try and close those gaps in our training and what the best are doing and apply that to the rest. We are seeing that in the averages.

The other issue when you look at our margins, our margins expanded. That is exactly what we want. Focusing in on the labor component because that is the other big piece of this thing and from our standpoint we have in these tough economic times we have chosen not to take it to lock in our employees wages. We have given them wage increases but where we are coming back is we want to get that on the efficiency side and as we look at the measures and metrics on our labor per event and also as a percent of revenue and once again using the analytics in our best in class is to find the gaps and close those gaps. Those are the two big fronts that we are applying.

Also on our continuous improvement which we are doing as well with our investment in our technology and our systems that is the other part. When you look at our SG&A as a percent that has also come down as well. So we are making progress on those three fronts.

Robert Willoughby – Banc of America

If you look at just the cost component side of things do you think we are in the fifth or sixth inning in terms of what you can achieve?

Thomas Crawford

No. That is one reason why we changed the organization. I have been chirping at this with our group and I think we are just scratching the surface. We rolled it out last year and as you could imagine in this kind of an industry you have cultural boundaries that we have to kind of break through. That is one reason why we changed the structure and we again our Senior Vice President of Operations was absolutely instrumental in this whole building the infrastructure of best in class and in getting things done and getting us to move together to capitalize that. I think we have hit the ball and are running to first base and we still have a long way to go. To me that is a positive.

Robert Willoughby – Banc of America

Any details, I know it was tiny in the grander scheme of things, but anecdotal what can you tell us about the acquisition that you did and should we factor in a couple of more of these over the course of the year or is that unlikely?

Thomas Crawford

I think right now in the condition we are in and the situation and market we are in we continue to look. We are active and have become a little bit more active in looking around. For planning purposes for 2009 I wouldn’t factor anything in from that standpoint especially when you look at the credit markets the way they are and we like our liquidity position and we are going to hold onto that and get our new revolver in place. So for 2009 we are continuing to court and look at things in the right way and to do our analysis and we do have activity in that area but again given the capital markets we are holding tight this year.

Robert Willoughby – Banc of America

Is it reasonable to expect stock is up $2 here that management will be in the market themselves buying after the market opens up?

Thomas Crawford

I think that is a reasonable assumption.

Robert Willoughby – Banc of America

When does that window open up?

Thomas Kitchen

The first part of next week. I believe Tuesday. It is Tuesday or Wednesday. I would have to double check.

Operator

The next question comes from Jamie Clement – Sidoti & Company.

Jamie Clement – Sidoti & Company

I guess maybe the first sort of series of questions should go to Tom Kitchen because you addressed the trusts. One of the areas that I think I am actually still a little confused with here is when you filed your 10K and then reiterated today the approximate 10% of gross profit for fiscal 2008 that could be lost as a result of the financial markets’ effect on the trust funds. What I don’t quite seem to get is why that number may not be larger and maybe significantly larger after the last eight weeks?

Thomas Kitchen

It would pay to look at that number and it is based on current market conditions and valuation. It is based on a number of factors. It is based on anticipation of reduced level of perpetual care income and it is also based on the reduced level of management fee income as well as a reduced level of funeral and cemetery services type revenue that we recognize in the trust funds.

Jamie Clement – Sidoti & Company

Actually, I think the three things you just mentioned are the perpetual care and the management fee on lower assets. That I understand. What I was a little unclear on was the scenario by where if somebody has a pre-need contract on where assets or that cash has been trusted and that pre-need contract becomes at-need and the value of assets are below the purchase price, if you will. Here is my question. If you don’t sell the underlying assets does that mean that other revenue, let’s say 1/3 of your funeral services are performed out of the backlog, does that mean that 1/3 is being booked effectively at the purchase price?

Thomas Kitchen

Let me answer it this way. I think first of all the part of your question that goes to the company’s accounting policy with regard to the recognition of gains and loss. We report that our accounting policy is based on realized gains and losses and during the fourth quarter and first quarter we realized in excess of some $50 million worth of losses that we have now allocated to all of the underlying contracts it relates to. So there will be some dilution in revenue in the future as a result of those realized losses around that. However, in managing the portfolios are taking a long-term view with regard to assessing whether you hold on to some of these securities or not. So every quarter we go through this rigorous analysis of determining which ones we believe we want to hold onto, which ones we are going to sell and which ones we believe don’t have a realistic probability of coming back any time soon. We make adjustments going forward.

If you look at in your analysis a contract, for example, hypothetically it was bought a year ago and then sold at something like $10,000 and invested in the market share it had some declines during the course of the FY08 period as a result of the changes in the capital market but not all of those contracts that you sell at the end of 2007 would be coming due during the course of the next year or two. These things are very long-term in nature, especially with regard to the funeral trusts and they will be averaging 10 or more years in terms of an average life of these contracts before we have to perform and have to realize any revenue related to those sales at some future period.

Jamie Clement – Sidoti & Company

So just to sort of clarify here, you manage the trust for the long-term. You think your assets are going to go up. But if there is a scenario or cluster of scenarios where the booked price of the service is less an asset value and you plan to hold the underlying assets over a period of time the revenue recognition is not based on that temporary decline in the asset values?

Thomas Kitchen

That is correct. And also I think I said during the course of my comments it is also important to point out the company has had the benefit over the last several years of realizing gains and losses in ordinary income that have been realized but not recognized for our financial statement purposes. So that income has been deferred and will be recognized as the contract to which it relates will be delivered. Looking at the unrealized loss at this point in time really just looking at one piece of the overall puzzle you really need to take into consideration the realized but unrecognized gains and losses.

Also too, I will put it into context that the company’s future operations or the significant majority of future operations really depend on at-need, cemetery and funeral business that is going to come in at that point in time. Our impairment analysis looks at the realized, unrealized gains and losses and we believe the book of business they relate to is still very profitable.

Jamie Clement – Sidoti & Company

In the kind of scenario we are talking about how much cash are you allowed to take out of the trust at that point in time when a pre-need contract becomes at-need? In other words could there be a significant difference between the revenue recognition and the short-term cash pull out you are allowed to take?

Thomas Kitchen

We are entitled to take out the principle in any realized gains and losses.

Jamie Clement – Sidoti & Company

Any realized gains and losses?

Thomas Kitchen

Yes.

Operator

This concludes today’s question-and-answer session. At this time I would like to turn the conference back over to Mr. Crawford for any additional comments.

Thomas Crawford

All I can say is I think Tom and I handled those questions real well and that I think I said about two things the whole time so we make a good team. Anyway, we appreciate all of you joining us today. We wanted to give you clarity on our investment trust portfolio. We feel we are living in a time of turbulence but we feel all the actions we have taken are prudent and as I said earlier we feel positive about our future even amidst all the turbulence we have got.

So again thank you for joining us. We look forward to talking with you three months from now.

Operator

This concludes today’s Stewart Enterprises, Inc. conference call. Thank you for joining us and have a wonderful day.

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Source: Stewart Enterprises, Inc. F1Q09 (Qtr End 01/31/09) Earnings Call Transcript
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