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Stewart Enterprises (NASDAQ:STEI)

Q2 2011 Earnings Call

June 09, 2011 11:00 am ET


Thomas Kitchen - Chief Executive Officer, President, Director and Member of Investment Committee

Lewis Derbes - Chief Financial Officer, Senior Vice President and Treasurer

Leslie Loyet - Vice President of Chicago Office


Albert Rice - Susquehanna Financial Group, LLLP

Robert Willoughby


Good day, everyone, and welcome to today's Stewart Enterprises Inc. Second Quarter 2011 Earnings Conference Call. As a reminder, today's call is being recorded. [Operator Instructions] I would now like to turn the conference over to Leslie Loyet of the Financial Relations Board. Please go ahead, Leslie.

Leslie Loyet

Thank you, Sarah. Good morning, everyone. On behalf of Stewart Enterprises, I would like to welcome everyone. By now, you should have already received a copy of the press release. If not, please visit Stewart's website at Management will provide an overview of the second 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 of the 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 revenue, 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 10-K for the year ended October 31, 2010.

The company uses adjusted earnings, EPS, EBITDA, net debt and free cash flow as financial measures. These financial measures are not in accordance with accounting principles 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 financials can be found on the company's website, again at, under Investor Information, Reconciliation of Non-GAAP Financial Measures, and can also be found in the company's press release dated June 8, 2011.

With that said, I'd like to introduce management of Stewart Enterprises. On the line, we have Tom Kitchen, President and Chief Executive Officer; and Lew Derbes, Chief Financial Officer. At this time, I'd like to turn the call over to Tom. Please go ahead.

Thomas Kitchen

Good morning, and thank you for joining us on the call today. I want to start by saying we believe we made significant progress in the second quarter, as indicated by several of the key metrics of the company's performance. For example, during the quarter, we experienced increases in same-store calls, average revenue for our funeral service and cemetery property sales, which generated an improvement in overall revenue, gross profit and earnings compared to the same period of last year.

We achieved a 19% increase in earnings to $10 million and a 22% increase in earnings per share to $0.11. After adjusting for our current period tax valuation allowance and a charge for the early extinguishment of debt, we reported a slight increase in adjusted net earnings to $9.2 million, and adjusted earnings per share remained at $0.10.

To highlight our funeral performance for the quarter, we increased our average revenue per funeral service and same-store calls, which generated a 3% increase in general revenue and a 7% increase in funeral gross profit compared to the same period of last year. We believe this demonstrates the value of leverage in our business.

While we experienced nearly a 7% decrease in preneed funeral sales compared to the second quarter of last year, we did see a 26% increase in preneed sales compared to the first quarter of this year. We remain committed to preneed funeral sales and believe the strong emphasis we place on preneed is important to the company's long-term potential and helps maintain and expand market share.

We continue to be encouraged by our cemetery property sales, which increased 6% compared to the second quarter of last year and 14% from the first quarter of 2011. The improvement in cemetery property sales was offset by a decrease in the completion of various cemetery projects during the quarter, resulting in a slight decrease in cemetery revenue and gross profit.

We have positive trust performance for the quarter, with a 4.5% overall return, which helped generate a 12% total return for the trailing 12 months. We also improved our capital structure by significantly extending our debt maturity profile at favorable terms. Lew will provide more details related to the transactions later in the call.

We have continued to repurchase our common stock in the open market during the first 6 months of 2011. We have purchased 1.5 million shares for $9.4 million. It's interesting to note, for the last several years, we have repurchased nearly 22 million shares of our common stock for approximately $157 million, resulting in a 20% decrease in total shares outstanding.

In addition, and over the same timeframe, the company reduced its outstanding debt by 21% or $87 million. After this initial deployment of nearly $250 million of free cash flow, I'm pleased to report we had approximately $79 million of cash on hand as of April 30, which is nearly 20% higher than our cash balance at October 31.

And finally, our leverage coverage ratio, as measured on a net of cash basis, has improved from 4x in 2005 to 2.6x as of April 2011, which further attests to the improved financial condition of the company.

And with that summary, I'd like to turn the call over to Lew.

Lewis Derbes

Thanks, Tom, and good morning to all. Today, I wanted to give you some further insight in a couple of key areas. First, I'll talk about the company's operating performance; second, our financial condition and capital structure; third, our tax planning strategies; and then finally, the performance of our trust portfolio.

Regarding our operating performance, I am pleased to report overall increases in revenue and gross profit, which generated improvements in earnings and earnings per share. Our Funeral business performed well during the second quarter. We achieved a 2% increase in average revenue per traditional call or a 4% increase in the average revenue per cremation and a 1% increase in same-store calls compared to the same period of last year. This represents the second consecutive quarter with increases in both calls and average revenues.

The improvements in our major drivers of the Funeral segment contributed to a 3% increase in funeral revenue, a 7% increase in funeral gross profit and a 90-basis-point improvement in funeral gross profit margin. As Tom mentioned, we believe this highlights the power of leverage in our business.

In regards to our Cemetery segment, we are encouraged by a 6% increase in cemetery property sales compared to the second quarter of last year and a 14% increase since the first quarter of this year. The improvement in cemetery property sales for the quarter was offset, primarily, by a decrease in construction on various cemetery contracts.

In addition, as a result of the low interest rate environment, we reduced interest rates on our installment sales, which ultimately resulted in a $300,000 decrease in our finance charge revenue.

Overall for the quarter, we achieved a 19% increase in earnings to $10 million and a 22% increase in earnings per share to $0.11.

After adjusting for a change in the current-period tax valuation allowance and the charge for the early extinguishment of debt, which I'll explain later in the call, we reported a slight increase in adjusted net earnings to $9.2 million, and adjusted earnings per share remained at $0.10.

Lastly, our EBITDA remained strong at $26 million for the second quarter and $100 million for the trailing 12 months.

Turning to our financial condition. As Tom mentioned earlier, we significantly improved our capital structure during the second quarter of 2011 by completing an offering of $200 million 6.5% senior notes scheduled to mature in April of 2019. We used the net proceeds to repurchase and redeem our outstanding $200 million 6.25% senior notes that were due in 2013. The decision to refinance our senior notes 2 years earlier than the maturity date was based on our favorable evaluation of the current market conditions, as we expect long-term interest rates to rise in the future.

In addition, we amended our $95 million revolving credit facility, which was undrawn and scheduled to mature in June of 2012 by increasing its size to $150 million and extending its maturity date to April of 2016. This facility currently remains undrawn. As a result of these transactions, we recorded a $1.8 million charge for the early extinguishment of debt during the second quarter of 2011. The refinancing has significantly extended our debt maturity profile and increased our borrowing capacity at favorable terms. We are pleased with the flexibilities these transactions have created and believe we are well positioned to respond to future strategic opportunities as they arise.

We also have continued to repurchase our common stock in the open market. Since the end of the first quarter of 2011, we bought an additional 400,000 shares of our common stock for approximately $2.5 million.

Moving on to taxes. In the second quarter of 2011, our effective tax rate decreased to 15%. This decrease was due, in part, to the favorable performance of our trust portfolio, which enabled us to record a $2.5 million reduction in our valuation allowance related to our capital loss carryforward. Additionally, a few years ago we initiated a comprehensive examination of our tax policies and implemented several IRS-approved changes, which have produced significant positive results. We continue to pursue further tax planning initiatives, which, if successful, will provide for additional potential cash tax savings.

As a result of these efforts, we have realized federal tax refunds and reductions of federal tax payments of nearly $60 million over the last 4 years and expect to further reduce our future tax payments by approximately $23 million, for a total cash tax savings in excess of $80 million. We have paid less than $400,000 of federal cash tax payments in the first 6 months of the year, and we expect to pay nominal federal cash tax payments in the last half of 2011 and throughout all of fiscal 2012.

In the second quarter of 2011, we paid $1.6 million more in net state tax payments compared to the second quarter of last year. In addition, in the second quarter of fiscal 2010, we received a $1.6 million federal tax refund. We do expect to receive an additional tax refund later this year. After consideration of this refund, we would expect to pay less than $3 million in total net cash tax payments for fiscal 2011.

Moving on to cash flow. During the second quarter of 2011, we generated $20.5 million in operating cash flow or $3.2 million less than the second quarter of last year. This reduction is a result of the previously mentioned increased state tax payments in the first 6 months of this year as well as the tax refund received last year. Absent the timing of tax payments and tax refunds, operating cash flow would have been slightly higher compared to the second quarter of 2010.

Our operating cash flow for the first 6 months of the year reflected a 35% improvement over last year, increasing to $35.7 million, which is the highest 6-month operating cash flow in 5 years.

In regards to the company's trust portfolio. During the second quarter of fiscal 2011, our preneed trust experienced a total return of 5%, and our perpetual care trust generated nearly a 4% return. Overall, total returns experienced for the trailing 12 months were 13% for our preneed trust and 10% for our perpetual care trust. Since October of 2010, the fair market value of our portfolio has improved by approximately $46 million. We have continued to diversify our portfolio with a passive investment approach. As of the end of the quarter, cash and exchange-traded funds represented approximately 40% of our trust portfolio. We believe the actions we have taken to diversify our portfolio and rebalance our asset mix have been beneficial and have lessened the volatility of our returns.

Now I'd like to turn the call back to Tom.

Thomas Kitchen

Thank you, Lew. In summary, after reviewing the second quarter and year-to-date financials, we remain optimistic about fiscal year 2011. Our vision for the company is to grow our business through both internal initiatives and acquisitions while maintaining a close focus on managing our operating costs. While we do this, we will continue to wisely allocate capital and invest in people, facilities, equipment and technology to enable us to maintain and expand our market share.

In sum, our collective focus will be on our shareholders, to provide them the best possible return; our customers and families served, to improve their experience; and our employees, by giving them the tools and training that will allow them to perform at the best-of-class level of performance. We will follow this strategy consistently every day, every quarter and every year. We’ve had a good first half to our fiscal year, and we look forward to further success in 2011. We believe our actions are moving the company in the right direction. And finally, I need to acknowledge the hard work and dedication of all of the company's valued employees. Their contributions and efforts are the principal reason for our success.

We're now ready to take any questions that you may have.

Question-and-Answer Session


[Operator Instructions] We'll go first to Robert Willoughby with Bank of America Merrill Lynch.

Robert Willoughby

Just a question. Lew, you touched on the tax -- some of the tax issues. I know you guys aren't crazy about providing forward guidance, but can you distill it down to a level that we're, at least, in the ballpark here, in terms of forecasting what that rate will be, going forward?

Lewis Derbes

Sure, Bob. I mean, certainly, during the first quarter, we had an unusual tax rate. It's associated with the Puerto Rican tax legislation change and the decrease in the corporate rate. This quarter, we had the tax valuation allowance reduction that we had as a result of the performance of our trust portfolio. Absent those types of unusual items, I'd expect the rate to return to a more normalized level of about 38%.

Robert Willoughby

Okay, perfect. And I see your dividend payments year-over-year are actually down. I would assume that's something you guys would address, that you'd seek to boost that dividend, is that a realistic expectation?

Lewis Derbes

Well, I mean, certainly we'll evaluate all of -- what our best deployment of free cash flow will be. Ultimately, the dividend decision would be a decision of the board. The reason that it’s down slightly is associated with our share repurchase program. There's just less outstanding shares to pay the dividends on.

Robert Willoughby

Right. And -- but is the philosophy of the company to be a dividend-growth company? Or is it just [indiscernible] just increased ownership and no more?

Thomas Kitchen

Bob, we, over the years -- a couple of years ago, took a look at the dividend, increased it from $0.10 to $0.12. It's something that the board considers virtually every board meeting in terms of what the right capital structure and the right returns are for the shareholders. So I would expect that to be addressed, going forward, and the board would make the decision about what to do. But I think that we believe -- I will tell you that from management and from our board's point of view, that we believe that an important use for the company's liquidity is to pay the dividend for the shareholders, and we look to provide a relevant rate of return to each of our shareholders through the dividend that’s paid.

Robert Willoughby

Okay. And lastly, do you just think -- if you look at the performance of the trust, stronger in the quarter relative to what, maybe, we thought the market would allow you to do. But then the share repurchases were a bit lower than where we thought. Is there any -- do you think about it -- is the share repurchase somewhat of a hedge for how the trusts are doing? Or are they completely uncorrelated? Do you think of them together? Do you think of them completely separately?

Thomas Kitchen

I would say that the 2 decisions are completely uncorrelated in terms of share repurchase. So we -- one thing that also impacted the company's ability to repurchase shares during the, certainly, the second quarter, were the financings that we were going through, the issuance of the senior notes as well as the refinancing of the bank debt we thought were significant enough transactions that warranted the company to stay out of the market during that period. And that did impact the company's ability to repurchase shares during that period. We have $12 million. As of April 30, we have approximately $12 million remaining. I think we've announced that we continued to buy about 400,000 shares post April 30, so we have probably approximately $10 million remaining on the current share repurchase. And that's an issue or subject that the board will take care of or address in the next meeting.

Robert Willoughby

Okay. And just lastly, you've guided to about $5 million in expenses associated with the cremation initiatives. Is that kind of equally weighted across over the course of the year, or front-end loaded at all, or more back-end loaded? Can you address that?

Thomas Kitchen

Well, we completed 4 cremation gardens during the period. We have an anticipation that we'll complete approximately 5 more for the balance of the year. And of course, we'll be spending on others that will be in progress, that will come to completion in the FY 2012 period, as well. We still believe the $5 million is a good approximate level of commitment and investment for cremation gardens. And I do need to emphasize that the $5 million we view as a part of the overall investment we make as in inventory -- in cemetery property inventory, is perhaps, maybe, as a little bit different emphasis, maybe a higher amount that we're placing on the cremation garden this year versus past years.

Robert Willoughby

But the $5 million, is it -- it sounds like, then, it's kind of ratable over the course of the year.

Thomas Kitchen

I would say that, that, for half and any other specific guidance, would be a good assumption.


[Operator Instructions] We'll go to A.J. Rice with Susquehanna Financial Group.

Albert Rice - Susquehanna Financial Group, LLLP

A couple of questions, if I could ask. First of all, you mentioned, obviously, the priority on the share buyback, but also that you would -- are open and looking at acquisitions. Can you give us a little bit more on the state of play and what's out there? I know there's been a couple of deals announced, net in sight [ph], for example, do you guys look at that? And also, just any other color you can provide.

Thomas Kitchen

Yes. AJ, first of all, we really can't comment specifically on anything we look at and whether we take a pass on it or not. So that's something that we're really unable to comment on. With regard to acquisitions, we've got a full pipeline in terms of leads that we are currently evaluating. We did do a small -- relatively small transaction the first half of -- in the first quarter of fiscal year 2011. And we've got one in particular. We're cautiously optimistic that we can get something done shortly for us, it would be a nice combination operation. So I can't say much more than that, but that's among other potential opportunities that we might have with regard to acquisitions. So for every one we do, we may be looking at anywhere from 10 to 20, and we're very disciplined about making sure that any acquisition fits the criteria that we've set out. And just to reiterate the criteria: We are looking for Stewart type of businesses, which means that we would prefer a combination operation in markets where we currently have a presence, and we would like larger rather than smaller operations. So using that criteria has certainly helped us become very disciplined about the types of businesses that we'd even consider, much less, purchase. So that is -- and also too, we want to make sure that the financial returns -- that we remain disciplined, that the economics of any acquisition are going to fit within the overall parameters that we set. We would like to see something that from -- in terms of an acquisition, in terms of an EBITDA multiple of less than 9x. But after we do the acquisition and post-acquisition and after consideration of the synergies, we'd be in the 6x to 8x.

Albert Rice - Susquehanna Financial Group, LLLP

Okay. I guess, just, I'm trying to figure out -- because there's, obviously, renewed talk of activity, but there haven't actually been that many deals by any of the consolidators, there's been a few. Is -- would you say that, relative to where we were a year ago, 6 months ago, are there more discussions behind the scenes? Or is it pretty steady, the number of discussions? How would you characterize it?

Thomas Kitchen

I believe there are more discussions. So that's for us, our company. We've also, internally, dedicated more resources to pursuing these types of transactions, so we've felt that that was a necessary step in order for us to become more engaged and, perhaps, more successful with regard to the acquisitions. We just -- we remain committed to it, but we will do it in a disciplined fashion with regard to the financial parameters that we've set out.

Albert Rice - Susquehanna Financial Group, LLLP

Okay. Obviously, we're encouraged, second quarter rebounding funeral case volumes, at-need case volumes. I guess, there seemed to be sort of a pickup in that January-February timeframe, and we're trying to figure out whether that was just some kind of an anomaly or whether there's any kind of consistency that's going to persist here. I don't know whether there's any point in looking intra-quarter, at the monthly variation. Is there anything you can draw from that that gives you more comfort? That maybe the turn here is, at least a stabilization, a modest improvement might be more persistent?

Thomas Kitchen

A.J., our experience with this is that the months can bounce around a little bit, and so you may have one month up shortly, another month off a little bit. And on balance, I think a quarter is a better, more relevant time period to look at and try to evaluate, directionally, where we think things are going. After the close in April, we’re putting together May, so we don't have final numbers, but on a preliminary basis, based on the daily metrics that we track, it appears that May of 2011 is in line with the 2010 May. So at this point in time, it -- we've got June and July left for the rest of the quarter, and our expectations is that, based on the initiatives that we're pursuing with regard to the advertising approach, the community outreach approach, the training that we're doing with regard to the funeral arrangers and sales training, that we're confident that we should be able to hold our market share and expand on our market share.

Albert Rice - Susquehanna Financial Group, LLLP

Okay. Then maybe I’ll just slip in one last one. You highlight, in the Cemetery business, particular, a decrease in construction. And I know you already commented in the prepared remarks about the reduction in the interest rate and the effect that had on the installment sales. Can you just give us a little more color about, maybe, the rationale for reducing the interest rate on the installment sales? And then also, what exactly was happening in the decrease in construction? I mean, those are small numbers, but I guess, if they persist, we – I’d love to know.

Lewis Derbes

A.J., this is Lew. As it relates to the interest rates, I mean, certainly, we assess the overall market environment and what interest rates are doing. Certainly, you -- almost anything you can buy nowadays, you can get for a very low interest rate. What we did is we put in some promotional programs that were really designed to capture a couple of items. First, it was designated for new property owners, okay? And the target there is to develop a relationship and build heritage with a new family. So the promotional programs were targeted at new property owners only, with a much larger down payment. And the reason for the much larger down payment, really, kind of backed into -- we wanted to make sure we're getting a higher-quality sale associated with the promotional program. And so when we get those larger down payments, our history and track record has indicated that they are much more likely to stick if somebody has that much put down as it relates to a down payment, it's something that's very difficult for them to walk away from. So the reduced -- the reduction was really associated with some promotional programs that we're looking at, developing relationships with new families and making sure that those were high-quality sales.

Albert Rice - Susquehanna Financial Group, LLLP

So is that temporary promotional program, or something that's going to be sort of ongoing?

Lewis Derbes

That promotion currently is not in place. Now I can't -- certainly, things change from time to time. We run different promotions, but this was a significant one that impacted the performance. I don't think it was significant. It was only $300,000, as we mentioned previously, but that program is not in place right now.

Albert Rice - Susquehanna Financial Group, LLLP

All right, and then the decrease in construction, just real quick?

Thomas Kitchen

A.J., we've got a revenue recognition that depends on construction in certain cemetery projects such as community [indiscernible] and so forth. And that, from period to period, could be down. We have a pipeline. The pipeline might not be as full as it was a year ago, but nevertheless, that going forward, these things are -- they could cause revenue to be a little lumpy in terms of when we complete those and bring them into revenue recognition. So that historically had been the case, and we have not seen any -- other than this period, we have not seen a drop-off significantly in the quarter.


[Operator Instructions] And there are no further questions at this time. I'll turn the conference back over to Mr. Kitchen for any closing or additional comments.

Thomas Kitchen

Well, thank you very much. And we'd like to thank all of you for joining us today, and we appreciate your interest and continued support of Stewart Enterprises. Thank you very much.


Ladies and gentlemen, that does conclude today's conference. Thank you for joining.

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