Executives
Thomas L. Ryan – President and Chief Executive Officer
Eric D. Tanzberger – Senior Vice President, Chief Financial Officer, and Treasurer
Analysts
Robert Willoughby – Bank of America/Merrill Lynch
Service Corporation International (SCI) Bank of America Merrill Lynch Health Care Conference Call May 15, 2012 8:00 PM ET
[Call Starts Abruptly]
The leading death care services provider. We toured its flagship property here in Las Vegas yesterday and are impressed. They just bought the dominant provider in this market positioned to grow ahead of the market in the coming years. Here to present for the Company is Tom Ryan. He is President and Chief Executive Officer. He is joined on the podium by Eric Tanzberger who is the Chief Financial Officer.
Thomas L. Ryan
Thank you, Bob, and thank you Bank of America for inviting us back again this year. For those of you listening on the call, we’ll direct you to the appropriate slides. I’ll take you straight to slide four. SCI at a glance. This just gives you an idea of the industry itself and kind of our position in the industry. We are the largest, as Bob mentioned, in North America in the funeral and cemetery business. We’ve got just over 1800 locations and from a market cap perspective are just about $2.5 billion.
Translated into revenues, you can see we’re about a 13% share as we can define it in North America, which is about $2.3 billion in revenue. One of the attributes about this industry that I think is compiling is the predictability of it. And one of the reasons it’s predictable is our ability to deferred revenues. These are very sales oriented organizations in our industry and we now approach $7 billion in backlog, and this represents just over three times our annual revenues. So again a predictable revenue stream, very predictable cash flow stream, and these are primarily supported by cash in state regulated trust funds that we have management oversight for.
We outsource that function to professionals, but they again have ultimate oversight over the direction of those funds. Or we fund those through third party life insurance policies, which again we would be the ultimate beneficiary of that have some component of growth and have a component of G&A revenues that can help defray the cost of growing that backlog.
So again the business is very cash flow friendly and you can see from our perspective, last year we generated $279 million in free cash flow. And our free cash flow per share has grown compounded more than 10% since 2004; we really implemented our new strategy. And we anticipate that this year the mid-point of the range will be about $300 million, and you can see we have a guidance range of $270 million to $330 million.
And it’s very important, I think, in a slow growth industry that you deploy this cash as best you can with the highest returns, and we do that through a blended approach of acquisition, share repurchase, a growing dividend and again kind of minding that debt maturity schedule to ensure that the appropriate risk is associated with reward. And all in, when you take all those things into consideration, it’s our belief that we’re poised to benefit from the aging of America and we’re beginning to see that through our pre-need efforts, and I’ve got a slide that I’ll show you that here in a minute.
So this here is the death care industry and landscape, and this just shows you some of the other public competitors and the relative size. And keep in mind these five companies together still represent less than 20% of an industry, so still very, very fragmented with room to grow. But you can see on a revenue basis, again, we’re $2.3 billion and on a property basis it all looks very relative in size. And I think the key component is to show you the free cash flow in the lower left hand corner.
And again if you look at this, what it tells me, and you have some slight accounting differences in models, MLPs, and things and the like, but if you boil it all down, I think it shows you that scale works in this industry. If you look at us and you look at Stewart, you can see a much higher cash flow, free cash flow generated per revenue dollar. And so we think that that can continue to go. Scale is a good thing in this industry, and we’ll continue to exploit it going forward on a cost basis. And I really think we’re at the forefront of beginning to exploit that on a revenue basis long-term. And again the total pre-need backlog, you can look to the far right and see again the predictability of the industry, and particularly as it relates to us.
Our competitive strengths, again, are our unparalleled network. We’re in 44 states, 43 states, eight Canadian provinces, and you can see the blend of business is just over 14,000 funeral homes and approaching 400 cemeteries. One of the things we launched, I guess now it’s been probably close to ten years is our Dignity Memorial brand, and the concept here long-term it’s our belief that the familiarity of this brand and what stands behind it will begin to bear fruit, like many other industries that the baby boomers transformed, the mom-and-pop grocery store, the mom-and-pop Home Depot.
You can see that a lot of other industries have been transformed by a brand that stood for value. And so it’s our belief that well there is a very sensitive issue and over time we’ll continue to have the local brand name, that Dignity particularly on a pre-need basis and carry some weight over long periods of time. And we’re getting a lot of internal benefits today. The other advantage, I think is our ability to leverage scale in this industry. And I think we’ve done a good job of beginning to leverage that scale, particularly on a local basis as it relates to personnel, vehicles and other resources, and a lot of this is perfected and fine tuned through strategic modeling and sharing of data across the network. We centralize and outsource our operating and accounting functions. A lot of what we do today is done overseas, particularly in India.
We have tremendous purchasing power, and again try to leverage that more and more. We've obviously done a good job with the big items, but there is more to go and believe that we can do more here in 2012 and 2013. And lastly, the pre-need sales opportunity, the transferability, the name recognition of Dignity. A lot of the things that we can exploit as it relates to growing that brand and growing our pre-need business. And we couldn’t do it without an ability to distribute strategy.
And we created Dignity University, which is a virtual University that opened the stores in 2004. So with over 21,000 employees, you can appreciate the fact that we have to have a platform to launch that strategy and the appropriate controls and systems that go along with it. So it’s our ability now to take something from concept and distribute it throughout the network, and the timing on that’s dramatically changed over the last few years.
This gives you a pictorial of our geographic footprint on page seven. And you can see the numbers of markets that we're in, and again you can get an idea of the concentration of the population in the United States. I will tell you this doesn't give you an idea of the relative size of what we perform. Our biggest markets, as you would expect are California, Texas, and Florida. We have, again, a big concentration, as you can see on the East Coast as well. In the newer markets that we've entered in Nevada, being Arizona, being Tennessee, and North Carolina, we've seen a lot of growth in those areas. And again, where are people going to retire? Where are people going to spend those years in life that they're going make this decision and we believe we are poised to benefit significantly when that business begins to come and we’re seeing it on the pre-need side today.
As far as financial results, in 2011 you can see from slide eight here that our 2011 results reached the high end of our guidance both in cash flow and normalized earnings per share. You can see the red bar that we generated $0.65 in 2011, which was a nice improvement over 2010 and on cash flow basis $279 million.
Our guidance for 2012 again I think tells you the strength and stability of our business model. Our guidance, mid-point of $0.70, you can see the range there $0.66 to $0.74 and the free cash flow mid-point is $300 million. So we feel very comfortable about this guidance and you can probably see why by our start in 2012. In the first quarter, we generated $0.20 in earnings per share compared to $0.17 quarter in 2011. The consensus out there is $0.18, so we had some upside surprise.
When you break it down it really was an unusual quarter in the sense we did beat it by $0.03 and we did it with a decline of 4.6% in our volume. So, on the cuff that sounds great, operating improvements generated $0.001 and the reduction of shares or returning of capital through share repurchase combined with a foreign currency gain generated another $0.02. And that was offset partially by a not-so-good tax rate. So you look at it and say well okay, that’s not so exciting. But we are pretty excited in the sense that our cemetery production grew at double digits in the second quarter, and we hung up a lot of that on the balance sheet.
About $10 million was deferred as we sold unconstructed property to the tune of about $8.5 million over the prior year quarter, and that will get built throughout this year. So again, we recognize the selling cost from the first quarter and so you get the benefit of the revenues without a selling cost once those projects get constructed. And we had a little issue as it relates to merchandize delivery as well, because of some supplier issues, which are being resolved. So again, bodes well for cemetery profits and earnings per share growth in the back half of the year.
So a very good quarter operationally, which is a little confusing on the surface. So the key business drivers that we talk about that are generating the results and what gives us the confidence to continue to deliver those results are as follows.
Cemetery pre-need sales production, and you can see here quarter-by-quarter. And if you start in 2009, you can see the fear factor of the global financial crisis in the first part of the year, and then really pre-need taking a hold again. People setting aside and saying let's do some planning. And this is where really our training and development and utilization of lead management systems and growing our sales force and investing in it has really begun to pay off, because think about the age of these folks.
These are the baby boomers. They're ready to be sold to. And you can see it by the red bar over the last few years we grew 7% on a comp basis on cemetery pre-need sales, this is all in, 6% during 2010. And in 2011, we grew 12.3% so this is a sustainable growth model we believe through better lead management more leads, and actually more bodies. We’ve got a growing sales force particularly on our community service side, which think of as outside sales.
As you can see in the first quarter of 2012 that trend continued with a 14% growth rate understanding what I told you before that the GAAP earnings only grew about 8 because of the deferral. But again, bodes well for future and again we think we can continue this in the high single digit numbers as we press forward in the coming years.
Pre-need funeral sales are just as important. They don’t show up through your GAAP statement they grow your backlog, but again you can see the success that we’ve experienced here.
If you look at the red bar again, we’ve got a 3% growth in 2009, followed by an 8% growth and another 7% growth on a comparable store basis, had a great first quarter of 2012 out the gate, now a sustainable 17%, but its our expectation that for the year that we should be generating in the mid-single digit and because of the first quarter maybe even pushing to the higher single digit growth. So again this is growing the backlog, which is very, very important, its not generating GAAP earnings today. I will show you the other thing that’s exciting about the feature on the next slide.
So you think about the future and what’s happening today, look at the red bar and the matured pre-need that is the pre-need going atneed today. And as you can see it's been moving up over time because of trust earnings, but today that red bar significantly below the green bar, which is the walk-in business today.
And now look at the blue dotted bar and that gives you an idea of what we’re putting into the backlog. So what’s coming out of the red bar, what’s going in the blue bar and there is a lot more business going in the blue bar. So as you think about the growth of the pre-need what’s coming out of the backlog, and how it's going to impact revenues and cash flow? We believe it’s going to affect it in a very positive way as you look at this graph.
And here, again, this is a busy slide, but take a look at it for a minute. The bar graph shows you the comparable volume on a comp-store basis, and again you can see 2009 was a disaster year, 6.7% down in senior volume and if we don’t anticipate seeing another year like that, but you can see the last two years been more within our guidance range.
It’s our belief that right now we are in a period of down 1% to 2% type of comp volume and that’s how we experienced in 2010, we’ve experienced in 2011. And you can see the first quarter was even a bit more of a challenge. But as you look at the lines above that, these represent that our average revenue per case, and the green line is the averages reported, so it would have Canadian currency issues in there and trust income, whereas the yellow line is truly what our customer spending and as you can see 2009 and 2010 were challenging, I mean these were times of great difficulty for the customer base because of unemployment, uncertainty, and particularly for the elderly, I think if you look at interest rates, CDs are paying less than 1%.
That is having an impact on our consumer, so we had to do something and if you look at what’s happening in 2011 and 2012 we’re beginning to move that number up, and you say yourself, how is that happening because it’s important particularly in a challenging funeral environment. Really three things are going on right now. One is we refreshed our Dignity packages. And remember, people tend to spend about $2500 more when they buy a package, and they're more satisfied according to our J.D. Power scores.
And what we did is we rolled out, in our Main Street locations, which were about 500 a new a more flexible package, before we had a very defined package, you couldn't have substitution. A lot of the lawyers were influencing how we did that, and most appropriately. But we stepped back for a minute, and our consumers said we want more flexibility, more choice. And so we now have a choice of different ancillary products, and you can choose from about eight. We allow substitution in the casket selection. And so that has resulted in, in those markets, taking our uptake from 30% to 33%.
Doesn't sound like a lot, but at $2,500 of funeral and a more satisfied, more loyal consumer, it's very, very effective. And it's had an impact on our overall average, without necessarily raising prices. The second thing we’ve done is the reception and event sales. And here we really took a standardized institutional approach to receptions and events. We probably had some people that were doing that on the ad-hoc basis, but we formed an opinion as a strategy and said let's begin to institute this, we are going to help people with, how they negotiate with our local vendor, what the contract looks like, what type of products and services, what about quality control, and what’s a fair margin for us and what's a fair margin to keep that caterer involved in what we're doing?
And like everything its very difficult, we get distributors training on Dignity University. And today about 50% of our locations have sold a reception or event or a catering event. And what we're finding is that in the first quarter that generates about $2.2 million, raised our average by $31 across the entire spectrum, 60 basis points. Only have our locations are participating at this point and that will go up.
On a pre-need basis we generated another $1 million. The last thing that isn't as impactful yet, but it is our e-commerce floral sales commission revenue. We've partnered with FTD, and this is a concept that goes after the friends and family. So here, if you've got Tom Ryan's obituary and you click on it, you go to our website and immediately it's going to ask you do you want to send flowers to the family? And good, better, best, select the one that you do. And again, we're not delivering flowers, we are the agent that delivers the customer, again to the floral network, so that generated about $430,000 of profit, because again we're just recognizing the commission, in the first quarter alone.
So again, we're trying to do things in a very difficult inflationary environment and a difficult volume environment to generate additional revenues, which align ourselves with our core values taking care of our client families on things, one-stop-shopping. We'll take care of your catering we'll take care of your flowers, and the rest.
With that, I'm going to turn it over to Eric, our CFO.
Eric D. Tanzberger
Thanks, Tom. On slide 17, you can see how we really market ourselves to investors, what we think is the most important metric. We've talked a lot about free cash flow per share you see in the guidance this morning, this afternoon I should say a $300 million is the midpoint.
But from a per share basis, since the beginning of 2000 we’ve really grown our free cash flow per share at about 16% from a component annual growth rate perspective, but as Tom mentioned, and you can see on this slide you see the number of properties in that single line in orange there, and at one point in time we had almost 4500 properties and as we’ve really shrunk the company and got to the operating platform that was sustainable and we could grow from, especially with Dignity University, implementing or giving us an avenue to implement strategy across our locations, that really takes you to 2004 to the 2005 timeframe and even from them with a level amount of properties around 2000 you could see that we’ve grown free cash flow per share on a compounded annual growth rate in the double-digit just over 10%.
We’re very proud of that, you see that we’ll continue our success in 2012, the mid point of our guidance of $1.36 per share is well above a $1.18 per share as well from 2011.
So what do we do in 2011 with the free cash flow generation, you could see that we produce just under $300 million of free cash flow per share, $279 million, we did drawn our revolver as well for total sources of just under $350 million and we took a pretty balanced approach in 2011.
We did just under $200 million of share repurchases, we did a good amount of acquisitions just over a $100 million of acquisitions, most notable at about $45 million was the Neptune acquisition during 2011, we paid about the same amount of that $45 million out in dividends as well as just under that debt repurchases as well as we continue to manage our debt maturity profile.
From a 2012 perspective in the first quarter our free cash flow was below prior year by about $10 million, but it was actually more than we expected about $10 million more than our expectations. We had a really good quarter from a free cash flow perspective, you can see at the bottom left of slide 19 that we paid higher cash taxes in the first quarter of 2012 of about $7.5 million and we also had higher incentive compensation payments resulting from better performance of about $10 million as well.
So that $17 million was a variable between those two and ultimately we did better than what we expected. From a deployment perspective on the right side of this slide on slide 19, you can see predominately we use the free cash flow for share repurchases that’s really more of a timing issue, more than anything else, we do had some situations under letter of intent right now from an acquisition perspective but we really didn’t close any acquisitions and we hope to change that for the remainder of 2012.
In terms of theoretically how we look at the free cash flow and deploying it as well, as I just mentioned our first choice is really through acquisitions. And we look at after tax returns and IRR that you could expect really well in excess of our weighted average cost of capital from a risk based perspective and you could really expect them to be in the low teens in terms of IRRs for us to pull the trigger and deploy the capital related to an acquisition.
Second to that absent any acquisition opportunities such as you saw in the first quarter of 2012, we will deploy capital into the share repurchases and again we look at free cash flow yield to determine how much capital we deploy in terms of the share repurchases. And then from a dividend perspective, we have a couple of metrics we look at you see on the slide on slide 20, we look at approximately, how much recurring net income should we deploy right now it is about 30%, we also look at a free cash flow metric as well from a fully tax long-term perspective in terms of form an opinion of how much to deploy per dividend.
And last week we actually had a board meeting and raised our dividend 20% from $0.05 per quarter to $0.06 per quarter, we’re very proud of that as well. And then lastly debt repurchases, think of that right now as managing our debt maturity profile but it’s a pretty good debt maturity profile that you can see on the next slide on slide 21, so we really aren’t putting a lot of capital to use on the debt maturities right now at the values of the bonds.
Our first maturity is not due until October of 2014, it’s $181 million well below our normalized free cash flow that we produced every year but we also have a long-term credit facility that you could see with over $400 million of availability which is out there until March of 2016.
From a leverage perspective, we’ve got pretty consistent leverage, we run the company, what we believe is appropriate on a net debt-to-EBITDA basis about 3 to 3.5. And you can see the last two years have been at the low end of that range, I think you’ll see continue as well. And then finally we believe SCI is a very solid long-term investment, you can see the significant but most importantly the consistent free cash flow stream that we’ve been able to produce, coupled with our strong liquidity, the financial flexibility and the favorable debt maturity profile really bodes well for us to have to deploy capital and grow the company as we go forward, with not to capital intensive differential growth strategies as well.
So with that, I think, Bob, we'll go ahead and open it up to questions.
Question-and-Answer Session
Thomas L. Ryan
Just a few to start off here, I guess if you look at the cash that you’re going to generate over the next several years not just this year but over the next few years in that demographic opportunity flows through. And we spoke yesterday about properties like the POM facility that there’s just not thousands of those out there for you to acquire, so I mean how do you realistically expect to get this amount of cash appropriately deployed without retiring your entire share base and with dividend getting back to entirely to shareholders?
Eric D. Tanzberger
Well, if we end up with one share, it'd be a pretty valuable share, Bob. No, I think you’re right. I think you've got to begin. As you get a ways out, I think that begins to become an issue because if we can grow like we think it’s going to grow.
We are going to generate bigger part of the cash. And I do think rationally it’s hard to deploy it in acquisition environment unless you want to start converting people that don’t want to be acquired, which isn’t a good thing. So I think it’s an issue that we’re studying today. I don’t think it’s an immediate issue, but again you can think about international expansion adjacent businesses, but at this point in time, we’re keenly focused on continuing to role up in an industry that we’re excited about. We think the demographics are going to shift and when they do, will be a much bigger network at that point of time.
Robert Willoughby – Bank of America/Merrill Lynch
Are there – I asked this question earlier. Are there services that you envision providing in the next five years that would require – I mean the FTD things as really require much in the capital investment if anything. And then what can you add? What could the cost you ultimately on that front?
Thomas L. Ryan
Right now, the things that we’re looking at really aren’t capital intensive. So I think the model is what you see what it is. And I think it would point towards a likely giving more back to shareholders to increasing dividends that probably more appropriately to share repurchase, again absent in a transformational type of acquisitions bid adjacent within the industry today.
Robert Willoughby – Bank of America/Merrill Lynch
And you did do a very intense survey, couple of years ago, and we’re just kind of curious why we haven’t seen more shuffling of the properties or maybe we have and it’s just not been disclosed, but there were some markets that would be more, ideal some markets that might be less ideal based on the demographic opportunity is that still?
Thomas L. Ryan
Yeah, we are using it today everyday in our markets and it really is very helpful by accounting. And so I think you’ve seen a slight shuffling at, again I think it verify the lot of things that we knew Bob. I mean if you tell somebody there is less people at Michigan today, it is not going to shock you, and we knew that before, it gives you an idea, where do you want to be situated?
Is it a buy or is it a build decision based upon that demographic. And so it has been helpful as we develop kind of our local market strategies, but it wasn’t game changing in any regard as to directionally where we are going. It just gives us a little more comfort about some of the decisions that we’re making in and quite honestly change our opinions about couple of decisions.
Robert Willoughby – Bank of America/Merrill Lynch
And we didn’t speak about to this yesterday the Neptune opportunity in this market which is such a high cremation market, can you possibly address you have one facility here I believe Neptune. What the business is like?
Thomas L. Ryan
Yeah I mean I think market-by-market it’s going to be slightly different, but the Neptune business here has been very successful. I think pretty much everywhere we’ve gone it’s done about what we expected to do. And it’s really a different customer. We’re finding that again this is the type of customer that is looking for that $600 or $700 cremation which you can make money at.
And so what this is attempting to do is a sales and marketing strategies so let’s get in front of those folks, explain to them why they need to spend a little bit more, not a lot more because it is important to them, and again pushing them up in the $1600 to $1800 range where we can make a decent margin and again serve that class family that historically we’ve been moving away from.
So this is the vehicle through which to do that. It’s not a high margin business and isn’t going to be but again it’s an important part and a growing part, not a dramatically growing part, but a growth market that we want to participate in, and again we can continue to utilize our scale to enhance the advantage.
Eric D. Tanzberger
Any other question?
Thomas L. Ryan
Nobody?
Robert Willoughby – Bank of America/Merrill Lynch
Tom, Bill, Martin? Somebody? We appreciate you guys coming today. Thank you very much
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