StoneMor Partners' CEO Discusses Q2 2012 Results - Earnings Call Transcript

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 |  About: StoneMor Partners L.P. (STON)
by: SA Transcripts

StoneMor Partners (NYSE:STON)

Q2 2012 Earnings Call

August 7, 2012 11:00 AM ET

Executives

John McNamara – Director, IR

Larry Miller – President and CEO

Tim Yost – CFO

Analysts

Colin Stewart

Robert Carlson

Nick Jensen

Chris Bailey

Operator

Welcome to the StoneMor Second Quarter’s Earnings Call. (Operator Instructions). I would now like to turn the conference over to John McNamara, Director of Investor Relations. Please go ahead, sir.

John McNamara

Good morning. Thank you for joining us today. Before we begin please take note that statements made in this conference call and in our public filings, releases in our websites which are not historical facts, maybe forward-looking statements that involve risks and uncertainties and are subject to change at any time. We caution investors at any forward-looking statements made by us are not guarantees of future performance. We disclaim any obligation to update any such factors or to announce to publically the results of any revisions to any of the forward-looking statements to reflect future events or developments. Furthermore, given the provisions of the SECs Regulation G which as you know limits our ability to provide non-GAAP financial information. We are only going to discuss non-GAAP financial information which is provided in the earnings release, leases and is therefore reconciled to comparable GAAP financial information.

The full earnings release can be found on our website at www.stonemor.com and I would now like to turn the call over to Larry Miller. Go ahead Larry.

Larry Miller

Thanks John and thank you for joining us for our second quarter earnings call. Normally at this time I kind of take you through the highlights of the quarter and you can see that we had a real solid quarter but given the kind of recent activity in our stock. We thought it might be better if I try to take behind the scenes a little bit and expand on some of our public information kind of help you better understand the company and see the company through our eyes because obviously we are very happy with the quarter and then when I am finished Tim, our CFO will take you through some of the actual details for the quarter. So one of the topics you want to talk about is operations and as we also remind you we report our production based revenues because it's representative of the current sales and operating performance of the company. And because it's certain revenue recognition policies which cemeteries must follow.

During the periods of growth significant portions of our GAAP revenues are deferred and if you look at our balance sheet you will see that number is almost $400 million, that’s future earnings that will commence at a company.

But many of the current operating expenses are charged to our P&L, so what happens is you get a skewed view of the realized earnings during the period. For us here we manage the company on the production base methodology and we can see the profits, the trends and make sure that company is doing everything it's supposed to be doing.

But unfortunately it kind of into it, just think about it we are making acquisitions, we are growing these new sales but a substantial portion of those sales are deferred. They go on to balance sheet but many of the cost associated with those acquisitions go on the P&L and that I think is one of the more confusing things about the company.

If we start growing the company which from a business perspective is not that’s for all of our stakeholders but if we did start growing the company what you would see is we would start to realize those revenues and earnings that are buried in the no pun intended in the deferred revenue and we will not be charging in the cost associated with those revenues because we had previously charged them in when we made the initial acquisitions.

So that point in time what you would see is a substantial build in GAAP earnings and that number would come much closer to what we call the accrual or the production based earnings. To help clarify that I would encourage you to review the M&D in our public documents because I think you will see that this will help better explain the relationship between the production base and the GAAP based revenue recognition. And further more when MLP and obviously cash is something that’s very critical if we stop making acquisitions, our analysis indicates that our operating cash would continue to grow well into the future. As a matter of fact it's projected to cover our dividend distribution beginning in 2014 and that’s operating cash that I know many of you like to look at, we give you a lot more information when we do adjusted operating and distributable cash but just looking with that acquisition and if you think about it, it makes sense because what would happen at that point is we would be withdrawing more cash out of the trust funds than what we were putting in, new money going in and we would also be collecting in more receivables than what we were adding because we were not doing any of the acquisitions.

It would be good from an optic perspective but the company would have stopped growing and that’s not something that’s consistent with our business model. Just to our balance sheet and liquidity, we have a very strong balance sheet and as we provided in a recent press release our cash is held in our merchandise trust and our accounts receivable, all of which ultimate flows to the company, a 100% of that merchandise trust fund belongs to the company and obviously so do the accounts receivable.

As we indicated just to kind of give you an example of what would happen if we service every liability that we had today, right now we went out and we bought all the merchandise and delivered all the services. What would happen is we would collect in our accounts receivable, we would collect a 100% of that trust fund, pay-off our liabilities, we are also adding paying off our accounts payable and 100% of our debt and what would the company look like at that point, what would our balance sheet look-alike. Well you would have over a $128 million of cash, our cash, our money sitting there which right now would cover about 2.5 years of the distribution.

We have $250 million in the perpetual care trust that we are the income beneficiary in perpetuity, we would have almost 13,000 acres of land, 272 cemeteries and 76 funeral homes all of which are free of debt. So we would have 350 profit centers, no debt and still have all that cash on our balance sheet and earnings from the trust fund. So and if you remember I think you might have heard us say this before, even if stop growing at our current rate of sales we have enough inventory or property to exceed 200 years of sales life. So again if we sat here and did absolutely nothing and made no additional acquisitions, we would be able to sustain our current sales rate which then should suggest that we would be able to maintain the distribution just from those operations.

Speaking about acquisitions, our acquisitions have been very profitable and the results consistent with our expectations. Since our inception, we have significantly increased our asset base and earning power without a significant increase in our debt and presently we have adequately put liquidity under our bank agreements. As a matter of fact, our assets since inception have grown from $627 million to $1.3 billion and our debt has only increased from a $103 million to $214 million.

Last week we announced that we closed 8 funeral homes, four cemeteries and two cremation facilities for a total package price of $25 million comprised of cash, equity and non-compete things. Family members will remain with the company and not only are the assets important and it really was one of the more attractive acquisition opportunities in the United States but having the family members key family members stay home with us, it is going to provide tremendous benefits to the company.

Nancy Lohman, who will be heading up our Florida operations is the President-Elect for the National Cemetery Association and for the next two years she will be a great ambassador for StoneMor and exposed us to many acquisition opportunities. Also introduced to some sure to lot of quality people.

Lohman, is President-Elect of the Florida Cemetery Association which should have the same benefits on a more local level than national but (inaudible) will be spending a lot of time representing the company and representing his business throughout the State of Florida. We are very pleased to have them join our firm. We do appreciate the complexity of our accounting and we will continue to try and provide more information, we will try to put more information on our website to try and get people an opportunity to better understand the company and to bridge that gap between what we report publically and what we are actually doing to enhance the shareholder value.

And with that I am going to turn it over to Tim to actually take you through the quarter.

Tim Yost

Thanks Larry. As you said overall we are very pleased with our quarterly results, the acquisitions that we made in late 2011 began contributing in earnest to our results for the quarter. We had increases in both GAAP and production based revenue, adjusted operating profit, cash flow from operations and distributable free cash flow. Our production based revenues increased by 8% from the same quarter of last year.

While all components of production based revenue increased with the exception of at-need contracts written we had an significant increase in the income generated from our trust funds. Additionally, three new contracts pre-need contracts written increased for the quarter by approximately 3%.

The slight decline in at-need revenue is primarily due to the declining number of debts that we have experienced in the market and others in our industry have reported been seeing the same, so our results are consistent with theirs. Our at-need business tends to drive our pre-need business so we are encouraged by the fact that even though our at-need business was slightly down for the quarter we still had strong pre-need results.

Based on the increase in contribution of our acquired locations, the greater portion of our production based revenues were deferred during the quarter. To recall Larry referenced the deferral to the balance-sheet of our current earnings. During the quarter, more was deferred because of the new acquisitions. So while our production based revenues increased by 8%, our GAAP recognized revenues increased by a more modest of 2.3%.

And due to significant increase in production based revenue, our adjusted operating profit increased by 19.2% when you compare it to the same quarter of last year. So they are very strong contributions from our new locations like to hire revenues and strong adjusted operating profits. So the two primary reasons for the increase is for us the trust income which has no associated variable expenses comprised 13.9% of our production based revenues during the second quarter 2012 but only accounted for 10% of our second quarter 2011 results.

If you recall the opposite was true last quarter and we made similar remark. We also mentioned last quarter that we are still in the process of integrating the cemeteries and funeral homes that we acquired in late 2011. While the results were tampered in the first quarter as expected we begun to reap the benefits of these locations during the second quarter.

We are encouraged by the continued increase in our performance in spite the small decline in the debt rate and a challenging economic environment. Our strong results also lead to significant increases in cash flow. Our cash flow provided by operations increased by $9.8 million when compared to the same quarter of last year.

This increase translated to a 13% increase in distributable free cash flow which was 13.3 million for the quarter. For the quarter our distributable free cash flow exceeded our distributions by 13%. Additionally, our backlog at the end of the quarter which was 396.5 million which represents a $10 million increase over the previous quarter.

The buildup and the backlog relates primarily to business generated our newly acquired properties and will be reflected in GAAP revenues as we deliver the underlying merchandise and services in the future. It's important that Larry mentioned when he was talking about to refer our D&A section of our 10Q. We have spent an exhaust amount of time explaining production based revenues, explaining how they relate to GAAP revenues, explaining how the deferrals work and commenting on the fluctuation in each of those by segment for the company as a total. So it's really worth reading and looking into if you want some more information.

One of the thing I want to mention and Larry also mentioned is that we completed the acquisition of the loan properties after the end of the quarter. We continue to see many other acquisition opportunities as well. We are really pleased that we are able to enter the Florida market with premier properties and bring these top notch operators on board. So in summary, it's a good solid quarter and highlighted by continuing growth in revenues, adjusted operating profit and distributable free cash flow and with that operator we would like to open it up for questions.

Question-and-Answer Session

(Operator Instructions). Our first question comes from the line of Colin Stewart (ph). Please proceed with your question.

Colin Stewart

I am not that familiar with StoneMor but we do invest, our firm invest really, has been investors for a long time in the funeral and cemetery business and I guess I am just trying to understand how to look at your company relative to some of the other large business in the industry and my specific question is related to the adjustment from GAAP to operating profit to adjusted operating profit and I guess how we should really think about that. If I look at the adjustment that you made this quarter, it appears that that deferred revenue that you're adding back into the adjustment is being added at about 76% EBITDA margin. Am I thinking about that correctly?

Larry Miller

That would make sense based on the direct variable cost related to that. Yes.

Colin Stewart

And so far, and tell me if I am incorrect in this assumption, but I imagine you must have future G&A and corporate overhead or other fixed costs that must be associated with bringing on those new customers that you at some point have to account for in the future. Is that correct?

Larry Miller

That's sort of exactly the message, I am glad you asked the question. The difficult part for us is that we're deferring high margin items and still continuing to operate the locations and it's not a cash, it's an accounting thing. We're operating the properties, we have ongoing location G&A. we have ongoing selling expenses that are not directly related to the sale. We have ongoing maintenance expenses. Those will not increase over time other than through inflation. They are what they are. So none of those costs are deferred on the balance sheet and that's what makes it very difficult to understand the profitability of our company, the growth scenario.

Colin Stewart

If you're drilling your business and you're going to have more customers in the future than you are today, but the adjustment you're making accounts only for, it adds back all of the revenue but only the variable cost, doesn’t that sort of mean that adjusted operating profits are overstated. Or because it's not accounting to that additional G&A?

Larry Miller

No there is no additional G&A. The G&A that you're referring to is already in the financial statements.

Colin Stewart

So if your business is bigger 10 years from now or five years from now you're saying your G&A is going to be exactly the same as it is today?

Larry Miller

If our business is bigger in that we've grown more locations, our G&A will increase but so will the amount of the revenue that we generate from those locations.

Colin Stewart

But it won't increase because you've got more customers due to same locations.

Larry Miller

I mean generally not. Once those cemeteries become mature from a pre-sell perspective which takes three to four years and this is not sort of a new conversation that we've had. We anticipate that the cemeteries will grow at a 3% area along with inflation. So I guess I'm just thinking about another way.

Colin Stewart

I mean if look at your adjusted operating profit for EBITDA margin this quarter, it would have been about 16.6% and if I add back the G&A to tread back in to what a gross margin would be, I get to about 26% gross margin on your business on an adjusted basis. So when I compare that to a service or a Stewart, for example, who have much bigger companies and presumably have more operating leverage and are spreading their fixed castle for a greater base, their gross margins on the cemetery businesses are 600-700 to a 1,000 basis points below yours. So is there any reason with the structure of your business that your cemetery gross margin will be so much higher?

Larry Miller

One of the things and I don't mean to speak for either SCI or Stewart, both great companies. But we put a much higher concentration of our effort into the premium sales. I believe that could potentially account for, are bringing sales people 100% commission and they are paid for their results. I don't by any means believe that we have any efficiencies or communist scale that they don't have.

Colin Stewart

It just seems like a big. I would have actually, I don't really know your company that well but, looking at from afar, and just getting to know of it, that I would have assumed your gross margins might be at or actually lower than the competitors. And I guess my last question just as it relates to your distribution, you've guys had a consistent history of paying your distribution but if we just look at investors, just looks at your cash flow statement, and I look at your year-to-date, your free cash flow, it's been over $12 million in the first six months of the year but you paid out $23 million in distribution. I do understand that if you had slowed the growth in the business that the cash flow would go up, but presumably that's not something you sound like you want to do. So, I guess my question is if you didn’t have access to capital markets, how would finance your distribution?

Larry Miller

Well there's two things, number one, let me just go back to the cash flow question first. The one thing that is difficult from a theory standpoint and our financial statements is that when you look at operating cash flow, one of the components is a use of cash for merchandise trust, okay. Essentially the cash that we collect from our customers, we put it in a separate trust account or bank account controlled by us, owned by us, but that appears on our cash flow statement as a use of cash. The money that we collect. So the cash inflows that we collected from our customers, some of it went from one bank account to another. So you absolutely have to add that back when you consider how much we generated in cash flow.

Colin Stewart

But all the other companies in the industry don't add that back?

Larry Miller

Because they aren't the net contributors to the trust. The one differentiation you have to make is that StoneMor is different and unique compared to SCI and Carriage in that we are primarily a cemetery company where we have four cemeteries for every funeral home we have and they are primarily funeral home companies. They are both different businesses with different accounting and it's sort of well worth that conversation and if you'd like to have it, you can give me a call in my office at any time.

Colin Stewart

But I always understood to the extent that those companies are growing their pre-need businesses which I know they, and I understand they have more funeral but Stewart for example has a fairly sizeable cemetery business that they actually if you look at their cash flow statement, I mean not to the degree that your businesses perhaps, but in many instances, many quarters or periods of time, their pre-need business has been a drag on cash flow, not a net contributor for the same reasons that yours is, so when they do their free cash flow calculation, they don't adjust out that money they are putting into the truck.

Larry Miller

I can't necessarily account for why Stewart doesn’t do what they do.

Colin Stewart

But it's still back to my initial question. If I look again in your cash flow statement, I understand you have to put those in the truck and you can't keep your hands on that even though down the road that money will belong to the company but in the near term you're having to use your back loans to basically finance the distribution and I guess my questions is, how long can you continue to do that?

Larry Miller

Again, our business model has always been to consider how we finance the company and we can continue to do it as long as we work with the banks. And Colin I think it's important to understand that we control the growth of the company. We control the growth of the pre-need sales. I mean it's not just simply a question of acquisitions. We can do what the other public companies did back in 2009 I guess, when the world was crashing around us. They cut down dramatically once their other than lock sales, the ground sales. [Multiple Speakers]. So they stopped aggressively marketing false markers opening and closing caskets and things like that. We have it, but we could do that. We could back down our pre-need sales and turn the company into essentially a cash machine.

Colin Stewart

Just so I understand, if you did that, your GAAP operating profit would go up and your cash flow would go up, correct?

Larry Miller

That's correct. [Multiple Speakers].

Colin Stewart

Would your adjusted operating profit go down in an instant?

Larry Miller

Now we're really starting to get into just too much detail. We appreciate…

Operator

Our next question comes from the line of Robert Carlson (ph). Please proceed with your question.

Robert Carlson

Yes, right about a litigation about one of the modules we had that was broken into? Has that been resolved with a recharge (inaudible)?

Larry Miller

No, you're breaking up a little bit Robert. No, I think I know the one you're talking about. We've actually been working with the family to try and resolve it’s a real tragedy but at this point, we're just doing everything we can to assist the family through a very, very difficult time. But there has been no resolution yet.

Operator

(Operator Instructions). Our next question comes from the line Nick Jensen (ph). Please proceed with your question.

Nick Jensen

I think last quarter you talked about your targets for this year was about 20 million kind of being drawed on the working capital line. Is that still the anticipation for this year even though that you've done a bay acquisition or should we think about that as a moving target now that you've completed the (inaudible) deal earlier this week or last month?

Larry Miller

Make it full. The $20 million that we're talking about is borrowings, working capital. We got acquisitions. So if you look at what we did in the first six months, we are on target to buy our $20 as the year when according to our plan. Obviously acquisitions are a different type of borrowing.

Nick Jensen

Okay and then should we think about how much can you maybe provide some specifics on how much you paid in terms of off your facility for the acquisition and kind of revenue slash/production based revenue accrual EBITDA acquired for the deal?

Tim Yost

That starts to run a 1,000 regulation G stuff that we can't quite get into at this moment.

Nick Jensen

In terms of just maybe the acquisition price of how much was put on the balance sheet versus how much units were offered?

Tim Yost

That we can answer

Larry Miller

Out of the 25 million of purchase price, the borrowing is closing was around 20 million and I can tell you that, even though it was a great acquisition, maybe multiple for in line with what we experienced in the past and what like to do.

Operator

Our next question comes from the line of Chris Bailey (ph). Please proceed with your question.

Chris Bailey

Just following up on cash flow, just help me get my head around this. You showed a very helpful release on July 27th, where you talked about capital sources and uses which lined up combat to 2007 and you made the adjustments for growth and receivables and merchandise trust. My question is as an investor, if I go back to 2007, so if I go from 2007 to 2011 which you have done, and I look at cash from operations cumulative being 63 million and I go back cumulatively over that same period and look at distributions paid, its 148 million. So roughly 2.4 to 1. How do I get comfort in your ability to continue to pay that distribution and would it make sense too. Because I completely there is value in 462 million of deferred revenue. Would it make sense to pay a distribution more almost like special once those receivables or trust reverse and the cash comes in the door?

Larry Miller

Two things, the one thing is, and as you said, you read our press release in which you saw the sources and uses of capital and what we use capital for, we borrowed for our build accounts receivable and we borrowed for our increase in merchandise trust. Those two items are components of operating cash flow. So those two items, again, the way we look at our business needed to be added back when you consider operating cash flow. So the difference winds back just being a timing difference. As we grow our base, the contribution of the existing commentaries will outweigh the contributions or the cash drains of the new cemeteries. That make sense?

Chris Bailey

Yes, I guess I was thinking if you used growth in receivables and growth in merchandise trust as a use of cash here, fine, no problem. Is it then double counting it consider that as part of cash from operations. If you want to use adjusted cash from operations where you add those items back to the 63 million, I understand that. But then is it necessarily use of cash. Maybe I might be missing something. I was just thinking since you accounted for as the use of cash here in this release, is it appropriate then to compare cash from operations to distributions?

Larry Miller

It's deducted from the operating cash, we finance that. That is growth. We grow in two ways. We grow not only through the acquisition of additional locations, we also grow through growth in pre-need sales. Those numbers indicated growth in pre-need sales when you are contributing the trust and your net account receivables is building. So what happens is, as we acquire these new locations, that may or not have robust or pre-need sales effort as we put into them, we have a build in pre-need sales. We know that, we model for it, that's part of our plans and part of our projections. If you want to look at borrowings for growth in merchandise trust and growth in accounts receivables, sort of came to deferred acquisition price, that's probably a fair comment , does that help at all?

Chris Bailey

Yes thank you. And my last question, just may be more for us in our street but just wanted your take on it. You have attractive dividend yield 9%, if I look at your credit which you're obligated to pay, you're not obligated to pay distributions, your debt yields, 11%, call it 10-11%, your dividend is 9%. What do you think the market is missing there or what will you tell investors what they have an opinion on that?

Larry Miller

Not positive, I understand, the question. Are you saying that the…

Chris Bailey

I am just saying when you talk, what do you think investors are missing your debt yields north of 10%, your equity yields is 9. Why do you think a part of capital structure that's senior is yielding more than your distributions in less now with your argument of growth and equity.

Larry Miller

You got to remember the two facts about the debts that's on our balance sheet, especially the public. We issued that debt in 2009. What we understand we are either the only, or one of the only first time issuers to issue debt in that market. The reason we did that was that our original line that we went public with came due in 2009. It was a five year deal, it came due in 2009. We had to go out and refinance it. We had no other choices. We saw the public debt markets and at the time, the first time issuer, smaller company in 2009 was required to pay a ton of quarter presently turn. [Multiple Speakers].

Operator

Our next question comes from the line of Joe (inaudible). Please proceed with your question.

Unidentified Analyst

I am at the office and some of the working capital borrowing questions were answered but while I have you, what is the current balance on the revolver?

Larry Miller

61 million.

Operator

(Operator Instructions). Our next question comes from the line of Greg (inaudible). Please proceed with your question.

Unidentified Analyst

I wanted to follow up on one of the previous caller's questions regarding your bond. I certainly appreciate why the coupon was, what it was when you issued the bond that's clearly what the market bared. But to the other caller's point, your bonds have traded below par for the better part of the last 12 months and are currently offered below par. So along the same line, do you look at that as buying those bonds back in the secondary market perhaps, realizing a gain on purchase as a better or equal use of capital to the dividend. Thank you.

Larry Miller

Yes Greg, right now because of the prepayment penalties and no call provisions, it's not even an option for the company. I don't have the bank agreements, I don't think we're even authorized to go ahead in to the open market and buy back the bonds under our revolver. So it is what it is. Then we get past the non-call period and depending on the economics, it certainly becomes a viable option.

One another point just to make on Greg's comment. The return (inaudible) on the acquisitions are much greater than that cost of debt anyhow. So I rather use the money that I have for acquisitions and its buyback at launch currently.

Operator

And there are no further questions at this time.

John McNamara

Okay operator, thank you very much and everybody that joined us today. Thank you. We were very proud of what we're accomplishing here and we certainly appreciate your support and please if you have a follow-up questions, we'd love to answer them and help people better understand the company. So thank you and enjoy the rest of your summer.

Operator

Ladies and gentlemen that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.

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