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Carriage Services, Inc. (NYSE:CSV)

Q2 2008 Earnings Call

August 8, 2008 10:30 am ET

Executives

Ken Dennard - Managing Director, DRG&E

Melvin C. Payne - Chairman, President and Chief Executive Officer

Billy Dixon - Chief Financial Officer and Executive Vice President

Analysts

James Clement - Sidoti & Company, LLC

Clinton D. Fendley - Davenport & Co. of Virginia, Inc.

Alan Webber - Sidoti & Company

Mike Scarangella - Merrill Lynch

Chris Sims - Shenkman Capital Management

Robert Kosowsky - OFI Institutional Asset Management

[Mark Effersade - Pimco]

Gerry Heffernan - Lord Abbett & Co.

[Mitch Almay - McAdams Company]

Operator

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Carriage Services second quarter earnings conference call. (Operator Instructions)

This conference is being recorded today, Friday, August 8, 2008, and at this time I'd like to turn the conference over to Ken Dennard of DRG&E. Please go ahead, sir.

Ken Dennard

Thanks, [Francia], and good morning, everyone. We appreciate you joining us for Carriage Services conference call to discuss second quarter 2008 results.

Before I turn the call over to management I have the normal housekeeping details to run through. If you'd like to be on the e-mail distribution list, fax list for future Carriage Services releases or if you had technical problems and didn't receive your copy yesterday afternoon, please call our offices at DRG&E and we'll be happy to assist you. That number's 713-529-6600.

Additionally, due to the fact the financial tables are very long and are wide for formatting for the wire services to have it one page or formatted correctly, we recommend that you download the *.pdf of the table that is on the Carriage website or it could be on my e-mail that I sent you yesterday.

If you'd like to listen to a replay of today's call, one will be available via webcast by going to Carriage's website at www.CarriageServices.com.

Additionally, in a few hours there will be a telephonic instant replay that'll be available 24 hours a day for the next week. The replay and access code are in the release yesterday afternoon.

Please note that information reported on this call speaks only as of today, August 8, 2008, and therefore you are advised that any time-sensitive information may not be accurate as of the time of any replay listing.

Also, as you know, certain statements made today on the conference call or elsewhere by or on behalf of the company that are not historical facts are intended to be forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Act of 1934, as amended.

These statements are based upon assumptions that the company believes are reasonable, however many factors that are discussed under forward-looking statements and cautionary statements in the company's annual report on Form 10K for the year ended December 31, 2007 and any subsequent SEC filings could cause the company's results in the future to differ materially from the forward-looking statements made today or in other documents or oral presentations made by or on behalf of the company.

A copy of the company's Form 10-K and 10-Q, news releases and other information are available for free on the Carriage Services website.

Now with that, I'd like to turn the call over to Mel Payne, Chairman and Chief Executive Officer.

Mel?

Melvin C. Payne

Thank you, Ken.

I would characterize our second quarter as the perfect storm of reported underperformance. And once again I find that perfect storms are very interesting. You don't know how bad they are until they're past, but that's my main point. This perfect storm has passed and will not be repeated.

After six straight quarters of excellent year-over-year performance, starting with the fourth quarter of 2006, we had a very weak quarter, with zero earnings per share. This underperformance was broad across our portfolio and reflected poor execution of our standards operating model in too many businesses in our portfolio, but also a difficult economic environment.

Some of the issues related to our underperformance were controllable, for example, salaries and benefits weren't managed to the actual weaker revenue, and some of the issues were not, for example, the spike in cremation rate. We are moving fast to take specific action to improve performance and have total confidence that our performance will improve sequentially in the third and fourth quarter and position 2009 for a return to positive revenue and margin trends.

Because of the weakness in the second quarter, however, we have lowered our rolling four-quarter outlook ending June 30, 2009 to reflect a reduction of $0.10 a share in the EPS range to $0.38 to $0.42 from $0.48 to $0.52 and a reduction of about $3 million in the consolidated EBITDA range to $39.5 million to $42.5 million from $43 to $45 million.

However, I want to emphasize that within the next 12 to 18 months we fully expect our performance to improve to a degree that our rolling four-quarter outlook will return to the $0.48 to $0.52 per share and the $43 to $45 million consolidated EBITDA.

Let me now walk you through some details of our trend reports to give a little more color. While I think we adequately cover the details of the quarter in the press release, what I would prefer to cover is the recent performance using the annual trend reports so that I can crystallize the path of improved performance expectations over the next 12 to 18 months much more specifically.

When looking at our annual trend - and we always show the annual trend report first in our press release and the quarterly second because only when you look at the longer-term trends can you truly understand the dynamics of our performance - if we look at same-store funeral volumes for the trailing four quarters ending June 30, 2008, our volumes are actually up almost 1%. In our business, which is a strong operating leverage business, if you have the volumes, you have something to manage, notwithstanding other issues like cremation rate and so on averages.

The same thing - that's the first increase in same-store volumes that we've had since 2004 on a trailing four-quarter basis, so we're very positive about that. And July continues to show good volume strength.

If we look at same-store funeral revenue, because of weakness in our averages and an uptick in the cremation rate, we only increased revenue 0.6%, but yet it was positive not negative. Where we have a problem in the second quarter was in our margin.

But if you look at the trailing four quarters, in same-store funeral operations we only declined 40 basis points from 38.1% to 37.7%. So if you look at how the model has been executed over the last four and a half years, we went up every year from 34.8 to 35.6 in '05 to 36.8 in '06 to 38.1 in '07 and we dipped down 40 basis points only notwithstanding a very weak second quarter.

The reason for that is we outperformed in the first quarter. Our same-store field EBITDA margin in the first quarter was 42.5%. That is not a sustainable margin. We never had a margin that high before. It was almost too good to be true and is now followed by a very weak quarter that will also be too bad to be true in the next quarter and the next quarter.

So you have to look at the longer-term trends. We do not have fundamental problems in our funeral home portfolio. Let me make it straight - we do not have fundamental problems. We have selected location issues. We do have some issues related to the mix, and we're working on how to improve our averages. But that is something we can control and will control and have actions to do so.

Where we have - on the same-store cemetery, our volume decline for the four quarters ending June 30 was only 0.7%. So we're pretty flat on internments, same-store internments. That's the first time we've had flat internments for awhile. We've had fairly serious declines in '07, in '05, and we're pleased that we have flat internments.

Where we had a problem with our same-store cemetery is on revenue and primarily that was related to same-store pre-need property sales. We had weak performance in the first quarter. I covered that in some detail. I can tell you that the weakness has continued in the second quarter, but I'm already seeing life in the top seven or eight cemeteries. We made a lot of progress with sales leadership, building sales teams. Between now and the end of the year I expect to see that continue to improve so that we head into 2009 with our larger cemeteries fully staffed with sales leadership and teams and product so that 2009 ought to look materially different than 2008.

At what point we return to the level of 2007, I don't know. But I do think we will reach that level some time on an annualized basis in 2009.

The acquisitions are not as integrated as we would have liked at this point, but I want to point out that our acquisition revenue for the trailing four quarters of $22.7 million will increase once we have owned these properties for a full year. We did make some acquisitions in the second half of last year that's not reflected.

I would expect annualized acquisition revenues of what we own today to be in the $26 to $27 million range, and I would expect the margin, the field EBITDA margin of the acquired revenue to get up to 36%, which is about what our same-store field EBITDA margin is today, even with the second quarter performance. And I would expect that to happen over the next 6 to 12 months.

The other issue that hurt us in the second quarter is continuing litigation expense on three or four cases that we do expect to be resolved in the next 12 months, plus we had separation expense on Joe Saporito.

Now if I walk you down to the bottom, the trailing four quarters, we earned $0.30 a share compared to $0.38 for all of '07. If you'll look at where we really got hurt, it's not that complicated. We did not get hurt materially on same-store funeral performance, comparing the trailing four quarters to 2007. We only dropped about 200-something thousand in field EBITDA, which is about a half a penny a share. We do not have a problem in our same-store funeral home operations that won't be repaired within the next six months.

Where we really had a problem and lost EPS was on the same-store cemetery performance, where we dropped about $0.09 a share looking at the trailing four quarters compared to 2007.

As I said earlier, we're making a lot of progress. We do expect to return to the 2007 level of performance some time in 2009. We will pick up that $0.09 on an annualized basis at that point.

On the acquisitions, if you look at $26, $27 annualized revenue and bring the margin up to 36% equal to our same-store portfolio, we will pick up another $0.06 per share. And if you eliminate the litigation expense, which will be non-recurring when we settle these cases and eliminate the overhead related to Joe's separation, you pick up another $0.05 a share.

So down at the bottom where you have $0.30 a share for the trailing four quarters and pick up $0.09 on the cemetery, $0.06 on the acquisition portfolio and $0.05 on variable overhead, you are now adding $0.20 to the $0.30 and you're in the midrange of what we believe is the sustainable earning power of our existing portfolio of operating assets. This is not shooting the moon. This is real, and we will do it.

At this point I'd like to introduce Billy Dixon. Billy joined our company about a month ago and he is already making a difference, so I'll turn the call over to Billy to make some remarks.

Billy?

Billy Dixon

Thanks, Mel.

I am very excited to be part of the Carriage team. The reason I joined Carriage is because I was very impressed with Carriage's being the best model and their standards operating model. I really think that is an excellent model that only needs to be refined in order to deliver the value that Mel has already explained is available for our shareholders. And I really see a lot of potential in Carriage and expect great things from the future of Carriage. And I'm just very excited to be part of the team and look forward to delivering shareholder value in the future.

Melvin C. Payne

Thank you, Billy.

I think one thing the second quarter certainly pointed out is that the consolidation platform that we call Carriage is sensitive. The leveraging dynamics that we have covered in our company investment profile, we've covered in press releases, it works both ways. We can get small increases in revenue, small increases in margin on the upside and it creates a lot of earnings momentum. But the reverse is true when we have a weak revenue environment and our expenses are not managed as tightly as they should.

Our platform is sensitive. We need to have more scale. We intend to add more scale over time so that it is less sensitive, but still has the same dynamic working for us.

With that, I'd like to open it up for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) Your first question comes from James Clement - Sidoti & Company, LLC.

James Clement - Sidoti & Company, LLC

Mel, I'm not sure if this is in the press release. Do you have an estimate on how the cremation spike hurt you from an EPS perspective?

Melvin C. Payne

Yes, I think that's about $0.03 a share.

James Clement - Sidoti & Company, LLC

And I guess what I would love to hear is a little bit more about, and you alluded to this in your prepared remarks, but of the things on the funeral side that I think you alluded to, certain aspects of the standards model not being executed properly. The things that you feel you have control over in the near term, can you give us a little bit more color on that, what you actually have control over, what went wrong and what you're doing to fix it right now?

Melvin C. Payne

Well, I mean, when you look at a quarter and isolate the quarter it looks terrible, but when you blend it with the first quarter, I mean, we stand by the margins for our same-store funeral portfolio for the six months. They're pretty awesome. If I told you three years ago we were going to have 37.7% same-store funeral field EBITDA margin for that period of time, that would be a pretty awesome result.

The problem is the volatility in it. And we had strong volumes in the first quarter. We did have a spike in cremation rates, so it ran the margin way up in the first quarter. I said at the time it wasn't sustainable. And now it sort of yo-yo'd back down the other way.

And I don't think  this is not radical surgery. What we had was weak revenue in some parts of our portfolio, not all parts of our portfolio. The East did extremely well. The West was the most underperforming region in the second quarter - their volumes were way down, their cremation rates were up - but they were also the outperformer in the first quarter. I mean, their margins in the first quarter were almost sinful.

So when you look at it across the country by region, by location, this is not a company in crisis, and I want to make that point. And it's a very important point. There are things we can do to improve expense control, but a lot of our places are running really well. And when you have a stabilization of volumes, you don't want to overreact. That's the worst thing you can do with a model like ours.

But there's, you know, we got some businesses in every region that need some attention. They're getting it, believe me, already. We didn't have to wait and see the result. They're getting a lot of attention. And it won't stay this way.

James Clement - Sidoti & Company, LLC

Mel, I guess what I'm sort of kind of getting at is you've got a rolling four-quarter outlook, right?

Melvin C. Payne

Yes.

James Clement - Sidoti & Company, LLC

So anomalies, i.e., strength in first quarter, weakness in second quarter, shouldn't really impact that much really one way or the other. Yet you're talking about - and I know that you don't have a lot of shares outstanding - but I guess, you know, you're still talking about a dime reduction. And I just, in terms of the outlook, I mean, is a third of that dime reduction just the assumption of a cremation rate? I mean, is that a - I'm just trying to understand the drivers.

Melvin C. Payne

I think the main thing on the dime is the cremation rate is definitely something that has caught us off guard. It spiked in the first quarter and I mentioned at the time it cost us $0.02 to $0.03 a share in the first quarter. It spiked in the second quarter; it cost a similar amount. We've confirmed that this is the kind of experience, let's say, the casket companies are having as well.

And so I don't know - we've never had a spike like this that sustained itself through six months. I've looked back over the portfolio and our cremation rate in the portfolio, same-store, has gone up about 100 to 120 basis points a year. I can't know why that is. I don't think it's related to the economy, but after six months I'm a little more cautious on saying it's going to -

James Clement - Sidoti & Company, LLC

And Mel, that's what I'm getting to. Nobody in your -- I mean, it seems like people are whispering about that, but nobody's really - nobody's willing to say hey, that actually may be going on here. And candidly, you know, I'm starting to wonder that myself a little bit.

Just changing gears a little bit -

Melvin C. Payne

But the other part of the $0.10, Jamie, it's only two things. It's the cremation and it's how long it will take the cemetery performance to get up. It's not a question of if, it's when. And in the next 12 months I can't guarantee that it will be back to the level of 2007, although I can guarantee it will be a lot better than it's been this year.

James Clement - Sidoti & Company, LLC

And Mel, that was my follow up question, just a little bit of an update on specifically kind of where you stand on has the new talent been identified? Do you have the people in place on the cemetery side?

And I guess also what I'm sort of wondering is the general economy, maybe after the first quarter, considering the work that you're doing on the cemetery side, does maybe a little incremental economic deterioration sort of cause you to be a little bit more cautious on the cemetery operations turnaround? Is that a driver here, reading between the lines?

Melvin C. Payne

Yes. I mean, we've asked the question here internally. What I saw in our numbers and I still don't quite understand it - I'm just being honest - I've never seen our at-need averages tick down year-over-year, which they did. You know, it wasn't much. It was just a little bit; I think $50. I commend the guys across town. Their averages were strong. I don't know why ours ticked down. I don't think they'll stay down. Whether that had anything to do with the economy, I couldn't say. I doubt it. I can't know that.

On the cemetery side, we've made great progress. We've hired - our structure is such that we only have four cemeteries in our East, we have three in our Western region, and we have two or three in our Central that are midsized and big and can make a material impact on our performance.

And we only have a few spots now that are not filled with good outstanding sales talent, including we have a full complement now at Rolling Hills for the first time in a long time and the talent is just A plus. So I think that alone will start to make a difference in the later part of this year. We have talent coming into the Eastern region that we didn't have before. I think that will begin to make a difference in the latter part of the year. In the Central, it's the same thing. We have some new talent there that will make a difference. And I'm beginning to see those differences manifest in pre-need property sales, for example, in July.

So I don't think - I just think we had a perfect storm. The litigation expense, I can't know when that's going to go away. It will go away. But the earning power of this company with what we own today should be $0.48 to $0.52 within the next 18 months.

Operator

Your next question comes from Clinton D. Fendley - Davenport & Co. of Virginia, Inc.

Clinton D. Fendley - Davenport & Co. of Virginia, Inc.

Mel, when we look at other companies in the market that have a higher cremation rate than you do, some of them have essentially priced themselves out of this low end cremation market. If I hear you correctly, are you now following a similar strategy here?

Melvin C. Payne

No. I don't - I mean, we're working really hard on providing tools and training to lessen the  to serve cremation families who might come in and not - they don't really know what they want and they may say something like, "We just want a cremation." We're trying to train our people that, when they say something like that, that doesn't mean they want a low-priced direct cremation. It means they don't want to be buried in the ground. They may want all the services. They may want products. You don't know what they want unless you present them all the options.

So we're doing a lot and we just went through a brand-new tool kit that will be rolled out in August, this month, and doing a lot of training because I think this - I don't know if it's here to stay at the level it is or the increase, but we need to do a better job with it. We're not trying to run them off.

Clinton D. Fendley - Davenport & Co. of Virginia, Inc.

Would your decentralized strategy that you have, would it prevent you from making any broader pricing changes if you wanted or were so inclined?

Melvin C. Payne

What do you mean by that, Clint?

Clinton D. Fendley - Davenport & Co. of Virginia, Inc.

I mean the fact that you kind of have the strategy of let's hire the top-notch A players. Let's put them in charge in the local market and let them make a lot of the pricing execution decisions on a local level.

Melvin C. Payne

Yes, we're not going to change our model because of one bad quarter. We had six straight good quarters and the model was working. We're not going to just throw it out the door because we had one weak quarter.

Clinton D. Fendley - Davenport & Co. of Virginia, Inc.

And if you looked across your portfolio, Mel, would you say that you have higher exposure to a customer base that is perhaps more price sensitive than maybe the market as a whole or some of your other competitors?

Melvin C. Payne

No, that would be an excuse I would offer up. I couldn't generalize by saying anything like that.

Clinton D. Fendley - Davenport & Co. of Virginia, Inc.

And I didn't hear much at all in regards to just commodity cost pressures in the quarter. What was the hit in the current quarter just from commodity costs and how are you planning on dealing with this on a go forward basis here?

Melvin C. Payne

Well, I mean, I don't think that was the main reason we had low margins. I think it was weak revenue and people didn't react to the weak revenue by keeping their expenses low, not everywhere but in too many of our locations on the funeral side, and then we just didn't have the preneed property sales on the cemetery side, simple as that. I mean, this is all about execution.

We do expect, however, to get some escalating merchandise costs on our caskets and some escalating merchandise cost in our cemeteries because the annual supplier increases come in the third quarter. And our people will react to those by adjusting their prices and so on because their standards require that they grow their business at sustainable margins. We have that well-defined. They will have to make adjustments to be able to operate their business within the margin range that have been defined by the standards.

Operator

Your next question comes from Alan Webber - Sidoti & Company.

Alan Webber - Sidoti & Company

Actually, a few questions. One is, when you talked about the rebuilding key cemetery sales leadership, are there still a certain number of cemeteries that need changes or that's been done? I wasn't really - I'm not that clear on that.

Melvin C. Payne

We have good strong operating leadership in all of our cemeteries. We've been working on the sales leadership over the last six to seven months. We only have three or four places - maybe two to three places - where we lack the sales leadership being in place. So we're in real good shape as far as having the sales leadership in place.

What we're not as far along doing, because a lot of that sales leadership is new, is having the complete teams recruited, trained, developed and enough of them, enough sales counselors selling the right product at the right prices. That will happen over the next five months incrementally.

Alan Webber - Sidoti & Company

And then a little more general question. You know, you put out something that I'm really not clear on. You put out the June report or outlook, which was, you know, in June, and then when you put out that you were authorized to repurchase stock, that was dated, I think, June - it was the middle of June or the late part of June - and you talked about confirming or reconfirming your long-term outlook. And yet here - so the June report's put out two months into the quarter. Your comments about the stock repurchase are, you know, the quarter's almost done. And yet you had this fall off. I guess I can't really understand how you could be caught off guard like that.

Melvin C. Payne

Well, we were surprised. I can't remember when we put that outlook out, but I think it was in May.

Billy Dixon

We still haven't changed our long-term outlook, though. I mean, the only thing that changed in our press release was our rolling four-quarter outlook. So, I mean, we haven't changed our long-term outlook.

Alan Webber - Sidoti & Company

But even the four quarter, when you put out a June report, it's just surprising that - you know, two months are done - that you wouldn't see signs of, you know, the EBITDA decline.

Melvin C. Payne

Well, I mean, I covered this with Jamie earlier. I've been - when we did the analysis of why our revenues were weak and saw that it was a pretty wide cremation spike, I've been surprised that that has continued to be the case. I don't know if that will change. I've become more conservative about predicting that it will go back to a 100 basis points increase, which is what it'd been over the last four years.

And on the cemetery side, I said at the end of the first quarter that we expected to rebound, but I didn't know exactly what the timing was but that we weren't changing our outlook until we knew more.

After the second quarter, I think it's clear that it's going to take a little longer, but it will be sustainable. So out of a - and then what really surprised me, to be honest, was the fact that our atneed averages declined, which told me that something was different. I can't quite put my finger on it, but out of a degree of caution, we don't want to keep having the same outlook when we're not exactly sure whether the economy's having an impact, why the cremation rates continue to be high. So we brought it down.

It's nothing more mysterious than that.

Alan Webber - Sidoti & Company

Oh, it was just the timing. Okay. Then my follow up was would you talk about sustainable earning power, $0.48 to $0.52 from the existing portfolio, could you just actually explain more what that means? Does that mean if there were no acquisitions that you'd - $0.4 or $0.52 would be kind of what it would peak at?

Melvin C. Payne

No. That means in the near term - and when I say near term we generally have been talking about 12 to 18 months - we believe that we can have a portfolio of performance, an overhead performance that will be in the $0.48 to $0.52 per share EPS range.

But that's with our cemetery performance returning to the '07 level, which we think is possible given the sales leadership and everything else that's been going on, our funeral home operations return to a more normal trend and don't stay down where the second quarter was, and we get rid of the litigation expense that so far this year equals $0.05 - no, $0.03 a share. That's a non-recurring type litigation on a few cases that we don't expect to recur.

If you put all those things back, you add $0.20 to the trailing four quarters, which is $0.30. You get up to $0.50 a share. We think we can do that in the next 12 to 18 months.

In other words, our rolling four-quarter outlook will go back up to that level, which we think is sustainable with our existing portfolio of assets without any more acquisitions.

Operator

(Operator Instructions) Your next question comes from Mike Scarangella - Merrill Lynch.

Mike Scarangella - Merrill Lynch

You touched on this earlier, Mel, about cremation and, you know, your ability to try to increase the averages there. Do you know what your cremation averages today and can you give us some perspective as to how that's trended in the last couple of quarters?

Billy Dixon

Yes, we've got it. Yes, our cremation averages have stayed the same in total from a rolling Q2 '07 to Q2 '08, and the pre-need have actually gone up quite a bit and the at-need came down just slightly.

And that's what Mel was talking about earlier, that we've seen the atneed cremation and burial averages come down slightly, 1% or 2%, year-over-year, but actually our averages in total, once you include preneed, have stayed the same on the cremation side.

So we have seen some success already from some of the training that we've done to increase sales productivity on serving the cremation customer. I mean, we don't believe a customer is somebody you want to turn away, which may be a strategy that other people have. We'd rather serve them and sell them more products that they may need.

Mike Scarangella - Merrill Lynch

Well, what is that cremation average, a dollar amount?

Billy Dixon

About $2,800.

Mike Scarangella - Merrill Lynch

And Mel, do you get the sense that people are pushing back on price as you try to add services to a cremation? Because I think we've always thought that that wasn't the driver of cremation, that it had more to do with traditions and thoughts about burial and that most of the time it wasn't price. Do you get the sense it's more and more becoming about price?

Melvin C. Payne

I couldn't say at all that the spike in cremation has anything to do with the economy. That's a stretch. I don't believe that to be the case. I think people make that decision based on disposition method, not price. I don't know that anyone else could say any different.

Mike Scarangella - Merrill Lynch

So you think you can get that cremation average up despite what's going on in the economy?

Melvin C. Payne

Absolutely.

Mike Scarangella - Merrill Lynch

With regard to the acquisition segment, I'm not sure how to read that. Those acquisitions are fairly new, so we had a really good first quarter with them. We had a fairly or weaker second quarter. So how do we read that? Are they doing well or not?

Melvin C. Payne

No, the volumes are doing great. I think we need some integration. We've had a lack of leadership in some cases. We recruited some people in a couple of cases that - we still have an open spot so we, unless you have the right leadership in place, you're not going to get the margins. So I wouldn't say our integration's as far along on the funeral side or the cemetery side. It's selective. It's not a matter of whether it will happen. It will happen. It's just taking a little longer, maybe six, nine months longer than I would have liked. But I think it will happen in the next six to 12 months. And those plans are well under way.

Operator

Your next question comes from Chris Sims - Shenkman Capital Management.

Chris Sims - Shenkman Capital Management

I know you mentioned at-need or cremation averages. What were the total atneed pricing up or down year-over-year percentage wise?

Melvin C. Payne

Yes. It's 2.5% total.

Billy Dixon

It's down 2.5%.

Melvin C. Payne

Down 2.5?

Billy Dixon

Oh, you just talking about at-need?

Chris Sims - Shenkman Capital Management

At-need, yes.

Melvin C. Payne

We report on at-need burial and at-need cremation.

Billy Dixon

Yes. At-need burial was down less than a percent and at-need cremation was down about a little over 2%.

Chris Sims - Shenkman Capital Management

And then, you know, second question, I know we've touched on a lot of points here but Q1 '08 obviously very strong EBITDA, about 10% year-over-year. You had the cemetery issues in Q1 as well as the spike in cremation rates also, but you had the stronger volume. I think it was about 3.5% up year-over-year.

This time around there's the same factors but you were about flat year-over-year in volumes. I'm just really not grasping how just a flat volume down from - up 3.5% in Q1 to flat this quarter generates down 25% in EBITDA. I know the pricing was down a little bit also, but the math just doesn't really make sense to me. If you could just comment on maybe some other issues that are going on that contributed to that.

Melvin C. Payne

Well, I think if you look at our performance by region, the large underperforming regions were the West to the greatest degree, then the Central, then the Eastern the least. And then you look business by business, and that's how we look at our company, the West was really a total outperformer in the first quarter, but extraordinarily high margins, volumes way up. In the second quarter, it was just the reverse.

That tends to be the way our industry goes, but it is not typically as volatile as that and I come back again to saying if we had had everything go right in the first quarter, without the cremation spike and without the extra litigation expense and all that, we would have earned $0.21, $0.23 a share.

I don't know what we'll earn next year, and I don't know if all those things will be there or not. But if we get the cemetery back performing and we get a break on our revenue on the funeral side, we can control the cost. The volatility in the volumes by region, by area, there's not a lot we can do about that except play your cards the best you can, and we didn't play our cards in the second quarter as well as we could. It's selective. There's no portfolio of sickness here.

I repeat, look at the trailing four quarters. You have to look at this business that way. It's not accorded  in our company it's very sensitive to these shifts, and it doesn't mean we're broken. We're not.

Billy Dixon

Chris, I think if you look at, you know, you're switching from a volume increase in the first quarter to, you know, a really average decrease in the second quarter, but the net effect of those is, you know, you're swinging almost $2 million of EBITDA just from that and variable expenses are another million. I mean, $3 million right there. We would have been $10.1 million instead of $7.1. So it makes a big difference.

Because of the way our operating model works, these small swings sometimes can have a large impact, especially when they happen quarter-to-quarter, where you're up, way up in volumes in one quarter and then flat volumes, but then your averages go down.

Operator

Your next question comes from Robert Kosowsky - OFI Institutional Asset Management.

Robert Kosowsky - OFI Institutional Asset Management

I was wondering if you could give us some detail as to, I guess, the monthly revenue trends over the second quarter and whether or not there's something that you saw the revenue being a little bit weaker and weaker and you were just hoping that the costs would come in a little bit quicker than they did? And kind of also give comments into the July month, too?

Melvin C. Payne

Yes, I think the first quarter, of course, we had strong revenue. It got stronger as the quarter went on. The flu season seemed to hit the West harder, and so their volumes were way up  way up. The East was the weakest in the first quarter - I mean, yes, the weakest on volumes and revenue.

And the second quarter it seemed to get weaker. It was weak in April. It got weaker in May and weaker in June. So it just tailed off in the second quarter by month. And, of course, that's on a revenue basis. The volumes were driving that. The volumes got weaker and the cremation rate stayed up, so I was, you know, we were surprised at the weakness in revenue over the quarter.

We've been pleasantly surprised by the strength in revenue in July. Don't know if that's an uptick that will be sustained, but we're up. We're up.

Robert Kosowsky - OFI Institutional Asset Management

Okay, so in the quarter it's basically a function of just revenue, I guess, declining sequentially and costs not really having a chance to react, I guess.

Melvin C. Payne

That's exactly what it was. And when you have a quarter like the first quarter, where volumes are real high and your margins go real high and then you have sort of the opposite occur, people don't adjust their costs, their variable costs as quickly given our model. I mean, if - but it is selective. It's not portfolio wide. We've got a number of businesses that didn't do a good job as their revenues tailed off quickly in the second quarter, and there is some corrective action going on there. But I don’t expect the margin in the second quarter to be repeated. Let me put it that way.

Robert Kosowsky - OFI Institutional Asset Management

And then as for the cremation increase, if it's not a function of the economy, do you think it's a function of maybe who your salespeople are targeting, like a particular demographic and those might be kind of a drift?

Melvin C. Payne

I think on the cremation mix on our funeral side, because 80% of our business is atneed, it's just choices being made by the consumer in terms of how they want to be disposed, disposition method. It's not related to our pre-need sales.

Operator

Your next question comes from [Mark Effersade - Pimco].

Mark Effersade - Pimco

I'm a little newer to the company, to the story here. I'm following Service Corp. more closely. But just some questions here on results, just cremation. What was the general story on why you had such a materially lower cremation rate than the national average or your publicly traded peers, like Service Corp. at 42%? You guys were about 33%, now flanked to 36%. But what's the sort of underlying backdrop there?

Melvin C. Payne

It's the footprint of our portfolio. We've got quite a few places in the Midwest and some places in the Southeast, Tennessee, where the cremation rate is very low, single digits in some cases, low double digits in many cases. We do have a concentration in California and our acquisition portfolio has a higher cremation rate than our same-store portfolio because we made some acquisitions in some high cremation areas.

But it's just a matter of how we built the company in the '90s. Quite a few places in the Northeast that traditionally had a much lower than national average cremation rate  Connecticut, New Jersey, so on.

Mark Effersade - Pimco

And just in those particular areas, with these single digit to low double-digit rates, I mean, what's your sense of why that is? For religious reasons or what's really driving that?

Melvin C. Payne

I would say it's just been customary. Cremation tends to be highest in urban areas, in major metropolitan areas in the West and in some cities, Florida, for example, high cremation rates. So we had quite a few places in smaller markets like Chattanooga, some places in Kentucky, Ohio, that weren't high cremation rate areas.

Mark Effersade - Pimco

The margins, I was looking at your margins, I mean, you have very impressive EBITDA margins, 25% kind of [zip code], which is actually the same as really Service Corp., which is basically 10 times your size in revenue and EBITDA. I'm just wondering sort of how, you know, actually 8%, you guys are 8% of their revenue so I'm trying to figure out kind of why you'd be able to have that kind of margin, what drives that given what would intuitively be scale economies, you know, at something over 10 times your size that would presumably offer maybe a margin advantage, operating leverage advantage?

Melvin C. Payne

Well, I'll have to tell you. Your question is a breath of fresh air. You know, I've been wanting to get that question for a long time. And if you were to read our company's investment profile, I think you would probably learn a lot about why our consolidated EBITDA margin has been historically higher, at least over the last couple of years.

I think Service Corp. has done a great job of integrating Alderwood, so their footprint has been leveraged and, I think, their EBITDA margin is increasing.

The reason ours has historically been high is because we have a very decentralized organization and it's very empowering for the local operator. We rolled out a standards operating model in '04 on the funeral side. We just are now doing that on the cemetery side and perfecting it. But you put in place some local, more entrepreneurial managers and empower them to make decisions to run their business, it can cut both ways. In the second quarter it hurt us a little bit, but over the last few years it's improved our margins substantially.

And so where we've been hurting ourselves over the last four years - and that's why we put out the longer-term trend reports - is we've been building the platform support overhead organization so that when we started growing we could integrate and grow these businesses and the operating leverage would kick in.

So the whole theme here for Carriage is to have a platform that is very leverageable over time and to grow the local business, have the operating leverage kick in, have the platform leverage kick in on the capital structure, have the overhead leverage kick in so that we get an earnings momentum, which we've had for six quarters until the second quarter. It went the other way. We will get that back. There's no doubt about it.

And our people, what I find about being a public company is you get a bad quarter like the second quarter and the market gets pretty distressed. But if you were to go around and talk to our people, there's a lot of excitement, especially on the cemetery side, where we've hired a lot of new talent.

And so it's not a matter will we get this consolidated EBITDA margin back up into the 24% to 26% range. It's not a matter of if, it's a matter of when. We will do that, and that's what we consider our sustainable earning power range of the total platform in all the operating companies we have. And it's all because we don't have many layers. We incent our people at the local level very generously, and we don't try to eat up the hard work in the field EBITDA performance by having too much regional overhead.

I think we're well done in terms of a total platform organization, so our total overhead ought to be flat and very leverageable. We get rid of this litigation expense and some extra stuff, we're good to go.

But that is a great question, and I appreciate it.

Mark Effersade - Pimco

I may follow up with more on that particular later, but moving on to just the - going back to cremation real quick, what's your company's thought on annual creep here, you know, in terms of, I guess, the next five years, perhaps, if you have a forecast of how you think the national cremation rate will move.

Melvin C. Payne

Well, we follow CANA. CANA's the Cremation Association of North America. All the casket companies are now doing lots of forecasting on cremation rates, of course, and they're getting into the cremation business. So we have a lot of input.

We try to forecast in our outlook both near term, which is the rolling four quarters, and the longer term through 2012, about a 1%, 120 basis point increase. Frankly, we've been surprised at the spike and the fact that it lasted through the first half. We've never seen anything like that before, so I don't know that we can say it's reached a new plateau in our footprint although we're cautious to say that it hasn't.

So I think right now in terms of forecasting the future mix change, we want to wait and see a little more data. We're very data driven. And see if this higher level of cremation rate sticks and what is the pace of increase from here.

Operator

Your next question comes from Gerry Heffernan - Lord Abbett & Co.

Gerry Heffernan - Lord Abbett & Co.

Gentlemen, I have to say, I am obviously a very disappointed shareholder, but I'm also very surprised at the way this conference call has gone here. You know, a lot of this talk, the cremation spike, yes, it was a spike in the second quarter, but there was also a spike in the first quarter. But I fail to see how that is any surprise for this reporting period that it should not have been addressed earlier.

The expenses being out of control, I'm very surprised. No one up to this point has brought up the fact that your CFO left in April, and it seems that whoever's left, the top management, just simply missed it, just wasn't keeping their eye on the ball.

In the first quarter we were willing to make the statement that the very high margins at the same-store funeral level were due to the increasingly talented group of [four EA] player managing partners, but where were they this quarter? Where was the expense management? Where was the, you know, the ability to change to the changing environment?

The perfect storm metaphor just - no, I'm ready to gag on that. I've got to tell you, thus far I really don't have any confidence that you've nailed down what it was you missed and, for that matter, why is it going to take a couple of quarters to correct when it seems to have all gone bad in one quarter?

Melvin C. Payne

Well, I'm sorry you're that disappointed and I'm sorry you dislike the call so much.

We were surprised at the revenue weakness, and it accelerated during the quarter. We don't try to control the operating expenses in Houston at each one of our businesses. That goes against the model. Either you accept that or you don't. You may just think it's a ridiculous model. I can't help the way you might think about it.

We've got some work to do. We're doing the work. Expenses were higher than they should have been, but it wasn't where we have the A-player people. We don't have A players everywhere, and we do have some performance issues in the portfolio and we're addressing them, but it will get back to where it should be.

We're not a centralized, top-down model and some people like that, some people don't like it. But it is what it is. I'm not going to apologize for it because until this quarter we were doing fantastic on same-store funeral performance. And if you look at the four quarter trailing, we're still doing relatively great on our funeral operations.

It's the cemetery performance where we really lost the earnings per share and the acquisition integration. I'm disappointed about that. But we're doing something about that, and we're doing it quickly and we will have it done over the next six to 12 months.

The cemetery, and I've said this repeatedly, we didn't know that business as well as we knew the funeral business. We're getting to know it real fast. We're bringing in great talent. We reorganized that in '06. We went to school on it in '07. We've learned enough to know we've got to get it right, and we're getting it right. The earning power of the company will get back to where I said it would within the timeframe I said it would.

And if I have no credibility on that, I'm sorry.

Operator

Thank you, sir. At this time we have time for one additional question and the final question is from [Mitch Almay - McAdams Company]. Please go ahead.

Mitch Almay - McAdams Company

I was calling - on June 18th you announced a share buyback, roughly $5 million, and today, of course, we have a stock price that's materially lower than that, so should afford the Board a different view as to the capital allocation going forward. I don't know if you can tell me how many shares were bought in the quarter or whether it is your intent at the current valuation to possibly increase and act on that.

Melvin C. Payne

We bought very few shares.

Billy Dixon

Yes, we only bought 17,900 shares, less than $122,000.

Melvin C. Payne

We abided by our own policy of - what do you call it? Trading window policy.

Billy Dixon

Which we're in a blackout period right now.

Melvin C. Payne

Yes. So we've been in a blackout period. At this point I think we're in no hurry to buy shares. There's activity in the industry. We want to see how that goes as well. So we'll just, you know, we want to get our performance up. That's the main thing we're working on, and then we'll see how it goes after that.

Mitch Almay - McAdams Company

Would you at least agree that authorizing a share buyback yet not acting on it is a little bit misleading for us? And if at this point you feel uncomfortable repurchasing shares, you should probably issue a press announcement that the Board has changed their mind and does not see it as an appropriate use of capital or act on it when the window does open, which I think is in two days.

Melvin C. Payne

Well, there are a number of reasons why we're just watching what goes on in our industry. Of course, you know, I don't have to tell you if you're following the other companies that there is a possibility that there could be some consolidation amongst the consolidators. If that happens, we have a history of making acquisitions out of consolidation of consolidators. And we don't want to be using up our capital until we see how that works out.

That's a change in the environment that wasn't there when we announced that buyback.

Operator

Thank you, sir. At this time I'd like to turn the call back over to Ken Dennard for closing remarks.

Ken Dennard

Mel, we're a few minutes over so give your final comments?

Melvin C. Payne

Yes, I'm disappointed in the second quarter, but I appreciate those of you who might understand and we'll do better and are doing better. So I look forward to reporting our progress during the balance of the year. Thank you very much.

Operator

Thank you. Ladies and gentlemen, this concludes the Carriage Services second quarter earnings conference call. This conference will be available for replay after 10:30 a.m. Eastern Time today through midnight Eastern Time. You may access the replay system at any time by dialing 3035903000 and entering the access code of 11118040 followed by the pound sign.

Thank you for your participation and at this time you may now disconnect.

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Source: Carriage Services, Inc. Q2 2008 Earnings Call Transcript
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