Mark Alexander – BofA
Good afternoon everyone my name is Mark Alexander, I am part of the High Yield Healthcare Team at BofA and I’m pleased to introduce Eric Tanzberger, the CFO and Treasurer of Service Corp International, as well as Debbie Young, the Director of Investor Relations.
Eric Tanzberger
Thanks Mark, good afternoon everybody and thank you for having us. Larry thanks for having us at your conference. There is a good job in the weather today down here in South Florida as usual.
So we’re going to start with a forward looking statements on page two, which refers as to our Safe Harbor projections and you can get more information with all of our filings with our 10-Qs or 10-Ks on our website which is sci-corp.com.
Starting with SCI at a glance. We are the largest owner of funeral homes and cemeteries in North America probably in the world for that matter with 1,800 locations that we own in the States as well as in Canada, just under $ 4 billion market cap $ 2.5 billion of revenues, about 13% market share as well the consolidated part of the industry is probably roughly about just under 20% of the market cap. So still a very highly fragmented industry owned by independent individuals, independent funeral homes and cemeteries as well.
One of the unique things about the industry is that we market to consumers on a pre-need basis where those consumers are selected cemetery property and are select in funeral and cemetery merchandised and services on a pre-need basis is a contractual relationship that’s actually funded by the consumer as well. That creates a tremendous situation for us where we have a backlog of over $ 7.5 billion of future revenues that again are in the process of being funded with cash or are funded with cash or are supported by a life insurance policy, where the proceeds of that policy comes to the funeral home at the time of need.
Another characteristic of the industry is consistency in the free cash flow stream and we’ll get into that in depth here today as well. A future characteristic is that the industry is very well poised for the aging of America. The baby-boomer generation which the oldest baby-boomers are now in the mid to upper 60s at this time is starting to effect in our cemetery segment, our industry and our particular company and will continue to positively effect from an organic growth perspective, the industry going forward over the next two years.
Lastly, if you’re familiar with our industry, there is further consolidation of consolidators. In May we announced the pending acquisition of Stewart Enterprises out of New Orleans by $ 1.4 billion deal with absorbing the debt as well, net of cash as well. And you could see that’s about a $ 500 million revenue company, with just under $ 120 million of EBITDA of 350, 360 locations compared to our 1,800 locations.
So, starting off with consistent and robust free cash flow on slide four. You see our nine months, we have shown growth in our free cash flow and you see the guidance on the right compared to prior years. The guidance is $ 305 million to $ 320 million ending the year of 2013, later in the presentation we will get to 2014 as well. And this guidance is about 12% to 18% depending on the range increased over 2012. And this increase in free cash flow or growth that we had which is largely driven by preneed cemetery sales is over and above an increase of about $ 15 million in cash taxes and we will have to get into cash taxes for the 2014 guidance as well in a few minutes.
From an earnings per share basis double digit growth as well, 12% growth in EPS in the first nine months at normalized earnings per share. The guidance on the lower right of slide five is a 9% to 14% range increase over 2012. And again this is true operating growth because as we started conversations at Stewart Enterprises for the acquisition late in 2012, it precluded us from really deploying capital in 2013 from either a share repurchase perspective as well as other tuck-in acquisitions during the year.
Starting now from the operations perspective and talking about the preneed cemetery sales production. You can see here on slide six that is a significant primary driver of growth for our company. You can also see from 2011 through 2013 we are really approaching and in fact passed over in certain years double-digit percentage of growth in preneed sales for cemetery property. What this really is this is the baby boomers starting to affect our industry and the first sales that they do or first thing that they think about as it relates to interact with our industry is buying cemetery property and that’s starting to occur right now and I have a slide on that in a second.
Secondly, we have done a lot of work in our sales leadership, we have done a tremendous job on productivity in the metrics associated with productivity of a large salesforce of about 4,000 sales counselors. Lately we have been focusing on continue to grow the sales management in the form of sales managers localized in the markets, as well as further growth in sales counselors to continue to be able to radiate into the communities and capture the growing demand because of the baby-boomers in the cemetery sale process.
On the funeral side, it’s a different story because we recognize revenues at the time of need. So when a death occurs. And the baby-boomers and the demographic play has not yet occurred in terms of the number of debts in the U.S. and in North America. So we have had low single digit percentage declines and the number of funeral service performed, which is generally offset by low single digit percentage increases and the average revenue for funeral service or the average ticket in our particular company.
Down below on slide seven, is the preneed funeral production growth, different than cemetery when you are selling preneed funeral products and services, we are referring that onto our balance sheet which is creating largely that $ 7.6 billion backlog as described on slide one. Those revenues and those cash flows get recognized at the time of need, which is a nice way of saying at the time of debt when the products and services are delivered to the client family.
Our competitive strength, this is a good slide on slide eight which really shows you graphically the footprint that we have at SCI across our other 1,400 funeral homes as well as just under 400 cemeteries and these are pre-Stewart numbers. So this is the Dignity Memorial network which is our brand in network at SCI.
And also this large scales gives us an ability to really leverage scale as well from a cost structure perspective. And you can see some of the items that are listed on slide eight, sharing a personnel, vehicles, other resources. Purchasing power, centralized, preneed sales opportunities and of course centralized or outsourced operating accounting functions as well.
Slide nine, shows you what I’ve been referring to you in the presentation so far as it relates to the favorable demographic trend. To the right you see, the population of age 60 and over in 2011 that 60 plus population was just under 19% of the U.S. population. That is projected to exceed 25% by 2030. And you could see on the graph a very favorable trend that’s going to affect this industry in terms of us as a company and a network able to market to these consumers on a preneed basis and recognize those revenues on the cemetery real estate sales side as well as build our backlog which are future revenues and future cash flows that will come to our company.
The aging demographics will benefit us because there is really three points that that consumer at these ages that you see in slide 10, touches our company. In the early 60s the first time that consumer touches our company is that’s the average age where someone decides they want to think about cemetery property, where they will buried for example, where they ashes and cremation situation will be entered in a mausoleum [need]. For example early 70s is the average age of the preneed funeral customer, that is when they are saying I want to pre-arrange my own funeral and funded in that situation. And then lastly the late 70s and early ages right now the average age of what we call the atneed consumer, that’s when the death is occurred. That’s when you’re providing us products and services and that’s when the moneys that are hung up on the balance sheet in the backlog and either invested with an insurance policy or invested into a trust fund, fund SCI in the form of operating cash flows.
So, let’s get a little more detail on the acquisition of Stewart Enterprises. Slide 12 late in May, we announced a planned acquisition for $ 13.25 per share again, about $ 1.4 billion deal inclusive of cash as well as the debt acquired. The acquisition is currently pending approval by the Federal Trade Commission in Washington. We still are anticipating a close in late December early 2014, I think it’s more likely of you heard us say publicly that we are continuing to hope to close it by the end of the year. So in December of 2013, but a lot of work needs to come together with the Federal Trade Commission. We’ve been working diligently with the FTC, but again as you go market by market it all comes together at the end and that should be coming together hopefully in the next couple of years.
Strategic rationale is filling out the footprint, getting ready for the baby-boomer generation continuing to have a complimentary geographic fit with the Stewart businesses in a highly fragmented industry. It’s also going to be a very compelling internal rate of return for our company as well, well above our weighted average cost of capital.
In terms of synergies, we are expecting about $ 60 million of synergies about $ 50 million of those are slated or estimated to come from a back office perspective and about $ 10 million from a purchasing power perspective.
This is a busy slide on slide 13 but what it’s trying to indicate to you is that we had a similar transaction called Alderwoods in November of 2006 with a similar sized company. And we originally thought that those synergies would be about $ 65 million, we ended being about $ 95 million whereas in the Stewart situation, we are expecting $ 60 million. Now past performance is no guarantee for the future as well but we do think that there is a possibility of additional synergies above the $ 60 million number that we have announced publicly that you see on slide 13.
Again, the financing is also in place for the Stewart acquisition. That’s what we did and really in the month June in early July after the public announcement. This is our debt maturity profile that you see on slide 14. This assumes that according to our offering memorandum when we did the financing in mid June of this year that we draw about $ 550 million on a $ 600 million term loan and that we draw about $ 200 million on a $ 500 million credit facility. That still leaves $ 266 million of liquidity as it relates to our bank credit facility as well as cash balances that we generally keep $ 100 million to $ 125 million of cash on hand. So despite the acquisition, we still will have a lot of liquidity and adequate liquidity for us at SCI.
You can also see the pending notes that were issued into escrow, the $ 425 million due in 2022. You can also see 6.5% of Stewart’s notes outstanding that are due in 2029 that we expect to absorb and remain outstanding during the acquisition — after the acquisition, I should say.
And again, consistent with the free cash flow stream, and a very good debt maturity profile that leads out the debt maturities over time in a manageable way, we also have substantial as well as consistent liquidity that we strongly believe in at SCI. You can see all the way from 2008 through 2013 we’ve had anywhere from high $ 300 million to $ 650 million currently of liquidity in the form of the cash balance in hand as well as the outstanding revolver capacity that we have. That $ 650 million should drop to about $ 350 million at the end of the acquisition, we’ll use probably about $ 100 million of cash and we estimate to draw about $ 200 million down of that credit facility as well. The $ 350 million after this transaction is still what we believe is well and above adequate liquidity and of course with the consistent free cash flow stream, we also believe it will grow from that point in time going forward after the acquisition.
And shifting to 2014 and talking about this free cash flow, the free cash flow is on the left side and the normalized earnings per share is on the right side, which shows the growth of about 17% over 2013 levels. That is the Stewart acquisition is soon to close as of its fully closed by January 1, 2014, it also includes growth in our preneed cemetery property business as I describe to you early in the presentation to arrive at an earnings per share range to the $ 1 to $ 1.10 per share on a normalized basis.
From a free cash flow basis, a little different story because of cash taxes. SCI over the past several years has not been a cash tax payer for the most part from a federal U.S. perspective due to net operating losses.
Those NOLs are now going to become fully utilized for the most part in 2013, a little bit in 2014. So our free cash flow would grow with a normalizing about 15% for the cash tax impact. However, as you could see on slide 16 at the top, we plan to pay an estimated $ 40 million more in cash taxes during 2014. So $ 30 million paid in 2013, about $ 17 million estimated to pay in 2014 and that’s going to hold the free cash flow somewhat constant because of the increase in cash taxes.
We also believe we’ll have a further increase in cash taxes during 2015 as well to get us to the full run rate. Think of it as an effective cash tax rate of 30% to 35% in that area that will be at in 2015 and then the free cash flow will not be — will be fully at that rate and grow from there in 2016.
Key assumptions you can see in your slides on page 17. I talked about the discussions with the SEC are ongoing. But for purposes of modelling, we modelled $ 35 to $ 45 million of EBITDA that will be sold mid-year as it relates to the Stewart acquisition. We assume that half of that $ 60 million synergies are recognized in 2014, so $ 30 million. And then some of the same things that we have modelled before with our business, continued growth in both funeral and cemetery preneed sales production as well.
In terms of shifting to page 15, excuse me, 2015 on page 18, the 2015 will have the other half, the second half of the synergies, so another $ 30 million of synergies that will be recognized from the Stewart acquisition on — in 2015.
We do believe as I have mentioned to you, there is a possibility of further synergies for example in our field operations. If you have an operating team that runs a market and we have an operating team that runs a market, you don’t need two operating teams running the same market. So that’s a good example of additional synergies that are not baked into the $ 60 million of synergies that we describe to you before.
Subsequent to that, we will then be able to deploy capital to add value in the form of tuck-in acquisitions, share repurchases, dividend and of course debt repurchases. We plan to de-lever after the close of the Stewart deal, we should be about 4.25 times levered on a net debt to EBITDA basis on our bank credit facility definition that’s filed.
We expect to be below four times pretty quickly because of the divestiture proceeds. The first $ 200 million of the divestiture proceeds have to go to the term loan and then there is also an amortization feature of the term loan. So look for us to be below four times pretty quickly in 2014 and then look for us to take a balanced capital deployment approach, which includes deleveraging, but also could possibly include other items on this page such as an increase in dividend or share repurchase program that we’ve been big believers on, in the past and take a balanced approach to get to our targeted leverage ratios which are generally about 3.25 to 3.5 times on again a net debt to EBITDA basis.
Lastly, to recap SCI. A solid long-term credit profile, a predominant player in terms of scale in a funeral and cemetery industry, significant and consistent cash flows, characteristic of our company and the characteristic of this industry as well. We believe strongly in very good liquidity as well as a favorable debt maturity profile which showed you the consistencies in the slides of the strong liquidity. We also have a very disciplined and focused capital allocation strategy. What we are telling you is these are the four areas that we’ll allocate capital to acquisitions, dividend, share repurchases and debt repurchases, deleveraging then to our target ratios and then perhaps opportunistic debt repurchases as it relates to near-term debt maturity profile, management which we have a track record of doing as well. What’s exciting about the industry is that the growth strategies are not capital intensive and there really is a benefit coming from an organic growth, from an attractive demographic trend with the baby boomers.
So with that Mark, I think I’ll go ahead and open it up to questions.