Welcome to the 4th Quarter 2018 Service Corporation International Earnings Conference Call. My name is Sylvia, and I will be your operator for today's call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session. Please note that this conference is being recorded.
I will now turn the call over to CSI Management. You may now begin.
Good morning to the STI call. Thanks for joining us as we discuss our Q4 and our year end results. As usual, I'm going to go through the customary Safe Harbor language before we begin with prepared remarks from the quarter from Tom and Eric. The comments made by our management team today will include statements that are not historical and are forward looking. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections.
These risks and uncertainties include, but are not limited to, those factors identified in our press release and in our filings with the SEC that are available on our website. In today's comments, we may also refer to certain non GAAP measurements such as adjusted EPS, adjusted operating cash flow and free cash flow. A reconciliation of these measurements to the appropriate measures calculated in accordance with GAAP is provided on our website and on our press release and eight ks that were filed yesterday or early this morning actually. All right, with that over with, I'll now turn the call over to Tom Ryan, Chairman and CEO.
Thanks, Debbie. Hello, everyone, and thank you for joining us on the call this morning. Today, I'd like to start by reflecting on the full year of 2018, then I'll get into the analysis of the 4th quarter and end with some color on our outlook for 2019. So first, some observations looking back at the year 2018. For the full year, we were proud to report double digit percentage growth in adjusted earnings per share and adjusted operating cash flow.
The $1.79 reported in adjusted earnings per share was a $0.24 or more than 15% improvement over 2017. Solid revenue increases, particularly in the cemetery segment, were somewhat offset operationally by higher salaries and wages from intentional adjustments made in the beginning of the year as well as from higher self insured health and general liability costs that were not anticipated. These increased costs impacted both business segments as well as general and administrative expense. In total, operations including the overhead burden contributed $0.11 to the $0.24 earnings per share improvement. Increased debt levels from acquisition funding and higher average variable rates tied to LIBOR led to higher interest expense for the year that effectively offset the favorable impact from lower average share count.
So the remaining $0.13 in earnings per share improvement for the year was from a favorable tax rate, which was primarily due to the lower federal rate from the 2017 Tax Act as well as favorable state tax results. Comparable Funeral segment operating profits for the year were over $369,000,000 a decrease of $3,600,000 as compared to the prior year. The funeral operating margin percentage was within our guidance range at 19.9%, down by 50 basis points. For the 2nd straight year, we saw comparable funeral volumes grow, while average revenue per case was relatively flat. We experienced a 1% inflationary growth at the customer level, which was offset by the negative effect on the average from a 140 basis point increase in the cremation volume mix.
For the year, SCI direct sales production grew in the high single digit percentages, but a change in how we allocate price at the contract level from a recognizable administrative fee to a deferred service revenue resulted in a temporary year over year decline in reported revenues and profits. Comparable cemetery profits for the year improved by over $36,000,000 and we expanded the operating margin percentage by 170 basis points above our guidance range to 30.4%. We experienced solid revenue growth of 4.3% for the year, primarily driven by the success of our pre need efforts. A solid double digit percentage increase in other revenue, which is primarily very high margin perpetual care trust fund income had a more pronounced impact on reported margin percentage. This solid operational performance and the resulting $610,000,000 of adjusted operating cash flow not only funded our over $200,000,000 of maintenance CapEx for our locations and cemetery inventory development, but funded almost $195,000,000 of purchase price, acquiring 35 new locations across several transactions and geographies.
Additionally, we spent another $32,000,000 on constructing new funeral homes, which have a slightly longer cash payback, but have the benefit of ideal location and an updated new facility, which should provide a nice trend of growth going forward. Even after this significant increase in growth capital investment for the year that I just mentioned, we were able to return more than $400,000,000 to our shareholders in the form of share repurchases and dividend, a 30% increase over 2017. We delivered these results, while at the same time making strategic investments in our digital platforms, our customer experience and engagement, and most of all in our people. Recall that we've previously mentioned the implementation of Beacon, our new tablet based prearrangement tool that provides a seamless digitized presentation for our client families while reducing the administrative burden for our sales counselors. It's exciting to see how this platform is beginning to yield more effective and productive sales force.
At year's end, we have rolled out Beacon for prearranged funeral sales to approximately 75% of our core funeral locations. There's a real upside opportunity early in 20 19 as we achieve deeper penetration into these markets that were rolled out over the latter half of twenty eighteen. Currently, we are supporting that uptake opportunity in the newly implemented markets and are now in the process of rolling Beacon into the Vancouver market. Then later in the second quarter, we plan to turn our primary attention and resources to the implementation of Beacon in our cemetery location. Cemetery is a more complex implementation, so the funeral learnings are crucial to successful cemetery implementation.
We should begin to roll into certain markets in the latter half of twenty nineteen and would anticipate a meaningful impact in 2020. Also during 2018, we did a complete overhaul of the look and feel of our location websites through dignitymemorial.com. These newly redesigned websites have helped us to reach an all time high in web traffic to the Dignity Memorial site with over 96,000,000 visitors and a 21% increase in traffic year over year. In 2018, our new websites produced a record number of website preneed leads and atneed customer interaction. This positive trend has continued into 2019.
Additionally, we've invested in resources and technology to drive improvements and visibility in our location online reputation rate, as well as generating consumer demand through digital marketing campaigns. We are continuing to invest 2019 and we believe this will provide significantly more leads at a much lower average price today and ultimately result in increased funeral market share and enhanced sales activities. Finally, we have made significant investments in our people. Early in the year, we made strategic adjustments and compensation for key customer facing employees. We have incrementally invested in training and development, specifically around initiatives dealing with broader inclusion and diversity training as well as leadership training.
I feel really good about the momentum of our team. Now for an overview of the Q4. As you saw in our press release yesterday, adjusted earnings per share grew $0.04 or 8% to $0.54 per share compared to the same period last year. We knew this would be a challenging comparable quarter on the operational earnings per share front for two primary reasons. First, last year's quarter had the beginning of a flu season impact that would make funeral volume comparisons difficult.
Next, while we're confident in preneed cemetery sales production growth in this quarter, we had almost $8,000,000 of cemetery revenue recognition in the prior year quarter associated with completed relatively large construction projects in Vancouver. So, we knew our comparable cemetery revenue recognition rate would be a challenge. The good news on the operational side is that preneed cemetery sales production was very strong, coming in with almost 12% growth. We were even able to overcome the lower recognition rate to grow profits and when combined with the profits from acquisitions, they contributed almost $0.04 to earnings per share growth for the quarter. Funeral profits were lower as volumes were down over 1% as we had anticipated.
Unfortunately, the cremation rate increased 170 basis points, putting downward pressure on the funeral average. Increased costs from wages and self insured healthcare expenses put further pressure on our funeral process. General and administrative expenses also increased and were higher than we anticipated as we increased the projected self insured liabilities associated with general, workman's comp and auto claims during the quarter. Additionally, we increased legal reserves associated with a legal settlement in the 4th quarter. The funeral profit decline and the increased general and administrative expense effectively offset the positive earnings per share growth from cemetery operations and acquisitions for the quarter.
Finally, interest expense offset the favorable impact of lower average shares outstanding. So, the quarter over quarter improvement was primarily attributable to a favorable tax rate at both the federal and state level. Now shifting to some more detail around the funeral operating performance for the 4th quarter. Comparable funeral revenue decreased $13,000,000 or approximately 3% compared to the same period last year and fell short of our expectation. This decline is primarily attributable to a decrease of $11,000,000 in our core revenue, where we saw an approximate 1.5% decline in both the volume and average revenue per case.
While we anticipated the decline in volume due to the pull forward impact of a strong flu season in late 2017, which continued into early 2018, the decline in sales average was higher than our expectations. The average revenue per case decline was despite a 70 basis point increase at the organic an unfavorable currency effect and the negative 4th quarter market returns effect on trust income more than overcame the slightly higher customer spend. I believe some of our increased cremation mix is attributable to us being more competitive for the price sensitive cremation customer, which is a good thing. Additionally, our mix change rates are consistent with KENA trends that we're now seeing. Recognized preneed revenues declined by $2,300,000 in the quarter.
This decline is a direct result of lower preneed sales production during the quarter from our non funeral home businesses. During the Q4, we had some temporary disruptions in sales caused by an early 2019 transition of our SCI Direct sales team from independent contractors to onboarding them as employees. We expect the temporary disruption to continue during the Q1 of 2019 and stabilize early in the second quarter. Shifting to funeral profit, we experienced a decline in operating profit of $7,700,000 and operating margins decreased 110 basis points to 20.1%, primarily due to the revenue decline. Although we continue to see increases in labor costs, including higher healthcare expenses, we saw reductions in overall selling related expenses, which helped to minimize the margin decline.
Comparable preneed funeral sales production decreased $4,200,000 or 2.1% in the Q4 of 2018 compared to 2017. We experienced a double digit decline in contracts written for our SCI Direct channel, which is primarily related to the temporary disruption of transitioning our counselors to employee status that I previously mentioned. For the core channel, we grew contracts sold slightly. We reduced the direct mail spend during the quarter as we transitioned to a new vendor and our sales team focus was tilted towards cemetery sales activity, which contributed nicely to our 4th quarter earnings. For the full year, we grew preneed funeral sales production, a solid 6 point 5% beyond our low single digit percentage guidance.
We believe this success was a direct result of the impact of our new Beacon system, which assists our sales counselors in a more effective and efficient customer interaction. We believe Beacon will continue to have a positive impact on 2019 sales activity. Now turning to our cemetery operations for the Q4. We are very pleased with the 4th quarter preneed sales performance. For the year, we guided that total preneed cemetery sales production would land in the 4% to 6% range.
Because of tough 2017 comps in the first half of twenty eighteen, we communicated to you that a lot of the year over year growth was going to come in the second half of the year. Well, our sales team delivered and was able to grow preneed cemetery sales by an impressive 12% in the 4th quarter, which resulted in a 4.3% increase for the year. So hats off to the entire sales organization. Now on to cemetery GAAP results, which you see in the income statement. Total comparable cemetery revenue grew more than $12,000,000 or almost 4% in the quarter.
We experienced a $17,000,000 or 7.5% increase in recognized preneed revenue, which was a function of the strong production I referred to, as well as higher merchandise and service deliveries. Recall how we grew preneed sales by 12%. So in the 4th quarter, we grew backlog production that should benefit the coming quarters as we construct the property recognizing revenue. Partially offsetting this recognized preneed revenue increase was a $4,500,000 decrease in perpetual care trust fund income. It's important to note that for the full year, our perpetual care trust fund earnings have increased an impressive $9,500,000 or 15%, partially reflecting our initiative to shift trust fund assets to a total return strategy in states where permitted.
However, last year, the incremental benefit of increased earnings associated with this strategy and excess income withdrawal opportunities was weighted to the 4th quarter. Therefore, this is more of a timing issue for our Q4 comparison. From a profit perspective, comparable cemetery operating profits grew about $3,000,000 nearly 3%. However, cemetery margins declined 30 basis points for the quarter. The margins from higher operating and sales driven revenues achieved were somewhat muted by the reduction of higher margin trust fund income, coupled with higher labor and healthcare costs.
Now let's shift to discussion about 2019. Our guidance for adjusted earnings per share in 2019 is $1.84 to $2.02 per share. At the midpoint of that range, dollars 1.93 this represents an 8% increase over 2018 earnings per share. This projected increase is absorbing a higher effective tax rate of just over 25% compared to the 23% adjusted effective tax rate we reported in 2018, which benefited from favorable state tax true ups. Therefore, at the midpoint of our guidance, pre tax earnings per share growth is projecting an 11% increase before incurring the higher tax rate for 2019.
We believe this increase will come as it has historically with the organic business contributing 4% to 6% growth in earnings per share and contributions from recently acquired businesses as well as the effect of the 2018 2019 share buybacks contributing an additional 4% to 6% of earnings per share growth. Allow me to briefly discuss the underlying assumptions regarding the base business growth for 2019. 1st, funeral revenue should grow around the flat to 2% range. We expect the Q1 volumes to be down as we've already seen in January, as it is comparing to a very robust 2018 quarter impacted by the heavy flu season. Based on history, we would expect the remaining 3 quarters to get back a significant portion of the activity.
We expect the average revenue per funeral to continue to be challenging with cremation mix negatively impacting moderate inflationary pricing. We will manage costs aggressively. For comparative purposes, it should be tilted more to the back half of the year and we anticipate margins for the year to be in the 20% or so range. Margin should contract in the Q1 and working back to positive comparisons in the latter 9 months. We anticipate preneed funeral sales production to grow in the mid single digit percentage range for the year as Beacon should have a spillover effect into 2019.
Next, we expect cemetery sales production and cemetery operating revenues to grow in the mid single digit percentage range. Other revenue predominantly comprised of perpetual care trust fund income, should be flat or grow moderately as a larger share of assets under our total return strategy grows income, but is somewhat offset by lower excess income distributions based upon the poor financial market performance at the end of 2018. As we think about quarterly cadence, we would expect very moderate cemetery profit growth, particularly in the first half of the year with a strong 4th quarter impacted by the completion of a number of constructive projects. We expect lower general and administrative expense as compared to 2018 with quarterly costs approximating $30,000,000 to $35,000,000 And finally, interest expense should be some $8,000,000 to $10,000,000 higher in 2019 as we have a higher average debt balance coupled with higher variable rates, which are tied to LIBOR. So to wrap it up, we'll continue to focus on driving revenue growth, leveraging our scale and deploying capital wisely to enhance shareholder value.
I want to thank our entire team for their tremendous efforts and for making our client families our number one priority. Finally, I would like to acknowledge the tremendous contribution of our President and Chief Operating Officer, Mike Webb, who is retiring at the end of March. For those of you that have been around for a while, you know that 16 years ago, Mike and I were given the opportunity to develop a strategy and a team here at SCI. While we've made our fair share of mistakes along the way, I believe we've helped to develop a powerful company and team that we are blessed to be a part of, a team that has delivered consistently over the years. There's not a person more responsible for our success than Mike Webb.
I'll truly miss my good friend, but as with most great leaders, Mike left a legacy and a talented executive team that we have today. With that, I'll turn the call over to Eric.
Thanks, Tom. Good morning, everybody. Today, I'd like to begin as we usually do by addressing cash flow during the Q4 and then I'll talk about our annual cash flow results and our capital deployment for 2018, which is a highlight for us and finally provide some details for our outlook for 2019. So as you saw in yesterday's press release, we reported strong adjusted operating cash flow of $164,000,000 for the quarter, which is an increase of $38,000,000 or 30% over the prior year. This growth though was primarily driven by a decrease in cash taxes paid as positive working capital effectively offset the slight declines in EBITDA and higher interest payments quarter over quarter.
Cash tax payments in the quarter were only $4,000,000 compared to $45,000,000 in the prior year quarter. The prior year was affected by the timing of cash tax payments related to Hurricane Harvey. The current quarter also benefited from tax reform as well as tax planning efforts. Cash interest payments in the quarter were $67,000,000 compared to $59,000,000 in the prior year quarter. This increase is due to impacts from both higher debt balances as well as higher floating rates over the prior year period.
While we are comfortable with our capital structure, we continue to evaluate our mix of floating versus fixed rate debt in the current interest environment and plan to manage accordingly. Lastly, as it relates to cash flow during the quarter, we benefited by approximately $20,000,000 of non earnings cash received mostly related to proceeds from our trust funds that we were able to deploy towards our capital deployment programs in the 4th quarter. Maintenance and cemetery development CapEx for the quarter combined the 2 components that we define as CapEx and our free cash flow calculation were approximately $59,000,000 which was $10,000,000 lower than the prior year as in 2017 we spent about $6,000,000 on the hurricane affected locations. For the full year, as Tom just mentioned, we generated 6 $10,000,000 in adjusted operating cash flows, an increase of $55,000,000 or an impressive 10% over the prior year. This includes the $20,000,000 of trust proceeds I just mentioned.
So a better number to use is 5.90 $1,000,000 which puts us right near the midpoint of our 2018 guidance range of $575,000,000 to 615,000,000 dollars We disclosed last year that we benefited in 2017 by a similar amount of non earnings related trust withdrawals. Therefore, on a year over year basis, these $220,000,000 working capital initiatives are effectively neutralized. So, with this in mind, the $55,000,000 growth over prior year is primarily due to reduction in our cash tax payments of about $70,000,000 which is offset by cash interest due to the higher debt balances and interest rates we just discussed earlier. Sticking with this topic of taxes, the $60,000,000 we paid in 2018 is a bit lower than we guided on our last call, which is $75,000,000 to 80 $5,000,000 partly due to the tax planning efforts that I just previously mentioned. And as we look ahead to 2019, we are modeling cash taxes to increase by approximately $40,000,000 which would total $100,000,000 which will be a significant headwind for cash flow in 20 19.
We do expect our tax team will continue work identifying tax accounting method change opportunities to help reduce cash taxes as we did in 20 18 and this good work is included in our 2019 cash tax estimates. Maintenance and cemetery development CapEx combined were approximately $204,000,000 for 2018, which is a little higher than our target of $195,000,000 As we strive to remain relevant with our customers, we identified additional opportunities to invest in our facilities as well as customer facing technology improvements, including our location websites. So deducting these recurring expenditures from adjusted cash flow, we calculate our free cash flow for the year at a healthy $406,000,000 or 13% increase over the prior year. So now let's discuss the highlight of
the year, which is clearly
Our liquidity and strong cash generation enabled us to continue our capital deployment strategy with a focus on creating long term value for our shareholders. Utilizing the $406,000,000 of free cash flow generated that I just mentioned, in addition to utilizing some of our cash balance, debt issuance and divestiture proceeds, 2018 was a standout year as we deployed $628,000,000 towards acquisitions, new location builds, dividends and share repurchases. This represents an impressive 56% increase over our 2017 deployment of capital of just over $400,000,000 Now let me walk you through the components of this. As Tom mentioned, it was just a great year for us in terms of acquisitions. We employed approximately $195,000,000 towards acquisitions, more than doubling the $81,000,000 invested in the prior year and significantly exceeding our target range of $50,000,000 to $100,000,000 Acquisitions continue to be our best use of capital as they generally result in a mid teen after tax cash IRR.
We're fortunate to have a couple of large sized deals we executed in 2018, allowing us to extend our operations in several states and areas, including Hawaii, Indiana, Texas and the Mid Atlantic area among others. In addition to acquisitions, we invested $32,000,000 in 2018 or 80% more than the $18,000,000 spent in the prior year on the new build and expansion of several funeral homes during the year, which we expect will provide positive returns to us going forward. This spend is going to develop our footprint in important markets such as Texas, Florida, Colorado and California through the construction of new funeral homes, crematory operations and personal care centers. Dividend payments in 2018 totaled $124,000,000 This was an increase of 14% over the prior year of $109,000,000 Going forward, we expect to continue increase in the dividend as the company's earnings grow as we target a payout ratio of 30% to 40% of normalized net income. Finally, we returned an impressive $278,000,000 of capital to investors in 2018 in the form of share repurchases, which has resulted in the number of shares outstanding being reduced to just under 181,500,000 shares.
We repurchased approximately 7,300,000 shares at an average price of $37.78 Subsequent to year end, we've continued this repurchase program, reducing our outstanding share count by an additional 200,000 shares for a total investment of just under $8,000,000 So now let's shift to our outlook for 2019 in terms of both cash flow and capital deployment. In our press release, we introduced our 2019 guidance range for adjusted operating cash flow excluding cash taxes of $650,000,000 to $710,000,000 When we include the $100,000,000 that were forecasted in forecast taxes, our 2019 guidance range for adjusted operating cash flow is $550,000,000 to $610,000,000 Beginning with the 2018 base of $590,000,000 that I already mentioned and neutralizing for cash taxes of about $60,000,000 in 2018, we have pre tax adjusted operating cash flow of $650,000,000 in 20.18. Based on the mid range per share guidance range, we expect EBITDA in 2019 to grow by about $35,000,000 which we pressured somewhat by an expected increase in cash interest netted to an incremental $30,000,000 of operating cash flow growth in 2019. This brings our 2019 pre tax adjusted operating cash flow expectation to $680,000,000 which is at the midpoint of the pre tax range we disclosed in the press release of $650,000,000 to $710,000,000 Taken out though, the 2019 expected cash taxes of $100,000,000 will be at around $580,000,000 of adjusted operating cash flows, which is the midpoint of our adjusted operating cash flow guidance range of $550,000,000 to $610,000,000 So moving on to CapEx, our expectations for maintenance and cemetery development capital spending in 2019 is $195,000,000 which is slightly lower than our 2018 spend.
Of this total, we estimate approximately $115,000,000 will go towards maintenance capital and the remaining $80,000,000 will go towards cemetery development spending as this capital continues to help drive superior returns for us. At the midpoint of our adjusted operating cash flow forecast guidance of $580,000,000 and adjusted for these recurring capital expenditure items, we calculated our 2019 free cash flow to be estimated at $385,000,000 In addition to the anticipated recurring CapEx of $195,000,000 I just mentioned, we expect to deploy $75,000,000 to $100,000,000 in acquisitions and other growth initiatives, including new funeral home construction opportunities, which together drive mid teen after tax IRRs
returns for us.
So, to summarize, our capital deployment strategy for 2019, we would expect to continue much of the same as you've seen from us. We follow a disciplined and balanced approach designed to yield the highest relative return. And of course, this strategy is predicated on our stable free cash flow, our robust liquidity, which was just over $770,000,000 at the end of the year, as well as favorable debt maturity profile. Additionally, our leverage at the end of the year, which is calculated as net debt to EBITDA in accordance with our credit facility, remained the same as last quarter at right about 3.85 times. So, in conclusion, 2018 was a good year for us as we're able to deploy more than $625,000,000 in capital to drive total shareholder return and to grow our company.
I echo Tom's comments and that none of this would have been possible without the hard work of our dedicated associates and we sincerely appreciate all of their efforts. With that, operator, that concludes our prepared remarks. We'll now open the call up to
And our first question comes from A. J. Rice from Credit Suisse.
J. Rice:] Hi, everybody. A couple of questions, if I could ask. First, the pickup you saw in the cremation rate in the Q4, as you drill down, do you think that's a change in trend? That pickup we're used to seeing.
Yes, A. J, this is Tom. Again, we don't have an exact measurement unfortunately, but I'd say this, if you look at the U. S. Cremation rate in general, it's probably been growing around 150 basis points over the last, call it, 5 years and maybe even pretty consistently.
If you look at SCI's business, we probably were closer to 100 until we stepped into 2018. So, while there may be a little bit of a shift from a consumer perspective. We actually think a lot of this may have a little to do with our efforts to capture cremation consumers, whether that be through the SCI Direct model, whether that be through some pricing change implementations in certain markets where we're more competitive for that, I'd say, price sensitive cremation consumer or whether it be through our digital efforts that now through the websites and search engine marketing that we're beginning to capture a larger share of what I'll call that, again, price conscious direct cremation consumers. So, I kind of view this as a positive thing. Unfortunately, it translates into an average that doesn't look so great.
But the truth is if we're getting more business that we wouldn't have gotten, we like that. So, yes, I don't see anything yet that tells me there's a definite shift in the overall numbers of those consumers.
And would you say you've reflected that? And then in your 2019 outlook, a little higher conversion to cremation?
Yes, I think we have. So, we're going to go forward believing that these are the types of levels that it could grow at. Now again, it could moderate again. I don't want to predict the future, but we believe that will continue, because we'll continue to compete more effectively, particularly for that consumer.
Okay. Eric's comments around the impact of the soft market, particularly in the Q4 December, I guess you highlighted 2 areas, the stuff coming out of
the preneed
funeral backlog into add need was a little bit of an impact. And then on the cemetery perpetual care, can you quantify those? And will that have a lingering impact in the at least in the first half and other markets rebound somewhat, but just trying to understand whether that will be an ongoing impact in the first half?
Yes. I think if you look at the first one you talked about, which was the funeral trust income comparisons, My recollection is it had a minor dampening effect on the 4th quarter to the tune of, let's say, dollars 15 to $20 on average, if I remember correctly. So, it wasn't anything significant. And again, as time goes on, if the market rebounds, those types of things will equalize. Eric will know the numbers on the other, but I'd tell you on the thing to understand about ECF, which I don't know that everybody understands as well, A lot of the ability to draw earnings is dictated by state law.
So, you may have certain states that allow you to take excess income as defined by that certain state and you can do it in certain periods. So as an example, if and you would expect this to be the case, if you looked at your excess income at the end of any certain year and you could withdraw that income, that is an opportunity to create cash flow and create income. Again, it's not in every stage, it's just in certain states. As you think about the Q4, because it dived down so bad and because the year of 2018 was a negative performance year, you probably aren't going to have as much excess income as you would in another year. Now, I don't want to tell you that we can only take it out of year end.
I'm just telling you that there are certain dates and different states restrict when you can take that out. Eric, do you have any color on that?
No. Remember that the internal care fund is split between really 2 separate portfolios. 1 is a total return portfolio, A. J, which we've been moving to over the last few years. And what as Tom has mentioned it is, when you set what you can take out of that return portfolio under the state laws in 2019, it's predicated on 2018 and maybe a couple other prior years.
So, when December got impacted, that's really set in stone for us in terms of 2019's internal care fund distributions, which means that the amount that's in our forecast is probably $2,000,000 to $3,000,000 less in 2019 than 2018. The flip side to that are the other trust funds such as Prairie Ranch Funeral and Cemetery Merchandise and Service Trust that largely rebounded in January and made up those losses. So, we do not have any type of detrimental impact built into our model that would affect funeral sales as average or the cemetery sales average during 2019 as a result of that rebound.
Okay. And then maybe last question just to ask you about acquisition pipeline. I know you had a very strong year in 2018. 2019, it sounds like you're sort of assuming a reversion to the $75,000,000 to $100,000,000 Is that just conservatism? I mean, what's the pipeline look like?
Is there any prospects for another outperformance year in 2019 on acquisitions?
The deals need to fall your way. So, I think that we're still seeing a very robust pipeline, which again, the visibility probably goes out about 9 to 12 months. And so, we're optimistic about our opportunities for this year. And again, depending on a few of these things and how they fall, we could end up at the high end, we could end up in the mid range, but we'll do them. We'll do them at the right returns for our shareholders.
And we're excited about the pipeline and we'll continue to do it. The other thing I'd just point you to is we're seeing more opportunities for new builds than you saw a pretty decent I realize it's not a huge amount of money, but quite a significant increase in the amount of money that we're spending to build new locations in the right place with the right type of facilities and the amenities that our customers today want. So, we're excited about both those channels as we move forward.
Okay. Thanks a lot.
Thanks, David.
Our following question comes from Joanna from Bank of America Merrill Lynch.
Good morning. Thanks for taking the question. So in terms of the guidance, so I appreciate the comments on the cash flow. In essence, right away, we should think about it is that EBITDA will grow to 4%, 5% and then operating cash flow excluding taxes and the sort of one time in nature $20,000,000 benefit. So operating cash flow excluding those two things would kind of grow in that 4% to 5% range, right?
Is that the way to think about it? [SPEAKER
SHACEY PETROVIC INSULET CORP.:]
.:]
I think that's right. The only thing I would just caution a little bit, Joanna, and this is kind of splitting hairs, but we talk about growing the operating profits at 4% to 6% and use the term EBITDA, I believe. If depreciation is flat, you're not going to grow it right on the add back. So, I'd just factor that in as you do your math. That's probably at the lower end of
that range. Yes. I'd say EBITDA is more of a 3% to 5% grower at the midpoint. And then that 4% to 6% is also a per share number, if you remember our 8% to 12% breakdown. And part of that is the reduction in shares helps that as well.
Right.
No, I was just trying to get the understanding of the EPS guidance kind of talking about 8% at the midpoint, but I guess adjusting for the tax of this 11%, but then the operating cash flow growth, I guess, is much slower, but there's a couple of things that make the comps there or comps much more difficult. So just stripping it out, I'm just thinking that sort of the operating to your point, operating earnings growing that mid single digits and then operating cash, excluding taxes and these one time benefits, also growing in the same range. But obviously, the reported operating cash is going to be down year over year, right? But then within that operating earnings kind of outlook, so it sounds like Q1 income are probably going to be down year over year in Q1. So that will imply sort of very robust growth, double digit growth in the rest of the year to get to that mid single digit, call it a low single to mid single digit growth for the year.
So what's driving that and how should we think about the progression? I know you I guess you've tried to flag the cemetery production, I guess materializing. So, is that pretty much Q4 or is there some things that is going to be benefiting Q2 and Q3?
Yes. I think Angela, there's a couple of ways to think about it. Let's start with funeral volumes. We if you go back to look at 2018, 18, we had a very impactful flu season. So, the volume in January was up 10%, the volume in February was up, call it 2.5%, 3% and the volume in March started to tick down 3%.
So, you started off the month with 10% up and you ended up a year that's up 0.5%. So again, you can get some really wild swings in these volumes. So now if you look at where we are today, we expensed to January that was down about 10% in volume. So, we're back to 2017 numbers, if it makes any sense. So, as we think about the rest of the year, you say, I start off with this really bad beginning and what experience has told us is you build that back across the year.
So, you think about the Q1, think of it being down potentially if history is right, call it 4% or 5% down in the Q1 and you would work your way back to close to even by the end of the year. So, funeral would have a very tilted year over year comparison where margin should be a lot better in the last three quarters in the Q1. The second thing I'd factor in is costs. As we think about costs and we've got every year we do we tighten our belt, look hard at cost initiatives. I would tell you that the biggest benefactor of cost initiatives will be in the middle part in latter part of the year.
So again, I'm pointing you towards the Q1 that's a challenge and the rest of the year getting better. That's going to help that you call it double digit growth margin in the back 9 months. And then finally, cemetery, I think cemetery is where we think we're going to grow production pretty consistently throughout the year. And so, the thing to always factor in about the cemetery's profit is that when are you going to construct these things, because you may be selling things that are unconstructed. Well, most of the completed construction occurs in the back half of the year.
So again, I think in our model, the biggest chunk of completed construction is going to be in the Q4. So, that's really what's driving it is, I'd call it a softer funeral environment in the Q1, a back end weighted cemetery because of construction and a little bit of this, I'll call it the expense management piece, but I think that's the smaller piece of them all. And that's really what's driving it, the Q1 underperformance followed by the, I'd say, impressive latter 9 months.
And is there something to be said about, I guess, the Q4 of this year or 2018, I'm sorry, that was impacted by the sales force, I guess, restructuring. So is there some sort of flow through in the beginning of 2019 from the changes that were occurring late, I guess, in 2018?
Yes, Joanna. I think if you take SCI Direct on its own, and again, it's just not as material as the other pieces, so why I failed to mention it. We would expect that the Q1 would be a little turbulent with the onboarding, because people are focused on getting people benefits online. And so there's a lot of distractions, you're probably not doing a lot of hiring. And our belief is and we're already experiencing it is, this is getting better.
So, we feel really good and you're right, as we get to the last quarter of the year, I'd expect a pretty nice bump in our production levels, particularly as you look at SEI Direct.
All right. And if I may, last one on the guidance, right. So obviously on the EPMs, the range, I guess, in terms of the growth, year over year growth is quite wide from growing only 3% to 13%. So I appreciate, I guess, commented that, I guess, if you execute better or towards the high end of your acquisitions that gets you to the higher end. So the lower end, how should we think about that?
What kind of what is baked in for the lower end of the EPS growth? [SPEAKER JAMES D.
BAER PETTIT MSCI, INC.:] D. Baer Pettit MSCI,
Inc.:] Well, the 3% to 13% assumes, remember, that it's the 8% growth at the midpoint of $1.93 Of course, what we've been saying this several times this morning is a lot of that is a $0.05 to $0.06 headwind in earnings per share related to the taxes going from 23% to 25% effective tax rate. Ultimately though, the operation should grow at the upper end as we've just described it. So, your question is what gets you there? And I think what gets you there is that funeral volumes rebound towards the back half of the year like Tom has just described it and gets to a point and has a similar inverse effect as last year did when we were down when we were up 10%, but ended the year at 0.5 percent as we're starting the year down 10%, we expect to get more to the same type level in the end of the year. I think also is that it assumes that cemetery preneed growth continues, but to get to the higher end of those ranges, you'll be more in the mid to high single digits and maybe get to those high single digits percentage growth to be able to get to the high end.
The low end is pretty easy. Some of that stuff doesn't happen and the volume doesn't come back as we expected in the back half of the year, our cemetery production stays more in the middle or low end, that's what really predicates the low end of the range. But we're very comfortable with what we described to you already of being in that 8% to 12%. And again, taken into fact the tax rate because the operations are performing in our opinion expect to perform at the upper end of that.
I'll go back to the queue. Thank you so much for the answers.
Our next question comes from Scott Schneeberger from Oppenheimer.
I got three questions. First one, just you talked about the organic growth for 2019 guidance greater in preneed cemetery or greater in preneed funeral? I assume both in that range, but elaborate a little bit more on the preneed expectations. Thanks.
Sure, Scott. I think we would expect them to be kind of an equivalent range. I think we're guiding both to the mid single digit range, which again, you can probably put your brackets around that however you like. We tend to just call that 4% to 6%. Could we be above that?
Sure. Could we be below it? Sure. But I think we're confident that both of those should achieve that. And I'd say the difference is, we've done 4 to 6 in cemetery for a really long time and it's not that surprising, because again, I think you've got a product mix differential where we're putting in better inventories that we can charge more money for.
And on the funeral side, it's always been a little more challenging. We've guided to the low single digits. We're up in the mid, because we believe Beacon is very effective at our ability to increase particularly the contract count, the number of future customers that we think is grabbing market share as well. So, I'd say that's the equalizer that makes funeral the same range as cemetery this year.
All right. Thanks. And then for my second question, it's a good segue. So Beacon and Funeral, obviously a great trend second and third quarter. We had the hiccup in 4th quarter here, still easy comps in the first half of the year.
I'm just kind of curious how you look at you said still only 75% penetrated. How much use are the sales folks? How much are they actually using it? What do you use is there a lot more beacon driven growth there? Is that going to be the catalyst in or the primary driver in the funeral pre need?
[SPEAKER THOMAS E. SALMON BERRY GLOBAL GROUP, INC.:] Salmon Berry Global Group, Inc.:] Yes, Scott, I think you hit it on the head. Yes. So, let me explain that. We're in 75% of the markets, if my memory serves me, about 50% of our production was out of Beacon at year end.
So, it gives you an idea that says, when we launch into a market, it's more complicated. Everybody probably thinks we announced Beacon and 100% compliance and everybody is using Beacon. Well, it is a big training exercise. There's also complications as you get into an individual funeral home versus, let's say, a combination facility in a state, because again, remember state law is driving a lot of particulars around how we present the contract, how we price it. So, a lot of times we may launch in a state.
I mean, California is a great example. We launched in California, but we are not 100 percent up and running in California yet. So, I just don't want anybody to take away that this is some automatic. Then we get into as you roll into a state, a state, you might find a bug in the software that we need to fix and go back. So, it's our belief that even within the 75 percent market, if we didn't go to another market, we've got a big lift as we move into 2019.
And so, we want to do it right, because I think the other thing, Scott, you understand, we've talked about this is getting the buy in. You're having a lot of people that you're trying to train and get them bought into why this is great. Well, the results are tremendous. I mean, so we can put counselors in front of them and say, look how much more productive, look how much more money they're making. That's the best thing in the world.
The worst thing in the world is roll it out and somebody go, this doesn't work. I'm going to put it aside and pull out my manual contract, because I have a customer in front of me and I don't want to be embarrassed. So, because it's customer facing, we're making sure that the bugs are worked out, that it's right, that the pricing is correct. Because the worst thing in the world is have our counselors say, I can't use the software, it's too cumbersome, it's too challenging. So, I promise you this, we're going to do it right.
It's going to be very impactful, I believe, continuing into funeral. It's our belief, while it's going to be harder and a little more complicated, it's going to have an impact on cemetery as well, but probably 2020.
All right. Thanks. That's helpful. And now, my last question is on Q1 specifically. I don't know if you want to actually get too much in the weeds with providing guidance, but $0.47 last year EPS, it feels like you could be significantly below that in 2019 and obviously you've talked about the progression of the year.
A lot of puts and takes there, but and maybe you want to get into some of the particularly the cost items, But might we be below a $0.40 number in the Q1 entering the year? I just want to get a sense of how we should be modeling this case as we progress? Thanks.
Yes, Scott. Again, we don't give quarterly guidance, so I hesitate to get too specific. But I think you're thinking of with volumes down, let's pretend they're down 4% or 5% for the quarter, which is historically the inverse of what happened in 2018. And you model that through and say, okay, at a variable cost rate, how much of that drops to the bottom line? That impact, you could probably back out of $0.47 I think it probably would get you close to the number that you quoted.
So that's not an unfair assumption. But again, I think there's scenarios where it's a little bit better than 40, and I guess there's a scenario where it's a little bit worse. But that's ballpark of what you probably should expect. And then again, kind of ramping up in the back half of the year, like Joanna mentioned, double digit type of earnings per share growth rates, particularly in the back half of the year.
All right. Thanks, Tom. Appreciate that color.
You bet, Scott. Thank you.
The following question comes from John Ransom from Raymond James.
Hey, good morning. Just going back to the cremation issue, when you sell a cremation through your direct channel versus through your funeral channel, what is the difference in ASP? And did I hear you right to say that the direct channel is growing faster than the traditional funeral channel?
Yes. I mean, the direct channel, John, and first of all, on the pricing differential, remember, when we sell a pre need through our non funeral home, we're probably averaging spend of around, let's call it $2,200 for round sake. Now within that spend, there's a away from home protection and insurance product that we might sell that also could include an earn. So, when you look at the service itself, it might be closer to $1100 or $1200 that's going to flow through your income statement when somebody is deceased, because we've pre sold the other products and delivered them. When you think about our core channel, the average spend of cremation consumers probably closer to $3,700 $3,800 Now what I was describing, John, before is, we're getting better at going what I call the price sensitive, because that $3,700 is probably a blend of people that are spending $5,700 So, there's more direct cremation consumer might average closer to $25,000 $2,600 I'm saying that I think we're competing more effectively today than we have historically for that consumer via the Internet, via price changes that we've made at certain locations where we believe it was opportunistic.
And again, I think just a general awareness of being more competitive. So, that's the way to think about cremation or the way we're thinking about cremation and we think we're growing it through both channels today.
So, what you're saying, just to make sure I'm clear, when the event actually happens in the direct channel, the incremental revenue is only $1100 You've already recognized some other revenue from an insurance product that you've already sold?
That is correct. If you're coming at the blend of what's coming out of the preneed backlog, right, if we're delivering somebody that previously sold, but we also have atneed business and that's probably a little bit higher than that average that were out there. So, it's probably close. So, you're exactly right. The blended average through the channel of servicing a funeral is probably about $1100, $1200
Okay.
Just kind of switching gears, if you look at the capital markets effect on your P and L, not the cash flow from your trust, I know that's not always good to your P and L. But Eric, what's the what was the bad guy in the Q4 from weak capital markets from an EBITDA standpoint versus what do you think would be the offsetting good guy in the Q1 assuming the markets hold knock on wood where they are now? How do we think about that?
Yes. I mean, I think for the I think ultimately the effect of the Q4 in terms of the markets when you think of prearranged funeral turn in at need and cemetery being delivered, the markets really got hammered in December. And so it really doesn't have a very material effect at the end of the day to the financials in the Q4. And of course, as I said before, when you go into 2019 in terms of that same average coming out of the backlog, those markets have generally rebounded. So we're not really predicting much of an effect.
What we were describing earlier was an internal care fund situation that ultimately had a lot to do with some withdrawals that we had last year and that was
probably a $3,000,000 to $4,000,000
as you described hate to use the word bad guy, but it was a $3,000,000 to $4,000,000 detriment quarter over quarter and that hit cemetery revenues and cash flows directly in the 4th quarter.
[SPEAKER JULIEN DUMOULIN SMITH:] John, I would just add, remember it's the volatility of what's happened in this quarter versus what happened last quarter to this calendar based approach. So, go back to 2018 a minute. January was a rocket ship and the markets got crushed
in February.
So, as I think about it, if we can continue strong for the quarter, you might have an actual nice comparison as you think about Q1 2019 versus Q1 2018. We could use a good comparison as
it relates to average backlog. That's right. They're kind of in that $3,000,000
to $4,000,000 range, something like that?
Yes, for cemetery, yes.
Yes, okay. And then lastly, I'm curious about the restructuring of your sales force. I mean, we've certainly seen other companies have kind of protracted material downturns when they restructure comps and what have you. What gives you the confidence that these guys are back in the saddle and that this is just a blip and not something more structural?
I think, 1, because we're getting feedback directly from the leadership of SCI Direct and I think it's gone quite a bit better. And I think ultimately, John, this is better for everybody because these sales counselors now by being employees enjoy some of the benefits of being an employee of SCI from insurance to retirement opportunities, whereas before they didn't have those. So, I think we think in the end, it's a better proposition. It's just turmoil while it's happening, because there's a lot of uncertainty. And like I said, you've got managers that are out there dealing with existing key employees versus, let's say, hiring, particularly in this one, it's about finding counselors to sell and
we're not doing a lot
of that while you're onboarding.
So, do you think ultimately you'll have lower turnover? Is that one of the main goals?
I do. I believe that will occur, yes.
Okay. Thank you. That's it for me.
Thanks, John.
The following question comes from Duncan Brown from Wells Fargo.
Hey, good morning. Most of my questions have been answered, but just wanted to follow-up, trying to get a better sense on what's going on in funeral core revenue per service, down 1.4%. And it sounds like trust fund impact was a little bit, but the vast majority of it was the cremation change. Is that correct? And maybe could you size that?
Yes. So, if I recall correctly, at the customer level, before you take away mix for the quarter, we saw 70 basis points of improvement. So, think of it as we got inflationary pricing at 70 basis points, which isn't exciting, but it's positive. And now I go back and I say 40 basis points of that was currency, believe it or not, because again, Canadian currency hurts us and you can correlate that with the oil market, right? Oil prices crashed in the Q4, Canadian currency crashes.
So, for the year, Canada is not a big deal, but the quarter is a pretty big deal. There's probably 20 basis points of trust income difference. So, now I've got 60 offset 70. So, to get to my 150 bps problem, I got a 160 basis point decrease because of the cremation mix change, if that makes sense Duncan. So, by far, the biggest is the cremation mix change.
With the oil markets rebounding in the Q1, I think currency is probably not going to be as big of an issue as we think about the year right now. So, the big thing to think about is that. And trust income, it's a minor part, but we're probably always the big gorilla to think about is always that cremation mix change and how big it is year over year. That's perfect. Thanks for sizing that.
And we have a follow-up from Joanna from Bank of America Merrill Lynch.
If I may just squeeze in on the Beacon discussion that was happening a while ago. So is there some sort of stats you can give us in terms of the performance in those markets where utilization of the Beacon system is getting better traction in terms of market share or some stats on the preneed sales or anything else you can give us that would be helpful? Thank you.
Sure, Judah. I don't have any at my fingertips. We're happy to try to share more of that. But I tell you this, like I said, market share is hard to define yet, because it's such a new product. And again, this is used on a preneed basis and we don't have good market share data for preneed.
But I will tell you that within places where we've implemented this and maybe the great example was, we first launched this, I think in like the second and third quarters, we saw a significant if you put comp markets against each other. I want to say, Steve, it was 400 basis points or 500 basis points differential. Jerry, is that right? Where as far as growth rates within the markets where we've implemented it versus not implemented it, 500. So, Jan, they're saying 500 basis points to take a, I'd say, a typical market and forgive me for rounding, if we're growing at 2% by putting Beacon in place, we're getting 7% growth is the types of things that we saw.
And again, those are in every market is going to be a little bit different. What's your take up rate? How is your sales force embracing change as far as technology in certain areas is more than others? So, there's a lot of factors, but generally that's the kind of difference. And quite honestly, what's really impressive is most of it is the number of contracts.
The average sales, pretty normal as we think about it. So, we're really seeing we're getting in front of more people. We're capturing more market share. And that's what's exciting to me is that eventually turns to add new revenue that will benefit the company.
Great. Thank you.
You're welcome.
I will now turn the call back over to the SCI management team.
Thanks so much everybody for being on the call. We look forward to talking to you for our Q1 earnings at the end of April, I believe. Thanks so much.
Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.