Welcome to the First Quarter 2017 Service Corporation International Earnings Conference Call. My name is Eric, and I'll 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 SCI Management. Please go ahead.
Hi, and good morning. This is Debbie Young, Director of Investor Relations at SCI. Before we begin today with prepared remarks about the quarter from Tom and Eric, let me just quickly go over the customary Safe Harbor language. 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. Today, 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 in our press release and 8 ks that were filed yesterday. With that behind us, I'll now turn the call over to Tom Ryan, SCI's Chairman and CEO.
Thank you, Debbie, and good morning, everyone, and thanks for joining us on the call today. Today, I'm planning to give an overview of the quarter followed by a more detailed analysis of our funeral and cemetery operations, and finally, comment on our outlook for 2017. Let's begin with an overview of the quarter. This was one of those special quarters where a lot of things just went our way. Having said that, success is where opportunity meets preparation and our team was prepared.
Excluding the significant special items like the IRS settlement, which had a significantly positive impact on earnings per share, we reported adjusted earnings per share of $0.38 for the quarter, which was a $0.10 increase over the prior year quarter. While we expected to have easier comparisons in the first half of 2017, you may recall we were facing a couple of headwinds in the Q1 related to the lost financial contribution from the LA Archdiocese property and the perpetual care capital gain distribution, which collectively contributed $0.03 in the prior year quarter. Offsetting these two headwinds in the quarter was a $0.03 non cash benefit in our tax provision related to a revised accounting standard for share based compensation. So at a high level, I would summarize the $0.10 increase in the quarter like this. Higher operating profits in our comparable business led by a double digit percentage increase in our preneed cemetery sales production and an increase in the funeral services performed contributed $0.07 of growth in adjusted earnings per share.
The remaining $0.03 of growth was attributed to lower interest expense, a lower adjusted tax rate from tax planning strategy and fewer shares outstanding. We also reported strong operating cash flows of $188,000,000 which was relatively flat as compared to the prior year. We accomplished this despite headwinds from expected higher cash taxes and interest payments as well as the loss of cash flows from capital gain distributions in the LA Archdiocese property. Eric will provide more color on this in a moment. We continue our commitment to deploying our free cash flow to the highest and best use.
In the Q1, we returned $108,000,000 back to our shareholders in the form of share repurchases and dividends paid. Additionally, during the quarter, we deployed $33,000,000 of capital towards acquisitions representing 5 transactions consisting of 6 funeral homes and 5 cemeteries and spent approximately $6,000,000 in construction of new funeral home location. Now let's talk about funeral operations and how they performed for the quarter. Comparable funeral revenue grew by $10,000,000 or just over 2% compared to the same period last year. Recall, we told you on our last call that we were anticipating an easier comparison in the first half of the year as funeral volumes were unusually weak in the prior year quarter.
However, volume in the current quarter came in above the levels that we had expected. As shown in the press release, core revenue increased $9,500,000 or 2.3%. Comparable core funeral services performed increased 1.1% and the core funeral average also grew 1.2%. When you exclude the impacts of cremation mix, which increased 110 basis points, we experienced a 1.9% improvement in organic growth at the customer level. We also continue to see growth in recognized preneed revenue of $3,300,000 or 11.5%.
Recall, these are the products within the preneed contract, which are delivered immediately after the sale, primarily Other funeral revenue, proponents of which is general agency revenue, was down $3,700,000 or 11% compared to the prior year quarter. While our preneed funeral sales production grew 1.8%, the increase was driven by SCI Direct, whose contracts are funded by trust, non insurance. Our core preneed funeral sales production declined by 1.4% and insurance funded production declined a bit more by $8,500,000 or 6.7%. I will address this core preneed funeral sales production decline in more detail in a moment. So finally, as it relates to the funeral margins, funeral operating profits grew $6,000,000 and operating margins expanded 70 basis points to 22.7% in the quarter.
In total, this operating profit growth is about what we would expect on the incremental revenues experienced during the quarter. High margin operating revenues were partially offset by the net negative impact from the loss of general agency revenues minus their selling costs as well as inflationary increases in our fixed cost structure. Now back to our discussion of preneed sales activity that I referenced earlier as it relates to the decline in general agency revenues for the quarter. Our preneed sales production increased $3,800,000 or 1.8 percent for the quarter. This was fueled by a $6,100,000 or 15.6% increase in SCI Direct production.
Core funeral sales production declined by $2,300,000 or 1.4%. Remember that the preponderance of our sales production is written by counselors that provide both cemetery and funeral products and services. In our new sales manager compensation plans, which revised the focus on counselor productivity, production credit has been enhanced for preneed cemetery property as well as near term funeral maturity or terminally imminent contracts as we have referred to them before. This has probably put a more acute emphasis on cemetery sales production and capturing near term funeral services, which is a good thing. However, it probably has had the effect of slightly drawing attention away from growing core preneed funeral sales production.
We still anticipate that with our enhanced sales tools that we can return the low to mid single digit growth in our core preneed funeral production later in the year. Now shifting to cemetery operation. I couldn't be more pleased with the exceptional growth in our cemetery segment during the quarter, as top line comparable cemetery revenue grew over $21,000,000 or 8%. Recognized preneed revenue accounted for $24,300,000 of the increase aided by a $3,600,000 increase in atneed revenue. This core revenue increase, which totaled 27,900,000 was slightly offset by a $7,200,000 decrease in perpetual care trust fund income.
This decline is due to a capital gain distribution received in the prior year quarter that did not reoccur in 2017. We would expect a similar decrease in perpetual care trust fund income in the second quarter, then the comparison should normalize as we move to the back half of twenty seventeen. While our comparable cemetery revenue recognized under GAAP grew at just over $21,000,000 during the quarter, our preneed sales production, which is our total selling activity more than kept pace, growing at an impressive $23,800,000 or 13%. Of this $23,800,000 increase in sales production, dollars 16,300,000 was from property sales. Of this impressive 14.1% increase in property sales, about half of the growth was generated from large sale activity of specialized inventory, which we continue to develop.
The other half was driven by increases in our core property sales from both higher quality sales and increased contract velocity. Preneed property sales production exceeded preneed property recognition by over $18,000,000 and this excess sales production should be recognized later in the year once we complete construction. Finally, cemetery operating profits grew $8,700,000 and operating margins expanded 140 basis points to 23.1%. High margin core revenue growth of $27,900,000 was partially offset by $7,200,000 revenue decline in perpetual care trust fund income, which carries a 100% margin. Fixed costs grew slightly higher than their anticipated inflationary levels, mainly due to increased maintenance and incentive compensation costs.
So to wrap it up, our team has delivered an extraordinary Q1 and I want to thank and congratulate everyone for their tremendous effort. We also feel good about our momentum going into the remainder of the year. While we exceeded our own expectations in the Q1, there is still 9 months to go as it relates to our annual guidance achievement. But we are optimistic that we can achieve earnings per share results at the higher end of our guidance, to be consistent with our past practice, we will refrain from reassessing our guidance until we reach the half year mark. Lastly, we continue pursuing our 3 core strategies of growing our revenues, leveraging our scale and deploying capital in a disciplined manner towards the highest and best use for the long term benefit of our company and our shareholders.
With that, I will turn the call over to Eric.
Thanks, Tom, and good morning, everybody. Today, as usual, I'm going begin by giving you a few thoughts on our cash flow results and capital deployment both during the quarter before touching upon some comments on our full year guidance. So let's start with the details of the cash flow during the quarter. And as you've seen and we've noted earlier, we generated a healthy $188,000,000 of adjusted operating cash flow during the quarter, which was as we anticipated slightly down from the prior year quarter. While quarterly cash earnings grew impressively over prior year, this growth was offset by a few items.
1st, and again as expected, cash tax payments increased nearly $12,000,000 as a result of our transition to becoming a full cash taxpayer. We paid about $19,000,000 during the quarter versus $7,000,000 in the prior year quarter in terms of cash taxes. 2nd, cash interest payments increased about $4,000,000 which is more of a timing issue among quarters and was also in line with our expectation. We paid about $20,000,000 in cash interest during the quarter versus about $16,000,000 dollars in the prior year quarter. 3rd, cash flow during the quarter was impacted by the $7,200,000 associated with cemetery perpetual care distributions that occurred last year and did not reoccur this year as well as the loss of a couple of $1,000,000 related to the contribution from certain businesses divested in the prior year.
And lastly, keep in mind that the excess tax benefit from the accounting change related to share based compensation benefited our adjusted EPS by about $0.03 per share or about $6,400,000 However, this accounting change had no impact as on our adjusted operating cash flow as we define it. Our recurring capital expenditures during the quarter, which again consists of maintenance CapEx and cemetery development CapEx came in at about $34,600,000 for the quarter, which is about $4,000,000 lower than prior year primarily related to timing of those expenditures. We also continue to be comfortable with our $180,000,000 expectation of these recurring capital expenditures for the full year of 2017. Going back to the quarter, when you deduct these quarterly recurring capital spend items from our adjusted cash flow from ops, we calculate our free cash flow for the Q1 to be about $154,000,000 which is about $3,000,000 over the prior year. Now let's shift to the cash deployment that we had during the quarter.
First, we have cash on hand of $238,000,000 $282,000,000 of availability on our long term credit facility at the end of the quarter. But after taking into account that some amount of our cash is encumbered primarily due to cash residing in Canada, which is about $110,000,000 as well as expected minimum operating cash flows, we believe our unencumbered liquidity to be approximately 4 $50,000,000 at March 31, which we view as very favorable. Our leverage measured on a net debt to EBITDA basis was 3.7 times and this remains well within our targeted range that we've consistently expressed of 3.5x to 4x in terms of leverage. Shifting to capital deployment, we deployed almost $150,000,000 of capital towards acquisitions, new location builds, dividends and share repurchases. In terms of the breakdown, we invested just over $33,000,000,000 in acquisitions and this includes some 1031 exchange funds of approximately $14,000,000 which is really representing a great start to the year.
As always, I want to reiterate that these acquisitions normally result in very compelling after tax cash IRR. To expand what Tom has already mentioned, these acquisitions occurred across our footprint, which include New York, Wisconsin, British Columbia, Iowa and Florida, and each are projected to generate after tax cash IRRs between 14% and 18%. Additionally, we also invested $6,000,000 on the new build expansion of several funeral homes during the quarter. And finally, we returned an impressive $108,000,000 of capital to our investors, committed just under $84,000,000 to repurchase 2,800,000 shares and paying just under $25,000,000 in dividend payment. The number of shares outstanding at the end of the quarter then has been reduced to just under 188,000,000 shares.
Now subsequent to the end of this quarter, we continued to buy back shares, invested in about $11,000,000 to repurchase just under about a 500,000 shares. Again, that's after the quarter ended. We still have 274,000,000 dollars of remaining share repurchase authorization, which gives us a substantial amount of capital deployment flexibility as we move forward in 2017. Now, I'd like to just take a minute and discuss taxes. First, I'd like to provide a brief update on the settlement of the IRS audit that I discussed in our last conference call in February.
During the quarter, we received from the IRS Office of Appeals a settlement of the audits for the tax years 1999 through 2005, which had the effect of increase in our taxes payable by a net amount of $40,000,000 The final computations remain under review by the IRS and are expected to be finalized soon with payment made shortly thereafter. But remember, we plan to fund this net dollars payment utilized in our credit facility and therefore we do not expect this will impact our planned capital deployment during 2017, nor do we expect this to have any meaningful impact to our liquidity or our leverage ratio. Staying on the topic of taxes, I'd also like to briefly touch upon our effective tax rate for the quarter, which you may have noticed appeared unusual. Our effective income tax rate on a GAAP basis for the Q1 was a tax benefit of 77%, predominantly due to the release of the tax reserves associated with this IRS audit settlement that I just mentioned. When you remove the effect of this IRS audit settlement, our adjusted effective tax rate was 30.6% for the quarter.
This quarterly rate was also positively affected by the share based compensation accounting change related to share based awards that were exercised during the Q1. So if we were to exclude the benefit from these options being exercised in the Q1, our normalized tax rate would have been 36.7%. This compares favorably to the 38.7% in the Q1 of 2016. And this 200 basis point reduction is a result of our ongoing tax planning initiative. Looking forward, I would expect our adjusted effective tax rate to trend around 36% to 37%, but that figure is absent any future positive tax rate effect from options being exercised in the remaining quarters of 2017.
So lastly, in conclusion,
we're off to
a great sales and operational start in 2017. Our robust cash flow coupled with the strength of our balance sheet continues to provide us with a tremendous amount of financial flexibility to continue to deploy our capital to increase shareholder value. We remain very confident with our existing 2017 guidance range for adjusted operating cash flow of 465 $1,000,000 to $505,000,000 This strong cash flow coupled with our substantial liquidity and our favorable near term debt maturity profile create a strong platform for us to continue deploying capital to the highest relative return opportunity. And as I mentioned in February, we expect to deploy $75,000,000 to $100,000,000 in acquisitions and new funeral home construction opportunities during the year. And based on our current share count and our dividend rate, we expect to pay around $100,000,000 in dividend during the year.
This allows any excess cash to be available for deployment to other value accretive opportunities, which include our share repurchase program. So we appreciate you joining us this morning and we'll now open it up for questions.
Thank you. We will now begin the question and answer session. And our first question comes from A. J. Rice from UBS.
A. J, your line is now open.
A.
J, if your line is on mute, please be sure to unmute. And our next question comes from Ryan Halstead from Wells Fargo. Ryan, your line is now open.
Thanks. Good morning.
Good morning, Ryan.
So I wanted to touch on the cemetery preneed sales production, which was a really strong quarter. I wanted to better understand the property growth that you called out, the 14% with half of that coming from the large prices. Can you just maybe give a little more color on is that is some of that related to some of that development that had been in process that you were selling in advance and booking once completed or is that something else?
Yes. So, the 14% Ryan is referring to production. So, it would have nothing to do with recognition. It would be what are we selling. And what we define as a large sale is a sale above $40,000 typically that's going to be an inventory product again back to our tiered product pricing, where we've developed something very special.
We completed some projects up in Vancouver that we had a lot of sales activity in the Q1 related to Ching Ming. And that was a big driver of our success when you think about that high end property. But to just give you a little bit of flavor, if you think about the units that we sell above $40,000 we probably sold them, do a little bit from memory, about 330 or 3.40 units above that in the Q1. And that compares to I think it's about a 90 unit increase over last year. So the velocity in that category is up about 40%.
And I think the production is about 20%. So, what you're really seeing is a lot more people going to that price point for what they view and we view as significant value in the type of property that we're able to develop.
Okay, that's helpful. And then, I mean, are there other cemetery development projects ongoing right now that you're currently selling into, but not recognizing any of the revenues or cash flows until it's completed. If you could just help us think about how to maybe capture that over the course of this year?
Yes. I mean, Rob, we're constantly, because again, I think this is a type of product that we're seeing the customers really want. So, we're always developing somewhere generally moving around the country in different sections. And the way to think about it, we had an unusual, I would say Vancouver was pretty big project that we completed in the Q4, but you're always going to see the same effect. You're going to see the Q1, your production is going to be higher than your recognition rate and that's probably going to continue into the back half the year.
And then generally in the for sure in the Q4 and some of the Q3, you'll begin to see a lot of that pent up sales that is going to get recognized associated with completion of the construction project. So we pointed out to you today, we've built about $18,000,000 of sales that didn't get recognized in the Q1. That number is going to go up in the 2nd quarter and then begin to get recognized as you approach the back half of the year.
Okay. That's very helpful. I appreciate that. Then maybe moving on to the funeral segment. Obviously, some great margin expansion there.
I understand there was some easier comps and still some good volume sort of above and beyond that. So
I guess what I was
wondering, my sort of, I guess, general rule of thumb has been that 1% to 2% same store funeral revenue growth is typically what you look for to maintain your margins. But you had some nice margin expansion. Was there any one aspect of your funeral revenue performance in the quarter that really drove that margin expansion?
Well, I think one of the things that's helpful is not big, but if you look at the revenue recognition from preneed sales, we grew that about I think it was $3,300,000 as you think about that category. That's growing it, I'm recalling about a 15% cliff. That's an exciting part of what we're doing and that again gets into SEI Direct and their success at selling a product that relates to that customer base. The other thing is, if you look at the core revenues, we're able to grow them, I believe, at around 2.3%. So back to your 1% to 2%, what that says is if we get 1% and some change, we ought to be able to hold our margins constant.
If we get above 2, then we probably should be growing our margins. We saw it, we're up 70 basis points in the Q1. So, it really kind of came in, Ryan, as we expected model. That isn't always the case. There can be some lumpiness in some of the costs sometimes, but it performed as we would have expected seeing the revenues come in like they did.
Okay. And then maybe my last question. It looks like there has been some nice production on the non funeral home side. I'd be curious just to hear your thoughts on where we are, I guess, in terms of cremation, the penetration or the sales cycle of preneed cremation contracts. Is there just kind of a sort of a catching up happening now in that sales cycle with the atneed customer profile?
Or are we seeing sort of a higher incidence rate of preneed customers choosing cremation plans?
I think we're seeing a slightly higher there's definitely a growth in that market. But as you think about SCI Direct and the way we think about it, a lot of the growth is organic. Some of it is opening new place and we'll continue to be able to expand into new markets as it relates to our variety of brands under SCI Direct. But having said that, it's going to it meets the law of bigger scale every time. So, if we open 3 stores when you have 50, that's one growth rate.
If you open 3 stores and you have 100, it's a different growth rate. So, at some point, this double digit growth, we expect to begin to move more towards maybe a high single digit, mid single digit. But what we're really excited about is our management team, SCI Direct has done a tremendous job of driving growth really beyond our expectations. And so we're excited about their continued ability to grow that and it will continue to be something that we'll call out because it's going to grow at higher rates than our core business.
Great. Thanks for taking my questions.
Thank you, Ron.
And our next question comes from Joanna Gajuk from Bank of America. Joanna, your line is now open.
Thank you. Thanks for taking the question. So if I just may quickly on the guidance, right away, you said that in general, you do not change your guidance range after Q1. So this time, you said you expect to be at the upper end on the adjusted EPS, but at the same time, you sort of kept the cash flow outlook unchanged, your range unchanged. So is it because kind of viewed the guidance somewhat conservative, but also reflecting the accounting change impact on EPS while it does not affect the cash flow outlook.
Is that how we should be thinking about it?
Yes. I think there's two factors, Joanna, and you just hit on 1. The share based compensation accounting change, which obviously isn't specific to SEI for every company, had an effect on the EPS. But the way we define adjusted operating cash flow that was never in our number. So it didn't have a cash effect based on what the guidance was built on in the first place.
That's really the first effect to it. The other thing is we have a substantial movement on our cash flow stream related to cash taxes. And there's some even more noise around IRS audit, but independent of putting all that aside, our normalized cash taxes as we become a full cash taxpayer means that our cash tax rate is getting pretty close to it will get pretty close to the rate in our provision in our income statement. And that bog year difference is about $40,000,000 to $45,000,000 compared to 2016. And that $40,000,000 to $45,000,000 is going to ebb and flow during the year, but that's a big bogey for us to overcome.
And it's kind of a little bit of a moving target. And for that reason, we felt more comfortable just reiterating the cash flow guidance at this point in time, coupled with kind of the policy that we just described and you mentioned earlier is that 3 months doesn't make a year and it's a little early to make any material changes in annual guidance.
All right. That's helpful. And then on the outlook, I guess, so to speak, so you still expect $180,000,000 of the recurring CapEx and you're still kind of reference the other commentary on the acquisition. So is that number when you talk about acquisition that includes the $25,000,000 on the funeral home development? Is that how you kind of combine?
No, it does not. The $180,000,000 is maintenance, CapEx, which is probably about $100,000,000 of it roughly and cemetery development CapEx of about $80,000,000 And that $80,000,000 is exactly what Tom was just talking about in terms of building the inventory that the sales force has to sell during the year. The amount that we will spend above and beyond that in terms of the growth CapEx, which relates to greenfield opportunities and such as you just mentioned is about $25,000,000 And again, that is over and above that $180,000,000
dollars
Okay, great. And then when you talk about acquisition, that's sort of you kind of view it as the same kind of bench for the year or is there more traction on the deal front?
Well, first of all, we're very excited about the pipeline related to the acquisition opportunities. And I think we were consistent now with what we said in February on that front. But to answer your question, we expect to spend probably about deploy capital is a better way to say it of $75,000,000 to $100,000,000 during the year. And yes, the $25,000,000 that you just described would be part of that basket that I just mentioned.
Okay, great. And if I may just may have one follow-up on the prepared commentary when you talk about the cemetery margins, which were very strong. But then you also mentioned something about higher costs there. So can you just flush it out a little bit more? Thank you.
Yes. I think when we mentioned the higher cost, it was slightly above inflationary levels for our fixed costs. And the 2 we called out, one was maintenance. And again, I think some of the timing for cemetery maintenance and the other piece was incentive compensation. So as you can expect, when you have good results like this, we've got accrued bonus for the company's bonus plan.
And so right now, those are pointing up pretty nicely. So, it just showed up a little more as we allocate that cost of funeral and cemetery. So again, that's probably more of a timing issue, but something that's a little higher than our 2% inflationary expectation.
Great. Thank you so much.
Thanks, Shannon.
Thank you.
And our next question comes from Scott Schneeberger from Oppenheimer. Scott, your line is now open.
Good morning. This is Daniel on for Scott. Congratulations on a good quarter. Can you guys give us an update on your cost savings initiatives? How impactful that might have been in the quarter and what do you expect for the next couple of quarters?
I think in general, as Tom just mentioned, we really want to hold our fixed cost structure to grow in the year 1% to 2%. And a large amount of our cost structure, of course, is personnel. And what comes of that is benefit. And we all know the pressures on benefit costs in our country right now. So there's other savings and synergies that we have defined to maintain that fixed cost structure and we're pretty good at doing that.
But generally, it's just making ourselves more efficient from the process, people, technology front. And getting a little bit more specific in that, for example, we implemented a F and A ERP system last year. It was Oracle. And from that, we expect change processes and create some synergies from that perspective. So it's more I would consider it more from a support function perspective in terms of that synergies and that support function is not just in Houston though, it's spread throughout our markets as well.
We've been doing a really good job, especially in the operational leadership in terms of creating those synergies for us and always make us more efficient, but at the same time supporting the customer service satisfaction that faces our customer, which again is the most important spend that we could have.
Okay, got it. Great. On funeral volumes and average revenue per service, can you guys help us think about the cadence there if we look out the couple of quarters?
Yes. I mean, I think the way to think about it, clearly, funerals are very seasonal thing. So, you're going to see your highest volumes in the Q1 and then the Q4 will be your 2nd highest volumes. And those are going to be driven more likely than not in what's happening with flu in a quarter over quarter basis. While we didn't see a big flu season this year, last year was an incredibly meek one.
So the comparison looks good. As we think about the rest of the year, we guide people to say we think it's going to be flat to slightly down on an annual basis. Our expectations for the back half of the year is to hopefully hold on to a flat year if we could do that or slightly below that. That would mean more than likely we're going to see a slight decline in the back half. Now having said that, we don't know.
I mean, that's just one of those things that unfortunately or fortunately, we don't have the ability to predict. But again, when you think about the capacity and our ability to flex costs, we're going to be nimble in how we deal with whatever the volume that comes to us in the next quarter has happened.
Got it. Thank you very much.
And our next question comes from A. J. Rice from UBS. A. J, your line is now open.
Thanks. I'll try again. Hello, everybody. First of all, obviously, we've been in a fairly robust financial markets for some time. I'm wondering if that has gotten to the point where it's starting to impact the relative attractiveness of the cases coming out of the preneed backlog versus your atneed.
Can you just comment on how those might compare these days, preneed maturing contract, it's been in your book for a while versus just in that need on a relative profitability and relative revenue per case?
Well, the as you saw in the press release, the preneed average that's coming out was pretty strong as you saw that, and it's stronger than the atneed average as well, A. J, from our core operation. See that the atneed was up just over 0.3%, but the preneed turned atneed is up about 3. Now I will tell you that there's some noise in there because of the situation that we changed last year that you've heard us talk about before related to customers that were deemed to be in our internal language, terminal in nature, where before those calls were including an atneed versus writing the contract on a preneed basis. When you adjust that noise out, A.
J, you still have a couple of 100 basis points increase in terms of year over year growth in the matured pre need average versus just a walk in average year over year. I think some of that has to do though with the incredible job that our prearranged funeral sales force has done, utilizing packages and utilizing the customer facing techniques to continue to drive that average of what's going into our backlog. And that I would say is the largest component of what we're starting to enjoy as it comes out. And you do have a good point though. The market has been affecting it and I do think we're enjoying 6% to 7%, maybe 5% to 6% nominal growth in the trust funds, but we are enjoying probably 2% to 3% real return growth in the trust funds and that's going to have an effect.
So, love that 2% growth of matured pre need, maybe that's 30, 40 basis points of it. Does it help? Yes. But is it the majority of it? It's really not.
It really has to do with again giving credit to our sales leadership and what we're able to do in terms of selling and giving the customer what they want that's going into the backlog on a prearranged basis.
Okay, that's great. And I know the initiatives to roll in, I guess, the HMIS system and then the Salesforce system more recently, Where are you at with that? Is that still sort of transition holding you back a little bit on the sales effort? Or is or should we start to see a reacceleration there pretty soon?
Yes, A. J, you mentioned a couple of different ones and I'll mention 3. So, sales force is really the customer relationship management tool. It is fully implemented, but I think the power of that, it's one of those things that over time as you begin to utilize it, it becomes part of your core of what you do. You begin to see the real benefits pay out.
I'd tell you that we're starting to see that. I think there's still a lot of runway as to what we can do with that product. You mentioned HMIS Plus. HMIS Plus is our customer facing tool that we're utilizing our funeral homes to make arrangements, generate the contract, but it takes people through, I'd say, a much more robust and consistent presentation of items offered. That is pretty much rolled out in its entirety.
Like everything, some places take to it really well. Some places we go back and do retraining. So, we're in that process. The last piece that you mentioned is we're taking what basically the customer facing opportunity of HMIS Plus and putting into what we call sales enablement. Sales enablement is going to allow our sales force to take that same power of what we do in the funeral home on the road.
And that is going to be launched in the back half of this year. And so again, the productivity from that when we did the test markets was pretty significant. So, we feel highly confident that that sales enablement tool should really enhance maybe the Q4 of 2017, but probably more appropriately 2018 2019 as you roll this thing throughout the country.
Okay. That's great. And then a final question, some reference to doing some transactions with a 1031 exchange. Can you just remind us what typically drives you doing it that way? And are the economics materially different on those transactions than traditional ones?
What it is, is that we go through periodic processes where we're divesting of excess cemetery land or businesses themselves. And when we do that, the tax laws allow you to put those funds into essentially a trust account over a period of time and you can utilize those funds to purchase or part of the purchase of the Nxt acquisition. And what that allows you to do is really shield you from a capital gain situation. And so it's a tax efficient mechanism of doing it, is the reason why we do it, A. J.
Does it have a material effect on the IRR? Not really.
Okay. All right. That's great. Thanks a lot.
And our next question comes from John Ransom from Raymond James. John, your line is now open.
Hi, good morning. At the higher end of your guidance, how should we think about preemie growth in cemetery for the rest of the year? I know you mentioned you sold some stuff that you're going to realize later, but I was having a hard time translating that relative to your kind of ongoing 6% to 8% goal?
Yes, John. I think it was a real upside Q1 in productivity. I think the way we think about it is, we had an idea of what we thought we could do on preneed cemetery sales and that's always going to be in the mid to high single digit growth rates. We did 13% in the Q1. I think when we think about the rest of the year, we still think that rest of the year can still achieve that 6% to 7%.
It isn't like I don't think it's our opinion that we're going to give back that trajectory, but I also would caution 13% is pretty high stepping. So that's probably not going to be sustainable. But I don't think of it as something that we pulled forward into the Q1 and we're going to give back in the back half of the year.
Right. Are you seeing any I mean, I know this is soft as hell, but are you seeing any uptick in what I'd call consumer confidence or just willingness to spend more? Or is it just correlating to other stuff?
Definitely, I think at the high end, we're seeing that. And particularly in certain markets again. And the correlation, John, a lot of times you can see it in housing prices. I mean, the markets that have the vroom, vroom going on in the real estate markets generally are markets where we see high end inventory that's moving. So it is correlating to consumer confidence.
I would say across the board, not so recognizable yet. But
from a
business perspective, you hear a lot of confidence in the market right now.
So the sales guys are wearing their MAGA hats, I guess, they're all in. The last thing I was just wanting to understand a little better. I know you've done a good job in the funeral sector of managing the cash flows using the insurance product. If your preneed cemetery sales grow, say, 10%, is that a short term working capital burn? Or are you managing your preneed cemetery to a cash neutral basis no matter what growth is?
It's a working capital burn because I think the average down payment is in the call it 35% to 40% range on cemetery. Now what ends up happening is if you do it long enough, you're beginning to layer in that collection base. So as an example, this quarter that I think was somewhat surprising to Eric and I as we're looking at the numbers is with these sales, you said, wow, you got a big use of capital. But the surprising thing was the collections that we're getting on the last few years, you also see that somewhat offset that working capital. So, yes, it's a temporary cash flow use, but it kind of quickly makes up for itself.
So again, let's assume, I mean, just for argument's sake of $5,000 cemetery sale, how much of that do you collect in your is it typically a 4 year installment sale and you collect 25% in year 1? I mean, just what's the kind of year 1 cash in cash out versus what you have to pay your sales guide and how long are those contracts generally?
First of all, if you purchase cemetery property, it'd probably be $100,000 but I'll do your 5.
I think Hey,
I drive a 20 10 Toyota. I live small.
So, you can afford I work for
a humble regional firm. I live small here.
So anyway, John, it varies. So what I was saying before is I think on average, we get 35%. But what is that 35%? Some people pay in full. Some people are going to put, I'd say, let's say 10% down, maybe 20% down, and they're going to pay over 3 to 5 year period on average.
But again, it's really across the board. You see different things in different regions and the like.
So you collect 35% and you got to pay the sales guide 20% or something?
Yes, I mean all in across the board about that.
Okay. So there's a point. So you're cash flow positive on average in year 1, it just might take a few months to get there.
Yes, pretty close because you're exactly right. Think about it, we don't have it. You're selling something, there's no cash outlay, it didn't like you're having to replace your widget. So that recognition has no cash other than selling costs associated with the property.
And then I'm sorry to keep drilling down, but so of that year, let's assume you collect 35% of the cash. How much are you generally recognizing something like and I know the accounting rules about revenue recognition are very arcane in cemetery, but how does that compare to the revenue you recognize in year 1? Is it 35% or is it a different number?
No, no. What happens is that once you get the 10% down, which again as Tom says predominantly happens on day 1, But once you build the Mausoleum in that example is when you get to recognize it, which could occur in the Q4, which is what you saw our last Q4 to make it lumpy. So when you take that, I know we're talking about a single contract, John, but when you take it across the entire network over an entire 12 months, think of it this way, about 90% to 92% of the amount that you sold actually goes through the income statement in the same year. I think that's a good rule of thumb for you to use when you're modeling.
Okay. John, the other thing is that we're talking about property sales. Think about a typical customer. If I buy property, merchandise and services, I'm going to make a rounded example, 60% of my spend is on property, which will be recognized when I sell it generally. And the other 20% buckets are merchandise and service.
Those are just like funeral. They're going to get put into a trust fund, they're going to get deferred and they get recognized when we deliver the product for the service.
And then my last question and going to the funeral side, what you're selling today into the backlog, how does that ASP compare to what your average ASP is, that you realize this quarter? In other words, is there a big premium? Are you selling stuff at a higher price today? Or is it kind of been not I know that there's a lift from stuff coming out of backlog. I'm just trying to figure out what that pig in the Python looks for kind of future ASP?
Yes. Pig in the Python is good. So we're selling it a few $100 above what's coming out today. So, I'd say that's a great thing. The one thing to keep in mind as you look at some of these disclosures, when we sell in SCI Direct, and remember SCI Direct is growing at a pretty rapid rate.
So when you blend it, sometimes it may look like it's coming down. But we view those as 2 different channels. If you look at it, SCI Direct is growing the average price per contract as well as our core business is growing the average price per contract. So when we say in the core business, what's coming in is 100 of dollars higher than what's coming out today.
And SCI Directs, what, 2,100, 2,200, something like that?
I think it's 23 now. Yes, it's about 2,300.
Okay, great. Thanks. That's all for me.
Thanks, John. Thanks, John.
We have no additional questions at this time.
Okay. We want to thank everybody for being on the call with us today. We look forward to speaking to you after our Q2 results in the last week of July. Have a great day.
Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.