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Edited Transcript of SCI earnings conference call or presentation 27-Apr-17 1:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Service Corporation International Earnings Call

Houston Apr 30, 2017 (Thomson StreetEvents) -- Edited Transcript of Service Corporation International earnings conference call or presentation Thursday, April 27, 2017 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Debbie Young

Service Corporation International - Director of IR

* Eric D. Tanzberger

Service Corporation International - CFO and SVP

* Thomas L. Ryan

Service Corporation International - Chairman of the Board and CEO

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Conference Call Participants

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* Albert J. Rice

UBS Investment Bank, Research Division - MD and Equity Research Analyst, Healthcare Facilities

* Daniel Erik Hultberg

Oppenheimer & Co. Inc., Research Division - Associate

* Joanna Sylvia Gajuk

BofA Merrill Lynch, Research Division - VP

* John Wilson Ransom

Raymond James & Associates, Inc., Research Division - MD, Equity Research and Director of Healthcare Research

* Ryan K. Halsted

Wells Fargo Securities, LLC, Research Division - Senior Equity Analyst

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Presentation

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Operator [1]

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Welcome to the First Quarter 2017 Service Corporation International Earnings Conference Call. My name is Eric, and I will be your operator for today's call. (Operator Instructions) Please note that this conference is being recorded.

I will now turn the call over to SCI management. Please go ahead.

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Debbie Young, Service Corporation International - Director of IR [2]

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Hi, 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-K that were filed yesterday.

With that behind us, I'll now turn the call over to Tom Ryan, SCI's Chairman and CEO.

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Thomas L. Ryan, Service Corporation International - Chairman of the Board and CEO [3]

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Thank you, Debbie, and good morning, everyone, and thanks for joining us on the call today. Today, I plan 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.

So let's begin with an overview of the quarter. This was one of the 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 our 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 first quarter related to the lost financial contribution from the L.A. Archdiocese property and the perpetual care capital gain distribution, which collectively contributed $0.03 in the prior year quarter. Offsetting these 2 headwinds in the quarter was a $0.03 noncash benefit in our tax provision related to revised accounting standard for share-based compensation.

So at high level, I would summarize the $0.10 increase in the quarter like this. Higher operating profits in our comparable businesses, 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 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 million, 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 L.A 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 first quarter, we returned $108 million back to our shareholders in the form of share repurchases and dividends paid. Additionally, during the quarter, we deployed $33 million of capital towards acquisitions representing 5 transactions, consisting of 6 funeral homes and 5 cemeteries, and spent approximately $6 million in construction of new funeral home locations.

Now let's talk about funeral operations and how they performed for the quarter.

Comparable funeral revenue grew by $10 million 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 level that we had expected. As shown in the press release, core revenue increased $9.5 million or 2.3%. Comparable core funeral services performed increased 1.1% and the core funeral average also grew 1.2%. When you exclude the impact 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 recognize preneed revenues of $3.3 million or 11.5%. Recall these are the products within the preneed contract, which were delivered immediately after the sale, primarily representing cremation-related merchandise and travel protection membership plans sold by our non-funeral home network.

Other funeral revenue, the preponderance of which is general agency revenue, was down $3.7 million 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, not insurance.

Our core preneed funeral sales production declined by 1.4% and insurance-funded production declined a bit more by $8.5 million 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 million 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 from incremental revenues experienced during the quarter. High-margin operating revenues were partially offset by the net negative impact from a 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 $3.8 million or 1.8% for the quarter. This was fueled by a $6.1 million or 15.6% increase in SCI Direct production. Core funeral sales production declined by $2.3 million or 1.4%. Remember that the proponents of our sales production is written by counselors that provide both cemetery and funeral products and services. And our new sales manager compensation plans, which we revised to focus on counselor productivity, production credit has been enhanced for preneed cemetery property as well as near-term funeral maturities 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 tool, that we can return to low to mid-single-digit growth in our core preneed funeral production later in the year.

Now shifting to cemetery operations. 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 million or 8%. Recognized preneed revenue accounted for $24.3 million of the increase, aided by a $3.6 million increase in atneed revenue. This core revenue increase, which totaled $27.9 million, was slightly offset by a $7.2 million increase to perpetual care trust fund income. This decline due to a capital gain distribution received in the prior year quarter that did not recur 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 2017. While our comparable cemetery revenue recognized under GAAP grew at just over $21 million during the quarter, our preneed sales production, which is our total selling activity, more than kept pace, growing at an impressive $23.8 million or 13%. Of this $23.8 million increase in sales production, $16.3 million was from property sales. Of this impressive 14.1% increase in property sales, about half of the growth was generated from large sale activity a 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 million and this excess sales production should be recognized later in the year once we complete construction.

Finally, cemetery operating profits grew $8.7 million and operating margins expanded 140 basis points to 23.1%. High-margin core revenue growth of $27.9 million was partially offset by $7.2 million revenue decline to perpetual care trust fund income, which carries a 100% margin. Fixed cost grew slightly higher than their anticipated inflationary levels, mainly due to increased maintenance and incentive compensation cost.

So wrap it up, our team has delivered an extraordinary first quarter 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 first quarter, there is still 9 months to go as it relates to our annual guidance achievement. While 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.

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Eric D. Tanzberger, Service Corporation International - CFO and SVP [4]

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Thanks, Tom, and good morning, everybody. Today, as usual, I'm going to 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 million 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. First, and again as expected, cash tax payments increased nearly $12 million as a result of our transition to becoming a full cash taxpayer. We paid about $19 million during the quarter versus $7 million in the prior year quarter in terms of cash tax. Second, cash interest payments increased about $4 million, which was more of a timing issue among quarters and was also in line with our expectations. We paid about $20 million in cash interest during the quarter versus about $16 million in the prior year quarter. Third, cash flow during the quarter was impacted by the $7.2 million associated with cemetery perpetual care distributions that occurred last year and did not recur this year as well as the loss of a couple of million dollars 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 $6.4 million. However, this accounting change has no impact on our adjusted operating cash flow as we define it.

Our recurring capital expenditures during the quarter, which again consist of maintenance CapEx and cemetery development CapEx, came in at about $34.6 million for the quarter, which is about $4 million lower than prior year, primarily related to the timing of those expenditures. We also continued to be comfortable with our $180 million 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 first quarter to be about $154 million, which is about $3 million 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 million and $282 million 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 million, as well as expected minimum operating cash flows, we believe our unencumbered liquidity to be approximately $450 million at March 31, which we view as very favorable. Our leverage, measured on a net debt to EBITDA basis, was 3.7x and this remains well within our targeted range that we've consistently expressed of 3.5 to 4x in terms of leverage.

Shifting to capital deployment. We deployed almost $150 million of capital towards acquisitions, new location builds, dividends and share repurchases. In terms of the breakdown, we invested just over $33 million in acquisitions and this includes some 1031 exchange funds of approximately $14 million, which is really representing a great start to the year. As always, I want to reiterate that these acquisitions normally resolve in very compelling after-tax cash IRRs. To expand what Tom has already mentioned, these acquisitions occurred across our footprints, 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 million on the new build and expansion of several funeral homes during the quarter. And finally, we returned an impressive $108 million of capital to our investors, committed just under $84 million to repurchase 2.8 million shares and paying just under $25 million in dividend payment. The number of shares outstanding at the end of the quarter then has been reduced to just under 188 million shares. Now subsequent to the end of this quarter, we continue to buy back shares, investing in about $11 million to repurchase just under about 0.5 million shares, again, that's after the quarter ended. We still have 274 million of remaining share repurchase authorization, which gives us some 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 increasing our taxes payable by a net amount of $40 million. 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 $40 million 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 first quarter 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 first quarter. So if we're to exclude the benefit from these options being exercised in the first quarter, our normalized tax rate would have been 36.7%. This compares favorably to the 38.7% in the first quarter of 2016. And this 200 basis point reduction is a result of our ongoing tax planning initiative.

Looking forward, I would expect that 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 million to $505 million. 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 million to $100 million in acquisitions, in 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 million in dividends 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're now opening it up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from A.J. Rice from UBS.

And our next question comes from Ryan Halsted from Wells Fargo.

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Ryan K. Halsted, Wells Fargo Securities, LLC, Research Division - Senior Equity Analyst [2]

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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?

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Thomas L. Ryan, Service Corporation International - Chairman of the Board and CEO [3]

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Yes. So the 14%, Ryan, is referring to production. So it would have nothing to do with recognition. It'd be what are we selling. And what we define as a large sale is the sale above $40,000, typically, that's going to be an inventory product and back to our tiered product pricing where we develop something very special. We completed some projects up in Vancouver that we had a lot of sales activity in the first quarter 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, doing a little bit from memory, about 330 to 340 units above that in the first quarter. And that compares to, I think, it's about 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 -- we view is significant value in the type of property that we're able to develop.

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Ryan K. Halsted, Wells Fargo Securities, LLC, Research Division - Senior Equity Analyst [4]

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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.

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Thomas L. Ryan, Service Corporation International - Chairman of the Board and CEO [5]

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Yes. I mean, Ryan, 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 we think about it, we had an unusual -- I would say Vancouver was a pretty big project that we completed in the fourth quarter, but you're always going to see the same effect. You're going to see the first quarter, your projections are going to be higher than your recognition rate. And that's probably going to continue into the back half of the year. And then generally in the, for sure, in the fourth quarter and some of the third quarter, you'll begin to see a lot of that pent-up sales that is going to get recognized associated with the completion of the construction project. So we pointed out to you today, we built about $18 million of sales that didn't get recognized in the first quarter. That number is going to go up in the second quarter and then begin to get recognized as you approach the back half of the year.

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Ryan K. Halsted, Wells Fargo Securities, LLC, Research Division - Senior Equity Analyst [6]

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Okay, that's very helpful. 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 volumes sort of above and beyond that. 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?

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Thomas L. Ryan, Service Corporation International - Chairman of the Board and CEO [7]

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Well, think if -- one of the things that's helpful is not -- it's big. But if you look at the revenue recognition from preneed sales, we grew that about, I think it was $3.3 million as you think about that category. That's growing at, I'm recalling, about a 15% clip and that's an exciting part of what we're doing. And that again gets into SCI 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 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. You saw that we're up 70 basis points in the first quarter. So it really kind of came in, Ryan, as we expect and model. That isn't always the case. There can be some lumpiness in some of the costs sometimes. But it performed as we would've expected, seeing the revenues come in like we did.

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Ryan K. Halsted, Wells Fargo Securities, LLC, Research Division - Senior Equity Analyst [8]

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Okay. And then maybe my last question. Looks like there has been some nice production on the non-funeral home side. I'd be just -- I'll 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?

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Thomas L. Ryan, Service Corporation International - Chairman of the Board and CEO [9]

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I think we're seeing a slightly higher -- there's definitely a growth in that market. But as you think about SCI Direct and why we think about it, a lot of the growth is organic. Some of it is opening new places. And we'll continue to be able to expand in the new markets as it relates to sort of a 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 a 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 a -- something that we'll call out because it's going to grow at higher rates than our core business.

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Operator [10]

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And our next question comes from Joanna Gajuk from Bank of America.

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Joanna Sylvia Gajuk, BofA Merrill Lynch, Research Division - VP [11]

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So if I just may quickly on the guidance, what you said that, in general, you do not change your guidance 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 view the guidance somewhat conservative but also reflecting the accounting change impact on EPS while it does not affect cash flow outlook? Is that how we should be thinking about it?

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Eric D. Tanzberger, Service Corporation International - CFO and SVP [12]

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Yes. I think there's 2 factors, Joanna, and you just hit on one. The share-based compensation accounting change, which obviously isn't specific to SCI, for every company, had an effect on the EPS with 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 -- will get pretty close to the rate in our provision in our income statement. And that bogey or difference is about $40 million to $45 million compared to 2016. And that $40 million to $45 million 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 a 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.

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Joanna Sylvia Gajuk, BofA Merrill Lynch, Research Division - VP [13]

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All right, that's helpful. And then on the outlook, I guess, so to speak. So you still expect the $180 million of the recurring CapEx and you're kind of referring the other commentary on the acquisitions. So is that number, when you talk about acquisition, that includes the $25 million on the funeral home development? Is that how you kind of combine it?

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Eric D. Tanzberger, Service Corporation International - CFO and SVP [14]

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No, it does not. The $180 million is maintenance CapEx, which is probably about $100 million of it roughly, and cemetery development CapEx of about $80 million. And that $80 million is exactly what Tom was just talking about in terms of building the inventory that the sales force then 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 million. And again, that is over and above that $180 million.

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Joanna Sylvia Gajuk, BofA Merrill Lynch, Research Division - VP [15]

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Okay, great. And then when you talk about acquisitions, 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?

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Eric D. Tanzberger, Service Corporation International - CFO and SVP [16]

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Well, first of all, we're very excited about the pipeline related to the acquisition opportunities that 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 million to $100 million during the year. And yes, the $25 million that you just described would be part of that basket that I just mentioned.

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Joanna Sylvia Gajuk, BofA Merrill Lynch, Research Division - VP [17]

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Okay, great. And if I may, just maybe one follow-up on the prepared commentary, when you talk about cemetery margins, which were very strong. But then you also mentioned something about higher cost there. So can you just flesh it out a little bit more?

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Thomas L. Ryan, Service Corporation International - Chairman of the Board and CEO [18]

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Yes, I think when we mentioned the higher cost, it was slightly above inflationary levels for our fixed cost. And the 2 we called out, one was maintenance, and again, I think some of this is timing of the cemetery maintenance. And the other piece was incentive compensation. So as you can expect, when you have good results like this, we've got to accrue 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 just a little higher than our 2% inflationary expectation.

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Operator [19]

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And our next question comes from Scott Schneeberger from Oppenheimer.

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Daniel Erik Hultberg, Oppenheimer & Co. Inc., Research Division - Associate [20]

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This Daniel on for Scott. 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?

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Eric D. Tanzberger, Service Corporation International - CFO and SVP [21]

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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 with that is benefit and we all know the pressure is on benefit cost in our country right now. So there's other savings in 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&A ERP system last year. It was Oracle. And from that, we expect to 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 synergies, and that support function is not just in Houston though, it's spread throughout our markets as well. But we're been doing a really good job, especially in 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.

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Daniel Erik Hultberg, Oppenheimer & Co. Inc., Research Division - Associate [22]

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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 a couple of quarters?

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Eric D. Tanzberger, Service Corporation International - CFO and SVP [23]

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Yes, I mean, I think the way to think about it, clearly, it's a very -- funeral is a very seasonal thing. So you're going to see your highest volumes in the first quarter and then the fourth quarter will be your second 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 can 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 on how we deal with whatever the volume that comes to us when the next quarters happen.

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Operator [24]

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And our next question comes from A.J. Rice from UBS.

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Albert J. Rice, UBS Investment Bank, Research Division - MD and Equity Research Analyst, Healthcare Facilities [25]

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First of all, obviously, we've been 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, so the cases coming out of the preneed backlog versus your atneed. Can you just comment on how those might compare these days, preneed maturing contracts, it's been in your book for a while, versus just an atneed on a relative profitability and relative revenue per case?

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Eric D. Tanzberger, Service Corporation International - CFO and SVP [26]

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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 included in the atneed versus writing the contract on a preneed basis. When you adjust that noise out, A.J., you still have a couple of hundred basis points increase in terms of year-over-year growth in the matured preneed average versus just the 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. Now 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 fund and that's going to have an effect. So of that 2% growth of matured preneed, 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.

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Albert J. Rice, UBS Investment Bank, Research Division - MD and Equity Research Analyst, Healthcare Facilities [27]

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Okay, that's great. And I know the initiatives to roll in, I guess, the HMIS system and then the sales force 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?

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Eric D. Tanzberger, Service Corporation International - CFO and SVP [28]

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A.J., we 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+. HMIS+ is our customer-facing tool that we're utilizing in 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 to do retraining. So we're in that process. The last piece that you mentioned is we're taking basically the customer-facing opportunity of HMIS+ and putting into what we call sales enablement, and sales enablement is going to allow our sales force 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 test markets, was pretty significant. So we feel highly confident that, that sales enablement tool should really enhance maybe the fourth quarter of 2017 but probably more appropriately '18 and '19 as you roll this thing throughout the country.

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Albert J. Rice, UBS Investment Bank, Research Division - MD and Equity Research Analyst, Healthcare Facilities [29]

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Okay, that's great. And then a final question. Some reference to doing some transactions with the 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?

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Eric D. Tanzberger, Service Corporation International - CFO and SVP [30]

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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 next 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.

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Operator [31]

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And our next question comes from John Ransom from Raymond James.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD, Equity Research and Director of Healthcare Research [32]

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At the higher end of your guidance, how should we think about preneed growth in cemetery for the rest of the year? I mean, you mentioned you sold some stuff that you're going to realize later but also translating that relative to your kind of ongoing 6% to 8% goal.

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Thomas L. Ryan, Service Corporation International - Chairman of the Board and CEO [33]

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Yes, John, I think it was a real upside first quarter 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 first quarter. I think -- 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 also caution 13% is pretty high stepping. So that's probably not going to be obtainable. But I don't think of it as something that we pull forward in the first quarter and we're going to give back in the back half of the year.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD, Equity Research and Director of Healthcare Research [34]

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Right. Are you seeing any -- but 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 parlaying to other stuff?

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Thomas L. Ryan, Service Corporation International - Chairman of the Board and CEO [35]

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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 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.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD, Equity Research and Director of Healthcare Research [36]

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So the sales guys are wearing their MAGA hats, I guess, or 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 mutual basis no matter what the growth is?

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Thomas L. Ryan, Service Corporation International - Chairman of the Board and CEO [37]

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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 that you do it long enough you're beginning to layer in that collection base. As an example, this quarter, I think, was somewhat surprising as Eric and I were 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.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD, Equity Research and Director of Healthcare Research [38]

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So again, let's assume, I mean, just for argument's sake, a $5,000 cemetery sale. How much of that do you collect every year? 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 yourself guide? And how long are those contracts generally?

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Thomas L. Ryan, Service Corporation International - Chairman of the Board and CEO [39]

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First of all, if you purchase cemetery property, it'd probably be $100,000 but I'll do your $5,000. 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 a 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.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD, Equity Research and Director of Healthcare Research [40]

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So you collect 35% and you got to pay the sales guy 20% or something?

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Thomas L. Ryan, Service Corporation International - Chairman of the Board and CEO [41]

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Yes, I mean, all-in across the board, about that.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD, Equity Research and Director of Healthcare Research [42]

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Okay. So there's a point. So you're cash flow positive on average in year 1. Just might take a few months to get...

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Thomas L. Ryan, Service Corporation International - Chairman of the Board and CEO [43]

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Yes, pretty close, too. You're exactly right. If you think about it, we don't have a -- you're selling stuff and there's no cash outlay. It isn't like you're having to replace your widget. So that recognition has no cash other than selling cost associated with the property.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD, Equity Research and Director of Healthcare Research [44]

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Yes. And I'm sorry to keep drilling down, but of that year, let's assume you collect 35% of the cash, how much are you generally recognizing? Is it something like -- 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?

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Eric D. Tanzberger, Service Corporation International - CFO and SVP [45]

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No, no, what happens is, is that once you get the 10% down which again, as Tom says, predominately happens on day 1. But once you build the mausoleum in that example is when you get to recognize it, which is going to occur in the fourth quarter, which is what you saw in our last fourth quarter 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.

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Thomas L. Ryan, Service Corporation International - Chairman of the Board and CEO [46]

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John, the other thing is that -- we're talking about property sales. Think about a typical customer, if I buy property, merchandise and services that I'm going to make a rounded example. 60% of my stance 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 what we deliver the product towards a service.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD, Equity Research and Director of Healthcare Research [47]

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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 realized this quarter? In other words, is there a big premium? Are you selling stuff using that prior price today or is it kind of not -- I know that there's a lift from stuff coming out of the backlog. I'm just trying to figure out what that pig in the python looks toward kind of future ASP?

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Thomas L. Ryan, Service Corporation International - Chairman of the Board and CEO [48]

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Yes. Pig in the python is good so we're selling it a few hundred dollars above what's coming out today so that's the great thing. The one thing to keep in mind as you look at some of these disclosures, when we sell an SCI Direct, 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 knew those as 2 different channels. If you look at SCI Direct, it's 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 hundreds of dollars higher than what's coming out today.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD, Equity Research and Director of Healthcare Research [49]

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And in SCI Direct, it's, what, $2,100, $2,200, something like that?

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Thomas L. Ryan, Service Corporation International - Chairman of the Board and CEO [50]

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I think it's $2,300 now.

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Eric D. Tanzberger, Service Corporation International - CFO and SVP [51]

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Yes, $2,300.

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Operator [52]

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We have no additional questions at this time.

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Thomas L. Ryan, Service Corporation International - Chairman of the Board and CEO [53]

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Okay. We want to thank everybody for being on the call with us today. We look forward to speaking to you after our second quarter results in the last week of July. Have a great day.

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Operator [54]

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Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.