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Edited Transcript of SCI earnings conference call or presentation 19-Feb-19 2:00pm GMT

Q4 2018 Service Corporation International Earnings Call

Houston Feb 21, 2019 (Thomson StreetEvents) -- Edited Transcript of Service Corporation International earnings conference call or presentation Tuesday, February 19, 2019 at 2:00:00pm 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 - Senior VP & CFO

* Sumner J. Waring

Service Corporation International - SVP of Operations

* Thomas Luke Ryan

Service Corporation International - Chairman & CEO

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Conference Call Participants

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* Albert J. William Rice

Crédit Suisse AG, Research Division - Research Analyst

* Duncan Brown

Wells Fargo Securities, LLC, Research Division - MD and Senior High Yield Health Care Analyst

* Joanna Sylvia Gajuk

BofA Merrill Lynch, Research Division - VP

* John Wilson Ransom

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

* Scott Andrew Schneeberger

Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst

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Presentation

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Operator [1]

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Welcome to the Fourth Quarter 2018 Service Corporation International Earnings Conference Call. My name is Sophia, 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 CSI (sic) [SCI] management. You may now begin.

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

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Good morning to the SCI call. Thanks for joining us as we discuss our fourth quarter and our year-end results. As usual, I'm going to go through the customary safe harbor language before we begin with prepared remarks from the quarter from Tom and Eric.

The comments made by our management team today will include statements that are not historical and are forward-looking. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, those factors identified in our press release and in our filings with the SEC that are available on our website. In today's comments, we may also refer to certain non-GAAP measurements such as adjusted EPS, adjusted operating cash flow and free cash flow. A reconciliation of these measurements to the appropriate measures, calculated in accordance with GAAP, is provided on our website and in our press release and 8-K that were filed yesterday -- or early this morning, actually. All right, with that over with, I'll now turn the call over to Tom Ryan, SCI's Chairman and CEO.

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Thomas Luke Ryan, Service Corporation International - Chairman & CEO [3]

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Thanks, Debbie. Hello, everyone, and thank you for joining us on the call this morning. Today, I'd like to start by reflecting on the full year of 2018, then I'll get into the analysis of the fourth quarter and end with some color on our outlook for 2019. So first, some observations looking back at the year 2018.

For the full year, we were proud to report double-digit percentage growth and adjusted earnings per share and adjusted operating cash flow. The $1.79 we reported on adjusted earnings per share was a $0.24 or more than 15% improvement over 2017. Solid revenue increases, particularly in the cemetery segment, were somewhat offset operationally by higher salaries and wages from intentional adjustments made in the beginning of the year as well as from higher self-insured health and general liability costs that were not anticipated. These increased costs impacted both business segment as well as general and administrative expense. In total, operations, including the overhead burden, contributed $0.11 to the $0.24 earnings per share improvement.

Increased debt levels from acquisition funding and higher average variable rates tied to LIBOR, led to higher interest expense for the year that effectively offset the favorable impact from lower average share count. So the remaining $0.13 in earnings per share improvement for the year was from a favorable tax rate, which was primarily due to the lower federal rate from the 2017 tax act as well as favorable state tax results.

Comparable funeral segment operating profits for the year were over $369 million, a decrease of $3.6 million compared to the prior year. The funeral operating margin percentage was within our guidance range at 19.9%, down by 50 basis points. For the second straight year, we saw comparable funeral volumes grow, while average revenue per case was relatively flat. We experienced a 1% inflationary growth at the customer level, which was offset by the negative effect on the average from a 140 basis point increase in the cremation volume mix.

For the year, SCI Direct sales production were in the high single-digit percentages but a change in how we allocate price at the contract level, from a recognizable administrative fee to the deferred service revenue, resulted in a temporary year-over-year decline in reported revenues and profits. Comparable cemetery profits for the year improved by over $36 million, and we expanded the operating margin percentage by 170 basis points, above our guidance range to 30.4%.

We experienced solid revenue growth of 4.3% for the year, primarily driven by the success of our preneed efforts. A solid double-digit percentage increase in other revenue, which is primarily very high-margin perpetual care trust fund income, had a more pronounced impact on reported margin percentage. This solid operational performance and the resulting $610 million of adjusted operating cash flow, not only funded our over $200 million of maintenance CapEx for our locations and cemetery inventory development, but funded almost $195 million of purchase price, acquiring 35 new locations across several transactions and geographies.

Additionally, we've spent another $32 million on constructing new funeral homes, which have a slightly longer cash payback but have the benefit of ideal location in an updated new facility, which should provide a nice trend of growth going forward. Even after this significant increase in growth capital investment for the year that I just mentioned, we were able to return more than $400 million to our shareholders in the form of share repurchases and dividends, a 30% increase over 2017. We delivered these results, while at the same time, making strategic investments in our digital platforms, our customer experience and engagement, and most of all, in our people. Recall that we've previously mentioned the implementation of Beacon, our new tablet-based prearrangement tool that provides a seamless digitized presentation for our client families, while reducing the administrative burden for our sales counselors. It's exciting to see how this platform is beginning to yield a more effective and productive sales force. At year's end, we have rolled out Beacon for prearranged funeral sales to approximately 75% of our core funeral locations. There is a real upside opportunity early in 2019, as we achieved deeper penetration into these markets that were rolled out over the latter half of 2018.

Currently, we are supporting that uptick opportunity in the newly implemented markets and are now in the process of rolling Beacon into the Vancouver market. Then later in the second quarter, we plan to turn our primary attention and resources to the implementation of Beacon in our cemetery locations. Cemetery is a more complex implementation so the funeral earnings are crucial to successful cemetery implementation. We should begin to roll into certain markets, in the latter half of 2019 and would anticipate a meaningful impact in 2020.

Also during 2018, we did a complete overhaul of the look and feel of our location websites through dignitymemorial.com. These newly redesigned websites have helped us to reach an all-time high in web traffic to the Dignity Memorial site with over 96 million visitors and a 21% increase in traffic year-over-year. In 2018, our new websites produced a record number of website preneed leads and atneed customer interactions. This positive trend has continued into 2019.

Additionally, we've invested in resources and technology to drive improvements and visibility in our location online reputation ratings, as well as generating consumer demand through digital market campaigns. We are continuing to invest in 2019, and we believe this will provide significantly more leads at a much lower average price today and also may result an increase in our market share and enhanced sales activities.

Finally, we have made significant investments in our people. Early in the year, we made strategic adjustments in compensation for key customer-facing employees. We have incrementally invested in training and development, specifically around initiatives dealing with broader inclusion and diversity training as well as leadership training. I feel really good about the momentum of our team.

Now for an overview of the fourth quarter. As you saw in our press release yesterday, adjusted earnings per share grew $0.04 or 8% to $0.54 per share compared to the same period last year. We knew this would be a challenging comparable quarter on an operational earnings per share front for 2 primary reasons. First, last year's quarter had the beginning of the flu season impact that would make funeral volumes comparison difficult. Next, while we're confident in preneed cemetery sales production growth in this quarter, we had almost $8 million of cemetery revenue recognition in the prior year quarter associated with completed, relatively large construction projects in Vancouver. So we knew our comparable cemetery revenue recognition rate would be a challenge. The good news on the operational side is that preneed cemetery sales production was very strong, coming in with almost 12% growth. We were even able to overcome the lower recognition rate to grow profits and when combined with the profits from acquisitions, they contributed almost $0.04 to earnings per share growth for the quarter. Funeral profits were lower, as volumes were down over 1% as we had anticipated. Unfortunately, the cremation rate increased 170 basis points, putting downward pressure on the funeral average. Increased costs from wages and self-insured health care expenses put further pressure on our funeral profits.

General and administrative expenses also increased and were higher than we anticipated, as we increased the projected self-insured liabilities associated with general workman's comp and auto claims during the quarter. Additionally, we increased legal reserves associated with a legal settlement in the fourth quarter. The funeral profit decline and the increased general and administrative expense effectively offset the positive earnings per share growth from cemetery operations and acquisitions for the quarter.

Finally, interest expense offset the favorable impact of lower average shares outstanding so the quarter-over-quarter improvement was primarily attributable to a favorable tax rate, at both the federal and state level.

Now shifting to some more detail around the funeral operating performance for the fourth quarter. Comparable funeral revenue decreased $13 million or approximately 3% compared to the same period last year and fell short of our expectations. This decline is primarily attributable to a decrease of $11 million in our core revenue, where we saw an approximate 1.5% decline in both the volume and average revenue per case. While we anticipated the decline in volume due to the full-forward impact of a strong flu season in late 2017, which continued into early 2018, the decline in sales average was higher than our expectations. The average revenue per case decline was despite a 70 basis point increase at the organic customer level, as an unfavorable 180 basis point increase in the core cremation mix and unfavorable currency effect in the negative fourth quarter market returns effect on trust income, more than overcame the slightly higher customer spend. I believe some of our increased cremation mix is attributable to us being more competitive for the price-sensitive cremation customer, which is a good thing. Additionally, our mix change rates are consistent with kind of trends that we're now seeing.

Recognized preneed revenues declined by $2.3 million in the quarter. This decline is a direct result of lower preneed sales production during the quarter from our nonfuneral home businesses. During the fourth quarter, we had some temporary disruptions in sales caused by an early 2019 transition of our SCI Direct sales team from independent contractors to onboarding them as employees. We expect the temporary disruption to continue during the first quarter of 2019 and stabilize early in the second quarter.

Shifting to funeral profit. We experienced a decline in operating profit of $7.7 million and operating margins decreased by 110 basis points to 20.1%, primarily due to the revenue decline. Although we continue to see increases in labor cost, including higher health care expenses, we saw reductions in overall selling-related expenses, which helped to minimize the margin decline. Comparable preneed funeral sales production decreased $4.2 million or 2.1% in the fourth quarter of 2018 compared to 2017. We experienced a double-digit decline in contracts written for our SCI Direct channel, which is primarily related to the temporary construction of transitioning our counselors to employee status that I previously mentioned. For the core channel, we grew contracts sold slightly. We reduced the direct mail spend during the quarter as we transitioned to a new vendor. And our sales team focus was tilted towards cemetery sales activity, which contributed nicely for our fourth quarter earnings.

For the full year, we grew preneed funeral sales production a solid 6.5%, beyond our low single-digit percentage guidance. We believe this success was a direct result of the impact of our new Beacon system, which assists our sales counselors in a more effective and efficient customer interaction. We believe Beacon will continue to have a positive impact on 2019 sales activity.

Now turning to our cemetery operations for the fourth quarter. We are very pleased with the fourth quarter preneed sales performance. For the year, we guided our total preneed cemetery sales production with land in the 4% to 6% range. Because of tough 2017 comps in the first half of 2018, we communicated to you that a lot of the year-over-year growth was going to come in the second half of the year. Well, our sales team delivered and was able to grow preneed cemetery sales by an impressive 12% in the fourth quarter, which resulted in a 4.3% increase for the year. So hats off to the entire sales organization.

Now onto cemetery GAAP results, which you see in the income statement. Total comparable cemetery revenue grew more than $12 million or almost 4% for the quarter. We experienced a $17 million or 7.5% increase in recognized preneed revenue, which was a function of the strong production I referred to as well as higher merchandise and service deliveries. Recall how we grew preneed sales by 12%, so in the fourth quarter, we grew backlog production that should benefit the coming quarters as we construct the property recognizing revenue. Partially offsetting this recognized preneed revenue increase, was a $4.5 million decrease in perpetual care trust fund income. It's important to note that for the full year, our perpetual care trust fund earnings has increased an impressive $9.5 million or 15%, partially reflecting our initiative to shift trust fund assets to a total return strategy in states where permitted. However last year, the incremental benefit of increased earnings associated with this strategy and excess income withdrawal opportunities was weighted to the fourth quarter. Therefore, this is more of a timing issue for our fourth quarter comparison.

From a profit perspective, comparable cemetery operating profits grew about $3 million and nearly 3%. However, cemetery margins declined 30 basis points for the quarter. The margins from higher operating and sales-driven revenues achieved were somewhat muted by the reduction of higher margin trust fund income, coupled with higher labor and healthcare costs.

Now let's shift to discussion about 2019. Our guidance for adjusted earnings per share in 2019 is $1.84 to $2.02 per share. At the midpoint of that range $1.93, this represents an 8% increase over 2018 earnings per share. This projected increase is absorbing a higher effective tax rate of just over 25% compared to the 23% adjusted effective tax rate we reported in 2018, which benefited from favorable state tax true ups. Therefore, at the midpoint of our guidance, pretax earnings per share growth is projecting an 11% increase before incurring the higher tax rate for 2019. We believe this increase will come as it has historically with the organic business contributing 4% to 6% growth in earnings per share and contributions from recently acquired businesses, as well as the effect of the 2018 and 2019 share buybacks contributing an additional 4% to 6% of earnings per share growth.

Allow me to briefly discuss the underlying assumptions regarding the base business growth for 2019. First, funeral revenue should grow around a flat to 2% range. We expect the first quarter volumes to be down, as we've already seen in January, as it is comparing to a very robust 2018 quarter impacted by the heavy flu season. Based on history, we would expect the remaining 3 quarters to give back a significant portion of the activity. We expect the average revenue per funeral to continue to be challenging with cremation mix negatively impacting moderate inflationary prices. We will manage costs aggressively. For comparative purposes, this should be tilted more to the back half of the year, and we anticipate margins for the year to be in a 20% or so range. Margin should contract in the first quarter and working back to positive comparisons in the latter 9 months. We anticipate preneed funeral sales production to grow in the mid-single-digit percentage range for the year as Beacon should have a spillover effect into 2019.

Next, we expect cemetery sales production and cemetery operating revenues to grow in the mid-single-digit percentage range. Other revenue, predominantly comprised of perpetual care trust fund income, should be flat or grow moderately. As the larger share of assets under our total return strategy grows income but is somewhat offset by lower excess income distributions, based upon the poor financial market performance at the end of 2018. As we think about quarterly cadence, we would expect a very moderate cemetery profit growth, particularly in the first half of the year with a strong fourth quarter impacted by the completion of a number of constructive projects. We expect lower general and administrative expense as compared to 2018 with quarterly costs approximating $30 million to $35 million.

And finally, interest expense should be some $8 million to $10 million higher in 2019 as we have a higher average debt balance, coupled with higher variable rates, which are tied to LIBOR. So to wrap it up, we'll continue to focus on driving revenue growth, leveraging our scale and deploying capital widely to enhance shareholder value. I want to thank our entire team for their tremendous efforts and for making our client families our #1 priority.

Finally, I would like to acknowledge the tremendous contribution of our President and Chief Operating Officer, Mike Webb, who's retiring at the end of March. For those of you that've been around for a while, you know that 16 years ago, Mike and I were given the opportunity to develop the strategy and a team here at SCI. While we've made our fair share of mistakes along the way, I believe we've helped to develop the powerful company and team that we are blessed to be a part of, a team that has delivered constantly over the years. There's not a person more responsible for our success than Mike Webb. I will truly miss my good friend, but as with most great leaders, Mike has left a legacy and the talented executive team that we have today. With that, I'll turn the call over to Eric.

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Eric D. Tanzberger, Service Corporation International - Senior VP & CFO [4]

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Thanks, Tom. Good morning, everybody. So I'd like to begin as I usually do by addressing cash flow during the fourth quarter, and then I'll talk about our annual cash flow results and our capital deployment for 2018, which is a highlight for us. And finally, provide some details for our outlook for 2019. So as you saw in yesterday's press release, we reported strong adjusted operating cash flow of $164 million for the quarter, which is an increase of $38 million or 30% over the prior year. This growth though was primarily driven by a decrease in cash taxes paid, as positive working capital effectively offset the slight declines in EBITDA and higher interest payments quarter-over-quarter. Cash tax payments in the quarter were only $4 million compared to $45 million in the prior year quarter, the prior year was affected by the timing of cash tax payments related to Hurricane Harvey. The current quarter also benefited from tax reform as well as tax planning efforts. Cash interest payments in the quarter were $67 million compared to $59 million in the prior year quarter. This increase is due to impacts from both higher debt balances as well as higher floating rates over the prior year period. While we are comfortable with our capital structure, we continue to evaluate our mix of floating versus fixed-rate debt in the current interest rate environment and plan to manage accordingly.

Lastly, as it relates to cash flow during the quarter, we benefited by approximately $20 million of nonearnings cash received, mostly related to proceeds from our trust funds that we were able to deploy towards our capital deployment programs in the fourth quarter. Maintenance in cemetery development CapEx for the quarter combined the 2 components that we define as CapEx in our free cash flow calculation were approximately $59 million, which was $10 million lower than the prior year. As in 2017, we spent about $6 million on the hurricane-affected locations. For the full year, as Tom just mentioned, we generated $610 million in adjusted operating cash flows, an increase of $55 million or an impressive 10% over the prior year. This includes the $20 million of trust proceeds I just mentioned, so a better number to use is $590 million, which puts us right near the midpoint of our 2018 guidance range of $575 million to $615 million. We disclosed last year that we benefited in 2017 by a similar amount of nonearnings related trust withdrawals. Therefore, on a year-over-year basis, these two $20 million working capital initiatives are effectively neutralized. So with this in mind, the $55 million growth over prior year is primarily due to a reduction in our cash tax payment of about $70 million, which is offset by cash interest due to the higher debt balances and interest rates we just discussed earlier.

Sticking with this topic of taxes, the $60 million we paid in 2018 is a bit lower than we guided on our last call, which is $75 million to $85 million, partly due to the tax planning efforts that I just previously mentioned. And as we look ahead to 2019, we are modeling cash taxes to increase by approximately $40 million, which would total $100 million, which will be a significant headwind for cash flow in 2019. We do expect our tax team will continue to work identifying tax accounting method change opportunities to help reduce cash taxes as we did in 2018, and this could work as included in our 2019 cash tax estimates.

Maintenance in cemetery development CapEx combined were approximately $204 million for 2018, which is a little higher than our target of $195 million. As we started to remain relevant with our customers, we identified additional opportunities to invest in our facilities as well as customer-facing technology improvements, including our location websites. So deducting these recurring expenditures from adjusted cash flow, we calculate our free cash flow for the year at a healthy $406 million or a 13% increase over the prior year.

So now let's discuss a highlight of the year, which is clearly our capital deployment. Our liquidity and strong cash generation enabled us to continue our capital deployment strategy with a focus on creating long-term value for our shareholders. Utilizing the $406 million of free cash flow generated that I just mentioned, and in addition to utilizing some of our cash balance, debt issuance and divestiture proceeds, 2018 was a standout year, as we deployed $628 million towards acquisitions, new location builds, dividends and share repurchases. This represents an impressive 56% increase over our 2017 deployment of capital of just over $400 million.

Now let me walk you through the components of this. As Tom mentioned, it was just a great year for us in terms of acquisitions. We deployed approximately $195 million towards acquisitions, more than doubling the $81 million invested in the prior year and significantly exceeding our target range of $50 million to $100 million. Acquisitions continue to be our best use of capital as they generally result in a mid-teen after-tax cash IRR. We're fortunate to have a couple of large sized deals we executed in 2018, allowing us to extend our operations in several states and areas, including Hawaii, Indiana, Texas and the mid-Atlantic area, among others. In addition to acquisitions, we invested $32 million in 2018 or 80% more than the $18 million spent in the prior year on the new build and expansion of several funeral homes during the year, which we expect will provide positive returns to us going forward.

This spend is going to develop our footprint in important markets such as Texas, Florida, Colorado and California, through the construction of new funeral homes, crematory operations and personal care centers. Dividend payments in 2018 totaled $124 million. This is an increase of 14% over the prior year of $109 million.

Going forward, we expect to continue increasing the dividend as the company's earnings grow as we target a payout ratio of 30% to 40% of normalized net income. Finally, we returned an impressive $278 million of capital to investors in 2018, in the form of share repurchases, which has resulted in the number of shares outstanding being reduced to just under 181.5 million shares. We repurchased approximately 7.3 million shares at an average price of $37.78. Subsequent to year-end, we've continued this repurchase program, reducing our outstanding share count by an additional 200,000 shares for a total investment of just under $8 million.

So now let's shift to our outlook for 2019 in terms of both cash flow and capital deployment. In our press release, we introduced our 2019 guidance range for adjusted operating cash flow, excluding cash taxes, of $650 million to $710 million. When we include the $100 million that were forecasted in forecast taxes, our 2019 guidance range for adjusted operating cash flow is $550 million to $610 million.

Beginning with the 2018 base of $590 million that I already mentioned and neutralizing for cash taxes of about $60 million in 2018, we have pretax adjusted operating cash flow of $650 million in 2018. Based on the midpoints for share guidance range, we expect EBITDA in 2019 to grow by about $35 million, which we have pressured somewhat by an expected increase in cash interest, netting to an incremental $30 million of operating cash flow growth in 2019. This brings our 2019 pretax adjusted operating cash flow expectation to $680 million, which is at the midpoint of the pretax range we disclosed in the press release of $650 million to $710 million. Taken out though, the 2019 expected cash taxes of $100 million will be at around $580 million of adjusted operating cash flows, which is the midpoint of our adjusted operating cash flow guidance range of $550 million to $610 million.

So moving on to CapEx. Our expectations for maintenance in cemetery development capital spending in 2019 is $195 million, which is slightly lower than our 2018 spend. Of this total, we estimate approximately $115 million will go towards maintenance capital and the remaining $80 million will go towards cemetery development spending, as this capital continues to help drive superior returns for us. At the midpoint of our adjusted operating cash flow forecast guidance of $580 million and adjusted for these recurring capital expenditures items, we calculated our 2019 free cash flow to be estimated at $385 million. In addition to the anticipated recurring CapEx of $195 million I just mentioned, we expect to deploy $75 million to $100 million in acquisitions and other growth initiatives, including new funeral home construction opportunities, which together, drive mid-teen after-tax IRRs returns for us.

So to summarize our capital deployment strategy for 2019, we'd expect to continue much of the same as you've seen from us. We follow a disciplined and balanced approach designed to yield the highest relative return. And of course, this strategy is predicated on our stable free cash flow, our robust liquidity, which was just over $770 million at the end of the year as well as favorable debt maturity profile. Additionally, our leverage at the end of the year, which is calculated as net debt-to-EBITDA in accordance with our credit facility, remained the same as last quarter at right about 3.85x.

So in conclusion, 2018 was a good year for us as we were able to deploy more than $625 million in capital to drive total shareholder return and to grow our company. I echo Tom's comments and that none of this would have been possible without the hard work of our dedicated associates, and we sincerely appreciate all of their efforts. With that -- operator, that concludes our prepared remarks. We'll now open the call up to 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. Price (sic) [A. J. Rice] from Crédit Suisse.

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Albert J. William Rice, Crédit Suisse AG, Research Division - Research Analyst [2]

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A couple of questions if I could ask. First, the pickup you saw in the cremation rate in the fourth quarter. As you drill down, do you think that's a change in trend? That seems to be an acceleration over the 50 to 100 basis point pickup we're used to seeing.

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Thomas Luke Ryan, Service Corporation International - Chairman & CEO [3]

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Yes, A.J., this is Tom. Again, we don't have an exact measurement unfortunately, but I'd say this, if you look at the U.S. cremation rate in general, it's probably been growing around the 150 basis points over the last, call it, 5 years and maybe, even pretty consistently. If you look at SCI's business, we probably were closer to 100 until we stepped into 2018. So while there may be a little bit of a shift from a consumer perspective, we actually think a lot of this may have a little to do with our efforts to capture cremation consumers, whether that be through the SCI Direct model, whether that be through some pricing change implementations in certain markets where we're more competitive. But I'd say price-sensitive cremation consumer or whether it be through our digital efforts that now through the websites and search engine marketing that we're beginning to capture a larger share of what I'll call that, again, price-conscious, direct-cremation consumer. So I kind of view this as a positive thing. Unfortunately, it translates into an average that doesn't look so great, but the truth is that we're getting more business than we wouldn't have gotten, we like that. So yes, I don't see anything yet that tells me there is a definite shift in the overall numbers of those consumers.

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Albert J. William Rice, Crédit Suisse AG, Research Division - Research Analyst [4]

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And would you say you've reflected that? And then, in your 2019 outlook, a little higher conversion to cremation?

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Thomas Luke Ryan, Service Corporation International - Chairman & CEO [5]

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Yes, I think we have. So we're going to go forward believing that these are the types of levels that it could grow at. Now again, it could moderate again, I don't want to predict the future. But we believe that will continue because we'll continue to compete more effectively, particularly for that consumer.

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Albert J. William Rice, Crédit Suisse AG, Research Division - Research Analyst [6]

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Okay. The -- Eric's comments around the impact of the soft market, particularly in the fourth quarter of December. I guess, you highlighted 2 areas. The stuff coming out of the preneed funeral backlog into atneed was a little bit of an impact. And then on the cemetery perpetual care, can you quantify those and will that have a lingering impact in the -- at least in the first half and other markets rebounded somewhat. But just trying to understand whether that'll be an ongoing impact in the first half?

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Thomas Luke Ryan, Service Corporation International - Chairman & CEO [7]

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Yes, I think if you look at the first one you talked about, which was the funeral trust income comparisons, my recollection is, it had a minor dampening effect on the fourth quarter to the tune of, let's say, $15 to $20 on average, if I remember it correctly. So it wasn't anything significant and again, as time goes on and the market rebounds, those types of things will equalize. Eric will know the numbers on the other, but I'll tell you on -- the thing to understand about ECF, which I don't know that everybody understands as well, a lot of the ability to draw earnings is dictated by the state law. So you may have certain states that allow you to take "excess income" as defined by that certain state, and you can do it in certain periods. So as an example, if -- and you would expect it to be the case, if you looked at your excess income at the end of any certain year, and you can withdraw that income that is an opportunity to create cash flow and create income. And again, this is not in every state, it's just in certain states. So if you think about the fourth quarter because it dives down so bad and because the year 2018 was a negative performance year, you probably aren't going to have as much excess income as you would in another year. Now I don't want to tell you this, we can only take it out at year-end. I'm just telling you that there are certain dates and different states restrict when you can take that out. Eric, do you have any color on that?

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Eric D. Tanzberger, Service Corporation International - Senior VP & CFO [8]

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No. I -- remember that the eternal care fund is split between really 2 separate portfolios: one is a total return portfolio, A.J, which we've been moving to over the last few years. And what has -- Tom has mentioned it is, when you set what you can take out of that return portfolio under the state laws in 2019, it's predicated on '18 and maybe a couple of other prior years. So when December got impacted, that's really set in stone for us in terms of '19's internal care fund distributions, which means that the amount that's in our forecast is probably $2 million to $3 million less in '19 than '18. The flip side to that are the other trust funds, such as clearance funeral and cemetery merchandise and service trust that marginally rebounded in January and made up those losses. So we do not have any type of detrimental impact built into our model that would affect funeral sales of average or the cemetery sales average during 2019 as a result of that rebound.

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Albert J. William Rice, Crédit Suisse AG, Research Division - Research Analyst [9]

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Okay. And maybe last question, just asking about acquisition pipeline. I know you had a very strong year in '18. '19, it sounds like you're sort of assuming a reversion of the $75 million to $100 million. Is that just conservatism? I mean, what's the pipeline look like? Is there prospects for another outperformance year in '19 on acquisitions?

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Eric D. Tanzberger, Service Corporation International - Senior VP & CFO [10]

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Yes, A.J., we surely didn't mean to dampen expectation. It's just like we say every year, to get to the high end of that range, a lot of the deals need to fall your way. So I think that we're still seeing a very robust pipeline, which again, the visibility probably goes out about 9 to 12 months. And so we're optimistic about our opportunities for this year. And again, depending on a few of these things and how they fall, we could end up at the high end, we could end up in the midrange. But we'll do them, we'll do them at the right returns for our shareholders and we're excited about the pipeline and will continue to do it. The other thing I just point you to is, we're seeing more opportunities for new build, and you saw a pretty decent, I realize it's not a huge amount of money, but quite a significant increased amount of money that we're spending to build new locations in the right place with the right type of facilities and the amenities that our customers today want. So we're excited about both those channels as we move forward.

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Operator [11]

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Our following question comes from Joanna from Bank of America Merrill Lynch.

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Joanna Sylvia Gajuk, BofA Merrill Lynch, Research Division - VP [12]

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So in terms of the guidance, I appreciate the comments on the cash flow. So in essence, right away, we should think about it is that EBITDA will grow this 4%, 5% and then operating cash flow, excluding taxes and the sort of onetime in nature $20 million benefit. Also operating cash flow, excluding those 2 things would kind of grow in that 4% to 5% range, right? Is that the way to think about it?

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Thomas Luke Ryan, Service Corporation International - Chairman & CEO [13]

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I think that's right. The only thing I would just caution a little bit, Joanna, and this kind of split hairs, but we talk about growing the operating profits at 4% to 6% and use the term EBITDA, I believe. If depreciation is flat, you're not going to grow it right on the add back. So I'd just factor that in as you do your math. That's probably at the lower end of that range.

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Eric D. Tanzberger, Service Corporation International - Senior VP & CFO [14]

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Yes, I'd say EBITDA is more of a 3% to 5% grower at the midpoint. And then that 4% or to 6% is also a per share number, if you remember our 8% to 12% breakdown. And part of that is -- the reduction in shares helps that as well.

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

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Right, no. I was trying to get understanding of EPS guidance kind of talking about 8% as the midpoint. But I guess adjusting for the tax of this 11%, but then the operating cash flow grow at I guess -- it's much slower where there's couple of things that make the comps [sail] or comps much more difficult, so distributing it out. I'm just thinking that sort of the operating viewpoint, operating earnings growing in that mid-single digits and then, operating cash, excluding taxes and this onetime benefit also grow in the same range. But obviously, the reported operating cash flow's going to be down year-over-year, right? But then within that operating earnings kind of outlook, so it sounds like Q1 income, probably going to be down year-over-year in Q1. So that will imply sort of a very robust growth, double-digit growth in the rest of the year to get to that mid-single-digit, call it, a low single-digit to mid-single-digit growth for the year? So what's driving that and how should we think about the progression? I know you -- I guess you've tried to flag the cemetery production I guess, materializing, so is that pretty much Q4? Is this something that's going to be benefiting Q2 and Q3?

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Thomas Luke Ryan, Service Corporation International - Chairman & CEO [16]

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Yes. I think -- as well as there's a couple of ways to think about it. Let's start with funeral volumes. We -- if you go back to look at 2018, we had a very impactful flu season. So the volume in January was up 10%, the volume in February was up, call it, 2.5%, 3% and the volume in March started to tick down to 3%. So you started off the month with 10% up and you ended up a year that's up 0.5%. So again, you can get some really wild swings in these volumes. So now if you look at where we are today, we experienced a January that was down about 10% in volume, so we're back to 2017 numbers, if it makes any sense. So as we think about the rest of the year, you say, I started off with this really bad beginning and what experience has told us is, you drill that back across the year. So just think about the first quarter, think of it being down potentially, if history is right, call it 4%, 5% down in the first quarter, and you would work your way back to close to even by the end of the year. So funeral would have a very tilted year-over-year comparison where margins should be a lot better in the last 3 quarters than the first quarter. The second thing I'd factor in is cost. As we think about costs, and we've got -- every year, we do -- we tighten our belt and look hard at cost initiatives, I would tell you that the biggest benefactor of cost initiatives will be in the middle part and the latter part of the year. So again, I'm pointing you toward the first quarter that's a challenge and the rest of the year getting better. That's going to help that -- you called it double-digit growth margin in the back 9 months. And then finally, cemetery. I think cemetery is a, what we think -- we're going to grow production pretty consistently throughout the year. And so the thing that always factor in about the cemetery's profits is that, when are you going to construct these things because you may be selling things that are not constructed when most of the completing construction occurs in the back half of the year. So again, I think in our model, the biggest chunk of completing construction is going to be in the fourth quarter. So that's really what's driving it is, I'd call it a softer funeral environment in the first quarter, a back-end weighted cemetery because of construction and a little bit of this, I'll just call it, the expense management fees. But then it got the smaller piece of them all, and that's really what's driving it, the first quarter underperformance followed by the, I'd say, impressive latter 9 months.

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

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And is there something to be said about, I guess, the Q4 of this year or -- I mean, 2018, I'm sorry that was impacted by these sales of forward, I guess, restructuring. So is there some sort of flow-through in the beginning of '19 from the changes that were occurring of late, I guess, in 2018?

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Thomas Luke Ryan, Service Corporation International - Chairman & CEO [18]

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Yes. Joanna, I think if you take SCI Direct on its own and again, it's just not as material as the other pieces so -- why I failed to mention it. We would expect that the first quarter would be a little turbulent with the onboarding because people are focused on getting people benefits online. And so there's a lot of distraction as they're probably not doing a lot of hiring. And our belief is, and we're already experiencing it is, this is getting better. So we feel really good, and you're right, as we get to the last quarter of the year, I'd expect a pretty nice bump in our production levels, particularly as you look at SCI Direct.

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Joanna Sylvia Gajuk, BofA Merrill Lynch, Research Division - VP [19]

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All right. If I may, last one on the guidance. So there's still, obviously on the EPS, the range, I guess, in terms of the growth -- year-over-year growth is quite wide from growing only 3% to 13%. So I appreciate it, I guess you commented that I guess, if you execute better or towards the high end of your acquisitions that gets you to the high end, so the lower end? How should we think about that? What -- kind of what is baked in for the low end of the EPS growth?

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Thomas Luke Ryan, Service Corporation International - Chairman & CEO [20]

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Well, the 3% to 13% assumes, remember that it's the 8% growth at the midpoint of $1.93. Of course, what we've been saying is, several times this morning is, a lot of that is $0.05 to $0.06 headwind in earnings per share related to the taxes, growing from 23% to 25% effective tax rate. Ultimately though, the operation should grow at the upper end, as we've just described it. So your question is, what gets you there? I think what gets you there is that funeral volumes rebound towards the back half of the year like Tom has just described it. And gets to a point -- and has a similar inverse effect this last year did, when we were down -- when we were up 10% but ended of the year at 0.5%. As we're starting the year down 10%, we expect to get more to the same type level in the end of the year. I think also is that it assumes that cemetery preneed growth continues but to get to the higher end of those ranges, you'll be more in the mid- to high single digits and maybe get to those high single digits percentage growth, to be able to get to the high end. For low end, it's pretty easy, it's some of that stuff that doesn't happen and the volume doesn't come back as we expected at the back half of the year. Our production -- our cemetery production stays more in the middle or low end, that's what really predicates the low end of the range. But we're very comfortable with the -- what we described to you already as being in that 8% to 12%. And again, taken into effect the tax rate because the operations are performing, in our opinion, expect to perform at the upper end of that.

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Operator [21]

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Our next question comes from Scott Schneeberger with Oppenheimer.

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Scott Andrew Schneeberger, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [22]

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I got 3 question. First one, just -- you talked about the organic growth for 2019 guidance being 4% to 6%, and you just covered a little bit in the last question. But what are you expecting? Greater in preneed cemetery or greater in preneed funeral, I assume both in that range, but please elaborate a little bit more on the preneed expectations?

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Thomas Luke Ryan, Service Corporation International - Chairman & CEO [23]

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Sure, Scott. I think we would expect them to be kind of in an equivalent range. I think we're guiding both to the mid-single-digit range, which again, you can probably put your brackets around that however you like. We tend to call that 4% to 6%. Could we be above that? Sure. Could we be below it? Sure. But I think we're confident that both of those should achieve that as -- the difference is, we've done 4% to 6% in cemetery for a really long time, and it's not that surprising because again, I think you got a product mix differential where we're putting in better inventories that we can charge more money for. And on the funeral side, it's always been a little more challenging, we've guided to the low single digits. We're up in the mids because we believe Beacon is very effective and our ability to increase particularly the contract counts, the number of future customers that we think is grabbing market share as well. So I'd say, that's the equalizer that makes funeral the same range of cemetery this year.

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Scott Andrew Schneeberger, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [24]

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All right. And then for my second question, it's a good segue. So Beacon and funeral, obviously a great trend second and third quarter. We had the hiccup in the fourth quarter here. Still easy comps in the first half of the year. I'm just kind of curious, how you look at -- you said you're still only 75% penetrated. How much use are the sales folks? How much are they actually using it? What are you -- is there a lot more Beacon-driven growth there? Is that going to be the catalyst in -- or the primary driver in the funeral preneed?

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Thomas Luke Ryan, Service Corporation International - Chairman & CEO [25]

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Yes. Scott. I think you hit it on the head, yes. So let me explain that. We're in 75% of the markets, if my memory serves me, about 50% of our production was up -- was out of Beacon at year-end. So it gives you an idea that says, when we launch into a market, it's more complicated -- everybody probably thinks, we announced Beacon at a 100% compliance and everybody's using Beacon, well there's a big training exercise. There's also complications as you get into an individual funeral home versus, let's say, combination facility and state. Because again, remember state law is driving a lot of particulars around how we present the contract, how we price it. So a lot of times we made a launch in the state, I mean, California's a great example. We launched in California, but we are not 100% up and running in California yet. So I just don't want anybody to take away that this is something automatic. Then we get into -- as you roll into a state, you might find a bug in the software that we need to fix and go back. So it's our belief that even within the 75% markets, if we didn't go to another market, we've got a big lift as we move into 2019. And so we want to do it right because -- I think the other thing, Scott, you understand, we talked about this is getting the buy in. You're having a lot of people this year, you're trying to train and get them bought into why this is great. Well the results are tremendous. I mean -- so we can put calculators in front of them and say look how much more productive, look how much more money they're making. That's the best thing in the world. The worst thing in the world is roll it out and somebody go, this doesn't work, I'm going to put it aside and pull out my manual contract because I have a customer in front of me and I don't want to be embarrassed. So because it's customer facing, we're making sure that bugs are worked out, that it's right, that the pricing is correct because the worst thing in the world is have our counselor say, I can't use the software, it's too cumbersome, it's too challenging. So I promise you this, we're going to do it right. It's going to be very impactful, I believe continuing into funeral. It's our belief, while it's going to be harder and a little more complicated, it's going to have an impact on cemetery as well but probably 2020.

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Scott Andrew Schneeberger, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [26]

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All right, that's helpful. And now my last question is on first quarter specifically. I don't know if you want to get too much in the weeds with providing guidance but $0.47 last year EPS, it feels like you could be significantly below that in '19, and obviously, you've talked about the progression of the year. A lot of puts and takes there but -- and maybe you want to get into -- some of the, particularly, the cost items. But might we be below a $0.40 number in the first quarter entering the year? I just want to get a sense of how should we should be modeling this case and -- as we progress?

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Eric D. Tanzberger, Service Corporation International - Senior VP & CFO [27]

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Scott, again, we don't give quarterly guidance so I hesitate to get too specific. But I think you're thinking of -- with volumes down, let's pretend they're down 4% or 5% for the quarter, which is historically, the inverse of what happened in '19. And you modeled that through and say, okay, at a variable cost rate, how much of that drops to the bottom line? That impact, you could probably back out a $0.47 and I think it probably would get you close to the number that you quoted. So that's not an unfair assumption. But again, I think there's scenarios where it's a little bit better than $0.40, and I guess there's a scenario where it's a little bit worse but that's ballpark of what you probably should expect. And then again, kind of ramping up in the back half of the year like Joanna mentioned, double-digit type of earnings per share growth rate, particularly in the back half of the year.

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Operator [28]

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The following question comes from John Ransom from Raymond James.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Director of Healthcare Research [29]

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Just going back to the cremation issue. When you sell a cremation through your direct channel versus through your funeral channel, what is the difference in ASP? And did I hear you right to say that the direct channel is growing faster than the traditional funeral channel?

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Thomas Luke Ryan, Service Corporation International - Chairman & CEO [30]

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Yes. I mean, the direct channel, John -- and first of all, the pricing differential. Remember, when we sell a preneed through our nonfuneral home, we're probably averaging spend of around, let's call it, $2200 for round's sake. Within that spin, there's a way-for-home protection and insurance product that we might sell that also could include an earn. So when you look at the service itself, it might be closer to $1100 or $1200 that's going to flow through your income statement when somebody is deceased. Because we've presold the other products and delivered them. When you think about our core channel, the average spend of a cremation consumer is probably closer to $3700, $3800. Now what I was describing, John, before is, we're getting better at going what I call the price-sensitive because that $3700 is probably a blend of the people that are spending $5700. So the -- there's more direct cremation consumers that might average to $2500, $2600. I'm saying that I think, we're competing more effectively than we have historically for that consumer via the Internet, via price changes that we've made at certain locations, where we believed it was opportunistic. And again, I think just a general awareness of being more competitive. So that's the way to think about cremation -- the way we're thinking about cremation, and we think we're growing through both channels today.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Director of Healthcare Research [31]

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So what you're saying, just to make it sound clear, when the event actually happens in the direct channel, the incremental revenue is only $1100. You've already recognized some other revenue from an insurance product that you've already sold?

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Thomas Luke Ryan, Service Corporation International - Chairman & CEO [32]

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That is correct. If you're coming at -- if there's a blend of what's coming out of a preneed backlog, right, because we're delivering somebody that we previously sold but we also have atneed business and that's probably a little bit higher than that average that we're out there. So it's probably close. So you're exactly right, the blended average, there's a channel of -- servicing a funeral's probably about $1100, $1200.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Director of Healthcare Research [33]

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Just kind of switching gears. If you look at the capital markets effect on your P&L, not the cash flow from your trust, I know that's not always going through your P&L, but Eric what was a bad guy in the fourth quarter from weak capital markets, from a EBITDA standpoint versus what do you think would be the offsetting good guy in the first quarter, assuming the markets hold, knock on wood, where they are now? How do we think about that?

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Eric D. Tanzberger, Service Corporation International - Senior VP & CFO [34]

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I mean, I think ultimately, the effect of the fourth quarter in terms of the markets, when you think of prearranged funeral turning that need and cemetery being delivered, the markets really got hammered in December. And so it really doesn't have a very material effect at the end of the day, to the financials in the fourth quarter. And of course, as I said before, when you go into 2019 in terms of that same average coming out of the backlog, those markets have generally rebounded. So we're not really predicting much of an effect, what we were describing earlier was an eternal care front situation that, ultimately had a lot to do with some withdrawals that we had last year. And that was probably a fee, just $4 million as you described, I hate that you used the word bad guys, but it was a $3 million to $4 million detriment quarter-over-quarter and that hit cemetery revenues and cash flows directly in the fourth quarter.

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Thomas Luke Ryan, Service Corporation International - Chairman & CEO [35]

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John, I would just add. Remember it's the volatility of what's happened in this quarter versus what happened last quarter because of this calendar-based approach. So go back to '18 for a minute, January was a rocket ship and the markets got crushed in the February. So as I think about it, we can continue strong for the quarter, then you might have an actual nice comparison as you think about the first quarter '19 versus first quarter '18, we could use a good comparison.

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Eric D. Tanzberger, Service Corporation International - Senior VP & CFO [36]

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As it relates to the bridge coming out of the backlog.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Director of Healthcare Research [37]

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They're kind of in that $3 million to $4 million range, something like that?

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Eric D. Tanzberger, Service Corporation International - Senior VP & CFO [38]

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Yes. For cemetery, yes.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Director of Healthcare Research [39]

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Yes. Okay. And then lastly, I'm curious about the restructuring of your sales force. I mean, we've certainly seen other companies have kind of protracted material downturns when they restructure comp and what have you. What gives you the confidence that these guys are back in the saddle and this is just a blip and not something more structural?

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Thomas Luke Ryan, Service Corporation International - Chairman & CEO [40]

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I think, one, because we're getting feedback directly from the leadership of SCI Direct, I think it's on quite a bit better. And I think ultimately, John, this is better for everybody because these sales counselors now by being employees, enjoy some of the benefits of being employee of SCI, from insurance to retirement opportunities whereas before, they didn't have those. So I think, we think in the end, it's a better proposition. It's just a turmoil while it's happening because there's a lot of uncertainty. And like I said, you got managers that are out there dealing with existing key employees versus, let's say, hiring particularly in this one. It's about finding counselors to sell, and we're not doing a lot of that while you're onboarding.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Director of Healthcare Research [41]

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So do you think ultimately, you'll have a lower turnover? Is that one of the main goals?

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Thomas Luke Ryan, Service Corporation International - Chairman & CEO [42]

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I do. I believe that will occur, yes.

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Operator [43]

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The following question comes from Duncan Brown from Wells Fargo.

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Duncan Brown, Wells Fargo Securities, LLC, Research Division - MD and Senior High Yield Health Care Analyst [44]

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Most of my questions have been answered but just wanted to follow up, trying to get a better sense on what's going on in funeral core revenue per service, down 1.4%. And it sounds like trust fund impact was a little bit but the vast majority of it was the cremation change. Is that correct? And maybe, could you size that?

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Thomas Luke Ryan, Service Corporation International - Chairman & CEO [45]

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Yes. So if I recall correctly, at the customer level, before you take away the mix for the quarter, we saw 70 basis points of improvement. So think of it as, we've got inflationary pricing of 70 basis points, which isn't exciting but it's positive. And now I go back and I say, 40 basis points of that was currency, believe it or not. Because again, Canadian currency hurts us and you can correlate that with the oil market, right. Oil prices crashed in the fourth quarter, Canadian currency crashes. So for the year, Canada's not a big deal, but for the quarter it's a pretty big deal. There's probably 20 basis points of trust income difference, so now I've got 60, offset 70. So to get to my 150 bps problem, I got 160 basis point decrease because of the cremation mix change, if that makes sense, Duncan. So by far the biggest is the cremation mix change with the holdout, markets rebounding in the first quarter, I think currency is probably not going to be a big of an issue, as we think about the year right now. So the big thing to think about is that, in trust income, it's a minor part, but it were probably always the big gorilla to think about is always that cremation mix change and how big it is year-over-year.

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Operator [46]

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And we have a follow-up from Joanna from Bank of America Merrill Lynch.

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Joanna Sylvia Gajuk, BofA Merrill Lynch, Research Division - VP [47]

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If I may just squeeze in on how the Beacon discussion that was happening a while ago. So is there some sort of stat you can give us in terms of the performance in those markets, where utilization of the Beacon system is getting better traction in terms of final market share or some stats on the preneed sales or anything else you can give us that would be helpful.

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Thomas Luke Ryan, Service Corporation International - Chairman & CEO [48]

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Sure, Joanna. I don't have any on my fingertips. We're happy to try to share more of that. But I'll tell you this, let's say, market share is hard to define yet because it's such a new product and again, this is used on a preneed basis. And we don't have good market share data for preneed. But I will tell you that within places where we've implemented this and maybe, the great example was we first launched this, I think in the like second third quarters, we saw a significant -- you put top markets against each other, I want to say, Steve, it was 400 or 500 basis points differential. Jay, is that right, where as far as growth rates within the markets where we've implemented it versus not implemented it?

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Sumner J. Waring, Service Corporation International - SVP of Operations [49]

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Right.

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Thomas Luke Ryan, Service Corporation International - Chairman & CEO [50]

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500 -- so Joanna, they're saying 500 basis point. So take a -- I'd say a typical market and forgive me for rounding, if we're growing at 2% by putting Beacon in place, we're getting 7% growth in the types of things that we saw. And again, those were in -- every market's going to be a little bit different, what's your take-up rate? How -- your sales force embracing change as far as technology in certain areas is more than others? So there's a lot of factors. But generally, that's the kind of difference. And quite honestly, what's really impressive is most of it is the number of contract. The average sale's pretty normal as we think about it. So we're really seeing -- we're getting in front of more people, we're capturing more market share and that's what's exciting to me is, and that eventually turns to atneed revenue that will benefit the company.

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Operator [51]

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I will now turn the call back over to the SCI management team.

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Thomas Luke Ryan, Service Corporation International - Chairman & CEO [52]

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Thanks so much, everybody, for being on the call. We look forward to talking to you for our first quarter's earnings at the end of April, I believe. Thanks so much.

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Operator [53]

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