Reprographics 101

Below, I’ve copied into this post a portion of an article I came across while visiting whattheythink.com. The article dealt with Merger & Acquisition “issues” (several different issues), but the portion I’ve cut from the article deals specifically with the “sales team” of the company that’s being considered for merger or acquisition (in other words, the sales team of the “seller.”)

When you buy a company, one of the greatest concerns, if not the greatest concern, is “will the company’s sales manager(s) and sales reps stay on with you, after you acquire the business, or, will they leave the company …. and take accounts with them?”

This, of course, assumes that most of the customers of the company-to-be-acquired are not under binding contractual commitments to continue to do business with the company, even if it is sold to, or merged into, another company. To the extent that customers do have contractual obligations to continue doing business with the company that’s being sold or merged, I would think that the concern about sales managers and sales reps would be somewhat less than would otherwise be the case if customers did not have any contractual obligations.

Of course, the “ideal” (Utopian) situation would be that, when a business is acquired, all of its customers and business will “stay put.” Sometimes that does happen, but, realistically speaking, that sometimes does not happen. Buying a business, or acquiring a business through a merger transaction, certainly has risks, many risks for that matter. To “insure” against the risk of loss of customers (the business customers generate), acquiring companies often, if not always (unless they’ve naively overlooked this issue) look to “covenant-not-to-compete” agreements (CNTC’s). (I, myself, have a CNTC, which stemmed from the sale of NGI to ARC in December 2007. Mine’s for 5 years. I also got stuck with a 5 year CNTC when we sold our first company in 1988.)

CNTC’s are valid in some states, but not in others. Quite frankly, I don’t see any reason why validity should vary state by state. But, that’s simply my own personal opinion.

Below, you will notice that the author (of the article that I earlier referred to – and you’ll find a link, below, to the full article) “suggests” that the buyer may want to talk directly to the seller’s salespeople (this, prior to consummating the purchase or merger transaction.)

About that suggestion that the author made, here’s my suggestion to prospective “sellers” ……It would probably be a good idea, before the seller allows the buyer to talk to the seller’s sales manager(s) and sales reps, to have the buyer agree to a “not-contact, not-pursue, not offer, not-hire” agreement with respect to the seller’s sales manager(s) and sales representatives. If there is no such agreement and if the deal falls through, what’s to prevent the “buyer” from hiring all of the seller’s sales manager(s) and sales reps (presuming they don’t have a non-compete)? And, even if the sales manager(s) and sales reps do have CNTC’s, I think that getting an agreement from the buyer “not to screw with” your sales manager(s) and sales reps, if the acquisition / merger deal falls apart, would be a smart thing to do. Certainly, some will disagree with my viewpoint on this issue.

Here’s the portion of the article I mentioned:

If You Build It, They Will Come (Maybe)

In any M&A transaction, nothing is more crucial to cement than the loyalty of the seller’s sales force. In cases where some or all of the sales force does not make the transition to the new owner, non-compete agreements can afford a measure of protection against loss of business from the accounts that these salespeople were handling. But, say NDP and MargolisBecker, non-compete protection isn’t as good as persuading everyone on the sales team to come along.

In any M&A transaction, nothing is more crucial to cement than the loyalty of the seller’s sales force.

There is no downside for the owner in obtaining non-compete agreements from salespeople, but non-competes are not absolute guarantees. It’s easier to enforce them in some states than in others, and there are circumstances in which it is nearly impossible to make them stick. Unless salespeople bound by non-competes are being compensated, invoking the agreements can be difficult.

When structuring the transaction, the better approach is to talk with the salespeople about what is happening and why staying on board will be advantageous to them. The buyer should conduct face-to-face meetings with the salespeople early on in the process and get them excited about joining the new company. When steps aren’t taken soon enough to head off defections, having non-compete agreements neither helps nor hurts.

The same kind of thinking applies to the decision that the buyer will have to make about the seller’s management team: should they be kept on, or should they be retired to avoid conflict with the new management structure? If the buyer believes that the seller’s managers are ineffective, then there are grounds for letting them go. On the other hand, if they possess skills that the buyer could use going forward, then their continued participation is a good idea.

The buyer should think about prospect of competition from personnel it chooses to cut loose. In the long run, it may prove wiser to keep them in the fold.

The buyer should also think about prospect of competition from personnel it chooses to cut loose. In the long run, it may prove wiser to keep them in the fold, especially if they have knowledge that differentiates them. Once separated, they can’t be stopped from going elsewhere. They are either going to join the merged company, or (absent agreements to the contrary) they are going to compete with it.

Here’s a link to the full article:

Devil in the Details: Issues and Answers in M&As

By Patrick Henry


Published: April 21, 2011

http://whattheythink.com/articles/50396-devil-details-issues-answers-m/?utm_source=whattheythink&utm_medium=email&utm_campaign=WhatTheyThink+Daily

This post is completely unrelated to the reprographics business and industry. It will be my only “rant” of the day.

“Government’s job is to protect citizens” (authored by Greg Neimi)

“Regardless of your political orientation, it is hard to argue with the proposition that the main reason for government is to protect the members of a society against the greed of their neighbors. Simply put, government exists because we are not content to live in a “survival of the fittest” jungle. Government protects each of us against those who are stronger, cleverer, greedier or simply meaner than we are.

The function of a business is exactly the opposite. It is to accumulate wealth either by creating it or taking it from others through trade. A business survives, in large part, by being bigger, richer, smarter or more ruthless than its competitors. It will resist any limit on those impulses that contribute to its own success.

While I don’t agree that the “main” reason for government is what the author stated it to be, I do believe that the reason he stated is certainly among the most important reasons, and I applaud the author for pointing out the basic difference between “running the government” vs. “running a business.” IMHO, he is totally “right on” with the remarks he made.

From a political-orientation perspective, I’m a conservative on “the size of government and on government spending”, I’m ultra-conservative when it comes to “defense,” but I tend towards the liberal-side of the spectrum when it comes to “education”, “social security” and “healthcare.” I also believe that lobbying has to be curtailed – that our elected officials should solely cater to, and vote on behalf of, their constituents rather than cater to, and put into motion bills that benefit, “corporations” and “organizations” (such as unions, etc.) I was horrified when the U.S. Supreme Court came out with a ruling that, quite basically, makes it possible for the rich and powerful to “buy” seats in the congress and senate. Our legislature is now for sale to “whoever has the most money to spend.” [It’s even worse than that (if it’s possible to be worse) in the state of Florida, where we now have a bunch of far-right, ultra-righteous, self-serving, ignorant, moron Republicans (hate to blame that on a “party, by the way) who’ve taken our state government hostage. That resulted from voter apathy.]

Well, to go on, I believe that it is the government’s responsibility to fund education. Without a well-educated (or, maybe I should say, without an “adequately-educated”) citizenry, the majority of our citizens would be ignorant and stupid and unproductive and incapable, and I certainly don’t see where that would best serve our interest as a nation/country. It is in everyone’s interest, I think, that we be an educated society. That’s why I’ve always felt that it should be a government obligation to fund public education. (If you want to go to private school, that’s your right, but you can pay for it.) To me, “public education” is a ‘basic need” and, therefore, a “public right.”

I feel exactly the same way about “healthcare”. I view healthcare as a “basic need” and, therefore, as a “basic right.” Every citizen in the U.S. should have government-provided healthcare. Paid for with our tax dollars. I am willing to pay my fair-share for the health care that less affluent citizens need. Our healthcare system in the U.S. is seriously broken. I laugh when I see the word “healthcare” in the names of companies that don’t provide any healthcare at all. Take, for example, UnitedHealth Group. UnitedHealth Group is NOT a healthcare company. UnitedHealth Group is an “insurance” company. And, it is an insurance company that is solely in business to achieve two objectives; a) to enrich the executives who run the company and b) to enrich the shareholders of the company. Any other conclusion – as to UnitedHealth Group’s objectives – is pure and utter bullshit.

So, going further, when I read, within the past couple of weeks, about the budget plan that Congressman Paul Ryan came up with, I was aghast at the elements of his idea for how the problem – of government spending for healthcare, in particular, government spending for Medicare – should be solved. His solution, a) continue Medicare for those currently getting Medicare and continue Medicare for anyone who now (or when the law passes) is 55 or older (they would be eligible for Medicare coverage when they reach 65) and, b) anyone not yet 55, well, they are “shit out of luck”, no Medicare for them. For them, the “government” will issue everyone a “voucher” that they can then use to pay towards the cost of health insurance from a private-sector health insurance company. Congressman Ryan, do you really have a full-deck upstairs? Your budget plan for how to deal with growing Medicare costs is totally uncaring, but worse, it is ignorant, moronic and – and, yes, just flat out stupid. Your plan shows an utterly infantile understanding as to how businesses in the private sector work (from a “pricing and profitability perspective”) and that you have a complete disregard for the “basic” rights of our country’s citizens. How in the world did you manage to get elected? Which insurance companies have managed to “buy” you? Let me be clear about this …..

I’m 64 years old, and, per “Congressman Ryan’s plan for Medicare”, I’ll get Medicare. So, I should have no concern about what Congressman Ryan is proposing, right? But, I do have a huge concern; my concern is for “all U.S. citizens”, regardless of their age. If our country really wants to control the cost of Medicare, Medicare should be expanded to cover every citizen. And, then, healthcare costs can be controlled by a team of managers whose job it is to hard-line negotiate costs (doctors’ services, lab tests, hospital stays, prescription medicine, clinic visits) across the board. That’s exactly what “health insurance” companies do “for” their policyholders. (“For”, hmmm, healthcare companies don’t actually negotiate costs for their policyholders, they do that because it creates the profit they pay to their executives and shareholders.) The main difference, between my plan and Congressman Ryan’s plan, is that, with my plan, health “insurance” companies would cease to exist. The money (in compensation and profits) that they, the healthcare insurance companies, are sucking out of the current healthcare system would be put to use in providing “actual” healthcare! Many people say that “government” cannot responsibly and effectively manage a national healthcare system. That’s bullshit. The government can do that. All it has to do is to hire very dedicated, very smart, very productive people to run the national healthcare system. From a “management and administration” perspective, it is ludicrous to think that a team of “government” people can’t do for a government healthcare system agency what a team of people currently does at a large private-sector healthcare insurance company.

Further, and this is to Congressman Ryan; if you really want to solve government spending for healthcare, you don’t “best” do that by short-changing our citizens; you do that by cutting out costs that are completely unnecessary (such as eliminating health “insurance” companies, altogether, meaning, cut out the total expense that they add to the healthcare system), you do that by ridding fraud from the healthcare system, and you do that by hard-line-cost-negotiating with prescription drug companies, doctors, private-sector hospital companies, private-sector lab test companies, private-sector clinics, etc. That’s what healthcare insurance companies do, and, if you think government employees charged with that same responsibility can’t do that, well, then you have no faith, no trust, in your fellow citizens. You seem to want to direct money to the private-sector healthcare insurance industry. Why is that? What have you received from that industry, from lobbyists in that industry, from companies involved in that industry? Is it because they funded your election to public office? Is it because they will continue to fund your future election races? If our country ends up with the “voucher” system your budget plan evidently proposes for Medicare, are you aware that the cost of healthcare insurance will end up being so ridiculously high that those vouchers will prove next to worthless? Are you so ignorant that you are not aware that private-sector healthcare insurance companies operate in an oligopoly? (That’s basically a “monopoly” by few.) If you think that healthcare insurance companies will decrease the cost of healthcare insurance because huge numbers of people are added to their premium rolls, then I have zero trust and faith that you have a full-deck upstairs. Private-sector healthcare insurance companies are currently pillaging their subscribers; it will grow even worse if Medicare is discontinued. Until I become eligible for Medicare coverage (next February, when I become 65), I have to have private healthcare insurance. The monthly premium cost I pay (for my wife and myself) is $2,228.55. That’s a ridiculously high cost. My monthly social security check (which I have not yet started and don’t plan on starting for a while) would not cover the cost of my current private-sector healthcare insurance premium. I’m a relatively affluent person, so I can actually afford to pay the healthcare insurance premiums I’ve been stuck with. But, if I were not, and most people are not, do you “have a clue” as to how financially devastating your Medicare proposal would be on the finances of senior citizens (and on the finances of citizens long after them), who, ten years from now, would have otherwise been eligible for Medicare? Do you really think that our country’s private-sector health insurance companies have a conscience? Do you think that private-sector health insurance companies won’t take advantage of their position (and the fact that there would eventually be no competition from the government, which would be the case once the Medicare system is completely done away with)? Do you believe that private-sector healthcare insurance companies “compete” with one another on the basis of price? If you do ‘believe’ any of those things, then you are completely and utterly naïve! When I ran a private sector company, we got our “cost increase notices”, annually, from the healthcare insurance companies we alternated using. The “alternating” of who we used each year was, quite basically, a game that the healthcare insurance companies play with their customers. They fully realize that, in order to give an appearance that there’s competition, they have to trade customers, sometimes every year. But, perhaps since you never ran a company, you don’t have a clue how that works. Don’t get me wrong, Congressman Ryan; I don’t think that you’re an idiot or a moron. You are probably a very upstanding guy and a very nice guy, and you’re certainly an upstanding citizen for taking the time to participate in the government of our country. I think, however, that you are completely misguided in your thinking about how to control the cost of government and how to deal with “basic rights” that citizens of our country deserve to have and that government should provide. I’ve paid a ton of income tax in my lifetime. I look at that as “my fair share” contribution – the price we pay, the price I pay and am willing to pay – for having a great country. I urge you not to pass laws that will, eventually, financially devastate the lives of most of, the vast majority of, the population of our great country.

Was that a long enough post?

I’m going to print this post and send it to Congressman Ryan and to President Obama.

Press Release issued by Xerox:

Wednesday, April 20, 2011

Rochester, N.Y. – The city of Riverside, Calif. and Xerox Corporation are working together to find new ways to save money.

After partnering with Affiliated Computer Services (ACS), A Xerox Company, to advance the city’s technology, Riverside is now adding Xerox managed print services (MPS), cutting costs by nearly 20 percent and reducing the time employees spend on print-related activities.



Riverside’s five-year Enterprise Print Services contract gives the city more time and resources to reallocate toward providing services for citizens, while Xerox manages the way documents are printed, shared and updated across city departments. Xerox’s print governance features – computer screen pop-ups that help employees redirect print jobs to the most cost-effective and energy-efficient machine – will deliver a positive impact to the city’s budget and environmental efforts.



During its 10-year relationship with Riverside, ACS has helped the city develop innovative technology to respond to issues that matter to the community. For example, citizens use their smartphones to report graffiti by emailing a photo of it to the 311 call center with their comments and the GPS location. The city then removes the graffiti within 24 hours. 

“The breadth of services and technology from Xerox gives us the right tools to run a more efficient city,” said Steve Reneker, chief information officer, Riverside. “As a result of these cost and productivity savings, we can sharpen our focus on providing citizens with services that make Riverside a great city.”

Xerox was positioned by Gartner, Inc., in the Leaders Quadrant in the 2010 Magic Quadrant for Managed Print Services Worldwide and the company was recognized as a leader in IDC’s Worldwide and U.S. Outsourced Print and Document Services Forecast and Analysis2 and in IDC’s 2010 MPS MarketScape report3. Xerox was also named a market leader in managed print services in Quocirca’s European Vendor “MPS Comes of Age” report 2010.

Sorry, second rant of the day…..

I graduated (somehow) with a degree in “accounting” and, during my time in college, took several courses in “income tax” (tax law, tax accounting, preparation of tax returns, etc.) I distinctly remember, even today, some 40+ years later, hearing the remark that one of our accounting professors made about “income tax.” He said, “tax ‘evasion’ is illegal. On the other hand, tax ‘avoidance’ is not only perfectly legal, it is, once you are out in the business world dealing with clients, what you must do for your clients; to do anything less would be tantamount to you not doing the best job you can for your clients.”

So, keeping that in mind, I’ve lately been reading “letters to the editors” [of the two newspapers I normally read (St Pete Times and New York Times)] and comments posted on various news-sites on the Internet , where “my fellow citizens” have been lambasting General Electric (GE) for not paying any federal income tax.

To lambast GE for practicing tax avoidance is utterly, flat-out, ignorant.

I read somewhere that GE has hundreds of accountants working in its corporate tax department. (I don’t recall the exact number; it was less than 1,000, but more than 500.) The “job” of those people is to legally avoid income tax …. and to do that to the maximum extent they can. Any “individual” would be totally stupid not to take the same approach. What, those who are criticizing GE are paying more in income tax than they actually have to? I think not. (And, if they are, they are stupid.)

The point being that ……… it’s not GE that should be taking the heat. Our Senators and Congressman (the current ones and their predecessors) are the ones that should be taking the heat, for it is they who created our income tax laws. And, while I’ve just said that, let me go one step further. Since our government is “of the people, by the people and for the people”, it is “we” who should share the heat, for we are the ones who elected the Senators and Congressman who voted the income tax laws into existence.

Therefore, if you don’t like GE not paying taxes (and don’t like it that other “corporations” pay little or no taxes), then, in subsequent elections, get off your ass and go to the polls and vote into office Senators and Congressmen who have the guts and fortitude to change the income tax laws. As it stands right now, our income tax laws, regulations, forms, publications, worksheets (blah, blah, blah) are mind-numbing – we must have the most ridiculous tax system in the world; it is totally out of control. Nevertheless, I doubt we’ll see any significant changes in my lifetime. Why? Well, chalk that up to voter apathy. We whine and complain … but what do we really do about the problem? Nothing.

Sorry, this post is not in any way shape or form related to the reprographics business or industry, but …. this is my blog, and I’m going to take this opportunity to rant, even if I’m the only one who ends up reading this post.

Well, for those of you who follow the stock market every day, you’re aware that the market tanked yesterday pretty much because Standard & Poor’s (S&P) one of the “premier” rating agencies, issued a “negative outlook” warning on U.S. debt obligations (U.S. Treasury Bills, Notes, Bonds, etc.)

And, you know that S&P is one of the credit rating agencies that somehow, some way, managed to pony-up incredibly outrageous “AAA” ratings on the CDO obligations (“collateralized debt obligations) that contained high-risk, junk-level mortgages, one of the reasons why our entire financial system came close to collapsing in 2008 (or, was it 2009, I’m having a memory-recall lapse right at this moment, but, whatever…)

I’m sitting here in my office (the public library) picturing, in my mind, the executive officers of S&P, who probably heavily shorted the markets just before they “issued” the negative outlook warning, sipping on their Pina Colada’s, Margaritas, etc. on the beach in the Cayman Islands ….. sitting there wondering when someone (anyone) will figure out what they are up to and put their asses in jail (or, better yet, do something to these people that would eliminate them from doing the crap they do.)

It is hard to believe that anyone still has any level of trust in the credit rating agencies.

Here’s the intro to an article that appeared on ABCnews.go.com, this afternoon…..

“S&P’s Credibility Under Fire As Agency Issues US Debt Warning; Bipartisan Senate Report Cited S&P for Enabling US Mortgage Meltdown”

Standard & Poor’s sent shockwaves through Wall Street and Washington when it lowered its outlook on U.S. federal debt to “negative,” but the credit-rating agency’s own credibility has recently been called into question.

Here’s a link to the full article:

https://docs.google.com/viewer?a=v&pid=explorer&chrome=true&srcid=0B81al4kFAU9JOTZlOWI1NDMtZDkxZi00ODM4LWI2MTItOWVlNjdkNDkyMzIy&hl=en&authkey=CM6c3gk

In a note to investors today, Morningstar Research’s analyst, who covers Iron Mountain, opines that Iron Mountain will ultimately dispose of its digital document management services business. Read on…..

Iron Mountain (NYSE: IRM) announced Tuesday (April 19, 2011) that it has come to an agreement with Elliott Associates (one of its largest shareholders) in which it will appoint two new directors of Elliott’s choosing and explore alternative business structures and models in order to enhance shareholder value. These alternatives include returning $2.2 billion in cash to shareholders by the end of 2013, with $1.2 billion being paid out over the next 12 months. In addition, the firm will form one new board committee to explore converting its current business structure into a real estate investment trust and convert its current finance committee into a strategic planning and capital allocation committee. The converted finance committee will review all capital-allocation decisions, which include all capital investments and disposals. Iron Mountain will also look at strategic alternatives for its various digital document management services, which we believe will ultimately be the disposition of this business. The firm said these actions should allow it to achieve returns on invested capital of 11% by 2013. We applaud Iron Mountain and Elliott for their efforts to enhance shareholder value and increase ROICs. We believe these actions are prudent, as we downgraded the firm’s moat rating from wide to narrow earlier last year on concerns about its ability to produce outsize ROICs for an extended period on par with other wide-moat firms. The firm will hold a conference call Wednesday to walk investors and analysts through these latest developments. We are placing Iron Mountain under review while we reassess all of our long-term assumptions, given what will most likely be a vastly different operating structure for the firm moving forward.
Vishnu Lekraj (Morningstar Research)

On April 8, 2011, Florida Reprographics filed with the Bankruptcy Court its Operating Report for February 2011.

Our most recent previous post covering the topic of Florida Reprographics’ Chapter 11 Bankruptcy matter took place on March 9^th. Today, we’re going to provide a brief “update”; this brief update to mention FR’s operating results, since filing Chapter 11 on November 30, 2011. FR is required to file a “monthly operating report.” Please note that, although the report requires FR to report “gross Income”, it is my understanding that “gross income” means “total cash receipts” for the month. So, FR isn’t required to report “Sales” on an accrual or GAAP basis, but, rather, on a “cash” basis. Consider that when you reflect on the numbers in the table.

We’ve done six previous posts on “Reprographics 101” about Florida Reprographics’ Chapter 11 Bankruptcy. If you want to review those earlier posts, enter “Florida Reprographics” in the search window on this blog.

The “table” below is an at-a-glance summary of the information FR has reported about its business operations since filing BK.

If FR’s results for full-year 2011, “gross receipts-wise”, end up at 12x the monthly average “gross receipts” results achieved during the first 3 months after FR filed for bankruptcy reorganization, then FR’s full-year 2011 “gross receipts” results will likely end up at around $417,000.

In 2006, prior to the ugly recession kicking in, FR (we estimate, based on our knowledge of FR’s operations at the time and on business conditions in the Tampa Bay Market Area at that time) generated “Sales” in excess of $2 million! So, at its current pace, FR’s Sales, at the current time, appear to be more than 75% “off peak.”

Going further, FR currently has (and has, since January, had) 7 employees. Dividing $417,000 in annual “gross receipts” by the number 7, equates to approximately $60,000 in “gross receipts” per employee. A few years ago, I recall ARC saying, in one of its SEC filings, that its average annual revenue “per employee” was over $120,000. Even today, with ARC’s substantially reduced Sales and employee-population numbers, ARC appears to be generating average annual revenues, per employee, of more than $110,00. Quite frankly, I don’t know how FR will be able to sustain a reprographics business enterprise with annual sales of only $60,000 per employee.

Now, I’d like to “re-mention” that the BK court, on January 7th, approved the owner’s (Chris Charles’) request for “officer compensation” at $4,000 “bi-weekly”, which is just north of $8,000 per month.

1. The Motion is GRANTED on a final basis as provided herein.

2. The Debtor is authorized to pay a salary of $4,000.00 on a bi-weekly basis to Christopher Charles, as President of the Debtor. To the extent Mr. Charles is reimbursed for expenses, the Debtor shall provide the detail to support such expenses to the United States Trustee upon request.

Based on FR’s most recent operating results (the past three month “Operating Reports filed with the BK court), I haven’t a clue how FR, going forward, will be able to pay-down its secured debt, let alone make any dent, at all, in its unsecured debt. At the same time, the owner, Chris Charles, will be “milking” nearly $100,000 per year from the business. Our BK laws are very strange.

Here’s a link that will take you to FR’s most recently filed (Feb 2011) Monthly Operating Report.

https://docs.google.com/viewer?a=v&pid=explorer&chrome=true&srcid=0B81al4kFAU9JYmU1OWM1MzgtNTJlZS00MGQzLThmMGQtYWMzZWM1NjNjNmFl&hl=en&authkey=COWp5zc

April 19, 2011….

New home construction jumped 7.2% to 549,000 in March — the highest rate in six months — easily beating economists’ expectations. Permits to begin building homes were up 11.2% to 594,000 for the month. The market for new homes was hit hard by the economic downturn as a glut of supply of already-existing homes for sale severely weakened demand for new homes being built.

Sorry, I couldn’t resist doing a post about this article…..

I’m a subscriber to Morningstar Research, but this particular article did not require me to log in to read it, so the report I’ve posted isn’t a “premium” article (I guess.)

Did you know that there’s a “death-care” industry? And, that the death-care industry is facing financial issues …. in spite of the fact that people are still dying …. and dying in record numbers! It looks like there’s a minor similarity between “reprographics” and the “casket” business. Cremation, evidently, is the “digital equivalent” of pdf files (or something like that. Hey, it’s early in the morning, and, although I’m typing, I’m not really “up”, yet.)

In the article, it says, “same-store cremation rates have risen to 42% today from 32% in 2000, and cremations typically provide lower absolute dollars on the margin line, given that they don’t carry as many ancillary, or up-sell services.”

Hey, someone needs to put some “life” back into the casket business! Who will be the first reprographer to extend their large-format color business to include “casket-graphics?” How about getting the NFL to license NFL team logos for casket-graphics? (I’m a Washington Redskins fan.) Or, how about a series of “surf-related” casket-graphics? Surf-on, into the never-never land!

Okay, here’s the article …. try not to laugh too hard. (Because, as that old song goes, “your day will come.”)

Dark Clouds for the Death-Care Industry

Longer life expectancies, unfavorable secular trends toward cremations, and intense price competition are hampering longer-term growth and profitability.

By Bradley Meeks | 04-18-11 |

Although much has been written about two uncertainties in life, none is more famous than a letter written by Benjamin Franklin to Jean-Baptiste Leroy in 1789, in which Franklin stated, “In this world nothing can be said to be certain, except death and taxes”. While death can be considered one of the two certainties in life, several unfavorable secular trends are hampering longer-term growth and profitability in the death-care industry.

Firms in the death-care industry have several qualities that, on the surface, make for solid investments. Firm’s like Service Corporation International (SCI) and Stewart Enterprises (STEI) generate robust positive free cash flow. The industry’s largest player, Service Corporation consistently generates roughly $250 million in equity free cash flow on average, equating to a free cash flow yield of 9%. Stewart generates roughly $55 million of equity free cash on average, with a three-year average yield of almost 8%. Additionally, these firms have a track record of repurchasing their own shares, and issuing albeit modest dividends.

Despite looking good on paper, digging deeper into the death-care business model and industry trends give us pause. While death can be considered one of the two certainties in life, a growing reliance on preneed sales creates top-line volatility, and generates investment risk for the industry’s players. Preneed sales occur when individuals specify in advance–and prepay for–cemetery and funeral property, products, and services prior to death. After booking a preneed sale, the proceeds are put into trust accounts, and are drawn down upon completion of certain activities in preparation of death or upon death. As such, when trust assets decline in value as they did over the Great Recession of 2009, the firm could be subject to capital injections to make up the difference. In a worst-case scenario, any sustained investment losses or insufficient investment yields could result in funds needed to pay for the cost of future services, merchandise, or cemetery maintenance. Death-care firms believe that the balances in trusts and escrow accounts–coupled with future earnings on trust balances–will be sufficient to cover the estimated cost of providing preneed services in the future. However, there is no guarantee, and from an investment standpoint, we would feel more comfortable if these services were priced or underwritten by life insurance actuaries, due to the massive size of the trust portfolio assets.

The reliance on preneed sales in the death-care industry is due to a lack of overall deaths in the marketplace. According to the United States Census Bureau, the number of deaths in the United States is expected to increase by roughly 1 percent per year, to only 2.9 million by 2020, from 2.5 million in 2008. Additionally, life expectancy and average life spans have increased due to increases in medical innovation and preventative health care, a trend that should persist, in our view. This low level of growth, coupled with intense competition from other traditional death-care firms–and less traditional big box retailers like Costco (COST) and Wal-Mart‘s (WMT) Sam’s Clubs–put additional emphasis on cost-cutting initiatives and operational efficiency to drive margins. Furthermore, while paying for a funeral at the time of death is unavoidable, paying in advance is not. Individual preneed purchases tend to be discretionary during economic downturns, which was apparent during the Great Recession, as revenue declined.

Adding additional pressure to operational results is the fact that cremations are gaining popularity relative to more traditional funeral services. Same-store cremation rates have risen to 42% today from 32% in 2000, and cremations typically provide lower absolute dollars on the margin line, given that they don’t carry as many ancillary, or up-sell services. Countries like Japan have almost a 100% cremation rate, while China cremates more individuals a year than any other country (with almost a 50% cremation rate). The United Kingdom has seen its cremation rate increase with the national average, rising to 70% currently from 35% in 1960. Even domestically, states on the West Coast tend to use cremations as a method of burial more so than the southeastern U.S. (with 60% cremation rates versus 20% cremation rates on average). The death-care industry is currently struggling with ways to convince consumers to purchase auxiliary services for cremations in an effort to increase profitability. However, we find it hard to believe that any amount of innovation, if possible, would supplant revenue from higher-margin, traditional interment services.

Ultimately we believe the old adage of two certainties in life–death and taxes–don’t necessarily hold in the investment world. Longer life expectancies, unfavorable secular trends toward cremations, and intense price competition will haunt the death-care industry for years to come, in our opinion.

About the Author

Bradley Meeks is a stock analyst on the Business and Financial Services team. Before joining Morningstar in January 2008, Meeks was a Senior Consultant at Deloitte & Touche LLP as part of the firm’s Capital Markets Group specializing in regulatory, risk management, and vendor due diligence for asset management firms. Meeks holds a bachelor’s degree in finance and management information systems from Miami University’s Richard T. Farmer school of business, and is a level three candidate for the CFA designation.