Service Corporation International (SCI) Earnings Call Transcript & Summary

Thank you. Thank you, everyone, for joining us at -- for our next presentation. This is Larry Bland with Bank of America. With our next presentation, we have Aaron Foley, Vice President and Treasurer from Service Corp. International. Before we get started, I would just like to thank, Aaron. And I know Eric and others and Tom in the past have been very, very supportive of joining us at our conference in Florida historically and virtually this year. But I truly want to thank you for joining us. You've always been very supportive. And with that, I will go ahead, and Aaron, as we had discussed, turn it over to you for some opening comments, and then we'll jump right into the Q&A off of the opening comments. So I'll turn over the floor to you.

Thank you, Larry. I appreciate that intro. I appreciate your time and your team pulling this together in this environment. I appreciate everyone who's joining us as well. I hope that everyone has been safe and your families are safe during this crazy time that we are going through. I'm sorry, I'm not able to see each of you. But as Larry and I were speaking earlier, I'm hoping this time next year, we're able to meet in person and just be looking at this in our rearview mirror as a memory. But again, appreciate everyone's time, and look forward to the conversation.

Yes. Aaron, it's just -- I thought maybe, obviously, a place we could start as many of the conversations have started. The environment, given the pandemic, I know you've seen a significant increase in certainly atneed funeral and cemetery revenues. Can you just speak to what your takeaway has kind of been through kind of year-to-date, if you will, from the pandemic, just for a little bit of backdrop for those on the call? And then what maybe you're seeing -- your thoughts are as you move towards year-end? And then maybe, in that same conversation, maybe just touching on the preneed side, what you're seeing in the way of COVID's impact on your preneed activity as well?

Sure, Larry. I think the first 2.5 months of the year, like pretty much everyone else, was business as usual. It really wasn't until mid-March that we just started to see a flurry of activity and an increase in the impact from COVID. And I think like many other companies, we were trying to figure out how to manage and how to properly operate in this new environment. And coming out of the first quarter, our cemetery preneed sales were down tremendously. I think in March, we were down somewhere along the lines of 40%. Our sales -- on the preneed cemetery side, our sales average had taken a significant hit too as the government mandates were put down and everyone really was hunkering down and trying to figure out really what was going on. We were down along the lines of 11% to 12% in our preneed average, but we did start seeing an uptick in volume. And as the second quarter progressed, as we started to figure out more effectively how to manage in this type of environment, started leveraging a lot of the technology that -- over the past several years that we have been working to put into place, really, we're able to start seeing an improvement in that preneed cemetery production. April, May, we're still a little bit struggling. But coming out June, we started to see just a significant increase in that cemetery production. Sales average started to taper off some from that 11% to 12% down. We were down about 8%. And then volume, as we've seen, just continued to increase. We did pretty quickly in the early stages of the pandemic on the funeral side, in cases where government-mandated shutdowns were in place, we put in place Facebook Live in about 1,100 or 1,200 locations across our footprint in only a matter of about 2 or 3 weeks. Our locations and management became very creative and managing in that type of environment, where you could have only maybe had 10 people in any gathering. Instead of having 1 service for 50 people, you have 5 services for 10 people apiece. And so really managed to figure out how to operate in that environment on the preneed side, really worked to leverage our Beacon tablet technology, which is a tool that our preneed sales counselors use to walk the families through the sales pitch using Webex, using DocuSign, really kind of bringing us forward to the third quarter, where we saw a 19% up volume quarter. Average was down about 3% or 4%. Our preneed cemetery sales were up 47% and atneed cemetery sales was up kind of commensurate with our atneed funeral -- on the atneed funeral side. And so we've come out of the third quarter just with very good operating results in an extremely unfortunate environment. And I think as we operated through that time, we've managed our capital structure. As many of you may have seen, we did issue with Bank of America an $850 million bond back in August at a tremendous rate to really help bolster our -- not only our infrastructure, but also our maturity profile. Our next major maturity isn't until 2027. We do have a small maturity of $150 million next year. But we were able to get that completed in the midst of this pandemic and really feel very confident kind of in our position of where we stand today ending the third quarter with a leverage of about just under 3.5x. As you look forward into the fourth quarter, we continued, as Tom said on the call, to see strong results coming through. Through the remainder of the fourth quarter, I think it's our perspective that volumes will continue to be strong, but maybe not as strong as what we saw in the third quarter. On the preneed cemetery sales front, there are really 3 components that drive what that increase in preneed cemetery sales are. The attachment associated with atneed case volume that comes through. If you have a wife, husband, partner who's passed away, you're going to want to go ahead and also preplan and purchase your own cemetery lot in those instances as well as other family members potentially associated with that service as well. You've seen an increase because of the aperture or people's consideration of COVID. Every time you turn around, you're hearing something about COVID on the Internet, on the radio, on this conference. So the end-of-life planning, it's just on the tops of people's minds. And then you've also got the technology advancements and the efficiencies that we've gained within our sales organization to just be more productive and efficient, really with fewer counselors and at a cheaper cost. And so looking forward during the fourth quarter, I'd say on the preneed cemetery side, Tom had mentioned on the call that we expect high single digits, maybe into low 10% teens type range for growth on the preneed cemetery side. So we're expecting to end the year strong. And then, of course, looking forward to 2021. We've put in place, I wouldn't even call it guidance, but I'd just put -- I'd say, guidepost for a very large range of $2.25 to $3 on an earnings per share perspective that run the gamut from COVID were to shut off completely as of December 31 and have no impact looking forward into next year, all the way to COVID runs, all the way through ending up with that $3 per share that we've noted.

Okay. Just a follow on your commentary. The -- can -- I guess maybe 2 thoughts. One, can you talk about kind of the longer-term takeaways, kind of what -- from what's been learned or continues to be kind of learned, if you will, in the -- this pandemic environment? And secondly, maybe the extension of that question because I think you had touched on this, can you talk about the true adoption of digital technologies during COVID and what extent this digital presence will play out longer term as well?

Yes. I think that what we've learned and took away from all of this is that we haven't necessarily been managing our sales force maybe as effectively as it could. We've been loading salesforce.com with a bunch of leads and really just kind of disseminating those leads on a first-come, first-serve basis, and we were able to execute and meet preneed production goals. But I think with the pandemic, we restructured the sales force some where we've made it a little bit more of a commission-only type structure. And then we also took those leads that had been fed into sales force and really directed those to some of our more productive salespeople. And so what we've been able to find is we've been able to close on these leads at a much lower cost than previously. And so that's one aspect that technology has impacted our preneed sales. Another aspect relates to just the training of our counselors. With any sales organization, you're going to have a decent amount of turnover. And whereas before, we were flying people around to different conferences to have training take place, now we've shifted to more remote or virtual learning type structure. And that's been able for us to clamp down more on noncustomer-facing cost. I think that some of those costs and some of those efficiencies that we've learned through this process will perpetuate going forward, particularly on the cemetery side. On the funeral side, it's a little bit different from a preneed perspective. On the funeral side, what we found is the production is really -- has a strong impact from these seminars that we've been able to hold in the past, these in-person and restaurant-type seminars that take place. And when you look back to the second quarter, our year-over-year preneed production was, I think, 27% down on a year-over-year basis. In the third quarter, we were about 2% or 3% down. And so we've improved upon that. But I think until we're able to get back into that seminar-type environment, that's been one aspect of our operations that we've not yet cracked the code, if you will, from an IT perspective of how best to tackle that issue and actually progress upon it. I think that we have employed some more on-demand type seminars and people who are reaching out on our websites, really trying to setup Webexs, offer those on-demand seminars and really seeing how we can drive some preneed sales on that front. But just keep in mind, too, versus the preneed cemetery property sale that takes place and is immediately impactful to earnings and cash flow, on the funeral side, generally, those preneed sales stay in the backlog for 10 to 12 years. And all of that cash flow, generally, that cash flow and those earnings are deferred until the time of need. So it's really not as impactful from an immediate period standpoint but longer term.

Yes. And you had touched on it briefly there, you had talked about the kind of the cost opportunities. And I think most recently, you talked about a $10 million to $20 million cost structure improvement versus kind of 2019. And your margins are certainly improved recently and certainly in 3Q. Are those -- some of the margins that you're posting as a profile in terms of gross or EBITDA margins, are they sustainable? Or is that -- are they somewhat, not to say, modified by the existing environment, are those sustainable at the current levels?

Yes. I'd say the 700 to 800 basis point year-over-year improvement in margin in both the funeral and cemetery segment is primarily driven by the volume that we're seeing coming through. As we've talked about a lot of times in the past, both the funeral and the cemetery segments have a pretty high fixed cost structure. So any incremental volume that's going to be coming through will have an outsized impact on that margin. That being said, as you noted, we did identify $10 million to $20 million of savings in our cost structure versus 2019. I don't think that we're going to remain at that level, but I do think that there will be some ongoing efficiencies or savings that will be maintained. I say that the bigger components would be on the selling cost side of things relating to advertising and promotional expenses, some of these efficiencies that I've talked about on the preneed counselor side of things. The noncustomer-facing costs, not only through counselor training and having those online, but throughout the organization, similar to the rest of the world, travel came to a halt. Meals and entertainment really abated as well. I'd expect that there'd probably be some amount of increase as we look forward to a post-COVID world, but I think there's also going to be an expectation that we have a good handle and manage those costs. And then finally, in some instances, on the funeral side, we found opportunities to better manage our FTEs and really operate under our clustering strategy of sharing resources and have identified more opportunities to really execute on that strategy and maintain that lower cost structure.

So there would be some retention on the margin side, that -- obviously, not the levels that we've seen year-over-year, but some some benefit at some level?

That's exactly right. Correct.

Okay. Great. And I know I get this question, you've kind of obviously given some guidance around '21, including kind of volumes and so forth. I mean how do you frame the vaccine -- I shouldn't say the vaccine, but how do you frame the pandemic within that thinking? Does -- has the pandemic kind of, I don't want to say, shifted volumes, there's a kind of front-loaded volumes in a way because of the activity and the kind of the death rate into 2020 versus what we'll see going forward? Has it shifted that outlook in any capacity?

No, I think it has. As we've said for many years, anytime you have a strong flu season, you're kind of accelerating deaths within the year earlier in the year to the detriment to the latter part of the year, but it's generally contained within any given year. When you think about COVID, though, I think that this is just a massive event that is occurring. And it's across many different age cohort bands that you're seeing, obviously, in the older age cohorts, an increase in the number of deaths primarily. But what -- I don't have necessarily an actuary or a statistician on the staff that we're digging into. But looking at some of the data that's out there of the COVID deaths that have occurred by age bands, comparing that to a normal death year, if you will, I'd say, holding all else equal, when you compare 2019 to, let's say -- a normalized 2019 to a normalized 2021, we are believing that 2020, we've kind of pulled forward about 7,000 or 8,000 deaths into 2020 that would have occurred in 2021. And that impact is reflected in that $2.25 to $3 guidance we gave for 2021. And so I'd say, like I mentioned, that December 31, 2020, assumption that no COVID happens or COVID's completely under control, that 2021 $2.25 does reflect the headwind of that 7,000 to 8,000 cases. But that being said, it's also going to reflect some uptick relating to average because you would expect that more people would be comfortable meeting and gathering and having bigger services. You'd also expect that we'd maintain some of these cost savings that we've been talking about as well.

Yes. Yes, that would be fair. From a -- I know I've always talked in the past with Eric and so on and so forth. But can you talk about the M&A environment and kind of the deployment of capital, if you will, to potential acquisition of what that environment looks like? I know you don't have a large bolus of big enough. As was touched on, you said there are some regional players and smaller players. Can you just touch on that environment and particularly the opportunity for acquisitions in terms of candidates and what you're seeing now? Has the pandemic environment changed any of that in any way in terms of opportunities?

Sure. So I'd say once in, let's say, the May, later May kind of time frame, once we figured out that our company, we were going to be stable and didn't have any issues really from a balance sheet or a liquidity type perspective. We were very anxious to identify opportunities to deploy that capital, really hoping that we would see more opportunities avail themselves. But really, during the second and third quarter, we really didn't see many acquisition opportunities come about. As we come into the fourth quarter, we are seeing a little bit more activity. And I'd say that we're somewhat positive that -- or feeling positive, I should say, that we should come closer to that $50 million to $75 million acquisition target that we set earlier in the year. But what I'd say is there are opportunities out there. We do look for situations where either we can fit into our current footprint to be able to take advantage of our clustering strategy and the sharing of resources. We look for opportunities where there's a consumer base who values the products and services that we do offer that is going to be somewhat of a scalable type location as well. And I'd say that we probably have a list of 600, 700 type locations that fit that criteria that we have teams out there just trying to cultivate and maintain relationships with that whenever they are ready for a liquidity event, they know that we are interested and able to have conversations as well as the capital to complete those. And so when you think though about some of the larger players like a Carriage, a NorthStar, who's private, those would probably be a little bit more difficult given the number of FTC locations that we've sold to them. So there have to be a good value proposition for us to go through that. There is a smaller firm, Park Lawn, who's growing quickly, who's got a good management team that we obviously are watching as well and maintaining conversations with. And then there's also a company in Canada called Arbor Memorial, a private company, who's locations complement ours up there very well that -- it's family run. But again, at the right time, if they're interested in talking, we're definitely interested and willing to speak with them. But really, none of those bigger opportunities, there's anything on the horizon with any of those. So we're trying to just continue to execute on our tuck-in acquisition strategy. And then kind of more broadly, when you step back and think about the deployment of capital in general, our first focus is deploying and investing in the business. And that's going to be through our maintenance and cemetery development capital program. I think this year probably is a little bit depressed from that level. We've guided to about $180 million. But I think when you look forward to next year, we probably expect to be back in that $230 million or so type range as we continue some cemetery development projects that we deferred from 2020 into 2021. Then we look to just maintain and be able to pay that dividend as well. But then looking to acquisitions, and that's kind of really our highest and best use of funds because we're able to manage to 15%, 20% upper teens type percent IRRs on that spend. Kind of after that, we're looking at our growth opportunities, looking at our footprint and trying to find areas that meet some of those criterias that I mentioned earlier that we can spend some capital there to grow our footprint. We don't have quite as good of a return on that money as acquisitions because it takes a little bit of time to get that EBITDA up and running. And then after that, absent other opportunities to deploy capital, we really employ an intrinsic value type calculation for our company, compare that to how we're trading. And depending on our debt maturity profile, leverage and liquidity, we'll then deploy capital to share buybacks.

Okay. Okay. And keeping within the scope, of say, the leverage profile that you've always maintained kind of in that 3.5 range or so thereabouts.

That's exactly right. I mean -- and just one note on that, when you look at where we ended September, we're slightly below the 3.5x range at 3.4, I think. But we're really looking at our models really all the way through 2021 to the end of 2021. We recognize at some point once COVID's under control, that there's probably going to be some quarters where we have some EBITDA headwinds as we drop off some stronger orders and add on a little bit weaker ones. And so just really managing the leverage pretty diligently that way.

Okay. I think I know the answer to this, Aaron, but I presume that any M&A activity outside of North America, in U.S., Canada would never -- would not be on the table. I know there's history going back many years ago. But I presume you wouldn't look at assets overseas?

That's exactly right. I mean as of right now, it kind of doesn't make sense. We have plenty of opportunities, we believe, here in the U.S. and Canada to execute on our strategy. We do monitor those markets. I think if we ever were to go back into there, it would be in kind of a more Western or more similar to the U.S. and Canada type market. So we'd be looking at probably the U.K., France or Australia. But with those types of acquisitions, you really just don't have the types of synergies that we're able to maintain or get here in the U.S. And so there would have to be a extreme comfort level in managing those businesses, but also there would have to be a very strong value opportunity that arises before we would even think about doing something along those lines, but that really just isn't even on the horizon right now.

Okay. Okay. I think we'll go ahead and wrap it up. I think we're at the end of our time here. If -- I'd like to -- I always want to thank you and your team always for joining us at our presentations at our conferences. It's truly appreciated. And thank you, Aaron, for taking the time today. And thanks to our investors who are on the line. Thank you for joining, and enjoy the rest of the day. Thanks again, Aaron.

Thank you, Larry. Thank you, everyone, and stay safe. Take care.

Thank you. Bye-bye.