Service Corporation International ($SCI)

All right. Thank you for coming to Service Corp. International, SCI. We have Aaron Foley. Senior Vice President, Treasurer; and this is Tomo Sano, mid-cap Analyst at JPMorgan. So to set the stage, I wanted to highlight why SCI is here with us today. SCI is North America's largest provider of funeral and cemetery services, uniquely positioned to benefit from demographic tailwinds and robust preneed backlogs. This scale brand and leadership and transformation towards a customer-centric experiences driven platform have delivered constant growth and strong free cash flow. That's one of the reasons we wanted to have you. So thank you, Aaron, to come to our conference. So kick things off. I think Aaron, it would be helpful to start with introductions of the SCI, who the company is, what you do and your story, please?

Sure. Thanks, Tomo, and thank you all for your time and yours as well. Aaron Foley, as you mentioned, SVP and Treasurer of SCI, have been here just over 18 years, actually came from Moody's Investors Service and started running our forecast and budgeting process at SCI and kind of just work my way up there, but kind of started at a very interesting time in the company's history and companies if you follow or understand the history of the company, it's grown through acquisitions. We went through a hyper acquisitive period during the 1990s, where at one point, we were in over 20 different countries with 4,500 locations. We did so with no focus on return on invested capital. It was just trying to get as many acquisitions under our belt as possible. And we've all seen how that unfolds in one way or another. We came up with about $1 billion worth of debt coming due in the next 12 months with negative free cash flow. And so we had to make some tough decisions. We ultimately had to liquidate all of our assets in those other 20 different countries to remain solvent, if you will. But really, since 2002 to 2005, then changed out the management team, really integrated 40 years of acquisitions that had never been integrated. And to get our footing under us. And really in 2005, kind of started the strategy that we're at now, following this 8% to 12% earnings growth framework, we did our first major acquisition after that time period and getting our feet under us in 2006 with Alderwoods, the next largest competitor. And so I was able to join right after that. And over the last 18 years, really helped to manage the capital structure, help with acquisitions, larger acquisitions, financing those over that and get more involved in the Investor Relations world over the last 12 to 15 years.

Thank you, Aaron. So SCI has transformed from a traditional funeral and cemetery operator to our customer-centric experience-driven platform, with a focus on operational excellence and talent development. What have you been the most important culture or organizational changes driving this transformation?

I would say that the business itself really you should split between a funeral and cemetery business. And I would say, to some degree, it really hasn't changed fundamentally through this transitional period. The funeral industry is truly a caring and compassionate industry. People come in as a calling to help people in their toughest times of their lives, to manage through the death of a loved one. Cemetery side rather, is really more of a sales-centric sales-focused type business. It's kind of a real estate play going out and selling individual lots of lands to our consumers. What I think we have come in and how we have changed the business is really through the scale that we have. Being able to leverage that scale to go out, we've got a 3,800 person sales force, go out and radiate into our competitor's backyard to build that backlog that we currently of $17 billion to drive the sales, continued cemetery property sales and go along on that front. As I mentioned, through the clustering approach that SCI has, we're able to go in and purchase caskets cheaper than anyone else. We're able to centralize resources as it relates to processing the entirety of the stream of operations for the death care cycle as it occurs. And so we're able to do that. We're able to go in and really tier the cemetery property, as I'm sure we'll talk about later. We've got the capital to go in where a cemetery had been a homogenous, just lots throughout the cemetery. We're able to go in and really dig out holes and create lakefront property. We're able to parse out property and create private family estates, private mausoleums and create from that base level entry-level type inventory all the way up to very customized type inventory as well. So we've got the capital to be able to do that. But also we've got the resources to cascade down from the very top, a very systemized and really consistent platform that we expect our employees to follow to ensure that we're able to maintain that customer-centric, that caring and compassionate approach to managing our business, but also taking advantage of the scale that we have.

Sure. And then how do you ensure the operational discipline if it comes to service quality and people-first culture remain embedded across such a large geographical like [indiscernible] network?

So I think I would say that the tone starts at the top with our CEO, Tom Ryan, cascading down to the President, Jay down to John, our Chief Operating Officer; Jerry, Head of Sales. But we've got a Dignity University as a platform, digital platform that we have that has tens of thousands of hours of online training that are available to our associates depending on their roles and responsibilities within the organization. They're required to take a certain curriculum of courses. And so we've got that requirement in place they follow to help create some of that consistency. There's also reporting. As you would expect, we make sure that from an operational perspective, all of our locations have P&Ls. And so we track those P&Ls. We monitor them. We ensure with the breadth of our operations, where there are outliers, whether it be positive or negative, we understand what is going on at those outliers, and we target into those to give them assistance or learn from them, how they're doing things differentially better and how we can cascade that throughout the rest of our organization. We also monitor online Google Stars to make sure that the Google Star ratings for the locations where we see, again, the outliers, whether positive or negative, how we can go in and just make sure that we can manage those instances, particularly where we're seeing lower Google Stars. As you know, in this type of industry or would expect, reputation is paramount and making sure that our reputation is true. Most of our locations, they really retained the name of the former owners on the side of the locations, but we do brand them as Dignity Memorial. Many of them as Dignity Memorial. So making sure that, that brand is upheld to a certain standard, and people know that when they come to one of our locations, what should expect from a service perspective.

You talk about branding and also the reputations, like to what are the key elements of your people power and talent retention strategies? And how do you maintain consistency and accountability across the 2,000-plus locations?

Yes, I'd say in addition to like that Dignity University, I was talking about and monitoring the Google Stars, we've also got internally a survey through historically had been great place to work. Now it's a we listen type survey that's performed through Workday. But we cascade that survey out to our 25,000 associates to better understand what we're doing well and what we may not be doing as well as an employer within the space. And so we will listen to all of that feedback. We will internalize it and try to figure out how can we make sure that we are doing the best that we can for the associates that we're working with. They are truly the lifeblood of our company, and they are the face of our company to make sure that, that reputation remains intact. So we definitely are monitoring that and that that's being reacted to, if you will, something that we've done more tactically, more recently that I would point to, and Tom actually mentioned it on the call recently is in our sales force, a 3,800 person sales force. We've gone and shifted a portion of our compensation. The cash portion hasn't changed, what's generally getting paid out for each sale. But we're shifting from a very more heavily focused variable component to slightly more toward a fixed component of salary. And the reason why we're doing that is, we have noticed that as we've made some shifts in certain different states to a more fixed structure, that the counselors do have more of a retention. The turnover does get reduced. And when you see lower turnover within a sales organization, which historically do have large turnovers, they are more productive. They're able to explain the services and products that we're selling better to the consumers, and they're better able to transact. But you're also -- we also noticed that we have a better quality of sale coming through, that there are fewer cancellations that come from counselors who've been on for a lot longer. And so we utilize those strategies. We try to figure out how to tweak tactically on the fringes to maximize the retention and ensure that we're managing the organization as well as we can.

And then moving to growth strategies. So SCI's strategy leverage demographic tailwinds, such as the aging baby boomer generation, robust preneed backlog and shift toward more personalized experience oriented services. So what are the main drivers to -- for a sustained revenue and margin growth as you convert pre-need to at-need contracts?

So as I mentioned earlier, we've got a $17 billion backlog of future revenue that's coming through that's a little over 4x future revenue. And you really kind of have to step back and split those between a trust contract and an insurance contract, particularly on the funeral side. On the cemetery side, it's really a 100% trust. And it's just the merchandise and service pre-need sales that are going into trust because the preneed property, which is really about 60% of our pre-need cemetery sales is really recognized at the time of time of purchase, so there's no need to trust those funds. But what I would say is right now, we're probably about half and half between trust and insurance, when you combine our funeral and our cemetery businesses. And on the trust side, we've got exposure to market risk, the ups and downs of market risk. And we always like to mention that it's really a muted impact for current period, any current period market drivers because we're only recognizing and pulling those funds out of the trust funds when we are performing the service or providing the products. And historically, those contracts have been in our backlog for a little -- around 10 to 14 years. And so in any given year, where there is a decline in the markets or an increase in the markets, only those contracts that are maturing during that time are going to be impacted immediately, but they've also got 8 to 9 years of embedded returns that they've benefited from or detracted from over the last 10 years. Usually, it's higher. We do have a 4% to 6% real return target on our trust funds that we've been able to exceed 70% of the time over the last 15 to 20 years. But we have market risk on the trust side. On the insurance side, we have credit risk with the preneed insurance provider that we work with. And so there's more stability there. We do garner a -- currently, it's about a mid-30% general agency commission on each of those sales that comes at the time of sale. And then over the time that those contracts are in the backlog, they're growing at about -- or creating about 1% per year of earnings on those. And so you've got these 2 different frameworks there for trust and insurance that are appealing out of the backlog as we provide these products and services. But specifically on the funeral side, what we do is we index our -- what's going into the backlog, our preneed average to our at-need average. And what you'll notice is our -- what's going into the backlog is about 4% to 5% higher than what we're currently selling an at-need funeral contract for. And then on top of that, what's coming out of the backlog, benefiting from the insurance accretion, benefiting from trust returns, what's coming out of the backlog maturing is about 8% to 10% higher. And so us seeing that we're able to exceed what we're doing on a current period gives us confidence that our preneed strategy is working. If you were to see those be the opposite way, it would not be as comforting of an approach to be taking from a strategy perspective. So on top of watching that backlog peel out, we've also had to -- for the history of the company, manage our fixed cost structure. We do have a very high cost structure, so making sure that those stay at or below inflationary type trends are very important to ensuring as those preneed maturities occur, we have a managed cost structure. So the margins that are benefit the company has maximized as possible.

And then how do you see the balance evolving between traditional burial cremations and new memorialization offerings? What are the most important growth opportunities in the next 3 to 5 years?

Sure. So I'd say right now, we're probably as a company, 62%, 63% cremation. So I like to say we're already the largest cremation provider in North America. And I think we have effectively manage the transition that we've witnessed over the last 30 years from more focus on burial to cremation. It's historically been around 100 to 200 basis points of shift that has occurred over the last 20 to 30 years. We're starting to see that moderate some, where we've seen cremation mixes stabilize in other countries around the world, that seems to be around 75% to 80%. So as we get closer to that full saturation point, if you will, you would expect that slope of increase to decline. And also, if you look at our top 15 markets or so that we operate in, there are several that are already at that saturation point. And so we've seen that 100 to 200 basis points of growth last year, it was closer to 50 basis points of growth. And I think that, that's going to ebb and flow some over the next several years as we do get closer to that. And -- but I think 50 to 100 basis points of growth is probably a fair expectation for change. Every 100 basis points of change is about a $13 million headwind to EBITDA on a $1.3 billion, $1.4 billion EBITDA company that's that's an impact, but I think it's a manageable impact. And to your point about how we are reacting and how we are evolving, the cost structure or a business that may have 80% cremation is much different than a business that may have only 30% cremation. You don't need as many people or necessarily as big of facilities. So as we see these changes evolve over time, we manage our cost structure accordingly. And on top of that, I think you've also heard us talk more recently about how we're putting our shoulder more behind a cremation opportunity on the cemetery side. So when you think about our business of about 2,000 locations, 1,500 funeral homes, 500 cemeteries, there's an overlap of about 300 locations that we call combo locations where there is a funeral home that sits directly on a cemetery. And some of the metrics that we've looked at, say that about 1 out of every 4 cremation services that we do at those combo funeral locations gets incurred at our cemetery. Whether that's through a cremation niche opportunity, which is basically a glass front box that people can put their urns as well as keepsakes in, the family can come back and remember their loved ones. We have columbariums, where the urn can be effectively interred. We've got scatter gardens and such. But we think that people don't really know that, that opportunity necessarily exist out there for the cremated remains. So we think that there may be an expectation or an impression that there remains just need to be taken home, that they may be left on the mantle for some time. But many times, they transition to a closet or something like that. And so if they knew that they had an opportunity to inter their loved one in a place that they could be remembered, we think that, that can be very much desired. And so we've started a strategy of really creating media and putting our shoulder behind it to see what this opportunity could grow to. Can that 25% that go into our current cemeteries currently? Could that grow to 30%, 35%, 40%? And again, we're at the very early innings. I can't say anything as it relates to what I expect the full impact of the company can be, but we're seeing some very promising results there.

And Aaron, I was impressed when I visited your Houston Memorial Park with the cemetery sometimes like over 2 million levels of offering that you have in the real estate. How do you plan to further unlock the value from your premium real estate portfolio and tiered cemetery inventory?

Sure. So we currently spend about $165 million every year call cemetery development CapEx. And that's where we go in and we'll look at our 500 cemeteries and see what inventory is available at these cemeteries and we will incur capital to develop sections of those cemeteries. We've got several thousand acres of undeveloped property and we'll either go through and develop that property or take existing property, develop property and put these private mausoleums on if there is a desire by our customer for that. And to your point, we've seen private mausoleums go for upwards of $5 million, $6 million, in some cases, from an inventory perspective. So you're going to continue to see us spend that $165 million to develop inventory at our cemeteries as we see the consumer velocity come through and the desire come through. I think to, again, our 3,700, 3,800 sales force out there, giving them the tools, giving them the training necessary to continue to get in front of those consumers to truly champion, hey, this is -- this facility is where you want to come and remember your loved one. We've spent the capital to maintain these to be the most beautiful parks, we believe, in each of the cities that we operate in. But what we're focusing on more tactically currently is focusing on increasing that headcount somewhat. We think that we've stabilized on a production per head count level. And we think that we can increase the number of head count while increasing production, not kind of reducing it across. So focusing on headcount, focusing on more seminars. We've kind of gotten away during COVID from doing as many seminars because, again, it's a gathering of people, eating food and advertising our products and services. And we're bringing those back. Those are some of our best leads that are out there. So increasing those more and we're seeing more impacts from doing that already. Working with some of our tools within our customer -- our CRM system to utilize more AI modules, to route the leads that we do receive. And if we expect them to be better type leads, those get routed to our better counselors to as quickly as possible, follow up on and make sure that we're able to convert that sale. And then finally, the fourth thing and Tom mentioned these, was focus on large sales really getting out there and making sure that the community knows that, hey, you don't need to just have homogenous lot. You can come through, and we do have this customized inventory. And we do find that there are many customers who do want that. So just continuing to focus in on that and ensuring that our team are able to sail as effectively as possible.

You talked about CRM and think it's Beacon platform. How are digital investments are, I would say, AI investments in data analytics supporting both growth and margin expansions for SCI?

Yes, I'd say that because we have the scale to incur capital to develop these tools that I think we're able to differentially benefit from versus our competitors. We're able to, for example, at the pre-need facility, take a tablet in there and go through the entire sales process, showing all the products and services that we offer to -- for the consumer to consider. They may not take it all, but it's kind of a choose your own adventure type book. You can choose a cremation or choose burial. You choose burial, it shows all the burial options, choose cremation, all the cremation options. And at the end of the process, what used to take a 3- to 4-hour type process of someone filling out by hand, all of the different selections that a consumer may desire, we've transitioned that to now a process that may take 1 to 1.5 hours. And so from a customer experience type perspective, it's much better. And we think that, that also enables us to be more competitive from a counselor perspective that if they know that they're not going to have to these processes, 3 to 4 hours to convert a sale, we're going to be the employer of choice in this industry from a sales counselor perspective. So I think utilizing technology from that perspective, utilizing it even in the back office to make it more efficient. We've gone through and taken a process that may have had 80, 90, 100 different forms that needed to be filled out across the process from picking up the loved one through the final disposition, we've been able to kind of aggregate that into 40 or 50 type forms and try to prepopulate as many as possible with the data that consistently needs to be included in each of those forms. And so I think all of those efforts that we're taking are trying to make a more efficient back office, more efficient structure for our sales counselors and our frontline employees dealing with the -- and working with the families. I think like many companies, we're kind of at the early stages of scratching how AI can benefit the company. Now there are a couple of places. We've already seen it, and it's not amazingly dramatic, but from an obituary writing perspective. A lot of those obituaries are currently written by our funeral directors. And historically, that may have been a 4- or 5-hour type process to truly thoughtfully sit down and write an obituary for someone's loved it. We can now take AI and take a conversation that we've had with the family to understand their loved one, what their loves were and put that into AI, and it can draft something really nice that can then just be tweaked. So something that used to take 5 or 6 hours now may take 30, 45 minutes. And so that's savings. We're seeing it on building websites as well, where we may not have a ton of media for a specific of our 2,000 locations that we operate in. But to build a website, we can put into AI, say, "Hey, we're looking for dryer climate-type photos, look through our library of media that we locations that we already have photos and help us build out a website that truly represents what this location would look like from a customer experience perspective. So that's helped out. But I think there are further opportunities that we're evaluating in the back office. There's -- I don't think that there's going to be something transformational in our industry like potentially in other industries. I think that people are going continue to want a caring and compassionate person to deal with in this industry. But I do think that from a financial analytics, financial processing type perspective, there are going to be more opportunities that we're continuing to explore and figuring out how we can best employ.

Thank you. So before I open up the questions, capital allocations and M&A, what are your criteria for evaluating M&A opportunities? And are there any specific geographies or service lines you're prioritizing?

I would say we -- as we've talked about the leveraging our scale dynamic, we truly try to find areas that are larger urban type markets, where we're able to get in and really use or share the usage of hearses, share funeral directors. The average funeral home in America may only do 100, 150 services per year. So you've got someone who's working for 1 day, but may just be waiting for something to happen the next 2. And so if you're able to cluster and leverage that scale, you're able to share cost a lot more effectively and maximize that margin. I think that we've got that benefit that's helping us out in that regard and excuse me, the M&A. We also look at markets that the consumer appreciates and values our products and services. And where we've seen a lot of our growth recently is more in the traditional Hispanic and traditional Asian communities on the West Coast in South Texas and Florida. So those are going to be where we're going to want to focus on. We generally -- we don't have hard and fast rules of thumb, but generally, a location that does at least 150 services per year that at least $2 million in revenue. So looking at opportunities there. I think in the U.S. and Canada, we -- the larger consolidator opportunities aren't necessarily as great. A lot of the acquisition opportunities for the larger consolidators. We've sold them either locations that we didn't want or we were required to sell from an FTC perspective. So to acquire those types of operations, I think we would ultimately be liquidating a lot of our existing or a lot of those locations that we couldn't ultimately have going forward. I think we're -- you've seen us spend more capital for growth perspective, filling out our footprint in areas where we may already have saturation, but we've seen the population shift or grow in one way or another. And we did that more recently in 2021 or so, we opened a cemetery on the west side of Houston. And historically, we haven't really opened cemeteries because of the cost of capital constraints associated, but we opened that cemetery. And within the first 2 years, we'd already achieved our year 7 or 8 projection of revenue turnover coming through. And then actually just this week, we've now opened a funeral home on that cemetery. Usually, we have to have a certain amount of interments coming in per year on a cemetery before we'll consider building a funeral home on that cemetery. And it's just been so successful. We've decided to go ahead and accelerate that as well. So we've probably identified a handful of other geographies around the U.S. where we're going to be deploying capital to drive that growth.

Thank you. I would pause here if anyone has any questions from the audience. All right. For the last a couple of questions, Aaron. Are there any aspects of SCI's business, such as your real estate portfolio, digital transformations and people first culture that you believe are underappreciated by investors?

I think it's been more of a near-term dynamic, but I think just the consistency and strength of our earnings and our cash flow. The last 3 or 4 years have been somewhat turbulent as we kind of went from $1.90 in 2019 of EPS, all the way up to $4.57 in 2022 with the impact of the COVID experience impacting our business. Now the last 3 years, we've seen an expected decline in volume that has been a headwind. We've also seen increases in interest rates that have been a headwind for many different companies. We've seen an increase in tax rates as well as some of the 2017 Tax Cuts and Jobs Act dynamics have flowed through. And then we've also kind of intentionally derisked our business and had some business changes at SCI Direct, our nonfuneral home business, where we're now deferring earns that we had historically been delivering and recognizing at the time of sale. Now those will be recognized into the future. I think what may be missed is we've got all that behind us. I think 2026, we're kind of getting into a period of renewed growth, and we feel that we're confident that we're back in this 8% to 12% earnings growth framework. When you look back from really 2005 when the management team really started the growth and 8% to 12% dynamic. We've been able to grow during that time by about 14% EPS growth. So above that 8% to 12% growth. I think that we're back. I think that people are kind of want to see that those dynamics are truly playing out and we're seeing that take place. But I think that that's an underappreciated aspect currently. I think that, that's -- as we continue through 2026 we'll see that come through. I think, too, that the $17 billion, $18 billion backlog that we have. Just the strength and consistency there as we believe that we're growing on the margins, we would be foolish to think that we're expanding market share with the entirety of our backlog. But I think we're expanding some market share on the margins. I think that that's underappreciated. And I think that as we get closer to the baby boomer demographic impacting our industry, it could be the latter part of this decade is kind of what we expect. The oldest baby boomers are 80 years old this year. Usually, when you've reached an 80-year-old type age, it's about 82, 83, kind of the average age. I think that once we start seeing that impact our industry, that's going to be pretty strong and powerful.

Thank you, Aaron. Aaron, thank you very much, and thank you for everyone joining. So this is it. Thank you.

Thank you, Tomo. Thank you, everyone.