Service Corporation International (SCI) 2004 Q4 法說會逐字稿

Good day, everyone and welcome to the Service Corporation International fourth quarter 2004 earnings release conference call. As a reminder today's call is being recorded. And now at this time for opening remarks and introductions I would like to turn the conference over to the management team of SCI. Please go ahead.

Good morning. This is Eric Tanzberger, Corporate Controller of SCI, and I want to thank everybody for taking the time this morning to be on this call. As you know, yesterday evening we filed our 10-K, which is available on our Website. And this morning we issued two press releases, one for our final 2004 earnings and our Q4 earnings and one giving guidance for 2005. Today on the call we're going to have some prepared remarks and then we'll open the call up for questions.

Before we start with the prepared remarks, I'd like to read the cautionary statement and remind everyone that there will be statements made today on this call by management that are not historical facts and are forward-looking statements made in reliance on the Safe Harbor protections provided under the Private Securities Litigation Reform Act of 1995. These statements may be accompanied by words such as believe, estimate, project, expect, or other similar words that convey the uncertainty of future events or outcomes. The statements that we are making today are based on assumptions that we as management believe are reasonable.

However, there are factors that could cause our actual results in the future to differ materially from the forward-looking statements that are in our releases, the 10-K or that we're making today on this call. These important factors which could cause the actual result to differ materially are listed in both press releases released this morning, as well as thoroughly disclosed in our form 10-K that was filed yesterday evening. I would also like to remind everybody that the press releases and the form 10-K are available on our Website, which is www.sci-corp.com. Also, a replay of this conference call will - - is also available on this Website under the Investor Relations page on our Website. With those introductory remarks I would now like to pass the call over to our newly elected President and Chief Executive Officer, Tom Ryan.

Thank you, Eric. Before I begin my comments with regard to the operational review; I'd like to start by apologizing for the delay we've incurred in filing our form 10-K. There are two primary reasons for this and I think most of you who have been on these calls before are fully aware of our trust reconciliation program we've got going on, along with the associated cemetery undeveloped - - I should say undelivered verification project. Both these projects were launched in 2004 and we've made significant progress in getting these two things behind us. The trust reconciliation project was completed and is now completely done as of this point in time. And on the cemetery undelivered verification project, we completed a very significant portion of it.

Having said that, one of the reasons for our delay was that we felt we needed additional time to increase the statistical sample that we had originally done associated with the remaining items in this project. The second item that had an impact on our delay in filing our 10-K was; we're in the midst of discussions with issues rate by the SEC on review letter we received in association with our 2003 10-K. Additionally, what you'll see in our 10-K filing are material weaknesses that we identified in association with our SOX 404 review. I'm here to tell you now that we do not find our results to date as acceptable. And we are going to do everything within our power to significantly improve the results that you'll see us report in 2005. With that said I'd like to move along and start into an overview of our operation.

First, I'll speak to our funeral segment. Overall, 2004 in our funeral segment was a challenging year. Our funeral segment margins did improve in 2004 as compared to 2003 but not at the levels that we had expected. Comparable funeral volumes were down year over year as you can see in the press release. This is disappointing to us and we must do a better job competing locally within our marketplace. Having said this, our results down 2.1% for the year, were consistent with others in the industry - - in our industry and other trends that we've seen. In particular, we had a very tough fourth quarter as it was compared to a very favorable fourth quarter in 2003.

On our comparable funeral averages, we - - they continue to increase. The reasons for these increases are the success of our dignity package plan, the rollout of our blueprint for success and the associated training and merchandising techniques, which to date are in 500 of our funeral locations. All of this is aligned with what we believe are the changing consumer wants and needs and our strategies to deal with those. The cremation mix change also is not changing as quickly as some might anticipate. It's within the lower end of our expectations year over year. And in addition, these comparable funeral average increases are occurring in the midst of certain localized merchandising pricing competitions. We're seeing competitors to local markets, some casket stores and others that have an impact on our ability to price our products within those marketplaces. So, having seen our funeral volumes down slightly, and our comparable funeral averages hanging in there very well in the face of the cremation mix change, our overhead costs were reduced year over year and this helps.

Having said that, other costs associated with our field, our field G&A costs, our field facility costs and our vehicle expenses increased more than we anticipated. Some of these costs are tied to the increase in energy prices year over year. As we look to 2005, associated with our funeral segment we would anticipate the following: First, a continued increase in our funeral average. Secondarily, comparable funeral volumes will be slightly down. Third item, improved cost containment measures. We believe we're continuously looking at improving our cost structure.

Having said that, we're aware that some of this cost structure improvement are going to be offset by increased costs associated with SOX 404 controls. Because of results that we incurred in 2004, we anticipate spending additional dollars within our field organization in order to improve the controls at that level in the Company. We also would expect to have improved results from our Kenyon International Emergency Services. As you'll recall, this unit in 2004 did not perform to the level we've seen in previous years. This year we expect improved results as we are associated today with unfortunately the disaster, the tsunami disaster in Thailand. And we've had on the ground, since that's occurred, anywhere from 40 to 85 personnel assisting the Thai government in dealing with the situation there.

The last point I would point out in 2005 is that we anticipate higher selling costs now because of the accounting change that we announced in our 10-K. We're going to begin to expense selling costs as incurred as opposed to the deferred and amortization method that we've utilized in the past. The key initiatives in the funeral segment that are going to be important to enhance our returns are: The continued rollout of our dignity blueprint for success. This is the displays associated with the related training. In addition, we believe as we enter our second year in our new management structure which was initiated in November 2003, we believe this accountability and the understanding of our local management's marketplace, that we'll compete more effectively. Third, continued emphasis on the dignity brand. We've spent a lot of time money and effort in rolling out our community service program as well as our national advertising. And again, behind the dignity brand and this will help us as we compete more effectively within our local markets.

And then our last item as it relate to key initiatives, I don't think this will have an impact on 2005. But we're going to spend a lot of time and effort in better understanding our segmentation of our customer base. Understanding the segments within our markets and designing the appropriate delivery mechanism in order to enhance the customer's satisfaction as well as our returns. I wouldn't anticipate much impact on this until we reach 2006 or 2007.

On the cemetery segment overall 2004 was a real success. Cemetery segment margins improved beyond our expectations, over 500 basis points year over year and also above our guidance range that we provided in 2004. We had very strong cemetery property production. Our cemetery property production, which is really our true sales activity, some of which gets deferred and some of which gets recognized was up over 8%.

Part of the reason for this was the success of our tiered product offerings within our cemetery and the associated top down selling with these tiered product offerings. Having said that, merchandise was more of a challenge due to monument stores and others as today we see people outside of our cemetery selling vaults and markers and related items into our cemeteries right across the street. Having said that, our production associated merchandise was essentially flat. Our overhead reductions and maintenance cost reductions associated with cemetery further enhance our returns in 2004 and really led to the dramatic improvement in our cemetery margins.

As we look to 2005, we would anticipate the following: First, continue to improve sales production. Secondarily, we will also encounter a reduction in recognized legacy revenues. Legacy revenues are revenues that were sold in a prior year that get recognized in the year of construction. So these revenues typically have no cash in the year of recognition. Having said that, we will probably recognize less of these in 2005 as we did in 2004. It's in association with our changing philosophy as to how we run our cemetery business. In the past, we may have presold a mausoleum for instance, five years before we construct it and we presold it, we - - typically we'd discount it and we typically would have to raise our selling cost in order to get it done.

We find that we're better served as a Company and the customer is better served in that we can reduce the time between the sale and the construction. And that's the philosophy we're using today as we move forward so we can price it more effectively. We know the cost parameters and can't get caught by the delays in - - let's say the input costs in building those programs. The third item as we look to '05; is we anticipate slightly lower trust earnings as we enter '05m because of interest rates and what's occurred there. In addition, we too on the cemetery side look for improved cost containment. We continuously today are looking at ways to reduce the costs associated with our delivery of products and services within this arena.

Having said that, once again, we are anticipating increased costs associated with our stocks control. We will spend additional monies this year in order to ensure that the field controls are appropriately working. We hope over time that these costs will slowly diminish as we improve our control at those levels. The last item as we look to '05 that people should anticipate are again higher selling costs because of the accounting change that we are making. We will recognize these costs as we incur them as opposed to deferral and amortize. The key initiatives to enhance our returns as we look to the cemetery business are the continued product series within our cemeteries and the related top down selling. We are not yet within all the potential cemeteries that could benefit from this program.

In addition, we're in the midst of a rollout of our cemetery pricing model. And this is a model that strategically prices the property, merchandise, and all related items to a cemetery based upon SCI's philosophy and strategy as to how that should be done. The third item, our dignity packages for cemeteries. These are in their infancy and really only rolled out to a handful of markets at this point in time. But this allows us to more competitively price our product offering and compete with the people that are sitting outside our cemeteries selling products and merchandise. In addition, dignity university, which continues to roll on, we are spending an inordinate amount of our allocated dollars on sales management. We believe this is very important to the future success of our cemetery and our pre-need programs on the funeral side. So within our sales management programs, we are instilling a tremendous amount of discipline as to how we manage the sales process.

And then lastly, I would just reiterate what I said on the funeral side. Our customer segmentation project. We will spend, again, a lot of time and effort in enhancing our ability to understand our segmentation and deliver the appropriate products and services in the most effective manner. Now I'd like to spend a few moments speaking to cash flow. Overall, 2004 cash flow we had a relatively good year. If you exclude the extra payroll from the free cash flow, we're really right in the middle of our guidance that we gave at the beginning of the year. As we look to 2005, we anticipate that we're going to see a reduction in our free cash flow of $15 million associated with us no longer owning the French operation. In addition, we will be funding $17 to $20 million in our 401K in lieu if funding the 401K, as we have in the past, for stock in the prior years. Again, associated with our ability to drive shareholder value, we are looking at our stock currency as something of good work. And this is in association with our increased allotment, share buyback program as well as the dividend that we announced a few months ago.

The third item is going to negatively impact our free cash flow for next year. The increment impact of approximately $5 to $8 million, from the Florida conversion, to bonding to trusts. These identifiable reductions om free cash flow are anticipated to be offset by: Number one, lower cash payroll costs of approximately $19 million due to the 11 year phenomenon that we incurred in 2004, which will not occur in 2005. And last, but not least, improved operating performance from our North American operation, primarily led by a lower cash interest stock, that was in our business. As we turn to earnings per share overall, let me first qualify my statement to say that the comparison I'm about to give is on an apples to apples basis for normalized earnings. This would not include the proposed accounting changes, nor would it include any impact from an asset sale or refinancing.

Generally, we see enhanced earnings year over year, primarily due to increased operating performance driven by lower interest expense. And in addition to that we see lower diluted share count from the impact of our share buyback program that's occurring the latter part of 2004 and to date, what we incurred in 2005. These two positive trends are somewhat offset by a loss of our French operation contribution which is approximately 2 pennies per share in 2004. The increase costs of SOX compliance which I've mentioned somewhat already. But we'll see increased cost of SOX compliance for additional control within our field margin. You'll see those show up in our margins. And in addition to that, the SOX compliance testing will show up in our G&A costs. And we anticipate, again, slightly higher costs associated with that activity in 2005. I'd love to see those costs come down. I promise you we're going to try to drive those costs down. But first and foremost, we've got to get our control environment more appropriate until we can begin to do that.

Last item, I might just mention, in the guidance that we've given in written form and the guidance I just talked to, we are not yet defining the higher selling cost that we anticipate because of the accounting change. I think in the guidance we say $14 million was the difference between the amortized - - I'm sorry deferred and amortized method and the expense as incur method for 2004; you could expect in 2005 something similar that again we need to adjust later, our guidance to reflect that new accounting. So with that, that concludes my comments. I thank you very much. And now I'm going to turn the comments over to Jeff Curtiss, our Senior Vice President and Chief Financial Officer.

Thanks Tom. SCI generated approximately $205 million of free cash flow in 2004. Free cash flow is defined in SCI's press releases issued today relating to the 2004 financial results and our 2005 outlook. In 2003, free cash flow was approximately $15 million higher. The decline in free cash flow in 2004 is primarily attributable to SCI's decision to trust approximately $15 million of funds for Florida Funeral and Cemetery Merchandise and Service Sales in 2004 rather than using Surety Bonding as SCI did in 2003. We also paid an extra $19 million in payroll in 2004 that occurs only once every 11 years. SCI's free cash flow excluding France, was approximately $190 million in 2004 and $211 million in 2003; representing a $21 million decline in 2004 for the same reasons as I have just noted.

Our 2004 free cash flow was at the lower end of our target range of 200 to 245 million. As outlined in our 2005 outlook press release, our target free cash flow range for 2005 is 200 to 220 million. In 2005, we expect additional Florida net trust deposits of $5 to $8 million and cash funding of our 401K plan of $17 to $20 million, to more than offset the benefit of the lower payroll cash payments in 2005 when compared to 2004. One key use of free cash flow during the third and fourth quarters of 2004 and the first quarter of 2005 has been our open market share repurchase program. Since August, we have acquired 31.4 million shares - - SCI shares at a cost of $214 million or an average cost of $6.82 per share.

SCI currently has $86 million of the approved stock repurchases yet to undertake and expects it will complete the approved programs during 2005. General and Administrative expenses when adjusted for litigation costs and accelerated amortization of information systems were about the same in 2004 when compared to 2003. These costs were also within our target range of $65 to $70 million in 2004. Increased expense due to Sarbanes-Oxley costs, trust verification project costs and long-term incentive plan accruals which were granted in lieu of stock options in 2003 and 2004; were offset by lower information technology costs and other cost reductions. In 2005, we expect general and administrative expenses to be in the $80 to $85 million range due to additional costs associated with internal controls and long-term incentives including the expensing of stock options as required effective mid-2005.

Interest expense declined in 2004 due to lower levels of outstanding debt. It was also reduced from prior reported amounts by $4 million due to the year end reclassification of surety bond fees to other income and expense. We also completed the funeral home and larger cemetery markets trust reconciliations in 2004 to confirm our trust assets and related deferred income and noncontrolling interest amounts on our balance sheet. The similar reconciliations for the smaller cemetery markets are still being processed but we expect to complete them in May and have everything done before we report first quarter results. We also will make an accounting change in the first quarter of 2005 to currently expense all pre-need selling costs. This will result in a noncash change in accounting charge of approximately $200 million after tax. And reduce pretax 2005 earnings by approximately $15 million.

EBITDA will also be decreased by approximately $60 million. However, it will not impact SCI's bank credit facility as it has special provisions dealing with changes in accounting. Our effective tax rate for 2004 was a benefit of 6% due primarily to tax benefits recognized associated with our sale of French business and the UK equity holdings, as well as the realization of some state tax loss carryovers. We continue to believe that a normalized effective tax rate for SCI is approximately 35%. We completed the sale of our Argentina and Uruguan businesses in early 2005 for approximately $20 million. The assets and liabilities associated with these businesses were classified as discontinued on our December 31, 2004, balance sheet. SCI's $2.9 billion of funeral cemetery merchandise and endowment care trusts. A good performance in 2004 particularly in the first and fourth quarters.

The returns include the impact of both trust - - earned income and changes in portfolio value but do not include the trust management fees and other costs of approximately 1.1% per annum. These returns also exclude trusts that had been invested in life insurance policies. For the year 2004 the funeral trusts had a return of 7.10%. The cemetery merchandise and service trusts had a return of 6.74%. And the endowment care trust had a return of 8.56%. In addition, the current market value of our portfolio of trust investments at December 31, 2004, exceeded our costs of these investments in the trust by approximately $151 million. SCI currently has cash balances exceeding $300 million. And it has a modest amount of debt maturing during the remainder of 2005. Our cash balances are enhanced by a nonrecurring $29 million federal income tax refund received in late March, 2005. This tax refund is not part of our 2005 free cash flow target.

Despite improvements - - significant improvements in internal controls in 2004, Tom and I will certify that SCI's internal controls were not effective as of December 31, 2004, in accordance with section 404 of the Sarbanes-Oxley Act. SCI has spent significant money and human resources in 2004 to enhance its internal controls. And it will continue to improve its internal controls in 2005 with the goal of achieving effective controls by year end. Details about SCI's internal control issues are outlined in our 2004 10-K. Management understands the necessity of achieving effective internal control compliance as soon as possible and has plans that should achieve it. With those comments we'll now go to the question and answer phase of the call.

Thank you. [OPERATOR INSTRUCTIONS] And we'll take our first question from A.J. Rice with Merrill Lynch.

It's actually Chris Rigg filling in for A.J. I was wondering what could be looks like significant year over year increases from Kenyon; could you talk a little about the profitability of that business? Or specifically how you think how that business will perform related to the tsunami related business you're going to pick up?

Sure, Chris. It's a small business, as you know, so it's not going to have a dramatic impact on SCI. But the model - - what Kenyon historically has done is, Kenyon was - - were the people that hit the ground when a disaster occurred. They were at the airplane crashes whether it was on the top of a mountain or somewhere else. And we had to a limited extent, some contracts with people to be on A retainer if and when a terrible event occurs. What's changed over the last couple of years and one of the reasons you see the margins going down for instance last year is we've invested some money in developing a technology now where we have a call center capability that no one else has. We have a call center that stretches across 5 continents and have language capabilities I believe somewhere in the neighborhood of 80 to 100 different languages. And so now we're better poised, with a little more money up front, to go to governments, to go to airlines, to go to businesses and say, we can handle that crisis for you. Even a - - think about the cruise ship, for instance. If something bad were to happen on a cruise ship, we have the software, the technology and the capability to handle a major crisis. And so armed with this, we believe that there are, again, governments, companies, airlines and the like that would find value in having this service because they can't do it themselves. And it doesn't make any sense to staff for something like this. So we are attempting to try to make this a more recurring revenue business, which we're slowly being successful in. As it relate to the tsunami disaster, this again and one of the reasons that we were called in is the technology that we have and the relationships we had with a variety of governments. So when you have a project like a tsunami disaster, you incur a lot of revenues with decent margins against that fixed cost base. So what you saw last year was a very poor performance because I think we had 3.5 million in revenue, which resulted in quite a bit of a loss. We would anticipate just on the tsunami alone, that - - you know, we'll make money in order to cover those fixed cost bases and probably then some.

Okay. Good. My second question and I'm not sure if I missed any conversations about this, but with regard to the dignity rollout, can you tell me where that stands? And sort of talk about it in the context of how many funeral homes had the dignity sales center in place this year and were really able to sell and not who just had it in place but were not just - -? Give me an idea of how much more you think that could contribute in 2005.

Well, I think it's two things. You know, last year was the initial phase of rolling this out. And by year end I believe, Chris, we had somewhere in the neighborhood of 500 locations that the displays were installed in and the people were trained to some extent. We really believe that the impact - - our plan now is to - - we've slowed down the 500 and really taken an analysis of what's good, what's bad, what should we change, what can we improve upon. And we think the real impact comes in the followup of we probably put in the latter half of the year 300 of those. It didn't get a significant impact from having it being in place. The work today going back and retraining in each of the 500 locations, we are going to begin to rollout again here shortly into some other new markets. But we would anticipate - - I would personally anticipate a better impact this year in 2005 than in 2004 by the simple fact of seeing the way this thing works. When you come back the second and third time and retrain and get people really understanding and engaged in what it's about that's when we're seeing lift in the specific locations. So we would anticipate additional lift from particularly the businesses we roll this into in the latter half of the year. I think the ones we roll it into new places we wouldn't anticipate a big impact in '05 but again, kind of an incremental impact in '06.

Okay. And then the last question I have is given the real estate focus in the investment community, I think you guys own about 70% of your funeral homes. Have you guys ever looking into - - is there any value to be realized there?

I think we're constantly looking at that, Chris. I mean, we're looking at enhancing shareholder value. So from time to time we will find situations where; let's say we have a funeral home that's not earning a great return that may have a tremendous real estate play associated with it just based on what's happening within that market. So from time to time we do take advantage of that on funeral homes. We also take advantage and look at what's the highest and best use for a cemetery property. What you've seen us do - - and all this shows up to the gain or loss on sales line item. So it really doesn't improve our core operations. But it's a great excess cash that can be utilized more effectively in other parts of the business. So we have a department that's focused on that. We're constantly doing it. You know, in any large methodology, I don't see that being a driver over the next couple years. But we sure understand that we have a portfolio of business that has some real core value in the real estate holding facilities.

And just a real quick follow you on that. I mean, outside, you know, sales of if facilities themselves or sales of cemetery property, is there any way to do something in a REIT type transaction or something along those lines that you've considered?

Well, you know, you never say never. I think historically we've looked at a variety of structures around that, particularly on the cemetery side. But there are some complications to that and I don't know at this point in time do we think that's the most efficient model. But we're constantly reviewing ways to enhance shareholder value and if one of those points us in that direction then we'd pursue it further.

Okay. Great. Thanks a lot.

And we'll take our next question from John Ransom with Raymond James.

Hi. Your 40 to 45 million in gross CapEx, what kind of return to you expect to realize from that? I mean, if we deduct this from free cash flow, is the return going to be seen in two or three years or how should we think about that?

I think, John - - this is Tom. I think the way to - - we need to really kind of break that into the components of what that growth CapEx would be. And I'll try to do it in three different segments. One would be our cemetery development growth CapEx. Here that will would be development of high end cemetery property that you've seen us have some success with in certain of our cemeteries. When we build these things sometimes they sell right away and quite a bit of them do, to be quite honest. Sometimes they don't and they may stay on our inventory you know, a number of years. And benefit future years by having that inventory available to sell. They also kind of indirectly benefit us in the fact that by having this higher end inventory and putting beautiful features within our cemeteries, it enhances the value of the surrounding business. So in that component it can have an immediate impact upon sale or it would impact future periods as well.

The second piece is - - of our strategic spending is the dignity displays that we're talking about. And here we think that these will have a great return on investments. But again, I think it's - - there is a lag factor. When we roll these things out, you get the associated training and we tend to see in markets where they mature, in markets where we get the training right, we see an increase in funeral average within those markets because people are selecting a wider variety of products and services that are associated with the consumer trends that we're seeing today. The third item would be construction of funeral homes. And we anticipate doing more of that. That's probably the preponderance of the increase that you're going to see in 2005 as you think about this. And there, John, the difference is this: Historically, we've had a real preference for buying existing businesses, which may or may not be mature. And therefore you've got a quick incremental earnings per share impact from owning a business that was mature.

The negative issue associated with that sometimes is maybe the growth possibilities weren't there. And so we bought into potentially a declining business. That is one of the reasons why you'll probably see our comparable volumes trending down in a lot of the major consolidators. So we've taken a little different approach in terms of what's the best long term internal rate of return for us. And in certain markets we're seeing that constructing funeral homes, either stand alone or up on our cemeteries are the best internal rate of return in excess of our weighted average cost of capital that we could do. And so we anticipate doing more of that. That will have not a lot of impact in '05 as you can imagine as you're constructing these. But it will have an incremental impact year after year after year and probably not fully benefit us until 3 to 5 years down the road when those volumes are up there and benefiting our long-term returns.

I mean, I understand the need to do that and I'm not disputing that. I guess philosophically, if this is going to be a recurring expense, is it really right to eliminate all this from free cash flow? Because if this is going to be an annuity for you and is in fact going to grow, how do you avoid double counting? In future years you'll get get the benefit of these investments into your free cash flow calculation and yet you eliminate the subtraction from your calculation. I'm just wondering how we think about this. Does this ever trend down or is this a recurring and growing number? And if so why wouldn't we look at all CapEx versus just the maintenance CapEx that you've identified?

I mean you could John. That's a valid point. I think as you break into the free bucket look at it this way: The dignity displays have a finite life. We'll be done probably this year. And so that portion of growth CapEx would go away. And you really shouldn't see that as you look forward. As we look at constructing funeral homes, you know, that's similar - - akin to an acquisition program. We could or could not do that based upon the returns of the business. And therefore we've always categorized that as growth as opposed to maintenance. At some point you would expect that we'd begin to give you guidance of what the returns are from this growth CapEx such as a new funeral home. It's just that we're not going to see an immediate impact today. But again, that can be turned on or turned off based on the opportunities that present themselves.

The cemetery property is probably the one that's the most difficult to get your arms around as to which bucket it goes into. And that is that we're developing high end cemetery property in the related cemeteries that I think can benefit from it. We will reach a point where we've got that in most of our cemeteries and you probably would see a reduction in the amount spent there. But I can see an argument that says where do you appropriately put that? And I think the reason we categorize it outside of maintenance CapEx is again, it is not a mandatory item to run these businesses. It is an item we choose to do in order to enhance returns.

How big is that third bucket, the cemetery enhancement bucket?

Last year we spent about $12 million, I believe, on the cemetery development piece.

Okay. And then the other question is now that you've written off and sold Argentina, where does that put us in terms of pushing out the point in time which you have become a taxpayer? What's your best guess now?

It's still the same John. In 2007 or 2008. We had taken into effect that we would be successful in that regard into account when we gave the guidance previously.

Okay.

Pardon the interruption. Let me hope up his line again. It will take just one moment.

Some of the other issues?

I'm sorry Mr Ransom. You got cut off. One moment. Could you repeat your question?

Sure. Are you there?

Hey, John.

Sorry I got cut off. This is your third year, I mean, we've got a nice annuity of the 200 to 220 million or so in free cash. Is this kind of where we are you think as a steady state throughout the rest of the decade until we get some secular spike in volumes? Have we taken all the costs out of the business that we can really take out at this point?

I think the answer is no, John. I think there are opportunities to enhance. As we look at this year, keep in mind you're absorbing a 17 - - year over year change of $17 million funding. I think as we continue to delever, obviously our interest costs are going to go down year over year unless we do something differently. And we believe that we can still find the opportunity for expense reduction and enhancements in our revenue. So we don't see that. Now, the one thing I will say is when we become a full taxpayer, that could be a significant amount of money. But at that point in time, it's our belief we'll have improvements in the other areas of cash flow which will - - which can offset that tax burden that's out in '07 and '08. So we feel pretty strong about our ability to improve cash flow and again, you know, absorb that tax payment when that occurs.

Okay. Thanks a lot.

Thank you.

And is that your final question, Mr. Ransom?

Yes, it is.

Okay. Thanks. And we'll take our next question from Mike Scarangella with Merrill Lynch.

Hi, good morning. Tom, as you think about the volume decrease in the quarter you mentioned obviously lower debt rates, which we've seen in the industry but you also mentioned challenges in your local markets. What's your ability to kind of break that up for us in the two buckets market share loss versus debt share decline in the quarter?

Mike it's really hard to do because it's such a local labor and the statistics really don't allow you to drill down. But I'll give you - - I'll try to help you. I can't be too precise. I would say that for the most part, we're following a lot of the trends that we see within our marketplace. There are reasons, I believe, that generally we are at a disadvantage compared to let's say a local competitor. And I'm speaking in my opinion and this is Tom's opinion on behalf of all the consolidators. When you think about what we did as consolidators, we bought businesses in order to grow fast. And so you bought a lot of businesses that were mature. I go back to my earlier statements. We bought a great business, very mature, a good part of town but the trends were set were people were moving. Either demographic trends changes and so you've got religious or ethnic cultural changes within a market. And/or you've just got population shifts in different parts of the city. And so we own some great businesses that may be experiencing slight decline as opposed to the independent person that went out into the suburbs, built a place or bought a little place and is experiencing a trend upward. Simply for the fact that the demographics have changed on them.

And I really believe that is a segment that's hurting all of us slightly. And so as we alter our strategies in particular, SCI, we're looking at how do we position ourselves in the growth markets. Whether it be for instance in the Hispanic marketplace. We believe that's an area that's going to grow and you're going to see us invest monies and time and effort within that segment in order to be on the forefront of growth as opposed to slight decline. The other thing I think that's hurting the consolidators and again, more particular to us, our structure was conducive to acquiring businesses and not necessarily competing as effectively as we could in the marketplace. When we changed - - when we simplified and standardized our business structure, we went to a management structure in November of 2003 where we have true accountability, I think, for the first time in a long time within our marketplace. And when you go to Dallas, Texas, there is a gentlemen, [Wes Killian] that runs Dallas, Texas. And every decision gets made through him. Whether it's pre-need, whether it's at-need cemetery or the like, he's making those decisions. And before, those decisions were being made, you know, by a committee that may not have lived in Dallas, Texas. So for the first time we've got true accountability, decision making in the local marketplace. And we think that's not a magic bullet for the next quarter but over time we're going to be more effective in dealing with our competitors and competing for their market share.

Just to build on your example, is your Dallas funeral director, is part of his performance judged by his market share gain or loss and is that measured for each funeral home?

Yes. We measure by funeral home and by market. He's measured by a lot of sticks. At the end of the day he's really incented is to grow his bottom line and to grow his production. Obviously the backlog of our business is in Dallas. But those things are measured and constantly monitored by our management system. And we're keenly aware of what's happening. Who our competitors are, whether it's a casket store or whether it's a competing business. And so absolutely we're doing those types of things. And that's why - - the problem is there is no consistent way to monitor market share in a market by market. The way they do in Dallas is different than Kansas City because somebody may count obituaries, well not everybody puts an obituary in the paper. So the only way to do it is to go back to death certificates filed or - - so there's some complications to getting very, very accurate market share data. But I will say this, again, we believe that we're improving our ability to compete. We also understand that the way this network was built up, that we may have to do some shifting because of demographics, because of changes in our marketplace as to where we reside and how we compete.

So not to beat a dead horse but at this time you don't have the data available to say market share wise you are up, down or flat in the quarter because of differences in measuring market share?

Whatever I said would be inaccurate. If you asked my gut feel I would again say that we saw a lower number of deaths, particularly in the fourth quarter and even in 2003. And a lot of that was associated with a very delayed or late flu season late in the year. In 2003 there was a flu epidemic in the latter part of 2004 - - I'm sorry the latter part of 2003 that didn't occur in 2004. Having said that, we have seen a flu impact in the early part of '05. It was slightly delayed I think as compared to what you saw last year. So I think that has a lot to do with it. Probably has the majority to do with it. I'm just telling you, that I think there's a couple of reasons why we aren't competing as effective as we ultimately can. And we are diligently working to improve that. And I would anticipate our ability to compete to improve over the years to come.

Okay fair enough. Let me just move on. I want to clarify a comment on the press release on your cash balance. It was 287 at year end. You had some money come in from asset sales, some money from a tax refund which gets me to about 338. But you're projecting a quarter end cash balance of 310. What other cash outflows would I be missing for the quarter because I also assuming you're generating free cash flows as well?

Share repurchases.

Share repurchases? Does that make up for most of that difference?

Yes, I think it would.

Okay great. And just lastly, Tom, you talked about various strategic initiatives, acquisitions, internal growth, share repurchases, dividends, how do you think, through the end of the year that leaves you on your absolute debt balance; up, down, or flat?

Our capital structure is at a point where I don't think we have a focus on reducing our debt further. We gave some guidance targets as to what was appropriate for debt to capital and we talked that the net debt to the total capital ought to be in the 40% to 45% range. We're slightly below that where we're at. So I think what we're going to try to do over a longer time frame, manage to those sort of levels, a combination of re-issuing securities to replace maturing debt, couple that with share repurchases with excess funds.

Is there a likelihood that that might go up by year end for many of those initiatives?

No not based on what I know in terms of our needs at this point in time. But I hope what we don't take it down to zero.

Okay great. Thank you very much.

And we'll take our next question from Matthew Sheller with ISF.

Hi. Yes, thank you. I had a question about some of the discussions that you had in New York, a number of months ago about the exclusive arrangement that you currently have with Batesville. That is I guess a 7 year arrangement set to end at the end of this year. And I kind of just want to ask you if you see at this point from the work you've done that you've mentioned kind of oversee as looking at sourcing opportunities, if there is an opportunity for a material change the next kind of 12 to 24 months in casket prices for you. A and B, what impact you think that will have on the - - and what is your interest in having it have on the total price of the service subject to some inflationary pressures? Thank you.

Let me first say we do have an agreement with Batesville and we're very pleased with the level of service and the product that we get and so today, you know, that is how we look at it. As we look out over, you know, the future and how we're going to source ourselves and supply ourselves; we're clearly going to look at the best opportunity for SCI. What's the best product at the most reasonable price. And again, we - - as we look at this, what we're seeing occur within the casket manufacturing business is; you're beginning to see some offshoring of manufacturing. And so overall, we would - - this would tend to believe that the manufacturing cost component of caskets is going to trend downwards. As you look at the other components of what caskets are, metal, wood and the like, we've seen some spikes in raw material costs that are clearly out there. So as we look to the future, I don't think we anticipate any significant changes to occur as far as our sourcing or cost structure with that.

I do believe that the trends within the business themselves because there are casket retailers, because Costco now actually has caskets on their Website believe it or not; the consumer is more informed as to what a casket - - a retail casket cost can be. And therefore I think it just changes the dynamic of the funeral arrangements associated with the service and with the casket or product pricing that we see. So we don't anticipate a big change. We do recognize that there are some changes going on within the way they're supplied and the way they're sold within the United States.

Could you give us some indication of what's been happening with casket prices in the last, kind of couple of quarters for you? A and B your kind of share of - - are you selling caskets for all the funerals that you do sell? Or are you getting people who are more often kind of coming in with their own product?

Well, I think as it relates to historical results, you're seeing a little more people come in in isolated markets in caskets. Not something that's dramatic across the United States, because I think people find certain value in arranging with a funeral professional the entire process. Having said that, there's some that are occurring. And from time to time, we're either matching prices within those markets and/or accepting delivery of those caskets within our funeral homes. But what I think it forces the funeral industry and again, you realize it's a very decentralized, very mom and pop nature, I think everybody's always envisions the funeral experience as kind of one big experience. I think what it's forcing people to do is really understand the value proposition of the products we're selling and the associated services that the consumer needs and wants. And what is the value associated with both those products.

But again, that's kind of a market by market basis and in a home by home basis. A funeral home that's very nice, a very large facility with a lot of other amenities is going to have a higher service charge than anybody that's operating out of a corner mall or an old 7/11. So I think that's where a lot of your differentiation occurs in service. What type of facility are you using, what type of professionals are you using. What services do you provide. Caskets will become more and more commoditized I believe over time. You're not there yet but that's where the trends tell us it's going to go and that's where every other industry that I've ever seen tends to see happen.

Do you still see this as a significant opportunity for you to just kind of change that mix and - - to the service? Or are you - - as you've done, you're kind of - - your studies here, are you less confident about that as an opportunity?

I think we see it overall as an opportunity. We see that by being the largest and by having the business that we own, we're in better position to deal with that consumer trend change than anybody else as it relates to our industry.

Thank you for taking my question.

And we'll take our next question from Jennifer Childe with Bear Stearns.

Good morning. Thanks for taking my question. I wanted to commend you on the improved transparency of the revenue breakdown. And I'm just - - wanted to - - is that something that you'll continue, the pre-need and at-need disclosure?

If it's helpful, Jennifer, we definitely will.

Okay. Good. Following on to John's question, can you give us the breakdown of how much of the gross cuts backs was spent on new homes versus the new displays?

Sure. The - - I think gross CapEx last year, Jennifer, this is Tom by the way was about approximately $30 million. It looks like about 8 million of that was new funeral home construction. 12 million was the cemetery development and then another - - and I've got a - - it looks like the display is essentially somewhere between $8 and $10 million so that's the breakdown of our gross CapEx in '04.

And how many new homes were constructed?

I don't have that in front of me, Jennifer. We'll get that to you. I can make an assumption it's definitely less than 10. I'll promise you that. But I don't know those exactly but if you want to call Debbie afterwards we'll get you that information.

Okay. Maybe you could just give us some color on what was behind the change in the accounting? I know you had discussions with the SEC but any more color would be helpful.

We had discussions not only with the SEC but with our auditors Price Waterhouse Coopers and in reviewing the matter, what we found was that there was a preferable method to what we were using. And the preferable method is the one that we're moving to. I would analogize it somewhat similar to our pension costing that occurred in the first quarter of 2004 where we moved to a different method there that was preferable to what we were previously using there. Both of them end up with somewhat similar results in that there's an initial charge. And then there's a change in the way the accounting is handled going forward. But we think that ultimately this will give us actually more control over our business as the current selling costs will immediately impact P&L.

And you gave us what the impact would have been on '04. I can't remember when you started capitalizing the costs. Do you have what the impact would have been on '03 or '02 if relevant?

Jennifer, we don't have it in front of us but we started capitalizing the costs since the beginning of time. So I would say that it would not be materially different from what you've seen in '04.

Okay. Just a couple more. Where are your trusts currently invested? What's the breakdown between equities and fixed income?

In aggregate?

Yes.

In aggregate, the equity balances are 36% for the funeral trusts. 54% for deaths. Short term investments are 5% and other which is primarily alternatives is 5%. For everything in aggregate it's 37% equities, 41% debt, 5% short term investments and 16% for alternatives.

Great. Thanks. And then last question, what percentage of your total backlog is in trust versus insurance funding vehicles?

Most of it is insurance. I don't have - - do we have those numbers at our fingertips here? We can get you those.

It's actually in the K, Jennifer, but we don't have it in front of us. But I would say that the backlog and the trust would be about 40% probably. There's more on the insurance side on the funeral side.

Okay. Thanks a lot.

The insurance side of course is not on our books.

Right. Okay. Thank you.

We do have the numbers now. I'm sorry. The backlog on the trust side is about 1.463 billion. And the backlog on the insurance side is 2.2 billion. And this is for the funeral business. Of course the trust business - - or the cemetery business is also.

Okay. Thank you.

And unfortunately due to time constraints that was our final question for today. I would like to turn the conference back over to our presenters for any additional or closing remarks.

This is Tom Ryan. I just wanted to thank everybody for participating today and we will be back talking at you in May, early part of May. Thank you.

And that does conclude today's teleconference. We do thank you for your participation. You may now disconnect.