Service Corporation International (SCI) 2005 Q1 法說會逐字稿

Hello everyone, thank you for holding and welcome to this Service Corporation International first quarter 2005 earnings release conference call. As a reminder today's call is being recorded.

At this time for opening remarks and introductions I'd like to turn the call over to the management team of SCI, please go ahead.

Good morning. My name is Eric Tanzberger the Corporate Controller of SCI and I want to welcome you to our quarterly conference call to discuss our financial results for the first quarter of 2005. As usual we are going to have some brief presentations to start, and then that will follow a -- we will follow with a question and answer session after the brief presentations.

Before we begin I would like to remind all persons on the call today that there will be statements that are not -- that are made today 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 outcome.

These statements are based on assumptions that we as management believe are reasonable today. However, there are many important factors that could cause the Company's actual results in the future to differ materially from the forward-looking statements that we will make today. These important factors are listed in our press release today, our SEC filings and in our 10-Q for the first quarter of 2005 which is scheduled to be filed later today.

Additionally, as you know, this call is being recorded and a replay of this -- a replay of this conference call will be available on our website for approximately 90 days on the investor page under the subheading "conference calls". The website is www.sci-corp.com.

With that I will now pass the call over to our President and Chief Executive Officer, Tom Ryan.

Thank you Eric and welcome everybody again. First of all let me start by saying that we're not as -- very pleased about it as I'm sure you're not, that we utilized our five day extension on filing our financial statements. However, having said that, we are very pleased by the fact that we completed the cemetery verification and reconciliation project and the additional time was utilized to complete that project and to work our auditors, Price Waterhouse Coopers, through some of those results.

I'm very pleased to say that we completed that project and the results came in pretty much anticipated with the sample projections that we had done back at the end of the year 2004. And from an operating perspective we're very, very pleased now to have good data on our backlogs that we can begin to utilize to run the business in a more effective manner.

Having said that, from an earnings per share perspective for the quarter, our recurring earnings per share from continuing ops turned in at $0.12 per share. This was above our expectations and was mainly due to stronger funeral segment performance, that we'll talk about a little bit later. From a cash flow perspective, our cash -- free cash flow that we generated, excluding the results from the French operations in 2004, slightly improved by approximately $5.3 million or 6.6%. We're generally very pleased with this result because we anticipated negative impacts from Florida bonding, from matching our 401(k) for the first time with cash and from additional cash costs associated with Sarbanes-Oxley.

Our working capital was somewhat negatively impacted by increased activity along all our business lines. In most of our businesses we are paying the bills first and collecting from our customers later, so we would anticipate some of that to turn around in the coming quarters. I'm now going to review our businesses on a segment basis.

And when I'm speaking to these segments I'll be utilizing comparable pro forma 2004 results. And as defined in our press release, comparable pro forma 2004 simply takes into account the accounting change associated with our deferred selling costs. As we mentioned before, that's about $15 million from a pretax EPS perspective when we evaluate these segments. And it actually has more of an impact on cemetery than funeral. As I walk through this just bear with me that those are the numbers that I'm utilizing.

On the funeral side of the business as we mentioned before, overall we had a very good start. We had a strong quarter comparing against a, as you will recall, a very strong 2004. So the funeral segment margins were slightly ahead of our expectations and we are very pleased.

On a comparable funeral volume basis quarter-over-quarter, we are up almost 1% again versus that strong Q1 2004 and for the most part we are consistent with others in the industry's trends. Mainly the volumes came in in February, March. January was still kind of a weak month for us as the flu and influenza season was a little delayed this year. From a comparable funeral average perspective our average was up just over 2%. And most of this can be attributed to the success of the Dignity package plan again. We are actually up approximately 140 basis points year-over-year on our at-need take up rate for the Dignity packages.

We have got the blueprint for success installed in 550 of our locations and keep in mind these packages represent the changing consumer wants and needs and place the emphasis on the products and services that they tell us that they need. This also -- this average increased in the face of a cremation mix change albeit the change was lower than anticipated. It was approximately 80 basis points for the quarter.

And again, in the midst of certain localized merchandising pricing competition with the monument sourcing at our cemeteries and as well as the casket stores that are out there, we continue to bear the brunt of that and continue to -- our average to be raised over 2%. Our overhead costs were reduced year-over-year which again contributed to positive funeral margin improvement and on the negative side our field G&A facility expenses increased more than we anticipated. Some of which is tied to increased energy prices, as well as the project that we continue to monitor, the CUVP project which I mentioned we recently completed as well as our increased SOX controls that were put into place the latter part of last year and the early part of this year.

Our Kenyon earnings were up -- I should say our Kenyon revenues were up over the prior year due to the tsunami disaster. The contribution is relatively flat, as profits from the tsunami operation were offset by planned expenditures to develop our strategic infrastructure. Our general agency revenues are down year-over-year, mainly due to two reasons. One, because of slightly reduced preneed funeral production and secondarily because of a products mix shift from a multipay life product to more flex products in our consumer base.

As we look to 2000 -- the rest of 2005 and outwards we would anticipate continued increases in our funeral average. We would anticipate that comparable volumes will begin to trend slightly down as we had such a strong first quarter. We would anticipate improved cost containment measures throughout the year. We also would look to -- for these to be offset for a lot of these costs because of the increased costs associated with our stock control. And also I would believe in the latter half of the year, we would begin to see G&A revenues begin to increase, as production increases and as we put in measures to again shift product back into that multipay life product that's more beneficial to the Company.

The key initiatives that are important in order to enhance returns. Number one, the continued success of our Dignity blueprint, both the displays and the associated training. The second year of our new management structure. You will recall, we reorganized our management structure November 2003 and we are beginning to see some improvement and some traction in those areas. Additionally, continued emphasis on the Dignity brand, utilizing community service programs and some of our advertising programs to penetrate markets and get the Dignity brand awareness more commonplace in the market.

And then also, not as impactful in 2005 but in 2006, we are embarking upon a customer segmentation project to help us identify better the appropriate customer segments for the Company and to then build the infrastructure in order to most efficiently and appropriately support those customer segments from a product perspective and from a level of service perspective.

On the preneed funeral production front for the first quarter, our preneed production was $86.6 million, which was down about $3.2 million or 3.6% on a comparable basis as compared to last year. And keep in mind last year our preneed funeral production was up approximately 5.8% at about $350 million.

On a cemetery segment basis, and first I'll speak to GAAP, or reported revenues and earnings. As anticipated, we had a reduction in recognized revenues due to lower legacy revenues associated with completed construction projects. Having said that, our projection was slightly lower than we had anticipated for the first quarter. Our cemetery margin percentage was essentially flat at 15.9% to the pro forma prior year, keep in mind the accounting change, even on an approximate $15 million lower in recognized revenue-based production. This was accomplished by significantly lowering the selling costs associated with the recognized revenues and the changes we implemented in July of 2004 to our sales compensation plan.

Our allocated overhead and maintenance expense reductions were partially offset by higher field G&A costs. Most of these G&A costs were borne in our larger cemeteries where our C-- our CUVP project has been going on for some time now and we are hoping that a lot of those increases were associated with the extra burden being placed on our large cemeteries.

From a cemetery production standpoint, and keep in mind when we sell cemetery property it may or may not get recognized in the period that it's sold, based upon the factors of a 10% down payment on property or the fact that it's been constructed. So, cemetery production is probably the best way to analyze what's happening within our cemetery business.

On a total comparable cemetery production basis, we generated $129.7 million of production revenue, which was about 3% lower than the prior year quarter or down about $4 million on a comparable basis. This was mainly due to reductions in property sales. As merchandise and service increases and decreases actually offset one another, this was the remainder piece. As you will recall last year, we produced $496.2 million, which was up about $16.2 million or 3% and actually our property revenues sold were up 8.2%. Keep in mind that we made sales comp changes in July of 2004.

So even though production is down slightly, if you take total compensation costs across both funeral and cemetery production, our costs of selling compensation was 14.9% in this first quarter versus 17.6% in last year's first quarter. This is a 270 basis point improvement and saved us approximately $7 million in hard cash quarter-on-quarter. So we still believe this was the appropriate thing to do, and as a matter of fact believe that our production's going to begin to ramp up throughout the year on a comparable basis.

As we look to 2005, we would anticipate continued improved sales production and actually in the property arena versus the merchandise arena. We also anticipate reduction in recognizable legacy revenues. Keep in mind these are revenues that typically don't have any cash associated with them. We do anticipate an actual decent second quarter as it relates to recognizing legacy revenues, but post that, there'll be deminimus amounts that we anticipate recognizing.

We also anticipate slightly lower trust earnings based upon the environment -- the interest rate environment which we are now in. We would anticipate improved cost containment, again as we look at the ways that we're managing our business. And these improved cost containments will be somewhat offset by increased costs associated with our SOX 404 control. Keep in mind we hope these are temporary costs. As we find better and improved ways to implement controls we can take those down in outer years.

The key initiatives to enhance returns associated with the cemetery -- continued product tiering in our cemeteries. We've discussed this strategy before, it's been successful in the ones we've rolled it out. And the associated rollout of the cemetery pricing model, again which will appropriately price the various products, services and merchandise that we sell within our cemeteries.

Dignity packages for cemeteries. We've initiated this in ten markets and have seen limited success when we have rolled these out. And we anticipate to continue to do that throughout our cemetery network.

And another item that we believe is going to enhance returns is our Dignity University focus on sales management. Our foundation for growth which instills tremendous discipline within our sales manager ranks and formulates SCI's opinion about how we should be managing our sales efforts on the ground. And again we've seen great results from the sales management that's participated in their markets.

And again to refer back to what we talked about on the funeral side, our newly initiated customer segmentation project whereby we will again be analyzing the segments within the businesses that we operate, hoping to select the most appropriate segments for us to [play], and helping us to develop the most appropriate infrastructure and approach to servicing those segments.

So with that I thank you for your time. This concludes my comments and I'm going to turn it over to Jeff Curtiss our Senior Vice President and Chief Financial Officer. Jeff.

Thanks Tom.

SCI generated approximately $85 million of free cash flow in the first quarter of 2005. Free cash flow is defined in SCI's press release issued today relating to our first quarter 2005 financial results. In the first quarter of 2004 SCI owned its French business for two months. During that period the French business had free cash flow of $15.5 million. When comparisons of SCI's free cash flow are made excluding this French business, cash flow increased by approximately $5.3 million in the first quarter of 2005 versus the same period of 2004.

Numerous factors contributed to this net positive change, but reduced bonus and payroll payments in the first quarter of 2005 were the largest factors. The key use of free cash flow during the quarter was our open market share repurchase program. Since August, we have acquired 36.9 million SCI shares at a cost of $253.4 million or an average cost of $6.86 per share. In the first quarter of 2005, SCI spent $103.6 million to acquire its shares.

To date during the second quarter of 2005, SCI has purchased approximately $40 million of its shares. Under existing board authority, SCI currently has $46.6 million of approved stock repurchases yet to undertake and expects that it will complete the approved share repurchase program during 2005.

During the first quarter, SCI received a $29 million nonrecurring tax refund. It also sold its Argentine business for over $21 million. These two transactions funded almost half of the share buybacks during the quarter. In May, SCI received $35 million from its French joint venture as that company undertook a refinancing of its capital structure. We expect to receive another $8 million cash distribution from the French joint venture later this year. SCI continues to own 25% of the refinanced company.

General and administrative expenses, when adjusted to exclude litigation expenses, increased $3.7 million in the first quarter of 2005 over the same period of 2004. This was primarily attributable to costs associated with Sarbanes-Oxley Act of -- particularly section 404 and the cemetery verification project that concluded in early May. First quarter G&A costs were consistent with the guidance SCI provided earlier this year.

Interest expense declined by $8 million in the first quarter of 2005 versus the same period of prior year due to lower levels of outstanding debt. SCI completed its cemetery verification project successfully and, as Tom mentioned, within the parameters previously expected. We made an accounting change in the first quarter of 2005 to currently expense all preneed selling costs. This resulted in a noncash change in accounting charge of approximately $187.5 million after taxes in the first quarter of 2005.

As Tom mentioned, it will also reduce pretax 2005 earnings by an estimated $15 million, as we now expense such costs as incurred during the year. This earnings impact was included in SCI's updated guidance provided in our April 15, 2005 press release. Our effective tax rate for the first quarter of 2005 was 35%.

SCI's $2.7 billion of funeral cemetery merchandise and endowment care trust had small portfolio losses in the first quarter of 2005. These losses include the impact of both trust earned income and changes in portfolio value, but do not include the trust management fees or related costs of approximately 1.1% per annum. The returns also exclude trusts that have invested in life insurance policies. For the first quarter of 2005 the funeral trust had a return of negative 0.44%. The cemetery merchandise and service trust had a return of negative 0.36%. And the endowment care trust had a return of negative 0.98%.

For the same quarter the S&P 500 index had a return of negative 2.15% and the Lehman Brothers aggregate bond index had a return of negative 0.48%. On a relative basis to similar portfolios the performance of SCI trusts were acceptable. In addition, the current market value of our portfolio trust investments at March 31, 2005, exceeded our costs of the investment in these trusts by approximately $53 million.

SCI currently has cash balances exceeding $300 million and it has a modest amount of debt maturing during the remainder of 2005. Now that the cemetery verification project is complete, SCI will spend significant money and human resources in 2005 to enhance its internal controls, with the goal of achieving effective controls by year end.

With those comments Kevin will now go to the question and answer portion of this call.

Thank you very much.

[OPERATOR INSTRUCTIONS]

We will go first to AJ Rice at Merrill Lynch.

Hi. Yes, hello everybody. Maybe just a couple of quick questions if I could ask. It's good to see the turn around in same-store funeral cases up 0.7% I know you comment on the flu had some positive impact you believe on that.

Is there any way to say what that might have been had it not been for unusual flu-related impact, I'm not sure there is. But -- and maybe give us any -- if this changes your assessment at all as to where you think the rest of the year could come out or even the next quarter or two?

Okay, AJ, I'll answer that, this is Tom.

I think it's very difficult to give you an exact number. What we thought the influenza effect wasn't in there, because in some cases you have it and in some cases you don't. One thing we know for sure, without that epidemic it would have gone down. To give you some flavor as to what we have seen continuing, as we look at April, that's probably the month that we have the most recent data for, we continue to believe that that influenza impact continued into the month of April.

As it relates to changing our perspective for the year, I really would hesitate to do that. Because what we found a lot of times, and this happened to us last year, we had a very strong first quarter and then what happened was the fourth quarter was really negatively impacted by the fact that there was a lack of influenza impact.

So I really hesitate to tell you anything other than, typically when we see strong quarters they are followed by some weaker ones as we look forward throughout the year.

Okay.

[inaudible] switch gears on the use of cash going forward, you've continued to be active on your share repurchase and I know you have got about 46 million left under the current authorization. Any change in direction or update in the thoughts as to the priorities on the cash use or -- and maybe in the same token, any update on the acquisition backdrop?

We'd love to deploy the cash in the business if we could find projects that have appropriate valuations to where we could make the types of returns that we expect. But absent doing that, it's a matter of adjusting our capital structure to basically come into line with the guidance we have given and right now we are sitting with a lot of money, over $300 million as I mentioned.

So I would expect, over a considerable period of time, the board will continue to review our capital structure. I might add, AJ, that beginning in June our current maturities of long-term debt will go up substantially, as the 2006 debt becomes current in June of '05.

Okay.

And then just last, I'm going to ask, I don't know if Tom, you want to make some comments about the lawsuit that was filed against various players in the industry released to the casket pricing issue and availability issue, sales practices, I guess.

Can you give us some perspective on that, whether that's something you are losing sleep over or not, maybe I thought I would throw that out.

I'll tell you what. I will let Jim Shelger, our Chief Legal Counsel, I will let him answer and I will probably follow up with something, too AJ.

Okay.

First we have not yet been served. We have read the lawsuit that we have seen on the Internet. And obviously, any time you're sued today in America you are concerned about it.

As we have said to our own employees, this litigation and the allegations contained in the complaint, with respect to our Company, are inconsistent with our practices, our ongoing training, both written and through lectures. We are obviously taking it very seriously. We are in the midst of conducting our own internal fact finding. Anticipate that we'll be providing a formidable defense to this lawsuit and that's all I can tell you right now.

Okay. All right. Thanks a lot.

Thank you.

Next up we have a question from John Ransom at Raymond James.

Hi. It's a simple math question. What was your ending share count?

It was --

Or if you want to give me the share count as of today.

At March 31st it was about 310 million was the ended balance. We have an updated one -- we have a draft of 10-Q that will take us through May. Jeff, do you have that one?

As of May 1st it was 309,367,000.

And May 1st, would that have reflected the full buyback of the incremental 45 million that you talked about?

No, not totally, because I think we bought back a few shares after May 1st.

Okay.

It reflects most of it.

Got you. And just a question on your free cash flow. You talked about $32 million of bonus payment issues. Could you elaborate on that a little further please?

Sure.

We had a situation that we described, I think in our year end conference call, that we had to make an extra payroll payment last year, which impacted our cash flow from last year. In other years that payroll payment would be made in the first quarter of that year. So that's somewhere between 17 and $20 million of the difference, in that we made it last year rather than this year in the first quarter.

The other issue is the bonuses were smaller, as you saw in the proxy, for '04 than they were for '03 and we pay those bonuses after year-end. So the reduced bonus payments occurred in '05 versus '04.

And that would go, John, all the way down to location manager. It's pretty consistently throughout our network, both at senior management, mid-management, location management, we saw year-over-year declines in the amount of bonuses paid because the attainment of goals.

I got you.

So if we make those adjustments, it looks like, if we adjust for the bonus and for the Kenyon, and for Sarbanes and the 401(k), it looks like cash flow is basically flat year-over-year, is that accurate, or were you missing something?

I would answer it slightly differently. Cash flow is a little less than what we had expected in our internal projections. But we think we have a path to basically continue to work on our working capital and those sort of things to get back on track, is how I would describe it.

Yes.

And [inaudible] lately. You had a $15 million hiccup from -- you called it unusual working capital activity, have you seen any of that reverse this quarter already and could you describe that a little more?

Yeah, I think I'll try that one, John.

As you would get, and this really goes in all lines of our business, take funeral as an example, what typically occurs is we [get word] of the casket, pay for the casket. We also would pay the ancillary items, so we may pay a preacher, we may pay for the rent a facility or we may advance the opening/closing costs on a cemetery,

Okay.

-- and then we bill our customer later. So with heavy activity in March year-over-year, what you end up happening is you are spending a lot of funds that you are going to go collect now in April, [inaudible] a 30-day average.

Sure.

So you probably have seen some of that already come back to you, I would assume this quarter.

We think we have. But, again, you like to get a little bit further away from this to see more results. But surely in the first few weeks of April we saw a lot of cash come in.

If we think about this quarter weaker volumes, but stronger cash collections might be something to think about as a likely scenario?

I would say that would be my guess based upon historical trends.

Okay.

And, just kind of stepping back from this minutia and looking -- last quarter you talked about some structural impediments to volume growth in terms of obviously the low U.S. death rate and also the location of your facilities being, in some cases, in the slower growth parts of town.

Just conceptually, what are you thinking out five years as -- are you just kind of locked into that and there's nothing to be done? Or conceptually, what other things might be on the horizon that wouldn't involve us in huge outlays of capital that might -- that might assist with that structural volume deficit that you are going to face probably for the balance of the decade?

I think there's a lot we can do about it, John. A couple things. One is, we still have not reached anywhere -- come close to reaching what the level of institutional excellence we continue to talk about. We have got to become more competitive in the marketplaces in which we operate. And, although we've made some improvements, there's a lot more to be done.

As we look at utilizing our capital in the future, what we want to begin to do, and that gets to this customer segmentation we're talking about, if we understand the better aligned consumer segments and the ones that we can make the most money in we're going to be begin to invest our future capital in segments that will grow, will become more profitable. So we are going to more strategically place our capital as we go forward into markets that have natural growth curves, we'd hope. And then all the while begin -- continue to improve our ability to complete within those market places.

We talked about the management structural change we did in November '03, that isn't a light switch that goes on, that's having the right people in the right places and understanding the markets in which we compete and having absolute accountability in those markets. I think that's going to continue, our community service activities programs, which are helping raise the awareness of Dignity and giving us tools to differentiate ourselves in the marketplaces, will again continue to help compete in -- within those areas. So we see really a two-fold plan.

One is, get better in the markets we are already in. And then as we use that precious capital that you are referring to, putting it in places like for instance, our Hispanic brand which is where we are going to invest a heavy proportion of the funds that we have. [inaudible] That is a -- that is actually our brand that we've begun. We are now in four markets -- Miami, LA, Chicago, and in the Rio Grande Valley in Texas. We will continue to expand on existing locations we own, operate new ones, and we believe begin to invest in growth curves that we can grow even if we didn't compete as effectively as we want to, but having said that we are going to compete very, very effectively.

Okay.

Then finally, gosh, what was I going to ask you? Well, I'm getting old I can't remember what was just in my head 30 seconds ago. I'll think of it and come back to you. Thanks a lot.

Thanks, John.

Moving on next to a question from Bill Burns at Johnson Rice.

Tom or Jeff, I was just wondering if you might elaborate on the reason for the accounting change, going to expensing direct selling costs, what you are trying to accomplish there?

There were a number of benefits of undergoing this accounting change. As you know, we have been managing the business based on cash flows and the new accounting method will align more properly with cash flows than the older method that we used.

We also were experiencing a fair amount of time and effort being put into making the management estimates that were associated with the prior method, not only the estimate on the amount of capitalized marketing costs, but also the various methods and approaches to amortizing it. And this will remove essentially, management estimate from the matter and will also remove the work associated with making those estimates, which we see as quite positive.

Also although, obviously there was a sizable write-off to begin with here, this will allow us going forward to impact our P&L more significantly as we basically incur marketing costs or decrease marketing costs.

So it gives us more ability to control the spending levels that hit the P&L. So I think there were a variety of potential benefits here. Eric you also worked on the preferability letter, is there anything you would like to add to that?

I think that it aligns the economics, the way we manage the business versus the economics of actually paying the counselors and it's one less estimate in our financial statements, it brings higher quality to financial statements.

Does that make sense to you, Bill?

Yes, it really does. Actually it really does. Some of those things I hadn't really thought about. But, obviously we are running this for cash, not to generate a fictitious kind of GAAP number here.

And Bill, I would -- this is Tom, I'd just add from an operational perspective we welcome it, because the accountability for sales costs has kind of been managed more centrally in the past and we have reduced a lot of costs and we think, made it more efficient. But doing this, it really pushes the accountability down to the location level.

Because now that local operations manager is going to face that P&L hit every month. So he is going to be looking into, are we utilizing our cash most appropriately as it relates to the selling costs, incentive programs, whatever it may be. So, we think it's going to add a level of accountability where the rubber meets the road and where we make our money. So, we are actually looking forward to managing in the new environment.

Okay.

Then if I could ask a quick follow-up question on the lawsuit. If you can't, okay. Are you all expecting to reserve for this?

No, not at this point.

Okay.

Was I right in hearing that you haven't actually been served yet?

That's correct, yes.

It's interesting that you haven't gotten the news where everybody else has in the sense that they have sent it out. I guess that's the way the tort system works, though.

We don't have a political statement to make at this time.

Thank you guys very much.

Next we have Tom Bacon at Lehman Brothers.

Yes, I just want to ask you a little bit about the buyback. Obviously some of the rating agencies have been critical there. And I know Jeff, you made a point of saying that your proceeds from the tax refund and Argentina covered your buybacks there.

I'm just wondering, has that forced you to rethink how aggressive you are going to be there or -- ?

No, I don't think so.

We pronounced earlier this year, some parameters in terms of cash flow coverage of interest and cash flow coverage of debt. And debt-to-capital type of structures that we felt were appropriate for the Company. We have been attempting to manage our business towards those goals. And I think those goals are still viewed by the board of directors as being sound goals.

Obviously, we're trying to make sense out of making sure that we maintain reasonable credit ratings in conjunction with that, but I believe we can do both.

I know you mentioned that in 2006 you will have more debt coming due, are you looking more on paying that back now versus refinancing it or --

We are looking at both those options. I wish I had refinanced it four months ago, given where interest rates have gone and spreads have gone. But we continually review that each month.

Okay.

And can you also just quantify in terms of the switch to surety bonding in Florida, I know that's continued to cost you some money, can you quantify what that was in the quarter?

Yes, I can.

We put in -- we trusted in Florida during the quarter and we put in about $4.1 million of net trust deposits. And this compares with the same quarter a year ago where we had just initiated the program of $1.2 million of net trust assets.

So, if you take the difference between those numbers, that's the incremental working capital requirement for the year-over-year associated with Florida trusting. Now, I'd expect that $4.1 million to creep up over time because many people pay over multiple years and as we continue to sell, those amounts will go up somewhat.

Okay.

And I also noticed in the release you were -- I guess some of the collections were running a little behind schedule. Is that -- is there a lot of variability in there with the economy or is that just -- ?

This is Tom Ryan.

We think it's really just, like I was saying before. We pay our bills pretty much currently. I'll give you an example, if we had a minister come out to -- in a local town to come out and do something for a family, we typically pay on the spot for that minister. And we will bill the family, which will more traditionally pay within a 25 to 30-day period depending upon where they are.

In other lines of our business, and Kenyon, very similar type of example, longer tail. When the tsunami disaster occurred, if you recall it was the day after Christmas, and we spent, I believe, $1.7 million in travel costs in moving morgues across the globe. We spent a lot of money up front, and then we billed governments for our services.

So the collection lag on that business, we actually spent somewhere in the neighborhood of $7 million in the first quarter putting equipment and people on the ground in Thailand. And that money came back to us beginning in April and will come back more in May and June as well. So, you begin to see some of the lags associated with doing business, traditional funeral business it's more like a 30-day lag, and the Kenyon example was probably more of a 90 to 120-day lag.

Okay, great thanks very much. That's all I had right now.

Next we'll take a question from Jennifer Childe at Bear Stearns.

Thanks. I wanted to drill down a little bit more on the cash flow.

Why was there such a strong positive contribution from preneed, particularly in light of the declining preneed volume if I heard you correctly, and I think the number was positive 35 million this quarter versus negative 2.5 last year?

If you look at the cash flow statement Jennifer, it's about a $40 million fluctuation in terms of more cash flow. I'm taking the two lines of both preneed funeral and preneed cemetery and looking at the source this quarter versus the source, actually it was net use of about 5, $6 million last quarter from the cash flow statement attached to the press release.

About half of that, about 20 of the 40 is the result of the accounting change. Whereas under the old method of accounting, when you were deferring this cost and amortizing those costs, you had that amortization expense added back up in the depreciation and amortization line item above working capital in your cash flow statement. And now -- and you therefore had an add back of that exact amount in working -- in working capital. And you don't have that anymore which caused year-over-year comparison of about a $20 million source of that 40.

The other 20 million relates to net trust withdrawals versus deposits. We have about 8 or $9 million more net trust withdrawals this quarter compared to last quarter. And I think that's just more of a timing thing than anything else. And then the last part of it, 10 to $12 million actually has to do with what you just said, the maturities coming down.

As you know, when you produce a preneed funeral contract for example, it's a cash flow positive event because you are taking in retainage from a customer. And when it matures, it's a cash flow negative event, because -- for this working capital line item because you have 100% of the revenues, but not a 100% of the cash. And when the decrease in trust maturities actually make this a positive variance from the prior year, because of that phenomenon, that's the 40 million.

Okay.

And then the $29 million benefit this quarter to cash flow from the decrease in other assets, what was that?

That was the $29 million tax refund that we received.

Okay.

And then finally, gross CapEx went up year-over-year, what's driving that increase?

It was the growth CapEx, I think it was -- all 3 million of it related to -- related to the growth projects during the quarter. Most of that went to some cemetery type -- of the new development high-end cemetery estates and those types of things that we were doing.

So you're not building more homes necessarily than you were last year?

I think there was -- there was about 1.5 to 2 million spent on new funeral home construction this quarter.

Jennifer, we are -- this is Tom.

We are anticipating doing more of that, but I don't think you have seen the impact yet in the first quarter. But as the quarters go on you will probably see more year-over-year spending on construction of funeral homes, not significant, but -- but some.

Okay. Thanks a lot.

Okay.

Question now from Mike Scarangella at Merrill Lynch.

Hey guys, good morning.

Tom, cemetery revenue a little lighter than I would have expected. I know part of the driver was less preneed production. You made some comments about it, would you mind just a little additional color on what's going on there and how that should trend out during the year?

Sure.

There's really two components to talk to, Mike and one is, we are now calling legacy revenues. And what that has to do with is, historically you can sell something, collect the money, but if it's not ready to deliver to the consumer, take a mausoleum project for example. You have to build the mausoleum before you can recognize the revenues under the rules. So, in a lot of our older models, and I'd say this is very typical of the industry, not just SCI, we presold things. So as an example, we would sell a mausoleum before we constructed it. We would sell it from a picture. When you sold it from a picture historically, what the industry has done is they have discounted what they charged you.

Number two, they would pay their counselors more to sell something because it's harder to sell, so now your costs went up. And number three, by the time you got around to building it the costs of cement or whatever the heck it is to build went up, and now all of your margin is practically gone out of the project.

So we philosophically have changed the way we view it. In that we believe we should be building it and then selling it. We know the construction costs, we know how we want to price it, we can sell it more effectively because they will pay more for it up front. So this shift in philosophy is going to erode our revenues, really over the last couple years because we'll have less stuff to build.

Now, there's still stuff to build because we sold it five years ago and we have to build it. But as we look at new projects, it's a build and sell philosophy which will put a little pressure on our revenues. The good news is, there's really no cash associated with those revenues because it's been spent previously.

Now, from a production standpoint in the first quarter. We were not pleased with our result. We are sliding behind where we thought we would be. Having said that, the first quarter of last year was a very strong cemetery production month. What we saw was that begin to build up a bit, but the costs associated with it were flaring kind of out of control.

So, in the mid-part of last year we changed the compensation to reflect the economic reality of what we are doing and we also went to a back to basics program. We developed some sales management programs which we have begun to roll out in the latter part of last year to really get back to the basics of running a sales force. Because we had relied too easily in the past upon incentive programs and I like to use the analogy putting gasoline on the fire, it gets a real quick burst of flame, but it doesn't have any sustainability.

So, we're looking at how do we build a good long-term fire and focusing on the basic fundamentals. And we believe we are beginning to see some traction in these programs. I would expect throughout the year that you would begin to see improvements as it relates to our cemetery production.

Okay.

And having said that, I guess you are comfortable with your cemetery revenue guidance for the year?

Yes.

I think the other thing you ought to keep in mind is within our cemeteries, for instance over the last really six, seven months, we have had a lot of resources tied up in the cemetery verification project. This is a huge administrative program and I would tell you great stories of teamwork, but a lot of our sales folks were helping out on this project.

And so I think, with those distractions out of the way and with the fundamental theme put into the business we would expect that yes, we can achieve those targets.

Okay. That's great. And Jeff, just two follow-up balance sheet questions.

I know you'd said that there's some near-term maturities and you certainly could either address them with cash or by a refinance. But I know you are below where you want to be on your debt-to-cap target. Is it -- is it -- should we be assuming that it's more likely you would go to the market and refinance than use cash, is that the right way to look at it?

Well, I think that's certainly an option we ought to seriously consider. We really -- interest rates, although they're headed up are quite low for high yield issuers if you look back over long periods of time. So it is something that we give serious consideration to.

I might add though, that if you take our balance sheet and reconfigure it and assume that our cash is reduced by a 100 to $200 million and that our equity would be reduced by a similar amount, what you will find is that we fit real well within those targeted debt-to-total cap ratios that we have promulgated as a target for the Company.

Okay.

And then just the last question, you have said in the past that funding your dividend and share buyback program from cash on the balance sheet was part of your goal, probably wouldn't need to incur additional debt, is that still the current thinking?

Excuse me. I didn't -- I didn't --

Sorry.

You said in the past that you could fund your dividend and share buyback program from cash on the balance sheet rather than incurring additional debt.

That's correct. We can.

And that's still a goal?

Yes, it is. What we're trying to do is manage our leverage ratios appropriately.

Okay, thanks guys.

And we will go back to John Ransom.

Okay. Recovered from Alzheimer's.

I know you sold Argentina in the first quarter, so where do this put your NOL and where do you think you are in terms of becoming a cash taxpayer, the latest on that? Thanks.

We had factored Argentina into the guidance we had given previously.

Okay.

Obviously having the sales transactions done assures you that you'll get it in the tax return, but it really doesn't change the year we'll become tax paying, we are still contemplating that to be around 2007.

2007. All right, thank you.

Next is Lee Cooperman at Omega Advisors.

It took a while, took a while.

Your rating agencies are going to appreciate this question. But basically, you had mentioned you have stated previously some financial goals or coverage ratios. I'm wondering whether you can share with -- them with us again, I apologize, I know you mentioned them before, but debt-to-capital, debt-to-EBITDA, and some kind of target interest rate coverage. And maybe I can get all my questions out at one time, as they're all connected.

And secondly, what kind of targeted level of net debt are you comfortable with? I think if I'm correct there's 164 million of debt maturing next year. Would the preference be to just pay it off, or just to refinance it? Third, I've read -- this is a ticklish question, but, I've read over the weekend somewhere that there have been $250 billion equity raised by private equity funds, which are going to look to get leveraged, something on the order of magnitude of four to one, a trillion dollars of equity they are looking to buy.

Do you feel comfortable with the idea that the stock you are buying back is being bought back at prices less than somebody would have to pay for 310 million shares outstanding that remain? In other words what I'm trying to get at, is do you have a view -- not that you're going to be susceptible to one of these [LVL] firms, but do you have a view that the private market value of the business is comfortably in excess of the open market prices you are paying for this repurchase program?

Just a few questions.

Okay.

Let me give you the ratios that we basically -- targets -- financial targets that we contemplated. The first one was net debt-to-total capital, and we said that the range there should be in the 40 to 45% range. And one of the differences we have with the rating agency is they tend to use gross debt-to-total capital in their assessment unless you'll make a commitment that the cash that you're reducing it by will be used for debt reduction. Obviously to the extent that you use that cash for other purposes it doesn't any longer become an issue.

Our second target was net debt-to-free cash flow in the range of 5 to 7 million -- 5 to 7 times, excuse me. And the following -- last one was free cash flow-to-interest expense to exceed 1 -- a ratio of 1.5.

And as I had mentioned previously on the call, if you were to reduce our equity by 100 to $200 million and you were to reduce our net debt obviously by that amount, you would end up with all of these three ratios aligning within the parameters of those targets. So we are not terribly far away from it at this point in time.

It will require absent some investment opportunities, some additional share capital reduction. And we review that each quarter with our board of directors. In terms of gross or net debt levels which we have being appropriate, I think all of us here feel very comfortable that the Company is appropriately leveraged at this point and we can handle 1.2 billion of gross debt and certainly can handle something less than 1 billion of net debt.

So we aren't really interested in this point of reducing our debt level meaningfully. That isn't to say we wouldn't reduce them by 50 to $100 million under the right set of circumstances. But our preference at this point would be to seriously look at refinancing opportunities, which we discussed previously.

And we do feel, I think, and our board feels, that the shares that we are purchasing in the open market are at a value price less than our intrinsic value. So we are not eroding our existing shareholders by overpaying for our stock. So on all the points I think Lee, that pretty well speaks to what you asked.

Does that suggest that -- there's only about 46 million left on the existing repurchase, are you about where you want to be when that 46 million is used or do you think that if the mister market continues to give us the opportunity, and the stock languishes around $7 a share or whatever you have been paying, that the board would want to reload?

Obviously it's difficult to predict the board, and it is a board issue, but my recommendation to them, if we get to that point is to at least seriously consider a reload.

Got you. Thank you very much for your responses, I appreciate it.

Thanks, Lee.

Well, thank you very much everyone for your participation in the question and answer session. I would like now to turn things back over to the management team for any additional or closing remarks.

This is Tom Ryan. I just wanted to thank everyone for participating today. And we will speak to you again in about three months. Thank you very much.

Thank you again for joining us today, everyone. That will conclude today's conference call, have a good day.