Service Corporation International (SCI) 2005 Q2 法說會逐字稿

Good day, and welcome to the Service Corporation International second-quarter 2005 earnings release conference call. As a reminder today's call is being recorded. At this time for opening remarks and introductions I would like to turn the call over to Mr. Eric Tanzberger. Please go ahead, sir.

Good morning. I want to thank everybody for taking the time today to join us on our second-quarter preliminary results conference call. I want to start by saying that the statements that you will hear today during this conference call that are not historical facts are forward-looking statements, made in reliance on the Safe Harbor protections provided under the Private Securities Litigation Reform Act of 1995. Some of these statements today 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 like this today are based on assumptions that we as management believe are reasonable. However, there are many important factors that could cause our actual results in the future to differ materially from the forward-looking statements that you will hear today on the conference call.

Some of those factors are listed on our press release that we issued last night, that is available on our website and has also been filed on form 8-K this morning. Our website is www.SCI-CORP.COM and you can also hear a replay of this conference call on that website as well. Today we will start with comments from Tom Ryan, our President and Chief Executive Officer.

Thanks, Eric. And thanks again for everybody to be here on the call. First let me start by recognizing and sharing with you the frustration with regards to the delays on this release and the associated filings of our form 10-Q. As a reminder to most of you, these reconciliation projects were massive. This involved the funeral reconciliation project that included over 430,000 contracts, cemetery reconciling items that totaled over 3.5 million items, and includes activities that span over decades as it relates to deferred revenue accounts from assets that historically were not on the Company's external financial statements. And under FIN 46 they were required at that point in time to be put on our financial statements and that led to a massive project that we undertook some eighteen months ago.

As stated in the release the restatement entries are not material to any prior periods but the total of these entries could not be held in the quarter, and therefore appropriate accounting required us to go back and restate prior years, which we have disclosed in the financial statement, the impact of those items. Two weeks ago our intention was to file our 10-Q based upon material completion of the reconciliation through June of 2005. Today we are releasing earnings but have decided to complete reconciliation in their entirety not just materially and filed the 10-Q and all related 10-Ks upon completion. This is what we believe is the right thing to do. It is anticipated that it will be complete within the next 60 days in filing all the related restatements in the Company's quarterly 10-Q.

These events should not be cause for concern about the financial or competitive strength of our Company. Despite the obvious distractions, management continues to explore and develop opportunities to capitalize on what we believe are tremendous opportunities for the future. With that I will turn our attention to the quarter and the six month end period. First, as it relates to our recurring earnings per share from continuing operations, we reported $0.07. This was in line with our expectations mainly achieved through stronger funeral segment performance, slightly offset by anticipated cemetery revenue declines, and higher pension and Sarbanes-Oxley costs, in addition to slightly lower funeral average than we anticipated.

On the cash flow front-end, really exceeded expectations. We had strong operating cash flow for the quarter as we experienced improved operating performance, enhanced working capital improvements and in addition, experienced lower cash interest up (ph) as it relates to the prior year quarter. Indeed I am very pleased with this achievement as we absorbed a few things. One, the continued impact of the switch from Florida bonding into Florida trusting, in addition, we are bearing the 401(k) match on a cash basis as opposed to the prior year where that was matched in stock.

And lastly, we're absorbing, as you can see from the release, increased costs associated with Sarbanes-Oxley and associated with these reconciliation projects which we will be done with shortly. As I speak to the various segments I will be using comparable pro forma 2004 which takes into account the accounting change on deferred selling costs.

On our funeral segment overall we continue to see strong volumes in the quarter as we experienced in the first quarter this year. Our funeral segment margins were in line with our expectations. Comparable funeral volumes for the quarter were up 2.4%, and so for the first half of the year we experienced a 1.5% increase. Albeit we believe we are better operators today and compete more effectively, the preponderance of this increase we associate with increased number of deaths within the markets we serve, particularly in the month of February through May.

Our comparable averages were lower-than-expected although albeit they increased. On a year-to-date basis those averages were up 1.9%. In the second quarter we experienced slightly lower accretion as it relates to our trust and insurance of pre-need products that go (indiscernible). In addition, the cremation mix change that we experienced was in line with our expectations approximating about 100 basis point increase. While overhead costs were reduced year-over-year, which helped, fields pension cost and vehicle expense increased more than we anticipated. As stock market returns impacted our pension costs, as those returns were lower than we anticipated, and energy costs associated with our vehicles were higher as many industries are experiencing today.

As we look at the remainder of 2005 we would anticipate the following. First, improvement in our funeral average as (indiscernible) shift in pricing should have positive impacts on an average as we go forward. We would expect our comparable volumes to begin to trend down slightly as we've experienced very favorable volumes in the first half of the year. History would tell us the comparable volumes would change in the other direction.

In addition, improved cost containment measures as we continue to have in place, offset by increased costs associated with our S-Ox compliance. And again we view these as 2005 issues that become more and more manageable as we move into the future. In addition, we looked in the latter half of this year to begin to increase our G&A revenue associated with our insurance products sold. As we've changed the sales compensation program to better enhance their ability to sell products that results in higher G&A revenues.

The key initiatives as we look to the future to enhance our return are continued emphasis on the Dignity blueprint, both displayed and the training associated with it. The continuation of our consistent management structure that is in its second year today, continued emphasis on the Dignity brand as we continue to focus on community service and advertising to raise the recognition level of the Dignity brand. And then not very impactful in '05 but the project we are undertaking today with Bain (ph) helping us understand customer segment, which should enhance our returns as we look out in '06, '07 and '08.

On the pre-need funeral production side our pre-need production was about $91.8 million, which is down 4.6 million or 4.8% compared to last year's second quarter. Keep in mind last year our full-year production was 350.6 million which as an increase approaching 6% over 2003.

On the cemetery segment we anticipated a reduction in recognized revenue as we knew we would experience lower legacy revenues from completed construction projects. That reduction was approximately 4.5 million for the quarter and on a year-to-date basis the revenue reduction is 16.8 million. Albeit our production for the year is up it is slightly lower than we anticipated in our own internal forecast. Cemetery margins for the quarter increased by approximately 300 basis points to 13.8% to compare to the pro forma prior year quarter of 10.8%. Even on an essentially flat revenue base as increased production offset lower legacy revenue. These cemetery margins have increased primarily due to significantly lowering selling costs associated with the recognized revenues through the changes we implemented in July 2004. On a quarter to date basis the selling cost savings approximate $4.5 million.

In addition, allocated overhead expense reductions were partially offset by increased healthcare and pension costs associated with our cemetery personnel. On the production side of the coin, our total comparable cemetery production both pre-need and at need without regard to recognition -- now we are talking about actual selling -- was $145.1 million and was up 8.1 million or 6% over the prior year. Most of this is associated with increased property sales. Keep in mind last year our production was 496.2 million, up approximately 3% and in particular our property sales were up 8.2, so we are continuing to see trends on the cemetery production side which are positive.

Remember we made the sales compensation changes in July 2004, so even though the production on a year-to-date basis was slightly down, as a matter of fact its 98.2% of prior year. Our total selling compensation as a percentage of all production both pre-need and at need cemetery as well as pre-need funeral, was 17.2% versus 19.8% in the prior year. That is a 260 basis point cash savings which approximated just over $13 million. Keep in mind we did this while essentially maintaining our sales efforts.

We are going -- you also should understand that change was made in July of 2004, and therefore from a comparable basis we should be on a more apples-to-apples as we look at the back half of the year. As we look to the finishing 2005, we look for continued improved sales production, particularly on property and less on merchandise. We see a reduction in recognizing legacy revenues and keep in mind these legacy revenues typically have no cash associated with them.

We also anticipate slightly lower trust earnings based upon market conditions that we are experiencing today. And we will continue to focus heavily on cost containment initiatives. These cost containment initiatives, though, should be offset by the increased costs that we're seeing on the S-Ox front, as well as finalizing some of these reconciliation projects that we've talked about. The key initiatives to enhance returns as we look forward on the cemetery side are continued product tiering in our cemeteries, the continued rollout of the cemetery pricing model focusing the appropriate pricing within the segments that the consumer values. And in addition we're rolling out Dignity packages on the cemetery side, and we're continuing our Dignity University focus on our sales management, our foundation for growth courses, which we hope with that investment will enhance the productivity of our sales managers across the country.

And lastly, again for 2006 and beyond, we are in the midst of our Bain study for about 2.5 months to a 4-month project which is going to help us better understand customer segmentation and rollout strategies that are aligned with those segmentations we as we look forward. With that I thank you for your patience and I am going to turn it over to Jeff.

Thanks, Tom. SCI generated approximately $62 million of free cash flow in the second quarter of 2005. Free cash flow is defined in SCI's press release issued yesterday relating to our second quarter of 2005 preliminary financial results. In the second quarter of 2004 SCI's free cash flow was approximately $25 million. The improved free cash flow in the second quarter of 2005 versus the same period of prior year is attributable to lower interest payments, improved collections from customers in pre-need trusts and improved operational performance. Year-to-date free cash flow is approximately 146.8 million in 2005. This compares to the same period in 2004 when free cash flow was 104.9 million, excluding the cash flow from the joint venture to French business.

On a year-to-date basis reduced payroll payments and bonus payments were also a significant factor in the improved 2005 cash flow. The key use of free cash flow during the quarter was our open market share repurchase program. Since August of 2004 SCI has acquired 43.6 million shares at a cost of approximately $301.5 million. At an average cost of $6.90 per share. Under existing Board authority SCI currently has approximately $98.5 million of approved stock repurchases yet to undertake.

Despite the $187 million charge related to the change in accounting for selling costs and the $300 million of share buybacks, SCI maintained a debt to total capitalization ratio of 44% and a net debt to capitalization ratio of 37% at June 30, 2005. Total debt was 1.26 billion, and net debt was 943 million at June 30, 2005. At June 30 current debt maturities were approximately 100 million, and cash and cash equivalents were 320 million. Current cash balances are approximately 40 million higher than that on June 30th.

General and administrative expenses when adjusted to exclude litigation expenses increased 5.4 million in the second quarter of 2005 over the same period of 2004. This was primarily attributable to costs associated with S-Ox 404, corporate governance and corporate auditing. Other income and expense in 2005 improved nearly $6 million in the second quarter of 2005 versus 2004 due to greater income on excess funds, and 2004 results reflected a foreign currency loss that was not repeated in 2005.

Interest expense declined by approximately $6 million in the second quarter of 2005 versus the same period of prior year due to lower levels of outstanding debt. Debt extinguishment costs of $13 million in the second quarter of 2005 related primarily to SCI's tender offer for the 2006 and 2007 debt maturities. Debt extinguishment costs of $16.8 million in the second quarter of 2004 related primarily to the tender of $200 million of the '05 debt maturity and calling the convertible debt.

Our effective tax rate for the second quarter of 2005 was approximately 42%. The tax rate was higher than 35% due to the negative impact of permanent differences in the book and tax values of underperforming businesses sold in North America during the quarter. We continue to forecast a 35% effective tax rate for the continuing operations during 2005.

SCI's 2.7 billion of funeral, cemetery merchandise and endowment care trust had good performance in the second quarter of 2005. This performance includes the impact of both trust earned income, as well as changes in portfolio value, but does 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 second quarter of 2005 the funeral trust had a return of 1.99%. The cemetery merchandise and service trust had a return of 2.19%, and the endowment care trust had a return of 3.12%. For the same quarter the S&P 500 index had a return of 1.37%. The Lehman Brothers aggregate bond index had a return of 3.01%.

On a relative basis to similar portfolios the performance of SCI's trust was acceptable. In addition, the current market value of our portfolio trust investments at June 30th exceeded our cost of the investments in these trusts by approximately $71 million. The entire management team at SCI is disappointed that our second quarter earnings press release was delayed, and the filing of our second quarter 10-Q will be further delayed. We are working diligently to file our 10-Q as soon as both SCI and its auditors are comfortable with its context. We are also strengthening our internal controls to minimize the probability that such errors will recur.

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

(OPERATOR INSTRUCTIONS) Tom Bacon (ph), Lehman Brothers.

I just wanted to ask a little bit -- I mean it looks compared to last year like the mix, the revenue mix in terms of the at need versus the pre-need was a little more slanted towards at need. And I would think that that would be positive for your average revenue per service. And I am just wondering if average revenue per service on a pre-need basis is much lower than what you're getting at need at the moment? Can you talk a little bit about the dynamics there?

Yes, Tom, let me talk in two dynamics. One is as it relates to a shorter period of time, the average coming out of your pre-need backlog can vary more significantly. I think if you look at the pre-need average in the second quarter of '05 versus the pre-need average in second quarter of '04 you will see a slight downtrend, and that relates to the imputed income either out of the trusts or out of the policies associated with that. If you look on a longer-term period like over the six-month period we see a much more normalized comparison. So I think our average overall is of up 1.9% over six months. It is slightly lower at 0.3% for the quarter, and I think the quarterly impact is much more attune to the fact that in the prior year we had more accretion associated with pre-need contracts than we did in the second quarter of this year.

So it is strictly basically the returns on the trust, more or less?

Returns on trusts and let's say the mix between what came out of trust and what came out of insurance because again when people die and what that was funded with would have a more material impact in a shorter period than it would in a longer period. Your comment about pre-need versus at need, there is a slight difference between the two albeit not dramatic. We are seeing the returns of the pre-need coming out of the at need that are approaching now our at need average.

And what was the in terms of the services I mean, you usually give the penetration of the Dignity packages. Do you have that data available?

I think we do. Eric, you have that in front of you? Generally, Tom let me talk to what's happening there. We are seeing our Dignity uptake average going up. We are seeing more people select the Dignity. I think associated with that we've got some operational implementation issues. We are seeing a little more discounting than we normally would. So while we are very pleased with the rates we are seeing Dignity climb at, we are probably not getting the full impact associated with that because we are seeing a little bit of an increase in discounting. So we're going to get behind that and understated it a little better, but overall we are seeing a higher penetration of Dignity on the at need selection rate.

Okay, and one other thing as far as the balance sheet is concerned, it looked like your deferred revenues both funeral and cemetery, I mean quarter to quarter were up, showed more of an increase than they typically do. And is that a byproduct of this trust verification and reconciliation project, or is it basically just better pre-need selling?

Tom, this is Eric. It is really neither. It is just a function of what came out of the backlog during the actual quarter itself. I do think that we are obviously going in, as you know, and adjusting the detail records within the reconciliations for the contract verification project. And that is underway, as you know. But for the most part it is just what came out of trust and the accretion associated with it for the quarter. And you will see fluctuations go through that especially as it relates to mix because you have to remember that the only thing that is on our balance sheet is the trust fund contracts. The amount that is coming out of the backlogs for the insurance is not on our balance sheet. So you have to keep that in mind as well when you see that.

The other point I would add is a portion of this that is Canadian based, changes with the currency rate changes on the Canadian dollar versus the U.S. dollar So you may see some fluctuations attributable to that, too.

Okay. That's all I have for now. Thank you.

From Raymond James and Associates, John Ransom.

Just looking at your cash flow statement, obviously there was a big benefit both in the quarter and in the six months. And I'm sorry -- net effect of cemetery production and deliveries is a $57 million roughly swing from last year to this year. A, could you elaborate on that a little bit? And B, what should we think about in terms of a sustainable trend as I guess I'm assuming a $43 million increase would not be sustainable over a longer cycle.

You have to remember what we talked about in the first quarter first of all, about the change in the amortization methods of deferred selling costs. We used to defer them and amortize them, and now we do not starting the first quarter of '05. And so you are not looking first of all at an apples-to-apples comparison related to that accounting change. So if you look at the funeral line and a funeral line is the source of say 10 million in the prior year and excuse me, and a use of 3 million in the current year, that difference, 8 million of that which is basically the entire differences related to the amortization change in accounting. And then when you go to cemetery and you look at a use of 14 million versus a source of 43 which is EUR57 (ph) million I assume, 31 of that is the accounting change itself which is trading a source which wasn't there last year.

The remaining amount, about 25 million, most of it is related to an increase in trust withdrawals during the quarter. That's probably about 14 of it, which is related to the pre-need sales and stuff coming through and having essentially better trust withdrawals in the prior year as we get better process and stuff going forward. And the other piece to it is a source related to maturities. The actual merchandise delivered for the quarter was less. And when you deliver something, if you go through the cash flow statement, think of working capital. When it actually matures or delivers it is essentially a cash flow negative event because you received some of the money in the past and if you have less of those maturities it kind of comes through as a source. So it's those components which makes up about 55 or so of your 57 million.

And you are saying 14 million is trust withdrawals?

Net trust withdrawals, yes, more trust coming out, more cash coming out of the trust than going in. It is really a function to be honest with you more of timing than anything else. But we are seeing improvements as we work through these reconciliation projects, we are seeing better process as such related to our trust administration.

And is that 14 million, is that a sustainable trend, or is that more of a onetime harvesting of what was always there?

I think for the quarter it wouldn't be. I mean over, if you think back on the first quarter, we were I think down versus prior year in terms of free cash flow by about 10 million or so. So I was looking at more as timing, and I think on a year-to-date basis I don't think there is really anything unusual coming out of there other than timing between the two quarters.

Okay, and I guess just another kind of bigger picture question you've done 147 million of free cash flow year-to-date. Your guidance is unchanged, so that implies that the midpoint 210 minus 150, roughly $60 million for the back half of the year. Could you just elaborate on that number because certainly that number on a quarterly basis would be kind of at the low end of what you generated historically. So are there some other timing issues in the first half of the year, onetime issues that wouldn't be replicated to help us think about your longer-term sustainable free cash flow?

Let me say generally, and Jeff and Eric can follow-up, two things, John. One is historically we have seen higher cash flows in the first half of the year than the second half of the year; it is somewhat seasonal. I know they've got the interest payment schedules in front of them which will help explain too. The other thing that I think is safe to say we are not spending our maintenance CapEx as at the same pace as we budgeted it. So I would expect and we see this from time to time that you will see our maintenance expenditures go up in the back half of the year. We probably haven't spent what we thought we would spend. (multiple speakers) touch on, and Jeff, you want to add anything?

The thing I would add, John, is that Tom made some points earlier as to the headwinds that we are picking on. One of them was the trusting situation in Florida. That in the first half of the year cost us about $4 million of cash flow. I think for the full year that is going to be in the 6 to 8 range. The second thing he mentioned was the 401(k). That was 8 million in the first half of the year, and we see that as being in the 17 million range for the full year. And then finally the S-Ox issues in the first half of the year that was about 10, and I don't want to estimate that for the second half of the year. But those are things that we're trying to undertake as we produce the cash flow that we had initially forecasted. Quite frankly the S-Ox costs are certainly exceeding what we thought they would.

I think we would say we are very pleased about our first-half performance, and we feel good about our guidance that is out there, John, is the best way to say it.

Well then it sounds like all the things Jeff ran through expect for S-Ox are going to be about the same dollar amount in the second half of the year versus the first half of the year.

I think that is fair to say, and I think some of the other differences like he said we typically do not experience the same level of cash flow from the operating cash flow. And then secondarily the maintenance CapEx ought to go up back half of the year versus first half. But John, I know where you're going. We feel very good about where we are. And again, depending on how the back half (technical difficulty) out we feel good about achieving our target.

And I guess the other question would be again, let's pull the trust effect out of the funeral revenue line for a minute. What are you seeing? You had a -- you're now 41% cremation. You mentioned discounting, a little pressure from discounting. But what are you seeing in terms of apples-to-apples pricing on an at need basis, factoring in the increase in cremations?

I think it is kind of a mixed bag, John. Everything is a little bit regional, but generally what we are seeing is more people focusing on the service side of this business. We talked about it before. I think there's less value perceived on the product side. You're going to see a more competitive atmosphere on the product side. And what we are finding is in markets where we've gone in and assessed that that people continue to find value in the services we provide and particularly some of the ancillary services we provide. So overall I think we feel very good going forward about general pricing, albeit we see a mix on the horizon that we've been talking about for some time where there appears to be more of a consumer focus on services versus product.

And I know your predecessor used to talk about this a lot, maybe it's not as important, but what is the Dignity mix now at need and pre-need? And where do you think that could go, and how much does that help you on the pricing side of this bundled approach?

Well, I think today, and Eric can get these exact numbers, but I think we're running at a clip in the second quarter of right around 20%, 20 to 26. We're about 20% of all at need contract that we perform today. And on this backlog we are probably putting it in about a 26% clip. It's difficult to say. I really believe there is opportunity to go a lot higher. The challenge, John, is always around how are you getting there. Are you going to get the impact that you forecast? Because again, you could make the Dignity take up right there to the moon if you discounted high enough and if you incent your sales force to do it. But I think in a healthy way it can continue to trend up and it's a function of training, it's a function of predominately (technical difficulty) a function of the showrooms we talked about. So I think we feel very positive about the long-term ability to grow Dignity but I think it is going to have to be at a pace that allows us to enjoy the benefits from it as opposed to just being able to tell you our Dignity rate went up.

What is the differential now kind of on an apples-to-apples basis between Dignity pricing and non Dignity pricing?

We don't have those in front of me today, John. Maybe we can provide those to you off-line, but we're continuing to see similar trends we've experienced in the past. People are selecting, as you know, the Dignity packages provide for a much wider array of products and services. So my recollection is that that differential is pretty significant, again associated with buying the MIMS (ph) buying the Aftercare Planner. And I think those differences are still running in the $2500 range. Eric, is that right?

Yes.

Okay. All right. Thanks a lot.

(OPERATOR INSTRUCTIONS) A. J. Rice, Merrill Lynch.

It is actually Chris Rigg for A.J. Just look at obviously the balance sheet cash position is very strong; near-term debt maturities a little less, around $91 million. I'm just wondering I know historically you have talked about your capital structure and possibly even being under levered at this point. Just wondering how you're thinking about your capital allocation going forward, whether you believe it is prudent to refinance the debt possibly, increase your leverage, just keep buying back stock? Just sort of high-level question what you think you're going to do going forward.

I think we want to maintain the current debt ratings that we have. We think they give us some flexibility and as a result I think what we're really focused on is the proper use of our cash. We would love to invest it in the business if we can find a way to get appropriate returns there. If we can't we will obviously use it to buy back shares and keep our ratios in line with the ratios that we mentioned on the Roadshow.

How involved have you been in the acquisition market at this point? Is the pricing still sticky too far out of where you want to pay, or has that been coming down at all? We just haven't seen a lot of acquisitions in the industry in quite some time. I'm just wondering at what point -- you know we talked about this a number of times historically, you think that might come back into a level that would be reasonable?

I think there is -- I will answer that two ways. One is generally we are not seeing it get more reasonable. Also, we are obviously being very selective about the types of businesses we want to be in, the markets that we want to be in. And we broached the topic before about we are in the mist now of a study with Bain, and the engagement with Bain that we're working with them on is to better understand customer segments in the U.S. And therefore understand customer segment footprint that we have today. And really drive our strategy off of the segment that match up best with SCI. So I think on the conclusion of this we will actually be even more laser focused on where we want to be and how we want to be there. And that may be an acquisition mode or we may decide that the fundamentals are such that we want to do it from a building approach as opposed to buying. So it's going to be very customer segment driven and therefore we really haven't gone out in a rash of trying to buy businesses in multiples that just don't make sense for us now. We've utilized a lot of our excess cash to buy back shares like Jeff said. We think that is a good value for our shareholders. But we do believe it will be opportunities and some will be buy and some will be build, and we can grow this business so among the segments, if that is aligned with SCI's capability.

Okay, and then just to clarify a point you had made on the volumes earlier, you said volumes in the second half are typically a bit weaker than what you would see in the first half. I guess you mean just in terms of relative to first and second quarter, is going to be stronger than third and fourth quarter. Or are you actually saying the third and fourth quarter comps are going to be that much more difficult, making it more -- making it also more difficult to achieve year-over-year same facility growth?

I think what I was trying to say in that statement is if you look at history, you look at death rates, they tend to be very predictable over longer periods of time and sometimes they are a little more choppy in shorter periods of time. If you look at the consolidators we have experienced as a group a deteriorating comparable volumes historically. Having said that and having a belief that a lot of this is market-driven, you would expect it in the first-half of the year we are all experiencing comparable volume increases that that would correct itself. Now I cannot predict the future. So let me say that. But I would only warn people to say if the number of funerals we are performing are very good in the front half and it is market driven, you would expect it to drop off at some point because a lot of the times death is accelerated through disease or through severe weather and so I really just put that more as a disclaimer. We have no idea what the back of the year will do, but we have experienced I think favorable trend in the first half.

Okay, and then my last question here is did you disclose what your total stocks expenses have been year-to-date so far? And if you can quantify that, can you give us an idea of what you think is sort of a recurring amount versus sort of a onetime ramp-up expense?

I don't know if we're in a position yet, Chris, to give you kind of what the normal run rate will be going forward. Certainly we've spent a significant amount on S-Ox versus prior year. I think from when we were talking about -- when Jeff was making his comments about S-Ox earlier when he was talking about kind of a $10 million increase, that was a year-to-date '05 versus a year-to-date '04 type increase. Not all the 10 million is related to S-Ox. It is also related to S-Ox associated exercises, mainly these funeral and cemetery trust reconciliations that we've been performing. So I think obviously that piece of it will significantly decrease going forward as we get through those projects.

Of the 10 million in increase in 2005, maybe about half of that or a little less than half of that are related to those reconciliations that we're well aware of that I just described to you. So that's kind of, when you think of a run rate, that is a way to kind of think about it in that sense. But for the most part, we're going to continue to have to spend the money that we need to spend to get into compliance and do the things according to our plan which we've discussed at length and disclosed in length for 2005 to get there. And we'll just have to see how it works out going through '05 before we can really predict for you how much, other than those reconciliations projects that I mentioned, would drop off into '06.

Chris, this is Tom. I think when we gave guidance about some of these topics before, we said our pure stocks costs that we believed we were going to incur were going to total between 12 and $15 million this year. Half of those relate to true S-Ox testing external costs and half of those, I believe we told you in our guidance, we said were additional controls we were putting in place associated with S-Ox compliance. We would like to believe over a period of time we can dramatically reduce those extra controls. As we improve our control structure over time, then we can eliminate some of those redundant controls as we better understand S-Ox. As it relates to the ongoing compliance, again, those should trend down probably not to the same extent as we better understand, as our external auditors better understand, the new S-Ox control environment.

So we're going to work hard to trend them down. I would expect slight decreases in '06 and probably a very aggressive shot at it as we get into '07.

Great. Thanks for the color.

Robert Willoughby, Banc of America Securities.

Thank you. Tom or Jeff, can you comment on the international revenues and profitability, any color you can add on that front?

Yes, I'll talk generally, Robert. This is Tom. On the international revenues, the preponderance of those are made up, particularly on the cemetery side, of our Chilean operations. And on the funeral side, I would say most of the profitability is associated with Singapore. Both of those businesses, as we've talked about before, are very good businesses. We have decided that we would run those businesses until such point in time -- long-term, they don't fit our strategy -- that maybe a buyer would come in at a reasonable level. Both of those, we have people that are interested. We have not determined for absolute fact that we're going to dispose of those, but we have a high level of interest in both those businesses. But again, I don't think they -- they came (inaudible) focusing on the North American side.

As it relates to the quarter, however, it looks like they turned in am I correct fairly strong performances?

It looks like, Robert, the revenues related to the international segment is about a little over $10 million for the quarter and gross profits are about 3 million of that. They have somewhat of a healthy margin to answer your question. And the preponderance of that is related to Chile which is the cemetery segment as Tom just described.

Okay, and just a remarkably ignorant question, is there any precedent at all for hurricanes, do you tend to do better or worse than in markets where they hit?

What I think happens is a couple of things, Robert. Unfortunately our businesses seem to have this every year. You experience in the aftermath quite a bit of expense associated with cleaning up, and sometimes repairs. A lot of those are insured so over a long period of time we may get some of that back in insurance. The other phenomenon that occurs as you can imagine, is pre-need sales tend to stop a few days before a hurricane and in the hard-hit areas they don't regain. Because everybody is focused -- the last thing on your mind is buying pre-need cemetery property or a pre-need funeral when you're worried about getting a roof on your house. So they tend to have a negative effect within the periods. But again, I think sometimes we see as people come out of those, have those horrifying experiences maybe more people over time begin to think about protection of themselves and taking care of those type of things. So over long periods of time they don't have necessarily have a negative effect. But in the short term they would.

That's great. Thank you.

Jennifer Childe with Bear Stearns.

A couple questions. First on the cemetery side, how much of the recognized pre-need is current sales versus previously closed sales, that don't have any sales expense associated with them since those expenses were written off? Or in other words, was any of the margin expansion on the cemetery side attributable to that?

Eric can get the exact numbers, Jennifer. This is Tom, by the way. Year-over-year my recollection is that what we're calling legacy revenues which is exactly what you're talking about, something we sold in a prior year that is recognized because it is built now. Those legacy revenues are down about 4.5 million quarter-over-quarter. And on the year they are down just over 16 million. So as it relates to comparables those actually should have a negative impact on our margins as you think about it. Again, they aren't cash, but our production as it relates to legacy is down both for the quarter and for the half year.

Okay. You may have answered this but I am not sure I understand there was a significant sequential increase in deferred revenue. In fact it was the largest sequential increase on record. Was that attributable to the reconciliation project?

When you say deferred revenue, you're talking about from a balance sheet perspective?

On the balance sheet, yes.

Right. I think a lot of it -- well first of all, the production sales were okay this quarter. As you know as Tom said they were about 98% or so. So I think that definitely is a piece to it. I would also say, for example if you look at General, Jennifer, in a funeral deferred pre-need funeral revenues went up 30 million but you also see that noncontrolling interests went down. Even though that noncontrolling interest is a function of those funeral and cemetery. So you kind of look at the deferred revenue lines together can see they went up, and you also see noncontrolling interest went down. And sometimes you will see those split. And what is happening is as you have new sales and the money isn't in the trust funds yet, you have deferred revenue. And noncontrolling interest is those same contracts with the amount of that is supported by the trust funds. So as money comes in from customers and gets placed in the trust, you will see money come out of deferred revenue and go into noncontrolling interest. When you have stronger sales and higher volumes and stuff is coming out of the backlog, you will actually see stuff coming out of noncontrolling interest, which is us taking it out of the trust fund. So I think a lot of that -- that is a lot of what is happening during the sequential year-over-year. Actually not sequential. It is the six months obviously is what we're talking about.

And can you also review for us how you calculate the trust accretion?

As defined in the press release, we -- there is a table on page 3 of the press release, and the margin is ticked, footnoted with footnote number three, and it is basically from a North American comparable standpoint as lease, its your funeral revenues backing out your GA revenue and your Kenyon revenue, and you can see that defined in the table. So its basically your funeral at need and funeral recognized pre-need revenues on a comparable same-store basis divided by your comparable funeral services that are performed in those same stores.

Are you asking how accretion is?

Yes, I think you're explaining same-store. I am wondering if you could walk us through how the trust accretion works.

It pertains to the particular contracts and trusts that basically mature. In other words, we have investment restrictions that apply differently in different states. So there is different accretion associated with each of the trusts and the contracts that comprise that trust. And so when a person dies in Georgia where we must invest in U.S. Treasuries only, the accretion might be quite small with that death depending on where it occurred or if a person died in Florida where we can use the (indiscernible)if he has been in the trust for a long time we could have a very sizable amount of accretion with that. But it is very comparable, Jennifer, to a 401(k) account. And the only difference is we basically take it to the account value at the time of demise.

The other thing that is important is when that contract that 401(k) contract goes at need reallocate realized and unrealized gains and losses. So the computation wouldn't matter as to whether or not you got realized gains or whatever. It is the value at that point in time, and that is what runs through your income statement.

And the reason I am asking is because one of the reasons you cited for the rather anemic increase in the revenue per call was trust returns. Yet your trust returns have been quite strong.

Yes, I think the trust returns when we talk about them overall are quite strong. Think about it this way, Jennifer. If I sold a contract that was in there for twelve years, I am going to have twelve years of accumulated earnings associated with that contract versus one I sold a year ago that only has got a year's worth of accretion associated with it. So from time to time if you get an older contract you tend to have more accretion associated with it. The other mix issue you're dealing with is if I have an insurance policy it has got a certain earnings rate versus a trust fund. So how many insurance contracts go at need versus trust would also play into how much accretion is in a quarter. Again, over longer periods of time we have not seen on an annual basis this be a material impact to us because of the large pools and the large number of contracts. But for this quarter there is enough to dampen that comparison.

Just a couple more. What assets were sold in the quarter? Was it just North American homes and cemeteries?

Yes, just North American homes and cemeteries, and I think disclosed in the release we had an indemnification associated with our UK business that we were released from that obligation. Basically time had expired associated with the tax indemnity on UK. So that was about I believe Eric an $8 million pre-tax --.

Right, and we also received, Jennifer, I think 30 to 35 million. I don't remember exact amount from (technical difficulty) not the disposition but just as we already talked about that in a previous release and conference call. That is also about investing activity.

Why did that increase sequentially?

I'm sorry, that deals with the refinancing.

Essentially we issued $300 million worth of debt but if you look you will see there are still some '06 and '07 maturities outstanding. So we basically in our tender offers did not get back $300 million worth of debt. We got back somewhere around 270, and I think the increase in the debt is roughly 10 million or something like that.

Okay, got it. And then finally, the number of funeral services in the second quarter of last year was revised downward by nearly 3% in this quarter's release. I'm curious why.

Because it is the same stores that exist today when you look at that table so it takes into effect the sales of businesses that occurred where last year we owned those locations and they are considered same-store '04 over '03. This year when you go in you are taking your same stores that you owned for '05 and comparing that volume to those same exact stores in '04.

Okay, all right. Thanks.

Kalmar Investments, Dana Walker.

Could you talk about the influences on funeral gross margin? They are spelled out in the press release, but I was hoping you could go into more detail given the flowthrough economics on increased volume in theory ought to be rather flush?

I will touch on that for you. First of all, as you look at our funeral revenues, we talked to 10.4 million of increased funeral revenues. 3.8 million of that is related to our Kenyon subsidiary. That is a specific project associated with our work in the efforts in the tsunami disaster. And a lot of the revenue the way Kenyon works is we are putting equipment on the ground or people on the ground that from time to time may not even have a markup. We may be buying things and passing it through. So what you tend to see in Kenyon on these special projects is very low gross margins associated with that business. We have not seen a year-over-year -- as a matter-of-fact we had a slight decline from our contribution in Kenyon even though we had the increase in revenue. So if you back Kenyon out of it, you you're looking at a little over $6.5 million of revenue which produced 2.6 million in gross profits. And some of the things again that kind of chip away at that we saw a bit of an increase associated with pension costs as a good example.

We -- our accounting associated with pension would assume that we get market returns over time that approximate somewhere in the 6 to 7% that will allow us not to incur pension expense. Because of the general markets did not perform well in the first half of the year, we've had to begin to assume that we may not achieve the returns to match the increase in cost associated with the frozen pension plans. So we have experienced approximately 2.2 million from increased pension costs year-over-year in the quarter that dampens those margins further. I think if you add those back you can see the incrementally of the revenues in the associated profits. Those are two things that weigh into that.

That is helpful. One last -- I seem to have an echo here. The issue related to discounting that you described earlier on Dignity, has even though Dignity is early in its rollouts or relatively early in its rollout, how large a role has discounting played prior to Q2 of '05, and can you put discounting in context?

Let me say this. First of all, discounting has been around since the beginning of time, so I don't want to pretend discounting is anything new. And we are not even sure. We have a lot of flexibility at the field level to offer discounts, let me give you an example. We may have unfortunately we see from time to time death of children, or death of policeman or fireman. When that occurs a lot of the time we are giving away our services, and we have a discount associated with it. I don't want to pretend that dramatically changes over time but there is a lot of reasons to provide discounts. And what we are seeing is increases in our Dignity rate and an associated increase in discounting, not necessarily particularly to Dignity. So we are still trying to understand better the dynamics of what is occurring. But it could be that we are seeing associated discounting to get people into packages and these are some of the things we need to work through.

And the other thing that we are seeing from time to time is we are seeing less of an emphasis on the casket; we are seeing more people buying caskets from third parties and/or coming in and price shopping against third-party prices. Again, we are trying to get that consumer matching prices. We're accepting delivery of caskets into our stores. And those types of things and again based upon your pricing being where it is, have impacts on your margins and those show up in the discount line item if you are going to discount something. So there is a lot of dynamics to discounting. We've had it over time; we've always had it in Dignity packages to some extent. So what we are really trying to understand what is happening a little better as it relates to Dignity. We've got ways of dealing with that, but we have a lot of flexibility at the local level as it relates to pricing.

So the funeral home Director has that flexibility in hand, or is that a field issue?

We have a process and rules of engagement, if you will, as to how we do that and approvals associated so I don't want to pretend they can do anything. But again, you deal, you're dealing with people at a very sensitive time in their lives. You're dealing with different economic situations. So there is room for Directors to deal with that. Now there are levels where they have to (inaudible) and all the like, so that has been around. That is not something new. What we are seeing is just kind of an increased level of discounting. Meantime we are seeing a growth in our Dignity. So we need to get behind a little better and understand it and we will deal with this in the coming quarter.

And that concludes the question-and-answer session today. Mr. Ryan, I would like to turn the conference back to you for any additional or closing remarks.

This is Tom Ryan, and I want to thank everybody again for attending the conference today. And we will talk to you again at our third-quarter earnings release. Thank you.

That concludes today's conference. We do thank you for your participation.