Service Corporation International (SCI) 2005 Q3 法說會逐字稿

Good day, everyone. Welcome to our Service Corporation International third-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 the management team of SCI. Please go ahead.

Good morning. This is Eric Tanzberger. I want to welcome everyone to our third-quarter earnings call this morning. We're going to start, as usual, with some prepared remarks and then we will follow with a question-and-answer session.

As you know, last night, we filed or Form 10-Q for the third quarter and that is available on our Web site at www.SCI-corp.com.

Before we begin with the prepared remarks, I want to mind everyone that there will be statements made today on this conference call 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. Such forward-looking statements may be accompanied by words such as believe, estimate, project, expect, and other words of that nature. The statements 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 we would make today. Those statements are listed in our Form 10-Q that was filed last night, as well as in our Form 10-K, both filings available on our Web site, as I mentioned earlier.

Additionally, this call is recorded today and a replay of this call is available on our Web site for approximately 90 days on the Investors page, under the subheading of "conference calls".

Now, to begin the prepared remarks, I'm going to turn the call over to Tom Ryan, our President and Chief Executive Officer.

Thank you, Eric, and welcome, everybody, to the call.

I'm going to start by taking a view of the Company at a 40,000-foot level to provide some overall business perspective and then begin to analyze, by business segment, some of the things we noted for the quarter, for the year-to-date, and then some of the expectations that we would like to communicate to you as we look forward.

So from an overall perspective, recurring earns per share from continuing ops was $0.04 for the quarter, which was slightly below our expectations. Strong improvement in cemetery production and better-than-expected funeral volumes were offset by a lower-than-expected funeral sales average, higher-than-anticipated SOX and recount (ph) project expenses, as well as increases in healthcare, pension, and certain energy costs.

For the nine months, our recurring earns per share, including Chile, was approximately $0.23. Strong funeral volumes and cemetery sales production again were partially offset by the lower-than-expected funeral sales average, lower G&A insurance commissions and lower cemetery legacy revenues.

On the cost side of the equation, increased costs associated with SOX, certain fringes, particularly health and pension, as well as rising energy costs, which show up in our fuel and utility bills, were a drag on our operating margins.

From a cash-flow perspective, we actually are very pleased. We had stronger-than-expected operating cash flows for the quarter due to improvements in our working capital, as well as cash interest reductions, which were partially offset by businesses that don't exist and produce cash in this period. Generally, we were very pleased with this because we are absorbing, as you can recall from our guidance, cash contributions to our 401(k) plan, which historically have been made with stock, as well as increasing costs associated with Sarbanes-Oxley, some of the costs around our reconciliation projects, which have come to a close here.

Now, I would like to get into the business segment analysis. As in the press release, when speaking to our segments, we are using comparable pro forma 2004 numbers, which take into consideration the accounting change as it relates to deferred selling costs that we implemented January 1 of this year

So on the Funeral segment, overall, we continue to see strong volume, as we've seen evidenced in the first half of the year. Funeral segment margins were disappointing, and I will get into that in just a moment. Comparable funeral volumes, as I mentioned just a minute ago, were flat quarter-over-quarter. On a year-to-date basis, we are up 1%. We're very pleased with this; this is surprising, I would say, as it relates to setting our target. We are seeing some consistency with others in the industry here, so we think the proponent to this is probably related to an increase in the number of deaths within our market. Having said that, I am highly confident that we are competing more effectively at the local levels generally, and some of this is related to that.

Probably the most disappointing thing, as I looked at the Funeral side, is our comparable funeral average for the quarter. For the quarter, it's flat, year-over-year; on a year-to-date basis, it's not as disappointing; it's 1.4% year-to-date, still not where we wanted it to be. I touched upon this, as you will recall, in our last call. It was at the end of August, and I mentioned that we have implemented some corrective actions around pricing and discounting that should have a positive impact, particularly for the fourth quarter. A lot of these corrections are being done with what I like to call brute force, and what I mean there is we still are in the process of centralizing certain controls around pricing that should allow us to manage this a lot easier in the future.

As you look to why the comparable average is down for the quarter, there's a couple things I'd like to mention. First of all, we continue to see success with our Dignity plan. We are actually growing that year-over-year better than we ever have. Unfortunately, discounts have eaten into that advantage. Our discounts are up approximately 206 basis points year-over-year, about $3.2 million impact for the quarter, and therefore has a negative impact on our funeral average of approximately $20.

In addition, we saw an increase in the cremation mix change. The cremation mix change was 140 basis points. I think the first half of the year, we were running slightly below 100 basis points, so this is some acceleration. Again, we don't know if that's a quarterly event or trend, but we continue to track.

The last piece that has impacted us is accretion is down in this quarter as related to 2004 on insurance and trust. Again, that has taken our preneed average, particularly preneed going atneed, down approximately 2% for the quarter. So those three things -- discounts, cremation mix change, and a slight reduction in accretion -- are the reason for our flat quarter-to-date result.

As it relates to the margins, our operating salaries and selling costs actually have been managed very effectively. Unfortunately, increased costs associated with SOX and the Recon projects increased costs associated with fringe, particularly healthcare as well as pension, and increased costs that are tied to energy, which would be the fuel for our vehicles as well as utilities that run our funeral homes and cemeteries. These have had unfavorable effects upon our margins. As you step back and look at the year-to-date, we've seen strong funeral volumes that than offset by a slightly weaker-than-expected average and larger cost increases associated with SOX, the fringes I mentioned, as well as energy costs.

As we look at the final quarter of 2005 and into 2006, we would anticipate, number one, improvement in the funeral sales average. We are in the midst, as many of you know, we've talked about before, of looking at a different way of pricing our products and services and implementing that price remodel throughout. In addition, we're in the midst of putting some centralized controls around how we price, both on the funeral side and on the cemetery side. We have already begun to see evidence of this taking hold in our October results. We've actually seen funeral averages in the range of 3 to 4% improvement, October-over-October, and so we feel like we've put some things in place that have begun to address the issues that I talked about before.

I would expect, again, if history is a predictor, that our comparable volumes could trend slightly down. We've actually enjoyed the three consecutive quarters and now a nine-month period of comparable volume increase. So history would tell us this should slow down at some point. We are not, however, seeing evidence of that at this point.

We also would expect improved cost-containment measures. We are a hawk on managing our costs. Some of these costs are not as easy to manage and are beyond our controls. Some of them are going to be related to SOX control; we expect increases associated with that. We expect increases in healthcare costs, as I think everybody is bearing the burden of right now. Again, I am not a predictor of energy, but we continue to see year-over-year increases in costs associated with energy.

The other positive thing that I would tell you to look for is increased G&A revenue associated with our preneed funeral production, as we have shifted the production mix to a more favorable product, shifting away from (indiscernible) and shifting to more underwritten insurance product.

As it relates to preneed funeral production for the quarter, our production was at $82.3 million; that's down about 4.5 million over the prior-year quarter, or 5.2% on a comparable basis. I would just remind you that, last year, we grew our preneed funeral sales production at 5.8% clip.

Now, I will turn our attention to the Cemetery segment. Cemetery revenues were very strong versus the prior-year quarter as well as versus our own internal expectation. Cemetery sales production increased almost $13 million for the quarter or 11% over the prior-year quarter.

Legacy revenues -- as you will recall, legacy revenues are prior-year sales, so these would be sales of cemetery land and property that occurred prior to 2005 but would be recognized in 2005 predominantly because we've completed construction of the project. The legacy revenues were slightly higher than the prior year but they fell short of our own internal expectations for the quarter.

Gross profits for Cemetery increased $3.1 million or 15.7%. The revenue increases I just discussed were partially offset by inflationary costs of merchandise increases. As you will recall, a lot of these were tied to commodity prices, which have gone up recently, as well as higher health and pension costs that I talked about on the Funeral segment. We've also seen a slight increase in administrative labor costs and these predominantly relate to the fact that we've been working diligently on Cemetery Trust Reconciliation Project, as well as funeral, in addition to the SOX control that we've put in place and continue to incur those costs to improve our control environment.

On a year-to-date basis, the revenue impact of increased Cemetery production has been offset by the lower legacy revenues, compared with the prior year, as well as reduced cemetery finance charges. On the expense side, much improved selling expenses have been somewhat offset by higher G&A costs, again associated with increases in health and pension, as well as increased costs around our SOX controls.

On the production side -- and you will recall on the Cemetery we have production, some of which gets recognized, some of which goes into backlog. I mentioned before that our total comparable Cemetery production, preneed and atneed, without regard to recognition, was $129.2 million, or up approximately 12.7 million or 11% for the quarter-to-date. This increase was driven by increased sales unit production, as well as a healthy increase in the average as driven by our cemetery pricing model that we discussed before. For the year-to-date, production is up 18.4 million or approximately 5%. Again, I would recall, in building our sales efforts back, last year, our production was actually up about 3% and property in and of itself was up about 8.2%.

What I'd also like to do is remind you that we made sales comp changes in July, 2004, some pretty drastic changes. So this increase in Cemetery production was achieved while total selling compensation cost as a percentage of all production, not GAAP revenue but production, was 19.2% versus last year's 23.1%. This is for the nine months year-to-date. That's a 390-basis point improvement for a cash savings of approximately $15 million year-over-year. We're very pleased that we are able to continue to drive production in a much more efficient sales structure.

As we look to the final quarter of 2005 and into 2006, we would anticipate the following -- first, continued improved sales production, particularly as it relates to property and service (indiscernible) less emphasis on merchandise. We are actually seeing this in October across our markets as in a few that I will mention, particularly Florida and certain parts of eastern Texas that have been impacted by Wilma and impacted by Rita. These markets, as you would expect, are not back and up and running strongly in October. But everywhere else, we are continuing to see improved sales production.

Production in recognized legacy revenues -- again, not dramatic here but slowly but surely, because of our model, we are selling less undeveloped property. Recall, this has no cash impact, although it does have an impact on our earnings.

We would expect improvements in cemetery finance charge revenue. We've done some things to (indiscernible) that effort. In addition, we would expect continued improved cost-containment. Some of this cost-containment is going to be offset, however, by increased costs associated with our SOX control. Again, as we get better and better, we can begin to hopefully manage those down over time.

With that, that concludes my comments. With that, I'm going to turn it over to Jeff Curtiss.

Thanks, Tom.

SCI generated approximately $47.2 million of free cash flow in the third quarter of 2005. Free cash flow is defined in SCI's press release issued yesterday relating to our third quarter of 2005 financial results. In the third quarter of 2004, SCI's free cash flow was approximately $46.3 million. The improved free cash flow in the third quarter of 2005 versus the same period of the prior year is attributable to net trust fund withdrawals and 1.8 million of lower interest payments. In addition, the third quarter of 2005 had $6 million of higher maintenance capital expenditures than did the third quarter of 2004.

Year-to-date free cash flow is approximately $194 million in 2005. This compares to the same period in 2004, when free cash flow was 151.3 million, excluding the cash flow from the French business, which was joint-ventured in the first quarter of 2004. On a year-to-date basis, reduced payroll payments and bonus payments and reduced working capital and interest payments were significant factors in the improved 2005 cash flow.

We are currently expecting SCI's full-year 2005 cash flow to be at the upper end of our guidance range of $220 million or slightly exceed this guidance range. Excuse me, that's 200 to $220 million, or slightly exceed the guidance range.

Under existing Board authority, SCI currently has approximately $85 million of approved SCI stock repurchases yet to complete. Despite the $187 million charge related to the change in accounting for deferred preneed selling costs and the $315 million of share buybacks, SCI maintains a total debt-to-capitalization ratio of 44% and a net debt-to-capitalization ratio of 32% at September 30, 2005. Total debt was 1.26 billion, and net debt was 768 million at September 30. Current debt maturities were approximately $88 million, and the cash and cash equivalents was approximately $492 million.

As reported on the second page of our press release, the third quarter of 2005 funeral preneed recognized revenue of $79.6 million. About half of that amount, or approximately $40 million, is attributable to trust contracts. This $40 million amount includes approximately $7.6 million of accumulated trust income on these contracts. The remainder of the third-quarter funeral preneed recognized revenues is from insurance contracts, which includes increased debt benefits of approximately $2.7 million over the face value of such contracts.

The third-quarter of 2005 cemetery recognized revenues includes $3.25 million of trust earnings from cemetery merchandise and service trusts (ph) and $8.9 million of trust earnings from endowment care trusts.

The third quarter of 2005 funeral and cemetery margins were adversely impacted, as Tom reported to you, by approximately $1.1 million of higher fuel and utility costs for the same period of prior year. We expect the fourth quarter of 2005 will be similarly impacted.

General and administrative expenses, when adjusted to exclude litigation-related costs, increased $2.4 million in the third quarter of 2005 over the same period of 2004. As Tom mentioned, this was primarily attributable to costs associated with SOX 404, the second-quarter financial restatement, auditing and other professional fees.

Other income and expense in the third quarter of 2005 was similar to the same period in 2004, as $3 million of greater income on excess funds was offset by reduced foreign currency gains. Interest expense declined by $800,000 in the third quarter of 2005 versus the same period of prior year, due to lower debt levels of outstanding debt. September year-to-date interest expense is reduced by approximately $14.8 million versus prior year.

The effective income tax benefit for the third quarter of 2005 was equal to 11% of the pre-tax loss. This reduced tax benefit results because of the negative impact of permanent differences in book and tax values of underperforming businesses sold in North America during the quarter. The September year-to-date 2005 effective tax rate was 43.7% for similar reasons. We continue to forecast a normalized, 35% effective tax rate for continuing operations during 2005.

SCI's $2.8 billion of funeral/cemetery merchandise and endowment care trusts had good performance in the third quarter of 2005. This performance includes the impact of both trust-earned income and 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 returns on cash and on trusts that have invested in life insurance policies. For the third quarter of 2005, the funeral trusts had a return of 3.07%. The cemetery merchandise and service trusts had a return of 2.97%. The endowment care trusts had a return of 0.52%.

For the same quarter, the S&P 500 index had a return of 3.6%. The Lehman Brothers aggregate bond index had a return of -0.67%. On a relative basis to similar portfolios, the performance of SCI's trusts was acceptable. In addition, the current market value of our portfolio of trust investments at September 30, 2005 exceeded our costs of the investments in those trusts by approximately $82 million. Year-to-date, the funeral trusts had a return of 4.65%, the cemetery trusts had a return of 4.84%, and the endowment care trusts had a return of 2.64%. The return of the S&P 500 index for the year-to-date was 2.76% and the Lehman Brothers' aggregate index return for the year-to-date basis was 1.82%.

Wayne, with those comments, we will now go to the question-and-answer phase of the call.

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

It's actually Chris Rigg filling in for A.J. Tom, you had mentioned early the call that you doing some things "with brute force" to get the funeral averages up. I was wondering if you could give us a little more detail as to what you're doing out in the field.

Maybe that was not the greatest way to convey my thoughts, Chris, but what I really mean by that is we had very decentralized controls as it relates to pricing, probably more decentralized on the cemetery side, which has worked well -- historically I should say has worked okay.

As we look in improving our business and as we look at the changing environment out there, we need to ensure that we understand what's happening within our pricing. So for instance, on the funeral side today, locations -- and again with location manager approval -- can make discounts available at that local level really the way they want to do it. Again, we can track it within our system when they do it, but the permission to do so is granted locally.

I think, as we look to the future -- so, today, what we've done it is, through our management structure, said listen, we are discounting too much, too often and we need to understand why we are discounting. So, we've made a concerted effort, the way we do it today, to focus people on discounts. Again, I believe that has begun to work.

The other thing that I think is a long-term solution -- and when I say long, I mean early part of 2006 -- is that we will implement controls through our system that allow us to control that on an a more central basis, so it doesn't have to be pushed down (inaudible) management structure. So hopefully that answers it.

No, it does. Thank you. Next question -- I don't know if you will have the answer to this, but Jeff, do you know what the pricing looked like, you know, the pure funeral call pricing? Was there any way you could ex out the impact of the cremation to give us an idea how the pure funeral rate was trending?

Yes, I think we've got those numbers. It looks like that the traditional, without cremation -- well, I will have to get it to you. It looks like it's up about 1%, but I want to confirm that and back it out with the math, Chris, before I give that to you.

Okay. Then, on the balance sheet, you guys obviously have a lot of cash. Are there any restrictions on that cash? You've paid out all your settlements, things like that; it's just fully available for you to do whatever you want with it?

There's no restrictions.

Okay. Then, I guess just could you give us a high-level rundown of how you view the balance sheet? You guys have reduced the debt pretty significantly over the last four or five years. You've got a lot of cash. I mean, do you believe you will refinance the debt that's currently on the balance sheet, or you'll pay it off, or use the cash for buybacks? Just any color you could provide would be great.

Well, at some point we may do some refinancing, but as long as interest rates are rising, it will pay us to wait to refinance later because the debt on our balance sheet should be cheaper as interest rates rise.

As you know, we have some maturities in December of this year, I think about 63 million. But then the next two years, really don't have many full maturities. So you're really talking about somewhere closer to 2008 or 2009 before we have maturities that would be material to us.

So I don't see debt reduction as being a key issue for us right now. We have promulgated some various ratios of net debt-to-total capital, net debt to free cash flow, and free cash flow to interest expense. We are underachieving in the sense that we are over-equitized by those various ratios. So I think obviously it's a Board decision, but I think share buybacks and hopefully investment opportunities will be more likely things we will be focusing on.

Okay, great. Thanks a lot.

John Ransom with Raymond James.

Good morning. I guess you guys continue to be, at the margin, a little more active on the asset-sale front then I probably would have expected six months ago. Can you tell me where you are in the portfolio rationalization process? Should we continue to think about some further dispositions or do you think you are almost done?

Yes, I think one of the things we've done, and we've talked about this a little more, is we've really developed, internally, a strategic plan to really examine what businesses do we want to be in, how do we view our customer segments. as we're going through those processes, we still have identified a certain amount of businesses -- I don't expect it to be material -- that don't fit our long-term strategy. So we are exiting some of those businesses. I don't expect those to be tremendous. Also, we keep in mind that these particular businesses that either don't make money or make very little money -- so you will continue to see some dispositions probably throughout this year. I wouldn't expect a significant amount.

Then I would hope, as we enter the latter part of 2006, (indiscernible) you are going to see that slow down and actually begin to see us grow our location count in the way that we want to do it, aligned with our strategy.

Okay. Then I guess, secondly, just a high-level question -- you know, there are a lot of crosscurrents here in terms of cremation, pricing pressure from discounting, kind of an erratic volume trend. As you look at all of these issues, what do you think? I mean, I know the Company can continue to chip away at its cost structure, but what do you thing is the single kind of overarching thing that you guys have to focus on, from a strategic standpoint, to outrun all of these things that are nipping at your heels?

Well, I think, first and foremost in the short-term, John, what we can do is get our pricing right. One of the things that we are in the midst of doing now is putting pricing in the right place where our consumers find value. What we're finding is less and less value associated with products and more and more value associated with service. Because we are mispriced, when you do discounts, we are typically doing discounts on the product side, because it's not in line with the consumer expectation. That continues to happen on a short-term basis.

On a longer-term basis, how we will differentiate is we now have a view of our consumer through segmentation, and we've segmented our consumers and I think you'll begin to see us interact with consumers from a merchandising display, from sales training; from everything that we do, it will begin to differentiate how we treat those consumers within the segment. So we think, longer-term, that's our strategic advantage. In the short-term, it's getting our pricing right and our discounting under control.

I guess, lastly, just looking at your cost structure, you guys have been chipping away for five years. How much is left there? Assuming volumes are kind of where they are and pricing you can move up maybe a couple hundred basis points a year, I mean, how much is left from a total cost perspective, over the intermediate-term, that remains an opportunity for you?

I don't think I can quantify it for you, John, but let me put it in perspective so you can think through it yourself. What we've really focused on, if you look at the last two to three years, is reducing the costs, what I would call the back-office costs. We've focused on the system, the processes; we've focused a lot at headquarters and some of our management structure. So most of the cost savings we've chipped away has been there.

I think, not to look at it from a cost-saving perspective, but if you think about being a great institutional company, we are in the midst of developing better ways -- we're taking our best practices that exist today and finding ways to implement those throughout our system, so looking at the best way to manage a fleet, the best way to manage centralized care, the best way to staff our funeral homes. So as we begin to implement some of these metrics, I think you'll see an increased efficiency as it relates to how we serve these customer segments. So, that, to me, is the next piece of the puzzle that we will begin to work on in 2006 and probably work into 2007. It requires a different level of discipline, a different level of communication than we've done in the past, but we see further efficiencies as it relates to improving the service associated with the customers that we serve.

Robert Willoughby with Banc of America Securities.

This is Matt Jackson for Bob. A couple of brief questions -- on the share repo front, do you expect to complete the current authorization by the end of the year?

Well, it depends on how many blocks will be available to us and how many days we will be able to be in the market. We've $85 million left and if you just did that through your normal daily volume limit, under (indiscernible), you probably wouldn't be able to complete it. However, if blocks are presented to us at a price that we feel comfortable with, it is possible we could.

Okay. Did you have any other updated comments on '05 guidance? Do you expect to give '06 guidance on the Q4 call -- preliminary '06 guidance?

Yes. We don't have any updated guidance. I think, in Jeff's comment, he mentioned that we are very comfortable with our cash flow performance year-to-date and we expect to be at the upper end or slightly exceed the previous guidance.

On the 2006 front, it would be our expectation to give you that guidance in our Q4 call, if not sooner, to be quite honest.

Lastly, could you attempt to quantify the EPS impact from hurricane exposure in the quarter?

Yes, I think we believe that hurricane exposure had about a 1.1 to $1.2 million impact on our bottom line for the quarter. There were other things that were bigger impact items; that's why we hadn't mentioned it, but both Katrina and Rita had an impact on our business and probably more importantly on our employees, and we've had quite a few people affected from these. Actually, Rita was probably a larger impact on us as it impacted our Port Arthur markets and Beaumont and folks in that area. So, it has been a big distraction and obviously a burden on our employees. From a financial perspective it's about 1.2 million.

Tom Bacon (ph) with Lehman Brothers.

Yes, Tom, you had mentioned that you think you are pretty successful in terms of winning share at the local level and also the references to the discounting in the Q, so the discounts were at a local level. So, could you talk a little bit about how you balance between market share gains and pricing when you do take the pricing up into -- higher in the organization?

Yes, Tom. First of all, I think what I said, just to clarify, we think the preponderance of the volume increase relates to a number of deaths in markets. So guess what I'm saying, generally, we have a real hard time defining on a national basis what's market share gains because it's really good national statistics. Our feeling is we're seeing other competitors that have large networks with similar types of trends.

So our first comment would be I think we are -- for lack of a better way of describing it -- enjoying a high-volume of year. Having said that, I know, from going market to market and what I see, that we are competing more effectively. I've got to believe, over time, we will do better.

To answer your specific question -- and it's a good one -- I don't believe, personally, that one has to do so much with the other. As we looked at our segmentation, we believe about 20% of the United States or 20% of our consumers have a heavy (indiscernible) and the primary driver being price. This typically isn't business that's very profitable for us. So, we think a lot of the pricing, or I should say the discounting issue, has a couple of things happening. One is we haven't given people a real strong opinion and trained them in the fact of what is good discounting and what is bad discounting. So, shame on us; we've got to do a better job and put some controls in place.

Also, I think a big piece of this has to do with the consumers' lack of value that's placed on the product side. If you've got products -- a lot of money put on the product side and not enough money on the service side, which is historically what has happened in this industry, this will happen. So, in certain markets where we made the shift, we are seeing people absolutely embracing our product and our services; we're not seeing negative volume trends where we've made the shift, so we feel pretty comfortable, with the actions that we've taken, that Q4 will see a much a better funeral average trends and beyond it will be a lot easier because we will have centralized control around pricing. I think that's important.

Right now, our senior management is spending a lot of time dealing with discounting without what I would call adequate centralized controls that help them do their job easier. So, we will have those in place in early '06, and this will become, I believe, less of an issue.

Hopefully that answers your question, Tom.

Is that kind of like they are basically discounting the caskets but they are not taking the pricing up on the other services, so they --?

Yes, we can't take it up. It gets back to when we put that price in front of the consumer, we honor the price. The problem is the pricing is wrong. The consumer doesn't see value in the product side and therefore, we've got to put the pricing on the side that they see value. If we are at a great location in the middle of town and we've got a very fine facility, that's what we should be charging for and not for a particular casket or a particular vault because, again, I think they see commoditization on the product side and services where we really differentiate ourselves, I believe, in the market place. So, that's what's happening. I think you'll see lesser discounts as we get our pricing right and then as we institute some rules around discounting and even particularly within our Dignity packages, which are aligned, by the way, with what our consumers tell us, then I think you'll see the pressure somewhat come off that funeral service average.

We are already seeing, and I mentioned before on the call, October -- after we've had some of these things in place, we are already seen the fruits of our labor. We are up somewhere in the neighborhood of between 3 and 4% for the month of October, so a great trend reversal of what we saw in the third quarter and actually in the second quarter, too. So we're seeing our plans take hold and very pleased with it and not only point out that I think, as a long-term solution, we've got to utilize technology and centralized controls to really manage this appropriately as we go forward.

In terms of the segmentation product -- project -- is that Bain (ph) project all done now at this point, or --?

Well, the first phase is what we wanted to do, which was four months in helping us look at segmentation and other things -- is completed. We are very pleased with the result. You know, now it's a lot of hard work but I think, again, it gives us a way to go forward with our strategy, which historically -- and I think a lot of the things we are headed towards, Tom, are correct and what this helps us do was, one, see some things maybe we didn't see before. Generally we were headed in the right direction, but now I think what's nice about this is we've got a strategy that's based upon fact, based upon a scientific method, as opposed to -- historically what we tried to do was just gut, and our guts normally have been pretty correct. But it helps us I think sell the story and the strategy a little better by basing it upon fact and having, again, kind of a formula for success. So, we are very pleased. I think a lot of the impact is probably beyond 2006, but we should begin to see some of the impact occurring in the 2006 as we implement some of these strategies and plans.

Okay. You also said that the free cash flow was helped by better net trust fund withdrawals. I mean, is that just sort of harvesting of preneed contracts that have been in the backlog for longer so there's higher associated returns with those?

Well, I also think it has to do with the process. Another piece to this is, as you will recall, one of our improvements was a new standardized system, HMIS, which we implemented. HMIS gives us better information to make more timely withdrawals and deposits where, historically, we made have to use estimates or use information from a variety of systems. So part of our improvement relates to better, more timely information as it relates to the trust process.

Jeff, would you add -- (multiple speakers)?

yes, I think that's essentially correct.

Okay. Also, as far as the penetration of the Dignity Memorial packages, do you have a figure on that for the quarter?

Sure. The Dignity Memorial package for the quarter Q3 2004 was 17.2% of the contracts we service were Dignity, now 20.1%. So, we've had a very good uptick as it relates to that blended average. I think, on the preneed backlog front, we are growing similarly, seeing improvements in there. So, we feel very good about Dignity. Our customers like it; they are utilizing -- the utilization of the ancillary products is up quite a bit. The field is embracing it. The one thing I think is muting some of the impact that's disappointing is the things that are happening around discounts. We think we have some plans in place that are going to take care of that in the fourth quarter, and again, longer-term solutions to take care of 2006 and beyond.

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

Jennifer Childe with Bear Stearns.

I just wanted to clarify -- you said that your average revenue for traditional service was up about 1%? So does that suggest that your revenue per cremation is down?

Let me try that one, Jennifer. Again, we're trying to search the data for a hard member for you.

No, I thought I heard you say it was -- your traditional was down $20.

No, I think what I said about the $20 is discounts have impacted the average year-over-year negatively to the tune of about $20. As you think about traditional pricing average revenue for the quarter -- and let me make sure I'm doing this right, Jen -- traditional internment average is up 1%, okay? (indiscernible) correctly from what I can see.

On the cremation front, it's actually up -- if I'm reading this right -- 3.3% as a blended cremation average.

What I told Chris is I thought I was up 1% but I need to run the calculation and come back again, Jennifer, and verify that number. We did cut some stuff roughly, but we don't have it in front of us in terms of the cremation as well.

Okay, but you think that both are up and it's just the mix that caused the total figure to be flat?

Well, you've got mix and you've got the preneeds going atneed, which I think I mentioned before is down about 2%, quarter-over-quarter, so that's a big piece of it, too, Jennifer.

Okay, that's what I wasn't including, okay. In terms of the increases that you're seeing in your merchandise costs, can you quantify that? Does it include caskets, correct? Because your prices are locked in on your caskets?

Correct. We actually have, within our contract, a cap on the increases that can occur for casket distribution, which is in line with what you're seeing -- generally inflationary costs. I think the others are experiencing worse, probably, because I know the cost of manufacturing caskets has gone up as it relates to particularly the raw material costs.

What I mentioned before I think was specific to Cemetery, Jennifer, when I talked about merchandise costs. As you can imagine, the cost of cement, the costs of a lot of the products that go into making vaults, for instance, have gone up dramatically because a lot of that is tied to higher commodities and that's really what I was mentioning on those items.

So, for instance, another big one that you'll see out there is bronze. Bronze is tied to the price of copper, and I will get my percentage wrong but 92% of bronze is copper, so copper prices, which have really shot up year-over-year, again have gone up pretty dramatically. We haven't necessarily been able to pass on those costs to the consumer at this point. So, that has given us a little bit of squeeze on the cemetery side, less of a squeeze on the funeral because of our contract (inaudible).

Okay, that's helpful. Thanks. Just to verify, when you talked about your cash flow being positively impacted by the trust withdrawals, I know that question was already asked, but so these are just normal withdrawals. There weren't any sort of special -- ?

It's just normal withdrawals, Jennifer, and it's only about 2 to 3 million; it's more in the $2 million range for this quarter.

Okay. When you said that you hoped to grow your portfolio, your homes in late '06 or '07, is that through building or buying? How many markets do you think can absorb a new home?

Well, I think the way we look at it is this -- we operate in just the -- it's probably not the best way to describe it because it isn't actually MSAs -- but we operate today in 77 markets. We have a market manager, a market director.

As we look to the future, Jennifer, what we've done is really stratified the United States -- we are in the midst of doing this -- to understand which consumers are where and what consumers line up with the direction that we want to go within these segments. We're doing that sampling as we speak today. But I think we will probably take our 15 to 20 top markets and begin to look at opportunities to buy or to build. Again, I think it really depends upon the type of facility that think we need and the availability of an acquisition candidate.

I don't want to pretend this is going to be -- we're going to turn on some spigot here and begin to pump these out, but begin to strategically select markets to build or to buy. Again, this may be associated with a customs-conscious type of consumer, whether it be the Hispanic market, Asian, Jewish, African-American -- looking at those segments where we are underinvested today and begin to grow within those markets and then a variety of other segments that we may want to pursue. So, it will be up build-or-buy strategy. I think you'll see more builds than we've done historically. In other words, buying isn't the only way to enter a market, and it will be a very centralized approach to where we go and how we do it, obviously with a lot of participation and leadership at the local level. But it's for us to say what markets do we want to be in and let's focus there, as opposed to what comes available is the way I would describe the difference in approach.

Historically, how many homes have you build per year?

I'd say, over the last few years, anywhere from three to five, in a big year probably six or seven. I think, again, you'll see that number increase as we go forward and hopefully you will begin to see us also do some limited acquisitions as they become available at reasonable prices in the markets that we want to grow in.

Mike Scherangelo (ph) with Merrill Lynch.

Good morning. Just looking at your cash balance, it's obviously grown significantly over the last year, which is a nice problem to have. I know you have 85 million in your share buyback left, which you will use some of that cash but you're also going to build cash it sounds like. The question is, at this level of cash, I mean this isn't a little cash; this is getting to be big number. Do you feel compelled to start to think about, okay, well we need to think about either a really big share buyback or a really big special dividend, a big M&A deal? Do you feel like you need to think differently about how to spend this cash?

I think the 492 million will go down as we go towards the end of the year. We have a lot of our interest payments in the second and fourth quarters, so that 9/30 balance you're seeing doesn't reflect necessarily the interest payment. It's obviously accrued throughout the year relatively equally, but it isn't paid, necessarily, equally.

Then in addition to that, we have the existing share buyback that will come out of that, plus we have about $70 million, maybe a little more than that, of debt maturities yet this year. So I think our view is at the year end, it may be a little stronger than this but it will be somewhere in the $300 million plus or minus range, probably plus is probably more likely than minus at that level.

As we've always mentioned, we want to keep about $100 million of extra cash on hand just to make sure we can meet any contingencies. So the amount we're probably dealing with is closer to the $250 million excess beyond what we would want to keep traditionally. We need to think about the various options we can do with that because I don't think it's so large that we have to take precipitous action.

I think, in answer to your question, Mike, just to add to what Jeff is saying, we're looking to grow again and so we're going to probably spend some money on doing that as things come available. In addition, I think we've already exhibited our willingness and our want, I should say, to distribute money back to the shareholders. So, we've implemented a dividend, a quarterly dividend, very recently, within the last year; we've also, I believe, done to date $315 million of share buyback, and that's really over about a 14-month period, some of which we've been out of the market for obvious reasons.

So, we see -- I guess at this point, it doesn't make any sense for us to launch any kind of big tender offer for our shares or look at a special dividend. But that's always in the back of our minds as we look at alternatives. If we get to the point where we don't think there's opportunities to grow, clearly those are things we would examine and discuss at the Board level.

Tom, do big M&A deals have any appeal at this point or do you still feel like you would just rather grow your own business organically?

Well, I think the best thing we can do -- the biggest opportunity we have is within our own business with smaller add-ins. We obviously, if we think we can run things better than others, which clearly we do, particularly in the long-term, it makes sense to have scale. So, would we look at something? Obviously we would look at something. I think we've just got to weigh what's happening internally within our organization and the value of expanding the network. So yes, I think it's something we always would consider, but it really isn't the driver of value. We see the driver of value being implementing this strategy and showing the shareholders what we can do to differentiate ourselves, which I don't think we've done.

So, to the extent we can do that and people can look at additional outlets and say now I understand incremental value -- so I would put it that way -- that let's focus on making a better mousetrap and then to the extent we can add scale, there's more value for everyone.

Great, that's helpful. I don't want to belabor the discounting point too much, but I was curious. Do you have a sense as to whether this is happening more on the preneed or the atneed side. First question.

The second question is do you know why your local guys are doing it? Are they responding to their competition, or do you think they get the sense that they should be incented to grow volume regardless of the economics of that volume?

I really don't think discounting drives volume. You know, most of this discounting -- from the preneed basis, you could make an argument that it does. By the way, we're seeing it in both preneed and atneed.

But I think, to answer your question, we're not driving volume by doing tremendous discounts and I don't think anybody believes that. I think a lot of this, again, has to do with some of what's happening on the product side; as the products go into more commoditized, as consumers have an opinion about what products should cost, we are finding that, again, our pricing is not right. So, we are fixing some of that pricing.

The other thing that I think occurs without any kind of rules of the road, which we don't have on a national basis -- people tend to do what feels right in a situation. So, we've got consumers that, above all, value quality and aren't looking for a discount. Everybody will take a discount, but a lot of it has to do with how you present and what you believe about the product that you are presenting. So part of it is probably a failure on our part as it relates to training and controls around that. So I don't want to pretend there will be no discounting -- of course there will be -- but I don't believe discounting drives volume. I don't think any of our senior management believes that. So, I think this is really a function of adding a level of education and discipline and controls around an area that, quite honestly, has lacked some of that. So we see it as a win-win, and of course, we will have some strategic discounting that makes sense, but again, that will be for the consumer to value discounts.

Okay. The last question was on Kenyon and your involvement in Louisiana. There was some press a few weeks ago that was less than favorable about expenses that you guys had submitted to Louisiana. Do you think there's any implications of that for you in terms of getting paid on that contract, or in terms of future business for Kenyon? Because I know it was a big help to you in the quarter.

We are in complete compliance with the contract. I think the article was not very well-written. A lot of times, you don't get a chance to rebut but we feel very comfortable that, number one, the job that our Kenyon employees and some of our employees of SCI that are working with Kenyon are doing is absolutely tremendous. We have done -- we really have led the effort to make that better and there's been a lot of roadblocks along the way.

As it relates to some of the expenses, again, they can get exploited. You know, buying a lot of beef jerky -- these are people that are working 15, 16-hour shifts, living in the tent in 100-degree weather that don't have any way to refrigerate food. So, what are you going to eat? By the way, there's no restaurant open, either.

So, you've got to put it in perspective, and you've got to understand what's behind it. We actually have a rebuttal for each one of those charges. I'm not going to get into it. But we feel very comfortable that our employees have acted professionally, that we've complied with the contracts and in no way should this have a bearing on what we're doing for the State of Louisiana or anybody else.

Okay, thanks a lot, guys.

Dana Walker with Kalmar Investments.

Well, I hope we end on a high note. The profit impact figure that you talked about from the hurricane of being 1.1 million or 1.2 million, would that be an operating-income number or net after-tax number?

It would be an operating income number, pre-tax.

As you talk about better regimenting your price list in the funeral home, I believe you're in the process of rolling out to markets a price list that better favors services. Can you talk about where you stand with that and whether that is primarily responsible for the improved pricing traction in October?

I think it's a piece of the traction. I mentioned before that our operating management has made this a top priority to address, and I think at the very senior level of the organization, with Steve Mack (ph) and Jay (indiscernible), I know they are talking about this formally every week and informally probably every other five minutes, so I think their attention and their infrastructure's attention to this detail have been a primary driver. But that shift is having an impact in the markets where we've implemented it. I believe we are in approximately 12 markets out of the 77 where we have made the shift in the pricing. We are seeing very favorable results.

We are going a bit slowly on purpose because we think it's important to understand the theory behind the pricing as opposed to changing the price list. So we're going market-to-market training folks, selling the concept, and getting that buy-in. We believe we will be in 25 markets by the end of the year, and then the remaining markets will be done in the first half of 2006.

The cremation percentage figure, which crept up at a higher than year-to-date pace -- do you have any color on that, or is that just too amorphous a figure to comment on?

We really don't, Dana. We saw a trend which was much lower than that -- for example, our last conference call, I think the second quarter, was much less than that; the increase I believe was like 0.7, 70 basis points for example. It just hit us in third quarter to be more like 140 basis points.

It's hard to determine. You see blips like this sometimes in your mix. It wouldn't be unusual when you had a blip in the third quarter like that to see the fourth quarter kind of throttle back a little bit. But it's too early to comment. It's 90 days worth of information, so I think it's too early to comment whether that's a trend or not.

Are you able to isolate any geographic trends, though, that make any sense or do you not have that type of color at this point?

We do, but there wasn't anything unusual when you looked at it across geographic areas.

Two last questions -- the G&A level that we've seen year-to-date, given some of the unusual spending related to the reconciliation and to Sarb-Ox -- as you look to '06 and '07, do you think this is a level that you ought to be able to sustain, if not improve upon, or are there to be inflationary pressure on G&A as well?

Over time, we should be able to improve on it.

Yes, I think, as we look to the fourth quarter and probably even in the first quarter next year, Dana, you know, we are still dealing with the same issues so the spend ought to be pretty consistent. Then we like to believe, with a much better report card to have in March of 2006, and again a year behind us on how we do this, that we can begin to manage some of those costs down. It's real hard to predict how much or how fast but surely a continued trend through fourth quarter and first quarter.

But you believe that the absolute level of spending rather than just on a percentage basis could trend lower over the next couple of years?

Correct.

The final question relates to free cash flow. You talked about the -- I think Eric chimed in about the immateriality of the cash flow effect on that. Is there anything in your judgment that's affecting free cash flow this year that you would consider to be anomalous and thus not suggestive of where you ought to be, plus perhaps some ongoing improvement in '06 and '07?

I think there's two things to keep in mind about our cash flow as you look further, particularly as you get out a few years. One, we're not a cash taxpayer, so keep in mind that won't be forever. Most likely, it will be the end of 2007 or potentially deferred I guess to the beginning of 2008.

As the other thing that I think is important to understand is we have commitments, covenants not to compete, that we entered into in our heavy acquisitive day. A lot of these covenants paid out over five and ten-year periods. If you think about the height of our acquisition activity, it was probably in the '95 to '98 era, particularly '96 to '98. So, as these ten-year payout contracts lapse, we have cash commitments that trickle down pretty aggressively, particularly as a get out to 2007 and 8. So, that will help offset some of the negative cash flow impacts that will occur when we become a cash taxpayer.

Otherwise, I think what we are seeing is improving trends in cash flow. A lot of times, we drive that by saying we are reducing interest costs and that's true. The other thing to keep in mind is a lot of that interest cost is being driven down by the fact that we are selling businesses. So, the businesses that we maintain are improving the cash flow characteristics associated with them.

We do believe, however, though, we've seen some working capital improvements over the last few years that probably aren't sustainable, so again, those will flatten out some. Those working capital improvements will shift, because predominantly they've been associated with receivables. I think there's still some work we can do on payables and inventory, stuff like that. But that hopefully gives you a general favor about how we feel about cash flow.

Jeff, do you --?

The only thing I would add to that is that, in 2006, we have an anomaly that we expect -- that relates to our long-term incentive plans, where we will be paying out, hopefully, depending on year-end values of our stock price relative to others, a fairly sizable cash payment that should not repeat on the same level going forward.

True.

By the way, looking at your gross margin percentage in the funeral home, which was softer, you described why it was the case in Q3. I presume that the steps that you talked about to tighten up cost management as well as some of the hoped-for full-quarter and perhaps full-year benefits from pricing, prospectively, ought to tighten up that whole gross margin comparison. Is that a fair expectation?

I think it's fair, and also keep in mind that it's a very seasonable business, so the third quarter would be our lowest margin, so fourth quarter ought to improve simply by the fact that it's a better season for the funeral business. But your point is exactly right; you ought to see some revenue improvement, I hope. Again, we are going to continue to monitor costs in the fourth quarter. I don't think there's much we can do about energy, SOX and to a lesser extent, fringe, because, again, healthcare costs continue to rise. So I don't know how much on the cost side we can do other than the things that we can control.

If you look at the 10-Q we just filed, you'll notice that the year-over-year change in pension costs, which are not a cash cost but they are a P&L cost, are roughly $7 million on the year-to-date basis. That isn't because our pension plan is performing poorly; it has more to do with the actuarial assumptions changes, year-to-year, but $7 million is a fairly significant number for us, if you think of our costs on a year-to-date basis.

Would that primarily hit you in the funeral home segment?

No, both.

It's a portion.

Okay. Thank you very much.

Thank you. That concludes the question-and-answer session on today's conference call. I'd like to turn the call back over to the management team for any final remarks.

This is Tom Ryan. Again, I want to thank you for participating in today's call, and we will be talking to you again with our fourth-quarter results in the early part of 2006. Thank you very much. Talk to you soon.