Service Corporation International (SCI) 2005 Q4 法說會逐字稿

Good day, everyone, and welcome to the Service Corporation International fourth quarter 2005 earnings release conference call. As a reminder, today's call is being recorded.

At this time, I would like to turn the call over to the management team of SCI. Please go ahead.

Good morning. I'm Eric Tanzberger. On behalf of the entire SCI's management team, I would like to welcome your to our 2005 earnings and 2006 outlook conference call. We'll have our standard remarks made by Tom and Jeff, and then we'll follow-up with the Q&A session.

I'd like to remind everyone that we will have forward-looking statements made today on this conference call, which we, in reliance on the safe harbor protections, provided under Private Securities Litigation Reform Act of 1995. These statements made by us today may be accompanied by words such as believe, estimate, project, expect, and other words of similar nature that convey the uncertainty of future events or outcomes.

We believe as management that these statements are based on assumptions that we believe are reasonable. However, many important factors could cause our actual results in the future to differ materially from the forward-looking statements that we would make today. I will refer you to those important factors in our filings with the Securities and Exchange Commission, which are available on our website free of charge, at www.sci-corp.com.

With that, 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 categorize my comments, really, in three different sections here. One, I'm going to begin to talk about 2005 and kind of step back at a glance on the year, the good things, the bad things. Then I'll review quickly the fourth quarter of the funeral segment and the cemetery segment. And then lastly, I'll give some comments as it relates to our 2006 outlook by business unit as well as cash flow and capital structure and the like.

So to begin with, as we step back and look at 2005, there are two things that we're generally very pleased with. The first one you'll notice is operating cash flow improvement. You'll notice that on a normalized our operating cash flow is up about $25 million or about 9%. That's a good thing for the year. I think we have a lot of positive momentum in that area. Secondarily, our comparable funeral revenues were very strong this year, both the volume and the average. Our comparable volume was up over 3,300 calls or about 1.4% for the year, and our average, we really finished the year strong in the fourth quarter, ended slightly over $4,400 and up $93 or 2.2% for the year.

Another very positive item for us was our cemetery sales production. Even though our GAAP revenues are down -- I'll get into that a little as we talk to the quarter -- our production -- sales production for the year was approximately $512 million, up over $24 million, and that's slightly higher than the 5% improvement year-over-year. So as you think about production, some of it gets recognized, some of it gets deferred, but at our core level, we're increasing sales on the cemetery side of our business.

Another item, I think we miss not to mention, the improved control environment. We spent a lot of time, a lot of effort, a lot of money in order to get to where we are today. But we're very, very pleased to tell you that we passed SOX 404, we got no material weaknesses to report this year, a dramatic improvement over the prior year. And lastly, and very important to you, shareholders, we've returned a lot of capital to shareholders. If you go back to the fourth quarter of 2004, since that time period of time, we spent over $350 million between share buybacks and initiating a dividend in returning cash to our shareholder base.

We're pleased as we look at 2005 for those accomplishments. The things we're not as pleased about were the cost to improve the control environment. Like I said before, we've spent tens of millions of dollars on SOX, on trust verification projects. The good news is we've got a greatly enhanced controlled environment. We've got better data, we can run our business better, so a great investment, but a costly one.

Secondarily, we bore the brunt of increased energy costs and increased healthcare costs. These are things that most companies around the country are feeling the pinch of, but again, I think we miss not to mention them, because they did have impacts on our margins. And lastly, we're not as pleased with the preneed funeral production. It was essentially flat. It was actually up $4 million to about $318 million of production. But that's not where we wanted to be. And that's an area that we want to focus some time and attention and resources to improve.

So that's my comments for the year. Now I'll move into the quarterly analysis. And if we look at the funeral segment, funeral profits for the quarter were up slightly over $10 million or 230 basis points, and our funeral margins moved to 18.7% for the quarter. This was driven by comparable funeral volumes that were up again 1.8%. We've seen this favorable trend throughout the year. So we are very, very pleased to continue to see it.

Having said that, we truly believe that there has been an increase in deaths really across the United States, and particularly in our markets, and that's probably what's driving the customer volume increase. Having said that, we also believe -- and we know for a fact -- we are competing much more effectively today than we were even a short few years ago. By having the consistent accountable operating structure in place since November 2003, we do believe we're competing more effectively in those markets where the increased deaths are occurring.

Additionally, our comparable funeral average had a very healthy increase, 4.8% in the first quarter. You will recall, we had challenges that we discovered in, really, August and September that we communicated to you last time, and we successfully managed those trends that we saw in late August and September, dealing with the discount issues and also implementing our strategically aligned pricing, which as you'll recall, took pricing really off the product to where the customer perceives the value on the service side. And again, that has some related reduction in discounts.

We also saw some higher trust fund increasing in the fourth quarter. We continue to see our Dignity take up rate go up. And this all was also absorbed in unusually large increase in the cremation mix change. It's actually up a 190 basis points for the quarter, which was a lot higher than we had anticipated.

For the most part, funeral expenses were in line with our expectations, other than higher allocated home office costs associated with Sarbanes-Oxley compliance, as well as the final remits of the trust verification projects and the like. So those costs that we report of that run off also impacted our margins. On the cemetery side of the business for the fourth quarter, when you look at this at first glance, you would say that the gross profits appeared disappointing when compared to the prior year. And actually, they don't. I'd say that it was about what we expected.

Now let me walk you through that a little bit. On the revenue side for the quarter, our sales production -- cemetery sales production was up $6 million or approximately 5%. Unfortunately, legacy revenues -- and you'll recall legacy revenues are revenues that we record in a year that the selling activity occurred in the prior year because, remember, the accounting rules require us to have develop or build that project. So again this is production from a prior year that shows up as recognition in the quarter. But that was down $7 million in the quarter year-over-year.

Another unusual item happened in the quarter, which is, as you recall we changed our strategy in how we build cemetery inventory properties. We are shortening the amount of time between construction and sale. And so in the latter part of last year, we build a lot of available inventory. And some of that stuff we've sold in previous quarters. So the fourth quarter had a large recognition of items that were sold in the first, second, and third quarters of last year was approximately $14 million of revenue recognized in the fourth quarter that related to sales in previous 2004 quarters. So an unusual item that shouldn't occur, because now we've got adequate inventory that we are selling and recognizing in the same period, because we've got a lot of inventory on hand.

So as you look at the quarter, total revenues recognized were down $3.1 million while fixed expenses grew $7 million, mainly related again to the SOX and trust verification project. I think the easiest way to kind of step back and understand cemetery is to look at the whole year. So let me walk you briefly through that. I think you get your head around how the margins should look in this business, how you evaluate success or lack thereof -- has been report.

First of all our cemetery sales production for the year, as I mentioned before was up $24 million. Very good performance. Unfortunately, and again, we anticipated this and communicated that was offset by a reduction of $21 million associated with these legacy revenues. So again you're looking at flat GAAP revenues, strong on the sales, reduced on the legacy side. That legacy GAAP is going to begin to go away. So you've got flat GAAP revenues, expenses grew by 4%, a little heavier than normal because of the SOX and trust verification project as well as limited energy and health care cost increases.

And therefore you saw a reduction in margin year-over-year. So as you think of the future, expenses are going to grow somewhere in the neighborhood of $12 million to $15 million, to the extent we can grow our revenues more than $12 million to $15 million, you will see our gross profits to go up. To the extent we can't cover those, and obviously it would go down.

I refer you that our cemetery sales production is up $24 million. So as this legacy issue works its way through, we expect cemetery margins to begin to inch forward if we can maintain the level of performance in our cemetery sales production line. So hopefully that clarifies a little bit about where we think our cemetery segment is and how you view it as we go forward.

Lastly, let me turn to 2006 outlook. As we look at our expectations for funeral in 2006, we would expect comparable volumes to move slightly down. And again that's more based upon historical trends as opposed to anything we see negative within our operations. We have the first year and I guess 10 years of comparable volume improvement, so it's clear that that's going to continue to go that way. January we did see trends continued to strong, February we are seeing a slight drop off in volumes, preliminary that we have seen. We would expect, I think, the country; I heard one statistic that in the Northeast was the warmest winter in 100 years. So again good January not so great February as far as funeral volume to that.

We also would expect continued increase in our average. We believe that the strategic pricing shift that will continue to our current will have an effect in 2006. We expect our dignity take up a rate to trend. I'll say it's going to be offset somewhat by cremation, make a change as well. We would expect an improved cost containment environment. We don't expect to spend the same amount of money on SOX in 2006, within 2005. In addition to that we're in the midst of implementing operating standards that will help us be more efficient in how we manage our businesses. And we begin to see some impact that 2006. Having said that, the trends show us that health care cost will continue to rise. We've anticipated that increase to be 10% to 12% for 2006.

Returning to the cemetery segment our expectations for '06 would be that we'd see continued improvement in our sales production, mentioned we were up 5% this year and again we would expect to continue trends such as that we're looking for 2006. We also would expect a very slight reduction in our legacy revenue recognition. The year-over-year delta is very small; it's not anything near to $21 million that we experienced in 2005 versus 2004.

Then on the cemetery side we would expect pretty normalized inflationary cost increases. This should result in a modest margin improvement in both sides of our business. As we look at our expectations for operating cash flow in 2006, I think it's important to put it in perspective, apples-and-apples as look at cash flow. There are two kinds of unusual anomalies' when you look at '06 trying to compare back to '05.

The first one is we have moved assets that were formerly under operating lease into capital leases, which requires us now to put the assets on the balance sheet and also put the debt on our books. We did this for a variety of reasons that Jeff will go over in his comment, but what it does is it increases your operating cash flow by approximately $20 million. That will have an impact in 2006. That's somewhat offset by an unusual cash long-term incentive payout that occurred in February of '06, up approximately [$16] million.

You may recall that long-term incentive for the executive management team was a performance unit plan 2003. And it had a cash payout that occurred in February of this year. The stock performance over that three-year period was 149%, which put us in the top portal of the peer in that analysis and therefore had an unusual payout. And again, because it was the entire long-term incentive, it was the number that they won't be replicated in the future.

Operationally if you take those few items and say they offset, from an operational cash flow perspective we expected to be relatively flat. What that is comparable operating cash flow improvement in our business; call it $20 million to $25 million. They will be offset by working capital deceleration. Let me explain that. We've had real improvements in our collections in AR both in the trust side and on the collection with the field level. As an example, our days sales outstanding were down somewhere in the neighborhood of four days over the last year. We are expecting continued improvement, but not at a four day clip, maybe around the day clip. So this deceleration of collection if you will -- will have approximately a $20 million impact both from the customer field level as well as money that we would pull out of trust.

So that we see operating cash relatively flat year-over-year. Next, if we take a look at CapEx, we expect there has been total CapEx of between $105 million to $120 million. Approximately $50 million of that CapEx relates to repairing roads and cemetery, fixing roofs in the LaGrone funeral homes, but that all through maintaining the existing assets that we have. We're going to spend another $40 million to $45 million on developing cemetery property.

And lastly we'll spend some more between $50 million and $20 million in constructing new funeral homes. That gives you the components of what we plan to standard it how over years. In addition, we have about $20 million of debt maturities that we would anticipate payoff with cash. And obviously, we expect to continue our dividend, which would be at least $30 million as we look out in 2006.

After funding, the things I just mentioned, the remainder we will take and we will seek to invest in higher returned growth opportunities, either through acquisitions, through new builds to the extent those can available, based upon our expanding this footprint, strategy that we have now. And to the extent those opportunities aren't available we will continue to buy back shares.

We view the company as being under leveraged at this point in time. We've talked before about appropriate capital structures, and today is our belief that we would reduce the outstanding equity with cash that we can't use to improve the business.

We also mentioned this last time, as I look into 2006, we'll be working diligently on our long-term strategy. As you'll recall from pervious conversation, it's built around really three items. First, is customer segmentation and beginning to view our customers in a way, and therefore, align our products, services, delivery, training, around these customer segments to best serve people align with their wants and needs.

Around that customer segmentation, we're going to continue to leverage our skill to its fullest potential. We don't believe we've done nearly what we should be doing. So we'll be developing more standardized operating practices and how we run our cemeteries, and how we're run our funeral homes. And we believe overtime, we'll continue to drive improvements in our margin.

And lastly inline with all this, we'll expand our footprint around the two strategy. As we look at opportunities things that will open and help leverage our scale, things didn't match out to be appropriate customer segmentation that we see out there. So this really is a pre-pronged approach that we're going to take as we move forward and implement this strategy throughout our entire network.

So with that I conclude my comments. And I'll turn it over to Jeff, our Senior Vice President and Chief Financial Officer. Jeff?

Thanks, Tom. SCI generated approximately 33.3 million of free cash flow in the fourth quarter of 2005 and 227.4 million of free cash flow for all of 2005. Free cash flow during 2005 exceeded SCI's guidance range, previously provided to shareholders. Free cash flow is defined in SCI's press release issued yesterday relating to our fourth quarter and full-year 2005 financial results.

In the fourth quarter of 2004, SCI's free cash flow was approximately $39 million and free cash for all of 2004 was approximately $205.8 million. In 2005, reduced payroll payments and bonus payments and reduced working capital and interest payments were significant factors in the improved cash flow.

Increased maintenance capital spending in the fourth quarter of 2005 of 3.6 million was a primary reason the fourth quarter of free cash flow was lower than the same period of prior year.

SCI's 2006 guidance press release issued yesterday evening provides the 2006 forecast financial information in the same manner in as we report financial results. And it provides greater detail on SCI's forecast capital spending. Effective January 1, 2006, SCI's amended its transportation equipment leases. As a result, as Tom mentioned, these leases will be capitalized in 2006 and this will add approximately $83 million of debt and assets to SCI's balance sheet.

The primary reason we chose to do this was to improve transparency, and also, in addition to that, I think, it will help us with our credit rating agencies in terms of formulating the amount of debt that we have on our balance sheet as a result of these particular leases. There is no meaningful impact of this change on net profits. As interest expense and depreciation expense will offset the rental expense avoided.

As mentioned in our 2006 guidance press release, operating margins and EBITDA will increase as a result as well as cash flow from operations due to this change. However, as Tom has explained, other items offset those matters.

Under SCI's Board authority, we had a currently, approximately $65 million of approved SCI's stock repurchase is yet to complete. Debt maturities in 2006 are modest in amount and I'd expect debt reduction of approximately $20 million to $25 million during 2006 assuming those debt prepayments and ignoring the capitalization of the transportation equipment leases.

Despite the 187 million charges related to the change in accounting group deferred preneed selling costs and the $325 million of share buybacks, SCI maintained a total debt-to-capitalization ratio of 43% and a net debt-to-capitalization ratio of 32% at the end of 2005. Total debt was approximately 1.2 billion, and net debt was approximately 750 million at year end.

As reported on page 2, of our fourth quarter press release, the fourth quarter of 2005 funeral preneed recognized comparable revenue was $90.2 million. And nearly half of that or approximately 43 million is attributable to trust contracts. This 43 million amounts includes approximately 8.3 million of accumulated trust income related to these contracts. The remainder of the fourth quarter, funeral preneed recognize revenues is from insurance contracts, which included increased debt benefits of approximately 2.6 million over the face value of such insurance contracts.

Of course, our insurance contracts pay SCI at 10 to 12% net commission on the face value of the policy upon sale, while there is no such cash return to SCI on the sale of the trust contract. The fourth quarter of 2005 cemetery recognized revenue included 3.1 million of trust earnings from cemetery merchandise and service trust and 6.9 million from trust earnings from endowment care trust.

General and administrative expenses, when adjusted to exclude litigation-related costs increased $15 million in 2005. This was primarily attributable to costs associated with increased accruals, SOX 404 cost, and the cost of the second quarter financial statement, which related to the trust verification project, other being in other professional fees.

The effective income tax benefit for the fourth quarter of 2005 was equal to 26% of the fourth quarter pre-tax income. This lower tax rate is due primarily to adjustments related to valuation allowances associated with state and local tax loss carry forwards. We believe a normalized 35% effective tax rate was appropriate for the continuing operations during 2005.

SCI's $2.8 billion of funeral, cemetery and merchandise and endowment care trust had good performance in the fourth 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, Canadian trusts, and trust that have been invested in life insurance policies.

For the fourth quarter of 2005, the funeral trust had a return of 1.84%, the cemetery and merchandise and service trust had a return of 1.94%, and the endowment care trust had a return of 1.18%. For the same quarter, the S&P Index had a return of 2.08% and the Lehman Brothers Aggregate Bond Index had a return of 0.6%. On a relative basis to similar portfolios, the performance of SCI's trust was acceptable.

During 2005 SCI's funeral trust had a return of 6.58%, the cemetery trust had a return of 6.88%, and the endowment care trust had a return of 3.85%. The return of the S&P 500 Index for the year was 4.91% and the Lehman Brothers Aggregate Bond Index was 2.43%. In addition, the current market value of our trust's portfolio, at the end of 2005, exceeded our cost of the investments in those trust by approximately $83.4 million.

With those comments, Cindy, we'll now go to the question-and-answer phase of the call.

[Operator Instructions].

We will take our first question from AJ Rice of Merrill Lynch.

Hi. Good morning, everyone. It's actually Chris Rigg filling in for AJ. My first question just deals with the acquisition environment. I was wondering if you could talk a little bit about, sort of, the perpetual question we have about acquisition multiples of what you see? And also if you could provide some color in terms of are there any larger pools of assets out where you could deploy more than just $5 million or $10 million at a time, because given the cash is building on the balance sheet, it looks like a more sizable transaction could be appropriate at this point?

Yes, Chris. This is Tom. I think, generally, like everything, time cures all. I think having patience -- my observation is a lot of the big consolidators are, have been working very diligently on improving the businesses that they own. And by taking this patient approach, you're beginning to see people they want to sell, if they really want to sell than the market will allow it to occur. You know, what happened before was there's a lot of deals forced to happen because of the aggressive environment is happening.

So as time goes on we're seeing deals from time-to-time. We actually close the deal, I think, yesterday, the day before in Georgia. We're talking to a few folks right now. So we're seeing it pick up a little, but again, I think it's a very seller driven advent as oppose to buyer driven advent. And I would expect that to, kind of, continue to trickle. As it relates to the big pools of assets, you know, I would tell you that we're not seeing a lot of that out there right now. A lot of the big regional grow up place that we've seen own businesses that we dispose that were -- just very disposed that ever all that we disposed of and to be quite honest, we're not interested in that kind of transaction.

Okay. Do you --- have you seen any-- do you think at all the, sort of, the income oriented entities out there or real estate place they are keeping some of these multiple tie, because, I think it -- as you guys, you sold some cemeteries to some more a few months ago, and I'm just wondering if guys like that who are less worried about EPS accretion or are in one way or another keeping the purchase multiple, sort of, artificially high at this point?

There could be some of that Chris, but also think both of those entities, you're talking about because of the unique structure they have, they're looking for very specific type of businesses. I think, again, I don't want to speak on behalf of them, but some more, because it's cemetery it's an amount phase strictly looking at cemeteries. It's hard for them to -- because of their structure to look it a lot of inner home opportunities. And so because they are kind of a unique niche of the market that could very well be the case for that niche, I guess, what I'm saying is that niche doesn't necessarily, that where we are looking as we look at segmentation.

so in the areas that we are concern with, we're not seeing in the multiples again you may have a seller that really don't want to sell, because he's not getting to the market price. But we're not being impacted by that I don't really.

Okay. And then I guess -- just a follow-up on, sort of, the cash position. It seems like -- I can't help, but notice that sort of the rate share repurchases have slow down somewhat, sort of, in the last quarter or so. I was wondering how you, sort of, view the share repurchase activity going forward. And you're not that far away from, sort of, finishing off your authorization of $400 million, sort of your thoughts and what do you think the Board might be thinking at this point?

I guess, what I was saying is that we stopped, basically our share buyback program, until we reported our financial results, which obviously are now out. And we'll start to backup at the appropriate time. At the same time, every time we have a board meeting we discussed capital structure, excess funds, and uses of cash. And so our board is very actively involved in the process of making the decisions on those priorities. And as you saw we would've -- should include dividend increases, too.

Okay. And just one last quick one, and then I'll jump off. Can you tell me what your, sort of, your run rate of operating leases is at this point? That's it. Thanks.

Usually it is -- Chris, you're talking about the expense itself as in the '05 financial results?

Well, actually -- you know more on go forward basis, what's that number would be? Just trying to get an idea what -- ?

We can probably get an estimate of it, Chris, but we do not have it right here at the table in front of us. I will say basically it is the primarily real estate at this point, yes, but we are operating business pertaining to -- since we have capitalized the transportation equipment leases for the most part, the bulk of our rentals going forward are those situations where we do not own funeral homes we are in.

Okay. Great. Thanks a lot.

Thank you. We'll move now to Robert Willoughby of Banc of America Securities.

Hi, good morning, this is Matt Jackson in for Bob. As a follow-up to the previous question, what is the amount of share repurchase you have baked into your '06 guidance? Is there any...

Now, we put none in there because we didn't want to have -- try to predict at this point in time. So again, you can run a model with a variety of options saying, at what prices are you buying back? We got simplified -- none in the guidance.

All right. Just making sure. And then secondarily, on the $20 million in debt repayment, can you give us the timing during the year on that? I guess what kind of a debt schedule for the year?

Jeff Curtiss The only meaningful maturity during the year -- we have a lot of really small things in [inaudible] but the only meaningful maturity was the portion of the '07 note that we tendered for and could not get -- I think it is about 11 million on the 20 million, maybe a little more than that. And I can get the exact data on maturities for you, but I did not have again in front of me. So we can give you a call.

Okay. I appreciate it. That's it.

Excuse me. I think it's October, Matt.

October. Okay.

I am sorry, June of '06.

Okay. That's helpful. Thanks Jeff.

Thank you. We'll now move to Tom Bacon of Lehman Brothers.

As far as the priorities from your -- for your cash, I mean it sounds like you are getting a little more optimistic on the acquisition front. I mean do I read that right or --?

Yes, Tom, I would just say that in the last three to six months, we are seeing more opportunities being presented to us at reasonable prices. And again, they're going to -- we would expect that to kind of continue. And again, we also look at -- as we look at our strategic plan, we look at buy versus build. So the way we are going at it now is we're looking at markets where the customer segmentation aligns right with our strategy. And we're going into these markets and looking for opportunities to buy and to the extent those unavailable, we may choose to buy some property and construct a funeral home. So, yes, you will see us investing in 2006, I think, a lot more than in the past, both through acquisition and through build.

And could you -- I mean could you talk a little bit about what your strategy is there? I mean is it sort of ones and twos to kind of fill in holes in your footprint or filling the holes as far as your segmentation is concerned or is it larger regional areas that you need to fill in or is it bigger things where you can take a lot of costs out? I mean how are you looking at those opportunities?

I mean we are looking at basically a return-driven analysis. We're looking at internal rates of returns and comparing against our [VAT]. I would say that I would expect most of the opportunities to come in small bunches. That's just the way these things are aggregated. Most of the regional stuff again is being rolled up. It is probably businesses that don't fit our model. At least that's our general impression. I wouldn't say there wouldn't be any. But more likely than not it's going to be very strategic acquisitions in markets and businesses that we want to own.

Okay. And as far as the CapEx budget, I mean it looks like it is a little heavier this year. I mean do you think -- obviously, you have been focused over the last few years and cleaning up the balance sheet and shedding some assets and getting down to a critical mass. But as far as the assets that you have, I mean do you feel that you maybe have underinvested a little bit and the CapEx could be a little bit higher moving forward or --?

Let me take it, Tom, whereas you [inaudible] it up, because I think there is a little confusion on the CapEx. As you'll recall, years ago, probably right out at 2000-1999, we came up with the concept of free cash flow. And what we did is we took capital expenditures and put them in one of two buckets, maintenance and growth. And the idea was what do we have to spend money on? Remember back then, cash was scarce.

And so we said where we do absolutely have to spend on and what's optional, and that would be cut. So you had what I call true maintenance capital. And then we made an attempt to go in and look at cemetery development, our cemetery inventory development and bifurcate what we thought was needed it, replacement in the cemetery versus growth opportunities.

As we began our internal budgeting process last year, we sat down and began to say, this is a useless exercise. Cemetery inventory is cemetery inventory. We shouldn't be trying to decide -- it's hard to decide what's growth and what's maintenance. So the new disclosure we think is much better in providing -- let's talk about our operating flow. And then we'd spend it now in, what I'll call, a three bucket.

And then beyond that, obviously, we get debt maturity dividends, which are requirements of the cash flow. But if you look at what we anticipate, in 2005, we spent $53 million to, what I'd say, truly maintain our facility. So again, fixing roads in cemeteries, [rouse] our mausoleums, rouse on air conditioners and funeral homes, that's 53 million bucks. We believe that we're going to have about the same amounts in this year as we did last year.

When you go to the developed cemetery property category, we spent approximately $32 million in developed cemetery properties. We think that's going to increase the 40 to 45 million. The reason for that is this. As you'll recall, strategically, we have shortened the timeframe between build and sell. We believe building high-end stuff allows you to sell it at a price that's more reflective of the value.

In the past we got in trouble because we sold off mass and build it five years later, more expensive. We had to discount it to move it. It was a very poor cash flow strategy and we've changed our strategy and now -- really since the fourth quarter of 2004, we have accelerated the pace of construction. As I look past 2006, I would expect a 40 million to 45 million in inventory to go down, because I think we will be caught up on developing the inventory, and it will begin to trend back the other way.

The next bucket there is construction of new funeral home facilities. We spent 11 million last year. We think at least 15 million to 20 this year. Now, if you recall, you have permits. You have to drop plan. So this is true cash spend. I think you'll see us designing and putting into place CEAs to spend a lot more money than 15 million to 20 million. This is an estimate of what we'll spend next year.

So as I look into the future, maintenance ought to stay flat, because I think we are caught up. We don't have any deferred maintenance. Inventory ought to trend down, because we finally built up appropriate inventory level that we need and I would expect construction to go up. And I would expect construction to go up, and I would also expect you to see our acquisition spending go up. So as you think of the future, that's the way I would view capital expenditures.

And just, I mean, as far as the cemetery properties that you're developing now, I mean, is it safe to say that versus building these big multistory mausoleums, you are building family estates where you can recover the capital more quickly, and then it sort of funds itself, as we move forward?

Generally, yes. Now, you know, there is still -- we build the mausoleums, because again we've got some that we committed to build for customers. But I think, as a general trend, you're seeing us go more to the private family estates, go more to lawn crypts and develop lawn crypts that are in the ground. And so it's really replenishing those inventories and making them available in our key cemeteries.

And so as we look forward, it will be selling those and not nearly as much in having to develop them. We again see a real spike this year in spending the money that we committed to build last year, plus the new stuff that we're going to build this year. And we expect that to tailback off in 2007 really and beyond.

And then also just quickly on the pricing realignment. I think you've given some date the last time on how many markets you hope to have that rolled out to by yearend. And I'm just wondering how many markets that you actually have that in, now, and how the progress is there?

I think as of yearend -- and this is in the K, I believe, that will be filed -- we are in 25 markets, as of yearend. We continued our hectic pace through January and February. And so it was our goal to be in all the markets at least by the end of June.

So I think today I'm being told we are in about 35 of those markets, and you'll recall, I think, it is 31 plus 42 and about 73 to 75 markets. So we're about halfway there, and we've got a lot of resources getting to these final 35 or 40 markets and would expect by the end of June to have all of those in place.

Okay. And just lastly, sort of, where are you with the segmentation, I mean? Are you trying that in any markets, now, or is that still pretty much in the strategy stage?

Well, we have done some things. We're going to segmentation in a number of markets. We're in the beginning of getting ready for those pilots. It's a lot of the -- if you think about it, what we're trying to do now is develop the -- you know, it's one thing to have a strategy, and it's another thing to have an implementation plan.

And so we're really getting our minds around what is different about these segments, and how should the facilities look different? How should presentations be done differently? How do we market these businesses differently? So a lot of what we're doing now is spending time upfront to make sure the infrastructure is right in rolling this out.

At the same time, we're educating our key local market management in the process. So I'd tell you that we're making great progress. But things like this take time, and the impact from this is beyond -- believe me, beyond 2006. It's a different way of viewing our facilities and viewing our customer, but we're very pleased with our progress.

I think it's just one of the things that's going to take time and a lot of effort, but there is a long-term payoff there.

Okay. Great. Just -- and Jeff, a long and healthy retirement. That's it for me, and thanks.

Thank you.

Thank you. Next, we'll next hear from John Ransom from Raymond James and Associates.

Hi. I guess I am down to asking picky in share count questions. I guess I didn't understand the 300-million fully diluted share number, just given the buyback activity that occurred in the fourth quarter and just, I guess, the 1% creep in share count. If you could help me with that, that'd be great.

I think we are on that. [inaudible] but a couple of things. One, you've got exercise of options that are going to occur. And secondarily, as you look at our long-term incentives for executive management, we do issue restricted shares and options. So I think it's just a reflection, John, of people exercising and a little bit on restricted shares.

And again, this isn't a -- this was not meant to be ours. What we think is going to happen to share count...

Yes.

...I truly would like to tell you, if we did nothing else, you can make your own assumption on how many shares we're going to buy back.

And...

So what...

Go ahead.

Well, what was the -- I'm sorry -- what was the total share count creep from options and restricted share grants in the year?

I don't have that schedule.

Yes. We don't have it. It will be filed today in the 10-K, though.

Okay.

But the other thing I'd to it is the 300 million that's disclosed in the outlook relates to diluted weighted average shares. So as Tom was saying, the difference between our shares outstanding today, at 2.95, and that is the diluted option and those type of thing.

Got it. So I guess another way to think about it, if you were to spend 100 -- if share count creeps up by 5 million, if you spend 100 million buy in your stock back, maybe, the first 40 million basically just gets you back to square one on the share count creep.

That's a fair assumption. Yes.

Okay. Okay. And secondly, could you talk a little bit more -- I mean, I know, you've rolled this pricing strategy out, and I did not catch the first couple of minutes of the call -- but could you just help out a little bit with -- the yield was a lot stronger than we were looking for, and I know you rolled out this pricing strategy -- could you just talk about your expectations for a yield for '06 and if fourth quarter was an aberration?

I think, first of all, the trend in the fourth quarter was not an aberration. I think we understand it very well. As we look forward, you'll recall, we also had trust income that happened in the fourth quarter that to me probably we wouldn't expect to recur.

So I would expect positive trends, John, as we look forward. At the same time, I think -- I would expect positive trends, as we go forward, but I don't think it's a level which you're seeing, right now.

So maybe 2 to 3% adjusted -- obviously, you're going to have a cremation creek, but maybe 2 to 3% might be reasonable?

Yes, I think so. And it really depends on that cremation. And the other thing to keep in mind is, as we rolled out this pricing, we are hitting the markets that had the highest impact first.

Okay.

Look it's the first 35 markets. I expect a bigger impact when the third 35 comes.

Got you. A couple of other things. Cash interest expense for the quarter and for the year -- Jeff, do you have that?

I do not have it right in front of me, John, but we can get it for you. Maybe, I have them in one of these sheets. Cash interest expense account.

It's not a huge spread. I know you just have the amortization of debt costs and that sort of thing. But I'd assume it's not a huge spread.

And we'll get it for you, John.

Okay. And I guess, finally, just from a financial standpoint, for argument's sake, let's say, you are trading at roughly 10 times pre-tax free cash flow. When you look at an acquisition now -- and I know this is all new really -- are you looking -- I know there are a lot of things to think about, but how do you think about the accretion or lack thereof from a free cash flow standpoint? Are you looking at it more from a GAAP EPS standpoint?

We are really looking at internal rate of return based on discounted cash flows. Now that's what drives our decisions.

Okay.

The other stuff, whether it's dilutive or whatever it is, John, obviously those things are factors but the primary driver really is about cash flows discounted back against our weighted average cost of capital, which we used internally to formulate the 8.6%, blended capital debt in equity and I've had some people tell me that's it's too high and too low and you know but --

Yes. So I guess the benchmark, I'd said, you are trading at, again, kind of 10 times number, what would you -- let's say, you found a property that was kind of an average property, I mean, kind of in line with what you own, I mean would you look to try to look for something at may be a 20% discount of where you are trading? Or how do you think about because obviously you always have to compare these things against virtue of just buying your stock back. So how do you compare the acquisition versus the share repos? Is there a spread you are thinking about there?

All I would say that at least in an acquisition you have a chance for some synergies whereas in a share buyback you really don't. But you want to make sure that you took into account the incremental risk -

Okay.

-- of taking on the additional business. John, I might also -- I do have the cash interest numbers for you now.

Okay.

36.4 for the quarter and 94.3 for the year.

Okay. I mean is there a number you think about because in terms -- on accretion in terms your free cash flow per share, is it something you are thinking about there, or is that too simplistic?

We do look at free cash flow but I wouldn't say that on the acquisitions we necessarily focus on that other than that is in the internal rate of return because the internal rate of return is measuring cash flows.

Okay. All right. Thanks a lot.

Thanks.

Thank you. We will take our next question from Mike Scarangella of Merrill Lynch.

Hi. Good morning, guys. On the acquisition topic, Tom, I think a lot of your comments seem to center around opportunities for buying some of those smaller private guys. I was wondering if you could tell us what your appetite is to get together with one of the big public peers. I guess the reason I ask is, as you guys have rationalized your portfolio and increased margins and kind of tightened the ship and I think your peers have done the same.

So I would imagine they are on a relative basis potentially more attractive. I think also on a multiple basis, it seems like from what we've heard the private guys are going for -- it might be more attractive and one of peers in particular gotten a lot cheaper in the last six months. So may be just -- what stars you would have to align do you think for SCI to get together with a public peer?

Well, I think, first of all -- and I have said this at a conference, I think, in December, one thing I applause our public competitors about, I think, they're doing some of the same things we did, which is figuring out what business is you really want to own. So if you look at particularly the bigger ones do it or all the people like that carry does not -- had the same disposition activity. They have been getting rid of businesses that -- to be quite honest, we probably would get rid of it, if they were in our portfolio. So I think the good news is from their perspective they have got properties that probably better align with us today than they would have a few years ago.

Secondarily, you are exactly right, to the extent you did match up with one of those, there is certain efficiencies to be added related to overhead. I mean clearly you can run these things with essentially one set of overhead versus two.

Having said all that, at the end of the day, it's really a seller driven transaction again. We don't sit up here wringing our hands about could be get them, should we get them because to us, [Stewart] or all those who carry, whoever comes along, it got to be a decision that they come to as the best thing for them. So we would listen, we would investigate, and we would be interested, but I think that's how it would come about. And again, I feel better about it today than I were before because I think their properties are good.

Any sense as to whether any of those guys are more ore less interested today than they have been in the past?

You know I don't think so. I mean, I think it's -- everybody -- the good news is, everybody has come out of the woods a little bit from three or four years ago. It's really just about your strategy and that's why I think it goes back to them. What is their strategy, is it to expand or is it -- and each of them has got their own.

So we're focused on driving our business. We are focused on our long-term strategy revolves around customer segmentation, leveraging scale, and we are going market to market and spending money, building places, buying places, if necessary and if something comes along and it makes sense to our shareholders, we will gladly look at it and make a decision.

Okay. I appreciate that color. I wanted to just ask you about the cremation rate, you guys have talked about how it's been -- you know that year-over-year increase has been picking up; it went up 190 basis points in the quarter. Do you have any sense -- is that happening in any particular region or is that broad based and then secondly, refresh us on what you guys are doing to kind of deal with that and/or capitalize on that?

I think it's relatively broad based. And I guess one the points I would make is, as we realign our pricing, obviously that's impacting the cremation pricing too, because the cremation customer uses our services he doesn't necessarily buy our caskets, but he uses our services. And one of the things I have noticed is in the -- although we haven't had a trend towards increased cremations, a lot of those cremations are with cremation with services and our trend in direct dispositions has slowed considerably.

I think there is a couple of ways to look at it. It is -- every market is different and we see spikes in a variety of markets, but I think as Jeff pointed, the good news is we are finding more and more cremation consumers that value additional services that we can provide. And in fact we view that as an opportunity with 41% of our customers already as cremation consumers. If we can capitalize on that, that's more of an opportunity than it is a concern.

Thanks. And did you say what your assumption was in your guidance for the cremation rate in '06?

I think we said 100 to 150 basis points.

130.

130.

130. Okay, so --

I think we have historically somewhere in that range. And you know quarter-to-quarter it can look a little goofy. We had 190 basis points in the fourth quarter but I think we had a quarter or two this year, where it was like 50 basis points, s it kind of jumps around depending on what's happening in those markets.

Okay. That's great. And just real quick, Jeff, could you update us on potential timing to register your recent on deal?

It's our highest priority once we get the K filed.

Okay. And I am sorry, that was supposed to happen this week -- I am sorry, next week?

Hopefully today, Mike.

Okay. All right. Great. Thank you, guys.

Thank you. We have time for one final question. We will take that from Dana Walker of Kalmar Investments.

I feel very special. Good morning. Could you talk about the outcome of your price management process compared to what your expectations had been in the funeral home?

I'd say generally very positive, but the best way to answer to that Dan is if you go market-by-market, we found certain markets that surprise us to the upside. We've got a few markets where we're, kind of, shocked because it's flat. They really had an impact and so we go mark-to-market and investigate what happens and why. But generally I'll have to tell you that it's very positive.

And also, very positive from the local funeral directors and arrangers, because they've seen this, you know, this is something that has been an irritant for them for some time. We're talking about people coming to our funeral homes because of the great service, or quality of the building, and again, the caskets has been in area where people don't need them as value added as maybe they once did.

So it's been in the price in the right place, the consumers love it, they did kind of survey's coming right behind this pricing change and we're seeing satisfaction toward a loyalty scores increasing where we have done the pricing change. So it's a win, win and a consumer friendly approach.

Can you describe how you're happy and yet your level of traction in certain markets seems to have not had an effect? Does that mean that we're likely to see in the same 35 markets where you are now, in effect, that the effect are to rise, complemented by going to additional markets or is not -- that's not what you would say?

Well, I think it ought to rise a little bit because, I remember these are being putting in the one at a time. And so you started your first one last year in March or April, and incrementally there has been in place. And then at some point, when you're comparing quarter-over-quarter you headed in that market for enough periods of time. So it's been a day with our first market.

In the second quarter of this year, San Jose will be apples-to-apples so there was impact for last year. So there is an incremental, kind of, a growing affect that ought to occur over 2006, and my point about the last 35 markets is a little bit of the doubting Thomas and me -- we'll see the effect when he gets here. For the most part, we're seeing a very positive effect in the market we've had in. But we have seen markets where it hasn't necessarily had that effect.

We still think it's a right thing to do because, again, customer satisfaction scores go up. Our internal customer, our front line funeral arrangers in they like -- they really understand the relationship with the consumers are telling in just the right direction. So whether it has a material impact or not, we knows it's the right way to go bind with our customers wants and needs.

Your gross margin targets for funerals are near those -- I suppose you realize margin and funeral is at the low end of your target range for '06 whereas your cemetery range seems to be roughly -- but your realization in 2005 was -- is in the middle of that range. Can you talk about what needs to happen in your judgment to be at the lower-end versus at the higher-end of these ranges in '06?

Yes. I think as you look at a lower range on the funeral side that would be driven by a really couple of things in my opinion. One is an unusually high cremation change, and probably most importantly, volume decline. You know, we had a very strong 2005, so again, this kind of, always managing to be a little bit paranoid, at some point you expect the number of deaths to drop off and so we don't hope that. We hope we continue to see comparable volume increases, but that would drive it towards the bottom. As we think about the top, I would say the top would be -- we continue to see comfortable volume growth and this pricing change impact is just as strong in last 35 as it was in the first 35, and that's going to drive you towards the top end of that range.

On the cemetery side, it's really going to be driven, in my opinion, cemetery sales production. So to the extent we can sell -- increase the selling activity within our cemetery sales force, we can drive it up towards 18%. Another impact would be trust income results. As you recall, we have merchandise service trust and we have endowment care trust on cemetery side and to the extent we have earnings, those drive our revenues and margins. So if we have unusually high returns that too should drive us towards the top. And the inverse is the same, to the extent we don't have great returns in those, it will drive us towards the bottom. So those are probably the key things to watch as we look out to 2006.

Two last questions, Tom, you mentioned at the front end of your conversation that you were underwhelmed by your preneed selling production. Maybe you could comment on the types of steps that you will take to drive better results?

And second question, can you describe what the P&L consequences might be in the first 12 to 18 months of a more aggressive acquisition posture in the funeral home business?

Okay. On the first one, it is important to think of these in two buckets. On the preneed cemetery side, we are very pleased. Our production is 5%. I think that's a good healthy clip. We see that continuing. We placed a lot of emphasis on developing inventory and selling techniques cemetery. Part of this drop off in funeral is really our fault, in the sense, that we probably emphasized cemetery to the detriment of funeral as we look at our sales force. A lot of our sales force can sell both or sell the other. We put more resources behind making to the cemetery sales grow and probably less behind the preneed funeral. Part of the reason was, we know that a very high percentage of our preneed funeral activity, the way we sell it is cannibalized. That a lot of these are people that would walk into our funeral homes anyway.

So even though we have not placed as much emphasis, we haven't seen active volumes drop off. So as we look to funeral one, we are going to - we've already done a little bit of this. We are investing in resources in order to manage that sales activity better. To track leads, make sure that we know the basics in selling are occurring and give our counselors the best chance they can with appropriate lease follow up in a way.

So I think you will see more of an emphasis on that and also begin to explore are there less cannibalized tracks that we can look at in order to drive funeral sales production. To begin, we can run it up real high. The industry has done in the past. But all it does is drain your cash flow and probably lock-in your customer you may would have gotten. So we are going to smart about it, but we are going to put some resources behind it. Your second question Danny was--?

Was about acquisitions affect on your P&L. If you do end up being somewhat more active forgetting about the trade-offs between lesser share count and similar share count, what are the P&L consequences of being more acquisitive?

I would say, Danny, to the extent we are buying at [normal cost], it's going to be pretty small than that. There are not enough, you can't do enough to have a major impact on a year. And on acquisitions -- I am sorry -- on builds, it's even quite possibly negative. In other worlds if we decide to construct a funeral, it will run a deficit more likely than not the first few years unless it's sitting on a cemetery property. And we're willing to take that if that's a smart thing to do from a long period of time. So I don't expect any mom and pop acquisition to have, any material impact on earnings per share in '06. Obviously as we go little overtime they could have a significant impact in '08, '09, 2010.

Thank you.

Thank you.

Thank you. That will conclude our question and answer session for today. I would like to turn the call back over to the management team for any additional or closing remarks.

This is Tom Ryan, and again I want to thank everybody for being on the call today and we will be speaking to you in our first quarter conference call. Thanks again.

This will concludes today's conference. We'd like to thank you all again for your participation, and wish you a great day.