Service Corporation International (SCI) 2006 Q3 法說會逐字稿

Good day, everyone, and welcome to the Service Corporation International third-quarter 2006 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 conference over to the management team of SCI. Please go ahead.

Good morning. This is Debbie Young, Director of Investor Relations for SCI. I want to welcome everyone to our third-quarter earnings call.

Before we begin, I'd like to remind everyone that the conference call today will contain some statements that are not historical fact and are forward-looking. These statements may be accompanied by words such as believe, estimate, project or similar expressions. These statements that we will make today are based on assumptions that we 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 will make today.

For more information related to these forward-looking statements and other important risk factors, please review our periodic filings with the SEC that are available on our website at www.SCI-Corp.com.

I also want to remind you that a replay of this conference call is available on that same website for approximately 90 days under the Investor page and under the sub-heading conference calls, again on www.SCI-Corp.com.

With that we're going to start with the prepared remarks and I will turn the call over to our President and Chief Executive Officer, Tom Ryan.

Thanks, Debbie, and thanks for everybody being on the call. As usual, I'm going to start my comments with summarizing some of the things that we are very pleased with as we look back at the third quarter.

The first item that I will touch upon is the Alderwoods transaction. We are very pleased with the fantastic job our team has been able to do in preparing for this integration. I can tell you that we feel extraordinarily prepared for day one and our ability to execute and communicate all along the way, which will result, I believe, in a very efficient and a very effective integration once we get started.

We continue as we get further and further along in understanding the dynamics of Alderwoods and how it compares back to us, we are very, very comfortable, as we've said before, with the synergies we've identified previously. We will be re-quantifying those for you more specifically once we close Alderwoods and had a chance to articulate a little more towards what we believe the ultimate synergies will be.

Lastly, it is not so great, but the final piece of getting this done really is outside of our hands. We are in the final stages of the Federal Trade Commission approval process. We do expect it to close in the fourth quarter. We believe most likely that will occur towards the end of November -- this month.

The second item that we are very pleased about is the increase we continue to see in our average revenue per funeral service. It is up 12.3% quarter-over-quarter. The average to-date is $4848, which is up about 11.4% when you exclude the full revenue comparison that we like to do to give you really an apples and apples view. This is primarily driven, as you know, by the strategic pricing initiative that was completed throughout our entire network in the month of August.

In addition, we continue to see great progress and are proud of where we are as it relates to our operating discipline and leveraging our scale. In particular, we have talked before about our staff management metrics, we call them the FTE, or full-time equivalent metrics, that allow us to implement processes that are much more efficient throughout our entire network -- to take those best practices and transplant them and disseminate them across. We had identified approximately $22 million run rate that we felt like we would be at by the end of the year and I'm pleased to tell you we are actually ahead of that schedule. And so very pleased with the result that is showing up in the third quarter and again will show up in the fourth.

In addition, you may have seen through [base built] announcements that we have renewed our agreement with [Basebuilt]. We are very pleased to have that in place as we move forward.

In addition, we are continuing to look at all of our supplier contracts. And we expect good things to happen there as we begin to renegotiate those and again, further leverage our scale.

Lastly, and I talked a little bit about this last time, we have put together a centralized Web-based procurement system for some of our other ancillary type of products that we utilize in our business. Again we're very pleased we are beginning to see savings and see the usage of that Web-based system increase.

So if you step back a minute and look at what's occurred, we had significant improvement in our funeral margins. And it's primarily attributable to the results of our strategic pricing initiatives coupled with the progress we have made in utilizing the staffing metrics to reduce our costs.

The last item that again I would point out is something we are very pleased, is the increase in our operating cash flow. About $114 million this quarter which is about a $45.6 million improvement over last year's third quarter. And Eric is going to give you little more color in his comments as to some of the reasons why.

Now for some of the items we're not as pleased with. One is our comfortable volume levels continue to be down. And I will give you little more color on that as I get into the specifics of the business lines. The cost for the improved control environment, again, I'm really talking to SOX and the interpretation of Sarbanes-Oxley Act -- we continue to spend at levels that we don't deem appropriate or beneficial. We do have a very improved control environment. We feel like there's opportunity in the future to leverage those costs down.

Cemetery margins this quarter were not where we would like them to be, and I'll talk a little bit more about that as we analyze business segments. If you take a look at our pre-need business, our funeral production this quarter, what we put into the backlog, was relatively flat at approximately $80 million with the prior year. We continue to see contracts written down to the tune of about 14%. But the value of the contracts written is up $617 over prior year. The resulting back into a 14% increase in the average contract written. Higher quality business, better products, appropriate commercial terms, focusing on reducing those rebates and eliminating a lot of the interest rebate incentives that we had out there before.

With that, I'm going to turn my comments to first, the funeral segment. As I mentioned a little bit earlier we are very pleased with the results of the funeral segment. Our profits, quarter-over-quarter, were up $17.2 million, or 610 basis points and resulted in a operating margin of 20.6%.

Our comparable funeral volumes again were down 5.9% in the quarter and 5.6% for the nine months. I wanted to take a little bit of time to walk you through our analysis of what is occurring within funeral volumes.

First of all, I think it is good to remember, as I have talked before, that 2005 each quarter was a comparable volume improvement. So in our minds we believe 2005 -- the deaths within our markets were up quite a bit. So we are comparing back against what I would call a pretty tough quarter each time.

We are seeing that we are directionally consistent with others in the industry. We have seen others' volumes be down, not to the extent ours are, but again, we do understand that if you look at all markets, we are beginning to see a reduction in the number of deaths in 2006 versus 2005.

As I mentioned in the first quarter, as we did our analysis, we saw a geographic concentration in the North Eastern United States, which accounted for that approximate 5% to 6% decline. In the second quarter we saw a more dispersed reduction in the number of deaths in our markets. But particular we called your attention to markets in the Pacific Northwest as well as some markets in Florida with the National Cremation Society grant, where local decisions were made to exit unprofitable businesses. That resulted in about 120 basis point decline as it related to the second quarter.

Now in the third quarter we have had even more time to really analyze this, and I wanted to give you our thoughts as we look at it. If you take a look at the quarter, our true at-need calls are down just over 2800 calls, at about 7.6%.

One of the best measures we know about understanding what is happening with market share are looking at cemetery interments. Our cemetery interments for the quarter were down 3.4%. And we think this is a good reflection of market, as most of these contracts were previously written and most of these again, you don't see a competitive environment in the cemetery side of the business as you do in funeral.

Also on a pre-need backlog, we are seeing a 3.7% reduction of the contracts being serviced out of that backlog. So it is our belief that within our markets we would expect about a 3.5% decline in the true at-need business.

The next item that we address is specifically the Pacific North West and the NCS businesses in Florida. We have tracked approximately 650 call loss of again kind of low priced cremation business, which takes about 180 basis points out of the true at-needs analysis. So if you take all those into consideration, there is an additional 200 basis points that isn't explained in what I talked about before.

And what we have done is segment our contracts by pricing. And what we have noticed by doing this segmentation is 89% of the lost volume is associated with a cremation contract under $2000. We believe that what is causing this is that our segmentation decision, our segmentation strategy that we've communicated, has given our local people permission not to chase highly discounted, low service cremation costs. And that is really what we are seeing.

We continue to believe that our strategic pricing really isn't having an impact on volume. Our JD Power surveys support that. Our interviews with our front-line employees support that. So again, we feel very good about the results of our strategic pricing.

Keep in mind, it is not our intention to drive away all of the low-end business. We continue to study and learn from our initiatives. And we may tweak in the future our pricing and discounting policies at the low end as we refine our segmentation strategy over the coming quarters.

I guess in conclusion, what I would say is our funeral margins are up over 600 basis points, and we're not upset with that result, as I think most of you can agree.

On the average side, as I mentioned before, our average is up 11.4% quarter-over-quarter. You will recall since the late August and September of 2005, we have been able to successfully manage those trends. The strategic pricing realignment, which I will remind you, focuses on service -- more on service and less on the product -- and the related reduction in those discounts.

Another item that is helping drive the overall average up is keep in mind, our pre-need to at-need average is up 6.5% this quarter over last year's third quarter. Why is that? Because you're seeing a higher quality of business written, particularly over the past four years, as we have introduced the Dignity pre-need products; we are seeing a better product being put into backlog. In addition to that, we have seen positive market returns in our trust business that contribute to that increase.

And as I think forward, keep this in mind -- with our new pricing strategy, the average contract we are putting in the backlog today is about $4867. And what we are pulling out of backlog today, which again is quite an increase, is at $4606. So what we are putting in already exceeds what we are pulling out with earnings by 5.7%. I think that bodes well for the continued impact of higher quality pre-need business impacting our future margins.

In addition, if you bifurcate what is happening between the cremation consumer and the burial consumer, our average cremation contract is up 19.9% in the third quarter of '06 versus the third quarter of '05. We now average $2722 for cremation consumers in the third quarter. Our average burials, up about $537, or 9.3%, and that contracts just at $6300.

As far as Dignity is concerned, we continue to track that and see success there. On our at-need cases, 20.6% of our contracts for Dignity versus 20.1% in last year's quarter. And particularly we are seeing more success on the cremation side. We are seeing 19.3% of our contracts from cremation versus 17% again last year. And in what we are putting in our pre-needs backlog, again, for Dignity contracts, our pre-need backlog 30.2% of the contracts we write are Dignity contracts versus 28.2% in last year's third quarter.

If you take a look at the cremation mix, I wanted to point you towards that. Our cremation mix has decreased 60 basis points to 40.8% this quarter. We do not believe this is a reverse in the cremation trend within the marketplace. And keep in mind quarter-to-quarter, this would be very volatile. If you add back the 1300 immediate disposition calls that we have lost year over year, you would see a cremation rate of 42.3% or an increase of 50 basis points. So it's our conclusion that the market hasn't necessarily changed, but our approach to the consumer has, and this is reflected in the decreased cremation mix.

For the most part on the funeral expense side, we managed very well, beyond our expectations. Funeral expenses are down $7 million quarter-over-quarter and this is attributable to staffing efficiencies and improvements in our vehicle costs year-over-year.

Switching to the Cemetery segment, you'll notice that our cemetery profits are down $4.4 million this year's quarter versus last. That is a 280 basis points reduction and our margin stood at 14.3%. Some of the reasons for that is we saw our sales production for the quarter relatively flat at approximately $125 million. In association with that, the GAAP recognition of that sales production as a percentage of the production was 93.6% this year versus 95.1% in last year's quarter. This is primarily caused by the fact that we had $6.2 million of increased recognition from construction contracts completed in the third quarter of 2005.

On the at-need selling front, we actually saw an increase in revenues to the tune of $2.7 million. And our pre-need sales are slightly down, and we believe possibly impacted by the recently enacted interest rebate changes that are occurring on the cemetery side.

In the category of Other revenue, you saw $18.5 million this year -- this quarter, versus $20.1 million in last year's first quarter. And this is -- the reduction is primarily lower finance charge income, again due to those change in rebate policies. We are not financing as much of our policies as we have in the past. We are collecting more up front.

Generally on the cemetery side, our expenses were very well managed. Metric driven efficiencies within our selling costs were more than offset by higher maintenance and administration costs that we are seeing in managing our cemetery (technical difficulty).

As I look to the fourth quarter of this year, I want to point you to what we believe are going to drive -- be impactful.

Number one, expect continued strong funeral averages due to the strategic pricing realignment project that we talked about so much. I would expect continued lost but very low-priced immediate disposition within our markets, and this will result in downward pressure again on that cremation mix as you begin to look at the fourth quarter.

In addition, we would expect the favorable impact of the staffing metrics that we have talked about and actually at an increasing rate as again this was really beginning to be implemented in June of this year.

If we turn to the cemetery side, I would expect improvements in our cemetery sales production in the fourth quarter versus the fourth quarter of 2005. But also expect an improved recognition ratio because our expectation is we will have some projects that again will get completed in the fourth quarter, which will allow us to enjoy a higher recognition rate of our production. I would expect continued efficiencies in the selling cost side as we utilize metrics to manage our staffing and sales force.

And lastly, expect to see maybe a little more of an impact from the staffing metrics we will use on the service side of the cemetery as we implement those strategies.

So with that, that concludes my remarks. I am going to turn now this presentation over to Eric Tanzberger, our Chief Financial Officer.

Thanks, Tom. I want to start with a few general comments like Tom did. And first of all, reiterate what Tom said about the Alderwoods close. We are very excited about it. As Tom mentioned, our financial information technology, accounting, HR, all of our teams -- operational teams, as well are very ready for the integration to begin. We enjoy a positive, very positive relationship with our Alderwoods counterparts. And we are really in good shape for the integration to start.

And in terms of financing, our financing for the Alderwoods deal is also in place. We have $500 million worth of new debt, long-term bonds that are in escrow waiting for the close of the deal after we received the SEC permission. We also have $150 million term loan that's ready to go and a $200 million private placement that is ready to go.

We've also announced tenders, as you know -- $145 million of our SCI 2009 bonds will be tendered and the $200 million of Alderwoods debt will also be tendered and that is ready to go. We will use about $570 million roughly in that area of cash for the deal upon closing.

Also, I would like to mention what will close on the same day is a new $300 million revolving credit facility as well that will replace our existing credit facility.

Shifting now to the financial performance of the quarter, again, I want to reiterate -- very strong financial performance this quarter. Recurring earnings per share of the $0.10 versus $0.04 for the quarters and $0.30 versus $0.21 for year to date versus prior year. Of course in our press release, is a reconciliation going from the GAAP earnings to the recurring earnings per share I just mentioned.

Cash flow from operations also very strong, about $114 million versus $68 million in the prior-year quarter. And from a year to date basis, $265 million versus $258 million for the year to date; that is cash from operations, and I will get into a little bit more details and comments on that in just a second.

Another piece of positive news was a press release yesterday evening that we issued that raises our dividend 20% and takes it from $0.025 per quarter to $0.03 per quarter and we are very excited about that as well.

Now shifting to the income statement results for the quarter, Tom really explained the general performance including the average and volume. I think I will just mention two other items of note on our income statement for the quarter.

First relates to interest expense. One thing I wanted to mention is that we have registered our 2017 bonds with the SEC. And if you recall, we are paying penalty interest of 100 basis points, which amounted to about $3 million per year. The SEC has declared this registration statement effective. We are in the process of exchanging those bonds for the new public bonds. And that should end -- that penalty interest will end later this month.

Also in the quarter is about $6.4 million of interest expense, which is really related to bridge financing fees, which is the $850 million bridge financing facility that we entered into with JPMorgan for the Alderwoods deal. And that, of course, is added back for recurring earnings per share. And we will see several pieces of financing fees over the next quarter that again will hit our income statement that we'll add back as a onetime basis.

Another items of note is what I described in the second-quarter conference call in August, and that was related to France. At that time, I did mention that we are expecting a distribution of about U.S. $11 million, and explained that at that point in time we expected to record that as other income and cash flow from operations, which in fact, we did. And just to recall that, we basically had already received our dollar value of our investment from this French investment. So we expected any earnings going forward that we receive from France to essentially be recorded in other income. And remember, we own about 25% of our French former operations. And because of the high leverage that we had over there, the earnings weren't recognized smoothly. And this $10 million is indicative of that, how it came in at one time. However, again, as I mentioned in our second quarter August conference call, the capital structure is somewhat stable now over in France. And we do expect $4 to $5 million of equity pickup per year, which will be smoothly going through our quarters going forward. And in fact in the third quarter of this year, we recognized $1.3 million, which is also included in other income.

Now shifting to the balance sheet, the cash balance, as you may have seen with our filing of our 10-Q this morning, was $637 million at September 30. We roughly enjoy the same basic balance of cash today as we speak, around $635 million. The debt balance really didn't move during the quarter. It is stable at about $1.3 billion. With very modest maturities in the short-term, with current maturities of only about $30 million. And again in terms of the balance sheet, we didn't do any share repurchases during the quarter. And we continue to have $36 million left on our authorization for the share repurchase programs.

Shifting to cash flow -- our cash flow from operations on a year-to-date basis was $255 million versus $258 million for the prior year. However, if you recall talking through the prior year, there was a $29 million tax refund and a $12 million payment on debt extinguishment, which was the net $17 million in the prior year balance. So if you normalize that, the $258 million in the prior year is really about $241 million cash flow from operations normalized for '05 compared to $265 million in '0, so up about $24 million.

Also, if you recall, our guidance for cash flow from operations was roughly expected to be flat in 2006. The guidance was $290 million to $315 million, which compared to a $296 million cash flow from operations in 2005 which also included a normalization with the tax refund and the debt extinguishment that I just described to you.

A couple of things that are in that guidance. First of all, we expected a shift from operating leases to capital leases, which should have a positive cash flow effect, about $20 million. And that is on track; it has affected positively about $15 million year to date, 9/30 in 2006. This was also expected to be offset by about a $[15] million long-term incentive compensation payment that was paid in Q1 of 2006.

We also described in our press release Kenyon receipts of about $10 million so far in 2006. That was also expected but was also expected to be offset by higher bonus payments in 2006.

So all of the items that I just described to you somewhat came in and washed each other. And the cash flow from operations is still up $24 million. It is primarily a function of the French dividend that I described to you of $11 million, more eternal care fund income than what we expected in our forecast, and also some improved operating actions that we had, including continued decrease in our days sales outstanding, for receivables; our up-front cash on our pre-need cemetery segment from our consumers continues to be at about 50% in terms of the up front cash. And again, we're just starting in the third quarter to see some improvements from staffing efficiencies as well which are reducing cash costs.

From a quarter to date basis, the cash flow from operations was $114 million versus $68 million, which is about a $46 million improvement. If you recall from the second-quarter August conference call, we had an issue where we had more payroll periods in the second quarter versus prior year and that was going to flip through in the third quarter of this year, and it did, which gave us an $18 million benefit when you compare the third quarter of '06 versus the third quarter of '05.

We also had some operating improvements as well, as I mentioned. The DSOs continued to improve. The staffing efficiencies helped with our cash costs. And as I mentioned, we had the French distribution that came in at $11 million during the quarter.

From a CapEx perspective, our maintenance and cemetery development CapEx was just under $22 million for the quarter, $16 million for the year to date. And we had very modest growth CapEx during the quarter of about $1 million and $3 million for year to date. Using the cash flow from operations for the quarter of about $114 million, with the maintenance and cemetery development CapEx, that would yield about $92 million in free cash flow for the quarter. And using the same calculation, it would yield about $205 million of free cash flow year to date.

You have to remember though when you look at that, you cannot annualize these numbers. There's a lot of ebbs and flows in cash interest payments within our cash flow statements. So Q3 is naturally a very high quarter four us because of less cash interest paid.

Speaking of that, the cash interest paid in the quarter was about $11 million, which totaled $60 million for the year to date. And the cash taxes paid were about $4 million in the quarter and about $11 million year to date. And going back to cash interest, we expect about $33 million of cash interest payments in the fourth quarter.

Shifting to some gross returns on our trust performance, pre-need funeral for the quarter had a return of 2.1%; pre-need cemetery had a return of 2.3%; and our eternal care funds had a return of 4.7%. So that totals about 2.8% return for the quarter for our trust funds. On a year-to-date basis, our returns are 4% for pre-need funeral and pre-need cemetery; 7% for the eternal care fund; so on average it's about a 4.8% return on our trust funds for year to date.

Going back to Alderwoods and I'm going to talk a little bit about the fourth quarter going forward -- but in terms of the capital structure related to Alderwoods, we have about $1.3 billion in debt today. After the acquisition, we will come out with about $2 billion of debt, which is the new $850 million of debt that I described to you already less the $150 million of the SCI tender that I also described. We will use $570 million of our cash balance. Again our cash is about $635 million today as we speak.

The first thing that we will do post acquisition is use cash flows from operations and asset sales to pay down the $150 million term loan. We also have the ability to pay down a portion of the $200 million private placement but we are really going to manage to our capital structure to make that decision, especially the net debt and net total capital ratio that we use, which we think is optimal around 45%. We also have other internal guidelines and ratios that relate to free cash flow and interest coverage and we think we will be within those guidelines within 2008. And you've seen those that in our presentations before that are on our Web site.

We continue to believe in a stock repurchase program as well. We will have some covenants which would preclude us in certain situations from buying back stock. For example, our net debt to EBITDA ratios need to fall below 4 times before we can do that. But we do feel that we will be within those parameters very quickly in '07, and we can start buying stock back again to eliminate spend. But just again, to reiterate, we continue to believe in that program.

Going forward in the fourth quarter, our original EPS guidance for the year for 2006 was about 30% to 34%, that did not include the $0.02 that we had from France from the $11 million distribution. So think of a revised guidance of about $0.32 to $0.36 year to date. We are currently at $0.30, so I think that for the fourth quarter ending the year in 2006 we will be at the very high end of that guidance or actually exceed that guidance by a couple of pennies.

Now remember, none of that that I just mentioned -- it all excludes Alderwoods. It doesn't have any effect from Alderwoods earnings coming in or any of the transition costs related to the Alderwoods deal.

Shifting to cash flow, our original guidance was $290 million to $315. We are now at $265 million. However, I did mention to you the $33 million of cash interest that is due in the fourth quarter so you can't really annualize that number.

We are also expecting to have a loss of cash interest income during the quarter as we used a substantial amount of our cash balances for the acquisition. So, therefore, from a cash flow from operations perspective, I foresee us being at the high end of 2006 or slightly exceed this cash flow guidance. But again, this excludes any benefit or onetime costs related to the Alderwoods acquisition.

In closing, looking forward in the fourth quarter, I think the thing that we are most excited about again is the Alderwoods acquisition. Excluding the onetime transition costs, this deal is expected to be accretive for us somewhat quickly for EPS but immediately for cash flows. The transition costs are in line with our estimates, which were about $60 million. The synergies that we have described so far were general and administrative and overhead synergies. And we have described $60 to $70 million. I believe we could safely say that we will be at the very high end of that range of synergies, and as Tom mentioned, there will also be more purchasing and operational synergies to come. However, we will wait till we close the Alderwoods deal and work more closely with the Alderwoods management and operations. And we anticipate quantifying more clearly the additional synergies in a mid-February 2007 conference call specifically related to that guidance of the combined company.

So with that, Miranda, I think we are ready to turn it over to a question-and-answer session.

(OPERATOR INSTRUCTIONS). Tom Bacon, Lehman Brothers.

Congratulations on a strong quarter. I was just -- Eric, could you in terms of the -- when you say you're going to be at the high end of the cash flow from ops guidance, but you also sort of went through a bunch of onetime things. Are you saying -- is that including France?

It does include the France. Yes, it does. I started saying -- (multiple speakers)

So including everything, you will be over the top end of the guidance?

Yes.

And as far as with the new Batesville agreement, can you -- I don't know if you'll be willing to do this at this point in time, but obviously you sort of know what Alderwoods spent on caskets, and you know what you spent in the last year. Can you quantify what the savings would be under the new agreement?

Well first of all, as you probably know, Tom, that agreement is confidential. So we are careful as to what we would say. What we can tell you is, we are very pleased with the agreement we have. And relative to what Alderwoods had, it is fortunate for us we've got a new agreement.

And then in terms of the market segmentation strategy, it seems like the first thing we're seeing here is you are moving away from direct cremations. And I was wondering maybe if you can talk about sort of where your progress is on market segmentation? Or is that kind of a back burner thing till we get Alderwoods integrated?

I wouldn't define it as back burner at all. It is a key component of our strategy. A lot of development is segmentation if you think about it. We are talking about developing unique ways to market to consumers, unique facility looks, unique product offerings. But we are in the midst of delivering -- or I should say developing -- those types of approaches. And so it will take a little bit of time before we are able to better refine our segmentation.

I believe what is happening today is we have recognized the fact that our core business is about service and memorialization. So we're looking -- we match well with consumers that want service and want memorialization, and that is being reflected in our numbers.

And by making that statement and by having that direction, a lot of folks that work for us, rightfully so, feel empowered to make decisions locally to say, if we have consumers that don't value those things, then, again, we are not going to continue to execute those contracts and not make money.

So I guess where I would point you towards, as we refine our customer segmentation, we are in no way saying we can't service those folks. What we're saying today is, that is not our primary business or concern.

So to refine the strategy, we may have a better way to interact with that consumer, find a more efficient way to deliver that lesser service. And so I would just say patiently as we move forward, that may be a segment that one day you see us increasing again. So today it's not our primary mission. Our primary mission is to accomplish what we're doing. And again I think the numbers speak for themselves -- 600 basis points -- we are pleased with the direction we are headed.

And as far as in the markets that you have done this, I mean I guess I would think that to a certain point that the independents are, rather than continuing to compete on price, might try to sort of move in under your pricing umbrella. So over time, does the market kind of equalize? And maybe if there is anything that you lost because of price, you'd get it back over time?

It is very hard to speak to that because again there's so much competition, there's so many independents and their actions -- I can't predict.

You would think like any market with perfect information, people will begin to align to where the consumer is going.

And as you know, the reason for what we did is we believe that the consumer finds value on the service side, finds differentiation, and value, service, and memorialization.

When you turn to the product side, historically we have offered a lot of options. But it is where the commoditization is beginning to occur. So we think the market is going to drive that, it is our opinion. And we went there first. And so it is my opinion that the independent consolidators will one day get there and the timeline, I really can't define for you.

But you are right. I don't know when all of that begins to occur.

Do you see any sign of it in some of the markets you have been in longer?

I see -- I would say more likely we are not seeing it yet. But in certain markets we're seeing competitors react and again, I think fully understand what is happening with the consumer out there.

(OPERATOR INSTRUCTIONS). John Ransom with Raymond James & Associates.

Tom, as we look out to 2007, what do you want the market to think about in terms of a normalized volume picture for you guys?

It is always hard to predict volume, John, as you know, because you don't know what is going to happen with the numbers --

Let's assume that the industry is 1% up over the cycles, the industry? I guess -- what -- the CBC numbers suggested volumes up mid single digits this quarter. So your differential was the widest I have seen this quarter. And that included some market actions and also some stuff you are doing. But I just want to make sure that -- if we assume 1% for the market, would we think about you guys being 2 or 3 points under that as you work through your kind of low margin slough off process?

That is a fair assumption. I can't make it for you, but I think you are thinking is correct. I would expect that we really begin to see the low-end comparisons show up in the second quarter of this year. So you think that 2007 -- we are continuing to make decisions along our segmentation strategy. So as I look at the first half of the year for sure, I would expect to be under those trends slightly. As you move to the back half of the year, you'd begin to see that stabilize more. And again, if we have some of our segmentation cooked a little bit, so that's the way I'd try to view it.

The first half, you are right. The second half, who knows? But, again, we feel like because of our strategic pricing while we are under in volume, we will more than make up for it on the revenue pricing side.

And I'm sorry, I missed part of the call. But is the Alderwoods transaction -- I know you have spoken to timing, is that transaction closing a little later than you thought? And is there something we need to think about there as to why that might be?

We have always said fourth quarter. I think last time we spoke, we anticipated it to occur within October is what I told you on the call.

And the reason -- what is happened is this -- we have executed along the timeline we expected. We really had kind of draft consent ready to go to the [FCC] by the end of September, early October. And it was our original expectation that that entire process would take about 30 days. But again, that is really in the FCC's court and they are going to take whatever they're going to take.

So what we found occurring is that they are taking a little longer than we had anticipated. It is now our revised expectation that this would most likely occur in the latter half of November.

And finally, as you look at your combined portfolios between yourselves and Alderwoods and you think through your segmentation, where do you think you might be in terms of future asset sales? What do you think may not fit long term with the combined entity?

We're not prepared yet as far as numbers of locations or things like that. But I will say that we both have gone through asset rationalization strategies. I would say ours is probably a little more acute than theirs was. It is our expectation that we will have assets that don't fit our long-term strategy. But we are really not in a position yet to define how much or what the financial impact may be at this point in time. We may be in a better position to do that, like Eric said, once we have closed the transaction and have really kind of mapped out for you guys in February how we view the impact on 2007.

And I'm sorry, I didn't ask this very well, but I guess with the combination, does this change your look at your own assets? Do you think there may be more assets than there would have been otherwise from your own portfolio -- say in markets where they've got some strength that you don't, for example? Or is this more going to come from the Alderwoods side?

It is probably more from Alderwoods. Because we have always looked at our assets as far as they're underperforming or what markets they are in. We've done a lot of that analysis. Now we have a few in the queue left to go. But if you think about it strategically, it is going to be more about the overlap. If I've got 10 businesses in a market and Alderwoods has 10 businesses in a market, always going to look at our footprint and say, is this the most effective and efficient footprint?

And you may find a real estate opportunity in two of the 20 locations that get sold. So I think as you look at trying to take synergies and looking at centralizing prep and some of the other things -- you will say asset sale opportunities in some of the larger markets, which could be our location, could be their location. They are going to be the preponderance of -- this is in a market that we want to be in, or this is in a facility that we want to own.

(OPERATOR INSTRUCTIONS). Jennifer Childe, Bear, Stearns.

Eric, how much of the funeral gross margin improvement was due to the reclassification of operating leases to capital leases?

It was about --

$2 million.

I was going to say for year to date, it's probably around $4 to $5 million. And I would say for the quarter it is about maybe $2 million that gets reclassified. Because on the fee -- the cash flow is different, Jennifer. A lot of it moves down to principal. But the only part that you have in your income statement is the part that goes down to interest expense. I think that is about $5 million for the whole year.

And I noticed that you reclassified in the third quarter of last year some funeral cost between products and services. And I am wondering what triggered that?

You're talking about in the Q?

In the Q.

In the Q, what we did is when we first had that stipulation, we actually -- it's very difficult for us to break it out between products and services because we have such a high fixed cost structure. And so it was actually a comment letter from the [SEC] that they came in and said make a guess and split it up. We did that in a certain way. And then we thought that we could dive in and get some more detail and try to allocate it a little bit better and a little bit more specifically. And we did that -- I don't remember -- third quarter -- it was sometime last year that we did that though.

Why did the use of funds from pre-need funeral production narrow so much from last year's nine months? And then looking forward, with Alderwoods on a combined basis, how should we think about funeral and cemetery pre-need as it relates to the cash flow, on a normalized basis? Should these line items be a source or a use of cash flow?

It is hard to tell, Jennifer. I think we will be able to do that more specifically after the close and on the February guidance call and help you with bad. I am not sure I'm in a position where I could answer exactly how their cash flow economics work within their pre-need program. We have a good guess but I think we would rather give you a more specific answer in the February guidance.

In terms of the maturities versus last year, there is only about a $9 million difference this year, and that is really -- there's not much there. We have continued, as we said before -- we expected to have better ability and processes this year, when we have outsourced trust to improve our collection speed. And you're kind of seeing a little bit of that, but there is really no unusual items that are in there for the nine months, compared to prior year.

And any estimate of the EBITDA associated with the -- I think it is $72 million in properties identified for sale so far with Alderwoods?

No, it was about $14 million that was in the offering memorandum. You may be thinking of the revenues, which were about $94 million in the offering memorandum. And the EBITDA was somewhere around $13 or $14 million, Jennifer.

This is again in the Q -- I have not seen the offering memorandum -- but there was $72 million in book value properties identified for sale that was announced?

Well, one thing that we had is we took a loss during the quarter, an impairment loss for those SCE properties as well as the [Stone Moore] disposition.

Once that -- we had to put those in our performance statements in our offering memorandum, we had to go ahead and take an impairment loss, which is about $30 million. I would have to go off line and get to your $72 million. I don't recognize that number. And we would have to do that off-line. I would be happy to do that.

(OPERATOR INSTRUCTIONS). Mike Hughes, Delaware investments.

It may be too early to comment on this, but maybe you can just comment on a high level -- if I look at Alderwoods revenue per funeral growth in the second quarter, it was about 3%. And yours in the current quarter adjusted for the -- the formal adjustment that you spoke to was 11.4%. So that is about an 800 basis point differential, and they are doing about $450 million in annual funeral revenue. So just applying that kind of pricing strategy to the Alderwoods portfolio, that, all else being equal would result in about an incremental $35 million in cash flow. Your synergy number -- does it include any of these type assumptions?

No, our synergy number that Eric talked to, the $60 to $70 million, is solely overhead savings associated with Alderwoods. So what it doesn't include, to your point, is it doesn't include purchasing synergies. It doesn't include any further synergies as it relates to other parts other than G&A. And very well to your point, as far as revenue is concerned, we haven't made any assumptions yet.

Your logic makes mathematical sense. But the most appropriate way to do it -- one, you could look at what is Alderwoods average revenue per sales today versus ours -- but you have to take into consideration what markets they are in. It is our belief and our expectation that we can increase that differential rate, their average revenue per case. We do not know yet what that number is. But again, based upon our strategic pricing model on the funeral side, and based upon some strategic pricing we have done on the cemetery, it would be our expectation that we can enhance those average revenue per contract in both sides of the business.

So once you close the deal, I would assume that you will -- I think you had worked with outside consultants in the past. Will they come in and kind of do the same segmentation work at Alderwoods? And how long -- what is the timeline before we would start to see the revenue increases per funeral at Alderwoods if you're able to put that new pricing strategy in place?

Well first of all, we would not need to bring in consultants, because we have in-housed that strategic analysis and the demographics and the like. So we will be quickly able to utilize the segmentation strategy and categorize the Alderwoods property more appropriately. And then to your second point, we mentioned early on, there's a very detailed integration plan that is set to occur. And as part of that integration plan, the pricing strategy is that key component that is scheduled to occur in 2007. And again, we've got a process that takes some time to roll in those markets. But be rest assured, we will be asked that pretty early on in 2007 and actually complete that. It is our anticipation to complete it in 2007.

Phenomenal job. Thank you.

And at this time there are no further questions. I will turn the call back over to the management team for any additional or closing remarks.

We just want to thank everybody for participating in the call today. And like Eric said, we will be back to talk to you most likely in mid-February for a guidance call, which will specifically associate with the Alderwoods transaction. And then again probably two weeks after that, sometime in that timeframe, we will have our fourth-quarter earnings call by the year ended 2006. Thanks, everybody, and we will talk to you then.

That does conclude today's conference call. We'd like to thank you all for your participation and have a great day.