FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

For the quarterly period ended September 30, 2004

or

For the transition period from                      to                     

Commission file number 1-6402-1

SERVICE CORPORATION INTERNATIONAL

713-522-5141
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to the filing requirements for the past 90 days.

Indicate by check mark whether the registrant is an accelerated filer (as defined in the Securities Exchange Act of 1934 Rule 12b-2).

The number of shares outstanding of the registrant’s common stock as of November 1, 2004 was 330,339,308 (net of treasury shares).

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SERVICE CORPORATION INTERNATIONAL
INDEX

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

SERVICE CORPORATION INTERNATIONAL
CONSOLIDATED STATEMENT OF OPERATIONS (UNAUDITED)

(In thousands, except per share amounts)

(See notes to unaudited consolidated financial statements)

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SERVICE CORPORATION INTERNATIONAL
CONSOLIDATED BALANCE SHEET (UNAUDITED)

(In thousands, except share amounts)

(See notes to unaudited consolidated financial statements)

4

SERVICE CORPORATION INTERNATIONAL
CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)

(In thousands)

(See notes to unaudited consolidated financial statements)

5

SERVICE CORPORATION INTERNATIONAL
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (UNAUDITED)

(In thousands)

(See notes to unaudited consolidated financial statements)

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SERVICE CORPORATION INTERNATIONAL
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts)

1. Nature of Operations

Service Corporation International (SCI or the Company) is the world’s largest provider of funeral and cemetery services. The Company owns and operates funeral service locations, cemeteries and crematoria located in seven countries. The Company also has a minority interest equity investment in funeral operations in France. In addition to its cemetery and funeral operations, the Company owns and operates Kenyon International Emergency Services, a disaster response team that engages in mass fatality and emergency response services.

     The funeral service and cemetery operations consist of funeral service locations, cemeteries, crematoria and related businesses. Personnel at the funeral service locations provide all professional services relating to funerals, including the use of funeral facilities and motor vehicles, and preparation and embalming services. Funeral related merchandise (including caskets, coffins, burial vaults, cremation receptacles, flowers and other ancillary products and services) is sold at funeral service locations. Certain funeral service locations contain crematoria. The Company sells preneed funeral services whereby a customer contractually agrees to the terms of a funeral to be performed in the future. The Company’s cemeteries provide cemetery property interment rights (including mausoleum spaces, lots and lawn crypts) and sell cemetery related merchandise (including stone and bronze memorials, burial vaults, casket and cremation memorialization products) and services (primarily merchandise installations and burial openings and closings). Cemetery items are sold on an atneed or preneed basis. Personnel at cemeteries perform interment services and provide management and maintenance of cemetery grounds. Certain cemeteries operate crematoria, and certain cemeteries contain gardens specifically for the purpose of cremation memorialization.

2. Summary of Significant Accounting Policies

Principles of Consolidation and Basis of Presentation

The consolidated financial statements for the three and nine months ended September 30, 2004 and 2003 include the accounts of the Company and all majority-owned subsidiaries and are unaudited but include all adjustments, consisting of normal recurring accruals and any other adjustments, which management considers necessary for a fair presentation of the results for these periods. These consolidated financial statements have been prepared in a manner consistent with the accounting policies described in the Company’s current report on Form 8-K filed September 2, 2004, which superseded the annual report on Form 10-K filed with the U. S. Securities and Exchange Commission for the year ended December 31, 2003, unless otherwise disclosed herein, and should be read in conjunction therewith. The accompanying year-end consolidated balance sheet was derived from the audited consolidated financial statements but does not include all disclosures required by accounting principles generally accepted in the United States of America. Operating results for interim periods are not necessarily indicative of the results that may be expected for the full year period.

     The Company has reclassified certain prior year amounts to conform to the current period financial presentation with no effect on previously reported results of operations, financial condition or cash flows.

Use of Estimates in the Preparation of Financial Statements

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that may affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of expenses during the reporting period. As a result, actual results could differ from these estimates.

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     The effective tax rate in the three months ended September 30, 2004 was an expense of 24.9% compared to a benefit of 38.2% in the three months ended September 30, 2003. The 2004 rate was favorably impacted by a $2,356 tax benefit adjustment resulting from a change in estimated 2003 federal tax liabilities. The tax benefit in the three months ended September 30, 2003 is due to the net loss for the quarter. The effective tax rate in the nine months ended September 30, 2004 was a benefit of 4.7% compared to an expense of 36.2% in the same period of 2003. The unusual tax rate in the nine months ended September 30, 2004 is due to non-cash tax benefits recognized from the joint venture of the French operations consummated in March 2004 and the sale of the Company’s equity investment in the United Kingdom in the second quarter of 2004. For more information, see note fifteen to the consolidated financial statements.

Equity Investments

At September 30, 2004, the Company had a minority investment in certain funeral operations in France. The Company accounts for this investment using the equity method of accounting for investments recorded in Deferred charges and other assets on the Company’s consolidated balance sheet.

Treasury Stock

The Company recently announced a share repurchase program authorizing the investment of up to $100,000 to repurchase its common stock. The Company makes purchases in the open market or through privately negotiated transactions subject to market conditions and normal trading restrictions. The Company accounts for the repurchase of its common stock under the par value method. The Company uses the average cost method on the subsequent reissuance of treasury shares. Any resulting differences between the average cost and the current market value upon issuance of treasury stock to the Company’s 401(k) plans are expensed as compensation cost.

3. Accounting Changes and New Accounting Pronouncements

In March 2004, the Financial Accounting Standards Board (“FASB”) reached consensus on the guidance provided by Emerging Issues Task Force Issue 03-1 (“EITF 03-1”), “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” The guidance is applicable to debt and equity securities that are within the scope of FASB Statement of Financial Accounting Standard (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” EITF 03-1 specifies that an impairment would be considered other-than-temporary unless (a) the investor has the ability and intent to hold an investment for a reasonable period of time sufficient for the recovery of the fair value up to (or beyond) the cost of the investment and (b) evidence indicating the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. EITF 03-1 was scheduled to be effective for reporting periods ending after June 15, 2004. The measurement and recognition provisions relating to debt and equity securities have been delayed until the FASB issues additional guidance. The Company adopted the disclosure provisions of EITF 03-1 during the period ended June 30, 2004. The adoption of the measurement and recognition provisions will not have a material impact on the consolidated financial statements, result of operations or liquidity of the Company.

Variable Interest Entities

In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin (ARB) No. 51.” This interpretation clarifies the application of ARB No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties.

In December 2003, the FASB revised FASB Interpretation No. 46 (FIN 46R).

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     Under the provisions of FIN 46R, the Company is required to consolidate certain cemeteries and trust assets. Merchandise and service trusts and cemetery perpetual care trusts are considered variable interest entities because the trusts meet the conditions of paragraphs 5(a) and 5(b)(1) of FIN 46R. That is, as a group, the equity investors (if any) do not have sufficient equity at risk and do not have the direct or indirect ability through voting or similar rights to make decisions about the trusts’ activities that have a significant effect on the success of the trusts. FIN 46R requires the Company to consolidate merchandise and service trusts and cemetery perpetual care trusts for which the Company is the primary beneficiary (i.e., those for which the Company absorbs a majority of the trusts’ expected losses). The Company is the primary beneficiary of a trust whenever a majority of the assets of the trust are attributable to deposits of customers of the Company.

Consolidation of Trusts: The Company implemented FIN 46R as of March 31, 2004, which resulted in the consolidation of the Company’s preneed funeral and cemetery merchandise and service trust assets and the Company’s cemetery perpetual care trusts. No cumulative effect of an accounting change was recognized by the Company as a result of the implementation of FIN 46R as it relates to the consolidation of the trusts. The implementation of FIN 46R affects certain line items on the Company’s consolidated balance sheet and statement of operations as described below; however, there is no impact to net income in the statement of operations as a result of the implementation. Additionally, the implementation of FIN 46R did not result in any net changes to the Company’s consolidated statement of cash flows; however, it does require certain financing and investing activities to be disclosed. See notes four through six to the consolidated financial statements.

     Although FIN 46R requires consolidation of most of the merchandise and service and perpetual care trusts, it does not change the legal relationships among the trusts, the Company and its customers. In the case of merchandise and service trusts, the customers are the legal beneficiaries. In the case of cemetery perpetual care trusts, the Company does not have a legal right to the perpetual care trust assets. For these reasons, upon consolidation of the trusts, the Company recognizes non-controlling interests in its financial statements to reflect third party interests in these trusts in accordance with FASB Statement No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liability and Equity” (SFAS 150). The Company classifies deposits to merchandise and service trusts as non-controlling liability interests and classifies deposits to cemetery perpetual care trusts as non-controlling equity interests.

     The Company records cash received from customers, which has not been deposited in trusts as restricted cash in Deferred charges and other assets in its consolidated balance sheet. At September 30, 2004, these pending deposits totaled $10,800. The Company continues to account for amounts received from customers prior to delivery of merchandise or services that are not required to be deposited in merchandise and service trusts as deferred revenue.

     Beginning March 31, 2004, the Company recognizes net realized investment earnings of the merchandise and service trusts and perpetual care trusts, as well as the related trustee investment expenses and taxes, within Other income, net. The Company then recognizes a corresponding expense within Other income, net representing the net realized earnings of those trusts that are attributable to the non-controlling interest holders. The corresponding credit for this expense is reflected in the Company’s consolidated balance sheet in Non-controlling interest in funeral and cemetery trusts for merchandise and service trusts or Non-controlling interest in perpetual care trusts for cemetery perpetual care trusts. The sum of these expenses recorded in Other income, net offset the net realized earnings of such trusts also recognized within Other income, net. Accordingly, the Company’s net income in the consolidated statement of operations is not affected by consolidation of the trusts in accordance with FIN 46R.

     To the extent the earnings of the trusts are distributed prior to the delivery of merchandise and/or services, a corresponding amount of non-controlling interest is reclassified to deferred revenue until the corresponding revenues are recognized. In the case of merchandise and service trusts, the Company recognizes as revenues, amounts previously attributed to non-controlling interests and deferred revenues upon the performance of services and delivery of merchandise, including earnings accumulated in these trusts. In the case of the cemetery perpetual care trusts, distributable earnings are recognized in cemetery revenues to the extent of qualifying cemetery maintenance costs.

     Prior to the implementation of FIN 46R and the consolidation of the trusts, monies received from customers and deposited into merchandise and service trusts until maturity of the preneed contract were recorded as receivables due from trust assets. Upon

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implementation of FIN 46R, the Company replaced receivables due from trust assets with the trust assets, at market, to the extent the Company was required to consolidate the trusts.

     An allowance for contract cancellation is provided based on historical experience. An allowance is no longer provided on the monies associated with the preneed contract that are held in trust, currently recorded as trust assets, but previously recorded as receivables due from trust assets. As such, the amount has decreased since the implementation of FIN 46R.

     Both the merchandise and services trusts and the cemetery perpetual care trusts hold investments in marketable securities that are classified as available-for-sale by the Company under the requirements of Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”). In accordance with SFAS 115, available-for-sale securities of the trusts are recorded at fair value, with unrealized gains and losses excluded from earnings and initially recorded as a component of Accumulated other comprehensive loss in the Company’s consolidated balance sheet. Using the guidance in EITF Topic D-41, “Adjustments in Assets and Liabilities for Holding Gains and Losses as Related to the Implementation of FASB Statement No. 115” (“Topic D-41”), unrealized gains and losses on available-for-sale securities of the trusts attributable to the non-controlling interest holders are not recorded as Accumulated other comprehensive income (loss), but are recorded as an adjustment to either Non-controlling interest in funeral and cemetery trusts or Non-controlling interest in perpetual care trusts. Therefore, unrealized gains and losses attributable to the non-controlling interest holders are reclassified from Accumulated other comprehensive income (loss) to either Non-controlling interest in funeral and cemetery trusts or Non-controlling interest in perpetual care trusts. The gross effect from applying Topic D-41 on the Company’s Accumulated other comprehensive income (loss) is disclosed in note fourteen of the consolidated financial statements. However, the Company’s Accumulated other comprehensive income (loss) on the face of the balance sheet is ultimately not affected by consolidation of the trusts.

     For additional discussion of the Company’s accounting policies after the implementation of FIN 46R, see notes four through seven to the consolidated financial statements.

Consolidation of Certain Cemeteries: Effective as of March 31, 2004, the Company consolidated certain cemeteries managed by the Company in accordance with FIN 46R. The Company recognized an after tax charge of $14,462, representing the cumulative effect of an accounting change, as a result of consolidating these cemeteries. The results of operations and cash flows of these cemeteries are included in the Company’s consolidated statements of operations and cash flows beginning March 31, 2004. Excluding the cumulative effect of accounting change, the effect of consolidating these entities did not have a significant impact on the Company’s reported results of operations.

Insurance Funded Preneed Insurance Contracts

The Company has changed its method of accounting for insurance funded preneed contracts as the Company has concluded that its insurance funded preneed funeral contracts are not assets and liabilities as defined by Statement of Financial Accounting Concepts No. 6, “Elements in Financial Statements.” Therefore, the Company has removed from its consolidated balance sheet amounts relating to insurance funded preneed funeral contracts previously recorded in Preneed funeral receivables and trust investments and Deferred preneed funeral revenues, which at December 31, 2003, were $3,505,094, respectively. The removal of these amounts did not have an impact on the Company’s consolidated stockholders’ equity, results of operations or cash flows. See note four to the consolidated financial statements for additional information on insurance related preneed funeral balances.

Pension Plans

In December 2003, the FASB revised SFAS No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits” (SFAS 132R). SFAS 132R requires additional disclosures about the assets, obligations, cash flows and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. The Company has adopted the revised disclosure requirements. The Company’s pension plans are frozen with no cost benefits accreting to participants except interest.

     Effective January 1, 2004, the Company changed its accounting for gains and losses on its pension plan assets and liabilities. The Company now recognizes such gains and losses in its consolidated statement of operations as such gains and losses are incurred under pension accounting. Prior to January 1, 2004, the Company amortized the difference between actual and expected investment returns

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and actuarial gains and losses over seven years (except to the extent that settlements with employees required earlier recognition). The Company believes the new method of accounting better reflects the economic nature of the Company’s pension plans and recognizes gains and losses on the pension plan assets and liabilities in the year the gains or losses occur. As a result of this accounting change, the Company recognized a charge for the cumulative effect of an accounting change of $33,599 (net of tax) as of January 1, 2004. This amount represents accumulated unrecognized net losses related to the pension plan assets and liabilities. In addition, for interim periods, the Company records net pension expense or income reflecting estimated returns on plan assets and obligations. The Company will recognize actual gains and losses on plan assets and obligations as actuarial information becomes available upon review of the annual remeasurement. See note ten to the consolidated financial statements for additional information on pensions.

     The three and nine months ended September 30, 2003 pro forma amounts in the table below reflect the new policy to recognize gains and losses on the pension plans as incurred and reflect interim estimates as mentioned above.

4. Preneed Funeral Activities

The Company sells price-guaranteed preneed funeral contracts through various programs. Because the services or merchandise will not be provided until the future, most states and provinces require that all or a portion of the customer payments under these contracts be protected for the benefit of the customers pursuant to applicable law. Some or all of the funds may be required to be placed into trust accounts or a surety bond may be posted in lieu of trusting (collectively “trust funded preneed funeral contracts”). Alternatively, where allowed, customers may purchase a life insurance or annuity policy from third party insurance companies to fund their preneed funeral (“insurance funded preneed funeral contracts”). The insurance policy proceeds, which include increasing insurance benefits, will be used to pay the Company for the funeral goods and services selected at the time of contract origination. Under either customer funding option, the Company enters into a preneed funeral contract with the customer to provide funeral services in the future. The contract amounts associated with unfulfilled insurance funded preneed funeral contracts are not reflected on the consolidated balance sheet. Effective March 31, 2004, the Company changed certain aspects of its accounting for trust funded preneed funeral contracts upon implementation of FIN 46R. For additional information, see note three to the consolidated financial statements. After the change, when a trust funded preneed funeral contract is consummated, the Company records an asset (included in Preneed funeral receivables and trust investments) and corresponding liability (included in Deferred preneed funeral revenues) for the contract price. When the Company receives payments from the customer, the Company deposits the amount required by law into the trust and reclasses the corresponding amount from Deferred preneed funeral revenues into Non-controlling interest in funeral and cemetery trusts. The Company deposited $8,542 and $32,770 into trusts during the three and nine months ended September 30, 2004, respectively and withdrew $18,509 and $38,817 from trusts during the three and nine months ended September 30, 2004, respectively.

     Direct selling costs related to trust funded preneed funeral contracts are deferred and included in Deferred charges and other assets in the Company’s consolidated balance sheet. The deferred selling costs are expensed in proportion to the corresponding trust funded preneed funeral contract revenue when recognized. Deferred selling costs associated with trust funded preneed funeral contracts were $111,953 and $113,920 at September 30, 2004 and at December 31, 2003, respectively. Direct selling costs incurred pursuant to the sales of insurance funded preneed funeral contracts are expensed as incurred.

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Preneed Funeral Receivables and Trust Investments

Preneed funeral receivables and trust investments, net of allowance for cancellation, represent trust assets and customer receivables related to unperformed, price-guaranteed trust funded preneed funeral contracts. The components of Preneed funeral receivables and trust investments in the Company’s consolidated balance sheet at September 30, 2004 and December 31, 2003 are as follows:

     An allowance for contract cancellation is provided based on historical experience. An allowance is no longer provided on the monies associated with the preneed contracts that are held in trust, currently recorded as trust investments, but previously recorded as receivables due from trust assets. As such, the amount has decreased since the implementation of FIN 46R.

     Upon cancellation of a trust funded preneed funeral contract, a customer is generally entitled to receive a refund of the funds held in trust. In many jurisdictions, the Company may be obligated to fund any shortfall if the amounts deposited by the customer exceed the funds in trust including investment income. As a result, when realized or unrealized losses of a trust result in trust funded preneed funeral contracts being under-funded, the Company assesses such contracts to determine whether a loss provision should be recorded. No loss amounts have been required to be recognized as of September 30, 2004 or December 31, 2003.

     Preneed funeral receivables and trust investments are reduced by the trust investment earnings the Company has been allowed to withdraw in certain states prior to maturity and amounts received from customers that are not required to be deposited into trust, pursuant to various state laws. These earnings are recorded in Deferred preneed funeral revenues until the service is performed or the merchandise is delivered.

     The cost and market values associated with funeral trust investments at September 30, 2004 are detailed below. The market value of funeral trust investments was based primarily on quoted market prices at September 30, 2004. The Company periodically evaluates investments for other-than-temporary impairment and as a result of its most recent review believes the unrealized losses of $29,410 related to trust investments are temporary in nature. At September 30, 2004, the Company’s unrealized losses greater than one year in duration primarily related to certain private equity and other investments.

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     Maturities of fixed income securities at September 30, 2004 are estimated as follows:

     During the three and nine months ended September 30, 2004, purchases of available-for-sale securities included in trust investments were $269,884 and $493,932, respectively and sales of available-for-sale securities included in trust investments were $276,927 and $561,306, respectively. These transactions resulted in $13,950 and $10,414 of realized gains and realized losses, respectively for the three months ended September 30, 2004. For the nine months ended September 30, 2004, sales transactions resulted in $29,981 and $17,059 of realized gains and realized losses, respectively. The Company uses the FIFO method to determine the cost of funeral trust available-for-sale securities sold during the period.

Deferred Preneed Funeral Revenues

At September 30, 2004, Deferred preneed funeral revenues, net of allowance for cancellation, represent future funeral service revenues including distributed trust investment earnings associated with unperformed trust funded preneed funeral contracts that are not held in trust accounts. Future funeral service revenues and net trust investment earnings that are held in trust accounts are included in Non-controlling interest in funeral and cemetery trusts. At December 31, 2003 and prior to the implementation of FIN 46R, Deferred preneed funeral revenues represent the original price of a trust funded preneed funeral contract plus the net trust investment earnings.

     An allowance for contract cancellation is provided based on historical experience. However, the amount has decreased since the implementation of FIN 46R, as the Company no longer provides an allowance for the deferred preneed funeral revenues now included in Non-controlling interest in funeral and cemetery trusts.

Insurance Funded Preneed Funeral Contracts

Not included in the consolidated balance sheet are insurance funded preneed funeral contracts that will be funded by life insurance or annuity contracts issued by third party insurers. The net amount of these contracts that have not been fulfilled at September 30, 2004 and December 31, 2003, including increasing insurance benefits and reduced by an allowance for cancellation, was approximately $2,204,237 and $3,505,094 (of which $1,515,984 related to the Company’s French operations at December 31, 2003), respectively, and were previously included in Preneed funeral receivables and trust investments with a corresponding liability in Deferred preneed funeral revenues. The proceeds of the life insurance policies or annuity contracts will be reflected in funeral revenues as these funerals are performed by the Company.

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5. Preneed Cemetery Activities

The Company sells price-guaranteed preneed cemetery contracts providing for future property interment rights, merchandise or services in advance of need at prices prevailing when the agreements are signed. Some or all of the funds received under these contracts for merchandise or services may be required to be placed into trust accounts, or a surety bond may be posted in lieu of trusting, pursuant to applicable law. Effective March 31, 2004, the Company changed certain aspects of its accounting for preneed cemetery contracts upon implementation of FIN 46R. For additional information, see note three to the consolidated financial statements. When the Company receives payments from the customer, the Company deposits the amount required by law into the trust and reclasses the corresponding amount from Deferred preneed cemetery revenues into Non-controlling interest in funeral and cemetery trusts. The Company deposited $42,997 and $75,835 into the trusts during the three and nine months ended September 30, 2004, respectively and withdrew $24,257 and $57,581 from the trusts during the three and nine months ended September 30, 2004, respectively.

     Direct selling costs related to preneed cemetery contracts are deferred and included in Deferred charges and other assets in the consolidated balance sheet. The deferred selling costs are expensed in proportion to the corresponding revenue when recognized. Deferred selling costs related to preneed cemetery contracts were $205,504 and $205,123 as of September 30, 2004 and December 31, 2003, respectively.

Preneed Cemetery Receivables and Trust Investments

Preneed cemetery receivables and trust investments, net of allowance for cancellation, represent trust investments and customer receivables (net of unearned finance charges) for contracts sold in advance of when the property interment rights, merchandise or services are needed. The components of Preneed cemetery receivables and trust investments in the consolidated balance sheet at September 30, 2004 and December 31, 2003 are as follows:

     Interest rates on cemetery contracts ranged from 3.5% to 15.7% for both periods presented. The average term of a financed preneed cemetery contract is approximately 4.6 years.

     An allowance for contract cancellation is provided based on historical experience with a corresponding decrease in Deferred preneed cemetery revenues. The amount of the allowance has decreased since the implementation of FIN 46R. An allowance is no longer provided on the monies associated with the preneed contract that are held in trust, currently recorded as trust investments, but previously recorded as receivables due from trust investments.

     The cost and market values associated with the cemetery merchandise and service trust investments at September 30, 2004 are detailed below. The market value of cemetery trust investments was based primarily on quoted market prices at September 30, 2004. The Company periodically evaluates investments for other-than-temporary impairment and as a result of the Company’s most recent review believes the unrealized losses of $24,891 related to trust investments are temporary in nature. At September 30, 2004, the Company’s unrealized losses greater than one year in duration primarily related to private equity and other investments.

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     Maturities of fixed income securities at September 30, 2004 are estimated as follows:

     During the three and nine months ended September 30, 2004, purchases of available-for-sale securities included in trust investments were $142,468 and $426,831, respectively and sales of available-for-sale securities included in trust investments were $185,794 and $470,090, respectively. These sale transactions resulted in $13,553 and $12,215 of realized gains and realized losses, respectively for the three months ended September 30, 2004. For the nine months ended September 30, 2004, sales transactions resulted in $30,279 and $20,755 of realized gains and realized losses, respectively. The Company uses the FIFO method to determine the cost of cemetery trust available-for-sale securities sold during the period.

Deferred Preneed Cemetery Revenues

At September 30, 2004, Deferred preneed cemetery revenues, net of allowance for cancellation, represent future preneed cemetery revenues including distributed trust investment earnings associated with unperformed trust funded preneed cemetery contracts that are not held in trust accounts. Future contract revenues and net trust investment earnings that are held in trust accounts are included in Non-controlling interest in funeral and cemetery trusts. At December 31, 2003 and prior to the implementation of FIN 46R, Deferred preneed cemetery revenues represent the original price of a trust funded preneed cemetery contract plus the net trust investment earnings.

     An allowance for contract cancellation is provided based on historical experience. However, the amount has decreased since the implementation of FIN 46R, as the Company no longer provides an allowance for the deferred preneed cemetery revenues now included in Non-controlling interest in funeral and cemetery trusts.

6. Cemetery Perpetual Care Trusts

The Company is required by state or provincial law to pay into perpetual care trusts a portion of the proceeds from the sale of cemetery property interment rights. As a result of the implementation of FIN 46R, the Company has consolidated the perpetual care trust investments with a corresponding amount recorded as Non-controlling interest in perpetual care trusts. The Company deposited $5,877 and $12,091 into trusts during the three and nine months ended September 30, 2004, respectively and withdrew $11,951 and $17,616 from trusts during the three and nine months ended September 30, 2004, respectively.

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     The cost and market value associated with trust investments held in perpetual care trusts at September 30, 2004 are detailed below. The market value of perpetual care trusts was based primarily on quoted market prices at September 30, 2004. The Company periodically evaluates investments for other-than-temporary impairments and as a result of its most recent review believes the unrealized losses of $4,802 related to trust assets are temporary in nature. There were no significant investments with unrealized losses at September 30, 2004 greater than one year in duration.

     Maturities of fixed income securities at September 30, 2004 are estimated as follows:

     During the three and nine months ended September 30, 2004, purchases of available-for-sale securities in the perpetual care trusts were $284,909 and $571,078, respectively and sales of available-for-sale securities in the perpetual care trusts were $283,402 and $559,921, respectively. These sale transactions resulted in $4,638 and $1,871 of realized gains and realized losses, respectively for the three months ended September 30, 2004. For the nine months ended September 30, 2004, these sales transactions resulted in $8,225 and $5,553 of realized gains and realized losses, respectively. The Company uses the FIFO method to determine the cost of perpetual care trusts available-for-sale securities sold during the period.

     Distributable earnings from these perpetual care trust investments are recognized in current cemetery revenues to the extent of qualifying cemetery maintenance costs. Recognized earnings related to these perpetual care trust investments were $9,974 and $7,428 for the three months ended September 30, 2004 and 2003, and $22,778 and $20,675 for the nine months ended September 30, 2004 and 2003, respectively.

7. Non-Controlling Interest in Funeral and Cemetery Trusts and in Perpetual Care Trusts

Non-Controlling Interest in Funeral and Cemetery Trusts

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Effective March 31, 2004, the Company consolidated the merchandise and service trusts associated with its preneed funeral and cemetery activities as a result of the implementation of FIN 46R. Although FIN 46R requires the consolidation of the merchandise and service trusts, it does not change the legal relationships among the trusts, the Company and its customers. The customers are the legal beneficiaries of these merchandise and service trusts, and therefore, their interests in these trusts represent a non-controlling interest in subsidiaries. For additional information, see note three to the consolidated financial statements.

Non-Controlling Interest in Perpetual Care Trusts

The Non-controlling interest in perpetual care trusts reflected in the consolidated balance sheet represents the cemetery perpetual care trusts, net of the accrued expenses and other long-term liabilities of the perpetual care trusts. For additional information, see note three to the consolidated financial statements.

     The components of Non-controlling interest in funeral and cemetery trusts and Non-controlling interest in perpetual care trusts in the Company’s consolidated balance sheet at September 30, 2004 are detailed below.

Debt Associated with Certain Trusts Consolidated by the Company

Certain trusts, consolidated with the adoption of FIN 46R and recorded in Preneed funeral receivables and trust investments, Preneed cemetery receivables and trust investments and Cemetery perpetual care trust investments, have indirect interests in real estate partnerships. These partnerships have incurred indebtedness of $77,898 that is included in Other liabilities in the consolidated balance sheet at September 30, 2004. The trusts’ obligation on this indebtedness is limited to their investment in the respective partnerships. The debt has interest rates ranging from 5.0% to 8.5% and maturities between 2011 and 2019.

Other income, net

The components of Other income, net in the Company’s consolidated statement of operations for the three months ended September 30, 2004 are detailed below. See notes three through six to the consolidated financial statements for further discussion of the amounts related to the funeral, cemetery and perpetual care trusts.

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The components of Other income, net in the Company’s consolidated statement of operations for the nine months ended September 30, 2004 are detailed below.

     Amounts included in Other income within Other income, net primarily relate to foreign currency gains and losses, interest income on notes receivable and general agency commissions from third party insurance companies.

8. Debt

Debt was as follows:

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     The Company’s consolidated debt had a weighted average interest rate of 7.08% and 6.95% at September 30, 2004 and December 31, 2003, respectively. Approximately 99% of the total debt had a fixed interest rate at September 30, 2004 and December 31, 2003.

Bank Credit Agreements

The Company’s bank credit agreement, which was executed on August 11, 2004, provides a total lending commitment of $200,000, including a sublimit of $175,000 for letters of credit. The agreement, which matures August 2007, replaces a $185,000 facility that was set to expire in July 2005. Upon closing, the Company transferred $72,456 in letters of credit, which were originally issued under the previously existing bank credit agreement. The new bank credit facility provides the Company with greater flexibility in terms of acquisitions, dividends and share repurchases. It is secured by the stock of the Company’s domestic subsidiaries and these domestic subsidiaries have guaranteed the Company’s indebtedness associated with this facility. The facility contains certain financial covenants, including a minimum interest coverage ratio, a maximum leverage ratio, maximum capital expenditure limitations, minimum net worth requirements and certain cash distribution restrictions. Interest rates for the outstanding borrowings will be based on various indices as determined by the Company. The Company also will pay a quarterly fee on the unused commitment, which ranges from 0.25% to 0.50%.

Debt Issuances and Additions

In connection with $250,000 of senior unsecured 6.75% notes due April 1, 2016, issued on April 14, 2004 in an unregistered offering, the Company filed a registration statement on September 2, 2004 with the Securities and Exchange Commission pursuant to a Registration Rights Agreement. In accordance with the terms of the Registration Rights Agreement, the interest rate on the new notes increased by 0.25% for the period that the Company failed to file the registration statement. During the period of July 14, 2004 to September 1, 2004, the interest rate on the notes increased by 0.25% for an aggregate incremental interest expense of $83. On September 2, 2004, the interest rate reverted to the stated rate of 6.75%. The majority of the holders of the unregistered notes have exchanged for registered notes.

     The holders of $221,633 of the Company’s 6.75% convertible subordinated notes due 2008 converted their holdings to equity on June 22, 2004, pursuant to the terms of the notes. The Company paid $7,480 in accrued interest to the holders. Simultaneously, the Company exercised its option by redeeming the remaining outstanding $91,061 of the notes. The Company paid a total of $97,649, including interest and premium, to the holders of the redeemed notes and recognized a $5,606 loss on the early extinguishment of debt, recorded in (Loss) gain on early extinguishment of debt, in the consolidated statement of operations during the quarter ended June 30, 2004.

Debt Extinguishments and Reductions

In March 2004, in connection with the joint venture of the Company’s operations in France, mortgage notes and other debt was reduced by approximately $24,194 for capital lease obligations related to vehicles used in the French operations.

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     In connection with the pending sale of the Company’s Argentina operations, approximately $9,174 at September 30, 2004 and $9,694 at December 31, 2003 were reclassified from mortgage notes and other debt to Liabilities of discontinued operations in the consolidated balance sheet. For additional information regarding this matter, see note sixteen to the consolidated financial statements.

     On April 15, 2004, as required by the terms of the agreement, the Company repaid the remaining $111,190 of the 7.375% notes due 2004.

     On April 22, 2004, the Company extinguished $200,000 aggregate principal amount of the 6.00% notes due 2005, pursuant to the Offer to Purchase, dated March 24, 2004. The Company paid $214,233 to the tendering holders, including a premium and accrued interest. As a result of the transaction, the Company recognized a loss on the early extinguishment of debt of $10,831, recorded in (Loss) gain on early extinguishment of debt, in the consolidated statement of operations. In early May 2004, the Company also purchased $8,650 aggregate principal amount of the 6.00% notes due 2005 in the open market. As a result of these transactions, the Company recognized a loss of $333, recorded in (Loss) gain on early extinguishment of debt, in the consolidated statement of operations.

Additional Debt Disclosures

At September 30, 2004 and December 31, 2003, the Company had deposited $188,176 and $95,325, respectively, in restricted, interest-bearing accounts that were pledged as collateral for various credit instruments and commercial commitments, including $135,000 included in Other current assets on the consolidated balance sheet which are held in escrow for settlement of certain litigation. The remaining $53,176 is included in Deferred charges and other assets in the consolidated balance sheet.

9. Derivatives

The Company occasionally participates in hedging activities using a variety of derivative instruments, including interest rate swap agreements, cross-currency swap agreements and forward exchange contracts. These instruments are used to hedge exposure to risk in the interest rate and foreign exchange rate markets. The Company has documented policies and procedures to monitor and control the use of derivative transactions, which may only be executed with a limited group of creditworthy financial institutions. The Company generally does not engage in derivative instruments for speculative or trading purposes, nor is it a party to leveraged derivatives.

     During the first quarter of 2004, the Company executed certain forward exchange contracts, having an aggregate notional value of EUR 240,000 and a corresponding notional value of $300,011 to hedge its net foreign investment in France. Upon receipt of the net proceeds from the joint venture transaction, the Company settled these derivative instruments and recorded a gain of $8,919 in Other comprehensive income (loss) in the consolidated statement of stockholders’ equity, which was then recognized pursuant to the sale of the Company’s operations in France in Gains and impairment (losses) on dispositions, net in the consolidated statement of operations.

     The Company also executed certain forward exchange contracts during the first half of 2004, having an aggregate notional value of GBP 22,436 and a corresponding notional value of $41,334, relating to the ultimate sale of its minority investment in and the repayment of its note receivable from a funeral and cemetery company in the United Kingdom. On April 8, 2004, the Company received the expected proceeds and settled these derivative instruments, recognizing a gain of $198, which was recorded in Other income, net in the consolidated statement of operations during the three months ended June 30, 2004.

     The Company was not a party to any derivative instruments at September 30, 2004 or December 31, 2003.

10. Retirement Plans

The Company has a non-contributory, defined benefit pension plan covering approximately 40% of its United States employees (US Pension Plan), a supplemental retirement plan for certain current and former key employees (SERP), a supplemental retirement plan for officers and certain key employees (Senior SERP) and a retirement plan for certain non-employee directors (Directors’ Plan). The Company also has a 401(k) employee savings plan.

     Effective January 1, 2004, the Company changed the accounting for gains and losses on its pension plan assets and obligations. The Company recognizes such gains and losses in its consolidated statement of operations in the year such gains and losses are incurred. Prior to January 1, 2004, the Company amortized the difference between actual and expected investment returns and actuarial gains and losses over seven years (except to the extent that settlements with employees required earlier recognition). For additional discussion of this accounting change, see note three to the consolidated financial statements.

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     Effective January 1, 2001, the Company curtailed its US Pension Plan, SERP, Senior SERP and Directors’ Plan. As these plans have been frozen, the participants do not earn additional benefit from additional years of service and the Company does not incur new service cost.

     Retirement benefits for the US Pension Plan are generally based on years of service and compensation. Required contributions are actuarially determined amounts consistent with the funding requirements of the Employee Retirement Income Security Act of 1974. Assets of the pension plan consist of core diversified and market neutral hedge funds, fixed income investments and marketable equity securities.

     Retirement benefits under the SERP are based on years of service and average monthly compensation, reduced by benefits under the US Pension Plan and Social Security. The Senior SERP provides retirement benefits based on years of service and position. The Directors’ Plan provides for an annual benefit to directors following their retirement, based on a vesting schedule.

     Most foreign employees are covered by their respective foreign government mandated or defined contribution plans that are adequately funded and are not considered significant to the financial condition or results of operations of the Company. The plans’ liabilities and their related costs are computed in accordance with the laws of the individual countries and appropriate actuarial practices.

     The components of net periodic pension plan benefit cost for the three and nine months ended September 30 were as follows:

     The Company recorded net pension income of $1,655 for the nine months ended September 30, 2004 based on actuarial information obtained from the Plan’s annual remeasurement as of September 30, 2004. Due to the write off of the $54,873 unrecognized net loss associated with the change in accounting principle on January 1, 2004, the Company’s amortization of unrecognized net loss is $0 for the three and nine months ended September 30, 2004 compared to $1,897 and $5,690 for the same periods of 2003.

     The plans’ weighted-average assumptions used to determine the net pension expense for the three and nine months ended September 30, 2004 and 2003 are as follows. The three and nine month periods ending September 30, 2004 reflect an adjustment based on results from the annual remeasurement. Due to the curtailment of the plans in 2001, the assumed rate of compensation increase is $0.

SERP, Senior SERP and Directors Plan

The retirement benefits under the SERP, Senior SERP and Directors’ Plan are unfunded obligations of the Company. As of December 31, 2003, the benefit obligation of the SERP, Senior SERP and Directors’ Plan was $33,764; however, the Company holds various life insurance policies with the intent to use the proceeds or any cash value buildup from such policies to assist in meeting, at least to the extent of such assets, the Senior SERP’s funding requirements. The face value of these insurance policies is approximately $51,082 while the cash surrender value of these insurance policies is approximately $33,470 as of September 30, 2004. In July 2004, the Company paid off an $11,383 loan and $517 in interest associated with these policies.

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US Pension Plan

In March 2004, the Company voluntarily contributed $20,000 to the frozen US Pension Plan. The fair value of the plan assets as of September 30, 2004 is $88,383, compared to a projected benefit obligation of $110,649 at December 31, 2003. As a result of the previously mentioned accounting change, the minimum pension liability adjustment included in Accumulated other comprehensive loss was $0 as of September 30, 2004 compared to $33,599 at December 31, 2003.

     The plan’s weighted-average asset allocations by asset category are as follows:

     Equity securities included shares of Company common stock in the amounts of $0 and $7,138 (nine percent of plan assets) at September 30, 2004 and December 31, 2003, respectively. On March 31, 2004, the plan assets were rebalanced to include investments in core diversified and market neutral hedge funds.

     The primary investment objective of the plan is to achieve a rate of investment return over time that will allow the plan to achieve a fully funded status, while maintaining prudent investment return volatility levels. In 2004, the investment strategy was revised to have a lower percentage invested in traditional equity securities and fixed income securities and instead include investments in hedge funds allowing for reduced volatility with limited reduction of returns. The Company has an asset allocation strategy of 35% traditional equity, 15% fixed income and 50% hedge funds. The investment strategy is managed within ranges that are centered at specific allocation targets. The specific allocations within the strategy, as well as individual asset class ranges are as follows:

11. Segment Reporting

The Company’s operations are both product and geographically based, and the reportable operating segments presented below include funeral and cemetery operations. The Company’s geographic areas include North America, Europe and Other Foreign. Other Foreign consists of the Company’s operations in Singapore and South America. Europe includes operations in Germany and France. The Company conducts both funeral and cemetery operations in the North America, Europe and Other Foreign geographic areas.

     The Company has reclassified certain prior year amounts to conform to the current period presentation with no effect on previously reported results of operations, financial condition or cash flows.

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     The Company’s reportable segment information is as follows:

     The following table reconciles gross profits from reportable segments to the Company’s consolidated income from continuing operations before income taxes and cumulative effects of accounting changes:

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     The Company’s geographic area information is as follows: