10-Q 1 sci-2013930x10q.htm 10-Q SCI-2013.9.30 -10Q
 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549

FORM 10-Q
R
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
For the quarterly period ended September 30, 2013
or
o     
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
For the transition period from                      to                       
Commission file number 1-6402-1
SERVICE CORPORATION INTERNATIONAL
(Exact name of registrant as specified in its charter)
Texas
 
74-1488375
(State or other jurisdiction of incorporation or organization)
 
(I. R. S. employer identification number)
 
 
 
1929 Allen Parkway, Houston, Texas
 
77019
(Address of principal executive offices)
 
(Zip code)
 
 
 
 
713-522-5141
 
(Registrant’s telephone number, including area code)
 
 
 
 
None
 
(Former name, former address, or former fiscal year, if changed since last report)
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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES þ NO o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES þ NO o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
 
 
(Do not check if smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). YES o NO þ
The number of shares outstanding of the registrant’s common stock as of October 22, 2013 was 211,960,401 (net of treasury shares).

 



SERVICE CORPORATION INTERNATIONAL
INDEX
 
 
 
Page
Results of Operations - Three and Nine Months Ended September 30, 2013 and 2012
 
 
 
 
 

2


GLOSSARY
The following terms are common to the deathcare industry, are used throughout this report, and have the following meanings:
Atneed — Funeral and cemetery arrangements sold after a death has occurred.
Burial Vaults — A reinforced container intended to inhibit the subsidence of the earth and house the casket after it is placed in the ground.
Cemetery Perpetual Care or Endowment Care Fund — A trust fund established for the purpose of maintaining cemetery grounds and property into perpetuity.
Cemetery Property — Developed lots, lawn crypts, and mausoleum spaces and undeveloped land we intend to develop.
Cemetery Property Revenue — Recognized sales of cemetery property when a minimum of 10% of the sales price has been collected and the property has been constructed or is available for interment.
Cemetery Merchandise and Services — Stone and bronze memorials, markers, merchandise installations, and burial openings and closings.
Cremation — The reduction of human remains to bone fragments by intense heat.
Funeral Merchandise and Services — Professional services relating to funerals and cremations and funeral-related merchandise, including caskets, casket memorialization products, burial vaults, cremation receptacles, cremation memorial products, and flowers.
Funeral Recognized Preneed Revenue — Funeral merchandise and products sold on a preneed contract and delivered before a death has occurred, including funeral merchandise and travel protection insurance, which primarily represents sales by the Neptune Society.
Funeral Services Performed — The number of funeral services provided after the date of death, sometimes referred to as funeral volume.
General Agency (GA) Revenues — Commissions we receive from third-party life insurance companies for life insurance policies or annuities sold to preneed customers for the purpose of funding preneed funeral arrangements. The commission rate paid is determined based on the product type sold, the length of payment terms, and the age of the insured/annuitant.
Interment — The burial or final placement of human remains in the ground, in mausoleums, or in cremation niches.
Lawn Crypt — An underground outer burial receptacle constructed of concrete and reinforced steel, which is usually pre-installed in predetermined designated areas.
Marker — A method of identifying a deceased person in a particular burial space, crypt, or niche. Permanent burial markers are usually made of bronze, granite, or stone.
Maturity — When the underlying contracted service is performed or merchandise is delivered, typically at death. This is the point at which preneed contracts are converted to atneed contracts (note — delivery of certain merchandise and services can occur prior to death).
Mausoleum — An above ground structure that is designed to house caskets and cremation urns.
Preneed — Purchase of products and services prior to a death occurring.
Preneed Backlog — Future revenues from unfulfilled preneed funeral and cemetery contractual arrangements.
Preneed Cemetery Production — Sales of preneed or atneed cemetery contracts. These earnings are recorded in Deferred preneed cemetery revenues until the service is performed or the merchandise is delivered.
Preneed Funeral Production — Sales of preneed funeral trust-funded and insurance-funded contracts. Preneed funeral trust-funded contracts are recorded in Deferred preneed funeral revenues until the service is performed or the merchandise is delivered. We do not reflect the unfulfilled insurance-funded preneed funeral contract amounts in our consolidated balance sheet. The proceeds of the life insurance policies or annuity contracts will be reflected in funeral revenues as these funerals are performed by the Company.
Sales Average — Average revenue per funeral service performed, excluding the impact of funeral recognized preneed revenue, GA revenue, and certain other revenues.
Trust Fund Income — Recognized earnings from our merchandise and service and perpetual care trust investments.
As used herein, “SCI”, “Company”, “we”, “our”, and “us” refer to Service Corporation International and companies owned directly or indirectly by Service Corporation International, unless the context requires otherwise.

3


PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

SERVICE CORPORATION INTERNATIONAL
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
 
(In thousands, except per share amounts)
Revenues
$
609,951

 
$
581,182

 
$
1,887,808

 
$
1,781,060

Costs and expenses
(493,872
)
 
(459,911
)
 
(1,486,308
)
 
(1,404,033
)
Gross profits
116,079

 
121,271

 
401,500

 
377,027

General and administrative expenses
(33,764
)
 
(26,410
)
 
(95,792
)
 
(81,927
)
Gains (losses) on divestitures and impairment charges, net
981

 
315

 
(5,533
)
 
883

Operating income
83,296

 
95,176

 
300,175

 
295,983

Interest expense
(38,080
)
 
(33,568
)
 
(103,589
)
 
(101,050
)
Gains on early extinguishment of debt, net

 

 
468

 

Other income (expense), net
666

 
2,317

 
(1,017
)
 
4,001

Income before income taxes
45,882

 
63,925

 
196,037

 
198,934

Provision for income taxes
(18,488
)
 
(22,128
)
 
(75,485
)
 
(71,183
)
Net income
27,394

 
41,797

 
120,552

 
127,751

Net income attributable to noncontrolling interests
(615
)
 
(735
)
 
(2,537
)
 
(1,588
)
Net income attributable to common stockholders
$
26,779

 
$
41,062

 
$
118,015

 
$
126,163

Basic earnings per share:
 
 
 
 
 
 
 
Net income attributable to common stockholders
$
0.13

 
$
0.19

 
$
0.56

 
$
0.58

Basic weighted average number of shares
211,954

 
214,914

 
211,721

 
216,974

Diluted earnings per share:

 
 
 
 
 
 
Net income attributable to common stockholders
$
0.12

 
$
0.19

 
$
0.55

 
$
0.57

Diluted weighted average number of shares
216,370

 
218,460

 
215,877

 
220,306

Dividends declared per share
$
0.07

 
$
0.06

 
$
0.20

 
$
0.17


(See notes to unaudited condensed consolidated financial statements)

4


SERVICE CORPORATION INTERNATIONAL
CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(UNAUDITED)

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
 
(In thousands)
 
(In thousands)
Net income
$
27,394

 
$
41,797

 
$
120,552

 
$
127,751

Other comprehensive income:
 
 
 
 
 
 
 
Foreign currency translation adjustments
7,497

 
13,513

 
(9,773
)
 
10,991

Total comprehensive income
34,891

 
55,310

 
110,779

 
138,742

Total comprehensive income attributable to noncontrolling interests
(620
)
 
(745
)
 
(2,532
)
 
(1,600
)
Total comprehensive income attributable to common stockholders
$
34,271

 
$
54,565

 
$
108,247

 
$
137,142


(See notes to unaudited condensed consolidated financial statements)



5


SERVICE CORPORATION INTERNATIONAL
CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED)
 
September 30, 2013
 
December 31, 2012
 
(In thousands, except share amounts)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
182,592

 
$
92,708

Receivables, net
78,990

 
101,817

Deferred tax assets
42,813

 
42,864

Inventories, net
24,612

 
24,560

Other
28,963

 
20,546

Total current assets
357,970

 
282,495

Preneed funeral receivables, net and trust investments
1,577,398

 
1,535,932

Preneed cemetery receivables, net and trust investments
2,003,478

 
1,826,835

Cemetery property, at cost
1,486,095

 
1,489,948

Property and equipment, net
1,623,187

 
1,641,101

Goodwill, net
1,377,946

 
1,382,410

Restricted Cash
419,548

 
4,457

Deferred charges and other assets
423,014

 
420,810

Cemetery perpetual care trust investments
1,120,726

 
1,099,580

Total assets
$
10,389,362

 
$
9,683,568

 
 
 
 
LIABILITIES & EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable and accrued liabilities
$
392,011

 
$
373,783

Current maturities of long-term debt
36,647

 
31,429

Income taxes
3,103

 
6,892

Total current liabilities
431,761

 
412,104

Long-term debt
2,257,103

 
1,916,621

Deferred preneed funeral revenues
523,091

 
536,647

Deferred preneed cemetery revenues
895,893

 
861,148

Deferred tax liability
530,670

 
471,198

Other liabilities
397,113

 
399,950

Deferred preneed funeral and cemetery receipts held in trust
2,793,456

 
2,624,321

Care trusts’ corpus
1,119,501

 
1,098,752

Commitments and contingencies (Note 15)

 

Equity:
 
 
 
Common stock, $1 per share par value, 500,000,000 shares authorized, 212,082,348 and 211,056,501 shares issued, respectively, and 211,960,401 and 211,046,501 shares outstanding, respectively
211,960

 
211,047

Capital in excess of par value
1,282,667

 
1,307,058

Accumulated deficit
(169,797
)
 
(286,795
)
Accumulated other comprehensive income
101,949

 
111,717

Total common stockholders’ equity
1,426,779

 
1,343,027

Noncontrolling interests
13,995

 
19,800

Total equity
1,440,774

 
1,362,827

Total liabilities and equity
$
10,389,362

 
$
9,683,568

(See notes to unaudited condensed consolidated financial statements)

6


SERVICE CORPORATION INTERNATIONAL
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)

 
Nine Months Ended
 
September 30,
 
2013
 
2012
 
(In thousands)
Cash flows from operating activities:
 
 
 
Net income
$
120,552

 
$
127,751

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Gains on early extinguishment of debt, net
(468
)
 

Depreciation and amortization
91,945

 
89,349

Amortization of intangible assets
16,619

 
17,950

Amortization of cemetery property
32,036

 
31,528

Amortization of loan costs
3,997

 
3,635

Provision for doubtful accounts
5,238

 
6,801

Provision for deferred income taxes
55,784

 
57,428

Losses (gains) on divestitures and impairment charges, net
5,533

 
(883
)
Share-based compensation
8,887

 
8,217

Excess tax benefits from share based awards
(6,083
)
 

Change in assets and liabilities, net of effects from acquisitions and divestitures:
 
 
 
Decrease in receivables
14,487

 
1,066

Increase in other assets
(14,636
)
 
(6,331
)
Increase in payables and other liabilities
24,767

 
6,623

Effect of preneed funeral production and maturities:
 
 
 
Decrease in preneed funeral receivables, net and trust investments
33,066

 
34,134

Decrease in deferred preneed funeral revenue
(10,202
)
 
(30,325
)
Decrease in deferred preneed funeral receipts held in trust
(34,026
)
 
(18,185
)
Effect of cemetery production and deliveries:
 
 
 
Increase in preneed cemetery receivables, net and trust investments
(49,500
)
 
(72,012
)
Increase in deferred preneed cemetery revenue
36,183

 
27,502

Decrease in deferred preneed cemetery receipts held in trust
(8,051
)
 
(480
)
Other
306

 
(3,481
)
Net cash provided by operating activities
326,434

 
280,287

Cash flows from investing activities:
 
 
 
Capital expenditures
(79,586
)
 
(80,973
)
Acquisitions
(8,543
)
 
(19,281
)
Proceeds from divestitures and sales of property and equipment, net
10,013

 
8,933

Net withdrawals (deposits) of resticted funds
341

 
(3,816
)
Net cash used in investing activities
(77,775
)
 
(95,137
)
Cash flows from financing activities:
 
 
 
Proceeds from issuance of long-term debt

 
17,907

Payments of debt
(91,794
)
 
(988
)
Principal payments on capital leases
(19,585
)
 
(19,303
)
Proceeds from exercise of stock options
4,954

 
17,347

Excess tax benefits from share based awards
6,083

 

Purchase of Company common stock
(1,708
)
 
(144,607
)
Payments of dividends
(42,371
)
 
(34,844
)
Purchase of noncontrolling interest
(8,333
)
 

Bank overdrafts and other
(5,479
)
 
868

Net cash used in financing activities
(158,233
)
 
(163,620
)
Effect of foreign currency on cash and cash equivalents
(542
)
 
1,448

Net increase in cash and cash equivalents
89,884

 
22,978

Cash and cash equivalents at beginning of period
92,708

 
128,569

Cash and cash equivalents at end of period
$
182,592

 
$
151,547

(See notes to unaudited condensed consolidated financial statements)

7


SERVICE CORPORATION INTERNATIONAL
CONDENSED CONSOLIDATED STATEMENT OF EQUITY
(UNAUDITED)
(In thousands)
 
Common
Stock
 
Treasury Stock
 
Capital in
Excess of
Par Value
 
Accumulated
Deficit
 
Accumulated
Other
Comprehensive
Income
 
Noncontrolling
Interests
 
Total
Balance at December 31, 2011
$
224,666

 
$
(1,710
)
 
$
1,430,330

 
$
(367,044
)
 
$
105,852

 
$
20,101

 
$
1,412,195

Comprehensive income

 

 

 
126,163

 
10,979

 
1,600

 
138,742

Dividends declared on common stock ($.17 per share)

 

 
(36,582
)
 

 

 

 
(36,582
)
Employee share-based compensation earned

 

 
8,217

 

 

 

 
8,217

Stock option exercises
2,853

 

 
14,494

 

 

 

 
17,347

Restricted stock awards, net of forfeitures
483

 

 
(483
)
 

 

 

 

Purchase of Company common stock

 
(12,400
)
 
(79,828
)
 
(52,379
)
 

 

 
(144,607
)
Noncontrolling interest payment

 

 

 

 

 
(405
)
 
(405
)
Other
82

 

 
866

 

 

 

 
948

Balance at September 30, 2012
$
228,084

 
$
(14,110
)
 
$
1,337,014

 
$
(293,260
)
 
$
116,831

 
$
21,296

 
$
1,395,855

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2012
211,057

 
(10
)
 
1,307,058

 
(286,795
)
 
111,717

 
19,800

 
1,362,827

Comprehensive income

 

 

 
118,015

 
(9,768
)
 
2,532

 
110,779

Dividends declared on common stock ($.20 per share)

 

 
(42,371
)
 

 

 

 
(42,371
)
Employee share-based compensation earned

 

 
8,887

 

 

 

 
8,887

Stock option exercises
573

 

 
4,524

 

 

 

 
5,097

Restricted stock awards, net of forfeitures
378

 
(3
)
 
(375
)
 

 

 

 

Purchase of Company common stock

 
(117
)
 
(717
)
 
(1,017
)
 

 

 
(1,851
)
Cancellation of Company Stock
(8
)
 
8

 

 

 

 

 

Tax Benefits Related to Share-Based Awards

 


 
6,083

 

 

 

 
6,083

Purchase of noncontrolling interest

 

 
(1,696
)
 

 

 
(6,637
)
 
(8,333
)
Noncontrolling interest payment

 

 

 

 

 
(1,700
)
 
(1,700
)
Other
82

 

 
1,274

 

 

 

 
1,356

Balance at September 30, 2013
$
212,082

 
$
(122
)
 
$
1,282,667

 
$
(169,797
)
 
$
101,949

 
$
13,995

 
$
1,440,774


(See notes to unaudited condensed consolidated financial statements)


8


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

9


1. Nature of Operations
We are North America’s largest provider of deathcare products and services, with a network of funeral service locations and cemeteries primarily operating in the United States and Canada. Our operations consist of funeral service locations, cemeteries, funeral service/cemetery combination locations, crematoria, and related businesses.
Funeral service locations provide all professional services relating to funerals and cremations, including the use of funeral facilities and motor vehicles and preparation and embalming services. Funeral-related merchandise, including caskets, casket memorialization products, burial vaults, cremation receptacles, cremation memorial products, flowers, and other ancillary products and services, is sold at funeral service locations. Cemeteries provide cemetery property interment rights, including developed lots, lawn crypts, and mausoleum spaces and sell cemetery-related merchandise and services, including stone and bronze memorials, markers, merchandise installations, and burial openings and closings. We also sell preneed funeral and cemetery merchandise and services whereby a customer contractually agrees to the terms of certain products and services to be provided in the future.
On May 29, 2013, we entered into a definitive agreement to acquire all of the outstanding shares of Stewart Enterprises, Inc. (Stewart) for $13.25 per share in cash. Stewart operates 217 funeral homes and 141 cemeteries as of July 31, 2013. The transaction provides us with an opportunity for growth consistent with our capital deployment strategy and will allow us the ability to serve a number of new, complementary areas, while enabling us to capitalize on what we believe will produce significant synergies and operating efficiencies. The transaction is valued at approximately $1.5 billion, which includes approximately $331.6 million of Stewart's debt. We expect to fund the transaction with cash on hand, the utilization of debt under our new credit agreement, the proceeds from the July 2013 issuance of our long-term senior notes as discussed in Note 9 and assuming $200.0 million of Stewart's debt. The acquisition is subject to, among other conditions, antitrust clearance. It is anticipated that the acquisition will be completed by the end of 2013 or in early 2014, however there can be no assurance that the acquisition will be completed by this time or at all.


10


2. Summary of Significant Accounting Policies
Principles of Consolidation and Basis of Presentation
Our unaudited condensed consolidated financial statements include the accounts of Service Corporation International (SCI) and all subsidiaries in which we hold a controlling financial interest. Our financial statements also include the accounts of the funeral merchandise and service trusts, cemetery merchandise and service trusts, and cemetery perpetual care trusts in which we have a variable interest and are the primary beneficiary. Our interim condensed consolidated financial statements are unaudited but include all adjustments, consisting of normal recurring accruals and any other adjustments, which management considers necessary for a fair statement of our results for these periods. Our unaudited condensed consolidated financial statements have been prepared in a manner consistent with the accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2012, unless otherwise disclosed herein, and should be read in conjunction therewith. The accompanying year-end condensed consolidated balance sheet data was derived from audited 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.
Reclassifications
Certain reclassifications have been made to prior amounts to conform to the current period financial statements presentation with no effect on our previously reported results of operations, consolidated financial position, or cash flows.
Use of Estimates in the Preparation of Financial Statements
The preparation of the unaudited condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions as described in our Annual Report on Form 10-K for the year ended December 31, 2012. These estimates and assumptions may affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the unaudited condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. As a result, actual results could differ from these estimates.
Preneed Funeral and Cemetery Receivables
We sell preneed funeral and cemetery contracts whereby the customer enters into arrangements for future merchandise and services prior to the time of need. As these contracts are entered into prior to the delivery of the related goods and services, the preneed funeral and cemetery receivables are offset by a comparable deferred revenue amount. These receivables generally have an interest component for which interest income is recorded when the interest amount is considered collectible and realizable, which typically coincides with cash payment. We do not accrue interest on financing receivables that are not paid in accordance with the contractual payment date given the nature of our goods and services, the nature of our contracts with customers, and the timing of the delivery of our services. We do not consider receivables to be past due until the service or goods are required to be delivered at which time the preneed receivable is paid or reclassified as a trade receivable with payment terms of less than 30 days. As the preneed funeral and cemetery receivables are offset by comparable deferred revenue amounts, we have no risk of loss related to these receivables.
If a preneed contract is canceled prior to delivery, state or provincial law governs the amount of the refund owed to the customer, if any, including the amount of the attributed investment earnings. Upon cancellation, we receive the amount of principal deposited to the trust and previously undistributed net investment earnings and, where required, issue a refund to the customer. We retain excess funds, if any, and recognize the attributed investment earnings (net of any investment earnings payable to the customer) as revenue in the consolidated statement of operations. In certain jurisdictions, we may be obligated to fund any shortfall if the amount deposited by the customers exceed the funds in trust. Based on our historical experience, we have provided an allowance for cancellation of these receivables, which is recorded as a reduction in receivables with a corresponding offset to deferred revenue.


11


3. Recently Issued Accounting Standards
Income Taxes
In July 2013, the Financial Accounting Standards Board (FASB) amended the Income Taxes Topic of the Accounting Standards Codification (ASC) to eliminate a diversity in practice for the presentation of unrecognized tax benefits when net operating loss carryforwards, similar tax losses, or tax credit carryforwards exist. The amendment requires that the unrecognized tax benefit be presented as a reduction of the deferred tax assets associated with the carryforwards except in certain circumstances when it would be reflected as a liability. This amendment is effective for us starting with our first quarter of 2014 and we are still evaluating the impact of adoption on our consolidated financial condition.
Foreign Currency
In March 2013, the FASB amended the Foreign Currency Matters Topic of the ASC to clarify the appropriate accounting when a parent ceases to have a controlling interest in a subsidiary or group of assets that is a business within a foreign entity. This clarification provides that the cumulative translation adjustment should only be released into net income if the loss of controlling interest represents complete or substantially complete liquidation of the foreign entity in which the subsidiary or asset group had resided. This amendment is effective for us starting with our first quarter of 2014 and adoption would impact our consolidated financial condition and results of operations if we dispose of a foreign entity.
Comprehensive Income
In February 2013, the FASB amended the Comprehensive Income Topic of the ASC to require reporting of amounts reclassified out of accumulated comprehensive income by component. We are required to present significant amounts reclassified to net income in their entirety by income statement line item and to cross reference any disclosure elsewhere in the notes for amounts reclassified in less than their entirety. We adopted this amendment effective January 1, 2013 and the appropriate disclosures are contained in Note 12.
Intangible Testing
In July 2012, the FASB amended the Intangibles - Goodwill and Other Topic of the ASC that allows us to make a qualitative assessment of whether it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount. If, after assessing the relevant information, we determine it is more likely than not that the fair value is more than the carrying amount, no additional analysis is necessary. If we determine it is more likely than not that the fair value is less than the carrying amount, then we are required to proceed to the quantitative approach. The amended guidance is effective for us as of our annual test in the fourth quarter of 2013, and adoption is not expected to impact our consolidated financial condition or results of operations.


12


4. Preneed Funeral Activities
Preneed funeral receivables, net and trust investments represent trust investments, including investment earnings, and customer receivables, net of unearned finance charges, related to unperformed, price-guaranteed preneed funeral contracts. Our funeral merchandise and service trusts are variable interest entities as defined in the Consolidation Topic of the ASC. In accordance with this guidance, we have determined that we are the primary beneficiary of these trusts, as we absorb a majority of the losses and returns associated with these trusts. Our cemetery trust investments detailed in Notes 5 and 6 are also accounted for as variable interest entities. When we receive payments from the customer, we deposit the amount required by law into the trust and reclassify the corresponding amount from Deferred preneed funeral revenues into Deferred preneed funeral and cemetery receipts held in trust. Amounts are withdrawn from the trusts after the contract obligations are performed. Cash flows from preneed funeral contracts are presented as operating cash flows in our unaudited condensed consolidated statement of cash flows.
 Preneed funeral receivables, net and trust investments are reduced by the trust investment earnings (realized and unrealized) that we have been allowed to withdraw in certain states prior to maturity. These earnings are recorded in Deferred preneed funeral revenues until the service is performed or the merchandise is delivered.
The table below sets forth certain investment-related activities associated with our preneed funeral merchandise and service trusts:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
 
(In thousands)
 
(In thousands)
Deposits
$
20,187

 
$
19,982

 
$
63,802

 
$
64,081

Withdrawals
24,242

 
22,943

 
92,491

 
78,034

Purchases of available-for-sale securities(1)
125,113

 
53,034

 
302,939

 
324,304

Sales of available-for-sale securities(1)
91,064

 
51,672

 
337,714

 
323,471

Realized gains from sales of available-for-sale securities
12,953

 
7,681

 
41,654

 
43,446

Realized losses from sales of available-for-sale securities
(2,212
)
 
(4,570
)
 
(8,378
)
 
(18,730
)
                                                                               
(1)
Reflects the rebalancing of Neptune Society trust assets during the current quarter.

The components of Preneed funeral receivables, net and trust investments in our unaudited condensed consolidated balance sheet at September 30, 2013 and December 31, 2012 are as follows:
 
September 30, 2013
 
December 31, 2012
 
(In thousands)
Trust investments, at fair value
$
1,005,320

 
$
977,973

Cash and cash equivalents
98,892

 
85,943

Insurance-backed fixed income securities
277,052

 
273,098

Trust investments
1,381,264

 
1,337,014

Receivables from customers
243,334

 
241,896

Unearned finance charge
(9,653
)
 
(8,645
)
 
1,614,945

 
1,570,265

Allowance for cancellation
(37,547
)
 
(34,333
)
Preneed funeral receivables, net and trust investments
$
1,577,398

 
$
1,535,932

The cost and fair values associated with our funeral merchandise and service trust investments recorded at fair value at September 30, 2013 and December 31, 2012 are detailed below. Cost reflects the investment (net of redemptions) of control holders in common trust funds, mutual funds, and private equity investments. Fair value represents the market value of the underlying securities held by the common trust funds, mutual funds at published values, and the estimated fair value of private equity investments (including debt as well as the estimated fair value related to the contract holder’s equity in majority-owned real estate investments).

13


 
September 30, 2013
 
Fair Value Hierarchy Level
 
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
 
 
 
 
 
(In thousands)
 
 
Fixed income securities:
 
 
 
 
 
 
 
 
 
U.S. Treasury
2
 
$
96,240

 
$
1,699

 
$
(4,499
)
 
$
93,440

Canadian government
2
 
105,784

 
48

 
(1,356
)
 
104,476

Corporate
2
 
50,520

 
2,864

 
(739
)
 
52,645

Residential mortgage-backed
2
 
2,362

 
20

 
(24
)
 
2,358

 
 
 
 
 
 
 
 
 
 
Equity securities:
 
 
 
 
 
 
 
 
 
Preferred stock
2
 
4,649

 
547

 
(50
)
 
5,146

Common stock:
 
 
 
 
 
 
 
 
 
United States
1
 
225,447

 
61,091

 
(3,989
)
 
282,549

Canada
1
 
23,793

 
2,912

 
(1,635
)
 
25,070

Other international
1
 
18,444

 
4,065

 
(509
)
 
22,000

Mutual funds:
 
 
 
 
 
 
 
 
 
Equity
1
 
175,783

 
17,256

 
(2,786
)
 
190,253

Fixed income
1
 
212,275

 
3,943

 
(17,339
)
 
198,879

Private equity
3
 
30,811

 
3,533

 
(7,359
)
 
26,985

Other
3
 
1,206

 
313

 

 
1,519

Trust investments
 
 
$
947,314

 
$
98,291

 
$
(40,285
)
 
$
1,005,320


 
December 31, 2012
 
Fair Value Hierarchy Level
 
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
 
 
 
 
 
(In thousands)
 
 
Fixed income securities:
 
 
 
 
 
 
 
 
 
U.S. Treasury
2
 
$
105,594

 
$
5,072

 
$
(880
)
 
$
109,786

Canadian government
2
 
110,399

 
861

 
(113
)
 
111,147

Corporate
2
 
51,611

 
2,531

 
(623
)
 
53,519

Residential mortgage-backed
2
 
3,123

 
57

 
(8
)
 
3,172

Asset-backed
2
 
129

 
3

 

 
132

Equity securities:
 
 
 
 
 
 
 
 
 
Preferred stock
2
 
3,603

 
211

 
(103
)
 
3,711

Common stock:
 
 
 
 
 
 
 
 
 
United States
1
 
230,971

 
38,514

 
(6,903
)
 
262,582

Canada
1
 
23,284

 
2,598

 
(1,271
)
 
24,611

Other international
1
 
18,089

 
1,874

 
(658
)
 
19,305

Mutual funds:
 
 
 
 
 
 
 
 
 
Equity
1
 
145,589

 
10,097

 
(6,728
)
 
148,958

Fixed income
1
 
225,365

 
7,314

 
(10,252
)
 
222,427

Private equity
3
 
36,626

 
221

 
(18,968
)
 
17,879

Other
3
 
542

 
202

 

 
744

Trust investments
 
 
$
954,925

 
$
69,555

 
$
(46,507
)
 
$
977,973


14


Where quoted prices are available in an active market, securities held by the common trust funds and mutual funds are classified as Level 1 investments pursuant to the three-level valuation hierarchy as required by the Fair Value Measurements and Disclosure (FVM&D) Topic of the ASC.
Where quoted market prices are not available for the specific security, fair values are estimated by using either quoted prices of securities with similar characteristics or an income approach fair value model with observable inputs that include a combination of interest rates, yield curves, credit risks, prepayment speeds, rating, and tax-exempt status. These funds are classified as Level 2 investments pursuant to the three-level valuation hierarchy as required by the FVM&D Topic of the ASC.
The valuation of private equity and other alternative investments requires management judgment due to the absence of quoted market prices, inherent lack of liquidity, and the long-term nature of such assets. The fair value of these investments is estimated based on the market value of the underlying real estate and private equity investments. The underlying real estate value is determined using the most recent available appraisals. As of September 30, 2013, private equity instruments are valued based on reported net asset values discounted by 0% to 20% for risk and 0% to 10% for liquidity. As of December 31, 2012, private equity instruments are valued based on reported net asset values discounted by 0% to 60% for risk and 0% to 25% for liquidity. A significant increase (decrease) in the discounts results in a directionally opposite change in the fair value of the instruments. Valuation policies and procedures are determined by our Trust Services department, which reports to our Chief Financial Officer.  Additionally, valuations are reviewed by our investment committee quarterly. These funds are classified as Level 3 investments pursuant to the three-level valuation hierarchy as required by the FVM&D Topic of the ASC.
As of September 30, 2013, our unfunded commitment for our private equity and other investments was $8.3 million which, if called, would be funded by the assets of the trusts. Our private equity and other investments include several funds that invest in limited partnerships, distressed debt, real estate, and mezzanine financing. These investments can never be redeemed by the funds. Instead, the nature of the investments in this category is that the distributions are received through the liquidation of the underlying assets of the funds. We estimate that the underlying assets will be liquidated over the next 2 to 10 years.
The change in our market-based funeral merchandise and service trust investments with significant unobservable inputs (Level 3) is as follows (in thousands):
 
Three Months Ended

September 30, 2013

September 30, 2012
 
Private Equity

Other

Private Equity

Other
Fair market value, beginning balance
$
26,333


$
1,457


$
16,359


$
909

Net unrealized gains (losses) included in Accumulated other comprehensive income(1)
1,830


256


(758
)

10

Net realized losses included in Other income, net(2)




(11
)

(1
)
Contributions
19




995



Distributions and other
(1,197
)

(194
)

(316
)

(4
)
Fair market value, ending balance
$
26,985


$
1,519


$
16,269


$
914


 
Nine Months Ended
 
September 30, 2013
 
September 30, 2012
 
Private Equity
 
Other
 
Private Equity
 
Other
Fair market value, beginning balance
$
17,879

 
$
744

 
$
15,986

 
$
912

Net unrealized gains (losses) included in Accumulated other comprehensive income(1)
14,441

 
1,126

 
(2,342
)
 
10

Net realized losses included in Other income, net(2)
(11
)
 
(2
)
 
(27
)
 
(1
)
Sales

 

 
(9
)
 

Contributions
2,221

 

 
3,554

 

Distributions and other
(7,545
)
 
(349
)
 
(893
)
 
(7
)
Fair market value, ending balance
$
26,985

 
$
1,519

 
$
16,269

 
$
914

                                                                               
(1)
All unrealized gains (losses) recognized in Accumulated other comprehensive income for our funeral merchandise and service trust investments are attributable to our preneed customers and are offset by a corresponding reclassification in Accumulated other comprehensive income to Deferred preneed funeral and cemetery receipts held in trust. See Note 7 for further information related to our Deferred preneed funeral and cemetery receipts held in trust.

15


(2)
All losses recognized in Other income, net for our funeral merchandise and service trust investments are attributable to our preneed customers and are offset by a corresponding reclassification in Other income, net to Deferred preneed funeral and cemetery receipts held in trust. See Note 7 for further information related to our Deferred preneed funeral and cemetery receipts held in trust.
Maturity dates of our fixed income securities range from 2013 to 2053. Maturities of fixed income securities, excluding mutual funds, at September 30, 2013 are estimated as follows:
 
Fair Value
 
(In thousands)
Due in one year or less
$
132,664

Due in one to five years
44,840

Due in five to ten years
44,962

Thereafter
30,453

 
$
252,919

   
Earnings from all our funeral merchandise and service trust investments are recognized in funeral revenues when a service is performed or merchandise is delivered. Fees charged by our wholly-owned registered investment advisor are also included in current revenues in the period in which they are earned. In addition, we are entitled to retain, in certain jurisdictions, a portion of collected customer payments when a customer cancels a preneed contract; these amounts are also recognized in current revenues. Recognized trust fund income (realized and unrealized) related to these trust investments were $11.4 million and $8.5 million for the three months ended September 30, 2013 and 2012, respectively. Recognized trust fund income (realized and unrealized) related to these trust investments were $35.7 million and $27.7 million for the nine months ended September 30, 2013 and 2012, respectively.
We assess our trust investments for other-than-temporary declines in fair value on a quarterly basis. Impairment charges resulting from this assessment are recognized as investment losses in Other income, net and a decrease to Preneed funeral receivables, net and trust investments. These investment losses, if any, are offset by the corresponding reclassification in Other income, net, which reduces Deferred preneed funeral receipts held in trust. See Note 7 for further information related to our Deferred preneed funeral receipts held in trust. For both the three months ended September 30, 2013 and 2012, we recorded a $0.2 million impairment charge for other-than-temporary declines in fair value related to unrealized losses on certain investments. For the nine months ended September 30, 2013 and 2012, we recorded a $0.8 million and a $0.7 million impairment charge, respectively, for other-than-temporary declines in fair value related to unrealized losses on certain investments.
We have determined that the remaining unrealized losses in our funeral merchandise and service trust investments are considered temporary in nature, as the unrealized losses were due to temporary fluctuations in interest rates and equity prices. The investments are diversified across multiple industry segments using a balanced allocation strategy to minimize long-term risk. We believe that none of the remaining securities are other-than-temporarily impaired based on our analysis of the investments. Our analysis included a review of the portfolio holdings and discussions with the individual money managers as to the sector exposures, credit ratings and the severity and duration of the unrealized losses. Our funeral merchandise and service trust investment unrealized losses, their associated fair values, and the duration of unrealized losses as of September 30, 2013 and December 31, 2012, respectively, are shown in the following tables:

16


 
September 30, 2013
 
In Loss Position
Less Than 12 Months
 
In Loss Position
Greater Than 12 Months
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
 
 
 
 
(In thousands)
 
 
 
 
Fixed income securities:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
29,033

 
$
(3,230
)
 
$
17,445

 
$
(1,269
)
 
$
46,478

 
$
(4,499
)
Canadian government
23,989

 
(1,100
)
 
6,252

 
(256
)
 
30,241

 
(1,356
)
Corporate
18,650

 
(446
)
 
4,317

 
(293
)
 
22,967

 
(739
)
Residential mortgage-backed
1,322

 
(23
)
 
19

 
(1
)
 
1,341

 
(24
)
Equity securities:
 
 
 
 
 
 
 
 
 
 
 
Preferred stock
1,214

 
(50
)
 

 

 
1,214

 
(50
)
Common stock:
 
 
 
 
 
 
 
 
 
 
 
United States
46,129

 
(3,097
)
 
4,069

 
(892
)
 
50,198

 
(3,989
)
Canada
4,590

 
(696
)
 
2,686

 
(939
)
 
7,276

 
(1,635
)
Other international
4,820

 
(358
)
 
740

 
(151
)
 
5,560

 
(509
)
Mutual funds:
 
 
 
 
 
 
 
 
 
 
 
Equity
15,211

 
(122
)
 
13,344

 
(2,664
)
 
28,555

 
(2,786
)
Fixed income
65,418

 
(3,149
)
 
53,809

 
(14,190
)
 
119,227

 
(17,339
)
Private equity

 

 
13,687

 
(7,359
)
 
13,687

 
(7,359
)
Total temporarily impaired securities
$
210,376

 
$
(12,271
)
 
$
116,368

 
$
(28,014
)
 
$
326,744

 
$
(40,285
)

 
December 31, 2012
 
In Loss Position
Less Than 12 Months
 
In Loss Position
Greater Than 12 Months
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
 
 
 
 
(In thousands)
 
 
 
 
Fixed income securities:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
22,357

 
$
(803
)
 
$
6,741

 
$
(77
)
 
$
29,098

 
$
(880
)
Canadian government
7,912

 
(113
)
 

 

 
7,912

 
(113
)
Corporate
7,809

 
(347
)
 
4,283

 
(276
)
 
12,092

 
(623
)
Residential mortgage-backed
956

 
(8
)
 

 

 
956

 
(8
)
Equity securities:
 
 
 
 
 
 
 
 
 
 
 
Preferred stock
1,220

 
(93
)
 
52

 
(10
)
 
1,272

 
(103
)
Common stock:
 
 
 
 
 
 
 
 
 
 
 
United States
70,752

 
(4,694
)
 
9,089

 
(2,209
)
 
79,841

 
(6,903
)
Canada
6,592

 
(652
)
 
2,516

 
(619
)
 
9,108

 
(1,271
)
Other international
7,606

 
(521
)
 
608

 
(137
)
 
8,214

 
(658
)
Mutual funds:
 
 
 
 
 
 
 
 
 
 
 
Equity
6,779

 
(126
)
 
26,340

 
(6,602
)
 
33,119

 
(6,728
)
Fixed income
38,686

 
(1,021
)
 
24,131

 
(9,231
)
 
62,817

 
(10,252
)
Private equity

 

 
17,389

 
(18,968
)
 
17,389

 
(18,968
)
Total temporarily impaired securities
$
170,669

 
$
(8,378
)
 
$
91,149

 
$
(38,129
)
 
$
261,818

 
$
(46,507
)


17


5. Preneed Cemetery Activities
 Preneed cemetery receivables, net and trust investments represent trust investments, including investment earnings, and customer receivables, net of unearned finance charges, for contracts sold in advance of when the property interment rights, merchandise, or services are needed. Our cemetery merchandise and service trusts are variable interest entities as defined in the Consolidation Topic of the ASC. In accordance with this guidance, we have determined that we are the primary beneficiary of these trusts, as we absorb a majority of the losses and returns associated with these trusts. The trust investments detailed in Notes 4 and 6 are also accounted for as variable interest entities. When we receive payments from the customer, we deposit the amount required by law into the trust and reclassify the corresponding amount from Deferred preneed cemetery revenues into Deferred preneed funeral and cemetery receipts held in trust. Amounts are withdrawn from the trusts when the contract obligations are performed. Cash flows from preneed cemetery contracts are presented as operating cash flows in our unaudited condensed consolidated statement of cash flows.
Preneed cemetery receivables, net and trust investments are reduced by the trust investment earnings (realized and unrealized) that we have been allowed to withdraw in certain states prior to maturity. These earnings are recorded in Deferred preneed cemetery revenues until the service is performed or the merchandise is delivered.
The table below sets forth certain investment-related activities associated with our preneed cemetery merchandise and service trusts:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
 
(In thousands)
 
(In thousands)
Deposits
$
27,407

 
$
25,010

 
$
81,019

 
$
75,717

Withdrawals
26,542

 
28,260

 
89,881

 
75,623

Purchases of available-for-sale securities
98,803

 
114,549

 
395,200

 
443,613

Sales of available-for-sale securities
73,171

 
111,663

 
407,503

 
428,350

Realized gains from sales of available-for-sale securities
19,965

 
9,754

 
66,284

 
57,636

Realized losses from sales of available-for-sale securities
(3,454
)
 
(6,962
)
 
(12,509
)
 
(25,028
)
The components of Preneed cemetery receivables, net and trust investments in our unaudited condensed consolidated balance sheet at September 30, 2013 and December 31, 2012 are as follows:
 
September 30, 2013
 
December 31, 2012
 
(In thousands)
Trust investments, at fair value
$
1,314,770

 
$
1,204,084

Cash and cash equivalents
99,682

 
86,923

Insurance-backed fixed income securities
4

 
9

Trust investments
1,414,456

 
1,291,016

Receivables from customers
673,342

 
614,599

Unearned finance charges
(30,430
)
 
(29,471
)
 
2,057,368

 
1,876,144

Allowance for cancellation
(53,890
)
 
(49,309
)
Preneed cemetery receivables, net and trust investments
$
2,003,478

 
$
1,826,835

The cost and fair values associated with our cemetery merchandise and service trust investments recorded at fair value at September 30, 2013 and December 31, 2012 are detailed below. Cost reflects the investment (net of redemptions) of control holders in common trust funds, mutual funds, and private equity investments. Fair value represents the market value of the underlying securities held by the common trust funds, mutual funds at published values, and the estimated fair value of private equity investments.

18


 
September 30, 2013
 
Fair Value Hierarchy Level
 
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
 
 
 
 
 
(In thousands)
 
 
Fixed income securities:
 
 
 
 
 
 
 
 
 
U.S. Treasury
2
 
$
109,856

 
$
2,436

 
$
(6,712
)
 
$
105,580

Canadian government
2
 
17,720

 
122

 
(320
)
 
17,522

Corporate
2
 
47,354

 
4,182

 
(654
)
 
50,882

Residential mortgage-backed
2
 
145

 
2

 
(1
)
 
146

Equity securities:
 
 
 
 
 
 
 
 
 
Preferred stock
2
 
7,744

 
892

 
(68
)
 
8,568

Common stock:
 
 
 
 
 
 
 
 
 
United States
1
 
368,746

 
115,819

 
(4,591
)
 
479,974

Canada
1
 
14,556

 
3,169

 
(1,010
)
 
16,715

Other international
1
 
32,773

 
8,507

 
(678
)
 
40,602

Mutual funds:
 
 
 
 
 
 
 
 
 
Equity
1
 
279,475

 
42,647

 
(2,512
)
 
319,610

Fixed income
1
 
270,478

 
6,126

 
(30,178
)
 
246,426

Private equity
3
 
26,894

 
4,258

 
(3,737
)
 
27,415

Other
3
 
1,089

 
242

 
(1
)
 
1,330

Trust investments
 
 
$
1,176,830

 
$
188,402

 
$
(50,462
)
 
$
1,314,770


 
December 31, 2012
 
Fair Value Hierarchy Level
 
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
 
 
 
 
 
(In thousands)
 
 
Fixed income securities:
 
 
 
 
 
 
 
 
 
U.S. Treasury
2
 
$
99,630

 
$
7,925

 
$
(841
)
 
$
106,714

Canadian government
2
 
17,562

 
402

 
(83
)
 
17,881

Corporate
2
 
43,515

 
2,456

 
(775
)
 
45,196

Residential mortgage-backed
2
 
150

 
4

 

 
154

Equity securities:
 
 
 
 
 
 
 
 
 
Preferred stock
2
 
5,840

 
334

 
(196
)
 
5,978

Common stock:
 
 
 
 
 
 
 
 
 
United States
1
 
363,190

 
71,613

 
(7,716
)
 
427,087

Canada
1
 
16,026

 
2,862

 
(846
)
 
18,042

Other international
1
 
29,889

 
3,687

 
(857
)
 
32,719

Mutual funds:
 
 
 
 
 
 
 
 
 
Equity
1
 
279,265

 
19,520

 
(9,921
)
 
288,864

Fixed income
1
 
251,687

 
10,975

 
(19,350
)
 
243,312

Private equity
3
 
32,785

 
77

 
(15,175
)
 
17,687

Other
3
 
407

 
44

 
(1
)
 
450

Trust investments
 
 
$
1,139,946

 
$
119,899

 
$
(55,761
)
 
$
1,204,084

Where quoted prices are available in an active market, securities held by the common trust funds and mutual funds are classified as Level 1 investments pursuant to the three-level valuation hierarchy as required by the FVM&D Topic of the ASC.
Where quoted market prices are not available for the specific security, fair values are estimated by using either quoted prices of securities with similar characteristics or an income approach fair value model with observable inputs that include a combination

19


of interest rates, yield curves, credit risks, prepayment speeds, rating, and tax-exempt status. These funds are classified as Level 2 investments pursuant to the three-level valuation hierarchy as required by the FVM&D Topic of the ASC.
The valuation of private equity and other alternative investments requires management judgment due to the absence of quoted market prices, inherent lack of liquidity, and the long-term nature of such assets. The fair value of these investments is estimated based on the market value of the underlying real estate and private equity investments. The underlying real estate value is determined using the most recent available appraisals. As of September 30, 2013, private equity instruments are valued based on reported net asset values discounted by 0% to 20% for risk and 0% to 10% for liquidity. As of December 31, 2012, private equity instruments are valued based on reported net asset values discounted by 0% to 60% for risk and 0% to 25% for liquidity. A significant increase (decrease) in the discounts results in a directionally opposite change in the fair value of the instruments. Valuation policies and procedures are determined by our Trust Services department, which reports to our Chief Financial Officer.  Additionally, valuations are reviewed by our investment committee quarterly. These funds are classified as Level 3 investments pursuant to the three-level valuation hierarchy as required by the FVM&D Topic of the ASC.
As of September 30, 2013, our unfunded commitment for our private equity and other investments was $8.6 million which, if called, would be funded by the assets of the trusts. Our private equity and other investments include several funds that invest in limited partnerships, distressed debt, real estate, and mezzanine financing. These investments can never be redeemed by the funds. Instead, the nature of the investments in this category is that the distributions are received through the liquidation of the underlying assets of the funds. We estimate that the underlying assets will be liquidated over the next 2 to 10 years.
The change in our market-based cemetery merchandise and service trust investments with significant unobservable inputs (Level 3) is as follows (in thousands):
 
Three Months Ended
 
September 30, 2013
 
September 30, 2012
 
Private Equity
 
Other
 
Private Equity
 
Other
Fair market value, beginning balance
$
26,627

 
$
1,258

 
$
15,796

 
$
433

Net unrealized gains (losses) included in Accumulated other comprehensive income(1)
2,015

 
277

 
(458
)
 
16

Net realized losses included in Other income, net(2)

 

 
(12
)
 
(1
)
Contributions
21

 

 
1,044

 

Distributions and other
(1,248
)
 
(205
)
 
(362
)
 
(7
)
Fair market value, ending balance
$
27,415

 
$
1,330

 
$
16,008

 
$
441


 
Nine Months Ended
 
September 30, 2013
 
September 30, 2012
 
Private Equity
 
Other
 
Private Equity
 
Other
Fair market value, beginning balance
$
17,687

 
$
450

 
$
15,219

 
$
436

Net unrealized gains (losses) included in Accumulated other comprehensive income(1)
15,245

 
1,253

 
(1,937
)
 
18

Net realized losses included in Other income, net(2)
(13
)
 
(3
)
 
(30
)
 
(2
)
Contributions
2,356

 

 
3,760

 

Distributions and other
(7,860
)
 
(370
)
 
(1,004
)
 
(11
)
Fair market value, ending balance
$
27,415

 
$
1,330

 
$
16,008

 
$
441

                                                                             
(1)
All unrealized gains (losses) recognized in Accumulated other comprehensive income for our cemetery merchandise and service trust investments are attributable to our preneed customers and are offset by a corresponding reclassification in Accumulated other comprehensive income to Deferred preneed funeral and cemetery receipts held in trust. See Note 7 for further information related to our Deferred preneed funeral and cemetery receipts held in trust.
(2)
All losses recognized in Other income, net for our cemetery merchandise and service trust investments are attributable to our preneed customers and are offset by a corresponding reclassification in Other income, net to Deferred preneed funeral and cemetery receipts held in trust. See Note 7 for further information related to our Deferred preneed funeral and cemetery receipts held in trust.
Maturity dates of our fixed income securities range from 2013 to 2043. Maturities of fixed income securities, excluding mutual funds, at September 30, 2013 are estimated as follows:

20


 
Fair Value
 
(In thousands)
Due in one year or less
$
23,074

Due in one to five years
59,767

Due in five to ten years
43,707

Thereafter
47,582

 
$
174,130

Earnings from all our cemetery merchandise and service trust investments are recognized in current cemetery revenues when a service is performed or merchandise is delivered. Fees charged by our wholly-owned registered investment advisor are also included in current revenues in the period in which they are earned. In addition, we are entitled to retain, in certain jurisdictions, a portion of collected customer payments when a customer cancels a preneed contract; these amounts are also recognized in current revenues. Recognized trust fund income (realized and unrealized) related to these trust investments were $9.2 million and $6.7 million for the three months ended September 30, 2013 and 2012, respectively. Recognized trust fund income (realized and unrealized) related to these trust investments were $28.1 million and $20.0 million for the nine months ended September 30, 2013 and 2012, respectively.
We assess our trust investments for other-than-temporary declines in fair value on a quarterly basis. Impairment charges resulting from this assessment are recognized as investment losses in Other income, net and a decrease to Preneed cemetery receivables, net and trust investments. These investment losses, if any, are offset by the corresponding reclassification in Other income, net, which reduces Deferred preneed cemetery receipts held in trust. See Note 7 for further information related to our Deferred preneed cemetery receipts held in trust. For both the three months ended September 30, 2013 and 2012, we recorded a $0.2 million impairment charge, respectively, for other-than-temporary declines in fair value related to unrealized losses on certain investments. For the nine months ended September 30, 2013 and 2012, we recorded a $1.5 million and a $0.8 million impairment charge, respectively, for other-than-temporary declines in fair value related to unrealized losses on certain investments.
We have determined that the remaining unrealized losses in our cemetery merchandise and service trust investments are considered temporary in nature, as the unrealized losses were due to temporary fluctuations in interest rates and equity prices. The investments are diversified across multiple industry segments using a balanced allocation strategy to minimize long-term risk. We believe that none of the remaining securities are other-than-temporarily impaired based on our analysis of the investments. Our analysis included a review of the portfolio holdings and discussions with the individual money managers as to the sector exposures, credit ratings, and the severity and duration of the unrealized losses. Our cemetery merchandise and service trust investment unrealized losses, their associated fair values and the duration of unrealized losses as of September 30, 2013 are shown in the following tables:

21


 
September 30, 2013
 
In Loss Position
Less Than 12 Months
 
In Loss Position
Greater Than 12 Months
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
 
 
 
 
(In thousands)
 
 
 
 
Fixed income securities:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
50,411

 
$
(5,255
)
 
$
16,678

 
$
(1,457
)
 
$
67,089

 
$
(6,712
)
Canadian government
9,713

 
(195
)
 
3,204

 
(125
)
 
12,917

 
(320
)
Corporate
15,191

 
(438
)
 
3,301

 
(216
)
 
18,492

 
(654
)
      Residential mortgage-backed
71

 
(1
)
 

 

 
71

 
(1
)
Equity securities:
 
 
 
 
 
 
 
 
 
 
 
Preferred stock
2,197

 
(68
)
 

 

 
2,197

 
(68
)
Common stock:
 
 
 
 
 
 
 
 
 
 
 
United States
64,772

 
(3,944
)
 
3,618

 
(647
)
 
68,390

 
(4,591
)
Canada
1,922

 
(434
)
 
1,881

 
(576
)
 
3,803

 
(1,010
)
Other international
8,001

 
(483
)
 
856

 
(195
)
 
8,857

 
(678
)
Mutual funds:
 
 
 
 
 
 
 
 
 
 
 
Equity
20,440

 
(406
)
 
14,252

 
(2,106
)
 
34,692

 
(2,512
)
Fixed income
110,221

 
(6,748
)
 
38,656

 
(23,430
)
 
148,877

 
(30,178
)
Private equity

 

 
6,863

 
(3,737
)
 
6,863

 
(3,737
)
Other

 

 
316

 
(1
)
 
316

 
(1
)
Total temporarily impaired securities
$
282,939

 
$
(17,972
)
 
$
89,625

 
$
(32,490
)
 
$
372,564

 
$
(50,462
)


 
December 31, 2012
 
In Loss Position
Less Than 12 Months
 
In Loss Position
Greater Than 12 Months
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
 
 
 
 
(In thousands)
 
 
 
 
Fixed income securities:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
28,626

 
$
(841
)
 
$

 
$

 
$
28,626

 
$
(841
)
Canadian government
5,319

 
(83
)
 

 

 
5,319

 
(83
)
Corporate
14,060

 
(571
)
 
2,137

 
(204
)
 
16,197

 
(775
)
Equity securities:
 
 
 
 
 
 
 
 
 
 
 
Preferred stock
1,497

 
(143
)
 
126

 
(53
)
 
1,623

 
(196
)
Common stock:
 
 
 
 
 
 
 
 
 
 
 
United States
82,989

 
(5,624
)
 
11,131

 
(2,092
)
 
94,120

 
(7,716
)
Canada
3,114

 
(461
)
 
1,115

 
(385
)
 
4,229

 
(846
)
Other international
9,056

 
(655
)
 
741

 
(202
)
 
9,797

 
(857
)
Mutual funds:
 
 
 
 
 
 
 
 
 
 
 
Equity
28,132

 
(1,427
)
 
43,172

 
(8,494
)
 
71,304

 
(9,921
)
Fixed income
54,533

 
(2,205
)
 
29,104

 
(17,145
)
 
83,637

 
(19,350
)
Private equity
46

 
(17
)
 
17,136

 
(15,158
)
 
17,182

 
(15,175
)
Other
8

 

 
378

 
(1
)
 
386

 
(1
)
Total temporarily impaired securities
$
227,380

 
$
(12,027
)
 
$
105,040

 
$
(43,734
)
 
$
332,420

 
$
(55,761
)


22


6. Cemetery Perpetual Care Trusts
We are required by state and provincial law to pay into cemetery perpetual care trusts a portion of the proceeds from the sale of cemetery property interment rights. Our cemetery perpetual care trusts are variable interest entities as defined in the Consolidation Topic of the ASC. In accordance with this guidance, we have determined that we are the primary beneficiary of these trusts, as we absorb a majority of the losses and returns associated with these trusts. The merchandise and service trust investments detailed in Notes 4 and 5 are also accounted for as variable interest entities. We consolidate our cemetery perpetual care trust investments with a corresponding amount recorded as Care trusts’ corpus. Cash flows from cemetery perpetual care trusts are presented as operating cash flows in our unaudited condensed consolidated statement of cash flows.
The table below sets forth certain investment-related activities associated with our cemetery perpetual care trusts:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
 
(In thousands)
 
(In thousands)
Deposits
$
6,139

 
$
6,501

 
$
19,789

 
$
18,866

Withdrawals
9,388

 
9,239

 
26,009

 
23,422

Purchases of available-for-sale securities
23,050

 
24,467

 
113,497

 
126,478

Sales of available-for-sale securities
25,805

 
27,733

 
82,556

 
101,110

Realized gains from sales of available-for-sale securities
4,871

 
3,328

 
13,772

 
7,522

Realized losses from sales of available-for-sale securities
(966
)
 
(1,518
)
 
(1,728
)
 
(5,435
)
The components of Cemetery perpetual care trust investments in our unaudited condensed consolidated balance sheet at September 30, 2013 and December 31, 2012 are as follows:
 
September 30, 2013
 
December 31, 2012
 
(In thousands)
Trust investments, at fair value
$
1,080,618

 
$
1,045,568

Cash and cash equivalents
40,108

 
54,012

Cemetery perpetual care trust investments
$
1,120,726

 
$
1,099,580

The cost and fair values associated with our cemetery perpetual care trust investments recorded at fair value at September 30, 2013 and December 31, 2012 are detailed below. Cost reflects the investment (net of redemptions) of control holders in common trust funds, mutual funds, and private equity investments. Fair value represents the value of the underlying securities or cash held by the common trust funds, mutual funds at published values, and the estimated fair value of private equity investments.

23


 
September 30, 2013
 
Fair Value Hierarchy Level
 
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
 
 
 
 
 
(In thousands)
 
 
Fixed income securities:
 
 
 
 
 
 
 
 
 
U.S. Treasury
2
 
$
731

 
$
16

 
$
(5
)
 
$
742

Canadian government
2
 
30,329

 
217

 
(561
)
 
29,985

Corporate
2
 
23,038

 
250

 
(222
)
 
23,066

Residential mortgage-backed
2
 
1,322

 
16

 
(11
)
 
1,327

Asset-backed
2
 
160

 
2

 
(2
)
 
160

Equity securities:
 
 
 
 
 
 
 
 
 
Preferred stock
2
 
3,359

 
174

 
(40
)
 
3,493

Common stock:
 
 
 
 
 
 
 
 
 
United States
1
 
179,225

 
37,782

 
(3,398
)
 
213,609

Canada
1
 
8,409

 
1,722

 
(726
)
 
9,405

Other international
1
 
6,885

 
704

 
(363
)
 
7,226

Mutual funds:
 
 
 
 
 
 
 
 
 
Equity
1
 
15,071

 
4,435

 
(59
)
 
19,447

Fixed income
1
 
708,858

 
35,127

 
(2,829
)
 
741,156

Private equity
3
 
28,215

 
475

 
(8,853
)
 
19,837

Other
3
 
10,011

 
1,154

 

 
11,165

Cemetery perpetual care trust investments
 
 
$
1,015,613

 
$
82,074

 
$
(17,069
)
 
$
1,080,618


 
December 31, 2012
 
Fair Value Hierarchy Level
 
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
 
 
 
 
 
(In thousands)
 
 
Fixed income securities:
 
 
 
 
 
 
 
 
 
U.S. Treasury
2
 
$
820

 
$
45

 
$
(1
)
 
$
864

Canadian government
2
 
30,159

 
709

 
(140
)
 
30,728

Corporate
2
 
22,877

 
537

 
(51
)
 
23,363

Residential mortgage-backed
2
 
1,498

 
41

 
(2
)
 
1,537

Asset-backed
2
 
161

 
10

 

 
171

Equity securities:
 
 
 
 
 
 
 
 
 
Preferred stock
2
 
5,637

 
61

 
(938
)
 
4,760

Common stock:
 
 
 
 
 
 
 
 


United States
1
 
163,173

 
19,609

 
(3,389
)
 
179,393

Canada
1
 
8,954

 
1,568

 
(731
)
 
9,791

Other international
1
 
14,693

 
1,392

 
(447
)
 
15,638

Mutual funds:
 
 
 
 
 
 
 
 
 
Equity
1
 
16,999

 
2,102

 
(211
)
 
18,890

Fixed income
1
 
680,921

 
61,172

 
(441
)
 
741,652

Private equity
3
 
24,727

 
338

 
(13,943
)
 
11,122

Other
3
 
9,653

 
1,110

 
(3,104
)
 
7,659

Cemetery perpetual care trust investments
 
 
$
980,272

 
$
88,694

 
$
(23,398
)
 
$
1,045,568

Where quoted prices are available in an active market, securities held by the common trust funds and mutual funds are classified as Level 1 investments pursuant to the three-level valuation hierarchy as required by the FVM&D Topic of the ASC.

24


Where quoted market prices are not available for the specific security, fair values are estimated by using either quoted prices of securities with similar characteristics or an income approach fair value model with observable inputs that include a combination of interest rates, yield curves, credit risks, prepayment speeds, rating, and tax-exempt status. These funds are classified as Level 2 investments pursuant to the three-level valuation hierarchy as required by the FVM&D Topic of the ASC.
The valuation of private equity and other alternative investments requires management judgment due to the absence of quoted market prices, inherent lack of liquidity, and the long-term nature of such assets. The fair value of these investments is estimated based on the market value of the underlying real estate and private equity investments. The underlying real estate value is determined using the most recent available appraisals. As of September 30, 2013, private equity instruments are valued based on reported net asset values discounted by 0% to 20% for risk and 0% to 10% for liquidity. As of December 31, 2012, private equity instruments are valued based on reported net asset values discounted by 0% to 60% for risk and 0% to 25% for liquidity. A significant increase (decrease) in the discounts results in a directionally opposite change in the fair value of the instruments. Valuation policies and procedures are determined by our Trust Services department, which reports to our Chief Financial Officer.  Additionally, valuations are reviewed by our investment committee quarterly. These funds are classified as Level 3 investments pursuant to the three-level valuation hierarchy as required by the FVM&D Topic of the ASC.
As of September 30, 2013, our unfunded commitment for our private equity and other investments was $1.4 million which, if called, would be funded by the assets of the trusts. Our private equity and other investments include several funds that invest in limited partnerships, distressed debt, real estate, and mezzanine financing. These investments can never be redeemed by the funds. Instead, the nature of the investments in this category is that the distributions are received through the liquidation of the underlying assets of the funds. We estimate that the underlying assets will be liquidated over the next 2 to 10 years.
The change in our market-based cemetery perpetual care trust investments with significant unobservable inputs (Level 3) is as follows (in thousands):
 
Three Months Ended
 
September 30, 2013
 
September 30, 2012
 
Private Equity
 
Other
 
Private Equity
 
Other
Fair market value, beginning balance
$
18,649

 
$
10,815

 
$
11,609

 
$
7,314

Net unrealized gains (losses) included in Accumulated other comprehensive income(1)
1,315

 
492

 
552

 
276

Net realized losses included in Other income, net(2)
(5
)
 
(3
)
 
(33
)
 
(8
)
Contributions

 

 
465

 

Distributions and other
(122
)
 
(139
)
 
(1,708
)
 
(129
)
Fair market value, ending balance
$
19,837

 
$
11,165

 
$
10,885

 
$
7,453


 
Nine Months Ended
 
September 30, 2013
 
September 30, 2012
 
Private Equity
 
Other
 
Private Equity
 
Other
Fair market value, beginning balance
$
11,122

 
$
7,659

 
$
10,849

 
$
6,890

Net unrealized gains included in Accumulated other comprehensive income(1)
7,404

 
3,926

 
670

 
813

Net realized losses included in Other income, net(2)
(100
)
 
(56
)
 
(103
)
 
(26
)
Sales

 

 
(26
)
 

Contributions
2,317

 

 
3,244

 

Distributions and other
(906
)
 
(364
)
 
(3,749
)
 
(224
)
Fair market value, ending balance
$
19,837

 
$
11,165

 
$
10,885

 
$
7,453

                                                                               
(1)
All unrealized gains (losses) recognized in Accumulated other comprehensive income for our cemetery perpetual care trust investments are offset by a corresponding reclassification in Accumulated other comprehensive income to Care trusts’ corpus. See Note 7 for further information related to our Care trusts’ corpus.
(2)
All (losses) gains recognized in Other income, net for our cemetery perpetual care trust investments are offset by a corresponding reclassification in Other income, net to Care trusts’ corpus. See Note 7 for further information related to our Care trusts’ corpus.

25


Maturity dates of our fixed income securities range from 2013 to 2043. Maturities of fixed income securities at September 30, 2013 are estimated as follows:
 
Fair Value
 
(In thousands)
Due in one year or less
$
7,764

Due in one to five years
27,927

Due in five to ten years
18,576

Thereafter
1,013

 
$
55,280

Distributable earnings from these cemetery perpetual care trust investments are recognized in current cemetery revenues to the extent we incur qualifying cemetery maintenance costs. Fees charged by our wholly-owned registered investment advisor are also included in current revenues in the period in which they are earned. Recognized trust fund income related to these trust investments were $9.5 million and $10.5 million for the three months ended September 30, 2013 and 2012, respectively. Recognized trust fund income related to these trust investments were $31.2 million and $29.6 million for the nine months ended September 30, 2013 and 2012, respectively.
We assess our trust investments for other-than-temporary declines in fair value on a quarterly basis. Impairment charges resulting from this assessment are recognized as investment losses in Other income, net and a decrease to Cemetery perpetual care trust investments. These investment losses, if any, are offset by the corresponding reclassification in Other income, net, which reduces Care trusts’ corpus. See Note 7 for further information related to our Care trusts’ corpus. For the three months ended September 30, 2013 and 2012, we did not record an impairment charge for other-than-temporary declines in fair value related to unrealized losses on certain investments. For the nine months ended September 30, 2013 and 2012, we recorded a $0.2 million and a $0.3 million impairment charge, respectively, for other-than-temporary declines in fair value related to unrealized losses on certain investments.
We have determined that the remaining unrealized losses in our cemetery perpetual care trust investments are considered temporary in nature, as the unrealized losses were due to temporary fluctuations in interest rates and equity prices. The investments are diversified across multiple industry segments using a balanced allocation strategy to minimize long-term risk. We believe that none of the remaining securities are other-than-temporarily impaired based on our analysis of the investments. Our analysis included a review of the portfolio holdings, and discussions with the individual money managers as to the sector exposures, credit ratings, and the severity and duration of the unrealized losses. Our cemetery perpetual care trust investment unrealized losses, their associated fair values and the duration of unrealized losses, are shown in the following tables.

26


 
September 30, 2013
 
In Loss Position
Less Than 12 Months
 
In Loss Position
Greater Than 12 Months
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
 
 
 
 
(In thousands)
 
 
 
 
Fixed income securities:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
356

 
$
(5
)
 
$
18

 
$

 
$
374

 
$
(5
)
Canadian government
16,705

 
(346
)
 
5,421

 
(215
)
 
22,126

 
(561
)
Corporate
11,231

 
(108
)
 
3,486

 
(114
)
 
14,717

 
(222
)
Residential mortgage-backed
560

 
(11
)
 
2

 

 
562

 
(11
)
Asset-backed
66

 
(1
)
 
15

 
(1
)
 
81

 
(2
)
Equity securities:
 
 
 
 
 
 
 
 
 
 
 
Preferred stock
1,083

 
(20
)
 
160

 
(20
)
 
1,243

 
(40
)
Common stock:
 
 
 
 
 
 
 
 
 
 
 
United States
30,801

 
(2,644
)
 
2,426

 
(754
)
 
33,227

 
(3,398
)
Canada
822

 
(96
)
 
1,817

 
(630
)
 
2,639

 
(726
)
Other international
2,977

 
(195
)
 
723

 
(168
)
 
3,700

 
(363
)
Mutual funds:
 
 
 
 
 
 
 
 
 
 
 
Equity
221

 
(14
)
 
207

 
(45
)
 
428

 
(59
)
Fixed income
134,626

 
(1,960
)
 
28,430

 
(869
)
 
163,056

 
(2,829
)
Private equity

 

 
19,333

 
(8,853
)
 
19,333

 
(8,853
)
Total temporarily impaired securities
$
199,448

 
$
(5,400
)
 
$
62,038

 
$
(11,669
)
 
$
261,486

 
$
(17,069
)

 
December 31, 2012
 
In Loss Position
Less Than 12 Months
 
In Loss Position
Greater Than 12 Months
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
 
 
 
 
(In thousands)
 
 
 
 
Fixed income securities:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
373

 
$
(1
)
 
$

 
$

 
$
373

 
$
(1
)
Canadian government
9,145

 
(140
)
 

 

 
9,145

 
(140
)
Corporate
5,439

 
(33
)
 
1,886

 
(18
)
 
7,325

 
(51
)
Residential mortgage-backed
183

 
(2
)
 

 

 
183

 
(2
)
Equity securities:
 
 
 
 
 
 
 
 
 
 
 
Preferred stock
3,115

 
(639
)
 
973

 
(299
)
 
4,088

 
(938
)
Common stock:
 
 
 
 
 
 
 
 
 
 
 
United States
38,323

 
(2,403
)
 
7,495

 
(986
)
 
45,818

 
(3,389
)
Canada
1,246

 
(281
)
 
1,055

 
(450
)
 
2,301

 
(731
)
Other international
4,712

 
(389
)
 
696

 
(58
)
 
5,408

 
(447
)
Mutual funds:
 
 
 
 
 
 
 
 
 
 
 
Equity
2,654

 
(127
)
 
404

 
(84
)
 
3,058

 
(211
)
Fixed income
10,552

 
(37
)
 
31,837

 
(404
)
 
42,389

 
(441
)
Private equity

 

 
10,752

 
(13,943
)
 
10,752

 
(13,943
)
Other

 

 
6,308

 
(3,104
)
 
6,308

 
(3,104
)
Total temporarily impaired securities
$
75,742

 
$
(4,052
)
 
$
61,406

 
$
(19,346
)
 
$
137,148

 
$
(23,398
)


27


7. Deferred Preneed Funeral and Cemetery Receipts Held in Trust and Care Trusts’ Corpus
Deferred Preneed Funeral and Cemetery Receipts Held in Trust
We consolidate the merchandise and service trusts associated with our preneed funeral and cemetery activities in accordance with the Consolidation Topic of the ASC. Although the guidance requires the consolidation of the merchandise and service trusts, it does not change the legal relationships among the trusts, us, or our customers. The customers are the legal beneficiaries of these merchandise and service trusts, and therefore their interests in these trusts represent a liability to us.
The components of Deferred preneed funeral and cemetery receipts held in trust in our unaudited condensed consolidated balance sheet at September 30, 2013 and December 31, 2012 are detailed below.
 
September 30, 2013
 
December 31, 2012
 
Preneed
Funeral
 
Preneed
Cemetery
 
Total
 
Preneed
Funeral
 
Preneed
Cemetery
 
Total
 
(In thousands)
 
(In thousands)
Trust investments
$
1,381,264

 
$
1,414,456

 
$
2,795,720

 
$
1,337,014

 
$
1,291,016

 
$
2,628,030

Accrued trust operating payables and other
(911
)
 
(1,353
)
 
(2,264
)
 
(1,827
)
 
(1,882
)
 
(3,709
)
Deferred preneed funeral and cemetery receipts held in trust
$
1,380,353

 
$
1,413,103

 
$
2,793,456

 
$
1,335,187

 
$
1,289,134

 
$
2,624,321

Care Trusts’ Corpus
The Care trusts’ corpus reflected in our unaudited condensed consolidated balance sheet represents the cemetery perpetual care trusts, including the related accrued expenses.
The components of Care trusts’ corpus in our unaudited condensed consolidated balance sheet at September 30, 2013 and December 31, 2012 are detailed below.
 
September 30, 2013
 
December 31, 2012
 
(In thousands)
Cemetery perpetual care trust investments
$
1,120,726

 
$
1,099,580

Accrued trust operating payables and other
(1,225
)
 
(828
)
Care trusts’ corpus
$
1,119,501

 
$
1,098,752

Other Income, Net
The components of Other income, net in our unaudited condensed consolidated statement of operations for the three and nine months ended September 30, 2013 and 2012 are detailed below. See Notes 4, 5, and 6 for further discussion of the amounts related to the funeral, cemetery, and cemetery perpetual care trusts.
 
Three Months Ended September 30, 2013
 
Funeral
Trusts
 
Cemetery
Trusts
 
Cemetery Perpetual
Care Trusts
 
Other, Net
 
Total
 
 
 
(In thousands)
 
 
Realized gains
$
12,953

 
$
19,965

 
$
4,871

 
$

 
$
37,789

Realized losses
(2,212
)
 
(3,454
)
 
(966
)
 

 
(6,632
)
Impairment charges
(157
)
 
(218
)
 

 

 
(375
)
Interest, dividend, and other ordinary income
2,470

 
3,171

 
5,372

 

 
11,013

Trust expenses and income taxes
(2,705
)
 
(3,512
)
 
(273
)
 

 
(6,490
)
Net trust investment income
10,349

 
15,952

 
9,004

 

 
35,305

Reclassification to deferred preneed funeral and cemetery receipts held in trust and care trusts’ corpus
(10,349
)
 
(15,952
)
 
(9,004
)
 

 
(35,305
)
Other income, net

 

 

 
666

 
666

Total other income, net
$

 
$

 
$

 
$
666

 
$
666



28


 
Nine Months Ended September 30, 2013
 
Funeral
Trusts
 
Cemetery
Trusts
 
Cemetery Perpetual
Care Trusts
 
Other, Net
 
Total
 
 
 
(In thousands)
 
 
Realized gains
$
41,654

 
$
66,284

 
$
13,772

 
$

 
$
121,710

Realized losses
(8,378
)
 
(12,509
)
 
(1,728
)
 

 
(22,615
)
Impairment charges
(803
)
 
(1,515
)
 
(189
)
 

 
(2,507
)
Interest, dividend, and other ordinary income
18,493

 
13,615

 
19,245

 

 
51,353

Trust expenses and income taxes
(7,743
)
 
(10,268
)
 
(1,857
)
 

 
(19,868
)
Net trust investment income
43,223

 
55,607

 
29,243

 

 
128,073

Reclassification to deferred preneed funeral and cemetery receipts held in trust and care trusts’ corpus
(43,223
)
 
(55,607
)
 
(29,243
)
 

 
(128,073
)
Other expense, net

 

 

 
(1,017
)
 
(1,017
)
Total other expense, net
$

 
$

 
$

 
$
(1,017
)
 
$
(1,017
)

 
Three Months Ended September 30, 2012
 
Funeral
Trusts
 
Cemetery
Trusts
 
Cemetery Perpetual
Care Trusts
 
Other, Net
 
Total
 
 
 
(In thousands)
 
 
Realized gains
$
7,681

 
$
9,754

 
$
3,328

 
$

 
$
20,763

Realized losses
(4,570
)
 
(6,962
)
 
(1,518
)
 

 
(13,050
)
Impairment charges
(151
)
 
(189
)
 
(4
)
 

 
(344
)
Interest, dividend, and other ordinary income
2,083

 
2,247

 
8,113

 

 
12,443

Trust expenses and income taxes
(2,288
)
 
(3,116
)
 
(727
)
 

 
(6,131
)
Net trust investment income
2,755

 
1,734

 
9,192

 

 
13,681

Reclassification to deferred preneed funeral and cemetery receipts held in trust and care trusts’ corpus
(2,755
)
 
(1,734
)
 
(9,192
)
 

 
(13,681
)
Other income, net

 

 

 
2,317

 
2,317

Total other income, net
$

 
$

 
$

 
$
2,317

 
$
2,317


 
Nine Months Ended September 30, 2012
 
Funeral
Trusts
 
Cemetery
Trusts
 
Cemetery Perpetual
Care Trusts
 
Other, Net
 
Total
 
 
 
(In thousands)
 
 
Realized gains
$
43,446

 
$
57,636

 
$
7,522

 
$

 
$
108,604

Realized losses
(18,730
)
 
(25,028
)
 
(5,435
)
 

 
(49,193
)
Impairment charges
(725
)
 
(781
)
 
(258
)
 

 
(1,764
)
Interest, dividend, and other ordinary income
10,834

 
8,308

 
22,170

 

 
41,312

Trust expenses and income taxes
(7,236
)
 
(9,367
)
 
(635
)
 

 
(17,238
)
Net trust investment income
27,589

 
30,768

 
23,364

 

 
81,721

Reclassification to deferred preneed funeral and cemetery receipts held in trust and care trusts’ corpus
(27,589
)
 
(30,768
)
 
(23,364
)
 

 
(81,721
)
Other income, net

 

 

 
4,001

 
4,001

Total other income, net
$

 
$

 
$

 
$
4,001

 
$
4,001


8. Income Taxes

Income tax expense during interim periods is based on our estimated annual effective income tax rate plus any discrete items which are recorded in the period in which they occur. Discrete items include, among others, such events as changes in estimates due to the finalization of tax returns, tax audit settlements, expiration of statute of limitations, and increases or decreases in valuation allowances on deferred tax assets. Our effective tax rate was 40.3% and 34.6% for the three months ended September 30, 2013

29


and 2012, respectively. Our effective tax rate was 38.5% and 35.8% for the nine months ended September 30, 2013 and 2012, respectively. The lower effective tax rate for the nine months ended September 30, 2012 was primarily due to the benefits associated with the settlement of a tax audit discussed below. The effective tax rate for the third quarter of 2013 is above the 35% federal statutory tax rate due to state tax expense which is partially offset by foreign earnings taxed at lower rates.
Internal Revenue Service Settlement
Our affiliate, SCI Funeral and Cemetery Purchasing Cooperative ("COOP"), is a corporation taxed under subchapter T of the United States Internal Revenue Code, the operation of which has resulted in the deferral of tax payments. The Internal Revenue Service (IRS), in connection with its audits of the COOP's 2003 - 2005 federal income tax returns, proposed adjustments that would accelerate amounts that the Company had previously deferred and would result in the payment of interest on those deferred tax payments. We reached a partial settlement with the IRS in the first quarter of 2012 and as a result the Company made a payment of $6.6 million which reduced our tax expense by $3.1 million for the three months ended March 31, 2012 for adjustments to our "unrecognized tax benefits" – that is, the aggregate tax effect of differences between tax return positions and the benefits recognized in our financial statements, and other tax matters.
Unrecognized Tax Benefits
As of September 30, 2013, the gross amount of our unrecognized tax benefits was $132.5 million and the gross amount of our accrued interest was $43.8 million. During the nine months ended September 30, 2013, our unrecognized tax benefit decreased by $11.5 million which did not significantly impact the unaudited condensed statement of operations since the majority of unrecognized tax benefits relate to temporary items. This is primarily due to the expiration of statute of limitations and a decrease in liability related to U.S. tax positions taken in prior years. Additional interest expense of $2.2 million was accrued during the quarter.
A number of years may elapse before particular tax matters, for which we have unrecognized tax benefits, are audited and finally settled. While we have effectively concluded our 2003 - 2005 tax years with respect to our affiliate the COOP, SCI and Subsidiaries' tax years 1999 - 2005 remain under review at the IRS Appeals level. SCI and Subsidiaries received a letter of no change to its tax liability for the years 2008 - 2010. Furthermore, SCI and its affiliates are under audit by various state and foreign jurisdictions for years through 2010. The outcome of each of these audits cannot be predicted at this time. It is reasonably possible that the amount of our unrecognized tax benefits could significantly increase or decrease over the next twelve months either because we prevail on positions or because the tax authorities prevail. Due to the uncertainty regarding the timing of completion of audits and possible outcomes, a current estimate of the range of increases or decreases that may occur within the next twelve months cannot be made.


30


9. Debt
Debt as of September 30, 2013 and December 31, 2012 was as follows:
 
September 30, 2013
 
December 31, 2012
 
(In thousands)
7.875% Debentures due February 2013
$

 
$
4,757

6.75% Senior Notes due April 2015
136,465

 
136,465

6.75% Senior Notes due April 2016
197,377

 
197,377

7.0% Senior Notes due June 2017
295,000

 
295,000

7.625% Senior Notes due October 2018
250,000

 
250,000

7.0% Senior Notes due May 2019
250,000

 
250,000

4.5% Senior Notes due November 2020
200,000

 
200,000

8.0% Senior Notes due November 2021
150,000

 
150,000

5.375% Senior Notes due January 2022
425,000

 

7.5% Senior Notes due April 2027
200,000

 
200,000

Bank credit facility

 
86,600

Obligations under capital leases
189,011

 
176,445

Mortgage notes and other debt, maturities through 2047
4,711

 
5,698

Unamortized pricing discounts and other
(3,814
)
 
(4,292
)
Total debt
2,293,750

 
1,948,050

Less current maturities
(36,647
)
 
(31,429
)
Total long-term debt
$
2,257,103

 
$
1,916,621

Current maturities of debt at September 30, 2013 were primarily comprised of our capital leases. Our consolidated debt had a weighted average interest rate of 5.72% and 6.28% at September 30, 2013 and December 31, 2012, respectively. Approximately 92% and 87% of our total debt had a fixed interest rate at September 30, 2013 and December 31, 2012, respectively.

Stewart Acquisition Financing
In conjunction with our entry into a definitive agreement to acquire Stewart (See Note 1) on May 28, 2013, the Company also entered into an agreement with a leading bank to provide $1.825 billion of committed financing. This committed financing consisted of a $500 million replacement revolving facility (to be provided in the event amendments to SCI's existing bank credit facility could not be obtained), a $600 million term loan, and a $725 million senior unsecured bridge facility.
In July 2013, we entered into a new credit agreement with a syndicate of banks. The new $1.1 billion credit agreement replaces the existing $500 million bank credit facility providing for a new $500 million bank credit facility and a $600 million term loan, both maturing in July 2018. A significant amount of the term loan will be drawn upon the closing of and used to fund the Stewart Acquisition and includes quarterly amortization requirements. After the acquisition, the credit agreement requires us to use the first $200 million of divestiture proceeds to prepay our term loan while our leverage ratio exceeds 3.75X (net debt to EBITDA as defined in the credit agreement). The new $500 million bank credit facility will be used partially to fund the Stewart acquisition, but will primarily exist to provide the Company with flexibility for general corporate purposes.
In June 2013, Stewart launched a consent solicitation from the holders of Stewart's $200 million 6.5% senior notes due April 2019, which notes are expected to remain outstanding after our acquisition of Stewart. The consent solicitation requested, among other things, the waiver of the holders' change of control rights as they relate to the Stewart acquisition. Consenting holders received a 0.25% fee based on the aggregate principal amount of notes for which consents were delivered (half of which was immediately payable and half of which will be paid upon the closing of the Stewart acquisition), and upon the closing of the Stewart Acquisition, SCI will provide a guarantee of the notes. This consent solicitation was successful and the applicable waivers will only be effective upon closing of the Stewart acquisition.
Finally, in July 2013, the Company issued $425 million in 5.375% Senior Notes due January 2022, in a private placement offering made in accordance with rule 144A under the Securities Act of 1933. Pending the closing of the Stewart acquisition, the net proceeds are being held in an escrow account and reported as restricted cash. The issuance of these notes was a non-cash financing activity as the funds were deposited directly to the escrow account. In the event the Stewart acquisition does not close, SCI is required to redeem the notes at par value to the bond holders. The notes are subject to the provisions of the Company's Senior Indenture dated as of February 1, 1993, as amended, which includes certain covenants limiting, among other things, the creation of liens securing indebtedness and sale-leaseback transactions.

31


With the aforementioned $1.1 billion credit agreement and the newly issued $425 million Senior Notes, we believe we have completed the necessary financing to fund the Stewart acquisition when the transaction closes.
Bank Credit Agreement
As of September 30, 2013, the Company had a $500 million bank credit facility due July 2018 with a syndicate of banks.
In conjunction with entering into the new bank credit facility, all outstanding cash advances of $86.6 million were repaid. Our new bank credit facility includes a $175 million sublimit for letters of credit and provides us with flexibility for working capital, if needed, and is guaranteed by a majority of our domestic subsidiaries. The subsidiary guaranty is a guaranty of payment of the outstanding amount of the total lending commitment, including letters of credit. The bank credit facility contains certain financial covenants, including a minimum interest coverage ratio, a maximum leverage ratio, and certain dividend and share repurchase restrictions. We have no outstanding cash advances under our bank credit facility but currently do use it to support $31.8 million of letters of credit. We pay a quarterly fee on the unused commitment, which was 0.25% for the third quarter. As of September 30, 2013, we have $468.2 million in borrowing capacity under the bank credit facility.
Debt Extinguishments and Reductions
During the first nine months of 2013, we paid an aggregate of $19.7 million to retire $19.6 million in capital lease obligations and $0.1 million to retire other debt. Certain of the above transactions resulted in the recognition of a gain of $0.5 million recorded in Gains on early extinguishment of debt, net in our unaudited condensed consolidated statement of operations.
During the first nine months of 2012, we paid an aggregate of $19.3 million to retire capital lease obligations with no associated gain or loss recognized on early extinguishment of this debt.
Capital Leases
During the nine months ended September 30, 2013 and 2012, we acquired $34.0 million and $51.0 million, respectively, of capital leases, primarily related to transportation equipment.

10. Credit Risk and Fair Value of Financial Instruments
Fair Value Estimates
The fair value estimates of the following financial instruments have been determined using available market information and appropriate valuation methodologies. The carrying values of cash and cash equivalents, trade receivables, and trade payables approximate the fair values of those instruments due to the short-term nature of the instruments. The fair values of receivables on preneed funeral and cemetery contracts are impracticable to estimate because of the lack of a trading market and the diverse number of individual contracts with varying terms.
The fair value of our debt instruments at September 30, 2013 and December 31, 2012 was as follows:
 
September 30, 2013
 
December 31, 2012
 
(In thousands)
7.875% Debentures due February 2013
$

 
$
4,786

6.75% Senior Notes due April 2015
145,676

 
150,112

6.75% Senior Notes due April 2016
216,621

 
222,049

7.0% Senior Notes due June 2017
327,450

 
341,094

7.625% Senior Notes due October 2018
284,560

 
298,750

7.0% Senior Notes due May 2019
266,875

 
276,250

4.5% Senior Notes due November 2020
190,500

 
204,500

8.0% Senior Notes due November 2021
170,250

 
186,000

5.375% Senior Notes due January 2022
407,469

 

7.5% Senior Notes due April 2027
207,500

 
215,500

Bank credit facility

 
86,600

Mortgage notes and other debt, maturities through 2047
4,711

 
5,698

Total fair value of debt instruments
$
2,221,612

 
$
1,991,339

The fair values of our long-term, fixed rate loans were estimated using market prices for those loans, and therefore they are classified within Level 1 of the Fair Value Measurements hierarchy as required by the FVM&D Topic of the ASC. The bank credit

32


agreement and the mortgage and other debt are classified within Level 3 of the Fair Value Measurements hierarchy. The fair values of these instruments have been estimated using discounted cash flow analysis based on our incremental borrowing rate for similar borrowing arrangements. A significant increase (decrease) in the inputs results in a directionally opposite change in the fair value of the instruments.

11. Share-Based Compensation
Stock Benefit Plans
We utilize the Black-Scholes option valuation model for estimating the fair value of our stock options. This model uses a range of assumptions related to volatility, the risk-free interest rate, the expected life, and the dividend yield. The fair values of our stock options are calculated using the following weighted average assumptions for the nine months ended September 30, 2013:
 
 
Nine Months Ended
Assumptions
 
September 30, 2013
Dividend yield
 
1.9
%
Expected volatility
 
35.2
%
Risk-free interest rate
 
0.7
%
Expected holding period (in years)
 
4.0

Stock Options
The following table sets forth stock option activity for the nine months ended September 30, 2013:
 
Options
 
Weighted-Average
Exercise Price
Outstanding at December 31, 2012
12,401,970

 
$
8.84

Granted
2,041,330

 
$
15.26

Exercised
(573,335
)
 
$
8.89

Canceled
(36,397
)
 
$
10.31

Outstanding at September 30, 2013
13,833,568

 
$
9.78

Exercisable at September 30, 2013
9,719,085

 
$
8.50

As of September 30, 2013, the unrecognized compensation expense related to stock options of $9.7 million is expected to be recognized over a weighted average period of 1.4 years.
Restricted Shares
Restricted share activity for the nine months ended September 30, 2013 was as follows:
 
Restricted
shares
 
Weighted-Average
Grant-Date
Fair Value
Nonvested restricted shares at December 31, 2012
1,104,579

 
$
9.78

Granted
378,280

 
$
15.26

Vested
(296,886
)
 
$
8.63

Canceled
(2,744
)
 
$
10.32

Nonvested restricted shares at September 30, 2013
1,183,229

 
$
11.81

As of September 30, 2013, the unrecognized compensation expense related to restricted shares of $7.5 million is expected to be recognized over a weighted average period of 1.4 years.

12. Equity
(All shares reported in whole numbers)
Our components of Accumulated other comprehensive income are as follows:

33


 
Foreign
Currency
Translation
Adjustment
 
Unrealized
Gains and
Losses
 
Accumulated
Other
Comprehensive
Income
 
 
 
(In thousands)
 
 
Balance at December 31, 2012
$
111,717

 
$

 
$
111,717

Activity in 2013
(9,768
)
 

 
(9,768
)
Increase in net unrealized gains associated with available-for-sale securities of the trusts, net of taxes

 
67,271

 
67,271

Reclassification of net unrealized gain activity attributable to the Deferred preneed funeral and cemetery receipts held in trust and Care trusts’ corpus’, net of taxes

 
(67,271
)
 
(67,271
)
Balance at September 30, 2013
$
101,949

 
$

 
$
101,949

The assets and liabilities of foreign operations are translated into U.S. dollars using the current exchange rate. The U.S. dollar amount that arises from such translation, as well as exchange gains and losses on intercompany balances of a long-term investment nature, are included in the foreign currency translation adjustment in Accumulated other comprehensive income.
Cash Dividends
On August 14, 2013, our Board of Directors approved a cash dividend of $.07 per common share. This dividend, totaling $14.8 million, was paid on September 30, 2013.
Share Repurchase Program
Subject to market conditions, normal trading restrictions, and limitations in our debt covenants, we may make purchases in the open market or through privately negotiated transactions under our stock repurchase program. During the nine months ended September 30, 2013, there were no share repurchases under our share repurchase program. The remaining dollar value of shares authorized to be purchased under our share repurchase program was approximately $190.1 million at September 30, 2013.
Noncontrolling Interests
During the nine months ended September 30, 2013, we acquired an additional 10% of the outstanding shares of The Neptune Society, Inc. for $8.3 million, increasing our ownership from 70% to 80%.

13. Segment Reporting
Our operations are both product based and geographically based, and the reportable operating segments presented below include our funeral and cemetery operations. Our geographic areas include United States, Canada, and Germany. We conduct both funeral and cemetery operations in the United States and Canada and funeral operations in Germany.
Our reportable segment information is as follows:
 
Funeral
 
Cemetery
 
Reportable
Segments
 
(In thousands)
Three Months Ended September 30,
 
 
 
 
 
Revenues from external customers:
 
 
 
 
 
2013
$
399,581

 
$
210,370

 
$
609,951

2012
$
388,365

 
$
192,817

 
$
581,182

Gross profits:
 
 
 
 
 
2013
$
67,088

 
$
48,991

 
$
116,079

2012
$
75,992

 
$
45,279

 
$
121,271

Nine Months Ended September 30,
 
 
 
 
 
Revenues from external customers:
 
 
 
 
 
2013
$
1,277,419

 
$
610,389

 
$
1,887,808

2012
$
1,209,067

 
$
571,993

 
$
1,781,060

Gross profits:
 
 
 
 
 
2013
$
267,457

 
$
134,043

 
$
401,500

2012
$
257,703

 
$
119,324

 
$
377,027


34


The following table reconciles gross profits from reportable segments to our consolidated income before income taxes:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
 
(In thousands)
 
(In thousands)
Gross profits from reportable segments
$
116,079

 
$
121,271

 
$
401,500

 
$
377,027

General and administrative expenses
(33,764
)
 
(26,410
)
 
(95,792
)
 
(81,927
)
Gains (losses) on divestitures and impairment charges, net
981

 
315

 
(5,533
)
 
883

Operating income
83,296

 
95,176

 
300,175

 
295,983

Interest expense
(38,080
)
 
(33,568
)
 
(103,589
)
 
(101,050
)
Gains on early extinguishment of debt, net

 

 
468

 

Other income (expense), net
666

 
2,317

 
(1,017
)
 
4,001

Income before income taxes
$
45,882

 
$
63,925

 
$
196,037

 
$
198,934

Our geographic area information is as follows:
 
United
States
 
Canada
 
Germany
 
Total
 
 
 
(In thousands)
 
 
Three Months Ended September 30,
 
 
 
 
 
 
 
Revenues from external customers:
 
 
 
 
 
 
 
2013
$
552,128

 
$
56,462

 
$
1,361

 
$
609,951

2012
$
523,600

 
$
56,280

 
$
1,302

 
$
581,182

Nine Months Ended September 30,
 
 
 
 
 
 
 
Revenues from external customers:
 
 
 
 
 
 
 
2013
$
1,717,909

 
$
165,330

 
$
4,569

 
$
1,887,808

2012
$
1,615,128

 
$
161,411

 
$
4,521

 
$
1,781,060


14. Supplementary Information
Revenues and Costs and Expenses
The detail of certain income statement accounts as presented in the unaudited condensed consolidated statement of operations is as follows:

35


 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
 
(In thousands)
 
(In thousands)
Property and merchandise revenues:
 
 
 
 
 
 
 
Funeral
$
138,015

 
$
133,756

 
$
441,767

 
$
412,039

Cemetery
153,770

 
137,787

 
433,249

 
403,620

Total property and merchandise revenues
291,785

 
271,543

 
875,016

 
815,659

Services revenues:
 
 
 
 
 
 
 
Funeral
231,511

 
228,392

 
748,217

 
720,285

Cemetery
49,921

 
48,854

 
157,706

 
147,356

Total services revenues
281,432

 
277,246

 
905,923

 
867,641

Other revenues
36,734

 
32,393

 
106,869

 
97,760

Total revenues
$
609,951

 
$
581,182

 
$
1,887,808

 
$
1,781,060

Property and merchandise costs and expenses:
 
 
 
 
 
 
 
Funeral
$
62,945

 
$
61,183

 
$
204,694

 
$
194,557

Cemetery
62,429

 
55,163

 
183,500

 
171,744

Total cost of property and merchandise
125,374

 
116,346

 
388,194

 
366,301

Services costs and expenses:
 
 
 
 
 
 
 
Funeral
138,420

 
131,076

 
414,481

 
390,489

Cemetery
24,318

 
23,984

 
76,869

 
74,542

Total cost of services
162,738

 
155,060

 
491,350

 
465,031

Overhead and other expense
205,760

 
188,505

 
606,764

 
572,701

Total costs and expenses
$
493,872

 
$
459,911

 
$
1,486,308

 
$
1,404,033


Non-Cash Investing Transactions
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
 
(In thousands)
 
(In thousands)
Options exercised by attestation

 

 
143

 

Shares repurchased

 

 
(143
)
 


15. Commitments and Contingencies
Insurance Loss Reserves
We purchase comprehensive general liability, morticians’ and cemetery professional liability, automobile liability, and workers’ compensation insurance coverage structured with high deductibles. The high-deductible insurance program means we are primarily self-insured for claims and associated costs and losses covered by these policies. As of September 30, 2013 and December 31, 2012, we have self-insurance reserves of $60.7 million and $57.5 million, respectively.
Litigation
We are a party to various litigation matters, investigations, and proceedings. For each of our outstanding legal matters, we evaluate the merits of the case, our exposure to the matter, possible legal or settlement strategies, and the likelihood of an unfavorable outcome. We intend to vigorously defend ourselves in the lawsuits described herein; however, if we determine that an unfavorable outcome is probable and can be reasonably estimated, we establish the necessary accruals. We hold certain insurance policies that may reduce cash outflows with respect to an adverse outcome of certain of these litigation matters. We accrue such insurance recoveries when they become probable of being paid and can be reasonably estimated.

36


Burial Practices Claims. We are named as a defendant in various lawsuits alleging improper burial practices at certain of our cemetery locations. These lawsuits include but are not limited to the Garcia, Sands, and Schwartz lawsuits described in the following paragraphs.
Reyvis Garcia and Alicia Garcia v. Alderwoods Group, Inc., Osiris Holding of Florida, Inc., a Florida corporation, d/b/a Graceland Memorial Park South, f/k/a Paradise Memorial Gardens, Inc., was filed in December 2004, in the Circuit Court of the Eleventh Judicial Circuit in and for Miami-Dade County, Florida, Case No. 04-25646 CA 32. Plaintiffs are the son and sister of the decedent, Eloisa Garcia, who was buried at Graceland Memorial Park South in March 1986, when the cemetery was owned by Paradise Memorial Gardens, Inc. Initially, the suit sought damages on the individual claims of the plaintiffs relating to the burial of Eloisa Garcia. Plaintiffs claimed that due to poor recordkeeping, spacing issues and maps, and the fact that the family could not afford to purchase a marker for the grave, the burial location of the decedent could not be readily located. Subsequently, the decedent’s grave was located and verified. In July 2006, plaintiffs amended their complaint, seeking to certify a class of all persons buried at this cemetery whose burial sites cannot be located, claiming that this was due to poor recordkeeping, maps, and surveys at the cemetery. Plaintiffs subsequently filed a third amended class action complaint and added two additional named plaintiffs. The plaintiffs are seeking unspecified monetary damages, as well as equitable and injunctive relief. On May 4, 2011, the trial court certified a class and we appealed that ruling. On July 31, 2013, the Court of Appeals reversed the order certifying the case. We cannot quantify our ultimate liability, if any, for the payment of any damages.
F. Charles Sands, individually and on behalf of all others similarly situated, v. Eden Memorial Park, et al.; Case No. BC421528; in the Superior Court of the State of California for the County of Los Angeles — Central District. This case was filed in September 2009 against SCI and certain subsidiaries regarding our Eden Memorial Park cemetery in Mission Hills, California. The plaintiff seeks compensatory, consequential and punitive damages as well as the appointment of a receiver to oversee cemetery operations. The plaintiff alleges the cemetery engaged in wrongful burial practices and did not disclose them to customers. After a hearing in February 2012, the court in May 2012 issued an order certifying classes of cemetery plot owners and their families based on alleged Company misrepresentation, concealment or nondisclosure of material facts regarding alleged improper burial practices pertaining to the period from February 1985 to September 2009. Pursuant to a court order, the Company may be precluded from making certain arguments that challenge the sufficiency of plaintiff's physical evidence, although the extent to which that order will apply at trial remains unclear. The case is scheduled for trial in November 2013. We cannot quantify our ultimate liability, if any, for the payment of any damages.
Barbara Schwartz & Carol Neitlich, Individually and on behalf of all others similarly situated v. SCI Funeral Services of Florida, Inc., et al.; Case No. 2012CA015954, In the Circuit Court of the 15th Judicial District in and for Palm Beach County, Florida. This lawsuit has been removed to the U.S. District Court for the Southern District of Florida and is now Case No. 9:12-CV-80180-DMM. This case was filed by counsel for plaintiffs in the Sands case regarding our Star of David Memorial Gardens Cemetery and Funeral Chapel and Bailey Memorial Gardens located in North Lauderdale, Florida. Plaintiffs seek to certify a class of cemetery plot owners and their families. Plaintiffs allege the cemetery engaged in wrongful burial practices and did not disclose them to customers. Plaintiffs seek compensatory, consequential and punitive damages as well as the appointment of a receiver to oversee the cemetery operations. On our motion, the court dismissed the plaintiffs' claims in March 2013. The plaintiffs are appealing the dismissal. We cannot quantify our ultimate liability, if any, for the payment of any damages.
Wage and Hour Claims. We are named a defendant in various lawsuits alleging violations of federal and state laws regulating wage and hour overtime pay, including but not limited to the Bryant and Helm lawsuits described below.
 Bryant, et al. v. Service Corporation International, et al.; Case No. RG-07359593; and Helm, et al. v. AWGI & SCI; Case No. RG-07359602; in the Superior Court of the State of California, County of Alameda. These cases were filed on December 5, 2007. These cases were removed to federal court in the U.S. District Court for the Northern District of California, San Francisco/Oakland Division. The Bryant case is now Case No. 3:08-CV-01190-SI and the Helm case is now Case No. C 08-01184-SI. On December 29, 2009, the court in the Helm case denied the plaintiffs’ motion to certify the case as a class action. The plaintiffs modified and refiled their motion for certification. On March 9, 2011, the court denied plaintiffs’ renewed motions to certify a class in both of the Bryant and Helm cases and dismissed the Helm case. The Helm plaintiff is appealing the court's order decertifying her claims. The individual claims in the Bryant case are still pending. The plaintiffs have also (i) filed additional lawsuits with similar allegations seeking class certification of state law claims in different states, and (ii) made a large number of demands for arbitration. We cannot quantify our ultimate liability, if any, in these lawsuits.
Claims Regarding Acquisition of Stewart Enterprises. We are named as a defendant in the following lawsuit.
Karen Moulton, Individually and on behalf of all others similarly situated v. Stewart Enterprises, Inc., Service Corporation International and others; Case No. 2013-5636; in the Civil District Court Parish of New Orleans. This case was filed as a class action in June 2013 against SCI and our subsidiary in connection with SCI's proposed acquisition of Stewart Enterprises, Inc. The plaintiffs allege that SCI aided and abetted breaches of fiduciary duties by Stewart Enterprises and its board of directors in negotiating the combination of Stewart Enterprises with a subsidiary of SCI. The plaintiffs seek damages and an injunction against

37


the proposed combination. We have filed exceptions to the plaintiffs’ complaint, but the case has been stayed until after the closing of the acquisition. We cannot quantify our ultimate liability, if any, for the payment of damages.
The ultimate outcome of the matters described above cannot be determined at this time. We intend to vigorously defend all of the above lawsuits; however, an adverse decision in one or more of such matters could have a material effect on us, our financial condition, results of operations, and cash flows.

16. Earnings Per Share
Basic earnings per common share (EPS) excludes dilution and is computed by dividing Net income attributable to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other obligations to issue common stock were exercised or converted into common stock or resulted in the issuance of common shares that then shared in our earnings.
A reconciliation of the numerators and denominators of the basic and diluted EPS computations is presented below:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
 
(In thousands, except per
share amounts)
 
(In thousands, except per
share amounts)
Amounts attributable to common stockholders:
 
 
 
 
 
 
 
Net income:
 
 
 
 
 
 
 
Net income — basic
$
26,779

 
$
41,062

 
$
118,015

 
$
126,163

After tax interest on convertible debt
13

 
13

 
38

 
38

Net income — diluted
$
26,792

 
$
41,075

 
$
118,053

 
$
126,201

Weighted average shares (denominator):
 
 
 
 
 
 
 
Weighted average shares — basic
211,954

 
214,914

 
211,721

 
216,974

Stock options
4,295

 
3,425

 
4,035

 
3,211

Convertible debt
121

 
121

 
121

 
121

Weighted average shares — diluted
216,370

 
218,460

 
215,877

 
220,306

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.13

 
$
0.19

 
$
0.56

 
$
0.58

Diluted
$
0.12

 
$
0.19

 
$
0.55

 
$
0.57

The computation of diluted EPS excludes outstanding stock options and convertible debt in certain periods in which the inclusion of such options and debt would be anti-dilutive in the periods presented. For the three months ended September 30, 2013 and September 30, 2012, total options not currently included in the computation of dilutive EPS were 1.4 million and 1.3 million, respectively. For the nine months ended September 30, 2013 and September 30, 2012, total options not currently included in the computation of dilutive EPS were 1.7 million and 1.8 million, respectively.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The Company
We are North America’s largest provider of deathcare products and services, with a network of funeral homes and cemeteries unequalled in geographic scale and reach. At September 30, 2013, we operated 1,431 funeral service locations and 374 cemeteries (including 214 combination locations) in North America, which are geographically diversified across 43 states, 8 Canadian provinces, and the District of Columbia. Our funeral segment also includes the operations of 12 funeral homes in Germany that we intend to exit when economic values and conditions are conducive to a sale. Our funeral service and cemetery operations consist of funeral service locations, cemeteries, funeral service/cemetery combination locations, crematoria, and related businesses. We sell cemetery property and funeral and cemetery products and services at the time of need and on a preneed basis.
On May 29, 2013, we announced our execution of a definitive agreement to acquire all of the outstanding shares of Stewart Enterprises, Inc. (Stewart), the second largest operator of funeral homes and cemeteries in North America. This transaction provides us with an opportunity for growth consistent with our capital deployment strategy and will allow us the ability to serve a number of new, complementary areas, while enabling us to capitalize on what we believe will produce significant synergies and operating efficiencies. The acquisition is subject to, among other conditions, antitrust clearance. It is anticipated that the acquisition will be

38


completed at the end of 2013 or in early 2014, however there can be no assurance that the acquisition will be completed by this time or at all.
Our financial position is enhanced by our $7.6 billion backlog of future revenues from both trust and insurance-funded sales at September 30, 2013, which is the result of preneed funeral and cemetery sales. Preneed selling provides us with a current opportunity to lock-in future market share while deterring the customer from going to a competitor in the future. We believe it adds to the stability and predictability of our revenue and cash flows. While revenue on the majority of preneed funeral sales is deferred until the time of need, sales of preneed cemetery property provides opportunities for full current revenue recognition (to the extent we collect 10% from the customer and the property is developed).
We believe we have the financial strength and flexibility to reward shareholders through dividends while maintaining a prudent capital structure and pursuing new opportunities for profitable growth. We also currently have approximately $190.1 million authorized to repurchase our common stock.
Factors affecting our operating results include: demographic trends in terms of population growth and average age, which impact death rates and number of deaths; establishing and maintaining leading market share positions supported by strong local heritage and relationships; effectively responding to increasing cremation trends by selling complementary services and merchandise; controlling salary and merchandise costs; and exercising pricing leverage related to our at-need revenues. The average revenue per funeral contract is influenced by the mix of traditional and cremation services because our average cremation service revenue is approximately half of the average revenue earned from a traditional burial service. To further enhance revenue opportunities we are developing memorialization products and services that specifically appeal to cremation customers. We believe that these additional products and services will help drive increases in cremation revenue in future periods.
For further discussion of our key operating metrics, see our Results of Operations and Cash Flow sections below.

Financial Condition, Liquidity and Capital Resources
Capital Allocation Considerations
We rely on cash flow from operations as a significant source of liquidity. Our cash flow from operating activities provided $326.4 million in the nine months ended September 30, 2013. In July 2013, we repaid the entire $86.6 million outstanding under our bank credit facility in conjunction with entering into a new bank credit facility associated with the Stewart acquisition financing. In addition, we have $468.2 million in excess borrowing capacity under our bank credit facility. We currently have no significant maturities of long-term debt until April 2015.
Our bank credit facility requires us to maintain certain leverage and interest coverage ratios. As of September 30, 2013, we were in compliance with all of our debt covenants. Our financial covenant requirements and actual ratios as of September 30, 2013 are as follows:
 
Per Credit Agreement
 
Actual
Leverage ratio
4.00 (Max)
 
2.69
Interest coverage ratio
3.00 (Min)
 
4.93
The bank credit facility maintains the same leverage and interest coverage ratios until the Stewart transaction closes. Upon closing, the leverage ratio will increase to a 5.00X maximum (net debt to EBITDA as defined in the credit agreement), while the interest coverage ratio will remain unchanged.
We believe the sources of liquidity can be supplemented by our ability to access the capital markets for additional debt or equity securities. We believe that our $182.6 million of cash on hand, future operating cash flows, and the available capacity under our credit facility will give us adequate liquidity to meet our short-term needs. In July 2013, as part of establishing financing for the Stewart acquisition, we issued $425 million in 5.375% Senior Notes due January 2022 and entered into a new $1.1 billion credit agreement due July 2018 with a syndicate of banks. The net proceeds of the $425 million 5.375% Senior Notes due January 2022 will be held in escrow, pending the closing of the Stewart acquisition. The credit agreement consists of a $500 million bank credit facility and a term loan of up to $600 million. The term loan will be drawn upon the closing of and used to fund the Stewart Acquisition. The bank credit facility will be used partially to fund the Stewart Acquisition, but will primarily exist to provide the company with flexibility for general corporate purposes and to give us access to capital markets to refinance our long-term debt if, and when, we choose to do so.
It is our intention to evaluate the best uses of our cash flow that will yield the highest value and return on capital. Our capital deployment strategy is prioritized as follows:

39


Reinvest in the core business. We expect to continue to focus on funding growth initiatives that generate increased profitability, revenue, and cash flows. Our primary internal growth initiative is to increase our funeral and cemetery preneed backlog to grow the Company over the long-term. We will also invest in the construction of funeral home facilities and in the construction of cemetery property to promote future cemetery sales growth. Lastly, from time to time we may have other smaller capital projects, primarily related to the improvement of processes and systems.
Invest in acquisitions. We intend to make acquisitions of funeral homes and cemeteries when pricing and terms are favorable. We expect an acquisition investment to earn an after-tax cash return that is in excess of our weighted average cost of capital with room for execution risk. We target businesses with favorable consumer segments and/or where we can achieve additional economies of scale.
On May 29, 2013, we announced our execution of a definitive agreement to acquire all of the outstanding shares of Stewart Enterprises, Inc. (Stewart), the second largest operator of funeral homes and cemeteries in North America. This transaction provides us with an opportunity for growth consistent with our capital deployment strategy and will allow us the ability to serve a number of new, complementary areas, while enabling us to capitalize on what we believe will produce significant synergies and operating efficiencies. The acquisition is subject to, among other conditions, antitrust clearance. It is anticipated that the acquisition will be completed at the end of 2013 or in early 2014, however there can be no assurance that the acquisition will be completed by this time or at all.
Repurchase shares. Absent a strategic acquisition opportunity, we believe share repurchases are attractive at the appropriate price. Currently, we have approximately $190.1 million authorized under our share repurchase program. We intend to make purchases from time to time in the open market or through privately negotiated transactions, subject to market conditions, debt covenants, and normal trading restrictions. Our credit agreement contains covenants that limit our ability to repurchase our common stock. There can be no assurance that we will buy our common stock under our share repurchase program in the future.
Pay a dividend. Beginning in November 2007, we began to pay quarterly dividends of $0.04 per common share. The quarterly dividend has steadily increased over the past few years with the latest increase to $0.07 per common share approved by the Board of Directors on May 8, 2013. We intend to continue to grow our cash dividend commensurate with the growth of our free cash flow. While we intend to pay regular quarterly cash dividends for the foreseeable future, all future dividends are subject to limitations in our debt covenants and final determination by our Board of Directors each quarter upon review of our financial performance.
Repurchase debt. While the Company has no significant debt maturities until April 2015, we will seek to make open market debt repurchases when it is opportunistic to do so relative to other capital deployment opportunities in order to manage our near-term debt maturity profile.
The Company has a relatively consistent annual cash flow stream which is generally resistant to down economic cycles. This cash flow stream is available to substantially reduce our long-term debt maturities should we choose to do so. Furthermore, the Company's capital expenditures are generally discretionary in nature and can be managed based on the availability of operating cash flow.
Cash Flow
We believe our ability to generate strong operating cash flow is one of our fundamental financial strengths and provides us with substantial flexibility in meeting operating and investing needs.
Operating Activities
Net cash provided by operating activities increased $46.1 million to $326.4 million in the first nine months of 2013 from $280.3 million in the first nine months of 2012. This increase was driven by:
a $115.9 million increase in cash receipts from customers;
a $35.5 million increase in net trust fund withdrawals;
a $5.0 million increase in General Agency (GA) receipts; partially offset by
a $75.7 million increase in vendor payments;
a $23.1 million increase in payroll;
a $6.1 million excess tax benefit from share based awards in 2013; and
a $5.1 million increase in cash tax payments.
Investing Activities

40


Cash flows from investing activities used $77.8 million in the first nine months of 2013 compared to using $95.1 million in the same period of 2012. This decrease was primarily attributable to a decrease of $10.7 million in cash spent on acquisitions, a $4.2 million increase in net withdrawals of restricted funds, a $1.4 million decrease in capital expenditures, and a $1.1 million million increase in cash receipts from divestitures and asset sales.
Financing Activities
Financing activities used $158.2 million in the first nine months of 2013 compared to using $163.6 million in the same period of 2012. This decrease was primarily driven by a $142.9 million decrease in repurchases of company common stock and a $6.1 million excess tax benefit from share based awards in 2013, partially offset by a $109.0 million increase in payments of debt, a $12.4 million decrease in proceeds from exercised stock options, an $8.3 million increase in purchases of noncontrolling interest, a $7.5 million increase in payments of dividends, and a $6.4 million increase in bank overdrafts and other.
We repurchased 0.1 million shares in the first nine months of 2013 for $1.7 million and 12.4 million shares in the same period of 2012 for $144.6 million.
We paid cash dividends of $42.4 million in the first nine months of 2013 and $34.8 million in the same period of 2012.
Financial Assurances
In support of our operations, we have entered into arrangements with certain surety companies whereby such companies agree to issue surety bonds on our behalf as financial assurance and/or as required by existing state and local regulations. The surety bonds are used for various business purposes; however, the majority of the surety bonds issued and outstanding have been used to support our preneed funeral and cemetery sales activities. The obligations underlying these surety bonds are recorded on the unaudited condensed consolidated balance sheet as Deferred preneed funeral revenues and Deferred preneed cemetery revenues. The breakdown of surety bonds between funeral and cemetery preneed arrangements, as well as surety bonds for other activities, is described below.
 
September 30, 2013
 
December 31, 2012
 
(Dollars in millions)
Preneed funeral
$
119.3

 
$
110.1

Preneed cemetery:

 
 
  Merchandise and services
113.2

 
114.6

  Pre-construction
2.9

 
7.2

Bonds supporting preneed funeral and cemetery obligations
235.4

 
231.9

Bonds supporting preneed business permits
3.0

 
2.9

Other bonds
18.3

 
17.2

Total surety bonds outstanding
$
256.7

 
$
252.0

When selling preneed funeral and cemetery contracts, we may post surety bonds where allowed by state law. We post the surety bonds in lieu of trusting a certain amount of funds received from the customer. The amount of the bond posted is generally determined by the total amount of the preneed contract that would otherwise be required to be trusted, in accordance with applicable state law. For the three months ended September 30, 2013 and 2012, we had $4.7 million and $4.2 million, respectively, of cash receipts attributable to bonded sales. For the nine months ended September 30, 2013 and 2012, we had $13.8 million and $14.4 million, respectively, of cash receipts attributable to bonded sales. These amounts do not consider reductions associated with taxes, obtaining costs, or other costs.
Surety bond premiums are paid annually and are automatically renewable until maturity of the underlying preneed contracts, unless we are given prior notice of cancellation. Except for cemetery pre-construction bonds (which are irrevocable), the surety companies generally have the right to cancel the surety bonds at any time with appropriate notice. In the event a surety company were to cancel the surety bond, we are required to obtain replacement surety assurance from another surety company or fund a trust for an amount generally less than the posted bond amount. Management does not expect that we will be required to fund material future amounts related to these surety bonds because of lack of surety capacity or surety company non-performance.
Preneed Funeral and Cemetery Activities and Backlog of Contracts
In addition to selling our products and services to client families at the time of need, we sell price-guaranteed preneed funeral and cemetery contracts, which provide for future funeral or cemetery services and merchandise. Since preneed funeral and cemetery services or merchandise will not be provided until sometime in the future, most states and provinces require that all or a portion of the funds collected from customers on preneed funeral and cemetery contracts be paid into merchandise and service trusts until

41


the merchandise is delivered or the service is performed. These trust funds own investments in equity and debt securities and mutual funds, which are sensitive to current market prices. In certain situations, as described above, where permitted by state or provincial laws, we post a surety bond as financial assurance for a certain amount of the preneed funeral or cemetery contract in lieu of placing funds into trust accounts.
 Trust-Funded Preneed Funeral and Cemetery Contracts: The funds are deposited into trust and invested by independent trustees in accordance with state and provincial laws. We retain any funds above the amounts required to be deposited into trust accounts and use them for working capital purposes, generally to offset the selling and administrative costs of our preneed programs.
The tables below detail our results of preneed funeral and cemetery production and maturities, excluding insurance contracts, for the three and nine months ended September 30, 2013 and 2012.
 
North America
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
 
(Dollars in millions)
 
(Dollars in millions)
Funeral:
 
 
 
 
 
 
 
Preneed trust-funded (including bonded):
 
 
 
 
 
 
 
Sales production
$
46.0

 
$
37.6

 
$
136.7

 
$
107.0

Sales production (number of contracts)
17,022

 
14,596

 
50,318

 
43,034

Maturities
$
43.8

 
$
42.5

 
$
141.7

 
$
133.0

Maturities (number of contracts)
12,358

 
12,362

 
40,247

 
39,802

Cemetery:
 
 
 
 
 
 
 
Sales production:
 
 
 
 
 
 
 
Preneed
$
133.7

 
$
114.9

 
$
414.7

 
$
379.3

Atneed
56.9

 
57.9

 
181.2

 
176.9

Total sales production
$
190.6

 
$
172.8

 
$
595.9

 
$
556.2

Sales production deferred to backlog:
 
 
 
 
 
 
 
Preneed
$
54.3

 
$
48.3

 
$
164.9

 
$
159.1

Atneed
43.1

 
42.8

 
136.3

 
132.7

Total sales production deferred to backlog
$
97.4

 
$
91.1

 
$
301.2

 
$
291.8

Revenue recognized from backlog:
 
 
 
 
 
 
 
Preneed
$
53.0

 
$
47.5

 
$
128.3

 
$
122.8

Atneed
44.2

 
43.7

 
135.5

 
131.7

Total revenue recognized from backlog
$
97.2

 
$
91.2

 
$
263.8

 
$
254.5


Insurance-Funded Preneed Funeral Contracts: Where permitted by state or provincial law, customers may arrange their preneed funeral contract by purchasing a life insurance or annuity policy from third-party insurance companies, for which we earn a commission as general sales agent for the insurance company. The policy amount of the insurance contract between the customer and the third-party insurance company generally equals the amount of the preneed funeral contract. As the insurance contract is between the insurance company and the customer, we do not reflect the unfulfilled insurance-funded preneed funeral contract amounts in our unaudited condensed consolidated balance sheet.
The table below details the results of insurance-funded preneed funeral production and maturities for the three and nine months ended September 30, 2013 and 2012, and the number of contracts associated with those transactions.

42


 
North America
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
 
(Dollars in millions)
 
(Dollars in millions)
Preneed funeral insurance-funded:
 
 
 
 
 
 
 
Sales production (1)
$
147.4

 
$
126.5

 
$
432.9

 
$
395.3

Sales production (number of contracts) (1)
25,135

 
21,714

 
74,618

 
67,430

General Agency revenue
$
27.3

 
$
24.1

 
$
79.3

 
$
71.7

Maturities
$
77.5

 
$
75.5

 
$
250.9

 
$
234.4

Maturities (number of contracts)
13,507

 
13,450

 
43,781

 
41,226


(1)
Amounts are not included in our unaudited condensed consolidated balance sheet.
North America Backlog of Preneed Funeral and Cemetery Contracts: The following table reflects our North America backlog of trust-funded deferred preneed funeral and cemetery contract revenues, including amounts related to Deferred preneed funeral and cemetery receipts held in trust at September 30, 2013 and December 31, 2012. Additionally, the table reflects our backlog of unfulfilled insurance-funded contracts (which are not included in our unaudited condensed consolidated balance sheet) at September 30, 2013 and December 31, 2012. The backlog amounts presented are reduced by an amount that we believe will cancel before maturity based on historical experience.
The table also reflects our preneed funeral and cemetery receivables and trust investments (fair value and cost bases) associated with the backlog of deferred preneed funeral and cemetery contract revenues, net of the estimated cancellation allowance. We believe that the table below is meaningful because it sets forth the aggregate amount of future revenues we expect to recognize as a result of preneed sales, as well as the amount of assets associated with those revenues. Because the future revenues exceed the asset amounts, future revenues will exceed the cash distributions actually received from the associated trusts.
 
September 30, 2013
 
December 31, 2012
 
Fair Value
 
Cost
 
Fair Value
 
Cost
 
 
 
(Dollars in billions)
 
 
Deferred preneed funeral revenues
$
0.50

 
$
0.50

 
$
0.53

 
$
0.53

Deferred preneed funeral receipts held in trust
1.38

 
1.32

 
1.34

 
1.32

 
$
1.88

 
$
1.82

 
$
1.87

 
$
1.85

Allowance for cancellation on trust investments
(0.16
)
 
(0.15
)
 
(0.15
)
 
(0.15
)
Backlog of trust-funded preneed funeral revenues
$
1.72

 
$
1.67

 
$
1.72

 
$
1.70

Backlog of insurance-funded preneed funeral revenues (1)
3.74

 
3.74

 
3.68

 
3.68

Total backlog of preneed funeral revenues
$
5.46

 
$
5.41

 
$
5.40

 
$
5.38

Preneed funeral receivables, net and trust investments
$
1.58

 
$
1.52

 
$
1.54

 
$
1.52

Allowance for cancellation on trust investments
(0.15
)
 
(0.15
)
 
(0.14
)
 
(0.14
)
Assets associated with backlog of trust-funded deferred preneed funeral revenues, net of estimated allowance for cancellation
$
1.43

 
$
1.37

 
$
1.40

 
$
1.38

Insurance policies associated with insurance-funded deferred preneed funeral revenues, net of estimated allowance for cancellation (1)
3.74

 
3.74

 
3.68

 
3.68

Total assets associated with backlog of preneed funeral revenues, net of estimated allowance for cancellation
$
5.17

 
$
5.11

 
$
5.08

 
$
5.06

Deferred preneed cemetery revenues
$
0.90

 
$
0.90

 
$
0.86

 
$
0.86

Deferred preneed cemetery receipts held in trust
1.41

 
1.27

 
1.29

 
1.23

 
$
2.31

 
$
2.17

 
$
2.15

 
$
2.09

Allowance for cancellation on trust investments
(0.15
)
 
(0.15
)
 
(0.15
)
 
(0.15
)
Total backlog of deferred cemetery revenues
$
2.16

 
$
2.02

 
$
2.00

 
$
1.94

Preneed cemetery receivables, net and trust investments
$
2.00

 
$
1.86

 
$
1.82

 
$
1.76

Allowance for cancellation on trust investments
(0.17
)
 
(0.17
)
 
(0.16
)
 
(0.16
)
Total assets associated with backlog of deferred cemetery revenues, net of estimated allowance for cancellation
$
1.83

 
$
1.69

 
$
1.66

 
$
1.60


43


                                              
(1)
Amounts are not included in our unaudited condensed consolidated balance sheet.

The fair value of our funeral and cemetery trust investments was based on a combination of quoted market prices, observable inputs such as interest rates or yield curves, and appraisals. The difference between the backlog and asset amounts represents the contracts for which we have posted surety bonds as financial assurance in lieu of trusting, the amounts collected from customers that were not required to be deposited into trust, and allowable cash distributions from trust assets. The table also reflects the amounts expected to be received from insurance companies through the assignment of policy proceeds related to insurance-funded funeral contracts.
Trust Investments
In addition to selling our products and services to client families at the time of need, we sell price-guaranteed preneed funeral and cemetery contracts, which provide for future funeral or cemetery services and merchandise. Since preneed funeral and cemetery services or merchandise will not be provided until sometime in the future, most states and provinces require that all or a portion of the funds collected from customers on preneed funeral and cemetery contracts be paid into trusts and/or preneed escrow accounts until the merchandise is delivered or the service is performed. Investment earnings associated with the trust investments are expected to mitigate the inflationary costs of providing the preneed funeral and cemetery services and merchandise in the future for the prices that were guaranteed at the time of sale.
Also, we are required by state and provincial law to pay a portion of the proceeds from the sale of cemetery property interment rights into perpetual care trusts. For these investments, the original corpus remains in the trust in perpetuity and the net ordinary earnings are intended to offset the expense to maintain the cemetery property. The majority of states require that net gains or losses are retained and added to the corpus, but certain states allow the net realized gains and losses to be included in the income that is distributed.
Independent trustees manage and invest all of the funds deposited into the funeral and cemetery merchandise and service trusts as well as the cemetery perpetual care trusts. The trustees are selected based on their respective geographic footprint and qualifications per state and provincial regulations. All of the trustees engage the same independent investment advisor either directly or indirectly through SCI's wholly-owned registered investment advisor. The trustees, with input from the investment advisor, establish an investment policy that serves as an operating document to guide the investment activities of the trusts including asset allocation and manager selection. The investments are also governed by state and provincial guidelines. Asset allocation for the funeral and cemetery merchandise and service trusts is generally based on matching the time period that we expect the funeral or cemetery preneed contract to be outstanding. Since net ordinary earnings are distributed monthly from the cemetery perpetual care trusts to offset cemetery maintenance costs, the cemetery perpetual care trusts contain a higher fixed income allocation than the funeral and cemetery merchandise and service trusts. The investment advisor recommends investment managers to the trustees that are selected on the basis of various criteria set forth in the investment policy. The primary investment objectives for the funeral and cemetery merchandise and service trusts include (1) achieving growth of principal over time sufficient to preserve and increase the purchasing power of the assets, and (2) preserving capital within acceptable levels of volatility. Preneed funeral and cemetery contracts generally take years to mature. Therefore, the funds associated with these contracts are often invested for several market cycles. While cemetery perpetual care trusts share the same investment objectives as listed above, these trusts emphasize providing a steady stream of investment income with some capital appreciation. The trusts seek to control risk and volatility through a combination of asset styles, asset classes, and institutional investment managers.
As of September 30, 2013, 84% of our trusts were under the control and custody of two large financial institutions engaged as preferred trustees. The U.S. trustees primarily use common trust fund structures as the investment vehicle for their trusts. Through the common trust fund structure, each respective trustee manages the allocation of assets through individual managed accounts or institutional mutual funds. In the event a particular state prohibits the use of a common trust fund as a qualified investment, the trustee utilizes institutional mutual funds. The U.S. trusts include a modest allocation to alternative investments, which are comprised primarily of private equity and real estate investments. These investments are structured as limited liability companies (LLCs) and are managed by certain trustees. The trusts that are eligible to allocate a portion of their investments to alternative investments purchase units of the respective LLCs.
Fixed Income Securities
Fixed income investments are intended to preserve principal, provide a source of current income, and reduce overall portfolio volatility. The SCI trusts have direct investments primarily in government fixed income securities. Insurance backed fixed income investments preserve the principal, guarantee annual appreciation, and reduce overall portfolio volatility.

44


Canadian government fixed income securities are investments in Canadian federal and provincial government instruments. In many cases, regulatory restrictions mandate that the funds from the sales of preneed funeral and cemetery products sold in certain Canadian jurisdictions must be invested in these instruments.
Equity Securities
Equity investments have historically provided long-term capital appreciation in excess of inflation. The SCI trusts have direct investments primarily in domestic equity portfolios that include large, mid, and small capitalization companies of different investment objectives (i.e., growth and value). The majority of the equity portfolio is managed by multiple institutional investment managers that specialize in an objective-specific area of expertise. Our equity securities are exposed to market risk; however, these securities are well-diversified. As of September 30, 2013, the largest single equity position represented less than 1% of the total equity securities portfolio.
Mutual Funds
The SCI trust funds employ institutional mutual funds where operationally or economically efficient. Institutional mutual funds are utilized to invest in various asset classes including US equities, non-US equities, convertible bonds, corporate bonds, government bonds, Treasury inflation protected securities (TIPS), high yield bonds, real estate investment trusts (REITs), and commodities. The mutual funds are governed by guidelines outlined in their individual prospectuses.
Private Equity
The objective of these investments is to provide high rates of return with controlled volatility. These investments are typically long-term in duration. These investments are diversified by strategy, sector, manager, and vintage year. Private equity exposure is accessed through limited liability companies (LLCs) established by certain preferred trustees. These LLCs invest in numerous limited partnerships, including private equity, fund of funds, distressed debt, and mezzanine financing. The trustees that have oversight of their respective LLCs work closely with the investment advisor in making all current investments.
Trust Performance
The trust fund income recognized from these investment assets continues to be volatile. During the twelve months ended September 30, 2013, the Standard and Poor’s 500 Index increased approximately 19.34% and the Barclay’s Aggregate Index decreased approximately 1.68%, while the combined SCI trusts increased approximately 11.52%.
SCI, its trustees, and its investment advisor continue to monitor the capital markets and the trusts on an ongoing basis. The trustees, with input from the investment advisor, will take prudent action as needed to achieve the investment goals and objectives of the trusts.

Results of Operations — Three Months Ended September 30, 2013 and 2012
Management Summary
Key highlights in the third quarter of 2013 were as follows:
Funeral gross profits decreased $8.9 million, or 11.7%, primarily due to inflationary increases in fixed costs and lower funeral services performed; and
Cemetery gross profits increased $3.7 million, or 8.2%, due primarily to an increase in cemetery recognized preneed revenues led by a strong growth in preneed sales production.
Results of Operations
In the third quarter of 2013, we reported net income attributable to common stockholders of $26.8 million ($0.12 per diluted share) compared to net income attributable to common stockholders in the third quarter of 2012 of $41.1 million ($0.19 per diluted share). These results were impacted by the following items:

45



 
2013
 
2012
 
(Dollars in thousands)
Net after-tax gains from the sale of assets
$
422

 
$
404

After-tax expenses related to system and process transition costs
$
(1,964
)
 
$
(1,515
)
After-tax expenses related to Stewart acquisition and transition costs
$
(8,798
)
 
$

After-tax expenses related to legal defense fees and labor matters
$
(590
)
 
$

Change in certain tax reserves and other
$
(792
)
 
$
(61
)
Consolidated Versus Comparable Results
The table below reconciles our consolidated GAAP results to our comparable, or “same store,” results for the three months ended September 30, 2013 and 2012. We define comparable operations (or same store operations) as those funeral and cemetery locations that were owned for the entire period beginning January 1, 2012 and ending September 30, 2013. The following tables present operating results for funeral and cemetery locations that were owned by us during this period.
Three Months Ended September 30, 2013
 
Consolidated
 
Less:
Results Associated with Acquisition/New Construction
 
Less:
Results Associated with Divestitures
 
Comparable
 
 
 
 
(Dollars in millions)
 
 
North America Revenue
 
 
 
 
 
 
 
 
Funeral revenue
 
$
398.2

 
$
10.2

 
$
0.3

 
$
387.7

Cemetery revenue
 
210.4

 

 

 
210.4

 
 
608.6

 
10.2

 
0.3

 
598.1

Germany revenue
 
1.4

 

 

 
1.4

Total revenue
 
$
610.0

 
$
10.2

 
$
0.3

 
$
599.5

North America Gross Profits
 
 
 
 
 
 
 
 
Funeral gross profits (losses)
 
$
66.8

 
$
1.4

 
$
(0.7
)
 
$
66.1

Cemetery gross profits (losses)
 
49.0

 

 
(0.3
)
 
49.3

 
 
115.8

 
1.4

 
(1.0
)
 
115.4

Germany gross profits
 
0.3

 

 

 
0.3

Total gross profits (losses)
 
$
116.1

 
$
1.4

 
$
(1.0
)
 
$
115.7

Three Months Ended September 30, 2012
 
Consolidated
 
Less:
Results Associated with Acquisition/New Construction
 
Less:
Results Associated with Divestitures
 
Comparable
 
 
 
 
(Dollars in millions)
 
 
North America Revenue
 
 
 
 
 
 
 
 
Funeral revenue
 
$
387.1

 
$
2.2

 
$
1.0

 
$
383.9

Cemetery revenue
 
192.8

 

 

 
192.8

 
 
579.9

 
2.2

 
1.0

 
576.7

Germany revenue
 
1.3

 

 

 
1.3

Total revenue
 
$
581.2

 
$
2.2

 
$
1.0

 
$
578.0

North America Gross Profits
 
 
 
 
 
 
 
 
Funeral gross profits (losses)
 
$
75.9

 
$
0.4

 
$
(0.6
)
 
$
76.1

Cemetery gross profits (losses)
 
45.3

 

 

 
45.3

 
 
121.2

 
0.4

 
(0.6
)
 
121.4

Germany gross profits
 
0.1

 

 

 
0.1

Total gross profits (losses)
 
$
121.3

 
$
0.4

 
$
(0.6
)
 
$
121.5

The following table provides the data necessary to calculate our consolidated average revenue per funeral service for the three months ended September 30, 2013 and 2012. We calculate average revenue per funeral service by dividing consolidated funeral

46


revenue, excluding General Agency (GA) revenues, recognized preneed revenues and certain other revenues, to avoid distorting our averages of normal funeral services revenue, by the number of consolidated funeral services performed during the period. Recognized preneed revenues are preneed sales of items that are delivered at the time of sale, including memorial merchandise and travel protection insurance and are excluded from our calculation of consolidated average revenue per services because the associated service has not yet been performed.
 
Three Months Ended
 
September 30,
 
2013
 
2012
 
(Dollars in millions,
except average
revenue per funeral service)
Consolidated funeral revenue
$
399.6

 
$
388.4

Less: Funeral consolidated recognized preneed revenue
19.6

 
14.4

Less: Consolidated GA revenue
27.3

 
24.1

Less: Other revenue
4.1

 
3.4

Adjusted consolidated funeral revenue
$
348.6

 
$
346.5

Consolidated funeral services performed
66,603

 
67,455

Consolidated average revenue per funeral service
$
5,234

 
$
5,137

The following table provides the data necessary to calculate our comparable average revenue per funeral service for the three months ended September 30, 2013 and 2012. We calculate average revenue per funeral service by dividing comparable funeral revenue, excluding comparable GA revenues, recognized preneed revenues and certain other revenues, to avoid distorting our averages of normal funeral services revenue, by the number of comparable funeral services performed during the period. Recognized preneed revenues are preneed sales of items that are delivered at the time of sale, including memorial merchandise and travel protection insurance and are excluded from our calculation of comparable average revenue per services because the associated service has not yet been performed.
 
Three Months Ended
 
September 30,
 
2013
 
2012
 
(Dollars in millions,
except average
revenue per funeral service)
Comparable funeral revenue
$
389.1

 
$
385.2

Less: Funeral comparable recognized preneed revenue
16.7

 
13.9

Less: Comparable GA revenue
27.0

 
24.1

Less: Other revenue
3.9

 
3.4

Adjusted comparable funeral revenue
$
341.5

 
$
343.8

Comparable funeral services performed
64,641

 
66,576

Comparable average revenue per funeral service
$
5,283

 
$
5,164

Funeral Results
Funeral Revenue
Consolidated revenues from funeral operations were $399.6 million in the third quarter of 2013 compared to $388.4 million for the same period in 2012. This increase is attributable to $8.0 million of additional revenues as the result of acquisitions through 2013 and 2012 and the $3.9 million increase in comparable revenues described below. These increases were partially offset by a decline of $0.7 million in revenues contributed by non-strategic assets that were divested throughout 2013 and 2012.
Comparable revenues from funeral operations were $389.1 million in the third quarter of 2013 compared to $385.2 million for the same period in 2012. This increase was primarily due to the 2.3% increase in comparable average revenue per funeral service described below, an increase in recognized preneed revenues for items that are delivered at the time of sale, and higher General Agency revenues. Neptune Society contributed $2.0 million or 9.7% to the revenue growth previously mentioned. These increases were partially offset by the 2.9% decrease in the number of comparable funeral services performed described below.
Funeral Services Performed

47


Our consolidated funeral services performed decreased 1.3% during the third quarter of 2013 compared to the same period in 2012. This is primarily the result of a 2.9% decrease in comparable funeral services performed, partially offset by acquisitions in 2013 and 2012. We believe the comparable decrease is consistent with trends experienced by other funeral service providers and industry vendors. Our comparable cremation rate of 50.2% in the third quarter of 2013 increased from 48.6% in 2012. This growth in comparable cremations was generated equally by cremations with service and direct cremations. While the average revenue for cremations of either type is lower than that for traditional burials, we continue to expand our cremation memorialization product and service offerings, which have resulted in higher revenue for cremation services.
Average Revenue Per Funeral Service
Our consolidated average revenue per funeral service increased $97, or 1.9%, in the third quarter of 2013 compared to 2012, primarily due to an increase in comparable average revenue per funeral service described below, partially offset by an increase in the number of cremations. Our comparable average revenue per funeral service increased $119, or 2.3%, in the third quarter of 2013 compared to the same period in 2012. This increase in comparable average revenue per funeral service is primarily from initiatives centered around better consumer choice and flexibility, such as enhanced Dignity packaging, increased receptions and event offerings, and expansion of floral offerings through e-commerce solutions. Excluding an unfavorable Canadian currency impact and higher funeral trust fund income, the average revenue per funeral service grew approximately 1.8% despite an increase in cremation rates.
Funeral Gross Profits
Consolidated funeral gross profits decreased $8.9 million, or 11.7%, in the third quarter of 2013 compared to the same period in 2012. This decrease is primarily attributable to a $9.8 million decrease in comparable gross profits described below and a decline of $0.1 million in gross profits contributed by non-strategic assets that were divested throughout 2013 and 2012, partially offset by $1.0 million of additional gross profits related to acquisitions that occurred in 2013 and 2012.
Comparable funeral gross profits decreased $9.8 million, or 12.9%, in the third quarter of 2013 compared to the same period in 2012. Comparable gross margin percentage decreased from 19.8% to 17.1% in the third quarter of 2013 when compared to the same period in 2012 primarily as a result of the increase in comparable revenue, including Neptune Society's revenue, described above being more than offset by the following:
a $3.8 million increase in selling compensation mostly driven by higher preneed funeral production;
a $3.1 million increase in overhead expenses including investments in our sales support infrastructure;
a $1.8 million increase in funeral expenses related to catering, reception, and event offerings; and
a $1.3 million increase in health insurance expenses.
Cemetery Results
Cemetery Revenue
Consolidated cemetery revenues increased $17.6 million, or 9.1%, in the third quarter of 2013 compared to the same period in 2012 as a result of the increase in comparable revenues. Comparable cemetery revenues increased $17.6 million, or 9.1%, primarily as a result of higher preneed property for which construction was completed and we received at least 10% of the sales price from the customer and higher merchandise revenues.
Cemetery Gross Profits
Consolidated cemetery gross profits increased $3.7 million, or 8.2%, in the third quarter of 2013 compared to the same period in 2012. This increase is primarily the result of the increase in comparable gross profits described below. This increase was partially offset by a decline of $0.3 million in gross profits contributed by non-strategic assets that were divested throughout 2013 and 2012.
Comparable cemetery gross profits increased $4.0 million, or 8.8%, and gross margin percentage decreased from 23.5% to 23.4% in the third quarter of 2013 compared to the same period in 2012 primarily as a result of the increase in comparable revenue described above partially offset by the following:
a $5.3 million increase in selling cost driven mostly by higher preneed cemetery production;
a $3.3 million increase in property and merchandise expenses driven by higher revenues; and
a $1.7 million increase in overhead expenses including investments in our sales support infrastructure.
Other Financial Statement Items

48


General and Administrative Expenses
General and administrative expenses increased $7.4 million to $33.8 million during the third quarter of 2013 compared to $26.4 million in the same period of 2012. The current quarter included $6.9 million of costs related to the pending acquisition of Stewart Enterprises and $2.3 million of other system integration costs. The prior year included, $2.3 million of costs related to the implementation of a new purchase order system and the transition to new outsource providers for certain accounting and administrative functions.
Gains (Losses) on Divestitures and Impairment Charges, Net
We recognized a $1.0 million net pre-tax gain on divestitures and impairment charges in the third quarter of 2013 compared to a $0.3 million net pre-tax gain in the same period of 2012, which is associated with the divestiture of non-strategic funeral and cemetery locations in the United States and Canada.
Interest expense
Interest expense increased $4.5 million to $38.1 million during the third quarter of 2013 compared to $33.6 million in the same period of 2012. The current period included $5.7 million of interest expense associated with the incremental debt raised in anticipation of the Stewart acquisition.
Other Income (Expense), Net
Other income (expense), net decreased $1.6 million to $0.7 million of income during the third quarter of 2013 compared to $2.3 million of income in the third quarter of 2012, primarily due to an unfavorable foreign currency impact from liability settlements between the U.S. and Canadian subsidiaries in the third quarter of 2012.
Provision for Income Taxes
Income tax expense during interim periods is based on our estimated annual effective income tax rate plus any discrete items which are recorded in the period in which they occur. Discrete items include, among others, such events as changes in estimates due to the finalization of tax returns, tax audit settlements, expiration of statute of limitations, and increases or decreases in valuation allowances. Our effective tax rate was 40.3% and 34.6% for the three months ended September 30, 2013 and 2012, respectively. The effective tax rate for the third quarter of 2013 is above the 35% federal statutory tax rate due to state tax expense which is partially offset by foreign earnings taxed at lower rates.

Weighted Average Shares
The diluted weighted average number of shares outstanding was 216.4 million during the third quarter of 2013, compared to 218.5 million in the same period of 2012. The decrease in the number of shares reflects the impact of shares repurchased under our share repurchase program.

Results of Operations — Nine Months Ended September 30, 2013 and 2012
Management Summary
Key highlights in the first nine months of 2013 were as follows:
Funeral gross profit increased $9.8 million, or 3.8%, due to higher funeral services performed and average revenue per funeral service, along with an increase in preneed revenues for items that are delivered at the time of sale. These increases were partially offset by higher selling expenses related to preneed sales initiatives and higher direct cost of services performed; and
Cemetery gross profit increased $14.7 million, or 12.3%, due to an increase in cemetery preneed property recognized revenue on higher sales production, higher trust fund income and higher atneed revenues, partially offset by higher selling compensation expenses and higher direct cost of services performed.
Results of Operations
In the first nine months of 2013, we reported net income attributable to common stockholders of $118.0 million ($0.55 per diluted share) compared to net income attributable to common stockholders in the first nine months of 2012 of $126.2 million ($0.57 per diluted share). These results were impacted by the following items:


49


 
2013
 
2012
 
(Dollars in thousands)
Net after-tax (losses) gains from the sale of assets
$
(3,490
)
 
$
99

After-tax gains from the early extinguishment of debt, net
$
296

 
$

After-tax expenses related to system and process transition costs
$
(3,783
)
 
$
(2,953
)
After-tax expenses related to Stewart acquisition and transition costs
$
(11,274
)
 
$

After-tax expenses related to legal defense fees and labor matters
$
(1,971
)
 
$

Change in certain tax reserves and other
$
(1,788
)
 
$
1,830

Consolidated Versus Comparable Results
The table below reconciles our consolidated GAAP results to our comparable, or “same store,” results for the nine months ended September 30, 2013 and 2012. We define comparable operations (or same store operations) as those funeral and cemetery locations that were owned for the entire period beginning January 1, 2012 and ending September 30, 2013. The following tables present operating results for funeral and cemetery locations that were owned by us during this period.
Nine Months Ended September 30, 2013
 
Consolidated
 
Less:
Results Associated with Acquisition/New Construction
 
Less:
Results Associated with Divestitures
 
Comparable
 
 
 
 
(Dollars in millions)
 
 
North America Revenue
 
 
 
 
 
 
 
 
Funeral revenue
 
$
1,272.8

 
$
27.1

 
$
1.7

 
$
1,244.0

Cemetery revenue
 
610.4

 

 
(0.1
)
 
610.5

 
 
1,883.2

 
27.1

 
1.6

 
1,854.5

Germany revenue
 
4.6

 

 

 
4.6

Total revenue
 
$
1,887.8

 
$
27.1

 
$
1.6

 
$
1,859.1

North America Gross Profits
 
 
 
 
 
 
 
 
Funeral gross profits (losses)
 
$
266.9

 
$
4.6

 
$
(0.4
)
 
$
262.7

Cemetery gross profits (losses)
 
134.0

 
(0.1
)
 
(0.3
)
 
134.4

 
 
400.9

 
4.5

 
(0.7
)
 
397.1

Germany gross profits
 
0.6

 

 

 
0.6

Total gross profits (losses)
 
$
401.5

 
$
4.5

 
$
(0.7
)
 
$
397.7

Nine Months Ended September 30, 2012
 
Consolidated
 
Less:
Results Associated with Acquisition/New Construction
 
Less:
Results Associated with Divestitures
 
Comparable
 
 
 
 
(Dollars in millions)
 
 
North America Revenue
 
 
 
 
 
 
 
 
Funeral revenue
 
$
1,204.6

 
$
2.2

 
$
5.1

 
$
1,197.3

Cemetery revenue
 
572.0

 

 
0.3

 
571.7

 
 
1,776.6

 
2.2

 
5.4

 
1,769.0

Germany revenue
 
4.5

 

 

 
4.5

Total revenue
 
$
1,781.1

 
$
2.2

 
$
5.4

 
$
1,773.5

North America Gross Profits
 
 
 
 
 
 
 
 
Funeral gross profits (losses)
 
$
257.3

 
$

 
$
(0.8
)
 
$
258.1

Cemetery gross profits (losses)
 
119.3

 

 
(0.1
)
 
119.4

 
 
376.6

 

 
(0.9
)
 
377.5

Germany gross profits
 
0.4

 

 

 
0.4

Total gross profits (losses)
 
$
377.0

 
$

 
$
(0.9
)
 
$
377.9



50


The following table provides the data necessary to calculate our consolidated average revenue per funeral service for the nine months ended September 30, 2013 and 2012. We calculate average revenue per funeral service by dividing consolidated funeral revenue, excluding General Agency (GA) revenues, recognized preneed revenues and certain other revenues, to avoid distorting our averages of normal funeral services revenue, by the number of consolidated funeral services performed during the period. Recognized preneed revenues are preneed sales of items that are delivered at the time of sale, including memorial merchandise and travel protection insurance and are excluded from our calculation of consolidated average revenue per services because the associated service has not yet been performed.
 
Nine Months Ended
 
September 30,
 
2013
 
2012
 
(Dollars in millions,
except average
revenue per funeral service)
Consolidated funeral revenue
$
1,277.4

 
$
1,209.1

Less: Funeral consolidated recognized preneed revenue
56.5

 
42.2

Less: Consolidated GA revenue
79.3

 
71.7

Less: Other revenue
12.7

 
9.6

Adjusted consolidated funeral revenue
$
1,128.9

 
$
1,085.6

Consolidated funeral services performed
216,434

 
211,012

Consolidated average revenue per funeral service
$
5,216

 
$
5,145

The following table provides the data necessary to calculate our comparable average revenue per funeral service for the three months ended September 30, 2013 and 2012. We calculate average revenue per funeral service by dividing comparable funeral revenue, excluding comparable GA revenues, recognized preneed revenues and certain other revenues to avoid distorting our averages of normal funeral services revenue, by the number of comparable funeral services performed during the period. Recognized preneed revenues are preneed sales of items that are delivered at the time of sale, including memorial merchandise and travel protection insurance and are excluded from our calculation of comparable average revenue per services because the associated service has not yet been performed.
 
Nine Months Ended
 
September 30,
 
2013
 
2012
 
(Dollars in millions,
except average
revenue per funeral service)
Comparable funeral revenue
$
1,248.6

 
$
1,201.8

Less: Funeral comparable recognized preneed revenue
51.2

 
41.3

Less: Comparable GA revenue
78.6

 
71.6

Less: Other revenue
12.3

 
9.7

Adjusted comparable funeral revenue
$
1,106.5

 
$
1,079.2

Comparable funeral services performed
210,226

 
209,405

Comparable average revenue per funeral service
$
5,263

 
$
5,154

Funeral Results
Funeral Revenue
Consolidated revenues from funeral operations were $1,277.4 million in the nine months ended September 30, 2013 compared to $1,209.1 million for the same period in 2012. This increase is primarily attributable to the $24.9 million of additional revenues as the result of acquisitions in 2013 and 2012 and a $46.8 million increase in comparable revenues described below. These increases were partially offset by a decline of $3.4 million in revenues contributed by non-strategic assets that were divested throughout 2013 and 2012. Comparable revenues from funeral operations were $1,248.6 million in the first nine months of 2013 compared to $1,201.8 million for the same period in 2012. This increase was primarily due to the 2.1% increase in average revenue per funeral service described below and the 0.4% increase in the number of comparable funeral services performed described below, as well as increased recognized preneed revenues for items that are delivered at the time of sale, and higher General Agency revenues. Neptune Society contributed $13.3 million or 23.4% to the revenue growth previously mentioned.

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Funeral Services Performed
Our consolidated funeral services performed increased 2.6% during the nine months ended September 30, 2013 compared to the same period in 2012, primarily as the result of acquisitions in 2013 and 2012 and a 0.4% increase in comparable funeral services performed. We believe this increase was somewhat impacted by extreme weather throughout North America in the first half of the year, and we believe is consistent with trends experienced by other funeral service providers and industry vendors. Our comparable cremation rate of 49.7% in the nine months ended September 30, 2013 increased from 48.4% in 2012. This growth in comparable cremations was generated equally by cremations with service and direct cremations. While the average revenue for cremations of either type is lower than that for traditional burials, we continue to expand our cremation memorialization product and service offerings, which have resulted in higher revenue for cremation services.
Average Revenue Per Funeral Service
Our consolidated average revenue per funeral service increased $71, or 1.4%, in the nine months ended September 30, 2013 compared to the same period in 2012, primarily as a result of the increase in comparable average revenue per funeral service described below partially offset by an increase in the number of cremations. Our comparable average revenue per funeral service increased $109, or 2.1%, in the nine months ended September 30, 2013 compared to the same period in 2012. This increase in comparable average revenue per funeral service is primarily from initiatives centered around better consumer choice and flexibility, such as enhanced Dignity packaging, increased receptions and event offerings, and expansion of floral offerings through e-commerce solutions. Excluding an unfavorable Canadian currency impact and higher funeral trust fund income, the average revenue per funeral service grew approximately 1.6% despite an increase in cremation rates. The addition of Neptune Society fulfilled contracts to our comparable results (which include only the cremation service component in our comparable analysis) has accelerated our cremation mix change and put slight downward pressure on our total average revenue per service.
Funeral Gross Profits
Consolidated funeral gross profits increased $9.8 million, or 3.8%, in the nine months ended September 30, 2013 compared to the same period in 2012. This increase is primarily attributable to a $4.8 million increase in comparable gross profits described below, $4.6 million of additional gross profits related to acquisitions that occurred in 2013 and 2012, and a $0.4 million increase in losses by non-strategic assets that were divested throughout 2013 and 2012.
Comparable funeral gross profits increased $4.8 million, or 1.9%, and the comparable gross margin percentage decreased from 21.5% to 21.1% in the nine months ended September 30, 2013 when compared to the same period in 2012 primarily as a result of the increase in comparable revenue, including Neptune Society's revenue, described above, partially offset by the following:
a $14.2 million increase in selling compensation mostly driven by higher preneed funeral production;
an $8.4 million increase in overhead expenses including investments in our sales support infrastructure;
a $6.5 million increase in funeral expenses related to catering, reception, and event offerings;
a $3.6 million increase in salary expense driven by the increase in funeral services performed described above;
a $1.7 million unfavorable impact related to an adjustment in self-insurance casualty reserves; and
a $1.3 million increase in health insurance expenses.
Cemetery Results
Cemetery Revenue
Consolidated revenues from our cemetery operations increased $38.4 million, or 6.7%, in the nine months ended September 30, 2013 compared to the same period in 2012 primarily as a result of the increase in comparable revenues described below. The increase was partially offset by a decline of $0.4 million in revenues contributed by non-strategic assets that were divested throughout 2013 and 2012. Comparable cemetery revenues increased $38.8 million, or 6.8%, primarily as a result of strong cemetery preneed property production for which construction was completed and we received at least 10% of the sales price from the customer during the nine months ended September 30, 2013, higher atneed and preneed merchandise and service revenues and increased trust fund income .
Cemetery Gross Profits
Consolidated cemetery gross profits increased $14.7 million, or 12.3%, in the nine months ended September 30, 2013 compared to the same period in 2012. This increase is primarily the result of the increase in comparable gross profits described below.

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Comparable cemetery gross profits increased $15.0 million, or 12.6%, and gross margin percentage increased from 20.9% to 22.0% in the nine months ended September 30, 2013 compared to the same period in 2012. This increase is primarily the result of higher revenues mentioned above, partially offset by the following:
a $15.5 million increase in comparable selling costs impacted by higher preneed cemetery production;
a $4.5 million increase in overhead expenses including investments in our sales support infrastructure; and
a $2.0 million increase in property and merchandise expenses driven by higher revenues.
Other Financial Statement Items
General and Administrative Expenses
General and administrative expenses increased $13.9 million to $95.8 million during the nine months ended September 30, 2013 compared to $81.9 million for the same period in 2012. The increase is primarily due to $10.1 million of costs related to the pending acquisition of Stewart Enterprises and $4.9 million of other system integration costs in 2013 partially offset by $4.5 million of costs related to the implementation of a new purchase order system and the transition to the new outsource providers for certain accounting and administrative functions in 2012.
Gains (Losses) on Divestitures and Impairment Charges, net
     We recognized a $5.5 million net pre-tax loss on divestitures and impairment charges in the nine months ended September 30, 2013, which is associated with the divestiture of non-strategic funeral and cemetery locations in North America, along with losses on the final settlement of an indemnification liability related to our former operations in Spain. In the nine months ended September 30, 2012, we recognized a $0.9 million net pre-tax gain on divestitures and impairment charges due to gains on indemnification reserves.
Other Income (Expense), Net
Other income (expense), net decreased $5.0 million to expense of $1.0 million during the nine months ended September 30, 2013, primarily due to a favorable foreign currency impact from liability settlements between the U.S. and Canadian subsidiaries in the first nine months of 2012.
Provision for Income Taxes
Income tax expense during interim periods is based on our estimated annual effective income tax rate plus any discrete items which are recorded in the period in which they occur. Discrete items include, among others, such events as changes in estimates due to the finalization of tax returns, tax audit settlements, expiration of statute of limitations, and increases or decreases in valuation allowances. Our effective tax rate was 38.5% and 35.8% for the nine months ended September 30, 2013 and 2012, respectively. The effective tax rate for the nine months ended September 30, 2013 is above the 35% federal statutory tax rate due to state tax expense which is partially offset by foreign earnings taxed at lower rates.
Weighted Average Shares
The diluted weighted average number of shares outstanding was 215.9 million during the nine months ended September 30, 2013, compared to 220.3 million in the same period of 2012. The decrease in the number of shares reflects the impact of shares repurchased under our share repurchase program.


Critical Accounting Policies
The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the unaudited condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Our critical accounting policies are disclosed in our Annual Report on Form 10-K for the year ended December 31, 2012.
No other significant changes to our accounting policies have occurred subsequent to December 31, 2012, except as described below within Recent Accounting Pronouncements and Accounting Changes.
Recent Accounting Pronouncements and Accounting Changes
For discussion of recent accounting pronouncements and accounting changes, see Part I, Item 1. Financial Statements, Note 3.


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Cautionary Statement on Forward-Looking Statements

The statements in this Form 10-Q that are not historical facts are forward-looking statements made in reliance on the “safe harbor” protections provided under the Private Securities Litigation Reform Act of 1995. These statements may be accompanied by words such as “believe,” “estimate,” “project,” “expect,” “anticipate,” or “predict,” that convey the uncertainty of future events or outcomes. These statements are based on assumptions that we believe are reasonable; however, many important factors could cause our actual results in the future to differ materially from the forward-looking statements made herein and in any other documents or oral presentations made by us, or on our behalf. Important factors, which could cause actual results to differ materially from those in forward-looking statements include, among others, the following:
Our affiliated funeral and cemetery trust funds own investments in equity securities, fixed income securities, and mutual funds, which are affected by market conditions that are beyond our control.
We may be required to replenish our affiliated funeral and cemetery trust funds in order to meet minimum funding requirements, which would have a negative effect on our earnings and cash flow.
Our ability to execute our strategic plan depends on many factors, some of which are beyond our control.  
Our credit agreements contain covenants that may prevent us from engaging in certain transactions. 
If we lost the ability to use surety bonding to support our preneed funeral and preneed cemetery activities, we may be required to make material cash payments to fund certain trust funds.
The funeral home and cemetery industry continues to be increasingly competitive.
Increasing death benefits related to preneed funeral contracts funded through life insurance or annuity contracts may not cover future increases in the cost of providing a price-guaranteed funeral service. 
The financial condition of third-party insurance companies that fund our preneed funeral contracts may impact our future revenues.
Unfavorable results of litigation, including currently pending class action cases concerning cemetery or burial practices, could have a material adverse impact on our financial statements.
Unfavorable publicity could affect our reputation and business.
If the number of deaths in our markets declines, our cash flows and revenues may decrease.
If we are not able to respond effectively to changing consumer preferences, our market share, revenues and profitability could decrease.
The continuing upward trend in the number of cremations performed in North America could result in lower revenues and gross profit. 
Our funeral home and cemetery businesses are high fixed-cost businesses. 
Regulation and compliance could have a material adverse impact on our financial results.
Increased costs, including potential increased health care costs, may have a negative impact on earnings and cash flows.
Cemetery burial practice claims could have a material adverse impact on our financial results. 
A number of years may elapse before particular tax matters, for which we have established accruals, are audited and finally resolved.
Declines in overall economic conditions beyond our control could reduce future potential earnings and cash flows and could result in future goodwill impairments and /or other intangible assets.
Any failure to maintain the security of the information relating to our customers, their loved ones, our associates and vendors could damage our reputation, could cause us to incur substantial additional costs and to become subject to litigation, and could adversely affect our operating results.
The acquisition of Stewart is subject to certain closing conditions that, if not satisfied or waived, will result in the acquisition not being completed, which may cause the market price of SCI common stock to decline.
We may fail to realize the anticipated benefits of the acquisition of Stewart.
The acquisition of Stewart may result in unexpected consequences to our business and results of operations.

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Our level of indebtedness following the completion of the acquisition of Stewart could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry and prevent us from fulfilling our obligations under our indebtedness.
For further information on these and other risks and uncertainties, see our Securities and Exchange Commission filings, including our 2012 Annual Report on Form 10-K, which was filed February 13, 2013. Copies of this document as well as other SEC filings can be obtained from our website at www.sci-corp.com. We assume no obligation to publicly update or revise any forward-looking statements made herein or any other forward-looking statements made by us, whether as a result of new information, future events or otherwise.


Item 3. Quantitative and Qualitative Disclosures About Market Risk
Marketable Equity and Debt Securities — Price Risk
In connection with our preneed funeral operations and preneed cemetery merchandise and service sales, the related funeral and cemetery trust funds own investments in equity and debt securities and mutual funds, which are sensitive to current market prices.
Cost and market values as of September 30, 2013 are presented in Part I, Item 1. Financial Statements and Notes 4, 5, and 6 of this Form 10-Q. Also, see Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, Financial Conditions, Liquidity and Capital Resources, for discussion of trust investments.


Item 4. Controls and Procedures
Disclosure Controls and Procedures
As of September 30, 2013, we carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)). Our disclosure controls and procedures are designed to ensure that information required to be disclosed in the Securities and Exchange Commission (SEC) reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time period specified by the SEC’s rules and forms and that such information is accumulated and communicated to management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure. The officers have concluded that our disclosure controls and procedures were effective as of September 30, 2013 and that the unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q fairly present, in all material respects, our financial condition, results of operations and cash flows for the periods presented in conformity with US GAAP.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings
Information regarding legal proceedings is set forth in Note 15 in Item 1 of Part I of this Form 10-Q, which information is hereby incorporated by reference herein.

Item 1A. Risk Factors
There have been no material changes in our Risk Factors as set forth in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2012, except as set forth below.
Any failure to maintain the security of the information relating to our customers, their loved ones, our associates, and our vendors could damage our reputation, could cause us to incur substantial additional costs and to become subject to litigation, and could adversely affect our operating results.
In the ordinary course of our business, we receive certain personal information, in both physical and electronic formats, about our customers, their loved ones, our associates, and our vendors. In addition, our on-line operations at our websites depend upon the secure transmission of confidential information over public networks, including information permitting cashless payments. We maintain substantial security measures to protect, and to prevent unauthorized access to, such information. Nevertheless, it is possible that computer hackers and others (through cyberattacks, which are rapidly evolving and becoming increasingly

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sophisticated, or by other means) might defeat our security measures in the future and obtain the personal information of customers, their loved ones, our associates, and our vendors that we hold. Further, our associates, contractors, or third parties with whom we do business may attempt to circumvent our security measures in order to misappropriate such information, and may purposefully or inadvertently cause a breach involving such information. A breach of our security measures could adversely affect our reputation with our customers and their loved ones, associates, and vendors, as well as our operations, results of operations, financial condition and liquidity, and could result in litigation against us or the imposition of penalties. Moreover, a security breach could require that we expend significant additional resources to upgrade further the security measures that we employ to guard such important personal information against cyberattacks and other attempts to access such information and could result in a disruption of our operations.
The acquisition of Stewart Enterprises, Inc. is subject to certain closing conditions that, if not satisfied or waived, will result in the acquisition not being completed, which may cause the market price of SCI common stock to decline.
The acquisition is subject to customary conditions to closing, including the approval of Stewart Enterprises, Inc.'s (Stewart) stockholders and the receipt of antitrust regulatory approvals. If any condition to the acquisition agreement is not satisfied or, if permissible, waived, the acquisition will not be completed. In addition, SCI and Stewart may terminate the acquisition agreement in certain circumstances. If the acquisition is not completed, the market price of SCI common stock may decline if the current market price reflects a market assumption that the acquisition will be completed. SCI will also still be obligated to pay certain investment banking, financing, legal and accounting fees, and related expenses.
We may fail to realize the anticipated benefits of the acquisition of Stewart.
The success of the acquisition will depend, in part, on our ability to realize the anticipated cost savings from reduced back-office and infrastructure expenses, elimination of duplicative public company and management structure costs, and improved purchasing power through greater scale. However, to realize the anticipated benefits from the acquisition, we must successfully combine the businesses of SCI and Stewart in a manner that permits those costs savings to be realized. If we are not able to successfully achieve these objectives, the anticipated benefits of the acquisition may not be realized fully or at all or may take longer or cost more to realize than expected. SCI and Stewart have operated and, until the completion of the acquisition, will continue to operate, independently. It is possible that the integration process could result in the loss of valuable employees, the disruption of each company's ongoing businesses, or inconsistencies in standards, controls, procedures, practices, and policies that could adversely impact our operations.
The acquisition of Stewart may result in unexpected consequences to our business and results of operations.
Although Stewart's business will generally be subject to risks similar to those to which we are subject to in our existing operations, we may not have discovered all risks applicable to Stewart's business during the due diligence process and such risks may not be discovered prior to closing. Some of these risks could produce unexpected and unwanted consequences for us. Undiscovered risks may result in us incurring financial liabilities, which could be material and have a negative impact on our business operations.
Our level of indebtedness following the completion of the acquisition of Stewart could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry and prevent us from fulfilling our obligations under our indebtedness.
We have a significant amount of indebtedness which will be increased substantially if and when we complete the acquisition of Stewart Enterprises. Our substantial indebtedness could have important consequences, including the following:
it may limit our ability to obtain additional debt or equity financing for working capital, capital expenditures, acquisitions, debt service requirements and general corporate or other purposes;
a substantial portion of our cash flows from operations will be dedicated to the payment of principal and interest on our indebtedness, including indebtedness we may incur in the future, and will not be available for other purposes, including to finance our working capital, capital expenditures, acquisitions and general corporate or other purposes;
it could limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate and place us at a competitive disadvantage compared to our competitors that have less debt;
it could make us more vulnerable to downturns in general economic or industry conditions or in our business, or prevent us from carrying out activities that are important to our growth;
it could increase our interest expense if interest rates in general increase because a portion of our indebtedness, including all of our indebtedness under our senior credit facilities, bears interest at floating rates; and
it could make it more difficult for us to satisfy our obligations with respect to our indebtedness, and any failure to comply with the obligations of any of our debt instruments, including any financial and other restrictive covenants,

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could result in an event of default under the agreements governing our other indebtedness which, if not cured or waived, could result in the acceleration of our indebtedness.
Any of the above listed factors could materially affect our business, cash flows, financial condition and results of operations.
In addition to our high level of indebtedness, we also have significant rental and other obligations under our operating and capital leases for funeral service locations, cemetery operating and maintenance equipment and transportation equipment. These obligations could further increase the risks described above.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On September 30, 2013, we issued 1,069 deferred common stock equivalents, or units, pursuant to provisions regarding dividends under the Amended and Restated Director Fee Plan to four non-employee directors. We did not receive any monetary consideration for the issuances. These issuances were unregistered because they did not constitute a “sale” within the meaning of Section 2(3) of the Securities Act of 1933, as amended.

Item 6. Exhibits
12.1
Ratio of earnings to fixed charges for the three and nine months ended September 30, 2013 and 2012.
31.1
Certification of Thomas L. Ryan as Chief Executive Officer in satisfaction of Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Eric D. Tanzberger as Principal Financial Officer in satisfaction of Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification of Periodic Financial Reports by Thomas L. Ryan as Chief Executive Officer in satisfaction of Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification of Periodic Financial Reports by Eric D. Tanzberger as Principal Financial Officer in satisfaction of Section 906 of the Sarbanes-Oxley Act of 2002.
101
Interactive data file.


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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
October 24, 2013
 
SERVICE CORPORATION INTERNATIONAL
 
By:  
/s/ Tammy Moore
 
 
Tammy Moore
 
 
Vice President and Corporate Controller
(Principal Accounting Officer)


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Index to Exhibits
12.1
Ratio of earnings to fixed charges for the three and nine months ended September 30, 2013 and 2012.
31.1
Certification of Thomas L. Ryan as Chief Executive Officer in satisfaction of Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Eric D. Tanzberger as Principal Financial Officer in satisfaction of Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification of Periodic Financial Reports by Thomas L. Ryan as Chief Executive Officer in satisfaction of Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification of Periodic Financial Reports by Eric D. Tanzberger as Principal Financial Officer in satisfaction of Section 906 of the Sarbanes-Oxley Act of 2002.
101
Interactive data file.


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