10-Q 1 sci-2012930x10q.htm 10-Q SCI-2012.9.30 -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, 2012
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 23, 2012 was 212,707,060 (net of treasury shares).

 


SERVICE CORPORATION INTERNATIONAL
INDEX
 
 
 
Page
 
 
 
 
 

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 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.
Cremation — The reduction of human remains to bone fragments by intense heat.
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.
Production — Sales of preneed funeral and preneed or atneed cemetery contracts.
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,
 
2012
 
2011
 
2012
 
2011
 
(In thousands, except per share amounts)
Revenues
$
581,182

 
$
572,999

 
$
1,781,060

 
$
1,729,472

Costs and expenses
(459,911
)
 
(465,949
)
 
(1,404,033
)
 
(1,380,953
)
Gross profits
121,271

 
107,050

 
377,027

 
348,519

General and administrative expenses
(26,410
)
 
(23,863
)
 
(81,927
)
 
(77,381
)
Gains (losses) on divestitures and impairment charges, net
315

 
(5,001
)
 
883

 
(15,264
)
Operating income
95,176

 
78,186

 
295,983

 
255,874

Interest expense
(33,568
)
 
(33,038
)
 
(101,050
)
 
(100,476
)
Losses on early extinguishment of debt, net
—

 
(1,355
)
 
—

 
(3,504
)
Other income, net
2,317

 
249

 
4,001

 
969

Income before income taxes
63,925

 
44,042

 
198,934

 
152,863

Provision for income taxes
(22,128
)
 
(9,027
)
 
(71,183
)
 
(51,181
)
Net income
41,797

 
35,015

 
127,751

 
101,682

Net (income) loss attributable to noncontrolling interests
(735
)
 
481

 
(1,588
)
 
(1,329
)
Net income attributable to common stockholders
$
41,062

 
$
35,496

 
$
126,163

 
$
100,353

Basic earnings per share:
 
 
 
 
 
 
 
Net income attributable to common stockholders
$
0.19

 
$
0.15

 
$
0.58

 
$
0.42

Basic weighted average number of shares
214,914

 
232,917

 
216,974

 
237,037

Diluted earnings per share:

 
 
 
 
 
 
Net income attributable to common stockholders
$
0.19

 
$
0.15

 
$
0.57

 
$
0.42

Diluted weighted average number of shares
218,460

 
235,513

 
220,306

 
239,528

Dividends declared per share
$
0.06

 
$
0.05

 
$
0.17

 
$
0.15


(See notes to unaudited condensed consolidated financial statements)
SERVICE CORPORATION INTERNATIONAL
CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(UNAUDITED)

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
 
(In thousands)
 
(In thousands)
Net income
$
41,797

 
$
35,015

 
$
127,751

 
$
101,682

Other comprehensive income:
 
 
 
 
 
 
 
Foreign currency translation adjustments
13,513

 
(23,149
)
 
10,991

 
(13,229
)
Total comprehensive income
55,310

 
11,866

 
138,742

 
88,453

Total comprehensive (income) loss attributable to noncontrolling interests
(745
)
 
498

 
(1,600
)
 
(1,316
)
Total comprehensive income attributable to common stockholders
$
54,565

 
$
12,364

 
$
137,142

 
$
87,137


(See notes to unaudited condensed consolidated financial statements)


SERVICE CORPORATION INTERNATIONAL
CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED)
 
September 30, 2012
 
December 31, 2011
 
(In thousands, except share amounts)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
151,547

 
$
128,569

Receivables, net
92,811

 
103,892

Deferred tax assets
38,222

 
44,316

Inventories, net
25,132

 
25,513

Other
25,777

 
25,803

Total current assets
333,489

 
328,093

Preneed funeral receivables, net and trust investments
1,527,633

 
1,478,865

Preneed cemetery receivables, net and trust investments
1,777,598

 
1,595,940

Cemetery property, at cost
1,490,930

 
1,497,703

Property and equipment, net
1,632,676

 
1,618,361

Goodwill
1,366,075

 
1,361,493

Deferred charges and other assets
414,410

 
430,851

Cemetery perpetual care trust investments
1,091,083

 
1,016,506

Total assets
$
9,633,894

 
$
9,327,812

 
 
 
 
LIABILITIES & EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable and accrued liabilities
$
366,883

 
$
358,904

Current maturities of long-term debt
31,289

 
23,554

Income taxes
6,522

 
3,150

Total current liabilities
404,694

 
385,608

Long-term debt
1,882,834

 
1,861,116

Deferred preneed funeral revenues
545,987

 
575,546

Deferred preneed cemetery revenues
868,085

 
833,303

Deferred tax liability
449,228

 
405,615

Other liabilities
405,638

 
414,773

Deferred preneed funeral and cemetery receipts held in trust
2,590,639

 
2,424,356

Care trusts’ corpus
1,090,934

 
1,015,300

Commitments and contingencies (Note 15)

 

Equity:
 
 
 
Common stock, $1 per share par value, 500,000,000 shares authorized, 228,083,679 and 224,665,395 shares issued, respectively, and 213,973,997 and 222,955,853 shares outstanding, respectively
213,974

 
222,956

Capital in excess of par value
1,337,014

 
1,430,330

Accumulated deficit
(293,260
)
 
(367,044
)
Accumulated other comprehensive income
116,831

 
105,852

Total common stockholders’ equity
1,374,559

 
1,392,094

Noncontrolling interests
21,296

 
20,101

Total equity
1,395,855

 
1,412,195

Total liabilities and equity
$
9,633,894

 
$
9,327,812

(See notes to unaudited condensed consolidated financial statements)

4

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

 
Nine Months Ended
 
September 30,
 
2012
 
2011
 
(In thousands)
Cash flows from operating activities:
 
 
 
Net income
$
127,751

 
$
101,682

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Losses on early extinguishment of debt, net
—

 
3,504

Depreciation and amortization
89,349

 
88,363

Amortization of intangible assets
17,950

 
19,497

Amortization of cemetery property
31,528

 
27,889

Amortization of loan costs
3,635

 
3,259

Provision for doubtful accounts
6,801

 
6,431

Provision for deferred income taxes
57,428

 
40,038

(Gains) losses on divestitures and impairment charges, net
(883
)
 
15,264

Share-based compensation
8,217

 
6,843

Change in assets and liabilities, net of effects from acquisitions and divestitures:
 
 
 
Decrease in receivables
4,857

 
13,583

(Increase) decrease in other assets
(6,331
)
 
2,560

Increase in payables and other liabilities
6,623

 
7,808

Effect of preneed funeral production and maturities:
 
 
 
Decrease in preneed funeral receivables, net and trust investments
30,343

 
47,263

Decrease in deferred preneed funeral revenue
(30,325
)
 
(30,724
)
Decrease in deferred preneed funeral receipts held in trust
(18,185
)
 
(33,203
)
Effect of cemetery production and deliveries:
 
 
 
Increase in preneed cemetery receivables, net and trust investments
(72,012
)
 
(47,977
)
Increase in deferred preneed cemetery revenue
27,502

 
26,502

Decrease in deferred preneed cemetery receipts held in trust
(480
)
 
(6,280
)
Other
(3,481
)
 
(989
)
Net cash provided by operating activities
280,287

 
291,313

Cash flows from investing activities:
 
 
 
Capital expenditures
(80,973
)
 
(85,936
)
Acquisitions
(19,281
)
 
(97,473
)
Proceeds from divestitures and sales of property and equipment, net
8,933

 
15,233

Other
(3,816
)
 
956

Net cash used in investing activities
(95,137
)
 
(167,220
)
Cash flows from financing activities:
 
 
 
Proceeds from issuance of long-term debt
17,907

 
65,000

Payments of debt
(988
)
 
(2,169
)
Early extinguishment of debt
—

 
(43,089
)
Principal payments on capital leases
(19,303
)
 
(17,186
)
Proceeds from exercise of stock options
17,347

 
7,694

Purchase of Company common stock
(144,607
)
 
(146,590
)
Payments of dividends
(34,844
)
 
(33,395
)
Bank overdrafts and other
868

 
3,573

Net cash used in financing activities
(163,620
)
 
(166,162
)
Effect of foreign currency on cash and cash equivalents
1,448

 
(1,740
)
Net increase (decrease) in cash and cash equivalents
22,978

 
(43,809
)
Cash and cash equivalents at beginning of period
128,569

 
170,846

Cash and cash equivalents at end of period
$
151,547

 
$
127,037

(See notes to unaudited condensed consolidated financial statements)
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, 2010
$
242,020

 
$
(985
)
 
$
1,603,112

 
$
(477,459
)
 
$
112,768

 
$
492

 
$
1,479,948

Comprehensive income
—

 
—

 
—

 
100,353

 
(13,216
)
 
1,316

 
88,453

Dividends declared on common stock ($.15 per share)
—

 
—

 
(35,140
)
 
—

 
—

 
—

 
(35,140
)
Employee share-based compensation earned
—

 
—

 
6,843

 
—

 
—

 
—

 
6,843

Stock option exercises
1,137

 
—

 
6,557

 
—

 
—

 
—

 
7,694

Restricted stock awards, net of forfeitures
539

 
—

 
(539
)
 
—

 
—

 
—

 
—

Purchase of Company common stock
—

 
(14,785
)
 
(109,914
)
 
(21,891
)
 
—

 
—

 
(146,590
)
Acquisition
—

 
—

 
—

 
—

 
—

 
18,857

 
18,857

Noncontrolling interest payment
—

 
—

 
—

 
—

 
—

 
(568
)
 
(568
)
Other
72

 

 
680

 
—

 
—

 
—

 
752

Balance at September 30, 2011
$
243,768

 
$
(15,770
)
 
$
1,471,599

 
$
(398,997
)
 
$
99,552

 
$
20,097

 
$
1,420,249

 
 
 
 
 
 
 
 
 
 
 
 
 
 
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


(See notes to unaudited condensed consolidated financial statements)


5

SERVICE CORPORATION INTERNATIONAL
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)
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 mausoleum spaces, lots, and lawn crypts, 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 products and services whereby a customer contractually agrees to the terms of certain products and services to be provided in the future.

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, 2011, 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.
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, 2011. 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 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 determines 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.
Fair Value Measurements
In May 2011, the Financial Accounting Standards Board (FASB) amended the Fair Value Measurements and Disclosure (FVM&D) Topic of the Accounting Standards Codification (ASC) to expand disclosures about items marked to fair value that are categorized within Level 3 of the fair value hierarchy to include qualitative explanations of the valuation methodology used, sensitivity analysis of the inputs into the valuation, and quantitative information about those inputs. The amendment also requires that items that are not measured at fair value but for which the fair value is disclosed also disclose the level in the fair value hierarchy in which those items were categorized. We adopted the amended guidance in the first quarter of 2012 and the appropriate disclosures are contained in Notes 4, 5, and 6.
Comprehensive Income
In June 2011, the FASB amended the Comprehensive Income Topic of the ASC to require the disclosure of the components of other comprehensive income, which we previously disclosed elsewhere in our filings, be shown as either part of one statement of comprehensive income or as a separate statement of comprehensive income immediately following the income statement. We adopted the amended guidance in the first quarter of 2012 and a separate Statement of Comprehensive Income is included herein.

3. Recently Issued Accounting Standards
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 in our annual test in the fourth quarter of 2013, and adoption is not expected to impact our consolidated financial condition or results of operations.
Goodwill Testing
In September 2011, 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 a reporting unit is less than its carrying amount, including goodwill. 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 in our annual test in the fourth quarter of 2012, and adoption is not expected to impact our consolidated financial condition or results of operations.

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:

6

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
 
(In thousands)
 
(In thousands)
Deposits
$
19,982

 
$
18,960

 
$
64,081

 
$
55,189

Withdrawals
22,943

 
26,789

 
78,034

 
79,734

Purchases of available-for-sale securities
53,034

 
140,554

 
324,304

 
387,545

Sales of available-for-sale securities
51,672

 
114,476

 
323,471

 
448,988

Realized gains from sales of available-for-sale securities
7,681

 
11,353

 
43,446

 
49,618

Realized losses from sales of available-for-sale securities
(4,570
)
 
(6,586
)
 
(18,730
)
 
(18,215
)
The components of Preneed funeral receivables, net and trust investments in our unaudited condensed consolidated balance sheet at September 30, 2012 and December 31, 2011 are as follows:
 
September 30, 2012
 
December 31, 2011
 
(In thousands)
Trust investments, at fair value
$
968,394

 
$
892,685

Cash and cash equivalents
87,519

 
101,111

Insurance-backed fixed income securities
272,677

 
277,650

Trust investments
1,328,590

 
1,271,446

Receivables from customers
241,377

 
246,601

Unearned finance charge
(8,557
)
 
(5,425
)
 
1,561,410

 
1,512,622

Allowance for cancellation
(33,777
)
 
(33,757
)
Preneed funeral receivables, net and trust investments
$
1,527,633

 
$
1,478,865

The cost and fair values associated with our funeral merchandise and service trust investments recorded at fair value at September 30, 2012 and December 31, 2011 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).

7

 
September 30, 2012
 
Fair Value Hierarchy Level
 
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
 
 
 
 
 
(In thousands)
 
 
Fixed income securities:
 
 
 
 
 
 
 
 
 
U.S. Treasury
2
 
$
104,430

 
$
5,093

 
$
(921
)
 
$
108,602

Canadian government
2
 
113,880

 
717

 
(84
)
 
114,513

Corporate
2
 
52,424

 
2,302

 
(574
)
 
54,152

Residential mortgage-backed
2
 
3,296

 
76

 
(4
)
 
3,368

Asset-backed
2
 
127

 
3

 
—

 
130

Equity securities:
 
 
 
 
 
 
 
 
 
Preferred stock
2
 
2,897

 
184

 
(135
)
 
2,946

Common stock:
 
 
 
 
 
 
 
 
 
United States
1
 
220,152

 
47,415

 
(8,259
)
 
259,308

Canada
1
 
23,081

 
2,036

 
(1,516
)
 
23,601

Other international
1
 
17,384

 
2,094

 
(574
)
 
18,904

Mutual funds:
 
 
 
 
 
 
 
 
 
Equity
1
 
147,131

 
6,464

 
(8,755
)
 
144,840

Fixed income
1
 
221,433

 
8,322

 
(8,908
)
 
220,847

Private equity
3
 
37,346

 
211

 
(21,288
)
 
16,269

Other
3
 
536

 
378

 
—

 
914

Trust investments
 
 
$
944,117

 
$
75,295

 
$
(51,018
)
 
$
968,394


 
December 31, 2011
 
Fair Value Hierarchy Level
 
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
 
 
 
 
 
(In thousands)
 
 
Fixed income securities:
 
 
 
 
 
 
 
 
 
U.S. Treasury
2
 
$
77,299

 
$
4,565

 
$
(373
)
 
$
81,491

Canadian government
2
 
114,586

 
838

 
(109
)
 
115,315

Corporate
2
 
49,210

 
1,849

 
(770
)
 
50,289

Residential mortgage-backed
2
 
3,292

 
71

 
(34
)
 
3,329

Asset-backed
2
 
126

 
6

 
—

 
132

Equity securities:
 
 
 
 
 
 
 
 
 
Preferred stock
2
 
2,041

 
50

 
(153
)
 
1,938

Common stock:
 
 
 
 
 
 
 
 
 
United States
1
 
258,738

 
40,992

 
(22,715
)
 
277,015

Canada
1
 
23,986

 
2,511

 
(1,771
)
 
24,726

Other international
1
 
18,954

 
1,045

 
(1,296
)
 
18,703

Mutual funds:
 
 
 
 
 
 
 
 
 
Equity
1
 
134,383

 
2,384

 
(18,982
)
 
117,785

Fixed income
1
 
193,134

 
5,044

 
(13,114
)
 
185,064

Private equity
3
 
35,017

 
218

 
(19,249
)
 
15,986

Other
3
 
484

 
428

 
—

 
912

Trust investments
 
 
$
911,250

 
$
60,001

 
$
(78,566
)
 
$
892,685

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.

8

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, 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 Treasury 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, 2012, our unfunded commitment for our private equity and other investments was $12.3 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
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
Fair value, beginning balance
$
17,268

 
$
29,031

 
$
16,898

 
$
21,359

Net unrealized losses included in Accumulated other comprehensive income(1)
(748
)
 
(7,757
)
 
(2,332
)
 
(1,001
)
Net realized losses included in Other income, net(2)
(12
)
 
(8
)
 
(28
)
 
(67
)
Purchases
—

 
18

 
—

 
18

Sales
—

 
(7,970
)
 
(9
)
 
(8,156
)
Contributions
995

 
7,615

 
3,554

 
9,397

Distributions and other
(320
)
 
(522
)
 
(900
)
 
(1,143
)
Fair value, ending balance
$
17,183

 
$
20,407

 
$
17,183

 
$
20,407

                                                                               
(1)
All unrealized 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.
(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 2012 to 2053. Maturities of fixed income securities, excluding mutual funds, at September 30, 2012 are estimated as follows:
 
Fair Value
 
(In thousands)
Due in one year or less
$
132,075

Due in one to five years
60,638

Due in five to ten years
52,893

Thereafter
35,159

 
$
280,765

Earnings from all our funeral merchandise and service trust investments are recognized in funeral revenues when a service

9

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 earnings (realized and unrealized) related to these trust investments were $8.5 million and $10.2 million for the three months ended September 30, 2012 and 2011, respectively. Recognized earnings (realized and unrealized) related to these trust investments were $27.7 million and $28.9 million for the nine months ended September 30, 2012 and 2011, 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 the three months ended September 30, 2012 and 2011, we recorded a $0.2 million and a $17.5 million impairment charge for other-than-temporary declines in fair value related to unrealized losses on certain investments, respectively. For the nine months ended September 30, 2012 and 2011, we recorded a $0.7 million and a $20.8 million impairment charge 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 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, 2012 and December 31, 2011, respectively, are shown in the following tables:
 
September 30, 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
$
23,489

 
$
(844
)
 
$
6,279

 
$
(77
)
 
$
29,768

 
$
(921
)
Canadian government
8,475

 
(84
)
 
—

 
—

 
8,475

 
(84
)
Corporate
11,083

 
(403
)
 
3,093

 
(171
)
 
14,176

 
(574
)
Residential mortgage-backed
712

 
(4
)
 
—

 
—

 
712

 
(4
)
Equity securities:
 
 
 
 
 
 
 
 
 
 
 
Preferred stock
824

 
(55
)
 
233

 
(80
)
 
1,057

 
(135
)
Common stock:
 
 
 
 
 
 
 
 
 
 
 
United States
47,144

 
(4,921
)
 
10,298

 
(3,338
)
 
57,442

 
(8,259
)
Canada
6,431

 
(877
)
 
2,385

 
(639
)
 
8,816

 
(1,516
)
Other international
3,855

 
(253
)
 
1,555

 
(321
)
 
5,410

 
(574
)
Mutual funds:
 
 
 
 
 
 
 
 
 
 
 
Equity
31,439

 
(406
)
 
32,304

 
(8,349
)
 
63,743

 
(8,755
)
Fixed income
47,052

 
(1,011
)
 
13,760

 
(7,897
)
 
60,812

 
(8,908
)
Private equity
614

 
(1,790
)
 
15,294

 
(19,498
)
 
15,908

 
(21,288
)
Total temporarily impaired securities
$
181,118

 
$
(10,648
)
 
$
85,201

 
$
(40,370
)
 
$
266,319

 
$
(51,018
)


10

 
December 31, 2011
 
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
$
6,977

 
$
(90
)
 
$
8,709

 
$
(283
)
 
$
15,686

 
$
(373
)
Canadian government
9,597

 
(109
)
 
—

 
—

 
9,597

 
(109
)
Corporate
17,328

 
(692
)
 
662

 
(78
)
 
17,990

 
(770
)
Residential mortgage-backed
600

 
(4
)
 
295

 
(30
)
 
895

 
(34
)
Equity securities:
 
 
 
 
 
 
 
 
 
 
 
Preferred stock
1,244

 
(153
)
 
—

 
—

 
1,244

 
(153
)
Common stock:
 
 
 
 
 
 
 
 
 
 
 
United States
84,450

 
(18,120
)
 
14,924

 
(4,595
)
 
99,374

 
(22,715
)
Canada
8,448

 
(1,491
)
 
513

 
(280
)
 
8,961

 
(1,771
)
Other international
7,263

 
(615
)
 
2,403

 
(681
)
 
9,666

 
(1,296
)
Mutual funds:
 
 
 
 
 
 
 
 
 
 
 
Equity
76,559

 
(9,173
)
 
26,053

 
(9,809
)
 
102,612

 
(18,982
)
Fixed income
68,378

 
(5,500
)
 
9,314

 
(7,614
)
 
77,692

 
(13,114
)
Private equity
1,977

 
(3,499
)
 
13,502

 
(15,750
)
 
15,479

 
(19,249
)
Total temporarily impaired securities
$
282,821

 
$
(39,446
)
 
$
76,375

 
$
(39,120
)
 
$
359,196

 
$
(78,566
)

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,
 
2012
 
2011
 
2012
 
2011
 
(In thousands)
 
(In thousands)
Deposits
$
25,010

 
$
25,946

 
$
75,717

 
$
76,442

Withdrawals
28,260

 
25,917

 
75,623

 
84,444

Purchases of available-for-sale securities
114,549

 
88,518

 
443,613

 
411,195

Sales of available-for-sale securities
111,663

 
78,721

 
428,350

 
407,272

Realized gains from sales of available-for-sale securities
9,754

 
10,134

 
57,636

 
51,225

Realized losses from sales of available-for-sale securities
(6,962
)
 
(8,758
)
 
(25,028
)
 
(19,994
)
The components of Preneed cemetery receivables, net and trust investments in our unaudited condensed consolidated balance sheet at September 30, 2012 and December 31, 2011 are as follows:

11

 
September 30, 2012
 
December 31, 2011
 
(In thousands)
Trust investments, at fair value
$
1,171,117

 
$
1,051,464

Cash and cash equivalents
94,446

 
104,554

Insurance-backed fixed income securities
4

 
5

Trust investments
1,265,567

 
1,156,023

Receivables from customers
590,448

 
517,917

Unearned finance charges
(30,805
)
 
(33,766
)
 
1,825,210

 
1,640,174

Allowance for cancellation
(47,612
)
 
(44,234
)
Preneed cemetery receivables, net and trust investments
$
1,777,598

 
$
1,595,940

The cost and fair values associated with our cemetery merchandise and service trust investments recorded at fair value at September 30, 2012 and December 31, 2011 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.
 
September 30, 2012
 
Fair Value Hierarchy Level
 
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
 
 
 
 
 
(In thousands)
 
 
Fixed income securities:
 
 
 
 
 
 
 
 
 
U.S. Treasury
2
 
$
97,653

 
$
8,116

 
$
(890
)
 
$
104,879

Canadian government
2
 
17,233

 
412

 
(62
)
 
17,583

Corporate
2
 
42,906

 
2,383

 
(788
)
 
44,501

Residential mortgage-backed
2
 
162

 
5

 
—

 
167

Equity securities:
 
 
 
 
 
 
 
 
 
Preferred stock
2
 
4,771

 
294

 
(286
)
 
4,779

Common stock:
 
 
 
 
 
 
 
 
 
United States
1
 
349,200

 
90,099

 
(10,828
)
 
428,471

Canada
1
 
15,146

 
2,465

 
(1,093
)
 
16,518

Other international
1
 
28,750

 
4,036

 
(851
)
 
31,935

Mutual funds:
 
 
 
 
 
 
 
 
 
Equity
1
 
264,373

 
10,128

 
(11,521
)
 
262,980

Fixed income
1
 
246,400

 
12,359

 
(15,904
)
 
242,855

Private equity
3
 
33,553

 
59

 
(17,604
)
 
16,008

Other
3
 
408

 
35

 
(2
)
 
441

Trust investments
 
 
$
1,100,555

 
$
130,391

 
$
(59,829
)
 
$
1,171,117



12

 
December 31, 2011
 
Fair Value Hierarchy Level
 
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
 
 
 
 
 
(In thousands)
 
 
Fixed income securities:
 
 
 
 
 
 
 
 
 
U.S. Treasury
2
 
$
51,022

 
$
6,438

 
$
(313
)
 
$
57,147

Canadian government
2
 
16,566

 
381

 
(24
)
 
16,923

Corporate
2
 
42,803

 
2,033

 
(961
)
 
43,875

Residential mortgage-backed
2
 
167

 
5

 
(2
)
 
170

Equity securities:
 
 
 
 
 
 
 
 
 
Preferred stock
2
 
3,365

 
86

 
(270
)
 
3,181

Common stock:
 
 
 
 
 
 
 
 
 
United States
1
 
408,075

 
71,138

 
(30,454
)
 
448,759

Canada
1
 
18,289

 
2,547

 
(1,780
)
 
19,056

Other international
1
 
30,501

 
1,843

 
(1,536
)
 
30,808

Mutual funds:
 
 
 
 
 
 
 
 
 
Equity
1
 
197,523

 
3,317

 
(24,911
)
 
175,929

Fixed income
1
 
248,529

 
11,670

 
(20,238
)
 
239,961

Private equity
3
 
30,783

 
53

 
(15,617
)
 
15,219

Other
3
 
306

 
130

 
—

 
436

Trust investments
 
 
$
1,047,929

 
$
99,641

 
$
(96,106
)
 
$
1,051,464

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 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, 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 Treasury 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, 2012, our unfunded commitment for our private equity and other investments was $13.0 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):

13

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
Fair value, beginning balance
$
16,229

 
$
14,674

 
$
15,655

 
$
6,251

Net unrealized losses included in Accumulated other comprehensive income(1)
(442
)
 
(8,530
)
 
(1,919
)
 
(1,545
)
Net realized losses included in Other (expense) income, net(2)
(13
)
 
(8
)
 
(32
)
 
(73
)
Contributions
1,044

 
7,910

 
3,760

 
9,762

Distributions and other
(369
)
 
59

 
(1,015
)
 
(290
)
Fair value, ending balance
$
16,449

 
$
14,105

 
$
16,449

 
$
14,105

                                                                               
(1)
All unrealized 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 2012 to 2041. Maturities of fixed income securities, excluding mutual funds, at September 30, 2012 are estimated as follows:
 
Fair Value
 
(In thousands)
Due in one year or less
$
9,154

Due in one to five years
58,737

Due in five to ten years
48,308

Thereafter
50,931

 
$
167,130

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 earnings (realized and unrealized) related to these trust investments were $6.7 million and $4.6 million for the three months ended September 30, 2012 and 2011, respectively. Recognized earnings (realized and unrealized) related to these trust investments were $20.0 million and $15.7 million for the nine months ended September 30, 2012 and 2011, 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 the three months ended September 30, 2012 and 2011, we recorded a $0.2 million and a $24.9 million impairment charge for other-than-temporary declines in fair value related to unrealized losses on certain investments, respectively. For the nine months ended September 30, 2012 and 2011, we recorded a $0.8 million and a $26.1 million impairment charge 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 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, 2012 are shown in the following tables:

14

 
September 30, 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
$
28,269

 
$
(890
)
 
$
—

 
$
—

 
$
28,269

 
$
(890
)
Canadian government
5,724

 
(62
)
 
—

 
—

 
5,724

 
(62
)
Corporate
17,118

 
(627
)
 
1,470

 
(161
)
 
18,588

 
(788
)
Equity securities:
 
 
 
 
 
 
 
 
 
 
 
Preferred stock
872

 
(77
)
 
603

 
(209
)
 
1,475

 
(286
)
Common stock:
 
 
 
 
 
 
 
 
 
 
 
United States
65,739

 
(6,698
)
 
14,006

 
(4,130
)
 
79,745

 
(10,828
)
Canada
2,791

 
(629
)
 
1,325

 
(464
)
 
4,116

 
(1,093
)
Other international
5,891

 
(395
)
 
2,117

 
(456
)
 
8,008

 
(851
)
Mutual funds:
 
 
 
 
 
 
 
 
 
 
 
Equity
44,774

 
(882
)
 
42,289

 
(10,639
)
 
87,063

 
(11,521
)
Fixed income
43,307

 
(1,051
)
 
27,517

 
(14,853
)
 
70,824

 
(15,904
)
Private equity
48

 
(23
)
 
15,451

 
(17,581
)
 
15,499

 
(17,604
)
Other
12

 
(1
)
 
382

 
(1
)
 
394

 
(2
)
Total temporarily impaired securities
$
214,545

 
$
(11,335
)
 
$
105,160

 
$
(48,494
)
 
$
319,705

 
$
(59,829
)


 
December 31, 2011
 
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
$
1,736

 
$
(51
)
 
$
3,038

 
$
(262
)
 
$
4,774

 
$
(313
)
Canadian government
4,024

 
(24
)
 
—

 
—

 
4,024

 
(24
)
Corporate
15,044

 
(850
)
 
1,747

 
(111
)
 
16,791

 
(961
)
Residential mortgage-backed
2

 
(1
)
 
15

 
(1
)
 
17

 
(2
)
Equity securities:
 
 
 
 
 
 
 
 
 
 
 
Preferred stock
1,583

 
(270
)
 
—

 
—

 
1,583

 
(270
)
Common stock:
 
 
 
 
 
 
 
 
 
 
 
United States
123,849

 
(26,401
)
 
17,085

 
(4,053
)
 
140,934

 
(30,454
)
Canada
7,694

 
(1,260
)
 
366

 
(520
)
 
8,060

 
(1,780
)
Other international
8,654

 
(629
)
 
3,772

 
(907
)
 
12,426

 
(1,536
)
Mutual funds:
 
 
 
 
 
 
 
 
 
 
 
Equity
115,725

 
(11,222
)
 
36,398

 
(13,689
)
 
152,123

 
(24,911
)
Fixed income
48,950

 
(7,686
)
 
9,367

 
(12,552
)
 
58,317

 
(20,238
)
Private equity
466

 
(254
)
 
14,213

 
(15,363
)
 
14,679

 
(15,617
)
Total temporarily impaired securities
$
327,727

 
$
(48,648
)
 
$
86,001

 
$
(47,458
)
 
$
413,728

 
$
(96,106
)

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,
 
2012
 
2011
 
2012
 
2011
 
(In thousands)
 
(In thousands)
Deposits
$
6,501

 
$
5,503

 
$
18,866

 
$
17,806

Withdrawals
9,239

 
10,269

 
23,422

 
28,098

Purchases of available-for-sale securities
24,467

 
87,135

 
126,478

 
413,176

Sales of available-for-sale securities
27,733

 
49,705

 
101,110

 
387,715

Realized gains from sales of available-for-sale securities
3,328

 
4,101

 
7,522

 
31,221

Realized losses from sales of available-for-sale securities
(1,518
)
 
(1,764
)
 
(5,435
)
 
(14,506
)
The components of Cemetery perpetual care trust investments in our unaudited condensed consolidated balance sheet at September 30, 2012 and December 31, 2011 are as follows:
 
September 30, 2012
 
December 31, 2011
 
(In thousands)
Trust investments, at fair value
$
1,033,292

 
$
952,573

Cash and cash equivalents
57,791

 
63,933

Cemetery perpetual care trust investments
$
1,091,083

 
$
1,016,506

The cost and fair values associated with our cemetery perpetual care trust investments recorded at fair value at September 30, 2012 and December 31, 2011 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.
 
September 30, 2012
 
Fair Value Hierarchy Level
 
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
 
 
 
 
 
(In thousands)
 
 
Fixed income securities:
 
 
 
 
 
 
 
 
 
U.S. Treasury
2
 
$
808

 
$
49

 
$
(1
)
 
$
856

Canadian government
2
 
29,977

 
734

 
(102
)
 
30,609

Corporate
2
 
19,597

 
548

 
(118
)
 
20,027

Residential mortgage-backed
2
 
1,562

 
51

 
(1
)
 
1,612

Asset-backed
2
 
161

 
9

 
—

 
170

Equity securities:
 
 
 
 
 
 
 
 
 
Preferred stock
2
 
5,641

 
1

 
(828
)
 
4,814

Common stock:
 
 
 
 
 
 
 
 
 
United States
1
 
158,941

 
23,050

 
(3,633
)
 
178,358

Canada
1
 
9,150

 
1,341

 
(860
)
 
9,631

Other international
1
 
16,256

 
1,340

 
(263
)
 
17,333

Mutual funds:
 
 
 
 
 
 
 
 
 
Equity
1
 
18,036

 
2,600

 
(132
)
 
20,504

Fixed income
1
 
674,118

 
57,906

 
(984
)
 
731,040

Private equity
3
 
24,600

 
337

 
(14,052
)
 
10,885

Other
3
 
9,464

 
1,088

 
(3,099
)
 
7,453

Cemetery perpetual care trust investments
 
 
$
968,311

 
$
89,054

 
$
(24,073
)
 
$
1,033,292


 
December 31, 2011
 
Fair Value Hierarchy Level
 
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
 
 
 
 
 
(In thousands)
 
 
Fixed income securities:
 
 
 
 
 
 
 
 
 
U.S. Treasury
2
 
$
981

 
$
39

 
$
—

 
$
1,020

Canadian government
2
 
29,015

 
686

 
(43
)
 
29,658

Corporate
2
 
21,197

 
528

 
(134
)
 
21,591

Residential mortgage-backed
2
 
1,662

 
53

 
(13
)
 
1,702

Asset-backed
2
 
83

 
2

 
(1
)
 
84

Equity securities:
 
 
 
 
 
 
 
 
 
Preferred stock
2
 
6,475

 
18

 
(1,146
)
 
5,347

Common stock:
 
 
 
 
 
 
 
 


United States
1
 
141,880

 
14,443

 
(9,113
)
 
147,210

Canada
1
 
13,374

 
1,483

 
(1,423
)
 
13,434

Other international
1
 
16,836

 
1,314

 
(1,421
)
 
16,729

Mutual funds:
 
 
 
 
 
 
 
 
 
Equity
1
 
21,801

 
1,598

 
(579
)
 
22,820

Fixed income
1
 
654,883

 
29,758

 
(9,402
)
 
675,239

Private equity
3
 
23,212

 
374

 
(12,737
)
 
10,849

Other
3
 
8,018

 
850

 
(1,978
)
 
6,890

Cemetery perpetual care trust investments
 
 
$
939,417

 
$
51,146

 
$
(37,990
)
 
$
952,573

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 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, 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 Treasury 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, 2012, our unfunded commitment for our private equity and other investments was $6.0 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
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
Fair value, beginning balance
$
18,923

 
$
19,055

 
$
17,739

 
$
17,089

Net unrealized gains (losses) included in Accumulated other comprehensive income(1)
828

 
(2,377
)
 
1,483

 
5,525

Net realized (losses) gains included in Other income, net(2)
(41
)
 
4

 
(129
)
 
(187
)
Sales
—

 
—

 
(26
)
 
(44
)
Contributions
465

 
18

 
3,244

 
115

Distributions and other
(1,837
)
 
856

 
(3,973
)
 
(4,942
)
Fair value, ending balance
$
18,338

 
$
17,556

 
$
18,338

 
$
17,556

                                                                               
(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.
Maturity dates of our fixed income securities range from 2012 to 2041. Maturities of fixed income securities at September 30, 2012 are estimated as follows:
 
Fair Value
 
(In thousands)
Due in one year or less
$
8,353

Due in one to five years
18,449

Due in five to ten years
25,112

Thereafter
1,360

 
$
53,274

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 earnings related to these trust investments were $10.5 million and $9.0 million for the three months ended September 30, 2012 and 2011, respectively. Recognized earnings related to these trust investments were $29.6 million and $31.0 million for the nine months ended September 30, 2012 and 2011, 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 both the three months ended September 30, 2012 and 2011, we recorded a $0.0 million impairment charge for other-than-temporary declines in fair value related to unrealized losses on certain investments. For both the nine months ended September 30, 2012 and 2011, we recorded a $0.3 million impairment charge 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 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.
 
September 30, 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
$
272

 
$
(1
)
 
$
—

 
$
—

 
$
272

 
$
(1
)
Canadian government
9,986

 
(102
)
 
—

 
—

 
9,986

 
(102
)
Corporate
8,237

 
(93
)
 
579

 
(25
)
 
8,816

 
(118
)
Residential mortgage-backed
136

 
(1
)
 
—

 
—

 
136

 
(1
)
Equity securities:
 
 
 
 
 
 
 
 
 
 
 
Preferred stock
3,744

 
(482
)
 
924

 
(346
)
 
4,668

 
(828
)
Common stock:
 
 
 
 
 
 
 
 
 
 
 
United States
30,487

 
(1,610
)
 
10,089

 
(2,023
)
 
40,576

 
(3,633
)
Canada
1,532

 
(359
)
 
1,027

 
(501
)
 
2,559

 
(860
)
Other international
3,445

 
(124
)
 
1,058

 
(139
)
 
4,503

 
(263
)
Mutual funds:
 
 
 
 
 
 
 
 
 
 
 
Equity
1,014

 
(28
)
 
508

 
(104
)
 
1,522

 
(132
)
Fixed income
34,621

 
(85
)
 
36,496

 
(899
)
 
71,117

 
(984
)
Private equity
—

 
—

 
10,516

 
(14,052
)
 
10,516

 
(14,052
)
Other
—

 
—

 
6,125

 
(3,099
)
 
6,125

 
(3,099
)
Total temporarily impaired securities
$
93,474

 
$
(2,885
)
 
$
67,322

 
$
(21,188
)
 
$
160,796

 
$
(24,073
)

 
December 31, 2011
 
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:
 
 
 
 
 
 
 
 
 
 
 
Canadian government
$
7,057

 
$
(43
)
 
$
—

 
$
—

 
$
7,057

 
$
(43
)
Corporate
3,854

 
(73
)
 
1,456

 
(61
)
 
5,310

 
(134
)
Residential mortgage-backed
58

 
(1
)
 
127

 
(12
)
 
185

 
(13
)
Asset-backed
51

 
(1
)
 
—

 
—

 
51

 
(1
)
Equity securities:
 
 
 
 
 
 
 
 
 
 
 
Preferred stock
4,393

 
(1,116
)
 
21

 
(30
)
 
4,414

 
(1,146
)
Common stock:
 
 
 
 
 
 
 
 
 
 
 
United States
39,716

 
(5,459
)
 
9,055

 
(3,654
)
 
48,771

 
(9,113
)
Canada
4,402

 
(772
)
 
565

 
(651
)
 
4,967

 
(1,423
)
Other international
5,738

 
(1,226
)
 
104

 
(195
)
 
5,842

 
(1,421
)
Mutual funds:
 
 
 
 
 
 
 
 
 
 
 
Equity
9,852

 
(564
)
 
2,717

 
(15
)
 
12,569

 
(579
)
Fixed income
144,350

 
(5,498
)
 
51,301

 
(3,904
)
 
195,651

 
(9,402
)
Private equity
254

 
(324
)
 
10,189

 
(12,413
)
 
10,443

 
(12,737
)
Other
140

 
(181
)
 
5,660

 
(1,797
)
 
5,800

 
(1,978
)
Total temporarily impaired securities
$
219,865

 
$
(15,258
)
 
$
81,195

 
$
(22,732
)
 
$
301,060

 
$
(37,990
)

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, 2012 and December 31, 2011 are detailed below.
 
September 30, 2012
 
December 31, 2011
 
Preneed
Funeral
 
Preneed
Cemetery
 
Total
 
Preneed
Funeral
 
Preneed
Cemetery
 
Total
 
(In thousands)
 
(In thousands)
Trust investments
$
1,328,590

 
$
1,265,567

 
$
2,594,157

 
$
1,271,446

 
$
1,156,023

 
$
2,427,469

Accrued trust operating payables and other
(1,531
)
 
(1,987
)
 
(3,518
)
 
(1,261
)
 
(1,852
)
 
(3,113
)
Deferred preneed funeral and cemetery receipts held in trust
$
1,327,059

 
$
1,263,580

 
$
2,590,639

 
$
1,270,185

 
$
1,154,171

 
$
2,424,356

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, 2012 and December 31, 2011 are detailed below.
 
September 30, 2012
 
December 31, 2011
 
(In thousands)
Cemetery perpetual care trust investments
$
1,091,083

 
$
1,016,506

Accrued trust operating payables and other
(149
)
 
(1,206
)
Care trusts’ corpus
$
1,090,934

 
$
1,015,300

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, 2012 and 2011 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, 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


 
Three Months Ended September 30, 2011
 
Funeral
Trusts
 
Cemetery
Trusts
 
Cemetery Perpetual
Care Trusts
 
Other, Net
 
Total
 
 
 
(In thousands)
 
 
Realized gains
$
11,353

 
$
10,134

 
$
4,101

 
$
—

 
$
25,588

Realized losses
(6,586
)
 
(8,758
)
 
(1,764
)
 
—

 
(17,108
)
Impairment charges
(17,533
)
 
(24,885
)
 
(5
)
 
—

 
(42,423
)
Interest, dividend, and other ordinary income
3,911

 
4,217

 
6,185

 
—

 
14,313

Trust expenses and income taxes
(2,116
)
 
(3,119
)
 
(647
)
 
—

 
(5,882
)
Net trust investment income
(10,971
)
 
(22,411
)
 
7,870

 
—

 
(25,512
)
Reclassification to deferred preneed funeral and cemetery receipts held in trust and care trusts’ corpus
10,971

 
22,411

 
(7,870
)
 
—

 
25,512

Other income, net
—

 
—

 
—

 
249

 
249

Total other income, net
$
—

 
$
—

 
$
—

 
$
249

 
$
249


 
Nine Months Ended September 30, 2011
 
Funeral
Trusts
 
Cemetery
Trusts
 
Cemetery Perpetual
Care Trusts
 
Other, Net
 
Total
 
 
 
(In thousands)
 
 
Realized gains
$
49,618

 
$
51,225

 
$
31,221

 
$
—

 
$
132,064

Realized losses
(18,215
)
 
(19,994
)
 
(14,506
)
 
—

 
(52,715
)
Impairment charges
(20,821
)
 
(26,081
)
 
(316
)
 
—

 
(47,218
)
Interest, dividend, and other ordinary income
15,085

 
16,545

 
25,775

 
—

 
57,405

Trust expenses and income taxes
(4,982
)
 
(7,385
)
 
(2,753
)
 
—

 
(15,120
)
Net trust investment income
20,685

 
14,310

 
39,421

 
—

 
74,416

Reclassification to deferred preneed funeral and cemetery receipts held in trust and care trusts’ corpus
(20,685
)
 
(14,310
)
 
(39,421
)
 
—

 
(74,416
)
Other income, net
—

 
—

 
—

 
969

 
969

Total other income, net
$
—

 
$
—

 
$
—

 
$
969

 
$
969



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 34.6% and 20.5% for the three months ended September 30, 2012 and 2011, respectively. Our effective tax rate was 35.8% and 33.5% for the nine months ended September 30, 2012 and 2011, respectively. We sold our Puerto Rican subsidiary in the third quarter of 2011. Our outside tax basis in the business was significantly higher than our book basis. Consequently, we recognized a tax loss that was significantly higher than the book loss on the sale which is permanent in nature. The lower effective tax rate for the three and nine months ended September 30, 2011 is primarily due to that sale.
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 nine months ended September 30, 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, 2012, the gross amount of our unrecognized tax benefits was $146.9 million and the gross amount of our accrued interest was $40.8 million. During the nine months ended September 30, 2012, our unrecognized tax benefit and gross accrued interest decreased by $9.4 million and $1.0 million respectively, due primarily to the conclusion of the IRS audit described above.
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 2003 - 2005 remain under review at the IRS Appeals level and SCI and Subsidiaries' tax years 1999 - 2002 remain under review at the IRS Examination level. Various state and foreign jurisdictions are auditing years through 2009. 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.

9. Debt
Debt as of September 30, 2012 and December 31, 2011 was as follows:
 
September 30, 2012
 
December 31, 2011
 
(In thousands)
7.875% Debentures due February 2013
$
4,757

 
$
4,757

7.375% Senior Notes due October 2014
180,692

 
180,692

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

8.0% Senior Notes due November 2021
150,000

 
150,000

7.5% Senior Notes due April 2027
200,000

 
200,000

Bank credit facility due March 2016
77,000

 
65,000

Obligations under capital leases
171,427

 
124,330

Mortgage notes and other debt, maturities through 2047
5,850

 
35,937

Unamortized pricing discounts and other
(4,445
)
 
(4,888
)
Total debt
1,914,123

 
1,884,670

Less current maturities
(31,289
)
 
(23,554
)
Total long-term debt
$
1,882,834

 
$
1,861,116

Current maturities of debt at September 30, 2012 were primarily comprised of our capital leases. Our consolidated debt had a weighted average interest rate of 6.54% and 6.69% at September 30, 2012 and December 31, 2011, respectively. Approximately 88% and 89% of our total debt had a fixed interest rate at September 30, 2012 and December 31, 2011, respectively.
Bank Credit Facility
The Company has a $500 million bank credit facility due March 2016 with a syndicate of banks, including a sublimit of $175 million for letters of credit.
As of September 30, 2012, we have $77.0 million outstanding cash advances under our bank credit facility and have used it to support $32.4 million of letters of credit. The bank credit facility 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 pay a quarterly fee on the unused commitment, which was 0.35% for the third quarter. As of September 30, 2012, we have $390.6 million in borrowing capacity under the bank credit facility.
Debt Extinguishments and Reductions
During the nine months ended September 30, 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.
During the nine months ended September 30, 2011, we paid $17.2 million to retire capital lease obligations and $43.1 million to retire $22.3 million aggregate principal amount of our 6.75% Senior Notes due April 2015, $16.9 million aggregate principal amount of our 6.75% Senior Notes due April 2016, and $3.9 million aggregate principal amount of our 7.875% Debentures due February 2013. Certain of the above transactions resulted in the recognition of a loss of $3.5 million recorded in Losses on early extinguishment of debt, net in our unaudited condensed consolidated statement of operations.
Capital Leases
During the nine months ended September 30, 2012 and 2011, we acquired $67.0 million and $27.1 million, respectively, of primarily transportation equipment capital leases.

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, 2012 and December 31, 2011 was as follows:
 
September 30, 2012
 
December 31, 2011
 
(In thousands)
7.875% Debentures due February 2013
$
4,757

 
$
4,971

7.375% Senior Notes due October 2014
199,439

 
196,954

6.75% Senior Notes due April 2015
150,112

 
150,083

6.75% Senior Notes due April 2016
220,569

 
216,375

7.0% Senior Notes due June 2017
340,725

 
323,025

7.625% Senior Notes due October 2018
296,875

 
276,875

7.0% Senior Notes due May 2019
275,625

 
262,500

8.0% Senior Notes due November 2021
184,875

 
167,550

7.5% Senior Notes due April 2027
216,200

 
195,750

Bank credit facility due March 2016
77,000

 
65,000

Mortgage notes and other debt, maturities through 2047
5,850

 
36,340

Total fair value of debt instruments
$
1,972,027

 
$
1,895,423

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 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, 2012:
 
 
Nine Months Ended
Assumptions
 
September 30, 2012
Dividend yield
 
1.8
%
Expected volatility
 
40.8
%
Risk-free interest rate
 
0.8
%
Expected holding period (in years)
 
5.0

Stock Options
The following table sets forth stock option activity for the nine months ended September 30, 2012:
 
Options
 
Weighted-Average
Exercise Price
Outstanding at December 31, 2011
13,404,216

 
$
7.88

Granted
2,035,400

 
11.17

Exercised
(2,852,880
)
 
6.08

Canceled
(44,600
)
 
$
9.61

Outstanding at September 30, 2012
12,542,136

 
$
8.82

Exercisable at September 30, 2012
8,283,698

 
$
8.31

As of September 30, 2012, the unrecognized compensation expense related to stock options of $8.8 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, 2012 was as follows:
 
Restricted
shares
 
Weighted-Average
Grant-Date
Fair Value
Nonvested restricted shares at December 31, 2011
1,165,170

 
$
7.53

Granted
483,170

 
11.18

Vested
(543,761
)
 
6.21

Nonvested restricted shares at September 30, 2012
1,104,579

 
$
9.78

As of September 30, 2012, the unrecognized compensation expense related to restricted shares of $6.8 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:

15

 
Foreign
Currency
Translation
Adjustment
 
Unrealized
Gains and
Losses
 
Accumulated
Other
Comprehensive
Income
 
 
 
(In thousands)
 
 
Balance at December 31, 2011
$
105,852

 
$
—

 
$
105,852

Activity in 2012
10,979

 
—

 
10,979

Increase in net unrealized gains associated with available-for-sale securities of the trusts, net of taxes
—

 
101,917

 
101,917

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
—

 
(101,917
)
 
(101,917
)
Balance at September 30, 2012
$
116,831

 
$
—

 
$
116,831

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 7, 2012, our Board of Directors approved a cash dividend of $.06 per common share. At September 30, 2012, this dividend totaling $12.8 million was recorded in Accounts payable and accrued liabilities and Capital in excess of par value in our unaudited condensed consolidated balance sheet. This dividend will be paid on October 31, 2012.
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, 2012, we repurchased 12,226,905 shares of common stock at an aggregate cost of $142.7 million, which is an average cost per common share of $11.67. After these repurchases, the remaining dollar value of shares authorized to be purchased under our share repurchase program was approximately $77.3 million at September 30, 2012.
Subsequent to September 30, 2012, we repurchased an additional 1,416,937 shares of common stock at an aggregate cost of $19.4 million, which is an average cost per share of $13.68. After these fourth quarter repurchases, the remaining dollar value of shares authorized to be purchased under our share repurchase program is approximately $57.9 million.

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:
 
 
 
 
 
2012
$
388,365

 
$
192,817

 
$
581,182

2011
$
384,003

 
$
188,996

 
$
572,999

Gross profits:
 
 
 
 
 
2012
$
75,992

 
$
45,279

 
$
121,271

2011
$
69,022

 
$
38,028

 
$
107,050

Nine Months Ended September 30,
 
 
 
 
 
Revenues from external customers:
 
 
 
 
 
2012
$
1,209,067

 
$
571,993

 
$
1,781,060

2011
$
1,178,362

 
$
551,110

 
$
1,729,472

Gross profits:
 
 
 
 
 
2012
$
257,703

 
$
119,324

 
$
377,027

2011
$
243,827

 
$
104,692

 
$
348,519

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,
 
2012
 
2011
 
2012
 
2011
 
(In thousands)
 
(In thousands)
Gross profits from reportable segments
$
121,271

 
$
107,050

 
$
377,027

 
$
348,519

General and administrative expenses
(26,410
)
 
(23,863
)
 
(81,927
)
 
(77,381
)
Gains (losses) on divestitures and impairment charges, net
315

 
(5,001
)
 
883

 
(15,264
)
Operating income
95,176

 
78,186

 
295,983

 
255,874

Interest expense
(33,568
)
 
(33,038
)
 
(101,050
)
 
(100,476
)
Losses on early extinguishment of debt, net
—

 
(1,355
)
 
—

 
(3,504
)
Other income, net
2,317

 
249

 
4,001

 
969

Income before income taxes
$
63,925

 
$
44,042

 
$
198,934

 
$
152,863

Our geographic area information is as follows:
 
United
States
 
Canada
 
Germany
 
Total
 
 
 
(In thousands)
 
 
Three Months Ended September 30,
 
 
 
 
 
 
 
Revenues from external customers:
 
 
 
 
 
 
 
2012
$
523,600

 
$
56,280

 
$
1,302

 
$
581,182

2011
$
518,754

 
$
52,824

 
$
1,421

 
$
572,999

Nine Months Ended September 30,
 
 
 
 
 
 
 
Revenues from external customers:
 
 
 
 
 
 
 
2012
$
1,615,128

 
$
161,411

 
$
4,521

 
$
1,781,060

2011
$
1,569,748

 
$
154,706

 
$
5,018

 
$
1,729,472


14. Supplementary Information
The detail of certain income statement accounts as presented in the unaudited condensed consolidated statement of operations is as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
 
(In thousands)
 
(In thousands)
Merchandise revenues:
 
 
 
 
 
 
 
Funeral
$
129,736

 
$
126,168

 
$
401,338

 
$
383,308

Cemetery
137,787

 
132,904

 
403,620

 
381,898

Total merchandise revenues
267,523

 
259,072

 
804,958

 
765,206

Services revenues:
 
 
 
 
 
 
 
Funeral
232,413

 
234,367

 
730,987

 
726,259

Cemetery
48,854

 
45,571

 
147,356

 
145,247

Total services revenues
281,267

 
279,938

 
878,343

 
871,506

Other revenues
32,392

 
33,989

 
97,759

 
92,760

Total revenues
$
581,182

 
$
572,999

 
$
1,781,060

 
$
1,729,472

Merchandise costs and expenses:
 
 
 
 
 
 
 
Funeral
$
62,958

 
$
64,156

 
$
199,778

 
$
197,539

Cemetery
55,163

 
56,703

 
171,744

 
166,936

Total cost of merchandise
118,121

 
120,859

 
371,522

 
364,475

Services costs and expenses:
 
 
 
 
 
 
 
Funeral
129,301

 
127,102

 
385,268

 
370,942

Cemetery
23,984

 
23,853

 
74,542

 
73,793

Total cost of services
153,285

 
150,955

 
459,810

 
444,735

Overhead and other expenses
188,505

 
194,135

 
572,701

 
571,743

Total costs and expenses
$
459,911

 
$
465,949

 
$
1,404,033

 
$
1,380,953


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, 2012 and December 31, 2011, we have self-insurance reserves of $51.6 million and $52.7 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.
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, Schwartz and Niven 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 are appealing that ruling. 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 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 February 2013. We cannot quantify our ultimate liability, if any, for the payment of any damages.
Barbara Schwartz et al., individually and on behalf of all others similarly situated v. SCI Funeral Services of Florida, Inc., et al.; Case No. 2012CA013207AB; in the Circuit Court of the 15th Judicial Circuit in and for Palm Beach County of Florida. This case was filed by counsel for plaintiffs in the preceding Sands case in July 2012 regarding (i) our Star of David Memorial Gardens Cemetery and Funeral Chapel & Baily Memorial Gardens located in North Lauderdale, Florida, and (ii) the Beth David Memorial Gardens and Chapel located in Hollywood, Florida (“Beth David”). Although we acquired Beth David in connection with our 2006 acquisition of Alderwoods Group, Inc., we never managed the cemetery and sold it to a third party shortly after closing on the Alderwoods acquisition. The defendants in the case include a Company subsidiary, a third party and others. The plaintiffs seek to certify a class of cemetery plot owners and their families who are Florida citizens. The plaintiffs allege the cemeteries engaged in wrongful burial practices and did not disclose them to customers. The plaintiffs seek actual damages as well as the appointment of a receiver to oversee cemetery operations.  In response to our motion to dismiss, the plaintiffs amended their complaint to dismiss certain parties and to withdraw their class claims; however, the plaintiffs have filed two additional lawsuits as set forth below.  Since the plaintiffs have withdrawn their class claims, we do not consider this case to be material and this case will not be described in our future reports.
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. We cannot quantify our ultimate liability, if any, for the payment of damages.
Janie Niven & Jennifer Mazzo, Individually and on behalf of all others similarly situated v. SCI Funeral Services of Florida, Inc., et al.; Case No. 2012CA015951, In the Circuit Court of the 15th Judicial District in and for Palm Beach County, Florida. This lawsuit was filed by plaintiffs in the preceding Sands and Schwartz cases regarding Beth David Memorial Gardens and Chapel located in Hollywood, Florida. Although we acquired the cemetery in connection with our 2006 acquisition of Alderwoods Group, Inc., we never managed the cemetery and sold it to a third-party shortly after closing on the Alderwoods acquisition. 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. We cannot quantify our ultimate liability, if any, for the payment of damages.
 Antitrust Claims. We were named as a defendant in an antitrust case filed in 2005. The case is Cause No 4:05-CV-03394; Funeral Consumers Alliance, Inc. v. Service Corporation International, et al.; in the United States District Court for the Southern District of Texas — Houston (“Funeral Consumers Case”). This was a purported class action on behalf of casket consumers throughout the United States alleging that we and several other companies involved in the funeral industry violated federal antitrust laws and state consumer laws by engaging in various anti-competitive conduct associated with the sale of caskets. After the U.S. Fifth Circuit Court of Appeals affirmed denial of class certification, we settled this case in September 2012 for an amount that is not material to the Company.
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 Prise, Bryant and Southern lawsuits described in the following paragraphs.
Prise, et al., v. Alderwoods Group, Inc., and Service Corporation International; Cause No. 06-164; in the United States District Court for the Western District of Pennsylvania (the “Wage and Hour Lawsuit”). The Wage and Hour Lawsuit was filed by two former Alderwoods (Pennsylvania), Inc. employees in December 2006 and was originally brought under the Fair Labor Standards Act (“FLSA”) and various state laws on behalf of all Alderwoods and SCI-affiliated employees who performed work for which they allegedly were not fully compensated, including work for which overtime pay was owed. Although the court initially conditionally certified an FLSA class of claims as to certain job positions for Alderwoods employees, the court granted our motion to decertify the class on September 9, 2011, and dismissed the claims of all collective members except two named plaintiffs. Of the two remaining plaintiffs, one has dismissed her claims with prejudice. The other plaintiff continues to assert her individual claims under the FLSA for alleged failure to maintain proper records and to pay overtime. She also seeks injunctive relief, unpaid wages, liquidated, compensatory, consequential and punitive damages, attorneys’ fees and costs, and pre- and post-judgment interest. We cannot quantify our ultimate liability, if any, in this lawsuit.
 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 by counsel for plaintiffs in the Wage and Hour Lawsuit. These cases assert state law claims similar to the federal claims asserted in the Wage and Hour Lawsuit. 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.
Southern, et al. v. SCI Kentucky Funeral Services, Inc.; Case No. 11CIO6501; in the Jefferson Circuit Court, Division Eight, Kentucky. This lawsuit was filed on October 6, 2011 against an SCI subsidiary and purports to have been brought on behalf of employees who worked in Kentucky as funeral directors. The plaintiffs allege causes of action for various violations of Kentucky wage and hour laws, and breach of contract. Plaintiffs seek unpaid wages, compensatory and exemplary relief, damages, attorneys' fees and costs, and pre- and post judgment interest. We cannot quantify our ultimate liability, if any, in this lawsuit.
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,
 
2012
 
2011
 
2012
 
2011
 
(In thousands, except per
share amounts)
 
(In thousands, except per
share amounts)
Amounts attributable to common stockholders:
 
 
 
 
 
 
 
Net income:
 
 
 
 
 
 
 
Net income — basic
$
41,062

 
$
35,496

 
$
126,163

 
$
100,353

After tax interest on convertible debt
13

 
13

 
38

 
38

Net income — diluted
$
41,075

 
$
35,509

 
$
126,201

 
$
100,391

Weighted average shares (denominator):
 
 
 
 
 
 
 
Weighted average shares — basic
214,914

 
232,917

 
216,974

 
237,037

Stock options
3,425

 
2,475

 
3,211

 
2,370

Convertible debt
121

 
121

 
121

 
121

Weighted average shares — diluted
218,460

 
235,513

 
220,306

 
239,528

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.19

 
$
0.15

 
$
0.58

 
$
0.42

Diluted
$
0.19

 
$
0.15

 
$
0.57

 
$
0.42

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, 2012 and September 30, 2011, total options and convertible debentures not currently included in the computation of dilutive EPS were 1.3 million and 5.1 million, respectively. For the nine months ended September 30, 2012 and September 30, 2011, total options and convertible debentures not currently included in the computation of dilutive EPS were 1.8 million and 5.5 million, respectively.

17. Acquisitions
Neptune
The Company acquired 70% of the outstanding shares of The Neptune Society, Inc. (Neptune) on June 3, 2011 for $44 million. Neptune is the nation's largest direct cremation organization which had a network of 30 locations in nine states at acquisition. Neptune operates under the brand names Neptune Society, Neptune Cremation Service, and Trident Society. With this acquisition, we will be expanding the footprint into a sector of the market that will continue to grow and that we do not currently target through our traditional funeral service and cemetery network. We have completed our evaluation of purchase price allocation.

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, 2012, we operated 1,429 funeral service locations and 374 cemeteries (including 215 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.
Our financial position is enhanced by our $7.1 billion backlog of future revenues from both trust and insurance-funded sales at September 30, 2012, 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 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 currently have approximately $57.9 million authorized to repurchase our common stock.

16

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 the average revenue for a cremation 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 $280.3 million in the nine months ended September 30, 2012. In addition, we have $390.6 million in excess borrowing capacity under our bank credit facility. We currently have no significant maturities of long-term debt until October 2014.
Our bank credit facility requires us to maintain certain leverage and interest coverage ratios. As of September 30, 2012, we were in compliance with all of our debt covenants. Our financial covenant requirements and actual ratios as of September 30, 2012 are as follows:
 
Per Credit Agreement
 
Actual
Leverage ratio
4.00 (Max)
 
3.03
Interest coverage ratio
3.00 (Min)
 
4.64
We believe our sources of liquidity can be supplemented by our ability to access the capital markets for additional debt or equity securities. We believe that our 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 as well as our long-term financial obligations.
While the Company has no significant debt maturities until October 2014, we have chosen to make open market debt repurchases when it is opportunistic to do so relative to other capital deployment opportunities. During the nine months ended September 30, 2012 and 2011, we bought our debt securities in the open market with principal totaling $0.0 million and $40.0 million, respectively.
Our bank credit facility expires in March 2016 and we believe we will be able to successfully renew this at the appropriate time. Our long term liquidity profile assumes that we will have access to the capital markets to refinance our long term debt if, and when, we choose to do so. 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.
From time to time we have business growth initiatives such as Dignity Memorial, Dignity Planning, and DignityMemorial.com. These growth initiatives are generally not capital intensive. As such, we plan to fund these initiatives using our cash flow from operations. Additionally, we do not believe that these aforementioned initiatives materially impact our short term or long term liquidity needs.
We expect to continue to focus on funding growth initiatives that generate increased profitability, revenue, and cash flows. These capital investments include the construction of high-end cemetery property (such as private family estates) and the construction of funeral home facilities. We will also consider the acquisition of additional deathcare operations that fit our long-term customer-focused strategy, if such acquisitions have the proper return on investment.
Beginning in November 2007, we began to pay quarterly dividends of $0.04 per common share. On February 9, 2011, our Board of Directors approved the payment of a quarterly dividend of $0.05 per common share and on August 7, 2012, approved a quarterly dividend of $0.06 per common share. 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.
Currently, we have approximately $57.9 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.

17

There can be no assurance that we will buy our common stock under our share repurchase program in the future.
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 decreased $11.0 million to $280.3 million in the nine months ended September 30, 2012 from $291.3 million in the nine months ended September 30, 2011. This decrease was primarily due to lower net trust withdrawals of $9.2 million and higher net cash tax payments of $15.8 million, which includes $6.6 million in partial settlement of certain IRS audit matters from prior periods, for which the company estimates additional payments of approximately $25.0 million during the next twelve months. These decreases were partially offset by an increase of $16.7 million in cash receipts from customers.
Investing Activities
Cash flows from investing activities used $95.1 million in the first nine months ended September 30, 2012 compared to using $167.2 million in the same period of 2011. This decrease was primarily attributable to a decrease of $78.2 million in cash spent on acquisitions (primarily the Neptune acquisition in 2011) and a $5.0 million decrease in capital expenditures, partially offset by a $6.3 million decrease in cash receipts from divestitures and asset sales and a $4.8 million increase in net deposits of restricted funds.
Financing Activities
Financing activities used $163.6 million in the first nine months ended September 30, 2012 compared to using $166.2 million in the same period of 2011. This decrease was primarily driven by a $44.3 million decrease in debt payments along with a $9.7 million increase of proceeds from exercise of stock options, partially offset by a $47.1 million decrease in proceeds from the issuance of long-term debt (net of debt issuance costs) and a $2.7 million decrease in bank overdrafts and other.
We repurchased 12.4 million shares in the first nine months ended September 30, 2012 for $144.6 million and 14.8 million shares in the same period of 2011 for $146.6 million.
We paid cash dividends of $34.8 million in the first nine months ended September 30, 2012 and $33.4 million in the same period of 2011.
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, 2012
 
December 31, 2011
 
(Dollars in millions)
Preneed funeral
$
110.1

 
$
116.6

Preneed cemetery:

 
 
  Merchandise and services
114.7

 
116.6

  Pre-construction
5.0

 
6.3

Bonds supporting preneed funeral and cemetery obligations
229.8

 
239.5

Other bonds
20.9

 
17.6

Total surety bonds outstanding
$
250.7

 
$
257.1

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, 2012 and 2011, we had $4.2 million and $4.8 million, respectively, of cash

18

receipts attributable to bonded sales. For the nine months ended September 30, 2012 and 2011, we had $14.4 million and $14.5 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 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, 2012 and 2011.
 
North America
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
 
(Dollars in millions)
 
(Dollars in millions)
Funeral:
 
 
 
 
 
 
 
Preneed trust-funded (including bonded):
 
 
 
 
 
 
 
Sales production
$
37.6

 
$
49.8

 
$
107.0

 
$
98.6

Sales production (number of contracts)
14,596

 
13,963

 
43,034

 
24,926

Maturities
$
42.5

 
$
60.4

 
$
141.6

 
$
153.5

Maturities (number of contracts)
12,362

 
13,766

 
39,802

 
34,485

Cemetery:
 
 
 
 
 
 
 
Sales production:
 
 
 
 
 
 
 
Preneed
$
114.9

 
$
115.8

 
$
379.3

 
$
349.6

Atneed
57.9

 
57.4

 
176.9

 
178.3

Total sales production
$
172.8

 
$
173.2

 
$
556.2

 
$
527.9

Sales production deferred to backlog:
 
 
 
 
 
 
 
Preneed
$
48.3

 
$
46.2

 
$
159.1

 
$
143.9

Atneed
42.8

 
43.1

 
132.7

 
135.2

Total sales production deferred to backlog
$
91.1

 
$
89.3

 
$
291.8

 
$
279.1

Revenue recognized from backlog:
 
 
 
 
 
 
 
Preneed
$
47.5

 
$
41.3

 
$
122.8

 
$
110.8

Atneed
43.7

 
44.0

 
131.7

 
135.4

Total revenue recognized from backlog
$
91.2

 
$
85.3

 
$
254.5

 
$
246.2


Insurance-Funded Preneed Funeral Contracts: Where permitted by state or provincial law, customers may arrange their

19

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, 2012 and 2011, and the number of contracts associated with those transactions.
 
North America
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
 
(Dollars in millions)
 
(Dollars in millions)
Preneed funeral insurance-funded:
 
 
 
 
 
 
 
Sales production (1)
$
126.5

 
$
124.8

 
$
395.3

 
$
359.8

Sales production (number of contracts) (1)
21,714

 
21,461

 
67,430

 
62,224

General Agency revenue
$
24.1

 
$
23.0

 
$
71.7

 
$
66.7

Maturities
$
75.5

 
$
69.9

 
$
234.4

 
$
217.8

Maturities (number of contracts)
13,450

 
12,569

 
41,226

 
39,649

                                                     
(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, 2012 and December 31, 2011. 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, 2012 and December 31, 2011. 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.

20

 
September 30, 2012
 
December 31, 2011
 
Fair Value
 
Cost
 
Fair Value
 
Cost
 
 
 
(Dollars in billions)
 
 
Deferred preneed funeral revenues
$
0.54

 
$
0.54

 
$
0.58

 
$
0.58

Deferred preneed funeral receipts held in trust
1.33

 
1.31

 
1.27

 
1.29

 
$
1.87

 
$
1.85

 
$
1.85

 
$
1.87

Allowance for cancellation on trust investments
(0.14
)
 
(0.14
)
 
(0.15
)
 
(0.15
)
Backlog of trust-funded preneed funeral revenues
$
1.73

 
$
1.71

 
$
1.70

 
$
1.72

Backlog of insurance-funded preneed funeral revenues (1)
3.42

 
3.42

 
3.40

 
3.40

Total backlog of preneed funeral revenues
$
5.15

 
$
5.13

 
$
5.10

 
$
5.12

Preneed funeral receivables, net and trust investments
$
1.53

 
$
1.51

 
$
1.48

 
$
1.50

Allowance for cancellation on trust investments
(0.14
)
 
(0.14
)
 
(0.14
)
 
(0.14
)
Assets associated with backlog of trust-funded deferred preneed funeral revenues, net of estimated allowance for cancellation
$
1.39

 
$
1.37

 
$
1.34

 
$
1.36

Insurance policies associated with insurance-funded deferred preneed funeral revenues, net of estimated allowance for cancellation (1)
3.42

 
3.42

 
3.40

 
3.40

Total assets associated with backlog of preneed funeral revenues, net of estimated allowance for cancellation
$
4.81

 
$
4.79

 
$
4.74

 
$
4.76

Deferred preneed cemetery revenues
$
0.87

 
$
0.87

 
$
0.83

 
$
0.83

Deferred preneed cemetery receipts held in trust
1.26

 
1.19

 
1.15

 
1.15

 
$
2.13

 
$
2.06

 
$
1.98

 
$
1.98

Allowance for cancellation on trust investments
(0.15
)
 
(0.15
)
 
(0.16
)
 
(0.16
)
Total backlog of deferred cemetery revenues
$
1.98

 
$
1.91

 
$
1.82

 
$
1.82

Preneed cemetery receivables, net and trust investments
$
1.78

 
$
1.71

 
$
1.60

 
$
1.59

Allowance for cancellation on trust investments
(0.15
)
 
(0.15
)
 
(0.15
)
 
(0.15
)
Total assets associated with backlog of deferred cemetery revenues, net of estimated allowance for cancellation
$
1.63

 
$
1.56

 
$
1.45

 
$
1.44

                                              
(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

21

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, 2012, 82% 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.
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, 2012, 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, 2012, the Standard and Poor’s 500 Index increased approximately 30.2% and the Barclay’s Aggregate Index

22

increased approximately 5.2%, while the combined SCI trusts increased approximately 17.1%.
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, 2012 and 2011
Management Summary
Key highlights in the third quarter of 2012 were as follows:
•
Funeral gross profits increased $7.0 million, or 10.1%, due to higher case volume primarily from preneed memorial merchandise sales of The Neptune Society and higher General Agency revenues, partially offset by lower atneed revenues and higher selling-related expenses related to preneed sales initiatives; and
•
Cemetery gross profits increased $7.3 million, or 19.2%, due to higher cemetery preneed property revenues and lower merchandise and selling-related expenses.
Results of Operations
In the third quarter of 2012, we reported net income attributable to common stockholders of $41.1 million ($0.19 per diluted share) compared to net income attributable to common stockholders in the third quarter of 2011 of $35.5 million ($0.15 per diluted share). These results were impacted by the following items:
 
2012
 
2011
 
(Dollars in thousands)
Net after-tax gains from the sale of assets
$
404

 
$
3,823

After-tax losses from the early extinguishment of debt, net
$
—

 
$
(864
)
After-tax expenses related to system and process transition costs
$
(1,515
)
 
$
(310
)
Change in certain tax reserves and other
$
(61
)
 
$
(934
)
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, 2012 and 2011. We define comparable operations (or same store operations) as those funeral and cemetery locations that were owned for the entire period beginning January 1, 2011 and ending September 30, 2012. The following tables present operating results for funeral and cemetery locations that were owned by us during this period.
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

 
$
24.1

 
$
0.2

 
$
362.8

Cemetery revenue
 
192.8

 
0.1

 
—

 
192.7

 
 
579.9

 
24.2

 
0.2

 
555.5

Germany revenue
 
1.3

 
—

 
—

 
1.3

Total revenue
 
$
581.2

 
$
24.2

 
$
0.2

 
$
556.8

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

 
$
3.6

 
$
(0.2
)
 
$
72.5

Cemetery gross profits (losses)
 
45.3

 
—

 
(0.1
)
 
45.4

 
 
121.2

 
3.6

 
(0.3
)
 
117.9

Germany gross profits
 
0.1

 
—

 
—

 
0.1

Total gross profits (losses)
 
$
121.3

 
$
3.6

 
$
(0.3
)
 
$
118.0

Three Months Ended September 30, 2011
 
Consolidated
 
Less:
Results Associated with Acquisition/New Construction
 
Less:
Results Associated with Divestitures
 
Comparable
 
 
 
 
(Dollars in millions)
 
 
North America Revenue
 
 
 
 
 
 
 
 
Funeral revenue
 
$
382.6

 
$
17.4

 
$
1.2

 
$
364.0

Cemetery revenue
 
189.0

 
—

 
0.7

 
188.3

 
 
571.6

 
17.4

 
1.9

 
552.3

Germany revenue
 
1.4

 
—

 
—

 
1.4

Total revenue
 
$
573.0

 
$
17.4

 
$
1.9

 
$
553.7

North America Gross Profits
 
 
 
 
 
 
 
 
Funeral gross profits (losses)
 
$
69.0

 
$
1.1

 
$
(1.0
)
 
$
68.9

Cemetery gross profits (losses)
 
38.0

 
(0.3
)
 
(0.2
)
 
38.5

 
 
107.0

 
0.8

 
(1.2
)
 
107.4

Germany gross profits
 
—

 
—

 
—

 
—

Total gross profits (losses)
 
$
107.0

 
$
0.8

 
$
(1.2
)
 
$
107.4

The following table provides the data necessary to calculate our consolidated average revenue per funeral service for the three months ended September 30, 2012 and 2011. We calculate average revenue per funeral service by dividing consolidated funeral revenue, excluding General Agency (GA) revenues and certain other revenues, including preneed merchandise sales of The Neptune Society, to avoid distorting our averages of normal funeral services revenue, by the number of consolidated funeral services performed during the period.
 
Three Months Ended
 
September 30,
 
2012
 
2011
 
(Dollars in millions,
except average
revenue per funeral service)
Consolidated funeral revenue
$
388.4

 
$
384.0

Less: Consolidated GA revenue
24.1

 
23.0

Less: Other revenue
17.6

 
16.7

Adjusted consolidated funeral revenue
$
346.7

 
$
344.3

Consolidated funeral services performed
67,455

 
67,374

Consolidated average revenue per funeral service
$
5,140

 
$
5,110

The following table provides the data necessary to calculate our comparable average revenue per funeral service for the three months ended September 30, 2012 and 2011. We calculate average revenue per funeral service by dividing comparable funeral revenue, excluding comparable GA 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.
 
Three Months Ended
 
September 30,
 
2012
 
2011
 
(Dollars in millions,
except average
revenue per funeral service)
Comparable funeral revenue
$
364.1

 
$
365.4

Less: Comparable GA revenue
23.7

 
22.9

Less: Other revenue
3.4

 
1.8

Adjusted comparable funeral revenue
$
337.0

 
$
340.7

Comparable funeral services performed
61,627

 
62,748

Comparable average revenue per funeral service
$
5,468

 
$
5,430

Funeral Results
Funeral Revenue
Consolidated revenues from funeral operations were $388.4 million in the third quarter of 2012 compared to $384.0 million for the same period in 2011. This increase is attributable to $6.7 million of additional revenues as the result of acquisitions through 2012 and 2011. These increases were partially offset by a decline of $1.0 million in revenues contributed by non-strategic assets that were divested throughout 2012 and 2011 and the $1.3 million decrease in comparable revenues described below.
Comparable revenues from funeral operations were $364.1 million in the third quarter of 2012 compared to $365.4 million for the same period in 2011. This decrease was primarily due to a decrease in the number of funeral services performed, partially offset by a higher average revenue per funeral service.
Funeral Services Performed
Our consolidated funeral services performed increased 0.1% during the third quarter of 2012 compared to the same period in 2011 primarily as the result of acquisitions in 2012 and 2011, partially offset by a 1.8% decrease in comparable funeral services performed. We believe the comparable decrease is consistent with trends experienced by other funeral service providers and industry vendors. Our comparable cremation rate of 45.3% in the third quarter of 2012 increased from 44.7% in 2011. 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 average sales for cremation services.
Average Revenue Per Funeral Service
Our consolidated average revenue per funeral service increased $30, or 0.6%, in the third quarter of 2012 compared to 2011, primarily as a result of the increase in comparable average revenue per funeral service described below, partially offset by our acquisition of Neptune which has a lower average. Our comparable average revenue per funeral service increased $38, or 0.7%, in the third quarter of 2012 compared to the same period in 2011. Excluding an unfavorable Canadian currency impact and lower funeral trust fund income, the average revenue per funeral service grew approximately 1.0%. This increase is primarily from initiatives centered around better consumer choice and flexibility, such as enhanced dignity packaging, increased receptions and events offerings, and expansion of floral offerings through e-commerce solutions.
Funeral Gross Profits
Consolidated funeral gross profits increased $7.0 million, or 10.1%, in the third quarter of 2012 compared to the same period in 2011. This increase is primarily attributable to $2.5 million of additional gross profits related to acquisitions that occurred in 2012 and a $3.7 million increase in comparable gross profits described below.
Comparable funeral gross profits increased $3.7 million, or 5.4%, in the third quarter of 2012 compared to the same period in 2011. Comparable gross margin percentage increased from 18.9% to 19.9% in the third quarter of 2012 when compared to the same period in 2011. Despite the slight decline in overall revenues, we were able to effectively manage our costs by enhancing efficiency of our labor force and improving sales-lead generation costs, which led to commendable improvements in both gross profits and gross margin percentage.
Cemetery Results
Cemetery Revenue
Consolidated cemetery revenues increased $3.8 million, or 2.0%, in the third quarter of 2012 compared to the same period in 2011 primarily as a result of the increase in comparable revenues described below. This increase was partially offset by a decline of $0.7 million in revenues contributed by non-strategic assets that were divested throughout 2012 and 2011. Comparable cemetery revenues increased $4.4 million, or 2.3%, primarily as a result of higher recognized preneed revenues related to the completion of construction projects, partially offset by lower sales of developed property.
Cemetery Gross Profits
Consolidated cemetery gross profits increased $7.3 million, or 19.2%, in the third quarter of 2012 compared to the same period in 2011. This increase is primarily the result of the increase in comparable gross profits described below.
Comparable cemetery gross profits increased $6.9 million, or 17.9%, and gross margin percentage increased from 20.4% to 23.6% in the third quarter of 2012 compared to the same period in 2011. The improvements in gross profit and gross margin resulted from the completion of new construction projects which typically generate comparatively higher margin because the associated selling cost have been recognized in prior periods.
Other Financial Statement Items
General and Administrative Expenses
General and administrative expenses increased $2.5 million to $26.4 million during the third quarter of 2012 compared to $23.9 million in the same period of 2011. The prior year quarter included a $1.4 million reimbursement of legal settlements, while the current quarter reflects the impact of higher incentive compensation expenses related to total shareholder return metrics. Also included in the third quarter of 2012 are $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 $0.3 million net pre-tax gain on divestitures and impairment charges in the third quarter of 2012, which is associated with the divestiture of non-strategic funeral and cemetery locations in the United States and Canada. In the third quarter of 2011, we recognized a $5.0 million net pre-tax loss on divestitures and impairment charges. This loss was primarily due to the sale of underperformed locations in North America and losses on indemnification reserves.
Losses on Early Extinguishment of Debt, Net
     During the third quarter of 2011, we purchased $13.8 million of our senior notes and debentures on the open market. As a result of these transactions, we recognized a loss of $1.4 million, which represents the write-off of unamortized deferred loan costs of $0.2 million and $1.2 million cost to early extinguish debt.
Other Income, Net
Other income, net increased $2.1 million to $2.3 million during the third quarter of 2012, primarily due to a favorable foreign currency impact from liability settlements between the U.S. and Canadian subsidiaries.
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 34.6% and 20.5% for the three months ended September 30, 2012 and 2011, respectively. We sold our Puerto Rican subsidiary in the third quarter of 2011. Our outside tax basis in the business was significantly higher than our book basis. Consequently, we recognized a tax loss that was significantly higher than the book loss on the sale which is permanent in nature. The lower effective tax rate for the three months ended September 30, 2011 is primarily due to that sale.

Weighted Average Shares
The diluted weighted average number of shares outstanding was 218.5 million during the third quarter of 2012, compared to 235.5 million in the same period of 2011. 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, 2012 and 2011
Management Summary
Key highlights in the first nine months ended September 30, 2012 were as follows:
•
Funeral gross profit increased $13.9 million, or 5.7%, due to higher preneed case volume primarily from preneed memorial merchandise sales of The Neptune Society and higher General Agency revenues, partially offset by higher selling expenses related to preneed sales initiatives; and
•
Cemetery gross profit increased $14.6 million, or 13.9%, due to an increase in cemetery preneed property sales production, partially offset by higher property and selling compensation expenses.
Results of Operations
In the first nine months ended September 30, 2012, we reported net income attributable to common stockholders of $126.2 million ($0.57 per diluted share) compared to net income attributable to common stockholders in the first nine months ended September 30, 2011 of $100.4 million ($0.42 per diluted share). These results were impacted by the following items:


23

 
2012
 
2011
 
(Dollars in thousands)
Net after-tax gains (losses) from the sale of assets
$
99

 
$
(3,064
)
After-tax losses from the early extinguishment of debt, net
$
—

 
$
(2,181
)
After-tax expenses related to system and process transition costs
$
(2,953
)
 
$
(1,300
)
Change in certain tax reserves and other
$
1,830

 
$
(2,746
)
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, 2012 and 2011. We define comparable operations (or same store operations) as those funeral and cemetery locations that were owned for the entire period beginning January 1, 2011 and ending September 30, 2012. The following tables present operating results for funeral and cemetery locations that were owned by us during this period.
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

 
$
65.9

 
$
1.4

 
$
1,137.3

Cemetery revenue
 
572.0

 
0.1

 
0.3

 
571.6

 
 
1,776.6

 
66.0

 
1.7

 
1,708.9

Germany revenue
 
4.5

 
—

 
—

 
4.5

Total revenue
 
$
1,781.1

 
$
66.0

 
$
1.7

 
$
1,713.4

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

 
$
7.2

 
$
(0.9
)
 
$
251.0

Cemetery gross profits (losses)
 
119.3

 
(0.3
)
 
—

 
119.6

 
 
376.6

 
6.9

 
(0.9
)
 
370.6

Germany gross profits
 
0.4

 
—

 
—

 
0.4

Total gross profits (losses)
 
$
377.0

 
$
6.9

 
$
(0.9
)
 
$
371.0

Nine Months Ended September 30, 2011
 
Consolidated
 
Less:
Results Associated with Acquisition/New Construction
 
Less:
Results Associated with Divestitures
 
Comparable
 
 
 
 
(Dollars in millions)
 
 
North America Revenue
 
 
 
 
 
 
 
 
Funeral revenue
 
$
1,173.4

 
$
26.1

 
$
5.6

 
$
1,141.7

Cemetery revenue
 
551.1

 
—

 
4.7

 
546.4

 
 
1,724.5

 
26.1

 
10.3

 
1,688.1

Germany revenue
 
5.0

 
—

 
—

 
5.0

Total revenue
 
$
1,729.5

 
$
26.1

 
$
10.3

 
$
1,693.1

North America Gross Profits
 
 
 
 
 
 
 
 
Funeral gross profits (losses)
 
$
243.4

 
$
2.6

 
$
(1.1
)
 
$
241.9

Cemetery gross profits (losses)
 
104.7

 
(0.3
)
 
0.1

 
104.9

 
 
348.1

 
2.3

 
(1.0
)
 
346.8

Germany gross profits
 
0.4

 
—

 
—

 
0.4

Total gross profits (losses)
 
$
348.5

 
$
2.3

 
$
(1.0
)
 
$
347.2


The following table provides the data necessary to calculate our consolidated average revenue per funeral service for the nine months ended September 30, 2012 and 2011. We calculate average revenue per funeral service by dividing consolidated funeral revenue, excluding General Agency (GA) revenues and certain other revenues including preneed merchandise sales of The Neptune

24

Society, to avoid distorting our averages of normal funeral services revenue, by the number of consolidated funeral services performed during the period.
 
Nine Months Ended
 
September 30,
 
2012
 
2011
 
(Dollars in millions,
except average
revenue per funeral service)
Consolidated funeral revenue
$
1,209.1

 
$
1,178.4

Less: Consolidated GA revenue
71.7

 
66.7

Less: Other revenue
47.1

 
22.0

Adjusted consolidated funeral revenue
$
1,090.3

 
$
1,089.7

Consolidated funeral services performed
211,012

 
207,873

Consolidated average revenue per funeral service
$
5,167

 
$
5,242

The following table provides the data necessary to calculate our comparable average revenue per funeral service for the nine months ended September 30, 2012 and 2011. We calculate average revenue per funeral service by dividing comparable funeral revenue, excluding comparable GA 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.
 
Nine Months Ended
 
September 30,
 
2012
 
2011
 
(Dollars in millions,
except average
revenue per funeral service)
Comparable funeral revenue
$
1,141.8

 
$
1,146.7

Less: Comparable GA revenue
70.4

 
66.5

Less: Other revenue
8.8

 
6.8

Adjusted comparable funeral revenue
$
1,062.6

 
$
1,073.4

Comparable funeral services performed
194,206

 
200,467

Comparable average revenue per funeral service
$
5,472

 
$
5,354

Funeral Results
Funeral Revenue
Consolidated revenues from funeral operations were $1,209.1 million in the first nine months ended September 30, 2012 compared to $1,178.4 million for the same period in 2011. This increase is primarily attributable to the $39.8 million of additional revenues as the result of acquisitions in 2012 and 2011. These increases were partially offset by a $4.9 million decrease in comparable revenues described below and a decline of $4.2 million in revenues contributed by non-strategic assets that were divested throughout 2012 and 2011. Comparable revenues from funeral operations were $1,141.8 million in the first nine months ended September 30, 2012 compared to $1,146.7 million for the same period in 2011. This decrease was primarily due to the 3.1% decrease in the number of comparable funeral services described below.
Funeral Services Performed
Our consolidated funeral services performed increased 1.5% during the first nine months ended September 30, 2012 compared to the same period in 2011, primarily as the result of acquisitions in 2012 and 2011 partially affected by a 3.1% decrease in comparable funeral services performed. We believe this increase was somewhat impacted by extreme weather throughout North America, and we believe is consistent with trends experienced by other funeral service providers and industry vendors. Our comparable cremation rate of 45.1% in the first nine months ended September 30, 2012 increased from 44.4% in 2011. 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 average sales for cremation services.
Average Revenue Per Funeral Service

25

Our consolidated average revenue per funeral service decreased $75, or 1.4%, in the first nine months ended September 30, 2012 compared to 2011, primarily as a result of our acquisition of Neptune which has a lower average, partially offset by the increase in comparable average revenue per funeral service described below. Our comparable average revenue per funeral service increased $118, or 2.2%, in the first nine months ended September 30, 2012 compared to the same period in 2011. Excluding an unfavorable Canadian currency impact and lower funeral trust fund income, the average revenue per funeral service grew approximately 2.5% despite an increase in cremation rates. This increase is primarily from initiatives centered around better consumer choice and flexibility, such as enhanced dignity packaging, increased receptions and events offerings, and expansion of floral offerings through e-commerce solutions.
Funeral Gross Profits
Consolidated funeral gross profits increased $13.9 million, or 5.7%, in the first nine months ended September 30, 2012 compared to the same period in 2011. This increase is primarily attributable to $4.6 million of additional gross profits related to acquisitions that occurred in 2012 and 2011 and a $9.1 million increase in comparable gross profits described below.
Comparable funeral gross profits increased $9.1 million, or 3.8%, and the comparable gross margin percentage increased from 21.1% to 22.0% in the first nine months ended September 30, 2012 when compared to the same period in 2011 primarily as a result of lower merchandise expenses and lower selling expenses related to current year preneed sales initiatives, partially offset by a decrease in comparable revenue described above.
Cemetery Results
Cemetery Revenue
Consolidated revenues from our cemetery operations increased $20.9 million, or 3.8%, in the first nine months ended September 30, 2012 compared to the same period in 2011 primarily as a result of the increase in comparable revenues described below. The increase was partially offset by a decline of $4.4 million in revenues contributed by non-strategic assets that were divested throughout 2012 and 2011. Comparable cemetery revenues increased $25.2 million, or 4.6%, primarily as a result of strong cemetery preneed property production during the first nine months ended September 30, 2012, partially offset by lower atneed revenues.
Cemetery Gross Profits
Consolidated cemetery gross profits increased $14.6 million, or 13.9%, in the first nine months ended September 30, 2012 compared to the same period in 2011. This increase is primarily the result of the increase in comparable gross profits described below.
Comparable cemetery gross profits increased $14.7 million, or 14.0%, and gross margin percentage increased from 19.2% to 20.9% in the first nine months ended September 30, 2012 compared to the same period in 2011. This increase is primarily the result of higher preneed revenues resulting from strong cemetery preneed production, partially offset by the following:
•
a $6.9 million increase in comparable selling cost resulting from higher production;
•
a $3.9 million increase in property expense; and
•
a $3.0 million increase in health insurance.
Other Financial Statement Items
General and Administrative Expenses
General and administrative expenses were $81.9 million during the first nine months ended September 30, 2012 compared to $77.4 million for the same period in 2011. This increase is primarily due to higher incentive compensation expenses related to total shareholder return metrics. Also included in the first nine months ended September 30, 2012 are $4.5 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 $0.9 million net pre-tax gain on divestitures and impairment charges in the first nine months ended September 30, 2012, due to gains on indemnification reserves. In the first nine months ended September 30, 2011, we recognized a $15.3 million net pre-tax loss on divestitures and impairment charges due to the sale of underperforming locations in North America and losses on indemnification reserves.
Losses on Early Extinguishment of Debt, Net

26

     During the first nine months ended September 30, 2011, we purchased $40.0 million of our senior notes and debentures on the open market. As a result of these transactions, we recognized a loss of $3.5 million, which represents the write-off of unamortized deferred loan costs of $0.4 million and $3.1 million cost to early extinguish debt.
Other Income, Net
Other income, net increased $3.0 million to $4.0 million during first nine months of 2012, primarily due to a favorable foreign currency impact from liability settlements between the U.S. and Canadian subsidiaries.
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 35.8% and 33.5% for the nine months ended September 30, 2012 and 2011, respectively. We sold our Puerto Rican subsidiary in the third quarter of 2011. Our outside tax basis in the business was significantly higher than our book basis. Consequently, we recognized a tax loss that was significantly higher than the book loss on the sale which is permanent in nature. The lower effective tax rate for the nine months ended September 30, 2011 is primarily due to that sale.
Weighted Average Shares
The diluted weighted average number of shares outstanding was 220.3 million during the first nine months ended September 30, 2012, compared to 239.5 million in the same period of 2011. 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, 2011.
No other significant changes to our accounting policies have occurred subsequent to December 31, 2011, 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.

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.

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•
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 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.
•
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.
•
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.
For further information on these and other risks and uncertainties, see our Securities and Exchange Commission filings, including our 2011 Annual Report on Form 10-K, which was filed February 13, 2012. 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, 2012 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, 2012, 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, 2012 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

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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, 2011, except that we have modified two of the risk factors to read as set forth below.
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.
We are subject to a variety of claims and lawsuits in the ordinary course of our business. Adverse outcomes in some or all of the pending cases may result in significant monetary damages or injunctive relief against us, as litigation and other claims are subject to inherent uncertainties. One or more classes of plaintiffs have been certified in two of our currently pending cases relating to burial or cemetery practices. Although we are appealing the class certifications or seeking to de-certify the classes, an adverse result in these cases, or any of our other pending lawsuits or other lawsuits that may arise in the future, could have a material adverse impact on our financial position, cash flows, and results of operations.
Cemetery burial practice claims could have a material adverse impact on our financial results.
Our cemetery practices have evolved and improved over time. Most of our cemeteries have been operating for decades and therefore, may have used practices and procedures that are outdated in comparison to today's standards. When cemetery disputes occur, we may be subjected to litigation and liability for improper burial practices, including (1) burial practices of a different era that are judged today in hindsight as being outdated, and (2) alleged violations of our practices and procedures by one or more of our associates. For example, the Sands case described elsewhere in this Quarterly Report on Form 10-Q alleges improper burial practices dating from February 1985 to September 2009. In addition, since we acquired most of our cemeteries, we may be subject to litigation and liability based upon actions or events that occurred before we acquired or managed the cemeteries. Claims or litigation based upon our cemetery burial practices could have a material adverse impact on our financial condition, results of operations, and cash flows.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On July 31, 2012, we issued 1,267 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.
As of September 30, 2012, the remaining dollar value of shares that may yet be purchased under our currently approved share repurchase program was approximately $77.3 million.
Period
Total number of shares purchased
 
Average price paid per share
 
Total number of shares purchased as part of publicly announced programs
 
Dollar value of shares that may yet be purchased under the programs
July 1, 2012 — July 31, 2012
15,700

 
$
12.00

 
15,700

 
$
116,994,815

 
August 1, 2012 — August 31, 2012
1,676,776

 
$
12.96

 
1,676,776

 
$
95,268,065

 
September 1, 2012 — September 30, 2012
1,322,791

 
$
13.60

 
1,322,791

 
$
77,275,905

 
 
3,015,267

 
 
 
3,015,267

 
 
 

Subsequent to September 30, 2012, we repurchased an additional 1,416,937 shares of common stock at an aggregate cost of $19.4 million, which is an average cost per share of $13.68. After these fourth quarter repurchases, the remaining dollar value of shares authorized to be purchased under our share repurchase program is approximately $57.9 million.


Item 6. Exhibits

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12.1
 
Ratio of earnings to fixed charges for the three and nine months ended September 30, 2012 and 2011.
 
 
 
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 25, 2012
 
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, 2012 and 2011.
 
 
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.


32