Service Corp International: Form 10-Q for the period ended Sep 30, 2013

The Company

We are North America’s largest provider of deathcare products and services, with a network of funeral homes and cemeteries unequalled in geographic scale and reach. At September 30, 2013, we operated 1,431 funeral service locations and 374 cemeteries (including 214 combination locations) in North America, which are geographically diversified across 43 states, 8 Canadian provinces, and the District of Columbia. Our funeral segment also includes the operations of 12 funeral homes in Germany that we intend to exit when economic values and conditions are conducive to a sale. Our funeral service and cemetery operations consist of funeral service locations, cemeteries, funeral service/cemetery combination locations, crematoria, and related businesses. We sell cemetery property and funeral and cemetery products and services at the time of need and on a preneed basis.

On May 29, 2013, we announced our execution of a definitive agreement to acquire all of the outstanding shares of Stewart Enterprises, Inc. (Stewart), the second largest operator of funeral homes and cemeteries in North America. This transaction provides us with an opportunity for growth consistent with our capital deployment strategy and will allow us the ability to serve a number of new, complementary areas, while enabling us to capitalize on what we believe will produce significant synergies and operating efficiencies. The acquisition is subject to, among other conditions, antitrust clearance. It is anticipated that the acquisition will be completed at the end of 2013 or in early 2014, however there can be no assurance that the acquisition will be completed by this time or at all.

Our financial position is enhanced by our $7.6 billion backlog of future revenues from both trust and insurance-funded sales at September 30, 2013, which is the result of preneed funeral and cemetery sales. Preneed selling provides us with a current opportunity to lock-in future market share while deterring the customer from going to a competitor in the future. We believe it adds to the stability and predictability of our revenue and cash flows. While revenue on the majority of preneed funeral sales is deferred until the time of need, sales of preneed cemetery property provides opportunities for full current revenue recognition (to the extent we collect 10% from the customer and the property is developed).

We believe we have the financial strength and flexibility to reward shareholders through dividends while maintaining a prudent capital structure and pursuing new opportunities for profitable growth. We also currently have approximately $190.1 million authorized to repurchase our common stock.

Factors affecting our operating results include: demographic trends in terms of population growth and average age, which impact death rates and number of deaths; establishing and maintaining leading market share positions supported by strong local heritage and relationships; effectively responding to increasing cremation trends by selling complementary services and merchandise; controlling salary and merchandise costs; and exercising pricing leverage related to our at-need revenues. The average revenue per funeral contract is influenced by the mix of traditional and cremation services because our average cremation service revenue is approximately half of the average revenue earned from a traditional burial service. To further enhance revenue opportunities we are developing memorialization products and services that specifically appeal to cremation customers. We believe that these additional products and services will help drive increases in cremation revenue in future periods.

For further discussion of our key operating metrics, see our Results of Operations and Cash Flow sections below.

Financial Condition, Liquidity and Capital Resources

Capital Allocation Considerations

We rely on cash flow from operations as a significant source of liquidity. Our cash flow from operating activities provided $326.4 million in the nine months ended September 30, 2013. In July 2013, we repaid the entire $86.6 million outstanding under our bank credit facility in conjunction with entering into a new bank credit facility associated with the Stewart acquisition financing. In addition, we have $468.2 million in excess borrowing capacity under our bank credit facility. We currently have no significant maturities of long-term debt until April 2015.

Our bank credit facility requires us to maintain certain leverage and interest coverage ratios. As of September 30, 2013, we were in compliance with all of our debt covenants. Our financial covenant requirements and actual ratios as of September 30, 2013 are as follows:

The bank credit facility maintains the same leverage and interest coverage ratios until the Stewart transaction closes. Upon closing, the leverage ratio will increase to a 5.00X maximum (net debt to EBITDA as defined in the credit agreement), while the interest coverage ratio will remain unchanged.

We believe the sources of liquidity can be supplemented by our ability to access the capital markets for additional debt or equity securities. We believe that our $182.6 million of cash on hand, future operating cash flows, and the available capacity under our credit facility will give us adequate liquidity to meet our short-term needs. In July 2013, as part of establishing financing for the Stewart acquisition, we issued $425 million in 5.375% Senior Notes due January 2022 and entered into a new $1.1 billion credit agreement due July 2018 with a syndicate of banks. The net proceeds of the $425 million 5.375% Senior Notes due January 2022 will be held in escrow, pending the closing of the Stewart acquisition. The credit agreement consists of a $500 million bank credit facility and a term loan of up to $600 million. The term loan will be drawn upon the closing of and used to fund the Stewart Acquisition. The bank credit facility will be used partially to fund the Stewart Acquisition, but will primarily exist to provide the company with flexibility for general corporate purposes and to give us access to capital markets to refinance our long-term debt if, and when, we choose to do so.

It is our intention to evaluate the best uses of our cash flow that will yield the highest value and return on capital. Our capital deployment strategy is prioritized as follows:

Reinvest in the core business. We expect to continue to focus on funding growth initiatives that generate increased profitability, revenue, and cash flows. Our primary internal growth initiative is to increase our funeral and cemetery preneed backlog to grow the Company over the long-term. We will also invest in the construction of funeral home facilities and in the construction of cemetery property to promote future cemetery sales growth. Lastly, from time to time we may have other smaller capital projects, primarily related to the improvement of processes and systems.

Invest in acquisitions. We intend to make acquisitions of funeral homes and cemeteries when pricing and terms are favorable. We expect an acquisition investment to earn an after-tax cash return that is in excess of our weighted average cost of capital with room for execution risk. We target businesses with favorable consumer segments and/or where we can achieve additional economies of scale.

On May 29, 2013, we announced our execution of a definitive agreement to acquire all of the outstanding shares of Stewart Enterprises, Inc. (Stewart), the second largest operator of funeral homes and cemeteries in North America. This transaction provides us with an opportunity for growth consistent with our capital deployment strategy and will allow us the ability to serve a number of new, complementary areas, while enabling us to capitalize on what we believe will produce significant synergies and operating efficiencies. The acquisition is subject to, among other conditions, antitrust clearance. It is anticipated that the acquisition will be completed at the end of 2013 or in early 2014, however there can be no assurance that the acquisition will be completed by this time or at all.

Repurchase shares. Absent a strategic acquisition opportunity, we believe share repurchases are attractive at the appropriate price. Currently, we have approximately $190.1 million authorized under our share repurchase program. We intend to make purchases from time to time in the open market or through privately negotiated transactions, subject to market conditions, debt covenants, and normal trading restrictions. Our credit agreement contains covenants that limit our ability to repurchase our common stock. There can be no assurance that we will buy our common stock under our share repurchase program in the future.

Pay a dividend. Beginning in November 2007, we began to pay quarterly dividends of $0.04 per common share. The quarterly dividend has steadily increased over the past few years with the latest increase to $0.07 per common share approved by the Board of Directors on May 8, 2013. We intend to continue to grow our cash dividend commensurate with the growth of our free cash flow. While we intend to pay regular quarterly cash dividends for the foreseeable future, all future dividends are subject to limitations in our debt covenants and final determination by our Board of Directors each quarter upon review of our financial performance.

Repurchase debt. While the Company has no significant debt maturities until April 2015, we will seek to make open market debt repurchases when it is opportunistic to do so relative to other capital deployment opportunities in order to manage our near-term debt maturity profile.

The Company has a relatively consistent annual cash flow stream which is generally resistant to down economic cycles. This cash flow stream is available to substantially reduce our long-term debt maturities should we choose to do so. Furthermore, the Company's capital expenditures are generally discretionary in nature and can be managed based on the availability of operating cash flow.

Cash Flow

We believe our ability to generate strong operating cash flow is one of our fundamental financial strengths and provides us with substantial flexibility in meeting operating and investing needs.

Operating Activities

Net cash provided by operating activities increased $46.1 million to $326.4 million in the first nine months of 2013 from $280.3 million in the first nine months of 2012. This increase was driven by:

• a $115.9 million increase in cash receipts from customers;
• a $35.5 million increase in net trust fund withdrawals;
• a $5.0 million increase in General Agency (GA) receipts; partially offset by
• a $75.7 million increase in vendor payments;
• a $23.1 million increase in payroll;
• a $6.1 million excess tax benefit from share based awards in 2013; and
• a $5.1 million increase in cash tax payments.

Investing Activities

Cash flows from investing activities used $77.8 million in the first nine months of 2013 compared to using $95.1 million in the same period of 2012. This decrease was primarily attributable to a decrease of $10.7 million in cash spent on acquisitions, a $4.2 million increase in net withdrawals of restricted funds, a $1.4 million decrease in capital expenditures, and a $1.1 million million increase in cash receipts from divestitures and asset sales.

Financing Activities

Financing activities used $158.2 million in the first nine months of 2013 compared to using $163.6 million in the same period of 2012. This decrease was primarily driven by a $142.9 million decrease in repurchases of company common stock and a $6.1 million excess tax benefit from share based awards in 2013, partially offset by a $109.0 million increase in payments of debt, a $12.4 million decrease in proceeds from exercised stock options, an $8.3 million increase in purchases of noncontrolling interest, a $7.5 million increase in payments of dividends, and a $6.4 million increase in bank overdrafts and other.

We repurchased 0.1 million shares in the first nine months of 2013 for $1.7 million and 12.4 million shares in the same period of 2012 for $144.6 million.

We paid cash dividends of $42.4 million in the first nine months of 2013 and $34.8 million in the same period of 2012.

Financial Assurances

In support of our operations, we have entered into arrangements with certain surety companies whereby such companies agree to issue surety bonds on our behalf as financial assurance and/or as required by existing state and local regulations. The surety bonds are used for various business purposes; however, the majority of the surety bonds issued and outstanding have been used to support our preneed funeral and cemetery sales activities. The obligations underlying these surety bonds are recorded on the unaudited condensed consolidated balance sheet as Deferred preneed funeral revenues and Deferred preneed cemetery revenues. The breakdown of surety bonds between funeral and cemetery preneed arrangements, as well as surety bonds for other activities, is described below.

(Dollars in millions)

When selling preneed funeral and cemetery contracts, we may post surety bonds where allowed by state law. We post the surety bonds in lieu of trusting a certain amount of funds received from the customer. The amount of the bond posted is generally determined by the total amount of the preneed contract that would otherwise be required to be trusted, in accordance with applicable state law. For the three months ended September 30, 2013 and 2012, we had $4.7 million and $4.2 million, respectively, of cash receipts attributable to bonded sales. For the nine months ended September 30, 2013 and 2012, we had $13.8 million and $14.4 million, respectively, of cash receipts attributable to bonded sales. These amounts do not consider reductions associated with taxes, obtaining costs, or other costs.

Surety bond premiums are paid annually and are automatically renewable until maturity of the underlying preneed contracts, unless we are given prior notice of cancellation. Except for cemetery pre-construction bonds (which are irrevocable), the surety companies generally have the right to cancel the surety bonds at any time with appropriate notice. In the event a surety company were to cancel the surety bond, we are required to obtain replacement surety assurance from another surety company or fund a trust for an amount generally less than the posted bond amount. Management does not expect that we will be required to fund material future amounts related to these surety bonds because of lack of surety capacity or surety company non-performance.

Preneed Funeral and Cemetery Activities and Backlog of Contracts

In addition to selling our products and services to client families at the time of need, we sell price-guaranteed preneed funeral and cemetery contracts, which provide for future funeral or cemetery services and merchandise. Since preneed funeral and cemetery services or merchandise will not be provided until sometime in the future, most states and provinces require that all or a portion of the funds collected from customers on preneed funeral and cemetery contracts be paid into merchandise and service trusts until the merchandise is delivered or the service is performed. These trust funds own investments in equity and debt securities and mutual funds, which are sensitive to current market prices. In certain situations, as described above, where permitted by state or provincial laws, we post a surety bond as financial assurance for a certain amount of the preneed funeral or cemetery contract in lieu of placing funds into trust accounts.

Trust-Funded Preneed Funeral and Cemetery Contracts: The funds are deposited into trust and invested by independent trustees in accordance with state and provincial laws. We retain any funds above the amounts required to be deposited into trust accounts and use them for working capital purposes, generally to offset the selling and administrative costs of our preneed programs.

The tables below detail our results of preneed funeral and cemetery production and maturities, excluding insurance contracts, for the three and nine months ended September 30, 2013 and 2012.

(Dollars in millions)

(Dollars in millions)

Insurance-Funded Preneed Funeral Contracts: Where permitted by state or provincial law, customers may arrange their preneed funeral contract by purchasing a life insurance or annuity policy from third-party insurance companies, for which we earn a commission as general sales agent for the insurance company. The policy amount of the insurance contract between the customer and the third-party insurance company generally equals the amount of the preneed funeral contract. As the insurance contract is between the insurance company and the customer, we do not reflect the unfulfilled insurance-funded preneed funeral contract amounts in our unaudited condensed consolidated balance sheet.

The table below details the results of insurance-funded preneed funeral production and maturities for the three and nine months ended September 30, 2013 and 2012, and the number of contracts associated with those transactions.

(Dollars in millions)

(Dollars in millions)

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

North America Backlog of Preneed Funeral and Cemetery Contracts: The following table reflects our North America backlog of trust-funded deferred preneed funeral and cemetery contract revenues, including amounts related to Deferred preneed funeral and cemetery receipts held in trust at September 30, 2013 and December 31, 2012. Additionally, the table reflects our backlog of unfulfilled insurance-funded contracts (which are not included in our unaudited condensed consolidated balance sheet) at September 30, 2013 and December 31, 2012. The backlog amounts presented are reduced by an amount that we believe will cancel before maturity based on historical experience.

The table also reflects our preneed funeral and cemetery receivables and trust investments (fair value and cost bases) associated with the backlog of deferred preneed funeral and cemetery contract revenues, net of the estimated cancellation allowance. We believe that the table below is meaningful because it sets forth the aggregate amount of future revenues we expect to recognize as a result of preneed sales, as well as the amount of assets associated with those revenues. Because the future revenues exceed the asset amounts, future revenues will exceed the cash distributions actually received from the associated trusts.

(Dollars in billions)

43

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

The fair value of our funeral and cemetery trust investments was based on a combination of quoted market prices, observable inputs such as interest rates or yield curves, and appraisals. The difference between the backlog and asset amounts represents the contracts for which we have posted surety bonds as financial assurance in lieu of trusting, the amounts collected from customers that were not required to be deposited into trust, and allowable cash distributions from trust assets. The table also reflects the amounts expected to be received from insurance companies through the assignment of policy proceeds related to insurance-funded funeral contracts.

Trust Investments

In addition to selling our products and services to client families at the time of need, we sell price-guaranteed preneed funeral and cemetery contracts, which provide for future funeral or cemetery services and merchandise. Since preneed funeral and cemetery services or merchandise will not be provided until sometime in the future, most states and provinces require that all or a portion of the funds collected from customers on preneed funeral and cemetery contracts be paid into trusts and/or preneed escrow accounts until the merchandise is delivered or the service is performed. Investment earnings associated with the trust investments are expected to mitigate the inflationary costs of providing the preneed funeral and cemetery services and merchandise in the future for the prices that were guaranteed at the time of sale.

Also, we are required by state and provincial law to pay a portion of the proceeds from the sale of cemetery property interment rights into perpetual care trusts. For these investments, the original corpus remains in the trust in perpetuity and the net ordinary earnings are intended to offset the expense to maintain the cemetery property. The majority of states require that net gains or losses are retained and added to the corpus, but certain states allow the net realized gains and losses to be included in the income that is distributed.

Independent trustees manage and invest all of the funds deposited into the funeral and cemetery merchandise and service trusts as well as the cemetery perpetual care trusts. The trustees are selected based on their respective geographic footprint and qualifications per state and provincial regulations. All of the trustees engage the same independent investment advisor either directly or indirectly through SCI's wholly-owned registered investment advisor. The trustees, with input from the investment advisor, establish an investment policy that serves as an operating document to guide the investment activities of the trusts including asset allocation and manager selection. The investments are also governed by state and provincial guidelines. Asset allocation for the funeral and cemetery merchandise and service trusts is generally based on matching the time period that we expect the funeral or cemetery preneed contract to be outstanding. Since net ordinary earnings are distributed monthly from the cemetery perpetual care trusts to offset cemetery maintenance costs, the cemetery perpetual care trusts contain a higher fixed income allocation than the funeral and cemetery merchandise and service trusts. The investment advisor recommends investment managers to the trustees that are selected on the basis of various criteria set forth in the investment policy. The primary investment objectives for the funeral and cemetery merchandise and service trusts include (1) achieving growth of principal over time sufficient to preserve and increase the purchasing power of the assets, and (2) preserving capital within acceptable levels of volatility. Preneed funeral and cemetery contracts generally take years to mature. Therefore, the funds associated with these contracts are often invested for several market cycles. While cemetery perpetual care trusts share the same investment objectives as listed above, these trusts emphasize providing a steady stream of investment income with some capital appreciation. The trusts seek to control risk and volatility through a combination of asset styles, asset classes, and institutional investment managers.

As of September 30, 2013, 84% of our trusts were under the control and custody of two large financial institutions engaged as preferred trustees. The U.S. trustees primarily use common trust fund structures as the investment vehicle for their trusts. Through the common trust fund structure, each respective trustee manages the allocation of assets through individual managed accounts or institutional mutual funds. In the event a particular state prohibits the use of a common trust fund as a qualified investment, the trustee utilizes institutional mutual funds. The U.S. trusts include a modest allocation to alternative investments, which are comprised primarily of private equity and real estate investments. These investments are structured as limited liability companies (LLCs) and are managed by certain trustees. The trusts that are eligible to allocate a portion of their investments to alternative investments purchase units of the respective LLCs.

Fixed Income Securities

Fixed income investments are intended to preserve principal, provide a source of current income, and reduce overall portfolio volatility. The SCI trusts have direct investments primarily in government fixed income securities. Insurance backed fixed income investments preserve the principal, guarantee annual appreciation, and reduce overall portfolio volatility.

Canadian government fixed income securities are investments in Canadian federal and provincial government instruments. In many cases, regulatory restrictions mandate that the funds from the sales of preneed funeral and cemetery products sold in certain Canadian jurisdictions must be invested in these instruments.

Equity Securities

Equity investments have historically provided long-term capital appreciation in excess of inflation. The SCI trusts have direct investments primarily in domestic equity portfolios that include large, mid, and small capitalization companies of different investment objectives (i.e., growth and value). The majority of the equity portfolio is managed by multiple institutional investment managers that specialize in an objective-specific area of expertise. Our equity securities are exposed to market risk; however, these securities are well-diversified. As of September 30, 2013, the largest single equity position represented less than 1% of the total equity securities portfolio.

Mutual Funds

The SCI trust funds employ institutional mutual funds where operationally or economically efficient. Institutional mutual funds are utilized to invest in various asset classes including US equities, non-US equities, convertible bonds, corporate bonds, government bonds, Treasury inflation protected securities (TIPS), high yield bonds, real estate investment trusts (REITs), and commodities. The mutual funds are governed by guidelines outlined in their individual prospectuses.

Private Equity

The objective of these investments is to provide high rates of return with controlled volatility. These investments are typically long-term in duration. These investments are diversified by strategy, sector, manager, and vintage year. Private equity exposure is accessed through limited liability companies (LLCs) established by certain preferred trustees. These LLCs invest in numerous limited partnerships, including private equity, fund of funds, distressed debt, and mezzanine financing. The trustees that have oversight of their respective LLCs work closely with the investment advisor in making all current investments.

Trust Performance

The trust fund income recognized from these investment assets continues to be volatile. During the twelve months ended September 30, 2013, the Standard and Poor’s 500 Index increased approximately 19.34% and the Barclay’s Aggregate Index decreased approximately 1.68%, while the combined SCI trusts increased approximately 11.52%.

SCI, its trustees, and its investment advisor continue to monitor the capital markets and the trusts on an ongoing basis. The trustees, with input from the investment advisor, will take prudent action as needed to achieve the investment goals and objectives of the trusts.

Results of Operations — Three Months Ended September 30, 2013 and 2012

Management Summary

Key highlights in the third quarter of 2013 were as follows:

• Funeral gross profits decreased $8.9 million, or 11.7%, primarily due to inflationary increases in fixed costs and lower funeral services performed; and
• Cemetery gross profits increased $3.7 million, or 8.2%, due primarily to an increase in cemetery recognized preneed revenues led by a strong growth in preneed sales production.

Results of Operations

In the third quarter of 2013, we reported net income attributable to common stockholders of $26.8 million ($0.12 per diluted share) compared to net income attributable to common stockholders in the third quarter of 2012 of $41.1 million ($0.19 per diluted share). These results were impacted by the following items:

(Dollars in thousands)

Consolidated Versus Comparable Results

The table below reconciles our consolidated GAAP results to our comparable, or “same store,” results for the three months ended September 30, 2013 and 2012. We define comparable operations (or same store operations) as those funeral and cemetery locations that were owned for the entire period beginning January 1, 2012 and ending September 30, 2013. The following tables present operating results for funeral and cemetery locations that were owned by us during this period.

(Dollars in millions)

(Dollars in millions)

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

(Dollars in millions, except average revenue per funeral service)

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

(Dollars in millions, except average revenue per funeral service)

Funeral Results

Funeral Revenue

Consolidated revenues from funeral operations were $399.6 million in the third quarter of 2013 compared to $388.4 million for the same period in 2012. This increase is attributable to $8.0 million of additional revenues as the result of acquisitions through 2013 and 2012 and the $3.9 million increase in comparable revenues described below. These increases were partially offset by a decline of $0.7 million in revenues contributed by non-strategic assets that were divested throughout 2013 and 2012.

Comparable revenues from funeral operations were $389.1 million in the third quarter of 2013 compared to $385.2 million for the same period in 2012. This increase was primarily due to the 2.3% increase in comparable average revenue per funeral service described below, an increase in recognized preneed revenues for items that are delivered at the time of sale, and higher General Agency revenues. Neptune Society contributed $2.0 million or 9.7% to the revenue growth previously mentioned. These increases were partially offset by the 2.9% decrease in the number of comparable funeral services performed described below.

Funeral Services Performed

Our consolidated funeral services performed decreased 1.3% during the third quarter of 2013 compared to the same period in 2012. This is primarily the result of a 2.9% decrease in comparable funeral services performed, partially offset by acquisitions in 2013 and 2012. We believe the comparable decrease is consistent with trends experienced by other funeral service providers and industry vendors. Our comparable cremation rate of 50.2% in the third quarter of 2013 increased from 48.6% in 2012. This growth in comparable cremations was generated equally by cremations with service and direct cremations. While the average revenue for cremations of either type is lower than that for traditional burials, we continue to expand our cremation memorialization product and service offerings, which have resulted in higher revenue for cremation services.

Average Revenue Per Funeral Service

Our consolidated average revenue per funeral service increased $97, or 1.9%, in the third quarter of 2013 compared to 2012, primarily due to an increase in comparable average revenue per funeral service described below, partially offset by an increase in the number of cremations. Our comparable average revenue per funeral service increased $119, or 2.3%, in the third quarter of 2013 compared to the same period in 2012. This increase in comparable average revenue per funeral service is primarily from initiatives centered around better consumer choice and flexibility, such as enhanced Dignity packaging, increased receptions and event offerings, and expansion of floral offerings through e-commerce solutions. Excluding an unfavorable Canadian currency impact and higher funeral trust fund income, the average revenue per funeral service grew approximately 1.8% despite an increase in cremation rates.

Funeral Gross Profits

Consolidated funeral gross profits decreased $8.9 million, or 11.7%, in the third quarter of 2013 compared to the same period in 2012. This decrease is primarily attributable to a $9.8 million decrease in comparable gross profits described below and a decline of $0.1 million in gross profits contributed by non-strategic assets that were divested throughout 2013 and 2012, partially offset by $1.0 million of additional gross profits related to acquisitions that occurred in 2013 and 2012.

Comparable funeral gross profits decreased $9.8 million, or 12.9%, in the third quarter of 2013 compared to the same period in 2012. Comparable gross margin percentage decreased from 19.8% to 17.1% in the third quarter of 2013 when compared to the same period in 2012 primarily as a result of the increase in comparable revenue, including Neptune Society's revenue, described above being more than offset by the following:

• a $3.8 million increase in selling compensation mostly driven by higher preneed funeral production;
• a $3.1 million increase in overhead expenses including investments in our sales support infrastructure;
• a $1.8 million increase in funeral expenses related to catering, reception, and event offerings; and
• a $1.3 million increase in health insurance expenses.

Cemetery Results

Cemetery Revenue

Consolidated cemetery revenues increased $17.6 million, or 9.1%, in the third quarter of 2013 compared to the same period in 2012 as a result of the increase in comparable revenues. Comparable cemetery revenues increased $17.6 million, or 9.1%, primarily as a result of higher preneed property for which construction was completed and we received at least 10% of the sales price from the customer and higher merchandise revenues.

Cemetery Gross Profits

Consolidated cemetery gross profits increased $3.7 million, or 8.2%, in the third quarter of 2013 compared to the same period in 2012. This increase is primarily the result of the increase in comparable gross profits described below. This increase was partially offset by a decline of $0.3 million in gross profits contributed by non-strategic assets that were divested throughout 2013 and 2012.

Comparable cemetery gross profits increased $4.0 million, or 8.8%, and gross margin percentage decreased from 23.5% to 23.4% in the third quarter of 2013 compared to the same period in 2012 primarily as a result of the increase in comparable revenue described above partially offset by the following:

• a $5.3 million increase in selling cost driven mostly by higher preneed cemetery production;
• a $3.3 million increase in property and merchandise expenses driven by higher revenues; and
• a $1.7 million increase in overhead expenses including investments in our sales support infrastructure.

Other Financial Statement Items

General and Administrative Expenses

General and administrative expenses increased $7.4 million to $33.8 million during the third quarter of 2013 compared to $26.4 million in the same period of 2012. The current quarter included $6.9 million of costs related to the pending acquisition of Stewart Enterprises and $2.3 million of other system integration costs. The prior year included, $2.3 million of costs related to the implementation of a new purchase order system and the transition to new outsource providers for certain accounting and administrative functions.

Gains (Losses) on Divestitures and Impairment Charges, Net

We recognized a $1.0 million net pre-tax gain on divestitures and impairment charges in the third quarter of 2013 compared to a $0.3 million net pre-tax gain in the same period of 2012, which is associated with the divestiture of non-strategic funeral and cemetery locations in the United States and Canada.

Interest expense

Interest expense increased $4.5 million to $38.1 million during the third quarter of 2013 compared to $33.6 million in the same period of 2012. The current period included $5.7 million of interest expense associated with the incremental debt raised in anticipation of the Stewart acquisition.

Other Income (Expense), Net

Other income (expense), net decreased $1.6 million to $0.7 million of income during the third quarter of 2013 compared to $2.3 million of income in the third quarter of 2012, primarily due to an unfavorable foreign currency impact from liability settlements between the U.S. and Canadian subsidiaries in the third quarter of 2012.

Provision for Income Taxes

Income tax expense during interim periods is based on our estimated annual effective income tax rate plus any discrete items which are recorded in the period in which they occur. Discrete items include, among others, such events as changes in estimates due to the finalization of tax returns, tax audit settlements, expiration of statute of limitations, and increases or decreases in valuation allowances. Our effective tax rate was 40.3% and 34.6% for the three months ended September 30, 2013 and 2012, respectively. The effective tax rate for the third quarter of 2013 is above the 35% federal statutory tax rate due to state tax expense which is partially offset by foreign earnings taxed at lower rates.

Weighted Average Shares

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

Results of Operations — Nine Months Ended September 30, 2013 and 2012

Management Summary

Key highlights in the first nine months of 2013 were as follows:

• Funeral gross profit increased $9.8 million, or 3.8%, due to higher funeral services performed and average revenue per funeral service, along with an increase in preneed revenues for items that are delivered at the time of sale. These increases were partially offset by higher selling expenses related to preneed sales initiatives and higher direct cost of services performed; and
• Cemetery gross profit increased $14.7 million, or 12.3%, due to an increase in cemetery preneed property recognized revenue on higher sales production, higher trust fund income and higher atneed revenues, partially offset by higher selling compensation expenses and higher direct cost of services performed.

Results of Operations

In the first nine months of 2013, we reported net income attributable to common stockholders of $118.0 million ($0.55 per diluted share) compared to net income attributable to common stockholders in the first nine months of 2012 of $126.2 million ($0.57 per diluted share). These results were impacted by the following items:

(Dollars in thousands)

Consolidated Versus Comparable Results

The table below reconciles our consolidated GAAP results to our comparable, or “same store,” results for the nine months ended September 30, 2013 and 2012. We define comparable operations (or same store operations) as those funeral and cemetery locations that were owned for the entire period beginning January 1, 2012 and ending September 30, 2013. The following tables present operating results for funeral and cemetery locations that were owned by us during this period.

(Dollars in millions)

(Dollars in millions)

50

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

(Dollars in millions, except average revenue per funeral service)

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

(Dollars in millions, except average revenue per funeral service)

Funeral Results

Funeral Revenue

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

Funeral Services Performed

Our consolidated funeral services performed increased 2.6% during the nine months ended September 30, 2013 compared to the same period in 2012, primarily as the result of acquisitions in 2013 and 2012 and a 0.4% increase in comparable funeral services performed. We believe this increase was somewhat impacted by extreme weather throughout North America in the first half of the year, and we believe is consistent with trends experienced by other funeral service providers and industry vendors. Our comparable cremation rate of 49.7% in the nine months ended September 30, 2013 increased from 48.4% in 2012. This growth in comparable cremations was generated equally by cremations with service and direct cremations. While the average revenue for cremations of either type is lower than that for traditional burials, we continue to expand our cremation memorialization product and service offerings, which have resulted in higher revenue for cremation services.

Average Revenue Per Funeral Service

Our consolidated average revenue per funeral service increased $71, or 1.4%, in the nine months ended September 30, 2013 compared to the same period in 2012, primarily as a result of the increase in comparable average revenue per funeral service described below partially offset by an increase in the number of cremations. Our comparable average revenue per funeral service increased $109, or 2.1%, in the nine months ended September 30, 2013 compared to the same period in 2012. This increase in comparable average revenue per funeral service is primarily from initiatives centered around better consumer choice and flexibility, such as enhanced Dignity packaging, increased receptions and event offerings, and expansion of floral offerings through e-commerce solutions. Excluding an unfavorable Canadian currency impact and higher funeral trust fund income, the average revenue per funeral service grew approximately 1.6% despite an increase in cremation rates. The addition of Neptune Society fulfilled contracts to our comparable results (which include only the cremation service component in our comparable analysis) has accelerated our cremation mix change and put slight downward pressure on our total average revenue per service.

Funeral Gross Profits

Consolidated funeral gross profits increased $9.8 million, or 3.8%, in the nine months ended September 30, 2013 compared to the same period in 2012. This increase is primarily attributable to a $4.8 million increase in comparable gross profits described below, $4.6 million of additional gross profits related to acquisitions that occurred in 2013 and 2012, and a $0.4 million increase in losses by non-strategic assets that were divested throughout 2013 and 2012.

Comparable funeral gross profits increased $4.8 million, or 1.9%, and the comparable gross margin percentage decreased from 21.5% to 21.1% in the nine months ended September 30, 2013 when compared to the same period in 2012 primarily as a result of the increase in comparable revenue, including Neptune Society's revenue, described above, partially offset by the following:

• a $14.2 million increase in selling compensation mostly driven by higher preneed funeral production;
• an $8.4 million increase in overhead expenses including investments in our sales support infrastructure;
• a $6.5 million increase in funeral expenses related to catering, reception, and event offerings;
• a $3.6 million increase in salary expense driven by the increase in funeral services performed described above;
• a $1.7 million unfavorable impact related to an adjustment in self-insurance casualty reserves; and
• a $1.3 million increase in health insurance expenses.

Cemetery Results

Cemetery Revenue

Consolidated revenues from our cemetery operations increased $38.4 million, or 6.7%, in the nine months ended September 30, 2013 compared to the same period in 2012 primarily as a result of the increase in comparable revenues described below. The increase was partially offset by a decline of $0.4 million in revenues contributed by non-strategic assets that were divested throughout 2013 and 2012. Comparable cemetery revenues increased $38.8 million, or 6.8%, primarily as a result of strong cemetery preneed property production for which construction was completed and we received at least 10% of the sales price from the customer during the nine months ended September 30, 2013, higher atneed and preneed merchandise and service revenues and increased trust fund income .

Cemetery Gross Profits

Consolidated cemetery gross profits increased $14.7 million, or 12.3%, in the nine months ended September 30, 2013 compared to the same period in 2012. This increase is primarily the result of the increase in comparable gross profits described below.

Comparable cemetery gross profits increased $15.0 million, or 12.6%, and gross margin percentage increased from 20.9% to 22.0% in the nine months ended September 30, 2013 compared to the same period in 2012. This increase is primarily the result of higher revenues mentioned above, partially offset by the following:

• a $15.5 million increase in comparable selling costs impacted by higher preneed cemetery production;
• a $4.5 million increase in overhead expenses including investments in our sales support infrastructure; and
• a $2.0 million increase in property and merchandise expenses driven by higher revenues.

Other Financial Statement Items

General and Administrative Expenses

General and administrative expenses increased $13.9 million to $95.8 million during the nine months ended September 30, 2013 compared to $81.9 million for the same period in 2012. The increase is primarily due to $10.1 million of costs related to the pending acquisition of Stewart Enterprises and $4.9 million of other system integration costs in 2013 partially offset by $4.5 million of costs related to the implementation of a new purchase order system and the transition to the new outsource providers for certain accounting and administrative functions in 2012.

Gains (Losses) on Divestitures and Impairment Charges, net

We recognized a $5.5 million net pre-tax loss on divestitures and impairment charges in the nine months ended September 30, 2013, which is associated with the divestiture of non-strategic funeral and cemetery locations in North America, along with losses on the final settlement of an indemnification liability related to our former operations in Spain. In the nine months ended September 30, 2012, we recognized a $0.9 million net pre-tax gain on divestitures and impairment charges due to gains on indemnification reserves.

Other Income (Expense), Net

Other income (expense), net decreased $5.0 million to expense of $1.0 million during the nine months ended September 30, 2013, primarily due to a favorable foreign currency impact from liability settlements between the U.S. and Canadian subsidiaries in the first nine months of 2012.

Provision for Income Taxes

Income tax expense during interim periods is based on our estimated annual effective income tax rate plus any discrete items which are recorded in the period in which they occur. Discrete items include, among others, such events as changes in estimates due to the finalization of tax returns, tax audit settlements, expiration of statute of limitations, and increases or decreases in valuation allowances. Our effective tax rate was 38.5% and 35.8% for the nine months ended September 30, 2013 and 2012, respectively. The effective tax rate for the nine months ended September 30, 2013 is above the 35% federal statutory tax rate due to state tax expense which is partially offset by foreign earnings taxed at lower rates.

Weighted Average Shares

The diluted weighted average number of shares outstanding was 215.9 million during the nine months ended September 30, 2013, compared to 220.3 million in the same period of 2012. The decrease in the number of shares reflects the impact of shares repurchased under our share repurchase program.

Critical Accounting Policies

The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the unaudited condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Our critical accounting policies are disclosed in our Annual Report on Form 10-K for the year ended December 31, 2012.

No other significant changes to our accounting policies have occurred subsequent to December 31, 2012, except as described below within Recent Accounting Pronouncements and Accounting Changes.

Recent Accounting Pronouncements and Accounting Changes

For discussion of recent accounting pronouncements and accounting changes, see Part I, Item 1. Financial Statements, Note 3.

Cautionary Statement on Forward-Looking Statements

The statements in this Form 10-Q that are not historical facts are forward-looking statements made in reliance on the “safe harbor” protections provided under the Private Securities Litigation Reform Act of 1995. These statements may be accompanied by words such as “believe,” “estimate,” “project,” “expect,” “anticipate,” or “predict,” that convey the uncertainty of future events or outcomes. These statements are based on assumptions that we believe are reasonable; however, many important factors could cause our actual results in the future to differ materially from the forward-looking statements made herein and in any other documents or oral presentations made by us, or on our behalf. Important factors, which could cause actual results to differ materially from those in forward-looking statements include, among others, the following:

• Our affiliated funeral and cemetery trust funds own investments in equity securities, fixed income securities, and mutual funds, which are affected by market conditions that are beyond our control.
• We may be required to replenish our affiliated funeral and cemetery trust funds in order to meet minimum funding requirements, which would have a negative effect on our earnings and cash flow.
• Our ability to execute our strategic plan depends on many factors, some of which are beyond our control.
• Our credit agreements contain covenants that may prevent us from engaging in certain transactions.
• If we lost the ability to use surety bonding to support our preneed funeral and preneed cemetery activities, we may be required to make material cash payments to fund certain trust funds.
• The funeral home and cemetery industry continues to be increasingly competitive.
• Increasing death benefits related to preneed funeral contracts funded through life insurance or annuity contracts may not cover future increases in the cost of providing a price-guaranteed funeral service.
• The financial condition of third-party insurance companies that fund our preneed funeral contracts may impact our future revenues.
• Unfavorable results of litigation, including currently pending class action cases concerning cemetery or burial practices, could have a material adverse impact on our financial statements.
• Unfavorable publicity could affect our reputation and business.
• If the number of deaths in our markets declines, our cash flows and revenues may decrease.
• If we are not able to respond effectively to changing consumer preferences, our market share, revenues and profitability could decrease.
• The continuing upward trend in the number of cremations performed in North America could result in lower revenues and gross profit.
• Our funeral home and cemetery businesses are high fixed-cost businesses.
• Regulation and compliance could have a material adverse impact on our financial results.
• Increased costs, including potential increased health care costs, may have a negative impact on earnings and cash flows.
• Cemetery burial practice claims could have a material adverse impact on our financial results.
• A number of years may elapse before particular tax matters, for which we have established accruals, are audited and finally resolved.
• Declines in overall economic conditions beyond our control could reduce future potential earnings and cash flows and could result in future goodwill impairments and /or other intangible assets.
• Any failure to maintain the security of the information relating to our customers, their loved ones, our associates and vendors could damage our reputation, could cause us to incur substantial additional costs and to become subject to litigation, and could adversely affect our operating results.
• The acquisition of Stewart is subject to certain closing conditions that, if not satisfied or waived, will result in the acquisition not being completed, which may cause the market price of SCI common stock to decline.
• We may fail to realize the anticipated benefits of the acquisition of Stewart.
• The acquisition of Stewart may result in unexpected consequences to our business and results of operations.
• Our level of indebtedness following the completion of the acquisition of Stewart could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry and prevent us from fulfilling our obligations under our indebtedness.

For further information on these and other risks and uncertainties, see our Securities and Exchange Commission filings, including our 2012 Annual Report on Form 10-K, which was filed February 13, 2013. Copies of this document as well as other SEC filings can be obtained from our website at www.sci-corp.com (http://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.

Marketable Equity and Debt Securities — Price Risk

In connection with our preneed funeral operations and preneed cemetery merchandise and service sales, the related funeral and cemetery trust funds own investments in equity and debt securities and mutual funds, which are sensitive to current market prices.

Cost and market values as of September 30, 2013 are presented in Part I, Item 1. Financial Statements and Notes 4, 5, and 6 of this Form 10-Q. Also, see Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, Financial Conditions, Liquidity and Capital Resources, for discussion of trust investments.

Disclosure Controls and Procedures

As of September 30, 2013, we carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)). Our disclosure controls and procedures are designed to ensure that information required to be disclosed in the Securities and Exchange Commission (SEC) reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time period specified by the SEC’s rules and forms and that such information is accumulated and communicated to management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure. The officers have concluded that our disclosure controls and procedures were effective as of September 30, 2013 and that the unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q fairly present, in all material respects, our financial condition, results of operations and cash flows for the periods presented in conformity with US GAAP.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

There have been no material changes in our Risk Factors as set forth in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2012, except as set forth below.

Any failure to maintain the security of the information relating to our customers, their loved ones, our associates, and our vendors could damage our reputation, could cause us to incur substantial additional costs and to become subject to litigation, and could adversely affect our operating results.

In the ordinary course of our business, we receive certain personal information, in both physical and electronic formats, about our customers, their loved ones, our associates, and our vendors. In addition, our on-line operations at our websites depend upon the secure transmission of confidential information over public networks, including information permitting cashless payments. We maintain substantial security measures to protect, and to prevent unauthorized access to, such information. Nevertheless, it is possible that computer hackers and others (through cyberattacks, which are rapidly evolving and becoming increasingly sophisticated, or by other means) might defeat our security measures in the future and obtain the personal information of customers, their loved ones, our associates, and our vendors that we hold. Further, our associates, contractors, or third parties with whom we do business may attempt to circumvent our security measures in order to misappropriate such information, and may purposefully or inadvertently cause a breach involving such information. A breach of our security measures could adversely affect our reputation with our customers and their loved ones, associates, and vendors, as well as our operations, results of operations, financial condition and liquidity, and could result in litigation against us or the imposition of penalties. Moreover, a security breach could require that we expend significant additional resources to upgrade further the security measures that we employ to guard such important personal information against cyberattacks and other attempts to access such information and could result in a disruption of our operations.

The acquisition of Stewart Enterprises, Inc. is subject to certain closing conditions that, if not satisfied or waived, will result in the acquisition not being completed, which may cause the market price of SCI common stock to decline.

The acquisition is subject to customary conditions to closing, including the approval of Stewart Enterprises, Inc.'s (Stewart) stockholders and the receipt of antitrust regulatory approvals. If any condition to the acquisition agreement is not satisfied or, if permissible, waived, the acquisition will not be completed. In addition, SCI and Stewart may terminate the acquisition agreement in certain circumstances. If the acquisition is not completed, the market price of SCI common stock may decline if the current market price reflects a market assumption that the acquisition will be completed. SCI will also still be obligated to pay certain investment banking, financing, legal and accounting fees, and related expenses.

We may fail to realize the anticipated benefits of the acquisition of Stewart.

The success of the acquisition will depend, in part, on our ability to realize the anticipated cost savings from reduced back-office and infrastructure expenses, elimination of duplicative public company and management structure costs, and improved purchasing power through greater scale. However, to realize the anticipated benefits from the acquisition, we must successfully combine the businesses of SCI and Stewart in a manner that permits those costs savings to be realized. If we are not able to successfully achieve these objectives, the anticipated benefits of the acquisition may not be realized fully or at all or may take longer or cost more to realize than expected. SCI and Stewart have operated and, until the completion of the acquisition, will continue to operate, independently. It is possible that the integration process could result in the loss of valuable employees, the disruption of each company's ongoing businesses, or inconsistencies in standards, controls, procedures, practices, and policies that could adversely impact our operations.

The acquisition of Stewart may result in unexpected consequences to our business and results of operations.

Although Stewart's business will generally be subject to risks similar to those to which we are subject to in our existing operations, we may not have discovered all risks applicable to Stewart's business during the due diligence process and such risks may not be discovered prior to closing. Some of these risks could produce unexpected and unwanted consequences for us. Undiscovered risks may result in us incurring financial liabilities, which could be material and have a negative impact on our business operations.

Our level of indebtedness following the completion of the acquisition of Stewart could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry and prevent us from fulfilling our obligations under our indebtedness.

We have a significant amount of indebtedness which will be increased substantially if and when we complete the acquisition of Stewart Enterprises. Our substantial indebtedness could have important consequences, including the following:

• it may limit our ability to obtain additional debt or equity financing for working capital, capital expenditures, acquisitions, debt service requirements and general corporate or other purposes;
• a substantial portion of our cash flows from operations will be dedicated to the payment of principal and interest on our indebtedness, including indebtedness we may incur in the future, and will not be available for other purposes, including to finance our working capital, capital expenditures, acquisitions and general corporate or other purposes;
• it could limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate and place us at a competitive disadvantage compared to our competitors that have less debt;
• it could make us more vulnerable to downturns in general economic or industry conditions or in our business, or prevent us from carrying out activities that are important to our growth;
• it could increase our interest expense if interest rates in general increase because a portion of our indebtedness, including all of our indebtedness under our senior credit facilities, bears interest at floating rates; and
• it could make it more difficult for us to satisfy our obligations with respect to our indebtedness, and any failure to comply with the obligations of any of our debt instruments, including any financial and other restrictive covenants,

could result in an event of default under the agreements governing our other indebtedness which, if not cured or waived, could result in the acceleration of our indebtedness.

Any of the above listed factors could materially affect our business, cash flows, financial condition and results of operations.

In addition to our high level of indebtedness, we also have significant rental and other obligations under our operating and capital leases for funeral service locations, cemetery operating and maintenance equipment and transportation equipment. These obligations could further increase the risks described above.