Recent Events
Acquisition
On October 14, 2009, we entered into a definitive support agreement in which we agreed to acquire all of the outstanding common shares of Keystone North America Inc. (Keystone) for C$8.00 per share in cash. Keystone operates 199 funeral homes and 15 cemeteries in North America. The total transaction is valued at approximately $256 million, including the assumption of Keystone's outstanding debt.
We have substantial cash on hand that will be used in the transaction and have entered into a commitment letter with JPMorgan Chase Bank, N.A. and Bank of America, N.A. providing for a $250 million bridge financing, subject to certain conditions identified therein. We believe that we have a number of debt capital market alternatives, and we will determine the optimal funding structure consisting of a combination of long-term permanent debt and short-term pre-payable debt prior to the close of the transaction.
The transaction is anticipated to close in the first quarter of 2010, subject to customary closing conditions, including expiration of the waiting period under the Hart-Scott-Rodino Antitrust Act; however, there can be no assurance the acquisition will be completed by this time or at all. Bank Credit Facility
In the fourth quarter of 2009, we intend to amend and extend our senior credit facility to increase the availability thereunder from $300 million to $400 million, and we expect to use cash on hand and the increased availability under our facility to prepay in full our privately placed $150 million aggregate principal amount of Series B Senior notes due November 2011. Financial Condition, Liquidity and Capital Resources Recent Volatility in Financial Markets
The weakened economy has created some volatility in our cemetery property sales production. During the nine months ended September 30, 2009, preneed and atneed comparable, or "same store", cemetery property production declined 4.0%, which negatively impacted our cemetery revenue. However, in the third quarter of 2009, we did experience significant recovery compared with the previous three quarters. Preneed and atneed comparable cemetery property sales production increased 15.9% from the prior year third quarter, which exceeded our expectations. See Item 1A of our Form 10-K for the fiscal year ended December 31, 2008 for further discussion of risks presented by the economy.
Our funeral, cemetery merchandise and service, and cemetery perpetual care trusts have been impacted by the volatility in the U.S. and global financial markets. The fair market value of our trust investments declined sharply in the second half of 2008. Since that time, our trusts have recovered commensurate with the overall improvement in the financial markets. During the nine months ended September 30, 2009, our combined trust fund assets increased 19.9%, primarily due to unrealized aggregate net gains. These gains were partially offset by realized aggregate net losses (excluding impairments) of $72.6 million in our preneed funeral and cemetery merchandise and service trusts. In addition, we realized aggregate net losses (excluding impairments) of $8.0 million in our cemetery perpetual care trusts.
As of September 30, 2009, we have cumulative net unrealized losses of $119.1 million in our preneed funeral and cemetery merchandise and service trusts, and cumulative net unrealized losses of $54.5 million in our cemetery perpetual care trusts, as discussed in Notes 4, 5, and 6 in Part I, Item 1, Financial Statements. In the third quarter of 2009, we experienced a substantial recovery in our trust investments, with net investment activity that reduced our net unrealized losses by $200.3 million in our preneed funeral and cemetery merchandise and service trusts and by $77.7 million in our cemetery perpetual care trusts. At September 30, 2009, these net unrealized losses represented 6.6% of our original cost basis of $2.6 billion. As explained in "Critical Accounting Policies, Fair Value Measurements" in our 2008 Annual Report on Form 10-K, changes in unrealized gains and/or losses related to these securities are reflected in Accumulated other comprehensive income and offset by the Deferred preneed funeral and cemetery receipts held in trustand Care trusts' corpus interests in those unrealized gains and/or losses. Therefore, the majority of these significant net unrealized losses are not reflected in our consolidated statement of operations for the nine months ended September 30, 2009. We do, however, rely on our trust investments to provide funding for the various contractual obligations that arise upon maturity of the underlying preneed contracts. Because of the long-term relationship between the establishment of trust investments and the required performance of the underlying contractual obligations, the impact of current market conditions that may exist at any given time is not necessarily indicative of our ability to generate profit on our future performance obligations.

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 until the merchandise is delivered or the service is performed. Investment earnings associated with our 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 or 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 and 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 our 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 regulations. All of our trustees engage the same independent investment advisor. The investment guidelines are governed by state and provincial legislation. 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. Asset allocation is based on regulatory guidelines and matched to the liability structure of each trust.
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;
(2) producing current income to support the specific objectives of each trust type; and (3) 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 class, manager, and security level diversification. The market values of our trust investments at September 30, 2009 are detailed below (in thousands).

                                                                               Total Funeral
                                        Funeral             Cemetery           and Cemetery           Cemetery
                                      Merchandise         Merchandise           Merchandise           Perpetual
                                      and Service         and Service           and Service          Care Funds            Total
Fixed income securities:
U.S. Treasury                         $     35,695        $     41,196        $        76,891        $     6,157        $    83,048
Canadian government                         93,156              14,945                108,101             25,178            133,279
Corporate                                   34,365               9,615                 43,980             40,011             83,991
Mortgage-backed                              5,107               9,299                 14,406              3,693             18,099
Asset-backed                                   150                   -                    150                  -                150
Equity securities:
Preferred stock                                  -                   -                      -              8,926              8,926
Common stock (based on
investment objectives):
Growth                                     150,657             208,432                359,089              4,098            363,187
Value                                      170,742             251,547                422,289            115,577            537,866
Mutual funds:
Equity                                      92,660             204,806                297,466             97,096            394,562
Fixed income                               135,243             178,713                313,956            470,757            784,713
Private equity                              10,911               3,788                 14,699              8,271             22,970
Other                                        1,298               1,346                  2,644              6,508              9,152

                                           729,984             923,687              1,653,671            786,272          2,439,943

Assets associated with
businesses held for sale                    (1,786 )           (49,424 )              (51,210 )          (19,778 )          (70,988 )
Cash and cash equivalents                  150,452             139,110                289,562             81,665            371,227
Insurance-backed fixed income
securities                                 214,999                   -                214,999                  -            214,999

Total trust assets                    $  1,093,649        $  1,013,373        $     2,107,022        $   848,159        $ 2,955,181

As of the end of the quarter, 96% of our trusts were under the control and custody of four preferred trustees. The three large 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. Our trusts have direct investments primarily in government fixed income securities.
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. Our 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 our 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, 2009, the largest single equity position represented less than 1% of our total equity securities portfolio. Mutual Funds
Our 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. Our 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 LLCs established by certain preferred trustees. These LLCs invest in numerous limited partnerships, including private equity, fund of funds, distressed debt, real estate, and mezzanine financing. The trustees that have oversight of their respective LLCs work closely with the investment advisor in making all current investments. Outlook for Trust Investments
The trust fund income recognized from these investment assets continues to be volatile. During the recent economic downturn, our trusts outperformed the broad market due to their diversified investment strategy. During the twelve months ended September 30, 2009, the Standard and Poor's 500 Index decreased approximately 7% and the combined SCI trusts increased approximately 5%. During the three months ended September 30, 2009, the Standard and Poor's 500 Index increased approximately 16% and the combined SCI trusts increased approximately 12%. As the capital markets continue to improve, we expect our trusts to participate in the recovery.

SCI, its trustees and the 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.
Capital Allocation Considerations
We rely on cash flow from operations as a significant source of liquidity. Our cash flow from operating activities provided $305.3 million during the nine months ended September 30, 2009. Our current cash and cash equivalents balance is approximately $200 million as of October 31, 2009. In addition, we have approximately $250 million in excess borrowing capacity under our revolving credit facility.
Our credit facility requires us to maintain certain leverage and interest coverage ratios. As of September 30, 2009, we were in compliance with all of our debt covenants. Our financial covenant requirements and actual ratios as of September 30, 2009 are as follows:

                                             Per credit
                                             agreement     Actual
                   Leverage ratio            4.25 (Max)     3.35
                   Interest coverage ratio   2.75 (Min)     3.73

Our financial covenant requirements under our credit facility become more restrictive over time. Under the existing agreement, our future leverage and interest coverage ratios are as follows:

                                      Leverage ratio (max)
                       2009                        4.25
                       2010                        3.75
                       Thereafter                  3.50

Interest coverage ratio (min) 2009 thru June 2010 2.75 Thereafter 3.00

We intend to amend and extend our senior credit facility to increase the availability thereunder from $300 million to $400 million, and we expect to use cash on hand and the increased availability under our facility to prepay in full our privately placed $150 million aggregate principal amount of Series B Senior notes due November 2011.
We believe our sources of liquidity can be supplemented by our ability to access the capital markets for additional debt or equity securities. However, given the current environment, interest rates on new borrowings are significantly higher than levels experienced in recent history. We believe that our cash on hand, future operating cash flows, and the available capacity under our credit facility will be adequate to meet our financial obligations over the next 12 months.
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 $71.9 million during the nine months ended September 30, 2009, compared to the nine months ended September 30, 2008. The increase was the result of a $90 million United States Federal transaction-related tax payment in the prior year, partially offset by an $18.1 million net decrease in working capital. The net decrease in working capital reflects lower collections of preneed and atneed receivables, which were partially offset by our cost control initiatives in the current year.
Investing Activities - Net cash used in investing activities decreased $72.4 million during the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008, primarily due to a decrease of $45.9 million in capital expenditures, a $20.5 million decrease in deposits of restricted funds, and a $5.2 million decrease in acquisition activity.

Financing Activities - Net cash used in financing activities increased by $52.8 million during the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008, primarily due to a $64.2 million increase in debt payments in 2009 to early extinguish certain of our debt, partially offset by a $7.3 million increase in proceeds from exercise of stock options. 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, 2009          December 31, 2008
                                                                              (Dollars in millions)
Preneed funeral                                                   $             126.6        $             130.6
Preneed cemetery:
Merchandise and service                                                         125.8                      132.4
Pre-construction                                                                  2.3                        2.9

Bonds supporting preneed funeral and cemetery obligations                       254.7                      265.9

Bonds supporting preneed business permits                                         4.6                        5.1
Other bonds                                                                      21.6                       17.7

Total surety bonds outstanding                                    $             280.9        $             288.7

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, 2009 and 2008, we had $6.0 million and $7.3 million, respectively, of cash receipts attributable to bonded sales. For the nine months ended September 30, 2009 and 2008, we had $18.6 million and $23.1 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 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.

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, 2009 and 2008.

                                                                          North America
                                                     Three Months Ended                    Nine Months Ended
                                                        September 30,                        September 30,
                                                   2009                2008              2009               2008
                                                    (Dollars in millions)                (Dollars in millions)
Funeral:
Preneed trust-funded (including bonded):
Sales production                                $      33.7          $   42.8        $      109.7         $  121.2

Sales production (number of contracts)                6,705             8,419              21,063           24,392

Maturities                                      $      41.4          $   49.2        $      130.6         $  157.4

Maturities (number of contracts)                      9,872            10,756              32,394           34,696

Cemetery:
Sales production:
Preneed                                         $     101.7          $   86.6        $      289.4         $  287.1
Atneed                                                 58.0              59.8               179.7            191.0

Total sales production                          $     159.7          $  146.4        $      469.1         $  478.1

Sales production deferred to backlog:
Preneed                                         $      41.4          $   37.8        $      120.2         $  118.7
Atneed                                                 43.8              45.7               137.9            145.6

Total sales production deferred to backlog      $      85.2          $   83.5        $      258.1         $  264.3

Revenue recognized from backlog:
Preneed                                         $      30.7          $   32.6        $       98.6         $   97.8
Atneed                                                 44.8              47.8               137.0            149.3

Total revenue recognized from backlog           $      75.5          $   80.4        $      235.6         $  247.1

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 . . .