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 December 31, 2012, we operated 1,437 funeral service locations and 374 cemeteries (including 213 combination locations) in North America, which are geographically diversified across 43 states, eight Canadian provinces, and the District of Columbia. Our funeral segment also includes the operations of 12 funeral homes in Germany that we intend to exit when economic values and conditions are conducive to a sale. Our funeral service and cemetery operations consist of funeral service locations, cemeteries, funeral service/cemetery combination locations, crematoria, and related businesses. We sell cemetery property and funeral and cemetery products and services at the time of need and on a preneed basis.
Our financial position is enhanced by our $7.4 billion backlog of future revenues from both trust and insurance-funded sales at December 31, 2012, which is the result of preneed funeral and cemetery sales. Preneed arrangements provide us with a current opportunity to lock-in future market share while deterring the customer from going to a competitor in the future. We believe it adds to the stability and predictability of our revenue and cash flows. While revenue on preneed funeral sales is deferred until the time of need, sales of preneed cemetery property provides opportunities for full current revenue recognition (to the extent we collect 10% from the customer and the property is developed).
We believe we have the financial strength and flexibility to reward shareholders through dividends while maintaining a prudent capital structure and pursuing new opportunities for profitable growth.
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, merchandise costs, and other expense categories; and exercising pricing leverage related to our at-need revenues. The average revenue per funeral contract is influenced by the mix of traditional and cremation services because our average cremation service revenue is approximately half of the average revenue earned from a traditional burial service. To further enhance revenue opportunities we are developing memorialization products and services that specifically appeal to cremation customers. We believe that these additional products and services will help drive increases in the average revenue for a cremation in future periods.
For further discussion of our key operating metrics, see our Results of Operations and Cash Flow sections below.

Financial Condition, Liquidity and Capital Resources

Capital Allocation Considerations
We rely on cash flow from operations as a significant source of liquidity. Our
cash flow from operating activities provided $369.2 million in 2012. In
addition, we have $380.4 million in excess borrowing capacity under our bank
credit facility. We 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 December 31, 2012, we were in compliance with all of our
debt covenants. Our financial covenant requirements and actual ratios as of
December 31, 2012 are as follows:
                        Per Credit Agreement   Actual
Leverage ratio                    4.00 (Max)     3.10
Interest coverage ratio           3.00 (Min)     4.69

We believe our sources of liquidity can be supplemented by our ability to access the capital markets for additional debt or equity securities. We believe that our cash on hand, future operating cash flows, and the available capacity under our credit facility will give us adequate liquidity to meet our short-term needs as well as our long-term financial obligations.
While the Company has no significant debt maturities until April 2015, we have chosen to make open market debt repurchases when it is opportunistic to do so relative to other capital deployment opportunities. During the year ended December 31, 2012, we redeemed our 7.375% Senior Notes due October 2014 with principal totaling $180.7 million. During the year ended December 31, 2011, we bought our debt securities in the open market with principal totaling $46.0 million.
Our bank credit facility expires in March 2016 and we believe we will be able to successfully renew this at the appropriate time. Our long term liquidity profile assumes that we will have access to the capital markets to refinance our long term debt if, and when, we choose to do so. The Company has a relatively consistent annual cash flow stream which is generally resistant to

down economic cycles. This cash flow stream is available to substantially reduce our long-term debt maturities should we choose to do so. Furthermore, the Company's capital expenditures are generally discretionary in nature and can be managed based on the availability of operating cash flow.
We continue to grow awareness for business growth initiatives such as Dignity Memorial, Dignity Planning, and DignityMemorial.com. These growth initiatives are generally not capital intensive. As such, we plan to fund these initiatives using our cash flow from operations. Additionally, we do not believe that these aforementioned initiatives materially impact our short term or long term liquidity needs.
We expect to continue to focus on funding growth initiatives that generate increased profitability, revenue, and cash flows. These capital investments include the construction of high-end cemetery property (such as private family estates) and the construction of funeral home facilities. We will also consider the acquisition of additional deathcare operations that fit our long-term customer-focused strategy, if such acquisitions have the proper return on investment. Our outlook for capital improvements at existing facilities and cemetery development expenditures in 2013 is $105 to $115 million. Beginning in November 2007, we began to pay quarterly dividends of $0.04 per common share. On February 9, 2011, our Board of Directors approved the payment of a quarterly dividend of $0.05 per common share and on August 7, 2012, approved a quarterly dividend of $0.06 per common share. While we intend to pay regular quarterly cash dividends for the foreseeable future, all future dividends are subject to limitations in our debt covenants and final determination by our Board of Directors each quarter upon review of our financial performance.
Currently, we have approximately $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.
Cash Flow
We believe our ability to generate strong operating cash flow is one of our fundamental financial strengths and provides us with substantial flexibility in meeting operating and investing needs.
Operating Activities
Net cash provided by operating activities decreased $18.9 million to $369.2 million in 2012 from $388.1 million in 2011. This decrease was driven by:
• a $35.7 million increase in vendor payments resulting primarily from improved visibility into company expenditures as a result of our newly installed purchase order system;

• a $21.6 million increase in payroll;

• a $13.3 million decrease in net trust fund withdrawals;

• a $17.0 million increase in cash tax payments; partially offset by,

• a $58.9 million increase in cash receipts from customers resulting from increased revenues primarily from acquisitions and improved collection rates at existing locations; and

• an $8.8 million increase in General Agency (GA) receipts due in part to acquisitions.

Net cash provided by operating activities increased $33.7 million to $388.1 million in 2011 from $354.4 million in 2010. This increase was driven by:
• a $98.2 million increase in cash receipts from customers resulting from increased revenues primarily from acquisitions and improved collection rates at existing locations;

• a $16.3 million increase in tax refunds and lower cash tax payments;

• a $16.7 million increase in General Agency (GA) receipts due in part to acquisitions;

• a $7.6 million increase in net trust fund withdrawals;

• a $3.5 million increase in royalty income; partially offset by,

• a $67.5 million increase in vendor payments resulting primarily from increases in variable costs from the Keystone acquisition;

• a $39.3 million increase in employee compensation as a result of acquisitions; and

• a $4.0 million increase in cash interest payments.

Investing Activities
Cash flows from investing activities used $175.0 million in 2012 compared to using $190.3 million in 2011. This decrease was primarily attributable to a decrease of $34.1 million in cash spent for acquisitions (primarily the Neptune acquisition in 2011) and a $2.7 million decrease in capital expenditures, partially offset by a $7.0 million decrease in withdrawals of restricted funds and a $14.6 million decrease in cash receipts from divestitures. Cash flows from investing activities used $190.3 million in 2011 compared to using $279.7 million in 2010. This decrease was primarily attributable to a decrease of $199.5 million in cash spent for acquisitions (primarily the Keystone acquisition in 2010), partially offset by a $66.3 million decrease in cash receipts from divestitures and assets sales, a $23.3 million decrease in withdrawals of restricted funds, and a $20.5 million increase in capital expenditures.
Financing Activities
Financing activities used $231.5 million in 2012 compared to using $238.7 million in 2011. This decrease was primarily driven by a $138.0 million increase in proceeds from the issuance of long-term debt (net of debt issuance costs), a $10.5 million decrease in the repurchases of Company common stock, a $10.2 million increase in proceeds from exercise of stock options, and a $7.0 million increase in bank overdrafts and other, partially offset by a $137.3 million increase in debt payments, a $15.5 million increase in dividend payments, a $3.0 million increase in purchases of non-controlling interest, and a $2.7 million increase in capital lease payments.
Financing activities used $238.7 million in 2011 compared to using $88.2 million in 2010. This increase was primarily driven by a $413.2 million decrease in proceeds from the issuance of long-term debt (net of debt issuance costs) and an $80.4 million increase in the repurchases of Company common stock, partially offset by a $316.2 million decrease in debt payments, a $23.2 million decrease in capital lease payments, and a $6.5 million increase in proceeds from exercise of stock options.
Off-Balance Sheet Arrangements, Contractual Obligations, and Commercial and Contingent Commitments
We have assumed various financial obligations and commitments in the ordinary course of conducting our business. We have contractual obligations requiring future cash payments under existing contractual arrangements, such as debt maturities, interest on long-term debt, operating lease agreements, and employment, consulting, and non-competition agreements. We also have commercial and contingent obligations that result in cash payments only if certain events occur requiring our performance pursuant to a funding commitment.
The following table details our known future cash payments (on an undiscounted basis) related to various contractual obligations as of December 31, 2012.

                                                            Payments Due by Period
Contractual Obligations              2013         2014-2015       2016-2017       Thereafter        Total
                                                            (Dollars in millions)
Debt maturities(1)                $    31.4     $     214.3     $     624.7     $    1,077.6     $ 1,948.0
Interest obligation on
long-term debt(2)                     124.2           238.8           184.1            256.0         803.1
Operating lease agreements(3)          12.1            18.5            13.5             45.3          89.4
Employment, consulting, and
non-competition agreements(4)           8.4            12.5             7.8             10.7          39.4
Pension obligation(5)                   3.5             6.6             5.3              9.4          24.8
Total contractual obligations     $   179.6     $     490.7     $     835.4     $    1,399.0     $ 2,904.7


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(2) Approximately 87% of our total debt is fixed rate debt for which the interest obligation was calculated at the stated rate. Future interest obligations on our floating rate debt are based on the current forward rate curve of the underlying index. See Note 10 in Part II, Item 8. Financial Statements and Supplementary Data, for additional information related to our future interest obligations.

(3) The majority of our lease arrangements contain options to (i) purchase the property at fair value on the exercise date, (ii) purchase the property for a value determined at the inception of the leases, or (iii) renew for the fair rental value at the end of the primary lease term. Our leases primarily relate to funeral service locations and cemetery operating and maintenance equipment. See Note 12 in Part II, Item 8. Financial Statements and Supplementary Data, for additional details related to our leases.

(4) We have entered into management employment, consulting, and non-competition agreements that contractually require us to make cash payments over the contractual period. The agreements have been primarily entered into with certain officers and employees and former owners of businesses acquired. Agreements with contractual periods less than one year are excluded. See Note 12 in Part II, Item 8. Financial Statements and Supplementary Data, for additional details related to these agreements.

(5) See Note 15 in Part II, Item 8. Financial Statements and Supplementary Data, for discussion of our pension plans.

The following table details our known potential or possible future cash payments (on an undiscounted basis) related to various commercial and contingent obligations as of December 31, 2012.

                                                            Expiration by Period
Commercial and Contingent
Obligations                          2013         2014-2015       2016-2017      Thereafter        Total
                                                            (Dollars in millions)
Surety obligations(1)             $   180.6     $         -     $         -     $         -     $   180.6
Long-term obligations related
to uncertain tax positions(2)     $     3.1            95.5             2.5            84.5         185.6
Letters of credit(3)                      -               -            33.0               -          33.0
Total commercial and contingent
obligations                       $   183.7     $      95.5     $      35.5     $      84.5     $   399.2


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(2) In accordance with the Income Tax Topic of the Financial Accounting Standards Board's (FASB) Accounting Standards Codification (ASC), we have recorded a liability for unrecognized tax benefits and related interest and penalties of $185.6 million as of December 31, 2012. See Note 9 in Part II, Item 8. Financial Statements and Supplementary Data, for additional information related to our uncertain tax positions. These amounts are reflected in the periods when the statutes of limitations expire.

(3) We are occasionally required to post letters of credit, issued by a financial institution, to secure certain insurance programs or other obligations. Letters of credit generally authorize the financial institution to make a payment to the beneficiary upon the satisfaction of a certain event or the failure to satisfy an obligation. The letters of credit are generally posted for one-year terms and are usually automatically renewed upon maturity until such time as we have satisfied the commitment secured by the letter of credit. We are obligated to reimburse the issuer only if the beneficiary collects on the letter of credit. We believe it is unlikely we will be required to fund a claim under our outstanding letters of credit. As of December 31, 2012, the full amount of our letters of credit was supported by our Bank credit facility, which expires in March 2016.

Not included in the above table are potential funding obligations related to our funeral and cemetery merchandise and service trusts. In certain states and provinces, we have withdrawn allowable distributable earnings including unrealized gains prior to the maturity or cancellation of the related contract. Additionally, some states have laws that either require replenishment of investment losses under certain circumstances or impose various restrictions when trust fund values drop below certain prescribed amounts. In the event that our trust investments do not recover from recent market declines, we may be required to deposit portions or all of these amounts into the respective trusts in some future period. As of December 31, 2012, we had unrealized losses of $7.4 million in the various trusts within these states.

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 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.

                                                            December 31,     December 31,
                                                                2012             2011
                                                                (Dollars in millions)
Preneed funeral                                            $      110.1     $      116.6
Preneed cemetery:
Merchandise and services                                          114.6            116.6
Pre-construction                                                    7.2              6.3
Bonds supporting preneed funeral and cemetery obligations         231.9            239.5
Bonds supporting preneed business permits                           2.9              2.2
Other bonds                                                        17.2             15.4
Total surety bonds outstanding                             $      252.0     $      257.1

When selling preneed funeral and cemetery contracts, we may post surety bonds where allowed by state law. We post the surety bonds in lieu of trusting a certain amount of funds received from the customer. The $231.9 million in bonds supporting preneed funeral and cemetery obligations differs from the $180.6 million potential funding obligation disclosed in our "Commercial and Contingent Obligations" table above because 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, at the time we enter into the contract. We would only be required to fund the trust for the portion of the preneed contract for which we have received payment from the customer, less any applicable retainage, in accordance with state law. For the years ended December 31, 2012, 2011, and 2010, we had $18.4 million, $18.9 million, and $18.8 million, respectively, of cash receipts from sales attributable to bonded contracts. 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 due to a 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. 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 collected from customers 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.
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. Our preneed funeral and cemetery trust assets are consolidated and recorded in our consolidated balance sheet at fair market value. Investment earnings on trust assets are generally accumulated in the trust and distributed as the revenue associated with the preneed funeral or cemetery contract is recognized or cancelled by the customer. In certain states and provinces, the trusts are allowed to distribute a portion of the investment earnings to us prior to that date.
If a preneed funeral or cemetery contract is cancelled prior to delivery, state or provincial law determines the amount of the refund owed to the customer, if any, including the amount of the attributed investment earnings. Upon cancellation, we receive the amount of principal deposited to trust and previously undistributed net investment earnings and, where required, issue a refund to the customer. We retain excess funds, if any, and recognize the attributed investment earnings (net of any investment earnings payable to the customer) as revenues in our consolidated statement of operations. In certain jurisdictions, we may be obligated to fund any shortfall if the amounts deposited by the customer exceed the funds in trust. Funds in trust assets exceeded customer deposits at December 31, 2012. See Off-Balance Sheet Arrangements, Contractual Obligations, and Commercial and Contingent Commitments for additional information about potential funding obligations related to our funeral and cemetery merchandise and

service trusts. Based on our historical experience, we have included a cancellation reserve for preneed funeral and cemetery contracts in our consolidated balance sheet of $131.3 million and $136.0 million as of December 31, 2012 and 2011, respectively.
The cash flow activity over the life of a trust-funded preneed funeral or cemetery contract from the date of sale to its recognition or cancellation is captured in the following operating cash flow line items in our consolidated statement of cash flows:
• Decrease in preneed funeral receivables, net and trust investments;

• Increase in preneed cemetery receivables, net and trust investments;

• Decrease in deferred preneed funeral revenue;

• Increase in deferred preneed cemetery revenue;

• Decrease in deferred preneed funeral receipts held in trust;

• Decrease in deferred preneed cemetery receipts held in trust; and

• Net income.

While the contract is outstanding, cash flow is provided by the amount retained from funds collected from the customer and any distributed investment earnings. At the time of death maturity, we receive the principal and undistributed investment earnings from the funeral trust and any remaining receivable due from the customer. At the time of delivery or storage of cemetery merchandise and service items for which we were required to deposit funds to trust, we receive the principal and undistributed investment earnings from the cemetery trust. There is generally no remaining receivable due from the customer, as our policy is to deliver preneed cemetery merchandise and service items only upon payment of the contract balance in full. This cash flow at the time of service, delivery, or storage is generally less than the associated revenue recognized, thus reducing cash flow from operating activities.

The tables below detail our North America results of preneed funeral and cemetery production and maturities, excluding insurance contracts, for the years ended December 31, 2012 and 2011.

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