# Carriage Services Inc: Form 10-Q for the period ended Sep 30, 2012

- Company: [Carriage Services Inc](/companies/csv.md) (CIK 1016281)
- Form: 10-Q
- Filed: 2012-11-07
- Accepted by EDGAR: Nov 7, 2012, 20:43 ET
- Period: 2012-09-30
- Accession: 0001193125-12-457293
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1016281/000119312512457293/d435731d10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1016281/000119312512457293/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2012-09-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2012-07-01 to 2012-09-30 | $49.5m | us-gaap:SalesRevenueNet |
| Revenue | 9 months, 2012-01-01 to 2012-09-30 | $151.1m | us-gaap:SalesRevenueNet |
| Cost of revenue | 3 months, 2012-07-01 to 2012-09-30 | $35.6m | us-gaap:CostOfRevenue |
| Cost of revenue | 9 months, 2012-01-01 to 2012-09-30 | $106.0m | us-gaap:CostOfRevenue |
| Gross profit | 3 months, 2012-07-01 to 2012-09-30 | $13.9m | us-gaap:GrossProfit |
| Gross profit | 9 months, 2012-01-01 to 2012-09-30 | $45.0m | us-gaap:GrossProfit |
| Operating income | 3 months, 2012-07-01 to 2012-09-30 | $8.4m | us-gaap:OperatingIncomeLoss |
| Operating income | 9 months, 2012-01-01 to 2012-09-30 | $29.0m | us-gaap:OperatingIncomeLoss |
| Interest expense | 3 months, 2012-07-01 to 2012-09-30 | $4.5m | us-gaap:InterestExpense |
| Interest expense | 9 months, 2012-01-01 to 2012-09-30 | $13.6m | us-gaap:InterestExpense |
| Income tax | 3 months, 2012-07-01 to 2012-09-30 | $346.0k | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 9 months, 2012-01-01 to 2012-09-30 | $5.0m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2012-07-01 to 2012-09-30 | $606.0k | us-gaap:NetIncomeLoss |
| Net income | 9 months, 2012-01-01 to 2012-09-30 | $7.7m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2012-07-01 to 2012-09-30 | $0.03 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 9 months, 2012-01-01 to 2012-09-30 | $0.42 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2012-07-01 to 2012-09-30 | $0.03 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 9 months, 2012-01-01 to 2012-09-30 | $0.43 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2012-07-01 to 2012-09-30 | 18,170,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Diluted shares (weighted) | 9 months, 2012-01-01 to 2012-09-30 | 18,212,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 9 months, 2012-01-01 to 2012-09-30 | $15.3m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 9 months, 2012-01-01 to 2012-09-30 | $10.3m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 9 months, 2012-01-01 to 2012-09-30 | $1.4m | us-gaap:PaymentsOfDividendsCommonStock |
| Share repurchases | 9 months, 2012-01-01 to 2012-09-30 | $4.5m | us-gaap:PaymentsForRepurchaseOfCommonStock |
| Cash and equivalents | at 2012-09-30 | $549.0k | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2012-09-30 | $30.6m | us-gaap:AssetsCurrent |
| Total assets | at 2012-09-30 | $715.9m | us-gaap:Assets |
| Current liabilities | at 2012-09-30 | $26.0m | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2012-09-30 | $584.8m | us-gaap:Liabilities |
| Shareholders' equity | at 2012-09-30 | $130.9m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 46,034 characters.

### OVERVIEW

#### General

We operate two types of businesses: funeral homes, which account for approximately 75% of our revenues, and cemeteries, which account for approximately 25% of our revenues. Funeral homes are principally service businesses that provide funeral services (traditional burial and cremation) and sell related merchandise, such as caskets and urns. Cemeteries are primarily a sales business that sells interment rights (grave sites and mausoleum spaces) and related merchandise, such as markers and outer burial containers. As of September 30, 2012, we operated 163 funeral homes in 26 states and 33 cemeteries in 12 states within the United States. Substantially all administrative activities are conducted in our home office in Houston, Texas.

We have implemented long-term initiatives in our operations designed to improve operating and financial results by growing market share and increasing profitability. We have a decentralized, entrepreneurial and local operating model that includes operating and financial standards developed from our best operations, along with incentive compensation plans to reward business managers for successfully meeting or exceeding the standards. The model essentially eliminates the use of line-item financial budgets in favor of the standards. The operating model and standards, to which we refer as the “Standards Operating Model,” focus on the key drivers of a successful operation, organized around three primary areas – market share, people and operating and financial metrics. The model and standards are the measures by which we judge the success of each business. To date, the Standards Operating Model has driven significant changes in our organization, leadership and operating practices. Most importantly, the Standards Operating Model allows us to measure the sustainable revenue growth and earning power of our portfolio of deathcare businesses, which then led to the development of our Strategic Acquisition Model, described below under “Acquisitions,” that guides our acquisition and disposition strategy. We expect both models to drive long-term, sustainable increases in market share, revenue, earnings and cash flow. The standards are not designed to produce maximum short-term earnings because we do not believe such performance is sustainable without ultimately stressing the business, which often leads to declining market share, revenues and earnings. Important elements of the Standards Operating Model include:

- *Balanced Operating Model –* We believe a decentralized structure works best in the deathcare industry. Successful execution of the Standards Operating Model is highly dependent on strong local leadership, intelligent risk taking, entrepreneurial drive and corporate support aligned with what we believe are the key drivers of a successful operation, organized around three primary areas – market share, people and operating and financial metrics.
- *Incentives Aligned with Standards –* Empowering Managing Partners to do the right things in their operations and local communities and providing appropriate support with operating and financial practices will enable long-term growth and sustainable profitability. Each Managing Partner participates in variable bonus plans whereby he or she earns a percentage of his or her business’ earnings based upon the actual standards achieved as long as its performance exceeds our minimum standards.
- *The Right Local Leadership –* Successful execution of our operating model is highly dependent on strong local leadership (as defined by our 4E Leadership Model), intelligent risk taking, and entrepreneurial empowerment. Over time, a Managing Partner’s performance is judged according to his or her achievement of the Standards for that business.

#### Funeral and Cemetery Operations

Factors affecting our funeral 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 packaging complementary services and merchandise; controlling salary and variable costs; and exercising pricing leverage related to our at-need business by increasing average revenues per funeral. In simple terms, volume and price are the two variables that affect funeral revenues. The average revenue per contract is influenced by the mix of traditional burial and cremation services because our average cremation service revenue is approximately one-third of the average revenue earned from a traditional burial service. Funeral homes have a relatively fixed cost structure. Thus, small changes in revenues, up or down, normally cause significant changes to our profitability.

Our funeral volumes have increased from 24,562 in 2008 to 26,807 in 2011 (compounded annual increase of 3.0%). Our funeral operating revenue has increased from $124.4 million in 2008 to $135.3 million in 2011 (compounded annual increase of 2.8%). The increases are primarily because of businesses we acquired in the last five years and our ability to increase the average revenue per funeral through expanded service offerings and packages. We experienced an increase of 4.9% in volumes and 7.8% in funeral operating revenues in the first nine months of 2012 compared to the first nine months of 2011, primarily as a result of the acquisitions completed during the trailing twelve months.

The percentage of funeral services involving cremations has increased from 38.2% for the year ended 2008 to 45.0% for the year ended 2011, and was 45.7% for the first nine months of 2012. A significant portion of that trend is the result of acquiring businesses in high cremation areas. On a same store basis, the cremation rate has risen to 44.1% for the first nine months of 2012, up from 42.7% for the year ended December 31, 2011, and 42.5% for the comparable nine month period in 2011.

Cemetery operating results are affected by the size and success of our sales organization. Approximately 50% of our cemetery revenues for the year ended December 31, 2011 related to preneed sales of interment rights and the delivery of related merchandise and services. For the nine months ended September 30, 2012, those preneed sales were approximately 48.7% of cemetery revenues. We believe that changes in the level of consumer confidence (a measure of whether consumers will spend for discretionary items) also affect the amount of cemetery revenues. Currently, approximately 22% of our cemetery revenues are attributable to investment earnings on trust funds and finance charges on preneed installment contracts. Changes in the capital markets and interest rates affect this component of our cemetery revenues.

Our cemetery financial performance from 2008 through 2011 was characterized by fluctuating operating revenues and field level profit margins. Cemetery operating revenue increased slightly from $38.0 million in 2008 to $38.1 million in 2011. Our goal is to build stronger teams of sales leaders and counselors in our larger and more strategically located cemeteries in order to focus on growth of our preneed property sales. Additionally, a portion of our capital expenditures in 2012 is designated to expand our cemetery product offerings.

#### Financial Revenue

We market funeral and cemetery services and products on a preneed basis. Preneed funeral or cemetery contracts enable families to establish, in advance, the type of service to be performed, the products to be used, and the cost of such products and services. Preneed contracts permit families to eliminate issues of making deathcare decisions at the time of need and allow input from other family members before the death occurs. We guarantee the price and performance of the preneed contracts to the customer.

Preneed funeral contracts are usually paid on an installment basis. The performance of preneed funeral contracts is usually secured by placing the funds collected in trust for the benefit of the customer or by the purchase of a life insurance policy, the proceeds of which will pay for such services at the time of need. Insurance policies, intended to fund preneed funeral contracts, cover the original contract price and generally include an element of growth (earnings) designed to offset future inflationary cost increases. Revenue from preneed funeral contracts, along with accumulated earnings, is not recognized until the time the funeral service is performed. The accumulated earnings from the trust investments and insurance policies is intended to offset the inflation in funeral prices. Additionally, we generally earn a commission from the insurance company from the sale of insurance-funded policies reflected as *Preneed Insurance Commission*. The commission income is recognized as revenue when the period of refund expires (generally one year), which helps us defray the costs we incur to originate the preneed contract (primarily commissions we pay to our sales counselors).

Preneed sales of cemetery interment rights are usually financed through interest-bearing installment sales contracts, generally with terms of up to five years, with such interest income reflected as *Preneed Cemetery Finance Charges*. In substantially all cases, we receive an initial down payment at the time the contract is signed. Occasionally, we have offered zero percent or low interest financing to promote sales as limited-time offers, and in those cases we impute interest at market rates and discount the sales value.

We have established a variety of trusts in connection with funeral home and cemetery operations as required under applicable state laws. Such trusts include (i) preneed funeral trusts; (ii) preneed cemetery merchandise and service trusts; and (iii) perpetual care trusts. These trusts are typically administered by independent financial institutions selected by us. Investment management and advisory services are provided either by our wholly-owned registered investment advisor (CSV RIA) or independent financial advisors. As of September 30, 2012, CSV RIA provides these services to one institution, which has custody of 65% of our trusts assets, for a fee based on the market value of trust assets. Under state trust laws, we are allowed to charge the trust a fee for advising on the investment of the trust assets and these fees are recognized as income as the services are provided. The investment advisors establish an investment policy that gives guidance on asset allocation, investment requirements, investment manager selection and performance monitoring. The investment objectives are toward generating long-term investment returns without assuming undue risk, while ensuring the management of assets are in compliance with applicable laws.

Preneed funeral trust fund income earned and the receipt and recognition of any insurance benefits are deferred until the service is performed. Applicable state laws generally require us to deposit a specified amount (which varies from state to state, generally 50% to 100% of the selling price) into a merchandise and service trust fund for preneed cemetery merchandise and service sales. The related trust fund income earned is recognized when the related merchandise and services are delivered. In most states, regulations require a portion (generally 10%) of the sale amount of cemetery property and memorials to be placed in a perpetual care trust. The income from perpetual care trusts provides a portion of the funds necessary to maintain the cemetery property and memorials in perpetuity. Perpetual care trust fund income is recognized as earned, in *Cemetery revenues.*

#### Acquisitions

Our growth strategy includes the execution of our Strategic Acquisition Model. The goal of this model is to ensure value addition to the Company through acquisitions by assessing the sustainable earning power of an acquisition candidate and investing in that business at an appropriate price. The prequalification of an acquisition candidate is determined by a ranking which includes territory demographics, customer preferences, market size, market share, barriers to entry, and volume and price trends (which reflects the business mix). The candidate is also assessed using our Standards Operating Model. The valuation of the acquisition candidate is then determined through a discounted cash flow model. During 2011, we acquired six funeral home businesses and no cemetery businesses. The consideration paid for the 2011 acquisitions was $18.6 million. During the first nine months of 2012, we acquired five funeral homes and one cemetery for $22.4 million.

#### Financial Highlights

Net income for the three months ended September 30, 2012 totaled $0.6 million, equal to $0.03 per diluted share, compared to net income for the three months ended September 30, 2011, which totaled $0.8 million, equal to $0.04 per diluted share. Net income for the nine months ended September 30, 2012 totaled $7.7 million, equal to $0.42 per diluted share, compared to $6.7 million for the nine months ended September 30, 2011, or $0.36 per diluted share. Total revenue for the three and nine months ended September 30, 2012 was $49.5 million and $151.1 million, respectively, an increase of 14.1% and 7.3%, respectively, compared to $43.4 million and $140.8 million, respectively, for the comparable periods in 2011. Our funeral segment experienced increases in revenue and gross profit primarily as a result of our acquisitions. Also, the average revenue per contract continues to increase and we have experienced better management of salaries and benefit costs. The cemetery segment experienced increases in revenue during the three and nine month periods due to higher trust fund earnings and increased recognized revenue from preneed property sales and deliveries of merchandise and services. Cemetery gross profit was higher for the three and nine months ended September 30, 2012 primarily as a result of higher revenue. We experienced increases in general and administrative expenses due to increases in severance costs and incentive compensation at the home office.

In certain states, we are allowed to withdraw realized trust earnings prior to delivery from cemetery merchandise and services trusts, which management describes as “Withdrawable trust income.” The Withdrawable trust income totaled $1.3 million and $4.9 million, respectively, for the three and nine month periods ended September 30, 2011, and $0.5 million and $1.3 million, respectively, for the three and nine month periods ended September 30, 2012. The year over year decline was attributable to substantial gains realized in the trust funds throughout 2011 that was not repeated in 2012. While the Withdrawable trust income is not recognized as revenue in our consolidated statements of operations, it increases cash flow from operations. The Withdrawable trust income is treated as a special item in our Non-GAAP income statement.

We are providing below a reconciliation of Non-GAAP net income (a non-GAAP measure) to net income from continuing operations (a GAAP measure). Non-GAAP net income is defined as net income from continuing operations, then adjusted for special items, including Withdrawable trust income, acquisition expenses and the other items in the table below. Non-GAAP net income is used as a supplemental financial measurement by management and investors to compare our current financial performance with our previous results and with the performance of other deathcare companies. The adjustment of special items in Non-GAAP income allows management to focus on the evaluation of operating performance as it primarily relates to our operating expenses. We do not intend for this information to be considered in isolation or as a substitute for other measures of performance prepared in accordance with GAAP.

*(In millions, except diluted EPS)*

|  | Three Months Ended September 30, 2011 Net Income | Diluted EPS | 2012 Net Income | Diluted EPS |
| --- | ---: | ---: | ---: | ---: |
| Net income from continuing operations, as reported | $0.7 | $0.04 | $0.5 | $0.03 |
| After-tax special items: |  |  |  |  |
| Withdrawable trust income | 0.8 | 0.04 | 0.3 | 0.01 |
| Acquisition expenses | 0.4 | 0.02 | 0.2 | 0.01 |
| Severance costs | — | — | 0.2 | 0.01 |
| Gain on repurchase of subordinated debentures | (0.2) | (0.01) | — | — |
| Losses on early extinguishment of debt and other costs | 0.1 | 0.01 | 1.8 | 0.10 |
| Non-GAAP net income | $1.8 | $0.10 | $3.0 | $0.16 |
| Diluted weighted average shares outstanding (in thousands) |  | 18,461 |  | 18,170 |

\- 25 -

*(In millions, except diluted EPS)*

|  | Nine Months Ended September 30, 2011 Net Income | Diluted EPS | 2012 Net Income | Diluted EPS |
| --- | ---: | ---: | ---: | ---: |
| Net income from continuing operations, as reported | $6.6 | $0.36 | $7.3 | $0.41 |
| After-tax special items: |  |  |  |  |
| Withdrawable trust income | 2.9 | 0.16 | 0.8 | 0.04 |
| Securities transaction expenses | 0.3 | 0.02 | — | — |
| Acquisition expenses | 0.6 | 0.03 | 0.5 | 0.03 |
| Severance costs | 0.1 | — | 0.5 | 0.03 |
| Gain on repurchase of subordinated debentures | (0.5) | (0.03) | — | — |
| Losses on early extinguishment of debt and other costs | 0.1 | 0.01 | 1.8 | 0.10 |
| Other | — | — | 0.1 | — |
| Non-GAAP net income | $10.1 | $0.55 | $11.0 | $0.61 |
| Diluted weighted average shares outstanding (in thousands) |  | 18,381 |  | 18,212 |

### OVERVIEW OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of the Consolidated Financial Statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, we evaluate estimates and judgments, including those related to revenue recognition, realization of accounts receivable, inventories, goodwill, other intangible assets, property and equipment, and deferred tax assets. We base our estimates on historical experience, third party data, and assumptions that we believe to be reasonable under the circumstances. The results of these considerations form the basis for making judgments about the amount and timing of revenues and expenses, the carrying value of assets, and the recorded amounts of liabilities. Actual results may differ from these estimates and such estimates may change if the underlying conditions or assumptions change. Historical performance should not be viewed as indicative of future performance, because there can be no assurance the margins, operating income, and net earnings as a percentage of revenues will be consistent from year to year.

Management’s discussion and analysis of financial condition and results of operations (“MD&A”) is based upon our Consolidated Financial Statements presented herewith, which have been prepared in accordance with accounting principles generally accepted in the United States. Our significant accounting policies are more fully described in Note 1 to our Consolidated Financial Statements included in this Form 10-Q. Our critical accounting policies are those that are both important to the portrayal of our financial condition and results of operations and require management’s most difficult, subjective, and complex judgment. These critical accounting policies are discussed in MD&A in our Annual Report on Form 10-K for the year ended December 31, 2011. There have been no significant changes to our critical accounting policies since the filing of our Annual Report on Form 10-K for the year ended December 31, 2011.

### RESULTS OF OPERATIONS

The following is a discussion of our results of continuing operations for the three and nine month periods ended September 30, 2011 and 2012. The term “same store” or “existing operations” refers to funeral homes and cemeteries acquired prior to January 1, 2008 and owned and operated for the entirety of each period being presented. Funeral homes and cemeteries purchased after December 31, 2007 are referred to as “acquired.” This classification of acquisitions has been important to management and investors in monitoring the results of these businesses and to gauge the leveraging performance contribution that a selective acquisition program can have on the total company performance. Depreciation and amortization and regional and unallocated funeral and cemetery costs are not included in operating profit.

*Funeral Home Segment.* The following tables set forth certain information regarding the revenues and operating profit from the funeral home operations for the three months ended September 30, 2011 compared to the three months ended September 30, 2012 and the nine months ended September 30, 2011 compared to the nine months ended September 30, 2012.

#### Three months ended September 30, 2011 compared to three months ended September 30, 2012 (dollars in thousands):

| Revenues: | Three Months Ended September 30, 2011 | 2012 | Change Amount% |  |
| --- | ---: | ---: | ---: | ---: |
| Same store operating revenue | $27,856 | $28,833 | $977 | 3.5% |
| Acquired operating revenue | 3,343 | 6,192 | 2,849 | 85.2% |
| Preneed funeral insurance commissions | 512 | 462 | (50) | (9.8)% |
| Preneed funeral trust earnings | 1,523 | 1,334 | (189) | (12.4)% |
| Total | $33,234 | $36,821 | $3,587 | 10.8% |
| Operating profit: |  |  |  |  |
| Same store operating profit | $9,568 | $10,635 | $1,067 | 11.1% |
| Acquired operating profit | 850 | 1,890 | 1,040 | 122.4% |
| Preneed funeral insurance commissions | 142 | 85 | (57) | (40.1)% |
| Preneed funeral trust earnings | 1,523 | 1,334 | (189) | (12.4)% |
| Total | $12,083 | $13,944 | $1,861 | 15.4% |

Funeral home same store operating revenues for the three months ended September 30, 2012 increased $1.0 million, or 3.5%, when compared to the three months ended September 30, 2011, as we experienced a 0.7% increase in the number of contracts, and the average revenue per contract increased 1.8%, or $99 per contract, to $5,514 for those existing operations. The average revenue per contract includes the impact of the funeral trust fund earnings recognized at the time that we provide the services pursuant to the preneed contract. Excluding funeral trust earnings, the average revenue per contract increased 2.8% to $5,291. The number of traditional burial contracts declined 2.2% while the average revenue per burial contract increased 4.0% to $8,298. The cremation rate for the same store businesses increased from 42.8% to 44.8%. The average revenue per same store cremation contract increased 1.1% to $3,085 and the number of cremation contracts increased 5.4%. Cremations with services declined from 38.1% of total cremation contracts in the third quarter of 2011 to 35.1% in the third quarter of 2012. The average revenue for “other” contracts, which are charges for merchandise or services for which we do not perform a funeral service and which make up approximately 7.1% of the total number of contracts, decreased 2.8% to $1,985.

Same store operating profit for the three months ended September 30, 2012 increased $1.1 million, or 11.1%, from the comparable three months of 2011, and as a percentage of funeral same store operating revenue, increased to 36.9% from 34.4%. The increase in profit is primarily the result of the increase in revenue complemented by lower salaries and wages in the current quarter.

Funeral home acquired revenues for the three months ended September 30, 2012 increased $2.8 million, or 85.2%, when compared to the three months ended September 30, 2011, as we experienced a 58.8% increase in the number of contracts, and an increase of 15.8%, to $4,638, in the average revenue per contract for those acquired operations. Excluding funeral trust earnings, the average revenue per contract increased 16.6% to $4,570. The cremation rate for the acquired businesses was 52.1% for the third quarter of 2012, down from 60.0% in the prior year period. The average revenue per cremation contract increased 7.8% to $2,944 for the third quarter of 2012 and the number of cremation contracts increased 37.9% compared to the same period of 2011. The reason for the large increase in the average revenue per contract and the significant decline in the cremation rate is because the businesses acquired during the fourth quarter of 2011 and in the first nine months of 2012 serve primarily traditional burial families.

Acquired operating profit for the three months ended September 30, 2012 increased $1.0 million from the comparable three months of 2011 and, as a percentage of revenue from acquired businesses, was 25.4% for the third quarter of 2011 compared to 30.5% for the third quarter of 2012. The improvement in operating profit margin is largely attributable to the businesses acquired that have been in our Company for less than one year.

The two categories of financial revenue (insurance commissions and trust earnings on matured preneed contracts) on a combined basis decreased 11.7% in revenue and 14.8% in operating profit, compared to the three months ended September 30, 2011 as a result of lower earnings on trust contracts. Trust earnings also include trust management fees charged by the company’s wholly-owned registered investment advisor based on the fair market value of the trust assets.

#### Nine months ended September 30, 2011 compared to nine months ended September 30, 2012 (dollars in thousands):

| Revenues: | Nine Months Ended September 30, 2011 | 2012 | Change Amount% |  |
| --- | ---: | ---: | ---: | ---: |
| Same store operating revenue | $91,188 | $90,146 | $(1,042) | (1.1)% |
| Acquired operating revenue | 9,594 | 18,516 | 8,922 | 93.0% |
| Preneed funeral insurance commissions | 1,399 | 1,363 | (36) | (2.6)% |
| Preneed funeral trust earnings | 4,837 | 4,426 | (411) | (8.5)% |
| Total | $107,018 | $114,451 | $7,433 | 6.9% |
| Operating profit: |  |  |  |  |
| Same store operating profit | $32,366 | $34,060 | $1,694 | 5.2% |
| Acquired operating profit | 2,412 | 6,135 | 3,723 | 154.3% |
| Preneed funeral insurance commissions | 296 | 286 | (10) | (3.4)% |
| Preneed funeral trust earnings | 4,837 | 4,426 | (411) | (8.5)% |
| Total | $39,911 | $44,907 | $4,996 | 12.5% |

Funeral home same store operating revenues for the nine months ended September 30, 2012 decreased $1.0 million, or 1.1%, when compared to the nine months ended September 30, 2011, as we experienced a 3.2% decrease in the number of contracts, while the average revenue per contract increased 1.6%, or $86 per contract, to $5,567 for those existing operations. The average revenue per contract includes the impact of the funeral trust fund earnings recognized at the time that we provide the services pursuant to the preneed contract. Excluding funeral trust earnings, the average revenue per contract increased 2.1% to $5,324. The number of traditional burial contracts declined 6.5% while the average revenue per burial contract increased 3.6% to $8,336. The cremation rate for the same store businesses rose from 42.5% to 44.1%. The average revenue per same store cremation contract increased 2.4% to $3,110 and the number of cremation contracts increased slightly 0.5%. Cremations with services declined from 38.7% of total cremation contracts in the nine months ended September 30, 2011 to 35.8% in the third quarter of 2012. The average revenue for “other” contracts, which make up approximately 7.4% of the total number of contracts, decreased 0.9% to $2,071.

Same store operating profit for the nine months ended September 30, 2012 increased $1.7 million, or 5.2%, from the comparable nine months of 2011, and as a percentage of funeral same store operating revenue, increased from 35.5% to 37.8%. Substantially all of the expense categories were lower compared to the nine months ended September 30, 2011, including a $0.7 million decline in discounts given on contracts and a $1.8 million decline in salaries, wages and health care costs.

Funeral home acquired revenues for the nine months ended September 30, 2012 increased $8.9 million, or 93.0%, when compared to the nine months ended September 30, 2011, as we experienced a 60.0% increase in the number of contracts, and an increase of 20.0%, to $4,598, in the average revenue per contract for those acquired operations. Excluding funeral trust earnings, the average revenue per contract increased 20.6% to $4,532. The cremation rate for the acquired businesses was 52.4% for the nine months ended September 30, 2012, down from 61.5% in the prior year period. The average revenue per cremation contract increased 9.6% to $2,988 for the nine months ended September 30, 2012 and the number of cremation contracts increased 36.4%.

Acquired operating profit for the nine months ended September 30, 2012 increased $3.7 million from the comparable nine months of 2011 and, as a percentage of revenue from acquired businesses, was 25.1% for the nine months ended September 30, 2011 compared to 33.1% for nine months ended September 30, 2012. The improvement in operating profit margin is largely attributable to additional margins in those acquired businesses that have been in our Company for less than one year.

The two categories of financial revenue, insurance commissions and trust earnings on matured preneed contracts, on a combined basis, decreased 7.2% in revenue and 8.2% in operating profit, compared to the nine months ended September 30, 2011. Trust earnings also include trust management fees charged by the company’s wholly-owned registered investment advisor based on the fair market value of the trust assets.

*Cemetery Segment*. The following tables set forth certain information regarding our revenues and operating profit from the cemetery operations for the three months ended September 30, 2011 compared to the three months ended September 30, 2012 and for the nine months ended September 30, 2011 compared to the nine months ended September 30, 2012.

#### Three months ended September 30, 2011 compared to three months ended September 30, 2012 (dollars in thousands):

| Revenues: | Three Months Ended September 30, 2011 | 2012 | Change Amount% |  |
| --- | ---: | ---: | ---: | ---: |
| Same store operating revenue | $8,827 | $10,150 | $1,323 | 15.0% |
| Acquired operating revenue | — | 60 | 60 | 100.0% |
| Cemetery trust earnings | 977 | 2,005 | 1,028 | 105.2% |
| Preneed cemetery finance charges | 330 | 453 | 123 | 37.3% |
| Total | $10,134 | $12,668 | $2,534 | 25.0% |
| Operating profit: |  |  |  |  |
| Same store operating profit | $1,689 | $2,432 | $743 | 44.0% |
| Acquired operating loss | — | (56) | (56) | (100.0)% |
| Cemetery trust earnings | 977 | 1,978 | 1,001 | 102.5% |
| Preneed cemetery finance charges | 330 | 453 | 123 | 37.3% |
| Total | $2,996 | $4,807 | $1,811 | 60.4% |

Cemetery same store operating revenues for the three months ended September 30, 2012 increased $1.3 million, or 15.0%, compared to the three months ended September 30, 2011. The increase in operating revenue was primarily attributable to preneed property sales which increased $0.9 million, or 23.5%. We experienced a 5.6% increase in the number of interment rights (property) sold, and a 11.7% increase in the average price per interment compared to the third quarter of 2011. The percentage of those interment rights sold that we were able to recognize as revenue, because we received at least 10% of the sales price from the customer, increased from 78.6% to 94.1%. Same store at-need revenue increased $0.4 million, or 12.1%, as at-need contracts increased 2.9% while revenue from deliveries of preneed merchandise and services remained flat.

Cemetery same store operating profit for the three months ended September 30, 2012 increased $0.7 million, or 44.0%. As a percentage of revenues, cemetery same store operating profit increased from 19.1% to 24.0%. The increase in operating profit is primarily a result of the increase in revenue offset by higher promotional expenses.

We acquired one cemetery in late second quarter of 2012 which primarily operates as an at-need business. This is the only business in this category.

The two categories of financial revenue consist of trust earnings and finance charges on preneed receivables. Total trust earnings increased 88.1%, when compared to the three months ended September 30, 2011. Earnings from perpetual care trust funds totaled $1.5 million for the three months ended September 30, 2012 compared to $0.6 million for the three months ended September 30, 2011, an increase of $0.9 million, or 159.0%. Trust earnings recognized upon the delivery of merchandise and service contracts declined 4.4% from the same period in 2011. Trust earnings also include trust management fees charged by the company’s wholly-owned registered investment advisor based on the fair market value of the trust assets. Finance charges on the preneed contracts increased 37.0% because of the increase in the total receivables outstanding and higher rates used.

#### Nine months ended September 30, 2011 compared to nine months ended September 30, 2012 (dollars in thousands):

| Revenues: | Nine Months Ended September 30, 2011 | 2012 | Change Amount% |  |
| --- | ---: | ---: | ---: | ---: |
| Same store operating revenue | $28,922 | $29,945 | $1,023 | 3.5% |
| Acquired operating revenue | — | 60 | 60 | 100.0% |
| Cemetery trust earnings | 3,855 | 5,316 | 1,461 | 37.9% |
| Preneed cemetery finance charges | 1,009 | 1,301 | 292 | 28.9% |
| Total | $33,786 | $36,622 | $2,836 | 8.4% |
| Operating profit: |  |  |  |  |
| Same store operating profit | $7,380 | $7,410 | $30 | 0.4% |
| Acquired operating profit | — | (65) | (65) | (100.0)% |
| Cemetery trust earnings | 3,855 | 5,289 | 1,434 | 37.2% |
| Preneed cemetery finance charges | 1,009 | 1,301 | 292 | 28.9% |
| Total | $12,244 | $13,935 | $1,691 | 13.8% |

Cemetery same store operating revenues for the nine months ended September 30, 2012 increased $1.0 million, or 3.5%, compared to the nine months ended September 30, 2011. Same store revenue from preneed property sales and deliveries of preneed merchandise and services deliveries increased $0.8 million, or 4.9%, while at-need revenues remained flat. We experienced a 4.0% increase in the number of interment rights (property) sold and a 5.6% increase in the average price per interment compared to the nine months ended September 30, 2011. The percentage of those interment rights sold that we were able to recognize as revenue, because we received at least 10% of the sales price from the customer, increased from 86.0% to 88.5%.

Cemetery same store operating profit for the nine months ended September 30, 2012 was flat compared to the same period in prior year. As a percentage of revenues, cemetery same store operating profit decreased from 25.5% to 24.7%. The increase in operating profit is primarily a result of the increase in revenue and lower salaries and wages and health care costs.

The two categories of financial revenue consist of trust earnings and finance charges on preneed receivables. Total trust earnings increased 35.5%, when compared to the nine months ended September 30, 2011. Earnings from perpetual care trust funds totaled $4.1 million for the nine months ended September 30, 2012 compared to $2.9 million for the nine months ended June 30, 2011, an increase of $1.2 million, or 42.1%. Trust earnings recognized upon the delivery of merchandise and service contracts increased $0.1 million to $1.1 million compared to the same period in 2011. Trust earnings also include trust management fees charged by the company’s wholly-owned registered investment advisor based on the fair market value of the trust assets. Finance charges on the preneed contracts increased 28.7%.

*Other.* General and administrative expenses totaled $15.3 million for the nine months ended September 30, 2012, an increase of $1.0 million, or 7.2%, compared to the nine months ended September 30, 2011, primarily due to increases in costs of approximately $0.9 million for incentive compensation and $0.6 million of severance costs offset by $0.5 million in expenses in 2011 related to a proposed securities transaction that did not occur in the current year. General and administrative expenses totaled $5.2 million for the three months ended September 30, 2012, an increase of $0.5 million, or 9.6%, compared to the same comparable period in prior year primarily due to increases for incentive compensation and severance costs.

*Income Taxes.* We recorded income taxes at the estimated effective rate of 42.5% for the year ended December 31, 2011 and 40.4% for the first nine months of 2012. We became a federal cash taxpayer in the fourth quarter of 2011. The decrease in the tax rate is primarily due to the utilization of state net operating losses that had not previously been recognized. We have approximately $43.8 million of state net operating loss carryforwards that will expire between 2013 and 2030, if not utilized. Based on management’s assessment of the various state net operating losses, it has been determined that it is more likely than not that we will not be able to realize the tax benefits of certain portions of the state losses. Accordingly, a valuation allowance has been established and is reviewed every quarter related to the deferred tax asset for the state operating losses. At September 30, 2012, the valuation allowance totaled $0.6 million.

### LIQUIDITY AND CAPITAL RESOURCES

#### Overview

Our primary sources of liquidity and capital resources are internally generated cash flows from operating activities and availability under our Credit Facility. We generate cash in our operations primarily from at-need sales and delivery of preneed sales. We also generate cash from earnings on our cemetery perpetual care trusts. We believe that existing cash balances, future cash flows from operations and borrowing under our Credit Facility will be sufficient to meet our anticipated working capital requirements, capital expenditures, scheduled debt payments, commitments, dividend payments and acquisitions. Based on our recent operating results, current cash position, anticipated future cash flows and sources of financing that we expect to have available, we do not anticipate any significant liquidity constraints in the foreseeable future. However, if our capital expenditures or acquisition plans for 2012 change, we may need to access the capital markets to obtain additional funding. Further, to the extent operating cash flow or access to and cost of financing sources are materially different than expected, future liquidity may be adversely affected. Please read Part I, Item IA “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011.

#### Cash Flows

We began 2012 with $1.1 million in cash and other liquid investments and ended the third quarter with $0.5 million in cash and $28.0 million drawn on our revolving credit facility.

The following table sets forth the elements of cash flow for the nine months ended September 30, 2012 (in millions):

|  |  |
| --- | ---: |
| Cash at January 1, 2012 | $1.1 |
| Cash flow from operating activities | 15.2 |
| Acquisitions | (22.4) |
| Borrowings on our Credit Facility | 26.6 |
| Maintenance capital expenditures | (3.2) |
| Dividends on common stock | (1.3) |
| Repurchase of common stock | (4.5) |
| Payment of loan origination costs and other charges | (4.7) |
| Growth capital expenditures – funeral homes | (5.3) |
| Growth capital expenditures – cemeteries | (1.8) |
| Other investing and financing activities | 0.1 |
| Cash provided by discontinued operations | 0.7 |
| Cash at September 30, 2012 | $0.5 |

For the nine months ended September 30, 2012 cash provided by continuing operating activities was $15.2 million as compared to $25.0 million for the nine months ended September 30, 2011. The decrease was due primarily to $1.5 million of payments of income taxes during the nine months ended September 30, 2012 whereas we had $1.3 million refunds for the same period in 2011. Accrued liabilities decreased $3.3 million from the same period last year as well as cemetery preneed receivables increased $1.2 million.

Our continuing investing activities resulted in a net cash outflow of $32.7 million for the nine months ended September 30, 2012, compared to a net cash outflow of $18.0 million for the nine months ended September 30, 2011. The increase in cash outflows from continuing investing activities was primarily due to increased acquisition activity in 2012 which totaled $22.4 million compared to $10.3 million for the nine months ended September 30, 2011. The cash outflows from continuing investing activities during the nine months ended September 30, 2012 for capital expenditures exceeded the comparable quarter of 2011, which totaled $10.3 million in the current year compared to $7.7 million for the nine months ended September 30, 2011. Capital expenditures during 2012 included $1.8 million for cemetery inventory development projects and $5.3 million for funeral home expansion projects. Funding for capital expenditures is provided from cash generated by our operations or our Credit Facility. Capital expenditures for the full year are anticipated to be approximately $4.5 million.

Our financing activities resulted in net cash inflow of $16.2 million for the nine months ended September 30, 2012, compared to a net cash outflow of $4.2 million for the nine months ended September 30, 2011. The increase in cash flows from financing activities is due to increased borrowings under our previous and existing revolving credit facility during the first three quarters of 2012 primarily to finance our acquisitions. The cash flows from financing activities during the first nine months of 2012 was also effected by the purchase of $4.5 million in treasury stock and payment of loan origination costs and other charges of $4.7 million, which did not occur during the first nine months of 2011, and dividend payments of $1.3 million, compared to $0.9 million during the same period in 2011.

#### Dividends

Our Board declared a quarterly cash dividend of $0.025 per share, totaling $0.4 million, which was paid on September 4, 2012 to record holders of our common stock as of August 17, 2012. For the nine months ended September 30, 2012, we have paid $1.3 million in cash dividends.

#### Debt Obligations

The outstanding principal of long-term debt at September 30, 2012 totaled $164.5 million and consisted of $130.0 million under our term loan facility, $28.0 million outstanding under our revolving credit facility and $6.5 million in acquisition indebtedness and capital lease obligations.

On August 30, 2012, we replaced our previous credit facility with the Credit Facility, a new $235 million secured bank credit facility with Bank of America, N.A. as the Administrative Agent comprised of a $105 million revolving credit facility and a $130 million term loan facility. The Credit Facility also contains an accordion provision to borrow up to an additional $40 million in revolving loans. The Credit Facility refinanced our previous credit facility, paid other transaction related fees and expenses and will provide for future corporate needs. The proceeds of the term loan borrowings were used to redeem and replace the Senior Notes, our existing 7 7/8% senior notes, which were scheduled to mature in 2015. The Credit Facility is set to mature on September 30, 2017 and is collateralized by all personal property and funeral home real property in certain states. Interest under the new Credit Facility is payable at prime or LIBOR options.

Our convertible junior subordinated debentures, payable to Carriage Services Capital Trust, or the Trust, pay interest at the fixed rate of 7% and, as of September 30, 2012, had an outstanding balance of approximately $89.8 million. Our convertible junior subordinated debentures matures in 2029. Substantially all the assets of the Trust consist of our convertible junior subordinated debentures. In 1999, the Trust issued 1.875 million shares of 7% convertible preferred securities, termed “TIDES”. The rights under the debentures are functionally equivalent to those of the TIDES. During the nine month period ending September 30, 2011, we repurchased 61,742 shares of these TIDES for approximately $2.2 million and recorded a gain of $0.8 million. No repurchases have been made in 2012.

Our convertible junior subordinated debentures and the TIDES, each contain a provision for the deferral of interest payments and distributions for up to 20 consecutive quarters. During any period in which distribution payments are deferred, distributions will continue to accumulate at the 7% annual rate. Also, the deferred distributions themselves accumulate distributions at the annual rate of 7%. During any deferral period, we are prohibited from paying dividends on the common stock or repurchasing common stock, subject to limited exceptions. We currently expect to continue paying the distributions as due.

We were in compliance with the covenants contained in the previous credit facility and the Senior Notes as of September 30, 2011. We were also in compliance with the covenants contained in the Credit Facility as of September 30, 2012. Key ratios that we must comply with include a Total Debt to EBITDA ratio that as of the last day of each quarter must not be greater than 3.75 to 1.00 and a fixed charge coverage ratio that must not be less than 1.20 to 1.00. As of September 30, 2012, the leverage ratio was 3.06 to 1.00 and the fixed charge coverage ratio was 2.41 to 1.00.

### SEASONALITY

Our business can be affected by seasonal fluctuations in the death rate. Generally, the death rate is higher during the winter months because the incidences of death from influenza and pneumonia are higher during this period than other periods of the year.

## Market risk

As filed, 3,468 characters.

In the ordinary course of business, we are typically exposed to a variety of market risks. Currently, these are primarily related to interest rate risk and changes in the values of securities associated with the preneed and perpetual care trusts. Management is actively involved in monitoring exposure to market risk and developing and utilizing appropriate risk management techniques when appropriate and when available for a reasonable price. We are not exposed to any other significant market risks including any commodity price risk or foreign exchange risk.

The following quantitative and qualitative information is provided about financial instruments to which we are a party at September 30, 2012, and from which we may incur future gains or losses from changes in market conditions. We do not enter into derivative or other financial instruments for speculative or trading purposes.

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 of such investments as of September 30, 2012 are presented in Notes 6, 8 and 10 to our Consolidated Financial Statements in this Form 10-Q. See also Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations in this Form 10-Q. The sensitivity of the fixed income securities is such that a 0.25% change in interest rates causes an approximate 1.56% change in the value of the fixed income securities.

We monitor current and forecasted interest rate risk in the ordinary course of business and seek to maintain optimal financial flexibility and solvency. As of September 30, 2012, we had $28.0 million outstanding under our revolving credit facility. Any further borrowings or voluntary prepayments against our revolving credit facility or any change in the floating rate would cause a change in interest expense. The Credit Facility allows for borrowings at two different interest rates; prime rate or LIBOR. The prime rate was 5.75% and the LIBOR margin was 3.5% at September 30, 2012. Assuming the outstanding balance remains unchanged, an increase of 100 basis points in the LIBOR rate would result in an increase in annual interest expense $0.3 million. We have not entered into interest rate hedging arrangements in the recent past, and currently have no plans to do so. Due to fluctuating balances in the amount outstanding under this agreement and current interest rates, we do not believe such arrangements to be cost effective.

We have previously issued convertible junior subordinated debentures payable to the Trust, which are carried on our Consolidated Balance Sheet at a cost of $89.8 million. The estimated fair value of these securities is estimated to be approximately $78.1 million at September 30, 2012, based on available broker quotes of the corresponding preferred securities issued by the Trust. The convertible junior subordinated debentures have a fixed interest rate of 7%, and therefore we do not have economic interest rate exposure on the debentures.

The remainder of our long-term debt and leases consist of non-interest bearing notes and fixed rate instruments that do not trade in a market, nor otherwise have a quoted market value. Any increase in market interest rates causes the fair value of those liabilities to decrease.

## Controls and procedures

As filed, 1,456 characters.

### Management’s Evaluation of Disclosure Controls and Procedures

Our management, including our principal executive and financial officers, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Exchange Act) as of the end of the period covered by this Form 10-Q. Our disclosure controls and procedures are designed to ensure that the information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and to ensure that such information is accumulated and communicated to management, including our principal executive and financial officers, as appropriate, to allow timely decisions regarding required disclosure. Based on such evaluation, our principal executive and financial officers have concluded that our disclosure controls and procedures were effective as of September 30, 2012 (the end of the period covered by this Form 10-Q).

### Changes in Internal Control over Financial Reporting

During the nine months ended September 30, 2012, there was no change in our system of internal control over financial reporting (defined in Rules 13a-15(f) or 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

## Risk factors

As filed, 739 characters.

There has been no material changes in our risk factors as previously disclosed in “Item 1A. Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2011. Readers should carefully consider the factors discussed in Part 1, Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K for the year ended December 31, 2011 are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or future results.

Filed Nov 7, 2012.
Source: SEC EDGAR, the filing index for accession 0001193125-12-457293. Last ingested by Listed: Nov 5, 2026, 19:16 ET. No prices; not investment advice.