UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended ~~September 30, 2005~~March 31, 2006


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number: 1-11961

CARRIAGE SERVICES, INC.

(Exact name of registrant as specified in its charter)


DELAWARE		76-0423828
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)


3040 Post Oak Boulevard, Suite 300, Houston, TX		77056
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (713) 332-8400

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesþ Noo

Indicate by check mark whether the ~~registrant~~Registrant is a large accelerated filer, an accelerated filer ~~(as defined by~~or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Securities Exchange ~~Act). Yes~~Act of 1934. (Check one):
o NoLarge accelerated filer þ Accelerated filer o Non-Accelerated filer

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ

The number of shares of the Registrant’s Common Stock, $.01 par value per share, outstanding as of ~~November~~May 1, ~~2005~~2006 was ~~18,458,673.~~18,564,010.

PART I –— FINANCIAL INFORMATION

Item 1. Financial Statements

CARRIAGE SERVICES, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)


	December 31,			September 30,			December 31,			March 31,
	2004			2005			2005			2006
				(unaudited)						(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	1,948		$	7,335		$	7,949		$	5,204
Short term investments		—			8,979			16,908			19,198
Accounts receivable — trade, net of allowance for doubtful accounts of $940 in 2004 and $827 in 2005		12,941			13,188
Accounts receivable — trade, net of allowance for doubtful accounts of $937 in 2005 and $1,036 in 2006								13,412			13,696
Assets held for sale		4,021			—			—			20,301
Inventories and other current assets		12,815			14,321			12,883			12,200

Total current assets		31,725			43,823			51,152			70,599


Preneed assets		133,423			142,658			135,826			131,877
Property, plant and equipment, at cost, net of accumulated depreciation of $40,531 in 2004 and $44,788 in 2005		104,893			105,698
Property, plant and equipment, at cost, net of accumulated depreciation of $45,694 in 2005 and $44,514 in 2006								105,435			102,603
Cemetery property		62,649			61,787			62,905			56,312
Goodwill		156,983			157,352			157,358			151,184
Deferred obtaining costs		35,701			—
Deferred charges and other non-current assets		8,581			24,945			25,608			25,943
Cemetery perpetual care trust investments		31,201			32,855			32,356			29,467

Total assets	$	565,156		$	569,118		$	570,640		$	567,985


LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Accounts payable	$	5,991		$	3,414
Accrued liabilities		16,048			13,558
Current portion of senior long-term debt and capital leases obligations							$	2,074		$	2,021
Accounts payable and accrued liabilities								22,163			16,860
Liabilities associated with assets held for sale		2,598			—			—			8,155
Current portion of senior long-term debt and capital leases obligations		2,155			2,182

Total current liabilities		26,792			19,154			24,237			27,036
Senior long-term debt, net of current portion		102,714			134,886			134,572			133,863
Convertible junior subordinated debenture due in 2029 to an affiliated trust		93,750			93,750			93,750			93,750
Obligations under capital leases, net of current portion		5,424			5,369			4,775			4,760
Deferred interest on convertible junior subordinated debenture		10,891			—
Deferred revenue		176,412			184,618			183,820			178,439

Total liabilities		415,983			437,777			441,154			437,848


Commitments and contingencies

Non-controlling interests in perpetual care trust investments		32,212			36,035			33,112			28,751
Non-controlling interests in perpetual care trust investments associated with assets held for sale		523			—			—			6,319
Stockholders’ equity:
Common Stock, $.01 par value; 80,000,000 shares authorized; 17,910,000 and 18,429,000 shares issued and outstanding at December 31, 2004 and September 30, 2005, respectively		179			184
Contributed capital		188,029			190,376
Common Stock, $.01 par value; 80,000,000 shares authorized;18,458,000 and 18,515,000 shares issued and outstanding at December 31, 2005 and March 31, 2006, respectively								185			185
Additional paid-in capital								190,502			190,778
Accumulated deficit		(71,056	)		(93,711	)		(92,921	)		(94,656	)
Deferred compensation		(714	)		(1,543	)		(1,392	)		(1,240	)

Total stockholders’ equity		116,438			95,306			96,374			95,067

Total liabilities and stockholders’ equity	$	565,156		$	569,118		$	570,640		$	567,985

CARRIAGE SERVICES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited and in thousands, except per share data)


	For the three months						For the nine months						For the three months
	ended September 30,						ended September 30,						ended March 31,
	2004			2005			2004			2005			2005			2006
Revenues, net
Revenues
Funeral	$	26,582		$	26,603		$	85,054		$	86,858		$	31,240		$	31,664
Cemetery		9,226			9,855			28,576			29,722			9,741			10,054

		35,808			36,458			113,630			116,580			40,981			41,718

Costs and expenses
Funeral		20,475			20,506			63,097			63,668			21,621			22,442
Cemetery		7,233			8,047			21,931			24,015			7,538			8,407

		27,708			28,553			85,028			87,683			29,159			30,849
Gross profit		8,100			7,905			28,602			28,897			11,822			10,869
General and administrative expenses		2,748			3,142			7,975			8,921			2,779			2,643
Goodwill impairment charge														—			907

Operating income		5,352			4,763			20,627			19,976			9,043			7,319
Interest expense		4,175			4,682			12,952			14,059			4,631			4,640
Additional interest and other costs of senior debt refinancing		—			—			—			6,933			6,693			—
Other (income) expense		423			(140	)		(468	)		249
Interest income and other														(58	)		(216	)

Total interest and other (income) expense		4,598			4,542			12,484			21,241
Total interest expense and other														11,266			4,424

Income (loss) from continuing operations before income taxes		754			221			8,143			(1,265	)		(2,223	)		2,895
(Provision) benefit for income taxes		(283	)		(81	)		(3,054	)		483			845			(1,409	)

Net income (loss) from continuing operations		471			140			5,089			(782	)
Income (loss) from continuing operations														(1,378	)		1,486
Discontinued operations
Operating income from discontinued operations		58			3			404			101			457			41
Gain on sales and (impairments) of discontinued operations		1,039			836			(2,011	)		1,302			462			(5,195	)
Income tax (provision) benefit		(411	)		(309	)		269			(522	)		(345	)		1,933

Income (loss) from discontinued operations		686			530			(1,338	)		881			574			(3,221	)
Cumulative effect of change in accounting method, net of tax benefit benefit		—			—			—			(22,756	)		(22,756	)		—

Net income (loss)	$	1,157		$	670		$	3,751		$	(22,657	)
Net loss													$	(23,560	)	$	(1,735	)


Basic earnings (loss) per common share
Continuing operations	$	0.03		$	0.01		$	0.29		$	(0.04	)	$	(0.08	)	$	0.08
Discontinued operations		0.04			0.03			(0.08	)		0.05			0.04			(0.17	)
Cumulative effect of change in accounting method		—			—			—			(1.25	)		(1.26	)		—

Net income (loss)	$	0.07		$	0.04		$	0.21		$	(1.24	)
Net loss													$	(1.30	)	$	(0.09	)


Diluted earnings (loss) per common share
Continuing operations	$	0.03		$	0.01		$	0.28		$	(0.04	)	$	(0.08	)	$	0.08
Discontinued operations		0.03			0.03			(0.07	)		0.05			0.04			(0.17	)
Cumulative effect of change in accounting method		—			—			—			(1.25	)		(1.26	)		—

Net income (loss)	$	0.06		$	0.04		$	0.21		$	(1.24	)
Net loss													$	(1.30	)	$	(0.09	)


Weighted average number of common and common equivalent shares outstanding:
Basic		17,834			18,426			17,751			18,294			18,127			18,484

Diluted		18,281			18,938			18,226			18,294			18,127			18,874

CARRIAGE SERVICES, ~~INC.~~INC

CONSOLIDATED STATEMENTS OF CASH ~~FLOWS~~FLOWS.

(unaudited and in thousands)


							For the three months
							ended March 31,
	For the nine months						2005			2006
	ended September 30,						(Revised,
	2004			2005			See Note 1)
Cash flows from operating activities:
Net income (loss) from continuing operations	$	5,089		$	(782	)
Adjustments to reconcile net income (loss) from continuing operations to net cash provided by (used in) continuing operating activities:
Depreciation		5,273			5,126
Amortization		3,702			2,283
Net Loss							$	(23,560	)	$	(1,735	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Cumulative effect of the change in accounting method								22,756			—
Depreciation and amortization								2,310			2,297
Loan cost amortization								213			179
Provision for losses on accounts receivable		1,781			2,112			765			840
Net (gain) loss on sale of business assets		(963	)		577
Impairment charge								—			907
Stock-based compensation		374			512			181			238
(Income) loss from discontinued operations								(574	)		3,221
Loss on early extinguishment of debt		—			978			738			—
Loss on sale of trust investments		235			—
Deferred income taxes		3,053			(483	)		(846	)		1,374
Other		502			11			(118	)		175
Changes in assets and liabilities, net of effects from acquisitions and dispositions (Increase) in accounts receivable		(885	)		(2,967	)
(Increase) in inventories and other current assets		(718	)		(1,814	)
(Increase) in deferred charges and other		(198	)		(779	)
(Increase) in deferred obtaining costs		(3,455	)		—
(Increase) in preneed trust investments		(869	)		(3,708	)
(Decrease) in accounts payable and accrued liabilities		(2,816	)		(4,781	)
Increase in deferred revenue		1,338			4,564
Increase (decrease) in deferred interest on convertible junior subordinated debenture		5,216			(10,345	)

Changes in assets and liabilities, net of effects from acquisitions and dispositions
Accounts receivable								(2,616	)		(731	)
Inventories and other current assets								(886	)		(12	)
Deferred charges and other								(60	)		(15	)
Preneed trust investments								(1,168	)		(2,615	)
Accounts payable and accrued liabilities								(3,391	)		(5,272	)
Deferred preneed revenue								2,438			2,249
Deferred interest on convertible junior subordinated debenture								(10,345	)		—

Net cash provided by (used in) operating activities of continuing operations		16,659			(9,496	)		(14,163	)		1,100
Net cash provided by operating activities of discontinued operations		514			62			296			81

Net cash provided by (used in) operating activities		17,173			(9,434	)		(13,867	)		1,181

Cash flows from investing activities:
Acquisition		—			(1,285	)
Net proceeds from sales of businesses and other assets		3,760			223			—			65
Purchase of short term investments		—			(20,851	)		(6,919	)		(13,790	)
Maturities of short term investments		—			11,872			—			11,501
Capital expenditures		(3,387	)		(5,487	)		(1,790	)		(1,110	)

Net cash provided by (used in) investing activities of continuing operations		373			(15,528	)
Net cash sales proceeds (purchases) of discontinued operations		(123	)		1,571
Net cash used in investing activities of continuing operations								(8,709	)		(3,334	)
Net cash provided by investing activities of discontinued operations								510			—

Net cash provided by (used in) investing activities		250			(13,957	)
Net cash used in investing activities								(8,199	)		(3,334	)

Cash flows from financing activities:
Net proceeds (payments) on bank line of credit		7,500			(25,600	)
Net payments on bank line of credit								(25,600	)		—
Payments on senior long-term debt and obligations under capital leases								(71,178	)		(777	)
Proceeds from the issuance of senior notes		—			130,000			130,000			—
Payments on senior long-term debt and obligations under capital leases		(25,117	)		(72,274	)
Proceeds from issuance of common stock		279			312
Proceeds from the exercise of stock options		187			515
Payment of financing costs		—			(4,175	)		(4,175	)		—
Proceeds from the exercise of stock options and employee stock purchase plan								192			156
Tax benefit from stock-based compensation expense								—			35

Net cash provided by (used in) financing activities of continuing operations								29,239			(586	)
Net cash used in financing activities of discontinued operations								(10	)		(6	)

Net cash provided by (used in) financing activities		(17,151	)		28,778			29,229			(592	)


Net increase in cash and cash equivalents		272			5,387			7,163			(2,745	)
Cash and cash equivalents at beginning of period		2,024			1,948			1,948			7,949

Cash and cash equivalents at end of period	$	2,296		$	7,335		$	9,111		$	5,204

CARRIAGE SERVICES, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) The Company

Carriage Services, Inc. (“Carriage” or the “Company”) is a leading provider of products and services in the death care industry in the United States. As of ~~September 30, 2005,~~March 31, 2006, the Company owned and operated ~~135~~133 funeral homes in 28 states and 29 cemeteries in 2812 states.

(b) Principles of Consolidation

The accompanying consolidated financial statements include the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated.

We have revised the Consolidated Statements of Cash Flows for the three months ended March 31, 2005 consistent with March 31, 2006 to reconcile net cash provided by operating activities from net income (loss) instead of net income (loss) from continuing operations.

(d) Interim Condensed Disclosures

The information for the three ~~and nine~~ month periods ended ~~September 30, 2004~~March 31, 2005 and ~~2005~~2006 is unaudited, but in the opinion of management, reflects all adjustments which are normal, recurring and necessary for a fair presentation of financial position and results of operations for the interim periods. Certain information and footnote disclosures, normally included in annual financial statements, have been condensed or omitted. ~~Except for Note 3, Change in Accounting for Preneed Selling Costs, the~~The accompanying consolidated financial statements have been prepared consistent with the accounting policies described in our annual report on Form 10-K for the year ended December 31, ~~2004,~~2005, and should be read in conjunction therewith. Certain amounts in the consolidated financial statements for the period ended in ~~2004~~2005 in this report have been reclassified to conform to current year presentation.

~~(d)~~(e) Cash Equivalents

The Company considers all investments purchased with an original maturity of three months or less at the time of purchase to be cash equivalents.

~~(e)~~(f) Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires ~~management~~us to make estimates and ~~assumptions~~judgments that ~~affect~~effect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Allowances from customer cancellations, refunds and bad debts are provided ~~as a percentage of recognized revenue~~ at the date the ~~sale~~contract is ~~recognized as revenue based on our historical experience.~~executed. In addition, we monitor changes in delinquency rates and provide additional bad debt and cancellation reserves when warranted. Our methodologies and the resulting estimates have been reliable in past periods. We do not expect to change the factors and assumptions used in calculating these reserves in the future.

~~(f)~~(g) Stock Plans and Stock Compensation

The Company has stock-based employee compensation plans in the form of restricted stock, stock option and employee stock purchase plans. The Company accounts for stock-based compensation under ~~APB Opinion~~Statement of Financial Accounting Standards No. ~~25, “Accounting for Stock Issued~~123R, “Share-Based Payment” (“FAS No. 123R”). FAS No. 123R requires companies to ~~Employees” whereby no~~recognize compensation expense in an amount equal to the fair value of the share-based payment issued to employees over the period of vesting. The fair value of share based payment is ~~recognized~~determined using the Black-Scholes valuation model. FAS No. 123R applies to all transactions involving issuance of equity by a company in exchange for goods and services, including employee services. The Company adopted FAS No. 123R in the ~~Consolidated Statement~~first quarter of ~~Operations and has adopted~~2006, using the ~~disclosure-only provisions~~modified prospective application method, which results in no restatement of ~~SFAS No. 123, “Accounting for Stock-Based Compensation” and SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.”~~the Company’s previously issued consolidated financial statements.

-6-

~~Had~~ Prior to 2006, the Company accounted for stock based compensation ~~cost for these plans been determined consistent with~~under APB No. 25 and provided the disclosures required under SFAS No. 123, “Accounting for Stock-Based Compensation”, ~~net income~~as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and ~~income per share would have been the following pro forma amounts (in thousands, except per share data):~~

Three months ended Nine months ended
September 30, September 30,
2004 2005 2004 2005
Net income (loss) available to common stockholders:
As reported $ 1,157 $ 670 $ 3,751 $ (22,657 )

Pro forma $ 1,070 $ 560 $ 3,490 $ (22,987 )
Net income (loss) per share available to common stockholders:
Basic
As reported $ 0.07 $ 0.04 $ 0.21 $ (1.24 )
Pro forma $ 0.06 $ 0.03 $ 0.20 $ (1.26 )
Diluted
As reported $ 0.06 $ 0.04 $ 0.21 $ (1.24 )
Pro forma $ 0.06 $ 0.03 $ 0.19 $ (1.26 )
Disclosure.”

The Company issued 268,000 shares of restricted common stock to certain officers of the Company in the first quarter of 2005. Twenty-five percent of the shares vest annually on each of the next four anniversary dates of the grant. The value of the stock at the date of grant was $4.99 per share, for a total of $1,337,320, which is amortized into expense over the vesting period.

~~2. FUTURE ACCOUNTING CHANGES~~

(h) Accounting Changes and Error Corrections

The Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting No. 154, “Accounting Changes and Error Corrections” (“FAS No. ~~154)~~154”). This statement is a replacement of Accounting Principles Board Opinion No. 20 and FAS No. 3. FAS No. 154 changes the requirements for the accounting for and reporting of a change in accounting principle and error corrections. It establishes, unless impracticable and absence of explicit transition requirements, retrospective application as the required method of a change in accounting principle to the newly adopted accounting principle. Also, it establishes guidance for reporting corrections of errors as reporting errors involves adjustments to previously issued financial statements similar to those generally applicable to reporting accounting changes retrospectively.FAS No. 154 also provides guidance for determining and reporting a change when retrospective application is impracticable. FAS No. 154 is effective for accounting changes and corrections of errors made in the fiscal years beginning after December 15, 2005. The Company ~~will adopt~~adopted the requirements beginning January 1, ~~2006.~~2006, which had no affect on the Company’s presentation and disclosure.

~~Stock Related Compensation~~2. CHANGE IN ACCOUNTING FOR STOCK-BASED COMPENSATION PLANS

~~In December 2004,~~Prior to January 1, 2006, the ~~Financial~~Company accounted for employee stock-based awards under the intrinsic value method following the recognition and measurement principle of APB Opinion No. 25, Accounting ~~Standards Board (“FASB”) issued~~for Stock Issued to Employees, and related Interpretations. Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. ~~123R, “Share-Based Payment”~~123 (Revised), Share-Based Payment (“~~FAS No.~~SFAS 123R”)~~. FAS No. 123R~~, which requires, ~~companies~~among other things, entities to recognize in the income statement the grant-date fair value of stock options and other stock-based awards over the service periods the awards are expected to vest.

Pursuant to the provisions of SFAS 123R, the Company applied the modified-prospective transition method. Under this method, the fair value provision of SFAS 123R is applied to new employee stock-based awards granted after December 31, 2005. Measurement and recognition of compensation cost for unvested awards at December 31, 2005, granted prior to the adoption of SFAS 123R, are recognized under the provisions of SFAS No 123, Accounting for Stock-Based Compensation (“SFAS 123”), after adjustments for estimated forfeiture. SFAS 123R no longer permits pro-forma disclosure for income statement periods after December 31, 2005 and compensation expense inwill be recognized for all stock-based awards based on grant-date fair value.

Carriage has two types of stock-based compensation plans for which the accounting is changed; stock options and an ~~amount~~employee stock purchase plan (“ESPP”). Options to purchase Carriage common stock have typically been granted with an exercise price equal to the fair market value at the date of grant with vesting occurring annually over four years. Because of changes in the Company’s compensation philosophy, options have not been awarded to officers of the Company since 2003 and only a small percentage of the outstanding stock options are currently unvested. The ESPP allows employees, through payroll deductions, to purchase Carriage common stock at 85% of the value of the ~~share-based payment (including share options, restricted share plans, performance-based~~common stock on the quarterly purchase dates or the annual grant date, whichever is lower.

The fair value of the stock option awards ~~share appreciation rights,~~ and ~~employee share purchase plans) issued to employees. FAS No. 123R applies to all transactions involving issuance of equity by a company in exchange~~the ESPP awards are determined using the Black-Scholes valuation model, which is consistent with the valuation methods previously utilized for ~~goods and services, including employee services. FAS No. 123R is effective~~the awards in the ~~first annual reporting period of~~footnote disclosures required under SFAS 123, as amended bySFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure. The Company recorded pretax stock-based compensation expense for the stock options and the ESPP totaling $51,000 for the first ~~fiscal year beginning on or after June 15, 2005. The Company will adopt FAS No.~~quarter 2006. Had SFAS 123R inbeen effective for the first ~~fiscal~~ quarter of ~~its 2006 fiscal year and expects to use~~2005, the modified prospective application method, which results in no restatement of the Company’s previously issued annual consolidated financial statements. The adoption of FAS No. 123R using the modified prospective application method is not expected toCompany would have ~~a material impact on the consolidated financial position and no impact on cash flows of the Company. The future~~recorded additional pretax stock-based compensation expense will vary in the future due to changes in the inputs. Management currently estimates that the adoption of FAS No. 123R will reduce net income in 2006 within a range of $0.1 million to $0.2 million.totaling $78,000.

-7-

The application of SFAS 123R has the following effect on the three months ended March 31, 2006 and 2005, respectively (in thousands).


	Three months ended
	March 31, 2006
						Results under
	As Reported			Effect of Change		Prior Method
Income from continuing operations before income taxes	$	2,895		$	51	$	2,946
Net loss available to common stockholders		(1,735	)		32		(1,703	)

Net loss per share available to common stockholders:
Basic	$	(0.09	)	$	—	$	(0.09	)
Diluted		(0.09	)		—		(0.09	)


	Three months ended
	March 31, 2005
	As Reported			Effect of Change			Pro Forma
Loss from continuing operations before income taxes	$	(2,223	)	$	(78	)	$	(2,301	)
Net loss available to common stockholders		(23,560	)		(49	)		(23,609	)

Net loss per share available to common stockholders:
Basic	$	(1.30	)	$	—		$	(1.30	)
Diluted		(1.30	)		—			(1.30	)

The following summary reflects stock option activity and related information for the quarter ending March 31, 2006.


				Weighted-Average		Aggregate
	Shares			Exercise Price		Intrinsic Value
	(000)

Outstanding at December 31, 2005		1,365		$	3.39
Granted		—		$	—
Exercised		(43	)	$	2.48
Cancelled and expired		(8	)	$	6.26

Outstanding at March 31, 2006		1,314		$	3.40	$	2,546

Exercisable at March 31, 2006		1,256		$	3.35	$	2,514

The total intrinsic value of options exercised was $100,000 during the first quarter of 2006 and $55,000 during the first quarter of 2005. As of March 31, 2006, there was $103,000 of unrecognized compensation cost, net of estimated forfeitures, related to nonvested stock options, which is expected to be recognized over a weighted average period of approximately 1.4 years.

The following summary provides additional information about stock options that are outstanding and exercisable at March 31, 2006 (shares in thousands).


	Options Outstanding						Options Exercisable
	Weighted-Average
Actual Range
of Exercise
Prices	Number		Remaining		Weighted-		Number		Remaining		Weighted-
150%	Outstanding		Contractual		Average		Exercisable at		Contractual		Average
increment	at 3/31/06		Life		Exercise Price		3/31/06		Life		Exercise Price
$1.19- 1.56		638		4.7	$	1.48		638		4.7	$	1.48
$2.06- 3.09		168		4.3	$	2.89		167		4.3	$	2.89
$3.12- 4.66		163		7.1	$	4.17		111		7.1	$	4.15
$4.77- 6.19		288		6.2	$	5.04		283		6.2	$	5.02
$13.25- 19.88		51		2.5	$	15.12		51		2.5	$	15.12
$21.00- 27.50		6		1.1	$	21.18		6		1.1	$	21.18

$1.19- 27.50		1,314		5.2	$	3.40		1,256		5.2	$	3.35

-8-

No stock options were granted in the first quarter of 2006 or the first quarter of 2005. The fair values of the ESPP granted at the beginning of 2006 and 2005 were estimated using the following assumptions:


	2005			2006
Assumptions:
Expected dividend yield		0	%		0	%
Expected volatility		50	%		58	%
Risk-free interest rate		3.00	%		4.25	%
Expected life (years)		.25, .50, .75, 1			.25, .50, .75, 1

The expected life represents the four calendar quarters from the grant date (January 1) to the purchase date (end of each quarter).

3. 2005 CHANGE IN ACCOUNTING FOR PRENEED SELLING COSTS

On June 30, 2005, the Company changed its method of accounting for deferred obtaining costs, which are preneed selling costs, incurred for the origination of prearranged funeral and cemetery service and merchandise sales contracts. Prior to this change, commissions and other costs that were related to the origination of prearranged funeral and cemetery service and merchandise sales were deferred and amortized with the objective of recognizing the selling costs in the same period that the related revenue is recognized. Under the prior accounting method, the commissions and other direct selling costs, which are current obligations that are paid and use operating cash flow, are not recognized currently in the income statement. The Company believes it is preferable to expense the current obligation for the commissions and other costs rather than defer these costs. The Company ~~also believes the new accounting method will improve the comparability of its reported earnings to the other deathcare companies. The Company has~~ applied this change in accounting method effective January 1, 2005. Therefore, the Company’s results of operations for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2005 are reported on the basis of our changed method.

As of January 1, 2005, the Company recorded a cumulative effect of change in accounting method of $35.8 million pretax or $22.8 million after tax (net of income tax benefit of $13.0 million), or ~~$1.25~~$1.26 per diluted share, which represents the cumulative balance of deferred preneed selling costs in the Company’s consolidated balance sheet. The table below presents the Company’s income (loss) from continuing operations before cumulative effect of change in accounting method, net income (loss), diluted earnings (loss) per share from continuing operations before cumulative effect of change in accounting method and diluted net earnings (loss) per share for the three and nine months ended September 30, 2005 had the Company not made this accounting change (in thousands, except per share amounts).

Three Months Ended Nine Months Ended
September 30, 2005 September 30, 2005
Effect of Results under Effect of Results under
As Reported Change Prior Method As Reported Change Prior Method
Income (loss) from continuing operations before cumulative effect of change in accounting method $ 140 $ 137 $ 277 $ (782 ) $ 1,579 $ 797
Net income (loss) 670 69 739 (22,657 ) 23,646 989
Diluted earnings (loss) per common share from continuing operations before cumulative effect of change in accounting method 0.01 0.01 0.02 (0.04 ) 0.08 0.04
Diluted earnings (loss) per common share 0.04 0.00 0.04 (1.24 ) 1.29 0.05

The table below presents the pro forma amounts for the three and nine months ended September 30, 2004 as if the accounting change had been in effect during those periods (in thousands, except per share amounts).

Three Months Ended Nine Months Ended
September 30, 2004 September 30, 2004
As As
Previously Effect of Previously Effect of
Reported Change Proforma Reported Change Proforma
Gross profit:
Funeral $ 6,101 $ (281 ) $ 5,820 $ 21,942 $ (826 ) $ 21,116

Cemetery 2,031 (542 ) 1,489 6,783 (1,580 ) 5,203

$ 8,132 $ (823 ) $ 7,309 $ 28,725 $ (2,406 ) $ 26,319
Income from continuing operations $ 489 $ (514 ) $ (25 ) $ 5,162 $ (1,504 ) $ 3,658
Net income (loss) 1,157 (255 ) 902 3,751 (1,258 ) 2,493
Diluted earnings per common share from continuing operations 0.03 (0.03 ) 0.00 0.28 (0.08 ) 0.20
Diluted earnings (loss) per common share 0.06 (0.01 ) 0.05 0.21 (0.07 ) 0.14

~~-8-~~

4. ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS

At ~~June 30, 2005, two~~March 31, 2006, a funeral home business and a combination funeral home and cemetery ~~businesses~~business were held for sale. ~~During July 2005,~~The sale of these operations both of which were in small markets not strategic to our future plans is expected to occur during the ~~Company closed on~~second quarter. The carrying value of the assets of these businesses was reduced to management’s estimate of fair value less estimated costs to sell by recording impairment charges totaling $5.2 million, a substantial portion of which related to specifically identified goodwill. We do not anticipate material future cash expenditures associated with the sale of ~~one of~~these businesses.

At March 31, 2006, assets and liabilities associated with the cemetery businesses. The sale transaction generated net cash proceeds totaling $1.1 million and a gain of approximately $0.8 million. Plans to sell the remaining cemetery were abandoned during the third quarter when the buyer decided against the transaction. We are operating this cemetery. The consolidated financial statements for the period ended in 2004 in this report have been reclassified to conform with current presentation. No businesses ~~were~~ held for sale ~~at September 30, 2005.~~in the accompanying balance sheet consisted of the following (in thousands):


	March 31, 2006
Assets:
Current assets	$	326
Property, plant and equipment, net		1,794
Preneed receivables and trust investments		6,409
Cemetery property, net		6,453
Goodwill		113
Deferred charges and other assets		33
Cemetery perpetual care trust investments		5,173

Total	$	20,301


Liabilities:
Current liabilities		130
Deferred revenue		1,750
Non-controlling interests in funeral and cemetery trust investments		6,275

Total	$	8,155


Noncontrolling interests in perpetual care trust investments related to assets held for sale	$	6,319

-9-

The operating results of the businesses held for sale, as well as ~~the gain~~impairments and gains or losses on the disposal are presented in the discontinued operations section of the consolidated statements of operations, along with the income tax effect on a comparative basis. Likewise, the operating results, the impairment charges and gains or losses from businesses sold in the prior year have been similarly reported for comparability. Revenues and operating income for the businesses presented in the discontinued operations section are as follows (in thousands):

For the three months For the nine months
ended September 30, ended September 30,
2004 2005 2004 2005

Revenues, net $ 423 $ 34 $ 1,986 $ 462


	For the three months
	ended March 31,
	2005		2006
Revenues, net	$	1,301	$	657
Operating Income	$	457	$	41

During January 2005, the Company closed on the sale of a funeral home business. The sale transaction generated net cash proceeds totaling $0.5 million and a gain of approximately $0.3 million.

5. SHORT TERM INVESTMENTS

Short term investments are investments purchased with an original maturity of greater than three months at the time of purchase. Short term investments at ~~September 30, 2005~~March 31, 2006 consisted of commercial paper with maturity dates that range from ~~October 2005~~April 2006 to ~~January~~July 2006 at rates ranging from ~~3.28~~4.16 percent to ~~3.65~~4.69 percent per anum. Market ~~value~~values approximates cost.

6. PRENEED ASSETS

Preneed assets consist of the following:


	December 31,		September 30,		December 31,		March 31,
	2004		2005		2005		2006
Cemetery preneed receivables and trust investments	$	65,855	$	70,178	$	67,995	$	65,701
Funeral preneed receivables and trust investments		49,494		55,041		50,420		48,731
Receivable from funeral trusts		18,074		17,439		17,411		17,445

	$	133,423	$	142,658	$	135,826	$	131,877

The cost and market values associated with cemetery preneed trust investments at ~~September 30, 2005~~March 31, 2006 are detailed below (in thousands). The Company believes the unrealized losses related to trust investments at ~~September 30, 2005~~March 31, 2006 are primarily related to changes in market interest rates and are temporary in nature. Net unrealized gains increased ~~$1.1 and $1.3~~$0.7 million for the three ~~and nine~~ months ended ~~September 30, 2005,~~March 31, 2006, respectively.


			Unrealized		Unrealized								Unrealized		Unrealized
	Cost		Gains		Losses			Market			Cost		Gains		Losses			Market

Cash, money market and other short-term investments	$	13,320	$	—	$	—		$	13,320
Cash and money market											$	4,181	$	—	$	—		$	4,181
Fixed income securities:
U.S. Treasury		—		—		—			—
U.S. Agency obligations		5,074		3		(58	)		5,019			4,849		—		(90	)		4,759
State obligations		12,134		214		(144	)		12,204			14,000		141		(297	)		13,844
Corporate		3,173		62		(40	)		3,195			3,321		27		(41	)		3,307
Other		8		—		—			8			7		—		—			7

Common stock												11,299		844		(174	)		11,969
Mutual funds:
Equity		13,180		3,424		(217	)		16,387			5,544		745		—			6,289
Fixed income		5,853		559		(2	)		6,410			7,064		25		(19	)		7,070
Other investments		273		23		(3	)		293			1,078		106		—			1,184

	$	53,015	$	4,285	$	(464	)	$	56,836
											$	51,343	$	1,888	$	(621	)	$	52,610


Accrued net investment income	$	204							204		$	232							232


Trust investments								$	57,040									$	52,842


Market value as a percentage of cost									107.6	%									102.9	%

8. CEMETERY PERPETUAL CARE TRUST INVESTMENTS

The Company is required by state law to pay a portion of the proceeds from the sale of cemetery property interment rights into perpetual care trust funds. The cost and market values associated with the trust investments held in perpetual care trust funds at ~~September 30, 2005~~March 31, 2006 are detailed below (in thousands). The Company believes the unrealized losses related to the trust investments ~~at September 30, 2005~~March 31, 2006 are temporary in nature. Net unrealized gains in creased $0.5 million for the three months ended March 31, 2006.


			Unrealized		Unrealized								Unrealized		Unrealized
	Cost		Gains		Losses			Market			Cost		Gains		Losses			Market

Cash, money market and other short-term investments	$	3,106	$	—	$	2		$	3,108

Cash and money market											$	1,652	$	—	$	—		$	1,652
Fixed income securities:
U.S. Treasury		698		9		(8	)		699			594		—		—			594
U.S. Agency obligation		7,352		11		(63	)		7,300			5,914		8		(143	)		5,779
State obligations		58		—		—			58			48		—		—			48
Corporate		2,431		92		(16	)		2,507			1,870		41		(13	)		1,898
Other		1,521		—		(4	)		1,517			406		—		(13	)		393
Common stock												9,527		923		(145	)		10,305
Mutual funds:
Equity		9,635		1,421		(148	)		10,908			4,106		490		(18	)		4,578
Fixed income		5,987		376		(7	)		6,356			3,890		43		(23	)		3,910
Other assets		144		117		—			261			199		20		—			219

	$	30,932	$	2,026	$	(244	)	$	32,714
											$	28,206	$	1,525	$	(355	)	$	29,376


Accrued net investment income	$	141							141		$	91							91


Trust investments								$	32,855									$	29,467



Market value as a percentage of cost									106.2	%									104.5	%

~~Amortization for the nine month periods ended September 30, 2004 and 2005 consists of the following (in thousands):~~

September 30, September 30,
2004 2005

Intangible assets $ 413 $ 403
Loan origination fees 603 475
Preneed contract obtaining costs 1,042 —
Cemetery interment and entombment costs 1,644 1,405

$ 3,702 $ 2,283

13. DEBT

At December 31, 2004, Carriage’s senior debt included a $45 million unsecured revolving bank credit facility that was scheduled to mature in March 2006 and $70.5 million of Senior Notes to insurance companies due in 2006 and 2008. In January 2005, the Company issued $130 million of 7.875 percent Senior Notes at par, due in 2015. The proceeds from these notes were used to refinance substantially all senior debt, bring current the cumulative deferred distributions on the convertible junior subordinated debenture and the TIDES, and for general corporate purposes. In March 2005, the Company paid the cumulative deferred distributions on the TIDES totaling $10.9 million. During April 2005, the Company entered into a $35 million senior secured revolving credit facility that matures in five years to replace the existing unsecured credit ~~facility.~~facility at that time. Borrowings under the new credit facility bear interest at prime or LIBOR options with the ~~initial~~current LIBOR option set at LIBOR plus 300 basis points and is collateralized by all personal property and funeral home real property in certain states. The facility is currently ~~undrawn and $24 million is available to borrow at September 30, 2005.~~undrawn.

Carriage, the parent entity, has no independent assets or operations. All assets and operations are held and conducted by subsidiaries, each of which (except for Carriage Services Capital Trust which is a single purpose entity that holds our debentures issued in connection with our TIDES) have fully and unconditionally guaranteed our obligations under the ~~new~~ Senior Notes. Additionally, we do not currently have any significant restrictions on our ability to receive dividends or loans from any subsidiary guarantor under the ~~new~~ Senior Notes.

In connection with the senior debt refinancing, the Company made a required “make whole” payment of $6.0 million in the form of additional interest and recorded a charge to write off $0.7 million of unamortized loan costs (in aggregate $4.2 million after tax, or $0.23 per diluted share) during the first quarter of 2005. In connection with the new senior secured revolving credit facility, the Company recorded a charge to write off $0.2 million or $0.01 per diluted share of unamortized loan costs during the second ~~quarter.~~quarter of 2005. These charges are included in the Consolidated Statement of Operations as additional interest and other costs of senior debt refinancing during the respective periods for 2005.

~~14. OTHER (INCOME) EXPENSE~~

~~The following table describes the components of other (income) expense of the Company for the three and nine months ended September 30, 2004 and 2005 (amounts in thousands):~~

Three months ended Three months ended Nine months ended Nine months ended
September 30, 2004 September 30, 2005 September 30, 2004 September 30, 2005
Diluted Diluted Diluted Diluted
Amount EPS impact Amount EPS impact Amount EPS impact Amount EPS impact

Net (gains) loss from the disposition of business assets $ (72 ) $ — $ 2 $ — $ (963 ) $ (0.03 ) $ 576 $ 0.02
Write off of software development costs 495 0.02 — — 495 0.02 — —
Interest income — — (142 ) (0.01 ) — — (327 ) (0.01 )

$ 423 $ 0.02 $ (140 ) $ (0.01 ) $ (468 ) $ (0.01 ) $ 249 $ 0.01

~~-15-~~


~~Item 2.~~
Item 2.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF
		FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

In addition to historical information, this Quarterly Report contains forward-looking statements within the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements include any projections of earnings, revenues, asset sales, acquisitions, cash balances and cash flow, debt levels or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements regarding future economic conditions or performance; any statements of belief; and any statements of assumptions underlying any of the foregoing. Forward-looking statements may include the words “may”, “will”, “estimate”, “intend”, “believe”, “expect”, “project”, “forecast”, “plan”, “anticipate” and other similar words.

Cautionary Statements

~~The Company cautions~~We caution readers that the following important factors, among others, in some cases have affected, and in the future could affect, ~~the Company’s~~our actual consolidated results and could cause ~~the Company’s~~our actual consolidated results in the future to differ materially from the goals and expectations expressed herein and in any other forward-looking statements made by or on behalf of ~~the Company.~~us. For further information regarding risks associated with our business and the ~~Company’s cautionary statements,~~death care industry, see Item ~~7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations”~~1A — Risk Factors in ~~the Company’s~~our annual report filed on Form 10-K for the year ended December 31, ~~2004.~~2005.

Risks related to our business

(1) Marketing and sales activities by existing and new competitors could cause us to lose market share and lead to lower revenues and gross profit.

(2) Our ability to generate preneed sales depends on a number of factors, including sales incentives and local and general economic conditions.

(3) Price competition could also reduce our market share or cause us to reduce prices to retain or recapture market share, either of which could reduce revenues and ~~gross profit.~~

~~(3) Improved performance in our funeral segment is highly dependent upon successful execution of our standards-based Being the Best operating model.~~margins.

(4) ~~Our ability to generate preneed sales depends on a number of factors, including sales incentives and local and general economic conditions.~~

~~(5) Earnings from and principal of trust funds and insurance contracts could be reduced by changes in financial markets.~~

~~(6)~~ Our ability to execute our growth strategy is highly dependent upon our ability to successfully identify suitable acquisition candidates and negotiate transactions on favorable terms.

~~(7) Our ability to successfully integrate acquisitions into the Company’s business and to realize expected revenues and profits from the acquired businesses.~~

~~(8)~~(5) Increased or unanticipated costs, such as insurance, taxes, new computer systems implementations and the cost of complying with Sarbanes-Oxley, may have a negative impact on our earnings and cash flows.

~~(9) Increases~~(6) Improved performance in ~~interest rates would increase interest costs when we borrow against~~ our ~~variable-rate bank credit facility and could have a material adverse effect on~~funeral segment is highly dependent upon successful execution of our ~~net income.~~standards-based Being the Best operating model.

~~(10)~~(7) Earnings from and principal of trust funds and insurance contracts could be reduced by changes in financial markets and the mix of securities owned.

(8) Covenant restrictions under our debt instruments may limit our flexibility in operating our business.

~~-17-~~

(5) Changes or increases in, or failure to comply with, regulations applicable to our business could increase costs or decrease cash flows.

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 a service business that provide funeral services (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 mausoleums) and related merchandise such as markers and memorials. As of ~~September 30, 2005,~~March 31, 2006, we operated ~~135~~133 funeral homes in 28 states and 29 cemeteries in 2812 states within the United States. Substantially all administrative activities are conducted in our home office in Houston, Texas.

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 merchandise costs; and exercising pricing leverage related to our at-need business to increase average revenues per contract. 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 and cremation services because our average cremation service revenue is approximately ~~35%~~38% 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.

We ~~have~~ implemented several significant long-term initiatives in our funeral operations at the beginning of 2004 designed to improve operating and financial results by growing market share and increasing profitability. ~~During the fall of 2003, we~~We introduced a more decentralized, entrepreneurial and local operating ~~model. At the same time, we introduced~~model that included operating and financial standards developed from our best funeral operations, along with an incentive compensation plan to reward business managers for successfully meeting or exceeding the standards. The operating model and standards, which we refer to as “Being the Best,” focus on the key drivers of a successful funeral 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 funeral business.

The cemetery operating results are affected by the size and success of our sales organization because approximately 55% of our cemetery revenues for the ~~nine~~three months ended ~~September 30, 2005~~March 31, 2006 relate to sales of grave sites and mausoleums and related merchandise and services before the time of need. We believe that changes in the level of consumer confidence (a measure of whether consumers will spend for discretionary items) also affects the amount of cemetery revenues. Approximately ~~10%~~11% of our cemetery revenues for the ~~nine~~three months ended ~~September 30, 2005~~March 31, 2006 are attributable to investment earnings on trust funds and finance charges on installment contracts. Changes in the capital markets and interest rates affect this component of our cemetery revenues. We are implementing operating and financial standards in our cemetery operations in 2006 similar to the funeral operations discussed above. The standards are organized around market share, people and operational and financial metrics to improve the long-term success of the cemeteries.

Financial Highlights

Net income from continuing operations for the three months ending ~~September 30, 2005~~March 31, 2006 totaled ~~$0.1~~$1.5 million, equal to ~~$0.01~~$0.08 per diluted share as compared to net ~~income~~loss from continuing operations of ~~$0.5 million for the third quarter of 2004, or $0.03 per diluted share.~~

~~-18-~~

~~The following items affected the comparability of income from continuing operations for the third quarter (in thousands, except per share amounts):~~

Amount, net of Earnings per
Income Tax Share

Income from continuing operations for the three months ended September 30, 2004 $ 471 $ 0.03

Decrease in gross profit from funeral and cemetery operations (including the change in accounting for preneed selling costs) (124 ) (0.01 )

Change in other income (expense) from 2004 to 2005 358 0.02

Higher interest expense (316 ) (0.02 )

Higher general and administrative expenses in 2005, primarily to document and evaluate internal controls and upgrade systems and processes (249 ) (0.01 )

Income from continuing operations for the three months ended September 30, 2005 $ 140 $ 0.01

~~Net loss from continuing operations for the first nine months of 2005 totaled $0.8 million, equal to ($0.04) per share as compared to net income from continuing operations of $5.1~~$1.4 million for the first ~~nine months~~quarter of ~~2004,~~2005, or ~~$0.28~~$0.08 per diluted share. The variance between the two periods was primarily due to a make-whole payment during the first quarter of 2005 to the former debtholders in connection with the repayment of the previously outstanding senior debt. We repaid this senior debt and paid the make-whole payment with proceeds from our $130 million senior note offering, which closed in January 2005. The make-whole payment resulted in additional pre-tax interest of $6.0 million, along with a charge in the amount of $0.7 million to write off the related unamortized loan costs, in total equal to $0.23 per diluted share. ~~Additionally,~~At the ~~change~~end of the first quarter of 2006, we decided not to renew a building lease for a business in ~~accounting for preneed selling costs in 2005 reduced net income from continuing operations by $1.0~~North California and recorded an impairment charge of $0.9 million, equal to $0.05 per diluted ~~share.~~share, related to exiting that business. Excluding the effect of these items, diluted earnings per share from continuing operations for the ~~nine~~three months ending ~~September 30,~~March 31, 2005 equaled ~~$0.24~~$0.15 compared to $0.13 for the ~~prior year nine~~three months ended ~~September 30, 2004~~March 31, 2006.

Loss from discontinued operations for the three months ending March 31, 2006 totaled $3.2 million, equal to $0.17 per diluted share. On March 31, 2006, we entered into a plan to sell two businesses, both of ~~$0.28.~~

which are in small markets not strategic to our future plans. We have recorded pre-tax impairment charges of approximately $5.2 million to write down the current book value to the estimated net proceeds. Income from discontinued operations for the ~~nine~~three months ending ~~September 30,~~March 31, 2005 totaled ~~$0.9~~$0.6 million, equal to ~~$0.05~~$0.04 per ~~diluted~~ share, and consisted primarily of a gain on the sale of a funeral home business during the first quarter and the sale of a cemetery business in the third quarter. Loss from discontinued operations for the nine months ending September 30, 2004 totaled $1.3 million, equal to ($0.07) per share, and consisted primarily of impairment charges for businesses sold in the second half of 2004.

-18-

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, 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, as there can be no assurance the margins, operating income and net earnings as a percentage of revenues will be sustained consistently from year to year.

Management’s discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements presented herewith, which have been prepared in accordance with U.S. generally accepted accounting principles. Our significant accounting policies are more fully described in Note 1 to the Consolidated Financial Statements included in our annual report on Form 10-K for the year ended December 31, ~~2004.~~2005. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

~~-19-~~

Funeral and Cemetery Operations

We record the sales of funeral merchandise and services when the funeral service is performed. Sales of cemetery interment rights are recorded as revenue in accordance with the retail land sales provisions of Statement of Financial Accounting Standards (SFAS) ~~No 66.,~~No. 66, “Accounting for Sales of Real Estate.” This method provides for the recognition of revenue in the period in which the customer’s cumulative payments exceed 10% of the contract price related to the real estate. Costs related to the sales of interment rights, which include property and other costs related to cemetery development activities, are charged to operations using the specific identification method in the period in which the sale of the interment right is recognized as revenue. Revenue from the sales of cemetery merchandise and services are recognized in the period in which the merchandise is delivered or the service is performed. Revenues to be recognized from the delivery of merchandise and performance of services related to contracts that were acquired in acquisitions are typically lower than those originated by the Company and are likely to exceed the cash collected from the contract and received from the trust at maturity. ~~We began expensing preneed selling costs as incurred in 2005 (see Accounting Change).~~

Allowances for customer cancellations, refunds and bad debts are provided at the date that the ~~sale~~contract is ~~recognized as revenue based on our historical experience.~~executed. In addition, we monitor changes in delinquency rates and provide additional bad debt and cancellation reserves when warranted. When preneed funeral services and merchandise are funded through third-party insurance policies, we earn a commission from the sale of the policies. Insurance commissions are recognized as revenues when the commission is no longer subject to refund, which is usually one year after the policy is issued.

~~Allowances from customer cancellations, refunds~~Preneed selling costs consist of sales commissions and ~~bad debts are provided as a percentage~~other direct related costs of originating preneed sales contracts. Prior to 2005, these costs were deferred and amortized into funeral and cemetery costs and expenses over the period we expect to perform the services or deliver the merchandise covered by the preneed contracts. The periods over which the costs were recognized ~~revenue at the date the sale is recognized as revenue~~were based on actuarial statistics for the actual contracts we hold, provided by a third-party administrator. Beginning in 2005, we changed our historical experience. In addition, we monitor changes in delinquency rates and provide additional bad debt and cancellation reserves when warranted. Our methodologies and the resulting estimates have been reliable in past periods. We do not expect to change the factors and assumptions used in calculating these reserves in the future.method of accounting for preneed selling costs. Preneed selling costs are now expensed as incurred.

Goodwill and Other Intangible Assets

The excess of the purchase price over the fair value of net identifiable assets acquired, as determined by management in transactions accounted for as purchases, is recorded as goodwill. Many of the acquired funeral homes have provided high quality service to families for generations. The resulting loyalty often represents a substantial portion of the value of a funeral business. Goodwill is typically not associated with or recorded for the cemetery businesses. In accordance with SFAS No. 142, we review the carrying value of goodwill at least annually on reporting units (aggregated geographically) to determine if facts and circumstances exist which would suggest that this intangible asset might be carried in excess of fair value. Fair value is determined by discounting the estimated future cash flows of the businesses in each reporting unit at the Company’s weighted average cost of capital less debt allocable to the reporting unit and by reference to recent sales transactions of similar businesses. The calculation of fair value can vary dramatically with changes in estimates of the number of future services performed, inflation in costs, and the Company’s cost of capital, which is impacted by long-term interest rates. If impairment is indicated, then an adjustment will be made to reduce the carrying amount of goodwill to fair value.

Income Taxes

The Company and its subsidiaries file a consolidated U.S. federal income tax return and separate income tax returns in the states in which we operate. We record deferred taxes for temporary differences between the tax basis and financial reporting basis of assets and liabilities, in accordance with SFAS 109, “Accounting for Income Taxes.” The Company records a valuation allowance to reflect the estimated amount of deferred tax assets for which realization is uncertain. Management reviews the

-19-

valuation allowance at the end of each quarter and makes adjustments if it is determined that it is more likely than not that the tax benefits will be realized.

Stock Compensation Plans

The Company has ~~four~~stock-based employee compensation plans in the form of restricted stock, incentive plans under which stock options have been issued. Additionally, the Company sponsors an Employee Stock Purchase Plan (ESPP) under which employees can purchase common stock at a discount. The stock options are granted with an exercise price equal to or greater than the fair market value of the Company’s Common Stock. Substantially all of the options granted under the four stock option ~~plans have ten-year terms. The options generally vest over a period of two to four years.~~and employee stock purchase plans. The Company accounts for ~~stock options and shares issued~~stock-based compensation under the ESPP under APB Opinion No. 25, under which no compensation cost is recognized in the Consolidated Statement of Operations and has adopted the disclosure-only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” and SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” Had the Company accounted for stock options and shares pursuant to its employee stock benefit plans under SFAS No. 123 for the three months ended September 30, 2004 and 2005, net income for those periods would have been lower by approximately $0.01 for each period.

~~In December 2004, the Financial Accounting Standards Board (“FASB”) issued~~ Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (“FAS No. 123R”). FAS No. 123R requires companies to recognize compensation expense in an amount equal to the fair value of the share-based payment ~~(including share options, restricted share plans, performance-based~~

~~-20-~~

~~awards, share appreciation rights, and employee share purchase plans)~~ issued to ~~employees.~~employees over the period of vesting. The fair value of share based payment is determined using the Black-Scholes valuation model. FAS No. 123R applies to all transactions involving issuance of equity by a company in exchange for goods and services, including employee services. ~~FAS No. 123R is effective in the first annual reporting period of the first fiscal year beginning on or after June 15, 2005.~~ The Company ~~will adopt~~adopted FAS No. 123R in the first ~~fiscal~~ quarter of ~~its~~ 2006, ~~fiscal year and expects to use~~using the modified prospective application method, which results in no restatement of the Company’s previously issued annual consolidated financial statements. ~~The adoption of FAS No. 123R using the modified prospective application method is not expected~~See Note 2 to ~~have a material impact on~~ the consolidated financial ~~position~~statements.

Prior to 2006 the Company accounted for stock based compensation under APB No. 25 and ~~will have no effect on cash flows of~~provided the ~~Company. The adoption of FAS 123R is estimated to reduce earnings in 2006~~disclosures required under SFAS No. 123, “Accounting for Stock-Based Compensation”, as amended by ~~approximately $0.01 per diluted share.~~SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure.”

Impairment of Long-Lived Assets

Except as noted for Goodwill, the Company reviews its long-lived assets for impairment when changes in circumstances indicate that the carrying amount of the net asset may not be recoverable in accordance with Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” Assets to be disposed of and assets not expected to provide any future service potential to the Company are recorded at the lower of carrying amount or fair value less estimated cost to sell. The revenues and expenses, as well as gains, losses and impairments, from those assets are reported in the discontinued operations section of the Consolidated Statement of Operations for all periods presented.

~~Variable Interest Entities~~Preneed Funeral and Cemetery Trust Funds

The Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46, as revised, (“FIN 46R”),“Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin (ARB) No. 51.”This interpretation clarifies the circumstances in which certain entities that do not have equity investors with a controlling financial interest must be consolidated by its sponsor. The Company implemented FIN 46R as of March 31, 2004, which resulted, for financial reporting purposes, in the consolidation of the Company’s preneed and perpetual care trust funds. The investments of such trust funds have been reported at market value and the Company’s future obligations to deliver merchandise and services have been reported at estimated settlement amounts. The Company has also recognized the non-controlling financial interests of third parties in the trust funds. There was no cumulative effect of an accounting change recognized by the Company as a result of the implementation of FIN 46R. The implementation of FIN 46R affected certain accounts on the Company’s balance sheet beginning March 31, 2004 as described below; however, it does not affect cash flow, net income or the manner in which we recognize and report revenues.

Although FIN 46R requires consolidation of preneed and perpetual care trusts, it does not change the legal relationships among the trusts, the Company and its customers. In the case of preneed trusts, the customers are the legal beneficiaries. In the case of perpetual care trusts, the Company does not have a right to access the corpus in the perpetual care trusts. For these reasons, the Company has recognized non-controlling interests in our financial statements to reflect third party interests in these consolidated trust funds.

Both the preneed trusts and the cemetery perpetual care trusts hold investments in marketable securities which have been classified as available-for-sale. The investments are reported at fair value, with unrealized gains and losses allocated to Non-controlling interests in trust investment in the Company’s consolidated balance sheet. Unrealized gains and losses attributable to the Company, but that have not been earned through the performance of services or delivery of merchandise, are allocated to deferred revenues.

Also beginning March 31, 2004, the Company began recognizing income, gains and losses, of the preneed trusts and cemetery perpetual care trusts. The Company recognizes a corresponding expense equal to the recognized earnings of these trusts attributable to the non-controlling interest holders. When such earnings attributable to the Company have not been earned through the performance of services or delivery of merchandise, the Company will record such earnings as deferred revenue.

For preneed trusts, the Company recognizes as revenues amounts attributed to the non-controlling interest holders and the Company, including accumulated earnings, when the contracted services have been performed and merchandise delivered. For cemetery perpetual care trusts, the Company recognizes investment earnings in cemetery revenues when such earnings are realized and distributable. Such earnings are intended to defray cemetery maintenance costs incurred by the Company.

~~-21-~~-20-

~~ACCOUNTING CHANGE~~

Preneed Selling Costs

On June 30, 2005, the Company changed its method of accounting for deferred obtaining costs, which are preneed selling costs incurred, for the origination of prearranged funeral and cemetery service and merchandise sales contracts. Prior to this change, commissions and other direct selling costs related to originating preneed funeral and cemetery service and merchandise sales contracts were deferred and amortized with the objective of recognizing the selling costs in the same period that the related revenue is recognized. Under the prior accounting method, the commissions and other direct selling costs, which are current obligations are paid and use operating cash flow, are not recognized currently in the income statement. The Company believes it is preferable to expense the current obligation for the commissions and other costs rather than defer these costs. The Company also believes the new accounting method will improve the comparability of its reported earnings. Because the three largest public deathcare companies now expense selling costs (two of which changed in 2005), investors and other users of the financial information will now be able to more easily compare our financial results to those deathcare companies.

The Company has applied this change in accounting method effective January 1, 2005. As of January 1, 2005, the Company recorded a cumulative effect of change in accounting method of $35.8 million pretax or $22.8 million after tax (net of income tax benefit of $13.0 million), or ~~$1.25~~$1.26 per diluted share, which represents the cumulative balance of deferred preneed selling costs in the Company’s consolidated balance sheet. ~~Therefore, the~~The Company’s results of operations ~~for the three and nine months ended September 30, 2005~~ are reported on the basis of our changed ~~method. The annual impact on earnings per diluted share is approximately $0.10. The change has no effect on cash flow from operations. Refer to Note 3 for the change in accounting~~ method for ~~preneed selling costs and comparison of results as reported in this quarterly report and under the previous method.~~both periods presented.

RESULTS OF OPERATIONS

The following is a discussion of the Company’s results of operations for the three ~~and nine~~ month periods ended ~~September 30, 2004~~March 31, 2005 and ~~2005.~~2006. Funeral homes and cemeteries owned and operated for the entirety of each period being compared are referred to as “same-store” or “existing operations.”

Funeral Home Segment. The following table sets forth certain information regarding the net revenues and gross profit of the Company from the funeral home operations for the three ~~and nine~~ months ended ~~September 30, 2004~~March 31, 2005 compared to the three ~~and nine~~ months ended ~~September 30, 2005.~~March 31, 2006. For purposes of our discussion, the revenue and gross profit of our businesses identified to be sold are included in the same-store classification up to the quarter prior to their sale.

Three months ended ~~September 30, 2004~~March 31, 2005 compared to three months ended ~~September 30, 2005~~March 31, 2006 (dollars in thousands):


	Three Months Ended										Three Months Ended
	September 30,				Change						March 31,					Change
	2004		2005		Amount			Percent			2005			2006		Amount			Percent

Total same-store revenue	$	26,190	$	25,945	$	(245	)		(0.9	%)	$	30,683		$	30,808	$	125			0.4	%
Acquired		—		45		45			*
Acquired and closed												90			269		179			*
Preneed insurance commissions revenue		392		613		221			56.0	%		467			587		120			25.7	%

Revenues from continuing operations	$	26,582	$	26,603	$	21			*		$	31,240		$	31,664	$	424			1.4	%

Revenues from discontinued operations	$	264	$	—	$	(264	)		*		$	596		$	467	$	(129	)		*


Total same-store gross profit	$	5,715	$	5,466	$	(249	)		(4.4	%)	$	9,154		$	8,564	$	(590	)		(6.4	)%
Acquired		—		18		18			*
Acquired and closed												(2	)		71		73			*
Preneed insurance commissions revenue		392		613		221			56.0	%		467			587		120			25.7	%

Gross profit from continuing operations	$	6,107	$	6,097	$	(10	)		*		$	9,619		$	9,222	$	(397	)		(4.1	)%

Gross profit from discontinued operations	$	19	$	2	$	(17	)		*		$	160		$	133	$	(27	)		*

~~Nine months ended September 30, 2004 compared to nine months ended September 30, 2005 (dollars in thousands):~~

Nine Months Ended
September 30, Change
2004 2005 Amount Percent
Total same-store revenue $ 84,019 $ 85,159 $ 1,140 1.4 %
Acquired — 45 45 *
Preneed insurance commissions revenue 1,035 1,654 619 60.0 %

Revenues from continuing operations $ 85,054 $ 86,858 $ 1,804 2.1 %

Revenues from discontinued operations $ 1,474 $ 19 $ (1,455 ) *

Total same-store gross profit $ 20,922 $ 21,518 $ 596 2.8 %
Acquired — 18 18 *
Preneed insurance commissions revenue 1,035 1,654 619 60.0 %

Gross profit from continuing operations $ 21,957 $ 23,190 $ 1,233 5.6 %

Gross profit from discontinued operations $ 265 $ (23 ) $ (288 ) *

* not meaningful

Funeral same-store revenues for the three months ended ~~September 30, 2005 decreased 0.9~~March 31, 2006 increased $0.1 million, or 0.4 percent, when compared to the three months ended ~~September 30, 2004,~~March 31, 2005 as we experienced a decrease of ~~0.5~~3.6 percent in the number of contracts and a ~~decrease~~increase of ~~0.4~~4.0 percent to ~~$5,309~~$5,116 in the average revenue per contract for those existing operations. Cremation services represented 33.3 percent of the number of funeral services during the ~~third~~first quarter of ~~2005,~~2006, an increase from ~~31.0~~32.8 percent in the ~~third~~first quarter of ~~2004.~~2005. The average revenue for burial contracts increased ~~2.7~~3.8 percent to ~~$6,726, while~~$6,947, and the average revenue for cremation contracts ~~decreased 0.4~~increased 10.0 percent to ~~$2,389. The increase in cremations had the effect of reducing revenues by $0.5 million and reducing the average revenue per contract by $98.~~$2,634.

Total funeral same-store gross profit for the three months ended ~~September 30, 2005~~March 31, 2006 decreased ~~$0.2~~$0.6 million from the comparable three months of ~~2004,~~2005, and as a percentage of funeral same-store revenue, declined from ~~21.8~~30.8 percent to ~~21.1%~~29.1 percent primarily because of ~~higher bad debts, repairs to~~increases in funeral ~~facilities and the change in accounting for preneed selling costs.~~

Funeral same-store revenues for the nine months ended September 30, 2005 increased 1.4 percent when compared to the nine months ended September 30, 2004, as we experienced a 0.1 percent decline in the number of contracts and an increase of 1.5 percent to $4,961 in the average revenue per contract for those existing operations. Cremation services represented 32.9 percent of the number of funeral services during the nine months ended September 30, 2005 compared to 31.2 percent for the nine months ended September 30, 2004. The average revenue for burial contracts increased 3.3 percent to $6,739, while the average revenue for cremation contracts increased 1.7 percent to $2,408. Preneed insurance commission revenue, which is generally recognized as revenue one year after origination, increased year over year because of an increasing emphasis on selling insurance related products and additions to our sales leadership during the previous two years.

Total funeral same-store gross profit for the nine months ended September 30, 2005 increased $0.6 million from the comparable nine months of 2004, and as a percentage of funeral same-store revenue, increased from 24.9 percent to 25.3 percent. The change in accounting method for preneed selling costs previously discussed was implemented prospectively as of January 1, 2005. We did not restate the results for 2004. The effect of that change was to reduce gross profit by $0.2 million for the nine month period ended September 30, 2005. Had we applied the new accounting method in 2004, funeral same-store gross profit would have increased by $1.4 million, or 6.9 percent from 2004 to 2005. We achieved positive operating ~~leverage because of better execution of our new standards-based operating model.~~expenses.

~~-23-~~

~~Interest expense~~is $51,000 for the three and nine month periods ended September 30, 2005 increased $0.5 and $1.1 million, or 12.1 and 8.5 percent, compared to the same periods ended September 30, 2004 because the total debt increased when the Company refinanced its senior debt earlier in 2005. Additionally, the current year expense is negatively impacted by higher loan fees.

~~Income Taxes.~~ The Company provided income taxes at the expected effective annual rate of 37.5 percent for continuing operations for the three and nine months ended September 30, 2004 and 36.7 percent and 38.2 percent for continuing operations for the three and nine months ended September 30, 2005, respectively. The tax benefit for the change in accounting method was recorded at the rate of 36.5 percent.

The Company has net operating loss carryforwards totaling approximately $14.3 million for Federal income tax purposes, as well as significant operating loss carryforwards in certain states. Because of the ability to use the net operating loss to offset taxable income and the timing of when revenue and expenses are recognized for tax purposes, we do not expect to pay Federal income taxes in 2005.stock-based compensation.

LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents totaled ~~$7.3~~$5.2 million at ~~September 30, 2005,~~March 31, 2006, representing an ~~increase~~decrease of ~~$5.4~~$2.7 million from December 31, ~~2004.~~2005. Short-term investments totaled ~~$9.0~~$19.2 at ~~September 30, 2005,~~March 31, 2006, compared to ~~none in the prior year.~~$16.9 at year end 2005. For the ~~nine~~three months ended ~~September 30, 2005,~~March 31, 2006, cash ~~used~~provided by operating activities was ~~$9.4~~$1.2 million as compared to cash ~~provided~~used of ~~$17.2~~$13.9 million for the ~~nine~~three months ended ~~September 30, 2004.~~March 31, 2005. Cash used by operating activities during 2005 included the $6.0 million make-whole payment and the payment of the previously deferred interest on the convertible junior subordinated debenture in the amount of $10.3 million. Additionally, increases in accounts receivable, preneed trust funds and other assets used $8.5 million of cash. Investing activities included $1.3 million for the acquisition of a funeral business in Florida, the first acquisition in over three years. Net cash provided by financing activities during 2005

The Company’s senior debt at March 31, 2006 totaled ~~$28.8~~$140.6 million and ~~was attributable~~consisted of $130.0 million in Senior Notes, a $35 million revolving line of credit and $10.6 million in acquisition indebtedness and capital lease obligations.

In April 2005, the Company entered into a $35 million senior secured revolving credit facility to ~~our senior debt refinancing.~~replace the existing unsecured credit facility. Borrowings under the new credit facility bear interest at prime or LIBOR options with the current LIBOR option set at LIBOR plus 300 basis points, matures in five years and is collateralized by all personal property and funeral home real property in certain states. The facility is currently undrawn.

-22-

In January 2005, the Company issued $130 million of 7.875 percent Senior Notes at par, due in 2015. The proceeds from these notes were used to refinance all then outstanding senior debt, including payments for accrued interest and make-whole payment, bring current the cumulative deferred distributions on the convertible junior subordinated debenture and the TIDES, and for general corporate purposes. The refinancing improved the Company’s liquidity because debt totaling approximately $96 million due in 2006 and 2008 was replaced by debt maturing in ten years.

The Company’s senior debt at September 30, 2005 totaled $142.4 million and consisted of the $130.0 million in Senior Notes, a $35 million revolving line of credit (none of which was outstanding at the time) and $12.4 million in acquisition indebtedness and capital lease obligations. Additionally, $0.7 million in letters of credit have been issued from the credit facility and are outstanding at September 30, 2005.

~~The Company’s~~ convertible junior subordinated debenture at ~~September 30, 2005~~March 31, 2006 total $93.75 million in principal amount, are payable to the Company’s affiliate trust, Carriage Services Capital Trust, bear interest at 7 percent and mature in 2029. Substantially all the assets of the Trust consist of the convertible junior subordinated debenture of the Company. The Trust issued 1.875 million shares of convertible preferred term income deferrable equity securities (TIDES). The rights of the debenture are functionally equivalent to those of the TIDES.

The convertible junior subordinated debenture payable to the affiliated trust and the TIDES each contain a provision for the deferral of interest payments and distributions for up to 20 consecutive quarters. During the period in which distribution payments are deferred, distributions continue to accumulate at the 7 percent annual rate. Also, the deferred distributions themselves accumulate distributions at the annual rate of 7 percent and are recorded as a liability. During the deferral period, Carriage is prohibited from paying dividends on the common stock or repurchasing its common stock, subject to limited exceptions. The Company, in complying with the conditions of the existing credit facility, began deferring interest payments on the subordinated debenture payable to the Company’s affiliated trust beginning with the September 1, 2003 payment. In the first quarter of 2005, the Company paid $10.3 million to bring the cumulative deferred distributions on the TIDES current. The Company expects to continue paying the distributions as due.

In April 2005, the Company entered into a $35 million senior secured revolving credit facility to replace the existing unsecured credit facility. Borrowings under the new credit facility bear interest at prime or LIBOR options with the initial LIBOR option set at LIBOR plus 300 basis points, matures in five years and is collateralized by all personal property and funeral home real property in certain states. The facility is currently undrawn and no borrowings are anticipated during 2005. $24.0 million is available to borrow at September 30, 2005.

The Company intends to use its cash and short-term investments, cash flow provided by operations ~~net~~(which is expected to total $11 to $12 million in 2006) and proceeds from the sale of ~~investments in property, plant and equipment,~~businesses, to acquire funeral home and cemetery businesses. The Company ~~does not intend~~also has the ability to draw on its revolving credit facility, subject to customary terms and conditions of the credit agreement, to finance acquisitions.

~~-25-~~

SEASONALITY

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

INFLATION

Inflation has not had a significant impact on the results of operations of the Company.

Item 3. Quantitative and Qualitative Disclosures ofabout Market Risk

Carriage is currently exposed to market risk primarily related to changes in interest rates related to the Company’s ~~variable rate bank credit facility~~debt, decreases in interest rates related to the Company’s short-term investments and changes in the values of securities associated with the preneed and perpetual care trusts. For information regarding the Company’s exposure to certain market risks, see Item 7A. “Quantitative and Qualitative Market Risk Disclosure” in the Company’s ~~2004~~2005 annual report filed on Form 10-K for the year ended December 31, ~~2004.~~2005. There have been no significant changes in the Company’s market risk from that disclosed in the Form 10-K for the year ended December 31, ~~2004.~~2005.

Item 4. Controls and Procedures

~~Under~~In accordance with the Securities Exchange Act of 1934 Rules 13a-15 and 15d-15, we carried out an evaluation under the supervision and with the participation of ~~our~~ management, including our ~~chief executive officer~~Chief Executive Officer and ~~chief financial officer, we conducted an evaluation~~Chief Financial Officer, of the effectiveness ~~of the design and operation~~ of our disclosure controls and procedures ~~as such term is defined under Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”),~~ as of the end of the period covered by this report. Based on ~~their~~that evaluation, our ~~chief executive officer~~Chief Executive Officer and ~~chief financial officer~~Chief Financial Officer concluded that ~~the Company’s~~our disclosure controls and procedures ~~are~~were effective atas of March 31, 2006 to provide reasonable assurance that information required to be disclosed in our reports filed or submitted under the ~~end of~~Exchange Act is recorded, processed, summarized, and reported within the ~~period. During~~time periods specified in the ~~period covered by this report, there were~~Securities and Exchange Commission’s rules and forms. Our disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

There has been no ~~changes~~change in our internal control over financial reporting ~~as such term is defined under Rule 13a-15(f) of~~that occurred during the ~~Exchange Act,~~three months ended March 31, 2006 that ~~have~~has materially affected, or ~~are~~is reasonably likely to materially affect, our internal control over financial reporting.

Based on the value of the Company’s common stock held by non-affiliates on June 30, 2005, Carriage will be an accelerated filer for the year ending December 31, 2005. As an accelerated filer, in accordance with Section 404 of the Sarbanes-Oxley Act of 2002, for the year ending December 31, 2005, we will perform a review of our internal control over financial reporting, and our internal control over financial reporting will be audited by our independent accountant. In order to comply with the Act, we are currently undergoing a comprehensive effort to document, verify and test key internal controls. During the documentation and verification phases, which are still underway, we have identified certain internal control issues which management concluded should be improved. However, to date we have not identified any material weaknesses in our internal controls as defined by the Public Company Accounting Oversight Board. Nonetheless, we are making improvements to our internal controls by revising or updating policies and procedures; training field personnel on procedures and best practices; improving segregation of duties when possible; enhancing information technology systems controls; and improving preventative controls. In particular, we are implementing a cemetery accounting and trusting system. In connection with the implementation of this system, we are converting data from the legacy systems to the new systems and reconciling reported balances. If additional internal control issues are identified by our continuing documentation and verification efforts, management will address those matters in a timely manner.

~~-26-~~-23-

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

Carriage and our subsidiaries are parties to a number of legal proceedings that arise from time to time in the ordinary course of business. While the outcome of these proceedings cannot be predicted with certainty, we do not expect these matters to have a material adverse effect on the financial statements.

We carry insurance with coverage and coverage limits consistent with our assessment of risks in our business and of an acceptable level of financial exposure. Although there can be no assurance that such insurance will be sufficient to mitigate all damages, claims or contingencies, we believe that our insurance provides reasonable coverage for known asserted or unasserted claims. In the event the Company sustained a loss from a claim and the insurance carrier disputed coverage or coverage limits, the Company may record a charge in a different period than the recovery, if any, from the insurance carrier.

Item 1A. Risk Factors

There have been no material changes in Carriage’s risk factors from those disclosed in Item 1A of its Annual Report on Form 10-K for the year ended December 31, 2005.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

None.

Issuance of Unregistered Securities

Carriage has a compensation policy for fees paid to its directors under which our directors may choose to receive director compensation fees either in the form of cash compensation or equity compensation based on the fair market value of our common stock based on the closing price published by the New York Stock Exchange on the date the fees are earned. The Company issued ~~3,101~~3,003 and ~~1,667~~2,886 shares of common stock to directors ~~with a value of approximately $14,500 and $10,600~~ in lieu of payment in cash for their fees for the ~~third~~first quarter of ~~2004~~2005 and ~~2005, respectively. The Company issued 9,351 and 6,800 shares of common stock to directors with a~~2006, respectively, the value of ~~$45,500 and $40,000 for the nine months ended September 30, 2004 and 2005, respectively.~~which was charged to operations. No underwriter was used in connection with this issuance. Carriage relied on the Section 4(2) exemption from the registration requirements of the Securities Act of 1933, as amended.

Item 3. Defaults Upon Senior Securities

None

Item 4. Submission of Matters to a Vote of Security Holders

None.

Item 5. Other Information

The Company reported on Form 8-K during the quarter covered by this report all information required to be reported on such form.

~~-27-~~

Item 6. Exhibits

4.1 — Amendment No. 1 to the Credit Agreement dated April 27, 2005 among Carriage Services, Inc., as the Borrower, Bank of America, N.A. as the Administrative Agent, Swing Line Lender and L/C Issuer, Wells Fargo Bank of Texas, National Association, as Syndication Agent and Other Lenders

~~11.1 — Computation of Per Share Earnings~~

~~31.1 — Certification of Periodic Financial Reports by Melvin C. Payne in satisfaction of Section 302 of the Sarbanes-Oxley Act of 2002~~

~~31.2 — Certification of Periodic Financial Reports by Joseph Saporito in satisfaction of Section 302 of the Sarbanes-Oxley Act of 2002~~

~~32.1 — Certification of Periodic Financial Reports by Melvin C. Payne in satisfaction of Section 906 of the Sarbanes-Oxley Act of 2002 and 18 U.S.C. Section 1350~~

~~32.2 —~~
11.1 — Computation of Per Share Earnings
31.1 — Certification of Periodic Financial Reports by Melvin C. Payne in satisfaction of Section 302 of the Sarbanes-Oxley Act of 2002
31.2 — Certification of Periodic Financial Reports by Joseph Saporito in satisfaction of Section 302 of the Sarbanes-Oxley Act of 2002
32 — Certification of Periodic Financial Reports by Melvin C. Payne and Joseph Saporito in satisfaction of Section 906 of the Sarbanes-Oxley Act of 2002 and 18 U.S.C. Section 1350

~~-28-~~-24-


	Page
PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Balance Sheets as of December 31, ~~2004~~2005 and ~~September 30, 2005~~March 31, 2006 (unaudited)		3

Consolidated Unaudited Statements of Operations for the Three Months ended ~~September 30, 2004 and~~March 31, 2005 and ~~Nine Months ended September 30, 2004 and 2005~~2006		4

Consolidated Unaudited Statements of Cash Flows for the ~~Nine~~Three Months ended ~~September 30, 2004~~March 31, 2005 and ~~2005~~2006		5

Condensed Notes to Consolidated Financial Statements		6

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		17

Item 3. Quantitative and Qualitative Disclosures ofabout Market Risk		2623

Item 4. Controls and Procedures		2623

PART II — OTHER INFORMATION

Item 1. Legal Proceedings		2724

Item 1A. Risk Factors		24

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		2724

Item 3. Defaults Upon Senior Securities		2724

Item 4. Submission of Matters to a Vote of Security Holders		2724

Item 5. Other Information		2724

Item 6. Exhibits		2824

Signatures		2925
~~Amendment No.1 to Credit Agreement~~
Computation of Per Share Earnings
Certification ofby Melvin C. Payne in satisfaction of Section 302
Certification ofby Joseph Saporito in satisfaction of Section 302
Certification ofby Melvin C. Payne ~~in satisfaction of Section 906~~
~~Certification of~~and Joseph Saporito ~~in satisfaction~~ of Section 906


	September 30,
	2005
Trust investments	$	57,040
Receivables from customers, excluding current portion		17,155
Unearned finance charges, excluding current portion		(3,277	)
Allowance for doubtful accounts, excluding current portion		(740	)

Preneed cemetery receivables and trust investments	$	70,178


	December 31,			March 31,
	2005			2006
Trust investments	$	54,768		$	52,842
Receivables from customers		17,304			17,270
Unearned finance charges		(3,143	)		(3,187	)
Allowance for doubtful accounts		(934	)		(1,224	)

Cemetery preneed receivables and trust investments	$	67,995		$	65,701


	For the three months						For the nine months						For the three months
	ended September 30,						ended September 30,						ended March 31,
	2004			2005			2004			2005			2005			2006

Investment income	$	1,068		$	1,698		$	1,955		$	2,824		$	804		$	1,237
Realized gains		208			390			262			2,023			1,061			2,161
Realized losses		(359	)		(35	)		(654	)		(484	)		(163	)		(860	)
Expenses		(232	)		(154	)		(434	)		(430	)		(185	)		(304	)
Increase in non-controlling interests in trust investments		(685	)		(1,899	)		(1,129	)		(3,933	)		(1,517	)		(2,234	)

	$	—		$	—		$	—		$	—		$	—		$	—


	December 31,		September 30,		December 31,		March 31,
	2004		2005		2005		2006

Deferred cemetery revenue	$	46,787	$	45,428	$	51,928	$	50,145
Deferred preneed funeral contracts revenue		30,973		29,631		29,446		29,562
Non-controlling interests in funeral and cemetery trust investments		98,652		109,559		102,446		98,732

	$	176,412	$	184,618	$	183,820	$	178,439


	Three months ended				Nine months ended
	September 30,				September 30,
	2004		2005		2004		2005
Net income (loss) available to common stockholders:
As reported	$	1,157	$	670	$	3,751	$	(22,657	)

Pro forma	$	1,070	$	560	$	3,490	$	(22,987	)
Net income (loss) per share available to common stockholders:
Basic
As reported	$	0.07	$	0.04	$	0.21	$	(1.24	)
Pro forma	$	0.06	$	0.03	$	0.20	$	(1.26	)
Diluted
As reported	$	0.06	$	0.04	$	0.21	$	(1.24	)
Pro forma	$	0.06	$	0.03	$	0.19	$	(1.26	)


	Three Months Ended						Nine Months Ended
	September 30, 2005						September 30, 2005
			Effect of		Results under					Effect of		Results under
	As Reported		Change		Prior Method		As Reported			Change		Prior Method
Income (loss) from continuing operations before cumulative effect of change in accounting method	$	140	$	137	$	277	$	(782	)	$	1,579	$	797
Net income (loss)		670		69		739		(22,657	)		23,646		989
Diluted earnings (loss) per common share from continuing operations before cumulative effect of change in accounting method		0.01		0.01		0.02		(0.04	)		0.08		0.04
Diluted earnings (loss) per common share		0.04		0.00		0.04		(1.24	)		1.29		0.05


	Three Months Ended								Nine Months Ended
	September 30, 2004								September 30, 2004
	As								As
	Previously		Effect of						Previously		Effect of
	Reported		Change			Proforma			Reported		Change			Proforma
Gross profit:
Funeral	$	6,101	$	(281	)	$	5,820		$	21,942	$	(826	)	$	21,116

Cemetery		2,031		(542	)		1,489			6,783		(1,580	)		5,203

	$	8,132	$	(823	)	$	7,309		$	28,725	$	(2,406	)	$	26,319
Income from continuing operations	$	489	$	(514	)	$	(25	)	$	5,162	$	(1,504	)	$	3,658
Net income (loss)		1,157		(255	)		902			3,751		(1,258	)		2,493
Diluted earnings per common share from continuing operations		0.03		(0.03	)		0.00			0.28		(0.08	)		0.20
Diluted earnings (loss) per common share		0.06		(0.01	)		0.05			0.21		(0.07	)		0.14


	Non-controlling Interests						March 31, 2006
					Total		Preneed		Preneed		Total
	Preneed Funeral		Preneed Cemetery		Preneed		Funeral		Cemetery		Preneed

Trust assets, at market value	$	52,519	$	57,040	$	109,559	$	45,892	$	52,842	$	98,732


Non-controlling interests	$	52,519	$	57,040	$	109,559	$	45,892	$	52,842	$	98,732


Non-controlling interests in assets held for sale							$	1,632	$	4,643	$	6,275


	For the nine months ended				For the three months ended
	September 30,				March 31,
	2004		2005		2005		2006

Cash paid for interest and financing costs	$	9,071	$	31,226	$	22,196	$	7,151


Cash paid for income taxes (state)	$	114	$	270	$	195	$	87


Restricted common stock issued to officers	$	—	$	1,337	$	1,337	$	—


Restricted cash investing and financing activities:

Proceeds from the sale of securities of the funeral and cemetery trusts			$	3,645	$	12,434	$	14,418


Purchase of available for sale securities of the funeral and cemetery trusts			$	4,865	$	20,440	$	10,579


Net deposits in trust accounts increasing noncontrolling interests			$	14,134	$	328	$	(7,573	)


	Amount, net of			Earnings per
	Income Tax			Share

Income from continuing operations for the three months ended September 30, 2004	$	471		$	0.03

Decrease in gross profit from funeral and cemetery operations (including the change in accounting for preneed selling costs)		(124	)		(0.01	)

Change in other income (expense) from 2004 to 2005		358			0.02

Higher interest expense		(316	)		(0.02	)

Higher general and administrative expenses in 2005, primarily to document and evaluate internal controls and upgrade systems and processes		(249	)		(0.01	)

Income from continuing operations for the three months ended September 30, 2005	$	140		$	0.01


11.1	—	Computation of Per Share Earnings

31.1	—	Certification of Periodic Financial Reports by Melvin C. Payne in satisfaction of Section 302 of the Sarbanes-Oxley Act of 2002

31.2	—	Certification of Periodic Financial Reports by Joseph Saporito in satisfaction of Section 302 of the Sarbanes-Oxley Act of 2002

32	—	Certification of Periodic Financial Reports by Melvin C. Payne and Joseph Saporito in satisfaction of Section 906 of the Sarbanes-Oxley Act of 2002 and 18 U.S.C. Section 1350


		~~CARRIAGE SERVICES, INC.~~
~~November 11, 2005~~		~~/s/ Joseph Saporito~~
~~Date~~		~~Joseph Saporito,~~
		~~Executive Vice President, Chief Financial Officer and Secretary (Principal Financial Officer and Accounting Officer)~~


	~~4.1~~	Amendment No. 1 to the Credit Agreement dated April 27, 2005 among Carriage Services, Inc., as the Borrower, Bank of America, N.A. as the Administrative Agent, Swing Line Lender and L/C Issuer, Wells Fargo Bank of Texas, National Association, as Syndication Agent and Other Lenders

	~~11.1~~
May 10, 2006		/s/ Joseph Saporito

Date		Joseph Saporito, Executive Vice President, Chief Financial Officer and Secretary (Principal Financial Officer)


	For the three months				For the nine months				For the three months
	ended September 30,				ended September 30,				ended March 31,
	2004		2005		2004		2005		2005		2006
Revenues, net
Goods
Funeral	$	11,590	$	11,586	$	37,329	$	37,961	$	13,629	$	13,621
Cemetery	$	6,577	$	7,107	$	20,863	$	20,953		6,735		7,006

Total Goods	$	18,167	$	18,693	$	58,192	$	58,914	$	20,364	$	20,627

Services
Funeral	$	14,992	$	15,017	$	47,725	$	48,897	$	17,611	$	18,043
Cemetery	$	2,649	$	2,748	$	7,713	$	8,769		3,006		3,048

Total Services	$	17,641	$	17,765	$	55,438	$	57,666	$	20,617	$	21,091


Total Net Revenues	$	35,808	$	36,458	$	113,630	$	116,580	$	40,981	$	41,718


Cost of revenues
Goods
Funeral	$	11,170	$	11,133	$	34,921	$	35,083	$	12,083	$	12,280
Cemetery	$	5,126	$	5,637	$	15,781	$	16,683		5,156		6,054

Total Goods	$	16,296	$	16,770	$	50,702	$	51,766	$	17,239	$	18,334

Services
Funeral	$	9,305	$	9,373	$	28,176	$	28,585	$	9,538	$	10,162
Cemetery	$	2,107	$	2,410	$	6,150	$	7,332		2,382		2,353

Total Services	$	11,412	$	11,783	$	34,326	$	35,917	$	11,920	$	12,515


Total Cost of revenues	$	27,708	$	28,553	$	85,028	$	87,683	$	29,159	$	30,849