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, 2006~~March 31, 2007


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 is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Securities Exchange Act of 1934. (Check one):

Large accelerated filero Accelerated filerþ Non-Accelerated filero

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, ~~2006~~2007 was ~~18,575,678.~~18,940,190.

CARRIAGE SERVICES, INC.

INDEX


	Page
PART I — FINANCIAL INFORMATION

Item 1. Financial Statements(Unaudited)

Consolidated Balance Sheets as of December 31, ~~2005~~2006 and ~~September 30, 2006 (unaudited)~~March 31, 2007		3

Consolidated ~~Unaudited~~ Statements of Operations for the Three Months ended ~~September 30, 2005 and~~March 31, 2006 and ~~Nine Months ended September 30, 2005 and 2006~~2007		4

Consolidated ~~Unaudited~~ Statements of Cash Flows for the ~~Nine~~Three Months ended ~~September 30, 2005~~March 31, 2006 and ~~2006~~2007		5

Condensed Notes to Consolidated Financial Statements ~~(unaudited)~~		6

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		1716

Item 3. Quantitative and Qualitative Disclosures ~~about~~About Market Risk		2421

Item 4. Controls and Procedures		2521

PART II — OTHER INFORMATION

Item 1. Legal Proceedings		2522

Item 1A. Risk Factors		2522

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		2522

Item 3. Defaults Upon Senior Securities		2522

Item 4. Submission of Matters to a Vote of Security Holders		2522

Item 5. Other Information		2622

Item 6. Exhibits		2622

~~Signatures~~Signature		27

~~Certifications~~		23
Computation of Per Share Earnings
Certification ~~of Periodic Financial Reports of~~Pursuant to Section 302
Certification ~~of Periodic Financial Reports of~~Pursuant to Section 302
Certification ~~of Periodic Financial Reports of~~Pursuant to Section 906

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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,
	2005			2006			2006			2007
				(unaudited)						(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	7,949		$	4,717		$	22,820		$	25,431
Short term investments		16,908			24,193			10,303			—
Accounts receivable — trade, net of allowance for doubtful accounts of $937 in 2005 and $1,012 in 2006		13,412			12,496
Accounts receivable, net of allowance for doubtful accounts of $925 in 2006 and $831 in 2007								13,822			15,202
Assets held for sale								2,634			—
Inventories and other current assets		12,883			12,710			11,883			12,072

Total current assets		51,152			54,116			61,462			52,705


Restricted cash		—			5,455			2,888			2,888
Preneed assets		135,826			130,983
Property, plant and equipment, at cost, net of accumulated depreciation of $45,694 in 2005 and $46,974 in 2006		105,435			103,116
Federal agency bonds								5,000			5,000
Preneed cemetery trust investments								55,483			56,687
Preneed funeral trust investments								44,851			62,836
Preneed receivables, net of allowance for bad debts of $492 in 2006 and $574 in 2007								15,127			19,440
Receivables from preneed funeral trusts								15,649			15,309
Property, plant and equipment, at cost, net of accumulated depreciation of $47,250 in 2006 and $48,777 in 2007								99,894			102,806
Cemetery property		62,905			56,494			57,798			61,373
Goodwill		157,358			151,269			148,845			153,155
Deferred charges and other non-current assets		25,608			24,911			25,459			23,291
Cemetery perpetual care trust investments		32,356			30,726			32,540			35,130

Total assets	$	570,640		$	557,070		$	564,996		$	590,620


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of senior long-term debt and capital leases obligations	$	2,074		$	1,550		$	1,610		$	1,690
Accounts payable and accrued liabilities		22,163			18,697
Accounts payable								7,148			7,991
Accrued liabilities								15,888			10,428
Liabilities associated with assets held for sale								1,061			—

Total current liabilities		24,237			20,247			25,707			20,109
Senior long-term debt, net of current portion		134,572			134,418			133,841			133,656
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		4,775			4,741			4,728			4,711
Deferred revenue		183,820			178,072
Deferred preneed cemetery revenue								50,785			52,064
Deferred preneed funeral revenue								28,289			32,529
Non-controlling interests in cemetery trust investments								55,483			56,687
Non-controlling interests in funeral trust investments								44,851			62,836

Total liabilities		441,154			431,228			437,434			456,342

Commitments and contingencies

Non-controlling interests in perpetual care trust investments		33,112			30,269			31,189			33,976
Stockholders’ equity:
Common Stock, $.01 par value; 80,000,000 shares authorized;18,458,000 and 18,557,000 shares issued and outstanding at December 31, 2005 and September 30, 2006, respectively		185			186

Common Stock, $.01 par value; 80,000,000 shares authorized;18,608,000 and 18,913,000 shares issued and outstanding at December 31, 2006 and March 31, 2007, respectively								186			189
Additional paid-in capital		190,502			191,260			190,524			191,269
Accumulated deficit		(92,921	)		(95,095	)		(94,337	)		(91,156	)
Deferred compensation		(1,392	)		(778	)

Total stockholders’ equity		96,374			95,573			96,373			100,302

Total liabilities and stockholders’ equity	$	570,640		$	557,070		$	564,996		$	590,620

The accompanying condensed notes are an integral part of these consolidated financial statements.

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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,
	2005			2006			2005			2006			2006			2007
Revenues
Revenues:
Funeral	$	25,988		$	27,285		$	84,949		$	87,395		$	30,988		$	32,571
Cemetery		9,563			8,215			28,715			27,451			10,054			10,087

		35,551			35,500			113,664			114,846			41,042			42,658

Costs and expenses
Field costs and expenses:
Funeral		20,025			21,400			62,232			65,267			18,776			19,676
Cemetery		7,763			8,469			23,217			24,974			6,814			6,296
Depreciation and amortization														1,913			2,122
Regional and unallocated funeral and cemetery costs														1,463			1,439

		27,788			29,869			85,449			90,241			28,966			29,533
Gross profit		7,763			5,631			28,215			24,605			12,076			13,125
General and administrative expenses		3,141			2,751			8,920			8,143
Corporate costs and expenses:
General, administrative and other														3,669			3,664
Home office depreciation and amortization														366			364

														4,035			4,028
Operating income		4,622			2,880			19,295			16,462			8,041			9,097
Interest expense		(4,649	)		(4,614	)		(13,961	)		(13,885	)		(4,636	)		(4,620	)
Additional interest and other costs of senior debt refinancing		—			—			(6,933	)		—
Interest income and other		140			911			(249	)		1,474
Interest income and other, net														216			445

Total interest expense and other		(4,509	)		(3,703	)		(21,143	)		(12,411	)
Total interest and other														(4,420	)		(4,175	)

Income (loss) from continuing operations before income taxes		113			(823	)		(1,848	)		4,051
(Provision) benefit for income taxes		(41	)		309			701			(1,520	)

Income (loss) from continuing operations		72			(514	)		(1,147	)		2,531
Income from continuing operations before income taxes														3,621			4,922
Provision for income taxes														(1,358	)		(1,895	)

Net income from continuing operations														2,263			3,027
Income (loss) from discontinued operations, net of tax		598			(51	)		1,245			(4,128	)		(3,998	)		395
Cumulative effect of change in accounting method, net of tax benefit		—			—			(22,756	)		—

Net income (loss)	$	670		$	(565	)	$	(22,658	)	$	(1,597	)	$	(1,735	)	$	3,422

Basic earnings (loss) per common share

Basic earnings (loss) per common share:
Continuing operations	$	—		$	(0.03	)	$	(0.06	)	$	0.14		$	0.12		$	0.16
Discontinued operations		0.04			—			0.07			(0.22	)		(0.21	)		0.02
Cumulative effect of change in accounting method		—			—			(1.25	)		—

Net income (loss)	$	0.04		$	(0.03	)	$	(1.24	)	$	(0.08	)	$	(0.09	)	$	0.18

Diluted earnings (loss) per common share
Diluted earnings (loss) per common share:
Continuing operations	$	—		$	(0.03	)	$	(0.06	)	$	0.13		$	0.12		$	0.16
Discontinued operations		0.04			—			0.07			(0.22	)		(0.21	)		0.02
Cumulative effect of change in accounting method		—			—			(1.25	)		—

Net income (loss)	$	0.04		$	(0.03	)	$	(1.24	)	$	(0.09	)	$	(0.09	)	$	0.18


Weighted average number of common and common equivalent shares outstanding:
Basic		18,426			18,563			18,294			18,531			18,484			18,763

Diluted		18,938			18,563			18,294			18,896			18,874			19,285

The accompanying condensed notes are an integral part of these consolidated financial statements.

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CARRIAGE SERVICES, INC

CONSOLIDATED STATEMENTS OF CASH FLOWS.

(unaudited and in thousands)


	For the nine months
	ended September 30,						For the three months
	2005			2006			ended March 31,
	(Revised, Note 1)						2006			2007
Cash flows from operating activities:
Net loss	$	(22,658	)	$	(1,597	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Net income (loss)							$	(1,735	)	$	3,422
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
(Income) loss from discontinued operations		(1,245	)		4,128			3,998			(395	)
Cumulative effect of the change in accounting method		22,756			—
Depreciation and amortization		7,202			6,577			2,279			2,493
Loan cost amortization		576			536			179			179
Provision for losses on accounts receivable		2,059			3,143			839			662
Net (Gain) loss on sale of business assets		580			(341	)
Stock-based compensation		512			650
Loss on early extinguishment of debt		978			—
Deferred income taxes (benefit)		(701	)		1,520
Changes in assets and liabilities, net of effects from acquisitions and dispositions
Loss on sale or disposition of business assets								175			—
Stock-based compensation expense								238			251
Deferred income taxes								1,358			1,723
Other								(35	)		57
Changes in operating assets and liabilities that provided (required) cash, net of effects from acquisitions and dispositions:
Accounts receivable		(1,905	)		860			(741	)		(884	)
Inventories and other current assets		(1,770	)		(156	)		(11	)		(174	)
Deferred charges and other		(806	)		—			(15	)		22
Preneed trust investments		(3,327	)		(4,112	)
Income tax payments, net		(270	)		(249	)
Preneed funeral and cemetery trust investments								(4,924	)		(2,041	)
Accounts payable and accrued liabilities		(5,360	)		(3,265	)		(5,242	)		(9,297	)
Deferred preneed revenue		4,417			1,626
Deferred interest on convertible junior subordinated debenture		(10,345	)		—
Deferred preneed funeral and cemetery revenue								7,588			(400	)
Non-controlling interests in preneed funeral and cemetery trusts								(3,030	)		2,752

Net cash provided by (used in) operating activities of continuing operations		(9,307	)		9,320			921			(1,628	)
Net cash provided by operating activities of discontinued operations		6			435			260			3

Net cash provided by (used in) operating activities		(9,301	)		9,755			1,181			(1,625	)

Cash flows from investing activities:
Acquisitions		(1,285	)		(1,071	)		—			(6,419	)
Net proceeds from sales of assets		223			680
Purchase of short term investments		(20,851	)		(45,927	)
Maturities of short term investments		11,872			38,643
Sales proceeds deposited into restricted accounts		—			(5,455	)
Proceeds from sales of businesses and other assets								65			—
Purchase of corporate investments								(13,790	)		—
Maturities of corporate investments								11,501			10,303
Capital expenditures		(5,582	)		(4,983	)		(1,116	)		(2,169	)

Net cash used in investing activities of continuing operations		(15,623	)		(18,113	)
Net cash provided by (used in) investing activities of continuing operations								(3,340	)		1,715
Net cash provided by investing activities of discontinued operations		1,533			6,437			6			2,420

Net cash used in investing activities		(14,090	)		(11,676	)
Net cash provided by (used in) investing activities								(3,334	)		4,135

Cash flows from financing activities:
Net payments on bank line of credit		(25,600	)		—
Payments on senior long-term debt and obligations under capital leases		(72,203	)		(1,801	)		(749	)		(394	)
Proceeds from the issuance of debt		—			922
Proceeds from the issuance of senior notes		130,000			—
Payment of financing costs		(4,175	)		—
Proceeds from the exercise of stock options and employee stock purchase plan		827			429			156			323
Tax benefit from stock-based compensation		—			61			35			172

Net cash provided by (used in) financing activities of continuing operations		28,849			(389	)		(558	)		101
Net cash used in financing activities of discontinued operations		(71	)		(922	)		(34	)		—

Net cash provided by (used in) financing activities		28,778			(1,311	)		(592	)		101


Net increase (decrease) in cash and cash equivalents		5,387			(3,232	)		(2,745	)		2,611
Cash and cash equivalents at beginning of period		1,948			7,949			7,949			22,820

Cash and cash equivalents at end of period	$	7,335		$	4,717		$	5,204		$	25,431

The accompanying condensed notes are an integral part of these consolidated financial statements.

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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, 2006,~~March 31, 2007, the Company owned and operated ~~131~~129 funeral homes in 27 states and 2829 cemeteries in 11 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 nine months ended September 30, 2005 consistent with September 30, 2006 to reconcile net cash provided by (used in) operating activities from net loss instead of net loss from continuing operations.

~~(d)~~ Interim Condensed Disclosures

The information for the three months ended March 31, 2006 and ~~nine month periods ended September 30, 2005 and 2006~~2007 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. 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, ~~2005,~~2006, and should be read in conjunction therewith. ~~Certain amounts in the consolidated financial statements for the period ended in 2005 in this report have been reclassified to conform to current year presentation.~~

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

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

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

The preparation of the consolidated financial statements ~~in conformity with U.S. generally accepted accounting principles~~ requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and ~~liabilities~~expenses. On an on-going basis, we evaluate estimates and ~~disclosure~~judgments, including those related to revenue recognition, realization of ~~contingent~~accounts receivable, intangible assets, property and ~~liabilities at~~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 ~~date~~circumstances. The results of these considerations form the ~~financial statements~~basis for making judgments about the amount and ~~the reported amounts~~timing of revenues and expenses, ~~during~~ the ~~reporting period.~~carrying value of assets and the recorded amounts of liabilities. Actual results ~~could~~may differ from ~~those estimates.~~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 consistent from year to year.

~~Allowances~~(f) Discontinued Operations

In accordance with the Company’s strategic portfolio policy, non-strategic businesses are reviewed to determine whether the business should be sold and proceeds redeployed elsewhere. A marketing plan is then developed for those locations which are identified as held for sale. When the Company receives a letter of intent and financing commitment from ~~customer cancellations, refunds and bad debts are provided at~~ the ~~date the contract is executed. In addition, we monitor changes in delinquency rates and provide additional bad debt and cancellation reserves when warranted. Our methodologies~~buyer and the ~~resulting estimates have been reliable in past periods. We do not expect~~sale is expected to ~~change~~occur within one year, the ~~factors~~location is no longer reported within the Company’s continuing operations. The assets and ~~assumptions used in calculating these reserves~~liabilities associated with the held for sale location are reclassified on the balance sheet and the operating results, as well as impairments, are presented on a comparative basis in the ~~future.~~discontinued operations section of the Consolidated Statements of Operations, along with the income tax effect.

(g) Stock Plans and ~~Stock~~Stock-Based Compensation

The Company has stock-based employee compensation plans in the form of restricted stock, stock option and employee stock purchase ~~plans.~~plans, which are described in more detail in Note 16 to the consolidated financial statements in our Form 10-K for the year ended December 31, 2006. The Company accounts for stock-based compensation under ~~Statement of Financial Accounting Standards~~SFAS 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~~awards issued to employees over the period of ~~vesting. The fair value of share based payments is determined using the Black-Scholes valuation model. FAS No. 123R~~vesting and applies to all transactions involving issuance of equity by a company in exchange for goods and services, including employee services. The fair value of awards for options or awards containing options is determined using the Black-Scholes valuation model. The Company adopted FAS No. 123R in the first quarter of 2006, using the modified prospective application ~~method, which results in no restatement of the Company’s previously issued consolidated financial statements.~~

Prior to 2006, the Company accounted for stock based compensation under APB No. 25 and provided the disclosures required under SFAS No. 123, “Accounting for Stock-Based Compensation”, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.”method.

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(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”). 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 adopted the requirements beginning January 1, 2006, which had no affect on the Company’s presentation and disclosure.

(i) Consideration of Misstatements

In September 2006, the SEC released Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (SAB 108), which provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The SEC staff believes that registrants should quantify errors using both a balance sheet and an income statement approach and evaluate whether either approach results in quantifying a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. The provisions of SAB 108 is effective for ~~Income Tax Uncertainties~~financial statements as of the beginning of the first fiscal year ending after November 15, 2006. The Company adopted the requirements at the beginning of the first quarter of 2007, which had no effect on the financial statements.

2. RECENTLY ISSUED ACCOUNTING STANDARDS

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”), which establishes a framework for measuring fair value in accordance with Generally Accepted Accounting Principles (“GAAP”) and expands disclosures about fair value measurements. This statement is effective as of the beginning of the entity’s first fiscal year that begins after November 15, 2007. The Company is currently evaluating the impact, if any, the adoption of SFAS No. 157 will have on its consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115 (“SFAS No. 159”). This statement permits entities to choose to measure many financial assets and liabilities and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This statement is effective as of the beginning of the entity’s first fiscal year beginning after November 15, 2007. The Company is currently evaluating the impact, if any, the adoption of SFAS No. 159 will have on its consolidated financial statements.

3. CHANGE IN ACCOUNTING FOR INCOME TAX UNCERTAINTIES

In June 2006, ~~the~~ FASB issued FASB Interpretation No. 48 ~~(FIN 48),~~ “Accounting for Uncertainty in Income Taxes ~~an interpretation of FASB Statement No. 109.” This interpretation~~(FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” ~~The interpretation~~FIN 48 prescribes ~~a recognition threshold~~how tax benefits for uncertain tax positions are to be recognized, measured, and ~~measurement attribute~~derecognized in financial statements; requires certain disclosures of uncertain tax matters; specifies how reserves for auncertain tax position ~~taken or expected to~~should be ~~taken in a tax return~~classified on the balance sheet; and ~~also~~ provides transition and interim period guidance, ~~on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The provisions of~~among other provisions. FIN 48 ~~are~~is effective for fiscal years beginning after December ~~31, 2006. We are currently evaluating what impact, if any, this statement will have on our financial statements.~~

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

~~Prior to January 1,~~15, 2006 and was adopted by the Company ~~accounted for employee stock-based awards under~~at the ~~intrinsic value method following~~beginning of the ~~recognition~~first quarter of 2007. The Company has reviewed its income tax positions and ~~measurement principle~~identified certain tax deductions, primarily related to business acquisitions that are not certain. The cumulative effect of ~~APB Opinion No. 25, Accounting for Stock Issued~~adopting FIN 48 has been recorded as a reduction to ~~Employees,~~the 2007 opening balance of Retained Earnings and related Interpretations. Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (Revised), Share-Based Payment (“SFAS 123R”), which requires, among other things, entities to recognizean increase in noncurrent liabilities in the ~~income statement the grant-date fair value~~amount of ~~stock options~~$241,000, which includes accrued interest and ~~other stock-based awards over the service periods the awards are expected~~penalties totaling $86,000. The Company’s policy with respect to ~~vest.~~

~~Pursuant~~potential penalties and interest is 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. Measurementrecord them as “other” expense 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 compensationinterest expense, ~~will 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 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 common stock on the quarterly purchase dates or the annual grant date, whichever is lower.respectively.

The ~~fair value~~Company has unrecognized tax benefits for Federal and state income tax purposes totaling $5.0 million at January 31, 2007, resulting from deductions totaling $13.4 million on Federal returns and $7.9 million on various state returns. The effect of ~~the stock option awards and the ESPP awards are determined using the Black-Scholes valuation model, which is consistent with the valuation methods previously utilized~~applying FIN 48 for the ~~awards in the footnote disclosures required under SFAS 123, as amended by SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure.~~three months ended March 31, 2007 was not material to operations. The Company ~~recorded pretax stock-based compensation expense~~has net operating loss carryforwards exceeding these deductions, and has accounted for these unrecognized tax benefits by reducing the ~~stock options and~~net operating loss carryforwards by the ~~ESPP totaling $198,000 for the first nine months~~amount of ~~2006. Had SFAS 123R been effective for the first nine months of 2005,~~these unrecognized deductions. In certain states, the Company ~~would have recorded additional pretax stock-based compensation totaling $234,000.~~has previously reduced its taxes payable by deductions that are not considered more likely than not. The cumulative effect of adopting FIN 48 specifically relates to those state income tax returns.

The Company’s Federal income tax returns for 2001 through 2006 are open tax years that may be examined by the Internal Revenue Service. The Company’s unrecognized state tax benefits are related to state returns open from 2001 through 2006. The Company believes it is reasonably possible it will recognize the unrecognized tax benefits upon the expiration of statutes of limitations of previously deducted expenses.

- 7 -

4. ACQUISITION

Effective January 1, 2007, the Company acquired a combination funeral home and cemetery business and a funeral home business in Texas for cash in the amount of $6.4 million and the assumption of liabilities totaling $4.7 million. The ~~application~~Company acquired substantially all the assets and assumed certain operating liabilities including obligations associated with existing preneed contracts. The assets and liabilities were recorded at fair value and included goodwill in the amount of ~~SFAS 123R has~~$4.3 million. The results of the acquired businesses are included in the Company’s results from the date of acquisition. The proforma impact of the acquisition on the prior period is not presented as the impact is not material to reported results.

The effect of the acquisition on the consolidated balance sheet at March 31, 2007 was as follows (in thousands):


Current Assets	$	1,177
Cemetery property		3,859
Property, plant & equipment		2,887
Goodwill		4,310
Preneed Assets		19,282
Non-current assets		295
Current liabilities		(4,423	)
Deferred preneed revenues		(1,433	)
Other liabilities		(310	)
Non-controlling interest in trusts		(19,225	)


Cash used for acquisition	$	6,419

5. DISCONTINUED OPERATIONS

The Company continually reviews locations to optimize the sustainable earning power and return on invested capital of the Company. The Company’s strategy, the Strategic Portfolio Optimization Model, uses strategic ranking criteria to identify disposition candidates. The execution of this strategy entails selling non-strategic businesses.

In the first quarter of 2007, the Company sold two funeral home businesses for approximately $2.4 million and recognized a gain of $0.7 million. During 2006, the Company recorded impairment charges totaling $6.1 million, which is related to specifically identified goodwill, for these businesses that were subsequently sold in 2006.

At December 31, 2006, assets and liabilities associated with the funeral home businesses held for sale in the accompanying balance sheet consisted of the following ~~effect on the three and nine months ended September 30, 2006 and 2005, respectively~~ (in thousands). The assets and liabilities associated with the funeral home business held for sale at March 31, 2006 were not material.

Three months ended
September 30, 2006
Results under
As Reported Effect of Change Prior Method
Loss from continuing operations before income taxes $ (823 ) $ 45 $ (778 )
Net loss available to common stockholders (565 ) 28 (537 )

Net loss per share available to common stockholders:
Basic $ (0.03 ) $ — $ (0.03 )
Diluted (0.03 ) — (0.03 )

Nine months ended
September 30, 2006
Results under
As Reported Effect of Change Prior Method
Income from continuing operations before income taxes $ 4,051 $ 198 $ 3,853
Net loss available to common stockholders (1,597 ) 124 (1,473 )

Net loss per share available to common stockholders:
Basic $ (0.08 ) $ — $ (0.08 )
Diluted (0.09 ) 0.01 (0.08 )

Three months ended
September 30, 2005
As Reported Effect of Change Pro Forma
Income from continuing operations before income taxes $ 113 $ (78 ) $ 35
Net income available to common stockholders 670 (49 ) 621

Net income per share available to common stockholders:
Basic $ 0.04 $ — $ 0.04
Diluted 0.04 — 0.04

Nine months ended
September 30, 2005
As Reported Effect of Change Pro Forma
Loss from continuing operations before income taxes $ (1,848 ) $ (234 ) $ (2,082 )
Net loss available to common stockholders (22,658 ) (146 ) (22,804 )

Net loss per share available to common stockholders:
Basic $ (1.24 ) $ (0.01 ) $ (1.25 )
Diluted (1.24 ) (0.01 ) (1.25 )


	December 31,
	2006
Assets:
Current assets	$	124
Property, plant and equipment, net		1,406
Preneed receivables and trust investments		634
Goodwill		324
Deferred charges and other assets		146

Total	$	2,634


Liabilities:
Current liabilities	$	229
Deferred preneed funeral contracts revenue		78
Senior long-term debt, net of current portion		54
Non-controlling interests in funeral and cemetery trust investments		700

Total	$	1,061

- 8 -

~~The following summary reflects stock option activity and related information for the nine months ending September 30, 2006.~~

Weighted-Average Aggregate
Shares Exercise Price Intrinsic Value
(in thousands) (in thousands)
Outstanding at December 31, 2005 1,365 $ 3.39
Granted 24 $ 4.81
Exercised (75 ) $ 2.76
Cancelled and expired (23 ) $ 7.22

Outstanding at September 30, 2006 1,291 $ 3.39 $ 2,347

Exercisable at September 30, 2006 1,246 $ 3.35 $ 2,332

The total intrinsic value of options exercised was $150,000 during the first nine months of 2006 and $491,000 during the first nine months of 2005. As of September 30, 2006, there was $81,000 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 one year.

~~The following summary provides additional information about stock options that are outstanding and exercisable at September 30, 2006 (shares in thousands).~~

Options Outstanding Options Exercisable
Actual Range Weighted- Weighted-
of Exercise Average Average
Prices Number Remaining Weighted- Number Remaining Weighted-
150% Outstanding Contractual Average Exercisable at Contractual Average
increment at 9/30/06 Life Exercise Price 9/30/06 Life Exercise Price
$1.19-     1.56 633 4.2 $ 1.49 633 4.2 $ 1.49
$2.06-     3.09 152 3.8 $ 2.89 152 3.8 $ 2.89
$3.12-     4.66 145 6.6 $ 4.20 105 6.5 $ 4.15
$4.77-     6.19 307 6.0 $ 5.02 302 6.0 $ 5.00
$13.25- 19.88 48 2.0 $ 15.06 48 2.0 $ 15.06
$21.00- 27.50 6 0.6 $ 21.19 6 0.6 $ 21.19

$1.19-   27.50 1,291 4.8 $ 3.39 1,246 4.7 $ 3.35

The Company granted stock options covering 24,000 shares to the non-officer directors during 2006 and during 2005. The fair value of the options granted in 2006 totaled $59,000. No additional options were granted in 2005 or the first nine months of 2006. The fair values of stock options granted in 2005 and 2006 and the ESPP granted at the beginning of 2005 and 2006 were estimated using the following assumptions:

Stock Options ESPP
2006 Assumptions:
Expected dividend yield 0 % 0 %
Expected volatility 58 % 58 %
Risk-free interest rate 4.25 % 4.25 %
Expected life (years) 5 .25, .50, .75, 1

Stock Options ESPP
2005 Assumptions:
Expected dividend yield 0 % 0 %
Expected volatility 50 % 50 %
Risk-free interest rate 3.00 % 3.00 %
Expected life (years) 5 .25, .50, .75, 1

~~The expected life of the ESPP grant represents the 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

~~- 9 -~~

costs. The Company applied this change in accounting method effective January 1, 2005. Therefore, the Company’s results of operations for the three and nine month periods ended September 30, 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 per diluted share, which represents the cumulative balance of deferred preneed selling costs in the Company’s consolidated balance sheet.

~~4. ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS~~

On July 25, 2006, Carriage Services, Inc. completed the sale of a funeral home business and a combination funeral home and cemetery business in the state of Indiana. The Company received net proceeds of $6.5 million as follows: (i) the sum of $7.5 million in cash less (ii) the issuance of a note payable to the buyer in the amount of $1.0 million. In accordance with the bank credit facility, approximately $5.5 million of the net cash proceeds are pledged and restricted for use only for acquisitions or capital expenditures. 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 $5.4 million during the first six months of 2006, a substantial portion of which related to specifically identified goodwill.

During September 2006, the Company ceased operations at a funeral home business when the lease on the property expired. The carrying value of the assets of this business was reduced to management’s estimate of fair value less estimated costs to sell by recording impairment charges totaling $0.9 million during the second quarter of 2006. The preneed contracts and other business assets were transferred to another company-owned funeral home in the area. No business was held for sale at September 30, 2006.

The operating results of businesses discontinued during the periods presented, as well as impairments and gains or losses on the disposal, are presented on a comparative basis in the discontinued operations section of the consolidated statements of operations, along with the income tax effect. Likewise, the operating results, 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,
2005 2006 2005 2006
Revenues $ 940 $ 210 $ 3,377 $ 1,949

Operating income $ 112 $ 30 $ 681 $ 355
Gain (losses) on sale and (impairments) 836 (111 ) 1,303 (6,443 )
(Provision) benefit for income taxes (350 ) 30 (739 ) 1,960

Income (loss) from discontinued operations $ 598 $ (51 ) $ 1,245 $ (4,128 )

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. During May 2005, the Company ceased operations at a funeral home business when the lease on the property expired. The preneed contracts and other business assets were transferred to another company-owned funeral home in the area. During July 2005, the Company closed on the sale of a cemetery business. The sale transaction generated net cash proceeds totaling $1.1 million and a gain of approximately $0.8 million.

~~5. SHORT TERM INVESTMENTS~~

Short term investments are investments purchased with an original maturity of greater than three months but less than a year at the time of purchase. Short term investments at September 30, 2006 consisted of commercial paper with maturity dates that range from October 2006 to February 2007 at rates ranging from 4.96% to 5.25% per annum. Market values approximates cost.


	For the three months
	ended March 31,
	2006			2007
Revenues	$	1,332		$	145


Operating income	$	222		$	(35	)
Impairment and gain on sale, respectively		(6,102	)		677
(Provision) benefit for income taxes		1,882			(247	)

Income (loss) from discontinued operations	$	(3,998	)	$	395

6. GOODWILL ~~AND OTHER INTANGIBLE ASSETS~~

Many of the acquired funeral homes, ~~and~~ former owners and staff have provided high quality service to families for generations. The resulting loyalty often represents a substantial portion of the value of a funeral business. 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.

~~- 10 -~~

The following table presents the changes in goodwill ~~for~~in the ~~nine months ended September 30, 2006~~accompanying consolidated balance sheet (in thousands):


	December 31,			March 31,
	2005			2007
Goodwill at December 31, 2005	$	157,358
Goodwill at beginning of year				$	148,845
Divestitures		(6,174	)		—
Acquisitions		85			4,310

Goodwill at September 30, 2006	$	151,269
Goodwill at end of period				$	153,155

7. PRENEED ~~ASSETS~~TRUST INVESTMENTS

~~Preneed assets consist of the following:~~

December 31, September 30,
2005 2006
Cemetery preneed receivables and trust investments $ 67,995 $ 65,974
Funeral preneed receivables and trust investments 50,420 48,182
Receivable from funeral trusts 17,411 16,827

$ 135,826 $ 130,983

Cemetery preneed ~~receivables and~~ trust investments

Cemetery preneed ~~receivables and~~ trust investments ~~net of allowance for cancellations,~~ represent trust fund assets ~~and customer receivables (net of unearned finance charges) for contracts sold in advance of~~that the Company will withdraw when the merchandise or services are ~~needed. The components of Cemetery preneed receivables and trust investments in the consolidated balance sheet at December 31, 2005 and September 30, 2006 are as follows (in thousands):~~

December 31, September 30,
2005 2006
Trust investments $ 54,768 $ 53,868
Receivables from customers 17,304 16,554
Unearned finance charges (3,143 ) (3,157 )
Allowance for doubtful accounts (934 ) (1,291 )

Cemetery preneed receivables and trust investments $ 67,995 $ 65,974

Cemetery preneed receivables and trust investments are reduced by the trust investment earnings the Company has been allowed to withdraw prior to performance by the Company and amounts received from customers that are not required to be deposited into trust, pursuant to various state laws. Preneed cemetery sales are usually financed through interest-bearing installment sales contracts, generally with terms of up to five years. The interest rates generally range between 12% and 14%.

provided. The cost and market values associated with cemetery preneed trust investments at ~~September 30, 2006~~March 31, 2007 are detailed below (in thousands). The Company believes the unrealized losses related to trust investments ~~at September 30, 2006 are primarily related to changes in market interest rates and equity values and~~ are temporary in nature. ~~Net unrealized gains decreased $0.1 million for the nine months ended September 30, 2006, respectively.~~


			Unrealized		Unrealized								Unrealized		Unrealized
	Cost		Gains		Losses			Market			Cost		Gains		Losses			Market
Cash and money market accounts	$	2,866	$	—	$	—		$	2,866		$	2,757	$	—	$	—		$	2,757
Fixed income securities:
U.S. Agency obligations		5,432		3		(57	)		5,378			20,629		29		(40	)		20,618
State obligations		14,663		159		(201	)		14,621			379		9		—			388
Corporate		3,048		19		(20	)		3,047			2,425		19		(12	)		2,432
Other		6		—		—			6			6		—		—			6

Common stock		10,235		961		(188	)		11,008			9,994		1,748		(104	)		11,638
Mutual funds:
Equity		11,221		671		(107	)		11,785			11,835		1,543		(114	)		13,264
Fixed income		4,845		83		(16	)		4,912			5,199		111		(11	)		5,299

											$	53,224	$	3,459	$	(281	)	$	56,402
	$	52,316	$	1,896	$	(589	)	$	53,623


Accrued investment income	$	245						$	245		$	285						$	285


Trust investments								$	53,868									$	56,687


Market value as a percentage of cost									103.0	%									106.5	%

- 119 -

The estimated maturities of the fixed income securities included above are as follows:

Due in one year or less $ 2,947
Due in one to five years 15,400
Due in five to ten years 4,936
Thereafter 161

$ 23,444

~~Funeral preneed receivables and~~Preneed funeral trust investments

~~Funeral preneed receivables and~~Preneed funeral trust investments ~~net of allowance for cancellations,~~ represent trust fund assets ~~and customer receivables related~~that the Company expects to ~~contracts sold in advance of~~withdraw when the services orand merchandise ~~is needed.~~are provided. Such contracts are secured by funds paid by the customer to the Company. ~~Funeral preneed~~Preneed funeral receivables and trust investments are reduced by the trust investment earnings the Company has been allowed to withdraw prior to performance by the Company and amounts received from customers that are not required to be deposited into trust, pursuant to various state laws.

The ~~components of Funeral preneed receivables and trust investments in the consolidated balance sheet at December 31, 2005 and September 30, 2006 are as follows (in thousands):~~

December 31, September 30,
2005 2006
Trust investments $ 47,678 $ 45,215
Receivables from customers 8,709 8,752
Allowance for contract cancellations (5,967 ) (5,785 )

Funeral preneed receivables and trust investments $ 50,420 $ 48,182

~~The~~ cost and market values associated with preneed funeral ~~preneed~~ trust investments at ~~September 30, 2006~~March 31, 2007 are detailed below (in thousands). The Company believes the unrealized losses related to trust investments ~~at September 30, 2006 are primarily related to changes in market interest rates and equity values and~~ are temporary in nature. ~~Net unrealized gains increased $0.2 million for~~

Unrealized Unrealized
Cost Gains Losses Market
Cash and money market accounts $ 17,768 $ — $ — $ 17,768
Fixed income securities:
U.S. Treasury 8,123 15 (14 ) 8,124
State obligations 10,965 90 — 11,055
Corporate 2,180 27 (21 ) 2,186
Mortgage Backed Securities 1,061 1 (16 ) 1,046

Common stock 5,608 1,750 (17 ) 7,341
Mutual funds:
Equity 10,576 1,352 (65 ) 11,863
Fixed income 3,206 269 (22 ) 3,453

Trust investments $ 59,487 $ 3,504 $ (155 ) $ 62,836

Market value as a percentage of cost 105.6 %

The estimated maturities of the ~~nine months ended September 30, 2006, respectively.~~fixed income securities included above are as follows:

Unrealized Unrealized
Cost Gains Losses Market
Cash and money market accounts $ 24,253 $ — $ — $ 24,253
Fixed income securities:
U.S. Treasury 369 — (11 ) 358
State obligations 1,680 50 — 1,730
Corporate 2,134 18 (30 ) 2,122
Obligations and guarantees of U.S. government agencies 1,179 1 (36 ) 1,144

Common stock 1,911 356 (43 ) 2,224
Mutual funds:
Equity 10,119 722 (16 ) 10,825
Fixed income 2,595 13 (49 ) 2,559

Trust investments $ 44,240 $ 1,160 $ (185 ) $ 45,215

Market value as a percentage of cost 102.2 %

Due in one year or less $ 3,169
Due in one to five years 14,235
Due in five to ten years 4,760
Thereafter 247

$ 22,411

Upon cancellation of a preneed funeral or cemetery contract, a customer is generally entitled to receive a refund of the corpus and some or all of the earnings held in trust. In certain jurisdictions, the Company is obligated to fund any shortfall if the amounts deposited by the customer exceed the funds in trust including some or all investment income. As a result, when realized or unrealized losses of a trust result in the trust being under-funded, the Company assesses whether it is responsible for replenishing the corpus of the ~~trust.~~trust, in which case a loss provision would be recorded. No loss amounts have been required to be recognized for the periods presented in the Consolidated Financial Statements.

- 10 -

Trust Investment Security Transactions

~~Receivable from Funeral Trusts~~ Cemetery and funeral trust investment security transactions recorded in Other income in the Consolidated Statement of Operations for the three months ended March 31, 2006 and 2007 are as follows (in thousands).

For the three months
ended March 31,
2006 2007
Investment income $ 777 $ 865
Realized gains 1,356 378
Realized losses (556 ) (174 )
Expenses (295 ) (172 )
Increase in non-controlling interests in trust investments (1,282 ) (897 )

$ — $ —

8. RECEIVABLES FROM PRENEED FUNERAL TRUSTS

The ~~receivable~~receivables from preneed funeral trusts represent assets in trusts which are controlled and operated by third parties in which the Company does not have a controlling financial interest (less than 50%) in the trust assets. The Company accounts for these investments at cost.

~~- 12 -~~

~~Trust Investment Security Transactions~~

~~Investment security transactions recorded in Other income in the Consolidated Statement of Operations for the three and nine months ended September 30, 2006 and 2005 are as follows (in thousands).~~

For the three months For the nine months
ended September 30, ended September 30,
2005 2006 2005 2006
Investment income $ 1,698 $ 1,049 $ 2,824 $ 3,408
Realized gains 390 484 2,023 3,586
Realized losses (35 ) (285 ) (484 ) (1,506 )
Expenses (154 ) (267 ) (430 ) (1,101 )
Increase in non-controlling interests in trust investments (1,899 ) (981 ) (3,933 ) (4,387 )

$ — $ — $ — $ —

8.9. CONTRACTS SECURED BY INSURANCE

Certain preneed funeral contracts are secured by life insurance contracts. Generally, the proceeds of the life insurance policies have been assigned to the Company and will be paid upon the death of the insured. The proceeds will be used to satisfy the beneficiary’s obligations under the preneed contract for services and merchandise. The preneed funeral contracts secured by insurance ~~which~~totaled $170 million at March 31, 2007, and are not included in the Company’s consolidated balance ~~sheet totaled $164 million at September 30, 2006.~~sheet.

9.10. 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, 2006~~March 31, 2007 are detailed below (in thousands). The Company believes the unrealized losses related to the trust investments ~~September 30, 2006 are primarily related to changes in market interest rates and equity values and~~ are temporary in nature. ~~Net unrealized gains increased $0.2 million for~~

Unrealized Unrealized
Cost Gains Losses Market
Cash and money market accounts $ 2,117 $ — $ — $ 2,117
Fixed income securities:
U.S. Treasury 202 — (2 ) 200
U.S. Agency obligation 6,080 10 (31 ) 6,059
State obligations 609 14 — 623
Corporate 1,049 26 (1 ) 1,074
Other 351 — (9 ) 342
Common stock 9,224 1,682 (99 ) 10,807
Mutual funds:
Equity 6,650 1,023 (104 ) 7,569
Fixed income 6,119 149 (5 ) 6,263

$ 32,401 $ 2,904 $ (251 ) $ 35,054

Accrued investment income $ 76 76

Trust investments $ 35,130

Market value as a percentage of cost 108.4 %

The estimated maturities of the ~~nine months ended September 30, 2006.~~fixed income securities included above are as follows:

Unrealized Unrealized
Cost Gains Losses Market
Cash and money market accounts $ 1,641 $ — $ — $ 1,641
Fixed income securities:
U.S. Treasury 499 4 (3 ) 500
U.S. Agency obligation 5,927 6 (63 ) 5,870
State obligations 609 17 — 626
Corporate 1,049 22 (2 ) 1,069
Other 370 — (11 ) 359
Common stock 9,160 1,073 (152 ) 10,081
Mutual funds:
Equity 5,625 472 (93 ) 6,004
Fixed income 4,405 111 (13 ) 4,503

$ 29,285 $ 1,705 $ (337 ) $ 30,653

Accrued investment income $ 73 73

Trust investments $ 30,726

Market value as a percentage of cost 104.9 %

Due in one year or less $ 2,162
Due in one to five years 4,448
Due in five to ten years 1,434
Thereafter 252

$ 8,296

- 1311 -

Non-controlling interests in cemetery perpetual care trusts represent the corpus of those trusts ~~for which the Company is only entitled to receive the~~plus undistributed income. The components of non-controlling interests in cemetery perpetual care trusts as of December 31, ~~2005~~2006 and ~~September 30, 2006~~March 31, 2007 are as follows:

December 31, September 30,
2005 2006
Trust assets, at market value $ 32,356 $ 30,726
Pending withdrawals of income (719 ) (517 )
Debt due to a perpetual care trust 1,092 —
Pending deposits 383 60

Non-controlling interests $ 33,112 $ 30,269

~~10. DEFERRED REVENUE~~

December 31, March 31,
2006 2007
Trust assets, at market value $ 32,540 $ 35,130
Pending withdrawals of income (1,351 ) (1,154 )

Non-controlling interests $ 31,189 $ 33,976

~~The components of deferred revenue~~Trust Investment Security Transactions

Perpetual care trust investment security transactions recorded in Other income in the ~~consolidated balance sheets at December~~Consolidated Statement of Operations for the three months ended March 31, ~~2005~~2006 and ~~September 30, 2006~~2007 are as ~~follows:~~follows (in thousands).

December 31, September 30,
2005 2006
Deferred cemetery contracts revenue $ 51,928 $ 49,521
Deferred preneed funeral contracts revenue 29,446 29,468
Non-controlling interests in funeral and cemetery trust investments 102,446 99,083

$ 183,820 $ 178,072

Non-controlling interests in funeral and cemetery preneed trusts represent deferred revenue related to assets held in the preneed trusts. The Company will recognize the revenue at the time the service is performed and merchandise is delivered. The components of Non-controlling interests in funeral and cemetery preneed trusts as of September 30, 2006 are as follows:

September 30, 2006
Preneed Preneed Total
Funeral Cemetery Preneed
Trust assets, at market value $ 45,215 $ 53,868 $ 99,083

Non-controlling interests $ 45,215 $ 53,868 $ 99,083


	For the three months
	ended March 31,
	2006			2007
Investment income		460		$	330
Realized gains		805			373
Realized losses		(304	)		(27	)
Expenses		(10	)		42
Increase in non-controlling interests in trust investments		(951	)		(718	)

	$	—		$	—

11. MAJOR SEGMENTS OF BUSINESS

Carriage conducts funeral and cemetery operations only in the United States. The following table presents revenue, ~~pretax~~pre-tax income from continuing operations and total assets by segment (in thousands):

Funeral Cemetery Corporate Consolidated
Revenues from continuing operations:
Nine months ended September 30, 2006 $ 87,395 $ 27,451 $ — $ 114,846
Nine months ended September 30, 2005 $ 84,949 $ 28,715 $ — $ 113,664

Income (loss) from continuing operations before income taxes:
Nine months ended September 30, 2006 $ 22,166 $ 2,404 $ (20,519 ) $ 4,051
Nine months ended September 30, 2005 $ 22,136 $ 4,841 $ (28,825 ) $ (1,848 )

Total assets:
September 30, 2006 $ 311,474 $ 178,063 $ 67,533 $ 557,070
December 31, 2005 $ 322,497 $ 189,684 $ 58,459 $ 570,640


	Funeral		Cemetery		Corporate			Consolidated
Revenues from continuing operations:
Three months ended March 31, 2007	$	32,571	$	10,087	$	—		$	42,658
Three months ended March 31, 2006	$	30,988	$	10,054	$	—		$	41,042

Income (loss) from continuing operations before income taxes:
Three months ended March 31, 2007	$	10,418	$	2,137	$	(7,633	)	$	4,922
Three months ended March 31, 2006	$	9,091	$	1,622	$	(7,092	)	$	3,621

Total assets:
March 31, 2007	$	329,612	$	196,158	$	64,850		$	590,620
December 31, 2006	$	309,140	$	181,225	$	74,631		$	564,996

- 1412 -

12. SUPPLEMENTAL DISCLOSURE OF STATEMENT OF OPERATIONS INFORMATION


	For the three months				For the nine months				For the three months
	ended September 30,				ended September 30,				ended March 31,
	2005		2006		2005		2006		2006		2007
Revenues
Goods
Funeral	$	11,281	$	11,797	$	37,039	$	37,696	$	13,306	$	13,649
Cemetery		6,940		5,618		20,479		19,030		7,006		7,023

Total goods	$	18,221	$	17,415	$	57,518	$	56,726	$	20,312	$	20,672

Services
Funeral	$	14,707	$	15,488	$	47,910	$	49,699	$	17,682	$	18,922
Cemetery		2,623		2,597		8,236		8,421		3,048		3,064

Total services	$	17,330	$	18,085	$	56,146	$	58,120	$	20,730	$	21,986


Total revenues	$	35,551	$	35,500	$	113,664	$	114,846	$	41,042	$	42,658


Cost of revenues
Goods
Funeral	$	10,834	$	11,572	$	34,208	$	35,711	$	10,618	$	11,028
Cemetery		5,604		6,090		16,465		18,221		5,073		4,574

Total goods	$	16,438	$	17,662	$	50,673	$	53,932	$	15,691	$	15,602

Services
Funeral	$	9,191	$	9,828	$	28,024	$	29,556	$	8,126	$	8,648
Cemetery		2,159		2,379		6,752		6,753		1,773		1,722

Total services	$	11,350	$	12,207	$	34,776	$	36,309	$	9,899	$	10,370


Total cost of revenues	$	27,788	$	29,869	$	85,449	$	90,241	$	25,590	$	25,972

- 13 -

13. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

The following information is supplemental disclosure for the Consolidated Statement of Cash Flows (in thousands):


	For the nine months ended				For the three months ended
	September 30,				March 31,
	2005		2006		2006			2007
Cash paid for interest and financing costs	$	31,226	$	16,163		7,151			7,083

Cash paid for income taxes (state)	$	270	$	249		87			255

Restricted common stock issued to officers	$	1,337	$	—		—			1,155

Net deposits (withdrawals) in preneed funeral trust investments						57			(335	)
Net deposits in preneed cemetery trust investments						(3,064	)		(1,204	)
Net deposits into perpetual care trusts						(2,154	)		(958	)
Net withdrawals from preneed funeral trust receivables						37			175
Net (deposits) withdrawals in cemetery trust receivables						368			(62	)
Net withdrawals (deposits) in preneed funeral receivables						(168	)		343
Net deposits (withdrawals) in preneed funeral trust accounts increasing deferred revenue						1,830			(189	)
Net deposits (withdrawals) in cemetery trust accounts increasing (decreasing) deferred revenue						5,758			(211	)
Net deposits (withdrawals) in preneed funeral trust accounts increasing (decreasing) noncontrolling interests						(1,787	)		335
Net deposits (withdrawals) in cemetery trust accounts increasing (decreasing) noncontrolling interests						(1,925	)		1,204
Deposits in perpetual care trust accounts increasing noncontrolling interests						682			1,213

Restricted cash investing and financing activities:
Proceeds from the sale of securities of the funeral and cemetery trusts	$	30,539	$	45,671

Purchases of available for sale securities of the funeral and cemetery trusts	$	38,713	$	38,028

Net deposits (withdrawals) in trust accounts increasing noncontrolling interests	$	7,675	$	1,622

Proceeds from the sale of available for sale securities of the funeral and cemetery trusts						14,418			13,868
Purchase of available for sale securities of the funeral and cemetery trusts						10,579			14,223
Net deposits (withdrawals) in trust accounts increasing (decreasing) noncontrolling interests						(7,573	)		11,702

14. DEBT

~~In January 2005, the~~The Company ~~issued~~has outstanding $130 million of 7.875 ~~percent~~% Senior Notes, ~~at par,~~ due in ~~2015.~~2015 and $93.75 million of 7.00% subordinated debt payable to an unconsolidated affiliate, Carriage Services Capital Trust, due in 2029. 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~~also has a $35 million senior secured revolving credit facility ~~that matures~~ in ~~five years to replace the existing unsecured credit facility at that time. Borrowings~~which borrowings under ~~the new~~ credit facility bear interest at prime or LIBOR options with the current LIBOR option set at

~~- 15 -~~

LIBOR plus 300 basis points and is collateralized by all personal property and by funeral home real property in certain states. The facility is currently undrawn.

Carriage, the parent entity, has no ~~independent~~material assets or ~~operations.~~operations independent of its subsidiaries. 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 the debentures issued in connection with our TIDES) have fully and unconditionally guaranteed our obligations under the Senior Notes. Additionally, the Company does not currently have any significant restrictions on our ability to receive dividends or loans from any subsidiary guarantor under the 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~~15. STOCK-BASED COMPENSATION

Stock options 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)~~employee stock purchase plan

No stock options were awarded during the first quarter of ~~2005. In connection~~2007. During the first quarter of 2007, employees purchased a total of 19,758 shares of common stock through the employee stock purchase plan (“ESPP”) at a weighted average price of $4.33 per share. The Company recorded pre-tax stock-based compensation expense for the stock options and the ESPP totaling $51,000 and $39,000 for the three months ended March 31, 2006 and 2007. As of March 31, 2007, there was $21,000 of total unrecognized compensation costs, net of estimated forfeitures, related to nonvested stock options that are expected to be recognized over a weighted-average period of approximately one year.

- 14 -

The fair value of the right (option) to purchase shares under the ESPP during 2006 and 2007, respectively, is estimated on the date of grant using the Black-Sholes option-pricing model with the ~~new senior secured revolving credit facility,~~following weighted average assumptions:


	Three Months Ended			Three Months Ended
Employee Stock Purchase Plan	March 31, 2006			March 31, 2007
Dividend yield	None			None
Expected volatility		50.0	%		23.7	%
Risk-free interest rate		4.04	%		4.96	%
Expected life (in years)		0.25			0.25

Expected volatilities are based on the historical volatility for the last twelve months of our stock. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yields in effect at the time of grant.

Restricted stock

The Company granted 180,500 shares of restricted stock to certain officers and employees during the first quarter of 2007, with a four-year vesting period. The Company recorded $152,000 and $141,000 in pre-tax compensation expense for the three months ended March 31, 2006 and 2007, respectively, related to the vesting of restricted stock awards. As of March 31, 2007, there was $1,748,000 of total unrecognized compensation costs related to unvested restricted stock awards, which is expected to be recognized over a weighted average period of approximately two years.

Directors’ compensation

During the three months ended March 31, 2006 and 2007, the Company ~~recorded~~issued unrestricted common stock to directors totaling 6,909 and 7,822 shares respectively, in lieu of payment in cash for their fees, the value of which totaled $35,000 and $40,000, respectively.

16. SUBSEQUENT ACQUISITION

The Company acquired substantially all the assets and assumed liabilities of a ~~charge to write off $0.2 million or $0.01 per diluted share of unamortized loan costs during the second quarter of 2005. These charges are included~~combination funeral home and cemetery business in California on April 2, 2007 in exchange for a cash payment at closing in the ~~Consolidated Statement~~amount of ~~Operations as additional interest and other costs of senior debt refinancing during nine months ended September 30, 2005.~~$8.0 million.

- 1615 -

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

We caution readers that the following important factors, among others, in some cases have affected, and in the future could affect, our actual consolidated results and could cause 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 us. For further information regarding risks associated with our business and the death care industry, see Item 1A – Risk Factors in our annual report filed on Form 10-K for the year ended December 31, ~~2005.~~2006.

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.~~margins.

(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 margins.

(4) 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.

(5) Increased or unanticipated costs, such as insurance, taxes and new computer systems implementations, may have a negative impact on our earnings and cash flows.

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

(7) ~~Smaller~~Our smaller businesses are typically dependent upon one or a few key employees for success.

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

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

Risks related to the death care industry

(1) Declines in the number of deaths in our markets can cause a decrease in revenues. Changes in the number of deaths are not predictable from market to market or over the short term.

(2) The increasing number of cremations in the United States could cause revenues to decline because we could lose market share to firms specializing in cremations. In addition, direct cremations produce minimal revenues for cemetery operations and lower funeral revenues.

(3) If we are not able to respond effectively to changing consumer preferences, our market share, revenues and profitability could decrease.

(4) Because the funeral and cemetery businesses are high fixed-cost businesses, changes in revenues can have a disproportionately large effect on cash flow and profits.

~~- 17 -~~

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

- 16 -

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, 2006,~~March 31, 2007, we operated ~~131~~129 funeral homes in 27 states and 2829 cemeteries in 11 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 ~~40%~~39% 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 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. We introduced a more decentralized, entrepreneurial and local operating 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 model essentially eliminated the use of financial budgets for the funeral homes. 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. To date, the “Being the Best” operating model and standards have not provided overall improvement in profitability. In certain businesses we have determined that the business managers do not possess the characteristics to succeed in this type of culture, and we are actively recruiting new managers who do. We have also determined that this model is most effective in larger businesses. Being the best is not something that occurs easily and quickly, but execution of the model should result in improving performance in 2007 and beyond.

The cemetery operating results are affected by the size and success of our sales ~~organization because approximately 60%~~organization. Approximately 53% of our cemetery revenues for the ~~nine~~three months ended ~~September 30, 2006~~March 31, 2007 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~~affect the amount of cemetery revenues. Approximately ~~11%~~9% of our cemetery revenues for the ~~nine~~three months ended ~~September 30, 2006~~March 31, 2007 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 have implemented several significant long-term initiatives in our operations designed to improve operating and financial results by growing market share and increasing profitability. We introduced a more decentralized, entrepreneurial and local operating model that included operating and financial standards developed from our best operations, along with an incentive compensation plan to reward business managers for successfully meeting or exceeding the standards. The model essentially eliminated the use of financial budgets. The operating model and standards, which we refer to as “Being the Best,” focus on the key drivers of a successful operation, organized around three primary areas – market share, people and operating and financial metrics. The model and standards are the measures by which we judge the success of each business. To date, the “Being the Best” operating model and standards have driven significant changes in our organization, leadership and operating practices. In certain businesses we have determined that the business managers do not possess the characteristics to succeed in this type of culture, and we have been actively recruiting new managers who do. We have also determined that this model is most effective in larger businesses. Being the best is not something that occurs easily and quickly, but we believe execution of the model should result in improving performance in 2007 and beyond.

Financial Highlights

Net ~~loss~~income from continuing operations for the three months ~~ending September 30, 2006~~ended March 31, 2007 totaled ~~$0.5~~$3.0 million, equal to ~~$(0.03)~~$0.16 per diluted share as compared to net income from continuing operations of $0.1 million for the third quarter of 2005. The third quarter is typically our weakest quarter for seasonal reasons. As discussed in the Cemetery Segment, the underperformance was related primarily to lower revenues and higher operating costs at our largest cementery in California.

~~Net income from continuing operations for the first nine months of 2006 totaled $2.5 million, equal to $0.13 per diluted share as compared to a net loss from continuing operations of $1.1~~$2.3 million for the first ~~nine months~~quarter of ~~2005,~~2006 or ~~$(0.06)~~$0.12 per diluted share. The ~~variance between~~improvement is due in large part to the ~~two periods was primarily due~~success of three initiatives in which we have focused our attention to ~~a make-whole payment during~~improve operating results for 2007: (1) the turnaround of existing Central Region funeral homes, (2) new leadership and sales growth at Rolling Hills Memorial Park and (3) operating results from 2007 acquisitions. The existing Central Region funeral homes generated 4.5% higher revenues and $0.4 million in additional net income, equal to $0.02 per diluted share in the first quarter of ~~2005~~2007 when compared to the ~~former debtholders~~same period in ~~connection~~2006. A new general manger was hired at the beginning of 2007 at Rolling Hills Memorial Park, and with the ~~repayment~~influence of ~~the previously outstanding senior debt. We repaid this senior debt~~that new leadership and ~~paid the make-whole payment with proceeds from our $130~~other improvements, revenues at Rolling Hills Memorial Park increased 28.9% which helped generate $0.3 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 $0.9 million to write off the related unamortized loan costs, in total~~net earnings, equal to ~~$0.24~~$0.015 per diluted share. ~~During the second quarter~~The acquisition of ~~2005 the Company incurred~~ a ~~loss on the sale~~combination funeral home and cemetery and a stand-alone funeral home in Corpus Christi, Texas in January 2007 generated revenues totaling $1.3 million and net income of ~~undeveloped land and costs in connection with refinancing the bank credit facility, which together totaled $0.8~~$0.2 million, equal to ~~$0.03~~$0.012 per diluted share. ~~During~~

Income from discontinued operations for the ~~third quarter of 2006 the Company recorded a gain on the sale of property of $0.5~~three months ended March 31, 2007 totaled $0.4 million, equal to $0.02 per diluted share. ~~Additionally,~~During January 2007, the Company ~~recorded charges~~completed the sale of ~~approximately $0.9 million for environmental remediation and severance. Excluding the effect~~a funeral home business, resulting in a pre-tax gain of ~~these items, diluted earnings per share from continuing operations for the nine months ending September 30, 2005 equaled $0.21 compared to $0.15 for the nine months ended September 30, 2006.~~

There are two areas that management is focusing its efforts to improve results: (1) The Central Region funeral operations which suffered a year over year decline in pretax profitability of $1.6 million, and (2) a cemetery in California, whose pretax earnings have declined by $2.1$0.7 million. ~~The decline in profitability in these two areas is equivalent to $0.12 per diluted share for~~

~~- 18 -~~

the nine month period. We recently made changes in leadership over each of these areas to focus on the issues affecting profits, such as local sales management, receivable collections and marketshare losses.

Loss from discontinued operations for the ~~nine~~three months ~~ending September 30,~~ended March 31, 2006 totaled ~~$4.1~~$4.0 million, equal to ~~$(0.22)~~$0.21 per diluted share. ~~On July 25,~~In March 2006, ~~the Company completed the sales of~~we entered into a plan to sell a funeral home business and a combination funeral home and cemetery business in the ~~state~~State of ~~Indiana.~~Indiana, both of which were in small markets not strategic to our future plans. We recorded pre-tax impairment charges ~~in 2006~~ of approximately ~~$5.4~~$6.1 million to write down the current book value to the estimated net proceeds. ~~During September 2006,~~The sales of these businesses were completed in the Company ceased operations at a funeral home business when the lease on the property expired. The carrying value of the assets of this business was reduced to management’s estimate of the realizable value by recording impairment charges totaling $0.9 million during the secondthird quarter of 2006. The preneed contracts and other business assets were transferred to another company-owned funeral home in the area. Income from discontinued operations for the nine months ending September 30, 2005 totaled $1.2 million, equal to $0.07 per share, and consisted primarily of a gain on the sale of a funeral home business during the first quarter of 2005.

- 17 -

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~~consistent 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.~~accounting principles generally accepted ~~accounting principles~~in the United States excluding certain year end adjustments because of the interim nature of the consolidated financial statements. 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, ~~2005.~~2006. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Funeral and Cemetery Operations

We record the sales of funeral and cemetery merchandise and services when the ~~funeral~~merchandise is delivered or 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)~~(FAS) No. 66, “Accounting for Sales of Real ~~Estate.”~~Estate”. This method generally 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.~~Company.

Allowances for bad debts and customer cancellations ~~refunds and bad debts~~ are provided at the date that the ~~contract~~sale is ~~executed.~~recognized as revenue. 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~~on the sale of the policies. Insurance commissions earned by the Company are recognized as revenues when the commission is no longer subject to refund, which is usually one year after the policy is issued.

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~~consist of ~~prearranged funeral and cemetery service and merchandise~~ sales ~~contracts. Prior to this change,~~ commissions that we pay our sales counselors and other direct ~~selling~~related costs ~~related to~~of 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 improves the comparability of its reported earnings because all of the public deathcare companies now apply this method.

The Company 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 per diluted share, which represents the cumulative balance of deferred preneed selling costs in

~~- 19 -~~

~~the Company’s consolidated balance sheet at the end of 2004. The Company’s results of operations are reported on the basis of our changed method for all periods presented.~~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~~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.”~~Taxes” and account for uncertain tax positions in accordance with FASB Interpretation No. 48 “Accounting for Uncertainty in 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 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 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 Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (“FAS No. 123R”). FAS No. 123R requires companies to recognize compensation expense in

- 18 -

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 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 first quarter of 2006, using the modified prospective application ~~method, which results in no restatement~~method.

We have granted restricted stock to certain officers and key employees of the ~~Company’s previously issued annual consolidated financial statements. See Note 2~~Company, which vest over a period of four years. These shares are valued at the dates granted and the value is charged to operations as the ~~consolidated financial statements.~~shares vest.

Discontinued Operations

~~Prior~~In accordance with the Company’s strategic portfolio policy, non-strategic businesses are reviewed to ~~2006,~~determine whether the businesses should be sold and the proceeds redeployed elsewhere. A marketing plan is then developed for those locations which are identified as held for sale. When the Company ~~accounted for stock based compensation under APB No. 25~~receives a letter of intent and ~~provided~~financing commitment from the ~~disclosures required under SFAS No. 123, “Accounting for Stock-Based Compensation”, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition~~buyer and ~~Disclosure.”~~

~~Impairment and Disposal 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 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 notsale is expected to ~~provide any future service potential to~~occur within one year, the ~~Company~~location is no longer reported within the Company’s continuing operations. The assets and liabilities associated with the held for sale location are ~~recorded at~~reclassified on the ~~lower of carrying amount or fair value less estimated cost to sell. The revenues~~balance sheet and ~~expenses,~~the operating results, as well as ~~gains, losses and~~ impairments, ~~from those assets~~ are ~~reported~~presented on a comparative basis in the discontinued operations section of the Consolidated ~~Statement~~Statements of Operations, ~~for all periods presented.~~

~~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

~~- 20 -~~

~~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, in connection~~along with the ~~implementation of FIN 46R, 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.tax effect.

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, 2005~~March 31, 2006 and ~~2006.~~2007. Funeral homes and cemeteries owned and operated for the entirety of each period being compared are referred to as “same-store” or “existing operations.” Gross profit for purposes of this analysis does not include regional and unallocated funeral and cemetery costs which total $1.5 million and $1.4 million, respectively.

Funeral Home Segment. The following table sets forth certain information regarding the ~~revenue~~revenues and gross profit of the Company from the funeral home operations for the three ~~and nine~~ months ended ~~September 30, 2005~~March 31, 2006 compared to the three ~~and nine~~ months ended ~~September 30, 2006.~~

~~Three months ended September 30, 2005 compared to three months ended September 30, 2006 (dollars~~March 31, 2007(dollars in thousands):.

Three Months Ended
September 30, Change
2005 2006 Amount Percent
Total same-store revenue $ 25,330 $ 26,378 $ 1,048 4.1 %
Acquired and closed 45 271 226 *
Preneed insurance commissions revenue 613 636 23 3.8 %

Revenues from continuing operations $ 25,988 $ 27,285 $ 1,297 5.0 %

Revenues from discontinued operations $ 614 $ 94 $ (520 ) *

Total same-store gross profit $ 5,401 $ 5,219 $ (182 ) (3.4 %)
Acquired and closed (51 ) 30 81 *
Preneed insurance commissions revenue 613 636 23 3.8 %

Gross profit from continuing operations $ 5,963 $ 5,885 $ (78 ) (1.3 %)

Gross profit from discontinued operations $ 126 $ (31 ) $ (157 ) *


*		~~not meaningful~~

~~- 21 -~~

~~Nine months ended September 30, 2005 compared to nine months ended September 30, 2006 (dollars in thousands):~~


	Nine Months Ended											Three Months Ended
	September 30,					Change						March 31,					Change
	2005			2006		Amount			Percent			2006		2007			Amount			%
Total same-store revenue	$	83,118		$	84,758	$	1,640			2.0	%	$	30,401	$	30,977		$	576			1.9	%
Acquired and closed		177			818		641			*
Acquired													—		952			952			*
Preneed insurance commissions revenue		1,654			1,819		165			10.0	%		587		642			55			9.4	%

Revenues from continuing operations	$	84,949		$	87,395	$	2,446			2.9	%	$	30,988	$	32,571		$	1,583			5.1	%

Revenues from discontinued operations	$	1,927		$	1,171	$	(756	)		*		$	1,142	$	145		$	(997	)		*


Total same-store gross profit	$	21,162		$	20,123	$	(1,039	)		(4.9	%)	$	10,354	$	10,598		$	244			2.4	%
Acquired and closed		(99	)		186		285			*
Acquired													—		367			367			*
Preneed insurance commissions revenue		1,654			1,819		165			10.0	%		587		642			55			9.4	%

Gross profit from continuing operations	$	22,717		$	22,128	$	(589	)		(2.6	%)	$	10,941	$	11,607		$	666			6.1	%

Gross profit from discontinued operations	$	416		$	234	$	(182	)		*		$	314	$	(35	)	$	(349	)		*


*		not meaningful

Funeral same-store revenues for the three months ended ~~September 30, 2006~~March 31, 2007 increased ~~$1.0~~$0.6 million, or ~~4.1 percent,~~1.9%, when compared to the three months ended ~~September 30, 2005~~March 31, 2006 as we experienced a decrease of ~~1.5 percent~~1.7% in the number of contracts and an increase of ~~5.7 percent~~3.6% to ~~$5,136~~$5,285 in the average revenue per contract for those existing operations. ~~Performance was strong in~~Total funeral same-store gross profit for the ~~Eastern Region, where~~three months ended March 31, 2007 increased $0.2 million from the ~~number~~comparable three months of ~~contracts~~2006, and as a percentage of funeral same-store revenue, increased ~~6.2 percent and the contract average increased 4.9 percent. The Western Region experienced a 7.0 percent decrease in the number of contracts, while the contract average increased 6.7 percent.~~from 34.1% to 34.2%. The Central Region ~~suffered a slight decline~~accounted for $419,000 of ~~1.2 percent~~the increase in same-store revenues and provided most of the increase in same-store profits. The improvement in the ~~number of contracts and an~~Central Region was due to the ability to realize a 6.4% increase ~~of 2.8 percent~~ in the average revenue per contract ~~average.~~and more aggressive expense management.

Acquired revenue and gross profit is related primarily to the businesses acquired at the beginning of 2007 in Corpus Christi, Texas.

Cremation services represented ~~34.9 percent~~35.0 % of the number of funeral services during the ~~third~~first quarter of ~~2006,~~2007, an increase from ~~1.6 percent~~33.4 % in the ~~third~~first quarter of ~~2005.~~2006. The average revenue for burial contracts increased ~~6.0 percent~~5.4 % to ~~$7,103,~~$7,309, and the average revenue for cremation contracts increased ~~8.1 percent~~6.7% to ~~$2,574.~~$2,817. The Company has addressed the growing demand for cremation by training the funeral directors to present multiple merchandise and service options to families, resulting in choices that produce higher revenues.

Total funeral same-store gross profit for the three months ended September 30, 2006 decreased $0.2 million from the comparable three months of 2005, and as a percentage of funeral same-store revenue, declined from 21.3 percent to 19.8 percent primarily because of increases in funeral operating expenses and adjustments to incentive compensation.

Funeral same-store revenues for the nine months ended September 30, 2006 increased 2.0 percent when compared to the nine months ended September 30, 2005, as we experienced a decrease of 2.0 percent in the number of contracts and an increase of 4.0 percent to $5,152 in the The average revenue ~~per contract~~ for ~~those existing operations. Cremation services represented 34.1~~“other” contracts, which make up approximately nine percent of the number of contracts, declined 8.4% to $2,132. Other contracts consist of charges for merchandise or services for which we do not perform a funeral ~~services~~service for the deceased during the nine months ended September 30, 2006 compared to 32.8 percent for the nine months ended September 30, 2005. The average revenue for burial contracts increased 3.8 percent to $7,024, while the average revenue for cremation contracts increased 8.2 percent to $2,631.period.

- 19 -

Total funeral same-store gross profit for the nine months ended September 30, 2006 decreased $1.0 million from the comparable nine months of 2005, and as a percentage of funeral same-store revenue, decreased from 25.5 percent to 23.7 percent. The decline for the nine month period was primarily due to the underperformance of the Central Region where pretax earnings were $1.6 million lower, equal to $0.05 per diluted share.

Cemetery Segment. The following table sets forth certain information regarding the ~~revenue~~revenues and gross profit of the Company from the cemetery operations for the three ~~and nine~~ months ended ~~September 30, 2005 compared to the three and nine months ended September 30, 2006:~~

~~Three months ended September 30, 2005~~March 31, 2006 compared to the three months ended ~~September 30, 2006 (dollars~~March 31, 2007(dollars in thousands):.

Three Months Ended
September 30, Change
2005 2006 Amount Percent
Revenues from continuing operations $ 9,563 $ 8,215 $ (1,348 ) (14.1 %)

Revenues from discontinued operations $ 326 $ 116 $ (210 ) *

Gross profit (loss) from continuing operations $ 1,800 $ (254 ) $ (2,054 ) (114.1 %)

Gross profit (loss) from discontinued operations $ (14 ) $ 61 $ 75 *


*		~~not meaningful~~

~~- 22 -~~

~~Nine months ended September 30, 2005 compared to the nine months ended September 30, 2006 (dollars in thousands):~~


	Nine Months Ended										Three Months Ended
	September 30,				Change						March 31,					Change
											2006			2007		Amount			%
Total same-store revenue											$	10,054		$	9,699	$	(355	)		(3.5	)%
Acquired												—			388		388			*
	2005		2006		Amount			Percent
Revenues from continuing operations	$	28,715	$	27,451	$	(1,264	)		(4.4	%)	$	10,054		$	10,087	$	33			0.3	%

Revenues from discontinued operations	$	1,450	$	778	$	(672	)		*		$	190		$	—	$	(190	)		*


Total same-store gross profit											$	2,599		$	2,901	$	302			11.6	%
Acquired												—			56		56			*

Gross profit from continuing operations	$	5,498	$	2,477	$	(3,021	)		(54.9	%)	$	2,599		$	2,957	$	358			13.8	%

Gross profit from discontinued operations	$	265	$	121	$	(144	)		*		$	(92	)	$	—	$	92			*


*		not meaningful

Cemetery same-store revenues ~~from continuing operations~~ for the three months ended ~~September 30, 2006~~March 31, 2007 decreased ~~$1.3~~$0.4 million, or ~~14.1 percent~~3.5% compared to the three months ended ~~September 30, 2005,~~March 31, 2006, the majority of which ~~$0.5 million related~~was due to the recognition of the sale of a private mausoleum ~~completion~~ in the ~~third quarter of last year. Atneed~~2006 period. Total atneed revenues ~~and the related gross profit were comparable at approximately $3.1~~increased from $3.5 million ~~and $2.4 million, respectively. Preneed~~to $3.8 million. Total revenue from preneed property ~~revenues decreased $0.7 million primarily as a function of a 10 percent decrease in~~sales increased $0.2 million. Though the number of ~~interment rights~~interments sold ~~at an average of $1,912 per site, which is 1.3 percent less than~~on a preneed basis remained the same, ~~period in~~ the prior year. Substantially all of the decrease in sales of interments occurred at our largest cemetery in California. Revenue from the delivery of preneed merchandise and services declined $0.4 million in comparing the two periods. Financial revenues (trust earnings and finance charges on installment contracts)average price per space increased ~~$0.1 million on the strength of higher trust earnings.~~5.0%.

Cemetery same-store gross profit ~~from continuing operations~~ for the three months ended ~~September 30, 2006 decreased $2.1~~March 31, 2007 increased $0.3 million from the comparable three months of ~~2005~~2006 and as a percentage of revenues ~~decreased~~increased from ~~18.8 percent~~25.9% to ~~(0.3) percent,~~30.0%, the ~~majority~~primary reason was an increase of ~~which is due to a decline~~pre-tax earnings of ~~$1.2 million, or $0.04 per diluted share,~~$476,000 at ~~the largest California cemetery. The Company determined,~~Rolling Hills Memorial Park. Secondarily, improvements in the third quarter that landscaping and development performed at this cemetery prior to Carriage’s ownership created an environmental watershed issue which will cost $0.7 million to remediate. These costs are recorded as expenses for the quarter. Additionally, the Company reorganized the leadership over the cemetery operations during the third quarter thatcollection efforts resulted in ~~severance costs of $0.2 million.~~lower bad debt expense.

Cemetery revenues from continuing operations for the nine months ended September 30, 2006 decreased $1.3 million or 4.4 percent compared to the nine months ended September 30, 2005 for the reasons discussed above for the third quarter. The average value of interment rights sold during the first nine months increased 3.2 percent to $2,047 while the number of interment rights sold declined 10.7 percent. Financial revenues (trust earningsAcquired revenue and finance charges on installment contracts) totaled approximately $2.8 million; a $0.2 million decline from the same period in the prior year, primarily the result of lower gains recognized on trust fund investments during the first half of the year.

~~Cemetery~~ gross profit ~~from continuing operations for~~represents the ~~nine months ended September 30, 2006 decreased $3.0 million from the comparable nine months~~results of ~~2005, and as a percentage of revenues decreased from 19.2 percent to 9.0 percent primarily due to the $2.1 million decline~~Seaside Cemetery in profitability of the California cemetery referred to above. That particular cemetery experienced a decline of $1.4 million in preneed property sales, an increase in bad debts of $0.2 million and a decline of $0.4 million in atneed revenues. We have made changes in the leadership of that business to focus on correcting these sales and operational issues.Corpus Christi, Texas.

Other. General, administrative and ~~administrative~~other expenses totaled $3.7 million for the three ~~and nine~~ months ended September 30, 2006 decreased $0.4 and $0.8 million or approximately 12.4 and 8.7 percent, respectively, as compared to the same periods of 2005 primarily because the 2005 period included higher professional fees related to our compliance with the internal control reporting requirements of Sarbanes-OxleyMarch 31, 2007 and the development of a new cemetery information system. 2006 is the first period in which the Company recognized compensation expense related to its stock options and employee stock purchase plan under a new accounting standard. See Note 2 to the Consolidated Financial Statement. Stock-based compensation totaling $45,000 and $198,000 is included in general and administrative expenses for the three ~~and nine months period ended September 30, 2006, respectively.~~

~~Other income for the nine~~ months ended ~~September 30, 2006 includes a gain on~~March 31, 2006. Included in this category are the ~~sale of excess real estate and interest income on~~costs to integrate the ~~short-term investments.~~businesses acquired in Corpus Christi.

Income Taxes

The Company recorded income taxes on earnings from continuing operations at the effective rate of ~~37.5 percent~~38.5% during ~~2006.~~2007. For ~~federal~~Federal income tax reporting purposes, Carriage has net operating loss carryforwards totaling ~~$21.6~~$6.9 million (excluding $13.3 million of unrecognized deductions) available at ~~September 30, 2006~~March 31, 2007 to offset future Federal taxable income, which expire between ~~2021and~~2021 and 2025 if not utilized. Carriage also has approximately ~~$80~~$72.3 million of state net operating loss carryforwards that will expire between 2006 and 2025, if not utilized. Based on management’s assessment of the various state net operating losses, it was determined that it is more likely than not that the Company will not be able to realize tax benefits on a substantial amount of the state losses. Accordingly, the Company established a valuation allowance against a substantial portion of the deferred tax asset related to the state operating losses.

~~- 23 -~~

LIQUIDITY AND CAPITAL RESOURCES

Cash ~~(including~~and corporate investments at March 31, 2007 totaled $33.3 million and consisted of $25.4 million in cash, $2.9 million in restricted ~~cash)~~cash and ~~short-term~~$5.0 million in Federal agency bonds. Cash and corporate investments totaled ~~$34.4~~$41.0 million at ~~September 30, 2006, representing an increase of $9.5 million from~~ December 31, ~~2005.~~2006. The decrease of $7.7 million since year end 2006 is primarily attributable to the $6.4 million used in the acquisition in the first quarter of 2007. For the ~~nine~~three months ended ~~September 30, 2006,~~March 31, 2007, cash ~~provided~~used by operating activities was ~~$9.8~~$1.6 million as compared to ~~cash used of $9.3~~$1.2 million for the ~~nine~~three months ended September 30, 2005. The $19.1 million improvement is primarily because the 2005 period 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. Year to date,March 31, 2006. Additionally, capital expenditures ~~total $5.0~~totaled $2.2 million compared to ~~$5.6~~$1.1 million in the prior year. ~~For the year 2006 the capital expenditures are expected to total approximately $6.5 million.~~

In ~~connection~~accordance with the terms of our credit facility, a portion of the cash proceeds from the sale of ~~a funeral home business and a combination~~ funeral home and cemetery ~~business during~~businesses are pledged to the ~~third quarter of 2006, and in accordance with the bank credit facility, approximately $5.5 million~~benefit of the ~~net cash proceeds~~lenders and are ~~pledged and~~ restricted for use only for acquisitions of similar businesses, capital expenditures, or ~~capital expenditures. The~~paydowns of debt. At March 31, 2007, $2.9 million was pledged for that purpose, and $1.5 million was released back to the Company ~~expects to use the restricted cash for those purposes in~~during April 2007.

- 20 -

The Company’s senior debt at ~~September 30, 2006~~March 31, 2007 totaled ~~$140.7~~$140.1 million and consisted of $130.0 million in ~~senior notes,~~Senior Notes, described below, and ~~$10.7~~$10.1 million in acquisition indebtedness and capital lease obligations. Additionally, $0.4 million in letters of credit were issued under the credit facility and were outstanding at March 31, 2007.

~~In April 2005, the~~The Company ~~entered into~~has a $35 million senior secured revolving credit facility that matures in 2010 and is collateralized by all personal property and funeral home real property in certain states. Borrowings under the new credit facility will bear interest at prime or LIBOR options with the current LIBOR option set at LIBOR plus 300 basis points. The revolving line of credit is currently undrawn.

~~In January 2005, the Company issued $130 million of 7.875% 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 2015.

~~The aggregate~~ principal amount of the Company’s convertible junior subordinated debenture is $93.75 million, is payable to the Company’s unconsolidated affiliate, ~~trust,~~ Carriage Services Capital Trust, bears interest at 7% and matures 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% annual rate. Also, the deferred distributions themselves accumulate distributions at the annual rate of 7%. 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 has exercised the deferral provision once when it began deferring interest payments 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 Companycurrently expects to continue paying the distributions as due.

The Company intends to use its cash and short-term investments, cash flow provided by operations (which is expected to total $9$14 to ~~$10~~$16 million in ~~2006)~~2007) and proceeds from the sale of businesses, to acquire funeral home and cemetery businesses. The Company also has the ability to draw on its revolving credit facility, subject to customary terms and conditions of the credit agreement, to finance acquisitions.

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 about Market Risk

Carriage is currently exposed to market risk primarily related to changes in interest rates related to the Company’s 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 annual report filed on Form 10-K for the year ended December 31, ~~2005.~~2006. 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, ~~2005.~~2006.

~~- 24 -~~

Item 4. Controls and Procedures

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 management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of ~~September 30, 2006~~March 31, 2007 to provide reasonable assurance that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the 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 change in our internal control over financial reporting that occurred during the ~~nine~~three months ended ~~September 30, 2006~~March 31, 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

- 21 -

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 our risk factors from those disclosed in Item 1A of our Annual Report on Form 10-K for the year ended December 31, ~~2005.~~2006.

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

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

~~None.~~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. Prior to May 2006, the shares issued to directors in lieu of payment in cash were unregistered. In connection with our Annual Meeting of Stockholders in May 2006, the stockholders approved our 2006 Long Term Incentive Plan and the Company registered the shares available for future issue for this compensation policy and other corporate purposes. The Company issued 1,667 unregistered shares of common stock to directors in lieu of payment in cash for their fees for the third quarter of 2005, the value of which was charged to operations. The Company issued 6,800 and 3,003 unregistered shares of common stock to directors in lieu of payment in cash for their fees for the nine months ended September 30, 2005 and 2006, respectively, the value of which was charged to operations. No underwriter was used in connection with these issuances. Carriage relied on the Section 4(2) exemption from the registration requirements of the Securities Act of 1933, as amended.None

Item 3. Defaults Upon Senior Securities

None

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

None

~~- 25 -~~

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.

Item 6. Exhibits


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

- 2622 -

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


		CARRIAGE SERVICES, INC.

~~November~~ May 9, ~~2006~~	2007	/s/ Joseph Saporito

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

- 2723 -

CARRIAGE SERVICES, INC.

INDEX OF EXHIBITS


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

- 2824 -


	Three months ended
	September 30, 2006
						Results under
	As Reported			Effect of Change		Prior Method
Loss from continuing operations before income taxes	$	(823	)	$	45	$	(778	)
Net loss available to common stockholders		(565	)		28		(537	)

Net loss per share available to common stockholders:
Basic	$	(0.03	)	$	—	$	(0.03	)
Diluted		(0.03	)		—		(0.03	)


	Three months ended
	September 30, 2005
	As Reported		Effect of Change			Pro Forma
Income from continuing operations before income taxes	$	113	$	(78	)	$	35
Net income available to common stockholders		670		(49	)		621

Net income per share available to common stockholders:
Basic	$	0.04	$	—		$	0.04
Diluted		0.04		—			0.04


				Weighted-Average		Aggregate
	Shares			Exercise Price		Intrinsic Value
	(in thousands)					(in thousands)
Outstanding at December 31, 2005		1,365		$	3.39
Granted		24		$	4.81
Exercised		(75	)	$	2.76
Cancelled and expired		(23	)	$	7.22

Outstanding at September 30, 2006		1,291		$	3.39	$	2,347

Exercisable at September 30, 2006		1,246		$	3.35	$	2,332


Options Outstanding							Options Exercisable
Actual Range			Weighted-						Weighted-
of Exercise			Average						Average
Prices	Number		Remaining		Weighted-		Number		Remaining		Weighted-
150%	Outstanding		Contractual		Average		Exercisable at		Contractual		Average
increment	at 9/30/06		Life		Exercise Price		9/30/06		Life		Exercise Price
$1.19- 1.56		633		4.2	$	1.49		633		4.2	$	1.49
$2.06- 3.09		152		3.8	$	2.89		152		3.8	$	2.89
$3.12- 4.66		145		6.6	$	4.20		105		6.5	$	4.15
$4.77- 6.19		307		6.0	$	5.02		302		6.0	$	5.00
$13.25- 19.88		48		2.0	$	15.06		48		2.0	$	15.06
$21.00- 27.50		6		0.6	$	21.19		6		0.6	$	21.19

$1.19- 27.50		1,291		4.8	$	3.39		1,246		4.7	$	3.35


	Stock Options			ESPP
2006 Assumptions:
Expected dividend yield		0	%		0	%
Expected volatility		58	%		58	%
Risk-free interest rate		4.25	%		4.25	%
Expected life (years)		5			.25, .50, .75, 1


	Stock Options			ESPP
2005 Assumptions:
Expected dividend yield		0	%		0	%
Expected volatility		50	%		50	%
Risk-free interest rate		3.00	%		3.00	%
Expected life (years)		5			.25, .50, .75, 1


Due in one year or less	$	2,947
Due in one to five years		15,400
Due in five to ten years		4,936
Thereafter		161

	$	23,444


Due in one year or less	$	3,169
Due in one to five years		14,235
Due in five to ten years		4,760
Thereafter		247

	$	22,411


Due in one year or less	$	2,162
Due in one to five years		4,448
Due in five to ten years		1,434
Thereafter		252

	$	8,296


	September 30, 2006
	Preneed		Preneed		Total
	Funeral		Cemetery		Preneed
Trust assets, at market value	$	45,215	$	53,868	$	99,083


Non-controlling interests	$	45,215	$	53,868	$	99,083