SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2005


o
~~For the quarterly period ended June 30, 2005~~

OR

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

For the transition period fromto

Commission file number: 1-11961

CARRIAGE SERVICES, INC.

(Exact name of registrant as specified in its charter)

~~DELAWARE~~		~~76-0423828~~
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
~~1900 Saint James Place, 4~~^th ~~Floor, 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. Yesýþ Noo

Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act).
Yeso Noýþ

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 ~~August 9,~~November 1, 2005 was ~~18,421,000.~~
18,458,673.

CARRIAGE SERVICES, INC.
INDEX
Page
PART I -— FINANCIAL INFORMATION
Item 1.
Financial Statements
Consolidated Balance Sheets as of December 31, 2004 and ~~June~~September 30, 2005 (unaudited)
3
Consolidated Unaudited Statements of Operations for the Three Months ended ~~June~~September 30, 2004 and 2005 and ~~Six~~Nine Months ended ~~June~~September 30, 2004 and 2005
4
Consolidated Unaudited Statements of Cash Flows for the ~~Six~~Nine Months ended ~~June~~September 30, 2004 and 2005
5
Condensed Notes to Consolidated Financial Statements
6
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
17
Item 3.
Quantitative and Qualitative Disclosures of Market Risk
26
Item 4.
Controls and Procedures
26
PART II -— OTHER INFORMATION
Item 1.
Legal Proceedings
27
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
27
Item 3.
Defaults Upon Senior Securities
27
Item 4.
Submission of Matters to a Vote of Security Holders
27
Item 5.
Other Information
27
Item 6. Exhibits
~~Exhibits~~
28
Signatures
29
Amendment No.1 to Credit Agreement
Computation of Per Share Earnings
Certification of Melvin C. Payne in satisfaction of Section 302
Certification of Joseph Saporito in satisfaction of Section 302
Certification of Melvin C. Payne in satisfaction of Section 906
Certification of Joseph Saporito in satisfaction of Section 906
-2-
2

PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
CARRIAGE SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)

December 31,

June 30,

2004

2005

(unaudited)

ASSETS

Current assets:

Cash and cash equivalents

$
1,948

$
8,352

Short term investments

—

12,849

Accounts receivable — trade, net of allowance for doubtful accounts of $940 in 2004 and $1,034 in 2005

12,941

12,562

Assets held for sale

4,021

6,546

Inventories and other current assets

12,815

13,198

Total current assets

31,725

53,507

Preneed receivables and trust investments:

Cemetery

65,855

66,300

Funeral

49,494

48,288

Receivable from funeral trusts

18,074

17,483

Property, plant and equipment, at cost, net of accumulated depreciation of $40,531 in 2004 and $43,386 in 2005

104,893

105,201

Cemetery property

62,649

61,237

Goodwill

156,983

156,983

Deferred obtaining costs

35,701

—

Deferred charges and other non-current assets

8,581

25,325

Cemetery perpetual care trust investments

31,201

32,655

Total assets

$
565,156

$
566,979

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:

Accounts payable

$
5,991

$
4,233

Accrued liabilities

16,048

16,944

Liabilities associated with assets held for sale

2,598

6,100

Current portion of senior long-term debt and capital leases obligations

2,155

2,180

Total current liabilities

26,792

29,457

Senior long-term debt, net of current portion

102,714

135,342

Convertible junior subordinated debenture due in 2029 to an affiliated trust

93,750

93,750

Obligations under capital leases, net of current portion

5,424

5,386

Deferred interest on convertible junior subordinated debenture

10,891

—

Preneed obligations:

Deferred cemetery revenue

46,787

46,163

Deferred preneed funeral contracts revenue

30,973

30,053

Non-controlling interests in funeral and cemetery trust investments

98,652

98,116

Total liabilities

415,983

438,267

Commitments and contingencies

Non-controlling interests in perpetual care trust investments

32,212

33,511

Non-controlling interests in perpetual care trust investments associated with assets held for sale

523

988

Stockholders’ equity:

Common Stock, $.01 par value; 80,000,000 shares authorized; 17,910,000 and 18,383,000 shares issued and outstanding at December 31, 2004 and June 30, 2005, respectively

179

184

Contributed capital

188,029

190,175

Accumulated deficit

(71,056
)
(94,384
)
Deferred compensation

(714
)
(1,762
)
Total stockholders’ equity

116,438

94,213

Total liabilities and stockholders’ equity

$
565,156

$
566,979

December 31, September 30,
2004 2005
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 1,948 $ 7,335
Short term investments — 8,979
Accounts receivable — trade, net of allowance for doubtful accounts of $940 in 2004 and $827 in 2005 12,941 13,188
Assets held for sale 4,021 —
Inventories and other current assets 12,815 14,321

Total current assets 31,725 43,823

Preneed assets 133,423 142,658
Property, plant and equipment, at cost, net of accumulated depreciation of $40,531 in 2004 and $44,788 in 2005 104,893 105,698
Cemetery property 62,649 61,787
Goodwill 156,983 157,352
Deferred obtaining costs 35,701 —
Deferred charges and other non-current assets 8,581 24,945
Cemetery perpetual care trust investments 31,201 32,855

Total assets $ 565,156 $ 569,118

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable $ 5,991 $ 3,414
Accrued liabilities 16,048 13,558
Liabilities associated with assets held for sale 2,598 —
Current portion of senior long-term debt and capital leases obligations 2,155 2,182

Total current liabilities 26,792 19,154
Senior long-term debt, net of current portion 102,714 134,886
Convertible junior subordinated debenture due in 2029 to an affiliated trust 93,750 93,750
Obligations under capital leases, net of current portion 5,424 5,369
Deferred interest on convertible junior subordinated debenture 10,891 —
Deferred revenue 176,412 184,618

Total liabilities 415,983 437,777

Commitments and contingencies
Non-controlling interests in perpetual care trust investments 32,212 36,035
Non-controlling interests in perpetual care trust investments associated with assets held for sale 523 —
Stockholders’ equity:
Common Stock, $.01 par value; 80,000,000 shares authorized; 17,910,000 and 18,429,000 shares issued and outstanding at December 31, 2004 and September 30, 2005, respectively 179 184
Contributed capital 188,029 190,376
Accumulated deficit (71,056 ) (93,711 )
Deferred compensation (714 ) (1,543 )

Total stockholders’ equity 116,438 95,306

Total liabilities and stockholders’ equity $ 565,156 $ 569,118

The accompanying condensed notes are an integral part of these consolidated financial statements.
-3-
3

CARRIAGE SERVICES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited and in thousands, except per share data)

For the three months
ended June 30,

For the six months
ended June 30,

2004

2005

2004

2005

Revenues, net

Funeral

$
27,697

$
28,438

$
58,472

$
60,255

Cemetery

9,593

9,564

19,070

19,590

37,290

38,002

77,542

79,845

Costs and expenses

Funeral

21,167

21,156

42,623

43,162

Cemetery

7,451

8,054

14,492

15,687

28,618

29,210

57,115

58,849

Gross profit

8,672

8,792

20,427

20,996

General and administrative expenses

2,545

3,000

5,228

5,779

Operating income

6,127

5,792

15,199

15,217

Interest expense

4,395

4,714

8,777

9,377

Additional interest and other costs of senior debt refinancing

—

240

—

6,933

Other (income) expense

(891
)
447

(891
)
390

Total interest and other (income) expense

3,504

5,401

7,886

16,700

Income (loss) from continuing operations before income taxes

2,623

391

7,313

(1,483
)
Provision (benefit) for income taxes

984

153

2,742

(561
)
Net income (loss) from continuing operations

1,639

238

4,571

(922
)
Discontinued operations

Operating income (loss) from discontinued operations

228

(16
)
420

96

Gain on sales and (impairments) of discontinued operations

(3,050
)
5

(3,050
)
465

Income tax (provision) benefit

725

4

653

(211
)
Income (loss) from discontinued operations

(2,097
)
(7
)
(1,977
)
350

Cumulative effect of change in accounting method, net of tax benefit benefit

—

—

—

(22,756
)
Net income (loss)

$
(458
)
$
231

$
2,594

$
(23,328
)
Basic earnings (loss) per common share

Continuing operations

$
0.09

$
0.01

$
0.26

$
(0.05
)
Discontinued operations

(0.12
)
—

(0.11
)
0.02

Cumulative effect of change in accounting method

—

—

—

(1.26
)
Net income (loss)

$
(0.03
)
$
0.01

$
0.15

$
(1.29
)
Diluted earnings (loss) per common share

Continuing operations

$
0.09

$
0.01

$
0.25

$
(0.05
)
Discontinued operations

(0.12
)
—

(0.11
)
0.02

Cumulative effect of change in accounting method

—

—

—

(1.26
)
Net income (loss)

$
(0.03
)
$
0.01

$
0.14

$
(1.29
)
Weighted average number of common and common equivalent shares outstanding:

Basic

17,764

18,325

17,710

18,227

Diluted

18,258

18,826

18,199

18,227

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

35,808 36,458 113,630 116,580

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

27,708 28,553 85,028 87,683
Gross profit 8,100 7,905 28,602 28,897
General and administrative expenses 2,748 3,142 7,975 8,921

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

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

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

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

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

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

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

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

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

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

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

Diluted 18,281 18,938 18,226 18,294

The accompanying condensed notes are an integral part of these consolidated financial statements.
-4-
4

CARRIAGE SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited and in thousands)

For the six months
ended June 30,

2004

2005

Cash flows from operating activities:

Net income (loss) from continuing operations

$
4,571

$
(922
)
Adjustments to reconcile net income (loss) from continuing operations to net cash provided by (used in) continuing operating activities:

Depreciation

3,500

3,374

Amortization

2,639

1,472

Provision for losses on accounts receivable

1,187

1,503

Net (gain) loss on sale of business assets

(891
)
574

Stock-based compensation

259

354

Loss on early extinguishment of debt

—

978

Loss on sale of trust investments

235

—

Deferred income taxes

2,742

(561
)
Other

9

(49
)
Changes in assets and liabilities, net of effects from dispositions

(Increase) in accounts receivable

(331
)
(2,258
)
(Increase) in inventories and other current assets

(50
)
(785
)
(Increase) in deferred charges and other

(176
)
(593
)
(Increase) in deferred obtaining costs

(2,238
)
—

(Increase) in preneed trust investments

(459
)
(2,472
)
(Decrease) in accounts payable and accrued liabilities

(1,392
)
(1,503
)
Increase in deferred preneed revenue

943

3,906

Increase (decrease) in deferred interest on convertible junior subordinated debenture

3,447

(10,345
)
Net cash provided by (used in) operating activities of continuing operations

13,995

(7,327
)
Net cash provided by operating activities of discontinued operations

313

327

Net cash provided by (used in) operating activities

14,308

(7,000
)

Cash flows from investing activities:

Net proceeds from sales of businesses and other assets

845

182

Purchase of short term investments

—

(12,849
)
Capital expenditures

(2,165
)
(3,456
)
Net cash used in investing activities of continuing operations

(1,320
)
(16,123
)
Net cash provided by (used in) investing activities of discontinued operations

(63
)
505

Net cash used in investing activities

(1,383
)
(15,618
)

Cash flows from financing activities:

Payments on bank line of credit

(10,200
)
(25,600
)
Proceeds from the issuance of senior notes

—

130,000

Payments on senior long-term debt and obligations under capital leases

(2,658
)
(71,794
)
Proceeds from issuance of common stock

162

211

Proceeds from the exercise of stock options

184

379

Payment of financing costs

—

(4,175
)
Net cash provided by (used in) financing activities of continuing operations

(12,512
)
29,021

Net cash used in financing activities of discontinued operations

—

—

Net cash provided by (used in) financing activities

(12,512
)
29,021

Net increase in cash and cash equivalents

413

6,404

Cash and cash equivalents at beginning of period

2,024

1,948

Cash and cash equivalents at end of period

$
2,437

$
8,352

For the nine months
ended September 30,
2004 2005
Cash flows from operating activities:
Net income (loss) from continuing operations $ 5,089 $ (782 )
Adjustments to reconcile net income (loss) from continuing operations to net cash provided by (used in) continuing operating activities:
Depreciation 5,273 5,126
Amortization 3,702 2,283
Provision for losses on accounts receivable 1,781 2,112
Net (gain) loss on sale of business assets (963 ) 577
Stock-based compensation 374 512
Loss on early extinguishment of debt — 978
Loss on sale of trust investments 235 —
Deferred income taxes 3,053 (483 )
Other 502 11
Changes in assets and liabilities, net of effects from acquisitions and dispositions (Increase) in accounts receivable (885 ) (2,967 )
(Increase) in inventories and other current assets (718 ) (1,814 )
(Increase) in deferred charges and other (198 ) (779 )
(Increase) in deferred obtaining costs (3,455 ) —
(Increase) in preneed trust investments (869 ) (3,708 )
(Decrease) in accounts payable and accrued liabilities (2,816 ) (4,781 )
Increase in deferred revenue 1,338 4,564
Increase (decrease) in deferred interest on convertible junior subordinated debenture 5,216 (10,345 )

Net cash provided by (used in) operating activities of continuing operations 16,659 (9,496 )
Net cash provided by operating activities of discontinued operations 514 62

Net cash provided by (used in) operating activities 17,173 (9,434 )

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

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

Net cash provided by (used in) investing activities 250 (13,957 )

Cash flows from financing activities:
Net proceeds (payments) on bank line of credit 7,500 (25,600 )
Proceeds from the issuance of senior notes — 130,000
Payments on senior long-term debt and obligations under capital leases (25,117 ) (72,274 )
Proceeds from issuance of common stock 279 312
Proceeds from the exercise of stock options 187 515
Payment of financing costs — (4,175 )

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

Net increase in cash and cash equivalents 272 5,387
Cash and cash equivalents at beginning of period 2,024 1,948

Cash and cash equivalents at end of period $ 2,296 $ 7,335

The accompanying condensed notes are an integral part of these consolidated financial statements.
-5-
5

CARRIAGE SERVICES, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
~~(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 ~~June~~September 30, 2005, the Company owned and operated ~~133~~135 funeral homes and 3029 cemeteries in 28 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.
(c) Interim Condensed Disclosures
The information for the three and ~~six~~nine month periods ended ~~June~~September 30, 2004 and 2005 is unaudited, but in the opinion of management, reflects all adjustments which are normal, recurring and necessary for a fair presentation of financial position and results of operations for the interim periods. Certain information and footnote disclosures, normally included in annual financial statements, have been condensed or omitted. Except for Note 3, Change in Accounting for Preneed Selling Costs, the accompanying consolidated financial statements have been prepared consistent with the accounting policies described in our annual report on Form 10-K for the year ended December 31, 2004, and should be read in conjunction therewith. Certain amounts in the consolidated financial statements for the period ended in 2004 in this report have been reclassified to conform to current year presentation.
(d)Cash Equivalents
The Company considers all investments purchased with an original maturity of three months or less at the time of purchase to be cash equivalents.
(e) Use of Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Allowances from customer cancellations, refunds and bad debts are provided as a percentage of recognized revenue at the date the sale is recognized as revenue based on our historical experience. In addition, we monitor changes in delinquency rates and provide additional bad debt and cancellation reserves when warranted. Our methodologies and the resulting estimates have been reliable in past periods. We do not expect to change the factors and assumptions used in calculating these reserves in the future.
(f) Stock Plans and Stock Compensation
The Company has stock-based employee compensation plans in the form of stock option and employee stock purchase plans. The Company accounts for stock-based compensation under APB Opinion No. 25, “Accounting for Stock Issued to Employees” whereby no compensation expense is recognized in the Consolidated Statement of Operations and has adopted the disclosure-only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” and SFAS No. 148, “Accounting for Stock-Based Compensation —– Transition and Disclosure.”
-6-
6

Had compensation cost for these plans been determined consistent with SFAS No. 123, “Accounting for Stock-Based Compensation”, net income and income per share would have been the following pro forma amounts (in thousands, except per share data):

Three months ended
June 30,

Six months ended
June 30,

2004

2005

2004

2005

Net income (loss) available to common stockholders:

As reported

$
(458
)
$
231

$
2,594

$
(23,328
)
Pro forma

$
(568
)
$
121

$
2,374

$
(23,548
)

Net income (loss) per share available to common stockholders:

Basic

As reported

$
(0.03
)
$
0.01

$
0.15

$
(1.29
)
Pro forma

$
(0.03
)
$
0.01

$
0.13

$
(1.30
)
Diluted

As reported

$
(0.03
)
$
0.01

$
0.14

$
(1.29
)
Pro forma

$
(0.03
)
$
0.01

$
0.13

$
(1.30
)

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

Pro forma $ 1,070 $ 560 $ 3,490 $ (22,987 )
Net income (loss) per share available to common stockholders:
Basic
As reported $ 0.07 $ 0.04 $ 0.21 $ (1.24 )
Pro forma $ 0.06 $ 0.03 $ 0.20 $ (1.26 )
Diluted
As reported $ 0.06 $ 0.04 $ 0.21 $ (1.24 )
Pro forma $ 0.06 $ 0.03 $ 0.19 $ (1.26 )
The Company issued 268,000 shares of restricted common stock to certain officers of the Company in the first quarter of 2005. Twenty-five percent of the shares vest annually on each of the next four anniversary dates of the grant. The value of the stock at the date of grant was $4.99 per share, for a total of $1,337,320, which is amortized into expense over the vesting period.
The Company also has a compensation plan for its outside directors under which directors may choose to accept fully vested shares of the Company’s common stock for all or a portion of their annual retainer and meeting fees. The value of the shares at the grant date is charged to expense. The Company issued 2,995 and 2,247 shares of common stock to directors equal to a charge of approximately $15,000 and $14,000 each period, respectively in lieu of payment in cash for their fees for the second quarter of 2004 and 2005, respectively. The Company issued 6,250 and 5,133 shares of common stock to directors equal to a charge of $31,000 and $29,000 for the six months ended June 30, 2004 and 2005, respectively.
2.~~RECENTLY APPLIED AND~~ FUTURE ACCOUNTING CHANGES
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 will adopt the requirements beginning January 1, 2006.
Stock Related Compensation
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (“FAS No. 123R”). FAS No. 123R requires companies to recognize compensation expense in an amount equal to the fair value of the share-based payment (including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans) issued to employees. FAS No. 123R applies to all transactions involving issuance of equity by a company in exchange for goods and services, including employee services. FAS No. 123R is effective in the first annual reporting period of the first fiscal year beginning on or after June 15, 2005. The Company will adopt FAS No. 123R in the first fiscal quarter of its 2006 fiscal year and expects to use the modified prospective application method, which results in no restatement of the Company’s previously issued annual consolidated financial statements. The adoption of FAS No. 123R using the modified prospective application method is not expected to have a material impact on the consolidated financial position orand no impact on cash flows of the ~~Company, and~~Company. The future compensation expense will vary in the future due to changes in the inputs. Management currently estimates that the adoption of FAS No. 123R will reduce net income in 2006 ~~by approximately~~within a range of $0.1 million to $0.2 million.
-7-
7

3.CHANGE IN ACCOUNTING FOR PRENEED SELLING COSTS
On June 30, 2005, the Company changed its method of accounting for deferred obtaining costs, which are preneed selling costs, incurred for the origination of prearranged funeral and cemetery service and merchandise sales contracts. Prior to this change, commissions and other costs that were related to the origination of prearranged funeral and cemetery service and merchandise sales were deferred and amortized with the objective of recognizing the selling costs in the same period that the related revenue is recognized. Under the prior accounting method, the commissions and other direct selling costs, which are current obligations that are paid and use operating cash flow, are not recognized currently in the income statement. The Company believes it is preferable to expense the current obligation for the commissions and other costs rather than defer these costs. The Company also believes the new accounting method will improve the comparability of its reported earnings to the other deathcare companies. The Company has applied this change in accounting method effective January 1, 2005. Therefore, the Company’s results of operations for the three and ~~six~~nine months ended ~~June~~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 ~~$1.26~~$1.25 per diluted share, which represents the cumulative balance of deferred preneed selling costs in the Company’s consolidated balance sheet. The table below presents the Company’s income (loss) from continuing operations before cumulative effect of change in accounting method, net income (loss), diluted earnings (loss) per share from continuing operations before cumulative effect of change in accounting method and diluted net earnings (loss) per share for the three and ~~six~~nine months ended ~~June~~September 30, 2005 had the Company not made this accounting change (in thousands, except per share amounts).

Three Months Ended
June 30, 2005

Six Months Ended
June 30, 2005

As Reported

Effect of
Change

Results under
Prior Method

As Reported

Effect of
Change

Results under
Prior Method

Income (loss) from continuing operations before cumulative effect of change in accounting method

$
238

$
376

$
614

$
(922
)
$
861

$
(61
)
Net income (loss)

231

388

619

(23,328
)
23,576

248

Diluted earnings (loss) per common share from continuing operations before cumulative effect of change in accounting method

0.01

0.02

0.03

(0.05
)
0.05

0.00

Diluted earnings (loss) per common share

0.01

0.02

0.03

(1.29
)
1.30

0.01

Three Months Ended Nine Months Ended
September 30, 2005 September 30, 2005
Effect of Results under Effect of Results under
As Reported Change Prior Method As Reported Change Prior Method
Income (loss) from continuing operations before cumulative effect of change in accounting method $ 140 $ 137 $ 277 $ (782 ) $ 1,579 $ 797
Net income (loss) 670 69 739 (22,657 ) 23,646 989
Diluted earnings (loss) per common share from continuing operations before cumulative effect of change in accounting method 0.01 0.01 0.02 (0.04 ) 0.08 0.04
Diluted earnings (loss) per common share 0.04 0.00 0.04 (1.24 ) 1.29 0.05
The table below presents the pro forma amounts for the three and ~~six~~nine months ended ~~June~~September 30, 2004 as if the accounting change had been in effect during those periods (in thousands, except per share amounts).

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

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

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

Three Months Ended
June 30, 2004

Six Months Ended
June 30, 2004

As
Previously
Reported

Effect of
Change

Proforma

As
Previously
Reported

Effect of
Change

Proforma

Gross profit:

Funeral

$
6,531

$
(284
)
$
6,247

$
15,861

$
(545
)
$
15,316

Cemetery

2,233

(506
)
1,727

4,752

(1,005
)
3,747

$
8,764

$
(790
)
$
7,974

$
20,613

$
(1,604
)
$
19,063

Income from continuing operations

$
1,697

$
(494
)
$
1,203

$
4,688

$
(1,969
)
$
3,719

Net income (loss)

(458
)
(514
)
(972
)
2,594

(1,003
)
1,591

Diluted earnings per common share from continuing operations

0.09

(0.03
)
0.06

0.26

(0.05
)
0.20

Diluted earnings (loss) per common share

(0.03
)
(0.03
)
(0.05
)
0.14

(0.06
)
0.09

The Company previously reported in its Form 10-Q for the quarter ended March 31, 2005 its operating results based on its prior accounting method of deferring preneed selling costs. The table below presents the data as of March 31, 2005 as previously reported and restated for gross profit, income (loss) from continuing operations before cumulative effect of change in accounting method, net income (loss), diluted earnings (loss) per share from continuing operations before cumulative effect of change in accounting method and diluted earnings (loss) per share amounts for the three months ended March 31, 2005 based on applying the change in accounting method for preneed selling costs effective January 1, 2005 (in thousands, except per share amounts).
8

Three Months Ended
March 31, 2005

As Previously
Reported

Effect of
Change

Restated

Gross profit:

Funeral

$
10,006

$
(195
)
$
9,811

Cemetery

3,042

(600
)
2,442

$
13,048

$
(795
)
$
12,253

Income (loss) from continuing operations before cumulative effect of change in accounting method

$
(644
)
$
(485
)
$
(1,129
)
Cumulative effect of change in accounting method

—

(22,756
)
(22,756
)
Net income (loss)

(371
)
(23,189
)
(23,560
)
Diluted earnings (loss) per common share from continuing operations before cumulative effect of change in accounting method

(0.04
)
(0.03
)
0.06

Diluted earnings (loss) per common share

(0.02
)
(1.28
)
(1.30
)
4.ASSETS HELD FOR SALE
At ~~December 31, 2004,~~June 30, 2005, two ~~funeral homes and a~~ cemetery ~~business~~businesses were held for sale. During ~~January~~July 2005, the Company closed on the sale of one of the ~~funeral home~~cemetery businesses. The sale transaction generated net cash proceeds totaling ~~$0.5~~$1.1 million and a gain of approximately ~~$0.3~~$0.8 million. ~~During May 2005,~~Plans to sell the ~~Company ceased operations at~~remaining cemetery were abandoned during the ~~other funeral home business~~third quarter when the ~~lease on~~buyer decided against the ~~property expired.~~transaction. We are operating this cemetery. The ~~preneed contracts and other business assets~~consolidated financial statements for the period ended in 2004 in this report have been reclassified to conform with current presentation. No businesses were ~~transferred to another company-owned funeral home in the area.~~
~~In May 2005, the Company identified an additional cemetery business to sell. The fair value less estimated costs to sell for this business has been determined to be greater than its carrying value.~~
~~In the second quarter of 2004, the Company identified three funeral home businesses as~~ held for sale which were later sold in 2004. The carrying value of the assets of two of those businesses was reduced to management’s estimate of fair value less estimated costs to sell by providing impairment charges totaling $3.1 million, a substantial portion of which related to specifically identified goodwill. The fair value less estimated costs to sell for the third business was determined to be greater than its carrying value.
~~At December 31, 2004 and June~~at September 30, ~~2005, assets and liabilities associated with the businesses held for sale in the accompanying balance sheet consisted of the following (in thousands):~~

December 31,
2004

June 30,
2005

Assets:

Current assets

$
200

$
308

Property, plant and equipment, net

393

100

Preneed receivables and trust investments

2,378

4,477

Cemetery property, net

462

744

Cemetery perpetual care trust investments

455

917

Deferred obtaining costs

133

—

Total

$
4,021

$
6,546

Liabilities:

Current liabilities

32

52

Deferred cemetery revenue

515

2,139

Non-controlling interests in funeral and cemetery trust investments

2,051

3,909

Total

$
2,598

$
6,100

Noncontrolling interests in perpetual care trust investments of assets held for sale

$
523

$
988

2005.
The operating results of the businesses held for sale as well as the gain on the disposal are presented in the discontinued operations section of the consolidated statements of operations, along with the income tax effect on a comparative basis. Likewise, the operating results, the impairment charges and gains or losses from businesses sold in the prior year have been similarly reported for comparability. Revenues ~~and operating income~~ for the businesses presented in the discontinued operations section are as follows (in thousands):
9

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

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

For the three months
ended June 30,

For the six months
ended June 30,

2004

2005

2004

2005

Revenues, net

$
921

$
267

$
1,842

$
706

Operating income

$
228

$
(16
)
$
420

$
96

~~In July 2005, the Company sold one of the cemetery businesses that was held for sale at June 30, 2005 for $1.1 million and recorded a gain of $0.8 million.~~
5.SHORT TERM INVESTMENTS
Short term investments are investments purchased with an original maturity of greater than three months at the time of purchase. Short term investments at ~~June~~September 30, 2005 consisted of commercial paper with maturity dates that range from ~~July~~October 2005 to ~~December 2005~~January 2006 at rates ranging from ~~2.72~~3.28 percent to ~~3.28~~3.65 percent per anum. Market value approximates cost.
6.PRENEED ~~RECEIVABLES AND TRUST INVESTMENTS~~ASSETS
Preneed assets consist of the following:

December 31, September 30,
2004 2005
Cemetery preneed receivables and trust investments $ 65,855 $ 70,178
Funeral preneed receivables and trust investments 49,494 55,041
Receivable from funeral trusts 18,074 17,439

$ 133,423 $ 142,658

Preneed cemetery receivables and trust investments
Preneed cemetery 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 when merchandise or services are needed. The components ofPreneed cemetery receivables and trust investmentsin the consolidated balance sheet at ~~June~~September 30, 2005 are as follows (in thousands):

June 30, 2005

Trust investments

$
53,042

Receivables from customers, excluding current portion, net

17,014

Unearned finance charges

(3,137
)
Allowance for doubtful accounts

(619
)
Preneed cemetery receivables and trust investments

$
66,300

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

Preneed cemetery receivables and trust investments $ 70,178

Preneed cemetery receivables and trust investmentsare 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 percent and 14 percent.
-9-
10

The cost and market values associated with cemetery preneed trust investments at ~~June~~September 30, 2005 are detailed below (in thousands). The Company believes the unrealized losses related to trust investments at ~~June~~September 30, 2005 are temporary in nature. Net unrealized gains increased ~~$0.8~~$1.1 and ~~$0.2~~$1.3 million for the three and ~~six~~nine months ended ~~June~~September 30, 2005, respectively.

Cost

Unrealized
Gains

Unrealized
Losses

Market

Cash, money market and other short-term investments

$
7,806

$
—

$
—

$
7,806

Fixed income securities:

U.S. Treasury

—

—

—

—

U.S. Agency obligations

4,694

22

25

4,691

State obligations

12,542

271

93

12,720

Corporate

3,249

95

25

3,319

Other

9

—

—

9

Common stock Mutual funds:

Equity

8,152

2,045

204

9,993

Fixed income

13,630

625

1

14,254

Other investments

—

—

—

—

$
50,082

$
3,058

$
348

$
52,792

Accrued net investment income

$
250

250

Trust investments

$
53,042

Market value as a percentage of cost

105.9
%

Unrealized Unrealized
Cost Gains Losses Market

Cash, money market and other short-term investments $ 13,320 $ — $ — $ 13,320
Fixed income securities:
U.S. Treasury — — — —
U.S. Agency obligations 5,074 3 (58 ) 5,019
State obligations 12,134 214 (144 ) 12,204
Corporate 3,173 62 (40 ) 3,195
Other 8 — — 8

Common stock
Mutual funds:
Equity 13,180 3,424 (217 ) 16,387
Fixed income 5,853 559 (2 ) 6,410
Other investments 273 23 (3 ) 293

$ 53,015 $ 4,285 $ (464 ) $ 56,836

Accrued net investment income $ 204 204

Trust investments $ 57,040

Market value as a percentage of cost 107.6 %

Preneed funeral receivables and trust investments
Preneed funeral receivables and trust investments, net of allowance for cancellations, represent trust fund assets and customer receivables related to contracts sold in advance of when the services or merchandise is needed. Such contracts are secured by funds paid by the customer to the Company.Preneed funeral receivables and trust investmentsare 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 ofPreneed funeral receivables and trust investmentsin the consolidated balance sheet at ~~June~~September 30, 2005 are as follows (in thousands):

September 30,
2005

Trust investments $ 52,519
Receivables from customers 8,951
Allowance for contract cancellations (6,429 )

Preneed funeral receivables and trust investments $ 55,041

-10-

June 30, 2005

Trust investments

$
45,074

Receivables from customers

8,971

Allowance for contract cancellations

(5,757
)

Preneed funeral receivables and trust investments

$
48,288

11

The cost and market values associated with funeral preneed trust investments at ~~June~~September 30, 2005 are detailed below (in thousands). The Company believes the unrealized losses related to trust investments at ~~June~~September 30, 2005 are temporary in nature. Net unrealized gains ~~decreased $0.1~~increased $0.2 and increased ~~$0.2~~$0.4 million for the three and ~~six~~nine months ended ~~June~~September 30, 2005, respectively.

Cost

Unrealized
Gains

Unrealized
Losses

Market

Cash, money market and other short-term investments

$
15,052

$
—

$
—

$
15,052

Fixed income securities:

U.S. Treasury

2,563

13

17

2,559

U.S. Agency obligations

1,922

96

—

2,018

State obligations

1,544

59

10

1,593

Other

197

—

4

193

Common stock Mutual funds:

Equity

2,939

738

68

3,609

Fixed income

19,623

646

219

20,050

Trust investments

$
43,840

$
1,552

$
318

$
45,074

Market value as a percentage of cost

102.8
%

Unrealized Unrealized
Cost Gains Losses Market

Cash, money market and other short-term investments $ 22,473 $ — $ — $ 22,473
Fixed income securities:
U.S. Treasury 1,968 5 (15 ) 1,958
U.S. Agency obligations 1,769 85 — 1,854
State obligations 1,534 55 (8 ) 1,581
Other 1,043 7 (10 ) 1,040
Common stock
Mutual funds:
Equity 2,916 604 (92 ) 3,428
Fixed income 19,492 926 (233 ) 20,185

Trust investments $ 51,195 $ 1,682 $ (358 ) $ 52,519

Market value as a percentage of cost 102.6 %

~~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 June 30, 2005 are detailed below (in thousands). The Company believes the unrealized losses related to the trust investments at June 30, 2005 are temporary in nature.

Cost

Unrealized
Gains

Unrealized
Losses

Market

Cash, money market and other short-term investments

$
4,300

$
—

$
—

$
4,300

Fixed income securities:

U.S. Treasury

698

13

4

707

U.S. Agency obligation

7,510

45

18

7,537

State obligations

58

—

—

58

Corporate

2,860

132

26

2,966

Other

1,559

1

1,558

Common stock Mutual funds:

Equity

6,698

722

125

7,295

Fixed income

7,651

345

41

7,955

Other assets

167

—

23

144

$
31,501

$
1,257

$
238

$
32,520

Accrued net investment income

$
135

135

Trust investments

$
32,655

Market value as a percentage of cost

103.7
%
Receivable from Preneed Funeral Contracts
The receivable from funeral trusts at ~~June~~September 30, 2005 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 ~~six~~nine months ended ~~June~~September 30, 2004 and 2005 are as follows (in thousands).

For the three months
ended June 30,

For the six months
Ended June 30,

2004

2005

2004

2005

Investment income

$
887

$
322

$
887

$
1,126

Realized gains

54

572

54

1,633

Realized losses

(295
)
(286
)
(295
)
(449
)
Expenses

(202
)
(91
)
(202
)
(276
)
Increase in non-controlling interests in trust investments

(444
)
(517
)
(444
)
(2,034
)

$
—

$
—

$
—

$
—

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

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

$ — $ — $ — $ —

7.CONTRACTS SECURED BY INSURANCE
Certain preneed funeral contracts are secured by life insurance contracts. 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 are not included in the Company’s consolidated balance sheet totaled ~~$163.0~~$186.8 million at ~~June~~September 30, 2005.
-11-
8.
~~NON-CONTROLLING INTERESTS IN FUNERAL AND CEMETERY TRUSTS AND IN PERPETUAL CARE TRUSTS~~
8. CEMETERY PERPETUAL CARE TRUST INVESTMENTS
     The Company is required by state law to pay a portion of the proceeds from the sale of cemetery property interment rights into perpetual care trust funds. The cost and market values associated with the trust investments held in perpetual care trust funds at September 30, 2005 are detailed below (in thousands). The Company believes the unrealized losses related to the trust investments at September 30, 2005 are temporary in nature.

Unrealized Unrealized
Cost Gains Losses Market

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

Fixed income securities:
U.S. Treasury 698 9 (8 ) 699
U.S. Agency obligation 7,352 11 (63 ) 7,300
State obligations 58 — — 58
Corporate 2,431 92 (16 ) 2,507
Other 1,521 — (4 ) 1,517
Common stock
Mutual funds:
Equity 9,635 1,421 (148 ) 10,908
Fixed income 5,987 376 (7 ) 6,356
Other assets 144 117 — 261

$ 30,932 $ 2,026 $ (244 ) $ 32,714

Accrued net investment income $ 141 141

Trust investments $ 32,855

Market value as a percentage of cost 106.2 %

Non-controlling interests in cemetery perpetual care trustsrepresent the corpus of those trusts for which the Company is only entitled to receive the income. The components ofNon-controlling interests in cemetery perpetual care trustsas of September 30, 2005 are as follows:

Cemetery
Perpetual Care

Trust assets, at market value $ 32,855
Pending withdrawals of income (229 )
Debt due to a perpetual care trust 1,098
Pending deposits 2,311

Non-controlling interests $ 36,035

-12-
9. DEFERRED REVENUE
Deferred revenue consists of the following:

December 31, September 30,
2004 2005

Deferred cemetery revenue $ 46,787 $ 45,428
Deferred preneed funeral contracts revenue 30,973 29,631
Non-controlling interests in funeral and cemetery trust investments 98,652 109,559

$ 176,412 $ 184,618

Non-controlling interests in funeral and cemetery preneed trustsrepresent deferred revenue related to assets held in the trusts. The Company will recognize the revenue at the time the service is performed and merchandise is delivered. ~~Non-controlling interests in cemetery perpetual care trusts~~ ~~represent ownership in those trusts in which the Company is entitled to receive the income.~~ The components ofNon-controlling interests in funeral and cemetery preneed trusts ~~and~~ ~~Non-controlling interests in cemetery perpetual care trusts~~as of ~~June~~September 30, 2005 are as follows:

Non-controlling Interests

Preneed Funeral

Preneed Cemetery

Total
Preneed

Cemetery
Perpetual Care

Trust assets, at market value

$
45,074

$
53,042

$
98,116

$
32,655

Pending withdrawals of income

—

—

—

(277
)
Debt due to a perpetual care trust

—

—

—

1,105

Pending deposits

—

—

—

28

$
—

$
—

$
—

$
856

Non-controlling interests

$
45,074

$
53,042

$
98,116

$
33,511

Non-controlling interests in assets held for sale

$
—

$
3,909

$
3,909

$
988

13

Non-controlling Interests
Total
Preneed Funeral Preneed Cemetery Preneed

Trust assets, at market value $ 52,519 $ 57,040 $ 109,559

Non-controlling interests $ 52,519 $ 57,040 $ 109,559

9.10. MAJOR SEGMENTS OF BUSINESS
Carriage conducts funeral and cemetery operations only in the United States. The following table presents external revenue, pretax income from continuing operations and total assets by segment (in thousands):

Funeral Cemetery Corporate Consolidated
External revenues from continuing operations:
Nine months ended September 30, 2005 $ 86,858 $ 29,722 $ — $ 116,580
Nine months ended September 30, 2004 $ 85,054 $ 28,576 $ — $ 113,630

Income (loss) from continuing operations before income taxes:
Nine months ended September 30, 2005 $ 23,192 $ 5,129 $ (29,586 ) $ (1,265 )
Nine months ended September 30, 2004 $ 22,233 $ 6,151 $ (20,241 ) $ 8,143

Total assets:
September 30, 2005 $ 329,328 $ 191,393 $ 48,397 $ 569,118
December 31, 2004 $ 344,940 $ 205,230 $ 14,986 $ 565,156
-13-

Funeral

Cemetery

Corporate

Consolidated

External revenues from continuing operations:

Six months ended June 30, 2005

$
60,255

$
19,590

$
—

$
79,845

Six months ended June 30, 2004

$
58,472

$
19,070

$
—

$
77,542

Income (loss) from continuing operations before income taxes:

Six months ended June 30, 2005

$
17,093

$
3,327

$
(21,903
)
$
(1,483
)
Six months ended June 30, 2004

$
16,054

$
4,578

$
(13,319
)
$
7,313

Total assets:

June 30, 2005

$
321,377

$
193,112

$
52,490

$
566,979

December 31, 2004

$
344,940

$
205,230

$
14,986

$
565,156

~~10.~~11. SUPPLEMENTAL DISCLOSURE OF STATEMENT OF OPERATIONS INFORMATION

For the three months
ended June 30,

For the six months
ended June 30,

2004

2005

2004

2005

Revenues, net

Goods

Funeral

$
12,161

$
12,457

$
25,739

$
26,375

Cemetery

$
7,002

$
6,900

$
14,063

$
13,642

Total Goods

$
19,163

$
19,357

$
39,802

$
40,017

Services

Funeral

$
15,536

$
15,981

$
32,733

$
33,880

Cemetery

$
2,591

$
2,664

$
5,007

$
5,948

Total Services

$
18,127

$
18,645

$
37,740

$
39,828

Total Net Revenues

$
37,290

$
38,002

$
77,542

$
79,845

Cost of revenues

Goods

Funeral

$
11,670

$
11,615

$
23,747

$
23,947

Cemetery

$
5,365

$
5,759

$
10,489

$
10,835

Total Goods

$
17,035

$
17,374

$
34,236

$
34,782

Services

Funeral

$
9,497

$
9,541

$
18,876

$
19,215

Cemetery

$
2,086

$
2,295

$
4,003

$
4,852

Total Services

$
11,583

$
11,836

$
22,879

$
24,067

Total Cost of revenues

$
28,618

$
29,210

$
57,115

$
58,849

14

For the three months For the nine months
ended September 30, ended September 30,
2004 2005 2004 2005
Revenues, net
Goods
Funeral $ 11,590 $ 11,586 $ 37,329 $ 37,961
Cemetery $ 6,577 $ 7,107 $ 20,863 $ 20,953

Total Goods $ 18,167 $ 18,693 $ 58,192 $ 58,914

Services
Funeral $ 14,992 $ 15,017 $ 47,725 $ 48,897
Cemetery $ 2,649 $ 2,748 $ 7,713 $ 8,769

Total Services $ 17,641 $ 17,765 $ 55,438 $ 57,666

Total Net Revenues $ 35,808 $ 36,458 $ 113,630 $ 116,580

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

Total Goods $ 16,296 $ 16,770 $ 50,702 $ 51,766

Services
Funeral $ 9,305 $ 9,373 $ 28,176 $ 28,585
Cemetery $ 2,107 $ 2,410 $ 6,150 $ 7,332

Total Services $ 11,412 $ 11,783 $ 34,326 $ 35,917

Total Cost of revenues $ 27,708 $ 28,553 $ 85,028 $ 87,683

~~11.~~12. 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
September 30,
2004 2005

Cash paid for interest and financing costs $ 9,071 $ 31,226

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

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

Restricted cash investing and financing activities:

Proceeds from the sale of securities of the funeral and cemetery trusts $ 3,645

Purchase of available for sale securities of the funeral and cemetery trusts $ 4,865

Net deposits in trust accounts increasing noncontrolling interests $ 14,134

-14-

For the six months ended
June 30,

2004

2005

Cash paid for interest and financing costs

$
9,249

$
24,512

Cash paid for income taxes (state)

$
35

$
219

Common stock issued to officers

$
—

$
1,337

Restricted cash investing and financing activities:

Proceeds from the sale of securities of the funeral and cemetery trusts

$
14,460

Purchase of available for sale securities of the funeral and cemetery trusts

$
13,408

Net deposits in trust accounts increasing noncontrolling interests

$
3,943

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

June 30, 2004

June 30, 2005

Intangible assets

$
233

$
226

Loan origination fees

482

378

Preneed contract obtaining costs

694

—

Cemetery interment and entombment costs

1,255

868

$
2,664

$
1,472

September 30, September 30,
2004 2005

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

$ 3,702 $ 2,283

~~12.~~13. DEBT~~DEBT~~
At December 31, 2004, ~~Carriage had~~Carriage’s senior debt included a $45 million unsecured revolving bank credit facility that was scheduled to mature in March ~~2006. Interest was payable at either the prime rate plus 1.25% or a rate indexed~~2006 and $70.5 million of Senior Notes to ~~LIBOR, at the option of the Company. The LIBOR option was set at LIBOR plus 275 basis points.~~insurance companies due in 2006 and 2008. In ~~order to comply with the conditions of the credit facility,~~January 2005, the Company ~~began deferring interest payments~~issued $130 million of 7.875 percent Senior Notes at par, due in ~~September 2003~~2015. The proceeds from these notes were used to refinance substantially all senior debt, bring current the cumulative deferred distributions on the ~~$93.75 million of~~ convertible junior subordinated debenture ~~payable to its affiliated trust, Carriage Services Capital Trust. As a result, cash distributions on~~and the ~~Company-obligated mandatorily redeemable convertible preferred securities (“TIDES”) of Carriage Services Capital Trust were deferred.~~TIDES, and for general corporate purposes. In March 2005, the Company paid the cumulative deferred distributions on the TIDES totaling $10.9 million. During April 2005, the Company entered into a $35 million senior secured revolving credit facility that matures in five years to replace the existing unsecured credit facility. Borrowings under the new credit facility bear interest at prime or LIBOR options with the initial LIBOR option set at LIBOR plus 300 basis points and is collateralized by all personal property and funeral home real property in certain states. The facility is currently undrawn and ~~no borrowings are anticipated during~~$24 million is available to borrow at September 30, 2005.
In January 2005, the Company issued $130 million of 7.875 percent Senior Notes at par, due in 2015. The proceeds from these notes were used to refinance all senior debt, bring current the cumulative deferred distributions on the convertible junior subordinated debenture and the TIDES, and for general corporate purposes. The Company’s bank credit facility was amended to permit the issuance of the Senior Notes. The Company filed a registration statement on Form S-4 in April 2005 with the Securities and Exchange Commission, and it was declared effective on June 24, 2005.
Carriage, the parent entity, has no independent assets or operations. All assets and operations are held and conducted by subsidiaries, each of which (except for Carriage Services Capital Trust which is a single purpose entity that holds our debentures issued in connection with our TIDES) have fully and unconditionally guaranteed our obligations under the new Senior Notes. Additionally, we do not currently have any significant restrictions on our ability to receive dividends or loans from any subsidiary guarantor under the new Senior Notes.
In connection with the senior debt refinancing, the Company made a required “make whole” payment of $6.0 million in the form of additional interest and recorded a charge to write off $0.7 million of unamortized loan costs (in aggregate $4.2 million after tax, or $0.23 per diluted share) during the first quarter of 2005. In connection with the new senior secured revolving credit facility, the Company recorded a charge to write off $0.2 million or $0.01 per diluted share of unamortized loan costs during the
15

second quarter. These charges are included in the Consolidated Statement of Operations as additional interest and other costs of senior debt refinancing for 2005.
~~13.~~14. OTHER (INCOME) EXPENSE
The following table describes the components of other (income) expense of the Company for the ~~six~~three and nine months ended ~~June~~September 30, 2004 and 2005 (amounts in thousands):

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

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

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

-15-

Three months ended

Three months ended

Six months ended

Six months ended

June 30, 2004

June 30, 2005

June 30, 2004

June 30, 2005

Amount

Diluted
EPS impact

Amount

Diluted
EPS impact

Amount

Diluted
EPS impact

Amount

Diluted
EPS impact

Net (gains) loss from the disposition of business assets

$
(891
)
$
(0.03
)
$
576

$
0.02

$
(891
)
$
(0.03
)
$
574

$
0.02

Interest income

—

—

(129
)
—

—

—

(184
)
(0.01
)

$
(891
)
$
(0.03
)
$
447

$
0.02

$
(891
)
$
(0.03
)
$
390

$
0.01

16
15. ACQUISITION
     The Company acquired a funeral home business consisting of two funeral homes in northern Florida for $1.3 million cash during September 2005. The acquisition was accounted for as a purchase of the assets of the business. The assets were recorded at fair value and included goodwill in the amount of $0.4 million. The Company did not assume any liabilities of the business except for the obligation to perform funeral services with a value of approximately $4.1 million secured by a similar amount of trust funds.
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Item 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
In addition to historical information, this Quarterly Report contains forward-looking statements within the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements include any projections of earnings, revenues, asset sales, acquisitions, cash balances and cash flow, debt levels or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements regarding future economic conditions or performance; any statements of belief; and any statements of assumptions underlying any of the foregoing. Forward-looking statements may include the words “may”, “will”, “estimate”, “intend”, “believe”, “expect”, “project”, “forecast”, “plan”, “anticipate” and other similar words.
Cautionary Statements
The Company cautions readers that the following important factors, among others, in some cases have affected, and in the future could affect, the Company’s actual consolidated results and could cause the Company’s actual consolidated results in the future to differ materially from the goals and expectations expressed herein and in any other forward-looking statements made by or on behalf of the Company. For further information regarding the Company’s cautionary statements, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s ~~2004~~ annual report filed on Form ~~10-K.~~
10-K for the year ended December 31, 2004.
Risks related to our business
(1) Marketing and sales activities by existing and new competitors could cause us to lose market share and lead to lower revenues and gross profit.
(2) Price competition could also reduce our market share or cause us to reduce prices to retain or recapture market share, either of which could reduce revenues and gross profit.
(3) Improved performance in our funeral segment is highly dependent upon successful execution of our standards-based Being the Best operating model.
(4) Our ability to generate preneed sales depends on a number of factors, including sales incentives and local and general economic conditions.
(5) Earnings from and principal of trust funds and insurance contracts could be reduced by changes in financial markets.
(6) Our ability to execute our growth strategy is highly dependent upon our ability to successfully identify suitable acquisition candidates and negotiate transactions on favorable terms.
(7) Our ability to successfully integrate acquisitions into the Company’s business and to realize expected revenues and profits from the acquired businesses.
          (8) Increased or unanticipated costs, such as insurance, taxes, new computer systems implementations and the cost of complying with Sarbanes-Oxley, may have a negative impact on our earnings and cash flows.
~~(8)~~
          (9) Increases in interest rates would increase interest costs when we borrow against our variable-rate bank credit facility and could have a material adverse effect on our net income.
~~(9)~~
          (10) Covenant restrictions under our debt instruments may limit our flexibility in operating our business.
-17-
17

Risks related to the death care industry
(1) Declines in the number of deaths in our markets can cause a decrease in revenues and gross profit. 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 no 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 primarily fixed-cost businesses, changes in revenues can have a disproportionately large effect on cash flow and profits.
(5) Changes or increases in, or failure to comply with, regulations applicable to our business could increase costs or decrease cash flows.
OVERVIEW
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 ~~June~~September 30, 2005, we operated ~~133~~135 funeral homes and 3029 cemeteries in 28 states within the United States. Substantially all administrative activities are conducted in our home office in Houston, Texas.
Factors affecting our funeral operating results include: demographic trends in terms of population growth and average age, which impact death rates and number of deaths; establishing and maintaining leading market share positions supported by strong local heritage and relationships; effectively responding to increasing cremation trends by packaging complementary services and merchandise; controlling salary and merchandise costs; and exercising pricing leverage related to our at-need business to increase average revenues per contract. In simple terms, volume and price are the two variables that affect funeral revenues. The average revenue per contract is influenced by the mix of traditional and cremation services because our average cremation service revenue is approximately 35% 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.
~~During the second half of 2003, we~~
     We have implemented several significant ~~changes~~long-term initiatives in our funeral operations designed to improve operating and financial results by growing market share and increasing profitability. WeDuring the fall of 2003, we introduced a more decentralized, entrepreneurial and local operating model. At the same time, we introduced operating and financial standards developed from our best funeral operations, along with an incentive compensation plan to reward business managers for successfully meeting or exceeding the standards. The operating model and standards, which we refer to as “Being the Best,” focus on the key drivers of a successful funeral operation, organized around three primary areas —– market share, people and operating and financial metrics.
The model and standards are the measures by which we judge the success of each funeral business.
The cemetery operating results are affected by the size and success of our sales organization because approximately ~~52%~~55% of our cemetery revenues for the ~~six~~nine months ended ~~June~~September 30, 2005 relate to sales of grave sites and mausoleums and related merchandise and services before the time of need. We believe that changes in the level of consumer confidence (a measure of whether consumers will spend for discretionary items) also affects the amount of cemetery revenues. Approximately ~~11%~~10% of our cemetery revenues for the ~~six~~nine months ended ~~June~~September 30, 2005 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.
Net income from continuing operations for the three months ending ~~June~~September 30, 2005 totaled ~~$0.2~~$0.1 million, equal to $0.01 per diluted share as compared to net income from continuing operations of ~~$1.6~~$0.5 million for the ~~second~~third quarter of 2004, or ~~$0.09~~$0.03 per diluted share. ~~Revenues increased by $0.7 million for the quarter on a year-over-year basis primarily due to a modest increase (2.7 percent) in funeral revenues.~~
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18

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

Amount,
net of
Income Tax

Earnings per
Diluted Shares

Income from continuing operations for the three months ended June 30, 2004

$
1,639

$
0.09

Increase in gross profit from funeral and cemetery operations prior to the change in accounting for preneed selling costs

449

0.02

Change in accounting for preneed selling costs

(375
)
(0.02
)

Gain from sales of business assets in the 2004 period compared to losses from sales in the 2005 period

(895
)
(0.05
)

Write-off of loan costs in 2005 related to the refinancing of the bank credit facility

(146
)
(0.01
)

Higher general and administrative expenses in 2005 to document and evaluate internal controls and upgrade systems and processes

(278
)
(0.01
)

Other, primarily higher interest expense

(156
)
(0.01
)

Income from continuing operations for the three months ended June 30, 2005

$
238

$
0.01

Amount, net of Earnings per
Income Tax Share

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

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

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

Higher interest expense (316 ) (0.02 )

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

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

Net loss from continuing operations for the first ~~six~~nine months of 2005 totaled ~~$0.9~~$0.8 million, equal to ($~~0.05)~~0.04) per share as compared to net income from continuing operations of ~~$4.6~~$5.1 million for the first ~~six~~nine months of 2004, or ~~$0.25~~$0.28 per diluted share. The variance between the two periods was primarily due to a make-whole payment during the first quarter of 2005 to the former debtholders in connection with the repayment of the previously outstanding senior debt. We repaid this senior debt and paid the make-whole payment with proceeds from our $130 million senior note offering, which closed in January 2005. The make-whole payment resulted in additional pre-tax interest of $6.0 million, along with a charge in the amount of $0.7 million to write off the related unamortized loan costs, in total equal to $0.23 per diluted share. Additionally, the change in accounting for preneed selling costs in 2005 reduced net income from continuing operations by ~~$1.4~~$1.0 million, equal to $0.05 per diluted share. Excluding the effect of these items, ~~total~~ diluted earnings per share from continuing operations for the ~~six~~nine months ending ~~June~~September 30, 2005 equaled ~~$0.23~~$0.24 compared to the prior year ~~six~~nine months ended ~~June~~September 30, 2004 of ~~$0.25.~~
$0.28.
Income from discontinued operations for the ~~six~~nine months ending ~~June~~September 30, 2005 totaled ~~$0.4~~$0.9 million, equal to ~~$0.02~~$0.05 per diluted share, and consisted primarily of a gain on the sale of a funeral home business during the first quarter and the sale of a cemetery business in the third quarter. Loss from discontinued operations for the ~~six~~nine months ending ~~June~~September 30, 2004 totaled ~~$2.0~~$1.3 million, equal to ~~$0.11~~($0.07) per share, and consisted primarily of impairment charges for businesses sold in the second half of 2004.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of the consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, we evaluate estimates and judgments, including those related to revenue recognition, realization of accounts receivable, intangible assets, property and equipment and deferred tax assets. We base our estimates on historical experience, third party data and assumptions that we believe to be reasonable under the circumstances. The results of these considerations form the basis for making judgments about the amount and timing of revenues and expenses, the carrying value of assets and the recorded amounts of liabilities. Actual results may differ from these estimates and such estimates may change if the underlying conditions or assumptions change. Historical performance should not be viewed as indicative of future performance, as there can be no assurance the margins, operating income and net earnings as a percentage of revenues will be sustained consistently from year to year.
Management’s discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements presented herewith, which have been prepared in accordance with U.S. generally accepted accounting principles. Our significant accounting policies are more fully described in Note 1 to the Consolidated Financial Statements included in our annual report on Form 10-K for the year ended December 31, 2004. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
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19

Funeral and Cemetery Operations
We record the sales of funeral merchandise and services when the funeral service is performed. Sales of cemetery interment rights are recorded as revenue in accordance with the retail land sales provisions of Statement of Financial Accounting Standards (SFAS) No ~~66,~~66., “Accounting for Sales of Real Estate.” This method provides for the recognition of revenue in the period in which the customer’s cumulative payments exceed 10% of the contract price related to the real estate. Costs related to the sales of interment rights, which include property and other costs related to cemetery development activities, are charged to operations using the specific identification method in the period in which the sale of the interment right is recognized as revenue. Revenue from the sales of cemetery merchandise and services are recognized in the period in which the merchandise is delivered or the service is performed. Revenues to be recognized from the delivery of merchandise and performance of services related to contracts that were acquired in acquisitions are typically lower than those originated by the Company and are likely to exceed the cash collected from the contract and received from the trust at maturity. We began expensing preneed selling costs as incurred in 2005 ~~(See~~(see Accounting Change).
Allowances for customer cancellations, refunds and bad debts are provided at the date that the sale is recognized as revenue based on our historical experience. In addition, we monitor changes in delinquency rates and provide additional bad debt and cancellation reserves when warranted. When preneed funeral services and merchandise are funded through third-party insurance policies, we earn a commission from the sale of the policies. Insurance commissions are recognized as revenues when the commission is no longer subject to refund, which is usually one year after the policy is issued.
Allowances from customer cancellations, refunds and bad debts are provided as a percentage of recognized revenue at the date the sale is recognized as revenue based on our historical experience. In addition, we monitor changes in delinquency rates and provide additional bad debt and cancellation reserves when warranted. Our methodologies and the resulting estimates have been reliable in past periods. We do not expect to change the factors and assumptions used in calculating these reserves in the future.
Goodwill and Other Intangible Assets
The excess of the purchase price over the fair value of net identifiable assets acquired, as determined by management in transactions accounted for as purchases, is recorded as goodwill. Many of the acquired funeral homes have provided high quality service to families for generations. The resulting loyalty often represents a substantial portion of the value of a funeral business. Goodwill is typically not associated with or recorded for the cemetery businesses. In accordance with SFAS No. 142, we review the carrying value of goodwill at least annually on reporting units (aggregated geographically) to determine if facts and circumstances exist which would suggest that this intangible asset might be carried in excess of fair value. Fair value is determined by discounting the estimated future cash flows of the businesses in each reporting unit at the Company’s weighted average cost of capital less debt allocable to the reporting unit and by reference to recent sales transactions of similar businesses. The calculation of fair value can vary dramatically with changes in estimates of the number of future services performed, inflation in costs, and the Company’s cost of capital, which is impacted by long-term interest rates. If impairment is indicated, then an adjustment will be made to reduce the carrying amount of goodwill to fair value.
Income Taxes
The Company and its subsidiaries file a consolidated U.S. federal income tax return and separate income tax returns in the states in which we operate. We record deferred taxes for temporary differences between the tax basis and financial reporting basis of assets and liabilities, in accordance with SFAS 109, “Accounting for Income Taxes.” The Company records a valuation allowance to reflect the estimated amount of deferred tax assets for which realization is uncertain. Management reviews the valuation allowance at the end of each quarter and makes adjustments if it is determined that it is more likely than not that the tax benefits will be realized.
Stock Compensation Plans
The Company has four stock incentive plans ~~currently in effect~~ under which stock options ~~may be~~have been issued. Additionally, the Company sponsors an Employee Stock Purchase Plan (ESPP) under which employees can purchase common stock at a discount. The stock options are granted with an exercise price equal to or greater than the fair market value of the Company’s Common Stock. Substantially all of the options granted under the four stock option plans have ten-year terms. The options generally vest over a period of two to four years. The Company accounts for stock options and shares issued under the ESPP under APB Opinion No. 25, under which no compensation cost is recognized in the Consolidated Statement of Operations and has adopted the disclosure-only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” and SFAS No. 148, “Accounting for Stock-Based Compensation —– Transition and Disclosure.” Had the Company accounted for stock options and shares pursuant to its employee stock benefit plans under SFAS No. 123 for the three months ended ~~March 31,~~September 30, 2004 and 2005, net income for those periods would have been lower by approximately $0.01 for each period.
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (“FAS No. 123R”). FAS No. 123R requires companies to recognize compensation expense in an amount equal to the fair value of the share-based payment (including share options, restricted share plans, performance-based
-20-
awards, share appreciation rights, and employee share purchase plans) issued to employees. FAS No. 123R
20

applies to all transactions involving issuance of equity by a company in exchange for goods and services, including employee services. FAS No. 123R is effective in the first annual reporting period of the first fiscal year beginning on or after June 15, 2005. The Company will adopt FAS No. 123R in the first fiscal quarter of its 2006 fiscal year and expects to use the modified prospective application method, which results in no restatement of the Company’s previously issued annual consolidated financial statements. The adoption of FAS No. 123R using the modified prospective application method is not expected to have a material impact on the consolidated financial position orand will have no effect on cash flows of the ~~Company, and will~~Company. The adoption of FAS 123R is estimated to reduce earnings in 2006 by ~~an estimated $0.03~~approximately $0.01 per diluted share.
Impairment of Long-Lived Assets
Except as noted for Goodwill, ~~and deferred obtaining costs,~~ the Company reviews its long-lived assets for impairment when changes in circumstances indicate that the carrying amount of the net asset may not be recoverable in accordance with Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived ~~Assets” (SFAS 144).~~Assets.” Assets to be disposed of and assets not expected to provide any future service potential to the Company are recorded at the lower of carrying amount or fair value less estimated cost to sell. The revenues and expenses, as well as gains, losses and impairments, from those assets are reported in the discontinued operations section of the Consolidated Statement of Operations for all periods ~~presented which represents a change in classification to our previously issued consolidated financial statements filed prior to our quarterly report on Form 10-Q for the periods ended June 30, 2004.~~
presented.
Variable Interest Entities
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 ~~did~~does not affect cash flow, net income or the manner in which we recognize and report revenues.
Although FIN 46R requires consolidation of preneed and perpetual care trusts, it does not change the legal relationships among the trusts, the Company and its customers. In the case of preneed trusts, the customers are the legal beneficiaries. In the case of perpetual care trusts, the Company does not have a right to access the corpus in the perpetual care trusts. For these reasons, the Company has recognized non-controlling interests in our financial statements to reflect third party interests in these consolidated trust funds.
Both the preneed trusts and the cemetery perpetual care trusts hold investments in marketable securities which have been classified as available-for-sale. The investments are reported at fair value, with unrealized gains and losses allocated to Non-controlling interests in trust investment in the Company’s consolidated balance sheet. Unrealized gains and losses attributable to the Company, but that have not been earned through the performance of services or delivery of merchandise, are allocated to deferred ~~revenues~~.
revenues.
Also beginning March 31, 2004, the Company ~~recognizes realized~~began recognizing income, gains and losses, of the preneed trusts and cemetery perpetual care trusts. The Company recognizes a corresponding expense equal to the ~~realized~~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 ~~realized~~ earnings, ~~accumulated,~~ 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.
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21

ACCOUNTING CHANGE
Preneed Selling Costs
On June 30, 2005, the Company changed its method of accounting for deferred obtaining costs, which are preneed selling costs incurred, for the origination of prearranged funeral and cemetery service and merchandise sales contracts. Prior to this change, commissions and other direct selling costs related to originating preneed funeral and cemetery service and merchandise sales contracts were deferred and amortized with the objective of recognizing the selling costs in the same period that the related revenue is recognized. Under the prior accounting method, the commissions and other direct selling costs, which are current obligations are paid and use operating cash flow, are not recognized currently in the income statement. The Company believes it is preferable to expense the current obligation for the commissions and other costs rather than defer these costs. The Company also believes the new accounting method will improve the comparability of its reported earnings. Because the three largest public deathcare companies now expense selling costs (two of which changed in 2005), investors and other users of the financial information will now be able to more easily compare our financial results to those deathcare companies.
     The Company has applied this change in accounting method effective January 1, 2005. As of January 1, 2005, the Company recorded a cumulative effect of change in accounting method of $35.8 million pretax or $22.8 million after tax (net of income tax benefit of $13.0 million), or ~~$1.26~~$1.25 per diluted share, which represents the cumulative balance of deferred preneed selling costs in the Company’s consolidated balance sheet. Therefore, the Company’s results of operations for the three and ~~six~~nine months ended ~~June~~September 30, 2005 are reported on the basis of our changed method. The annual impact on earnings per diluted share is approximately $0.10. The change has no effect on cash flow from operations. Refer to Note 3 for the change in accounting method for preneed selling ~~costs.~~
costs and comparison of results as reported in this quarterly report and under the previous method.
RESULTS OF OPERATIONS
The following is a discussion of the Company’s results of operations for the three and ~~six~~nine month periods ended ~~June~~September 30, 2004 and 2005. Funeral homes and cemeteries owned and operated for the entirety of each period being compared are referred to as “same-store” or “existing operations.”
Funeral Home Segment. The following table sets forth certain information regarding the net revenues and gross profit of the Company from the funeral home operations for the three and ~~six~~nine months ended ~~June~~September 30, 2004 compared to the three and ~~six~~nine months ended ~~June~~September 30, 2005. For purposes of our discussion, the revenue and gross profit of our businesses identified to be sold are included in the same-store classification up to the quarter prior to their sale.
Three months ended ~~June~~September 30, 2004 compared to three months ended ~~June~~September 30, 2005 (dollars in thousands):

Three Months Ended
September 30, Change
2004 2005 Amount Percent

Total same-store revenue $ 26,190 $ 25,945 $ (245 ) (0.9 %)
Acquired — 45 45 *
Preneed insurance commissions revenue 392 613 221 56.0 %

Revenues from continuing operations $ 26,582 $ 26,603 $ 21 *

Revenues from discontinued operations $ 264 $ — $ (264 ) *

Total same-store gross profit $ 5,715 $ 5,466 $ (249 ) (4.4 %)
Acquired — 18 18 *
Preneed insurance commissions revenue 392 613 221 56.0 %

Gross profit from continuing operations $ 6,107 $ 6,097 $ (10 ) *

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

* not meaningful
-22-

Three Months Ended
June 30,

Change

2004

2005

Amount

Percent

Total same-store revenue

$
27,373

$
27,864

$
491

1.8
%
Preneed insurance commissions revenue

324

574

250

77.2
%
Revenues from continuing operations

$
27,697

$
28,438

$
741

2.7
%
Revenues from discontinued operations

$
593

$
—

$
(593
)

*

Total same-store gross profit

$
6,206

$
6,708

$
502

8.1
%
Preneed insurance commissions revenue

324

574

250

77.2
%
Gross profit from continuing operations

$
6,530

$
7,282

$
752

11.5
%
Gross profit from discontinued operations

$
137

$
(4
)
$
(141
)

*
* not meaningful
22

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

Six Months Ended
June 30,

Change

2004

2005

Amount

Percent

Total same-store revenue

$
57,830

$
59,214

$
1,384

2.4
%
Preneed insurance commissions revenue

642

1,041

399

62.2
%
Revenues from continuing operations

$
58,472

$
60,255

$
1,783

3.1
%
Revenues from discontinued operations

$
1,210

$
19

$
(1,191
)

*

Total same-store gross profit

$
15,207

$
16,052

$
845

5.6
%
Preneed insurance commissions revenue

642

1,041

399

62.2
%
Gross profit from continuing operations

$
15,849

$
17,093

$
1,244

7.9
%
Gross profit from discontinued operations

$
246

$
(25
)
$
(271
)

*

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

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

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

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

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

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

* not meaningful
* not meaningful
Funeral same-store revenues for the three months ended ~~June~~September 30, 2005 ~~increased 1.8~~decreased 0.9 percent when compared to the three months ended ~~June~~September 30, 2004, as we experienced a decrease of ~~1.0~~0.5 percent in the number of contracts and ~~an increase~~a decrease of ~~2.8~~0.4 percent to ~~$5,055~~$5,309 in the average revenue per contract for those existing operations. Cremation services represented ~~32.5~~33.3 percent of the number of funeral services during the ~~second~~third quarter of 2005, an increase from ~~31.9~~31.0 percent in the ~~second~~third quarter of 2004. The average revenue for burial contracts increased ~~4.0~~2.7 percent to ~~$6,804,~~$6,726, while the average revenue for cremation contracts ~~increased 1.6~~decreased 0.4 percent to ~~$2,442.~~
$2,389. The increase in cremations had the effect of reducing revenues by $0.5 million and reducing the average revenue per contract by $98.
Total funeral same-store gross profit for the three months ended ~~June~~September 30, 2005 ~~increased $0.5~~decreased $0.2 million from the comparable three months of 2004, and as a percentage of funeral same-store revenue, ~~increased~~declined from ~~22.7~~21.8 percent to ~~24.1 percent. Gross profit benefited not only from the~~21.1% primarily because of higher ~~revenues, but also from better expense management in some of our largest expense categories including reductions in salaries and benefits and merchandise costs. Included in the costs~~bad debts, repairs to funeral facilities and the ~~expenses~~change in accounting for ~~2004 is an additional $0.3 million for property tax expense related to a retroactive property revaluation in California.~~
preneed selling costs.
Funeral same-store revenues for the ~~six~~nine months ended ~~June~~September 30, 2005 increased ~~2.4~~1.4 percent when compared to the ~~six~~nine months ended ~~June~~September 30, 2004, as we experienced a ~~increase of~~ 0.1 percent decline in the number of contracts and an increase of ~~2.3~~1.5 percent to ~~$4,995~~$4,961 in the average revenue per contract for those existing operations. Cremation services represented ~~32.4~~32.9 percent of the number of funeral services during the ~~six~~nine months ended ~~June~~September 30, 2005 compared to ~~31.3~~31.2 percent for the ~~six~~nine months ended ~~June~~September 30, 2004. The average revenue for burial contracts increased ~~3.6~~3.3 percent to ~~$6,745,~~$6,739, while the average revenue for cremation contracts increased ~~2.6~~1.7 percent to ~~$2,416.~~
$2,408. Preneed insurance commission revenue, which is generally recognized as revenue one year after origination, increased year over year because of an increasing emphasis on selling insurance related products and additions to our sales leadership during the previous two years.
Total funeral same-store gross profit for the ~~six~~nine months ended ~~June~~September 30, 2005 increased ~~$0.8~~$0.6 million from the comparable ~~six~~nine months of 2004, and as a percentage of funeral same-store revenue, increased from ~~26.3~~24.9 percent to ~~27.1~~25.3 percent. ~~We achieved positive operating leverage because of better execution of our new standards-based operating model.~~
The change in accounting method for preneed selling costs previously discussed was implemented prospectively as of January 1, 2005. We did not restate the results for 2004. The effect of that change was to reduce gross profit by ~~$139,000 and $195,000~~$0.2 million for the ~~three and six~~nine month ~~periods~~period ended ~~June~~September 30, 2005. Had we applied the new accounting method in 2004, funeral same-store gross profit would have increased by $1.4 million, or 6.9 percent from 2004 to 2005. We achieved positive operating leverage because of better execution of our new standards-based operating model.
-23-
23

Cemetery Segment. The following table sets forth certain information regarding the net revenues and gross profit of the Company from the cemetery operations for the three and ~~six~~nine months ended ~~June~~September 30, 2004 compared to the three and nine months ended September 30, 2005:
Three months ended September 30, 2004 compared to the three months ended ~~June~~September 30, ~~2005:~~
2005 (dollars in thousands)

Three Months Ended
September 30, Change
2004 2005 Amount Percent
Revenues from continuing operations $ 9,226 $ 9,855 $ 629 6.8 %

Revenues from discontinued operations $ 159 $ 34 $ (125 ) *

Gross profit from continuing operations $ 1,993 $ 1,808 $ (185 ) 9.3 %

Gross profit from discontinued operations $ 39 $ 1 $ (38 ) *

* not meaningful
~~Three~~Nine months ended ~~June~~September 30, 2004 compared to the ~~three~~nine months ended ~~June~~September 30, 2005 (dollars in thousands)

Three Months Ended
June 30,

Change

2004

2005

Amount

Percent

Total same-store revenues

$
9,921

$
9,831

$
(90
)
(0.9
)%
Less businesses held for sale

328

267

(61
)

*
Revenues from continuing operations

$
9,593

$
9,564

$
(29
)
(0.3
)%
Revenues from discontinued operations

$
328

$
267

$
(61
)

*

Total same-store gross profit

$
2,233

$
1,498

$
(735
)
(32.9
)%
Less businesses held for sale

91

(12
)
(103
)

*
Gross profit from continuing operations

$
2,142

$
1,510

$
(632
)
(29.5
)%
Gross profit from discontinued operations

$
91

$
(12
)
$
(103
)

*

Nine Months Ended
September 30, Change
2004 2005 Amount Percent
Revenues from continuing operations $ 28,576 $ 29,722 $ 1,146 4.0 %

Revenues from discontinued operations $ 512 $ 443 $ (69 ) *

Gross profit from continuing operations $ 6,645 $ 5,707 $ (938 ) 14.1 %

Gross profit from discontinued operations $ 139 $ 124 $ (15 ) *

* not meaningful
~~Six months ended June 30, 2004 compared to the six months ended June 30, 2005 (dollars in thousands)~~

Six Months Ended
June 30,

Change

2004

2005

Amount

Percent

Total same-store revenues

$
19,702

$
20,277

$
575

2.9
%
Less businesses held for sale

632

687

55

*
Revenues from continuing operations

$
19,070

$
19,590

$
520

2.7
%
Revenues from discontinued operations

$
632

$
687

$
55

*

Total same-store gross profit

$
4,752

$
4,024

$
(728
)
(15.3
)%
Less businesses held for sale

174

121

(53
)

*
Gross profit from continuing operations

$
4,578

$
3,903

$
(675
)
(14.7
)%
Gross profit from discontinued operations

$
174

$
121

$
(53
)

*
* not meaningful
* not meaningful
Cemetery revenues from continuing operations for the three months ended ~~June~~September 30, 2005 ~~declined slightly~~increased 0.6 million compared to the three months ended ~~June~~September 30, ~~2004, however the 2004 period included~~2004. Preneed property revenues ~~of $0.3~~increased $0.5 million because we recognized $0.5 million from the completion of ~~mausoleums. Preneed property sales were $0.7 million, or 20 percent, greater than the prior year quarter, yet $0.9 million of~~mausoleums in the current year period. The average value of interment rights sold during the quarter ~~sales was not recognized as revenue because construction was not completed.~~increased 7.9 percent to $1,972 while the number of interment rights sold declined 11.0 percent. The number of interments performed decreased ~~7.2~~10.9 percent ~~but~~and, consequently, our at-need ~~property~~ revenues ~~remain flat because the volume decline was offset~~declined by ~~an increase in the average revenue per at-need interment.~~$0.4 million. Deliveries of preneed merchandise and services increased $0.4 million year over year. Financial revenues (trust earnings and finance charges on installment contracts) ~~increased $0.1 million compared to~~totaled approximately $750,000; the ~~second~~same as the third quarter of the prior year.
Cemetery gross profit from continuing operations for the three months ended ~~June~~September 30, 2005 decreased ~~$0.6~~$0.2 million from the comparable three months of 2004 and as a percentage of revenues decreased from ~~22.3~~21.6 percent to ~~15.8~~18.3 percent. The accounting change for preneed selling costs reduced gross profit by ~~$0.6~~$0.2 million in the current year quarter.
Cemetery revenues from continuing operations for the ~~six~~nine months ended ~~June~~September 30, 2005 increased ~~$0.5~~$1.1 million, or ~~2.7~~4.0 percent, compared to the ~~six~~nine months ended ~~June~~September 30, ~~2004.~~2004 substantially because of higher deliveries of merchandise and services. The number of preneed contracts written in the ~~six~~nine months ended ~~June~~September 30, of 2005 declined ~~5.5~~4.5 percent to ~~4,602~~6,485 compared to the same period in 2004. Average revenue per preneed contract written during the ~~six~~nine months ended ~~June~~September 30, 2005 increased ~~14.8~~8.9 percent to ~~$2,917~~$2,862 compared to the ~~six~~nine months ended ~~June~~September 30, 2004. Financial revenues (trust earnings and finance charges on installment contracts) ~~increased $1.0~~totaled approximately $3.0 million, ~~compared to~~approximately $0.9 million higher than the prior ~~year because of $0.6 million recognized gains on sales of securities in the perpetual care trust funds in 2005 compared to recognized losses of $0.2 million in 2004.~~
24
year.

Cemetery gross profit from continuing operations for the ~~six~~nine months ended ~~June~~September 30, 2005 decreased ~~$0.7~~$0.9 million and as a percentage of revenues decreased from ~~24.0~~23.3 percent to ~~20.0~~19.2 percent from the comparable ~~six~~nine months of 2004. The accounting change for preneed selling costs reduced ~~gross~~ profitability ~~$1.2~~$1.4 million for the ~~six~~nine months ended ~~June~~September 30, 2005.
Other. General and administrative expenses, for the three and ~~six~~nine months ended ~~June~~September 30, 2005 increased ~~$0.5~~$0.4 and ~~$0.6~~$0.9 million or approximately ~~17.9~~14.3 and ~~10.5~~11.9 percent, respectively, as compared to the same periods of 2004 primarily because the 2005 period included higher audit and professional fees related to our on-going effort to comply with the internal control reporting requirements of Sarbanes-Oxley, ~~and~~ upgrading systems and ~~processes.~~processes and the relocation of our home office. Such costs are expected to result in higher general and administrative expenses during the remainder of 2005.
-24-
Interest expense for the three and ~~six~~nine month periods ended ~~June~~September 30, 2005 increased ~~$0.3~~$0.5 and ~~$0.6~~$1.1 million, or ~~7.3~~12.1 and ~~6.8~~8.5 percent, compared to the same periods ended ~~June~~September 30, 2004 because the total debt increased when the Company refinanced its senior debt earlier in 2005. Additionally, the current year expense is negatively impacted by higher loan fees.
Income Taxes. The Company provided income taxes at the expected effective annual rate of 37.5 percent for continuing operations for the three and ~~six~~nine months ended ~~June~~September 30, 2004 and ~~39.1~~36.7 percent and ~~37.8~~38.2 percent for continuing operations for the three and ~~six~~nine months ended ~~June~~September 30, 2005, respectively. The tax benefit for the change in accounting method was recorded at the rate of 36.5 percent.
The Company has net operating loss carryforwards totaling approximately ~~$10.8~~$14.3 million for Federal income tax purposes, as well as significant operating loss carryforwards in certain states. Because of the ability to use the net operating loss to offset taxable income and the timing of when revenue and expenses are recognized for tax purposes, we do not expect to pay Federal income taxes in 2005.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents totaled ~~$8.4~~$7.3 million at ~~June~~September 30, 2005, representing an increase of ~~$6.5~~$5.4 million from December 31, 2004. Short-term investments totaled ~~$12.8~~$9.0 at ~~June~~September 30, 2005, compared to none in the prior year. For the ~~six~~nine months ended ~~June~~September 30, 2005, cash used by operating activities was ~~$7.0~~$9.4 million as compared to cash provided of ~~$14.3~~$17.2 million for the ~~six~~nine months ended ~~June~~September 30, 2004. Cash used by operating activities during 2005 included the $6.0 million make-whole payment and the payment of the previously deferred interest on the convertible junior subordinated debenture in the amount of $10.3 million. ~~Capital expenditures increased~~Additionally, increases in accounts receivable, preneed trust funds and other assets used $8.5 million of cash. Investing activities included $1.3 million ~~from~~for the ~~2004 period.~~acquisition of a funeral business in Florida, the first acquisition in over three years. Net cash provided by financing activities ~~of $29.0~~during 2005 totaled $28.8 million and was ~~used primarily~~attributable to ~~repay all~~our senior debt ~~then outstanding and the balance was invested in short term investments.~~
refinancing.
In January 2005, the Company issued ~~7.875 percent~~ $130 million of 7.875 percent Senior Notes at par, due in 2015. The proceeds from these notes were used to refinance all then outstanding senior debt, including payments for accrued interest and make-whole payment, bring current the cumulative deferred distributions on the convertible junior subordinated debenture and the TIDES, and for general corporate purposes. The refinancing improved the Company’s liquidity because debt totaling approximately $96 million due in 2006 and 2008 was replaced by debt maturing in ten years.
The Company’s senior debt at ~~June~~September 30, 2005 totaled ~~$142.9~~$142.4 million and consisted of the $130.0 million in Senior Notes, a $35 million revolving line of credit (none of which was outstanding at the time) and ~~$12.9~~$12.4 million in acquisition indebtedness and capital lease obligations. Additionally, $0.7 million in letters of credit have been issued from the credit facility and are outstanding at ~~June~~September 30, 2005.
The Company’s convertible junior subordinated debenture at ~~June~~September 30, 2005 total $93.75 million in principal amount, are payable to the Company’s affiliate trust, Carriage Services Capital Trust, bear interest at 7 percent and mature in 2029. Substantially all the assets of the Trust consist of the convertible junior subordinated debenture of the Company. The Trust issued 1.875 million shares of convertible preferred term income deferrable equity securities (TIDES). The rights of the debenture are functionally equivalent to those of the TIDES.
The convertible junior subordinated debenture payable to the affiliated trust and the TIDES each contain a provision for the deferral of interest payments and distributions for up to 20 consecutive quarters. During the period in which distribution payments are deferred, distributions continue to accumulate at the 7 percent annual rate. Also, the deferred distributions themselves accumulate distributions at the annual rate of 7 percent and are recorded as a liability. During the deferral period, Carriage is prohibited from paying dividends on the common stock or repurchasing its common stock, subject to limited exceptions. The Company, in complying with the conditions of the existing credit facility, began deferring interest payments on the subordinated debenture payable to the Company’s affiliated trust beginning with the September 1, 2003 payment. In the first quarter of 2005, the Company paid $10.3 million to bring the cumulative deferred distributions on the TIDES current. The Company expects to continue paying the distributions as due.
In April 2005, the Company entered into a $35 million senior secured revolving credit facility to replace the existing unsecured credit facility. Borrowings under the new credit facility bear interest at prime or LIBOR options with the initial LIBOR
25

option set at LIBOR plus 300 basis points, matures in five years and is collateralized by all personal property and funeral home real property in certain states. The facility is currently undrawn and no borrowings are anticipated during 2005.
$24.0 million is available to borrow at September 30, 2005.
The Company intends to use cash flow provided by operations, net of investments in property, plant and equipment, to acquire funeral home and cemetery businesses. The Company does not intend to draw on its revolving credit facility to finance acquisitions.
-25-
~~SEASONALITY~~
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 of Market Risk
Carriage is currently exposed to market risk primarily related to changes in interest rates related to the Company’s ~~debt~~variable rate bank credit facility and changes in the values of securities associated with the preneed and perpetual care trusts. For information regarding the Company’s exposure to certain market risks, see Item 7A. “Quantitative and Qualitative Market Risk Disclosure” in the Company’s 2004 annual report filed on Form 10-K for the year ended December 31, 2004. There have been no significant changes in the Company’s market risk from that disclosed in the Form 10-K for the year ended December 31, 2004.
Item 4. Controls and Procedures
Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report. Based on their evaluation, our chief executive officer and chief financial officer concluded that the Company’s disclosure controls and procedures are effective at the end of the period. During the period covered by this report, there were no changes in our internal control over financial reporting, as such term is defined under Rule 13a-15(f) of the Exchange Act, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
As
     Based on the value of the Company’s common stock held by non-affiliates on June 30, 2005, ~~we became~~Carriage will be an accelerated ~~filer.~~filer for the year ending December 31, 2005. As an accelerated filer, in accordance with Section 404 of the Sarbanes-Oxley Act of 2002, for the year ending December 31, 2005, we will perform a review of our internal control over financial reporting, and our internal control over financial reporting will be audited by our independent accountant. In order to comply with the Act, we are currently undergoing a comprehensive effort to document, verify and test key internal controls. During the documentation and verification phases, which are still underway, we have identified certain internal control issues which management concluded should be improved. However, to date we have not identified any material weaknesses in our internal controls as defined by the Public Company Accounting Oversight Board. Nonetheless, we are making improvements to our internal controls by revising or updating policies and procedures; training field personnel on procedures and best practices; improving segregation of duties when possible; enhancing information technology systems controls; and improving preventative controls. In particular, we are implementing a cemetery accounting and trusting ~~system and a funeral preneed accounting and trusting~~ system. In connection with the implementation of ~~these systems,~~this system, we are converting data from the legacy systems to the new systems and reconciling reported balances. If additional internal control issues are identified by our continuing documentation and verification efforts, management will address ~~the matter~~those matters in a timely manner.
-26-
26

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 2.Unregistered Sales of Equity Securities and Use of Proceeds
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
None.
Issuance of Unregistered Securities
Carriage has ~~an adopted~~a compensation policy for fees paid to its directors under which our directors may choose to receive director compensation fees either in the form of cash compensation or equity compensation based on the fair market value of our common stock based on the closing price published by the New York Stock Exchange on the date the fees are earned. The Company issued ~~2,995~~3,101 and ~~2,247~~1,667 shares of common stock to directors ~~equal to~~with a ~~charge~~value of approximately ~~$15,000~~$14,500 and ~~$14,000 each period, respectively,~~$10,600 in lieu of payment in cash for their fees for the ~~second~~third quarter of 2004 and 2005, respectively. The Company issued ~~6,250~~9,351 and ~~5,133~~6,800 shares of common stock to directors ~~equal to~~with a ~~charge~~value of ~~$31,000~~$45,500 and ~~$29,000~~$40,000 for the ~~six~~nine months ended ~~June~~September 30, 2004 and 2005, respectively. No underwriter was used in connection with this issuance. Carriage relied on the Section 4(2) exemption from the registration requirements of the Securities Act of 1933, as amended.
Item 3.Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
The Company’s 2005 annual meeting was held on May 10, 2005. The director nominee was elected and the amendment to the 1996 Directors Stock Option Plan was approved. The voting tabulation was as follows:
Name of Nominee/Plan

Number of Votes
For

Number of Votes
Against

Number of Votes
Withheld

Ronald A. Erickson

14,650,608

—

1,673,906

1996 Directors Stock Option Plan amendment to increase shares available to 425,000

7,748,806

2,162,873

6,412,835

~~The terms of the following directors continue after the meeting as follows:~~
~~Director~~
~~Expiration of Term at~~
~~Annual Shareholder’s Meeting~~
~~Melvin C. Payne~~
~~2006~~
~~Joe R. Davis~~
~~2006~~
~~Vincent D. Foster~~
~~2007~~
~~Mark F. Wilson~~
~~2007~~
     None.
Item 5. Other Information
The Company reported on Form 8-K during the quarter covered by this report all information required to be reported on such form.
-27-
27

Item 6. Exhibits
4.1 — Amendment No. 1 to the Credit Agreement dated April 27, 2005 among Carriage Services, Inc., as the Borrower, Bank of America, N.A. as the Administrative Agent, Swing Line Lender and L/C Issuer, Wells Fargo Bank of Texas, National Association, as Syndication Agent and Other Lenders
11.1 — Computation of Per Share Earnings
31.1 — Certification of Periodic Financial Reports by Melvin C. Payne in satisfaction of Section 302 of the Sarbanes-Oxley Act of 2002
31.2 — Certification of Periodic Financial Reports by Joseph Saporito in satisfaction of Section 302 of the Sarbanes-Oxley Act of 2002
32.1 — Certification of Periodic Financial Reports by Melvin C. Payne in satisfaction of Section 906 of the Sarbanes-Oxley Act of 2002 and 18 U.S.C. Section 1350
32.2 — Certification of Periodic Financial Reports by Joseph Saporito in satisfaction of Section 906 of the Sarbanes-Oxley Act of 2002 and 18 U.S.C. Section 1350
-28-
SIGNATURE
     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.
~~4.5~~
—
CARRIAGE SERVICES, INC.
November 11, 2005 /s/ Joseph Saporito
Date Joseph Saporito,
Executive Vice President, Chief Financial Officer and Secretary (Principal Financial Officer and Accounting Officer)
-29-
CARRIAGE SERVICES, INC.
INDEX OF EXHIBITS
4.1 Amendment No. 1 to the Credit Agreement dated April 27, 2005 among Carriage Services, Inc., as the Borrower, Bank of America, N.A. as the Administrative Agent, Swing Line Lender and L/C Issuer, Wells Fargo Bank of Texas, National Association, as Syndication Agent and Other Lenders
~~11.1~~
—
11.1
Computation of Per Share Earnings
~~18.1~~
—
31.1
~~Preferability letter regarding change in accounting method~~
~~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~~
—
31.2
Certification of Periodic Financial Reports by Joseph Saporito in satisfaction of Section 302 of the Sarbanes-Oxley Act of 2002
~~32.1~~
—
32.1
Certification of Periodic Financial Reports by Melvin C. Payne in satisfaction of Section 906 of the Sarbanes-Oxley Act of 2002 and 18 U.S.C. Section 1350
~~32.2~~
—
32.2
Certification of Periodic Financial Reports by Joseph Saporito in satisfaction of Section 906 of the Sarbanes-Oxley Act of 2002 and 18 U.S.C. Section 1350
-30-
28

~~SIGNATURE~~
~~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.~~
~~August 12, 2005~~
~~/s/ Joseph Saporito~~
~~Date~~
~~Joseph Saporito,~~
~~Executive Vice President, Chief Financial Officer and~~
~~Secretary (Principal Financial Officer and Accounting~~
~~Officer)~~
29

~~CARRIAGE SERVICES, INC.~~
~~INDEX OF EXHIBITS~~
~~(a) Exhibits~~
~~4.5~~
Credit Agreement dated April 27, 2005 among Carriage Services, Inc., as the Borrower, Bank of America, N.A. as the Administrative Agent, Swing Line Lender and L/C Issuer, Wells Fargo Bank of Texas, National Association, as Syndication Agent and Other Lenders
~~11.1~~
~~Computation of Per Share Earnings~~
~~18.1~~
~~Preferability letter regarding change in accounting method~~
~~31.1~~
~~Certification of Periodic Financial Reports by Melvin C. Payne in satisfaction of Section 302 of the Sarbanes-Oxley Act of 2002~~
~~31.2~~
~~Certification of Periodic Financial Reports by Joseph Saporito in satisfaction of Section 302 of the Sarbanes-Oxley Act of 2002~~
~~32.1~~
~~Certification of Periodic Financial Reports by Melvin C. Payne in satisfaction of Section 906 of the Sarbanes-Oxley Act of 2002 and 18 U.S.C. Section 1350~~
~~32.2~~
~~Certification of Periodic Financial Reports by Joseph Saporito in satisfaction of Section 906 of the Sarbanes-Oxley Act of 2002 and 18 U.S.C. Section 1350~~
30


		Page
PART I -— FINANCIAL INFORMATION

Item 1.	Financial Statements

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

Consolidated Unaudited Statements of Operations for the Three Months ended ~~June~~September 30, 2004 and 2005 and ~~Six~~Nine Months ended ~~June~~September 30, 2004 and 2005			4

Consolidated Unaudited Statements of Cash Flows for the ~~Six~~Nine Months ended ~~June~~September 30, 2004 and 2005			5

Condensed Notes to Consolidated Financial Statements			6

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

Item 3.	Quantitative and Qualitative Disclosures of Market Risk			26

Item 4.	Controls and Procedures			26

PART II -— OTHER INFORMATION

Item 1.	Legal Proceedings			27

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds			27

Item 3.	Defaults Upon Senior Securities			27

Item 4.	Submission of Matters to a Vote of Security Holders			27

Item 5.	Other Information			27

Item 6. Exhibits	~~Exhibits~~		28

Signatures			29
Amendment No.1 to Credit Agreement
Computation of Per Share Earnings
Certification of Melvin C. Payne in satisfaction of Section 302
Certification of Joseph Saporito in satisfaction of Section 302
Certification of Melvin C. Payne in satisfaction of Section 906
Certification of Joseph Saporito in satisfaction of Section 906

	December 31,			June 30,
	2004			2005
				(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	1,948		$	8,352
Short term investments	—			12,849
Accounts receivable — trade, net of allowance for doubtful accounts of $940 in 2004 and $1,034 in 2005	12,941			12,562
Assets held for sale	4,021			6,546
Inventories and other current assets	12,815			13,198
Total current assets	31,725			53,507
Preneed receivables and trust investments:
Cemetery	65,855			66,300
Funeral	49,494			48,288
Receivable from funeral trusts	18,074			17,483
Property, plant and equipment, at cost, net of accumulated depreciation of $40,531 in 2004 and $43,386 in 2005	104,893			105,201
Cemetery property	62,649			61,237
Goodwill	156,983			156,983
Deferred obtaining costs	35,701			—
Deferred charges and other non-current assets	8,581			25,325
Cemetery perpetual care trust investments	31,201			32,655
Total assets	$	565,156		$	566,979
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	5,991		$	4,233
Accrued liabilities	16,048			16,944
Liabilities associated with assets held for sale	2,598			6,100
Current portion of senior long-term debt and capital leases obligations	2,155			2,180
Total current liabilities	26,792			29,457
Senior long-term debt, net of current portion	102,714			135,342
Convertible junior subordinated debenture due in 2029 to an affiliated trust	93,750			93,750
Obligations under capital leases, net of current portion	5,424			5,386
Deferred interest on convertible junior subordinated debenture	10,891			—
Preneed obligations:
Deferred cemetery revenue	46,787			46,163
Deferred preneed funeral contracts revenue	30,973			30,053
Non-controlling interests in funeral and cemetery trust investments	98,652			98,116
Total liabilities	415,983			438,267
Commitments and contingencies
Non-controlling interests in perpetual care trust investments	32,212			33,511
Non-controlling interests in perpetual care trust investments associated with assets held for sale	523			988
Stockholders’ equity:
Common Stock, $.01 par value; 80,000,000 shares authorized; 17,910,000 and 18,383,000 shares issued and outstanding at December 31, 2004 and June 30, 2005, respectively	179			184
Contributed capital	188,029			190,175
Accumulated deficit	(71,056		)	(94,384		)
Deferred compensation	(714		)	(1,762		)
Total stockholders’ equity	116,438			94,213
Total liabilities and stockholders’ equity	$	565,156		$	566,979


	December 31,			September 30,
	2004			2005
				(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	1,948		$	7,335
Short term investments		—			8,979
Accounts receivable — trade, net of allowance for doubtful accounts of $940 in 2004 and $827 in 2005		12,941			13,188
Assets held for sale		4,021			—
Inventories and other current assets		12,815			14,321

Total current assets		31,725			43,823

Preneed assets		133,423			142,658
Property, plant and equipment, at cost, net of accumulated depreciation of $40,531 in 2004 and $44,788 in 2005		104,893			105,698
Cemetery property		62,649			61,787
Goodwill		156,983			157,352
Deferred obtaining costs		35,701			—
Deferred charges and other non-current assets		8,581			24,945
Cemetery perpetual care trust investments		31,201			32,855

Total assets	$	565,156		$	569,118


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	5,991		$	3,414
Accrued liabilities		16,048			13,558
Liabilities associated with assets held for sale		2,598			—
Current portion of senior long-term debt and capital leases obligations		2,155			2,182

Total current liabilities		26,792			19,154
Senior long-term debt, net of current portion		102,714			134,886
Convertible junior subordinated debenture due in 2029 to an affiliated trust		93,750			93,750
Obligations under capital leases, net of current portion		5,424			5,369
Deferred interest on convertible junior subordinated debenture		10,891			—
Deferred revenue		176,412			184,618

Total liabilities		415,983			437,777

Commitments and contingencies
Non-controlling interests in perpetual care trust investments		32,212			36,035
Non-controlling interests in perpetual care trust investments associated with assets held for sale		523			—
Stockholders’ equity:
Common Stock, $.01 par value; 80,000,000 shares authorized; 17,910,000 and 18,429,000 shares issued and outstanding at December 31, 2004 and September 30, 2005, respectively		179			184
Contributed capital		188,029			190,376
Accumulated deficit		(71,056	)		(93,711	)
Deferred compensation		(714	)		(1,543	)

Total stockholders’ equity		116,438			95,306

Total liabilities and stockholders’ equity	$	565,156		$	569,118

	For the three months ended June 30,						For the six months ended June 30,
	2004			2005			2004			2005
Revenues, net
Funeral	$	27,697		$	28,438		$	58,472		$	60,255
Cemetery	9,593			9,564			19,070			19,590
	37,290			38,002			77,542			79,845
Costs and expenses
Funeral	21,167			21,156			42,623			43,162
Cemetery	7,451			8,054			14,492			15,687
	28,618			29,210			57,115			58,849
Gross profit	8,672			8,792			20,427			20,996
General and administrative expenses	2,545			3,000			5,228			5,779
Operating income	6,127			5,792			15,199			15,217
Interest expense	4,395			4,714			8,777			9,377
Additional interest and other costs of senior debt refinancing	—			240			—			6,933
Other (income) expense	(891		)	447			(891		)	390
Total interest and other (income) expense	3,504			5,401			7,886			16,700

Income (loss) from continuing operations before income taxes	2,623			391			7,313			(1,483		)
Provision (benefit) for income taxes	984			153			2,742			(561		)
Net income (loss) from continuing operations	1,639			238			4,571			(922		)
Discontinued operations
Operating income (loss) from discontinued operations	228			(16		)	420			96
Gain on sales and (impairments) of discontinued operations	(3,050		)	5			(3,050		)	465
Income tax (provision) benefit	725			4			653			(211		)
Income (loss) from discontinued operations	(2,097		)	(7		)	(1,977		)	350
Cumulative effect of change in accounting method, net of tax benefit benefit	—			—			—			(22,756		)
Net income (loss)	$	(458	)	$	231		$	2,594		$	(23,328	)
Basic earnings (loss) per common share
Continuing operations	$	0.09		$	0.01		$	0.26		$	(0.05	)
Discontinued operations	(0.12		)	—			(0.11		)	0.02
Cumulative effect of change in accounting method	—			—			—			(1.26		)
Net income (loss)	$	(0.03	)	$	0.01		$	0.15		$	(1.29	)
Diluted earnings (loss) per common share
Continuing operations	$	0.09		$	0.01		$	0.25		$	(0.05	)
Discontinued operations	(0.12		)	—			(0.11		)	0.02
Cumulative effect of change in accounting method	—			—			—			(1.26		)
Net income (loss)	$	(0.03	)	$	0.01		$	0.14		$	(1.29	)
Weighted average number of common and common equivalent shares outstanding:
Basic	17,764			18,325			17,710			18,227
Diluted	18,258			18,826			18,199			18,227


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

		35,808			36,458			113,630			116,580

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

		27,708			28,553			85,028			87,683
Gross profit		8,100			7,905			28,602			28,897
General and administrative expenses		2,748			3,142			7,975			8,921

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

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

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

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

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

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

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

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

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

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

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

Diluted		18,281			18,938			18,226			18,294

	Three months ended June 30,					Six months ended June 30,
	2004			2005		2004		2005
Net income (loss) available to common stockholders:
As reported	$	(458	)	$	231	$	2,594	$	(23,328	)
Pro forma	$	(568	)	$	121	$	2,374	$	(23,548	)

Net income (loss) per share available to common stockholders:
Basic
As reported	$	(0.03	)	$	0.01	$	0.15	$	(1.29	)
Pro forma	$	(0.03	)	$	0.01	$	0.13	$	(1.30	)
Diluted
As reported	$	(0.03	)	$	0.01	$	0.14	$	(1.29	)
Pro forma	$	(0.03	)	$	0.01	$	0.13	$	(1.30	)


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

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

	Three Months Ended June 30, 2005						Six Months Ended June 30, 2005
	As Reported		Effect of Change		Results under Prior Method		As Reported			Effect of Change		Results under Prior Method
Income (loss) from continuing operations before cumulative effect of change in accounting method	$	238	$	376	$	614	$	(922	)	$	861	$	(61	)
Net income (loss)	231		388		619		(23,328		)	23,576		248
Diluted earnings (loss) per common share from continuing operations before cumulative effect of change in accounting method	0.01		0.02		0.03		(0.05		)	0.05		0.00
Diluted earnings (loss) per common share	0.01		0.02		0.03		(1.29		)	1.30		0.01


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


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

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

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

	Three Months Ended June 30, 2004									Six Months Ended June 30, 2004
	As Previously Reported			Effect of Change			Proforma			As Previously Reported		Effect of Change			Proforma
Gross profit:
Funeral	$	6,531		$	(284	)	$	6,247		$	15,861	$	(545	)	$	15,316

Cemetery	2,233			(506		)	1,727			4,752		(1,005		)	3,747

	$	8,764		$	(790	)	$	7,974		$	20,613	$	(1,604	)	$	19,063
Income from continuing operations	$	1,697		$	(494	)	$	1,203		$	4,688	$	(1,969	)	$	3,719
Net income (loss)	(458		)	(514		)	(972		)	2,594		(1,003		)	1,591
Diluted earnings per common share from continuing operations	0.09			(0.03		)	0.06			0.26		(0.05		)	0.20
Diluted earnings (loss) per common share	(0.03		)	(0.03		)	(0.05		)	0.14		(0.06		)	0.09

	Three Months Ended March 31, 2005
	As Previously Reported			Effect of Change			Restated
Gross profit:
Funeral	$	10,006		$	(195	)	$	9,811
Cemetery	3,042			(600		)	2,442
	$	13,048		$	(795	)	$	12,253
Income (loss) from continuing operations before cumulative effect of change in accounting method	$	(644	)	$	(485	)	$	(1,129	)
Cumulative effect of change in accounting method	—			(22,756		)	(22,756		)
Net income (loss)	(371		)	(23,189		)	(23,560		)
Diluted earnings (loss) per common share from continuing operations before cumulative effect of change in accounting method	(0.04		)	(0.03		)	0.06
Diluted earnings (loss) per common share	(0.02		)	(1.28		)	(1.30		)

	December 31, 2004		June 30, 2005
Assets:
Current assets	$	200	$	308
Property, plant and equipment, net	393		100
Preneed receivables and trust investments	2,378		4,477
Cemetery property, net	462		744
Cemetery perpetual care trust investments	455		917
Deferred obtaining costs	133		—
Total	$	4,021	$	6,546

Liabilities:
Current liabilities	32		52
Deferred cemetery revenue	515		2,139
Non-controlling interests in funeral and cemetery trust investments	2,051		3,909
Total	$	2,598	$	6,100

Noncontrolling interests in perpetual care trust investments of assets held for sale	$	523	$	988

	June 30, 2005
Trust investments	$	53,042
Receivables from customers, excluding current portion, net	17,014
Unearned finance charges	(3,137		)
Allowance for doubtful accounts	(619		)
Preneed cemetery receivables and trust investments	$	66,300

	Cost		Unrealized Gains		Unrealized Losses		Market

Cash, money market and other short-term investments	$	7,806	$	—	$	—	$	7,806
Fixed income securities:
U.S. Treasury	—		—		—		—
U.S. Agency obligations	4,694		22		25		4,691
State obligations	12,542		271		93		12,720
Corporate	3,249		95		25		3,319
Other	9		—		—		9

Common stock Mutual funds:
Equity	8,152		2,045		204		9,993
Fixed income	13,630		625		1		14,254
Other investments	—		—		—		—

	$	50,082	$	3,058	$	348	$	52,792

Accrued net investment income	$	250					250

Trust investments							$	53,042

Market value as a percentage of cost							105.9		%


			Unrealized		Unrealized
	Cost		Gains		Losses			Market

Cash, money market and other short-term investments	$	13,320	$	—	$	—		$	13,320
Fixed income securities:
U.S. Treasury		—		—		—			—
U.S. Agency obligations		5,074		3		(58	)		5,019
State obligations		12,134		214		(144	)		12,204
Corporate		3,173		62		(40	)		3,195
Other		8		—		—			8

Common stock
Mutual funds:
Equity		13,180		3,424		(217	)		16,387
Fixed income		5,853		559		(2	)		6,410
Other investments		273		23		(3	)		293

	$	53,015	$	4,285	$	(464	)	$	56,836


Accrued net investment income	$	204							204


Trust investments								$	57,040


Market value as a percentage of cost									107.6	%

	June 30, 2005

Trust investments	$	45,074
Receivables from customers	8,971
Allowance for contract cancellations	(5,757		)

Preneed funeral receivables and trust investments	$	48,288


	Cemetery
	Perpetual Care

Trust assets, at market value	$	32,855
Pending withdrawals of income		(229	)
Debt due to a perpetual care trust		1,098
Pending deposits		2,311


Non-controlling interests	$	36,035

	Non-controlling Interests
	Preneed Funeral		Preneed Cemetery		Total Preneed		Cemetery Perpetual Care

Trust assets, at market value	$	45,074	$	53,042	$	98,116	$	32,655
Pending withdrawals of income	—		—		—		(277		)
Debt due to a perpetual care trust	—		—		—		1,105
Pending deposits	—		—		—		28
	$	—	$	—	$	—	$	856

Non-controlling interests	$	45,074	$	53,042	$	98,116	$	33,511
Non-controlling interests in assets held for sale	$	—	$	3,909	$	3,909	$	988


	Non-controlling Interests
					Total
	Preneed Funeral		Preneed Cemetery		Preneed

Trust assets, at market value	$	52,519	$	57,040	$	109,559


Non-controlling interests	$	52,519	$	57,040	$	109,559

ACCOUNTING CHANGE

Item 3. Quantitative and Qualitative Disclosures of Market Risk

Item 4. Controls and Procedures

Item 3.Defaults Upon Senior Securities

Item 5. Other Information

	Funeral		Cemetery		Corporate			Consolidated
External revenues from continuing operations:
Six months ended June 30, 2005	$	60,255	$	19,590	$	—		$	79,845
Six months ended June 30, 2004	$	58,472	$	19,070	$	—		$	77,542

Income (loss) from continuing operations before income taxes:
Six months ended June 30, 2005	$	17,093	$	3,327	$	(21,903	)	$	(1,483	)
Six months ended June 30, 2004	$	16,054	$	4,578	$	(13,319	)	$	7,313

Total assets:
June 30, 2005	$	321,377	$	193,112	$	52,490		$	566,979
December 31, 2004	$	344,940	$	205,230	$	14,986		$	565,156


	For the nine months ended
	September 30,
	2004		2005

Cash paid for interest and financing costs	$	9,071	$	31,226


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


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


Restricted cash investing and financing activities:

Proceeds from the sale of securities of the funeral and cemetery trusts			$	3,645


Purchase of available for sale securities of the funeral and cemetery trusts			$	4,865


Net deposits in trust accounts increasing noncontrolling interests			$	14,134

	For the six months ended June 30,
	2004		2005

Cash paid for interest and financing costs	$	9,249	$	24,512

Cash paid for income taxes (state)	$	35	$	219

Common stock issued to officers	$	—	$	1,337

Restricted cash investing and financing activities:

Proceeds from the sale of securities of the funeral and cemetery trusts			$	14,460

Purchase of available for sale securities of the funeral and cemetery trusts			$	13,408

Net deposits in trust accounts increasing noncontrolling interests			$	3,943

	June 30, 2004		June 30, 2005

Intangible assets	$	233	$	226
Loan origination fees	482		378
Preneed contract obtaining costs	694		—
Cemetery interment and entombment costs	1,255		868
	$	2,664	$	1,472

	Three months ended						Three months ended					Six months ended						Six months ended
	June 30, 2004						June 30, 2005					June 30, 2004						June 30, 2005
	Amount			Diluted EPS impact			Amount			Diluted EPS impact		Amount			Diluted EPS impact			Amount			Diluted EPS impact

Net (gains) loss from the disposition of business assets	$	(891	)	$	(0.03	)	$	576		$	0.02	$	(891	)	$	(0.03	)	$	574		$	0.02
Interest income	—			—			(129		)	—		—			—			(184		)	(0.01		)
	$	(891	)	$	(0.03	)	$	447		$	0.02	$	(891	)	$	(0.03	)	$	390		$	0.01


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

	Amount, net of Income Tax			Earnings per Diluted Shares

Income from continuing operations for the three months ended June 30, 2004	$	1,639		$	0.09

Increase in gross profit from funeral and cemetery operations prior to the change in accounting for preneed selling costs	449			0.02

Change in accounting for preneed selling costs	(375		)	(0.02		)

Gain from sales of business assets in the 2004 period compared to losses from sales in the 2005 period	(895		)	(0.05		)

Write-off of loan costs in 2005 related to the refinancing of the bank credit facility	(146		)	(0.01		)

Higher general and administrative expenses in 2005 to document and evaluate internal controls and upgrade systems and processes	(278		)	(0.01		)

Other, primarily higher interest expense	(156		)	(0.01		)

Income from continuing operations for the three months ended June 30, 2005	$	238		$	0.01


	Amount, net of			Earnings per
	Income Tax			Share

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

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

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

Higher interest expense		(316	)		(0.02	)

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

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

	Three Months Ended June 30,					Change
	2004		2005			Amount			Percent

Total same-store revenue	$	27,373	$	27,864		$	491		1.8	%
Preneed insurance commissions revenue	324		574			250			77.2	%
Revenues from continuing operations	$	27,697	$	28,438		$	741		2.7	%
Revenues from discontinued operations	$	593	$	—		$	(593	)		*

Total same-store gross profit	$	6,206	$	6,708		$	502		8.1	%
Preneed insurance commissions revenue	324		574			250			77.2	%
Gross profit from continuing operations	$	6,530	$	7,282		$	752		11.5	%
Gross profit from discontinued operations	$	137	$	(4	)	$	(141	)		*

Name of Nominee/Plan	Number of Votes For	Number of Votes Against	Number of Votes Withheld

Ronald A. Erickson	14,650,608	—	1,673,906

1996 Directors Stock Option Plan amendment to increase shares available to 425,000	7,748,806	2,162,873	6,412,835