CARRIAGE SERVICES INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. OVERVIEW General Carriage Services, Inc. (“Carriage,” the “Company,” “we,” “us,” or “our”) was incorporated in the State of Delaware in December 1993 and is a leading U.S. provider of funeral and cemetery services and merchandise. We operate in two business segments: Funeral Home Operations, which currently account for approximately 75% of our revenue, and Cemetery Operations, which currently account for approximately 25% of our revenue. At March 31, 2021, we operated 173 funeral homes in 26 states and 32 cemeteries in 12 states. We compete with other publicly held and independent operators of funeral and cemetery companies. We believe we are a market leader in most of our markets. Funeral home and cemetery businesses provide products and services to families in three principal areas: (i) ceremony and tribute, generally in the form of a funeral or memorial service; (ii) disposition of remains, either through burial or cremation; and (iii) memorialization, generally through monuments, markers or inscriptions. Our funeral homes offer a complete range of services to meet a family’s funeral needs, including consultation, the removal and preparation of remains, the sale of caskets and related funeral merchandise, the use of funeral home facilities for visitation and memorial services and transportation services. Most of our funeral homes have a non-denominational chapel on the premises, which permits family visitation and services to take place at one location and thereby reduces transportation costs and inconvenience to the family. Our cemeteries provide interment rights (primarily grave sites, lawn crypts, mausoleum spaces and niches), related cemetery merchandise (such as outer burial containers, memorial markers and floral placements) and services (interments, inurnments and installation of cemetery merchandise). We provide funeral and cemetery services and products on both an “atneed” (time of death) and “preneed” (planned prior to death) basis. Recent Developments Divestitures During the three months ended March 31, 2021, we divested two funeral homes for a total of $2.8 million, at a gain of $0.3 million. Convertible Notes Conversions and Maturity During the three months ended March 31, 2021, we converted approximately $2.4 million in aggregate principal amount of our 2.75% convertible subordinated notes due 2021 (the “Convertible Notes”) held by certain holders for approximately $3.8 million in cash. The Convertible Notes matured on March 15, 2021, at which time all Convertible Notes outstanding, approximately $0.2 million in aggregate principal amount, were paid in full in cash at par value. Therefore, no Convertible Notes remain outstanding at March 31, 2021. Business Impact under the Macroeconomic Environment of COVID-19 On March 11, 2020, COVID-19 was deemed a global pandemic and since then, the Company has continued to proactively monitor and assess the pandemic’s current and potential impact to the Company’s operations. Beginning in early March 2020, the Company’s senior leadership team took certain steps to assist our businesses in appropriately adjusting and adapting to the conditions resulting from the COVID-19 pandemic. Our businesses have been designated as essential services and, therefore, each one of the Company’s business locations remains open and ready to provide service to their communities in this time of need. While our businesses provide an essential public function, along with a critical responsibility to the communities and families they serve, the health and safety of our employees and the families we serve remain our top priority. The Company has taken additional steps during this time to continually review and update our processes and procedures to comply with all regulatory mandates and procure additional supplies to ensure that each of our businesses have appropriate personal protective equipment to provide these essential services. Additionally, in many of our business locations, we have also updated staffing and service guidelines, such as reducing the number of team members present for a service, restricting the size and number of attendees and adjusting other operating procedures. The Company has also implemented additional safety and precautionary measures as it concerns our businesses’ day-to-day interaction with the families and communities they serve. The overall impact of the macroeconomic environment to the deathcare industry from COVID-19 may provide varying results as compared to other industries. Our industry’s revenues are impacted by various factors, including the number of funeral services performed, the average price for a service and the mix of traditional burial versus cremation contracts. Changes - 42 - in the macroeconomic environment as a result of the pandemic have, to this point, led to an increase in volume and may create situations where people choose to spend less on funerals by purchasing less expensive caskets, minimize the scale of services and visitations, or elect not to make a preneed funeral or cemetery arrangement. During this time, our businesses have been focused on being innovative and resourceful, providing some type of immediate service as part of the grieving process. Gathering restrictions across many areas of the country have, in some cases, limited our ability to provide large, in-person memorialization services and we have seen client families elect webcasting and livestreaming services, hold services with smaller attendance or rotating visitors, outdoor services, or in some cases, choose to delay services to a future date. Within our financial reporting environment, we have considered various areas that could affect the results of our operations, though the scope, severity and duration of these impacts remain uncertain at this time because the COVID-19 pandemic is continually evolving and the ultimate impact of COVID-19 remains uncertain. Certain estimates inherently involve assumptions about future events and annual results, making reliable estimates for those matters challenging in periods of economic instability. We do not believe we are vulnerable to certain concentrations, whether by geographic area, revenue for specific products or our relationships with our vendors. Our relationships with our vendors and suppliers have remained consistent and we continue to receive reliable service. Remote working arrangements, when utilized, have not materially affected our ability to maintain and support operations, including financial reporting systems, internal controls over financial reporting, and disclosure controls and procedures. We believe our access to capital, the cost of our capital, or the sources and uses of our cash should be relatively consistent in the near term, but given the unprecedented nature of COVID-19, we also believe, it is prudent for us to take a broad-based approach to ensuring we maintain financial flexibility throughout the expected duration of the pandemic. While the expected duration of the pandemic is unknown, we have not currently experienced any material negative impacts to our liquidity position, access to capital, or cash flows as a result of COVID-19. See Liquidity within Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, for additional information related to our liquidity position. We have also applied certain measures of the CARES Act, which has provided a cash benefit in the form of tax payment refunds, tax credits related to employee retention, cash deferral for the employer portion of the Social Security tax and anticipated minimal cash taxes for 2020. Although we expect to take advantage of certain tax relief provisions of the CARES Act, we do not believe it will have a significant impact on our short-term or long-term liquidity position. See Item 1, Financial Statements and Supplementary Data, Note 1 for additional information related to the CARES Act. The COVID-19 pandemic, and related gathering restrictions issued by state and local officials, did impact aspects of our financial results in the first quarter including revenue, volume, preneed cemetery sales, and average revenue per contract. We will continue to assess these impacts and implement appropriate procedures, plans, strategy, and issue any disclosures that may be required, as the situation surrounding the pandemic and related gathering restrictions evolves. Funeral Home Operations Our funeral homes offer a complete range of high value personal services to meet a family’s funeral needs, including consultation, the removal and preparation of remains, the sale of caskets and related funeral merchandise, the use of funeral home facilities for visitation and remembrance services and transportation services. Factors affecting our funeral operating results include, but are not limited to: demographic trends relating to population growth and average age, which impact death rates and number of deaths; establishing and maintaining leading market share positions supported by strong local heritage and relationships; effectively responding to increasing cremation trends by selling complementary services and merchandise; controlling salary and merchandise costs; and exercising pricing leverage to increase average revenue per contract. Cemetery Operations Our cemeteries provide interment rights (grave sites and mausoleum spaces) and related merchandise, such as markers and outer burial containers both on an atneed and preneed basis. Factors affecting our cemetery operating results include, but are not limited to: the size and success of our sales organization; local perceptions and heritage of our cemeteries; our ability to adapt to changes in the economy and consumer confidence; and our response to fluctuations in capital markets and interest rates, which affect investment earnings on trust funds, finance charges on installment contracts and our securities portfolio within the trust funds. Business Strategy Our business strategy is based on strong, local leadership with entrepreneurial principles that is focused on sustainable long term market share, revenue, and profitability growth in each local business. We believe Carriage has the most innovative operating model in the funeral and cemetery industry, which we are able to achieve through a decentralized, high-performance culture operating framework linked with incentive compensation programs that attract top-quality industry talent to our organization. We also believe that Carriage provides a unique consolidation and operating framework that offers a highly - 43 - attractive succession planning solution for owners who want their legacy family business to remain operationally prosperous in their local communities. Our Mission Statement states that “we are committed to being the most professional, ethical and highest quality funeral and cemetery service organization in our industry” and our Guiding Principles state our core values, which are comprised of: • Honesty, integrity and quality in all that we do; • Hard work, pride of accomplishment, and shared success through employee ownership; • Belief in the power of people through individual initiative and teamwork; • Outstanding service and profitability to hand-in-hand; and • Growth of the company is driven by decentralization and partnership. Our five Guiding Principles collectively embody our Being The Best high-performance culture and operating framework. Our operations and business strategy are built upon the execution of the following three models: • Standards Operating Model; • 4E Leadership Model; and • Strategic Acquisition Model. Standards Operating Model Our Standards Operating Model is focused on growing local market share, providing personalized high-value services to our client families and guests, and operating financial metrics that drive long-term, sustainable revenue growth and improved earning power of our portfolio of businesses by employing leadership and entrepreneurial principles that fit the nature of our high-value personal service business. Standards Achievement is the measure by which we judge the success of each business and incentivize our local managers and their teams. Our Standards Operating Model is not designed to produce maximum short-term earnings because we believe such performance is unsustainable and will ultimately stress the business, which very often leads to declining market share, revenue and earnings. 4E Leadership Model Our 4E Leadership Model requires strong local leadership in each business to grow an entrepreneurial, decentralized, high-value, personal service and sales business at sustainable profit margins. Our 4E Leadership Model is based upon principles established by Jack Welch during his tenure at General Electric, and is based upon 4E qualities essential to succeed in a high performance culture: Energy to get the job done; the ability to Energiz e others; the Edge necessary to make difficult decisions; and the ability to Execute and produce results. To achieve a high level within our Standards in a business year after year, we require local Managing Partners that have the 4E Leadership skills to entrepreneurially grow the business by hiring, training and developing highly motivated and productive local teams. Strategic Acquisition Model Our Standards Operating Model led to the development of our Strategic Acquisition Model, which guides our acquisition strategy. We believe that both models, when executed effectively, will drive long-term, sustainable increases in market share, revenue, earnings and cash flow. We believe a primary driver of higher revenue and profits in the future will be the execution of our Strategic Acquisition Model using strategic ranking criteria to assess acquisition candidates. As we execute this strategy over time, we expect to acquire larger, higher margin strategic businesses. We have learned that the long-term growth or decline of a local branded funeral and cemetery business is reflected by several criteria that correlate strongly with five to ten year performance in volumes (market share), revenue and sustainable field-level earnings before interest, taxes, depreciation and amortization (“EBITDA”) margins (a non-GAAP measure). We use criteria such as cultural alignment, volume and price trends, size of business, size of market, competitive standing, demographics, strength of brand and barriers to entry to evaluate the strategic position of potential acquisition candidates. Our financial valuation of the acquisition candidate is then determined through the application of an appropriate after-tax cash return on investment that exceeds our cost of capital. Our belief in our Mission Statement and Guiding Principles and proper execution of the three models that define our strategy have given us a competitive advantage in every market where we compete. We believe that we can execute our three models without proportionate incremental investment in our consolidation platform infrastructure and without additional fixed regional and corporate overhead. This gives us a competitive advantage that is evidenced by the sustained earning power of our portfolio as defined by our EBITDA margin. - 44 - LIQUIDITY AND CAPITAL RESOURCES Overview Our primary sources of liquidity and capital resources are internally generated cash flows from operating activities and availability under our Credit Facility. We generate cash in our operations primarily from atneed sales and delivery of preneed sales. We also generate cash from earnings on our cemetery perpetual care trusts. Based on our recent operating results, current cash position and anticipated future cash flows, we do not anticipate any significant liquidity constraints in the foreseeable future. We have the ability to draw on our Credit Facility, subject to its customary terms and conditions. However, if our capital expenditures or acquisition plans change, we may need to access the capital markets to obtain additional funding. Further, to the extent operating cash flow or access to and cost of financing sources are materially different than expected, future liquidity may be adversely affected. For additional information regarding known material factors that could cause cash flow or access to and cost of finance sources to differ from our expectations, please read Part I, Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2020 and Part II, Item 1A “Risk Factors” in this Quarterly Report on Form 10-Q. Our plan is to remain focused on integrating our newly acquired businesses and to use cash on hand and borrowings under our Credit Facility primarily for general corporate purposes, payment of dividends and debt obligations. However, if the conditions set forth in our conditional notice of redemption are satisfied and we are able to redeem our existing Senior Notes on June 1, 2021, then it may provide us the ability, from a capital allocation perspective, to potentially resume strategic acquisitions, internal growth capital expenditures, share repurchases, dividend increases and further debt repayments. See Item 1, Financial Statements and Supplementary Data, Note 18 for additional details regarding the notice of conditional redemption for our Senior Notes. We also expect continued divestiture activity for the next 6-9 months, which could yield approximately $3-5 million of cash from the proceeds of the sale. From time to time we may also use available cash resources (including borrowings under our Credit Facility) to repurchase shares of our common stock, subject to satisfying certain financial covenants in our Credit Facility. We believe that our existing and anticipated cash resources will be sufficient to meet our anticipated working capital requirements, capital expenditures, scheduled debt payments, commitments and dividends for the next 12 months. Cash Flows We began 2021 with $0.9 million in cash and ended the first quarter with $0.4 million in cash. At March 31, 2021, we had borrowings of $28.3 million outstanding on our Credit Facility compared to $47.2 million at December 31, 2020. The following table sets forth the elements of cash flow (in thousands): Three months ended March 31, 2020 2021 Cash at beginning of year $ 716 $ 889 Net cash provided by operating activities 13,546 26,811 Acquisitions of businesses (28,000) — Acquisitions of real estate — (350) Proceeds from divestitures and sale of other assets 78 2,800 Capital expenditures (2,738) (4,347) Net cash used in investing activities (30,660) (1,897) Net borrowings (payments) on our Credit Facility, acquisition debt and finance lease obligations 29,713 (19,133) Conversions and maturity of the Convertibles Notes — (3,980) Payment of debt issuance and transaction costs (14) (7) Net proceeds (payments) related to employee equity plans 127 (17) Dividends paid on common stock (1,339) (1,799) Other financing costs (169) (461) Net cash provided by (used in) financing activities 28,318 (25,397) Cash at end of the period $ 11,920 $ 406 - 45 - Operating Activities For the three months ended March 31, 2021, cash provided by operating activities was $26.8 million compared to $13.5 million for the three months ended March 31, 2020. The increase of $13.3 million is a reflection of the resilient cash generating ability of our portfolio of high-quality funeral home and cemetery operations. Our operating income (excluding the non-cash impact of the divestitures and impairment charges) increased $9.1 million in addition to other favorable working capital changes. Investing Activities Our investing activities, resulted in a net cash outflow of $1.9 million for the three months ended March 31, 2021 compared to $30.7 million for the three months ended March 31, 2020, a decrease of $28.8 million. Acquisition and Divestiture Activity During the three months ended March 31, 2021, we sold two funeral homes for $2.8 million and purchased real estate for $0.4 million. During the three months ended March 31, 2020, we acquired a funeral home and cemetery combination business in Lafayette, California for $33.0 million in cash, of which $5.0 million was deposited in escrow in 2019 and $28.0 million was paid in 2020. Capital Expenditures For the three months ended March 31, 2021, capital expenditures (comprising of growth and maintenance spend) totaled $4.3 million compared to $2.7 million for the three months ended March 31, 2020, an increase of $1.6 million. The following tables present our growth and maintenance capital expenditures (in thousands): Three months ended March 31, 2020 2021 Growth Cemetery development $ 954 $ 1,486 Renovations at certain businesses 141 710 Other 87 11 Total Growth $ 1,182 $ 2,207 Three months ended March 31, 2020 2021 Maintenance Facility repairs and improvements $ 246 $ 253 Vehicles 428 514 General equipment and furniture 649 1,130 Paving roads and parking lots 132 182 Other 101 61 Total Maintenance $ 1,556 $ 2,140 Financing Activities Our financing activities resulted in a net cash outflow of $25.4 million for the three months ended March 31, 2021 compared to a net cash inflow of $28.3 million for the three months ended March 31, 2020, an increase of $53.7 million. During the three months ended March 31, 2021, we had net payments on our Credit Facility, acquisition debt and finance leases of $19.1 million, we paid $1.8 million in dividends and $4.0 million for the conversions and maturity of our Convertible Notes. During the three months ended March 31, 2020, we had net borrowings on our Credit Facility, acquisition debt and finance leases of $29.7 million and paid $1.3 million in dividends. Share Repurchase During the three months ended March 31, 2021, we did not repurchase any shares of our common stock. At March 31, 2021, we had approximately $25.6 million available for repurchases under our share repurchase program. - 46 - Dividends Our Board declared the following dividends payable on the dates below (in thousands, except per share amounts): 2020 Per Share Dollar Value March 1 st $ 0.075 $ 1,339 2021 Per Share Dollar Value March 1 st $ 0.100 $ 1,799 Credit Facility, Lease Obligations and Acquisition Debt The outstanding principal of our Credit Facility, lease obligations and acquisition debt at March 31, 2021 is as follows (in thousands): March 31, 2021 Credit Facility $ 28,300 Finance leases 5,776 Operating leases 21,933 Acquisition debt 5,355 Total $ 61,364 Credit Facility At March 31, 2021, our $190.0 million senior secured revolving credit facility (the “Credit Facility”) was comprised of: (i) a $190.0 million revolving credit facility, including a $15.0 million subfacility for letters of credit and a $10.0 million swingline, and (ii) an accordion or incremental option allowing for future increases in the facility size by an additional amount of up to $75.0 million in the form of increased revolving commitments or incremental term loans. The final maturity of the Credit Facility will occur on May 31, 2023. The Credit Facility is secured by a first-priority perfected security interest in and lien on substantially all of the Company’s personal property assets and those of the Credit Facility Guarantors. In the event the Company’s actual Total Leverage Ratio is not at least 0.25 less than the required Total Leverage Ratio covenant level, at the discretion of the Administrative Agent, the Administrative Agent may unilaterally compel the Company and the Credit Facility Guarantors to grant and perfect first-priority mortgage liens on fee-owned real property assets which account for no less than 50% of funeral operations EBITDA. The Credit Facility contains customary affirmative covenants, including, but not limited to, covenants with respect to the use of proceeds, payment of taxes and other obligations, continuation of the Company’s business and the maintenance of existing rights and privileges, the maintenance of property and insurance, amongst others. In addition, the Credit Facility also contains customary negative covenants, including, but not limited to, covenants that restrict (subject to certain exceptions) the ability of the Company and its subsidiaries party thereto as guarantors (the “Credit Facility Guarantors”) to incur additional indebtedness, grant liens on assets, make investments, engage in mergers and acquisitions, and pay dividends and other restricted payments, and certain financial covenants. As of March 31, 2021, we were subject to the following financial covenants under our Credit Facility: (A) a Total Leverage Ratio not to exceed 5.50 to 1.00, (B) a Senior Secured Leverage Ratio (as defined in the Credit Facility) not to exceed 2.00 to 1.00 as of the end of any period of four consecutive fiscal quarters, and (C) a Fixed Charge Coverage Ratio (as defined in the Credit Facility) of not less than 1.20 to 1.00 as of the end of any period of four consecutive fiscal quarters. These financial maintenance covenants are calculated for the Company and its subsidiaries on a consolidated basis. We were in compliance with the total leverage ratio, fixed charge coverage ratio and senior secured leverage ratio covenants contained in our Credit Facility as of March 31, 2021. At March 31, 2021, we had outstanding borrowings under our Credit Facility of $28.3 million. We also had one letter of credit for $2.1 million outstanding under the Credit Facility, which bears interest at 3.125% and will expire on November 25, 2021. The letter of credit will automatically renew annually and secures our obligations under our various self-insured policies. At March 31, 2021, we had $159.6 million of availability under the Credit Facility after giving effect to the $2.1 million of the outstanding letter of credit. Outstanding borrowings under our Credit Facility bear interest at either a prime rate or a LIBOR rate, plus an applicable margin based upon our leverage ratio. At March 31, 2021, the prime rate margin was equivalent to 1.5% and the LIBOR rate margin was 2.5%. The weighted average interest rate on our Credit Facility was 4.3% and 3.3% for the three months ended March 31, 2020 and 2021, respectively. - 47 - The interest expense and amortization of debt issuance costs related to our Credit Facility are as follows (in thousands): Three months ended March 31, 2020 2021 Credit Facility interest expense $ 1,230 $ 445 Credit Facility amortization of debt issuance costs 126 118 Lease Obligations Our lease obligations consist of operating and finance leases. We lease certain office facilities, certain funeral homes and equipment under operating leases with original terms ranging from one to nineteen years. Many leases include one or more options to renew, some of which include options to extend the leases for up to 26 years. We lease certain funeral homes under finance leases with original terms ranging from ten to forty years. The lease cost related to our operating leases and short-term leases and depreciation expense and interest expense related to our finance leases are as follows (in thousands): Three months ended March 31, 2020 2021 Operating lease cost $ 957 $ 960 Short-term lease cost 32 49 Variable lease cost 25 41 Finance lease cost: Depreciation of lease right-of-use assets $ 109 $ 108 Interest on lease liabilities 126 120 Acquisition Debt Acquisition debt consists of deferred purchase price and promissory notes payable to sellers. A majority of the deferred purchase price and notes bear no interest and are discounted at imputed interest rates ranging from 7.3% to 10.0%. Original maturities range from five to twenty years. The imputed interest expense related to our acquisition debt is as follows (in thousands): Three months ended March 31, 2020 2021 Acquisition debt imputed interest expense $ 127 $ 97 Convertible Subordinated Notes due 2021 During the three months ended March 31, 2021, we converted approximately $2.4 million in aggregate principal amount of our Convertible Notes held by certain holders for approximately $3.8 million in cash. The Convertible Notes matured on March 15, 2021, at which time all Convertible Notes outstanding, approximately $0.2 million in aggregate principal amount, were paid in full in cash at par value. Therefore, no Convertible Notes remain outstanding at March 31, 2021. The interest expense and accretion of debt discount and debt issuance costs related to our Convertible Notes are as follows (in thousands): Three months ended March 31, 2020 2021 Convertible Notes interest expense $ 43 $ 18 Convertible Notes accretion of debt discount 65 20 Convertible Notes amortization of debt issuance costs 6 1 The effective interest rate on the unamortized debt discount for both the three months ended March 31, 2020 and 2021 was 11.4%. The effective interest rate on the debt issuance costs for the three months ended March 31, 2020 and 2021 was 3.2% and 3.1%, respectively. Senior Notes due 2026 At March 31, 2021, the principal amount of our 6.625% senior notes due 2026 (the “Senior Notes”) was $400.0 million. The Senior Notes were issued under an indenture, dated as of May 31, 2018 (the “Indenture”), among us, certain of our existing subsidiaries (collectively, the “Subsidiary Guarantors”), as guarantors, and Wilmington Trust, National Association., as trustee. The Senior Notes are unsecured, senior obligations and are fully and unconditionally guaranteed on a senior unsecured basis, jointly and severally, by each of the Subsidiary Guarantors. The Senior Notes are due on June 1, 2026 unless earlier redeemed - 48 - or repurchased and bear interest at 6.625% per year, which is payable semi-annually in arrears on June 1 and December 1 of each year. We may redeem all or part of the Senior Notes at any time prior to June 1, 2021 at a redemption price equal to 100% of the principal amount of Senior Notes redeemed, plus a “make whole” premium, and accrued and unpaid interest, if any, to the date of redemption. We have the right to redeem the Senior Notes at any time on or after June 1, 2021 at the redemption prices described in the Indenture, plus accrued and unpaid interest, if any, to the date of redemption. Additionally, at any time before June 1, 2021, we may redeem up to 40% of the aggregate principal amount of the Senior Notes issued with an amount equal to the net proceeds of certain equity offerings, at a price equal to 106.625% of the principal amount of the Senior Notes, plus accrued and unpaid interest, if any, to the date of redemption; provided that (1) at least 60% of the aggregate principal amount of the Senior Notes (including any additional Senior Notes) originally issued under the Indenture remain outstanding immediately after the occurrence of such redemption (excluding Senior Notes held by us); and (2) each such redemption must occur within 180 days of the date of the closing of each such equity offering. If a “change of control” occurs, holders of the Senior Notes will have the option to require us to purchase for cash all or a portion of their Senior Notes at a price equal to 101% of the principal amount of the Senior Notes, plus accrued and unpaid interest. In addition, if we make certain asset sales and do not reinvest the proceeds thereof or use such proceeds to repay certain debt, we will be required to use the proceeds of such asset sales to make an offer to purchase the Senior Notes at a price equal to 100% of the principal amount of the Senior Notes, plus accrued and unpaid interest. The Indenture contains restrictive covenants limiting our ability and our Restricted Subsidiaries (as defined in the Indenture) to, among other things, incur additional indebtedness or issue certain preferred shares, create liens on certain assets to secure debt, pay dividends or make other equity distributions, purchase or redeem capital stock, make certain investments, sell assets, agree to certain restrictions on the ability of Restricted Subsidiaries to make payments to us, consolidate, merge, sell or otherwise dispose of all or substantially all assets, or engage in transactions with affiliates. The Indenture also contains customary events of default. The interest expense and amortization of debt discount, debt premium and debt issuance costs related to our Senior Notes are as follows (in thousands): Three months ended March 31, 2020 2021 Senior Notes interest expense $ 6,625 $ 6,625 Senior Notes amortization of debt discount 129 138 Senior Notes amortization of debt premium 54 58 Senior Notes amortization of debt issuance costs 67 74 At March 31, 2021, the fair value of the Senior Notes, which are Level 2 measurements, was $417.6 million. The debt discount, the debt premium and the debt issuance costs are being amortized using the effective interest method over the remaining term of approximately 62 months of the Senior Notes. The effective interest rate on the unamortized debt discount and the unamortized debt issuance costs for the Senior Notes, issued in May 2018, for both three months ended March 31, 2020 and 2021 was 6.87% and 6.69%, respectively. The effective interest rate on the unamortized debt premium and the unamortized debt issuance costs for the Senior Notes, issued in December 2019, for both three months ended March 31, 2020 and 2021 was 6.20% and 6.88%, respectively. On April 30, 2021, we delivered a notice of conditional redemption to the trustee for the Senior Notes to call for redemption on June 1, 2021, all of the outstanding aggregate principal amount of the Senior Notes at a redemption price of 104.969% of the principal amount thereof, plus accrued and unpaid interest up to, but excluding, the scheduled redemption date. Our redemption obligation is conditioned on and subject to the completion of the offering of $400 million in aggregate principal amount of 4.25% Senior Notes due 2029 and the entry into an amended and restated credit facility in connection with the closing of the offering. - 49 - FINANCIAL HIGHLIGHTS Below are our financial highlights (in thousands except for volumes and averages): Three months ended March 31, 2020 2021 Revenue $ 77,490 $ 96,637 Funeral contracts 11,493 13,296 Average revenue per funeral contract $ 5,233 $ 5,276 Preneed interment rights (property) sold 1,868 2,658 Average price per preneed interment right sold $ 3,779 $ 4,551 Gross profit $ 23,171 $ 35,061 Net income (loss) $ (4,197) $ 12,933 Revenue for the three months ended March 31, 2021 increased $19.1 million compared to the three months ended March 31, 2020, as we experienced a 15.7% increase in total funeral contracts primarily due to a peak spike in Covid deaths in the first quarter of 2021 when compared to the first quarter of 2020, which resulted in market share gains for the majority of our businesses, while the average revenue per funeral contract remained flat. In addition, we experienced a 42.3% increase in the number of preneed interment rights (property) sold, as well as a 20.4% increase in the average price per interment right sold of 20.4%, primarily due to 1) the full integration of the cemetery acquisitions made in the fourth quarter of 2019 and first quarter of 2020, and 2) the execution of the initial stages of our two year cemetery sales strategy of building high performance sales teams and standardized sales systems across our portfolio of cemeteries. Gross profit for the three months ended March 31, 2021 increased $11.9 million compared to the three months ended March 31, 2020, primarily due to the increase in revenue from both our funeral home and cemetery segments, as well as disciplined expense and cost management by leaders at each business. Net income for the three months ended March 31, 2021 increased $17.1 million compared to the three months ended March 31, 2020, primarily due to the increase in gross profit and the $14.7 million impairment charge we recorded in the first quarter of 2020 that did not occur in first quarter of 2021, offset by the $7.8 million increase in tax expense in the first quarter of 2021 as we experienced a net loss in the first quarter of 2020. Further discussion of Revenue and the components of Gross profit for our funeral home and cemetery segments is presented herein under “– Results of Operations.” Further discussion of General, administrative and other expenses, Home office depreciation and amortization expense, Interest expense, Income taxes and other components of income and expenses are presented herein under “– Other Financial Statement Items.” - 50 - REPORTING AND NON-GAAP FINANCIAL MEASURES We also present our financial performance in our “Operating and Financial Trend Report” (“Trend Report”) as reported in our earnings release for the three months ended March 31, 2021 issued on April 21, 2021 and discussed in the corresponding earnings conference call. The Trend Report is used as a supplemental financial statement by management and investors to compare our current financial performance with our previous results and with the performance of other companies. We do not intend for this information to be considered in isolation or as a substitute for other measures of performance prepared in accordance with United States generally accepted accounting principles (“GAAP”). The Trend Report is a non-GAAP statement that also provides insight into underlying trends in our business. Below is a reconciliation of Net income (loss), a GAAP measure, to Adjusted net income, a non-GAAP measure, (in thousands): Three months ended March 31, 2020 2021 Net income (loss) $ (4,197) $ 12,933 Special items, net of tax (1) Acquisition expenses 90 — Severance and separation costs (2) 228 1,244 Accretion of discount on Convertible Notes (1) 65 20 Gain on divestitures (3) — (213) Net impact of impairment of goodwill and other intangibles (3) 9,757 — Litigation reserve 59 — Natural disaster and pandemic costs (4) 111 706 Adjusted net income (5) $ 6,113 $ 14,690 (1) Special items are defined as charges or credits included in our GAAP financial statements that can vary from period to period and are not reflective of costs incurred in the ordinary course of our operations. Special items are taxed at the federal statutory rate of 21.0%, except for the Accretion of the discount on Convertible Notes, as this is a non-tax deductible item. The Gain on divestitures and the Net impact of impairment of goodwill and other intangibles taxed at the operating tax rate during the respective period (described below). (2) The increase is due to separation costs related to the resignation of two members of senior leadership in the first quarter of 2021. (3) Net of the operating tax rate of 33.6% in 2020 and 31.0% in 2021. (4) The increase is primarily due to health and safety expenses, including personal protective equipment (“PPE”). In the first quarter of 2020, we purchased PPE during the last few weeks of March 2020 when the Pandemic began compared to three months in the first quarter of 2021. (5) Adjusted net income is defined as Net income plus adjustments for Special items and other expenses or gains that we believe do not directly reflect our core operations and may not be indicative of our normal business operations. - 51 - Below is a reconciliation of Gross profit (a GAAP measure) to Operating profit (a non-GAAP measure) (in thousands): Three months ended March 31, 2020 2021 Gross profit $ 23,171 $ 35,061 Cemetery property amortization 877 1,517 Field depreciation expense 3,290 3,136 Regional and unallocated funeral and cemetery costs 2,756 6,073 Operating profit (1) $ 30,094 $ 45,787 (1) Operating profit is defined as Gross profit less Cemetery property amortization, Field depreciation expense and Regional and unallocated funeral and cemetery costs. Our operations are reported in two business segments: Funeral Home and Cemetery. Below is a breakdown of Operating profit (a non-GAAP measure) by Segment (in thousands): Three months ended March 31, 2020 2021 Funeral Home $ 24,274 $ 32,906 Cemetery 5,820 12,881 Operating profit $ 30,094 $ 45,787 Operating profit margin (1) 38.8% 47.4% (1) Operating profit margin is defined as Operating profit as a percentage of Revenue. Further discussion of Operating profit for our funeral home and cemetery segments is presented herein under “– Results of Operations.” RESULTS OF OPERATIONS The following is a discussion of our results of operations for the three months ended March 31, 2021 and 2020. The term “same store” refers to funeral homes and cemeteries acquired prior to January 1, 2017 and owned and operated for the entirety of each period being presented, excluding certain funeral home and cemetery businesses that we intend to divest in the near future. The term “acquired” refers to funeral homes and cemeteries purchased after December 31, 2016, excluding any funeral home and cemetery businesses that we intend to divest in the near future. This classification of acquisitions has been important to management and investors in monitoring the results of these businesses and to gauge the leveraging performance contribution that a selective acquisition program can have on total company performance. The term “divested” when discussed in the Funeral Home Segment, refers to the two funeral homes we sold in first quarter of 2021. “Planned divested” refers to the funeral home and cemetery businesses that we intend to divest. “Ancillary” in the Funeral Home Segment represents our flower shop, pet cremation business and online cremation business. Cemetery property amortization, Field depreciation expense and Regional and unallocated funeral and cemetery costs, are not included in Operating profit, a non-GAAP financial measure. Adding back these items will result in Gross profit, a GAAP financial measure. - 52 - Funeral Home Segment The following table sets forth certain information regarding our Revenue and Operating profit from our funeral home operations (in thousands): Three months ended March 31, 2020 2021 Revenue: Same store operating revenue $ 46,696 $ 56,683 Acquired operating revenue 8,885 10,139 Divested/planned divested revenue 2,757 1,217 Ancillary revenue 1,151 1,207 Preneed funeral insurance commissions 366 330 Preneed funeral trust and insurance 1,887 2,198 Total $ 61,742 $ 71,774 Operating profit: Same store operating profit $ 18,062 $ 25,812 Acquired operating profit 3,247 4,467 Divested/planned divested operating profit 673 134 Ancillary operating profit 295 242 Preneed funeral insurance commissions 156 91 Preneed funeral trust and insurance 1,841 2,160 Total $ 24,274 $ 32,906 The following measures reflect the significant metrics over this comparative period: Three months ended March 31, 2020 2021 Same store: Contract volume 9,058 11,028 Average revenue per contract, excluding preneed funeral trust earnings $ 5,155 $ 5,140 Average revenue per contract, including preneed funeral trust earnings $ 5,344 $ 5,318 Burial rate 36.9% 36.6% Cremation rate 55.0% 57.0% Acquired: Contract volume 1,733 2,002 Average revenue per contract, excluding preneed funeral trust earnings $ 5,127 $ 5,065 Average revenue per contract, including preneed funeral trust earnings $ 5,182 $ 5,135 Burial rate 42.0% 41.1% Cremation rate 54.6% 54.1% Funeral home same store operating revenue for the three months ended March 31, 2021 increased $10.0 million compared to the three months ended March 31, 2020. The increase in operating revenue is primarily due to a 21.7% same store contract volume increase, while the average revenue per contract excluding preneed interest, remained flat in the three months ended March 31, 2021 compared to the same period in 2020. The increase in volume is primarily due to a peak spike in Covid deaths in the first quarter of 2021, which resulted in market share gains for the majority of our businesses. Funeral home same store operating profit for the three months ended March 31, 2021 increased $7.8 million when compared to the three months ended March 31, 2020. The comparable operating profit margin increased 680 basis points to 45.5%. The increase in operating profit is primarily due to the increase in same store operating revenue along with disciplined expense and cost management by leaders at each business. Operating expenses as a percent of operating revenue decreased 6.9% for the three months ending 2021 compared to the same period in 2020. The largest decrease was in salaries and benefits, which decreased 3.7% as a percent of operating revenue as we increased revenue without adding extra personnel. - 53 - Funeral home acquired operating revenue for the three months ended March 31, 2021 increased $1.3 million compared to the three months ended March 31, 2020. The increase in operating revenue is primarily due to a 15.5% increase in acquired contract volume primarily due to the increased deaths related to the COVID-19 pandemic and broad market share gains, which was partially offset by a 1.2% decrease in the average revenue per contract, excluding preneed interest, due to a 90 basis point decrease in the burial rate, along with a 5.4% decrease of cremation contracts with services. Acquired operating profit for the three months ended March 31, 2021 increased $1.2 million when compared to the three months ended March 31, 2020. The comparable operating profit margin increased 760 basis points to 44.1%. The increase in operating profit is primarily due to the increase in acquired operating revenue along with disciplined expense and cost management by leaders at each business. The operating margin of the nine businesses acquired in the fourth quarter of 2019 increased 310 basis points and the operating margin of the business acquired in the first quarter of 2020 increased 520 basis points during the three months ended March 31, 2021 compared to the same period in 2020. Overall acquired operating expenses as a percent of operating revenue decreased 7.5%, with the largest decrease in salaries and benefits of 5.9% as we increased revenue without adding extra personnel. Ancillary revenue, which is recorded in Other revenue , represents revenue from our flower shop, pet cremation and online cremation businesses acquired in the fourth quarter of 2019. Ancillary revenue increased 4.9% for the three months ending March 31, 2021 compared to the three months ending March 31, 2020 primarily due to an increase in our online cremation business. Ancillary operating profit decreased 18.0% for the three months ended March 31, 2021 compared to the same period in 2020, primarily due to an increase in operating expenses with the largest increase in third party pick up and embalming and general and administrative expenses at our online cremation business. Preneed funeral insurance commissions and preneed funeral trust and insurance, also recorded in Other revenue , on a combined basis, increased $0.3 million or 12.2% for the three months ended March 31, 2021 compared to the same period in 2020. The increase is primarily related to a 13.9% increase in preneed contracts maturing to atneed which triggers the recognition of trust earnings on matured contracts. Operating profit for preneed funeral insurance commissions and preneed trust and insurance, on a combined basis, increased $0.3 million or 12.7% for the same comparative period, primarily due to the increase in preneed funeral trust and insurance revenue. Cemetery Segment The following table sets forth certain information regarding our Revenue and Operating profit from our cemetery operations (in thousands): Three months ended March 31, 2020 2021 Revenue: Same store operating revenue $ 10,907 $ 14,621 Acquired operating revenue 2,799 6,980 Divested/planned divested revenue 58 108 Preneed cemetery trust revenue 1,742 2,889 Preneed cemetery finance charges 242 265 Total $ 15,748 $ 24,863 Operating profit: Same store operating profit $ 3,167 $ 5,711 Acquired operating profit 827 4,102 Divested/planned divested operating profit 3 38 Preneed cemetery trust operating profit 1,581 2,765 Preneed cemetery finance charges 242 265 Total $ 5,820 $ 12,881 - 54 - The following measures reflect the significant metrics over this comparative period: Three months ended March 31, 2020 2021 Same store: Preneed revenue as a percentage of operating revenue 58% 58% Preneed revenue (in thousands) $ 6,303 $ 8,460 Atneed revenue (in thousands) $ 4,604 $ 6,162 Number of preneed interment rights sold 1,561 1,887 Average price per interment right sold $ 3,615 $ 3,879 Acquired: Preneed revenue as a percentage of operating revenue 62% 64% Preneed revenue (in thousands) 1,736 $ 4,444 Atneed revenue (in thousands) 1,063 $ 2,537 Number of preneed interment rights sold 300 750 Average price per interment right sold $ 4,696 $ 5,800 Cemetery same store preneed revenue increased $2.2 million for the three months ended March 31, 2021 compared to the same period in 2020, as we experienced a 20.9% increase in the number of interments rights sold, as well as a 7.3% increase in the average price per interment right sold. The increase is primarily due to the execution of the initial stages of our two year cemetery sales strategy of building high performance sales teams and standardized sales systems across our portfolio of cemeteries. Cemetery same store atneed revenue, which represents 42% of our same store operating revenue, increased $1.6 million as we experienced a 23.7% increase in same store atneed contracts and an 8.3% increase in the average sale per contract for the three months ended March 31, 2021 compared to the same period in 2020, primarily due to the increased deaths related to the COVID-19 pandemic. Cemetery same store operating profit for the three months ended March 31, 2021 increased $2.5 million from the same period in 2020. The comparable operating profit margin increased 1,010 basis points to 39.1% primarily as a result of the increase in operating revenue, along with disciplined expense and cost management by leaders at each business. Operating expenses as a percent of operating revenue decreased 10.0% in the first quarter of 2021 compared to the same period in 2020, most notably in salaries and wages, which decreased 4.5% as a percent of operating revenue, followed by promotional expenses and facilities and grounds costs which decreased 1.8% and 1.3% respectively, as a percent of operating revenue. There are three businesses in our acquired cemetery portfolio, two of which were acquired in the fourth quarter of 2019 and one acquired in the first quarter of 2020. In the first quarter of 2020, we hired new sales leadership at two of the newly acquired cemeteries and continued to build their respective sales team throughout the year. As a result, our acquired cemetery portfolio experienced a $2.7 million increase in preneed revenue and a $1.5 million increase in atneed revenue for the period ended March 31, 2021 compared to the same period in 2020. Cemetery acquired operating profit increased $3.3 million for three months ended March 31, 2021. The comparable operating profit margin increased 2,930 basis points to 58.8% primarily as a result of the increase in operating revenue, along with disciplined expense and cost management by leaders at each business. Operating expenses as a percent of operating revenue decreased 29% in the first quarter of 2021 compared to the same period in 2020, as we experienced decreases in the majority of our operating costs, most notably in salaries and wages, which decreased 17% as a percent of operating revenue, as we increased revenue without adding extra personnel. Preneed cemetery trust revenue and preneed cemetery finance charges, which are recorded in Other revenue , on a combined basis increased $1.2 million for the three months ended March 31, 2021 compared to the same period in 2020. The increase in our trust fund income is primarily due to our execution of a major repositioning strategy beginning at the height of the COVID-19 market crisis in March 2020, substantially increasing our preneed cemetery trust revenue and operating profit. We experienced a $0.9 million increase in income and a $0.2 million increase in realized capital gains within our trusts in the first quarter of 2021 compared to the same period of 2020. Operating profit for the two categories of Other revenue , on a combined basis, increased $1.2 million for three months ended March 31, 2021 compared to the same period in 2020 primarily due to the increase in preneed cemetery trust revenue. - 55 - Cemetery property amortization . Cemetery property amortization totaled $1.5 million for the three months ended March 31, 2021, an increase of $0.6 million compared to the three months ended March 31, 2020, due to the increase in property sold across our cemetery portfolio. Field depreciation. Depreciation expense for our field businesses decreased $0.2 million for the three months ended March 31, 2021 compared to the three months ended March 31, 2020. The decrease was primarily due to building structures and older vehicles becoming fully depreciated without any newly acquired building structures and vehicles to offset the decrease. Regional and unallocated funeral and cemetery costs. Regional and unallocated funeral and cemetery costs consist of salaries and benefits for regional management, field incentive compensation and other related costs for field infrastructure. Regional and unallocated funeral and cemetery costs totaled $6.1 million for the three months ended March 31, 2021, an increase of $3.3 million primarily due to the following: (1) a $2.2 million increase in cash incentives and equity compensation, as a result of our improved performance, which reinforces our strategy of aligning incentives with long-term value creation; (2) a $0.7 million increase in health and safety expenses related to the COVID-19 pandemic; and (3) a $0.4 million increase in other general administrative costs. Other Financial Statement Items General, administrative and other. General, administrative and other expenses totaled $8.8 million for the three months ended March 31, 2021, an increase of $2.9 million compared to the three months ended March 31, 2020. The increase was primarily attributable to the following: (1) a $1.4 million increase in cash incentives and equity compensation, as a result of our improved performance, which reinforces our strategy of aligning incentives with long-term value creation; (2) a $1.3 million increase in separation expenses related to the resignation of two members of senior leadership; and (3) a $0.2 million increase in other general administrative costs. Home office depreciation and amortization. Home office depreciation and amortization expense totaled $0.3 million for the three months ended March 31, 2021, a decrease of $0.1 million compared to the three months ended March 31, 2020 primarily due to equipment and software at the home office becoming fully depreciated in the latter half of 2020 without any newly acquired assets to offset the decrease. Net loss (gain) on divestitures and impairments charges. The components of Net loss (gain) on divestitures and impairment charges are as follows (in thousands): Three months ended March 31, 2020 2021 Goodwill impairment $ 13,632 $ — Tradename impairment 1,061 — Gain on divestitures — (308) Total $ 14,693 $ (308) During the three months ended March 31, 2021, we divested two funeral homes for a gain of $0.3 million. During the three months ended March 31, 2020, we recorded an impairment for goodwill of $13.6 million as the carrying amount of our funeral homes in the Eastern Region Reporting Unit exceeded the fair value and we recorded an impairment for certain of our tradenames of $1.1 million as the carrying amount of these tradenames exceeded the fair value. Interest expense . Interest expense totaled $7.6 million for the three months ended March 31, 2021, a decrease of $0.8 million compared to the three months ended March 31, 2020, primarily due to decreased borrowings on our Credit Facility. Income taxes. Our income tax expense was $5.6 million for the three months ended March 31, 2021 compared to an income tax benefit of $2.2 million for the three months ended March 31, 2020. Our operating tax rate before discrete items was 31.0% and 33.6% for the three months ended March 31, 2021 and 2020. We filed carryback refund claims for the 2018 and 2019 tax years as allowed by the legislative changes included in the CARES Act. As a result of requesting a tax refund in excess of $5 million, we must receive Joint Committee approval and undergo an audit for the tax year ending December 31, 2018. This audit is currently in progress. In 2020, the 2018 tax return was amended to take full advantage of the CARES Act legislative benefits resulting in additional losses that increase the amount of our carryback refund claim. The majority of the net operating losses generated in 2018 are the result of filing non-automatic accounting method changes relating to the recognition of revenue from our cemetery property and merchandise and services sales. Due to the uncertainty of receiving Internal Revenue Service approval regarding our non-automatic accounting method changes, a reserve has been recorded against the benefit derived from this carrying back that the net operating losses generated. At March 31, 2021, the reserve for uncertain tax positions was $3.7 million. - 56 - OVERVIEW OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of the Consolidated Financial Statements requires us to make estimates and judgments that affect the amounts reported in the unaudited consolidated financial statements and accompanying notes. 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 revenue and expenses, the carrying value of assets and the recorded amounts of liabilities. Actual results may differ from these estimates and such estimates may change if the underlying conditions or assumptions change. Historical performance should not be viewed as indicative of future performance because there can be no assurance that our margins, operating income and net income, as a percentage of revenue, will be consistent from year to year. Management’s discussion and analysis of financial condition and results of operations (“MD&A”) is based upon our Consolidated Financial Statements presented herewith, which have been prepared in accordance with GAAP. Our critical accounting policies are discussed in MD&A in our Annual Report on Form 10-K for the year ended December 31, 2020. SEASONALITY Our business can be affected by seasonal fluctuations in the death rate. Generally, the death rate is higher during the winter months because the incidences of death from influenza and pneumonia are higher during this period than other periods of the year.