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 70% of our revenue, and Cemetery Operations, which currently account for approximately 30% of our revenue. At March 31, 2022, we operated 168 funeral homes in 26 states and 31 cemeteries in 11 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 Share Repurchase Program On February 23, 2022, our Board of Directors (our “Board”) authorized an increase in our share repurchase program to permit us to purchase up to an additional $75.0 million under our share repurchase program, in addition to amounts previously authorized. At March 31, 2022, our share repurchase program had $57.1 million authorized for repurchases. Divestitures During the three months ended March 31, 2022, we sold two funeral homes for an aggregate of $0.9 million for a loss of $0.7 million. 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. Throughout the pandemic, the Company’s senior leadership team has taken steps to assist our businesses in appropriately adjusting and adapting to the conditions resulting from the COVID-19 pandemic. Our businesses are open and ready to provide service to the families and communities they serve. 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. We continue to 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. The Company 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 the pandemic 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. During the first quarter of 2022, we continued to see the number of funeral contracts normalize to pre-COVID-19 levels. Regardless of these recent trends, our businesses have remained focused on being innovative and resourceful, providing families immediate service as part of the grieving process. - 40 - 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 ultimate impact of COVID-19 remains uncertain, including the potential impacts of new variants of COVID-19, such as the Delta and Omicron variants, and any resulting government responses to such variants. We do not believe we are particularly vulnerable to concentrations, with respect to 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. To date, we have not experienced any material supply chain impacts or disruptions from our vendors. 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. 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 Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, Liquidity and Capital Resources for additional information related to our liquidity position. During the first quarter of 2022, we continued to see a decrease in COVID-19-related deaths and the normalization of funeral contracts to pre-COVID-19 levels at broadly higher funeral contract revenue averages. During this same time, we have not seen an adverse impact to our overall financial performance. Although we expect these trends to continue, we will continue to assess these impacts, including the potential impacts of new variants of COVID-19, such as the Delta and Omicron variants, and implement appropriate procedures, plans, strategy, and issue any disclosures that may be required, as the situation surrounding the pandemic and related regulatory mandates and restrictions, if any, 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 and 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 attractive succession planning solution for independent funeral home 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 go hand-in-hand; and • Growth of the Company is driven by decentralization and partnership. - 41 - 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 our 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 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. - 42 - 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 (defined below). 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 and we may not be able to obtain such funding on terms and conditions that are acceptable to us. 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, 2021. Our plan is to use cash on hand and borrowings under our Credit Facility primarily for general corporate purposes, payment of dividends and debt obligations, strategic acquisitions, internal growth capital expenditures, share repurchases, dividend increases and further debt repayments. We also expect continued divestiture activity for the next three to six months, which could yield an aggregate of approximately $3-4 million of cash from the proceeds of the sales. 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 and in the Indenture (defined below) governing our Senior Notes (defined below). 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, as well as our long-term financial obligations. Cash Flows We began 2022 with $1.1 million in cash and ended the first quarter with $0.9 million in cash. At March 31, 2022, we had borrowings of $174.2 million outstanding on our Credit Facility compared to $155.4 million at December 31, 2021. The following table sets forth the elements of cash flow (in thousands): Three months ended March 31, 2021 2022 Cash at beginning of the year $ 889 $ 1,148 Net cash provided by operating activities 26,811 15,801 Acquisitions of real estate (350) (2,575) Proceeds from divestitures and sale of other assets 2,800 1,026 Proceeds from insurance reimbursements — 676 Capital expenditures (4,347) (6,883) Net cash used in investing activities (1,897) (7,756) Net borrowings on our Credit Facility, acquisition debt and finance lease obligations (19,133) 18,700 Conversions and maturity of the Convertibles Notes (3,980) — Net proceeds related to employee equity plans (17) 374 Dividends paid on common stock (1,799) (1,725) Purchase of treasury stock — (25,655) Other financing costs (461) — Net cash used in financing activities (25,390) (8,306) Cash at end of the period $ 413 $ 887 Operating Activities For the three months ended March 31, 2022, cash provided by operating activities was $15.8 million compared to $26.8 million for the three months ended March 31, 2021. The decrease of $11.0 million is primarily due to unfavorable working capital changes in accrued liabilities and income tax receivables. - 43 - Investing Activities Our investing activities, resulted in a net cash outflow of $7.8 million for the three months ended March 31, 2022 compared to $1.9 million for the three months ended March 31, 2021, a decrease of $5.9 million. Acquisition and Divestiture Activity During the three months ended March 31, 2022, we sold two funeral homes for an aggregate of $0.9 million and purchased real property for $2.6 million. During the three months ended March 31, 2021, we sold one funeral home for $1.5 million and real property for $1.3 million and we purchased real property for $0.4 million. Capital Expenditures For the three months ended March 31, 2022, capital expenditures (comprising of growth and maintenance spend) totaled $6.9 million compared to $4.3 million for the three months ended March 31, 2021, an increase of $2.6 million. The following tables present our growth and maintenance capital expenditures (in thousands): Three months ended March 31, 2021 2022 Growth Cemetery development $ 1,486 $ 2,264 Renovations at certain businesses (1) 710 1,155 Other 11 (148) Total Growth $ 2,207 $ 3,271 (1) During the three months ended March 31, 2022, we spent $0.4 million for renovations on two businesses that were affected by Hurricane Ida, all of which was reimbursed by our property insurance. Three months ended March 31, 2021 2022 Maintenance Facility repairs and improvements $ 253 $ 1,067 Vehicles 514 795 General equipment and furniture 1,130 1,339 Paving roads and parking lots 182 311 Other 61 100 Total Maintenance $ 2,140 $ 3,612 Financing Activities Our financing activities resulted in a net cash outflow of $8.3 million for the three months ended March 31, 2022 compared to $25.4 million for the three months ended March 31, 2021, a decrease of $17.1 million. During the three months ended March 31, 2022, we had net borrowings on our Credit Facility, acquisition debt and finance leases of $18.7 million, offset by $25.7 million for the purchase of treasury stock and $1.7 million in dividends. 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. Share Repurchase On February 23, 2022, our Board authorized an increase in our share repurchase program to permit us to purchase up to an additional $75.0 million under our share repurchase program, in addition to amounts previously authorized and outstanding in accordance with Rule 10b-18 of the Securities Exchange Act of 1934, as amended (“the Exchange Act”). Prior to the Board's approval of the increase, we had $8.1 million remaining available for repurchase under our authorized program. - 44 - Share repurchase activity is as follows (dollar value in thousands): Three months ended March 31, 2021 2022 Number of Shares Repurchased (1) — 490,000 Average Price Paid Per Share $ — $ 53.08 Dollar Value of Shares Repurchased (1) $ — $ 26,010 (1) During the three months ended March 31, 2022, 52,242 shares settled in April 2022, which had a cost of $2.8 million. Our shares were purchased in the open market at times and in amounts as management determined appropriate based on factors such as market conditions, legal requirements and other business considerations. Shares purchased pursuant to the repurchase program are currently held as treasury shares. At March 31, 2022, our share repurchase program had $57.1 million authorized for repurchases. Dividends Our Board declared the following dividends payable on the dates below (in thousands, except per share amounts): 2022 Per Share Dollar Value March 1 st $ 0.1125 $ 1,725 2021 Per Share Dollar Value March 1 st $ 0.1000 $ 1,799 Credit Facility, Lease Obligations and Acquisition Debt The outstanding principal of our Credit Facility, lease obligations and acquisition debt at March 31, 2022 is as follows (in thousands): March 31, 2022 Credit Facility $ 174,200 Finance leases 5,445 Operating leases 20,131 Acquisition debt 4,487 Total $ 204,263 Credit Facility At March 31, 2022, our senior secured revolving credit facility (the “Credit Facility”) was comprised of: (i) a $200.0 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 13, 2026. Our obligations under the Credit Facility are unconditionally guaranteed on a joint and several basis by the same subsidiaries which guarantee the Senior Notes (defined below) and certain of our subsequently acquired or organized domestic subsidiaries (collectively, the “Subsidiary Guarantors”). The Credit Facility allows for future increases in the facility size in the form of increased revolving commitments or new incremental term loans by an additional amount of up to $75.0 million in the aggregate. 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 Subsidiary Guarantors. In addition, the Credit Facility includes provisions which require the Company and the Subsidiary Guarantors, upon the occurrence of an event of default or 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 under the Credit Facility, to grant additional liens on real property assets accounting for no less than 50% of the Company’s and the Subsidiary Guarantors’ funeral operations if requested by the administrative agent. 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 the Subsidiary Guarantors to incur indebtedness, grant - 45 - liens, make investments, engage in mergers and acquisitions, and pay dividends and other restricted payments, and certain financial maintenance covenants. At March 31, 2022, we were subject to the following financial covenants under our Credit Facility: (A) a Total Leverage Ratio not to exceed 5.00 to 1.00 and (B) 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 all of the covenants contained in our Credit Facility as of March 31, 2022. At March 31, 2022, we had outstanding borrowings under the Credit Facility of $174.2 million. We also had one letter of credit for $2.3 million under the Credit Facility. The letter of credit will expire on November 25, 2022 and is expected to automatically renew annually and secures our obligations under our various self-insured policies. At March 31, 2022, we had $23.5 million of availability under the Credit Facility. 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, 2022, the prime rate margin was equivalent to 0.875% and the LIBOR rate margin was 1.875%. The weighted average interest rate on our Credit Facility was 3.3% and 2.1% for the three months ended March 31, 2021 and 2022, respectively. The interest payments on our remaining borrowings under the Credit Facility will be determined based on the average outstanding balance of our borrowings and the prevailing interest rate during that time. The interest expense and amortization of debt issuance costs related to our Credit Facility are as follows (in thousands): Three months ended March 31, 2021 2022 Credit Facility interest expense $ 445 $ 847 Credit Facility amortization of debt issuance costs 118 88 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 twenty years. Many leases include one or more options to renew, some of which include options to extend the leases for up to forty years. We lease certain funeral homes under finance leases with original terms ranging from ten to forty years. At March 31, 2022, operating and finance lease obligations were $37.4 million, with $4.4 million payable within 12 months. 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 $ 960 $ 848 Short-term lease cost 49 102 Variable lease cost 41 7 Finance lease cost: Depreciation of leased assets $ 108 $ 108 Interest on lease liabilities 120 113 Total finance lease cost 228 221 Total lease cost $ 1,278 $ 1,178 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 nine to twenty years. At March 31, 2022, acquisition debt obligations were $7.3 million, with $0.8 million payable within 12 months. The imputed interest expense related to our acquisition debt is as follows (in thousands): Three months ended March 31, 2021 2022 Acquisition debt imputed interest expense $ 97 $ 80 - 46 - Senior Notes At March 31, 2022, the principal amount of our 4.25% senior notes due in May 2029 (the “Senior Notes”) was $400.0 million. The Senior Notes were issued under an indenture, dated as of May 13, 2021 (the “Indenture”), among the Company, the Subsidiary 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 mature on May 15, 2029, unless earlier redeemed or purchased and bear interest at 4.25% per year, which is payable semi-annually in arrears on May 15 and November 15 of each year, beginning on November 15, 2021. We may redeem the Senior Notes, in whole or in part, at the redemption price of 102.13% on or after May 15, 2024, 101.06% on or after May 15, 2025 and 100% on or after May 15, 2026, plus accrued and unpaid interest, if any, to, but excluding, the redemption date. At any time before May 15, 2024, we may also redeem all or part of the Senior Notes at the redemption prices described in the Indenture, plus accrued and unpaid interest, if any, to (but excluding) the date of redemption. In addition, before May 15, 2024, we may redeem up to 40% of the aggregate principal amount of the Senior Notes outstanding using an amount of cash equal to the net proceeds of certain equity offerings, at a price of 104.25% of the principal amount of the Senior Notes, plus accrued and unpaid interest, if any, to (but excluding) the date of redemption; provided that (1) at least 50% of the aggregate principal amount of the Senior Notes (including any additional Senior Notes) outstanding under the Indenture remain outstanding immediately after the occurrence of such redemption (unless all Senior Notes are redeemed concurrently), and (2) each such redemption must occur within 180 days of the date of the consummation of any 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 debt discount and the debt issuance costs are being amortized using the effective interest method over the remaining term of approximately 86 months of the Senior Notes. For the three months ended March 31, 2022, the effective interest rate on the unamortized debt discount and the unamortized debt issuance costs for the Senior Notes was 4.42% and 4.30%, respectively. For the three months ended March 31, 2021, the effective interest rate on the unamortized debt discount and unamortized debt issuance costs for our $400 million in aggregate principal amount of 6.625% senior notes due 2026 (the “Original Senior Notes”) was 6.69%. For the three months ended March 31, 2021, the effective interest rate on the unamortized debt premium and the unamortized debt issuance costs for the additional Original Senior Notes, issued in December 2019 was 6.88%. All of our Original Senior Notes were redeemed on June 1, 2021. At March 31, 2022, the fair value of the Senior Notes, which are Level 2 measurements, was $373.4 million. 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, 2021 2022 Senior Notes interest expense $ 6,625 $ 4,250 Senior Notes amortization of debt discount 138 121 Senior Notes amortization of debt premium 58 — Senior Notes amortization of debt issuance costs 74 34 At March 31, 2022, our future interest payments on our outstanding balance were $125.3 million, with $17.0 million payable within 12 months. - 47 - FINANCIAL HIGHLIGHTS Below are our financial highlights (in thousands except for volumes and averages): Three months ended March 31, 2021 2022 Revenue $ 96,637 $ 98,161 Funeral contracts 13,296 13,515 Average revenue per funeral contract $ 5,276 $ 5,396 Preneed interment rights (property) sold 2,658 2,378 Average price per preneed interment right sold $ 4,551 $ 4,490 Gross profit $ 35,061 $ 34,478 Net income $ 12,933 $ 16,402 Revenue for the three months ended March 31, 2022 increased $1.5 million compared to the three months ended March 31, 2021, as we experienced a 1.6% increase in funeral contract volume, as well as a 2.3% increase in average revenue per funeral contract primarily due to market share gains and higher normalized death rates, offset by a 10.5% decrease in the number of preneed interment rights (property) sold, as well as a 1.3% decrease in the average price per interment right sold. Gross profit for the three months ended March 31, 2022 decreased $0.6 million compared to the three months ended March 31, 2021, primarily due to the decrease in revenue from our cemetery segment. Net income for the three months ended March 31, 2022 increased $3.5 million compared to the three months ended March 31, 2021, primarily due to a $2.0 million decrease in interest expense, a $1.9 million gain on insurance reimbursements and a $0.6 million decrease in income tax expense, offset by a $1.1 million increase in net loss on divestitures, disposals and impairments charges. 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, Interest expense, Income taxes and other components of income and expenses are presented herein under “– Other Financial Statement Items.” 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, 2022 issued on April 27, 2022 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. - 48 - Below is a reconciliation of Net income, a GAAP measure, to Adjusted net income, a non-GAAP measure, (in thousands): Three months ended March 31, 2021 2022 Net income $ 12,933 $ 16,402 Special items (1) Severance and separation costs (2) 1,575 — Accretion of discount on Convertible Notes (1) 20 — Net loss on divestitures and other costs (1) (308) 703 Net gain on insurance reimbursements (3) — (1,899) Disaster recovery and pandemic costs (4) 894 168 Change in uncertain tax reserves and other (1) — (533) Sum of special items $ 2,181 $ (1,561) Tax effect on special items (1) 424 (273) Adjusted net income (5) $ 14,690 $ 15,114 (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. In 2021, Special items were 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 Net loss on divestitures and other costs were taxed at the operating tax rate for the period. In 2022, Special items were taxed at the operating tax rate for the period, except for the Change in uncertain tax reserves and other, as this item is a tax benefit. (2) Costs related to the termination or resignation of certain key members of leadership in the first quarter of 2021. (3) Net gain recognized on insurance reimbursements for property damaged caused by Hurricane Ida that occurred during the third quarter of 2021. (4) Relates to health and safety expenses, including personal protective equipment (“PPE”) due to COVID-19. We purchased more PPE during the first quarter of 2021 compared to the same period in 2022. (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. Below is a reconciliation of Gross profit (a GAAP measure) to Operating profit (a non-GAAP measure) (in thousands): Three months ended March 31, 2021 2022 Gross profit $ 35,061 $ 34,478 Cemetery property amortization 1,517 1,332 Field depreciation expense 3,136 3,297 Regional and unallocated funeral and cemetery costs 6,073 6,347 Operating profit (1) $ 45,787 $ 45,454 (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, 2021 2022 Funeral Home $ 32,906 $ 33,735 Cemetery 12,881 11,719 Operating profit $ 45,787 $ 45,454 Operating profit margin (1) 47.4% 46.3% (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.” - 49 - RESULTS OF OPERATIONS The following is a discussion of our results of operations for the three months ended March 31, 2022 and 2021. The term “same store” refers to funeral homes and cemeteries acquired prior to January 1, 2018 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, 2017, 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 one funeral home we sold and one funeral home we merged with another business in an existing market in the three months ended March 31, 2021 and two funeral homes we sold in the three months ended March 31, 2022 . The term “divested” when discussed in the Cemetery Segment, refers to one cemetery we sold during 2021. “Planned divested” refers to the funeral home 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. 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, 2021 2022 Revenue: Same store operating revenue $ 58,983 $ 61,632 Acquired operating revenue 7,985 8,610 Divested/planned divested revenue 1,061 609 Ancillary revenue 1,207 1,070 Preneed funeral insurance commissions 330 263 Preneed funeral trust and insurance 2,208 2,171 Total $ 71,774 $ 74,355 Operating profit: Same store operating profit $ 26,652 $ 27,510 Acquired operating profit 3,644 3,750 Divested/planned divested operating profit 107 111 Ancillary operating profit 242 221 Preneed funeral insurance commissions 91 12 Preneed funeral trust and insurance 2,170 2,131 Total $ 32,906 $ 33,735 - 50 - The following measures reflect the significant metrics over this comparative period: Three months ended March 31, 2021 2022 Same store: Contract volume 11,303 11,675 Average revenue per contract, excluding preneed funeral trust earnings $ 5,218 $ 5,279 Average revenue per contract, including preneed funeral trust earnings $ 5,393 $ 5,445 Burial rate 37.2% 35.0% Cremation rate 56.5% 56.9% Acquired: Contract volume 1,748 1,706 Average revenue per contract, excluding preneed funeral trust earnings $ 4,568 $ 5,047 Average revenue per contract, including preneed funeral trust earnings $ 4,649 $ 5,123 Burial rate 38.4% 36.9% Cremation rate 56.4% 57.5% Funeral home same store operating revenue increased $2.6 million for the three months ended March 31, 2022 compared to the same period in 2021. The increase in operating revenue is primarily related to a 3.3% increase in same store contract volume, as well as a 1.2% increase in the average revenue per contract excluding preneed interest. The same store contract volume increased in spite of a 38.7% decrease in COVID-19 related contracts for the first quarter of 2022 compared to the first quarter of 2021. This additional volume increase is primarily due to market share gains and higher normalized death rates. The increase in average revenue per contract in the first quarter of 2022 reflects an increase in both burial and cremation contracts with services compared to the first quarter of 2021. The percentage of cremation contracts had the largest increase with a 3.4% increase in cremation contracts with memorial service. This increase is primarily due to our continued focus to welcome and educate families on the many products and service options that are available with cremation. Funeral home same store operating profit for the three months ended March 31, 2022 increased $0.9 million when compared to the same period in 2021. The comparable operating profit margin decreased 60 basis points to 44.6%. The increase in operating profit is primarily related to the increase in same store operating revenue, offset by a slight increase in bad debt expenses as a percent of revenue, which is due to the aging of higher accounts receivable related to high sales volume in the third quarter of 2021 due to the COVID-19 spike. Funeral home acquired operating revenue for the three months ended March 31, 2022 increased $0.6 million compared to the same period in 2021. The increase in operating revenue is primarily due to a 10.5% increase in the average revenue per contract excluding preneed interest, offset by a 2.4% decrease in acquired contract volume. The average revenue per contract in the first quarter of 2022 reflects an increase in both burial and cremation contracts with services compared to the first quarter of 2021. The percentage of cremation contracts had the largest increase with a 4.1% increase in cremation contracts with memorial services. This increase is primarily due to our continued focus to welcome and educate families on the many products and service options that are available with cremation. The acquired contract volume decrease is primarily related to the 57.1% decrease in COVID-19 related contracts for the first quarter of 2022 compared to the first quarter of 2021. Funeral home acquired operating profit for the three months ended March 31, 2022 increased $0.1 million when compared to the same period in 2021. The comparable operating profit margin decreased 200 basis points to 43.6%. The increase in operating profit is primarily related to the increase in acquired operating revenue, offset by an increase in operating expenses as a percent of operating revenue. Overall acquired operating expenses increased 2.1% as a percent of operating revenue with the largest increases in bad debt expense of 1.0% and salaries and benefits expense of 0.4%. The increase in bad debt expense is due to the aging of higher accounts receivable related to a high volume of sales due to the COVID-19 spike during the third quarter of 2021. The increase in salaries and benefits relates to filling vacant managing partner positions at three of our acquired businesses. Ancillary revenue, which is recorded in Other revenue , represents revenue from our flower shop, pet cremation and online cremation businesses, decreased $0.1 million, while Ancillary operating profit remained flat for the three months ended March 31, 2022 compared to the same period in 2021. Preneed funeral insurance commissions and preneed funeral trust and insurance revenue (recorded in Other revenue ) on a combined basis, decreased $0.1 million for the three months ended March 31, 2022 compared to the same period in 2021. The decrease is primarily related to the decrease in funeral insurance commissions, as preneed insurance sales decreased over the prior year due to the uncertainty of COVID-19. Operating profit for preneed funeral insurance commissions and preneed trust - 51 - and insurance, on a combined basis, decreased $0.1 million for the same comparative period, primarily due to the decrease in preneed funeral insurance commission 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, 2021 2022 Revenue: Same store operating revenue $ 14,635 $ 14,251 Acquired operating revenue 6,980 6,297 Divested revenue 80 — Preneed cemetery trust revenue 2,903 3,014 Preneed cemetery finance charges 265 244 Total $ 24,863 $ 23,806 Operating profit: Same store operating profit $ 5,704 $ 5,300 Acquired operating profit 4,102 3,299 Divested operating profit 31 — Preneed cemetery trust operating profit 2,779 2,876 Preneed cemetery finance charges 265 244 Total $ 12,881 $ 11,719 The following measures reflect the significant metrics over this comparative period: Three months ended March 31, 2021 2022 Same store: Preneed revenue as a percentage of operating revenue 58% 57% Preneed revenue (in thousands) $ 8,458 $ 8,103 Atneed revenue (in thousands) $ 6,177 $ 6,148 Number of preneed interment rights sold 1,899 1,781 Average price per interment right sold $ 4,075 $ 3,994 Acquired: Preneed revenue as a percentage of operating revenue 64% 63% Preneed revenue (in thousands) $ 4,443 $ 3,990 Atneed revenue (in thousands) $ 2,537 $ 2,307 Number of preneed interment rights sold 750 597 Average price per interment right sold $ 5,800 $ 5,969 Cemetery same store preneed revenue decreased $0.4 million for the three months ended March 31, 2022 compared to the same period in 2021, as we experienced a 6.2% decrease in the number of interment rights sold, as well as a 2.0% decrease in the average price per interment right sold. Cemetery same store atneed revenue, which represents 43% of our same store operating revenue, remained flat for the three months ended March 31, 2022 compared to the same period in 2021. Cemetery same store operating profit for the three months ended March 31, 2022 decreased $0.4 million from the same period in 2021, primarily due to the decrease in operating revenue. The comparable operating profit margin decreased 180 basis points to 37.2%. Operating expenses as a percent of operating revenue increased 1.8% with the largest increases in general and administrative expenses of 1.1% and salaries and benefits expenses of 0.4%, primarily due to the lower comparative costs in the prior period due to COVID-19 restrictions. - 52 - Cemetery acquired businesses experienced a $0.5 million decrease in preneed revenue and a $0.2 million decrease in atneed revenue for the three months ended March 31, 2022 compared to the same period in 2021. In the first quarter of 2022, we experienced a 20.4% decrease in the number of interment rights sold, which was slightly offset by a 2.9% increase in the average price per interment right sold. The decrease in interment rights sold is primarily due to atypical group and larger sales at our Virginia business in the first quarter of 2021. Group or larger sales impact the interment counts, as multiple interments are listed on a single contract, which creates a high comparable on interments sold in the prior period compared to the current period. Cemetery acquired operating profit decreased $0.8 million for the three months ended March 31, 2022 from the same period in 2021. The comparable operating profit margin decreased 640 basis points to 52.4% primarily as a result of the decrease in operating revenue and a 6.4% increase in operating expenses as a percent of operating revenue. The areas with the largest increases are as follows: (1) salaries, benefits and atneed commissions increased 2.2%, (2) facilities and grounds increased 1.5%, (3) general and administrative expenses increased 1.0% and (4) promotional expenses increased 0.9%. Preneed cemetery trust revenue and preneed cemetery finance charges (recorded in Other revenue ) on a combined basis increased $0.1 million for the three months ended March 31, 2022 compared to the same period in 2021. The increase in trust revenue is due to an increase in realized gains on delivered merchandise and services contracts and an increase in income in our perpetual care trust fund. Operating profit for the two categories of Other Revenue , on a combined basis, increased $0.1 million for the three months ended March 31, 2022 compared to the same period in 2021 primarily due to the increase in revenue. Cemetery property amortization . Cemetery property amortization totaled $1.3 million for the three months ended March 31, 2022, a decrease of $0.2 million compared to the same period in 2021, primarily due to the decrease in property sold across our cemetery portfolio. Field depreciation. Depreciation expense for our field businesses totaled $3.3 million for the three months ended March 31, 2022, an increase of $0.2 million compared to the same period in 2021, primarily due to depreciation from computer equipment assets added in the latter half of 2021. 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 $6.3 million for the three months ended March 31, 2022, an increase of $0.3 million compared to the same period in 2021, primarily due to the following: (1) a $0.3 million increase in other general administrative costs, which includes higher travel costs; (2) a $0.3 million increase in salary and benefits expenses, which includes additional cemetery sales employees; and (3) a $0.3 million increase in incentive award trips and annual managing partner meetings, which were postponed in the prior year due to COVID-19, offset by (4) a $0.6 million decrease in health and safety expenses related to COVID-19. Other Financial Statement Items General, administrative and other. General, administrative and other expenses totaled $8.6 million for the three months ended March 31, 2022, a decrease of $0.6 million compared to the same period in 2021, primarily due to the following: (1) a $1.6 million decrease in separation expense related to the resignation of two members of senior leadership in the first quarter of 2021; and (2) a $0.1 million decrease in divestiture expenses, offset by (3) a $0.5 million increase in cash incentives and equity compensation; (4) a $0.3 million increase in other general administrative costs, which includes higher online marketing and advertising costs and software license fees for new technology; and (5) a $0.3 million increase in salary and benefits expenses, which includes five new employees in our recently developed marketing department. Net (gain) loss on divestitures, disposals and impairments charges. The components of Net (gain) loss on divestitures, disposals and impairment charges are as follows (in thousands): Three months ended March 31, 2021 2022 Net (gain) loss on divestitures and real property $ (308) $ 703 Net loss on disposals of fixed assets — 64 Total $ (308) $ 767 We divested two funeral homes for an aggregate net loss of $0.7 million and we divested one funeral home and real property for a net gain of $0.3 million, during the three months ended March 31, 2022 and 2021, respectively. - 53 - Interest expense . Interest expense related to our various debt arrangement is as follows (in thousands): Three months ended March 31, 2021 2022 Senior Notes $ 6,779 $ 4,406 Credit Facility 563 935 Finance leases 120 113 Acquisition debt 97 80 Convertible Notes 19 — Other 6 8 Total $ 7,584 $ 5,542 Gain on insurance reimbursements. During the three months ended March 31, 2022, we recorded a gain on the reimbursements received from insurance for property damaged by Hurricane Ida that occurred during third quarter of 2021. Income taxes. Income tax expense totaled $5.1 million and $5.6 million for the three months ended March 31, 2022 and 2021. Our operating tax rate before discrete items was 26.5% and 31.0% for the three months ended March 31, 2022 and 2021, respectively. On June 30, 2020, we filed carryback refund claims for the 2018 and 2019 tax years. 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. On October 11, 2021, we received an adverse ruling from the IRS related to our accounting method change for cemetery property revenue recognition filed in 2018 and subsequently filed an automatic accounting method change to adopt the IRS’ preferred method of revenue recognition for cemetery property effective for the year ending December 31, 2021. On March 2, 2022, we received approval from the IRS regarding our method change filed related to the revenue recognition of cemetery merchandise and services sales. As a result, we recorded a $0.5 million reduction to the reserve for uncertain tax positions during the three months ended March 31, 2022. At December 31, 2021 and March 31, 2022, the reserve for uncertain tax positions was $3.8 million and $3.2 million, respectively, related to carrying back the NOLs generated in the tax year ended December 31, 2018, filed under the CARES Act on June 30, 2020. OVERVIEW OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of our Consolidated Financial Statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. Understanding our accounting policies and the extent to which our management uses judgment, assumptions and estimates in applying these policies is integral to understanding our Consolidated Financial Statements. Our critical accounting policies are more fully described in Part I, Item 1, Financial Statements, Note 1. We have identified Business Combinations and Goodwill as those accounting policies that require significant judgments, assumptions and estimates and that have a significant impact on our financial condition and results of operations. These policies are considered critical because they may result in fluctuations in our reported results from period to period due to the significant judgments, estimates and assumptions about complex and inherently uncertain matters and because the use of different judgments, assumptions or estimates could have a material impact on our financial condition or results of operations. Actual results may differ from these estimates and such estimates may change if the underlying conditions or assumptions change. Historical performance should not be viewed as indicative of future performance because there can be no assurance the margins, operating income and net earnings, as a percentage of revenue, will be consistent from period to period. We evaluate our critical accounting estimates and judgments required by our policies on an ongoing basis and update them as appropriate based on changing conditions. 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. - 54 -