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 provider of funeral and cemetery services and merchandise in the United States. We operate in two business segments: Funeral Home Operations, which currently accounts for approximately 70% of our total revenue, and Cemetery Operations, which currently accounts for approximately 30% of our total revenue. At March 31, 2023, we operated 173 funeral homes in 26 states and 32 cemeteries in 11 states. We compete with other publicly held, privately held and independent operators of funeral and cemetery companies. 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 memorial markers, outer burial containers and monuments) 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 Board of Directors On February 22, 2023, the Board of Directors (the “Board”) of the Company elected Carlos R. Quezada, President and Chief Operating Officer, to serve as a Class II director, effective that same date, until the Company’s 2025 annual meeting of stockholders. The Board also appointed Mr. Quezada to serve as Vice Chairman of the Board. Mr. Quezada will serve as a non-independent member of the Board, and the Board does not expect to appoint Mr. Quezada to any of its standing committees. Following the appointment of Mr. Quezada, the Board is now comprised of six directors, including four independent directors. Code of Business Conduct and Ethics On February 22, 2023, our Board, on the recommendation of the Board’s Audit Committee, approved various amendments to the Company’s Code of Business Conduct and Ethics (the “Code”), which applies to all directors, officers and employees of the Company and its subsidiaries. In addition to making certain technical and administrative updates, the amendments to the Code include, among other things, summarizing and clarifying the Company’s existing compliance requirements and also identifies and expands upon certain policies, including those related to bribery and kickbacks, antitrust, political activity and improper influence on auditors. As disclosed in our Annual Report on Form 10-K for the year ended December 31, 2022, copies of the Code, as amended, are posted on our website under “Investors - Corporate Governance.” Leadership Changes Effective March 13, 2023, L. Kian Granmayeh was appointed to serve as the Company’s Executive Vice President, Chief Financial Officer and Treasurer (Principal Financial Officer). Acquisitions On March 22, 2023, we acquired three funeral homes, two cemeteries and a cremation focused business in the Bakersfield, California area for $44.0 million. Divestitures During the three months ended March 31, 2023, we sold one funeral home and two cemeteries for $0.8 million for a loss of $0.1 million. - 32 - Business Impacts of COVID-19 The overall macroeconomic impact from the pandemic to the funeral and cemetery industry may provide varying results as compared to other industries. Our industry’s revenues are impacted by various factors, including for example, fluctuations in the death rate, the number of funeral services performed, the average price for a service and the mix of traditional burial versus cremation contracts. During the three months ended March 31, 2023, deaths directly attributable from COVID-19 now have minimal direct impact on the overall death rate, although the overall death rate remains slightly higher than the pre-pandemic period, and we are unable to predict or forecast the duration or variation of this increased death rate with any certainty. As a result, we experienced lower volumes, revenues, earnings and margins when compared to the first quarter of 2022, but overall financial performance remains at or above prior reporting periods during and prior to the pandemic. Although we expect these death rate trends to continue, we will continue to assess these impacts, including the potential impacts of any emerging or new public health threats, and implement appropriate procedures, plans, strategies, and issue any disclosures that may be required, as the situation evolves. 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. Within our financial reporting environment, we have considered the impact of COVID-19 on the assumptions and estimates used in preparing our consolidated financial statements. In the opinion of management, all material adjustments necessary for a fair presentation of the Company’s financial results for the quarter have been made, but are complicated by our inability to predict or forecast the duration or variation of the increased death rate with any certainty. 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. To date, we have not experienced any material supply chain impacts or disruptions from our vendors attributable to COVID-19 and we continue to receive reliable service. We believe our access to capital, the cost of our capital, and the sources and uses of our cash should be relatively consistent in the near term. While the expected duration and potential future impacts of the pandemic are 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. For additional information related to our liquidity position, see Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, Liquidity and Capital Resources. Inflationary Trends During the three months ended March 31, 2023, we continued to experience modest cost increases and surcharges from our vendors and suppliers on merchandise and goods due to broader inflationary, raw material cost increases, and global supply chain impacts. For example, we experienced higher costs related to full-time hourly base rates, utilities, funeral supplies, merchandise costs and insurance. Although we have taken steps to mitigate these cost increases and we expect these impacts to continue throughout the current year, the ultimate scope and duration of these impacts are unknown at this time. More broadly, the U.S. economy continues to experience higher rates of inflation, which has impacted a wide variety of industries and sectors, with consumers facing rising prices. Such inflation may negatively impact consumers or discretionary spending, including the amount that consumers are able to spend on our services, although we have not experienced such impacts to date and our industry has been largely resilient to similar adverse economic and market environments in the past. Although we expect these trends to continue throughout the current year, we will continue to assess these impacts and take the appropriate steps, if necessary, to mitigate these cost increases, if possible. 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 - 33 - 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. 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 ranking criteria to assess acquisition candidates. As we execute this strategy over time, we expect to acquire larger, higher margin strategic businesses in growing markets. 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 - 34 - 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. 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 or seek further borrowing capacity from our lenders 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, 2022. Our plan is to remain focused on integrating our recently acquired businesses and prioritizing our capital allocation for debt repayments, the payment of dividends and debt obligations and internal growth capital expenditures, which we expect to fund using cash on hand and borrowings under our Credit Facility, along with general corporate purposes, as allowed under our Credit Facility. We believe that our existing and anticipated cash resources, including, as needed, additional borrowings or other financings that we may be able to obtain, 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 2023 with $1.2 million in cash and ended the first quarter with $1.3 million in cash. At March 31, 2023, we had borrowings of $213.6 million outstanding on our Credit Facility compared to $190.7 million at December 31, 2022. The following table sets forth the elements of cash flow (in thousands): Three months ended March 31, 2022 2023 Cash at beginning of the year $ 1,148 $ 1,170 Net cash provided by operating activities 15,801 25,869 Acquisitions of businesses and real property (2,575) (44,000) Proceeds from divestitures and sale of other assets 1,026 1,275 Proceeds from insurance claims 676 421 Capital expenditures (6,883) (4,982) Net cash used in investing activities (7,756) (47,286) Net borrowings on our Credit Facility, acquisition debt and finance lease obligations 18,700 22,773 Net proceeds from employee equity plans 374 428 Dividends paid on common stock (1,725) (1,661) Purchase of treasury stock (25,655) — Net cash provided by (used in) financing activities (8,306) 21,540 Cash at end of the period $ 887 $ 1,293 - 35 - Operating Activities For the three months ended March 31, 2023, cash provided by operating activities was $25.9 million compared to $15.8 million for the three months ended March 31, 2022. The increase of $10.1 million is primarily due to a $7.0 million withdrawal of realized capital gains and earnings from our preneed cemetery trust investments, as well as favorable working capital changes in accrued liabilities. Investing Activities Our investing activities, resulted in a net cash outflow of $47.3 million for the three months ended March 31, 2023 compared to $7.8 million for the three months ended March 31, 2022, an increase of $39.5 million. Acquisition and Divestiture Activity During the three months ended March 31, 2023, we acquired a business consisting of three funeral homes, two cemeteries and one cremation focused business for $44.0 million. In addition, we sold one funeral home and two cemeteries for $0.8 million. 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. Capital Expenditures For the three months ended March 31, 2023, capital expenditures (comprised of growth and maintenance spend) totaled $5.0 million compared to $6.9 million for the three months ended March 31, 2022, a decrease of $1.9 million. The following tables present our growth and maintenance capital expenditures (in thousands): Three months ended March 31, 2022 2023 Growth Cemetery development $ 2,264 $ 2,118 Renovations at certain businesses (1) 1,155 906 Other (148) 116 Total Growth $ 3,271 $ 3,140 (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, which occurred during the third quarter of 2021, all of which was reimbursed by our property insurance. Three months ended March 31, 2022 2023 Maintenance Facility repairs and improvements $ 1,067 $ 89 General equipment and furniture 1,339 909 Vehicles 795 233 Paving roads and parking lots 311 156 Information technology infrastructure improvements — 309 Other 100 146 Total Maintenance $ 3,612 $ 1,842 Financing Activities Our financing activities resulted in a net cash inflow of $21.5 million for the three months ended March 31, 2023 compared to a net cash outflow of $8.3 million for the three months ended March 31, 2022, an increase of $29.8 million. During the three months ended March 31, 2023, we had net borrowings on our Credit Facility, acquisition debt and finance leases of $22.8 million, offset by $1.7 million in dividends. 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. - 36 - Share Repurchase Share repurchase activity is as follows (dollar value in thousands): Three months ended March 31, 2022 2023 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 stock. At March 31, 2023, our share repurchase program had $48.9 million authorized for repurchases. Dividends Our Board declared the following dividends payable on the dates below (in thousands, except per share amounts): 2023 Per Share Dollar Value March 1 st $ 0.1125 $ 1,661 2022 Per Share Dollar Value March 1 st $ 0.1125 $ 1,725 Credit Facility, Lease Obligations and Acquisition Debt The outstanding principal of our Credit Facility, lease obligations and acquisition debt at March 31, 2023 is as follows (in thousands): March 31, 2023 Credit Facility $ 213,600 Finance leases 5,052 Operating leases 19,872 Acquisition debt 3,971 Total $ 242,495 Credit Facility At March 31, 2023, our senior secured revolving credit facility (the “Credit Facility”) was comprised of: (i) a $250.0 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 aggregate 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 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 liens, make investments, engage in mergers and acquisitions, and pay dividends and other restricted payments, and certain financial maintenance covenants. At March 31, 2023, we were subject to the following financial covenants under our Credit Facility: (A) a Total Leverage Ratio not to exceed 6.00 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, 2023. - 37 - At March 31, 2023, we had outstanding borrowings under the Credit Facility of $213.6 million. We also had one letter of credit for $2.3 million under the Credit Facility. The letter of credit will expire on November 27, 2023 and is expected to automatically renew annually and secures our obligations under our various self-insured policies. At March 31, 2023, we had $34.1 million of availability under the Credit Facility. Outstanding borrowings under our Credit Facility bear interest at a prime rate or a Bloomberg Short-Term Bank Yield Index (“BSBY”) rate, plus an applicable margin based on our leverage ratio. At March 31, 2023, the prime rate margin was equivalent to 2.375% and the BSBY rate margin was 3.375%. The weighted average interest rate on our Credit Facility was 2.1% and 7.9% for the three months ended March 31, 2022 and 2023, respectively. The interest expense and amortization of debt issuance costs related to our Credit Facility are as follows (in thousands): Three months ended March 31, 2022 2023 Credit Facility interest expense $ 847 $ 3,811 Credit Facility amortization of debt issuance costs 88 138 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. Lease Obligations Our lease obligations consist of operating and finance leases. We lease certain office facilities, certain funeral homes, equipment and vehicles 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, 2023, operating and finance lease obligations were $36.3 million, with $5.0 million payable within 12 months. The components of lease cost are as follows (in thousands): Three months ended March 31, 2022 2023 Operating lease cost $ 848 $ 875 Short-term lease cost 102 94 Variable lease cost 7 58 Finance lease cost: Depreciation of leased assets $ 108 $ 108 Interest on lease liabilities 113 105 Total finance lease cost 221 213 Total lease cost $ 1,178 $ 1,240 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, 2023, acquisition debt obligations were $5.6 million, with $0.7 million payable within 12 months. The imputed interest expense related to our acquisition debt is as follows (in thousands): Three months ended March 31, 2022 2023 Acquisition debt imputed interest expense $ 80 $ 71 Senior Notes At March 31, 2023, 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. - 38 - 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 74 months of the Senior Notes. The effective interest rate on the unamortized debt discount and the unamortized debt issuance costs for the Senior Notes for both the three months ended March 31, 2022 and 2023 was 4.42% and 4.30%, respectively. At March 31, 2023, the fair value of the Senior Notes, which are Level 2 measurements, was $328.2 million. The interest expense and amortization of debt discount and debt issuance costs related to our Senior Notes are as follows (in thousands): Three months ended March 31, 2022 2023 Senior Notes interest expense $ 4,250 $ 4,250 Senior Notes amortization of debt discount 121 127 Senior Notes amortization of debt issuance costs 34 36 At March 31, 2023, our future interest payments on our outstanding balance were $108.3 million, with $17.0 million payable within 12 months. FINANCIAL HIGHLIGHTS Below are our financial highlights (in thousands except for volumes and averages): Three months ended March 31, 2022 2023 Revenue $ 98,161 $ 95,514 Funeral contracts 13,515 12,415 Average revenue per funeral contract $ 5,396 $ 5,527 Preneed interment rights (property) sold 2,378 2,504 Average price per preneed interment right sold $ 4,490 $ 4,496 Gross profit $ 34,478 $ 31,055 Net income $ 16,402 $ 8,844 Revenue for the three months ended March 31, 2023 decreased $2.6 million compared to the three months ended March 31, 2022, as we experienced an 8.1% decrease in funeral contract volume, which was partially offset by a 2.4% increase in the average revenue per funeral contract and a 5.3% increase in the number of preneed interment rights (property) sold, while the average price per interment right sold remained flat. The contract volume decrease is primarily a result of the significant decline in COVID-19 related deaths in 2023 as compared to 2022, as these deaths now have a minimal impact on the overall death rate. The increase in interment rights sold is due exclusively to our newly acquired cemetery businesses, not present in the comparative quarter of 2022. Gross profit for the three months ended March 31, 2023 decreased $3.4 million compared to the three months ended March 31, 2022, due to the decrease in revenue from our funeral home segment, as well as increases in operating expenses in both our funeral home and cemetery segments. Net income for the three months ended March 31, 2023 decreased $7.6 million compared to the three months ended March 31, 2022, primarily due to the following: (1) the $3.4 million decrease in gross profit, (2) a $3.0 million increase in interest expense, (3) a $1.6 million increase in general and administrative expenses, (4) a $1.2 million impact from divestitures, disposals and insurance reimbursements, offset by (5) a $1.6 million decrease in income tax expense. Further discussion of Revenue and the components of Gross profit for our funeral home and cemetery segments is presented 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 under “– Other Financial Statement Items.” - 39 - REPORTING AND NON-GAAP FINANCIAL MEASURES We also present our financial performance in our “Condensed Operating and Financial Trend Report” (“Trend Report”) as reported in our earnings release for the three months ended March 31, 2023 issued on May 3, 2023, 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 Gross profit (a GAAP financial measure) to Operating profit (a non-GAAP financial measure) (in thousands): Three months ended March 31, 2022 2023 Gross profit $ 34,478 $ 31,055 Cemetery property amortization 1,332 1,201 Field depreciation expense 3,297 3,357 Regional and unallocated funeral and cemetery costs 6,347 5,437 Operating profit (1) $ 45,454 $ 41,050 (1) Operating profit is defined as Gross profit plus 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-financial GAAP measure) by Segment (in thousands): Three months ended March 31, 2022 2023 Funeral Home $ 33,735 $ 28,966 Cemetery 11,719 12,084 Operating profit $ 45,454 $ 41,050 Operating profit margin (1) 46.3% 43.0% (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 under “– Results of Operations.” - 40 - RESULTS OF OPERATIONS The following is a discussion of our results of operations for the three months ended March 31, 2023 and 2022. We previously classified our funeral homes and cemeteries as “same store” or “acquired” in our results of operations discussion in our quarterly and annual filings prior to December 31, 2022. Same store generally referred to funeral homes and cemeteries acquired at least five years before the reporting period being presented, while acquired generally referred to funeral homes and cemeteries acquired within the preceding five years of the reporting period being presented, both of which excluded certain funeral homes and cemeteries that we intended to divest. In an effort to simplify the discussion of our results of operations, provide meaningful metrics to investors to compare our results to previous periods and provide more insight into the underlying long-term performance trends in our business, we have combined both the same store and acquired categories and now refer to this combination as “operating”. The term “operating” in the Funeral Home and Cemetery Segment simply refers to all our funeral homes and cemeteries owned and operated in the current reporting period, excluding certain funeral home and cemetery businesses that we have divested or intend to divest in the near future. The term “divested” when discussed in the Funeral Home Segment, refers to one funeral home we sold in the three months ended March 31, 2023 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 two cemeteries we sold during the three months ended March 31, 2023. “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. Funeral Home Segment The following table sets forth certain information regarding our Revenue and Operating profit for our funeral home operations (in thousands): Three months ended March 31, 2022 2023 Revenue: Operating $ 70,212 $ 66,463 Divested/planned divested 589 108 Ancillary 1,070 1,057 Other 2,484 2,457 Total $ 74,355 $ 70,085 Operating profit: Operating $ 31,273 $ 26,628 Divested/planned divested 48 (26) Ancillary 221 146 Other 2,193 2,218 Total $ 33,735 $ 28,966 The following operating measures reflect the significant metrics over this comparative period: Contract volume 13,393 12,384 Average revenue per contract, excluding preneed funeral trust earnings $ 5,242 $ 5,367 Average revenue per contract, including preneed funeral trust earnings $ 5,398 $ 5,531 Cremation rate 57.1% 59.1% Funeral home operating revenue decreased $3.7 million for the three months ended March 31, 2023 compared to the three months ended March 31, 2022. The decrease in operating revenue is primarily driven by a 7.5% decrease in contract volume, which was partially offset by a 2.4% increase in the average revenue per contract excluding preneed interest. The contract - 41 - volume decrease is primarily a result of the significant decline in COVID-19 related deaths in 2023 as compared to 2022, as these deaths now have a minimal impact on the overall death rate. The increase in average revenue per contract is primarily due to a combination of price increases and our continued focus on educating families on the many products and service options that are available with burials and cremations. Funeral home operating profit for the three months ended March 31, 2023 decreased $4.6 million when compared to the same period in 2022, primarily due to an increase in operating expenses as a percentage of revenue. The comparable operating profit margin decreased 440 basis points to 40.1%. Operating expenses as a percentage of revenue increased 4.5% with the largest increase in salary and benefits expenses of 2.2%, facilities and grounds expenses of 1.0%, general and administrative expenses of 0.6%, and other funeral costs of 0.4%. The increase in operating expenses is partially due to higher costs from inflationary impacts concentrated in our full-time hourly base rates, utilities and funeral supplies. Ancillary revenue, which represents revenue from our flower shop, pet cremation and online cremation businesses remained flat and Ancillary operating profit decreased $0.1 million for the three months ended March 31, 2023 compared to the three months ended March 31, 2022. Other revenue and other operating profit, which consists of preneed funeral insurance commissions and preneed funeral trust and insurance remained flat for the three months ended March 31, 2023, compared to the three months ended March 31, 2022. Cemetery Segment The following table sets forth certain information regarding our Revenue and Operating profit for our cemetery operations (in thousands): Three months ended March 31, 2022 2023 Revenue: Operating $ 20,475 $ 21,605 Divested/planned divested 73 42 Other 3,258 3,782 Total $ 23,806 $ 25,429 Operating profit: Operating $ 8,595 $ 8,393 Divested/planned divested 4 12 Other 3,120 $ 3,679 Total $ 11,719 $ 12,084 The following operating measures reflect the significant metrics over this comparative period: Preneed revenue as a percentage of operating revenue 59.0% 58.0% Preneed revenue (in thousands) $ 12,078 $ 12,447 Atneed revenue (in thousands) $ 8,396 $ 9,157 Number of preneed interment rights sold 2,365 2,499 Average price per interment right sold $ 4,510 $ 4,500 Cemetery operating revenue increased $1.1 million for the three months ended March 31, 2023 compared to the three months ended March 31, 2022, as we experienced a 5.7% increase in the number of preneed interment rights sold, while the average price per preneed interment right sold remained flat. The increase in interment rights sold is due exclusively to our newly acquired cemetery businesses, not present in the comparative quarter of 2022. Cemetery atneed revenue, which represents 42.0% of our total operating revenue, increased $0.8 million for the three months ended March 31, 2023, compared to the same period of the prior year, primarily due to an increase in sales of merchandise and services. Cemetery operating profit decreased $0.2 million for the three months ended March 31, 2023 compared to the three months ended March 31, 2022, primarily due to an increase in operating expenses as a percentage of revenue. The comparable operating profit margin decreased 320 basis points to 38.8%. Operating expenses as a percent of operating revenue increased 3.1% with the largest increase in merchandise costs of 0.9%, salary and benefits expenses of 0.9% and facilities and grounds expenses of 0.6%. The increase in operating expenses is partially due to higher costs from inflationary impacts concentrated in our utilities and merchandise costs. - 42 - Other revenue, which consists of preneed cemetery trust revenue and preneed cemetery finance charges, increased $0.5 million for the three months ended March 31, 2023, compared to the three months ended March 31, 2022. The increase is primarily due to an increase in dividends and interest income in our perpetual care trust fund. Other operating profit increased $0.6 million for the same comparative period, primarily due to the increase in revenue. Cemetery property amortization . Cemetery property amortization totaled $1.2 million for the three months ended March 31, 2023, a decrease of $0.1 million compared to the same period in 2022. The decrease is due to fewer sales of private mausoleums in the first quarter of 2023, which generally have a higher cost of construction. Field depreciation. Depreciation expense for our field businesses totaled $3.4 million for the three months ended March 31, 2023, an increase of $0.1 million compared to the same period in 2022, primarily due to acquisitions made in latter half of 2022. 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 $5.4 million for the three months ended March 31, 2023, a decrease of $0.9 million compared to the same period in 2022, primarily due to the following: (1) a $0.5 million decrease in cash incentives and equity compensation; (2) a $0.3 million decrease in incentive award trips and annual managing partner meetings; and (3) a $0.1 million decrease in other general expenses. Other Financial Statement Items General, administrative and other. General, administrative and other expenses, which includes salaries and benefits, cash and equity incentive compensation for the Houston support office totaled $10.2 million for the three months ended March 31, 2023, an increase of $1.6 million compared to the same period in 2022, primarily due to an increase in salary and benefits expense, along with increased cash and equity incentive compensation, as a result of having a complete senior leadership team at the end of the current period. Net loss on divestitures, disposals and impairments charges. The components of Net loss on divestitures, disposals and impairment charges are as follows (in thousands): Three months ended March 31, 2022 2023 Net loss on divestitures $ 703 $ 82 Net loss on disposals of fixed assets 64 159 Total $ 767 $ 241 During the three months ended March 31, 2023 and 2022, we divested one funeral home and two cemeteries for an aggregate loss of $0.1 million and we divested two funeral homes for a loss of $0.7 million, respectively. Interest expense . Interest expense related to its respective debt arrangement is as follows (in thousands): Three months ended March 31, 2022 2023 Senior Notes $ 4,406 $ 4,413 Credit Facility 935 3,949 Finance leases 113 105 Acquisition debt 80 71 Other 8 1 Total $ 5,542 $ 8,539 (Gain) loss on property damage, net of insurance claims. During the three months ended March 31, 2023, we recorded a $0.3 million loss, net of insurance proceeds, for property damaged by a fire that occurred during first quarter of 2023. During the three months ended March 31, 2022, we recorded a $1.9 million gain, net of insurance proceeds, for property damaged by Hurricane Ida that occurred during the third quarter of 2021. Other, net. During the three months ended March 31, 2023, we recorded a $0.5 million gain on the sale of other real property not used in business operations. Income taxes. Income tax expense totaled $3.5 million for the three months ended March 31, 2023, a decrease of $1.6 million compared to the same period in 2022, primarily due to lower pre-tax income in the current period. Our operating tax rate before discrete items was 28.9% and 26.5% for the three months ended March 31, 2023 and 2022, respectively. - 43 - 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 II, Item 8 “Financial Statements and Supplementary Data” in Note 1 in our Annual Report on Form 10-K for the year ended December 31, 2022. 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 and may be further affected by epidemics and pandemics, like COVID-19. Generally, the number of deaths 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. For example, we experienced fluctuations in the death rate due to COVID-19, with a result of increased deaths during the duration of the pandemic. Although deaths directly attributable from COVID-19 now have minimal direct impact on the overall death rate, the overall death rate remains higher than the pre-COVID-19 pandemic period. As a result, we are unable to predict or forecast the duration or variation of this increased death rate with any certainty.