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 June 30, 2023, we operated 172 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 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 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 - Resignation; Election; and Review of Potential Strategic Alternatives On June 15, 2023, Dr. Achille Messac, a member of our Board of Directors (the “Board”), provided notice of his resignation from the Board, effective on that date. Dr. Messac’s resignation was not a result of any disagreement with the Company on any matter related to its operations, policies or practices. On June 21, 2023, the Board elected Chad Fargason to serve as a Class II Director until the Company’s 2025 annual meeting of shareholders. Mr. Fargason was appointed to serve on the Audit Committee, along with being appointed Chairman of the Corporate Governance Committee. On June 29, 2023, the Board announced it had initiated a process to explore potential strategic alternatives, possibly including a sale, merger or other potential strategic or financial transaction, to maximize shareholder value. Leadership Changes On June 21, 2023, the Board appointed Carlos R. Quezada, to serve as Chief Executive Officer (“CEO”), effective on that date, as part of a planned succession of Melvin C. Payne, founder and former CEO. Concurrently with the appointment of Mr. Quezada as CEO, Mr. Payne stepped down as CEO and the Board approved his appointment as Executive Chairman of the Board, effective on that date. On June 21, 2023, the Board appointed Steven D. Metzger, to serve as President, along with remaining in his role as Secretary, effective on that date. Strategic Partnership Agreement On May 16, 2023, we received a $6.0 million incentive payment from a vendor for entering into a strategic partnership agreement to market and sell prearranged funeral services in the future. Inflationary and Macroeconomic Trends During the second quarter of 2023, we continued to experience modest cost increases and surcharges from our vendors and suppliers on merchandise and goods due to increases in the cost of raw materials, as well as broader inflationary, and global supply chain impacts, along with rising interest rates. For example, we experienced higher costs related to full-time hourly base rates, utilities, funeral supplies, merchandise costs, insurance, and increased borrowing costs under our Credit Facility. - 35 - 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 memorial 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 (primarily grave sites, lawn crypts, mausoleum spaces and niches) and related cemetery merchandise (such as memorial markers, outer burial containers and monuments) and services (interments, inurnments and installation of cemetery merchandise) 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. 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. - 36 - 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 Leadership 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 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 - 37 - 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 second quarter with $1.0 million in cash. At June 30, 2023, we had borrowings of $204.0 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): Six months ended June 30, 2022 2023 Cash at beginning of the year $ 1,148 $ 1,170 Net cash provided by operating activities 30,177 39,187 Acquisitions of businesses and real property (2,601) (44,000) Proceeds from divestitures and sale of other assets 3,720 1,973 Proceeds from insurance claims 2,167 1,092 Capital expenditures (13,468) (8,960) Net cash used in investing activities (10,182) (49,895) Net borrowings on our Credit Facility, acquisition debt and finance lease obligations 19,598 13,044 Payment of debt issuance for the Credit Facility and Senior Notes (339) — Net proceeds from employee equity plans 774 804 Dividends paid on common stock (3,455) (3,340) Purchase of treasury stock (36,663) — Net cash provided by (used in) financing activities (20,085) 10,508 Cash at end of the period $ 1,058 $ 970 Operating Activities For the six months ended June 30, 2023, cash provided by operating activities was $39.2 million compared to $30.2 million for the six months ended June 30, 2022. The increase of $9.0 million is primarily due to an $8.6 million withdrawal of realized capital gains and earnings from our preneed funeral and cemetery trust investments and receiving a $6.0 million incentive payment from a vendor for entering into a strategic partnership agreement to market and sell prearranged funeral services in the future, offset by unfavorable working capital changes in accrued liabilities and accounts payable. Investing Activities Our investing activities, resulted in a net cash outflow of $49.9 million for the six months ended June 30, 2023 compared to $10.2 million for the six months ended June 30, 2022, an increase of $39.7 million. Acquisition and Divestiture Activity During the six months ended June 30, 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 and real property for $1.2 million. We also received proceeds of $1.1 million from our property insurance policy for the reimbursement of renovation costs for certain of our funeral businesses damaged by Hurricane Ian that occurred during the third quarter of 2022 and a fire that occurred during the first quarter of 2023. During the six months ended June 30, 2022, we sold real property for $2.9 million and we sold two funeral homes for an aggregate of $0.9 million and purchased real property for $2.6 million. Capital Expenditures For the six months ended June 30, 2023, capital expenditures (comprised of growth and maintenance spend) totaled $9.0 million compared to $13.5 million for the six months ended June 30, 2022, a decrease of $4.5 million. - 38 - The following tables present our growth and maintenance capital expenditures (in thousands): Six months ended June 30, 2022 2023 Growth Cemetery development $ 3,673 $ 3,505 Renovations at certain businesses (1) 3,620 1,623 Other 193 109 Total Growth $ 7,486 $ 5,237 (1) During the six months ended June 30, 2023, we spent $0.5 million for renovations on two businesses that were affected by Hurricane Ian, which occurred during the third quarter of 2022 and $0.3 million for renovations on one business that was damaged by a fire, which occurred during the first quarter of 2023, all of which was reimbursed by our property insurance. During the six months ended June 30, 2022, we spent $2.1 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. Six months ended June 30, 2022 2023 Maintenance General equipment and furniture $ 2,347 $ 2,260 Facility repairs and improvements 1,599 249 Vehicles 1,129 443 Paving roads and parking lots 485 330 Other 422 441 Total Maintenance $ 5,982 $ 3,723 Financing Activities Our financing activities resulted in a net cash inflow of $10.5 million for the six months ended June 30, 2023 compared to a net cash outflow of $20.1 million for the six months ended June 30, 2022, an increase of $30.6 million. During the six months ended June 30, 2023, we had net borrowings on our Credit Facility, acquisition debt and finance leases of $13.0 million, offset by $3.3 million in dividends. During the six months ended June 30, 2022, we had net borrowings on our Credit Facility, acquisition debt and finance leases of $19.6 million, offset by $36.7 million for the purchase of treasury stock and $3.5 million in dividends. Share Repurchase Share repurchase activity is as follows (dollar value in thousands): Three months ended June 30, Six months ended June 30, 2022 2023 2022 2023 Number of Shares Repurchased 205,496 — 695,496 — Average Price Paid Per Share $ 40.02 $ — $ 49.22 $ — Dollar Value of Shares Repurchased $ 8,224 $ — $ 34,234 $ — 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 June 30, 2023, our share repurchase program had $48.9 million authorized for repurchases. - 39 - Cash Dividend 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 June 1 st $ 0.1125 $ 1,679 2022 Per Share Dollar Value March 1 st $ 0.1125 $ 1,725 June 1 st $ 0.1125 $ 1,730 Credit Facility, Lease Obligations and Acquisition Debt The outstanding principal of our Credit Facility, lease obligations and acquisition debt at June 30, 2023 is as follows (in thousands): June 30, 2023 Credit Facility $ 204,000 Finance leases 4,946 Operating leases 19,441 Acquisition debt 3,948 Total $ 232,335 Credit Facility At June 30, 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 (as defined in Note 12) 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 June 30, 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 June 30, 2023. At June 30, 2023, we had outstanding borrowings under the Credit Facility of $204.0 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 June 30, 2023, we had $43.7 million of availability under the Credit Facility. Outstanding borrowings under our Credit Facility bear interest at a prime rate or the Bloomberg Short-Term Bank Yield Index (“BSBY”) rate, plus an applicable margin based on our leverage ratio. At June 30, 2023, the prime rate margin was equivalent to 2.625% and the BSBY rate margin was 3.625%. The weighted average interest rate on our Credit Facility was 2.9% and 8.6% for the three months ended June 30, 2022 and 2023, respectively and 2.5% and 8.3% for the six months ended June 30, 2022 and 2023, respectively. - 40 - The interest expense and amortization of debt issuance costs related to our Credit Facility are as follows (in thousands): Three months ended June 30, Six months ended June 30, 2022 2023 2022 2023 Credit Facility interest expense $ 1,314 $ 4,668 $ 2,161 $ 8,479 Credit Facility amortization of debt issuance costs 96 138 184 276 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 June 30, 2023, operating and finance lease obligations were $35.3 million, with $5.0 million payable within 12 months. The components of lease cost are as follows (in thousands): Three months ended June 30, Six months ended June 30, 2022 2023 2022 2023 Operating lease cost $ 853 $ 917 $ 1,701 $ 1,792 Short-term lease cost 76 92 178 186 Variable lease cost 16 56 23 114 Finance lease cost: Depreciation of leased assets $ 109 $ 109 $ 217 $ 217 Interest on lease liabilities 112 103 225 208 Total finance lease cost 221 212 442 425 Total lease cost $ 1,166 $ 1,277 $ 2,344 $ 2,517 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 June 30, 2023, acquisition debt obligations were $5.5 million, with $0.8 million payable within 12 months. Original maturities range from nine to twenty years. The imputed interest expense related to our acquisition debt is as follows (in thousands): Three months ended June 30, Six months ended June 30, 2022 2023 2022 2023 Acquisition debt imputed interest expense $ 79 $ 71 $ 159 $ 142 Senior Notes At June 30, 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. 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 71 months of the Senior Notes. The effective interest rate on the unamortized debt discount and the - 41 - unamortized debt issuance costs for the Senior Notes for both the three and six months ended June 30, 2022 and 2023 was 4.42% and 4.30%, respectively. At June 30, 2023, the fair value of the Senior Notes, which are Level 2 measurements, was $343.1 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 June 30, Six months ended June 30, 2022 2023 2022 2023 Senior Notes interest expense $ 4,230 $ 4,250 $ 8,480 $ 8,500 Senior Notes amortization of debt discount 122 128 243 255 Senior Notes amortization of debt issuance costs 35 37 69 73 At June 30, 2023, our future interest payments on our outstanding balance were $99.9 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 June 30, Six months ended June 30, 2022 2023 2022 2023 Revenue $ 90,600 $ 97,678 $ 188,761 $ 193,192 Funeral contracts 11,006 11,431 24,521 23,846 Average revenue per funeral contract $ 5,493 $ 5,492 $ 5,439 $ 5,510 Preneed interment rights (property) sold 3,511 3,391 5,889 5,895 Average price per preneed interment right sold $ 4,337 $ 5,237 $ 4,398 $ 4,922 Gross profit $ 27,712 $ 31,202 $ 62,190 $ 62,257 Net income $ 10,899 $ 8,286 $ 27,301 $ 17,130 Revenue for the three months ended June 30, 2023 increased $7.1 million compared to the three months ended June 30, 2022, as we experienced a 3.9% increase in funeral contract volume, while the average revenue per funeral contract remained flat, and a 20.8% increase in the average price per interment right sold, slightly offset by a 3.4% decrease in the number of preneed interment rights (property) sold. Gross profit for the three months ended June 30, 2023 increased $3.5 million compared to the three months ended June 30, 2022, primarily due to the increase in revenue from both our funeral home and cemetery segments. Net income for the three months ended June 30, 2023 decreased $2.6 million compared to the three months ended June 30, 2022, primarily due to the following: (1) a $3.4 million increase in interest expense; (2) a $2.6 million impact from divestitures, disposals and insurance reimbursements; (3) a $1.0 million increase in general and administrative expenses, offset by (4) the $3.5 million increase in gross profit and (5) an $0.8 million decrease in income tax expense. Revenue for the six months ended June 30, 2023 increased $4.4 million compared to the six months ended June 30, 2022, as we experienced a 1.3% increase in the average revenue per funeral contract, while funeral contract volume decreased 2.8%, and an 11.9% increase in the average price per interment right sold, while the number of preneed interment rights (property) sold remained flat. The contract volume decrease is primarily a result of the significant decline in COVID-19 related deaths in the first quarter of 2023 as compared to the same period in 2022, as these deaths now have a minimal impact on the overall death rate. Gross profit for the six months ended June 30, 2023 increased $0.1 million compared to the six months ended June 30, 2022, due to the increase in revenue from our cemetery segment, offset by increases in operating expenses in both our funeral home and cemetery segments. Net income for the six months ended June 30, 2023 decreased $10.2 million compared to the six months ended June 30, 2022, primarily due to the following: (1) a $6.4 million increase in interest expense; (2) a $3.5 million impact from divestitures, disposals and insurance reimbursements; (3) a $2.6 million increase in general and administrative expenses, offset by (4) a $2.4 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.” - 42 - 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.” 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 June 30, 2023 issued on August 2, 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 June 30, Six months ended June 30, 2022 2023 2022 2023 Gross profit $ 27,712 $ 31,202 $ 62,190 $ 62,257 Cemetery property amortization 1,704 1,892 3,036 3,093 Field depreciation expense 3,253 3,555 6,550 6,912 Regional and unallocated funeral and cemetery costs 5,966 4,131 12,313 9,568 Operating profit (1) $ 38,635 $ 40,780 $ 84,089 $ 81,830 (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 June 30, Six months ended June 30, 2022 2023 2022 2023 Funeral Home $ 24,152 $ 23,947 $ 57,887 $ 52,913 Cemetery 14,483 16,833 26,202 28,917 Operating profit $ 38,635 $ 40,780 $ 84,089 $ 81,830 Operating profit margin (1) 42.6% 41.7% 44.5% 42.4% (1) Operating profit margin is defined as operating profit as a percentage of revenue. Further discussion of operating profit for our Funeral Home and Cemetery segments is presented under “– Results of Operations.” - 43 - RESULTS OF OPERATIONS The following is a discussion of our results of operations for the three and six months ended June 30, 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 six months ended June 30, 2023 and two funeral homes we sold in the six months ended June 30, 2022. The term “divested” when discussed in the Cemetery segment, refers to two cemeteries we sold during the six months ended June 30, 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, our monument company, our pet cremation business and our online cremation businesses. 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 June 30, 2022 2023 Revenue: Operating $ 58,108 $ 60,800 Divested/planned divested 557 210 Ancillary 980 1,232 Other 2,293 2,263 Total $ 61,938 $ 64,505 Operating profit: Operating $ 21,999 $ 21,891 Divested/planned divested 14 29 Ancillary 151 73 Other 1,988 1,954 Total $ 24,152 $ 23,947 The following operating measures reflect the significant metrics over this comparative period: Contract volume 10,912 11,398 Average revenue per contract, excluding preneed funeral trust earnings $ 5,325 $ 5,334 Average revenue per contract, including preneed funeral trust earnings $ 5,488 $ 5,489 Cremation rate 57.4% 58.4% Funeral home operating revenue increased $2.7 million for the three months ended June 30, 2023 compared to the three months ended June 30, 2022. The increase in operating revenue is primarily driven by a 4.5% increase in contract volume, - 44 - while the average revenue per contract excluding preneed interest remained flat. The contract volume increase is primarily due to our newly acquired funeral home businesses, which were not present in the comparative quarter of 2022. Funeral home operating profit for the three months ended June 30, 2023 decreased $0.1 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 190 basis points to 36.0%. Operating expenses as a percentage of revenue increased 1.9% with the largest increases in salary and benefits expenses of 1.4% and general and administrative expenses of 0.5%. 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 increased $0.3 million and Ancillary operating profit decreased $0.1 million for the three months ended June 30, 2023 compared to the three months ended June 30, 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 June 30, 2023, compared to the three months ended June 30, 2022. The following table sets forth certain information regarding our revenue and operating profit for our funeral home operations (in thousands): Six months ended June 30, 2022 2023 Revenue: Operating $ 128,127 $ 127,044 Divested/planned divested 1,339 537 Ancillary 2,050 2,289 Other 4,777 4,720 Total $ 136,293 $ 134,590 Operating profit: Operating $ 53,183 $ 48,416 Divested/planned divested 151 106 Ancillary 372 219 Other 4,181 4,172 Total $ 57,887 $ 52,913 The following operating measures reflect the significant metrics over this comparative period: Contract volume 24,271 23,746 Average revenue per contract, excluding preneed funeral trust earnings $ 5,279 $ 5,350 Average revenue per contract, including preneed funeral trust earnings $ 5,438 $ 5,510 Cremation rate 57.2% 58.7% Funeral home operating revenue decreased $1.1 million for the six months ended June 30, 2023 compared to the six months ended June 30, 2022. The decrease in operating revenue is primarily driven by a 2.2% decrease in contract volume, which was partially offset by a 1.3% increase in the average revenue per contract excluding preneed interest. The contract volume decrease is primarily a result of the significant decline in COVID-19 related deaths in the first quarter of 2023 as compared to the same period in 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 six months ended June 30, 2023 decreased $4.8 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 340 basis points to 38.1%. Operating expenses as a percentage of revenue increased 3.4% with the largest increases in salary and benefits expenses of 1.9%, facilities and grounds expenses of 0.7%, general and administrative expenses of 0.5% and other funeral costs of 0.3%. 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. - 45 - Ancillary revenue, which represents revenue from our flower shop, pet cremation and online cremation businesses increased $0.2 million and Ancillary operating profit decreased $0.2 million for the six months ended June 30, 2023 compared to the six months ended June 30, 2022. Other revenue and other operating profit, which consists of preneed funeral insurance commissions and preneed funeral trust and insurance, remained flat for the six months ended June 30, 2023, compared to the six months ended June 30, 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 June 30, 2022 2023 Revenue: Operating $ 25,104 $ 29,142 Divested/planned divested 57 — Other 3,501 4,031 Total $ 28,662 $ 33,173 Operating profit (loss): Operating $ 11,136 $ 12,940 Divested/planned divested (18) (2) Other 3,365 3,895 Total $ 14,483 $ 16,833 The following operating measures reflect the significant metrics over this comparative period: Preneed revenue as a percentage of operating revenue 66.0% 67.0% Preneed revenue (in thousands) $ 16,476 $ 19,385 Atneed revenue (in thousands) $ 8,628 $ 9,757 Number of preneed interment rights sold 3,506 3,391 Average price per interment right sold $ 4,341 $ 5,237 Cemetery operating revenue increased $4.0 million for the three months ended June 30, 2023 compared to the three months ended June 30, 2022, as we experienced a 20.6% increase in the average price per preneed interment right sold, slightly offset by a 3.3% decrease in preneed interment rights sold. Cemetery atneed revenue, which represents 33.0% of our total operating revenue, increased $1.1 million for the three months ended June 30, 2023, compared to the same period of the prior year, primarily due to an increase in sales of merchandise and services from our newly acquired cemetery businesses, not present in the comparative quarter of 2022. Cemetery operating profit increased $1.8 million for the three months ended June 30, 2023 compared to the three months ended June 30, 2022, due to the increase in revenue. The comparable operating profit margin remained flat at 44.4%. Operating expenses as a percent of operating revenue also remained flat. Other revenue, which consists of preneed cemetery trust revenue and preneed cemetery finance charges, increased $0.5 million for the three months ended June 30, 2023, compared to the three months ended June 30, 2022. The increase is primarily due to realized capital gains in the current year compared to the prior year and an increase in income in our perpetual care trust fund. Other operating profit increased $0.5 million for the same comparative period, primarily due to the increase in revenue. - 46 - The following table sets forth certain information regarding our revenue and operating profit for our cemetery operations (in thousands): Six months ended June 30, 2022 2023 Revenue: Operating $ 45,579 $ 50,747 Divested/planned divested 130 42 Other 6,759 7,813 Total $ 52,468 $ 58,602 Operating profit (loss): Operating $ 19,731 $ 21,333 Divested/planned divested (14) 10 Other 6,485 7,574 Total $ 26,202 $ 28,917 The following operating measures reflect the significant metrics over this comparative period: Preneed revenue as a percentage of operating revenue 63.0% 63.0% Preneed revenue (in thousands) $ 28,555 $ 31,833 Atneed revenue (in thousands) $ 17,024 $ 18,914 Number of preneed interment rights sold 5,871 5,890 Average price per interment right sold $ 4,409 $ 4,924 Cemetery operating revenue increased $5.2 million for the six months ended June 30, 2023 compared to the six months ended June 30, 2022, as we experienced an 11.7% increase in the average price per preneed interment right sold, while the number of preneed interment rights sold remained flat. Cemetery atneed revenue, which represents 37.0% of our total operating revenue increased $1.9 million for the six months ended June 30, 2023, compared to the same period of the prior year, primarily due to an increase in sales of merchandise and services from our newly acquired cemetery businesses, which were not present in the comparative period of 2022. Cemetery operating profit increased $1.6 million for the six months ended June 30, 2023 compared to the six months ended June 30, 2022. The comparable operating profit margin decreased 130 basis point to 42.0%. Operating expenses as a percent of operating revenue increased 1.2% primarily due to an increase in salary and benefits expenses. Other revenue, which consists of preneed cemetery trust revenue and preneed cemetery finance charges, increased $1.1 million for the six months ended June 30, 2023, compared to the six months ended June 30, 2022. The increase is primarily due to an increase in income in our perpetual care trust fund and an increase in finance charges on preneed sales. Other operating profit increased $1.1 million for the same comparative period, primarily due to the increase in revenue. Cemetery property amortization. Cemetery property amortization totaled $1.9 million and $3.1 million for the three and six months ended June 30, 2023, respectively, an increase of $0.2 million and $0.1 million, respectively, compared to the same period in 2022, primarily due to the increase in property sold across our cemetery portfolio. Field depreciation. Depreciation expense for our field businesses totaled $3.6 million and $6.9 million for the three and six months ended June 30, 2023, respectively, an increase of $0.3 million and $0.4 million, respectively, compared to the same period in 2022, primarily due to acquisitions made in latter half of 2022 and our March 2023 acquisition. 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 $4.1 million for the three months ended June 30, 2023, a decrease of $1.8 million compared to the same period in 2022, primarily due to the following: (1) a $0.7 million decrease in cash incentives and equity compensation; (2) a $0.7 million decrease in incentive award trips and annual managing partner meetings and (3) a $0.4 million decrease in other expenses. Regional and unallocated funeral and cemetery costs totaled $9.6 million for the six months ended June 30, 2023, a decrease of $2.7 million compared to the same period in 2022, primarily due to the following: (1) a $1.3 million decrease in cash incentives and equity compensation; (2) a $1.1 million decrease in incentive award trips and annual managing partner meetings and (3) a $0.3 million decrease in other expenses. - 47 - 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 June 30, 2023, an increase of $1.0 million compared to the same period in 2022, primarily due to the following: (1) $1.4 million increase in salary and benefits expense and cash and equity incentive compensation, as a result of having a complete senior leadership team, including current year executive promotions, offset by (2) a $0.4 million decrease in other expenses, including lower online marketing costs and travel costs. General, administrative and other expenses totaled $20.4 million for the six months ended June 30, 2023, an increase of $2.6 million compared to the same period in 2022, primarily due to the following: (1) a $3.2 million increase in salary and benefits expense and cash and equity incentive compensation, as a result of having a complete senior leadership team, including current year executive promotions, offset by (2) a $0.6 million decrease in other expenses, including lower online marketing costs and travel costs. 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 June 30, Six months ended June 30, 2022 2023 2022 2023 Net (gain) loss on divestitures $ (1,278) $ — $ (575) $ 82 Impairments related to assets held for sale — 243 — 243 Net loss on disposals of fixed assets 85 22 149 181 Total $ (1,193) $ 265 $ (426) $ 506 During the six months ended June 30, 2023, we sold one funeral home and two cemeteries for a loss of $0.1 million. We also recognized an impairment of $0.2 million related to property, plant and equipment for assets held for sale. During the six months ended June 30, 2022, we sold real property and two funeral homes for a net gain of $0.6 million. Interest expense . Interest expense related to its respective debt arrangement is as follows (in thousands): Three months ended June 30, Six months ended June 30, 2022 2023 2022 2023 Senior Notes $ 4,387 $ 4,414 $ 8,793 $ 8,827 Credit Facility 1,409 4,806 2,344 8,755 Finance leases 112 103 225 209 Acquisition debt 79 71 159 142 Other 1 2 9 2 Total $ 5,988 $ 9,396 $ 11,530 $ 17,935 Net (gain) loss on property damage, net of insurance claims. During the three and six months ended June 30, 2023, we recorded a $0.2 million gain and $36,000 loss, respectively, net of insurance proceeds, primarily for property damaged by a fire that occurred during first quarter of 2023. During the three and six months ended June 30, 2022, we recorded a $1.4 million gain and $3.3 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 and six months ended June 30, 2023, we recorded a $0.1 million gain and $0.6 million gain, respectively, on the sale of other real property not used in business operations. Income taxes. Income tax expense totaled $3.4 million for the three months ended June 30, 2023, a decrease of $0.8 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 28.0% for both the three months ended June 30, 2023 and 2022. Income tax expense totaled $6.9 million for the six months ended June 30, 2023, a decrease of $2.4 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 28.5% and 27.2% for six months ended June 30, 2023 and 2022, respectively. - 48 - 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, including any new or emerging public health threats. 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.