CARRIAGE SERVICES, INC. OVERVIEW
General
Carriage Services, Inc. ("Carriage," the "Company," "we," "us," or "our") was incorporated in theState of Delaware inDecember 1993 and is a leadingU.S. provider of funeral and cemetery services and merchandise. We operate in two business segments: Funeral Home Operations, which currently account for approximately 80% of our revenue, and Cemetery Operations, which currently account for approximately 20% of our revenue. AtJune 30, 2020 , we operated 186 funeral homes in 29 states and 32 cemeteries in 11 states. We compete with other publicly held and independent operators of funeral and cemetery companies. We believe we are a market leader in most of our markets. 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. Our cemeteries provide interment rights (grave sites and mausoleum spaces) and related merchandise, such as markers and outer burial containers. We provide funeral and cemetery services and products on both an "atneed" (time of death) and "preneed" (planned prior to death) basis. Recent Developments Credit Facility OnMay 18, 2020 , we received a waiver under our Credit Facility for the failure to comply with the Total Leverage Ratio covenant for the fiscal quarter endedMarch 31, 2020 . In connection with the waiver, the Credit Facility was also amended to increase the interest rate margin applicable to borrowings by up to 0.625% at each pricing level based on the Total Leverage Ratio. We are in compliance with the total leverage ratio, fixed charge coverage ratio and senior secured leverage ratio covenants contained in our Credit Facility as ofJune 30, 2020 . Dividend Increase OnMay 19, 2020 , the Board of Directors (the "Board") approved an increase of$0.05 to our annual dividend beginning with the next dividend declaration in the third quarter. The annual dividend is now$0.35 per share. Performance Awards OnMay 19, 2020 , we cancelled all the Performance Awards previously awarded to all individuals in 2019 and 2020 and the Compensation Committee of the Board approved a new Performance Award Agreement (the "New Agreement") for certain eligible employees. Pursuant to the New Agreement, the target share awards for each of the eligible employees will vest onDecember 31, 2024 if the Company's common stock reaches one of five pre-determined growth targets for a sustained period beginning on the grant date ofMay 19, 2020 and ending onDecember 31, 2024 . Executive Leadership Changes OnJune 25, 2020 ,William W. Goetz resigned as President and Chief Operating Officer effectiveJune 26, 2020 .Mr. Goetz further agreed to resign from his position as a director on the Board, also effective as ofJune 26, 2020 . The resignation was not the result of any disagreementMr. Goetz had with the Company on any matter relating to the Company's operations, policies, and practices. OnJune 25, 2020 ,Carlos Quezada joined the Company as Vice President of Cemetery Sales and Marketing. His primary responsibilities include building High Performance sales teams and standardized sales systems across our portfolio of cemetery businesses. Prior to joining Carriage,Mr. Quezada was a Managing Director for another publicly traded deathcare company. He also has held prior leadership roles in sales and operations in the deathcare and hospitality industries. Executive Management reduction in base salaries OnApril 19, 2020 , the Company initiated measures to address potential future challenges from the COVID-19 pandemic. These measures included cost reduction efforts, including, among other things, a temporary reduction in the base salaries for the Company's executive officers. The Compensation Committee of the Board approved the temporary reductions in compensation. OnJune 26, 2020 , the Compensation Committee of the Board voted to reinstate the 2020 annual base salaries for the executive officers back to 100% due to the Company's performance. The reinstatement of 2020 annual base salaries is effective as ofJune 28, 2020 . The annual base salary reductions for the Company's executive officers fromApril 19, 2020 throughJune 27, 2020 have been treated as a temporary pay cut, and the lost wages from that time period will not be paid. - 40 - -------------------------------------------------------------------------------- Board of Directors reduction in retainer fees OnApril 23, 2020 , the Board approved a temporary reduction of the quarterly retainer for our non-employee directors from$35,000 per quarter to$29,750 per quarter (or 15%) effectiveApril 19, 2020 . OnJune 26, 2020 , the Board voted to reinstate the compensation fees back to 100%, effective as ofJune 28, 2020 . Business Impact under the Macroeconomic Environment of COVID-19 OnMarch 11, 2020 , COVID-19 was deemed a global pandemic and since then, the Company has continued to proactively monitor and assess the pandemic's current and potential impact to the Company's operations. Since early March, the Company's senior leadership team has taken certain steps to assist our businesses in appropriately adjusting and adapting to the conditions resulting from the COVID-19 pandemic. Our businesses have been designated as essential services and, therefore, each one of the Company's business locations remains open and ready to provide service to their communities in this time of need. While our businesses provide an essential public function, along with a critical responsibility to the communities and families they serve, the health and safety of our employees and the families we serve remain our top priority. The Company has taken additional steps during this time to continually review and update our processes and procedures to comply with all regulatory mandates and procure additional supplies to ensure that each of our businesses have appropriate personal protective equipment to provide these essential services. Additionally, in many of our business locations, we have also updated staffing and service guidelines, such as reducing the number of team members present for a service, restricting the size and number of attendees and adjusting other operating procedures. The Company has also implemented additional safety and precautionary measures as it concerns our businesses' day-to-day interaction with the families and communities they serve. The overall impact of the macroeconomic environment to the deathcare industry from COVID-19 may provide varying results as compared to other industries. Our industry's revenues are impacted by various factors, including the number of funeral services performed, the average price for a service and the mix of traditional burial versus cremation contracts. Changes in the macroeconomic environment as a result of the pandemic may not necessarily impact volume, but could create situations where people choose to spend less on funerals by purchasing less expensive caskets, minimize the scale of services and visitations, or elect not to make a preneed funeral or cemetery arrangement. During this time, our businesses have been focused on being innovative and resourceful, providing some type of immediate service as part of the grieving process. Gathering and travel restrictions across many areas of the country have limited our ability to provide large, in-person memorialization services and we have seen client families elect webcasting and livestreaming services, hold services with smaller attendance or rotating visitors, or in some cases, choose to delay services to a future date. We have also offered various incentives to our customers and sales counselors to continue to foster sales in our cemeteries. Within our financial reporting environment, we have considered various areas that could affect the results of our operations, though the scope, severity and duration of these impacts remain uncertain at this time because the COVID-19 pandemic is continually evolving and the ultimate impact of COVID-19 remains uncertain. Certain estimates inherently involve assumptions about future events and annual results, making reliable estimates for those matters challenging in periods of economic instability. We do not believe we are vulnerable to certain concentrations, whether by geographic area, revenue for specific products or our relationships with our vendors. Our relationships with our vendors and suppliers have remained consistent and we continue to receive utmost service. Remote working arrangements have not adversely affected our ability to maintain and support operations, including financial reporting systems, internal controls over financial reporting, and disclosure controls and procedures. We believe our access to capital, the cost of our capital, or the sources and uses of our cash should be relatively consistent in the near term, but given the unprecedented nature of COVID-19, we also believe, it is prudent for us to take a broad-based approach to ensuring we maintain financial flexibility throughout the expected duration of the pandemic. We have, as part of a larger plan, taken steps to reduce overall expenses throughout the rest of 2020. For example, discretionary spending, such as growth capital expenditures (primarily cemetery inventory development) will be tightly managed and minimized during this time. Moreover, our executive officers and non-employee directors voluntarily agreed to temporary reductions in salary compensation fromApril 19, 2020 throughJune 28, 2020 (see above herein). While the expected duration of the pandemic is unknown, we have not currently experienced any material impacts to our liquidity position, access to capital, or cash flows as a result of COVID-19. See Liquidity within Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations, for additional information related to our liquidity position. We have also applied certain measures of the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"), which was enacted onMarch 27, 2020 , which we anticipate should provide a cash benefit in the form of a tax payment refund, tax credits related to employee retention, cash deferral for the employer portion of theSocial Security tax and anticipated minimal cash taxes for 2020. Although we expect to take advantage of certain tax relief provisions of the CARES Act, we do not believe it will have a significant impact on our short-term or long-term liquidity position. See Item 1, Financial Statements and Supplementary Data, Note 1 for additional information related to the CARES Act. - 41 - -------------------------------------------------------------------------------- The COVID-19 pandemic, and related gathering restrictions issued by state and local officials, did impact, while not material, aspects of our financial results in the second quarter and year to date, including revenue, volume, preneed cemetery sales, and average revenue per contract. We will continue to assess these impacts and implement appropriate procedures, plans, strategy, and issue any disclosures that may be required, as the situation surrounding the pandemic and related gathering restrictions evolves. Funeral Home Operations Our funeral homes offer a complete range of high value personal services to meet a family's funeral needs, including consultation, the removal and preparation of remains, the sale of caskets and related funeral merchandise, the use of funeral home facilities for visitation and remembrance services and transportation services. Factors affecting our funeral operating results include, but are not limited to: demographic trends relating to population growth and average age, which impact death rates and number of deaths; establishing and maintaining leading market share positions supported by strong local heritage and relationships; effectively responding to increasing cremation trends by selling complementary services and merchandise; controlling salary and merchandise costs; and exercising pricing leverage to increase average revenue per contract. Cemetery Operations Our cemeteries provide interment rights (grave sites and mausoleum spaces) and related merchandise, such as markers and outer burial containers both on an atneed and preneed basis. Factors affecting our cemetery operating results include, but are not limited to: the size and success of our sales organization; local perceptions and heritage of our cemeteries; our ability to adapt to changes in the economy and consumer confidence; and our response to fluctuations in capital markets and interest rates, which affect investment earnings on trust funds, finance charges on installment contracts and our securities portfolio within the trust funds. Business Strategy Our business strategy is based on strong, local leadership with entrepreneurial principles that is focused on sustainable long-term market share, revenue, and profitability growth in each local business. We believe Carriage has the most innovative operating model in the funeral and cemetery industry, which we are able to achieve through a decentralized, high-performance culture and operating framework linked with incentive compensation programs that attract top-quality talent to our organization. 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
• Growth of the Company Is Driven by Decentralization and Partnership
Our five Guiding Principles collectively embody our Being The Best high-performance culture, operating framework. Our operations and business strategy are built upon the execution of the following three models: • Standards Operating Model
• 4E Leadership Model
• Strategic Acquisition Model
Our belief in our Mission Statement and Guiding Principles that define us and
proper execution of the following three models that define our strategy, have
given us the competitive advantage in any market in which 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.
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
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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 the late 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 Energize
others; the Edge necessary to make difficult decisions; and the ability to
Execute and produce results. To achieve a high level within our Standards in a
business year after year, we require local Managing Partners that have the 4E
Leadership skills to entrepreneurially grow the business by hiring, training and
developing highly motivated and productive local teams.
Strategic Acquisition Model
Our Standards Operating Model led to the development of our Strategic
Acquisition Model, which guides our acquisition strategy. We believe that both
models, when executed effectively, will drive long-term, sustainable increases
in market share, revenue, earnings and cash flow. We believe a primary driver of
higher revenue and profits in the future will be the execution of our Strategic
Acquisition Model using strategic ranking criteria to assess acquisition
candidates. As we execute this strategy over time, we expect to acquire larger,
higher margin strategic businesses.
We have learned that the long-term growth or decline of a local branded funeral
and cemetery business is reflected by several criteria that correlate strongly
with five to ten year performance in volumes (market share), revenue and
sustainable field-level earnings before interest, taxes, depreciation and
amortization ("EBITDA") margins (a non-GAAP measure). We use criteria such as
cultural alignment, volume and price trends, size of business, size of market,
competitive standing, demographics, strength of brand and barriers to entry to
evaluate the strategic position of potential acquisition candidates. Our
financial valuation of the acquisition candidate is then determined through the
application of an appropriate after-tax cash return on investment that exceeds
our cost of capital.
LIQUIDITY AND CAPITAL RESOURCES
Overview
Our primary sources of liquidity and capital resources are internally generated
cash flows from operating activities and availability under our Credit Facility.
We generate cash in our operations primarily from atneed sales and delivery of
preneed sales. We also generate cash from earnings on our cemetery perpetual
care trusts. Based on our recent operating results, current cash position, steps
taken to reduce overall expenses throughout the rest of 2020, and anticipated
future cash flows, we do not anticipate any significant liquidity constraints in
the foreseeable future. However, if our capital expenditures, acquisition or
divestiture plans, or business impacts from the pandemic change, we may need to
access the capital markets to obtain additional funding. Further, to the extent
operating cash flow or access to and cost of financing sources are materially
different than expected, future liquidity may be adversely affected. For
additional information regarding known material factors that could cause cash
flow or access to and cost of finance sources to differ from our expectations,
please read (i) Part II, Item 1A "Risk Factors" in this Quarterly Report on Form
10-Q and (ii) Part I, Item 1A "Risk Factors" in our Annual Report on Form 10-K
for the year ended December 31, 2019 .
Our plan is to remain focused on integrating our newly acquired businesses and
to use cash on hand and borrowings under our Credit Facility primarily for
general corporate purposes and for payment of dividends and our debt
obligations. Discretionary spending, such as internal growth projects and
expenditures (primarily cemetery inventory development, along with funeral home
expansion projects) will be tightly managed and minimized during the remainder
of 2020. We also expect increased divestiture activity for the next 12-18 months
which we anticipate will yield approximately $15 million of additional cash from
the proceeds of the sale. From time to time we may also use available cash
resources (including borrowings under our Credit Facility) to, subject to
satisfying certain financial covenants in our Credit Facility, repurchase shares
of our common stock and our remaining 2.75% convertible subordinated notes due
2021 ("Convertible Notes") in open market or privately negotiated transactions.
We have the ability to draw on our Credit Facility, subject to its customary
terms and conditions.
As of June 30, 2020 , we have net unrealized losses of $10.8 million in our
trusts. At June 30, 2020 , these net unrealized losses represented 4% of our
original cost basis of $242.1 million . The decline in fair value is largely due
to changes in interest rates and other market conditions as a result of
COVID-19. Our investments are diversified across multiple industry segments
using a balanced allocation strategy to minimize long-term risk. In addition, we
do not intend to sell and it is likely that we will not be required to sell the
securities prior to their anticipated recovery. Changes in unrealized gains
and/or losses related to these securities are reflected in Other comprehensive
income and offset by the Deferred preneed funeral and cemetery receipts held in
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trust and Care trusts' corpus interests in those unrealized gains and/or losses.
There is no impact on earnings until such time that the loss is realized in the
trusts, allocated to the preneed contracts and the services are performed or the
merchandise is delivered, causing the contract to be withdrawn from the trust in
accordance with state regulations.
We rely on our trust investments to provide funding for the various contractual
obligations that arise upon maturity of the underlying preneed contracts.
Because of the long-term relationship between the establishment of trust
investments and the required performance of the underlying contractual
obligations, the impact of current market conditions that may exist at any given
time is not necessarily indicative of our ability to generate profit on our
future performance obligations.
In light of recent developments relating to COVID-19, we believe that our
existing and anticipated cash resources will be sufficient to meet our
anticipated working capital requirements, capital expenditures, scheduled debt
payments, commitments and dividends for the next 12 months.
Cash Flows
We began 2020 with $0.7 million in cash and other liquid investments and ended
the second quarter with $0.7 million . As of June 30, 2020 , we had borrowings of
$89.7 million outstanding on our Credit Facility compared to $83.8 million as of
December 31, 2019 .
The following table sets forth the elements of cash flow for the six months
ended June 30, 2019 and 2020 (in thousands):
Six months ended June 30,
2019 2020
Cash at beginning of year $ 644 $ 716
Net cash provided by operating activities 21,912 31,001
Acquisitions - (28,011 ) Net proceeds from the sale of other assets 100 78 Capital expenditures (8,654 ) (5,786 ) Net cash used in investing activities (8,554 )
(33,719 )
Net borrowings (payments) on our Credit Facility, acquisition debt and finance lease obligations (3,410 )
5,221
Redemption of the Convertibles Notes (27 ) -
Payment of debt issuance costs related to the Senior Notes
- (66 )
Net proceeds from employee equity plans 763 390
Dividends paid on common stock (2,725 ) (2,682 )
Purchase of treasury stock (7,756 ) -
Other financing costs (162 ) (169 )
Net cash provided by (used in) financing activities (13,317 ) 2,694
Cash at end of the period $ 685 $ 692
Operating Activities
For the six months ended June 30, 2020 , cash provided by operating activities
was $31.0 million compared to $21.9 million for the six months ended June 30,
2019 . The increase of $9.1 million is a reflection of the resilient cash
generating ability of our portfolio of high-quality funeral home and cemetery
operations. Our operating income (excluding the non-cash $14.7 million
impairment charge of goodwill and tradenames recorded in the first quarter)
increased $6.3 million in addition to other favorable working capital changes.
Investing Activities
Our investing activities, resulted in a net cash outflow of $33.7 million for
the six months ended June 30, 2020 compared to $8.6 million for the six months
ended June 30, 2019 , an increase of $25.1 million .
During the six months ended June 30, 2020 , we acquired a funeral home and
cemetery combination business in Lafayette, California for $33.0 million in
cash, of which $5.0 million was deposited in escrow in 2019 and $28.0 million
was paid at closing in 2020. We also paid an additional $0.2 million for our
acquisition of the cemetery business in Fairfax, Virginia to reimburse the
sellers for certain incremental taxes resulting from the 338(h)(10) election
under the Internal Revenue Code, which was offset by the receipt of $0.2 million
in cash related to the sellers closing all operating bank accounts in place
prior to the acquisition.
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For the six months ended
Six months ended June 30,
2019 2020
Growth
Cemetery development$ 2,673 $ 2,127 Renovations at certain businesses 1,727 319 Live streaming equipment 23 388 Other 56 54 Total growth expenditures$ 4,479 $ 2,888 Maintenance Facility repairs and improvements $ 922$ 694 Vehicles 1,179 634 General equipment and furniture 1,545 1,176 Paving roads and parking lots 362 181 Other 167 213 Total maintenance expenditures$ 4,175 $ 2,898 Total capital expenditures$ 8,654 $ 5,786 Financing Activities Our financing activities resulted in a net cash inflow of$2.7 million for the six months endedJune 30, 2020 compared to a net cash outflow of$13.3 million for the six months endedJune 30, 2019 , an increase of$16.0 million . During the six months endedJune 30, 2020 , we had net borrowings on our Credit Facility of$5.9 million and payments on our acquisition debt and finance leases of$0.7 million and paid$2.7 million in dividends. During the six months endedJune 30, 2019 , we had net payments on our Credit Facility of$2.5 million , payments on our acquisition debt and finance leases of$0.9 million , we paid$2.7 million in dividends and repurchased treasury stock for$7.8 million . Dividends During the six months endedJune 30, 2019 and 2020, our Board declared the following dividends payable on the dates below (in thousands, except per share amounts): 2019 Per Share Dollar Value March 1st$ 0.075 $ 1,360 June 1st$ 0.075 $ 1,365 2020 Per Share Dollar Value March 1st$ 0.075 $ 1,339 June 1st$ 0.075 $ 1,343 OnMay 19, 2020 , the Board approved an increase of$0.05 to our annual dividend beginning with the next dividend declaration in the third quarter. Share Repurchases During the six months endedJune 30, 2020 , we did not repurchase any shares of common stock pursuant to our share repurchase program. AtJune 30, 2020 , we had approximately$25.6 million available for repurchases under our share repurchase program. - 45 - --------------------------------------------------------------------------------
Credit Facility, Lease Obligations and Acquisition Debt
The outstanding principal of our Credit Facility, lease obligations and
acquisition debt at
June 30, 2020
Credit Facility $ 89,700
Finance leases 6,002
Operating leases 22,591
Acquisition debt 6,427
Total $ 124,720
Credit Facility
At June 30, 2020 , our Credit Facility was comprised of: (i) a $190.0 million
revolving credit facility, including a $15.0 million subfacility for letters of
credit and a $10.0 million swingline, and (ii) an accordion or incremental
option allowing for future increases in the facility size by an additional
amount of up to $75.0 million in the form of increased revolving commitments or
incremental term loans. The final maturity of the Credit Facility will occur on
May 31, 2023 .
The Credit Facility is secured by a first-priority perfected security interest
in and lien on substantially all of the Company's personal property assets and
those of the Credit Facility Guarantors. In the event the Company's actual Total
Leverage Ratio is not at least 0.25 less than the required Total Leverage Ratio
covenant level, at the discretion of the Administrative Agent, the
Administrative Agent may unilaterally compel the Company and the Credit Facility
Guarantors to grant and perfect first-priority mortgage liens on fee-owned real
property assets which account for no less than 50% of funeral operations EBITDA.
As of June 30, 2020 , we were subject to the following financial covenants under
our Credit Facility: (A) a Total Leverage Ratio not to exceed, (i) 5.75 to 1.00
for the quarters ended March 31, 2020 , June 30, 2020 and September 30, 2020 and
(ii) 5.50 to 1.00 for the quarter ended December 31, 2020 and each quarter ended
thereafter, (B) a Senior Secured Leverage Ratio (as defined in the Credit
Facility) not to exceed 2.00 to 1.00 as of the end of any period of four
consecutive fiscal quarters, and (C) a Fixed Charge Coverage Ratio (as defined
in the Credit Facility) of not less than 1.20 to 1.00 as of the end of any
period of four consecutive fiscal quarters. These financial maintenance
covenants are calculated for the Company and its subsidiaries on a consolidated
basis.
On May 18, 2020 , we received a waiver under our Credit Facility for the failure
to comply with the Total Leverage Ratio covenant for the fiscal quarter ended
March 31, 2020 . In connection with the waiver, the Credit Facility was also
amended to increase the interest rate margin applicable to borrowings by up to
0.625% at each pricing level based on the Total Leverage Ratio.
We were in compliance with the total leverage ratio, fixed charge coverage ratio
and senior secured leverage ratio covenants contained in our Credit Facility as
of June 30, 2020 .
We have one letter of credit outstanding under the Credit Facility issued on
November 30, 2019 for approximately $2.0 million , which bears interest at 2.125%
and will expire on November 25, 2020 . The letter of credit automatically renews
annually and secures our obligations under our various self-insured policies.
Outstanding borrowings under our Credit Facility bear interest at either a prime
rate or a LIBOR rate, plus an applicable margin based upon our leverage ratio.
As of June 30, 2020 , the prime rate margin was equivalent to 2.00% and the LIBOR
rate margin was 3.00%. The weighted average interest rate on our Credit Facility
was 3.6% and 3.9% for the three and six months ended June 30, 2020 ,
respectively. The weighted average interest rate on our Credit Facility was 3.9%
and 4.0% for the three and six months ended June 30, 2019 , respectively.
The interest expense and amortization of debt issuance costs related to our
Credit Facility during the three and six months ended June 30, 2019 and 2020 is
as follows (in thousands):
Three months ended June 30, Six months ended June 30,
2019 2020 2019 2020
Credit Facility interest expense $ 362 $ 1,106 $ 740 $ 2,336
Credit Facility amortization of debt
issuance costs 54 118 108 245
- 46 --------------------------------------------------------------------------------- Lease Obligations Our lease obligations consist of operating and finance leases. We lease certain office facilities, certain funeral homes and equipment under operating leases with original terms ranging from one to nineteen years. Many leases include one or more options to renew, some of which include options to extend the leases for up to 26 years. We lease certain funeral homes under finance leases with original terms ranging from ten to forty years. The lease cost related to our operating leases and short-term leases and depreciation expense and interest expense related to our finance leases during the three and six months endedJune 30, 2019 and 2020 are as follows (in thousands): Three months ended June 30, Six months ended June 30, 2019 2020 2019 2020 Operating lease cost $ 942$ 954 $ 1,862 $ 1,911 Short-term lease cost 59 39 133 96 Finance lease cost: Depreciation of lease right-of-use assets $ 131$ 109 $ 263$ 218 Interest on lease liabilities 131 125 263 251 Acquisition Debt Acquisition debt consists of deferred purchase price and promissory notes payable to sellers. A majority of the deferred purchase price and notes bear no interest and are discounted at imputed interest rates ranging from 7.3% to 10.0%. Original maturities range from five to twenty years. The imputed interest expense related to our acquisition debt during the three and six months endedJune 30, 2019 and 2020 is as follows (in thousands): Three months ended June 30,
Six months ended
2019 2020 2019 2020
Acquisition debt imputed interest expense $ 161 $ 124 $
329
Convertible Subordinated Notes due 2021 AtJune 30, 2020 , the principal amount of the liability component of our Convertible Notes was$6.3 million , the net carrying amount was$6.1 million and the carrying amount of the equity component was$0.8 million . The fair value of the Convertible Notes, which are Level 2 measurements, was$6.4 million atJune 30, 2020 . The Convertible Notes are due inMarch 2021 and bear interest at 2.75% per year, which is payable semi-annually in arrears onMarch 15 andSeptember 15 of each year. The interest expense and accretion of debt discount and debt issuance costs related to our Convertible Notes during the three and six months endedJune 30, 2019 and 2020 is as follows (in thousands): Three months endedJune 30 ,
Six months ended
2019 2020 2019 2020
Convertible Notes interest expense $ 44 $ 43 $ 87 $ 87
Convertible Notes accretion of debt
discount 59 66 117 131
Convertible Notes amortization of debt
issuance costs 5 6 11 12
The remaining unamortized debt discount and the remaining unamortized debt
issuance costs are being amortized using the effective interest method over the
remaining term of approximately eight months of the Convertible Notes. The
effective interest rate on the unamortized debt discount for both the three and
six months ended June 30, 2019 and 2020 was 11.4%. The effective interest rate
on the debt issuance costs for both three and six months ended June 30, 2019 and
2020 was 3.2%.
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Senior Notes due 2026
At June 30, 2020 , the principal amount of our Senior Notes was $400.0 million .
The fair value of the Senior Notes, which are Level 2 measurements, was $419.9
million at June 30, 2020 . The Senior Notes are due on June 1, 2026 and bear
interest at 6.625% per year, which is payable semi-annually in arrears on June 1
and December 1 of each year.
The interest expense and amortization of debt discount, debt premium and debt
issuance costs related to our Senior Notes during the three and six months ended
June 30, 2019 and 2020 is as follows (in thousands):
Three months ended June 30, Six months ended June 30,
2019 2020 2019 2020
Senior Notes interest expense $ 5,383 $ 6,625 $ 10,766 $ 13,250
Senior Notes amortization of debt
discount 122 131 242 260
Senior Notes amortization of debt premium - 55 - 109
Senior Notes amortization of debt
issuance costs 34 69 68 136
The debt discount, the debt premium and the debt issuance costs are being
amortized using the effective interest method over the remaining term of
approximately 71 months of the Senior Notes. The effective interest rate on the
unamortized debt discount and the unamortized debt issuance costs for the
initial Senior Notes, which were issued in May 2018 , for both the three and six
months ended June 30, 2020 was 6.87% and 6.69%, respectively. The effective
interest rate on the unamortized debt premium and the unamortized debt issuance
costs for the additional Senior Notes, which were issued in December 2019 , for
both the three and six months ended June 30, 2020 was 6.20% and 6.90%,
respectively.
FINANCIAL HIGHLIGHTS
Below are our financial highlights for the three months ended June 30, 2019 and
2020 (in thousands except for volumes and averages):
Three months ended June 30,
2019 2020
Revenue $ 67,752 $ 77,477
Funeral contracts 9,366 11,737
Average revenue per funeral contract $ 5,557 $ 4,908
Preneed interment rights (property) sold 2,056 2,338
Average price per preneed interment right sold$ 3,660 $ 3,988 Gross profit$ 19,250 $ 25,160 Net income$ 4,862 $ 6,397 Revenue for the three months endedJune 30, 2020 increased$9.7 million compared to the three months endedJune 30, 2019 , as we experienced a 25.3% increase in total funeral contracts primarily due to the funeral home acquisitions made in the fourth quarter of 2019 and first quarter of 2020, offset by a decrease in the average revenue per funeral contract of 11.7%. In addition, we experienced an increase of 13.7% in the number of preneed interment rights (property) sold primarily due to the cemetery acquisitions made in the fourth quarter of 2019 and first quarter of 2020, as well as an increase in the average price per interment right sold of 9.0%. Gross profit for the three months endedJune 30, 2020 increased$5.9 million compared to the three months endedJune 30, 2019 , primarily due to the increase in revenue from both our funeral home and cemetery segments due to the acquisitions made in the fourth quarter of 2019 and first quarter of 2020, as well as measures the Company has taken to control costs during the COVID-19 pandemic. Net income for the three months endedJune 30, 2020 increased$1.5 million compared to the three months endedJune 30, 2019 , primarily due to the increase in gross profit, offset by the increase in interest expense related to our Senior Notes and Credit Facility. - 48 - --------------------------------------------------------------------------------
Below are our financial highlights for the six months ended
Six months ended June 30,
2019 2020
Revenue $ 136,833 $ 154,967
Funeral contracts 19,247 23,230
Average revenue per funeral contract $ 5,597 $ 5,069
Preneed interment rights (property) sold 3,518
4,206
Average price per preneed interment right sold$ 3,721 $ 3,895 Gross profit$ 40,850 $ 48,331 Net income$ 11,387 $ 2,200 Revenue for the six months endedJune 30, 2020 increased$18.1 million compared to the six months endedJune 30, 2019 , as we experienced a 20.7% increase in total funeral contracts primarily due to the funeral home acquisitions made in the fourth quarter of 2019 and first quarter of 2020, offset by a decrease in the average revenue per funeral contract of 9.4%. In addition, we experienced an increase of 19.6% in the number of preneed interment rights (property) sold primarily due to the cemetery acquisitions made in the fourth quarter of 2019 and first quarter of 2020, as well as an increase of 4.7% in the average price per interment right sold. Gross profit for the six months endedJune 30, 2020 increased$7.5 million compared to the six months endedJune 30, 2019 , primarily due to the increase in revenue from both our funeral home and cemetery segments due to the acquisitions made in the fourth quarter of 2019 and first quarter of 2020, as well as measures the Company has taken to control costs during the COVID-19 pandemic. Net income for the six months endedJune 30, 2020 decreased$9.2 million compared to the six months endedJune 30, 2019 , primarily due to the$14.7 million impairment of goodwill and tradenames recorded in the first quarter and$4.2 million increase in interest expense related to our Senior Notes and Credit facility, offset by the$7.5 million increase in gross profit. Further discussion of Revenue and the components of Gross profit for our funeral home and cemetery segments is presented herein under "- Results of Operations." Further discussion of General, administrative and other expenses, Home office depreciation and amortization expense, Interest expense, Income taxes and other components of income and expenses are presented herein under "- Other Financial Statement Items." - 49 - -------------------------------------------------------------------------------- REPORTING AND NON-GAAP FINANCIAL MEASURES We also present our financial performance in our "Operating and Financial Trend Report" ("Trend Report") as reported in our earnings release for the three and six months endedJune 30, 2020 datedJuly 28, 2020 and discussed in the corresponding earnings conference call. This 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 withUnited States generally accepted accounting principles ("GAAP"). The Trend Report is a non-GAAP statement that also provides insight into underlying trends in our business. Below is a reconciliation of Net income (a GAAP measure) to Adjusted net income (a non-GAAP measure) for the three and six months endedJune 30, 2019 and 2020 (in thousands): Three months ended June 30, Six months ended June 30, 2019 2020 2019 2020 Net income $ 4,862$ 6,397 $ 11,387 $ 2,200 Special items, net of tax(1) Acquisition and divestiture expenses - 36 - 126 Severance and separation costs 483 217 654 445 Performance awards cancellation and exchange - 56 - 56 Accretion of discount on Convertible Notes(1) 60 66 117 131 Net impact of impairment of goodwill and other intangibles(2) - 51 - 9,808 Litigation reserve 281 154 380 213 Natural disaster and pandemic costs - 657 - 768 Other special items - 371 - 371 Adjusted net income(3) $ 5,686$ 8,005 $ 12,538 $ 14,118
(1) Special items are defined as charges or credits included in our GAAP financial
statements that can vary from period to period and are not reflective of costs
incurred in the ordinary course of our operations. Special Items are taxed at
the federal statutory rate of 21% for the three and six months ended
2019 and 2020, except for the Accretion of the discount on the Convertible
Notes, as this is a non-tax deductible item and the Net impact of impairment of
goodwill and other intangibles (described below). (2) The Net impact of impairment of goodwill and other intangibles special item is
net of the operating tax rate of 33.3%. (3) Adjusted net income is defined as Net income plus adjustments for Special items
and other expenses or gains that we believe do not directly reflect our core
operations and may not be indicative of our normal business operations.
Below is a reconciliation of Gross profit (a GAAP measure) to Operating profit
(a non-GAAP measure) for the three and six months ended June 30, 2019 and 2020
(in thousands):
Three months ended June 30 ,
Six months ended
2019 2020 2019 2020
Gross profit $ 19,250 $ 25,160 $ 40,850 $ 48,331
Cemetery property amortization 1,169 1,097 2,018 1,974
Field depreciation expense 3,059 3,247 6,144 6,537
Regional and unallocated funeral and
cemetery costs 3,622 3,717 6,411 6,473
Operating profit(1) $ 27,100 $ 33,221 $ 55,423 $ 63,315 (1) Operating profit is defined as Gross profit less Cemetery property
amortization, Field depreciation expense and Regional and unallocated funeral
and cemetery costs.
- 50 --------------------------------------------------------------------------------- Our operations are reported in two business segments: Funeral Home and Cemetery. Below is a breakdown of Operating profit (a non-GAAP measure) by Segment for the three and six months endedJune 30, 2019 and 2020 (in thousands): Three months endedJune 30 ,
Six months ended
2019 2020 2019 2020
Funeral Home $ 20,420 $ 25,552 $ 43,587 $ 49,826
Cemetery 6,680 7,669 11,836 13,489
Operating profit $ 27,100 $ 33,221 $ 55,423 $ 63,315
Operating profit margin(1) 40.0 % 42.9 % 40.5 % 40.9 %
(1) Operating profit margin is defined as Operating profit as a percentage of Revenue.
Further discussion of Operating profit for our funeral home and cemetery segments is presented herein under "- Results of Operations." RESULTS OF OPERATIONS The following is a discussion of our results of operations for the three and six months endedJune 30, 2020 and 2019. The term "same store" refers to funeral homes and cemeteries acquired prior toJanuary 1, 2016 and owned and operated for the entirety of each period being presented, excluding certain funeral home businesses that we intend to divest in the near future. The term "acquired" refers to funeral homes and cemeteries purchased afterDecember 31, 2015 , excluding any funeral home businesses that we intend to divest in the near future. This classification of acquisitions has been important to management and investors in monitoring the results of these businesses and to gauge the leveraging performance contribution that a selective acquisition program can have on total company performance. The term "divested" when discussed in the Funeral Home Segment, refers to the three funeral home businesses whose building leases expired, one funeral home business we sold and a funeral home business we merged with a business in an existing market in 2019. "Planned divested" in the Funeral Home Segment refers to the funeral home businesses that we intend to divest in the near future. "Ancillary" in the Funeral Home Segment represents our flower shop, pet cremation business and online cremation business inTexas . 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. - 51 - -------------------------------------------------------------------------------- Funeral Home Segment The following table sets forth certain information regarding our Revenue and Operating profit from our funeral home operations for the three months endedJune 30, 2020 compared to the three months endedJune 30, 2019 (in thousands): Three months ended June 30, 2019 2020 Revenue: Same store operating revenue$ 41,690 $
42,664
Acquired operating revenue 6,298
11,337
Divested/planned divested revenue 2,390
1,852
Ancillary funeral services revenue -
1,117
Preneed funeral insurance commissions 329
326
Preneed funeral trust and insurance 1,800 1,825 Total$ 52,507 $ 59,121 Operating profit: Same store operating profit$ 15,550 $ 18,026 Acquired operating profit 2,445 4,672 Divested/planned divested operating profit 535
562
Ancillary funeral services operating profit -
321
Preneed funeral insurance commissions 134
160
Preneed funeral trust and insurance 1,756 1,811 Total$ 20,420 $ 25,552 The following measures reflect the significant metrics over this comparative period: Three months ended June 30, 2019 2020 Same store: Contract volume 7,844 8,785
Average revenue per contract, excluding preneed funeral trust earnings
$ 5,315 $ 4,856 Average revenue per contract, including preneed funeral trust earnings$ 5,512 $ 5,037 Burial rate 38.5 % 36.2 % Cremation rate 53.7 % 57.5 % Acquired: Contract volume 961 2,350
Average revenue per contract, excluding preneed funeral trust earnings
$ 6,554 $ 4,824 Average revenue per contract, including preneed funeral trust earnings$ 6,681 $ 4,894 Burial rate 47.0 % 40.6 % Cremation rate 46.1 % 54.9 % Funeral home same store operating revenue for the three months endedJune 30, 2020 increased$1.0 million compared to the three months endedJune 30, 2019 . The increase in operating revenue is primarily due to a 12.0% same store contract volume increase in the three months endedJune 30, 2020 compared to the same period in 2019. The increase was offset by a decrease in contract averages excluding preneed interest of 8.6%. The decrease in funeral contract averages for the three months endedJune 30, 2020 compared to the same period in 2019 is primarily due to a 230 basis point decrease in the burial rate. In addition, in the three months endedJune 30, 2020 , we experienced a decrease in services performed due to the restrictions placed on gatherings mandated by state and local governments due to COVID-19. For both burial and cremation contracts for which memorial services were performed, we experienced a 940 and 1240 basis point decrease in the number of these contracts, respectively, in the three months endedJune 30, 2020 . Funeral same store operating profit for the three months endedJune 30, 2020 increased$2.5 million when compared to the three months endedJune 30, 2019 , and the comparable operating profit margin increased 500 basis points to 42.3%. The increase in operating margin is primarily due to the increase in same store operating revenue and a 5.0% decrease in operating costs. Same - 52 - -------------------------------------------------------------------------------- store salaries and benefits for the three months endedJune 30, 2020 had the largest decrease of$0.4 million or 1.6% compared to the three months endedJune 30, 2019 . The decrease in salaries and benefits was primarily due to the decrease in part-time funeral staff needed to assist with memorial services, offset by an increase in the demand for pickup and embalming services due to increased contracts. The decrease in other operating costs was a result of disciplined expense and cost management by local leaders at each business during the COVID-19 pandemic. Funeral home acquired operating revenue for the three months endedJune 30, 2020 increased$5.0 million , as our funeral home acquired portfolio for the three months endedJune 30, 2020 included nine funeral home businesses added through four acquisitions in the fourth quarter of 2019 and one business acquired in the first quarter of 2020 not present in the three months endedJune 30, 2019 . Acquired operating profit for the three months endedJune 30, 2020 increased$2.2 million when compared to the three months endedJune 30, 2019 . Operating profit margin increased 240 basis points to 41.2% for the three months endedJune 30, 2020 compared to the same period in 2019. The increase is primarily due to certain measures taken to control costs during the COVID-19 pandemic, slightly offset by lower margins for our most recent acquisition compared to our other acquired businesses, particularly with regard to higher salaries and benefits expenses. We expect the operating margins for our recently acquired business to improve as we focus on integrating this business into our high performance framework of the Standards Operating Model. Ancillary funeral services revenue, which is recorded in Other revenue, represents revenue from our flower shop, pet cremation business and online cremation business inTexas , which were acquired in the fourth quarter of 2019. Operating profit from our ancillary funeral service businesses was$0.3 million for the three months endedJune 30, 2020 , with an operating profit margin of 28.7%. Preneed funeral insurance commissions and preneed funeral trust and insurance, also recorded in Other revenue, on a combined basis, remained flat for the three months endedJune 30, 2020 compared to the same period in 2019. Operating profit for preneed funeral insurance commissions and preneed trust and insurance, on a combined basis, increased$0.1 million or 4.3% for the same comparative period in 2019 primarily due to a reduction in preneed trust and insurance expenses. The following table sets forth certain information regarding our Revenue and Operating profit from our funeral home operations for the six months endedJune 30, 2020 compared to the six months endedJune 30, 2019 (in thousands): Six months ended June 30, 2019 2020 Revenue: Same store operating revenue$ 86,565 $ 87,249 Acquired operating revenue 13,032 22,859 Divested/planned divested revenue 4,780
4,062
Ancillary funeral services revenue -
2,268
Preneed funeral insurance commissions 688
692
Preneed funeral trust and insurance 3,605 3,733 Total$ 108,670 $ 120,863 Operating profit: Same store operating profit$ 33,564 $ 35,152 Acquired operating profit 5,162 8,900 Divested/planned divested operating profit 1,074
1,169
Ancillary funeral services operating profit -
616
Preneed funeral insurance commissions 266
321
Preneed funeral trust and insurance 3,521 3,668 Total$ 43,587 $ 49,826 - 53 -
--------------------------------------------------------------------------------
The following measures reflect the significant metrics over this comparative
period:
Six months ended June 30,
2019 2020
Same store:
Contract volume 16,113 17,508Average revenue per contract, excluding preneed funeral trust earnings
$ 5,372 $ 4,983 Average revenue per contract, including preneed funeral trust earnings$ 5,565 $ 5,170 Burial rate 38.9 % 36.4 % Cremation rate 53.3 % 56.4 % Acquired: Contract volume 1,966 4,516
Average revenue per contract, excluding preneed funeral trust earnings
$ 6,629 $ 5,062 Average revenue per contract, including preneed funeral trust earnings$ 6,757 $ 5,131 Burial rate 48.5 % 41.1 % Cremation rate 44.6 % 54.3 % Funeral home same store operating revenue for the six months endedJune 30, 2020 increased$0.7 million compared to the six months endedJune 30, 2019 . The increase in operating revenue is due to an 8.7% same store contract volume increase in the six months endedJune 30, 2020 compared to the same period in 2019. The increase was offset by a decrease in contract averages excluding preneed interest of 7.2%. The decrease in funeral contract averages for the six months endedJune 30, 2020 compared to the same period in 2019 is primarily due to a 250 basis point decrease in the burial rate. Beginning in the latter half ofMarch 2020 , we saw a decrease in services performed due to the restrictions placed on gatherings mandated by state and local governments as the COVID-19 pandemic became more prominent and individuals began to practice social distancing to comply with applicable shelter in place and related orders. For both burial and cremation contracts for which memorial services were performed, we experienced a 580 and 820 basis point decrease in the number of these contracts, respectively, in the six months endedJune 30, 2020 . Funeral same store operating profit for the six months endedJune 30, 2020 increased$1.6 million when compared to the six months endedJune 30, 2019 , and the comparable operating profit margin increased 150 basis points to 40.3%. The increase in operating margin is due to the increase in same store operating revenue and a 1.5% decrease in operating costs. Same store promotional costs for the six months endedJune 30, 2020 had the largest decrease of$0.4 million or 0.5% compared to the six months endedJune 30, 2019 . The decrease in promotional costs and other operating costs resulted from cost control measures undertaken during the COVID-19 pandemic. Funeral home acquired operating revenue for the six months endedJune 30, 2020 increased$9.8 million , as our funeral home acquired portfolio for the six months endedJune 30, 2020 included nine funeral home businesses added through four acquisitions in the fourth quarter of 2019 and one business acquired in the first quarter of 2020 not present in the six months endedJune 30, 2019 . Acquired operating profit for the six months endedJune 30, 2020 increased$3.7 million when compared to the six months endedJune 30, 2019 . Operating profit margin decreased 70 basis points to 38.9% for the six months endedJune 30, 2020 compared to the same period in 2019. The decrease is primarily due to the recently acquired businesses (discussed above), as operating profit margins for these businesses were lower compared to our other acquired businesses, particularly with regard to higher salaries and benefits expenses. However, the operating margins for our 2019 acquired businesses have increased 440 basis points in the second quarter of 2020 compared to the first quarter of 2020 and we expect continuous improvement as we focus on integrating all of our newly acquired businesses into our high performance framework of the Standards Operating Model. Ancillary funeral services revenue, which is recorded in Other revenue, represents revenue from our flower shop, pet cremation business and online cremation business inTexas , which were acquired in the fourth quarter of 2019. Operating profit from our ancillary funeral service businesses was$0.6 million for the six months endedJune 30, 2020 , with an operating profit margin of 27.2%. Preneed funeral insurance commissions and preneed funeral trust and insurance, also recorded in Other revenue, on a combined basis, increased$0.1 million or 3.1% for the six months endedJune 30, 2020 compared to the same period in 2019. The increase is due to the increase in preneed trust and insurance. Operating profit for preneed funeral insurance commissions and preneed trust and insurance, on a combined basis, increased$0.2 million or 5.3% for the same comparative period in 2019, primarily due to the increase in revenue and reduction of preneed trust and insurance expenses. - 54 - -------------------------------------------------------------------------------- Cemetery Segment The following table sets forth certain information regarding our Revenue and Operating profit from our cemetery operations for the three months endedJune 30, 2020 compared to the three months endedJune 30, 2019 (in thousands): Three months ended June 30, 2019 2020 Revenue: Same store operating revenue$ 13,227 $ 11,694 Acquired operating revenue - 4,055 Preneed cemetery trust and insurance 1,623 2,367 Preneed cemetery finance charges 395 240 Total$ 15,245 $ 18,356 Operating profit: Same store operating profit$ 4,808 $ 3,674 Acquired operating profit - 1,434 Preneed cemetery trust and insurance 1,477 2,321 Preneed cemetery finance charges 395 240 Total$ 6,680 $ 7,669 The following measures reflect the significant metrics over this comparative period: Three months ended June 30, 2019 2020 Same store: Preneed revenue as a percentage of operating revenue 64 % 61 % Preneed revenue (in thousands)$ 8,455 $
7,089
Atneed revenue (in thousands)$ 4,772 $
4,605
Number of preneed interment rights sold 2,056
1,786
Average price per interment right sold$ 3,660 $
3,900
Acquired:
Preneed revenue as a percentage of operating revenue n/a
62 %
Preneed revenue (in thousands) n/a $ 2,522
Atneed revenue (in thousands) n/a $
1,533
Number of preneed interment rights sold n/a
552
Average price per interment right sold n/a $
4,273
Cemetery same store preneed revenue for the three months endedJune 30, 2020 decreased$1.4 million due to the decrease in cemetery property revenue as we experienced a 13.1% decrease in the number of preneed interment rights sold, offset by a 6.6% increase in the average price per interment right sold. The decrease in the number of preneed interment rights sold is primarily due to the COVID-19 pandemic as individuals began practicing social distancing to comply with applicable shelter in place and related orders, which resulted in our preneed sales personnel being unable to meet with families at our businesses, in certain areas of the country, during this time. In addition, these restrictions impacted our ability to host annual events at certain cemeteries notably the Ching Ming festival during April andMemorial Day festivities during May. Cemetery same store atneed revenue, which represents 39.0% of our same store operating revenue decreased$0.2 million , as we experienced a 3.1% decrease in the average sale per contract, while the number of atneed contracts sold remained flat. Cemetery same store operating profit for the three months endedJune 30, 2020 decreased$1.1 million from the same period in 2019. The comparable operating profit margin decreased 490 basis points to 31.4% for the three months endedJune 30, 2020 from 36.3% in the same period in 2019. The decrease in operating profit margin is the result of an 11.6% decrease in operating revenue, offset by a 4.8% decrease in operating costs. Operating expense as a percent of operating revenue increased in two categories for the three months endedJune 30, 2020 compared to the same period in 2019. Most notably, salaries and benefits increased 1.2% as a percentage of revenue and the allowance for credit losses expense increased 2.4% as a percentage of revenue. - 55 - -------------------------------------------------------------------------------- The increase in salaries and benefits is due to additional support staff hired in the latter half of 2019. The increase in the allowance for credit losses is due to slower payments on financed receivables particularly in the states most affected by COVID-19. Our acquired cemetery portfolio includes two businesses acquired during the fourth quarter of 2019 and one business acquired during the first quarter of 2020. These three businesses contributed$4.1 million in operating revenue and$1.4 million in operating profit for the three months endedJune 30, 2020 . Preneed cemetery trust and insurance and preneed cemetery finance charges, which are recorded in Other revenue, on a combined basis increased$0.6 million for the three months endedJune 30, 2020 compared to the same period in 2019. Earnings in our perpetual care trust fund increased$0.6 million due to our acquisitions. Operating profit for the two categories of Other revenue, on a combined basis, increased$0.7 million for the three months endedJune 30, 2020 compared to the same period in 2019, primarily due to the increase in perpetual care trust fund revenue. The increase in our trust fund income is primarily due to our major capital deployment during and after the COVID-19 market crash inMarch 2020 , which we expect will produce sustainable increases in both revenue and operating profit throughout the year. The following table sets forth certain information regarding our Revenue and Operating profit from our cemetery operations for the six months endedJune 30, 2020 compared to the six months endedJune 30, 2019 (in thousands): Six months ended June 30, 2019 2020 Revenue: Same store operating revenue$ 24,516 $ 22,639 Acquired operating revenue - 6,854 Preneed cemetery trust and insurance 2,874 4,128 Preneed cemetery finance charges 773 483 Total$ 28,163 $ 34,104 Operating profit: Same store operating profit$ 8,469 $ 6,825 Acquired operating profit - 2,261 Preneed cemetery trust and insurance 2,594 3,920 Preneed cemetery finance charges 773 483 Total$ 11,836 $ 13,489 The following measures reflect the significant metrics over this comparative period: Six months ended June 30, 2019 2020 Same store: Preneed revenue as a percentage of operating revenue 62 % 59 % Preneed revenue (in thousands)$ 15,114 $
13,400
Atneed revenue (in thousands)$ 9,402 $
9,239
Number of preneed interment rights sold 3,518
3,354
Average price per interment right sold$ 3,721 $
3,762
Acquired:
Preneed revenue as a percentage of operating revenue n/a
62 %
Preneed revenue (in thousands) n/a $ 4,258
Atneed revenue (in thousands) n/a $
2,596
Number of preneed interment rights sold n/a
852
Average price per interment right sold n/a$ 4,422 - 56 -
-------------------------------------------------------------------------------- Cemetery same store preneed revenue for the six months endedJune 30, 2020 decreased$1.7 million due to the decrease in cemetery property revenue as we experienced a 4.7% decrease in the number of preneed interments sold compared to the same period in 2019, offset slightly by a 1.1% increase in the average price per interment right sold. The decrease in the number of preneed interment rights sold is primarily due to the COVID-19 pandemic as individuals began practicing social distancing to comply with applicable shelter in place and related orders, which resulted in our preneed sales personnel being unable to meet with families at our businesses, in certain areas of the country, during this time. Cemetery same store atneed revenue, which represents 41% of our same store operating revenue, decreased$0.2 million as we experienced a 1.3% decrease in the average sale per contract, while the number of atneed contracts sold remained flat. Cemetery same store operating profit for the six months endedJune 30, 2020 decreased$1.6 million from the same period in 2019. The comparable operating profit margin decreased 440 basis points to 30.1% for the six months endedJune 30, 2020 from 34.5% in the same period in 2019. The decrease in operating profit margin is a result of a 7.7% decrease in operating revenue and a 1.5% decrease in operating costs. Operating expense as a percent of operating revenue increased in three categories in the six months endedJune 30, 2020 compared to the same period in 2019. Our allowance for credit losses expense increased 1.7%, promotional expense increased 1.2% and salaries and wages increased 1.0% as a percentage of revenue. The increase in the allowance for credit losses is due to slower payments on financed receivables particularly in the states most affected by COVID-19. The increase in promotional expenses is due to the addition of marketing personnel and increased counselor bonuses at certain cemeteries. Salaries and benefits related to the beautification and maintenance of our cemetery grounds were fairly flat but increased as a percentage of revenue. Our acquired cemetery portfolio includes two businesses acquired during the fourth quarter of 2019 and one business acquired during the first quarter of 2020. These three businesses contributed$6.9 million in operating revenue and$2.3 million in operating profit for the six months endedJune 30, 2020 . Preneed cemetery trust and insurance and preneed cemetery finance charges, which are recorded in Other revenue, on a combined basis increased$1.0 million for the six months endedJune 30, 2020 compared to the same period in 2019. Earnings in our perpetual care trust fund increased$1.4 million primarily from acquisitions and an increase in realized gains and was partially offset by$0.3 million decrease in finance charge revenue. The decrease in finance charge revenue is due to our enhanced preneed cemetery property sales strategy of reducing interest rates on preneed contracts. Operating profit for the two categories of Other revenue, on a combined basis, also increased$1.0 million for the six months endedJune 30, 2020 compared to the same period in 2019 due to the increase in revenue. The increase in our trust fund income is primarily due to our major capital deployment during and after the COVID-19 market crash inMarch 2020 , which we expect will produce sustainable increases in both revenue and operating profit throughout the year. Cemetery property amortization. Cemetery property amortization totaled$1.1 million for the three months endedJune 30, 2020 , a decrease of$0.1 million compared to the three months endedJune 30, 2019 . Cemetery property amortization remained flat at$2.0 million for the six months endedJune 30, 2020 compared to the six months endedJune 30, 2019 . Field depreciation. Depreciation expense for our field businesses increased$0.2 million for the three months endedJune 30, 2020 compared to the three months endedJune 30, 2019 . Depreciation expense for our field businesses increased$0.4 million for the six months endedJune 30, 2020 compared to the six months endedJune 30, 2019 . The increase was primarily attributable to additional depreciation expense from the assets acquired through our 2019 and first quarter 2020 acquisitions. 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$3.7 million for the three months endedJune 30, 2020 , an increase of$0.1 million primarily due to a$0.4 million increase related to a state audit assessment, a$0.3 million increase in expenses related to the COVID-19 pandemic and a$0.1 million increase in other general and administrative costs, offset by a$0.7 million decrease in severance expense. Regional and unallocated funeral and cemetery costs totaled$6.5 million for the six months endedJune 30, 2020 , an increase of$0.1 million primarily due to a$0.4 million increase related to a state audit assessment, a$0.4 million increase in expenses due to the COVID-19 pandemic, offset by a$0.6 million decrease in severance expense and a$0.1 million decrease in other general administrative costs. Other Financial Statement Items General, administrative and other. General, administrative and other expenses totaled$6.5 million for the three months endedJune 30, 2020 , an increase of$0.8 million compared to the three months endedJune 30, 2019 . The increase was primarily attributable to a$0.6 million increase in incentive compensation, a$0.3 million increase in public company costs, a$0.2 million increase in litigation reserve, offset by a$0.2 million decrease in other general administrative costs and a$0.1 million decrease in acquisition expenses. - 57 - -------------------------------------------------------------------------------- General, administrative and other expenses totaled$12.5 million for the six months endedJune 30, 2020 , an increase of$1.2 million compared to the six months endedJune 30, 2019 . The increase was primarily attributable to a$0.5 million increase in salaries, benefits and severance costs, a$0.4 million increase in incentive and equity compensation, a$0.3 million increase in public company costs, a$0.3 million increase in litigation reserve and a$0.1 million increase in acquisition expenses, offset by a$0.4 million decrease in other general administrative costs. Home office depreciation and amortization. Home office depreciation and amortization expense remained flat at$0.4 million and$0.7 million for the three and six months endedJune 30, 2020 , compared to the three and six months endedJune 30, 2019 primarily due to machinery and equipment at the home office becoming fully depreciated in 2019, offset by additional software assets purchased in the latter half of 2019. Impairment of goodwill and other intangibles. As a result of the economic conditions caused by the response to COVID-19, we performed a quantitative assessment of our goodwill and indefinite-lived intangible assets atMarch 31, 2020 . We recorded a goodwill impairment of$13.6 million related to our funeral homes in the Eastern Reporting Unit as the carrying value of goodwill exceeded the fair value atMarch 31, 2020 . We also recorded a$1.1 million impairment charge to certain of our tradenames as the carrying amount of these tradenames exceeded the fair value. Interest expense. Interest expense totaled$8.4 million for the three months endedJune 30, 2020 , an increase of$2.1 million compared to the three months endedJune 30, 2019 . Interest expense totaled$16.8 million for the six months endedJune 30, 2020 , an increase of$4.2 million compared to the six months endedJune 30, 2019 . The increase was primarily due to increased borrowings on our Credit Facility and the$75.0 million of additional Senior Notes we issued onDecember 19, 2019 . Accretion of discount on convertible subordinated notes. We recognized accretion of the discount on our Convertible Notes of$0.1 million for both the three months endedJune 30, 2020 and 2019 and$0.1 million for both the six months endedJune 30, 2020 and 2019. Income taxes. We calculate our quarterly income tax expense using a forecasted annual effective tax rate and we adjust for any discrete items arising during the quarter. Our income tax expense was$3.4 million and$2.1 million for the three months endedJune 30, 2020 and 2019, respectively and$1.3 million and$4.8 million for the six months endedJune 30, 2020 and 2019, respectively. Our operating tax rate before discrete items was 33.5% and 29.2% for the three months endedJune 30, 2020 and 2019, and 33.3% and 28.5% for the six months endedJune 30, 2020 and 2019, respectively. The increase in our overall effective tax rate is due to the unfavorable tax impact of impairment of goodwill and other intangibles recorded in the first quarter of 2020 for businesses that were previously acquired through stock acquisitions. In connection with the CARES Act, we expect to file a claim for a refund during 2020 to carryback the net operating losses generated in the tax years endingDecember 31, 2018 and 2019 and have included the anticipated impact in our current provision. In an effort to maximize the expected benefits afforded by the CARES Act we plan to amend our 2018 tax return to include the additional first year depreciation deduction for qualified improvement property. The majority of the net operating losses generated in 2018 are the result of filing non-automatic accounting method changes relating to the recognition of revenue from our cemetery property and merchandise and services sales. Due to the uncertainty of the timing of receiving Internal Revenue Service approval for non-automatic accounting method changes, a reserve has been recorded against the benefit derived from this carrying back that the net operating losses generated. OVERVIEW OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of the Consolidated Financial Statements requires us to make estimates and judgments that affect the amounts reported in the unaudited consolidated financial statements and accompanying notes. We base our estimates on historical experience, third-party data and assumptions that we believe to be reasonable under the circumstances. The results of these considerations form the basis for making judgments about the amount and timing of revenue and expenses, the carrying value of assets and the recorded amounts of liabilities. Actual results may differ from these estimates and such estimates may change if the underlying conditions or assumptions change. Historical performance should not be viewed as indicative of future performance because there can be no assurance that our margins, operating income and net income, as a percentage of revenue, will be consistent from year to year. Management's discussion and analysis of financial condition and results of operations ("MD&A") is based upon our Consolidated Financial Statements presented herewith, which have been prepared in accordance with GAAP. Our critical accounting policies are discussed in MD&A in our Annual Report on Form 10-K for the year endedDecember 31, 2019 . - 58 - --------------------------------------------------------------------------------
SEASONALITY
Our business can be affected by seasonal fluctuations in the death rate. Generally, the death rate is higher during the winter months because the incidences of death from influenza and pneumonia are higher during this period than other periods of the year. Item 3. Quantitative and Qualitative Disclosures About Market Risk. In the ordinary course of business, we are typically exposed to a variety of market risks. Currently, these are primarily related to interest rate risk and changes in the values of securities associated with the preneed and perpetual care trusts. Management is actively involved in monitoring exposure to market risk and developing and utilizing appropriate risk management techniques when appropriate and when available for a reasonable price. We are not exposed to any other significant market risks other than those related to COVID-19 which are described in more detail in Item 1A - Risk Factors below. The following quantitative and qualitative information is provided about financial instruments to which we are a party atJune 30, 2020 and from which we may incur future gains or losses from changes in market conditions. We do not enter into derivative or other financial instruments for speculative or trading purposes. Hypothetical changes in interest rates and the values of securities associated with the preneed and perpetual care trusts chosen for the following estimated sensitivity analysis are considered to be reasonable near-term changes generally based on consideration of past fluctuations for each risk category. However, since it is not possible to accurately predict future changes in interest rates, these hypothetical changes may not necessarily be an indicator of probable future fluctuations. The following information about our market-sensitive financial instruments constitutes a "forward-looking statement." In connection with our preneed funeral operations and preneed cemetery merchandise and service sales, the related funeral and cemetery trust funds own investments in equity and debt securities and mutual funds, which are sensitive to current market prices. Cost and market values of such investments as ofJune 30, 2020 are presented in Item 1, "Condensed Notes to Consolidated Financial Statements," Notes 6 and 7 to our Consolidated Financial Statements in this Quarterly Report on Form 10-Q. The sensitivity of the fixed income securities is such that a 0.25% change in interest rates causes an approximate 1.59% change in the value of the fixed income securities. We monitor current and forecasted interest rate risk in the ordinary course of business and seek to maintain optimal financial flexibility, quality and solvency. As ofJune 30, 2020 , we had outstanding borrowings under the Credit Facility of$89.7 million . Any further borrowings or voluntary prepayments against the Credit Facility or any change in the floating rate would cause a change in interest expense. We have the option to pay interest under the Credit Facility at either prime rate or the LIBOR rate plus a margin. AtJune 30, 2020 , the prime rate margin was equivalent to 2.00% and the LIBOR rate margin was 3.00%. Assuming the outstanding balance remains unchanged, a change of 100 basis points in our borrowing rate would result in a change in income before taxes of$0.9 million . We have not entered into interest rate hedging arrangements in the past. Management continually evaluates the cost and potential benefits of interest rate hedging arrangements. Our Convertible Notes bear interest at the fixed annual rate of 2.75%. The Convertible Notes do not contain a call feature. AtJune 30, 2020 , the carrying value of the Convertible Notes on our Consolidated Balance Sheet was$6.1 million and the fair value of the Convertible Notes was$6.4 million based on the last traded or broker quoted price, as reported by theFinancial Industry Regulatory Authority, Inc. ("FINRA )". Increases in market interest rates may cause the value of the Convertible Notes to decrease, but such changes will not affect our interest costs. Our Senior Notes bear interest at the fixed annual rate of 6.625%. We may redeem all or part of the Senior Notes at any time prior toJune 1, 2021 at a redemption price equal to 100% of the principal amount of Senior Notes redeemed, plus a "make whole" premium, and accrued and unpaid interest, if any, to the date of redemption. We have the right to redeem the Senior Notes at any time on or afterJune 1, 2021 at the redemption prices described in the indenture governing the Senior Notes, plus accrued and unpaid interest, if any, to the date of redemption. AtJune 30, 2020 , the carrying value of the Senior Notes on our Consolidated Balance Sheet was$395.7 million and the fair value of the Senior Notes was$419.9 million based on the last traded or broker quoted price, as reported byFINRA . Increases in market interest rates may cause the value of the Senior Notes to decrease, but such changes will not affect our interest costs. The remainder of our long-term debt and leases consist of non-interest bearing notes and fixed rate instruments that do not trade in a market and do not have a quoted market value. Any increase in market interest rates causes the fair value of those liabilities to decrease, but such changes will not affect our interest costs. - 59 -
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