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. AtMarch 31, 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 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, because death occurs on a relatively consistent basis. 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 highly uncertain. Certain estimates inherently involve assumptions about future events and annual results, making reliable estimates for those matters challenging in periods of extreme 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. Our employees at the Houston Support Office, which account for approximately 5% of our total employee population, were the primary group affected by stay-at-home state and local orders. - 36 -
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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. However, we believe given the unprecedented nature of COVID-19, 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 effective as ofApril 19, 2020 . 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. See Item 1, Financial Statements and Supplementary Data, Note 1 for additional information related to the CARES Act. The COVID-19 pandemic, and related gathering restrictions issued by state and local officials, did impact aspects of our financial results in the first quarter, including revenue, preneed cemetery sales, and average revenue per contract. While it is difficult to gauge the exact extent of that impact over the last few weeks of the first quarter, the Company will continue to 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 industry 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
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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 the lateJack 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 localManaging Partners that have the 4E Leadership skills to entrepreneurially grow the business by hiring, training and developing highly motivated and productive local teams. Strategic Acquisition Model Our Standards Operating Model led to the development of our Strategic Acquisition Model, which guides our acquisition strategy. We believe that both models, when executed effectively, will drive long-term, sustainable increases in market share, revenue, earnings and cash flow. We believe a primary driver of higher revenue and profits in the future will be the execution of our Strategic Acquisition Model using strategic ranking criteria to assess acquisition candidates. As we execute this strategy over time, we expect to acquire larger, higher margin strategic businesses. We have learned that the long-term growth or decline of a local branded funeral and cemetery business is reflected by several criteria that correlate strongly with five to ten year performance in volumes (market share), revenue and sustainable field-level earnings before interest, taxes, depreciation and amortization ("EBITDA") margins (a non-GAAP measure). We use criteria such as cultural alignment, volume and price trends, size of business, size of market, competitive standing, demographics, strength of brand and barriers to entry to evaluate the strategic position of potential acquisition candidates. Our financial valuation of the acquisition candidate is then determined through the application of an appropriate after-tax cash return on investment that exceeds our cost of capital. Our belief in our Mission Statement and Guiding Principles that define us and proper execution of the 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. 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 endedDecember 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 - 38 -
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expansion projects) will be tightly managed and minimized during the remainder of 2020. 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 ofMarch 31, 2020 , we have net unrealized losses of$45.1 million in our trusts. AtMarch 31, 2020 , these net unrealized losses represented 18% of our original cost basis of$245.2 million . The decline in fair value is largely due to changes in interest rates and other market conditions. 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 (loss) and offset by the Deferred preneed funeral and cemetery receipts held in 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 first quarter with$11.9 million . As ofMarch 31, 2020 , we had borrowings of$114.0 million outstanding on our Credit Facility compared to$83.8 million as ofDecember 31, 2019 . The following table sets forth the elements of cash flow for the three months endedMarch 31, 2019 and 2020 (in thousands): Three months ended March 31, 2019 2020 Cash at beginning of year$ 644 $ 716 Net cash provided by operating activities 10,994 13,546 Acquisitions - (28,000 ) Net proceeds from the sale of other assets 100 78 Capital expenditures (3,543 ) (2,738 ) Net cash used in investing activities (3,443 ) (30,660 ) Net borrowings (payments) on our Credit Facility, acquisition debt and finance lease obligations (6,571 ) 29,713
Payment of debt issuance costs related to the Senior Notes
- (14 ) Net proceeds from employee equity plans 572 127 Dividends paid on common stock (1,360 ) (1,339 ) Other financing costs (162 ) (169 ) Net cash provided by (used in) financing activities (7,521 ) 28,318 Cash at end of the period$ 674 $ 11,920
Operating Activities
For the three months ended
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Investing Activities Our investing activities, resulted in a net cash outflow of$30.7 million for the three months endedMarch 31, 2020 compared to$3.4 million for the three months endedMarch 31, 2019 , an increase of$27.3 million . During the three months endedMarch 31, 2020 , we acquired a funeral home and cemetery combination business inLafayette, California for$33.0 million in cash, of which$5.0 million was deposited in escrow in 2019 and$28.0 million was paid in 2020. For the three months endedMarch 31, 2020 , capital expenditures totaled$2.7 million compared to$3.5 million for the three months endedMarch 31, 2019 , a decrease of$0.8 million . The following tables present our growth and maintenance capital expenditures (in thousands): Three months endedMarch 31, 2019 2020
Growth
Cemetery development $ 1,067$ 954 Renovations at certain businesses 744 141 Other 39 87 Total growth expenditures $ 1,850$ 1,182
Maintenance
Facility repairs and improvements $ 217$ 246 Vehicles 587 428 General equipment and furniture 781 649 Paving roads and parking lots 61 132 Other 47 101 Total maintenance expenditures $ 1,693$ 1,556 Total capital expenditures $ 3,543$ 2,738 Financing Activities Our financing activities resulted in a net cash inflow of$28.3 million for the three months endedMarch 31, 2020 compared to a net cash outflow of$7.5 million for the three months endedMarch 31, 2019 , an increase of$35.8 million . During the three months endedMarch 31, 2020 , we had net borrowings on our Credit Facility of$30.2 million and payments on our acquisition debt and finance leases of$0.5 million and paid$1.3 million in dividends. During the three months endedMarch 31, 2019 , we had net payments on our Credit Facility of$6.1 million and payments on our acquisition debt and finance leases of$0.5 million and paid$1.4 million in dividends. Dividends During the three months endedMarch 31, 2019 and 2020, our Board of Directors declared the following dividends payable on the dates below (in thousands, except per share amounts): 2019 Per Share Dollar Value March 1st$ 0.075 $ 1,360 2020 Per Share Dollar Value March 1st$ 0.075 $ 1,339
Share Repurchases
During the three months ended
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Credit Facility, Lease Obligations and Acquisition Debt
The outstanding principal of our Credit Facility, lease obligations and
acquisition debt at
March 31, 2020 Credit Facility$ 114,000 Finance leases 6,074 Operating leases 22,942 Acquisition debt 6,547 Total$ 149,563 Credit Facility AtMarch 31, 2020 , our Credit Facility was comprised of: (i) a$190.0 million revolving credit facility, which includes 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 onMay 31, 2023 . The Credit Facility is secured by a first-priority perfected security interest in and lien on substantially all of the Company's personal property assets and those of the Credit Facility Guarantors. In the event the Company's actual Total Leverage Ratio is not at least 0.25 less than the required Total Leverage Ratio covenant level, at the discretion of the Administrative Agent, the Administrative Agent may unilaterally compel the Company and the Credit Facility Guarantors to grant and perfect first-priority mortgage liens on fee-owned real property assets which account for no less than 50% of funeral operations EBITDA. The Credit Facility contains customary affirmative covenants, including, but not limited to, covenants with respect to the use of proceeds, payment of taxes and other obligations, continuation of the Company's business and the maintenance of existing rights and privileges, the maintenance of property and insurance, amongst others. In addition, the Credit Facility also contains customary negative covenants, including, but not limited to, covenants that restrict (subject to certain exceptions) the ability of the Company and its subsidiaries and party thereto as guarantors (the "Credit Facility Guarantors") to incur additional indebtedness, grant liens on assets, make investments, engage in mergers and acquisitions, and pay dividends and other restricted payments, and certain financial covenants. As ofMarch 31, 2020 , we were subject to the following financial covenant under our Credit Facility: (A) a Total Leverage Ratio not to exceed, (i) 5.75 to 1.00 for the quarters endedMarch 31, 2020 ,June 30, 2020 andSeptember 30, 2020 and (ii) 5.50 to 1.00 for the quarter endedDecember 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. As more fully described below, we were not in compliance with the Total Leverage Ratio covenant for the quarter endedMarch 31, 2020 . As ofMarch 31, 2020 , the Company was not in compliance with the Total Leverage Ratio covenant requirement as noted above. 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. Immediately following the effectiveness of the limited waiver and fourth amendment,$74.0 million remained available for borrowing under the Credit Facility. We are in compliance with the fixed charge coverage ratio and senior secured leverage ratio covenants contained in our Credit Facility as ofMarch 31, 2020 . We expect to be in compliance with all of our covenant requirements for the next twelve months. We had one letter of credit issued onNovember 30, 2019 and outstanding under the Credit Facility for approximately$2.0 million , which bears interest at 2.125% and will expire onNovember 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 ofMarch 31, 2020 , the prime rate margin was equivalent to 1.50% and the LIBOR rate margin was 2.50%. The weighted average interest rate on our Credit Facility for the three months endedMarch 31, 2019 and 2020 was 4.1% and 4.3%, respectively. - 41 -
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The interest expense and amortization of debt issuance costs related to our
Credit Facility during the three months ended
Three months ended March 31, 2019 2020 Credit Facility interest expense $ 379$ 1,230 Credit Facility amortization of debt issuance costs 54 126 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 months endedMarch 31, 2019 and 2020 are as follows (in thousands): Three months ended March 31, 2019 2020 Operating lease cost $ 924$ 957 Short-term lease cost 75 57 Finance lease cost: Depreciation of lease right-of-use assets $ 132$ 109 Interest on lease liabilities 132 126
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 Credit acquisition debt during the
three months ended
Three months ended March 31, 2019 2020 Acquisition debt imputed interest expense $ 168$ 127 Convertible Subordinated Notes due 2021 AtMarch 31, 2020 , the principal amount of the liability component of our Convertible Notes was$6.3 million , the net carrying amount was$6.0 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 atMarch 31, 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 months endedMarch 31, 2019 and 2020 is as follows (in thousands): Three months ended March 31, 2019 2020 Convertible Notes interest expense $ 44 $ 43 Convertible Notes accretion of debt discount 57 65 Convertible Notes amortization of debt issuance costs 6 6
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 11 months of the Convertible Notes. The
effective interest rate on the unamortized debt discount for both the three
months ended
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Senior Notes due 2026 AtMarch 31, 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$432.3 million atMarch 31, 2020 . The Senior Notes are due onJune 1, 2026 and bear interest at 6.625% per year, which is payable semi-annually in arrears onJune 1 andDecember 1 of each year. The interest expense and amortization of debt discount, debt premium and debt issuance costs related to our Senior Notes during the three months endedMarch 31, 2019 and 2020 is as follows (in thousands): Three months ended March 31, 2019 2020 Senior Notes interest expense$ 5,383 $ 6,625 Senior Notes amortization of debt discount 120 129 Senior Notes amortization of debt premium - (54 ) Senior Notes amortization of debt issuance costs 34 67
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 74 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
Three Months Ended March 31, 2019 2020 Revenue$ 69,081 $ 77,490 Funeral contracts 9,881 11,493 Average revenue per funeral contract$ 5,635 $ 5,233 Preneed interment rights (property) sold 1,462 1,868 Average price per preneed interment right sold$ 3,808 $ 3,779 Gross profit$ 21,600 $ 23,171 Net income (loss)$ 6,525 $ (4,197 )
Revenue for the three months ended
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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 quarter endedMarch 31, 2020 datedMay 19, 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 (loss) (a GAAP measure) to Adjusted net income (a non-GAAP measure) for the three months endedMarch 31, 2019 and 2020 (in thousands): Three months ended March 31, 2019 2020 Net income (loss)$ 6,525 $ (4,197 )
Special items, net of tax except for items noted by **(1) Acquisition and divestiture expenses
- 90 Severance and retirement costs 171 228 Accretion of discount on Convertible Notes** 57 65 Net impact of impairment of goodwill and other intangibles(2) - 9,757 Litigation reserve 99 59 Natural disaster costs - 111 Adjusted net income(3)$ 6,852 $ 6,113
(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 percent for the three months endedMarch 31, 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 33.6%. (3) Adjusted net income is defined as Net income (loss) 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 months endedMarch 31, 2019 and 2020 (in thousands): Three months ended March 31, 2019 2020 Gross profit$ 21,600 $ 23,171 Cemetery property amortization 849 877 Field depreciation expense 3,085 3,290 Regional and unallocated funeral and cemetery costs 2,789 2,756 Operating profit(1)$ 28,323 $ 30,094
(1) Operating profit is defined as Gross profit less Cemetery property
amortization, Field depreciation expense and Regional and unallocated funeral and cemetery costs. - 44 -
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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 months ended
Three months ended March 31, 2019 2020 Funeral Home$ 23,167 $ 24,274 Cemetery 5,156 5,820 Operating profit$ 28,323 $ 30,094 Operating profit margin(1) 41.0 % 38.8 %
(1) Operating profit margin is defined as Operating profit as a percentage of Revenue.
Further discussion of Operating profit for our funeral home and cemetery segments is presented herein under "- Results of Operations." RESULTS OF OPERATIONS The following is a discussion of our results of operations for the three months endedMarch 31, 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. - 45 -
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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 ended
Three Months Ended March 31, 2019 2020 Revenue: Same store operating revenue$ 45,018 $ 44,866 Acquired operating revenue 6,953 11,714 Divested/planned divested revenue 2,027 1,722 Ancillary funeral services revenue - 1,151 Preneed funeral insurance commissions 359 366 Preneed funeral trust and insurance 1,806 1,923 Total$ 56,163 $ 61,742 Operating profit: Same store operating profit$ 18,071 $ 17,236 Acquired operating profit 2,739 4,245 Divested/planned divested operating profit 459 466 Ancillary funeral services operating profit - 295 Preneed funeral insurance commissions 133 160 Preneed funeral trust and insurance 1,765 1,872 Total$ 23,167 $ 24,274 The following measures reflect the significant metrics over this comparative period: Three Months Ended March 31, 2019 2020 Same store: Contract volume 8,289 8,762
Average revenue per contract, excluding preneed funeral trust earnings
$ 5,431 $ 5,121 Average revenue per contract, including preneed funeral trust earnings$ 5,618 $ 5,314 Burial rate 39.3 % 36.9 % Cremation rate 53.0 % 55.1 % Acquired: Contract volume 1,050 2,208
Average revenue per contract, excluding preneed funeral trust earnings
$ 6,623 $ 5,305 Average revenue per contract, including preneed funeral trust earnings$ 6,746 $ 5,372 Burial rate 50.1 % 41.8 % Cremation rate 43.0 % 53.4 %
Funeral home same store operating revenue for the three months ended
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Same store salaries and benefits for the three months endingMarch 31, 2020 had the largest increase of$0.4 million compared to the three months endedMarch 31, 2019 . The increase in salaries and benefits was primarily due to the increase in contract volume as we experienced an increase in the demand for pickup and embalming services. The costs for funeral supplies for the three months endingMarch 31, 2020 increased$0.1 million compared to the same period in 2019 as our funeral homes ramped up their purchases of supplies in preparation for COVID-19. The provision for credit losses increased$0.1 million compared to the three months endingMarch 31, 2020 compared to the three months endingMarch 31, 2019 . Funeral home acquired operating revenue for the three months endedMarch 31, 2020 increased$4.8 million , as our funeral home acquired portfolio for the three months endedMarch 31, 2020 included nine funeral home businesses over four acquisitions acquired in the fourth quarter of 2019 and one business acquired in the first quarter of 2020 not present in the three months endedMarch 31, 2019 . Acquired operating profit for the three months endedMarch 31, 2020 increased$1.5 million when compared to the three months endedMarch 31, 2019 . Operating profit margin decreased 320 basis points to 36.2% for the three months endedMarch 31, 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. We expect the operating margins for our recently acquired businesses to increase as we focus on integrating these 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$0.3 million for the three months endedMarch 31, 2020 , with an operating profit margin of 25.6%. Preneed funeral insurance commissions and preneed funeral trust and insurance, also recorded in Other revenue, on a combined basis, increased$0.1 million or 5.7% for the three months endedMarch 31, 2020 compared to the same period in 2019. The increase is primarily due to the increase in preneed trust and insurance, while preneed funeral commissions remained fairly flat. Operating profit for preneed funeral insurance commissions and preneed trust and insurance, on a combined basis, increased 7.1% for the same comparative period in 2019, primarily due to the increase in funeral trust and insurance revenue. Cemetery Segment The following table sets forth certain information regarding our Revenue and Operating profit from our cemetery operations for the three months endedMarch 31, 2020 compared to the three months endedMarch 31, 2019 (in thousands): Three Months Ended March 31, 2019 2020 Revenue: Same store operating revenue$ 11,289 $ 10,945 Acquired operating revenue - 2,799 Preneed cemetery trust and insurance 1,251 1,761 Preneed cemetery finance charges 378 243 Total$ 12,918 $ 15,748 Operating profit: Same store operating profit $ 3,661$ 3,151 Acquired operating profit - 827 Preneed cemetery trust and insurance 1,117 1,599 Preneed cemetery finance charges 378 243 Total $ 5,156$ 5,820 - 47 -
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The following measures reflect the significant metrics over this comparative period:
Three Months Ended March 31, 2019 2020 Same store: Preneed revenue as a percentage of operating revenue 59 % 58 % Preneed revenue (in thousands)$ 6,661 $ 6,311 Atneed revenue (in thousands)$ 4,629 $ 4,634 Number of preneed interment rights sold 1,462 1,568 Average price per interment right sold$ 3,808 $ 3,604
Acquired:
Preneed revenue as a percentage of operating revenue n/a 62 % Preneed revenue (in thousands) n/a$ 1,736 Atneed revenue (in thousands) n/a$ 1,063 Number of preneed interment rights sold n/a 300 Average price per interment right sold n/a$ 4,696 Cemetery same store preneed revenue for the three months endedMarch 31, 2020 decreased$0.3 million due to the decrease in cemetery property revenue as we experienced a 5.4% decrease in the average price of interments, offset by a 7.3% increase in the number of preneed interment rights sold compared to the same period in 2019. Cemetery same store atneed revenue, which represents approximately 42% of our same store operating revenue remained flat as we experienced a 0.7% increase in the average sale per contract, offset by a 0.6% decrease in the number of atneed contracts sold. Cemetery same store operating profit for the three months endedMarch 31, 2020 decreased$0.5 million from the same period in 2019. The comparable operating profit margin decreased 360 basis points to 28.8% for the three months endedMarch 31, 2020 from 32.4% in the same period in 2019. The decrease in operating profit margin is a result of the decrease in operating revenue and a 2.2% increase in operating costs, most notably a$0.2 million increase in promotional expenses. 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$2.8 million in revenue and$0.8 million in operating profit for the three months endedMarch 31, 2020 . Preneed cemetery trust and insurance and preneed cemetery finance charges, which are recorded in Other revenue, on a combined basis increased$0.4 million for the three months endedMarch 31, 2020 compared to the same period in 2019. Earnings in our perpetual care trust fund increased$0.5 million due to our acquisitions. Operating profit for the two categories of Other revenue, on a combined basis, also increased$0.3 million for the three months endedMarch 31, 2020 compared to the same period in 2019. Cemetery property amortization. Cemetery property amortization remained flat at$0.9 million for the three months endedMarch 31, 2020 compared to the three months endedMarch 31, 2019 . Field depreciation. Depreciation expense for our field businesses increased$0.2 million for the three months endedMarch 31, 2020 compared to the three months endedMarch 31, 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 remained flat at$2.8 million for the three months endedMarch 31, 2020 , compared to the three months endedMarch 31, 2019 . Other Financial Statement Items General, administrative and other. General, administrative and other expenses totaled$5.9 million for the three months endedMarch 31, 2020 , an increase of$0.3 million compared to the three months endedMarch 31, 2019 . The increase was primarily attributable to a$0.5 million increase in salaries and benefits and severance costs, offset by a$0.2 million decrease in incentive and equity compensation costs. - 48 -
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Home office depreciation and amortization. Home office depreciation and amortization expense remained flat at$0.4 million for the three months endedMarch 31, 2020 , compared to the three months endedMarch 31, 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 endedMarch 31, 2020 , an increase of$2.1 million compared to the three months endedMarch 31, 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 endedMarch 31, 2020 and 2019. Income taxes. We calculate our quarterly income tax expense (benefit) using a forecasted annual effective tax rate and we adjust for any discrete items arising during the quarter. Our income tax benefit was$2.2 million for the three months endedMarch 31, 2020 compared to an income tax expense of$2.7 million for the three months endedMarch 31, 2019 . Our operating tax rate before discrete items was 33.6% and 28.0% for the three months endedMarch 31, 2020 and 2019, respectively. We recorded$0.7 million of additional tax expense in the three months endedMarch 31, 2020 related to the impairment of goodwill and other intangibles for businesses that were previously acquired as a stock acquisition, which caused an increase of 3.6% in our operating tax rate. 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 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 . 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. - 49 -
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