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SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
Commission file number: 1-11961
CARRIAGE SERVICES, INC. (Exact name of registrant as specified in its charter)
Registrant's telephone number, including area code: (713) 332-8400
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
The number of shares of the Registrant's Common Stock, $.01 par value per share, outstanding as of November 6, 2002 was 17,070,502.
CARRIAGE SERVICES, INC.
INDEX
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CARRIAGE SERVICES, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except share data)
The accompanying condensed notes are an integral part of these consolidated financial statements.
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CARRIAGE SERVICES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited and in thousands, except per share data)
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CARRIAGE SERVICES, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited and in thousands)
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CARRIAGE SERVICES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited and in thousands)
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CARRIAGE SERVICES, INC. CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
1. BASIS OF PRESENTATION
Carriage Services, Inc., (the "Company") is a leading provider of products and services in the death care industry in the United States. As of September 30, 2002, the Company owned and operated 149 funeral homes and 30 cemeteries in 29 states.
The accompanying consolidated financial statements include the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated.
The information for the three and nine month periods ended September 30, 2001 and 2002 is unaudited, but in the opinion of management, reflects all adjustments which are of a normal, recurring nature necessary for a fair presentation of financial position and results of operations for the interim periods. Certain information and footnote disclosures, normally included in annual financial statements, have been condensed or omitted pursuant to the rules of the SEC. The accompanying consolidated financial statements have been prepared consistent with the accounting policies described in our annual report on Form 10-K for the year ended December 31, 2001, and should be read in conjunction therewith. Certain amounts in the December 31, 2001 consolidated balance sheet have been classified differently than in the consolidated balance sheet included in our annual report on Form 10-K. Additionally, preneed funeral and cemetery costs have been reclassified from investing activities to operating activities in the September 30, 2001 consolidated statement of cash flows to conform to current year presentation.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
2. ACCOUNTING CHANGES
In June 2001, the Financial Accounting Standards Board issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141 addresses financial accounting and reporting for goodwill and other intangible assets acquired in a business combination at acquisition. SFAS No. 142 addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. This Statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements.
The provisions of SFAS No. 141 apply to all business combinations initiated after June 30, 2001. The provisions also apply to all business combinations accounted for using the purchase method for
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which the date of acquisition is July 1, 2001 or later. The adoption of SFAS No. 141 by the Company had no effect on its consolidated financial statements.
The provisions of SFAS No. 142 were required to be applied starting with fiscal years beginning after December 15, 2001. The Company adopted SFAS No. 142 as of the beginning of the first quarter of 2002. The effect of SFAS No. 142 on the Company is the elimination of the amortization of goodwill, which prior to 2002 was amortized over 40 years, and the testing for impairment of goodwill on an annual basis. Had the adoption of SFAS No. 142 occurred at the beginning of the previous year, the results would have been as follows (in thousands, except per share amounts):
See Management's Discussion and Analysis of Financial Condition and Results of Operations for proforma disclosure of this accounting change which additionally incorporates the impact of the change in the tax rate discussed in Note 4 on the reported results for 2001. The Company performed a review of goodwill as of January 1, 2002 by comparing the fair value of the Company's reporting units (funeral home business by region) to the carrying value of the reporting units, and no impairment was recorded at the implementation date of the new accounting standard. Goodwill acquired during the nine months ended September 30, 2002, included $1.0 million for performance-based contingent consideration payments on a prior year acquisition and $0.9 million for a funeral home acquisition in the second quarter of 2002.
In August 2001 the Financial Accounting Standards Board issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS No. 144 addresses financial accounting and reporting of long-lived assets, other than goodwill, that are to be disposed by sale or otherwise (e.g. discontinued operations), and is effective for financial statements issued for fiscal years beginning after December 15, 2001. The Company adopted SFAS No. 144 as of the beginning of the first quarter of 2002 which had no effect on the Company's financial position or results of operations.
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3. MAJOR SEGMENTS OF BUSINESS
Carriage conducts funeral and cemetery operations only in the United States. The following table presents external revenue, net income and total assets by segment (in thousands):
4. INCOME TAXES
For 2001, the Company had an effective financial statement tax rate of 20 percent, reflecting the benefit of previously unrecognized tax losses from prior periods related to the Fresh Start restructuring program. When the Company incurred the Fresh Start restructuring costs and write-downs in late 2000 and proceeded to dispose of low performing businesses, it could not be assured that it would generate enough future taxable income to utilize the sizeable tax benefits created by the tax losses on asset sales. To acknowledge this uncertainty at the time, the Company recorded a "valuation allowance" to offset these tax benefits until such time that it could be determined that the Company would be able to deduct them. Based on the positive operating results subsequent to 2000 and management's forecast of future positive operating results, management determined in the first quarter of 2002 that it is more likely than not that the Company will be able to utilize substantially all of these previously unrecognized tax benefits. Accordingly, in the first quarter of 2002 the Company recorded a special one-time tax benefit in the amount of $12.8 million, equal to $0.73 per diluted share, which eliminated substantially all of the valuation allowance. The Company estimates that its effective tax rate will be 38.5 percent for financial statement purposes in 2002, excluding the reduction of the deferred tax valuation allowance. Had the Company also used the 38.5 percent tax rate for the nine months ended September 30, 2001, net income for that period, excluding the effect of the change in accounting for goodwill amortization discussed in Note 2, would have been lower by $1,495,000 or $0.09 per diluted share.
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
Carriage is a leading provider of death care services and products in the United States. Our historical focus has been on operational enhancements at facilities currently owned to increase revenues and gross profit, as well as growth through acquisitions (although we have not pursued the acquisition strategy since 1999). That focus has resulted in high standards of service, operational performance, and an infrastructure containing measurement and management systems. In 2000, the operating strategy was dramatically shifted to focus upon increasing operating cash flow. In November 2000, we launched a multi-faceted, restructuring program, called "Fresh-Start", which was designed to increase financial and operating performance, improve cash flow, reduce debt, and assist Carriage in fulfilling our mission of being the highest quality funeral and cemetery service organization in the industry. Beginning with the fourth quarter of 2000, we have been focused on executing elements of Fresh Start.
The goals of Fresh Start were and remain restoring credibility to our operating and consolidation model, increasing and better aligning our earnings and cash flow, restoring market credibility to our balance sheet, reducing our debt, and re-accessing the capital markets.
The principal elements of Fresh Start include downsizing our corporate organization; changing our operating leadership; changing our preneed funeral organizational strategy; stratifying by performance our funeral and cemetery portfolios; implementing action plans to improve underperforming businesses; disposing of some underperforming businesses; adjusting the carrying basis of other underperforming businesses; and modifying financial covenants with lenders to facilitate execution of Fresh Start. Most of the elements of Fresh Start have been accomplished and we are seeing the benefits of these actions in our operating results.
Net income totaled $18.6 million in the first nine months of 2002, or $1.06 per diluted share. Excluding a $12.8 million, or $0.73 per share special tax benefit, net income was $5.8 million, or $0.33 per diluted share. Two significant accounting events occurred during the nine months ended September 30, 2002: the elimination of goodwill amortization in connection with the implementation of SFAS No.142, which totaled $3.4 million in the first nine months of 2001, and the change in the Company's tax rate from 20 percent to 38.5 percent. Had those two events occurred at the beginning of 2001, net income and diluted earnings per share would have totaled $7.0 million and $0.40, respectively, for the first nine months of 2001.
The full year impact to diluted earnings per share, by quarter, for 2001 of these two events would have been as follows:
Income from operations, which we define as earnings before interest and income taxes, increased as a percentage of net revenues, from 15.3% for the third quarter of 2001 to 15.6% for the third quarter of 2002 and from 19.1% for the nine months ended September 30, 2001 to 20.7% for the nine months ended September 30, 2002. This improvement was primarily due to the elimination of amortization for goodwill beginning January 1, 2002, offset in part by a $0.7 million charge related to
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the termination of an employment agreement with a former officer, $0.5 million in professional fees incurred in connection with changes in tax accounting methods and higher insurance costs. Revenues from funeral homes decreased 2.6% and revenues from cemeteries decreased 8.6% in the third quarter of 2002 compared to the same period in 2001 primarily as a result of a decline in same-store revenues period to period, lower preneed insurance commission revenue and lower cemetery preneed property sales. Other factors that attributed to a decrease in funeral revenue are a lower national death rate compared to the third quarter of 2001 and competition from independent operators in some local markets. Also, approximately 72 percent of its funeral revenue was generated from traditional funeral services and 28 percent from cremation services, as compared to 73 percent and 27 percent in the third quarter of last year. The average revenue for cremation services increased by 0.6 percent when compared to the third quarter of last year. Cemetery revenues were negatively impacted by a weaker economy that resulted in lower discretionary spending by consumer and lower returns on investment funds. Specifically, we experienced a 2.8% decrease in preneed merchandise and service deliveries, a 6.1% decrease in sales of interment and entombment sites and a 1.9% decrease in income from perpetual care trusts and finance charges. The decline in cemetery revenue was offset partially by a 2.2% increase in at-need sales of property, services and merchandise.
Gross margins for the funeral homes increased from 21.0% in the third quarter of 2001 to 26.1% in the third quarter of 2002 primarily because of the elimination of goodwill amortization. As a percentage of cemetery net revenues, cemetery gross margin was 24.1% in the third quarter of 2002 compared to 24.6% in the third quarter of 2001.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements presented herewith, which have been prepared in accordance with generally accepted accounting principles. Our significant accounting policies are summarized in Note 1 to the consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2001. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Funeral and Cemetery Operations
We record the sales of funeral merchandise and services when the funeral service is performed. Sales of cemetery interment rights are recorded as revenue in accordance with the retail land sales provisions of Statement of Financial Accounting Standards (SFAS) No 66, "Accounting for Sales of Real Estate". This method provides for the recognition of revenue in the period in which the customer's cumulative payments exceed 10% of the contract price related to the real estate. Costs related to the sales of interment rights, which include property and other costs related to cemetery development activities, are charged to operations using the specific identification method in the period in which the sale of the interment right is recognized as revenue. Revenue from the sales of cemetery merchandise and services are recognized in the period in which the merchandise is delivered or the service is performed. Revenues to be recognized from the delivery of merchandise and performance of services related to contracts that were acquired in acquisitions are typically lower than those originated by the Company and are likely to exceed the cash collected from the contract and received from the trust at maturity.
Allowances for customer cancellations, refunds and bad debts are provided at the date of sale based on our historical experience. In addition, we monitor changes in delinquency rates and provide additional bad debt and cancellation reserves when warranted. When preneed funeral services and merchandise are funded through third-party insurance policies, we earn a commission on the sale of the
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policies. Insurance commissions are recognized as revenues at the point at which the commission is no longer subject to refund, which is typically one year after the policy is issued.
Preneed Funeral Contracts & Deferred Preneed Funeral Contracts Revenue
Cash proceeds from preneed funeral sales are deposited to a trust or to purchase of a third-party insurance product. Unperformed guaranteed preneed funeral contracts are included in the consolidated balance sheets as preneed funeral contracts. The balance in this asset account represents amounts due from customer receivables and third-party insurance companies, and the amounts deposited with the trustee and the accumulated earnings on these deposits. A corresponding credit is recorded to deferred preneed funeral contracts revenue. The funeral revenue is not recorded until the service is performed. The trust income earned and the increases in insurance benefits on the insurance products are also deferred until the service is performed, in order to offset inflation in cost to provide the service in the future.
Deferred Obtaining Costs
Deferred obtaining costs consist of sales commissions and other direct related costs of originating preneed sales contracts. These costs are deferred and amortized into funeral and cemetery costs and expenses over the expected timing of the performance of the services or delivery of the merchandise covered by the preneed contracts. Effective October 1, 2001, we changed the pattern of the periods over which the costs are recognized to more closely track actuarial statistics, provided by a third party administrator, based on the actual contracts we hold. The effect of this change was to reduce expense in the fourth quarter of 2001 by approximately $0.5 million from that which would have been recorded using the prior methodology.
Goodwill and Other Intangible Assets
The excess of the purchase price over the fair value of net identifiable assets acquired, as determined by management in transactions accounted for as purchases, is recorded as goodwill. Many of the acquired funeral homes have provided high quality service to families for generations. The resulting loyalty often represents a substantial portion of the value of a funeral business. Goodwill is typically not associated with or recorded for the cemetery businesses. In accordance with SFAS No. 142, we review the carrying value of goodwill at least annually on a regional basis to determine if facts and circumstances exist which would suggest that this intangible asset might be carried in excess of fair value. Fair value is determined by discounting the estimated future cash flows of the businesses in each region at the Company's weighted average cost of capital less debt allocable to the region. The calculation of fair value can vary dramatically with changes in estimates of the number of future services performed, inflation in costs and the Company's cost of capital. If impairment is indicated, then an adjustment will be made to reduce the carrying amount of goodwill to fair value. No impairments were recorded during the nine months ended September 30, 2002.
Income Taxes
The Company and its subsidiaries file a consolidated U.S. federal income tax return. We record deferred taxes for temporary differences between the tax basis and financial reporting basis of assets and liabilities, in accordance with SFAS 109, "Accounting for Income Taxes".
For 2001, the Company had an effective financial statement tax rate of 20 percent, reflecting the benefit of previously unrecognized tax losses from prior periods related to the Fresh Start restructuring program. When the Company incurred the Fresh Start restructuring costs and write-downs in late 2000 and proceeded to dispose of low performing businesses, it could not be assured that it would generate enough future taxable income to utilize the sizeable tax benefits created by the tax losses on asset sales.
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To acknowledge this uncertainty at the time, the Company recorded a "valuation allowance" to offset these tax benefits until such time that it could be determined that the Company would be able to deduct them. Based on the positive operating results subsequent to 2000 and management's forecast of future positive operating results, management determined in the first quarter of 2002 that it is more likely than not that the Company will be able to utilize substantially all of these previously unrecognized tax benefits. Accordingly, in the first quarter of 2002 the Company recorded a special one-time tax benefit in the amount of $12.8 million, equal to $0.73 per diluted share, which eliminated substantially all of the valuation allowance. The Company estimates that its effective tax rate for financial statement purposes is 38.5% in 2002, excluding the affect of the reversal of the deferred tax valuation allowance. Had the Company also used the 38.5 percent tax rate for the nine months ended September 30, 2001, net income for that period, excluding the effect of the change in accounting for goodwill amortization discussed in Note 2, would have been lower by $1,495,000 or $0.09 per diluted share.
Stock Options and Employee Stock Purchase Plan
The Company has four stock option plans currently in effect under which stock options may be issued. Additionally, the Company sponsors an Employee Stock Purchase Plan (ESPP) under which employees can purchase common stock at a discount. The stock options are granted with an exercise price equal to or greater than the fair market value of the Company's Common Stock. Substantially all of the options granted under the four stock option plans have ten-year terms. The options generally vest over a period of two to four years. The Company accounts for stock options and shares issued under the ESPP under APB Opinion No. 25, under which no compensation cost is recognized in the Consolidated Statement of Operations. Had compensation cost for options granted in 2002 and shares issued under the ESPP in 2002 been determined consistent with SFAS No. 123, "Accounting for Stock Based Compensation", for 2002, additional compensation expense totaling $0.5 million, equal to $0.02 per diluted share, would be recorded.
RESULTS OF OPERATIONS
The following is a discussion of the Company's results of operations for the three and nine month periods ended September 30, 2001 and 2002. For purposes of the revenue discussion, the Company's funeral home businesses are in three groups, as a result of the stratification of our funeral homes. A "core" group which represents approximately two-thirds of our revenues and cash flow, a second "underperforming" group, and a third group consisting of businesses that are "targeted for sale". Currently none of the cemetery businesses are stratified into these categories and none of the cemeteries are currently held for sale. Additionally, funeral homes and cemeteries owned and operated for the entirety of each period being compared are referred to as "same-store" or "existing operations".
Funeral Home Segment. The following table sets forth certain information regarding the net revenues, field EBITDA (earnings before interest, taxes, depreciation and amortization) and gross profit of the Company from its funeral home operations for the three and nine months ended September 30, 2001 compared to the three and nine months ended September 30, 2002. Field EBITDA differs from gross profit in that it excludes preneed insurance commissions revenue, corporate overhead allocations and depreciation and amortization.
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Three months ended September 30, 2001 compared to three months ended September 30, 2002 (dollars in thousands)
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Nine months ended September 30, 2001 compared to nine months ended September 30, 2002(dollars in thousands)
Funeral same-store revenues for the three months ended September 30, 2002 increased 0.7% when compared to the three months ended September 30, 2001, as we experienced a decrease of 0.8% in the number of services and a increase of 1.5% in the average revenue per service for those existing operations. The decrease in the number of services compares favorably with the reported 2.9% decline in the national mortality rates for the three month period. The increase in the average revenue per service of 1.5% was negatively affected by an increase in the cremation rate from 27% to 28%. The average revenue for cremation services increased 0.6%. The number of funeral services increased 0.3% for the core group in comparing the third quarter of 2002 to the third quarter of 2001, and the average revenue per service for those existing locations increased 1.6% in comparing those same periods. The number of funeral services performed by the underperforming group decreased 2.7% while the average revenue per service increased 1.1% in comparing the third quarter 2002 to the third quarter of 2001. In addition to the net revenues from funeral location operations above, insurance commission revenues from preneed funeral contract sales totaled $0.4 million for the three months ended September 30, 2002, as compared to $0.9 million for the three months ended September 30, 2001, primarily due to nonrecurring commissions in the prior year period on the conversion of trust funded contracts to insurance funded contracts.
Total funeral same-store gross profit for the three months ended September 30, 2002 increased $1.7 million or 35.4% from the comparable three months of 2001. The higher gross profit is primarily due to the elimination of goodwill amortization which totaled $1.1 million during the three months ended September 30, 2001.
Funeral same-store revenues for the nine months ended September 30, 2002 decreased 0.3% when compared to the nine months ended September 30, 2001, as we experienced a decrease of 2.4% in the
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number of services and an increase of 2.1% in the average revenue per service for those existing operations. The number of funeral services decreased 1.7% for the core group in comparing the nine months ended September 30, 2002 to the nine months ended September 30, 2001, while the average revenue per service for those existing locations increased 2.1% in comparing those same periods. The number of funeral services for the underperforming group decreased 4.1% while the average revenue per service increased 2.8% in comparing the nine months ended September 30, 2002 to the nine months ended September 30, 2001.
Total funeral field EBITDA for the nine months ended September 30, 2002 decreased $1.4 million or 4.1% from the comparable nine month period in the prior year, the largest factor for which was the contribution associated with businesses we sold during 2001. As a percentage of revenue, the field EBITDA margin for the nine months ended September 30, 2002 of 36.1% was relatively consistent with the prior year period.
Total funeral same-store gross profit for the nine months ended September 30, 2002 increased $5.0 million or 25.2% from the comparable nine months of 2001 primarily due to the elimination of goodwill amortization which totaled $3.3 million during the nine months ended September 30, 2001. The decrease in commission revenues is due primarily to 2001 nonrecurring commissions on the conversion of trust funded contracts to insurance funded contracts.
Cemetery Segment. The following table sets forth certain information regarding the net revenues, field EBITDA and gross profit of the Company from its cemetery operations for the three and nine months ended September 30, 2001 compared to the three and nine months ended September 30, 2002.
Three months ended September 30, 2001 compared to three months ended September 30, 2002(dollars in thousands)
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Nine months ended September 30, 2001 compared to nine months ended September 30,2002(dollars in thousands)
Cemetery same-store net revenues for the three months ended September 30, 2002 decreased $0.7 million, or 7.9%, over the three months ended September 30, 2002, and cemetery same-store gross profit decreased $0.2 million, or 10.7%, over the comparable three months of 2001. Cemetery revenues have been negatively affected by the weak economy and internal challenges in restaffing the preneed sales group. In particular, we experienced a 2.8% decrease in preneed merchandise and service deliveries, a 6.1% decrease in sales of interment and entombment sites and a 1.9% decrease in income from perpetual care trusts and finance charges which have resulted in a decline in field EBITDA. Total gross margin decreased from 24.6% for the three months ended September 30, 2001 to 24.1% for the three months ended September 30, 2002. Gross margin in the prior year included an employment termination charge of $120,000 and the current year period benefited by the lower bad debt experience.
Cemetery same-store net revenues for the nine months ended September 30, 2002 decreased $1.9 million over the nine months ended September 30, 2002, and cemetery same-store gross profit decreased $0.7 million over the comparable nine months of 2001. Total gross margin decreased slightly from 24.2% for the nine months ended September 30, 2001 to 23.9% for the nine months ended September 30, 2002.
Other. General and administrative expenses for the quarter ended September 30, 2002 increased $1.1 million as compared to the third quarter of 2001. These expenses, as a percentage of net revenues, increased from 6.6% to 10.0% because of a $0.7 million charge related to the termination of an employment agreement with a former officer and $0.5 million in professional fees incurred in connection with changes in tax accounting methods. Excluding these two unusual charges, general and administrative expenses totaled 6.7% of net revenues.
Interest expense and other financing costs for the three months ended September 30, 2002 declined slightly compared to the third quarter of 2001 primarily because average debt outstanding was less than the average debt outstanding in the same period for 2001.
Income Taxes. The following table sets forth the components of the provision (benefit) of income taxes of the Company for the three and nine months ended September 30, 2001 compared to the three and nine months ended September 30, 2002.
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Three months ended September 30, 2001 compared to three months ended September 30, 2002
Nine months ended September 30, 2001 compared to nine months ended September 30,2002
The Company has a net operating loss carryforward for Federal income tax purposes. Because of the ability to use the net operating loss to offset taxable income and the timing of when revenue and expenses are recognized for tax purposes, we do not expect to pay Federal income taxes in 2002 and 2003.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents totaled $3.7 million at September 30, 2002, representing an increase of $1.0 million from December 31, 2001. It is Carriage's practice to maintain low cash balances and to apply available cash against its revolving line of credit, described below, to minimize interest expense. If the Company needs cash for working capital or investment purposes, it can always draw on the line of credit. For the nine months ended September 30, 2002, cash provided by operations was $14.3 million as compared to $21.8 million for the nine months ended September 30, 2001. The higher level of cash provided by operations in the nine months during 2001 was primarily due to $2.2 million in tax refunds received in 2001 and catch-up trust withdrawals in the 2001 period totaling $3.5 million that normally would have been withdrawn during the 2000 year. Cash used in investing activities was $6.8 million for the nine months ended September 30, 2002 compared to cash provided in the amount of $3.8 million for the first nine months of 2001, the change being primarily due to the combination of proceeds from the sale of businesses during the first nine months of 2001 in the amount of $8.4 million and use of cash for an acquisition that closed in the second quarter of 2002 and an earnout related to an acquisition in a prior year totaling $2.2 million in 2002.
The ability to generate free cash flow from operations is particularly important as this measures the cash produced by the businesses which may be used to repay indebtedness or make acquisitions. We define free cash flow from operations as cash flow provided by operations less all capital expenditures. For the nine months ended September 30, 2002, free cash flow provided by operations
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was $9.4 million as compared to $17.2 million for the nine months ended September 30, 2001. Our strong free cash flow from operations is a function of consistently high levels of field EBITDA, improved working capital management, and disciplined spending and capital allocation. Free cash flow generated during the fourth quarter of the year will be dedicated to reducing debt to our goal of $150 million. Uses of free cash flow during the nine months ended September 30, 2002, include the payment of $6.3 million of remaining contingent acquisition obligations, $1.1 million on an acquisition and the reduction of our debt by $1.7 million.
The Company's debt at September 30, 2002 totaled $155.5 million and consisted of $99.3 million in senior debt notes, a $100 million revolving credit facility ($35.0 million outstanding at September 30, 2002) and $21.2 million in acquisition indebtedness and capital lease obligations. The balance sheet category "Assets Held for Sale" is net of debt totaling $1.0 million.
The $99.3 million in senior debt notes are unsecured, mature in tranches of $22.9 million in 2004, $54.1 million in 2006 and $22.3 million in 2008 and bear interest at the fixed rates of 7.73%, 7.96% and 8.06%, respectively.
The Company has a revolving credit facility with a group of banks. The credit facility, maturing in 2004, is unsecured and contains customary restrictive covenants, including a restriction on the payment of dividends on common stock, and requires that we maintain certain financial ratios. Interest under the credit facility is provided at both LIBOR and prime rate options. As of September 30, 2002, the Company's debt to total capitalization was 45.5 percent as compared to 47.8 percent at December 31, 2001. During October 2002, management voluntarily reduced the capacity of the revolving line of credit from $100 million to $75 million to reduce bank fees on a portion that is not expected to be used. With the lower capacity, the Company has $39 million available to draw under the credit facility.
We believe that cash flow from operations and borrowings under the credit facility should be sufficient to fund anticipated capital expenditures as well as other operating requirements. Because future cash flows and the availability of financing are subject to a number of variables, such as the Company's operating performance, timing of debt maturities and the number and size of acquisitions made by the Company, there can be no assurance that the Company's capital resources will be sufficient to fund its capital needs. Additional debt and equity financing may be required in the future. The availability and terms of these capital sources will depend on prevailing market conditions and interest rates and the then-existing financial condition of the Company.
ACCOUNTING CHANGES
In June 2001, the Financial Accounting Standards Board issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141 addresses financial accounting and reporting for goodwill and other intangible assets acquired in a business combination at acquisition. SFAS No. 142 addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. This Statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. The provisions of SFAS No. 141 apply to all business combinations initiated after June 30, 2001. The provisions also apply to all business combinations accounted for using the purchase method for which the date of acquisition is July 1, 2001 or later. The adoption of SFAS No. 141 by the Company had no effect on its consolidated financial statements. The provisions of SFAS No. 142 were required to be applied starting with fiscal years beginning after December 15, 2001. The Company adopted SFAS No. 142 as of the beginning of the first quarter of 2002. The effect of SFAS No. 142 on the Company is the elimination of the amortization of goodwill, which prior to 2002 was amortized over 40 years, and the testing for impairment of goodwill on an annual basis. See Note 2 to the Consolidated Financial Statements for proforma disclosure of this accounting change and the change in
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the tax rate discussed in Note 4 on the reported results for 2001. The Company performed a review of goodwill as of January 1, 2002 by comparing the fair value of the Company's reporting units (funeral home businesses by region) to the carrying value of the reporting units, and no impairment was required to be reported at the implementation date of the new accounting standard.
In August 2001 the Financial Accounting Standards Board issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS No. 144 addresses financial accounting and reporting of long-lived assets, other than goodwill, that are to be disposed by sale or otherwise, and is effective for financial statements issued for fiscal years beginning after December 15, 2001. The Company adopted SFAS No. 144 as of the beginning of the first quarter of 2002 which had no effect on the Company's financial position or results of operations.
In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145 ("SFAS No. 145"), "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." Among other provisions, SFAS No. 145 rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt". Accordingly, gains or losses from extinguishment of debt shall not be reported as extraordinary items unless the extinguishment qualifies as an extraordinary item under the criteria of APB No. 30. Gains and losses from extinguishment of debt that do not meet the criteria of APB. No. 30 should be reclassified to income from continuing operations in all prior periods presented. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002.
In July 2002, the FASB issued Statement of Financial Accounting Standards No. 146 ("SFAS No. 146"), "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities. This statement requires that a liability for a cost associated with and exit or disposal activity be recognized when the liability is incurred. Previous guidance, provided under Emerging Issues Task Force ("EITF") No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including certain costs incurred in a restructuring)," required an exit cost liability to be recognized at the date of an entity's commitment to an exit plan. The provisions of this statement are effective for exit or disposal activities that are initiated by a company after December 31, 2002.
SEASONALITY
The Company's business can be affected by seasonal fluctuations in the death rate. Generally, death rates are higher during the winter months.
INFLATION
Inflation has not had a significant impact on the results of operations of the Company.
Item 3. Quantitative and Qualitative Disclosures of Market Risk
There has been no material change in the Company's position regarding quantitative and qualitative disclosures of market risk from that disclosed in the Company's 2001 Form 10-K.
Item 4. Controls and Procedures
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PART II—OTHER INFORMATION
Item 1. Legal Proceedings
The Company and its subsidiaries are parties to a number of legal proceedings that arise from time to time in the ordinary course of business. While the outcome of these proceedings cannot be predicted with certainty, we do not expect these matters to have a material adverse effect.
We carry insurance with coverages and coverage limits that we believe to be customary in the funeral home and cemetery industries. Although there can be no assurance that such insurance will be sufficient to protect against all contingencies, we believe that our insurance protection is reasonable in view of the nature and scope of our operations.
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
Item 4. Submission to Matters to A Vote of Security Holders
None.
Item 5. Other Information
Forward-Looking Statements
In addition to historical information, this Quarterly Report contains forward-looking statements made by the management of Carriage Services, Inc. (the "Company" or "Carriage"). Such statements are typically identified by terms expressing future expectations or goals. These forward-looking statements, although made in good faith, are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in these forward-looking statements. Factors that might cause such a difference include Carriage's inability to sell businesses and properties held for sale for their carrying value, to maintain or increase free cash flow from operations, or to achieve internal growth from our businesses; adverse changes in economic and financial market conditions, including declining stock prices, increasing interest rates, and restricted credit availability; lower death rates; changing consumer preferences; competition in our markets; Carriage's inability to maintain operating ratios within the limits set forth within our financing arrangements; and changes in government regulation of the death care industry. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's opinions only as of the date hereof. We undertake no obligation to revise or publicly release the results of any revision of these forward-looking statements. Readers should carefully review the Cautionary Statements described in this and other documents we file from time to time with the Securities and Exchange Commission, including Annual Reports on Form 10-K and Current Reports on Form 8-K filed by Carriage throughout 2002.
Cautionary Statements
The Company cautions readers that the following important factors, among others, in some cases have affected, and in the future could affect, the Company's actual consolidated results and could cause the Company's actual consolidated results in the future to differ materially from the goals and expectations expressed herein and in any other forward-looking statements made by or on behalf of the Company.
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(1) Maintaining or achieving growth in free cash flow from operations depends primarily on achieving anticipated levels of earnings before depreciation, amortization and other non-cash charges, maintaining the amount of expected cash income taxes payable, controlling capital expenditures to budgeted levels, collecting accounts receivable and managing preneed sales origination costs to current or lower levels.
(2) Achieving the Company's revenue goals also is affected by the volume and prices of the products and services sold, as well as the mix of products and services sold. The annual sales targets set by the Company are believed to be achievable, but the inability of the Company to achieve planned volume or prices could cause the Company not to meet anticipated levels of revenue. In certain markets the Company expects to increase prices, but in certain markets prices could be lowered to protect market share. The ability of the Company to achieve volume or price targets at any location depends on numerous factors, including the capabilities of the local operating staff, the local economy, the local death rate, competition and changes in consumer preferences, including cremation.
(3) Revenue also is affected by the level of preneed sales in both current and prior periods. The level of preneed sales may be adversely affected by numerous factors, including deterioration in the economy, which causes individuals to have less discretionary income, changes in consumer spending preferences, as well as changes in marketing approach, commission practices and contractual terms.
(4) In addition to the factors discussed above, financial performance may be affected by other important factors, including the following:
The Company also cautions readers that it assumes no obligation to update or publicly release any revisions to forward-looking statements made herein or any other forward-looking statements made by, or on behalf of, the Company.
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ITEM 6. Exhibits and Reports on Form 8-K
A report on Form 8-K was filed with the SEC on July 24, 2002 in connection with the resignation of Thomas C. Livengood and certain other matters.
A report on Form 8-K was filed with the SEC on August 14, 2002 in connection with furnishing to the SEC the certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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CERTIFICATIONS
I, Melvin C. Payne, certify that:
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I, Joseph Saporito, certify that:
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