UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

þ		Annual Report Pursuant To Section 13 Or 15(d) Of The Securities Exchange Act Of 1934

For The Fiscal Year Ended December 31, 2005

o		Transition Report Pursuant To Section 13 Or 15(d) Of The Securities Exchange Act Of 1934

CARRIAGE SERVICES, INC.

Delaware		76-0423828
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
3040 Post Oak Blvd., Suite 300, Houston, TX		77056
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (713) 332-8400

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Common Stock, $.01 Par Value		New York Stock Exchange
Series G Preferred Stock Purchase Rights		New York Stock Exchange
(Title Of Class)		(Name of Exchange on which registered)

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
None

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Exchange Act of 1933.
Yes o No þ

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
Yes o No þ

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 þ No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes þ No o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer as defined in Rule 12b-2 of the Securities Exchange Act of 1934. o Large accelerated filer þ Accelerated filer o Non-Accelerated filer

Indicate by check mark whether the registrant is a shell company as defined by Rule 12b-2 of the Securities Exchange Act of 1934. Yes o No þ

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2005 was approximately $98.1 million based on the closing price of $6.05 per share on the New York Stock Exchange.

The number of shares of the registrant’s Common Stock, $.01 par value per share outstanding as of February 28, 2006 was 18,485,250.

Portions of the definitive proxy statement to be delivered in connection with the 2006 annual meeting of stockholders are incorporated in Part III of this Report.

 

 

CAUTIONARY NOTE

     This annual report contains forward-looking statements of our management regarding factors that we believe may affect our performance in the future. Such statements typically are identified by terms expressing our future expectations or projections of revenues, earnings, earnings per share, cash flow, market share, capital expenditures, effects of operating initiatives, gross profit margin, debt levels, interest costs, tax benefits and other financial items. All forward-looking statements, although made in good faith, are based on assumptions about future events and are therefore inherently uncertain, and actual results may differ materially from those expected or projected. Important factors that may cause our actual results to differ materially from expectations or projections include those described under the heading “Forward-Looking Statements” in Item 7. Forward-looking statements speak only as of the date of this report, and we undertake no obligation to update or revise such statements to reflect new circumstances or unanticipated events as they occur.

PART I

ITEM 1. BUSINESS

GENERAL

     We are a leading provider of death care services and merchandise in the United States. We operate two types of businesses: funeral homes, which currently account for approximately 75% of our total revenue, and cemeteries, which currently account for approximately 25% of our total revenue. As of December 31, 2005, we operated 133 funeral homes in 28 states and 29 cemeteries in 12 states. We primarily serve suburban markets and believe we are a market leader (first or second) in most of those markets. We provide funeral and cemetery services and products on both an “at-need” (time of death) and “preneed” (planned prior to death) basis.

     Our operations are divided into two business segments:

•

Funeral Home Operations. Funeral homes are principally service businesses that provide burial and cremation services and sell related merchandise, such as caskets and urns. Given the high fixed cost structure associated with funeral home operations, we believe the following are key factors affecting our profitability:

	•		favorable demographic trends in terms of 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 packaging complementary services and merchandise;
	•		controlling salary and merchandise costs; and
	•		exercising pricing leverage related to our at-need business to increase average revenues per contract.

•

Cemetery Operations. Cemeteries are primarily a sales business that provides interment rights (grave sites and mausoleums) and related merchandise, such as markers and memorials. Our cemetery operating results are impacted by the success of our sales organization because approximately 37% of our cemetery revenues during the year ended December 31, 2005 was generated from preneed sales of interment rights. We believe that changes in the level of consumer confidence (a measure of whether consumers will spend money on discretionary items) also impact the amount of such preneed sales. Cemetery revenues generated from at-need service and merchandise sales generally are subject to many of the same key profitability factors as in our funeral home business. Approximately 10% of our cemetery revenues during the year ended December 31, 2005 was attributable to investment earnings on trust funds and finance charges on installment contracts.

     Our business strategy is based on strong, local leadership and entrepreneurial principles that we believe drive market share, revenue growth, and profitability in our local markets. We implemented our new funeral operating model, called “Being the Best,” at the beginning of 2004. The standards based model emphasizes growing market share and improving long-term profitability by employing leadership and entrepreneurial principles that fit the nature of our local, personal service, high value business. This new model also requires our local and corporate leaders to change our focus from short-term profitability to the drivers of success that create long-term profitability and value for our shareholders. Our operating model emphasizes:

•

decentralized management of our local businesses;

	•		financial and operational standards based upon drivers of success of our best businesses;
	•		variable compensation that rewards our managers as if they are owners;
	•		finding, developing and retaining the best people in our industry; and
	•		information technology designed to support local business and corporate management decisions, measure performance of our businesses against our financial and operational standards, and ensure adherence to established internal control procedures.

     We believe we were successful in achieving our near-term goals in 2005 as evidenced by:

	•		increasing revenues and gross profit our funeral home businesses as a result of our new operating model;
	•		improving our credit profile with the $130 million senior debt offering in January 2005; and
	•		acquiring a funeral home business that met our profile.

     Our near-term objectives for 2006 and 2007 include:

	•		continuing to improve our operating and financial performance by executing our “Being the Best” funeral and cemetery operating models;
	•		increasing our profitability and cash flow;
	•		executing a disciplined acquisition program of funeral businesses that match a profile based on our Being the Best standards.

     Our longer-term objectives over the next five years include:

	•		continuous improvement and portfolio optimization driven by our Being the Best operating model;
	•		increasing market share and profitability;
	•		formalizing and fully implementing a disciplined acquisition program; and
	•		raising equity proceeds to enhance our capital structure and support our growth strategy as appropriate opportunities arise.

DEATH CARE INDUSTRY

     Death care companies provide products and services to families in three principal areas: (i) ceremony and tribute, generally in the form of a funeral or memorial service; (ii) disposition of remains, either through burial or cremation; and (iii) memorialization, generally through monuments, markers or inscriptions. The death care industry in the United States is characterized by the following fundamental attributes (the statistics included in this report are based on public reports from financial research firms or public websites):

Death Rates

     Death rates in the United States have been relatively stable on a long-term historical basis. The number of deaths in the United States increased at an annual rate of approximately 1% for the period from 1980 to 2000. From 2001 to 2003, death rates deviated from this long-term trend by declining year-over-year for a three-year period, which is the first time year-over-year declines occurred since the mid-1970s. We understand that the death rate for 2005 increased 0.2 percent compared to 2004 and increased 0.3 percent from 2003 to 2004. The number of deaths per year in the United States is expected to increase from approximately 2.5 million in 2005 to 2.6 million in 2010 according to the United States Bureau of the Census. In addition, the segment of the United States population over 65 years of age is expected to increase by over 13% from approximately 34.9 million in 2000 to 39.6 million in 2010.

Cremation

     In recent years, there has been a steady, gradual increase in the number of families in the United States that have chosen cremation as an alternative to traditional methods of burial. According to industry studies, cremations represented approximately 10% of the U.S. burial market in 1980 and approximately 28% in 2003. Cremation rates can vary significantly based upon geographic, religious

and cultural traditions. Historically, direct cremation has been offered as a less costly alternative to a traditional burial. However, cremation is being increasingly accepted as part of a package of funeral services that includes memorials, merchandise and options for the interment of remains.

Highly Fragmented Ownership

     We estimate that there are approximately 22,000 funeral homes and 10,000 cemeteries in the United States and that the domestic funeral service industry generates approximately $15 billion of revenue annually. The four largest public operators of both funeral homes and cemeteries in the United States are Service Corporation International, Alderwoods Group, Stewart Enterprises, and Carriage Services. We believe these four companies collectively represent approximately 20% of death care revenues in the United States. Independent businesses represent the remaining amount of industry revenue, accounting for an estimated 80% share. During most of the 1990s, there was a trend toward independent firms consolidating with public operators. However, few acquisitions have occurred since 1999 and there have been a number of independent entrants in local markets. As a result, the industry continues to be characterized by a large number of locally-owned, independent businesses.

Heritage and Tradition

     Death care businesses have traditionally been family-owned businesses that have built a local heritage and tradition through successive generations, providing a foundation for ongoing business opportunities from established client family relationships and related referrals. Given the sensitive nature of our business, we believe that relationships fostered at the local level build trust in the community and are a key driver of market share. While new entrants may enter any given market, the time and resources required to develop local heritage and tradition serve as important barriers to entry.

Deleveraging

     Until 1999, the industry experienced consolidation of independent death care businesses by a few large, primarily publicly owned death care consolidators that sought to benefit from economies of scale, improved managerial control, more effective operating strategies and greater financial resources. From 2000 to 2005, these consolidators have been divesting selected properties and other assets, and using proceeds from such dispositions, together with cash flow, to accelerate debt reduction and build cash blances. We expect the level of dispositions to substantially decline.

Preneed Marketing

     In addition to at-need sales, we and certain other death care providers sell products and services on a preneed basis. Selling products and services on a preneed basis, if properly executed, provides a backlog of future revenue and enhances the heritage and market share of an established funeral home or cemetery. However, most of our preneed sales lock in the revenue from future services at current prices and result in paying certain costs, such as sales commissions, at the time the preneed contract is originated.

BUSINESS STRATEGY

Implement Operating Initiatives

     During the last five years, we and the other public consolidators have been restructuring our organizations and improving our financial condition, liquidity and cash flow. On January 1, 2004, we introduced our “Being the Best” standards, a more decentralized and entrepreneurial financial operating model for our funeral homes. On January 1, 2006 we implemented a similar model to our cemetery business. We believe the execution of our Being the Best standards-based funeral operating model has resulted in operational improvements in our funeral segment. Those operational improvements include, among other things, improved showroom presentation and merchandising, achievement of higher prices per service and improved staffing and cost management. Key elements of our overall business strategy include the following:

—

Decentralized Funeral Operating Model. We believe that a decentralized operating model is best suited to grow market share and improve financial performance in the funeral industry. This new operating model focuses on key drivers of a successful funeral business, organized around three primary areas — market share, people, and operational and financial metrics. Successful execution of our new operating model is highly dependent on strong local leadership, entrepreneurial empowerment and corporate support. In order to align this model with financial performance across the organization, we developed a set of customized standards for each funeral business based on the financial results and attributes of our best properties, adjusting for size and percentage of cremations. Our managing partners participate in a variable bonus plan in which they earn a percentage of their business’ earnings based upon the actual standards achieved. Under this new program, we believe our managing partners have the opportunity to be compensated at close to the same level as if they owned the business.

	—		Decentralized Cemetery Operating Model. We also believe that a decentralized operating model is best suited to grow market share and improve financial performance in the cemetery industry. This new operating model focuses on key drivers of a successful cemetery business, similarly organized around three primary areas — market share, people, and operational and financial metrics. A principal initiative is to emphasize property sales, which strengthen the ties between our cemeteries and these clients. Successful execution of our new operating model is highly dependent on strong local leadership, entrepreneurial empowerment and corporate support. In order to align this model with financial performance across the organization, we developed a set of standards for all of our cemeteries based on the financial results and attributes of the best of these businesses. Our managing partners participate in a variable bonus plan in which they earn a percentage of their business’ earnings based upon the actual standards achieved. Under this new program, we believe our managing partners have the opportunity to be compensated at close to the same level as if they owned the business.
	—		Presentation and Packaging of Services and Merchandise. We believe packaging funeral services and merchandise offers both simplicity and convenience for our client families. Well-conceived and thoughtful packages eliminate much of the effort and discomfort experienced by client families concerning matters about which they do not have much knowledge during a very stressful and emotional time. We have entered into updated arrangements with four primary casket suppliers to support our strategy and control wholesale costs. We also anticipate that our packaging strategy will result in increased revenue per cremation service over time as more families select packages that provide services and merchandise. The percentages of funeral services conducted by us in which cremation was chosen as the manner in which to dispose of remains was 31% for the year ended December 31, 2004 and 33% for the year ended December 31, 2005. For the year ended December 31, 2005, approximately 63% of the number of our total cremation services were direct cremations (where no viewing, visitation, or merchandise is involved, although a memorial service may be held) and 37% included additional services and merchandise.
	—		Preneed Funeral Sales Program. We operate under a local, decentralized preneed sales strategy whereby each business location customizes its preneed program to its local needs. We emphasize insurance-funded contracts over trusted contracts in most markets, as insurance products allow us to earn commission income to improve our cash flow and offset a significant amount of the up-front costs associated with preneed sales. In addition, the cash flow and earnings from insurance contracts are more stable than traditional trust fund investments. In markets that depend on preneed sales for market share, we supplement the arrangements written by funeral directors with sales sourced by sales counselors and third party sellers.
	—		Systems and Support Enhancements. We periodically perform targeted reviews of our systems and support services with the objective of improving effectiveness and streamlining processes. We recently completed an upgrade of our funeral services system to improve its features and functions and implemented a cemetery system during 2005. We will continue to review and change corporate processes to improve efficiency and effectiveness.
	—		Renewed Corporate Development Efforts. We believe that our improved capital structure, resulting in part from the $130 million offering in January 2005 of senior debt due in 2015 and which bears interest at 7.785% per annum, positions us to pursue a strategy of disciplined growth, affording us the flexibility to redeploy our cash flow toward selective acquisitions that meet our criteria. We expect to continue to improve our credit profile as we invest our cash flow into businesses that will contribute incremental revenues, earnings and cash flow. We will be applying the standards and practices established under our Being the Best operating model to qualify acquisition candidates, ensuring that they are a proper fit and can be readily integrated into our portfolio. Ideal candidates would be those that are demonstrated market leaders, have strong local management, have owners and family members whose objectives are aligned with ours, and have field-level operating margins consistent with our best performing properties. We will look to geographic areas that complement our existing markets, with a primary focus on suburban markets with growing populations of 100,000 or more, preferably in the Northeast and on the West Coast. We expect to give the most serious consideration to firms with at least 300 calls annually (or at least $1.5 million in annual revenue).

OUR STRENGTHS

     Market Leader in Our Suburban and Rural Markets. We are the fourth largest publicly traded death care company in the United States. Our operations are located in suburban and rural markets, where we primarily compete with smaller, independent operators with significantly less financial and managerial resources. Most of our suburban markets have populations of 100,000 or more. In over 70% of our funeral home markets, we believe that we are either first or second in local market share.

     Partnership Culture. Our funeral homes and cemeteries are managed by individuals with extensive death care experience, often within their local markets. Our funeral home managing partners have responsibility for day-to-day operations but are required to follow our Being the Best operating and financial standards. This strategy allows each local business to maintain its unique identity within its local market and to capitalize on its reputation and heritage while our senior management maintains supervisory controls and provides support services from our corporate headquarters. We believe our culture will be very attractive to owners of premier

independent businesses that fit our profile of suitable acquisition candidates.

     Flexible Capital Structure. In January 2005, we met our goal of reaccessing the capital markets by completing our $130 million senior debt offering. We used the net proceeds to pay off the existing senior debt that had near term maturities and accrued interest on our TIDES (described below). This transaction eliminated all near-term debt maturity issues. We believe that our capital structure provides us with financial flexibility, which allows us to focus our efforts on improving operations and growing the Company. After completion of the offering, we have four primary components in our capital structure:

	•		the $130 million senior notes issued in January 2005 which have a 2015 maturity;
	•		a revolving credit facility, described under the heading “Liquidity and Capital Resources” in Item 7;
	•		our convertible junior subordinated debenture payable to our affiliate trust, which has the ability to defer payments of interest, and a 2029 maturity (our TIDES); and
	•		our common stock.

     Stable Cash Flow. Since 2000, we have demonstrated the ability to generate stable cash flow. Prior to 2005, our primary use of cash flow was to repay debt. We have also demonstrated an ability to manage capital expenditures to a consistent level. Adjusted cash flow (cash flow from operations less special charges and capital expenditures) for 2005 totaled $9.7 million. We intend to use cash flow to fund a selective growth strategy. Our growth strategy is the primary way we expect to increase shareholder value, which means that we need to achieve a much higher return on invested capital during this growth cycle compared to the 90’s cycle. We will reassess our capital allocation strategy annually, but at this point we believe that our financial goals will best be achieved by continuing to improve the operating and financial performance of our existing portfolio while selectively making new acquisitions.

     Strong Field-Level Operating Margins. We believe that our field-level operating margins are among the highest reported by the public companies in the death care industry and that this performance is a testament to the success of our business strategies. These strong margins and the ability to control costs are important advantages in a business such as ours that is characterized by a high fixed-cost structure. We will continue to seek ways to improve our financial performance, and we believe that our standards-based operating model implemented at the beginning of 2005 will continue to yield positive improvement in our financial results.

     Effective Management of Funeral Preneed Sales. We believe our local, decentralized strategy allows us to adapt our preneed sales selectively to best address the competitive situation in our markets. In highly competitive markets, we execute a more aggressive preneed sales program. In less competitive markets where we have a strong market position, we deploy a more passive preneed sales program. In certain of our markets, we do not deploy a formal preneed program. This approach allows us to target the investment in preneed sales to markets where we have the opportunity to reinforce our market share. Because approximately 80% of our revenues are generated from at-need sales, we retain significant pricing leverage in our funeral business.

     Integrated Information Systems. We have implemented information systems to support local business decisions and to monitor performance of our businesses compared to financial and performance standards. All of our funeral homes and cemeteries are connected to our corporate headquarters, which allows us to monitor and assess critical operating and financial data in order to analyze the performance of individual locations on a timely basis. Furthermore, our information system infrastructure provides senior management with a critical tool for monitoring and adhering to our established internal controls, which is critical given our decentralized model and the sensitive nature of our business operations.

     Proven Management Team. Our management team, headed by Company founder Mel Payne, is characterized by a dynamic culture that reacts quickly and proactively to address changing market conditions and emerging trends. We believe this culture has been critical to our successful recent efforts and will provide an important advantage as the death care industry evolves. We are committed to continue operating an efficient corporate organization and strengthening our corporate and local business leadership. We believe that our Being the Best operating model will ensure this commitment at all levels of the organization. At year-end 2005 we reorganized our funeral and cemetery divisions into four Regions, each headed by a Regional Partner. This change should engender more cooperation and synergy between our funeral and cemetery operations and support the goal of market-share and volume growth in our most significant markets. The four Regional Partners will report to Mel Payne in the role of Chief Operating Officer.

OPERATIONS

     We conduct our funeral and cemetery operations only in the United States. Our operations are divided into two segments: funeral operations and cemetery operations. Information for each of our segments is presented below and in our financial statements set forth herein.

Funeral Home Operations

     At December 31, 2005, we operated 133 funeral homes in 28 states. Funeral home revenues currently account for approximately 75% of our total revenues. The funeral home operations are managed by a team of experienced death care industry professionals and selected region-level individuals with substantial management experience in service industries. See Note 20 to the Consolidated Financial Statements for the year ended December 31, 2005, for segment data related to funeral home operations.

     Our funeral homes offer a complete range of services to meet a family’s funeral needs, including consultation, the removal and preparation of remains, the sale of caskets and related funeral merchandise, the use of funeral home facilities for visitation and worship, and transportation services. Most of our funeral homes have a non-denominational chapel on the premises, which permits family visitation and religious services to take place at one location and thereby reduces our transportation costs and inconvenience to the family.

     Funeral homes are principally a service business that provides burial and cremation services and sells related merchandise, such as caskets and urns. Given the high fixed cost structure associated with funeral home operations, we believe the following are key factors affecting our profitability:

	—		favorable demographic trends in terms of population growth and average age, which impact death rates and number of deaths;
	—		leading market share positions supported by strong local heritage and relationships;
	—		effectively responding to increasing cremation trends by packaging complementary services and merchandise;
	—		controlling salary and merchandise costs; and
	—		exercising pricing leverage related to our at-need business to increase average revenues per contract.

Cemetery Operations

     As of December 31, 2005, we operated 29 cemeteries in 12 states. The cemetery operations are managed by a team of experienced death care industry and sales professionals. Cemetery revenues currently account for approximately 25% of our total revenues. See Note 20 to the Consolidated Financial Statements for the year ended December 31, 2005, for segment data related to cemetery operations.

     Our cemetery products and services include interment services, the rights to interment in cemetery sites (including grave sites, mausoleum crypts and niches) and related cemetery merchandise such as memorials and vaults. Cemetery operations generate revenues through sales of interment rights and memorials, installation fees, fees for interment and cremation services, finance charges from installment sales contracts and investment income from preneed cemetery merchandise and perpetual care trusts.

     Our cemetery operating results are impacted by the success of our sales organization because approximately 37% of our cemetery revenues was generated from preneed sales of interment rights during the year ended December 31, 2005. An additional 19% of our 2005 cemetery revenues was from deliveries of merchandise and services previously sold on preneed contracts. We believe that changes in the level of consumer confidence (a measure of whether consumers will spend money on discretionary items) also impact the amount of such preneed sales. Cemetery revenues generated from at-need services and merchandise sales generally are subject to many of the same key profitability factors as in our funeral home business. Approximately 10% of our cemetery revenues was attributable to investment earnings on trust funds and finance charges on installment contracts during the year ended December 31, 2005.

Preneed Programs

     In addition to sales of funeral merchandise and services, cemetery interment rights and cemetery merchandise and services at the time of need, we also market funeral and cemetery services and products on a preneed basis. Preneed funeral or cemetery contracts enable families to establish, in advance, the type of service to be performed, the products to be used and the cost of such products and services. Preneed contracts permit families to eliminate issues of making death care plans at the time of need and allow input from other family members before the death occurs.

     Preneed funeral contracts are usually paid on an installment basis. The performance of preneed funeral contracts is usually secured by placing the funds collected in trust for the benefit of the customer or by the purchase of a life insurance policy, the proceeds of which will pay for such services at the time of need. Insurance policies, intended to fund preneed funeral contracts, cover

the original contract price and generally include an element of growth (earnings) designed to offset future inflationary cost increases. Revenue from preneed funeral contracts, along with accumulated earnings, are not recognized until the time the funeral service is performed. The commission income is recognized as revenue when the period of refund expires (generally one year), which helps us defray the costs we incur to originate the preneed contract (primarily commissions we pay to our sales counselors). Additionally, we generally earn a commission from the insurance company from the sale of insurance-funded policies. Prior to 2005, the direct marketing commissions and costs incurred from the sale of preneed funeral contracts were deferred and amortized on an actuarial method to match the expected maturity of the preneed contracts. Effective January 1, 2005, the Company changed its method for accounting for deferred obtaining costs and began expensing all costs as incurred. See Note 3 to the Consolidated Financial Statements for the year ended December 31, 2005, for more detailed discussion of the Company’s accounting change.

     In addition to preneed funeral contracts, we also offer “preplanned” funeral arrangements whereby a client determines in advance substantially all of the details of a funeral service without any financial commitment or other obligation on the part of the client until the actual time of need. Preplanned funeral arrangements permit a family to avoid issues of making death care plans at the time of need and enable a funeral home to establish relationships with a client that may eventually lead to an at-need sale.

     Preneed sales of cemetery interment rights are usually financed through interest-bearing installment sales contracts, generally with terms of up to five years. In substantially all cases, we receive an initial down payment at the time the contract is signed. The interest rates generally range between 12% and 14%. Preneed sales of cemetery interment rights are generally recorded as revenue when 10% of the contract amount related to the interment right has been collected. Merchandise and services may similarly be sold on an installment basis, but revenue is recorded when delivery has occurred. Allowances for customer cancellations and refunds are recorded at the date that the contract is executed and periodically evaluated thereafter based upon historical experience.

     Carriage sold 4,936 and 4,877 preneed funeral contracts during the years ended December 31, 2004 and 2005, respectively. At December 31, 2005, we had a backlog of 58,531 preneed funeral contracts to be delivered in the future. Approximately 20% of the funeral revenues recognized during each of the last three years and during the twelve months ended December 31, 2005 originated through preneed contracts. Cemetery revenues that originated from preneed contracts represented approximately 50% and 55% of Carriage’s net cemetery revenues for both 2004 and 2005, respectively.

     As of December 31, 2005, we employed a staff of 220 advance-planning and family service representatives for the sale of preneed products and services.

TRUST FUNDS AND INSURANCE CONTRACTS

     We have established a variety of trusts in connection with our funeral home and cemetery operations as required under applicable state law. Such trusts include (i) preneed funeral trusts; (ii) preneed cemetery merchandise and service trusts; and (iii) perpetual care trusts. These trusts are typically administered by independent financial institutions selected by us. We also use independent financial advisors for investment management and advisory services.

     Preneed funeral sales generally require deposits to a trust or purchase of a third-party insurance product. The trust fund income earned and any increase in insurance benefits are deferred until the service is performed, in order to offset possible inflation in cost when providing the service in the future. The trust funds and deferred revenue are reflected on Carriage’s balance sheet. In most states, we are not permitted to withdraw principal or investment income from such trusts until the funeral service is performed. Some states, however, allow for the retention of a percentage (generally 10%) of the receipts to offset any administrative and selling expenses, which we defer until the service is provided. The aggregate balance of our preneed funeral contracts held in trust, insurance contracts and receivables from customers was approximately $272.3 million as of December 31, 2005.

     We are generally required under applicable state laws to deposit a specified amount (which varies from state to state, generally 50% to 100% of selling price) into a merchandise and service trust fund for cemetery merchandise and services preneed sales. The related trust fund income earned is recognized when the related merchandise and services are delivered. We are generally permitted to withdraw the trust principal and the accrued income when the merchandise is purchased, when service is provided by us or when the contract is cancelled. The merchandise and service trust fund balances, in the aggregate, totaled approximately $54.8 million as of December 31, 2005.

     In most states, regulations require a portion (generally 10%) of the sale amount of cemetery property and memorials to be placed in a perpetual care trust. The income from these perpetual care trusts provides the funds necessary to maintain cemetery property and memorials in perpetuity. The trust fund income is recognized, as earned, in cemetery revenues. While we are entitled to withdraw the income from our perpetual care trust to provide for the maintenance of the cemetery property and memorials, we are not entitled to withdraw any of the principal balance of the trust fund. The perpetual care trust balances totaled approximately $32.4 million at December 31, 2005.

     For additional information with respect to our trusts, see Note 6, 7 and 8 to the Consolidated Financial Statements for the year ended December 31, 2005.

COMPETITION

     The operating environment in the death care industry has been highly competitive. Publicly traded companies operating in the United States are Service Corporation International, Alderwoods Group, Stewart Enterprises, Keystone North America and StoneMor Partners. In addition, a number of smaller, non-public companies have been active in acquiring and operating funeral homes and cemeteries.

     Our funeral home and cemetery operations usually face competition in the markets that they serve. Our primary competition in most of our markets is from local independent operators. We have observed an increase in new start-up competition in certain areas of the country, which in any one market may have impacted our profitability because of the high fixed cost nature of funeral homes. Market share for funeral homes and cemeteries is largely a function of reputation and heritage, although competitive pricing, professional service and attractive, well-maintained and conveniently located facilities are also important. Because of the importance of reputation and heritage, market share increases are usually gained over a long period of time. The sale of preneed funeral services and cemetery property has increasingly been used by many companies as a marketing tool to build market share.

     There has been increasing competition from providers specializing in specific services, such as cremations, who offer minimal service and low-end pricing. We also face competition from companies that market products and related information over the Internet and non-traditional casket stores in certain markets. We have experienced relatively limited impact in our specific markets from these competitors to date.

REGULATION

     Our funeral home operations are subject to substantial regulation by the Federal Trade Commission ( the “FTC”), as well as other federal, state and local agencies. Certain regulations contain minimum standards for funeral industry practices, require extensive price and other affirmative disclosures to the customer at the time of sale and impose mandatory itemization requirements for the sale of funeral products and services. The FTC has been reviewing the Trade Rule on Funeral Industry Practices (the “Funeral Rule”), which defines certain acts or practices as unfair or deceptive and contains certain requirements to prevent these acts or practices. At this time, the FTC has not proposed changes to the regulation. We believe we are in substantial compliance with the Funeral Rule.

     We are subject to the requirements of the federal Occupational Safety and Health Act (“OSHA”) and comparable state statutes. The OSHA hazard communication standard, the United States Environmental Protection Agency community right-to-know regulations under Title III of the federal Superfund Amendment and Reauthorization Act and similar state statutes require us to organize information about hazardous materials used or produced in our operations. Certain of this information must be provided to employees, state and local governmental authorities and local citizens.

     Our operations, including our preneed sales activities and the management and administration of preneed trust funds, are also subject to regulation, supervision and licensing under state laws and regulations. We believe that we are in substantial compliance with all such laws and regulations.

     In accordance with the rules of the New York Stock Exchange, we submitted a Section 12(a) CEO Certification in 2005, which was not qualified in any manner. In addition, in accordance with the rules, attached as Exhibits 31.1 and 31.2 are our CEO and CFO certifications as required by Section 302 of the Sarbanes-Oxley Act of 2002.

EMPLOYEES

     As of December 31, 2005, we and our subsidiaries employed 1,781 employees, of whom 935 were full-time and 846 part-time. All of our funeral directors and embalmers possess licenses required by applicable regulatory agencies. We believe that our relationship with our employees is good. Approximately ten of our employees in Nevada have elected to have the local teamsters union represent them in contract negotiations with the Company. To date, the Company has not entered into any contracts with the union.

AVAILABLE INFORMATION

     Our website address is www.carriageservices.com. Available on this website under “Investor Relations-Investor Relations Menu – SEC Filings,” free of charge, are Carriage’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, insider reports on Forms 3, 4 and 5 filed on behalf of directors and officers and amendments to those reports as soon as

reasonably practicable after such materials are electronically filed with or furnished to the United States Securities and Exchange Commission (“SEC”).

     Also posted on our website, and available in print upon request, are charters for the Company’s Audit Committee, Compensation Committee and Corporate Governance Committee. Copies of the Code of Business Conduct and Ethics and the Corporate Governance Guidelines are also posted on the Company’s website under the “Corporate Governance” section. Within the time period required by the SEC and the New York Stock Exchange, Inc., the Company will post on its website any modifications to the Codes and any waivers applicable to senior officers as defined in the applicable Code, as required by the Sarbanes-Oxley Act of 2002.

ITEM 1A. RISK FACTORS

RISKS RELATED TO OUR BUSINESS

Marketing and sales activities by existing and new competitors could cause us to lose market share and lead to lower revenues and margins.

     We face competition in all of our markets. Most of our competitors are independently owned, and some are relatively recent market entrants. Certain of the recent entrants are individuals who were formerly employed by us or by our competitors and have relationships and name recognition within our markets. As a group, independent competitors tend to be aggressive in distinguishing themselves by their independent ownership, and they promote their independence through advertising, direct mailings and personal contact. Increasing pressures from new market entrants and continued advertising and marketing by competitors in local markets could cause us to lose market share and revenues. In addition, competitors may change the types or mix of products or services offered. These changes may attract customers, causing us to lose market share and revenue as well as to incur costs in response to competition to vary the types or mix of products or services offered by us.

Our ability to generate preneed sales depends on a number of factors, including sales incentives and local and general economic conditions.

     Declines in preneed sales would reduce our backlog and revenue and could reduce our future market share. On the other hand, a significant increase in preneed sales can have a negative impact on cash flow as a result of commissions and other costs incurred without corresponding revenues.

     As we have localized our preneed sales strategies, we are continuing to refine the mix of service and product offerings in both our funeral and cemetery segments, including changes in our sales commission and incentive structure. These changes could cause us to experience declines in preneed sales in the short-run. In addition, economic conditions at the local or national level could cause declines in preneed sales either as a result of less discretionary income or lower consumer confidence. Declines in preneed cemetery property sales would reduce current revenue, and declines in other preneed sales would reduce our backlog and future revenue and could reduce future market share.

     Preneed sales of cemetery property and funeral and cemetery merchandise and services are generally cash flow negative initially, primarily due to the commissions paid on the sale, the portion of the sales proceeds required to be placed into trust or escrow and the terms of the particular contract such as the size of the down payment required and the length of the contract. As a result, preneed sales reduce cash flow available for other activities, and, to the extent preneed activities are increased, cash flow will be further reduced.

Price competition could also reduce our market share or cause us to reduce prices to retain or recapture market share, either of which could reduce revenues and margins.

     We have historically experienced price competition primarily from independent funeral home and cemetery operators, and from monument dealers, casket retailers, low-cost funeral providers and other non-traditional providers of services or products. New market entrants tend to attempt to build market share by offering lower cost alternatives. In the past, this price competition has resulted in our losing market share in some markets. In other markets, we have had to reduce prices thereby reducing profit margins in order to retain or recapture market share. Increased price competition in the future could further reduce revenues, profit margins and our backlog.

Our ability to execute our growth strategy is highly dependent upon our ability to successfully identify suitable acquisition candidates and negotiate transactions on favorable terms.

     There has been little acquisition activity by us or the other public companies in the death care industry over the preceding five years, and there is no assurance that we will be able to identify candidates that meet our criteria or that we will be able to reach terms with identified candidates for transactions that are acceptable to us. We intend to apply standards established under our Being the

Best operating model in qualifying acquisition candidates, and there is no assurance that we will be successful in doing so or that we will find attractive candidates that satisfy these standards.

Increased or unanticipated costs, such as insurance, taxes, new computer systems implementations and the cost of complying with Sarbanes-Oxley, may have a negative impact on our earnings and cash flows.

     We have experienced material increases in certain costs during the previous two years, such as documenting and testing our internal controls to comply with Sarbanes-Oxley and implementing computer systems. We will incur costs in these two areas and others in 2006, which costs can only be estimated. These types of cost increases may impair our ability to achieve revenue growth that exceeds our cost increases. Our 2006 plan assumes that we will be successful in increasing revenues at a rate that is greater than the growth in the cost of sales. We can give no assurance that we will be successful in achieving such increases.

Improved performance in our funeral segment is highly dependent upon successful execution of our standards-based Being the Best operating model.

     At the beginning of 2004, we implemented our new standards-based Being the Best operating model to improve and better measure performance in our funeral operations. We developed standards according to nine criteria, each with a different weighting, designed around market share, people, and operational and financial metrics. We also incentivise our location managing partners by giving them the opportunity to earn a fixed percentage of the field-level earnings before interest taxes, depreciation and amortization based upon the number and weighting of the standards achieved. Our expectation is that, over time, the Being the Best operating model will result in our maintaining or improving field-level margins, market share, customer satisfaction and overall financial performance, but there is no assurance that these goals will be met.

Earnings from and principal of trust funds and insurance contracts could be reduced by changes in financial markets and the mix of securities owned.

     Earnings and investment gains and losses on trust funds and insurance contracts are affected by financial market conditions and the mix of fixed-income and equity securities that we choose to maintain in the funds. During 2004 and 2005, we revised the mix of investments within the cemetery trusts according to our new asset allocation model in an effort to increase earnings and lower volatility. We expect to make similar changes in the funeral trusts in 2006. We may not choose the optimal mix for any particular market condition. Declines in earnings from perpetual care trust funds would cause a decline in current revenues, while declines in earnings from other trust funds could cause a decline in future cash flows and revenues.

Covenant restrictions under our debt instruments may limit our flexibility in operating our business.

     The terms of our credit facility and the indenture governing the Senior Notes may limit our ability and the ability of our subsidiaries to, among other things:

	—		incur additional debt;
	—		pay dividends or make distributions or redeem or repurchase stock;
	—		make investments;
	—		grant liens;
	—		make capital expenditures;
	—		enter into transactions with affiliates;
	—		enter into sale-leaseback transactions;
	—		sell assets; and
	—		acquire the assets of, or merge or consolidate with, other companies.

     Our credit facility also requires us to maintain certain financial ratios. Complying with these restrictive covenants and financial ratios, as well as those that may be contained in any future debt agreements, may impair our ability to finance our future operations or capital needs or to take advantage of other favorable business opportunities. Our ability to comply with these restrictive covenants and financial ratios will depend on our future performance, which may be affected by events beyond our control. Our failure to

comply with any of these covenants or restrictions when they apply will result in a default under the particular debt instrument, which could permit acceleration of the debt under that instrument and, in some cases, the acceleration of debt under other instruments that contain cross-default or cross-acceleration provisions. In the event of an event of default, or in the event of a cross-default or cross-acceleration, we may not have sufficient funds available to make the required payments under our debt instruments. If we are unable to repay amounts owed under the terms of our amended senior secured credit facility, the lenders thereunder may be entitled to sell certain of our funeral assets to satisfy our obligations under the agreement.

RISKS RELATED TO THE DEATH CARE INDUSTRY

Declines in the number of deaths in our markets can cause a decrease in revenues. Changes in the number of deaths are not predictable from market to market or over the short term.

     Declines in the number of deaths could cause at-need sales of funeral and cemetery services, property and merchandise to decline, which could decrease revenues. Although the United States Bureau of the Census estimates that the number of deaths in the United States will increase through 2010, longer life spans could reduce the rate of deaths. In addition, changes in the number of deaths can vary among local markets and from quarter to quarter, and variations in the number of deaths in our markets or from quarter to quarter are not predictable. These variations may cause our revenues to fluctuate and our results of operations to lack predictability.

The increasing number of cremations in the United States could cause revenues to decline because we could lose market share to firms specializing in cremations. In addition, direct cremations produce no revenues for cemetery operations and lower funeral revenues.

     Our traditional cemetery and funeral service operations face competition from the increasing number of cremations in the United States. Industry studies indicate that the percentage of cremations has steadily increased and that cremations will represent approximately 35% of the U.S. burial market by the year 2010, compared to approximately 28% in 2003. The trend toward cremation could cause cemeteries and traditional funeral homes to lose market share and revenues to firms specializing in cremations. In addition, direct cremations (with no funeral service, casket, urn, mausoleum niche, columbarium niche or burial) produce no revenues for cemetery operations and lower revenues than traditional funerals and, when delivered at a traditional funeral home, produce lower profit margins as well.

If we are not able to respond effectively to changing consumer preferences, our market share, revenues and profitability could decrease.

     Future market share, revenues and profits will depend in part on our ability to anticipate, identify and respond to changing consumer preferences. During the last five years, we have implemented new product and service strategies based on results of customer surveys that we conduct on a continuous basis. However, we may not correctly anticipate or identify trends in consumer preferences, or we may identify them later than our competitors do. In addition, any strategies we may implement to address these trends may prove incorrect or ineffective.

Because the funeral and cemetery businesses are high fixed-cost businesses, changes in revenue can have a disproportionately large effect on cash flow and profits.

     Companies in the funeral home and cemetery business must incur many of the costs of operating and maintaining facilities, land and equipment regardless of the level of sales in any given period. For example, we must pay salaries, utilities, property taxes and maintenance costs on funeral homes and maintain the grounds of cemeteries regardless of the number of funeral services or interments performed. Because we cannot decrease these costs significantly or rapidly when we experience declines in sales, declines in sales can cause margins, profits and cash flow to decline at a greater rate than the decline in revenues.

Changes or increases in, or failure to comply with, regulations applicable to our business could increase costs or decrease cash flows.

     The death care industry is subject to extensive regulation and licensing requirements under federal, state and local laws. For example, the funeral home industry is regulated by the Federal Trade Commission, which requires funeral homes to take actions designed to protect consumers. State laws impose licensing requirements and regulate preneed sales. Embalming and cremation facilities are subject to stringent environmental and health regulations. Compliance with these regulations is burdensome, and we are always at risk of not complying with the regulations or facing costly and burdensome investigations from regulatory authorities.

     In addition, from time to time, governments and agencies propose to amend or add regulations, which could increase costs or decrease cash flows. For example, federal, state, local and other regulatory agencies have considered and may enact additional

legislation or regulations that could affect the death care industry. Several states and regulatory agencies have considered or are considering regulations that could require more liberal refund and cancellation policies for preneed sales of products and services, limit or eliminate our ability to use surety bonding, increase trust requirements and prohibit the common ownership of funeral homes and cemeteries in the same market. If adopted by the regulatory authorities of the jurisdictions in which we operate, these and other possible proposals could have a material adverse effect on us, our financial condition, our results of operations and our future prospects. For additional information regarding the regulation of the death care industry, see “Business — Regulation”.

ITEM 1B. UNRESOLVED STAFF COMMENTS

     None.

ITEM 2. PROPERTIES

     At December 31, 2005, we operated 133 funeral homes in 28 states and 29 cemeteries in 12 states. Carriage owns the real estate and buildings for 80% of our funeral homes and leases facilities for the remaining 20%. Carriage owns 24 cemeteries and operates five cemeteries under long-term contracts with municipalities and non-profit organizations at December 31, 2005. Ten funeral homes are operated in combination with cemeteries as these locations are physically located on the same property or very close proximity and under same management . The 29 cemeteries operated by Carriage have an inventory of unsold developed lots totaling approximately 115,000 and 106,000 at December 31, 2004 and 2005, respectively. In addition, approximately 609 acres are available for future development. We anticipate having a sufficient inventory of lots to maintain our property sales for the foreseeable future. The specialized nature of our business requires that our facilities be well-maintained. Management believes this standard is met.

     The following table sets forth certain information as of December 31, 2005, regarding Carriage’s properties used by the funeral homes segment and by the cemeteries segment identified by state:

		Number of
		Funeral Homes								Number of Cemeteries
State		Owned				Leased(1)				Owned				Managed
California			16				3				3				0
Connecticut			6				2				0				0
Florida			6				3				6				3
Georgia			3				0				0				0
Idaho			4				1				1				0
Illinois			1				4				1				0
Indiana			2				0				1				0
Iowa			2				0				0				0
Kansas			7				0				0				0
Kentucky			10				3				1				0
Maryland			1				0				0				0
Massachusetts			6				0				0				0
Michigan			4				0				0				0
Missouri			0				1				0				0
Montana			1				0				0				0
Nevada			2				0				2				1
New Jersey			4				1				0				0
New Mexico			1				0				0				0
New York			1				1				0				0
North Carolina			1				2				1				0
Ohio			4				3				0				1
Oklahoma			1				0				1				0
Rhode Island			4				0				0				0
Tennessee			3				0				0				0
Texas			11				0				6				0
Virginia			3				1				1				0
Washington			1				1				0				0
West Virginia			1				1				0				0
Total			106				27				24				5

     Carriage’s corporate headquarters occupy approximately 37,000 square feet of leased office space in Houston, Texas. At December 31, 2005, we operated 560 vehicles, of which 557 are owned and 3 are leased.

ITEM 3. LEGAL PROCEEDINGS

     Carriage and our 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 on the financial statements.

     We carry insurance with coverage and coverage limits consistent with our assessment of risks in our business and of an acceptable level of financial exposure. Although there can be no assurance that such insurance will be sufficient to mitigate all damages, claims or contingencies, we believe that our insurance provides reasonable coverage for known asserted or unasserted claims. In the event the Company sustained a loss from a claim and the insurance carrier disputed coverage or coverage limits, the Company may record a charge in a different period than the recovery, if any, from the insurance carrier.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     None.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

     Carriage’s Common Stock is traded on the New York Stock Exchange under the symbol “CSV”. The following table presents the quarterly high and low sale prices as reported by the New York Stock Exchange:

2005		High				Low
First Quarter		$	5.71			$	4.77
Second Quarter		$	6.30			$	5.20
Third Quarter		$	6.75			$	6.00
Fourth Quarter		$	6.41			$	4.76

2004
First Quarter		$	4.58			$	3.20
Second Quarter		$	4.10			$	3.25
Third Quarter		$	3.64			$	2.99
Fourth Quarter		$	3.75			$	3.13

     As of February 28, 2006, there were 18,485,250 shares of Carriage’s Common Stock outstanding. The Common Stock shares outstanding are held by approximately 300 stockholders of record. Each share is entitled to one vote on matters requiring the vote of stockholders. We believe there are approximately 5,000 beneficial owners of the Common Stock.

     We have never paid a cash dividend on our Common Stock. Carriage currently intends to retain earnings to fund the growth and development of our business. Any future change in our policy will be made at the discretion of our Board of Directors in light of the financial condition, capital requirements, earnings prospects of Carriage and any limitations imposed by lenders or investors, as well as other factors the Board of Directors may deem relevant.

     We have a compensation policy for fees paid to its directors under which our nonemployee directors may choose to receive director compensation fees either in the form of cash or common stock based on the fair market value of our common stock based on the closing price published by the New York Stock Exchange on the date the fees are earned. We issued 13,709 shares of its common stock to the directors who elected to receive their 2005 fees in common stock. No underwriter was used in connection with this issuance. We relied on the Section 4(2) exemption from the registration requirements of the Securities Act of 1993, as amended.

     We did not repurchase any of our equity securities in the fourth quarter of the year ended December 31, 2005.

ITEM 6. SELECTED FINANCIAL DATA

     The following table sets forth selected consolidated financial information for Carriage that has been derived from the audited Consolidated Financial Statements of Carriage as of and for each of the years ended December 31, 2001, 2002, 2003, 2004, and 2005. These historical results are neither indicative of our future performance, nor necessarily comparable as a result of a change in accounting methods discussed below.

     Our historical financial data included in the table below as of and for the year ended December 31, 2001 is derived from our Consolidated Financial Statements audited by Arthur Andersen LLP, independent public accountants, which has ceased operations. The historical financial data included in the table below as of and for the years ended December 31, 2002, 2003, 2004 and 2005 is derived from our Consolidated Financial Statements audited by KPMG LLP, independent registered public accounting firm.

     We adopted FASB Interpretation No. 46, as revised (“FIN 46R”), Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin (ARB) No. 51, as of March 31, 2004. The adoption of FIN 46R resulted in the consolidation of funeral and cemetery merchandise and service, and perpetual care trusts in our consolidated balance sheet at fair value. We do not consolidate certain funeral trusts for which we do not absorb a majority of their expected losses and, therefore, are not considered a primary beneficiary of these funeral trusts under FIN 46R. The adoption of FIN 46R also resulted in the deconsolidation of Carriage Services Capital Trust, the issuer of TIDES preferred securities. Instead, we now report as a liability the junior subordinated debenture payable to the Trust. Amounts and balances prior to March 31, 2004 have not been restated to reflect the adoption of FIN 46R.

     We adopted Statement of Financial Accounting’s Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144) during 2004. The application of that standard resulted in, among other things, the presentation of the revenues and expenses, as well as gains, losses and impairments, from business units sold, discontinued or held for sale in the discontinued operations section of the consolidated statements of operations for all periods presented.

     The Company changed its method of accounting for deferred obtaining costs, which are preneed selling costs incurred for the origination of prearranged funeral and cemetery service and merchandise sales contracts, effective January 1, 2005. The change affects the comparability of the operating results in the following table. Prior to this change, commissions and other direct selling costs related to originating preneed funeral and cemetery service and merchandise sales contracts were deferred and amortized with the objective of recognizing the selling costs in the same period that the related revenue is recognized. Under the new accounting method, the commissions and other direct selling costs, which are current obligations are paid and use operating cash flow, are expensed as incurred. The Company’s results of operations for the year ended December 31, 2005 is reported on the basis of our changed method, but the periods prior to 2005 are reported using the prior accounting method. See Note 3 of Notes to Consolidated Financial Statements for the year ended December 31, 2005.

     You should read this historical financial data together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this report and Carriage’s Consolidated Financial Statements and notes thereto included elsewhere in this report.

						Year ended December 31,
		2001				2002				2003				2004				2005
		(in thousands, except per share and operating data)
INCOME STATEMENT DATA:
Revenues, net:
Funeral		$	119,543			$	114,631			$	112,209			$	112,504							$	116,072
Cemetery			37,245				34,217				34,351				37,390								38,962
Total net revenues			156,788				148,848				146,560				149,894								155,034
Gross profit:
Funeral			30,423				33,250				29,084				29,452								30,410
Cemetery			8,435				8,222				8,521				8,874								6,855
Total gross profit			38,858				41,472				37,605				38,326								37,265
General and administrative expenses			8,698				10,557				10,492				10,665								12,383
Other charges (income)			—				871				432				495								(822	)
Operating income			30,160				30,044				26,681				27,166								25,704
Interest expense			(20,266	)			(19,679	)			(17,900	)			(17,027	)							(18,711	)
Additional interest and other costs of senior debt refinancing			—				—				—				—								(6,933	)
Other income (expense)			—				865				657				940								(73	)
Income (loss) before income taxes			9,894				11,230				9,438				11,079								(13	)
(Provision) benefit for income taxes			(1,979	)			8,475				(3,539	)			(91	)							(32	)
Net income (loss) from continuing operations			7,915				19,705				5,899				10,988								(45	)
Income (loss) from discontinued operations			1,087				573				726				(1,754	)							936
Cumulative effect of the change in accounting, net of taxes			—				—				—				—								(22,756	)
Net income (loss)			9,002				20,278				6,625				9,234								(21,865	)
Preferred stock dividends			37				—				—				—								—
Net income (loss) available to common stockholders		$	8,965			$	20,278			$	6,625			$	9,234							$	(21,865	)
Earnings (loss) per share
Basic:
Continuing operations		$	0.47			$	1.17			$	0.34			$	0.62							$	—
Discontinued operations			0.07				0.03				0.04				(0.10	)							0.05
Cumulative effect of the change in accounting principle			—				—				—				—								(1.24	)
Basic earnings (loss) per share		$	0.54			$	1.20			$	0.38			$	0.52							$	(1.19	)
Diluted:
Continuing operations		$	0.45			$	1.13			$	0.33			$	0.60							$	—
Discontinued operations			0.06				0.03				0.04				(0.09	)							0.05
Cumulative effect of the change in accounting principle			—				—				—				—								(1.24	)
Diluted earnings (loss) per share		$	0.51			$	1.16			$	0.37			$	0.51							$	(1.19	)
Weighted average number of common and common equivalent shares outstanding:
Basic			16,696				16,973				17,444				17,786								18,334
Diluted			17,492				17,433				17,808				18,260								18,334
OPERATING AND FINANCIAL DATA:
Funeral homes at end of period			148				144				139				135								133
Cemeteries at end of period			30				30				30				30								29
Funeral services performed			24,818				23,990				23,323				22,673								22,792
Preneed funeral contracts sold			3,857				5,456				5,174				4,936								4,877
Backlog of preneed funeral contracts			67,099				59,412				59,696				60,309								58,531
Depreciation and amortization		$	15,679			$	9,526			$	9,934			$	10,790							$	9,224
BALANCE SHEET DATA:
Total assets		$	552,167			$	549,948			$	538,917			$	565,156							$	570,640
Working capital (deficit)			(1,006	)			(1,598	)			(14,285	)			4,933								26,915
Long-term debt, net of current maturities			148,508				141,207				105,355				102,714								134,572
Convertible junior subordinated debenture (1)			—				—				—				93,750								93,750
Redeemable convertible preferred stock (TIDES) (1)			90,058				90,193				90,327				—								—
Stockholders’ equity		$	81,578			$	98,091			$	105,930			$	116,438							$	96,374

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

     We operate two types of businesses: funeral homes, which account for approximately 75% of our revenues, and cemeteries, which account for approximately 25% of our revenues. Funeral homes are principally a service business that provide funeral services (burial and cremation) and sell related merchandise, such as caskets and urns. Cemeteries are primarily a sales business that sells interment rights (grave sites and mausoleums) and related merchandise such as markers and memorials. As of December 31, 2005, we operated 133 funeral homes in 28 states and 29 cemeteries in 12 states within the United States. Substantially all administrative activities are conducted in our home office in Houston, Texas.

     Factors affecting our funeral operating results include: demographic trends in terms of 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 packaging complementary services and merchandise; controlling salary and merchandise costs; and exercising pricing leverage related to our at-need business to increase average revenues per contract. In simple terms, volume and price are the two variables that affect funeral revenues. The average revenue per contract is influenced by the mix of traditional and cremation services because our average cremation service revenue is approximately 36% of the average revenue earned from a traditional burial service. Funeral homes have a relatively fixed cost structure. Thus small changes in revenues, up or down, normally cause significant changes to our profitability.

     We implemented several significant long-term initiatives in our funeral operations at the beginning of 2004 designed to improve operating and financial results by growing market share and increasing profitability. We introduced a more decentralized, entrepreneurial and local operating model that included operating and financial standards developed from our best funeral operations, along with an incentive compensation plan to reward business managers for successfully meeting or exceeding the standards. The operating model and standards, which we refer to as “Being the Best,” focus on the key drivers of a successful funeral operation, organized around three primary areas — market share, people and operating and financial metrics. The model and standards are the measures by which we judge the success of each funeral business.

     The cemetery operating results are affected by the size and success of our sales organization because approximately 55% of our cemetery revenues for the year ended December 31, 2005 relate to sales of grave sites and mausoleums and related merchandise and services before the time of need. We believe that changes in the level of consumer confidence (a measure of whether consumers will spend for discretionary items) also affect the amount of cemetery revenues. Approximately 10% of our cemetery revenues for the year ended December 31, 2005 are attributable to investment earnings on trust funds and finance charges on installment contracts. Changes in the capital markets and interest rates affect this component of our cemetery revenues. We are implementing operating and financial standards in our cemetery operations in 2006 similar to the funeral operations discussed above. The standards are organized around market share, people and operational and financial metrics to improve the long-term success of the cemeteries.

     Prior to 2001, we accumulated a large amount of debt and contingent obligations from acquisitions. Our business strategy during the four years ended December 31, 2004 focused on increasing operating cash flow and improving our financial condition by reducing debt to lower our interest expense and improve our credit profile. We have not been actively seeking businesses to acquire; instead we have been focused on selling underperforming businesses and reducing our debt. We have sold 38 funeral homes and 13 cemeteries along with 22 parcels of excess real estate. We have reduced our debt and contingent obligations by approximately $87 million during the period January 1, 2001 through December 31, 2004. During January 2005, we refinanced our senior debt by issuing $130 million of Senior Notes due in 2015. This refinancing represented a milestone. The refinancing was the culmination of the effort to reaccess the capital markets and to extend the maturities of our senior debt and to gain the flexibility to reinvest our cash flow in our core business. We plan to use the net cash proceeds from the offering and our cash flow to grow our Company through selective acquisitions. We ended the year with approximately $25 million in cash and short-term investments, primarily from the proceeds of the Senior Notes and positive cash flow. During September 2005, we acquired a funeral business consisting of two chapels in northern Florida, the first acquisition since 2002.

     We changed our method of accounting for preneed selling costs in 2005 which affects the comparability of the costs and expenses in the results of operations. The cumulative impact of the change was a charge in the amount of $22.8 million, net of tax, equal to $1.24 per diluted share. See the following section, Accounting Method Change, and Note 3 to the Consolidated Financial Statements.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

     The preparation of the Consolidated Financial Statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, we evaluate estimates and judgments, including those

related to revenue recognition, realization of accounts receivable, intangible assets, property and equipment and deferred tax assets. 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 revenues 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 the margins, operating income and net earnings as a percentage of revenues will be sustained consistently from year to year.

     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 accounting principles generally accepted in the United States. Our significant accounting policies are summarized in Note 1 to the Consolidated Financial Statements. 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 generally 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 that the contract is executed. 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 policies. Insurance commissions are recognized as revenues when the commission is no longer subject to refund, which is usually one year after the policy is issued.

     Preneed selling costs consist of sales commissions and other direct related costs of originating preneed sales contracts. Prior to 2005, these costs were deferred and amortized into funeral and cemetery costs and expenses over the period we expect to perform the services or deliver the merchandise covered by the preneed contracts. The periods over which the costs were recognized were based on actuarial statistics for the actual contracts we hold, provided by a third-party administrator. Beginning in 2005, we changed our method of accounting for preneed selling costs. Preneed selling costs are now expensed as incurred.

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 reporting units (aggregated geographically) 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 reporting unit at the Company’s weighted average cost of capital less debt allocable to the reporting unit and by reference to recent sales transactions of similar businesses. 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, which is impacted by long-term interest rates. If impairment is indicated, then an adjustment will be made to reduce the carrying amount of goodwill to fair value.

Income Taxes

     The Company and its subsidiaries file a consolidated U.S. federal income tax return and separate income tax returns in the states in which we operate. 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.” The Company records a valuation allowance to reflect the estimated amount of deferred tax assets for which realization is uncertain. Management reviews the valuation allowance at the end of each quarter and makes adjustments if it is determined that it is more likely than not that the tax benefits will be realized.

Stock Compensation Plans

     The Company has four stock incentive plans under which stock options have been 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 and has adopted the disclosure-only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” and SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” Had the Company accounted for stock options and shares pursuant to its employee stock benefit plans under SFAS No. 123 for the years ended December 31, 2004 and 2005, net income for those periods would have been lower by approximately $0.01 for each period.

     In December 2004, the FASB issued FASB Statement No. 123 (revised 2005), Share-Based Payment, which is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation. Statement 123 (R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash Flows. Statement 123 (R) requires all share-based payments to employees, including grants of employee stock options and the employee stock purchase plan, to be recognized in the income statement based on their fair values and the pro forma disclosure alternative is no longer allowable under Statement 123 (R). The revised standard is effective in the first annual reporting period of the first fiscal year beginning after June 15, 2005. The Company will adopt FAS No. 123R in the first fiscal quarter of its 2006 fiscal year and expects to use the modified prospective application method, which results in no restatement of the Company’s previously issued annual Consolidated Financial Statements. The adoption of FAS No. 123R using the modified prospective applications method is not expected to have a material impact on the consolidated financial position and no impact on cash flows of the Company. The future compensation expense will vary in the future due to changes in the number, value and vesting terms of stock-based instruments granted to employees. Management currently estimates that the adoption of FAS No. 123R will reduce net income in 2006 within a range of $0.1 million to $0.2 million.

     We have also granted restricted stock to certain officers of the Company, which vest over a period of four years. These shares are valued at the dates granted and the value is charged to operations as the shares vest.

Impairment of Long-Lived Assets

     Except as noted for Goodwill, the Company reviews its long-lived assets for impairment when changes in circumstances indicate that the carrying amount of the net asset may not be recoverable in accordance with Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” Assets to be disposed of and assets not expected to provide any future service potential to the Company are recorded at the lower of carrying amount or fair value less estimated cost to sell. The revenues and expenses, as well as gains, losses and impairments, from those assets are reported in the discontinued operations section of the Consolidated Statement of Operations for all periods presented.

Preneed Funeral and Cemetery Trust Funds

     The Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46, as revised, (“FIN 46R”), “Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin (ARB) No. 51.” This interpretation clarifies the circumstances in which certain entities that do not have equity investors with a controlling financial interest must be consolidated by its sponsor. The Company implemented FIN 46R as of March 31, 2004, which resulted, for financial reporting purposes, in the consolidation of the Company’s preneed and perpetual care trust funds. The investments of such trust funds have been reported at market value and the Company’s future obligations to deliver merchandise and services have been reported at estimated settlement amounts. The Company has also recognized the non-controlling financial interests of third parties in the trust funds. There was no cumulative effect of an accounting change recognized by the Company as a result of the implementation of FIN 46R. The implementation of FIN 46R affected certain accounts on the Company’s balance sheet beginning March 31, 2004 as described below; however, it does not affect cash flow, net income or the manner in which we recognize and report revenues.

     Although FIN 46R requires consolidation of preneed and perpetual care trusts, it does not change the legal relationships among the trusts, the Company and its customers. In the case of preneed trusts, the customers are the principal beneficiaries. In the case of perpetual care trusts, the Company does not have a right to access the corpus in the perpetual care trusts. For these reasons, the Company has recognized non-controlling interests in our financial statements to reflect third party interests in these consolidated trust funds.

     Both the preneed trusts and the cemetery perpetual care trusts hold investments in marketable securities which have been classified as available-for-sale. The investments are reported at fair value, with unrealized gains and losses allocated to Non-controlling interests in trust investment in the Company’s consolidated balance sheet. Unrealized gains and losses attributable to the Company, but that have not been earned through the performance of services or delivery of merchandise, are allocated to deferred revenues.

     Also beginning March 31, 2004, the Company began recognizing the income, gains and losses of the preneed trusts and the unrealized income, gains and losses of the cemetery perpetual care trusts. The Company recognizes a corresponding expense equal to the recognized earnings of these trusts attributable to the non-controlling interest holders. When such earnings attributable to the Company have not been earned through the performance of services or delivery of merchandise, the Company will record such earnings as deferred revenue.

     For preneed trusts, the Company recognizes as revenues amounts attributed to the non-controlling interest holders and the Company, including accumulated earnings, when the contracted services have been performed and merchandise delivered. For cemetery perpetual care trusts, the Company recognizes investment earnings in cemetery revenues when such earnings are realized and distributable. Such earnings are intended to defray cemetery maintenance costs incurred by the Company.

Accounting Changes

     The Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting No. 154, “Accounting Changes and Error Corrections” (“FAS No. 154). This statement is a replacement of Accounting Principles Board Opinion No. 20 and FAS No. 3. FAS No. 154 changes the requirements for the accounting for and reporting of a change in accounting principle and error corrections. It establishes, unless impracticable and in the absence of explicit transition requirements, retrospective application as the required method of a change in accounting principle to the newly adopted accounting principle. Also, it establishes guidance for reporting corrections of errors as reporting errors involves adjustments to previously issued financial statements similar to those generally applicable to reporting accounting changes retrospectively. FAS No. 154 also provides guidance for determining and reporting a change when retrospective application is impracticable. FAS No. 154 is effective for accounting changes and corrections of errors made in the fiscal years beginning after December 15, 2005. The Company will adopt the requirements beginning January 1, 2006, which is not expected to have an effect on the Company’s 2005 financial statements.

ACCOUNTING METHOD CHANGE

Preneed Selling Costs

     On June 30, 2005, the Company changed its method of accounting for deferred obtaining costs, which are preneed selling costs incurred, for the origination of prearranged funeral and cemetery service and merchandise sales contracts. Prior to this change, commissions and other direct selling costs related to originating preneed funeral and cemetery service and merchandise sales contracts were deferred and amortized with the objective of recognizing the selling costs in the same period that the related revenue is recognized. Under the prior accounting method, the commissions and other direct selling costs, which are current obligations are paid and use operating cash flow, are not recognized currently in the income statement. The Company believes it is preferable to expense the current obligation for the commissions and other costs rather than defer these costs. The Company also believes the new accounting method improves the comparability of its reported earnings with other public companies in the death care industry. Because the three largest public death care companies now expense selling costs (two of which changed in 2005), investors and other users of the financial information will now be able to more easily compare our financial results to those deathcare companies.

     The Company has applied this change in accounting method effective January 1, 2005. As of January 1, 2005, the Company recorded a cumulative effect of change in accounting method of $35.8 million pretax or $22.8 million after tax (net of income tax benefit of $13.0 million), or $1.24 per diluted share, which represents the cumulative balance of deferred preneed selling costs in the Company’s consolidated balance sheet. Therefore, the Company’s results of operations for the year ended December 31, 2005 is reported on the basis of our changed method. The annual impact on earnings per diluted share is approximately $0.05. The change has no effect on cash flow from operations. Refer to Note 3 to the Consolidated Financial Statements for the year ended December 31, 2005, for the change in accounting method for preneed selling costs and comparison of results as reported in this annual report and under the previous method.

SELECTED INCOME AND OPERATIONAL DATA

     The following table sets forth certain income statement data for Carriage expressed as a percentage of net revenues for the periods presented:

		Year Ended December 31,
		2003				2004				2005
Total revenues			100.0	%			100.0	%			100.0	%
Total gross profit			25.7				25.6				24.0
General and administrative expenses			7.2				7.1				8.0
Operating income			18.2				18.1				16.6
Interest expense			12.2				11.4				12.1

     The following table sets forth the number of funeral homes and cemeteries owned and operated by Carriage for the periods presented:

		Year Ended December 31,
		2003				2004				2005
Funeral homes at beginning of period			144				139				135
Acquisitions			—				—				2
Divestitures, mergers or closures of existing funeral homes			5				4				4
Funeral homes at end of period			139				135				133
Cemeteries at beginning of period			30				30				30
Acquisitions			—				—				—
Divestitures			—				—				1
Cemeteries at end of period			30				30				29

     The following is a discussion of Carriage’s results of operations for 2003, 2004, and 2005. The term “same-store” or “existing operations” refers to funeral homes and cemeteries owned and operated for the entirety of each period being compared.

YEAR ENDED DECEMBER 31, 2005 COMPARED TO YEAR ENDED DECEMBER 31, 2004

     The following is a discussion of the Company’s results of operations for the years ended December 31, 2004 and 2005.

     Net income (loss), which includes the effect of discontinued operations, totaled $(1.19) per diluted share compared to $0.51 per share for 2004. The decrease is primarily attributable to additional interest of $6.9 million, or $0.25 per diluted share, specifically related to the senior debt refinancing and the change in accounting method of $22.8 million, net, equal to $1.24 per diluted share in 2005. Additionally, 2004 benefited from a $4.1 million income tax benefit related to the change in the deferred tax valuation allowance. This added $0.22 per diluted share to 2004’s earnings.

     Funeral Home Segment. The following table sets forth certain information regarding the net revenues and gross profit of the Company from the funeral home operations for the year ended December 31, 2005 compared to the year ended December 31, 2004.

		Year Ended
		December 31,								Change
		2004				2005				Amount				Percent
		(dollars in thousands)
Total same-store revenue		$	110,903			$	113,342			$	2,439				2.2	%
Acquired and closed			282				435				153				54.3	%
Preneed insurance commissions revenue			1,319				2,295				976				74.0	%
Revenues from continuing operations		$	112,504			$	116,072			$	3,568				3.2	%
Revenues from discontinued operations		$	1,972			$	279			$	(1,693	)			(85.9	)%
Total same-store gross profit		$	28,213			$	28,190			$	(23	)			(0.1	)%
Acquired and closed			(80	)			(75	)			5				6.3	%
Preneed insurance commissions revenue			1,319				2,295				976				74.0	%
Gross profit from continuing operations		$	29,452			$	30,410			$	958				3.3	%
Gross profit from discontinued operations		$	208			$	(29	)		$	(237	)			(113.9	)%

     Funeral same-store revenues for the year ended December 31, 2005 increased $2.4 million, or 2.2%, when compared to the year ended December 31, 2004, as we experienced an increase of 1.9% to $4,993 in the average revenue per service and an increase of 58 additional contracts, or 0.3%, for those existing operations. Cremation services represented 32.8% of the number of funeral services during 2005 compared to 31.3% for 2004, and our average revenue per cremation service increased 2.2 percent to $2,434.

     Total funeral same-store gross profit for the year ended December 31, 2005 was essentially flat compared to 2004 and gross profit from continuing operations increased $1.0 million, equal to the $1.0 million increase in preneed insurance commission revenue. Gross profit for the year ended December 31, 2005 was minimally affected by the change in accounting method for preneed selling costs. See Note 3 to the Consolidated Financial Statements for a discussion of the change in accounting method. Funeral costs and expenses increased approximately $2.6 million or 3.1% from 2004. The most significant variance year over year was noncash charge of $0.8 million in 2005 to modify the employee vacation plan.

     Cemetery Segment. The following table sets forth certain information regarding the net revenues and gross profit of the Company from the cemetery operations for the year ended December 31, 2004 compared to the year ended December 31, 2003:

		Year Ended
		December 31,								Change
		2004				2005				Amount				Percent
		(dollars in thousands)
Revenues from continuing operations		$	37,390			$	38,962			$	1,572				4.2	%
Revenues from discontinued operations		$	640			$	443			$	(197	)			(30.8	)%
Gross profit from continuing operations		$	8,874			$	6,855			$	(2,019	)			(22.8	)%
Gross profit from discontinued operations		$	149			$	133			$	(16	)			(10.7	)%

     No cemetery businesses were acquired during the two years; one cemetery, which is included in discontinued operations, was sold during 2005.

     Cemetery revenues from continuing operations for the year ended December 31, 2005 increased $1.6 million, or 4.2%, over the year ended December 31, 2004 as investment income and gains from the perpetual care trust funds contributed $1.1 million to the year over year improvement. Cemetery gross profit from continuing operations decreased $2.0 million, or 22.8%, compared to 2004, substantially due to higher preneed selling costs as a result of the change in accounting method. Gross profit for the year ended December 31, 2005 was reduced by approximately $1.5 million for the change in accounting method for preneed selling costs. See Note 3 to the Consolidated Financial Statements for a discussion of the change in accounting method. Excluding the affect of the change in accounting method for preneed selling costs, gross margin from continuing operations decreased from 18.1% for the year ended December 31, 2004 to 17.6% for the year ended December 31, 2005 due to higher costs of maintaining the facilities and grounds.

     Other. General and administrative expenses increased $1.7 million for the year ended December 31, 2005 primarily because of higher professional and consulting fees related to compliance with the Sarbanes-Oxley Act of 2002 and implementing a new cemetery system.

     Interest expense for the year ended December 31, 2005 increased $1.7 million, or 9.9%, compared to the year ended December 31, 2004. Although debt outstanding has increased by approximately $31 million, or 28.2%, during 2005, we are not reporting a proportional increase in interest expense because the 2004 expense was negatively impacted by higher loan fees and compound interest on the deferred interest on the convertible subordinated debentures.

     Income Taxes. See Note 15 to the Consolidated Financial Statements for a discussion of the income taxes for 2004 and 2005.

YEAR ENDED DECEMBER 31, 2004 COMPARED TO YEAR ENDED DECEMBER 31, 2003

     The following is a discussion of the Company’s results of operations for the years ended December 31, 2003 and 2004.

     Diluted earnings per share from continuing operations for the year ended December 31, 2004 were $0.60. Excluding the reduction in the deferred tax valuation allowance of $4.1 million or $0.22 per diluted share, the 15.2 percent improvement from $0.33 to $0.38 per share was attributable to lower interest expense and improvements in both funeral and cemetery profitability. Net income for 2004, which includes the effect of discontinued operations, totaled $0.51 per diluted share ($0.29 per share excluding the reduction in the deferred tax valuation allowance equal to $0.22 per share) compared to $0.37 per share for 2003. A significant portion of the decrease is attributable to impairment charges before taxes of $ 3.7 million, equal to $ 0.13 per diluted share, net of gains totaling $1.0 million pretax, equal to $0.03 per diluted share, from the sales in 2004 of three funeral home businesses.

     Funeral Home Segment. The following table sets forth certain information regarding the net revenues and gross profit of the Company from the funeral home operations for the year ended December 31, 2004 compared to the year ended December 31, 2003. For purposes of our discussion, the revenue and gross profit of our businesses identified to be sold are included in the same-store classification up to the quarter prior to their sale.

		Year Ended
		December 31,								Change
		2003				2004				Amount				Percent
		(dollars in thousands)
Total same-store revenue		$	111,737			$	112,304			$	567				0.5	%
Less businesses held for sale			(757	)			(807	)			(50	)			*
Preneed insurance commissions revenue			1,608				1,319				(289	)			(18.0	)%
Revenues from continuing operations		$	112,588			$	112,816			$	228				0.2	%
Revenues from discontinued operations		$	3,148			$	1,660			$	(1,488	)			(47.3	)%
Total same-store gross profit		$	27,602			$	28,212			$	610				2.2	%
Less businesses held for sale			(112	)			(102	)			10				*
Preneed insurance commissions revenue			1,608				1,319				(289	)			(18.0	)%
Gross profit from continuing operations		$	29,098			$	29,429			$	331				1.1	%
Gross profit from discontinued operations		$	412			$	263			$	(149	)			(36.2	)%

     Funeral same-store revenues for the year ended December 31, 2004 increased $0.6 million, or 0.5%, when compared to the year ended December 31, 2003, as we experienced an increase of 3.4% to $4,903 in the average revenue per service for those existing operations and the number of services declined by 659, or 2.9%. Cremation services represented 31.9% of the number of funeral services during 2005, compared to 30.7% for 2003.

     Total funeral same-store gross profit for the year ended December 31, 2004 increased $0.6 million, or 2.2% from 2003, as a result of the increase in same-store revenues given the predominately fixed cost structure of our businesses. Funeral costs and expenses remained constant from 2003.

     Cemetery Segment. The following table sets forth certain information regarding the net revenues and gross profit of the Company from the cemetery operations for the year ended December 31, 2004 compared to the year ended December 31, 2003:

		Year Ended
		December 31,								Change
		2003				2004				Amount				Percent
		(dollars in thousands)
Total same-store revenue		$	35,086			$	38,030			$	2,944				8.4	%
Less businesses held for sale			(735	)			(640	)			95				*
Revenues from continuing operations		$	34,351			$	37,390			$	3,039				8.8	%
Revenues from discontinued operations		$	735			$	640			$	(95	)			(12.9	)%
Total same-store gross profit		$	8,791			$	9,023			$	232				2.6	%
Less businesses held for sale			(270	)			(149	)			121				*
Gross profit from continuing operations		$	8,521			$	8,874			$	353				4.1	%
Gross profit from discontinued operations		$	270			$	149			$	(121	)			(44.8	)%

     No cemetery businesses were acquired or sold during the two years; one cemetery was held for sale at the end of 2004.

     Cemetery same-store revenues for the year ended December 31, 2004 increased $2.9 million, or 8.4%, over the year ended December 31, 2003, and cemetery same store gross profit increased $0.2 million, or 2.6%, over 2003. Revenues from preneed interment sales increased $2.6 million. Though the number of interments sold on a preneed basis remained the same, the average price per space increased 15.1%. Continuing gross margin decreased from 24.8% for the year ended December 31, 2003 to 23.7% for the year ended December 31, 2004 due to higher sales discounts, bad debts and facilities and grounds costs. Higher sales discounts on property negatively impacted revenues and gross profit by $0.8 million year-over-year. Bad debts were $1.0 million higher than the prior year and facilities and grounds expenses increased $0.3 million, primarily due to higher property taxes, insurance and utilities.

     Other. General and administrative expenses increased $0.2 million for the year ended December 31, 2004 primarily because 2004 included higher depreciation on computer and software additions during the last 12 months and higher professional fees, a large portion of which related to compliance with the Sarbanes-Oxley Act of 2002.

     Other charges in 2004 consist primarily of a pretax charge of $0.5 million to write off capitalized costs of a cemetery accounting system development project that the Company terminated.

     Included in other income for 2004 are pretax gains totaling $0.9 million from the sales of real estate and other assets.

     Interest expense for the year ended December 31, 2004 declined $0.9 million, or 4.9%, compared to the year ended December 31, 2003. While the debt outstanding has decreased by approximately $25 million, or 19.2%, during 2004, we did not realize a proportional decrease in interest expense because the current year expense was negatively impacted by higher loan fees and compound interest on the deferred interest on the convertible subordinated debenture.

     Income Taxes. The Company recorded income taxes for continuing operations at the effective rate of 38.5 percent and 37.6 percent (excluding the effect of the change in the valuation allowance) for the years ended December 31, 2003 and 2004, respectively. The Company recognized tax benefits related to the change in the valuation allowance related to its deferred tax assets of $0.1 million and $4.1 million in 2003 and 2004, respectively. The remaining valuation allowance at December 31, 2004 was attributable to the deferred tax asset related to the state operating losses.

LIQUIDITY AND CAPITAL RESOURCES

     Cash and cash equivalents totaled $7.9 million at December 31, 2005, representing an increase of $6.0 million from December 31, 2004. Additionally, short term investments totaled $16.9 million at year end 2005 compared to zero at December 31, 2004. The primary source of the increase in cash and short term investments is due to the refinancing of our senior debt in January 2005. For the year ended December 31, 2005, cash provided by operating activities was $1.7 million compared to $24.2 million for the year ended December 31, 2004. Of the $22.5 million decrease in cash provided from operating activities, $17.3 million was attributable to the $10.3 million payment of deferred interest on the convertible junior subordinated debenture in 2005 compared to the deferral of this interest totaling $7.0 million in the prior period. The Company also paid additional interest totaling $6.0 million in connection with the senior note refinancing to pay off the old notes early. Cash used in investing activities totaled $24.2 million for the year ended December 31, 2005 compared to cash used in the amount of $1.3 million for the year ended December 31, 2004, because we invested

net of maturities, $16.9 million,, in short term investments, acquired a funeral business for $1.3 million and spent $2.5 million more for capital expenditures. The additional capital expenditures were related to our new cemetery computer systems and mausoleums. Cash provided from financing activities of $28.4 million in 2005 consisted primarily of the proceeds from the senior note refinancing compared to debt repayments in 2004 and 2003. Cash and short-term investments totaled $24.9 million at year end.

     In January 2005, the Company issued $130 million of 7.875% Senior Notes due in 2015. The proceeds from these notes were used to refinance our outstanding senior debt, including payments for accrued interest and make-whole payment, bring current the deferred distributions on the convertible junior subordinated debentures and the TIDES, and for general corporate purposes. In connection with the early retirement of the senior debt, the Company made a required “make whole” payment of $6.0 million in the form of additional interest and recorded a charge to write off $0.7 million of unamortized loan costs. These charges equal $4.2 million after tax, or $0.23 per diluted share, and was reported in the first quarter of 2005. The refinancing improved the Company’s liquidity because debt totaling approximately $96 million due in 2006 and 2008 was replaced by debt maturing in ten years.

     The outstanding principal of our senior debt at December 31, 2005 totaled $141.4 million and consisted of $130.0 million in Senior Notes, a $35 million revolving line of credit, and $11.4 million in acquisition indebtedness and capital lease obligations. Additionally, $0.7 million in letters of credit were issued under the credit facility and were outstanding at December 31, 2005.

     In April 2005, the Company entered into a $35 million senior secured revolving credit facility to replace the existing unsecured credit facility. Borrowings under the new credit facility bear interest at prime or LIBOR options with the initial LIBOR option set at LIBOR plus 300 basis points, matures in five years and is collateralized by all personal property and funeral home real property in certain states. The facility is currently undrawn, except for the letters of credit referred to above, and no borrowings are anticipated during 2006. $34.3 million is available to borrow at December 31, 2005.

     A total of $93.8 million was outstanding on December 31, 2005 on our convertible junior subordinated debenture. Amounts outstanding under the debenture are payable to the Company’s affiliate trust, Carriage Services Capital Trust, bear interest at 7.0% and mature in 2029. Substantially all the assets of the Trust consist of the convertible junior subordinated debentures of the Company. In 1999, the Trust issued 1.875 million shares of term income deferrable equity securities (“TIDES”). The rights of the debentures are functionally equivalent to those of the TIDES.

     The convertible junior subordinated debenture payable to the affiliated trust and the TIDES each contain a provision for the deferral of interest payments and distributions for up to 20 consecutive quarters at the Company’s discretion. During the period in which distribution payments are deferred, distributions will continue to accumulate at the 7.0% annual rate. Also, the deferred distributions themselves accumulate distributions at the annual rate of 7.0% and are recorded as a liability. During the deferral period, we are prohibited from paying dividends on the common stock or repurchasing its common stock, subject to limited exceptions. The company deferred distributions on the TIDES from September 2003 through December 2004. In March 2005, the Company paid the $10.3 million for the cumulative deferred distributions on the TIDES and is currently paying the quarterly interest and distributions.

     Management believes we have enough cash and liquidity to meet our operating needs and execute our acquisition strategy. We do no expect to borrow on our credit facility.

Contractual Obligations

     The following table summarizes our balance sheet liabilities to make future payments as of December 31, 2005. Where appropriate we have indicated the footnote to our annual Consolidated Financial Statements where additional information is available.

																		Payments By Period
																		(in millions)
		Note																												After
		Reference				Total				2006				2007				2008				2009				2010				5 Years
Long-term debt			11			$	136.6				2.1				1.5				2.0				0.4				0.1				130.5
Capital lease obligations			14				15.9				0.6				0.6				0.6				0.7				0.7				12.7
Convertible junior subordinated debenture (a)			12				93.8				—				—				—				—				—				93.8
Total contractual obligations						$	246.3				2.7				2.1				2.6				1.1				0.8				237.0

Off-Balance Sheet Arrangements

     The following table summarizes our off-balance sheet arrangements as of December 31, 2005. Where appropriate we have indicated the footnote to our annual Consolidated Financial Statements where additional information is available.

																		Payments By Period
																		(in millions)
		Note																												After
		Reference				Total				2006				2007				2008				2009				2010				5 Years
Operating leases			14				12.7				2.0				2.1				1.9				1.3				1.0				4.4
Interest payments on long-term debt			11				246.8				17.8				17.6				17.4				17.4				17.2				159.4
Noncompete agreements			14				2.6				1.0				0.7				0.5				0.2				0.1				0.1
Consulting agreements			14				0.9				0.4				0.2				0.2				0.1				—				—
Executive Management agreements			14				3.2				1.3				0.7				0.5				0.5				0.2				—
Total contractual cash obligations						$	266.2				22.5				21.3				20.5				19.5				18.5				163.9

     The obligations related to our off-balance sheet arrangements are significant to our future liquidity; however, although we can provide no assurances, we anticipate that these obligations will be funded from cash provided from our operating activities. If we are not able to meet these obligations with cash provided for by our operating activities, we may be required to access the capital markets or draw down on our credit facilities.

     Additionally, we are party to a variety of contractual agreements under which we may be obligated to indemnify the other party for certain matters. These contracts primarily relate to the purchase or sale of business assets, commercial contracts and operating leases and arose through representations and warranties (e.g., ownership of assets or environmental matters). The terms of these indemnifications range in duration and may not be explicitly defined.

SEASONALITY

     The Company’s business can be affected by seasonal fluctuations in the death rate. Generally, the 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.

INFLATION

     Inflation has not had a significant impact on the results of Carriage’s operations.

FORWARD-LOOKING STATEMENTS

     In addition to historical information, this Annual Report contains forward-looking statements within the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements include any projections of earnings, revenues, asset sales, cash flow, debt levels or other financial items; any statements of the plans, strategies and objectives of management for future operation; any statements regarding future economic conditions or performance; any statements of belief; and any statements of assumptions underlying any of the foregoing. Forward-looking statements may include the words “may”, “will”, “estimate”, “intend”, “believe”, “expect”, “project”, “forecast”, “plan”, “anticipate” and other similar words.

ITEM 7A. QUANTITATIVE AND QUALITATIVE MARKET RISK DISCLOSURE

     Carriage is exposed to market risk primarily related to potential increases in interest rates related to the Company’s debt, decreases in interest rates related to the Company’s short-term investments and changes in the values of securities associated with the preneed and perpetual care trusts. Management is actively involved in monitoring exposure to market risk and developing and utilizing appropriate risk management techniques when appropriate and when available for a reasonable price. We are not exposed to any other significant market risks including commodity price risk, nor foreign currency exchange risk.

     Carriage monitors current and forecasted interest rate risk in the ordinary course of business and seeks to maintain optimal financial flexibility, quality and solvency. As of December 31, 2005, approximately 92% of total debt is fixed rate obligations. Given the current outlook for increasing interest rates, we believe the current bias to fixed rate debt is appropriate.

     We do not currently have any floating rate long-term borrowings outstanding under our $35 million floating rate line of credit. If we borrow against the line of credit, any change in the floating rate would cause a change in interest expense.

     The 7.875% Senior Notes were issued at par and are carried at a cost of $130 million. Current quotes indicate that cost approximates market value. The convertible junior subordinated debenture payable to Carriage Services Capital Trust pay interest at the fixed rate of 7% and are carried on the Company’s balance sheet at a cost of approximately $93.8 million. We estimate a value of $84 million and $79 million at December 31, 2004 and 2005, respectively, based on available broker quotes of the corresponding preferred securities issued by the Trust. Increases in market interest rates may cause the value of these instruments to decrease but such changes will not affect the Company’s interest costs. The remainder of Carriage’s long-term debt and leases consist of non-interest bearing notes and fixed rate instruments that do not trade in a market, or otherwise have a quoted market value. Any increase in market interest rates causes the fair value of those liabilities to decrease.

     Securities subject to market risk consist of investments held by our preneed funeral, cemetery merchandise and services and perpetual care trust funds. See Note 6 and 8 to our Consolidated Financial Statements for the estimate of the fair values of those securities.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CARRIAGE SERVICES, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

		Page
CONSOLIDATED FINANCIAL STATEMENTS:
Management’s Report on Internal Control over Financial Reporting		29
Attestation of Independent Registered Public Accounting Firm		30
Report of Independent Registered Public Accounting Firm		31
Consolidated Balance Sheets as of December 31, 2004 and 2005		32
Consolidated Statements of Operations for the Years Ended December 31, 2003, 2004 and 2005		33
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2003, 2004 and 2005		34
Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2003, 2004 and 2005		35
Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, 2004 and 2005		36
Notes to Consolidated Financial Statements		37

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

     Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined under Rule 13a-15(f) promulgated under the Securities Exchange Act of 1934, as amended.

     Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s Consolidated Financial Statements for external purposes in accordance with generally accepted accounting principles.

     Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit the preparation of the Consolidated Financial Statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with appropriate authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the Consolidated Financial Statements.

     Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

     Management conducted an assessment of the Company’s internal control over financial reporting as of December 31, 2005 using the framework specified in Internal Control — Integrated Framework, published by the Committee of Sponsoring Organizations of the Treadway Commission. Based on such assessment, management has concluded that the Company’s internal control over financial reporting was effective as of December 31, 2005.

     Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005 has been audited by KPMG LLP, an independent registered public accounting firm, which also audited the financial statements of the Company for the year ended December 31, 2005, as stated in their report which is presented in this Annual Report.

/s/ Melvin C. Payne
Melvin C. Payne
Chairman of the Board, President and Chief Executive Officer
/s/ Joseph Saporito
Joseph Saporito
Executive Vice President and Chief Financial Officer
March 10, 2006

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders
Carriage Services, Inc.:

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Carriage Service, Inc. maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Carriage Service, Inc. management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of Carriage Service, Inc.’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that Carriage Services, Inc. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Carriage Services, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Carriage Services, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations and comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2005, and our report dated March 10, 2006 expressed an unqualified opinion on those Consolidated Financial Statements.

/s/ KPMG LLP

Houston, Texas
March 10, 2006

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders
Carriage Services, Inc.:

We have audited the accompanying consolidated balance sheets of Carriage Services, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations, comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2005. These Consolidated Financial Statements are the responsibility of Carriage Services, Inc.’s management. Our responsibility is to express an opinion on these Consolidated Financial Statements and financial statement schedules based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the Consolidated Financial Statements referred to above present fairly, in all material respects, the financial position of Carriage Services, Inc. and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Carriage Services, Inc.’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 10, 2006 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

As discussed in Note 3 to the Consolidated Financial Statements, the Company changed its method of accounting for preneed selling costs in 2005.

/s/ KPMG LLP

Houston, Texas
March 10, 2006

31

CARRIAGE SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)

		December 31,
		2004				2005
ASSETS
Current assets:
Cash and cash equivalents		$	1,948			$	7,949
Short term investments			—				16,908
Accounts receivable-
Trade, net of allowance for doubtful accounts of $940 in 2004 and $937 in 2005			12,941				13,412
Assets held for sale			4,021				—
Inventories and other current assets			12,815				12,883
Total current assets			31,725				51,152
Preneed receivables and trust investments:
Cemetery			65,855				67,995
Funeral			49,494				50,420
Receivables from preneed funeral contracts			18,074				17,411
Property, plant and equipment, net of accumulated depreciation of $40,831 in 2004 and $45,694 in 2005			104,893				105,435
Cemetery property			62,649				62,905
Goodwill			156,983				157,358
Deferred obtaining costs			35,701				—
Deferred charges and other non-current assets			8,581				25,608
Cemetery perpetual care trust investments			31,201				32,356
Total assets		$	565,156			$	570,640
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued liabilities		$	22,039			$	22,163
Liabilities associated with assets held for sale			2,598				—
Current portion of long-term debt and obligations under capital leases			2,155				2,074
Total current liabilities			26,792				24,237
Senior long-term debt, net of current portion			102,714				134,572
Convertible junior subordinated debenture due in 2029 to an affiliated trust			93,750				93,750
Obligations under capital leases, net of current portion			5,424				4,775
Deferred interest on convertible junior subordinated debentures			10,891				—
Deferred cemetery revenue			46,787				51,928
Deferred preneed funeral contracts revenue			30,973				29,446
Non-controlling interests in funeral and cemetery trust investments			98,652				102,446
Total liabilities			415,983				441,154
Commitments and contingencies
Non-controlling interests in perpetual care trust investments			32,212				33,112
Non-controlling interests in perpetual care trust investments associated with assets held for sale			523				—
Stockholders’ equity:
Common Stock, $.01 par value; 80,000,000 shares authorized; 17,910,000 and 18,458,000 issued and outstanding in 2004 and 2005, respectively			179				185
Additional paid-in capital			188,029				190,502
Accumulated deficit			(71,056	)			(92,921	)
Deferred compensation			(714	)			(1,392	)
Total stockholders’ equity			116,438				96,374
Total liabilities and stockholders’ equity		$	565,156			$	570,640

The accompanying notes are an integral part of these Consolidated Financial Statements.

CARRIAGE SERVICES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)

		For the years ended December 31,
		2003				2004				2005
Revenues
Funeral		$	112,209			$	112,504			$	116,072
Cemetery			34,351				37,390				38,962
			146,560				149,894				155,034
Costs and expenses
Funeral			83,125				83,052				85,662
Cemetery			25,830				28,516				32,107
			108,955				111,568				117,769
Gross profit			37,605				38,326				37,265
General and administrative expenses			10,492				10,665				12,383
Other charges (income)			432				495				(822	)
Operating income			26,681				27,166				25,704
Interest expense			(17,900	)			(17,027	)			(18,711	)
Additional interest and other costs of senior debt refinancing			—				—				(6,933	)
Other income (loss)			657				940				(73	)
Total interest expense and other			(17,243	)			(16,087	)			(25,717	)
Income (loss) from continuing operations before income taxes			9,438				11,079				(13	)
Provision for income taxes			(3,539	)			(91	)			(32	)
Net income (loss) from continuing operations			5,899				10,988				(45	)
Discontinued operations
Operating income from discontinued operations			662				357				104
Gains on sales and (impairments) of discontinued operations			499				(2,630	)			1,301
Income tax (provision) benefit			(435	)			519				(469	)
Income (loss) from discontinued operations			726				(1,754	)			936
Cumulative effect of change in accounting method, net of tax benefit			—				—				(22,756	)
Net income (loss)		$	6,625			$	9,234			$	(21,865	)
Basic earnings (loss) per share:
Continuing operations		$	0.34			$	0.62			$	—
Discontinued operations		$	0.04			$	(0.10	)		$	0.05
Cumulative effect of change in accounting method		$	—			$	—			$	(1.24	)
Net income (loss)		$	0.38			$	0.52			$	(1.19	)
Diluted earnings (loss) per share:
Continuing operations		$	0.33			$	0.60			$	—
Discontinued operations		$	0.04			$	(0.09	)		$	0.05
Cumulative effect of change in accounting method		$	—			$	—			$	(1.24	)
Net income (loss)		$	0.37			$	0.51			$	(1.19	)
Weighted average number of common and common equivalent shares outstanding:
Basic			17,444				17,786				18,334
Diluted			17,808				18,260				18,334