PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

CARRIAGE SERVICES, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

	December 31,			June 30,
	2004			2005
				(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	1,948		$	8,352
Short term investments	—			12,849
Accounts receivable — trade, net of allowance for doubtful accounts of $940 in 2004 and $1,034 in 2005	12,941			12,562
Assets held for sale	4,021			6,546
Inventories and other current assets	12,815			13,198
Total current assets	31,725			53,507
Preneed receivables and trust investments:
Cemetery	65,855			66,300
Funeral	49,494			48,288
Receivable from funeral trusts	18,074			17,483
Property, plant and equipment, at cost, net of accumulated depreciation of $40,531 in 2004 and $43,386 in 2005	104,893			105,201
Cemetery property	62,649			61,237
Goodwill	156,983			156,983
Deferred obtaining costs	35,701			—
Deferred charges and other non-current assets	8,581			25,325
Cemetery perpetual care trust investments	31,201			32,655
Total assets	$	565,156		$	566,979
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	5,991		$	4,233
Accrued liabilities	16,048			16,944
Liabilities associated with assets held for sale	2,598			6,100
Current portion of senior long-term debt and capital leases obligations	2,155			2,180
Total current liabilities	26,792			29,457
Senior long-term debt, net of current portion	102,714			135,342
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			5,386
Deferred interest on convertible junior subordinated debenture	10,891			—
Preneed obligations:
Deferred cemetery revenue	46,787			46,163
Deferred preneed funeral contracts revenue	30,973			30,053
Non-controlling interests in funeral and cemetery trust investments	98,652			98,116
Total liabilities	415,983			438,267
Commitments and contingencies
Non-controlling interests in perpetual care trust investments	32,212			33,511
Non-controlling interests in perpetual care trust investments associated with assets held for sale	523			988
Stockholders’ equity:
Common Stock, $.01 par value; 80,000,000 shares authorized; 17,910,000 and 18,383,000 shares issued and outstanding at December 31, 2004 and June 30, 2005, respectively	179			184
Contributed capital	188,029			190,175
Accumulated deficit	(71,056		)	(94,384		)
Deferred compensation	(714		)	(1,762		)
Total stockholders’ equity	116,438			94,213
Total liabilities and stockholders’ equity	$	565,156		$	566,979

The accompanying condensed notes are an integral part of these consolidated financial statements.

CARRIAGE SERVICES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited and in thousands, except per share data)

	For the three months ended June 30,						For the six months ended June 30,
	2004			2005			2004			2005
Revenues, net
Funeral	$	27,697		$	28,438		$	58,472		$	60,255
Cemetery	9,593			9,564			19,070			19,590
	37,290			38,002			77,542			79,845
Costs and expenses
Funeral	21,167			21,156			42,623			43,162
Cemetery	7,451			8,054			14,492			15,687
	28,618			29,210			57,115			58,849
Gross profit	8,672			8,792			20,427			20,996
General and administrative expenses	2,545			3,000			5,228			5,779
Operating income	6,127			5,792			15,199			15,217
Interest expense	4,395			4,714			8,777			9,377
Additional interest and other costs of senior debt refinancing	—			240			—			6,933
Other (income) expense	(891		)	447			(891		)	390
Total interest and other (income) expense	3,504			5,401			7,886			16,700

Income (loss) from continuing operations before income taxes	2,623			391			7,313			(1,483		)
Provision (benefit) for income taxes	984			153			2,742			(561		)
Net income (loss) from continuing operations	1,639			238			4,571			(922		)
Discontinued operations
Operating income (loss) from discontinued operations	228			(16		)	420			96
Gain on sales and (impairments) of discontinued operations	(3,050		)	5			(3,050		)	465
Income tax (provision) benefit	725			4			653			(211		)
Income (loss) from discontinued operations	(2,097		)	(7		)	(1,977		)	350
Cumulative effect of change in accounting method, net of tax benefit benefit	—			—			—			(22,756		)
Net income (loss)	$	(458	)	$	231		$	2,594		$	(23,328	)
Basic earnings (loss) per common share
Continuing operations	$	0.09		$	0.01		$	0.26		$	(0.05	)
Discontinued operations	(0.12		)	—			(0.11		)	0.02
Cumulative effect of change in accounting method	—			—			—			(1.26		)
Net income (loss)	$	(0.03	)	$	0.01		$	0.15		$	(1.29	)
Diluted earnings (loss) per common share
Continuing operations	$	0.09		$	0.01		$	0.25		$	(0.05	)
Discontinued operations	(0.12		)	—			(0.11		)	0.02
Cumulative effect of change in accounting method	—			—			—			(1.26		)
Net income (loss)	$	(0.03	)	$	0.01		$	0.14		$	(1.29	)
Weighted average number of common and common equivalent shares outstanding:
Basic	17,764			18,325			17,710			18,227
Diluted	18,258			18,826			18,199			18,227

The accompanying condensed notes are an integral part of these consolidated financial statements.

CARRIAGE SERVICES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited and in thousands)

	For the six months ended June 30,
	2004			2005
Cash flows from operating activities:
Net income (loss) from continuing operations	$	4,571		$	(922	)
Adjustments to reconcile net income (loss) from continuing operations to net cash provided by (used in) continuing operating activities:
Depreciation	3,500			3,374
Amortization	2,639			1,472
Provision for losses on accounts receivable	1,187			1,503
Net (gain) loss on sale of business assets	(891		)	574
Stock-based compensation	259			354
Loss on early extinguishment of debt	—			978
Loss on sale of trust investments	235			—
Deferred income taxes	2,742			(561		)
Other	9			(49		)
Changes in assets and liabilities, net of effects from dispositions
(Increase) in accounts receivable	(331		)	(2,258		)
(Increase) in inventories and other current assets	(50		)	(785		)
(Increase) in deferred charges and other	(176		)	(593		)
(Increase) in deferred obtaining costs	(2,238		)	—
(Increase) in preneed trust investments	(459		)	(2,472		)
(Decrease) in accounts payable and accrued liabilities	(1,392		)	(1,503		)
Increase in deferred preneed revenue	943			3,906
Increase (decrease) in deferred interest on convertible junior subordinated debenture	3,447			(10,345		)
Net cash provided by (used in) operating activities of continuing operations	13,995			(7,327		)
Net cash provided by operating activities of discontinued operations	313			327
Net cash provided by (used in) operating activities	14,308			(7,000		)

Cash flows from investing activities:
Net proceeds from sales of businesses and other assets	845			182
Purchase of short term investments	—			(12,849		)
Capital expenditures	(2,165		)	(3,456		)
Net cash used in investing activities of continuing operations	(1,320		)	(16,123		)
Net cash provided by (used in) investing activities of discontinued operations	(63		)	505
Net cash used in investing activities	(1,383		)	(15,618		)

Cash flows from financing activities:
Payments on bank line of credit	(10,200		)	(25,600		)
Proceeds from the issuance of senior notes	—			130,000
Payments on senior long-term debt and obligations under capital leases	(2,658		)	(71,794		)
Proceeds from issuance of common stock	162			211
Proceeds from the exercise of stock options	184			379
Payment of financing costs	—			(4,175		)
Net cash provided by (used in) financing activities of continuing operations	(12,512		)	29,021
Net cash used in financing activities of discontinued operations	—			—
Net cash provided by (used in) financing activities	(12,512		)	29,021

Net increase in cash and cash equivalents	413			6,404
Cash and cash equivalents at beginning of period	2,024			1,948
Cash and cash equivalents at end of period	$	2,437		$	8,352

The accompanying condensed notes are an integral part of these consolidated financial statements.

Had compensation cost for these plans been determined consistent with SFAS No. 123, “Accounting for Stock-Based Compensation”, net income and income per share would have been the following pro forma amounts (in thousands, except per share data):

	Three months ended June 30,					Six months ended June 30,
	2004			2005		2004		2005
Net income (loss) available to common stockholders:
As reported	$	(458	)	$	231	$	2,594	$	(23,328	)
Pro forma	$	(568	)	$	121	$	2,374	$	(23,548	)

Net income (loss) per share available to common stockholders:
Basic
As reported	$	(0.03	)	$	0.01	$	0.15	$	(1.29	)
Pro forma	$	(0.03	)	$	0.01	$	0.13	$	(1.30	)
Diluted
As reported	$	(0.03	)	$	0.01	$	0.14	$	(1.29	)
Pro forma	$	(0.03	)	$	0.01	$	0.13	$	(1.30	)

The Company issued 268,000 shares of restricted common stock to certain officers of the Company in the first quarter of 2005. Twenty-five percent of the shares vest annually on each of the next four anniversary dates of the grant. The value of the stock at the date of grant was $4.99 per share, for a total of $1,337,320, which is amortized into expense over the vesting period.

The Company also has a compensation plan for its outside directors under which directors may choose to accept fully vested shares of the Company’s common stock for all or a portion of their annual retainer and meeting fees. The value of the shares at the grant date is charged to expense. The Company issued 2,995 and 2,247 shares of common stock to directors equal to a charge of approximately $15,000 and $14,000 each period, respectively in lieu of payment in cash for their fees for the second quarter of 2004 and 2005, respectively. The Company issued 6,250 and 5,133 shares of common stock to directors equal to a charge of $31,000 and $29,000 for the six months ended June 30, 2004 and 2005, respectively.

2. RECENTLY APPLIED AND FUTURE ACCOUNTING CHANGES

Accounting Changes and Error Corrections

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 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 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.

Stock Related Compensation

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (“FAS No. 123R”). FAS No. 123R requires companies to recognize compensation expense in an amount equal to the fair value of the share-based payment (including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans) issued to employees. FAS No. 123R applies to all transactions involving issuance of equity by a company in exchange for goods and services, including employee services. FAS No. 123R is effective in the first annual reporting period of the first fiscal year beginning on or 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 application method is not expected to have a material impact on the consolidated financial position or cash flows of the Company, and will reduce net income in 2006 by approximately $0.1 million.

3. CHANGE IN ACCOUNTING FOR 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 costs that were related to the origination of prearranged funeral and cemetery service and merchandise sales 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 that 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 will improve the comparability of its reported earnings to the other deathcare companies. The Company has applied this change in accounting method effective January 1, 2005. Therefore, the Company’s results of operations for the three and six months ended June 30, 2005 are reported on the basis of our changed method.

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 $1.26 per diluted share, which represents the cumulative balance of deferred preneed selling costs in the Company’s consolidated balance sheet. The table below presents the Company’s income (loss) from continuing operations before cumulative effect of change in accounting method, net income (loss), diluted earnings (loss) per share from continuing operations before cumulative effect of change in accounting method and diluted net earnings (loss) per share for the three and six months ended June 30, 2005 had the Company not made this accounting change (in thousands, except per share amounts).

	Three Months Ended June 30, 2005						Six Months Ended June 30, 2005
	As Reported		Effect of Change		Results under Prior Method		As Reported			Effect of Change		Results under Prior Method
Income (loss) from continuing operations before cumulative effect of change in accounting method	$	238	$	376	$	614	$	(922	)	$	861	$	(61	)
Net income (loss)	231		388		619		(23,328		)	23,576		248
Diluted earnings (loss) per common share from continuing operations before cumulative effect of change in accounting method	0.01		0.02		0.03		(0.05		)	0.05		0.00
Diluted earnings (loss) per common share	0.01		0.02		0.03		(1.29		)	1.30		0.01

The table below presents the pro forma amounts for the three and six months ended June 30, 2004 as if the accounting change had been in effect during those periods (in thousands, except per share amounts).

	Three Months Ended June 30, 2004									Six Months Ended June 30, 2004
	As Previously Reported			Effect of Change			Proforma			As Previously Reported		Effect of Change			Proforma
Gross profit:
Funeral	$	6,531		$	(284	)	$	6,247		$	15,861	$	(545	)	$	15,316

Cemetery	2,233			(506		)	1,727			4,752		(1,005		)	3,747

	$	8,764		$	(790	)	$	7,974		$	20,613	$	(1,604	)	$	19,063
Income from continuing operations	$	1,697		$	(494	)	$	1,203		$	4,688	$	(1,969	)	$	3,719
Net income (loss)	(458		)	(514		)	(972		)	2,594		(1,003		)	1,591
Diluted earnings per common share from continuing operations	0.09			(0.03		)	0.06			0.26		(0.05		)	0.20
Diluted earnings (loss) per common share	(0.03		)	(0.03		)	(0.05		)	0.14		(0.06		)	0.09

The Company previously reported in its Form 10-Q for the quarter ended March 31, 2005 its operating results based on its prior accounting method of deferring preneed selling costs. The table below presents the data as of March 31, 2005 as previously reported and restated for gross profit, income (loss) from continuing operations before cumulative effect of change in accounting method, net income (loss), diluted earnings (loss) per share from continuing operations before cumulative effect of change in accounting method and diluted earnings (loss) per share amounts for the three months ended March 31, 2005 based on applying the change in accounting method for preneed selling costs effective January 1, 2005 (in thousands, except per share amounts).

	Three Months Ended March 31, 2005
	As Previously Reported			Effect of Change			Restated
Gross profit:
Funeral	$	10,006		$	(195	)	$	9,811
Cemetery	3,042			(600		)	2,442
	$	13,048		$	(795	)	$	12,253
Income (loss) from continuing operations before cumulative effect of change in accounting method	$	(644	)	$	(485	)	$	(1,129	)
Cumulative effect of change in accounting method	—			(22,756		)	(22,756		)
Net income (loss)	(371		)	(23,189		)	(23,560		)
Diluted earnings (loss) per common share from continuing operations before cumulative effect of change in accounting method	(0.04		)	(0.03		)	0.06
Diluted earnings (loss) per common share	(0.02		)	(1.28		)	(1.30		)

4. ASSETS HELD FOR SALE

At December 31, 2004, two funeral homes and a cemetery business were held for sale. During January 2005, the Company closed on the sale of one of the funeral home businesses. The sale transaction generated net cash proceeds totaling $0.5 million and a gain of approximately $0.3 million. During May 2005, the Company ceased operations at the other funeral home business when the lease on the property expired. The preneed contracts and other business assets were transferred to another company-owned funeral home in the area.

In May 2005, the Company identified an additional cemetery business to sell. The fair value less estimated costs to sell for this business has been determined to be greater than its carrying value.

In the second quarter of 2004, the Company identified three funeral home businesses as held for sale which were later sold in 2004. The carrying value of the assets of two of those businesses was reduced to management’s estimate of fair value less estimated costs to sell by providing impairment charges totaling $3.1 million, a substantial portion of which related to specifically identified goodwill. The fair value less estimated costs to sell for the third business was determined to be greater than its carrying value.

At December 31, 2004 and June 30, 2005, assets and liabilities associated with the businesses held for sale in the accompanying balance sheet consisted of the following (in thousands):

	December 31, 2004		June 30, 2005
Assets:
Current assets	$	200	$	308
Property, plant and equipment, net	393		100
Preneed receivables and trust investments	2,378		4,477
Cemetery property, net	462		744
Cemetery perpetual care trust investments	455		917
Deferred obtaining costs	133		—
Total	$	4,021	$	6,546

Liabilities:
Current liabilities	32		52
Deferred cemetery revenue	515		2,139
Non-controlling interests in funeral and cemetery trust investments	2,051		3,909
Total	$	2,598	$	6,100

Noncontrolling interests in perpetual care trust investments of assets held for sale	$	523	$	988

The operating results of the businesses held for sale as well as the gain on the disposal are presented in the discontinued operations section of the consolidated statements of operations, along with the income tax effect on a comparative basis. Likewise, the operating results, the impairment charges and gains or losses from businesses sold in the prior year have been similarly reported for comparability. Revenues and operating income for the businesses presented in the discontinued operations section are as follows (in thousands):

	For the three months ended June 30,					For the six months ended June 30,
	2004		2005			2004		2005

Revenues, net	$	921	$	267		$	1,842	$	706

Operating income	$	228	$	(16	)	$	420	$	96

In July 2005, the Company sold one of the cemetery businesses that was held for sale at June 30, 2005 for $1.1 million and recorded a gain of $0.8 million.

5. SHORT TERM INVESTMENTS

Short term investments are investments purchased with an original maturity of greater than three months at the time of purchase. Short term investments at June 30, 2005 consisted of commercial paper with maturity dates that range from July 2005 to December 2005 at rates ranging from 2.72 percent to 3.28 percent per anum. Market value approximates cost.

6. PRENEED RECEIVABLES AND TRUST INVESTMENTS

Preneed cemetery receivables and trust investments

Preneed cemetery receivables and trust investments, net of allowance for cancellations, represent trust fund assets and customer receivables (net of unearned finance charges) for contracts sold in advance of when merchandise or services are needed. The components of Preneed cemetery receivables and trust investments in the consolidated balance sheet at June 30, 2005 are as follows (in thousands):

	June 30, 2005
Trust investments	$	53,042
Receivables from customers, excluding current portion, net	17,014
Unearned finance charges	(3,137		)
Allowance for doubtful accounts	(619		)
Preneed cemetery receivables and trust investments	$	66,300

Preneed cemetery receivables and trust investments are reduced by the trust investment earnings the Company has been allowed to withdraw prior to performance by the Company and amounts received from customers that are not required to be deposited into trust, pursuant to various state laws. Preneed cemetery sales are usually financed through interest-bearing installment sales contracts, generally with terms of up to five years. The interest rates generally range between 12 percent and 14 percent.

The cost and market values associated with cemetery preneed trust investments at June 30, 2005 are detailed below (in thousands). The Company believes the unrealized losses related to trust investments at June 30, 2005 are temporary in nature. Net unrealized gains increased $0.8 and $0.2 million for the three and six months ended June 30, 2005, respectively.

	Cost		Unrealized Gains		Unrealized Losses		Market

Cash, money market and other short-term investments	$	7,806	$	—	$	—	$	7,806
Fixed income securities:
U.S. Treasury	—		—		—		—
U.S. Agency obligations	4,694		22		25		4,691
State obligations	12,542		271		93		12,720
Corporate	3,249		95		25		3,319
Other	9		—		—		9

Common stock Mutual funds:
Equity	8,152		2,045		204		9,993
Fixed income	13,630		625		1		14,254
Other investments	—		—		—		—

	$	50,082	$	3,058	$	348	$	52,792

Accrued net investment income	$	250					250

Trust investments							$	53,042

Market value as a percentage of cost							105.9		%

Preneed funeral receivables and trust investments

Preneed funeral receivables and trust investments, net of allowance for cancellations, represent trust fund assets and customer receivables related to contracts sold in advance of when the services or merchandise is needed. Such contracts are secured by funds paid by the customer to the Company. Preneed funeral receivables and trust investments are reduced by the trust investment earnings the Company has been allowed to withdraw prior to performance by the Company and amounts received from customers that are not required to be deposited into trust, pursuant to various state laws.

The components of Preneed funeral receivables and trust investments in the consolidated balance sheet at June 30, 2005 are as follows (in thousands):

	June 30, 2005

Trust investments	$	45,074
Receivables from customers	8,971
Allowance for contract cancellations	(5,757		)

Preneed funeral receivables and trust investments	$	48,288

The cost and market values associated with funeral preneed trust investments at June 30, 2005 are detailed below (in thousands). The Company believes the unrealized losses related to trust investments at June 30, 2005 are temporary in nature. Net unrealized gains decreased $0.1 and increased $0.2 million for the three and six months ended June 30, 2005, respectively.

	Cost		Unrealized Gains		Unrealized Losses		Market

Cash, money market and other short-term investments	$	15,052	$	—	$	—	$	15,052
Fixed income securities:
U.S. Treasury	2,563		13		17		2,559
U.S. Agency obligations	1,922		96		—		2,018
State obligations	1,544		59		10		1,593
Other	197		—		4		193
Common stock Mutual funds:
Equity	2,939		738		68		3,609
Fixed income	19,623		646		219		20,050

Trust investments	$	43,840	$	1,552	$	318	$	45,074

Market value as a percentage of cost							102.8		%

Cemetery perpetual care trust investments

The Company is required by state law to pay a portion of the proceeds from the sale of cemetery property interment rights into perpetual care trust funds. The cost and market values associated with the trust investments held in perpetual care trust funds at June 30, 2005 are detailed below (in thousands). The Company believes the unrealized losses related to the trust investments at June 30, 2005 are temporary in nature.

	Cost		Unrealized Gains		Unrealized Losses		Market

Cash, money market and other short-term investments	$	4,300	$	—	$	—	$	4,300
Fixed income securities:
U.S. Treasury	698		13		4		707
U.S. Agency obligation	7,510		45		18		7,537
State obligations	58		—		—		58
Corporate	2,860		132		26		2,966
Other	1,559				1		1,558
Common stock Mutual funds:
Equity	6,698		722		125		7,295
Fixed income	7,651		345		41		7,955
Other assets	167		—		23		144

	$	31,501	$	1,257	$	238	$	32,520

Accrued net investment income	$	135					135

Trust investments							$	32,655

Market value as a percentage of cost							103.7		%

Receivable from Preneed Funeral Contracts

The receivable from funeral trusts at June 30, 2005 represent assets in trusts which are controlled and operated by third parties in which the Company does not have a controlling financial interest (less than 50%) in the trust assets. The Company accounts for these investments at cost.

Trust Investment Security Transactions

Investment security transactions recorded in Other income in the Consolidated Statement of Operations for the three and six months ended June 30, 2004 and 2005 are as follows (in thousands).

	For the three months ended June 30,						For the six months Ended June 30,
	2004			2005			2004			2005

Investment income	$	887		$	322		$	887		$	1,126
Realized gains	54			572			54			1,633
Realized losses	(295		)	(286		)	(295		)	(449		)
Expenses	(202		)	(91		)	(202		)	(276		)
Increase in non-controlling interests in trust investments	(444		)	(517		)	(444		)	(2,034		)
	$	—		$	—		$	—		$	—

7. CONTRACTS SECURED BY INSURANCE

Certain preneed funeral contracts are secured by life insurance contracts. The proceeds of the life insurance policies have been assigned to the Company and will be paid upon the death of the insured. The proceeds will be used to satisfy the beneficiary’s obligations under the preneed contract for services and merchandise. The preneed funeral contracts secured by insurance which are not included in the Company’s consolidated balance sheet totaled $163.0 million at June 30, 2005.

8.	NON-CONTROLLING INTERESTS IN FUNERAL AND CEMETERY TRUSTS AND IN PERPETUAL CARE TRUSTS

Non-controlling interests in funeral and cemetery preneed trusts represent deferred revenue related to assets held in the trusts. The Company will recognize the revenue at the time the service is performed and merchandise is delivered. Non-controlling interests in cemetery perpetual care trusts represent ownership in those trusts in which the Company is entitled to receive the income. The components of Non-controlling interests in funeral and cemetery preneed trusts and Non-controlling interests in cemetery perpetual care trusts as of June 30, 2005 are as follows:

	Non-controlling Interests
	Preneed Funeral		Preneed Cemetery		Total Preneed		Cemetery Perpetual Care

Trust assets, at market value	$	45,074	$	53,042	$	98,116	$	32,655
Pending withdrawals of income	—		—		—		(277		)
Debt due to a perpetual care trust	—		—		—		1,105
Pending deposits	—		—		—		28
	$	—	$	—	$	—	$	856

Non-controlling interests	$	45,074	$	53,042	$	98,116	$	33,511
Non-controlling interests in assets held for sale	$	—	$	3,909	$	3,909	$	988

9. MAJOR SEGMENTS OF BUSINESS

Carriage conducts funeral and cemetery operations only in the United States. The following table presents external revenue, income from continuing operations and total assets by segment (in thousands):

	Funeral		Cemetery		Corporate			Consolidated
External revenues from continuing operations:
Six months ended June 30, 2005	$	60,255	$	19,590	$	—		$	79,845
Six months ended June 30, 2004	$	58,472	$	19,070	$	—		$	77,542

Income (loss) from continuing operations before income taxes:
Six months ended June 30, 2005	$	17,093	$	3,327	$	(21,903	)	$	(1,483	)
Six months ended June 30, 2004	$	16,054	$	4,578	$	(13,319	)	$	7,313

Total assets:
June 30, 2005	$	321,377	$	193,112	$	52,490		$	566,979
December 31, 2004	$	344,940	$	205,230	$	14,986		$	565,156

10. SUPPLEMENTAL DISCLOSURE OF STATEMENT OF OPERATIONS INFORMATION

	For the three months ended June 30,				For the six months ended June 30,
	2004		2005		2004		2005
Revenues, net
Goods
Funeral	$	12,161	$	12,457	$	25,739	$	26,375
Cemetery	$	7,002	$	6,900	$	14,063	$	13,642
Total Goods	$	19,163	$	19,357	$	39,802	$	40,017

Services
Funeral	$	15,536	$	15,981	$	32,733	$	33,880
Cemetery	$	2,591	$	2,664	$	5,007	$	5,948
Total Services	$	18,127	$	18,645	$	37,740	$	39,828

Total Net Revenues	$	37,290	$	38,002	$	77,542	$	79,845

Cost of revenues
Goods
Funeral	$	11,670	$	11,615	$	23,747	$	23,947
Cemetery	$	5,365	$	5,759	$	10,489	$	10,835
Total Goods	$	17,035	$	17,374	$	34,236	$	34,782

Services
Funeral	$	9,497	$	9,541	$	18,876	$	19,215
Cemetery	$	2,086	$	2,295	$	4,003	$	4,852
Total Services	$	11,583	$	11,836	$	22,879	$	24,067

Total Cost of revenues	$	28,618	$	29,210	$	57,115	$	58,849

11. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

The following information is supplemental disclosure for the Consolidated Statement of Cash Flows (in thousands):

	For the six months ended June 30,
	2004		2005

Cash paid for interest and financing costs	$	9,249	$	24,512

Cash paid for income taxes (state)	$	35	$	219

Common stock issued to officers	$	—	$	1,337

Restricted cash investing and financing activities:

Proceeds from the sale of securities of the funeral and cemetery trusts			$	14,460

Purchase of available for sale securities of the funeral and cemetery trusts			$	13,408

Net deposits in trust accounts increasing noncontrolling interests			$	3,943

Amortization for the six month periods ended June 30, 2004 and 2005 consists of the following (in thousands):

	June 30, 2004		June 30, 2005

Intangible assets	$	233	$	226
Loan origination fees	482		378
Preneed contract obtaining costs	694		—
Cemetery interment and entombment costs	1,255		868
	$	2,664	$	1,472

12. DEBT

At December 31, 2004, Carriage had a $45 million unsecured revolving bank credit facility that was scheduled to mature in March 2006. Interest was payable at either the prime rate plus 1.25% or a rate indexed to LIBOR, at the option of the Company. The LIBOR option was set at LIBOR plus 275 basis points. In order to comply with the conditions of the credit facility, the Company began deferring interest payments in September 2003 on the $93.75 million of convertible junior subordinated debenture payable to its affiliated trust, Carriage Services Capital Trust. As a result, cash distributions on the Company-obligated mandatorily redeemable convertible preferred securities (“TIDES”) of Carriage Services Capital Trust were deferred. In March 2005, the Company paid the cumulative deferred distributions on the TIDES totaling $10.9 million. During April 2005, the Company entered into a $35 million senior secured revolving credit facility that matures in five years 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 and is collateralized by all personal property and funeral home real property in certain states. The facility is currently undrawn and no borrowings are anticipated during 2005.

In January 2005, the Company issued $130 million of 7.875 percent Senior Notes at par, due in 2015. The proceeds from these notes were used to refinance all senior debt, bring current the cumulative deferred distributions on the convertible junior subordinated debenture and the TIDES, and for general corporate purposes. The Company’s bank credit facility was amended to permit the issuance of the Senior Notes. The Company filed a registration statement on Form S-4 in April 2005 with the Securities and Exchange Commission, and it was declared effective on June 24, 2005.

Carriage, the parent entity, has no independent assets or operations. All assets and operations are held and conducted by subsidiaries, each of which (except for Carriage Services Capital Trust which is a single purpose entity that holds our debentures issued in connection with our TIDES) have fully and unconditionally guaranteed our obligations under the new Senior Notes. Additionally, we do not currently have any significant restrictions on our ability to receive dividends or loans from any subsidiary guarantor under the new Senior Notes.

In connection with the senior debt refinancing, 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 (in aggregate $4.2 million after tax, or $0.23 per diluted share) during the first quarter of 2005. In connection with the new senior secured revolving credit facility, the Company recorded a charge to write off $0.2 million or $0.01 per diluted share of unamortized loan costs during the

second quarter. These charges are included in the Consolidated Statement of Operations as additional interest and other costs of senior debt refinancing for 2005.

13. OTHER (INCOME) EXPENSE

The following table describes the components of other (income) expense of the Company for the six months ended June 30, 2004 and 2005 (amounts in thousands):

	Three months ended						Three months ended					Six months ended						Six months ended
	June 30, 2004						June 30, 2005					June 30, 2004						June 30, 2005
	Amount			Diluted EPS impact			Amount			Diluted EPS impact		Amount			Diluted EPS impact			Amount			Diluted EPS impact

Net (gains) loss from the disposition of business assets	$	(891	)	$	(0.03	)	$	576		$	0.02	$	(891	)	$	(0.03	)	$	574		$	0.02
Interest income	—			—			(129		)	—		—			—			(184		)	(0.01		)
	$	(891	)	$	(0.03	)	$	447		$	0.02	$	(891	)	$	(0.03	)	$	390		$	0.01

Risks related to the death care industry

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

(2) 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.

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

(4) Because the funeral and cemetery businesses are primarily fixed-cost businesses, changes in revenues can have a disproportionately large effect on cash flow and profits.

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

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 June 30, 2005, we operated 133 funeral homes and 30 cemeteries in 28 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 35% 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.

During the second half of 2003, we implemented several significant changes in our funeral operations designed to improve operating and financial results by growing market share and increasing profitability. We introduced a more decentralized, entrepreneurial and local operating model. At the same time, we introduced 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 cemetery operating results are affected by the size and success of our sales organization because approximately 52% of our cemetery revenues for the six months ended June 30, 2005 relate to sales of grave sites and mausoleums and related merchandise 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 affects the amount of cemetery revenues. Approximately 11% of our cemetery revenues for the six months ended June 30, 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.

Net income from continuing operations for the three months ending June 30, 2005 totaled $0.2 million, equal to $0.01 per diluted share as compared to net income from continuing operations of $1.6 million for the second quarter of 2004, or $0.09 per diluted share. Revenues increased by $0.7 million for the quarter on a year-over-year basis primarily due to a modest increase (2.7 percent) in funeral revenues.

The following items affected the comparability of income from continuing operations for the second quarter (in thousands, except per share amounts):

	Amount, net of Income Tax			Earnings per Diluted Shares

Income from continuing operations for the three months ended June 30, 2004	$	1,639		$	0.09

Increase in gross profit from funeral and cemetery operations prior to the change in accounting for preneed selling costs	449			0.02

Change in accounting for preneed selling costs	(375		)	(0.02		)

Gain from sales of business assets in the 2004 period compared to losses from sales in the 2005 period	(895		)	(0.05		)

Write-off of loan costs in 2005 related to the refinancing of the bank credit facility	(146		)	(0.01		)

Higher general and administrative expenses in 2005 to document and evaluate internal controls and upgrade systems and processes	(278		)	(0.01		)

Other, primarily higher interest expense	(156		)	(0.01		)

Income from continuing operations for the three months ended June 30, 2005	$	238		$	0.01

Net loss from continuing operations for the first six months of 2005 totaled $0.9 million, equal to ($0.05) per share as compared to net income from continuing operations of $4.6 million for the first six months of 2004, or $0.25 per diluted share. The variance between the two periods was primarily due to a make-whole payment during the first quarter of 2005 to the former debtholders in connection with the repayment of the previously outstanding senior debt. We repaid this senior debt and paid the make-whole payment with proceeds from our $130 million senior note offering, which closed in January 2005. The make-whole payment resulted in additional pre-tax interest of $6.0 million, along with a charge in the amount of $0.7 million to write off the related unamortized loan costs, in total equal to $0.23 per diluted share. Additionally, the change in accounting for preneed selling costs in 2005 reduced net income from continuing operations by $1.4 million, equal to $0.05 per diluted share. Excluding the effect of these items, total diluted earnings per share from continuing operations for the six months ending June 30, 2005 equaled $0.23 compared to the prior year six months ended June 30, 2004 of $0.25.

Income from discontinued operations for the six months ending June 30, 2005 totaled $0.4 million, equal to $0.02 per diluted share, and consisted primarily of a gain on the sale of a funeral home business during the first quarter. Loss from discontinued operations for the six months ending June 30, 2004 totaled $2.0 million, equal to $0.11 per share, and consisted primarily of impairment charges for businesses sold in the second half of 2004.

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, as 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 U.S. generally accepted accounting principles. Our significant accounting policies are more fully described in Note 1 to the Consolidated Financial Statements included in our annual report on Form 10-K for the year ended December 31, 2004. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Funeral and Cemetery Operations

We record the sales of funeral merchandise and services when the funeral service is performed. Sales of cemetery interment rights are recorded as revenue in accordance with the retail land sales provisions of Statement of Financial Accounting Standards (SFAS) No 66, “Accounting for Sales of Real Estate.” This method provides for the recognition of revenue in the period in which the customer’s cumulative payments exceed 10% of the contract price related to the real estate. Costs related to the sales of interment rights, which include property and other costs related to cemetery development activities, are charged to operations using the specific identification method in the period in which the sale of the interment right is recognized as revenue. Revenue from the sales of cemetery merchandise and services are recognized in the period in which the merchandise is delivered or the service is performed. Revenues to be recognized from the delivery of merchandise and performance of services related to contracts that were acquired in acquisitions are typically lower than those originated by the Company and are likely to exceed the cash collected from the contract and received from the trust at maturity. We began expensing preneed selling costs as incurred in 2005 (See Accounting Change).

Allowances for customer cancellations, refunds and bad debts are provided at the date that the sale is recognized as revenue based on our historical experience. In addition, we monitor changes in delinquency rates and provide additional bad debt and cancellation reserves when warranted. When preneed funeral services and merchandise are funded through third-party insurance policies, we earn a commission from 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.

Allowances from customer cancellations, refunds and bad debts are provided as a percentage of recognized revenue at the date the sale is recognized as revenue based on our historical experience. In addition, we monitor changes in delinquency rates and provide additional bad debt and cancellation reserves when warranted. Our methodologies and the resulting estimates have been reliable in past periods. We do not expect to change the factors and assumptions used in calculating these reserves in the future.

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 currently in effect under which stock options may be issued. Additionally, the Company sponsors an Employee Stock Purchase Plan (ESPP) under which employees can purchase common stock at a discount. The stock options are granted with an exercise price equal to or greater than the fair market value of the Company’s Common Stock. Substantially all of the options granted under the four stock option plans have ten-year terms. The options generally vest over a period of two to four years. The Company accounts for stock options and shares issued under the ESPP under APB Opinion No. 25, under which no compensation cost is recognized in the Consolidated Statement of Operations 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 three months ended March 31, 2004 and 2005, net income for those periods would have been lower by approximately $0.01 for each period.

applies to all transactions involving issuance of equity by a company in exchange for goods and services, including employee services. FAS No. 123R is effective in the first annual reporting period of the first fiscal year beginning on or 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 application method is not expected to have a material impact on the consolidated financial position or cash flows of the Company, and will reduce earnings in 2006 by an estimated $0.03 per diluted share.

Impairment of Long-Lived Assets

Except as noted for Goodwill and deferred obtaining costs, 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” (SFAS 144). 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 which represents a change in classification to our previously issued consolidated financial statements filed prior to our quarterly report on Form 10-Q for the periods ended June 30, 2004.

Variable Interest Entities

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 did 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 legal 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 recognizes realized income, gains and losses, of the preneed trusts and cemetery perpetual care trusts. The Company recognizes a corresponding expense equal to the realized 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 realized earnings accumulated, 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 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 will improve the comparability of its reported earnings. Because the three largest public deathcare 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 $1.26 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 three and six months ended June 30, 2005 are reported on the basis of our changed method. The annual impact on earnings per diluted share is approximately $0.10. The change has no effect on cash flow from operations. Refer to Note 3 for the change in accounting method for preneed selling costs.

RESULTS OF OPERATIONS

The following is a discussion of the Company’s results of operations for the three and six month periods ended June 30, 2004 and 2005. Funeral homes and cemeteries owned and operated for the entirety of each period being compared are referred to as “same-store” or “existing operations.”

Funeral Home Segment. The following table sets forth certain information regarding the net revenues and gross profit of the Company from the funeral home operations for the three and six months ended June 30, 2004 compared to the three and six months ended June 30, 2005. 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.

Three months ended June 30, 2004 compared to three months ended June 30, 2005 (dollars in thousands):

	Three Months Ended June 30,					Change
	2004		2005			Amount			Percent

Total same-store revenue	$	27,373	$	27,864		$	491		1.8	%
Preneed insurance commissions revenue	324		574			250			77.2	%
Revenues from continuing operations	$	27,697	$	28,438		$	741		2.7	%
Revenues from discontinued operations	$	593	$	—		$	(593	)		*

Total same-store gross profit	$	6,206	$	6,708		$	502		8.1	%
Preneed insurance commissions revenue	324		574			250			77.2	%
Gross profit from continuing operations	$	6,530	$	7,282		$	752		11.5	%
Gross profit from discontinued operations	$	137	$	(4	)	$	(141	)		*

* not meaningful

Six months ended June 30, 2004 compared to six months ended June 30, 2005 (dollars in thousands):

	Six Months Ended June 30,					Change
	2004		2005			Amount			Percent

Total same-store revenue	$	57,830	$	59,214		$	1,384		2.4	%
Preneed insurance commissions revenue	642		1,041			399			62.2	%
Revenues from continuing operations	$	58,472	$	60,255		$	1,783		3.1	%
Revenues from discontinued operations	$	1,210	$	19		$	(1,191	)		*

Total same-store gross profit	$	15,207	$	16,052		$	845		5.6	%
Preneed insurance commissions revenue	642		1,041			399			62.2	%
Gross profit from continuing operations	$	15,849	$	17,093		$	1,244		7.9	%
Gross profit from discontinued operations	$	246	$	(25	)	$	(271	)		*

* not meaningful

Funeral same-store revenues for the three months ended June 30, 2005 increased 1.8 percent when compared to the three months ended June 30, 2004, as we experienced a decrease of 1.0 percent in the number of contracts and an increase of 2.8 percent to $5,055 in the average revenue per contract for those existing operations. Cremation services represented 32.5 percent of the number of funeral services during the second quarter of 2005, an increase from 31.9 percent in the second quarter of 2004. The average revenue for burial contracts increased 4.0 percent to $6,804, while the average revenue for cremation contracts increased 1.6 percent to $2,442.

Total funeral same-store gross profit for the three months ended June 30, 2005 increased $0.5 million from the comparable three months of 2004, and as a percentage of funeral same-store revenue, increased from 22.7 percent to 24.1 percent. Gross profit benefited not only from the higher revenues, but also from better expense management in some of our largest expense categories including reductions in salaries and benefits and merchandise costs. Included in the costs and the expenses for 2004 is an additional $0.3 million for property tax expense related to a retroactive property revaluation in California.

Funeral same-store revenues for the six months ended June 30, 2005 increased 2.4 percent when compared to the six months ended June 30, 2004, as we experienced a increase of 0.1 percent in the number of contracts and an increase of 2.3 percent to $4,995 in the average revenue per contract for those existing operations. Cremation services represented 32.4 percent of the number of funeral services during the six months ended June 30, 2005 compared to 31.3 percent for the six months ended June 30, 2004. The average revenue for burial contracts increased 3.6 percent to $6,745, while the average revenue for cremation contracts increased 2.6 percent to $2,416.

Total funeral same-store gross profit for the six months ended June 30, 2005 increased $0.8 million from the comparable six months of 2004, and as a percentage of funeral same-store revenue, increased from 26.3 percent to 27.1 percent. We achieved positive operating leverage because of better execution of our new standards-based operating model.

The change in accounting method for preneed selling costs previously discussed was implemented prospectively as of January 1, 2005. We did not restate the results for 2004. The effect of that change was to reduce gross profit by $139,000 and $195,000 for the three and six month periods ended June 30, 2005.

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 three and six months ended June 30, 2004 compared to the three months ended June 30, 2005:

Three months ended June 30, 2004 compared to the three months ended June 30, 2005 (dollars in thousands)

	Three Months Ended June 30,					Change
	2004		2005			Amount			Percent

Total same-store revenues	$	9,921	$	9,831		$	(90	)	(0.9	)%
Less businesses held for sale	328		267			(61		)		*
Revenues from continuing operations	$	9,593	$	9,564		$	(29	)	(0.3	)%
Revenues from discontinued operations	$	328	$	267		$	(61	)		*

Total same-store gross profit	$	2,233	$	1,498		$	(735	)	(32.9	)%
Less businesses held for sale	91		(12		)	(103		)		*
Gross profit from continuing operations	$	2,142	$	1,510		$	(632	)	(29.5	)%
Gross profit from discontinued operations	$	91	$	(12	)	$	(103	)		*

* not meaningful

Six months ended June 30, 2004 compared to the six months ended June 30, 2005 (dollars in thousands)

	Six Months Ended June 30,				Change
	2004		2005		Amount			Percent

Total same-store revenues	$	19,702	$	20,277	$	575		2.9	%
Less businesses held for sale	632		687		55				*
Revenues from continuing operations	$	19,070	$	19,590	$	520		2.7	%
Revenues from discontinued operations	$	632	$	687	$	55			*

Total same-store gross profit	$	4,752	$	4,024	$	(728	)	(15.3	)%
Less businesses held for sale	174		121		(53		)		*
Gross profit from continuing operations	$	4,578	$	3,903	$	(675	)	(14.7	)%
Gross profit from discontinued operations	$	174	$	121	$	(53	)		*

* not meaningful

Cemetery revenues from continuing operations for the three months ended June 30, 2005 declined slightly compared to the three months ended June 30, 2004, however the 2004 period included revenues of $0.3 million from the completion of mausoleums. Preneed property sales were $0.7 million, or 20 percent, greater than the prior year quarter, yet $0.9 million of the current quarter sales was not recognized as revenue because construction was not completed. The number of interments performed decreased 7.2 percent, but at-need property revenues remain flat because the volume decline was offset by an increase in the average revenue per at-need interment. Financial revenues (trust earnings and finance charges on installment contracts) increased $0.1 million compared to the second quarter of the prior year.

Cemetery gross profit from continuing operations for the three months ended June 30, 2005 decreased $0.6 million from the comparable three months of 2004 and as a percentage of revenues decreased from 22.3 percent to 15.8 percent. The accounting change for preneed selling costs reduced gross profit by $0.6 million in the current year quarter.

Cemetery revenues from continuing operations for the six months ended June 30, 2005 increased $0.5 million, or 2.7 percent, compared to the six months ended June 30, 2004. The number of preneed contracts written in the six months ended June 30, of 2005 declined 5.5 percent to 4,602 compared to the same period in 2004. Average revenue per preneed contract written during the six months ended June 30, 2005 increased 14.8 percent to $2,917 compared to the six months ended June 30, 2004. Financial revenues (trust earnings and finance charges on installment contracts) increased $1.0 million compared to the prior year because of $0.6 million recognized gains on sales of securities in the perpetual care trust funds in 2005 compared to recognized losses of $0.2 million in 2004.

Cemetery gross profit from continuing operations for the six months ended June 30, 2005 decreased $0.7 million and as a percentage of revenues decreased from 24.0 percent to 20.0 percent from the comparable six months of 2004. The accounting change for preneed selling costs reduced gross profitability $1.2 million for the six months ended June 30, 2005.

Other. General and administrative expenses, for the three and six months ended June 30, 2005 increased $0.5 and $0.6 million or approximately 17.9 and 10.5 percent, respectively, as compared to the same periods of 2004 primarily because the 2005 period included higher professional fees related to our on-going effort to comply with the internal control reporting requirements of Sarbanes-Oxley and upgrading systems and processes. Such costs are expected to result in higher general and administrative expenses during the remainder of 2005.

Interest expense for the three and six month periods ended June 30, 2005 increased $0.3 and $0.6 million, or 7.3 and 6.8 percent, compared to the same periods ended June 30, 2004 because the total debt increased when the Company refinanced its senior debt earlier in 2005. Additionally, the current year expense is negatively impacted by higher loan fees.

Income Taxes. The Company provided income taxes at the expected effective annual rate of 37.5 percent for continuing operations for the three and six months ended June 30, 2004 and 39.1 percent and 37.8 percent for continuing operations for the three and six months ended June 30, 2005, respectively. The tax benefit for the change in accounting method was recorded at the rate of 36.5 percent.

The Company has net operating loss carryforwards totaling approximately $10.8 million for Federal income tax purposes, as well as significant operating loss carryforwards in certain states. Because of the ability to use the net operating loss to offset taxable income and the timing of when revenue and expenses are recognized for tax purposes, we do not expect to pay Federal income taxes in 2005.

LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents totaled $8.4 million at June 30, 2005, representing an increase of $6.5 million from December 31, 2004. Short-term investments totaled $12.8 at June 30, 2005, compared to none in the prior year. For the six months ended June 30, 2005, cash used by operating activities was $7.0 million as compared to cash provided of $14.3 million for the six months ended June 30, 2004. Cash used by operating activities included the $6.0 million make-whole payment and the payment of the previously deferred interest on the convertible junior subordinated debenture in the amount of $10.3 million. Capital expenditures increased $1.3 million from the 2004 period. Net cash provided by financing activities of $29.0 million was used primarily to repay all senior debt then outstanding and the balance was invested in short term investments.

In January 2005, the Company issued 7.875 percent $130 million of Senior Notes at par, due in 2015. The proceeds from these notes were used to refinance all then outstanding senior debt, including payments for accrued interest and make-whole payment, bring current the cumulative deferred distributions on the convertible junior subordinated debenture and the TIDES, and for general corporate purposes. 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 Company’s senior debt at June 30, 2005 totaled $142.9 million and consisted of the $130.0 million in Senior Notes, a $35 million revolving line of credit (none of which was outstanding at the time) and $12.9 million in acquisition indebtedness and capital lease obligations. Additionally, $0.7 million in letters of credit have been issued from the credit facility and are outstanding at June 30, 2005.

The Company’s convertible junior subordinated debenture at June 30, 2005 total $93.75 million in principal amount, are payable to the Company’s affiliate trust, Carriage Services Capital Trust, bear interest at 7 percent and mature in 2029. Substantially all the assets of the Trust consist of the convertible junior subordinated debenture of the Company. The Trust issued 1.875 million shares of convertible preferred term income deferrable equity securities (TIDES). The rights of the debenture 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. During the period in which distribution payments are deferred, distributions continue to accumulate at the 7 percent annual rate. Also, the deferred distributions themselves accumulate distributions at the annual rate of 7 percent and are recorded as a liability. During the deferral period, Carriage is prohibited from paying dividends on the common stock or repurchasing its common stock, subject to limited exceptions. The Company, in complying with the conditions of the existing credit facility, began deferring interest payments on the subordinated debenture payable to the Company’s affiliated trust beginning with the September 1, 2003 payment. In the first quarter of 2005, the Company paid $10.3 million to bring the cumulative deferred distributions on the TIDES current. The Company expects to continue paying the distributions as due.

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

PART II — OTHER INFORMATION

Item 1. 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 2. Unregistered Sales of Equity Securities and Use of Proceeds

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

None.

Issuance of Unregistered Securities

Carriage has an adopted compensation policy for fees paid to its directors under which our directors may choose to receive director compensation fees either in the form of cash compensation or equity compensation 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. The Company issued 2,995 and 2,247 shares of common stock to directors equal to a charge of approximately $15,000 and $14,000 each period, respectively, in lieu of payment in cash for their fees for the second quarter of 2004 and 2005, respectively. The Company issued 6,250 and 5,133 shares of common stock to directors equal to a charge of $31,000 and $29,000 for the six months ended June 30, 2004 and 2005, respectively. No underwriter was used in connection with this issuance. Carriage relied on the Section 4(2) exemption from the registration requirements of the Securities Act of 1933, as amended.

Item 3. Defaults Upon Senior Securities

None

Item 4. Submission of Matters to a Vote of Security Holders

The Company’s 2005 annual meeting was held on May 10, 2005. The director nominee was elected and the amendment to the 1996 Directors Stock Option Plan was approved. The voting tabulation was as follows:

Name of Nominee/Plan	Number of Votes For	Number of Votes Against	Number of Votes Withheld

Ronald A. Erickson	14,650,608	—	1,673,906

1996 Directors Stock Option Plan amendment to increase shares available to 425,000	7,748,806	2,162,873	6,412,835

The terms of the following directors continue after the meeting as follows:

Director		Expiration of Term at Annual Shareholder’s Meeting

Melvin C. Payne		2006

Joe R. Davis		2006

Vincent D. Foster		2007

Mark F. Wilson		2007

Item 5. Other Information

The Company reported on Form 8-K during the quarter covered by this report all information required to be reported on such form.

ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2005

OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

DELAWARE		76-0423828
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

1900 Saint James Place, 4^th Floor, Houston, TX		77056
(Address of principal executive offices)		(Zip Code)

PART I - FINANCIAL INFORMATION

Item 1.	Financial Statements

Consolidated Balance Sheets as of December 31, 2004 and June 30, 2005 (unaudited)

Consolidated Unaudited Statements of Operations for the Three Months ended June 30, 2004 and 2005 and Six Months ended June 30, 2004 and 2005

Consolidated Unaudited Statements of Cash Flows for the Six Months ended June 30, 2004 and 2005

Condensed Notes to Consolidated Financial Statements

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 3.	Quantitative and Qualitative Disclosures of Market Risk

Item 4.	Controls and Procedures

PART II - OTHER INFORMATION

Item 1.	Legal Proceedings

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds

Item 3.	Defaults Upon Senior Securities

Item 4.	Submission of Matters to a Vote of Security Holders

Item 5.	Other Information

Item 6.	Exhibits

Signatures

4.5	—	Credit Agreement dated April 27, 2005 among Carriage Services, Inc., as the Borrower, Bank of America, N.A. as the Administrative Agent, Swing Line Lender and L/C Issuer, Wells Fargo Bank of Texas, National Association, as Syndication Agent and Other Lenders

11.1	—	Computation of Per Share Earnings

18.1	—	Preferability letter regarding change in accounting method

31.1	—	Certification of Periodic Financial Reports by Melvin C. Payne in satisfaction of Section 302 of the Sarbanes-Oxley Act of 2002

31.2	—	Certification of Periodic Financial Reports by Joseph Saporito in satisfaction of Section 302 of the Sarbanes-Oxley Act of 2002

32.1	—	Certification of Periodic Financial Reports by Melvin C. Payne in satisfaction of Section 906 of the Sarbanes-Oxley Act of 2002 and 18 U.S.C. Section 1350

32.2	—	Certification of Periodic Financial Reports by Joseph Saporito in satisfaction of Section 906 of the Sarbanes-Oxley Act of 2002 and 18 U.S.C. Section 1350

				CARRIAGE SERVICES, INC.


August 12, 2005				/s/ Joseph Saporito
Date				Joseph Saporito,
				Executive Vice President, Chief Financial Officer and Secretary (Principal Financial Officer and Accounting Officer)

Cautionary Statements

OVERVIEW

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

ACCOUNTING CHANGE

Item 3. Quantitative and Qualitative Disclosures of Market Risk

Item 4. Controls and Procedures

Item 3. Defaults Upon Senior Securities

Item 5. Other Information

		(a) Exhibits

4.5		Credit Agreement dated April 27, 2005 among Carriage Services, Inc., as the Borrower, Bank of America, N.A. as the Administrative Agent, Swing Line Lender and L/C Issuer, Wells Fargo Bank of Texas, National Association, as Syndication Agent and Other Lenders

11.1		Computation of Per Share Earnings

18.1		Preferability letter regarding change in accounting method

31.1		Certification of Periodic Financial Reports by Melvin C. Payne in satisfaction of Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of Periodic Financial Reports by Joseph Saporito in satisfaction of Section 302 of the Sarbanes-Oxley Act of 2002

32.1		Certification of Periodic Financial Reports by Melvin C. Payne in satisfaction of Section 906 of the Sarbanes-Oxley Act of 2002 and 18 U.S.C. Section 1350

32.2		Certification of Periodic Financial Reports by Joseph Saporito in satisfaction of Section 906 of the Sarbanes-Oxley Act of 2002 and 18 U.S.C. Section 1350