CARRIAGE SERVICES INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K

/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001

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

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COMMISSION FILE NUMBER: 1-11961
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CARRIAGE SERVICES, INC.
(Exact name of registrant as specified in its charter)

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

1900 SAINT JAMES PLACE, 4TH FLOOR, HOUSTON, TX 77056
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (713) 332-8400
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

CLASS A COMMON STOCK, $.01 PAR VALUE NEW YORK STOCK EXCHANGE
(Title Of Class) (Name of Exchange on which registered)

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NONE
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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 /X/ No / /
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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. / /

The aggregate market value of the voting stock held by non-affiliates
(affiliates being, for these purposes only, directors, executive officers and
holders of more than 5% of Carriage's Class A Common Stock) of the Registrant as
of March 25, 2002 was approximately $45,000,000 based on the closing price of
$4.95 per share on the New York Stock Exchange.
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The number of shares of the Registrant's Class A Common Stock, $.01 par
value per share, and Class B Common Stock, $.01 par value per share, outstanding
as of March 25, 2002 was 16,912,596 and 0 respectively.

DOCUMENTS INCORPORATED BY REFERENCE

Proxy Statement in connection with the 2002 annual meeting of shareholders,
incorporated in Part III of this Report.

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FORWARD-LOOKING STATEMENTS

In addition to historical information, this Annual Report contains
forward-looking statements made by the management of Carriage
Services, Inc.(the "Company" or "Carriage"). Such statements are typically
identified by terms expressing future expectations or goals. These
forward-looking statements, although made in good faith, are subject to certain
risks and uncertainties that could cause actual results to differ materially
from those reflected in these forward-looking statements. Factors that might
cause such a difference include the following: Carriage's inability to sell
businesses and properties held for sale for their carrying value, to maintain or
increase free cash flow from operations, or to achieve internal growth from our
businesses; adverse changes in economic and financial market conditions,
including declining stock prices, increasing interest rates, and restricted
credit availability; lower death rates; changes in accounting principles;
changing consumer preferences; competition in our markets; Carriage's inability
to maintain operating ratios within the limits set out within our financing
arrangements; loss contingencies and changes in government regulation of the
death care industry. Readers are cautioned not to place undue reliance on these
forward-looking statements, which reflect management's opinions only as of the
date hereof. We undertake no obligation to revise or publicly release the
results of any revision of these forward-looking statements. Readers should
carefully review the Cautionary Statements described in this and other documents
we file from time to time with the Securities and Exchange Commission, including
Quarterly Reports on Form 10-Q and Current Reports on Form 8-K filed by Carriage
throughout 2002.

CAUTIONARY STATEMENTS

The Company cautions readers that the following important factors, among
others, in some cases have affected, and in the future could affect, the
Company's actual consolidated results and could cause the Company's actual
consolidated results in the future to differ materially from the goals and
expectations expressed herein and in any other forward-looking statements made
by or on behalf of the Company.

(1) Maintaining or achieving growth in free cash flow from operations
depends primarily on achieving anticipated levels of earnings before
depreciation, amortization and other non-cash charges, maintaining the amount of
expected cash income taxes payable, controlling capital expenditures to budgeted
levels, collecting accounts receivable and managing preneed sales origination
costs to current or lower levels.

(2) Achieving the Company's revenue goals is affected by the volume and
prices of the products and services sold, as well as the mix of products and
services sold. The annual sales targets set by the Company are believed to be
achievable, but the inability of the Company to achieve planned volume or prices
could cause the Company not to meet anticipated levels of revenue. In most
markets the Company expects to increase prices, but in certain markets prices
could be lowered to protect market share. The ability of the Company to achieve
volume or price targets at any location depends on numerous factors, including
the capabilities of the local operating staff, the local economy, the local
death rate, competition and changes in consumer preferences, including
cremations.

(3) Revenue also is affected by the level of preneed sales in both current
and prior periods. The level of preneed sales may be adversely affected by
numerous factors, including deterioration in the economy, which causes
individuals to have less discretionary income, changes in consumer spending
preferences, as well as changes in our marketing approach, commission practices
and contractual terms. Future revenue will also be affected by the Company's
decision in the latter half of 2000 to eliminate the national preneed sales and
marketing organization and to manage future preneed activities at the local
business level.

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(4) In addition to the factors discussed above, financial performance may be
affected by other important factors, including the following:

(a) The ability of the Company to retain or attract key personnel.

(b) The amount and rate of growth in the Company's general and
administrative expenses.

(c) Changes in interest rates, which can increase or decrease the amount the
Company pays on borrowings with variable rates of interest.

(d) The ability of the Company to stay within the limits of the credit
ratios set out in the debt covenants, such as the debt-to-capital ratio,
debt-to-EBITDA ratio, and the fixed charge coverage ratio.

(e) Availability and related terms of debt and equity financing to fund
operating needs.

(f) Changes in government regulations, including tax rates and their effects
on corporate structure.

(g) Changes in inflation and other general economic conditions domestically,
affecting financial markets (e.g. marketable security values).

(h) Unanticipated legal proceedings and unanticipated outcomes of legal
proceedings.

(i) Changes in accounting policies and practices required by generally
accepted accounting principles or the Securities and Exchange
Commission, such as writedowns to the asset carrying values for goodwill
and other long-lived assets.

The Company also cautions readers that it assumes no obligation to update or
publicly release any revisions to forward-looking statements made herein or any
other forward-looking statements made by, or on behalf of, the Company.

PART I

ITEM 1. BUSINESS

THE COMPANY

Carriage is a leading provider of death care services and products in the
United States. As of December 31, 2001, we operated 148 funeral homes and 30
cemeteries in 29 states. Carriage provides a complete range of services relating
to funerals, burials and cremations, including the planning and coordination of
personalized funerals, use of funeral home facilities and providing
transportation services, the performance of cemetery interment services and the
management and maintenance of cemetery grounds. We also sell related products
and merchandise including caskets, burial vaults, garments, cemetery interment
rights, stone and bronze memorials, as well as other items. From 1996 to 1999,
the Company grew rapidly as a result of a high level of acquisition activity. In
1999, growth slowed and the level of acquisition activity was sharply curtailed
to allow Carriage to focus on the improvement of operating results. Fiscal 2000
was a transitional year including a decline in operating profitability, the
adoption of a substantially changed accounting method for preneed cemetery
sales, and the implementation of a two-year multi-element restructuring program
termed "Fresh Start" which was intended to improve financial and operating
performance. As a result of these factors, the 2000 earnings per share fell to
$.06 from operations before special charges and cumulative effect of accounting
changes and a loss of $8.23 per share including these special charges and the
accounting change. Most of the elements of Fresh Start have now been
accomplished, and we have seen the benefits of these actions in our 2001
operating results as diluted earnings per share was $.51; cash flow from
operations exceeded $27 million and debt was reduced by $30 million.

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Since Carriage's formation in 1991, we have focused on distinguishing
ourselves from our competitors by developing an employee-driven organization
that emphasizes: (i) providing the highest level of personalized service to
client families, (ii) comprehensive employee training, (iii) a decentralized
management structure, and (iv) location management incentive compensation which
shares the benefits of location profitability above predetermined levels.
Significant concerns existed at the end of 2000 regarding the financial
stability and the credibility of the operating and consolidation models of the
death care industry. The beginning of an industry-wide recovery from the high
leverage and nominal cash flow of the past several years highlighted the year
2001. We, as well as other members of the industry, shifted our focus to
improving existing businesses and selling those that do not fit into long-term
strategies.

In response to the changing industry environment, we initiated, in
July 2000, a review of our funeral home and cemetery portfolios, operating
strategies, organizational structure, and financial covenants under Carriage's
credit agreements. As a result, Carriage launched, in September 2000, a
multi-faceted, restructuring program called "Fresh Start". During the last two
quarters of 2000, we eliminated a large portion of our administrative and
general overhead and began executing new operating strategies under new
leadership. Carriage's preneed funeral strategy has now changed from a national,
centralized strategy to a unique, local, decentralized strategy whereby each
local business will have a program customized to its needs and managed by the
local funeral home manager or regional manager. The cemetery organization has
been substantially streamlined, and there is now singular responsibility and
accountability for both sales and operations. Our human resources strategy is to
high-grade our personnel, which includes promoting, recruiting, and training
top-quality managers and leaders to replace those who are not able to perform up
to our Fresh Start standards. We conducted a rigorous review of the businesses
we own and stratified the funeral homes and cemeteries into three groups: a
healthy core group, an underperforming group, and a group that we targeted to
sell. Impairment and other special charges totaling $102.3 million were recorded
in 2000 in connection with Fresh Start. One critical element of Fresh Start was
to modify our financial covenants with our banks and insurance company lenders
so that we could execute all elements of our plan, including any expected
adjustments to Carriage's cemetery revenues, earnings and net worth resulting
from the adoption of the Staff Accounting Bulletin No. 101, Revenue Recognition
in Financial Statements. We believe that the implementation of Fresh Start has
enhanced our ability to effectively compete.

The year 2001 was the first full year of Fresh Start and the positive
results are apparent. By effectively executing the elements of the plan, we will
set the stage for success in years to come. Cost reduction initiatives led to a
decline of 15% in general and administrative expenses in comparing 2000 to 2001.
We have turned to new leadership at all levels in the Company to reposition
Carriage for the future. During 2001 new leaders in Human Resources and
Information Technology were elevated to executive officers of the Company
because of their strategic importance. We made good progress with our leadership
upgrading initiatives in 2001, yet this remains our greatest opportunity in
2002. Our preneed funeral strategy has changed from a national, centralized one
to a local, decentralized strategy which enabled us to decrease our cash
investment in 2001 by approximately 60%, yet we believe that the quality of the
program improved. We have recently adjusted the strategy in certain markets to
increase the level of preneed funeral sales during 2002. Since Fresh Start was
initiated, we have sold 27 funeral homes, 12 cemeteries and 9 parcels of excess
real estate for approximately $17 million of net proceeds, of which
$11.9 million was realized in 2001. While there could be additional dispositions
in the future, we are more inclined to work on improving the results of the
remaining underperforming businesses. We have invested heavily in new funeral
home corporate leadership at the regional vice president and regional manager
levels during 2001, which we expect to result in healthier and more profitable
businesses in 2002 and into the future. We will also be investing in new
cemetery leadership at the regional and location levels in 2002 in order to
achieve higher revenues and profitability.

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Carriage was incorporated in Delaware on December 29, 1993, and became a
public reporting company in August 1996. Our principal executive office is
located at 1900 Saint James Place, 4th Floor, Houston, Texas 77056, and our
telephone number is (713) 332-8400.

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:

HIGHLY FRAGMENTED OWNERSHIP. A significant majority of death care operators
consist of small, family-owned businesses that control one or several funeral
homes or cemeteries in a single community. Management estimates that there are
approximately 23,000 funeral homes and 9,600 commercial (as opposed to
religious, family, fraternal, military or municipal) cemeteries in the United
States. Approximately 25% of the 2001 U.S. death care industry revenues are
represented by Carriage and the three other largest publicly traded domestic
death care companies.

BARRIERS TO ENTRY. Death care businesses have traditionally been
transferred to successive generations within a family and in most cases have
developed a local heritage and tradition that act as a barrier for those wishing
to enter an existing market. Heritage and tradition afford an established
funeral home or cemetery a local franchise and provide the opportunity for
repeat business. Other difficulties faced by entities desiring to enter a market
include local zoning restrictions, substantial capital requirements, increasing
regulatory burdens and scarcity of cemetery land in certain urban areas. In
addition, established firms' backlog of preneed, prefunded funerals or presold
cemetery and mausoleum spaces also makes it difficult for new entrants to gain
entry into the marketplace. Since 2000, with many of the large death care
consolidators restructuring their operating models, we have seen some barriers
to entry lessened as new competitors have captured market share in some areas.
We do not believe this trend represents a long-term change in the industry.

STABILITY. The death rates in the United States are relatively stable. The
number of deaths in the United States has increased at a compounded rate of
approximately 1% since 1980. While the number of deaths typically varies from
year to year by 1-2%, industry studies show that the average age of the
population is increasing. Because of the relative stability, individual funeral
home business failures are uncommon. As a result, ownership of independent
funeral home and cemetery businesses generally has not experienced significant
turnover and the aggregate number of funeral homes and cemeteries in the United
States has remained relatively constant.

CONSOLIDATION. Until 1999, the industry experienced a trend toward
consolidation of independent death care operations with a few large, primarily
publicly owned death care providers that sought to benefit from economies of
scale, improved managerial control and more effective strategic planning and
greater financial resources. The trend resulted principally from increased
regulation, a desire on the part of small, family operated funeral businesses to
address family succession and estate planning issues, and a desire for
liquidity. An active acquisition market for funeral homes and cemeteries
provided a source of potential liquidity that was not as readily available to
individual owners in the past. The consolidation trend was suspended in 1999,
and none of the publicly traded companies are currently pursuing significant
acquisitions at this time. The consolidators, including Carriage, were facing
financial pressure and high debt levels as a result of having paid too much for
businesses that are not performing as expected. Each of the consolidators began
selling selected properties and other assets in 2000 in order to reduce their
debt levels. Certain restructurings have also been announced during 2000 and
2001 that resulted in large nonrecurring charges as the consolidators changed
various operating strategies.

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PRENEED MARKETING. In addition to sales at the time of death or on an "at
need" basis, death care products and services are being sold prior to the time
of death or on a "preneed" basis by some death care providers who have developed
sophisticated marketing organizations to actively promote such products and
services. At the same time, consumers are becoming more aware of the benefits of
advanced planning, such as the financial assurance and peace of mind achieved by
establishing, in advance, a fixed price and type of service, and the elimination
of the emotional strain of making death care plans at the time of need.
Effective marketing of preneed products and services provides a backlog of
future business. We believe sales of preneed products and services, including
cemetery and interment rights and preneed funeral services, are purchased
primarily by people between the ages of 50 and 80. In 2000, we modified our
preneed funeral sales marketing from a nationwide sales program to a sales
program which is controlled, on a market-by-market basis, and managed by the
local funeral home manager or a third party contractor.

CREMATION. In recent years, there has been steady, gradual growth 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 26% of the U.S. burial market in 2001 and
are projected at 36% for 2010, as compared to approximately 10% in 1980. Many
parts of the Southern and Midwestern United States and many non-metropolitan
communities exhibit significantly lower rates of cremation as a result of
religious and cultural traditions. Cremation, historically, has been marketed as
a less costly alternative to interment. However, cremation is increasingly
marketed as part of a complete service package that includes traditional funeral
services and memorialization.

BUSINESS STRATEGY

Our business strategy is to emphasize increasing operating cash flow and
improving profitability at the business location level through strategies that
do not require significant investments of new capital. We plan to continue
reducing our debt and improving our leverage ratios. Our focus is on improving
our organizational leadership and quality of personnel. We made outstanding
progress in 2001 toward achievement of our Fresh Start goals. Continued
successful execution during 2002 would, in our view, reposition the company as a
leader in our industry and should enable us to resume careful, intelligent
external growth in 2003.

"FRESH START" RESTRUCTURING PROGRAM. During the third quarter of 2000,
Carriage initiated a multi-faceted restructuring program termed "Fresh Start" in
response to the changing industry environment and deterioration of the Company's
operating results during 2000. The program began with a review of the funeral
home and cemetery portfolios, operating strategies, organizational structure,
and financial covenants under the Company's credit agreements. Key elements of
"Fresh Start" are as follows:

GOALS AND PRINCIPAL ELEMENTS. The two-year goals for the restructuring
program, announced in November, 2000, were to (1) restore credibility to our
operating and consolidation model; (2) increase and better align our earnings
and cash flow; (3) restore market value credibility to our balance sheet;
(4) reduce our debt; and (5) re-access the capital markets. The principal
elements of Fresh Start included the downsizing of our corporate organization,
changing our operating leadership, changing our preneed funeral marketing
strategy, stratifying by performance the funeral home and cemetery portfolios,
implementing action plans to improve underperforming businesses, disposing of
some underperforming businesses, reviewing and adjusting the carrying basis of
other underperforming businesses, and the modification of financial covenants
with lenders to facilitate the execution of the program.

PROGRAM IMPLEMENTATION. Downsizing of our corporate organization was
completed in the fourth quarter of 2000 and has resulted in the elimination of a
large portion of our operating and

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administrative overhead. Our infrastructure is now better suited for a
non-acquisition environment, and we are executing our new operating strategies
under new leadership.

The new operating leadership is widely dispersed from major divisions to
individual locations, and we have recruited top-quality managers and leaders to
replace those who were not able to perform up to our Fresh Start standards.
Offering incentives to our new local leadership has become an important part of
our Human Resources strategy. We have begun a new Funeral Home Partnership
program designed to foster market share growth by establishing realistic short
and long-term business plans and performance goals that are balanced with
attractive short and long-term rewards.

Our preneed funeral strategy has also changed significantly. We have gone
from a national, centralized strategy to a local, decentralized strategy in
which each business will have a program customized to its local needs.
Accordingly, we have eliminated the national funeral sales organization and
consolidated most existing preneed investments with one trustee. This enabled us
to substantially downsize the Houston administrative support infrastructure and
relocate our smaller corporate staff to more modest facilities.

In reviewing our funeral home and cemetery portfolios, we divided all of our
locations into two main groups: a healthy core group, which represents the
majority of our revenues and cash flow, and a second underperforming group.
There is a smaller third group that consists of businesses that we targeted for
sale. After completing this stratification, we then established new performance
standards consistent with our mission of 'Becoming the Best'. No longer will we
allow the success of our best businesses, managers and employees to be unfairly
diluted by the underperformance of our weaker businesses. Where there are local
market share losses or leadership problems, specific action plans have been
designed to deal with underperforming properties. These action plans included
the decision to sell the businesses that cannot meet our new standards. Since
Fresh Start was initiated in 2000, Carriage has sold 27 funeral properties, 12
cemeteries and 9 parcels of excess real estate for net proceeds of $17 million.
A relatively small number of additional properties may be sold in 2002. The
carrying value of the businesses targeted for sale were written down to the
estimated net realizable value.

As the final element of Fresh Start we modified the financial covenants with
our banks and insurance lenders so that we could execute all elements of the
plan. Notwithstanding the difficult industry environment, we received strong
support from our lenders for initiating an aggressive, proactive plan of action.
During 2001, we used cash flow from operations and proceeds from the sale of the
businesses to reduce our debt by $30 million.

OPERATING STRATEGY. While our strategies have changed, our mission to
become the best funeral and cemetery service organization in the industry has
not. We believe our operating strategies increase the performance level of our
properties significantly above the level that they could achieve if they were
operating as stand-alone independent businesses. Key elements of our operating
strategy that complement the restructuring program include the following:

PERSONALIZED SERVICE. We believe that providing personalized service
results in increased customer satisfaction, increased market share, more
motivated employees and consistently higher levels of profitability. We have
placed a great deal of emphasis upon recruiting new leaders, communicating to
our employees the linkage between personalized service, customer satisfaction,
market share increases and profitability throughout the organization.

EMPLOYEE TRAINING. We have made a significant commitment of financial and
human resources to a company-wide training effort. The training is designed to
improve the management of and communication among employees and to develop
personalized service that will be of value to clients. In training employees to
deliver personalized service, we emphasize employee listening and communication
skills in working towards the goal of uniquely memorializing the life of an
individual. We have been focusing on integrating the concepts and practices of
our training program into our

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operations. We believe that this long-term investment in our employees will,
over time, lead to increased market share, resulting in higher profitability.

ENHANCED SYSTEMS. We utilize a computer system linked to all of our funeral
homes to monitor and access critical operating and financial data in order to
analyze the performance of individual locations on a timely basis and institute
corrective action if necessary. The Internet is used as a medium to internally
disseminate information between locations. We began a program in mid 2001 to
review our business processes and systems with the goals of simplifying and
providing more useful, cost-efficient information to our field operations. We
are planning to invest part of our improved profitability in a systems upgrade
initiative in 2002 and 2003 which is intended to improve our performance and
efficiency and position us for further growth.

HIGH STANDARDS OF PERFORMANCE. We continually establish targets to
emphasize and enhance customer service and operational and financial
performance. These standards are designed to identify management's expectations
for high achievement in these three key performance areas and are communicated
to employees through our extensive training programs and monitored by strong
corporate leadership and a proactive corporate support system. We invested
heavily in new funeral home corporate field leadership at the regional vice
president and regional manager levels during 2001. We fully expect this
investment in new, strong funeral home corporate leadership to result in a
healthier and more profitable portfolio this year and in the future. We believe
that the differential field level earnings before interest, taxes, depreciation
and amortization (EBITDA) margin between our core and our underperforming
groups, which was almost 500 basis points in 2001, will narrow substantially
over the next two years. We will also be investing in new cemetery leadership at
the regional and location levels in 2002 in order to achieve broader portfolio
sales and profit performance through specific action plans.

QUALITY REVIEW MANAGEMENT SYSTEMS. We have developed quality-based
management systems which operate within our decentralized management structure.
These systems involve quantifiable customer survey input in addition to
operational and financial measurements of performance. With the assistance of
our training staff, these systems are being implemented at the local level under
the direction of our regional vice presidents and regional managers. These
leaders provide an additional level of operational support and feedback to our
local managers.

INCENTIVE COMPENSATION. We have established a compensation structure that
is designed to create and maintain an ownership mentality to align overall
compensation to our performance objectives. Local management is awarded
meaningful cash bonuses or other rewards for achieving specified service,
operational and financial performance objectives. We also have stock option
programs, which award options to certain employees based upon their performance.
As a result, many management and key employees have the opportunity to increase
their personal net worth through strong performance.

COST SAVINGS AND OPERATING EFFICIENCIES. Our larger size, as compared to
local operators, allows favorable pricing and terms to be achieved from vendors
through volume discounts on significant expenditures, such as caskets, vaults,
memorials and vehicles. In addition, while operational functions and management
responsibility are retained at the local level, centralizing certain financial,
accounting, legal, administrative and employee benefit functions allow for more
efficient and cost-effective operations.

RATIONALIZATION OF OUR PRENEED FUNERAL SALES PROGRAM. We have developed a
productive preneed funeral sales program that is expected to provide significant
benefits for years into the future. This program has not been developed,
however, without significant costs. Preneed sales frequently require an
immediate cash outlay by the seller to fund commissions and promotional
expenditures. Beginning in 2000, we began selling insurance funded contracts in
most markets that

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allow us to earn commission income and improve our cash flow. In 2001 the
program focused on markets that depended on preneed for market share and
exposure with most of the sales coming from selling funeral directors. 2002
brings an expansion of the program with all locations utilizing some type of
preneed program whether it be by in-house sales by funeral directors, in-house
sales by sales counselors or by using third party sellers. We will continue to
use insurance funded contracts as the main funding vehicle.

ACQUISITION STRATEGY. Since 1999, acquisitions by public consolidators of
independent funeral homes and cemeteries have virtually ceased throughout the
death care industry, including Carriage Services, as the focus has changed to
improving cash flow and operating results from existing businesses. We believe
that consolidation can work in this industry, but only if acquisition prices are
substantially lower than we experienced during 1997-1999 and we are highly
selective in the locations acquired. Acquisition activity is expected to be
minimal during 2002 and then resume intelligently and strategically in 2003,
funded primarily through internally generated cash flow.

IMPAIRMENTS AND ASSET DISPOSITION STRATEGY. In connection with Fresh Start,
as previously stated, a review was performed of the businesses that we owned and
those businesses were stratified into three groups: core, underperforming and
targeted for sale. Long-term cash flow forecasts were prepared to determine
whether we would recover our investment through operations on the
underperforming properties. In those instances in which our investment in a
business exceeded the estimated future cash flows, the investment was written
down, through an impairment charge, to the present value of those future cash
flows. Impairment charges totaled $51 million for the underperforming businesses
that we will continue to operate. An estimate of the net realizable value was
determined for those businesses targeted for sale to determine whether we could
expect to recover our investment from the sale of those businesses. Where the
investment exceeded the fair value less costs to sell, an impairment charge was
recorded for the deficiency, which totaled approximately $30 million in the
aggregate, reducing our investment in businesses targeted for sale to
approximately $10 million.

For the year 2000, the underperforming group generated 31% of funeral home
revenue and 28% of field level cash flow; and the targeted for sale group 8% of
funeral home revenues and 4% of cash flow. For the year 2001, the
underperforming group represented 30% of funeral home revenue and 27% of field
level cash flow; while the targeted for sale (and businesses actually sold or
closed in 2001) group was 6% of funeral home revenues and 4% of cash flow.

OPERATIONS

Our local funeral home operations, cemetery operations and preneed programs
are managed by individuals with extensive death care industry experience. The
local operators continue to have responsibility for day-to-day operations, but
are required to follow centralized service and financial standards. We believe
this strategy permits each local firm to maintain its unique style of operation
and to capitalize on its reputation and heritage while Carriage maintains
centralized supervisory controls and provides specialized services at the
corporate level. We have a commitment to strong information systems. Systems are
linked to all of the funeral homes to monitor and assess critical operating and
financial data in order to analyze the performance of individual funeral homes
on a timely basis. Management is able to access customer transaction data and
other operating information from the Houston support center to ensure the
quality of operating performance and to implement any necessary corrective
actions.

FUNERAL HOME OPERATIONS. As of December 31, 2001, Carriage operated 148
funeral homes in 29 states. Funeral home revenues accounted for approximately
78% and 76% of our net revenues for each of the years ended December 31, 2000
and 2001, respectively. The funeral home operations are managed by a team of
experienced death care industry professionals as well as selected

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region-level individuals with substantial management experience in other service
industries. These individuals were recruited from outside the industry bringing
with them the best operating practices that have been proven successful in other
service industries. See Note 14 to the consolidated financial statements for
segment data related to funeral home operations.

Our funeral homes offer a complete range of services to meet families'
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 religious services 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, reducing inconvenience to the family.

CEMETERY OPERATIONS. As of December 31, 2001, we operated 30 cemeteries in
12 states. Cemetery revenues accounted for approximately 22% and 24% of our net
revenues for each of the years ended December 31, 2000 and 2001, respectively.

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

At the beginning of the fourth quarter of 2000, Carriage Services, along
with others in the industry, implemented the Securities and Exchange
Commission's Staff Accounting Bulletin No. 101-"Revenue Recognition in Financial
Statements" (SAB 101). The most significant impact of adopting SAB 101 was the
deferral of revenue and related expenses for cemetery merchandise and services
until they are delivered instead of recognizing them at the time of sale, as we
did previously. Income earned on merchandise and services funds in trust are
also deferred until delivery occurs. As a result of SAB 101, the Company has
deferred cemetery revenue of approximately $90 million which will be recognized
in future periods. Implementation of SAB 101 had the pro forma effect of
reducing revenues by $9.8 million and pre-tax income by $5.1 million or $0.21
per diluted share for the full year 2000, compared to $13.6 million and
$7.4 million or $0.30 per diluted share for 1999. Included in the Consolidated
Statement of Operations for 2000 is a charge in the amount of $59.7 million,
before taxes, relating to the cumulative effect of the change in accounting
principle in connection with the implementation of SAB 101. The SAB 101
accounting changes have had no effect on cash flow. See Note 14 to the
consolidated financial statements for segment data related to funeral home and
cemetery operations.

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, in accordance with prices prevailing at the
time the contract is signed, rather than when the products and services are
delivered. Preneed contracts permit families to eliminate the emotional strain
of making death care plans at the time of need and enable Carriage to establish
a portion of our future market share. Proceeds from the sale of preneed funeral
contracts are not recognized as revenue until the time the funeral service is
performed.

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 built-in escalation clauses
designed to offset future inflationary cost increases. During the early part of
2000, we shifted our focus from the sale of trust-funded contracts to

10

the sale of insurance funded contracts. The shift toward insurance products has
improved the Company's cash flow and reduced the costs associated with the
administration of trust accounts.

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 the emotional strain 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.

In the fourth quarter of 2000, we eliminated the national and regional
preneed funeral marketing organizations and assigned responsibility for preneed
sales to the local funeral home manager. Preneed funeral sales are only
emphasized in those markets that are most competitive. Preneed cemetery sales
are overseen by the regional operating management. As of December 31, 2001, we
employed a staff of 219 advance-planning representatives for the sale of preneed
products and services, which represents an increase of 18% since 1997, but a
reduction from the 290 employed at the end of 2000.

Carriage sold 7,651 and 5,459 preneed funeral contracts during the years
ended December 31, 2000 and 2001, respectively. At December 31, 2001, we had a
backlog of 64,947 preneed funeral contracts to be delivered in the future.
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 9% and 14%. Preneed sales of cemetery interment rights
are recorded as revenue when 10% of the contract amount has been collected.
Merchandise and services revenue is recorded when delivery has occurred. Costs
related to the generation of the preneed contracts and delivery of the products
and services are recognized concurrent with the related revenue. We always
receive an initial payment at the time the contract is signed. Allowances for
customer cancellations and refunds are accrued at the date of sale based upon
historical experience.

Cemetery revenues that originated from preneed contracts represented
approximately 59% and 61% of Carriage's net cemetery revenues for the year 2000
and the year 2001, respectively.

COMPETITION

The operating environment in the death care industry has been highly
competitive. Our publicly traded competitors are Service Corporation
International, Alderwoods Group, Inc. (formerly known as The Loewen
Group, Inc.), and Stewart Enterprises, Inc. In addition, a number of smaller
companies have been active in acquiring and operating funeral homes and
cemeteries.

Our funeral home and cemetery operations generally face competition in the
markets that they serve. Our primary competition in most of our markets is from
local independent operators. 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. The sale of preneed funeral services and cemetery
property has increasingly been used by many companies as a marketing tool to
build market share. Because of the importance of reputation and heritage, market
share increases are usually gained over a long period of time.

There have been some competitors adopting low-end pricing and service
strategies. We also face competition from companies that market products and
related information over the Internet, as well as non-traditional casket stores
in certain markets. We have felt relatively limited impact in certain markets
from these competitors to date.

11

TRUST FUNDS AND INSURANCE CONTRACTS

GENERAL. 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
Carriage. We also use independent professional managers to advise us on
investment matters.

PRENEED FUNERAL TRUSTS AND INSURANCE CONTRACTS. Preneed funeral sales are
facilitated by deposits to a trust or purchase of a third-party insurance
product. All preneed funeral sales are deferred until the service is performed.
The trust fund income earned and any increase in insurance benefits are also
deferred until the service is performed, in order to offset possible inflation
in cost when providing the service in the future. Although direct marketing
costs and commissions incurred from the sale of preneed funeral contracts are a
current use of cash, such costs are also deferred and amortized over the
expected timing of the performance of the services related to the preneed
funeral sales. The related assets 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 $231.9 million and $220.0 million as of
December 31, 2000 and 2001, respectively.

PRENEED CEMETERY MERCHANDISE AND SERVICE TRUSTS. 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 sold on a preneed
basis. The related trust fund income earned is recognized when the related
merchandise and services are delivered. We are 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, were approximately $30.2 million and
$38.1 million as of December 31, 2000 and 2001, respectively.

PERPETUAL CARE TRUSTS. In certain states, regulations require a portion
(generally 10%) of the sale amount of cemetery property and memorials to be
placed in trust. These perpetual care trusts provide the funds necessary to
maintain cemetery property and memorials in perpetuity. The related trust fund
income earned is recognized in current revenues as trust earnings. 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 and therefore, none of
the principal balance is reflected in Carriage's balance sheet. The perpetual
care trust balances were approximately $29.4 million and $29.9 million as of
December 31, 2000 and 2001, respectively.

For additional information with respect to Carriage's trusts, see Note 1 of
the Consolidated Financial Statements.

REGULATION

Our funeral home operations are subject to substantial regulation by the
Federal Trade Commission (the "FTC"). 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.

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

12

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. We are
also subject to the Federal Americans with Disabilities Act and similar laws,
which, among other things, may require that we modify our facilities to comply
with minimum accessibility requirements for disabled persons.

Our operations, including our preneed sales and trust funds, are also
subject to extensive regulation, supervision and licensing under numerous other
federal, state and local laws and regulations. See "Trust Funds."

We believe that we are in substantial compliance with all such laws and
regulations. Federal and state legislatures and regulatory agencies frequently
propose new laws, rules and regulations, some of which, if enacted, could have a
material adverse effect on Carriage's results of operations. We cannot predict
the outcome of any proposed legislation or regulations or the effect that any
such legislation or regulations might have on Carriage.

EMPLOYEES

As of December 31, 2001, the Company and its subsidiaries employed 1,907
employees, of whom 1,023 were full-time and 884 part-time. Included in the total
number of employees are 219 advance planning representatives. All of our funeral
directors and embalmers possess licenses required by applicable regulatory
agencies. We believe that our relationship with our employees is good. No
employees of Carriage or its subsidiaries are members of a collective bargaining
unit.

ITEM 2. PROPERTIES

At December 31, 2001, we operated 148 funeral homes and 30 cemeteries in 29
states. Carriage owns the real estate and buildings for 75% of our funeral homes
and leases facilities for the remaining 25%. Carriage owns 25 cemeteries and
operates 5 cemeteries under long-term contracts with municipalities at
December 31, 2001. Seven funeral homes are operated in combination with
cemeteries. The 30 cemeteries operated by Carriage have an inventory of unsold
developed lots totaling approximately 140,000 and 107,000 at December 31, 2000
and 2001, respectively. In addition, approximately 780 acres are available for
future development. We anticipate having a sufficient inventory of lots to
maintain our property sales for the foreseeable future.

13

The following table sets forth certain information as of December 31, 2001,
regarding Carriage's funeral homes and cemeteries by state:

- ------------------------

(1) The leases, with respect to these funeral homes, have remaining terms
ranging from one to fifteen years, and, generally, we have the right to
renew past the initial terms and a right of first refusal on any proposed
sale of the property where these funeral homes are located.

Carriage's corporate headquarters occupy approximately 32,500 square feet of
leased office space in Houston, Texas.

At December 31, 2001, we operated 662 vehicles, of which 642 are owned and
20 are leased.

The specialized nature of our business requires that our facilities be well
maintained. Management believes that this standard is met.

14

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 us.

We carry insurance with coverages and coverage limits that we believe to be
customary in the funeral home and cemetery industries. Although there can be no
assurance that such insurance will be sufficient to protect us against all
contingencies, we believe that our insurance protection is reasonable in view of
the nature and scope of our operations.

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

None.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Carriage's Class A 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:

As of March 25, 2002, there were 16,912,596 shares of Carriage's Class A
Common Stock and no shares of the Class B Common Stock outstanding. All Class B
Common Stock that was outstanding was automatically converted to Class A Common
Stock on December 31, 2001. The holders of Class B Common Stock were previously
entitled to ten votes for each share held on all matters submitted to a vote of
Common stockholders. The Class A Common Stock shares outstanding are held by
approximately 260 stockholders of record. Each Class A share is entitled to one
vote on matters requiring the vote of shareholders. We believe there are
approximately 4,000 beneficial owners of the Class A Common Stock.

We have never paid a cash dividend on our Common Stock. Carriage currently
intends to retain earnings to finance the growth and development of our business
and does not anticipate paying any cash dividends on our common stock in the
foreseeable future. Any future change in our dividend policy will be made at the
discretion of our Board of Directors in light of the financial condition,
capital requirements, earnings and prospects of Carriage and any restrictions
under credit agreements, as well as other factors the Board of Directors may
deem relevant.

During December 2000, the Company's Board of Directors authorized the
issuance of an aggregate of 365,915 shares of our Class A Common Stock to
executive officers and other key employees of the Company, as bonus grants in
recognition of their performance in 2000, which were paid in 2001. The

15

Company relied upon the exemption provided by Section 4(2) of the Securities Act
of 1933 in issuing the stock.

ITEM 6. SELECTED FINANCIAL DATA

The income statement data presented hereunder for the years 1997 through
1999 was prepared using the accounting principles employed prior to the
implementation of SAB 101 which was effective January 1, 2000.

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

OVERVIEW

Carriage is a leading provider of death care services and products in the
United States. Our historical focus has been on operational enhancements at
facilities currently owned to increase revenues and gross profit, as well as
growth through acquisitions (although this activity was curtailed significantly
beginning in 1999). That focus has resulted in high standards of service,
operational performance, and an infrastructure containing measurement and
management systems. In 2000, the operating strategy was dramatically shifted to
focus upon increasing operating cash flow. In November 2000, we launched a
multi-faceted, restructuring program, called "Fresh Start", which was designed
to increase financial and operating performance, improve cash flow, reduce debt,
and assist Carriage in fulfilling our mission of being the highest quality
funeral and cemetery service organization in the industry. During the fourth
quarter of 2000 and the year 2001, we were focused on executing the elements of
Fresh Start.

The implementation of SAB 101 retroactively effective with the beginning of
the year 2000 had a significant impact on our operating results, particularly on
the accounting for cemetery revenues and costs. The accounting changes are
summarized as follows:

1) Preneed sales of interment rights (burial property)-Revenue and all
costs are now recognized in accordance with the retail land sales
provisions of Statement of Financial Accounting Standards No. 66,
"Accounting for Sales of Real Estate". This method provides that revenue
is recognized in the period in which the customer's cumulative payments
equal or exceeds 10% of the contract price related to the interment
right. Previously, the revenue and costs were recognized at the time of
contract execution with the customer.

2) Preneed sales of merchandise-Revenue and all costs are now recognized
when the merchandise is delivered. Previously, the revenue and costs
were recognized at the time of contract execution with the customer.

3) Preneed sales of cemetery service fees (primarily openings and closings
of burial property and installations of markers)-Revenue and all costs
are deferred until the service is performed. Previously, the revenue and
costs were recognized at the time of contract execution with the
customer.

4) Earnings on cemetery merchandise and services trusts-The trust earnings
are deferred until the underlying merchandise is delivered or the
service is performed. Previously the earnings were recognized as they
were earned on the trust investments.

17

5) Preneed cemetery trust funds-Previously, cemetery trust funds were
netted against preneed liabilities on the balance sheet. The amount of
these trusts, beginning January 1, 2000, are included in the non-current
asset section of the balance sheet.

6) Preneed funeral contracts and deferred preneed funeral contract
revenue-The amount of the preneed funeral contracts receivable, the
amount of the funds deposited in trust and the amount of life insurance
contracts are recognized as an asset on the balance sheet titled
"Preneed funeral contracts". The amount of the preneed funeral contracts
is also recognized in the liability section of the balance sheet titled
"Deferred preneed funeral contracts revenue". Prior to January 1, 2000,
these assets and liabilities were not recorded on the balance sheet.

The following table presents selected financial data for the years 1997
through 1999 on a pro forma basis assuming the application of the change in
accounting principle at the beginning of the earliest year presented:

All of the following 1997 through 1999 amounts, and comparisons thereto in
the Overview, Results of Operations and Year Ended December 31, 2000 Compared to
Year Ended December 31, 1999 sections, have been adjusted for the pro forma
effect of applying the change in accounting to those periods for comparability.
The principle reason for the change between the revenues and gross profits, when
comparing the results for the year ended December 31, 2000 to the historical
results for the year ended December 31, 1999, is the implementation of SAB 101.

Income from operations, which we define as earnings before special and other
charges, interest and income taxes increased, as a percentage of net revenues,
from 16.0% in 1997 to 20.5% in 1998

18

then decreased to 19.3% in 1999 and to 13.5% in 2000. For the year ended
December 31, 2001, income from operations increased, as a percentage of net
revenues, to 19.4% as a result of sales of poorly performing businesses, cost
containment initiatives, as well as other benefits of Fresh Start. Gross margins
for funeral homes increased from 25.1% in 1997 to 30.0% in 1998 and decreased to
27.9% in 1999 and to 21.1% in 2000 before increasing to 25.3% in 2001. As a
percentage of cemetery net revenues, cemetery gross profit has steadily
increased from 9.8% in 1997, to 13.6% in 1998, to 14.7% in 1999, and to 15.0% in
2000, then increased dramatically to 23.1% in 2001 as a result of revenues
increasing 8.1% and a lower cost structure in 2001.

We experienced significant growth after the end of 1996 when we owned 86
facilities. We acquired 54 facilities in 1997, 55 facilities in 1998, 31
facilities in 1999 and two additional facilities in 2000. In a deliberate and
managed process, we increased personnel and related infrastructure as a function
of the increase in our revenue run-rate. As a consequence, general and
administrative expenses increased from $5.3 million in 1997; to $7.6 million in
1998; to $9.3 million in 1999, excluding the special charge of $2.5 million; to
$10.3 million in 2000, excluding the special and other charges totaling
$102.3 million; and decreased to $8.7 million in 2001. However, general and
administrative expenses, as a percentage of revenues over these periods, were
7.1% in 1997, 6.9% in 1998, 6.0% in 1999, exclusive of the special charge, 6.3%
in 2000, exclusive of the special and other charges and 5.4% in 2001. A key
element of the Fresh Start program was the downsizing of our corporate
organization, which was completed during the fourth quarter of 2000.

During 1997, we acquired 44 funeral homes and ten cemeteries for an
aggregate consideration of approximately $118 million. We acquired 48 funeral
homes and seven cemeteries during 1998 for approximately $159 million. During
1999, we acquired 17 funeral homes and 14 cemeteries for an aggregate
consideration of approximately $45 million. We funded these acquisitions through
cash flow from operations, additional borrowings under our credit facilities and
issuance of preferred and common stock. During 1999, we reduced the prices we
were willing to pay for businesses as compared to the two most recent years,
which resulted in a decline in acquisitions and related spending for 1999. In
2000, acquisition activity was limited to one funeral home and a long-term
agreement to manage a municipal cemetery. We did not acquire any new businesses
in 2001.

By the middle of 2000 it became clear that we were losing market share in
certain of our markets and costs were not being reduced where we were losing
business. As part of our Fresh Start program, a rigorous review of the funeral
home and cemetery businesses was conducted during the third and fourth quarter
of 2000, and our businesses were stratified into three groups: core,
underperforming and targeted for sale. An estimate of the fair value less costs
to sell was determined for each of the businesses that are categorized as
targeted for sale. Impairment charges aggregating approximately $29.3 million
are included in special and other charges in the 2000 Consolidated Statement of
Operations for those businesses targeted for sale to reduce the carrying value
to the estimated fair value less costs to sell. Since Fresh Start was initiated,
we have sold 27 funeral homes, 12 cemeteries and 9 parcels of excess real estate
for approximately $17 million of net proceeds. Long-term cash flow forecasts
were prepared to evaluate the carrying value for those businesses categorized as
underperforming. In those instances in which our investment in the long-lived
assets of particular businesses was determined to exceed estimated future cash
flows, the investment was written down, through an impairment charge, to the
present value of those future cash flows. Impairment charges totaling
$51 million are also included in Special and other charges in the 2000 Statement
of Operations for the businesses that are categorized as underperforming.

In the 2000 Consolidated Statement of Operations, other items included in
special and other charges, that totaled $18.4 million, consists of costs related
to employee terminations as a result of downsizing the corporate organization,
accruals for office closures, write-offs of other assets and adjustments to
depreciation and amortization that resulted from restructuring actions.

19

Special charges totaling approximately $7.5 million and $4.4 million are
included in accounts payable and accrued liabilities in the accompanying
consolidated balance sheet at December 31, 2000 and 2001, respectively.

RESULTS OF OPERATIONS

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

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

The following is a discussion of the Company's results of operations in
1999, 2000 and 2001. For purposes of this discussion, the Company's locations
are in three groups, as a result of the stratification of our funeral home and
cemetary portfolios in 2000. A "core" group which represents approximately
two-thirds of our revenues and cash flow, a second "underperforming" group, and
a third group consisting of businesses that are "targeted for sale."
Additionally, funeral homes and cemetaries owned and operated for the entirety
of each period being compared are referred to as "existing operations."

20

YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000

Funeral Home Segment. The following sets forth certain information
regarding Carriage's net revenues and gross profit from our funeral home
operations during the years ended December 31, 2000 and 2001:

- ------------------------

* Not meaningful.

Funeral same-store revenues for the year ended December 31, 2001 were up
2.2% when compared to the year ended December 31, 2000, as we experienced a
decrease of 0.9% in the number of services and an increase of 3.1% in the
average revenue per service for those existing operations. The lower total net
revenues were primarily a result of the decline in revenues related to the
businesses that we have sold during 2000 and 2001. The number of funeral
services decreased 1.5% for the core group in comparing 2001 to 2000, while the
average revenue per service for those existing locations increased 3.0% in
comparing the two years. The number of funeral services for the underperforming
group decreased 0.1% while the average revenue per service increased 3.4% in
comparing 2001 to 2000.

In addition to the net revenues from funeral location operations above,
insurance commission revenues from preneed funeral contract sales totaled
$2.0 million and $3.7 million for the years ended December 31, 2000 and 2001,
respectively. Revenue in 2001 included higher than normal level of commissions
resulting from the conversion of previously sold trust funded contracts to
insurance funded contracts. Commissions received from new sales of preneed
funeral insurance were also higher than in 2000. These commissions are recorded
when they have been held beyond their refund period, which is generally one
year. The shift in preneed marketing strategy which led to a year-over-year
decline in preneed funeral sales during 2001, and the one-year lag in reporting
commissions received as revenue, are expected to result in a decrease in 2002
revenue and gross profit from preneed insurance commissions of approximately
$1.3 million.

Total funeral same-store gross profit for the year ended December 31, 2001
increased $2.9 million or 12.0% from the year ended December 31, 2000. The
higher gross profit is due primarily to

21

depreciation and amortization that was $3.1 million less than the prior period
due to the impairments recorded in the latter half of 2000.

Cemetery Segment. The following sets forth certain information regarding
Carriage's net revenues and gross profit from cemetery operations for the years
ended December 31, 2000 and 2001:

- ------------------------

* Not meaningful.

Cemetery same-store net revenues for the year ended December 31, 2001
increased $3.6 million over the year ended December 31, 2000, and cemetery
same-store gross profit increased $3.0 million over the year 2000. The higher
same-store net revenues resulted primarily from an increase of $3.1 million from
core operations. The higher same-store gross profit reflected an increase of
$2.6 million from core operations and $0.4 million from cemeteries that have
been targeted for sale. Total gross margin increased from 15.0% for the year
ended December 31, 2000 to 23.1% for the year ended December 31, 2001, primarily
due to a higher level of deliveries of previously contracted preneed merchandise
and services, increased property sales and improved business practices.

Other

General and administrative expenses for the year ended December 31, 2001,
decreased $1.6 million or 15.2% from 2000. As a percentage of net revenues,
general and administrative expenses decreased from 6.3% in 2000 to 5.4% in 2001
resulting from the downsizing of the corporate organization and other cost
saving initiatives of Fresh Start.

Interest expense and financing costs for the year ended December 31, 2001,
decreased $0.4 million or 1.7% from 2000. While the average debt outstanding
during 2001 was less than the average debt outstanding during 2000, we
experienced higher amortization of loan costs in 2001 due to debt modification
fees incurred late in the year 2000. Additionally, the amount of interest
capitalized on construction in progress declined from $621,000 in 2000 to
$298,000 in 2001.

There were no special charges for the year ended December 31, 2001. Special
charges and other charges for the year ended December 31, 2000, were
$102.3 million as discussed in the "Overview" section above.

Preferred dividends of $81,000 for 2000 and $37,000 for 2001 were subtracted
from net income in computing earnings attributable to common stockholders for
purposes of computing basic and diluted earnings per common share.

22

We provided for tax benefits and income taxes on income before income taxes
at a combined state and federal tax rate of 7.9% and 20.0% for the years ended
December 31, 2000 and 2001, respectively. The sale of properties in 2000 and
2001 generated substantial losses for income tax purposes. The low tax rate for
the year 2000 was due to the limitation on the tax benefit, of the losses
deducted in 2000, to the amount that can reasonably be expected to be refunded
in the foreseeable future from carrybacks of the tax loss. The rate for 2001
benefited from the utilization of tax benefits that were generated in the fourth
quarter of 2000, those tax benefits are recognized when realized through taxable
income. We will continue to evaluate the realizability of the valuation
allowance for deferred taxes in each future reporting period. If the valuation
allowance is determined to be realizable, the allowance will be reversed and the
ongoing effective tax rate will increase to a tax rate that is closer to 37%.

Effective October 1, 2001, we changed the period over which we recognize the
costs of obtaining preneed sales contracts to more closely track actuarial
statistics provided by a third party administrator based on the actual contracts
held by Carriage. The effect of this change was to reduce expense in the fourth
quarter of 2001 by approximately $0.5 million from that which would have been
recorded using the prior methodology.

YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999

Funeral Home Segment. The following table sets forth certain information
regarding Carriage's net revenues and gross profit from our funeral home
operations during the years ended December 31, 1999 and 2000:

Existing operations performed 504 (2.5%) fewer services in 2000, compared to
1999, at an average price that was $12 higher than 1999, resulting in a decrease
in revenue of $2,481,000 from 2000 to 1999. Acquired operations provided an
increase in revenue of $5,869,000, and there was a decrease in revenue in
comparing 2000 to 1999 of $1,245,000 because of businesses that were sold or
discontinued during the period.

The impact on field level revenues by the three groups was as follows:

Gross profit decreased from 1999 to 2000 primarily because of the operating
results of the underperforming and targeted for sale groups and higher operating
costs that we did not effectively pass through by way of higher prices to the
consumer. Within our existing businesses, the decline in gross profit was very
pronounced in the underperforming and targeted for sale groups. Higher

23

operating costs occurred in the form of casket and merchandise price increases,
insurance increases, as well as general inflation in salaries and wages.
Additionally, depreciation and amortization were higher in 2000, compared to
1999.

Cemetery Segment. The following sets forth certain information regarding
Carriage's net revenues and gross profit from cemetery operations for the years
ended December 31, 1999 and 2000:

Cemeteries acquired in 1999 and 2000 contributed additional revenues of
approximately $4 million and attributed to the majority of the increase in gross
profit.

Other

General and administrative expenses for the year ended December 31, 2000,
increased $1.0 million or 10.7% over 1999. As a percentage of net revenues,
general and administrative expenses increased from 6.0% in 1999 to 6.3% in 2000.

Interest expense for the year ended December 31, 2000, increased
$3.3 million or 19.3% over 1999 resulting from higher financing costs and
interest rates, and higher debt levels resulting from the prior year
acquisitions.

Preferred dividends of $93,000 for 1999 and $81,000 for 2000 were subtracted
from net income in computing earnings attributable to common stockholders for
purposes of computing basic and diluted earnings per common share.

Carriage provided for income taxes and tax benefits on income before income
taxes and extraordinary item at a combined state and federal tax rate of 43.8%
and 7.9% for the years ended December 31, 1999 and 2000, respectively.
Amortization of goodwill related to certain acquisitions, which is
nondeductible, is the primary cause of our effective rate exceeding the combined
federal and state statutory income tax rates in 1999. The sale of properties in
2000 generated substantial losses for income tax purposes. The low tax rate for
the year 2000 is due to the limitation on the tax benefit, of those losses, to
the amount that can reasonably be expected to be refunded in the foreseeable
future from carrybacks of the tax loss.

LIQUIDITY AND CAPITAL RESOURCES

For the year ended December 31, 2001, cash provided by operations was
$27.7 million as compared to $16.9 million for the year ended December 31, 2000.
The improvement came despite the divestiture of a significant number of
properties in 2001. Specifically, we decreased corporate overhead, spent
$6.3 million less in our preneed programs and accelerated collections of
accounts receivable and trust distributions from matured preneed contracts.
Pretax free cash flow from operations increased

24

from $1.7 million in 2000 to $18.2 million in 2001 benefiting from a lower level
of capital expenditures as indicated below:

Refer to the consolidated statements of cash flows for a detail of all items
effecting cash flows during the three years ended December 31, 2001.

Cash provided by investing activities was $6.8 million for the year ended
December 31, 2001 compared to cash used by investing activities of
$18.5 million in 2000, primarily because of the lower capital expenditures and
higher proceeds from sales of businesses in 2001 as compared to 2000. In 2001,
cash flow used by financing activities amounted to approximately $35.0 million,
primarily due to the payments to reduce our debt, a critical element in our
Fresh Start restructuring program. As part of the purchase price consideration
in the acquisition of certain funeral homes and cemeteries, we issued shares of
common stock and guaranteed the stock would trade at certain agreed-upon levels.
At December 31, 2001, the Company had two remaining contingent stock price
guarantees payable to prior owners outstanding totaling $5.3 million which are
scheduled to be paid during the first quarter of 2002. Aside from these
obligations, the Company currently intends to utilize the majority of free cash
flow and proceeds from the sale of assets to reduce the amount of debt
outstanding and thereby improve credit ratios. Cash and cash equivalents totaled
$2.7 million at December 31, 2001, representing a decrease of $466,000 from
December 31, 2000.

On June 3, 1999, the Company's subsidiary, Carriage Services Capital Trust,
completed the sale of 1,875,000 units of 7% convertible preferred securities,
with a maturity in 30 years, resulting in approximately $90 million in net
proceeds that are included in the Company's consolidated balance sheets as
Company-obligated mandatorily redeemable convertible preferred securities of
Carriage Services Capital Trust. Dividends are tax deductible and may be
deferred at our option for up to five years. For purposes of debt ratios, under
our revolving credit and senior note agreements, the convertible preferred
securities are treated as equity.

On July 1, 1999, the Company issued $110 million in senior debt notes for
which $102 million is outstanding at December 31, 2001. The notes are unsecured,
mature in traunches of $23 million in 2004, $56 million in 2006 and $23 million
in 2008 and bear interest at the fixed rates of 7.73%, 7.96% and 8.06%,
respectively.

As of December 31, 2000, we had 1,182,500 shares of Series D Preferred Stock
issued and outstanding. During 2001, we redeemed 1,000,000 shares in a noncash
exchange in connection with the sale of certain businesses to the holder of
those shares at value of $1.00 per share. Effective December 31, 2001, we
redeemed the remaining 182,500 shares at a redemption price of $1.00 per share.

At December 31, 1999, the Company had a credit facility with a group of
banks for a $260 million revolving line of credit. On November 6, 2000, we
modified our credit agreement to include a reduction in our bank revolving
credit facility from $260 million to $100 million. The reduction in the
revolving credit capacity reflected our intention to not make any additional
large acquisitions and, therefore we did not wish to continue paying a
commitment fee for availability above $100 million.

25

With $32.0 million outstanding and $68.0 million available under our revolving
credit facility at December 31, 2001, the Company is currently positioned with
adequate financial liquidity. We have no significant maturities until 2004 and
expect to have sufficient free cash flow to satisfy or refinance our scheduled
maturities as they occur. At December 31, 2001, the Company's debt to total
capitalization was 47.8 percent.

The Company's credit facility and senior note modifications in late 2000
included new covenants containing the following: (1) flexibility in the minimum
net worth requirement to allow for the restructuring charges taken as part of
the Fresh Start Initiative; (2) the addition of a limit on the maximum ratio of
debt to earnings before interest, taxes, depreciation and amortization, which
becomes more restrictive over time; and (3) the addition of a provision limiting
acquisitions above a certain size without prior approval. While the Company
projects that we will be able to stay within our financial covenants, there is
no assurance that we will be successful in doing so.

Related modifications to the senior note agreement additionally require that
a significant portion of any proceeds from the sales of assets be offered to the
note holders as prepayment of the amounts outstanding. These prepayments are
made at par value. During 2001 prepayments were made in the amount of
$8.0 million related to the proceeds from the sales of assets.

We do not have any liquidity sources or financing arrangements with
unconsolidated or limited purpose entities in which we may be economically or
legally required or reasonably likely to fund losses of an unconsolidated,
limited purpose entity, provide it with additional funding, issue securities
pursuant to a call option held by that entity, purchase the entity's capital
stock or assets, or otherwise may be financially affected by the performance or
non-performance of an entity or counterparty to a transaction or arrangement.

During 2000 the Company modified its approach to marketing preneed funeral
contracts to: (1) emphasize insurance products over trust products;
(2) eliminate the national and regional overhead management structure: and
(3) outsource a significant portion of the administration. These changes
significantly reduced the cash investment that has historically been required to
generate this backlog of business. In 1999, $49.1 million of preneed funeral
sales were generated for a cash outlay of $9.5 million. In 2000, $33.7 million
of preneed funeral sales were generated for a cash outlay of $6.0 million. In
2001, $23.9 million of preneed funeral sales were generated for a cash outlay of
$2.1 million.

During the twelve months ended December 31, 2001, the Company incurred
approximately $5.0 million in capital expenditures, primarily related to
refurbishing and improving funeral home facilities and construction of lawn
crypts and mausoleums at cemeteries. The Company believes that cash flow from
operations and borrowings under the credit facility should be sufficient to fund
anticipated capital expenditures as well as other ongoing operating
requirements. During 2000, the Company spent approximately $2 million for the
acquisition of a cemetery municipal agreement, one funeral home and other
acquisition related activity. Acquisition spending during 2001 was limited to a
performance-based contingent consideration payment on a prior year acquisition.
The Company anticipates that the capital expenditures in 2002 will primarily be
limited to those that are required to maintain the revenue capability of its
existing businesses. It does not anticipate making significant capital
expenditures to grow or enhance new revenue streams or acquire new businesses.
Other commitments for investing activities for 2002 include the final payment in
the amount of $1,040,442 related to a performance-based contingent purchase
price payment. Because future cash flows and the availability of financing are
subject to a number of variables, there can be no assurance that the Company's
capital resources will be sufficient to fund its capital needs. Additional debt
and equity financings may be required in the future. The availability and terms
of these capital sources will depend on prevailing market conditions and
interest rates and the then-existing financial condition of the Company.

26

The following table summarizes our obligations and commitments to make
future payments under contracts, such as debt and lease agreements, as well as
other financial commitments. Where appropriate we have indicated the footnote to
our annual consolidated financial statements where additional information is
available.

RELATED PARTY TRANSACTIONS

Two of the Company's directors are prior owners of previously unrelated
businesses that Carriage acquired in 1997. As an incentive, the Company entered
into arrangements with the directors to pay them 10% of the amount by which the
annual field level cash flow exceeds predetermined targets on certain businesses
in their respective geographic region through 2008, with a final payment equal
to a multiple of six times the average of the last three years payments. The
business purpose of the arrangements was to incentivise the directors to provide
Carriage with high quality acquisition targets and to participate in the
management of those businesses post-acquisition so that cash flows grow over
time. The terms were determined by reference to similar arrangements within the
death care industry. The incentives earned by the two directors totaled $92,000,
$117,000 and $136,000 for the years 1999, 2000 and 2001, respectively.

In connection with the 1997 acquisition of two funeral homes from a group of
individuals, one of which is one of the directors referred to in the preceding
paragraph, a portion of the purchase price of each of those funeral homes was to
be payable based on a formula related to the annual field level cash flows
subsequent to the year of acquisition. The business purpose was to determine the
final purchase prices of the acquisitions since both were expected to show
strong growth in cash flow. The terms were negotiated by the sellers, one of
which later was appointed to director of Carriage. The contingent purchase price
payments paid to the director totaled $524,107 and $47,673 during the years 2000
and 2001, respectively. The final contingent purchase price payment totals
$1,040,442, of which $572,107 is payable to the director in March 2002.

The Company rents office space, at an annual rate of $19,000 per year
through 2005, from an entity in which one of the Company's directors has a
financial interest. The terms were determined by reference to rentals of similar
office space in the area.

ACCOUNTING CHANGES

(A) PRENEED REVENUES AND COSTS

In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101--"Revenue Recognition in Financial Statements" (SAB
101). This SAB deals with various revenue recognition issues; certain ones of
which are pertinent to the death care industry. As a result,

27

we have changed our method of recognizing preneed revenues and certain related
costs of originating preneed cemetery contracts. SAB 101 was effective as of the
beginning of 2000, but because of extensions to allow for implementation, we
implemented the changes beginning with the fourth quarter of 2000 and restated
quarters 1 through 3 in our annual report on Form 10-K for the year ended
December 31, 2000.

Previously, we had recognized sales of cemetery interment rights, together
with associated merchandise and services as revenues at the time contracts were
signed. Costs related to the sales of interment rights were charged to
operations using the specific identification method. The costs for cemetery
merchandise and services sold, but not delivered, was previously accrued as an
expense at the time the cemetery revenue was recognized. Trust income on
cemetery merchandise and service trusts was recognized when earned by the trust.

Under the new accounting principle, we follow Statement of Financial
Accounting Standards No. 66, "Accounting for Sales of Real Estate", in
recognizing the revenue from the sales of cemetery interment rights. Under this
method, revenue is generally recognized in the period when the customer's
payments equal or exceed 10% of the contract price related to the interment
right. Costs related to the sales of interment rights are charged to operations
using the specific identification method in the period in which the sale of the
interment right is recognized as revenue. Revenues and costs related to the
sales of cemetery merchandise and services, and earnings from the related trust
funds, are deferred until the period in which the merchandise is delivered or
the service is provided.

The Company recorded a non-cash charge of approximately $39.0 million, after
reduction for income taxes of approximately $21 million, or $2.43 per share, to
reflect the cumulative effect of the change in accounting principle as of the
beginning of 2000. The effect of this change on the nine months ended
September 30, 2000, before the cumulative effect of the accounting change, was
to decrease net income $3.3 million, or $.21 per diluted share. The revenue not
recognized is included in the accompanying consolidated balance sheet in the
caption "Deferred revenue and preneed liabilities".

(B) DERIVATIVE FINANCIAL INSTRUMENTS

The Financial Accounting Standards Board (FASB) has issued Statement of
Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities", for which the effective date was deferred
to years beginning after June 15, 2000 by SFAS No. 137, and amended by SFAS
No. 138 to establish accounting and financial reporting standards for certain
derivative instruments and certain hedging activities. The key provisions of
SFAS No. 133, as amended, are that certain derivatives will be recognized as an
asset or liability at their fair value and that later changes in fair value are
generally reported in earnings or other comprehensive income. The Company is
currently engaged in interest rate swaps which have a notional amount of
$30 million to hedge against rising interest rates on its variable rate
long-term debt.

The Company recorded a non-cash benefit of $1,000, net of related income tax
benefit, in the consolidated statement of comprehensive income to reflect the
cumulative effect of the change in accounting principle as of the beginning of
2001.

The Company recorded non-cash charges of approximately $1.1 million,
excluding the related income tax benefit, in the consolidated statement of
comprehensive income and $180,000, before related tax benefit, in the
consolidated statements of operations to record the changes in the liability for
the interest rate swaps during the year ended December 31, 2001.

(C) 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. Such

28

amounts are amortized over 40 years using the straight-line method. Many of our
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. Carriage reviews the carrying value of Goodwill at
least quarterly on a location-by-location basis to determine, if facts and
circumstances exist which would suggest that this intangible asset might be
impaired or that the amortization period needs to be modified. If indicators are
present which indicate impairment may be present, we have prepared a projection
of the undiscounted cash flows of the location to determine if the intangible
assets, as well as the investment in other long-lived assets, are recoverable
based on these undiscounted cash flows. If impairment was indicated, then an
adjustment was made to reduce the carrying amount of Goodwill and other
long-lived assets to their fair value. During the year ended December 31, 2000,
approximately $61.6 million of impairments were recorded against Goodwill (see
Note 7).

In June 2001, the FASB issued SFAS No. 141, "Business Combinations" and SFAS
No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141 addresses
financial accounting and reporting for goodwill and other intangible assets
acquired in a business combination at acquisition. SFAS No. 142 addresses how
intangible assets that are acquired individually or with a group of other assets
(but not those acquired in a business combination) should be accounted for in
financial statements upon their acquisition. This Statement also addresses how
goodwill and other intangible assets should be accounted for after they have
been initially recognized in the financial statements.

The provisions of SFAS No. 141 apply to all business combinations initiated
after June 30, 2001. The provisions also apply to all business combinations
accounted for using the purchase method for which the date of acquisition is
July 1, 2001 or later.

The provisions of SFAS No. 142 are required to be applied starting with
fiscal years beginning after December 15, 2001. Goodwill and intangible assets
acquired after June 30, 2001, were subject immediately to the amortization
provisions of this Statement. We adopted SFAS No. 142 on January 1, 2002.

The effect of SFAS No. 142 on the Company will be the elimination of the
amortization of goodwill, which is currently being amortized over 40 years, and
the testing for impairments of goodwill on an annual basis. The Company
estimates that the proforma earnings, excluding goodwill amortization, for 2001
would have been earnings of $0.71 per diluted share, compared to a proforma loss
of $0.35 per diluted share for 2000. While we have not yet completed our review
of goodwill, we have no reason to believe that any impairment will be required,
primarily because of the extensive review and related impairment charges
recorded in 2000 as part of Fresh Start.

(D) IMPAIRMENT OF LONG-LIVED ASSETS

In August 2001 the FASB issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets". SFAS No. 144 addresses financial accounting
and reporting of long-lived assets, other than goodwill, that are to be disposed
by sale or otherwise, and is effective for financial statements issued for
fiscal years beginning after December 15, 2001. The Company believes that the
implementation of SFAS No. 144 will not have a material effect on the Company's
financial position or results of operations.

SEASONALITY

Although the death care business is relatively stable and fairly
predictable, our business can be affected by seasonal fluctuations in the death
rate. Generally, death rates are higher during the winter months.

29

INFLATION

Inflation has not had a significant impact on the results of Carriage's
operations during the last three years.

ITEM 7A. QUANTITATIVE AND QUALITATIVE MARKET RISK DISCLOSURE

Carriage is exposed to market risk primarily related to potential adverse
changes in interest rates as discussed below. Management is actively involved in
monitoring exposure to market risk and developing and utilizing appropriate risk
management techniques. We are not exposed to any other significant market risks
including commodity price risk, nor foreign currency exchange risk.

Carriage is currently exposed to market risk from changes in interest rates.
Our variable rate long-term borrowings primarily consist of the $32 million
outstanding under our $100 million floating rate line of credit maturing in
2004. Any change in the floating rate will cause a change in interest expense.
We seek to minimize the risk that interest rates will increase by entering into
interest rate swap transactions. As of December 31, 2001, we were engaged in two
interest rate swaps in which we exchange the floating rate payments for fixed
rate payments at 90-day intervals. The interest rate swaps have a combined
notional amount of $30 million, mature in 2003, and have a weighted average
fixed rate of 5.5475% and a fair value of ($1,238) at December 31, 2001. The
fair value of the swaps are recorded as a liability in the balance sheet at
December 31, 2001. Any decrease in market interest rates, assuming all other
things being equal, causes the fair value of our interest rate swaps to
decrease. The remainder of Carriage's long-term debt and leases consist of
non-interest bearing notes and fixed rate instruments. Any increase in market
interest rates causes the fair value of those liabilities to decrease.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements and supplementary data required by this Item 8 are
incorporated under Item 14 in Part IV of this report.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by Item 10 is incorporated by reference to the
Registrant's definitive proxy statement relating to its 2002 annual meeting of
shareholders, which proxy statement will be filed pursuant to Regulation 14A of
the Securities Exchange Act of 1934, as amended (the "Exchange Act"), within
120 days after the end of the last fiscal year.

ITEM 11. EXECUTIVE COMPENSATION

The information required by Item 11 is incorporated by reference to the
Registrant's definitive proxy statement relating to its 2002 annual meeting of
shareholders, which proxy statement will be filed pursuant to Regulation 14A of
the Exchange Act within 120 days after the end of the last fiscal year.

30

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by Item 12 is incorporated by reference to the
Registrant's definitive proxy statement relating to its 2002 annual meeting of
shareholders, which proxy statement will be filed pursuant to Regulation 14A of
the Exchange Act within 120 days after the end of the last fiscal year.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by Item 13 is incorporated by reference to the
Registrant's definitive proxy statement relating to its 2002 annual meeting of
shareholders, which proxy statement will be filed pursuant to Regulation 14A of
the Exchange Act within 120 days after the end of the last fiscal year.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) 1 FINANCIAL STATEMENTS

The following financial statements and the Report of Independent Public
Accountants are filed as a part of this report on the pages indicated:

(a) 2 FINANCIAL STATEMENT SCHEDULES

The following Financial Statement Schedule and the Report of Independent
Accountants on Financial Statement Schedule are included in this report on the
pages indicated:

All other schedules are omitted as the required information is inapplicable
or the information is presented in the consolidated financial statements or
related notes.

(a) 3 EXHIBITS

The exhibits to this report have been included only with the copies of this
report filed with the Securities and Exchange Commission. Copies of individual
exhibits will be furnished to stockholders upon written request to Carriage
Services, Inc. and payment of a reasonable fee.

- ------------------------

(*) Filed herewith.

(b) REPORTS ON FORM 8-K

None

34

SIGNATURES

PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT ON ITS BEHALF
BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED ON MARCH 28, 2002.

CARRIAGE SERVICES, INC.

By: /s/ MELVIN C. PAYNE
----------------------------------------------
Melvin C. Payne
CHAIRMAN OF THE BOARD, CHIEF EXECUTIVE OFFICER,
AND PRESIDENT

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Registrant and
on the dates indicated.

35

CARRIAGE SERVICES, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

36

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Carriage Services, Inc.

We have audited the accompanying consolidated balance sheets of Carriage
Services, Inc. (a Delaware corporation) and subsidiaries as of December 31, 2000
and 2001 and the related consolidated statements of operations, comprehensive
income (loss), changes in stockholders' equity and cash flows for each of the
three years in the period ended December 31, 2001. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.

We conducted our audits in accordance with auditing standards generally
accepted in the 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 financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Carriage
Services, Inc., and subsidiaries as of December 31, 2000 and 2001, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2001 in conformity with accounting
principles generally accepted in the United States.

As explained in Note 2 to the consolidated financial statements, the Company
changed, effective January 1, 2000, its method of accounting for revenue and
costs related to sales of cemetery interment rights, together with the
associated merchandise and services, and the related trust earnings, as well as
the balance sheet presentation of preneed funeral contracts to conform to the
Securities and Exchange Commission's Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial Statements".

ARTHUR ANDERSEN LLP

Houston, Texas
March 10, 2002

37

CARRIAGE SERVICES, INC.

CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS, EXCEPT SHARE DATA)

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

38

CARRIAGE SERVICES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT PER SHARE DATA)

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

39

CARRIAGE SERVICES, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(IN THOUSANDS)

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

40

CARRIAGE SERVICES, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

(IN THOUSANDS)

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

41

CARRIAGE SERVICES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

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

42

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BUSINESS

Carriage Services, Inc. ("Carriage" or the "Company") was founded in 1991
and incorporated under the laws of the State of Delaware on December 29, 1993.
The Company owns and operates funeral homes and cemeteries throughout the United
States. The Company provides professional services related to funerals and
interments at its funeral homes and cemeteries. Preneed funerals and preneed
cemetery property are marketed in the geographic markets served by Carriage's
locations.

PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION

The financial statements include the consolidated financial statements of
Carriage Services, Inc. and its subsidiaries. In consolidation, all significant
intercompany balances and transactions have been eliminated. Certain prior year
amounts in the consolidated financial statements have been reclassified to
conform to current year presentation.

The accounting policies and procedures reflected herein have been
consistently followed during the periods presented, except for the change in
accounting principle discussed in Note 2. The discussion included in the summary
of significant accounting policies reflects the Company's current policies and
principles for year 2000 and 2001 as a result of the Company's application of
the Securities and Exchange Commission Staff Accounting Bulletin
No. 101--"Revenue Recognition in Financial Statements" (SAB 101), which was
adopted effective January 1, 2000. Prior periods presented are not required to
be restated for such change in accounting principle. See Note 2 for a discussion
of the accounting principle change and its cumulative effect as of January 1,
2000, and our discussion of the nature of the accounting principle change
compared to principles applied in years prior to 2000.

FUNERAL AND CEMETERY OPERATIONS

The Company records the sales of funeral merchandise and services upon
performance of the funeral service. 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.
Allowances for customer cancellations, refunds and bad debts are provided at the
date of sale based on the historical experience of Carriage. In addition, the
Company monitors changes in delinquency rates and provides additional bad debt
and cancellation reserves when warranted. When preneed funeral services and
merchandise are funded through third-party insurance policies, the Company earns
a commission on the sale of the policies. Insurance commissions are recognized
as revenues at the point at which the commission is no longer subject to refund.
Accounts receivable-Trade, net consists of approximately $12.9 million and
$8.6 million of funeral receivables and approximately $5.1 million and
$7.0 million of current cemetery receivables at December 31, 2000 and 2001,
respectively. Non-current cemetery receivables, those payable after one year,
are included in Deferred charges and other non-current assets on the
consolidated balance sheets. The non-current cemetery accounts receivable
balances, net of amounts in assets held for sale, were approximately
$20.4 million and $16.6 million at December 31, 2000 and 2001, respectively (see
Note 4).

43

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
PRENEED FUNERAL CONTRACTS

Preneed funeral sales are affected by deposits to a trust or purchase of a
third-party insurance product. Pursuant to SAB 101 implementation, unperformed
guaranteed preneed funeral contracts are included in the consolidated balance
sheets as Preneed funeral contracts. The balance in this asset account
represents amounts due from customer receivables and third-party insurance
companies, and the amounts deposited with the trustee and the accumulated
earnings on these deposits. A corresponding credit is recorded to Deferred
preneed funeral contracts revenue. The funeral revenue is not recorded until the
service is performed. The trust income earned and the increases in insurance
benefits on the insurance products are also deferred until the service is
performed, in order to offset inflation in cost to provide the service in the
future. The preneed insurance products totaled approximately $150.9 million and
$146.0 million and the preneed funeral trust assets were approximately
$91.4 million and $89.9 million at December 31, 2000 and 2001, respectively,
which in the opinion of management, exceeds the estimated future cost to perform
services and provide products under such arrangements. The types of instruments
in which the trusts may invest are regulated by state agencies.

The components of preneed funeral contracts in the consolidated balance
sheet at December 31 are as follows (in thousands):

The following summary reflects the composition of the assets held in trust
to satisfy Carriage's future obligations under preneed funeral arrangements. The
cost basis includes interest and dividends

44

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
that have been earned on the trust assets. Fair value includes unrealized gains
and losses on trust assets.

DEFERRED PRENEED FUNERAL CONTRACTS REVENUE

Deferred preneed funeral contracts revenue represents the original contract
price, trust earnings and increasing insurance benefits on unperformed
guaranteed preneed funeral contracts. The amount of unperformed preneed funeral
contracts to be funded by trust or third-party insurance companies are included
in Deferred preneed funeral contracts revenue in the consolidated balance
sheets.

PRENEED CEMETERY MERCHANDISE AND SERVICE TRUST FUNDS

Carriage is also generally required, by certain states, to deposit a
specified amount into a merchandise and service trust fund for cemetery
merchandise and service contracts sold on a preneed basis. The principal and
accumulated earnings of the trust may be withdrawn by us upon maturity
(generally, the death of the purchaser) or cancellation of the contracts. Trust
fund investment income is recorded to deferred revenue as trust earnings accrue
in the trusts, and recognized in current revenues

45

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
in the period the service is performed or merchandise delivered. Merchandise and
service trust fund balances were comprised of the following at December 31, 2000
and 2001, respectively:

PERPETUAL AND MEMORIAL CARE TRUST

In accordance with respective state laws, the Company is required to deposit
a specified amount into perpetual and memorial care trust funds for each
interment/entombment right and memorial sold. Income from the trust fund is used
to provide care and maintenance for the cemeteries and mausoleums and is
periodically distributed to Carriage and recognized as revenue when realized by
the trust. The perpetual and memorial care trust assets were approximately
$29.4 million and $29.9 million at December 31, 2000 and 2001, respectively,
which, in the opinion of management, will cover future obligations to provide
care and maintenance for our cemeteries and mausoleums. The Company does not
have the right to withdraw any of the principal balances of these funds and,
accordingly, these trust fund balances are not reflected in the accompanying
consolidated balance sheets.

DEFERRED OBTAINING COSTS

Deferred obtaining costs consist of sales commissions and other direct
related costs of originating preneed sales contracts. These costs are deferred
and amortized in funeral and cemetery costs and expenses over the expected
timing of the performance of the services or delivery of the merchandise covered
by the preneed contracts (see Note 4). Effective October 1, 2001, the Company
changed the period over which the costs are recognized to more closely track
actuarial statistics, provided by a third party administrator, based on the
actual contracts held by Carriage. The effect of this change was to reduce
expense in the fourth quarter of 2001 by approximately $0.5 million from that
which would have been recorded using the prior methodology.

46

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
CASH AND CASH EQUIVALENTS

Carriage considers all highly liquid investments with an original maturity
of three months or less to be cash equivalents.

DERIVATIVE FINANCIAL SECURITIES

Carriage enters into interest rate swap agreements to reduce the impact of
changes in interest rates on our floating rate debt. The swap agreements are
agreements to exchange floating rates for fixed interest payments periodically
over the life of the agreements without the exchange of the underlying notional
amounts. The differential paid or received is recognized as an adjustment to
interest expense. The Company does not hold or issue financial instruments for
trading purposes. Prior to 2001 and the effective date of SFAS No. 133, the
values of the interest rate swaps were not recorded in the consolidated balance
sheets.

The Financial Accounting Standards Board (FASB) issued SFAS No. 133,
"Accounting For Derivative Instruments and Hedging Activities", for which the
effective date was deferred to years beginning after June 15, 2000 by SFAS
No. 137, and amended by SFAS No. 138 to establish accounting and financial
reporting standards for certain derivative instruments and certain hedging
activities. The key provisions of SFAS No. 133, as amended, are that every
derivative will be recognized as an asset or liability at its fair value and
that later changes in fair value are generally reported in earnings or other
comprehensive income. The Company is currently engaged in interest rate swaps
which have a notional amount of $30 million to hedge against rising interest
rates on its variable rate long-term debt. The swaps have a fair value of
approximately $2,000 and approximately $(1.2) million at December 31, 2000 and
December 31, 2001, respectively. The swaps, which were carried off-balance sheet
prior to 2001, were recorded as an asset when the Company implemented SFAS 133
January 1, 2001. As interest rates change, the value of the interest rate swaps
change. The recorded value of the interest rate swaps is adjusted on the balance
sheet through other comprehensive income for swaps that are designated as hedges
and through current earnings for swaps that are not designated as hedges.

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. Such amounts are amortized over 40 years
using the straight-line method. 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. Carriage
reviews the carrying value of goodwill at least quarterly on a
location-by-location basis to determine, if facts and circumstances exist which
would suggest that this intangible asset might be impaired or that the
amortization period needs to be modified. If indicators are present which
indicate potential impairment Carriage has prepared a projection of the
undiscounted cash flows of the location to determine if the intangible assets,
as well as the investment in other long-lived assets, are recoverable based on
these undiscounted cash flows. If impairment was indicated, then an adjustment
was made to reduce the carrying amount of goodwill and other long-lived assets
to their fair value. During the year ended December 31, 2000, approximately
$61.6 million of impairments were recorded against Goodwill (see Note 7). No
impairments were recorded during the year ended December 31, 2001.

47

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
In June 2001, the FASB issued SFAS No. 141, "Business Combinations" and SFAS
No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141 addresses
financial accounting and reporting for goodwill and other intangible assets
acquired in a business combination at acquisition, requires the use of the
purchase method of accounting and requires the recognition of acquired
intangible assets apart from goodwill if the acquired intangible assets meet
certain criteria. SFAS No. 142 addresses how intangible assets that are acquired
individually or with a group of other assets (but not those acquired in a
business combination) should be accounted for in financial statements upon their
acquisition. This Statement also addresses how goodwill and other intangible
assets should be accounted for after they have been initially recognized in the
financial statements.

The provisions of SFAS No. 141 apply to all business combinations initiated
after June 30, 2001. The provisions also apply to all business combinations
accounted for using the purchase method for which the date of acquisition is
July 1, 2001 or later.

The provisions of SFAS No. 142 are required to be applied starting with
fiscal years beginning after December 15, 2001. Goodwill and intangible assets
acquired after June 30, 2001, were subject immediately to the amortization
provisions of this Statement. Carriage adopted SFAS No. 142 on January 1, 2002.

The effect of SFAS No. 142 on the Company includes the elimination of the
amortization of goodwill which is currently being amortized over 40 years, the
testing for impairments of goodwill on an annual basis and the identification of
reporting units for the purpose of assessing potential future impairments of
goodwill. While the Company has not yet completed the review of goodwill, the
Company has no reason to believe that any impairment will be required, primarily
because of the extensive review and related impairment charges recorded in 2000
as part of Fresh Start.

IMPAIRMENT OF LONG-LIVED ASSETS

In August 2001 the Financial Accounting Standards Board issued SFAS
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS
No. 144 addresses financial accounting and reporting of long-lived assets, other
than goodwill, that are to be disposed by sale or otherwise, and is effective
for financial statements issued for fiscal years beginning after December 15,
2001. The Company believes that the implementation of SFAS No. 144 will not have
a material effect on the Company's financial position or results of operations.

INVENTORY

Inventory is recorded at the lower of its cost basis (determined by the
specific identification method) or net realizable value.

PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment are stated at cost. The costs of ordinary
maintenance and repairs are charged to operations as incurred, while renewals
and betterments are capitalized. Capitalized interest was approximately $770,000
and $298,000 in 2000 and 2001, respectively. Depreciation of

48

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
property, plant and equipment is computed based on the straight-line method over
the following estimated useful lives of the assets:

Property, plant and equipment was comprised of the following at
December 31, 2000 and 2001:

During 1999, 2000 and 2001, the Company recorded $6,111,000, $7,142,000 and
$6,335,000, respectively, in depreciation expense in the accompanying
consolidated statements of operations.

INCOME TAXES

Carriage Services, Inc. and its subsidiaries file a consolidated U.S.
federal income tax return. Carriage records 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", (see
note 9).

COMPUTATION OF EARNINGS PER COMMON SHARE

Basic earnings per share is computed using the weighted average number of
common shares outstanding during the period. Diluted earnings per share is
computed using the weighted average number of common and dilutive common
equivalent shares outstanding during the period. Dilutive common equivalent
shares consist of stock options and convertible preferred stock (see Note 13).

FAIR VALUE OF FINANCIAL INSTRUMENTS

Carriage believes that the carrying value approximates fair value for cash
and cash equivalents. Additionally, our floating rate credit facility
approximates its fair value. Management also believes that the carrying value of
our fixed rate debt approximates fair value. Management estimates that the fair

49

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
value of the company-obligated mandatorily redeemable convertible preferred
securities of Carriage Services Capital Trust at December 31, 2000 and 2001 is
approximately $38 million and $54 million, respectively, based on available
broker quotes.

USE OF ESTIMATES

The preparation of financial statements in conformity with generally
accepted accounting principles in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.

2. 2000 ACCOUNTING PRINCIPLE CHANGE

PRENEED REVENUES AND COSTS

In December 1999, the Securities and Exchange Commission issued SAB 101.
This SAB deals with various revenue recognition issues; certain ones of which
are pertinent to the death care industry. As a result, Carriage has changed our
method of recognizing preneed revenues and certain related costs of originating
preneed cemetery contracts. SAB 101 was effective as of the beginning of 2000,
but because of extensions to allow for implementation, the Company implemented
the changes beginning with the fourth quarter of 2000 and restated quarters 1
through 3 in Note 15, QUARTERLY FINANCIAL DATA. Fiscal years prior to 2000 were
not required to be restated.

Previously, Carriage had recognized sales of cemetery interment rights,
together with associated merchandise and services as revenues at the time
contracts were signed. Costs related to the sales of interment rights were
charged to operations using the specific identification method. The costs for
cemetery merchandise and services sold, but not delivered, was previously
accrued as an expense at the time the cemetery revenue was recognized. Similarly
trust income on cemetery merchandise and service trusts was previously
recognized when earned by the trust.

Under the new accounting principle, the Company will follow SFAS No. 66,
"Accounting for Sales of Real Estate", in recognizing the revenue from the sales
of cemetery interment rights. This method is generally characterized by
recognizing the sale in the period when the customer's payments equal or exceed
10% of the contract price related to the interment right. Costs related to the
sales of interment rights are charged to operations using the specific
identification method in the period in which the sale of the interment right is
recognized as revenue. Revenues and costs related to the sales of cemetery
merchandise and services, and earnings from the related trust funds, are
deferred until the period in which the merchandise is delivered or the service
is provided.

The Company recorded a non-cash charge of approximately $39.0 million, after
reduction for income taxes of approximately $20.8 million, or $2.43 per share,
to reflect the cumulative effect of the change in accounting principle as of the
beginning of the year. The effect of this change on the year ended December 31,
2000, before the cumulative effect of the accounting change was to decrease net
income $4.7 million, or $.29 per diluted share. If the new accounting principle
had been in effect in 1999 and 1998, net income would have been $5.9 million, or
$.36 per diluted share, and $6.7 million, $.44 per diluted share, respectively.
The revenue not recognized is included in the consolidated balance sheet in the
caption "deferred cemetery revenue and preneed liabilities".

50

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

2. 2000 ACCOUNTING PRINCIPLE CHANGE (CONTINUED)
The amount of the preneed funeral contracts receivable, the amount of the
funds deposited in trust and the amount of life insurance contracts are
recognized on the balance sheet as preneed funeral contracts and deferred
preneed funeral contracts revenue. Prior to the implementation of the SAB, these
preneed funeral accounts were maintained off-balance sheet. Previously, cemetery
trust funds were netted against preneed liabilities on the balance sheet. The
amount of these trusts, beginning January 1, 2000 are included in the
non-current asset section of the consolidated balance sheet.

3. ASSETS HELD FOR SALE

During the latter half of 2000, management identified certain businesses and
other assets to be sold as part of the Company's Fresh Start initiative (a
multi-element restructuring program which was intended to improve financial and
operating performance). The carrying value of the net assets of those businesses
and other assets has been reduced to management's estimate of fair value less
estimated costs to sell by providing a charge for impairment in the amount of
$29.3 million. In estimating fair value, management considered, among other
things, the range of preliminary prices being discussed with potential buyers.
At December 31, 2000, assets held for sale, net represented the net assets of 26
funeral homes, 13 cemeteries and 14 parcels of real estate. During 2001 the
Company sold or closed 16 funeral homes, eight cemeteries and four parcels of
real estate for $11.9 million. At December 31, 2001, assets held for sale, net
represents 10 funeral homes, five cemeteries and 10 parcels of real estate. A
summary of the net assets included in the category is as follows:

The operating results of the businesses held for sale included in the
consolidated statement of operations for each of the three years in the period
ended December 31, 2001 were as follows:

51

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

4. DEFERRED CHARGES AND OTHER NON-CURRENT ASSETS

Deferred charges and other non-current assets, net of amounts included in
assets held for sales at December 31, 2000 and 2001 were as follows:

The cost of agreements not to compete with former owners of businesses
acquired is amortized over the term of the respective agreements, ranging from
four to ten years. Deferred debt expense (included in "other" above) is being
amortized over the term of the related debt. Non-current cemetery receivables
result from the multi-year payment terms in the underlying contracts.

5. LONG-TERM DEBT AND RELATED DERIVATIVES

LONG-TERM DEBT

Carriage's long-term debt consisted of the following at December 31:

On November 6, 2000, modifications to the credit facility and senior notes,
which included a reduction in our bank revolving credit facility from
$260 million to $100 million, were finalized. The Company decided to reduce its
revolving credit capacity because management no longer intended to use our
excess credit to make large acquisitions and did not want to continue to pay a
commitment fee for availability that was not going to be used. The credit
facility contains customary restrictive covenants, including a restriction on
the payments of dividends on common stock and requires Carriage to maintain
certain financial ratios. The availability under the credit facility totaled
$67.8 million at December 31, 2001.

52

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

5. LONG-TERM DEBT AND RELATED DERIVATIVES (CONTINUED)
During 1999, Carriage issued $110 million in senior debt notes ("the Senior
Notes") and used the proceeds to reduce the amount outstanding under our
revolving line of credit. The unsecured notes mature in traunches of
$23 million in 2004, $56 million in 2006 and $23 million in 2008 and bear
interest at the fixed rates of 7.73%, 7.96% and 8.06%, respectively. The Senior
Notes contain restrictive covenants similar to the credit facility (described
above) and additionally require that a significant portion of any proceeds from
the sales of assets be offered to the note holders as prepayment of the amounts
outstanding. During 2001 prepayments were made in the amount of $8.0 million
related to proceeds from the sale of assets.

The Company was in compliance with the covenants contained in the credit
facility and the Senior Notes as of or during the years ended December 31, 2000
and 2001.

Acquisition debt consists of deferred purchase prices payable to sellers.
The deferred purchase price notes bear interest at 0%, discounted at imputed
interest rates ranging from 6% to 8%, with maturities from three to 15 years.

The aggregate maturities of long-term debt as of December 31, 2001 and for
the next five years are approximately $2,524,000, $2,340,000, $57,569,000,
$2,152,000 and $57,756,000, respectively and $29,142,000 thereafter.

In connection with the repayment and refinancing of the credit facility in
June 1999, we recognized an extraordinary loss of approximately $200,000, net of
income tax benefit of approximately $151,000, for the write-off of the deferred
loan costs associated with the early retirement of the debt.

DERIVATIVE FINANCIAL INSTRUMENTS

Carriage entered into interest rate swap agreements during 1998 with
financial institutions to manage interest costs. Interest on our debt is
primarily floating. To manage the risk that interest rates will rise, the
Company agreed to exchange the floating rate payments for fixed rate payments,
at 90-day intervals, calculated by reference to agreed-upon notional principal
amounts. The following presents information for the interest rate swaps, which
are recorded as liabilities in the December 31, 2001 balance sheet (in
thousands):

Notional amount............................................. $30,000
Weighted average fixed rate................................. 5.55%
Maturity.................................................... 2003
Fair value (liability)...................................... $(1,238)

6. COMPANY OBLIGATED MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED SECURITIES OF
CARRIAGE SERVICES CAPITAL TRUST

During June 1999, Carriage, through its wholly-owned subsidiary, Carriage
Services Capital Trust, completed the sale of 1,875,000 units of 7% convertible
preferred securities, resulting in approximately $90 million in net proceeds to
the Company. The convertible preferred securities have a liquidation amount of
$50 per unit, and are convertible into Carriage's Class A Common Stock at the
equivalent conversion price of $20.4375 per share of Class A Common Stock. The
securities mature in 2029 and are guaranteed on a subordinated basis by the
Company. Distributions are payable quarterly, but may be deferred at our option
for up to twenty consecutive quarters.

53

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

7. SPECIAL AND OTHER CHARGES

In connection with the Company's Fresh Start initiative in the second half
of 2000, decisions were made to sell certain businesses and assets, to evaluate
the carrying value of underperforming businesses, and to implement certain
organizational changes to downsize or eliminate certain corporate functions,
including the termination of 40 employees in corporate development, preneed
sales and marketing, and administration. Long-term cash flow forecasts were
prepared to determine whether the Company would recover its investment through
operations for the underperforming businesses. In those instances in which the
investment in a business exceeded the estimated undiscounted future cash flows,
the investment was written down, through an impairment charge, to the present
value of those future cash flows. Impairment charges totaled $51 million for the
underperforming businesses that the Company will continue to operate. An
estimate of the fair value less costs to sell was determined for those
businesses targeted for sale to determine whether the investment in the business
would be recovered through its sale. Where the investment exceeded the net
realizable value, impairment charges were recorded totaling approximately
$29.3 million (see Note 3). Charges related to this initiative include
impairments totaling approximately $61.6 million related to Goodwill, are
included in the statement of operations in the caption titled "Special and other
charges" and are as follows:

Special and other charges totaling $7.5 million and $4.4 million are
included in accounts payable and accrued liabilities in the accompanying
consolidated balance sheets at December 31, 2000 and 2001, respectively.

8. COMMITMENTS AND CONTINGENCIES

LEASES

Carriage leases certain office facilities, vehicles and equipment under
operating leases for terms ranging from one to 15 years. Certain of these leases
provide for an annual adjustment. Rent expense was approximately $3,359,000,
$4,819,000 and $4,547,000 for 1999, 2000 and 2001, respectively.

Assets acquired under capital leases are included in property, plant and
equipment in the accompanying consolidated balance sheets in the amount of
$6,445,000 in 1999, $1,075,000 in 2000 and $2,782,000 in 2001, net of
accumulated depreciation. Related obligations are included in current and
long-term debt.

54

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

8. COMMITMENTS AND CONTINGENCIES (CONTINUED)

At December 31, 2001, future minimum lease payments under noncancellable
lease agreements were as follows:

AGREEMENTS AND EMPLOYEE BENEFITS

Carriage has entered into various agreements not to compete with former
owners of businesses acquired. Payments for such agreements are generally not
made in advance. These agreements are generally for one to 10 years and provide
for future payments annually, quarterly or monthly. The aggregate payments due
under these agreements for the next five years are approximately $1,713,000,
$1,515,000, $1,252,000, $944,000 and $610,000, respectively and $586,000
thereafter.

Carriage sponsors a defined contribution plan (401k) and an employee stock
purchase plan for the benefit of its employees. The expense for these plans has
not been significant for the periods presented. In addition, the Company does
not offer any other post-retirement or post-employment benefits.

LITIGATION

Certain of the funeral homes located in California that were acquired by
Carriage in early 1997, along with other death care providers, have been
defendants in litigation in the state of California alleging that a flight
service contracted to dispose of cremains failed to properly carry out its
duties. The Company, with the advice of legal counsel, has been of the opinion
that there have been adequate insurance coverages, indemnities and reserves such
that the results of this litigation would not have a material effect on the
consolidated financial position or results of operations. Subsequent to
December 31, 1999, the litigation was settled. The amount paid in the settlement
was fully covered by the Company's insurance. As a result of the settlement, the
Company reversed the estimated liability previously recorded for the matter in
the amount of $2 million, effective December 31, 1999.

55

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

8. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Additionally, the Company is, from time to time, subject to routine
litigation arising in the normal course of business. The Company, with the
advice of legal counsel, similarly believe that the results of any such routine
litigation or other pending legal proceedings will not have a material effect on
the consolidated financial position or results of operations.

9. INCOME TAXES

The provision (benefit) for income taxes for 1999, 2000 and 2001 consisted
of:

A reconciliation of taxes to the U.S. federal statutory rate to those
reflected in the consolidated statements of operations for 1999, 2000 and 2001
is as follows:

56

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

9. INCOME TAXES (CONTINUED)
The tax effects of temporary differences that give rise to significant
deferred tax assets and liabilities at December 31, 2000 and 2001 were as
follows:

The non-current net deferred tax asset is included in Deferred charges and
other non-current assets at December 31, 2000 and 2001.

Carriage has recorded 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. During 2001, the Company recognized a reduction in the valuation
allowance as an income tax benefit in the amount of $3.0 million for tax
deductions taken in 2001 for which the expense was recorded in 2000 for
accounting purposes. At December 31, 2001, Carriage had approximately
$25 million of state net operating loss carryforwards that will expire between
the years 2001 and 2021, if not utilized.

10. STOCKHOLDERS' EQUITY

COMMON STOCK VOTING CLASSES

The Company currently has two classes of Common Stock (Class A and
Class B). The two classes have virtually the same rights and preferences, except
that the holders of Class A Common Stock are entitled to one vote for each share
held on all matters submitted to a vote of common stockholders, whereas the
holders of Class B Common Stock are entitled to ten votes for each share.
Effective December 31, 2001, all Class B Common Stock automatically converted
into Class A Common Stock on a one-for-one basis.

STOCK OPTION PLANS

Carriage has four stock option plans currently in effect under which future
grants may be issued: the 1995 Stock Incentive Plan (the "1995 Plan"), the 1996
Stock Option Plan (the "1996 Plan"), the 1996 Directors' Stock Option Plan (the
"Directors' Plan") and the 1998 Stock Option Plan for Consultants (the
"Consultants' Plan"). 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.

57

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

10. STOCKHOLDERS' EQUITY (CONTINUED)
Options under each of the plans and those outstanding at December 31, 2001
are as follows:

The Company accounts for stock options issued to employees under APB Opinion
No. 25, under which no compensation cost has been recognized. 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:

Each of the plans is administered by a stock option committee appointed by
the Board of Directors. The plans allow for options to be granted as
non-qualified options, incentive stock options, reload options, alternative
appreciation rights and stock bonus options. As of December 31, 2001 only
non-qualified options and incentive stock options have been issued. The options
are granted with an exercise price equal to or greater than the then fair market
value of Carriage's Common Stock as determined by the Board of Directors.

58

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

10. STOCKHOLDERS' EQUITY (CONTINUED)
A summary of the status of the plans at December 31, 2000 and 2001 and
changes during the year ended is presented in the table and narrative below:

All of the options outstanding at December 31, 2001 have exercise prices
between $1.19 and $27.50, with a weighted average exercise price of $3.34 and a
weighted average remaining contractual life of 8.6 years.

The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in 2000 and 2001, respectively: risk-free interest
rates of 4.74% and 4.77%; expected dividend yield of 0% for each year; expected
lives of five years; expected volatility of 56% and 61%.

EMPLOYEE STOCK PURCHASE PLAN

Beginning in 1998, Carriage provided all employees the opportunity to
purchase Class A Common Stock through payroll deductions. Purchases are made
quarterly; the price being 85% of the lower of the price on the grant date or
the purchase date. During 2000, employees purchased a total of 214,581 shares at
a weighted average price of $2.34 per share. In 2001, employees purchased a
total of 260,634 shares at a weighted average price of $1.32 per share.

STOCK PRICE GUARANTEES

As part of the purchase price consideration in the acquisition of certain
funeral homes and cemeteries, the Company issued shares of Class A Common Stock
and guaranteed the stock would trade at certain agreed-upon levels during
defined future periods ranging from one to three years. Should the stock not
trade at these levels, then the Company would makeup the difference by issuing
additional shares or paying the seller additional cash during the years 2000
through 2002. The present value of these price guarantees has been recorded as
part of the purchase price of these acquisitions. During 2000 and 2001, the
Company paid $3,297,000 and $4,935,000, respectively in satisfaction of the
guarantee obligations that matured in those years. The final remaining
obligations total $5,286,000 and are scheduled to be paid in the first quarter
of 2002.

11. REDEEMABLE PREFERRED STOCK

Carriage had 20,000,000 authorized shares of Series D Preferred Stock with a
par value of $.01 per share, of which 1,182,500 shares were issued and
outstanding at December 31, 2000. During 2001,

59

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

11. REDEEMABLE PREFERRED STOCK (CONTINUED)
Carriage redeemed 1,000,000 shares at $1.00 per share in an exchange and
divestiture of business assets with the holder of those shares. The holders of
Series D Preferred Stock received preferential dividends at an annual rate
ranging from $0.06 to $0.07 per share, payable quarterly, during the period that
the stock was outstanding. Effective December 31, 2001, Carriage redeemed the
remaining 182,250 shares then outstanding at a redemption price of $1.00 per
share, together with all accrued and unpaid dividends.

12. RELATED PARTY TRANSACTIONS

Two of the Company's directors are prior owners of previously unrelated
businesses that Carriage acquired in 1997. As an incentive, the Company entered
into arrangements with the directors to pay them 10% of the amount by which the
annual field level cash flow exceeds predetermined targets on certain businesses
in their respective geographic region through 2008, then a multiple of six times
the average of the last three years payments. The business purpose of the
arrangements was to incentivise the directors to provide Carriage with high
quality acquisition targets and to participate in the management of those
businesses so that cash flows grow over time. The terms were determined by
reference to similar arrangements within the death care industry. The incentives
earned by the two directors totaled $92,000, $117,000 and $136,000 for the years
1999, 2000 and 2001, respectively.

In connection with the 1997 acquisition of two funeral homes from a group of
individuals, one of which is one of the directors referred to in the preceding
paragraph, a portion of the purchase price of each of those funeral homes was to
be payable based on a formula related to the annual field level cash flows
subsequent to the year of acquisition. The business purpose was to determine the
final purchase prices of the acquisitions since both were expected to show
strong growth in cash flow. The terms were negotiated by the sellers, one of
which later was appointed to director of Carriage. The contingent purchase price
payments paid to the director totaled $524,107 and $47,673 during the years 2000
and 2001, respectively. The final contingent purchase price payment totals
$1,040,442, of which $572,243 is payable to the director in March 2002.

The Company rents office space, at an annual rate of $19,000 per year
through 2005, from an entity in which one of the Company's directors has a
financial interest. The terms were determined by reference to rentals of similar
office space in the area.

60

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

13. EARNINGS (LOSS) PER SHARE

The following table sets forth the computation of the basic and diluted
earnings per share for 1999, 2000 and 2001:

Common stock equivalents are excluded in the calculation of weighted average
shares outstanding when a company reports a net loss for a period. The number of
potentially antidilutive shares excluded from the calculation of fully diluted
earnings per share was .8 million for the year ended December 31, 2000, because
of the net loss for the year.

61

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

14. MAJOR SEGMENTS OF BUSINESS

Carriage conducts funeral and cemetery operations only in the United States.

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(a) A substantial portion of the special and other charges relates to the
funeral segment of the business.

62

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

15. QUARTERLY FINANCIAL DATA (UNAUDITED)

The tables below set forth consolidated operating results by fiscal quarter
for the years ended December 31, 2000 and 2001, in thousands, except earnings
per share. The first, second and third quarters of the fiscal year 2000 have
been restated for the accounting change discussed in Note 2, which was
implemented at the beginning of the fourth quarter of 2000, but retroactive to
January 1, 2000.

63

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

15. QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED)

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(a) Earnings per share is computed independently for each of the quarters
presented. Therefore, the sum of the quarterly per share amounts does not
equal the total computed for the year due to stock transactions which
occurred during the periods presented.

64

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
ON FINANCIAL STATEMENT SCHEDULE

To Carriage Services, Inc.:

We have audited in accordance with generally accepted auditing standards,
the consolidated financial statements of Carriage Services, Inc. and
subsidiaries included in this Form 10-K, and have issued our report thereon
dated March 10, 2002. Our audit was made for the purpose of forming an opinion
on the basic financial statements taken as a whole. The schedule listed in
Part IV, Item 14 (a)(2) for Carriage Services, Inc. and subsidiaries is the
responsibility of the Company's management and is presented for purposes of
complying with the Securities and Exchange Commission's rules and is not part of
the basic financial statements. This schedule has been subjected to the auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.

ARTHUR ANDERSEN LLP

Houston, Texas
March 10, 2002.

65

CARRIAGE SERVICES, INC.

SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS

(IN THOUSANDS)