In an 8-K filing dated November 29, 2018, StoneMor disclosed that it had ended its relationship with Deloitte and hired Grant Thornton as its auditor. With this move, the partnership is closer to catching up on its SEC filings after more than two years of delays in filing its financial statements on time. If so, much of the anxiety expressed by the market in STON’s low share price will subside; but the stock’s recovery potential is still difficult to measure because of the uncertainty of the partnership’s future profit potential.
StoneMor fell off investors’ radar screens in August 2016, when the partnership disclosed that it would have to restate its 2015 full year financial statements (and also its 2016 first and second quarter financials). In its amended 2015 10-K was filed in November 2016, the partnership disclosed several material weaknesses in its internal controls.
The filing of the amended 10-K late in the year interrupted the preparation of all financial statements for 2016. Consequently, STON’s 2016 10-K was not filed until November 2017. In that report, the partnership disclosed an expanded list of material weaknesses in internal controls.
The late filing of the 2016 10-K caused a similar delay in the preparation and filing of the 2017 financial statements. STON’s 2017 10-K was filed in July 2018. The partnership has also not yet filed any of its 2018 quarterly financial statements; however, it did report preliminary 2018 first quarter results in a November 8 press release.
Although the material weaknesses in internal controls are continuing, the partnership attributed the delay in the 2018 interim report filings to the late filing of the 2017 10-K and also to the adoption of the new revenue recognition accounting standard (ASC 606).
The 2018 delay is also likely due to the change in auditors. In its filing with the SEC, StoneMor said that there had been no disagreements with Deloitte on any accounting matters and that it had authorized Deloitte to respond fully to the inquiries of Grant Thornton about the internal control weaknesses.
With this extraordinarily long delay in meeting its financial statement filing requirements, it is a good bet that StoneMor wanted to have its new auditors review the 2018 interim financial statements before they are filed to avoid possible errors and also to ensure that the new auditors agree with the choices that the Partnership has made in the adoption of ASC 606.
StoneMor’s stock has declined more or less steadily since the restated 2015 10-K was filed in November 2016. Most recently, the stock took a sharp dip at the beginning of July when the 2017 10-K was filed and also again in November, beginning right around the time that the preliminary 2018 first quarter earnings were released.
The 2018 first quarter results brought more disappointing news to investors. The Partnership reported revenues of $77.9 million, down 6% from the prior year. Prior year revenues benefited from an unusually large backlog of preneed cemetery merchandise, but revenues from funeral homes also declined. StoneMor also said that if ASC 606 had been applied to the prior year, its 2017 first quarter revenues would have been $1.2 million lower.
The decline in revenues combined with higher operating expenses, attributable in large part to the financial reporting catch-up effort, led to a widening of StoneMor’s operating loss (total revenues minus total costs and expenses) from $1.1 million to $6.1 million. Likewise, EBITDA (which I define as operating income (loss) plus non-cash cost of lots sold plus depreciation and amortization plus provisions for bad debt (i.e. cancellations)) declined from $7.8 million in 2017 to negative $0.7 million in 2018. So along with the financial reporting delays, the Partnership’s financial performance has deteriorated.
StoneMor has also disclosed that the delay in issuing its 2018 first quarter financial statements has triggered an event of default in its bank credit agreement. The Partnership said that it is working to obtain a waiver from the banks, but there are no guarantees that it will be able to do so. Moreover, there may be a cost associated with obtaining this waiver.
The deterioration in financial performance also raises questions about the Partnership’s ability to service its debt. StoneMor’s debt has increased 5.6% to $322 million over the past year. At the same time, a 2017 goodwill impairment charge combined with the deterioration in profitability has reduced its equity book value from $170 million to $53 million. Thus, its ratio of debt-to-total capitalization has increased from 64.2% at the end of the 2017 first quarter to 85.9% at the end of the 2018 first quarter.
Yet, there have been some positive developments, as well. Despite the bank debt default and deterioration in financial performance, StoneMor has announced that it is moving to a decentralized operating structure and has hired three division presidents to focus on boosting sales, profitability and accountability. The Partnership is also implementing a comprehensive cost reduction initiative.
Although the temporary increase in operating expenses associated with the financial reporting catch-up effort will be reversed in the coming quarters, the move to a decentralized operating structure will probably add several million dollars of operating expenses annually and it will likely take at least a few quarters (or longer) for StoneMor to generate the top line growth and reductions in other expenses to more than offset this expense. Presumably, the Partnership would not undertake this effort unless the banks were on board.
Although investors will likely heave a sigh of relief once StoneMor catches up on its financial statement filings, their enthusiasm may be tempered by the actual results reported in those delayed financial statements. It is a fair bet that StoneMor’s performance for the 2018 second and third quarters will continue to be weak. I do not expect to see a meaningful improvement in its financial performance until the 2018 fourth quarter at the earliest and more likely by the second or third quarters of 2019.
As a guess, I believe that the catch-up in financial statement filings alone would probably add at least $1 to StoneMor’s current share price of around $2.50. That rebound could be higher, if the Partnership does not report any further deterioration in its quarterly performance. Investor confidence will also get a boost if and when the Partnership begins to host conference calls again.
While StoneMor’s equity book value has dropped sharply over the past year, its equity market value of $93 million is still well above book value (i.e. 1.8 times book value). Although that shows that there is still downside risk in the equity units, it also suggests that the market has some confidence in the Partnership’s ability to turn itself around.
December 14, 2018
Stephen P. Percoco
Lark Research
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