S-1/A 1 ds1a.htm AMENDMENT #6 TO FORM S-1 Amendment #6 to Form S-1
Table of Contents

As filed with the Securities and Exchange Commission on September 3, 2004

Registration No. 333-114354


UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

Amendment No. 6

to

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 


 

STONEMOR PARTNERS L.P.

(Exact Name of Registrant as Specified in Its Charter)

 


 

Delaware   7200   80-0103159
(State or Other Jurisdiction of Incorporation or Organization)  

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

 

155 Rittenhouse Circle

Bristol, PA 19007

(215) 826-2800

(Address, Including Zip Code, and Telephone Number, including

Area Code, of Registrant’s Principal Executive Offices)

 

William R. Shane

155 Rittenhouse Circle

Bristol, PA 19007

(215) 826-2800

(Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent for Service)

 


 

Copies to:

William N. Finnegan IV

Thomas P. Mason

Vinson & Elkins L.L.P.

1001 Fannin, Suite 2300

Houston, Texas 77002

(713) 758-2222

 

Joshua Davidson

Baker Botts L.L.P.

910 Louisiana

Houston, Texas 77002

(713) 229-1234

 


 

Approximate date of commencement of proposed sale to the public:

As soon as practicable after this Registration Statement becomes effective.

 

If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.    ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box.    ¨

 


 

The Registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment that specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the SEC acting pursuant to said Section 8(a), may determine.

 



Table of Contents

The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

Subject to Completion, dated September 3, 2004

 

PROSPECTUS    

 

LOGO

StoneMor Partners L.P.

 

3,675,000 Common Units

 


 

We are a limited partnership recently formed by Cornerstone Family Services, Inc., primarily to own and operate cemeteries in the United States. This is the initial public offering of our common units, which are a class of limited partner interests. We expect the initial public offering price to be between $18.50 and $20.50 per common unit. Holders of common units are entitled to receive distributions of cash from our operations of $0.4625 per unit per quarter, or $1.85 per unit on an annualized basis, before any such distributions are paid on our subordinated units. We will only make these distributions to the extent we have sufficient cash from operations. The common units have been approved for listing on the NASDAQ National Market under the symbol “STON.”

 

Investing in our common units involves risk. Please read “ Risk Factors” beginning on page 15.

 

These risks include the following:

 

    We may not have sufficient cash from operations to pay the minimum quarterly distribution after we have paid our expenses, including the expenses of our general partner, funded merchandise and perpetual care trusts and established necessary cash reserves.

 

    Adverse conditions in the financial markets may reduce the principal and earnings held in merchandise and perpetual care trusts and adversely affect our revenues and cash flow.

 

    If state laws or interpretations of existing state laws change or if new laws are enacted, we may be required to increase trust deposits or to alter the timing of withdrawals from trusts, which may have a negative impact on our revenues and cash flow.

 

    We may not be able identify, complete, fund or successfully integrate additional cemetery acquisitions.

 

    Our general partner and its affiliates have conflicts of interest and limited fiduciary duties, which may permit them to favor their own interests to your detriment.

 

    Following the completion of this offering, affiliates of our general partner will own sufficient units to block any attempt to remove our general partner.

 

    You will experience immediate and substantial dilution of $6.64 per common unit.

 

    You may be required to pay taxes on income from us even if you do not receive any cash distributions from us.

 

     Per Common Unit

   Total

Initial public offering price

   $                     $                 

Underwriting discount (1)

   $      $  

Proceeds, before expenses, to StoneMor Partners L.P.

   $      $  

(1) Excludes advisory fees payable to Lehman Brothers Inc. of $            .

 

We have granted the underwriters a 30-day option to purchase up to 551,250 additional common units on the terms set forth above to cover over-allotments of common units, if any. If the over-allotment option is exercised, the parent of our general partner will be deemed to be a selling unitholder of these units. Please see “Selling Unitholder.”

 

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

Lehman Brothers, on behalf of the underwriters, expects to deliver the common units on or about                     , 2004.

 


 

LEHMAN BROTHERS

MERRILL LYNCH & CO.

UBS INVESTMENT BANK

RAYMOND JAMES

 

                , 2004


Table of Contents

 

 

LOGO


Table of Contents

TABLE OF CONTENTS

 

PROSPECTUS SUMMARY

   1

StoneMor Partners L.P.

   1

Partnership Structure and Management

   3

The Offering

   6

Summary of Tax Considerations

   9

Summary Historical and Pro Forma Financial and Operating Data

   10

RISK FACTORS

   15

Risks Related to Our Business

   15

We may not have sufficient cash from operations to pay the minimum quarterly distribution after we have paid our expenses, including the expenses of our general partner, funded merchandise and perpetual care trusts and established necessary cash reserves.

   15

Our indebtedness limits cash flow available for our operations and for distribution to our partners.

   15

Adverse conditions in the financial markets may reduce the principal and earnings of the investments held in merchandise and perpetual care trusts and adversely affect our revenues and cash flow.

   15

Pre-need sales typically generate low or negative cash flow in the periods immediately following sales.

   16

Because fixed costs are inherent in our business, a decrease in our revenues can have a disproportionate effect on our cash flow and profits.

   16

Our failure to attract and retain qualified sales personnel and management could have an adverse effect on us.

   16

We may not be able to identify, complete, fund or successfully integrate additional cemetery acquisitions.

   17

If the trend toward cremation in the United States continues, our revenues may decline.

   17

Regulatory and Legal Risks

   17

If state laws or interpretations of existing state laws change or if new laws are enacted, we may be required to increase trust deposits or to alter the timing of withdrawals from trusts, which may have a negative impact on our revenues and cash flow.

   17

If state laws or their interpretations change, or new laws are enacted relating to the ownership of cemeteries and funeral homes, our business, financial condition and results of operations could be adversely affected.

   17

We are subject to legal restrictions on our marketing practices that could adversely affect the volume of our sales.

   18

We are subject to environmental and health and safety regulations that may adversely affect our operating results.

   18

Risks Inherent in an Investment in Us

   18

Our general partner and its affiliates have conflicts of interest and limited fiduciary duties, which may permit them to favor their own interests to your detriment.

   18

Following the completion of this offering, affiliates of our general partner will own sufficient common and subordinated units to block any attempt to remove our general partner.

   19

Unitholders have limited voting rights.

   19

Our general partner can transfer its ownership interest in us without unitholder consent under certain circumstances, and the control of our general partner may be transferred to a third party without unitholder consent.

   19

You will experience immediate and substantial dilution of $6.64 per common unit.

   20

We may issue additional common units without your approval, which would dilute your existing ownership interests.

   20

Cost reimbursements due our general partner may be substantial and will reduce the cash available for distribution to you.

   20

 

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In establishing cash reserves, our general partner may reduce the amount of available cash for distribution to you.

   20

Our general partner has a limited call right that may require you to sell your units at an undesirable time or price.

   21

You may be required to repay distributions that you have received from us.

   21

Tax Risks to Common Unitholders

   21

We may have tax liabilities related to periods before our initial public offering and less net operating losses available to reduce taxable income and therefore tax liabilities for future periods.

   21

Changes in the ownership of our units, including the changes occurring as a result of this offering, may result in annual limitations on our use of net operating losses available to reduce taxable income, which could increase our tax liabilities and decrease cash available for distribution in future taxable periods.

   22

Our tax treatment depends on our status as a partnership for federal income tax purposes, as well as our not being subject to entity-level taxation by individual states. If the IRS treats us as a corporation or we become subject to entity-level taxation, it would reduce the amount of cash available for distribution to you.

   22

We have subsidiaries that will be treated as corporations for federal income tax purposes and subject to corporate-level income taxes.

   23

A successful IRS contest of the federal income tax positions we take may adversely affect the market for our common units, and the cost of any IRS contest will be borne by our unitholders and our general partner.

   23

You may be required to pay taxes on income from us even if you do not receive any cash distributions from us.

   23

Tax gain or loss on disposition of common units could be more or less than expected.

   23

Tax-exempt entities and regulated investment companies face unique tax issues from owning common units that may result in adverse tax consequences to them.

   23

We will register as a tax shelter. This may increase the risk of an IRS audit of us or you.

   24

We will treat each purchaser of common units as having the same tax benefits without regard to the actual common units purchased. The IRS may challenge this treatment, which could adversely affect the value of the common units.

   24

You will likely be subject to state and local taxes in states where you do not live as a result of an investment in units.

   24

USE OF PROCEEDS

   25

CAPITALIZATION

   26

DILUTION

   27

CASH DISTRIBUTION POLICY

   28

Quarterly Distributions of Available Cash

   28

Operating Surplus and Capital Surplus

   28

Distributions of Available Cash from Operating Surplus

   30

Distributions of Available Cash from Capital Surplus

   30

Subordination Period

   31

Adjustment of Minimum Quarterly Distribution and Target Distribution Levels

   32

Distributions of Cash Upon Liquidation

   33

CASH AVAILABLE FOR DISTRIBUTION

   34

Pro Forma, As Adjusted Available Cash from Operating Surplus for 2003 and the First Half of 2004

   34

Estimated Available Cash from Operating Surplus through September 30, 2005

   35

SELECTED HISTORICAL AND PRO FORMA FINANCIAL AND OPERATING DATA

   37

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

   43

Overview

   43

Critical Accounting Policies and Estimates

   53

Results of Operations

   55

Liquidity and Capital Resources

   61

Off-Balance Sheet Arrangements

   70

Inflation

   70

Seasonality

   70

Recent Accounting Pronouncements

   70

Quantitative and Qualitative Market Risk Disclosure

   71

INDUSTRY OVERVIEW

   73

General

   73

Industry Characteristics

   73

BUSINESS

   75

Our Partnership

   75

Business Strategies

   75

Business Strengths

   77

Operations

   78

Sales Contracts

   80

Trusts

   80

Sales Personnel, Training and Marketing

   80

Properties

   81

Competition

   83

Regulation

   84

Environmental Regulations and Liabilities

   85

Employees

   86

Legal Proceedings

   86

MANAGEMENT

   87

StoneMor GP LLC Will Manage Us

   87

Directors and Executive Officers of StoneMor GP LLC

   88

Reimbursement of Expenses of our General Partner

   90

Executive Compensation

   90

Employment Agreements

   92

Compensation of Directors

   93

Long-Term Incentive Plan

   94

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

   96

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

   97

Distributions and Payments to our General Partner and its Affiliates

   97

Formation Stage

   97

Operational Stage

   97

Liquidation Stage

   98

Ownership Interests in our General Partner

   98

Election of Directors

   100

Agreements Governing the Transactions

   100

Omnibus Agreement

   100

Relationships and Related Transactions with CFSI LLC and Cornerstone Family Services LLC

   101

 

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CONFLICTS OF INTEREST AND FIDUCIARY DUTIES

   103

Conflicts of Interest

   103

Fiduciary Duties

   105

DESCRIPTION OF THE COMMON UNITS

   108

The Units

   108

Transfer Agent and Registrar

   108

Transfer of Common Units

   108

Limited Voting Rights

   109

DESCRIPTION OF THE SUBORDINATED UNITS

   110

Subordination

   110

Conversion of Subordinated Units

   110

Distributions Upon Liquidation

   110

Limited Voting Rights

   110

THE PARTNERSHIP AGREEMENT

   111

Organization and Duration

   111

Purpose

   111

Power of Attorney

   111

Capital Contributions

   111

Limited Liability

   112

Voting Rights

   113

Issuance of Additional Securities

   114

Amendment of the Partnership Agreement

   115

Merger, Sale or Other Disposition of Assets

   118

Termination and Dissolution

   118

Liquidation and Distribution of Proceeds

   118

Withdrawal or Removal of the General Partner

   119

Transfer of General Partner Interest

   120

Transfer of Incentive Distribution Rights

   120

Transfer of Ownership Interests in the General Partner

   121

Change of Management Provisions

   121

Limited Call Right

   121

Meetings; Voting

   121

Status as Limited Partner or Assignee

   122

Non-Citizen Assignees; Redemption

   123

Indemnification

   123

Reimbursement of Expenses

   123

Books and Reports

   123

Right to Inspect Our Books and Records

   124

Registration Rights

   124

UNITS ELIGIBLE FOR FUTURE SALE

   125

MATERIAL TAX CONSEQUENCES

   127

Partnership Status

   127

Limited Partner Status

   129

Tax Consequences of Unit Ownership

   129

Tax Treatment of Operations

   134

Disposition of Common Units

   135

Uniformity of Units

   137

Tax-Exempt Organizations and Other Investors

   138

Administrative Matters

   138

State, Local and Other Tax Considerations

   141

 

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INVESTMENT IN STONEMOR PARTNERS L.P. BY EMPLOYEE BENEFIT PLANS

   142

SELLING UNITHOLDER

   143

UNDERWRITING

   144

Commissions and Expenses

   144

Indemnification

   145

Over-Allotment Option

   145

Lock-Up Agreements

   145

Stabilization, Short Positions and Penalty Bids

   146

Listing

   147

Passive Market Making

   147

Public Market

   147

Affiliations

   147

NASD Conduct Rules

   147

Discretionary Sales

   148

Electronic Distribution

   148

Directed Unit Program

   148

VALIDITY OF THE COMMON UNITS

   149

EXPERTS

   149

WHERE YOU CAN FIND MORE INFORMATION

   149

FORWARD-LOOKING STATEMENTS

   150

INDEX TO FINANCIAL STATEMENTS

   F-1

APPENDIX A—Form of Amended and Restated Agreement
of Limited Partnership of StoneMor Partners L.P.

   A-1

APPENDIX B—Form of Application for Transfer of Common Units

   B-1

APPENDIX C—Glossary of Terms

   C-1

APPENDIX D—Pro Forma, as Adjusted, Available Cash From Operating Surplus

   D-1

 


 

You should rely only on the information contained in this prospectus. We have not, and the underwriters have not, authorized any other person to provide you with different information. If anyone provides you with different or inconsistent information, you should not rely on it. We are not, and the underwriters are not, making an offer to sell these securities in any jurisdiction where an offer or sale is not permitted. You should assume that the information appearing in this prospectus is accurate as of the date on the front cover of this prospectus only. Our business, financial condition, results of operations and prospects may have changed since that date.

 

Until                      , 2004 (25 days after the date of this prospectus), all dealers that buy, sell or trade our common units, whether or not participating in this offering, may be required to deliver a prospectus. Dealers are also obligated to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

 

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PROSPECTUS SUMMARY

 

StoneMor Partners L.P.

 

We are the fourth-largest owner and operator of cemeteries in the United States. As of June 30, 2004, we operated 132 cemeteries in 12 states, located primarily in the eastern United States. The cemetery products and services that we sell include:

 

Interment Rights


 

Merchandise


 

Services


•      burial lots

•      lawn crypts

•      mausoleum crypts

•      cremation niches

•      perpetual care rights

 

•      burial vaults

•      caskets

•      grave markers and grave marker bases

•      memorials

 

•      installation of burial vaults

•      installation of caskets

•      installation of other cemetery merchandise

 

We sell these products and services both at the time of death, which we refer to as at-need, and prior to the time of death, which we refer to as pre-need. Our sales of real property, including burial lots (with and without installed vaults and grave marker bases), lawn and mausoleum crypts and cremation niches, generate qualifying income sufficient for us to be treated as a partnership for federal income tax purposes. In 2003, we performed more than 22,000 burials and sold more than 15,000 interment rights (net of cancellations). Based on our sales of interment spaces in 2003, our cemeteries have a weighted average sales life of 219 years.

 

We focus on generating pre-need sales of cemetery products and services, which generate product and service backlog and provide us with a relatively predictable stream of revenue and cash flows. Our emphasis on pre-need sales also increases the volume of our at-need sales. It has been our experience that if a close family member of one of our pre-need customers dies without pre-need burial arrangements, we are likely to be chosen to provide the at-need products and services for that family member. While at-need sales are not as predictable as pre-need sales, we believe that the relatively stable death rate and the link between pre-need and at-need sales will continue to provide us with a steady stream of revenues and cash flow from our at-need sales.

 

When we sell pre-need products and services, we are required by state law to deposit a portion of the total sales price into a merchandise trust to ensure that we will have sufficient cash in the future to purchase the products and perform the services. When we sell cemetery interment rights, whether pre-need or at-need, we are required by state law to deposit a portion of the total sales price into a perpetual care trust for the maintenance in perpetuity of our cemeteries.

 

The following chart shows our 2003 revenues by category:

 

LOGO

 

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In the first six months of 2004, pre-need sales and at-need sales accounted for approximately 43.0% and 34.2%, respectively, of our revenues.

 

We were recently formed as a Delaware limited partnership to own and operate the assets and businesses previously owned and operated by Cornerstone Family Services, Inc., or Cornerstone, which will be converted into CFSI LLC, a limited liability company, prior to this offering. Cornerstone was founded in 1999 by members of our management team and a group of private equity investment funds, which we refer to as the McCown De Leeuw funds or McCown De Leeuw, in order to acquire a group of 123 cemetery properties and 4 funeral homes. Since that time, Cornerstone has acquired ten additional cemeteries and one funeral home, built two funeral homes and sold one cemetery. “StoneMor Partners L.P.,” “we,” “our,” “us” or similar terms, when used in a historical context, refer to Cornerstone Family Services, Inc. (and, after its conversion, CFSI LLC) and its subsidiaries and when used in the present tense or prospectively, refer to StoneMor Partners L.P. and its subsidiaries.

 

Summary of Risk Factors

 

An investment in our common units involves risks associated with our business, our partnership structure and the tax characteristics of our common units. We describe these risks under the caption “Risk Factors” and they include, among others, the following:

 

    We may not have sufficient cash from operations to pay the minimum quarterly distribution after we have paid our expenses, including the expenses of our general partner, funded merchandise and perpetual care trusts and established necessary cash reserves.

 

    Adverse conditions in the financial markets may reduce the principal and earnings of the investments held in merchandise and perpetual care trusts and adversely affect our revenues and cash flow.

 

    Pre-need sales typically generate low or negative cash flow in the periods immediately following sales.

 

    Our failure to attract and retain qualified sales personnel and management could have an adverse effect on us.

 

    If state laws or interpretations of existing state laws change or if new laws are enacted, we may be required to increase trust deposits or alter the timing of withdrawals from trusts, which may have a negative impact on our revenues and cash flow.

 

    We may not be able to identify, complete, fund or successfully integrate additional cemetery acquisitions.

 

    Our general partner and its affiliates have conflicts of interest and limited fiduciary duties, which may permit them to favor their own interests to your detriment.

 

    Following the completion of this offering, affiliates of our general partner will own sufficient common and subordinated units to block any attempt to remove our general partner.

 

    You will experience immediate and substantial dilution of $6.64 per common unit.

 

    You may be required to pay taxes on income from us even if you do not receive any cash distributions from us.

 

    Our tax treatment depends on our status as a partnership for federal income tax purposes, as well as our not being subject to entity-level taxation by individual states. If the IRS treats us as a corporation or we become subject to entity-level taxation, it would reduce the amount of cash available for distribution to you.

 

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Industry Outlook

 

The U.S. cemetery and funeral home industry, which is often referred to as the death care industry, is highly fragmented. According to the Information for Industry, Inc., a market research firm, there were approximately 7,000 cemeteries and crematories and 16,000 funeral homes in the United States in 2001. In 2003, approximately 730 cemeteries and crematories and 2,400 funeral homes were owned by the four existing publicly traded death care companies, and the remainder were owned by local, independent operators and privately held consolidators, like us.

 

The death care industry benefits from the long-term stability of the death rate. According to the U.S. Department of Commerce, the number of deaths in the United States is expected to increase approximately 1% per year over the next ten years. The target market for pre-need sales is the 45-year-old to 64-year-old age group because they generally purchase pre-need cemetery products and services at a higher rate than other age groups. According to the U.S. Department of Commerce, the 45-year-old to 64-year-old age group is expected to experience a 2.6% compound annual growth rate from 2000 to 2010 and to represent approximately 26.5% of the U.S. population by 2010, as compared to 22.2% in 2000. As these baby boomers age, the customer base for pre-need sales is expected to increase.

 

Partnership Structure and Management

 

Our operations will be conducted through, and our operating assets will be owned by, our direct and indirect subsidiaries. Initially, we will have one direct subsidiary, StoneMor Operating LLC, a limited liability company that will own equity interests in a number of subsidiary operating companies.

 

StoneMor GP LLC, as our general partner, will manage our operations and activities. The executive officers and the directors of our general partner previously served as executive officers and directors of Cornerstone Family Services, Inc. Our general partner will not receive any management fee or other compensation in connection with its management of our business, but it will be reimbursed for expenses that it incurs on our behalf. Our general partner is also entitled to distributions on its general partner interest and, if specified levels of distributions are made on the common and subordinated units, on its incentive distribution rights. Members of our management will hold direct and indirect interests in our general partner.

 

Unlike the holders of common stock in a corporation, you will have only limited voting rights on matters affecting our business. You will not have the right to elect our general partner or its directors on an annual or other continuing basis. Our general partner may not be removed except by the vote of the holders of at least 66 2/3% of the outstanding common and subordinated units, including units owned by our general partner and its affiliates, voting together as a single class. Because of their controlling ownership interest in our general partner, the McCown De Leeuw funds will be able to control the election of a majority of the directors of our general partner. And because these funds will indirectly control greater than 33 1/3% of our units, they will be able to prevent the removal of our general partner.

 

Our general partner has a legal duty to manage us in a manner beneficial to our unitholders. This legal duty originates in state statutes and judicial decisions and is commonly referred to as a “fiduciary” duty. However, the officers and directors of our general partner also have fiduciary duties to manage our general partner’s business in a manner beneficial to our general partner and its affiliates, including the McCown De Leeuw funds. Conflicts of interest may arise in the future between us and our unitholders, on the one hand, and our general partner and its affiliates, including the McCown De Leeuw funds, on the other hand. These conflicts include decisions made by our general partner (such as the amount and timing of borrowings or whether to acquire additional cemeteries) that may result in our general partner receiving incentive distributions or the conversion of subordinated units (which are owned by affiliates of our general partner) into common units.

 

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Our partnership agreement limits the fiduciary duties and liability of our general partner and its officers and directors to unitholders that would otherwise exist under applicable state law. Our partnership agreement also restricts the remedies available to unitholders for actions that might otherwise constitute breaches of our general partner’s and its officers’ and directors’ fiduciary duties. By purchasing a common unit, you are treated as having consented to various actions contemplated in the partnership agreement and conflicts of interest that might otherwise be considered a breach of fiduciary or other duties under applicable state law.

 

Our principal executive offices are located at 155 Rittenhouse Circle, Bristol, Pennsylvania 19007, and our phone number is (215) 826-2800. Our website is located at http://www.stonemor.com. Information on our website or any other website is not incorporated by reference into this prospectus and does not constitute a part of this prospectus.

 

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The following diagram depicts our organizational structure and ownership after giving effect to CFSI LLC’s contribution of substantially all of its assets and operations to us and this offering of common units.

 

LOGO

 


* Cornerstone Family Services, Inc. will be converted into CFSI LLC prior to the closing of this offering.

 

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The Offering

 

Common units offered by us

3,675,000 common units 4,226,250 common units if the underwriters exercise their over-allotment option in full. CFSI LLC, the parent of our general partner, will be deemed to be the selling unitholder of any common units sold upon exercise of the over-allotment option. Please see “Selling Unitholder.” The information in this prospectus assumes that the over-allotment option is not exercised.

 

Units outstanding after this offering

4,239,782 common units, representing a 49.0% limited partner interest in us.

 

 

4,239,782 subordinated units, representing a 49.0% limited partner interest in us.

 

Use of proceeds

We intend to use the net proceeds from this offering, together with the net proceeds of $79.0 million from the private placement of senior secured notes by our subsidiaries, to:

 

    repay approximately $132.2 million in debt of CFSI LLC, including $103.1 million in a term loan, $26.5 million of revolving debt outstanding under the existing credit facility and $2.6 million in other outstanding debt;

 

    pay approximately $9.7 million of expenses associated with this offering, the proposed private placement of senior secured notes and the related formation and contribution transactions; and

 

    reserve approximately $3.9 million for general partnership purposes, including for the construction of mausoleum crypts and lawn crypts and for the purchase of equipment needed to install burial vaults.

 

One-half of the net proceeds from any exercise of the underwriters’ over-allotment option will be used for general partnership purposes, and the other half will be used to redeem from CFSI LLC a number of common units equal to the number of common units sold upon exercise of the over-allotment option. If CFSI LLC does not hold a number of common units that is equal to or greater than the number of common units sold upon exercise of the over-allotment option, we will redeem from CFSI LLC a number of subordinated units that is equal to the shortfall. CFSI LLC will use the proceeds from this redemption to repurchase a portion of its Class A membership interests. Please see “Selling Unitholder.”

 

Cash distributions

We intend to make minimum quarterly distributions of $0.4625 per unit if we have sufficient cash from our operations after we have paid our expenses, including the expenses of our general partner, funded

 

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merchandise and perpetual care trusts and established necessary cash reserves. In general, we will pay any cash distributions we make each quarter in the following manner:

 

    first, 98% to the common units and 2% to our general partner, until each common unit has received a minimum quarterly distribution of $0.4625 plus any arrearages from prior quarters;

 

    second, 98% to the subordinated units and 2% to our general partner, until each subordinated unit has received a minimum quarterly distribution of $0.4625; and

 

    third, 98% to all units, pro rata, and 2% to our general partner, until each unit has received a distribution of $0.5125.

 

 

If cash distributions per unit exceed $0.5125 in any quarter, our general partner will receive increasing percentages, up to a maximum of 50%, of the cash we distribute in excess of that amount. We refer to these distributions as incentive distributions.

 

 

We believe, based on the assumptions beginning on page 35 of this prospectus, that we will have sufficient cash from our operations, together with working capital borrowings made in connection with the growth of our pre-need sales program, to enable us to make the minimum quarterly distribution of $0.4625 on all of our common units and subordinated units for each quarter through September 30, 2005. The amount of estimated cash available for distribution generated during 2003 would have been sufficient to allow us to pay the full minimum quarterly distribution on all of our common units but would not have been sufficient to allow us to pay the full minimum quarterly distribution on all of our subordinated units during that period. The amount of estimated cash available for distribution generated during the first six months of 2004 would have been sufficient to allow us to pay the full minimum quarterly distribution on all of our common and subordinated units during that period. Please read “Cash Available for Distribution” and Appendix D to this prospectus to see a calculation of our ability to pay the minimum quarterly distribution during these periods.

 

Subordinated units

CFSI LLC will initially own all of our subordinated units. The principal difference between our common units and subordinated units is that in any quarter during the subordination period the subordinated units are entitled to receive the minimum quarterly distribution of $0.4625 only after the common units have received the minimum quarterly distribution and arrearages in the payment of the minimum quarterly distribution from prior quarters. Subordinated units will not accrue arrearages. The subordination period will end once we meet the financial tests in the partnership agreement, but it generally cannot end before September 30, 2009. These financial tests require us to have earned and paid the minimum quarterly distribution on all of our outstanding units for three consecutive four-quarter periods.

 

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When the subordination period ends, all remaining subordinated units will convert into common units on a one-for-one basis, and the common units will no longer be entitled to arrearages.

 

 

If we meet the financial tests in the partnership agreement for any three consecutive four-quarter periods ending on or after September 30, 2007, 25% of the subordinated units will convert into common units. If we meet these tests for any three consecutive four-quarter periods ending on or after September 30, 2008, an additional 25% of the subordinated units will convert into common units. The early conversion of the second 25% of the subordinated units may not occur until at least one year after the early conversion of the first 25% of subordinated units.

 

Issuance of additional units

In general, during the subordination period we may issue up to 2,119,891 additional common units, or 50% of the common units outstanding immediately after this offering, without obtaining unitholder approval. We can also issue an unlimited number of common units for acquisitions, expansion capital improvements and debt repayments that, in each case, increase cash flow from operations per unit on an estimated pro forma basis and for the redemption of outstanding common units if the redemption price equals the net proceeds per unit, before expenses, to us.

 

Limited call right

If at any time our general partner and its affiliates own more than 80% of the outstanding common units, our general partner has the right, but not the obligation, to purchase all of the remaining common units at a price not less than the then-current market price of the common units.

 

Senior secured notes

Concurrently with this offering, our operating company and its subsidiaries will issue and sell $80.0 million in aggregate principal amount of senior secured notes. For a description of the senior secured notes please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Senior Secured Notes.” The closing of this offering is contingent upon the completion of the private placement of the senior secured notes.

 

New credit facility

Concurrently with this offering, our operating company and its subsidiaries will enter into a new credit facility consisting of a $12.5 million revolving credit facility and a $22.5 million acquisition facility. For a description of the new credit facility, please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—New Credit Facility.” The closing of this offering is contingent upon the closing of the new credit facility.

 

Listing

Our common units have been approved for listing on the NASDAQ National Market under the symbol “STON.”

 

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Summary of Tax Considerations

 

The following discussion, insofar as it relates to U.S. federal income tax laws, is based in part upon the opinion of Vinson & Elkins L.L.P., counsel to our general partner and us, contained in “Material Tax Consequences.” This summary is qualified by the discussion in “Material Tax Consequences,” particularly the qualifications on the opinions of Vinson & Elkins L.L.P. therein.

 

Partnership Status

 

In the opinion of Vinson & Elkins L.L.P., we will be classified for federal income tax purposes as a partnership, and the beneficial owners of common units will generally be considered our limited partners. Accordingly, we will pay no federal income taxes, and a common unitholder will be required to report in his federal income tax return his share of our income, gains, losses and deductions. In general, cash distributions to a common unitholder will be taxable only if, and only to the extent that, they exceed the tax basis in his common units.

 

Partnership Allocations

 

In general, our income and loss will be allocated to our general partner and our unitholders for each taxable year in accordance with their respective percentage interests in us. In determining his federal income tax liability, a unitholder will be required to take into account his share of our income for each of our taxable years ending within or with the unitholder’s taxable year even if cash distributions are not made to him.

 

Ratio of Taxable Income to Distributions

 

We estimate that if you hold the common units that you purchase in this offering through the record date for distributions for the quarter ended December 31, 2008, you will be allocated, on a cumulative basis, an amount of taxable income for that period that will be less than 75% of the cash distributed to you with respect to that period. A substantial portion of the income that will be allocated to you is expected to be qualified dividend income, which for individuals is subject to a significantly lower maximum federal income tax rate (currently 15%) than ordinary income (currently taxable at a maximum rate of 35%). If you are an individual taxable at the maximum rate of 35% on ordinary income, the effect of this lower qualified dividend rate is to produce an after-tax return to you that is the same as if the amount of federal taxable income allocated to you for that period were less than 50% of the cash distributed to you for that period.

 

Disposition of Common Units

 

A unitholder who sells common units will recognize gain or loss equal to the difference between the amount realized and the adjusted tax basis of the common units sold. A unitholder’s initial tax basis for a common unit purchased in this offering will generally be the amount paid for the common unit. A unitholder’s basis will generally be increased by his share of our income and decreased by his share of our losses and distributions. Thus, distributions of cash from us to a unitholder in excess of the income allocated to him will, in effect, become taxable income if he sells the common units at a price greater than his adjusted tax basis even if the price is less than his original cost. A portion of the amount realized (whether or not representing gain) may be ordinary income.

 

State, Local and Other Tax Considerations

 

In addition to federal income taxes, unitholders will likely be subject to other taxes, such as state and local income taxes, unincorporated business taxes, and estate, inheritance or intangible taxes that are imposed by the various jurisdictions in which a unitholder resides or in which we do business or own property. Each of the states in which we will initially own assets and do business currently imposes a personal income tax. Some of the states may require us, or we may elect, to withhold from amounts to be distributed to a unitholder. Withholding may not relieve the nonresident unitholder from the obligation to file an income tax return. Based on current law and our estimate of our future operations, we anticipate that any amounts required to be withheld will not be material. Vinson & Elkins L.L.P. has not rendered an opinion on the state or local tax consequences of an investment in us.

 

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Summary Historical and Pro Forma Financial and Operating Data

 

The table on the next page presents summary historical financial and operating data of our predecessor, Cornerstone Family Services, Inc., and pro forma financial data of StoneMor Partners L.P. for the periods and as of the dates indicated. The summary historical financial data for Cornerstone Family Services, Inc. as of June 30, 2004 and for the six months ended June 30, 2004 and June 30, 2003 are derived from the unaudited consolidated financial statements of Cornerstone Family Services, Inc. The summary historical financial data for Cornerstone Family Services, Inc. as of and for the years ended December 31, 2001, 2002 and 2003 are derived from the audited consolidated financial statements of Cornerstone Family Services, Inc.

 

The unaudited pro forma consolidated financial statements of StoneMor Partners L.P. give pro forma effect to the contribution of substantially all of the assets and liabilities of Cornerstone Family Services, Inc. and its subsidiaries to StoneMor Partners L.P. and its subsidiaries, the completion of this offering, the completion of our proposed private placement of senior secured notes and the use of the net proceeds of this offering and the proposed private placement of senior secured notes as described in “Use of Proceeds.” The summary pro forma financial data presented for the year ended December 31, 2003 and as of and for the six months ended June 30, 2004 are derived from our unaudited pro forma consolidated financial statements. The pro forma balance sheet data assumes the offering, the proposed private placement and the related formation and contribution transactions occurred as of June 30, 2004. The pro forma statement of operations data for the year ended December 31, 2003 and for the six months ended June 30, 2004 assumes the offering, the proposed private placement of senior secured notes and the related formation and contribution transactions occurred on January 1, 2003. You can find a more extensive explanation of the pro forma data in the notes to our unaudited pro forma consolidated financial statements.

 

The table on the next page includes EBITDA, as adjusted. We present EBITDA, as adjusted, because this information is relevant to our business. This calculation is not presented in accordance with U.S. generally accepted accounting principles, or GAAP, and should not be considered in isolation or as a substitute for net income (loss), income from operations or cash flow as reflected in our historical consolidated financial statements. We explain and reconcile EBITDA, as adjusted, to net cash provided by operating activities, its most directly comparable financial measure that is calculated and presented in accordance with GAAP, in “—Non-GAAP Financial Measures.”

 

The table on the next page should be read together with, and is qualified in its entirety by reference to, the audited and unaudited historical and unaudited pro forma consolidated financial statements and the accompanying notes included elsewhere in this prospectus. The table should also be read with “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

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SUMMARY HISTORICAL AND PRO FORMA FINANCIAL AND OPERATING DATA

 

    Cornerstone Family Services, Inc. Historical (1)

    StoneMor Partners L.P.
Pro Forma (1)


 
    Year Ended December 31,

   

Six Months

Ended June 30,


    Year Ended
December 31,
2003


  Six
Months
Ended
June 30,
2004


 
    2001

    2002

    2003

    2003

    2004

     
    (in thousands, except per unit data)  

Statement of Operations Data:

                                                     

Cemetery revenues

  $ 73,865     $ 74,168     $ 77,978     $ 37,428     $ 43,096     $ 77,978   $ 43,096  

Funeral home revenues

    961       1,360       1,724       859       1,012       1,724     1,012  
   


 


 


 


 


 

 


Total revenues

    74,826       75,528       79,702       38,287       44,108       79,702     44,108  
   


 


 


 


 


 

 


Cost of goods sold (exclusive of depreciation shown separately below):

                                                     

Land and crypts

    5,946       5,948       4,346       2,404       2,224       4,346     2,224  

Perpetual care

    2,404       2,434       2,585       1,279       1,350       2,585     1,350  

Merchandise

    3,453       3,634       3,123       1,796       2,622       3,123     2,622  

Selling expense

    15,480       15,413       15,584       7,654       9,545       15,584     9,545  

Cemetery expense

    16,990       17,191       17,732       8,599       9,734       17,732     9,734  

General and administrative expense

    8,594       9,020       9,407       4,617       4,864       9,407     4,864  

Overhead (including $1,178 of stock-based compensation in 2003)(2)

    9,892       11,820       12,579       4,704       4,991       11,597     4,500  

Depreciation and amortization

    4,337       4,893       5,001       2,373       2,481       5,001     2,481  

Funeral home expense

    996       1,343       1,513       741       890       1,513     890  
   


 


 


 


 


 

 


Total costs and expenses

    68,092       71,696       71,870       34,168       38,701       70,888     38,210  
   


 


 


 


 


 

 


Operating profit

    6,734       3,832       7,832       4,119       5,407       8,814     5,898  

Expenses related to terminated debt offering and refinancing(3)

    7,000       —         —         —         —         —       —    

Interest expense

    15,550       14,828       11,376       6,067       5,284       6,128     3,064  
   


 


 


 


 


 

 


Income (loss) before income taxes and cumulative effect of change in accounting principle

    (15,816 )     (10,996 )     (3,544 )     (1,948 )     123       2,686     2,834  

Income taxes (benefit):

                                                     

State and franchise taxes

    (294 )     546       1,455       305       714       1,370     500  

Federal

    (4,945 )     (1,453 )     1,010       (342 )     224       429     (702 )
   


 


 


 


 


 

 


Total income taxes (benefit)

    (5,239 )     (907 )     2,465       (37 )     938       1,799     (202 )
   


 


 


 


 


 

 


Income (loss) before cumulative effect of change in accounting principle

    (10,577 )     (10,089 )     (6,009 )     (1,911 )     (815 )     887     3,036  
   


 


 


 


 


 

 


Cumulative effect of change in accounting principle (4)

    —         5,934       —         —         —         —       —    
   


 


 


 


 


 

 


Net income (loss)

  $ (10,577 )   $ (4,155 )   $ (6,009 )   $ (1,911 )   $ (815 )   $ 887   $ 3,036  
   


 


 


 


 


 

 


Pro forma net income per unit:

                                                     

Basic and diluted

                                          $ 0.10   $ 0.35  

Balance Sheet Data (at period end):

                                                     

Cemetery property

  $ 154,394     $ 153,413     $ 151,200             $ 151,550           $ 151,550  

Total assets (5)

    357,562       356,293       355,685               480,724             480,475  

Deferred cemetery revenues, net (6)

    91,208       103,580       115,233               119,680             119,680  

Total debt

    133,474       134,732       130,708               130,963             80,000  

Redeemable preferred stock (par value $0.01, 12,764 and 15,514 shares issued and outstanding at December 31, 2002 and 2003, respectively and 13,400 and 17,103 shares issued and outstanding at June 30, 2003 and 2004, respectively) (7)

    —         12,764       15,514               17,103       —       —    

Total stockholders’/partners’ equity

    63,960       48,920       41,980               39,576             111,307  

Cash Flow Data:

                                                     

Net cash provided by (used in):

                                                     

Operating activities

  $ 12,589     $ 11,042     $ 7,146     $ (338 )   $ (367 )              

Investing activities

    (5,766 )     (8,913 )     (3,129 )     (1,741 )     (3,395 )              

Financing activities

    (8,011 )     1,258       (4,022 )     (1,234 )     254                

Other Financial Data:

                                                     

EBITDA, as adjusted

  $ 18,031     $ 26,741     $ 29,627     $ 15,573     $ 15,137                

Change in assets and liabilities that provided (used) cash:

                                                     

Merchandise trusts receivable

    6,206       594       (128 )     342       —                  

Due from merchandise trust

    13,533       (1,379 )     (170 )     (473 )     (1,249 )              

Merchandise liability

    (827 )     (3,427 )     (3,224 )     (2,543 )     (3,126 )              

Capital expenditures:

                                                     

Maintenance capital expenditures

    1,922       3,378       1,184       660       1,005                

Expansion capital expenditures, including acquisitions and dispositions

    3,844       5,535       1,945       1,081       2,390                

 

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     Cornerstone Family Services, Inc. Historical

     Year Ended December 31,

   Six Months
Ended June 30,


     2001

   2002

   2003

   2003

   2004

Operating Data:

                                  

Interments performed

     22,122      22,693      22,281      11,159      11,338

Cemetery revenues per interment performed (8)

   $ 3,339    $ 3,215    $ 3,500    $ 3,354    $ 3,801

Interment rights sold (9):

                                  

Lots (8)

     12,684      11,933      12,442      6,005      6,563

Mausoleum crypts (including pre-construction)

     1,921      2,271      2,314      1,221      1,052

Niches

     389      436      445      243      280
    

  

  

  

  

Total interment rights sold (8)(9)

     14,994      14,640      15,201      7,469      7,895
    

  

  

  

  

Cemetery revenues per interment right sold (8)(9)

   $ 4,926    $ 4,984    $ 4,196    $ 5,010    $ 5,459

Number of contracts written

     52,353      51,012      47,939      24,897      23,877

Aggregate contract amount, in thousands (excluding interest)

   $ 89,726    $ 89,106    $ 90,551    $ 46,896    $ 47,516

Average amount per contract (excluding interest)

   $ 1,714    $ 1,747    $ 1,889    $ 1,884    $ 1,990

Number of pre-need contracts written

     23,824      23,194      22,276      11,805      10,911

Aggregate pre-need contract amount, in thousands (excluding interest)

   $ 57,306    $ 59,177    $ 60,854    $ 31,736    $ 31,190

Average amount per pre-need contract (excluding interest)

   $ 2,405    $ 2,551    $ 2,732    $ 2,688    $ 2,859

Number of at-need contracts written

     28,529      27,818      25,663      13,092      12,966

Aggregate at-need contract amount, in thousands

   $ 32,421    $ 29,928    $ 29,698    $ 15,160    $ 16,326

Average amount per at-need contract

   $ 1,136    $ 1,076    $ 1,157    $ 1,158    $ 1,259

(1) Includes results of operations of 12 cemeteries that we operate under management agreements with the cemetery associations that own them.
(2) Includes write-off of $1.3 million of expenses in 2002 and $715,000 in 2003 incurred in connection with a potential acquisition of a group of cemeteries in Michigan that we determined would be unlikely to take place. Also includes $1.7 million in corporate bonuses paid in 2003 and an annual payment of a $0.6 million to $0.8 million fee to MDC Management Company IV, LLC, which is the general partner of certain of the McCown De Leeuw funds. Also includes $1.2 million of stock-based compensation in 2003, which is discussed in Note 12 to our historical consolidated financial statements.
(3) Represents expenses incurred in connection with a proposed high-yield debt offering that was not completed and a refinancing of our existing credit facility. The expenses included $2.4 million of legal and accounting fees, $2.2 million of consulting and other advisory fees, $1.8 million of bank amendment fees and $0.6 million of miscellaneous expenses, including printing costs, rating-agency fees and title-company fees.
(4) Represents negative goodwill recorded on January 1, 2002 as a result of the implementation of SFAS Nos. 141 and 142.
(5) Includes principal of perpetual care and merchandise trusts stated on our balance sheet at fair value as of June 30, 2004 in accordance with FASB Interpretation No. 46 and No. 46 revised, Consolidation of Variable Interest Entities: an Interpretation of Accounting Research Bulletin No. 51, which we adopted as of March 31, 2004. In previous periods, includes principal held in merchandise trusts stated on our balance sheets at cost and does not include perpetual care trust principal in accordance with then industry practice.
(6) Represents revenues to be recognized from sales of pre-need products and services and the related income and capital gains on merchandise trusts. We recognize revenues from sales of pre-need interment rights to constructed mausoleums and lawn crypts when we have collected at least 10% of the sales price. We defer recognition of revenues from sales of pre-need interment rights to unconstructed mausoleums and lawn crypts until we have collected at least 10% of the sales price, at which point we recognize revenues on the percentage-of-completion basis. We recognize revenues from sales of pre-need merchandise and services, other than perpetual care services, when we satisfy the criteria for delivery of the merchandise to the customer or perform the services for the customer. At that time, we also recognize the related income and capital gains from merchandise trusts.
(7) Represents preferred stock issued to the McCown De Leeuw funds and members of management that will be converted into Class A membership interests in CFSI LLC prior to the closing of this offering.
(8) Excludes in 2002 the sale of a tract of developed land equivalent to 9,600 burial lots to a municipality in Pennsylvania for $1.2 million.
(9) Net of cancellations. Counts the sale of a double-depth burial lot as the sale of two interment rights.

 

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Non-GAAP Financial Measures

 

We present EBITDA, as adjusted, because this information is relevant to our business. We define EBITDA, as adjusted, as net income before:

 

    interest;

 

    taxes;

 

    depreciation and amortization;

 

    cost of land and crypts sold;

 

    change in deferred cemetery revenues, net; and

 

    cumulative effect of change in accounting principle.

 

In our presentation of EBITDA, as adjusted, we adjusted EBITDA (defined as earnings before interest, taxes, depreciation and amortization) for the following items:

 

    Cost of land and crypts sold, an expense item resulting from our sales of burial lots, lawn crypts and mausoleum crypts, which is based on the historical allocation of our original cemetery acquisition and construction costs to individual burial lots and crypts. Management considers this expense to represent the depletion of our interment spaces that are available for sale.

 

    Increase (decrease) in deferred cemetery revenues, net, which represents the net change in pre-need cemetery products and services sold that have not been delivered or performed during the period presented and therefore not recognized as revenues. Because it includes the change in deferred cemetery revenues, net, EBITDA, as adjusted, is able to reflect the deferred revenues from contracts written and their related expenses generated in a particular period.

 

    Cumulative effect of change in accounting principle, which reflects the adoption of new accounting policies. In 2002, cumulative effect of change in accounting principle reflects the implementation of SFAS Nos. 141 and 142, which required us to eliminate our recorded negative goodwill. Prior to the implementation of SFAS Nos. 141 and 142, we amortized negative goodwill over a 40-year period. Management considers this adjustment to EBITDA, as adjusted, to be an acceleration of amortization that would have been recognized in future periods.

 

Management and external users of our financial statements, such as our investors, use EBITDA, as adjusted, as an important financial measure to assess the ability of our assets to generate cash sufficient to pay interest on our indebtedness, meet capital expenditure and working capital requirements, pay quarterly distributions on the common and subordinated units and otherwise meet our obligations as they become due.

 

There are material limitations to using a measure such as EBITDA, as adjusted, including the difficulty associated with using it as the sole measure to compare the results of one company to another and the inability to analyze significant items that directly affect a company’s net income (loss) or operating income. In addition, our calculation of EBITDA, as adjusted, may not be consistent with similarly titled measures of other companies and should be viewed in conjunction with measures that are computed in accordance with GAAP. Management compensates for these limitations in considering EBITDA, as adjusted, in conjunction with its analysis of other GAAP financial measures, such as net income (loss) and net cash provided by (used in) operating activities.

 

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The following table presents a reconciliation of EBITDA, as adjusted, to net cash provided by operating activities, its most directly comparable GAAP financial measure, on a historical basis, for the periods presented:

 

 

     Cornerstone Family Services, Inc. Historical

 
     (in thousands)  
     Year Ended December 31,

     Six Months
Ended June 30,


 
     2001

     2002

     2003

     2003

     2004

 

Reconciliation of “EBITDA, as adjusted” to “Net cash provided by operating activities”:

                                            

Net cash provided by (used in) operating activities

   $ 12,589      $ 11,042      $ 7,146      $ (338 )    $ (367 )

Interest paid

     16,235        12,959        12,918        5,175        5,062  

Income taxes paid

     2,615        1,790        814        555        650  

Refinancing expense

     (500 )      —          —          —          —    

Stock compensation

     —          —          (1,178 )      —          —    

Changes in operating working capital:

                                            

Accounts receivable

     2,474        (2,564 )      1,900        2,209        1,673  

Due from merchandise trust

     (13,533 )      1,379        170        473        1,249  

Merchandise trusts receivable

     (6,206 )      (594 )      128        (342 )      —    

Prepaid expenses

     (221 )      192        49        443        (196 )

Other current assets

     —          (820 )      168        40        (29 )

Other assets

     (793 )      (392 )      1,674        202        6,730  

Accounts payable and accrued and other liabilities

     4,544        322        2,614        4,613        (2,761 )

Merchandise liability

     827        3,427        3,224        2,543        3,126  
    


  


  


  


  


EBITDA, as adjusted

   $ 18,031      $ 26,741      $ 29,627      $ 15,573      $ 15,137  
    


  


  


  


  


 

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RISK FACTORS

 

Risks Related to Our Business

 

We may not have sufficient cash from operations to pay the minimum quarterly distribution after we have paid our expenses, including the expenses of our general partner, funded merchandise and perpetual care trusts and established necessary cash reserves.

 

The amount of cash we can distribute on our units principally depends upon the amount of cash we generate from operations, which fluctuates from quarter to quarter based on, among other things:

 

    the volume of our sales;

 

    the prices at which we sell our products and services; and

 

    the level of our operating costs.

 

In addition, the actual amount of cash we will have available for distribution will depend on other factors, such as working capital borrowings, capital expenditures and funding requirements for trusts and our ability to withdraw amounts from trusts.

 

If we had completed the transactions contemplated in this prospectus on January 1, 2003, we believe that our cash from operations generated during 2003 would not have been sufficient to allow us to pay the full minimum quarterly distribution for 2003 on all of our common units and all of our subordinated units. We refer to our estimate of cash available for distribution as our pro forma, as adjusted, available cash from operating surplus in Appendix D, where we have calculated this amount for 2003 and the first six months of 2004. Pro forma, as adjusted, available cash from operating surplus generated during 2003 would have been sufficient to pay the full minimum quarterly distribution on the common units for 2003 but would have been sufficient to pay only 73.5% of the minimum quarterly distribution on the subordinated units for 2003. Please read Appendix D for a description of the adjustments that we made to our pro forma available cash from operating surplus to arrive at the as-adjusted amounts described above.

 

If the assumptions set forth in “Cash Available for Distribution” are not realized, we may not be able to pay the minimum quarterly distribution or any amount on the common units or the subordinated units, in which event the market price of the common units may decline materially. We expect that we will need working capital borrowings of approximately $3.7 million during the twelve-month period ending September 30, 2005 in order for us to have sufficient operating surplus to pay the full minimum quarterly distribution on all of our common and subordinated units for that period, although the actual amount of working capital borrowings could be materially more or less.

 

Our indebtedness limits cash flow available for our operations and for distribution to our partners.

 

On a pro forma basis as of June 30, 2004, we had $80.0 million in debt. Leverage makes us more vulnerable to economic downturns. Because we are obligated to dedicate a portion of our cash flow to service our debt obligations, our cash flow available for operations and for distribution to our partners will be reduced. The amount of indebtedness we have could limit our flexibility in planning for, or reacting to, changes in the markets in which we compete, and require us to dedicate more cash flow to service our debt than we desire. Our ability to satisfy our indebtedness as required by the terms of our debt will be dependent on, among other things, the successful execution of our long-term strategic plan. Subject to limitations in our new credit facility and under the senior secured notes, we may incur additional debt in the future, for acquisitions or otherwise, and servicing this debt could further limit our cash flow.

 

Adverse conditions in the financial markets may reduce the principal and earnings of the investments held in merchandise and perpetual care trusts and adversely affect our revenues and cash flow.

 

A substantial portion of our revenues is generated from investment returns that we realize from merchandise and perpetual care trusts. Earnings and investment gains and losses on investments by merchandise and perpetual

 

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care trusts are affected by financial market conditions that are not within our control. Because the majority of merchandise and perpetual care trust principal is invested in fixed-income securities, investments held in these trusts are particularly susceptible to changes in interest rates. Merchandise trust principal invested in equity securities is also sensitive to the performance of the stock market. Earnings are also affected by the mix of fixed-income and equity securities that our investment managers choose to maintain in the trusts and by the fact that our investment managers may not choose the optimal mix for any particular market condition.

 

Declines in earnings from merchandise and perpetual care trusts could cause declines in current and future revenues and cash flow. In addition, any significant or sustained investment losses could result in merchandise trusts having insufficient funds to cover our cost of delivering products and services, or in perpetual care trusts offsetting less of our cemetery maintenance costs. In either case, we would be required to use our operating cash to deliver those products and perform those services, which could decrease our cash available for distribution. These events could have a material adverse effect on our financial condition and results of operations.

 

Pre-need sales typically generate low or negative cash flow in the periods immediately following sales.

 

When we sell cemetery merchandise and services on a pre-need basis, we pay commissions on the sale to our salespeople and are required by state law to deposit a portion of the sales proceeds into a merchandise trust. In addition, most of our customers finance their pre-need purchases under installment contracts over a number of years. Depending on the trusting requirements of the states in which we operate, the applicable sales commission rates and the amount of the down payment, our cash flow from payments on installment contracts is typically negative until we have paid the sale commission due on the sale or until we purchase the products or perform the services and are permitted to withdraw funds we have deposited in the merchandise trust. To the extent we increase pre-need activities, state trusting requirements are increased or we delay the purchase of the products or performance of the services we sell on a pre-need basis, our cash flow immediately following pre-need sales may be further reduced, and our ability to service our debt and make distributions to our partners could be adversely affected.

 

Because fixed costs are inherent in our business, a decrease in our revenues can have a disproportionate effect on our cash flow and profits.

 

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

 

Our failure to attract and retain qualified sales personnel and management could have an adverse effect on us.

 

Our ability to attract and retain a qualified sales force and other personnel is an important factor in achieving future success. Buying cemetery and funeral home products and services, especially at-need products and services, is very emotional for most customers, so our sales force must be particularly sensitive to our customers’ needs. We cannot assure you that we will be successful in our efforts to attract and retain a skilled sales force. If we are unable to maintain a qualified and productive sales force, our revenues may decline, and our cash available for distribution may decrease.

 

We are also dependent upon the continued services of our key officers. The loss of any of our key officers could have a material adverse effect on our business, financial condition and results of operations. We may not be able to locate or employ on acceptable terms qualified replacements for senior management or key employees if their services were no longer available. We do not maintain key employee insurance on any of our executive officers.

 

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We may not be able to identify, complete, fund or successfully integrate additional cemetery acquisitions.

 

A primary component of our business strategy is to grow through acquisitions of cemeteries and, to a lesser extent, funeral homes. We cannot assure you that we will be able to identify and acquire cemeteries on terms favorable to us or at all. We may face competition from other death care companies in making acquisitions. Our ability to make acquisitions in the future may be limited by our inability to secure adequate financing, restrictions under our existing or future debt agreements, competition from third parties or a lack of suitable properties. For example, we are not permitted to make acquisitions for more than $2.5 million, or any series of acquisitions aggregating more than $20.0 million in any consecutive 12-month period, without the requisite consent of the lenders under our new credit facility. Also, when we acquire cemeteries that do not have an existing pre-need sales program or a significant amount of pre-need products and services that have been sold but not yet delivered or performed, the operation of the cemetery and implementation of a pre-need sales program after acquisition may require significant amounts of working capital. This may make it more difficult for us to make acquisitions. Furthermore, the amount of common units we can issue to fund acquisitions in the next three years is limited by the restrictions that would be placed on our ability to use our net operating losses if such issuances resulted in an ownership change under federal tax laws. Please read “Risk Factors—Tax Risks to Common Unitholders—Changes in the ownership of our units, including the changes occurring as a result of this offering, may result in annual limitations on our use of net operating losses available to reduce taxable income, which could increase our tax liabilities and decrease cash available for distribution in future taxable periods.”

 

If the trend toward cremation in the United States continues, our revenues may decline.

 

We and other death care companies that focus on traditional methods of interment face competition from the increasing number of cremations in the United States. Industry studies indicate that the percentage of cremations has steadily increased and that cremations will represent approximately 36% of the United States death care market by the year 2010, compared to approximately 28% in 2002. Because the products and services associated with a cremation, such as niches and urns, produce lower revenues than the products and services associated with a traditional interment, a continuing trend toward cremations may reduce our revenues and, therefore, our cash available for distribution.

 

Regulatory and Legal Risks

 

Our operations are subject to regulation, supervision and licensing under numerous federal, state and local laws, ordinances and regulations, including extensive regulations concerning trusts, pre-need sales, cemetery ownership, marketing practices, crematories, environmental matters and various other aspects of our business.

 

If state laws or interpretations of existing state laws change or if new laws are enacted, we may be required to increase trust deposits or to alter the timing of withdrawals from trusts, which may have a negative impact on our revenues and cash flow.

 

We are required by state laws to deposit specified percentages of the proceeds from our pre-need and at-need sales of interment rights into perpetual care trusts and proceeds from our pre-need sales of cemetery products and services into merchandise trusts. These laws also determine when we are allowed to withdraw funds from those trusts. If those laws or the interpretations of those laws change or if new laws are enacted, we may be required to deposit more of the sales prices we receive from our sales into the trusts or to defer withdrawals from the trusts, thereby decreasing our cash flow until we are permitted to withdraw the deposited amounts. This could also reduce our cash available for distribution.

 

If state laws or their interpretations change, or new laws are enacted relating to the ownership of cemeteries and funeral homes, our business, financial condition and results of operations could be adversely affected.

 

Some states, such as New Jersey, require cemeteries to be organized in the nonprofit form but permit those nonprofit entities to contract with for-profit companies for management services. The New Jersey Cemetery Act was recently recodified to reflect certain technical amendments that may be interpreted to prohibit for-profit

 

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entities like us from managing cemeteries located in New Jersey. We manage five cemeteries in New Jersey which accounted for approximately 13.4% of our revenues in the first six months of 2004. Because the regulations implementing the amendments have not yet been adopted, the impact of these amendments is unknown. If the implementing regulations prohibit us from managing cemeteries in New Jersey, our business, financial condition and results of operations could be adversely affected.

 

We are subject to legal restrictions on our marketing practices that could adversely affect the volume of our sales.

 

The enactment or amendment of legislation or regulations relating to marketing activities may make it more difficult for us to sell our products and services. For example, the recently enacted federal “do not call” legislation has adversely affected our ability to market our products and services using telephone solicitation by limiting who we may call and increasing our costs of compliance. As we result, we have increased our reliance on direct mail marketing and telephone follow-up with existing contacts. Additional laws or regulations limiting our ability to market through direct mail, over the telephone, through internet and e-mail advertising or door-to-door may make it difficult to identify potential customers, which could increase our costs of marketing. Both increases in marketing costs and restrictions on our ability to market effectively could reduce our revenues and could have an adverse effect on our business, operations and financial condition, as well as our ability to make cash distributions to you.

 

We are subject to environmental and health and safety regulations that may adversely affect our operating results.

 

Our cemetery and funeral home operations are subject to numerous federal, state and local environmental and health and safety regulations. We may become subject to liability for the removal of hazardous substances under the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) and similar state laws. Under CERCLA and similar state laws, joint and several liability may be imposed on various parties, regardless of fault or the legality of the original disposal activity. Our funeral home, cemetery and crematory operations include the use of some materials that may meet the definition of “hazardous substances” under CERCLA and thus may give rise to liability if released to the environment through a spill or discharge. We cannot assure you that we will not face liability under CERCLA for any conditions at our properties, and we cannot assure you that these liabilities will not be material.

 

Our funeral home operations are generally subject to federal and state regulations regarding the disposal of medical waste, and are also subject to regulation by federal, state or local authorities under the Emergency Planning and Community Right-to-Know Act (EPCRA). We are required to maintain, and may be required to submit to state and local authorities, a list of any hazardous materials we use under EPCRA Tier One and Tier Two reporting requirements.

 

Our crematory operations are subject to regulation under the federal Clean Air Act and any analogous state laws. If new regulations applicable to our crematory operations were to be adopted, they could require permits or capital expenditures that would increase our costs of operation and compliance.

 

Risks Inherent in an Investment in Us

 

Our general partner and its affiliates have conflicts of interest and limited fiduciary duties, which may permit them to favor their own interests to your detriment.

 

Following the offering, CFSI LLC will own an aggregate 55.5% limited partner interest in us and will own all of the Class A units of our general partner. Conflicts of interest may arise between CFSI LLC and its affiliates, including our general partner, on the one hand, and us and our unitholders, on the other hand. As a result of these conflicts, our general partner may favor its own interests and the interests of its affiliates over the interests of the unitholders. These conflicts include, among others, the following situations:

 

   

The board of directors of our general partner is elected by the owners of our general partner. Although our general partner has a fiduciary duty to manage us in good faith, the directors of our general partner

 

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also have a fiduciary duty to manage our general partner in a manner beneficial to the owners of our general partner.

 

    Our partnership agreement limits the liability of our general partner, reduces its fiduciary duties and restricts the remedies available to unitholders for actions that might, without the limitations, constitute breaches of fiduciary duty.

 

    Our general partner determines the amount and timing of asset purchases and sales, capital expenditures, borrowings, issuances of additional limited partner interests and reserves, each of which can affect the amount of cash that is distributed to unitholders.

 

    Our partnership agreement does not restrict our general partner from causing us to pay it or its affiliates for any services rendered to us or entering into additional contractual arrangements with any of these entities on our behalf.

 

    Our general partner controls the enforcement of obligations owed to us by our general partner and its affiliates.

 

    In some instances, our general partner may cause us to borrow funds in order to permit the payment of distributions, even if the purpose or effect of the borrowing is to make a distribution on the subordinated units, to make incentive distributions or to hasten the expiration of the subordination period.

 

Following the completion of this offering, affiliates of our general partner will own sufficient common and subordinated units to block any attempt to remove our general partner.

 

Our general partner generally may not be removed except upon the vote of the holders of at least 662/3% of the outstanding units voting together as a single class. Because affiliates of our general partner will own approximately 56.7% of all the units, our general partner currently cannot be removed without the consent of its affiliates. Also, if our general partner is removed without cause during the subordination period and units held by the general partner and its affiliates are not voted in favor of that removal, all remaining subordinated units will automatically be converted into common units and any existing arrearages on the common units will be extinguished. This would adversely affect the common units by prematurely eliminating their distribution and liquidation preference over the subordinated units, which would otherwise have continued until we had met certain distribution and performance tests.

 

Unitholders have limited voting rights.

 

Unitholders have only limited voting rights on matters affecting our business and, therefore, limited ability to influence management’s decisions regarding our business. Unitholders did not select our general partner or elect the board of directors of our general partner and will have no right to select our general partner or elect its board of directors in the future. We are not required to have a majority of independent directors on our board, but we are required to establish and maintain an audit committee, which must be made up of at least three independent directors within one year of this offering. We cannot assure you that the persons who control our general partner will elect more independent directors than are necessary to satisfy our audit committee composition requirements, even though most listed corporations are required to have a majority of independent directors on their boards.

 

Unitholders’ voting rights are further restricted by the partnership agreement provision providing that any units held by a person that owns 20% or more of any class of units then outstanding, other than the general partner, its affiliates, their transferees and persons who acquired such units with the prior approval of the board of directors of our general partner, cannot be voted on any matter. In addition, the partnership agreement contains provisions limiting the ability of unitholders to call meetings or to acquire information about our operations, as well as other provisions limiting the unitholders’ ability to influence the manner or direction of management.

 

Our general partner can transfer its ownership interest in us without unitholder consent under certain circumstances, and the control of our general partner may be transferred to a third party without unitholder consent.

 

Our general partner may transfer its general partner interest to a third party in a merger or in a sale of all or substantially all of its assets without the consent of the unitholders. Furthermore, there is no restriction in the

 

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partnership agreement on the ability of the owners of our general partner to transfer their ownership interest in the general partner to a third party. The new owner of our general partner would then be in a position to replace the board of directors and officers of the general partner with its own choices and thereby influence the decisions taken by the board of directors and officers.

 

You will experience immediate and substantial dilution of $6.64 per common unit.

 

The assumed initial public offering price of $19.50 per unit exceeds our pro forma net tangible book value of $12.86 per unit as of June 30, 2004. Based on the assumed initial public offering price, you will incur immediate and substantial dilution of $6.64 per common unit. The main factor causing dilution is that our general partner and its affiliates acquired interests in us at equivalent per unit prices less than the public offering price.

 

We may issue additional common units without your approval, which would dilute your existing ownership interests.

 

During the subordination period, our general partner may cause us to issue up to 2,119,891 additional common units, or 50% of the common units outstanding immediately after this offering, without your approval. Our general partner may also cause us to issue an unlimited number of additional common units or other equity securities of equal rank with the common units, without your approval, in numerous circumstances during the subordination period. For a description of those circumstances, please read “The Partnership Agreement—Issuance of Additional Securities.”

 

After the end of the subordination period, we may issue an unlimited number of limited partner interests of any type without the approval of the unitholders. You will not have the right to approve our issuance at any time of equity securities ranking junior to the common units.

 

The issuance of additional common units or other equity securities of equal or senior rank will have the following effects:

 

    your proportionate ownership interest in us will decrease;

 

    the amount of cash available for distribution on each unit may decrease;

 

    because a lower percentage of total outstanding units will be subordinated units, the risk that a shortfall in the payment of the minimum quarterly distribution will be borne by the common unitholders will increase;

 

    the relative voting strength of each previously outstanding unit may be diminished; and

 

    the market price of the common units may decline.

 

Cost reimbursements due our general partner may be substantial and will reduce the cash available for distribution to you.

 

Prior to making any distribution on the common units, we will reimburse our general partner and its affiliates, including CFSI LLC and the officers and directors of our general partner, for all expenses they incur on our behalf. Please read “Conflicts of Interest and Fiduciary Duties—Conflicts of Interest.” The reimbursement of expenses could adversely affect our ability to pay cash distributions to you. Please read “Certain Relationships and Related Transactions.” Our general partner determines the amount of these expenses. In addition, our general partner and its affiliates may provide us with other services for which we will be charged fees as determined by our general partner.

 

In establishing cash reserves, our general partner may reduce the amount of available cash for distribution to you.

 

The partnership agreement requires our general partner to deduct from operating surplus cash reserves that it establishes to fund our future operating expenditures. The partnership agreement also permits the general partner to reduce available cash by establishing cash reserves for the proper conduct of our business, to comply with

 

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applicable law or agreements to which we are a party or to provide funds for future distributions to partners. These reserves will affect the amount of cash available for distribution to you.

 

Our general partner has a limited call right that may require you to sell your units at an undesirable time or price.

 

If, at any time, our general partner and its affiliates own more than 80% of the common units, our general partner will have the right, but not the obligation, which it may assign to any of its affiliates or to us, to acquire all, but not less than all, of the remaining common units held by unaffiliated persons at a price not less than their then-current market price. As a result, you may be required to sell your common units at an undesirable time or price and may not receive any return on your investment. You may also incur a tax liability upon the sale of your units. For further information about the call right, please read “The Partnership Agreement—Limited Call Right.”

 

You may be required to repay distributions that you have received from us.

 

Under certain circumstances, unitholders may have to repay amounts wrongfully returned or distributed to them. Under Section 17-607 of the Delaware Revised Uniform Limited Partnership Act, we may not make a distribution to you if the distribution would cause our liabilities to exceed the fair value of our assets. Delaware law provides that for a period of three years from the date of the impermissible distribution, limited partners who received the distribution and who knew at the time of the distribution that it violated Delaware law will be liable to the limited partnership for the distribution amount. Assignees who become substituted limited partners are liable for the obligations of the assignor to make contributions to the partnership. However, assignees are not liable for obligations unknown to the assignee at the time the assignee became a limited partner if the liabilities could not be determined from the partnership agreement. Liabilities to partners on account of their partnership interest and liabilities that are non-recourse to the partnership are not counted for purposes of determining whether a distribution is permitted.

 

Tax Risks to Common Unitholders

 

In addition to reading the following risk factors, you should read “Material Tax Consequences” for a full discussion of the expected material federal income tax consequences of owning and disposing of common units.

 

We may have tax liabilities related to periods before our initial public offering and less net operating losses available to reduce taxable income and therefore tax liabilities for future taxable periods.

 

Because our business was conducted by an affiliated group of corporations during periods prior to the completion of this offering, we will have federal and state income tax liabilities that relate to our prior operations and to transactions related to our formation. We expect our formation taxes to consist of approximately $600,000 of state income taxes resulting from CFSI LLC’s conveyance of certain assets to us immediately prior to this offering. In addition, the amount of cash distributions we receive from our corporate subsidiaries over the next several years will depend in part upon the amount of net operating losses available to those subsidiaries to reduce the amount of income subject to federal income tax they would otherwise pay. As of December 31, 2003, Cornerstone, our predecessor, and its affiliated group of corporate subsidiaries, had a consolidated federal net operating loss carryover of approximately $20.2 million, and we expect our taxable subsidiaries to have a federal net operating loss carryover of approximately $35.0 million upon the closing of this offering as a result of our restructuring immediately prior to this offering. These net operating losses will begin to expire in 2019 and are available to reduce future taxable income that would otherwise be subject to federal income taxes. The amount of net operating losses available to reduce the income tax liability of our corporate subsidiaries in future taxable years could be reduced as a result of the prior operations and the transactions occurring immediately before this offering.

 

We will be indemnified by CFSI LLC against additional income tax liabilities, if any, that arise from our operations prior to this offering, and income tax liabilities, if any, that arise from the consummation of the transactions related to our formation in excess of $600,000 if those liabilities are asserted by the IRS or any state taxing authority prior to the expiration of the applicable statutes of limitations for income taxes of Cornerstone for its taxable period ending with the conversion of Cornerstone into CFSI LLC (generally, three years from the

 

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filing of the tax return for such period). We will also be indemnified by CFSI LLC against any liabilities we may be subject to in the future resulting from a reduction in our net operating losses as a result of such prior operations or as a result of such formation transactions in excess of that which is believed to result from them at the time of the offering. We cannot assure you that we will not ultimately be responsible for any or all of these liabilities, if they occur. Any increase in the tax liabilities of our corporate subsidiaries because of a reduction in net operating losses not recouped under the indemnity will reduce our cash available for distribution.

 

Changes in the ownership of our units, including the changes occurring as a result of this offering, may result in annual limitations on our use of net operating losses available to reduce taxable income, which could increase our tax liabilities and decrease cash available for distribution in future taxable periods.

 

The use of the net operating losses by our corporate subsidiaries may be limited if the ownership of our units changes such that our corporate subsidiaries are deemed to have an “ownership change” under applicable provisions of the Internal Revenue Code. In general, an ownership change will occur if the percentage of our units, based on the value of the units, owned by certain unitholders or groups of unitholders increases by more than fifty percentage points during a three-year period. For this purpose, the unitholders who acquire interests in us pursuant to this offering will be treated as a single group, as will those persons who acquire units in any subsequent offering we may make. If the underwriters’ over-allotment option is exercised, the public group acquiring units in this transaction will own roughly 49% of the total partnership interests outstanding after completion of this offering, and those units would likely constitute more than 50% of the value of all ownership interests in us. However, applicable Treasury regulations provide generally that if in a public offering units are issued solely for cash, for purposes of calculating the percentage of ownership change resulting from the transaction, the acquiring unitholders will be deemed to acquire only 50% of the number of units they actually acquire. Vinson & Elkins L.L.P. has opined that this offering, standing alone, should not result in an ownership change. However, no ruling has been or will be requested from the IRS regarding this issue, and an opinion of counsel represents only the counsel’s legal judgment and does not bind the IRS or the courts. Thus there remains some risk that this offering will result in an ownership change. If an ownership change does occur, each of our corporate subsidiaries would be restricted annually in its ability to use its net operating losses to reduce its federal taxable income to an amount equal to the value of the corporation on the date of the ownership change multiplied by the applicable federal long-term tax-exempt rate in effect at such time. The federal long-term tax-exempt rate is currently 4.72%. Any such restriction would have a material adverse impact on our ability to make the full minimum quarterly distribution on our common and subordinated units. If this offering does not result in an ownership change, we will be limited in the additional units we can issue in the next three years without triggering an ownership change. While we do not anticipate that an ownership change will occur prior to December 31, 2008, the date by which we expect the majority of our subsidiaries’ net operating losses to be completely utilized, we cannot assure you that such ownership change will not occur. If an ownership change should occur during this period, an increase in tax liabilities of our corporate subsidiaries could result, which would reduce the amount of cash available for distribution to you. Furthermore, in order to avoid the consequences of an ownership change, we may refrain from making some acquisitions that we otherwise would finance at least in part with additional units or the proceeds of an offering of common units. As a result, we may be less able to implement our acquisition growth strategy during the next three years.

 

Our tax treatment depends on our status as a partnership for federal income tax purposes, as well as our not being subject to entity-level taxation by individual states. If the IRS treats us as a corporation or we become subject to entity-level taxation, it would reduce the amount of cash available for distribution to you.

 

The after-tax economic benefit of an investment in the common units depends largely on our being treated as a partnership for federal income tax purposes. We have not requested, and do not plan to request, a ruling from the IRS on this or any other tax matter affecting us.

 

If we were treated as a corporation for federal income tax purposes, we would pay federal income tax on our income at the corporate tax rate, which is currently a maximum of 35%. Distributions to you would generally be taxed again as corporate distributions, and no income, gains, losses or deductions would flow through to you. Because a tax would be imposed upon us as a corporation, our cash available for distribution to you would be

 

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substantially reduced. Therefore, our treatment as a corporation would result in a material reduction in the after-tax return to the unitholders, likely causing a substantial reduction in the value of our common units.

 

Current law may change so as to cause us to be treated as a corporation for federal income tax purposes or otherwise subject us to entity-level taxation. In addition, because of widespread state budget deficits, several states are evaluating ways to subject partnerships to entity-level taxation through the imposition of state income, franchise and other forms of taxation. If any of these states were to impose a tax on us, the cash available for distribution to you would be reduced. The partnership agreement provides that if a law is enacted or existing law is modified or interpreted in a manner that subjects us to taxation as a corporation or otherwise subjects us to entity-level taxation for federal, state or local income tax purposes, the minimum quarterly distribution amount and the target distribution amounts will be adjusted to reflect the impact of that law on us.

 

We have subsidiaries that will be treated as corporations for federal income tax purposes and subject to corporate-level income taxes.

 

Some of our operations will be conducted through subsidiaries that are organized as C corporations. Accordingly, these corporate subsidiaries will be subject to corporate-level tax, which will reduce the cash available for distribution to our partnership and, in turn, to you. If the IRS were to successfully assert that these corporations have more tax liability than we anticipate or legislation was enacted that increased the corporate tax rate, the cash available for distribution could be reduced more than we anticipate.

 

A successful IRS contest of the federal income tax positions we take may adversely affect the market for our common units, and the cost of any IRS contest will be borne by our unitholders and our general partner.

 

We have not requested a ruling from the IRS with respect to our treatment as a partnership for federal income tax purposes or any other matter affecting us. The IRS may adopt positions that differ from the conclusions of our counsel expressed in this prospectus or from the positions we take. It may be necessary to resort to administrative or court proceedings to sustain some or all of our counsel’s conclusions or the positions we take. A court may not agree with all of our counsel’s conclusions or positions we take. Any contest with the IRS may materially and adversely impact the market for our common units and the price at which they trade. In addition, our costs of any contest with the IRS will be borne indirectly by our unitholders and our general partner because the costs will reduce our cash available for distribution.

 

You may be required to pay taxes on income from us even if you do not receive any cash distributions from us.

 

Because our unitholders will be treated as partners to whom we will allocate taxable income which could be different in amount than the cash we distribute, you will be required to pay any federal income taxes and, in some cases, state and local income taxes on your share of our taxable income even if you receive no cash distributions from us. You may not receive cash distributions from us equal to your share of our taxable income or even the tax liability that results from that income.

 

Tax gain or loss on disposition of common units could be more or less than expected.

 

If you sell your common units, you will recognize a gain or loss equal to the difference between the amount realized and your tax basis in those common units. Prior distributions to you in excess of the total net taxable income you were allocated for a common unit, which decreased your tax basis in that common unit, will, in effect, become taxable income to you if the common unit is sold at a price greater than your tax basis in that common unit, even if the price is less than your original cost. A substantial portion of the amount realized, whether or not representing gain, may be ordinary income. In addition, if you sell your units, you may incur a tax liability in excess of the amount of cash you receive from the sale.

 

Tax-exempt entities and regulated investment companies face unique tax issues from owning common units that may result in adverse tax consequences to them.

 

Investment in common units by tax-exempt entities, such as individual retirement accounts (known as IRAs) and regulated investment companies (known as mutual funds) raises issues unique to them. For example, some of

 

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our income allocated to organizations that are exempt from federal income tax, including individual retirement accounts and other retirement plans, will be unrelated business taxable income and will be taxable to them. Very little of our income will be qualifying income to a regulated investment company. If you are a tax-exempt entity or a regulated investment company, you should consult your tax advisor before investing in our common units.

 

We will register as a tax shelter. This may increase the risk of an IRS audit of us or you.

 

We have applied to register with the IRS as a “tax shelter.” The federal income tax laws require that some types of entities, including some partnerships, register as tax shelters in response to the perception that they claim tax benefits that may be unwarranted. As a result, we may be audited by the IRS and tax adjustments may be made. Any unitholder owning less than a 1% profit interest in us has very limited rights to participate in the income tax audit process. Further, any adjustments in our tax returns will lead to adjustments in your tax returns and may lead to audits of your tax returns and adjustments of items unrelated to us. You would bear the cost of any expense incurred in connection with an examination of your personal tax return.

 

Recently issued Treasury regulations require taxpayers to report certain information on Internal Revenue Service Form 8886 if they participate in a “reportable transaction.” Unitholders may be required to file this form with the IRS if we participate in a “reportable transaction.” A transaction may be a reportable transaction based upon any of several factors. Unitholders are urged to consult with their own tax advisor concerning the application of any of these factors to their investment in our common units. Congress is considering legislative proposals that, if enacted, would impose significant penalties for failure to comply with these disclosure requirements. The Treasury regulations also impose obligations on “material advisors” that organize, manage or sell interests in registered “tax shelters.” As stated above, we have applied to register as a tax shelter, and, thus, one of our material advisors will be required to maintain a list with specific information, including unitholder names and tax identification numbers, and to furnish this information to the IRS upon request. Unitholders are urged to consult with their own tax advisor concerning any possible disclosure obligation with respect to their investment and should be aware that we and our material advisors intend to comply with the list and disclosure requirements.

 

We will treat each purchaser of common units as having the same tax benefits without regard to the actual common units purchased. The IRS may challenge this treatment, which could adversely affect the value of the common units.

 

Because we cannot match transferors and transferees of common units and because of other reasons, we will take depreciation and amortization positions that may not conform to all aspects of the Treasury regulations. A successful IRS challenge to those positions could adversely affect the amount of tax benefit available to you. It also could affect the timing of these tax benefits or the amount of gain from the sale of common units and could have a negative impact on the value of our common units or result in audit adjustments to your tax returns. Please read “Material Tax Consequences—Tax Consequences of Unit Ownership—Section 754 Election” for a further discussion of the effect of the depreciation and amortization positions we will adopt.

 

You will likely be subject to state and local taxes in states where you do not live as a result of an investment in units.

 

In addition to federal income taxes, you will likely be subject to other taxes, including foreign, state and local taxes, unincorporated business taxes and estate, inheritance or intangible taxes that are imposed by the various jurisdictions in which we do business or own property, even if you do not live in any of those jurisdictions. You will likely be required to file foreign, state and local income tax returns and pay state and local income taxes in some or all of these jurisdictions. Further, you may be subject to penalties for failure to comply with those requirements. We will initially own assets and do business in Alabama, Connecticut, Delaware, Georgia, Maryland, New Jersey, Ohio, Pennsylvania, Rhode Island, Tennessee, Virginia and West Virginia. Each of these states currently imposes a personal income tax. As we make acquisitions or expand our business, we may own assets or do business in additional states that impose a personal income tax. It is your responsibility to file all United States federal, foreign, state and local tax returns. Our counsel has not rendered an opinion on the state or local tax consequences of an investment in the common units.

 

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USE OF PROCEEDS

 

We expect to receive net proceeds of approximately $66.8 million from the sale of 3,675,000 common units offered by this prospectus, after deducting underwriting discounts but before paying estimated offering expenses. We base this amount on an assumed initial public offering price of $19.50 per common unit. Concurrently with the closing of this offering, we expect to receive net proceeds of approximately $79.0 million from the private placement of senior secured notes by our subsidiaries, after deducting the private placement fee but before paying estimated offering expenses.

 

We intend to use the net proceeds of $66.8 million from this offering, together with the net proceeds of $79.0 million from the private placement of senior secured notes by our subsidiaries, to:

 

    repay approximately $132.2 million in debt of CFSI LLC, including $103.1 million in a term loan, $26.5 million of revolving debt outstanding under the existing credit facility and $2.6 million in other outstanding debt;

 

    pay approximately $9.7 million of expenses associated with this offering, the proposed private placement of senior secured notes and the related formation and contribution transactions; and

 

    reserve approximately $3.9 million for general partnership purposes, including for the construction of mausoleum crypts and lawn crypts and for the purchase of equipment needed to install burial vaults.

 

As of June 30, 2004, approximately $103.1 million in a term loan and $25.5 million of revolving debt was outstanding under the existing credit facility. The term loan and the outstanding revolving debt bear interest at the aggregate rate of 4.5% plus the greater of LIBOR and 3.5%, which aggregate rate was 8.0% as of June 30, 2004. Beginning on September 15, 2004, the term loan and revolving debt bear interest at the rate of 18.0% per annum with 2.0% increases on each of January 1, 2005 and April 1, 2005. The term loan and revolving debt are due and payable on June 30, 2005. As of June 30, 2004, we had $2.4 million in other outstanding debt with a weighted average interest rate of 5.5% per year and a weighted average maturity of 1.5 years.

 

If the underwriters’ over-allotment option is exercised, we will use one-half of the net proceeds for general partnership purposes, and we will use the other half to redeem from CFSI LLC a number of common units equal to the number of common units sold upon exercise of the over-allotment option. If CFSI LLC does not hold a number of common units that is equal to or greater than the number of common units sold upon exercise of the over-allotment option, we will redeem from CFSI LLC a number of subordinated units that is equal to the shortfall. As a result, CFSI LLC will be deemed to be a selling unitholder. CFSI LLC will use the net proceeds from this redemption to repurchase a portion of its Class A membership interests. Please see “Selling Unitholder.”

 

Pending application of the $3.9 million of proceeds reserved for general partnership purposes, we may invest those proceeds in short-term marketable securities.

 

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CAPITALIZATION

 

The following table shows:

 

    our historical capitalization as of June 30, 2004; and

 

    our pro forma capitalization as of June 30, 2004, which reflects the offering of the common units, the proposed private placement of our senior secured notes, the application of the net proceeds in the manner described under “Use of Proceeds” on the preceding page and the related formation and contribution transactions.

 

This table is derived from, should be read in conjunction with, and is qualified in its entirety by reference to, our historical and pro forma financial statements and the accompanying notes included elsewhere in this prospectus. You should also read this table in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

     As of June 30, 2004

     Actual

    Pro Forma

     (in thousands)

Cash and cash equivalents

   $ 2,046     $ 10,608
    


 

Long-term debt, including current portion:

              

Term loan

   $ 103,096     $ —  

Revolving credit

     25,500       —  

Other debt

     2,367       —  

New debt:

              

Credit facility

     —         —  

Senior secured notes

     —         80,000
    


 

Total long-term debt

     130,963       80,000
    


 

Preferred stock

     17,103 (1)     —  

Owners’ equity:

              

Owners’ equity

     39,576 (2)     —  

Held by public:

              

Common units

     —         58,101

Held by the general partner and its affiliates:

              

Common units

     —         6,037

Subordinated units

     —         45,320

General partner interest

     —         1,849
    


 

Total equity

     39,576       111,307
    


 

Total capitalization

   $ 187,642     $ 191,307
    


 


(1) Represents the outstanding shares of Cornerstone preferred stock that will be converted into Class A membership interests in CFSI LLC prior to the closing of this offering.

 

(2) Includes promissory notes receivable representing loans to purchase common stock in Cornerstone in an aggregate principal amount of $150,000 that were classified on our historical balance sheet as of June 30, 2004 within stockholders’ equity and will be retained by CFSI LLC and not contributed to us in connection with the related formation and contribution transactions.

 

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DILUTION

 

Dilution is the amount by which the offering price paid by the purchasers of common units sold in this offering will exceed the net tangible book value per unit after the offering. Assuming an initial public offering price of $19.50 per common unit, on a pro forma basis as of June 30, 2004, after giving effect to the offering of common units and the related formation transactions, our net tangible book value was $111.3 million, or $12.86 per common unit. Purchasers of common units in this offering will experience substantial and immediate dilution in net tangible book value per common unit for financial accounting purposes, as illustrated in the following table:

 

Assumed initial public offering price per common unit

          $ 19.50

Pro forma net tangible book value per common unit before the offering (1)

   $ 11.36       

Increase in net tangible book value per common unit attributable to purchasers in the offering

   $ 1.50       
    

      

Less: Pro forma net tangible book value per common unit after the offering (2)

          $ 12.86
           

Immediate dilution in net tangible net book value per common unit to purchasers in the offering

          $ 6.64
           


(1) Determined by dividing the total number of units to be issued to our general partner and its affiliates for their contribution of assets and liabilities (564,782 common units, 4,239,782 subordinated units and the 2% general partner interest, which has a dilutive effect equivalent to 173,052 units) into the net tangible book value of our predecessor’s contributed assets and liabilities ($56,529,000). Our general partner’s dilutive-effect equivalent was determined by multiplying the total number of units deemed to be outstanding (i.e., the total number of common and subordinated units outstanding divided by 98%) by our general partner’s 2% general partner interest, after giving effect to the application of the net proceeds of the offering and the related transactions.
(2) Determined by dividing the total number of units (4,239,782 common units, 4,239,782 subordinated units and the 2% general partner interest, which has a dilutive effect equal to 173,052 units) to be outstanding after the offering into our pro forma net tangible book value, after giving effect to the application of the net proceeds of this offering.

 

The following table sets forth the number of units that we will issue and the total consideration contributed to us by the general partner and its affiliates in respect of their units and by the purchasers of common units in this offering upon consummation of the transactions contemplated by this prospectus:

 

     Units Acquired

    Total Consideration

    Average Price
Paid Per Unit


     Number

   Percent

    Amount

   Percent

   

General partner and its affiliates (1)(2)

   4,977,616    57.5 %   $ 56,529,000    44.1 %   $ 11.36

New investors

   3,675,000    42.5       71,662,500    55.9       19.50
    
  

 

  

     

Total

   8,652,616    100.0 %   $ 128,191,500    100.0 %      
    
  

 

  

     

(1) Upon the consummation of the transactions contemplated by this prospectus, our general partner and its affiliates will own an aggregate of 564,782 common units, 4,239,782 subordinated units and the 2% general partner interest, which has a dilutive effect equivalent to 173,052 units.
(2) The assets contributed by our general partner and its affiliates will be recorded at historical cost in accordance with GAAP. Book value of the consideration provided by our general partner and its affiliates, as of June 30, 2004, was $56.5 million.

 

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CASH DISTRIBUTION POLICY

 

Quarterly Distributions of Available Cash

 

General.    Within approximately 45 days after the end of each quarter, beginning with the quarter ending December 31, 2004, we will distribute all of our available cash to unitholders of record on the applicable record date. We will adjust the minimum quarterly distribution for the period from the closing of this offering through December 31, 2004 based on the actual length of the period.

 

Available cash for any quarter consists of cash on hand at the end of that quarter, plus cash on hand from working capital borrowings made after the end of the quarter but before the date of determination of available cash for the quarter, less cash reserves. Cash and other investments held in merchandise trusts and perpetual care trusts are not treated as available cash until they are distributed to us.

 

Minimum Quarterly Distribution.    Common units are entitled to receive distributions from operating surplus of $0.4625 per unit per quarter, or $1.85 per unit per year, before any such distributions are paid on our subordinated units. We cannot guarantee you that we will be able to pay the minimum quarterly distribution on the common units in any quarter. We will be prohibited from making any distributions to unitholders if the distributions would cause an event of default, or if an event of default is existing, under our debt agreements.

 

General Partner Interest and Incentive Distribution Rights.    As of the date of this offering, our general partner will be entitled to 2% of all distributions that we make prior to our liquidation. Our general partner has the right, but not the obligation, to contribute a proportionate amount of capital to us to maintain its 2% general partner interest. The general partner’s 2% interest in these distributions may be reduced if we issue additional units in the future and our general partner does not contribute a proportionate amount of capital to us to maintain its 2% general partner interest.

 

Our general partner also currently holds incentive distribution rights that entitle it to receive increasing percentages, up to a maximum of 50%, of the cash we distribute from operating surplus in excess of $0.5125 per unit. The maximum distribution of 50% includes distributions paid to the general partner on its 2% general partner interest but does not include any distributions that the general partner may receive on units that it owns.

 

Operating Surplus and Capital Surplus

 

General.    All cash distributed to unitholders will be characterized as either “operating surplus” or “capital surplus.” We distribute available cash from operating surplus differently than available cash from capital surplus. We will treat all available cash distributed as coming from operating surplus until the sum of all available cash distributed since we began operations equals the operating surplus as of the most recent date of determination of available cash. We will treat any amount distributed in excess of operating surplus, regardless of its source, as capital surplus.

 

Operating Surplus.    Operating surplus consists of:

 

    our cash balance on the closing date of this offering; plus

 

    $5.0 million (as described below); plus

 

    cash receipts from our operations, including cash withdrawn from merchandise and perpetual care trusts; plus

 

    working capital borrowings made after the end of a quarter but before the date of determination of operating surplus for that quarter; less

 

    operating expenditures, including cash deposited in merchandise and perpetual care trusts, maintenance capital expenditures and the repayment of working capital borrowings; less

 

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    the amount of cash reserves for future operating expenditures and maintenance capital expenditures.

 

As reflected above, operating surplus includes $5.0 million in addition to our cash balance on the closing date of this offering, cash receipts from our operations and cash from working capital borrowings. This amount does not reflect actual cash on hand at closing that is available for distribution to our unitholders. Rather, it is a provision that will enable us, if we choose, to distribute as operating surplus up to $5.0 million of cash we receive in the future from non-operating sources, such as asset sales outside the ordinary course of business, sales of our equity and debt securities, and long-term borrowings, that would otherwise be distributed as capital surplus.

 

As described above, operating surplus is reduced by the amount of our maintenance capital expenditures but not our expansion capital expenditures. For our purposes, maintenance capital expenditures are those capital expenditures required to maintain, over the long term, the operating capacity of our capital assets, and expansion capital expenditures are those capital expenditures that increase, over the long term, the operating capacity of our capital assets.

 

Examples of maintenance capital expenditures include costs to build roads and install sprinkler systems on our cemetery properties and purchases of equipment for those purposes and, in most instances, costs to develop new areas of our cemeteries. Examples of expansion capital expenditures include costs to identify and complete acquisitions of new cemeteries and funeral homes and to construct new funeral homes. Costs to construct mausoleum crypts and lawn crypts may be considered to be a combination of maintenance capital expenditures and expansion capital expenditures. Our general partner, with the concurrence of its conflicts committee, may allocate capital expenditures between maintenance capital expenditures and expansion capital expenditures and may determine the period over which maintenance capital expenditures will be subtracted from operating surplus.

 

Capital Surplus.    Capital surplus consists of:

 

    borrowings other than working capital borrowings;

 

    sales of our equity and debt securities; and

 

    sales or other dispositions of assets for cash (other than sales or other dispositions of excess cemetery property in an aggregate amount not to exceed $1.0 million in any four-quarter period; sales or other dispositions of inventory, accounts receivable and other current assets in the ordinary course of business; and sales or other dispositions of assets as a part of normal retirements or replacements).

 

The $1.0 million exception for sales of excess cemetery property may be increased by our general partner, with the concurrence of its conflicts committee, if the size of our operations increases as a result of acquisitions or other expansions.

 

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Distributions of Available Cash from Operating Surplus

 

The following table illustrates the priority of distributions of available cash from operating surplus between the unitholders and our general partner during the subordination period. The amounts set forth under “Marginal Percentage Interest in Distributions” are the percentage interests of our general partner and the unitholders in any available cash from operating surplus we distribute up to and including the corresponding amount in the column titled “Total Quarterly Distribution Target Amount,” until the available cash from operating surplus that we distribute reaches the next target distribution level, if any. The percentage interests shown for our general partner include its 2% general partner interest and assume the general partner has contributed any additional capital required to maintain its 2% general partner interest and has not transferred the incentive distribution rights.

 

   

Total Quarterly

Distribution Target

Amount


  

Marginal Percentage

Interest in

Distributions


 
      

Common

Unitholders


    

Subordinated

Unitholders


    

Common and

Subordinated

Unitholders


    

General

Partner


 

Minimum Quarterly Distribution

    up to $0.4625    98 %              2 %

Arrearages on Minimum Quarterly Distribution

    up to $0.4625    98 %              2 %

Minimum Quarterly Distribution

    up to $0.4625         98 %         2 %

First Target Distribution

  above $ 0.4625 up to $0.5125              98 %    2 %

Second Target Distribution

  above $ 0.5125 up to $0.5875              85 %    15 %

Third Target Distribution

  above $ 0.5875 up to $0.7125              75 %    25 %

Thereafter

    above $0.7125              50 %    50 %

 

When the subordination period ends, all remaining subordinated units will convert into common units on a one-for-one basis and will then participate, pro rata, with the other common units in distributions of available cash.

 

Distributions of Available Cash from Capital Surplus

 

We do not currently expect to make any distributions of available cash from capital surplus. However, to the extent that we make any distributions of available cash from capital surplus, they will be made in the following manner:

 

    first, 98% to all unitholders, pro rata, and 2% to our general partner, until we have distributed for each common unit that was issued in this offering an amount of available cash from capital surplus equal to the initial public offering price;

 

    second, 98% to the common unitholders, pro rata, and 2% to our general partner, until we have distributed for each common unit an amount of available cash from capital surplus equal to any unpaid arrearages in payment of the minimum quarterly distribution on the common units; and

 

    thereafter, we will make all distributions of available cash from capital surplus as if they were from operating surplus.

 

The partnership agreement treats a distribution of capital surplus as the repayment of the initial unit price from this initial public offering, which is a return of capital. The initial public offering price less any distributions of capital surplus per unit is referred to as the “unrecovered initial unit price.” Each time a distribution of capital surplus is made, the minimum quarterly distribution and the target distribution levels will be reduced in the same proportion as the corresponding reduction in the unrecovered initial unit price.

 

Because distributions of capital surplus will reduce the minimum quarterly distribution, after any of these distributions are made, it may be easier for the general partner to receive incentive distributions and for the subordinated units to convert into common units. Any distribution of capital surplus before the unrecovered

 

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initial unit price is reduced to zero cannot be applied, however, to the payment of the minimum quarterly distribution or any arrearages in the payment of the minimum quarterly distribution on the common units from prior quarters.

 

If we distribute capital surplus on a unit issued in this offering in an amount equal to the initial unit price and have paid all arrearages on the common units, the minimum quarterly distribution and the target distribution levels will be reduced to zero. Once the minimum quarterly distribution and target distribution levels are reduced to zero, all subsequent distributions will be from operating surplus, with 50% being paid to the holders of units and 50% to our general partner.

 

Subordination Period

 

General.    During the subordination period the common units will have the right to receive distributions of available cash from operating surplus in an amount equal to the minimum quarterly distribution of $0.4625 per unit, plus any arrearages in the payment of the minimum quarterly distribution on the common units from prior quarters, before any distributions of available cash from operating surplus may be made on the subordinated units. Upon expiration of the subordination period, all subordinated units will convert into common units on a one-for-one basis and will then participate, pro rata, with the other common units in distributions of available cash, and the common units will no longer be entitled to arrearages.

 

Expiration of Subordination Period.    The subordination period will extend until the first day of any quarter beginning after September 30, 2009 that each of the following tests are met:

 

    distributions of available cash from operating surplus on each of the outstanding common units and subordinated units for the three consecutive four-quarter periods immediately preceding that date equaled or exceeded the minimum quarterly distribution;

 

    the “adjusted operating surplus” (as defined below) generated during the three consecutive four-quarter periods immediately preceding that date equaled or exceeded the sum of the minimum quarterly distributions on all of the outstanding common units and subordinated units and the related distribution on the 2% general partner interest; and

 

    there are no arrearages in payment of the minimum quarterly distribution on the common units.

 

In addition, if the unitholders remove our general partner other than for cause and units held by our general partner and its affiliates are not voted in favor of that removal:

 

    the subordination period will end and each subordinated unit will immediately convert into one common unit;

 

    any existing arrearages in payment of the minimum quarterly distribution on the common units will be extinguished; and

 

    our general partner will have the right to convert its general partner interest and its incentive distribution rights into common units or to receive cash in exchange for those interests.

 

Early Conversion of Subordinated Units.    If the tests for ending the subordination period are satisfied for any three consecutive four-quarter periods ending on or after September 30, 2007, 25% of the subordinated units will convert into an equal number of common units. Similarly, if those tests are also satisfied for any three consecutive four-quarter periods ending on or after September 30, 2008, an additional 25% of the subordinated units will convert into an equal number of common units. The second early conversion of subordinated units may not occur, however, until at least one year following the end of the period for the first early conversion of subordinated units.

 

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Adjusted Operating Surplus.    Adjusted operating surplus is a measure that we use to determine the operating surplus that is actually earned in a test period by excluding items from prior periods that affect operating surplus in the test period. Adjusted operating surplus consists of:

 

    operating surplus generated with respect to that period; less

 

    any net increase in working capital borrowings with respect to that period but only to the extent that outstanding working capital borrowings exceed $5.0 million as a result of such increase; less

 

    any net decrease in cash reserves for operating expenditures with respect to that period not relating to an operating expenditure made with respect to that period; less

 

    the amount, if any, by which the aggregate principal amount withdrawn from merchandise trusts with respect to that period exceeds the aggregate amount deposited into merchandise trusts with respect to that period; plus

 

    any net decrease in working capital borrowings with respect to that period but only to the extent that such decrease would reduce outstanding working capital borrowings to an amount not less than $5.0 million; plus

 

    any net increase in cash reserves for operating expenditures with respect to that period required by any debt instrument for the repayment of principal, interest or premium; plus

 

    the amount, if any, by which the aggregate amount deposited into merchandise trusts with respect to that period exceeds the aggregate principal amount withdrawn from merchandise trusts with respect to that period.

 

The limitations on the effect of net increases and net decreases in working capital borrowings set forth in the second and fifth bullet points above will become inoperative and have no further effect with respect to any period ending after September 30, 2006.

 

Adjustment of Minimum Quarterly Distribution and Target Distribution Levels

 

In addition to adjusting the minimum quarterly distribution and target distribution levels to reflect a distribution of capital surplus, if we combine our units into fewer units or subdivide our units into a greater number of units, we will proportionately adjust:

 

    the minimum quarterly distribution;

 

    the target distribution levels;

 

    the unrecovered initial unit price;

 

    the number of common units issuable during the subordination period without a unitholder vote; and

 

    the number of common units into which a subordinated unit is convertible.

 

For example, if a two-for-one split of the common units should occur, the minimum quarterly distribution, the target distribution levels and the unrecovered initial unit price would each be reduced to 50% of its initial level, the number of common units issuable during the subordination period without a unitholder vote would double and each subordinated unit would be convertible into two common units. We will not make any adjustment by reason of the issuance of additional units for cash or property.

 

In addition, if legislation is enacted or if existing law is modified or interpreted in a manner that causes us to become taxable as a corporation or otherwise subject to taxation as an entity for federal, state or local income tax purposes, we will reduce the minimum quarterly distribution and the target distribution levels for each quarter by multiplying each distribution level by a fraction, the numerator of which is available cash for that quarter and the denominator of which is the sum of available cash for that quarter plus our general partner’s estimate of our aggregate liability for the income taxes payable by reason of that legislation or interpretation. To the extent that the actual tax liability differs from the estimated tax liability for any quarter, the difference will be accounted for in subsequent quarters.

 

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Distributions of Cash Upon Liquidation

 

If we dissolve in accordance with the partnership agreement, we will sell or otherwise dispose of our assets in a process called liquidation. We will first apply the proceeds of liquidation to the payment of our creditors. We will distribute any remaining proceeds to the unitholders and our general partner, in accordance with their respective capital account balances, as adjusted to reflect any taxable gain or loss upon the sale or other disposition of our assets in liquidation.

 

The allocations of taxable gain upon liquidation are intended, to the extent possible, to allow the holders of common units to receive proceeds equal to their unrecovered initial unit price plus the minimum quarterly distribution for the quarter during which liquidation occurs plus any arrearages in the payment of the minimum quarterly distribution on the common units from prior quarters prior to any allocation of gain to the common units. There may not be sufficient taxable gain upon our liquidation to enable the holders of common units to fully recover all of these amounts, even though there may be cash available for distribution to the holders of subordinated units. Any additional taxable gain will be allocated in a manner intended to allow our general partner to receive proceeds in respect of its incentive distribution rights.

 

If there are losses upon liquidation, they will first be allocated to the subordinated units and the general partner interest until the capital accounts of the subordinated units have been reduced to zero and then to the common units and the general partner interest until the capital accounts of the common units have been reduced to zero. Any remaining loss will be allocated to the general partner interest.

 

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CASH AVAILABLE FOR DISTRIBUTION

 

We intend to pay each quarter, to the extent we have sufficient available cash from operating surplus including working capital borrowings, the minimum quarterly distribution of $0.4625 per unit, or $1.85 per unit per year, on all of our outstanding common units and subordinated units.

 

Available cash for any quarter consists of cash on hand at the end of that quarter, plus cash on hand from working capital borrowings after the end of the quarter but before the date of determination of available cash for the quarter, less cash reserves. Operating surplus consists of all cash on hand at the closing of this offering, plus $5.0 million, plus cash generated from our operations and from working capital borrowings, less operating and maintenance capital expenditures, repayments of working capital borrowings and cash reserves for future operating and maintenance capital expenditures.

 

The amounts of available cash from operating surplus needed to pay the minimum quarterly distribution for one quarter and for four quarters on the common units, the subordinated units and the 2% general partner interest to be outstanding immediately after this offering are approximately:

 

     One Quarter

   Four Quarters

     (in thousands)

Common units

   $ 1,960.9    $ 7,843.6

Subordinated units

     1,960.9      7,843.6

2% general partner interest

     80.0      320.1
    

  

Total

   $ 4,001.8    $ 16,007.3
    

  

 

Pro Forma, As Adjusted, Available Cash from Operating Surplus for 2003 and the First Half of 2004

 

If we had completed the transactions contemplated in this prospectus on January 1, 2003, pro forma, as adjusted, available cash from operating surplus generated during 2003 and the first half of 2004 would have been approximately $13.9 million and $8.8 million, respectively. These amounts would have been sufficient to pay the full minimum quarterly distribution on all of our common units and 73.5% of the minimum quarterly distribution on our subordinated units for 2003 and the full minimum quarterly distribution on all of our common units and subordinated units for the first half of 2004. We derived the amounts of pro forma, as adjusted, available cash from operating surplus by subtracting the estimated incremental expenses and maintenance capital expenditures discussed below from our pro forma available cash from operating surplus shown on Appendix D and then adding the one-time cash flow items discussed below.

 

If we had completed the transactions contemplated in this prospectus on January 1, 2003, pro forma available cash from operating surplus generated during 2003 and the first half of 2004 would have been approximately $13.4 million and $6.6 million, respectively. Pro forma available cash from operating surplus does not include any incremental expenses we will incur as a result of being a public company, such as costs associated with annual and quarterly reports to unitholders, tax return and Schedule K-1 preparation and distribution, investor relations, registrar and transfer agent fees and incremental insurance costs. We expect these incremental expenses to be approximately $1.3 million per year and have made adjustments for this amount in our calculation of pro forma, as adjusted, available cash from operating surplus. Furthermore, we have historically treated all capital expenditures to construct mausoleum crypts and lawn crypts as expansion capital expenditures, which would not reduce operating surplus. Under our partnership agreement, to the extent that the general partner, with the concurrence of the conflicts committee, determines that all or a portion of these construction capital expenditures are to maintain, rather than increase, our operating capacity, it will designate these capital expenditures as maintenance capital expenditures, which will reduce operating surplus. We estimate that approximately $0.6 million and $0.3 million of capital expenditures reported on our financial statements as expansion capital expenditures in 2003 and the first half of 2004, respectively, would have been designated as maintenance capital expenditures under the partnership agreement and have made adjustments for these amounts

 

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in our calculation of pro forma, as adjusted, available cash from operating surplus. In addition, our pro forma available cash from operating surplus includes certain one-time cash flow items that we believe will not occur on an ongoing basis and are therefore excluded. In 2003, these items include expenses of $1.0 million associated with this offering and a payment of $1.4 million related to the settlement of disputes over the acquisition of cemetery properties and funeral homes from the Loewen Group, Inc. in 1999. In the six months ended June 30, 2004, the one-time cash flow items consisted of $3.2 million of expenses associated with this offering.

 

We derived the amounts shown above from our pro forma financial statements in the manner described in Appendix D. The pro forma adjustments in the pro forma financial statements are based upon currently available information and certain estimates and assumptions. The pro forma financial statements do not purport to present our results of operations had the transactions contemplated in this prospectus actually been completed as of the date indicated. Furthermore, the pro forma financial statements have been prepared on an accrual basis while available cash from operating surplus is calculated under our partnership agreement on a cash accounting basis. As a consequence, while the amounts of pro forma, as adjusted, available cash from operating surplus shown above are calculated in a manner that is consistent with our partnership agreement they should only be viewed as a general indication of the amounts of available cash from operating surplus that we might have generated if we had completed the transactions contemplated in this prospectus on January 1, 2003.

 

Estimated Available Cash from Operating Surplus through September 30, 2005

 

We believe that, following completion of this offering, we will have sufficient available cash from operating surplus, including working capital borrowings in connection with the growth of our pre-need sales program, to allow us to make the full minimum quarterly distribution on all of our common units and subordinated units for each quarter through September 30, 2005.

 

Our belief is based on a number of specific assumptions, including the material assumptions set forth below, which relate to the twelve-month period ending September 30, 2005. For a more detailed explanation of the concepts and terms described below, please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Overview.”

 

    The number of burials performed will remain consistent with the number of burials performed in 2003.

 

    The volume of sales of cemetery products and services will increase by 3.0% per annum over the volume of sales of cemetery products and services in 2003.

 

    The average price of cemetery products and services will increase by 3.0% per annum over the average price of such cemetery products and services in 2003.

 

    The percentage of pre-need cemetery products delivered and services performed out of total deferred cemetery revenues, net, will approximate the percentage of pre-need cemetery products delivered and services performed in 2003 out of total deferred cemetery revenues, net.

 

    The volume of cancellations arising from non-payment of pre-need contracts will approximate the volume of cancellations in 2003.

 

    The average rate of return on realized earnings on funds held in merchandise trusts will decrease by 2.1% over the average rate of return on those funds in 2003.

 

    The average rate of return on realized earnings on funds held in perpetual care trusts will decrease by 0.5% over the average rate of return on those funds in 2003.

 

    Maintenance capital expenditures to be funded with operating cash flow will be $1.8 million. We will use $3.9 million of the net proceeds of this offering to pay expenses associated with the construction of mausoleums and to purchase equipment for the installation of burial vaults.

 

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    The cost of goods sold as a percentage of revenues will approximate the percentage of actual cost of goods sold in 2003 as a percentage of revenues.

 

    Direct selling expense directly related to cemetery sales, such as sales commission, will increase by 4.3% over direct selling expense in 2003, and selling expense indirectly related to cemetery sales, such as postage and advertising, will increase by 1.0% over indirect selling expense in 2003.

 

    Cemetery expense will increase 5.0% over cemetery expense in 2003.

 

    Home office expense will increase by $1.3 million over home office expense in 2003 as a result of our becoming a public company.

 

    The cash tax reduction due to the use of federal and state net operating loss carryovers will be $2.5 million.

 

    We will borrow $3.7 million under our new credit facility for working capital requirements, primarily because we are growing our pre-need sales programs at some of our cemeteries. The growth in our pre-need sales programs will have a negative cash flow effect initially because of interest costs on the related working capital borrowings, sales costs and the funding requirements of merchandise and perpetual care trusts.

 

    We will not make any material acquisitions or dispositions of assets.

 

    Any changes in federal, state or local environmental, regulatory or tax laws, or the enforcement or interpretation thereof, will not materially affect our operations.

 

    Overall economic conditions and economic conditions in the areas where we operate will not change materially.

 

While we believe that these assumptions are reasonable in light of management’s current beliefs concerning future events, the assumptions underlying the projections are inherently uncertain and are subject to significant business, economic, regulatory and competitive risks and uncertainties that could cause actual results to differ materially from those we anticipate. If our assumptions are not realized, the actual available cash from operating surplus that we generate could be substantially less than that currently expected and could, therefore, be insufficient to permit us to make the full minimum quarterly distribution on all units, in which event the market price of the common units may decline materially. Consequently, the statement that we believe that we will have sufficient available cash from operating surplus, together with working capital borrowings made in connection with the growth of our pre-need sales program, to pay the full minimum quarterly distribution on all units for each quarter through September 30, 2005 should not be regarded as a representation by us or the underwriters or any other person that we will make such a distribution. When reading this section, you should keep in mind the risk factors and other cautionary statements under the heading “Risk Factors” and elsewhere in this prospectus.

 

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SELECTED HISTORICAL AND PRO FORMA FINANCIAL AND OPERATING DATA

 

The following table presents selected historical financial and operating data of our predecessor, Cornerstone Family Services, Inc., and pro forma financial data of StoneMor Partners L.P. for the periods and as of the dates indicated. The selected historical financial data for Cornerstone Family Services, Inc. as of June 30, 2004 and for the six months ended June 30, 2004 and June 30, 2003 are derived from the unaudited consolidated financial statements of Cornerstone Family Services, Inc. The selected historical financial data for Cornerstone Family Services, Inc. as of and for the nine month period ended December 31, 1999 and as of and for the years ended December 31, 2000, 2001, 2002 and 2003 are derived from the audited consolidated financial statements of Cornerstone Family Services, Inc. We were formed in March 1999 to acquire 123 cemetery properties and four funeral homes from The Loewen Group, Inc. As a result, we have not presented historical results for any period prior to the nine-month period ended December 31, 1999.

 

Effective January 1, 2000, we adopted SEC Staff Accounting Bulletin 101, “Revenue Recognition in Financial Statements,” or SAB 101, in which the SEC expressed its views on applying GAAP to selected revenue recognition issues. Note (3) to the following table sets forth adjusted data summarizing our results of operations for the nine month period ended December 31, 1999 and the year ended December 31, 2000 as if we had adopted SAB 101 as of March 31, 1999, the date on which we commenced operations.

 

The unaudited pro forma consolidated financial statements of StoneMor Partners L.P. give pro forma effect to the contribution of substantially all of the assets and liabilities of Cornerstone Family Services, Inc. and its subsidiaries to StoneMor Partners L.P., the completion of this offering, the completion of our proposed private placement of senior secured notes and the use of the net proceeds of this offering and the proposed private placement as described in “Use of Proceeds.” The selected pro forma financial data presented for the year ended December 31, 2003 and as of and for the six months ended June 30, 2004 are derived from our unaudited pro forma consolidated financial statements. The pro forma balance sheet data assumes the offering, the proposed private placement and the related formation and contribution transactions occurred as of June 30, 2004. The pro forma statement of operations data for the year ended December 31, 2003 and for the six months ended June 30, 2004 assumes the offering, the proposed private placement and the related formation and contribution transactions occurred on January 1, 2003. You can find a more detailed explanation of the pro forma data in the notes to our unaudited pro forma consolidated financial statements.

 

The table on the next page includes EBITDA, as adjusted. This calculation is not presented in accordance with GAAP and should not be considered in isolation or as a substitute for net income (loss), income from operations or cash flow as reflected in our historical consolidated financial statements. We explain and reconcile EBITDA, as adjusted, to net cash provided by operating activities, its most directly comparable financial measure that is calculated and presented in accordance with GAAP, in “—Non-GAAP Financial Measures.”

 

The following table should be read together with, and is qualified in its entirety by reference to, the audited and unaudited historical and unaudited pro forma consolidated financial statements and the accompanying notes included elsewhere in this prospectus. The table should also be read with “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

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Cornerstone Family Services, Inc.

Historical (1)


    StoneMor Partners L.P.
Pro Forma (1)


 
   

Nine Month

Period Ended

December 31,

1999(2)(3)


    Year Ended December 31,

    Six Months
Ended June 30,


    Year Ended
December 31,
2003


  Six Months
Ended
June 30,
2004


 
      2000(3)

    2001

    2002

    2003

    2003

    2004

     
    (in thousands, except per unit data)  

Statement of Operations Data:

                                                                     

Cemetery revenues

  $ 65,569     $ 63,158     $ 73,865     $ 74,168     $ 77,978     $ 37,428     $ 43,096     $ 77,978   $ 43,096  

Funeral home revenues

    421       739       961       1,360       1,724       859       1,012       1,724     1,012  
   


 


 


 


 


 


 


 

 


Total revenues

    65,990       63,897       74,826       75,528       79,702       38,287       44,108       79,702     44,108  
   


 


 


 


 


 


 


 

 


Cost of goods sold (exclusive of depreciation shown separately below):

                                                                     

Land and crypts

    3,941       4,810       5,946       5,948       4,346       2,404       2,224       4,346     2,224  

Perpetual care

    1,077       2,157       2,404       2,434       2,585       1,279       1,350       2,585     1,350  

Merchandise

    4,528       2,497       3,453       3,634       3,123       1,796       2,622       3,123     2,622  

Selling expense

    14,706       13,166       15,480       15,413       15,584       7,654       9,545       15,584     9,545  

Cemetery expense

    10,082       15,454       16,990       17,191       17,732       8,599       9,734       17,732     9,734  

General and administrative expense

    5,579       9,314       8,594       9,020       9,407       4,617       4,864       9,407     4,864  

Overhead (including $1,178 of stock-based compensation in 2003) (4)

    8,794       10,126       9,892       11,820       12,579       4,704       4,991       11,597     4,500  

Depreciation and amortization

    2,564       4,291       4,337       4,893       5,001       2,373       2,481       5,001     2,481  

Funeral home expense

    472       891       996       1,343       1,513       741       890       1,513     890  
   


 


 


 


 


 


 


 

 


Total costs and expenses

    51,743       62,706       68,092       71,696       71,870       34,168       38,701       70,888     38,210  
   


 


 


 


 


 


 


 

 


Operating profit

    14,247       1,191       6,734       3,832       7,832       4,119       5,407       8,814     5,898  

Expenses related to terminated debt offering and refinancing (5)

    1,743       —         7,000       —         —         —         —         —       —    

Interest expense

    10,818       16,677       15,550       14,828       11,376       6,067       5,284       6,128     3,064  
   


 


 


 


 


 


 


 

 


Income (loss) before income taxes and cumulative effect of change in accounting principle

    1,686       (15,486 )     (15,816 )     (10,996 )     (3,544 )     (1,948 )     123       2,686     2,834  

Income taxes (benefit):

                                                                     

State and franchise taxes

    424       (851 )     (294 )     546       1,455       305       714       1,370     500  

Federal

    (424 )     (3,206 )     (4,945 )     (1,453 )     1,010       (342 )     224       429     (702 )
   


 


 


 


 


 


 


 

 


Total income taxes (benefit)

          (4,057 )     (5,239 )     (907 )     2,465       (37 )     938       1,799     (202 )
   


 


 


 


 


 


 


 

 


Income (loss) before cumulative effect of change in accounting principle

    1,686       (11,429 )     (10,577 )     (10,089 )     (6,009 )     (1,911 )     (815 )     887     3,036  
   


 


 


 


 


 


 


 

 


Cumulative effect of change in accounting principle (6)

    —         (13,594 )     —         5,934       —         —         —         —       —    
   


 


 


 


 


 


 


 

 


Net income (loss)

  $ 1,686     $ (25,023 )   $ (10,577 )   $ (4,155 )   $ (6,009 )   $ (1,911 )   $ (815 )   $ 887   $ 3,036  
   


 


 


 


 


 


 


 

 


Pro forma net income per unit:

                                                                     

Basic and diluted

                                                          $ 0.10   $ 0.35  

Balance Sheet Data (at period end):

                                                                     

Cemetery property

  $ 148,643     $ 157,873     $ 154,394     $ 153,413     $ 151,200             $ 151,550           $ 151,550  

Total assets (7)

    370,877       382,439       357,562       356,293       355,685               480,724             480,475  

Deferred cemetery revenues, net (8)

    38,671       83,194       91,208       103,580       115,233               119,680             119,680  

Total debt

    146,807       151,452       133,474       134,732       130,708               130,963             80,000  

Redeemable preferred stock (par value $0.01, 12,764 and 15,514 shares issued and outstanding at December 31, 2002 and 2003, respectively and 13,400 and 17,103 shares issued and outstanding at June 30, 2003 and 2004, respectively) (9)

    —         —         —         12,764       15,514               17,103       —       —    

Total stockholders’/partners’ equity

    93,598       66,557       63,960       48,920       41,980               39,576             111,307  

Cash Flow Data:

                                                                     

Net cash provided by (used in):

                                                                     

Operating activities

  $ 2,877     $ 6,918     $ 12,589     $ 11,042     $ 7,146     $ (338 )   $ (367 )              

Investing activities

    (41,354 )     (10,502 )     (5,766 )     (8,913 )     (3,129 )     (1,741 )     (3,395 )              

Financing activities

    34,032       4,340       (8,011 )     1,258       (4,022 )     (1,234 )     254                

Other Financial Data:

                                                                     

EBITDA, as adjusted

  $ 17,399     $ 33,465     $ 18,031     $ 26,741     $ 29,627     $ 15,573     $ 15,137                

Change in assets and liabilities that provided (used) cash:

                                                                     

Merchandise trusts receivable

    (1,728 )     (6,174 )     6,206       594       (128 )     342       —                  

Due from merchandise trust

    (12,044 )     (1,939 )     13,533       (1,379 )     (170 )     (473 )     (1,249 )              

Merchandise liability

    2,617       (2,527 )     (827 )     (3,427 )     (3,224 )     (2,543 )     (3,126 )              

Capital expenditures:

                                                                     

Maintenance capital expenditures

    5,604       3,414       1,922       3,378       1,184       660       1,005                

Expansion capital expenditures, including acquisitions and dispositions

    23,706       7,088       3,844       5,535       1,945       1,081       2,390                

 

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     Cornerstone Family Services, Inc. Historical (1)

     Years Ended December 31,

   Six Months
Ended June 30,


     2000

   2001

   2002

   2003

   2003

   2004

Operating Data (10):

                                         

Interments performed

     21,657      22,122      22,693      22,281      11,159      11,338

Cemetery revenues per interment performed (11)

   $ 2,916    $ 3,339    $ 3,215    $ 3,500    $ 3,354    $ 3,801

Interment rights sold(12):

                                         

Lots (11)

     12,839      12,684      11,933      12,442      6,005      6,563

Mausoleum crypts (including pre-construction)

     2,280      1,921      2,271      2,314      1,221      1,052

Niches

     391      389      436      445      243      280
    

  

  

  

  

  

Total interment rights sold (11)(12)

     15,510      14,994      14,640      15,201      7,469      7,895
    

  

  

  

  

  

Cemetery revenues per interment right sold (11)(12)

   $ 4,072    $ 4,926    $ 4,984    $ 5,130    $ 5,010    $ 5,459

Number of contracts written

     50,404      52,353      51,012      47,939      24,897      23,877

Aggregate contract amount, in thousands (excluding interest)

   $ 81,078    $ 89,726    $ 89,106    $ 90,551    $ 46,896    $ 47,516

Average amount per contract (excluding interest)

   $ 1,609    $ 1,714    $ 1,747    $ 1,889    $ 1,884    $ 1,990

Number of pre-need contracts written

     23,369      23,824      23,194      22,276      11,805      10,911

Aggregate pre-need contract amount, in thousands (excluding interest)

   $ 53,777    $ 57,306    $ 59,177    $ 60,854    $ 31,736    $ 31,190

Average amount per pre-need contract (excluding interest)

   $ 2,301    $ 2,405    $ 2,551    $ 2,732    $ 2,688    $ 2,859

Number of at-need contracts written

     27,035      28,529      27,818      25,663      13,092      12,966

Aggregate at-need contract amount, in thousands

   $ 27,301    $ 32,421    $ 29,928    $ 29,698    $ 15,160    $ 16,326

Average amount per at-need contract

   $ 1,010    $ 1,136    $ 1,076    $ 1,157    $ 1,158    $ 1,259

(1) Includes results of operations of 12 cemeteries that we operate under management agreements with the cemetery associations that own them.

 

(2) In March 1999, we commenced our operations when we acquired 123 cemetery properties and four funeral homes from The Loewen Group, Inc.

 

(3) Effective January 1, 2000, we adopted SEC Staff Accounting Bulletin 101, “Revenue Recognition in Financial Statements,” in which the SEC expressed its views on applying GAAP to selected revenue recognition issues. The following data summarizes our results of operations for the nine month period ended December 31, 1999 and the year ended December 31, 2000 as if we had adopted SAB 101 as of March 31, 1999, the date on which we commenced operations (dollars in thousands):

 

 

    

Nine Month Period Ended

December 31, 1999


   

Year Ended

December 31, 2000


 
     Actual

   As
Adjusted


    Actual

    As
Adjusted


 

Total revenues

   $ 65,990    $ 38,206     $ 63,897     $ 63,897  

Total costs and expenses

     51,743      41,519       62,706       62,706  

Net income (loss) before cumulative effect of change in accounting principle

     14,247      (3,313 )     1,191       1,191  

Cumulative effect of change in accounting principle

     —        (13,594 )     (13,594 )     —    

Net income (loss)

     1,686      (11,908 )     (25,023 )     (11,429 )

 

  The adoption of SAB 101 had no effect on our consolidated cash flows.

 

(4) Includes write-off of $1.3 million of expenses in 2002 and $715,000 in 2003 incurred in connection with a potential acquisition of a group of cemeteries in Michigan that we determined would be unlikely to take place. Also includes $1.7 million in corporate bonuses in 2003 and the annual payment of a $0.6 million to $0.8 million fee to MDC Management Company IV, LLC. Also includes $1.2 million of stock-based compensation in 2003, which is discussed in Note 12 to our historical consolidated financial statements.

 

(5) Represents expenses incurred in connection with a proposed high-yield debt offering that was not completed and a refinancing of our existing credit facility. The expenses included $2.4 million of legal and accounting fees, $2.2 million of consulting and other advisory fees, $1.8 million of bank amendment fees and $0.6 million of miscellaneous expenses, including printing costs, ratings-agency fees and title-company fees.

 

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(6) In 2000, represents the effect of the adoption of SAB 101 (see note (3) above). In 2002, represents negative goodwill recorded as a result of the implementation of SFAS Nos. 141 and 142. Please see the notes to our historical consolidated financial statements.

 

(7) Includes principal of perpetual care and merchandise trusts stated on our balance sheet at fair value as of June 30, 2004 in accordance with FASB Interpretation No. 46 and No. 46 revised, Consolidation of Variable Interest Entities: an Interpretation of Accounting Research Bulletin No. 51, which we adopted as of March 31, 2004. In previous periods, includes principal held in merchandise trusts stated on our balance sheets at cost and does not include perpetual care trust principal in accordance with then industry practice. Please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Recent Accounting Pronouncements” and the notes to our historical consolidated financial statements.

 

(8) Represents revenues to be recognized from sales of pre-need products and services and the related income and capital gains on merchandise trusts. We recognize revenues from sales of pre-need interment rights to constructed mausoleums and lawn crypts when we have collected at least 10% of the sales price. We defer recognition of revenues from sales of pre-need interment rights to unconstructed mausoleums and lawn crypts until we have collected at least 10% of the sales price, at which point we recognize revenues on the percentage-of-completion basis. We recognize revenues from sales of pre-need merchandise and services, other than perpetual care services, when we satisfy the criteria for delivery of the merchandise to the customer or perform the services for the customer. At that time, we also recognize the related income and capital gains from merchandise trusts. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Overview—Cemetery Operations—Sources of Revenues” and “—Trusting.”

 

(9) Represents preferred stock issued to the McCown De Leeuw funds and members of management that will be converted into Class A membership interests of CFSI LLC prior to the closing of this offering.

 

(10) Does not include information for the nine-month period ended December 31, 1999 because of the different lengths of the period and because a different accounting standard was applied during the nine-month period.

 

(11) Excludes in 2002 the sale of a tract of developed land equivalent to 9,600 burial lots to a municipality in Pennsylvania for $1.2 million.

 

(12) Net of cancellations. Counts the sale of a double-depth burial lot as the sale of two interment rights.

 

Non-GAAP Financial Measures

 

We present EBITDA, as adjusted, because this information is relevant to our business. We define EBITDA, as adjusted, as net income before:

 

    interest;

 

    taxes;

 

    depreciation and amortization;

 

    cost of land and crypts sold;

 

    change in deferred cemetery revenues, net; and

 

    cumulative effect of change in accounting principle.

 

In our presentation of EBITDA, as adjusted, we adjusted EBITDA (defined as earnings before interest, taxes, depreciation and amortization) for the following items:

 

   

Cost of land and crypts sold, an expense item resulting from our sales of burial lots, lawn crypts and mausoleum crypts, which is based on the historical allocation of our original cemetery acquisition and

 

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construction costs to individual burial lots and crypts. Management considers this expense to represent the depletion of our interment spaces that are available for sale.

 

    Increase (decrease) in deferred cemetery revenues, net, which represents the net change in pre-need cemetery products and services sold that have not been delivered or performed during the period presented and therefore not recognized as revenues. Because it includes the change in deferred cemetery revenues, net, EBITDA, as adjusted, is able to reflect the deferred revenues from contracts written and their related expenses generated in a particular period.

 

    Cumulative effect of change in accounting principle, which reflects the adoption of new accounting policies. In 2000, we adopted SAB 101, as described in note 3 to the table included in “Selected Historical Financial and Operating Data.” Management considers this adjustment to EBITDA, as adjusted, to reflect the deferral of revenues and expenses generated during periods prior to January 1, 2000 and does not reflect revenues and expenses generated during 2000. In 2002, cumulative effect of change in accounting principle reflects the implementation of SFAS Nos. 141 and 142, which required us to eliminate our recorded negative goodwill. Prior to the implementation of SFAS Nos. 141 and 142, we amortized negative goodwill over a 40-year period. Management considers this adjustment to EBITDA, as adjusted, to be an acceleration of amortization that would have been recognized in future periods.

 

Management and external users of our financial statements, such as our investors, use EBITDA, as adjusted, as an important financial measure to assess the ability of our assets to generate cash sufficient to pay interest on our indebtedness, meet capital expenditure and working capital requirements, pay quarterly distributions on the common and subordinated units and otherwise meet our obligations as they become due.

 

There are material limitations to using a measure such as EBITDA, as adjusted, including the difficulty associated with using it as the sole measure to compare the results of one company to another and the inability to analyze significant items that directly affect a company’s net income (loss) or operating income. In addition, our calculation of EBITDA, as adjusted, may not be consistent with similarly titled measures of other companies and should be viewed in conjunction with measures that are computed in accordance with GAAP. Management compensates for these limitations in considering EBITDA, as adjusted, in conjunction with its analysis of other GAAP financial measures, such as net income (loss) and net cash provided by (used in) operating activities.

 

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The following table presents a reconciliation of EBITDA, as adjusted, to net cash provided by operating activities, its most directly comparable GAAP financial measure, on a historical basis, for the periods presented:

 

    Cornerstone Family Services, Inc. Historical

 
    Nine Month Period
Ended
December 31, 1999


    Year Ended December 31,

    Six Months Ended
June 30,


 
      2000

    2001

    2002

    2003

    2003

    2004

 
    (in thousands)  

Reconciliation of “EBITDA, as adjusted” to “Net cash provided by operating activities”:

                                                       

Net cash provided by (used in) operating activities

  $ 2,877     $ 8,857     $ 12,589     $ 11,042     $ 7,146     $ (338 )   $ (367 )

Interest paid

    10,818       15,156       16,235       12,959       12,918       5,175       5,062  

Income taxes paid

    —         —         2,615       1,790       814       555       650  

Stock compensation

    —         —         —         —         (1,178 )     —         —    

Refinancing expense

    —         —         (500 )     —         —         —         —    

Changes in operating working capital:

                                                       

Accounts receivable

    139       (2,132 )     2,474       (2,564 )     1,900       2,209       1,673  

Due from merchandise trust

    1,728       6,174       (13,533 )     1,379       170       473       1,249  

Merchandise trusts receivable

    —         —         (6,206 )     (594 )     128       (342 )     —    

Prepaid expenses

    749       385       (221 )     192       49       443       (196 )

Other current assets

    408       133       —         (820 )     168       40       (29 )

Other assets

    3,313       2,434       (793 )     (392 )     1,674       202       6,730  

Accounts payable and accrued and other liabilities

    (17 )     (65 )     4,544       322       2,614       4,613       (2,761 )

Merchandise liability

    (2,616 )     2,523       827       3,427       3,224       2,543       3,126  
   


 


 


 


 


 


 


EBITDA, as adjusted

  $ 17,399     $ 33,465     $ 18,031     $ 26,741     $ 29,627     $ 15,573     $ 15,137  
   


 


 


 


 


 


 


 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

 

You should read the following discussion of the financial condition and results of operations of Cornerstone Family Services, Inc. in conjunction with the historical consolidated financial statements of Cornerstone Family Services, Inc. and the unaudited pro forma consolidated financial statements of StoneMor Partners L.P. included elsewhere in this prospectus. Among other things, those historical and pro forma financial statements include more detailed information regarding the basis of presentation for the following information.

 

Overview

 

We are a limited partnership recently formed by our predecessor, Cornerstone Family Services, Inc., to own and operate cemeteries and funeral homes. We are the fourth-largest owner and operator of cemeteries in the United States. As of June 30, 2004, we operated 132 cemeteries in 12 states, located primarily in the eastern United States. We own 120 of these cemeteries, and we operate the remaining 12 under long-term management agreements with the cemetery associations that own the cemeteries. As a result of these agreements and other control arrangements, we consolidate the results of the 12 managed cemeteries in our historical consolidated financial statements. Subsequent to June 30, 2004, we acquired the ownership of one of these cemetery associations and no longer operate it under a management agreement.

 

We sell cemetery products and services both at the time of death, which we refer to as at-need, and prior to the time of death, which we refer to as pre-need. During 2003, we performed over 22,000 burials and sold more than 15,000 interment rights (net of cancellations).

 

Our cemetery operations accounted for approximately 98% of our revenues in 2003 and in the first six months of 2004. Our remaining revenues during those periods were from our funeral home operations described below. Upon completion of this offering, we will be the only publicly traded death care company with substantially all of its operations focused on cemeteries.

 

Cemetery Operations

 

Sources of Revenues.    Our results of operations are determined primarily by the volume of sales of products and services and the timing of product delivery and performance of services. We derive our revenues primarily from:

 

    at-need sales of cemetery interment rights, merchandise and services, which we recognize as revenues at the time of sale;

 

    pre-need sales of cemetery interment rights, which we generally recognize as revenues when we have collected 10% of the sales price from the customer;

 

    pre-need sales of cemetery merchandise, which we recognize as revenues when we satisfy the criteria specified below for delivery of the merchandise to the customer;

 

    pre-need sales of cemetery services, other than perpetual care services, which we recognize as revenues when we perform the services for the customer;

 

    accumulated merchandise trust earnings related to the delivery of pre-need cemetery merchandise and the performance of pre-need cemetery services, which we recognize as revenues when we deliver the merchandise or perform the services;

 

    income from perpetual care trusts, which we recognize as revenues as the income is earned in the trust; and

 

    other items, such as interest income on pre-need installment contracts and sales of land.

 

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Revenues from pre-need sales of cemetery merchandise and the related accumulated merchandise trust earnings are deferred until the merchandise is “delivered” to the customer, which generally means that:

 

    the merchandise is complete and ready for installation or, in the case of merchandise other than burial vaults, storage on third-party premises;

 

    the merchandise is either installed or stored at an off-site location, at no additional cost to us, and specifically identified with a particular customer, except as described below; and

 

    the risks and rewards of ownership have passed to the customer.

 

We generally satisfy these delivery criteria by purchasing the merchandise and either installing it on our cemetery property or storing it, at the customer’s request, in third-party warehouses, at no additional cost to us, until the time of need. With respect to burial vaults, we install the vaults rather than storing them to satisfy the delivery criteria. When merchandise is stored for a customer, we may issue a certificate of ownership to the customer to evidence the transfer to the customer of the risks and rewards of ownership.

 

Deferred Cemetery Revenues, Net.    Deferred revenues from pre-need sales and related merchandise trust earnings are reflected on our balance sheet in deferred cemetery revenues, net, until we recognize the amounts as revenues. Deferred cemetery revenues, net, also includes deferred revenues from pre-need sales that were entered into by entities we acquired prior to the time we acquired them. These entities include those that we acquired at the time of the formation of Cornerstone and other entities we subsequently acquired. We recognize revenues from these acquired pre-need sales in the manner described above—that is, when we deliver the merchandise to, or perform the services for, the customer. Our profit margin on these pre-need sales is generally less than our profit margin on other pre-need sales because, in accordance with industry practice at the time these acquired pre-need sales were made, none of the selling expenses were recognized at the time of sale. As a result, we are required to recognize all of the expenses (including deferred selling expenses) associated with these acquired pre-need sale when we recognize the revenues from that sale. Under current industry practice, we recognize certain expenses, such as indirect selling costs, maintenance costs and general and administrative costs, at the time the pre-need sale is made and defer other expenses, such as direct selling costs and costs of goods sold, until we recognize revenues on the sale. As a result, our profit margin on current pre-need sales is generally higher than on the pre-need sales we acquired.

 

Revenues by State.    The following table shows the percentage of revenues attributable to each of the states in which we operate for the periods presented:

 

     Year Ended December 31,

   

Six Months
Ended
June 30,

2004


 
     2001

    2002

    2003

   

Pennsylvania

   26.0 %   29.2 %   27.4 %   33.1 %

New Jersey

   15.3     15.2     18.3     13.8  

Virginia

   18.4     18.6     16.0     19.1  

Maryland

   13.1     12.7     14.4     12.1  

West Virginia

   21.2     15.7     13.5     12.2  

Ohio

   3.6     5.2     5.6     5.2  

Tennessee

   0.7     1.0     1.4     1.1  

Alabama

   —       0.8     1.1     1.0  

Georgia

   0.6     0.7     1.0     1.0  

Connecticut

   0.6     0.5     0.7     0.9  

Delaware

   0.2     0.2     0.3     0.3  

Rhode Island

   0.3     0.2     0.3     0.2  
    

 

 

 

Total

   100.0 %   100.0 %   100.0 %   100.0 %
    

 

 

 

 

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Principal Products and Services.    The following table shows the percentage of revenues attributable to our principal products, services and other items during the periods presented:

 

     Year Ended December 31,

    Six Months
Ended June 30,


 
      
     2001

    2002

    2003

    2003

    2004

 

Pre-need sales:

                              

Burial lots

   8.0 %   8.8 %   9.9 %   8.8 %   7.7 %

Mausoleum crypts

   7.8     8.4     7.6     9.9     6.1  

Markers

   5.9     5.5     6.7     6.2     7.2  

Grave marker bases

   1.9     1.6     4.1     2.1     3.0  

Burial vaults

   2.6     7.0     3.0     3.3     4.6  

Lawn crypts

   1.8     1.1     0.9     1.0     0.6  

Caskets

   1.6     1.3     1.1     1.1     5.4  

Initial openings and closings (1)

   2.3     2.3     3.4     2.4     5.5  

Other (2)

   3.9     3.1     3.0     3.3     2.9  
    

 

 

 

 

Total pre-need sales

   35.8 %   39.1 %   39.7 %   38.1 %   43.0 %
    

 

 

 

 

Interest income from pre-need installment contracts

   6.1 %   6.2 %   5.4 %   5.6 %   4.7 %
    

 

 

 

 

Investment income from trusts:

                              

Perpetual care trusts

   8.8 %   8.7 %   8.5 %   9.9 %   8.1 %

Merchandise trusts

   3.8     4.3     6.4     4.9     3.6  
    

 

 

 

 

Total investment income from trusts

   12.6 %   13.0 %   14.9 %   14.8 %   11.7 %
    

 

 

 

 

At-need sales:

                              

Openings and closings (3)

   15.8 %   15.7 %   15.0 %   15.9 %   13.9 %

Markers

   8.5     8.2     7.9     8.6     7.9  

Burial lots

   3.0     4.9     3.1     3.3     3.1  

Mausoleum crypts

   2.0     1.9     1.8     2.0     2.2  

Grave marker bases

   2.6     2.7     2.6     2.8     2.7  

Foundations and inscriptions (4)

   1.9     1.9     1.7     1.8     1.6  

Burial vaults

   1.4     1.4     1.3     1.3     1.4  

Other (5)

   6.1     2.2     1.6     1.9     1.4  
    

 

 

 

 

Total at-need sales

   41.3 %   38.9 %   35.0 %   37.6 %   34.2 %
    

 

 

 

 

Funeral home revenues

   1.3 %   1.8 %   2.2 %   2.2 %   2.3 %

Other revenues (6)

   2.9     1.0     2.8     1.7     4.1  
    

 

 

 

 

Total revenues

   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %
    

 

 

 

 


(1) Installation of the burial vault into the ground.
(2) Includes revenues from niches, mausoleum lights, cremations, pet cemeteries, installations of burial vaults and markers sold to our customers by third parties and pre-need sales made in connection with the relocation of other cemetery interment rights, primarily in 2001, as a result of the West Virginia highway project described below. Also includes document-processing fees on pre-need contracts and fees from sales of travel care protection, which covers shipping costs of a body if death occurs more than 100 miles from the place of residence.
(3) Installation of the burial vault into the ground and the placement of the casket into the vault.
(4) Installation of the marker on the ground and its inscription.
(5) Includes revenues from lawn crypts, decorative lights installed on mausoleum crypts, installations of burial vaults and markers sold to our customers by third parties and cremation fees. Also includes document-processing fees on at-need contracts.
(6) Includes sales of manufactured burial vaults to third parties, sales of cemetery and undeveloped land, commissions from sales of pre-need funeral policies and death benefit policies provided through a third-party insurance provider and other miscellaneous revenues.

 

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Pre-need Sales.    Pre-need products and services are typically sold on an installment basis with terms ranging from 12 months to 84 months, with an average of 37 months. Our pre-need contracts are subject to “cooling-off” periods, generally between three and thirty days, required by state law during which the customer may elect to cancel the contract and receive a full refund of amounts paid. Subject to applicable state law, if customers cancel after the cooling-off period, we are generally permitted to retain the amounts already paid on contracts, including any amounts that were required to be deposited into trust. Historically, our customers have cancelled contracts representing approximately 10% of our pre-need sales (based on contract dollar amounts) after the cooling-off period. If the products and services purchased under a pre-need contract are needed for interment before payment has been made in full, the balance due becomes immediately due and must be paid in cash.

 

Approximately 54% of our pre-need sales contracts do not bear interest. Historically, we did not charge interest on pre-need sales contracts having a term of 12 months or less, and beginning in 2003 we stopped charging interest on pre-need contracts with terms of 36 months or less. In those cases, interest is imputed at varying market rates, currently 5.75%. The interest rates on our interest-bearing pre-need contracts range from 6% to 13%, with a weighted average interest rate of 7%. We offer prepayment incentives to customers whose pre-need contracts are longer than 36 months and bear interest. If those customers pay their contracts in full in less than 12 months, we rebate the interest that we collected from them. Even though this rebate policy reduces the amount of interest income we receive on our accounts receivable, the net effect is an increase in our immediate cash flow. Interest income from pre-need sales, including imputed interest, accounted for 5.4% of our 2003 revenues.

 

Trusting.    We are generally required by state law to place a portion of the sales price of cemetery interment rights, whether at-need or pre-need, into a perpetual care trust to maintain the cemetery property in perpetuity. The amount that we are required to deposit into a perpetual care trust varies from state to state but is generally 10% to 15% of the sales price of the interment right. As payments are received from the customer, we deposit a pro rata amount of the payment into a perpetual care trust. For example, if we receive a payment of 20% of the sales price from the customer, we would deposit into the perpetual care trust 20% of the total amount required to be placed into trust for that sale.

 

Under the state laws that require the creation of the perpetual care trusts, we are not permitted to withdraw the trust principal, and our creditors and customers have no right to make claim to the funds deposited into these trusts. Amounts held in these perpetual care trusts are invested by third-party investment managers as discussed in more detail below. As a result, we do not possess legal title to the trust principal in these perpetual care trusts; however, in accordance with current industry practice, amounts deposited into perpetual care trusts are reflected at fair market value on the asset portion of our balance sheet as of June 30, 2004 as an asset entitled “perpetual care trusts, restricted, at fair value,” and an equal amount is reflected on the liabilities, preferred stock and common stockholders’ equity portion of our balance sheet as an item entitled “non-controlling interest in perpetual care trusts.” For periods ending before March 31, 2004, we did not include perpetual care trust principal on our balance sheet in accordance with prior industry practice. We recognize income from perpetual care trusts in our revenues as it is earned in the trust, regardless of when we withdraw it. We are permitted under state law to withdraw the investment income, such as interest and dividends, but not the capital gains, from perpetual care trusts, generally on a monthly basis. To maximize the income generated by perpetual care trusts, we have established investment guidelines for the third-party investment managers so that substantially all of the funds held in perpetual care trusts are invested in intermediate-term, investment-grade, fixed-income securities, high-yield fixed-income securities and real estate investment trusts. We are required to use all amounts withdrawn from perpetual care trusts for cemetery maintenance and administration.

 

We are generally required by state law to deposit a portion of the sales price of pre-need cemetery merchandise and services, or the estimated current cost of providing that merchandise and those services, into a merchandise trust to ensure that we will have sufficient funds in the future to purchase the merchandise or perform the services. The amount we are required to deposit into a merchandise trust varies from state to state but

 

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is generally 40% to 70% of the sales price of the merchandise or services. As payments are received from the customer, we deposit a pro rata amount of the payment into the merchandise trust. For example, if we receive a payment of 20% of the sales price from the customer, we would deposit into the merchandise trust 20% of the total amount required to be placed into trust for the merchandise and services sold.

 

Under the state laws that require the creation of the merchandise trusts, we are not permitted to withdraw the trust principal, except as described below, and our creditors and customers have no right to make claim to the funds deposited into these trusts. Amounts held in these merchandise trusts are invested by third-party investment managers as discussed in more detail below. As a result, we do not possess legal title to the trust principal in these merchandise trusts; however, in accordance with current industry practice, amounts deposited into merchandise trusts are reflected at fair value on our balance sheet as of June 30, 2004 as an asset called merchandise trusts, restricted, at fair value. For periods ending prior to March 31, 2004, amounts deposited into merchandise trust were reflected at cost on our balance sheet as an asset called due from merchandise trust, in accordance with prior industry practice. Earnings on funds held in merchandise trusts, including investment income and capital gains, are included separately on our balance sheet in deferred cemetery revenues, net. These amounts remain on our balance sheet until we recognize them as revenues. We recognize amounts withdrawn from merchandise trusts, including principal, as revenues when we satisfy the criteria for delivery of the related merchandise discussed above or perform the related services.

 

We are permitted to withdraw the investment income, such as interest and dividends, as well as capital gains, from merchandise trusts at varying times depending on the applicable state law. In most states, we are permitted to make monthly withdrawals of investment income, but in other states we are permitted to withdraw income less frequently or only upon death. In all states, however, we are permitted to withdraw trust principal and earnings to purchase the merchandise or perform the services or, generally, when the customer cancels the contract. We invest the amounts deposited into merchandise trusts, within specified investment guidelines, primarily in intermediate-term, investment-grade fixed-income securities, high-yield fixed-income securities, real estate investment trusts and, to a lesser extent, equity securities and cash.

 

The income earned on funds held in perpetual care trusts and merchandise trusts can be materially affected by fluctuations in interest rates and, in the case of merchandise trusts, by the performance of the stock market to the extent that the funds held in merchandise trusts are invested in equity securities. Earnings on merchandise and perpetual care trusts that we recognized as revenues accounted for 14.9% of our 2003 revenues and 11.7% of our revenues in the first six months of 2004. During 2001, 2002 and 2003, our average annual rates of return from realized earnings on funds held in merchandise trusts, before restructuring losses in 2001 and 2002, were 7.8%, 6.9% and 7.6%, respectively, and our average annual rates of return from realized earnings on funds held in perpetual care trusts were 6.3%, 6.1% and 5.9%, respectively. During the first six months of 2004, our average annualized rates of return from realized earnings on funds held in merchandise trusts and perpetual care trusts were 5.8% and 5.9%, respectively. We cannot assure you, however, that that we will continue to be successful in achieving any particular return in the future.

 

Amounts held in trusts are invested by third-party investment managers who are selected by the Trust and Compliance Committee of our board of directors. These investment managers are required to invest our trust funds in accordance with applicable state law and internal investment guidelines adopted by our Trust and Compliance Committee. Our investment managers are monitored by third-party investment advisors selected by our Trust and Compliance Committee who advise the Committee on the determination of asset allocations, evaluate the investment managers and provide detailed monthly reports on the performance of each merchandise and perpetual care trust.

 

Unrealized gains and losses in merchandise trusts have no immediate impact on our revenues, earnings or cash flow unless the fair market value of the funds declines below the estimated costs to deliver the related products and services, in which case we would be required to record a current charge to earnings equal to the difference between the fair market value of the funds and the estimated costs. Over time, gains and losses

 

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realized in merchandise trusts are allocated to the underlying pre-need contracts and affect the amount of trust earnings to be recognized as revenues when we deliver the related products or perform the related services. As of June 30, 2004, the aggregate fair market value of funds held in merchandise trusts exceeded our costs to purchase the related products and perform the related services by $71.3 million.

 

At the time we enter into a pre-need contract, we determine both the amount required to be deposited into a merchandise trust and our cost to purchase the related products and perform the related services. We determine the amount required to be deposited into a merchandise trust based on applicable state law. We determine our cost to purchase a product using the actual current cost of the product as indicated on the price list from the manufacturer at the time we enter into the pre-need contract. We determine our cost to perform a service based on the current cost of the labor necessary to perform the service at the time we enter into the pre-need contract. Our cost to purchase certain products, such as grave markers, grave marker bases and caskets, is generally fixed through 2005 under supply agreements with the manufacturers of those products. We are able to control the cost of the vaults we are required to purchase by manufacturing most of those vaults. We are also able to control the cost to perform services, such as openings and closings, by purchasing the necessary equipment and using our employees to perform these services for us.

 

Our cost to purchase any product or to perform any service is generally less than 30% of the retail price of such product or service. The retail price is the price at which we sell the product or service to our customers. Because each state in which we operate requires us to deposit into a merchandise trust an amount equal to at least 30% of the retail price (and usually a greater percentage) of the related products and services, our cost to purchase these products and perform those services is generally less than the amount required to be deposited in trust.

 

As of June 30, 2004, approximately 65.0% of the fair market value of the amounts held in merchandise trusts was invested in fixed-income securities to ensure that the market value of those funds will be sufficient to cover our cost to purchase the related products and perform the related services at the time of purchase and performance.

 

Some states impose additional restrictions on our ability to withdraw merchandise trust earnings if those trusts have realized losses. For example, if a Pennsylvania merchandise trust realizes a loss, the trust is required to recover the amount of the realized loss, either by earning income or generating capital gains, before we are allowed to withdraw earnings, except to purchase the related products or perform the related services. Other states, such as Virginia, permit continued withdrawals of merchandise trust earnings following a realized loss so long as the fair market value of the funds held in trust equals or exceeds the cost of the related products and services. We realized approximately $9.1 million of total losses in merchandise trusts in 2001 and $1.3 million of total losses in merchandise trusts in 2002. Of the total losses, approximately $6.5 million were in Pennsylvania merchandise trusts. All of the realized losses in the Pennsylvania merchandise trusts were recovered by the first quarter of 2004.

 

Cash Flow.    The impact of pre-need sales on near-term cash flow depends primarily on the commissions paid on the sale, the portion of the sales price required to be deposited into trust and the terms of the particular contract, such as the amount of the required down payment, the products purchased and the length of the contract. Customers are required to make a down payment on a pre-need contract of at least 5% of the total sales price, with the average down payment equal to 12% of the total sales price. When we receive a payment from a customer on a pre-need contract, we first deposit the requisite portion into trust as required by state law. Then, we pay all or a portion of the commission due to the salesperson responsible for the sale. We generally pay commissions to our pre-need sales personnel based on a percentage, usually 8% to 24%, of the total sales price, but only to the extent that cash is received from the customer. If the down payment received from the customer is not sufficient to cover the entire commission, the remaining commission is paid from subsequent installments, but only to the extent of 80% of the cash received from the customer in each installment. Because we are required to deposit a portion of each installment into trust, we are usually required to use our own cash to cover a

 

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portion of the commission due to the salesperson. Accordingly, pre-need sales are generally cash flow negative initially but become cash flow positive at varying times over the life of the contract, generally six to seven months after the down payment is made, depending upon the trust requirements, the terms of the particular contract, the sales commission paid and the timing of delivery or performance of the related products and services.

 

For example, on a pre-need contract with a total sales price of $1,000, a 10% down payment, a 40% perpetual care and merchandise trusting requirement, a 15% sales commission and a one-year term without interest, our short-term cash flow would be as follows:

 

    When we receive the $100 down payment from the customer, we would deposit 40% of the payment, or $40, into trust and pay 100% of the commission due to the salesperson, or $150, but only to the extent that we received cash from the customer, or $100. Our total cash obligations would be $140 even though we only received $100 from the customer. We would use $40 of our operating cash to pay the sales commission and, at this time, would be cash flow negative on the contract.

 

    In month one, when we receive the first $75 installment from the customer, we would deposit 40%, or $30, into trust and pay 100% of the balance of the commission due to the salesperson, or $50. Our total cash obligations would be $80 even though we only received $75 from the customer. We would use $5 of our operating cash to pay sales commission and would still be cash flow negative on the contract.

 

    In month two, when we receive the next $75 installment from the customer, we would deposit 40%, or $30, into trust, but we would have no further commission due on the sale. The remaining $45 received from the customer would go back into our operating cash, and we would break even on the contract on a cash-flow basis.

 

    In month three, when we receive the next $75 installment from the customer, we would deposit 40%, or $30, into trust and the remaining $45 would go back into our operating cash. In this month, we would become cash flow positive on the contract.

 

We can enhance our operating cash flow by purchasing and delivering many of our products in advance of the time of customer need, either by installing them in the customer’s burial space (in the case of burial vaults) or storing them for the customer, and by performing certain services prior to the time of need. For example, within the allowances of state law, we purchase burial vaults, grave markers and caskets, and perform initial openings and closings to install the burial vault in the ground before the time of need. When we satisfy the criteria for delivery of pre-need products or perform pre-need services, we are permitted to withdraw the related principal and any income and capital gains that we have not already withdrawn from the merchandise trust, and we recognize the amounts withdrawn, including amounts previously withdrawn, as revenues. Advance purchasing helps us avoid the negative cash flow impact of depositing significant portions of our sales proceeds in trusts while earning rates on those trusts that are currently less than interest rates we pay on our debt. To the extent that we can purchase and deliver products and perform services in advance of the time of need, we can accelerate, within the limitations of GAAP, the timing of our revenue recognition for these products and services. As a result, decisions made by our management to purchase and deliver products or perform services in advance, for cash flow or other reasons, affects the timing of revenue recognition from the underlying sales.

 

In 1999 and 2000, the rates of return on funds held in merchandise and perpetual care trusts generally exceeded the interest rates on our outstanding debt. We focused on increasing our assets by holding the funds deposited in merchandise and perpetual care trusts until the time of need and borrowing under our credit facility any cash needed for our operations. In 2001, however, market conditions changed, and the interest rates on our outstanding debt generally exceeded our rates of return on funds held in merchandise and perpetual care trusts. We began to consider alternative methods for increasing our cash flow in response to these declining rates of return. By 2003, we had adjusted our cash flow management to accelerate the withdrawal of funds from merchandise trusts, within the limitations of applicable state law, and to purchase and deliver pre-need products and perform pre-need services in advance of the time of need. We used the amounts withdrawn from merchandise trusts, after

 

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deducting our costs to purchase the related products and perform the related services, to service our outstanding debt and operate our business. The availability of these withdrawn funds for our operations reduced the amount of additional borrowings we otherwise would have been required to make under our credit facility, and we did not incur the interest expense that would have been associated with those borrowings.

 

We are somewhat limited, however, in our ability to purchase some products in advance of the time of need because of their availability. Given our large volume of pre-need sales, it is unlikely that our suppliers could provide, or we could manufacture, all of the products included in our pre-need backlog at any given time. For example, we generally need over 20,000 vaults per year to fulfill our pre-need contract obligations, of which we manufacture approximately 18,000 at our plant. We must purchase any excess from third party suppliers who must also meet the demands of other cemetery operators.

 

We are seeking competitive bids from third-party providers of burial vaults to assist us in meeting the demands of our accelerated purchase and delivery program. We are also limited in our ability to perform certain services in advance of the time of need because of their nature or our resources. For example, we cannot perform the final opening and closing, which is the placing of the casket into the ground, or inscribe the date of death on the monument or marker until the time of need. Even if we chose to perform all of the services in our pre-need backlog that could be performed in advance of need, such as installing all of the burial vaults in our pre-need backlog, we would not currently have the labor, equipment or other resources to perform all of those services in a short period of time.

 

Substantially all of the assets and liabilities of Cornerstone, our predecessor, will be contributed to us prior to the closing of this offering. We do not expect any of the transactions effecting these contributions to have any impact on our cash flow going forward.

 

At-need Sales.    At-need sales of products and services are required to be paid for in full with cash at the time of sale. At that time, we first deposit any amount required to be placed in perpetual care trusts. Then we pay commissions, which are usually equal to 5% of the total sales price, to our sales personnel. We are not required to deposit any amounts from our at-need sales into merchandise trusts.

 

Expenses.    Our primary variable operating costs are cost of goods sold and selling expenses. Cost of goods sold reflects the actual cost of purchasing products and performing services and ranged from 20% to 25% of the related sales price for the last three years. Fixed-price contracts with our major suppliers allow us to keep the cost of some products constant through 2005. Selling expense consists of salesperson and sales management payroll costs, including selling commissions, bonuses and employee benefits, and other costs of obtaining product and service sales, such as advertising, marketing, postage and telephone. Selling expense also includes override commissions paid to our cemetery managers based on the volume of sales made for the cemeteries they manage. Override commissions are generally 4% to 6% of gross sales price and are payable weekly. Selling expense has historically averaged between 36% and 41% of product and service sales.

 

Additionally, we self-insure medical expenses of our employees up to certain individual and aggregate caps after which our insurer is responsible for additional medical expenses. Our self-insurance policy may result in variability in our future operating expenses.

 

In addition to our variable operating expenses, we incur fixed costs, primarily for cemetery expense, depreciation of property and equipment and general and administrative expense for our cemeteries. Cemetery expense represents the cost to maintain and repair our cemetery properties and consists primarily of labor and equipment, utilities, real estate taxes and other maintenance items. Repairs necessary to maintain our cemeteries are expensed as they are incurred. Other maintenance costs required over the long term to maintain the operating capacity of our cemeteries, such as to build roads and install sprinkler systems, are capitalized. We depreciate our property and equipment on a straight-line basis over their estimated useful lives. General and administrative expense, which does not include corporate overhead, includes primarily insurance and other costs necessary to maintain our cemetery offices.

 

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Direct costs associated with pre-need sales of cemetery merchandise and services, such as sales commissions and cost of goods sold, are reflected in the balance sheet in deferred cemetery revenues, net, and are expensed as the merchandise is delivered or the services are performed. Indirect costs, such as marketing and advertising costs, are expensed in the period in which they are incurred.

 

Sales of cemetery lots and interment rights, whether at-need or pre-need, typically generate a higher profit margin than the other products and services we sell. This is primarily because our cost of goods sold is lower on these sales. When we purchase cemetery property, we allocate the purchase price to the property based on the number of burial lots. As we recognize revenues from sales of interment rights or land, we expense the cost of the associated lots as the cost of goods sold.

 

Cost Saving Initiatives.    Our operations are organized geographically in five regions, which allows us to reduce operating and administrative costs by sharing sales and administrative personnel, equipment and other resources. We have recently completed several measures intended to reduce our operating costs. For example, we renegotiated the pricing of some of our contracts with a number of our major vendors and suppliers and provided our operating personnel with purchase credit cards that enable them to process transactions directly into our accounting system, which has reduced our administrative costs. We also reduced the sales commission rates payable to our sales personnel and renegotiated the pricing of some of our employee benefit plans.

 

Outlook.    We believe that in order to expand our cemetery operations, we must attract new customers, continue to attract and hire talented sales personnel and management and enhance our current marketing department to generate additional pre-need sales. Our principal target market is the 45-to 64-year-old category because this age group typically purchases pre-need products and services at a higher rate than younger age groups. This target age group is expected to experience a 2.6% compounded annual growth rate from 2000 to 2010, or approximately three times the annual growth rate for the public overall. We believe that the aging of the “baby boom” generation will more than offset the impact of increased life expectancy.

 

We believe that competition experienced by individual cemetery properties is generally limited to existing cemeteries within the same area. Competition from new entrants is minimized by the significant barriers to establishing a new cemetery in any particular location, including the availability of land, compliance with local regulatory requirements and the significant start-up capital costs, such as paving roads and installing sprinkler systems. Heritage and tradition also make it difficult to establish a new cemetery, as existing cemeteries have often served multiple generations of families and have developed strong family loyalty.

 

The death care industry is facing challenges, however, including an increasing trend toward cremation and difficulty in attracting and retaining high quality sales and management personnel to the industry.

 

We intend to expand our operations through accretive acquisitions of high-quality cemetery properties. However, our valuations of potential acquisitions of high-quality cemeteries may be below the current sellers’ expectations, which may make it more difficult for us to complete acquisitions of desired properties on terms acceptable to us, or at all. Furthermore, we are not permitted to make acquisitions for more than $2.5 million, or any series of acquisitions aggregating more than $20.0 million in any consecutive 12-month period, without the requisite consent of the lenders under our new credit facility. In addition, we may face competition for future acquisitions because several large death care companies have recently announced their intention to resume some level of acquisition activity. When we acquire cemeteries that do not have an existing pre-need sales program or a significant amount of pre-need products and services that have been sold but not yet delivered or performed, the operation of the cemetery and implementation of a pre-need sales program after acquisition may require significant amounts of working capital. This may make it more difficult for us to make accretive acquisitions.

 

During 2004, we plan to grow our existing base of cemetery revenues by continuing our program to accelerate the purchase and delivery of pre-need products and the performance of pre-need services and by increasing pre-need sales while diligently managing our cash expenses. We intend to use a portion of the net

 

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proceeds of this offering to purchase additional equipment that we will use to perform pre-need services, such as the installation of burial vaults, in accordance with our accelerated performance program. We also expect to have greater access to burial vaults and caskets, through contracts negotiated with third-party suppliers, which will help us satisfy the requirements of our accelerated purchase and delivery program. We also intend to take advantage of other opportunities to grow our cemetery operations through acquisitions as described above.

 

We expect our 2004 cemetery revenues to increase over 2003 levels primarily as a result of an increase in deliveries of pre-need products and performance of pre-need services in 2004. We expect to deliver more pre- need products and perform more pre-need services in 2004 than in 2003 because we expect to minimize the period of time between signing pre-need contracts and delivering or performing the related products or services for all of 2004, as described above, whereas we were still implementing these measures in 2003. The expected increase in 2004 cemetery revenues is also attributable to an increase in retail prices in 2004 of approximately 3%. Because we generally increase prices by 3% each year, some of the anticipated increase in 2004 cemetery revenues is expected to be attributable to the higher average sales prices of pre-need products and services sold in prior years for which the revenues are recognized in 2004 compared to the average sales prices of pre-need products and services for which revenues were recognized in 2003.

 

We also expect our volume of pre-need sales in 2004 to increase over 2003 levels primarily as a result of the growth in our principal target market of 45- to 64-year olds who generally purchase pre-need products and services at a higher rate than younger age groups.

 

Funeral Home Operations

 

We also derive revenues from the sale of funeral home merchandise, including caskets and related funeral merchandise, and services, including removal and preparation of remains, the use of our facilities for visitation, worship and performance of funeral services and transportation services. These services and merchandise are sold by us almost exclusively at the time of need by salaried licensed funeral directors. In 2003 and during the six months of 2004, our funeral home revenues accounted for 2.2% and 2.3%, respectively, of our revenues. More than 420 funerals were performed at our funeral homes in 2003.

 

We generally include revenues from pre-need casket sales in the results of our cemetery operations. However, some states require that caskets be sold by funeral homes, and revenues from casket sales in those states are included in our funeral home results. We do not report the results of our funeral home operations as a separate business segment.

 

Each of our seven funeral homes is located on the grounds of one of the cemeteries that we own. As a result, we are able to combine certain general and administrative expenses that relate to both the cemetery and the funeral home at the same location. Our other funeral home operating expenses consist primarily of compensation to our funeral directors and the cost of caskets.

 

Other

 

Corporate Overhead.    We incur fixed costs for corporate overhead primarily for centralized functions, such as payroll, accounting, collections and professional fees. Following the completion of this offering, we will incur expenses relating to reporting requirements under U.S. federal securities laws and certain other additional expenses of being a public company. These expenses are not reflected in our historical results and are estimated to be $1.3 million per year.

 

Consolidation.    Our historical operations are part of a consolidated group for financial reporting purposes that includes the 12 cemeteries we operate under long-term management contracts with the cemetery associations that own the cemetery properties. Subsequent to June 30, 2004, we acquired the ownership of one of these cemetery associations and no longer operate it under a management agreement.

 

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Income Taxes.    Our historical financial statements include the effects of applicable U.S. federal and state income taxes in order to comply with GAAP. We are a limited partnership that has elected to be treated as a partnership for U.S. federal income tax purposes and therefore not be subject to U.S. federal or applicable state income taxes. See “Material Tax Consequences.” In order to be treated as a partnership for federal income tax purposes, at least 90% of our gross income must be qualifying income, which includes income from the sale of real property, including burial lots (with and without installed vaults and grave marker bases), lawn and mausoleum crypts and cremation niches. Most of our activities that do not generate qualifying income, such as the sale of other cemetery products, the provision of perpetual care services, the operation of our managed cemeteries and all funeral home operations, will be owned by and conducted through these corporate subsidiaries, which will be subject to tax on their net taxable income. Dividends we receive from corporate subsidiaries will be qualifying income. Please see “Material Tax Consequences—Partnership Status.”

 

Critical Accounting Policies and Estimates

 

Our discussion and analysis of our financial condition and results of operations are based on the historical consolidated financial statements of Cornerstone Family Services, Inc. We prepared these financial statements in conformity with GAAP. The preparation of these financial statements required us to make estimates, judgments and assumptions that affected the reported amounts of assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We based our estimates, judgments and assumptions on historical experience and known facts and other assumptions that we believed to be reasonable under the circumstances. After completion of this offering, we expect to make similar estimates, judgments and assumptions on the same basis as we have historically. Our actual results in future periods may differ from these estimates under different assumptions and conditions. We believe that the following accounting policies or estimates had or will have the greatest potential impact on our consolidated financial statements for periods ending after the completion of this offering.

 

Revenue Recognition.    At-need sales of cemetery interment rights, merchandise and services and at-need sales of funeral home merchandise and services are recognized as revenues when the interment rights or merchandise is delivered or the services are performed.

 

Revenues from pre-need sales of cemetery interment rights in constructed burial property are deferred until at least 10% of the sales price has been collected. Revenues from pre-need sales of cemetery interment rights in unconstructed burial property, such as mausoleum crypts and lawn crypts, are deferred until at least 10% of the sales price has been collected, at which time revenues are recognized using the percentage-of-completion method of accounting. The percentage-of-completion method of accounting requires us to estimate the percentage of completion as of the balance sheet date and future costs (including estimates for future inflation). Changes to our estimates of the percentage of completion or the related future costs would impact the amount of recognized and deferred revenues.

 

Revenues from pre-need sales of cemetery merchandise and services are deferred until the merchandise is delivered or the services are performed. Investment earnings generated by funds required to be deposited into merchandise trusts, including realized gains and losses, in connection with pre-need sales of cemetery merchandise and services are deferred until the associated merchandise is delivered or the services are performed.

 

We defer recognition of the direct costs associated with pre-need sales of cemetery products and services. Direct costs are those costs that vary with and are directly related to obtaining new pre-need cemetery business and the actual cost of the products and services we sell. Direct costs are expensed when the related revenues are recognized. Until that time, direct costs are reflected on our balance sheet in deferred cemetery revenues, net.

 

Allowance for Cancellations.    Allowances for cancellations arising from non-payment of pre-need contracts are estimated at the date of sale based upon our historical cancellation experience. Due to the number of

 

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estimates and projections used in determining an expected cancellation rate and the possibility of changes in collection patterns resulting from modifications to our collection policies or contract terms, actual collections could differ from these estimates.

 

Impairment of Long-Lived Assets.    We monitor the recoverability of long-lived assets, including cemetery property, property and equipment and other assets, based on estimates using factors such as current market value, future asset utilization, business and regulatory climate and future undiscounted cash flows expected to result from the use of the related assets. Our policy is to record an impairment loss in the period when it is determined that the sum of future undiscounted cash flows is less than the carrying value of the asset. Modifications to our estimates could result in our recording impairment charges in future periods.

 

Property and Equipment.    Property and equipment is recorded at cost and depreciated on a straight-line basis. Maintenance and repairs are charged to expense as incurred, whereas additions and major replacements are capitalized and depreciated over the estimated useful life of the asset. We estimate that the useful lives of our buildings and improvements are 10 to 40 years, that the useful lives of our furniture and equipment are 5 to 10 years and that the useful lives of our leasehold improvements are the respective terms of the leases. These estimates could be impacted in the future by changes in market conditions or other factors.

 

Income Taxes.    We make estimates and judgments to calculate some of our tax liabilities and determine the recoverability of some of our deferred tax assets, which arise from temporary differences between the tax and financial statement recognition of revenues and expenses. We also estimate a reserve for deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods.

 

In evaluating our ability to recover deferred tax assets, we consider all available positive and negative evidence, including our past operating results, recent cumulative losses and our forecast of future taxable income. In determining future taxable income, we make assumptions for the amount of taxable income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require us to make judgments about our future taxable income and are consistent with the plans and estimates we use to manage our business. Any reduction in estimated future taxable income may require us to record an additional valuation allowance against our deferred tax assets. An increase in the valuation allowance would result in additional income tax expense in the period and could have a significant impact on our future earnings.

 

After completion of this offering, we expect to reduce the amount of our future taxable income as a result of our treatment as a partnership for U.S. federal tax purposes. However, some of our operations will be continue to be conducted through corporate subsidiaries that will be subject to applicable U.S. federal and state income taxes. Accordingly, changes in our income tax plans and estimates may impact our earnings in future periods.

 

As of December 31, 2003, Cornerstone, our predecessor, and its affiliated group of corporate subsidiaries had a consolidated federal net operating loss carryover of approximately $20.2 million, and we expect our subsidiaries to have a federal net operating loss carryover of approximately $35.0 million upon the closing of this offering as a result of our restructuring immediately prior to this offering. These net operating losses will begin to expire in 2019 and are available to reduce future taxable income of our taxable subsidiaries which would otherwise be subject to federal income taxes. Our ability to use such federal net operating losses may be limited by changes in the ownership of our units deemed to result in an “ownership change” under the applicable provisions of the Internal Revenue Code. Please read “Risk Factors—Changes in the ownership of our units, including the changes occurring as a result of this offering, may result in annual limitations on our use of net operating losses available to reduce taxable income, which could increase our tax liabilities and decrease cash available for distribution in future taxable periods.”

 

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Results of Operations

 

The following table summarizes our results of operations for the periods presented (dollars in thousands):

 

     Year Ended December 31,

    Six Months Ended
June 30,


 
     2001

    2002

    2003

    2003

    2004

 

Statement of Operations Data:

                                        

Revenues:

                                        

Cemetery

   $ 73,865     $ 74,168     $ 77,978     $ 37,428     $ 43,096  

Funeral home

     961       1,360       1,724       859       1,012  
    


 


 


 


 


Total

   $ 74,826     $ 75,528     $ 79,702     $ 38,287     $ 44,108  
    


 


 


 


 


Costs and Expenses:

                                        

Cost of goods sold:

                                        

Land and crypts

   $ 5,946     $ 5,948     $ 4,346     $ 2,404     $ 2,224  

Perpetual care

     2,404       2,434       2,585       1,279       1,350  

Merchandise

     3,453       3,634       3,123       1,796       2,622  

Selling expense

     15,480       15,413       15,584       7,654       9,545  

Cemetery expense

     16,990       17,191       17,732       8,599       9,734  

General and administrative expense

     8,594       9,020       9,407       4,617       4,864  

Corporate overhead

     9,892       11,820       12,579       4,704       4,991  

Depreciation and amortization

     4,337       4,893       5,001       2,373       2,481  

Funeral home expense

     996       1,343       1,513       741       890  

Interest expense

     15,550       14,828       11,376       6,067       5,284  

Expense related to terminated debt offering and refinancing

     7,000       —         —         —         —    

Income taxes (benefit)

     (5,239 )     (907 )     2,465       (37 )     938  

Cumulative effect of change in accounting principle

     —         (5,934 )     —         —         —    
    


 


 


 


 


Net loss

   $ (10,577 )   $ (4,155 )   $ (6,009 )   $ (1,911 )   $ (815 )
    


 


 


 


 


Balance Sheet Data (as of period end):

                                        

Deferred cemetery revenues, net

   $ 91,208     $ 103,580     $ 115,233             $ 119,680  

 

Six Months Ended June 30, 2004 versus Six Months Ended June 30, 2003

 

Cemetery Revenues.    Cemetery revenues were $43.1 million in the first half of 2004, an increase of $5.7 million, or 15.2%, as compared to $37.4 million in the first half of 2003. Cemetery revenues from pre-need sales, including interest income from pre-need installment contracts and investment income from trusts, were $26.2 million in the first half of 2004, an increase of $3.8 million, or 17.1%, as compared to $22.4 million in the first half of 2003. The increase primarily resulted from more casket deliveries ($2.0 million), performance of more initial opening and closings ($1.6 million), more deliveries of pre-need monument bases and markers ($1.3 million) and more vault deliveries ($0.7 million). The increase in the deliveries of pre-need products and services in the first half of 2004 were a result of management’s continuation of cash flow management initiatives implemented in 2003. These increases were offset by a decrease in deliveries of pre-construction mausoleum crypts of $1.1 million. Cemetery revenues from pre-need sales was also impacted as a result of lower accumulated earnings from merchandise trusts allocated to pre-need products delivered during the first half of 2004. Total revenues from merchandise and perpetual care trusts in the first half of 2004 was lower by $0.5 million than in the first half of 2003.

 

Cemetery revenues from at-need sales in the first half of 2004 were $15.1 million, an increase of $0.7 million, or 5.0%, as compared to $14.4 million in the first half of 2003. The increase in cemetery revenues from

 

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at-need sales was primarily attributable to higher sales of monument bases and markers of $0.2 million, higher sales of at-need mausoleum crypts of $0.2 million and higher sales of at-need interment rights of $0.1 million.

 

Other cemetery revenues were $1.8 million in the first half of 2004, an increase of $1.1 million, or 171%, from $0.7 million in the first half of 2003. The increase in other cemetery revenues was primarily attributable to an increase in one-time sales of undeveloped land for net proceeds of $0.8 million.

 

Costs of Goods Sold.    Cost of goods sold was $6.2 million in the first half of 2004, an increase of $0.6 million, or 13.1%, as compared to $5.5 million in the first half of 2003. As a percentage of cemetery revenues, cost of goods sold decreased to 14.4% in the first half of 2004 from 14.6% in the first half of 2003. The decrease in cost of goods sold as a percentage of cemetery revenue was attributable to the high gross profit margin on the sale of undeveloped land in the first half of 2004.

 

Selling Expense.    Total selling expense was $9.5 million in the first half of 2004, an increase of $1.9 million, or 24.7% as compared to $7.6 million in the first half of 2003. Sales commissions and other compensation expenses contributed $6.9 million to total selling expense during the first half of 2004, an increase of $1.7 million, or 33.2%, compared to $5.2 million in the first half of 2003. As a percentage of pre-need sales, sales commissions and other compensation expenses were 36.4% in the first half of 2004, as compared to 35.6% in the first half of 2003. Approximately $1.2 million of this increase is primarily attributable to higher commissions and bonuses relating to a higher level of product deliveries. An increase in employee benefits due to an increase in self-insured medical claims contributed to $0.5 million of the increase. Indirect selling expenses were $2.6 million during the first half of 2004, an increase of $0.2 million or 6.8%, from $2.4 million in the first half of 2003. This increase was primarily due to higher lead generation costs such as telemarketing and advertising, and higher hiring and training costs for a total of $0.2 million.

 

Cemetery Expense.    Cemetery expense was $9.7 million in the first half of 2004, an increase of $1.1 million, or 12.8%, as compared to $8.6 million in the first half of 2003. This increase was primarily due to an increase in medical benefit costs of $0.4 million, payroll expenses of $0.2 million, and higher cemetery maintenance costs of $0.2 million.

 

General and Administrative Expense.    General and administrative expense was $4.9 million in the first half of 2004, an increase of $0.3 million, or 5.3%, as compared to $4.6 million in the first half of 2003. The increase was primarily attributable to an increase in higher medical benefits costs of $0.2 million.

 

Funeral Home Revenues and Expense.    Funeral home revenues were $1.0 million in the first half of 2004, an increase of $0.1 million, or 17.6%, as compared to $0.9 million in the first half of 2003. The primary reason for the increase was an increase in the number of services performed, 316 in the first half of 2004 compared to 261 in the first half of 2003. Funeral home expenses were $0.9 million in the first half of 2004, an increase of approximately $0.2 million, or 19.9%, as compared to $0.7 million in the first half of 2003.

 

Corporate Overhead.    Corporate overhead was $5.0 million in the first half of 2004, an increase of $0.3 million, or 6.5%, as compared to $4.7 million in the first half of 2003. The increase was primarily attributable to higher payroll and medical benefit costs of approximately $0.4 million, which were offset by lower operating costs of $0.1 million.

 

Depreciation and Amortization.    Depreciation and amortization was $2.5 million in the first half of 2004, an increase of $0.1 million, or 4.6%, as compared to $2.4 million in the first half of 2003. The increase was primarily due to higher depreciation expenses for vehicles and cemetery equipment placed in service during 2003.

 

Interest Expense.    Interest expense was $5.3 million in the first half of 2004, a decrease of $0.8 million, or 14.8%, as compared to $6.1 million in the first half of 2003. This decrease was primarily the result of the

 

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expiration of our interest rate swap in February 2003, which prior to its expiration, fixed the interest rate of $75.0 million of our variable rate term loan at 10.99%. In March 2003, we replaced this swap with an interest rate cap that caps the interest rate on $55.0 million of our variable rate term loan at 9.5%. The expiration of the swap enabled us to benefit from the low interest rate environment at that time and lowered the interest rate on $75.0 million of our debt from 10.99% in the first two months of 2003 to 8.0% for the remainder of 2003 and for the first half of 2004. The remaining decline in interest expense was due to our net repayment of long-term debt of $6.0 million since the first half of 2003.

 

Provision (Benefit) for Income Taxes.    Provision for income taxes was $0.9 million in the first half of 2004 as compared to a benefit from income taxes of $40,000 during the first half of 2003. The change in provision (benefit) for income taxes was primarily due to income before income taxes earned during the first half of 2004 of $0.1 million as compared to a loss before income taxes during the first half of 2003 of $1.9 million and a change in the proportion of tax exempt losses relative to taxable losses.

 

Net Loss.    Net loss was $0.8 million during the first half of 2004, a decrease of $1.1 million, or 58%, as compared to a net loss of $1.9 million during the first half of 2003. The decrease in net loss was primarily attributable to the increase in operating profit of $1.3 million and the decrease in interest expense of $0.8 million offset by the change in the provision (benefit) for income taxes of $1.0 million.

 

Deferred Cemetery Revenue.    Deferred cemetery revenues, net, increased $4.5 million, or 3.9% in the first half of 2004, from $115.2 million as of December 31, 2003 to $119.7 million as of June 30, 2004. In the comparable period in 2003, deferred cemetery revenues, net, increased $6.6 million, or 6.3%, from $103.5 million as of December 31, 2002 to $110.1 million as of June 30, 2003. The net increase in the first half of 2004 was primarily attributable to an increase in sales of pre-need cemetery products and services that were not delivered or performed in the first half of 2004. We added $11.6 million in pre-need sales of cemetery merchandise and services, net of deferred costs and cancellations, to our pre-need sales backlog during the first half of 2004 as compared to $11.3 million added during the first half of 2003. These increases were offset by revenues recognized, net of costs, of $7.1 million, including accumulated merchandise trust earnings, during the first half of 2004 related to the delivery and performance of pre-need cemetery merchandise and services as compared to $4.7 million of revenues recognized in the first half of 2003.

 

Year Ended December 31, 2003 versus Year Ended December 31, 2002

 

Cemetery Revenues.    Cemetery revenues were $78.0 million in 2003, an increase of $3.8 million, or 5.1%, as compared to $74.2 million in 2002. Cemetery revenues from pre-need sales, including interest income from pre-need installment contracts and investment income from trusts, were $47.8 million in 2003, an increase of $3.8 million, or 8.6%, as compared to $44.0 million in 2002. The increase in cemetery revenues from pre-need sales was primarily attributable to an increase in deliveries of pre-need monument bases and markers of $1.8 million and $1.6 million, respectively, and an increase in performances of initial openings and closings of $1.0 million. These 2003 increases were partially due to management’s implementing initiatives to maximize cash flow, which included purchasing and delivering products and performing services in advance of need to enable withdrawal of funds from merchandise trusts. Pre-need sales also increased as a result of bulk sales of cemetery plots to religious organizations for $0.7 million and an increase in income recognized from merchandise trusts of $1.9 million. These increases were partially offset by a net decrease in sales of burial vaults of $1.7 million because fewer vaults were installed in 2003 than in 2002.

 

Cemetery revenues from at-need sales in 2003 were $27.9 million, a decrease of $1.6 million, or 5.4%, as compared to $29.5 million in 2002. The decrease in cemetery revenues from at-need sales was primarily attributable to the sale in 2002 of a tract of developed cemetery land to a municipality in Pennsylvania for $1.2 million.

 

Other cemetery revenues were $2.3 million in 2003, an increase of $1.6 million, or 228.6%, from $0.7 million in 2002. The increase in other cemetery revenues was primarily attributable to an increase in one-time sales of undeveloped land of $0.5 million, an increase in accounts receivable recoveries of $0.4 million and an increase in sales of manufactured burial vaults to other cemetery operators of $0.3 million.

 

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Cost of Goods Sold.    Cost of goods sold was $10.1 million in 2003, a decrease of $1.9 million, or 16.3%, as compared to $12.0 million in 2002. This decrease was primarily attributable to the sale in 2002 of a tract of developed cemetery land to a municipality in Pennsylvania with a cost basis of $1.0 million. As a percentage of cemetery revenues, cost of goods sold decreased to 12.9% in 2003 from 16.2% in 2002. The decrease in cost of goods sold as a percentage of cemetery revenues was primarily attributable to the relatively low gross profit margin earned on the sale of the tract of cemetery land to a municipality in Pennsylvania in 2002 as well as changes in mix of products sold during 2003.

 

Selling Expense.    Total selling expense was $15.6 million in 2003, an increase of $0.2 million, or 1.1% as compared to $15.4 million in 2002. Sales commissions and other compensation expenses contributed $10.8 million to total selling expense during 2003, an increase of $0.6 million, or 5.9%, as compared to $10.2 million in 2002. The increase in sales commissions and other compensation expenses was primarily due to the increase in pre-need sales discussed above. As a percentage of pre-need sales, sales commissions and other compensation expenses were 22.5% in 2003, as compared to 23.2% in 2002. Indirect selling expenses were $4.8 million during 2003, a decrease of $0.4 million, or 7.7%, from $5.2 million in 2002. The decrease in indirect selling expenses was primarily attributable to decreases in hiring and training expenses and sales supplies expenses of $0.4 million and $0.2 million, respectively. These decreases were principally due to small reductions in our hiring and training programs as well as a continuation of our cost cutting initiatives initiated in 2002. These decreases were partially offset by an increase in advertising and marketing expenses of $0.4 million, primarily due to the implementation of a marketing campaign for private mausoleums.

 

Cemetery Expense.    Cemetery expense was $17.7 million in 2003, an increase of $0.5 million, or 3.2%, as compared to $17.2 million in 2002. This increase was primarily due to an increase in cemetery employee benefits costs of $0.3 million. The remaining increase of $0.2 million was attributable to a decline in capitalized salary and benefits due to decreases in labor costs resulting from lower mausoleum construction activity during 2003.

 

General and Administrative Expense.    General and administrative expense was $9.4 million in 2003, an increase of $0.4 million, or 4.3%, as compared to $9.0 million in 2002. The increase was primarily attributable to an increase in medical benefits expense in 2003 of $0.5 million as a result of an increase in employee medical claims and an increase in insurance costs during 2003 of $0.2 million as a result of increasing insurance premiums, offset by lower salary expenses of $0.2 million due to cost cutting measures enacted at the end of 2002.

 

Funeral Home Revenues and Expense.    Funeral home revenues were $1.7 million in 2003, an increase of $0.4 million, or 26.8%, as compared to $1.4 million in 2002. This increase was primarily due to the addition of two funeral homes in 2002 that were owned and operated for the full year in 2003. Funeral home expense was $1.5 million in 2003, an increase of $0.2 million, or 12.7%, as compared to $1.3 million in 2002. This increase resulted from the addition of two funeral homes described above.

 

Corporate Overhead.    Corporate overhead was $12.6 million in 2003, an increase of $0.8 million, or 6.4%, as compared to $11.8 million in 2002. The increase was due primarily to a $1.2 million stock-based compensation award in 2003 and an increase of $1.6 million related to bonuses earned during 2003 pursuant to our corporate bonus plan. Under the corporate bonus plan, certain of our executives are eligible to receive bonuses that are primarily based on achieving adjusted earnings and cash flow targets. During 2002, these targets were not met and no bonuses were earned or paid under the plan. These increases were partially offset by the incurrence of $1.3 million of costs in connection with an acquisition that we terminated in 2002. Declines in corporate development and accounting salaries of $0.5 million also partially offset the increase.

 

Depreciation and Amortization.    Depreciation and amortization was $5.0 million in 2003, an increase of $0.1 million, or 2.2%, as compared to $4.9 million in 2002. The increase was primarily due to the acquisition of vehicles and cemetery equipment in 2003.

 

Interest Expense.    Interest expense was $11.4 million in 2003, a decrease of $3.5 million, or 23.3%, as compared to $14.8 million in 2002. This decrease was primarily the result of the expiration of our interest rate

 

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swap in February 2003 which, prior to its expiration, fixed the interest rate of $75.0 million of our variable rate term loan at 10.99%. We replaced this swap with an interest rate cap that caps the interest rate on $55.0 million of our variable rate term loan at 9.5%. The expiration of the swap enabled us to benefit from the low current interest rate environment and lowered the interest rate on $75.0 million of our debt from 10.99% in 2002 to 8% in 2003. The remaining decline in interest expense was due to our net repayment of long-term debt of $4.0 million during 2003.

 

Provision (Benefit) for Income Taxes.    Income tax expense was $2.5 million in 2003 as compared to a benefit from income taxes of $0.9 million in 2002. The change in income tax expense (benefit) was primarily due to a decline in loss before income taxes, an accrual for additional state taxes due on properties acquired from the Loewen Group for the tax years 1994 through 1998 as a result of an IRS examination of the tax returns for those years and changes in the proportion of tax exempt losses relativ