SGU

Business Context and Reporting Period

Company: Star Gas Partners, L.P. (SGU) and Star Gas Finance Company.
Reporting Period: Quarterly period ended December 31, 2010 (First Quarter of Fiscal Year 2011).
Business Overview: A master limited partnership operating as a retail distributor of home heating oil and propane, primarily serving residential and commercial customers in the Northeast and Mid-Atlantic regions. The company also provides installation, maintenance, and ancillary home services.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total sales increased 31.7% to $459.5 million, driven by a 17.4% increase in retail volume (112.7 million gallons vs. 96.0 million gallons) and higher wholesale product prices. Volume growth was attributed to colder weather (5.4% colder than prior year) and acquisitions.
• Profitability: Net income rose 71.2% to $20.6 million. Operating income increased 64.0% to $43.7 million, aided by a $13.9 million unrealized gain on derivative instruments compared to a $3.4 million gain in the prior year.
• Debt Restructuring: The company issued $125.0 million in 8.875% Senior Notes due 2017 and used proceeds to redeem $82.5 million of 10.25% Senior Notes due 2013. This resulted in a $1.7 million loss on debt redemption but lowered the overall interest rate burden.
• Liquidity: Cash and cash equivalents decreased significantly from $61.1 million to $13.8 million. This decline is primarily due to seasonal working capital requirements (increased receivables and inventory) and the timing of debt refinancing activities.
• Customer Base: Net customer attrition was 0.5% (2,200 accounts), an improvement over the 0.7% attrition in the prior year. The total customer base grew approximately 11.0% year-over-year due to acquisitions.

Outlook, Risks, and Management Commentary

• Seasonality: The business is highly seasonal, with approximately 30% of volume sold in the first fiscal quarter and 50% in the second. Cash is typically used in operations during winter quarters and generated in spring/summer.
• Weather Hedge: The company holds a weather hedge contract with a maximum payout of $12.5 million if heating degree-days fall below 92.5% of the 10-year average for the period November 1, 2010, through March 31, 2011.
• Tax Position: The company has Federal Net Operating Loss (NOL) carryforwards of approximately $9.1 million (excluding $7.3 million acquired). Management expects to utilize substantially all remaining NOLs in the next 12 months, after which cash tax payments will increase significantly.
• Capital Structure: Management is considering an election to be taxed as a corporation to reduce administrative costs associated with issuing K-1 forms, though no decision has been made.
• Risks: Key risks include volatility in wholesale heating oil prices, customer attrition due to price sensitivity or natural gas conversion, and the impact of weather conditions on demand.
• Subsequent Events: On January 25, 2011, a quarterly distribution of $0.0775 per unit was declared. An exchange offer for the private 8.875% Senior Notes was issued in January 2011.

Investor Verification Checklist

• Working Capital Trends: Verify the sustainability of the $115 million increase in accounts receivable and the $10 million increase in inventory against seasonal norms.
• Debt Covenants: Confirm continued compliance with the revolving credit facility's fixed charge coverage ratio (1.10x minimum) and availability requirements ($43.5 million minimum).
• Derivative Exposure: Assess the impact of the $13.9 million unrealized gain on derivatives on future earnings volatility as positions settle.
• Tax Liability: Monitor the utilization of NOLs and the projected increase in cash tax payments once these carryforwards are exhausted.
• Customer Attrition: Track net customer attrition rates relative to the base business versus acquired accounts to gauge organic growth stability.