SGU

Business Context and Reporting Period

Company: Star Gas Partners, L.P. (Master Limited Partnership)

Reporting Period: Three months ended December 31, 2009 (First Quarter of Fiscal Year 2010).

Business Overview: The Partnership is a home heating oil distributor and services provider operating primarily in the Northeast and Mid-Atlantic regions. It serves approximately 370,000 full-service residential and commercial customers and 7,000 propane customers. Operations are conducted through its subsidiary, Petro Holdings, Inc.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Total sales decreased 13.4% to $348.8 million. Product sales dropped 14.8% due to a 13.0% decrease in home heating oil volume (95.4 million gallons vs. 109.6 million gallons) and lower selling prices. Volume decline was attributed to warmer weather (5.0% warmer than prior year), net customer attrition, and conservation.
• Profitability Improvement: The company reported a net income of $12.0 million compared to a net loss of $8.0 million in the prior year. This turnaround was driven primarily by a $40.2 million favorable change in the fair value of derivative instruments (a $3.4 million gain in 2009 vs. a $36.9 million loss in 2008) and lower operating costs.
• Margin Compression: Home heating oil gross margins decreased by $0.0418 per gallon (4.5%) to $0.8820, reflecting rising product costs at the start of the heating season.
• Customer Attrition: Net customer attrition improved to 0.7% (2,600 accounts lost) compared to 1.4% (5,500 accounts lost) in the prior year, though gross customer gains declined significantly.
• Share Repurchases: The Partnership repurchased 4.3 million common units for $16.9 million under its authorized program.

Guidance, Outlook, and Risks

• Distribution Increase: On January 21, 2010, the Partnership declared a quarterly distribution of $0.0725 per common unit, an increase of $0.005 from the prior quarter.
• Debt Redemption: The Partnership announced the redemption of $50 million in principal amount of its 10.25% Senior Notes due in 2013, scheduled for February 19, 2010.
• Liquidity: The company maintains a $240 million revolving credit facility (expandable to $290 million during heating season). As of December 31, 2009, availability was $196 million, and the company was in compliance with fixed charge coverage ratios.
• Tax Structure Evaluation: Management is evaluating an election to be taxed as a corporation (C-Corp) rather than a partnership to reduce administrative costs and simplify tax reporting for unitholders. This could occur in calendar 2010 or later.
• Risks: Key risks include weather variability (warmer winters reduce demand), volatility in wholesale heating oil prices, customer attrition due to natural gas conversions or economic conditions, and the potential impact of the tax structure election on unitholders.

Investor Verification Checklist

• Derivative Accounting Impact: Verify the extent to which net income is driven by non-cash changes in the fair value of derivative instruments rather than core operational margins.
• Working Capital Seasonality: Confirm the cash burn in Q1 is consistent with seasonal inventory buildup and budget payment plan collections, noting the $73 million cash outflow from operations.
• Debt Covenants: Monitor compliance with the fixed charge coverage ratio (1.1x minimum) and availability requirements ($43.5 million minimum) under the revolving credit facility.
• Customer Base Trends: Track net customer attrition rates and the mix of price-protected vs. variable price customers, as this impacts margin stability.
• Tax Election Timeline: Watch for announcements regarding the potential election to be taxed as a corporation and the associated tax implications for unitholders.