SGU

Business Context and Reporting Period

Company: Star Gas Partners, L.P. (SGU)

Filing Type: Form 10-K (Annual Report)

Period Ended: September 30, 2010

Business Overview: Star Gas Partners is a master limited partnership and the largest retail distributor of home heating oil in the United States. It operates primarily in the Northeast and Mid-Atlantic regions, serving approximately 404,000 full-service residential and commercial home heating oil customers and 10,000 propane customers. The company also provides installation, maintenance, and repair of heating and air conditioning equipment, as well as ancillary home services.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue: Total sales increased slightly by 0.5% to $1.21 billion. This was driven by an 11.0% increase in home heating oil selling prices, which offset an 11.8% decline in volume.
• Volume Decline: Retail home heating oil volume dropped by 41.4 million gallons (11.8%). The primary drivers were warmer temperatures (9.1% warmer than fiscal 2009) and net customer attrition of 5.0% (19,800 accounts).
• Profitability: Net income decreased significantly by $102.7 million (78.4%). This decline was primarily due to the absence of a one-time $86.4 million non-cash income tax benefit recorded in fiscal 2009 from the release of a valuation allowance on net operating losses.
• Acquisitions: The company completed five acquisitions totaling approximately $68.8 million, adding roughly 56,100 accounts. These acquisitions were completed after the heating season, resulting in operating losses for the remainder of the fiscal year.
• Debt Reduction: Long-term debt decreased by approximately $50 million due to the repurchase of $50 million face value of 10.25% Senior Notes.

Guidance, Outlook, and Risks

• Debt Refinancing: On November 16, 2010, the company completed a Rule 144A offering of $125.0 million in 8.875% Senior Notes due 2017. Proceeds are being used to redeem the remaining $82.5 million of 10.25% Senior Notes due in 2013.
• Seasonality: The business is highly seasonal, with approximately 80% of annual volume sold during the peak heating season (October through March). The company generally realizes net income in the first two fiscal quarters and net losses in the third and fourth.
• Weather Risk: Financial performance is heavily dependent on weather conditions. To mitigate this, the company entered into a weather hedge contract for the 2010-2011 heating season with a maximum payout of $12.5 million.
• Customer Attrition: The company faces ongoing risks from customer attrition due to price competition, natural gas conversions, and economic conditions. Net attrition improved to 5.0% in 2010 from 7.6% in 2009.
• Tax Outlook: The company expects to utilize substantially all of its remaining Federal Net Operating Loss (NOL) carryforvals within the next 12 to 15 months. Once exhausted, cash tax payments will increase significantly, reducing cash available for distributions.
• Unit Repurchase: The company authorized a new repurchase plan (Plan II) for up to 7.0 million common units in July 2010.

Investor Verification Checklist

• Valuation Allowance Release: Verify the impact of the $86.4 million non-cash tax benefit in 2009 on the comparability of net income figures.
• NOL Expiration: Confirm the timeline for the utilization of remaining Federal NOLs and the projected increase in cash tax liabilities thereafter.
• Acquisition Integration: Assess the financial performance of the five acquisitions completed in fiscal 2010, which were initially loss-making due to timing.
• Weather Sensitivity: Monitor heating degree days for the 2010-2011 season to evaluate the effectiveness of the weather hedge and volume projections.
• Debt Covenants: Review the fixed charge coverage ratio and availability under the revolving credit facility to ensure compliance with distribution requirements.