SGU

Business Context and Reporting Period

Company: Star Gas Partners, L.P. (SGU) and Star Gas Finance Company.
Reporting Period: Quarterly period ended March 31, 2007 (Fiscal Q2 2007).
Business Overview: A master limited partnership and home heating oil distributor serving approximately 438,000 residential and commercial customers in the Northeast and Mid-Atlantic regions. The company operates through its subsidiary, Petro Holdings, Inc.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue: Three-month sales increased 7.0% to $576.9 million, driven by a 6.9% increase in home heating oil volume (195.1 million gallons) due to colder weather, partially offset by net customer attrition. Six-month sales decreased 4.8% to $907.2 million due to a 6.2% volume decline.
• Profitability: Net income for the three months ended March 31, 2007, increased 38.5% to $74.9 million compared to $54.1 million in the prior year. Six-month net income increased significantly to $79.6 million from $25.7 million.
• Derivative Impact: A major driver of the income increase was a favorable change in the fair value of derivative instruments, resulting in an $18.5 million credit for the quarter and a $12.1 million credit for the six-month period. In the prior year six-month period, derivatives resulted in a $29.3 million charge.
• Customer Attrition: Net customer losses improved significantly. For the three months ended March 31, 2007, the company lost 5,300 accounts (1.3% of base) compared to 10,500 accounts (2.4%) in the prior year.
• Interest Expense: Decreased 35.5% to $5.1 million for the quarter due to a recapitalization in April 2006 that reduced total debt by approximately $92.5 million.

Guidance, Outlook, and Risks

• Outlook: Management expects home heating oil volume for the remainder of fiscal 2007 to be less than the comparable period in fiscal 2006, excluding weather impacts, due to net customer attrition and conservation.
• Acquisitions: The company is actively pursuing acquisitions to increase market share. In May 2007, a dealership was purchased for $3.8 million. The revolving credit facility was amended to allow for larger and more frequent acquisitions.
• Liquidity: The company has $172.7 million in availability under its $260 million revolving credit facility. No working capital borrowings were outstanding as of March 31, 2007.
• Legal Proceedings: A consolidated class action lawsuit regarding securities violations was dismissed by the court in August 2006. Plaintiffs appealed the dismissal in April 2007; discovery remains stayed. Management intends to defend vigorously.
• Restatement: Financial statements for periods prior to September 30, 2006, were restated to correct accounting for derivative instruments and pension expense amortization. This restatement significantly altered prior year comparative figures.
• Weather Risk: The company utilizes weather insurance to mitigate the risk of warm weather reducing demand. A $4.3 million receivable from a weather insurance contract was recorded and subsequently paid in April 2007.

Investor Verification Checklist

• Derivative Accounting: Verify the impact of the restatement on prior year comparables and the volatility introduced by marking derivatives to market without hedge accounting treatment.
• Customer Attrition Trends: Monitor the net loss of customers (5,300 in Q2) against gross gains to assess the sustainability of the volume base.
• Weather Sensitivity: Assess the reliance on weather insurance payouts and the impact of temperature variations on quarterly volume and gross margins.
• Debt Covenants: Confirm compliance with the fixed charge coverage ratio (3.1 to 1.0 as of March 31, 2007) and availability requirements under the amended credit facility.
• Legal Status: Track the status of the appealed class action lawsuit and potential fee-shifting motions.