SGU

Business Context and Reporting Period

Company: Star Gas Partners, L.P. (SGU) and Star Gas Finance Company
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2010 (Third Fiscal Quarter)
Business Overview: A master limited partnership operating as a home heating oil distributor and service provider in the Northeast and Mid-Atlantic regions. Operations are conducted through Petro Holdings, Inc., serving approximately 410,000 full-service residential and commercial customers.

Key Financial Metrics

Note: Figures are in millions unless otherwise noted. Adjusted EBITDA is a non-GAAP measure.

Material Changes vs. Prior Period

• Volume Decline: Retail home heating oil volume decreased 18.9% (3 months) and 12.6% (9 months) compared to the prior year, primarily due to warmer temperatures (27.5% warmer in Q3) and net customer attrition.
• Profitability Impact: Despite a 3.0% increase in product sales for the quarter, the company reported a net loss of $10.0 million for the three months ended June 30, 2010, compared to a net loss of $1.9 million in the prior year. This was driven by a $12.0 million unfavorable non-cash change in the fair value of derivative instruments and lower product gross profit.
• Acquisitions: The company completed four acquisitions, including Champion Energy Corporation (approx. $50.1 million purchase price), adding approximately 55,600 accounts. Goodwill increased by $19.9 million.
• Debt Reduction: Long-term debt decreased from $133.1 million (Sept 30, 2009) to $82.8 million (June 30, 2010) following the redemption of $50.0 million in 10.25% Senior Notes in February 2010.
• Tax Position: Income tax expense increased significantly for the nine-month period ($33.7 million vs. $3.9 million prior year) due to the release of a valuation allowance in the prior fiscal year, resulting in the recognition of deferred tax assets.

Guidance, Outlook, and Risks

• Seasonality: Results are highly seasonal; approximately 75% of volume is sold in the first two fiscal quarters (heating season). Current results are not indicative of full-year performance.
• Customer Renewals: Approximately 77% of price-protected customers face annual renewal. Management notes that higher renewal prices may adversely impact acceptance rates and future liquidity.
• Derivative Volatility: The company does not designate derivatives as hedging instruments under GAAP, leading to significant earnings volatility from mark-to-market adjustments on unhedged positions.
• Capital Allocation: The Board authorized a new repurchase program ("Plan II") for up to 7.0 million common units. A quarterly distribution of $0.0725 per unit was declared for August 2010.
• Liquidity: The company maintains a $240 million revolving credit facility (expandable to $290 million during heating season). As of June 30, 2010, availability was $112.8 million, and the company was in compliance with fixed charge coverage ratios.
• Tax Structure: Management is evaluating an election to be taxed as a corporation to reduce administrative costs associated with K-1 filings, though this could have short-term tax implications for unitholders.

Investor Verification Checklist

• Derivative Exposure: Verify the extent of unrealized gains/losses on derivatives and their impact on reported net income versus realized cash flow.
• Customer Attrition Rates: Monitor net customer attrition (3.3% for the nine months ended June 30, 2010) and the success of renewal rates for price-protected contracts.
• Weather Sensitivity: Assess the impact of heating degree days on volume, as warmer weather significantly reduced sales in the current period.
• Debt Covenants: Confirm continued compliance with the fixed charge coverage ratio (1.10x minimum) and availability requirements ($43.5 million minimum) under the credit facility.
• Acquisition Integration: Review the financial performance of the Champion Energy Corporation acquisition and the associated $4.1 million remediation liability.