SGU

Business Context and Reporting Period

Company: Star Gas Partners, L.P. (SGU) and Star Gas Finance Company.
Reporting Period: Quarterly period ended June 30, 2007 (Fiscal Q2 2007).
Business Overview: A master limited partnership and home heating oil distributor serving approximately 452,000 residential and commercial customers in the Northeast and Mid-Atlantic regions. The company operates through a single reportable segment.

Key Financial Metrics

Note: EBITDA figures include significant non-cash gains from derivative instruments.

Material Changes vs. Prior Period

• Volume and Sales: For the three months ended June 30, 2007, retail home heating oil volume increased 23.8% (to 56.9 million gallons) driven by colder weather (30.3% colder than the prior year). Conversely, for the nine-month period, volume decreased 2.4% due to net customer attrition and warmer weather in the first fiscal quarter.
• Profitability: Net loss for the quarter improved significantly from $(34.1) million in 2006 to $(8.3) million in 2007. For the nine months, the company reported a net income of $71.3 million compared to a net loss of $(8.3) million in the prior year.
• Derivative Impact: A primary driver of the nine-month income was a $17.0 million non-cash gain from the increase in the fair value of derivative instruments. In the prior year's nine-month period, derivatives resulted in a $27.1 million charge.
• Customer Attrition: Net customer losses improved to 15,500 accounts (3.7% of base) for the nine months ended June 30, 2007, compared to 24,200 accounts (5.4%) in the prior year.
• Acquisitions: The company acquired five retail dealers for approximately $12.3 million during the nine-month period, compared to no acquisitions in the prior year.

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 and acquisition impacts, due to net customer attrition and conservation.
• Liquidity: The company holds $132.8 million in cash and has $175.5 million in availability under its $260 million revolving credit facility. No borrowings were outstanding under the facility as of June 30, 2007.
• Capital Allocation: The company is actively pursuing acquisitions to increase market share, with six acquisitions completed through August 8, 2007, totaling $14.0 million.
• Legal Proceedings: A consolidated class action lawsuit (In re Star Gas Securities Litigation) remains on appeal. The district court previously dismissed the complaint, but plaintiffs filed a notice of appeal in April 2007. Oral argument is scheduled for after October 1, 2007. Management believes an unfavorable outcome is not probable and has not accrued a liability.
• Restatement: Financial statements for periods prior to September 30, 2006, were restated to properly account for derivative instruments under SFAS 133 and pension expense amortization.

Investor Verification Checklist

• Derivative Volatility: Verify the sustainability of earnings given the $17.0 million non-cash gain from derivatives in the nine-month period, which significantly inflated operating income.
• Customer Attrition Rates: Monitor the trend of net customer losses (currently 5.0% annualized) and the effectiveness of the transition to a local customer service model.
• Weather Sensitivity: Assess the impact of weather insurance contracts and the company's exposure to warm weather reducing volume in the peak heating season.
• Legal Exposure: Track the status of the In re Star Gas Securities Litigation appeal and potential fee-shifting motions.
• Acquisition Integration: Evaluate the return on investment for recent acquisitions and the ability to maintain margins while integrating new dealers.