UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2002 -------------- OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________ to _________ Commission File Number: 33-98490 -------- STAR GAS PARTNERS, L.P. ----------------------- (Exact name of registrant as specified in its charter) Delaware 06-1437793 - -------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2187 Atlantic Street, Stamford, Connecticut 06902 - -------------------------------------------------------------------------------- (Address of principal executive office) (203) 328-7300 - -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) - -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ------- ------- Indicate the number of shares outstanding of each issuer's classes of common stock, as of April 23, 2002: 25,151,946 Common Units 3,134,110 Senior Subordinated Units 345,364 Junior Subordinated Units 325,729 General Partner Units
STAR GAS PARTNERS, L.P. AND SUBSIDIARIES INDEX TO FORM 10-Q Part I Financial Information Page Item 1 - Condensed Consolidated Financial Statements Condensed Consolidated Balance Sheets as of September 30, 2001 and March 31, 2002 3 Condensed Consolidated Statements of Operations for the Three months ended March 31, 2001 and March 31, 2002 and for the Six months ended March 31, 2001 and March 31, 2002 4 Condensed Consolidated Statements of Comprehensive Income for the Three months ended March 31, 2001 and March 31, 2002 and for the Six months ended March 31, 2001 and March 31, 2002 5 Condensed Consolidated Statement of Partners' Capital for the six months ended March 31, 2002 6 Condensed Consolidated Statements of Cash Flows for the six months ended March 31, 2001 and March 31, 2002 7 Notes to Condensed Consolidated Financial Statements 8-15 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 16-21 Item 3 - Quantitative and Qualitative Disclosures About Market Risk 22 Part II Other Information: Item 6 - Exhibits and Reports on Form 8-K 22 Signatures 23 2
STAR GAS PARTNERS, L.P. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands) September 30, March 31, 2001 2002 ----------------- -------------- (unaudited) Assets Current assets Cash and equivalents $ 17,228 $ 38,243 Receivables, net of allowance of $11,364 and $8,465, respectively 104,973 141,899 Inventories 41,130 36,607 Prepaid expenses and other current assets 21,931 23,417 ------------ ------------ Total current assets 185,262 240,166 ------------ ------------ Property and equipment, net 235,371 240,469 Long-term portion of accounts receivable 6,752 6,672 Intangibles and other 471,434 481,918 ---------- ---------- Total assets $ 898,819 $ 969,225 ========== ========== Liabilities and Partners' Capital Current liabilities Accounts payable $ 35,800 $ 34,783 Working capital facility borrowings 13,866 35,222 Current maturities of long-term debt 11,886 39,265 Accrued expenses 77,678 63,571 Unearned service contract revenue 24,575 25,500 Customer credit balances 65,207 46,159 ---------- ---------- Total current liabilities 229,012 244,500 ---------- ---------- Long-term debt 457,086 422,859 Other 14,457 14,332 Partners' Capital Common unitholders 209,911 278,745 Subordinated unitholders 2,772 14,462 General partner (2,220) (1,774) Accumulated other comprehensive income (loss) (12,199) (3,899) ---------- ---------- Total Partners' Capital 198,264 287,534 ---------- ---------- Total Liabilities and Partners' Capital $ 898,819 $ 969,225 ========== ========== See accompanying notes to condensed consolidated financial statements. 3
STAR GAS PARTNERS, L.P. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited) <TABLE> <CAPTION> Three Months Ended March 31, Six Months Ended March 31, ---------------------------------------- ------------------------------------- (in thousands, except per unit data) 2001 2002 2001 2002 ------------------ ------------------- ---------------- ------------------ <S> <C> <C> <C> <C> Sales $ 470,447 $ 411,285 $ 793,951 $ 697,508 Costs and expenses: Cost of sales 317,970 251,982 549,272 436,229 Delivery and branch expenses 57,839 67,589 107,173 123,910 Depreciation and amortization 10,372 14,509 20,019 29,012 General and administrative expenses 8,638 9,167 15,520 17,352 TG&E customer acquisition expense 718 185 1,371 406 Unit compensation expense 719 (475) 1,219 165 ------------- -------------- ------------- ------------- Operating income 74,191 68,328 99,377 90,434 Interest expense, net 9,003 9,757 17,120 19,901 Amortization of debt issuance costs 151 307 296 619 ------------- ------------- ------------- ------------- Income before income taxes and cumulative effect of change in accounting principle 65,037 58,264 81,961 69,914 Income tax expense (benefit) 923 (1,952) 1,639 (1,805) ------------- ------------- ------------- ------------- Income before cumulative change in accounting principle 64,114 60,216 80,322 71,719 Cumulative effect of change in accounting principle for adoption of SFAS No. 133, net of income taxes - - 1,466 - ------------- ------------- ------------- ------------- Net income $ 64,114 $ 60,216 $ 81,788 $ 71,719 ============= ============= ============= ============= General Partner's interest in net income $ 964 $ 681 $ 1,247 $ 820 ------------- ------------- ------------- ------------- Limited Partners' interest in net income $ 63,150 $ 59,535 $ 80,541 $ 70,899 ============= ============= ============= ============= Net income per Limited Partner Unit: Basic $ 2.86 $ 2.09 $ 3.83 $ 2.57 ============= ============= ============= ============= Diluted $ 2.85 $ 2.09 $ 3.81 $ 2.56 ============= ============= ============= ============= Basic weighted average number of Limited Partner Units outstanding 22,063 28,506 21,022 27,623 ============= ============= ============= ============= Diluted weighted average number of Limited Partner Units 22,176 28,506 21,135 27,686 ============= ============= ============= ============= </TABLE> See accompanying notes to condensed consolidated financial statements. 4
STAR GAS PARTNERS, L.P. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited) <TABLE> <CAPTION> Three Months Ended March 31, Six Months Ended March 31, --------------------------------- ------------------------------- (in thousands) 2001 2002 2001 2002 -------------- --------------- ------------- --------------- <S> <C> <C> <C> <C> Net income $ 64,114 $ 60,216 $ 81,788 $ 71,719 Other comprehensive income (loss) Unrealized gain (loss) on derivative instruments (1,803) 725 (8,108) (8,340) -------------- ------------- -------------- ------------- Comprehensive income $ 62,311 $ 60,941 $ 73,680 $ 63,379 ============= ============= ============= ============= Reconciliation of Accumulated Other Comprehensive Income (loss) Balance, beginning of period $ 3,889 $ (16,599) $ - $ (12,199) Cumulative effect of the adoption of SFAS No. 133 - - 10,544 - Current period reclassification to earnings (1,927) 11,975 (2,277) 16,640 Current period other comprehensive income (loss) (1,803) 725 (8,108) (8,340) -------------- ------------- -------------- -------------- Balance, end of period $ 159 $ (3,899) $ 159 $ (3,899) ============== ============== ============== ============== </TABLE> See accompanying notes to condensed consolidated financial statements. 5
STAR GAS PARTNERS, L.P. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF PARTNERS' CAPITAL (unaudited) <TABLE> <CAPTION> (in thousands, except per unit amounts) Number of Units --------------------------------------- Other Total Senior Junior General Senior Junior General Comprehensive Partners' Common Sub. Sub. Partner Common Sub. Sub. Partner Income Capital ------ ---- ---- ------- ------ ---- ---- ------- ------ ------- <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Balance as of September 30, 2001 23,394 2,717 345 326 $209,911 $ 3,483 $ (711) $ (2,220) $(12,199) $198,264 Issuance of units: Common 1,758 34,483 34,483 Senior subordinated 417 6,824 6,824 Net income 62,264 7,765 870 820 71,719 Other comprehensive income, net 8,300 8,300 Distributions: ($1.150 per unit) (27,913) (3,371) (398) (374) (32,056) ------- ------- ------ -------- -------- -------- ------ -------- -------- -------- Balance as of March 31, 2002 25,152 3,134 345 326 $278,745 $ 14,701 $ (239) $ (1,774) $ (3,899) $287,534 ======= ======= ====== ======== ======== ======== ====== ======== ======== ======== </TABLE> See accompanying notes to condensed consolidated financial statements. 6
STAR GAS PARTNERS, L.P. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) <TABLE> <CAPTION> (in thousands) Six Months Ended March 31, ---------------------------------------- 2001 2002 -------------------- ------------------ <S> <C> <C> Cash flows provided by (used in) operating activities: Net income $ 81,788 $ 71,719 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 20,019 29,012 Amortization of debt issuance cost 296 619 Unit compensation expense 1,219 165 Provision for losses on accounts receivable 3,747 2,861 (Gains) loss on sales of fixed assets (42) 59 Cumulative effect of change in accounting principle for the adoption of SFAS No. 133 (1,466) - Changes in operating assets and liabilities: Increase in receivables (132,641) (39,087) Decrease in inventories 12,594 5,381 Decrease (increase) in other assets 727 (380) Increase in accounts payable 9,137 702 Decrease in other current and long-term liabilities (23,656) (20,426) --------- --------- Net cash provided by (used in) operating activities (28,278) 50,625 --------- --------- Cash flows provided by (used in) investing activities: Capital expenditures (7,065) (8,180) Proceeds from sales of fixed assets 207 1,290 Acquisitions (70,210) (38,566) ---------- ---------- Net cash used in investing activities (77,068) (45,456) ---------- ---------- Cash flows provided by (used in) financing activities: Working capital facility borrowings 120,850 70,850 Working capital facility repayments (86,297) (49,494) Acquisition facility borrowings 31,700 55,150 Acquisition facility repayments (51,600) (44,650) Repayment of debt (6,834) (17,348) Proceeds from issuance of debt 69,647 - Distributions (24,032) (32,056) Increase in deferred charges (415) (812) Proceeds from issuance of Common Units, net 59,314 34,236 Other (989) (30) --------- --------- Net cash provided by financing activities 111,344 15,846 --------- --------- Net increase in cash 5,998 21,015 Cash at beginning of period 10,910 17,228 --------- --------- Cash at end of period $ 16,908 $ 38,243 ========= ========= </TABLE> See accompanying notes to condensed consolidated financial statements. 7
STAR GAS PARTNERS, L.P. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1) Partnership Organization Star Gas Partners, L.P. ("Star Gas Partners" or the "Partnership") is a diversified home energy distributor and services provider, specializing in heating oil, propane, natural gas and electricity. Star Gas Partners is a Master Limited Partnership, which at March 31, 2002 had outstanding 25.2 million common limited partner units (trading symbol "SGU" representing a 86.9% limited partner interest in Star Gas Partners) and 3.1 million senior subordinated units (trading symbol "SGH" representing a 10.8% limited partner interest in Star Gas Partners), which are traded on the New York Stock Exchange. Additional interest in Star Gas Partners are comprised of 0.3 million junior subordinated units (representing a 1.2% limited partner interest in Star Gas Partners) and 0.3 million general partner units (representing a 1.1% general partner interest in Star Gas Partners). Operationally, the Partnership is organized as follows: o Petro Holdings, Inc. ("Petro" or the "heating oil segment"), is the nation's largest retail distributor of home heating oil and serves approximately 515,000 customers in the Northeast and Mid-Atlantic. Petro is an indirect wholly owned subsidiary of Star Gas Propane, L.P. o Star Gas Propane, L.P., ("Star Gas Propane" or the "propane segment") is a wholly owned subsidiary of the Partnership. Star Gas Propane markets and distributes propane gas and related products to more than 280,000 customers in the Midwest, Northeast, Florida and Georgia. o Total Gas and Electric ("TG&E" or the "natural gas and electric reseller segment") is an energy reseller that markets natural gas and electricity to residential households in deregulated energy markets in the states of New York, New Jersey, Florida, Maryland and the District of Columbia and serves approximately 50,000 residential customers. TG&E is an 80% owned subsidiary of the Partnership. o Star Gas Partners includes the office of the Chief Executive Officer and in addition has the responsibility for maintaining investor relations and investor reporting for the Partnership. 2) Summary of Significant Accounting Policies Basis of Presentation The Consolidated Financial Statements include the accounts of Star Gas Partners, L.P., and its subsidiaries. TG&E's revenue and expenses are also consolidated with the Partnership with a deduction for the net loss allocable to the minority interest, which amount has been limited based upon the equity of the minority interest. All material intercompany items and transactions have been eliminated in consolidation. The financial information included herein is unaudited; however, such information reflects all adjustments (consisting solely of normal recurring adjustments) which are, in the opinion of management, necessary for the fair statement of financial condition and results for the interim periods. The results of operations for the three and six month periods ended March 31, 2001 and March 31, 2002 are not necessarily indicative of the results to be expected for the full year. Inventories Inventories are stated at the lower of cost or market and are computed on a first-in, first-out basis. At the dates indicated, the components of inventory were as follows: September 30, 2001 March 31, 2002 ------------------ -------------- (in thousands) Propane gas $ 9,546 $ 5,288 Propane appliances and equipment 3,635 4,032 Fuel oil 12,403 13,002 Fuel oil parts and equipment 12,332 12,255 Natural gas 3,214 2,030 ------- ------- $41,130 $36,607 ======= ======= Reclassifications Certain prior year amounts have been reclassified to conform with the current year presentations. 8
2) Summary of Significant Accounting Policies - (continued) TG&E Valuation Allowance on Terminated Accounts Since the acquisition of TG&E, the Partnership has encountered customer credit deficiencies and problems with collecting TG&E receivables. At September 30, 2001, TG&E had more than 50,000 terminated customers who collectively owed $15.5 million, virtually all of which were greater than 90 days old. The September 30, 2001 balance included $5.3 million of accounts receivable that predated TG&E's acquisition by the Partnership, which were assigned no value and were not reflected in the financial statements. At September 30, 2001, the gross amount of receivables from terminated accounts on the Partnership's books (before bad debt reserves) was approximately $10.0 million, against which the Partnership has a bad debt reserve of $6.0 million. Consequently, out of approximately $15.0 million owed TG&E by terminated accounts all but $4.0 million has been reserved. During fiscal 2002, TG&E implemented the personnel and systems necessary to proceed with a collection effort targeting these terminated accounts during fiscal 2002. This effort included reconstructing account history and implementing software enhancements that will allow TG&E to fully pursue the collection of these terminated accounts during the third fiscal quarter. Based upon preliminary collection information and results obtained to date, the reserve established at September 30, 2001 appears appropriate in light of the circumstances and will continue to be reviewed as we obtain further information. Derivatives and Hedging The Partnership periodically hedges a portion of its home heating oil, propane and natural gas purchases through the use of futures, options, collars and swap agreements. The purpose of the hedges is to provide a measure of stability in the volatile market of home heating oil, propane and natural gas prices and to manage its exposure to commodity price risk under certain existing sales commitments. The Partnership also has derivative agreements that management has decided not to designate as hedge transactions for accounting purposes and as such, mark-to-market adjustments are recognized currently in earnings. The accounting treatment of changes in fair value is dependent upon whether or not a derivative instrument is designated as a hedge, and if so, the type of hedge. For derivatives designated as cash flow hedges, changes in fair value are recognized in other comprehensive income until the hedged item is recognized in earnings. All of the Partnership's derivative instruments entered into for the purchase of heating oil, propane and natural gas to be sold to price plan customers are designated as cash flow hedges. For derivatives recognized as fair value hedges, changes in fair value are recognized in the statement of operations and are offset by related changes in fair value of the hedged item. Substantially all of the derivative instruments entered into in order to mitigate the price exposure for firm commitments relating to the purchase of heating oil, propane and natural gas to be sold to price plan customers are designated as fair value hedges. Changes in the fair value of derivative instruments, which are not designated as hedges or which do not qualify for hedge accounting are recognized currently in earnings. For the three months ended March 31, 2002, the increase in accumulated other comprehensive income is principally attributable to the reclassification to current period income of accumulated losses on cash flow hedges that settled during the period. For the six month period ended March 31, 2002, the increase is attributable to those same reclassifications of accumulated losses on cash flow hedges that settled during the period offset in part by the increase in the effective portion of certain cash flow hedges from the first fiscal quarter. Accounting Principles Not Yet Adopted In July 2001, the FASB issued Statement No. 141, "Business Combinations" and Statement No. 142, "Goodwill and Other Intangible Assets." Statement No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as for all purchase method business combinations completed after June 30, 2001. Statement No. 141 also specifies criteria that intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. Statement No. 142 will require that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually in accordance with the provisions of Statement No. 142. Statement No. 142 will also require that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." 9
2) Summary of Significant Accounting Policies - (continued) The Partnership adopted the provisions of Statement No. 141 effective July 1, 2001 and Statement No. 142 is required to be adopted effective October 1, 2002. Futhermore, any goodwill and any intangible asset determined to have an indefinite useful life that are acquired in a purchase method business combination completed after June 30, 2001 will not be amortized, but will continue to be evaluated for impairment in accordance with the appropriate pre-Statement No. 142 accounting literature. Goodwill and intangible assets acquired in business combinations completed before July 1, 2001 will continue to be amortized prior to the adoption of Statement No. 142. Statement No. 141 will require upon adoption of Statement No. 142, that the Partnership evaluate its existing intangible assets and goodwill that were acquired in a prior purchase method business combination, and to make any necessary reclassifications in order to conform with the new criteria in Statement No. 141 for recognition apart from goodwill. Upon adoption of Statement No. 142, the Partnership will be required to reassess the useful lives and residual values of all intangible assets acquired in purchase business combinations, and make any necessary amortization period adjustments by the end of the first interim period after adoption. In addition, to the extent an intangible asset is identified as having an indefinite useful life, the Partnership will be required to test the intangible asset for impairment in accordance with the provisions of Statement No. 142 within the first interim period. Any impairment loss will be measured as of the date of adoption and recognized as the cumulative effect of change in accounting principle in the first interim period. In connection with the transitional goodwill impairment evaluation, Statement No. 142 will require the Partnership to perform an assessment of whether there is an indication that goodwill is impaired as of the date of adoption. To accomplish this the Partnership must identify its reporting units and determine the carrying value of each reporting unit by assigning the assets and liabilities, including the existing goodwill and intangible assets, to those reporting units as of the date of adoption. The Partnership will then have up to six months from the date of adoption to determine the fair value of each reporting unit and compare it to the reporting unit's carrying amount. To the extent a reporting unit's carrying amount exceeds its fair value, an indication exists that the reporting unit's goodwill may be impaired and the Partnership must perform the second step of the transitional impairment test. In the second step, the Partnership must compare the implied fair value of the reporting unit's goodwill, determined by allocating the reporting unit's fair value to all of its assets (recognized and unrecognized) and liabilities in a manner similar to a purchase price allocation in accordance with Statement No. 141, to its carrying amount, both of which would be measured as of the date of adoption. This second step is required to be completed as soon as possible, but no later than the end of the year of adoption. Any transitional impairment loss will be recognized as the cumulative effect of a change in accounting principle in the Partnership's statement of operations. As of March 31, 2002, the Partnership had unamortized goodwill in the amount of $275.9 million. The Partnership also has $199.3 million of unamortized identifiable intangible assets, which will be subject to the transition provisions of Statements No. 141 and No. 142. Amortization expense related to goodwill was $3.9 million and $4.1 million for the six months ended March 31, 2001 and 2002, respectively. Since July 1, 2001, the Partnership's adoption date of Statement No. 141, the Partnership acquired $79.4 million of goodwill subject to this Statement. As a result, these assets were not amortized by $0.8 million and $1.5 million, for the three and six months ended March 31, 2002, respectively. Because of the extensive effort needed to comply with adopting Statements No. 141 and No. 142, it is not practicable to reasonably estimate the impact of adopting these Statements on the Partnership's financial statements at the date of this report, including whether any transitional impairment losses will be required to be recognized as the cumulative effect of change in accounting principle. In August 2001, the FASB issued Statement No. 143, "Accounting for Asset Retirement Obligations" ("SFAS No. 143"). Statement No. 143 requires recording the fair market value of an asset retirement obligation as a liability in the period in which a legal obligation associated with the retirement of tangible long-lived assets is incurred. Statement No. 143 also requires recording a corresponding asset, and to depreciate that amount over the life of the asset. The liability is then increased at the end of each period to reflect the passage of time and changes in the initial fair value measurement. The Partnership is required to adopt the provisions of Statement No. 143, effective October 1, 2002 and has not yet determined the extent of its impact, if any. In October 2001, the FASB issued Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"). Statement No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets. It also extends the reporting requirements to report separately as discontinued operations, components of an entity that have either been disposed of or classified as held for sale. The Partnership is required to adopt the provisions of Statement No. 144, effective October 1, 2002 and has not yet determined the extent of its impact, if any. 10
3) Interest Rate Swaps Effective March 26, 2002, the heating oil segment entered into two interest rate swap agreements ("Swap Agreement") with Bank of America and JP Morgan, related to the semi-annual interest payments due on the $73.0 million fixed rate Senior Note due 2006 ("Senior Note"). The Swap Agreements, which expire August 1, 2006, require both the Bank of America and JP Morgan to each pay an amount based on the stated fixed interest rate (annual rate 8.05%) pursuant to the Senior Notes for an aggregate $2.9 million due every six months on August 1 and February 1. In exchange, the heating oil segment is required to make semi-annual floating interest rate payments on the 1st of August and February based on an annual interest rate equal to the 6 month LIBOR interest rate plus 2.83% applied to the same notional amount of $73.0 million. 4) Segment Reporting In accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information", the Partnership has four reportable segments: a retail distributor of heating oil, a retail distributor of propane, a reseller of natural gas and electricity and the public master limited partnership, Star Gas Partners. Management has chosen to organize the enterprise under these four segments in order to leverage the expertise it has in each industry, allow each segment to continue to strengthen its core competencies and provide a clear means for evaluation of operating results. The heating oil segment is primarily engaged in the retail distribution of home heating oil, related equipment services, and equipment sales to residential and commercial customers. It operates primarily in the Northeast and Mid-Atlantic states. Home heating oil is principally used by the Partnership's residential and commercial customers to heat their homes and buildings, and as a result, weather conditions have a significant impact on the demand for home heating oil. The propane segment is primarily engaged in the retail distribution of propane and related supplies and equipment to residential, commercial, industrial, agricultural and motor fuel customers, in the Midwest, Northeast, Florida and Georgia. Propane is used primarily for space heating, water heating and cooking by the Partnership's residential and commercial customers and as a result, weather conditions also have a significant impact on the demand for propane. The natural gas and electric reseller segment is primarily engaged in offering natural gas and electricity to residential consumers in deregulated energy markets. In deregulated energy markets, customers have a choice in selecting energy suppliers to power and / or heat their homes. As a result, a significant portion of this segment's revenue is directly related to weather conditions. TG&E operates in ten markets in the Northeast, Mid-Atlantic, Florida and the District of Columbia, where competitors range from independent resellers, like TG&E, to large public utilities. TG&E has been instituting new credit policies and installing new information systems, which are designed to improve TG&E's credit approval process deficiency and collection problems. The public master limited partnership segment includes the office of the Chief Executive Officer and has the responsibility for maintaining investor relations and investor reporting for the Partnership. The following are the statements of operations and balance sheets for each segment as of and for the periods indicated. There were no inter-segment sales. 11
4) Segment Reporting (continued) <TABLE> <CAPTION> (in thousands) Three Months Ended ------------------------------------------------------------------------------------------------------- March 31, 2001 March 31, 2002 (unaudited) (unaudited) ---------------------------------------------------- ----------------------------------------------- Heating Heating Statements of Operations Oil Propane TG&E Partners Consol. Oil Propane TG&E Partners Consol. - ------------------------ --- ------- ---- -------- ------- --- ------- ---- --------- -------- <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Sales $332,612 $92,320 $45,515 $ - $470,447 $322,620 $ 74,636 $ 14,029 $ - $411,285 Cost of sales 226,246 51,303 40,421 - 317,970 211,850 29,400 10,732 - 251,982 Delivery and branch 42,056 15,783 - - 57,839 51,717 15,872 - - 67,589 Deprec. and amortization 6,838 3,294 238 2 10,372 10,011 4,143 353 2 14,509 G & A expense 2,883 1,589 2,610 1,556 8,638 4,118 1,780 2,928 341 9,167 TG&E customer acquisition expense - - 718 - 718 - - 185 - 185 Unit compensation expense - - - 719 719 - - - (475) (475) -------- ------- ------- ------- -------- -------- -------- -------- ------ -------- Operating income (loss) 54,589 20,351 1,528 (2,277) 74,191 44,924 23,441 (169) 132 68,328 Net interest expense (income) 5,747 2,967 805 (516) 9,003 6,455 3,228 835 (761) 9,757 Amortization of debt issuance costs 98 53 - - 151 243 64 - - 307 -------- ------- ------- ------- -------- -------- -------- -------- ------ -------- Income (loss) before income taxes 48,744 17,331 723 (1,761) 65,037 38,226 20,149 (1,004) 893 58,264 Income tax (benefit) 850 72 1 - 923 (2,000) 48 - - (1,952) -------- ------- ------- ------- -------- -------- -------- -------- ------ -------- Net income (loss) $ 47,894 $17,259 $ 722 $(1,761) $ 64,114 $ 40,226 $ 20,101 $ (1,004) $ 893 $ 60,216 ======== ======= ======= ======= ======== ======== ======== ======== ====== ======== Capital expenditures $ 2,021 $ 914 $ 12 $ - $ 2,947 $ 1,492 $ 1,089 $ 218 $ - $ 2,799 ======== ======= ======= ======= ======== ======== ======== ======== ====== ======== <CAPTION> (in thousands) Six Months Ended ----------------------------------------------------------------------------------------------------- March 31, 2001 March 31, 2002 (unaudited) (unaudited) ---------------------------------------------------- ----------------------------------------------- Heating Heating Statements of Operations Oil Propane TG&E Partners Consol. Oil Propane TG&E Partners Consol. - ------------------------ --- ------- ---- -------- ------- --- ------- ---- --------- ------- <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Sales $564,675 $163,763 $65,513 $ - $793,951 $545,023 $129,011 $ 23,474 $ - $697,508 Cost of sales 398,282 92,694 58,296 - 549,272 362,219 55,014 18,996 - 436,229 Delivery and branch 77,733 29,440 - - 107,173 94,169 29,741 - - 123,910 Deprec. and amortization 13,111 6,427 477 4 20,019 20,258 8,046 704 4 29,012 G & A expense 5,286 3,235 4,302 2,697 15,520 6,831 3,401 5,396 1,724 17,352 TG&E customer acquisition expense - - 1,371 - 1,371 - - 406 - 406 Unit compensation expense - - - 1,219 1,219 - - - 165 165 -------- -------- ------- ------- -------- -------- -------- -------- -------- ------- Operating income (loss) 70,263 31,967 1,067 (3,920) 99,377 61,546 32,809 (2,028) (1,893) 90,434 Net interest expense (income) 10,911 5,693 1,331 (815) 17,120 13,113 6,601 1,710 (1,523) 19,901 Amortization of debt issuance costs 192 104 - - 296 491 128 - - 619 --------- -------- ------- ------- -------- -------- --------- ---------- -------- ------- Income (loss) before income taxes 59,160 26,170 (264) (3,105) 81,961 47,942 26,080 (3,738) (370) 69,914 Income tax (benefit) 1,525 113 1 - 1,639 (1,900) 95 - - (1,805) -------- -------- ------- ------- -------- -------- --------- ---------- -------- ------- Income (loss) before cumulative change in accounting principle 57,635 26,057 (265) (3,105) 80,322 49,842 25,985 (3,738) (370) 71,719 Cumulative change in accounting principle 2,093 (229) (398) - 1,466 - - - - - -------- -------- -------- ------- -------- -------- --------- -------- -------- ------- Net income (loss) $ 59,728 $ 25,828 $ (663) $(3,105) 81,788 $ 49,842 $ 25,985 $ (3,738) $ (370)$71,719 ======== ======== ======== ======= ======== ======== ======== ========= ======== ======= Capital expenditures $ 4,461 $ 2,535 $ 69 $ - $ 7,065 $ 4,620 $ 2,982 $ 578 $ - $ 8,180 ========= ======== ======== ======= ======== ======== ======== ======== ======== ======= </TABLE> 12
4) Segment Reporting (continued) <TABLE> <CAPTION> (in thousands) March 31, 2002 September 30, 2001 (unaudited) ------------------------------------------------- --------------------------------------------------- Heating (1) Heating (1) Balance Sheets Oil Propane TG&E Partners Consol. Oil Propane TG&E Partners Consol. - -------------- --- ------- ---- --------- ------- --- ------- ---- --------- ------- <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Assets Current assets Cash and equivalents $ 7,181 $ 3,655 $ 102 $ 6,290 $ 17,228 $ 15,782 $ 18,969 $ 1,241 $ 2,251 $ 38,243 Receivables, net 82,484 12,002 10,487 - 104,973 114,029 17,335 10,535 - 141,899 Inventories 24,735 13,181 3,214 - 41,130 25,257 9,320 2,030 - 36,607 Prepaid expenses and other current assets 16,921 3,523 2,349 - 21,931 16,581 6,703 995 - 23,417 -------- -------- ------- -------- -------- -------- -------- -------- -------- -------- Total current assets 131,321 32,361 16,152 6,290 185,262 171,649 52,327 14,801 2,251 240,166 Property and equipment, net 72,204 162,680 487 - 235,371 67,497 172,055 917 - 240,469 Long-term portion of accounts receivable 6,752 - - - 6,752 6,672 - - - 6,672 Investment in subsidiaries - 108,035 - 194,647 - - 156,615 - 286,828 - Intangibles and other 381,348 77,750 12,117 219 471,434 370,483 99,659 11,561 215 481,918 -------- -------- ------- ------- -------- -------- -------- -------- -------- -------- Total assets $591,625 $380,826 $28,756 $201,156 $898,819 $616,301 $ 480,656 $ 27,279 $289,294 $969,225 ======== ======== ======= ======== ======== ======== ======== ======== ======== ======== Liabilities and Heating (1) Heating (1) Partners' Capital Oil Propane TG&E Partners Consol. Oil Propane TG&E Partners Consol. --- ------- ---- --------- ------- --- ------- ---- --------- ------- Current Liabilities Accounts payable $ 22,407 $ 5,682 $ 7,711 $ - $ 35,800 $ 21,512 $ 5,766 $ 7,505 $ - $ 34,783 Working capital Facility borrowings - 8,400 5,466 - 13,866 32,000 - 3,222 - 35,222 Current maturities of of long-term debt 1,184 8,702 2,000 - 11,886 26,641 10,624 2,000 - 39,265 Accrued expenses and other current liabilities 63,895 10,267 1,052 2,464 77,678 50,081 10,616 1,020 1,854 63,571 Due to affiliate (185) (1,450) 2,069 (434) - (1,546) 938 1,564 (956) - Unearned service contract revenue 24,575 - - - 24,575 25,500 - - - 25,500 Customer credit balances 45,456 18,053 1,698 - 65,207 34,657 7,056 4,446 - 46,159 -------- -------- ------- ------- -------- -------- -------- -------- -------- -------- Total current liabilities 157,332 49,654 19,996 2,030 229,012 188,845 35,000 19,757 898 244,500 Long-term debt 314,148 142,375 563 - 457,086 258,732 163,564 563 - 422,859 Other 12,110 2,307 40 - 14,457 12,109 2,183 40 - 14,332 Partners' Capital Equity Capital 108,035 186,490 8,157 199,126 198,264 156,615 279,909 6,919 288,396 287,534 -------- --------- -------- -------- --------- --------- --------- --------- --------- --------- Total liabilities and Partners' Capital $591,625 $ 380,826 $ 28,756 $201,156 $ 898,819 $616,301 $ 480,656 $ 27,279 $ 289,294 $ 969,225 ======== ========= ======== ======== ========= ======== ========= ========= ========= ========= </TABLE> (1) The consolidated amounts include the necessary entries to eliminate the investment in Petro Holdings, Star Gas Propane and TG&E. 13
5) Acquisitions During the six-month period ending March 31, 2002, the Partnership acquired one retail heating oil dealer and four retail propane dealers. The aggregate consideration for these acquisitions accounted for by the purchase method of accounting was approximately $38.6 million. Purchase prices have been allocated to the acquired assets and liabilities based on their respective fair market values on the dates of acquisition. The purchase prices in excess of the fair values of net assets acquired are classified as intangibles in the Condensed Consolidated Balance Sheets. The following table indicates the allocation of the aggregate purchase price paid for these acquisitions and the respective periods of amortization assigned: (in thousands) Useful Lives ------------ Land $ 522 -- Buildings 490 30 years Furniture & fixtures 459 10 years Fleet 1,535 5 - 30 years Tanks and equipment 8,259 5 - 30 years Customer lists 18,027 7 - 15 years Restrictive covenants 10 5 years Goodwill 7,706 -- Working capital 1,558 -- ------- Total $38,566 ======= Sales and net income have been included in the Condensed Consolidated Statements of Operations from the respective dates of acquisition. The following pro forma information presents the results of operations for the six months ending March 31, 2002 of the Partnership, including the acquisitions previously described, as if the acquisitions had taken place on October 1, 2001. (in thousands, except per unit data) Sales $ 707,108 Net income $ 72,799 General Partner's interest in net income $ 832 Limited Partners' interest in net income $ 71,967 Basic net income per limited partner unit $ 2.51 Diluted net income per limited partner unit $ 2.51 6) Supplemental Disclosure of Cash Flow Information (in thousands) Six Months Ended March 31, 2001 2002 ---- ---- Cash paid during the period for: Income taxes $ 577 $ 747 Interest $ 15,460 $ 22,932 14
7) Earnings Per Limited Partner Unit <TABLE> <CAPTION> Three Months Ended March 31, Six Months Ended March 31, (in thousands, except per unit data) (unaudited) (unaudited) ----------- ----------- 2001 2002 2001 2002 ---- ---- ---- ---- <S> <C> <C> <C> <C> Income before cumulative effect of change in accounting principle per Limited Partner unit Basic $ 2.86 $ 2.09 $ 3.76 $ 2.57 Diluted $ 2.85 $ 2.09 $ 3.74 $ 2.56 Cumulative effect of change in accounting principle per Limited Partner unit Basic $ - $ - $ 0.07 $ - Diluted $ - $ - $ 0.07 $ - Net income per Limited Partner unit Basic $ 2.86 $ 2.09 $ 3.83 $ 2.57 Diluted $ 2.85 $ 2.09 $ 3.81 $ 2.56 Basic Earnings Per Unit: ----------------------- Net income $ 64,114 $ 60,216 $ 81,788 $ 71,719 Less: General Partner's interest in net income 964 681 1,247 820 ----------- ----------- ----------- ----------- Limited Partners' interest in net income $ 63,150 $ 59,535 $ 80,541 $ 70,899 =========== =========== =========== =========== Common Units 19,021 25,037 18,020 24,207 Senior Subordinated Units 2,697 3,124 2,657 3,071 Junior Subordinated Units 345 345 345 345 ----------- ----------- ----------- ----------- Weighted average number of Limited Partner units Outstanding 22,063 28,506 21,022 27,623 =========== =========== =========== =========== Basic earnings per unit $ 2.86 $ 2.09 $ 3.83 $ 2.57 =========== =========== =========== =========== Diluted Earnings Per Unit: ------------------------- Limited Partners' interest in net income $ 63,150 $ 59,535 $ 80,541 $ 70,899 =========== =========== =========== =========== Weighted average number of Limited Partner units outstanding 22,063 28,506 21,022 27,623 Senior subordinated units anticipated to be issued under employee incentive plan 113 - 113 63 ----------- ----------- ----------- ----------- Diluted weighted average number of Limited Partner units 22,176 28,506 21,135 27,686 =========== =========== =========== =========== Diluted earnings per unit $ 2.85 $ 2.09 $ 3.81 $ 2.56 =========== =========== =========== =========== </TABLE> 8) Subsequent Events Amendment to Bank Agreement - On April 25, 2002, the heating oil segment amended its bank facilities to modify certain financial covenant and default provisions for the period January 1, 2002 through December 31, 2002. This amendment also waived any failure of the heating oil segment to comply with its financial covenants for the period January 1, 2002 to the amendment effective date. Cash Distributions - On April 30, 2002, the Partnership announced that it would pay a cash distribution of $0.575 per Common Unit and $0.2500 per Senior Subordinated Unit, for the quarter ended March 31, 2002. The distribution will be paid on May 15, 2002, to unitholders of record on May 6, 2002. 15
STAR GAS PARTNERS, L.P. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Statement Regarding Forward-Looking Disclosure This Report includes "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act which represent the Partnership's expectations or beliefs concerning future events that involve risks and uncertainties, including those associated with the effect of weather conditions on the Partnership's financial performance, the price and supply of home heating oil, propane, electricity and natural gas and the ability of the Partnership to obtain new accounts and retain existing accounts. All statements other than statements of historical facts included in this Report including, without limitation, the statements under "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere herein, are forward-looking statements. Although the Partnership believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from the Partnership's expectations ("Cautionary Statements") are disclosed in this Report, including without limitation and in conjunction with the forward-looking statements included in this Report. All subsequent written and oral forward-looking statements attributable to the Partnership or persons acting on its behalf are expressly qualified in their entirety by the Cautionary Statements. Overview In analyzing the financial results of the Partnership, the following matters should be considered. The primary use for heating oil, propane and natural gas is for space heating in residential and commercial applications. As a result, weather conditions have a significant impact on financial performance and should be considered when analyzing changes in financial performance. In addition, gross margins vary according to customer mix. For example, sales to residential customers generate higher profit margins than sales to other customer groups, such as agricultural customers. Accordingly, a change in customer mix can effect gross margins without necessarily impacting total sales. The heating oil, propane and natural gas industries are seasonal in nature with peak activity occurring during the winter months. Accordingly, results of operations for the periods presented are not indicative of the results to be expected for a full year. The Partnership adopted SFAS No. 133 on October 1, 2000 and has since recorded its derivatives at fair market value. As a result, net income for the six months ended March 31, 2001 was $0.4 million more than it would have been had the Standard not been adopted and net income for the six months ended March 31, 2002 was $3.8 million more than it would have been had the Standard not been adopted. Net income for the quarter ended March 31, 2001 was $0.7 million less than it would have been had the Standard not been adopted and net income for the quarter ended March 31, 2002 was $2.4 million less than it would have been had the Standard not been adopted. The effect of the Standard has no impact in how the Partnership evaluates its ability to make the minimum quarterly distribution. 16
THREE MONTHS ENDED MARCH 31, 2002 COMPARED TO THREE MONTHS ENDED MARCH 31, 2001 - --------------------------------------------- For the three months ended March 31, 2002, retail volume of home heating oil and propane increased 12.4 million gallons, or 4.8%, to 271.7 million gallons, as compared to 259.4 million gallons for the three months ended March 31, 2001. This increase was due to a 10.1 million gallon increase in the heating oil segment and by a 2.3 million gallon increase in the propane segment. The impact of additional volume provided as a result of acquisitions was largely offset by the impact of significantly warmer temperatures and to a much lesser extent by customer attrition in the heating oil segment. Temperatures in the Partnership's areas of operations were an average of 16.1% warmer than in the prior year's comparable quarter and approximately 17% warmer than normal. Sales For the three months ended March 31, 2002, sales decreased $59.2 million, or 12.6%, to $411.3 million, as compared to $470.4 million for the three months ended March 31, 2001. This decrease was due to $10.0 million lower home heating oil segment sales, $17.7 million lower propane segment sales and a $31.5 million decrease in TG&E sales. Sales decreased largely as a result of lower selling prices which were only partially offset by sales from the higher retail volume in the heating oil and propane segments. Selling prices decreased versus the prior year's comparable period in response to lower supply costs. Sales of rationally related products including heating equipment installation and service and water softeners increased in the heating oil segment by $9.3 million and by $0.5 million in the propane segment from the prior year's comparable quarter due to acquisitions and organic growth. Cost of Sales For the three months ended March 31, 2002, cost of sales decreased $66.0 million, or 20.8%, to $252.0 million, as compared to $318.0 million for the three months ended March 31, 2001. This decrease was due to $14.4 million of lower cost of sales at the home heating oil segment, $21.9 million lower propane segment cost of sales and a $29.7 million decrease in TG&E cost of sales. Cost of sales decreased due to the impact of lower supply cost partially offset by the cost of sales for the higher retail volume. While selling prices and supply cost decreased on a per gallon basis, the decrease in selling prices was less than the decrease in supply costs, which resulted in an increase in per gallon margins for heating oil, propane and an overall Partnership wide margin increase. TG&E's margins for the quarter ended March 31, 2002 were lower than the margins experienced for the prior comparable quarter. Delivery and Branch Expenses For the three months ended March 31, 2002, delivery and branch expenses increased $9.8 million, or 16.9%, to $67.6 million, as compared to $57.8 million for the three months ended March 31, 2001. This increase was due to an additional $9.7 million of delivery and branch expenses at the heating oil segment and a $0.1 million increase in delivery and branch expenses for the propane segment. Delivery and branch expenses increased both at the heating oil and propane segments due to additional operating cost associated with acquired companies and for the impact of inflation. Depreciation and Amortization Expenses For the three months ended March 31, 2002, depreciation and amortization expenses increased $4.1 million, or 39.9%, to $14.5 million, as compared to $10.4 million for the three months ended March 31, 2001. This increase was primarily due to additional depreciation and amortization related to heating oil and propane acquisitions. General and Administrative Expenses For the three months ended March 31, 2002, general and administrative expenses increased $0.5 million, or 6.1%, to $9.2 million, as compared to $8.6 million for the three months ended March 31, 2001. The increase was due to additional general and administration expenses for the acquisition of Meenan Oil Co., Inc. and other acquisitions partially offset by lower general and administrative expenses at the Partnership level. The Partnership level decrease was primarily due to a reduction in the accrual for compensation earned for unit appreciation rights previously granted. 17
TG&E Customer Acquisition Expense For the three months ended March 31, 2002, TG&E customer acquisition expense decreased $0.5 million, or 74.2% to $0.2 million, as compared to $0.7 million for the three months ended March 31, 2001. This TG&E expense is for the cost of acquiring new accounts through the services of a third party direct marketing company. Unit Compensation Expense For the three months ended March 31, 2002, unit compensation expense decreased $1.2 million, or 166.1%, to a negative $0.5 million, as compared to $0.7 million for the three months ended March 31, 2001. The decrease was due to a reduction in the accrual for units expected to be earned versus the prior year under the Partnership's Unit Incentive Plan pursuant to which certain employees were granted senior subordinated units as an incentive for increased efforts during employment and as an inducement to remain in the service of the Partnership. The Partnership believes that these contingent units will not vest for fiscal 2002. Interest Expense, net For the three months ended March 31, 2002, interest expense net increased $0.8 million, or 8.4%, to $9.8 million, as compared to $9.0 million for the three months ended March 31, 2001. This increase was due to additional interest expense for the financing of propane and heating oil acquisitions partially offset by lower interest expense for working capital borrowings. Income Tax Expense (benefit) For the three months ended March 31, 2002, income tax expense decreased $2.9 million, or 311.5%, to a tax benefit of $2.0 million, as compared to an expense of $0.9 million for the three months ended March 31, 2001. This decrease was due to the availability of carrying back certain Federal tax losses resulting from a change in the tax laws enacted in this quarter of approximately $2.2 million and for lower state income taxes based upon the lower pretax earnings achieved for the three months ended March 31, 2002. Net Income For the three months ended March 31, 2002, net income decreased $3.9 million, or 6.1%, to $60.2 million, as compared to $64.1 million for the three months ended March 31, 2001. The decrease was due to a $7.7 million decrease in net income at the heating oil segment and a $1.7 million decrease in net income at TG&E partially offset by a $2.8 million increase in net income at the propane segment and a $2.7 million reduction in the net loss at the Partnership level. The reduction in the net income was primarily due to the impact of the warmer weather, partially offset by a per gallon improvement in gross profit margins, a reduction in unit compensation and unit appreciation rights accruals, the tax benefit of the loss carryback and from net income generated by acquisitions. Earnings before interest, taxes, depreciation and amortization, TG&E customer acquisition expense and unit compensation expense, less net gain (loss) on sales of fixed assets and before the impact of SFAS No. 133 (EBITDA) For the three months ended March 31, 2002, earnings before interest, taxes, depreciation and amortization, TG&E customer acquisition expense and unit compensation expense, less net gain (loss) on sales of fixed assets and before the impact of SFAS No. 133 (EBITDA) decreased $1.7 million, or 1.9% to $85.0 million as compared to $86.7 million, for the three months ended March 31, 2001. This decrease was due to $3.6 million less EBITDA generated by the heating oil segment and a $2.4 million decrease in the TG&E segment's EBITDA partially offset by a $3.1 million increase in the propane segment and a $1.2 million increase at the Partnership level. The decrease in EBITDA was largely due to the impact of warmer temperatures, partially offset by higher per gallon gross profit margins and EBITDA generated by acquisitions. EBITDA should not be considered as an alternative to net income (as an indicator of operating performance) or as an alternative to cash flow (as a measure of liquidity or ability to service debt obligations), but provides additional information for evaluating the Partnership's ability to make the Minimum Quarterly Distribution. The definition of "EBITDA" set forth above may be different from that used by other companies. 18
SIX MONTHS ENDED MARCH 31, 2002 COMPARED TO SIX MONTHS ENDED MARCH 31, 2001 - ------------------------------------------- Volume For the six months ended March 31, 2002, retail volume of home heating oil and propane increased 8.2 million gallons, or 1.9%, to 442.5 million gallons, as compared to 434.3 million gallons for the six months ended March 31, 2001. This increase was due to a 10.4 million gallon increase in the heating oil segment partially offset by a 2.2 million decrease in the propane segment. The impact of additional volume provided by acquisitions was offset by the impact of significantly warmer temperatures and to a much lesser extent by customer attrition in the heating oil segment. Temperatures in the Partnership's areas of operations were an average of 21.6% warmer than in the prior year's comparable period and approximately 19% warmer than normal. Sales For the six months ended March 31, 2002, sales decreased $96.4 million, or 12.1%, to $697.5 million, as compared to $794.0 million for the six months ended March 31, 2001. This decrease was due to $19.7 million lower home heating oil segment sales, $34.8 million lower propane segment sales and a $42.0 million decrease in TG&E sales. Sales decreased largely as a result of lower selling prices which were only partially offset by sales from the higher retail volume in the heating oil and propane segments. Selling prices decreased versus the prior year's comparable period in response to lower supply costs. Sales of rationally related products including heating equipment installation and service and water softeners increased in the heating oil segment by $24.0 million and by $1.5 million in the propane segment from the prior year's comparable six months due to acquisitions and organic growth. Cost of Sales For the six months ended March 31, 2002, cost of sales decreased $113.0 million, or 20.6%, to $436.2 million, as compared to $549.3 million for the six months ended March 31, 2001. This decrease was due to $36.1 million of lower cost of sales at the home heating oil segment, $37.7 million lower propane segment cost of sales and a $39.3 million decrease in TG&E cost of sales. Cost of sales decreased due to the impact of lower supply cost partially offset by the cost of sales for the higher retail volume sales. While selling prices and supply cost decreased on a per gallon basis, the decrease in selling prices was less than the decrease in supply costs, which resulted in an increase in per gallon margins. Delivery and Branch Expenses For the six months ended March 31, 2002, delivery and branch expenses increased $16.7 million, or 15.6%, to $123.9 million, as compared to $107.2 million for the six months ended March 31, 2001. This increase was due to an additional $16.4 million of delivery and branch expenses at the heating oil segment and a $0.3 million increase in delivery and branch expenses for the propane segment. Delivery and branch expenses increased both at the heating oil and propane segments due to additional operating cost associated with acquired companies and for the impact of inflation. The increase in delivery and branch expenses was mitigated due to the purchase of weather insurance that allowed the Partnership to record approximately $6.4 million of net weather insurance recoveries. Depreciation and Amortization Expenses For the six months ended March 31, 2002, depreciation and amortization expenses increased $9.0 million, or 44.9%, to $29.0 million, as compared to $20.0 million for the six months ended March 31, 2001. This increase was primarily due to additional depreciation and amortization related to heating oil and propane acquisitions. 19
General and Administrative Expenses For the six months ended March 31, 2002, general and administrative expenses increased $1.8 million, or 11.8%, to $17.4 million, as compared to $15.5 million for the six months ended March 31, 2001. The increase was due to additional general and administration expenses for the acquisition of Meenan Oil Co., Inc. and other acquisitions as well as for increased compensation expense for TG&E. The increased compensation for TG&E was incurred for professional staff additions, hiring of personnel for its collection project and for severances paid to former employees in connection with the relocation if its corporate office to New Jersey. General and administrative expense were lower at the Partnership level due to a reduction in the accrual for compensation earned for unit appreciation rights previously granted. TG&E Customer Acquisition Expense For the six months ended March 31, 2002, TG&E customer acquisition expense decreased $1.0 million, or 70.4% to $0.4 million, as compared to $1.4 million for the six months ended March 31, 2001. This TG&E segment expense is for the cost of acquiring new accounts through the services of a third party direct marketing company. Unit Compensation Expense For the six months ended March 31, 2002, unit compensation expense decreased $1.1 million, or 86.5%, to $0.2 million, as compared to $1.2 million for the six months ended March 31, 2001. The decrease was due to a reduction in the accrual for units expected to be earned versus the prior year under the Partnership's Unit Incentive Plan pursuant to which certain employees were granted senior subordinated units as an incentive for increased efforts during employment and as an inducement to remain in the service of the Partnership. The Partnership believes that these contingent units will not vest for fiscal 2002. Interest Expense, net For the six months ended March 31, 2002, interest expense net increased $2.8 million, or 16.2%, to $19.9 million, as compared to $17.1 million for the six months ended March 31, 2001. This increase was due to additional interest expense for the financing of propane and heating oil acquisitions partially offset by lower interest expense for working capital borrowings. Income Tax Expense (benefit) For the six months ended March 31, 2002, income tax expense decreased $3.4 million, or 210.1%, to a tax benefit of $1.8 million, as compared to an expense of $1.6 million for the six months ended March 31, 2001. This decrease was due to the availability of carrying back certain Federal tax losses resulting from a change in the tax laws enacted during the current six months of approximately $2.2 million and for lower state income taxes based upon the lower pretax earnings achieved for the six months ended March 31, 2002. Cumulative Effect of Adoption of Accounting Principle For the six months ended March 31, 2001, the Partnership recorded a $1.5 million increase in income arising from the adoption of SFAS No. 133. Net Income For the six months ended March 31, 2002, net income decreased $10.1 million, or 12.3%, to $71.7 million, as compared to $81.8 million for the six months ended March 31, 2001. The decrease was due to a $9.9 million decrease in net income at the heating oil segment and a $3.1 million increase in the net loss at TG&E partially offset by a $0.2 million increase in net income at the propane segment and a $2.7 million reduction in the net loss at the Partnership level. The reduction in the net income was primarily due to the impact of the warmer weather, partially offset by a per gallon improvement in gross profit margins, net weather insurance recoveries, the tax benefit of the tax loss carryback and from net income generated by acquisitions. 20
Earnings before interest, taxes, depreciation and amortization, TG&E customer acquisition expense and unit compensation expense, less net gain (loss) on sales of fixed assets and before the impact of SFAS No. 133 (EBITDA) For the six months ended March 31, 2002, earnings before interest, taxes, depreciation and amortization, TG&E customer acquisition expense and unit compensation expense, less net gain (loss) on sales of fixed assets and before the impact of SFAS No. 133 (EBITDA) decreased $6.7 million, or 5.4% to $116.3 million as compared to $123.0 million, for the six months ended March 31, 2001. This decrease was due to $6.2 million of less EBITDA generated by the heating oil segment and a $3.6 million decrease in the TG&E segment's EBITDA partially offset by a $2.1 million increase in the propane segment and a $1.0 million increase at the Partnership level. The decrease in EBITDA was largely due to the impact of warmer temperatures, partially offset by higher per gallon gross profit margins, net weather insurance recoveries and EBITDA generated by acquisitions. EBITDA should not be considered as an alternative to net income (as an indicator of operating performance) or as an alternative to cash flow (as a measure of liquidity or ability to service debt obligations), but provides additional information for evaluating the Partnership's ability to make the Minimum Quarterly Distribution. The definition of "EBITDA" set forth above may be different from that used by other companies. Liquidity and Capital Resources During the six months ended March 31, 2002, the Partnership sold 1.7 million Common Units (including the exercise of the over-allotment option), the net proceeds of which, net of underwriter's discount, commission, and offering expenses was $34.2 million. These funds combined with net cash provided by $31.9 million in net working capital and acquisition facility borrowings, $1.3 million in proceeds from the sale of fixed assets, and $50.6 million generated from operating activities, totaled $118.0 million. Such funds were used for acquisitions of $38.6 million, distributions of $32.1 million, debt repayment of $17.3 million, capital expenditures of $8.2 million and other financing activities of $0.8 million. As a result of the above activity cash increased by $21.0 million to $38.2 million. Due to the impact on operations of the extremely warm weather conditions experienced during the six months ended March 31, 2002, the Partnership's heating oil segment was not able to comply with certain of its bank facility agreement covenants. The noncompliance was resolved with an amendment to the heating oil segment's bank facility agreements, signed on April 25, 2002. The agreement amended the financial covenants through December 31, 2002 and waived any non compliance with these covenants for the period January 1, 2002 to the amendment's effective date. As a result, the heating oil segment is currently in compliance with these covenants. However, any future failure to comply with the various restrictive and affirmative covenants of the Partnership's various bank and note facility agreements could negatively impact the Partnership's ability to incur additional debt, pay distributions and cause certain debt to become currently payable. For the remainder of fiscal 2002, the Partnership anticipates paying interest of approximately $19 million and anticipates growth and maintenance capital additions of approximately $8 million. In addition, the Partnership plans to pay distributions on its units to the extent there is sufficient available cash in accordance with the partnership agreement. The Partnership also plans to pursue strategic acquisitions as part of its business strategy and to prudently fund such acquisitions through a combination of debt and equity. Based on its current cash position, proceeds from the above mentioned common unit offering, bank credit availability and anticipated net cash to be generated from operating activities, the Partnership expects to be able to meet all of its obligations for the next twelve months. 21
Item. 3. Quantitive and Qualitative Disclosures About Market Risk -------------------------------------------------------- The Partnership is exposed to interest rate risk primarily through its bank credit facilities. The Partnership utilizes these borrowings to meet its working capital needs and also to fund the short-term needs of its acquisition program. At March 31, 2002, the Partnership had outstanding borrowings of approximately $63.7 million under its Bank Credit Facilities. The Partnership also has an interest rate swap for $73.0 million of fixed rate borrowings. In the event that interest rates associated with these facilities were to increase 100 basis points, the impact on future cash flows would be a decrease of approximately $1.4 million annually. The Partnership also selectively uses derivative financial instruments to manage its exposure to market risk related to changes in the current and future market price of home heating oil, propane and natural gas. The Partnership does not hold derivatives for trading purposes. The value of market sensitive derivative instruments is subject to change as a result of movements in market prices. Consistent with the nature of hedging activity, associated unrealized gains and losses would be offset by corresponding decreases or increases in the purchase price the Partnership would pay for the product being hedged. Sensitivity analysis is a technique used to evaluate the impact of hypothetical market value changes. Based on a hypothetical ten percent increase in the cost of product at March 31, 2002, the potential gain on the Partnership's hedging activity would be to increase the fair market value of these outstanding derivatives by $0.7 million to a fair market value of $1.2 million; and conversely a hypothetical ten percent decrease in the cost of product would decrease the fair market value of these outstanding derivatives by $0.4 million to a fair market value of $0.2 million. PART II OTHER INFORMATION ------------------------- Item 6. Exhibits and Reports on Form 8-K -------------------------------- (a) Exhibits Included Within: ------------------------ 10.29 - Parity debt credit agreement, dated as of February 22, 2002 between Star Gas Propane, L.P., Fleet National Bank, as Administrative Agent, and Bank of America, N.A., as Documentation Agent. 10.30 - Waiver and third amendment to second amended and restated credit agreement, dated as of April 25, 2002 between Petroleum Heat and Power Co., Inc., and Bank of America, N.A., as Agent. (b) Reports on Form 8-K: ------------------- 1/7/02 - This Form 8-K consists of a copy of the underwriting agreement for a firm commitment public offering of up to 1,500,000 common units of the registrant that were previously registered pursuant to a shelf registration statement on Form S-3 (SEC File No. 333-57994). 22
SIGNATURE --------- Pursuant to the requirements of the Securities Exchange Act of 1934, the Partnership has duly caused this report to be signed on its behalf of the undersigned thereunto duly authorized: Star Gas Partners, L.P. By: Star Gas LLC (General Partner) Signature Title Date --------- ----- ---- /s/ Ami Trauber Chief Financial Officer April 30, 2002 ---------------------- Ami Trauber Star Gas LLC (Principal Financial Officer) /s/ James J. Bottiglieri Vice President April 30, 2002 ---------------------- James J. Bottiglieri Star Gas LLC 23