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, 2003
OR
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
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 incorporation or organization)
(I.R.S. Employer Identification No.)
2187 Atlantic Street, Stamford, Connecticut 06902
(Address of principal executive office)
(203) 328-7310
(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 by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
Yes x No ¨
Indicate the number of shares outstanding of each issuer’s classes of common stock, as of April 23, 2003:
28,970,446
Common Units
3,139,110
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, 2002 and March 31, 2003
3
Condensed Consolidated Statements of Operations for the three months ended March 31, 2002 and March 31, 2003 and six months ended March 31, 2002 and March 31, 2003
4
Condensed Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2002 and March 31, 2003 and six months ended March 31, 2002 and March 31, 2003
5
Condensed Consolidated Statement of Partners’ Capital for the six months endedMarch 31, 2003
6
Condensed Consolidated Statements of Cash Flows for the six months ended March 31, 2002and March 31, 2003
7
Notes to Condensed Consolidated Financial Statements
8-17
Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations
18-28
Item 3—Quantitative and Qualitative Disclosures About Market Risk
29
Item 4—Controls and Procedures
Part II Other Information:
Item 6—Exhibits and Reports on Form 8-K
30
Signatures
31
Certifications
32-33
2
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
September 30,
2002
March 31,
2003
(unaudited)
ASSETS
Current assets
Cash and cash equivalents
$
61,481
69,142
Receivables, net of allowance of $8,282 and $11,428, respectively
83,452
260,101
Inventories
39,453
56,826
Prepaid expenses and other current assets
37,815
39,020
Total current assets
222,201
425,089
Property and equipment, net
241,892
239,275
Long-term portion of accounts receivables
6,672
6,892
Goodwill
264,551
260,650
Intangibles, net
193,370
180,219
Deferred charges and other assets, net
15,080
14,192
Total Assets
943,766
1,126,317
LIABILITIES AND PARTNERS’ CAPITAL
Current liabilities
Accounts payable
20,360
53,520
Working capital facility borrowings
26,195
135,600
Current maturities of long-term debt
72,113
23,759
Accrued expenses
69,444
78,408
Unearned service contract revenue
30,549
27,655
Customer credit balances
70,583
18,125
Total current liabilities
289,244
337,067
Long-term debt
396,733
470,301
Other long-term liabilities
25,525
27,340
Partners’ capital
Common unitholders
242,696
297,200
Subordinated unitholders
3,105
12,942
General partner
(2,710
)
(1,718
Accumulated other comprehensive loss
(10,827
(16,815
Total Partners’ capital
232,264
291,609
Total Liabilities and Partners’ Capital
See accompanying notes to condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months EndedMarch 31,
Six Months EndedMarch 31,
(in thousands, except per unit data)
Sales:
Product
372,243
623,703
611,078
958,415
Installations, service and appliances
39,042
45,117
86,430
95,385
Total sales
411,285
668,820
697,508
1,053,800
Costs and expenses:
Cost of sales
206,572
407,080
338,456
608,407
Cost of installations, service and appliances
45,410
52,181
97,773
106,201
Delivery and branch expenses
67,589
86,644
123,910
161,158
Depreciation and amortization expenses
14,509
12,885
29,012
25,733
General and administrative expenses
8,877
14,034
17,923
26,883
Operating income
68,328
95,996
90,434
125,418
Interest expense
(10,600
(11,494
(21,503
(20,525
Interest income
843
856
1,602
1,517
Amortization of debt issuance costs
(307
(554
(619
(991
Loss on redemption of debt
—
(181
Income before income taxes and cumulative effect of changein accounting principle
58,264
84,623
69,914
105,238
Income tax expense (benefit)
(1,952
1,460
(1,805
2,135
Income before cumulative effect of change in accountingprinciple
60,216
83,163
71,719
103,103
Cumulative effect of change in accounting principle for adoptionof SFAS No. 142
(3,901
Net income
99,202
General Partner’s interest in net income
681
832
820
992
Limited Partners’ interest in net income
59,535
82,331
70,899
98,210
Net income per Limited Partner unit:
Basic
2.09
2.54
2.57
3.03
Diluted
2.53
2.56
3.02
Basic weighted average number of
Limited Partner units outstanding
28,506
32,453
27,623
32,452
Diluted number of Limited Partner units
32,561
27,686
32,560
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Six Months Ended
Other comprehensive income (loss)Net unrealized gain (loss) on derivative instruments
12,700
(6,468
8,300
(5,988
Comprehensive income
72,916
76,695
80,019
93,214
Reconciliation of Accumulated Other Comprehensive Income (Loss)
Pension Plan
Obligations
Derivative
Instruments
Total
Balance as of September 30, 2001
(4,149
(8,050
(12,199
Reclassification to earnings
16,640
Unrealized holding loss arising during the period
(8,340
Other comprehensive income
Balance as of March 31, 2002
250
(3,899
Balance as of September 30, 2002
(15,745
4,918
(7,685
Unrealized holding gain arising during the period
1,697
Other comprehensive loss
Balance as of March 31, 2003
(1,070
CONDENSED CONSOLIDATED STATEMENT OF PARTNERS’ CAPITAL
(in thousands, except per unit amounts)
Number of Units
Common
Senior Sub.
Junior Sub.
General Partner
Accum.Other Comprehensive Income (Loss)
Total Partners’ Capital
Balance as ofSeptember 30, 2002
28,970
3,134
345
326
4,337
(1,232
Issuance of senior subordinated units
70
87,685
9,484
1,041
Other comprehensiveloss, net
Unit compensation expense:
135
Senior subordinated
818
Distributions:
($1.15 per unit)
(33,316
($0.50 per unit)
(1,576
Balance as ofMarch 31, 2003
3,139
13,133
(191
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended March 31,
Cash flows provided by (used in) operating activities:
Adjustments to reconcile net income to net cash provided by (used in)operating activities:
Depreciation and amortization
Amortization of debt issuance cost
619
991
Unit compensation expense
165
1,023
181
Provision for losses on accounts receivable
2,861
3,526
Loss on sales of fixed assets, net
59
54
Cumulative effect of change in accounting principle for theadoption of SFAS No. 142
3,901
Changes in operating assets and liabilities:
Increase in receivables
(39,087
(180,418
Decrease (increase) in inventories
5,381
(17,253
Increase in other assets
(380
(5,220
Increase in accounts payable
702
32,824
Decrease in other current and long-term liabilities
(20,426
(40,629
Net cash provided by (used in) operating activities
50,625
(76,085
Cash flows provided by (used in) investing activities:
Capital expenditures
(8,180
(7,990
Proceeds from sales of fixed assets
1,290
367
Acquisitions
(38,566
(1,837
Net cash used in investing activities
(45,456
(9,460
Cash flows provided by (used in) financing activities:
70,850
179,000
Working capital facility repayments
(49,494
(69,595
Acquisition facility borrowings
55,150
Acquisition facility repayments
(44,650
(33,300
Proceeds from the issuance of debt
196,932
Repayment of debt
(17,348
(137,226
Distributions
(32,056
(34,892
Increase in deferred charges
(812
(7,713
Proceeds from issuance of Common Units, net
34,236
Other
(30
Net cash provided by financing activities
15,846
93,206
Net increase in cash
21,015
7,661
Cash at beginning of period
17,228
Cash at end of period
38,243
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Star Gas Partners, L.P. (“Star Gas” or the “Partnership”) is a diversified home energy distributor and services provider, specializing in heating oil, propane, natural gas and electricity. Star Gas is a master limited partnership, which at March 31, 2003 had outstanding 29.0 million common units (NYSE: “SGU” representing an 88.4% limited partner interest in Star Gas Partners) and 3.1 million senior subordinated units (NYSE: “SGH” representing a 9.5% limited partner interest in Star Gas Partners) outstanding. Additional Partnership interests include 0.3 million junior subordinated units (representing a 1.1% limited partner interest) and 0.3 million general partner units (representing a 1.0% general partner interest).
Star Gas Propane, L.P. (“Star Gas Propane”) is the Partnership’s operating subsidiary and, together with its direct and indirect subsidiaries, accounts for substantially all of the Partnership’s Assets, sales and earnings. Both the Partnership and Star Gas Propane are Delaware limited partnerships that were formed in October 1995 in connection with the Partnership’s initial public offering. The Partnership is the sole limited partner of Star Gas Propane with a 99% limited partnership interest.
The general partner of both the Partnership and Star Gas Propane is Star Gas LLC, a Delaware limited liability company. The Board of Directors of Star Gas LLC is appointed by its members. For information concerning the members of Star Gas LLC and its Board of Directors see “Item 10. Directors and Executive Officers of the Registrant” in the registrant’s annual report Form 10-K for fiscal year ended September 30, 2002. Star Gas LLC owns an approximate 1% general partner interest in the Partnership and also owns an approximate 1% general partner interest in Star Gas Propane.
The Partnership’s propane operations (the “propane segment”) are conducted through Star Gas Propane and its subsidiaries. Star Gas Propane markets and distributes propane gas and related products to over 300,000 customers in the Midwest, Northeast, Florida and Georgia.
The Partnership’s heating oil operations (the “heating oil segment”) are conducted through Petro Holdings, Inc. (“Petro”) and its direct and indirect subsidiaries. Petro is a Minnesota corporation that is an indirect wholly owned subsidiary of Star Gas Propane. Petro is the nation’s largest retail distributor of home heating oil and serves approximately 500,000 customers in the Northeast and Mid-Atlantic.
The Partnership’s electricity and natural gas operations (the “natural gas and electric reseller segment” are conducted through Total Gas & Electric, Inc. (“TG&E”), a Florida corporation, that is an indirect wholly-owned subsidiary of Petro. TG&E is an energy reseller that markets natural gas and electricity to residential households in deregulated energy markets in New York, New Jersey, Florida and Maryland and serves over 70,000 residential customers. TG&E was formerly a wholly owned subsidiary of the Partnership, but subsequent to September 30, 2002, it became a wholly owned indirect subsidiary of Petro.
Star Gas Finance Company is a direct wholly-owned subsidiary of the Partnership that has no material assets or operations and was formed for the sole purpose of being a corporate co-issuer of certain of the Partnership’s indebtedness.
Basis of Presentation
The Condensed Consolidated Financial Statements include the accounts of Star Gas Partners, L.P., and its subsidiaries. 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, 2002 and March 31, 2003 are not necessarily indicative of the results to be expected for the full year.
These statements have been prepared on a basis that is substantially consistent with the accounting principles applied in our annual report on Form 10-K for the year ended September 30, 2002.
8
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, 2002
March 31, 2003
Propane gas
6,175
8,574
Propane appliances and equipment
3,981
4,279
Fuel oil
15,555
25,299
Fuel oil parts and equipment
11,746
12,141
Natural gas
1,996
6,533
Property, plant and equipment, consists of the following:
Property, plant and equipment
331,162
339,590
Less: accumulated depreciation
89,270
100,315
Reclassifications
Certain prior year amounts have been reclassified to conform with the current year presentation.
Derivatives and Hedging
The Partnership 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 believes it is prudent to minimize the variability and price risk associated with the purchase of home heating oil and propane. Accordingly, it is the Partnership’s objective to hedge the cash flow variability associated with forecasted purchases of its inventory held for resale through the use of derivative instruments when appropriate. To a lesser extent, the Partnership also hedges the fair value of inventory on hand or firm commitments to purchase inventory. To meet these objectives, it is the Partnership’s policy to enter into various types of derivative instruments to (i) manage the variability of cash flows resulting from the price risk associated with forecasted purchases of home heating oil, propane, and natural gas and (ii) hedge the downside price risk of firm purchase commitments and in some cases physical inventory on hand.
Derivatives that are not designated as hedges must be adjusted to fair value through income. Changes in the fair value of a derivative that is highly effective and that is designated and qualifies as a fair value hedge, along with the loss or gain on the hedged asset or liability or unrecognized firm commitment of the hedged item that is attributable to the hedged risk are recorded in earnings. Changes in the fair value of a derivative that is highly effective and that is designated and qualifies as a cash-flow hedge are recorded in accumulated other comprehensive income, until earnings are affected by the variability in cash flows of the designated hedged item. The ineffective portion of a derivative’s change in fair value is immediately recognized in earnings.
All derivative instruments are recognized on the balance sheet at their fair value. On the date the derivative contract is entered into, the Partnership designates the derivative as either a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (fair value hedge), or a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge). The Partnership formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as fair value or cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Partnership also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair value or cash flows of hedged items. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, the Partnership discontinues hedge accounting prospectively. When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective hedge, the Partnership continues to carry the derivative on the balance sheet at its fair value, and recognizes changes in the fair value of the derivative through current-period earnings.
9
For the three and six months ended March 31, 2003, the change in accumulated other comprehensive income (loss) is principally attributable to the increase in fair value of existing cash flow hedges more than offset by the reclassification to net income of accumulated gains on cash flow hedges that settled during the period.
Goodwill and Other Intangible Assets
Statement No. 142, “Goodwill and Other Intangible Assets” requires 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 also requires 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 Statement No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”
The Partnership adopted the applicable provisions of Statement No. 142 on October 1, 2002, and recorded a non-cash charge of $3.9 million to reduce the carrying value of the TG&E segment’s goodwill. This charge is reflected as a cumulative effect of change in accounting principle in the Partnership’s condensed consolidated statement of operations for the six months ended March 31, 2003. The Partnership will perform its annual impairment review during the fourth fiscal quarter of each year, commencing in the fourth quarter of fiscal 2003.
Accounting Policies not yet Adopted
In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46, “Consolidation of Variable Interest Entities.” This Interpretation clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements”, to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The interpretation requires consolidation of variable interest entities if certain conditions are met. The requirements are effective immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. The Partnership does not expect the adoption to have a material impact to the Partnership’s financial position or results of operations.
10
On October 1, 2002, the heating oil segment repaid an outstanding principal balance of $45.3 million to the holders of its 9.0% senior secured notes that were then due.
In March 2002, the heating oil segment entered into two interest rate swap agreements designed to hedge $73.0 million in underlying fixed rate senior note obligations, in order to reduce overall interest expense. The swap agreements would have expired August 1, 2006, but were terminated by mutual agreement on October 17, 2002. The swaps required the counterparties to 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 was required to make semi-annual floating interest rate payments on the first 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. The swap agreements were recognized as fair value hedges. Amounts to be paid or received under the interest rate swap agreements were accrued and recognized over the life of the agreements as an adjustment to interest expense. Upon termination on October 17, 2002, Petro received $4.8 million which was reflected as a basis adjustment to the fair values of the related debt and is being amortized using the effective yield over the remaining lives of the swap agreements as a reduction of interest expense.
On February 6, 2003, Star Gas and Star Gas Finance Company, a wholly owned subsidiary of Star Gas, jointly issued $200.0 million face value Senior Notes due on February 15, 2013. These notes accrue interest at an annual rate of 10.25% and require semi-annual interest payments on February 15 and August 15 of each year commencing on August 15, 2003. These notes are redeemable at the option of the Partnership, in whole or in part, from time to time by payment of a premium as defined. These notes were priced at 98.466% for total gross proceeds of $196.9 million. The Partnership also incurred $7.2 million of fees and expenses in connection with the issuance of these notes resulting in net proceeds of $189.7 million. During the quarter ended March 31, 2003, Star Gas used $131.0 million from the proceeds of the 10.25% Senior Notes to repay existing long-term debt and working capital facility borrowings and recognized a $0.2 million loss on redemption of debt. The debt discount related to the issuance of the 10.25% Senior Notes was $3.1 million and will be amortized to interest expense through February 2013.
The Partnership has three reportable operating segments: retail distribution of heating oil, retail distribution of propane and reselling of natural gas and electricity. The administrative expenses for the public master limited partnership, Star Gas Partners, have not been allocated to the segments. Management has chosen to organize the enterprise under these three 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 New York, New Jersey, Maryland and Florida.
The public master limited partnership includes the office of the Chief Executive Officer and has the responsibility for maintaining investor relations and investor reporting for the Partnership.
11
The following are the condensed statements of operations and balance sheets for each segment as of and for the periods indicated. There were no inter-segment sales.
Three Months Ended March 31,
Statements of Operations
Heating
Oil
Propane
TG&E
Partners
& Other
Consol.
287,722
70,492
14,029
470,969
112,618
40,116
Installation, service, and appliance
34,898
4,144
40,100
5,017
322,620
74,636
511,069
117,635
Cost and expenses:
Cost of product
167,342
28,498
10,732
308,305
63,330
35,445
Cost of installation, service and appliances
44,508
902
–
51,163
1,018
Delivery and branch
51,717
15,872
66,506
20,138
Deprec. and amort
10,011
4,143
353
8,604
4,184
97
G & A expense
4,118
1,780
3,113
(134
5,039
2,695
2,286
4,014
Operating income (loss)
44,924
23,441
(169
132
71,452
26,270
2,288
(4,014
Interest (expense) income, net
(6,455
(3,228
(835
761
(9,757
(5,671
(2,878
(101
(1,988
(10,638
(243
(64
(429
(49
(76
212
(393
Income (loss) before income taxes
38,226
20,149
(1,004
893
65,564
22,950
2,187
(6,078
(2,000
48
1,385
75
Net income (loss)
40,226
20,101
64,179
22,875
1,492
1,089
218
2,799
2,278
1,119
71
3,468
468,247
119,357
23,474
721,824
182,826
53,765
76,776
9,654
84,231
11,154
545,023
129,011
806,055
193,980
266,688
52,772
18,996
462,837
98,264
47,306
95,531
2,242
103,549
2,652
94,169
29,741
122,080
39,078
Deprec. and amort.
20,258
8,046
704
17,171
8,341
221
6,831
3,401
5,802
1,889
9,420
4,915
4,978
7,570
61,546
32,809
(2,028
(1,893
90,998
40,730
1,260
(7,570
(13,113
(6,601
(1,710
1,523
(19,901
(10,665
(6,177
(182
(1,984
(19,008
(491
(128
(814
47,942
26,080
(3,738
(370
79,731
34,059
1,078
(9,630
(1,900
95
1,985
150
Income (loss) before cumulative change in accounting principle
49,842
25,985
77,746
33,909
Cumulative change in accounting principle
(2,823
4,620
2,982
578
8,180
4,935
2,959
96
7,990
12
Balance Sheets
&
Other (1)
Current assets:
49,474
8,904
474
2,629
19,555
14,717
164
34,706
Receivables, net
70,063
10,669
2,720
211,241
31,303
17,557
27,301
10,156
37,440
12,853
34,817
2,793
1,009
(804
36,338
3,094
264
(676
181,655
32,522
6,199
1,825
304,574
61,967
24,518
34,030
66,854
174,298
740
64,695
173,874
706
Long-term portion of accounts receivable
Investment in subsidiaries
137,689
(137,689
4,112
191,834
(195,946
219,031
35,502
10,018
6,117
132,628
60,129
613
122,314
57,411
494
12,902
2,178
6,218
1,457
6,517
Total assets
619,742
442,318
17,570
(135,864
727,836
522,045
31,835
(155,399
Current Liabilities:
11,070
5,725
3,565
23,595
9,567
20,3588
23,000
3,195
126,000
9,600
60,787
10,626
700
13,259
10,500
Accrued expenses and other current liabilities
53,754
12,633
1,170
1,887
58,541
8,930
2,410
8,527
Due to affiliates
(293
(3,321
2,855
759
(3,904
(5,412
3,101
6,215
49,346
16,487
4,750
12,339
3,508
228,213
42,150
16,235
2,646
257,485
36,693
28,147
14,742
230,384
166,349
170,218
103,125
196,958
Due to affiliate
81,842
(81,842
23,456
2,069
25,501
1,839
Partners’ Capital:Equity Capital
231,750
1,335
(138,510
192,790
380,388
3,688
(285,257
Total liabilities and Partners’ Capital
On October 1, 2002, Star Gas adopted Statement No. 142, which required the Partnership to discontinue amortizing goodwill. Statement No. 142 also requires that goodwill be reviewed for impairment upon adoption of Statement No. 142 and annually thereafter. The Partnership will perform its annual impairment review during the fourth fiscal quarter of each year, commencing in the fourth quarter of 2003.
13
Under Statement No. 142, goodwill impairment is deemed to exist if the net book value of a reporting unit exceeds its estimated fair value. If goodwill of a reporting unit is determined to be impaired, the amount of impairment is measured based on the excess of the net book value of the goodwill over the implied fair value of the goodwill. The Partnership’s reporting units are consistent with the operating segments identified in Note 4—Segment Reporting.
Upon adoption of Statement No. 142 in the first fiscal quarter of 2003, the Partnership recorded a non-cash charge of approximately $3.9 million to reduce the carrying value of its goodwill for its TG&E segment. This charge is reflected as a cumulative effect of change in accounting principle in the Partnership’s condensed consolidated statement of operations for the three month period ended December 31, 2002. In calculating the impairment charge, the fair value of the reporting units were estimated using a discounted cash flow methodology.
A summary of changes in the Partnership’s goodwill during the six month period ended March 31, 2003, by business segment is as follows (in thousands):
Heating Oil Segment
Segment
Balance as of October 1, 2002
First fiscal quarter impairment charge
Intangible assets subject to amortization consist of the following (in thousands):
Gross Carrying Amount
Accumulated
Amortization
Net
Gross Carrying
Amount
Customer lists
257,284
70,332
186,952
82,580
174,704
Covenants not to compete
12,343
5,925
6,418
12,449
6,934
5,515
269,627
76,257
269,733
89,514
The Partnership’s results for the three months and six months ended March 31, 2002 on a historic basis did not reflect the impact of the provisions of Statement No. 142. Had the Partnership adopted Statement No. 142 on October 1, 2001, the unaudited pro forma effect on Basic and Diluted net income and Limited Partners’ interest in net income would have been as follows:
Three Months Ended
(in thousands except per unit data)
As reported net income
Add: Goodwill amortization, net of income taxes
2,043
Adjusted net income
62,259
75,831
867
Adjusted Limited Partners’ interest in net income
61,555
74,964
Net income per Limited Partner unit: Basic Basic & Diluted
2.11
2.59
3.06
0.07
0.15
2.18
2.74
0.02
0.03
2.16
2.71
Net income per Limited Partner unit: Diluted
2.55
3.05
14
$26,505
2004
26,504
2005
26,010
2006
24,847
2007
24,197
2008
22,266
Useful Lives
Land
1,325
Tanks and equipment
425
5-30 years
Restrictive covenants
107
5 years
Working capital
(20
1,837
Sales
715,281
74,093
846
73,247
Basic net income per limited partner unit
2.50
Diluted net income per limited partner unit
2.49
Cash paid during the period for:
Income taxes
577
698
Interest
15,460
20,218
Non-cash financing activities:
Decrease in long-term debt for the termination ofinterest rate swap
(1,219
Increase in long-term debt for amortization of debtdiscount cost
27
Decrease in other assets
1,192
15
Star Gas Partners, L.P. guarantees the payments required under the heating oil segment’s bank credit facilities, which at March 31, 2003 consisted of a $123.0 million working capital facility, a $20.0 million insurance letter of credit facility and a $50.0 million acquisition facility. In addition, Star Gas Partners, L.P. also guarantees the payments required for the heating oil segment’s senior notes, which at March 31, 2003 consisted of $179.0 million of principal obligations. Star Gas Partners, L.P. also guarantees payments required under supply contracts with natural gas and electricity suppliers for its TG&E segment that total approximately $13.3 million and also guarantees approximately $4.4 million of Petro performance bonds.
Three Months
Ended March 31,
Six Months
Income before cumulative effect of change inaccounting principle per Limited Partner unit:
3.15
3.14
Cumulative effect of change in accounting principle per Limited Partner unit:
(0.12
Basic Earnings Per Unit:
Less: General Partner’s interest in net income
25,037
24,207
3,124
3,138
3,071
3,137
Weighted average number of Limited Partner units outstanding
Basic earnings per unit
Diluted Earnings Per Unit:
Effect of diluted securities
Senior subordinated units anticipated to be issued under employee incentive plan
108
63
Diluted weighted average number of Limited Partner units
Diluted earnings per unit
16
Cash Distributions—On April 30, 2003, the Partnership announced that it would pay a cash distribution of $0.575 per Common Unit and $0.575 per Senior Subordinated Unit, Junior Subordinated Unit and General Partner Interest for the quarter ended March 31, 2003. The distribution will be paid on May 15, 2003, to unitholders of record on May 13, 2003.
Acquisitions—On April 8, 2003, the Partnership completed the acquisition of a distributor of home heating oil located in Pennsylvania with annual sales of approximately 12 million gallons of home heating oil and 4 million gallons of commercial fuels.
Heating Oil Segment Reorganization —In connection with the heating oil segment’s business reorganization project, the Partnership announced its reorganization plan to its impacted employees in April 2003 and will recognize a liability of approximately $2.0 million related to certain employee termination benefits and separation costs. This total amount of approximately $2.0 million will be incurred and recorded throughout the remainder of fiscal 2003.
17
Item 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Statement Regarding Forward-Looking Disclosure
This Report includes “forward-looking statements” 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 affect 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. Therefore, results of operations for the periods presented are not indicative of the results to be expected for a full year.
The following is a discussion of the historical condition and results of operations of Star Gas Partners, L.P. and its subsidiaries, and should be read in conjunction with the historical Financial and Operating Data and Notes thereto included elsewhere in this quarterly report on Form 10-Q.
18
THREE MONTHS ENDED MARCH 31, 2003
COMPARED TO THREE MONTHS ENDED MARCH 31, 2002
Volume
For the three months ended March 31, 2003, retail volume of home heating oil and propane increased 74.9 million gallons, or 27.6%, to 346.6 million gallons, as compared to 271.7 million gallons for the three months ended March 31, 2002. This increase was due to a 61.5 million gallon increase in the heating oil segment and a 13.4 million gallon increase in the propane segment. The increase in volume reflects the impact of significantly colder temperatures and the impact of an additional 5.8 million gallons provided by acquisitions. Customer attrition, largely in the home heating oil segment’s lower margin commercial business, partially offset these volume increases. Temperatures in the Partnership’s areas of operations were an average of 29.6% colder than in the prior year’s comparable quarter and approximately 9.0% colder than the thirty year average for the period July 1, 1971 through June 30, 2000, “normal” as reported by the National Oceanic and Atmospheric Administration (“NOAA”).
For the three months ended March 31, 2003, sales increased $257.5 million, or 62.6%, to $668.8 million, as compared to $411.3 million for the three months ended March 31, 2002. This increase was due to $188.4 million higher home heating oil sales, $43.0 million higher propane segment sales and a $26.1 million increase in TG&E sales. Sales increased largely due to the higher retail volume sold and as a result of higher selling prices. Selling prices increased versus the prior year’s comparable period in response to higher supply costs. Sales of rationally related products, including heating and air conditioning equipment installation and service and water softeners increased by $5.2 million in the heating oil segment and by $0.9 million in the propane segment from the prior year’s comparable period due to acquisitions and from colder temperatures.
Cost of Product
For the three months ended March 31, 2003, cost of product increased $200.5 million, or 97.1%, to $407.1 million, as compared to $206.6 million for the three months ended March 31, 2002. This increase was due to $141.0 million of higher cost of product at the home heating oil segment, $34.8 million higher cost of product at the propane segment and a $24.7 million increase in TG&E cost of product. Cost of product increased largely due to the higher retail volume sold and from higher supply cost.
Cost of Installations, Service and Appliances
For the three months ended March 31, 2003, cost of installations, service and appliances increased $6.8 million, or 14.9%, to $52.2 million, as compared to $45.4 million for the three months ended March 31, 2002. This increase was due to an additional $6.7 million in the heating oil segment and by $0.1 million in the propane segment from the prior year’s comparable period due to the increase in sales of these products and from additional cost of service expenses resulting from the colder temperatures.
Delivery and Branch Expenses
For the three months ended March 31, 2003, delivery and branch expenses increased $19.1 million, or 28.2%, to $86.6 million, as compared to $67.6 million for the three months ended March 31, 2002. This increase was due to an additional $14.8 million of delivery and branch expenses at the heating oil segment and a $4.3 million increase in delivery and branch expenses for the propane segment. The period to period comparison was impacted by the purchase of weather insurance that allowed the Partnership to record approximately $0.3 million of net weather insurance recoveries in the fiscal 2002 period versus a $2.1 million expense in the fiscal 2003 period for weather insurance premiums paid. Excluding the impact of weather insurance, delivery and branch expenses would have increased $16.7 million, or 24.7%, for the three months ended March 31, 2003, which was largely due to the additional operating cost associated with increased volumes delivered and to the impact of operating expense and wage increases.
19
Depreciation and Amortization Expenses
For the three months ended March 31, 2003, depreciation and amortization expenses decreased $1.6 million, or 11.2%, to $12.9 million, as compared to $14.5 million for the three months ended March 31, 2002. This decrease was primarily due to the impact of the Partnership’s adoption of Statement No. 142 which required the Partnership to stop amortizing goodwill effective October 1, 2002. Approximately $2.0 million of goodwill amortization was included in depreciation and amortization expense for the three months ended March 31, 2002.
General and Administrative Expenses
For the three months ended March 31, 2003, general and administrative expenses increased $5.2 million, or 58.1%, to $14.0 million, as compared to $8.9 million for the three months ended March 31, 2002. This increase was largely due to the inclusion of $0.4 million of incremental expense related to the on-going business reorganization project in the heating oil segment, a $3.2 million increase in the accrual for compensation earned for unit appreciation rights and restricted stock awards previously granted and for other increases of $2.3 million largely due to increased bonus compensation based upon results for the fiscal 2003 quarter. The increase was partially offset by lower general and administrative expenses at TG&E of approximately $0.8 million largely due to lower bad debt and collection expenses.
Interest Expense
For the three months ended March 31, 2003, interest expense increased $0.9 million, or 8.4%, to $11.5 million, as compared to $10.6 million for the three months ended March 31, 2002. This increase was largely due to additional interest expense for higher average outstanding working capital borrowings and to the impact of the $200 million 10.25% senior note issuance.
Loss on Redemption of Debt
For the three months ended March 31, 2003, the Partnership recorded a $0.2 million expense largely consisting of the unamortized deferred debt issuance cost associated with long-term debt repaid with the proceeds of the $200 million senior note issuance partially offset by the gain on extinguishment applicable to the portion of the related debt that was repaid with the proceeds of the $200 million senior note issuance.
Income Tax Expense
For the three months ended March 31, 2003, income tax expense increased $3.4 million to $1.5 million, as compared to a tax benefit of $2.0 million for the three months ended March 31, 2002. This increase was due to higher state income taxes based upon the higher pretax earnings achieved for the three months ended March 31, 2003 and the absence in fiscal 2003 of the tax benefit from federal tax loss carryback of $2.2 million recorded in fiscal 2002.
Net Income
For the three months ended March 31, 2003, net income increased $22.9 million, or 38.1%, to $83.2 million, as compared to $60.2 million for the three months ended March 31, 2002. The increase was due to a $24.0 million increase in net income at the heating oil segment income, a $2.8 million increase in net income at the propane segment and a $3.2 million increase in the net income at TG&E partially offset by a $7.0 million increase in the net loss at the Partnership level. The increase in net income was primarily due to the impact of colder weather.
20
SIX MONTHS ENDED MARCH 31, 2003
COMPARED TO SIX MONTHS ENDED MARCH 31, 2002
For the six months ended March 31, 2003, retail volume of home heating oil and propane increased 124.1 million gallons, or 28.1%, to 566.6 million gallons, as compared to 442.5 million gallons for the six months ended March 31, 2002. This increase was due to a 97.8 million gallon increase in the heating oil segment and a 26.3 million gallon increase in the propane segment. The increase in volume reflects the impact of significantly colder temperatures and the impact of an additional 11.0 million gallons provided by acquisitions. Customer attrition, largely in the home heating oil segment’s lower margin commercial business, partially offset these volume increases. The Partnership also believes that a shift in the delivery pattern at the heating oil segment decreased volume for the six months ended March 31, 2003 by an estimated 11.0 million gallons. Typical delivery patterns would have resulted in these gallons being delivered in the first six months of 2003 but were actually delivered in the three months ended September 30, 2002. Temperatures in the Partnership’s areas of operations were an average of 31.5% colder than in the prior year’s comparable six months and approximately 8.5% colder than normal as reported by NOAA.
For the six months ended March 31, 2003, sales increased $356.3 million, or 51.1%, to $1,053.8 million, as compared to $697.5 million for the six months ended March 31, 2002. This increase was due to $261.0 million higher home heating oil sales, $65.0 million higher propane segment sales and a $30.3 million increase in TG&E sales. Sales increased largely due to the higher retail volume sold and as a result of higher selling prices. Selling prices increased versus the prior year’s comparable period in response to higher supply costs. Sales of rationally related products, including heating and air conditioning equipment installation and service and water softeners increased by $7.5 million in the heating oil segment and by $1.5 million in the propane segment from the prior year’s comparable period due to acquisitions and from colder temperatures.
For the six months ended March 31, 2003, cost of product increased $270.0 million, or 79.8%, to $608.4 million, as compared to $338.5 million for the six months ended March 31, 2002. This increase was due to $196.1 million of higher cost of product at the home heating oil segment, $45.5 million higher cost of product at the propane segment and a $28.3 million increase in TG&E cost of product. Cost of product increased largely due to the higher retail volume sold and from higher supply cost.
For the six months ended March 31, 2003, cost of installations, service and appliances increased $8.4 million, or 8.6%, to $106.2 million, as compared to $97.8 million for the three months ended March 31, 2002. This increase was due to an additional $8.0 million in the heating oil segment and by $0.4 million in the propane segment from the prior year’s comparable period due to the increase in sales of these products and from additional cost of service expenses resulting from the colder temperatures.
For the six months ended March 31, 2003, delivery and branch expenses increased $37.2 million, or 30.1%, to $161.2 million, as compared to $123.9 million for the six months ended March 31, 2002. This increase was due to an additional $27.9 million of delivery and branch expenses at the heating oil segment and a $9.3 million increase in delivery and branch expenses for the propane segment. The period to period comparison was impacted by the purchase of weather insurance that allowed the Partnership to record approximately $6.4 million of net weather insurance recoveries in the fiscal 2002 period versus a $3.6 million expense in the fiscal 2003 period for weather insurance premiums paid. Excluding the impact of weather insurance, delivery and branch expenses would have increased $27.1 million, or 21.9%, for the six months ended March 31, 2003, which was largely due to the additional operating cost associated with increased volumes delivered and to the impact of operating expense and wage increases.
21
For the six months ended March 31, 2003, depreciation and amortization expenses decreased $3.3 million, or 11.3%, to $25.7 million, as compared to $29.0 million for the six months ended March 31, 2002. This decrease was primarily due to the impact of the Partnership’s adoption of Statement No. 142 which required the Partnership to stop amortizing goodwill effective October 1, 2002. Approximately $4.1 million of goodwill amortization was included in depreciation and amortization expense for the six months ended March 31, 2002.
For the six months ended March 31, 2003, general and administrative expenses increased $9.0 million, or 50.0%, to $26.9 million, as compared to $17.9 million for the six months ended March 31, 2002. This increase was largely due to the inclusion of $1.5 million of incremental expense related to the on-going business process redesign project in the heating oil segment, a $3.9 million increase in the accrual for compensation earned for unit appreciation rights and restricted stock awards previously granted and for other increases of $4.4 million largely due to increased bonus compensation based upon results for the fiscal 2003 six months. The increase was partially offset by lower general and administrative expenses at TG&E of approximately $0.8 million largely due to lower bad debt and collection expenses.
Business Process Redesign—Heating Oil Division
The heating oil segment continues to progress with its on-going business reorganization project during the six months ended March 31, 2003. The heating oil segment is seeking to take advantage of its large size and utilize modern technology to increase the efficiency and quality of services provided to its customers. The segment is seeking to create a more customer oriented service company to significantly differentiate itself from its competitive peers. A core business process redesign project began in fiscal 2002 with an exhaustive effort to identify customer expectations and document existing business processes. During fiscal 2002, the Partnership recorded $2.0 million in expenses relating to this project.
Preliminary conclusions indicate that improved processes and related technology investments could have a meaningful impact on reducing the heating oil segment’s annual operating costs. Technology investments in particular are a critical element of our strategy to improve the efficiency and quality of services provided to our customers. To this end, the heating oil segment is now testing second generation hand-held technology for the automation of our service workforce. These wireless hand held data terminals will allow our service and installation professionals on demand access to customer repair history, data to provide instant part and repair quotations, and capabilities to invoice at the completion of service.
The comprehensive process redesign efforts led the Partnership to a conclusion that regional and corporate consolidation of certain operational activities is expected to create operating efficiencies and cost savings for heating oil customers. Selective outsourcing in the areas of customer relationship management will be undertaken as both a business improvement and a cost reduction strategy. The Partnership believes that outsourcing customer inquiries are expected to improve performance and leverage the technology and system redundancy. In addition, the Partnership believes an outsourcing partner has more flexibility to manage extreme seasonal volume spikes while providing a consistent and guaranteed level of quality service. Technology benefits are expected to include enhanced capabilities for customer inquiries via automated interactive telephone response and the web. Outsourcing is expected to both dramatically improve customer services while reducing annual operating costs.
The $1.8 million incremental expense in the first six months of fiscal 2003 related to this redesign project largely consisted of consulting fees and travel related expenditures. The expenses related to the on-going business implementation redesign project will continue throughout fiscal 2003. In connection with this plan, the Partnership announced its reorganization plan to the impacted employees in April 2003 and will recognize a liability of approximately $2.0 million related to certain employee termination benefits and separation costs. This total amount of approximately $2.0 million will be incurred and recorded throughout the remainder of fiscal 2003. The Partnership also expects to expend an additional $3.1 million for non-separation cost for the remainder of fiscal 2003 related to the reorganization. These expenditures will consist of truck rebranding, consulting and duplicative salaries during the transition period. For fiscal 2004, the Partnership expects additional expenses related to this program of $1.9 million.
22
By the completion of the program, total expenditures will be $25.9 million of which $15.1 million will be for investments in technology. Through March 31, 2003, $8.3 million was spent with the balance to be purchased over the remainder of fiscal 2003 and into fiscal 2004. It is anticipated that the program will improve operating income by approximately $15.0 million annually of which $9.0 million is expected to be realized in fiscal 2004 and with the remainder in fiscal 2005 and fiscal 2006. The Partnership believes that these levels of savings will be realized, there can be no assurance that these amounts will actually be forthcoming, nor that other events will offset the expected benefits.
For the six months ended March 31, 2003, interest expense decreased $1.0 million, or 4.5%, to $20.5 million, as compared to $21.5 million for the six months ended March 31, 2002. This decrease was largely due to a lower weighted average balance of long-term debt outstanding during the six months ended March 31, 2003 compared to the six month period ended March 31, 2002. This decrease resulted from the repayment of debt since March 31, 2002.
For the six months ended March 31, 2003, income tax expense increased $3.9 million to $2.1 million, as compared to a tax benefit of $1.8 million for the six months ended March 31, 2002. This increase was due to higher state income taxes based upon the higher pretax earnings achieved for the six months ended March 31, 2003 and the absence in fiscal 2003 of the tax benefit from a federal tax loss carryback of $2.2 million recorded in fiscal 2002.
Cumulative Effect of Change in Accounting Principle
For the six months ended March 31, 2003, the Partnership recorded a $3.9 million decrease in net income arising from the adoption of Statement No. 142 to reflect the impairment of its goodwill for its TG&E segment.
For the six months ended March 31, 2003, net income increased $27.5 million, or 38.3%, to $99.2 million, as compared to $71.7 million for the six months ended March 31, 2002. The increase was due to a $27.9 million increase in net income at the heating oil segment, from a $7.9 million increase in net income at the propane segment and by a $0.9 million decrease in the net loss at TG&E partially offset by a $9.3 million increase in the net loss at the Partnership level. The increase in net income was primarily due to the impact of colder weather and lower depreciation and amortization partially offset by the $3.9 million decrease in net income at the TG&E segment resulting from the adoption of Statement No. 142.
23
Liquidity and Capital Resources
The ability of Star Gas to satisfy its obligations will depend on its future performance, which will be subject to prevailing economic, financial, business, and weather conditions, and other factors, most of which are beyond its control. Future capital requirements of Star Gas are expected to be provided by cash flows from operating activities and cash on hand at March 31, 2003. To the extent future capital requirements exceed cash flows from operating activities:
Cash Flows
Operating Activities. Cash used in operating activities for the six months ended March 31, 2003 was $76.1 million as compared to cash provided by operating activities of $50.6 million for the six months ended March 31, 2002. The net cash used in operations of $76.1 million for fiscal 2003 consisted of net income of $99.2 million, noncash charges of $35.4 million, primarily depreciation and amortization of $26.7 million, which were offset by an increase in operating assets and liabilities of $210.7 million. Operating assets and liabilities have increased in fiscal year 2003 from fiscal year 2002, primarily due to a $141.3 million increase in accounts receivable resulting from the higher sales largely due to the colder weather experienced for the six months ended March 31, 2003.
Investing Activities. Star Gas completed two acquisitions during the six months ended March 31, 2003, investing $1.8 million. This expenditure for acquisitions is reflected in the cash used in investing activities of $9.5 million along with the $8.0 million invested for capital expenditures. The $8.0 million for capital expenditures is comprised of $4.0 million of capital additions needed to sustain operations at current levels and $4.0 million for capital expenditures incurred in connection with the heating oil segment’s business process redesign program and for customer tanks and other capital expenditures to support growth of operations. The capital expenditures made for the business process redesign program were largely for the purchase of modern technology to increase the efficiency and quality of services provided to its customers. Investing activities also includes proceeds from the sale of fixed assets of $0.4 million.
Financing Activities. During the six months ended March 31, 2003, funds were provided by $189.7 million of net proceeds from the Partnership’s $200 million senior note offering in February 2003 and from increased bank working capital borrowings of $109.4 million. Cash distributions paid to Unitholders of $34.9 million, debt repayments of $170.6 million and other financing activities of $0.4 million reduced the net cash provided by financing activities to $93.2 million.
As a result of the above activity, cash increased by $7.7 million to $69.1 million as of March 31, 2003.
24
Earnings before interest, taxes, depreciation and amortization (EBITDA)
For the six months ended March 31, 2003, EBITDA increased $27.6 million, or 23.1% to $147.1 million as compared to $119.4 million for the six months ended March 31, 2002. This increase was due to $26.6 million of more EBITDA generated by the heating oil segment, a $7.9 million increase in the propane segment EBITDA partially offset by $1.1 million lower TG&E EBITDA and by a $5.7 million reduction in EBITDA at the Partnership level. The increase in EBITDA was largely due to the impact of colder temperatures in our areas of operations as reported by the National Oceanic and Atmospheric Administration. TG&E’s EBITDA was negatively impacted by the inclusion of a non-cash $3.9 million decrease in net income for the cumulative effect of a change in accounting principle arising from the adoption of Statement No. 142 to reflect the impairment of its goodwill. 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. EBITDA is calculated for the fiscal six months ended March 31 as follows:
Plus:
Interest expense, net
19,901
19,008
EBITDA
119,446
147,069
Financing and Sources of Liquidity
The Partnership’s heating oil segment has a bank credit facility, which includes a working capital facility, providing for up to $123.0 million of borrowings to be used for working capital purposes, an acquisition facility, providing for up to $50.0 million of borrowings to be used for acquisitions and for capital expenditures and a $20.0 million insurance letter of credit facility. The working capital facility and letter of credit facility will expire on June 30, 2004. The acquisition facility will convert to a term loan for any outstanding borrowings on June 30, 2004, which balance will be payable in eight equal quarterly principal payments. To provide additional working capital capacity for the past heating season, the Partnership temporarily converted $20.0 million of its heating oil segment’s acquisition facility to a working capital facility which will expire on April 30, 2003. At March 31, 2003, $126.0 million of working capital borrowings were outstanding.
The Partnership’s propane segment has a bank credit facility, which consists of a $25.0 million acquisition facility, a $25.0 million parity debt facility that can be used to fund maintenance and growth capital expenditures and an $18.0 million working capital facility. The working capital facility expires on September 30, 2003. Borrowings under the acquisition and parity debt facilities will revolve until September 30, 2003, after which time any outstanding loans thereunder, will amortize in quarterly principal payments with a final payment due on September 30, 2005. At March 31, 2003, $2.0 million of Parity Debt Facility borrowings and $9.6 million of working capital borrowings were outstanding.
The Partnership’s bank credit facilities and debt agreements contain several financial tests and covenants restricting the various segments and Partnership’s ability to pay distributions, incur debt and engage in certain other business transactions. In general these tests are based upon achieving certain debt to cash flow ratios and cash flow to interest expense ratios. In addition, amounts borrowed under the working capital facilities are subject to a requirement to maintain a zero balance for at least forty-five consecutive days. 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 and/or pay distributions and could cause certain debt to become currently payable.
As of March 31, 2003, the Partnership was in compliance with all debt covenants.
25
On February 6, 2003, Star Gas and Star Gas Finance Company, a wholly owned subsidiary of Star Gas, jointly issued $200.0 million face value Senior Notes due on February 15, 2013. These notes accrue interest at an annual rate of 10.25% and require semi-annual interest payments on February 15 and August 15 of each year commencing on August 15, 2003. These notes are redeemable at the option of the Partnership, in whole or in part, from time to time by payment of a premium as defined. These notes were priced at 98.466% for total gross proceeds of $196.9 million. The Partnership also incurred $7.2 million of fees and expenses in connection with the issuance of these notes resulting in net proceeds of $189.7 million. During the quarter ended March 31, 2003, Star Gas used $131.0 million from the proceeds of the 10.25% Senior Notes to repay existing long-term debt and working capital facility borrowings and has designated an additional $18.3 million of the proceeds to repay existing long-term debt by September 30, 2003. The remaining proceeds of $40.4 million will be used for general Partnership purposes including acquisitions.
The Partnership has $494.1 million of debt outstanding as of March 31, 2003 (amount does not include working capital borrowings), with significant maturities occurring over the next five years. The following summarizes the Partnership’s long-term debt maturities during fiscal years ending September 30, exclusive of amounts that have been repaid through March 31, 2003:
18.3 million
19.5 million
25.3 million
81.4 million
38.7 million
Thereafter
310.9 million
The remaining fiscal 2003 maturities will be refinanced with a portion of the proceeds from the issuance of the $200 million 10.25% senior notes. However, funding for future year’s debt maturities will largely be dependent upon new debt or equity issuances.
In general, the Partnership distributes to its partners on a quarterly basis, all of its Available Cash in the manner described below. Available Cash is defined for any of the Partnership’s fiscal quarters, as all cash on hand at the end of that quarter, less the amount of cash reserves that are necessary or appropriate in the reasonable discretion of the general partner to (i) provide for the proper conduct of the business; (ii) comply with applicable law, any of its debt instruments or other agreements; or (iii) provide funds for distributions to the common unitholders and the senior subordinated unitholders during the next four quarters, in some circumstances.
The Partnership believes that the purchase of weather insurance could be an important element in the Partnership’s ability to maintain the stability of its cash flows. In August 2002, the Partnership purchased weather insurance that could have provided up to $20.0 million of coverage for the impact of warm weather on the Partnership’s operating results for the 2002—2003 heating season. No amounts were received under the policies during fiscal 2003 due to the colder than normal temperatures. In addition, the Partnership purchased a base of $12.5 million of weather insurance coverage for each year from 2004—2007. The amount of insurance proceeds that could be realized under these policies is calculated by multiplying a fixed dollar amount by the degree day deviation from an agreed upon cumulative degree day strike price.
For the remainder of fiscal 2003, the Partnership anticipates paying interest of approximately $23.6 million and anticipates growth and maintenance capital additions of approximately $9.5 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 plans to fund acquisitions made through a combination of debt and equity. Based on its current cash position, proceeds from the fiscal 2002 common unit offerings and from the $200 million 10.25% senior notes, 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 fiscal 2003.
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Accounting Principles Not Yet Adopted
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with Generally Accepted Accounting Principles requires management to establish accounting policies and make estimates and assumptions that affect reported amounts of assets and liabilities at the date of the Consolidated Financial Statements. Star Gas evaluates its policies and estimates on an on-going basis. The Partnership’s Consolidated Financial Statements may differ based upon different estimates and assumptions. Star Gas believes the following are its critical accounting policies:
The FASB issued Statement No. 142, “Goodwill and Other Intangible Assets” in June 2001. Statement No. 142 requires that goodwill 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 also requires that intangible assets with definite useful lives, such as customer lists, continue to be amortized over their respective estimated useful lives.
Statement No. 142 was adopted on October 1, 2002, with the Partnership now calculating amortization using the straight-line method over periods ranging from 5 to 15 years for intangible assets with definite useful lives. Star Gas uses amortization methods and determines asset values based on its best estimates using reasonable and supportable assumptions and projections. Star Gas assesses the useful lives of intangible assets based on the estimated period over which Star Gas will receive benefit from such intangible assets such as historical evidence regarding customer churn rate. In some cases, the estimated useful lives are based on contractual terms. At March 31, 2003, the Partnership had $180.2 million of net intangible assets subject to amortization. If circumstances required a change in estimated useful lives of the assets, it could have a material effect on results of operations. For example, if lives were shortened by one year, the Partnership estimates that amortization for these assets for the six month period ended March 31, 2003 would have increased by approximately $1.4 million.
Statement No. 142 also requires the Partnership’s goodwill to be assessed annually for impairment. These assessments involve management’s estimates of future cash flows, market trends and other factors. If goodwill is determined to be impaired, a loss is recorded in accordance with Statement No. 142. At March 31, 2003, the Partnership had $260.7 million of goodwill. Intangible assets with finite lives must be assessed for impairment whenever changes in circumstances indicate that the assets may be impaired. Similar to goodwill, the assessment for impairment requires estimates of future cash flows related to the intangible asset. To the extent the carrying value of the assets exceeds it future cash flows, an impairment loss is recorded based on the fair value of the asset.
Critical Accounting Policies and Estimates (continued)
Depreciation of Property, Plant and Equipment
Depreciation is calculated using the straight-line method based on the estimated useful lives of the assets ranging from 3 to 30 years. Net property, plant and equipment was $239.3 million for the Partnership at March 31, 2003. If circumstances required a change in estimated useful lives of the assets, it could have a material effect on results of operations. For example, if lives were shortened by one year, the Partnership estimates that depreciation for the six month period ended March 31, 2003 would have increased by approximately $2.0 million.
Assumptions Used in the Measurement of the Partnership’s Defined Benefit Obligations
SFAS No. 87, “Employers’ Accounting for Pensions” requires the Partnership to make assumptions as to the expected long-term rate of return that could be achieved on defined benefit plan assets and discount rates to determine the present value of the plans’ pension obligations. The Partnership evaluates these critical assumptions at least annually.
The discount rate enables the Partnership to state expected future cash flows at a present value on the measurement date. The rate is required to represent the market rate for high-quality fixed income investments. A lower discount rate increases the present value of benefit obligations and increases pension expense. A 25 basis point decrease in the discount rated used for fiscal 2002 would have increased pension expense by approximately $0.1 million and would have increased the minimum pension liability by another $1.7 million. The Partnership assumed a discount rate of 6.75% for its fiscal 2002 financials.
The Partnership considers the current and expected asset allocations, as well as historical and expected returns on various categories of plan assets to determine its expected long-term rate of return on pension plan assets. A 25 basis point decrease in the expected return on assets would have increased pension expense in fiscal 2002 by approximately $0.1 million. The Partnership assumed an 8.5% rate of return on plan assets for its 2002 financials.
Insurance Reserves
The Partnership’s heating oil segment has in the past and is currently self-insuring a portion of workers’ compensation, auto and general liability claims. In February 2003, the propane segment also began self-insuring a portion of its workers’ compensation, auto and general liability claims. The Partnership establishes reserves based upon expectations as to what its ultimate liability will be for these claims. The Partnership continually evaluates the potential for changes in loss estimates with the support of qualified actuaries. As of September 30, 2002, the heating oil segment had approximately $25.1 million of insurance reserves. The ultimate settlement of these claims could differ materially from the assumptions used to calculate the reserves which could have a material effect on results of operations.
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Item 3.
Quantitative and Qualitative Disclosures About Market Risk
The Partnership is exposed to interest rate risk primarily through its Bank Credit Facilities due to the fact that they are subject to variable interest rates. 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, 2003, the Partnership had outstanding borrowings totaling $629.7 million, of which approximately $137.6 million is subject to variable interest rates under its Bank Credit Facilities. 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, 2003, the potential gain on the Partnership’s hedging activity would be to increase the fair market value of these outstanding derivatives by $4.8 million to a fair market value of $11.1 million; and conversely a hypothetical ten percent decrease in the cost of product would decrease the fair market value of these outstanding derivatives by $4.8 million to a fair market value of $1.5 million.
Item 4.
Controls and Procedures
Within the 90-day period prior to the filing of this report, an evaluation was carried out under the supervision and with the participation of the Partnership’s management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of our disclosure controls and procedures. Based on that evaluation, the CEO and CFO have concluded that the Partnership’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Partnership’s reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. Subsequent to the date of their evaluation, there were no significant changes in the Partnership’s internal controls or in other factors that could significantly affect the disclosure controls, including any corrective actions with regard to significant deficiencies and material weaknesses.
PART II OTHER INFORMATION
Item 6.
Exhibits and Reports on Form 8-K
99.1 Section 906 Certificate
99.2 Section 906 Certificate
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, 2003
Ami Trauber
Star Gas LLC
(Principal Financial Officer)
JAMES J. BOTTIGLIERI
Vice President
James J. Bottiglieri
CERTIFICATIONS
I, Irik P. Sevin, certify that:
Date: April 30, 2003
/s/ IRIK P. SEVIN
Irik P. Sevin
Chief Executive Officer
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I, Ami Trauber, certify that:
/s/ AMI TRAUBER
33