Star Group LP (SGU) 2008 Q3 法說會逐字稿

Good morning. My name is Wes, and I will be your conference operator today. At this time, I would like to welcome everyone to the Star Gas Partners fiscal 2008 third quarter results conference call. All lines have been placed on mute to prevent any background noise. After these speakers' remarks, there will be a question and answer session.

(OPERATOR INSTRUCTIONS)

Thank you. I will now turn the conference over to Mr. Dan Donovan, President and Chief Executive Officer of Star Gas Partners. Please go ahead, sir.

Thanks, Wes. Good morning, and thank you for joining our call and webcast today. With me is Star's Chief Financial Officer, Rich Ambury and our Senior Vice President of Operations, Steve Goldman.

Before we being, I'd like to ask Rob Rinderman of our investor relations firm, Jaffoni & Collins, to read the Safe Harbor statement. Rob?

Thank you, Dan. Good morning, everyone. This conference call will include forward-looking statements that reflect the partnership's expectations or beliefs concerning future events that involve risks and uncertainties, including those associated with the effect of weather conditions on our financial performance, the price and supply of home heating oil, consumption patterns of our customers, our ability to obtain satisfactory gross profit margins and our ability to obtain new accounts and retain existing customers.

Our ability to make a strategic acquisition, the impact of litigation, the continuing residual impact of the business process redesign project, and our ability to address issues related to that project, our ability to contract for our future supply needs, natural gas conversion, future union relations and the outcome of current and future union negotiations, the impact of future environmental, health and safety regulations, the ability to attract and retain employees, customer creditworthiness, counterparty creditworthiness, marketing plans and general economic conditions.

All statements other than statements of historical fact included in this conference call 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 are disclosed in this conference call and in the partnership's annual report on Form 10-K for the fiscal year ended September 30, 2007, and on its Form 10-Q for the fiscal 2008 third quarter, ended June 30, 2008.

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 statement. Unless otherwise required by law, the partnership undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise after the date of this conference call.

Now, I'd like to turn it back to Dan Donovan for his opening remarks.

Thanks, Rob. To begin, Rich Ambury is going to give a brief financial review of the fiscal third quarter and the nine-month period ending June 30, 2008. My remarks will follow and then we'll be happy to take your questions.

Rich?

Thanks, Dan, and good morning, everyone, and thank you for joining us to discuss our results for the third fiscal quarter and the nine months ending June 30, 2008. Let's look at the top-line volume for the quarter.

We sold 46 million gallons, compared to 57 million gallons last year. This decrease of 19% was largely due to 14% warmer temperatures, a decline in our customer base, conservation efforts by our customers and the loss of several high-volume but low-margin commercial accounts.

When you look at our per-gallon margins, they reached $0.755, up from $0.675 realized in the prior period, and contributing to this increase was a benefit of some relatively low-cost inventory at the beginning of the period. We realized a gross profit from our service and installation business of $5.4 million, which represents an improvement of $2.5 million versus the prior quarter, and when you look at our operating expenses, they did increase by $4.2 million.

That increase was largely due to a provision for bad debt of $3 million and $2.2 million in costs from our standalone acquisitions. The increase in the reserve was largely driven by an increase in our sales dollars.

Due to the seasonal nature of our business, the third quarter normally generates an adjusted EBITDA loss and this loss widened by $5.5 million to $9.5 million, as the impact of higher per-gallon margins and the improvement in service and installation profitability was more than offset by the impact of bad debt expense and the effects of warm weather and conservation on volume.

We recorded a mark-to-market gain on our hedges, which is non-cash, and these hedges were for future deliveries and that gain was $30 million during the quarter. This compares to a similar gain for the three months ending June 30, 2007, of $4.9 million. We posted net income of $11.8 million, which compares to a loss of $8.3 million for the third fiscal quarter of 2007.

This change of $20 million was driven by the non-cash change in the fair value of derivatives of $25 million, reduced by a $5.5 million reduction in the EBITDA generated in the quarter. Moving over to the nine months, we sold 329 million gallons, compared to 351 million gallons last year. This decline of 6.5% again was due to a reduction in the customer base, some conservation and slightly warmer temperatures.

While temperatures were a bit warmer than last year, they were still almost 6% for the nine months warmer than normal. Our per-gallon margins reached $0.728, up about $0.005 versus the prior nine months. Again, we reduced our service department costs and improved this area by $5 million.

When you look at our operating expenses, they're up by $11.9 million and a large portion of this increase is due to weather insurance. As we've discussed in prior quarters, we recorded a benefit of $4.3 million in 2007, which reduced operating costs. Despite the warm weather in 2008, we did not record a similar benefit.

For the nine months, we had higher bad debt expense of $5.5 million, due to the increase in sales and our standalone acquisitions added $7.5 million in costs. To compensate for the volume decline, we were able to reduce our operating expenses by approximately $5 million. Adjusted EBITDA was $67 million, or $22 million less than the prior period, due to the lower home heating oil volume, the absence of weather insurance and an increase in our reserve for bad debt expense.

We posted net income for the nine months of $78.5 million. I would like to recap the impact of the increase in our product cost on our results. Not only did we have to provide a larger reserve for bad debts of $5 million, but our negative interest expense was increased by $2 million.

Conservation and other volume impacts were also impacted by the increase in the price of heating oil, and that led to a reduction in EBITDA of between $4 million and $6 million, and the margins realized on our ceiling or cap customers were also squeezed, which reduced our profitability by $3.5 million, as well.

Given the fact that our per-gallon margins on a majority of our price-protected customers are set prior to the winter season, our ability to manage through these issues on a real-time basis in the very near term is diminished. There is a built-in lag effect, so to speak.

As we are in the thick of our renewals season, we are attempting to increase our margin expectations for these added costs of doing business. And moving over to our balance sheet, as of June 30, 2008, we had over $220 million in working capital, cash of $90 million and long-term debt of $174 million.

During the quarter, cash provided from operating activities was $127 million. Over $109 million of this cash flow was a change in our accounts receivable. That said, our DSOs of accounts receivable has increased by eight days to 58 days. As we reported at the end of the second quarter, our DSOs were up by eight days, as well. So based on this measure we did not lose any ground on our collections of our accounts receivable this year versus last year.

When you look at our days sales outstanding, about half of the increase are coming from our budget or [Smart Pay] customers, who have been making their monthly payments as scheduled, but who have never really been invoiced for these amounts because they are paying their monthly budget payments. On the amount that they have been delivered, we have not invoiced these customers. We are truing up these customers in July and August, when their budget period ends. And as of this morning we had over $126 million invested in cash.

Back to you, Dan.

Okay, thanks, Rich. While we have seen some downward pressure in the price of heating oil since mid July, the quarter ending June 30th was, to say the least, tumultuous in terms of both price and volatility. Just to give you some examples, monthly average Merc heating oil prices in 2008 versus 2009 reflect the year-over-year cent-per-gallon increase of $1.33 in April, $1.74 in May and $1.82 in June.

During the two-day period of June 4th to June 6th, 2008, we saw a $0.43 per gallon increase in the [spot] cash price. A 22-day period in May of this year saw an increase of $0.84 per gallon. The average monthly NYMEX heating oil settlement increased over $0.80 per gallon from April 1st to June 30th in 2008. In comparison, during the same quarter in 2007, this price increase was only $0.25 per gallon, and this change was considerably less than previous years.

In spite of all this volatility, our heating oil margins in the fiscal third quarter exceeded the prior year and our budgeted expectations. Volume for the three-month period was affected by conservation and attrition, both driven by record heating oil prices and a weak economy. While offset somewhat by additional volume provided by the acquisitions we made since the last year, warmer temperatures were also a strong contributing factor to the decline in volume.

This was especially significant in the month of April. April '08 degree days were only 68% of the April '07 total. Account losses were adversely impacted by the continuing surge in the price, as well as by a 25% increase in prospective accounts that were rejected due to creditworthiness issues.

But, during the quarter, account gains improved. Basically, they improved due to an increase in customer referrals and other net gains. As a result, for the quarter ending June 30, 2008, we gained 1,300 more accounts than the previous year's quarter. This gain was partially offset by 800 more account losses than the 2007 third quarter, and thus resulted in 500 fewer net lost customers than the previous year's quarter.

In the weak economic environment that many consumers face today, collecting accounts receivable is a challenging task, but we have taken several new credit and collection initiatives at our credit center and at our field operations to bolster this important area. Some of these include, we utilize our customer service -- or we have utilized our customer service staff to make more proactive calls.

We've increased our credit staff and the number of hours worked. We are increasing customers' payment options. We've redesigned collection letters, and we are emphasizing incentive programs to stimulate collections, something that we've always done, but we're just emphasizing it a little bit more.

As mentioned in our news release, we have increased our reserve for doubtful accounts, but we are hopeful that the prior-year payment patterns will continue. On the acquisition front, we completed three purchases in the fiscal third quarter, closed on another acquisition in July, and are looking to close on one or two more by the end of August. We continue to be in various stages of evaluation on several others.

The acquisitions we completed this fiscal year through July 31, 2008, total approximately 2.8 million gallons. In aggregate, we have completed 14 acquisitions since January 2007. The challenging market condition created by the high price of oil has significantly increased the number of potential opportunities for Star.

However, it would be clearly unwise for us to purchase customer lists that don't benefit the partnership in the long term. We will therefore continue to maintain our discipline when evaluating potential purchases to consider only those that we feel would be a profitable fit with Star's operations.

At this time, we will be pleased to address any questions you have, so, Wes, could you please open the phone lines for questions?

(OPERATOR INSTRUCTIONS)

Your first question comes from [Brad Krest], private investor.

Looking forward to the start of hopefully the distribution, what would be the [math] or the issues surrounding that, or can you talk about that, looking into just the date you'd -- press release was early '09 (inaudible)?

I didn't really get the last part of that. Your voice sort of tailed off. Can you just repeat that again, please?

The distributors, the minimum distributors and looking forward to that in the first quarter, can you talk about that? Is there a certain level of EBITDA or there are issues or things that we should be aware of in terms of how that's going to shape up and what the level of distribution would be or anything you can -- ?

No. As we've been saying all along since April of '06, we're planning on paying that first distribution, which would be paid in February of '09 for the first quarter, and we feel that that's still going to happen.

And is that -- so the level that's set in the partnership agreement is a certain level? Could it be higher? Is there anything like that? Maybe you'll talk about that more when it's --

As we've said right from the beginning, our first priority is still to grow with any cash that we may have through acquisitions, which we're trying to do and be very disciplined on that, but of course there are other options -- debt repayment, special distributors, unit repurchases, although the unit repurchase can't happen until after April of 2009.

So we have that all on the table, but acquisitions, as we were looking at, and as of right now we plan on paying the distribution, as we've stated right from the get-go.

I got one more. The way that units have been trading, it just appears the market's got some sense of -- obviously with the price of heating oil, but almost like a distressed feel to it that you look at what you guys are doing and you guys, you have access to credit. Within a certain range of heating oil prices, you guys are a stable operation, correct? It's not like there's --

Yes, we believe so, and we believe our numbers show that over the last two or three years.

Okay, thank you.

You're welcome.

Your next question comes from Michael Prouting of 10K.

Hi, guys.

Hi.

It was pretty tough getting on the call this morning, almost as tough as finding cheap heating oil. A couple of questions. Did you say how much you spent on acquisitions in the quarter?

We did say that.

It'll be in the Q, though, of course, right?

It's definitely in the Q, but I don't have the number right off the top of my head. Hold on one second. For the quarter, it's $1.3 million.

$1.3 million, okay. Any thoughts in terms of how much cash from operations you might generate in the September quarter?

You'll have to put those numbers together yourself. We do collect more of our receivables -- we still will collect more of our receivables in the next quarter, as well. And, as I said already, we've got a cash balance invested today of $126 million, which compares to the $90 million that we had as of June. So in 30 days we've got a cash build of the difference between 126 and 90. That's $36 million.

Okay. So I imagine with the price of crude coming down here, I guess I should check heating oil, has heating oil also tracked the decline in crude?

Yes, heating oil has come down to about, as of yesterday, $3.23, $3.25, something in that range. That's the Merc number. The cash spot number might be a little bit different. So, yes, it has definitely been coming down since somewhere around July 17th we've in a down market, which is good.

I'm curious what you're seeing on the marketplace from competitors at this point. Are there many folks that are going out of business in the current environment? Are people more willing sellers? Any thoughts, comments on that?

We haven't heard of any bankruptcies since the one company in Connecticut which went out in the second quarter. There might have been a few smaller ones that I don't know of. But from what we hear, everybody is having problems, and it just makes sense that they would, because with this high cost of oil, working capital is not only a bigger number, but it's also harder to get, given the credit crisis.

So we are seeing more dealers who claim to be having problems and we are hearing from more dealers who think that it might be a good time to sell their business. So even with the price down at $3.23, you're talking about a pretty big number, still, so there are going to be some strains on other companies, in our opinion.

Right. Well, I guess at the same time, though, it doesn't sound like there's enough people exiting the business that's really going to change the fact that it's going to continue to be extremely competitive, right?

I would think so. It's always been a competitive business, a very competitive business, and we expect it to stay that way and we gear our marketing and sales program to operate in that environment.

And just finally, I've heard anecdotally that some of the gas utilities are being a lot more generous/aggressive in helping people convert. Any thoughts/comments on that?

Yes, they definitely are. There are certain utilities in our footprint that do that and they do become very aggressive. They realize that they have a price advantage right now, but one thing you've got to remember is that this price advantage is the first price advantage that they've had in a long time.

For instance -- it's different in all of our marketing areas, but in some of the areas, in the last 20 years, they've had a price advantage two of those years. We've had the price advantage the other 18 years. Their marketing effort to convert people because gas is cheaper really doesn't hold much water when you look at the payback scenario, because we expect things to go back to normal.

But not only that. it could cost you anywhere between $3,000 to $9,000 to convert from oil to gas. I will admit that they are out there trying to do a better job at that and the industry is out there trying to get the real facts out and hopefully we'll be doing a lot more of that in the coming months.

Great. All right. Thanks for taking my questions.

Sure.

Your next question comes from [Mike Mulligan], private investor.

Good morning. I'm just kind of wondering after reading about the SemGroup bust and I wonder if you could comment on your hedging operations and what kind of controls you might have so I don't get some kind of a rogue trader that could get the Company in trouble. Thank you.

I'll ask Rich to give a little bit more color on it, but the one thing that we do is we hedge, we don't speculate. We hedge our protected price product and we also hedge so that our cost is more equal to the market on a daily basis and we have some very tight controls on how that's done. It's a daily activity that's looked at very closely by several people.

But, Rich, do you just want to give a little bit more color to that?

Yes, we don't try to call the market. We don't say that the market looks good to buy heating oil. We don't say the market looks bad to buy heating oil. In fact, you go back to a conference call, one or two conference calls, when folks were mad at us that we didn't lock in heating oil when it was lower.

But what we do is every day we go through our customer base and find out the number of customers who are on protected price and at what levels they are on our customer file with and we lock in how much we need, based on monthly deliveries for these customers each and every day and we put on hedges that are 0.5 million gallons, 500,000-gallon hedges that we put. And the majority of those hedges are put on with folks in our bank group, because they are secured by the collateral in our assets.

And, again, we don't try to call the market. We do have some physical inventory and we short that physical inventory to, if you will, unprice it and have that physical inventory float with the market. So if the market goes up, we're able to -- our costs will go up with the market. And if the market goes down, which we like, we'll be able to lower our prices to our customers. So, again, we don't take any risk.

Thank you.

And the hedging operation reports directly to me.

Your next question comes from Brad Krest, private investor.

Just had one more. Looking at your guys' business and just out here trying to understand it, you guys have been doing this for years and years and years. What are the scenarios -- obviously a huge driver is the price of heating oil, obviously, but what are the scenarios -- like, if you guys look at these crazy, price going up, price going down, what are the scenarios that obviously this is good for us as it impacts customer behavior, people locking in? Is it like a steady price?

This crazy volatility, does that actually help you guys to lock in, the working capital aspect? Can you just talk about being in the business for a long time, kind of the ups and downs of the prices and how that plays out in terms of the business?

High price and volatility do not help us. High price and volatility hurt us. We would much rather have a stable price and a lower price and a cold winter. The way we get customers is not through the price of oil. We get customers through service. We consider ourselves a service company, not an oil company.

We provide a service whereby we protect our customers' largest assets, their homes, and if we could have a stable price and we could give them the good service that they deserve, which we do, year in and year out. That's one reason that the cold winter is helpful to us, because it gives us the opportunity to prove to them that our service is superior than most of our competition. That's how we keep these customers.

So we look for stability in price, low volatility, hopefully a reasonable price where we can make our margins and allow us to deliver the superior service that we try to do each and every day.

Great, and just one -- are you seeing in the customers, are they at this point more interested in locking in? Like, if this price comes down here? Are they sort of like, I can't believe this. I'm just going to ride it and I'm having trouble with my mortgage anyway, or is there any sense you have of that?

A lot of customers, over almost 50% of our customer base, stay on a market price. And there's great advantages to staying on a market price. While you go with the ups and downs of the market, you are not paying any extra fee for what it costs companies to hedge that.

Some companies charge an up-front fee. Some companies just build it into their price. So the market price is something that almost 50% of our customer base still likes. The other 50%, basically, if they do lock in, they like a program we call the ceiling program. Some people call it a cap program, but basically there is a catastrophic price that they will not go higher than, and their price can fluctuate below that with the market.

Of course, there's a cost for that, too, and our hedging cost, which we mentioned in our Q, hedging costs have gone up tremendously, and last year, to hedge a ceiling customer, it might have cost us $0.14 or $0.15 a gallon. This year, that's well over $0.50 a gallon, and that has to be built into the price.

But even at those levels, some customers want that protection, and we have not pulled any programs at all. We offer any price protection program a person wants, but still a lot of customers go along with the fact that, hey, a market price might be the best thing for me. What they look to us for, really, is the level of service that we can deliver along with the pricing options that we also have available.

Thank you.

Your next question comes from Michael Prouting of 10K.

Hi. I had a slight variation on the previous question, which is that I realized that especially in the current market environment, the spread between crude and heating oil is being variable, to say the least.

But is there -- as you guys look back over the course of many years in this business, is there a magic number in terms of the price of crude at which this becomes, shall we say, a better business, at which customers aren't quite so price sensitive, in which your competitors aren't quite so price aggressive, in which the gas utilities don't have quite the pricing advantage, et cetera?

When crude was down, say, from $40 to $60 to $70 a barrel, heating oil was in a range then where we did have an advantage. As I said, for most years, we've had an advantage over gas utilities. So far as the competition, when we were charging less than $1 a gallon, it was very competitive. When we're charging $4 a gallon, it's very competitive. I've never seen it not competitive, but we're used to dealing with that. We understand how the market is, and we feel that we can hang in there with the best, mainly because of how we market our services.

So I don't know if it really makes that much of a difference, other than the fact, as we've said, we would love to see the price go down a lot more.

Okay, but it sounds like, from what you're saying, that the price of crude would have to drop a lot in order for, shall we say, the current characteristics of the business to move back in your favor.

No, any drop whatsoever is going to help. The drop of the last two or three weeks helped a lot, so I'll take any drop that we get. We're flexible enough and we're nimble enough to be able to market in any environment.

Okay, sure. And then just finally, again, as far as the gas is concerned, it sounds as though there could be some significant increase in the amount of LNG that's being imported into the U.S. next year. Any thoughts on that and how that could affect the market?

It depends upon what the price of it is. If our price is favorable to that, gas is going to go back to being a fuel that's not going to have that price advantage. The gas utilities try to market their product not only based upon price, but based upon environmental standards. But the bottom line is that natural gas is methane, so environmentally I really find it hard to understand how they could even market it on that basis.

On the basis of cost or the basis of supply, they would go hand in hand. And if their cost is equal to ours, or more than ours, which has been the case in most years, we'll do very well against them.

All right, thanks.

(OPERATOR INSTRUCTIONS)

Your next question comes from [Ed Olson], private investor.

Good morning. Nice performance in a tough environment. I noticed the lack of institutions on the call this morning. Do you read anything into that? And there was a block of 700,000 shares that traded earlier this month, or last month -- sorry, this month. Any idea what the nature of the sell was and why?

Second question, you all bought stock, which I think gave the holders a great deal of confidence, and wonder if that's going to be repeated. And then, finally, what date should we look towards to see what the exact amount that would be paid on the distribution and the potential of any special dividend or special distribution being declared. Thank you.

Let me try to answer one and two and then I'll ask Rich to talk about number three. We have no idea who sold that bock. There are many institutional investors, which we speak to from time to time, but we really don't know who that is.

We also don't know what the rhyme or reason is for our units moving up or down. The economy is bad, it moves. It doesn't seem to react to what the economy's doing. It doesn't seem to react to what the price of oil is doing, because we've seen the price of oil go in both ways and we just don't see any direct connection there. So what the reasons are, we really don't know.

And, Rich, do you want to just talk about -- ?

I'll add to that, too, is that when we recapitalized in April of 2006, we did exchange some debt for equity and it was roughly $13.5 million units exchanged at that time for some large holders. Yes, some of the investment banks have kind of fallen on some hard times, so maybe they had to sell a position.

We expect to fully pay the $0.27 annually, and as far as any special distributors go, we'll have to evaluate that with our cash position and where heating oil prices are over the next year.

Do you note any slowdown in the institutional interest? In other words, again today, I think there might have been one or two only. Most of the questioners were private investors.

No, we really don't notice any lack of interest. We get questions from time to time from them, just like we always did.

Okay, and then one other point. You might note that the low point on the chart was the day that that stock printed.

Yes.

Thank you.

You're welcome.

And, ladies and gentlemen, at this time I'm showing no further questions.

No other questions, Wes?

Actually, we do have a last question from [Jeff Graham] of [Bandera Partners].

Hello, guys.

Hey, Jeff.

That was an extremely good quarter. I guess I thought I would hop in just because of all of the questions about the lack of institutional investors. The question that I'll ask, I guess, the thing that popped out at us, is we saw that they're doing a strategic review at Griffith.

And the thing that we're curious and excited about is the possibility of doing a big deal at some point in the near future, and I'm curious to hear your thoughts about that, because we know that there are some larger players out there that could potentially be on the block.

As I said before and we've been saying all along, our number-one priority is acquisitions, and obviously a large acquisition such as that that you mentioned, or any of the other acquisitions that might be considered in that category or even a little bit less than that, we're very interested in and we definitely would want to look at those.

In some cases, we think that they would be very good fits with the Star footprint and with our company in general, whether they're in our footprint or not. So obviously we would be very interested in any activity that could come our way in regards to larger acquisitions.

Well, thanks a lot, guys, and keep up the good work.

Thanks, Jeff.

Thanks.

And, gentlemen, at this time, I'm showing no further questions.

Okay, well, I just want to thank everybody for joining us today and I thank you for your ongoing interest in Star Gas, and we look forward to sharing the year-end results with you on our next call. Have a good day. Thanks.

Ladies and gentlemen, that concludes the Star Gas Partners Fiscal 2008 Third Quarter Results Conference Call. We appreciate your time. You may now disconnect.