Star Group LP (SGU) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen. And welcome to the Star Gas fiscal second quarter earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder, this conference is being recorded. I would like to introduce your host for today's conference, Mr. Dan Donovan, CEO of Star Gas Partners. Mr. Donovan, you may begin.

Okay, thank you. Good morning, and thanks, everyone, for joining our call and webcast. With me today is Star's Chief Financial Officer, Rich Ambury, and our Chief Operating Officer, Steve Goldman. I'll be providing some brief remarks about the acquisition announced in our press release, after which Rich will review the fiscal second quarter ended March 31st. And that will be followed by some comments from Steve regarding Star's operating results in the second quarter. And of course then we'll be happy to take your questions. Before we begin, Chris Witty of our Investor Relations firm, Darrow Associates, will read the Safe Harbor statement. Go ahead, Chris.

Thanks, Dan, and good morning. This conference call may include forward-looking statements that represent the Partnership's expectations and beliefs concerning future events that involve risks and uncertainties and may cause the Partnership's actual performance to be materially different from the performance indicated or implied by such statements. All statements other than statements of historical facts 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 and Form 10-K for the fiscal year ended September 30, 2009. 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. Unless otherwise required by law, the Partnership under takes no obligation to publicly 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. I'd now like to turn it back to Dan Donovan. Dan?

Thanks, Chris. As we announced in our press release, we just completed the acquisition of Champion Energy Corporation for $50 million plus working capital, which is estimated to be about $11.3 million. Champion operates several full-service home heating oil companies in Connecticut, New Hampshire, New York, Pennsylvania, Virginia and Maryland. These companies market under various brand names, and similar to our operations they sell, service and install heating, cooling and plumbing equipment.

Champion services over 45,000 residential and commercial customers, which amounts to an increase in our customer base of approximately 12%. Champion's most recently completed fiscal year ended June 30, 2009. They posted sales of $152 million, generating $9.5 million in adjusted EBITDA. During this period the company sold 32.5 million gallons of residential home heating oil, 4.1 million gals of commercial heating oil and about 8.1 million gallons of other petroleum products.

Obviously you can see that the size and geographic footprint of Champion is attractive, but we're most impressed with their management and those people who supervise all of the local operations, because they're well known for their ability to deliver excellent service to their customer base. Our plan is to continue utilizing this management team to maintain and grow Champion's customer base, keep their current practices, and when practical enhance them with operational and marketing synergies from Star.

We believe Champion is an excellent fit for Star, and we're eager to work with them going forward. Just like us, the Champion employees take great pride in the home heating services they've been offering their customers for many years. This acquisition significantly increases our customer base, complements our internal retention efforts. It enhances our organic growth opportunities, and it strengthen the breadth and depth of our operations. Under the Star Gas banner we expect Champion to continue with the same tradition of excellence in customer service that both companies taking pride in.

Turning to our own operations for a moment, our investors know that each year brings its own set of challenges. During fiscal 2010, that challenge has been exemplified by the return of high oil prices. The average New York Harbor wholesale spot or cash price for heating oil in May 2009, a year ago, was $1.48 per gallon. Today that price is $2.11 per gallon, and it was as high as $2.32 just seven days ago. This $0.62 to $0.84 gallon increase means much higher pricing from retailers this year, which could trigger many to shop around. We feel we're well prepared at Star to handle the multifaceted type of conversation that may generate with -- that customers may generate in their conversations with us. It's a demanding and difficult task, but we feel we're up to it.

In regard to attrition, we've shown significant progress through the second quarter in reducing attrition from previous years. Net attrition has been reduced by 3% versus the same period last year, with the biggest improvement coming from a reduction in lost accounts. While we gained 8,000 fewer new account than the previous year, we reduced our losses by over 20,000 accounts versus the six months ending 03/31/09.

Steve Goldman will touch on this in a moment, but I can assure you even though the results have improved, we're not satisfied with them. We'll continue to make improvements in attrition, because to us that's our primary goal, is to keep our customers. With that, I'll turn the ball over to Rich Ambury to provide some comments on the second quarter financial results.

Thanks, Dan, andgood morning, everyone. For the quarter, our volume sales were down 19 million gallons, or 11%, due to warmer temperatures of 8% versus the prior period in net customer attrition. Degree days were warmer than normal by approximately 6%. The higher temperatures were largely due to a warming trend that began in March 2010, which was 25% warmer than March 2009. This warming trend has continued, with April being 29% warmer than April 2009. Our home heating oil margins increased by $0.07 per gallon this quarter.

You might recall that in the prior year period our per gallon margins were adversely impacted by the fact that fixed price customers decided to terminate their arrangements with us due to price -- terminate their arrangements with us early due to price volatility. In the three months ending March 31, 2009, we were burdened with the high cost of product for those customers that was only partially offset by liquidating damages. Still total gross profit declined by $4.7 million this quarter, as the impact of higher margins and an improvement in service and installation profitability could not totally offset the quarter's volume decline.

In looking at our operating expenses, delivery and branch expenses and general administrative expense declined by $4 million, which almost totally offset the decline in gross profit. We posted net income in the quarter of $41 million, a decrease of $68 million due to an unfavorable change in the fair value of derivative of around $38 million, lower income from buying our debt of approximately $7 million, and an increase in deferred income taxes of $25 million.

Let me see if I can add more color to those items. While we have recorded a net noncash credit from marking our markets -- our derivatives to market of $5 million in this quarter, the net noncash credit in the prior period was $42 million and represents the realization of an unrealized loss, that was recorded in the first quarter of fiscal 2009, that was realized and reversed the cost of goods sold in the second quarter of fiscal 2009.

Regarding our bonds, this February we called $50 million of our bonds at a slight premium and recorded a loss of $1.1 million. This compares to the second quarter of fiscal 2009 when we bought $25 million of bonds at a discount to face value and recorded a gain of $6 million.

Our deferred taxes went up because we released the valuation allowance on our NOLs at the end of fiscal year 2009, and we are now recording the utilization of these NOLs through the income statement. As a reminder, over the past several years we've utilized a good portion of our NOL.. At the end of December 2009, the NOLs amounted to some $52 million. After we exhaust the NOL, our cash taxes will increase significantly, which will reduce the amount of funds available for distributions.

Adjusted EBITDA for the quarter declined just $0.75 million to $74 million, as operating expense almost totally offset the reduction in gross profit. In looking at the six-month period, our volume sales were down 33 million gallons, or 12%, due to warmer temperatures of 7% versus the prior period and net customer attrition of 4.7%. Our home heating oil margins increased by $0.027 per gallon, or 3% for the six month period. Total gross profit declined by $20.5 million, as the impact of higher margins and an improvement in service and installation profitability could not totally offset the volume decline.

In looking at our operating expenses, delivery branch and G&A expense declined by $11 million, or 7.5% for the six months, due to lower insurance expense of $4 million, lower bad debt of $1.4 million and a decline of vehicle fuel cost of $2.8 million.

We posted net income of $53 million for the six month period, a decrease of $48 million, again, largely due to an increase of deferred income tax expense of $36 million and lower income from buying our debt of $11 million. Adjusted EBITDA for the six months declined by $9.6 million to $101 million, as the decline of volume due to warmer weather and net customer attrition more than offset the effects of higher margins and lower operating expenses.

As of March 31, 2010, we had cash of $54 million and borrowings under our revolver of $19 million. We used this cash to fund the Champion acquisition, and as of this morning our invested cash was $16 million and our borrowings under our revolver was zero.

In looking at the balance of the year, I would like to point out that the warmer temperatures has -- the warmer temperatures for April has impacted our volume, and we expect volume to be down for April by about 8.3 million gallons. In addition we believe that our margins will be down a little bit from last year as well, and don't forget that we did just buy the Champion acquisition, and we're going to set to some of the losses of the Champion acquisition. With that I'd like to turn it over to Steve for his comments.

Thank you, Rich, and good morning, everyone. Let me start off by saying that we are very excited by the addition of the Champion group of companies to the Star Gas organization. Having worked closely with their senior management leading up to the purchase, we feel very strongly about the synergies that will be realized between our two companies, and we envision benefits to Champion from the established buying programs and pricing tools developed at Star over the last several years. We see a seamless transition going forward.

Aside from this transition, let me just comment on the current operating environment. This past quarter was challenging on several fronts, most notably the unpredictable and dramatic weather conditions, as well as an economy that continued to stifle certain purchases. We began the period with very cold weather, which led us up to -- ramp up our service operations, and we were confronted in many areas with multiple snowstorms, including several in Maryland, which had rarely seen such weather conditions. We were very pleased by how our operations handled these challenges, as our customers truly saw the difference that we provide in the area of service.

However, March brought with it unusually warm weather, and so our operating managers had to react rapidly to reduce staffing and other related expenses. Once again, our management team performed very well. We know that the ability to adapt and quickly respond to changing conditions is a reflection of our strong management and dedicated workforce.

In the area of economic challenges, we still saw some hesitancy on the part of consumers to make major purchases in the way of large installations and some elective service work this quarter. However, we have more recently begun to see some better activity in certain areas reflecting the strengthening economy.

Overall during this past quarter we continue to see improved results in most aspects of our operations. We previously mentioned that we had aggressively focused our management team and believed the changes we made have clearly contributed to better results throughout the Company. The area we're most proud of is the continuing reduction in attrition, and several of our divisions grew organically during the first six months of this fiscal year. As stated before, this will always be a major focus for Star.

We've also seen a very noticeable reduction in insurance claims, in particular lower general liability and worker injury claims. These two areas of operational improvement, customer retention and insurance claims, have been directly impacted by our focus on increased management accountability. We've instituted very specific training programs as well as inspection programs that serve as the drivers for long-term performance gains in these and other areas. We have a great sense of confidence that the operating structure now in place will continue to lead to improved financial results and better customer service.

As we continue to work on all phases of our business, we are carefully reviewing are additional ancillary services that would benefit both our customers' needs as well as Star's profitability. We believe there are opportunities in the areas of plumbing, security, propane service, and natural gas equipment service, and are excited about the possibility to expand in such markets. Overall here at Star, the most noticeable dimension operationally that we're announcing is a very positive spirit fostered by an environment in which employees see themselves recognized for their achievements and their contributions to improving our business and serving our customers in an exemplary manner. With that, I'll turn it back over to Dan.

Thanks, Steve. At this time we'll be pleased to address any questions you may have, so, Chuck, could you please open the phone lines for questions?

Thank you, sir. (Operator Instructions). One moment for our first question. Our first question comes from Mac Sykes of Gabelli & Company.

Good afternoon, gentlemen. I just had a couple questions on the Champion acquisition. First, can we assume they've been facing the similar trends of customer attrition over the last few years that Star Gas has witnessed?

Over, say, from 2007 through 2009, yes. In some areas a little bit worse, but in several areas, especially recently, a little bit better. They have that same focus that we have on striving for excellence in customer service, because we know that's what keeps our customers with us. So I would say that the results have been similar, yes.

Okay. And why was the interest expense, about $4.5 million, why was it so high with the company with the sales that they had? Was it a very cost bankly -- high cost resolver cost revolver?

They had about, I believe, $30 million of debt, and there was an interest rate on that. And working capital borrowings. I mean they're not going to be structured -- we're not going to be structured in the same fashion that they had.

Okay. I guess cuff -- off the cuff calculations, EBITDA margins for them, about 6%, just from the financials here, as of June 30, '09, and then comparing those to about 13.5%. I know it moves around a little bit. I mean, can we imagine that division getting closer to the margins over time, maybe the next year or two with Star Gas?

Well, we really don't look at it as a percent. We kind of look at it as EBITDA per customer or EBITDA per gallon.

Okay. So I'm just -- I guess what I'm trying to get at is, just thinking about the transaction cost, is it looks like it was six times '09 EBITDA, but generally we've talked about acquisitions being four and five times. So I just wanted to see if I could understand those numbers a little bit better, I guess.

Okay. Well, the long-term assets that we bought were $50 million, and it makes approximately $9.5 million, $10 million, or a multiple of five. Now sellers, doesn't want to sit around and collect his receivable, so we're collect the receivables, we're going buy his inventory in part, and part of the transaction actually came with working capital and cash. We view those as liquid assets. They're really not part of the multiple when we talk about our multiples on acquisition.

Okay. Thank you very much.

You're welcome.

Thank you. Our next question comes from [Richie Gohl] of [Agon]. Go ahead, your line is open.

Hey, guys. I wanted to get an update if you guys have one in terms of share repurchase and the dividend.

Well, the dividend, we're still paying $0.29 annually.

Paid on the 14th.

Just paid on the 14th. And I believe we have around 1.5 million units still to buy on our share repurchase plan. Maybe a little bit underneath that.

And has -- in terms of bond repurchases and use of cash, I mean has your guys' view of the market changed, where you'll focus more on acquisitions, or are you guys still committed to the share repurchase program?

Well acquisitions is always first on our list. Obviously when acquisitions weren't happening, we were looking at paying down debt, which is a good thing, and buying back units, which is also a good thing. But we are looking at other acquisitions right now, and we're are optimistic that there will some other acquisitions we'll be able to close in on before the beginning of the next heating season.

Is it your view those would be funded through revolver borrowings since cash is low?

They would be funded with our own internal cash as we collect our receivables.

Okay.

There will come a point in time where we probably will have to do some kind of financing to finance a rather large acquisition, so to speak, because we've spent about $150 million, $160 million over the past 14, 15 months.

Great. Thank you.

(Operator Instructions). And our next question comes from Michael Prouting of 10K Capital.

Hey, guys. Good morning.

Good morning, Mike.

Nice execution. As usual, I've got several questions. Firstly, what was the reason for the decline in customer credit balances?

Sure. Well, last year, if you remember, the -- if you remember back to the summer -- let me see if I can get my dates right -- the summer of 2008, heating oil prices were very high, and as the summer of 2008, that's when we set the budgets for those customers. So those customers were paying, if you will, a high budget, and then the market declined after that, so there was a lot of collections on those customer credit balances, because to a certain extent the customers were paying off a high budget. This year, while there was some movement in prices up, actually going the other way, but the change was not as large, folks were set with a -- probably a lower budget in the summer of 2009 going into fiscal 2010. So you basically had two different market conditions driving the budget payment plans, and caused a large swing in the cash received from budget customers. All, in this business, quite frankly normal.

Okay, good. I just wanted to understand that. Secondly, on the acquisition, in terms of multiples or margins or whatever, I mean it looks to me actually that that their EBITDA margins are pretty similar to yours, because if you look at you guys on a trailing 12 month basis, your adjusted EBITDA margin is 6.4%, which is actually pretty much identical to their EBITDA margin. Am I looking at that the right way?

Yes, that's one way of looking at it, sure.

Okay. So it sounds like their business profitability metrics, et cetera,are pretty similar to yours, then.

We look at it on an EBITDA per account basis. They're very close to ours. And without the same corporate overhead that we have, they may be a little bit better. We're looking -- there will be synergies that we'll be able to take advantage of going forward, so we're optimistic that that's going to be good for us.

Can you quantify those synergies at all?

No, not right now.

Okay. Are there any synergies in terms of, say, market overlap or, I guess, reducing pricing pressure in any of your geographic markets?

Yes,we see some of those, but we also are concerned about one thing, and that's keeping the customers, so the last thing we're going to do is look at an area, and say, hey, this is just a few miles from a Meenan operation or a Leffler operation or a Petro operation, and we're going to meld that in with that. You're not going to keep your customers that way. The customers they have are very long-term, loyal customers, who are going to continue doing business with that particular company.

Over time you can maintain that brand, that separate brand identity, and still get some operating synergies. You may have a management person who might be handling both operations. I have no idea what they are going to be, and that's why I wouldn't quantify them, but we're always looking for that -- expense abatement, expense control, is always very up on the top of our list at things we look at every day.

Okay, thanks. Any major risks that you're looking at in terms of acquisition integration or just execution challenges?

Yes. Well, probably it's the challenge I mentioned in my comments, and that is with the price of oil up somewhere around $0.60 to $0.80, depending on what day you're at, customers are going to be hearing much higher prices this year than last year. They don't follow the market like us, so they're going to hear, hey, my price is higher. So you have to have good people on the telephone who can handle that conversation, explain to them why, explain to them why they want to stray with us, but that's not a problem that Champion has. It's a problem that we have, and it's a problem that every heating oil company will have, because prices are higher.

Sure. Last question on the acquisition. Can you give us just any background on how the acquisition came about?

It was something that we were talking to the principals over the last several years really. And we've talked from time to time. Never had anything definitive. And we started talking more seriously beginning of this year, and it just developed this way. That's usually how it works out. They know us. They know the type of company we are. They know what we've done with this business since 2004. It fit what they thought they would like to see this business going, and I think we paid a fair price. It just happened.

So there was no major factor that -- I mean, given that you've been in discussions for so long, was there anything timing-wise that caused you to come to terms now versus a year or two years ago or whatever?

No. No, not really. I mean, the way you get acquisitions in this business is talking to people. That's just part of the normal everyday job that we have if we're going to acquire companies. We try to talk to people about -- answer their questions, if they did want to sell their business, and this was one of those long-term conversations.

And they're taking cash. Can you give us any background on their decision to take cash rather than stock, or your willingness to use stock, units or whatever?

No, I really can't give any background on it. That's their decision. That's what they were looking for.

Okay. And does this indicate -- or when you look at the acquisition environment, do you get the sense that more deals are starting to get to more serious stage of discussions, or any flavor on that?

Yes. Compared to last year -- and as you can see, we didn't do any acquisitions since October of '08. The first one we did, we did a small one a month ago, and now of course this one. People are starting to talk to us a little bit more than had been. The activity has picked up a little bit. Again, as Rich was talking about before, just like on the budget accounts, what the price of oil does, what the oil markets do, influence a whole bunch of things. It influences the thoughts that other dealers may have about, well, should I stay, should I sell. And it's just something that they -- a decision they make as to when they want to talk. But most of them are going to want to do it after the season. They're not going to want to be really talking in the middle of season, because they're very busy.

Okay, got you. Then just a couple of others. Conversion from LP, can you update us in terms of your thinking and timing around that?

There's really been no update. We're still thinking about it. We'll let you know.

Okay. And then just finally, use of cash. I guess one question I had here is, I'm just trying to understand how you guys think about use of cash, because it seems like on the one hand list debt is [better], but on the other hand, you guys do generate a lot of earnings and a lot of cash. And as you make your acquisitions, have greater ability to generate cash,it seems like, if anything, you should actually be increasing the amount of debt on the balance sheet rather than reducing it. I'm just trying to understand how you think about your debt levels and use of cash going forward.

Yes. Like I said over the last 15 months we've used $150 million, $160 million to make this acquisition, to buy back debt, and buy back our units. So the excess liquidity that we've had and enjoyed over the last three or four years, we've used a good portion of that up. So you're right, large acquisitions going forward will need some kind of debt component to be funded.

All right. Just buying back debt -- buying back debt at a discount seems to make sense to me. Buying back debt at this point to pay a premium doesn't, on the face of it, make a lot of sense to me.

I don't disagree with you.

Okay. All right, thanks.

Thank you. Our next question comes from Ed Olson, private investor.

Good morning. No complaints, but just one comment that many of us, especially on the retail side, are in it for the increasing dividend. So I just put that reminder on the table, and thank you.

Sure.

Okay, Ed, thanks.

Mr. Donovan, at this time I'm showing no further questions. I'd like to turn the call over to you for any further remarks.

Okay. I just want to thank everybody for taking their time with us today, and I thank them for being interested in Star Gas. We appreciate that. We look forward to sharing the fiscal third quarter results with everyone in August. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Have a great day.