Suburban Propane Partners LP (SPH) 2005 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to be the Suburban Propane second quarter 2005 financial results conference call. (OPERATOR INSTRUCTIONS). As a reminder, today's call is being recorded.

I would now like to turn the call over to Mr. Bob Plante. Please go ahead, sir.

Good morning everyone. Welcome to Suburban's second quarter and fiscal 2005 conference call. I am Bob Plante, Vice President and Chief Financial Officer. Hosting our call this morning will be Mark Alexander, President and Chief Executive Officer. Also joining us is Mike Dunn, our Senior Vice President of Corporate Development.

The purpose of today's call is to review our second quarter fiscal 2005 financial results, along with our current outlook for the business. As usual, once we have concluded our prepared remarks we will open the session up for questions.

Before we get started, I would like to remind you that statements made in the course of this conference call that relate to the Partnership's or management's expectations or predictions are forward-looking statements. The partnership's actual results may differ materially from those projected in such forward-looking statements.

Additional information that could cause actual results to differ materially from those discussed in forward-looking statements is contained in the Partnership's SEC filings, including its Form 10-K for the fiscal year ended September 25, 2004 as well as its 10-Q for the quarter ended December 25, 2004. In addition, we anticipate filing our 10-Q for the second quarter ended March 26 later on today. Copies of all these filings can be obtained by contacting the Partnership or the SEC.

Certain non-GAAP measures will be discussed in this call. We provided a description of those measures, as well as a discussion of why we believe this information is useful, in our Form 8-K furnished to the SEC this morning. The Form 8-K can be accessed through a link on our website at SuburbanPropane.com.

At this point, I would like to get started by turning the call over to Mark Alexander.

Thanks, everybody, for joining us this morning. As was the case in our first quarter of fiscal 2005, our results for the second quarter were unfavorably impacted by both unseasonably warm weather throughout the country as well as conservation efforts by our customers in response to the high energy price environment.

Nationwide heating degree days were at 96% of normal for the quarter, despite a burst of cold weather in March, compared to 99% of normal in the prior year quarter. Weather during the critical months of January and February was extremely warm, approaching near record levels. In addition, and in response to record high commodity prices, our customers took steps to conserve energy and put off purchases in the hopes that prices would eventually fall.

As Bob will discuss in a moment, commodity prices, especially fuel oil, remain high. To partially offset the impact of the warmer weather, the conservation efforts of our customers, and the negative impact on fuel oil margins, we continued to successfully manage retail margins in our propane business and have maintained our prudent expense controls throughout the quarter.

In a few minutes, I will have some additional thoughts on our quarterly distribution as well as our outlook for the remainder of the fiscal year. At this point however, I will turn it back over to Bob to discuss our second quarter results in more detail. Bob?

As we discuss the financial results for the quarter, to be consistent with our reported reporting for previous periods I am excluding the impact of an unrealized non-cash loss of $2.8 million from our current quarter results applicable to FAS 133 accounting, which compares to a $1.1 million gain in the prior year quarter.

EBITDA for our second fiscal quarter ended March 26, 2005 totaled $88.1 million compared to 105.1 million for the same quarter a year ago. As outlined in our press release this morning, prior year results included a net favorable impact of $6.4 million which I am excluding for comparative purposes. That resulted from certain significant non-recurring items, specifically a $14.2 million gain from the sale of certain non-strategic customer service centers in the Midwest; a non-cash charge 5.6 million included within the cost of products sold related to the settlement of futures contracts, which were marked to market under purchase accounting for the Agway acquisition; and a $2.2 million restructuring charge related to the integration of certain back office functions and operations in the Northeast.

Net income for the quarter totaled $68.3 million or $1.99 per common unit, compared to 85.1 million or $2.46 per common unit in the prior year, again excluding the 6.4 million of onetime items described above.

Retail sales of propane during the quarter totaled 199.1 million gallons, a decrease of 20.8 million gallons from a year ago. Sales of fuel oil and other refined fuels amounted to 92.9 million gallons for the quarter, versus 104.2 million gallons in the prior year.

As Mark indicated, volumes were significantly impacted by the warmer than normal weather nationwide, especially in January, as well as the conservation efforts of our customers. In addition, sales of refined fuels were lower than in the prior year quarter due to our decision to exit certain lower margin, low sulfur diesel markets, as well as the retail gasoline station business.

Propane prices for the quarter ending March averaged about $0.79 per gallon basis (indiscernible) versus $0.6765 per gallon for the same quarter a year ago. That is a 17% increase in base product cost year-over-year. Propane prices continue to track higher in a counter-seasonal rally.

Propane is currently off at $0.815. Basic (ph) Mountain (ph) Belleview heating oil prices for the quarter ending March averaged $1.4025 per gallon and are currently trading at around $1.47. Last year at the same time, heating oil prices were trading around $0.92. That is about a 60% increase year-over-year.

Gross margin of $206.9 million for the quarter was 17.8 million or 7.9% lower than the prior year quarter. That is due principally to the negative impact on sales volumes attributable to the warmer weather and conservation. In addition, during the second quarter of fiscal 2005 commodity prices experienced unprecedented high levels of extreme volatility, restricting margin opportunities in our fuel oil business, primarily as a result of a pricing program which pre-established a maximum price per gallon, coupled with the fact that February and March Lions were not hedged due to the market volatility.

Partially offsetting the negative impact of these factors were they continued strong margins in our propane business. Combined operating and general administrative expenses of $119.7 million decreased $6.2 million, or almost 5% from a year ago. This favorable variance in expenses was attributable primarily to lower compensation and employee benefit related expenses, offset partially by higher expenses for professional services in connection with the work required to ensure compliance with the Sarbanes-Oxley Act, as well as higher costs, especially fuel, to operate our fleet.

Capital spending during the quarter totaled $7.4 million, of which 1.9 million was being maintenance related.

Turning to our balance sheet, shortly after the close of our second quarter we completed a successful debt refinancing, which accomplished three very important objectives. First, we significantly extended our debt maturities and eliminated the refinancing risk associated with the annual amortization requirements of the redeemed notes. Second, we reduced our expected annual interest expense for at least the next five years. And finally, we have eliminated certain restrictive covenants that were included in the redeemed notes, leaving us with considerably more flexibility going forward.

In connection with this refinancing, as previously announced, we'll record a onetime charge of approximately 36.1 million during the third quarter of fiscal 2005 to reflect the loss on debt extinguishment associated with a $31.9 million prepayment premium, and a write-off of $4.2 million of unamortized bond issuance costs associated with the redeemed notes.

Particularly with what has transpired with respect to interest rates and spreads since the date we completed this refinancing, we're very pleased that we were able to take advantage of this unique opportunity provided by the historically low interest rate environment. Mark?

As announced in our press release on April 21, Suburban has declared a quarterly distribution of $0.6125 per common unit. This distribution, which equates to an annual distribution rate of $2.45 per unit, will be paid on May 10 for our second quarter ended March 26, 2005.

As I mentioned during our last quarterly conference call, due to seasonal nature of our business, we do not expect that we'll be able to make up the year to date shortfall in our results over the remaining 6 months of the fiscal year. However, it is important to realize that we feel that this shortfall was a result of two separate onetime factors. Let me try to explain that.

Our shortfall in earnings had little to do with the core propane segment. In fact, to the contrary. As you'll see in the segment information within our 10-Q, which we're filing today, our core propane business actually performed quite well in spite of warm weather.

On the other hand, as Bob mentioned earlier, an unprecedented volatile and high-cost commodity market caused a squeeze in fuel oil margins and was the primary negative contributor to our quarterly results. In addition, difficulties in systems integration have caused a delay in recognizing additional synergies beyond those originally anticipated, particularly in the areas of routing and forecasting.

All said, the good news is that we have already identified and our currently implementing solutions. We view these setbacks as non-recurring and we believe we're well-positioned for a significant increase in earnings for next year, even if there is a repeat of unfavorable weather conditions and high product costs.

Our solid capital structure and historically strong coverage ratios allow us to weather this storm and focus on the future. We're concentrating our efforts on driving our operational efficiencies available from the combined Agway Energy Suburban entity in the Northeast. In addition to our operating areas, we remain focused on customer retention and growth initiatives.

As Bob indicated, our balance sheet remains solid and we are in a strong position to entertain additional acquisition opportunities as they arise. As always, we appreciate your attention this morning, and I would now like to turn the call over -- like to open the call for questions. John, if you could help us with that please?

(OPERATOR INSTRUCTIONS). Yves Siegel.

Mark, could you quantify those two onetime factors that you described, and maybe elaborate on what you are thinking in terms of additional synergies? And why, even if you have volatile commodity prices next year, why -- I will let you elaborate, and maybe I will follow-up with a question.

I understand the question. Let me talk about the systems delay. The systems integration and our systems implementation -- what we were coming near the end of, prior to the Agway acquisition, was a rollout of the last major IS system that we needed -- get to a point where we had our complete IS infrastructure in place was a retail system. It is a billing and accounts receivable system.

With the integration of Agway, we had to add that on top of that and that was more complicated than we had envisioned. What it meant was, it pushed us back about a year in recognizing some synergies, above and beyond what we originally planned for. So it would have been icing on the cake, it is just going to come later.

That is somewhere in the neighborhood of $8 to $10 million. It could be as much as that. And that is big. So we expect to get that over the next year or so. And we've got specific deadlines and plans in place that -- we will have the systems in place and implemented throughout the entire U.S., including our Agway legacy stores in the Northeast. With that, Mike, do you want to talk about the situation in the fuel oil margins, what it cost us and what we're doing about it?

The number we're probably looking at there is in the vicinity of $15 to $17 million. Is that all recoverable? Probably. Again, not being able to know what the competitive posture is going to be in the marketplace next year, nor do we understand or have a grasp on what the commodity is going to cost us.

To take you back a little bit in time, just to kind of give you a brief overview of our thought process with respect to entering this, our first year in heating oil, and dealing with the cap program. The cap price is an evolution of a market price that we are forced, to a certain extent, to compete with. In May/June, heating oil was valued at about $1, at which point in time we arrived at our cap price, which was $1.69. The marketplace, I will tell you, was $1.39. But the market was beginning to ask somewhat peculiar. It had already gone up $0.10 in the April/May period to the May/June period. So we were a bit more cautious.

At that particular point in time we established a price -- we hedged probably 75% of our projected volumes at a cost that was somewhat reasonable and easy to recover with respect to your expected margins. When you look historically at the price charts, you'll see that both volatility and prices tend to ease. That is ease, not Yves, tends to ease in the Jan./March cycle, particularly in the Feb./March period.

So between May/June and July/August the commodity had accelerated 20% in value, where we were looking at a $1.19 price. But more importantly, volatility had doubled, thus doubling the cost to protect the programs. So by the time you got into the August period, before you even delivered anything at $1.69, you were already looking at a doubling of cost.

So we, based on historical information, basically decided to lift our leg in the Feb/March cycle. Needless to say, the market didn't behave as it had historically done. And we were looking at prices and volatility that had accelerated as high as 34%. In January, we had a price range of $1.19 to $1.42. In February we had a price range of $1.23 to $1.49. And in March, we had a price range of $1.51 to $1.66. And on top of that, weather became much colder in March. So even if the program was hedged, you had a 50% increase in volume because of the weather issue. Answer your question, Yves, with respect to historical?

Yes. You got me worried when you said eased and Yves, I got confused.

In any event, I wanted to take a little bit of time just to kind of explain the history and the thought process so that we can explain a little bit better for you how we're going to mitigate that situation going forward.

Before you go on, when you said you lifted your leg, does that mean you unwound some of the hedges?

No, that means we elected not to put them on because the cost -- your basic net margins in heating oil hover in the $0.15 to $0.20, $0.25 range. The cost to protect these programs got as high as $0.15 to $0.16. So again, it was a business decision to be quite frank with you.

Before you go on then -- and so you were still -- you hedged 75% of your projected volumes, but then volumes actually increased in March, I think is what you said.

Volumes began to increase in February, but most importantly in March, yes.

Just help me -- when you started the program, you said heating oil prices were $1, and you were capping prices at $1.69?

Correct.

That $0.69 seems unusually wide. And you said you were just trying to be conservative. So if I take $0.69 and I subtract out -- is the historical cost $0.15, is that what you said, to put on the hedges?

No, the historical cost to put on the hedge is anywhere from $0.02 to $0.04. (multiple speakers).

I will take $0.04 -- so from the get go, it sounds like you started with a $0.65 built-in gross margin?

No, you are looking at a spot price of $1. You've got to take into consideration your carry cost going forward and the forward curve in the marketplace. That $1.00 was for spot.

Also, our selling price isn't $1.69.

Exactly. That is a cap price.

That is a cap price. It is not (multiple speakers).

You see that is the misnomer in the heating oil environment, to be quite frank with you. People come out and offer basically a policy against catastrophic change in the marketplace. And in fact, it has become almost a fixed-price because it is that close to the marketplace. As I said, competition where we established a 1.69 price was at $1.39.

Frankly, the cap price was set too close to the market. In hindsight we could say that, because what happened was an unprecedented volatility in the commodity. But many people do the same thing. They confuse the cap price with our everyday low price. They are two different things.

I got it.

It is just a protection -- the cap number is a catastrophic protection for the customer, as Mike said.

And the issue was that I am willing to tell you that every gallon we delivered from September through April was delivered at the cap rush (ph) (technical difficulty) because of the market.

Which is also unprecedented.

Unprecedented.

I keep interrupting, I apologize. The next part of the answer is you are going to say what you're doing differently now. But before you even answer that, why wouldn't you at the time that you enter into the commitment, lock up 100%? Why did you only do 75%? Why do have that exposure on time?

Because we are all assuming it is a guarantee. It is a cap price in a will call environment. So that means that if there is a competitor out there that undercuts your price, there's no assurances that you're going to get that volume. So you're basically hedging something that you're not sure is going to be executed upon.

Okay.

It is a very awkward situation that the heating industry has put itself into.

Plus Yves, we agree with you with the benefit of hindsight. There is no debating that. You're absolutely right. But at the time that we were living through, trying to make the decision, it was the right decision at that time because you don't have a commitment of volume. So why even tried to hedge something? And historically, prices dropped from there. Prices have never been this high, not even close to this high.

And it is the volatility that was critical.

But looking back, you're right, should have hedged it. No doubt about it.

So what are you going to do differently?

Going forward, we're going to educate our customers on the cap program being a protection against catastrophe, and that our everyday low price is going to be whatever the market dictates and they go about it. We will also, at that particular point in time, once we established our cap price, put the appropriate hedges in place for the year in anticipation of again a volatile marketplace. It is going to become more of an objective process, I suppose, than a personal process.

At this particularly point in time, yes, we believe in our heart of hearts that the market will not replicate what we experienced this year. However, in unsure times and without historical reference, we're rewriting history with this year. We need to err on the side of caution.

We are absolutely sure that is will not happen again. Let me make that clear. You don't know what the market is going to do, but even if the market goes crazy again next year, we will have it protected.

How much money are we talking about as it relates specifically to this quarter? And of your heating oil gallons, how much is under that cap program?

Typically 60% to 70%.

Can we back into what this cost you for this specific quarter?

Yes, yes, it was about $15 million impact.

15 million for this quarter?

You don't have to back into it (multiple speakers).

(multiple speakers) That's what it is. It is $15 million.

Wow, that is huge.

And it is going to cost us a couple of million (multiple speakers) next quarter.

In the second quarter. The program extended till the end of April. So the program is finished now for this year, the old program, if you will. But we will see an impact in April. And again, the 15 million and really relates to the fact that February and March were not hedged.

Last question, and I will -- and I apologize for taking so much time.

It is an important topic. We want to get it out there.

So 20/20 hindsight being what is, do you like this heating oil business in terms of acquisitions? Are you --?

(indiscernible) forward opportunity looks terrific. (laughter)

We learned a lesson, a valuable one. And the answer to your question is yes, we are not shaken at all by the potential of the fuel oil business. We don't like what just happened, but we've got a fix in place and I am sure of that. But if there are opportunities in fuel oil, for the right price, we would jump at it. Absolutely.

(OPERATOR INSTRUCTIONS) David Fleischer.

I guess I'm still trying to figure this out. Why is there a cap price at all?

(multiple speakers) good question. (multiple speakers).

(multiple speakers) it's endemic to this business and strikes to me, if you give someone an open-ended guarantee like that -- (technical difficulty) awfully valuable put option, and there should be some awfully good quid pro quo or get rid of it. Or maybe this is a terrible business to be in. I guess I don't understand why, even if it is a once in a lifetime opportunity, you're protecting them -- why should you protect them?

You're absolutely right. It is exactly our view. And this might be the one -- the event that enables us to change that program. And that is exactly the way we're looking at it.

If I go back in history, the program was introduced by a -- as a smaller supplier in the '80s. And what it was, was just what Mike described as a protection -- basically an insurance policy for a catastrophic event which never happened. You look at the historical volatility in prices for fuel oil, it never happened.

What it evolved to was that year-over-year, since the price of fuel oil was predictable and fairly stable, and pretty boring, that that cap price got closer and closer to current markets. And what it ended up turning into, particularly in a year like we just experienced, was a fixed-price program, which was not its intent.

So I think we have an opportunity to change that. And if need be, we will lead the industry to do that. But you're right, there's absolutely no downside for the customer, and all the downside by the companies who offer this program. It is a terrible program.

I guess I see even more so that way, that you're not in the business of accepting risk. You're in the business of having stable predictable cash flow.

Absolutely right.

You say it is once in 100 year, once in 20 year type scenario -- you hear that much to much. We have all these once in 100 year hurricanes and once in 100 year floods happening more and more frequently, and statistics don't go back far enough to make those kinds of statements. And you know when there isn't an obvious and real quid pro quo, I think -- why is this a business to be in, maybe it the other question, if this sort of competitive disadvantage in this exists?

If we can change the format of this program, you're absolutely correct. But we're doing it.

David, we are changing the program. We agree with everything you are saying. And the process will become purely objective. If you go back to what I was saying, in May/June when we established a $1.69 price, based historical information, there was cushioned there. Okay?

I understand that. Maybe 5 out of 6 years, or 10 out of 11 years, that would be just fine. But you're not being paid for that one time that it doesn't work, as you just found out the hard way.

Right. (multiple speakers).

You're absolutely correct.

Absolutely right. And where we're going, we're not going to play it that way.

I hear you. But if you're not going to play it and others do play it that way, a lot of small boys out there who might just see risk differently and not quantify risk properly, you lose customers and this business isn't what it was supposed to be.

Yes. And one or two things are going to happen. They will go out of business, the competition. Or we will get out of the business. I just think that is exaggerating it. Frankly, I think it is a good business to be in. I -- we can protect the risk. Right now, a common mistake would be to overreact to the circumstances. We're not going to do that.

(multiple speakers) I hear you say that, but I guess what I am wondering is you say, well, we learned a lesson. We won't make this mistake again. I didn't appreciate earlier that this was a risk that existed, and maybe you didn't either. Now the obvious question is well, what other risks are there in this business that we don't know about?

You have known us a long time. And you know we're very direct. So if something like this causes you to lose confidence in us, then that would disappoint me. And you should act accordingly. But I am telling you, we have -- we're on top of our game. We know what is going on and we have fixed the situation. Things happen like that. If we thought that we were taking the kind of risk that this resulted into, we wouldn't have done it.

I am sure of that, Mark. I know you wouldn't have. Let me leave that and switch over to the other question that seems less relevant right now, but probably is more relevant. I would like to get a little more perspective as Mike and you give us most quarters on the marketplace.

It is a tough time to be talking about the market, given that we just came out of the winter season, we're not going into it. So it is probably a little less relevant than usual, but I would like to just understand what you have seen on the competitive side as far as margins, which stayed pretty good on the propane side, but just to understand the competitive nature of the business and what you see as you're coming out of this winter and getting organized, prepared for next winter -- how you're thinking about the marketplace?

As conservative as we usually do. The hiccup with heating oil certainly didn't bounce into propane. And propane was equally as volatile and as expensive and made new prices. We again stick to our base mantra, which is where Mark has the confidence to talk about heating oil. We're going to structure the heating oil business the same way we structured the propane business over the last 7 years.

Propane, we have just about completed all of our supply contracts for propane for next season. 95% of them are on a price to be fixed basis. Okay? At this particular point in time, you're 100% right. We're not in a business to take risk. So we're certainly not enamored with an $0.81 price. We're not going to get long, nor are we going to get short. But the surety of supply is critical to us based on the service component of our business. Therefore, that is taken care of. If you're asking us for a price view, we have none.

And just to reiterate (multiple speakers).

It was more we're asking you for the margin view -- the discipline in the marketplace is I guess really what I was looking for you to comment on.

For which (indiscernible) propane or fuel oil?

We're on propane now.

It is acting pretty traditionally. It is pretty solid. And people are being very responsive -- responsible.

You also might want point out, too, it is not something that we generally talk to. But from a customer attrition perspective, we have not experienced any.

Let me just ask you on that one, because your volumes were down more than the weather was warmer than normal. And I thought I was hearing you say that you were in a customer gain mode. You said customers were conserving, in a high-priced environment they conserve. I'm not sure how you answer this question, but I would love to get your perspective as best you can on the relative conservation versus the warmer than normal, versus customer gains, losses. What is happening on particularly the customer gain/loss side?

This is Bob. Let me just clarify the weather. When you look at the quarterly statistics, it is a little misleading. You've got to go back to January. January was 8% warmer than normal versus 2% colder than normal last year. And if you look at the first three weeks of January, which are probably -- if you really want to get finite, that's got to be the most critical period of the season. It was even warmer than that.

If you get to the end of the quarter and see weather in the 95% to 96% of normal range for the quarter, it is a little bit misleading. Specifically, to our customer attrition, we have for the fiscal year and to date a net positive customer gain, which is a continuation of a trend that really -- as you know we saw a couple of years ago us get back to break even on net customer gains. Last year we had a small gain. This year we have a gain on the fiscal year to date as well.

So we're not seeing -- we're seeing improvement with respect to customer churn. That is a battle that is going to continue forever. But on a net basis, we have customer gains not only through the second quarter but continuing now into the third quarter.

Thank you.

Thank you. And just one last point to David's comment. If you were to choose to sit on the sidelines and wait and see what happens next year, I would say okay. I am comfortable with that position if you were to take it, because I am absolutely sure we're going to prove, everybody, that we fixed the situation and it won't happen again. I'm always that confident. And you know me, I am conservative. And I don't say anything unless I am absolutely sure. And I am absolutely sure. John, are there any other questions?

No further questions.

Great. We appreciate that. Appreciate the candor of the questions. They are right on. They are right spot on. We're focused on those issues as well. And we're looking forward to the future here, because things are bright. And we're solid and we look forward to some potential deal flow as well. We appreciate your support and attention this morning, and we look forward to talking with you next quarter. Thanks very much. John, thanks for helping us out. Appreciate it.

You're welcome. Ladies and gentlemen, this conference is available for replay starting today at 4 PM Eastern, will last until tomorrow, May 6 at midnight. You may access the replay at any time by dialing 1-800-475-6701 and entering the access code 778999. (OPERATOR INSTRUCTIONS). That does conclude your conference for today. Thank you for your participation. You may now disconnect.