STAR GROUP, L.P. — Interim / Quarterly Report 1998

May 7, 1998

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, 1998 -------------- OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [No Fee Required] For the transition period from _ to _ Commission File Number: 33-98490 -------- STAR GAS PARTNERS, L.P. ----------------------- (Exact name of registrant as specified in its charter) Delaware 06-1437793 - ------------------------------------ -------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2187 Atlantic Street, Stamford, Connecticut 06902 - ------------------------------------------------------------------------------- (Address of principal executive office) (Zip Code) (203) 328-7300 - ------------------------------------------------------------------------------- (Registrant's telephone number, including area code) - -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of May 6, 1998: Star Gas Partners, L.P. 3,831,727 Common Units 2,396,078 Subordinated Units STAR GAS PARTNERS, L.P. AND SUBSIDIARY INDEX TO FORM 10-Q PAGE ---- PART I FINANCIAL INFORMATION: Item 1 - Financial Statements Consolidated Balance Sheets as of September 30, 1997 and March 31, 1998 3 Consolidated Statements of Operations for the three months ended March 31, 1997 and for the three months ended March 31, 1998 4 Consolidated Statements of Operations for the six months ended March 31, 1997 and for the six months ended March 31, 1998 5 Consolidated Statements of Cash Flows for the six months ended March 31, 1997 and for the six months ended March 31, 1998 6 Consolidated Statement of Partners' Capital for the six months ended March 31, 1998 7 Notes to Consolidated Financial Statements 8-10 Item 2 - Management's Discussion and Analysis of Financial Conditions and Results of Operations 11-16 PART II OTHER INFORMATION: Item 6 - Exhibits and Reports on Form 8-K 17 Signature 18 2 STAR GAS PARTNERS, L.P. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)

See accompanying notes to consolidated financial statements. 3 STAR GAS PARTNERS, L.P. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER UNIT AMOUNTS) (UNAUDITED)

See accompanying notes to consolidated financial statements. 4 STAR GAS PARTNERS, L.P. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER UNIT AMOUNTS) (UNAUDITED)

See accompanying notes to consolidated financial statements. 5 STAR GAS PARTNERS, L.P. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)

See accompanying notes to consolidated financial statements. 6 STAR GAS PARTNERS, L.P. AND SUBSIDIARY CONSOLIDATED STATEMENT OF PARTNERS' CAPITAL (IN THOUSANDS, EXCEPT PER UNIT DATA) (UNAUDITED)

See accompanying notes to consolidated financial statements. 7 STAR GAS PARTNERS, L.P. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 1998 1) BASIS OF PRESENTATION The unaudited consolidated financial statements reflect all adjustments which are, in the opinion of management, necessary for a fair statement of the interim periods presented. All adjustments to the financial statements were of a normal recurring nature. The propane industry is seasonal in nature because propane is used primarily for heating in residential and commercial buildings. Therefore, the results of operations for the periods ended March 31, 1997 and March 31, 1998 are not necessarily indicative of the results to be expected for a full year. Inventories Inventories are stated at the lower of cost or market and are computed on a first-in, first-out basis. At the dates indicated, the components of inventory were as follows: SEPTEMBER 30, MARCH 31, 1997 1998 ------------- --------- Propane gas $4,805 $1,817 Appliances and equipment 1,792 1,842 ------ ------ $6,597 $3,659 ====== ====== 2) BASIC AND DILUTED NET INCOME PER LIMITED PARTNER UNIT Basic net income per Limited Partner Unit is computed by dividing net income, after deducting the General Partner's 2.0% interest, by the weighted average number of Common Units and Subordinated Units outstanding. Diluted net income per Limited Partner Unit, reflects the dilutive effect of the unit option plan. 3) COMMITMENTS AND CONTINGENCIES In the ordinary course of business, the Partnership is threatened with, or is named in, various lawsuits. The Partnership is not a party to any litigation which individually or in the aggregate could reasonably be expected to have a material adverse effect on the company. 4) RELATED PARTY TRANSACTIONS The Partnership has no employees, except for certain employees of its corporate subsidiary, Stellar Propane Service Corporation, and is managed and controlled by Petroleum Heat and Power Co., Inc. ("Petro"). Pursuant to the Partnership Agreement, the General Partner is entitled to reimbursement 8 4) RELATED PARTY TRANSACTIONS (CONTINUED) for all direct and indirect expenses incurred or payments it makes on behalf of the Partnership, and all other necessary or appropriate expenses allocable to the Partnership or otherwise reasonably incurred by the General Partner in connection with operating the Partnership's business. For the six months ended March 31, 1998, the Partnership reimbursed the General Partner and Petro $10.0 million representing salary, payroll tax and other compensation paid to the employees of the General Partner and to Petro for certain corporate functions such as finance and compliance. In addition, the Partnership reimbursed Petro $0.3 million relating to the Partnership's share of the costs incurred by Petro in conducting the operations of a certain shared branch location which includes managerial services. 5) ACQUISITIONS On October 22, 1997, pursuant to a purchase agreement ("Stock Purchase Agreement") dated as of October 20, 1997, Star Gas Corporation ("General Partner") purchased 240 shares of Common Stock ($100 par value) of Pearl Gas Co. ("Pearl"), an Ohio Corporation, representing all of the issued and outstanding capital stock of Pearl. The purchase price for said stock was $22.6 million and was paid in cash. The assets purchased included working capital of $1.9 million. Funding for the stock purchase and related transaction expenses of $0.4 million was provided by a $23.0 million bank acquisition facility. Subsequent to the acquisition of the common stock of Pearl, Pearl was merged into the General Partner in a tax-free liquidation. Immediately following the merger, a Conveyance and Contribution Agreement was entered into by, and among, the Partnership, the OLP and the General Partner. The General Partner contributed to the OLP all of the Pearl assets it obtained in the merger of Pearl into the General Partner. In exchange, the General Partner received a 2.7% limited partnership interest in the OLP and a 0.00028% general partnership interest in the OLP. In addition, the OLP assumed all of the liabilities associated with the Pearl stock purchase prior and subsequent to the merger, including the $23.0 million of bank debt. The aggregate value of the Partnership's interests transferred to the General Partner from the OLP was $3.5 million. The issuance of the partnership interests to the General Partner is intended to compensate the General Partner for additional significant income tax liabilities which would be reflected in the consolidated federal income tax return of Star Gas' parent corporation, Petro. The issuance of such partnership interests was approved by the Audit Committee of the General Partner and the Executive Committee of Petro. The General Partner then exchanged the above described interest in the OLP for a 0.00027% general partnership interest in the Partnership and 148 common units in the Partnership, at a per unit price based upon the average closing price of the Partnership's common units ten days prior to the execution of the Stock Purchase Agreement. The OLP then repaid the $23.0 million acquisition facility with $2.0 million of available cash and $21.0 million borrowed under the OLP's own acquisition facility. 9 5) ACQUISITIONS (CONTINUED) Pearl markets and distributes propane in Ohio and Michigan through a storage and distribution system consisting of five offices, fifteen bulk storage plants, fifty employees and over forty-five vehicles. For the twelve months ended September 30, 1997, Pearl sold approximately 14.3 million gallons of propane, primarily to residential customers. Pearl currently serves over 12,000 active customers. Sales and net income have been included in the Consolidated Statements of Operations from October 22, 1997. On February 20, 1998, the Partnership acquired the propane operations and assets of Tri-County Propane, which is based in Williamstown, Kentucky. The aggregate consideration for this acquisition, accounted for under the purchase method was approximately $0.6 million. Unaudited pro forma data giving effect to the acquisitions as if they had been acquired on October 1 of the year preceding the year of purchase is as follows: SIX MONTHS ENDED ------------------------------ MARCH 31, ------------------------------ 1997 1998 -------------- -------------- Sales $108,855 $80,319 ======== ======= Net income $ 13,805 $10,208 ======== ======= Basic and diluted net income per limited partner unit $ 2.17 $ 1.61 ======== ======= 6) PUBLIC OFFERING On December 16, 1997, the Partnership completed a public offering of 809,000 Common Units, representing Limited Partner interests, at a price of $21.25 a unit. The net proceeds received of $15.7 million, after deducting underwriting discounts, commissions and expenses, were used to repay $10.0 million borrowed under the Partnership's bank acquisition facility and $5.7 million borrowed under its working capital facility. In connection with the issuance of the Common Units, the General Partner made a capital contribution of $0.3 million. 7) FIRST MORTGAGE NOTES In January 1998, the Operating Partnership issued $11.0 million of First Mortgage Notes with an annual interest rate of 7.17%. The proceeds from these notes were used to repay $11.0 million borrowed under the Operating Partnership's acquisition facility. These First Mortgage Notes will mature on September 15, 2010, and will require a prepayment of $5.5 million on March 15, 2010. Interest is payable semi-annually on March 15 and September 15. 8) SUBSEQUENT EVENT - CASH DISTRIBUTION On April 21, 1998 the Partnership announced that it would pay a cash distribution of $0.55 per Limited Partner Unit for the three months ended March 31, 1998. The distribution is payable on May 14, 1998 to holders of record as of May 1, 1998. 10 STAR GAS PARTNERS, L.P. AND SUBSIDIARY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS THREE MONTHS ENDED MARCH 31, 1998 - --------------------------------- COMPARED TO THREE MONTHS ENDED MARCH 31, 1997 - --------------------------------------------- OVERVIEW In analyzing the financial results of the Partnership, the following matters should be considered. Propane's primary use is for 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 profit margins vary according to the customer mix. For example, sales to residential customers generate higher gross profit margins than sales to other customer groups, such as agricultural customers. Accordingly, a change in customer mix can affect gross profit without necessarily impacting total sales. Lastly, the propane industry is seasonal in nature with peak activity occurring during the winter months. Accordingly, results of operations for the periods presented are not necessarily indicative of the results to be expected for a full year. This quarterly report on form 10-Q contains forward-looking information that is subject to risks and uncertainties. The factors that could cause actual results to differ materially include the effects of weather, competitive and propane pricing pressure and other factors impacting the propane distribution industry. Readers are cautioned not to place undue reliance on this forward-looking information, which generally speak only as of the date of this report on form 10-Q. VOLUME For the three months ended March 31, 1998, retail propane volume increased 1.1 million gallons, or 3.3%, to 34.0 million gallons, as compared to 32.9 million for the three months ended March 31, 1997. The increase was due to the additional volume provided by the october 1997 acquisition of pearl gas, which was mostly offset by the impact of temperatures, as measured on a degree day basis, that were 14.3% warmer than the previous year's comparable period. In addition, for the three months ended March 31, 1998, temperatures were 21.1% warmer than normal. For the three months ended March 31, 1998, wholesale propane volume declined by 3.3 million gallons, or 34.6%, to 6.3 million gallons, as compared to 9.6 million gallons for the three months ended March 31, 1997. This decline was due in part to the abnormally warm winter weather and a reduction in spot sales to certain customers. 11 SALES For the three months ended March 31, 1998, sales declined $8.6 million, or 18.4%, to $37.9 million, as compared to $46.4 million for the three months ended March 31, 1997. This decline was primarily due to weather-related reductions in volume and lower retail and wholesale selling prices. Retail and wholesale selling prices declined versus the prior year's comparable period in response to the lower propane supply costs. To a certain extent, the additional sales provided by the Pearl operations mitigated the effects of the warm winter weather. COST OF SALES For the three months ended March 31, 1998, cost of sales decreased $9.4 million, or 37.6%, to $15.6 million, as compared to $24.9 million for the three months ended March 31, 1997. Cost of sales declined from the prior period due to lower wholesale propane supply costs and a decline in wholesale volume sold. This decline was partially offset by the cost of sales attributable to the Pearl operations. GROSS PROFIT For the three months ended March 31, 1998, gross profit increased $0.8 million, or 3.7%, to $22.3 million, as compared to $21.5 million for the three months ended March 31, 1997. This increase in gross profit was attributable to higher retail and wholesale per gallon margins and the increase in retail volume associated with the Pearl acquisition. This increase in gross profit was less than expected due to the impact on volume of the abnormally warm temperatures. DELIVERY AND BRANCH EXPENSES For the three months ended March 31, 1998, delivery and branch expenses increased $0.1 million, or 0.9%, to $9.6 million, as compared to $9.5 million for the three months ended March 31, 1997. This increase was primarily due to expenses of $0.8 million relating to the Pearl operations. Excluding the costs of the Pearl operations, delivery and branch expenses declined $0.7 million, as the Partnership was able to reduce branch costs in response to the warm winter weather. DEPRECIATION AND AMORTIZATION EXPENSE For the three months ended March 31, 1998, depreciation and amortization expense increased $0.3 million, or 10.5%, to $2.9 million, as compared to $2.6 million for the three months ended March 31, 1997. This increase was due to the impact of the Pearl acquisition. GENERAL AND ADMINISTRATIVE EXPENSES For the three months ended March 31, 1998, general and administrative expenses declined $0.9 million, or 36.8%, to $1.4 million, as compared to $2.3 million for the three months ended March 31, 1997. The decline was primarily due to the recognition of expenses relating to the strategic initiative, which was concluded during March 1997. 12 INTEREST EXPENSE, NET For the three months ended March 31, 1998, interest expense, net increased $0.1 million, or 5.9%, to $1.9 million, as compared to $1.8 million for the three months ended March 31, 1997. This change was primarily due to an increase in long-term debt associated with the Pearl acquisition. NET INCOME For the three months ended March 31, 1998, net income increased $1.1 million, or 19.5% to $6.4 million, as compared to $5.3 million for the three months ended March 31, 1997. The increase in net income was primarily attributable to the impact of the Pearl acquisition. During the three months ended March 31, 1998, the Partnership, excluding the Pearl operations, was able to achieve approximately the same level of net income as the prior year's comparable period, despite the effect of temperatures that were 14.3% warmer. EBITDA For the three months ended March 31, 1998, EBITDA (defined as operating income plus depreciation and amortization less net gain (loss) on sales of assets) increased $1.6 million, or 16.1%, to $11.3 million, as compared to $9.7 million for the three months ended March 31, 1997. The increase in EBITDA exceeded the increase in both retail volume and gross profit, primarily through a reduction in delivery and branch expenses in response to the warm temperatures and a lower level of general and administrative expenses. 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. 13 STAR GAS PARTNERS, L.P. AND SUBSIDIARY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS SIX MONTHS ENDED MARCH 31, 1998 - ------------------------------- COMPARED TO SIX MONTHS ENDED MARCH 31, 1997 - ------------------------------------------- VOLUME For the six months ended March 31, 1998, retail propane volume increased 5.3 million gallons, or 7.8%, to 72.6 million gallons, as compared to 67.3 million gallons for the six months ended March 31, 1997. The increase was entirely due to the October 22, 1997 acquisition of Pearl Gas, which provided 9.0 million gallons of additional volume. The positive impact of the Pearl acquisition was partially offset by the effect of temperatures which were 6.9% warmer than the prior year's comparable period and 11.4% warmer than normal. For the six months ended March 31, 1998, wholesale propane volume declined by 7.9 million gallons, or 33.3%, to 15.9 million gallons, as compared to 23.8 million gallons for the six months ended March 31, 1997. This decline was due in part to the abnormally warm winter weather and a reduction in spot sales to certain customers. SALES For the six months ended March 31, 1998, sales declined $17.6 million, or 18.1%, to $79.7 million, as compared to $97.3 million for the six months ended March 31, 1997. This decline was due to weather-related reductions in retail and wholesale volume, the reduction in wholesale spot sales and lower retail and wholesale selling prices, partially offset by the additional sales provided by the Pearl operations. During the six months ended March 31, 1998, retail and wholesale selling prices declined versus the prior year's comparable period in response to lower propane supply costs. COST OF SALES For the six months ended March 31, 1998, cost of sales declined $16.7 million, or 31.0%, to $37.2 million, as compared to $53.9 million for the six months ended March 31, 1997. This decline was largely due to lower propane supply costs and lower wholesale sales volume, partially offset by the cost of sales attributable to the Pearl operations. GROSS PROFIT For the six months ended March 31, 1998, gross profit declined $0.9 million, or 2.0%, to $42.5 million, as compared to $43.4 million for the six months ended March 31, 1997. This change was attributable to lower wholesale volume and a decline in wholesale and retail margins. As expected, per gallon margins were lower than the prior year's comparable period when the Partnership benefited from unusual supply and wholesale market conditions. 14 GROSS PROFIT (CONTINUED) While retail margins for the six months ended March 31, 1998 were lower than the comparable 1997 period, these margins compare favorably with those achieved during the six month periods ending March 31, 1996 and March 31, 1995. DELIVERY AND BRANCH EXPENSES For the six months ended March 31, 1998, delivery and branch expenses increased $0.4 million, or 2.0%, to $19.7 million, as compared to $19.4 million for the six months ended March 31, 1997. This increase was solely due to the additional operating costs associated with the Pearl operations. Excluding the Pearl operations, delivery and branch expenses were $1.0 million less than the prior year's comparable period due to lower insurance costs and management's ability to reduce operating costs in response to the warm winter weather. DEPRECIATION AND AMORTIZATION For the six months ended March 31, 1998, depreciation and amortization expense increased $0.5 million, or 9.9%, to $5.7 million, as compared to $5.2 million for the six months ended March 31, 1997, primarily due to additional depreciation expense associated with the Pearl acquisition. GENERAL AND ADMINISTRATIVE EXPENSES For the six months ended March 31, 1998, general and administrative expenses decreased $1.1 million, or 27.6%, to $2.8 million, as compared to $3.9 million for the six months ended March 31, 1997. This decline was primarily due to the recognition of expenses relating to the strategic initiative, which was concluded during March 1997. INTEREST EXPENSE, NET For the six months ended March 31, 1998, interest expense, net increased $0.3 million, or 9.5%, to $4.0 million, as compared to $3.7 million for the six months ended March 31, 1997. This change was primarily due to the additional long-term borrowing associated with the Pearl Gas acquisition. INCOME TAX EXPENSE Income tax expense primarily represents certain state income taxes related to the partnership's wholly-owned corporation which conducts non-qualifying master limited partnership business. NET INCOME For the six months ended March 31, 1998, net income decreased $1.1 million, or 10.2%, to $10.1 million, as compared to $11.2 million for the six months ended March 31, 1997. This decline was primarily due to lower wholesale gross profit and increases in depreciation and amortization expenses, as well as interest costs relating to the financing of the Pearl Gas acquisition. 15 EBITDA For the six months ended March 31, 1998, EBITDA (defined as operating income plus depreciation and amortization less net gain (loss) on sales of assets) declined only $0.2 million to $20.0 million. This slight reduction was achieved in a period which was impacted by 11.4% warmer than normal temperatures, as the effects of the abnormally warm winter weather were mostly offset by the additional EBITDA provided from the Pearl acquisition and reductions in total operating expenses. 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. LIQUIDITY AND CAPITAL RESOURCES For the six months ended March 31, 1998, net cash provided by operating activities decreased $3.3 million, to $11.9 million, as compared to $15.2 million for the six months ended March 31, 1997. This decrease was primarily due to the additional cash requirements of inventory and accounts payable and lower cash flow due to lower net income. Net cash used in investing activities decreased $1.6 million to $2.0 million for the six months ended March 31, 1998, as compared to $3.6 million for the six months ended March 31, 1997. The decline was primarily due to the receipt of $1.8 million in cash from the October 1997 Pearl Gas Conveyance. Net cash flows used in financing activities declined $5.8 million to $2.5 million for the six months ended March 31, 1998, as compared to $8.4 million for the six months ended March 31, 1997. Additional capital was raised during the six months ended March 31, 1998 to finance the Partnership's acquisition program. The Partnership raised $27.1 million in capital through the offering of additional Common Units, $16.1 million in net proceeds, including a General Partner contribution of $0.3 million, and the private placement of $11.0 million of 7.17% First Mortgage Notes due 2010. These proceeds were used to repay $23.0 million of long-term debt conveyed in the Pearl Gas acquisition. For the six months ended March 31, 1998, unitholder distributions of $6.5 million were paid. The Partnership's cash requirements for the remainder of fiscal 1998 include maintenance capital expenditures of approximately $1.0 million and interest payments of $3.8 million on its First Mortgage Notes. In addition, the Partnership plans to pay $7.0 million of Limited and General Partner distributions. Based on its current cash position, bank credit availability and expected net cash from operating activities, the partnership expects to be able to meet all of these obligations for fiscal 1998, as well as all of its other current obligations as they become due. The Partnership has a number of information system improvement initiatives under way that will require increased expenditures during the next several years. These initiatives include the modification of certain computer software and hardware systems to be Year 2000 compliant. Although the final estimates to modify current systems have not yet been determined, the Partnership does not expect that such costs will have a material effect on the Partnership's results of operations or financial position. 16 PART II: OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K - ------- -------------------------------- (a) Exhibits Included Within: ------------------------ (10.12) THIRD AMENDMENT dated as of April 15, 1998 (this "Third Amendment"), to the Credit Agreement dated as of December 13, 1995 (as amended prior to the date hereof, the "Credit Agreement"), among Star Gas Propane, L.P., a Delaware limited partnership (the "Borrower"), the lenders party thereto, The First National Bank of Boston (now known as BankBoston, N.A.), as Administrative Agent (the "Administrative Agent"), and NationsBank, N.A., as Documentation Agent (the "Documentation Agent", and together with the Administrative Agent, the "Agents"). (27) Financial Data Schedule (b) Reports on Form 8-K ------------------- No reports on Form 8-K have been filed during this quarter for which this report is filed. 17 SIGNATURE --------- Pursuant to the requirements of the Securities Exchange Act of 1934, the Company 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 Corporation (General Partner) SIGNATURE TITLE DATE - --------- ----- ---- /s/ Joseph P. Cavanaugh President May 7, 1998 ------------------- Star Gas Corporation Joseph P. Cavanaugh (Principal Executive Officer) /s/ Richard F. Ambury Vice President Finance May 7, 1998 ------------------- Star Gas Corporation Richard F. Ambury (Principal Financial & Accounting Officer) 18