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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended March 27, 2004
Commission File Number: 1-14222
SUBURBAN PROPANE PARTNERS, L.P.
(Exact name of registrant as specified in its charter)
DELAWARE 22-3410353
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
240 Route 10 West
Whippany, NJ 07981
(973) 887-5300
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
As of May 3, 2004, there were 30,256,767 Common Units outstanding.
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SUBURBAN PROPANE PARTNERS, L.P. AND SUBSIDIARIES
INDEX TO FORM 10-Q
PART I Page
----
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidated Balance Sheets as of March 27, 2004
and September 27, 2003........................................................... 1
Condensed Consolidated Statements of Operations for the three months ended
March 27, 2004 and March 29, 2003................................................ 2
Condensed Consolidated Statements of Operations for the six months ended
March 27, 2004 and March 29, 2003................................................ 3
Condensed Consolidated Statements of Cash Flows for the six months ended
March 27, 2004 and March 29, 2003................................................ 4
Condensed Consolidated Statement of Partners' Capital for the six months ended
March 27, 2004................................................................... 5
Notes to Condensed Consolidated Financial Statements............................. 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.................................... 16
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK...................................................................... 29
ITEM 4. CONTROLS AND PROCEDURES.......................................................... 31
PART II
ITEM 1. LEGAL PROCEEDINGS................................................................ 32
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................................. 32
Signatures...................................................................................... 33
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements
("Forward-Looking Statements") as defined in the Private Securities Litigation
Reform Act of 1995 relating to the Partnership's future business expectations
and predictions and financial condition and results of operations. Some of these
statements can be identified by the use of forward-looking terminology such as
"prospects," "outlook," "believes," "estimates," "intends," "may," "will,"
"should," "anticipates," "expects" or "plans" or the negative or other variation
of these or similar words, or by discussion of trends and conditions, strategies
or risks and uncertainties. These Forward-Looking Statements involve certain
risks and uncertainties that could cause actual results to differ materially
from those discussed or implied in such Forward-Looking Statements ("Cautionary
Statements"). The risks and uncertainties and their impact on the Partnership's
operations include, but are not limited to, the following risks:
o The impact of weather conditions on the demand for propane, fuel oil and
other refined fuels;
o Fluctuations in the unit cost of propane, fuel oil and other refined fuels;
o The ability of the Partnership to compete with other suppliers of propane,
fuel oil and other energy sources;
o The impact on propane, fuel oil and other refined fuel prices and supply
from the political, military and economic instability of the oil producing
nations, global terrorism and other general economic conditions;
o The ability of the Partnership to realize fully, or within the expected
time frame, the expected cost savings and synergies from the acquisition of
Agway Energy;
o The ability of the Partnership to acquire and maintain reliable
transportation for its propane, fuel oil and other refined fuels;
o The ability of the Partnership to retain customers;
o The impact of energy efficiency and technology advances on the demand for
propane and fuel oil;
o The ability of management to continue to control expenses;
o The impact of changes in applicable statutes and government regulations, or
their interpretations, including those relating to the environment and
global warming and other regulatory developments on the Partnership's
business;
o The impact of legal proceedings on the Partnership's business;
o The Partnership's ability to implement its expansion strategy into new
business lines and sectors; and
o The Partnership's ability to integrate acquired businesses successfully.
Some of these Forward-Looking Statements are discussed in more detail in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in this Quarterly Report. On different occasions, the Partnership or
its representatives have made or may make Forward-Looking Statements in other
filings that the Partnership makes with the Securities and Exchange Commission
(the "SEC"), in the press releases or in oral statements made by or with the
approval of one of its authorized executive officers. Readers are cautioned not
to place undue reliance on Forward-Looking or Cautionary Statements, which
reflect management's opinions only as of the date made. The Partnership
undertakes no obligation to update any Forward-Looking or Cautionary Statement.
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 in this Quarterly Report and in future SEC
reports.
SUBURBAN PROPANE PARTNERS, L.P. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
MARCH 27, SEPTEMBER 27,
2004 2003
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 61,426 $ 15,765
Accounts receivable, less allowance for doubtful accounts
of $6,358 and $2,519, respectively 167,720 36,437
Inventories 60,682 41,510
Prepaid expenses and other current assets 32,105 5,200
----------- -----------
Total current assets 321,933 98,912
Property, plant and equipment, net 414,425 312,790
Goodwill and indefinite lived intangible assets 285,610 243,236
Other intangible assets, net 28,050 1,035
Other assets 21,372 9,657
----------- -----------
Total assets $ 1,071,390 $ 665,630
=========== ===========
LIABILITIES AND PARTNERS' CAPITAL
Current liabilities:
Accounts payable $ 50,751 $ 26,204
Accrued employment and benefit costs 35,001 20,798
Current portion of long-term borrowings 42,908 42,911
Accrued insurance 10,763 7,810
Customer deposits and advances 26,384 23,958
Accrued interest 10,608 7,457
Other current liabilities 18,697 8,575
----------- -----------
Total current liabilities 195,112 137,713
Long-term borrowings 515,915 340,915
Postretirement benefits obligation 33,332 33,435
Accrued insurance 16,399 20,829
Accrued pension liability 45,233 42,136
Other liabilities 13,315 6,524
----------- -----------
Total liabilities 819,306 581,552
----------- -----------
Commitments and contingencies
Partners' capital:
Common Unitholders (30,257 and 27,256 units issued and outstanding
at March 27, 2004 and September 27, 2003, respectively) 332,433 165,950
General Partner 3,789 1,567
Deferred compensation (5,954) (5,795)
Common Units held in trust, at cost 5,954 5,795
Unearned compensation (4,766) (2,171)
Accumulated other comprehensive loss (79,372) (81,268)
----------- -----------
Total partners' capital 252,084 84,078
----------- -----------
Total liabilities and partners' capital $ 1,071,390 $ 665,630
=========== ===========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
1
SUBURBAN PROPANE PARTNERS, L.P. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER UNIT AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED
---------------------------
MARCH 27, MARCH 29,
2004 2003
--------- ---------
Revenues
Propane and refined fuels $463,512 $266,423
Other 111,066 21,231
--------- ---------
574,578 287,654
Costs and expenses
Cost of products sold 346,736 142,231
Operating 109,840 64,709
General and administrative 17,392 10,149
Restructuring costs 2,179 --
Depreciation and amortization 9,223 6,800
--------- ---------
485,370 223,889
Income before interest expense and provision for income taxes 89,208 63,765
Interest expense, net 10,770 8,876
--------- ---------
Income before provision for income taxes 78,438 54,889
Provision for income taxes 83 37
--------- ---------
Income from continuing operations 78,355 54,852
Discontinued operations (Note 12):
Gain on sale of customer service centers 14,205 2,404
Income from discontinued customer service centers -- 1,050
--------- ---------
Net income $ 92,560 $ 58,306
========= =========
General Partner's interest in net income $ 2,616 $ 1,484
--------- ---------
Limited Partners' interest in net income $ 89,944 $ 56,822
========= =========
Income per Common Unit - basic
Income from continuing operations $ 2.52 $ 2.17
Discontinued operations 0.45 0.14
--------- ---------
Net income $ 2.97 $ 2.31
--------- ---------
Weighted average number of Common Units outstanding - basic 30,257 24,631
--------- ---------
Income per Common Unit - diluted
Income from continuing operations $ 2.51 $ 2.16
Discontinued operations 0.45 0.14
--------- ---------
Net income $ 2.96 $ 2.30
--------- ---------
Weighted average number of Common Units outstanding - diluted 30,372 24,692
--------- ---------
The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
SUBURBAN PROPANE PARTNERS, L.P. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER UNIT AMOUNTS)
(UNAUDITED)
SIX MONTHS ENDED
-------------------------
March 27, March 29,
2004 2003
--------- ---------
Revenues
Propane and refined fuels $650,712 $439,730
Other 144,535 47,164
--------- ---------
795,247 486,894
Costs and expenses
Cost of products sold 457,035 234,712
Operating 172,594 123,234
General and administrative 27,894 19,170
Restructuring costs 2,179 --
Depreciation and amortization 16,452 13,773
--------- ---------
676,154 390,889
Income before interest expense and provision for income taxes 119,093 96,005
Interest expense, net 20,481 17,732
--------- ---------
Income before provision for income taxes 98,612 78,273
Provision for income taxes 166 167
--------- ---------
Income from continuing operations 98,446 78,106
Discontinued operations (Note 12):
Gain on sale of customer service centers 14,205 2,404
Income from discontinued customer service centers -- 1,050
--------- ---------
Net income $112,651 $ 81,560
========= ========
General Partner's interest in net income $ 3,124 $ 2,075
--------- ---------
Limited Partners' interest in net income $109,527 $ 79,485
========= ========
Income per Common Unit - basic
Income from continuing operations $ 3.31 $ 3.09
Discontinued operations 0.47 0.14
--------- ---------
Net income $ 3.78 $ 3.23
--------- ---------
Weighted average number of Common Units outstanding - basic 28,942 24,631
--------- ---------
Income per Common Unit - diluted
Income from continuing operations $ 3.29 $ 3.08
Discontinued operations 0.48 0.14
--------- ---------
Net income $ 3.77 $ 3.22
--------- ---------
Weighted average number of Common Units outstanding - diluted 29,053 24,688
--------- ---------
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
SUBURBAN PROPANE PARTNERS, L.P. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED
---------------------------
March 27, March 29,
2004 2003
--------- ---------
Cash flows from operating activities:
Net income $ 112,651 $ 81,560
Adjustments to reconcile net income to net cash
provided by operations:
Depreciation expense 15,520 13,543
Amortization of intangible assets 932 230
Amortization of debt origination costs 621 711
Amortization of unearned compensation 584 419
Gain on disposal of property, plant and
equipment, net (161) (320)
Gain on sale of customer service centers (14,205) (2,404)
Changes in assets and liabilities, net of acquisition:
(Increase) in accounts receivable (66,431) (57,795)
(Increase)/decrease in inventories (6,681) 913
(Increase) in prepaid expenses and other current assets (11,847) (3,031)
Increase in accounts payable 7,690 5,723
Increase/(decrease) in accrued employment
and benefit costs 7,973 (2,397)
Increase in accrued interest 3,151 8
(Decrease) in other accrued liabilities (25,365) (16,624)
(Increase) in other noncurrent assets (928) (551)
(Decrease)/increase in other noncurrent liabilities (170) 3,381
--------- ---------
Net cash provided by operating activities 23,334 23,366
--------- ---------
Cash flows from investing activities:
Capital expenditures (12,857) (6,041)
Aquisition of Agway Energy, net of cash acquired (211,181) --
Proceeds from sale of property, plant and equipment 429 1,061
Proceeds from sale of customer service centers, net 23,969 5,654
--------- ---------
Net cash (used in)/provided by investing activities (199,640) 674
--------- ---------
Cash flows from financing activities:
Long-term debt repayments -- (59)
Long-term debt issuance 175,000 --
Expenses associated with debt agreements (5,908) --
Net proceeds from issuance of Common Units 87,566 --
Partnership distributions (34,691) (29,065)
--------- ---------
Net cash provided by/(used in) financing activities 221,967 (29,124)
--------- ---------
Net increase/(decrease) in cash and cash equivalents 45,661 (5,084)
Cash and cash equivalents at beginning of period 15,765 40,955
--------- ---------
Cash and cash equivalents at end of period $ 61,426 $ 35,871
========= =========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
SUBURBAN PROPANE PARTNERS, L.P. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF PARTNERS' CAPITAL
(IN THOUSANDS)
(UNAUDITED)
Accumulated
Number of Common Other Total
Common Common General Deferred Units in Unearned Comprehensive Partners' Comprehensive
Units Unitholders Partner Compensation Trust Compensation (Loss) Capital Income
---------- ----------- ------- ------------ -------- ------------ ------------ --------- ------------
Balance at September 27, 2003 27,256 $ 165,950 $ 1,567 $ (5,795) $ 5,795 $ (2,171) $ (81,268) $ 84,078
Net income 109,527 3,124 112,651 $ 112,651
Other comprehensive loss:
Net unrealized gains on cash
flow hedges 6,403 6,403 6,403
Reclassification of realized
gains on cash flow hedges
into earnings (4,507) (4,507) (4,507)
---------
Comprehensive income $ 114,547
=========
Partnership distributions (33,789) (902) (34,691)
Sale of Common Units under
public offering, net of
expenses 2,990 87,566 87,566
Common Units issued under
Restricted Unit Plan 11 -
Common Units distributed
into trust (159) 159 -
Grants issued under
Restricted Unit Plan,
net of forfeitures 3,179 (3,179) -
Amortization of Restricted
Unit Plan, net of
forfeitures 584 584
------- --------- -------- -------- -------- --------- --------- ----------
Balance at March 27, 2004 30,257 $ 332,433 $ 3,789 $ (5,954) $ 5,954 $ (4,766) $ (79,372) $252,084
======= ========= ======== ======== ======== ========= ========= ==========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
SUBURBAN PROPANE PARTNERS, L.P. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER UNIT AMOUNTS)
(UNAUDITED)
1. BASIS OF PRESENTATION
PRINCIPLES OF CONSOLIDATION. The consolidated financial statements include the
accounts of Suburban Propane Partners, L.P. (the "Partnership"), its partner and
its direct and indirect subsidiaries. All significant intercompany transactions
and accounts have been eliminated. The accompanying condensed consolidated
financial statements are unaudited and have been prepared in accordance with the
rules and regulations of the Securities and Exchange Commission. They include
all adjustments that the Partnership considers necessary for a fair statement of
the results for the interim periods presented. Such adjustments consist only of
normal recurring items, unless otherwise disclosed. These financial statements
should be read in conjunction with the Partnership's Annual Report on Form 10-K
for the fiscal year ended September 27, 2003, including management's discussion
and analysis of financial condition and results of operations contained therein.
Due to the seasonal nature of the Partnership's operations, the results of
operations for interim periods are not necessarily indicative of the results to
be expected for a full year.
FISCAL PERIOD. The Partnership's fiscal periods end on the Saturday nearest the
end of the quarter.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. The Partnership enters into a
combination of exchange-traded futures and option contracts, forward contracts
and in certain instances, over-the-counter options (collectively "derivative
instruments") to manage the price risk associated with future purchases of the
commodities used in its operations, principally propane and heating oil, as well
as to ensure supply during periods of high demand. All derivative instruments
are reported on the balance sheet, within other current assets or other current
liabilities, at their fair values pursuant to Statement of Financial Accounting
Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended by SFAS No. 138 and No. 149 ("SFAS 133"). On the date
that futures, forward and option contracts are entered into, the Partnership
makes a determination as to whether the derivative instrument qualifies for
designation as a hedge. Changes in the fair value of derivative instruments are
recorded each period in current period earnings or other comprehensive
income/(loss) ("OCI"), depending on whether a derivative instrument is
designated as a hedge and, if it is, the type of hedge. For derivative
instruments designated as cash flow hedges, the Partnership formally assesses,
both at the hedge contract's inception and on an ongoing basis, whether the
hedge contract is highly effective in offsetting changes in cash flows of hedged
items. Changes in the fair value of derivative instruments designated as cash
flow hedges are reported in OCI to the extent effective and reclassified into
cost of products sold during the same period in which the hedged item affects
earnings. The mark-to-market gains or losses on ineffective portions of cash
flow hedges are recognized in cost of products sold immediately. Changes in the
fair value of derivative instruments that are not designated as hedges are
recorded in current period earnings within operating expenses. A portion of the
Partnership's option contracts are not classified as hedges and, as such,
changes in the fair value of these derivative instruments are recognized within
operating expenses as they occur.
At March 27, 2004, the fair value of derivative instruments described above
resulted in derivative assets of $5,374 included within prepaid expenses and
other current assets and derivative liabilities of $491 included within other
current liabilities. Operating expenses include unrealized (non-cash) gains in
the amount of $1,094 for the three months ended March 27, 2004 and unrealized
losses in the amount of $352 for the three months ended March 29, 2003,
attributable to the change in fair value of derivative instruments not
designated as hedges. Operating expenses include unrealized (non-cash) gains in
the amount of $301 for the six months ended March 27, 2004 and unrealized losses
in the amount of $1,376 for the six months ended March 29, 2003, attributable to
the change in fair value of derivative instruments not designated as hedges. At
March 27, 2004, unrealized gains on derivative instruments designated as cash
flow hedges in the amount of $767 were included in OCI and are expected to be
recognized in earnings during the next 12 months as the hedged transactions
occur. However, due to the volatility of the commodities market, the
corresponding value in OCI is subject to change prior to its impact on earnings.
6
USE OF ESTIMATES. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Estimates have been made by management in the areas of
insurance and litigation reserves, environmental reserves, pension and other
postretirement benefit liabilities and costs, valuation of derivative
instruments, asset valuation assessment, as well as the allowance for doubtful
accounts. Actual results could differ from those estimates, making it reasonably
possible that a change in these estimates could occur in the near term.
2. ACQUISITION OF AGWAY ENERGY
On December 23, 2003, the Partnership acquired substantially all of the assets
and operations of Agway Energy Products, LLC, Agway Energy Services, Inc. and
Agway Energy Services PA, Inc. (collectively referred to as "Agway Energy") for
$206,000 in cash, subject to certain purchase price adjustments, pursuant to an
asset purchase agreement dated November 10, 2003 between the Operating
Partnership and Agway, Inc. (the "Acquisition"). Agway Energy, based in
Syracuse, New York, is a leading regional marketer of propane, fuel oil,
gasoline and diesel fuel primarily in New York, Pennsylvania, New Jersey and
Vermont. To complement its core marketing and delivery business, Agway Energy
also installs and services a wide variety of home comfort equipment,
particularly in the areas of heating, ventilation and air conditioning. The
Acquisition was consistent with the Partnership's business strategy of prudently
pursuing acquisitions of retail propane distributors and other energy-related
businesses that can complement or supplement its core propane operations and
also expanded our presence in the northeast energy market.
During the second quarter of fiscal 2004, the Partnership and Agway, Inc. agreed
upon the amount of working capital acquired in the Acquisition in accordance
with the Purchase and Sale Agreement and, as a result, the Partnership received
a purchase price adjustment in the amount of $945 from Agway, Inc. Additionally,
in connection with the Acquisition, the Partnership negotiated non-compete
agreements with certain members of the management of Agway Energy resulting in a
cash payment in the amount of $2,650. Accordingly, the total cost of the
Acquisition, including approximately $3,500 in transaction related costs, was
approximately $211,205.
The Acquisition was financed through net proceeds of $87,566 from the issuance
of 2,990,000 Common Units in December 2003 (see Note 11) with the remainder
funded by a portion of the net proceeds from the offering of unsecured 6.875%
senior notes (see Note 6). The results of Agway Energy have been included in the
Partnership's consolidated financial statements from the date of the
Acquisition. Given the size and complexity of the Acquisition, a final
determination of purchase accounting adjustments, including the allocation of
the purchase price to the assets acquired and liabilities assumed based on their
respective fair values, has not yet been finalized. As of March 27, 2004, the
cost of the Acquisition has been preliminarily allocated to the assets acquired
and liabilities assumed according to estimated fair values and is subject to
adjustment when additional information concerning asset and liability valuations
is finalized.
7
The total cost of the Acquisition has been preliminarily allocated as follows:
Net current assets $ 28,790
Property, plant and equipment 111,665
Intangible assets 28,045
Goodwill 43,330
Other assets, principally environmental escrow asset 8,500
Deferred tax assets 20,022
Deferred tax asset valuation allowance (20,022)
Severance and other restructuring costs (625)
Environmental reserve (8,500)
---------
Total cost of Acquisition $ 211,205
=========
Property, plant and equipment. The fair value of acquired property, plant and
equipment, including land, buildings, storage equipment, vehicles, tanks and
cylinders and computer equipment is based upon their respective value-in-use,
unless there was a known plan to dispose of an asset. Assets to be disposed of
or otherwise abandoned were not assigned a value. Additional adjustments to the
fair value of property, plant and equipment acquired may be recorded as the
Partnership further refines its plans to integrate the operations of Agway
Energy.
Intangible assets. The Partnership is finalizing a valuation of the fair value
of identifiable intangible assets. Based on the preliminary valuation,
identifiable intangible assets include the fair value of customer lists of
$19,865, trade names of $3,513, non-compete agreements of $2,700 and below
market lease arrangements of $1,967. The values assigned to customer lists and
trade names are being amortized on a straight-line basis over a period of 15
years. The non-compete agreements are being amortized on a straight-line basis
over the non-compete period ranging from one to two years and the value assigned
to the lease arrangements is being amortized over the remaining 21-year lease
term.
Goodwill. In accordance with the requirements of SFAS No. 142, "Goodwill and
Other Intangible Assets," the residual goodwill and acquired indefinite-lived
intangible assets related to the $6,800 value assigned to the assembled
workforce will not be amortized. Such goodwill and intangible assets are
deductible for tax purposes.
Environmental escrow asset and reserves. The Partnership acquired certain
surplus properties with either known or probable environmental exposure, some of
which are currently in varying stages of investigation, remediation or
monitoring. Additionally, the Partnership identified that certain active sites
acquired contained environmental exposures which may require further
investigation, future remediation or ongoing monitoring activities. Based on the
Partnership's current best estimate of future costs for environmental
investigations, remediation and ongoing monitoring activities associated with
acquired properties with either known or probable environmental exposures an
environmental reserve in the amount of $8,500 has been established in purchase
accounting.
Under the Purchase and Sale Agreement, Agway, Inc. has set aside $15,000 from
the total purchase price in a separate escrow account to fund any future
environmental costs and expenses. Accordingly, in the preliminary allocation of
the purchase price, the Partnership established a corresponding environmental
escrow asset in the amount of $8,500 related to the future reimbursement from
escrowed funds for environmental spending. Under the terms of the Purchase and
Sale Agreement, the escrowed funds will be used to fund environmental costs and
expenses during the first three years following the closing date of the
Acquisition. Subject to amounts withheld with respect to any pending claims made
prior to the third anniversary of the closing date of the Acquisition, any
remaining escrowed funds will be remitted to Agway, Inc. at the end of the
three-year period.
Deferred taxes. For tax purposes, the assets and operations of the propane
business line are reported within the Operating Partnership. Accordingly, the
earnings attributable to the propane operations are not subject to federal and
state income taxes at the entity level; rather, such earnings are included in
the tax returns of the individual
8
partners. All other assets and operations acquired are reported within an
indirect, wholly-owned subsidiary of the Operating Partnership that will be
subject to corporate-level federal and state income taxes. The deferred tax
assets established in purchase accounting represent the tax effect of temporary
differences between the financial statement basis and tax basis of assets
acquired and liabilities assumed as of the Acquisition date. The temporary
differences primarily relate to certain accruals and reserves established for
book purposes that are expected to give rise to future tax deductions.
A full valuation allowance has been established in purchase accounting to offset
the deferred tax assets since, based on the Partnership's current projections of
future taxable income for the corporate entities, it is more likely than not
that the benefits of these future deductible items will not be utilized. To the
extent future projections of taxable income indicate deferred tax assets may be
utilized, the valuation allowance will be reversed, with a corresponding
reduction to goodwill.
Severance and other restructuring costs. Termination benefits and relocation
costs associated with employees of Agway Energy affected by integration and
restructuring plans were recorded as part of purchase accounting. The
individuals affected have been identified and their termination or relocation
benefits have been communicated. Activities associated with the restructuring
plans are expected to occur during the first twelve months following the
Acquisition. Additional plans for integration and restructuring have been
developed and are expected to result in additional restructuring costs to be
recorded within purchase accounting during the third and fourth quarters of
fiscal 2004.
Derivative assets. Net current assets acquired includes a derivative asset in
the amount of $7,860 representing the fair value of futures and option contracts
acquired that were identified as hedges of future purchases of heating oil and
propane. As the underlying futures and option contracts are settled the
derivative assets are charged to cost of products sold as an offset to the
realized gains from contract settlement. The impact on cost of products sold
represents a non-cash charge resulting from the application of purchase
accounting on derivative instruments acquired. For the three and six months
ended March 27, 2004, the Partnership recorded a non-cash charge of $5,610
within cost of products sold related to contracts settled during the period.
Pro Forma Results. The following unaudited pro forma information presents the
results of operations of the Partnership as if the Acquisition had occurred at
the beginning of the periods shown. The pro forma information, however, is not
necessarily indicative of the results of operations assuming the Acquisition had
occurred at the beginning of the periods presented, nor is it necessarily
indicative of future results.
THREE MONTHS ENDED
----------------------------------------
MARCH 27, MARCH 29,
2004 2003
------------------ -------------------
AS REPORTED PRO FORMA
Revenues $ 574,578 $ 559,465
Income from continuing operations 78,355 76,912
Income from continuing operations per Common Unit - basic $ 2.52 $ 2.47
SIX MONTHS ENDED
----------------------------------------
MARCH 27, MARCH 29,
2004 2003
------------------ -------------------
PRO FORMA PRO FORMA
Revenues $ 963,572 $ 927,030
Income from continuing operations 102,737 104,142
Income from continuing operations per Common Unit - basic $ 3.30 $ 3.34
9
The as reported and pro forma income from continuing operations for the three
and six months ended March 27, 2004 above include the $2,179 restructuring
charge recorded in the second quarter of fiscal 2004, as further described in
note 3 below. This restructuring charge was not reflected in the pro forma
results for the three and six months ended March 29, 2003.
The Partnership is in the process of determining the information which will be
reviewed by its chief operating decision maker in accordance with SFAS No. 131,
"Disclosures About Segments of and Enterprise," as a result of the addition of
the multiple energy products and services of Agway Energy and expects to begin
reporting segment information in the third quarter of fiscal 2004.
3. RESTRUCTURING COSTS
During the second quarter of fiscal 2004, in connection with the initial
integration of certain management and back office functions of Agway Energy, the
Partnership's management approved and initiated plans to restructure the
operations of both the Partnership and Agway Energy. Restructuring charges
related to plans that have an impact on the assets, employees and operations of
the Partnership will be recorded in current period earnings when specific
decisions are approved and costs associated with such activities are incurred.
Severance and other restructuring or relocation costs associated with assets,
employees and operations of Agway Energy are recorded as liabilities assumed in
the purchase business combination and result in an increase to goodwill.
For the three and six months ended March 27, 2004, the Partnership recorded a
restructuring charge of $2,179 within the consolidated statement of operations
related primarily to employee termination costs incurred as a result of actions
taken during the second quarter of fiscal 2004. The restructuring of the
operations of the Partnership and Agway Energy will continue throughout the
remainder of fiscal 2004 in order to achieve the anticipated synergies from the
combined operations. As a result, additional restructuring charges including
severance, costs of vacating duplicative facilities and contract termination and
other exit costs, as well as asset impairment charges are expected to be
incurred during the third and fourth quarters of fiscal 2004. The components of
restructuring charges that were both expensed and recorded as part of purchase
accounting are as follows:
UTILIZATION RESERVE AT
RESTRUCTURING THROUGH MARCH 27,
COSTS INCURRED MARCH 27, 2004 2004
--------------------- ---------------------- -----------------
Charges expensed:
Severance and other employee costs $ 2,179 $ (401) $ 1,778
===================== ====================== =================
CHARGES RECORDED IN PURCHASE ACCOUNTING:
Severance and other employee costs $ 100 $ - $ 100
Relocation costs 525 - 525
--------------------- ---------------------- -----------------
Total $ 625 $ - $ 625
===================== ====================== =================
The $1,778 in accrued severance and other termination benefits as of March 27,
2004 are expected to be paid over the course of the next twelve months.
4. INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined using
a weighted average method for propane and refined fuels and a standard cost
basis for appliances, which approximates average cost. Inventories consist of
the following:
MARCH 27, SEPTEMBER 27,
2004 2003
------------------ -------------------
Propane and refined fuels $ 48,576 $ 34,033
Appliances and related parts 12,106 7,477
------------------ -------------------
$ 60,682 $ 41,510
================== ===================
10
5. INCOME PER UNIT
Basic income per Common Unit is computed by dividing income, after deducting the
General Partner's approximate 2.5% interest, by the weighted average number of
outstanding Common Units. Diluted income per Common Unit is computed by dividing
income, after deducting the General Partner's approximate 2.5% interest, by the
weighted average number of outstanding Common Units and time vested Restricted
Units granted under the 2000 Restricted Unit Plan. In computing diluted income
per Common Unit, weighted average Common Units outstanding used to compute basic
income per Common Unit were increased by 115,266 units and 111,058 units for the
three and six months ended March 27, 2004, respectively, and 60,225 units and
56,607 units for the three and six months ended March 29, 2003, respectively, to
reflect the potential dilutive effect of the unvested portion of the time vested
Restricted Units outstanding using the treasury stock method. Net income is
allocated to the Common Unitholders and the General Partner in accordance with
their respective Partnership ownership interests, after giving effect to any
priority income allocations for incentive distributions allocated to the General
Partner.
6. LONG-TERM BORROWINGS
Long-term borrowings consist of the following:
MARCH 27, SEPTEMBER 27,
2004 2003
------------------ ------------------
Senior Notes, 7.54%, due June 30, 2011 $ 340,000 $ 340,000
Senior Notes, 6.875%, due December 15, 2013 175,000 -
Senior Notes, 7.37%, due June 30, 2012 42,500 42,500
Note payable, 8%, due in annual installments
through 2006 1,321 1,322
Amounts outstanding under the Revolving
Credit Agreement - -
Other long-term liabilities 2 4
------------------ ------------------
558,823 383,826
Less: current portion 42,908 42,911
------------------ ------------------
$ 515,915 $ 340,915
------------------ ------------------
On December 23, 2003, the Partnership and Suburban Energy Finance Corporation,
the co-issuer and wholly-owned subsidiary of the Partnership, issued $175,000
aggregate principal amount of Senior Notes (the "2003 Private Placement") with
an annual interest rate of 6.875% through a private placement under Rule 144A
and Regulation S of the Securities Act of 1933. On April 15, 2004, pursuant to a
registration rights agreement, the Partnership launched an offer to exchange the
$175,000 senior notes that were issued on December 23, 2003 with $175,000 senior
notes that were registered with the SEC and which have substantially the same
terms as the 2003 Private Placement (the "2003 Senior Notes"). The holders of
senior notes that were issued on December 23, 2003 have until May 13, 2004 to
exchange their notes for the 2003 Senior Notes. The Partnership's obligations
under the 2003 Senior Notes are unsecured and will rank senior in right of
payment to any future subordinated indebtedness and equally in right of payment
with any future senior indebtedness. The 2003 Senior Notes are structurally
subordinated to, which means they rank effectively behind, the senior notes and
other liabilities of the Partnership's subsidiary operating partnership,
Suburban Propane, L.P. (the "Operating Partnership"). The 2003 Senior Notes will
mature December 15, 2013, and require semiannual interest payments beginning on
June 15, 2004. The Partnership may redeem some or all of the 2003 Senior Notes
any time on or after December 15, 2008, at redemption prices specified in the
indenture governing the 2003 Senior Notes (the "2003 Senior Note Agreement").
The 2003 Senior Note Agreement contains certain restrictions applicable to the
Partnership and certain of its subsidiaries with respect to (i) the incurrence
of additional indebtedness; and (ii) liens, investments, guarantees, loans,
advances, payments, mergers, consolidations, distributions, sales of assets and
other transactions.
11
On March 5, 1996, pursuant to a Senior Note Agreement (the "1996 Senior Note
Agreement"), the Operating Partnership issued $425,000 of Senior Notes (the
"1996 Senior Notes") with an annual interest rate of 7.54%. The Operating
Partnership's obligations under the 1996 Senior Note Agreement are unsecured and
rank on an equal and ratable basis with the Operating Partnership's obligations
under the 2002 Senior Note Agreement and the Revolving Credit Agreement
discussed below. The 1996 Senior Notes will mature June 30, 2011, and require
semiannual interest payments. Under the terms of the 1996 Senior Note Agreement,
the Operating Partnership is obligated to pay the principal on the 1996 Senior
Notes in equal annual payments of $42,500 which started July 1, 2002.
On July 1, 2002, the Operating Partnership received net proceeds of $42,500 from
the issuance of 7.37% Senior Notes due June, 2012 (the "2002 Senior Notes") and
used the funds to pay the first annual principal payment of $42,500 due under
the 1996 Senior Note Agreement. The Operating Partnership's obligations under
the agreement governing the 2002 Senior Notes (the "2002 Senior Note Agreement")
are unsecured and rank on an equal and ratable basis with the Operating
Partnership's obligations under the 1996 Senior Note Agreement and the Revolving
Credit Agreement. Rather than refinance the second annual principal payment of
$42,500 due under the 1996 Senior Note Agreement, the Partnership elected to
repay this principal payment on June 30, 2003. The third annual principal
payment of $42,500 under the 1996 Senior Note Agreement is due July 1, 2004. The
Partnership expects that it will be able to make this payment from cash flow
from operations, its cash position or availability under its Revolving Credit
Agreement. Alternatively, the Partnership may elect to refinance this next
principal payment through either a private placement of senior notes or the
issuance of additional senior notes under the 2003 Senior Note Agreement.
On May 8, 2003, the Operating Partnership entered into the Second Amended and
Restated Credit Agreement which extended the Revolving Credit Agreement until
May 31, 2006 (as amended and restated, the "Revolving Credit Agreement"). The
Revolving Credit Agreement provides a $75,000 working capital facility and a
$25,000 acquisition facility. Borrowings under the Revolving Credit Agreement
bear interest at a rate based upon either LIBOR plus a margin, Wachovia National
Bank's prime rate or the Federal Funds rate plus 1/2 of 1%. An annual fee
ranging from .375% to .50%, based upon certain financial tests, is payable
quarterly whether or not borrowings occur. As of March 27, 2004 and September
27, 2003, there were no borrowings outstanding under the Revolving Credit
Agreement.
The 1996 Senior Note Agreement, the 2002 Senior Note Agreement and the Revolving
Credit Agreement contain various restrictive and affirmative covenants
applicable to the Operating Partnership; including (a) maintenance of certain
financial tests, including, but not limited to, a leverage ratio less than 5.0
to 1, an interest coverage ratio in excess of 2.50 to 1 and a leverage ratio of
less than 5.25 to 1 when the underfunded portion of the Partnership's pension
obligations is used in the computation of the ratio, (b) restrictions on the
incurrence of additional indebtedness, and (c) restrictions on certain liens,
investments, guarantees, loans, advances, payments, mergers, consolidations,
distributions, sales of assets and other transactions. The Partnership and the
Operating Partnership were in compliance with all covenants and terms of the
1996 Senior Note Agreement, the 2002 Senior Note Agreement, the 2003 Senior Note
Agreement and the Revolving Credit Agreement as of March 27, 2004.
Debt origination costs representing the costs incurred in connection with the
placement of, and the subsequent amendments to, the Partnership's Senior Notes
and Revolving Credit Agreement were capitalized within other assets and are
being amortized on a straight-line basis over the term of the respective debt
agreements. In connection with the issuance of the 2003 Senior Notes, the
Partnership incurred debt origination costs of $5,782 which were capitalized
within other assets and will be amortized over the 10-year maturity of the 2003
Senior Notes. Other assets at March 27, 2004 and September 27, 2003 include debt
origination costs with a net carrying amount of $11,252 and $5,960,
respectively. Aggregate amortization expense related to deferred debt
origination costs included within interest expense was $371 and $621 for the
three and six months ended March 27, 2004, respectively, and $364 and $711 for
the three and six months ended March 29, 2003, respectively.
Interest expense, net for the six months ended March 27, 2004 included a
one-time fee of $1,936 related to a financing commitment received in connection
with the Acquisition incurred during the first quarter of fiscal 2004.
12
7. DISTRIBUTIONS OF AVAILABLE CASH
The Partnership makes distributions to its partners approximately 45 days after
the end of each fiscal quarter of the Partnership in an aggregate amount equal
to its Available Cash for such quarter. Available Cash, as defined in the Second
Amended and Restated Partnership Agreement, generally means all cash on hand at
the end of the respective fiscal quarter less the amount of cash reserves
established by the Board of Supervisors in its reasonable discretion for future
cash requirements. These reserves are retained for the proper conduct of the
Partnership's business, the payment of debt principal and interest and for
distributions during the next four quarters. Distributions by the Partnership in
an amount equal to 100% of its Available Cash will generally be made 98.29% to
the Common Unitholders and 1.71% to the General Partner prior to the public
offering described in Note 11 (the "Public Offering"), and 98.46% to the Common
Unitholders and 1.54% to the General Partner subsequent to the Public Offering,
subject to the payment of incentive distributions to the General Partner to the
extent the quarterly distributions exceed a target distribution of $0.55 per
Common Unit.
As defined in the Second Amended and Restated Partnership Agreement, the General
Partner has certain Incentive Distribution Rights ("IDRs") which represent an
incentive for the General Partner to increase distributions to Common
Unitholders in excess of the target quarterly distribution of $0.55 per Common
Unit. With regard to the first $0.55 per Common Unit of quarterly distributions
paid in any given quarter, 98.46% of the Available Cash is distributed to the
Common Unitholders and 1.54% is distributed to the General Partner (98.29% and
1.71%, respectively, prior to the Public Offering). With regard to the balance
of quarterly distributions in excess of the $0.55 per Common Unit target
distribution, 85% of the Available Cash is distributed to the Common Unitholders
and 15% is distributed to the General Partner.
On April 22, 2004, the Partnership declared an increase in its quarterly
distribution to $0.60 per Common Unit, or $2.40 on an annualized basis, in
respect of the second quarter of fiscal 2004 payable on May 11, 2004 to holders
of record on May 4, 2004, compared to $0.5875 per Common Unit in the first
quarter of fiscal 2004, and compared to $0.5750 per Common Unit for the second
quarter of the prior year. This quarterly distribution includes incentive
distribution rights payable to the General Partner to the extent the quarterly
distribution exceeds $0.55 per Common Unit.
8. 2000 RESTRICTED UNIT PLAN
During fiscal 2004, the Partnership awarded 115,730 Restricted Units under the
2000 Restricted Unit Plan at an aggregate value of $3,546. Restricted Units
issued under the 2000 Restricted Unit Plan vest over time with 25% of the Common
Units vesting at the end of each of the third and fourth anniversaries of the
issuance date and the remaining 50% of the Common Units vesting at the end of
the fifth anniversary of the issuance date. Restricted Unit Plan participants
are not eligible to receive quarterly distributions or vote their respective
Restricted Units until vested. Restrictions also limit the sale or transfer of
the Common Units by the award recipients during the restricted periods. The
value of the Restricted Unit is established by the market price of the Common
Units at the date of grant. Restricted Units are subject to forfeiture in
certain circumstances as defined in the 2000 Restricted Unit Plan. Upon award of
Restricted Units, the unamortized unearned compensation value is shown as a
reduction to partners' capital. The unearned compensation is amortized ratably
to expense over the restricted periods.
9. COMMITMENTS AND CONTINGENCIES
The Partnership is self-insured for general and product, workers' compensation
and automobile liabilities up to predetermined amounts above which third party
insurance applies. At March 27, 2004 and September 27, 2003, the Partnership had
accrued insurance liabilities of $27,162 and $28,639, respectively, representing
the total estimated losses under these self-insurance programs. The Partnership
is also involved in various legal actions that have arisen in the normal course
of business, including those relating to commercial transactions and product
liability. Management believes, based on the advice of legal counsel, that the
ultimate resolution of these matters will not have a material adverse effect on
the Partnership's financial position or future results of operations, after
considering its self-insurance liability for known and unasserted self-insurance
claims.
13
The Partnership is subject to various laws and governmental regulations
concerning environmental matters and expects that it will be required to expend
funds to participate in remediation of these matters. In connection with the
Acquisition, the Partnership acquired certain surplus properties with either
known or probable environmental exposure, some of which are currently in varying
stages of investigation, remediation or monitoring. Additionally, the
Partnership identified that certain active sites acquired contained
environmental exposures which may require further investigation, future
remediation or ongoing monitoring activities. The environmental exposures
include instances of soil and/or groundwater contamination associated with the
handling and storage of fuel oil, gasoline and diesel fuel. In the preliminary
allocation of the purchase price to the assets acquired and liabilities assumed
in the Acquisition, the Partnership established an environmental reserve of
$8,500. This reserve estimate was based on the Partnership's current best
estimate of future costs for environmental investigations, remediation and
ongoing monitoring activities associated with acquired properties with either
known or probable environmental exposures.
Under the Purchase and Sale Agreement, however, Agway, Inc. set aside $15,000
from the total purchase price in a separate escrow account to fund any such
future environmental costs and expenses. Accordingly, in the preliminary
allocation of the purchase price, the Partnership established a corresponding
environmental escrow asset in the amount of $8,500 related to the future
expected reimbursement from escrowed funds for environmental spending. Under the
terms of the Purchase and Sale Agreement, the escrowed funds will be used to
fund such environmental costs and expenses during the first three years
following the closing date of the Acquisition. Subject to amounts withheld with
respect to any pending claims made prior to the third anniversary of the closing
date of the Acquisition, any remaining escrowed funds will be remitted to the
sellers at the end of the three-year period.
Estimating the extent of the Partnership's responsibility for a particular site
and the method and ultimate cost of remediation of that site requires a number
of assumptions and estimates on the part of management. As a result, the
ultimate outcome of remediation of the sites may differ from current estimates.
As additional information becomes available, estimates will be adjusted as
necessary. Based on information currently available, and taking into
consideration the level of the environmental reserve and the $15,000
environmental escrow, management believes that any liability that may ultimately
result from changes in current estimates will not have a material impact on the
results of operations, financial position or cash flows of the Partnership.
10. GUARANTEES
The Partnership has residual value guarantees associated with certain of its
operating leases, related primarily to transportation equipment, with remaining
lease periods scheduled to expire periodically through fiscal 2009. Upon
completion of the lease period, the Partnership guarantees that the fair value
of the equipment will equal or exceed the guaranteed amount, or the Partnership
will pay the lessor the difference. Although the equipment's fair value at the
end of their lease terms has historically exceeded the guaranteed amounts, the
maximum potential amount of aggregate future payments the Partnership could be
required to make under these leasing arrangements, assuming the equipment is
deemed worthless at the end of the lease term, is approximately $17,505. Of this
amount, the fair value of residual value guarantees for operating leases entered
into after December 31, 2002 was $2,781 and $2,067 which is reflected in other
liabilities, with a corresponding amount included within other assets, in the
accompanying condensed consolidated balance sheet as of March 27, 2004 and
September 27, 2003, respectively.
11. PUBLIC OFFERING
On December 16, 2003, the Partnership sold 2,600,000 Common Units in a public
offering at a price of $30.90 per Common Unit realizing proceeds of $76,026, net
of underwriting commissions and other offering expenses. On December 23, 2003,
following the underwriters' full exercise of their over-allotment option, the
Partnership sold an additional 390,000 Common Units at $30.90 per Common Unit,
generating additional net proceeds of $11,540. The aggregate net proceeds of
$87,566 were used to fund a portion of the purchase price for the Acquisition.
These transactions increased the total number of Common Units outstanding to
30,256,767. As a result of the Public Offering, the combined General Partner
interest in the Partnership was reduced from 1.71% to 1.54% while the Common
Unitholder interest in the Partnership increased from 98.29% to 98.46%.
14
12. DISCONTINUED OPERATIONS
On January 9, 2004, the Partnership sold ten customer service centers in Texas,
Oklahoma, Missouri and Kansas for total cash proceeds of approximately $24,000.
This divestiture is in line with the Partnership's strategy of divesting
operations in slower growing or non-strategic markets in an effort to identify
opportunities to optimize the return on assets employed. The Partnership
recorded a gain on sale of approximately $14,205 for the three and six months
ended March 27, 2004 which has been accounted for within discontinued operations
pursuant to Statement of Financial Accounting Standards ("SFAS") No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144").
In accordance with SFAS 144, the individual captions on the consolidated
statements of operations for the three and six months ended March 27, 2004 and
March 29, 2003 exclude the results from these discontinued operations. The net
impact on the Partnership's discontinued operations was not significant for the
three and six months ended March 27, 2004 and resulted in income from
discontinued customer service centers of $1,050 for the three and six months
ended March 29, 2003.
13. PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS
In December 2003, SFAS No. 132 (revised), "Employers' Disclosures about Pensions
and Other Postretirement Benefits" (the "revised SFAS 132") was issued. The
revised SFAS 132 requires additional disclosures in annual financial statements
regarding types of plan assets held, investment strategies, measurement dates,
plan obligations and cash flows, as well as certain disclosures in both interim
and annual financial statements regarding components of net periodic benefit
cost/(expense) and employer contributions. The following table provides the
components of net periodic benefit costs for the three and six month periods
ended March 27, 2004 and March 29, 2003:
OTHER
PENSION BENEFITS POSTRETIREMENT BENEFITS
------------------- -----------------------
THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 27, MARCH 29, MARCH 27, MARCH 29,
2004 2003 2004 2003
--------- --------- --------- ----------
Service cost $ -- $ 157 $ 5 $ 4
Interest cost 2,266 2,844 750 660
Expected return on plan assets (2,389) (3,014) -- --
Amortization of prior service costs -- -- (180) (180)
Recognized net actuarial loss 1,497 1,017 -- 86
--------- --------- --------- ----------
Net periodic benefit cost $ 1,374 $ 1,004 $ 575 $ 570
========= ========= ========= ==========
SIX MONTHS ENDED SIX MONTHS ENDED
MARCH 27, MARCH 29, MARCH 27, MARCH 29,
2004 2003 2004 2003
--------- --------- --------- ----------
Service cost $ -- $ 314 $ 10 $ 8
Interest cost 4,882 5,688 1,500 1,320
Expected return on plan assets (4,778) (6,028) -- --
Amortization of prior service costs -- -- (360) (360)
Recognized net actuarial loss 2,994 2,034 -- 172
--------- --------- --------- ----------
Net periodic benefit cost $ 3,098 $ 2,008 $ 1,150 $ 1,140
========= ========= ========= ==========
There are no projected minimum employer contribution requirements for fiscal
year 2004 under our defined benefit pension plan. The projected annual
contributions requirements related to the Partnership's postretirement health
care and life insurance benefit plan for the fiscal year ended September 25,
2004 are $2,500, of which $1,253 has been contributed during the six month
period ended March 27, 2004.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following is a discussion of the financial condition and results of
operations of the Partnership as of and for the three and six months ended March
27, 2004. The discussion should be read in conjunction with the historical
consolidated financial statements and notes thereto included in the Annual
Report on Form 10-K for the most recent fiscal year ended September 27, 2003.
FACTORS THAT AFFECT OUR OPERATING RESULTS AND FINANCIAL CONDITION
PRODUCT COSTS
The level of profitability in the retail propane and fuel oil businesses is
largely dependent on the difference between retail sales price and product cost.
The unit cost of propane and fuel oil is subject to volatile changes as a result
of product supply or other market conditions, including, but not limited to,
economic and political factors impacting crude oil and natural gas supply or
pricing. Product cost changes can occur rapidly over a short period of time and
can impact profitability. There is no assurance that we will be able to pass on
product cost increases fully or immediately, particularly when product costs
increase rapidly. Therefore, average retail sales prices can vary significantly
from year to year as product costs fluctuate with propane, fuel oil, crude oil
and natural gas commodity market conditions.
SEASONALITY
The retail propane and fuel oil distribution businesses are seasonal
because of propane and fuel oil's primary use for heating in residential and
commercial buildings. Historically, approximately two-thirds of our retail
propane volume is sold during the six-month peak heating season from October
through March. The fuel oil business (which we recently acquired through the
Acquisition of Agway Energy) tends to have an even greater impact from
seasonality given its more limited use for space heating and, as such, we expect
that approximately three-fourths of our fuel oil volumes will be sold between
October and March. Consequently, sales and operating profits are concentrated in
our first and second fiscal quarters. Cash flows from operations, therefore, are
greatest during the second and third fiscal quarters when customers pay for
products purchased during the winter heating season. Lower operating profits and
either net losses or lower net income during the period from April through
September (our third and fourth fiscal quarters) are expected. To the extent
necessary, we will reserve cash from the second and third quarters for
distribution to Common Unitholders in the first and fourth fiscal quarters.
WEATHER
Weather conditions have a significant impact on the demand for propane and
fuel oil for both heating and agricultural purposes. Many of our customers rely
heavily on propane or fuel oil as a heating source. Accordingly, the volume sold
is directly affected by the severity of the winter weather in our service areas,
which can vary substantially from year to year. In any given area, sustained
warmer-than-normal temperatures will tend to result in reduced propane and fuel
oil use, while sustained colder-than-normal temperatures will tend to result in
greater use.
RISK MANAGEMENT
Product supply contracts are generally one-year agreements subject to
annual renewal and generally permit suppliers to charge posted market prices
(plus transportation costs) at the time of delivery or the current prices
established at major delivery points. Since rapid increases in the cost of
propane or fuel oil may not be immediately passed on to retail customers, such
increases could reduce profitability. We engage in risk management activities to
reduce the effect of price volatility on our product costs and to help ensure
the availability of product during periods of short supply. We are currently a
party to propane and fuel oil futures contracts traded on the New York
Mercantile Exchange (the "NYMEX") and enter into forward and option agreements
with third parties to purchase and sell propane or fuel oil at fixed prices in
the future. Risk management activities are monitored by an internal Commodity
Risk Management Committee, made up of five members of management, through
enforcement of our
16
Commodity Trading Policy and reported to our Audit Committee. Risk management
transactions may not always result in increased product margins. See the
additional discussion in Item 3 of this Quarterly Report.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Certain amounts included in or affecting our consolidated financial
statements and related disclosures must be estimated, requiring management to
make certain assumptions with respect to values or conditions that cannot be
known with certainty at the time the financial statements are prepared. The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. We are also subject to risks and uncertainties that
may cause actual results to differ from estimated results. Estimates are used
when accounting for depreciation and amortization of long-lived assets, employee
benefit plans, self-insurance and legal reserves, environmental reserves,
allowance for doubtful accounts, asset valuation assessment and valuation of
derivative instruments. We base our estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Any effects on our business, financial position or results of
operations resulting from revisions to these estimates are recorded in the
period in which the facts that give rise to the revision become known to us.
Our significant accounting policies are summarized in Note 2 - Summary of
Significant Accounting Policies included within the Notes to Consolidated
Financial Statements section of the Annual Report on Form 10-K for the most
recent fiscal year ended September 27, 2003. We believe that the following are
our critical accounting policies:
REVENUE RECOGNITION. We recognize revenue from the sale of propane and fuel oil
at the time product is delivered to the customer. Revenue from the sale of
appliances and equipment is recognized at the time of sale or when installation
is complete, as applicable. Revenue from repair and maintenance activities is
recognized upon completion of the service.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. We maintain allowances for doubtful accounts
for estimated losses resulting from the inability of our customers to make
required payments. We estimate our allowance for doubtful accounts using a
specific reserve for known or anticipated uncollectible accounts, as well as an
estimated reserve for potential future uncollectible accounts taking into
consideration our historical write-offs. If the financial condition of one or
more of our customers were to deteriorate resulting in an impairment in their
ability to make payments, additional allowances could be required.
PENSION AND OTHER POSTRETIREMENT BENEFITS. We estimate the rate of return on
plan assets, the discount rate to estimate the present value of future benefit
obligations and the cost of future health care benefits in determining our
annual pension and other postretirement benefit costs. In accordance with
generally accepted accounting principles, actual results that differ from our
assumptions are accumulated and amortized over future periods and therefore,
generally affect our recognized expense and recorded obligation in such future
periods. While we believe that our assumptions are appropriate, significant
differences in our actual experience or significant changes in market conditions
may materially affect our pension and other postretirement obligations and our
future expense. See the Liquidity and Capital Resources section of Item 7 -
Management's Discussion and Analysis of Financial Condition and Results of
Operations in the Annual Report on Form 10-K for the year ended September 27,
2003 for additional disclosure regarding pension and other postretirement
benefits.
SELF-INSURANCE RESERVES. Our accrued insurance reserves represent the estimated
costs of known and anticipated or unasserted claims under our general and
product, workers' compensation and automobile insurance policies. Accrued
insurance provisions for unasserted claims arising from unreported incidents are
based on an analysis of historical claims data. For each claim, we record a
self-insurance provision up to the estimated amount of the
17
probable claim or the amount of the deductible, whichever is lower, utilizing
actuarially determined loss development factors applied to actual claims data.
ENVIRONMENTAL RESERVES. We establish reserves for environmental exposures when
it is probable that a liability has been incurred and the amount of the
liability can be reasonably estimated based upon our best estimate of costs
associated with environmental remediation and ongoing monitoring activities.
Accrued environmental reserves are exclusive of claims against third parties,
except where contribution or reimbursement from such third parties has been
agreed and we are reasonably assured of receiving such contribution or
reimbursement. Environmental reserves are not discounted.
GOODWILL IMPAIRMENT ASSESSMENT. We assess the carrying value of goodwill at a
reporting unit level, at least annually, based on an estimate of the fair value
of the respective reporting unit. Fair value of the reporting unit is estimated
using either (i) a market value approach taking into consideration the quoted
market price of our Common Units; or (ii) discounted cash flow analyses taking
into consideration estimated cash flows in a ten-year projection period and a
terminal value calculation at the end of the projection period.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. See Item 3 of this Quarterly
Report for additional information about accounting for derivative instruments
and hedging activities.
EXECUTIVE SUMMARY OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The second quarter of fiscal 2004 ended March 27, 2004 was the first full
quarter that includes the results from the Acquisition of substantially all of
the assets and operations of Agway Energy, which closed on December 23, 2003.
This Acquisition expands our product and service offerings in the northeast
energy market with the addition of fuel oil and other refined products, as well
as expansion of our heating, ventilation and air conditioning ("HVAC") service
activities. The addition of Agway Energy has had a significant impact on our
financial position, results of operations and cash flows in both the three and
six month period ended March 27, 2004. The total cost of the Acquisition was
approximately $211.2 million, consisting of the $205.0 million purchase price
(net of a $1.0 million favorable purchase price adjustment for working capital),
plus fees and expenses associated with the Acquisition. The Acquisition was
financed through a combination of $87.6 million in net proceeds from the
issuance of 2,990,000 Common Units and the remainder from a portion of the net
proceeds from the issuance of $175.0 million in 6.875% senior notes, both during
December 2003.
As a result, we reported record earnings for the second quarter ended March
27, 2004 with net income of $92.6 million, or $2.97 per Common Unit, an increase
of $34.3 million (58.8%) compared to net income of $58.3 million, or $2.31 per
Common Unit, in the prior year quarter. EBITDA (as defined and reconciled below)
of $112.6 million for the three months ended March 27, 2004 increased $38.6
million (52.2%) compared to $74.0 million from the prior year quarter. For the
six month period ended March 27, 2004, we reported net income of $112.7 million,
or $3.78 per Common Unit, compared to $81.6 million, or $3.23 per Common Unit,
in the prior year period. EBITDA for the six month period ended March 27, 2004
increased $36.6 million (32.3%) to $149.8 million compared to $113.2 million in
the prior year period.
EBITDA and net income for the second quarter and first half of fiscal 2004
were favorably impacted by the net result of certain significant items, mainly
relating to: (i) a $14.2 million gain from the sale of ten customer service
centers in Texas, Oklahoma, Missouri and Kansas considered to be non-strategic,
compared to a $2.4 million gain from the sale of five customer service centers
during the second quarter of fiscal 2003; (ii) a non-cash charge of $5.6 million
included within cost of products sold relating to the settlement of futures
contracts which were marked-to-market under purchase accounting for the
Acquisition; and, (iii) a $2.2 million restructuring charge related to our
initial efforts to integrate certain management and back office functions of
Agway Energy. These significant items had a net positive impact of $4.0 million
on the year-over-year comparison of net income and EBITDA.
From an operational perspective, retail propane volumes for the three month
period ended March 27, 2004 of 219.9 million gallons increased 36.9 million
gallons, or 20.2%, compared to the prior year quarter primarily as a result of
the addition of Agway Energy, offset slightly by warmer than normal nationwide
average temperatures
18
during the quarter. Sales of fuel oil and other refined fuels for the three
month period ended March 27, 2004 amounted to 110.6 million gallons. Nationwide
average temperatures, as reported by the National Oceanic and Atmospheric
Administration ("NOAA"), averaged 3% warmer than normal in the second quarter of
fiscal 2004 compared to 2% colder than normal in the prior year quarter, or 5%
warmer temperatures year-over-year. For the six month period ended March 27,
2004, retail propane volumes increased 29.0 million gallons, or 9.0%, to 351.9
million gallons, primarily as a result of the Acquisition. Volumes for the six
month period ended March 27, 2004 were negatively impacted by 4% warmer than
normal average nationwide temperatures compared to 2% colder than normal
temperatures in the prior year period.
The first six months of fiscal 2004 marked several milestones for our
Partnership, highlighted by the Acquisition and the successful completion of a
concurrent follow-on equity offering and debt offering to finance the
Acquisition. Following our record earnings level for the quarter ended March 27,
2004, we ended the second quarter of fiscal 2004 with approximately $61.4
million in cash and cash equivalents and had no amounts outstanding under our
Revolving Credit Agreement as of March 27, 2004. During the first three months
following the Acquisition, we have taken certain steps, as anticipated, to
integrate the upper management and back office functions of Agway Energy. As we
look ahead to the remainder of fiscal 2004, with the peak heating season behind
us, we will focus on achieving synergies in our field operations and operational
efficiencies from the combined entity. As was the case in the second quarter of
fiscal 2004, we expect to incur additional restructuring charges and other costs
to integrate the combined operations during the third and fourth quarters of
fiscal 2004 in order to achieve the anticipated synergies from the Acquisition.
Based on our current estimates of our cash flow from operations, our strong cash
position at the end of the second quarter of fiscal 2004 and our availability
under the Revolving Credit Agreement (unused borrowing capacity under the
working capital facility of $61.5 million at March 27, 2004), we expect to have
sufficient funds to meet our current and future obligations, including the
additional cash requirements to fund our integration efforts.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 27, 2004 COMPARED TO THREE MONTHS ENDED MARCH 29, 2003
Revenues. Revenues increased $286.9 million, or 99.7%, to $574.6 million
for the three months ended March 27, 2004 compared to $287.7 million for the
three months ended March 29, 2003. Revenues from retail propane activities of
$341.1 million for the three months ended March 27, 2004 increased $78.4
million, or 29.8%, compared to $262.7 million in the prior year quarter. This
increase is the result of increased propane sales volumes, coupled with an
increase in average selling prices. Retail propane gallons sold increased 36.9
million gallons, or 20.2%, to 219.9 million gallons in the second quarter of
fiscal 2004 compared to 183.0 million gallons in the prior year quarter. The
increase in retail propane gallons sold was attributable to the addition of
Agway Energy, offset to an extent by warmer nationwide average temperatures
during the second quarter of fiscal 2004 compared to the prior year quarter.
Temperatures nationwide, as reported by NOAA, averaged 3% warmer than normal in
the second quarter of fiscal 2004 compared to 2% colder than normal in the prior
year quarter, or 5% warmer temperatures year-over-year. Average selling prices
increased approximately 8.2% as a result of sustained higher commodity prices
for propane. The average posted price of propane during the second quarter of
fiscal 2004 increased approximately 1% compared to the average posted prices in
the prior year quarter.
Revenues from sales of fuel oil and other refined fuels amounted to $110.6
million for the three month period ended March 27, 2004 attributable to 110.6
million gallons sold from the addition of Agway Energy. Revenues from wholesale
and risk management activities of $11.8 million for the three months ended March
27, 2004 increased $8.1 million, compared to revenues of $3.7 million for the
three months ended March 29, 2003. The increase in wholesale and risk management
activities results from slightly higher volumes sold in the wholesale market.
Revenue from other sources, including sales of natural gas and electricity in
deregulated markets, HVAC service activities and sales of appliances and related
parts, of $111.1 million for the three months ended March 27, 2004 increased
$89.9 million compared to other revenue in the prior year quarter of $21.2
million. The increase in other revenues is primarily attributable to the
addition of natural gas and electricity marketing and service and maintenance
revenues from Agway Energy.
19
Cost of Products Sold. The cost of products sold reported in the
consolidated statements of operations represents the weighted average unit cost
of propane and fuel oil sold, including transportation costs to deliver product
from our supply points to storage or to our customer service centers. Cost of
products sold also includes the cost of appliances and related parts sold or
installed by our customer service centers computed on a basis that approximates
the average cost of the products. Cost of products sold is reported exclusive of
any depreciation and amortization as such amounts are reported separately within
the consolidated statements of operations.
Cost of products sold increased $204.5 million to $346.7 million for the
three months ended March 27, 2004 compared to $142.2 million in the prior year
quarter. The increase results primarily from the aforementioned increase in
retail propane volumes sold, as well as the addition of fuel oil and other
refined fuel sales volumes during the second quarter of fiscal 2004, which had a
combined impact of $127.4 million on the fiscal 2004 second quarter compared to
the prior year quarter. Higher commodity prices for propane during the fiscal
2004 second quarter also resulted in an increase in cost of products sold in the
amount of $21.5 million compared to the prior year quarter. Increased wholesale
and risk management activities, noted above, caused an increase of $8.5 million
in cost of products sold compared to the prior year quarter.
Additionally, cost of products sold for the three months ended March 27,
2004 included a $5.6 million non-cash charge associated with the settlement of
futures contracts that were acquired in the Acquisition. As the underlying
futures and option contracts are settled the derivative assets are charged to
cost of products sold as an offset to the realized gains from contract
settlement. The impact on cost of products sold represents a non-cash charge
resulting from the application of purchase accounting on derivative instruments
acquired. In addition, the increase in revenues attributable to natural gas and
electricity marketing, HVAC service activities and sales of appliances and
related parts noted above had a $41.5 million impact on cost of products sold in
the second quarter of fiscal 2004 compared to the prior year quarter.
For the three months ended March 27, 2004, cost of products sold represented
60.3% of revenues compared to 49.4% in the prior year quarter. The increase in
the cost of products sold as a percentage of revenue during the second quarter
of fiscal 2004 compared to the prior year quarter results primarily from the
addition of sales from fuel oil and other refined fuels, as well as the
increased level of HVAC service and other sales activity generated from the
Acquisition of Agway Energy. Generally, the percentage of the commodity price
for fuel oil and other refined fuels on revenues tends to be between 20% and 30%
higher than propane costs are as a percentage of propane revenues. Additionally,
as was the case prior to the Acquisition, the percentage of cost of products
sold for sales of appliances and related parts and HVAC services tends to be
higher than that for the retail propane activities. Accordingly, the different
mix of product sales during the second quarter of fiscal 2004 compared to the
prior year quarter has had an impact on this percentage comparison.
Operating Expenses. All other costs of operating our retail distribution
and appliance sales and service operations are reported within operating
expenses in the consolidated statements of operations. These operating expenses
include the compensation and benefits of field and direct operating support
personnel, costs of operating and maintaining our vehicle fleet, overhead and
other costs of our purchasing, training and safety departments and other direct
and indirect costs of our customer service centers. Operating expenses increased
69.7%, or $45.1 million, to $109.8 million for the three months ended March 27,
2004 compared to $64.7 million for the three months ended March 29, 2003.
Operating expenses in the second quarter of fiscal 2004 include a $1.1 million
unrealized (non-cash) gain representing the net change in fair values of
derivative instruments during the quarter, compared to a $0.4 million unrealized
loss in the prior year quarter (see Item 3 Quantitative and Qualitative
Disclosures About Market Risk for information on our policies regarding the
accounting for derivative instruments).
In addition to the non-cash impact of changes in the fair value of
derivative instruments, operating expenses increased primarily from the impact
on employee, vehicle and facility costs from the addition of the Agway Energy
operations for a full quarter. The most significant impact on operating expenses
in the second quarter of fiscal 2004 was primarily attributable to (i) $25.0
million increased employee compensation and benefit costs related to an increase
in field personnel, (ii) $7.2 million increase in vehicle related costs
associated with the addition of the Agway Energy fleet, (iii) $2.5 million
higher costs associated with operating and maintaining our facilities from the
addition of the Agway Energy customer service centers, (iv) $2.3 million
increased insurance costs, (v) $0.7 million
20
increased marketing and advertising costs, (vi) $0.7 million higher pension
costs and, (vii) $0.6 million higher medical costs.
General and Administrative Expenses. All costs of our back office support
functions, including compensation and benefits for executives and other support
functions, as well as other costs and expenses to maintain finance and
accounting, treasury, legal, human resources, corporate development and the
information systems functions are reported within general and administrative
expenses in the consolidated statements of operations. General and
administrative expenses of $17.4 million for the three months ended March 27,
2004 were $7.3 million, or 72.3%, higher than the prior year quarter of $10.1
million. The increase was primarily attributable to the impact of $4.5 million
higher employee compensation and benefit costs as a result of higher profit
levels and increased overall headcount to support increased activities from the
Acquisition. In addition, in connection with the transition of Agway Energy we
have incurred transition services fees in the amount of $2.3 million related to
back office functions being performed by Agway, Inc. on our behalf during the
first six months following the Acquisition, as well as higher travel and
professional services fees associated with integration activities during the
second quarter of fiscal 2004.
Restructuring Costs. During the second quarter of fiscal 2004, in
connection with the initial integration of certain management and back office
functions of Agway Energy, we recorded a $2.2 million restructuring charge
associated with employee termination and other benefit costs incurred as a
result of actions taken during the quarter. The restructuring and integration of
our field and back office functions will continue throughout the remainder of
fiscal 2004 in order to achieve the anticipated synergies from the combined
operations. As a result, additional restructuring charges including severance,
costs of vacating duplicative facilities and contract termination and other exit
costs, as well as asset impairment charges are expected to be incurred during
the third and fourth quarters of fiscal 2004.
Depreciation and Amortization. Depreciation and amortization expense
increased $2.4 million, or 35.3%, to $9.2 million for the three months ended
March 27, 2004 primarily as a result of the additional depreciation and
amortization attributable to the acquired property, plant and equipment and
identifiable intangible assets.
Income Before Interest Expense and Income Taxes and EBITDA. Income before
interest expense and income taxes of $89.2 million in the three months ended
March 27, 2004 increased $25.4 million, or 39.8%, compared to $63.8 million in
the prior year quarter. Earnings before interest, taxes, depreciation and
amortization ("EBITDA") amounted to $112.6 million for the three months ended
March 27, 2004, compared to $74.0 million for the prior year quarter, an
increase of $38.6 million, or 52.2%. The increase in income before interest
expense and income taxes and in EBITDA compared to the prior year quarter
reflects the nearly 100% increase in revenues attributable to increased propane
volumes, as well as the addition of multiple energy product offerings, including
the increased level of HVAC service activities, from the addition of Agway
Energy. The favorable impact on revenues and related margins was offset, to an
extent, by the added operating and general and administrative costs described
above to support the increased level of field operations, as well as to support
integration and restructuring activities. In addition, the $14.2 million gain
reported in the second quarter of fiscal 2004 and the $2.4 million gain reported
in the second quarter of fiscal 2003 from the sale of customer service centers
(reported within discontinued operations as described below) had a favorable
impact on EBITDA in both the current and prior year quarters.
EBITDA represents net income before deducting interest expense, income
taxes, depreciation and amortization. Our management uses EBITDA as a measure of
liquidity and we are including it because we believe that it provides our
investors and industry analysts with additional information to evaluate our
ability to meet our debt service obligations and to pay our quarterly
distributions to holders of our Common Units. Moreover, our senior note
agreements and our Revolving Credit Agreement require us to use EBITDA as a
component in calculating our leverage and interest coverage ratios. EBITDA is
not a recognized term under generally accepted accounting principles ("GAAP")
and should not be considered as an alternative to net income or net cash
provided by operating activities determined in accordance with GAAP. Because
EBITDA as determined by us excludes some, but not all, items that affect net
income, it may not be comparable to EBITDA or similarly titled measures used by
other companies. The following table sets forth (i) our calculation of EBITDA
and (ii) a reconciliation of EBITDA, as so calculated, to our net cash provided
by operating activities (amounts in thousands):
21
THREE MONTHS ENDED
-----------------------
MARCH 27, MARCH 29,
2004 2003
---------- ----------
Net income $ 92,560 $ 58,306
Add:
Provision for income taxes 83 37
Interest expense, net 10,770 8,876
Depreciation and amortization 9,223 6,800
---------- ----------
EBITDA 112,636 74,019
---------- ----------
Add / (subtract):
Provision for income taxes (83) (37)
Interest expense, net (10,770) (8,876)
(Gain) / loss on disposal of property, plant and equipment, net (79) 26
Gain on sale of customer service centers (14,205) (2,404)
Changes in working capital and other assets and liabilities (75,726) (47,740)
---------- ----------
Net cash provided by operating activities $ 11,773 $ 14,988
========== ==========
Net cash provided by investing activities $ 15,355 $ 3,235
========== ==========
Net cash used in financing activities $ (18,348) $ (14,533)
========== ==========
Interest Expense. Net interest expense increased $1.9 million, or 21.3%, to
$10.8 million in the second quarter of fiscal 2004 compared to $8.9 million in
the prior year quarter. The increase in net interest expense is a result of the
net impact of the addition of $175.0 million of 6.875% senior notes associated
with financing for the Acquisition of Agway Energy, offset by $42.5 million
lower amounts outstanding under our 7.54% senior notes as a result of the
repayment of a portion of the principal on July 1, 2003.
Discontinued Operations. As part of our overall business strategy, we
continually monitor and evaluate our existing operations to identify
opportunities that will allow us to optimize our return on assets employed by
selectively consolidating or divesting operations in slower growing or
non-strategic markets. In line with that strategy, we sold ten customer service
centers in Texas, Oklahoma, Missouri and Kansas during the second quarter of
fiscal 2004 for total cash proceeds of approximately $24.0 million. We recorded
a gain on sale of approximately $14.2 million, which has been accounted for
within discontinued operations pursuant to Statement of Financial Accounting
Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." In the prior year quarter, we sold five customer service
centers for total cash proceeds of approximately $5.7 million, resulting in a
gain on sale of approximately $2.4 million. Additionally, discontinued
operations for the three months ended March 29, 2003 includes $1.1 million
related to earnings generated in the second quarter of fiscal 2003 from the
customer service centers discontinued in the second quarter of fiscal 2004.
SIX MONTHS ENDED MARCH 27, 2004 COMPARED TO SIX MONTHS ENDED MARCH 29, 2003
Revenues. Revenues increased $308.3 million, or 63.3%, to $795.2 million
for the six months ended March 27, 2004 compared to $486.9 million for the six
months ended March 29, 2003. Revenues from retail propane activities of $517.9
million for the six months ended March 27, 2004 increased $87.9 million, or
20.4%, compared to $430.0 million in the prior year period. This increase is the
result of an increase in propane sales volumes, coupled with an increase in
average selling prices in line with higher commodity prices for propane. Despite
nationwide average temperatures, as reported by NOAA, that were 4% warmer than
normal and 6% warmer than the prior year, retail propane gallons sold increased
29.0 million gallons, or 9.0%, to 351.8 million gallons for the six months ended
March 27, 2004. The increase is primarily attributable to the addition of Agway
Energy from the date of the Acquisition, offset to an extent by the impact of
the warmer temperatures. Average selling prices increased approximately 8.4% as
a result of sustained higher commodity prices for propane. The average posted
price of propane during the first six months of fiscal 2004 increased
approximately 8% compared to the average posted prices in the prior year period.
22
Revenues from sales of fuel oil and other refined fuels amounted to $112.6
million for the six months ended March 27, 2004 attributable to 112.2 million
gallons sold from the addition of Agway Energy on December 23, 2003. Revenues
from wholesale and risk management activities of $20.2 million for the six
months ended March 27, 2004 increased $10.8 million, compared to revenues of
$9.4 million for the six months ended March 29, 2003. Revenue from other
sources, including natural gas and electricity marketing to deregulated markets,
HVAC service activities and sales of appliances and related parts, of $144.5
million for the six months ended March 27, 2004 increased $97.3 million compared
to other revenue in the prior year period of $47.2 million. The increase in
other revenues is primarily attributable to the addition of sales of natural gas
and electricity and service and maintenance revenues from Agway Energy.
Cost of Products Sold. Cost of products sold increased $222.3 million, or
94.7%, to $457.0 million for the six months ended March 27, 2004 compared to
$234.7 million in the prior year period. The increase results primarily from the
increase in retail propane volumes sold, as well as the addition of fuel oil and
other refined fuel sales volumes, which had a combined impact of $122.9 million
on the year-over-year comparison of cost of products sold. Higher commodity
prices for propane during the first half of fiscal 2004 also resulted in an
increase in cost of products sold by $36.7 million compared to the prior year.
Increased wholesale and risk management activities, noted above, caused an
increase of $11.0 million in cost of products sold compared to the prior year
period.
Additionally, cost of products sold for the six months ended March 27, 2004
included a $5.6 million non-cash charge associated with the settlement of
futures contracts that were acquired in the Acquisition. As the underlying
futures and option contracts are settled the derivative assets are charged to
cost of products sold as an offset to the realized gains from contract
settlement. The impact on cost of products sold represents a non-cash charge
resulting from the application of purchase accounting on derivative instruments
acquired. In addition, the increase in revenues attributable to natural gas and
electricity marketing, HVAC service activities and sales of appliances and
related parts noted above had a $46.1 million impact on cost of products sold in
the six months ended March 27, 2004 compared to the prior year period. For the
six months ended March 27, 2004, cost of products sold represented 57.5% of
revenues compared to 48.2% in the prior year period. As described in the three
month comparison above, the increase in the cost of products sold as a
percentage of revenue during the first half of fiscal 2004 compared to the prior
year period results primarily from the different mix of products sold and
increased levels of HVAC service activities.
Operating Expenses. Operating expenses of $172.6 million for the six month
ended March 27, 2004 increased $49.4 million, or 40.0%, compared to $123.2
million for the prior year period. Operating expenses in the first half of
fiscal 2004 include a $0.3 million unrealized (non-cash) gain representing the
net change in fair values of derivative instruments during the period, compared
to a $1.4 million unrealized loss in the prior year period (see Item 3
Quantitative and Qualitative Disclosures About Market Risk for information on
our policies regarding the accounting for derivative instruments). In addition
to the non-cash impact of changes in the fair value of derivative instruments,
operating expenses increased $51.1 million as a result of (i) $26.1 million
increased employee compensation and benefit costs associated with the addition
of Agway Energy personnel and increased earnings, (ii) $7.6 million increased
costs for operating our fleet as a result of the addition of the Agway Energy
fleet, (iii) $2.7 million higher costs to operate the additional customer
service centers acquired, (iv) $2.7 million incremental insurance costs, (v)
$1.1 million higher pension costs, and (vi) $1.0 million higher medical costs.
General and Administrative Expenses. General and administrative expenses of
$27.9 million for the six months ended March 27, 2004 were $8.7 million, or
45.3%, higher than the prior year period of $19.2 million. The increase was
primarily attributable to the impact of $5.0 million higher employee
compensation and benefit costs as a result of higher profit levels and increased
overall headcount, as well as $2.3 million related to transition services fees
paid to Agway, Inc. for back office support provided subsequent to the
Acquisition. In addition, we incurred incremental travel and professional fees
in the first quarter of fiscal 2004 associated with our efforts to acquire Agway
Energy and higher costs in the second quarter of fiscal 2004 in connection with
our integration efforts.
Restructuring Costs. As discussed in more detail in the three month
comparison above, during the second quarter of fiscal 2004 we recorded a $2.2
million restructuring charge associated with employee termination and
23
other benefit costs incurred as a result of actions taken during the second
quarter to integrate certain management and back office functions of Agway
Energy.
Depreciation and Amortization. Depreciation and amortization expense
increased 19.6% to $16.5 million for the six months ended March 27, 2004
compared to $13.8 million for the prior year period, primarily as a result of
the additional depreciation and amortization associated with the acquired
tangible and intangible assets.
Income Before Interest Expense and Income Taxes and EBITDA. Income before
interest expense and income taxes of $119.1 million in the six months ended
March 27, 2004 increased $23.1 million, or 24.1%, compared to $96.0 million in
the prior year period. Earnings before interest, taxes, depreciation and
amortization ("EBITDA") amounted to $149.8 million for the six months ended
March 27, 2004, compared to $113.2 million for the prior year period, an
increase of $36.6 million, or 32.3%. The increases in income before interest
expense and income taxes and in EBITDA compared to the prior year period
reflects the favorable impact on revenues and related margins from the addition
of the Agway Energy operations. This favorable impact was offset, to an extent,
by the added operating and general and administrative costs to support the
increased level of field operations, as well as to support integration and
restructuring activities. Additionally, the warmer than normal temperatures
experienced during the first half of fiscal 2004, described above, negatively
impacted volumes for the period compared to the prior year. In addition, the
$14.2 million gain reported in the second quarter of fiscal 2004 and the $2.4
million gain reported in the second quarter of fiscal 2003 from the sale of
customer service centers (reported within discontinued operations) had a
favorable impact on EBITDA in both the current and prior year periods.
EBITDA represents net income before deducting interest expense, income
taxes, depreciation and amortization. Our management uses EBITDA as a measure of
liquidity and we are including it because we believe that it provides our
investors and industry analysts with additional information to evaluate our
ability to meet our debt service obligations and to pay our quarterly
distributions to holders of our Common Units. Moreover, our senior note
agreements and our Revolving Credit Agreement require us to use EBITDA as a
component in calculating our leverage and interest coverage ratios. EBITDA is
not a recognized term under generally accepted accounting principles ("GAAP")
and should not be considered as an alternative to net income or net cash
provided by operating activities determined in accordance with GAAP. Because
EBITDA as determined by us excludes some, but not all, items that affect net
income, it may not be comparable to EBITDA or similarly titled measures used by
other companies. The following table sets forth (i) our calculation of EBITDA
and (ii) a reconciliation of EBITDA, as so calculated, to our net cash provided
by operating activities (amounts in thousands):
SIX MONTHS ENDED
----------------------
MARCH 27, MARCH 29,
2004 2003
--------- ---------
Net income $ 112,651 $ 81,560
Add:
Provision for income taxes 166 167
Interest expense, net 20,481 17,732
Depreciation and amortization 16,452 13,773
--------- ---------
EBITDA 149,750 113,232
--------- ---------
Add / (subtract):
Provision for income taxes (166) (167)
Interest expense, net (20,481) (17,732)
Gain on disposal of property, plant and equipment, net (161) (320)
Gain on sale of customer service centers (14,205) (2,404)
Changes in working capital and other assets and liabilities (91,403) (69,243)
--------- ---------
Net cash provided by operating activities $ 23,334 $ 23,366
========= =========
Net cash used in (provided by) investing activities $(199,640) $ 674
========= =========
Net cash provided by / (used in) financing activities $ 221,967 $ (29,124)
========= =========
24
Interest Expense. Net interest expense increased $2.8 million, or 15.8%, to
$20.5 million in the first half of fiscal 2004 compared to $17.7 million in the
prior year period, primarily as a result of a one-time fee of $1.9 million
related to financing commitments for the Acquisition incurred during the first
quarter of fiscal 2004. In addition, net interest expense increased as a result
of the net impact of the addition of $175.0 million of 6.875% senior notes
associated with financing for the Acquisition, offset by $42.5 million lower
amounts outstanding under our 7.54% senior notes.
Discontinued Operations. As described above, we sold ten customer service
centers in Texas, Oklahoma, Missouri and Kansas during the second quarter of
fiscal 2004 for total cash proceeds of approximately $24.0 million. We recorded
a gain on sale of approximately $14.2 million, which has been accounted for
within discontinued operations. In the prior year quarter, we sold five customer
service centers for total cash proceeds of approximately $5.7 million, resulting
in a gain on sale of approximately $2.4 million. Additionally, discontinued
operations for the six months ended March 29, 2003 includes $1.1 million related
to earnings generated in the first half of fiscal 2003 from the customer service
centers discontinued in the second quarter of fiscal 2004.
LIQUIDITY AND CAPITAL RESOURCES
Due to the seasonal nature of the propane and fuel oil businesses, cash
flows from operating activities are greater during the winter and spring
seasons, our second and third fiscal quarters, as customers pay for products
purchased during the heating season. For the six months ended March 27, 2004,
net cash provided by operating activities was $23.3 million compared to cash
provided by operating activities of $23.4 million for the six months ended March
29, 2003. The slight decrease was primarily due to increased earnings for the
six months ended March 27, 2004 compared to the prior year period, offset by a
$22.2 million increase in the investment in working capital. The changes in
working capital result primarily from an increase in accounts receivable and
inventories in line with increased sales volumes and higher commodity prices,
offset to a degree by lower payments under employee compensation plans and
higher accounts payable.
Net cash used in investing activities of $199.6 million for the six months
ended March 27, 2003 consists of the net impact of the total cost of the
Acquisition of Agway Energy of approximately $211.2 million, offset to an extent
by net proceeds from the sale of ten customer service centers of $24.0 million
and net proceeds of $0.4 million from the sale of property, plant and equipment.
Additionally, capital expenditures amounted to $12.9 million (including $2.5
million for maintenance expenditures and $10.4 million to support the growth of
operations) for the six month period ended March 27, 2004. Net cash provided by
investing activities of $0.7 million during the six months ended March 29, 2003
consisted of net proceeds from the sale of five customer service centers of $5.7
million and net proceeds of $1.0 million from the sale of property, plant and
equipment; offset by capital expenditures of $6.0 million (including $1.7
million for maintenance expenditures and $4.3 million to support the growth of
operations).
Net cash provided by financing activities for the six months ended March
27, 2004 was $222.0 million as a result of (i) the issuance of $175.0 million
aggregate principal amount of 6.875% senior notes due 2013, a portion of which
was used to fund a portion of the Acquisition and, (ii) the net proceeds of
$87.6 million from a follow-on public offering of 2,990,000 Common Units
(including full exercise of the underwriters' over-allotment option) during
December 2003 to fund a portion of the Acquisition; offset by (i) the payment of
our quarterly distributions of $0.5875 per Common Unit during each of the first
two quarters of fiscal 2004 amounting to $34.7 million and, (ii) $5.9 million in
fees associated with the issuance of the senior notes noted above. Net cash used
in financing activities for the six months ended March 29, 2003 was $29.1
million, primarily reflecting payment of our quarterly distributions of $0.5750
per Common Unit during the first and second quarters of fiscal 2003.
On December 23, 2003, we issued $175.0 million aggregate principal amount
of senior notes with an annual interest rate of 6.875% through a private
placement under Rule 144A and Regulation S of the Securities Act of 1933. On
April 15, 2004, pursuant to a registration rights agreement, we launched an
offer to exchange the $175.0 million senior notes that were issued on December
23, 2003 with $175.0 million senior notes that were registered with the SEC and
which have substantially the same terms as the senior notes issued on December
23, 2003 (the "2003 Senior Notes"). The holders of senior notes that were issued
on December 23, 2003 have until May 13, 2004 to exchange their notes for the
2003 Senior Notes. We used approximately $122.4 million from the issuance of the
25
6.875% senior notes to fund a portion of the total cost of the Acquisition and
the remaining net proceeds for general partnership purposes, which include
working capital purposes, capital expenditures or debt reduction. Our
obligations under the 2003 Senior Notes are unsecured and will rank senior in
right of payment to any future subordinated indebtedness and equally in right of
payment with any future senior indebtedness. The 2003 Senior Notes are
structurally subordinated to, which means they rank effectively behind, the
senior notes and other liabilities of the Operating Partnership. The 2003 Senior
Notes will mature December 15, 2013, and require semiannual interest payments
beginning on June 15, 2004. We may redeem some or all of the 2003 Senior Notes
any time on or after December 15, 2008, at redemption prices specified in the
indenture governing the 2003 Senior Notes (the "2003 Senior Note Agreement").
The 2003 Senior Note Agreement contains certain restrictions applicable to us
and certain of our subsidiaries with respect to (i) the incurrence of additional
indebtedness; and (ii) liens, investments, guarantees, loans, advances,
payments, mergers, consolidations, distributions, sales of assets and other
transactions.
On March 5, 1996, pursuant to a Senior Note Agreement (the "1996 Senior
Note Agreement"), our Operating Partnership issued $425.0 million of senior
notes (the "1996 Senior Notes") with an annual interest rate of 7.54%. Our
Operating Partnership's obligations under the 1996 Senior Note Agreement are
unsecured and rank on an equal and ratable basis with its obligations under the
2002 Senior Note Agreement and the Revolving Credit Agreement discussed below.
Under the terms of the 1996 Senior Note Agreement, our Operating Partnership
became obligated to pay the principal on the 1996 Senior Notes in equal annual
payments of $42.5 million starting July 1, 2002, with the last such payment due
June 30, 2011. On July 1, 2002, we received net proceeds of $42.5 million from
the issuance by our Operating Partnership of 7.37% Senior Notes due June, 2012
(the "2002 Senior Notes") and used the funds to pay the first annual principal
payment of $42.5 million due under the 1996 Senior Note Agreement. Our Operating
Partnership's obligations under the agreement governing the 2002 Senior Notes
(the "2002 Senior Note Agreement") are unsecured and rank on an equal and
ratable basis with its obligations under the 1996 Senior Note Agreement and the
Revolving Credit Agreement. Rather than refinance the second annual principal
payment of $42.5 million due under the 1996 Senior Note Agreement, we elected to
repay this principal payment on June 30, 2003. The third annual principal
payment of $42.5 million under the 1996 Senior Note Agreement is due July 1,
2004. We expect that we will be able to be make this payment from cash flow from
operations, our cash position or availability under our Revolving Credit
Agreement. Alternatively, we may elect to refinance this next principal payment
through either a private placement of senior notes or the issuance of additional
senior notes under the 2003 Senior Note Agreement.
Our Operating Partnership's Revolving Credit Agreement, which provided a
$75.0 million working capital facility and a $25.0 million acquisition facility,
matures on May 31, 2006. Borrowings under the Revolving Credit Agreement bear
interest at a rate based upon either LIBOR plus a margin, Wachovia National
Bank's prime rate or the Federal Funds rate plus 1/2 of 1%. An annual fee
ranging from .375% to .50%, based upon certain financial tests, is payable
quarterly whether or not borrowings occur. As of March 27, 2004 and September
27, 2003, there were no borrowings outstanding under the Revolving Credit
Agreement. As of March 27, 2004, we had $61.5 million of unused borrowing
capacity under the working capital facility of our Revolving Credit Agreement,
after considering the impact on borrowing availability from outstanding letters
of credit associated with our casualty insurance coverage and certain operating
lease obligations. We are currently evaluating the adequacy of the borrowing
capacity provided under the Revolving Credit Agreement in light of the
additional seasonal cash needs of Agway Energy, as well as any future needs that
may arise as a result of our growth initiatives. Although not currently
contemplated, we may need to increase the borrowing capacity of the Revolving
Credit Agreement in the future to accommodate seasonal working capital
requirements associated with the added business activity from Agway Energy.
The 1996 Senior Note Agreement, the 2002 Senior Note Agreement and the
Revolving Credit Agreement contain various restrictive and affirmative covenants
applicable to the Operating Partnership, including (a) maintenance of certain
financial tests, including, but not limited to, a leverage ratio of less than
5.0 to 1, an interest coverage ratio in excess of 2.5 to 1 and a leverage ratio
of less than 5.25 to 1 when the underfunded portion of our pension obligations
is used in the computation of the ratio, (b) restrictions on the incurrence of
additional indebtedness, and (c) restrictions on certain liens, investments,
guarantees, loans, advances, payments, mergers, consolidations, distributions,
sales of assets and other transactions. Our Operating Partnership was in
compliance with all covenants and terms of all of its debt agreements as of
March 27, 2004 and at the end of each fiscal quarter for all periods presented.
26
We will make distributions in an amount equal to all of our Available Cash,
as defined in the Second Amended and Restated Partnership Agreement,
approximately 45 days after the end of each fiscal quarter to holders of record
on the applicable record dates. The Board of Supervisors reviews the level of
Available Cash on a quarterly basis based upon information provided by
management. On April 22, 2004, we declared an increase in our quarterly
distribution rate to $0.60 per Common Unit, or $2.40 on an annualized basis, in
respect of the second quarter of fiscal 2004 payable on May 11, 2004 to Common
Unitholders of record on May 4, 2004. This quarterly distribution represents a
$0.0125 per Common Unit, $0.05 per Common Unit annualized, increase from the
prior quarter.
Quarterly distributions include Incentive Distribution Rights ("IDRs")
payable to the General Partner to the extent the quarterly distribution exceeds
$0.55 per Common Unit. The IDRs represent an incentive for the General Partner
(which is owned by the management of the Partnership) to increase the
distributions to Common Unitholders in excess of $0.55 per Common Unit. With
regard to the first $0.55 of the Common Unit distribution, 98.46% of the
Available Cash is distributed to the Common Unitholders and 1.54% is distributed
to the General Partner (98.29% and 1.71%, respectively, prior to our December
2003 public offering). With regard to the balance of the Common Unit
distributions paid, 85% of the Available Cash is distributed to the Common
Unitholders and 15% is distributed to the General Partner.
LONG-TERM DEBT OBLIGATIONS AND OTHER COMMITMENTS
Long-term debt obligations and future minimum rental commitments under
noncancelable operating lease agreements as of March 27, 2004 are due as follows
(amounts in thousands):
REMAINDER FISCAL
OF FISCAL FISCAL FISCAL FISCAL 2008 AND
2004 2005 2006 2007 THEREAFTER TOTAL
-------- -------- -------- -------- -------- --------
Long-term debt $ 42,908 $ 42,940 $ 42,975 $ 42,500 $387,500 $558,823
Operating leases 12,807 17,949 11,912 7,540 7,092 57,300
-------- -------- -------- -------- -------- --------
Total long-term debt obligations
and lease commitments $ 55,715 $ 60,889 $ 54,887 $ 50,040 $394,592 $616,123
======== ======== ======== ======== ======== ========
Additionally, we have standby letters of credit in the aggregate amount of
$43.4 million, in support of our casualty insurance coverage and certain lease
obligations, which expire periodically through March 1, 2005.
We have residual value guarantees associated with certain of our operating
leases, related primarily to transportation equipment, with remaining lease
periods scheduled to expire periodically through fiscal 2009. Upon completion of
the lease period, we guarantee that the fair value of the equipment will equal
or exceed the guaranteed amount, or we will pay the difference. Although the
equipment's fair value at the end of its lease term has historically exceeded
the guaranteed amounts, the maximum potential amount of aggregate future
payments we could be required to make under these leasing arrangements, assuming
the equipment is deemed worthless at the end of the lease term, is approximately
$17.5 million. Of this amount, the fair value of residual value guarantees for
operating leases entered into after December 31, 2002 was $2.8 million and $2.1
million which is reflected in other liabilities, with a corresponding amount
included within other assets, in the accompanying condensed consolidated balance
sheets as of both March 27, 2004 and September 27, 2003, respectively.
PUBLIC OFFERING
On December 16, 2003, we sold 2,600,000 Common Units in a public offering
at a price of $30.90 per Common Unit realizing proceeds of $76.0 million, net of
underwriting commissions and other offering expenses. On December 23, 2003,
following the underwriters' full exercise of their over-allotment option, we
sold an additional 390,000 Common Units at $30.90 per Common Unit, generating
additional net proceeds of $11.6 million. The aggregate net proceeds of $87.6
million were used to fund a portion of the purchase price for the Acquisition.
These
27
transactions increased the total number of Common Units outstanding to
30,256,767. As a result of the Public Offering, the combined General Partner
interest was reduced from 1.71% to 1.54% while the Common Unitholder interest
increased from 98.29% to 98.46%.
RECENTLY ISSUED ACCOUNTING STANDARDS
In December 2003, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 132 (revised), "Employers'
Disclosures about Pensions and Other Postretirement Benefits" (the "revised SFAS
132"). The revised SFAS 132 requires additional disclosures in annual financial
statements regarding types of plan assets held, investment strategies,
measurement dates, plan obligations and cash flows, as well as certain
disclosures in both interim and annual financial statements regarding components
of net periodic benefit cost/(expense) and employer contributions. The revised
SFAS 132 interim disclosures requirements were adopted as of and for the second
quarter ended March 27, 2004. The annual disclosure requirements will be
included in our Annual Report on Form 10-K for the year ended September 25,
2004.
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains Forward-Looking Statements as
defined in the Private Securities Litigation Reform Act of 1995 relating to the
Partnership's future business expectations and predictions and financial
condition and results of operations. Some of these statements can be identified
by the use of forward-looking terminology such as "prospects," "outlook,"
"believes," "estimates," "intends," "may," "will," "should," "anticipates,"
"expects" or "plans" or the negative or other variation of these or similar
words, or by discussion of trends and conditions, strategies or risks and
uncertainties. These Forward-Looking Statements involve certain risks and
uncertainties that could cause actual results to differ materially from those
discussed or implied in such Forward-Looking Statements. The risks and
uncertainties and their impact on the Partnership's operations include, but are
not limited to, the following risks:
o The impact of weather conditions on the demand for propane, fuel oil and
other refined fuels;
o Fluctuations in the unit cost of propane, fuel oil and other refined fuels;
o The ability of the Partnership to compete with other suppliers of propane,
fuel oil and other energy sources;
o The impact on propane, fuel oil and other refined fuel prices and supply
from the political, military and economic instability of the oil producing
nations, global terrorism and other general economic conditions;
o The ability of the Partnership to realize fully, or within the expected
time frame, the expected cost savings and synergies from the acquisition of
Agway Energy;
o The ability of the Partnership to acquire and maintain reliable
transportation for its propane, fuel oil and other refined fuels;
o The ability of the Partnership to retain customers;
o The impact of energy efficiency and technology advances on the demand for
propane and fuel oil;
o The ability of management to continue to control expenses;
o The impact of changes in applicable statutes and government regulations, or
their interpretations, including those relating to the environment and
global warming and other regulatory developments on the Partnership's
business;
o The impact of legal proceedings on the Partnership's business;
o The Partnership's ability to implement its expansion strategy into new
business lines and sectors; and
o The Partnership's ability to integrate acquired businesses successfully.
On different occasions, the Partnership or its representatives have
made or may make Forward-Looking Statements in other filings that the
Partnership makes with the SEC, in press releases or in oral statements made by
or with the approval of one of its authorized executive officers. Readers are
cautioned not to place undue reliance on Forward-Looking or Cautionary
Statements, which reflect management's opinions only as of the date made. The
Partnership undertakes no obligation to update any Forward-Looking or Cautionary
Statement. 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 in this Quarterly
Report and in future SEC reports.
28
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of March 27, 2004, we were a party to exchange-traded futures and option
contracts, forward contracts and in certain instances, over-the-counter options
(collectively "derivative instruments") to manage the price risk associated with
future purchases of the commodities used in its operations, principally propane
and fuel oil. Futures and forward contracts require that we sell or acquire
propane or fuel oil at a fixed price at fixed future dates. An option contract
allows, but does not require, its holder to buy or sell propane or fuel oil at a
specified price during a specified time period; the writer of an option contract
must fulfill the obligation of the option contract, should the holder choose to
exercise the option. At expiration, the contracts are settled by the delivery of
the product to the respective party or are settled by the payment of a net
amount equal to the difference between the then current price and the fixed
contract price. The contracts are entered into in anticipation of market
movements and to manage and hedge exposure to fluctuating prices of propane and
fuel oil, as well as to help ensure the availability of product during periods
of high demand.
Market risks associated with the trading of futures, options and forward
contracts are monitored daily for compliance with our Commodity Risk Management
Policy which includes volume limits for open positions. Open inventory positions
are reviewed and managed daily as to exposures to changing market prices.
MARKET RISK
We are subject to commodity price risk to the extent that propane or fuel
oil market prices deviate from fixed contract settlement amounts. Futures traded
with brokers of the NYMEX require daily cash settlements in margin accounts.
Forward and option contracts are generally settled at the expiration of the
contract term either by physical delivery or through a net settlement mechanism.
CREDIT RISK
Futures are guaranteed by the NYMEX and, as a result, have minimal credit
risk. We are subject to credit risk with forward and option contracts to the
extent the counterparties do not perform. We evaluate the financial condition of
each counterparty with which we conduct business and establish credit limits to
reduce exposure to credit risk of non-performance.
DERIVATIVE INSTRUMENTS
We account for derivative instruments in accordance with the provisions of
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities"
("SFAS 133"), as amended by SFAS No. 137 and SFAS No. 138. All derivative
instruments are reported on the balance sheet, within other current assets or
other current liabilities, at their fair values. On the date that futures,
forward and option contracts are entered into, we make a determination as to
whether the derivative instrument qualifies for designation as a hedge. Changes
in the fair value of derivative instruments are recorded each period in current
period earnings or other comprehensive income/(loss) ("OCI"), depending on
whether a derivative instrument is designated as a hedge and, if it is, the type
of hedge. For derivative instruments designated as cash flow hedges, we formally
assess, both at the hedge contract's inception and on an ongoing basis, whether
the hedge contract is highly effective in offsetting changes in cash flows of
hedged items. Changes in the fair value of derivative instruments designated as
cash flow hedges are reported in OCI to the extent effective and reclassified
into cost of products sold during the same period in which the hedged item
affects earnings. The mark-to-market gains or losses on ineffective portions of
cash flow hedges are recognized in cost of products sold immediately. Changes in
the fair value of derivative instruments that are not designated as hedges are
recorded in current period earnings within operating expenses. A portion of our
option contracts are not classified as hedges and, as such, changes in the fair
value of these derivative instruments are recognized within operating expenses
as they occur. Fair values for forward contracts and futures are derived from
quoted market prices for similar instruments traded on the NYMEX.
29
At March 27, 2004, the fair value of derivative instruments described above
resulted in derivative assets of $5.4 million included within prepaid expenses
and other current assets and derivative liabilities of $0.5 million included
within other current liabilities. Operating expenses include unrealized
(non-cash) gains in the amount of $1.1 million for the three months ended March
27, 2004 and unrealized losses in the amount of $0.4 million for the three
months ended March 29, 2003 attributable to the change in fair value of
derivative instruments not designated as hedges. Operating expenses include
unrealized gains in the amount of $0.3 million for the six months ended March
27, 2004 and unrealized losses in the amount of $1.4 million for the six months
ended March 29, 2003 attributable to the change in fair value of derivative
instruments not designated as hedges. At March 27, 2004, unrealized gains on
derivative instruments designated as cash flow hedges in the amount of $0.8
million were included in OCI and are expected to be recognized in earnings
during the next 12 months as the hedged transactions occur. However, due to the
volatility of the commodities market, the corresponding value in OCI is subject
to change prior to its impact on earnings.
SENSITIVITY ANALYSIS
In an effort to estimate the exposure of unfavorable market price
movements, a sensitivity analysis of open positions as of March 27, 2004 was
performed. Based on this analysis, a hypothetical 10% adverse change in market
prices for each of the future months for which an option, futures and/or forward
contract exists indicates either a reduction in potential future gains or
potential losses in future earnings of $1.3 million and $0.8 million as of March
27, 2004 and March 29, 2003, respectively. See also Item 7A of our Annual Report
on Form 10-K for the fiscal year ended September 27, 2003.
The above hypothetical change does not reflect the worst case scenario.
Actual results may be significantly different depending on market conditions and
the composition of the open position portfolio at any given point in time.
30
ITEM 4. CONTROLS AND PROCEDURES
Our management, including our principal executive officer and principal
financial officer, have evaluated the effectiveness of our "disclosure controls
and procedures" (as defined in Rule 13a-15(e) of the Securities Exchange Act of
1934) as of March 27, 2004. Based on such evaluation, our principal executive
officer and principal financial officer have concluded that as of March 27,
2004, such disclosure controls and procedures are effective for the purpose of
ensuring that material information required to be in this Quarterly Report on
Form 10-Q is made known to them by others on a timely basis. Other than the
impact of the recently completed acquisition of Agway Energy, there have not
been any changes in our internal control over financial reporting (as defined in
Rule 13a-15(f) of the Securities Exchange Act of 1934) during the quarter ending
March 27, 2004 that have materially affected or are reasonably likely to
materially affect our internal control over financial reporting. This
Acquisition is changing how transactions are being processed and/or the
functional areas responsible for the transaction processing. As a result, where
appropriate, we are changing the design and operation of our internal control
structure. We believe we are taking the necessary steps to monitor and maintain
appropriate internal controls over financial reporting during this change.
31
PART II
ITEM 1. LEGAL PROCEEDINGS
On May 23, 2001, our Operating Partnership was named as an additional
defendant in an action previously brought by Heritage Propane Partners against
SCANA Corporation and Cornerstone Ventures, L.P. arising out of our acquisition
of substantially all of the propane assets of SCANA in November of 1999. We
believe that all of the claims asserted against our Operating Partnership are
without merit and are defending the action vigorously. The court has entered an
order setting this matter for trial beginning on October 4, 2004. At the close
of discovery, we intend to file a motion for summary judgment to dismiss the
claims asserted against our Operating Partnership. See additional discussion of
this matter in the Annual Report on Form 10-K for the most recent fiscal year
ended September 27, 2003.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.29 Asset Purchase Agreement by and among Ferrellgas, L.P., Suburban
Sales and Service, Inc. and Suburban Propane, L.P. dated as of
January 9, 2004.
31.1 Certification of the President and Chief Executive Officer Pursuant
to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Vice President and Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the President and Chief Executive Officer Pursuant
to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of the Vice President and Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
(b) The Partnership filed the following Reports on Form 8-K with the Securities
and Exchange Commission during the three months ended March 27, 2004:
On January 15, 2004, the Partnership filed two press releases announcing
(i) the completion of the Agway Energy acquisition and (ii) the sale of
certain propane related assets to Ferrellgas, L.P., as exhibits to a
Current Report on Form 8-K.
On March 19, 2004 the Partnership filed (i) the unaudited condensed
combined financial statements of Agway Energy Group (Agway Energy Products
LLC, Agway Energy Services Inc. and Agway Energy Services PA, Inc.) as of
September 30, 2003 and June 30, 2003 and for each of the three months ended
September 30, 2003 and 2002 and the notes related thereto, and (ii) the
unaudited pro forma condensed combined statement of operations of Suburban
Propane Partners, L.P. and Agway Energy for the three month period ended
December 27, 2003 and the notes related thereto, as exhibits to a Current
Report on Form 8-K.On October 14, 2003, the Partnership filed the unaudited
balance sheets of the General Partner, as of June 28, 2003 and September
28, 2002, as an exhibit to a Current Report on Form 8-K.
Other items under Part II are not applicable.
32
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Suburban Propane Partners, L.P.
May 11, 2004 /s/ ROBERT M. PLANTE
- ------------ --------------------
Date Robert M. Plante
Vice President and Chief Financial Officer
May 11, 2004 /s/ MICHAEL A. STIVALA
- ------------ ----------------------
Date Michael A. Stivala
Controller
(Principal Accounting Officer)
33