Inergy Holdings, L.P. F4Q08 (Qtr End 09/30/08) Earnings Call Transcript

Inergy Holdings, L.P. (NRGP)

F4Q08 Earnings Call

December 1, 2008 11:00 am ET

Executives

John Sherman – Chief Executive Officer, President

Phillip Elbert – Chief Operating Officer, President of Inergy Propane

R. Brooks Sherman, Jr. – Executive Vice President, Chief Financial Officer

William Moler – Executive Vice President, Midstream

Andrew Atterbury – Executive Vice President, Corporate Development

Analysts

Darren Horowitz – Raymond James

Ronald Londa – Wachovia Capital Markets

Adam [Roggenberg] – GLP

[Peter Segal] – Barclays Capital

James [Campell] – [HITE]

Selmon Akyol – Stifel Nicolaus

Mona Yee – Schroder Investment Management

Presentation

Operator

I would like to welcome to the Inergy fourth quarter and fiscal year ending 2008 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. (Operator Instructions)

Thank you. Mr. Sherman you may begin your conference.

Brooks Sherman

Welcome everyone to Inergy’s fourth quarter and fiscal year 2008 earnings call. With me today are John Sherman, our President and CEO; Phil Elbert, our President of Inergy Propane; Bill Moler, Executive Vice President of Midstream operations and Andy Atterbury, our Executive Vice President of Corporate Development.

The format of our call today is similar to those we have had in the past. I’ll turn in a minute to John for opening remarks. He will then turn it back to me to take a walk through the fourth quarter and annual results. Then we will open it up for question-and-answer.

Before I turn it over to John let me read a brief forward-looking statement. In our discussion this morning we may communicate forward-looking information. Various risk factors may cause actual results to differ materially from any projections in these forward-looking statements. We provide a detailed discussion of the various risk factors in our SEC filings and we encourage you to review our filings.

With that I will turn it over to John.

John Sherman

Thank you Brooks. While we are reporting our fourth quarter and full year fiscal 2008 results today, those periods have been in the history books for awhile. Our attention is now focused on fiscal 2009 and achieving our current and future objectives on behalf of our investors.

That said, our 2008 performance builds on our track record of consistently achieving overall targeted financial results. Our propane operating teams again responded to a challenging environment, navigating effectively despite much higher propane prices and corresponding customer conservation.

The margins were up year-over-year about 10% and we operated efficiently despite higher fuel costs. Our supply, wholesale and transportation unit had a solid year ensuring our ability to deliver reliably in peak season while managing product costs very effectively for the entire operation.

Midstream operations continued to increase their relative contribution. As expected they are about 35% of our cash flow today. Midstream gross profit was up about 60% over prior year. Our Northeast Natural Gas Storage and Transportation unit had another solid year while continuing to make that business more valuable with the expansion of Stagecoach, Steuben and our upgraded Bath LPG storage.

We are now tied in a connected to Millennium as of the last two weeks via the Stagecoach lateral and are expecting the first gas flows later this month.

Early returns on our U.S. salt investment are better than expected. Salt mining flows are steady and recurring in nature and our long-term potential there has more upside than we underwrote in both natural gas and LPG storage.

Back to 2009, the present. In our propane business we are currently operating in a favorable environment. The lower product costs are positively impacting gross margins as well as operating expenses as the result of significantly lower fuel costs versus last year. Our Midstream business is fee based back by long-term contracts with high grade customers, has virtually zero commodity price exposure and we have solid visibility for increased distributable cash flow from capital already invested.

Bottom line, our earnings outlook in 2009 is very solid based upon a favorable environment for our propane business and the fee-based nature of our Midstream cash flows. We have existing credit capacity to finish out committed capital projects and visibility to increased distributable cash flow from existing operations which actually de-levers the company from an EBITDA multiple perspective.

In my view we are well positioned for the current environment and should distinguish ourselves should the market shake out and better understand the nature of our cash flows and our relative financial flexibility.

With that I’ll turn it over to Brooks and I look forward to the question-and-answer session.

Brooks Sherman

Thanks John. First, I’ll walk through our results of operations.

In 2008 we sold 42 million retail gallons of propane versus about 48.5 million. We earned retail gross profit this year of $39.2 million of those gallons, up from $37 million last year so we earned a margin this year of about $0.93 versus $0.76 last year so the strong margins as we have shown all year are helping to make up for the lower volume sales associated with the conservation we have seen from our customers.

Our Midstream gross profit in the quarter was $25.5 million up from $16 million reported in last year’s quarter. That 59% increase is reflected in the growth of that segment of our business. Phase II is on service and on time. Our ASC acquisition as well as our west coast operation and our Bath Storage Facility performing well and the successful diversifications, obviously the difference maker you see in this quarter.

Other propane gross profit was $22.4 million this year and this quarter versus $16.2 million last year. The increase there is attributable to acquisitions and other propane income focused on our service labor with the lower volume sales that we have and gives us total gross profit this year’s quarter of $87.1 million up 26% from the $69.2 million last year.

Our cash operating expenses in this September 30 quarter were $64.7 million up from $56 million last year, an $8.8 million increase. $5.5 million of that is due to acquisitions. The balance of the increase is due to higher insurance and benefits costs partially offset by lower salaries as we focus on getting the most out of our retail businesses in what John described was a challenging environment.

Other income of about $900,000 versus $500,000 last year. Our partners in our ASC business is about $600,000 attributable to them to give us adjusted EBITDA in this year’s quarter of $22.7 million, about $9 million increase over the $13.8 million last year. So healthy improvement quarter-over-quarter and reflects a higher percentage of Midstream contributions and solid operations in our propane business.

Moving on down to net income, in this year’s quarter we had long-term and equity compensation of about $2.3 million versus about $200,000 last year. The increase there in the equity composition, the largest part of the increase, is the issuance of NRGY restricted units to most all sections [inaudible] in lieu of fiscal year 2008 cash bonuses that were due.

Depreciation and amortization this year were $25.9 million up due to acquisitions from the $22.5 million last year. A little bit of a FAS 133 charge in both years. Interest expense this year of $15.9 million up from $12.9 million last year attributable to higher outstanding borrowings with acquisitions and the completion on some projects and spending on the projects partially offset by lower rates on our bank facility. We reported a loss on the sale of assets in this year’s quarter of about $12.3 million versus $6.4 million last year. This year’s loss is the result of the disposal and planned disposals primarily of tanks associated with our elimination of less profitable customers that were either low margin, low volume or we had a poor payment history with them.

Income tax this year was about $100,000 versus $200,000 last year. This has us arrived at net income in this year’s quarter of about $33.1 million. Net loss this quarter $33.1 million and a net loss last year of $28.3 million in this seasonal quarter.

Just to walk down through distributable cash flow. This year was $22.7 million of adjusted EBITDA. If you back off of that our cash interest of about $15.4 million, maintenance capEx in the quarter of $1.8 million, and $100,000 of income tax has us earning $5.4 million positive DCF this year’s fourth quarter versus about an $800,000 negative DCF in last year’s quarter. Then as we reported in the press release our net loss this quarter of $21.4 million when you exclude the items we described in the press release, so net income per unit is a loss of $0.62 this year versus $0.59 last year.

Rolling forward to our annual results of operation, our retail gallon sales in fiscal 2008 were about 332 million gallons versus 362 million last year. That is a decrease of 30 million gallons. We did have about 12 million of acquisition gallons in there so a decrease of about 40 million gallons from same store operations is really due to the substantially higher Mont Bellevue propane costs we saw year-over-year.

Retail propane gross profit was about the same in both years at $313 million. So that reflects the higher margin per gallon. This year we were able to earn about $0.94 versus $0.865 last year. So better margins year round obviously driven by our winter margins. As always we are out in front on the margins going into the winter. We always go into the winter season assuming warmer than normal and we did so again this year.

Our Midstream gross profit was $92 million for fiscal 2008, up from about $58 million last year so about a 60% increase reflective of the growth in the trends we have had in these businesses. Phase II completion of Stagecoach was in service all year. ASC was an acquisition we completed in October 2007. Continued strong performance from West Coast and Bath as I mentioned for the quarter and also having executed a long-term contract for Bath back in April.

Other propane gross profit was $97.4 million this year up from $85 million last year, acquisition driven. Also our wholesale units were able to take advantage of supply disruptions, market inefficiencies in the places where we have a strong presence. There is a great deal of discipline and focus in non-retail just as we have in retail.

Total gross profit was $502 million up about $46 million from the $456 million reported last year. Our cash operating expenses for fiscal 2008 totaled $262 million about a $15 million increase from the $247 million reported last year. We had about $16 million in opEx increase due to acquisitions and we had higher fuel costs for the vehicles, higher insurance and higher benefits also contributed. Those increases were more than offset by lower wages as we have reduced total headcount in meeting the challenging environment.

Other income was about $1 million this year versus $1.9 million last year. Our ASC partner share of cash flow is $2.3 million in 2008 with that new acquisition and that gives us adjusted EBITDA for fiscal 2008 of $239 million up about $28 million from the $211 million we reported last year.

Moving on down to net income, long-term incentive and equity comp was $3.5 million this year versus $700,000 last year, as I talked about for the quarter. Depreciation and amortization were $98 million this year versus $83 million last year reflective of both acquisitions and Phase II being in service this year and the depreciation on that. Interest expense of about $61 million this year versus $52 million last year. Higher average debt outstanding with acquisitions and Phase II completion partially offset by lower rates in our bank facility. Our net loss for the year was about $11.5 million versus $8 million last year, as I discussed for the quarter.

Income taxes were about $700,000 in each year which gives us net income for the year of [audio break] about $67 million last year. Our distributable cash flow, as you saw in the press release, for this year was $174 million versus about $156 million last year. Net income as we reported in the press release excluding the items we described was about $76.7 million or $0.81 per unit versus $74.4 million or $0.98 per unit last year.

Before we open it up to Q and A, as you saw in the press release we do reaffirm our guidance for 2009. We are expecting adjusted EBITDA to be in the range of $277 million to $294 million in fiscal 2009.

With that, we would be happy to open it up for any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Darren Horowitz – Raymond James.

Darren Horowitz – Raymond James

My first question is on the capEx forecast. Have there been any changes in the schedule? Specifically around the west coast expansion, I know that it was looking to be pretty lumpy mostly in the first quarter fiscal 2009 and you had your [inaudible] plan underway as well as the [cogen] plan. Can you just give us an update there?

Brooks Sherman

We do expect to complete the west coast project this spring. We have got today about $25 million remaining to spend on that west coast project and we expect that to be up and running around April 1 at the economics we have talked about.

Darren Horowitz – Raymond James

Switching gears over to liquidity, can you give us an update on where you are at on your $425 million credit facility and any additional clarity there.

Brooks Sherman

Our $425 million bank facility, the first clarification I would point out there is Lehman was a participant in that facility, or is a participant in that facility. We had about $10 million unfunded from them so we have to think about that facility today in terms of it being about a $415 million facility. Outstanding on the working capital line today we have about $111 million and on the acquisition line about $202 million so about $313 million borrowed on that facility and LC’s outstanding of about $28 million.

Darren Horowitz – Raymond James

As it relates to acquisitions have you seen any concession on asking multiple prices?

Brooks Sherman

As it relates to acquisitions with the kind of capital markets environment we are experiencing today our cost of capital and our acquisitions we are not really looking. Those multiples aren’t there at this kind of cost of capital. I think across the board as we look at all MLP’s and ourselves included. We continue to evaluate them but without there being incremental financing opportunity right alongside that acquisition we will be very mindful of how we will proceed there. So we are not in that mode right now of acquiring.

Darren Horowitz – Raymond James

Is it possible then based on the capEx you had ear marked for inorganic growth on the propane side to maybe look at it maybe shifting towards LPG storage initiatives or something else that gives you more visible cash flow over the next couple of years?

Brooks Sherman

I think as we look at it, and again just with the cost of capital where it is today, we will have to find special projects in the financing along with those to see that happen. We certainly keep an eye on the market both from an acquisition standpoint and organic growth standpoint but also on the capital markets and the financing opportunities to capitalize appropriately on those. We will be very disciplined as we move forward. Our acquisitions and growth projects obviously have to be accretive at the time we would enter into them. We are just very mindful of the environment we are in.

Phillip Elbert

I might just add on the propane acquisition side, remember that the high quality retailers we typically target are well capitalized businesses that are really in a sell or keep decision. As Brooks mentioned really across the propane consolidation space at current costs of capital it is just kind of a clear keep decision on the part of sellers in the short-term but I do also think that one could surmise that once this thing comes back to some sense of normalcy there could be some pent up demand from sellers.

Darren Horowitz – Raymond James

When you look at the overall bottle evolving over the next couple of years am I right in thinking when you are balancing your ROIC’s on Midstream versus other aspects of the business and you are looking at what the stable stream of cash flow gives you it really is a model that is evolving more towards 50/50 Midstream/Propane structure. Is that how we should look at it?

John Sherman

We like both sides of the business as we have always said and that has not changed today. It is going to be that we would execute on those transactions that make the greatest economic sense to us and we have very good operators in both lines of businesses and that is the way we would proceed.

Operator

The next question comes from Ronald Londa – Wachovia Capital Markets.

Ronald Londa – Wachovia Capital Markets

You alluded earlier, or at least John did, about more potential from U.S. salt acquisitions. Can you expand upon that?

William Moler

I will tell you that our U.S. salt acquisition has exceeded our plans to date on a month-to-month basis since we have owned it. Our boiler project is progressing and we expect that to be complete towards early spring, that energy savings project. We have been pursuing additional product sales in both our pharmaceutical and industrial lines and early returns on those new cash flows are positive. Our sub-surface investigation of convertible cavern space is progressing and we are working towards an LPG storage facility being the first line of revenue available to us from this previously solutioned mined cavern space. However, as Brooks noted the capital markets and financing along with that project is something we are going to consider as we move forward.

Ronald Londa – Wachovia Capital Markets

What do you think the capital requirements would be for developing that LPG storage?

William Moler

Right now we are in the process of investigating and putting our estimates together. LPG is considerably less capital invested than natural gas conversion, with higher returns and better multiples on that invested capital. When we have that project ready to announce we will announce the full capital and revenues expected to come in from that project.

Brooks Sherman

That is a discretionary, obviously, capital spend that we can make there and so we will analyze both the spend side of it as well as the capital raise side of it before we would proceed with any further development there.

Ronald Londa – Wachovia Capital Markets

The LPG development there does that have any effect on the Bath facility? Are they separate entities from a geographic standpoint?

William Moler

Geographically those are both in the Northeast. Bath is primarily a butane storage facility that is served by rail and it comes from the east coast refiners. We expect LPG at U.S. Salt to be primarily propane coming from Marcellus Salt Production, Canadian volumes, etc. but primarily a propane storage and it will be pipe, rail and truck connected. So operationally and product wise they are different animals.

Ronald Londa – Wachovia Capital Markets

The mid point of your guidance is about $285 million for next year. I was curious from the standpoint of your internal estimates, what percentage of that do you think will be Midstream?

Brooks Sherman

As we look at that about 35% of that midpoint would be Midstream, so 65% propane in 2009.

Ronald Londa – Wachovia Capital Markets

It looked to me like from the same-store sales standpoint you had about a 5% drop in gallonage. How much of that do you think would be conservation? How much would you ascribe to weather?

Phillip Elbert

I think the conservation effort we see based on our internal calculations is closer to 8% and weather being virtually flat.

Operator

The next question comes from Adam [Roggenberg] – GLP.

Adam [Roggenberg] – GLP

When you said that you have enough capacity under your revolver to fund existing capEx what exactly do you mean by that?

Brooks Sherman

What we look at today is, as I stated earlier, we have about $25 million yet to spend on the west coast and we do want to complete that. We are probably about 80% complete with that today so that is a de-levering event to finish that and receive cash flow from those operations. We have about $15 million firmly committed for expenditures in the summer around some of our storage projects and that is really the extent of what we deem to be our committed capital to date. The balance of our capital that we talked about is discretionary and so we sit in very good shape today from a liquidity standpoint.

Adam [Roggenberg] – GLP

So when you say it is discretionary meaning you don’t have commitments to spend that capital either with producers or in terms of buying materials?

Brooks Sherman

That’s right.

Adam [Roggenberg] – GLP

In terms of the salt acquisition, again building out the storage that is all discretionary?

William Moler

Yes it is.

Operator

The next question comes from [Peter Segal] – Barclays Capital.

[Peter Segal] – Barclays Capital

I’m just trying to reconcile the increase in debt for the fourth quarter. I have about $180 million, and traditionally I guess the quarter has seen a working capital source for cash. I don’t know what that number is for the quarter and maybe that is my plug. But out of about $125 million spent from capital spending for U.S. Salt at the traditional capEx, do those numbers sound about right and what is working cap number?

Brooks Sherman

I think on our acquisition revolver that balance at June 30, the increase in that, is predominately U.S. Salt. The total increase is about $150 million from June 30 to where we are today of about $202 million. So that is predominately U.S. Salt and then expenditures on the west coast and a couple of small retail acquisitions are in there as well.

Then on the working capital front the September quarter and obviously through on to today this is a period where we generally are borrowing on working capital as we have supplies built, etc. for the winter.

[Peter Segal] – Barclays Capital

But during the fourth quarter was there working capital source or use?

Brooks Sherman

We had a use of working capital as we had gone through the fourth quarter.

[Peter Segal] – Barclays Capital

Can you tell me how much that was?

Brooks Sherman

Our working capital balance at September 30, as we said in the press release, was about $65 million at September 30. Our balance at June 30 I would have to look that up.

[Peter Segal] – Barclays Capital

For capEx for 2009, in your analyst day you had been projecting $142 million, you just seem to be mentioning on the previous question that really you only have to spend approximately $40 million. The difference between those two amounts, what are your expectations? Are you expecting to kind of go off those projects or are you canceling some of those already?

Brooks Sherman

We are continuing to evaluate the capital markets as we look to complete those projects. The commitments that I mentioned are the commitments that we have today. The balance of that spend is really at our discretion. With capital costs of ours where they are today and the capital markets where they are today overall we will just continue to evaluate that and see how things open up on 2009 but they are truly at our discretion and we will just continue to stay on top of them.

[Peter Segal] – Barclays Capital

So we should think of this as kind of on-hold for now at least until there is a change in the capital markets?

Brooks Sherman

I think that is right. That number on the working capital by the way was $16 million.

Operator

The next question comes from James [Campell] – [HITE].

James [Campell] – [HITE]

I was wondering if you could comment on NRGP. It is at such low liquidity and good value are you thinking at all about how you might rationalize the capital structure or perhaps eliminate the IDR’s?

John Sherman

That is something we continue to look at NRGP. It is thinly traded. It is, we think, a lot of the reason behind where it is trading today, the GP sector overall is trading a lot worse than it has been historically. We will not be making any quick decisions there. We are big holders of that as management and so we have a vested interest in not only NRGP but NRGY so we will always look to do what we believe is best for the entire partnership structure. So no immediate plans I would say.

James [Campell] – [HITE]

It is just particularly frustrating among the GP’s with lack of liquidity. I think we all suffer from that and I think it is very hard for investors to come in because they realize it is like you can get in but you can’t get out. Any way you guys can sharpen the pencils and look at a way to rationalize it, certainly when you look at Suburban or others in the propane business there is a precedent for this and anything you could do to help us out would certainly be appreciated.

John Sherman

I think we are aligned with you there on a long-term basis and we will make sure this entire capital structure…today we are in kind of a dislocated environment but certainly long-term we are going to make sure this capital structure is competitive from top to bottom.

Operator

The next question comes from Selmon Akyol – Stifel Nicolaus.

Selmon Akyol – Stifel Nicolaus

Could you give a little bit more color around you said you disposed of tanks or less profitable customers in particular how many and are there more to purge?

Phillip Elbert

What that is really all about is just we have high expectations and focus on the efficient use of capital and that includes surplus capital. Really a combination of three years of conservation where it gives you opportunities to downsize your delivery capacity as well as constant rationalization of unprofitable accounts especially when you are an acquisitive company like we have been the last few years those are really where the opportunities are born. What we are really trying to do there is first and foremost make sure we aren’t buying new tanks for new customers we pick up. We first recycle these tanks we pick up from unprofitable accounts, but then secondarily to the extent there is a surplus there we think it is just a very efficient use of capital to turn that into cash.

Order of magnitude I think on the trailing 12-month basis typically due to lack of usage, poor credit terms or poor credit history and just low margin I would say on a typical year we might go out and terminate our relationship with maybe 20,000 or 25,000 customers due to that. As our analyst conference slide showed over the last 3 years we have downsized our delivery capacity about 20%. So it is just a continuation of that focus.

Selmon Akyol – Stifel Nicolaus

In terms of lower fuel costs benefiting margins any chance to lock in going forward over the second quarter as well?

Phillip Elbert

By lock in you mean are we going to hedge our fuel costs?

Selmon Akyol – Stifel Nicolaus

Right.

Phillip Elbert

No. I don’t think that is a focus on our part. We think that any sort of position taking with your fuel costs is really a net position, it is not a hedge. We believe all our competitors out there pay the market price of fuel and by paying the market price we see ourselves in a fairly riskless position.

Operator

The next question comes from Mona Yee – Schroder Investment Management.

Mona Yee – Schroder Investment Management

What is your target distribution?

John Sherman

When we look at distribution we look forward. We have always stated we are comfortable in that 1075 or 11 range at NRGY.

Mona Yee – Schroder Investment Management

Also, I guess for the next three months that is when you have most use of working capital. Do you need to increase it or is this sufficient? What do you have under your revolver right now?

Brooks Sherman

With what we have outstanding today and at the point we are in the winter history would tell us that the most additional borrowings we should see there might be $15 million or less. So we feel we have adequate capacity to see us through winter and on top of that we have seen propane prices come down a lot which serves to benefit our working capital use as well.

Mona Yee – Schroder Investment Management

So what is your distribution carriage for this quarter then?

Brooks Sherman

As we look forward is how we look at the distribution. We are over 1.1 times as we look ahead for a year. I think we exited fiscal 2008 covering over 1.05 times so we exited and we are looking forward even better.

Operator

There are no further questions at this time. Mr. Sherman are there any closing remarks?

Brooks Sherman

We would like to thank you all for joining us today and we appreciate the attention and support.

Operator

This concludes today’s conference. You may now disconnect.

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