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Executives

Brooks Sherman - EVP & CFO

John Sherman - President & CEO

Phil Elbert - COO & President of Inergy Propane

Bill Moler - SVP of Midstream Operations

Andy Atterbury - SVO of Corporate Development

Analysts

Ethan Bellamy - Wunderlich Securities

Ron Londe - Wells Fargo

Darren Horowitz - Raymond James

Brian Zarahn - Barclays Capital

Ross Haberman - Haberman Fund

James Jampel - HITE

Inergy, L.P. (NRGY) F1Q10 (Qtr End 12/31/09) Inergy, L.P. Earnings Call February 2, 2010 11:00 AM ET

Operator

Good morning. My name is Lushonda and I will be your conference operator today. At this time, I would like to welcome everyone to the Inergy first quarter 2010 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

Thank you, Lushonda and thank you everyone for joining us today on our first quarter fiscal 2010 earnings call. With me today are John Sherman, our President and CEO, Phil Elbert, our Chief Operating Officer and President of Inergy Propane, Bill Moler, Senior Vice President of Midstream Operations and Andy Atterbury, Senior Vice President of Corporate Development.

The format of today's call will be such that John will open up with an overview of the quarter and our business. Bill Moler will then give you an update on our projects and other Midstream Operations items. And I will then run through the quarter results before we open it up for the Q&A session.

Before I turn it over to John, first let me read our forward-looking statement. In our discussion today, 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. John?

John Sherman

Thank you, Brooks. Good morning and thank you for your attendance on the call today. I want to talk to you today first of all our performance in the December quarter, how the March quarter is shaping up so far, and our full year outlook and update you on development activities in our Midstream business.

For the quarter, $106 million in adjusted EBIT overall was slightly better than planned and all business units delivered results either right in line or a little better than expected. We designed this business to produce predictable earnings and steady growth and I would be happy with four quarters like this ever here. I think the combination of our high-residential, high-tank control Propane business with our fee based Midstream business is paying off for investors.

That said, one quarter does not make a year but with these results and the performance we have seen in January, we feel very good about achieving our full year financial objectives. In the propane business, we are right on target. Our people managed through an increasing commodity prices environment and delivered targeted margins while continuing our trend of operating more efficiently, although, not reflected in the December quarter, our recent acquisitions, Liberty Propane and MGS are performing very well to underwritten economics.

As you know, when we integrate a new acquisition, we put these businesses under a microscope and the early results are very encouraging. Bill Moler will update you in a minute on some of the developments in our Midstream business, but speaking to the December quarter performance, the storage business was right on target benefiting some from the early in service date for Thomas Corners. Our Salt Operations continue to exceed expectations and our West Coast business had a strong quarter.

We recently accessed the equity market for $200 million in proceeds. That was a very efficient capital raise in a strong market and keeps us in a position of strength which we consider important, as we evaluate opportunities. Brooks and the finance team have done a great job managing the balance sheet over the last year and we have a lot of flexibility as we sit here today.

In summary, we had a solid quarter and we expect to achieve our full year objectives. Growth projects are on track. We continue to evaluate acquisition opportunities that meet our criteria and we have positioned the balance sheet with the strength and flexibility to execute our strategy.

I have one more comment before I turn it over to Bill that might be relevant to investors. There have been a couple of recent developments in the market that I think reflect favorably on the value of our asset portfolio. I am referring to the Williams restructuring and the recent announcement by Plains that they will be spinning out their storage business in an IPO. I think these deals indicate the potential for more opportunity and we will be paying particular attention to the Plains storage IPO, as it gets valued by the market.

With that, I will turn it over to Bill for a few comments on Midstream developments.

Bill Moler

Thank you, John. We wanted to take the opportunity this morning to review with you some recent Midstream developments. First, we are pleased to announce that we have closed a small transaction with National Grid/KeySpan to acquire their 25% equity in Steuben Gas Storage for $11 million. As you know, we currently own and operate the Steuben Gas Storage facility, with this transaction, we are increasing our effective ownership of the asset from 55% to 80% and we are very excited to expand our ownership of this asset as it increases cash flow to [Inergy-wide] and further saw opportunities for wheeling and interconnectivity and our development of the hub in New York State.

Secondly, regarding the closing of our Seneca Lake acquisition that we announced several weeks ago, this process is on track with our expectations. We have had meetings with the various state and federal regulatory groups including the FERC and expect to have filings submitted to those various regulators by the end of the month. We expect to receive authority to transfer the assets and expect to close this deal this summer.

Our pipeline projects are MARC I and North-South projects, we are happy to say that preceding agreements for the MARC I and North-South projects continue to progress well. It's anticipated that we should be making a more thorough announcement on the North-South project here in the near-term and that the preceding agreements for the MARC I project will follow closely behind.

You've seen various parties announce in Manhattan and just upstream of the city some exciting in the market projects. The production and LDC community, whom we are working with seem to be working from East to West on garnering capacity and there is a logical sequence to this developing supply base in an expanded market. We are actively in discussions with the market and expect to announce success in very short order.

One last note of interest is an update on our Finger Lakes LPG project in Watkins Glen at U.S. Salt, this project is ready to start construction and is only awaiting final permitting in order to start construction. We've completed the design, have ordered all the equipment, we have developed interconnects with TEPCO pipeline and with Norfolk Southern railroad and hope to begin construction immediately upon receipt of the necessary approvals. We are excited to get this project online and serving the northeast market and using it to deal with the incremental NGLs that are being processed from Marcellus gas supplies.

That concludes the update and I look forward to any questions you may have in the Q&A. Brooks?

Brooks Sherman

Thanks, Bill. I'll walk through our first quarter here before we open it up for Q&A. In the first quarter starting with retail propane gallons, we sold 102.5 million retail propane gallons compared to about 104.4 million in last year's quarter with weather about 2% warmer in this year's quarter than last that produced retail propane gross profit of $110 million this year down from about $120.7 million last year.

As we talked a lot about since last year, the market conditions last year were ripe for great margins, which we achieved and which we stated since that we expected to hold on to the vast majority of that gain in margin that we did see last year and we've done just that. Our $1.07 retail propane per gallon margin in this year's quarter equates to our holding onto about 70% of the margin per gallon we gained in last year's quarter. So, a good result for us year-to-date and we're doing even better than that, a bit better than that through January.

Midstream gross profit increased $10.5 million this year over last year, almost 50%, that increase is attributable to a combination of higher West Coast gross profit with the Beumer now up and running as well as improvement in our storage operations with early contributions from the Thomas Corner storage project, the North Lateral contributing for the fourth quarter this year versus a partial last year. And also U.S. Salt had better gross profit this year than last.

Other propane gross profit this year about $30.7 million versus $32 million last year. Our wholesale and logistics group performed better year-over-year helping to offset a little bit lower other retail propane that was down a little bit similar to the retail propane gallons. That gives us total gross profit, cash gross profit this year of $173.2 million versus about $174.7 million last year, helping to offset that small decline in total gross profit, our cash operating expenses in this year's quarter, $66.4 million down from $72.2 million last year.

The lower OpEx this year is really a result of both lower personnel cost, primarily incentive compensation with the out performance we had last year, as well as lower bad debt expense this year and vehicle expense this year, partially offsetting those decreases were slightly higher insurance costs.

We have our ASC partners sharing in each quarter about $0.5 million bringing us down to adjusted EBITDA for this year's quarter of $106.3 million versus $102 million last year, so a 4% increase in adjusted EBITDA. To work down the net income coming off of adjusted EBITDA, we have long-term and equity compensation this year of about $2.1 million, $600,000 last year.

Depreciation and amortization increased to $37.1 million this year up from $26.3 million last year, that's all largely due to the [Beumer] on the West Coast up and running this year for the full quarter while in last year, it was still under construction.

In this year's quarter there's a FAS 133 gain that we take out of $2 million. You add that back, you get to net income last year was a loss of $400,000. Interest expense, this year is $21.1 million up from $16.8 million last year that is really largely rate driven primarily from the bonds that we placed $225 million, in January of 2009.

In this year's quarter, we had about $2 million of a loss on sale of assets versus $700,000 last year and a little bit of income tax, as you arrive at net income this year of $46 million versus $57.2 million last year. And so earnings per unit adjusted for the items, as we did in the press release, is $0.49 per unit this year versus $0.92 last year.

DCF this quarter, you take the $106.3 million of adjusted EBITDA, there's $20 million of cash interest in this year's quarter, $2.3 million of maintenance CapEx and then the income taxes has you arrive at roughly $84 million versus $84.2 million last year. So, pretty flat to last year there.

Also in the press release, a couple of things you saw, our debt balances as of December 31, just to give you some current balances, as of today there, our working capital facility is $22 million today and then with the equity offering that we did, we paid down our acquisition revolver that acquisition revolver balance today is $111 million.

And also in the press release, you saw that we reiterated our adjusted EBITDA guidance in that range of $340 million to $350 million that we had done a couple of weeks ago on our acquisitions call.

With that, Lushonda, I think will open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your fist question comes from the line of Ethan Bellamy with company Wunderlich Securities.

Ethan Bellamy - Wunderlich Securities

Thanks. A couple questions. What is the cash flow multiple on the Steuben deal and does the ownership change alter in any way how that asset will be managed?

John Sherman

It won't alter the way that it's being managed. It does give us an opportunity to integrate it more consistently with the development of our hub network in New York and just as all of our acquisitions are this is accretive to NRGY unit holders.

Ethan Bellamy - Wunderlich Securities

Okay. Who owns the remaining stake?

John Sherman

There are two other parties that own 10% each, we are in negotiations and discussions with them at this point as well.

Ethan Bellamy - Wunderlich Securities

On the retail propane gallons, can you give us the same-store sales numbers net of acquisitions and give us a sense for where the other deterioration in volumes is coming from?

Phil Elbert

This is Phil, Ethan, it's approximately 3% reduction which again, the 12/31 quarter is a hard time to really pin down your volumes. We would like to look at them more on March 31, but a 3% same-store decline with weather being off 2% is certainly very in line with expectations and frankly a much better trend than the industry has experienced the last few years in terms of conservation.

Operator

Your next question comes from the line of Ron Londe with Wells Fargo.

Ron Londe - Wells Fargo

Thank you. The decline in gross profit from the other propane operations, can you kind of single out what the $2 million difference might have been?

Brooks Sherman

Ron, that's really going to be around a couple of things, our Distillate business, similar to propane, we had experienced a great margin environment last year so that's a contributor. And then, our Service business would've been off a little bit, but not a lot but that's really the components of the decline.

Ron Londe - Wells Fargo

Okay. Also, what's been your experience year-to-date from the standpoint of margins and volume?

Phil Elbert

Ron, this is Phil.

Ron Londe - Wells Fargo

From December 31st.

Phil Elbert

You mean in terms of January?

Ron Londe - Wells Fargo

January.

Phil Elbert

You know, Ron, obviously, there was some nice weather kind of right around the first of the year, the first 10 days of the year. We're off to a very nice start in January, margins, the early returns are that we are actually starting to see margins higher than a year ago and certainly adequate volume to make us optimistic about the March quarter, but of course it's only a third of the way through also.

Ron Londe - Wells Fargo

Have you seen any significant mix change from the standpoint of the propane business?

Bill Moler

Mix, as in market segment?

Ron Londe - Wells Fargo

Yes, market segment and residential versus commercial that kind of.

Bill Moler

Well, our annual mix is very comparable to what our historical has been, kind of, 65% to 70% residential volume. No question the March quarter will have a relatively higher amount of residential sales compared to commercial and Ag relative to the December quarter. So the mix, if your question is, we have the more profitable segments of our market higher margin environments dominate the March quarter more than the December, the answer is yes.

Ron Londe - Wells Fargo

Okay, thank you.

Bill Moler

Thank, Ron.

Operator

Your next question comes from the line of Darren Horowitz with Raymond James.

Darren Horowitz - Raymond James

Good morning. Just a couple of quick questions. First, on the MARC 1 hub line North-South project, has anything changed, as it relates to the scale or the scope of that project? And I assume that as things progress here, and hopefully, we see some announcements is it still going to be targeted for the fall of 2011?

Bill Moler

You know the dates are shifting a little bit, Darren, I think that December 2011 is probably, late 2011 is probably fine for the North-South project. We may get into 2012 on the MARC I, as we get those things buttoned up, but the size and scope of them at this point have not changed from what was previously announced. It looks like we're heading towards that size of project.

Darren Horowitz - Raymond James

Okay. And then, for U.S. Salt, as you get ready to begin construction, do you have a better gauge of when the in service date could be there?

Bill Moler

We are targeting summer of this year.

Darren Horowitz - Raymond James

Okay. And then, just one quick housekeeping question for you, Brooks. From an operating and administrative expense perspective, you guys have done a good job rationalizing costs and if you adjust for the seasonality in the business, if our model is running correctly, it would point to you guys arriving at the lower end of your guidance for this year. Is that a fair assumption and are there things that you guys have done in terms of rationalizing costs that possibly could be repeatable going forward?

Brooks Sherman

Phil, you want to address rationalizing costs and then I can just talk about the year there?

Phil Elbert

Sure. Well, Darren, as people, who follow us know, we've spent a lot of time rationalizing costs for four years straight, where we have consciously lowered our operating headcounts, branch operations vehicles by 20% to 25%. Those rationalizations are really a function of what kind of conservation we find year-over-year. So, last few years, what we were going through, some conserving trends, you certainly need less capacity out in the field to deliver your cash flow. We think because we're seeing some evidence of those volume trends flattening out, our expectation going forward would be to see some modest operating expense improvement, but probably not as significant as we have seen the last couple years.

Brooks Sherman

Yeah, and on our OpEx kind of run rate this year, what we put out in our guidance that was prior to the Liberty, MGS acquisition. So that range will change. We haven't put out anything new there. We've pretty much stuck with adjusted EBITDA. I think we talked about the gallons that we would get from those businesses on an annual basis, but we haven't expressed the details around that. So, the adjusted EBITDA guidance we put out is good. That's where we believe, we will see yourselves this year, I think, if you reference kind of our run rate last year, our guidance, I think you can kind of work your way into that.

Darren Horowitz - Raymond James

Okay. Thanks guys

Phil Elbert

Thanks Darren.

Operator

Your next question comes from the line of Brian Zarahn, Barclays Capital.

Brian Zarahn - Barclays Capital

Provide a little more color on the performance of Liberty? And how is the business performing on the West Coast?

Phil Elbert

Sure. This is Phil again. As far as the recent acquisitions that we have closed on here in the last few weeks those acquisitions consolidated are performing better than we modeled them for year one. So, they're certainly off to a good start. On the West Coast, we've had a good first quarter there which is really what we expected now that the growth project is completed. As I think most people know the demands for isobutane out on the West Coast are less than 50% of what they are in the peak, it's a back ended profitability where an April through September our volumes will improve significantly. But for the 12/31 quarter for the West Coast is a little bit of, I don't want to call it a nonevent but it's certainly the low side of the cycle. So, we're pleased with how we started out.

Brian Zarahn - Barclays Capital

I was referring more to the Liberty footprint.

Phil Elbert

More to the liberty?

Brian Zarahn - Barclays Capital

Yeah.

Phil Elbert

Yeah, as I say really across the board that Liberty footprint has performed extremely well for the three or four weeks, we have had control of it.

Brian Zarahn - Barclays Capital

Okay. And can you give, elaborate a bit on your interest in the Plains gas storage?

John Sherman

You mean relative to my comment earlier?

Brian Zarahn - Barclays Capital

Yeah.

John Sherman

I think, really the thought there was just if you think about, we've thought a lot over the past few years about how to make sure we finance the growth for our Midstream business as efficiently as possible, we've looked at a number of options. An IPO could be one of those, as we sit here today, propane cash flows are valued certainly better than they used to be. The propane discount relative to the MLP sector's narrowed and been eliminated. We have also believed for some time that our Midstream business would trade at the top of the sector given its credit profile and growth prospects. So, I think, just in general, I would just tell you that we continue to evaluate options for our investors really focused on optimizing long-term returns. We sit here today, pretty, certainly happy with our current capital costs. We are able to invest capital and provide an attractive return for our unit holders, but want to keep an eye on this claims valuation with the idea that long-term certainly we want to maximize returns. So, that's the nature of my comment.

Brian Zarahn - Barclays Capital

That’s helpful, thank you.

Operator

(Operator Instructions). Your next question comes from the line of Ross Haberman with Haberman Fund.

Ross Haberman - Haberman Fund

Thanks gentlemen, how are you?

John Sherman

Fine, thank you.

Ross Haberman - Haberman Fund

I was wondering if you could just go over pro-forma with the acquisitions, the total amount of debt and the number of units pro-forma with the acquisitions and the recent offerings?

John Sherman

Yeah, in the press release, in the table on page five of the press release, it lists our debt as of December 31st. And so, if you look at that 12/31/09 column that $245 million that was out on the acquisition revolver.

Ross Haberman - Haberman Fund

Right.

John Sherman

That is now $111 million, we paid down with proceeds of the equity offering and we borrowed for the MGS acquisition and some CapEx. The rest of those debt balances would be pretty much the same, as what they were at 12/31.

Ross Haberman - Haberman Fund

And how much cash and how many units are pro-forma?

John Sherman

Cash on the balance sheet is nominal. You'll see, no, I shouldn't say nominal, it's a big number, but cash on the balance sheet is $15.8 million and we have now 65.4 million units outstanding.

Ross Haberman - Haberman Fund

Okay. Just one further question, are you guys going to look strictly at propane expansion opportunities or perhaps Salt as well?

John Sherman

Did you say perhaps Salt as well?

Ross Haberman - Haberman Fund

Yeah.

John Sherman

Our Salt business is directly complementary to what we are doing in the Northeast relative to the addition of gas storage capacity in the Northeast marketplace. We utilize the caverns that Salt creates and subsequently come in and either store LPGs or natural gas in those caverns. I am not saying, we wouldn't ever look to expand Salt. Salt is doing a great job, they have increased their business considerably and they're very good at it. I would say that where it makes sense and where there opportunities to combine our platforms, we would look at those aggressively.

Ross Haberman - Haberman Fund

Thanks, guys. Best of luck.

Brooks Sherman

Just to clarify, we have 65.6 million common units outstanding.

Ross Haberman - Haberman Fund

65.6. Okay. Thanks again.

John Sherman

Thank you.

Operator

Your next question is a follow-up from the line of Ethan Bellamy with Wunderlich Securities.

Ethan Bellamy - Wunderlich Securities

John, I thought somebody else would ask this but just to follow-up on your opening remarks about the Williams transaction, could you just weigh in on and tell us how you think that potentially could benefit you guys? And then secondly, more importantly, I think, the sector is seeing some incentive distribution rights, eliminations or reductions. Have you looked at that? Is that something you consider going forward to reduce the cost of capital at NRGY? And then lastly, you do have a registration statement on NRGP, is that something that you would expect to be used or is it just sitting there to maintain maximum flexibility?

John Sherman

You know, Ethan, my comment on Williams restructuring is, I think, less specific than my comments on the Plains I.P. I think, just in general, I thought that reflected very favorably on the MLP sector, I think, it could lead to others looking at maybe finding ways to get quality assets in MLPs and we're always looking for opportunities to expand our platform.

The second question was about the IDR and I think our position on that is the way it has always been. If you look at our structure today, we are capable of investing capital at good returns at NRGY that give a good return to the NRGY shareholder and also benefit the NRGP shareholder. We think that having that publicly traded general partner gives us a valuable currency that we can use strategically.

At this point, as you know, we have done things in the past where NRGP intervened on behalf of NRGY to make sure cost of capital is competitive. We think that that is the way to look at it currently, that it's really on a deal-by-deal basis, but again, I think, you can count on us to on a long-term basis, we're going to act in the best interest of all of our stakeholders.

As it relates to the shelf, I don't think, you know, Brooks might want to comment there. But that's really nothing other than I think it's prudent to have an active shelf in both, you know, for both sets of securities in the event we wanted to use that currency, but there's nothing imminent or no plans there.

Brooks Sherman

That's right.

Ethan Bellamy - Wunderlich Securities

Thanks guys.

John Sherman

Thanks Ethan.

Operator

Your next question comes from the line of James Jampel with HITE.

James Jampel - HITE

Hi, I'll point out another omission, which is the comment on the acquisition pipeline.

John Sherman

Is this just how it looks, James?

James Jampel - HITE

Yes.

Andy Atterbury

James, this is Andy.

James Jampel - HITE

…before it, not a mention today.

Andy Atterbury

Well, yeah. There's only so much we can ever say about that, but from where we sit today, I think, the acquisition pipeline looks very good both from a size perspective and also from a quality perspective. I would probably emphasize the quality piece, as it relates to any kind of a trend that you could point to and that's not surprising that as we allocate capital between first class development projects like MARC I and the North-South pipeline for example and new acquisition opportunities, you're going to see the acquisition that we pursue and eventually fund will have similarly quality characteristics to our projects. But that's how I characterize our acquisition pipeline today, that's where our operating and commercial capabilities that we bring to an opportunity and through a competitive capital allocation process, our acquisition pipeline as it evolves, it's continuously upgrading to focus more on the high-quality opportunities.

James Jampel - HITE

Thanks.

Andy Atterbury

Thanks, James.

Operator

There are no further questions at this time. I would like to turn the call back over to Mr. Sherman.

Brooks Sherman

Thank you, Lushonda and thank you everyone for joining us today. We appreciate your attendance and support. Thank you.

Operator

This concludes today's conference call. You may now disconnect.

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