Quarterly Report for period ended June 30, 2005
Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2005

 

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                      to                     .

 

COMMISSION FILE NUMBER: 0-32453

 

Inergy, L.P.

(Exact name of registrant as specified in its charter)

 

Delaware   43-1918951
(State or other jurisdiction of   (IRS Employer
incorporation or organization)   Identification No.)
Two Brush Creek Blvd., Suite 200   64112
Kansas City, Missouri   (Zip code)
(Address of principal executive offices)    

 

(816) 842-8181

(Registrant’s telephone number, including area code)

 

                                                                                                                                                                                                                              

(Former name, former address and former fiscal year,

if changed since last report)

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the last 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 ¨

 

The following units were outstanding at August 1, 2005:

 

Common Units

   26,254,645

Senior Subordinated Units

   5,478,568

Junior Subordinated Units

   1,145,084

 



Table of Contents

 

INERGY, L.P.

INDEX TO FORM 10-Q

 

     Page

Part I – Financial Information

    

Item 1 – Financial Statements of Inergy, L.P.:

    

Consolidated Balance Sheets as of June 30, 2005 (unaudited) and September 30, 2004

   3

Unaudited Consolidated Statements of Operations for the Three and Nine Months Ended June 30, 2005 and 2004

   5

Unaudited Consolidated Statement of Partners’ Capital for the Nine Months Ended June 30, 2005

   6

Unaudited Consolidated Statements of Cash Flows for the Nine Months Ended June 30, 2005 and 2004

   7

Unaudited Notes to Consolidated Financial Statements

   10

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operation

   26

Item 3 – Quantitative and Qualitative Disclosures About Market Risk

   37

Item 4 – Controls and Procedures

   39

Part II – Other Information

    

Item 1 – Legal Proceedings

   40

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

   40

Item 3 – Defaults Upon Senior Securities

   40

Item 4 – Submission of Matters to a Vote of Security Holders

   40

Item 5 – Other Information

   40

Item 6 – Exhibits

   40

Signatures

   41

 

2


Table of Contents

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

INERGY, L.P. AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

     June 30, 2005
(Unaudited)


    September 30,
2004


 
     (In Thousands)  

Assets

                

Current assets:

                

Cash

   $ 21,059     $ 2,256  

Accounts receivable, less allowance for doubtful accounts of $3,774,000 and $1,078,000 at June 30, 2005 and September 30, 2004, respectively

     57,340       49,441  

Inventories

     58,280       56,404  

Prepaid expenses and other current assets

     15,807       5,494  

Assets from price risk management activities

     6,726       23,015  
    


 


Total current assets

     159,212       136,610  

Property, plant and equipment, at cost:

                

Land and buildings

     64,683       20,246  

Office furniture and equipment

     15,891       10,173  

Vehicles

     68,627       32,719  

Tanks and plant equipment

     453,837       189,519  
    


 


       603,038       252,657  

Less accumulated depreciation

     (61,837 )     (37,404 )
    


 


Property, plant and equipment, net

     541,201       215,253  

Intangible assets:

                

Covenants not to compete

     21,959       11,498  

Deferred financing costs

     19,777       5,242  

Deferred acquisition costs

     514       104  

Customer accounts

     205,080       74,154  
    


 


       247,330       90,998  

Less accumulated amortization

     (27,297 )     (17,398 )
    


 


Intangible assets, net

     220,033       73,600  

Goodwill

     207,212       78,128  

Other

     4,076       228  
    


 


Total assets

   $ 1,131,734     $ 503,819  
    


 


 

3


Table of Contents

INERGY, L.P. AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS (continued)

 

     June 30, 2005
(Unaudited)


    September 30,
2004


 
     (In Thousands)  

Liabilities and partners’ capital

                

Current liabilities:

                

Accounts payable

   $ 60,638     $ 54,621  

Accrued expenses

     29,287       15,977  

Customer deposits

     23,669       13,937  

Liabilities from price risk management activities

     4,499       29,640  

Current portion of long-term debt

     6,423       23,615  
    


 


Total current liabilities

     124,516       137,790  

Long-term debt, less current portion

     530,091       113,986  

Partners’ capital:

                

Common unitholders (26,254,645 and 17,626,506 units issued and outstanding as of June 30, 2005 and September 30, 2004, respectively)

     451,334       224,600  

Senior subordinated unitholders (5,478,568 units issued and outstanding)

     24,034       25,352  

Junior subordinated unitholders (1,145,084 units issued and outstanding)

     (2,483 )     (2,296 )

Non-managing general partner

     4,242       4,387  
    


 


Total partners’ capital

     477,127       252,043  
    


 


Total liabilities and partners’ capital

   $ 1,131,734     $ 503,819  
    


 


 

See accompanying notes.

 

4


Table of Contents

 

INERGY, L.P. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands, Except Per Unit Data)

(unaudited)

 

     Three Months Ended
June 30,


    Nine Months Ended
June 30,


 
     2005

    2004

    2005

    2004

 

Revenue:

                                

Propane

   $ 127,493     $ 57,540     $ 708,201     $ 345,787  

Other

     46,109       12,175       137,294       34,578  
    


 


 


 


       173,602       69,715       845,495       380,365  

Cost of product sold (excluding depreciation and amortization as shown below)

                                

Propane

     86,064       45,788       502,109       262,163  

Other

     36,934       6,940       91,581       13,778  
    


 


 


 


       122,998       52,728       593,690       275,941  
    


 


 


 


Gross profit

     50,604       16,987       251,805       104,424  

Expenses:

                                

Operating and administrative

     52,078       20,027       146,055       60,514  

Depreciation and amortization

     13,865       5,591       35,094       15,267  
    


 


 


 


Operating income (loss)

     (15,339 )     (8,631 )     70,656       28,643  

Other income (expense):

                                

Interest expense, net

     (9,144 )     (1,443 )     (23,018 )     (5,810 )

Write-off of deferred financing costs

     —         —         (6,990 )     (1,216 )

Make whole premium charge

     —         —         —         (17,949 )

Swap value received

     —         —         —         949  

Gain (loss) on sale of property, plant and equipment

     (270 )     143       (170 )     (136 )

Finance charges

     576       238       1,488       591  

Other

     82       6       234       84  
    


 


 


 


Income (loss) before income taxes

     (24,095 )     (9,687 )     42,200       5,156  

Provision for income taxes

     24       113       358       164  
    


 


 


 


Net income (loss)

   $ (24,119 )   $ (9,800 )   $ 41,842     $ 4,992  
    


 


 


 


Partners’ interest information for the three and nine months ended June 30, 2005 and 2004:

                                

Non-managing general partners’ interest in net income

   $ (339 )   $ (196 )   $ 5,390     $ 100  
    


 


 


 


Limited partners’ interest in net income (loss):

                                

Common unit interest

   $ (18,989 )   $ (5,728 )   $ 28,489     $ 3,012  

Senior subordinated unit interest

     (3,963 )     (3,340 )     6,586       1,620  

Junior subordinated unit interest

     (828 )     (536 )     1,377       260  
    


 


 


 


Total limited partners’ interest in net income

   $ (23,780 )   $ (9,604 )   $ 36,452     $ 4,892  
    


 


 


 


Net income (loss) per limited partner unit:

                                

Basic

   $ (0.72 )   $ (0.42 )   $ 1.20     $ 0.23  
    


 


 


 


Diluted

   $ (0.72 )   $ (0.42 )   $ 1.18     $ 0.22  
    


 


 


 


Weighted average limited partners’ units outstanding:

                                

Basic

     32,878       22,950       30,321       21,551  
    


 


 


 


Diluted

     32,878       22,950       30,930       22,011  
    


 


 


 


 

See accompanying notes.

 

5


Table of Contents

 

INERGY, L.P. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENT OF PARTNERS’ CAPITAL

(In Thousands)

(unaudited)

 

     Common
Unit
Capital


    Senior
Subordinated
Unit
Capital


    Junior
Subordinated
Unit
Capital


    Non-Managing
General Partner
and Affiliate


    Total
Partners’
Capital


 

Balance at September 30, 2004

   $ 224,600     $ 25,352     $ (2,296 )   $ 4,387     $ 252,043  

Net proceeds from issuance of common units

     230,122       —         —         —         230,122  

Distributions

     (32,671 )     (8,088 )     (1,603 )     (5,555 )     (47,917 )

Comprehensive income:

                                        

Net income

     28,489       6,586       1,377       5,390       41,842  

Unrealized gain on derivative instruments

     783       181       38       20       1,022  

Foreign currency translation

     11       3       1       —         15  
                                    


Comprehensive income

                                     42,879  
    


 


 


 


 


Balance at June 30, 2005

   $ 451,334     $ 24,034     $ (2,483 )   $ 4,242     $ 477,127  
    


 


 


 


 


 

See accompanying notes.

 

6


Table of Contents

 

INERGY, L.P. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

(unaudited)

 

     Nine Months Ended
June 30,


 
     2005

    2004

 

Operating activities

                

Net income

   $ 41,842     $ 4,992  

Adjustments to reconcile net income to net cash provided by operating activities:

                

Depreciation

     25,238       10,925  

Amortization

     9,856       4,342  

Amortization of deferred financing costs

     1,328       1,197  

Write-off of deferred financing costs

     6,990       1,216  

Provision for doubtful accounts

     1,944       484  

Make whole premium charge

     —         17,949  

(Gain) loss on disposal of property, plant and equipment

     170       136  

Net asset (liabilities) from price risk management activities

     (7,832 )     424  

Changes in operating assets and liabilities, net of effects from acquisitions:

                

Accounts receivable

     17,837       (10,543 )

Inventories

     24,863       11,524  

Prepaid expenses and other current assets

     7,349       (1,792 )

Other assets

     (2,488 )     43  

Accounts payable

     (24,116 )     15,195  

Accrued expenses

     3,368       768  

Customer deposits

     (26,387 )     (7,238 )
    


 


Net cash provided by operating activities

     79,962       49,622  

Investing activities

                

Acquisitions, net of cash acquired

     (588,863 )     (56,698 )

Purchases of property, plant and equipment

     (25,049 )     (10,005 )

Deferred acquisition costs incurred

     (411 )     (4 )

Proceeds from sale of property, plant and equipment

     2,721       1,572  
    


 


Net cash used in investing activities

     (611,602 )     (65,135 )

 

7


Table of Contents

INERGY, L.P. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(In Thousands)

(unaudited)

 

     Nine Months Ended
June 30,


 
     2005

    2004

 

Financing activities

                

Proceeds from issuance of long-term debt

   $ 1,345,879     $ 268,138  

Principal payments on long-term debt

     (954,847 )     (287,089 )

Deferred financing costs incurred

     (22,809 )     (897 )

Payment of make whole premium charge

     —         (17,949 )

Contribution from non-managing general partner

     —         1,790  

Distributions

     (47,917 )     (27,205 )

Net proceeds from issuance of Common Units

     230,122       83,290  
    


 


Net cash provided by financing activities

     550,428       20,078  
    


 


Effect of foreign exchange rate changes on cash

     15       (84 )
    


 


Net increase (decrease) in cash

     18,803       4,481  

Cash at beginning of period

     2,256       3,528  
    


 


Cash at end of period

   $ 21,059     $ 8,009  
    


 


Supplemental disclosure of cash flow information

                

Cash paid during the period for interest

   $ 20,655     $ 4,773  
    


 


Supplemental schedule of noncash investing and financing activities

                

Acquisition of NGL business through the issuance of obligations

     —       $ 1,970  
    


 


Additions to covenants not to compete through the issuance of noncompete obligations

   $ 7,881     $ 2,096  
    


 


Increase (decrease) in the fair value of long-term debt and the related interest rate swap

   $ 801     $ (316 )
    


 


 

8


Table of Contents

INERGY, L.P. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(In Thousands)

(unaudited)

 

     Nine Months Ended
June 30,


 
     2005

    2004

 

Acquisitions of retail propane companies, net of cash acquired:

                

Current assets

   $ (72,081 )   $ (4,997 )

Property, plant and equipment

     (329,028 )     (42,072 )

Intangible assets

     (141,387 )     (13,798 )

Goodwill

     (129,085 )     (5,483 )

Other assets

     (1,359 )     —    

Current liabilities

     76,196       7,556  

Non-compete liabilities

     7,881       2,096  
    


 


     $ (588,863 )   $ (56,698 )
    


 


 

See accompanying notes.

 

9


Table of Contents

 

INERGY, L.P. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1 – Organization and Basis of Presentation

 

Organization

 

The consolidated financial statements of Inergy, L.P. (the “Company”) include the accounts of the Company and its subsidiaries Inergy Propane, LLC and Inergy Acquisition Company, LLC (the “Operating Companies”) which, collectively, are referred to as “Inergy.” Inergy Partners, LLC (the “Non-Managing General Partner”), a subsidiary of Inergy Holdings, L.P. (“Holdings”) which was formerly Inergy Holdings, LLC, owns the Non-Managing General Partner interest representing an approximate 1.4% unsubordinated general partner’s interest in the Company. Inergy GP, LLC (the “Managing General Partner”), a wholly owned subsidiary of Holdings, has sole responsibility for conducting our business and managing our operations. Holdings is a holding company whose principal business, through its subsidiaries, is its management of and ownership in Inergy, L.P. Holdings also directly owns the incentive distribution rights with respect to Inergy, L.P.

 

Basis of Presentation

 

The financial information as of June 30, 2005 and for the three-month and nine-month periods ended June 30, 2005 and 2004 contained herein is unaudited. The Company believes this information has been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and Article 10 of Regulation S-X. The Company also believes this information includes all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows for the periods then ended. The retail distribution business is largely seasonal due to propane’s primary use as a heating source in residential and commercial buildings. Accordingly, the results of operations for the three-month and nine-month periods ended June 30, 2005 and 2004 are not indicative of the results of operations that may be expected for the entire year.

 

The accompanying financial statements should be read in conjunction with the consolidated financial statements of Inergy, L.P. and subsidiary and the notes thereto included in Form 10-K/A as filed with the Securities and Exchange Commission for the year ended September 30, 2004.

 

Reclassifications

 

Certain reclassifications have been made to the consolidated financial statements for the three and nine months ended June 30, 2004 to conform to the three and nine months ended June 30, 2005.

 

10


Table of Contents

INERGY, L.P. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 2 – Accounting Policies

 

Financial Instruments and Price Risk Management

 

Inergy, through its wholesale operations, holds propane inventory, sells propane to various propane users, retailers, and resellers and offers price risk management services to these customers as part of its marketing and distribution operations. Inergy’s wholesale operations also sell propane to energy marketers and dealers and therefore Inergy enters into fixed price forward purchase and sales contracts. Derivative financial instruments used in connection with these activities are accounted for using the mark-to-market method in accordance with Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities”. Inergy’s overall objective for entering into such derivative financial instruments, including those designated as fair value hedges of Inergy’s inventory positions, is to manage its exposure to fluctuations in commodity prices and changes in the fair market value of its inventories as well as to ensure an adequate physical supply will be available.

 

SFAS No. 133 requires recognition of all derivative instruments in the balance sheets and measures them at fair value. Certain of Inergy’s commodity derivative financial instruments have been designated as hedges of selected inventory positions, and qualify as fair value or cash flow hedges, as defined in SFAS No. 133. For derivative instruments designated as hedges, Inergy uses regression analysis and the dollar offset method to 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 fair value or variability in cash flow of hedged items. Changes in the fair value of derivative instruments designated as fair value or cash flow hedges are reported in the balance sheet as price risk management assets or liabilities. Changes in the fair value of derivatives that qualify as cash flow hedges are recorded in accumulated other comprehensive income until earnings are affected by the variability in cash flows of the designated hedged item. The ineffective portions of hedging derivatives are recognized immediately in cost of product sold.

 

During the three months and nine months ended June 30, 2005, Inergy recognized a net loss of $0.1 million and a net loss of $0.8 million, respectively, related to the ineffective portion of its hedging instruments and net losses of $0.7 million and $0.8 million, respectively, related to the portion of the hedging instruments Inergy excluded from its assessment of hedge effectiveness. Changes in the fair value of derivative instruments that are not designated as hedges are recorded in current period earnings in accordance with SFAS No. 133.

 

The cash flow impact of financial instruments is reflected as cash flows from operating activities in the consolidated statements of cash flows.

 

Furthermore, Inergy has elected to use the special hedge accounting rules in SFAS No. 133 and hedge the fair value of certain of its inventory positions, whereby the hedged inventory is marked to market. Changes in the fair value of the hedge and the hedged item are recorded as a component of costs of products sold.

 

11


Table of Contents

INERGY, L.P. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 2 – Accounting Policies (continued)

 

Revenue Recognition

 

Sales of propane and other liquids are recognized at the time product is shipped or delivered to the customer. Gas processing and fractionation fees are recognized upon delivery of the product. Revenue from the sale of propane appliances and equipment is recognized at the time of sale or installation. Revenue from repairs and maintenance is recognized upon completion of the service.

 

Expense Classification

 

Cost of products sold consists of tangible products sold including all propane and other natural gas liquids sold and all propane related appliances sold. Operating and administrative expenses consist of all expenses incurred by us other than those described above in cost of products sold and depreciation and amortization. Certain of our operating and administrative expenses and depreciation and amortization are incurred in the distribution of our product sales but are not included in cost of product sold. These were $15.4 million and $6.8 million in the three months ended June 30, 2005, and 2004, respectively and were $39.7 million and $19.8 million in the nine months ended June 30, 2005, and 2004, respectively.

 

Use of Estimates

 

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amount of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the year. Actual results could differ from those estimates.

 

Inventories

 

Inventories for retail operations, which mainly consist of propane gas and other liquids, are stated at the lower of cost or market and are computed using the average-cost method or on a first-in, first-out basis. Wholesale propane inventories are stated at the lower of cost, determined by either using the average-cost or first-in, first-out method versus the market unless designated as being hedged by forward sales contracts. Wholesale propane inventories being hedged and carried at market at June 30, 2005 and September 30, 2004 amount to $33.6 million and $40.7 million, respectively.

 

12


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INERGY, L.P. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 2 – Accounting Policies (continued)

 

Inventories consist of (in thousands):

 

     June 30,
2005


   September 30,
2004


Propane gas and other liquids

   $ 49,846    $ 53,295

Appliances, parts and supplies

     8,434      3,109
    

  

     $ 58,280    $ 56,404
    

  

 

Income Per Unit

 

Basic net income per limited partner unit is computed by dividing net income, after considering the Non-Managing General Partner’s interest, by the weighted average number of common and subordinated units outstanding. Diluted net income per limited partner unit is computed by dividing net income, after considering the Non-Managing General Partner’s interest, by the weighted average number of common and subordinated units outstanding and the dilutive effect of unit options granted under the long-term incentive plan. All limited partnership units and per limited partner unit amounts have been restated to reflect the two-for-one split which was effective January 12, 2004. See Note 4, Two-For-One Unit Split. The following table presents the calculation of basic and dilutive net income per limited partner unit (in thousands, except per unit data):

 

     Three Months Ended
June 30,


    Nine Months Ended
June 30,


     2005

    2004

    2005

   2004

Numerator:

                             

Net income (loss)

   $ (24,119 )   $ (9,800 )   $ 41,842    $ 4,992

Less: Non-Managing General Partner’s interest in net income (loss)

     (339 )     (196 )     5,390      100
    


 


 

  

Limited partners’ interest in net income (loss) – basic and diluted

   $ (23,780 )   $ (9,604 )   $ 36,452    $ 4,892
    


 


 

  

Denominator:

                             

Weighted average limited partners’ units outstanding – basic

     32,878       22,950       30,321      21,551

Effect of dilutive unit options outstanding

     —         —         609      460
    


 


 

  

Weighted average limited partners’ units outstanding – dilutive

     32,878       22,950       30,930      22,011
    


 


 

  

Net income (loss) per limited partner unit:

                             

Basic

   $ (0.72 )   $ (0.42 )   $ 1.20    $ 0.23
    


 


 

  

Diluted

   $ (0.72 )   $ (0.42 )   $ 1.18    $ 0.22
    


 


 

  

 

13


Table of Contents

INERGY, L.P. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 2 – Accounting Policies (continued)

 

Accounting for Unit-Based Compensation

 

Inergy has a unit-based employee compensation plan, which is accounted for under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees” for all periods presented and presents the fair value method pro forma disclosures required under the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148 “Accounting for Stock-Based Compensation – Transition and Disclosure.” No unit-based employee compensation cost is reflected in net income, as all options granted under the plan had an exercise price equal to the market value of the underlying common units on the date of grant. The following table illustrates the effect on net income and net income per limited partner unit as if Inergy had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” to unit-based employee compensation. For purposes of pro forma disclosures, the estimated fair value of an option is amortized to expense over the option’s vesting period. Inergy’s pro forma information for each of the three and nine month periods ended June 30, 2005 and 2004 is as follows (in thousands, except per unit data):

 

     Three Month Ended
June 30,


    Nine months ended
June 30,


     2005

    2004

    2005

   2004

Net income (loss) as reported

   $ (24,119 )   $ (9,800 )   $ 41,842    $ 4,992

Deduct: Total unit-based employee compensation expense determined under fair value method for all awards

     58       55       185      166
    


 


 

  

Pro forma net income (loss)

   $ (24,177 )   $ (9,855 )   $ 41,657    $ 4,826
    


 


 

  

Deduct: Non-managing general partners’ interest in net income (loss)

   $ (339 )   $ 196     $ 5,390    $ 100
    


 


 

  

Pro forma limited partners’ interest in net income (loss) for the three and nine month periods ended June 30, 2005 and 2004

   $ (23,838 )   $ (9,659 )   $ 36,267    $ 4,726
    


 


 

  

Net income (loss) per limited partner unit:

                             

Basic – as reported

   $ (0.72 )   $ (0.42 )   $ 1.20    $ 0.23
    


 


 

  

Basic – pro forma

   $ (0.73 )   $ (0.42 )   $ 1.20    $ 0.22
    


 


 

  

Pro forma net income (loss) per limited partner unit:

                             

Diluted – as reported

   $ (0.72 )   $ (0.42 )   $ 1.18    $ 0.22
    


 


 

  

Diluted – pro forma

   $ (0.73 )   $ (0.42 )   $ 1.17    $ 0.22
    


 


 

  

 

14


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INERGY, L.P. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 2 – Accounting Policies (continued)

 

As the effects of including the incremental units associated with options are antidilutive for the quarters ended June 30, 2005 and 2004, both basic earnings per unit and diluted earnings per unit reflect the same calculation. Weighted average antidilutive unit options outstanding totaled 622,708 and 453,472 for the quarters ended June 30, 2005 and 2004, respectively.

 

Recently Issued Accounting Pronouncements

 

On December 16, 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), Share-Based Payment, which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation. SFAS 123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash Flows. Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative.

 

SFAS No. 123(R) must be adopted no later than October 1, 2005. Early adoptions will be permitted in periods in which financial statements have not yet been issued. We expect to adopt SFAS No. 123(R) on October 1, 2005.

 

SFAS No. 123(R) permits public companies to adopt its requirements using one of two methods:

 

A “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS No. 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of SFAS No. 123 for all awards granted to employees prior to effective date of SFAS No. 123(R) that remain unvested as of the effective date.

 

A “modified retrospective” method which includes the requirements of the modified prospective described above, but also permits entities to restate based on the amounts previously recognized under SFAS No. 123 for purposes of pro forma disclosures either (a) all prior periods presented or (b) prior interim periods of the year of adoption.

 

The company plans to adopt SFAS No. 123(R) using the modified prospective method.

 

15


Table of Contents

INERGY, L.P. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 2 – Accounting Policies (continued)

 

As permitted by SFAS No. 123, the Company currently accounts for share-based payments to employees using Opinion 25’s intrinsic value method and, as such, generally recognizes no compensation cost for employee stock options. Accordingly, the adoption of SFAS No. 123(R)’s fair value method will not have a significant impact on our results of operations, and it will not have a significant impact on our overall financial position. The impact of adoption of SFAS No. 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had we adopted SFAS No. 123(R) in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123 as described in the disclosure of pro forma net income and earnings per share in the footnotes to the consolidated financial statements.

 

SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4,” amends the existing standard that provides guidance on accounting for inventory costs and specifically clarifies that abnormal amounts of costs should be recognized as period costs. This statement is effective for the fiscal year beginning after June 15, 2005. The adoption of SFAS No. 151 is not expected to have a material effect on the Company’s consolidated financial statements.

 

SFAS No. 153, “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions” eliminates the narrow exception for nonmonetary exchanges of similar productive assets and replaces it with a broader exception for exchanges of nonmonetary assets that do not have commercial substance. Further, the amendments made by SFAS No. 153 are based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. Previously, Opinion No. 29 required that the accounting for an exchange of a productive asset for a similar productive asset or an equivalent interest in the same or similar productive asset should be based on the recorded amount of the asset relinquished. The statement is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges in fiscal periods beginning after the date of issuance. The provisions of this statement shall be applied prospectively. The adoption of SFAS No. 153 is not expected to have a material effect on the Company’s consolidated financial statements.

 

SFAS No. 154, “Accounting Changes and Error Corrections” is a replacement of APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements. Statement 145 applies to all voluntary changes in accounting principle and changes the accounting for and a reporting of a change in accounting principle. Statement 154 requires retrospective application to the prior periods’ financial statements of a voluntary change in accounting principle unless it is impracticable. Statement 154 is effective for the accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 is not expected to have a material effect on the Company’s consolidated financial statements.

 

16


Table of Contents

INERGY, L.P. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 3 – Long-Term Debt

 

Long-term debt consisted of the following (in thousands):

 

     June 30,
2005


   September 30,
2004


Credit agreement

   $ 100,800    $ 132,153

Senior unsecured notes

     425,801      —  

Obligations under noncompetition agreements and notes to former owners of businesses acquired

     9,913      5,446

Other

     —        2
    

  

       536,514      137,601

Less current portion

     6,423      23,615
    

  

     $ 530,091    $ 113,986
    

  

 

Effective in December 2004, the Company executed a new credit agreement with its existing lenders in addition to others. The credit agreement consists of a $250.0 million revolving acquisition facility and a $75.0 million working capital facility. We have the option to use up to $25.0 million of available borrowing capacity from our revolving acquisition facility for working capital purposes. The credit agreement expires in December 2009 and is guaranteed by all of our domestic subsidiaries. The proceeds of the new credit agreement were used to repay the outstanding balance of the existing credit agreement. This resulted in the write-off of deferred financing costs associated with the existing credit agreement of $1.5 million.

 

We are required to reduce the principal outstanding on the revolving working capital line of credit to $5 million or less for a minimum of 30 consecutive days during the period commencing March 1 and ending September 30. At September 30, 2004, we were required to reduce the principal outstanding on the revolving working capital line of credit to $4 million or less for a minimum of 30 consecutive days during the period commencing March 1 and ending September 30. As such $4 million of the outstanding balance at September 30, 2004 has been classified as long-term liabilities in the accompanying consolidated balance sheets. At June 30, 2005 and September 30, 2004, the total balance outstanding under the existing credit agreements was $100.8 million and $132.2 million, respectively, including $8.5 million and $26.4 million, respectively, under the working capital facilities. The prime rate and Eurodollar plus the applicable spreads were between 5.76% and 7.25% at June 30, 2005, and between 3.77% and 4.75% at September 30, 2004, for all outstanding debt under the credit agreement.

 

The credit agreements contain several covenants which, among other things, require the maintenance of various financial performance ratios, restrict the payment of distributions to unitholders, and require financial reports to be submitted periodically to the financial institutions. Unused borrowings under the credit agreements amounted to $209.7 million and $162.2 million at June 30, 2005 and September 30, 2004, respectively.

 

17


Table of Contents

INERGY, L.P. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 3 – Long-Term Debt (continued)

 

In December 2004, we entered into a 364-day credit facility and borrowed $375.0 million under this facility. The borrowings under this facility were used to finance part of the Star Gas Propane acquisition and related expenses. The 364-day credit facility was guaranteed by all of our domestic subsidiaries and was secured on an equal basis with our revolving credit facilities. The borrowings under this facility were permanently repaid with the net proceeds from our offering of senior unsecured notes and the 364-day facility was terminated. This resulted in the write-off of deferred financing costs associated with the 364-day facility of $5.5 million.

 

On December 22, 2004, the Company and its wholly-owned subsidiary, Inergy Finance Corp., completed a private placement of $425 million in aggregate principal amount of 6.875% senior unsecured notes due 2014 (the “Senior Notes”). The senior unsecured notes contain covenants similar to the credit agreement. The net proceeds from the Senior Notes were used to repay all amounts drawn under the 364-day credit facility, with the $39.9 million balance of the net proceeds being applied to the revolving acquisition credit facility.

 

The notes represent senior unsecured obligations and rank pari passu in right of payment with all of our other present and future senior indebtedness. The senior unsecured notes are jointly and severally guaranteed by all current domestic subsidiaries. The notes have certain call features which allow us to redeem the notes at specified prices based on date redeemed.

 

In the quarter ending March 2005, the Company entered into four interest rate swap agreements scheduled to mature in December 2014, each designed to hedge $25 million in underlying fixed rate senior unsecured notes, in order to manage interest rate risk exposure. These swap agreements, which expire on the same date as the maturity date of the related senior unsecured notes, require the counterparty to pay us an amount based on the stated fixed interest rate on the notes due every six months. In exchange, we are required to make semi-annual floating interest rate payments on the same dates to the counterparty based on an annual interest rate equal to the 6 month LIBOR interest rate plus spreads between 1.95% and 2.20% applied to the same notional amount of $100 million. The swap agreements have been recognized as fair value hedges. Amounts to be received or paid under the agreements are accrued and recognized over the life of the agreements as an adjustment to interest expense. We recognized the approximate $0.8 million increase in the fair market value of the related senior unsecured notes at June 30, 2005 with a corresponding increase in the fair value of its interest rate swaps, which are recorded in other assets.

 

18


Table of Contents

INERGY, L.P. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 3 – Long-Term Debt (continued)

 

The aggregate amounts of principal to be paid on the outstanding long-term debt during the next five years ending June 30 and thereafter are as follows, in thousands of dollars:

 

2006

   $ 6,423

2007

     2,257

2008

     2,020

2009

     960

2010

     97,961

Thereafter

     426,893
    

     $ 536,514
    

 

In June 2002, we entered into a note purchase agreement with a group of institutional lenders pursuant to which we issued $85.0 million aggregate principal amount of senior secured notes with a weighted average interest rate of 9.07% and a weighted average maturity of 5.9 years. The senior secured notes consisted of the following: $35 million principal amount of 8.85% senior secured notes with a 5-year maturity, $25.0 million principal amount of 9.10% senior secured notes with a 6-year maturity, and $25.0 million principal amount of 9.34% senior secured notes with a 7-year maturity. The net proceeds from these senior secured notes were used to repay a portion of the amount outstanding under the credit facility. The funds from a public unit offering, together with net new borrowings under the revolving credit facility were used to repay in full $85.0 million aggregate principal amount of senior secured notes, plus a make whole premium charge of approximately $17.9 million in January 2004. All related interest rate swap agreements were cancelled in conjunction with the repayment of $85 million of senior secured notes. The make whole premium charge of $17.9 million was recorded as a charge to earnings in the quarter ended March 31, 2004 together with the write-off of the $1.2 million deferred financing costs associated with the senior secured notes, partially offset by a $0.9 million gain from the cancellation of the interest rate swaps.

 

In August 2002, the “Operating Company” entered into two interest rate swap agreements each designed to hedge $10 million in underlying fixed rate senior secured notes, in order to manage interest rate risk exposure. In October 2002, the Operating Company entered into three additional interest rate swap agreements each designed to hedge $5 million in underlying fixed rate senior secured notes. In January 2004, all interest rate swap agreements were cancelled in conjunction with the repayment of $85 million of senior secured notes.

 

At June 30, 2005, the Company was in compliance with all of its debt covenants.

 

19


Table of Contents

INERGY, L.P. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 4 – Two-for-One Unit Split

 

On December 10, 2003, the Board of Directors of our Managing General Partner declared a two-for-one split of the outstanding common and subordinated units. The split entitled unitholders of record at the close of business on January 2, 2004 to receive one additional unit for each unit held as of such date. The distribution was made on January 12, 2004. The effect of the split was to double the number of all outstanding units and to reduce by half the minimum quarterly per unit distribution and the targeted distribution levels. All common and subordinated unit amounts and per unit amounts have been restated to reflect the two-for-one split.

 

Note 5 – Partner’s Capital

 

In December 2004, we issued 3,568,139 Common Units to unrelated third parties resulting in proceeds of $91.0 million. These proceeds were obtained to partially fund the acquisition of Star Gas Propane, L.P.

 

Also in December 2004, we issued 4,400,000 Common Units in a public offering, resulting in proceeds of $121.3 million, net of underwriter’s discount, commission, and offering expenses. These funds were used to repay borrowings under our credit agreement.

 

In January 2005, the underwriters of the December 2004 4,400,000 Common Unit offering exercised their over-allotment provision and we issued 660,000 common units in a follow-on offering, resulting in proceeds of approximately $17.9 million, net of underwriters’ discounts, commissions, and offering expenses. These funds were used to repay borrowings under our credit agreement.

 

Quarterly Distributions of Available Cash

 

On May 13, 2005, a quarterly distribution of $0.50 per limited partner unit was paid to unitholders of record on May 6, 2005 with respect to the second fiscal quarter of 2005, which totaled $19.2 million. On July 25, 2005, we declared a distribution of $0.51 per limited partner unit to be distributed on August 12, 2005 to unitholders of record on August 5, 2005, for a total distribution of $19.9 million with respect to the third fiscal quarter of 2005.

 

On February 14, 2005, a quarterly distribution of $0.475 per limited partner unit was paid to unitholders of record on February 7, 2005 with respect to the first fiscal quarter of 2005, which totaled $17.6 million.

 

We distributed $0.405 per limited partner unit on May 14, 2004 to unitholders of record on May 7, 2004, for a total distribution of $9.9 million with respect to the second fiscal quarter of 2004. On August 13, 2004, Inergy distributed $0.415 per limited partner unit to its unitholders of record on August 6, 2004, for a total distribution of $10.2 million with respect to the third fiscal quarter of 2004.

 

20


Table of Contents

INERGY, L.P. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 6 – Commitments and Contingencies

 

We periodically enter into agreements to purchase fixed quantities of propane at fixed prices with suppliers. At June 30, 2005, the total of these firm purchase commitments was approximately $88.2 million.

 

At June 30, 2005, we were contingently liable for letters of credit outstanding totaling $14.5 million, which guarantee various transactions.

 

During the three months ended December 31, 2004, our subsidiary, Star Gas Propane, L.P. was a named defendant in multiple federal securities class action lawsuits alleging that public disclosures made by its former parent, Star Gas Partners, L.P., were in violation of various securities laws including Rule 10b-5. Star Gas Partners, L.P has agreed to indemnify us for this liability. We do not expect this lawsuit to have a material effect on our results of operations or financial condition because we believe that the claim is without merit. However, if the lawsuit was decided adversely to Star Gas Propane, L.P. and Star Gas Partners, L.P. was unable to fulfill its indemnification obligation to us, this lawsuit could have a material effect on our results of operations or financial condition.

 

We are not currently a party to any material litigation. Our operations are subject to all operating hazards and risks normally incidental to handling, storing, transporting and otherwise providing for use by consumers of combustible liquids such as propane. As a result, at any given time we are a defendant in various legal proceedings and litigation arising in the ordinary course of business. We maintain insurance policies with insurers in amounts and with coverages and deductibles as our managing general partner believes are reasonable and prudent. However, we cannot assure that this insurance will be adequate to protect us from all material expenses related to potential future claims for personal and property damage or that these levels of insurance will be available in the future at economical prices. In addition, the occurrence of an explosion may have an adverse effect on the public’s desire to use our products.

 

Note 7 – Segments

 

Our financial statements reflect two reportable segments: retail sales operations and wholesale sales operations. Retail sales operations include all retail operations and transportation services. Wholesale sales operations include wholesale supply, marketing and distribution, and natural gas processing and NGL fractionation operations. Results of operations for acquisitions that occurred during the nine months ended June 30, 2005 are included in the retail sales operation reportable segment. Revenues, gross profit and identifiable assets for each of our reportable segments are presented below.

 

The identifiable assets associated with each reportable segment include accounts receivable and inventories. The net asset/liability from price risk management, as reported in the accompanying consolidated balance sheets, is related to the wholesale segment.

 

21


Table of Contents

INERGY, L.P. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 7 – Segments (continued)

 

The following segment information is presented in thousands of dollars:

 

     Three Months Ended June 30, 2005

     Retail
Sales
Operations


   Wholesale
Sales
Operations


   Intersegment
Eliminations


    Total

Propane revenues

   $ 80,987    $ 77,889    $ (31,383 )   $ 127,493

Distillate revenues

     14,644      —        —         14,644

Fractionation and other midstream revenues

     —        19,448      —         19,448

Transportation revenues

     3,033      —        —         3,033

Propane-related appliance sales revenues

     2,950      —        —         2,950

Retail service revenues

     3,236      —        —         3,236

Rental service and other revenues

     2,798      —        —         2,798

Gross profit

     46,162      5,024      (582 )     50,604

Identifiable assets

     51,661      63,959      —         115,620

 

     Three Months Ended June 30, 2004

     Retail
Sales
Operations


   Wholesale
Sales
Operations


   Intersegment
Eliminations


    Total

Propane revenues

   $ 25,271    $ 42,633    $ (10,364 )   $ 57,540

Distillate revenues

     698      —        —         698

Fractionation and other midstream revenues

     —        6,572      —         6,572

Transportation revenues

     2,038      —        —         2,038

Propane-related appliance sales revenues

     965      —        —         965

Retail service revenues

     714      —        —         714

Rental service and other revenues

     1,188      —        —         1,188

Gross profit

     14,672      2,315      —         16,987

Identifiable assets

     19,103      41,979      —         61,082

 

     Nine Months Ended June 30, 2005

     Retail
Sales
Operations


   Wholesale
Sales
Operations


   Intersegment
Eliminations


    Total

Propane revenues

   $ 451,654    $ 397,782    $ (141,235 )   $ 708,201

Distillate revenues

     59,269      —        —         59,269

Fractionation and other midstream revenues

     —        41,725      —         41,725

Transportation revenues

     8,229      —        —         8,229

Propane-related appliance sales revenues

     7,309      —        —         7,309

Retail service revenues

     11,494      —        —         11,494

Rental service and other revenues

     9,268      —        —         9,268

Gross profit

     237,695      15,103      (993 )     251,805

Identifiable assets

     51,661      63,959      —         115,620

 

22


Table of Contents

INERGY, L.P. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 7 – Segments (continued)

 

     Nine Months Ended June 30, 2004

     Retail
Sales
Operations


   Wholesale
Sales
Operations


   Intersegment
Eliminations


    Total

Propane revenues

   $ 170,900    $ 261,108    $ (86,221 )   $ 345,787

Distillate revenues

     1,572      —        —         1,572

Fractionation and other midstream revenues

     —        17,886      —         17,886

Transportation revenues

     5,903      —        —         5,903

Propane-related appliance sales revenues

     3,701      —        —         3,701

Retail service revenues

     2,628      —        —         2,628

Rental service and other revenues

     2,888      —        —         2,888

Gross profit

     91,223      13,811      (610 )     104,424

Identifiable assets

     19,103      41,979      —         61,082

 

Note 8 – Business Acquisitions

 

In November 2004, we acquired the propane assets of Moulton Gas Service, Inc., headquartered in Wapakoneta, OH. In December 2004, we acquired Star Gas Propane, L.P. headquartered in Stamford, CT and the propane assets of Northwest Propane, Inc, headquartered in Holly, MI. In May 2005, we acquired the assets of three other retail propane companies. The aggregate purchase price for these acquisitions, net of cash acquired was $588.9 million.

 

The operating results for these acquisitions are included in our consolidated results of operations from the dates of acquisition through June 30, 2005.

 

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Table of Contents

INERGY, L.P. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 8 – Business Acquisitions (continued)

 

The purchase price of Star Gas Propane, L.P. approximated $487.7 million, net of cash acquired. In connection with the acquisition, we entered into a 364-day credit facility and borrowed $375.0 million under this facility on December 17, 2004. On December 22, 2004, the Company and its wholly-owned subsidiary, Inergy Finance Corp., completed a private placement of $425 million in aggregate principal amount of 6.875% senior unsecured notes due 2014 (the “Senior Notes”). We used the net proceeds from the $425 million private placement of Senior Notes to repay all amounts drawn under the 364-day credit facility, with the $39.9 million balance of the net proceeds being applied to the revolving acquisition credit facility. We also issued 3,568,139 Common Units to unrelated third parties to partially fund the acquisition. The allocation of the total consideration for the Star Gas Propane, L.P. acquisition is as follows (in millions):

 

Current assets, net of cash acquired

   $ 54.6  

Property, plant and equipment

     285.7  

Intangible assets

     108.6  

Goodwill

     90.5  

Other assets

     1.4  

Current liabilities

     (52.0 )

Non-compete liabilities

     (1.1 )
    


     $ 487.7  
    


 

The purchase price allocation has been prepared on a preliminary basis, and changes are expected when the appraisals are completed and additional information becomes available.

 

The following unaudited pro forma data summarizes the results of operations for the periods indicated as if the Star Gas Propane, L.P. acquisition had been completed October 1, 2003 and 2004, the beginning of the 2004 and 2005 fiscal years. Star Gas Propane, L.P. meets the criteria of a significant subsidiary. Pro forma information is not presented for other acquisitions as they do not qualify as significant subsidiaries. The pro forma data give effect to actual operating results prior to the acquisition and adjustments to interest expense, customers’ accounts amortization expense and depreciation expense. These pro forma amounts do not purport to be indicative of the results that would have been obtained if the acquisitions had occurred on October 1, 2003 and 2004 or that will be obtained in the future.

 

     Three month period ended

    Nine month period ended

     June 30,
2005


    June 30,
2004


    June 30,
2005


  

June 30,

2004


Revenue

   $ 173,602     $ 119,528     $ 904,217    $ 675,746

Net income (loss)

     (24,119 )     (24,314 )     32,816      18,433

Non-managing general partners’ interest in net income (loss)

   $ (339 )   $ (110 )   $ 5,253    $ 1,212
    


 


 

  

Limited partners’ interest in net income (loss)

   $ (23,780 )   $ (24,204 )   $ 27,563    $ 17,221
    


 


 

  

Pro forma net income (loss) per limited partner unit:

                             

Basic - pro forma

   $ (0.72 )   $ (1.05 )   $ 0.91    $ 0.80

Diluted - pro forma

   $ (0.72 )   $ (1.05 )   $ 0.89    $ 0.78
    


 


 

  

 

24


Table of Contents

INERGY, L.P. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 9 – Subsequent Events

 

On July 11, 2005, Inergy announced it has executed an agreement to purchase the membership interests of the entities that own the Stagecoach natural gas storage facility located in Tioga county, New York, for approximately $205 million. Stagecoach is a high performance, multi-cycle natural gas storage facility. In addition to the approximate $205 million purchase price for the in-service Stagecoach facility, Inergy will also purchase the rights to the Phase II expansion project of Stagecoach for $25 million. Inergy intends to fund the approximate $230 million purchase price initially through bank borrowings of approximately $205 million and a $25 million capital contribution from Inergy Holdings, L.P. Inergy expects to finance the $205 million portion of the purchase price with longer-term capital through a combination of equity and debt issuances. In exchange for the $25 million capital contribution, Inergy will issue special units to Inergy Holdings, L.P. The special units will provide for a 12% paid-in-kind return until the Phase II expansion project is complete and operational at which time the special units will convert to common units.

 

25


Table of Contents
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation

 

Our “Management’s Discussion and Analysis of Financial Condition and Results of Operations” should be read in conjunction with the accompanying consolidated financial statements and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Annual Report on Form 10-K for the fiscal year ended September 30, 2004 of Inergy, L.P.

 

The statements in this Quarterly Report on Form 10-Q that are not historical facts, including most importantly, those statements preceded by, or that include the words “may”, “believes”, “expects”, “anticipates” or the negation thereof, or similar expressions, constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements include, but are not limited to, statements that: (i) we believe our wholesale supply, marketing and distribution business complements our retail distribution business, (ii) we expect recovery of goodwill through future cash flows associated with acquisitions, and (iii) we believe that anticipated cash from operations and borrowings under our credit facility will be sufficient to meet our liquidity needs for the foreseeable future. Such forward-looking statements involve risks, uncertainties and other factors which may cause the actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, but are not limited to, the following: weather in our area of operations; market price of propane; availability of financing; changes in, or failure to comply with, government regulations; the costs, uncertainties and other effects of legal and administrative proceedings and other risks and uncertainties detailed in our Securities and Exchange Commission filings. For those statements, we claim the protection of the safe harbor for forward-looking statements contained in the Reform Act. We will not undertake and specifically decline any obligation to publicly release the result of any revisions to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect events or circumstances after anticipated or unanticipated events.

 

Overview

 

We are a rapidly growing retail and wholesale propane marketing and distribution business. We also own, as part of our wholesale and supply operations, an NGL business in California, which includes natural gas processing, NGL fractionation, NGL rail and truck terminals, bulk storage, trucking and marketing operations. We have grown primarily through acquisitions of retail propane operations. Since the inception of Inergy’s predecessor in 1996, Inergy has acquired 48 propane businesses. Inergy further intends to pursue its growth objectives through, among other things, future acquisitions, maintaining a high percentage of retail sales to residential customers, operating in attractive markets and focusing its operations under established, and locally recognized trade names.

 

In November 2004, we acquired the propane assets of Moulton Gas Service, Inc., headquartered in Wapakoneta, OH. In December 2004, we acquired Star Gas Propane, L.P. headquartered in Stamford, CT and the propane assets of Northwest Propane, Inc, headquartered in Holly, MI.

 

The operating results for Star Gas Propane, L.P. from December 1, 2004 are included in our consolidated results of operations. The operating results of Moulton Gas Service, Inc. and Northwest Propane, Inc. are included in our consolidated results of operations from the dates of acquisition.

 

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The purchase price of Star Gas Propane, L.P. approximated $487.7 million, net of cash acquired. In connection with the acquisition, we entered into a 364-day credit facility and borrowed $375.0 million under this facility on December 17, 2004. On December 22, 2004, we, together with our wholly-owned subsidiary, Inergy Finance Corp., completed a private placement of $425 million in aggregate principal amount of the Issuers’ 6.875% senior unsecured notes due 2014 (the “Senior Notes”). We used the net proceeds from the $425 million private placement of Senior Notes to repay all amounts drawn under the 364-day credit facility, with the $39.9 million balance of the net proceeds being applied to the revolving acquisition credit facility. Inergy, L.P. also issued 3,568,139 common units to unrelated third parties to partially fund the acquisition.

 

Because a substantial portion of our propane is used in the weather-sensitive residential markets, the temperatures realized in our areas of operations, particularly during the six-month peak heating season, have a significant effect on our financial performance. As a result, operating income is highest October through March, and we generally experience net losses from April through September. In any given area, warmer-than-normal temperatures will tend to result in reduced propane use, while sustained colder-than-normal temperatures will tend to result in greater propane use. Therefore, we use information on normal temperatures in understanding how historical results of operations are affected by temperatures that are colder or warmer than normal and in preparing forecasts of future operations, which are based on the assumption that normal weather will prevail in each of our operating regions. “Heating degree days” are a general indicator of weather impacting propane usage and are calculated for any given period by adding the difference between 65 degrees and the average temperature of each day in the period (if less than 65 degrees).

 

The retail propane business is a “margin-based” business where the level of profitability is largely dependent on the difference between sales prices and product cost. The unit cost of propane is subject to volatile changes as a result of product supply or other market conditions. Propane unit cost changes can occur rapidly over a short period of time and can impact margins as sales prices may not change as rapidly. There is no assurance that we will be able to fully pass on product cost increases, particularly when product costs increase rapidly. We have generally been successful in passing on higher propane costs to our customers and have historically maintained or increased our gross margin per gallon in periods of rising costs.

 

We believe our wholesale supply, marketing and distribution business complements our retail distribution business. Through our wholesale operations, we distribute propane and also offer price risk management services to propane retailers, resellers and other related businesses as well as energy marketers and dealers, through a variety of financial and other instruments. We engage in derivative transactions to reduce the effect of price volatility on our product costs and to help ensure the availability of propane during periods of short supply.

 

Three Months Ended June 30, 2005 Compared to Three Months Ended June 30, 2004

 

Volume. During the three months ended June 30, 2005, we sold 48.6 million retail gallons of propane, an increase of 30.4 million gallons, or 166% over the 18.2 million retail gallons sold during the same three-month period in 2004. The increase in retail sales volume was principally due to the December 2004 acquisition of Star Gas Propane, L.P. and the eleven other retail propane companies for which results are only included in the 2004 period subsequent to the date of acquisition.

 

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Acquisition-related volume accounted for approximately 32.2 million gallons of this increase, with this increase partially offset by approximately 1.8 million lesser gallon sales primarily as a result of customer conservation due to higher propane sales prices. Higher selling prices were a result of an approximate 23% higher propane cost per gallon on average for the three months ended June 30, 2005 compared to the same three-month period in 2004.

 

Wholesale gallons delivered during the three months ended June 30, 2005 were 57.3 million gallons, as compared to 53.7 million gallons during the same three-month period in 2004. This increase was primarily attributable to increased sales volumes to new and existing customers.

 

Revenues. Revenues in the three months ended June 30, 2005 were $173.6 million, an increase of $103.9 million, or 149%, from $69.7 million during the same three-month period in 2004.

 

Revenues from retail sales were $106.0 million in the three months ended June 30, 2005 (after elimination of sales to our wholesale operations), an increase of $76.3 million, or 256%, compared to $29.7 million during the same three-month period in 2004. Retail propane revenues accounted for approximately $55.2 million of this increase comprised of an increase of approximately $52.7 million from acquisition-related volume and an increase of approximately $5.6 million as a result of higher selling prices with these increases partially offset approximately $3.1 from the lower sales volumes at our existing locations. In addition to retail propane sales, these revenues consist of transportation revenues, distillate sales, tank rentals, appliance sales and service income with these revenues increasing by approximately $21.1 primarily due to acquisitions.

 

Revenues from wholesale sales were $67.6 million in the three months ended June 30, 2005 (after elimination of sales to our retail operations), an increase of $27.6 million, or 69%, compared to $40.0 million during the same three-month period in 2004. Approximately $11.8 million of this increase was attributable to the higher per gallon selling price of propane, due to its higher cost, with the balance of the increase, approximately $15.8 million, the result of volume increases generated in our wholesale operations.

 

Cost of Product Sold. Retail cost of product sold in the three months ended June 30, 2005 was $60.4 million, an increase of $45.3 million, or 301%, compared to $15.1 million during the same three-month period in 2004. Approximately $27.9 million of this increase was attributable to acquisition-related retail propane sales. In addition, the higher average cost of propane resulted in increased cost of product of approximately $2.0 million offset by $3.1 million lesser cost of product as a result of the lower propane volume sales at our existing locations. Other retail cost of product sales increased as a result of acquisitions and were $20.6 million in the three months ended June 30, 2005, an increase of $18.5 million, compared to only $2.1 million in the prior year. The other retail cost of product sales is primarily distillate products which is substantially a result of the acquisition of Star Gas Propane, L.P. Wholesale cost of product sold in the three months ended June 30, 2005 was $62.6 million, an increase of $24.9 million or 66%, from wholesale cost of product sold of $37.7 million during the same three-month period in 2004. Approximately $10.6 million of this increase was primarily related to the increased average cost of propane in the three months ended June 30, 2005, with the balance of the increase, approximately $14.3 million, the result of the increased volumes experienced in our wholesale operations. Our cost of product sold consists of tangible products sold including all propane and other natural gas liquids sold and all propane-related appliances sold. Other costs incurred in conjunction with

 

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the distribution of these products are included in operating and administrative expenses and consist primarily of wages to delivery personnel and delivery vehicle costs consisting of fuel costs, repair and maintenance and lease expense. These costs approximated $12.4 million and $5.6 million in the three months ended June 30, 2005 and 2004, respectively. In addition, the depreciation expense associated with the delivery vehicles is reported within depreciation and amortization expense and amounted to $3.0 million and $1.2 million in the three months ended June 30, 2005 and 2004, respectively. Since we include these costs in our operating and administrative expenses rather than in cost of product sold, our results may not be comparable to other entities in our lines of business.

 

Gross Profit. Retail gross profit was $45.6 million in the three months ended June 30, 2005 compared to $14.7 million during the same three-month period in 2004. This increase of approximately $30.9 million was primarily attributable to an increase of approximately $28.3 million in retail propane gross profit. This retail propane gross profit increase was the result of an increase in retail gallons sold as a result of acquisitions which accounted for approximately $24.8 million of the increase in addition to an increase in margin per gallon at our existing locations which amounted to an increase of approximately $3.7 million. The volume decrease at our existing locations partially offset these increases by approximately $0.2 million. Other retail gross profits increased by approximately $2.6 million with the increase attributable to acquisitions. Wholesale gross profit was $5.0 and $2.3 million, respectively, (after elimination of gross profit attributable to our retail operations) in the three months ended June 30, 2005 and 2004. This increase was primarily attributable to increased margins per gallon, and an increase in volume.

 

Operating and Administrative Expenses. Operating and administrative expenses increased to $52.1 million in the three months ended June 30, 2005 as compared to $20.0 million in the same three-month period in 2004. The increase in our operating and administrative expenses were attributable to increases in personnel expenses of $19.0 million, general operating expenses of $9.9 million including insurance, professional services and facility costs, and increased vehicle costs of $3.2 million resulting primarily from acquisitions.

 

Depreciation and Amortization. Depreciation and amortization increased to $13.9 million in the three months ended June 30, 2005 from $5.6 million during the same three-month period in 2004 as a result of retail propane acquisitions.

 

Interest Expense. Interest expense increased to $9.1 million in the three month period ended June 30, 2005 as compared to $1.4 million during the same three-month period in 2004. Interest expense increased primarily due to an increase in the average debt outstanding including the additional financing related to the acquisition of Star Gas Propane, L.P. and higher average interest rates.

 

Make Whole Premium Charge, Write-off of Deferred Financing Costs, and Swap Value Received. In January 2004, we repaid in full our $85.0 million senior secured notes before their scheduled maturity dates. As such, we were required to pay an additional amount of approximately $17.9 million as a make whole payment which was recorded as a charge to earnings in the quarter ended March 31, 2004. We used proceeds from our January 2004 common unit offering and borrowings from our bank credit facility for this repayment. In addition, we also recorded a charge to earnings of approximately $1.2 million in the quarter ended March 31, 2004, to write-off deferred financing costs associated with the senior secured notes. Partially offsetting these charges was a $0.9 million gain from the cancellation of interest rate swap agreements also associated with the Senior Notes.

 

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Net Income (loss). Net loss was $(24.1) million for the three months ended June 30, 2005 compared to the net loss of $(9.8) million in the same three-month period in 2004. The increased net loss was attributable to the greater increase in operating and administrative expenses, depreciation and amortization, and interest expense, offsetting increases in retail and wholesale gross profit, all primarily the result of acquisitions.

 

EBITDA. For the three months ended June 30, 2005, loss before interest, taxes, depreciation and amortization was $(1.1) million compared to $(2.7) million during the same three-month period in 2004. The increase was primarily attributable to increased sales volumes due to acquisitions partially offset by an increase in operating and administrative expenses. EBITDA is defined as income before taxes, plus net interest expense (inclusive of write-off of deferred financing costs) and depreciation and amortization expense. EBITDA should not be considered an alternative to net income, income before income taxes, cash flows from operating activities, or any other measure of financial performance calculated in accordance with generally accepted accounting principles as those items are used to measure operating performance, liquidity or ability to service debt obligations. We believe that EBITDA provides additional information for evaluating our ability to make the minimum quarterly distribution and is presented solely as a supplemental measure. EBITDA, as we define it, may not be comparable to EBITDA or similarly titled measures used by other corporations or partnerships.

 

     Three Months Ended
June 30,


 
     2005

    2004

 
     (in thousands)  

EBITDA:

                

Net income (loss)

   $ (24,119 )   $ (9,800 )

Interest expense, net

     9,144       1,443  

Provision for income taxes

     24       113  

Depreciation and amortization

     13,865       5,591  
    


 


EBITDA

   $ (1,086 )   $ (2,653 )
    


 


 

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Nine Months Ended June 30, 2005 Compared to Nine Months Ended June 30, 2004

 

Volume. During the nine months ended June 30, 2005, we sold 269.7 million retail gallons of propane, an increase of 152.3 million gallons, or 130% over the 117.4 million retail gallons sold during the same nine-month period in 2004. The increase in retail sales volume was principally due to the December 2004 acquisition of Star Gas Propane, L.P. and the eighteen other retail propane companies for which results are only included in the 2004 period subsequent to the date of acquisition. Acquisition-related volume accounted for approximately 168.0 million gallons of this increase, partially offset by approximately 15.7 million lesser gallon sales as a result of customer conservation due to higher propane sales prices and warmer weather. Higher selling prices were a result of an approximate 23% higher propane cost per gallon on average for the nine months ended June 30, 2005 compared to the same nine-month period in 2004 and the weather in our areas of operations was approximately 1% warmer in the nine months ended June 30, 2005 compared to the same period in 2004.

 

Wholesale gallons delivered during the nine months ended June 30, 2005 was 325.9 million gallons, as compared to 290.1 million gallons during the same nine-month period in 2004. This increase was primarily attributable to increased sales volumes and to a lesser extent, the acquisitions of Star Gas Propane, L.P., and one other retail propane company where wholesale volumes exist.

 

Revenues. Revenues in the nine months ended June 30, 2005 were $845.5 million, an increase of $465.1 million, or 122%, from $380.4 million during the same nine-month period in 2004.

 

Revenues from retail sales were $539.3 million in the nine months ended June 30, 2005 (after elimination of sales to our wholesale operations), an increase of $357.6 million, or 197%, compared to $181.7 million during the same nine-month period in 2004. Retail propane revenues accounted for approximately $278.7 million of this increase with approximately $277.4 million of this increase the result of the acquisition-related volume and an increase of approximately $28.2 million the result higher selling prices with these increases partially offset approximately $26.9 million from the lower sales volumes at our existing locations. In addition to retail propane sales, these revenues consist of transportation revenues, distillate sales, tank rentals, appliance sales and service income with these revenues increasing by approximately $78.9 million primarily due to acquisitions.

 

Revenues from wholesale sales were $306.2 million in the nine months ended June 30, 2005 (after elimination of sales to our retail operations), an increase of $107.5 million, or 54%, compared to $198.7 million during the same nine-month period in 2004. Approximately $54.7 million of this increase was attributable to the higher per gallon selling price of propane, due to its higher cost, an increase of approximately $14.8 million due to two retail acquisitions with wholesale operations, with the balance of the increase, approximately $38.0 million, the result of volume increases generated in our existing wholesale operations.

 

Cost of Product Sold. Retail cost of product sold in the nine months ended June 30, 2005 was $302.6 million, an increase of $211.5 million, or 232%, compared to $91.1 million during the same nine-month period in 2004. Approximately $150.4 million of this increase was attributable to acquisition-related retail propane sales. In addition, the higher average cost of propane resulted in increased cost of product of approximately $19.6 million partially offset by $13.1 million lesser cost of product as a result of the lower propane volume sales at our existing locations. Other retail cost of product sales increased as a result of acquisitions and were $59.6 million in the nine months ended

 

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June 30, 2005, an increase of $54.6 million compared to only $5.0 million in the prior year. The other retail cost of product sales is primarily distillate products which is substantially a result of the acquisition of Star Gas Propane, L.P. Wholesale cost of product sold in the nine months ended June 30, 2005 was $291.1 million, an increase of $106.3 million or 58%, from wholesale cost of product sold of $184.8 million during the same nine-month period in 2004. Approximately $54.8 million of this increase was primarily related to the increased average cost of propane in the nine months ended June 30, 2005, an increase of $13.5 million due to two retail acquisitions with wholesale operations, with the balance of the increase, approximately $38.0 million, the result of the increased volumes experienced in our wholesale operations. Our cost of product sold consists of tangible products sold including all propane and other natural gas liquids sold and all propane-related appliances sold. Other costs incurred in conjunction with the distribution of these products are included in operating and administrative expenses and consist primarily of wages to delivery personnel and delivery vehicle costs consisting of fuel costs, repair and maintenance and lease expense. These costs approximated $32.1 million and $16.5 million in the nine months ended June 30, 2005 and 2004, respectively. In addition, the depreciation expense associated with the delivery vehicles is reported within depreciation and amortization expense and amounted to $7.6 million and $3.3 million in the nine months ended June 30, 2005 and 2004, respectively. Since we include these costs in our operating and administrative expenses rather than in cost of product sold, our results may not be comparable to other entities in our lines of business.

 

Gross Profit. Retail gross profit was $236.7 million in the nine months ended June 30, 2005 compared to $90.6 million during the same nine-month period in 2004. This increase of approximately $146.1 million was primarily attributable to an increase of approximately $122.0 million in retail propane gross profit. This retail propane gross profit increase was the result of an increase in retail gallons sold as a result of acquisitions which accounted for approximately $127.0 million of the increase as well as an increase in margin per gallon at our existing locations which amounted to an increase of approximately $8.6 million. The volume decrease at our existing locations discussed above partially offset these increases by approximately $13.6 million. The remaining $24.1 million increase is a result of an increase in other retail product sales attributable to acquisitions. Wholesale gross profit was $15.1 and $13.8 million, respectively, (after elimination of gross profit attributable to our retail operations) in the nine months ended June 30, 2005 and 2004. This $1.3 million increase is primarily attributable to two retail acquisitions with wholesale operations as discussed above, and to a lesser extent, increased gross margin per gallon.

 

Operating and Administrative Expenses. Operating and administrative expenses increased to $146.1 million in the nine months ended June 30, 2005 as compared to $60.5 million in the same nine-month period in 2004. The increase in our operating and administrative expenses were attributable to increases in personnel expenses of $50.9 million, general operating expenses of $25.3 million including insurance, professional services and facility costs, and increased vehicle costs of $9.4 million resulting primarily from acquisitions.

 

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Depreciation and Amortization. Depreciation and amortization increased to $35.1 million in the nine months ended June 30, 2005 from $15.3 million during the same nine-month period in 2004 as a result of retail propane acquisitions.

 

Interest Expense. Interest expense increased to $23.0 million in the nine month period ended June 30, 2005 including amortization of deferred financing costs of $1.3 million as compared to $5.8 million during the same nine-month period in 2004 which included amortization of deferred financing costs of $1.2 million. Interest expense increased primarily due to an increase in the average debt outstanding including the additional financing related to the acquisition of Star Gas Propane, L.P. and higher average interest rates.

 

Make Whole Premium Charge, Write-off of Deferred Financing Costs, and Swap Value Received. In December 2004, a charge of $7.0 million was recorded as a result of the write-off of deferred financing costs associated with the repayment of the previously existing credit agreement and the 364-day facility. In January 2004, we repaid in full our $85.0 million senior secured notes before their scheduled maturity dates. As such, we were required to pay an additional amount of approximately $17.9 million as a make whole payment which was recorded as a charge to earnings in the quarter ended March 31, 2004. We used proceeds from our January 2004 common unit offering and borrowings from our bank credit facility for this repayment. In addition, we also recorded a charge to earnings of approximately $1.2 million in the quarter ended March 31, 2004, to write-off deferred financing costs associated with the senior secured notes. Partially offsetting these charges was a $0.9 million gain from the cancellation of interest rate swap agreements also associated with the Senior Notes.

 

Net Income. Net income increased to $41.8 million for the nine months ended June 30, 2005 from $5.0 million in the same nine-month period in 2004. The increase in net income was attributable to the increase in retail gross profit together with the non-recurrence of the make whole premium charge in the 2004 period, partially offset by increases in operating and administrative expenses, depreciation and amortization, and interest expense, all primarily the result of acquisitions.

 

EBITDA. For the nine months ended June 30, 2005, income before interest, taxes, depreciation and amortization was $107.3 million compared to $44.4 million during the same nine-month period in 2004. The increase was primarily attributable to increased sales volumes due to acquisitions partially offset by an increase in operating and administrative expenses. EBITDA is defined as income before taxes, plus net interest expense (inclusive of write-off of deferred financing costs) and depreciation and amortization expense. EBITDA should not be considered an alternative to net income, income before income taxes, cash flows from operating activities, or any other measure of financial performance calculated in accordance with generally accepted accounting principles as those items are used to measure operating performance, liquidity or ability to service debt obligations. We believe that EBITDA provides additional information for evaluating our ability to make the minimum quarterly distribution and is presented solely as a supplemental measure. EBITDA, as we define it, may not be comparable to EBITDA or similarly titled measures used by other corporations or partnerships.

 

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     Nine Months Ended
June 30,


 
     2005

   2004

 
     (in thousands)  

EBITDA:

               

Net income

   $ 41,842    $ 4,992  

Interest expense, net

     23,018      5,810  

Write-off of deferred financing costs

     6,990      1,216  

Make whole premium charge

     —        17,949  

Swap Value Received

     —        (949 )

Provision for income taxes

     358      164  

Depreciation and amortization

     35,094      15,267  
    

  


EBITDA

   $ 107,302    $ 44,449  
    

  


 

Liquidity and Sources of Capital

 

In December 2004, we issued 3,568,139 common units to unrelated third parties resulting in proceeds of $91.0 million. These proceeds were obtained to partially fund the acquisition of Star Gas Propane, L.P.

 

Also in December 2004, we issued 4,400,000 common units in a public offering, resulting in proceeds of $121.3 million, net of underwriter’s discount, commission, and offering expenses. These funds were used to repay borrowings under our credit agreement.

 

In January 2005, the underwriters of the December 2004 4,400,000 common unit offering exercised their over-allotment provision and we issued 660,000 common units in a follow-on offering, resulting in proceeds of approximately $17.9 million, net of underwriters’ discounts, commissions, and offering expenses. These funds were used to repay borrowings under our credit agreement.

 

Cash flows provided by operating activities of $80.0 million in the nine months ended June 30, 2005 consisted primarily of: net income of $41.8 million, net non-cash charges of $45.5 million relating to depreciation and amortization of $35.1 million, $7.0 million in write-offs of deferred financing costs related to the repayment of the previously existing credit agreement and 364-day credit facility and $3.4 million of other non-cash charges; and a decrease in cash flows of $7.3 million associated with the changes in operating assets and liabilities, including net liabilities from price risk management activities. The cash used in the changes in operating assets and liabilities is primarily due to an increase in accounts receivable and inventories due to acquisition-related growth, the seasonal nature of the business and increased wholesale volumes, an increase in net assets from price risk management activities, offset by a decrease in customer deposits as a result of acquisition-related activity and a decrease in accounts payable due to greater propane purchases due to increased size. Cash flows provided by operating activities of $49.6 million in the same nine-month period in 2004 consisted primarily of: net income of $5.0 million, net non-cash charges of $36.2 million relating to depreciation and amortization of $15.3 million, a make whole premium charge of $17.9 million associated with the early repayment of the senior secured notes and other net non-cash charges of $3.0 million; and an increase in cash flows of $8.4 million associated with the changes in operating assets and liabilities, including net liabilities from price risk management activities. The source of cash associated with the changes in operating assets and liabilities is primarily due to an increase in accounts payable and a reduction in inventory, partially offset

 

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by an increase in accounts receivable and prepaid expenses and other current assets, and a decrease in customer deposits. These changes are attributable to the seasonal nature of the business and our retail and wholesale growth.

 

Cash used in investing activities was $611.6 million in the nine months ended June 30, 2005 as compared to $65.1 million in the same nine-month period in 2004. The nine months ended June 30, 2005 investing activities included a use of cash of $588.9 million, net of cash acquired for the acquisition of three retail propane companies, including Star Gas Propane, L.P. Investing activities during the same nine-month period in 2004 included a use of cash of $56.7 million for the acquisitions of EOTT Energy, L.P.’s west coast NGL business and fourteen retail propane companies. Additionally, in the nine months ended June 30, 2005 and 2004, we expended $25.0 million and $10.0 million, respectively for additions of property, plant and equipment to accommodate our growing operations, and we expended $0.4 million and less than $0.1 million for deferred acquisition costs for prospective acquisitions. Proceeds from sale of property, plant and equipment of $2.7 million and $1.6 million were received in the nine months ended June 30, 2005 and 2004, respectively.

 

Cash provided by financing activities was $550.4 million in the nine months ended June 30, 2005 and $20.1 million in the same nine-month period in 2004. Cash provided (used) by financing activities in the nine months ended June 30, 2005 and the nine months ended June 30, 2004 included net borrowings of $391.0 million and net payments of $(19.0) million, respectively, under debt agreements, including borrowings and repayments of our revolving working capital and acquisition credit facility and the issuance of our senior unsecured notes. In addition, net proceeds were received from the issuance of common units of $230.1 million, and $83.3 million in the nine months ended June 30, 2005 and 2004, respectively. Contributions from non-managing general partner of $1.8 million were received in the nine months ended June 30, 2004. Offsetting these cash sources were $47.9 million and $27.2 million of distributions in the nine months ended June 30, 2005 and 2004, respectively. Deferred financing costs of $22.8 million and $0.9 million were incurred in the nine months ended June 30, 2005 and the nine months ended June 30, 2004, respectively, related to debt incurred to complete the acquisitions. Additionally, in the nine months ended June 30, 2004, the early repayment of our senior secured notes resulted in a make whole premium payment to the lenders in the amount of $17.9 million.

 

The following table summarizes our long-term debt and operating lease obligations as of June 30, 2005 in thousands of dollars:

 

     Total

   Less than
1 year


   1-3 years

   4-5 years

   After
5 years


Aggregate amount of principal and interest to be paid on the outstanding long-term debt

   $ 856,159    $ 42,336    $ 75,120    $ 166,314    $ 572,389

Future minimum lease payments under noncancelable operating leases

     16,474      5,520      6,295      2,723      1,936

Standby letters of credit

     14,460      11,586      2,174      700      —  

 

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The following table summarizes the change in the unrealized fair value of our energy contracts related to our risk management activities for the nine months ended June 30, 2005 and the same nine-month period in 2004 where settlement has not yet occurred (in thousands of dollars):

 

     Nine Months Ended

 
     June 30, 2005

    June 30, 2004

 

Net unrealized gains and (losses) in fair value of contracts outstanding at beginning of period

   $ (6,626 )   $ 3,104  

Initial recorded value of new contracts entered into during the period

     —         2,723  

Net unrealized gain/(loss) acquired through acquisition during the period

     1,881       —    

Change in fair value of contracts attributable to market movement during the year

     9,627       (4,054 )

Realized (gains)/losses recognized

     (2,655 )     907  
    


 


Net unrealized gains in fair value of contracts outstanding at June 30, 2005

   $ 2,227     $ 2,680  
    


 


 

Of the outstanding unrealized gain as of June 30, 2005, all contracts had a maturity of less than one year.

 

We believe that anticipated cash from operations and borrowings under our amended and restated credit facility will be sufficient to meet our liquidity needs for the foreseeable future. If our plans or assumptions change or are inaccurate, or we make any acquisitions, we may need to raise additional capital. We may not be able to raise additional funds or may not be able to raise such funds on favorable terms.

 

Seasonality

 

The retail market for propane is seasonal because it is used primarily for heating in residential and commercial buildings. Approximately three-quarters of our retail propane volume is sold during the peak heating season from October through March. Consequently, sales and operating profits are generated mostly in the first and fourth calendar quarters of each year.

 

Description of Credit Facility

 

Effective in December 2004, we executed a new credit agreement with our existing lenders in addition to others. The credit agreement consists of a $250.0 million revolving acquisition facility and a $75.0 million working capital facility. We have the option to use up to $25.0 million of available borrowing capacity from our revolving acquisition facility for working capital purposes. The credit agreement expires in December 2009 and carries terms, conditions, and covenants substantially similar to the previous credit agreement as described in the Form 10-K for the year ended September 30, 2004. The credit agreement is guaranteed by all of our domestic subsidiaries.

 

This credit agreement accrues interest at either prime rate or Eurodollar plus applicable spreads, resulting in interest rates of 5.76% to 7.25% at June 30, 2005. At June 30, 2005, borrowings outstanding under the credit facility were $100.8 million, including $8.5 million outstanding under the revolving

 

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working capital facility. Of the entire outstanding credit facility balance of $100.8 million, $97.3 million is classified as long term in the accompanying June 30, 2005 consolidated balance sheet.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

Interest Rate Risk

 

We have long-term debt and a revolving line of credit subject to the risk of loss associated with movements in interest rates. At June 30, 2005, we had floating rate obligations totaling approximately $100.8 million for amounts borrowed under our credit agreement and an additional $100.0 million of floating rate obligations as a result of interest rate swap agreements as discussed below.

 

In the quarter ending March 2005, we entered into four interest rate swap agreements scheduled to mature in December 2014, each designed to hedge $25 million in underlying fixed rate senior unsecured notes, in order to manage interest rate risk exposure. These swap agreements, which expire on the same date as the maturity date of the related senior unsecured notes and contain call provisions consistent with the underlying senior unsecured notes, require the counterparty to pay us an amount based on the stated fixed interest rate on the notes due every six months. In exchange, we are required to make semi-annual floating interest rate payments on the same dates to the counterparty based on an annual interest rate equal to the 6 month LIBOR interest rate plus spreads between 1.95% and 2.20% applied to the same notional amount of $100 million. The swap agreements have been recognized as fair value hedges. Amounts to be received or paid under the agreements are accrued and recognized over the life of the agreements as an adjustment to interest expense. We recognized the approximate $0.8 million increase in the fair market value of the related senior unsecured notes at June 30, 2005 with a corresponding increase in the fair value of its interest rate swaps, which are recorded in other assets.

 

If the floating rate were to increase by 100 basis points from June 2005 levels, our interest expense would increase by a total of approximately $2.0 million per year.

 

Commodity Price, Market and Credit Risk

 

Inherent in our contractual portfolio are certain business risks, including market risk and credit risk. Market risk is the risk that the value of the portfolio will change, either favorably or unfavorably, in response to changing market conditions. Credit risk is the risk of loss from nonperformance by suppliers, customers or financial counterparties to a contract. We take an active role in managing and controlling market and credit risk and have established control procedures, which are reviewed on an ongoing basis. We monitor market risk through a variety of techniques, including daily reporting of the portfolio’s position to senior management. We attempt to minimize credit risk exposure through credit policies and periodic monitoring procedures. The counterparties associated with assets from price risk management activities as of June 30, 2005 and 2004 were propane retailers, resellers, energy marketers and dealers.

 

The propane industry is a “margin-based” business in which gross profits depend on the excess of sales prices over supply costs. As a result, our profitability will be sensitive to changes in wholesale prices of propane caused by changes in supply or other market conditions. When there are sudden and sharp increases in the wholesale cost of propane, we may not be able to pass on these increases to our customers through retail or wholesale prices. Propane is a commodity and the price we pay for it can

 

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fluctuate significantly in response to supply or other market conditions. We have no control over supply or market conditions. In addition, the timing of cost pass-throughs can significantly affect margins. Sudden and extended wholesale price increases could reduce our gross profits and could, if continued over an extended period of time, reduce demand by encouraging our retail customers to conserve or convert to alternative energy sources.

 

We engage in hedging transactions, including various types of forward contracts, options, swaps and future contracts, to reduce the effect of price volatility on our product costs, protect the value of our inventory positions, and to help ensure the availability of propane during periods of short supply. We attempt to balance our contractual portfolio by purchasing volumes only when we have a matching purchase commitment from our wholesale customers. However, we may experience net unbalanced positions from time to time which we believe to be immaterial in amount. In addition to our ongoing policy to maintain a balanced position, for accounting purposes we are required, on an ongoing basis, to track and report the market value of our purchase obligations and our sales commitments.

 

Notional Amounts and Terms

 

The notional amounts and terms of these financial instruments as of June 30, 2005 and September 30, 2004 include fixed price payor for 8.8 million and 4.9 million barrels of propane, respectively, and fixed price receiver for 9.6 million and 6.5 million barrels of propane, respectively. Notional amounts reflect the volume of transactions, but do not represent the amounts exchanged by the parties to the financial instruments. Accordingly, notional amounts do not accurately measure our exposure to market or credit risks.

 

Fair Value

 

The fair value of the derivative financial instruments related to price risk management activities as of June 30, 2005, and September 30, 2004 was assets of $6.7 million and $23.0 million, respectively, and liabilities of $4.5 million and $29.6 million, respectively. All intercompany transactions have been appropriately eliminated. The market prices used to value these transactions reflect management’s best estimate considering various factors including closing exchange and over-the-counter quotations, recent transactions, time value and volatility factors underlying the commitments.

 

Sensitivity Analysis

 

A theoretical change of 10% in the underlying commodity value would result in a change of approximately $0.2 million in the market value of the contracts as there were approximately 2.7 million gallons of net unbalanced positions at June 30, 2005.

 

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Item 4. Controls and Procedures

 

We maintain controls and procedures designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified by the rules and forms of the SEC, and that information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. An evaluation was performed under the supervision and with the participation of our management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as such terms are defined in Rule 13a-15(e) and 15d-15(e) of the Exchange Act). Based upon that evaluation, management, including the Chief Executive Officer and the Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were adequate and effective as of June 30, 2005. There have been no change in the Company’s internal controls over financial reporting (as defined in Rule 13(e)-15 or Rule 15d-15(f) of the Exchange Act) or in other factors during the fiscal quarter covered by this report that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting, and there have been no corrective actions with respect to significant deficiencies and material weaknesses in our internal controls.

 

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PART II — OTHER INFORMATION

 

Item 1. Legal Proceedings

 

A federal securities class action was filed in October 2004 against Star Gas Partners, L.P. and certain of its executive officers (“Star Defendants”) in the United States District Court for the District of Connecticut. The allegations are that Star Gas Defendants purportedly violated Section 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and Securities and Exchange Commission Rule 10b-5. Following the initiation of this claim, 17 additional class action complaints were filed including White v. Star Gas, et al,, which was filed in October 2004 in the United States District Court for the District of Connecticut. Star Gas Propane, L.P. was named as a defendant in the White case. The Court ruled on April 8, 2005 that the cases should be consolidated and it appointed lead counsel to prepare a Consolidated Amended Complaint. On June 20, 2005 the Consolidated Amended Complaint was filed. The Consolidated Amended Complaint did not name Star Gas Propane, L.P. as a defendant.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

None.

 

Item 3. Defaults Upon Senior Securities

 

None.

 

Item 4. Submission of Matters to a Vote of Security Holders

 

None.

 

Item 5. Other Information

 

None.

 

Item 6. Exhibits

 

31.1    Certification of Chief Executive Officer of Inergy, L.P. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2    Certification of Chief Financial Officer of Inergy, L.P. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1    Certification of Chief Executive Officer of Inergy, L.P. 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 Chief Financial Officer of Inergy, L.P. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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SIGNATURE

 

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.

 

        INERGY, L.P.
            By:  

INERGY GP, LLC

               

(its managing general partner)

Date: August 9, 2005       By:  

/s/ R. Brooks Sherman, Jr.

               

R. Brooks Sherman, Jr.

                Senior Vice President and Chief Financial Officer
                (Principal Financial Officer and Principal
                Accounting Officer)

 

41

Computation of Earnings to Fixed Charges

Exhibit 12.1

 

Inergy, L.P. and Subsidiary

Computation of Earnings to Fixed Charges

(In Thousands)

 

     Three Months Ended

    Nine Months Ended

 
     6/30/2005

    6/30/2004

    6/30/2005

   6/30/2004

 

Earnings:

                               

Net income (loss)

   $ (24,118 )   $ (9,800 )   $ 41,842    $ 4,992  

Income taxes

     24       113       358      164  

Interest expense

     9,144       1,443       23,018      5,810  

Interest expense related to write-off of deferred financing costs

     —         —         6,990      1,216  

Interest expense related to make whole premium charge

     —         —         —        17,949  

Interest income related to swap value received

     —         —         —        (949 )

Interest portion of operating leases

     751       415       2,090      1,096  
    


 


 

  


Earnings for ratio calculation

   $ (14,199 )   $ (7,829 )   $ 74,298    $ 30,278  
    


 


 

  


Fixed charges:

                               

Interest expense

   $ 9,144     $ 1,443     $ 23,018    $ 5,810  

Interest expense related to write-off of deferred financing costs

     —         —         6,990      1,216  

Interest expense related to make whole premium charge

     —         —         —        17,949  

Interest income related to swap value received

     —         —         —        (949 )

Interest portion of operating leases

     751       415       2,090      1,096  
    


 


 

  


Total fixed charges

   $ 9,895     $ 1,858     $ 32,098    $ 25,122  
    


 


 

  


Ratio of earnings to fixed charges

     n/a       n/a       2.31      1.21  
    


 


 

  


 

For purposes of determining the ratio of earnings to fixed charges, earnings are defined as earnings (loss) from continuing operations before income taxes, plus fixed charges. Fixed charges consist of interest expense on all indebtedness, the amortization of deferred financing costs, interest expense related to the write-off of deferred financing costs and interest associated with operating losses. Earnings were inadequate to cover fixed charges by $24.1 million for the three months ended June 30, 2005 and $9.7 million for the three months ended June 30, 2004.

Section 302 CEO Certification

Exhibit 31.1

 

CERTIFICATIONS

 

I, John J. Sherman, certify that:

 

1. I have reviewed this Quarterly report on Form 10-Q of Inergy, L.P.;

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

 

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

 

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: August 9, 2005

 

/s/ John J. Sherman

John J. Sherman

President and Chief Executive Officer

Section 302 CFO Certification

Exhibit 31.2

 

CERTIFICATIONS

 

I, R. Brooks Sherman, Jr., certify that:

 

1. I have reviewed this Quarterly report on Form 10-Q of Inergy, L.P.;

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

 

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

 

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: August 9, 2005

 

/s/ R. Brooks Sherman, Jr.

R. Brooks Sherman, Jr.

Senior Vice President and Chief Financial Officer

Section 906 CEO Certification

Exhibit 32.1

 

Certification of the Chief Executive Officer

 

Pursuant to 18 U.S.C. Section 1350

 

As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

In connection with the Quarterly Report of Inergy, L.P. (the “Company”) on Form 10-Q for the period ended June 30, 2005 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, John J. Sherman, Chief Executive Officer of Inergy, L.P., certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

 

  (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

  (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

/s/ John J. Sherman

John J. Sherman

Chief Executive Officer

August 9, 2005

 

A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.

Section 906 CFO Certification

Exhibit 32.2

 

Certification of the Chief Executive Officer

 

Pursuant to 18 U.S.C. Section 1350

 

As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

In connection with the Quarterly Report of Inergy, L.P. (the “Company”) on Form 10-Q for the period ended June 30, 2005 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, R. Brooks Sherman, Jr., Chief Financial Officer of Inergy, L.P., certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

 

  (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

  (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

/s/ R. Brooks Sherman, Jr.

R. Brooks Sherman, Jr.

Chief Financial Officer

August 9, 2005

 

A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.