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NRGY > SEC Filings for NRGY > Form 10-Q on 9-Aug-2011All Recent SEC Filings

Show all filings for INERGY L P

Form 10-Q for INERGY L P


9-Aug-2011

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

"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 of Inergy, L.P. for the fiscal year ended September 30, 2010.

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 ("Reform Act"). Such forward-looking statements include, but are not limited to, statements that: (i) the North/South Pipeline project is expected to have firm transportation capacity of 325,000 dekatherms per day and the Finger Lakes LPG expansion project is expected to convert certain of the US Salt caverns into LPG storage with a capacity of up to 5 million barrels, (ii) management believes that Inergy does not have material potential liability in connection with the unitholder class action lawsuits that would have a significant financial impact on its consolidated financial condition, results of operations or cash flows,
(iii) we believe that volatility in commodity prices will continue, and our ability to adjust to and manage our operations in response to this volatility may impact our operations and financial results, (iv) we believe that the economic downturn that began in the second half of 2008 has caused certain of our retail propane customers to conserve and thereby purchase less propane,
(v) we believe our midstream operations could be negatively affected in the long term by sustained downturns or sluggishness in the economy, which could affect long-term demand and market prices for natural gas and NGLs, (vi) we anticipate completion of our announced midstream capital expansion projects at various times in 2011 and 2012, and (vii) 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 protections 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 growing retail and wholesale propane supply, marketing and distribution business. We also own and operate a growing midstream business that includes five natural gas storage facilities ("Stagecoach", "Thomas Corners", "Steuben", "Seneca Lake" and "Tres Palacios"), a liquefied petroleum gas ("LPG") storage facility ("Finger Lakes LPG"), a natural gas liquids ("NGL") business and a solution-mining and salt production company ("US Salt"). We further intend to pursue our growth objectives in the propane and midstream business through, among other things, future acquisitions. Our propane acquisition strategy focuses on propane companies that meet our acquisition criteria, including targeting acquisition prospects that maintain a high percentage of retail sales to residential customers, operating in attractive markets and focusing our operations under established and locally recognized trade names. Our midstream growth objectives focus both on organically expanding our existing assets and acquiring future operations that leverage our existing operating platform, produce predominantly fee-based cash flow characteristics and have future organic or commercial expansion characteristics.

Both of our operating segments, propane and midstream, are supported by business development personnel groups. These groups' daily responsibilities include research, sourcing, financial analysis and due diligence of potential acquisition targets and organic growth opportunities. These employees work closely with the operators of both of our segments in the course of their work to ensure the appropriate growth opportunities are pursued.


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We have grown primarily through acquisitions. Since the inception of our predecessor in November 1996 through June 30, 2011, we have acquired 89 companies, including 82 retail propane companies and 7 midstream businesses, for an aggregate purchase price of approximately $2.9 billion, including working capital, assumed liabilities and acquisition costs.

On October 14, 2010, we completed the acquisition of Tres Palacios Gas Storage LLC ("Tres Palacios"), which owns and operates a natural gas storage facility located in Matagorda County, Texas. Tres Palacios leases the surface and subsurface rights necessary to operate and expand the storage facility under an operating lease that expires on December 31, 2037, which is subject to automatic renewal for two 20-year extension periods unless Tres Palacios elects not to extend the term of the lease. The lease payments vary based on the FERC-certificated working gas capacity of the caverns which are in service as well as an incremental payment for physical volumes of gas injected and / or withdrawn from the caverns in service. Based on our current estimates, which assumes cavern 4 will be in service during the second fiscal quarter of 2014, we anticipate that the contractual obligation as of June 30, 2011, to be the following (in millions, excluding the above mentioned incremental payments as future volumes are currently unknown):

Total Less than 1 year 1-3 years 4-5 years After 5 years $ 406.7 $ 11.4 $ 24.5 $ 31.3 $ 339.5

On October 19, 2010, we completed the acquisition of the propane assets of Schenck Gas Services, LLC ("Schenck"), located in East Hampton, New York. On November 15, 2010, we completed the acquisition of the propane assets of Pennington Energy Corporation ("Pennington"), headquartered in Morenci, Michigan. Most recently, on July 13, 2011, we acquired the Seneca Lake natural gas storage facility and two related pipeline laterals from NYSEG.

The purchase price allocations for these acquisitions have been prepared on a preliminary basis pending final asset valuation and asset rationalization, and changes are expected when additional information becomes available. Changes to final asset valuation of prior fiscal year acquisitions have been included in our consolidated financial statements but are not material.

The retail propane distribution business is largely seasonal due to propane's primary use as a heating source in residential and commercial buildings. As a result, cash flows from operations are generally highest from November through April when customers pay for propane purchased during the six-month peak heating season of October through March.

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 of October through March, have a significant effect on our financial performance. 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 how weather impacts 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). While a substantial portion of our propane is used by our customers for heating needs, our propane operations are geographically diversified and not all of our propane sales are weather sensitive. Together, these factors may make it difficult to draw definitive conclusions as to the correlation of our gallon sales to weather calculations comparing weather in a year to normal or to the prior year.

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 costs. Propane prices continued to be volatile during 2010 and thus far in 2011. At the main pricing hub of Mount Belvieu, Texas ("Mt. Belvieu Price") during the three-month period ended June 30, 2011, the average Mt. Belvieu Price was $1.50 with prices ranging from a low of $1.38 per gallon to a high of $1.62 per gallon and a price of $1.49 per gallon at June 30, 2011. During the nine-month period ended June 30, 2011, the average propane price was $1.38 with propane prices ranging from a low of $1.17 per gallon to a high of $2.29 per gallon. Further the average Mt. Belvieu Price in our fiscal years of 2008, 2009 and 2010 was $1.59, $0.77 and $1.12 per gallon, respectively. Our ability to pass on price increases to our customers and our hedging program has historically limited the impact that such volatility has had on our results from operations and we will continue to hedge virtually 100% of our exposure from fixed prices; however, those higher propane costs have led to higher selling prices by us and have negatively impacted our volume sales and may continue to do so in the future for reasons discussed below. While we have historically been successful in passing on any price increases to our customers, there can be no guarantees that this trend


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will continue in the future. In periods of increasing propane costs, we have experienced a decline in our gross profit as a percentage of revenues. In addition, during those periods we have historically experienced conservation of propane gallons used by our customers in addition to lesser gallon sales as a result of customers switching to lower price propane providers as well as alternative energy sources, all of which has resulted in a decline in gross profit. These trends generally increase in periods of sustained cost increases such as we have experienced thus far in fiscal 2011. Further, improved technology in new appliances, including those using propane, has resulted in fewer gallons of propane used by our customers for their needs thus resulting in lesser gallon sales for us. In periods of decreasing costs, we have experienced an increase in our gross profit as a percentage of revenues. There is no assurance that because propane prices decline customers will use more propane and thus historical gallon sales declines we've attributed to customer conservation and losses will reverse. Propane is a by-product of both crude oil refining and natural gas processing and thus typically follows the same pricing pattern as these two commodities with crude oil pricing being the more influential of the two historically. The prices of crude oil and natural gas had maintained historically high costs in calendar years 2007 and 2008 before both began to fall rather dramatically in late 2008 and throughout the 2008-2009 winter season. While natural gas pricing has remained at historically low levels since this decline, crude oil costs leveled off in the spring of 2009 before beginning another increase that persisted through both winter seasons of 2009-2010 and 2010-2011 with propane prices following a similar pattern for the majority of this time. As such, our selling prices of propane have been at higher levels in order to attempt to maintain our historical gross margin per gallon with these higher prices negatively impacting our volume sales for the reasons discussed above. We do not attempt to predict the underlying commodity prices; however, we monitor these prices daily and adjust our operations and retail prices to maintain expected margins by passing on the wholesale costs to end users of our product. We believe that volatility in commodity prices will continue, and our ability to adjust to and manage our operations in response to this volatility may impact our operations and financial results.

We believe that the economic downturn that began in the second half of 2008 has caused certain of our retail propane customers to conserve and thereby purchase less propane and in some instances shop for lower prices that may be available from other suppliers or shop for alternative energy sources to replace some or all of their propane usage. This trend is expected to continue throughout the life of the economic downturn. In addition, although we believe the economic downturn has not currently had a material impact on our cash collections, it is possible that a prolonged economic downturn could have a negative impact on our future cash collections.

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, including:

forward contracts involving the physical delivery of propane;

swap agreements which requires payments to (or receipt of payments from) counterparties based on the differential between a fixed and variable price for propane; and

options, futures contracts on the New York Mercantile Exchange and other contractual arrangements.

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. 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.

Our midstream operations primarily include the storage, processing, fractionation and sale of natural gas and NGLs and, to a lesser extent, the wholesale distribution of salt from solution mining operations of US Salt. The cash flows from these operations are predominantly fee-based under one to ten year contracts with substantial, creditworthy counterparties and, therefore, are generally economically stable and not significantly affected in the short term by changing commodity prices, seasonality or weather fluctuations.

The majority of our operating cash flows in our midstream operations are generated by our natural gas storage operations. Most of our natural gas storage revenues are based on regulated market-based tariff rates, which are driven in large part by competition and demand for our storage capacity and deliverability. Demand for storage in our key midstream market in the northeastern United States is projected to continue to be strong, driven by a shortage in storage capacity and a higher than average annual growth in natural gas demand. This demand growth is primarily driven by the natural gas-fired


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electric generation sector and conversion from petroleum based fuels. Demand for storage in Texas is expected to strengthen driven primarily by growth in natural gas fired generation and increasing gas supplies from growing shale developments such as the Eagle Ford shale. Demand for storage can be negatively impacted during periods in which there is a narrow seasonal spread between current and future natural gas prices. The natural gas industry is currently experiencing a significant shift in the sources of supply, and this dramatic change could affect our operations.

We believe our midstream operations could be negatively affected in the long term by sustained downturns or sluggishness in the economy, which could affect long-term demand and market prices for natural gas and NGLs, all of which are beyond our control and could impair our ability to meet our long-term goals. However, we also believe that the contractual fee-based nature of our midstream operations may serve to mitigate this potential risk.

Traditionally, supply to our markets has come from the Gulf Coast region, onshore and offshore, as well as from Canada. The national supply profile is shifting to new sources of natural gas from basins in the Rockies, Mid-Continent, Appalachia and East Texas. In addition, the natural gas supply outlook includes new LNG regasification facilities under various stages of development in multiple locations. LNG can be a new source of potential supply, but the timing and extent of incremental supply ultimately realized from LNG is yet to be determined and, at present, LNG remains a small percentage of the overall supply to the markets we serve. These supply shifts and other changes to the natural gas market may have an impact on our storage operations and our development plans and may ultimately drive the need for more domestic capacity for natural gas storage.

Currently, we have three significant capital projects related to our midstream operations: (1) Finger Lakes LPG storage expansion, (2) North/South Pipeline Project and (3) MARC I Hub Line Project. The Finger Lakes LPG storage expansion project relates to the development of certain caverns acquired in the acquisition of US Salt in August 2008. The solution mining process creates caverns that can be developed into LPG or natural gas storage after the salt has been extracted. The Finger Lakes LPG expansion project, which is located in Watkins Glenn, New York, is expected to convert certain of the caverns at US Salt into LPG storage with a capacity of up to 5 million barrels. While we anticipate completion of this project in the first half of fiscal 2012, this completion continues to be pending regulatory approval, which approval progress thus far has been slow so there can be no assurance this completion date will be met.

The North/South Pipeline Project consists of adding additional compression and measurement facilities to our existing Stagecoach Laterals and when completed is expected to have firm transportation capacity of 325,000 dekatherms per day. We received the FERC approvals required for the project in January 2011, and commenced construction in February. The North/South Project is supported by long-term contracts and is expected to be placed into service by late 2011.

The MARC I Hub Line Project is a 40 mile, 30" bi-directional pipeline located in Bradford, Sullivan, and Lycoming counties in Pennsylvania. The planned pipeline will extend between our Stagecoach South Lateral interconnect with Tennessee Gas Pipeline Company's ("TGP") 300 Line near its compressor station 319 and Transco's Leidy Line near its compressor station 517. The MARC I Hub Line Project is expected to have a minimum of 550,000 dekatherms per day of firm transportation capacity. The FERC issued an Environmental Assessment of the project on May 27, 2011 (including a recommendation that an order authorizing the project contain a "finding of no significant impact"), and the company and various interveners have filed comments in response to the EA. We expect the MARC I Hub Line Project to be placed into service in mid-2012.

Our MARC I Hub Line Project and the North/South Project, when placed into service, will allow us to wheel volumes on a firm transportation basis through approximately 75 miles of pipe to and from TPG's 300 Line, Transco's Leidy Line and the Millennium Pipeline and all points in between. The two projects combined are expected to add over 55,000 horsepower of additional compression and 875,000 dekatherms per day of transportation capacity to our midstream business in the Northeast.

In connection with the Seneca Lake acquisition, ASC has filed an application and reservoir suitability report with the New York State Department of Environmental Conservation, in which ASC requests approval to expand the Seneca Lake gas storage facility to add 595,800 Mcf of additional working gas capacity.

As we execute on our strategic objectives, capital expansion projects will continue to be an important part of our growth plan. We have committed capital and investment expenditures at June 30, 2011, of approximately $60.2 million in our midstream operations. These capital requirements, along with the refinancings of normal maturities of existing debt, will


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require us to continue long-term borrowings. An inability to access capital at competitive rates could adversely affect our ability to implement our strategy. Market disruptions or a downgrade in our credit ratings may increase the cost of borrowing or adversely affect our ability to access one or more sources of liquidity. During the past several years, capital expansion projects have been exposed to cost pressures associated with the availability of skilled labor and the pricing of materials. Although certain costs have begun to decrease, there will be continual focus on project management activities to address these pressures as we move forward with planned expansion opportunities. Significant cost increases could negatively affect the returns ultimately earned on current and future expansions.

Our midstream operations in the United States are subject to regulations at the federal and state level. Regulations applicable to the gas and NGL storage industries have a significant effect on the nature of our midstream operations and the manner in which they operate. Changes to regulations are ongoing and we cannot predict the future course of changes in the regulatory environment or the ultimate effect that any future changes will have on our midstream operations.

Results of Operations

Three Months Ended June 30, 2011 Compared to Three Months Ended June 30, 2010

The following table summarizes the consolidated statement of operations
components for the three months ended June 30, 2011 and 2010, respectively (in
millions):



                                                Three Months Ended
                                                     June 30,                            Change
                                               2011             2010          In Dollars        Percentage
Revenue                                     $    388.7       $    291.6      $       97.1              33.3 %
Cost of product sold                             271.7            187.1              84.6              45.2

Gross profit                                     117.0            104.5              12.5              12.0
Operating and administrative expenses             77.4             75.3               2.1               2.8
Depreciation and amortization                     48.0             40.5               7.5              18.5
Loss on disposal of assets                         0.5              2.1              (1.6 )           (76.2 )

Operating loss                                    (8.9 )          (13.4 )             4.5              33.6
Interest expense, net                            (27.2 )          (23.1 )            (4.1 )           (17.7 )
Early extinguishment of debt                      (0.2 )             -               (0.2 )               *
Other income                                       1.1              0.8               0.3              37.5

Loss before income taxes                         (35.2 )          (35.7 )             0.5               1.4
Benefit (provision) for income taxes              (0.3 )            0.6              (0.9 )          (150.0 )

Net loss                                         (35.5 )          (35.1 )            (0.4 )            (1.1 )
Net loss attributable to non-controlling
partners                                            -              47.5             (47.5 )               *

Net income (loss) attributable to
partners                                    $    (35.5 )     $     12.4      $      (47.9 )           386.3 %

* Not meaningful

The following table summarizes revenues, including associated volume of gallons sold, for the three months ended June 30, 2011 and 2010, respectively (in millions):

                                                              Revenues                                                      Gallons
                                          Three Months Ended                                            Three Months Ended
                                               June 30,                       Change                         June 30,                       Change
                                         2011            2010        In Dollars       Percent          2011            2010         In Units       Percent
Propane
Retail propane                        $    120.1      $    104.3     $      15.8          15.1 %          45.7            45.0            0.7           1.6 %
Wholesale propane                          100.3            63.5            36.8          58.0            66.6            57.1            9.5          16.6
Other retail                                43.0            38.3             4.7          12.3              -               -              -             -
Midstream                                  125.3            85.5            39.8          46.5              -               -              -             -

Total                                 $    388.7      $    291.6     $      97.1          33.3 %         112.3           102.1           10.2          10.0 %


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Volume. During the three months ended June 30, 2011, we sold 45.7 million retail gallons of propane, an increase of 0.7 million gallons or 1.6% from the 45.0 million retail gallons sold during the same three-month period in 2010. Gallons sold during the three months ended June 30, 2011, increased slightly as compared to the same prior year period as a result of acquisition-related volume of 1.5 million gallons, partially offset by lower volumes sold at our existing locations of 0.8 million gallons. During the three months ended June 30, 2011, we believe that retail propane gallon sales were impacted by several ongoing factors, including most notably customer conservation and high commodity prices.

Wholesale gallons delivered increased 9.5 million gallons, or 16.6%, to 66.6 million gallons in the three months ended June 30, 2011, from 57.1 million gallons in the three months ended June 30, 2010. The increase was due primarily to higher demand and volumes sold to existing and new customers.

The total natural gas liquid gallons sold or processed by our West Coast NGL operations increased 8.5 million gallons, or 9.9%, to 94.2 million gallons during the three months ended June 30, 2011, from 85.7 million gallons during the same three-month period in 2010. This increase was primarily attributable to . . .

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