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

Show all filings for INERGY L P

Form 10-Q for INERGY L P


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 the Finger Lake LPG expansion project in the first half of fiscal 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.


We are a growing retail and wholesale propane supply, marketing and distribution business. We also own and operate a growing midstream business that includes four natural gas storage facilities ("Stagecoach", "Thomas Corners", "Steuben" 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 March 31, 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 March 31, 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 $ - $ 22.8 $ 28.2 $ 355.7

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.

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 March 31, 2011, the average Mt. Belvieu Price was $1.40 with prices ranging from a low of $1.31 per gallon to a high of $2.29 per gallon and a price of $1.37 per gallon at March 31, 2011. During the six-month period ended March 31, 2011, the average propane price was $1.33 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 will continue in the future. In periods of increasing propane costs, we have experienced a decline in our gross profit

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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.

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.

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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 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.

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") 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. 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 45,000 horsepower of additional compression and 875,000 dekatherms per day of transportation capacity to our midstream business in the Northeast.

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 March 31, 2011, of approximately $85.2 million in our midstream operations. These capital requirements, along with the refinancings of normal maturities of existing debt, will 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.

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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 March 31, 2011 Compared to Three Months Ended March 31, 2010

The following table summarizes the consolidated statement of operations
components for the three months ended March 31, 2011 and 2010, respectively (in

                                               Three Months Ended
                                                    March 31,                            Change
                                             2011              2010           In Dollars         Percentage
Revenue                                    $   720.5        $    691.1       $       29.4                4.3 %
Cost of product sold                           477.7             451.4               26.3                5.8

Gross profit                                   242.8             239.7                3.1                1.3
Operating and administrative expenses           81.7              87.2               (5.5 )             (6.3 )
Depreciation and amortization                   47.4              40.1                7.3               18.2
Loss on disposal of assets                       0.3               1.7               (1.4 )            (82.4 )

Operating income                               113.4             110.7                2.7                2.4
Interest expense, net                          (27.2 )           (23.0 )             (4.2 )            (18.3 )
Early extinguishment of debt                   (49.4 )              -               (49.4 )                *
Other income                                      -                0.1               (0.1 )                *

Income before income taxes                      36.8              87.8              (51.0 )            (58.1 )
Provision for income taxes                       0.2               0.6               (0.4 )            (66.7 )

Net income                                      36.6              87.2              (50.6 )            (58.0 )
Net income attributable to
non-controlling partners                          -              (65.9 )             65.9                  *

Net income attributable to partners        $    36.6        $     21.3       $       15.3               71.8 %

* Not meaningful

The following table summarizes revenues, including associated volume of gallons sold, for the three months ended March 31, 2011 and 2010, respectively (in millions):

                                                                 Revenues                                                     Gallons
                                            Three Months Ended                                            Three Months Ended
                                                 March 31,                      Change                         March 31,                     Change
                                             2011          2010        In Dollars        Percent           2011          2010        In Units       Percent
Retail propane                            $    349.4      $ 371.5     $      (22.1 )         (5.9 )%         129.7        147.2          (17.5 )       (11.9 )%
Wholesale propane                              191.0        180.0             11.0            6.1            139.4        144.1           (4.7 )        (3.3 )
Other retail                                    73.3         67.3              6.0            8.9               -            -              -             -
Storage, fractionation and midstream           106.8         72.3             34.5           47.7               -            -              -             -

Total                                     $    720.5      $ 691.1     $       29.4            4.3 %          269.1        291.3          (22.2 )        (7.6 )%

Volume. During the three months ended March 31, 2011, we sold 129.7 million retail gallons of propane, a decline of 17.5 million gallons or 11.9% from the 147.2 million retail gallons sold during the same three-month period in 2010. Gallons sold during the three months ended March 31, 2011, decreased as compared to the same prior year period as a result of lower volumes sold at our existing locations of 22.3 million gallons, partially offset by acquisition-related volume of 4.8 million gallons. There were several factors, we believe, that contributed to the declining volumes at existing locations: (1) continued customer conservation, which we believe has resulted from the continued impact of the overall weak United States economic environment and higher propane costs, which continued to increase during the three month period ended March 31, 2011,
(2) volume declines from net customer losses due primarily to higher sales prices, and (3)

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the impact of warmer temperatures in our South and Southeast areas of operations. The average wholesale cost of propane has increased approximately 12% during the three months ended March 31, 2011, compared to the same prior year period and the average cost for the most recent trailing twelve month period was approximately 23% higher than for the comparable prior trailing twelve month period, continuing to impact customer buying decisions and conservation trends. Gallon sales were impacted by warmer weather in our South and Southeast areas of operations as it was approximately 20% warmer during the three months ended March 31, 2011 compared to the same prior year period. Volume was further impacted by colder weather in certain areas of our operations, notably the Northeast and Midwest, which combined were approximately 7.3% colder than last year and approximately 4.0% colder than normal. On a consolidated retail basis, the weather was approximately 1.3% warmer than last year and 2.5% colder than normal for our geographic areas.

Wholesale gallons delivered decreased 4.7 million gallons, or 3.3%, to . . .

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