UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934
Date of report (Date of earliest event reported) February 17, 1999
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Petroleum Heat and Power Co., Inc.
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(Exact name of registrant as specified in its charter)
Minnesota 1-9358 06-1183025
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(State or other jurisdiction (Commission File Number) (IRS Employer
of incorporation) Identification No.)
2187 Atlantic Street, Stamford, CT 06902
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (203) 325-5400
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Not Applicable
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(Former name or former address, if changed since last report.)
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Item 5. Other Events
This Form 8-K consists of the Registrant's audited consolidated balance sheets
as of December 31, 1997 and 1998, and the related consolidated statements of
operations, changes in stockholders' equity (deficiency), and cash flows for
each of the years in the three-year period ended December 31, 1998. It also
includes management's discussion and analysis of results of operations and
financial condition.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION
Overview
In analyzing the Company's results, investors should consider a variety of
factors unique to the Company and the heating oil industry. These include the
Company's active acquisition program and the rapid rate of amortization of
customer lists purchased in home heating oil acquisitions. First, the financial
results of a given year do not reflect the full impact of the year's
acquisitions. Acquisitions made during the spring and summer months generally
have a negative effect on earnings in the calendar year in which they are made.
Second, substantially all purchased intangibles are comprised of customer lists
and convenants not to compete. Amortization of customer lists is a non-cash
expense which is amortized 90% over a six-year period and the balance over a
25-year period. The covenants not to compete are amortized over the lives of the
covenants, which generally range from five to seven years. The Company acquired
the customer lists and equipment of thirteen unaffiliated fuel oil dealers in
1996 and eleven in 1997; no acquisitions were made in 1998.
A significant focus of the Company has been the restructuring and corporate
identity programs begun in April of 1996. These programs are targeted to
heighten responsiveness to customers, improve brand awareness among heating oil
consumers and increase operational productivity, as well as reduce overhead
costs. The regionalization of the Company's New York/Long Island operations was
completed in 1997, and similar efforts in the Mid-Atlantic region have begun. In
order to optimize the impact of these programs, the Company continues to
evaluate appropriate operating structures for the rest of the Company. For 1997
and 1998 in the metro New York region, the Company's first consolidated region,
measurable improvements were recorded in almost all significant operating
categories. Despite these indications, however, it should be noted that no
assurances can be given as to the ultimate impact of the program on the
Company's financial results in any of the Company's regions.
1998 Compared to 1997
In analyzing the Company's 1998 results to 1997 results, certain significant
factors should be considered. We believe that 1998 was among the warmest years
in the twentieth century with temperatures 17.7% above normal and 16.0% higher
than 1997. Largely as a result of this weather, home heating oil volume declined
85.6 million gallons and sales were $140.1 million below 1997 levels. However,
operating loss increased by only $1.3 million as the Company was able to offset,
to a certain extent, the effects of this weather through increased heating oil
margins and through sizeable reductions in operating expenses relating to its
operational restructuring and corporate overhead reduction programs.
Volume. Home heating oil volume decreased 20.9% to 324.7 million gallons for the
twelve months ended December 31, 1998, as compared to 410.3 million gallons for
the twelve months ended December 31, 1997. This decline was largely due to 16.0%
warmer weather for 1998, believed to be caused by the effects of the climatic
phenomenon known as "El Nino." In addition, volume was negatively impacted by
16.9 million gallons from the Company's Hartford, CT operation, which was sold
in November 1997, and by net account attrition and delivery scheduling.
Partially offsetting these factors was the acquisition by the Company of eleven
individually insignificant heating oil companies during 1997, the full effects
of which were not realized until 1998.
Net sales. Net sales decreased 25.6% to $408.0 million for the twelve months
ended December 31, 1998, as compared to $548.1 million for the twelve months
ended December 31, 1997. This decline reflects the impact of decreased volume as
well as the impact of lower selling prices associated with lower wholesale
costs.
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Cost of sales. Cost of sales decreased 30.1% to $265.5 million for the twelve
months ended December 31, 1998, as compared to $379.7 million for the twelve
months ended December 31, 1997, due to the decline in volume and lower wholesale
costs mentioned above. Cost of sales declined more than net sales as the Company
was able to increase home heating oil margins by 3.3 cents per gallon in 1998 as
compared to 1997. Also contributing to the decline in cost of sales was a
decline in service expense, which cost is included in cost of sales. The service
expense decline was a result of both the Company's improved operating efficiency
and the warmer weather.
Selling, general and administrative expenses. Selling, general and
administrative expenses decreased 14.8% to $87.3 million for the twelve months
ended December 31, 1998, as compared to $102.4 million for the twelve months
ended December 31, 1997. This $15.1 million decline was due both to reductions
in certain expenses resulting from the Company's operational restructuring
programs, and to the Company's ability to reduce overhead costs in response to a
decline in volume. Also contributing to this decline were significant reductions
in corporate staff and other expenses which were part of a cost reduction
program begun in December 1997.
Direct delivery expenses. Direct delivery expenses decreased 18.0% to $24.6
million for the twelve months ended December 31, 1998, as compared to $30.0
million for the twelve months ended December 31, 1997, reflecting the Company's
ability to reduce costs both in response to a weather-related decline in volume
and, to a lesser extent, through its productivity improvements.
Restructuring charges. Restructuring charges of $0.5 million for the twelve
months ended December 31, 1998 represent the continuation in the first quarter
of 1998 of corporate staff reductions. Charges for the twelve months ended
December 31, 1997, which total $2.9 million, represent costs associated with the
Company's regionalization and consolidation program in the New York/Long Island
and Mid Atlantic regions, as well as corporate staff reductions made in the
fourth quarter of 1997.
Corporate identity expenses. Corporate identity expenses decreased to $0.2
million for the twelve months ended December 31, 1998, as compared to $4.1
million for the twelve months ended December 31, 1997. These expenses represent
costs associated with the Company's brand identity program, implemented in the
Company's New York and Mid Atlantic regions primarily during 1997, with
completion of the Mid Atlantic region in 1998. These costs include the cost of
repainting all delivery and service vehicles to reflect the Company's new
identity.
Star Gas transaction expenses. Star Gas transaction expenses of $4.8 million for
the twelve months ended December 31, 1998 represent costs incurred, consisting
primarily of legal, printing, advisory, and professional charges relating to the
Company's previously announced merger with Star Gas Partners. It is expected
that the Company will incur a total of $7.5 to $8.5 million of costs associated
with this transaction, the remainder of which will be incurred in 1999.
Amortization of customer lists. Amortization of customer lists decreased 6.9% to
$16.7 million for the twelve months ended December 31, 1998, as compared to
$17.9 million for the twelve months ended December 31, 1997, reflecting the
impact of certain customer lists becoming fully amortized which were not offset
by the full year amortization for the 1997 acquisitions.
Depreciation and amortization of plant and equipment. Depreciation and
amortization of plant and equipment decreased 3.3% to $7.0 million for the
twelve months ended December 31, 1998, as compared to $7.2 million for the
twelve months ended December 31, 1997, as the impact of certain assets becoming
fully depreciated exceeded the impact of the Company's recent fixed asset
additions.
Amortization of deferred charges. Amortization of deferred charges decreased
8.7% to $2.9 million for the twelve months ended December 31, 1998, as compared
to $3.2 million for the twelve months ended December 31, 1997, reflecting the
impact of certain deferred charges becoming fully amortized.
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Operating loss. Operating loss increased 275.9% to a loss of $1.8 million for
the twelve months ended December 31, 1998, as compared to a loss of $0.5 million
for the twelve months ended December 31, 1997. This decline was attributable to
the weather-related decline in volume for the period, partially offset by the
Company's reductions in operating expenses and improvements in home heating oil
margins.
Net interest expense. Net interest expense decreased 3.0% to $30.7 million for
the twelve months ended December 31, 1998, as compared to $31.7 million for the
twelve months ended December 31, 1997. This was due to a slight decline in
average borrowings outstanding.
Other. Other income decreased to $0.1 million for the twelve months ended
December 31, 1998, as compared to $11.4 million for the twelve months ended
December 31, 1997, as the 1997 results include the gain on the sale of the
Company's Hartford, CT operations in November 1997.
Equity in loss of Star Gas Partnership. Equity in the loss of Star Gas
Partnership increased 376.6% to a loss of $1.1 million for the twelve months
ended December 31, 1998, as compared to a loss of $0.2 million for the twelve
months ended December 31, 1997. This decline was largely due to the impact of
warm weather on Star Gas Partner's operations.
Net loss. Net loss increased 54.3% to a loss of $35.3 million for the twelve
months ended December 31, 1998, as compared to a loss of $22.9 million for the
twelve months ended December 31, 1997. This increase was attributable to the
weather-related decline in volume for the period, partially offset by the
Company's reductions in operating expenses and improvements in home heating oil
margins. In addition, 1997 was favorably impacted by the $11.3 million gain for
the November 1997 sale of the Company's Hartford, CT operations.
Operating income before depreciation, amortization, and provision for
supplemental benefits.* Operating income before depreciation, amortization, and
provision for supplemental benefits declined 11.5% to $25.1 million for the
twelve months ended December 31, 1998, as compared to $28.4 million for the
twelve months ended December 31, 1997. This $3.3 million decline was far less
than the 85.6 million gallon decline in volume for the same period, which was
primarily attributable to an increase in the Company's heating oil margins and
to sizable reductions in operating expenses related to the Company's operational
restructuring programs and its ability to contain costs in response to warm
weather.
* Operating income before depreciation, amortization, and provision for
supplemental benefits should not be considered as an alternative to net
income (as an indicator of operating performance) or as an alternative to
cash flow (as a measure of liquidity or availability to service debt
obligations), but provides additional significant information in that it
is a principal basis upon which the Company assesses its financial
performance. It should be noted that the definition set forth above may
include different items than what other companies may use.
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1997 Compared to 1996
Volume. Home heating oil volume decreased 10.1% to 410.3 million gallons for the
twelve months ended December 31, 1997, as compared to 456.1 million gallons for
the twelve months ended December 31, 1996. In addition to 5.8% warmer weather in
1997 than in 1996, volume was negatively impacted by net account attrition and
the sale of the Company's Hartford, CT operations, partially offset by the
acquisition of 24 individually insignificant heating oil companies since the
beginning of 1996.
Net sales. Net sales decreased 9.9% to $548.1 million for the twelve months
ended December 31, 1997, as compared to $608.2 million for the twelve months
ended December 31, 1996 due to the decreased volume described above.
Cost of sales. Cost of sales decreased 11.1% to $379.7 million for the twelve
months ended December 31, 1997, as compared to $427.4 million for the twelve
months ended December 31, 1996 due to the decreased volume described above. Cost
of sales decreased more than net sales due to an increase of 1.7 cents per
gallon in home heating oil margins in 1997 as compared to 1996.
Selling, general and administrative expenses. Selling, general and
administrative expenses decreased 3.2% to $102.4 million for the twelve months
ended December 31, 1997, as compared to $105.6 million for the twelve months
ended December 31, 1996. This decline was due both to reductions in certain
expenses resulting from the Company's operational restructuring programs and to
the Company's ability to reduce certain overhead costs in response to a decline
in volume and was achieved despite inflationary pressures. Also of importance,
but of smaller impact on 1997 financials, were significant corporate staff
reductions taken in December of 1997 as part of our corporate restructuring
programs.
Direct delivery expenses. Direct delivery expenses decreased 9.4% to $30.0
million for the twelve months ended December 31, 1997, as compared to $33.1
million for the twelve months ended December 31, 1996, reflecting the Company's
ability to reduce costs relating to weather impacted lower volume.
Restructuring charges. Restructuring charges increased from $1.2 million for the
twelve months ended December 31, 1996 to $2.9 million for the twelve months
ended December 31, 1997, representing costs associated with the Company's
regionalization and consolidation programs in the New York/Long Island and Mid
Atlantic regions.
Corporate identity expenses. Corporate identity expenses for the twelve months
ended December 31, 1997 were $4.1 million, as compared to $2.7 million for the
twelve months ended December 31, 1996. These costs are associated with the
Company's brand identity program, implemented in Long Island during 1996 and the
Company's New York and Mid Atlantic regions during 1997, and include the cost of
repainting all delivery and service vehicles to reflect the Company's new
identity. Through this program the Company intends to capitalize on its size by
building significant brand equity in one "Petro" brand name, rather than the
multiple names previously in use.
Pension curtailment. Pension curtailment expenses for the twelve months ended
December 31, 1997 were $0.7 million, as compared to $0.6 million for the twelve
months ended December 31, 1996. These expenses represent the freezing of
benefits under the Company's defined benefit pension plan resulting from the
consolidation of Long Island and New York City operations.
Amortization of customer lists. Amortization of customer lists decreased 3.8% to
$17.9 million for the twelve months ended December 31, 1997, as compared to
$18.6 million for the twelve months ended December 31, 1996, as the impact of
certain customer lists becoming fully amortized exceeded the impact of
amortization associated with the Company's recent acquisitions.
Depreciation of plant and equipment. Depreciation and amortization of plant and
equipment increased 9.6% to $7.2 million for the twelve months ended December
31, 1997, as compared to $6.6 million for the twelve months ended December 31,
1996, as a result of certain investments related to the Company's operational
restructuring programs in the New York and Mid Atlantic regions, as well as the
impact of the Company's acquisitions.
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Amortization of deferred charges. Amortization of deferred charges increased
9.9% to $3.2 million for the twelve months ended December 31, 1997, as compared
to $2.9 million for the twelve months ended December 31, 1996, as the impact of
the amortization associated with the Company's recent acquisitions exceeded the
impact of certain deferred charges becoming fully amortized.
Provision for supplemental benefits. Provision for supplemental benefits
declined to $0.6 million for the twelve months ended December 31, 1997, as
compared to $0.9 million for the twelve months ended December 31, 1996. These
supplemental benefits reflect the extension of the exercise date of certain
options previously issued and a change in the provision due to a reduction of
the accrual required under the vesting schedule of those options.
Operating income (loss): Operating income decreased to an operating loss of $0.5
million for the twelve months ended December 31, 1997, as compared to operating
income of $8.8 million for the twelve months ended December 31, 1996. This
decline was largely a result of the weather-related decline in volume and an
increase in restructuring and corporate identity expenses, partially offset by
the Company's ability to reduce certain operating expenses and an increase in
the Company's heating oil margins.
Net interest expense. Net interest expense decreased to $31.7 million for the
twelve months ended December 31, 1997, as compared to $32.4 million for the
twelve months ended December 31, 1996. This reduction resulted from both a
slight decline in average borrowings outstanding and average rate.
Other income. Other income for the twelve months ended December 31, 1997 was
$11.4 million, as compared to $1.8 million for the twelve months ended December
31, 1996. These amounts reflect the sale of the Company's Hartford, CT heating
oil operations in 1997 and the Company's Springfield, MA operations in 1996.
Proceeds from these sales were used to make investments in other regions of the
Company's operations and to repay debt.
Equity in income (loss) of Star Gas partnership. Equity in the earnings of Star
Gas Partnership declined to a loss of $0.2 million for the twelve months ended
December 31, 1997, as compared to earnings of $2.3 million for the twelve months
ended December 31, 1996. This decrease was due to the impact of warm weather on
Star Gas Partner's propane volume and net income.
Extraordinary item. The extraordinary charge in 1996 of $6.4 million resulted
from the retirement of $43.8 million of 12.25% Subordinated Debentures due 2005.
This charge included both a prepayment premium of $4.8 million and a write-off
of deferred charges of $1.6 million associated with the issuance of that debt.
Net loss. Net loss improved 19.1% to a net loss of $22.9 million for the twelve
months ended December 31, 1997, as compared to a net loss of $28.3 million for
the twelve months ended December 31, 1996. This improvement was due to the gain
recognized on the sale of the Company's Hartford, CT business during the year,
partially offset by the impact of warm first quarter weather on both the
Company's and Star's volume, and to an increase in restructuring and corporate
identity expenses.
Operating income before depreciation, amortization, and provision for
supplemental benefits. Operating income before depreciation, amortization, and
provision for supplemental benefits decreased to $28.4 million for the twelve
months ended December 31, 1997, as compared to $37.7 million for the twelve
months ended December 31, 1996. This decline was due to decreased volume
resulting from the warm 1997 weather and to an increase in restructuring and
corporate identity costs, partially offset by improved heating oil margins.
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Liquidity and Financial Condition
Net cash provided by operating activities of $19.3 million combined with the
$1.3 million net proceeds from the sale of Star Gas Partners Common Units
amounted to $20.6 million. These funds were utilized in investing activities for
the purchase of fixed assets of $4.6 million; and in financing activities to
repay senior notes payable of $1.1 million, repay subordinated notes of $1.1
million, repay net working capital borrowings of $3.0 million, pay cash
dividends of $7.0 million, increase the cash collateral account maintained with
the Company's lenders to secure certain letter-of-credit obligations of $2.4
million, redeem preferred stock of $4.2 million, and for other financing
activities of $2.8 million, which is comprised mainly of the redemption of $2.3
million of Notes Payables issued in connection with the purchase of fuel oil
dealers. These financing activities were partially offset by cash provided from
the Star Gas distributions of $4.4 million, the proceeds from the sale of fixed
assets of $0.2 million, and proceeds from dividend reinvestments of $0.6
million. As a result of the above activities, the Company's cash balance
decreased by $0.4 million since December 31, 1997.
In July 1998, the Company renewed its $47.0 million working capital revolving
credit facility which will expire in June 1999. In consideration for the
extension of this facility to June 1999, the Company agreed to, amongst other
things, pay no common cash dividends and not make any acquisitions of other
companies. As the Company's current capital constraints already imposes a limit
to such activity, the impact of these prohibitions is minimal. At December 31,
1998 no amount was outstanding under this credit facility.
As part of the Star Gas / Petro Transaction, the Company plans to enter into a
bank facilities agreement for approximately $100.0 million in senior secured
facilities with a group of commercial banks. The bank facilities will consist of
three separate tranches, a $40 million working capital facility, a $10 million
letter of credit facility, and a $50 million acquisition facility. The working
capital facility and letter of credit facility would expire on June 30, 2001.
The acquisition facility would convert into a term loan on June 30, 2001 which
would be payable in eight equal quarterly principal payments. Should the Star
Gas / Petro Transaction be unsuccessful, the Company would expect to renew the
existing working capital revolving credit facility or replace it with a similar
facility.
As part of the Star Gas / Petro Transaction, the Company plans to sell
approximately $90.0 million of Senior Secured Notes, the net proceeds of which
will be used for the restructuring of the Company's debt and redemption of the
preferred stock.
If the Star Gas / Petro Transaction does not occur, the Company's 1999
obligations would include paying $4.4 million of preferred dividends, redeeming
$4.2 million of redeemable preferred stock, funding the $2.5 million needed to
collateralize the remaining uncollateralized balance of the acquisition letter
of credits and repaying $2.1 million of senior and senior subordinated notes
(which were paid in January 1999). The Company has no material commitments for
capital expenditures.
Based on the Company's expectation of securing a working capital facility, the
Company's working capital position, and the expected net cash to be provided by
operating activities, the Company expects to be able to meet all the above
mentioned obligations in 1999.
The Company has substantial repayment obligations on indebtedness that become
due beginning in the year 2000. If the proposed Star Gas / Petro Transaction is
completed, these obligations are expected to be refinanced on or before their
maturities. In the event that such transaction does not occur, the Company will
explore alternatives including the repayment or refinancing of such maturities.
If such alternatives cannot be effected, it could have a material adverse affect
on the Company.
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Year 2000
The "Year 2000" issue is the result of computer programs being written using two
digits rather than four to define a specific year. Absent corrective actions, a
computer program that has date sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in system
failures or miscalculations causing disruptions to various activities and
operations.
The Company conducted a comprehensive review of its computer systems to identify
the systems that could be affected by the Year 2000 issue and has developed a
plan to address this issue. The scope of this review included the assessment of
the Company's information technology environment as well as the compliance
attainment efforts of the Company's major service providers. Most key suppliers
and business partners have been contacted with regard to their Year 2000 state
of readiness such as the Company's software developer, significant suppliers,
payroll provider, and banking partners, and the Company has obtained reasonable
comfort that this issue is being adequately addressed.
In addition, the Company has engaged a prominent information technology
consulting firm ("IT Firm") to advise and ensure that it maintains a focused
strategy to successfully address the Year 2000 issue on a timely basis. This IT
Firm will contribute an added layer of comfort for Year 2000 compliance, based
on their independent assessment derived from continuous exposure analyses which
are designed to assess the costs and efforts needed to maintain and/or repair
the Company's critical business systems.
The Company's main applications and operating systems have a combination of
compliant and non-compliant systems. The primary computer platform which
supports much of the Company's operations was designed to be Year 2000
compliant, and the Company has obtained a compliance warranty attesting to this
fact. However, the Company has identified potential problem areas and assessed a
total cost of approximately $350,000 to make the entire system Year 2000
compliant, which includes the IT Firm's consulting fees. The Company's state of
readiness to make each identified area Year 2000 compliant is at the
implementation stage.
Through December 31, 1998 the Company has incurred approximately $50,000 in Year
2000 compliance expenses for applications and hardware, and it expects to incur
an additional $300,000 through the summer of 1999 for additional applications
and hardware, as well as the IT Firm's consulting fees.
Furthermore, the Company has also accelerated the planned replacement of its
internal messaging system in order to gain company-wide Year 2000 messaging
compatibility. Through December 31, 1998 the Company has incurred approximately
$30,000 of expenses for this project, and expects to incur an additional
$220,000 by the summer of 1999 to complete the project.
If the Company fails to be Year 2000 compliant, a worst case scenario would be
system failures and miscalculations that could adversely affect operations.
However, because the primary computer platform which currently supports much of
the Company's operations is already Year 2000 compliant and continues to show
positive test results like those of other existing and newly installed Year 2000
compliant systems being tested, the Company would experience only minor
operational disruptions even in such worst case scenario. Business contingency
plans designed to mitigate the Company's worst case scenario and potential
disruptions to business operations include continued substantive pre-testing of
existing and newly installed Year 2000 compliant systems. This coupled with the
Company's existing effort to relieve information technology systems from
non-critical, non-Year 2000 projects, while simultaneously planning the
availability of all information technology personnel before, during, and after
the Year 2000 changeover is designed to mitigate the effects of potential
business disruptions.
Notwithstanding the substantive work involved in making all its systems Year
2000 compliant, the Company could still potentially experience disruptions to
some aspects of its various activities and operations, including those resulting
from non-compliant systems utilized by unrelated third party governmental and
business entities.
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Noncompliance with The NASDAQ Stock Market Minimum Bid Price Requirement
The Company received notification from The NASDAQ Stock Market ("NASDAQ") that
its Class A Common Stock was not in compliance pursuant to the newly enacted
NASD Market Place Rules regarding the minimum bid price requirement. The Company
responded to NASDAQ outlining its position as to why NASDAQ should not take any
action to delist Petro's Class A Common Stock from its National Market System
("NMS"). Among the reasons given for not delisting the stock was the possibility
of the Star Gas / Petro Transaction. The original NASDAQ Hearing Panel granted a
very limited exception to the continued listing requirements based upon the
Company's written request. The Company responded by requesting a full oral
hearing on this matter as provided for under the NASD Market Place Rules.
The full oral hearing took place in November 1998 before a NASDAQ Listing
Qualification Panel (the "Panel") resulting in a January 1999 determination
subject to certain conditions, to not delist the Company from the NMS. Such
conditions for the Company's continued NMS listing include a continued
commitment on the Company's behalf to regain compliance with the NASD Market
Place Rules within a reasonable time period and to sustain compliance over the
long-term. Other conditions include a closing price of at least $1.00 per share
for the Class A Common Stock on or before March 1, 1999, and thereafter at a
price of at least $1.00 per share for a minimum of ten consecutive trading days.
If the Company fails to meet these conditions the Panel has determined that the
Company's Class A Common Stock will be delisted from the NMS.
A delisting could have a material adverse effect on the liquidity, trading, and
price for the Class A Common Stock. If the Star Gas / Petro Transaction does not
occur, no assurance can be given as to the continued listing of the Class A
Common Stock in the NMS.
Quantitative and Qualitative Disclosures about Market Risk
The Company is exposed to interest rate risk primarily through its working
capital revolving credit facility and market risk through its futures contracts.
The Company uses its working capital revolving credit facility to meet its
working capital needs. At December 31, 1998 no amount was outstanding under the
working capital revolving credit facility.
The Company selectively uses derivative financial instruments to manage its
exposure to market risk related to changes in the current and commodity market
price of #2 home heating oil. The Company does not hold derivatives for trading
purposes. The value of market sensitive derivative instruments is subject to
change as a result of movements in market prices. Consistent with the nature of
hedging activity, associated unrealized gains and losses would be offset by
corresponding decreases or increases in the purchase price the Company would pay
for the #2 home heating oil being hedged. Sensitivity analysis is a technique
used to evaluate the impact of hypothetical market value changes. Based on a
hypothetical ten percent increase in the cost of # 2 home heating oil at
December 31, 1998, the potential unrealized losses on the Company's hedging
activity would be reduced by $1.9 million; and conversely a hypothetical ten
percent decrease would increase the unrealized losses by the same amount.
Accounting Changes
In June 1998 the FASB issued SFAS No. 133 - "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. This
statement is effective for all fiscal quarters of all fiscal years beginning
after June 15, 1999. The Company is assessing the disclosure requirements of
SFAS No. 133.
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STATEMENT REGARDING FORWARD-LOOKING DISCLOSURE
This Report includes "forward-looking statements" within the meaning of Section
27A of the Securities Act and Section 21E of the Exchange Act which represent
the Company's expectations or beliefs concerning future events that involve
risks and uncertainties, including those associated with the effect of weather
conditions on the Company's financial performance, the price and supply of home
heating oil, the ability of the Company to obtain new accounts and retain
existing accounts and the ability of the Company to realize cost reductions from
its operational restructuring program. All statements other than statements of
historical facts included in this Report including, without limitation, the
statements under "Management's Discussion and Analysis of Results of Operations
and Financial Condition" and "Business" and elsewhere herein, are
forward-looking statements. Although the Company believes that the expectations
reflected in such forward-looking statements are reasonable, it can give no
assurance that such expectations will prove to have been correct. Important
factors that could cause actual results to differ materially from the Company's
expectations ("Cautionary Statements") are disclosed in this Report, including
without limitation, in conjunction with the forward-looking statements included
in this report. All subsequent written and oral forward-looking statements
attributable to the Company or persons acting on its behalf are expressly
qualified in their entirety by the Cautionary Statements.
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PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE
Consolidated Financial Statements of Petroleum Heat and Power Co.,
Inc. and Subsidiaries
Independent Auditors' Report F-2
Consolidated Balance Sheets, December 31, 1997 and 1998 F-3
Consolidated Statements of Operations, Years ended
December 31, 1996, 1997 and 1998 F-4
Consolidated Statements of Changes in Stockholders'
Equity (Deficiency),
Years ended December 31, 1996, 1997 and 1998 F-5
Consolidated Statements of Cash Flows, Years ended
December 31, 1996, 1997 and 1998 F-6
Notes to Consolidated Financial Statements F-7
Schedule for the years ended December 31, 1996, 1997 and 1998:
II - Valuation and Qualifying Accounts F-28
All other schedules are omitted because they are not applicable or the
required information is shown in the consolidated financial statements or
notes thereto.
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Stockholders and Board of Directors of
Petroleum Heat and Power Co., Inc.:
We have audited the accompanying consolidated balance sheets of
Petroleum Heat and Power Co., Inc. and subsidiaries as of December 31, 1997 and
1998, and the related consolidated statements of operations, changes in
stockholders' equity (deficiency) and cash flows for each of the years in the
three-year period ended December 31, 1998. In connection with our audits of the
consolidated financial statements, we also have audited the financial statement
schedule as listed in the accompanying index. These consolidated financial
statements and financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedule based on our
audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial position of
Petroleum Heat and Power Co., Inc. and subsidiaries as of December 31, 1997 and
1998, and the results of their operations and their cash flows for each of the
years in the three-year period ended December 31, 1998 in conformity with
generally accepted accounting principles. Also in our opinion, the related
financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, present fairly, in all
material respects, the information set forth therein.
KPMG LLP
Stamford, Connecticut
February 16, 1999
F-2
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except per share data)
<TABLE>
<CAPTION>
December 31,
----------------------
1997 1998
--------- ---------
<S> <C> <C>
Assets
Current assets:
Cash $ 2,390 $ 2,004
Restricted cash -- 4,900
Accounts receivable (net of allowance of $980 and $944) 78,987 56,845
Inventories 16,285 17,534
Prepaid expenses 6,203 5,978
Notes receivable and other current assets 1,259 1,045
--------- ---------
Total current assets 105,124 88,306
--------- ---------
Property, plant and equipment - net 30,615 28,124
Intangible assets (net of accumulated amortization
of $285,850 and $306,822)
Customer lists 69,265 52,596
Deferred charges 24,924 21,849
--------- ---------
94,189 74,445
--------- ---------
Investment in and advances to the Star Gas Partnership 27,499 20,755
Deferred gain on Star Gas Transaction (19,964) (19,964)
--------- ---------
7,535 791
--------- ---------
Restricted cash 9,350 6,900
Other assets 1,033 965
--------- ---------
$ 247,846 $ 199,531
========= =========
Liabilities and Stockholders' Equity (Deficiency)
Current liabilities:
Working capital borrowings $ 3,000 $ --
Current debt 2,391 8,021
Current maturities of redeemable preferred stock 4,167 4,167
Accounts payable 14,759 10,129
Customer credit balances 20,767 27,884
Unearned service contract revenue 15,321 15,430
Accrued expenses and other liabilities 32,283 31,652
--------- ---------
Total current liabilities 92,688 97,283
--------- ---------
Supplemental benefits and other long-term liabilities 5,043 4,984
Pension plan obligation 5,702 5,780
Notes payable and other long-term debt 16,507 8,381
Senior notes payable 63,100 62,050
Senior subordinated and subordinated notes payable 209,350 208,300
Redeemable and exchangeable preferred stock 32,489 28,578
Common stock redeemable at option of stockholder (83 Class A
and 21 Class C shares and 41 Class A and 10 Class C shares) 656 328
Note receivable from stockholder (656) (328)
Stockholders' equity (deficiency):
Preferred stock-no par value; 1,000 shares authorized,
0 and 787 shares issued and outstanding -- --
Class A common stock-par value $.10 per share; 60,000 shares
authorized, 23,606 and 23,865 shares issued and outstanding 2,361 2,387
Class B common stock-par value $.10 per share; 6,500 shares
authorized, 11 and 11 shares issued and outstanding 1 1
Class C common stock-par value $.10 per share; 5,000 shares
authorized, 2,577 and 2,587 shares issued and outstanding 258 259
Additional paid-in capital 81,358 83,024
Deficit (256,365) (296,759)
Accumulated other comprehensive income (4,646) (4,737)
--------- ---------
Total stockholders' equity (deficiency) (177,033) (215,825)
--------- ---------
$ 247,846 $ 199,531
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(In thousands, except per share data)
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Net sales $ 608,161 $ 548,141 $ 408,019
Costs and expenses
Cost of sales 427,388 379,748 265,526
Selling, general and administrative expenses 105,601 102,377 87,268
Direct delivery expense 33,102 30,006 24,613
Restructuring charges 1,150 2,850 535
Corporate identity expenses 2,659 4,136 152
Star Gas transaction expenses -- -- 4,823
Pension curtailment expense 557 654 --
Amortization of customer lists 18,611 17,903 16,669
Depreciation of plant and equipment 6,574 7,204 6,969
Amortization of deferred charges 2,888 3,175 2,899
Provision for supplemental benefits 873 565 358
--------- --------- ---------
Operating income (loss) 8,758 (477) (1,793)
Other income (expense):
Interest expense (34,669) (33,813) (33,037)
Amortization of debt issuance cost (1,872) (1,464) (1,404)
Interest income 2,257 2,145 2,305
Other 1,842 11,445 112
--------- --------- ---------
Loss before income taxes, equity interest
and extraordinary item (23,684) (22,164) (33,817)
Income taxes 500 500 400
--------- --------- ---------
Loss before equity interest
and extraordinary item (24,184) (22,664) (34,217)
--------- --------- ---------
Share of income (loss) of Star Gas
Partnership 2,283 (235) (1,120)
--------- --------- ---------
Loss before extraordinary item (21,901) (22,899) (35,337)
--------- --------- ---------
Extraordinary item-loss on early
extinguishment of debt (6,414) -- --
--------- --------- ---------
Net loss $ (28,315) $ (22,899) $ (35,337)
========= ========= =========
Preferred Stock dividends (2,389) (4,644) (5,057)
--------- --------- ---------
Net loss applicable to common stock $ (30,704) $ (27,543) $ (40,394)
========= ========= =========
Basic and Diluted losses per common
share before extraordinary item:
Class A and C Common Stock $ (0.95) $ (1.06) $ (1.52)
Extraordinary loss per common share:
Class A and C Common Stock (0.25) -- --
Basic and Diluted losses per common share:
Class A and C Common Stock $ (1.20) $ (1.06) $ (1.52)
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity (Deficiency)
Years Ended December 31, 1996, 1997 and 1998
(In thousands)
<TABLE>
<CAPTION>
Common Stock
---------------------------------------------------------
Class A Class B Class C Accumulated
--------------------------------------------------------- Additional Other
No. of No. of No. of Paid-In Comprehensive
Shares Amount Shares Amount Shares Amount Capital Deficit Income Total
------ ------ ------ ------ ------ ------ ------- ------- ------ -----
------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at 12/31/95 22,653 $2,266 14 $1 2,558 $256 $76,418 $(174,972) $(4,872) $(100,903)
Net loss (28,315) (28,315)
Other comprehensive
income:
Minimum pension
liability adj. (1,193) (1,193)
----------
Comprehensive income (29,508)
Cash dividends
declared and paid
(See notes 7 & 8) (13,880) (13,880)
Cash div. payable
(See notes 7 & 8) (3,857) (3,857)
Class A Common Stock
issued under the
Div. Reinvest. Plan 302 30 2,034 2,064
Other (24) (2) (3) -- 9 1 352 351
------------------------------------------------------------------------------------------------------------
Balance at 12/31/96 22,931 2,294 11 1 2,567 257 78,804 (221,024) (6,065) (145,733)
Net loss (22,899) (22,899)
Other comprehensive
income:
Minimum pension
liability adj. 1,419 1,419
----------
Comprehensive income (21,480)
Cash dividends
declared and paid
(See notes 7 & 8) (10,479) (10,479)
Cash div. payable
(See notes 7 & 8) (1,963) (1,963)
Class A Common Stock
issued under the
Div. Reinvest. Plan 691 69 2,331 2,400
Other (16) (2) 10 1 223 222
------------------------------------------------------------------------------------------------------------
Balance at 12/31/97 23,606 2,361 11 1 2,577 258 81,358 (256,365) (4,646) (177,033)
Net loss (35,337) (35,337)
Other comprehensive
income:
Minimum pension
liability adj. (91) (91)
----------
Comprehensive income (35,428)
Cash dividends
declared and paid
(See notes 7 & 8) (5,057) (5,057)
Class A Common Stock
issued under the
Div. Reinvest. Plan 271 27 583 610
Jr. Convertible
preferred stock
issued in connection
with exchange offer 1,216 1,216
Other (12) (1) 10 1 (133) (133)
------------------------------------------------------------------------------------------------------------
Balance at 12/31/98 23,865 $2,387 11 $1 2,587 $259 $83,024 $(296,759) $(4,737) $(215,825)
============================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
F - 5
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
(In thousands) Years Ended December 31,
--------------------------------
1996 1997 1998
-------- -------- --------
<S> <C> <C> <C>
Cash flows from (used in) operating activities:
Net loss $(28,315) $(22,899) $(35,337)
Adjustments to reconcile net loss to
net cash provided by (used in) operating activities:
Amortization of customer lists 18,611 17,903 16,669
Depreciation of plant and equipment 6,574 7,204 6,969
Amortization of deferred charges 2,888 3,175 2,899
Amortization of debt issuance costs 1,872 1,464 1,404
Share of (income)loss of Star Gas (2,283) 235 1,120
Provision for losses on accounts receivable 1,882 1,853 1,419
Provision for supplemental benefits 873 565 358
Loss on early extinguishment of debt 6,414 -- --
Gain on sale of business (1,781) (11,284) --
Other 105 (186) (126)
Change in Operating Assets and Liabilities, net of
effects of acquisitions and dispositions:
Decrease in accounts receivable 117 12,522 20,723
Decrease (increase) in inventory (1,671) 5,799 (1,249)
Decrease (increase) in other current assets (575) 845 439
Decrease (increase) in other assets (86) (123) 68
Decrease in accounts payable (3,836) (4,229) (4,630)
Increase (decrease) in customer credit balances (2,142) 3,299 7,117
Increase (decrease) in unearned service contract revenue (147) (67) 109
Increase (decrease) in accrued expenses (2,352) 2,568 1,332
-------- -------- --------
Net cash provided by (used in) operating activities (3,852) 18,644 19,284
-------- -------- --------
Cash flows from (used in) investing activities:
Minimum quarterly distributions from Star Gas Partnership 4,313 5,507 4,367
Acquisitions (28,493) (16,252) --
Capital expenditures (6,874) (6,980) (4,584)
Proceeds from sale of business 4,073 15,571 --
Net proceeds from sales of fixed assets 788 1,174 218
-------- -------- --------
Net cash provided by (used in) investing activities (26,193) (980) 1
-------- -------- --------
Cash flows from (used in) financing activities:
Net proceeds from sale of Star Gas Partnership units -- -- 1,271
Net proceeds from issuance of common stock 2,064 2,400 610
Net proceeds from issuance of preferred stock -- 28,323 --
Repayment of senior notes payable (1,050) (1,050) (1,050)
Repurchase of subordinated notes (49,612) (1,050) (1,050)
Redemption of preferred stock (4,167) (4,167) (4,167)
Repurchase of common stock (39) -- --
Credit facility borrowings 51,000 16,000 5,000
Credit facility repayments (29,000) (35,000) (8,000)
Net decrease (increase) in restricted cash 3,000 (6,350) (2,450)
Cash dividends paid (17,702) (14,336) (7,020)
Other 523 (3,301) (2,815)
-------- -------- --------
Net cash provided by (used in) financing activities (44,983) (18,531) (19,671)
-------- -------- --------
Net (decrease) in cash (75,028) (867) (386)
Cash at beginning of year 78,285 3,257 2,390
-------- -------- --------
Cash at end of year $ 3,257 $ 2,390 $ 2,004
======== ======== ========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the year for:
Interest $ 37,007 $ 33,879 $ 33,304
Income taxes 215 140 162
Noncash investing and financing activities:
Issuance of notes payable -- -- --
Acquisitions -- (26,467) --
Asset conveyance to Star Gas Partnership -- 26,467 --
Star Gas Partnership units received pursuant to asset conveyance -- (3,467) --
Increase in tax liability from asset conveyance -- 3,467 --
Issuance of junior preferred stock pursuant to subordinated
bond and cumulative redeemable preferred stock exchange -- -- 1,216
Increase in deferred charges -- -- (1,216)
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
(1) Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Petroleum Heat and
Power Co., Inc. ("Petro") and its subsidiaries ("the Company"), each of which is
wholly owned. The Company currently operates in twenty-six major markets in the
Northeast, including the metropolitan areas of Boston, New York City, Baltimore,
Providence, and Washington DC serving approximately three hundred and forty
thousand customers in those areas. Credit is granted to substantially all of
these customers with no individual account comprising a concentrated credit
risk.
The Company is primarily engaged in the retail distribution of #2 home heating
oil, related equipment services, and equipment sales to residential and
commercial customers. It operates from twenty-four branches / depots and
thirteen satellites primarily in the Northeast United States. #2 home heating
oil is principally used by the Company's residential and commercial customers to
heat their homes and buildings, and as a result, weather conditions have a
significant impact on the demand for the product. Actual weather conditions can
vary substantially from year to year, and accordingly can significantly affect
the Company's performance.
In addition, the Company through its wholly owned subsidiary Star Gas
Corporation ("Star Gas"), has a 40.5% equity interest in Star Gas, L.P. (the
"Partnership") which is being accounted for by the equity method. Additionally,
Star Gas is the general partner of the Partnership. The Partnership is primarily
engaged in the retail distribution of propane and related equipment and supplies
to residential, commercial, industrial, agricultural and motor fuel customers.
The Partnership believes that it is the eighth largest retail propane
distributor in the United States, serving approximately one hundred and
sixty-six thousand customers from fifty-five branch locations and thirty-two
satellite storage facilities in the Midwest and nineteen branch locations and
fourteen satellite storage facilities in the Northeast. The Partnership also
serves approximately thirty wholesale customers from its wholesale operation in
southern Indiana (see note 2 and 3).
Comprehensive Income
The Company's comprehensive income consists of net income and other
comprehensive income, the sole component of which is the minimum pension
liability adjustment.
Use of Estimates
The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amounts of revenue and expenses during the reporting period. Actual
results could differ from those estimates.
Revenue Recognition
Sales of fuel oil and heating equipment are recognized at the time of delivery
of the product to the customer or at the time of sale or installation. Revenue
from repairs and maintenance service is recognized upon completion of the
service. Payments received from customers for heating equipment service
contracts are deferred and amortized into income over the terms of the
respective service contracts, on a straight line basis, which generally do not
exceed one year.
F-7
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
(1) Summary of Significant Accounting Policies (Continued)
Equity Accounting for Star Gas Investment
The Company has accounted for its investment in the Partnership using the equity
method of accounting since the Partnership's initial public offering in December
1995 (see note 2 and 3). The Company believes that the equity method is
appropriate due to the Partnership Agreement which places significant
restrictions on the General Partner's authority to make Partnership decisions
such as possessing or assigning specific partnership property, admitting a new
partner, or transferring its interest as General Partner. The Partnership
Agreement also allows for the removal of the General Partner by a 2/3 vote of
the common unitholders. In addition, Petro has no voting rights, except to the
extent that the Company holds Common Units, which are minimal.
Inventories
Inventories are stated at the lower of cost or market using the first-in,
first-out method. The components of inventories were as follows at the dates
indicated:
December 31,
---------------------
1997 1998
---- ----
Fuel oil $ 9,246 $ 11,158
Parts and equipment 7,039 6,376
========= =========
$ 16,285 $ 17,534
========= =========
Property, Plant and Equipment
Property, plant and equipment are carried at cost. Depreciation is computed
using the straight-line method over the estimated useful lives of the assets.
Customer Lists and Deferred Charges
Customer lists are recorded at cost less accumulated amortization. Amortization
for the fuel oil customer lists is computed using the straight-line method with
90% of the cost amortized over six years and 10% of the cost amortized over 25
years.
Deferred charges include goodwill and payments related to covenants not to
compete. The covenants are amortized using the straight-line method over the
terms of the related contracts while goodwill is amortized using the
straight-line method over a twenty-five year period. Also included as deferred
charges are the costs associated with the issuance of the Company's subordinated
debt. Such costs are being amortized using the interest method over the lives of
the instruments.
The Company assesses the recoverability of intangible assets at the end of each
fiscal year and, when appropriate, at the end of each fiscal quarter, by
comparing the carrying values of such intangibles to market values, where a
market exists, supplemented by cash flow analyses to determine that the carrying
values are recoverable over the remaining estimated lives of the intangibles
through undiscounted future operating cash flows. When an intangible asset is
deemed to be impaired, the amount of impairment is measured based on market
values, as available, or by projected operating cash flows, using a discount
rate reflecting the Company's assumed average cost of funds.
Advertising Expenses
Advertising costs are expensed as they are incurred. Advertising expenses were
$2,947, $3,294 and $2,503 for 1996, 1997 and 1998 respectively.
Issuance of Stock by Subsidiaries
At the time a subsidiary sells its stock to an unrelated party a gain is
recognized only if there are no significant uncertainties regarding realization.
Customer Credit Balances
Customer credit balances represent payments received from customers pursuant to
a budget payment plan (whereby customers pay their estimated annual fuel charges
on a fixed monthly basis) in excess of actual deliveries billed.
F-8
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
(1) Summary of Significant Accounting Policies - (Continued)
Concentration of Revenue with Guaranteed Maximum Price Customers
Approximately 25% of the Company's heating oil volume is sold to individual
customers under an agreement pre-establishing the maximum sales price of oil
over a twelve month period. The maximum price at which oil is sold to these
capped-price customers is renegotiated in the Spring of each year in light of
then current market conditions. The Company currently enters into forward
purchase contracts and futures contracts for a substantial majority of the oil
it sells to these capped-price customers in advance and at a fixed cost. Should
events occur after a capped-sales price is established that increases the cost
of oil above the amount anticipated, margins for the capped-price customers
whose oil was not purchased in advance would be lower than expected, while those
customers whose oil was purchased in advance would be unaffected. Conversely,
should events occur during this period that decrease the cost of oil below the
amount anticipated, margins for the capped-price customers whose oil was
purchased in advance could be lower than expected, while those customers whose
oil was not purchased in advance would be unaffected or higher than expected.
For the year ended December 31, 1997 the Company purchased put options to hedge
the risk associated with a decrease in heating oil prices in situations where
forward purchase contracts and futures contracts had been entered into to match
capped-price customer commitments. The cost of acquiring these options was
recognized in cost of goods sold over the life of each option agreement. For the
year ended December 31, 1998 the Company did not purchase similar put options.
In accordance with SFAS No. 80, "Accounting for Futures Contracts," futures
contracts are classified as a hedge when the item to be hedged exposes the
company to price risk and the futures contract reduces that risk exposure.
Future contracts that relate to transactions that are expected to occur are
accounted for as a hedge when the significant characteristics and expected terms
of the anticipated transactions are identified and it is probable that the
anticipated transaction will occur. If a transaction does not meet the criteria
to qualify as a hedge, it is considered to be speculative. Any gains or losses
associated with futures contracts which are classified as speculative are
recognized in the current period. If a futures contract that has been accounted
for as a hedge is closed or matures before the date of the anticipated
transaction, the accumulated change in value of the contract is carried forward
and included in the measurement of the related transaction. Option contracts are
accounted for in the same manner as futures contracts. At December 31, 1997 and
1998 the Company had futures contracts to buy #2 home heating oil with notional
amounts totaling $11,925 and $17,406, and futures contracts to sell #2 home
heating oil with notional amounts totaling $5,061 and $0 respectively.
At December 31, 1997 the Company had put options outstanding with an aggregate
notional value of $14,438 to hedge the risk associated with approximately 50% of
the 33.8 million gallons of heating oil forward purchase contracts and 20.6
million gallons under futures contracts, that expired at various times with no
contract expiring later than April 1998. At December 31, 1998 the Company did
not have similar put options, but did have 15.7 million gallons of heating oil
forward purchase contracts and 38.8 million gallons of futures contracts, which
expire at various times with no contract expiring later than May 1999. The
unrealized losses on the Company's hedging activity was ($2.7) million and
($6.0) million at December 31, 1997 and 1998 respectively. This hedging activity
is designed to help the Company achieve its planned margins and represents
approximately 23% and 24% of the expected total #2 oil volume for the
corresponding 1997 and 1998 period.
The carrying amount of all hedging financial instruments at December 31, 1997
and 1998 was $488 and $3,009 respectively, and were included in Prepaid Expenses
on the Consolidated Balance Sheet. The risk that counterparties to such
instruments may be unable to perform is minimized by limiting the counterparties
to major oil companies and major financial institutions, including the New York
Mercantile Exchange. The Company does not expect any losses due to such
counterparty default.
Corporate Identity Expenses
Corporate identity expenses represent the costs associated with the Company's
brand identity program, implemented first in Long Island in 1996 and in the
Company's Metro New York and Mid Atlantic regions in 1997. These expenses
include the cost of repainting all delivery and service vehicles to reflect the
Company's new identity, and are expensed as they are incurred.
F-9
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
(1) Summary of Significant Accounting Policies - (Continued)
Star Gas Transaction Expenses
Star Gas transaction expenses represent costs incurred in association with the
Company's previously announced business combination with the Partnership (see
note 3). These expenses include legal, printing, advisory, and other
professional charges incurred to accomplish this business combination, and are
expensed as they are incurred. The Company estimates that it will incur a total
of $7.5 million to $8.5 million of costs associated with this transaction. If
this transaction is successfully completed, the Partnership will reimburse the
Company approximately $7.0 million for these expenses.
Environmental Costs
The Company expenses, on a current basis, costs associated with managing
hazardous substances and pollution in ongoing operations. The Company also
accrues for costs associated with the remediation of environmental pollution
when it becomes probable that a liability has been incurred and the amount can
be reasonably estimated.
Income Taxes
The Company files a consolidated Federal Income Tax return with its
subsidiaries. Deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial statement
carrying amount of assets and liabilities and their respective tax bases and
operating loss carryforwards. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled.
Basic and Diluted Earnings (Losses) per Common Share
The company computes basic and diluted earnings per share in accordance with the
requirements of the Financial Accounting Standards Board ("FASB") Statement of
Financial Accounting Standards ("SFAS") No. 128 - "Earnings Per Share". When the
impact of converting dilutive securities are antidilutive, the computation
treats such conversions as having no effect and presents basic and diluted
earnings per share as the same amount during periods with losses (see note 17).
Accounting Changes
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 130 - "Reporting Comprehensive
Income." SFAS No. 130 establishes standards for reporting and displaying changes
in equity that results from non-owner transactions and events. This statement is
effective for fiscal years beginning after December 15, 1997. The Company
adopted SFAS No. 130 and has made the appropriate disclosures.
In June 1997 the FASB issued SFAS No. 131 - "Disclosures about Segments of an
Enterprise and Related Information." SFAS No. 131 requires disclosures about
segments of an enterprise and related information such as the different types of
business activities and economic environments in which a business operates. This
statement is effective for fiscal years beginning after December 15, 1997. The
Company adopted SFAS No. 131 and in accordance with the Statement has disclosed
its only reportable segment.
In February 1998 the FASB issued SFAS No. 132 - "Employer's Disclosures about
Pensions and Other Postretirement Benefits." SFAS No. 132 attempts to
standardize the disclosure requirements for pensions and other postretirement
benefits. This statement is effective for fiscal years beginning after December
15, 1997. The Company adopted SFAS No. 132 and has made the appropriate
disclosures.
In June 1998 the FASB issued SFAS No. 133 - "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. This
statement is effective for all fiscal quarters of all fiscal years beginning
after June 15, 1999. The Company is assessing the impact and disclosure
requirements of SFAS No. 133.
F-10
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
(2) Star Gas Investment
In December 1993, the Company acquired an approximate 29.5% equity interest
(42.8% voting interest) in Star Gas for $16.0 million in cash. Each of the other
investors in Star Gas granted the Company an option, exercisable to December 31,
1998, to purchase such investor's interest in Star Gas. In December 1994, the
Company exercised its right to purchase the remaining outstanding common equity
of Star Gas by paying $3.8 million in cash and issuing approximately 2.5 million
shares ($22.1 million) of the Company's Class A Common Stock. The Company also
incurred $0.9 million of acquisition related cost in connection with the Star
Gas acquisition. The acquisition was accounted for as a purchase and accordingly
the purchase price was allocated to the underlying assets and liabilities based
upon the Company's estimate of their respective fair value at the date of
acquisition. The fair value of assets acquired was $141.3 million (including
$3.3 million in cash) and liabilities and preferred stock was $109.5 million.
The excess of the purchase price over the fair value of assets acquired and
liabilities assumed was $9.0 million and was being amortized over a period of
twenty-five years.
The Company's investment in Star Gas was accounted for using the equity method
from December 23, 1993 to December 7, 1994, at which time the Company exercised
its right to purchase the remaining outstanding common equity of Star Gas (the
"Star Gas Acquisition"). From December 8, 1994 to December 19, 1995 while Star
Gas was a wholly owned subsidiary of Petro, Star Gas operations, assets and
liabilities were included in the consolidated financial statements of the
Company.
In November 1995, Star Gas organized Star Gas Partners, L.P. a Delaware limited
partnership (the "Partnership") and Star Gas and the Partnership together
organized Star Gas Propane, L.P., a Delaware limited partnership ("Operating
Partnership"). In December 1995, Petro transferred substantially all of its
propane assets and liabilities to Star Gas, and Star Gas transferred ("Star Gas
Conveyance") substantially all of its assets (including the propane assets
transferred by Petro) in exchange for a general partnership interest in the
Operating Partnership and the assumption by the Operating Partnership of
substantially all of the liabilities of Star Gas. The total value of the assets
conveyed to the Operating Partnership was $156.5 million. Concurrently with the
Star Gas Conveyance, Star Gas issued approximately $85.0 million in First
Mortgage Notes to certain institutional investors. In connection with the Star
Gas Conveyance, the Operating Partnership assumed $91.5 million of Star Gas
liabilities including the $85.0 million of First Mortgage Notes; however, Star
Gas retained approximately $83.7 million in cash from the proceeds of the First
Mortgage Notes. As a result of the foregoing transactions ("1995 Star Gas
Transaction"), Star Gas received a 46.5% equity interest in the Partnership, and
Petro received distributions from the public sale of 2.6 million Master Limited
Partnership units at $20.46 per share for $51.0 million in cash. In order for
the Partnership to begin operations with $6.2 million of working capital, Star
Gas and the Operating Partnership agreed that the amount of debt assumed by the
Operating Partnership would be adjusted upward or downwards to the extent that
the working capital of the Operating Partnership at closing was more or less
than $6.2 million. At closing, the net working capital of the Operating
Partnership was $9.2 million and as a result, $3.0 million was paid to Petro in
January 1996.
In accordance with the Company's accounting policies, the Company deferred the
gain of approximately $20.0 million for this transaction because the Company
holds subordinate units which do not have a readily ascertainable market price
creating an uncertainty regarding realization, and due to the fact that Star Gas
as general partner had a $6.0 million additional capital contribution obligation
to enhance the Partnership's ability to make quarterly distributions on the
common units (at December 31, 1998, these funds were no longer restricted at the
Star Gas level and had been released to Petro since the quarterly guarantee
provisions were fulfilled). The Company will recognize the gain from this
transaction when the Company's subordinated units convert into common units in
accordance with the terms of the partnership agreement. In general, full
conversion of subordinated units to common units will take place no earlier than
the first day of any quarter beginning on or after January 1, 2001, based upon
the satisfaction of certain performance criteria for a period of at least three
non-overlapping consecutive four-quarter periods immediately preceding the
conversion date.
In October 1997, Star Gas acquired the outstanding stock of an unaffiliated Ohio
propane company ("1997 Star Gas Transaction") and in an equal exchange
subsequently transferred all of such assets to the Partnership for the
assumption of $23 million of debt incurred by Star Gas in connection with this
acquisition, a 0.00027% general partnership interest in the Partnership along
with one hundred and forty-eight thousand Partnership common units, and the
assumption by Star Gas of approximately $3.5 million of future income tax
liabilities resulting from this asset conveyance. Subsequently in December 1997,
the Company sold twenty-four thousand common units and in January 1998 sold
sixty-three thousand common units.
F-11
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
(2) Star Gas Investment (Continued)
As a result of the Partnership's secondary public offering in December 1997 a
difference of $2.4 million between the Company's carrying value of its
investment in the Partnership and its ownership percentage of the underlying net
assets of the Partnership, is being amortized to income over twenty-five years.
As of December 31, 1998 Petro has, through Star Gas, a 40.5% equity interest in
the Partnership and Star Gas is its general partner.
(3) Star Gas / Petro Transaction
On October 23, 1998, the Partnership and Petro jointly announced that they have
signed a definitive merger agreement pursuant to which Petro would be acquired
by the Partnership and would become a wholly-owned subsidiary of the Partnership
("the Star Gas/Petro transaction"). It is anticipated that this acquisition will
be accounted for using the purchase method of accounting. This transaction would
be effected through Petro shareholders exchanging their approximate 26.5 million
shares of Petro Common Stock for an approximate 3.2 million limited partnership
units and General Partnership units of the Partnership which will be
subordinated to the existing Common Units of the Partnership.
Of the 3.2 million subordinated Partnership units anticipated to be distributed
to Petro shareholders, 2.5 million will be Senior Subordinated Units and 0.7
million will be Junior Subordinated Units and General Partnership Units. The
Senior Subordinated Units will be publicly registered and tradable (they are
expected to be listed on the New York Stock Exchange) and will be subordinated
in distributions to the Partnership's Common Units. The Junior Subordinated
Units and General Partnership Units will not be registered nor publicly tradable
and will be subordinated to both the Common Units and the Senior Subordinated
Units. The Senior Subordinated Units will be exchanged with holders of Petro's
Class A and Class C Common Stock, other then shares held by Audrey Sevin, Irik
Sevin, and two corporations controlled by Wolfgang Traber, whose shares will be
exchanged for Junior Subordinated Units and General Partnership Units.
Pursuant to the partnership subordination provision, distributions on the
Partnership's Senior Subordinated Units may be made only after distributions of
Available Cash on Common Units meet the Minimum Quarterly Distribution ("MQD")
requirement. Distributions on the Partnership's Junior Subordinated Units and
General Partner Units may be made only after distributions of Available Cash on
Common Units and Senior Subordinated Units meet the MQD requirement. The
Subordination Period will generally extend until the Partnership earns and pays
its MQD for three years. As a condition of the Star Gas/Petro transaction, the
Partnership agreement will be amended so that no distribution will be paid on
the Senior Subordinated Units, Junior Subordinated Units, or the General Partner
Units except to the extent Available Cash is earned from operations beginning
with the quarter ending December 31, 1999. The first possible distribution is
February 2000.
Like many other publicly traded master limited partnerships, the Partnership
contains a provision which provides the General Partner with incentive
distributions in excess of certain targeted amounts. This provision will be
modified so that should there be any such incentive distributions, they will be
made pro rata to the holders of Senior Subordinated Units, Junior Subordinated
Units, and General Partner Units. In connection with the Star Gas/Petro
transaction, the Senior Subordinated Units, Junior Subordinated Units and
General Partnership Units can earn, pro rata, 0.3 million additional Senior
Subordinated Units each year that Petro meets certain financial goals to a
maximum of 0.9 million additional Senior Subordinated Units.
F-12
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
(3) Star Gas / Petro Transaction (Continued)
In connection with the Star Gas/Petro transaction, the Partnership intends to
raise approximately $170 million through a public offering of Common Units and
$90 million through a private offering of debt securities. The net proceeds from
these offerings will be used primarily to redeem approximately $240 million in
Petro public and private debt and preferred stock. Any such offering will be
made only by means of a prospectus or in transactions not requiring registration
under securities laws.
In October 1998, Petro completed an exchange offer with the holders of its 10
1/8% notes, 9 3/8% debentures, and 12 1/4% debentures and entered into
individually negotiated agreements with the holders of its 12 7/8% preferred
stock. In the debt exchange offer and preferred stock agreements, the holders of
approximately 98.5% in aggregate principal amount and liquidation preference of
Petro's public debt and preferred stock exchanged those securities for a like
principal amount and liquidation preference of new securities, the terms of
which are in all material respects the same as the terms of the old securities,
except that (1) the new debt securities are senior to the old debt securities,
and (2) the terms of the new debt securities and the new preferred stock (i)
give Petro the right to redeem these securities at the closing of the Star Gas /
Petro transaction but not later than April 1, 1999 at; 103.5% of face value for
the new 12 1/4% debentures; 100% of face value for the new 10 1/8% notes; 100%
of face value for the new 9 3/8% debentures; and $23.00 per share for the new 12
7/8% preferred stock; and (ii) eliminate substantially all covenants from the
indentures under which the old debt securities were issued. The tendering
holders of the old 12 7/8% preferred stock have also granted Petro an
irrevocable proxy to vote all their shares of preferred stock in favor of the
acquisition proposal at the special meeting.
In the debt exchange offer, Petro issued an aggregate 0.8 million shares of
junior convertible preferred stock (convertible to Petro Class A Common Stock on
a share for share basis) to the tendering holders. At the completion of the
transaction, those shares will be exchanged into an aggregate 0.1 million
Partnership Common Units in the merger. Holders of these shares have also
granted Petro an irrevocable proxy or have agreed to vote these shares in favor
of the acquisition proposal.
Petro currently has a 40.5% equity interest in the Partnership representing its
2.4 million Subordinated Units and a 2.0% interest in the Partnership or the
equivalent of 0.1 million units. As part of the Transaction, these units will be
contributed to the Partnership by Petro in exchange for one hundred and three
thousand Common Units and approximately 2.0 million Senior Subordinated Units.
The Common Units will be exchanged by Petro with the holders of Petro Junior
Convertible Preferred Stock and the Senior Subordinated Units ultimately be
exchanged with a portion of the holders of Petro's Common Stock. After
completion of the Star Gas/Petro transaction, the Petro shareholders will own
approximately 20% of the Partnership's equity through Subordinated Units and
General Partnership Units. The holders of the Partnership's Common Units
(including an estimated 8.9 million Common Units that will be sold in the
Partnership's $170 million public offering) will own an approximate aggregate
80% equity interest in the Partnership following the completion of the
transaction. The General Partner of the Partnership will be a newly organized
Delaware limited liability company that will be owned by certain officers and
directors of Petro consisting of Irik Sevin, Audrey Sevin and two entities
affiliated with Wolfgang Traber.
The completion of the Star Gas/Petro Transaction is subject to the receipt of
regulatory approvals, the approval of Star's non-affiliated Common unitholders
and non-affiliated Petro shareholders and other necessary partnership and
corporate approvals, as well as the successful completion of the debt and equity
offerings.
F-13
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
(4) Property, Plant and Equipment
The components of property, plant and equipment and their estimated useful lives
were as follows at the indicated dates:
December
----------------- Estimated
1997 1998 Useful Lives
-------- ------- --------------
Land $ 2,088 2,088
Buildings 5,641 6,672 20-45 years
Fleet and other equipment 38,065 38,811 3-7 years
Tanks and equipment 1,460 1,932 8-20 years
Furniture and fixtures 18,678 19,757 5-7 years
Leasehold improvements 7,465 7,719 Term of leases
-------- -------
73,397 76,979
Less accumulated depreciation 42,782 48,855
-------- -------
$ 30,615 $28,124
======== =======
(5) Notes Payable and Other Long-Term Debt
Notes payable and other long-term debt, including working capital borrowings and
current maturities of long-term debt, consisted of the following at the
indicated dates:
<TABLE>
<CAPTION>
December 31,
-----------------
1997 1998
---- ----
<S> <C> <C>
Notes payable to banks under credit facility (a) $ 3,000 $ --
Notes payable in connection with the purchase of fuel oil dealers and
other notes payable, due in monthly, quarterly and annual installments
with interest at various rates ranging from 8% to 15% per annum,
maturing at various dates through the year 2004 16,798 14,302
------- -------
19,798 14,302
Less current maturities, including working capital borrowings 3,291 5,921
------- -------
$16,507 $ 8,381
======= =======
</TABLE>
a) Pursuant to the July 1998 extension of the Credit Agreement as restated
and amended (Credit Agreement), the Company may borrow up to $47.0 million
under a working capital revolving credit facility with a sublimit under a
borrowing base established weekly. Amounts borrowed under the working
capital revolving credit facility are subject to a 60 day clean-up
requirement during the period April 1 to September 30 of each year, and
this portion of the Credit Agreement expires on June 29, 1999. The Company
pays a facility fee of 0.5% on the unused portion of this facility. At
December 31, 1998, no amount was outstanding under the working capital
revolving credit facility.
The Credit Agreement also includes a $14.1 million acquisition letter of
credit facility all of which has been used to support notes given to
certain sellers of heating oil companies. The Credit Agreement provides
that on June 30, 1998 and June 29, 1999 that 83.3% and 100% respectively,
of the facility outstanding be cash collateralized. As of December 31,
1998 $11.8 million (83.3%) of this facility has been cash collateralized
in accordance with the agreement.
Interest under the Credit Agreement is payable monthly on the working
capital revolving credit facility and is based upon a floating rate
selected by the Company of either the Eurodollar Loan Rate or the
Alternate Base Rate, plus 50 to 125 basis points on Alternate Base Rate
Loans and 175 to 250 basis points on Eurodollar Loans, based upon the
Interest Coverage Ratio (as defined in the Credit Agreement). Eurodollar
Loan Rate means the prevailing rate in the interbank Eurodollar market
adjusted for reserve requirements. Alternate Base Rate means the greater
of (i) the prime or base rate of The Chase Manhattan Bank in effect or
(ii) the Federal funds rate in effect plus 1/2 of 1%. The weighted average
rate for 1997 and 1998 was 7.75% and 7.62% respectively.
The fees for the Credit Agreement acquisition letters of credit range from
225 to 300 basis points based upon the same ratio as that used for the
working capital revolving credit facility. To the extent that the letters
of credit are cash collateralized the fee is reduced to 25 basis points.
F-14
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
(5) Notes Payable and Other Long-Term Debt - (Continued)
Under the terms of the Credit Agreement, the Company is restricted from
incurring any indebtedness except subordinated debt and certain other
indebtedness specifically authorized, if certain ratios of EBITDA to
interest are met. The Company is also restricted from amongst other
things, in paying common cash dividends and making acquisitions of other
companies, as well as not selling, transferring, or conveying customer
lists except, among other exceptions, from a sale where the net cash
proceeds are used to cash collateralize the acquisition letters of credit.
The Credit Agreement also provides that the Company is required to
maintain certain minimum levels of cash flow and EBITDA, as well as
certain ratios of EBITDA to net interest expense, and limits the total
amount of capital expenditures to $4.0 million per four consecutive
quarters. In the event of noncompliance with certain of the covenants, the
bank has the right to declare all amounts outstanding to be due and
payable immediately.
As collateral for the Credit Agreement the Company granted to the lenders
a security interest in its receivables which at December 31, 1998 was
$56,845.
The Company expects to renew or replace the working capital revolving
credit facility prior to June 29, 1999. Based on this expected renewal and
the Company's working capital position and expected net cash to be
provided by operating activities, the Company expects to be able to meet
all of its obligations in 1999.
Aggregate annual maturities including working capital borrowings, but excluding
the requisite $2.5 million acquisition letter of credit facility cash
collateralization due in June 1999 are as follows as of December 31, 1998:
Years Ending
December 31,
- ------------
1999 $ 5,921
2000 $ 8,141
2001 60
2002 60
2003 60
Thereafter 60
-------
$14,302
=======
(6) Senior, Senior Subordinated, and Subordinated Notes Payable
Senior, Senior Subordinated, and Subordinated Notes Payable at the dates
indicated, consisted of:
<TABLE>
<CAPTION>
December 31,
-------------------
1997 1998
---- ----
<S> <C> <C>
10.90% Senior Notes (a) $ 60,000 $ 60,000
14.10% Senior Subordinated and Senior Notes (b) 8,300 6,200
10 1/8% Senior Subordinated and Subordinated Notes (c) 50,000 50,000
9 3/8% Senior Subordinated and Subordinated Debentures (d) 75,000 75,000
12 1/4% Senior Subordinated and Subordinated Debentures (e) 81,250 81,250
-------- --------
Total Senior, Senior Subordinated, and Subordinated Notes Payable 274,550 272,450
Less short-term Senior Subordinated Notes (b) 1,050 1,050
Less short-term Senior Notes (b) 1,050 1,050
Less long-term Senior Notes (a)(b) 63,100 62,050
-------- --------
Total long-term Senior Subordinated and Subordinated Notes Payable $209,350 $208,300
======== ========
</TABLE>
In October 1998, Petro completed an exchange offer with the holders of its 10
1/8% notes, 9 3/8% debentures, and 12 1/4% debentures. In the debt exchange
offer the holders of approximately 98.5% in aggregate principal amount of
Petro's public debt exchanged those securities for a like principal amount of
new securities, the terms of which are in all material respects the same as the
terms of the old securities, except that (1) the new debt securities are senior
to the old debt securities, and (2) the terms of the new debt securities (i)
give Petro the right to redeem these securities at the closing of the Star Gas /
Petro transaction but not later than April 1, 1999 at; 103.5% of face value for
the new 12 1/4% debentures; 100% of face value for the new 10 1/8% notes; and
100% of face value for the new 9 3/8% debentures; and (ii) eliminate
substantially all covenants from the indentures under which the old debt
securities were issued.
F-15
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
(6) Senior, Senior Subordinated, and Subordinated Notes Payable - (Continued)
a) On September 1, 1988, the Company authorized the issuance of $60.0 million
of Subordinated Notes originally due October 1, 1998 bearing interest
payable semiannually at an average rate of 11.96% ("11.96% Notes"). In
connection with the Company's 9 3/8% Subordinated Debenture offering in
February 1994 (see note 6d) $30.0 million of the 11.96% Notes became
ranked as senior debt. In February 1997 the Company entered into
agreements ("Private Debt Modification") to among other things, exchange
$30.0 million of the 11.96% Notes then ranked as subordinated debt for
senior debt, and to extend the maturity date of the 11.96% Notes from
October 1, 1998 to October 1, 2002 with $15.0 million sinking fund
payments due on October 1, 2000 and October 1, 2001 and the remaining
$30.0 million balance due on October 1, 2002. The Company paid
approximately $1.1 million in fees and expenses to obtain such
modifications. In addition, effective October 1, 1998, the interest on
these notes were lowered to 10.9%. The debt instruments were not
considered to be substantially different since the cash flow effect on a
present value basis was less than 10 percent. Accordingly, the
modification was not accounted for as an extinguishment of debt. All such
notes are redeemable at the option of the Company, in whole or in part
upon payment of a premium rate as defined.
b) On January 15, 1991, the Company authorized the issuance of $12.5 million
of 14.10% Subordinated Notes due January 15, 2001 bearing interest payable
quarterly. In connection with the Company's 9 3/8% Subordinated Debenture
offering in February 1994 (see note 6d) $6.25 million of these notes
became ranked as senior debt. The notes are redeemable at the option of
the Company, in whole or in part upon payment of a premium rate as
defined. On each January 15th commencing 1996 and ending January 15, 2000,
the Company is required to repay $2.1 million of these Notes. The
remaining principal of $2.0 million is due on January 15, 2001. No premium
is payable in connection with these required payments.
c) On April 6, 1993, the Company issued $50.0 million of 10 1/8% Subordinated
Notes due April 1, 2003 which are redeemable at the Company's option, in
whole or in part, at any time on or after April 1, 1998 upon payment of a
premium rate as defined. Interest is payable semiannually.
d) On February 3, 1994, the Company issued $75.0 million of 9 3/8%
Subordinated Debentures due February 1, 2006 which are redeemable at the
Company's option, in whole or in part, at any time on or after February 1,
1999 upon payment of a premium rate as defined. Interest is payable
semiannually.
In connection with the offering of its 9 3/8% Subordinated Debentures, the
Company received consents of the holders of a majority of each class of
subordinated debt and redeemable preferred stock (see note 8) to certain
amendments to the respective agreements. In consideration for the
consents, the Company paid holders of certain subordinated debt a cash
payment of $0.6 million and caused approximately $42.6 million of the
subordinated debt at December 31, 1994 to be ranked as senior debt. In
addition, the Company agreed to increase dividends on the redeemable
preferred stock by $2.00 per share per annum. The Company also paid
approximately $1.5 million in fees and expenses to obtain such consents.
e) On February 3, 1995, the Company issued $125.0 million of 12 1/4%
Subordinated Debentures due February 1, 2005 which are redeemable at the
Company's option, in whole or in part, at any time on or after February 1,
2000 upon payment of a premium rate as defined. On February 5, 1996, a
portion of the proceeds received as a result of the Star Gas MLP Offering
(see note 2) were used to retire $43.8 million of the $125.0 million 12
1/4% Subordinated Debentures. The Company paid $4.8 million, representing
an 11% premium to retire this portion of the debt. Interest on these
debentures is payable semi-annually.
Expenses connected with the above outstanding offerings, and amendments thereto,
amounted to approximately $15.8 million, which includes $1.2 million paid in
debt consents permitting the Star Gas MLP Offering (see note 2). At December 31,
1997 and 1998, the unamortized balances relating to notes still outstanding
amounted to approximately $8.4 million and $7.0 million respectively, and such
balances are included in Deferred Charges and Pension Costs on the Consolidated
Balance Sheet.
F-16
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
(6) Senior, Senior Subordinated, and Subordinated Notes Payable - (Continued)
Aggregate annual maturities including sinking fund payments at December 31, 1998
are as follows:
Years Ended
December 31,
- ------------
1999 $ 2,100
2000 17,100
2001 17,000
2002 30,000
2003 50,000
Thereafter 156,250
--------
$272,450
========
The Company has substantial repayment obligations on indebtedness that become
due beginning in the year 2000. If the proposed Star Gas / Petro Transaction
(see note 3) is completed, these obligations are expected to be refinanced on or
before their maturities. In the event that such transaction does not occur, the
Company will explore alternatives including the repayment or refinancing of such
maturities. If such alternatives cannot be effected, it could have a material
adverse affect on the Company.
Total accrued interest on notes payable, and senior and subordinated notes which
were included in accrued expenses and other liabilities were $10,664 and $10,160
at December 31, 1997 and 1998 respectively.
(7) Common Stock and Common Stock Dividends
The Company's outstanding Common Stock consists of Class A Common Stock, Class B
Common Stock and Class C Common Stock, each with various designations, rights
and preferences.
Holders of Class A Common Stock and Class C Common Stock have identical rights,
except that holders of Class A Common Stock are entitled to one vote per share
and holders of Class C Common Stock are entitled to ten votes per share. Holders
of Class B Common Stock do not have voting rights, except as required by law, or
in certain limited circumstances.
The following table summarizes the cash dividends declared on Common Stock and
the cash dividends declared per common share for the years indicated:
Years Ended December 31,
----------------------------
Cash dividends declared 1996 1997 1998
---- ---- ----
Class A $ 13,789 $ 7,019 $ --
Class C 1,559 779 --
Cash dividends declared per share
Class A $ .60 $ .30 $ --
Class C .60 .30 --
Under the Company's most restrictive dividend limitation imposed by certain debt
covenants, $31.6 million was available at December 31, 1998 for the payment of
dividends on all classes of Capital Stock. Under these covenants the amount
available for dividends is increased each quarter by 50% of the cash flow, as
defined, for the previous fiscal quarter, and by the new issuance of capital
stock. Notwithstanding these covenants, the Company is however currently
restricted from paying common stock dividends under its bank credit agreement.
On October 1, 1995 the Company began offering a Dividend Reinvestment and Stock
Purchase Plan which provides holders of the Company's Class A Common Stock and
Class C Common Stock a vehicle to reinvest their dividends and purchase
additional shares of Class A Common Stock at a 5% discount from the current
market price without incurring any fees. In addition, optional cash deposits
receive a 3% discount from the market price. Pursuant to the plan offering,
three hundred and two thousand, six hundred and ninety-one thousand, and two
hundred and seventy-one thousand additional Class A Common Shares were issued in
1996, 1997, and 1998 respectively.
F-17
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
(8) Preferred Stock, Redeemable Preferred Stock and Exchangeable Preferred
Stock
The Company entered into agreements dated as of August 1, 1989 with John Hancock
Mutual Life Insurance Company and Northwestern Mutual Life Insurance Company to
sell up to two hundred and fifty thousand shares of its Redeemable Preferred
Stock, par value $0.10 per share, at a price of one hundred dollars per share,
which shares are exchangeable into Subordinated Notes due August 1, 1999 ("1999
Notes").
On August 1 of each year, one-sixth of the number of originally issued shares of
each series of Redeemable Preferred shares outstanding, less the number of
shares of such series previously exchanged for 1999 Notes, are to be redeemed,
with the final redemption occurring on August 1, 1999. The redemption price is
one hundred dollars per share plus all accrued and unpaid dividends to such
August 1. As of December 31, 1997 and 1998, eighty-three thousand shares and
forty-two thousand shares respectively were outstanding of which forty-two
thousand shares were reflected as current.
In February 1997 the Company issued one million two hundred thousand shares of
its 12 7/8% Exchangeable Preferred Stock ("Exchangeable Preferred Stock") due
February 15, 2009, par value $0.10 per share, at a price of twenty-five dollars
per share. The Company incurred $1,678 of offering costs in connection with this
preferred stock issuance. Dividends are payable on these shares on February 15,
May 15, August 15 and November 15 of each year. These shares are callable at
twenty-three dollars per share at the closing of the Star Gas / Petro
transaction but not later than April 1, 1999 otherwise, the liquidation
preference on the Exchangeable Preferred Stock is twenty-five dollars per share,
and they are redeemable at the option of the Company in whole or in part, at any
time on or after February 15, 2002 upon payment of a premium rate as defined.
Subject to certain conditions the Company may also issue an additional eight
hundred thousand shares of Exchangeable Preferred Stock. Also, on any scheduled
dividend payment date on or after February 15, 2000 at the Company's option
these Exchangeable Preferred Stock may be exchanged into 12 7/8% Junior
Subordinated Exchangeable Debentures due 2009. At December 31, 1997 and 1998
$30.0 million of Exchangeable Preferred Stock was outstanding.
In August and September of 1998 the Company issued seven hundred and
eighty-seven thousand of no par value preferred stock ("Junior Convertible
Preferred Stock") in connection with the Star Gas / Petro transaction. These
shares were issued in addition to other consideration, for the early redemption
rights of its 9 3/8% Subordinated Debentures, 10 1/8% Subordinated Notes, 12
1/4% Subordinated Debentures and 12 7/8% Exchangeable Preferred Stock (see note
3). The Company issued such holders three and thirty-seven one-hundredths shares
of Junior Convertible Preferred Stock for each thousand dollars in principal
amount or liquidation preference of such securities. Each share of Junior
Convertible Preferred Stock will be exchangeable into thirteen one-hundredths of
a Partnership Common Unit at the conclusion of the Star Gas/Petro transaction
representing a maximum of approximately one hundred and three Common Units.
Should the transaction not be consummated, the Junior Convertible Preferred
Stock will be convertible into a like number of Class A Common Stock (see note
3).
Preferred dividends of $2,389, $4,644 and $5,057 were declared on all classes of
preferred stock in 1996, 1997, and 1998 respectively.
Aggregate annual maturities of Redeemable Preferred Stock and Exchangeable
Preferred Stock are as follows as of December 31, 1998:
Years Ended
December 31
- -----------
1999 $ 4,167
2000 --
2001 --
2002 --
2003 --
Thereafter 30,000
-------
$34,167
=======
F-18
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
(9) Pension Plans
Effective December 31, 1996 the Company consolidated all of its defined
contribution pension plans and froze the benefits for nonunion personnel covered
under defined benefit pension plans. In the third quarter of 1997 the Company
froze the benefits of its New York City union defined benefit pension plan as a
result of operation consolidations. In freezing the defined benefit pension
plans and the New York City union defined benefit pension plan the Company
incurred $557 and $654 of expenses in 1996 and 1997 respectively, for pension
curtailment costs relating to the amortization of certain previously
unrecognized pension expenses.
The defined benefit and defined contribution plans covered substantially all of
the Company's nonunion employees. Benefits under the frozen defined benefit
plans were generally based on years of service and each employee's compensation.
Benefits under the consolidated defined contribution plan are based on an
employees compensation. Pension expense under all non-union plans for the years
ended December 31, 1996, 1997 and 1998 was $4,350, $4,036 and $4,428
respectively, net of amortization of the pension obligation acquired.
The following tables provide a reconciliation of the changes in the plans'
benefit obligations, fair value of assets, and a statement of the funded status
at the indicated dates:
<TABLE>
<CAPTION>
December 31,
--------------------
Reconciliation of Benefit Obligations 1997 1998
---- ----
<S> <C> <C>
Benefit obligations at beginning of year $ 29,323 $ 29,258
Service cost 116 --
Interest cost 1,895 1,930
Actuarial (gain) loss 977 (63)
Benefit payments (1,384) (1,547)
Settlements (1,669) (2,201)
-------- --------
Benefit obligation at end of year $ 29,258 $ 27,377
======== ========
Reconciliation of Fair Value of Plan Assets
Fair value of plan assets at beginning of year $ 20,367 $ 22,292
Actual return on plan assets 2,780 2,561
Employer contributions 2,458 615
Benefit payments (1,384) (1,547)
Settlements (1,929) (2,883)
-------- --------
Fair value of plan assets at end of year $ 22,292 $ 21,038
======== ========
<CAPTION>
Funded Status 1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Benefit obligation $ 29,323 $ 29,258 $ 27,377
Fair value of plan assets 20,367 22,292 21,038
Unrecognized transition (asset) obligation (65) (52) (39)
Unrecognized prior service cost 453 -- --
Unrecognized net actuarial (gain) loss 6,812 5,807 4,776
-------- -------- --------
Prepaid (accrued) benefit cost prior to additional
liability (1,756) (1,211) (1,602)
Amount included in comprehensive income 6,065 4,646 4,737
-------- -------- --------
Prepaid (accrued) benefit cost $ (7,821) $ (5,857) $ (6,339)
======== ======== ========
Components of Net Periodic Benefit Cost
Service cost $ 1,630 $ 116 $ --
Interest cost 1,974 1,895 1,930
Expected return on plan assets 1,573 1,787 1,846
Amortization of unrecognized transition (asset)
obligation 60 (13) (13)
Amortization of prior service cost 76 49 --
Recognized net (gains) losses 678 369 160
Settlement (gain) loss -- 344 572
Curtailment (gain) loss 557 404 --
-------- -------- --------
Net periodic benefit cost after curtailments
and settlements $ 3,402 $ 1,377 $ 803
======== ======== ========
Weighted-Average Assumptions Used in the Measurement of
the Company's Benefit Obligation as of December 31,
Discount rate 6.5% 6.5% 6.5%
Expected return on plan assets 8.5% 8.5% 8.5%
Rate of compensation increase 4.0% N/A N/A
</TABLE>
F-19
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
(9) Pension Plans - (Continued)
In addition, the Company made contributions to union-administered pension plans
during the years ended December 31, 1996, 1997 and 1998 of $2,996, $2,508, and
$1,991 respectively.
The Company recorded an additional minimum pension liability for underfunded
plans of $4,698 as of December 31, 1998, representing the excess of unfunded
accumulated benefit obligations over plan assets. A corresponding amount is
recognized as an intangible asset except to the extent that these additional
liabilities exceed the related unrecognized prior service costs and net
transition obligation, in which case the increase in liabilities is charged as a
reduction of stockholders' equity of $4,737 as of December 31, 1998.
In connection with the purchase of shares of a predecessor company as of January
1, 1979 by a majority of the Company's present holders of Class C Common Stock,
the Company assumed a pension liability in the aggregate amount of $1,512 as
adjusted, representing the excess of the actuarially computed present value of
accumulated vested plan benefits over the net assets available for such
benefits. Such liability, which amounted to $1,108 and $1,082 at December 31,
1997 and 1998 is being amortized over 40 years and is included in supplemental
benefits and other long-term liabilities at those dates.
Under a 1992 supplemental benefit agreement, Malvin P. Sevin, the Company's then
Chairman and Co-Chief Executive Officer, was entitled to receive $25 per month
for a period of one hundred twenty months following his retirement. In the event
of his death, his designated beneficiary is entitled to receive such benefit.
Mr. Sevin passed away in December 1992, prior to his retirement. The amounts
accrued for such benefit payable net of payments made at December 31, 1997 and
1998 were $1,204, and $1,005 respectively and are included in supplemental
benefits and other long-term liabilities on the balance sheets at those dates.
(10) Leases
The Company leases office space and other equipment under noncancelable
operating leases which expire at various times through 2017. Certain of the real
property leases contain renewal options and require the Company to pay property
taxes.
The future minimum rental commitments at December 31, 1998 for all operating
leases having an initial or remaining noncancelable term of one year or more are
as follows:
Years Ending Operating
December Leases
- ------------ ---------
1999 $ 4,333
2000 3,763
2001 3,194
2002 3,437
2003 3,292
Thereafter 19,056
--------
$ 37,075
========
Rental expense under operating leases for the years ended December 31, 1996,
1997 and 1998 was $6,461, $7,475, and $6,621 respectively.
F-20
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
(11) Income Taxes
Income tax expense was comprised of the following for the indicated periods:
Years Ended December 31,
---------------------------
1996 1997 1998
---- ---- ----
Current:
Federal $ - $ - $ -
State 500 500 400
--- --- ---
$ 500 $ 500 $ 400
==== ==== ====
The sources of deferred income tax expense (benefit) and the tax effects of each
were as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------
1996 1997 1998
------- ------- -------
<S> <C> <C> <C>
Excess of book over tax (tax over book) depreciation $ (81) $ (227) $ (432)
Excess of book over tax amortization expense (2,051) (2,490) (2,727)
Excess of book over tax vacation expense (180) (107) (12)
Excess of book over tax restructuring expense (206) (618) 254
(Excess of book over tax) tax over book bad debt expense (41) 37 12
(Excess of book over tax) tax over book supplemental benefit expense (14) 14 20
Equity in income (loss) of Star Gas Partnership 2,597 1,037 (1,048)
Other, net (228) 5 197
Recognition of tax benefit of net operating loss to the
extent of current and previous recognized temporary differences (9,114) (4,491) (8,130)
Change in valuation allowance 9,318 6,840 11,866
------- ------- -------
$ -- $ -- $ --
======= ======= =======
</TABLE>
The components of the net deferred tax assets and the related valuation
allowance for 1997 and 1998 using current rates were as follows:
Years Ended December 31,
-----------------------
1997 1998
-------- --------
Net operating loss carryforwards $ 39,690 $ 47,820
Excess of tax over book depreciation (4,814) (4,382)
Excess of book over tax amortization 6,114 8,841
Excess of book over tax vacation expense 1,600 1,612
Excess of book over tax restructuring expense 824 570
Excess of book over tax bad debt expense 333 321
Excess of book over tax supplemental benefit expense 666 646
Equity in loss (income) of Star Gas Partnership (2,775) (1,727)
Other, net 360 163
-------- --------
41,998 53,864
Valuation allowance (41,998) (53,864)
-------- --------
$ -- $ --
======== ========
A valuation allowance is provided when it is more likely than not that some
portion of the deferred tax asset will not be realized. The Company has
determined, based on the Company's recent history of annual net losses, that a
full valuation allowance is appropriate.
At December 31, 1998, the Company had the following income tax loss
carryforwards for Federal Income Tax reporting purposes:
Expiration
Date
----
2005 $ 26,651
2006 15,012
2007 1,367
2008 8,400
2009 1,662
2010 23,356
2011 26,554
2012 13,948
2018 23,695
--------
$140,645
========
F-21
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
(12) Related Party Transactions
In October 1986, Irik P. Sevin purchased one hundred sixty-one thousand shares
of Class A Common Stock and forty thousand shares of Class C Common Stock of the
Company for $1,280 (which was the fair market value as established by the
Pricing Committee pursuant to the Stockholders' Agreement). The purchase price
was financed by a note due December 31, 1999. The note requires annual payments
of interest and principal, payable in cash or Class A Common Stock of the
Company, until complete satisfaction. In accordance with the note repayment
schedule and the criteria for stock payment valuation, Mr. Sevin surrendered
sixty-one thousand Class A Common Shares representing $411 of value, sixty-two
thousand Class A Common Shares representing $392 of value, and fifty-eight
thousand Class A Common Shares representing $370 of value in December 1996, 1997
and 1998 respectively. The criteria agreed upon for valuing stock payment for
this transaction is the average market price ten days prior to payment or
$6.3479 per share, whichever is greater. The outstanding balance of the note was
$984, $656, and $328 at December 31, 1996, 1997, and 1998 respectively. Interest
accrues on the outstanding balance of the note at the LIBOR rate in effect for
each month plus 0.75%. Mr. Sevin has entered into an agreement with the Company
that he will not sell or otherwise transfer to a third party any of the shares
of Class A Common Stock or Class C Common Stock received pursuant to this
transaction until the note has been paid in full.
The existing holders of Class C Common Stock of the Company have entered into a
Shareholders' Agreement which provides that each will vote his shares to elect
certain designated directors. The Shareholders' Agreement also provides for
first refusal rights to the Company if a holder of Class C Common Stock receives
a bona fide written offer from a third party to buy such holder's Class C Common
Stock.
(13) Restructuring Charges
Late in 1995 the Company completed a study with a leading consulting firm to
help provide a structure for superior customer service, a brand image, and
reduced operating costs. Over the last few years the Company has dedicated a
large amount of effort toward defining the best organizational structure, and
has implemented various initiatives toward achieving this objective.
As part of the initial implementation of this program, Petro undertook certain
business improvement strategies in its Long Island, New York region. These steps
included the consolidation of the region's five home heating oil branches into
one central customer service center and three depots. The regional customer
service center consolidated accounting, credit, customer service and the sales
function into a single new facility in Port Washington, Long Island. All
external communications and marketing previously undertaken in the five branches
were centralized into this one location freeing the three newly configured
depots to focus on oil delivery and heating equipment repair, maintenance and
installation, in mutually exclusive operating territories. The Company incurred
$1.2 million in restructuring expenses in 1996, for costs associated with the
initial implementation of the restructuring program and reported such expenses
in restructuring charges. This cost was comprised of $0.5 million in termination
benefit arrangements for the twenty-three servicemen and drivers, twenty-eight
credit and customer service personnel, and eight sales, general, and
administrative personnel displaced by the program; and $0.7 million for
continuing lease obligations for an unused, non-cancelable, non-strategic
facility.
In 1997 the Company continued with its restructuring program and combined its
three New York City branches into one new central depot that specializes in
delivery, installation, maintenance, and service functions, and like the Long
Island depots, is supported by the Port Washington facility. The Company also
proceeded with its commitment to define the best possible organizational
structure, by restructuring select branch and corporate responsibilities to
eliminate redundant functions and locate responsibilities where they can best
serve customers and the Company. Toward achieving these strategic intentions the
Company incurred $2.9 million in restructuring expenses in 1997, and reported
such expenses in restructuring charges. This cost was comprised of $2.0 million
in termination benefit arrangements for twenty-three servicemen and drivers, ten
credit and customer service personnel, and twenty-two sales, general, and
administrative personnel displaced by the program; and $0.9 million for
continuing lease obligations for three unused, non-cancelable, non-strategic
facilities. The Company continued its restructuring and cost reduction
initiative in the first quarter of 1998, incurring $0.5 million in termination
benefit arrangements with four sales, general, and administrative personnel.
The total unpaid amounts included in accrued expenses and other liabilities are
$2.4 million and $1.7 million respectively at December 31, 1997 and 1998. These
amounts predominately represent continuing lease obligations as all the
termination benefit arrangements have been paid.
F-22
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
(13) Restructuring Charges - (Continued)
This liability is expected to be paid and relieved as follows:
Year Ended
December 31,
- ------------
1999 $ 500
2000 300
2001 100
2002 100
2003 200
Thereafter 500
------
$1,700
======
(14) Stock Options
In March 1994 the Company issued stock options to Irik P. Sevin to purchase one
hundred thousand shares of Class A Common Stock. The option price for each such
share is $8.50, the then market value of the stock on the date the options were
granted. These options vested upon issuance are non-transferable and expire on
March 31, 2004.
In June 1994, the Board of Directors and shareholders adopted the Petroleum Heat
and Power Co., Inc. 1994 Stock Option Plan, which authorized one million shares
of the Company's Class A Common Stock to be granted from time to time, and to
vest at various times, to key employees, officers, directors, consultants,
advisers, or agents, who help contribute to the long-term success and growth of
the firm, at prices not less than the fair market value at the date of grant and
at terms not to exceed ten years.
As allowable by SFAS No. 123, the Company will continue to apply APB Opinion No.
25, Accounting for Stock Issued to Employees, and related interpretations in
accounting for its stock compensation plan, and does not recognize compensation
expense for its stock-based compensation plan.
Had compensation cost for this plan been determined based upon the fair value at
the grant date for awards under this plan consistent with the methodology
prescribed under SFAS No. 123, the Company's net loss and loss per share for
1997 and 1998 would have been increased by approximately nineteen thousand
dollars, or $0.0007 per share, and one hundred twenty-eight thousand dollars, or
$0.0048 per share respectively. All options were granted at an amount equal to
the quoted market price of the Company's stock at the date of the grants and
vest at various times with no vesting period exceeding five years. The proforma
costs charged against income for options granted are based on the following
assumptions calculated on a straight line basis over the vesting period of the
grants for options granted prior to 1998, and calculated as a period expense for
those granted in 1998. The average fair value of the options granted during 1997
was $0.21 per option on the date of grant using the Black-Scholes option-pricing
model with the following assumptions: dividend yield of 12.97%, volatility of
35%, risk-free interest rate of 6.19%, assumed forfeiture rate of 0%, and an
average expected life of 10 years. The fair value of the options granted during
1998 was $1.27 per option on the date of grant using the Black-Scholes
option-pricing model with the following assumptions: dividend yield of 0%,
volatility of 52%, risk-free interest rate of 5.83%, assumed forfeiture rate of
50%, and an expected life of 10 years.
F-23
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
(14) Stock Options - (Continued)
Information relating to stock options during 1996, 1997 and 1998 are summarized
as follows:
<TABLE>
<CAPTION>
Number of Shares Weighted-Average
Range of -------------------- Exercise Price
Exercise Prices Class A Class C Per Share Total
--------------- ------- ------- --------- -----
<S> <C> <C> <C> <C> <C>
Shares under option at
December 31, 1995 $ 4.10 to $11.25 1,393 103 $ 7.66 $11,447
Granted $ 6.87 to $ 7.38 132 -- 7.21 955
Exercised -- -- -- -- --
Expired / Forfeited $ 7.50 to $ 7.50 24 6 7.50 225
-------------------------------------------------------------------------
Shares under option at
December 31, 1996 $ 4.10 to $11.25 1,501 97 7.62 12,177
Granted $ 3.00 to $ 3.13 40 -- 3.05 122
Exercised -- -- -- -- --
Expired / Forfeited $ 4.10 to $ 8.77 1,097 79 7.16 8,410
-------------------------------------------------------------------------
Shares under option at
December 31, 1997 $ 3.00 to $11.25 444 18 8.41 3,889
Granted $ 1.81 to $ 1.81 200 -- 1.81 362
Exercised -- -- -- -- --
Expired / Forfeited $ 3.13 to $11.25 319 18 8.78 2,964
-------------------------------------------------------------------------
Shares under option at
December 31, 1998 $ 1.81 to $ 8.50 325 -- $ 3.96 $ 1,287
=========================================================================
Shares exercisable from $ 1.81 to $ 3.00 225 -- $ 1.94 $ 437
Shares exercisable $ 8.50 100 -- 8.50 850
-------------------------------------------------------------------------
Total shares exercisable
at December 31, 1998 $ 1.81 to $ 8.50 325 -- $ 3.96 $ 1,287
=========================================================================
</TABLE>
The weighted average life of the shares exercisable from $1.81 to $3.00 is 8.8
years, and the weighted average life of the shares exercisable at $8.50 is 5.3
years.
F-24
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
(15) Acquisitions
During 1996, the Company acquired the customer lists and equipment of thirteen
unaffiliated fuel oil dealers. The aggregate consideration for these
acquisitions, accounted for by the purchase method, was approximately $28,500;
and approximately 90% of this consideration was for customer lists, goodwill,
and covenants not to compete.
In June 1996, the Company sold its Springfield Massachusetts operations to an
unaffiliated fuel oil dealer. The Company received proceeds of approximately
$4,100 and realized a gain on this transaction of approximately $1,800.
During 1997, the Company acquired the customer lists and equipment of eleven
unaffiliated fuel oil dealers. The aggregate consideration for these
acquisitions, accounted for by the purchase method, was approximately $16,300;
and approximately 90% of this consideration was for customer lists, goodwill,
and covenants not to compete.
In November 1997, the Company sold its Hartford Connecticut operation to an
unaffiliated fuel oil dealer. The Company received proceeds of approximately
$15,600 and recognized a gain on this transaction of approximately $11,400.
The Company did not make any acquisitions nor sell any branches in 1998.
Sales and net income of the acquired companies are included in the consolidated
statements of operations from the respective dates of acquisition.
Unaudited pro forma data giving effect to the purchased and disposed businesses,
as if they had been acquired on January 1 of the year preceding the year of
purchase and disposal, with adjustments, primarily for amortization of
intangibles are as follows:
<TABLE>
<CAPTION>
1996 1997
---- ----
<S> <C> <C>
Net sales $ 607,240 $ 538,988
Loss before extraordinary item $ (23,029) $ (22,397)
Net loss $ (29,443) $ (22,397)
Preferred stock dividends (2,389) (4,644)
--------- ---------
Net loss applicable to common stockholders (Numerator) $ (31,832) $ (27,041)
========= =========
Class A Common Stock 22,983 23,441
Class B Common Stock 12 11
Class C Common Stock 2,598 2,598
--------- ---------
Weighted average number of shares outstanding (Denominator) 25,593 26,050
========= =========
Basic and Diluted losses per common share
before extraordinary item:
Class A and C Common Stock $ (0.99) $ (1.04)
Extraordinary loss per common share:
Class A and C Common Stock $ (0.25) $ --
Basic and Diluted losses per common share:
Class A and C Common Stock $ (1.24) $ (1.04)
</TABLE>
(16) Litigation
The Company is not party to any litigation which individually or in the
aggregate could reasonably be expected to have a material adverse effect on the
Company.
F-25
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
(17) Disclosures About the Fair Value of Financial Instruments
Cash, Restricted Cash, Accounts Receivable, Notes Receivable and Other Current
Assets, Working Capital Borrowings, Accounts Payable and Accrued Expenses
The carrying amount approximates fair value because of the short maturity of
these instruments.
Long-Term Debt, Subordinated Notes Payable, Senior Notes Payable and Cumulative
Redeemable Exchangeable Preferred Stock
The fair values of each of the Company's long-term financing instruments,
including current maturities, are based on the amount of future cash flows
associated with each instrument, discounted using the Company's current
borrowing rate for similar instruments of comparable maturity.
The estimated fair value of the Company's financial instruments are summarized
as follows:
<TABLE>
<CAPTION>
At December 31, 1997 At December 31, 1998
-------------------- --------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
<S> <C> <C> <C> <C>
Long-term debt $ 16,798 $ 15,853 $ 14,302 $ 13,488
Senior Subordinated and
Subordinated notes payable 210,400 197,883 209,350 198,394
Senior notes payable 64,150 64,343 63,100 61,408
Preferred stock 36,656 39,722 32,745 33,894
</TABLE>
Limitations
Fair value estimates are made at a specific point in time, based on relevant
market information and information about the financial instrument. These
estimates are subjective in nature and involve uncertainties and matters of
significant judgment and therefore cannot be determined with precision. Changes
in assumptions could significantly affect the estimates.
(18) Earnings Per Share
December 31,
------------------------------
1996 1997 1998
---- ---- ----
Basic Earnings Per Share:
Net loss $(28,315) $(22,899) $(35,337)
Less: Preferred stock dividends (2,389) (4,644) (5,057)
-------- -------- --------
Loss available to common stockholders
(Numerator) $(30,704) $(27,543) $(40,394)
======== ======== ========
Class A Common Stock 22,983 23,441 23,962
Class B Common Stock 12 11 11
Class C Common Stock 2,598 2,598 2,598
-------- -------- --------
Weighted average number of shares outstanding
(Denominator) 25,593 26,050 26,571
======== ======== ========
Basic losses per share $ (1.20) $ (1.06) $ (1.52)
======== ======== ========
Diluted Earnings Per Share:
Effect of dilutive securities $ -- $ -- $ --
-------- -------- --------
Loss available to common stockholders
(Numerator) $(30,704) $(27,543) $(40,394)
======== ======== ========
Effect of dilutive securities -- -- --
-------- -------- --------
Weighted average number of shares outstanding
(Denominator) 25,593 26,050 26,571
======== ======== ========
Diluted losses per share $ (1.20) $ (1.06) $ (1.52)
======== ======== ========
Certain potentially dilutive securities issued (i.e. options) are not considered
in the above calculation due to the fact that they would be anti-dilutive.
F-26
<PAGE>
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
(19) Selected Quarterly Financial Data - (Unaudited)
The seasonal nature of the Company's business results in the sale by the Company
of approximately 50% of its volume of home heating oil in the first quarter and
30% of its volume of home heating oil in the fourth quarter of each year. The
Company generally realizes net income in both of these quarters and net losses
during the warmer quarters ending June and September.
<TABLE>
<CAPTION>
Three Months Ended
------------------------------------------------------------
3/31/97 6/30/97 9/30/97 12/31/97 Total
------- ------- ------- -------- -----
<S> <C> <C> <C> <C> <C>
Net sales $ 248,095 $ 87,972 $ 50,788 $ 161,286 $ 548,141
Income (loss) before income taxes and
equity interest $ 31,285 $ (25,550) $ (37,959) $ 10,060 $ (22,164)
Net income (loss) $ 33,388 $ (27,454) $ (40,316) $ 11,483 $ (22,899)
Preferred dividends (896) (921) (1,861) (966) (4,644)
--------- ---------- ---------- ---------- ----------
Net income (loss) available to common
stockholders $ 32,492 $ (28,375) $ (42,177) $ 10,517 $ (27,543)
========= ========== ========== ========== ==========
Basic earnings (losses) per common share:
Class A and C Common Stock $ 1.26 $ (1.09) $ (1.61) $ 0.40 $ (1.06)
Diluted earnings (losses) per common share:
Class A and C Common Stock $ 1.26 $ (1.09) $ (1.61) $ 0.40 $ (1.06)
Weighted average number of common
shares outstanding:
Class A Common Stock 23,150 23,326 23,538 23,751 23,441
Class B Common Stock 11 11 11 11 11
Class C Common Stock 2,598 2,598 2,598 2,598 2,598
<CAPTION>
Three Months Ended
------------------------------------------------------------
3/31/98 6/30/98 9/30/98 12/31/98 Total
------- ------- ------- -------- -----
<S> <C> <C> <C> <C> <C>
Net sales $ 183,139 $ 66,227 $ 42,113 $ 116,540 $ 408,019
Income (loss) before income taxes and
equity interest $ 24,761 $ (20,897) $ (31,860) $ (5,821) $ (33,817)
Net income (loss) $ 26,978 $ (22,974) $ (34,215) $ (5,126) $ (35,337)
Preferred dividends (1,563) (965) (1,562) (967) (5,057)
--------- ---------- ---------- ---------- ----------
Net income (loss) available to common
stockholders $ 25,415 $ (23,939) $ (35,777) $ (6,093) $ (40,394)
========= ========== ========== ========== ==========
Basic earnings (losses) per common share:
Class A and C Common Stock $ .96 $ (.90) $ (1.35) $ (.23) $ (1.52)
Diluted earnings (losses) per common share:
Class A and C Common Stock $ .95 $ (.90) $ (1.35) $ (.23) $ (1.52)
Basic weighted average number of common
shares outstanding:
Class A Common Stock 23,955 23,962 23,965 23,965 23,962
Class B Common Stock 11 11 11 11 11
Class C Common Stock 2,598 2,598 2,598 2,598 2,598
Diluted weighted average number of common
shares outstanding:
Class A Common Stock 24,155 23,962* 23,965* 23,965* 23,962*
Class B Common Stock 11 11 11 11 11
Class C Common Stock 2,598 2,598 2,598 2,598 2,598
</TABLE>
* 0 shares included for the effects of stock grants and convertible
securities due to the loss in the period.
F-27
<PAGE>
SCHEDULE II
PETROLEUM HEAT AND POWER CO., INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 1996, 1997 and 1998
<TABLE>
<CAPTION>
Additions
---------
Balance Charged
at to Costs Other Balance
Beginning and Changes Add at End
Year Description of Year Expenses /(Deduct) of Year
- ---- ----------- ------- -------- --------- -------
<S> <C> <C> <C> <C> <C>
1996 Accumulated amortization:
Customer lists $ 225,333 $ 18,611 $ (4,104) (1) $ 239,840
Deferred charges 39,123 4,760 (237) (1) 43,646
--------- -------- --------- ---------
$ 264,456 $ 23,371 $ (4,341) $ 283,486
========= ======== ========= =========
Allowance for doubtful
accounts $ 969 $ 1,882 $ (1,763) (2) $ 1,088
========= ======== ========= =========
1997 Accumulated amortization:
Customer lists $ 239,840 $ 17,903 $ (18,292) (3) $ 239,451
Deferred charges 43,646 4,639 (1,886) (3) 46,399
--------- -------- --------- ---------
$ 283,486 $ 22,542 $ (20,178) $ 285,850
========= ======== ========= =========
Allowance for doubtful
accounts $ 1,088 $ 1,853 $ (1,961) (2) $ 980
========= ======== ========= =========
1998 Accumulated amortization:
Customer lists $ 239,451 $ 16,669 $ -- $ 256,120
Deferred charges 46,399 4,303 -- 50,702
--------- -------- --------- ---------
$ 285,850 $ 20,972 $ -- $ 306,822
========= ======== ========= =========
Allowance for doubtful
accounts $ 980 $ 1,419 $ (1,455) (2) $ 944
========= ======== ========= =========
</TABLE>
(1) Valuation and qualifying accounts conveyed through the disposition of the
Springfield Massachusetts branch location
(2) Bad debts written off net of any recoveries
(3) Valuation and qualifying accounts conveyed through the disposition of the
Hartford Connecticut branch location
F-28
<PAGE>
SIGNATURES
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 hereunto duly authorized.
PETROLEUM HEAT AND POWER CO., INC.
----------------------------------
(Registrant)
Date: 2/18/99 By: Irik P. Sevin
------- ------------------------------
Irik P. Sevin
Chairman of the Board, Chief
Executive Officer, Chief
Financial and Accounting
Officer and Director
