Ladies and gentlemen, thank you for standing by. Welcome to Suburban Propane's second quarter 2018 financial results conference call. At this time, all participant lines are in a listen-only mode. Later, there will be an opportunity for your questions. Instructions will be given at that time. As a reminder, today's conference call is being recorded. I would like to start the conference with the forward-looking statement. This conference contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, relating to the partnership's future business expectations and predictions and financial condition and results of operations. These forward-looking statements involve certain risks and uncertainties.
The partnership has listed some of the important factors that could cause actual results to differ materially from those discussed in such forward-looking statements, which are referred to as cautionary statements in its earnings press release, which can be viewed on the company's website. All subsequent written and oral forward-looking statements attributable to the partnership or persons acting on its behalf are expressly qualified in their entirety by such cautionary statements. At this time, I would now like to turn the conference over to the Vice President and Treasurer, Davin D'Ambrosio. Please go ahead.
Thank you, Leah, and good morning, everyone. Thank you for joining us this morning for our fiscal 2018 second quarter earnings conference call. Joining me this morning are Mike Stivala, our President and Chief Executive Officer; Mike Kuglin, Chief Financial Officer and Chief Accounting Officer; and Steve Boyd, our Chief Operating Officer. This morning, we will review our second quarter financial results, along with our current outlook for the business. As usual, once we concluded our prepared remarks, we will open the session to questions. Before getting started, I'd like to briefly re-emphasize what the operator has just explained about forward-looking statements.
Additional information about factors that could cause actual results to differ materially from those discussed in forward-looking statements is contained in the partnership's SEC filings, including its Form 10-K for the fiscal year ended September 30th, 2017, and its Form 10-Q for the period ended March 31st, 2018, which will be filed by the end of business today. Copies of these filings may be obtained by contacting the partnership or the SEC. Certain non-GAAP measures will be discussed on this call. We have provided a description of those measures, as well as a discussion of why we believe this information to be useful in our Form 8-K furnished to the SEC this morning. Form 8-K can be accessed through a link on our website at suburbanpropane.com. At this point, I would like to turn the call over to Mike Stivala for some opening remarks. Mike?
Thanks, Davin, thank you all for joining us this morning. Building off of the momentum from our strong first quarter performance, colder average temperatures provided support for increased customer demand in the second quarter. As a result, we are very pleased to report an improvement of $24.1 million, or 17.5% in our adjusted EBITDA for the second quarter of fiscal 2018 compared to the prior year. Our operations personnel did an outstanding job meeting the increased demand with an intense focus on all aspects of our business, delivering exceptional service, solid margin management, and effectively managing costs and operating efficiencies. While the quarter presented some extreme weather variability, heating degree days were reported as 9% cooler than last year's second quarter, yet 6% warmer than normal, our propane volumes increased by more than 10%.
As we indicated at the start of this fiscal year, coming off back-to-back record warm temperatures in fiscal 2016 and 2017's heating season, we were taking a very different approach to estimating customer demand for developing our manpower plan and our cost infrastructure. In fact, we developed our business plans for fiscal 2018 based on customer demand expectations, assuming a weather pattern that would be more reflective of the 10-year average heating degree days or 7% warmer than the 30-year average, which has traditionally been considered to be normal. Now that we are through the first half of fiscal 2018, the heart of the heating season, weather was effectively in line with that 10-year average and 7% cooler than the comparable prior year period. Our propane volumes responded accordingly with an increase of more than 8% versus the first six months of last year.
Through the first half of fiscal 2018, our adjusted EBITDA increased $33 million, or nearly 15% compared to the prior year. With the improvement in earnings and cash flows, we are also making significant strides in our stated goal to restore our financial strength following the past two consecutive years of record warm temperatures. We used excess cash flow to reduce indebtedness during the second quarter, combined with the higher earnings, our leverage ratio improved to 4.58 times at the end of March 2018. Our distribution coverage on a maintenance CapEx basis has also meaningfully improved to nearly 1.3 times based on trailing 12-month distributable cash flow compared to our pro forma cash distributions at the current annualized distribution rate of $2.40 per common unit.
With the extended cold temperatures across the majority of our service territories from mid-March through the end of April, we have also seen higher customer demand continue in the early part of our fiscal third quarter, which has set up a great start to our second half performance. In a moment, I'll come back for some closing remarks. At this point, I'd like to turn the call over to Mike Kuglin to discuss our second quarter results in more detail. Mike?
Thanks, Mike, good morning, everyone. As Mike indicated in his opening remarks, we reported another solid improvement in earnings compared to the prior year. Earnings benefited from a combination of higher volume sold, higher unit margins, and continued savings from operating efficiencies that helped partially offset higher variable operating costs resulting from higher customer demand. To be consistent with previous reporting, as I discuss our second quarter results, I'm excluding the impact of unrealized non-cash mark-to-market adjustments on derivative instruments used in risk management activities, which result in an unrealized loss of $3.7 million in the second quarter of fiscal 2018, compared to an unrealized loss of $2.5 million in the prior year. Additionally, net income and EBITDA for the prior year include a loss on debt extinguishment of $1.6 million associated with refinancing of our 2021 senior notes.
Excluding these items, net income for the second quarter of fiscal 2018 increased to $110.5 million, or $1.80 per common unit, compared to net income of $87.9 million, or $1.44 per common unit in the prior year. Adjusted EBITDA for the second quarter of fiscal 2018 amounted to $162.1 million, an increase of $24.1 million or 17.5% compared to the prior year. Retail propane gallons sold in the second quarter of fiscal 2018 of 169.7 million gallons, increased 15.8 million gallons or 10.3% compared to the prior year. Sales of fuel oil and other refined fuels of 13.6 million gallons increased 5% compared to the prior year. Our volumes benefited from cooler temperatures experienced throughout the majority of our service territories, which contributed to an increase in customer demand for heating needs.
The year-over-year increase in volume sold slightly outpaced the increase in heating degree days, which were 9% cooler than the prior year in our service territories. The heating degree days for the quarter were concentrated in January and March, as average temperatures for those months were at or near normal levels. However, average temperatures for the month of February were 16% warmer than normal and only slightly cooler than the record warm temperatures in February 2017. In the commodity markets, the price of propane gradually decreased during the quarter, which provided a slight tailwind for margin management. The price of propane, basis Mont Belvieu, steadily dropped from $0.97 per gallon at the beginning of the second quarter to $0.80 per gallon at the end of the quarter.
Although prices generally declined from January to March, average wholesale prices for the quarter were still 18% higher than Q2 of last year. Total gross margins of $293.3 million for the second quarter of fiscal 2018 increased $32.7 million or 12.6% compared to the prior year, primarily due to the higher volume sold and higher average unit margins. With respect to expenses, while volume sold increased more than 10% year-over-year, combined operating and G&A expenses increased 7% compared to the prior year. This increase reflects higher variable operating costs attributable to an increase in deliveries and other operational activities to support higher demand, as well as higher variable compensation associated with higher earnings.
I'd also point out that our G&A expenses for the prior year second quarter included a credit of $2 million as a result of reversing accruals for variable compensation to reflect estimated amounts earned at the end of last year's second quarter. Net interest expense of $19.4 million for the second quarter of fiscal 2018 increased $1.9 million or 11% compared to the prior year, primarily due to a higher level of outstanding borrowings under revolving credit facilities. Total capital spending of the second quarter of fiscal 2018 amounted to $9.6 million compared to $10.4 million in the prior year. At the beginning of the third quarter, we closed on the acquisition of a propane operation strategically located in our Florida market for a total purchase price of $11.9 million.
Now looking at our year-to-date performance, as Mike indicated, adjusted EBITDA for the first half of fiscal 2018 increased $33 million or nearly 15% compared to the prior year. Our earnings benefited from an 8% increase in propane volume sold on temperatures that were 7% cooler than the prior year in our service territories, as well as higher average unit margins and continued operating efficiencies that helped partially offset higher variable operating costs. Turning to our balance sheet, we have now moved through our historically high period of seasonal working capital needs. During the second quarter, we funded our working capital and capital expenditures and also paid down revolver borrowings by roughly $36 million from operating cash flow. The combination of the increase in earnings and debt repayment during the second quarter result in our consolidated leverage ratio improving to 4.58 times at the end of Q2.
We are well within our debt covenant requirements and remain focused on restoring our balance sheet strength, which includes achieving a target leverage profile in the mid to upper three times. Back to you, Mike.
Great. Thanks, Mike. As announced in our April 26th press release, our board of supervisors declared our quarterly distribution of $0.60 per common unit. In respect of our second quarter of fiscal 2018, that equates to an annualized rate of $2.40 per common unit. The quarterly distribution will be paid on May 15th to our unit holders of record as of May the 8th. Just a few final remarks. Heading into fiscal 2018, our people and our operating platform were well prepared to respond to a return of a closer to normal weather pattern. During some very harsh weather conditions this winter, our people worked tirelessly to serve our customers and local communities, maintaining their focus on the safety and comfort of our customers. At the same time, we continued to deliver on our customer base growth and retention initiatives.
We developed a good operational plan for fiscal 2018. Our volumes responded to the improvement in weather. We continued to manage costs with just a modest increase despite the higher operational activities. Our earnings and cash flows are in line with our expectations through the first half, and our financial metrics continue to get stronger. In fact, our leverage is trending toward our target range of below four times. The excess cash flow generated is helping accelerate our debt reduction efforts, and we have dramatically improved our distribution coverage. We are very well positioned operationally and financially to continue to pursue our strategic growth initiatives. One additional comment. 2018 marks a significant milestone for Suburban Propane. We are celebrating our 90th year as a leader and innovator in the propane industry.
We are very proud that our roots date back to the very beginning, when our founder in 1928 set out to solve a problem to bring propane gas delivery to the home. From a garage in the small town of West Orange, New Jersey, Suburban Propane has grown to be a nationwide retail distributor in 41 states, and our more than 3,200 employees have maintained their commitment to supporting and meeting the energy needs of our customers in every local community we serve. I just want to once again, take this opportunity to thank all of the employees of Suburban Propane for their efforts in continuing to remain focused on providing exceptional service to our customer base during a very challenging winter. As always, we appreciate your support and attention this morning. Now I'll be happy to open the call up for questions.
Leah, would you mind helping us with that?
Thank you. Ladies and gentlemen, if you would like to ask a question, please press star then one on your telephone keypad. You will hear a tone indicating you have been placed in queue. You may remove yourself from this queue by depressing the pound key. Our first question is from the line of Merrick Zack with Citigroup. Please go ahead.
Hi. Good morning, everyone.
Good morning, Merrick.
Can you comment on the attrition rates this year and if you've seen any uptick in churn relative to prior years, maybe due to increased competition or be it from either other operators or alternative fuels?
I think, as I mentioned in my opening remarks, we have a very intense focus on customer base growth and retention. Our people are doing an outstanding job delivering on those initiatives. In fact, every quarter, every year, we're continuing to see that trend improve. Yes, there's always competition in this industry. It's a very fragmented industry. Suburban offers a great value proposition, and we've been executing on delivering the highest quality service to our customer base. In times like we just experienced this past winter, where you do experience some stress in the system, that's when Suburban Propane shines the most. I think we did an outstanding job meeting the demand this year and delivering in some very harsh conditions, whether it be bad snowstorms, ice conditions. We're there to meet the needs of our customers.
Even when supply gets a little tight, our relationships and our logistics personnel do an outstanding job getting product where it needs to be. I'm extremely proud of what we've accomplished with our customer base. We haven't seen attrition deteriorate. In fact, we've done an even better job with our customer base year in and year out.
Okay, great. Just one more on the M&A front. Have you seen an increase in the number or size of operators or assets coming to market versus prior years? On those lines, are you open to acquisitions of either players larger than mom and pops or customer or asset packages at this time?
As far as your first question, I think the amount of businesses is pretty much the same as history. There's always going to be a list of potential businesses for sale. We did close, as Mike mentioned in his opening remarks, we closed on a nice business that we had our eye on in Florida. We did that in April, and it fits perfectly into our footprint down there. It's the second decent size acquisition in that Florida market that we've been able to do in the past three years. I think we're proving that we're open to doing acquisitions. To your point about size, absolutely. I think if there was a good A regional-sized player that became for sale, I think we would be a very logical acquirer, and we'd take a hard look at it.
The reality is those businesses don't come to market all that often. We'll see. We'll see what happens.
Okay, great. Thank you. That's all for me.
Thanks, Merrick.
We have a question from the line of Ben Ballow with Raymond James. Please go ahead.
Hey, good morning.
Morning, Ben.
Congrats on the quarter. I'm sure it's nice to have a little bit more normalized weather. On the OpEx and G&A, it was good leverage combined up 7%. You mentioned the $2 million within G&A last year, but if you adjust for that, it was up around 30% year-over-year. First off, did I hear, or is that correct? How should we think about kind of separating the two, just the divergence and the growth between those two metrics of OpEx and G&A? How should we think of that run rate on G&A?
The driver for the G&A was essentially variable compensation. Given the seasonal nature of the business, the expenses for our annual compensation are heavily weighted towards the first half of the year. If you look at G&A for the first half, it's up a little less than $8 million, which is probably a fair expectation for G&A on a full year basis. Of course, operating expenses are going to follow that of customer demand, but operating expenses for the second quarter were only up about 2% on volumes that were 10% higher. On a year-to-date basis, our operating expenses are only up a little more than 1% on volumes that were 8% higher.
Ben, remember, we've always talked about the flexible nature of our cost structure, and these couple of extreme years is a perfect example of that, where we have a highly pay-for-performance structure here, which does allow us to ratchet back our expenses dramatically when the earnings aren't there because of weather. This year, obviously, the earnings are significantly improved. As a result, we'll have more variable compensation for all of the employees that are earning it throughout the company. Even with funding that incremental variable compensation, the earnings are up dramatically. It's something that we've talked about for years. It's a significant component of our cost structure that allows us to flex up and down when weather cooperates or doesn't cooperate.
Okay. Just thinking around the second half, that would be $8 million growth in the second half or 50%, 30%. That's not sort of the norm.
No. The 8% increase in the first half, I would not say would be replicated in the second half, I would say-
Okay. That's helpful.
I would say the first half is roughly equivalent to the full year increase.
Okay. That makes sense. You mentioned the April volume, kind of weather-driven volume. Can you quantify what the volume growth, and is it fair to think about April historically? Obviously, that's going to be quite variable depending on weather, but historically, April being around two-thirds of the fiscal third quarter volume.
Yeah. I think as far as April goes, historically being two-thirds of the third quarter volume, probably close. This year, April has really provided a strong tailwind for the quarter. We don't give guidance, so I won't give you exactly what that is other than to say you saw the weather pattern. April itself was about 15% colder than normal throughout most of the country. Actually, when you look at the weather pattern this year, yes, as Mike pointed out, February was close to record warm. The momentum that came out of January helped support February volumes, then the March weather, then carrying that into April, has really made this year look exactly like what we expected it to be, which was close to that 10-year average. Yet that's not necessarily true in all of our service territories either.
The West Coast actually didn't really get weather at all until the March timeframe. When you look at this year and the volume performance given the way the weather played out, it didn't play out the same in every location. Yet, when you bring it all together as an average, it's going to be right in line with our expectations. We're really pleased with this year, and it wasn't a perfect weather pattern, but it was right in line with what we expected.
Great. Thank you for the color, and congrats again.
Great. Thanks, Ben.
Next, we go to the line of Michael Gaugler with Janney Montgomery Scott. Please go ahead.
Yeah. Can you guys talk a little bit about the fuel oil and refined fuels business and natural gas and electricity businesses, and maybe how those are performing, and then, I guess how you see those fitting in the portfolio longer term? If you guys are pursuing acquisitions in those areas, or if you just view those as some diversified businesses in the short term, or I guess how you're looking at them in general?
Yeah. There's two different answers there, Mike. One is, fuel oil business, it's part of our platform. It was something that we acquired when we bought Agway back in 2003. It's a more competitive market than propane. What we have today is pretty sustainable. We've stabilized that customer base. The customer base is highly complementary of our propane customer base. We frankly don't have any desire to seek acquisitions, I would say. I guess if there was a business that had a good size propane business and it came with fuel oil, then we wouldn't snub our nose at it, if you will. But we're not looking to grow that business, and we make a decent operating income off of that business. The natural gas and electric business is a nice little niche business for us in New York and Pennsylvania. It's a good contributor to EBITDA.
It's really a marketing business where we don't take any commodity risk. We back-to-back the product to the customer. These are deregulated markets where we provide an alternative to the customer base versus doing business with the utility. We have a unique value-added product that our customers really appreciate that we offer. We've been very successful just organically growing that business. There's not a lot of acquisition opportunities in that space, but what there is opportunities to expand in other parts of the country that deregulation in the natural gas and electricity markets is embraced. For instance, Maryland is the next territory that we have actually recently applied to do business in, and we'll be starting to market in Maryland shortly. New Jersey is another state that embraces deregulation.
We're not actively marketing in New Jersey yet, but I would say that that's probably a target market for us. I think we have some really good opportunities organically. It's a nice little business for us.
Great. Maybe you can touch on, just in general, your growth capital projection spending for maybe the rest of the year. You mentioned the acquisition. I guess you view more spending coming or just kind of smaller just growth projects?
I would say consistent to what we talked about coming into the year. We were targeting our total CapEx to be around $35 million, split between maintenance growth 15 and 20. That excludes acquisitions. The acquisition that we disclosed on the beginning of the third quarter is roughly $12 million. That would certainly be incremental to those CapEx numbers.
Thanks.
Thanks, Mike.
Ladies and gentlemen, as a reminder, if you have a question, please press star one at this time. There are no other questions. You may continue.
Okay, great. Thanks, Leah, for your help today, and thank you all for your time and attention this morning. We look forward to speaking with you again following our third quarter results in early August. Thank you.
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