Laying a New Cornerstone

Amid swirling rumors of an imminent sale to a competing major marketer, the future of CornerStone Propane should be decided in the next few months.

The propane and investment communities are speculating about CornerStone’s viability coming off strong heating-season sales. The California-based retail giant, whose financial troubles forced it from the New York Stock Exchange last year, recently announced that it has “broadened the mandate of its financial advisor . . . to assist CornerStone in evaluating a wide range of options regarding its future, including the possible sale of the company.” Those options no longer include Chapter 11 bankruptcy, as company officials considered last summer.

Despite sales of $4.2 billion and a net worth estimated at $203 million, analysts say CornerStone’s massive debt load is a major obstacle to any sale. Yet industry sources confirm that the publicly owned partnership has been negotiating with several prospective buyers.

Acting CEO Curtis Solsvig, who took the reins of the flailing company last summer, would not comment on any offers to buy the company. But he does confirm that the time is right to make a move.

“Now that we’re out of the heating season, I think that process will be moving into high gear,” he says.

What Went Wrong

CornerStone was formed in 1996 with the merging of three propane retail companies: Coast Gas, Synergy Gas and Empire Energy. Keith Baxter and Charles Kittrell, who had guided an impressive 10-year growth period for Coast Gas, served as chief executive officer and chief operating officer.

Curtis Solsvig, acting CEO for CornerStone Propane.

In 1997, CornerStone sold 340 million retail gallons to 380,000 customers in 27 states, making it the nation’s fourth-largest propane retailer after its first full year of operations. Its stock price peaked that same year at $23.62. Through 2001, the company was still the nation’s sixth-largest retail marketer with sales of 275 million gallons to 440,000 customers in 34 states throughout the East, South, Central regions and the West Coast.

In that period, CornerStone grew its energy trading business as a way to distinguish itself and diversify. Its commercial energy wholesale and integrated logistics team — Coast Energy Group — grew to be one of the nation’s leading purchasers, processors, suppliers and marketers of propane, crude, natural gas and other natural gas liquids.

But successive warm winters, burgeoning debt and healthy losses within that trading division caused drastic financial problems.

As with other publicly held propane retailers, CornerStone relied on acquisition growth to generate sufficient return for investors. According to annual reports, the company made 43 acquisitions from 1997 through 2000 at a price of more than $252 million. Funded primarily by loans, CornerStone’s debt to market capital ratio hit 95 percent while interest expenses shot up to $36.7 million in 2000.

Former CornerStone executives Keith Baxter, Ronald Goedde and Charles Kittrell earned lucrative bonuses for growing the company via acquisitions.

In 2000, it decided to expand the physical natural gas operations of the Coast Energy Group division into gas financial instruments. Management subsequently concluded that strategy was incompatible and discontinued operations in the fourth quarter, realizing a loss of $5.6 million.

Meanwhile, warm weather continued to squeeze propane sales. Lower propane prices and fewer gallons sold dropped revenues for the retail business by $110.3 million — 29.5 percent — to $263.4 million for the nine months ended March 31, 2002, the date of the company’s last filings.

The foundering giant tried to right itself by selling its Canadian crude oil business in 2001, and sold or closed all midstream crude oil pipeline, gathering and marketing assets of the Coast Energy Group division last year.

But the sale of those assets, combined with lower commodity prices for all energy products, caused revenues to drop by $2.7 million – almost 71 percent – to $1.1 million for the nine months ending March 31, 2002.

According to industry analysts, the circumstances played havoc with the company’s cash flow. CornerStone reported a deficit working capital position of $26.5 million for the nine months ending March 31, 2002, compared to a positive $7.8 million for the year ended June 30, 2001.

Investors were bailing. Company stock prices plummeted from $18.38 in 2000 to less than 25 cents. The beleaguered firm decided not to issue an earnings release for its fiscal year ending June 30, 2002. As a result, the New York Stock Exchange suspended its stock trading.

New Hand at the Helm

With industry observers wagering whether the company could stave off creditors long enough to make it to the 2002-03 heating season, CornerStone officials last July dumped Baxter and Kittrell and hired Everett & Solsvig, a management consulting firm specializing in business restructuring. Its two principals, Robert S. Everett and Curtis G. Solsvig, were named chief restructuring officer and chief executive officer, respectively.

The outlook for the new leaders, who had no previous experience in the propane industry, was bleak. CornerStone was highly leveraged for its earnings capacity and was still coping with the aftermath of its unsuccessful trading business. Facing significant liquidity problems heading into winter, Solsvig was concerned about running out of cash.

He also saw problems with the decentralized structure of the company’s retail operations.

“The company lost opportunities to get better control of its costs and better control of information because of that decentralization,” Solsvig says. “The retail business was not very well managed at the top, so it had an excessive cost structure. They had way too many people, spending money on things that I don’t think were worthwhile.”

Industry insiders point to lavish compensation bonuses to former executives as examples of that spending. Baxter, Kittrell, Chief Financial Officer Ronald J. Goedde and Vice President William L. Woods each earned annual acquisition incentives beyond their salaries and other standard bonuses. According to public records, Baxter was paid more than $1.8 million; Kittrell made $1.3 million; Goedde earned $1.2 million; and Woods was paid $781,000 in acquisition incentives alone from 1999 through 2001.

“They definitely had (acquisition bonuses) as part of their incentive compensation,” Solsvig acknowledges. “It was a structure that encouraged them to make acquisitions, and they had an incentive based on the volume of acquisitions they did. There seem to be a lot of people in the industry who know what this deal was. Everybody told me that they don’t have a deal like that. I will say that I was surprised when I saw the structure of those deals, too.”

Yet Solsvig says it’s a mistake to assume the executives overpaid for companies because it boosted their bonuses.

“You can’t just look at it in a vacuum,” he says. “This was a process overseen by the board, so I don’t think it’s fair to characterize it as a situation where they are going out and, in effect, writing their own bonus check by overpaying for acquisitions. There was oversight to it.”

But did those payments compound CornerStone’s heightening cash flow woes?

“I’m not comfortable saying that the company got to where it was because of excessive senior management compensation as a result of this bonus structure,” Solsvig says. “These guys were in a real tough financial situation last summer. I’ve never seen a situation where folks are in a tough spot because they’ve had superior management doing a great job leading the company. It’s usually, among other things, because there is weak management. But I think (blaming executive compensation) is stretching it way too far.

“If you go back to the last SEC filing, you’ll see that they’ve got $365 million in senior secured debt, $45 million in debt at the parent level, and then they borrowed on a $50 million line of credit. So they had somewhere between $410 million to $460 million of debt, and that didn’t all go to pay executive bonuses.”

Solsvig would not concur with nor dispute the contention that CornerStone overpaid for many acquisitions.

“I think it’s fair to say that within the industry, the perception is that the company overpaid for acquisitions in the retail propane business,” he says. “I haven’t done the analysis to say that was or wasn’t the case, but that certainly seems to be the perceived wisdom within the industry.”

Back to Basics

Coast Energy Group was generating 90 percent of CornerStone’s revenue – approaching $4 billion a year – but yielding just 18 percent of its gross profit. Comparatively, the $350 million in retail sales turned a healthy margin.

“CEG was a huge resource commitment. They spent significant amounts of money on acquisitions in that business. They committed a lot of capital to that, and that’s a business that lost money for them,” Solsvig says.

“Retail generates the EBITDA. Without a doubt, the money-generating part of this business is the retail propane business.”

So he and his management team decided to steer the company back to its retail roots. The decision was buoyed by their belief that CornerStone’s retail operations had a solid business core in place.

“We felt we had a good set of managers, a pretty well-run operation at the local level, and some very talented people in the company who were prepared to commit to the process of restructuring the business,” Solsvig says.

The Fix

To conserve cash, the company chose not to make a $5.6 million interest payment on three classes of debt that was due on July 31, 2002.

Additionally, it took steps to dramatically reduce overhead. About 10 percent of its 1,900 employees were let go as the company consolidated 14 of its 252 customer service centers. The summer furlough program was extended into the heating season, wages were frozen, and discretionary spending and capital expenditures were drastically chopped.

All of those steps had significant impact, but were not nearly enough to fix the financial problems, according to Solsvig.

“We determined that the remnant of the energy trading business, which at that point was just in the propane wholesale business, was not making any real money,” he says. “Without any doubt, it was a huge consumer of working capital. So we decided to exit it and, if possible, sell.”

With the winter heating season approaching, CornerStone sold its wholesale business – including four terminals and propane inventory – to Enterprise Products Partners for $12 million in cash. CornerStone also chose to outsource all of its supply procurement to Enterprise. The deal closed in November.

“We were able to exit that business, reduce our working capital needs dramatically and get some cash out of the sale. That was the turning point. We felt extremely confident in our ability to operate through the season with the financial resources at our disposal,” he explains.

Outsourcing CornerStone’s entire procurement operation to Enterprise also proved to be a boon through a long, cold winter heating season that challenged supply for many marketers nationwide.

“We experienced excellent economics in terms of propane pricing this winter. This was a tough season on a lot of people. Supply got tight at some points, but Enterprise kept us going right through the season. We didn’t have any service failures because of supply problems,” Solsvig says.

“Using them as our vendor helped us to significantly reduce the cost associated with getting supply. We also think that partnering with someone as strong as Enterprise actually enabled us to reduce what our costs would have been if we had been buying on our own. It was an important contributor to our successful winter.”

The new management team continues to press for cost reductions and better efficiencies throughout the company. The evolution of a hand-held device, coupled with other internally developed technology, is being counted on to reduce the amount of data input and allow the driver to do much more on the route.

“We think that’s going to give us the potential for continuing cost reductions and improvement in service without requiring extraordinarily high capital spending levels,” Solsvig says.

Still, CornerStone’s future remains in limbo. How does management engender loyalty and productivity from employees at a time of such uncertainty?

“Our experience says the way you do that is to be honest with people about the situation. We have communicated a lot about what’s going on. We’ve been able to tell them we have a good company, a cooperative set of investors that wants to see the company prosper, and that we don’t know exactly what the future holds. It could hold any one of several possible scenarios,” he says.

“The best thing that everybody can do for themselves and the company is to keep their heads down and push hard.”