UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal year ended September 30, 1996 ------------------ OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [No Fee Required] For the transition period from to --------- --------- Commission File Number: 33-98490 --------- STAR GAS PARTNERS, L.P. ----------------------- (Exact name of registrant as specified in its charter)Delaware 06-1437793- ------------------------------- ---------------(State or other jurisdiction of (I.R.S. Employerincorporation or organization) Identification No.)2187 Atlantic Street, Stamford, Connecticut 06902- ----------------------------------------------------------------------------(Address of principal executive office) (Zip Code)(203) 328-7300- ----------------------------------------------------(Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Units -------------------------------------------- (Title of class)Indicate by check mark whether the registrant (1) has filed all reports requiredto be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes X No ---- Indicate by check mark if disclosure of delinquent filer pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof registrant's knowledge, in definitive proxy or information statementsincorporated be reference in Part III of this Form 10-K or any amendment to thisForm 10-K. [ X ]The aggregate market value of Star Gas Partners, L.P. Common Units held by non-affiliates of Star Gas Partners, L.P. on November 13, 1996 was approximately$64,328,000. At November 13, 1996 there were outstanding 2,875,000 Common Unitsand 2,396,078 Subordinated Units, each representing limited partner interests.Documents Incorporated by Reference: None STAR GAS PARTNERS, L.P. 1996 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS PART I Page Item 1. Business 3Item 2. Properties 11Item 3. Legal Proceedings 11Item 4. Submission of Matters to a Vote of Security Holders 11 PART IIItem 5. Market for the Registrant's Units and Related Unitholder Matters 12Item 6. Selected Historical and Pro Forma Financial and Operating Data 13Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 14Item 8. Financial Statements and Supplementary Data 22Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 22 PART IIIItem 10. Directors and Executive Officers of the Registrant 22Item 11. Executive Compensation 26Item 12. Security Ownership of Certain Beneficial Owners and Management 28 Item 13. Certain Relationships and Related Transactions 30 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 31 2 PART I ITEM 1. BUSINESSBusiness of Star Gas Partners, L.P. Star Gas Partners, L.P. (the "Partnership" or the "MLP"), is apublicly traded Delaware limited partnership, and was formed on October 16,1995. The Partnership's activities are conducted through its subsidiary StarGas Propane, L.P. (the "Operating Partnership" or the "OLP"). The MLP, with a99% limited partner interest, is the sole limited partner of the OperatingPartnership. The Operating Partnership accounts for nearly all of the MLP'sconsolidated assets, sales and operating income.Business of Star Gas Propane, L.P. The Operating Partnership, a Delaware limited partnership, was formed onOctober 16, 1995, to acquire, own and operate the propane business and assetsand related liabilities of Star Gas Corporation (the "Company", "Star Gas", the"General Partner") and the propane operations and assets and liabilities of StarGas' parent corporation, Petroleum Heat and Power Co., Inc. ("Petro"), aMinnesota corporation, (collectively hereinafter referred to as the "Star GasGroup" or the "Predecessor Company"). The Company has retained a 1% generalpartner interest in the MLP and also holds a 1.0101% general partner interest inthe Operating Partnership, representing a 2% general partner interest in thePartnership on a combined basis. The General Partner conducts, directs andmanages all activities of the Partnership and the Operating Partnership and isreimbursed on a monthly basis for all direct and indirect expenses it incurs ontheir behalf including the cost of employee wages.General The Partnership is primarily engaged in the retail distribution of propane andrelated supplies and equipment to residential, commercial, industrial,agricultural and motor fuel customers. The Partnership believes that it is theninth largest retail propane distributor in the United States, servingapproximately 153,000 customers from 49 branch locations and 21 satellitestorage facilities in the Midwest and 18 branch locations and 13 satellitestorage facilities in the Northeast. The Partnership also serves approximately70 wholesale customers from its wholesale operation in southern Indiana.Formation In December 1993, Petro, the nation's largest home heating oil distributor,acquired a 29.5% equity interest in Star Gas. In December 1994, Petro exercisedits option to purchase the remaining equity. Immediately after Petro's initialinvestment, new management was installed and significant restructuring effortswere commenced in order to improve Star Gas' performance. As part of thisprogram in December 1993, Star Gas sold its underperforming Texas propaneoperations and in November 1994 its propane operations in southern Georgia, aswell as its unrelated common carrier trucking business in August 1994. Inaddition, Star Gas undertook a corporate reorganization which involved asubstantial reduction in personnel, the relocation of its corporate headquartersto Stamford, Connecticut, the implementation of new pricing policies, budgetingtechniques and safety and training programs, and the centralization of certainmanagement reporting functions. As a result of this restructuring, Star Gas now 3 Formation (continued)consists of 49 branches in the Midwest and 18 branches in the Northeast. Thesebranches have historically been its most profitable. In December 1995, (i) Petro conveyed all of its propane assets and relatedliabilities to Star Gas and (ii) Star Gas and its subsidiaries conveyedsubstantially all of their assets (other than $83.6 million in cash and certainnon-operating assets) to the Operating Partnership (the "Star Gas Conveyance")in exchange for general and limited partner interests in the OperatingPartnership and the assumption by the Operating Partnership of substantially allof the liabilities of Star Gas and its subsidiaries (excluding certain incometax liabilities and certain long-term obligations of Star Gas that were assumedby Petro). Immediately after the Star Gas Conveyance, Star Gas and itssubsidiaries conveyed their limited partner interests in the OperatingPartnership to Star Gas Partners in exchange for an aggregate of 2.4 millionSubordinated Units of limited partner interest in Star Gas Partners.Recent Events On August 1, 1996, the Partnership announced that it has retained MorganStanley & Co., Incorporated to assist it in the development and consideration ofstrategic alternatives designed to maximize value for its unitholders.Alternatives to be investigated may include, but will not be limited to, thesale or merger of Star Gas.Industry Background Propane is extracted from natural gas or oil wellhead gas at processing plantsor separated from crude oil during the refining process. Propane is normallytransported and stored in a liquid state under moderate pressure orrefrigeration for ease of handling in shipping and distribution. When thepressure is released or the temperature is increased, it is usable as aflammable gas. Propane is colorless and odorless; an odorant is added to allowits detection. Propane is clean-burning, producing negligible amounts ofpollutants when consumed. According to the National Propane Gas Association,the domestic retail market for propane is approximately 9.4 billion gallonsannually, with limited growth for retail demand for the product. Based uponinformation contained in the Energy Information Administration's Annual EnergyReview-1995, propane accounts for approximately 3.7% of household energyconsumption in the United States.Business Strategy The Partnership's business strategy is to maximize cash flow and profitabilitythrough internal growth, controlling operating costs and acquisitions. ThePartnership's focus is on acquiring smaller to medium-sized local and regionalindependent propane distributors, particularly those with a relatively largepercentage of residential customers, which generate higher margins than othertypes of customers. In order to facilitate the Partnership's acquisition strategy, the OperatingPartnership has entered into Bank Credit Facilities which consist of a $25.0million Acquisition Facility and a $12.0 million Working Capital Facility. Inaddition to borrowings under the Bank Credit Facilities, the Partnership mayfund future acquisitions from internal cash flow or from the issuance ofadditional Partnership units. 4 Marketing And Operations As of September 30, 1996, the Partnership distributed propane to approximately153,000 retail customers in 13 states from 67 branch locations. ThePartnership's operations are conducted under several leading trademarks andtrade names, including: Star Gas(R), Star Gas Service/TM/, Silgas Inc./TM/, BlueFlame(R), Maingas/TM/ and Arrow Gas/TM/. (The Partnership does not have theright to use the trademark Star Gas/ /in the State of New York nor does thePartnership have the right to use the Blue Flame/ /trademark in certain limitedareas outside of the Partnership's current area of operations). The marketingareas served by the Partnership are generally rural but also include suburban areas where natural gas is generally not available. The Partnership's retailoperations are located primarily in the Northeast and Midwest regions of theUnited States: NORTHEAST MIDWEST- --------- ------- Connecticut New York Indiana KentuckyStamford Poughkeepsie Akron GlencoeHartford Washingtonville Batesville Prospect Bedford ShelbyvilleMaine Pennsylvania Bluffton WilliamstownFairfield Hazelton Coal CityFryeburg Wind Gap College Corner MichiganSkowhegan Columbia City HillsdaleWells Rhode Island DecaturWindham Davisville Ferdinand Ohio Greencastle DefianceMassachusetts Jeffersonville DeshlerBelchertown Linton FairfieldRochdale Madison Ft. RecoveryWestfield New Salisbury HebronSwansea N. Manchester Ironton N. Vernon LancasterNew Hampshire N. Webster Lewisburg(from Fryeburg, ME) Portland Lynchburg Remington MaconNew Jersey Richmond MilfordMaple Shade Salem Mt. OrabTuckahoe Seymour Northstar Sulphur Springs Ripley Versailles Sabina Warren Waverly Waterloo West Union Winamac West Virginia (from Ironton, OH) The distribution of propane at the retail level generally involves largenumbers of small deliveries averaging 100-150 gallons each to residential,commercial, industrial, agricultural and motor fuel users. Homeowners orresidential customers use propane primarily for space heating, waterheating, 5 Marketing And Operations (continued)clothes drying and cooking. Commercial customers such as motels, restaurants,retail stores and laundromats, generally use propane for the same purposes asresidential customers. Industrial users, such as manufacturers, use propane asa heating and energy source in manufacturing and drying processes. In addition,propane is used to dry crops, cure tobacco and as a fuel source for certainmotor vehicles. During the fiscal year ended September 30, 1996, approximately 71% of thePartnership's sales (by volume of gallons sold) were to retail customers (ofwhich approximately 56%, 22%, 13%, and 9% were sales to residential customers,industrial/commercial customers, agricultural customers and motor fuelcustomers, respectively) and approximately 29% were to wholesale customers.Sales to residential customers in fiscal year 1996 accounted for 65% of thePartnership's gross profit on propane sales, reflecting the higher-margin natureof this segment of the market. From its branch locations, the Partnership also sells, installs and servicesequipment related to its propane distribution business, including heating andcooking appliances and, at some locations, rents water softeners. Typicalbranch locations consist of an office, appliance showroom, warehouse and servicefacilities, with one or more 12,000 to 30,000 gallon bulk storage tanks on ornear the premises. Satellite facilities typically contain only storage tanks. Retail deliveries of propane are usually made to customers by means of thePartnership's fleet of 242 bobtail and rack trucks. Propane is pumped from thebobtail truck, which generally holds 2,000 to 3,000 gallons, into a stationarystorage tank on the customer's premises. The Partnership generally owns thesestorage tanks. The capacity of these tanks ranges from approximately 24 gallonsto approximately 1,000 gallons. The Partnership also delivers propane to retailcustomers in portable cylinders, which typically are picked up and replenishedat the Partnership distribution locations, then returned to the retail customer.To a limited extent, the Partnership also delivers propane to certain end usersof propane in larger trucks known as transports (which have an average capacityof approximately 9,000 gallons). End users receiving transport deliveriesinclude industrial customers, large-scale heating accounts, such as local gasutilities which use propane as a supplemental fuel to meet peak demandrequirements, and large agricultural accounts which use propane for crop dryingand space heating. "See Item 2--Properties". A majority of the Partnership's residential customers receive their propanesupply pursuant to an automatic delivery system which eliminates the customer'sneed to make an affirmative purchase decision. The Partnership delivers propaneto its customers an average of approximately six times during the year,depending upon weather conditions and historical consumption patterns. Inaddition, the Partnership provides emergency service seven days a week, 52 weeksa year. Management believes its propane customer base to be relatively stable.In excess of 95% of the Partnership's retail propane customers lease their tanksfrom the Partnership. In most states, certain fire safety regulations restrictthe refilling of a leased tank solely to the propane supplier that owns thetank. The inconvenience associated with switching tanks greatly reduces apropane customer's tendency to change distributors. Profits in the retail propane business are primarily based on margins, thecents-per-gallon difference between the purchase price and the sales price ofpropane. The Partnership generally purchases propane in the contract and spotmarkets, primarily from natural gas processors and major oil companies, on a 6 Marketing and Operations (continued)short-term basis, therefore, its supply costs fluctuate with market pricefluctuations. Should wholesale propane prices decline in the future, thePartnership's margins on its retail propane distribution business shouldincrease in the short-term because retail prices tend to change less rapidlythan wholesale prices. Should the wholesale cost of propane increase, forsimilar reasons retail margins and profitability would likely be reduced atleast for the short-term until retail prices can be increased. The retail market for propane is seasonal because it is used primarily forheating in residential and commercial buildings. Approximately 70% - 75% of thePartnership's retail propane volume is sold during the peak heating season fromOctober through March, as many customers use propane for heating purposes.Consequently, sales and operating profits are concentrated in the first andsecond fiscal quarters (October through March). To the extent necessary, thePartnership will reserve cash flows from the first and second quarters fordistribution to holders of Common Units in the third and fourth fiscal quarters.In addition, sales volume traditionally fluctuates from year to year in responseto variations in weather, prices and other factors. The Partnership believesthat the broad geographic distribution of its operations helps to minimizeexposure to regional weather or economic patterns.Supply The Partnership obtains propane from approximately 25 sources, all of whichare domestic or Canadian oil companies, including Amoco Canada MarketingCorporation; Ashland Inc.; Enron Gas Liquids, Inc.; Marathon Company; MarkwestHydrocarbons Partners, Ltd.; Amerigas Propane, L.P.; Shell Oil Company; ShellCanada Limited; Sea-3 Inc.; Sun Company Inc.; Texaco Natural Gas Liquids (adivision of Texaco Natural Gas Inc.); and Warren Gas Liquids, Inc. Suppliesfrom these sources have traditionally been readily available, although noassurance can be given that supplies of propane will be readily available in thefuture. Substantially all of the Partnership's propane supply for its Northeast retailoperations are purchased under annual or longer term supply contracts, which generally provide for pricing in accordance with posted prices at the time ofdelivery. Certain of the contracts provide for minimum and maximum amounts ofpropane to be purchased. During the year ended September 30, 1996, none of thePartnership's Northeast suppliers accounted for more than 10% of thePartnership's volumes. The Partnership typically supplies its Midwest retail and wholesale operationsby a combination of (i) spot purchases from suppliers at Mont. Belvieu, Texas,which are transported by pipeline to the Partnership's 21 million gallonunderground storage facility in Seymour, Indiana ("the Seymour Facility"), andthen delivered to the Midwest branches and (ii) purchases from a number ofMidwest refineries which are transported by truck to the branches eitherdirectly or via the Seymour Facility. Most of the refinery purchases arepurchased under contract. The Seymour Facility is located on the TEPPCO Partners, L.P. pipeline system.The pipeline is connected to the Mont. Belvieu storage facilities and is one ofthe largest conduits of supply for the U.S. propane industry. The SeymourFacility allows the Partnership to buy and store large quantities of propaneduring periods of low demand, which generally occur during the summer months. 7 Supply (continued)The General Partner believes that this ability allows the Partnership to achievecost savings to an extent generally not available to the Partnership'scompetitors in its Midwest markets. For fiscal 1996, 35% of the Midwest volume was purchased on the spot marketfrom various Mont. Belvieu sources, and 18% was purchased from three refineriesin Illinois and Indiana owned by Amoco Canada Marketing Corp. Ten otherrefineries provided the remaining required supplies. The Partnership believesthat its diversification of suppliers will enable it to purchase all of itssupply needs at market prices if supplies are interrupted from any of thesources, without a material disruption of its operations. Propane is generally transported from refineries, pipeline terminals andstorage facilities (including the Partnership's Seymour Facility), and coastalterminals to the Partnership's branch location bulk plants by a combination ofthe Partnership's own highway transport fleet, common carriers, owner-operatorsand railroad tank cars. Branches and their related satellites typically haveone or more 12,000 to 30,000 gallon storage tanks.Competition The Partnership's business is highly competitive. However, long-standingcustomer relationships are typical of the retail propane industry. Retailpropane customers generally lease their storage tanks from their suppliers. Thelease terms and, in most states, certain fire safety regulations restrict therefilling of a leased tank solely to the propane supplier that owns the tank.The inconvenience of switching tanks minimizes a customer's tendency to switchamong suppliers of propane. The ability to compete effectively further depends on the reliability ofservice, responsiveness to customers and the ability to maintain competitiveprices. The Partnership believes that its superior service capabilities andcustomer responsiveness differentiate it from many of its competitors. Branchoperations offer emergency service twenty-four hours per day, seven days perweek. Propane competes primarily with electricity, natural gas and fuel oil as anenergy source on the basis of price, availability and portability. Propane isgenerally less expensive to use than electricity for space heating, waterheating, clothes drying and cooking and competes effectively in those parts ofthe country where propane is cheaper than electricity on an equivalent BritishThermal Unit basis. Propane is generally more expensive than natural gas, butserves as an alternative to natural gas in rural and suburban areas wherenatural gas is unavailable or portability of product is required. The expansionof natural gas into traditional propane markets has historically been inhibitedby the capital costs required to expand distribution and pipeline systems.Although the extension of natural gas pipelines tends to displace propanedistribution in the areas affected, the Partnership believes that newopportunities for propane sales arise as more geographically remote areas are developed. Although propane is similar to fuel oil in space heating and waterheating applications as well as in market demand and price, propane and fuel oilhave generally developed their own distinct geographic markets. Becausefurnaces and appliances that burn propane will not operate on fuel oil, aconversion from one fuel to the other requires the installation of newequipment. 8 Competition (continued) In addition to competing with alternative energy sources, the Partnershipcompetes with other companies engaged in the retail propane distributionbusiness. Competition in the propane industry is highly fragmented andgenerally occurs on a local basis with other large full-service multi-statepropane marketers, smaller local independent marketers and farm cooperatives.Based on industry publications, the Partnership believes that the ten largestmulti-state marketers, including the Partnership, account for less than 35% ofthe total retail sales of propane in the United States, and that no singlemarketer has a greater than 10% share of the total retail market in the UnitedStates. Most of the Partnership's branches compete with five or more marketersor distributors. The principal factors influencing competition among propanemarketers are price and service. Each retail distribution outlet operates inits own competitive environment as retail marketers locate in close proximity tocustomers to lower the cost of providing service. The typical retaildistribution outlet has an effective marketing radius of approximately 35 miles.Employees The Partnership has no employees, except for certain employees of itscorporate subsidiary, Stellar Propane Service Corporation and is managed by theGeneral Partner pursuant to the Partnership Agreement. As of September 30,1996, Star Gas had 617 employees providing full time services to the OperatingPartnership of which 50 were employed by the corporate office in Stamford,Connecticut and 567 were located in branch offices of which 201 wereadministrative, 264 were engaged in transportation and storage and 102 wereengaged in field servicing. Approximately 75 of Star Gas' employees arerepresented by six different local chapters of labor unions. Management believes that its relations with both its union and non-unionemployees are satisfactory.Government Regulations The Partnership is subject to various federal, state and local environmental,health and safety laws and regulations. Generally, these laws imposelimitations on the discharge of pollutants and establish standards for thehandling of solid and hazardous wastes. These laws include the ResourceConservation and Recovery Act, the Comprehensive Environmental Response,Compensation and Liability Act ("CERCLA"), the Clean Air Act, the OccupationalSafety and Health Act, the Emergency Planning and Community Right to Know Act,the Clean Water Act and comparable state statues. CERCLA, also known as the"Superfund" law, imposes joint and several liability without regard to fault orthe legality of the original conduct on certain classes of persons that areconsidered to have contributed to the release or threatened release of ahazardous substance into the environment. Propane is not a hazardous substancewithin the meaning of CERCLA. Such laws and regulations could result in civilor criminal penalties in cases of non-compliance or impose liability forremediation costs. To date, the Partnership has not been named as a party toany litigation in which the Partnership is alleged to have violated or otherwiseincurred liability under any of the foregoing laws and regulations. In connection with all acquisitions of retail propane businesses that involvethe purchase of real estate, the Partnership conducts a due diligenceinvestigation to attempt to determine whether any substance other than propanehas been sold from, or stored, on any such real estate prior to its purchase. 9 Government Regulations (continued) Such due diligence includes questioning the seller, obtaining representationsand warranties concerning the seller's compliance with environmental laws and visual inspections of the properties, whereby the General Partner's employees,and in certain cases, independent environmental consulting firms hired by theGeneral Partner, look for evidence of hazardous substances or the existence ofunderground storage tanks. National Fire Protection Association Pamphlets No. 54 and No. 58, whichestablish rules and procedures governing the safe handling of propane, orcomparable regulations, have been adopted as the industry standard in all of thestates in which the Partnership operates. In some states these laws areadministered by state agencies, and in others they are administered on amunicipal level. With respect to the transportation of propane by truck, thePartnership is subject to regulations promulgated under the Federal MotorCarrier Safety Act. These regulations cover the transportation of hazardousmaterials and are administered by the United States Department ofTransportation. The Partnership conducts ongoing training programs to helpensure that its operations are in compliance with applicable regulations. ThePartnership maintains various permits that are necessary to operate some of itsfacilities, some of which may be material to its operations. Managementbelieves that the procedures currently in effect at all of its facilities forthe handling, storage and distribution of propane are consistent with industrystandards and are in compliance in all material respects with applicable lawsand regulations. Future developments, such as stricter environmental, health or safety laws andregulations thereunder, could affect Partnership operations. It is notanticipated that the Partnership's compliance with or liabilities underenvironmental, health and safety laws and regulations, including CERCLA, willhave a material adverse effect on the Partnership. To the extent that there areany environmental liabilities unknown to the Partnership or environmental,health or safety laws or regulations are made more stringent, there can be noassurance that the Partnership's results of operations will not be materiallyand adversely affected.Trademarks And Tradenames The Partnership utilizes a variety of trademarks and tradenames which it owns,including Star Gas/(R)/, Silgas Inc./TM/, Blue Flame/(R)/,Maingas/TM/ and Arrow Gas/TM/. The Partnership regards its trademarks, tradenames and otherproprietary rights as valuable assets and believes that they have significantvalue in the marketing of its products. (The Partnership does not have the rightto use the trademark Star Gas/TM/in the State of New York nor does thePartnership have the right to use the Blue Flame/TM/trademark in certain limitedareas outside of the Partnership's current area of operations). 10 ITEM 2. PROPERTIES As of September 30, 1996, the Partnership owned 55 of its 67 branch locationsand 25 of its 33 satellite storage facilities and leased the balance. Inaddition, the Partnership owns the Seymour Facility, in which it stores propanefor itself and third parties. The Partnership leases its corporate headquartersin Stamford, Connecticut, as well as office and training facilities in theMidwest. The transportation of propane requires specialized equipment. The trucksutilized for this purpose carry specialized steel tanks that maintain thepropane in a liquefied state. As of September 30, 1996, the Partnership had afleet of 25 tractors, 44 transport trailers, 242 bobtail and rack trucks and 256other service and pick-up trucks, the majority of which are owned. ThePartnership owns 24 and leases 22 automobiles. As of September 30, 1996, thePartnership owned approximately 194 bulk storage tanks with typical capacitiesof 12,000 to 30,000 gallons, approximately 193,000 stationary customer storagetanks with typical capacities of 24 to 1,000 gallons and approximately 32,000portable propane cylinders with typical capacities of 5 to 24 gallons. Theobligations of the Partnership under its borrowings are secured by liens andmortgages on all real and personal property of the Partnership. ITEM 3. LEGAL PROCEEDINGS - LITIGATION Propane is a flammable, combustible gas. Serious personal injury and propertydamage can occur in connection with its transportation, storage or use. ThePartnership, in the ordinary course of business, is threatened with or is named as a defendant in various lawsuits which, among other items, seek actual andpunitive damages for product liability, personal injury and property damage.The Partnership maintains liability insurance policies with insurers in suchamounts and with such coverages and deductibles as the General Partner believesis reasonable and prudent. However, there can be no assurance that suchinsurance will be adequate to protect the Partnership from material expensesrelated to such personal injury or property damage or that such levels ofinsurance will continue to be available in the future at economical prices. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the security holders of the Partnershipduring the fiscal year ended September 30, 1996. 11 PART II ITEM 5. MARKET FOR REGISTRANT'S UNITS AND RELATED MATTERS The Common Units, representing common limited partner interests in thePartnership, are listed and traded on the Nasdaq National Market under thesymbol SGASZ. The Common Units began trading on December 20, 1995, at aninitial public offering price of $22.00 per Common Unit. The following tablesets forth the high and low sales prices for the Common Units on the NasdaqNational Market and the cash distribution declared per Common Unit for theperiods indicated. Common Unit Price Range Distributions 1996 Declared Per Unit ----------------------- -----------------Fiscal Quarter High Low 1996- ---------------- ----------------------- ----------------- First Quarter 22.50 $22.00 Second Quarter 22.50 $21.13 Third Quarter 22.00 $19.75 $0.6225/(a)/ Fourth Quarter 24.75 $20.50 $0.5500 (a) This distribution amounted to $0.6225 per unit and represented a pro rata distribution of $0.0725 per unit for the period December 20, 1995 to December 31, 1995 and a quarterly distribution of $0.55 per unit for the three months ended March 31, 1996. As of September 30, 1996, there were approximately 104 holders of record ofthe Partnership's Common Units. There is no established public trading marketfor the Partnership's 2,396,073 subordinated units, representing limited partnerinterests ("Subordinated Units") which are all held by Star Gas Corporation.The Partnership makes quarterly distributions to its partners in an aggregateamount equal to its Available Cash (as defined) for such quarter. AvailableCash generally means, with respect to any fiscal quarter of the Partnership, allcash on hand at the end of such quarter, plus all additional cash on hand as ofthe date of determination resulting from borrowings subsequent to the end ofsuch quarter, less the amount of cash reserves required under certain lendingarrangements and certain discretionary reserves established by the GeneralPartners for future cash requirements. These reserves are retained to providefor the proper conduct of the Partnership's business, the payment of debtprincipal and interest and to provide funds for distribution during the nextfour quarters. The full definition of Available Cash is set forth in theAgreement of Limited Partnership of the Partnership. The information concerningrestrictions on distributions required by Item 5 is incorporated herein byreference to Note 10 to the Partnership's Consolidated Financial Statementswhich begin on page F-1 of this Report. Distributions of Available Cash to theSubordinated Unitholders are subject to the prior rights of the CommonUnitholders to receive the Minimum Quarterly Distribution ("MQD") for each quarter during the subordination period, and to receive any arrearages in thedistribution of the MQD on the Common Units for prior quarters during thesubordination period. 12 ITEM 6. SELECTED HISTORICAL AND PRO FORMA FINANCIAL AND OPERATING DATA The following table sets forth selected historical and pro forma and otherdata of the Partnership and the Star Gas Group and should be read in conjunctionwith the more detailed financial statements included elsewhere in this report.See Item 7. Management's Discussion and Analysis of Financial Condition andResults of Operations. The Selected Pro Forma Financial Data is derived from the pro forma financialinformation of the Partnership and should be read in conjunction therewith. SeeItem 14, Note 14 - of Notes to Consolidated Financial Statements. Partnership/Star Gas Group--Historical ----------------------------------------------------------------- Partnership ProForma (b) Year Ended September 30, Year Ended ----------------------------------------------------------------- September 30, 1992 1993 1994 1995 1996(a) 1996 -------- -------- -------- -------- -------- ------------- Statement of Operations Data: (In thousands, except per Unit data) (unaudited) Sales....................................... $124,113 $143,216 $128,040 $104,550 $119,634 $119,634 Gross profit................................ 65,902 69,861 69,487 54,890 61,077 61,077 Depreciation and amortization............... 13,750 16,703 13,039 10,073 9,808 9,870 Operating income (loss)..................... 7,474 (30,313)/(d)/ 9,393 2,555 9,802 9,866 Interest expense (net)...................... 16,043 16,479 10,497 8,549 7,124 6,713 Net income (loss)/(c)/...................... (7,282) (47,049)/(d)/ (1,404) (6,169) 2,593 3,128 Net income per Unit/(e)/.................... - - - - - $ .58Balance Sheet Data (end of period): Current assets.............................. $ 23,284 $ 20,637 $ 17,374 $ 14,266 $ 17,842 $ 17,842 Total assets................................ 195,480 157,847 147,608 155,393 156,913 156,913 Long-term debt.............................. 123,488 123,992 70,163 1,389 85,000 85,000 Due to Petro................................ - 4,723 8,809 86,002 - - Predecessor's equity (deficiency)/Partners'Capital............... 42,804 (2,825) 44,328 44,305 61,398 61,398Other Data: EBITDA/(c)(f)/.............................. $ 20,991 $ 19,652 $ 21,946 $ 13,541 $ 19,870 $ 19,996 Retail propane gallons sold................. 92,289 114,405 110,069 89,133 96,294 96,294- ----------------------(a) Reflects the results of operations of the Predecessor company for the period October 1, 1995 through December 20, 1995 and the results of Star Gas Partners, L.P. from December 20, 1995 through September 30, 1996. The operating results for the year September 30, 1996 were combined to facilitate an analysis of the fundamental operating data. For the actual results of the Partnership from December 20, 1995 through September 30, 1996, see Item 14, Page F-4.(b) For a description of the assumptions used in preparing the Summary Selected Pro Forma Financial and Operating Data, see Item 14, Note 14 - of Notes to Consolidated Financial Statements.(c) The decline in operating income, net income and EBITDA during the fiscal year 1995 was primarily due to the significantly warmer than normal weather conditions during the 1995 heating season. See Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations.(d) Includes a loss of approximately $33.0 million in respect of a charge for the impairment of long-lived assets.(e) Net income per Unit is computed by dividing the limited partners' interest in net income by the limited partners' weighted average number of units outstanding.(f) EBITDA is defined as operating income plus depreciation, amortization, less net gain (loss) on sale of businesses and other non-cash charges (including the impairment of long-lived assets). EBITDA 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 ability to service debt obligations), but provides additional information for evaluating the Partnership's ability to make the Minimum Quarterly Distribution. 13 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSOverview In analyzing the historical financial results of the Star Gas Corporation andthe financial results of the Partnership, the following matters, should beconsidered. Following Petro's initial investment in Star Gas in December 1993, newmanagement initiated significant restructuring efforts in order to focus andexpand its operations in its most profitable geographic markets, the Midwest andNortheast. These activities included Star Gas' divestiture of its Texas propaneoperations in August 1994, the sale of its southern Georgia operations inNovember 1994, and the completion of seven acquisitions totaling 5.7 milliongallons annually in its core Midwest and Northeast markets Gross profit margins vary according to the customer mix. For example, salesto certain customer groups, such as residential or commercial, generate highergross profit margins than sales to other customer groups, such as agriculturalcustomers. Accordingly, a change in customer mix can affect gross profitwithout necessarily impacting total sales. Because propane's primary use is for heating in residential and commercialbuildings, weather conditions have a significant impact on the financialperformance of the Partnership. Management believes that despite year-to-yearfluctuations, average temperatures have been relatively stable over time.Nevertheless, as reflected by the unusually warm weather in fiscal 1995, actualyearly weather conditions can vary substantially from historical averages.Accordingly, in analyzing changes in financial performance, the weatherconditions in which the Partnership/Star Gas Group operated in any given periodshould be considered. The following discussion reflects the results of operations and operatingdata of the Predecessor Company for the years ended September 30, 1994 and 1995and is compared to the combined results of the Predecessor Company for theperiod October 1, 1995 through December 20, 1995, and the results of Star GasPartners, L.P. from December 20, 1995 through September 30, 1996. The operatingresults of the Predecessor Company and Star Gas Partners for the year endedSeptember 30, 1996 were combined to facilitate an analysis of the fundamentaloperating data. 14 FISCAL YEAR ENDED SEPTEMBER 30, 1996- ------------------------------------COMPARED TO FISCAL YEAR ENDED SEPTEMBER 30, 1995- ------------------------------------------------Volume For the year ended September 30, 1996, retail propane volume increased 8.0%or 7.2 million gallons to 96.3 million gallons, as compared to 89.1 milliongallons for the year ended September 30, 1995. Excluding the divested southernGeorgia operations, which contributed 1.9 million gallons in fiscal 1995, retailpropane volume increased 10.4% or 9.1 million gallons. Propane sold toresidential and commercial customers increased 17.9% or 11.5 million gallons,due to colder temperatures, acquisitions and internal account growth. Based ondegree days in areas in which the Partnership operates, fiscal 1996 was 6.5%colder than normal and 19.5% colder than fiscal 1995. While the residential andcommercial market segments were favorably impacted by the colder temperatures,sales to agricultural customers, who use propane predominately in the graindrying process, declined by approximately 2.5 million gallons primarily due tothe unusually dry crop harvest during the first fiscal quarter. For fiscal1996, propane sold to wholesale customers was 39.0 million gallons, virtuallyunchanged from the fiscal 1995 level.Sales Sales increased 14.4% or $15.0 million, to $119.6 million for fiscal 1996, ascompared to $104.6 million for fiscal 1995. Excluding the results attributableto the southern Georgia operations, which contributed $2.1 million of sales infiscal 1995, sales rose $17.1 million or 16.7% due to increased volume andhigher retail and wholesale selling prices.Cost of Sales Cost of sales increased 17.9% or $8.9 million to $58.6 million for fiscal1996, as compared to $49.7 million for fiscal 1995. While cost of salesdeclined by $1.0 million due to the disposition of the southern Georgia assets,cost of sales in the core Midwest and Northeast operations increased by $9.9million due to the increase in volume and higher per gallon wholesale propanecosts. During the first quarter of fiscal 1996, the partnership was able tolower its cost of sales through the utilization of its underground storagefacility, however, this benefit was offset during the second fiscal quarter by arapid spike in wholesale propane costs.Gross Profit Gross profit increased 11.3% or $6.2 million, to $61.1 million for fiscal1996 as compared to $54.9 million for fiscal 1995. Excluding $1.0 million ofgross profit earned by the divested southern Georgia operations in fiscal 1995,gross profit increased 13.4% or $7.2 million and was attributable to the retailvolume growth, improved wholesale gross profit margins and increased revenuesfrom the sale, service and rental of appliances. Partially offsetting thesepositive influences on gross profit were the effects of the second quarter risein wholesale propane costs and the decline in sales to lower margin agriculturalcustomers. On an overall basis, per gallon retail gross profit marginsincreased as a greater proportion of the Partnership's sales were made to highermargin residential and commercial customers. 15 Delivery and Branch Expenses Delivery and branch expenses declined 1.3% or $0.5 million to $34.8 millionfor fiscal 1996 as compared to $35.2 million for fiscal 1995. This decline wasdue to the elimination of $1.6 million of operating costs attributable to thesouthern Georgia operations which was partially offset by an increase of $1.1million or 3.4% in the remaining core operations. The 10.4% volume increase andthe impact on operating costs of the severe winter weather experienced in thePartnership's Northeast markets were the primary factors for the $1.1 millionincrease in operating costs in the core operations. On a per gallon basis,operating costs in the Midwest and Northeast operations declined 6.4% due tolower insurance expense, improved operating efficiencies and economies of scaleachieved in connection with growing the Partnership's customer base.Depreciation and AmortizationDepreciation and amortization expense declined $0.3 million to $9.8 million forfiscal 1996, as compared to $10.1 million for fiscal 1995 primarily due to areduction in these expenses due to the divestiture of the southern Georgiaoperations.General and Administrative Expenses General and administrative expenses increased approximately $0.3 million to$6.5 million for fiscal 1996, as compared to $6.1 million for fiscal 1995. Thisincrease was primarily due to $0.4 million of non-recurring expenses associatedwith certain professionals engaged by the partnership to assist management inanalyzing and structuring two significant acquisition candidates.Net Gain (Loss) on Sales of Assets Loss on sales of assets declined to $0.3 million for fiscal 1996 from $0.9million in fiscal 1995. During fiscal 1995 a loss of $0.7 million was recordedin connection with the sale of the southern Georgia operations.Interest Expense (Net) Interest expense, net of interest income, declined 16.7% or $1.4 million to$7.1 million for fiscal 1996, as compared to $8.5 million for fiscal 1995. Thisreduction was primarily due to a decline in the weighted average long-term borrowing rate and additional income generated on higher cash balances. Forfurther discussions concerning the Partnership's current debt structure, referto footnote 10 of the consolidated financial statements.Income Tax Expense Income tax expense for fiscal 1996 was approximately $0.1 million. Thisexpense primarily represents certain state income taxes that the Star Gas Groupwas required to pay. Subsequent to December 20, 1995, taxes on income will beborne by the Partners and not the Partnership, except for income taxes relating 16 to the Partnership's wholly owned corporate subsidiary which conducts non-qualifying master limited partnership business.Net Income Net Income increased $8.8 million to $2.6 million for fiscal 1996 as comparedto a loss of $6.2 million in fiscal 1995. The improvement was attributable tothe 10.4% increase in retail propane volume, the positive impact of divestingthe southern Georgia operations and lower non-cash expenses, including the losson sales of assets.EBITDA EBITDA (defined as operating income plus depreciation and amortization lessnet gain (loss) of sale of assets) increased $6.3 million or 46.7% to $19.9million for fiscal 1996 as compared to $13.5 million for fiscal 1995. Thisimprovement in EBITDA was the result of the volume increase associated withcolder temperatures and growth in the Partnership's customer base due to bothacquisitions and internal marketing, partially offset by the impact of lowerper-gallon gross profit margins experienced during the second quarter of fiscal1996. For continuing operations, delivery and branch expenses declined by 6.4%,when measured on a per gallon basis, due to the impact of the cost reductionprograms implemented over the past two years and the increase in volume. Alsocontributing to the growth in EBITDA was the divestiture of the southern Georgiaoperations, which reduced EBITDA in the prior year by approximately $0.6million. EBITDA should not be considered as an alternative to net income (as anindicator of operating performance) or as an alternative to cash flow (as ameasure of liquidity or ability to service debt obligations), but providesadditional information for evaluating the Partnership's ability to make theMinimum Quarterly Distribution.Fiscal Year Ended September 30, 1995Compared to Fiscal Year Ended September 30, 1994- ------------------------------------------------Volume During the first and second quarters of fiscal 1995, the Star Gas Groupoperated in unusually warm weather conditions. Based on degree days, the Midwestwas 14.0% warmer in fiscal 1995 than fiscal 1994, and 11.9% warmer than normal.In the Northeast, fiscal 1995 was 10.0% warmer than fiscal 1994, and 9.1% warmerthan normal. The Winter included in the first and second quarters of fiscal1995 was the second warmest in the last 30 years in the areas serviced by theStar Gas Group. During fiscal 1995, retail propane volume declined 19.0% to 89.1 milliongallons, as compared to 110.1 million gallons for fiscal 1994. The dispositionof the southern Georgia and Texas operations accounted for 15.7 million gallons,or 75.4%, of the decline. Retail volume for core operations in the Midwest andNortheast declined 5.6%, from 92.4 million gallons to 87.2 million gallons, dueto temperatures that were 12.2% warmer than the previous year in all areas inwhich the Partnership operates. The Star Gas Group was able to partially 17 mitigate the effect of warmer than normal weather through internal accountgrowth of approximately 2% as well as the consummation of three acquisitionsduring fiscal 1995. For fiscal 1995, wholesale volume decreased 17.7% to 39.0 million gallons, ascompared to 47.4 million gallons for fiscal 1994. The volume decrease wasprimarily attributable to the warmer than normal weather described above. Inaddition, there was a reduction of 2.9 million gallons sold to certain wholesalecustomers who purchase propane on a spot basis.Sales Sales declined 18.3% to $104.6 million for fiscal 1995, as compared to $128.0million for fiscal 1994. Of this decline, $16.5 million was attributable to thedivestiture of the southern Georgia and Texas operations. For the core Midwestand Northeast operations, sales declined $6.9 million, or 6.3%, as the impact ofthe warm weather was partially offset by increases in sales associated withinternal growth and acquisitions as well as an increase in average sellingprices, largely in response to higher wholesale product costs.Cost of Sales Cost of sales fell 15.2%, or $8.9 million, to $49.7 million for fiscal 1995,as compared to $58.6 million for fiscal 1994. The divestiture of the southernGeorgia and Texas operations accounted for $7.7 million, or 86.6%, of thisreduction. Cost of sales for the remaining operations declined $1.2 million dueto the decrease in volume, offset by an unexpected increase in wholesale supplycosts during the first two quarters of fiscal 1995.Gross Profit Gross profit declined 21.0% to $54.9 million for fiscal year 1995, ascompared to $69.5 million for fiscal year 1994. This decline can be attributedto the sale of the southern Georgia and Texas operations, which accounted for$8.8 million, or 60.4% of the reduction; lower volumes resulting from theabnormally warm weather; and a reduction in per gallon gross profit margins, dueto the rapid and unexpected increase in wholesale supply costs in the fiscalfirst quarter, which was not reflected in increased selling prices until thefiscal second quarter.Delivery and Branch Expenses Delivery and branch expenses decreased 15.2% to $35.2 million for fiscal1995, as compared to $41.5 million for fiscal 1994. The divestiture of thesouthern Georgia and Texas operations alone accounted for a reduction of $7.2million. Despite the effect of inflation on delivery and branch expenses, theseexpenses increased only $0.9 million or 2.6% in the core Midwest and Northeastoperations. 18 Depreciation and Amortization Depreciation of plant and equipment declined 19.5% to $6.6 million for fiscal1995, as compared to $8.2 million for fiscal 1994. This was partially due tothe divestiture of the southern Georgia and Texas operations, which accountedfor $0.7 million of the decline. Excluding those operations, depreciationdeclined 11.0% from $7.3 million to $6.5 million, largely due to the impact ofpurchase accounting fair value adjustments in December 1994 that reallocatedasset values to longer-lived assets at the Star Gas Group, partially offset byadditional depreciation associated with acquisitions and purchases of fixedassets. Amortization of intangible assets, including customer lists, declined 29.2%to $3.4 million in fiscal 1995, as compared to $4.8 million for fiscal 1994. Theprimary factor in this decline was the purchase accounting fair valueadjustments in December 1994, which, while increasing the total base ofamortizable intangible assets, resulted in a reallocation of value to categoriesof assets with longer lives, thereby decreasing the annual amortization expense.General and Administrative Expenses General and administrative expenses increased 1.9% to $6.1 million for fiscal1995, as compared to $6.0 million for fiscal 1994. This increase was due tolegal and professional fees of $0.6 million associated with nonrecurring eventsincluding the restructuring of Star Gas' debt and bank credit facilities, offsetby a reduction in other general and administrative expenses, which declineddespite the impact of inflationary pressures on these costs. Net Gain (Loss) on Sale of Assets During fiscal 1995, Star Gas recorded a one-time book loss of $0.7 millionin connection with its sale of the southeast Georgia operations. In fiscal1994, a gain of $0.5 million was recorded in connection with the sale of itsGardner, Massachusetts facility.Interest Expense (Net) Interest expense declined 18.6% to $8.5 million for fiscal 1995, ascompared to $10.5 million for fiscal 1994. This change was primarily due to thepurchase of Star Gas by Petro, the related financial restructuring and theretirement of debt associated with the sale of the southern Georgia operations.Income Tax Expense Despite a pretax loss of $6.0 million for fiscal 1995, the Star Gas Group wasrequired to pay certain state income taxes on profitable subsidiaries that werenot included in consolidated state returns. Income tax expense decreased to$0.2 million in fiscal 1995, as compared to $0.3 million in fiscal 1994, whenthe pretax loss was $1.1 million. 19 Net Income (Loss) The Star Gas Group posted a net loss of $6.2 million for fiscal 1995, ascompared to a net loss of $1.4 million for fiscal 1994, primarily due to lowervolume associated with the abnormally warm winter.EBITDA EBITDA declined 38.3% to $13.5 million for fiscal 1995, as compared to $21.9million for fiscal 1994. The divestiture of the southern Georgia and Texasoperations accounted for approximately 15.7% of the decline in EBITDA. Theremaining EBITDA decline resulted primarily from the impact of the significantlywarmer than normal weather on sales in the core Midwest and Northeast markets,which was not fully offset by sales associated with modest internal accountgrowth and acquisitions. EBITDA should not be considered as an alternative tonet income (as an indicator of operating performance) or as an alternative tocash flow (as a measure of liquidity or ability to service debt obligations),but provides additional information for evaluating the Partnership's ability tomake the Minimum Quarterly Distribution.Accounting Changes In March 1995, the Financial Accounting Standards Board (FASB) issuedStatement of Financial Accounting Standards (SFAS) No. 121 - "Accounting for theImpairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of."Effective for fiscal years beginning after December 15, 1995, SFAS No. 121requires companies to review assets for impairment losses related to long-livedassets, certain intangibles and assets to be disposed. The impact of adaptingSFAS No. 121 will be immaterial, if any. In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-BasedCompensation." SFAS No. 123 permits companies either to adopt a new method ofaccounting for employee stock options and similar equity instruments or tocontinue following the historical accounting method with supplemental pro formadisclosures. The Partnership will continue its historical practice, and providethe necessary pro forma information when it adopts the standard in fiscal 1997.Liquidity And Capital Resources For the year ended September 30, 1996, cash flow provided by operatingactivities of $10.0 million consisted of $2.6 million of net income and $9.8million of depreciation and amortization, which was offset by a $2.3 millionincrease in working capital and other changes. Inventories increased by $2.3million due to both an increase in gallons stored and higher per unit propanecosts. Net accounts receivable increased by $0.6 million due to an increase insales in the fourth quarter of fiscal 1996 compared to the fourth quarter offiscal 1995. Cash used in investing activities was $7.0 million for 1996, asthe proceeds from the sale of fixed assets of $0.8 million were used topartially fund $2.4 million of acquisitions and $5.3 million of growth and maintenance capital expenditures. 20 In December 1995, Star Gas issued $85.0 million of First Mortgage Notes withan interest rate of 8.04% that provided $83.7 million in cash, net of expenses.(The liability for these notes was assumed by the Operating Partnership pursuantto the Conveyance Agreement). Star Gas used the net proceeds from these notesto repay $44.4 million of debt and preferred stock, pay dividends of $21.3million, and loan $12.0 million, all to Petro, and $6.0 million was retained byStar Gas to fund the General Partner's additional contribution obligation.During fiscal 1996, the Partnership sold 2.9 million Common Units, representingLimited Partnership interests, which provided $55.9 million in cash, net ofexpenses. The majority of the proceeds from this public offering were used torepay $53.8 million to Petro, representing $50.3 million of debt and $3.5million of additional indebtedness resulting from the excess of working capitalover $6.2 million at the time of closing. During the year ended September 30, 1996, the Partnership paid cashdistributions of $1.17 per Limited Partner Unit. These distributions coveredthe period from December 20, 1995, when the Partnership began operations, toJune 30, 1996, the end of the third quarter of fiscal 1996. On October 8, 1996,the Partnership declared its fourth quarter cash distribution of $0.55 perLimited Partner Unit, to be paid on November 15, 1996. The Partnership'sannualized distribution is presently $2.20 per Limited Partner Unit. The ability of the Partnership to satisfy its obligations is dependent uponfuture performance, which will be subject to prevailing economic, financial,business and weather conditions and other factors, many of which are beyond itscontrol. For the fiscal year ending September 30, 1997, the General Partnerbelieves that the Partnership will have sufficient funds to meet its obligationsand enable it to meet its obligations with respect to the First Mortgage Notesissued in December 1995, and enable it to distribute the Minimum QuarterlyDistribution ($0.55 per Unit) on all Common Units and Subordinated Units,although no assurance can be given with respect to such distributions. Futuremaintenance and working capital needs of the Partnership are expected to beprovided by cash generated from future operations, existing cash balances andits $12.0 million Working Capital Facility. In order to fund expansive capitalprojects and future acquisitions, the Partnership may issue additional CommonUnits or borrow under its $25.0 million Acquisition Facility. The First Mortgage Notes and Bank Credit Facility contain variousrestrictive convenants applicable to the Operating Partnership and itssubsidiary, the most restrictive relating to additional indebtedness, sale anddisposition of assets and transactions with affiliates. In addition, theOperating Partnership is prohibited from making cash distributions of theMinimum Quarterly Distribution if a default or event of default exists or wouldexist upon making such distribution, or if the Operating Partnership fails tomeet certain coverage tests. The Operating Partnership is in compliance with allrequirements, tests, limitations and covenants related to the First MortgageNotes and Bank Credit Facility. 21 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA SEE INDEX TO FINANCIAL STATEMENTS PAGE F-1 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE NONE PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTPartnership Management The General Partner manages and operates the activities of the Partnership.Unitholders do not directly or indirectly participate in the management oroperation of the Partnership. The General Partner owes a fiduciary duty to the Unitholders. Notwithstanding any limitation on obligations or duties, theGeneral Partner will be liable, as the general partner of the Partnership, forall debts of the Partnership (to the extent not paid by the Partnership), exceptto the extent that indebtedness or other obligations incurred by the Partnershipare made specifically non-recourse to the General Partner. William P. Nicoletti and Elizabeth K. Lanier, who are neither officers oremployees of the General Partner nor directors, officers or employees of anyaffiliate of the General Partner, have been appointed to serve on the AuditCommittee of the General Partner's Board of Directors with the authority toreview, at the request of the General Partner, specific matters as to which theGeneral Partner believes there may be a conflict of interest in order todetermine if the resolution of such conflict proposed by the General Partner isfair and reasonable to the Partnership. Any matters approved by the AuditCommittee will be conclusively deemed to be fair and reasonable to thePartnership, approved by all partners of the Partnership and not a breach by theGeneral Partner of any duties it may owe the Partnership or the Unitholders. Inaddition, the Audit Committee will review external financial reporting of thePartnership, will recommend engagement of the Partnership's independentaccountants and will review the Partnership's procedures for internal auditingand the adequacy of the Partnership's internal accounting controls. With respectto such additional matters, the Audit Committee may act on its own initiative toquestion the General Partner and, absent the delegation of specific authority bythe entire Board of Directors, its recommendations with regard thereto will beadvisory. As is commonly the case with publicly traded limited partnerships, thePartnership will not directly employ any of the persons responsible for managingor operating the Partnership. The current management and workforce of Star Gasand certain employees of Petro will continue to manage and operate thePartnership's business as officers and employees of the General Partner and itsAffiliates. See Item 1 - Business--Employees. 22 Directors and Executive Officers of the General Partner The following table sets forth certain information with respect to thedirectors and executive officers of the General Partner. Executive officers anddirectors are elected for one-year terms. Name Age Position with the General Partner ---- --- --------------------------------- Irik P. Sevin..................... 49 Chairman of the Board of DirectorsWilliam G. Powers, Jr............. 43 President and Chief Executive OfficerDavid R. Eastin................... 38 Vice President--OperationsNorman L. Bushey.................. 67 Vice President-- Safety/ComplianceRichard F. Ambury................. 39 Vice President-FinanceAudrey L. Sevin................... 70 Director and SecretaryThomas J. Edelman................. 45 DirectorPaul Biddelman.................... 50 DirectorWolfgang Traber................... 52 DirectorWilliam P. Nicoletti.............. 51 DirectorElizabeth K. Lanier............... 45 DirectorIrik P. Sevin has been the Chairman of the Board of Directors of Star Gas sinceDecember 1993. Mr. Sevin has been a director of Petro since its organization inOctober 1983, and Chairman of the Board of Petro since January 1993. Mr. Sevinhas been President of Petro, Inc. since November 1979 and of Petro since 1983.Mr. Sevin was an associate in the investment banking division of Kuhn Loeb & Co.and then Lehman Brothers Kuhn Loeb Incorporated from February 1975 to December1978. Mr. Sevin is a graduate of the Cornell University School of Industrialand Labor Relations (B.S.), New York University School of Law (J.D.) and theColumbia University School of Business Administration (M.B.A.). William G. Powers, Jr. has been President of Star Gas since December 1993. Priorto joining Star Gas, he was employed by Petro from 1984 to 1993 where he servedin various capacities, including Regional Operations Manager and Vice Presidentof Acquisitions. He has participated in over 90 acquisitions for Petro. From1977 to 1983, he was employed by The Augsbury Corporation, a company engaged inthe wholesale and retail distribution of fuel oil and gasoline throughout NewYork and New England and served as Vice President of Marketing and Operations.Mr. Powers is a graduate of the University of Notre Dame (B.A. 1975) and theUniversity of Vermont Graduate School of Business (M.B.A. 1984).David R. Eastin has served as Vice President of Operations of the GeneralPartner since September 1995. He joined Star Gas in 1992, and served as aRegional Manager and as Director of Operations--Eastern Area. Prior to joiningStar Gas, he was employed by Ferrellgas, Inc. (1987 through 1992) and apredecessor company, Buckeye Gas Products (1980 through 1987), in a variety ofoperational capacities. Mr. Eastin is a graduate of the University of Tulsa(B.S. 1980) and Duquesne University (M.B.A. 1985).Richard F. Ambury has been Vice President-Finance of Star Gas since February1996. Prior to joining Star Gas, he was employed by Petro from 1983-1996 wherehe served in various accounting/finance capacities. 23 Norman L. Bushey has served as Vice President of Safety/Compliance of theGeneral Partner since September 1995. Prior thereto he served as the NortheastArea Safety Manager for Star Gas following Star Gas' acquisition of Maingas,Inc. in 1988. From 1974 through 1988, Mr. Bushey served as Vice President andGeneral Manager of Maingas, Inc. From 1953 through 1974, Mr. Bushey was employedby Suburban Propane.Audrey L. Sevin has been a director of Star Gas since December 1993 and theSecretary of Star Gas since June 1994. Mrs. Sevin has been a director andSecretary of Petro since its organization in October 1983. Mrs. Sevin was adirector, executive officer and principal shareholder of A. W. Fuel Co., Inc.from 1952 until its purchase by Petro in May 1981. Mrs. Sevin is a graduate ofNew York University (B.S.).Thomas J. Edelman has been a director of Star Gas from December 1993 throughJune 1995 and since October 1995. Mr. Edelman has been a director of Petrosince its organization in October 1983. Mr. Edelman is the President and aDirector of Snyder Oil Corporation, a company he co-founded, since 1981. Mr.Edelman also serves as Chairman of Lomak Petroleum, Inc., a company herestructured in 1988 and which he served as Chairman and CEO until 1992 and asChairman and CEO of Patina Oil & Gas Corporation, a NYSE listed affiliate ofSnyder Oil. Prior to 1981, Mr. Edelman was Vice President of The First BostonCorporation and from 1975 through 1980 was with Lehman Brothers Kuhn LoebIncorporated. Mr. Edelman received his Bachelor of Arts Degree from PrincetonUniversity and his Masters Degree in Finance from the Harvard UniversityGraduate School of Business Administration. Mr. Edelman serves as a director ofCommand Petroleum Limited, an affiliate of Snyder Oil. Mr. Edelman also servesas a trustee of the Hotchkiss School.Paul Biddelman has been a director of Star Gas from December 1993 through June1995 and since October 1995. Mr. Biddelman has been a director of Petro sinceOctober 1994. Mr. Biddelman has been Treasurer of Hanseatic Corporation sinceApril 1992. Mr. Biddelman joined Hanseatic from Clements Taee BiddelmanIncorporated, a merchant banking firm which he co-founded in 1991. From 1982through 1990, he was a Managing Director in Corporate Finance at Drexel BurnhamLambert Incorporated. Mr. Biddelman also worked in corporate finance at Kuhn,Loeb & Co. from 1975 to 1979, and at Oppenheimer & Co. from 1979 to 1982. Mr.Biddelman is a director of Celadon Group, Inc., Electronic Retailing SystemsInternational, Inc., Insituform Technologies, Inc., Oppenheimer Group, Inc., andPremier Parks, Inc.Wolfgang Traber has been a director of Star Gas from December 1993 through June1995 and since October 1995. Mr. Traber has been a director of Petro since itsorganization in October 1983. Mr. Traber is Chairman of the Board of HanseaticCorporation, a private investment corporation in New York, New York. Mr. Traberis a director of Deltec Asset Management Corporation, Blue Ridge Real EstateCompany, Hellespont Tankers Ltd. and M.M. Warburg & Co.William P. Nicoletti has been a director of Star Gas since November 1995. Since1991, Mr. Nicoletti has been Managing Director of Nicoletti & Company Inc., a private investment bank servicing clients in energy-related industries. From1988 through 1990, he was a Managing Director and head of the Energy and NaturalResources Group of PaineWebber Incorporated. From 1969 through 1987 he was withE.F. Hutton & Company Inc., where from 1980 through 1987 he was a Senior VicePresident and head of the Energy and Natural Resources Group. He is alsoChairman of the Board of Amerac Energy Corporation and a director of StatesRailL.L.C. 24 Elizabeth K. Lanier has been a director of Star Gas since November 1995. SinceJune 1996, Ms. Lanier has been Vice President and Chief of Staff for CinergyCorp. Before joining Cinergy, Ms. Lanier was a partner in the law firm of Frost& Jacobs in Cincinnati Ohio. From 1976 through 1982, she was associated withDavis Polk & Wardwell in New York, New York. Ms. Lanier is a graduate of SmithCollege (B.A.) and the Columbia University School of Law (J.D.).Audrey Sevin is the mother of Irik P. Sevin. There are no other familialrelationships between any of the directors and executive officers.Meetings and Compensation of Directors During fiscal 1996, the Board of Directors met three times. All Directorsattended each meeting. Star Gas pays each director including the chairman anannual fee of $17,500. Members of the audit committee receive an additional$5,000 per annum.Committees of the Board of Directors The Company's Board of Directors has an Audit Committee and a CompensationCommittee. The members of each committee are appointed by the Board ofDirectors for a one year term and until their respective successors are elected. In connection with the Partnership's decision to explore strategicalternatives to maximize shareholder value, the board of directors has appointeda special committee to review the proposals received by Morgan Stanley & Co.,Incorporated. Ms. Lanier and Mr. Nicoletti are members of this specialcommittee and will receive $20,000 each for compensation in serving on thiscommittee.Audit Committee The duties of the Audit Committee are described above under "PartnershipManagement". The members of the Audit Committee are Elizabeth K. Lanier and William P.Nicoletti. Members of the Audit Committee may not be employees of the Company.Compensation Committee The duties of the Compensation Committee are (i) to determine the annualsalary, bonus and other benefits, direct and indirect, of any and all namedexecutive officers (as defined under Regulation S-K promulgated by theSecurities and Exchange Commission), (ii) to review and recommend to the fullBoard any and all matters related to benefit plans covering the foregoingofficers and any other employees in the event such matters are appropriate forstockholder approval, and (iii) to administer the Partnership's Unit Option Planas the Option Committee thereunder. The members of the Compensation Committeeare Wolfgang Traber and Irik P. Sevin.Reimbursement of Expenses of the General Partner The General Partner does not receive any management fee or othercompensation in connection with its management of the Partnership. The GeneralPartner is reimbursed at cost for all expenses incurred on behalf of thePartnership, including the costs of compensation described herein properlyallocable to the Partnership, and all other expenses necessary or appropriate tothe conduct of 25 the business of, and allocable to, the Partnership. The Partnership Agreementprovides that the General Partner shall determine the expenses that are allocable to the Partnership in any reasonable manner determined by the GeneralPartner in its sole discretion. Affiliates of the General Partner, includingPetro, perform certain management and acquisition services for the GeneralPartner on behalf of the Partnership. Such affiliates do not receive a fee forsuch services, but are reimbursed for all direct and indirect expenses incurredin connection therewith. In addition, the General Partner owns 2,396,078 subordinated units of thePartnership and is entitled to receive distributions on such Units, and theGeneral Partner is entitled to incentive distributions in respect of its generalpartner interest. ITEM 11. EXECUTIVE COMPENSATION The following table sets forth the annual salary, bonuses and all othercompensation awards and payouts to the President and Chief Executive Officer andto certain named executive officers of the General Partner for services renderedto Star Gas and its subsidiaries during the fiscal years ended September 30,1996 and 1995. Summary Compensation Table Annual Compensation ------------------------------------------ Other Annual Name and Principal Position Year Salary Bonus Compensation - ----------------------------------- ---- ------------- -------- ------------ William G. Powers, Jr. 1996 $225,000 $100,000 $21,071/(1)/ President and Chief Executive 1995 $219,231 $ 75,000 $18,094/(1)/ Officer David R. Eastin 1996 $106,826 $ 26,707 $ 3,214/(2)/ Vice President - Operations 1995 $ 89,896 $ 10,000 $ 9,292/(3)/ Richard F. Ambury 1996 $ 99,667/(4)/ $ 25,000 - Vice President - FinanceNorman L. Bushey 1996 $ 63,000 $ 15,750 $ 1,900/(2)/ Vice President - Safety/Compliance- --------------------(1) Represents amounts paid in lieu of contribution under Star Gas' 401(k) plan.(2) Represents matching contributions paid to Star Gas' 401(k) plan.(3) Represents a $7,570 relocation allowance and Star Gas' matching contribution to Mr. Eastin's 401(k) retirement plan of $1,722.(4) Mr. Ambury joined the General Partner on February 1, 1996.Transition Compensation/Severance Plan In connection with the Partnership's decision to explore strategicalternatives to maximize shareholders value, the General Partner has adopted aTransition Compensation/Severance plan for its employees and named executiveofficers which is triggered by the successful completion of a transaction by thePartnership involving a sale of the Partnership's business. Under the plan, Mr.Powers will receive an amount equal to approximately twice his current annualcompensation including bonus, Mr. Ambury will receive an amount equal to hiscurrent salary, and Messrs. Eastin and Bushey will receive an amount equal toone-half their annual salary. If there is a change in Messrs. Eastin's andBushey's employment status, they will also receive an additional amount equal totheir annual salary. 26 Aggregated Option Exercises in Last Fiscal Year and Fiscal Year End Option Values Number of Unexercised Options at September 30, 1996 Value of In the Money Options Name Exercisable(E)/Unexercisable(U) at September 30, 1996 - ---- ------------------------------- --------------------- William G. Powers, Jr. 30,000 (U) $0David R. Eastin 10,000 (U) $0(1) Values are calculated by deducting the exercise price from the fair market value of the common units as of September 30, 1996.Options Granted in Last Fiscal Year The following table sets forth certain information concerning options grantedduring 1996 to the named executives: Individual Grants Potential Realizable- ------------------------------------------------------------------------------------------ Value at Assumed % of Total Annual Rates of Stock Options Prices Appreciation Granted to Exercise Market Price for Option Term Options Employees Price on the Date Expiration --------------- Name Granted in 1996 ($ Share) of Grant Date 5% 10% ---- -------------- ---------- -------- ------------ ---------- -- ---- William G. Powers, Jr. 30,000/(1)(2)/ 75.0% $22.00 $22.00 12/20/05 $554,000 $1,402,000David R. Eastin 10,000/(1)(2)/ 25.0% $22.20 $22.00 12/20/05 $138,500 $ 350,600- ----------------- (1) The options were issued in December 1995 in connection with the Common Unit offering.(2) These options become exercisable on January 12, 2001.Unit Option Plan In December 1995, the General Partner adopted the 1995 Star Gas CorporationUnit Option Plan (the "Unit Option Plan"), which currently authorizes theissuance of options (the "Unit Options") and Unit Appreciation Rights ("UARS")covering up to 300,000 Subordinated Units to certain officers and employees ofthe General Partner. A total of 40,000 options were granted to key executivesin December 1995. The Unit Options have the following characteristics: 1)exercise price of $22 per unit, which is an estimate of the fair market value ofthe Subordinated Units at the time of grant, 2) vest over five year period, 3)exercisable after January 12, 2001, assuming the lapse of the subordinationperiod and 4) expire on the tenth anniversary of the date of grant. Uponconversion of the Subordinated Units held by the General Partner and itsaffiliates, the Unit Options granted will convert to Common Unit Options. 27 401(k) Plan The Star Gas Corporation Employee Savings Plan is a voluntary definedcontribution plan covering non-union and union employees who have attained theage of 21 and who have completed one year of service. Participant's in the planmay elect to contribute a sum not to exceed 15% of a participant's compensation.For non-union employees, the Company contributes a matching amount equaling theparticipant's contribution not to exceed 3% of the participant's compensation.In addition, the plan does allow the Company to contribute an additionaldiscretionary amount which will be allocated to each defined participant basedon each participant's compensation as a percentage of total compensation of allparticipant's. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENTOwnership of Common and Subordinated Units The following table set forth certain information as of September 30, 1996regarding the beneficial ownership of (i) the Common and Subordinated Units ofthe Partnership by certain beneficial owners and all directors of the GeneralPartner, each of the named executive officers and all directors and executive officers as a group. The General Partner knows of no person beneficially owningmore than 5% of the Common Units. Units Name and Address of Beneficially Percent of Title of Class Beneficial Owner Owned (1) Class -------------- ---------------- --------- ----- Common Units Richard F. Ambury/(1)/ 525 -Subordinated Units Star Gas Corporation/(1)/ 2,396,078 100% - ------------------/(1)/ The address of such person is care of the Partnership at 2187 Atlantic Street, Stamford, CT 06902. 28 Ownership of Petro Common Stock by the Directors and Executive Officers of theGeneral Partner The table below sets forth as of September 30, 1996, the beneficial ownershipof Petro Common Stock by each director and each named executive officer of theGeneral Partner, as well as the directors and all of the executive officers ofthe General Partner as a group. The total shares beneficially owned by thedirectors and executive officers as a group, including 288,759 shares of Class ACommon Stock and 44,190 shares of Class C Common Stock subject to optionsexercisable within the next 60 days, represent 22.66% of Petro's outstandingClass A Common Stock and 55.23% of Petro's outstanding Class C Common Stock.Each share of Class A Common Stock is entitled to one vote and each share ofClass C Common Stock is entitled to 10 votes, but otherwise the two Classes havethe same rights. The Class A Common Stock is traded on the Nasdaq NationalMarket. Number of Shares (1) Percent of Total --------------------------------- ---------------------- Percent of Total Voting Name Class A Class C Class A Class C Power (2) - --------------------------------- -------------- ------------ -------- -------- ------------- Audrey L. Sevin (3).............. 1,893,573 477,716 8.23% 18.39% 13.61% Irik P. Sevin(3)(4).............. 1,127,876 245,831 4.84% 9.31% 7.21% Wolfgang Traber (5).............. 1,652,203/(6)/ 606,472/(7)/ 7.18% 23.35% 15.75% Thomas J. Edelman................ 593,049/(8)/ 129,019 2.58% 4.97% 3.84%Paul Biddelman (3)............... 2,386 -- 0.01% -- --William G. Powers, Jr.(3)........ -- -- -- -- --Richard F. Ambury (3)............ 12,345 -- 0.05% -- 0.03%David R. Eastin (3).............. -- -- -- -- --Norman L. Bushey (3)............. -- -- -- -- --Elizabeth K. Lanier (9).......... -- -- -- -- --William P. Nicoletti (10)........ -- -- -- -- -- All officers and directors as a group (10 persons).............. 5,281,432 1,459,038 22.66% 55.23% 39.96%- --------------------(1) For purposes of this table, a person or group is deemed to have ''beneficial ownership'' of any shares which such person has the right to acquire within 60 days after September 30, 1996. For purposes of calculating the percentage of outstanding shares held by each person named above, any shares which such person has the right to acquire within 60 days after September 30, 1996 are deemed to be outstanding, but not for the purpose of calculating the percentage ownership of any other person.(2) Total voting power means the total voting power of all shares of Class A Common Stock and Class C Common Stock. This column reflects the percentage of total voting power represented by all shares of Class A Common Stock and Class C Common Stock held by the named persons.(3) The address of such person is c/o the Partnership at 2187 Atlantic Street, Stamford, CT 06902.(4) Includes options to purchase 276,759 shares of Class A Common Stock and 44,190 shares of Class C Common Stock.(5) The address of such person is 450 Park Avenue, New York, NY 10022.(6) These shares are owned of record by Hanseatic Corp., 450 Park Avenue, New York, NY 10022, which has the power to vote the shares under discretionary account arrangements, which power may be revoked at any time by Mr. Traber.(7) Includes 597,434 shares of Class C Common Stock owned of record by Deltec on behalf of Tortosa GmbH of which Mr. Traber is the beneficial owner.(8) Includes 76,000 shares of Class A Common Stock owned by Mr. Edelman's wife and minor children.(9) The address of such person is 221 E. Fourth St., 30th Fl., Cincinnati, OH 45202.(10) The address of such person is 1155 Avenue of the Americas, 29th Fl., New York, NY 10036. Section 16(a) of the Securities and Exchange Act of 1934 requires the GeneralPartner's officers and directors, and persons who own more than 10% of aregistered class of the Partnership's equity securities, to file reports ofbeneficial ownership and changes in beneficial ownership with the Securities and 29 Exchange Commission ("SEC"). Officers, directors and greater than 10 percentunitholders are required by SEC regulation to furnish the General Partner withcopies of all Section 16(a) forms. Based solely on its review of the copies of such forms received by theGeneral Partner, or written representations from certain reporting persons thatno Form 5's were required for those persons, the General Partner believes thatduring fiscal year 1996 all filing requirements applicable to its officers,directors, and greater than 10 percent beneficial owners were met in a timelymanner. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The Partnership and the General Partner have certain ongoing relationshipswith Petro and its Affiliates. Affiliates of the General Partner, includingPetro, perform certain administrative services for the General Partner on behalfof the Partnership. Such Affiliates do not receive a fee for such services, butare reimbursed for all direct and indirect expenses incurred in connectiontherewith. For the period December 20, 1995 through September 30, 1996, the Partnershipreimbursed the General Partner and Petro $14.4 million representing salary,payroll tax and other compensation to the employees of the General Partner,including $0.3 million paid to Petro for corporate services such as compliance,supply and finance. In addition, the Partnership has reimbursed Petro for $1.9million relating to the Partnership's share of the costs incurred by Petro inconducting the operations of certain shared branch locations which includemanagerial services. Petro and the General Partner entered into a Management Services Agreement onDecember 21, 1993 pursuant to which Petro agreed to provide executive, financialand managerial oversight services to the General Partner for a period of tenyears. Pursuant to the Management Services Agreement, Petro was entitled to ayearly management fee of $500,000, plus a bonus under certain circumstances. Forthe fiscal years ended September 30, 1995 and 1994, the General Partner paidfees of $500,000 and $575,000, respectively, pursuant to the Management ServicesAgreement. The Management Services Agreement was terminated in December 1995. Prior to Petro's acquisition of Star Gas, Star Gas engaged Nicoletti &Company Inc., an investment banking firm owned by William P. Nicoletti, who isnow a director of the General Partner, to perform certain investment bankingservices for Star Gas. Pursuant to such engagement, Star Gas paid Nicoletti &Company Inc. fees of $81,600, $521,500 and $40,000 for services rendered during1994, 1993 and 1992, respectively. In 1995 Star Gas paid Nicoletti & CompanyInc. $20,000 in advisory fees in connection with a proposed acquisition. Elizabeth K. Lanier, a director of the General Partner, was a partner in thelaw firm of Frost & Jacobs, in Cincinnati, Ohio until June 1996. Frost & Jacobshas acted as counsel to Star Gas in connection with certain litigation matters. 30 In 1993 Star Gas paid an aggregate of $50,000 in advisory fees to WarwickEnergy Advisors, Inc. (Warwick), a company controlled by Thomas Edelman, now adirector of the General Partner and Petro. In 1993, Petro paid Warwick and Mr.Edelman an aggregate of $211,500 in advisory fees in connection with Petro'sacquisition of Star Gas. In 1994, Petro paid Mr. Edelman an additional $248,500 in such fees. In 1995, Petro paid Mr. Edelman $20,000 in advisory fees inconnection with a proposed acquisition by Star Gas. For a discussion of certain indebtedness of the General Partner to Petro, seeNote 10 of the notes to the financial statements. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1. Financial Statements See "Index to Consolidated Financial Statements and Financial Statement Schedule" set forth on page F-1. 2. Financial Statement Schedule. See "Index to Consolidated Financial Statements and Financial Statement Schedule" set forth on page F-1. 3. Exhibits. See "Index to Exhibits" set forth on page 32. (b) Reports on Form 8-K. The Partnership did not file a Form 8-k during the quarter ended September 30, 1996. 31 INDEX TO EXHIBITS Description ----------- Exhibit Number Description ------ ----------- (1) 3.1 Form of Agreement of Limited Partnership of Star Gas Partners, L.P. (included as Appendix A to the Prospectus) (1) 3.2 Form of Agreement of Limited Partnership of Star Gas Propane, L.P. (1) 10.1 Form of Credit Agreement among Star Gas Propane, L.P. and certain banks (1) 10.2 Form of Conveyance and Contribution Agreement among Star Gas Corporation, the Partnership and the Operating Partnership (1) 10.3 Form of First Mortgage Note Agreement among certain insurance companies, Star Gas Corporation and Star Gas Propane, L.P. (1) 10.4 Intercompany Debt (1) 10.5 Form of Non-competition Agreement between Petro and the Partnership (1) 10.6 Form of Star Gas Corporation 1995 Unit Option Plan (1) 10.7 Amoco Supply Contract (1) 21 Subsidiaries of the registrant (2) 27 Financial data schedule _____________________________________ (1) Incorporated by reference to the same Exhibit to Registrant's Statement on Form S-1, File No. 33-98496, filed with the Commission on December 13, 1995. (2) Filed herein 32 SIGNATURE- ---------Pursuant to the requirements of the Securities Exchange Act of 1934, the Companyhas duly caused this report to be signed on its behalf by the undersignedthereunto duly authorized: Star Gas Partners, L.P. By: Star Gas Corporation (General Partner) William G. Powers, Jr. ---------------------- By:/s/William G. Powers, Jr. William G. Powers, Jr. President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, thisreport has been signed by the following persons in the capacities and on thedate indicated:Signature Title Date- --------- ----- ----/s/ William G. Powers, Jr. President November 14, 1996 ----------------------- Star Gas Corporation William G. Powers, Jr. (Principal Executive Officer) /s/ Richard F. Ambury Vice President - Finance November 14, 1996 ----------------------- Star Gas Corporation Richard F. Ambury (Principal Financial and Accounting Officers) /s/ Irik P. Sevin Director November 14, 1996 ----------------------- Star Gas Corporation Irik P. Sevin /s/ Audrey L. Sevin Director November 14, 1996 ----------------------- Star Gas Corporation Audrey L. Sevin /s/ William P. Nicoletti Director November 14, 1996 ----------------------- Star Gas Corporation William P. Nicoletti /s/ Elizabeth K. Lanier Director November 14, 1996 ----------------------- Star Gas Corporation Elizabeth K. Lanier /s/ Paul Biddleman Director November 14, 1996 ----------------------- Star Gas Corporation Paul Biddleman /s/ Thomas J. Edelman Director November 14, 1996 ----------------------- Thomas J. Edelman/s/ Wolfgang Traber Director November 14, 1996 ----------------------- Wolfgang Traber 33 STAR GAS PARTNERS, L.P. AND SUBSIDIARY INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE PAGE ----Part II Financial Information: Item 8 - Financial Statements Star Gas Partners, L.P. and the Star Gas Group (Predecessor) ----------------------------------------------------------- Independent Auditors' Report F-2 Consolidated Balance Sheets as of September 30, 1996 and 1995 (Predecessor) F-3 Consolidated Statements of Operations from October 1 through December 20, 1995 (Predecessor) and, from December 20, 1995 through September 30, 1996, and the years ended September 30, 1995 and 1994 (Predecessor) F-4 Consolidated Statements of Partners' Capital/ Predecessor Equity from December 20, 1995 through September 30, 1996 and from October 1, through December 20, 1995 (Predecessor) and the years ended September 30, 1995 and 1994 (Predecessor) F-5 Consolidated Statements of Cash Flows from October 1 through December 20, 1995 (Predecessor) and December 20 through September 30, 1996 and the years ended September 30, 1995 and 1994 (Predecessor) F-6 Notes to Consolidated Financial Statements F-7 - F-21 Schedule for the years ended September 30, 1996, 1995 and 1994 II. Valuation and Qualifying Accounts F-22 All other schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or the notes therein. F-1 INDEPENDENT AUDITORS' REPORTThe Partners of Star Gas Partners, L.P.: We have audited the accompanying consolidated financial statements of Star Gas Partners, L.P. and Subsidiary and its Predecessor as of September 30, 1996 and 1995 for each of the years in the three-year period ended September 30, 1996 as listed in the accompanying index. In connection with our audit of the consolidated financial statements we have also audited the financial statement schedule listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Partnership'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 Star Gas Partners, L.P. and Subsidiary and its Predecessor at September 30, 1996 and 1995 and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 1996, 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, presents fairly, in all material respects, the information set forth therein. KPMG Peat Marwick LLPStamford, ConnecticutNovember 13, 1996 F-2 STAR GAS PARTNERS, L.P. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (in thousands) September 30, September 30, 1995 1996 (Predecessor) ------------- -------------- Assets Current assets: Cash $ 1,106 $ 727 Receivables, net of allowance of $291 and $362, respectively 7,226 6,436 Inventories 8,494 6,154 Prepaid expenses and other current assets 1,016 949 -------- -------- Total current assets 17,842 14,266 -------- -------- Property and equipment, net 97,733 98,687 Intangibles and other assets, net 41,338 42,440 -------- -------- Total assets $156,913 $155,393 ======== ======== Liabilities and Partners' Capital/Predecessor Equity Current liabilities: Bank credit facility borrowings and current debt $ 2,350 $ 748 Accounts payable 1,991 2,824 Accrued expenses 3,097 3,000 Dividends payable - 4,875 Customer credit balances 2,858 3,305 -------- -------- Total current liabilities 10,296 14,752 -------- -------- Long-term debt 85,000 1,389 Due to Petro - 86,002 Other long-term liabilities 219 320 Cumulative redeemable preferred stock - 8,625 Predecessor Equity 44,305 Partners' Capital: Common unitholders 52,821 Subordinated unitholder 8,410 General partner 167 -------- -------- Total Partners' Capital/Predecessor Equity 61,398 44,305 -------- -------- Total Liabilities and Partners' Capital/Predecessor Equity $156,913 $155,393 ======== ======== See accompanying notes to consolidated financial statements. F-3 STAR GAS PARTNERS, L.P. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per unit amounts) October 1, October 1, 1995 December 20, 1995 Year Year through 1995 through Ended Ended December 20, 1995 through September 30, September 30, September 30, 1995 September 30, 1996 1995 1994 (Predecessor) 1996 (Combined) (Predecessor) (Predecessor) -------------- -------------- -------------- -------------- -------------- Sales $28,159 $91,475 $119,634 $104,550 $ 128,040 Cost of sales 12,808 45,749 58,557 49,660 58,553 ------- ------- ------- -------- -------- Gross profit 15,351 45,726 61,077 54,890 69,487 Delivery and branch 7,729 27,021 34,750 35,222 41,530 Depreciation and amortization 2,177 7,631 9,808 10,073 13,039 General and administrative 1,349 5,108 6,457 6,127 6,011 Net gain (loss) on sales of assets (113) (147) (260) (913) 486 ------- ------- ------- -------- -------- Operating income 3,983 5,819 9,802 2,555 9,393 Interest expense, net 1,922 5,202 7,124 8,549 10,497 ------- ------- ------- -------- -------- Income (loss) before income taxes 2,061 617 2,678 (5,994) (1,104) Income tax expense 60 25 85 175 300 ------- ------- ------- -------- -------- Net income (loss) $ 2,001 $ 592 $ 2,593 $ (6,169) $ (1,404) ======= ======= ======== ======== ========= General Partner's interest in net income $ 12 ------- Limited Partners' interest in net income $ 580 ======= Net Income per Limited Partner unit $ .11 ======= Weighted average number of Limited Partner units outstanding 5,271 ======= See accompanying notes to consolidated financial statements. F-4 STAR GAS PARTNERS, L.P. AND SUBSIDIARY CONSOLIDATED STATEMENT OF PARTNERS' CAPITAL/PREDECESSOR EQUITY (in thousands) Partners' Capital For the period ended December 20, 1995 through September 30, 1996 Number of Units Total -------------------- General Partners' Common Subordinated Common Subordinated Partner Capital ------ ------------ -------- ------------- -------- ---------- Balance as of December 20, 1995 - - - - - - Contribution of assets, net - 2,396 $ - $10,956 $ 225 $11,181 Issuance of Common Units, net 2,875 - 55,875 - 56 55,931 Distributions (3,371) (2,809) (126) (6,306) Net income - - 317 263 12 592 ------ ------- ------- ------- ----- ------- Balance as of September 30, 1996 2,875 2,396 $52,821 $ 8,410 $ 167 $61,398 ====== ======= ======= ======= ===== ======= Predecessor's Equity Years ended September 30, 1994 and 1995 and the period October 1, 1995 through December 20, 1995 8% Cumulative Total Preferred Convertible 12.5% Capital in Common Predecessor's Stock Preferred Preferred Excess of Treasury Equity Series A Stock Stock Par Value Deficit Stock (Old) (Deficiency) -------- ----- ----- --------- ------- ---------- ----------- Old New --- --- Balance as of Sept. 30, 1993 $ 41 $ 1 $ - $ - $58,472 $(59,151) $(2,188) $ (2,825)Recapitalization (41) (1) 525 - 52,413 - 2,188 55,084Redemption of preferred Stock - - (56) - (5,685) - - (5,741)Stock dividends declared - - 31 - 3,136 (3,931) - (764)Cash dividends preferred stock - - - - - (22) - (22) Net loss - - - - - (1,404) - (1,404) ------ ------ ------ ------ ------- ------ ------ ------- Balance as of Sept. 30, 1994 - - 500 - 108,336 (64,508) - 44,328Conversion of preferred stock - - (266) 319 (53) - - -Redemption of preferred stock - - (49) - (5,042) - - (5,091)Stock dividends declared - - 4 - 368 (732) - (360)Cash dividends preferred stock - - - - - (5,287) - (5,287)Purchase accounting adjustment - - - - (51,906) 68,790 - 16,884 Net loss - - - - - (6,169) - (6,169) ------ ------ ------ ------ ------- ------ ------ ------- Balance as of Sept. 30, 1995 - - 189 319 51,703 (7,906) - 44,305 Dividends (21,309) (21,309)Additional capital contribution - - - - 4,184 - - 4,184Net income - - - - - 2,001 - 2,001 ------ ------ ------ ------ ------- ------ ------ ------- Balance as of Dec. 20, 1995 $ - $ - $ 189 $ 319 $55,887 $(27,214) $ - $ 29,181 ====== ====== ====== ====== ======= ====== ====== ======= See accompanying notes to consolidated financial statements. F-5 STAR GAS PARTNERS, L.P. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) October 1, 1995 through October 1, 1995 December 20, December 20, 1995 through 1995 through September 30, 1996 (Predecessor) September 30, 1996 (combined) ------------- ------------------ ------------------ Cash Flows from Operating activities: Net income (loss) $ 2,001 $ 592 $ 2,593 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 2,177 7,631 9,808 Provision for losses on accounts receivable 101 321 422 Net (gain) loss on sales of assets 113 147 260 Changes in operating assets and liabilities: Decrease (increase) in receivables (2,779) 1,766 (1,013) Decrease (increase) in inventories 1,430 (3,770) (2,340) Decrease (increase) in prepaid and other assets (455) 754 299 Increase (decrease) in other current liabilities (1,703) 1,757 54 Decrease in other long-term liabilities (12) (89) (101) -------- -------- -------- Net cash provided by operating activities 873 9,109 9,982 -------- -------- -------- Cash Flows from Investing activities: Capital expenditures (1,617) (3,715) (5,332) Business acquisitions - (2,440) (2,440) Proceeds from sales of fixed assets 566 252 818 Proceeds from sale of businesses - - - -------- -------- -------- Net cash provided by (used in) investing activities (1,051) (5,903) (6,954) -------- -------- -------- Cash Flows from Financing activities: Net borrowings (repayments) under bank credit facilities - 2,350 2,350 Borrowings (repayments) of debt (35,783) (53,780) (89,563) Repayments of preferred stock (8,625) - (8,625) Net proceeds from the issuance of preferred stock - - - Cash dividends paid (21,309) - (21,309) Distributions - (6,306) (6,306) Loan to Petro (12,000) - (12,000) Proceeds from issuance of First Mortgage Notes 85,000 - 85,000 Proceeds from issuance of Common Units, net - 55,931 55,931 Debt placement and credit agreement expenses (1,313) (814) (2,127) Cash retained by general partner (6,000) - (6,000) -------- -------- -------- Net cash provided by (used in) financing activities (30) (2,619) (2,649) -------- -------- -------- Net increase (decrease) in cash (208) 587 379 Cash at beginning of period 727 519 727 -------- -------- -------- Cash at end of period $ 519 $ 1,106 $ 1,106 ======== ======== ======== Year Ended Year Ended September 30, September 30, 1995 1994 (Predecessor) (Predecessor) ------------ --------- Cash Flows from Operating activities: Net income (loss) $(6,169) $ (1,404) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 10,073 13,039 Provision for losses on accounts receivable 809 589 Net (gain) loss on sales of assets 913 (258) Changes in operating assets and liabilities: Decrease (increase) in receivables 1,390 306 Decrease (increase) in inventories (1,196) 1,631 Decrease (increase) in prepaid and other assets 188 396 Increase (decrease) in other current liabilities (5,504) (12,017) Decrease in other long-term liabilities (87) (175) ------- -------- Net cash provided by operating activities 417 2,107 ------- -------- Cash Flows from Investing activities: Capital expenditures (7,988) (5,419) Business acquisitions (4,557) (2,690) Proceeds from sales of fixed assets 707 480 Proceeds from sale of businesses 13,250 1,650 ------- -------- Net cash provided by (used in) investing activities 1,412 (5,979) ------- -------- Cash Flows from Financing activities: Net borrowings (repayments) under bank credit facilities (4,000) (2,809) Borrowings (repayments) of debt 6,576 (13,416) Repayments of preferred stock (5,091) (5,740) Net proceeds from the issuance of preferred stock - 26,254 Cash dividends paid (412) (22) Distributions - - Loan to Petro - - Proceeds from issuance of First Mortgage Notes - 700 Proceeds from issuance of Common Units, net - - Debt placement and credit agreement expenses - - Cash retained by general partner - - ------- -------- Net cash provided by (used in) financing activities (2,927) 4,967 ------- -------- Net increase (decrease) in cash (1,098) 1,095 Cash at beginning of period 1,825 730 ------- -------- Cash at end of period $ 727 $ 1,825 ======= ======== See accompanying notes to consolidated financial statements. F-6 STAR GAS PARTNERS, L.P. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands except per share data)1) Partnership Organization and Formation Star Gas Partners, L.P. ("Star Gas Partners" or the "Partnership") was formed on October 16, 1995, as a Delaware limited partnership. Star Gas Partners and its subsidiary, Star Gas Propane, L.P., a Delaware limited partnership, (the "Operating Partnership") were formed to acquire, own and operate substantially all of the propane operations and assets and liabilities of Star Gas Corporation ("Star Gas"), a Delaware corporation (and the general partner of Star Gas Partners and the Operating Partnership) and the propane operations and assets and liabilities of Star Gas' parent corporation, Petroleum Heat and Power Co., Inc., a Minnesota corporation ("Petro"), (collectively hereinafter referred to as the "Star Gas Group" or the "Predecessor Company"). The Operating Partnership is, and the Star Gas Group was, engaged in the marketing and distribution of propane gas and related appliances to retail and wholesale customers in the United States located principally in the Midwest and Northeast. On December 20, 1995, (i) Petro conveyed all of its propane assets and related liabilities to Star Gas and (ii) Star Gas and its subsidiaries conveyed substantially all of their assets (other than $83.7 million in cash from the proceeds of the First Mortgage Notes and certain non-operating assets) to the Operating Partnership (the "Star Gas Conveyance") in exchange for general and limited partner interests in the Operating Partnership and the assumption by the Operating Partnership of substantially all of the liabilities of Star Gas and its subsidiaries (excluding certain income tax liabilities and certain other long-term obligations of Star Gas that were assumed by Petro), including the First Mortgage Notes and approximately $53.8 million in outstanding Star Gas debt due to Petro. The net book value of the assets contributed by Star Gas and its subsidiaries to the Operating Partnership exceeded the liabilities assumed by $11.2 million. Immediately after the Star Gas Conveyance, Star Gas and its subsidiaries conveyed their limited partner interests in the Operating Partnership to Star Gas Partners in exchange for an aggregate of 2.4 million Subordinated Units of limited partner interest in Star Gas Partners. Of the $83.7 million in cash retained by the General Partner, $35.8 was paid to Petro in satisfaction of additional indebtedness, $8.6 million was used to redeem preferred stock of the General Partner held by Petro, $12.0 million was loaned to Petro, and $6.0 million was retained to be available to fund the General Partner's additional capital contribution obligation. The remaining $21.3 million was paid to Petro as dividends. During fiscal 1996, Star Gas Partners completed its initial public offering of 2.9 million Common Units, including overallotment shares of 0.3 million, representing Limited Partner interests, at a price of $22.00 a unit. The net proceeds received of $55.9 million, after deducting underwriting discounts, commissions and expenses were contributed to the Operating Partnership and F-7 1) Partnership Organization and Formation - Continued used to repay $50.3 million of debt due to Petro, which was assumed by the Operating Partnership in the Star Gas Conveyance and the Partnership used the balance of $5.6 million for general operating purposes. In order that the Partnership would commence operations with $6.2 million of working capital on December 20, 1995, the Conveyance Agreement provided that the amount of debt due to Petro at closing would be adjusted upwards or downwards to the extent that the Star Gas Partners' net working capital exceeded or was less than $6.2 million. At closing, net working capital was $9.7 million and $3.5 million was repaid to Petro on January 18, 1996. The General Partner holds a 1.0% general partner interest in Star Gas Partners and a 1.0101% general partner interest in the Operating Partnership. Star Gas Partners and the Operating Partnership have no employees, except for certain employees of its corporate subsidiary Stellar Propane Service Corporation. The General Partner conducts, directs and manages all activities of Star Gas Partners and the Operating Partnership and is reimbursed on a monthly basis for all direct and indirect expenses it incurs on their behalf including the cost of employee wages.2) Acquisition by Petro In December 1993, Petro acquired an approximate 29.5% interest in Star Gas for $16.0 million. Petro exercised its right in December 1994 to purchase the remaining outstanding common equity of Star Gas by paying $3.8 million in cash and issuing approximately 2.5 million shares of its common stock. The acquisition was accounted for as a purchase, accordingly, the purchase price was allocated to the underlying assets and liabilities based upon their estimated 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 is being amortized over a period of twenty-five years.3) Divestitures In November 1994, the Company sold all of its retail propane operations located in southern Georgia for $13,250 in cash, realizing a loss of $695 on the sale. In September 1994, the Company sold one of its retail propane operations, in the Northeast for approximately $650, net of expenses, realizing a gain of $459 on the sale. In December 1993, the Company, in an effort to improve profitability and to concentrate on its core business, sold one of its wholly owned subsidiaries, Federal Petroleum Company, for $1,650 in cash and an 8% interest bearing note in the amount of $500. The note is due in 48 monthly installments commencing on November 1, 1994 and ending October 1, 1998. At September 30, 1993, the Company adjusted the carrying value and the net assets of Federal to then equal the expected sales price of $2,150. F-8 4) Summary of Significant Accounting Policies Basis of Presentation The Consolidated Financial Statements for the period December 20, 1995 through September 30, 1996 include the accounts of Star Gas Partners, L.P., the Operating Partnership and its corporate subsidiary, Stellar Propane Service Corp., collectively referred to herein as (the "Partnership"). The Consolidated Financial Statements for the period October 1, through December 20, 1995 and the years ended September 30, 1995 and 1994 include the propane operations, assets and liabilities of the Star Gas Group. All material intercompany items and transactions have been eliminated in consolidation and certain reclassifications have been made to the 1995 and 1994 financial statements to conform to the 1996 presentation. Net Income per Limited Partner Unit Net income per Limited Partner Unit is computed by dividing net income, after deducting the General Partner's 2.0% interest, by the weighted average number of Common Units and Subordinated Units outstanding. Revenue Recognition Sales of propane and propane appliances are recognized at the time of delivery of the product to the customer or at the time of sale or installation. Revenue from service repairs and maintenance is recognized upon completion of the service provided. Inventories Inventories are stated at the lower of cost or market and are computed on a first-in, first-out basis. At the dates indicated the components of inventory were as follows: September 30, -------------------- 1996 1995 ------ ------ Propane gas................... $6,625 $4,594 Appliances and equipment...... 1,869 1,560 ------ ------ $8,494 $6,154 ====== ====== Substantially all of the Partnership's propane supply for the Northeast retail operations are purchased under supply contracts. Certain of the supply contracts provide for minimum and maximum amounts of propane to be purchased thereunder, and provide for pricing in accordance with posted prices at the time of delivery or include a pricing formula that typically is based on current market prices. One supply agreement, representing approximately 7,200 gallons, extends through March 31, 1999. During 1996, spot purchases from Mont. Belvieu sources accounted for approximately 26% of the Partnership's total volume of propane purchases, while the three single largest suppliers accounted for approximately 32% of total propane purchases. Property and Equipment Property and equipment are stated at cost. Depreciation is computed over the estimated useful lives of the depreciable assets using the straight-line method. F-9 4) Summary of Significant Accounting Policies - Continued Intangible Assets The excess of cost over the fair value of net assets resulting from the acquisition of the Company by Petro in December 1994 is being amortized using the straight-line method over 25 years. For the period October 1993 through December 1994, goodwill was being amortized over 10 years. Other intangible assets, including covenants not to compete and customer lists are recorded at cost and are being amortized over their estimated useful lives, ranging from 1 to 15 years. Also included as intangible assets are the costs associated with the issuance of the Company's First Mortgage Notes which are being amortized under the interest method over the life of the notes. The Partnership assesses the recoverability of intangible assets 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 intangible impairment is measured based on market values, as available, or by projected cash flows. Customer Credit Balances Customer credit balances primarily represents pre-payments received from customers pursuant to a budget payment plan (whereby customers pay their estimated annual propane gas charges on a fixed monthly basis) in excess of actual deliveries billed. Use of Estimates In accordance with generally accepted accounting principles, management of the Partnership has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these financial statements. Actual results could differ from those estimates. Cash Equivalents The Partnership considers all highly liquid investments with a maturity of three months or less, when purchased, to be cash equivalents. Income Taxes The Partnership is a master limited partnership. As a result, for Federal income tax purposes, earnings or losses are allocated directly to the individual partners. Except for the Partnership's corporate subsidiary which generates non-qualifying Master Limited Partnership income in the northeast, no recognition has been given to income taxes in the accompanying financial statements of the Partnership. Net earnings for financial statement purposes may differ significantly from taxable income reportable to unitholders as a result of differences between the tax basis and financial reporting basis of assets and liabilities and the due to taxable income allocation requirements of the Partnership agreement. F-10 4) Summary of Significant Accounting Policies - Continued Since December 1994 and prior to the Partnership's formation, the Predecessor filed a consolidated Federal income tax return with Petro and its affiliates. Income taxes were computed as though each company filed its own income tax return. Deferred income taxes were recognized for the tax consequences of temporary differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. Prior to the December 1994 acquisition by Petro, Star Gas filed consolidated tax returns with its subsidiaries.5) Quarterly Distribution of Available Cash The Partnership will distribute to its partners, on a quarterly basis, all of its Available Cash. "Available Cash" generally means, with respect to any fiscal quarter of the Partnership, all cash on hand at the end of such quarter, less the amount of cash reserves that are necessary or appropriate in the reasonable discretion of the General Partner. Distribution by the Partnership in an amount equal to 100% of its Available Cash will generally be made 98% to the Common and Subordinated Unitholders and 2% to the General Partner, subject to the payment of incentive distributions in the event Available Cash exceeds the Minimum Quarterly Distribution ($0.55) on all Units. To the extent there is sufficient Available Cash, the holders of Common Units have the right to receive the Minimum Quarterly Distribution, plus any arrearage, prior to the distribution of Available Cash to holders of Subordinated Units. Common Units will not accrue arrearage for any quarter after the end of the Subordination Period (as defined below) and Subordinated Units will not accrue any arrearage with respect to distributions for any quarter. The first distribution commenced with the quarter ending March 31, 1996 and was paid on May 15, 1996 to holders of record as of May 1, 1996. The initial distribution was $0.6225 per unit and represented a pro rata distribution of $0.0725 per unit for the period December 20, 1995 to December 31, 1995 and a quarterly distribution of $0.55 per unit for the three months ended March 31, 1996. The distribution for the quarter ending June 30, 1996 of $0.55 was paid on August 15, 1996 to holders of record as of August 1, 1996. For the quarter ending September 30, 1996 the Partnership announced on October 8, 1996 that it will pay a distribution of $0.55 per unit payable November 15, 1996 to the Unitholders of record November 1, 1996. To enhance the Partnership's ability to pay the Minimum Quarterly Distribution on the Common Units, the General Partner has agreed, subject to certain limitations, to contribute additional capital to the Partnership in the amount necessary to distribute the Minimum Quarterly Distribution on all outstanding Common Units for such quarter. As of September 30, 1996, the General Partner's additional Capital Contribution obligation was $3.0 million. F-11 6) Distributions from Operating Surplus During Subordination Period The Subordination Period will generally extend until the first day of any quarter beginning on or after January 1, 2001 in respect of which (i) distributions of Available Cash from Operating Surplus on the Common Units and the Subordinated Units equals or exceeds the sum of the Minimum Quarterly Distribution on all of the outstanding Common Units and Subordinated Units with respect to each of the three non-overlapping four-quarter periods immediately preceding such date, (ii) the Adjusted Operating Surplus generated during each of the three immediately preceding non-overlapping four-quarter periods equals or exceeds the sum of the Minimum Quarterly Distribution on all of the outstanding Common Units and Subordinated Units during such periods and (iii) there are no arrearages in payment of the Minimum Quarterly Distribution on the Common Units. Prior to the end of the Subordination Period, a portion of the Subordinated Units will convert into Common Units on the first day after the record date established for any quarter ending on or after March 31, 1999 (with respect to 599,020 of the Subordinated Units) and March 31, 2000 (with respect to an additional 599,020 of the Subordinated Units), on a cumulative basis, in respect of which (i) distributions of Available Cash from Operating Surplus on the Common Units and the Subordinated Units equals or exceeds the sum of the Minimum Quarterly Distribution on all of the outstanding Common Units and Subordinated Units with respect to each of the three non-overlapping four- quarter periods immediately preceding such date, (ii) the Adjusted Operating Surplus generated during each of the three immediately preceding non- overlapping four-quarter periods equals or exceeds the sum of the Minimum Quarterly Distribution on all of the outstanding Common Units and Subordinated Units during such periods and (iii) there are no arrearages in payment of the Minimum Quarterly Distribution on the Common Units.7) Acquisitions - Pro Forma During 1996, 1995 and 1994, the Partnership acquired several propane dealers with an aggregate cost of $2,440, $4,557 and $2,690 respectively. The acquisitions were accounted for under the purchase method of accounting. Purchase prices have been allocated to the acquired assets and liabilities based on their respective fair market values on the dates of acquisition. The purchase prices in excess of the fair values of net assets acquired were classified as intangibles in the Consolidated Balance Sheets. Sales and net income have been included in the Consolidated Statements of Operations from the respective dates of acquisition. Unaudited Pro forma data giving effect to the purchased business as if they had been acquired on October 1 of the year preceding the year of purchase. Years Ended September 30, ----------------------------- 1996 1995 1994 ---- ---- ---- Sales $120,645 $107,714 $132,549 Net income (loss) 2,817 (6,260) (1,471) F-12 8) Property, Plant and Equipment The components of property, plant and equipment and their estimated useful lives were as follows at the indicated dates: September 30, Estimated ---------------- 1996 1995 Useful Lives ---- ---- ------------ Land $ 3,916 $ 4,796 Buildings 8,945 8,465 30 years Fleet 12,679 11,432 5 - 30 years Tanks and equipment 82,296 76,754 5 - 30 years Furniture and fixtures 2,440 2,432 10 years -------- -------- Total $110,276 $103,879 Less: accumulated depreciation (12,543) (5,192) -------- -------- Total $ 97,733 $ 98,687 ======== ======== 9) Intangibles and Other Assets The components of intangibles and other assets were as follows at the indicated dates: September 30, --------------- 1996 1995 --------- -------- Goodwill $ 14,186 $ 13,681 Covenants not to compete 2,040 1,879 Customer lists 28,797 28,797 Deferred charges and other assets 2,795 1,350 -------- -------- Total $ 47,818 $ 45,707 Less: accumulated amortization (6,480) (3,267) -------- -------- Total $ 41,338 $ 42,440 ======== ======== 10) Long-Term Debt and Working Capital Borrowings In December 1995, the General Partner issued $85.0 million of first mortgage notes (the "First Mortgage Notes") with an annual interest rate of 8.04%. These notes were assumed as part of the Star Gas Conveyance by the Operating Partnership. The Operating Partnership's obligations under the First Mortgage Note Agreement are secured, on an equal basis with the Operating Partnership's obligations under the Bank Credit Facilities, by a mortgage on substantially all of the real property and liens on substantially all of the operating facilities, equipment and other assets of the Operating Partnership. The First Mortgage Notes will mature September 15, 2009, and will require semiannual prepayments, without premium on the principal thereof, beginning on March 15, 2001. Interest is payable semiannually on March 15 and September 15. For the year ended September 30, 1996, the Partnership paid interest in the amount of $5.1 million on the First Mortgage Notes. The First Mortgage Note Agreement contains various restrictive and affirmative covenants applicable to the Operating Partnership, including restrictions on the incurrence of additional indebtedness and restrictions on certain investments, guarantees, loans, sales of assets and other transactions. As of September 30, 1996, the Partnership was in compliance with all borrowing agreement covenants, as amended. F-13 10) Long-Term Debt and Working Capital Borrowings - Continued The Bank Credit Facilities consist of a $25.0 million Acquisition Facility and a $12.0 million Working Capital Facility. The agreement governing the Bank Credit Facilities contains covenants and default provisions generally similar to those contained in the First Mortgage Note Agreement. As of September 30, 1996, $2,350 was outstanding under the Working Capital Facility. The Bank Credit Facilities bear interest at a rate based upon, at the Partnership's option, either the London Interbank Offered Rate plus a margin or a Base Rate (each as defined in the Bank Credit Facilities). The weighted average interest rate for borrowings under the Working Capital Facility was 8.25% at September 30, 1996 and for fiscal 1996. In addition, the Partnership is required to pay a fee for unused commitments which amounted to $104 for fiscal 1996. The Working Capital Facility will expire December 31, 1998, but may be extended annually thereafter with the consent of the banks. Borrowings under the Acquisition Facility will revolve until September 30, 1998, after which time any outstanding loans thereunder, will amortize quarterly in equal principal payments with a final payment due on December 31, 2001. However, there must be no amount outstanding under the Working Capital Facility for at least 30 consecutive days during each fiscal year. As of September 30, 1995, the Star Gas Group had $86,002 of notes due to Petro with interest rates ranging from 8.75% to 12.625% with a final maturity of August 2001. The debt due to Petro was repaid on December 20, 1995 with a portion of the proceeds from the sale of the First Mortgage Notes and the sale of the Common Units. In connection with certain acquisitions, the Star Gas Group had obligations payable to former owners aggregating $2,137, of which $748 was classified as current as of September 30, 1995. These obligations primarily consisted of capital lease obligations, notes payable and payments pursuant to certain covenants not- to-compete and consulting agreements and were assumed by Petro as part of the Star Gas Conveyance. As of September 30, 1996, the annual maturities of the First Mortgage Notes and the Working Capital Facility are set forth in the following table: 1997 $ 2,350 1998 - 1999 - 2000 - 2001 1,923 Thereafter 83,077 ------- $87,350 ======= F-14 11) Employee Benefit Plans Star Gas has a 401(k) plan which covers certain eligible union and non- union employees. Subject to IRS limitations, the 401(k) plan provides for each employee to contribute from 1% to 15% of compensation. Star Gas contributes to non-union participants a matching amount up to a maximum of 3% of compensation. Aggregate matching contributions made to the 401(k) plan during fiscal 1996, 1995 and 1994 were $293, $247 and $131, respectively. Star Gas also makes monthly contributions on behalf of its union employees to a union sponsored defined benefit plan. The amount charged to expense was $278, $238 and $207 in fiscal 1996, 1995 and 1994, respectively. 12) Unit Option Plan On December 20, 1995, the General Partner adopted the 1995 Star Gas Corporation Unit Option Plan (the "Unit Option Plan"), which currently authorizes the issuance of options (the "Unit Options") and Unit Appreciation Rights ("UARS") covering up to 300,000 Subordinated Units to certain officers and employees of the General Partner. A total of 40,000 options were granted to key executives in December 1995. The Unit Options have the following characteristics: 1) exercise price of $22 per unit, which is an estimate of the fair market value of the Subordinated Units at the time of grant, 2) vest over five year period, 3) exercisable after January 1, 2001, assuming the subordination's period elapsed, and 4) expire on the tenth anniversary of the date of grant. Upon conversion of the Subordinated Units held by the General Partner and its affiliates, the Unit Options granted will convert to Common Unit Options.13) Lease Commitments The Partnership has entered into certain operating leases for office space, trucks and other equipment. The future minimum rental commitments at September 30, 1996 under leases having an initial or remaining noncancellable term of one year or more are as follows: 1997 $ 883 1998 828 1999 317 2000 266 2001 251 Thereafter 720 ------ Total Minimum lease payments $3,265 ====== The Partnership incurred rent expense of $1,212, $1,160 and $1,685 in 1996, 1995 and 1994, respectively. F-15 14) Unaudited Pro Forma Financial Information The accompanying unaudited Pro Forma Condensed Consolidated Statements of Operations for the twelve months ended September 30, 1996 and 1995 were derived from the Consolidated Statement of Operations of the Partnership from December 20, 1995 through September 30, 1996 and the Statements of Operations of the Star Gas Group, for the periods October 1, 1994 through September 30, 1995 and October 1, 1995 through December 20, 1995. The Pro Forma Condensed Consolidated Statements of Operations were prepared to reflect the effects of Partnership formation as if it had been completed in its entirety as of the beginning of the periods presented. However, these statements do not purport to present the results of operations of the Partnership had partnership formation actually been completed as of the beginning of the periods presented. In addition, the Pro Forma Condensed Consolidated Statements of Operations are not necessarily indicative of the results of future operations of the Partnership and should be read in conjunction with the Consolidated Financial Statements of the Predecessor Company and the Partnership. F-16 14) Unaudited Pro Forma Financial Information - Continued STAR GAS PARTNERS, L.P. AND SUBSIDIARY PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per unit amounts) (unaudited) Fiscal Year Ended September 30, -------------------- 1996 1995 --------- --------- Sales $119,634 $102,496 Cost of sales 58,557 48,649 -------- -------- Gross profit 61,077 53,847 -------- -------- Operating expenses 41,081 39,888 Depreciation and amortization 9,870 10,147 Net loss on sales of assets (260) (278) -------- -------- Operating income 9,866 3,534 Interest expense (net) 6,713 7,134 -------- -------- Income (loss) before income taxes 3,153 (3,600) Income tax expense 25 25 -------- -------- Net income (loss) $ 3,128 $ (3,625) ======== ======== General Partner's interest in net income (loss) 63 (73) -------- -------- Limited Partners' interest in net income (loss) $ 3,065 $ (3,552) ======== ======== Net income (loss) per Limited Partner unit $0.58 $(0.67) ======== ======== Weighted average number of Limited Partner units outstanding 5,271 5,271 ======== ======== Other data: Distributable cash: EBITDA/(A)/ $ 19,996 $ 13,959 Less: Interest expense 6,713 7,134 Income taxes 25 25 Maintenance capital expenditures/(B)/ 2,288 4,222 -------- -------- Distributable cash 10,970 2,578 General Partners' interest (220) (52) -------- -------- Distributable cash available for Limited Partners $ 10,750 $ 2,526 ======== ======== Distributable cash available per Limited Partner unit $2.04 $0.48 ======== ======== Retail propane gallons sold 96,294 87,202 ======== ======== (A) EBITDA is defined as operating income (loss) plus depreciation and amortization expense and less net gain (loss) on sales of assets. EBITDA 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 ability to service debt obligations), but provides additional information for evaluating the Partnership's ability to make the Minimum Quarterly Distribution.(B) Maintenance capital expenditures net of certain proceeds from fixed asset sales. F-17 14) Unaudited Pro Forma Financial Information - Continued Significant pro forma adjustments reflected in the above data include the following:1. For the year ended September 30, 1995 the elimination of the results of the Star Gas Group's propane operations in Southern Georgia.2. For the years ended September 30, 1996 and September 30, 1995, the elimination of management fees paid by the Star Gas Group to Petro.3. For the years ended September 30, 1996 and September 30, 1995, the addition of the estimated incremental general and administrative costs associated with operating as a publicly traded partnership.4. For the years ended September 30, 1996 and September 30, 1995, an adjustment to interest expense to reflect the repayment of debt due to Petro and to reflect the interest expense associated with the First Mortgage Notes and Bank Credit Facility.5. For the years ended September 30, 1996 and September 30, 1995, the elimination of the provision for income taxes, as taxes on income will be borne by the Partners and not the Partnership, except for corporate income taxes relative to the Partnership's wholly owned corporate subsidiary, which conducts non-qualifying Master Limited Partnership business.15) Unaudited General Partner Financial Statements The following presents the Condensed Consolidated Balance Sheet as of September 30, 1996 together with the Condensed Consolidated Statement of Operations of the General Partner, Star Gas Corporation and Subsidiaries, for the period December 20, 1995 through September 30, 1996. STAR GAS CORPORATION AND SUBSIDIARIES Condensed Consolidated Balance Sheet (in thousands) (unaudited)Assets Current assets: Cash $ 3,154 Interest receivable 1,062 Other receivables 5,941 ------- Total current assets 10,157Note receivable from Petro 12,000Investment in Partnership 8,577 ------- Total assets $30,734 ======= Liabilities and Shareholder's EquityCurrent liabilities:Accrued expenses $ 32 -------Shareholder's equity 30,702 ------- Total liabilities and shareholder's equity $30,734 ======= F-18 15) Unaudited General Partner Financial Statements - Continued STAR GAS CORPORATION AND SUBSIDIARIES Condensed Consolidated Statement of Operations (in thousands) (unaudited) December 20, 1995 through September 30, 1996 ------------------ Revenues: Reimbursement of employee expenses from Operating Partnership $14,102 Expenses: Cost of employee services provided to Operating Partnership 14,102 ------- Operating income - Interest income 1,246 ------- Income before equity interest in Star Gas Partners, L.P. 1,246 Share of income of Star Gas Partners, L.P. 275 ------- Net income $ 1,521 ======= 16) Supplemental Disclosures of Cash Flow Information: Years Ended September 30, -------------------------- 1996 1995 1994 ------- -------- ------- Cash paid during the year for: Income taxes $ 80 $ 2,950 $ 356 ------- ------- ------- Interest $5,088 $ 4,284 $15,052 ======= ======= ======= Non-cash adjustment: Purchase accounting adjustment: Increase in intangibles $23,028 Decrease in property & equipment (680) Increase in other accrued expenses (4,000) Increase in long-term debt (1,700) Decrease in deferred income taxes 236 ------- $16,884 ======= Dividends declared $ 4,875 ======= F-19 17) Commitments and Contingencies In the ordinary course of business, the Partnership is threatened with, or is named in, various lawsuits. The Partnership is not a party to any litigation which individually or in the aggregate could reasonably be expected to have a material adverse effect on the company. 18) Related Party Transactions The Partnership has no employees except for certain employees of its corporate subsidiary, Stellar Propane Service Corporation and is managed and controlled by the General Partner. Pursuant to the Partnership Agreement, the General Partner is entitled to reimbursement for all direct and indirect expenses incurred or payments it makes on behalf of the Partnership, and all other necessary or appropriate expenses allocable to the Partnership or otherwise reasonably incurred by the General Partner in connection with operating the Partnership's business. For the period December 20, 1995 through September 30, 1996, the Partnership reimbursed the General Partner and Petro $14.4 million representing salary, payroll tax and other compensation paid to the employees of the General Partner, including $0.3 million paid to Petro for certain corporate functions such as finance and compliance. In addition, the Partnership reimbursed Petro for $1.9 million relating to the Partnership's share of the costs incurred by Petro in conducting the operations of certain shared branch locations which include managerial services.19) Retention of Morgan Stanley & Co., Incorporated On August 1, 1996, the Partnership announced that it has retained Morgan Stanley & Co., Incorporated to assist it in the development and consideration of strategic alternatives designed to maximize value for its unitholders. Alternatives to be investigated may include, but are not limited to, the sale or merger of Star Gas.20) Disclosures About the Fair Value of Financial Instruments Cash, Accounts Receivable, Notes Receivable and Other Current Assets, Working Capital Borrowing, Accounts Payable and Accrued Expenses ---------------------------------------------------------------- The carrying amount approximates fair value because of the short maturity of these instruments. Long-Term Debt -------------- The fair values of each of the Partnership'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. F-20 20) Disclosures About the Fair Value of Financial Instruments - Continued The estimated fair value of the Partnership's long term debt is summarized as follows: At September 30, 1996 --------------------- Carrying Estimated Amount Fair Value ------ ---------- Long-term debt $85,000 $80,11721) Selected Quarterly Financial Data (Unaudited) The seasonal nature of the Partnership's business results in the sale by the Partnership of approximately 35% of its volume in the first fiscal quarter and 40% of its volume in the second fiscal quarter of each year. The Partnership generally realizes net income in both of these quarters and net losses during the quarters ending June and September. Three Months Ended ------------------------------------------------------------------- December 31, March 31, June 30, September 30, 1995 1996 1996 1996 Total ----------- ---------- --------- --------- --------- Sales $34,634/(a)/ $47,080 $ 18,416 $ 19,504 $119,634 Gross profit 18,729/(a)/ 22,599 9,933 9,816 61,077 Income (loss) before taxes 3,546/(a)/ 7,244 (4,029) (4,083) 2,678 Net income (loss) 3,486/(a)/ 7,230 (4,046) (4,077) 2,593 Limited Partner interest in net income (loss) 1,455/(b)/ 7,085 (3,965) (3,995) 580 Net income (loss) per Limited Partner Unit $ 0.28/(b)/ $1.34 ($ 0.75) ($ 0.76) $0.11 Predecessor Three Months Ended ------------------------------------------------------------------------- December 31, March 31, June 30, September 30, 1994 1995 1995 1995 Total ------------ ---------- --------- ------------ --------- Sales $32,324 $38,347 $ 16,718 $ 17,161 $104,550 Gross profit 16,174 20,564 9,052 9,100 54,890 Income (loss) before taxes (1,025) 5,663 (4,875) (5,757) (5,994) Net income (loss) (1,100) 5,633 (4,910) (5,792) (6,169) (a) Reflects the results of operations of the Predecessor Company for the period October 1, 1995 through December 20, 1995 and of Star Gas Partners, L.P. from December 20, 1995 through December 31, 1995.(b) Reflects limited partners interest from December 20, 1995 through December 31, 1995. F-21 Schedule II STAR GAS PARTNERS, L.P. AND SUBSIDIARY VALUATION AND QUALIFYING ACCOUNTS Years Ended September 30, 1996, 1995 and 1994 (In thousands) Additions ------------------------------------------------- Balance at Charged to Charged to Other Beginning Costs and Other Changes Balance at Year Description of Year Expenses Account Add(Deduct) End of Year - ---- ----------- ------- -------- ------- ---------- ----------- 1996 Allowance for doubtful (184)/(a)/ accounts $362 422 (309)/(b)/ $291 ===== === ===== ==== 1995 Allowance for doubtful accounts $521 809 (968)/(b)/ $362 ==== === ===== ==== 1994 Allowance for doubtful accounts $716 589 (784)/(b)/ $521 ==== === ===== ==== (a) Amount excluded from the Star Gas Conveyance which took place on December 20, 1995.(b) Bad debts written off (net of recoveries). F-22 5 0001002590 STAR GAS PARTNERS, L.P. 1,000 12-MOS SEP-30-1995 DEC-30-1995 SEP-30-1996 1,106 0 7,517 291 8,494 17,842 110,276 12,543 156,913 10,296 85,000 0 0 61,231 167 156,913 87,919 91,475 45,749 31,707 7,495 422 5,485 617 25 592 0 0 0 592 0.11 0.11COMMON - IN DECEMBER 1995 STAR GAS PARTNERS, L.P. ISSUED COMMON ANDSUBORDINATED UNITS WHICH REPRESENT LIMITED PARTNER INTERESTS. THESE UNITS ARECONSIDERED TO POSSESS THE CHARACTERISTICS OF COMMON STOCK AND ARE BOTH INCLUDEDIN THE DETERMINATION OF EPS.OTHER-SE - REPRESENTS THE GENERAL PARTNER'S INTEREST IN THE PARTNERSHIP ANDIS CLASSIFIED HERE SINCE IT DOES NOT POSSESS THE RELEVANT CHARACTERISTICS OFEITHER COMMON OR PREFERRED STOCK.