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, 1997 ------------------ 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 21, 1997 was approximately$66,500,000. At November 21, 1997 there were outstanding 3,022,727 Common Units and 2,396,078 Subordinated Units, each representing limited partnerinterests.Documents Incorporated by Reference: None STAR GAS PARTNERS, L.P. 1997 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS PART I Page Item 1. Business 3Item 2. Properties 11Item 3. Legal Proceedings - Litigation 11Item 4. Submission of Matters to a Vote of Security Holders 11 PART II Item 5. Market for the Registrant's Units and Related Matters 12Item 6. Selected Historical 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 21Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 21 PART III Item 10. Directors and Executive Officers of the Registrant 21Item 11. Executive Compensation 25Item 12. Security Ownership of Certain Beneficial Owners and Management 27Item 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. BUSINESS STRUCTURE Star Gas Partners L.P. (the "Partnership" or the "MLP") was formed on October16, 1995 to acquire and operate the propane business of Star Gas Corporation(the "Company", "Star Gas" or the "General Partner") and its parent corporationPetroleum Heat and Power Co., Inc. ("Petro" and, together with Star Gascollectively the "Star Gas Group" or the "Predecessor Company"). Substantiallyall of the consolidated assets and liabilities of the MLP are accounted for byStar Gas Propane, L.P. (the "Operating Partnership" or the "OLP") in which theMLP owns a 99% limited partnership interest and the Company owns a 1% generalpartnership interest. The General Partner directs and manages all activities of the Partnershipsand the Operating Partnership and is reimbursed on a monthly basis for alldirect and indirect expenses it incurs on their behalf, including the cost ofemployees.ACQUISITION OF PEARL GAS On October 22, 1997, the OLP completed its acquisition of Pearl Gas Co.("Pearl") which is based in Bowling Green, Ohio. Pearl sells over 14 milliongallons of propane annually to over 12,000 customers, operating in northwestOhio, southern Michigan and northeast Indiana. Over 80% of Pearl's volume issold to residential customers.BUSINESS The Partnership is primarily engaged in the retail distribution of propane and related supplies and equipment to residential, commercial, industrial,agricultural and motor fuel customers. Including the operations of Pearl GasCo., the Partnership believes that it is the eighth largest retail propanedistributor in the United States, serving approximately 162,000 customers from54 branch locations and 30 satellite storage facilities in the Midwest and 18branch locations and 15 satellite storage facilities in the Northeast. ThePartnership also serves approximately 60 wholesale customers from its wholesaleoperation in southern Indiana.INDUSTRY BACKGROUND Propane is used primarily for space heating, water heating and cooking byresidential and commercial customers, which constitute the largest portion ofthe customer base. Propane is extracted from natural gas or oil wellhead gas atprocessing plants or separated from crude oil during the refining process.Propane is normally transported and stored in a liquid state under moderatepressure or refrigeration for ease of handling in shipping anddistribution. When the pressure is released or the temperature is increased, itis usable as a flammable gas. Propane is colorless and odorless; an odorant isadded to allow its detection. Propane is clean-burning, producing negligibleamounts of pollutants when consumed. According to the National Propane GasAssociation, the domestic retail market for propane is approximately 9.4 billiongallons annually, 3 INDUSTRY BACKGROUND (CONTINUED)with limited growth for retail demand for the product. Based upon informationcontained in the Energy Information Administration's Annual Energy Review-1995,propane accounts for approximately 3.8% of household energy consumption in theUnited States.BUSINESS STRATEGY The Partnership's strategy is to maximize its cash flow and profitability,primarily through internal growth, controlling operating costs and acquisitionswhich have the potential for generating attractive returns on investment. Theretail propane industry is mature and experiences only limited growth in totaldemand for the product. The propane industry is also large and highlyfragmented, with approximately 6,000 independently owned and operateddistributors. The Partnership focuses on acquiring smaller to medium-sizedlocal and regional independent propane distributors, particularly those with arelatively large percentage of residential customers, which generate highermargins than other types of customers, and those located in the Midwest andNortheast, where the Partnership believes it can attain higher margins than inother areas of the United States. Although there are no formal arrangements between Petro and the Partnership,the Partnership anticipates that it will continue to have access to Petro'smanagement expertise. In particular, the Partnership believes that theextensive experience of Petro's management team in making acquisitions in thehome heating oil industry, which has many similar characteristics to the propaneindustry provides the Partnership with a competitive advantage. Additionally,the field of potential acquisition candidates for the Partnership is broadenedbecause of the ability to acquire companies with both home heating oil andpropane operations, with the Partnership retaining the propane, operations andPetro retaining the home heating oil operations or the Partnership retaining both the propane and the home heating oil operations or the Partnership retaining both the propane and the home heating oil operations. In this regard,although the Partnership does not presently have any home heating oiloperations, it may consider acquiring or retaining such operations in the futureto the extent that the Partnership is able to identify attractive acquisitioncandidates in the home heating oil field. In order to facilitate the Partnership's acquisition strategy, the OperatingPartnership has entered into the Bank Credit Facilities which consist of a $25.0million Acquisition Facility (of which $21.0 million was outstanding as ofOctober 31, 1997) and a $12.0 million Working Capital Facility (of which $2.4million was outstanding as of October 31, 1997). In addition to borrowingsunder the Bank Credit Facilities, the Partnership may fund future acquisitionsfrom internal cash flow, the issuance of additional Partnership interests orincurrence of additional long-term debt. While the Partnership regularly considers and evaluates acquisitions as partof its ongoing acquisition program, the Partnership does not have any presentagreements or commitments with respect to any acquisition. There can be noassurance that the Partnership will identify attractive acquisition candidatesin the future or that it will be able to acquire such candidates or obtainfinancing for such acquisitions on acceptable terms. If the Partnership is ableto make acquisitions, there can be no assurance, however, that such acquisitionswill not dilute earnings and distributions to Unitholders. The General Partnerhas broad discretion in making acquisitions and it is expected that the GeneralPartner will not generally seek Unitholder approval of acquisitions.MARKETING AND OPERATIONS As of October 31, 1997, the Partnership distributed propane to approximately162,000 retail customers in 13 states from 72 branch locations. ThePartnership's operations are conducted under several leading trademarks andtrade names, including: Star Gas(R), Star Gas Service/TM/, Silgas/TM/, BlueFlame(R), Maingas/TM/, 4 MARKETING AND OPERATIONS (CONTINUED)Arrow Gas/TM/, Mid-Hudson Valley Propane/TM/, Coleman Gas Service/TM/, H & SGas/TM/, Isch Gas/TM/, Wilhoyte L.P. Gas/TM/ and Rural Natural Gas/TM/ and PearlGas/TM/. (The Partnership does not have the right to use the trademark StarGas(R) in the State of New York nor does the Partnership have the right to usethe Blue Flame(R) trademark in certain limited areas outside of thePartnership's current area of operations). The marketing areas served by thePartnership are generally rural but also include suburban areas where naturalgas is generally not available.The Partnership's retail operations are located primarily in the Northeast andMidwest regions of the United States:NORTHEAST MIDWEST - --------- -------CONNECTICUT PENNSYLVANIA INDIANA KENTUCKY (continued)Stamford Hazelton Akron ShelbyvilleHartford Wind Gap Batesville Williamstown BedfordMAINE RHODE ISLAND Bluffton MICHIGANFairfield Davisville Coal City HillsdaleFryeburg College Corner Somerset CenterSkowhegan Columbia City Wells Decatur OHIOWindham Ferdinand Bowling Green Greencastle CincinnatiMASSACHUSETTS Jeffersonville DefianceBelchertown Linton DeshlerRochdale Madison Ft. RecoveryWestfield New Salisbury HebronSwansea N. Manchester Ironton N. Vernon KentonNEW HAMPSHIRE N. Webster Lancaster(from Fryeburg, ME) Portland Lewisburg Remington LynchburgNEW JERSEY Richmond MaconMaple Shade Salem MaumeeTuckahoe Seymour McClure Sulphur Springs MilfordNEW YORK Versailles Mt. OrabPoughkeepsie Warren North StarWashingtonville Waterloo Ripley Winamac Sabina Waverly KENTUCKY West Union Glencoe Prospect 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, water heating,clothes drying and cooking. Commercial customers such as motels, restaurants, 5 MARKETING AND OPERATIONS (CONTINUED)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, 1997, approximately 71% of thePartnership's sales (by volume of gallons sold) were to retail customers (ofwhich approximately 52%, 21%, 18% 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 1997 accounted for 62% 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 269 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, for itsshort-term requirements, therefore, its supply costs fluctuate with market pricefluctuations. Should wholesale propane prices decline in the future, the 6 MARKETING AND OPERATIONS (CONTINUED) Partnership'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 largely generated in the firstand second fiscal quarters (October through March). To the extent necessary,the Partnership 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 over 25 sources, all of which aredomestic or Canadian oil companies, including Amoco Canada Marketing Group;Ashland Petroleum Company; Bayway Refining Company; Ferrell North America;Marathon Oil Company; Markwest Hydrocarbons; Mobil Oil Company; Petro Canada LPGInc.; Shell Canada Limited; Shell Oil Company; and Warren Gas Liquids, Inc.Supplies from these sources have traditionally been readily available, althoughno assurance can be given that supplies of propane will be readily available inthe future. Substantially all of the Partnership's propane supply for its Northeastretail operations are purchased under annual or longer term supply contracts,which generally provide for pricing in accordance with market prices at the timeof delivery. Certain of the contracts provide for minimum and maximum amountsof propane to be purchased. During the year ended September 30, 1997, none ofthe Partnership's Northeast suppliers accounted for more than 10% of thePartnership's volumes. The Partnership typically supplies its Midwest retail and wholesaleoperations by a combination of (i) spot purchases from suppliers at Mont.Belvieu, Texas, which are transported by pipeline to the Partnership's 21million gallon underground storage facility in Seymour, Indiana ("the SeymourFacility"), and then delivered to the Midwest branches and (ii) purchases from anumber of Midwest refineries which are transported by truck to the brancheseither directly 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.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. 7 SUPPLY (CONTINUED) For fiscal 1997, 43% of the Midwest volume was purchased on the spot marketfrom various Mont. Belvieu sources, and 21% was purchased from three refineriesin Illinois and Indiana owned by the Amoco Canada Marketing Group. The balancewas purchased from five separate suppliers. The Partnership believes that itsdiversification of suppliers will enable it to purchase all of its supply needsat market prices if supplies are interrupted from any of the sources, without amaterial 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-operators and 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 aredeveloped. 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. 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 8 COMPETITION (CONTINUED)marketers, including the Partnership, account for less than 35% of the totalretail sales of propane in the United States, and that no single marketer has agreater than 10% share of the total retail market in the United States. Most ofthe Partnership's branches compete with five or more marketers or distributors.The principal factors influencing competition among propane marketers are priceand service. Each retail distribution outlet operates in its own competitiveenvironment as retail marketers locate in close proximity to customers to lowerthe cost of providing service. The typical retail distribution outlet has aneffective 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 October 31, 1997,Star Gas had 630 employees providing full time services to the OperatingPartnership, of which 44 were employed by the corporate office in Stamford,Connecticut and 586 were located in branch offices, of which 191 wereadministrative, 281 were engaged in transportation and storage and 114 wereengaged in field servicing. Approximately 78 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. Such due diligence includes questioning the seller, obtaining representationsand warranties concerning the seller's compliance with environmental laws andvisual inspections of the properties, in which employees of the General Partner,and in certain cases, independent environmental consulting firms hired by theGeneral Partner, look for evidence of hazardous substances or the existence ofunderground storage tanks. 9 GOVERNMENT REGULATIONS (CONTINUED) 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. On August 18, 1997, the U.S. Department of Transportation (the "DOT") published its Final Rule for Continued Operation of the Present Propane Trucks(the "Final Rule"). The Final Rule is intended to address perceived risks duringthe transfer of propane. The Final Rule required certain immediate changes inthe industry operating procedures, including retrofitting all propane deliverytrucks. The Partnership, as well as the National Propane Gas Association("NPGA") and the propane industry in general, believe that the Final Rule cannotpracticably be complied with in its current form. On October 15, 1997, five ofthe principal multi-state propane marketers (unrelated to the Partnership) filedan action against the DOT in the United States District Court for the WesternDistrict of Missouri seeking to enjoin enforcement of the Final Rule. The NPGAsubsequently filed a similar suit. In addition, in November 1997, a bill wasintroduced in the United State House of Representatives that would prohibit theDOT from enforcing certain provisions of the Final Rule. At this time, thePartnership cannot determine the likely outcome of the litigation or theproposed legislation or what the ultimate long-term cost of compliance with the Final Rule will be to the Partnership and the propane industry in general. Future developments, such as stricter environmental, health or safety lawsand regulations 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. 10 ITEM 2. PROPERTIES As of October 31, 1997, the Partnership owned 58 of its 72 branch locationsand 34 of its 45 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 October 31, 1997, the Partnership had afleet of 28 tractors, 38 transport trailers, 269 bobtail and rack trucks and 314other service and pick-up trucks, the majority of which are owned. ThePartnership owns 20 and leases 33 automobiles. As of October 31, 1997, thePartnership owned approximately 238 bulk storage tanks with typical capacitiesof 12,000 to 30,000 gallons, approximately 203,000 stationary customer storagetanks with typical capacities of 24 to 1,000 gallons and approximately 34,000portable 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 andproperty damage can occur in connection with its transportation, storage or use.The Partnership, in the ordinary course of business, is threatened with or isnamed as a defendant in various lawsuits which, among other items, seek actualand punitive damages for product liability, personal injury and property damage.However, the Partnership is not a party to any litigation which individually orin the aggregate could reasonably be expected to have a material adverse effecton the results of operations or the financial condition of the Partnership. ThePartnership maintains liability insurance policies with insurers in such amountsand with such coverages and deductibles as the General Partner believes isreasonable and prudent. However, there can be no assurance that such insurancewill be adequate to protect the Partnership from material expenses related tosuch personal injury or property damage or that such levels of insurance willcontinue 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 thePartnership during the fiscal year ended September 30, 1997. 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 closing 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 HIGH LOW DECLARED PER UNIT ------------------------------------------------ -------------------- Fiscal Quarter 1996 1997 1996 1997 1996 1997 - -------------- ---- ---- ---- ---- ---- ---- First Quarter $22.50 $23.88 $22.00 $21.75 -- $0.55Second Quarter $22.50 $24.63 $21.13 $20.75 -- $0.55Third Quarter $22.00 $21.88 $19.75 $19.00 $0.6225/(a)/ $0.55Fourth Quarter $24.75 $23.50 $20.50 $21.00 $0.5500 $0.55 - ---------(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, 1997, 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 eachquarter 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 FINANCIAL AND OPERATING DATA The following table sets forth selected historical and other data of thePartnership and the Star Gas Group and should be read in conjunction with themore detailed financial statements included elsewhere in this report. See Item7. Management's Discussion and Analysis of Financial Condition and Results ofOperations. The Selected Financial Data is derived from the financial information of thePartnership and should be read in conjunction therewith. Partnership/Star Gas Group--Historical ---------------------------------------------------------------------------- Year Ended September 30, ------------------------ 1993 1994 1995 1996(a) 1997 ---- ---- ---- ---- ---- (in thousands, except for per unit data) Sales....................................... $ 143,216 $ 128,040 $ 104,550 $ 119,634 $ 135,159 Gross profit................................ 69,861 69,487 54,890 61,077 62,948 Depreciation and amortization............... 16,703 13,039 10,073 9,808 10,405 Operating income (loss)..................... (30,313)(c) 9,393 2,555(b) 9,802 9,003 Interest expense (net)...................... 16,479 10,497 8,549 7,124 6,966 Net income (loss)........................... (47,049)(c) (1,404) (6,169)(b) 2,593 2,012 Net income per Unit(d)...................... -- -- $ .11(f) $ .37 Cash distribution declared per unit......... -- -- $ 1.17(f) $ 2.20 BALANCE SHEET DATA (END OF PERIOD): Current assets.............................. $ 20,637 $ 17,374 $ 14,266 $ 17,842 $ 14,165 Total assets................................ 157,847 147,608 155,393 156,913 147,469 Long-term debt.............................. 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..................................... (2,825) 44,328 44,305 61,398 51,578OTHER DATA: EBITDA(e)................................... $ 19,652 $ 21,946 $ 13,541(b) $ 19,870 $ 19,703 Retail propane gallons sold................. 114,405 110,069 89,133 96,294 94,893 - ----------------------------------(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 ended 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) 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.(c) Includes a loss of approximately $33.0 million in respect of a charge for the impairment of long-lived assets.(d) 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.(e) EBITDA is defined as operating income plus depreciation, amortization, less net gain (loss) on sale of businesses and equipment 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.(f) Represents net income per unit and cash distributions paid per unit for the period December 20, 1995 through September 30, 1996. 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 Group and thefinancial 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 Texasoperation in August 1994, the sale of its southern Georgia operations inNovember 1994, and the completion of six acquisitions totaling 4.7 milliongallons annually in its core Midwest and Northeast markets from June 1994 toJuly 1996. The results for fiscal 1997 do not include the operating results ofthe Partnership's most recent acquisition, Pearl Gas Co., which was completed onOctober 22, 1997. Gross profit margins vary according to the customer mix. For example, sales to 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 year ended September 30, 1995 and iscompared to the combined results of the Predecessor Company for the periodOctober 1, 1995 through December 20, 1995, and the results of the MLP fromDecember 20, 1995 through September 30, 1996 and for the year ended September30, 1997. The operating results of the Predecessor Company and the MLP for theyear ended September 30, 1996 were combined to facilitate an analysis of thefundamental operating data. 14 FISCAL YEAR ENDED SEPTEMBER 30, 1997- ------------------------------------COMPARED TO FISCAL YEAR ENDED SEPTEMBER 30, 1996- ------------------------------------------------VOLUMEFor the year ended September 30, 1997, retail propane volume declined 1.4million gallons, or 1.5%, to 94.9 million gallons, as compared to 96.3 milliongallons for fiscal 1996. The decline was primarily attributable to the effecton volume of warmer temperatures experienced during the second fiscal quartercompared to the prior year's second fiscal quarter and to customer conservationefforts attributable to significantly higher propane selling prices. ThePartnership was able to mitigate the effects of the warmer temperatures onretail propane volume through both internal account growth and two acquisitionscompleted since March 15, 1996. Also favorably impacting the year-to-yearcomparison was an increase in sales to agricultural customers, resulting from areturn to more normal propane demand for grain drying.SALESFor the year ended September 30, 1997, sales increased $15.5 million, or 13.0%,to $135.2 million, as compared to $119.6 million for the year ended September30, 1996. The increase was due to higher selling prices in response to anindustry wide significant increase in propane supply costs experienced duringfiscal 1997.COST OF SALESCost of sales increased $13.7 million, or 23.3%, to $72.2 million for fiscal1997, as compared to $58.6 million for fiscal 1996. The increase was due tohigher per gallon propane supply costs.GROSS PROFITGross profit increased $1.9 million, or 3.1%, to $62.9 million for fiscal 1997,as compared to $61.1 million for fiscal 1996. The increase in gross profitresulted from higher per gallon margins across all market segments which waspartially offset by the impact of slightly lower retail propane volume.DELIVERY AND BRANCH EXPENSESDelivery and branch expenses increased $1.7 million, or 4.8%, to $36.4 millionfor fiscal 1997, as compared to $34.8 million for fiscal 1996. The increase wasprimarily due to the additional expenses associated with the first fiscal quarter's increase in agricultural volume, higher vehicle operating costs due toan increase in fuel costs and higher employee benefit expenses.DEPRECIATION AND AMORTIZATIONDepreciation and amortization expenses increased $0.6 million, or 6.1%, to $10.4million for fiscal 1997, as compared to $9.8 million for fiscal 1996, due to theimpact of two acquisitions completed since March 15, 1996, the amortization ofcertain deferred charges relating to the Partnership's First Mortgage Notes anddepreciation expense associated with capital expenditures made during fiscal1997 and 1996. 15 GENERAL AND ADMINISTRATIVE EXPENSESGeneral and administrative expenses increased $0.4 million, or 5.6%, to $6.8million for fiscal 1997, as compared to $6.5 million for fiscal 1996. Thisincrease was primarily due to $0.9 million of one-time expenses associated withthe exploration of strategic alternatives designed to maximize unitholder value including, without limitation, the sale or merger of the Partnership offset bylower acquisition related expenses. On March 3, 1997, the Partnership decided toterminate its efforts to seek a merger or possible sale of the Partnership.INTEREST EXPENSE, NETInterest expense , net declined $0.1 million, or 2.2%, to $7.0 million forfiscal 1997, as compared to $7.1 million for fiscal 1996. This reduction wasprimarily due to a decline in the weighted average borrowing rate.INCOME TAX EXPENSEIncome tax expense primarily represents certain state income taxes related tothe Partnership's wholly owned corporate subsidiary which conducts non-qualifying master limited partnership business.NET INCOMENet income decreased $0.6 million or 22.4% to $2.0 million for fiscal 1997, ascompared to $2.6 million for fiscal 1996. This decrease was attributable to theincrease in operating expenses, $0.9 million of one-time costs associated withthe exploration of strategic alternatives and $0.6 million of depreciation andamortization which was partially offset by $1.9 million increase in grossprofit.EBITDAEBITDA (defined as operating income (loss) plus depreciation and amortizationless net gain (loss) on sales of businesses and equipment) decreased $0.2million, or 1.0%, to $19.7 million for fiscal 1997, as compared to $19.9 millionfor fiscal 1996. Excluding the one-time expenses associated with the strategicalternative, EBITDA increased $0.7 million, or 3.7%, to $20.6 million due toimproved per gallon margins across all market segments and growth in thecustomer base provided by both internal marketing and acquisition efforts.EBITDA should not be considered as an alternative to net income (as an indicatorof operating performance) or as an alternative to cash flow (as a measure ofliquidity or ability to service debt obligations) but provides additionalinformation for evaluating the Partnership's ability to make the MinimumQuarterly Distribution. 16 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 southern Georgia 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. 17 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 AMORTIZATION Depreciation and amortization expense declined $0.3 million to $9.8 millionfor fiscal 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 $0.4 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-termborrowing rate and additional income generated on higher cash balances. Forfurther discussions concerning the Partnership's debt structure. (See Note 10of the Consolidated Financial Statements of the Partnership.)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 relatingto 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. 18 EBITDA EBITDA (defined as operating income (loss) plus depreciation and amortizationless net gain (loss) of sale of businesses and equipment) increased $6.3 millionor 46.7% to $19.9 million for fiscal 1996 as compared to $13.5 million forfiscal 1995. This improvement in EBITDA was the result of the volume increaseassociated with colder temperatures and growth in the Partnership's customerbase due to both acquisitions and internal marketing, partially offset by theimpact of lower per-gallon gross profit margins experienced during the secondquarter of fiscal 1996. For continuing operations, delivery and branch expensesdeclined by 6.4%, when measured on a per gallon basis, due to the impact of thecost reduction programs implemented over the past two years and the increase involume. Also contributing to the growth in EBITDA was the divestiture of thesouthern Georgia operations, which reduced EBITDA in the prior year byapproximately $0.6 million. 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.LIQUIDITY AND CAPITAL RESOURCES For fiscal 1996, net cash flow provided by operating activities of $10.0million consisted of $2.6 million of net income and $9.8 million of depreciationand amortization, which was offset by a $2.4 million increase in working capitaland other changes. Inventories increased by $2.3 million due to both anincrease in propane gallons stored and higher per unit propane costs. Netaccounts receivable increased by $0.6 million due to an increase in sales in the fourth quarter of fiscal 1996 compared to the fourth quarter of fiscal 1995.Net cash used in investing activities was $7.0 million for 1996, as the proceedsfrom the sale of fixed assets of $0.8 million were used to partially fund $2.4million of acquisitions and $5.3 million of capital expenditures, including $2.3million of maintenance capital expenditures. For fiscal 1997, net cash flow provided by operating activities of $19.0million combined with $0.3 million from the sale of certain fixed assetsamounted to $19.3 million. These funds were utilized in investing activities tofund $5.3 million of capital expenditures (including $3.1 million of maintenancecapital expenditures), in financing activities to repay net credit facilityborrowings of $2.4 million and to pay Partnership distributions of $11.8million. As a result of the above activities, cash at September 30, 1997declined by $0.2 million to $0.9 million, as compared to $1.1 million on hand atthe beginning of the period. On October 22, 1997, the Partnership completed the Pearl Gas Acquisition. Thetotal cost of the acquisition Gas was $23.0 million which was paid cash(including estimated working capital of $1.9 million which is subject toadjustments) and includes $0.4 million of transactional expenses plus theissuance of limited and general partner interests in the Partnership, including147,727 Common Units issued to the General Partner (valued in total as ofacquisition date at $3.5 million). The Partnership funded the cash purchaseprice with $2.0 million of available cash and $21.0 million borrowed under thePartnership's Acquisition Facility. (See Note 7 to the Consolidated FinancialStatements for further discussion of this transaction). Based on its current cash position, bank credit availability and expected netcash flow from operating activities, the Partnership expects to be able to meetall of its obligations for fiscal 1998, as well as all of its other currentobligations as they become due. For fiscal 1998, the Partnership anticipatespaying interest on its First Mortgage Notes and acquisition facility of $8.3million, anticipates paying Limited and General Partner distributions of $12.1million, and plans to purchase fixed assets of approximately $3.0 million. 19 LIQUIDITY AND CAPITAL RESOURCES Certain statements in this Annual Report that do not reflect historicalinformation are forward-looking statements. These include statements aboutmarkets in 1998; cost reduction targets; return on capital goals; ongoing andplanned capacity additions and expansions. Important factors that could causeactual results to differ materially from those discussed in such forward-lookingstatements include: supply/demand balance for the Partnership's products,competitive pricing pressures, weather patterns, and changes in industry lawsand regulations. 20 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 REGISTRANT PARTNERSHIP 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 theUnitholders. 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 noremployees 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 management and workforce of Star Gas andcertain employees of Petro manage and operate the Partnership's business asofficers and employees of the General Partner and its Affiliates. See Item 1 -Business--Employees. 21 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(1).................... 50 Chairman of the Board of DirectorsWilliam G. Powers, Jr............... 44 President and Chief Executive OfficerDavid R. Eastin..................... 39 Vice President -- Operations Norman L. Bushey.................... 68 Vice President -- Safety/ComplianceRichard F. Ambury................... 40 Vice President-FinanceAudrey L. Sevin..................... 71 Director and SecretaryThomas J. Edelman................... 46 DirectorPaul Biddelman...................... 51 DirectorWolfgang Traber(1).................. 53 DirectorWilliam P. Nicoletti(2)............. 52 DirectorElizabeth K. Lanier(2).............. 46 Director- --------------------(1) Member of the Compensation Committee(2) Member of the Audit Committee IRIK 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 1979, 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.Prior to joining Star Gas, he was employed by Petro from 1984 to 1993 where heserved in various capacities, including Regional Operations Manager and VicePresident of Acquisitions. He has participated in over 90 acquisitions forPetro. From 1977 to 1983, he was employed by The Augsbury Corporation, acompany engaged in the wholesale and retail distribution of fuel oil andgasoline throughout New York and New England and served as Vice President ofMarketing and Operations. Mr. Powers is a graduate of the University of NotreDame (B.A. 1975) and the University of Vermont Graduate School of Business(M.B.A. 1984).DAVID R. EASTIN has served as Vice President of Operations of Star Gas sinceSeptember 1995. He joined Star Gas in 1992, and served as a Regional Managerand as Director of Operations--Eastern Area. Prior to joining Star Gas, he wasemployed by Ferrellgas, Inc. (1987 through 1992) and a predecessor company,Buckeye Gas Products (1980 through 1987), in a variety of operationalcapacities. Mr. Eastin is a graduate of the University of Tulsa (B.S. 1980) andDuquesne University (M.B.A. 1985). 22 RICHARD F. AMBURY has been Vice President of 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. From 1979 to 1983, Mr.Ambury was employed by a predecessor firm of KPMG Peat Marwick LLP, a publicaccounting firm. Mr. Ambury graduated from Marist College with a degree inBusiness Administration in 1979 and has been a Certified Public Accountant since1981.NORMAN L. BUSHEY has served as Vice President of Safety/Compliance of Star Gassince September 1995. Prior thereto he served as the Northeast Area SafetyManager for Star Gas following Star Gas' acquisition of Maingas, Inc. in 1988.From 1974 through 1988, Mr. Bushey served as Vice President and General Managerof Maingas, Inc. From 1953 through 1974, Mr. Bushey was employed by SuburbanPropane.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 1979. 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 1979. Mr. Edelman is the Chairman of theBoard, President and Chief Executive Office of Patina Oil & Gas Corporationsince its formation in May 1996. Mr. Edelman also serves as Chairman of LomakPetroleum, Inc. He co-founded Snyder Oil Corporation and was its President anda Director from 1981 through February 1997. Prior to 1981, he was a VicePresident of The First Boston Corporation. From 1975 through 1980, Mr. Edelmanwas with Lehman Brothers Kuhn Loeb Incorporated. Mr. Edelman received hisBachelor of Arts Degree from Princeton University and his Masters Degree inFinance from Harvard University's Graduate School of Business Administration.Mr. Edelman serves as a Director of Paradise Music & Entertainment, Inc.,Weatherford Enterra, Inc., and serves as a Trustee of The Hotchkiss School.PAUL BIDDELMAN has been a Director of Star Gas from December 1993 through June1995 and since October 1995, and a Director of Petro since October 1994. Mr.Biddelman has been Treasurer of Hanseatic Corporation since April 1992. Mr.Biddelman is also a Director of Celadon Group, Inc., Electronic Retailing Systems International, Inc., Insituform Technologies, Inc. and Premier 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 1979. 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., aprivate 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 waswith E.F. Hutton & Company Inc., where from 1980 through 1987 he was a SeniorVice President and head of the Energy and Natural Resources Group. He is alsoChairman of the Board of Amerac Energy Corporation and a Director of DomainEnergy Corporation and StatesRail, Inc. 23 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. On November 7, 1997, the General Partner announced that William G. Powers,Jr., the President and Chief Executive Officer of the General Partner, hadbeen appointed as the President of Petro, effective as of December 1, 1997 andthat Joseph P. Cavanaugh, Senior Vice President of Petro, will succeed Mr.Powers as President and Chief Executive Officer of the General Partner. TheGeneral Partner also announced that Mr. Powers will become a Director of theGeneral Partner and a member of the newly organized management committee ofthe Board of Directors of the General Partner (consisting of Mr. Powers andIrik P. Sevin, Chairman of the Board) effective as of December 1, 1997. Mr. Cavanaugh, 60, has been Senior Vice President-Safety and Compliance ofPetro since January 1993. From October 1985 to January 1993, Mr. Cavanaugh wasVice President of Petro. Mr. Cavanaugh was Controller of Petro, Inc. from 1973to 1985 and of Petro from its organization in 1983 until 1994. Mr. Cavanaugh hasalso taken an active role in assisting the Partnership's management with thedevelopment of safety/compliance programs, assisting with acquisitions and theirsubsequent integration into the Partnership and with the Partnership's riskmanagement efforts, since Petro's initial involvement with the Star Gas Group in1993. Mr. Cavanaugh is a graduate of Iona College (B.B.A.) and Pace University(M.S. in Taxation).MEETINGS AND COMPENSATION OF DIRECTORS During fiscal 1997, the Board of Directors met six times, including one viatelephonic conference. All Directors attended each meeting except for Messrs.Sevin and Edelman who attended six meetings and Mr. Traber who attended fivemeetings. Star Gas pays each director including the chairman an annual 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 appointed aspecial committee to review the proposals received by Morgan Stanley & Co.,Incorporated. Ms. Lanier and Mr. Nicoletti received $20,000 each forcompensation in serving on this committee. 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 other compensationin connection with its management of the Partnership. The General Partner isreimbursed at cost for all expenses incurred on behalf of the Partnership,including the costs of compensation described herein properly allocable to thePartnership, and all other expenses necessary or appropriate to the conduct ofthe business of, and allocable to, the Partnership. 24 The Partnership Agreement provides that the General Partner shall determinethe expenses that are allocable to the Partnership in any reasonable mannerdetermined by the General Partner in its sole discretion. Affiliates of theGeneral Partner, including Petro, perform certain management and acquisitionservices for the General Partner on behalf of the Partnership. Such affiliatesdo not receive a fee for such services, but are reimbursed for all direct andindirect expenses incurred in connection therewith. In addition, the General Partner owns 2,396,078 subordinated units and147,727 common units of the Partnership and is entitled to receive distributionson such Units, and the General Partner is entitled to incentive distributions inrespect of its general partner 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 30,1997, 1996 and 1995. SUMMARY COMPENSATION TABLE Annual Compensation ------------------------------------------------------------ OTHER ANNUAL NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION- ------------------------------------------ ---- ------ ----- ------------ William G. Powers, Jr. President and Chief Executive Officer 1997 $225,000 $100,000 $20,803 (1) 1996 $225,000 $100,000 $21,071 (1) 1995 $219,231 $ 75,000 $18,094 (1)Richard F. Ambury Vice President - Finance 1997 $143,000 $35,750 $20,408 (1) 1996 $ 99,667(4) $25,000 -- David R. Eastin Vice President - Operations 1997 $120,000 $30,000 $ 3,214 (2) 1996 $106,826 $26,707 $ 9,292 (3) 1995 $ 89,896 $10,000 --Norman L. Bushey Vice President - Safety/Compliance 1997 $70,000 $17,500 $ 2,625 (2) 1996 $63,000 $15,750 $ 1,900 (2)- ------------------------------(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 Star Gas on February 1, 1996. 25 AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION VALUES NUMBER OF UNEXERCISED OPTIONS AT SEPTEMBER 30, 1997 VALUE OF IN THE MONEY OPTIONSNAME Exercisable(E)/Unexercisable(U) AT SEPTEMBER 30, 1997(1) - --------------------------------- -------------------------------- ----------------------------- William G. Powers, Jr. 30,000 (U) $3,750David R. Eastin 10,000 (U) $1,250 - --------------------------------(1) Values are calculated by deducting the exercise price from the fair market value of the common units as of September 30, 1997.OPTIONS GRANTED IN LAST FISCAL YEAR None.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.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 allows the Company to contribute an additionaldiscretionary amount which will be allocated to each participant based on suchparticipant's compensation as a percentage of total compensation of allparticipant's. 26 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT OWNERSHIP OF COMMON AND SUBORDINATED UNITS The following table set forth certain information as of November 4, 1997regarding 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 executiveofficers 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 --Common Units Star Gas Corporation(1) 147,727 4.8%Subordinated Units Star Gas Corporation(1) 2,396,078 100.0%- ---------(1) The address of such person is care of the Partnership at 2187 Atlantic Street, Stamford, CT 06902. 27 OWNERSHIP OF PETRO COMMON STOCK BY THE DIRECTORS AND EXECUTIVE OFFICERS OF THEGENERAL PARTNER The table below sets forth as of November 1, 1997, 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 393,518 shares of Class ACommon Stock and 70,379 shares of Class C Common Stock subject to optionsexercisable within the next 60 days, represent 22.03% of Petro's outstandingClass A Common Stock and 55.67% 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. Petro's Class A Common Stock is traded on the NASDAQ NationalMarket (Symbol: HEAT). 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)................ 1,888,624 477,716 7.95% 18.39% 13.41%Irik P. Sevin (3).................. 1,167,847(4) 272,020(4) 4.84% 10.20% 7.65%Wolfgang Traber (5)................ 1,652,203(6) 606,472(7) 6.96% 23.35% 15.52%Thomas J. Edelman (3).............. 593,049(8) 129,019 2.50% 4.97% 3.79%Paul Biddelman (5)................. 1,654,589(6) 597,424 6.97% 23.00% 15.34%William G. Powers, Jr. (3) -- -- -- -- --Richard F. Ambury (3).............. 12,345(9) -- 0.05% -- 0.02%David R. Eastin (3) -- -- -- -- --Norman L. Bushey (3) -- -- -- -- --Elizabeth K. Lanier (10) -- -- -- -- --William P. Nicoletti (11) -- -- -- -- --All officers and directors as a group (11 persons)................ 5,316,454 1,485,227 22.03% 55.67% 39.86% - -------------------------- (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 November 1, 1997. 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 November 1, 1997 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 381,518 shares of Class A Common Stock and 70,379 shares of Class C Common Stock. (5) The address of such person is 450 Park Avenue, New York, NY 10022. (6) Includes 1,652,203 shares held by Hanseatic Americas LDC, a Bahamian limited duration company in which the sole managing member is Hansabel Partners, LLC, a Delaware limited liability company in which the sole managing member is Hanseatic Corporation, a New York corporation ("Hanseatic"). Messrs. Traber and Biddelman are executive officers of Hanseatic and Mr. Traber holds in excess of a majority of the shares of capital stock of Hanseatic. (7) Includes 298,717 shares owned by each of Hanseatic and Tortosa Vermogensverwaltungsgesellschaft gmbh ("Tortosa"), a German corporation owned and controlled by Hubertus Langen, and as to which Hanseatic and Tortosa each hold shared voting power. (8) Includes 76,000 shares of Class A Common Stock owned by Mr. Edelman's wife and minor children. (9) Includes options to purchase 12,000 shares of Class A Common Stock.(10) The address of such person is 221 E. Fourth St., 30th Fl., Cincinnati, OH 45202.(11) The address of such person is 1155 Avenue of the Americas, 29th Fl., New York, NY 10036. 28 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 andExchange 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 1997 all filing requirements applicable to its officers,directors, and greater than 10 percent beneficial owners were met in a timelymanner. 29 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 October 1, 1996 through September 30, 1997, the Partnershipreimbursed the General Partner and Petro $17.1 million representing salary,payroll tax and other compensation to the employees of the General Partner,including $0.2 million paid to Petro for corporate services such as compliance,supply and finance. In addition, the Partnership has reimbursed Petro for $0.9million relating to the Partnership's share of the costs incurred by Petro inconducting the operations of a certain shared branch location which includesmanagerial 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.For the fiscal years ended September 30, 1995, the General Partner paid fees of$500,000 pursuant to the Management Services Agreement. The Management ServicesAgreement 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. In1997, Star Gas paid Mr. Nicoletti $20,000 for serving on the Board of DirectorsSpecial Committee which explored the possible sale or merger of the Partnership. 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.In 1997, Star Gas paid Ms. Lanier $20,000 for serving on the Board of DirectorsSpecial Committee which explored the possible sale or merger of the Partnership. 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 $248,500in 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. 30 PART IVITEM 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 31. (b) Reports on Form 8-K. The Partnership did not file a Form 8-K during the quarter ended September 30, 1997. 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 (3) 99.1 Stock Purchase Agreement dated October 20, 1997 (3) 99.2 Conveyance and Contribution Agreement (3) 99.3 Second Amendment dated October 21, 1997 to the Bank Credit Agreement ___________________ (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. (3) Incorporated by reference to the same Exhibit to Registrants Statement on Form 8-K filed on October 23, 1997. 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 of 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 OfficerPursuant to the requirements of the Securities Exchange Act of 1934, this reporthas been signed by the following persons in the capacities and on the dateindicated: Signature Title Date- --------- ----- ----/s/ William G. Powers, Jr. President November 24, 1997 ---------------------- Star Gas Corporation William G. Powers, Jr. Principal Executive Officer)/s/ Richard F. Ambury Vice President - Finance November 24, 1997 ----------------- Star Gas Corporation Richard F. Ambury (Principal Financial and Accounting Officer)/s/ Irik P. Sevin Director November 24, 1997 -------------------- Star Gas Corporation Irik P. Sevin /s/ Audrey L. Sevin Director November 24, 1997 -------------------- Star Gas Corporation Audrey L. Sevin /s/ William P. Nicoletti Director November 24, 1997 -------------------- Star Gas Corporation William P. Nicoletti /s/ Elizabeth K. Lanier Director November 24, 1997 -------------------- Star Gas Corporation Elizabeth K. Lanier /s/ Paul Biddelman Director November 24, 1997 -------------------- Star Gas Corporation Paul Biddelman /s/ Thomas J. Edelman Director November 24, 1997 -------------------- Star Gas Corporation Thomas J. Edelman /s/ Wolfgang Traber Director November 24, 1997 -------------------- Star Gas Corporation 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 Subsidiary and the Star Gas ------------------------------------------------------- Group(Predecessor) ------------------ Independent Auditors' Report ................................. F-2 Consolidated Balance Sheets as of September 30, 1996 and 1997...................................................... F-3 Consolidated Statements of Operations for the year ended September 30, 1995 (Predecessor), and from October 1, 1995 through December 20, 1995 (Predecessor), December 20, 1995 through September 30, 1996, and the year ended September 30, 1997.......................................................... F-4 Consolidated Statement of Partners' Capital for the period December 20, 1995 through September 30, 1996 and the year ended September 30, 1997 and the Consolidated Statement of Predecessor's Equity for year ended September 30, 1995 (Predecessor) and the period October 1, 1995 through December 20, 1995 (Predecessor)............................................ F-5 Consolidated Statements of Cash Flows for the year ended September 30, 1995 (Predecessor), and from October 1, 1995 through December 20, 1995 (Predecessor), December 20, 1995 through September 30, 1996, and the year ended September 30, 1997 ......................................................... F-6 Notes to Consolidated Financial Statements .................. F-7 -- F-18 Schedule for the years ended September 30, 1995, 1996 and 1997 II. Valuation and Qualifying Accounts ................. F-19 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 consolidated financial statements of Star Gas Partners, L.P. and Subsidiary and its Predecessor as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule as 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 as of September 30, 1996 and 1997 and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 1997, 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. Stamford, Connecticut KPMG Peat Marwick LLP November 7, 1997 F-2 STAR GAS PARTNERS, L.P. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) SEPTEMBER 30, SEPTEMBER 30, 1996 1997 ---- ---- ASSETS Current assets: Cash and cash equivalents $ 1,106 $ 889 Receivables, net of allowance of $291 and $273, respectively 7,226 5,720 Inventories 8,494 6,597 Prepaid expenses and other current assets 1,016 959 -------- -------- Total current assets 17,842 14,165 Property and equipment, net 97,733 95,282Intangibles and other assets, net 41,338 38,022 -------- -------- Total assets $156,913 $147,469 ======== ========LIABILITIES AND PARTNERS' CAPITALCurrent Liabilities: Bank credit facility borrowings $ 2,350 $ -- Accounts payable 1,991 3,178 Accrued expenses 2,757 3,004 Accrued interest 340 321 Customer credit balances 2,858 4,343 -------- -------- Total current liabilities 10,296 10,846 -------- -------- Long-term debt 85,000 85,000Other long-term liabilities 219 45Partners' Capital: Common unitholders 52,821 47,573 Subordinated unitholder 8,410 4,034 General partner 167 (29) -------- -------- Total Partners' Capital 61,398 51,578 -------- -------- Total Liabilities and Partners' Capital $156,913 $147,469 ======== ========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) YEAR OCTOBER 1, 1995 DECEMBER 20, OCTOBER 1, 1995 ENDED THROUGH 1995 THROUGH SEPTEMBER 30, DECEMBER 20, THROUGH SEPTEMBER 30, YEAR ENDED 1995 1995 SEPTEMBER 30, 1996 SEPTEMBER 30, (Predecessor) (Predecessor) 1996 (Combined) 1997 ----------------- ------------------- --------------- ----------------- ---------------- Sales $104,550 $28,159 $91,475 $119,634 $135,159 Cost of sales 49,660 12,808 45,749 58,557 72,211 -------- ------- ------- -------- -------- Gross profit 54,890 15,351 45,726 61,077 62,948 Delivery and branch 35,222 7,729 27,021 34,750 36,427 Depreciation and amortization 10,073 2,177 7,631 9,808 10,405 General and administrative 6,127 1,349 5,108 6,457 6,818 Net (loss) on sales of assets (913) (113) (147) (260) (295) -------- ------- ------- -------- -------- Operating income 2,555 3,983 5,819 9,802 9,003 Interest expense, net 8,549 1,922 5,202 7,124 6,966 -------- ------- ------- -------- -------- Income (loss) before income taxes (5,994) 2,061 617 2,678 2,037 Income tax expense 175 60 25 85 25 -------- ------- ------- -------- -------- Net income (loss) $ (6,169) $ 2,001 $ 592 $ 2,593 $ 2,012 ======== ======= ======= ======== ========General Partner's interest in net income $ 12 $ $40 ------- -------- Limited Partners' interest in net income $ 580 $ 1,972 ======= ======== Net Income per Limited Partner unit $ 0.11 $ 0.37 ======= ======== Weighted average number of Limited Partner units outstanding 5,271 5,271 ======= ======== See accompanying notes to consolidated financial statements. F-4 STAR GAS PARTNERS, L.P. AND SUBSIDIARY CONSOLIDATED STATEMENT OF PARTNERS' CAPITAL AND PREDECESSOR EQUITY (IN THOUSANDS, EXCEPT PER UNIT DATA) PREDECESSOR'S EQUITY YEAR ENDED SEPTEMBER 30, 1995 AND THE PERIOD OCTOBER 1, 1995 THROUGH DECEMBER 20, 1995 8% Total Cumulative 12.5% Capital in Predecessor's Preferred Preferred Excess of Equity Stock Stock Par Value Deficit (Deficiency) --------- --------- ---------- ------- ----------- Balance as of September 30, 1994 $ 500 $ -- $108,336 $(64,508) $44,328 Conversion 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 September 30, 1995 189 319 51,703 (7,906) 44,305 Dividends (21,309) (21,309) Additional capital contribution -- -- 4,184 -- 4,184 Net income -- -- -- 2,001 2,001 ----- ---- -------- -------- -------Balance as of December 20, 1995 $ 189 $319 $ 55,887 $(27,214) $29,181 ===== ==== ======== ======== ======= PARTNERS' CAPITAL FOR THE PERIOD ENDED DECEMBER 20, 1995 THROUGH SEPTEMBER 30, 1996 AND THE YEAR ENDED SEPTEMBER 30, 1997 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 Net Income -- -- 317 263 12 592 Distributions ($1.17 per unit) -- -- (3,371) (2,809) (126) (6,306) ----- ----- ------- ------- ----- --------Balance as of September 30, 1996 2,875 2,396 52,821 8,410 167 61,398 ----- ----- ------- ------- ----- -------- Net Income -- -- 1,077 895 40 2,012 Distributions ($2.20 per unit) -- -- (6,325) (5,271) (236) (11,832) ----- ----- ------- ------- ----- --------Balance as of September 30, 1997 2,875 2,396 $47,573 $ 4,034 $ (29) $ 51,578 ===== ===== ======= ======= ===== ========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 YEAR ENDED THROUGH OCTOBER 1, 1995 SEPTEMBER 30, DECEMBER 20 DECEMBER 20, 1995 THROUGH 1995 1995 THROUGH SEPTEMBER 30, 1996 YEAR ENDED (PREDECESSOR) (PREDECESSOR) SEPTEMBER 30, 1995 (COMBINED) SEPTEMBER 30, 1997 ------------ ---------- ------------------ ----------------- ----------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ (6,169) $ 2,001 $ 592 $ 2,593 $ 2,012 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 10,073 2,177 7,631 9,808 10,405 Provision for losses on accounts receivable 809 101 321 422 312 Net (gain) loss on sales of assets 913 113 147 260 295 Changes in operating assets and liabilities: Decrease (increase) in receivables 1,390 (2,779) 1,766 (1,013) 1,193 Decrease (increase) in inventories (1,196) 1,430 (3,770) (2,340) 1,897 Decrease (increase) in prepaid and other assets 188 (455) 754 299 124 Increase (decrease) in other current liabilities (5,504) (1,703) 1,757 54 2,900 Decrease in other long-term liabilities (87) (12) (89) (101) (174) -------- -------- -------- -------- -------- Net cash provided by operating activities 417 873 9,109 9,982 18,964 -------- -------- -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (7,988) (1,617) (3,715) (5,332) (5,279) Business acquisitions (4,557) -- (2,440) (2,440) -- Proceeds from sales of fixed assets 707 566 252 818 374 Proceeds from sale of businesses 13,250 -- -- -- -- -------- -------- -------- -------- -------- Net cash provided by (used in) investing activities 1,412 (1,051) (5,903) (6,954) (4,905) -------- -------- -------- -------- --------CASH FLOWS FROM FINANCING ACTIVITIES: Credit facility borrowings 6,700 -- 5,850 5,850 5,000 Credit facility repayments (10,700) -- (3,500) (3,500) (7,350) Acquisition facility borrowings 700 -- -- -- 3,350 Acquisition facility repayments (700) -- -- -- (3,350) Borrowings (repayments) of debt 6,576 (35,783) (53,780) (89,563) -- Repayments of preferred stock (5,091) (8,625) -- (8,625) -- Cash dividends paid (412) (21,309) -- (21,309) -- Distributions -- -- (6,306) (6,306) (11,832) 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) (94) Cash retained by general partner -- (6,000) -- (6,000) -- -------- -------- -------- -------- -------- Net cash used in financing activities (2,927) (30) (2,619) (2,649) (14,276) -------- -------- -------- -------- -------- Net increase (decrease) in cash (1,098) (208) 587 379 (217) Cash at beginning of period 1,825 727 519 727 1,106 -------- -------- -------- -------- --------Cash at end of period $ 727 $ 519 $ 1,106 $ 1,106 $ 889 ======== ======== ======== ======== ======== 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 UNIT 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" or the "OLP") 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 interests in Star Gas Partners. Of the $83.7 million in cash retained by the General Partner, $35.8 million 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 over allotment 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 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. F-7 1) PARTNERSHIP ORGANIZATION AND FORMATION (CONTINUED) 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. The Operating Partnership is and the Star Gas Group was, primarily engaged in the retail distribution of propane and related supplies and equipment to residential, commercial, industrial, agricultural and motor fuel customers, operating from 49 branches in the Midwest and 18 branches in the Northeast. Propane is used primarily for space heating, water heating and cooking by the Partnership's residential and commercial customers and as a result, weather conditions have a significant impact on the demand for propane for both heating and agricultural purposes. Accordingly, actual weather conditions can vary substantially from year to year, significantly affecting the Partnership's financial performance.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) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The Consolidated Financial Statements for the year ended September 30, 1995 and the period October 1, 1995 through December 20, 1995 include the propane operations, assets and liabilities of the Star Gas Group. The Consolidated Financial Statements for the period December 20, 1995 through September 30, 1996 and for the year ended September 30, 1997 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"). All material intercompany items and transactions have been eliminated in consolidation and certain reclassifications have been made to the 1995 and 1996 financial statements to conform to the 1997 presentation. F-8 3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 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 1997 ------ ------ Propane gas............... $6,625 $4,805 Appliances and equipment.. 1,869 1,792 ------ ------ $8,494 $6,597 ====== ====== 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 1995, 1996 and 1997 spot purchases from Mont. Belvieu sources accounted for an aggregate of approximately 8%, 26% and 36%, respectively, of the Partnership's total volume of propane purchases. In addition, the three single largest suppliers accounted for an aggregate of approximately 56%, 32% and 31%, respectively, of total propane purchases in 1995, 1996 and 1997. 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. 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 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. F-9 3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) It is the Partnership's policy to review intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. The Partnership determines that the carrying values of intangible assets are recoverable over their remaining estimated lives through undiscounted future cash flow analysis. If such a review should indicate that the carrying amount of the intangible assets is not recoverable, it is the Partnership's policy to reduce the carrying amount of such assets to fair value. Customer Credit Balances Customer credit balances represent pre-payments received from customers. These payments relate primarily to a budget payment plan whereby customers pay their estimated annual propane gas charges on a fixed monthly basis and the payments made have exceeded 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, no recognition has been given to Federal 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 due to taxable income allocation requirements of the Partnership agreement. From 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.4) QUARTERLY DISTRIBUTION OF AVAILABLE CASH The Partnership distributes 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. F-10 4) QUARTERLY DISTRIBUTION OF AVAILABLE CASH (CONTINUED) 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. During fiscal 1996, distributions of $1.17 per unit (including the initial distribution) were declared and paid on all common, subordinated and general partnership interests. The aggregate amount paid for such distributions was $6.3 million during fiscal 1996. During fiscal 1997, distributions of $2.20 per unit were declared and paid on all common, subordinated and general partnership interests. The aggregate paid for such distributions was $11.8 million during fiscal 1997.5) 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. F-11 6) ACQUISITIONS - PRO FORMA During fiscal 1995 and 1996, the Partnership acquired several propane dealers with an aggregate cost of $4.6 million and $2.4 million, in each respective fiscal year. There were no acquisitions of propane dealers made during fiscal 1997. 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 businesses as if they had been acquired on October 1 of the year preceding the year of purchase. YEARS ENDED SEPTEMBER 30, ------------------------- 1995 1996 ---- ---- Sales $107,714 $120,645 ======== ========Net income (loss) $(6,260) $2,817 ======== ========7) SUBSEQUENT EVENTS - ACQUISITION OF PEARL GAS CO. On October 22, 1997, pursuant to a purchase agreement ("Stock Purchase Agreement") dated as of October 20, 1997, Star Gas Corporation purchased 240 shares of Common Stock ($100 par value) of Pearl Gas Co. ("Pearl"), an Ohio Corporation, representing all of the issued and outstanding capital stock of Pearl. Pearl markets and distributes propane in Ohio and Michigan through a storage and distribution system consisting of five offices, fifteen bulk storage plants, fifty employees and over forty-five vehicles. For the twelve months ended September 30, 1997, Pearl sold approximately 14.3 million gallons of propane, primarily to residential customers. Pearl currently serves over 12,000 active customers. The purchase price for said stock was $22.6 million and was paid in cash. The purchase price included estimated working capital of $1.9 million. This amount will be adjusted on or before December 5, 1997 upward or downward based on actual working capital as of October 21, 1997. The amount of consideration for the Pearl Common Stock was determined by arms length bargaining between Star Gas and the Sellers. Funding for the stock purchase was provided by a $23.0 million bank acquisition facility. Subsequent to the acquisition of the common stock of Pearl, Pearl was merged into Star Gas in a tax-free liquidation. On October 22, 1997, a Conveyance and Contribution Agreement was entered into by, and among, the Partnership, the OLP and Star Gas Corporation. Star Gas Corporation contributed to the OLP all of the Pearl assets it obtained in the stock purchase of Pearl Gas and the subsequent merger of Pearl into Star Gas Corporation. In exchange, Star Gas received a 2.7% limited partnership interest in the OLP and a 0.00028% general partnership interest in the OLP. In addition, the OLP assumed all of the liabilities associated with the Pearl stock purchase prior and subsequent to the merger, including the $23.0 million of bank debt. The aggregate value of the interests transferred to Star Gas from the OLP is $3.5 million. F-12 7) SUBSEQUENT EVENTS - ACQUISITION OF PEARL GAS CO. (CONTINUED) The issuance of the additional partnership interests to Star Gas is intended to compensate Star Gas for additional significant income tax liabilities which would be reflected in the consolidated federal income tax return of Star Gas' parent corporation, Petro. The issuance of such partnership interests was approved by the Audit Committee of Star Gas and the Executive Committee of Petro. Star Gas then exchanged the above described interest in the OLP for a 0.00027% general partnership interest in the Partnership and 148 common units in the Partnership, at a per unit price based upon the average closing price of the Partnership's common units ten days prior to the execution of the Stock Purchase Agreement. The OLP then repaid the $23.0 million acquisition facility with $2.0 million of available cash and $21.0 million borrowed under the OLP's own acquisition facility.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, ---------------------- 1996 1997 USEFUL LIVES ---- ---- ------------ Land $ 3,916 $ 4,060 - Buildings 8,945 8,871 30 years Fleet 12,679 14,464 5 - 30 years Tanks and equipment 82,296 84,766 5 - 30 years Furniture and fixtures 2,440 2,504 10 years -------- -------- Total 110,276 114,665 Less: accumulated depreciation (12,543) (19,383) -------- -------- Total $ 97,733 $ 95,282 ======== ======== 9) INTANGIBLES AND OTHER ASSETS The components of intangibles and other assets were as follows at the indicated dates: September 30, ----------------------- 1996 1997 ---- ---- Goodwill $14,186 $14,186 Covenants not to compete 2,040 2,040 Customer lists 28,797 28,797 Deferred charges and other assets 2,795 2,822 ------- ------- Total 47,818 47,845 Less: accumulated amortization (6,480) (9,823) ------- ------- Total $41,338 $38,022 ======= ======= F-13 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, 1997, the Partnership paid interest in the amount of $6.8 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, 1997, the Partnership was in compliance with all borrowing agreement covenants, as amended. 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, 1997, there were no outstanding borrowings under the Acquisition Facility or 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 Partnership is required to pay a fee for unused commitments which amounted to $0.1 million for fiscal 1996 and $0.2 million for fiscal 1997. The Working Capital Facility will expire December 31, 1999, 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, 1997, the annual maturities of the First Mortgage Notes are set forth in the following table: 1998 $ -- 1999 -- 2000 -- 2001 1,923 2002 8,703 Thereafter 74,374 ------- $85,000 ======= In connection with the Pearl acquisition, the Operating Partnership borrowed $21.0 million under the Acquisition Facility on October 22, 1997. 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 1.0% to 15.0% of compensation. Star Gas contributes to non-union participants a matching amount up to a maximum of 3.0% of compensation. Aggregate matching contributions made to the 401(k) plan during fiscal 1995, 1996 and 1997 were $0.2 million, $0.3 million and $0.4 million, 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 $0.2 million, $0.3 million and $0.4 million in fiscal 1995, 1996 and 1997, 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) an 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 a five year period, 3) are exercisable after January 1, 2001, assuming the subordination period has 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. No UARS have been granted pursuant to the plan.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, 1997 under leases having an initial or remaining non-cancelable term of one year or more are as follows: 1998 $ 906 1999 786 2000 701 2001 669 2002 540 Thereafter 345 ------ Total Minimum lease payments $3,947 ====== The Partnership incurred rent expense of $1.2 million, $1.2 million and $1.3 million in 1995, 1996 and 1997, respectively. F-15 14) SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION YEARS ENDED SEPTEMBER 30, ---------------------------------------------------- 1995 1996 1997 ----------------- --------------- --------------- Cash paid during the year for: Income taxes $2,950 $ 80 $ 7 ====== ====== ====== Interest $4,284 $5,088 $7,170 ====== ====== ======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 =======15) 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 Partnership.16) 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 fiscal year ended September 30, 1996 and September 30, 1997, the Partnership reimbursed the General Partner and Petro $14.4 million and $17.1 million, respectively, representing salary, payroll tax and other compensation paid to the employees of the General Partner, including $0.3 million and $0.2 million paid to Petro for certain corporate functions such as finance and compliance. In addition, the Partnership reimbursed Petro for $1.9 million and $0.9 million for the fiscal year ended September 30, 1996 and September 30, 1997, respectively, relating to the Partnership's share of the costs incurred by Petro in conducting the operations of a certain shared branch location which includes managerial services. F-16 17) 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. The estimated fair value of the Partnership's long-term debt is summarized as follows: AT SEPTEMBER 30, 1997 --------------------- CARRYING ESTIMATED Amount Fair Value -------- ---------- Long-term debt $85,000 $86,726 ======= ======= F-17 18) 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 THREE MONTHS ENDED ------------------------------------------------------------------------------------------------ DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30, 1996 1997 1997 1997 Total ------------------ ----------------- ----------------- ------------------- -----------------Sales $50,876 $46,442 $20,078 $17,763 $135,159 Gross profit 21,849 21,523 10,446 9,130 62,948 Income (loss) before taxes 5,898 5,332 (4,138) (5,055) 2,037 Net income (loss) 5,892 5,325 (4,143) (5,062) 2,012 Limited Partner interest in net income (loss) 5,774 5,218 (4,060) (4,960) 1,972 Net income (loss) per Limited Partner Unit $1.10 $0.99 ($0.77) ($0.94) $0.37 (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-18 Schedule II STAR GAS PARTNERS, L.P. AND SUBSIDIARY VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED SEPTEMBER 30, 1995, 1996 AND 1997 (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 ---- ----------- ---------- ---------- ---------- ----------- ----------- 1995 Allowance for doubtful accounts $521 809 (968)(a) $362 ==== === ==== ====1996 Allowance for doubtful (184)(b) accounts $362 422 (309)(a) $291 ==== === ==== ====1997 Allowance for doubtful accounts $291 312 (330)(a) $273 ==== === ==== ====_______________(a) Bad debts written off (net of recoveries).(b) Amount excluded from the Star Gas Conveyance which took place on December 20, 1995. F-19 5 0001002590 STAR GAS PARTNERS, L.P. 1,000 12-MOS SEP-30-1997 OCT-01-1996 SEP-30-1997 889 0 5,993 273 6,597 14,165 114,665 19,383 147,469 10,846 85,000 0 0 51,607 (29) 147,469 130,685 135,159 72,211 42,933 10,511 312 7,155 2,037 25 2,012 0 0 0 2,012 0.37 0.371. COMMON - IN DECEMBER 1995 STAR GAS PARTNERS, L.P. ISSUED COMMON AND SUBORDINATED UNITS WHICH REPRESENT LIMITED PARTNER INTERESTS. THESE UNITS ARE CONSIDERED TO POSSESS THE CHARACTERISTICS OF COMMON STOCK AND ARE BOTH INCLUDED IN THE DETERMINATION OF EPS.2. OTHER-SE - REPRESENTS THE GENERAL PARTNER'S INTEREST IN THE PARTNERSHIP AND IS CLASSIFIED HERE SINCE IT DOES NOT POSSESS THE RELEVANT CHARACTERISTICS OF EITHER COMMON OR PREFERRED STOCK.