Table of Contents UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, DC 20549 FORM 10-K (Mark One) xxANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended September 30, 2004 OR ¨¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number: 001-14129 Commission File Number: 333-103873 STAR GAS PARTNERS, L.P.STAR GAS FINANCE COMPANY(Exact name of registrants as specified in its charters) DelawareDelaware 06-143779375-3094991(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) 2187 Atlantic Street, Stamford, Connecticut 06902(Address of principal executive office) (Zip Code) (203) 328-7310(Registrants’ telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registeredCommon Units New York Stock ExchangeSenior Subordinated Units New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrant was required 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 filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form10-K. ¨ Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). x The aggregate market value of Star Gas Partners, L.P. Common Units held by non-affiliates of Star Gas Partners, L.P. on March 31, 2004 was approximately$820,309,841. As of December 8, 2004, the registrants had units and shares outstanding for each of the issuers classes of common stock as follows: Star Gas Partners, L.P. Common Units 32,165,528Star Gas Partners, L.P. Senior Subordinated Units 3,245,233Star Gas Partners, L.P. Junior Subordinated Units 345,364Star Gas Partners, L.P. General Partner Units 325,729Star Gas Finance Company Common Shares 100 Documents Incorporated by Reference: None Table of Contents STAR GAS PARTNERS, L.P. 2004 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS Page PART I Item 1. Business 3Item 2. Properties 23Item 3. Legal Proceedings - Litigation 24Item 4. Submission of Matters to a Vote of Security Holders 25 PART II Item 5. Market for the Registrant’s Units and Related Matters 26Item 6. Selected Historical Financial and Operating Data 28Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 31Item 7A. Quantitative and Qualitative Disclosures about Market Risk 54Item 8. Financial Statements and Supplementary Data 54Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 54Item 9A. Controls and Procedures 54 PART III Item 10. Directors and Executive Officers of the Registrant 55Item 11. Executive Compensation 59Item 12. Security Ownership of Certain Beneficial Owners and Management 63Item 13. Certain Relationships and Related Transactions 64Item 14. Principal Accounting Fees and Services 64 PART IV Item 15. Exhibits and Financial Statement Schedules 65Appendix A Tax Consequences to Unitholders Upon Sale of The Propane Segment 2 Table of Contents PART IITEM 1.BUSINESS Structure Star Gas Partners, L.P. (“Star Gas” or the “Partnership”) is a diversified home energy distributor and services provider, specializing in heating oil and propane.Star Gas is a master limited partnership, which at September 30, 2004 had outstanding 32.2 million common units (NYSE: “SGU” representing an 89.1%limited partner interest in Star Gas) and 3.2 million senior subordinated units (NYSE: “SGH” representing a 9.0% limited partner interest in Star Gas).Additional Partnership interests include 0.3 million junior subordinated units (representing a 1.0% limited partner interest) and 0.3 million general partnerunits (representing a 0.9% general partner interest). The Partnership is organized as follows: •Star Gas Propane, L.P. (“Star Gas Propane”) is the Partnership’s operating subsidiary and, together with its direct and indirect subsidiaries, accountsfor substantially all of the Partnership’s assets, sales and earnings. Both the Partnership and Star Gas Propane are Delaware limited partnerships thatwere formed in October 1995 in connection with the Partnership’s initial public offering. The Partnership is the sole limited partner of Star GasPropane with a 99.99% limited partnership interest. •The general partner of both the Partnership and Star Gas Propane is Star Gas LLC, a Delaware limited liability company. The Board of Directors ofStar Gas LLC is appointed by its members. Star Gas LLC owns an approximate 1% general partner interest in the Partnership and also owns anapproximate .01% general partner interest in Star Gas Propane. •The Partnership’s propane operations (the “propane segment”) are conducted through Star Gas Propane and its direct subsidiaries. Star GasPropane primarily markets and distributes propane gas, heating oil, and other petroleum fuels and related products to approximately 334,000customers located primarily in the Midwest and Northeast regions, Florida and Georgia. On November 18, 2004, the Partnership signed anagreement for the sale of the propane segment, which is discussed below. •The Partnership’s heating oil operations (the “heating oil segment”) are conducted through Petro Holdings, Inc. (“Petro”) and its directsubsidiaries. Petro is a Minnesota corporation that is an indirect wholly owned subsidiary of Star Gas Propane. Petro is a retail distributor of homeheating oil and serves over 515,000 customers in the Northeast and Mid-Atlantic regions. •Star Gas Finance Company is a direct wholly owned subsidiary of the Partnership. Star Gas Finance Company serves as the co-issuer, jointly andseverally with the Partnership, of the Partnership’s $265 million 10¼% Senior Notes, which are due in 2013. The Partnership is dependent ondistributions including intercompany interest payments from its subsidiaries to service the Partnership’s debt obligations. The distributions fromthe Partnership’s subsidiaries are not guaranteed and are subject to certain loan restrictions. Star Gas Finance Company has nominal assets andconducts no business operations. The Partnership was formerly engaged as an energy reseller that marketed natural gas and electricity to residential households in deregulated energy marketsthrough Total Gas & Electric, Inc. (“TG&E”), a Florida corporation, that was an indirect wholly-owned subsidiary of Petro. On March 31, 2004, thePartnership sold the stock and business of TG&E in an all-cash transaction to a private party. The Partnership received net proceeds of approximately $12.5million and recorded a loss of approximately $0.5 million from the sale of TG&E. The Partnership files annual, quarterly, current and other reports and information with the SEC. These filings can be viewed and downloaded from the internetat the SEC’s website at www.sec.gov. In addition, these SEC filings are available at no cost as soon as reasonably practicable after the filing thereof on thePartnership’s website at www.star-gas.com/Edgar.cfm. These reports are also available to be read and copied at the SEC’s public reference room located atJudiciary Plaza, 450 5th Street, N.W., Washington, D.C. 20549. The public may obtain information on the operation of the public reference room by callingthe SEC at 1-800-SEC-0330. You may also obtain copies of these filings and other information at the offices of the New York Stock Exchange located at 11Wall Street, New York, New York 10005. 3 Table of ContentsRecent Events On October 18, 2004, the Partnership announced that it had advised the heating oil segment’s bank lenders that this segment would not be able to make therequired representations included in the borrowing certificate under its working capital line. In addition, the Partnership notified such lenders that, for thequarter ending December 31, 2004 and for the foreseeable future thereafter, the heating oil segment will be unlikely to satisfy the drawing condition thatrequires that the consolidated funded debt of the Partnership not exceed 5.00 times its consolidated operating cash flow. Further, the Partnership advised thelenders that the heating oil segment may not be able to maintain a zero balance under the working capital facility (except for letter of credit obligations) for45 consecutive days from April 1, 2005 to September 30, 2005, as required by the heating oil segment’s covenants. The Partnership indicated that the sourceof the problem is a combination of (a) the inability to pass on the full impact of record wholesale heating oil prices to customers and (b) the effects ofunusually high customer attrition principally related to the heating oil segment’s operational restructuring undertaken in the past 18 months. The Partnership also announced that it anticipated that because of the requirements of the Partnership’s current and potential bank lenders, it will not bepermitted to make any distributions on its common units. In addition, the Partnership announced that the heating oil segment’s bank lenders had agreed to permit the heating oil segment to request new workingcapital advances daily while the Partnership was in discussions with such bank lenders about modifying the terms and conditions of the heating oil segment’scredit agreement. In connection with that understanding the bank lenders requested that the Partnership allow an independent financial advisor to review theheating oil segment’s operations and performance on their behalf. On November 5, 2004, the Partnership announced that the heating oil segment had entered into a letter amendment and waiver under its credit agreementwith Wachovia Bank, N.A. As a result of the amendment, the heating oil segment was able to continue to borrow funds under the credit agreement to supportits working capital requirements for the near term. The amendment provides for the waiver, through December 17, 2004, of various terms under the creditagreement. The amendment also amends for the waiver period the financial covenant regarding the Partnership’s consolidated funded debt to cash flow ratioand the financial covenant regarding the heating oil segment’s cash flow to interest expense ratio. The Partnership also announced that its propane segment had entered into a commitment letter with JPMorgan Securities Inc. and JPMorgan Chase Bank.Under the commitment letter, as amended, JP Morgan Chase Bank committed, subject to certain conditions, to provide a $350 million ($260 million if thepropane segment is sold, as discussed below) asset-based senior secured revolving credit facility referred to herein as the revolving credit facility and a$300,000,000 senior secured bridge facility referred to herein as the bridge facility to refinance (the “refinancing transactions”) all of the heating oilsegment’s and the propane segment’s (if the propane segment is not sold) working capital facilities and senior secured notes. On November 18, 2004, the Partnership announced that it had signed an agreement to sell its propane segment, held largely through Star Gas Propane toInergy Propane LLC (“Inergy”), the operating subsidiary of Inergy, L.P., for $475 million subject to certain adjustments. The Partnership anticipatesrecognizing a gain in excess of approximately $150 million from the sale of the propane segment. In addition, the Partnership gave notice to holders of theheating oil segment’s secured notes of its optional election to prepay such secured notes, representing an aggregate payment, including principal, interestand estimated premium, of approximately $182 million. The Partnership subsequently gave notice of its optional election to prepay its propane segment’ssecured notes involving an aggregate payment including principal, interest and estimated premium, of approximately $114 million. The aggregate amountpayable with regard to both sets of secured notes is approximately $296 million. As discussed elsewhere herein, these payments are expected to be made fromeither the proceeds of the sale of the propane segment or the JP Morgan Chase Bank bridge facility. The partnership expects to recognize a loss ofapproximately $43 million on the early redemption of this debt in its first quarter of fiscal 2005. For additional information concerning the sale of thepropane segment, see Item 1 – Business - “Sale of the Propane Segment; Prepayment of Subsidiaries’ Secured Notes.” If the sale of the propane segment to Inergy is not consummated for any reason by December 17, 2004, the Partnership’s commitment from JP Morgan Chasewill remain unaffected. On that date, the Partnership would expect to draw down JP Morgan Chase’s bridge facility if the propane segment sale has not beenconsummated. The proceeds from the bridge facility would be used to repay the Partnership’s subsidiaries’ secured notes, which will become due on that datebecause of the Partnership’s notice of prepayment. The Partnership also would expect to close on that date the asset based revolving credit agreementunderwritten by JP Morgan Chase to replace the existing revolving credit agreements of the 4 Table of ContentsPartnership’s subsidiaries. Therefore, the Partnership will be able to restructure its indebtedness as disclosed in the Partnership’s previous press release datedNovember 5, 2004, provided that it is able to satisfy the conditions in the JP Morgan Chase commitment. The JP Morgan Chase commitment for the bridgefacility and the revolving credit facility is subject to a number of conditions and there can be no assurance that the Partnership will meet those conditions.See “Liquidity and Capital Resources – Financing and Sources of Liquidity, Following Refinancing Transactions.” If the propane segment is sold (either before or after December 17, 2004), the revolving credit facility will be reduced to $260 million and the liens on all ofthe assets of the propane segment would be released. If the sale of the propane segment does not close until after the Partnership has drawn down on thebridge facility, the Partnership will use a portion of the sales proceeds to repay the bridge loan. The remaining proceeds will be applied in accordance withthe terms of the indenture relating to the Partnership’s 10-1/4% senior notes due 2013 (“MLP Notes”), which is discussed below under “Liquidity and CapitalResources – Financing and Sources of Liquidity, Following Refinancing Transactions.” If the agreement for the sale of the propane segment is terminated, thePartnership will seek to repay the bridge facility through the issuance of senior secured notes issued by the heating oil segment and the propane segment in apublic or private offering. For a further discussion of the refinancing transactions, see “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results ofOperations.” Sale of the Propane Segment; Prepayment of Subsidiaries’ Secured Notes Background On November 18, 2004, the Partnership signed an agreement to sell its propane distribution and services segment, held largely through Star Gas Propane,L.P., to Inergy for $475 million, subject to certain adjustments. Following the Partnership’s press release of October 18, 2004 concerning the heating oilsegment’s borrowing problems, the Partnership was approached by Inergy regarding its interest in acquiring the Partnership’s propane segment. In connectionwith addressing this possibility, the board of directors of the Partnership’s general partner formed a special committee comprised of two independent directorsto determine whether a transaction would be fair to the non-affiliated unitholders of the Partnership as a whole. The special committee, in turn, engagedseparate financial and legal advisors to assist it. The board monitored the negotiation with Inergy and considered other possible alternatives, including a saleof less than all of the propane segment, a sale of the heating oil segment, a sale of the entire Partnership and delaying any discussion regarding a sale andsimply restructuring the debt of the Partnership. The special committee and full board considered the tax impact of the announced transaction andparticularly why the sale of the propane segment would generate adverse tax consequences to a number of unitholders, particularly those that had held theirunits the longest. The special committee and full board considered the likelihood of consummation of the transaction and the specific terms of the purchaseagreement with Inergy. The agreement includes a provision permitting the Partnership to terminate the agreement should a superior proposal be made for thepropane segment or the Partnership as a whole upon a payment of a breakup fee. The analyses presented to the special committee and the board indicated that the sale of the propane segment would, by deleveraging the balance sheet of thePartnership, likely advance the time when it would be possible for the Partnership to resume regular distributions on the Partnership’s common units, at somelevel, although the special committee and full board understood that there could be no assurance that the Partnership would make distributions on thecommon units, at any level, in the future. The analyses also indicated that, irrespective of the sale of the propane segment, it is unlikely that the Partnershipwill resume regular distributions to the senior subordinated and junior subordinated units for the foreseeable future. After considering and partially in reliance on the advice of its advisors, the special committee unanimously determined that the sale of the propane segmentto Inergy on the terms described above was fair to the non-affiliated unitholders of the Partnership as a whole. After considering the advice of their advisorsand an analysis of the issues, the Audit Committee unanimously determined that the transaction was fair to the Partnership, and the Audit Committee and thefull board unanimously approved the execution of the agreement to sell the Partnership’s propane segment to Inergy. The Partnership believes that the salewill improve the Partnership’s financial condition which should have the effect of increasing the heating oil segment’s opportunities. 5 Table of ContentsTerms of the Agreement. General description. The agreement with Inergy contemplates that Inergy will purchase the Partnership’s propane segment for $475 million in cash, subjectto adjustment without assumption of the propane segment’s indebtedness for borrowed money at the time of sale. The purchase price is subject to certainadjustments including a working capital adjustment. The transaction is expected to close in late December 2004. For purposes of economic effect, thetransaction will be effective as of November 30, 2004 and Inergy will assume all profits subsequent to that date. Upon completion of the sale of the propane segment, the Partnership will restate prior years’ results to include the results of the propane segment and the gainon the disposition as a component of discontinued operations. No financing condition. The purchaser’s obligation to close is not conditioned on receipt of financing although the purchaser will need financing tocomplete the purchase. General conditions. The sale is conditioned on a number of customary closing conditions, including the passage of the applicable waiting period under theHart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, the filing for which was made on November 18, 2004. The agreement provides that thePartnership will enter into a five-year non-competition agreement with respect to the propane segment in certain regions. The agreement also provides for abreakup fee to Inergy in the event that the Partnership terminates the agreement because of a superior offer for the propane segment or the Partnership entersinto an agreement providing for the sale of the Partnership in its entirety. The Partnership can terminate the agreement if the transaction does not close byDecember 20, 2004, and Inergy can terminate the agreement if the transaction does not close by December 31, 2004. There can be no assurance that all of theconditions to closing will be met. The Partnership believes that no unitholder approval is required and none is going to be requested. Partnership status. Star Gas will continue to be classified as a partnership for federal income tax purposes after the sale of the propane segment. Nonetheless,because the heating oil business is held through a corporate subsidiary, following the sale nearly all of Star Gas’ earnings will be subject to corporate-levelincome taxes, whereas prior to the sale most of the earnings from the propane business are not subject to entity-level taxation. By virtue of net operating losscarryforwards, the Partnership does not anticipate that the corporate subsidiary will pay substantial federal income taxes for several years. Use of Proceeds from the Sale of the Propane Segment Proceeds from the sale of the propane segment will be used to repay $296 million that will be owing with respect to the secured notes at the Partnership’ssubsidiaries, to repay outstanding borrowings under the propane segment’s credit facilities, and to pay expenses related to the sale of the propane segment. Thereafter, pursuant to the terms of the indenture relating to the Partnership’s MLP Notes, the Partnership will be obligated, within 360 days of the sale, toapply the net proceeds of the sale of the propane segment either to reduce indebtedness of the Partnership or of a restricted subsidiary, or to make aninvestment in assets or capital expenditures useful to the Partnership’s or any subsidiary’s business. To the extent any net proceeds that are not so appliedexceed $10 million (“excess proceeds”), the indenture requires the Partnership to make an offer to all holders of MLP Notes to purchase for cash that numberof MLP Notes that may be purchased with excess proceeds at a purchase price equal to 100% of the principal amount of MLP Notes plus accrued and unpaidinterest to the date of purchase. The Partnership cannot estimate the amount, if any, of excess proceeds that will result from the sale of the propane segment.Accordingly, the Partnership cannot predict the size of any offer to purchase the MLP Notes and whether or to what extent holders of MLP Notes will acceptthe offer to purchase when made. Tax Consequences to Unitholders Upon Sale of the Propane Segment The Partnership’s unitholders will recognize gain or loss associated with the sale of the propane business based on a number of factors, including eachindividual holder’s basis in the Partnership units held, and the tax consequences of such sale will accrue to the record holders as of the date of the sale. Basedon its preliminary calculations, in general the Partnership estimates that, depending on the profile of the unitholder, the gain can be as high as approximately$11 per common unit and loss as high as $4.27. In general, the Partnership anticipates that holders who have held units for a substantial period of time,particularly those who purchased units prior to 2002, and those who purchased units at a low purchase price, will recognize the most gain. A holder’s taxbasis in units will be increased by the amount of gain recognized. If a holder sells units prior to the consummation of the sale of the propane business, suchholder may recognize substantially less gain than would a holder who continues to hold through the date of consummation of the sale. For additionalinformation concerning the tax consequences to unitholders, see Appendix A. 6 Table of ContentsUnitholders are encouraged to consult with their own tax advisors with respect to the application of tax laws to their particular situations. Prepayment of the Partnership’s Subsidiaries’ Secured Notes On November 18, 2004, the Partnership gave the holders of the heating oil segment’s secured notes notice of prepayment of all of the notes on December 17,2004. As contemplated by the note purchase agreements relating to the notes, the prepayment amount will be 100% of the principal amount outstanding($157.2 million), together with interest accrued thereon to the date of prepayment ($3.6 million) and an estimated make-whole amount ($21 million). ThePartnership subsequently gave notice of the prepayment of the propane segment’s secured notes. The prepayment amount for the propane segment’s securednotes will be 100% of the outstanding principal amount ($96.3 million), together with accrued interest thereon to the date of prepayment ($1.9 million) andan estimated make-whole amount ($16 million). The aggregate amount payable for the heating oil segment’s notes and the propane segment notes isapproximately $296 million. These payments are expected to be made from either the proceeds of the sale of the propane segment or the JP Morgan Bankbridge facility. Amendments to Partnership Agreements The Partnership has adopted certain amendments to its amended and restated agreement of limited partnership as well as certain amendments to the amendedand restated agreement of limited partnership of Star Gas Propane in order to permit the sale of the propane segment. 7 Table of ContentsIntroduction to Business Seasonality The Partnership’s fiscal year ends on September 30. All references to quarters and years in this document are to fiscal quarters and years unless otherwisenoted. The seasonal nature of the Partnership’s business results in the sale of approximately 30% of its volume in the first quarter (October through December)and 45% of its volume in the second quarter (January through March) of each year, the peak heating season, because propane and heating oil are primarilyused for space heating in residential and commercial buildings. The Partnership generally realizes net income in both of these quarters and net losses duringthe quarters ending in June and September. The Partnership typically has negative working capital at September 30, due to seasonality. In addition, salesvolume typically fluctuates from year to year in response to variations in weather, wholesale energy prices and other factors. Gross profit is not only affectedby weather patterns but also by changes in customer mix. For example, sales to residential customers ordinarily generate higher margins than sales to othercustomer groups, such as commercial or agricultural customers. In addition, gross profit margins vary by geographic region. Accordingly, gross profit marginscould vary significantly from year to year in a period of identical sales volumes. Propane The propane segment is primarily engaged in the retail distribution of propane and related supplies and equipment to residential, commercial, industrial,agricultural and motor fuel customers. Customers are served from 122 branch locations and 136 satellite storage facilities in the Midwest and Northeastregions and Florida and Georgia. In addition to its retail business, the segment also serves wholesale customers. Based on sales dollars, approximately 96% ofpropane sales were to retail customers and approximately 4% were to wholesale customers. Retail sales have historically had a greater profit margin, morestable customer base and less price sensitivity as compared to the wholesale business. Propane, also known as a liquid petroleum gas (lpg) ranks as the fourth most important source of residential heating in the United States, according to the U.S.Department of Energy - Energy Information Administration, 2001 Residential Energy Consumption Survey. Excluding propane gas grills, residential andcommercial demand accounts for approximately 45% of all propane used in the United States. Of the 106.9 million households in the United States, 9.3million households depend on propane. Because 54% of these households rely on propane for their primary heating fuel, sales of propane are highlyseasonal. Propane is most commonly used to provide energy to areas not serviced by the natural gas distribution system. Thus, it competes mainly withheating oil and electricity for space heating purposes. Residential customers are typically homeowners, while commercial customers include motels,restaurants, retail stores and laundromats. Industrial users, such as manufacturers, use propane as a heating and energy source in manufacturing and dryingprocesses. In addition, propane is used to supply heat for drying crops and as a fuel source for certain vehicles. Propane is extracted from natural gas at processing plants or separated from crude oil during the refining process. It is normally transported and stored in aliquid state under moderate pressure or refrigeration for ease of handling in shipping and distribution. When the pressure is released or the temperature isincreased, propane is usable as a flammable gas. Propane is colorless and odorless; an odorant is added to allow its detection. Home Heating Oil Home heating oil customers are served from 19 locations in the Northeast and Mid-Atlantic regions, from which the heating oil segment delivers heating oiland other petroleum products and installs and repairs heating equipment 24 hours a day, seven days a week, 52 weeks a year. These services are an integralpart of its basic heating oil business, and are intended to maximize customer satisfaction and loyalty. In fiscal 2004, the heating oil segment’s salesrepresented approximately 74% of sales from home heating oil; 17% from the installation and repair of heating and air conditioning equipment; and 9% fromthe sale of other petroleum products, including diesel fuel and gasoline, to commercial customers. In fiscal 2004, sales to residential customers represented87% of the retail heating oil gallons sold and 92% of heating oil gross profits. Heating oil can be used for residential and commercial heating purposes, and it is a significant source of fuel used to heat business and residences in the NewEngland and Mid-Atlantic regions. According to the U.S. Department of Energy—Energy Information Administration, 2001 Residential EnergyConsumption Survey, these regions account for approximately 77% of the households in the United States where heating oil is the main space-heating fuel.Approximately 31% of the homes in the region use heating oil as their main space-heating fuel. In recent years, demand for home heating oil has beenaffected by conservation efforts and conversions to natural gas. In addition, as the number of new homes that use oil heat has not been significant, there hasbeen virtually no increase in the customer base due to housing starts. 8 Table of ContentsIndustry Characteristics The retail propane and home heating oil industries are both mature, with total demand expected to remain relatively flat or to decline slightly. ThePartnership believes that these industries are relatively stable and predictable due principally to the non-discretionary nature of propane and home heatingoil use. Accordingly, the demand for propane and home heating oil has historically been relatively unaffected by general economic conditions but has been afunction of weather conditions. It is common practice in both the propane and home heating oil distribution industries to price products to customers basedon a per gallon margin over wholesale costs. As a result, distributors generally seek to maintain their margins by passing wholesale costs through tocustomers, thus insulating themselves from the volatility in wholesale heating oil and propane prices. However, during periods of sharp price fluctuations insupply costs, distributors may be unable or unwilling to pass the entire product cost increases or decreases through to customers. In these cases, significantincreases or decreases in per gallon margins may result. In addition, the timing of cost pass-throughs can significantly affect margins. See “Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The propane and home heating oil distribution industries arehighly fragmented, characterized by a large number of relatively small, independently owned and operated local distributors. Each year a significant numberof these local distributors have sought to sell their business for reasons that include retirement and estate planning. In addition, the propane and heating oildistribution industries are becoming more complex due to increasing environmental regulations and escalating capital requirements needed to acquireadvanced, customer-oriented technologies. Primarily as a result of these factors, both industries are undergoing consolidation, and the propane segment andthe heating oil segment have been active consolidators in each of their markets. Recent Acquisitions In fiscal 2004, the Partnership completed the purchase of three retail heating oil dealers for an aggregate of $3.5 million and ten retail propane dealers for anaggregate of $14.0 million. 9 Table of ContentsPropane Segment As indicated above under “Sale of the Propane Segment; Prepayment of Subsidiaries’ Secured Notes,” the Partnership has signed an agreement for the sale ofits propane segment. The following is a description of such business. Operations Retail propane operations are located in the following states: Connecticut Indiana (continued) Michigan New York (continued) PennsylvaniaStamford Loogootee Charlotte Hudson Beaver SpringsSouth Windsor Madison Chassell Penn Yan Hazleton Nashville Coleman Poughkeepsie MansfieldFlorida New Salisbury Germfask Ticonderoga Mt. PoconoBronson N. Manchester Gwinn Washingtonville Wind GapChiefland Portland Mattawan Crystal River Remington Munising Ohio Rhode IslandHigh Springs Richmond Osseo Bowling Green DavisvilleKissimmee Rushville Owosso Columbiana Melbourne Seymour Somerset Center Columbus VermontNew Smyrna Beach Sulphur Springs Defiance BenningtonPompano Beach Versailles Minnesota Deshler Brandon Warren Caledonia Dover Manchester CenterGeorgia Waterloo Fairfield MiddleburyBlakely Winamac NewHampshire Hebron Montpelier Berlin Ironton MorrisvilleIllinois Kentucky Brentwood Jamestown St. AlbansScales Mound Dry Ridge Ossipee Kenton White River Junction Shelbyville Lancaster Lewisburg West VirginiaIndiana Maine New Jersey Lynchburg (from Ironton, OH)Batesville Fairfield Bridgeton Maumee Bedford Fryeburg Maple Shade Mt. Orab WisconsinBloomfield Wells Pleasantville Mt. Vernon Black River FallsBluffton Windham Woodbine North Star ChetekColumbia City Ripley La CrosseDecatur Massachusetts New York Sabina MaustonGreencastle Belchertown Addison Waverly MinocquaJeffersonville Rochdale Bridgehampton West Union MondoviLawrence Springfield Corinth Winchester OwenLiberty Swansea Granville Richland Centre Westfield Shell Lake In addition to selling propane, the propane segment also sells home heating oil and installs related equipment, including heating and cooking appliances.Several locations sell bottled water and sell or lease water conditioning equipment. Typical branch locations consist of an office, an appliance showroom anda warehouse and service facility, with one or more 12,000 to 30,000 gallon bulk storage tanks. Satellite facilities typically contain only storage tanks. Thedistribution of propane at the retail level for the most part involves large numbers of small deliveries averaging 100 to 150 gallons to each customer. Retaildeliveries of propane are usually made to customers by means of the propane segment’s fleet of bobtail and rack trucks. Currently the propane segment owns or leases a total of 746 bobtail, boom and rack trucks. Propane is pumped from a bobtail truck, which generally holds2,000 to 3,000 gallons, into a storage tank at the customer’s premises. The capacity of these tanks ranges from approximately 24 gallons to approximately1,000 gallons. The propane segment also delivers propane to retail customers in portable cylinders, which typically are picked up and replenished atdistribution locations, then returned to the retail customer. To a lesser extent, the propane segment also delivers propane to certain end-users of propane inlarger trucks known as transports. These trucks have an average capacity of approximately 9,000 gallons. End-users receiving transport deliveries includeindustrial customers, large-scale heating accounts, such as local gas utilities that use propane as a supplemental fuel to meet peak demand requirements, andlarge agricultural accounts that use propane for crop drying and space heating. 10 Table of ContentsCustomers During the last fiscal year, the propane segment’s residential volume, excluding the impact of volume obtained through acquisitions, decreased 2.7% due toattrition and other factors including consumer conservation and increased competition from low cost providers. Management expects some degree of attritionto continue in 2005 and perhaps beyond. However, the propane segment has continued to grow through acquisitions and it completed ten acquisitions withapproximately 14,000 customers and total annual volumes of 13.7 million gallons during fiscal 2004. Approximately 70% of the propane segment’s retailpropane sales are made to residential customers and 30% of retail propane sales are made to commercial and agricultural customers. Sales to residentialcustomers in fiscal 2004 accounted for approximately 75% of propane gross profit on propane sales, reflecting the higher-margins of this segment of themarket. In excess of 90% of the propane customers lease their tanks from the propane segment. In most states, due to fire safety regulations, a leased tank mayonly be refilled by the propane distributor that owns that tank. The inconvenience associated with switching tanks greatly reduces a propane customer’stendency to change distributors. Over half of the propane segment’s residential customers receive their propane supply under an automatic delivery system.The amount delivered is based on weather and historical consumption patterns. The automatic delivery system eliminates the customer’s need to makeaffirmative purchase decisions. The propane segment provides emergency service 24 hours a day, seven days a week, 52 weeks a year. Competition The propane industry is highly competitive; however, long-standing customer relationships are typical of the retail propane industry. The ability to competeeffectively within the propane industry depends on the reliability of service, responsiveness to customers and the ability to maintain competitive prices. Thepropane segment believes that its superior service capabilities and customer responsiveness differentiates it from many of its competitors. Branch operationsoffer emergency service 24 hours a day, seven days a week, 52 weeks a year. Competition in the propane industry is highly fragmented and generally occurson a local basis with other large full-service multi-state propane marketers, smaller local independent marketers and farm cooperatives. According to LP GasMagazine – February 2003, the ten largest multi-state marketers, including the Partnership’s propane segment, account for approximately 32% of the totalretail sales of propane in the United States, and no single marketer has a greater than 10% share of the total retail market in the United States. Most of thepropane segment’s branches compete with five or more marketers or distributors. The principal factors influencing competition among propane marketers areprice and service. Each branch operates in its own geographic market. While retail marketers locate in close proximity to customers to lower the cost ofproviding delivery and service, the typical retail distribution outlet has an effective marketing radius of approximately 35 miles. Propane competes primarily with electricity, natural gas and fuel oil as an energy source on the basis of price, availability and portability. Propane isgenerally more expensive than natural gas, but serves as an alternative to natural gas in rural and suburban areas where natural gas is unavailable orportability of product is required. The expansion of natural gas into traditional propane markets has historically been inhibited by the capital costs requiredto expand distribution and pipeline systems. Although the extension of natural gas pipelines tends to displace propane distribution in the areas affected, thePartnership believes that new opportunities for propane sales arise as more geographically remote areas are developed. Although propane is similar to fuel oilin space heating and water heating applications, as well as in market demand and price, propane and fuel oil have generally developed their own distinctgeographic markets. Because furnaces that burn propane will not operate on fuel oil, a conversion from one fuel to the other requires the installation of newequipment. 11 Table of ContentsHome Heating Oil Segment Operations The Partnership’s heating oil segment serves over 515,000 customers in the Northeast and Mid-Atlantic regions. In addition to selling home heating oil, theheating oil segment installs, maintains and repairs heating and air conditioning equipment. To a limited extent, it also markets other petroleum products.During the 12 months ended September 30, 2004, the total sales in the heating oil segment were comprised of approximately 74% from sales of home heatingoil; 17% from the installation and repair of heating equipment; and 9% from the sale of other petroleum products. The heating oil segment provides homeheating equipment repair service 24 hours a day, seven days a week, 52 weeks a year. It also regularly provides various incentives to obtain and retaincustomers. The heating oil segment is consolidating its operations under two primary brand names, Petro and Meenan, which it is building by employing anupgraded sales force, together with a professionally developed integrated marketing campaign, including broadcast and print advertising media, includingdirect mail. The heating oil segment has a nationwide toll free telephone number, 1-800-OIL-HEAT, which it believes helps facilitate customer needs. The heating oil segment is seeking to take advantage of its large size and to utilize modern technology to increase the efficiency and quality of servicesprovided to its customers. The segment is seeking to create a more customer-oriented service approach to significantly differentiate itself from its competitors.A core business process redesign project began in fiscal 2002 with an exhaustive effort to identify customer expectations and document existing businessprocesses. These findings led to a conclusion that improved processes, consolidation of operations, technology investments and selective outsourcing couldhave a meaningful impact on improving customer services while reducing annual operating costs. The Partnership believes the technology it employs can improve the efficiency and quality of services provided to its heating oil customers. The heating oilsegment has now deployed second generation hand-held devices for the automation of its service workforce. These wireless handheld-data terminals allowservice and installation professionals on demand access to customer repair history, data to provide instant part and repair quotations, the ability to invoice atthe completion of service and identify customer service issues. Consolidation of certain heating oil operational activities have been undertaken to create operating efficiencies and cost savings. Service technicians arebeing dispatched from two consolidated locations rather than 27 local offices which was previously the case. Oil delivery is now being managed from 11regional locations rather than 27 local offices. The organization continues to adjust to these significant operational changes. The Partnership has recently completed a transition to outsourcing in the area of customer contact management as both a customer satisfaction and a costreduction strategy. The Partnership hopes outsourcing customer inquiries through a centralized call center may improve performance, service and leveragethe technology to eliminate system redundancy available from third-party service organizations. In addition, an outsourcing partner has greater flexibility tomanage extreme seasonal volume. The complexity of customer interactions combined with the Partnership’s goal for service excellence has led to protractedtraining and implementation efforts. During fiscal 2004, the heating oil segment experienced startup operational problems with its centralized call center and equipment service dispatch, whichthe Partnership believes contributed to an increase in customer attrition. The heating oil segment believes that it has made progress in correcting theseoperational problems. See “Risk Factors.” The heating oil segment operates and markets in the following states: New York Massachusetts New JerseyBronx, Queens and Kings Counties Boston (Metropolitan) CamdenDutchess County Northeastern Massachusetts LakewoodStaten Island (Centered in Lawrence) Newark (Metropolitan)Eastern Long Island Worcester North BrunswickWestern Long Island RockawayWestchester/Putnam Counties Pennsylvania TrentonOrange County Allenstown New York County Berks County Rhode Island Bucks County ProvidenceConnecticut Harrisburg County NewportBridgeport—New Haven Lancaster County Fairfield County Lebanon County Maryland/Virginia/D.C.Litchfield County Philadelphia Arlington York County Baltimore Washington, D.C. (Metropolitan) 12 Table of ContentsCustomers During the 12 months ended September 30, 2004, approximately 87% of the heating oil segment’s heating oil sales were made to homeowners, with theremainder to industrial, commercial and institutional customers. Over the three fiscal years, ended September 30, 2003, the heating oil segment experiencedaverage annual attrition of approximately 1.3%, excluding the impact of acquisitions. During fiscal 2004, the heating oil segment experienced annualcustomer attrition of 6.6%, excluding the impact of acquisitions. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results ofOperations.” The Partnership believes this segment’s attrition rate has risen because of greater than normal price competition related to the unprecedented risein oil prices and because of startup operational problems associated with the business process redesign project, primarily caused by the transition to acentralized call center. Prior to the 2004 winter heating season, the heating oil segment attempted to develop a competitive advantage in customer service,and as part of that effort, centralized its heating equipment service dispatch and engaged a centralized call center to fulfill its telephone requirements. Theimplementation of this initiative is taking longer and incurring greater difficulties than the heating oil segment had anticipated, which adversely impactedthe customer base. In addition, Management’s decision to upgrade the credit quality of its customer base and reduce related bad debt also contributed to theincreased customer loss. While the Partnership believes that the heating oil segment has made progress in correcting the early inefficiencies associated with its centralized customerservice, and that it has significantly improved its responsiveness to customer needs, the Partnership expects that customer attrition will likely continue at arate higher than experienced in each of the three years ended September 30, 2003 into the 2004-2005 winter heating season and the 2004 attrition willadversely impact volume during 2005 and perhaps beyond. Customer losses are the result of various factors, including customer relocation, price, natural gas conversions, service issues and credit problems. Customergains are a result of marketing and service programs. While the heating oil segment often loses customers when they move from their homes, it is able toretain a majority of these homes by obtaining the purchaser as a customer. Approximately 90% of the heating oil customers receive their home heating oilunder an automatic delivery system without the customer having to make an affirmative purchase decision. These deliveries are scheduled by computer,based upon each customer’s historical consumption patterns and prevailing weather conditions. The heating oil segment delivers home heating oilapproximately six times during the year to the average customer. The segment’s practice is to bill customers promptly after delivery. Approximately 32% ofits customers are on a budget payment plan, whereby their estimated annual oil purchases and service contract are paid for in a series of equal monthlypayments. On each of September 30, 2004 and September 30, 2003, approximately 48% of the heating oil customers had agreements establishing a fixed or maximumprice per gallon over a 12-month period (“price plan customers”). This percentage could increase or decrease during fiscal 2005 based upon marketconditions. The fixed or maximum price per gallon at which home heating oil is sold to these price plan customers is generally renegotiated based on currentmarket conditions at the beginning of each heating season. The heating oil segment currently enters into derivative instruments (futures, options, collars andswaps) in order to hedge a majority of the heating oil it expects to sell to price plan customers. The heating oil segment uses these fixed price derivativeinstruments to mitigate its exposure to changing commodity prices. Competition The heating oil segment competes with distributors offering a broad range of services and prices, from full-service distributors, like itself, to those offeringdelivery only. Long-standing customer relationships are typical in the industry. Like most companies in the home heating oil business, the heating oilsegment provides home heating equipment repair service on a 24-hour-a-day, seven days-a-week, 52 weeks-a-year basis. This tends to build customer loyalty.As a result of these factors, it is difficult for the heating oil segment to acquire new retail customers, other than through acquisitions. In some instanceshomeowners have formed buying cooperatives that seek to purchase fuel oil from distributors at a price lower than individual customers are otherwise able toobtain. The heating oil segment also competes for retail customers with suppliers of alternative energy products, principally natural gas, propane, andelectricity. The rate of conversion from the use of home heating oil to natural gas is primarily affected by the relative retail prices of the two products and thecost of replacing an oil fired heating system with one that uses natural gas, in addition to environmental concerns. The Partnership believes thatapproximately 1% of its home heating oil customer base annually converts from home heating oil to natural gas. 13 Table of ContentsSuppliers and Supply Arrangements Propane Segment The propane segment obtains propane from over 30 sources, including BP Canada Energy Marketing Corp., CHS, Inc., Centennial Gas Liquid, LLC., DawsonOil Company Ltd., Duke Energy NGL Services, LP, Dynegy Inc., Enterprise Products Partners, Kinetic Resources, U.S.A., Marathon Oil Company, MarkwestHydrocarbons and Transammonia Inc. Supplies from these sources have traditionally been readily available, although there is no assurance that supplies ofpropane will continue to be readily available. The majority of the propane supply is purchased under annual or longer term supply contracts that generally provide for pricing in accordance with marketprices at the time of delivery. Some of the contracts provide for minimum and maximum amounts of propane to be purchased. The product supplied for thecontracts come from refineries, gas processing plants and bulk purchases at the Mont Belvieu trading and storage complex. Most of the bulk purchases atMont Belvieu are physically moved through the TEPPCO Partners, L.P. pipeline system, to both the Seymour underground storage facility, which thePartnership owns and leases to TEPPCO Partners, L.P. in southern Indiana, and north into the Pennsylvania and New York areas to supplement purchasesmade by the segment in the Northeast region. This lease agreement provides the propane segment the ability to store at all times throughout the terms of thisagreement 21 million gallons of product storage or approximately 11% of the propane segment’s annual supply requirements, along the TEPPCO Partners,L.P. pipeline system. The Seymour facility is located on the TEPPCO Partners, L.P. pipeline system. The pipeline is connected to the Mont Belvieu, Texasstorage facilities and is one of the largest conduits of supply for the U.S. propane industry. The Partnership believes that its diversification of suppliers willenable it to purchase all of its supply needs at market prices if supplies are interrupted from any of these sources without a material disruption of itsoperations. The Partnership also believes that relations with its current suppliers are satisfactory. The propane segment purchases derivative instruments in order to mitigate its exposure to market risk and hedge the cash flow variability associated withforecasted purchases of propane held for resale to price plan customers. At September 30, 2004, the propane segment had outstanding derivative instrumentswith the following banks and brokers: JPMorgan, Morgan Stanley Dean Witter, Bank of America, Fimat and BP North America Petroleum, a division of BPProducts North America, Inc. Heating Oil Segment The heating oil segment obtains fuel oil in either barge, pipeline or truckload quantities, and has contracts with over 80 terminals for the right to temporarilystore heating oil at facilities it does not own. Purchases are made under supply contracts or on the spot market. The home heating oil segment has marketprice based contracts for a majority of its petroleum requirements with 12 different suppliers, the majority of which have significant domestic sources for theirproduct, and many of which have been suppliers to the heating oil segment for over ten years. The segment’s current suppliers are: Amerada HessCorporation, BP North America Petroleum, a division of BP Products North America, Inc., Cargill Inc. Petroleum Trading, Citgo Petroleum Corp., George E.Warren Corp., Global Companies LLC., Inland Fuels Terminals, Inc., Mieco, Inc., Morgan Stanley Capital Group, Inc., Northville Industries, Sprague Energyand Sun Oil Company. Supply contracts typically have terms of 12 months. All of the supply contracts provide for maximum and in certain cases minimumquantities. In most cases the supply contracts do not establish in advance the price of fuel oil. This price is based upon spot market prices at the time ofdelivery plus a fee ranging from $.0050 to $.0375 per gallon. The Partnership believes that its policy of contracting for substantially all of its supply needswith diverse and reliable sources will enable it to obtain sufficient product should unforeseen shortages develop in worldwide supplies. The Partnership alsobelieves that relations with its current suppliers are satisfactory. The heating oil segment purchases derivative instruments in order to mitigate its exposure to market risk and hedge the cash flow variability associated withforecasted purchases of home heating oil inventory held for resale to price plan customers. At September 30, 2004 the heating oil segment had outstandingderivative instruments with the following banks or brokers: JPMorgan, Société Genéralé, Royal Bank of Canada, Morgan Stanley Dean Witter, Refco andFimat. 14 Table of ContentsEmployees As of September 30, 2004, the propane segment had 1,217 full-time employees, of whom 62 were employed by the corporate office and 1,155 were located inbranch offices. Of these 1,155 branch employees, 448 were managerial and administrative staff; 471 were engaged in transportation and storage and 236 wereengaged in field servicing. Approximately 141 of the propane segment’s employees are represented by nine different local chapters of labor unions.Management believes that its relations with both its union and non-union employees are satisfactory. As of September 30, 2004, the home heating oil segment had 3,019 employees, of whom 703 were office, clerical and customer service personnel; 1,136 wereheating equipment repairmen; 476 were oil truck drivers and mechanics; 428 were management and 276 were employed in sales. In addition, approximately400 seasonal employees are rehired annually to support the requirements of the heating season. Included in the heating oil segment’s employees areapproximately 1,135 employees that are represented by 17 different local chapters of labor unions. Management believes that its relations with both its unionand non-union employees are satisfactory. Government Regulations The Partnership is subject to various federal, state and local environmental, health and safety laws and regulations. Generally, these laws impose limitationson the discharge of pollutants and establish standards for the handling of solid and hazardous wastes. These laws include the Resource Conservation andRecovery Act, the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), the Clean Air Act, the Occupational Safety andHealth Act, the Emergency Planning and Community Right to Know Act, the Clean Water Act and comparable state statutes. CERCLA, also known as the“Superfund” law, imposes joint and several liabilities without regard to fault or the legality of the original conduct on certain classes of persons that areconsidered to have contributed to the release or threatened release of a hazardous substance into the environment. Heating oils and certain automotive wasteproducts generated by the Partnership’s fleet are hazardous substances within the meaning of CERCLA. These laws and regulations could result in civil orcriminal penalties in cases of non-compliance or impose liability for remediation costs. The heating oil segment is currently a named “potentially responsibleparty” in one CERCLA civil enforcement action. This action is in its early stages of litigation with preliminary discovery activities taking place. ThePartnership believes that this action will have no material impact on its financial condition or results of operations. Propane is not considered a hazardoussubstance within the meaning of CERCLA. National Fire Protection Association Pamphlets No. 54 and 58, which establish rules and procedures governing the safe handling of propane, or comparableregulations, have been adopted as the industry standard in all of the states in which the Partnership operates. In some states these laws are administered bystate agencies, and in others they are administered on a municipal level. With respect to the transportation of heating oils, gasoline and propane by truck, thePartnership is subject to regulations promulgated under the Federal Motor Carrier Safety Act. These regulations cover the transportation of hazardousmaterials and are administered by the U.S. Department of Transportation. The Partnership conducts ongoing training programs to help ensure that itsoperations are in compliance with applicable regulations. The Partnership maintains various permits that are necessary to operate some of its facilities, someof which may be material to its operations. The Partnership believes that the procedures currently in effect at all of its facilities for the handling, storage anddistribution of propane are consistent with industry standards and are in compliance in all material respects with applicable laws and regulations. For acquisitions that involve the purchase or leasing of real estate, the Partnership conducts a due diligence investigation to attempt to determine whetherany hazardous or other regulated substance has been sold from or stored on, any of that real estate prior to its purchase. This due diligence includesquestioning the seller, obtaining representations and warranties concerning the seller’s compliance with environmental laws and performing site assessments.During this due diligence the Partnership’s employees, and, in certain cases, independent environmental consulting firms review historical records anddatabases and conduct physical investigations of the property to look for evidence of hazardous substances, compliance violations and the existence ofunderground storage tanks. Future developments, such as stricter environmental, health or safety laws and regulations thereunder, could affect Partnership operations. It is not anticipatedthat the Partnership’s compliance with or liabilities under environmental, health and safety laws and regulations, including CERCLA, will have a materialadverse effect on the Partnership. To the extent that there are any environmental liabilities unknown to the Partnership or environmental, health or safety lawsor regulations are made more stringent, there can be no assurance that the Partnership’s results of operations will not be materially and adversely affected. 15 Table of ContentsRisk Factors An investment in the Partnership involves a high degree of risk. Investors should carefully review the following risk factors concerning the Partnership. If thePartnership completes the sale of its propane segment, the risk factors relating to the propane segment that are discussed below would no longer be applicableto the Partnership. The Partnership’s heating oil segment has liquidity issues that raise questions concerning the Partnership’s ability to continue as a going concern. The Partnership’s heating oil segment has liquidity issues relating to the heating oil segment’s inability to comply with the borrowing conditions under itscurrent credit agreement that raises questions concerning the Partnership’s ability to continue as a going concern. The report of the Partnership’s independentregistered public accounting firm on the Partnership’s consolidated financial statements as of September 30, 2004 and 2003, and for the three years endedSeptember 30, 2004, includes an explanatory paragraph with respect to these liquidity issues. The Partnership believes that the closing of the refinancingtransactions discussed above, and the sale of the propane segment, will satisfactorily address these liquidity issues. The Partnership’s consolidated financialstatements do not include any adjustment that might result from the outcome of this uncertainty. If the Partnership is unable to close the new revolving creditfacility and either the bridge facility or the sale of the propane segment by December 17, 2004, the Partnership would be unable to find other sources offinancing before December 17, 2004 to refinance the heating oil segment’s and propane segment’s credit facilities and to repay the heating oil segment’s andpropane segment’s institutional indebtedness, which are due and payable on such date. In such event if the Partnership were not able to obtain suchalternative sources of financing and is not successful in rescheduling the maturity dates of such indebtedness, the Partnership may be forced to seek theprotection of the bankruptcy courts. The Sale of the Propane Segment May Adversely Affect the Partnership’s Future Operating Results On November 18, 2004, the Partnership signed an agreement to sell its propane distribution and services business for a purchase price of $475 million,subject to adjustment. For the fiscal year ended September 30, 2004, the propane segment accounted for $349 million of the Partnership’s sales and $29million of the Partnership’s operating income. For more information on the results of operations of the propane segment, see “Item 7 – Management’sDiscussion and Analysis of Financial Condition and Results of Operations.” If the propane segment is sold, the loss of the propane business operating incomecould adversely affect the Partnership’s future operating results. The Partnership’s substantial debt and other financial obligations could impair its financial condition and its ability to fulfill its debt obligations. After giving effect to the refinancing transactions and sale of the propane segment, and before the application of excess proceeds to purchase MLP notes, thePartnership’s total debt would have been approximately $267.6 million as of September 30, 2004 compared to $528.1 million on an actual basis. If thePartnership does not sell the propane segment, its total debt on a pro forma basis after giving effect to the refinancing transactions would have beenapproximately $569.8 million as of September 30, 2004. See “Item 7. Management’s Discussions and Analysis of Financial Conditions and Results ofOperations-Liquidity and Capital Resources.” The Partnership’s substantial indebtedness and other financial obligations could: •impair its ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions, general corporate purposes orother purposes; •result in higher interest expense in the event of increases in interest rates since some of its debt is, and will continue to be, at variable rates ofinterest; •have a material adverse effect on it if the Partnership fails to comply with financial and affirmative and restrictive covenants in its debt agreementsand an event of default occurs as a result of a failure that is not cured or waived; •require it to dedicate a substantial portion of its cash flow to payments on its indebtedness and other financial obligations, thereby reducing theavailability of its cash flow to fund working capital and capital expenditures; •limit its flexibility in planning for, or reacting to, changes in its business and the industry in which the Partnership operates; and •place it at a competitive disadvantage compared to its competitors that have proportionately less debt. If the Partnership is unable to meet its debt service obligations and other financial obligations, it could be forced to restructure or refinance its indebtednessand other financial transactions, seek additional equity capital or sell its assets. The Partnership may then be unable to obtain such financing or capital or sellits assets on satisfactory terms, if at all. 16 Table of ContentsSince weather conditions may adversely affect the demand for propane and home heating oil, the Partnership’s financial condition is vulnerable towarm winters. Weather conditions have a significant impact on the demand for both propane and home heating oil because the Partnership’s customers depend on theseproducts principally for space heating purposes. As a result, weather conditions may materially adversely impact the Partnership’s operating results andfinancial condition. During the peak heating season of October through March, sales of propane represent approximately 70% to 75% of the Partnership’sannual retail propane volume and sales of home heating oil represent approximately 75% to 80% of the Partnership’s annual home heating oil volume.Actual weather conditions can vary substantially from year to year, significantly affecting the Partnership’s financial performance. Furthermore, warmer thannormal temperatures in one or more regions in which the Partnership operates can significantly decrease the total volume the Partnership sells and the grossprofit realized on those sales and, consequently, the Partnership’s results of operations. For example, in fiscal 2000 and especially fiscal 2002, temperatureswere significantly warmer than normal for the areas in which the Partnership sells propane and home heating oil, which adversely affected the amount ofEBITDA that it generated during these periods. In fiscal year 2002, temperatures in the Partnership’s areas of operation were an average of 18.4% warmer thanin fiscal year 2001 and 18.0% warmer than normal. The Partnership has purchased weather insurance to help minimize the adverse effect of weather volatilityon its cash flows, of which there can be no assurance. Weather variations also affect demand for propane from agricultural customers, because dry weatherduring the harvest season reduces demand for propane used in crop drying. The Partnership’s operating results will be adversely affected if the heating oil segment and propane segment experience significant customer lossesthat are not offset or reduced by customer gains. The heating oil segment’s net attrition of home heating oil customers averaged approximately 4% per year over the three years through 2004. This raterepresents the net of its annual customer loss rate. For fiscal 2004, the heating oil segment’s net customer attrition, after adjusting for customer acquisitions,was approximately 6.6%. Customer losses are the result of various factors, including: •customer relocations; •supplier changes based primarily on price and service; •natural gas conversions; and •credit problems. The continuing unprecedented rise in the price of heating oil has intensified price competition which has adversely impacted the heating oil segment’smargins and added to the heating oil segment’s difficulties in reducing customer attrition. The heating oil segment believes its attrition rate has risen notonly because of increased price competition related to the rise in oil prices but also because of operational problems. Prior to the 2004 winter heating season,the heating oil segment attempted to develop a competitive advantage in customer service, and as part of that effort, centralized its heating equipment servicedispatch and engaged a centralized call center to fulfill its telephone requirements. The implementation of this initiative is taking longer and incurringgreater difficulties than the heating oil segment had anticipated, which adversely impacted the customer base. While the Partnership believes that the heating oil segment has made progress in correcting the early inefficiencies associated with its customer service, andthat it has improved its responsiveness to customer needs, the Partnership expects that attrition will, at least to some extent, continue into the 2004-2005winter heating season and perhaps beyond. The Partnership notes that even to the extent that attrition can be halted, the current reduced customer base willadversely impact net income for fiscal 2005 and perhaps beyond. For fiscal 2004, the propane segment’s net customer attrition, after adjusting for customer acquisition, was approximately 2.7%. The heating oil segment and propane segment may not be able to achieve net gains of customers and may continue to experience customer attrition in thefuture. 17 Table of ContentsSudden and sharp oil and propane price increases that cannot be passed on to customers may adversely affect the Partnership’s operating results. The retail propane and home heating oil industries are “margin-based” businesses in which gross profits depend on the excess of retail sales prices oversupply costs. Consequently, the Partnership’s profitability is sensitive to changes in wholesale prices of propane and heating oil caused by changes in supplyor other market conditions. Many of these factors are beyond the Partnership’s control and thus, when there are sudden and sharp increases in the wholesalecosts of propane and heating oil, the Partnership may not be able to pass on these increases to its customers through retail sales prices. As of September 30,2004, the wholesale cost of home heating oil, as measured by the closing price of the New York Mercantile Exchange had increased by 38% to $1.39 pergallon from $1.01 per gallon as of June 30, 2004. This represents a 78% increase over the heating oil price per gallon of $0.78 per gallon on September 30,2003. Per gallon heating oil prices subsequently increased to a high of $1.59 per gallon on October 22, 2004, before retreating to $1.23 per gallon as ofDecember 10, 2004. When heating oil prices increased, in the fourth quarter of fiscal 2004 the heating oil segment’s retail sales prices did not increase asrapidly as the increase in heating oil prices, which resulted in lower per gallon margins. In addition, the timing of cost pass-throughs can significantly affectmargins. Wholesale price increases could reduce the Partnership’s gross profits and could, if continuing over an extended period of time, reduce demand byencouraging conservation or conversion to alternative energy sources. A significant portion of the Partnership’s home heating oil and propane volume is sold to price-protected heating oil only customers and its operatingresults could be adversely affected by changes in the cost of supply that the Partnership cannot pass on to these customers or otherwise protect against. A significant portion of its home heating oil volume is sold to individual customers under an agreement pre-establishing the maximum sales price or a fixedprice of home heating oil over a 12-month period. The maximum price at which home heating oil is sold to these price-protected customers is generallyrenegotiated prior to the heating season of each year based on current market conditions. The Partnership currently enters into forward purchase contracts,futures contracts and option contracts for a substantial majority of the heating oil the Partnership sells to these price-protected customers in advance and at afixed cost. Should events occur after a price protected sales price is established that increase the cost of home heating oil above the amount anticipated,margins for the price-protected customers whose heating oil was not purchased in advance would be lower than expected, while those customers whoseheating oil was purchased in advance would be unaffected. Conversely, should events occur during this period that decrease the cost of heating oil below theamount anticipated, margins for the price-protected customers whose heating oil was purchased in advance could be lower than expected, while margins forthose customers whose heating oil was not purchased in advance would be unaffected or higher than expected. For the fiscal year ended September 30, 2004,approximately 43% of its retail home heating oil volume sales and approximately 18% of its retail propane volume sales were under a price-protected plan. If the Partnership does not make acquisitions on economically acceptable terms, its future financial performance will be limited. Neither the propane nor the home heating oil industry is a growth industry because of increased competition from alternative energy sources. A significantportion of the Partnership’s growth in the past decade has been directly tied to its acquisition programs. Accordingly, its future financial performance will beimpacted by its ability to continue to make acquisitions at attractive prices. The Partnership cannot be assured that it will be able to identify attractiveacquisition candidates in the future or that the Partnership will be able to acquire businesses on economically acceptable terms if at all. In particular thefinancial resources available to the Partnership are likely to be limited. Factors that may adversely affect the Partnership’s propane and home heating oilsegments’ operating and financial results, such as warm weather patterns, may further limit its access to capital and adversely affect its ability to makeacquisitions. Any acquisition may involve risks, including: •an increase in its indebtedness; •the inability to integrate the operations of the acquired business; •the inability to successfully expand its operations into new territories; •the diversion of management’s attention from other business concerns; and •an excess of customer loss or loss of key employees from the acquired business. In addition, acquisitions may be dilutive to earnings and distributions to the unitholders and any additional debt incurred to finance acquisitions may affectthe Partnership’s ability to make distributions to the unitholders. 18 Table of ContentsBecause of the highly competitive nature of the retail propane and home heating oil segments, the Partnership may not be able to retain existingcustomers or acquire new customers, which would have an adverse impact on its operating results and financial condition. If both the propane and home heating oil segments are unable to compete effectively, the Partnership may lose existing customers or fail to acquire newcustomers, which would have a material adverse effect on its results of operations and financial condition. Many of the propane competitors and potential competitors are larger or have substantially greater financial resources than the Partnership does, which mayprovide them with some advantages. Generally, competition in the past few years has intensified, partly as a result of warmer-than-normal weather. Most ofthe propane segment’s retail branch locations compete with five or more marketers or distributors. The principal factors influencing competition with otherretail marketers are: •price; •reliability and quality of service; •responsiveness to customer needs; •safety concerns; •long-standing customer relationships; •the inconvenience of switching tanks and suppliers; and •the lack of growth in the industry. The Partnership’s home heating oil business competes with heating oil distributors offering a broad range of services and prices, from full service distributors,like the heating oil segment, to those offering delivery only. Competition with other companies in the home heating oil industry is based primarily oncustomer service and price with some of the heating oil segment’s competitors historically offering lower prices than this segment. Long-standing customerrelationships are typical in the industry. It is customary for companies to deliver home heating oil to their customers based upon weather conditions andhistorical consumption patterns, without the customer making an affirmative purchase decision. Most companies provide home heating equipment repairservice on a 24-hour-per-day basis. In some cases, homeowners have formed buying cooperatives to purchase fuel oil from distributors at a price lower thanindividual customers are otherwise able to obtain. As a result of these factors, it may be difficult for the heating oil segment to acquire new customers. The increase in price competition resulting from the continuing unprecedented rise in the price of heating oil has adversely impacted the heating oilsegment’s ability to retain customers and attract new customers. The heating oil segment believes its attrition rate had risen not only because of the rise in oilprices but also because of operational problems. Prior to the 2004 winter heating season, the heating oil segment attempted to develop a competitiveadvantage in customer service, and as part of that effort, centralized its heating equipment service dispatch and engaged a centralized call center to fulfill itstelephone requirements. The implementation of this initiative is taking longer and incurring greater difficulties than the heating oil segment had anticipated,which adversely impacted the customer base. While the Partnership believes that the heating oil segment has made progress in correcting the earlyinefficiencies associated with its customer service, and that it has significantly improved its responsiveness to customer needs, the Partnership expects thatattrition will continue into the 2004-2005 winter heating season and perhaps beyond. The Partnership can make no assurances that it will be able to compete successfully on the basis of these factors. If a competitor attempts to increase marketshare by reducing prices, the Partnership’s operating results and financial condition could be materially and adversely affected. The home heating oilsegment also competes for customers with suppliers of alternative energy products, principally natural gas. In addition, competition from alternative energysources has been increasing as a result of reduced regulation of many utilities, including natural gas and electricity. The Partnership could face additionalprice competition from alternative heating sources such as electricity and natural gas as a result of deregulation in those industries. Over the past five years,conversions by the heating oil segment’s customers from heating oil to other sources have averaged approximately 1% per year of the homes it serves. 19 Table of ContentsEnergy efficiency and new technology may reduce the demand for our products and adversely affect our operating results. Increased conservation and technological advances, including installation of improved insulation and the development of more efficient furnaces and otherheating devices, have adversely affected the demand for the Partnership’s products by retail customers. Future conservation measures or technologicaladvances in heating, conservation, energy generation or other devices might reduce demand and adversely affect our operating results. The Partnership is subject to operating and litigation risks that could adversely affect its operating results to the extent not covered by insurance. The Partnership’s operations are subject to all operating hazards and risks normally incidental to handling, storing, transporting and otherwise providingcustomers with combustible or flammable liquids such as propane and home heating oil. As a result, the Partnership may be a defendant in various legalproceedings and litigation arising in the ordinary course of business. The Partnership maintains insurance policies with insurers in amounts and withcoverages and deductibles as it believes are reasonable. However, there can be no assurance that this insurance will be adequate to protect the Partnershipfrom all material expenses related to potential future claims for remediation costs and personal and property damage or that these levels of insurance will beavailable in the future at economical prices. In addition, the occurrence of an explosion, whether or not the Partnership is involved, may have an adverseeffect on the public’s desire to use its products. The Partnership is the subject of a number of class action lawsuits alleging violation of the federal securities laws, which if decided adversely to it couldhave a material adverse effect on the Partnership’s financial condition. On or about October 21, 2004, a purported class action lawsuit on behalf of a purported class of unitholders was filed against the Partnership and varioussubsidiaries and officers and directors in the United States District Court of the District of Connecticut (Carter v. Star Gas Partners, L.P., et al, No 3:04-cv-01766-IBA, et. al, subsequently, 14 additional class action complaints, alleging the same or substantially similar claims, were filed in the same district court:(1) Feit v. Star Gas, et al, Civil Action No. 04-1832 (filed on 10/29/2004), (2) Lila Gold v. Star Gas, et al, Civil Action No. 04-1791 (filed on 10/22/2004), (3)Jagerman v. Star Gas, et al, Civil Action No. 04-1855 (filed on 11/3/2004), (4) McCole, et al v. Star Gas, et al, Civil Action No. 04-1859 (filed on 11/3/2004),(5) Prokop v. Star Gas, et al, Civil Action No. 04-1785 (filed on 10/22/2004), (6) Seigle v. Star Gas, et al, Civil Action No. 04-1803 (filed on 10/25/3004), (7)Strunk v. Star Gas, et al, Civil Action No. 04-1815 (filed on 10/27/2004), (8) Harriette S. & Charles L. Tabas Foundation v. Star Gas, et al, Civil Action No.04-1857 (filed on 11/3/2004), (9) Weiss v. Star Gas, et al, Civil Action No. 04-1807 (filed on 10/26/2004), (10) White v. Star Gas, et al, Civil Action No. 04-1837 (filed on 10/9/2004), (11) Wood v. Star Gas, et al, Civil Action No. 04-1856 (filed on 11/3/2004) (12) Yopp v. Star Gas, et al, Civil Action No. 04-1865(filed on 11/3/2004), (13) Kiser v. Star Gas, et al, Civil Action No. 04-1884 (filed on 11/9/2004), and (14) Lederman v. Star Gas, et al, Civil Action No. 04-1873 (filed on 11/5/2004) (including the Carter Complaint, collectively referred to herein as the “Class Action Complaints”). The Class Action plaintiffs generally allege that the Partnership violated Section 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, andSecurities and Exchange Commission Rule 10b-5 promulgated thereunder, by purportedly failing to disclose, among other things: (1) problems with therestructuring of Star Gas’s dispatch system and customer attrition related thereto; (2) that Star Gas’s heating oil division’s business process improvementprogram was not generating the benefits allegedly claimed; (3) that Star Gas was struggling to maintain its profit margins in its heating oil division; (4) thatStar Gas’s second quarter 2004 profit margins were not representative of its ability to pass on heating oil price increases; and (5) that Star Gas was facing aninability to pay its debts and that, as a result, its credit rating and ability to obtain future financing was in jeopardy. The Class Action plaintiffs seek anunspecified amount of compensatory damages including interest against the defendants jointly and severally and an award of reasonable costs and expenses.The Partnership will defend against the Class Actions vigorously. However, the Partnership is unable to predict the outcome of these lawsuits at this time. In the event that one or more of the above actions were decided adversely to the Partnership, it could have a material effect on the Partnership’s results ofoperations, financial condition or liquidity. 20 Table of ContentsThe Partnership’s results of operations and financial condition may be adversely affected by governmental regulation and associated environmentaland regulatory costs. The home heating oil business is subject to a wide range of federal and state laws and regulations related to environmental and other regulated matters. Theheating oil segment has implemented environmental programs and policies designed to avoid potential liability and costs under applicable environmentallaws. It is possible, however, that the heating oil segment will have increased costs due to stricter pollution control requirements or liabilities resulting fromnoncompliance with operating or other regulatory permits. New environmental regulations might adversely impact the heating oil segment’s operations,including underground storage and transportation of home heating oil. In addition, the environmental risks inherently associated with the home heating oiloperations, such as the risks of accidental release or spill, are greater than those associated with the Partnership’s propane operations. It is possible thatmaterial costs and liabilities will be incurred, including those relating to claims for damages to property and persons. In the Partnership’s acquisition of Meenan, the Partnership assumed all of Meenan’s environmental liabilities. In the Partnership’s acquisition of Meenan Oil Company, or “Meenan,” in August 2001, the Partnership assumed all of Meenan’s environmental liabilities,including those related to the cleanup of contaminated properties, in consideration of a reduction of the purchase price of $2.7 million. Subsequent toclosing, the Partnership established an additional reserve of $2.3 million to cover potential costs associated with remediating known environmentalliabilities, bringing the total reserve to $5.0 million. To date, remediation expenses against this reserve have totaled $2.8 million. While the Partnershipbelieves this reserve will be adequate, it is possible that the extent of the contamination at issue or the expense of addressing it could exceed the Partnership’sestimates and thus the costs of remediating these known liabilities could materially exceed the amounts reserved. Conflicts of interest have arisen and could arise in the future as a result of relationships between the general partner and its affiliates, on the one hand, andStar Gas Propane or the Partnership and its limited partners, on the other hand. As a result of these conflicts the general partner may favor its own interests andthose of its affiliates over the interests of the unitholders. The nature of these conflicts is ongoing and includes the following considerations: •Except for Irik P. Sevin, who is subject to a non-competition agreement, the general partner’s affiliates are not prohibited from engaging in otherbusiness or activities, including direct competition with the Partnership. •The general partner determines the amount and timing of asset purchases and sales, capital expenditures, borrowings and reserves, each of whichcan impact the amount of cash that is distributed to unitholders of the Partnership and available to pay the notes. •The general partner controls the enforcement of obligations owed to the Partnership by the general partner. •The general partner decides whether to retain separate counsel, accountants or others to perform services for the Partnership. •In some instances the general partner may borrow funds in order to permit the payment of distributions to the unitholders of the Partnership. The risk of terrorism and political unrest in the Middle East may adversely affect the economy and the price and availability of home heating oil andpropane. Terrorist attacks, such as the attacks that occurred in New York, Pennsylvania and Washington, D.C. on September 11, 2001, and political unrest in theMiddle East may adversely impact the price and availability of home heating oil and propane, the Partnership’s results of operations, its ability to raisecapital and its future growth. The impact that the foregoing may have on the Partnership’s industry in general, and on the Partnership in particular, is notknown at this time. An act of terror could result in disruptions of crude oil or natural gas supplies and markets, the sources of home heating oil and propane,and its facilities could be direct or indirect targets. Terrorist activity may also hinder the Partnership’s ability to transport propane if its means oftransportation become damaged as a result of an attack. Instability in the financial markets as a result of terrorism could also affect the Partnership’s ability toraise capital. Terrorist activity could likely lead to increased volatility in prices for home heating oil and propane. Insurance carriers are routinely excludingcoverage for terrorist activities from their normal policies, but are required to offer such coverage as a result of new federal legislation. The Partnership hasopted to purchase this coverage with respect to its property and casualty insurance programs. This additional coverage has resulted in additional insurancepremiums. 21 Table of ContentsCash Distributions are Not Guaranteed and May Fluctuate with the Partnership’s Performance and Reserve Requirements Because Distributions on the common and subordinated units and partnership securities are dependent on the amount of cash generated, distributions mayfluctuate based on the Partnership’s performance. The actual amount of cash that is available will depend upon numerous factors, including: •profitability of operations; •required principal and interest payments on debt; •cost of acquisitions; •issuance of debt and equity securities; •fluctuations in working capital; •capital expenditures; •adjustments in reserves; •prevailing economic conditions; and •financial, business and other factors. Some of these factors are beyond the control of the general partner. The partnership agreement gives the general partner discretion in establishing reserves for the proper conduct of the Partnership’s business. These reserveswill also affect the amount of cash available for distribution. The general partner may establish reserves for distributions on the senior subordinated unitsonly if those reserves will not prevent the Partnership from distributing the full minimum quarterly distribution, plus any arrearages, on the common units forthe following four quarters. On October 18, 2004, the Partnership announced that it would not pay a distribution on the common units as a result of the requirements of its bank lenders.The Partnership had previously announced the suspension of distributions on the senior subordinated units on July 29, 2004. 22 Table of Contents ITEM 2.PROPERTIES Propane Segment As of September 30, 2004, the propane segment owned 98 of its 122 branch locations and 98 of its 135 satellite storage facilities and leased the balance. Inaddition, the propane segment owns a facility in Seymour, Indiana, in which it stores propane for itself and third parties. The propane segment leases itscorporate headquarters in Stamford, Connecticut and Florence, Kentucky. The transportation of propane requires specialized trucks which carry specialized steel tanks that maintain the propane in a liquified state. As of September30, 2004, Star Gas Propane had a fleet of 10 tractors, 29 transport trailers, 746 bobtail, boom and rack trucks and 585 other service and pick-up trucks, themajority of which are owned. As of September 30, 2004, the propane segment owned or leased 409 bulk storage tanks with typical capacities of 12,000 to 30,000 gallons the majority ofwhich are owned; approximately 359,000 stationary customer storage tanks with typical capacities of 24 to 1,000 gallons; and 65,000 portable propanecylinders with typical capacities of 5 to 24 gallons. The propane segment’s obligations under its borrowings are secured by liens and mortgages on all of itsreal and personal property. Heating Oil Segment The heating oil segment provides services to its customers from 19 locations and 36 satellites, which include 33 depots and 36 satellites, 30 of which areowned and 39 of which are leased, in 32 marketing areas in the Northeast and Mid-Atlantic Regions of the United States. As of September 30, 2004, theheating oil segment had a fleet of 1,117 truck and transport vehicles the majority of which are owned and 1,334 services vans the majority of which areleased. The heating oil segment leases its corporate headquarters in Stamford, Connecticut. The heating oil segment’s obligations under its borrowings aresecured by liens and mortgages on substantially all of its real and personal property. 23 Table of Contents ITEM 3.LEGAL PROCEEDINGS – LITIGATION Litigation On or about October 21, 2004, a purported class action lawsuit on behalf of a purported class of unitholders was filed against the Partnership and varioussubsidiaries and officers and directors in the United States District Court of the District of Connecticut (Carter v. Star Gas Partners, L.P., et al, No 3:04-cv-01766-IBA, et. al. Subsequently, 14 additional class action complaints, alleging the same or substantially similar claims, were filed in the same district court:(1) Feit v. Star Gas, et al, Civil Action No. 04-1832 (filed on 10/29/2004), (2) Lila Gold v. Star Gas, et al, Civil Action No. 04-1791 (filed on 10/22/2004), (3)Jagerman v. Star Gas, et al, Civil Action No. 04-1855 (filed on 11/3/2004), (4) McCole, et al v. Star Gas, et al, Civil Action No. 04-1859 (filed on 11/3/2004),(5) Prokop v. Star Gas, et al, Civil Action No. 04-1785 (filed on 10/22/2004), (6) Seigle v. Star Gas, et al, Civil Action No. 04-1803 (filed on 10/25/3004), (7)Strunk v. Star Gas, et al, Civil Action No. 04-1815 (filed on 10/27/2004), (8) Harriette S. & Charles L. Tabas Foundation v. Star Gas, et al, Civil Action No.04-1857 (filed on 11/3/2004), (9) Weiss v. Star Gas, et al, Civil Action No. 04-1807 (filed on 10/26/2004), (10) White v. Star Gas, et al, Civil Action No. 04-1837 (filed on 10/9/2004), (11) Wood v. Star Gas, et al, Civil Action No. 04-1856 (filed on 11/3/2004) (12) Yopp v. Star Gas, et al, Civil Action No. 04-1865(filed on 11/3/2004), (13) Kiser v. Star Gas, et al, Civil Action No. 04-1884 (filed on 11/9/2004), and (14) Lederman v. Star Gas, et al, Civil Action No. 04-1873 (filed on 11/5/2004) (including the Carter Complaint, collectively referred to herein as the “Class Action Complaints”). The Class Action plaintiffs generally allege that the Partnership violated Section 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, andSecurities and Exchange Commission Rule 10b-5 promulgated thereunder, by purportedly failing to disclose, among other things: (1) problems with therestructuring of Star Gas’s dispatch system and customer attrition related thereto; (2) that Star Gas’s heating oil division’s business process improvementprogram was not generating the benefits allegedly claimed; (3) that Star Gas was struggling to maintain its profit margins in its heating oil division; (4) thatStar Gas’s second quarter 2004 profit margins were not representative of its ability to pass on heating oil price increases; and (5) that Star Gas was facing aninability to pay its debts and that, as a result, its credit rating and ability to obtain future financing was in jeopardy. The Class Action plaintiffs seek anunspecified amount of compensatory damages including interest against the defendants jointly and severally and an award of reasonable costs and expenses.The Partnership will defend against the Class Actions vigorously. However, the Partnership is unable to predict the outcome of these lawsuits at this time. In the event that one or more of the Class Actions were decided adversely to the Partnership, it could have a material effect on the Partnership’s results ofoperations, financial position or liquidity. On or about November 15, 2004, certain plaintiffs in their capacity as unitholders of the Partnership commenced a derivative lawsuit in United States DistrictCourt in Connecticut (Arnold V. Sevin et al., No. 3-04-cv-01884-AWT) (the “Federal Derivative Complaint”). The litigation asserts derivative claims onbehalf of the Partnership against officers and directors of the Partnership. The Partnership is named as a nominal defendant. The unitholder plaintiffs allegeinjuries and damages purportedly resulting from violations of state law, including breaches of fiduciary duty, abuse of control, gross mismanagement, wasteof corporate assets, unjust enrichment and insider trading that allegedly occurred between July 25, 2000 and November 15, 2004. The Federal DerivativeComplaint specifically alleges that the individual officer and director defendants in connection with their management of the Partnership purportedly madevarious false or misleading statements that artificially inflated the value of the Partnership’s units and allegedly profited thereby by selling the Partnership’sunits at inflated prices. The Federal Derivative Complaint seeks unspecified compensatory damages from the individual defendants, equitable and/orinjunctive relief and restitution from the defendants to the Company, together with reasonable costs and expenses incurred in the action, including counselfees and accountant and expert fees. On or about November 24, 2004, another shareholder derivative action was filed in Connecticut State Court by Marie J. Beers (“Beers”), derivatively onbehalf of Star Gas Partners, L.P., against Star Gas, LLC, Ami Trauber and Irik P. Sevin, entitled Beers v. Star Gas, LLC, et al. (the “State Court DerivativeAction”). The Partnership is named as a nominal defendant. The State Court Derivative Action alleges breaches of fiduciary duty, gross negligence, waste ofcorporate assets and for disgorgement of the proceeds of insider trading. The allegations in the State Court Derivative Action closely parallel those in theClass Action Complaints. The complaint in the State Court Derivative Action seeks a determination that the action is a proper derivative action andcertifying Beers as an appropriate representative of the Company for purposes of the action, along with a declaration that each of the defendants breached itsfiduciary duty to the Company. In addition, the complaint in the State Court Derivative Action seeks unspecified compensatory damages from thedefendants, jointly and severally. The Partnership’s operations are subject to all operating hazards and risks normally incidental to handling, storing and transporting and otherwise providingfor use by consumers of combustible liquids such as propane and home heating oil. 24 Table of ContentsAs a result, at any given time the Partnership is a defendant in various legal proceedings and litigation arising in the ordinary course of business. ThePartnership maintains insurance policies with insurers in amounts and with coverages and deductibles as the general partner believes are reasonable andprudent. However, the Partnership cannot assure that this insurance will be adequate to protect it from all material expenses related to potential future claimsfor personal and property damage or that these levels of insurance will be available in the future at economical prices. In addition, the occurrence of anexplosion may have an adverse effect on the public’s desire to use the Partnership’s products. In the opinion of management, except as described above thePartnership is not a party to any litigation, which individually or in the aggregate could reasonably be expected to have a material adverse effect on thePartnership’s results of operations, financial position or liquidity. ITEM 4.SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 25 Table of Contents PART IIITEM 5.MARKET FOR REGISTRANT’S UNITS AND RELATED MATTERS The common units, representing common limited partner interests in the Partnership, are listed and traded on the New York Stock Exchange, Inc. (“NYSE”)under the symbol “SGU”. The common units began trading on the NYSE on May 29, 1998. Previously, the common units had traded on the NASDAQNational Market under the symbol “SGASZ.” The Partnership’s senior subordinated units began trading on the NYSE on March 29, 1999 under the symbol “SGH.” The senior subordinated Units becameeligible to receive distributions in February 2000, and the first distribution was made in August 2000. The following tables set forth the high and low closingprice ranges for the common and senior subordinated units and the cash distribution declared on each unit for the fiscal 2003 and 2004 quarters indicated. SGU - Common Unit Price Range DistributionsDeclared Per Unit High Low Quarter Ended FiscalYear2003 FiscalYear2004 FiscalYear2003 FiscalYear2004 FiscalYear2003 FiscalYear2004December 31, $18.81 $24.93 $16.65 $21.79 $0.575 $0.575March 31, $20.75 $25.59 $18.75 $22.85 $0.575 $0.575June 30, $22.79 $25.53 $19.00 $20.00 $0.575 $0.575September 30, $22.97 $24.25 $20.91 $20.54 $0.575 $0.575 SGH - Senior Subordinated Unit Price Range DistributionsDeclared Per Unit High Low Quarter Ended FiscalYear2003 FiscalYear2004 FiscalYear2003 FiscalYear2004 FiscalYear2003 FiscalYear2004December 31, $13.94 $21.60 $9.90 $20.01 $0.250 $0.575March 31, $15.35 $23.80 $12.35 $20.45 $0.250 $0.575June 30, $19.50 $23.90 $13.67 $18.75 $0.575 $0.575September 30, $20.90 $22.65 $18.55 $12.62 $0.575 $— As of September 30, 2004, there were approximately 939 holders of record of common units, and approximately 124 holders of record of senior subordinatedunits. On October 18, 2004, the Partnership announced that it would not pay a distribution on the common units as a result of the requirements of its lenders. ThePartnership had previously announced the suspension of distributions on the senior subordinated units on July 29, 2004 and it is unlikely that regulardistributions on the senior subordinated units will be resumed in the foreseeable future. For more information on the relative rights and preferences of thesenior subordinated units, see the Partnership’s partnership agreement, which is incorporated by reference in this Annual Report as described in Item 15. OnDecember 1, 2004, the closing price of SGU-common unit was $5.91 per unit and the closing price of SGH-senior subordinated unit was $4.30 per unit. There is no established public trading market for the Partnership’s 345,364 Junior Subordinated Units and 325,729 general partner units. In general, the Partnership had distributed to its partners, on a quarterly basis, all of its Available Cash in the manner described below. Available Cash isdefined for any of the Partnership’s fiscal quarters, as all cash on hand at the end of that quarter, less the amount of cash reserves that are necessary orappropriate in the reasonable discretion of the general partner to (i) provide for the proper conduct of the business; (ii) comply with applicable law, any of itsdebt instruments or other agreements; or (iii) provide funds for distributions to the common unitholders and the senior subordinated unitholders during thenext four quarters. The general partner may not establish cash reserves for distributions to the senior subordinated units unless the general partner has determined that theestablishment of reserves will not prevent it from distributing the minimum quarterly distribution on any common unit arrearages and for the next fourquarters. The full definition of Available Cash is set forth in the Agreement of Limited Partnership of the Partnership. Information concerning restrictions ondistributions required in this section is incorporated herein by reference to footnote 5 to the Partnership’s Consolidated Financial Statements, which begin onpage F-1 of this Form 10-K. 26 Table of ContentsThe revolving credit facility and, as applicable, the bridge facility or the senior secured notes, will impose certain restrictions on the Partnership’s ability topay distributions to unitholders. The Partnership believes that the sale of the propane segment would, by de-leveraging the Partnership’s balance sheet, likelyadvance the time when it would be possible for the Partnership to resume regular distributions on the common units. The Partnership believes that whether ornot the propane segment is sold, it is unlikely that the Partnership will resume distributions on the senior subordinated units, junior subordinated units andgeneral partner units for the foreseeable future. 27 Table of Contents ITEM 6.SELECTED HISTORICAL FINANCIAL AND OPERATING DATA The following table sets forth selected historical and other data of the Partnership and should be read in conjunction with the more detailed financialstatements included elsewhere in this report. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. OnNovember 17, 2004, the Partnership signed an agreement to sell its propane distribution and services segment to Inergy for $475 million in cash, withoutassumption of the propane segment’s indebtedness. The purchase price is subject to certain post-closing adjustments, including a working capital adjustment.The transaction is expected to close on December 17, 2004. Upon completion of the sale of the propane segment, the Partnership will restate prior years’ results to include the results of the propane segment and the gainon the disposition as a component of discontinued operations. The Partnership anticipates recognizing a gain in excess of approximately $150 million fromthe sale of the propane segment. 28 Table of Contents ITEM 6.SELECTED HISTORICAL FINANCIAL AND OPERATING DATA (Continued) The Selected Financial Data is derived from the financial information of the Partnership and should be read in conjunction therewith. Fiscal Year Ended September 30, (in thousands, except per unit data) 2000(c) 2001(c) 2002(c) 2003 2004 Statement of Operations Data: Sales $721,061 $994,299 $985,895 $1,382,268 $1,453,937 Costs and expenses: Cost of sales 479,563 687,967 629,360 938,558 996,053 Delivery and branch expenses 156,862 200,059 235,708 293,523 325,686 General and administrative expenses 18,470 26,366 26,271 50,331 30,029 Depreciation and amortization expenses 34,292 42,462 57,227 52,493 57,343 Operating income 31,874 37,445 37,329 47,363 44,826 Interest expense, net 26,478 32,579 37,070 40,567 45,903 Amortization of debt issuance costs 534 737 1,447 2,232 3,646 Loss on redemption of debt — — — 181 — Income (loss) from continuing operations before income taxes 4,862 4,129 (1,188) 4,383 (4,723)Income tax expense (benefit) 490 1,497 (1,456) 1,500 1,525 Income (loss) from continuing operations 4,372 2,632 268 2,883 (6,248)Income (loss) from discontinued operations before cumulativeeffects of changes in accounting principles (3,019) (9,347) (11,437) 1,230 923 Loss on sale of TG&E segment, net of income taxes — — — — (538)Cumulative effects of changes in accounting principles fordiscontinued operations: Adoption of SFAS No. 133 — (398) — — — Adoption of SFAS No. 142 — — — (3,901) — Income (loss) before cumulative effects of changes in accounting principle forcontinuing operations 1,353 (7,113) (11,169) 212 (5,863)Cumulative effects of changes in accounting principle for adoptionof SFAS No. 133 — 1,864 — — — Net income (loss) $1,353 $(5,249) $(11,169) $212 $(5,863) Weighted average number of limited partner units: Basic 18,288 22,439 28,790 32,659 35,205 Diluted 18,288 22,552 28,821 32,767 35,205 Per Unit Data: Basic and diluted income (loss) from continuing operations per unit (a) $0.24 $0.12 $0.01 $0.09 $(0.18)Basic and diluted net income (loss) per unit (a) $0.07 $(0.23) $(0.38) $0.01 $(0.16)Cash distribution declared per common unit $2.30 $2.30 $2.30 $2.30 $2.30 Cash distribution declared per senior sub. unit $0.25 $1.98 $1.65 $1.65 $1.73 Balance Sheet Data (end of period): Current assets $126,990 $185,262 $222,201 $211,109 $234,171 Total assets $618,976 $898,819 $943,766 $975,610 $960,976 Long-term debt $308,551 $456,523 $396,733 $499,341 $503,668 Partners’ Capital $139,178 $198,264 $232,264 $189,776 $169,771 Summary Cash Flow Data: Net Cash provided by operating activities $30,606 $63,696 $64,033 $50,595 $65,840 Net Cash used in investing activities $(65,893) $(255,816) $(61,462) $(101,089) $(12,149)Net Cash provided by (used in) financing activities $43,950 $199,521 $44,781 $(3,539) $(49,167)Other Data: Earnings (loss) from continuing operations before interest, taxes,depreciation and amortization (EBITDA) (b) $66,166 $81,771 $94,556 $99,675 $102,169 Propane segment’s retail gallons sold 107,557 137,031 141,974 175,054 203,088 Heating oil segment’s retail gallons sold 345,684 427,168 457,749 567,024 551,612 (a)Income (loss) from continuing operations per unit is computed by dividing the limited partners’ interest in income (loss) from continuing operations bythe weighted average number of limited partner units outstanding. Net income (loss) per unit is computed by dividing the limited partners’ interest innet income (loss) by the weighted average number of limited partner units outstanding. 29 Table of Contents ITEM 6.SELECTED HISTORICAL FINANCIAL AND OPERATING DATA (Continued) (b)EBITDA from continuing operations should not be considered as an alternative to net income (as an indicator of operating performance) or as analternative to cash flow (as a measure of liquidity or ability to service debt obligations), but provides additional information for evaluating thePartnership’s ability to make the Minimum Quarterly Distribution. The revolving credit facility and, as applicable, the bridge facility or the seniorsecured notes, will impose certain restrictions on the Partnership’s ability to pay distributions to unitholders. The Partnership believes that the sale ofthe propane segment would, by de-leveraging the Partnership’s balance sheet, likely advance the time when it would be possible for the Partnership toresume regular distributions on the common units. The Partnership believes that whether or not the propane segment is sold, it is unlikely that thePartnership will resume distributions on the senior subordinated units, junior subordinated units and general partner units for the foreseeable future. The definition of “EBITDA” set forth above may be different from that used by other companies. EBITDA from continuing operations is calculated forthe fiscal years ended September 30 as follows: 2000 2001 2002 2003 2004 Income (loss) from continuing operations $4,372 $2,632 $268 $2,883 $(6,248)Cumulative effects of changes in accounting principle for adoption of SFAS No. 133 forcontinuing operations — 1,864 — — — Plus: Income tax expense (benefit) 490 1,497 (1,456) 1,500 1,525 Amortization of debt issuance cost 534 737 1,447 2,232 3,646 Interest expense, net 26,478 32,579 37,070 40,567 45,903 Depreciation and amortization 34,292 42,462 57,227 52,493 57,343 EBITDA from continuing operations $66,166 $81,771 $94,556 $99,675 $102,169 (c)The Partnership’s results for fiscal years ended September 30, 2000, 2001 and 2002 do not reflect the impact of the provisions of SFAS No. 142. 30 Table of Contents ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Statement Regarding Forward-Looking Disclosure This Report includes “forward-looking statements” which represent the Partnership’s expectations or beliefs concerning future events that involve risks anduncertainties, including those associated with the effect of weather conditions on the Partnership’s financial performance, the price and supply of homeheating oil and propane, the Partnership’s ability to obtain satisfactory gross profit margins, the ability of the Partnership to obtain new accounts and retainexisting accounts, the realization of savings from the business process redesign project at the heating oil segment, the ability of the Partnership to correctoperational problems with such project and the closings of a new revolving credit facility and bridge facility in connection with the refinancing transactionsand the sale of the propane segment. All statements other than statements of historical facts included in this Report including, without limitation, thestatements under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business” and elsewhere herein, areforward-looking statements. Although the Partnership believes that the expectations reflected in such forward-looking statements are reasonable, it can giveno assurance that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from thePartnership’s expectations (“Cautionary Statements”) are disclosed in this Report, including without limitation and in conjunction with the forward-lookingstatements included in this Report. All subsequent written and oral forward-looking statements attributable to the Partnership or persons acting on its behalfare expressly qualified in their entirety by the Cautionary Statements. Recent Events On October 18, 2004, the Partnership announced that it had advised the heating oil segment’s bank lenders that this segment would not be able to make therequired representations included in the borrowing certificate under its working capital line. In addition, the Partnership notified such lenders that, for thequarter ending December 31, 2004 and for the foreseeable future thereafter, the heating oil segment will be unlikely to satisfy the drawing condition thatrequires that the consolidated funded debt of the Partnership not exceed 5.00 times its consolidated operating cash flow. Further, the Partnership advised thelenders that the heating oil segment may not be able to maintain a zero balance under the working capital facility (except for letter of credit obligations) for45 consecutive days from April 1, 2005 to September 30, 2005, as required by the heating oil segment’s covenants. The Partnership indicated that the sourceof the problem is a combination of (a) the inability to pass on the full impact of record heating oil prices to customers and (b) the effects of unusually highcustomer attrition principally related to the heating oil segment’s operational restructuring undertaken in the past 18 months. The Partnership alsoannounced that it anticipated that because of the requirements of the Partnership’s current and potential bank lenders, it will not be permitted to make anydistributions on its common units. In addition, the Partnership announced that the heating oil segment’s bank lenders had agreed to permit the heating oil segment to request new workingcapital advances daily while the Partnership was in discussions with such lenders about modifying the terms and conditions of the heating oil segment’scredit agreement. In connection with that understanding, the bank lenders requested that the Partnership allow an independent financial advisor to review theheating oil segment’s operations and performance on their behalf. On November 5, 2004, the Partnership announced that the heating oil segment had entered into a letter amendment and waiver under its credit agreement. Asa result of the amendment, the heating oil segment was able to continue to borrow funds under the credit agreement to support its working capitalrequirements for the near term. The amendment provides for the waiver, through December 17, 2004, of various terms under the credit agreement. Theamendment also amends for the waiver period the financial covenant regarding the Partnership’s consolidated funded debt to cash flow ratio and the financialcovenant regarding the heating oil segment’s cash flow to interest expense ratio. The Partnership also announced that its propane segment had entered into a commitment letter with JPMorgan Securities Inc. and JPMorgan Chase Bank.Under the commitment letter, as amended, JP Morgan Chase Bank committed, subject to certain conditions to provide a $350 million ($260 million if thepropane segment is sold, as discussed below) asset-based senior secured revolving credit facility referred to herein as the revolving credit facility and a $300million senior secured bridge facility referred to herein as the bridge facility to refinance (the “refinancing transactions”) all of the heating oil segment andthe propane segment’s working capital facilities (if the propane segment is not sold) and senior secured notes. 31 Table of ContentsOn November 18, 2004, the Partnership announced that it had signed an agreement to sell its propane segment, held largely through Star Gas Propane toInergy, the operating subsidiary of Inergy, L.P., for $475 million, subject to certain adjustments. In addition, the Partnership gave notice to holders of theheating oil segment’s secured notes of its optional election to prepay such secured notes, representing an aggregate payment, including principal, interestand estimated premium, of approximately $182 million. The Partnership subsequently gave notice of its optional election to prepay its propane segment’ssecured notes involving an aggregate payment including principal, interest and estimated premium, of approximately $114 million. The aggregate amountpayable with regard to both sets of secured notes is approximately $296 million. As discussed elsewhere herein, these payments are expected to be made fromeither the proceeds of the sale of the propane segment or the JP Morgan Chase bridge facility. For additional information concerning the sale of the propanesegment, see Item 1 – Business—“Sale of the Propane Segment; Prepayment of Subsidiaries’ Secured Notes.” If the sale of the propane business to Inergy is not consummated for any reason by December 17, 2004, the Partnership’s commitment from JP Morgan Chasewill remain unaffected. On that date, the Partnership would expect to draw down JP Morgan Chase’s bridge facility if the propane segment sale has not beenconsummated. The proceeds from the bridge facility would be used to repay the Partnership’s subsidiaries’ secured notes which will become due on that datebecause of the Partnership’s notice of prepayment. The Partnership also would expect to close on that date the asset based revolving credit agreementunderwritten by JP Morgan Chase to replace the existing revolving credit agreements of the Partnership’s subsidiaries. Therefore, the Partnership will be ableto restructure its indebtedness as disclosed in the Partnership’s previous press release dated November 5, 2004, provided that it is able to satisfy theconditions in the JP Morgan Chase commitment. The JP Morgan Chase commitment for the bridge facility and the revolving credit facility is subject to anumber of conditions and there can be no assurance that the Partnership will meet those conditions. See “Liquidity and Capital Resources - Financing andSources of Liquidity Following Refinancing Transactions.” If the propane segment is sold (either before or after December 17, 2004), the revolving credit facility will be reduced to $260 million and the liens on all ofthe assets of the propane segment would be released. If the sale of the propane segment does not close until after the Partnership has drawn down on thebridge facility, the Partnership will use a portion of the sales proceeds to repay the bridge loan. The remaining proceeds will be applied in accordance withthe terms of the indenture relating to the Partnership’s MLP Notes, which is discussed below under “Liquidity and Capital Resources- Financing and Sourcesof Liquidity Following Refinancing Transactions.” If the agreement for the sale of the propane segment is terminated, the Partnership will seek to repay thebridge facility through the issuance of senior secured notes issued by the heating oil segment and the propane segment in a public or private offering. Results of Operations Overview In analyzing the Partnership’s financial results, the following matters should be considered. The Partnership’s fiscal year ends on September 30. All references to quarters and years respectively in this document are to fiscal quarters and years unlessotherwise noted. The seasonal nature of the Partnership’s business results in the sale of approximately 30% of its volume in the first quarter (October throughDecember) and 45% of its volume in the second quarter (January through March) of each year, the peak heating season, because propane and heating oil areprimarily used for space heating in residential and commercial buildings. The Partnership generally realizes net income in both of these quarters and netlosses during the quarters ending June and September. The Partnership typically has negative working capital at the end of each fiscal year due toseasonality. In addition, sales volume typically fluctuates from year to year in response to variations in weather, wholesale energy prices and other factors.Gross profit is not only affected by weather patterns but also by changes in customer mix. For example, sales to residential customers ordinarily generatehigher margins than sales to other customer groups, such as commercial or agricultural customers. In addition, gross profit margins vary by geographic region.Accordingly, gross profit margins could vary significantly from year to year in a period of identical sales volumes. As discussed below under the heading “ Cost of Product,” when heating oil wholesale costs increased, the heating oil segment’s retail sales prices did notincrease as rapidly as the increase in heating oil prices, which resulted in lower per gallon margins. In general, the timing of cost pass-throughs cansignificantly affect margins. 32 Table of ContentsAs of September 30, 2004, the wholesale cost of home heating oil, as measured by the closing price of the New York Mercantile Exchange had increased by38% to $1.39 from $1.01 on June 30, 2004. This represents a 78% increase over the heating oil price per gallon of $0.78 on September 30, 2003. Per gallonheating oil prices subsequently increased to a high of $1.59 per gallon on October 22, 2004, before retreating to $1.23 per gallon as of December 10, 2004.The unprecedented rise in the wholesale price of heating oil has adversely impacted the heating oil segment’s margins and added to the heating oil segment’sdifficulties in both attracting new and retaining existing customers. The heating oil segment believes its rate of customer loss has risen not only because ofthe greater than normal price competition resulting from the rise in oil prices but also because of operational problems in the heating oil segment andmanagement’s decision to upgrade the credit quality of its customer base. Prior to the 2004 winter heating season, the heating oil segment attempted todevelop a competitive advantage in customer service and, as part of that effort, centralized the heating equipment service and oil dispatch functions andengaged a centralized call center to fulfill its telephone requirements. The implementation of this initiative is taking longer and incurring greater difficultiesthan the heating oil segment had anticipated, which adversely impacted the customer base. As a result of the above, for fiscal 2004, the heating oil segmentexperienced annual customer attrition of approximately 6.6% excluding the impact of acquisitions. For fiscal 2003, before the increase in the price of homeheating oil and the full implementation of the business process improvement program, the rate of customer loss was approximately 1.3%. While the Partnership believes that the heating oil segment has made progress in correcting the early inefficiencies associated with its customer service, andthat it has improved its responsiveness to customer needs, the Partnership expects that attrition will continue into the 2004-2005 winter heating season andperhaps beyond. The Partnership notes that even to the extent that attrition can be halted, the current reduced customer base will adversely impact net incomefor fiscal 2005 and perhaps beyond. The following is a discussion of the results of operations of the Partnership and its subsidiaries, and should be read in conjunction with the historicalFinancial and Operating Data and Notes thereto included elsewhere in this Report. The Partnership completed the sale of its TG&E subsidiaries in March2004. The following discussion reflects the historical results for the TG&E segment as discontinued operations. Also, on November 18, 2004, the Partnershipsigned an agreement for the sale of its propane segment. Upon final consummation of this transaction, the propane segment will be reflected as a discontinuedoperation and the historical statements will be reclassified to reflect this presentation. 33 Table of Contents Fiscal Year Ended September 30, 2004 (Fiscal 2004) Compared to Fiscal Year Ended September 30, 2003 (Fiscal 2003) Statements of Operations by Segment Years Ended September 30, (in thousands) 2003 2004 Statements of Operations Heating Oil Propane Partners &Others Consol. Heating Oil Propane Partners &Others Consol. Sales: Product $934,967 $255,946 $— $1,190,913 $921,443 $317,139 $— $1,238,582 Installations, service and appliances 168,001 23,354 — 191,355 183,648 31,707 — 215,355 Total sales 1,102,968 279,300 — 1,382,268 1,105,091 348,846 — 1,453,937 Cost and expenses: Cost of product 598,397 139,008 — 737,405 594,153 185,725 — 779,878 Cost of installations, service and appliances 195,146 6,007 — 201,153 204,902 11,273 — 216,175 Delivery and branch expenses 217,244 76,279 — 293,523 232,985 92,701 — 325,686 Depreciation & amortization expenses 35,535 16,958 — 52,493 37,313 20,030 — 57,343 General and administrative expenses 22,356 10,568 17,407 50,331 16,535 10,092 3,402 30,029 Operating income (loss) 34,290 30,480 (17,407) 47,363 19,203 29,025 (3,402) 44,826 Net interest expense 22,760 11,037 6,770 40,567 28,038 10,321 7,544 45,903 Amortization of debt issuance costs 1,655 194 383 2,232 2,750 166 730 3,646 (Gain) loss on redemption of debt (212) 393 — 181 — — — — Income (loss) from continuing operations beforeincome taxes 10,087 18,856 (24,560) 4,383 (11,585) 18,538 (11,676) (4,723)Income tax expense 1,200 300 — 1,500 1,240 285 — 1,525 Income (loss) from continuing operations 8,887 18,556 (24,560) 2,883 (12,825) 18,253 (11,676) (6,248)Income from discontinued operations beforecumulative effect of change in accountingprinciple — — 1,230 1,230 — — 923 923 Loss on sale of TG&E segment, net of taxes — — — — — — (538) (538)Cumulative effect of change in accountingprincipal - adoption of SFAS 142 — — (3,901) (3,901) — — — — Net income (loss) $8,887 $18,556 $(27,231) $212 $(12,825) $18,253 $(11,291) $(5,863) 34 Table of Contents Volume For fiscal 2004, retail volume of home heating oil and propane increased 12.6 million gallons, or 1.7%, to 754.7 million gallons, as compared to 742.1million gallons for fiscal 2003. An analysis by segment is found below: (in millions of gallons) Heating OilSegment PropaneSegment Total Volume – Fiscal 2003 567.0 175.1 742.1 Impact of warmer temperatures (43.9) (10.4) (54.3)Impact of acquisitions 36.1 44.3 80.4 Net customer attrition (18.2) (6.5) (24.7)Other 10.6 0.6 11.2 Change (15.4) 28.0 12.6 Volume – Fiscal 2004 551.6 203.1 754.7 Retail volume sold in the heating oil segment declined by 15.4 million gallons, or 2.7%, to 551.6 million gallons for fiscal 2004, as compared to 567.0million gallons for fiscal 2003. We believe that this 15.4 million gallon decline at the heating oil segment was due to the impact of warmer temperatures andnet customer attrition partially offset by acquisitions and other volume changes. Net customer attrition is the difference between gross customer losses andcustomers added through internal marketing efforts. Customers added through acquisitions do not impact the calculation of net attrition. Temperatures in theheating oil segment’s geographic areas of operations were 7.7% warmer in fiscal 2004 than in fiscal 2003 and approximately 0.2% warmer than normal asreported by the National Oceanic Atmospheric Administration (“NOAA”). At September 30, 2004, after adjusting for acquisitions, the heating oil segment estimates that it had approximately 6.6% fewer home heating oil customersthan as of September 30, 2003. For the quarter ended September 30, 2004, the heating oil segment (excluding acquisitions) lost approximately 11,000customers (net) as compared to the quarter ended September 30, 2003, in which the heating oil segment lost approximately 1,000 customers (net). We believethat net customer attrition is the result of various factors including but not limited to price, service and credit. The continued rise in the price of heating oil,especially during the fourth quarter of fiscal 2004, added to the heating oil segment’s difficulties in reducing customer attrition. The Partnership believes thatthe unprecedented rise in heating oil prices has increased the competitive pressures facing its heating oil segment. As wholesale prices have risen, many ofthe Partnership’s competitors have not raised their retail prices to fully offset the wholesale price rise. In an effort to minimize the loss of customers to pricecompetition, the Partnership has also not increased its prices to fully offset for the rise in wholesale prices, resulting in reduced margins. Nevertheless, manyof the Partnership’s competitors appear to have succeeded in inducing the Partnership’s customers to leave through various price-related strategies. ThePartnership believes that going forward it may need to be even more sensitive to price competition, resulting in the possibility of further reductions inmargins. In addition, prior to the 2004 winter heating season, the heating oil segment attempted to develop a competitive advantage in customer service and, as part ofthat effort, centralized its heating equipment service dispatch and engaged a centralized call center to respond to telephone inquiries. The implementation ofthat initiative has taken longer than the heating oil segment anticipated, impacting customer service. The Partnership believes that the heating oil segment’srate of customer loss in fiscal 2004 was due to a combination of higher energy prices, operational and customer service problems together with theimplementation of stricter customer credit requirements towards the end of fiscal 2004. For fiscal 2004, retail volume sold at the propane segment increased 28.0 million gallons, or 16.0%, to 203.1 millions gallons, as compared to 175.1 milliongallons for fiscal 2003. This increase in volume reflects the additional 44.3 million gallons provided by acquisitions, partially offset by the impact of warmertemperatures and customer attrition. Temperatures in the propane segment’s geographic areas of operations were 9.0% warmer in fiscal 2004 than in fiscal2003 and 4.4% warmer than normal as reported by NOAA. At September 30, 2004, after adjusting for acquisitions, the propane oil segment estimates that ithad approximately 2.7% fewer customers than at September 30, 2003. The propane segment believes that the increase in the price of propane was the primaryreason for the net attrition in fiscal 2004. The Partnership believes that greater than normal price competition resulting from many of the propane segment’scompetitors, including farmers cooperatives in the Midwest, appear to have succeeded in inducing the propane segment’s customers to leave through variousprice- related strategies. 35 Table of ContentsProduct Sales For fiscal 2004, product sales increased $47.7 million, or 4.0%, to $1,238.6 million, as compared to $1,190.9 million for fiscal 2003. At the heating oilsegment, product sales declined by $13.5 million, or 1.4%, to $921.4 million in fiscal 2004, as compared to $935.0 million in fiscal 2003. While warmertemperatures and customer losses at the heating oil segment led to a reduction in product sales, the decline was partially offset by an increase in product salesattributable to acquisitions and higher selling prices. At the propane segment, product sales increased by $61.2 million, or 23.9%, to $317.1 million, ascompared to $255.9 million in fiscal 2003 largely due to higher retail volume sold. This increase at the propane segment was primarily due to the additionalsales from acquisitions and higher selling prices, which offset the impact of warmer weather and customer attrition. As experienced in the heating oil segment,selling prices at the propane segment were higher in fiscal 2004 than in fiscal 2003 in response to higher wholesale propane supply costs. Sales, Installation, Service and Appliances For fiscal 2004, installation, service and appliance sales increased $24.0 million, or 12.5%, to $215.4 million as compared to $191.4 million for fiscal 2003.At the heating oil segment, installation, service and appliance sales increased $15.6 million, or 9.3%, to $183.6 million for fiscal 2004, as compared to$168.0 million for fiscal 2003 due to acquisitions and measures taken in the last several years to increase service revenues. In the propane segment,installation, service and appliance sales increased $8.4 million, or 35.8%, to $31.7 million in fiscal 2004, as compared to $23.4 million in fiscal 2003 largelydue to acquisitions. This large increase in the propane segment was greater than in prior years due to the acquisition of Home Energy in the fourth quarter offiscal 2003, which accounted for $6.9 million of the increase in installation, service and appliance sales. Cost of Product For fiscal 2004, cost of product increased $42.5 million, or 5.8%, to $779.9 million, as compared to $737.4 million for fiscal 2003. In the heating oil segment,cost of product declined by $4.2 million, or 0.7%, to $594.2 million in fiscal 2004, as compared to $598.4 million in fiscal 2003, as the impact of netcustomer attrition and warmer temperatures exceeded wholesale cost increases and the additional product requirement for acquisitions. In the propanesegment, cost of product increased $46.7 million, or 33.6%, to $185.7 million in fiscal 2004 as compared to $139.0 million in fiscal 2003. This increase wasdue to acquisitions and an increase in wholesale supply costs, which more than offset a reduction in cost of product due to warmer temperatures and netcustomer attrition. While selling prices and wholesale prices increased on a per gallon basis at both segments, the increase in selling prices exceeded the increase in supply costsduring the first nine months of fiscal 2004. At September 30, 2004, heating oil supply costs were approximately 38% higher than at June 30, 2004 andpropane supply costs were approximately 25% higher for the same period. During the three months ended September 30, 2004, the segments were not able tofully pass these increases on to their respective customers. As a result, per gallon margins for the three months ended September 30, 2004 declined by 2.3cents per gallon at the heating oil segment and 2.9 cents per gallon at the propane segment, as compared to the three months ended September 30, 2003,which partially offset per gallon margin increases that the segments’ experienced earlier in the year. The per gallon margins realized in both segments for thethree months ended September 30, 2004 were significantly less than expectations. For fiscal 2004, per gallon margin increases were realized in the basebusiness compared to fiscal 2003 (excluding the impact of acquisitions) of 0.8 cents per gallon at the heating oil segment and 2.7 cents per gallon at thepropane segment. Overall per gallon margins at the propane segment declined in fiscal 2004 as compared to fiscal 2003 due to the mix of volume attributableto acquisitions. The Partnership continues to experience high wholesale supply costs and believes that it will not be able to pass all these increases on to its customersthrough retail sales prices. If wholesale supply costs remain volatile and at historically high levels, per gallon profit margins and results are likely to beadversely impacted. See “Recent Performance” below. Cost of Installations, Service and Appliances For fiscal 2004, costs of installations, service and appliances increased $15.0 million, or 7.4%, to $216.2 million, as compared to $201.2 million for fiscal2003 representing a reduction in the loss historically associated with installations, service and appliances. At the heating oil segment, cost of installations,service and appliances increased $9.8 million, or 5.0%, to $204.9 million in fiscal 2004, as compared to $195.1 million in fiscal 2003. This change wasprimarily due to acquisitions and wage and other cost increases. In the propane segment, cost of installations, service and appliances increased $5.3 million, or 87.7%, to $11.3 million in fiscal 2004, as compared to $6.0million in fiscal 2003 due to the previously noted acquisition of Home Energy in the fourth fiscal quarter of 2003 whose full year impact is first reflected infiscal 2004. 36 Table of ContentsDelivery and Branch Expenses For fiscal 2004, delivery and branch expenses increased $32.2 million, or 11.0%, to $325.7 million in fiscal 2004, as compared to $293.5 million in fiscal2003. At the heating oil segment, delivery and branch expenses increased $15.7 million, or 7.2%, to $233.0 million in fiscal 2004, as compared to $217.2million in fiscal 2003. This increase in the heating oil segment of $15.7 million was due to a higher level of fixed and variable operating costs attributable toacquisitions, (primarily those completed in eastern Pennsylvania) of $10.1 million and approximately $6.3 million due to operating and wage increases.These increases in delivery and branch expenses were partially reduced by cost reductions relating to lower volume delivered due to warmer temperatures andnet customer attrition experienced in fiscal 2004. Prior to the 2004 winter heating season, the heating oil segment attempted to develop a competitiveadvantage in customer service, and as part of that effort centralized its heating equipment service dispatch and engaged a centralized call center to respond totelephone inquiries. Start-up challenges associated with this initiative impacted the customer base and unanticipated training and support was required. Theexpected savings from this initiative were less than expected. At the propane segment, delivery and branch expenses increased $16.4 million, or 21.5%, to $92.7 million as compared to $76.3 million for fiscal 2003. Thisincrease of $16.4 million was due to additional operating costs associated with acquisitions at the propane segment of $14.9 million (of which $11.5 millionis attributable to the Home Energy acquisition), and approximately $2.2 million due to operating and wage increases. As in the heating oil segment, thedelivery and branch expense increases at the propane segment was partially offset by cost reductions relating to lower volume attributable to warmer weatherand net customer losses. Depreciation and Amortization For fiscal 2004, depreciation and amortization expenses increased $4.9 million, or 9.2%, to $57.3 million, as compared to $52.5 million for fiscal 2003. Thisincrease was primarily due to a larger depreciable base of assets, as a result of the impact of recent acquisitions at both the heating oil and propane segmentsand to increased depreciation resulting from the technology investment made by the heating oil segment in centralizing its customer service and dispatcherfunctions. Increases of $1.8 million and $3.1 million were experienced at the heating oil and propane segments, respectively. General and Administrative Expenses For fiscal 2004, general and administrative expenses declined $20.3 million, or 40.3%, to $30.0 million, as compared to $50.3 million for fiscal 2003. At thePartnership level, general and administrative expenses declined by $14.0 million from $17.4 million in fiscal 2003 to $3.4 million in fiscal 2004, due to a$10.4 million reduction in the expense for compensation earned for unit appreciation rights on the Partnership’s senior subordinated units, a $2.5 millionreduction in restricted stock awards and a reduction of $1.4 million in bonus compensation expense. For fiscal 2004, Partnership level expenses totaled $3.4million which included $2.5 million in salary expense and bonus, $4.9 million in legal and administrative costs, partially offset by a credit of $4.0 million forunit appreciation rights. For fiscal 2003, Partnership expenses totaled $17.4 million which included $3.4 million in salary and bonus expense, $9.0 million inunit appreciation rights and restricted stock awards expense and $5.0 million in legal and administrative costs. At the heating oil segment, general andadministrative expenses declined by $5.8 million, or 26.0%, to $16.5 million in fiscal 2004 from $22.4 million in fiscal 2003. This decline was due to areduction in certain expenses relating to the heating oil segment’s centralized customer service and dispatch project of $7.0 million. The reduction in generaland administrative expenses at the heating oil segment was partially offset by $1.2 million in additional expenses due to severances paid and a higher levelof legal and professional expenses. At the propane segment, general and administrative expenses declined $0.5 million, or 4.5%, to $10.1 million for fiscal2004, as compared to $10.6 million for fiscal 2003. Operating Income (Loss) For fiscal 2004, operating income decreased $2.5 million, or 5.4%, to $44.8 million, as compared to $47.4 million for fiscal 2003. At the Partnership level,the operating loss decreased by $14.0 million from a $17.4 million loss in fiscal 2003 to a $3.4 million loss in fiscal 2004 due to a $10.4 million reduction inthe accrual for compensation earned for unit appreciation rights on Partnership’s senior subordinated units, lower restricted stock awards of $2.5 million andlower bonus compensation expense of $1.4 million. At the heating oil segment, operating income declined by $15.1 million, or 44.0%, to $19.2 million, ascompared to $34.3 million for fiscal 2003. This decline was due to warmer temperatures of 7.7% in the heating oil segment’s geographic areas of operationsin fiscal 2004 than in fiscal 2003, net customer attrition, operating and wage increases and higher depreciation and amortization expense, which werereduced in part by the operating income attributable to acquisitions, an increase in per gallon gross profit margins of the base business, lower expensesassociated with the heating oil segment’s centralized customer service and dispatch project and increased service revenues. At the propane segment,operating income declined $1.5 million, or 4.8%, to $29.0 million, as compared to $30.5 million for fiscal 2003. This decline was due to warmer temperaturesof 9.0% in the propane segment’s geographic areas of operations in fiscal 2004 compared to fiscal 2003, net customer attrition, operating and wage increasesand higher depreciation and amortization, reduced in part by operating income from acquisitions and higher per gallon margins. 37 Table of ContentsInterest Expense For fiscal 2004, interest expense increased $4.9 million, or 11.1%, to $49.4 million, as compared to $44.4 million for fiscal 2003. This increase was due tohigher principal amount of long-term debt outstanding and an increase in the Partnership’s weighted average interest rate during fiscal 2004, as compared tofiscal 2003. Amortization of Debt Issuance Costs For fiscal 2004, amortization of debt issuance costs increased $1.4 million, or 63.4%, to $3.6 million, as compared to $2.2 million for fiscal 2003. Thisincrease was largely due to the amortization of debt issuance costs for the Partnership’s $265.0 million senior notes offerings and for the amortization of bankfees incurred in connection with refinancing certain bank facilities. Income Tax Expense Income tax expense for fiscal 2004 was $1.5 million and represents certain state income taxes. The amount recorded in fiscal 2004 was unchanged from fiscal2003. Income (Loss) From Continuing Operations For fiscal 2004, income (loss) from continuing operations decreased $9.1 million, to a loss of $6.2 million, as compared to income of $2.9 million for fiscal2003. This decline was due to a $21.7 million decrease in income at the heating oil segment and a decline in income at the propane segment of $0.3 millionpartially offset by $12.9 million in lower losses at the Partnership level. Income (loss) from continuing operations declined as the effects of warmertemperatures, other volume changes, including customer losses, operating and wage increases and an increase in interest expense were partially offset by thepositive impacts of acquisitions, improved per gallon gross profit margins on the base business and lower compensation expenses at the Partnership level of$14.3 million in the form of unit appreciation rights, restricted stock awards and bonus expense. Income From Discontinued Operations For fiscal 2004, income from discontinued operations decreased $0.3 million. This income relates to the operating results from the TG&E segment that wassold on March 31, 2004. Loss On Sale of TG&E Segment For fiscal 2004, the Partnership recorded a $0.5 million loss on the sale of TG&E. Cumulative Effect of Change in Accounting Principle For fiscal 2003, the Partnership recorded a $3.9 million charge arising from the adoption of Statement No. 142 to reflect the impairment of its goodwill forTG&E. Net Income (loss) For fiscal 2004, net income (loss) decreased $6.1 million, to a loss of $5.9 million, as compared to $0.2 million in income for fiscal 2003. The change was dueto a $9.1 million decrease in income from continuing operations, a $0.3 million decrease in income from discontinued operations and the $0.5 million losson the sale of TG&E. Net income was also impacted by the adoption of SFAS No. 142, which resulted in a charge of $3.9 million in fiscal 2003. 38 Table of ContentsEarnings From Continuing Operations Before Interest, Taxes, Depreciation and Amortization (EBITDA) For the fiscal year ended September 30, 2004, EBITDA increased $2.5 million, or 2.5%, to $102.2 million as compared to $99.7 million for fiscal 2003. Thisincrease was due to $2.0 million additional EBITDA generated by the propane segment and $14.0 million additional EBITDA at the Partnership level largelydue to the reduction in the accrual for compensation earned for unit appreciation rights, reduced by a decline in EBITDA at the heating oil segment of $13.5million. 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 ameasure of liquidity or ability to service debt obligations), but provides additional information for evaluating the Partnership’s ability to make the MinimumQuarterly Distribution. EBITDA for the Partnership is calculated for the fiscal years ended September 30 as follows: Fiscal Year EndedSeptember 30, (in thousands) 2003 2004 Income (loss) from continuing operations $2,883 $(6,248)Plus: Income tax expense 1,500 1,525 Amortization of debt issuance costs 2,232 3,646 Interest expense, net 40,567 45,903 Depreciation and amortization 52,493 57,343 EBITDA 99,675 102,169 Add/(subtract) Loss of redemption of debt 181 — Income tax expense (1,500) (1,525)Interest expense, net (40,567) (45,903)Unit compensation expense 2,606 86 Provision for losses on accounts receivable 7,726 8,749 Gain on sales of fixed assets, net (156) (226)Change in operating assets and liabilities (17,370) 2,490 Net cash used in operating activities $50,595 $65,840 39 Table of Contents Fiscal Year Ended September 30, 2003 (Fiscal 2003) Compared to Fiscal Year Ended September 30, 2002 (Fiscal 2002) Statements of Operations by Segment Years Ended September 30, (in thousands) 2002 2003 Statements of Operations Heating Oil Propane Partners &Others Consol. Heating Oil Propane Partners &Others Consol. Sales: Product $637,619 $176,741 $— $814,360 $934,967 $255,946 $— $1,190,913 Installations, service and appliances 152,759 18,776 — 171,535 168,001 23,354 191,355 Total sales 790,378 195,517 — 985,895 1,102,968 279,300 — 1,382,268 Cost and expenses: Cost of product 368,324 78,227 — 446,551 598,397 139,008 — 737,405 Cost of installations, service and appliances 178,171 4,638 — 182,809 195,146 6,007 — 201,153 Delivery and branch expenses 174,030 61,678 — 235,708 217,244 76,279 — 293,523 Depreciation & amortization expenses 40,437 16,783 7 57,227 35,535 16,958 — 52,493 General and administrative expenses 13,630 8,526 4,115 26,271 22,356 10,568 17,407 50,331 Operating income (loss) 15,786 25,665 (4,122) 37,329 34,290 30,480 (17,407) 47,363 Net interest expense (income) 24,087 13,227 (244) 37,070 22,760 11,037 6,770 40,567 Amortization of debt issuance costs 1,197 250 — 1,447 1,655 194 383 2,232 (Gain) loss on redemption of debt — — — — (212) 393 — 181 Income (loss) from continuing operations beforeincome taxes (9,498) 12,188 (3,878) (1,188) 10,087 18,856 (24,560) 4,383 Income tax expense (benefit) (1,700) 244 — (1,456) 1,200 300 — 1,500 Income (loss) from continuing operations (7,798) 11,944 (3,878) 268 8,887 18,556 (24,560) 2,883 Income (loss) from discontinued operations beforecumulative effect of change in accountingprinciple — — (11,437) (11,437) — — 1,230 1,230 Cumulative effect of change in accountingprincipal - adoption of SFAS 142 — — — — — — (3,901) (3,901) Net income (loss) $(7,798) $11,944 $(15,315) $(11,169) $8,887 $18,556 $(27,231) $212 40 Table of ContentsVolume For fiscal 2003, retail volume of home heating oil and propane increased 142.4 million gallons, or 23.7%, to 742.1 million gallons, as compared to 599.7million gallons for fiscal 2002. An analysis by segment is found below: (in millions of gallons) Heating OilSegment PropaneSegment Total Volume – Fiscal 2002 457.7 142.0 599.7 Impact of colder temperatures 125.1 20.0 145.1 Impact of acquisitions 12.1 13.9 26.0 Net customer attrition (14.5) (4.9) (19.4)Other (13.4) 4.1 (9.3) Change 109.3 33.1 142.4 Volume – Fiscal 2003 567.0 175.1 742.1 Retail volume sold in the heating oil segment increased by 109.3 million gallons, or 23.9%, to 567.0 million gallons for fiscal 2003, as compared to 457.7million gallons for fiscal 2002. The Partnership believes that this 109.3 gallon increase at the heating oil segment was due to the impact of coldertemperatures and acquisition reduced by net customer attrition and other volume changes. Net customer attrition is the difference between gross customerlosses and customers added through internal marketing efforts. Customers added through acquisitions do not impact the calculation of net attrition.Temperatures in the heating oil segment’s geographic areas of operations were 32.3% colder in fiscal 2003 than in fiscal 2002 and approximately 10.4%colder than normal as reported by NOAA. For fiscal 2003, retail volume sold at the propane segment increased 33.1 million gallons, or 23.3%, to 175.1 million gallons, as compared to 142 milliongallons for fiscal 2002. This increase in volume reflects the additional 13.9 million gallons provided by acquisitions, the impact of colder temperatures,reduced by net customer attrition. Temperatures in the propane segment’s geographic areas of operations were 21.8% colder in fiscal 2003 than in fiscal 2002and 5.0% colder than normal as reported by NOAA. Product Sales For fiscal 2003, product sales increased $376.6 million, or 46.2%, to $1,190.9 million, as compared to $814.4 million for fiscal 2002. At the heating oilsegment, product sales increased by $297.3 million, or 46.6%, to $935.0 million in fiscal 2003, as compared to $637.6 million in fiscal 2002. This increase atthe heating oil segment was primarily due to colder temperatures, additional sales from acquisitions and higher selling prices reduced in part by customerattrition. Selling prices at the heating oil segment were higher in fiscal 2003 than in fiscal 2002 in response to higher home heating oil supply costs. At thepropane segment, product sales increased by $ 79.2 million, or 44.8%, to $255.9 million in fiscal 2003, as compared to $176.7 million in fiscal 2002. Thisincrease at the propane segment was primarily due to colder temperatures, additional sales from acquisitions and higher selling prices, reduced in part bycustomer attrition. As experienced in the heating oil segment, selling prices at the propane segment were higher in fiscal 2003 than in fiscal 2002 in responseto higher wholesale propane supply costs. Sales, Installation, Service and Appliances For fiscal 2003, installations and appliance sales increased $19.8 million, or 11.6%, to $191.4 million, as compared to $171.5 million for fiscal 2002. At theheating oil segment, installation, service and appliance sales increased to $15.2 million or 10.0%, to $168.0 million, as compared to $152.8 million in fiscal2002 due to acquisitions, colder temperatures and measures taken to increase service revenue. For the propane segment, installation, service and appliancerevenues increased by $4.6 million, or 24.3%, to $23.4 million in fiscal 2003, as compared to $18.8 million is fiscal 2002. This increase was due toacquisitions, which accounted for $3.6 million of the increases. 41 Table of ContentsCost of Product For fiscal 2003, cost of product increased $290.9 million, or 65.1% to $737.4 million, as compared to $446.6 million for fiscal 2002. In the heating oilsegment, cost of product increased by $230.1 million, or 62.5%, to $598.4 million, as compared to $368.3 million for fiscal 2002. This increase was primarilydue to colder temperatures, additional sales from acquisitions and higher selling prices which offset customer attrition. At the heating oil segment, theincrease in selling prices exceeded the increase in wholesale supply costs. As a result, per gallon margins increased by 0.7 cents in the base business(excluding the impact of acquisitions). In the propane segment, cost of product increased by $60.8 million, or 77.6%, to $139.0 million, as compared to $78.2 million in fiscal 2002. This increasewas primarily due to colder temperatures and additional sales from acquisitions, which offset customer attrition. At the propane segment, the increase inwholesale supply costs exceeded the increase in related selling prices. As a result, per gallon margins declined in the base business (excluding the impact ofacquisitions) by 2.6 cents. Cost of Installations, Service and Appliances For fiscal 2003, costs of installations, service and appliances increased $18.3 million, or 10.0%, to$ 201.2 million as compared to $182.8 million for fiscal2002. At the heating oil segment, cost of installations, service and appliances increased $17.0 million, or 9.5% to $195.1 million in fiscal 2003, as comparedto $178.2 million in fiscal 2002. This change was primarily due to acquisitions and wage and other cost increases. In the propane segment, cost ofinstallations, services and appliances increased $1.4 million, or 29.5%, to $6.0 million in fiscal 2003, as compared to $4.6 million in fiscal 2002 due toacquisitions. Delivery and Branch Expenses For fiscal 2003, delivery and branch expenses increased $57.8 million, or 24.5%, to $293.5 million, as compared to $235.7 million for fiscal 2002. Thisincrease was due to an additional $43.2 million of delivery and branch expenses at the heating oil segment and a $14.6 million increase in delivery andbranch expenses for the propane segment. The period to period comparison was impacted by the purchase of weather insurance that allowed the Partnershipto record approximately $6.4 million of net weather insurance recoveries in the fiscal 2002 period versus a $3.6 million expense in the fiscal 2003 period forweather insurance premiums paid. The remaining increase in delivery and branch expenses of $47.8 million, for fiscal 2003, was largely due to the additionaloperating cost associated with increased volumes delivered, higher marketing costs at the heating oil segment of $5.7 million, higher bad debt expense of$2.9 million at the heating oil segment, higher bad debt expense of $0.4 million at the propane segment and to the impact of operating expense and wageincreases. Depreciation and Amortization Expenses For fiscal 2003, depreciation and amortization expenses decreased $4.7 million, or 8.3%, to $52.5 million, as compared to $57.2 million for fiscal 2002.During fiscal 2002, approximately $7.8 million of goodwill amortization was included in depreciation and amortization expense. As of October 1, 2002,goodwill is no longer amortized in accordance to SFAS No. 142. Depreciation and amortization expense related to acquisitions and fixed asset additionsacquired after September 30, 2002, resulted in increases which partially offset the decrease attributable to goodwill amortization. General and Administrative Expenses For fiscal 2003, general and administrative expenses increased $24.1 million, or 91.6%, to $50.3 million, as compared to $26.3 million for fiscal 2002. Thisincrease was largely due to the inclusion of $7.4 million of incremental expense related to the business process redesign project in the heating oil segment, a$9.9 million increase in the accrual for compensation earned for unit appreciation rights and restricted stock awards previously granted and for otherincreases of $6.8 million, largely due to increased bonus compensation based upon results for fiscal 2003 ($1.9 million), higher legal and professionalexpenses at the Partnership level ($2.4 million) and for increased expenses at the propane segment ($2.0 million) for its increased size. The increase in legaland professional expenses at the Partnership level were largely attributable to achieving and maintaining compliance with SEC rules and regulations,acquisitions and financing related issues. 42 Table of ContentsThe heating oil segment undertook to consolidate certain heating oil operational activities in an attempt to create operating efficiencies and cost savingswith service technicians being dispatched from two consolidated locations rather than 27 local offices and oil delivery being managed from 11 regionallocations rather than 27 local offices. A transition to outsourcing in the area of customer relationship management was undertaken as both a customersatisfaction and a cost reduction strategy. The Partnership believed outsourcing customer inquiries would improve performance and leverage technology toeliminate system redundancy available from third party service organizations. In addition, an outsourcing partner has greater flexibility to manage extremeseasonal volume. The complexity of customer interactions combined with the Partnership’s goal for service excellence led to protracted training efforts. Theheating oil segment began introducing call based technology enhancements including capabilities for customer inquiries via automated interactivetelephone response and the web. The $7.4 million incremental expense in fiscal 2003 ($9.4 million of actual fiscal 2003 expense) related to this redesign project largely consisted ofconsulting fees, employee termination benefits and separation cost and travel- related expenditures. In connection with this project, the Partnership reducedthe size of its work force and recognized a liability of approximately $2.0 million related to certain employee termination benefits and separation costs. Interest Expense For fiscal 2003, interest expense increased $3.9 million, or 9.7%, to $44.4 million, as compared to $40.5 million for fiscal 2002. This increase was largely dueto additional interest expense of $1.5 million for higher average outstanding working capital borrowings and due to additional interest related to the higherinterest rate on the Partnership’s $200.0 million debt offering partially offset by interest expense related to the debt repaid with the offering. Income Tax Expense For fiscal 2003, income tax expense increased $3.0 million to $1.5 million, as compared to a tax benefit of $1.5 million for fiscal 2002. This increase was dueto higher state income taxes based upon the higher pretax earnings achieved for fiscal 2003 and the absence in fiscal 2003 of the tax benefit from a federaltax loss carryback of $2.2 million recorded in fiscal 2002. Income from Continuing Operations For fiscal 2003, net income from continuing operations increased $2.6 million, to $2.9 million, as compared to $0.3 million for fiscal 2002. The increase wasdue to a $16.7 million increase in net income at the heating oil segment, a $6.6 million increase in the propane segment offset by a $20.7 million increase inthe net loss at the Partnership level. This increase was primarily due to the impact of colder weather on continuing operations and lower depreciation andamortization for continuing operations. Income (Loss) from Discontinued Operations For fiscal 2003, the income from discontinued operations increased $12.7 million from a loss of $11.4 million in fiscal 2002 to income of $ 1.2 million infiscal 2003. TG&E was sold on March 31, 2004. For fiscal 2003, the Partnership recorded a $3.9 million decrease in net income arising from the adoption ofSFAS No. 142 to reflect the impairment of its goodwill for its TG&E segment which is reflected herein as discontinued operations. Net Income (Loss) For fiscal 2003, net income increased $11.4 million or 101.9% to $0.2 million, as compared to a loss of $11.2 million in fiscal 2002. This increase was due tothe increase in net income from continuing operations of $2.6 million, the additional net income provided from discontinued operations of $12.7 millionpartially offset by the $3.9 million decrease in net income at the discontinued TG&E segment from the adoption of SFAS No. 142. 43 Table of ContentsRecent Performance The following is a discussion of certain important factors that have had a significant impact on the Partnership’s recent performance. Volume For the three months ended September 30, 2004, retail volume of home heating oil and propane decreased 0.7 million gallons, or 1.0%, to 68.5 milliongallons, as compared to 69.2 million gallons for the three months ended September 30, 2003. Retail volume sold in the heating segment declined by 1.5million gallons, or 3.6%, to 41.1 million gallons for the three months ended September 30, 2004, as compared to 42.6 million gallons for the three monthsended September 30, 2003. The Partnership believes that this decline was due to the impact of customer attrition throughout fiscal 2004. Based on thepreliminary data available to it, the Partnership believes that for the period from October 1, 2004 to November 30, 2004, retail volume sold in the heating oilsegment declined by 5.5 million gallons, or 7.3%, to 70.0 million gallons, as compared to 75.4 million gallons in the prior year’s comparable period. Thiswas primarily due to the carryover impact of the 6.6% customer attrition from fiscal 2004. Temperatures in the heating oil segment’s geographic areas ofoperations for the period October 1, 2004 to November 30, 2004 were approximately similar to the prior year’s comparable period. For the three months ended September 30, 2004, the heating oil segment lost 11,000 accounts (net) or approximately 2.2% of its customer base, as comparedto the three months ended September 30, 2003 in which the heating oil segment lost 1,000 accounts (net) or approximately 0.2% of its customer base. ThePartnership believes that net customer losses are a result of various factors including but not limited to price, service and credit. The continuous rise in theprice of heating oil especially during the fourth quarter of fiscal 2004 added to the heating oil segment’s difficulties in reducing customer attrition. As ofSeptember 30, 2004, the cost of home heating oil, as measured by the closing price of the New York Mercantile Exchange, had increased by 38% to $1.39from $1.01 on June 30, 2004. Based on the preliminary data available to it, the Partnership believes that for the period from October 1, 2004 to November 30,2004, the heating oil segment lost approximately 1,000 accounts (net), versus the two months ending November 30, 2003 in which the heating oil segment’snet customer loss was approximately 500 accounts (net). While the heating oil segment believes its customer service has improved in October and November2004 versus the comparable two months in the previous year, at this time, the heating oil segment cannot estimate the net customer attrition rate for fiscal2005. However, even if the net customer attrition rate is reduced, the lower customer base resulting from the fiscal 2004 customer attrition will continue toadversely affect the Partnership during fiscal 2005 and perhaps beyond. Retail volume sold in the propane segment increased by 0.8 million gallons, or 3.1%, to 27.4 million gallons for the three months ended September 30, 2004,as compared to 26.6 million gallons for the three months ended September 30, 2003. The Partnership believes that this 0.8 million gallon increase was due tothe additional volume provided from acquisitions, partially offset by the carryover effect of 2.7% customer attrition in fiscal 2004. For the period fromOctober 1, 2004 to November 30, 2004, retail volume sold at the propane segment declined by 5.1 million gallons, or 15.0%, to 28.7 million gallons, ascompared to 33.7 million gallons in the prior year’s comparable period. The decline was due to the carryover effect of customer attrition from fiscal 2004 andlower agriculture volume, partially offset by the impact of acquisitions. Temperatures for the propane segment’s geographic areas of operations wereapproximately similar in both periods. For the three months ended September 30, 2004, the propane segment lost 3,400 accounts (net) or approximately 1.0% of its customer base, as compared tothe three months ended September 30, 2003 in which the propane segment lost 9,300 accounts (net) or approximately 3.1% of its customer base. Based on thepreliminary data available to us, the Partnership believes that for the period from October 1, 2004 to November 30, 2004, the propane segment gainedapproximately 2,900 accounts (net) as compared to the prior year’s comparable period in which the propane segment lost approximately 200 accounts (net).At this time, the propane segment cannot estimate the net customer attrition rate for fiscal 2005; however, even if the net customer attrition rate is reduced,the lower customer base resulting from the fiscal 2004 customer attrition will continue to adversely effect the Partnership through the date of the proposedsale of the propane segment and, if the propane segment is not sold, through the remainder of fiscal 2005 and perhaps beyond. 44 Table of ContentsCost of Product As of September 30, 2004, the wholesale cost of home heating oil, as measured by the closing price of the New York Mercantile Exchange had increased by38% to $1.39 from $1.01 on June 30, 2004. Per gallon heating oil prices subsequently increased to a high of $1.59 per gallon on October 22, 2004, beforeretreating to $1.23 per gallon as of December 10, 2004. As of September 30, 2004, the wholesale cost of propane, as reported by Oil Price Information Servicehad increased 25% to $0.84 per gallon from $0.67 per gallon on June 30, 2004. The per gallon price of propane subsequently increased to a high of $0.97 onOctober 25, 2004 before retreating to $0.76 per gallon as of December 10, 2004. During the three months ended September 30, 2004, the segments were not able to fully pass these increases on to their respective customers resulting in adecline in per gallon margins (in the base business, excluding the impact of acquisitions) for the three months ended September 30, 2004 as compared to thethree months ended September 30, 2003 of approximately 2.3 cents at the heating oil segment and 2.9 cents at the propane segment. The per gallon marginsrealized at both segments were significantly less than expectations. The Partnership continues to experience high wholesale supply costs and believes that it will not be able to pass all these increases on to its customersthrough retail sales prices. If wholesale supply costs remain at volatile and historically high levels, per gallon profit margins and results are likely to beadversely impacted. The continuous rise and the volatility in the price of heating oil have adversely impacted the heating oil segment’s per gallon gross profit margins.Preliminary indications are that the per gallon margins for the period from October 1, 2004 to November 30, 2004 will be lower than the comparable periodfor fiscal 2003. At the propane segment, preliminary indications are that the per gallon gross profit margins for the period from October 1, 2004 to November30, 2004 will be lower than the prior year’s comparable period. Operating Expenses Late in the fourth quarter of fiscal 2004, the heating oil segment launched a new marketing campaign and its success has yet to be determined. For the periodfrom October 1, 2004 to November 30, 2004, based upon the preliminary information available to it, the heating oil segment anticipates that operatingexpenses will increase by $4.5 million, as compared to the prior year’s two-month period, due to wage and cost increases, additional expenses associated withthe outsourced call center and higher marketing costs of $1.3 million. At the propane segment, the Partnership believes that operating expenses will alsoincrease by $2.0 million. In addition, the Partnership anticipates additional fees and expenses at the heating oil segment and at the partnership levelattributable to the refinancings described below. Sale of Propane and Refinancing Costs and Expenses The Partnership has signed an agreement to sell its propane distribution and services business, held through the propane segment to Inergy for $475 million,subject to certain adjustments. In addition, the Partnership has given notice to holders of the secured notes of the heating oil segment of its optional electionto prepay the secured notes, representing an aggregate payment, including principal, interest and estimated premium, of approximately $182 million. ThePartnership has also given notice to the holders of the secured notes of its propane segment of its optional election to prepay the secured notes representingan aggregate payment including principal, interest and estimated premium, of approximately $114 million. The aggregate amount payable with regard toboth sets of secured notes is approximately $296 million. As discussed elsewhere herein, these payments are expected to be made from either the proceeds ofthe sale of the propane segment or the JP Morgan Chase bridge facility. The Partnership is taking steps to put in place, on or before December 17, 2004, a new asset based loan facility to refinance the working capital indebtednessof the heating oil segment as well as a bridge facility to provide funds to repay the heating oil segment’s and propane segment’s institutional indebtedness ifthe sale of the propane segment is not completed by such date. In connection with the sale of the propane segment, the refinancing of the heating oilsegment’s working capital facility and certain covenant modifications required of the heating oil segment’s current bank facilities, the Partnership estimatesfees and expenses associated with these transactions will range from $20.0 million to $35.0 million. If these transactions are completed, the Partnershipestimates that between $9.0 million and $12.5 million of fees and expenses will be charged to income during the first quarter of fiscal 2005 and between $7.6million and $10.2 million will be capitalized as a deferred charge. The Partnership also expects to record a loss on the early extinguishment of long-term debtof approximately $43 million, which includes pre-payment premiums paid of $36.5 million and the write-off of approximately $6.2 million of previouslycapitalized deferred financing costs. It is estimated that the Partnership will record a gain on the sale of the propane segment in excess of approximately $150million and is subject to adjustment. Through December 10, 2004, the Partnership had paid $8.2 million in fees and expenses relating to the above transactions, which are included in the aboveestimates. 45 Table of ContentsLiquidity and Capital Resources The ability of the Partnership to satisfy its obligations will depend on its future performance, which will be subject to prevailing economic, financial,business and weather conditions, the ability to pass on the full impact of record heating oil prices to customers, the effects of higher customer attrition andother factors, most of which are beyond its control. Future capital requirements of the Partnership are expected to be provided by cash flows from operatingactivities and cash on hand at September 30, 2004. To the extent future capital requirements exceed cash flows from operating activities, the Partnershipanticipates that: a)working capital will be financed by the Partnership’s new revolving credit facility as discussed below and repaid from subsequent seasonalreductions in inventory and accounts receivable; and b)maintenance and growth capital expenditures, mainly for customer tanks, will be financed in fiscal 2005 by the use of the new revolving creditfacility. See “ Financing and Sources of Liquidity Following Refinancing Transactions” below. Operating Activities The net cash provided by operating activities of $65.8 million for fiscal 2004 consisted of losses from continuing operations of $6.2 million, non-cashcharges of $69.6 million and $2.5 million provided from a decline in operating assets and liabilities. For fiscal 2004, net cash provided by the change inoperating assets and liabilities was $2.5 million. In fiscal 2003, the change in operating assets and liabilities resulted in a use of cash amounting to $17.4million. This change of $19.9 million is largely due to the cash required to finance accounts receivable. In fiscal 2003, sales increased by $396.4 million, or40.2%, to $1,382.3 million, which resulted in an increase in accounts receivable of $24.0 million or 6.1% of the increase in sales. In contrast to the changefrom fiscal 2002 to 2003, sales for fiscal 2004 increased $71.7 million, or 5.2%, to $1,453.9 million, as compared to 2003 and resulted in an increase inaccounts receivable of $6.2 million or 8.6% of the increase in sales. Investing Activities During fiscal 2004, the Partnership completed 13 acquisitions, investing $17.5 million, and spent $9.4 million for capital expenditures comprised of $4.4million incurred to sustain operations at current levels and $5.4 million to support growth of operations. Investing activities also includes $12.5 million fromthe sale of TG&E and $2.3 million from the sale of excess fixed assets. As a result, cash flows used in investing activities were $12.1 million. During fiscal 2003, the Partnership completed ten acquisitions, investing $84.4 million. This expenditure for acquisitions is included in the cash used ininvesting activities of $101.2 million along with the $18.5 million invested for capital expenditures. The $18.5 million for capital expenditures is comprisedof $7.1 million of capital additions needed to sustain operations at current levels and $11.4 million for capital expenditures incurred in connection with theheating oil segment’s business process redesign program and for customer tanks and other capital expenditures to support growth of operations. Investingactivities also includes proceeds from the sale of fixed assets of $1.7 million. Financing Activities Cash flows used in financing activities were $49.2 million for fiscal 2004. During this period, $105.5 million of cash was provided from the issuance of $70.5million in MLP Notes and the issuance of $35.0 million in common units. Also during this period $154.7 million of cash was used to pay unit distributions of$79.9 million, $64.3 million went to repay the acquisition facility and other long-term debt, $4.0 million was used to repay working capital borrowings, and$6.5 million in deferred charges were paid, primarily $5.8 million relating to the renewal of the heating oil segment’s bank credit facilities and debt relatedfinancing costs. As a result of the above activity and $1.5 million of cash provided by discontinued operations, cash increased by $6.0 million to $16.1 million as ofSeptember 30, 2004. 46 Table of ContentsFinancing and Sources of Liquidity Following Refinancing Transactions In accordance with the JP Morgan Chase Bank Commitment Letter, the heating oil segment and propane segment intend to enter into a $350 millionrevolving credit facility agreement with a group of lenders led by JP Morgan Chase Bank, as administrative agent on or before December 17, 2004. (Upon thesale of the propane segment, the revolving credit facility would be reduced to $260 million). At the same time, the heating oil segment and propane segmentintend to enter into a $300 million bridge facility agreement. The revolving credit facility agreement is intended to close on December 17, 2004, subject tocompliance with customary closing conditions. If the sale of the propane segment closes on or before December 17, 2004, the Partnership would not drawdown on the bridge facility. Otherwise, the Partnership would expect to close the bridge facility agreement at the same time as the closing of the revolvingcredit agreement. The proceeds of the revolving credit facility and, as applicable, the bridge facility or the sale of the propane segment, will be used torefinance the heating oil segment and propane segment’s existing working capital facilities, to refinance all of the outstanding institutional indebtedness ofthe heating oil segment and the propane segment, including any premiums that are payable thereunder and to pay various transaction expenses. The revolving credit facility will provide the heating oil segment and propane segment with the ability to borrow up to $350 million for working capitalpurposes (subject to certain borrowing base limitations), including the issuance of up to $75 million in letters of credit. Obligations under the revolvingcredit facility will be secured by liens on substantially all of the assets of the heating oil segment and the propane segment, accounts receivable, inventory,general intangibles, real property, fixtures and equipment. If the propane segment is sold (either before or after December 17, 2004), the revolving creditfacility will be reduced to $260 million (subject to borrowing base limitations) and the liens on all of the assets of the propane segment would be released.Obligations under the revolving credit facility will be guaranteed by the propane segment and heating oil segment subsidiaries and by the Partnership. If the sale of the propane segment does not close until after the Partnership has drawn down on the bridge facility, the Partnership will use a portion of thesales proceeds to repay the bridge loan. Thereafter, pursuant to the terms of the indenture relating to the Partnership’s MLP Notes, the Partnership will beobligated, within 360 days of the sale, to apply the net proceeds of the sale of the propane segment either to reduce indebtedness of the Partnership or of arestricted subsidiary, or to make an investment in assets or capital expenditures useful to the Partnership’s or any subsidiary’s business. To the extent any netproceeds that are not so applied exceed $10 million (“excess proceeds”), the indenture requires the Partnership to make an offer to all holders of MLP Notesto purchase for cash that number of MLP Notes that may be purchased with excess proceeds at a purchase price equal to 100% of the principal amount of theMLP Notes plus accrued and unpaid interest to the date of purchase. The Partnership cannot determine the amount of excess proceeds that will result from thesale of the propane segment. Accordingly, the Partnership cannot predict the size of any offer to purchase MLP Notes and whether or to what extent holders ofMLP Notes will accept the offer to purchase when made. If the agreement for the sale of the propane segment is terminated, the Partnership will seek to repay the bridge facility through the issuance of senior securednotes issued by the heating oil segment and propane segment in a public or private offering. Following consummation of the refinancing transactions, the Partnership’s primary source of liquidity will be internally generated cash the remainingproceeds from the sale of the propane segment, if such segment is sold, and the revolving credit facility. At September 30, 2004, the Partnership would havehad $152.2 million of cash and cash equivalents available to fund its operations on a pro forma basis after giving effect to the refinancing transactions, sale ofthe propane segment and before the application of excess proceeds to purchase MLP Notes. Total bank borrowing would be reduced from $8.0 million tozero. If the propane segment is not sold, the Partnership would have had $3.0 million of cash and cash equivalents available to fund its operations on a proforma basis as of September 30, 2004 after giving effect to the refinancing transactions. Total bank borrowing would increase from $8.0 million to $25.8million and the Partnership’s total availability under its new revolving credit facility would have been $73.7 million (after giving effect to outstanding lettersof credit and expected borrowing base limitations). After giving effect to the refinancing transactions and sale of the propane segment, and before the application of excess proceeds to purchase MLP Notes, thePartnership’s total long-term debt would have been approximately $267.6 million as of September 30, 2004 compared to $528.1 million on an actual basis. Ifthe Partnership does not sell the propane segment, its total long-term debt on a pro forma basis after giving effect to the refinancing transactions would havebeen $569.8 million as of such date. 47 Table of ContentsThe following summarizes the long-term debt maturities that the Partnership would have had as of September 30, 2004, on a pro forma basis, in the first caseafter giving effect to the refinancing transactions and sale of the propane segment and in the second case if the propane segment is not sold: (in millions) Refinancing Transactions andSale of Propane Segment2005 $1.32006 $0.82007 $— 2008 $— 2009 $— Thereafter $267.7 Refinancing Transactions WithoutSale of Propane Segment2005 $1.32006 $0.82007 $— 2008 $— 2009 $— Thereafter $567.6 The Partnership expects that its significant liquidity requirements after the refinancing transaction will consist of payments on MLP Notes (and the bridgefacility or senior secured notes if the propane segment is not sold) and working capital requirements and capital expenditures. The revolving credit facility and, as applicable, the bridge facility or the senior secured notes, will impose certain restrictions on the Partnership, includingrestrictions on its ability to incur additional indebtedness, to pay distributions, make investments, grant liens, sell its assets and engage in certain otheractivities. The revolving credit facility and, as applicable, the bridge facility or the senior secured notes, will also require the Partnership to maintain certainfinancial ratios, and will contain borrowing conditions and customary events of default, including nonpayment of principal or interest, violation ofcovenants, inaccuracy of representations and warranties, cross-defaults to other indebtedness, bankruptcy and other insolvency events. The occurrence of anevent of default or an acceleration under the revolving credit facility and, as applicable, the bridge facility or the senior secured notes, would result in itsinability to obtain further borrowings under that facility, which could adversely affect its liquidity. An acceleration under the revolving credit facility and, asapplicable, the bridge facility or the senior secured notes, would result in a default under the MLP Notes and, as applicable, the Partnership’s other fundeddebt. Based on the Partnership’s current level of operations, the Partnership believes that its existing financial resources together with its current and anticipatedcash from operations, the revolving credit facility and the proceeds of the sale of the propane segment or the bridge facility or senior secured notes, if thepropane segment is not sold, should be adequate for the foreseeable future to make required payments of principal and interest on its debt and fund itsworking capital and capital expenditure requirements. The Partnership cannot assure you, however, that its business will generate sufficient cash flow fromoperations or that future borrowings will be available under its revolving credit facility in an amount sufficient to enable the Partnership to service its debt,including the MLP Notes and, as applicable, the bridge facility or the senior secured notes, and to fund its other liquidity needs. If the Partnership is unable to close the revolving credit facility and either the bridge facility or the sale of the propane segment by December 17, 2004, thePartnership would not be able to find other sources of financing before December 17, 2004 to refinance the heating oil segment’s and propane segment’scredit facilities and to repay the heating oil segment’s and propane segment’s institutional indebtedness, which are due and payable on such date. In suchevent, if the Partnership is not successful in rescheduling the maturity dates of such indebtedness, the Partnership may be forced to seek the protection of thebankruptcy courts. To the extent the Partnership makes acquisitions, or otherwise expand its operations in the future, it may require new sources of funding,including additional debt which could further increase its leverage. The Partnership cannot assure you that it will be able to raise any necessary funds inaddition to those currently available to the Partnership through bank financing or the issuance of equity or debt securities on terms acceptable to thePartnership, if at all. The revolving credit facility and, as applicable, the bridge facility or the senior secured notes, will impose certain restrictions on the Partnership’s ability topay distributions to unitholders. The Partnership believes that the sale of the propane segment would, by de-leveraging the Partnership’s balance sheet, likelyadvance the time when it would be possible for the Partnership to resume regular distributions on the common units. The Partnership believes that whether ornot the propane segment is sold, it is unlikely that the Partnership will resume regular distributions on the senior subordinated units, junior subordinatedunits and general partner units for the foreseeable future. 48 Table of ContentsHistorical Financing and Sources of Liquidity At September 30, 2004, the Partnership’s heating oil segment had a bank credit facility consisting of three facilities totaling $235.0 million having a maturitydate of June 30, 2006. These facilities consisted of a $150.0 million revolving credit facility, the proceeds of which are to be used for working capitalpurposes, a $35.0 million revolving credit facility, the proceeds of which were to be used for the issuance of standby letters of credit in connection withsurety, worker’s compensation and other financial guarantees, and a $50.0 million revolving credit facility, the proceeds of which were to be used to financeor refinance certain acquisitions and capital expenditures, for the issuance of letters of credit in connection with acquisitions and, to the extent that there isinsufficient availability under the working capital facility. At September 30, 2004, $8.0 million of working capital borrowings and $34.5 million of theinsurance letters of credit were outstanding. At September 30, 2004, the Partnership’s propane segment had a bank credit facility, which consisted of a $25.0 million acquisition facility, a $25.0 millionparity debt facility that could be used to fund maintenance and growth capital expenditures and a $24.0 million working capital facility. The working capitalfacility expired on September 30, 2006. Borrowings under the acquisition and parity debt facilities revolved until September 30, 2006, after which time anyoutstanding loans thereunder, would amortize in quarterly principal payments with a final payment due on September 30, 2008. At September 30, 2004, $2.0million of parity debt facility borrowings were outstanding. The Partnership’s bank credit facilities and debt agreements contain several financial tests and covenants restricting the various segments and Partnership’sability to pay distributions, incur debt and engage in certain other business transactions. In general these tests are based upon achieving certain debt to cashflow ratios and cash flow to interest expense ratios. In addition, the heating oil segment’s working capital facility requires the heating oil segment to maintaina zero balance for at least forty-five consecutive days. The propane segment’s working capital facility has a similar requirement which is thirty consecutivedays. Failure to comply with the various restrictive and affirmative covenants of the Partnership’s various bank and note facility agreements could negativelyimpact the Partnership’s ability to incur additional debt and/or pay distributions and could cause certain debt to become currently payable. As of September 30, 2004, the Partnership was in compliance with all debt covenants, except for the required ratio of Consolidated Cash Flow toConsolidated Interest Expense as defined in the heating oil segment’s bank facilities. The heating oil segment obtained a waiver of this covenant onNovember 5, 2004 through December 17, 2004. On October 13, 2004, the heating oil segment advised its bank lenders that it would not be able to make therequired representations included in the borrowing certificate under its working capital line. In addition, the heating oil segment notified its lenders that, forthe quarter ending December 31, 2004 and for the foreseeable future thereafter, the heating oil segment will be unlikely to satisfy the drawing condition thatrequires that the consolidated funded debt of the Partnership not exceed 5.00 times its consolidated operating cash flow. Further, the heating oil segmentadvised the lenders that the heating oil segment may not be able to maintain a zero balance under the working capital facility (except for letter of creditobligations) for 45 consecutive days from April 1, 2005 to September 30, 2005, as required by the heating oil segment’s covenants. See “Recent Events.” On November 5, 2004, the heating oil segment entered into a letter amendment and waiver under its heating oil segment credit agreement. As a result of theamendment, the heating oil segment expects to be able to continue to borrow funds under the credit agreement to support its working capital requirements forthe near term. The amendment provides for the waiver, through December 17, 2004, of various terms under the credit agreement. The amendment also amendsfor the waiver period the financial covenant regarding the Partnership’s consolidated funded debt to cash flow ratio and the financial covenant regarding theheating oil segment cash flow to interest expense ratio. The Partnership is relying upon the closing of the revolving credit facility to provide funds to repaythe amounts outstanding under the heating oil segment and propane segment’s current bank facilities and to provide an ongoing source of working capital. On January 22, 2004, the Partnership and Star Gas Finance Company jointly issued $35.0 million face value senior notes due on February 15, 2013. Thesenotes accrue interest at an annual rate of 10.25% and require semi-annual interest payments on February 15 and August 15 of each year commencing onFebruary 15, 2004. These notes are redeemable at the option of the Partnership, in whole or in part, from time to time by payment of a premium as defined.These notes were priced at 110.5% for total gross proceeds of $38.7 million. The Partnership also incurred $0.5 million of fees and expenses in connectionwith the issuance of these notes, resulting in net proceeds of $38.2 million. The net proceeds from the offering were largely used to repay indebtedness. In February 2004, the Partnership received net proceeds after expenses of $35.0 million from a publicly underwritten equity offering for the sale of 1,495,000common units. The net proceeds from this underwriting were largely used to repay indebtedness. 49 Table of ContentsOn July 8, 2004, the Partnership and Star Gas Finance Company jointly issued $30.0 million face value senior notes due on February 15, 2013. These notesaccrue interest at an annual rate of 10.25% and require semi-annual interest payments on February 15 and August 15 of each year commencing on February15, 2004. These notes are redeemable at the option of the Partnership, in whole or in part, from time to time by payment of a premium as defined. These noteswere priced at 106.3% for total gross proceeds of $31.9 million. The Partnership also incurred $0.7 million of fees and expenses in connection with theissuance of these notes, resulting in net proceeds of $31.2 million. The net proceeds from the offering were largely used to repay indebtedness. The Partnership has $528.1 million of debt outstanding as of September 30, 2004 (amount does not include working capital borrowings of $8.0 million), withsignificant maturities occurring over the next five years. The following summarizes the Partnership’s long-term debt maturities during fiscal years endingSeptember 30, exclusive of amounts that have been repaid through September 30, 2004: (in millions) 2005 $24.4(a)2006 $81.4 2007 $38.7 2008 $17.6 2009 $17.5 Thereafter $348.5 (a)On November 18, 2004, the Partnership gave notice to holders of the heating oil segment’s secured notes of its optional election to prepay suchsecured notes and gave notice of its optional election to prepay its propane segment’s secured notes. As a result, the amount due in fiscal 2005increases by $233.2 million to $257.6 million. The Partnership’s heating oil segment’s bank facilities allow for the refinancing of up to $20.0 million of existing senior debt and the Partnership’s propanesegment’s bank facilities allow for the refinancing of up to $25.0 million of existing senior debt. The refinancing capabilities are subject to capacity andother restrictions. The Partnership is dependent upon the closing of the bridge facility and/or the sale of the propane segment to fund the repayment of thisindebtedness. In general, the Partnership distributes to its partners on a quarterly basis, all of its Available Cash in the manner described in Note 3 (Quarterly Distribution ofAvailable Cash) of the Consolidated Financial Statements. Available Cash is defined for any of the Partnership’s fiscal quarters, as all cash on hand at the endof that quarter, less the amount of cash reserves that are necessary or appropriate in the reasonable discretion of the general partner to (i) provide for the properconduct of the business; (ii) comply with applicable law, any of its debt instruments or other agreements; or (iii) provide funds for distributions to thecommon unitholders and the senior subordinated unitholders during the next four quarters, in some circumstances. On October 18, 2004, the Partnershipannounced that it would not pay a distribution on the common units as a result of the requirements of its lenders. The Partnership had previously announcedthe suspension of distributions on the senior subordinated units on July 29, 2004 and it is unlikely that regular distributions on the senior subordinated unitswill be resumed in the foreseeable future. For more information on the relative rights and preferences of the senior subordinated units, see the Partnership’spartnership agreement which is incorporated by reference in this Annual Report as described in Item 15. The Partnership believes that the purchase of weather insurance could be an important element in the Partnership’s ability to maintain the stability of its cashflows. The Partnership purchased weather insurance that could have provided up to $20.0 million of coverage for the impact of warm weather on the heatingoil segment’s operating results for the 2002 - 2003 and 2003 - 2004 heating seasons. No amounts were received under the policies during fiscal 2003 and2004 due to colder than normal temperatures. In addition, the Partnership purchased a base of $12.5 million of weather insurance coverage for each year from2005 – 2007 and purchased an additional $7.5 million of weather insurance coverage for fiscal 2005. The amount of insurance proceeds that could berealized under these policies is calculated by multiplying a fixed dollar amount by the degree day deviation from an agreed upon cumulative degree daystrike price. 50 Table of ContentsContractual Obligations and Off-Balance Sheet Arrangements It is not the Partnership’s business practice to enter into off-balance sheet arrangements with third parties. See Note 14 to the Partnership’s consolidatedfinancial statements for a description of the Partnership’s off-balance sheet arrangements. Long-term contractual obligations, except for our long-term debt obligations, are not recorded in our Consolidated Balance Sheet. Non-cancelable purchaseobligations are obligations the Partnership incurs during the normal course of business, based on projected needs. The table below summarizes the payment schedule of contractual obligations at September 30, 2004 (in thousands): Payments Due by Year Total Less Than1 Year 1-3Years 3-5Years More Than5 YearsLong-term debt obligations (a) $503,668 $— $120,094 $35,100 $348,474Operating lease obligations (b) 49,822 10,334 14,913 9,854 14,721Purchase obligations (c) 21,754 10,792 8,613 2,345 4 $575,244 $21,126 $143,620 $47,299 $363,199 (a)Excludes current maturities of long-term debt of $24.4 million which are classified within current liabilities. On November 18, 2004, the Partnershipgave notice of holders of the heating oil segment’s secured notes of its optional election to prepay such secured notes and gave notice of its optionalelection to prepay its propane segment’s secured notes. As a result, the amount due in fiscal 2005 increases by $233.2 million to $257.6 million. (b)The Partnership has entered into various operating leases for office space, trucks, vans and other equipment from third parties with lease terms runningfrom one day to 16 years. (c)Reflects non-cancelable commitments as of September 30, 2004. 51 Table of ContentsCritical Accounting Policies and Estimates The preparation of financial statements in conformity with Generally Accepted Accounting Principles requires management to establish accounting policiesand make estimates and assumptions that affect reported amounts of assets and liabilities at the date of the Consolidated Financial Statements. Star Gasevaluates its policies and estimates on an on-going basis. The Partnership’s Consolidated Financial Statements may differ based upon different estimates andassumptions. The Partnership’s critical accounting policies have been reviewed with the Audit Committee of the Board of Directors. The Partnership’s significant accounting policies are discussed in Note 3 to the Consolidated Financial Statements. Star Gas believes the following are itscritical accounting policies: Goodwill and Other Intangible Assets The Partnership calculates amortization using the straight-line method over periods ranging from 7 to 15 years for intangible assets with definite useful lives.Star Gas uses amortization methods and determines asset values based on its best estimates using reasonable and supportable assumptions and projections.Star Gas assesses the useful lives of intangible assets based on the estimated period over which Star Gas will receive benefit from such intangible assets suchas historical evidence regarding customer churn rate. In some cases, the estimated useful lives are based on contractual terms. At September 30, 2004, thePartnership had $180.2 million of net intangible assets subject to amortization. If circumstances required a change in estimated useful lives of the assets, itcould have a material effect on results of operations. For example, if lives were shortened by one year, the Partnership estimates that amortization for theseassets for fiscal 2004 would have increased by approximately $3.0 million. SFAS No. 142 requires the Partnership’s goodwill to be assessed at least annually for impairment. These assessments involve management’s estimates offuture cash flows, market trends and other factors to determine the fair value of the reporting unit, which includes the goodwill to be assessed. If the carryingamount of goodwill exceeds its implied fair value and is determined to be impaired, an impairment charge is recorded. At September 30, 2004, the Partnershiphad $276.1 million of goodwill. Intangible assets with finite lives must be assessed for impairment whenever changes in circumstances indicate that the assetsmay be impaired. Similar to goodwill, the assessment for impairment requires estimates of future cash flows related to the intangible asset. To the extent thecarrying value of the assets exceeds it future cash flows, an impairment loss is recorded based on the fair value of the asset. The Partnership tests the carryingamount of goodwill annually during the fourth quarter of its fiscal year. The Partnership has determined that there is no impairment of goodwill at either theheating oil segment or propane segment as of September 30, 2003 and 2004. Depreciation of Property, Plant and Equipment Depreciation is calculated using the straight-line method based on the estimated useful lives of the assets ranging from 1 to 30 years. Net property, plant andequipment was $247.5 million for the Partnership at September 30, 2004. If circumstances required a change in estimated useful lives of the assets, it couldhave a material effect on results of operations. For example, if lives were shortened by one year, the Partnership estimates that depreciation for fiscal 2004would have increased by approximately $3.3 million. Assumptions Used in the Measurement of the Partnership’s Defined Benefit Obligations SFAS No. 87, “Employers’ Accounting for Pensions” as amended by SFAS No. 132 “Employers Disclosure about Pensions and Other Postretirement Benefits”requires the Partnership to make assumptions as to the expected long-term rate of return that could be achieved on defined benefit plan assets and discountrates to determine the present value of the plans’ pension obligations. The Partnership evaluates these critical assumptions at least annually. The discount rate enables the Partnership to state expected future cash flows at a present value on the measurement date. The rate is required to represent themarket rate for high-quality fixed income investments. A lower discount rate increases the present value of benefit obligations and increases pension expense.A 25 basis point decrease in the discount rated used for fiscal 2004 would have increased pension expense by approximately $0.1 million and would haveincreased the minimum pension liability by another $1.8 million. The Partnership assumed a discount rate of 6.00% as of September 30, 2004. The Partnership considers the current and expected asset allocations, as well as historical and expected returns on various categories of plan assets todetermine its expected long-term rate of return on pension plan assets. The expected long-term rate of return on assets is developed with input from thePartnership’s qualified actuaries. The long-term rate of return assumption used for determining net periodic pension expense for fiscals 2003 and 2004 was8.5% and 8.25% respectively. As of September 30, 2003, this assumption was reduced to 8.25% for determining net periodic pension expense. A further 25basis point decrease in the expected return on assets would have increased pension expense in fiscal 2004 by approximately $0.1 million. Over the life of the plans, both gains and losses have been recognized by the plans in the calculation of annual pension expense. As of September 30, 2004,$15.4 million of unrecognized losses remain to be recognized by the plans. These losses may result in increases in future pension expense as they arerecognized. 52 Table of ContentsAllowance for Doubtful Accounts The Partnership periodically reviews past due customer accounts receivable balances. After giving consideration to economic conditions, overdue status andother factors, the Partnership establishes an allowance for doubtful accounts at each of its segments which it deems sufficient to cover future potential losses.As a result, actual losses could differ from management’s estimates; however, based on historical experience, the Partnership does not expect its estimate ofuncollectible accounts to vary significantly from actual losses. Insurance Reserves The Partnership’s heating oil segment has in the past and is currently self-insuring a portion of workers’ compensation, auto and general liability claims. InFebruary 2003, the propane segment also began self-insuring a portion of its workers’ compensation claims. The Partnership establishes reserves based uponexpectations as to what its ultimate liability may be for these claims using developmental factors based upon historical claim experience. The Partnershipcontinually evaluates the potential for changes in loss estimates with the support of qualified actuaries. As of September 30, 2004, the heating oil segmenthad approximately $30.1 million of insurance reserves and the propane segment had $1.4 million of insurance reserves. The ultimate settlement of theseclaims could differ materially from the assumptions used to calculate the reserves which could have a material adverse effect on results of operations. 53 Table of Contents ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Partnership is exposed to interest rate risk primarily through its bank credit facilities. The Partnership utilizes these borrowings to meet its workingcapital needs and also to fund the short-term needs of its acquisition program. At September 30, 2004, the Partnership had outstanding borrowings totaling $536.1 million, of which approximately $10.0 million is subject to variableinterest rates under its Bank Credit Facilities. In the event that interest rates associated with these facilities were to increase 100 basis points, the impact onfuture cash flows would be a decrease of approximately $0.1 million annually. The Partnership also selectively uses derivative financial instruments to manage its exposure to market risk related to changes in the current and futuremarket price of home heating oil and propane. The value of market sensitive derivative instruments is subject to change as a result of movements in marketprices. Consistent with the nature of hedging activity, associated unrealized gains and losses would be offset by corresponding decreases or increases in thepurchase price the Partnership would pay for the home heating oil, propane or natural gas being hedged. Sensitivity analysis is a technique used to evaluatethe impact of hypothetical market value changes. Based on a hypothetical ten percent increase in the cost of product at September 30, 2004, the potentialimpact on the Partnership’s hedging activity would be to increase the fair market value of these outstanding derivatives by $14.1 million to a fair marketvalue of $45.4 million; and conversely a hypothetical ten percent decrease in the cost of product would decrease the fair market value of these outstandingderivatives by $12.4 million to a fair market value of $19.0 million. ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements and financial statement schedules referred to in the index contained on page F-1 of this report are incorporated herein by reference. ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE NONE ITEM 9A.CONTROLS AND PROCEDURES (a)Evaluation of disclosure controls and procedures. The General Partner’s principal executive officer and its principal financial officer evaluated the effectiveness of the Partnership’s disclosure controlsand procedures as of the end of the period covered by this report. Based on that evaluation, such principal executive officer and principal financialofficer concluded that the Partnership’s disclosure controls and procedures as of the end of the period covered by this report have been designed andare functioning effectively to provide reasonable assurance that the information required to be disclosed by the Partnership in reports filed under theSecurities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. TheGeneral Partner and the Partnership believes that a control system, no matter how well designed and operated, can not provide absolute assurance thatthe objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud,if any, within a company have been detected. (b)Change in Internal Control over Financial Reporting. No change in the Partnership’s internal control over financial reporting occurred during the Partnership’s most recent fiscal quarter that has materiallyaffected, or is reasonably likely to materially affect the Partnership’s internal control over financial reporting. 54 Table of Contents PART III ITEM 10.DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Partnership Management Star Gas LLC is the general partner of the Partnership. The membership interests in Star Gas LLC are owned by Audrey L. Sevin, Irik P. Sevin and HanseaticAmericas, Inc. The members holding a majority of interests in the General Partner appoint the directors of the General Partner. A majority of interests in theGeneral Partner are currently held in the aggregate by Irik P. Sevin and his mother, Audrey L. Sevin. The General Partner manages and operates the activitiesof the Partnership. Unitholders do not directly or indirectly participate in the management or operation of the Partnership. The General Partner owes afiduciary duty to the Unitholders. However, the Partnership agreement contains provisions that allow the General Partner to take into account the interest ofparties other than the Limited Partners in resolving conflict of interest, thereby limiting such fiduciary duty. Notwithstanding any limitation on obligationsor duties, the General Partner will be liable, as the general partner of the Partnership, for all debts of the Partnership (to the extent not paid by the Partnership),except to the extent that indebtedness or other obligations incurred by the Partnership are made specifically non-recourse to the General Partner. William P. Nicoletti, Paul Biddelman and Stephen Russell, who are neither officers nor employees of the General Partner nor directors, officers or employeesof any affiliate of the General Partner, have been appointed to serve on the Audit Committee of the General Partner’s Board of Directors. The Partnership’sBoard of Directors adopted an Audit Committee Charter during fiscal 2003. A copy of this charter is available on the Partnership’s website at www.Star-Gas.com. The Audit Committee has the authority to review, at the request of the General Partner, specific matters as to which the General Partner believesthere may be a conflict of interest in order to determine if the resolution of such conflict proposed by the General Partner is fair and reasonable to thePartnership. Any matters approved by the Audit Committee will be conclusively deemed fair and reasonable to the Partnership, approved by all partners ofthe Partnership and not a breach by the General Partner of any duties it may owe the Partnership or the holders of Limited Partnership Units. In addition, theAudit Committee reviews the external financial reporting of the Partnership, selects and engages the Partnership’s independent accountants and approves allnon audit engagements of the independent accountants. With respect to the additional matters, the Audit Committee may act on its own initiative to questionthe General Partner and, absent the delegation of specific authority by the entire Board of Directors, its recommendations will be advisory. The Board of Directors of the General Partner has adopted a set of Partnership Governance Guidelines in accordance with the requirements of the New YorkStock Exchange. A copy of these Guidelines is available on the Partnership’s website at www.Star-Gas.com. As is commonly the case with publicly traded limited partnerships, the Partnership does not directly employ any of the persons responsible for managing oroperating the Partnership. The management and workforce of the propane segment and certain employees of the heating oil segment manage and operate thePartnership’s business as officers of the General Partner and its Affiliates. See Item 1 - Business - Employees. Directors and Executive Officers of the General Partner Directors are elected for one-year terms. The following table shows certain information for directors and executive officers of the general partner as ofDecember 9, 2004: Name Age Position with the General PartnerIrik P. Sevin (b) 57 Chairman, President and Chief Executive OfficerAmi Trauber 65 Executive Vice President - Chief Financial OfficerJoseph P. Cavanaugh 67 Chief Executive Officer – Propane SegmentDavid A. Shinnebarger 45 Executive Vice President – Chief Marketing OfficerDaniel P. Donovan 58 President - Heating Oil SegmentRichard F. Ambury 47 Vice President and TreasurerAudrey L. Sevin 78 Director, SecretaryPaul Biddelman(a) (b)(c) 58 DirectorWilliam P. Nicoletti(c) 59 DirectorStephen Russell(a) (c) 64 Director(a)Member of the Compensation Committee (b)Member of the Distribution Committee (c)Member of the Audit Committee 55 Table of ContentsIrik P. Sevin has been the Chairman of the Board and Chief Executive Officer of Star Gas LLC since March 1999 and President since November 2003. FromDecember 1993 to March 1999, Mr. Sevin served as Chairman of the Board of Directors of Star Gas Corporation, the predecessor general partner. Mr. Sevinhas been a Director of Petro since its organization in October 1979, and Chairman of the Board of Petro since January 1993 and served as President of Petrofrom 1979 through January 1997. Mr. Sevin was an associate in the investment banking division of Kuhn Loeb & Co. and then Lehman Brothers Kuhn LoebIncorporated from February 1975 to December 1978. Ami Trauber has been Chief Financial Officer of Star Gas LLC since November 2001. From 1996 to 2001, Mr. Trauber was the Chief Financial Officer ofSyratech Corporation, a consumer goods company. From 1991 to 1995, Mr. Trauber was the President, Chief Operating Officer and part owner of Ed’s West,Inc., an apparel company. From 1978 to 1990, Mr. Trauber was Corporate Vice President – Finance and Controller of Harcourt General, Inc., a fortune 500conglomerate. Joseph P. Cavanaugh has been Chief Executive Officer of the propane segment since March 1999 and Executive Vice President, Acquisitions of Star GasLLC since November 2003. From December 1997 to March 1999 Mr. Cavanaugh served as President and Chief Executive Officer of Star Gas Corporation, thepredecessor general partner. From October 1979 to December 1997, Mr. Cavanaugh held various financial and management positions with Petro. Prior to hiscurrent appointment Mr. Cavanaugh was also active in the Partnership’s management with the development of safety/compliance programs, assisting withacquisitions and their subsequent integration into the Partnership. David A. Shinnebarger has been Executive Vice President - Chief Marketing Officer of Star Gas LLC since November 2003. From February 2001 to February2003, Mr. Shinnebarger served as partner at Peppers and Rodgers Group; from March 2000 to February 2001 he served as vice president and general managerof E-Stamp Corporation; from December 1998 to March 2000 he worked as senior engagement manager of McKinsey & Company; from September 1983 toMarch 1998 he served as marketing manager to the United States Postal Service; and from January 1981 to September 1983 he worked as an executiverecruiter for Northrop Services, Inc. Daniel P. Donovan has been President of the heating oil segment since May 2004. From January 1980 to May 2004, he held various management positionswith Meenan Oil, including Vice President and General Manager. From 1971 to 1980, he worked for Mobil Oil. His last position with Mobil Oil wasPresident and General Manger of their heating oil subsidiary in New York City. Richard F. Ambury has been Vice President and Treasurer of Star Gas LLC since March 1999. From February 1996 to March 1999, Mr. Ambury served asVice President - Finance of Star Gas Corporation, the predecessor general partner. Mr. Ambury was employed by Petro from June 1983 through February1996, where he served in various accounting/finance capacities. From 1979 to 1983, Mr. Ambury was employed by a predecessor firm of KPMG, a publicaccounting firm. Mr. Ambury has been a Certified Public Accountant since 1981. Audrey L. Sevin has been a Director of Star Gas LLC since March 1999 and was a Director of Star Gas Corporation, the predecessor general partner fromDecember 1993 to March 1999. Mrs. Sevin served as the Secretary of Star Gas Corporation from June 1994 to March 1999. Mrs. Sevin had been a Directorand Secretary of Petro since its organization in October 1979. Mrs. Sevin was a Director, executive officer and principal shareholder of A. W. Fuel Co., Inc.from 1952 until its purchase by Petro in May 1981. Paul Biddelman has been a Director of Star Gas LLC since March 1999 and was a Director of Star Gas Corporation, the predecessor general partner fromDecember 1993 to March 1999. Mr. Biddelman was a director of Petro from October 1994 until March 1999. Mr. Biddelman has been President of HanseaticCorporation since December 1997. From April 1992 through December 1997, he was Treasurer of Hanseatic Corporation. Mr. Biddelman is a director ofCeladon Group, Inc., Insituform Technologies, Inc., Six Flags, Inc. and System One Technologies, Inc. William P. Nicoletti has been a Director of Star Gas LLC since March 1999 and was a Director of Star Gas Corporation, the predecessor general partner fromNovember 1995 until March 1999. He is Managing Director of Nicoletti & Company, Inc., a private investment banking firm. Mr. Nicoletti was formerly asenior officer and head of Energy Investment Banking for E. F. Hutton & Company, Inc., PaineWebber Incorporated and McDonald Investments, Inc. Mr.Nicoletti is a director of MarkWest Energy Partners, L.P. and Russell-Stanley Holdings, Inc. Stephen Russell has been a Director of Star Gas LLC since October 1999 and was a director of Petro from July 1996 until March 1999. He has been Chairmanof the Board and Chief Executive Officer of Celadon Group Inc., an international transportation company, since its inception in July 1986. Mr. Russell hasbeen a member of the Board of Advisors of the Johnson Graduate School of Management, Cornell University since 1983. Audrey Sevin is the mother of Irik P. Sevin. There are no other familial relationships between any of the directors and executive officers. 56 Table of ContentsMeetings and Compensation of Directors During fiscal 2004, the Board of Directors met seven times. All Directors attended each meeting except that Mr. Russell did not attend two meetings. Eachnon-management Director receives an annual fee of $27,000 plus $1,500 for each regular meeting attended and $750 for each telephonic meeting attended.The Chairman of the Audit Committee receives an annual fee of $12,000 while other Audit Committees members receive an annual fee of $6,000. TheChairman of the Compensation Committee receives an annual fee of $6,000 while other non-management members of the Compensation Committee andDistribution Committee receive an annual fee of $3,000. Each member of the Audit Committee receives $1,500 for every regular meeting attended and $750for every telephonic meeting attended. Each non-management member of the Compensation Committee and Distribution Committee receives $1,000 for eachregular meeting attended and $500 for each telephonic meeting attended. In October 2004, a Special Committee of the Board of Directors was established forpurposes of reviewing the sale of the propane segment. The members of this Committee received a one-time fee of $100,000 each plus $1,500 for each regularmeeting attended and $750 for each telephonic meeting. See “Special Committee” below. Effective October 1, 2004 the lead director receives an annual feeof $10,000. Messrs. Biddelman, Nicoletti and Russell each had 1,700 previously granted restricted senior subordinated units vest for fiscal 2003 under thePartnership’s Director and Employee Unit Incentive Plan. The value as of September 30, 2003 of these Senior Subordinated Units was $34,867 for eachdirector. As of September 30, 2004, each director had 1,700 Restricted Senior Subordinated Units still outstanding that subsequently terminated withoutvesting as the performance target for such restricted units was not met. In lieu of director fees, Messrs. Biddelman, Nicoletti and Russell each was granted 2,709 senior subordinated unit appreciation rights during fiscal 2003.Each of these directors forfeited $4,200 of director fees to obtain these rights. The Unit Appreciation Rights vested in three equal installments on October 1,2002, October 1, 2003 and October 1, 2004. The grantee will be entitled to receive payment in cash for these UARs on October 1, 2005 (subject to deferral toa date no later than October 1, 2007) equal to the excess of the fair market value as defined of a Senior Subordinated Unit on the respective vesting dates overthe strike price of $10.70. The Partnership may elect to deliver senior subordinated units in satisfaction of this payment rather than cash, subject tocomplying with applicable securities regulations. These units were granted under the same program as units granted to the Chief Executive Officer and othercertain named executives – see Item 11 – Executive Compensation. Committees of the Board of Directors Star Gas LLC’s Board of Directors has three standing committees; an Audit Committee, a Compensation Committee and a Distribution Committee. Themembers of each such committee are appointed by the Board of Directors for a one-year term and until their respective successors are elected. The Board ofDirectors has also appointed a Special Committee in connection with the sale of the propane segment, which is discussed below. Audit Committee The duties of the Audit Committee are described above under “Partnership Management.” The current members of the Audit Committee are William P. Nicoletti, Paul Biddelman and Stephen Russell. During fiscal 2004, the audit committee met tentimes. Members of the Audit Committee may not be employees of Star Gas LLC or its affiliated companies and must otherwise meet the New York StockExchange and SEC independence requirements for service on the Audit Committee. The Partnership’s Board of Director’s has determined that Mr. Nicoletti,the Chairman of the Audit Committee, meets the definition of an Audit Committee financial expert under applicable SEC and NYSE regulations and has alsodetermined that all of the members of the Audit Committee, including Mr. Nicoletti meet the independence requirements of the NYSE and the SEC. Compensation Committee The current members of the Compensation Committee are Paul Biddelman and Stephen Russell. Mr. Russell was appointed as a member of the CompensationCommittee in December 2004. Pursuant to resolutions adopted by the Board of Directors, effective as of October 1, 2003, the Chief Executive Officer has theauthority to recommend (other than with respect to himself) and the Compensation Committee the authority to set: (i) the general compensation policies ofthe Partnership and any of the Partnership’s subsidiaries or subsidiary partnerships, its general partner or other affiliates whose cost is borne directly orindirectly by Star; (ii) the terms of compensation plans and compensation levels for officers of the Partnership; (iii) the salary and bonus ranges for officers ofthe Partnership, including the performance criteria and target compensation on all performance based compensation plans or programs and the specificamounts within those ranges; (iv) the terms of any equity or equity-linked securities to be granted to any employee or director of the Partnership; and (v) theaccruals to be utilized in the financial statements related to such compensation. Distribution Committee The current members of the Distribution Committee are Irik Sevin and Paul Biddelman. The duties of the Distribution Committee are to discuss and review,and recommend to the Board of Directors, the Partnership’s distributions. During fiscal 2004, the Distribution Committee met four times. 57 Table of ContentsSpecial Committee In October 2004, the Board of Directors established a special committee of two independent directors (Messrs. Nicoletti and Russell) to exercise all power andauthority of the Board of Directors in examining the fairness to the nonaffiliated unitholders of the Partnership taken as a whole, of the consideration to bereceived by the Partnership from any sale, merger or other similar transaction involving the propane assets and business of the Partnership. For additionalinformation, see “Item 1 – Business – Sale of the Propane Segment; Prepayment of Subsidiaries’ Secured Notes.” Reimbursement of Expenses of the General Partner The General Partner does not receive any management fee or other compensation for its management of Star Gas Partners. The General Partner is reimbursedfor all expenses incurred on the behalf of Star Gas Partners, including the cost of compensation, which is properly allocable to Star Gas Partners. Thepartnership agreement provides that the General Partner shall determine the expenses that are allocable to Star Gas Partners in any reasonable mannerdetermined by the General Partner in its sole discretion. In addition, the General Partner and its affiliates may provide services to Star Gas Partners for which areasonable fee would be charged as determined by the General Partner. Adoption of Code of Ethics The Partnership has adopted a written code of ethics that applies to the Partnership’s officers, directors and employees. A copy of the Code of Ethics isavailable on the Partnership’s website at www.Star-Gas.com or a copy may be obtained without charge, by contacting Richard F. Ambury, (203) 328-7200. Non-Management Directors The non-management directors on the Board of Directors of the general partner are Messrs. Biddelman, Nicoletti and Russell. The non-management directorshave selected Mr. Nicoletti to serve as lead director to chair executive sessions of the non-management directors. Unitholders interested in contacting thelead director or the non-management directors as a group may do so by contacting William P. Nicoletti c/o Star Gas L.P., 2187 Atlantic Street, Stamford, CT,06902. 58 Table of ContentsITEM 11.EXECUTIVE COMPENSATION The following table sets forth the annual salary, bonuses and all other compensation awards and payouts to the Chief Executive Officer and to the namedexecutive officers for services rendered to Star Gas and its subsidiaries during the fiscal years ended September 30, 2002, 2003 and 2004. Summary Compensation TableAnnual Compensation Long-TermCompensation Name and Principal Position Year Salary Bonus OtherAnnualCompensation RestrictedStockAwards SecuritiesUnderlyingUARs AllOtherCompensation Irik P. Sevin, 2004 $650,000 $— $65,736(1) $(2) 77,419 Chairman of the Board, President and Chief ExecutiveOfficer 20032002 $$505,000596,250(3) $$985,200— (4) $$14,60014,600(5)(5) 77,419 Ami Trauber, 2004 $370,800 $— $12,201(5) 46,452 Chief Financial Officer (6) 2003 $298,800(3) $272,550(4) $11,762(5) 46,452 2002 $327,000 $— 54,472 Joseph P. Cavanaugh, 2004 $267,800 $— $494,169(7) (2) Executive Vice President 2003 $267,800 $268,060(4) $18,768(7) 2002 $257,100 $95,000 $18,755(7) David A. Shinnebarger, 2004 $284,375 $— $— 4,500 Executive Vice President (8) Daniel P. Donovan, 2004 $253,654 $28,000 $24,614(5) 22,903 President of Heating Oil Segment (9) Angelo J. Catania, 2004 $253,167 $— $252,466(10) — 480,000(11)Executive Vice President of 2003 $276,250 $576,580(4) $11,521(5) Heating Oil Segment (12) 2002 $272,880 $— $14,661(5) (1)This amount represents the following: $15,275 company paid contributions under Petro’s 401(k) defined contribution retirement plan and professionalfees totaling $41,153 and $9,328 for personal use of company owned vehicles. (2)As of September 30, 2004, the following restricted grants of senior subordinated units granted under the Partnership’s Employee Unit Incentive Planvalued at the September 30, 2004 closing price and the number of units granted were outstanding and not yet vested as follows: Irik P. Sevin -$252,400 (20,000 units), and Joseph P. Cavanaugh - $75,720 (6,000 units). (3)Fiscal 2003 salary amounts reflects the reduction in salary that each named executive forfeited to obtain his respective fiscal 2003 grant of restrictedunit appreciation rights as follows: Irik P. Sevin - $120,000, and Ami Trauber - $72,000. (4)Fiscal 2003 bonus amount includes the value as of September 30, 2003 of senior subordinated units vested in fiscal 2003 under the Partnership’sDirector and Employee Unit Incentive Plan as follows: Irik P. Sevin - $410,200, Joseph P. Cavanaugh - $123,060, and Angelo Catania $174,800. Mr.Trauber was also granted 5,000 senior subordinated units for his 2003 bonus performance at a value of $102,550 as of September 30, 2003. (5)These amounts represent company paid contributions under Petro’s 401(k) defined contribution retirement plan. (6)Mr. Trauber assumed the position of the Chief Financial Officer effective November 1, 2001. (7)For fiscal 2002, 2003 and 2004, these amounts represent funds paid in lieu of company paid contributions to the Partnership’s retirement plans. Infiscal 2004, other annual compensation represents a $474,679 distribution from the Partnership’s SERP retirement plan. Mr. Cavanaugh becameeligible in fiscal 2004 to receive distributions from the SERP plan. (8)Mr. Shinnebarger assumed the position of Executive Vice President effective November 1, 2003. (9)Mr. Donovan assumed the position of President of the Heating Oil Segment effective May 1, 2004. (10)This amount represents the following: payment of $235,795 to Mr. Catania to surrender any and all rights and benefits granted to him under thePartnership’s Employee Incentive Plan, and $16,671 of company paid contributions under Petro’s 401(k) defined contribution retirement plan. (11)Represents a severance payment pursuant to Mr. Catania’s employment agreement. (12)Mr. Catania was Executive Vice President of the Heating Oil Segment until May 2004. 59 Table of Contents Option/UAR Grants in Last Fiscal Year Number ofSecuritiesUnderlyingUAR’s Granted Percent ofTotal UAR’sGranted toEmployees inFiscal Year PotentialRealizableValueat AssumedAnnual Ratesof Unit PriceAppreciationfor Option TermName ExercisePrice ExpirationDate 5% 10%David Shinnebarger 4,500(a) 100% $22 (a) $7,676 $15,865 (a)Mr. Shinnebarger was granted 4,500 Unit Appreciation Rights pursuant to his employment agreement. The Rights vest in four equal annualinstallments commencing in November 2003. Mr. Shinnebarger is entitled to receive a payment in cash in respect of each vested right equal to theexcess of the Fair Market Value of a Common Unit on the Vesting Date over $22.00 (as adjusted); provided, however, at any time 30 days before aRight becomes vested, Mr. Shinnebarger has the right to defer payment to any date not more than five years after such Right becomes vested in whichcase the cash payment shall be deferred until the Deferred Date and shall be based upon the value of a senior subordinated unit on the deferred daterather than the vesting date. 60 Table of Contents Aggregated Option/UAR Exercises in Last Fiscal Yearand Fiscal Year End Option/UAR Values Name Number ofUnexercisedUARs atSeptember 30,2004Exercisable(E)/Unexercisable(U) (1) Value ofIn the MoneyUARsat September30, 2004Irik P. Sevin 513,438 (U) $2,393,148Ami Trauber 100,924 (U) $181,472Daniel P. Donovan 22,903 (U) $69,608David A. Shinnebarger 4,500 (U) $— (1)UARs were not exercisable during the last fiscal year. The UARs listed in the above table include 77,419 UARs and 46,452 UARs, respectively, issuedto Messrs. Sevin and Trauber in fiscal 2003 in lieu of salary (see the Summary Compensation Table above). These UARs vested in three equalinstallments on October 1, 2002; October 1, 2003 and October 1, 2004. Messrs. Sevin and Trauber will be entitled to receive payment in cash for theseUARs on October 1, 2005 (subject to deferral to a date no later than October 1, 2007) equal to the excess of the fair market value of a seniorsubordinated unit on the respective vesting dates over the strike price of $10.70. The Partnership may elect to deliver senior subordinated units insatisfaction of this payment rather than cash, subject to complying with applicable securities regulations. The remaining UARs listed in the above tablerepresent the right of the grantee to receive payment in cash equal to the excess of the fair market value of a senior subordinated unit (Except withrespect to Mr. Shinnebarger who was granted common unit appreciation rights. The payment would equal the excess of the fair market value of acommon unit.) on the respective vesting dates for such appreciation rights UARs over the respective exercise prices, which range from $7.626 to$20.90 per unit (subject to deferral). Long-Term Incentive Plans – Awards in Last FiscalNoneEquity Compensation Plan Information Plan category (a)Number ofsecurities to beissued uponexercise ofoutstandingoptions,warrants andrights (b)Weighted-averageexerciseprice ofoutstandingoptions,warrantsand rights (c)Number ofsecuritiesremainingavailable forfutureissuanceunder equitycompensationplans(excludingsecuritiesreflected incolumn (a))Equity compensation plans approved by security holders — — — Equity compensation plans not approved by security holders (1) — 240,000 Total (1) — 240,000 (1)Grants to acquire 107,000 senior subordinated units terminated as of September 30, 2004, without vesting when the performance target for suchgranting was not met. 61 Table of ContentsEmployment Contracts Agreement with Irik Sevin The Partnership entered into an employment agreement (the “Employment Agreement”) with Mr. Sevin effective October 1, 2001. Mr. Sevin’s EmploymentAgreement has an initial term of five years, and automatically renews for successive one-year periods, unless earlier terminated by the Partnership or by Mr.Sevin or otherwise terminated in accordance with the Employment Agreement. The Employment Agreement for Mr. Sevin provides for an annual base salaryof $600,000 which shall increase at the rate of $25,000 per year commencing in fiscal 2003. In addition, Mr. Sevin may earn a bonus of up to 80% of hisannual base salary (the “Targeted Bonus”) for services rendered based upon certain performance criteria. Mr. Sevin can also earn certain equity incentives ifthe Partnership meets certain performance criteria specified in the Employment Agreement. In addition, Mr. Sevin is entitled to certain supplementalexecutive retirement benefits (“SERP”) if he retires after age 65. If a “change of control” (as defined in the Employment Agreement) of the Partnership occursand prior thereto or at any time within two years subsequent to such change of control the Partnership terminates the Executive’s employment without“cause” or the Executive resigns with “good reason” or the Executive terminates his employment during the thirty day period commencing on the firstanniversary of a change of control, then Mr. Sevin will be entitled to (i) a lump sum payment equal to Mr. Sevin’s annual base salary through the TerminationDate, to the extent not previously paid, plus a prorated portion of that year’s Targeted Bonus, plus his anticipated annual base salaries, Targeted Bonuses andequity incentives for the three years following the termination date; (ii) the continuation of Mr. Sevin’s group insurance benefits for two years following thetermination date; (iii) a cash payment equal to the value of 325,000 senior subordinated units; and (iv) the acceleration of Mr. Sevin’s SERP benefits. If Mr.Sevin’s employment is terminated without “cause” or for “good reason” prior to a change of control, then Mr. Sevin will be entitled to items (i) (but notcontinued equity incentives), (ii) and (iv) (as described in the prior sentence). Upon Mr. Sevin’s death or disability, Mr. Sevin (or in the event of his death, hisnamed beneficiary, or, if none, his estate) will receive a monthly payment beginning on his death or disability and continuing until age 65 (or in the case ofhis death until he would have reached age 65) equal to 60% of his base salary plus the prior year bonus divided by 12, but each payment is reduced by themonthly payment paid under other plans maintained by the Partnership. The Employment Agreement provides that if any payment received by Mr. Sevin issubject to a federal excise tax under Section 4999 of the Internal Revenue Code, the payment will be grossed up to permit Mr. Sevin to retain a net amount onan after-tax basis equal to what he would have received had the excise tax not been payable. Agreement with Daniel P. Donovan The Partnership entered into an employment agreement with Mr. Donovan effective as of May 5, 2004. Mr. Donovan’s employment agreement has a term ofthree years unless otherwise terminated in accordance with the employment agreement. The employment agreement provides for an annual base salary of$300,000. In addition, Mr. Donovan may earn a bonus of up to 35% of his base salary for services rendered based upon certain performance criteria. Mr.Donovan is also entitled to receive 10,000 units annually under a long-term incentive plan that is to be developed by the Partnership. The employmentagreement provides for one year’s salary as severance if Mr. Donovan’s employment is terminated without cause or by Mr. Donovan for good reason. Agreement with Joseph P. Cavanaugh In connection with the sale of the propane segment, the Partnership has agreed to pay the segment’s Chief Executive Officer, Joseph Cavanaugh, a bonusequal to three times Mr. Cavanaugh’s annual salary and bonus upon the successful completion of the sale. Agreement with David Shinnebarger The Partnership entered into an employment agreement with Mr. Shinnebarger effective as of November 17, 2003. Mr. Shinnebarger’s employment agreementhas an initial term of three years unless earlier terminated in accordance with the employment agreement. The Employment Agreement provides for an initialannual base salary of $325,000. In addition, Mr. Shinnebarger may earn a bonus of up to 100% of the base salary for services rendered based upon certainperformance criteria. The annual base salary will be increased in years 2 and 3 in accordance with normal salary adjustments made to the Partnership’s othersenior executives. The potential bonus increases to 150% of the base salary in the second year of employment and 200% of the base salary in the third year ofemployment. A portion of any bonus is payable in cash and a portion is payable in Common Units. Mr. Shinnebarger was also granted 4,500 common unitappreciation rights with the strike price of $22 per unit which vest 25% upon grant and 25% per year on each of the three anniversary dates thereafter. Theemployment agreement provides for six months salary as termination pay if Mr. Shinnebarger’s employment is terminated without cause or by Mr.Shinnebarger for good reason. Agreement with Angelo Catania As a result of Mr. Catania’s termination of employment in May 2004, the Partnership paid Mr. Catania a lump sum payment equal to $480,000 as severancepursuant to his employment agreement. Mr. Catania is subject to post-employment restrictions, such as confidentiality, non-competition and non-solicitationrestrictions. 401(k) Plan Mr. Sevin, Mr. Trauber and Mr. Ambury are covered under a 401(k) defined contribution plan maintained by Petro. Participants in the plan may elect tocontribute a sum not to exceed 17% of a participant’s compensation or the maximum limit under the Internal Revenue Code. Under this plan, Petro makes a4% core contribution of a participant’s compensation up to $205,000 and matches 2/3 of each amount that a participant contributes with a maximumemployer match of 2%. 62 Table of Contents ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table shows the beneficial ownership as of December 9, 2004 of common units, senior subordinated units, junior subordinated units andgeneral partner units by: (1)Star Gas LLC and certain beneficial owners; (2)each of the named executive officers and directors of Star Gas LLC; (3)all directors and executive officers of Star Gas LLC as a group; and (4)each person the Partnership knows to hold 5% or more of Star Gas Partners’ units. Except as indicated, the address of each person is c/o Star Gas Partners, L.P. at 2187 Atlantic Street, Stamford, Connecticut 06902-0011. Common Units SeniorSubordinated Units JuniorSubordinated Units General Partner Units(a) Name Number Percentage Number Percentage Number Percentage Number Percentage Star Gas LLC — — % 29,133 * % — — % 325,729 100%Irik P. Sevin — — 56,469 (b) 1.6 53,426 15.5 325,729 (b) 100 Audrey L. Sevin 6,000 * 42,829 (b) 1.4 153,131 44.3 325,729 (b) 100 Hanseatic Americas, Inc. — — 29,133 (b) * 138,807 40.2 325,729 (b) 100 Paul Biddelman — — 8,057 * — — — — William P. Nicoletti — — 5,252 * — — — — Stephen Russell — — 5,252 * — — — — Richard F. Ambury 2,125 * — — — — — — Ami Trauber — — — — — — — — Joseph P. Cavanaugh 1,000 * 9,169 — — — — — David Shinnebarger — — — — — — — — Daniel P. Donovan — — — — — — — — All officers and directors and Star Gas LLC as agroup (11 persons) 9,125 * 97,895 3.0% 206,557 59.8% 325,729 100%Third Point Management Company LLC(c) 2,000,000 6.2% (a)For purpose of this table, the number of General Partner Units is deemed to include the 0.01% General Partner interest in Star Gas Propane. (b)Assumes each of Star Gas LLC owners may be deemed to beneficially own all of Star Gas LLC’s general partner units and senior subordinated units,however, they disclaim beneficial ownership of these units, except to the extent of their proportionate interest therein. (c)According to a Schedule 13G filed with the SEC on October 26, 2004, Third Point Management Company L.L.C. (“Third Point”) is a Delaware limitedliability, which serves as investment manager or adviser to a variety of hedge funds and managed accounts with respect to Common Units directlyowned by the funds and accounts. Mr. Daniel S. Loeb is the managing director of Third Point and controls its business activities with respect to theCommon Units. Third Point’s address is 360 Madison Avenue, New York, NY 10017. *Amount represents less than 1%. Section 16(a) of the Securities Exchange Act of 1934 requires the General Partner’s officers and directors, and persons who own more than 10% of a registeredclass of the Partnership’s equity securities, to file reports of beneficial ownership and changes in beneficial ownership with the Securities and ExchangeCommission (“SEC”). Officers, directors and greater than 10 percent unitholders are required by SEC regulation to furnish the General Partner with copies ofall Section 16(a) forms. Based solely on its review of the copies of such forms received by the General Partner, or written representations from certain reporting persons that no Forms5 were required for those persons, the General Partner believes that during fiscal year 2004 all filing requirements applicable to its officers, directors, andgreater than 10 percent beneficial owners were met in a timely manner, except that Mr. Trauber did not timely file one Form 4 relating to the purchase of132,488 senior subordinated units pursuant to an automatic dividend reinvestment transaction in his brokerage account that occurred without his knowledge. 63 Table of Contents ITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The Partnership and the General Partner have certain ongoing relationships with Petro and its affiliates. Affiliates of the General Partner, including Petro,perform certain administrative services for the General Partner on behalf of the Partnership. Such affiliates do not receive a fee for such services, but arereimbursed for all direct and indirect expenses incurred in connection therewith. Mrs. Audrey Sevin, a Director of the General Partner, also serves as the Secretary of the General Partner. As a full-time employee of the Partnership, Mrs.Audrey Sevin provides employee and unitholder relations services for which she receives a salary of $199,000 per annum. Mrs. Sevin was the beneficiary of aretirement plan for her late husband, Mr. Malvin Sevin. Petro Inc., a subsidiary of the Partnership, paid Mrs. Sevin $300,000 per annum from January 1993until December 2002 as the beneficiary of his retirement plan. ITEM 14.PRINCIPAL ACCOUNTANT FEES AND SERVICES The following table presents the aggregate fees for professional audit services rendered by KPMG LLP including fees for the audit of the Partnership’s annualfinancial statements for the fiscal years 2003 and 2004, and for fees billed for other services rendered by KPMG LLP (in thousands). 2003 2004Audit Fees (1) $877 $900Audit-Related Fees (2) 171 298 Audit and Audit-Related Fees 1,048 1,198Tax Fees (3) 335 261 Total Fees $1,383 $1,459 (1)Audit fees were for professional services rendered in connection with audits and quarterly reviews of the consolidated financial statements of thePartnership, review of and preparation of consents for registration statements filed with the Securities and Exchange Commission, for review of thePartnership’s tax provision and for subsidiary statutory audits. Audit fees incurred in connection with registration statements were $227,000 and$236,000 for fiscal years 2003 and 2004, respectively. (2)Audit-related fees were principally for audits of financial statements of certain employee benefit plans, internal controls reviews and other servicesrelated to financial accounting and reporting standards. (3)Tax fees related to services for tax consultation and tax compliance. Audit Committee: Pre-Approval Policies and Procedures. At its regularly scheduled and special meetings, the Audit Committee of the Board of Directorsconsiders and pre-approves any audit and non-audit services to be performed by the Partnership’s independent accountants. The Audit Committee hasdelegated to its chairman, an independent member of the Partnership’s Board of Directors, the authority to grant pre-approvals of non-audit services providedthat the service(s) shall be reported to the Audit Committee at its next regularly scheduled meeting. Promptly after the effective date of the Sarbanes-Oxley Act of 2002, the Audit Committee approved all non-audit services being performed at that time by thePartnership’s principal accountant. On June 18, 2003, the Audit Committee adopted its pre-approval policies and procedures. Since that date, there have beenno non-audit services rendered by the Partnership’s principal accountants that were not pre-approved. 64 Table of Contents PART IV ITEM 15.EXHIBITS AND FINANCIAL STATEMENT SCHEDULES 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 66 65 Table of Contents INDEX TO EXHIBITS ExhibitNumber Description 4.2 Amended and Restated Agreement of Limited Partnership of Star Gas Partners, L.P.(2) 4.3 Amended and Restated Agreement of Limited Partnership of Star Gas Propane, L.P.(2) 4.4 Amendment No. 1 dated as of April 17, 2001 to Amended and Restated Agreement of Limited Partnership of Star Gas Partners, L.P.(11) 4.5 Unit Purchase Rights Agreement dated April 17, 2001(12) 4.6 Amendment No. 2 to Amended and Restated Agreement of Limited Partnership of Star Gas Partners, L.P.(16) 4.7 Amendment No. 3 to Amended and Restated Agreement of Limited Partnership of Star Gas Partners.(20) 4.8 Amendment No. 1 to Amended and Restated Agreement of Limited Partnership of Star Gas Propane.(20)10.2 Form of Conveyance and Contribution Agreement among Star Gas Corporation, the Partnership and the Operating Partnership.(3)10.3 Form of First Mortgage Note Agreement among certain insurance companies, Star Gas Corporation and Star Gas Propane L.P.(3)10.4 Intercompany Debt(3)10.5 Form of Non-competition Agreement between Petro and the Partnership(3)10.6 Form of Star Gas Corporation 1995 Unit Option Plan(3)(10)10.7 Amoco Supply Contract(3)10.11 Note Agreement, dated as of January 22, 1998, by and between Star Gas and The Northwestern Mutual Life Insurance Company(6)10.14 Agreement and Plan of Merger by and among Petroleum Heat and Power Co., Inc., Star Gas Partners, L.P., Petro/Mergeco, Inc., and Star GasPropane, L.P.(2)10.15 Exchange Agreement(2)10.16 Amendment to the Exchange Agreement dated as of February 10, 1999(2).10.19 $12,500,000 8.67% First Mortgage Notes, Series A, due March 30, 2012. $15,000,000 8.72% First Mortgage Notes, Series B, due March 30, 2015 dated as of March 30, 2000(5)10.21 June 2000 Star Gas Employee Unit Incentive Plan(6)(10)10.22 $40,000,000 Senior Secured Note Agreement(7)10.23 Note Purchase Agreement for $7,500,000 – 7.62% First Mortgage Notes, Series A, due April 1, 2008 and $22,000,000 – 7.95% FirstMortgage Notes, Series B, due April 1, 2011(8)10.26 Note Agreement dated as of July 30, 2001 for $103,000,000 by Star Gas Partners, L.P., Petro Holdings, Inc., Petroleum Heat and Power Co.,Inc., and the agents Bank of America, N.A. and First Union Securities, Inc.(14)10.27 Employment agreement dated as of September 30, 2001 between Star Gas LLC, and Irik P. Sevin.(10)(14)10.28 Meenan Equity Purchase Agreement dated July 31, 2001(13)10.32 Amended and restated credit agreement dated September 23, 2003, between Star Gas Propane, LP and the agents, JPMorgan Chase Bank andWachovia Bank, N.A.(19)10.33 Parity debt agreement, dated September 30, 2003, between Star Gas Propane, LP, and the agents, Fleet National Bank, Wachovia Bank, N.A.and JPMorgan Chase Bank(19)10.34 Employment agreement between Petro Holdings, Inc. and Angelo J. Catania(10)(19)10.35 Credit agreement dated December 22, 2003, between Petroleum Heat and Power Co., Inc. and the agents, Fleet National Bank, JPMorganChase Bank and LaSalle Bank National Association.(17)10.36 First supplemental indenture dated January 22, 2004 to the indenture dated February 6, 2003 for the Partnership’s 10 ¼% Senior Notes due2013.(17)10.37 Agreement to sell the stock and business of Total Gas & Electric.(18)10.38 Indenture for the 10 ½% senior notes due February 2013.(2)10.39 Letter Amendment and Waiver No. 2 to Petro Credit Agreement.(1)10.40 Employment Agreement between the Registrant and David Shinnebarger.(1)(10)10.41 Employment Agreement between Petro Holdings, Inc. and Daniel P. Donovan.(1)(10)10.42 Interest Purchase Agreement for the sale of the propane operations(20)10.43 Non-Competition Agreement(20)14 Code of ethics(19)21 Subsidiaries of the Registrant(1) 23.1 Consent of KPMG LLP(1)31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a).(1)31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a).(1)32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Actof 2002(1)32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Actof 2002(1) 66 Table of Contents INDEX TO EXHIBITS (continued) (1)Filed herewith. (2)Incorporated by reference to an Exhibit to the Registrant’s Registration Statement on Form S-4, File No. 333-103873, filed with the Commission March17, 2003. (3)Incorporated by reference to the same Exhibit to Registrant’s Registration Statement on Form S-1, File No. 33-98490, filed with the Commission onDecember 13, 1995. (4)Incorporated by reference to the same Exhibit to Registrant’s Registration Statement on Form S-3, File No. 333-47295, filed with the Commission onMarch 4, 1998. (5)Incorporated by reference to the same Exhibit to Registrant’s Quarterly Report on Form 10-Q filed with the Commission on April 26, 2000. (6)Incorporated by reference to the same Exhibit to Registrant’s Quarterly Report on Form 10-Q filed with the Commission on August 10, 2000. (7)In Accordance with item 601(B)(4)(iii) of Regulation S-K, the Partnership will provide a copy of this document to the SEC upon request. (8)Incorporated by reference to the same Exhibit to Registrant’s Quarterly Report on Form 10-Q filed with the Commission on May 10, 2001. (9)Incorporated by reference to the same Exhibit to Registrant’s Quarterly Report on Form 10-Q filed with the Commission on August 13, 2001. (10)Management compensation agreement. (11)Incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K dated April 16, 2001. (12)Incorporated by reference to Exhibit 4.1 to the Registrant’s Registration Statement on Form 8-A filed with the Commission on April 18, 2001. (13)Incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K dated July 31, 2001. (14)Incorporated by reference to the same Exhibit to Registrant’s Annual Report on Form 10-K filed with the Commission on December 20, 2001. (15)Incorporated by reference to the same Exhibit to Registrant’s Quarterly Report on Form 10-Qfiled with the Commission on April 30, 2002. (16)Incorporated by reference to the same Exhibit to Registrant’s Quarterly Report on Form 10-Q filed with the Commission on June 30, 2003. (17)Incorporated by reference to the same Exhibit to Registrant’s Quarterly Report on Form 10-Q filed with the Commission on December 31, 2003. (18)Incorporated by reference to the same Exhibit to Registrant’s Quarterly Report on Form 10-Q filed with the Commission on March 31, 2004. (19)Incorporated by reference to the same exhibit to Registrant’s Annual Report on Form 10-K for the fiscal year ended September 30, 2003, that was filedwith the Commission on December 22, 2003. (20)Incorporated by reference to the Registrant’s Current Report on Form 8-K dated November 18, 2004. 67 Table of Contents SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the General Partner has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized: Star Gas Partners, L.P.By: Star Gas LLC (General Partner)By: /s/ Irik P. Sevin Irik P. Sevin Chairman of the Board and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dateindicated: Signature Title Date/s/ Irik P. SevinIrik P. Sevin Chairman of the Board, Chief Executive Officer andDirectorStar Gas LLC December 14, 2004/s/ Ami TrauberAmi Trauber Chief Financial Officer(Principal Financial and Accounting Officer)Star Gas LLC December 14, 2004/s/ Audrey L. SevinAudrey L. Sevin DirectorStar Gas LLC December 14, 2004/s/ Paul BiddelmanPaul Biddelman DirectorStar Gas LLC December 14, 2004/s/ William P. NicolettiWilliam P. Nicoletti DirectorStar Gas LLC December 14, 2004/s/ Stephen RussellStephen Russell DirectorStar Gas LLC December 14, 2004 68 Table of Contents SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersignedthereunto duly authorized: Star Gas Finance CompanyBy: (Registrant)By: /s/ Irik P. Sevin Irik P. Sevin Chairman of the Board and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dateindicated: Signature Title Date/s/ Irik P. SevinIrik P. Sevin Chairman of the Board, Chief Executive Officer andDirector (Principle Executive Officer)Star Gas Finance Company December 14, 2004/s/ Ami TrauberAmi Trauber Chief Financial Officer(Principal Financial and Accounting Officer)Star Gas Finance Company December 14, 2004/s/ Audrey L. SevinAudrey L. Sevin DirectorStar Gas Finance Company December 14, 2004 69 Table of Contents STAR GAS PARTNERS, L.P. AND SUBSIDIARIESINDEX TO CONSOLIDATED FINANCIAL STATEMENTSAND FINANCIAL STATEMENT SCHEDULE PagePart II Financial Information: Item 8 - Financial Statements Report of Independent Registered Public Accounting Firm F-2 Consolidated Balance Sheets as of September 30, 2003 and 2004 F-3 Consolidated Statements of Operations for the years ended September 30, 2002, 2003 and 2004 F-4 Consolidated Statements of Comprehensive Income (Loss) for the years ended September 30, 2002, 2003 and 2004 F-5 Consolidated Statements of Partners’ Capital for the years ended September 30, 2002, 2003 and 2004 F-6 Consolidated Statements of Cash Flows for the years ended September 30, 2002, 2003 and 2004 F-7 Notes to Consolidated Financial Statements F-8 - F-35 Schedule for the years ended September 30, 2002, 2003 and 2004 II. Valuation and Qualifying Accounts F-36 All other schedules are omitted because they are not applicable or the required information is shown in the consolidatedfinancial statements or the notes therein. F-1 Table of Contents STAR GAS PARTNERS, L.P. AND SUBSIDIARIESREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Partners of Star Gas Partners, L.P.: We have audited the consolidated financial statements of Star Gas Partners, L.P. and Subsidiaries as listed in the accompanying index. In connectionwith our audits of the consolidated financial statements, we have also audited the financial statement schedule as listed in the accompanying index. Theseconsolidated financial statements and financial statement schedule are the responsibility of the Partnership’s management. Our responsibility is to express anopinion on these consolidated financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe thatour 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 Subsidiaries as of September 30, 2003 and 2004 and the results of their operations and their cash flows for each of the years in the three-year periodended September 30, 2004, in conformity with U.S. 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 forththerein. The accompanying financial statements have been prepared assuming that the Partnership will continue as a going concern. As discussed in Note 2 tothe consolidated financial statements, the Partnership’s home heating oil segment advised its bank lenders that the heating oil segment would not be able tomake the required representations included in the borrowing certificate under its working capital line of credit and that it is unlikely that it would be able tomeet certain conditions for drawing under this line of credit for the quarter ending December 31, 2004 and for the foreseeable future thereafter. The heatingoil segment entered into a letter amendment and waiver under its credit agreement whereby it enables borrowings under its working capital line of creditthrough December 17, 2004. After that date, no further borrowings will be available under this working capital line of credit. These factors raise substantialdoubt about the Partnership’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2. Theconsolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. As discussed in Notes 3 and 8 to the consolidated financial statements, Star Gas Partners, L.P. adopted the provisions of Statement of FinancialAccounting Standards No. 142, “Goodwill and Other Intangible Assets,” as of October 1, 2002. KPMG LLPStamford, ConnecticutDecember 10, 2004 F-2 Table of Contents STAR GAS PARTNERS, L.P. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS Years EndedSeptember 30, (in thousands) 2003 2004 ASSETS Current assets Cash and cash equivalents $10,044 $16,058 Receivables, net of allowance of $7,542 and $7,180, respectively 100,511 103,432 Inventories 38,561 47,624 Prepaid expenses and other current assets 51,470 67,057 Net current assets of discontinued operations 10,523 — Total current assets 211,109 234,171 Property and equipment, net 261,867 247,524 Long-term portion of accounts receivables 7,145 6,337 Goodwill 272,740 276,137 Intangibles, net 201,468 180,239 Deferred charges and other assets, net 14,414 16,568 Net long-term assets of discontinued operations 6,867 — Total Assets $975,610 $960,976 LIABILITIES AND PARTNERS’ CAPITAL Current liabilities Accounts payable $27,140 $35,940 Working capital facility borrowings 12,000 8,000 Current maturities of long-term debt 22,847 24,418 Accrued expenses 82,356 73,168 Unearned service contract revenue 32,036 36,768 Customer credit balances 74,716 84,162 Net current liabilities of discontinued operations 7,569 — Total current liabilities 258,664 262,456 Long-term debt 499,341 503,668 Other long-term liabilities 27,829 25,081 Partners’ capital (deficit) Common unitholders 210,636 167,367 Subordinated unitholders (57) (6,768)General partner (3,082) (3,702)Accumulated other comprehensive income (loss) (17,721) 12,874 Total Partners’ capital 189,776 169,771 Total Liabilities and Partners’ Capital $975,610 $960,976 See accompanying notes to consolidated financial statements. F-3 Table of Contents STAR GAS PARTNERS, L.P. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS Years Ended September 30, (in thousands, except per unit data) 2002 2003 2004 Sales: Product $814,360 $1,190,913 $1,238,582 Installations, service and appliances 171,535 191,355 215,355 Total sales 985,895 1,382,268 1,453,937 Cost and expenses: Cost of product 446,551 737,405 779,878 Cost of installations, service and appliances 182,809 201,153 216,175 Delivery and branch expenses 235,708 293,523 325,686 Depreciation and amortization expenses 57,227 52,493 57,343 General and administrative expenses 26,271 50,331 30,029 Operating income 37,329 47,363 44,826 Interest expense (40,495) (44,432) (49,362)Interest income 3,425 3,865 3,459 Amortization of debt issuance costs (1,447) (2,232) (3,646)Loss on redemption of debt — (181) — Income (loss) from continuing operations before income taxes (1,188) 4,383 (4,723)Income tax expense (benefit) (1,456) 1,500 1,525 Income (loss) from continuing operations 268 2,883 (6,248)Income (loss) from discontinued operations before cumulative effect of change in accounting principle, and losson sale of segment, net of income taxes (11,437) 1,230 923 Loss on sale of segment, net of income taxes — — (538)Cumulative effect of changes in accounting principle for discontinued operations - Adoption of SFAS No. 142 — (3,901) — Net income (loss) $(11,169) $212 $(5,863) General Partner’s interest in net income (loss) $(116) $2 $(57) Limited Partners’ interest in net income (loss) $(11,053) $210 $(5,806) Basic and diluted income (loss) from continuing operations per Limited Partner unit $0.01 $0.09 $(0.18) Basic and diluted net income (loss) per Limited Partner unit $(0.38) $0.01 $(0.16) Weighted average number of Limited Partner units outstanding: Basic 28,790 32,659 35,205 Diluted 28,821 32,767 35,205 See accompanying notes to consolidated financial statements. F-4 Table of Contents STAR GAS PARTNERS, L.P. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) Years Ended September 30, (in thousands) 2002 2003 2004 Net income (loss) $(11,169) $212 $(5,863)Other comprehensive income (loss): Unrealized gain (loss) on derivative instruments 12,968 (5,425) 29,436 Unrealized gain (loss) on pension plan obligations (11,596) (1,469) 1,159 Comprehensive gain (loss) $(9,797) $(6,682) $24,732 Reconciliation of Accumulated Other Comprehensive Income (Loss) (in thousands) Pension PlanObligations DerivativeInstruments Total Balance as of September 30, 2001 $(4,149) $(8,050) $(12,199)Reclassification to earnings — 16,252 16,252 Unrealized loss on pension plan obligations (11,596) — (11,596)Unrealized loss on derivative instruments — (3,284) (3,284) Other comprehensive income (loss) (11,596) 12,968 1,372 Balance as of September 30, 2002 (15,745) 4,918 (10,827)Reclassification to earnings — (8,074) (8,074)Unrealized loss on pension plan obligations (1,469) — (1,469)Unrealized gain on derivative instruments — 2,649 2,649 Other comprehensive loss (1,469) (5,425) (6,894)Balance as of September 30, 2003 (17,214) (507) (17,721)Reclassification to earnings — (11,843) (11,843)Unrealized gain on pension plan obligations 1,159 — 1,159 Unrealized gain on derivative instruments — 41,279 41,279 Other comprehensive income 1,159 29,436 30,595 Balance as of September 30, 2004 $(16,055) $28,929 $12,874 See accompanying notes to consolidated financial statements. F-5 Table of Contents STAR GAS PARTNERS, L.P. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF PARTNERS’ CAPITALYears Ended September 30, 2002, 2003 and 2004 Number of Units Common SeniorSub. JuniorSub. GeneralPartner AccumulativeOtherComprehensiveIncome (Loss) TotalPartners’Capital (in thousands, except per unit amounts) Common SeniorSub. JuniorSub. GeneralPartner Balance as of September 30, 2001 23,394 2,717 345 326 $209,911 $3,483 $(711) $(2,220) $(12,199) $198,264 Issuance of units: Common 5,576 100,409 100,409 Senior Subordinated 417 6,742 6,742 Net Loss (9,815) (1,115) (123) (116) (11,169)Other Comprehensive Income, net 1,372 1,372 Unit Compensation Expense: Common 201 201 Senior Subordinated 166 166 Distributions: ($2.30 per unit) (58,010) (58,010)($1.65 per unit) (4,939) (4,939)($1.15 per unit) (398) (374) (772) Balance as of September 30, 2002 28,970 3,134 345 326 242,696 4,337 (1,232) (2,710) (10,827) 232,264 Issuance of units 1,701 8 34,180 34,180 Net Income 189 20 1 2 212 Other Comprehensive Loss, net (6,894) (6,894)Unit Compensation Expense: Common 204 204 Senior Subordinated 2,402 2,402 Distributions: ($2.30 per unit) (66,633) (66,633)($1.65 per unit) (5,188) (5,188)($1.15 per unit) (397) (374) (771) Balance as of September 30, 2003 30,671 3,142 345 326 210,636 1,571 (1,628) (3,082) (17,721) 189,776 Issuance of units 1,495 103 34,996 34,996 Net Loss (5,222) (530) (54) (57) (5,863)Other Comprehensive Income, net 30,595 30,595 Unit Compensation Expense: Common 76 76 Senior Subordinated 10 10 Distributions: ($2.30 per unit) (73,119) (73,119)($1.725 per unit) (5,540) (597) (563) (6,700) Balance as of September 30, 2004 32,166 3,245 345 326 $167,367 $(4,489) $(2,279) $(3,702) $12,874 $169,771 See accompanying notes to consolidated financial statements. F-6 Table of Contents STAR GAS PARTNERS, L.P. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended September 30, (in thousands) 2002 2003 2004 Cash flows provided by (used in) operating activities: Net income (loss) $(11,169) $212 $(5,863)Deduct: (Income) loss from discontinued operations 11,437 (1,230) (923)Loss on sale of discontinued operations — — 538 Add: Cumulative effect of change in accounting principles for the adoption of SFAS No. 142 fordiscontinued operations — 3,901 — Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 57,227 52,493 57,343 Amortization of debt issuance cost 1,447 2,232 3,646 Loss on redemption of debt — 181 — Unit compensation expense 367 2,606 86 Provision for losses on accounts receivable 4,315 7,726 8,749 (Gain) loss on sales of fixed assets, net 336 (156) (226)Changes in operating assets and liabilities, net of amounts related to acquisitions: Decrease (increase) in receivables 9,691 (23,991) (10,683)Decrease (increase) in inventories 1,587 1,610 (8,613)Decrease (increase) in other assets (17,671) (12,314) 7,001 Increase (decrease) in accounts payable (11,559) 10,054 9,050 Increase in other current and long-term liabilities 18,025 7,271 5,735 Net cash provided by operating activities 64,033 50,595 65,840 Cash flows provided by (used in) investing activities: Capital expenditures (14,340) (18,377) (9,424)Proceeds from sales of fixed assets 1,882 1,679 2,251 Cash proceeds from disposition of segment — — 12,495 Acquisitions (49,004) (84,391) (17,471) Net cash used in investing activities (61,462) (101,089) (12,149) Cash flows provided by (used in) financing activities: Working capital facility borrowings 89,850 178,000 170,900 Working capital facility repayments (75,250) (189,000) (174,900)Acquisition facility borrowings 73,250 94,600 8,550 Acquisition facility repayments (54,650) (81,600) (54,150)Proceeds from issuance of debt — 197,333 70,512 Repayment of debt (22,931) (155,543) (18,721)Distributions (63,721) (72,592) (79,819)Proceeds from issuance of Common Units 100,244 34,180 34,996 Increase in deferred charges (2,103) (8,917) (6,535)Other 92 — — Net cash provided by (used in) financing activities 44,781 (3,539) (49,167) Net cash provided by (used in) discontinued operations (3,471) 3,070 1,490 Net increase (decrease) in cash 43,881 (50,963) 6,014 Cash and cash equivalents at beginning of period 17,126 61,007 10,044 Cash and cash equivalents at end of period $61,007 $10,044 $16,058 See accompanying notes to consolidated financial statements. F-7 Table of Contents STAR GAS PARTNERS, L.P. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1)Partnership Organization Star Gas Partners, L.P. (“Star Gas” or the “Partnership”) is a diversified home energy distributor and services provider, specializing in heating oil andpropane. Star Gas is a master limited partnership, which at September 30, 2004 had outstanding 32.2 million common units (NYSE: “SGU”representing an 89.1% limited partner interest in Star Gas Partners) and 3.2 million senior subordinated units (NYSE: “SGH” representing a 9.0%limited partner interest in Star Gas Partners). Additional Partnership interests include 0.3 million junior subordinated units (representing a 1.0% limitedpartner interest) and 0.3 million general partner units (representing a 0.9% general partner interest). The Partnership is organized as follows: •Star Gas Propane, L.P. (“Star Gas Propane”) is the Partnership’s operating subsidiary and, together with its direct and indirect subsidiaries, accountsfor substantially all of the Partnership’s assets, sales and earnings. Both the Partnership and Star Gas Propane are Delaware limited partnerships thatwere formed in October 1995 in connection with the Partnership’s initial public offering. The Partnership is the sole limited partner of Star GasPropane with a 99.99% limited partnership interest. •The general partner of both the Partnership and Star Gas Propane is Star Gas LLC, a Delaware limited liability company. The Board of Directors ofStar Gas LLC is appointed by its members. Star Gas LLC owns an approximate 1% general partner interest in the Partnership and also owns anapproximate 0.01% general partner interest in Star Gas Propane. •The Partnership’s propane operations (the “propane segment”) are conducted through Star Gas Propane and its direct subsidiaries. Star GasPropane markets and distributes propane gas and related products to approximately 334,000 customers located primarily in the Midwest,Northeast, Florida and Georgia. See Note 2 regarding the sale of the propane segment. •The Partnership’s heating oil operations (the “heating oil segment”) are conducted through Petro Holdings, Inc. (“Petro”) and its direct andindirect subsidiaries. Petro is a Minnesota corporation that is an indirect wholly owned subsidiary of Star Gas Propane. Petro is a retail distributorof home heating oil and serves approximately 515,000 customers in the Northeast and Mid Atlantic region. •Star Gas Finance Company is a direct wholly-owned subsidiary of the Partnership. Star Gas Finance Company serves as the co-issuer, jointly andseverally with the Partnership, of the Partnership’s $265 million 10¼% Senior Notes, which are due in 2013. The Partnership is dependent ondistributions from its subsidiaries to service the Partnership’s debt obligations. The distributions from the Partnership’s subsidiaries are notguaranteed and are subject to certain loan restrictions. Star Gas Finance Company has nominal assets and conducts no business operations. 2)Recent Events On October 13, 2004, the Partnership advised the heating oil segment’s bank lenders that this segment would not be able to make the requiredrepresentations included in the borrowing certificate under its working capital line. In addition, the Partnership notified such lenders that, for thequarter ending December 31, 2004 and for the foreseeable future thereafter, the heating oil segment will be unlikely to satisfy the drawing conditionthat requires that the consolidated funded debt of the Partnership not exceed 5.00 times its consolidated operating cash flow. Further, the Partnershipadvised the lenders that the heating oil segment may not be able to maintain a zero balance under the working capital facility (except for letter of creditobligations) for 45 consecutive days from April 1, 2005 to September 30, 2005, as required by the heating oil segment’s covenants. F-8 Table of Contents2)Recent Events - (continued) On October 15, 2004, the heating oil segment’s bank lenders had agreed to permit the heating oil segment to request new working capital advancesdaily while the Partnership was in discussions with such bank lenders about modifying the terms and conditions of the heating oil segment’s creditagreement. In connection with that understanding the bank lenders requested that the Partnership allow an independent financial advisor to review theheating oil segment’s operations and performance on their behalf. On November 5, 2004, the Partnership’s heating oil segment entered into a letter amendment and waiver under its credit agreement with WachoviaBank, N.A. As a result of the amendment, the heating oil segment was able to continue to borrow funds under the credit agreement to support itsworking capital requirements for the near term. The amendment provides for the waiver, through December 17, 2004, of various terms under the creditagreement. The amendment also amends for the waiver period the financial covenant regarding the Partnership’s consolidated funded debt to cash flowratio and the financial covenant regarding the heating oil segment’s cash flow to interest expense ratio. On October 28, 2004, the Partnership’s propane segment entered into a commitment letter with JPMorgan Securities Inc. and JPMorgan Chase Bank.Under the commitment letter, as amended, JP Morgan Chase Bank committed, subject to certain conditions, to provide a $350 million ($260 million, ifthe propane segment is sold, as discussed below) asset-based senior secured revolving credit facility referred to herein as the revolving credit facilityand a $300 million senior secured bridge facility referred to herein as the bridge facility to refinance (the “refinancing transactions”) all of the heatingoil segment’s and the propane segment’s (if the propane segment is not sold) working capital facilities and senior secured notes. On November 18, 2004, the Partnership entered into an agreement to sell its propane segment, held largely through Star Gas Propane to Inergy PropaneLLC (“Inergy”), the operating subsidiary of Inergy, L.P., for $475 million subject to certain adjustments. In addition, the Partnership gave notice toholders of the heating oil segments secured notes of its optional election to prepay such secured notes, representing an aggregate payment, includingprincipal, interest and estimated premium, of approximately $182 million. The Partnership subsequently gave notice of its optional election to prepayits propane segment’s secured notes involving an aggregate payment including principal, interest and estimated premium, of approximately $114million. The aggregate amount payable with regard to both sets of secured notes is approximately $296 million. The Partnership expects to recognize aloss on the early redemption of this debt. The Partnership’s commitment from JP Morgan Chase is not contingent upon the consummation of the sale of the propane segment. Accordingly, thePartnership believes it would be able to draw down JP Morgan Chase’s bridge facility to repay the Partnership’s subsidiaries’ secured notes which willbecome due on December 17, 2004 because of the Partnership’s notice of prepayment. The Partnership also intends to close on that date the asset basedrevolving credit agreement underwritten by JP Morgan Chase to replace the existing revolving credit agreements of the Partnership’s subsidiaries. TheJP Morgan Chase commitment for the bridge facility and the revolving credit facility are subject to a number of conditions and there can be noassurance that the Partnership will meet those conditions. If the propane segment is sold (either before or after December 17, 2004), the revolving credit facility requires that the total commitment be reduced to$260 million and the liens on all of the assets of the propane segment be released. If the Partnership is unable to close the new revolving credit facility and either the bridge facility or the sale of the propane segment by December 17,2004, the Partnership would be unable to refinance the heating oil segment’s and propane segment’s credit facilities and to repay the heating oilsegment’s and propane segment’s institutional indebtedness, which are due and payable on such date. In such an event, if the Partnership were notsuccessful in rescheduling the maturity dates of such indebtedness, the Partnership may be forced to seek the protection of the bankruptcy courts. F-9 Table of Contents3)Summary of Significant Accounting Policies Basis of Presentation The Consolidated Financial Statements include the accounts of Star Gas Partners, L.P. and its subsidiaries. All material intercompany items andtransactions have been eliminated in consolidation. The Partnership’s natural gas and electricity operations segment which was acquired in April 2000 was sold on March 31, 2004. These operations wereconducted through Total Gas & Electric, Inc. (“TG&E”), a Florida corporation. As a result of the sale of the TG&E segment, the Partnership has restatedits fiscal years ended September 30, 2002 and September 30, 2003, results to include the results of the TG&E segment as a component of discontinuedoperations in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. Reclassification Certain prior year amounts have been reclassified to conform with the current year presentation. Use of Estimates The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results coulddiffer from those estimates. Revenue Recognition Sales of propane, heating oil, propane/heating oil and air conditioning equipment are recognized at the time of delivery of the product to the customeror at the time of sale or installation. Revenue from repairs and maintenance service is recognized upon completion of the service. With respect toannually billed customer tank rental charges, revenues are recorded on a straight-line basis over one year. Payments received from customers forheating oil equipment service contracts are deferred and amortized into income over the terms of the respective service contracts, on a straight-linebasis, which generally do not exceed one year. Basic and Diluted Net Income (Loss) per Limited Partner Unit Net Income (Loss) per Limited Partner Unit is computed by dividing net income (loss), after deducting the General Partner’s interest, by the weightedaverage number of Common Units, Senior Subordinated Units and Junior Subordinated Units outstanding. Cash Equivalents The Partnership considers all highly liquid investments with a maturity of three months or less, when purchased, to be cash equivalents. Inventories Inventories are stated at the lower of cost or market and are computed on a first-in, first-out basis. Property, Plant, and Equipment Property, plant, and equipment are stated at cost. Depreciation is computed over the estimated useful lives of the depreciable assets using the straight-line method. Goodwill and Intangible Assets Goodwill and intangible assets include goodwill, customer lists and covenants not to compete. Goodwill is the excess of cost over the fair value of net assets in the acquisition of a company. The Partnership amortized goodwill using the straight-line method over a twenty-five year period for goodwill acquired prior to July 1, 2001. In accordance with the provisions of SFAS No. 141 “BusinessCombinations”, goodwill acquired after June 30, 2001 was not amortized. On October 1, 2002, the Partnership adopted the provisions of SFAS No. 142“Goodwill and Other Intangible Assets.” SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized,but instead be tested for impairment at least annually. SFAS No. 142 also requires intangible assets with definite useful lives be amortized over theirrespective estimated useful lives to their estimated residual values, and reviewed for impairment. On October 1, 2002, the Partnership ceasedamortization of all goodwill. The Partnership also recorded a non-cash charge of $3.9 million in its first fiscal quarter of 2003 to reduce the carryingvalue of the discontinued TG&E segment’s goodwill. This charge is reflected as a cumulative effect of change in accounting principle in thePartnership’s consolidated statement of operations for the year ended September 30, 2003. The Partnership performed its annual impairment reviewduring its fiscal fourth quarter and it concluded that there was no impairment to the carrying value of goodwill, as of August 31, 2004. Customer lists are the names and addresses of the acquired company’s patrons. Based on the historical retention experience of these lists, Star GasPropane amortizes customer lists on a straight-line basis over ten to fifteen years. Petro amortizes customer lists on a straight-line basis over seven toten years. Covenants not to compete are non-compete agreements established with the owners of an acquired company and are amortized over the respectivelives of the covenants on a straight-line basis, which are generally five years. F-10 Table of Contents3)Summary of Significant Accounting Policies - (continued) Impairment of Long-lived Assets It is the Partnership’s policy to review intangible assets and other long-lived assets, in accordance with SFAS No. 144, for impairment whenever eventsor changes in circumstances indicate that the carrying amount of such assets may not be recoverable. The Partnership determines that the carryingvalues of such assets are recoverable over their remaining estimated lives through undiscounted future cash flow analysis. If such a review shouldindicate that the carrying amount of the assets is not recoverable, it is the Partnership’s policy to reduce the carrying amount of such assets to fair value. Deferred Charges Deferred charges represent the costs associated with the issuance of debt instruments and are amortized over the lives of the related debt instruments. Advertising Expense Advertising costs are expensed as they are incurred. Advertising expenses were $6.8 million, $8.2 million and $9.1 million in 2002, 2003 and 2004,respectively. Customer Credit Balances Customer credit balances represent pre-payments received from customers pursuant to a budget payment plan (whereby customers pay their estimatedannual usage on a fixed monthly basis) and the payments made have exceeded the charges for deliveries. Environmental Costs The Partnership expenses, on a current basis, costs associated with managing hazardous substances and pollution in ongoing operations. ThePartnership also accrues for costs associated with the remediation of environmental pollution when it becomes probable that a liability has beenincurred and the amount can be reasonably estimated. Insurance Reserves The Partnership accrues for workers’ compensation, general liability and auto claims not covered under its insurance policies based upon actuarialexpectations as to what its ultimate liability will be for these claims. Employee Unit Incentive Plan When applicable, the Partnership accounts for stock-based compensation arrangements in accordance with APB No. 25. Compensation costs for fixedawards on pro-rata vesting are recognized on a straight-line basis over the vesting period. The Partnership adopted an employee and director unitincentive plan to grant certain employees and directors senior subordinated limited partner units (“incentive units”), as an incentive for increasedefforts during employment and as an inducement to remain in the service of the Partnership. Grants of incentive units vest as follows: twenty percentimmediately, with the remaining amount vesting annually over four consecutive installments if the Partnership achieves annual targeted distributablecash flow. The Partnership records an expense for the incentive units granted, which require no cash contribution, over the vesting period for thoseunits which are probable of being issued. 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 individualpartners. Except for the Partnership’s corporate subsidiaries, no recognition has been given to Federal income taxes in the accompanying financialstatements of the Partnership. While the Partnership’s corporate subsidiaries will generate non-qualifying Master Limited Partnership revenue,dividends from the corporate subsidiaries to the Partnership are generally included in the determination of qualified Master Limited Partnershipincome. In addition, a portion of the dividends received by the Partnership from the corporate subsidiaries will be taxable to the partners. Net earningsfor financial statement purposes will differ significantly from taxable income reportable to partners as a result of differences between the tax basis andfinancial reporting basis of assets and liabilities and due to the taxable income allocation requirements of the Partnership agreement. For most corporate subsidiaries of the Partnership, a consolidated Federal income tax return is filed. Deferred tax assets and liabilities are recognized forthe future tax consequences attributable to differences between the financial statement carrying amount of assets and liabilities and their respective taxbases and operating loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income inthe years in which those temporary differences are expected to be recovered or settled. F-11 Table of Contents3)Summary of Significant Accounting Policies - (continued) Concentration of Revenue with Price Plan Customers During fiscal 2004, approximately 43% of the heating oil volume sold in the heating oil segment and approximately 15% of the retail volume sold atthe propane segment was sold to individual customers under an agreement pre-establishing a fixed or maximum sales price of home heating oil over atwelve month period (“price plan customers”). The fixed or maximum price at which home heating oil is sold to these price plan customers is generallyrenegotiated prior to the heating season of each year based on current market conditions. The heating oil segment currently enters into derivativeinstruments (futures, options, collars and swaps) for a substantial majority of the heating oil it anticipates selling to these price plan customers. Shouldevents occur after a price plan customer’s price is established that increases the cost of home heating oil above the amount anticipated, margins for theprice plan customers whose heating oil was not purchased in advance would be lower than expected, while those customers whose heating oil waspurchased in advance would be unaffected. Conversely, should events occur during this period that decrease the cost of heating oil below the amountanticipated, margins for the price plan customers whose heating oil was purchased in advance could be lower than expected, while those customerswhose heating oil was not purchased in advance would be unaffected or higher than expected. Derivatives and Hedging The Partnership uses derivative instruments to manage the majority of its exposure to market risk related to changes in the current and future marketprice of home heating oil and propane purchased for resale to price plan customers. It is the Partnership’s objective to hedge the cash flow variabilityassociated with forecasted purchases of its inventory held for resale to price plan customers through the use of derivative instruments when appropriate.To a lesser extent, the Partnership may hedge the fair value of inventory on hand or firm commitments to purchase inventory. To meet these objectives,it is the Partnership’s policy to enter into various types of derivative instruments to (i) manage the variability of cash flows resulting from the price riskassociated with forecasted purchases of home heating oil and propane purchased for resale to price plan customers, (ii) hedge the downside price risk offirm purchase commitments and in some cases physical inventory on hand. All derivative instruments are recognized on the balance sheet at their fair market value. On the date the derivative contract is entered into, thePartnership designates the derivative as either a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (fairvalue hedge), or a hedge of a forecasted purchase or the variability of cash flows to be received or paid related to a recognized asset or liability (cashflow hedge). The Partnership formally documents all relationships between hedging instruments and hedged items, as well as its risk-managementobjective and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as fair value or cashflow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Partnership alsoformally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highlyeffective in offsetting changes in fair value or cash flows of hedged items. Changes in the fair value of a derivative that is highly effective and that is designated and qualifies as a fair value hedge, along with the loss or gain onthe hedged asset or liability or unrecognized firm commitment of the hedged item that is attributable to the hedged risk are recorded in earnings.Changes in the fair value of a derivative that is highly effective and that is designated and qualifies as a cash-flow hedge are recorded in accumulatedother comprehensive income, until earnings are affected by the variability in cash flows of the designated hedged item. The ineffective portion of aderivative’s change in fair value is immediately recognized in earnings. When it is determined that a derivative is not highly effective as a hedge or that is has ceased to be a highly effective hedge, the Partnershipdiscontinues hedge accounting prospectively. When hedge accounting is discontinued because it is determined that the derivative no longer qualifiesas an effective hedge, the Partnership continues to carry the derivative on the balance sheet at its fair value, and recognized changes in the fair value ofthe derivative through current-period earnings. F-12 Table of Contents4)Discontinued Operations TG&E was the partnership’s energy reseller that marketed natural gas and electricity to residential households in deregulated energy markets in NewYork, New Jersey, Florida and Maryland and served approximately 65,000 residential customers. TG&E’s operations were conducted through TotalGas & Electric, Inc., a Florida corporation, that was an indirect wholly-owned subsidiary of Petro. On March 31, 2004, the Partnership sold the stockand business of TG&E in an all-cash transaction to a private party. The Partnership received proceeds of approximately $12.5 million and recorded aloss of $538,000 from the sale of TG&E. As a result of the sale of the TG&E segment and in accordance with SFAS No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets”, the Partnership has restated its fiscal years ended September 30, 2002 and September 30, 2003, toinclude the results of the TG&E segment as a component of discontinued operations. Income (loss) from discontinued operations does not includeallocations of interest expense from the Partnership. Income from discontinued operations for the years ended September 30, are as follows (in thousands): Years Ended September 30, 2002 2003 2004Sales $39,163 $81,480 $52,413Cost of sales 32,618 71,789 46,867Depreciation and amortization 1,822 667 258General and administrative expenses 15,728 7,780 4,255 (11,005) 1,244 1,033Net interest expense 432 14 — Income (loss) from discontinued operations before income taxes, loss on sale of segment and cumulative effect ofchanges in accounting principles, net of taxes (11,437) 1,230 1,033Income tax expense — — 110 Income (loss) from discontinued operations before cumulative effect of changes in accounting principles, net of incometaxes (11,437) 1,230 923Cumulative effects of changes in accounting principles — (3,901) — Income (loss) from discontinued operations $(11,437) $(2,671) $923 5)Quarterly Distribution of Available Cash In general, the Partnership has distributed to its partners on a quarterly basis all “Available Cash.” Available Cash generally means, with respect to anyfiscal quarter, all cash on hand at the end of such quarter less the amount of cash reserves that are necessary or appropriate in the reasonable discretionof the General Partner to (1) provide for the proper conduct of the Partnership’s business, (2) comply with applicable law or any of its debt instrumentsor other agreements or (3) in certain circumstances provide funds for distributions to the common unitholders and the senior subordinated unitholdersduring the next four quarters. The General Partner may not establish cash reserves for distributions to the senior subordinated units unless the GeneralPartner has determined that in its judgment the establishment of reserves will not prevent the Partnership from distributing the Minimum QuarterlyDistribution (“MQD”) on all common units and any common unit arrearages thereon with respect to the next four quarters. Certain restrictions ondistributions on senior subordinated units, junior subordinated units and general partner units could result in cash that would otherwise be AvailableCash being reserved for other purposes. Cash distributions will be characterized as distributions from either Operating Surplus or Capital Surplus asdefined in the Partnership agreement. The senior subordinated units, the junior subordinated units, and general partner units are each a separate class of interest in Star Gas Partners, and therights of holders of those interests to participate in distributions differ from the rights of the holders of the common units. F-13 Table of Contents5)Quarterly Distribution of Available Cash - (continued) In general, Available Cash may be distributed per quarter based on the following priorities: •First, to the common units until each has received $0.575, plus any arrearages from prior quarters. •Second, to the senior subordinated units until each has received $0.575. •Third, to the junior subordinated units and general partner units until each has received $0.575. •Finally, after each has received $0.575, Available Cash will be distributed proportionately to all units until target levels are met. If distributions of Available Cash exceed target levels greater than $0.604, the senior subordinated units, junior subordinated units and general partnerunits will receive incentive distributions. In August 2000, the Partnership commenced quarterly distributions on its senior subordinated units at an initial rate of $0.25 per unit. From February2001 to July 2002, the Partnership increased the quarterly distributions on its senior subordinated units, junior subordinated units and general partnerunits to $0.575 per unit. In August 2002, the Partnership announced that it would decrease distributions to its senior subordinated units to $0.25 perunit and would eliminate the distributions to its junior subordinated units and general partner units. In April 2003, the Partnership announced that itwould increase the distributions to its senior subordinated units to $0.575 per unit and that it would resume distributions of $0.575 per unit to itsjunior subordinated units and general partner units. In order for any subordinated unit to receive a distribution, common units must be paid alloutstanding minimum quarterly distributions, including arrearages. On October 18, 2004 the Partnership announced that it would not be permitted to make any distributions on its common units for the quarter endedSeptember 30, 2004. The Partnership had previously announced the suspension of distributions on the senior subordinated units on July 29, 2004. The revolving credit facility and, as applicable, the bridge facility or the senior secured notes, will impose certain restrictions on the Partnership’sability to pay distributions to unitholders. The Partnership believes that the sale of the propane segment would, by de-leveraging the Partnership’sbalance sheet, likely advance the time when it would be possible for the Partnership to resume regular distributions on the common units. ThePartnership believes that whether or not the propane segment is sold, it is unlikely that the Partnership will resume distributions on the seniorsubordinated units, junior subordinated units and general partner units for the foreseeable future. The subordination period will end once the Partnership has met the financial tests stipulated in the partnership agreement, but it generally cannot endbefore September 30, 2007. However, if the general partner is removed under some circumstances, the subordination period will end. When thesubordination period ends, all senior subordinated units and junior subordinated units will convert into Class B common units on a one-for-one basis,and each common unit will be redesignated as a Class A common unit. The main difference between the Class A common units and Class B commonunits is that the Class B common units will continue to have the right to receive incentive distributions and additional units. The subordination period will generally extend until the first day of any quarter after each of the following three events occur: 1)distributions of Available Cash from Operating Surplus on the common units, senior subordinated units, junior subordinated units and generalpartner units equal or exceed the sum of the minimum quarterly distributions on all of the outstanding common units, senior subordinated units,junior subordinated units and general partner units for each of the three non-overlapping four-quarter periods immediately preceding that date; 2)the Adjusted Operating Surplus generated during each of the three immediately preceding non-overlapping four-quarter periods equaled orexceeded the sum of the minimum quarterly distributions on all of the outstanding common units, senior subordinated units, junior subordinatedunits and general partner units during those periods on a fully diluted basis for employee options or other employee incentive compensation.This includes all outstanding units and all common units issuable upon exercise of employee options that have, as of the date of determination,already vested or are scheduled to vest before the end of the quarter immediately following the quarter for which the determination is made. Italso includes all units that have as of the date of determination been earned by but not yet issued to our management for incentivecompensation; and 3)there are no arrearages in payment of the minimum quarterly distribution on the common units. F-14 Table of Contents6)Segment Reporting At September 30, 2004, the Partnership had two reportable operating segments: retail distribution of heating oil and retail distribution of propane. Theadministrative expenses for the public master limited partnership, Star Gas Partners, have not been allocated to the segments. Management has electedto organize the enterprise under these two segments in order to (i) leverage the expertise it has in each industry, (ii) allow each segment to continue tostrengthen its core competencies and (iii) provide a clear means for evaluation of operating results. The heating oil segment is primarily engaged in the retail distribution of home heating oil, related equipment services, and equipment sales toresidential and commercial customers. It operates primarily in the Northeast and Mid-Atlantic regions. Home heating oil is principally used by thePartnership’s residential and commercial customers to heat their homes and buildings, and as a result, weather conditions have a significant impact onthe demand for home heating oil. The propane segment is primarily engaged in the retail distribution of propane and related supplies and equipment to residential, commercial,industrial, agricultural and motor fuel customers, in the Midwest, Northeast, Florida and Georgia. Propane is used primarily for space heating, waterheating and cooking by the Partnership’s residential and commercial customers and as a result, weather conditions also have a significant impact onthe demand for propane. See Note 2 regarding the sale of the propane segment. The results of the propane segment will be included as a component ofdiscontinued operations in accordance with SFAS 144, “Accounting for Impairment or Disposal of Long-Lived Assets” in the Partnership’s futureconsolidated financial statements upon consummation of the sale of the propane segment. The public master limited partnership includes the office of the Chief Executive Officer and has the responsibility for maintaining investor relationsand investor reporting for the Partnership. F-15 Table of Contents 6)Segment Reporting (continued) The following are the statements of operations and balance sheets for each segment as of and for the periods indicated. There were no inter-segmentsales. Years Ended September 30, 2003 2004 (in thousands) Heating Oil Propane(1) Partners &Others(2) Consol. Heating Oil Propane(1) Partners &Others(2) Consol. Statements of Operations Sales $1,102,968 $279,300 $— $1,382,268 $1,105,091 $348,846 $— $1,453,937 Cost of sales 793,543 145,015 — 938,558 799,055 196,998 — 996,053 Delivery and branch expenses 217,244 76,279 — 293,523 232,985 92,701 — 325,686 Depreciation & amortization expenses 35,535 16,958 — 52,493 37,313 20,030 — 57,343 General and administrative expenses 22,356 10,568 17,407 50,331 16,535 10,092 3,402 30,029 Operating income (loss) 34,290 30,480 (17,407) 47,363 19,203 29,025 (3,402) 44,826 Net interest expense 22,760 11,037 6,770 40,567 28,038 10,321 7,544 45,903 Amortization of debt issuance costs 1,655 194 383 2,232 2,750 166 730 3,646 (Gain) loss on redemption of debt (212) 393 — 181 — — — — Income (loss) from continuing operationsbefore income taxes 10,087 18,856 (24,560) 4,383 (11,585) 18,538 (11,676) (4,723)Income tax expense 1,200 300 — 1,500 1,240 285 — 1,525 Income (loss) from continuing operations 8,887 18,556 (24,560) 2,883 (12,825) 18,253 (11,676) (6,248)Income from discontinued operationsbefore loss on sale of segment andcumulative effect of change in acctprinciple — — 1,230 1,230 — — 923 923 Loss on sale of TG&E segment, net oftaxes — — — — — — (538) (538)Cumulative effect of change inaccounting principle - adoption ofSFAS 142 — — (3,901) (3,901) — — — — Net income (loss) $8,887 $18,556 $(27,231) $212 $(12,825) $18,253 $(11,291) $(5,863) Capital expenditures $12,856 $5,521 $— $18,377 $3,984 $5,440 $— $9,424 Total Assets $622,005 $ 451,358 $(97,753) $975,610 $597,867 $421,971 $(58,862) $960,976 (in thousands) Year Ended September 30, 2002 Heating Oil Propane(1) Partners &Others(2) Consol. Statements of Operations Sales $790,378 $195,517 $— $985,895 Cost of sales 546,495 82,865 — 629,360 Delivery and branch expenses 174,030 61,678 — 235,708 Depreciation & amortization expenses 40,437 16,783 7 57,227 General and administrative expenses 13,630 8,526 4,115 26,271 Operating income (loss) 15,786 25,665 (4,122) 37,329 Net interest expense (income) 24,087 13,227 (244) 37,070 Amortization of debt issuance costs 1,197 250 — 1,447 Income (loss) from continuing operations before income taxes (9,498) 12,188 (3,878) (1,188)Income tax expense (benefit) (1,700) 244 — (1,456) Income (loss) from continuing operations (7,798) 11,944 (3,878) 268 Loss from discontinued operations before cumulative effect of change in acct. principle — — (11,437) (11,437) Net income (loss) $(7,798) $11,944 $(15,315) $(11,169) Capital expenditures $9,105 $5,235 $— $14,340 Total Assets $620,381 $391,052 $(112,614) $898,819 F-16 Table of Contents6)Segment Reporting – (continued) September 30, 2003 September 30, 2004(in thousands) HeatingOil Propane(1) Partners &Others (2) Consol. HeatingOil Propane(1) Partners &Others (2) Consol.Balance Sheets ASSETS Current assets: Cash and cash equivalents $4,244 $5,788 $12 $10,044 $4,561 $11,366 $131 $16,058Receivables, net 84,814 15,697 — 100,511 84,005 19,427 — 103,432Inventories 24,146 14,415 — 38,561 34,213 13,411 — 47,624Prepaid expenses and other current assets 48,168 3,736 (434) 51,470 61,549 6,084 (576) 67,057Net current assets of discontinued operations 10,523 — — 10,523 — — — — Total current assets 171,895 39,636 (422) 211,109 184,328 50,288 (445) 234,171Property and equipment, net 75,715 186,152 — 261,867 63,701 183,823 — 247,524Long-term portion of accounts receivable 6,108 1,037 — 7,145 5,458 879 — 6,337Investment in subsidiaries — 103,604 (103,604) — — 65,369 (65,369) — Goodwill 232,602 40,138 — 272,740 233,522 42,615 — 276,137Intangibles, net 123,415 78,053 — 201,468 103,925 76,314 — 180,239Deferred charges & other assets, net 5,403 2,738 6,273 14,414 6,933 2,683 6,952 16,568Net long-term assets of discontinued operations 6,867 — — 6,867 — — — — Total Assets $622,005 $451,358 $(97,753) $975,610 $597,867 $421,971 $(58,862) $960,976 LIABILITIES AND PARTNERS’ CAPITAL Current Liabilities: Accounts payable $19,428 $7,712 $— $27,140 $25,058 $10,930 $(48) $35,940Working capital facility borrowings 6,000 6,000 — 12,000 8,000 — — 8,000Current maturities of long-term debt 12,597 10,250 — 22,847 14,168 10,250 — 24,418Accrued expenses and other current liabilities 60,582 9,222 12,552 82,356 56,042 8,792 8,334 73,168Due to affiliates (2,385) (7,600) 9,985 — 1,329 21,842 (23,171) — Unearned service contract revenue 31,023 1,013 — 32,036 35,361 1,407 — 36,768Customer credit balances 49,258 25,458 — 74,716 54,857 29,305 — 84,162Net current liabilities of discontinuedoperations 7,569 — — 7,569 — — — — Total current liabilities 184,072 52,055 22,537 258,664 194,815 82,526 (14,885) 262,456Long-term debt 191,380 110,850 197,111 499,341 148,045 88,000 267,623 503,668Due to affiliate 116,417 — (116,417) — 165,684 — (165,684) — Other long-term liabilities 26,532 1,297 — 27,829 23,954 1,127 — 25,081Partners’ Capital: Equity Capital 103,604 287,156 (200,984) 189,776 65,369 250,318 (145,916) 169,771 Total Liabilities and Partners’ Capital $622,005 $451,358 $(97,753) $975,610 $597,867 $421,971 $(58,862) $960,976 (1)See Note 2 regarding the sale of the propane segment. (2)The Partner and Other amounts include the balance sheet and statement of operations of the Public Master Limited Partnership, Star Gas FinanceCompany, as well as the necessary consolidation entries to eliminate the investment in Petro Holdings and Star Gas Propane. F-17 Table of Contents7)Inventories The components of inventory were as follows: September 30,(in thousands) 2003 2004Propane gas $8,288 $7,096Propane appliances and equipment 5,153 3,672Heating oil and other fuels 12,268 22,989Fuel oil parts and equipment 12,852 13,867 $38,561 $47,624 Inventory Derivative Instruments The Partnership periodically hedges a portion of its home heating oil and propane purchases through futures, options, collars and swap agreements. To hedge a substantial portion of the purchase price associated with heating oil gallons anticipated to be sold to its price plan customers, thePartnership at September 30, 2004 had outstanding 74.1 million gallons of swap contracts to buy heating oil with a notional value of $71.5 millionand a fair value of $20.4 million; 30.7 million gallons of futures contracts to buy heating oil with a notional value of $33.2 million and a fair value of$8.2 million; 6.6 million gallons of purchased call option contracts to buy heating oil with a notional value of $13.1 million and a fair value of $2.4million. The contracts expire at various times with no contract expiring later than September 30, 2005. The Partnership recognizes the fair value ofthese derivative instruments as assets. To hedge a substantial portion of the purchase price associated with propane gallons anticipated to be sold to its fixed price customers, the Partnershipat September 30, 2004 had outstanding swap contracts to buy 33.1 million gallons of propane with a notional value of $27.3 million and a fair valuetotaling $0.4 million. The contracts expire at various times with no contracts expiring later than September 30, 2005. The Partnership recognizes thefair value of these derivative instruments as assets. For the year ended September 30, 2003, the Partnership recognized the following for derivative instruments designated as cash flow hedges: $14.3million gain in earnings due to instruments which expired during the fiscal year ended September 30, 2003, $0.5 million unrealized loss inaccumulated other comprehensive income due to the effective portion of derivative instruments outstanding at September 30, 2003, $0.3 million lossdue to hedge ineffectiveness for derivative instruments outstanding during the year ended September 30, 2003. For derivative instruments accountedfor as fair value hedges, the Partnership recognized a $0.2 million unrealized loss in earnings due to instruments which expired or settled during thefiscal year ended September 30, 2003, and a $0.2 million loss in earnings for the change in the fair value of derivative instruments outstanding duringthe year ended September 30, 2003. For derivative instruments not designated as hedging instruments, the Partnership recognized a $2.5 million loss inearnings due to instruments which expired during the fiscal year ended September 30, 2003, and a $0.3 million loss for the change in fair value ofderivative instruments outstanding at September 30, 2003. For the year ended September 30, 2004, the Partnership recognized the following for derivative instruments designated as cash flow hedges: $23.8million gain in earnings due to instruments expiring or settled during the current year, $28.9 million unrealized gain in accumulated othercomprehensive income due to the effective portion of derivative instruments outstanding at September 30, 2004, and approximately $2.5 millionunrealized gain in earnings resulting from hedge ineffectiveness for derivative instruments outstanding at September 30, 2004. For derivativeinstruments accounted for as fair value hedges, the Partnership recognized a $2.6 million loss in earnings due to instruments expiring or settled duringthe current year, and a $2.2 million unrealized loss in earnings for the change in the fair value of derivative instruments outstanding at September 30,2004. For derivative instruments not designated as hedging instruments, the Partnership recognized a $2.9 million loss in earnings due to instrumentsexpiring or settled during the year, and a $1.9 million unrealized loss for the change in fair value of derivative instruments outstanding at September30, 2004. The Partnership recorded $31.4 million for the fair value of all of its derivative instruments, to other current assets, at September 30, 2004. The balanceof approximately $28.9 million in accumulated other comprehensive income for the effective portion of cash flow hedges is expected to be reclassifiedinto earnings, through cost of goods sold, over the next 12 months. F-18 Table of Contents8)Property, Plant and Equipment The components of property, plant and equipment and their estimated useful lives were as follows: September 30, (in thousands) 2003 2004 Estimated Useful LivesLand $22,820 $23,208 — Buildings and leasehold improvements 39,218 39,580 4 -30 yearsFleet and other equipment 71,648 72,057 1 -30 yearsTanks and equipment 191,060 196,006 8 -30 yearsFurniture and fixtures 49,466 53,388 3 - 12 years Total 374,212 384,239 Less accumulated depreciation 112,345 136,715 Property and equipment, net $261,867 $247,524 9)Goodwill and Other Intangible Assets On October 1, 2002, the Partnership adopted the provisions of SFAS No. 142, which required the Partnership, among other things to discontinueamortizing goodwill. SFAS No. 142 also requires that goodwill be reviewed for impairment at least annually. Under SFAS No. 142, goodwill impairment is deemed to exist if the carrying amount of a reporting unit exceeds its estimated fair value. If it isdetermined that the goodwill of a reporting unit is impaired, an impairment charge is recorded to the extent that the carrying amount of a reporting unitexceeds fair value. In calculating the estimated fair value of the reporting units, a discounted cash flow methodology is utilized. The Partnership’sreporting units are consistent with the operating segments identified in Note 6 – Segment Reporting. Upon adoption of SFAS No. 142 in the first fiscal quarter of 2003, the Partnership recorded a non-cash charge of approximately $3.9 million to reducethe carrying value of its goodwill for its discontinued TG&E segment. This charge is reflected as a cumulative effect of change in accounting principlein the Partnership’s consolidated statement of operations for the fiscal year ended September 30, 2003. The Partnership has completed its annualimpairment review during its fourth fiscal quarter of 2003 and 2004, and determined that there is no additional impairment to goodwill in each of itsoperating segments. A summary of changes in the Partnership’s goodwill during the year ended September 30, 2004, by business segment is as follows (in thousands): Heating OilSegment PropaneSegment TotalBalance as of October 1, 2002 $219,031 $35,502 $254,533Fiscal 2003 acquisitions 13,571 4,636 18,207 Balance as of September 30, 2003 232,602 40,138 272,740Fiscal 2004 acquisitions 920 2,477 3,397 Balance as of September 30, 2004 $233,522 $42,615 $276,137 Intangible assets subject to amortization consist of the following (in thousands): September 30, 2003 September 30, 2004 Gross CarryingAmount AccumulatedAmortization Net Gross CarryingAmount AccumulatedAmortization NetCustomer lists $289,323 $92,877 $196,446 $297,065 $120,885 $176,180Covenants not to compete 12,959 7,937 5,022 14,103 10,044 4,059 $302,282 $100,814 $201,468 $311,168 $130,929 $180,239 F-19 Table of Contents9)Goodwill and Other Intangible Assets - (continued) The Partnership’s results for the fiscal year ended September 30, 2002 on a historic basis did not reflect the impact of the provisions of SFAS No. 142.Had the Partnership adopted SFAS No. 142 on October 1, 2001, the unaudited pro forma effect on Basic and Diluted net income (loss) and LimitedPartners’ interest in net income (loss) would have been as follows: Net Income (Loss) Basic and Diluted NetIncome (Loss) Per Unit (in thousands, except per unit data) 2002 2003 2004 2002 2003 2004 As reported: net income (loss) $(11,169) $212 $(5,863) $(0.39) $0.01 $(0.17)Add: Goodwill amortization 8,275 — — 0.29 — — — Income tax impact — — — — — — — Adjusted: Net income (loss) (2,894) 212 (5,863) (0.10) 0.01 $(0.17)General Partner’s interest in net income (loss) (30) 2 (57) — — — Adjusted: Limited Partners’ interest in net income (loss) $(2,864) $210 $(5,806) $(0.10) $0.01 $(0.16) Amortization expense for intangible assets was $25.5 million, $26.8 million and $30.1 million for the fiscal years ended September 30, 2002, 2003 and2004, respectively. Total estimated annual amortization expense related to other intangible assets subject to amortization, for the year endedSeptember 30, 2005 and the four succeeding fiscal years ended September 30, is as follows (in thousands of dollars): Amount2005 $30,1652006 $29,2632007 $28,5092008 $26,5942009 $18,303 10)Long-Term Debt and Bank Facility Borrowings (See Note 2 “Recent Events”) The Partnership’s long-term debt at September 30, 2003 and 2004 is as follows: September 30. (in thousands) 2003 2004 Star Gas 10.25% Senior Notes (a) $197,111 $267,623 Propane Segment: 8.04% First Mortgage Notes (b) 61,500 51,250 8.70% First Mortgage Notes (b) 27,500 27,500 7.89% First Mortgage Notes (b) 17,500 17,500 Acquisition Facility Borrowings (c) 12,600 — Parity Debt Facility Borrowings (c) 2,000 2,000 Working Capital Facility Borrowings (c) 6,000 — Heating Oil Segment: 7.92% Senior Notes (d) 61,000 53,000 8.25% Senior Notes (e) 77,292 77,000 8.96% Senior Notes (f) 30,000 30,000 Working Capital Facility Borrowings (g) 6,000 8,000 Acquisition Facility Borrowings (g) 33,000 — Acquisition Notes Payable and other (h) 931 459 Subordinated Debentures (i) 1,754 1,754 Total debt 534,188 536,086 Less current maturities (22,847) (24,418)Less working capital facility borrowings (12,000) (8,000) Total long-term portion debt $499,341 $503,668 F-20 Table of Contents10)Long-Term Debt and Bank Facility Borrowings - (continued) (a)On February 6, 2003, the Partnership and its wholly owned subsidiary, Star Gas Finance Company, jointly issued $200.0 million face valueSenior Notes due on February 15, 2013. These notes accrue interest at an annual rate of 10.25% and require semi-annual interest payments onFebruary 15 and August 15 of each year commencing on August 15, 2003. These notes are redeemable at the option of the Partnership, in wholeor in part, from time to time by payment of a premium, as defined. These notes were priced at 98.466% for total gross proceeds of $196.9 million.The Partnership also incurred $7.2 million of fees and expenses in connection with the issuance of these notes resulting in net proceeds of$189.7 million. During the year ended September 30, 2003, the Partnership used $169.0 million from the proceeds of the 10.25% Senior Notes torepay existing long-term debt and working capital facility borrowings, $17.7 million for acquisitions, $3.0 million for capital expenditures, andrecognized a $0.2 million loss on redemption of debt. The debt discount related to the issuance of the 10.25% Senior Notes was $3.1 million andwill be amortized and included in interest expense through February 2013. In January 2004, Star Gas and its wholly owned subsidiary, Star GasFinance Company, jointly issued $35.0 million of 10.25% Senior Notes, due 2013 in a private placement. These notes were issued at a premiumto par for total net proceeds of $38.1 million. Also in July 2004, Star Gas and its wholly owned subsidiary, Star Gas Finance Company, issued$30.0 million face value 10.25% Senior Notes, due February 15, 2013 in a private placement. These notes were issued at a premium to par fortotal net proceeds of $32.4 million, which includes $1.2 million of accrued interest. The net proceeds of these two offerings resulted in net cashreceived of $70.5 million. (b)In December 1995, Star Gas Propane assumed $85.0 million of first mortgage notes (the “First Mortgage Notes”) with an annual interest rate of8.04% in connection with the initial Partnership formation. In January 1998, Star Gas Propane issued an additional $11.0 million of FirstMortgage Notes with an annual interest rate of 7.17%. In March 2000, Star Gas Propane issued $27.5 million of 8.70% First Mortgage Notes. InMarch 2001, Star Gas issued $29.5 million of First Mortgage Notes with an average annual interest rate of 7.89% per year. Obligations under theFirst Mortgage Note Agreements are secured, on an equal basis with Star Gas Propane’s obligations under the Star Gas Propane Bank CreditFacilities, by a mortgage on substantially all of the real property and liens on substantially all of the operating facilities, equipment and otherassets of Star Gas Propane. The First Mortgage Notes require semiannual payments, without premium on the principal thereof, which began onMarch 15, 2001 and have a final maturity of March 30, 2015. Interest on the First Mortgage Notes is payable semiannually in March andSeptember. The First Mortgage Note Agreements contain various restrictive and affirmative covenants applicable to Star Gas Propane; the mostrestrictive of these covenants relate to the incurrence of additional indebtedness and restrictions on dividends, certain investments, guarantees,loans, sales of assets and other transactions. In fiscal 2003, the Propane segment repaid $11.0 million of its 7.17% First Mortgage Notes, $12.9million of its 8.04% First Mortgage Notes and $12.0 million of its 7.89% First Mortgage Notes from the net proceeds of the $200.0 millionSenior Note issuance. On March 15, 2004, the propane segment repaid $5.2 million of its 8.04% Senior Notes that was due March 15, 2004, fromthe net proceeds of the $38.1 million, 10.25% Senior Notes, that were issued in January 2004. On September 15, 2004, the propane segment alsorepaid $5.1 million of its 8.04% Senior Notes, that was due on September 15, 2004, from the net proceeds of the $31.2 million, 10.25% SeniorNotes that were issued in July 2004. (c)At September 30, 2004, the Star Gas Propane Bank Credit Facilities consisted of a $25.0 million Acquisition Facility, a $25.0 million Parity DebtFacility and a $24.0 million Working Capital Facility. At September 30, 2004, there were no borrowings outstanding under its AcquisitionFacility and Working Capital Facility and $2.0 million of borrowings outstanding under its Parity Debt Facility. The agreement governing theBank Credit Facilities contains covenants and default provisions generally similar to those contained in the First Mortgage Note Agreements.The Bank Credit Facilities bear interest at a rate based upon the London Interbank Offered Rate plus a margin (as defined in the Bank CreditFacilities). The Partnership is required to pay a fee for unused commitments which amounted to $0.2 million, $0.2 million and $0.1 millionduring fiscal 2002, 2003 and 2004, respectively. For fiscal 2003 and 2004, the weighted average interest rate on borrowings under thesefacilities was 4.0% and 3.4%, respectively. At September 30, 2004, the interest rate on the borrowings outstanding was 2.9%. Borrowings underthe Working Capital Facility requires a minimum period of 30 consecutive days during each fiscal year that the facility will have no amountoutstanding. This facility will expire on September 30, 2006. Borrowings under the Acquisition and Parity Debt Facilities will revolve untilSeptember 30, 2006, after which time any outstanding loans thereunder, will amortize in eight equal quarterly principal payments with a finalpayment due on September 30, 2008. F-21 Table of Contents10)Long-Term Debt and Bank Facility Borrowings - (continued) (d)The Petro 7.92% Senior Secured Notes were issued in six separate series in a private placement to institutional investors as part of its acquisitionby the Partnership. The Senior Secured Notes are guaranteed by Star Gas Partners and are secured equally and ratably with Petro’s existing seniordebt and bank credit facilities by Petro’s cash, accounts receivable, notes receivable, inventory and customer list. Each series of Senior SecuredNotes will mature between April 1, 2003 and April 1, 2014. Only interest on each series is due semiannually. On the last interest payment date foreach series, the outstanding principal amount is due and payable in full. The note agreements for the senior secured notes contain variousnegative and affirmative covenants. The most restrictive of the covenants include restrictions on payment of dividends or other distributions byStar Gas Partners if certain ratio tests as defined in the note agreement are not achieved. On February 6, 2003 and April 1, 2003, the heating oilsegment repaid $18.0 million and $11.0 million of its 7.92% Senior Notes from the net proceeds of the $200.0 million 10.25% Senior Noteissuance in February 2003, respectively. On April 1, 2004, the heating oil segment also repaid $8.0 million of its 7.92% Senior Notes from thenet proceeds of the $38.1 million 10.25% Senior Note issuance in January 2004. (e)The Petro Senior Notes bear an average interest rate of 8.25%. These Senior Notes pay interest semiannually and were issued under agreementsthat are substantially identical to the agreement under which the 7.92% and 8.96% Senior Notes were issued. These notes are also guaranteed byStar Gas Partners. The largest series has an annual interest rate of 8.05% and a maturity date of August 1, 2006 in the amount of $73.0 million.The remaining series bear an annual interest rate of 8.73% and are due in equal annual sinking fund payments due August 1, 2009 and ending onAugust 1, 2013. In March 2002, the heating oil segment entered into two interest rate swap agreements designed to hedge $73.0 million in underlying fixed ratesenior note obligations. The swap agreements required the counterparties to pay an amount based on the stated fixed interest rate (annual rate8.05%) pursuant to the senior notes for an aggregate $2.9 million due every six months on August 1 and February 1. In exchange, the heating oilsegment was required to make semi-annual floating interest rate payments on August 1 and February 1 based on an annual interest rate equal tothe 6 month LIBOR interest rate plus 2.83% applied to the same notional amount of $73.0 million. The swap agreements were recognized as fairvalue hedges. Amounts to be paid or received under the interest rate swap agreements were accrued and recognized over the life of theagreements as an adjustment to interest expense. At September 30, 2002, Petro recognized a $6.1 million increase in the fair value of its interestrate swaps which is recorded in other assets with the fair value of long-term debt increasing by a corresponding amount at that date. On October17, 2002, Petro signed mutual termination agreements of its interest rate swap transactions and received $4.8 million which was reflected as abasis adjustment to the fair values of the related debt and is being amortized using the effective yield over the remaining lives of the swapagreements as a reduction of interest expense. On February 6, 2003, the heating oil segment repaid $26.0 million, of its 8.25% Senior Notes from the net proceeds of the $200.0 million SeniorNote issuance. In September 2003, the heating oil segment entered into an interest rate swap agreement designed to hedge $55.0 million in underlying fixedrate senior note obligations. The swap agreement, which will expire on August 1, 2006, requires the counterparty to pay an amount based on thestated fixed interest rate (annual rate 8.05%) pursuant to the senior notes for $2.2 million due every six months on August 1 and February 1. Inexchange, the heating oil segment is required to make semi-annual floating interest rate payments on August 1 and February 1 based on anannual interest rate equal to the 6 month LIBOR interest rate plus 5.52% applied to the same notional amount of $55.0 million. The swapagreements were recognized as fair value hedges. Amounts to be paid or received under the interest rate swap agreements were accrued andrecognized over the life of the agreements as an adjustment to interest expense. On March 11, 2004, Petro and the counterparty signed mutualtermination agreements relating to its interest rate swap transactions. Petro terminated these obligations and liabilities in advance of itsscheduled termination date, August 1, 2006, and received $0.5 million. This amount was reflected as a basis adjustment to the fair values of therelated debt and is being amortized using the effective yield over the remaining lives of the swap agreements as a reduction of interest expense. (f)The Petro 8.96% Senior Notes which pay interest semiannually, were issued under agreements that are substantially identical to the agreementsunder which the Partnership’s other Senior Notes were issued. These notes are also guaranteed by Star Gas Partners. These notes were issued inthree separate series. The largest series has annual sinking fund payments of $2.9 million due beginning November 1, 2004 and endingNovember 1, 2010. The other two series are due on November 1, 2004 and November 1, 2005. On February 6, 2003, the Heating Oil segmentrepaid $10.0 million, of these Senior Notes that was due on November 1, 2004, from the net proceeds of the $200.0 million Senior Note issuanceon February 6, 2003. F-22 Table of Contents10)Long-Term Debt and Bank Facility Borrowings - (continued) (g)In December 2003, the heating oil segment entered into a new credit agreement consisting of three facilities totaling $235.0 million having amaturity date of June 30, 2006. These facilities consist of a $150.0 million revolving credit facility, which is to be used for working capitalpurposes, a $35.0 million revolving credit facility, which is to be used for the issuance of standby letters of credit in connection with surety,worker’s compensation and other financial guarantees, and a $50.0 million revolving credit facility, which is to be used to finance or refinancecertain acquisitions and capital expenditures, for the issuance of letters of credit in connection with acquisitions and, to the extent that there isinsufficient availability under the working capital facility. These facilities refinanced and replaced the existing credit agreements, which totaled$193.0 million. The former facilities consisted of a working capital facility and an insurance letter of credit facility that were due to expire onJune 30, 2004. These new facilities also replaced the heating oil segments acquisition facility that was due to convert to a term loan on June 30,2004. The Petro Bank Facilities consist of three separate facilities; a $150.0 million working capital facility, a $35.0 million insurance letter of creditfacility and a $50.0 million acquisition facility. At September 30, 2004, there was a $3.0 million weather insurance letter of credit outstanding,$8.0 million of borrowings under the working capital facility, $34.5 million insurance letter of credit facility. At September 30, 2004 there wasno outstanding balance under the acquisition facility. The working capital facility and letter of credit facility will expire on June 30, 2006.Amounts borrowed under the working capital facility are subject to a requirement to maintain a zero balance for 45 consecutive days during theperiod from April 1 to September 30 of each year. In addition, each facility will bear an interest rate that is based on either the LIBOR or anotherbase rate plus a set percentage. The bank facilities agreement contains covenants and default provisions generally similar to those contained inthe note agreement for the Senior Secured Notes with additional covenants. The Partnership is required to pay a commitment fee, whichamounted to $0.9 million for the years ended September 30, 2003 and 2004, respectively. For the years ended September 30, 2003 and 2004, theweighted average interest rate for borrowings under these facilities was 3.4% and 2.9% respectively. As of September 30, 2004, the interest rateon the borrowings outstanding was 4.75%. (h)These Petro notes were issued in connection with the purchase of fuel oil dealers and other notes payable and are due in monthly and quarterlyinstallments. Interest is at various rates ranging from 5% to 15% per annum, maturing at various dates through 2007. (i)These Petro Subordinated Debentures consist of $0.7 million of 9 3/8% Subordinated Notes due February 1, 2006, and $1.1 million of 12 1/4%subordinated notes due February 1, 2005. In October 1998, the indentures under which the 9 3/8% and 12 1/4% subordinated notes were issuedwere amended to eliminate substantially all of the covenants provided by the indentures. As of September 30, 2004, the Partnership was in compliance with all debt covenants, except for the required ratio of consolidated cash flow to consolidatedinterest expense in the heating oil segments bank facility. The heating oil segment obtained a waiver of this covenant on November 5, 2004 throughDecember 17, 2004. As of September 30, 2004, the maturities including working capital borrowings during fiscal years ending September 30 are set forth inthe following table: (in thousands) 2005 $32,4182006 $81,4002007 $38,6952008 $17,6002009 $17,500Thereafter $348,473 F-23 Table of Contents11)Acquisitions During fiscal 2002, the Partnership acquired four retail heating oil dealers and seven retail propane dealers. The aggregate purchase price wasapproximately $48.2 million. During fiscal 2003, the Partnership acquired three retail heating oil dealers and seven retail propane dealers. The aggregate purchase price wasapproximately $84.4 million. During fiscal 2004, the Partnership acquired three retail heating oil dealers and ten retail propane dealers. The aggregate purchase price wasapproximately $17.5 million. The following table indicates the allocation of the aggregate purchase price paid and the respective periods of amortization assigned for the fiscal2002, fiscal 2003 and fiscal 2004 acquisitions. (in thousands) 2002 2003 2004 Useful LivesLand $1,466 $2,062 $335 — Buildings 1,950 5,844 401 30 yearsFurniture and equipment 750 1,321 66 10 yearsFleet 2,919 10,064 1,327 1-30 yearsTanks and equipment 10,583 9,251 2,539 5-30 yearsCustomer lists 20,383 34,937 7,742 7-15 yearsRestrictive covenants 650 616 1,144 1-5 yearsGoodwill 8,429 18,207 3,397 — Working capital 1,024 2,089 520 — Total $48,154 $84,391 $17,471 Acquisitions are accounted for under the purchase method of accounting. Purchase prices have been allocated to the acquired assets and liabilitiesbased on their respective fair values on the dates of acquisition. The purchase prices in excess of the fair values of net assets acquired were classified asgoodwill in the Consolidated Balance Sheets. Sales and net income have been included in the Consolidated Statements of Operations from therespective dates of acquisition. Customer lists are amortized on a straight line basis over ten to fifteen years at the propane segment and over seven toten years at the heating oil segment. The weighted average useful lives of customer lists acquired in fiscal 2002, fiscal 2003 and fiscal 2004 are 14years, 12 years and 11 years, respectively. The following unaudited pro forma information presents the results of operations of the Partnership, including the acquisitions previously described, asif the acquisitions had been acquired on October 1, of the year preceding the year of purchase. This pro forma information is presented forinformational purposes; it is not indicative of future operating performance. Years Ended September 30, in thousands (except per unit data) 2002 2003 2004 Sales $1,146,692 $1,543,295 $1,474,793 Net income (loss) $(7,863) $13,621 $(4,274)General Partner’s interest in net income (loss) (81) 128 (40) Limited Partners’ interest in net income (loss) $(7,782) $13,493 $(4,234) Basic net income (loss) per limited partner unit $(0.22) $0.38 $(0.12) Diluted net income (loss) per limited partner unit $(0.22) $0.38 $(0.12) F-24 Table of Contents12)Employee Benefit Plans Propane Segment The propane segment has a 401(k) plan, which covers certain eligible non-union and union employees. Subject to IRS limitations, the 401(k) planprovides for each employee to contribute from 1.0% to 15.0% of compensation. The propane segment contributes to non-union participants a matchingamount up to a maximum of 3.0% of compensation. Aggregate matching contributions made to the 401(k) plan during fiscal 2002, 2003 and 2004were $0.5 million, $0.6 million and $0.6 million, respectively. For the fiscal years 2002, 2003 and 2004 the propane segment made contributions onbehalf of its union employees to union sponsored defined benefit plans of $0.8 million, $0.9 million and $0.9 million, respectively. Heating Oil Segment The heating oil segment has a 401(k) plan, which covers certain eligible non-union and union employees. Subject to IRS limitations, the 401(k) planprovides for each employee to contribute from 1.0% to 17.0% of compensation. The Partnership makes a 4% core contribution of a participant’scompensation and matches 2/3 of each amount a participant contributes up to a maximum of 2.0% of a participant’s compensation. The Partnership’saggregate contributions to the heating oil segment’s 401(k) plan during fiscal 2002, 2003 and 2004 were $4.6 million, $5.2 million and $5.4 million,respectively. As a result of the Petro acquisition, the Partnership assumed Petro’s pension liability. Effective December 31, 1996, the heating oil segmentconsolidated all of its defined contribution pension plans and froze the benefits for non-union personnel covered under defined benefit pension plans.In 1997, the heating oil segment froze the benefits of its New York City union defined benefit pension plan as a result of operation consolidations.Benefits under the frozen defined benefit plans were generally based on years of service and each employee’s compensation. As part of the Meenanacquisition, the Partnership assumed the pension plan obligations and assets for Meenan’s company sponsored plan. This plan was frozen and mergedinto the Partnership’s defined benefit pension for non-union personnel as of January 1, 2002. Since these plans are frozen, the projected benefitobligation and the accumulated benefit obligation are the same. The Partnership’s pension expense for all defined benefit plans during fiscal 2002,2003 and 2004 were $0.1 million, $1.6 million and $1.0 million, respectively. F-25 Table of Contents12)Employee Benefit Plans - (continued) The following tables provide a reconciliation of the changes in the heating oil segment’s plan benefit obligations, fair value of assets, and a statementof the funded status at the indicated dates (using a measurement date of September 30): Years Ended September 30, (in thousands) 2003 2004 Reconciliation of Benefit Obligations Benefit obligations at beginning of year $58,164 $62,004 Service cost — — Interest cost 3,810 3,593 Actuarial loss 5,796 827 Benefit payments (5,681) (5,538)Settlements (85) (565) Benefit obligation at end of year $62,004 $60,321 Reconciliation of Fair Value of Plan Assets Fair value of plan assets at beginning of year $42,847 $52,395 Actual return on plan assets 6,207 4,486 Employer contributions 9,107 585 Benefit payments (5,681) (5,538)Settlements (85) (565) Fair value of plan assets at end of year $52,395 $51,363 Funded Status Benefit obligation $62,004 $60,321 Fair value of plan assets 52,395 51,363 Amount included in accumulated other comprehensive income (17,214) (15,355)Unrecognized net actuarial loss 17,214 15,355 Accrued benefit cost $9,609 $8,958 Years Ended September 30, 2002 2003 2004 Components of Net Periodic Benefit Cost Service cost $— $— $— Interest cost 3,893 3,810 3,593 Expected return on plan assets (4,085) (3,542) (4,170)Net amortization 291 1,288 1,486 Settlement loss 22 4 116 Net periodic benefit cost $121 $1,560 $1,025 Years Ended September 30, 2002 2003 2004 Weighted-Average Assumptions Used in the Measurement of the Partnership’s Benefit Obligation as of theperiod indicated Discount rate 6.75% 6.00% 6.00%Expected return on plan assets 8.50% 8.25% 8.25%Rate of compensation increase N/A N/A N/A The expected return on plan assets is determined based on the expected long-term rate of return on plan assets and the market–related value of planassets determined using fair value. The Partnership recorded an additional minimum pension liability for underfunded plans of $17.2 million at September 30, 2003 and $15.4 million atSeptember 30, 2004 representing the excess of unfunded accumulated benefit obligations over plan assets. A corresponding amount is recognized as anincrease or as a reduction of the Partnership’s capital through a charge to accumulated other comprehensive income (loss). Expected benefit payments over each of the next five years will total approximately $700,000 per year. Expected benefit payments for the five yearsthereafter will aggregate approximately $2.8 million. In addition, the heating oil segment made contributions to union-administered pension plans of $5.4 million for fiscal 2002, $5.8 million for fiscal 2003 and $5.2 million for fiscal 2004. F-26 Table of Contents12)Employee Benefit Plans - (continued) The Partnership’s Pension Plan assets by category are as follows: Years Ended September 30,(in thousands) 2003 2004Asset Categories Equity Securities $33,686 $33,892Debt Securities 18,610 17,223Cash Equivalents 99 248 $52,395 $51,363 The Plan’s objectives are to have the ability to pay benefit and expense obligations when due, to maintain the funded ratio of the Plan, to maximizereturn within reasonable and prudent levels of risk in order to minimize contributions and charges to the profit and loss statement, and to control costsof administering the Plan and managing the investments of the Plan. The strategic asset allocation of the Plan (currently 65% domestic equities and35% domestic fixed income) is based on a long term perspective and the premise that the Plan can tolerate some interim fluctuations in market valueand rates of return in order to achieve long-term objectives. The Partnership’s expected long-term rate of return on plan assets is updated at least annually, taking into consideration our asset allocation, historicalreturns on the types of assets held, and the current economic environment. Based on these factors, the Partnership expects its pension assets will earn anaverage of 8.25% per annum. The expected long-term rate of return assumption was decreased from 8.50% to 8.25% effective September 30, 2003. F-27 Table of Contents13)Income Taxes Income tax expense (benefit) was comprised of the following for the indicated periods: Years Ended September 30,(in thousands) 2002 2003 2004Current: Federal $(2,200) $— $— State 744 1,500 1,525Deferred — — — $(1,456) $1,500 $1,525 The passage of the “Job Creation and Worker Assistance Act of 2002,” increased the Alternative Minimum Tax Net Operating Loss Deductionlimitation from 90% to 100% for net operating losses generated in 2002. The tax law change resulted in the recovery of alternative minimum taxespreviously paid in the amount of approximately $2.2 million. The sources of the deferred income tax expense (benefit) and the tax effects of each were as follows: Years Ended September 30, (in thousands) 2003 2004 Depreciation $(1,712) $614 Amortization expense (1,267) 1,396 Vacation expense 63 (140)Restructuring expense 41 52 Bad debt expense 1,800 1,066 Hedge accounting (132) (489)Supplemental benefit expense 127 — Pension contribution 2,628 (387)Other, net (36) (114)Recognition of tax benefit of net operating loss to the extent of current and previous recognizedtemporary differences (4,422) (11,006)Change in valuation allowance 2,910 9,008 $— $— The components of the net deferred taxes and the related valuation allowance for the years ended September 30, 2003 and September 30, 2004 usingcurrent tax rates are as follows: Years Ended September 30, (in thousands) 2003 2004 Deferred Tax Assets: Net operating loss carryforwards $46,325 $57,331 Vacation accrual 2,011 2,151 Restructuring accrual 132 80 Bad debt expense 2,791 1,725 Amortization 2,500 1,104 Excess of book over tax hedge accounting 122 611 Other, net 117 231 Total deferred tax assets 53,998 63,233 Valuation allowance (41,730) (50,738) Net deferred tax assets $12,268 $12,495 Deferred Tax Liabilities: Depreciation $6,413 7,027 Pension contribution 5,855 5,468 Total deferred tax liabilities $12,268 $12,495 Net deferred taxes $— $— F-28 Table of Contents13)Income Taxes - (continued) In order to fully realize the net deferred tax assets, the Partnership’s corporate subsidiaries will need to generate future taxable income. A valuationallowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. Based upon the level of currenttaxable income and projections of future taxable income of the Partnership’s corporate subsidiaries over the periods which the deferred tax assets aredeductible, management believes it is more likely than not that the Partnership will not realize the full benefit of its deferred tax assets, at September30, 2003 and 2004. At September 30, 2004, the Partnership had net income tax loss carryforwards for Federal income tax reporting purposes of approximately $142.6million of which approximately $50.1 million are limited in accordance with Federal income tax law. The losses are available to offset future Federaltaxable income through 2024. 14)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, 2004, under operating leases having an initial or remaining non-cancelable term of one yearor more are as follows: (in thousands) Heating OilSegment PropaneSegment Total2005 $9,228 $1,106 $10,3342006 7,852 997 8,8492007 5,143 921 6,0642008 4,436 764 5,2002009 3,975 679 4,654Thereafter 12,743 1,978 14,721 Total future minimum lease payments $43,377 $6,445 $49,822 The propane segment leases its Seymour, Indiana underground storage facility to TEPPCO Partners, L.P. effective as of May 2003. This agreementprovides TEPPCO Partners, L.P. storage capacity of 21 million gallons at any one time in this facility. This agreement provides the propane segmentstorage capacity of 21 million gallons at any one time in TEPPCO Partners, L.P.’s pipeline system. The agreement also requires TEPPCO Partners, L.P.,to pay the propane segment $0.2 million annually. This lease agreement will expire on December 31, 2007. The Partnership’s rent expense for the fiscal years ended September 30, 2002, 2003 and 2004 was $12.8 million, $14.2 million and $16.6 million,respectively. F-29 Table of Contents15)Unit Grants In June 2000, the Partnership granted 565 thousand restricted senior subordinated units to management and outside directors. These units were granted underthe Partnership’s Employee and Director Incentive Unit Plans. One-fifth of the units immediately vested with the remaining units vesting annually in fourequal installments if the Partnership achieves specified performance objectives for each of the respective fiscal years. The units for fiscal 2001 and 2003 werevested while the units for fiscal 2002 and 2004 were not vested since the Partnership did not meet its specified objectives for those years. In September 2000, the Partnership granted 436 thousand senior subordinated unit appreciation rights (“UARs”) and 87 thousand restricted seniorsubordinated units to Irik P. Sevin. The unit appreciation rights are fully vested as of December 1, 2003. Mr. Sevin will be entitled to receive payment in cashfor these rights equal to the excess of the fair market value of a senior subordinated unit on the date exercisable over the exercise price. The grant of restrictedsenior subordinated units will vest in four equal installments on December 1 of 2001 through 2004. Distributions on the restrictive units will accrue to theextent declared. In December 2001, the Partnership granted 25 thousand restricted common units to Mr. Sevin. The grant of restricted common units will vest in four equalinstallments on January 1 of 2002 through 2005. Distributions on the restrictive units will accrue to the extent declared. In fiscal 2002, the Partnership granted an additional 54 thousand restricted senior subordinated unit appreciation rights to certain members of management.One-quarter of these units immediately vested with the remaining units vesting annually in three equal installments. In fiscal 2003, the Partnership granted an additional 257 thousand restricted senior subordinated unit appreciation rights to management and outsidedirectors. One-third of these units immediately vested with the remaining units vesting annually in two equal installments. The following table summarizes information concerning common and senior subordinated UARs of the Partnership outstanding at September 30, 2004: Price Number ofUnitsOutstanding AveragePeriod toPaymentDate $7.6259 54,715 0.3 years $7.8536 381,304 0.3 years $10.1800 3,150 0.6 years $10.7000 188,749 1.0 years $11.0000 5,000 1.3 years $11.0500 5,000 1.2 years $20.9000 54,472 0.3 years $22.0000 4,500 1.1 years Total / Weighted Average $9.7738 696,890 0.4 years The Partnership recorded $0.4 million, $2.6 million and $0.1 million of general and administrative expense for restricted unit grants during fiscal yearsended September 30, 2002, September 30, 2003 and September 30, 2004, respectively. The Partnership recorded income of $1.3 million, expense of$6.4 million and income of $4.0 million for unit appreciation rights during fiscal years 2002, 2003 and 2004, respectively. F-30 Table of Contents16)Supplemental Disclosure of Cash Flow Information Years Ended September 30, (in thousands) 2002 2003 2004 Cash paid during the period for: Income taxes $1,869 $1,326 $1,011 Interest 36,589 41,956 45,747 Non-cash investing activities: Acquisitions: Increase in property and equipment, net (95) — — (Increase) decrease in intangibles and other asset 945 — — Increase (decrease) in assumed pension obligation (3,977) — — Increase (decrease) in accrued expense (3,615) — — Increase of subordinated unitholders capital 6,742 — — Non-cash financing activities: Decrease (increase) in other asset for interest rate swaps (6,068) 748 293 Increase (decrease) in long-term debt for interest rate swaps 6,068 (927) (293)Increase in long-term debt for amortization of debt discount — 179 — 17)Commitments and Contingencies On or about October 21, 2004, a purported class action lawsuit on behalf of a purported class of unitholders was filed against the Partnership andvarious subsidiaries and officers and directors in the United States District Court of the District of Connecticut (Carter v. Star Gas Partners, L.P., et al,No 3:04-cv-01766-IBA, et. al, subsequently, 14 additional class action complaints, alleging the same or substantially similar claims, were filed in thesame district court: (1) Feit v. Star Gas, et al, Civil Action No. 04-1832 (filed on 10/29/2004), (2) Lila Gold v. Star Gas, et al, Civil Action No. 04-1791(filed on 10/22/2004), (3) Jagerman v. Star Gas, et al, Civil Action No. 04-1855 (filed on 11/3/2004), (4) McCole, et al v. Star Gas, et al, Civil ActionNo. 04-1859 (filed on 11/3/2004), (5) Prokop v. Star Gas, et al, Civil Action No. 04-1785 (filed on 10/22/2004), (6) Seigle v. Star Gas, et al, CivilAction No. 04-1803 (filed on 10/25/3004), (7) Strunk v. Star Gas, et al, Civil Action No. 04-1815 (filed on 10/27/2004), (8) Harriette S. & Charles L.Tabas Foundation v. Star Gas, et al, Civil Action No. 04-1857 (filed on 11/3/2004), (9) Weiss v. Star Gas, et al, Civil Action No. 04-1807 (filed on10/26/2004), (10) White v. Star Gas, et al, Civil Action No. 04-1837 (filed on 10/9/2004), (11) Wood v. Star Gas, et al, Civil Action No. 04-1856 (filedon 11/3/2004) (12) Yopp v. Star Gas, et al, Civil Action No. 04-1865 (filed on 11/3/2004), (13) Kiser v. Star Gas, et al, Civil Action No. 04-1884 (filedon 11/9/2004), and (14) Lederman v. Star Gas, et al, Civil Action No. 04-1873 (filed on 11/5/2004) (including the Carter Complaint, collectivelyreferred to herein as the “Class Action Complaints”). The Class Action plaintiffs generally allege that the Partnership violated Section 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended,and Securities and Exchange Commission Rule 10b-5 promulgated thereunder, by purportedly failing to disclose, among other things: (1) problemswith the restructuring of Star Gas’s dispatch system and customer attrition related thereto; (2) that Star Gas’s heating oil division’s business processimprovement program was not generating the benefits allegedly claimed; (3) that Star Gas was struggling to maintain its profit margins in its heatingoil division; (4) that Star Gas’s second quarter 2004 profit margins were not representative of its ability to pass on heating oil price increases; and (5)that Star Gas was facing an inability to pay its debts and that, as a result, its credit rating and ability to obtain future financing was in jeopardy. TheClass Action plaintiffs seek an unspecified amount of compensatory damages including interest against the defendants jointly and severally and anaward of reasonable costs and expenses. The Partnership will defend against the Class Actions vigorously. However, the Partnership is unable to predictthe outcome of these lawsuits at this time. F-31 Table of Contents17)Commitments and Contingencies – (continued) In the event that one or more of the above actions were decided adversely to the Partnership, it could have a material adverse effect on the Partnership’sresults of operations, financial position or liquidity. On or about November 15, 2004, certain plaintiffs in their capacity as unitholders of the Partnership commenced a derivative lawsuit in United StatesDistrict Court in Connecticut (Arnold V. Sevin et al., No. 3-04-cv-01884-AWT) (the “Federal Derivative Complaint”). The litigation asserts derivativeclaims on behalf of the Partnership against officers and directors of the Partnership. The Partnership is named as a nominal defendant. The unitholderplaintiffs allege injuries and damages purportedly resulting from violations of state law, including breaches of fiduciary duty, abuse of control, grossmismanagement, waste of corporate assets, unjust enrichment and insider trading that allegedly occurred between July 25, 2000 and November 15,2004. The Federal Derivative Complaint specifically alleges that the individual officer and director defendants in connection with their managementof the Partnership purportedly made various false or misleading statements that artificially inflated the value of the Partnership’s units and allegedlyprofited thereby by selling the Partnership’s units at inflated prices. The Federal Derivative Complaint seeks unspecified compensatory damages fromthe individual defendants, equitable and/or injunctive relief and restitution from the defendants to the Partnership, together with reasonable costs andexpenses incurred in the action, including counsel fees and accountant and expert fees. On or about November 24, 2004, another shareholder derivative action was filed in Connecticut State Court by Marie J. Beers (“Beers”), derivativelyon behalf of Star Gas Partners, L.P., against Star Gas, LLC, Ami Trauber and Irik P. Sevin, entitled Beers v. Star Gas, LLC, et al. (the “State CourtDerivative Action”). The Partnership is named as a nominal defendant. The State Court Derivative Action alleges breaches of fiduciary duty, grossnegligence, waste of corporate assets and for disgorgement of the proceeds of insider trading. The allegations in the State Court Derivative Actionclosely parallel those in the Class Action Complaints. The complaint in the State Court Derivative Action seeks a determination that the action is aproper derivative action and certifying Beers as an appropriate representative of the Company for purposes of the action, along with a declaration thateach of the defendants breached its fiduciary duty to the Partnership. In addition, the complaint in the State Court Derivative Action seeks unspecifiedcompensatory damages from the defendants, jointly and severally. The Partnership’s operations are subject to all operating hazards and risks normally incidental to handling, storing and transporting and otherwiseproviding for use by consumers of combustible liquids such as propane and home heating oil. As a result, at any given time the Partnership is adefendant in various legal proceedings and litigation arising in the ordinary course of business. The Partnership maintains insurance policies withinsurers in amounts and with coverages and deductibles as the general partner believes are reasonable and prudent. However, the Partnership cannotassure that this insurance will be adequate to protect it from all material expenses related to potential future claims for personal and property damage orthat these levels of insurance will be available in the future at economical prices. In addition, the occurrence of an explosion may have an adverseeffect on the public’s desire to use the Partnership’s products. In the opinion of management, except as described above the Partnership is not a party toany litigation, which individually or in the aggregate could reasonably be expected to have a material adverse effect on the Partnership’s results ofoperations, financial position or liquidity. F-32 Table of Contents18)Disclosures About the Fair Value of Financial Instruments Cash, Accounts Receivable, Notes Receivable, Inventory Derivative Instruments, Interest Rate Swaps, Working Capital Facility Borrowings, and AccountsPayable The carrying amount approximates fair value because of the short maturity of these instruments or because they are carried at fair value. 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 flowsassociated with each instrument, discounted using the Partnership’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 (in thousands): At September 30, 2003 At September 30, 2004 CarryingAmount EstimatedFair Value CarryingAmount EstimatedFair ValueLong-term debt $522,188 $555,832 $528,086 $577,792 Limitations Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. Theseestimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changesin assumptions could significantly affect the estimates. F-33 Table of Contents19)Earnings Per Limited Partner Units Years Ended September 30, (in thousands, except per unit data) 2002 2003 2004 Income (loss) from continuing operations per Limited Partner unit: Basic $0.01 $0.09 $(0.18)Diluted $0.01 $0.09 $(0.18)Income (loss) from discontinued operations before cumulative effect of change in accounting principle, net ofincome taxes per Limited Partner unit: Basic $(0.39) $0.04 $0.03 Diluted $(0.39) $0.04 $0.03 Loss on sale of segment, net of income taxes per Limited Partner unit: Basic $— $— $(0.01)Diluted $— $— $(0.01)Cumulative effect of change in accounting principle for adoption of SFAS No. 142 for discontinued operations perLimited Partner unit: Basic $— $(0.12) $— Diluted $— $(0.12) $— Net income (loss) per Limited Partner unit: Basic $(0.38) $0.01 $(0.16)Diluted $(0.38) $0.01 $(0.16)Basic Earnings Per Unit: Net income (loss) $(11,169) $212 $(5,863)Less: General Partners’ interest in net income (loss) (116) 2 (57) Limited Partner’s interest in net income (loss) $(11,053) $210 $(5,806) Common Units 25,342 29,175 31,647 Senior Subordinated Units 3,103 3,139 3,213 Junior Subordinated Units 345 345 345 Weighted average number of Limited Partner units outstanding 28,790 32,659 35,205 Basic earnings (losses) per unit $(0.38) $0.01 $(0.16) Diluted Earnings Per Unit: Effect of dilutive securities $— $— $— Limited Partners’ interest in net income (loss) $(11,053) $210 $(5,806) Effect of dilutive securities 31 108 — Weighted average number of Limited Partner units outstanding 28,821 32,767 35,205 Diluted earnings (losses) per unit $(0.38) $0.01 $(0.16) For fiscal 2002, fully diluted per unit does not include any amount prior to the date of issuance of 24,000 common units granted to Mr. Sevin inDecember 2001 as well as the 110,000 senior subordinated units that vested pursuant to the employee incentive plan in December 2001 and the303,000 senior subordinated units distributed in November 2001 pursuant to the heating oil segment achieving certain financial test because theimpact of these issuances were antidilutive. F-34 Table of Contents20)Selected Quarterly Financial Data (unaudited) The seasonal nature of the Partnership’s business results in the sale by the Partnership of approximately 30% of its volume in the first fiscal quarter and45% of its volume in the second fiscal quarter of each year. The Partnership generally realizes net income in both of these quarters and net lossesduring the quarters ending June and September. Three Months Ended (in thousands – except per unit data) December 31,2003 March 31,2004 June 30,2004 September 30,2004 Total Sales $418,017 $625,389 $229,155 $181,376 $1,453,937 Operating income (loss) 31,219 93,373 (29,993) (49,773) 44,826 Income (loss) from continuing operations before income taxes 19,131 80,671 (42,159) (62,366) (4,723)Gain (loss) on sale of segment, net of income taxes — 230 (247) (521) (538)Net income (loss) 19,312 80,653 (42,531) (63,297) (5,863)Limited Partner interest in net income (loss) 19,118 79,914 (42,126) (62,712) (5,806)Net income (loss) per Limited Partner unit: Basic and diluted (a) $0.56 $2.27 $(1.18) $(1.75) $(0.16) Three Months Ended(in thousands - except per unit data) December 31,2002 March 31,2003 June 30,2003 September 30,2003 TotalSales $371,331 $628,704 $216,865 $165,368 $1,382,268Operating income (loss) 30,450 93,708 (25,698) (51,097) 47,363Income (loss) from continuing operations before income taxes 21,724 82,436 (37,186) (62,591) 4,383Net income (loss) 16,039 83,163 (37,852) (61,138) 212Limited Partner interest in net income (loss) 15,880 82,331 (37,474) (60,527) 210Net income (loss) per Limited Partner unit: Basic and diluted (a) $0.49 $2.54 $(1.15) $(1.82) $0.01 (a)The sum of the quarters do not add-up to the total due to the weighting of Limited Partner Units outstanding. F-35 Table of Contents Schedule II STAR GAS PARTNERS, L.P. AND SUBSIDIARIESVALUATION AND QUALIFYING ACCOUNTSYears Ended September 30, 2002, 2003 and 2004(in thousands) Year Description Balance atBeginningof Year Charged toCosts &Expenses OtherChangesAdd(Deduct) Balance atEnd of Year2002 Allowance for doubtful accounts $4,512 $4,315 $(5,019) (a) $3,808 2003 Allowance for doubtful accounts $3,808 $7,726 $ 472 (4,464(b)) (a) $7,542 2004 Allowance for doubtful accounts $7,542 $8,749 $(9,111) (a) $7,180 (a)Bad debts written off (net of recoveries). (b)Amount acquired as part of the Ultramar acquisition. F-36 Table of Contents APPENDIX A Tax Consequences to Unitholders Upon Sale of the Propane Business. The Partnership’s unitholders will recognize gain or loss associated with the sale of the propane business based on a number of factors, including eachindividual holder’s basis in the Partnership units held, and the tax consequences of such sale will accrue to the record holders as of the date of the sale. Basedon its preliminary calculations, in general the Partnership estimates that, depending on the profile of the unitholder, the gain can be as high as approximately$11 per common unit and loss as high as $4.27. In general, the Partnership anticipates that holders who have held units for a substantial period of time,particularly those who purchased units prior to 2002, and those who purchased units at a low purchase price, will recognize the most gain. A holder’s taxbasis in units will be increased by the amount of gain recognized. If a holder sells units prior to the consummation of the sale of the propane business, suchholder may recognize substantially less gain than would a holder who continues to hold through the date of consummation of the sale. The following is a treatment of the possible tax consequences with respect to a sale of the Partnership’s propane business to a unitholder of record on the dateof the sale. This treatment is based on certain estimates and assumptions made by the Partnership. Moreover, this treatment is based on the Partnership’sinterpretation and judgment as to the effect of the sale of the propane business under current provisions of the Internal Revenue Code of 1986, as amended,existing and proposed regulations and current administrative rulings and court decisions, all of which are subject to change even retroactively. Thus, changesin these authorities may cause the tax consequences to vary substantially from the consequences described below. Moreover, the Partnership cannot assureyou that the Internal Revenue Service will agree with its interpretation and judgments. The following schedule sets forth the Partnership’s estimate as to the amount of gain per unit to be allocated to unitholders who purchased their units at thestated price in the month indicated and is based upon the Partnership’s best available estimates as to the variables mentioned. A unitholder who purchasedhis units during other months or at other prices should be able to estimate the amount of gain or loss to be allocated to him based upon comparable purchaseprices and months of purchase. For unitholders who bought their units before 2004 the gain will generally be ordinary income subject to a maximum rate of35% federal. For those who bought in 2004, the gain should generally be capital gain subject to a maximum rate of 15% federal. Common Unitholders Month PurchasePrice Gain/(Loss) December, 1995 $22.00 $10.53 April, 1999 13.68 10.88 September, 1999 16.13 8.54 February, 2001 17.44 5.01 September, 2001 18.55 1.73 February, 2002 20.83 (.11)October, 2002 17.65 1.10 September, 2003 21.32 (4.27)November, 2004 7.00 3.59 Senior Subordinated Unitholders Month PurchasePrice Gain/(Loss) April, 1999 7.13 13.73 May, 2001 15.56 5.29 October, 2002 9.60 7.97 April, 2003 14.40 6.70 June, 2003 17.31 2.47 November, 2004 7.55 3.21 November, 2004 2.30 6.88 Table of ContentsThe Partnership will provide the gain or loss to be allocated to each unitholder from the sale of the propane business after the end of the current taxable yearas a part of its normal process of providing detailed tax information to its unitholders. It is the responsibility of each unitholder to investigate the legal and tax consequences associated with his continued investment in us. The Partnershipstrongly recommends that each unitholder consult, and depend upon, his own tax counsel or other advisor with regard to the matters described herein,including whether to hold his units or sell them prior to the consummation of the sale of the propane business. In that regard, it should be noted that a sale of the units is itself a taxable event. Gain or loss will be recognized on a sale of units equal to the differencebetween the amount realized and the unitholder’s tax basis for the units sold. A unitholder’s amount realized will be measured by the sum of the cash or thefair market value of other property he receives. Prior distributions from us in excess of cumulative net taxable income for a unit that decreased a unitholder’s tax basis in that unit will, in effect, becometaxable income if the unit is sold at a price greater than the unitholder’s tax basis in that unit, even if the price received is less than his original cost. Except as noted below, gain or loss recognized by a unitholder, other than a “dealer” in units, on the sale or exchange of a unit held for more than one yearwill generally be taxable as capital gain or loss. Capital gain recognized by an individual on the sale of units held more than 12 months will generally betaxed at a maximum federal rate of 15%. A portion of this gain or loss, which will likely be substantial, however, will be separately computed and taxed asordinary income or loss under Section 751 of the Internal Revenue Code to the extent attributable to assets giving rise to depreciation recapture or other“unrealized receivables” or to “inventory items” the Partnership owns. The term “unrealized receivables” includes potential recapture items, includingdepreciation recapture. Ordinary income attributable to unrealized receivables, inventory items and depreciation recapture may exceed net taxable gain realized upon the sale of aunit and may be recognized even if there is a net taxable loss realized on the sale of a unit. Thus, a unitholder may recognize both ordinary income and acapital loss upon a sale of units. Net capital loss may offset capital gains and no more than $3,000 of ordinary income, in the case of individuals, and may only be used to offset capital gainin the case of corporations. Unitholders are encouraged to consult with their own tax advisors with respect to the application of tax laws to their particular situations. Exhibit 10.39 LETTER AMENDMENT & WAIVER NO. 2 Dated as of November 5, 2004 To the banks, financial institutionsand other institutional lenders(collectively, the “Lenders”)parties to the Credit Agreementreferred to below and toWachovia Bank, National Association, asadministrative agent (in such capacity,the “Agent”) for the Lenders Ladies and Gentlemen: We refer to the Credit Agreement dated as of December 22, 2003 among PETROLEUM HEAT AND POWER CO., INC., a Minnesota corporation (the“Borrower”), the various financial institutions as are or may become parties thereto (collectively, the “Lenders”), WACHOVIA BANK, NATIONALASSOCIATION, as Agent for the Lenders and as issuer of certain letters of credit, LASALLE BANK NATIONAL ASSOCIATION, as issuer of certain letters ofcredit, FLEET NATIONAL BANK, as Syndication Agent, and JPMORGAN CHASE BANK and LASALLE BANK, NATIONAL ASSOCIATION, as Co-Documentation Agents, as amended by the Letter Amendment and Waiver No. 1, dated as of October 28, 2004 (as the same may be further amended,supplemented or otherwise modified in writing from time to time, the “Credit Agreement”). Capitalized terms not otherwise defined in this Letter Amendmentand Waiver have the same meanings as specified in the Credit Agreement. It is hereby agreed by you and us as follows: 1. The Credit Agreement is, effective as of the Effective Date (as defined below), hereby amended as follows: (a)Section 1.1 is hereby amended to add the following definitions in the correct alphabetical order: “Budget Failure” means, as of the last Business Day of any calendar week, the aggregate amount of Facility A Loans and Facility C Loans shallhave exceeded the budgeted amount for the end of such calendar week (as set forth in Annex B to the Letter Amendment and Waiver No. 2). “JPMorgan Commitment Letter” means the commitment letter dated as of October 28, 2004 among Star Propane, JPMorgan Securities Inc. andJPMorgan Chase Bank. “JPMorgan Commitment Termination Date” means the earlier of the date (i) on which JPMorgan Chase Bank or any affiliate thereof givesnotice to the Borrower of the termination, failure of a condition with respect to or other declination of consummation regarding the commitments underthe JPMorgan Commitment Letter or (ii) of the expiration Petroleum Heat Letter Amendment and Waiver or termination of the commitments under the JPMorgan Commitment Letter in accordance with the terms thereof. “Letter Amendment and Waiver No. 2” means the Letter Amendment and Waiver No. 2 dated as of November 5, 2004 with respect to the CreditAgreement. “Second Amendment Effective Date” means the date on which the Letter Amendment and Waiver No. 2 becomes effective.” (b)Section 6.2.1(f) is hereby amended by replacing the ratio “5.00 to 1.00” appearing therein with the ratio “5.15 to 1.00”. (c)Section 6.2.1(k) is hereby amended by deleting the amount $97,500,000 appearing therein and substituting therefor the amount $194,685,000. (d)Section 6.2.1(l) is hereby amended by adding the following after the word “acquisitions” appearing at the end thereof: “, the payment or prepayment of principal or interest to the Noteholders or the payment of transaction fees pursuant to the JPMorganCommitment Letter.” (e)Section 6.2.1 is hereby further amended by (i) removing the word “and” from the end of subsection (k) thereof, (ii) replacing the “.” at the end ofsubsection (l) thereof with “;” and (iii) adding new subsections (m), (n), (o), (p) and (q) thereto to read as follows: “(m) as of the first Business Day of each calendar week following the Second Amendment Effective Date, the Borrower has provided to the Agenta forecast of Holdings’ consolidated weekly cash expenditures and cash receipts for the period through January 28, 2005, with a comparison toactual amounts for the calendar weeks that have occurred since the Second Amendment Effective Date, all in a format and in detail reasonablysatisfactory to the Agent; (n) the Borrower has provided to the Agent a budget for Holdings on a consolidated basis, including therein balance sheets and statements ofincome and cash flows by month for the period through September 30, 2005, and by the tenth Business Day of each calendar month the Borrowerhas provided the Agent with a comparison to actual amounts for each calendar month that has occurred since the Second Amendment EffectiveDate, all in a format and in detail reasonably satisfactory to the Agent; (o) no later than December 17, 2004, Star Gas Partners shall have obtained consents from the holders of Indebtedness of Star Propane to allowStar Propane to provide, and shall have caused Star Propane to provide, a duly authorized and executed subordinated guarantee, in form andsubstance reasonably satisfactory to the Agent with respect to all the Obligations as well as all obligations owing to the Noteholders; (p) if Star Gas Partners or any of its Subsidiaries shall have received net cash proceeds from the sale or other disposition of all or a substantialportion of the assets or equity of any of its operating divisions or any of its Subsidiaries (other than the Borrower and its Subsidiaries), Star GasPartners shall cause such net cash proceeds that remain after giving effect to the repayment of net lien obligations secured by the assets of anysuch division or Subsidiary, to be applied to the prepayment of the Obligations in the manner set forth in the last paragraph 2 Petroleum Heat Letter Amendment and Waiver of Section 3.1.3, provided that the Commitments shall have been automatically and permanently reduced by an amount equal to the amount ofsuch prepayment; and (q) the Borrower and Star Gas Partners each shall not have entered into any amendment or other modification with respect to, or granted anyapprovals or consents under, the JPMorgan Commitment Letter, without the prior written consent of the Agent on behalf of the Required Lenders(such consent not to be unreasonably withheld).” 2. We hereby request that the Lenders and the Agent waive, solely for the period commencing November 6, 2004 and ending upon the earliest to occurof (a) the JPMorgan Commitment Termination Date, (b) the date on which a Budget Failure occurs or (c) December 17, 2004 (the “Waiver TerminationDate”), (i) the requirements of Section 6.2.1(d) with respect to the matters described in paragraph 3 of the Borrowing Request dated as of October 15, 2004and (ii) the requirements of Section 8.2.4(b), it being understood that the ratio therein shall be 2.10 to 1.00 solely for the period commencing on November 5,2004 and ending on the Waiver Termination Date. 3. This Letter Amendment and Waiver shall become effective as of the date first above written when, and only when, (a) the Agent shall have receivedcounterparts of this Letter Amendment and Waiver executed by the undersigned and the Required Lenders or, as to any of the Lenders, advice satisfactory tothe Agent that such Lender has executed this Letter Amendment and Waiver, (b) the Agent shall have received, for the account of each Lender which shallhave executed this Letter Amendment and Waiver before 5:00 pm (New York time) on November 4, 2004, an amendment fee in an aggregate amount equal to0.50% of each such Lender’s Commitments, (c) payment in full of all expenses of the Agent, including expenses related to this Letter Amendment and Waiver(including all outstanding legal fees of Shearman & Sterling LLP, counsel to the Agent incurred in connection with the preparation, negotiation andexecution of this Letter Amendment and Waiver), shall have been made by the Borrower, (d) no more than $97,500,000 in Loans and L/C Obligations shallbe outstanding under the Facilities on such date, (e) the JPMorgan Commitment Letter shall have been duly executed and delivered by each of the partiesthereto and shall be in form and substance reasonably satisfactory to the Required Lenders and the Agent, (f) the Agent shall have received a forecast of theweekly cash expenditures and cash receipts for each week through the period ending January 28, 2005, in form and substance reasonably satisfactory to theAgent (the “Weekly Forecast”), (g) the Agent shall have received a month-by-month budget for the monthly periods ending September 30, 2005, includingtherein balance sheets and statements of income and cash flows in form and substance reasonably satisfactory to the Agent and (h) the Agent shall havereceived fully executed counterparts of the Consent attached hereto as Annex A (such date of satisfaction of such conditions being the “Effective Date”). 4. The Borrower hereby confirms that on and as of the date hereof and after giving effect to the terms of this Letter Amendment and Waiver (a) therepresentations and warranties contained in the Credit Agreement and each of Loan Documents are correct in all material respects (other than (i) any suchrepresentations and warranties, that, by their terms, refer to a specific date and (ii) the representation and warranty contained in Section 7.8 to the extent (butonly to the extent) of the matters described in paragraph 3 of the Borrowing Request dated as of October 15, 2004), and (b) no event has occurred and iscontinuing which constitutes a Default. It is understood and agreed that Borrowing Requests through the Waiver Termination Date may contain the samequalifications as set forth in subclause (ii) above. 5. On and after the effectiveness of this Letter Amendment and Waiver, each reference in the Credit Agreement to “this Agreement”, “hereunder”,“hereof” or words of like import referring to the Credit Agreement, and each reference in the Notes and each of the other Loan Documents to “the CreditAgreement”, “thereunder”, “thereof” or words of like import referring to the Credit Agreement, shall mean and be a reference to the Credit Agreement, asamended by this Letter Amendment and Waiver. 3 Petroleum Heat Letter Amendment and Waiver 6. The Credit Agreement and each of the Loan Documents, except to the extent they are modified by the amendments and waiver specified herein, areand shall continue to be in full force and effect and are hereby in all respects ratified and confirmed. Without limiting the generality of the foregoing, theLoan Documents and all of the Collateral described therein do and shall continue to secure the payment of all Obligations of the Borrower under the LoanDocuments. The execution, delivery and effectiveness of this Letter Amendment and Waiver shall not, except as expressly provided herein, operate as awaiver of any right, power or remedy of any Lender or the Agent under the Loan Documents, nor constitute a waiver of any provision of the Loan Documents. 7. If you agree to the terms and provisions of the waiver requested in paragraph 2 above and the other terms and provisions of this Letter Amendmentand Waiver, please evidence such agreement by executing and returning a counterpart of this Letter Amendment and Waiver by facsimile (with three originalcounterparts to follow by mail) to Jaime Genua at Shearman & Sterling LLP, 599 Lexington Avenue, New York, NY 10022, facsimile (646) 848-4257, nolater than 3:00 p.m. (New York City time) on November 4, 2004. 8. The provisions of this Letter Amendment and Waiver may be amended or otherwise modified with the consent of the Borrower and the RequiredLenders. 9. This Letter Amendment and Waiver may be executed in any number of counterparts and by different parties hereto in separate counterparts, each ofwhich when so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. Delivery of anexecuted counterpart of a signature page to this Letter Amendment and Waiver by telecopier shall be effective as delivery of a manually executed counterpartof this Letter Amendment and Waiver. 4 Petroleum Heat Letter Amendment and Waiver 10. This Letter Amendment and Waiver shall be governed by, and construed in accordance with, the laws of the State of New York. Very Truly Yours,PETROLEUM HEAT AND POWER CO., INC.By: Name: Title: Petroleum Heat Letter Amendment and Waiver Lenders: Institution By: Title: Petroleum Heat Letter Amendment and Waiver Acknowledged and AcceptedWACHOVIA BANK, NATIONAL ASSOCIATION, asAdministrative Agent and as a LenderBy: Title Petroleum Heat Letter Amendment and Waiver ANNEX A CONSENT Dated as of November 5, 2004 Each of the undersigned, as a Guarantor under the Guarantee Agreements, dated as of December 22, 2003 (as amended and supplemented or otherwisemodified through the date hereof, the “Guarantee Agreements”) in favor of the Secured Parties under the Credit Agreement referred to in the foregoing LetterAmendment and Waiver (the “Secured Parties”) and as a Grantor under the Security Agreements dated as of December 22, 2003 (as amended andsupplemented or otherwise modified through the date hereof, the “Security Agreements”) in favor of such Secured Parties, hereby consents to such LetterAmendment and Waiver and hereby confirms and agrees that (a) each Loan Document to which it is a party is, and shall continue to be, in full force and effectand is hereby ratified and confirmed in all respects and (b) the Collateral described in each Loan Document to which such Guarantor is a party do, and shallcontinue to, secure the payment of all the Secured Obligations (in each case as defined therein). Capitalized terms used herein and not otherwise defined shallhave the meanings assigned to such terms in the Credit Agreement. STAR GAS PARTNERS, L.P.By: Star Gas LLC, its General PartnerBy: Title:MEENAN OIL CO., L.P.By: Meenan Oil Co., Inc., its General PartnerBy: Title:PETRO HOLDINGS, INC.PETRO, INC.MAXWHALE CORP.RICHLAND PARTNERS, LLCCOLUMBIA PETROLEUM TRANSPORTATION, LLCORTEP OF PENNSYLVANIA, INC.MAREX CORPORATIONA.P. WOODSON COMPANYMEENAN OIL CO., INC.MEENAN HOLDINGS OF NEW YORK, INC.By: Title: Petroleum Heat Letter Amendment and Waiver ANNEX B MAXIMUM ALLOWED FACILITY A AND FACILITY C LOANS Week beginning: 11/1/2004 11/8/2004 11/15/2004 11/22/2004 11/29/2004 12/6/2004 12/13/2004Maximum allowed: $63,000,000 $76,925,000 $97,175,000 $117,425,000 $136,685,000 $149,185,000 $160,185,000 Petroleum Heat Letter Amendment and Waiver Exhibit 10.40 STAR GAS PARTNERS, L.P.CLEARWATER HOUSE2187 ATLANTIC STREETSTAMFORD, CONNECTICUT 06902 IRIK SEVIN 203-325-5472CHAIRMAN AND CEO (FAX) 203-328-7470 October 17, 2003 Mr. David Anthony Shinnebarger Dear David: As you are aware, we are all very excited about your joining Star Gas Partners, L.P. as its Chief Marketing Officer. We believe your broad strategic perspectivecombined with strong execution approach to marketing will be of great assistance in Star’s realizing it’s full growth potential. With that in mind, I have setforth below the terms of your employment. 1.Title and Responsibilities: You will be hired by Star Gas Partners, L.P. as its Chief Marketing Officer reporting directly to me as Star’s Chief Executive Officer. In that roleyou will be responsible for all sales and marketing activities at Star’s two operating subsidiaries, Star Gas Propane and Petroleum Heat and PowerCo., Inc. While your primary focus will initially be to improve customer retention and attraction at Petro, it is expected you will also oversee StarPropane’s marketing and sales activities as well as assist both subsidiaries in selling additional rationally related products. 2.Compensation: Your annual compensation will consist of a $325,000 annual base salary, plus an annual end-of-year bonus potential equivalent to 100% of basesalary for the first year of employment, 150% of base salary in the second year of employment and 200% of base salary in the third year ofemployment, as described in greater detail below. The annual base salary will be increased in years two and three in accordance with normalsalary adjustments made to the Company’s other senior executives. In addition, you will be granted, upon commencement of employment, 4,500Common Unit Appreciation Rights with a strike price of $22 per unit to vest 25% upon grant and 25% per year on each of the three anniversarydates, thereafter. David Anthony ShinnebargerOctober 17, 2003Page Two In regard to employee benefits, you will be entitled to participate in the same programs provided generally to Star’s other senior executives. 3.Annual Bonus Calculation As referred to in the “Compensation” section of this letter, you will be entitled to an annual bonus to be calculated as follows: Your first year bonus will be based on the increase from November 1, 2003 – September 30, 2004 in customers purchasing home heating oil fromStar’s Petroleum Heat and Power subsidiary, excluding the effect of accounts obtained through Petro’s acquisition program for two yearsfollowing the purchase of such accounts. To the extent the customer count remains the same at the end of the period as in the beginning, a bonusof 30% of your salary will be earned (“Base Bonus”). You will be entitled to a bonus over and above this 30%, up to 100% of your annual basesalary to the extent there is a 3% net increase in customer count (“Supplemental Bonus”). The actual bonus earned of this additional 70%potential will be 23.3% of your salary for each 1% net increase in customer count up to a maximum of 3%. Any portion of this 70% potential canonly be earned if gross customer losses are less than 12.5% (i.e., 2% below the 14.5% annual customer churn rate budgeted for Petro’s 2003Fiscal Year). See Exhibit I for an example of this calculation. Your second year bonus will be based on the increase in customers purchasing home heating oil from Petro from October 1, 2004 – September30, 2005, excluding the effect of accounts obtained through the Petro’s acquisition program. To the extent the net customer count increases 2%from the beginning to the end of the period, a bonus of 30% of salary will be earned. You will earn a bonus over and above this 30% up to 150%of your annual base salary, to the extent there is an 8% increase in customer count. The actual bonus earned of this additional 120% potentialwill be 20% of salary for each 1% net increase in customer count from 3% to 8%. Any portion of this 120% can only be earned if gross customerlosses are less than 10.5% of the company’s beginning of Fiscal Year 2005 customer base. David Anthony ShinnebargerOctober 17, 2003Page Three Your third year bonus will be based on the increase in customers purchasing home heating oil from Petro from October 1, 2005 – September 30,2006, excluding the effect of accounts obtained through the Petro’s acquisition program. To the extent the customer count increases 2%, fromthe beginning to the end of this period, a bonus of 30% of your salary will be earned. You will earn a bonus over and above this 30% up to 200%of your annual base salary, to the extent there is an 8% increase in customer count. The actual bonus earned of this additional 170% potentialwill be 28.3% of salary for each 1% increase in customer count from 3% to 8%. Any portion of this 170% can only be earned if gross customerlosses are less than 8.5% of the company’s beginning of Fiscal Year 2006 customer base. Please note, that while this is the expected formula to be used in calculating your 2006 Fiscal Year bonus, that is three years away, and shouldcircumstances change, the two of us will discuss at the beginning of that year, whether this formula remains the appropriate basis for bonuscalculation. It is assumed that all marketing programs used to achieve the customer count performance upon which your bonus is based, will involveprofitable customers that provide the company with a 17.5% Internal Rate of Return over the expected life of the account. Payment Your annual bonus will be paid at the same time as bonuses are remitted to the Company’s other senior executives. Payment of your earned bonus will be as follows: a)The 30% Base Bonus will be paid in cash b)The Supplemental Bonus earned over and above 30% of salary will be paid 1/3 in cash and 2/3 in Star Gas Partner’s Common LimitedPartner Units. These units will be granted as of the date on which the calculation is made and will vest 1/3 upon grant, 1/3 one year laterand 1/3 two years thereafter. Notwithstanding the foregoing, any portion of your bonus that would have been due in units will be paid in cash if Star Gas Partners has notreceived all required regulatory approvals to issue the units to you. David Anthony ShinnebargerOctober 17, 2003Page Four 4.Term: While we expect that you will be with us at least for the three years over which your units vest, your employment will be at will and eitherof us can terminate on 90 days notice; however, if the Company should terminate your employment for any reason other than for “cause” duringyour first year of employment, the Partnership will pay you one year’s annual base salary for severance, to be paid out over the following year. Ifthe Company should terminate your employment for any reason other than for “cause” in subsequent years of employment, the Partnership willpay you six (6) month’s annual base salary as severance, to be paid out over the six months following termination. Should your employment beterminated, no bonus will be paid for the year during which the relationship has been severed and all unvested bonus payments shall terminate.Also, should you find other employment during the severance period, your severance compensation shall terminate as of the commencementdate of your new employment. For the purpose of this agreement, “Cause” shall mean termination based upon your (i) willful breach or willfulneglect of your duties and responsibilities, (ii) conviction (or plea of noto contendere) of a felony occurring on or after the execution of thisAgreement, (iii) material breach of this Agreement or any other Agreement to which you and Star Gas Partners are parties (iv) violation of anyrequirements of law to which you are subject as an officer of Star Gas Partners, or (iv) failure to comply after due notice with Star Gas Partners’reasonable orders or directives or policies. Regarding terms of the severance outlined above, should Star Gas Partners fail to perform in accordance with these terms and/or compensate youfor earned bonus due under “Section 3. Annual Bonus”, subsections “Calculation” and “Payment”, you will be entitled to reasonable costs ofcollection, including attorneys’ fees. Further, Star Gas Partners agrees to pay all costs associated with arbitration of any disputes as to pay and/orbonus compensation as a first step towards avoiding litigation. 5.Post Termination Restrictions: Should you leave the Company’s employment for any reason, (a) you will not reveal any confidentialinformation concerning the Company including, without limitations, our then current and planned business and marketing programs andstrategies, (b) for a period of 24 months following such termination, you will not interfere with the Company’s business relationship with any ofits then employees, vendors or consultants or directly or indirectly implement the strategies contained in any of the Company’s then marketingor business programs for your own benefit or for the benefit of anyone else, and (c) for a period of 24 months you will not accept employment orhave any business relationship with, any home heating oil or propane distributor. David Anthony ShinnebargerOctober 17, 2003Page Five 6.General: This letter represents our entire understanding, superceding all prior oral or written communication, and is being undertaken withouteither of us relying on any statement or projection provided by the other, but solely on our respective expertise, analysis and investigations. Again, we think Star has some very exciting opportunities and we look forward to working together with you, towards realizing its potential. Sincerely,Star Gas Partners, L. P.Irik P. SevinChief Executive OfficerAccepted and Agreed to by:by /s/ David A. Shinnebarger David Shinnebarger Exhibit I Bonus CalculationExample CustomersDecreaseBelowBeginning ofPeriod Level 0%CustomerGrowth 1%CustomerGrowth 4%CustomerGrowth Customers – Beginning of Period: 400,000A/C 400,000A/C 400,000A/C 400,000A/CGross Customers – End of Period: 402,000 404,200 408,200 420,200 Customers Obtained Through Acquisitions (4,200) (4,200) (4,200) (4,200) Net Customers – End of Period: 397,800 400,000 404,000 416,000 % Increase (Decrease) (.6)% — 1.0% 4.0%Base Bonus - % 0 30% 30% 30% $ — $97,500 $97,500 $97,500 Supplemental Bonus - % — — 23.3% 70.0% $ — — 75,725 227,500 Total Bonus — $97,500 $173,225 $325,000 Gross Customer Loss During Period # 46,000A/C 50,000A/C 52,000A/C 49,600A/C% 11.5% 12.5% 13.0% 12.4%Effect on Bonus No Effect No Effect NoSupplementalBonus No Effect Exhibit 10.41 July 12, 2004 Dan Donovan Dear Dan: This letter confirms your promotion to the position of President of Petroleum Heat and Power Co., Inc. (“Petro”) effective May 5, 2004. We are pleased tooffer you the following compensation package and other terms, the levels and conditions of which will be in effect for three years following the date of thisletter, unless otherwise modified by agreement between you and Petro. Base Salary: Your base annual salary will be $300,000. You will be paid $12,500.00 semi-monthly, subject to withholding of all applicable taxes andbenefit deductions. Annual Bonus: Your annual target performance based bonus will be 35% of your annual salary. Long Term Incentive Plan: The Company is in the process of developing a Long Term Incentive Plan that will give certain key members of seniormanagement a long term wealth creation opportunity that will be submitted to the Board of Directors for approval. It is anticipated at this time thatawards under the Plan will be in the firm of certain restricted common units and that your target award is anticipated to be 10,000 units annually overthe five years of the program with a potential supplemental grant at the end of five years. Your eligibility to participate in the Long Term IncentivePlan on the anticipated terms described above is subject to the approval of the Compensation Committee of the Board of Directors and the terms of thePlan. Automobile: You will transition to a monthly car allowance of $1,225.00 upon reaching 60,000 miles on your company car in accordance with thePetro Car Policy. Benefit Coverage: You will be eligible to participate in the company’s benefits plans in accordance with their terms and conditions. Mr. Dan DonovanJuly 12, 2004Page 2 Terms: It is understood that your employment is at will and that either party can terminate the relationship at any time. If the company terminates youremployment for reasons other than for cause, or you terminate your employment for good reason, you will be entitled to one years salary as severance.In consideration of this offer you agree that while you are an employee of the Company and for twelve months thereafter, you will not compete with theCompany nor become involved either as an employee, as a consultant or in any other capacity, in the sale of heating oil or propane on a retail basis.You agree that you will not reveal any confidential information concerning Star Gas Partners L.P. and that you will not solicit nor seek to hire,employees of the Company during that time. Please indicate your acceptance of this offer by signing and dating this letter below. Should you have any questions, please do not hesitate to call me. Sincerely, Irik P. Sevin Accepted:Chairman By: /s/ Dan Donovan Dan Donovan Exhibit 21 A.P. Woodson Company – District of ColumbiaColumbia Petroleum Transportation, LLC - DelawareMarex Corporation - MarylandMaxwhale Corp. - MinnesotaMeenan Holdings of New York, Inc. – New YorkMeenan Oil Co., Inc. - DelawareMeenan Oil Co., L.P. - DelawareOrtep of Pennsylvania, Inc. - PennsylvaniaPetro Holdings, Inc. - MinnesotaPetro Plumbing Corporation – New JerseyPetro, Inc. - DelawarePetroleum Heat and Power Co., Inc. - MinnesotaRegionOil Plumbing, Heating and Cooling Co., Inc. – New JerseyRichland Partners, LLC - PennsylvaniaStar Gas Finance Company - DelawareStar Gas Propane, L.P. - DelawareStar/Petro, Inc. - MinnesotaStellar Propane Service Corp. – New YorkTG&E Service Company, Inc. - Florida Exhibit 23.1 Consent of Independent Registered Public Accounting Firm The Partners ofStar Gas Partners, L.P.: We consent to incorporation by reference in the registration statements No. 333-100976 on Form S-3, No. 333-49751 on Form S-4 and Nos. 333-40138, 333-46714 and 333-53716 on Form S-8 of Star Gas Partners, L.P. of our report dated December 10, 2004, relating to the consolidated balance sheets of Star GasPartners, L.P. and Subsidiaries as of September 30, 2003 and 2004, and the related consolidated statements of operations, comprehensive income (loss),partners’ capital and cash flows for each of the years in the three-year period ended September 30, 2004 and related financial statement schedule, which reportappears in this Form 10-K of Star Gas Partners, L.P. Our report dated December 10, 2004 contains an explanatory paragraph that states the Partnership’s heating oil segment will not have sufficient borrowingcapacity after December 17, 2004, which raises substantial doubt about the Partnership’s ability to continue as a going concern. The consolidated financialstatements and financial statement schedule do not include any adjustments that might result from the outcome of this uncertainty. Our report refers to the adoption of Statement of Financial Accounting Standards No. 142. /s/ KPMG LLPStamford, ConnecticutDecember 14, 2004 Exhibit 31.1 CERTIFICATIONS I, Irik P. Sevin, certify that: 1.I have reviewed this annual report on Form 10-K of Star Gas Partners, L.P. and Star Gas Finance Company (“Registrants”); 2.Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary tomake the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the periodcovered by this annual report; 3.Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all materialrespects the financial condition, results of operations and cash flows of the registrants as of, and for, the periods presented in this annual report; 4.The registrants’ other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e)) for the registrants and have: (a)designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under oursupervision, to ensure that material information relating to the registrants, including their consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which this annual report is being prepared; (b)evaluated the effectiveness of the registrants’ disclosure controls and procedures and presented in this annual report our conclusionsabout the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on suchevaluation; and (c)disclosed in this annual report any change in the registrants’ internal control over financial reporting that occurred during the registrants’most recent fiscal quarter (the registrants’ fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonablylikely to materially affect, the registrants’ internal control over financial reporting; and 5.The registrants’ other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, tothe registrants’ auditors and the audit committee of the registrants’ board of directors: (a)all significant deficiencies and material weaknesses the design or operation of internal control over financial reporting which arereasonably likely to adversely affect the registrants’ ability to record, process, summarize and report financial information and; (b)any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants’ internalcontrol over financial reporting. Date: December 14, 2004 /s/ Irik P. SevinIrik P. SevinChief Executive OfficerStar Gas Partners, L.P.Star Gas Finance Company Exhibit 31.2 CERTIFICATIONS I, Ami Trauber, certify that: 1.I have reviewed this annual report on Form 10-K of Star Gas Partners, L.P. and Star Gas Finance Company (“Registrants”); 2.Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary tomake the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the periodcovered by this annual report; 3.Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all materialrespects the financial condition, results of operations and cash flows of the registrants as of, and for, the periods presented in this annual report; 4.The registrants’ other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e)) for the registrants and have: (a)designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under oursupervision, to ensure that material information relating to the registrants, including their consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which this annual report is being prepared; (b)evaluated the effectiveness of the registrants’ disclosure controls and procedures and presented in this annual report our conclusionsabout the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on suchevaluation; and (c)disclosed in this annual report any change in the registrants’ internal control over financial reporting that occurred during the registrants’most recent fiscal quarter (the registrants’ fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonablylikely to materially affect, the registrants’ internal control over financial reporting; and 5.The registrants’ other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, tothe registrants’ auditors and the audit committee of the registrants’ board of directors: (c)all significant deficiencies and material weaknesses the design or operation of internal control over financial reporting which arereasonably likely to adversely affect the registrants’ ability to record, process, summarize and report financial information and; (d)any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants’ internalcontrol over financial reporting. Date: December 14, 2004 /s/ Ami TrauberAmi TrauberChief Financial OfficerStar Gas Partners, L.P.Star Gas Finance Company Exhibit 32.1 CERTIFICATION PURSUANT TO18 U.S.C. SECTION 1350AS ADOPTED PURSUANT TO SECTION 906OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Star Gas Partners, L.P. (the “Partnership”) and Star Gas Finance Company on Form 10-K for the year endedSeptember 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Irik P. Sevin, Chief Executive Officer of thePartnership and Star Gas Finance Company, certify to my knowledge pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, following due inquiry, I believe that: (1)The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2)The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of thePartnership and Star Gas Finance Company. A signed original of this written statement required by Section 906 has been provided to Star Gas Partners, L.P. and will be retained by Star Gas Partners, L.P.and furnished to the Securities and Exchange Commission or its staff upon request. STAR GAS PARTNERS, L.P.STAR GAS FINANCE COMPANYBy: STAR GAS LLC (General Partner)December 14, 2004 By: /s/ Irik P. Sevin Irik P. SevinChief Executive OfficerStar Gas Partners, L.P.Star Gas Finance Company Exhibit 32.2 CERTIFICATION PURSUANT TO18 U.S.C. SECTION 1350AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Star Gas Partners, L.P. (the “Partnership”) and Star Gas Finance Company on Form 10-K for the year endedSeptember 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Ami Trauber, Chief Financial Officer of thePartnership and Star Gas Finance Company, certify to my knowledge pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, following due inquiry, I believe that: (1)The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2)The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of thePartnership and Star Gas Finance Company. A signed original of this written statement required by Section 906 has been provided to Star Gas Partners, L.P. and will be retained by Star Gas Partners, L.P.and furnished to the Securities and Exchange Commission or its staff upon request. STAR GAS PARTNERS, L.P.STAR GAS FINANCE COMPANYBy: STAR GAS LLC (General Partner)December 14, 2004 By: /s/ Ami Trauber Ami TrauberChief Financial OfficerStar Gas Partners, L.P.Star Gas Finance Company
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