Table of ContentsUNITED 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, 2005 OR ¨¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934 For the transition period from to Commission File Number: 001-14129Commission 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 ofincorporation or organization) (I.R.S. EmployerIdentification 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 if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x. Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x 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 Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No 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, 2005 was approximately$102,477,000. As of December 8, 2005, 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 3,391,982Star 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 ContentsSTAR GAS PARTNERS, L.P. 2005 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS Page PART I Item 1. Business 3Item 1A. Risk Factors 12Item 1B. Unresolved Staff Comments 18Item 2. Properties 19Item 3. Legal Proceedings - Litigation 20Item 4. Submission of Matters to a Vote of Security Holders 20 PART II Item 5. Market for the Registrant’s Units and Related Matters 21Item 6. Selected Historical Financial and Operating Data 23Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 25Item 7A. Quantitative and Qualitative Disclosures about Market Risk 48Item 8. Financial Statements and Supplementary Data 48Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 48Item 9A. Controls and Procedures 48Item 9B. Other Information 49 PART III Item 10. Directors and Executive Officers of the Registrant 50Item 11. Executive Compensation 53Item 12. Security Ownership of Certain Beneficial Owners and Management 57Item 13. Certain Relationships and Related Transactions 59Item 14. Principal Accounting Fees and Services 59 PART IV Item 15. Exhibits and Financial Statement Schedules 60 2 Table of Contents PART I ITEM 1. BUSINESS Statement Regarding Forward-Looking Disclosure This Annual Report on Form 10-K includes “forward-looking statements” which represent our expectations or beliefs concerning future events that involverisks and uncertainties, including those associated with the recapitalization, the effect of weather conditions, on our financial performance, the price andsupply of home heating oil, the consumption patterns of our customers, our ability to obtain satisfactory gross profit margins, our ability to obtain newaccounts and retain existing accounts, our ability to effect strategic acquisitions or redeploy assets, the ultimate disposition of Excess Proceeds from the saleof the propane segment, the impact of litigation, the impact of the business process redesign project at the heating oil segment and our ability to addressissues related to that project, our ability to contract for our future supply needs, natural gas conversions, future union relations and outcome of current unionnegotiations, the impact of future environmental, health, and safety regulations, customer credit worthiness, and marketing plans. All statements other thanstatements of historical facts included in this Report including, without limitation, the statements under “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” and elsewhere herein, are forward-looking statements. Although we believe that the expectations reflected insuch forward-looking statements are reasonable, we can give no assurance that such expectations will prove to have been correct and actual results may differmaterially from those projected as a result of certain risks and uncertainties. These risks and uncertainties include, but are not limited to, those set forth underthe heading “Risk Factors,” “Business Initiatives and Strategy,” and “Business Outlook Fiscal 2006.” Without limiting the foregoing the words “believe”,“anticipate”, “plan”, “expect”, “seek”, “estimate” and similar expressions are intended to identify forward-looking statements. Important factors that couldcause actual results to differ materially from our expectations (“Cautionary Statements”) are disclosed in this Annual Report on Form 10-K. All subsequentwritten and oral forward-looking statements attributable to the Partnership or persons acting on its behalf are expressly qualified in their entirety by theCautionary Statements. Unless otherwise required by law, we undertake no obligation to update or revise any forward-looking statements, whether as a resultof new information, future events or otherwise after the date of this Report. Structure Star Gas Partners, L.P. (“Star Gas,” the “Partnership,” “we,” “us,” or “our,”) is a home heating oil distributor and services provider. Star Gas is a master limitedpartnership, which at September 30, 2005 had outstanding 32.2 million common units (NYSE: “SGU” representing an 88.8% limited partner interest in StarGas) and 3.4 million senior subordinated units (NYSE: “SGH” representing a 9.4% limited partner interest in Star Gas). Additional Partnership interestsinclude 0.3 million junior subordinated units (representing a 0.9% limited partner interest) and 0.3 million general partner units (representing a 0.9% generalpartner interest). The Partnership is organized as follows: • The general partner of the Partnership is Star Gas LLC, a Delaware limited liability company. The Board of Directors of Star Gas LLC is appointedby its members. Star Gas LLC’s general partner interest represents approximately a 1% interest in the Partnership. • The Partnership’s heating oil operations (the “heating oil segment”, “Petro,” “we,” “us,” or “our”) are conducted through Petro Holdings, Inc. andits subsidiaries. Petro is a Minnesota corporation that is an indirect wholly owned subsidiary of Star/Petro, Inc., which is a 99.99% subsidiary ofthe Partnership. The remaining .01% equity interest in Star/Petro, Inc. is owned by Star Gas LLC. Petro is a retail distributor of home heating oiland as of September 30, 2005 served approximately 480,000 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 10 1/4% 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. We were formerly engaged in the retail distribution of propane and related supplies and equipment to residential and commercial customers in the Midwestand Northeast regions of the United States, Florida and Georgia (the “propane segment”). In December 2004, we completed the sale of all of our interests inthe propane segment to Inergy Propane, LLC (“Inergy”) for a purchase price of $481.3 million. We recorded a gain on this sale of approximately $157million. We file annual, quarterly, current and other reports and information with the SEC. These filings can be viewed and downloaded from the Internet at the SEC’swebsite at www.sec.gov. In addition, these SEC filings are available at no cost as soon as reasonably practicable after the filing thereof on our website atwww.star-gas.com/Edgar.cfm. These reports are also available to be read and copied at the SEC’s public reference room located at Judiciary Plaza, 450 5thStreet, N.W., Washington, D.C. 20549. The public may obtain information on the operation of the public reference room by calling the 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 11 Wall Street, New York,New York 10005. 3 Table of ContentsSummary of Significant Events and Developments • Sale of propane segment • New Credit Facility • Unitholder suit • Goodwill Write-down • MLP Notes • Departure of Chairman and CEO • Home Heating Oil Price Volatility • Customer attrition • Recapitalization Sale of propane segment In December 2004 we completed the sale of our propane segment to Inergy for a cash purchase price of $481.3 million and recognized a gain ofapproximately $157 million from the sale after closing costs of approximately $14 million. $311 million of the proceeds from the sale were used torepurchase senior secured notes and first mortgage notes of the heating oil segment and propane segment, together with associated prepaymentpremiums, accrued interest and the amounts then outstanding under the propane segment’s working capital facility. Our propane segment representedapproximately 24% and 20% of our total revenue in fiscal 2004 and 2003, respectively, and 64% of our operating income in each of fiscal 2004 and2003, respectively. The historical results of the propane segment are reflected as discontinued operations in our consolidated financial statements. New Credit Facility On December 17, 2004 we executed a new $260 million revolving credit facility with a group of lenders led by J.P. Morgan Chase Bank, N.A. This newfacility provides us the ability to borrow up to $260 million for working capital purposes (subject to certain borrowing base limitations and coverageratios) and replaced the heating oil segment’s existing $235 million credit facility. Fees and expenses totaling approximately $8.0 million wereincurred in connection with consummating the new facility. On November 3, 2005, the revolving credit facility was amended to increase the facilitysize by $50 million to $310 million for the peak winter months from December through March of each year. Obligations under the new revolving creditfacility are secured by liens on substantially all of the assets of the Partnership, the heating oil segment and its subsidiaries. Unitholder Suit In October 2004, a purported class action lawsuit was filed against the Partnership and various subsidiaries and current and former officers anddirectors. Subsequently, 16 additional class action complaints alleging the same or substantially similar claims were filed in the same district court.The complaints generally allege that the Partnership violated sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended. The courthas consolidated the class action complaints and appointed a lead plaintiff. On September 23, 2005 we filed motions to dismiss. Plaintiffs replied tothese motions on November 23, 2005 and we expect to file our reply briefs on or about December 20, 2005. In the interim, discovery in the matterremains stayed. We intend to continue to defend against this purported class action lawsuit vigorously. Goodwill Write-down During the second quarter of fiscal 2005, we incurred a non-cash goodwill impairment charge of $67 million at the heating oil segment as a result oftriggering events that occurred during the second quarter of fiscal 2005. These triggering events included a significant decline in our unit price and thedetermination that operating results for fiscal year 2005 would be significantly lower than previously expected. MLP Notes In accordance with the terms of the indenture relating to the Partnership’s 10 1/4% Senior Notes (“MLP Notes”), we are permitted, within 360 days ofthe sale, to apply the net proceeds (the “Net Proceeds”) of the sale of the propane segment either to reduce indebtedness (and reduce any relatedcommitment) of the Partnership or of a restricted subsidiary, or to make an investment in assets or capital expenditures useful to the business of thePartnership or any of its subsidiaries as in effect on the issue date of the MLP Notes (the “Issue Date”) or any business related, ancillary orcomplementary to any of the businesses of the Partnership on the Issue Date (each a “Permitted Use” and collectively the “Permitted Uses”). To theextent any Net Proceeds that are not so applied exceed $10 million (“Excess Proceeds”), the indenture requires us to make an offer to all holders ofMLP Notes to purchase for cash that number of MLP Notes that may be purchased with Excess Proceeds at a purchase price equal to 100% of theprincipal amount of the MLP Notes plus accrued and unpaid interest to the date of purchase. At September 30, 2005, Excess Proceeds totaled $93.2million. As of December 2, 2005 all Excess Proceeds were applied toward a Permitted Use. See “Recapitalization” below and “Risk Factors—If our useof the net proceeds from the sale of the propane segment does not comply with the terms of the Indenture for the MLP Notes we may be subject toliability to the note holders, which could have a material adverse effect on us.” 4 Table of ContentsDeparture of Chairman and CEO On March 7, 2005 (“the Termination Date”), Star Gas LLC and Mr. Irik P. Sevin entered into a letter agreement and general release (the “Agreement”).In accordance with the Agreement, Mr. Sevin resigned from employment as the Chairman and Chief Executive Officer and President of Star Gas LLC(and its subsidiaries) under the employment agreement between Mr. Sevin and Star Gas LLC dated as of September 30, 2001. In addition, under termsof the Agreement Mr. Sevin transferred his member interests in Star Gas LLC to a voting trust of which Mr. Sevin is one of three trustees. Under theterms of the voting trust, those interests will be voted in accordance with the decision of a majority of the trustees. Pursuant to the Agreement,Mr. Sevin is entitled to an annual consulting fee totaling $395,000 for a period of five years following the Termination Date. In addition, theAgreement provides for Mr. Sevin to receive a retirement benefit equal to $350,000 per year for a 13-year period beginning with the month followingthe five-year anniversary of the Termination Date. At March 31, 2005, we recorded a liability for $4.2 million, which represents the present value of thecost of the Agreement. Home Heating Oil Price Volatility The wholesale price of heating oil, like any other market commodity, is generally set by the economic forces of supply and demand. Rapid globalexpansion is fueling an ever-increasing demand for oil. Home heating oil prices are closely linked to the price refiners pay for crude oil because crudeoil is the principal cost component of home heating oil. Crude oil is bought and sold in the international marketplace and as such is subject to theeconomic forces of supply and demand worldwide. The United States imports more than 60% of the petroleum products it consumes. The wholesalecost of home heating oil as measured by the New York Mercantile Exchange (“Nymex”) at September 30, 2005, 2004 and 2003 was $2.06, $1.39 and$0.78, respectively The current marketplace for petroleum products including home heating oil has been extremely volatile. In a volatile market even small changes insupply or demand can dramatically affect prices. The changes we have seen this past year and continue to experience have been significant. Heating oilprices are subject to price fluctuations if demand rises sharply because of excessively cold weather and/or disruptions at refineries and instability inkey oil producing regions. Ultimately these increases in wholesale prices are, in most instances, borne by our customers. Because of these high priceswe have experienced increased attrition in our customer base and a decrease in heating oil volume sold per customer (“conservation”). For fiscal 2005,over 75% of our revenue is attributable to the retail sale and delivery of home heating oil. About half of our retail sales of home heating oil are tocustomers who agree to pay a fixed or maximum price per gallon for each delivery over the next 12 months (“protected price” customers). Theremaining retail sales are to customers that pay a variable price based principally on the daily spot price plus our profit margin. We mitigate our exposure to our price protected customers in a volatile market by hedging our fixed and maximum price sales through the purchase ofexchange traded options and futures, and over the counter options and swaps, and we mitigate our exposure to variable priced customers, in mostinstances, by passing through higher home heating oil costs directly to such customers. Customer Attrition We experienced net customer attrition of 7.1% in fiscal 2005. This compares to net attrition of 6.4% and 1.5% in fiscal 2004 and 2003, respectively.This increase in net customer attrition over the past two years can be attributed to: (i) a combination of the effect of our premium service/premium pricestrategy during a period when customer price sensitivity increased due to high energy prices; (ii) our decision in fiscal 2005 to maintain reasonableprofit margins going forward in spite of competitors aggressive pricing tactics; (iii) the lag effect of customer attrition related to service and deliveryproblems experienced by customers in prior fiscal years; (iv) continued customer dissatisfaction with the centralization of customer care; and(v) tightened customer credit standards. For the period from October 1 to November 30, 2004, we gained 530 accounts (net), or 0.1% of our homeheating oil customer base as compared to the period from October 1 to November 30, 2005 in which we lost 4,315 accounts (net), or 0.9% of ourcustomer base. Recapitalization On December 2, 2005 the board of directors of Star Gas LLC approved a strategic recapitalization of Star Gas Partners that, if approved by unitholdersand completed, would result in a reduction in the outstanding amount of our 10 1/4% Senior Notes due 2013 (“Senior Notes”), of betweenapproximately $87 million and $100 million. The recapitalization includes a commitment by Kestrel Energy Partners, LLC (or “Kestrel”) and its affiliates to purchase $15 million of new equitycapital and provide a standby commitment in a $35 million rights offering to our common unitholders, at a price of $2.00 per common unit. We wouldutilize the $50 million in new equity financing, together with an additional $10 million to $23.1 million from operations, to repurchase at least $60million in face amount of our Senior Notes and, at our option, up to approximately $73.1 million of Senior Notes. In addition, certain noteholders haveagreed to convert approximately $26.9 million in face amount of such notes into newly issued common units at a conversion price of $2.00 per unit inconnection with the closing of the recapitalization. 5 Table of ContentsWe have entered into agreements with the holders of approximately 94% in principal amount of our Senior Notes which provide that: the noteholderscommit to, and will, tender their Senior Notes at par (i) for a pro rata portion of $60 million or, at our option, up to approximately $73.1 million in cash,(ii) in exchange for approximately 13,434,000 new common units at a conversion price of $2.00 per unit (which new units would be acquired byexchanging approximately $26.9 million in face amount of Senior Notes) and (iii) in exchange for new notes representing the remaining face amountof the tendered notes. The principle terms of the new senior notes such as the term and interest rate are the same as the Senior Notes. The closing of thetender offer is conditioned upon the closing of the transactions under the Kestrel unit purchase agreement, which is discussed below. Upon closing thetransaction we will incur a gain or loss on the exchange of Senior Notes for common units based on the difference between the $2.00 per unitconversion price and the fair value per unit represented by the per unit price in the open market on the conversion date. Subject to and until the transaction closing, the noteholders have agreed not to accelerate indebtedness due under the senior notes or initiate anylitigation or proceeding with respect to the Senior Notes. The noteholders have further agreed to: waive any default under the indenture; not to tenderthe Senior Notes in the change of control offer which will be required to be made following the closing of the transactions under the unit purchaseagreement with Kestrel; and to consent to certain amendments to the existing indenture. The agreement with the noteholders further provides for thetermination of its provisions in the event that the Kestrel unit purchase agreement is no longer in effect. The understandings and agreementscontemplated by these transactions will terminate if the transaction does not close prior to April 30, 2006. We believe the proposed recapitalization would substantially strengthen our balance sheet and thereby assist us in meeting our liquidity and capitalrequirements, which we believe would improve our future financial performance and as a result enhance unitholder value. In addition to enhancingunitholder value, we believe we will be able to operate more efficiently going forward with less long-term debt. As part of the recapitalization transaction, we have entered into a definitive unit purchase agreement with Kestrel and its affiliates, which provides for,among other things: the receipt by us of $50 million in new equity financing through the issuance to Kestrel’s affiliates of 7,500,000 common units at$2.00 per unit for an aggregate of $15 million and the issuance of an additional 17,500,000 common units in a rights offering to our commonunitholders at an exercise price of $2.00 per unit for an aggregate of $35 million. The rights will be non-transferable, and an affiliate of Kestrel hasagreed to buy any common units not subscribed for in the rights offering. Under the terms of the unit purchase agreement, Kestrel Heat, LLC, or KestrelHeat, a wholly owned subsidiary of Kestrel, will become our new general partner and Star Gas LLC, our current general partner, will receive noconsideration for its removal as general partner. In addition, the unit purchase agreement provides for the adoption of a second amended and restated agreement of limited partnership that will, amongother matters: • provide for the mandatory conversion of each outstanding senior subordinated unit and junior subordinated unit into one common unit; • change the minimum quarterly distribution to the common units from $0.575 per quarter, or $2.30 per year, to $0.0675 per unit, or $0.27 peryear, which shall commence accruing October 1, 2008 and, eliminate all previously accrued cumulative distribution arrearages whichaggregated $92.5 million at November 30, 2005; • suspend all distributions of available cash by us through the fiscal quarter ending September 30, 2008; • reallocate the incentive distribution rights so that, commencing October 1, 2008, the new general partner units in the aggregate will beentitled to receive 10% of the available cash distributed once $.0675 per quarter, or $0.27 per year, has been distributed to common unitsand general partner units and 20% of the available cash distributed in excess of $0.1125 per quarter, or $.45 per year, provided there are noarrearages in minimum quarterly distributions at the time of such distribution (under our current partnership agreement if quarterlydistributions of available cash exceed certain target levels, the senior subordinated units, junior subordinated units and general partner unitswould receive an increased percentage of distributions, resulting in their receiving a greater amount on a per unit basis than the commonunits). The recapitalization is subject to certain closing conditions including the approval of our unitholders, approval of the lenders under our revolvingcredit facility, and the successful completion of the tender offer for our Senior Notes. 6 Table of ContentsAs a result of the challenging financial and operating conditions that we have experienced since fiscal 2004, we have not been able to generatesufficient available cash from operations to pay the minimum quarterly distribution of $0.575 per unit on our partnership securities. Theseconditions led to the suspension of distributions on our senior subordinated units, junior subordinated units and general partner units on July 29,2004 and to the suspension of distributions on the common units on October 18, 2004. We believe that the proposed amendments to our partnership agreement will simplify our capital structure, provide internally generated funds forfuture investment and align the minimum quarterly distribution more closely with the levels of available cash from operations that we expect togenerate in the future. Kestrel is a private equity investment firm formed by Yorktown Energy Partners VI, L.P., Paul A. Vermylen, Jr. and other investors. YorktownEnergy Partners VI, L.P. is a New York-based private equity investment partnership, which makes investments in companies engaged in theenergy industry. Yorktown affiliates and Mr. Vermylen were investors in Meenan Oil Co. L.P. from 1983 to 2001, during which timeMr. Vermylen served as President of Meenan. Meenan was sold to us in 2001. It is possible that the units purchased as part of the recapitalization transaction or units purchased by one or more than one 5% unitholders wouldtrigger an IRC Section 382 limitation relating to certain net operating loss carryforwards. An ownership change occurs for purposes of Section 382when there is a direct or indirect sale or exchange of more than 50% by one or more than one 5% shareholders. If an ownership change has occurred inaccordance with Section 382, future limitations in the utilization of net operating losses could be significant. It is possible that the Partnership’ssubsidiary, Star/Petro, Inc., will not be able to use any of its currently existing net income tax loss carryforwards in the future. Business Overview As of September 30, 2005 we serviced approximately 480,000 customers from locations in the Northeast and Mid-Atlantic regions. We are the largest retaildistributor of home heating oil in the United States. In addition to selling home heating oil we install, maintain and repair heating and air conditioningequipment. To a limited extent, we also market other petroleum products including diesel fuel and gasoline to commercial customers. During fiscal 2005, thetotal sales in the heating oil segment were comprised of approximately 75% from sales of home heating oil; 15% from the installation and repair of heatingequipment; and 10% from the sale of other petroleum products. We provide home heating equipment repair service 24 hours a day, seven days a week, 52weeks a year. These services are an integral part of our heating oil business, and are intended to maximize customer satisfaction and loyalty. We alsoregularly provide various incentives to obtain and retain customers. We have consolidated our heating oil operations under two primary brand names, Petroand Meenan. In fiscal 2005, sales to residential customers represented 84% of the retail heating oil gallons sold and 92% of heating oil gross profits. We have operations and markets in the following states: New York Massachusetts New JerseyBronx, Queens and Kings CountiesDutchess CountyStaten IslandEastern Long IslandWestern Long IslandWestchester/Putnam CountiesOrange County Boston (Metropolitan)Northeastern Massachusetts(Centered in Lawrence)Worcester CamdenLakewoodNewark (Metropolitan)North BrunswickRockawayTrenton Pennsylvania AllentownBerks CountyBucks CountyHarrisburg CountyLancaster CountyLebanon CountyPhiladelphiaYork County Rhode IslandConnecticut ProvidenceNewportBridgeport—New HavenFairfield CountyLitchfield County Maryland/Virginia/D.C. ArlingtonBaltimoreWashington, D.C. (Metropolitan) 7 Table of ContentsIndustry Characteristics Heating oil is primarily used for residential and commercial heating purposes, and it is a significant source of fuel used to heat businesses and residences inthe New England 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 these regions use heating oil as their main space-heating fuel. In recent years, as the price of home heating oil increased,customers tended to increase their conservation efforts, which decreased their consumption of home heating oil. In addition, weather conditions have asignificant impact on demand for home heating oil for heating purposes. The retail home heating oil industry is mature, with total market demand expected to decline slightly in the foreseeable future. Therefore, our ability to growwithin the industry is dependent on our ability to acquire other retail distributors as well as the success of our marketing programs designed to attract andretain customers to help offset customer losses. We believe that the home heating oil industry is relatively stable and predictable due principally to the non-discretionary nature of home heating oil use. Accordingly, the demand for home heating oil has historically been relatively unaffected by general economicconditions but has been affected by weather conditions and most recently a very volatile commodity market. It is common practice in the home heating oildistribution industry to price products to customers based on a per gallon margin over wholesale costs. As a result, we believe distributors such as ourselvesgenerally seek to maintain their margins by passing wholesale price increases through to customers, thus insulating themselves from the volatility inwholesale heating oil prices. However, during periods of significant fluctuations in wholesale prices, which currently exists and occurred throughout fiscal2005, distributors may be unable or unwilling to pass the entire product cost increases or decreases through to customers. In these cases, significant increasesor decreases in per gallon margins may result. In addition, the timing of cost pass-throughs can significantly affect margins. The retail home heating oilindustry is highly fragmented, characterized by a large number of relatively small, independently owned and operated local distributors. In addition, theindustry is becoming more complex and costly due to increasing environmental regulations. Business initiatives and strategy Prior to the fiscal 2004 winter heating season, we attempted to develop a competitive advantage in customer service through a business process redesignproject and, as part of that effort, centralized our heating equipment service and oil dispatch functions and engaged a centralized customer care center tofulfill our telephone requirements for a majority of our home heating oil customers. We experienced significant difficulties in advancing this initiative duringfiscal 2004 and 2005, which adversely impacted our customer base and costs. To date, the customers’ experience has been below the level associated withother premium service providers and below the level of service provided by the heating oil segment in prior years which we believe contributed to increasedcustomer attrition in fiscal 2004 and 2005 The savings from this initiative were less than expected and the costs to operate under the centralized format weregreater than originally estimated. We believe we have identified the problems associated with the centralization efforts and continue to address these issues by structuring the customer callcenter into work groups that parallel Petro’s district structure, adding customer service specialists at the district level, providing continuous in-house trainingat the customer care center, and establishing a general manager of customer retention. In addition, we have begun answering customer calls locally in twodistricts. We are continuing our initiative of moving toward decentralization of our operations to maximize contact at the local level, while continuing toassess the efficiency of certain centralized operations. The general manager of customer retention reports directly to the President and Chief Operating Officerof the Partnership. Despite these efforts, we continued to experience high net attrition rates in fiscal 2005, and we expect that high net attrition rates maycontinue through fiscal 2006 and perhaps beyond. Even to the extent that the rate of attrition can be reduced, the current reduced customer base willadversely impact net income in the future. The quantitative factors we use to measure the effectiveness of our customer care center and field operations – such as customer satisfaction scores, telephonewaiting times and abandonment rates at the customer care center, oil delivery run-outs and heating equipment repair and maintenance response times – haveimproved meaningfully during fiscal 2005, as compared to the same period in fiscal 2004. We implemented a series of cost reduction initiatives in fiscal 2005 including facility consolidations, the reduction of non-essential personnel and thereduction and re-evaluation of certain marketing programs. We believe this will be an ongoing process as we continue to review our operating expenses. Webelieve operating expenses were reduced by approximately $10.0 million, on an annualized basis, in 2005. A portion of these expense reductions wererealized during fiscal 2005 and the remainder will be realized in fiscal 2006. In addition, a wage freeze has been implemented for senior management in fiscal2006. Going forward our strategy is to increase unit-holder value through (i) internal growth, (ii) operational efficiencies and productivity improvements,(iii) increased market share through strategic and disciplined acquisitions of local heating oil distributors, and (iv) strategic recapitalization of our long-termdebt. 8 Table of ContentsWe believe opportunities exist to add customers internally in order to help offset customer losses through strategic marketing programs designed to retainexisting customers and attract new customers through renewed focus on our sales and marketing efforts, with strong local and regional direction combinedwith employee incentive programs. We utilize advertising campaigns such as radio advertisements, billboards, newsprint, and telephone directoryadvertisements to increase brand recognition. We also engage in direct marketing campaigns and advertising on the Internet. We intend to continue to merge operations and functions where overlaps exist and intend to divest and/or redeploy under-performing operations and assets.In addition, we do not intend to reduce our retail prices to unreasonably low levels to customers, and intend to retain our profit margins in spite of ourcompetitors’ aggressive pricing tactics. We plan to expand our customer base through strategic and disciplined acquisitions of local heating oil distributors. We intend to focus on acquisitions thatcan be efficiently operated individually or combined with our existing operations. Under the terms of our revolving credit facility, we were restricted frommaking any acquisitions prior to June 17, 2005. Thereafter there are limitations on the size of individual acquisitions and an annual limitation on totalacquisitions. In addition, there are certain financial tests that must be satisfied before an acquisition can be consummated. We may not be able to satisfy thesetests with our current levels of debt and interest expense. On December 2, 2005 the board of directors of Star Gas approved a strategic recapitalization of the Partnership. The recapitalization includes a commitmentKestrel and its affiliates to purchase $15 million of new equity capital and provide a standby commitment in a $35 million rights offering to our commonunitholders, at a price of $2.00 per common unit. The recapitalization is subject to certain closing conditions including the approval of our unitholders,approval of the lenders under our revolving credit facility, and the successful completion of the tender offer for our senior notes. See “Recapitalization.” We would utilize the $50 million in new equity financing, together with an additional $10 million up to $23.1 million from operations, to repurchase at least$60 million in face amount of our senior notes and at our option, up to $73.1 million of senior notes. In addition, certain noteholders have agreed to convertapproximately $26.9 million in face amount of such notes into 13,434,000 newly issued common units. We believe the proposed recapitalization would substantially strengthen our balance sheet and thereby assist us in meeting our liquidity and capitalrequirements, which we believe will improve our future financial performance and as a result enhance unitholder value. In addition to enhancing unitholdervalue, we believe we will be able to operate more efficiently going forward with less long-term debt. Customers Our customer base is comprised of three types of customers, residential variable, residential protected price and commercial/industrial. The residentialvariable customer generally has the highest per gallon gross profit margin. During fiscal 2005, approximately 86% of heating oil sales were made to homeowners, with the remainder to industrial, commercial and institutionalcustomers. Sales to residential customers ordinarily generate higher margins than sales to other customer groups, such as commercial customers. Due to thegreater price sensitivity of residential protected price customers, the per gallon margins realized from these customers generally are less than variable pricedresidential customers. Commercial/industrial customers are characterized as large volume users and contribute the lowest per gallon margin. Gross profitmargins can also vary by geographic region. Accordingly, gross profit margins could vary significantly from year to year in a period of identical salesvolumes. For fiscal 2004 and fiscal 2005, approximately 43% and 48%, respectively, of home heating oil sold was to customers who had agreements establishing afixed or maximum price per gallon that they would pay for home heating oil over the following 12-month period. This percentage could increase or decreaseduring fiscal 2006 based upon market conditions. The fixed or maximum price per gallon at which home heating oil is sold to these protected price customersis generally renegotiated based on current market conditions before the beginning of each heating season. In addition during the fourth quarter of fiscal 2005,and to date in fiscal 2006 we decided not to reduce our retail prices (including those prices included in our protected price contracts) to customers in order tomaintain our product margins in spite of our competitors aggressive pricing tactics. At September 30, 2005, 37.5% of our home heating oil customers had aprice protection plan compared to 47.7% at September 30, 2004. Customers that have not yet renewed their price protected program for the next season could switch to a competitor and customer attrition in the future couldincrease. We purchase derivative instruments (futures, options, collars and swaps) in order to hedge a substantial majority of the heating oil we expect to sellto protected price customers that have renewed their price plans for the following twelve months, mitigating our exposure to changing commodity prices. As of September 30, 2005, approximately 93% of our home heating oil customers received their home heating oil under an automatic delivery systemwithout the customer having to make an affirmative purchase decision. These deliveries are scheduled based upon 9 Table of Contentseach customer’s historical consumption patterns and prevailing weather conditions. We deliver home heating oil approximately six times during the year tothe average customer. Our practice is to bill customers promptly after delivery. Approximately 36% of our customers are on a budget payment plan, wherebytheir estimated annual oil purchases and service contract are paid for in a series of equal monthly payments. Approximately 7% of our home heating oil customers consist of accounts that from time to time call to schedule a delivery rather than receiving a delivery onan automatic basis. These accounts actively manage their consumption and are referred to as “will call” customers. We believe that we have experienced adecline in home heating oil volume sales to these will call customers. This decline may be due to conservation or their decision to purchase all or a portion oftheir heating oil requirements from another dealer. We experienced annual net customer attrition of approximately 7.1% in fiscal 2005. The net customer attrition rate in fiscal 2005 was higher than the rateexperienced in fiscal 2004 (6.4%), and higher than that experienced in the preceding several years. For fiscal 2003, before the full implementation of thebusiness process redesign project and before the increase in the wholesale price of home heating oil, we experienced annual net customer attrition of 1.5%.Net customer attrition for the fiscal years’ 2005 and 2004 resulted from: (i) a combination of the effect of our premium service/premium price strategy whencustomer price sensitivity increased due to high energy prices; (ii) our decision in fiscal 2005 to maintain reasonable profit margins going forward in spite ofcompetitors aggressive pricing tactics; (iii) the lag effect of customer attrition related to service and delivery problems experienced by customers in priorfiscal years; (iv) continued customer dissatisfaction with the centralization of customer care; and (v) tightened customer credit standards. For the period fromOctober 1 to November 30, 2004, we gained 530 accounts (net) or 0.1% of our home heating oil customer base as compared to the period from October 1 toNovember 30, 2005 in which we lost 4,315 accounts (net) or 0.9% of our customer base. Net customer attrition is the difference between gross customer losses and customers added through marketing efforts. Customers added through acquisitionsare not included in the calculation of net customer attrition. For fiscal 2004 and 2005, gross customer losses were approximately 19.5% and 20.0%,respectively, and gross customer gains were approximately 13.1% and 12.9%, respectively. The gain of a new customer does not fully compensate for the lossof an existing customer during the first year because of the expenses that are incurred to acquire a new customer and the higher attrition rate associated withnew customers. It costs on average $500 to acquire a new customer. Gross customer losses are the result of a number of factors, including move-outs, price competition and service issues. When a customer moves out of an existing home, we count the “move out” as a loss. If we are successful in signing up the new homeowner, the “move in” istreated as a gain. For fiscal 2004 and 2005, move outs were 6.4% and 6.9%, respectively, of our customer base and the move ins were 3.6% and 3.2%,respectively, of our customer base. Suppliers and Supply Arrangements We purchase fuel oil for delivery in either barge, pipeline or truckload quantities, and have contracts with over 100 terminals for the right to temporarily storeheating oil at facilities we do not own. Purchases are made under supply contracts or on the spot market. We enter into market price based contracts for asubstantial majority of our petroleum requirements with eight different suppliers, the majority of which have significant domestic sources for their product,and many of which have been suppliers to the heating oil segment for over ten years. Our current contract suppliers are: BP North America, Citgo PetroleumCorporation, Global Companies, Inland Fuels Terminals, Inc., Mieco, Inc., NIC Holding Corp., Sprague Energy and Sunoco, Inc. Supply contracts typicallyhave terms of 12 months. All of the supply contracts provide for maximum and in certain cases minimum quantities and require advance payment. In prioryears our supply contracts provided us with two-to-three-day credit terms. Since last year our suppliers are now requiring pre-payment. In most cases thesupply contracts do not establish in advance the price of fuel oil. This price is based upon spot market prices at the time of delivery plus a differential of up to$.045 per gallon. We believe that our policy of contracting for the majority of our anticipated supply needs with diverse and reliable sources will enable us toobtain sufficient product should unforeseen shortages develop in worldwide supplies. We believe that relations with current suppliers are satisfactory. We purchase derivative instruments including commodity swaps and options, traded on the over-the-counter financial markets, and futures and optionstraded on the New York Mercantile Exchange in order to mitigate our exposure to market risk and hedge the cash flow variability associated with thepurchase of home heating oil inventory held for resale to our protected price customers and in some cases physical inventory on hand and in transit. AtSeptember 30, 2005 we had outstanding derivative instruments with the following banks or brokers: JPMorgan Chase Bank, NA, Morgan Stanley DeanWitter, BP North America Petroleum and Fimat. Competition We compete with distributors offering a broad range of services and prices, from full-service distributors, like ourselves, to those offering delivery only. Ourcompetitors typically offer lower prices. Like many companies in the home heating oil business, we provide home heating equipment repair service on a 24-hour-a-day, seven-day-a-week, 52 weeks a year basis. This tends to build customer loyalty. As a result of these factors, it is difficult for us to increase ourmarket share, other than through acquisitions. In some 10 Table of Contentsinstances homeowners have formed buying cooperatives that seek to purchase fuel oil from distributors at a price lower than individual customers areotherwise able to obtain. We also compete for retail customers with suppliers of alternative energy products, principally natural gas, propane, and electricity.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 the cost ofreplacing an oil fired heating system with one that uses natural gas, in addition to environmental concerns. We believe that approximately 1% of the homeheating oil customer base annually converts from home heating oil to natural gas. The expansion of natural gas into traditional home heating oil markets inthe Northeast has historically been inhibited by the capital costs required to expand distribution and pipeline systems. Most of our retail home heating oil distribution locations compete with several smaller marketers or distributors, primarily on the basis of reliability ofservice, price, and response to customer needs. Each retail distribution location operates in its own competitive environment because home heating oildistributors and marketers typically reside in close proximity to their customers in order to minimize the cost of providing service. Seasonality Our fiscal year ends on September 30. All references to quarters and years in this document are to fiscal quarters and years unless otherwise noted. Theseasonal nature of our business results in the sale of approximately 30% of our volume in the first quarter (October through December) and 45% of ourvolume in the second quarter (January through March) of each year, the peak heating season, because heating oil is primarily used for space heating inresidential and commercial buildings. We generally realize net income in both of these quarters and net losses during the quarters ending in June andSeptember. In addition, sales volume typically fluctuates from year to year in response to variations in weather, wholesale energy prices and other factors. Acquisitions In fiscal 2004, we completed the purchase of three retail heating oil dealers for an aggregate cost of $3.5 million. We made no acquisitions in fiscal2005. Under the terms of our revolving credit facility, we were restricted from making any acquisitions prior to June 17, 2005. Thereafter there are limitationson the size of individual acquisitions and an annual limitation on total acquisitions. In addition, there are certain financial tests that must be satisfied beforean acquisition can be consummated. We may not be able to satisfy these tests with our current levels of debt and interest expense. Employees As of September 30, 2005, we had 2,773 employees, of whom 638 were office, clerical and customer service personnel; 1,041 were heating equipmentrepairmen; 426 were oil truck drivers and mechanics; 400 were management and 268 were employed in sales. Included in the heating oil segment’semployees are approximately 1,000 employees that are represented by 17 different local chapters of labor unions. Some of these unions have unionadministered pension plans that have significant unfunded liabilities, a portion of which could be assessed to us should we withdraw from these plans. Inaddition, approximately 485 seasonal employees are rehired annually to support the requirements of the heating season. We are currently involved in threeunion negotiations and believe that our relations with both our union and non-union employees are generally satisfactory. Government Regulations We are subject to various federal, state and local environmental, health and safety laws and regulations. Generally, these laws impose limitations on thedischarge of pollutants and establish standards for the handling of solid and hazardous wastes. These laws include the Resource Conservation and RecoveryAct, the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), the Clean Air Act, the Occupational Safety and Health 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 are considered to havecontributed to the release or threatened release of a hazardous substance into the environment. Heating oils and certain automotive waste products generatedby the Partnership’s fleet are hazardous substances within the meaning of CERCLA. These laws and regulations could result in civil or criminal penalties incases of non-compliance or impose liability for remediation costs. The heating oil segment is currently a named “potentially responsible party” in oneCERCLA civil enforcement action. This action is in its early stages of litigation with preliminary discovery activities taking place. We do not believe thatthis action will have a material impact on our financial condition or results of operations. For acquisitions that involve the purchase or leasing of real estate, we conduct a due diligence investigation to attempt to determine whether any hazardousor other regulated substance has been sold from or stored on any of that real estate prior to its purchase. This 11 Table of Contentsdue diligence includes questioning the seller, obtaining representations and warranties concerning the seller’s compliance with environmental laws andperforming site assessments. During this due diligence our employees, and, in certain cases, independent environmental consulting firms review historicalrecords and databases and conduct physical investigations of the property to look for evidence of hazardous substances, compliance violations and theexistence of underground storage tanks. Future developments, such as stricter environmental, health or safety laws and regulations thereunder, could affect our operations. To the extent that there areany environmental liabilities unknown to us or environmental, health or safety laws or regulations are made more stringent, there can be no assurance that ourresults of operations will not be materially and adversely affected. Trademarks and Service Marks We market our products and services under various trademarks, which we own. They include marks such as Petro and Meenan. We believe that the Petro,Meenan and other trademarks and service marks are an important part of our ability to effectively maintain and service our customer base. ITEM 1A RISK FACTORS An investment in the Partnership involves a high degree of risk. Security holders and Investors should carefully review the following risk factors. The continuation of high wholesale energy costs may adversely affect our liquidity. Under our revolving credit facility, as amended, we may borrow up to $260 million, which increases to $310 million during the peak winter months fromDecember through March of each year, (subject to borrowing base limitations and coverage ratio) for working capital purposes subject to maintainingavailability (as defined in the credit agreement) of $25 million or a fixed charge coverage ratio of not less than 1.1 to 1.0. Recent dynamics of the heating oil industry have adversely impacted working capital requirements, principally as follows: • High selling prices require additional borrowing to finance accounts receivable; however, we may borrow only approximately 85% againsteligible accounts receivable and 40% to 80% of eligible inventory. In addition we may borrow up to $35 million against fixed assets and customerlists, which is reduced by $7.0 million each year over the life of the credit agreement. • At present, suppliers are not providing credit terms to us, requiring us to pay in advance for product. Historically, we have enjoyed, on average,two-to three-day credit terms providing additional credit support during the heating season. • Due to our current credit position, our ability to execute certain hedging strategies has been curtailed, which we anticipate will require us topurchase a greater proportion of Nymex futures contracts to meet our hedging strategy than we have in the past. These contracts require an initialmargin at the time of purchase and we are required to fund maintenance margins based on daily market adjustments should the market price ofhome heating oil decrease. The payment of these margins, if required, may be well in advance of settlement and will have an adverse impact onliquidity. • In addition to the foregoing, there is a risk that accounts receivable collection experience may not equal that of prior periods since customers areowing larger amounts which could be outstanding for longer periods of time. If our credit requirements should exceed the amounts available under our revolving credit facility or should we fail to maintain the required availability, wewould not have sufficient working capital to operate our business, which could have a material adverse effect on our financial condition and results ofoperations. Our substantial debt and other financial obligations could impair our financial condition and our ability to fulfill our debt obligations. We had total debt, exclusive of our working capital facility, of approximately $268.2 million as of September 30, 2005. Our substantial indebtedness andother financial obligations could: • impair our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions or general corporate purposes; • have a material adverse effect on us if we fail to comply with financial and affirmative and restrictive covenants in our debt agreements and anevent of default occurs as a result of a failure that is not cured or waived; 12 Table of Contents • require us to dedicate a substantial portion of our cash flow for interest payments on our indebtedness and other financial obligations, therebyreducing the availability of our cash flow to fund working capital and capital expenditures; • limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; and • place us at a competitive disadvantage compared to our competitors that have proportionately less debt. If we are unable to meet our debt service obligations and other financial obligations, we could be forced to restructure or refinance our indebtedness and otherfinancial transactions, seek additional equity capital or sell our assets. We may then be unable to obtain such financing or capital or sell our assets onsatisfactory terms, if at all. If our use of the net proceeds from the sale of the propane segment does not comply with the terms of the Indenture for the MLP Notes, we may be subjectto liability to the note holders, which could have a material adverse effect on us. In December 2004, we completed the sale of our propane segment. Pursuant to the terms of the indenture relating to the MLP Notes, we are permitted, within360 days of the sale, to apply the Net Proceeds to a Permitted Use. To the extent there are any Excess Proceeds, the indenture requires us to make an offer toall holders of MLP Notes to purchase for cash that number of MLP Notes that may be purchased with Excess Proceeds at a purchase price equal to 100% ofthe principal amount of the MLP Notes plus accrued and unpaid interest to the date of purchase. After payment of certain debt and transaction expenses, the Net Proceeds from the propane segment sale were approximately $156.3 million. As ofSeptember 30, 2005, we had utilized $53.1 million of such Net Proceeds to invest in working capital assets, purchase capital assets and repay long-term debt,which reduced the amount of Net Proceeds in excess of $10 million not applied toward a Permitted Use to $93.2 million as of September 30, 2005. As ofDecember 2, 2005, all Excess Proceeds have been applied toward a Permitted Use. See “Recapitalization.” We understand, based on informal communications, that certain holders of MLP Notes may take the position that the use of Net Proceeds to invest in workingcapital assets is not a Permitted Use under the indenture. We disagree with this position and have communicated our disagreement with these noteholders.However, if our position is challenged and we are unsuccessful in defending our position, this would constitute an event of default under the indenture ifdeclared either by the holders of 25% in principal amount of the MLP Notes or by the trustee. In such event, all amounts due under the senior notes wouldbecome immediately due and payable, which would have a material adverse effect on our ability to continue as a going concern. The report of ourindependent registered public accounting firm on our consolidated financial statements as of September 30, 2005 and 2004, and for the three years endedSeptember 30, 2005, includes an explanatory paragraph with respect to the impact of this matter on our ability to continue as a going concern if this matter isresolved adversely to us. We have reached an agreement with the holders of 94% in aggregate principal amount of the senior notes to resolve this matter,which is subject to our completing the proposed recapitalization, of which there can be no assurance. Since weather conditions may adversely affect the demand for home heating oil, our financial condition is vulnerable to warm winters. Weather conditions have a significant impact on the demand for home heating oil because our customers depend on this product principally for spaceheating purposes. As a result, weather conditions may materially adversely impact our operating results and financial condition. During the peak heatingseason of October through March, sales of home heating oil historically have represented approximately 75% to 80% of our annual home heating oil volume.Actual weather conditions can vary substantially from year to year, significantly affecting our financial performance. Furthermore, warmer than normaltemperatures in one or more regions in which we operate can significantly decrease the total volume we sell and the gross profit realized on those sales and,consequently, our results of operations. For example, in fiscal 2000 and especially fiscal 2002, temperatures were significantly warmer than normal for theareas in which we sell home heating oil, which adversely affected the amount of EBITDA that we generated during these periods. In fiscal 2002, temperaturesin our areas of operation were an average of 18.4% warmer than in fiscal 2001 and 18.0% warmer than normal. We purchase weather insurance to helpminimize the adverse effect of weather volatility on our cash flows, of which there can be no assurance. Our operating results will be adversely affected if we experience significant customer losses that are not offset or reduced by customer gains. Our net attrition rate of home heating oil customers for fiscal 2003, 2004 and 2005 was approximately 1.5%, 6.4% and 7.1%, respectively. This raterepresents the net of our annual customer loss rate after customer gains. For fiscal 2003, 2004 and 2005, gross customer losses were 16.4%, 19.5% and 20%,respectively. For fiscal 2003, 2004 and 2005, gross customer gains were 14.9%, 13.1% and 12.9%, respectively. The gain of a new customer does not fullycompensate for the loss of an existing customer during the first year because of the expenses incurred to acquire a new customer and the higher attrition rateassociated with new customers. Customer losses are the result of various factors, including: • supplier changes based primarily on price competition, particularly during periods of high energy costs 13 Table of Contents • quality of service issues, including those related to our centralized call center • credit problems; and • customer relocations. The continuing unprecedented rise and volatility in the price of heating oil has intensified price competition, which has adversely impacted our margins andadded to our difficulty in reducing customer attrition. We believe our attrition rate has risen not only because of increased price competition related to therise in oil prices but also because of operational problems. Prior to the 2004 winter heating season, we attempted to develop a competitive advantage incustomer service and, as part of that effort, centralized a majority of our heating equipment service dispatch and engaged a centralized call center to fulfilltelephone requirements for a majority of our home heating oil customers. We experienced difficulties in advancing this initiative during fiscal 2004, whichadversely impacted our customer base and costs. In fiscal 2004 and 2005, the customer experience was below the level associated with other premium serviceproviders and below the level of service provided by us in prior years. We believe that we have identified the problems associated with the centralization efforts and are taking steps to address these issues. We expect that high netattrition rates may continue through fiscal 2006 and perhaps beyond and even to the extent the rate of attrition can be halted, attrition from prior fiscal yearswill adversely impact net income in the future. We believe that this increase in net customer attrition over the past two years can be attributed to: (i) a combination of the affect of our premiumservice/premium price strategy when customer price sensitivity increased due to high energy prices; (ii) our decision in fiscal 2005 to maintain reasonableprofit margins going forward in spite of competitors’ aggressive pricing tactics; (iii) the lag effect of customer attrition related to service and deliveryproblems experienced by customers in prior fiscal years; (iv) continued customer dissatisfaction with the centralization of customer care; and (v) tightenedcustomer credit standards. We have continued to experience net customer attrition during fiscal 2006. If wholesale prices remain high, we believe the risk of customer losses due tocredit problems, especially for commercial customers, may increase and bad debt expense will also increase. We may not be able to achieve net gains of customers and may continue to experience net customer attrition in the future. Sudden and sharp oil price increases that cannot be passed on to customers may adversely affect our operating results. The retail home heating oil industry is a “margin-based” business in which gross profit depends on the excess of retail sales prices over supply costs.Consequently, our profitability is sensitive to changes in the wholesale price of home heating oil caused by changes in supply or other market conditions.These factors are beyond our control and thus, when there are sudden and sharp increases in the wholesale cost of home heating oil, we may not be able topass on these increases to customers through increased retail sales prices. As of September 30, 2005, the wholesale cost of home heating oil, as measured bythe closing price on the New York Mercantile Exchange, had increased by 48% to $2.06 per gallon from $1.39 per gallon as of September 30, 2004. Duringfiscal 2005, per gallon home heating oil prices peaked at $2.18 on September 1, 2005. Wholesale price increases could reduce our gross profits and could, ifcontinuing over an extended period of time, reduce demand by encouraging conservation or conversion to alternative energy sources. In an effort to retainexisting accounts and attract new customers, we may offer discounts, which will impact the net per gallon gross margin realized. A significant portion of our home heating oil volume is sold to price-protected customers and our gross margins could be adversely affected if we arenot able to effectively hedge against fluctuations in the volume and cost of product sold to these customers. A significant portion of our 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. For the fiscal year ended September 30, 2005, approximately 48% of our retail home heating oil volumesales were under a price protected plan. The price at which home heating oil is sold to these price protected customers is generally renegotiated prior to theheating season of each year based on current market conditions. We currently purchase futures contracts, swaps and option contracts for a substantial majorityof the heating oil that we expect to sell to these price-protected customers that have agreements in place in advance and at a fixed or maximum cost pergallon. We purchase these positions when a price protected customer renews his purchase commitment for the next 12 months. We utilize various hedgingstrategies in order to “lock in” the per gallon margin for price protected customers. The amount of home heating oil volume that we hedge per price protectedcustomer is based upon the estimated fuel consumption per customer, per month. In the event that the actual usage exceeds the amount of the hedged volumeon a monthly basis, we could be required to obtain additional volume at unfavorable margins. In addition, should actual usage be less than the hedgedvolume we may have excess inventory on hand at unfavorable costs. 14 Table of ContentsIf we do not make acquisitions on economically acceptable terms, our future financial performance will be limited. The home heating oil industry is not a growth industry because new housing generally does not use oil heat and increased competition exists from alternativeenergy sources. A significant portion of our growth in the past decade has been directly tied to our acquisition program. Accordingly, future financialperformance will depend on our ability to make acquisitions at attractive prices. We cannot assure that we will be able to identify attractive acquisitioncandidates in the home heating oil sector in the future or that we will be able to acquire businesses on economically acceptable terms. Factors that mayadversely affect home heating oil operating and financial results may limit our access to capital and adversely affect our ability to make acquisitions. Underthe terms of our revolving credit facility, the heating oil segment was restricted from making any acquisitions through June 17, 2005 and thereafterindividual acquisitions may not exceed an aggregate of $25 million. In addition, the heating oil segment is restricted from making any acquisition unlessavailability (essentially borrowing base availability less borrowings) was at least $40 million, on a pro forma basis, during the last 12 month period endingon the date of such acquisition. These restrictions severely limit our ability to make acquisitions. Any acquisition may involve potential risks to us andultimately to our unitholders, including: • an increase in our indebtedness; • an increase in our working capital requirements • our inability to integrate the operations of the acquired business; • our inability to successfully expand our 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 unitholders and any additional debt incurred to finance acquisitions may amongother things, affect our ability to make distributions to our unitholders. Because of the highly competitive nature of the retail home heating oil industry, we may not be able to retain existing customers or acquire newcustomers, which would have an adverse impact on our operating results and financial condition. If the home heating oil business is unable to compete effectively, we may lose existing customers or fail to acquire new customers, which would have amaterial adverse effect on our results of operations and financial condition. We compete with heating oil distributors offering a broad range of services and prices, from full service distributors, like us, to those offering delivery only.Competition with other companies in the home heating oil industry is based primarily on customer service and price. It is customary for companies to deliverhome heating oil to their customers based upon weather conditions and historical consumption patterns, without the customer making an affirmativepurchase decision. Most companies provide home heating equipment repair service on a 24-hour-per-day basis. In some cases, homeowners have formedbuying cooperatives to purchase fuel oil from distributors at a price lower than individual customers are otherwise able to obtain. As a result of these factors,it may be difficult to acquire new customers. We can make no assurances that we will be able to compete successfully. If competitors continue to increase market share by reducing their prices, as webelieve occurred recently, our operating results and financial condition could be materially and adversely affected. We also compete for customers withsuppliers of alternative energy products, principally natural gas. Competition from alternative energy sources has been increasing as a result of reducedregulation of many utilities, including natural gas and electricity, and the high price of oil. We could face additional price competition from electricity andnatural 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 tonatural gas have averaged approximately 1% per year. The continuing unprecedented rise in the price of heating oil has intensified price competition, which has adversely impacted our product margins and addedto our difficulty in reducing customer attrition. We believe our attrition rate has risen not only because of increased price competition related to the rise in oilprices, but also because of operational problems. Prior to the 2004 winter heating season, we attempted to develop a competitive advantage in customerservice and, as part of that effort, centralized a majority of our heating equipment service dispatch and engaged a centralized call center to fulfill telephonerequirements for the majority of our home heating oil customers. We experienced difficulties in advancing this initiative during fiscal 2004 and 2005, whichadversely impacted our customer base and costs. In fiscal 2004 and 2005 the customer experience was below the level associated with other premium serviceproviders and below the level of service provided by us in prior years. We believe that we have identified the problems associated with these centralization efforts and are taking steps to address these issues We expect that highnet attrition rates may continue through fiscal 2006 and perhaps beyond and even to the extent that the rate of attrition can be halted, attrition in prior fiscalyears will adversely impact net income in the future. 15 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 our products by retail customers. Future conservation measures or technological advances in heating,conservation, energy generation or other devices might reduce demand and adversely affect our operating results. We are subject to operating and litigation risks that could adversely affect our operating results whether or not covered by insurance. Our operations are subject to all operating hazards and risks normally incidental to handling, storing, transporting and otherwise providing customers withhome heating oil. As a result, we may be a defendant in legal proceedings and litigation arising in the ordinary course of business. We maintain insurance policies with insurers in amounts and with coverage and deductibles as we believe are reasonable. However, there can be no assurancethat this insurance will be adequate to protect us from all material expenses related to potential future claims for remediation costs and personal and propertydamage or that these levels of insurance will be available in the future at economical prices. Our insurance reserves may not be adequate to cover actual losses. We self-insure a portion of workers’ compensation, automobile and general liability claims. We establish reserves based upon expectations as to what ourultimate liability will be for these claims using developmental factors based upon historical claim experience. We periodically evaluate the potential forchanges in loss estimates with the support of qualified actuaries. As of September 30, 2005, we had approximately $33.8 million of insurance reserves andhad issued $43.8 million in letters of credit for current and future claims. The ultimate settlement of these claims could differ materially from the assumptionsused to calculate the reserves, which could have a material effect on our results of operations. We are the subject of a number of class action lawsuits alleging violation of the federal securities laws, which if decided adversely, could have amaterial adverse effect on our 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 entitled Carter v. Star Gas Partners, L.P., et al, No. 3:04-cv-01766-IBA, et al. Subsequently, 16 additional class action complaints, alleging the same or substantially similar claims, were filed in the same districtcourt: (1) Feit v. Star Gas, et al. Civil Action No. 04-1832 (filed on 10/29/2004), (2) Lila Gold vs. Star Gas, et al, Civil Action No. 04-1791 (filed on10/22/2004), (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 vs. 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 10/25/2004), (7) Strunk v. Star Gas, et al, Civil Action No. 04-1815 (filed on 10/27/2004), (8) Harriette S. & Charles L. Tabas Foundation vs. StarGas, 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 vs. Star Gas et al, Civil Action No. 04-1856 (filed on 11/3/2004), (12) Yopp vs. Star Gas, etal, 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), (14) Lederman v. Star Gas, etal, Civil Action No. 04-1873 (filed on 11/5/2004), (15) Dinkes v. Star Gas, et al, Civil Action No. 04-1979 (filed 11/22/2004) and (16) Gould v. Star Gas, etal, Civil Action No. 04-2133 (filed on 12/17/2004) (including the Carter Complaint, collectively referred to herein as the “Class Action Complaints”). Theclass actions have been consolidated into one action entitled In re Star Gas Securities Litigation, No 3:04cv1766 (JBA). The class action plaintiffs generally allege that the Partnership violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, andRule 10-b5 promulgated thereunder, by purportedly failing to disclose, among other things: (1) problems with the restructuring of Star Gas’s dispatch systemand customer attrition related thereto; (2) that Star Gas’ heating oil segment’s business process improvement program was not generating the benefitsallegedly claimed; (3) that Star Gas was struggling to maintain its profit margins in its heating oil segment; (4) that Star Gas’s fiscal 2004 second quarterprofit 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 andthat, as a result, its credit rating and ability to obtain future financing was in jeopardy. The class action plaintiffs seek an unspecified amount ofcompensatory damages including interest against the defendants jointly and severally and an award of reasonable costs and expenses. On February 23, 2005,the Court consolidated the Class Action Complaints and heard argument on motions for the appointment of lead plaintiff. On April 8, 2005, the Courtappointed the lead plaintiff. Pursuant to the Court’s order, the lead plaintiff filed a consolidated amended complaint on June 20, 2005 (the “ConsolidatedAmended Complaint”). The Consolidated Amended Complaint named: (a) Star Gas Partners, L.P.; (b) Star Gas LLC; (c) Irik Sevin; (d) Audrey Sevin;(e) Hanseatic Americas, Inc.; (f) Paul Biddelman; (g) Ami Trauber; (h) A.G. Edwards & Sons Inc.; (i) UBS Investment Bank; and (j) RBC Dain Rauscher Inc. asdefendants. The Consolidated Amended Complaint added claims arising out of two registration statements and the same transactions under Sections 16 Table of Contents11, 12(a)(2) and 15 of the Securities Act of 1933 as well as certain allegations concerning the Partnership’s hedging practices. On September 23, 2005,defendants filed motions to dismiss the Consolidated Amended Complaint for failure to state a claim under the federal securities laws and failure to satisfythe applicable pleading requirements of the Private Securities Litigation Reform Act of 1995 (“PSLRA”), and the Federal Rules of Civil Procedure. Plaintiffsfiled their response to defendants’ motions to dismiss on or about November 23, 2005 and defendants are scheduled to file their reply briefs on or aboutDecember 20, 2005. In the interim, discovery in the matter remains stayed pursuant to the mandatory stay provisions of the PSLRA. While no prediction maybe made as to the outcome of litigation, we intend to defend against this class action vigorously. In the event that the above action is decided adversely to us, it could have a material effect on our results of operations, financial condition and liquidity Our results of operations and financial condition may be adversely affected by governmental regulation and associated environmental and regulatorycosts. 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. Wehave implemented environmental programs and policies designed to avoid potential liability and costs under applicable environmental laws. It is possible,however, that we will experience increased costs due to stricter pollution control requirements or liabilities resulting from noncompliance with operating orother regulatory permits. New environmental regulations might adversely impact operations, including underground storage and transportation of homeheating oil. In addition, there are environmental risks inherently associated with home heating oil operations, such as the risks of accidental release or spill. Itis possible that material costs and liabilities will be incurred, including those relating to claims for damages to property and persons. Before August 2006, wemust implement certain changes to ensure compliance with amended Environmental Protection Agency regulations. We currently estimate that the capitalrequired to effectuate these requirements will range from $1.0 to $1.5 million. In our acquisition of Meenan, we assumed all of Meenan’s environmental liabilities. In our acquisition of Meenan Oil Company, or “Meenan,” in August 2001, we assumed all of Meenan’s environmental liabilities, including those related tothe cleanup of contaminated properties, in consideration of a reduction of the purchase price of $2.7 million. Subsequent to closing, we established anadditional reserve of $2.3 million to cover potential costs associated with remediating known environmental liabilities, bringing the total reserve to $5.0million. To date, remediation expenses against this reserve have totaled $3.1 million. While we believe this reserve is adequate, it is possible that the extentof the contamination at issue or the expense of addressing it could exceed our estimates and thus the costs of remediating these known liabilities couldmaterially exceed the amount 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,and the Partnership and its limited partners, on the other hand. 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, and thePartnership or any of the limited partners, on the other hand. As a result of these conflicts the general partner may favor its own interests and those of itsaffiliates 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 us. • 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, if any, available for distribution to unitholders, and available to pay principal and interest on debt. • 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 unitholders. The risk of global terrorism and political unrest may adversely affect the economy and the price and availability of home heating oil and have amaterial adverse effect on our business, financial condition, and results of operations. 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, our results of operations, our 17 Table of Contentsability to raise capital and our future growth. The impact that the foregoing may have on the heating oil industry in general, and on our business in particular,is not known at this time. An act of terror could result in disruptions of crude oil supplies and markets, the source of home heating oil, and its facilities couldbe direct or indirect targets. Terrorist activity may also hinder our ability to transport home heating oil if our normal means of transportation becomedamaged as a result of an attack. Instability in the financial markets as a result of terrorism could also affect our ability to raise capital. Terrorist activity couldlikely lead to increased volatility in prices for home heating oil. Insurance carriers are routinely excluding coverage for terrorist activities from their normalpolicies, but are required to offer such coverage as a result of new federal legislation. We have opted to purchase this coverage with respect to our propertyand casualty insurance programs. This additional coverage has resulted in additional insurance premiums. The impact of hurricanes and other natural disasters could cause disruptions in supply and have a material adverse effect on our business, financialcondition and results of operations. Hurricanes, particularly in the Gulf of Mexico, and other natural disasters may cause disruptions in the supply chains for home heating oil and otherpetroleum products. Disruptions in supply could have a material adverse effect on our business, financial condition and results of operations, causing anincrease in wholesale prices and decrease in supply. Cash distributions (if any) are not guaranteed and may fluctuate with performance and reserve requirements. Because distributions on the common and subordinated units are dependent on the amount of cash generated, distributions may fluctuate based on ourperformance. The actual amount of cash that is available will depend upon numerous factors, including: • profitability of operations; • required principal and interest payments on debt; • debt covenants • margin account requirements; • cost of acquisitions; • issuance of debt and equity securities; • fluctuations in working capital; • capital expenditures; • adjustments in reserves; • prevailing economic conditions; • financial, business and other factors; and • increased pension funding requirements Most 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 our business. These reserves will also affectthe amount of cash available for distribution. The general partner may establish reserves for distributions on the senior subordinated units only if thosereserves will not prevent the Partnership from distributing the full minimum quarterly distribution, plus any arrearages, on the common units for the followingfour quarters. On October 18, 2004, we announced that we would not pay a distribution on the common units as a result of the requirements of our bank lenders. We hadpreviously announced the suspension of distributions on the senior subordinated units on July 29, 2004. The revolving credit facility and the indenture forthe MLP Notes both impose certain restrictions on our ability to pay distributions to unitholders. It is unlikely that regular distributions on the common unitsor senior subordinated units will be resumed in the foreseeable future. See “Recapitalization.” ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. 18 Table of Contents ITEM 2. PROPERTIES We provide services to our customers from 19 principle operating locations and 47 depots, 29 of which are owned and 37 of which are leased, in 32marketing areas in the Northeast and Mid-Atlantic regions of the United States. As of September 30, 2005, we had a fleet of 1,049 truck and transportvehicles, the majority of which were owned and 1,245 services vans, the majority of which are leased. We lease our corporate headquarters in Stamford,Connecticut. Our obligations under our credit facility are secured by liens and mortgages on substantially all of the Partnership’s and subsidiaries real andpersonal property. 19 Table of Contents ITEM 3. LEGAL PROCEEDINGS – 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 entitled Carter v. Star Gas Partners, L.P., et al, No. 3:04-cv-01766-IBA, et.al. Subsequently, 16 additional class action complaints, alleging the same or substantially similar claims, were filed in the same districtcourt: (1) Feit v. Star Gas, et al. Civil Action No. 04-1832 (filed on 10/29/2004), (2) Lila Gold vs. Star Gas, et al, Civil Action No. 04-1791 (filed on10/22/2004), (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 vs. 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 10/25/2004), (7) Strunk v. Star Gas, et al, Civil Action No. 04-1815 (filed on 10/27/2004), (8) Harriette S. & Charles L. Tabas Foundation vs. StarGas, 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 vs. Star Gas et al, Civil Action No. 04-1856 (filed on 11/3/2004), (12) Yopp vs. Star Gas, etal, 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), (14) Lederman v. Star Gas, etal, Civil Action No. 04-1873 (filed on 11/5/2004), (15) Dinkes v. Star Gas, et al, Civil Action No. 04-1979 (filed 11/22/2004) and (16) Gould v. Star Gas, etal, Civil Action No. 04-2133 (filed on 12/17/2004) (including the Carter Complaint, collectively referred to herein as the “Class Action Complaints”). Theclass actions have been consolidated into one action entitled In re Star Gas Securities Litigation, No 3:04cv1766 (JBA). The class action plaintiffs generally allege that the Partnership violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, andRule 10-b5 promulgated thereunder, by purportedly failing to disclose, among other things: (1) problems with the restructuring of Star Gas’s dispatch systemand customer attrition related thereto; (2) that Star Gas’s heating oil segment’s business process improvement program was not generating the benefitsallegedly claimed; (3) that Star Gas was struggling to maintain its profit margins in its heating oil segment; (4) that Star Gas’s fiscal 2004 second quarterprofit 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 andthat, as a result, its credit rating and ability to obtain future financing was in jeopardy. The class action plaintiffs seek an unspecified amount ofcompensatory damages including interest against the defendants jointly and severally and an award of reasonable costs and expenses. On February 23, 2005,the Court consolidated the Class Action Complaints and heard argument on motions for the appointment of lead plaintiff. On April 8, 2005, the Courtappointed the lead plaintiff. Pursuant to the Court’s order, the lead plaintiff filed a consolidated amended complaint on June 20, 2005 (the “ConsolidatedAmended Complaint”). The Consolidated Amended Complaint named: (a) Star Gas Partners, L.P.; (b) Star Gas LLC; (c) Irik Sevin; (d) Audrey Sevin;(e) Hanseatic Americas, Inc.; (f) Paul Biddelman; (g) Ami Trauber; (h) A.G. Edwards & Sons Inc.; (i) UBS Investment Bank; and (j) RBC Dain Rauscher Inc. asdefendants. The Consolidated Amended Complaint added claims arising out of two registration statements and the same transactions under Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 as well as certain allegations concerning the Partnership’s hedging practices. On September 23, 2005, defendantsfiled motions to dismiss the Consolidated Amended Complaint for failure to state a claim under the federal securities laws and failure to satisfy the applicablepleading requirements of the Private Securities Litigation Reform Act of 1995 (“PSLRA”), and the Federal Rules of Civil Procedure. Plaintiffs filed theirresponse to defendants’ motions to dismiss on or about November 23, 2005 and defendants are scheduled to file their reply briefs on or about December 20,2005. In the interim, discovery in the matter remains stayed pursuant to the mandatory stay provisions of the PSLRA. While no prediction may be made as tothe outcome of litigation, we intend to defend against this class action vigorously. In the event that the above action is decided adversely to us, it could have a material effect on our results of operations, financial condition and liquidity. Our operations are subject to all operating hazards and risks normally incidental to handling, storing and transporting and otherwise providing for use byconsumers of combustible liquids such as propane and home heating oil. As a result, at any given time we are a defendant in various legal proceedings and litigation arising in the ordinary course of business. We maintain insurancepolicies with insurers in amounts and with coverages and deductibles we believe are reasonable and prudent. However, we cannot assure that this insurancewill be adequate to protect us from all material expenses related to potential future claims for personal and property damage or that these levels of insurancewill be available in the future at economical prices. In addition, the occurrence of an explosion may have an adverse effect on the public’s desire to use ourproducts. In the opinion of management, except as described above we are not a party to any litigation, which individually or in the aggregate couldreasonably be expected to have a material adverse effect on our results of operations, financial position or liquidity. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 20 Table of Contents PART II ITEM 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 2004 and 2005 quarters indicated. SGU - Common Unit PriceRange DistributionsDeclared per Unit High Low FiscalYear2004 FiscalYear2005 FiscalYear2004 FiscalYear2005 FiscalYear2004 FiscalYear2005Quarter Ended December 31, $24.93 $22.23 $21.79 $4.32 $0.575 $— March 31, $25.59 $7.22 $22.85 $3.11 $0.575 $— June 30, $25.53 $4.11 $20.00 $1.94 $0.575 $— September 30, $24.25 $3.64 $20.54 $2.39 $0.575 $— SGH - Sr. Subordinated Unit PriceRange DistributionsDeclared per Unit High Low FiscalYear2004 FiscalYear2005 FiscalYear2004 FiscalYear2005 FiscalYear2004 FiscalYear2005Quarter Ended December 31, $21.60 $14.05 $20.01 $2.31 $0.575 $— March 31, $23.80 $4.42 $20.45 $2.05 $0.575 $— June 30, $23.90 $4.60 $18.75 $1.15 $0.575 $— September 30, $22.65 $3.35 $12.62 $2.12 $— $— As of September 30, 2005, there were approximately 599 holders of record of common units, and approximately 104 holders of record of senior subordinatedunits. On October 18, 2004, we announced that we would not pay a distribution on our common units. We had previously announced the suspension ofdistributions on the senior subordinated units on July 29, 2004. We did not pay a distribution on any outstanding units in fiscal 2005. It is unlikely thatregular distributions on the common units or senior subordinated units will be resumed in the foreseeable future. While we hope to position ourselves to paysome regular distribution on the common units in future years, of which there can be no assurance, it is considerable less likely that regular distributions willever resume on the senior subordinated units because of their subordination terms. As of November 25, 2005 there are arrearages aggregating five minimumquarterly distributions on our common units amounting to approximately $92.5 million No distribution may be made on our senior subordinated notes untilthese arrearages have been paid. For more information on the relative rights and preferences of the senior subordinated units, see the Partnership’s Agreementof Limited Partnership, which is incorporated by reference in this Annual Report as described in Item 15. On December, 9, 2005, the closing price of SGU-common unit was $2.19 per unit and the closing price of SGH-senior subordinated unit was $2.15 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, we had distributed to our partners, on a quarterly basis, all of our Available Cash in the manner described below. Available Cash is defined for anyof 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 or appropriate in thereasonable discretion of the general partner to (i) provide for the proper conduct of the business; (ii) comply with applicable law, any of its debt instrumentsor other agreements; (iii) provide funds for distributions to the common unitholders and the senior subordinated unitholders during the next four quarters. Wedid not pay a distribution on any outstanding units during fiscal 2005. 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. 21 Table of ContentsThe revolving credit facility and the indenture for the MLP Notes both impose certain restrictions on our ability to pay distributions to unitholders. It isunlikely that regular distributions on the common units or senior subordinated units will be resumed in the foreseeable future. If the proposed recapitalization occurs, our Agreement of Limited Partnership will be amended to provide for no mandatory distributions until afterSeptember 30, 2008. See Item 1 “Recapitalization.” Tax Matters Star Gas Partners is a master limited partnership and thus not subject to federal income taxes. Instead, our unitholders are required to report for income taxpurposes their allocable share of our income, gains, losses, deductions and credits, regardless of whether we make distributions. Accordingly, each commonunitholder should consult its own tax advisor in analyzing the federal, state and local tax consequences applicable to their ownership or disposition of ourunits. Star Gas reports its tax information on a calendar year basis, while financial reporting is based on a fiscal year ending September 30. 22 Table of Contents ITEM 6. SELECTED HISTORICAL FINANCIAL AND OPERATING DATA The selected financial data as of September 30, 2004 and 2005, and for the years ended September 30, 2003, 2004 and 2005 is derived from the financialstatements of the Partnership included elsewhere in this Report. The selected financial data as of September 30, 2001, 2002 and 2003 and for the fiscal yearsended September 30, 2001 and 2002 is derived from financial statements of the Partnership not included elsewhere in this Report. See Item 7. Management’sDiscussion and Analysis of Financial Condition and Results of Operations. Fiscal Years Ended September 30, (in thousands, except per unit data) 2001(c) 2002(c) 2003 2004 2005 Statement of Operations Data: Sales $767,959 $790,378 $1,102,968 $1,105,091 $1,259,478 Costs and expenses: Cost of sales 563,803 546,495 793,543 799,055 983,779 Delivery and branch expenses 142,968 174,030 217,244 232,985 231,581 Depreciation and amortization expenses 28,595 40,444 35,535 37,313 35,480 General and administrative expenses 19,374 17,745 39,763 19,937 43,418 Goodwill impairment charge — — — — 67,000 Operating income (loss) 13,219 11,664 16,883 15,801 (101,780)Interest expense, net (20,716) (23,843) (29,530) (36,682) (31,838)Amortization of debt issuance costs (506) (1,197) (2,038) (3,480) (2,540)Gain (loss) on redemption of debt — — 212 — (42,082) Loss from continuing operations before income taxes (8,003) (13,376) (14,473) (24,361) (178,240)Income tax expense (benefit) 1,200 (1,700) 1,200 1,240 696 Loss from continuing operations (9,203) (11,676) (15,673) (25,601) (178,936)Income (loss) from discontinued operations, net of inc. taxes 2,488 507 19,786 20,276 (4,552)Gain (loss) on sales of discontinued operations, net of inc. taxes — — — (538) 157,560 Cumulative effects of changes in accounting principles for discontinuedoperations: Adoption of SFAS No. 133 (627) — — — — Adoption of SFAS No. 142 — — (3,901) — — Income (loss) before cumulative effects of changes in accounting principle forcontinuing operations (7,342) (11,169) 212 (5,863) (25,928)Cumulative effects of changes in accounting principle for adoption ofSFAS No. 133 2,093 — — — — Net income (loss) $(5,249) $(11,169) $212 $(5,863) $(25,928) Weighted average number of limited partner units: Basic 22,439 28,790 32,659 35,205 35,821 Diluted 22,552 28,821 32,767 35,205 35,821 Per Unit Data: Basic and diluted loss from continuing operations per unit (a) $(0.40) $(0.40) $(0.48) $(0.72) $(4.95)Basic and diluted net income (loss) per unit (a) $(0.23) $(0.38) $0.01 $(0.16) $(0.72)Cash distribution declared per common unit $2.30 $2.30 $2.30 $2.30 $— Cash distribution declared per senior sub. unit $1.98 $1.65 $1.65 $1.73 $— Balance Sheet Data (end of period): Current assets $185,262 $222,201 $211,109 $234,171 $311,432 Total assets $898,819 $943,766 $975,610 $960,976 $629,261 Long-term debt $456,523 $396,733 $499,341 $503,668 $267,417 Partners’ Capital $198,264 $232,264 $189,776 $169,771 $145,108 Summary Cash Flow Data: Net Cash provided by (used in) operating activities $38,078 $18,773 $15,365 $13,669 $(54,915)Net Cash provided by (used in) investing activities $(295,885) $(12,381) $(48,395) $6,447 $467,431 Net Cash provided by (used in) financing activities $263,355 $28,135 $48,049 $(19,874) $(306,694)Other Data: Earnings from continuing operations before interest, taxes, depreciation andamortization (EBITDA) (b) $43,907 $52,108 $52,630 $53,114 $(108,382)Heating oil segment’s retail gallons sold 427,168 457,749 567,024 551,612 487,300 (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. 23 Table of ContentsITEM 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 our abilityto make the minimum quarterly distribution. The working capital facility and the senior secured notes, impose certain restrictions on our ability to paydistributions to unitholders. On October 18, 2004, we announced that we would not pay a distribution on the common units. We had previouslyannounced the suspension of distributions on the senior subordinated units on July 29, 2004. We did not pay a distribution on any outstanding unitsin fiscal 2005. It is unlikely that regular distributions on the common units or senior subordinated units will be resumed in the foreseeable future.While we hope to position ourselves to pay some regular distribution on the common units in future years, of which there can be no assurance, it isconsiderably less likely that regular distributions will ever resume on the senior subordinated units because of their subordination terms. See Item 1“Recapitalization.” The definition of “EBITDA” set forth above may be different from that used by other companies. EBITDA from continuing operations is calculated for thefiscal years ended September 30 as follows: (in thousands) 2001 2002 2003 2004 2005 Loss from continuing operations $(9,203) $(11,676) $(15,673) $(25,601) $(178,936)Cumulative effects of changes in accounting principle for adoption of SFAS No. 133 forcontinuing operations 2,093 — — — — Plus: Income tax expense (benefit) 1,200 (1,700) 1,200 1,240 696 Amortization of debt issuance cost 506 1,197 2,038 3,480 2,540 Interest expense, net 20,716 23,843 29,530 36,682 31,838 Depreciation and amortization 28,595 40,444 35,535 37,313 35,480 EBITDA from continuing operations $43,907 $52,108 $52,630 $53,114 $(108,382) (c)Our results for fiscal years ended September 30, 2001 and 2002 do not reflect the impact of the provisions of SFAS No. 142. 24 Table of Contents ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Statement Regarding Forward-Looking Disclosure This Annual Report on Form 10-K includes “forward-looking statements” which represent our expectations or beliefs concerning future events that involverisks and uncertainties, including those associated with the recapitalization, the effect of weather conditions on our financial performance, the price andsupply of home heating oil, the consumption patterns of our customers, our ability to obtain satisfactory gross profit margins, our ability to obtain newaccounts and retain existing accounts, our ability to effect strategic acquisitions or redeploy assets, the ultimate disposition of Excess Proceeds from the saleof the propane segment, the impact of litigation, the impact of the business process redesign project at the heating oil segment and our ability to addressissues related to that project, our ability to contract for our future supply needs, natural gas conversions, future union relations and outcome of current unionnegotiations, the impact of future environmental, health, and safety regulations, customer credit worthiness, and marketing plans. All statements other thanstatements of historical facts included in this Report including, without limitation, the statements under “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” and elsewhere herein, are forward-looking statements. Although we believe that the expectations reflected insuch forward-looking statements are reasonable, we can give no assurance that such expectations will prove to have been correct and actual results may differmaterially from those projected as a result of certain risks and uncertainties. These risks and uncertainties include, but are not limited to, those set forth underthe heading “Risk Factors,” “Business Initiatives and Strategy,” and “Business Outlook Fiscal 2006.” Without limiting the foregoing the words “believe”,“anticipate,” “plan,” “expect,” “seek,” “estimate” and similar expressions are intended to identify forward-looking statements. Important factors that couldcause actual results to differ materially from our expectations (“Cautionary Statements”) are disclosed in this Annual Report on Form 10-K. All subsequentwritten and oral forward-looking statements attributable to the Partnership or persons acting on its behalf are expressly qualified in their entirety by theCautionary Statements. Unless otherwise required by law, we undertake no obligation to update or revise any forward-looking statements, whether as a resultof new information, future events or otherwise after the date of this Report. Overview In analyzing our financial results, the following matters should be considered. The following is a discussion of the historical condition and results of operations of the Partnership and its subsidiaries, and should be read in conjunctionwith the historical Financial and Operating Data and Notes thereto included elsewhere in this Report. We completed the sale of our TG&E segment in March2004 and propane segment in December 2004. The following discussion reflects the historical results for the TG&E segment and propane segment asdiscontinued operations. Our fiscal year ends on September 30. All references to quarters and years respectively in this document are to fiscal quarters and years unless otherwisenoted. The seasonal nature of our business results in the sale of approximately 30% of our volume of home heating oil in the first fiscal quarter (Octoberthrough December) and 45% of our volume in the second fiscal quarter (January through March) of each year, the peak heating season, because heating oil isprimarily used for space heating in residential and commercial buildings. We generally realize net income in both of these quarters and net losses during thequarters ending June and September. In addition, sales volume typically fluctuates from year to year in response to variations in weather, wholesale energyprices and other factors. Gross profit is not only affected by weather patterns but also by changes in customer mix. For example, sales to our residentialvariable customers ordinarily generate higher margins than sales to our other customer groups, such as residential protected or commercial customers. Inaddition, our gross profit margins vary by geographic region. Accordingly, gross profit margins could vary significantly from year to year in a period ofidentical sales volumes. 25 Table of ContentsSummary of Significant Events and Developments • Sale of propane segment • New Credit Facility • Unitholder suit • Goodwill Write-down • MLP Notes • Departure of Chairman and CEO • Home Heating Oil Price Volatility • Customer attrition • Operating expense /control • Recapitalization Sale of propane segment In December 2004 we completed the sale of our propane segment to Inergy for a cash purchase price of $481.3 million and recognized a gain ofapproximately $157 million from the sale after closing costs of approximately $14 million. $311 million of the proceeds from the sale were used torepurchase senior secured notes and first mortgage notes of the heating oil segment and propane segment, together with associated prepaymentpremiums, accrued interest and the amounts then outstanding under the propane segment’s working capital facility. Our propane segment representedapproximately 24% and 20% of our total revenue in fiscal 2004 and 2003, respectively, and 64% of our operating income in each of fiscal 2004 and2003. The historical results of the propane segment are reflected as discontinued operations in our consolidated financial statements. New Credit Facility On December 17, 2004 we executed a new $260 million revolving credit facility with a group of lenders led by J.P. Morgan Chase Bank, N.A. This newfacility provides us the ability to borrow up to $260 million for working capital purposes (subject to certain borrowing base limitations and coverageratios) and replaced the heating oil segment’s existing $235 million credit facility. Fees and expenses totaling approximately $8.0 million wereincurred in connection with consummating the new facility. On November 3, 2005, the revolving credit facility was amended to increase the facilitysize by $50 million to $310 million for the peak winter months from December through March of each year. Obligations under the new revolving creditfacility are secured by liens on substantially all of the assets of the Partnership, the heating oil segment and its subsidiaries. Unitholder Suit In October 2004, a purported class action lawsuit was filed against the Partnership and various subsidiaries and current and former officers anddirectors. Subsequently, 16 additional class action complaints alleging the same or substantially similar claims were filed in the same district court.The complaints generally allege that the Partnership violated sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended. The courthas consolidated the class action complaints and appointed a lead plaintiff. On September 23, 2005 we filed motions to dismiss. Plaintiffs replied tothese motions on November 23, 2005 and we expect to file our reply briefs on or about December 20, 2005. In the interim, discovery in the matterremains stayed. We intend to continue to defend against this purported class action lawsuit vigorously. Goodwill Write-down During the second quarter of fiscal 2005 we incurred a non-cash goodwill impairment charge of $67 million at the heating oil segment as a result oftriggering events that occurred during the second quarter of 2005. These triggering events included a significant decline in our unit price and thedetermination that operating results for fiscal 2005 would be significantly lower than previously expected. MLP Notes In accordance with the terms of the indenture relating to the Partnership’s 10 1/4% Senior Notes (“MLP Notes”), we are permitted within 360 days of thesale, to apply the net proceeds (the “Net Proceeds”) of the sale of the propane segment either to reduce indebtedness (and reduce any relatedcommitment) of the Partnership or of a restricted subsidiary, or to make an investment in assets or capital expenditures useful to the business of thePartnership or any of its subsidiaries as in effect on the issue date of the MLP Notes (the “Issue Date”) or any business related, ancillary orcomplementary to any of the businesses of the Partnership on the Issue Date (each a “Permitted Use” and collectively the “Permitted Uses”). To theextent any Net Proceeds that are not so applied exceed $10 million (“Excess Proceeds”), the indenture requires us to make an offer to all holders ofMLP Notes to purchase for cash that number of MLP Notes that may be purchased with Excess Proceeds at a purchase price equal to 100% of theprincipal amount of the MLP Notes plus accrued and unpaid interest to the date of purchase. At September 30, 2005, the amount of Net Proceeds inexcess of $10 million not yet applied toward a Permitted Use totaled $93.2 million. As of December 2, 2005 all Excess Proceeds were applied toward aPermitted Use. We understand, based on informal communications, that certain holders of MLP Notes may take the position that the use of NetProceeds to invest in working capital assets is not a Permitted Use under the indenture. We disagree with this position and have communicated ourdisagreement with these noteholders. However, if our position is challenged and we are unsuccessful in defending our position, this 26 Table of Contentswould constitute an event of default under the indenture if declared either by the holders of 25% in principal amount of the senior notes or by the trustee. Insuch event, all amounts due under the senior notes would become immediately due and payable, which would have a material adverse effect on our ability tocontinue as a going concern. The report of our independent registered public accounting firm on our consolidated financial statements as of September 30,2005 and 2004, and for the three years ended September 30, 2005, includes an explanatory paragraph with respect to the impact of this matter on our abilityto continue as a going concern if this matter is resolved adversely to us. We have reached an agreement with the holders of 94% in aggregate principalamount of the senior notes to resolve this matter, which is subject to our completing the proposed recapitalization, of which there can be no assurance. See“Recapitalization” below. 27 Table of ContentsDeparture of Chairman and CEO On March 7, 2005 (“the Termination Date”), Star Gas LLC and Mr. Irik P. Sevin entered into a letter agreement and general release (the “Agreement”).In accordance with the Agreement, Mr. Sevin resigned from employment as the Chairman and Chief Executive Officer and President of Star Gas LLC(and its subsidiaries) under the employment agreement between Mr. Sevin and Star Gas LLC dated as of September 30, 2001. In addition, under termsof the agreement Mr. Sevin transferred his member interests in Star Gas LLC to a voting trust of which Mr. Sevin is one of three trustees. Under theterms of the voting trust, those interests will be voted in accordance with the decision of a majority of the trustees. Pursuant to the Agreement,Mr. Sevin is entitled to an annual consulting fee totaling $395,000 for a period of five years following the Termination Date. In addition, theAgreement provides for Mr. Sevin to receive a retirement benefit equal to $350,000 per year for a 13 year period beginning with the month followingthe five year anniversary of the Termination Date. At March 31, 2005, we recorded a liability for $4.2 million, which represents the present value of thecost of the agreement. Home Heating Oil Price Volatility The wholesale price of heating oil, like any other market commodity, is generally set by the economic forces of supply and demand. Rapid globalexpansion is fueling an ever-increasing demand for oil. Home heating oil prices are closely linked to the price refiners pay for crude oil because crudeoil is the principal cost component of home heating oil. Crude oil is bought and sold in the international marketplace and as such is subject to theeconomic forces of supply and demand worldwide. The United States imports more than 60% of the petroleum products it consumes. The wholesalecost of home heating oil as measured by the New York Mercantile Exchange (“Nymex”) at September 30, 2005, 2004 and 2003 was $2.06, $1.39 and$0.78, respectively The current marketplace for petroleum products including home heating oil has been extremely volatile. In a volatile market even small changes insupply or demand can dramatically affect prices. The changes we have seen this past year and continue to experience have been significant. Heating oilprices are subject to price fluctuations if demand rises sharply because of excessively cold weather and/or disruptions at refineries and instability inkey oil producing regions. Ultimately, increases in wholesale prices are, in most instances, borne by our customers. Because of these high prices wehave experienced increased attrition in our customer base and a decrease in heating oil volume sold per customer (“conservation”). For fiscal 2005,over 75% of our revenue is attributable to the retail sale and delivery of home heating oil. About half of our retail sales of home heating oil are tocustomers who agree to pay a fixed or maximum price per gallon for each delivery over the next twelve months (protected price customers). Theremaining retail sales are to customers that pay a variable price based principally on the daily spot price plus our profit margin. We mitigate our exposure to our price protected customers in a volatile market by hedging our fixed and maximum price sales through the purchase ofexchange traded options and futures, and over the counter options and swaps, and we mitigate our exposure to variable priced customers, in mostinstances, by passing through higher home heating oil costs directly to such customers. Customer attrition Net customer attrition is the difference between gross customer losses and customers added through marketing efforts. Customers added throughacquisitions are not included in the calculation of net customer attrition. The gain of a new customer does not fully compensate for the loss of anexisting customer during the first year because of the expenses that must be incurred to acquire a new customer and the higher attrition rate associatedwith new customers. Gross customer losses are the result of a number of factors, including price competition, move-outs, and service issues. When acustomer moves out of an existing home we count the “move out” as a loss and if we are successful in signing up the new homeowner, the “move in” istreated as a gain. Gross customer gains and gross customer losses for fiscal 2003, 2004 and 2005 is found below: Fiscal Year Ended Description 2003 2004 2005 Gross Customer Gains 71,800 67,400 63,800 Gross Customer Losses (78,800) (100,500) (98,900) Net Customer Loss (7,000) (33,100) (35,100) Net customer attrition as a percent of the home heating oil customer base for fiscal 2003, 2004, and 2005 is found below: Fiscal Year Ended Description 2003 2004 2005 Gross Customer Gains 14.9% 13.1% 12.9%Gross Customer Losses (16.4)% (19.5)% (20.0)% Net Customer Attrition (1.5)% (6.4)% (7.1)% 28 Table of ContentsNet home heating oil customers accounts added (lost) for fiscal 2003, 2004, and 2005 by quarter is as follows: Quarter Ended Fiscal 2003 Fiscal 2004 Fiscal 2005 December 31 3,500 (3,300) (2,000)March 31 (3,700) (8,600) (9,900)June 30 (5,900) (10,300) (7,400)September 30 (900) (10,900) (15,800) TOTAL (7,000) (33,100) (35,100) We experienced net customer attrition of 7.1% in fiscal 2005. This compares to net attrition of 6.4% and 1.5% in fiscal 2004 and 2003, respectively.This increase in net customer attrition for both fiscal 2004 and 2005 can be attributed to: (i) a combination of the effect of our premiumservice/premium price strategy during a volatile period when customer price sensitivity increased due to high energy prices; (ii) our decision in fiscal2005 to maintain reasonable profit margins going forward in spite of competitors’ aggressive pricing tactics; (iii) the lag effect of customer attritionrelated to service and delivery problems experienced in prior fiscal years; (iv) continued customer dissatisfaction with the centralization of customercare; and (v) tightened customer credit standards. If wholesale prices remain high, we believe the risk of customer losses due to credit problems, especially for commercial customers, may increase andbad debt expense will also increase. We have continued to experience net customer attrition during fiscal 2006. For the period from October 1 toNovember 30, 2005 we lost 4,315 accounts (net ) or 0.9% of our home heating oil customer base as compared to the period from October 1 toNovember 30, 2004 in which we gained 530 accounts (net) or 0.1% of our customer base. For fiscal 2005, we lost approximately 35,100 accounts (net) or 2,000 more than the 33,100 accounts (net) lost in fiscal 2004. This increased loss of2,000 accounts is largely due to the factors described above as well as losses of fixed price accounts that were renewed at a low fixed price in thesummer and fall of 2004, as the heating oil segment, in an attempt to retain customers, did not raise prices sufficiently to offset the increase in the costof home heating oil and which chose not to renew at higher prices in fiscal 2005. During the three months ended September 30, 2005, we lost 15,800accounts (net) or 3.2% of our home heating oil customer base, as compared to the three months ended September 30, 2004 in which we lost 10,900accounts (net) or 2.1% of its home heating oil customer base. This increased loss of 4,900 accounts is largely due to losses attributable to accounts thatwere renewed at a low fixed price in the summer and fall of 2004 and who chose not to renew at higher prices in fiscal 2005. We cannot predict whetherthis trend will continue. Over the past several months, we have modified our marketing plan and are seeking to increase the home heating oil productmargins realized on new accounts as well as some of our less profitable accounts. We anticipate that while this program could improve net income andlower marketing expenses, fewer new accounts will likely be added which will result in higher net customer attrition in the near term. Prior to the fiscal 2004 winter heating season, we attempted to develop a competitive advantage in customer service through a business processredesign project and, as part of that effort, centralized our heating equipment service and oil dispatch functions and engaged a centralized customercare center to fulfill our telephone requirements for a majority of our home heating oil customers. We experienced difficulties in advancing thisinitiative during fiscal 2004, which adversely impacted the customer base and our costs. The savings from this initiative were less than expected andthe costs to operate under the centralized format were greater than originally estimated. The 6.4% net customer attrition rate in fiscal 2004 was higher than the rate experienced in fiscal 2003 and higher than in the preceding several years.For fiscal 2003, before the full implementation of the business process and redesign project and before the increase in the wholesale price of homeheating oil, we experienced annual net customer attrition of 1.5%. We believe we have identified the problems associated with our centralization efforts and have addressed these issues by structuring the customer callcenter (that we sometimes refer to in this Annual Report as the customer care center) into work groups that parallel Petro’s district structure, addingcustomer retention specialists at the district level, answering a portion of customer calls in two districts, providing continuous in-house training at thecustomer care center, and establishing a general manager of customer retention. The general manager of customer retention reports directly to thePresident. Despite these efforts, we continued to experience high net attrition rates in 2005, and we expect that high net attrition rates may continuethrough fiscal 2006 and perhaps beyond. Even to the extent that the rate of attrition may be halted, the current reduced customer base will adverselyimpact net income in the future. 29 Table of ContentsThe quantitative factors we use to measure the effectiveness of the customer care center and field operations – such as customer satisfaction scores,telephone waiting times and abandonment rates at the customer care center, oil delivery run-outs and heating equipment repair and maintenanceresponse times – have improved meaningfully during fiscal 2005, as compared to the same periods in fiscal 2004 and fiscal 2003. Operating expense/control We have implemented a series of cost reduction initiatives in fiscal 2005 including facility consolidations, the reduction of non-essential personneland the reduction and re-evaluation of certain marketing programs. We believe this will be an ongoing process over the next several months as wecontinue to review our operating expenses. We believe that operating expenses have been reduced by approximately $10.0 million at the heating oilsegment and by approximately $1.3 million at the partners’ level. A portion of these expense reductions were realized during fiscal 2005 and theremainder are expected to be realized in fiscal 2006. In addition, a wage freeze has been implemented for senior management in fiscal 2006. We renewed our officers’ and directors’ insurance for the policy year beginning April 2005. The annual premium is $2.7 million and represents anincrease of $2.2 million over the prior year’s policy. Recapitalization On December 2, 2005 the board of directors of Star Gas LLC approved a strategic recapitalization of Star Gas Partners that, if approved by unitholdersand completed, would result in a reduction in the outstanding amount of our 101/4% Senior Notes due 2013 ( “Senior Notes”), of betweenapproximately $87 million and $100 million. The recapitalization includes a commitment by Kestrel Energy Partners, LLC (or “Kestrel”) and its affiliates to purchase $15 million of new equitycapital and provide a standby commitment in a $35 million rights offering to our common unitholders, at a price of $2.00 per common unit. We wouldutilize the $50 million in new equity financing, together with an additional $10 million to $23.1 million from operations, to repurchase at least $60million in face amount of our Senior Notes and, at our option, up to approximately $73.1 million of Senior Notes. In addition, certain noteholders haveagreed to convert approximately $26.9 million in face amount of Senior Notes into newly issued common units at a conversion price of $2.00 per unitin connection with the closing of the recapitalization. We have entered into agreements with the holders of approximately 94% in principal amount of our Senior Notes which provide that: the noteholderscommit to, and will, tender their Senior Notes at par (i) for a pro rata portion of $60 million or, at our option, up to approximately $73.1 million in cash,(ii) in exchange for approximately 13,434,000 new common units at a conversion price of $2.00 per unit (which new units would be acquired byexchanging approximately $26.9 million in face amount of Senior Notes) and (iii) in exchange for new notes representing the remaining face amountof the tendered notes. The principle terms of the new senior notes, such as the term and interest rate are the same as the Senior Notes. The closing of thetender offer is conditioned upon the closing of the transactions under the Kestrel unit purchase agreement, which is discussed below. Upon closing thetransaction we will incur a gain or loss on the exchange of Senior Notes for common units based on the difference between the $2.00 per unitconversion price and the fair value per unit represented by the per unit price in the open market on the conversion date. Subject to and until the transaction closing, the noteholders have agreed not to accelerate indebtedness due under the senior notes or initiate anylitigation or proceeding with respect to the Senior Notes. The noteholders have further agreed to: waive any default under the indenture; not to tenderthe Senior Notes in the change of control offer which will be required to be made following the closing of the transactions under the unit purchaseagreement with Kestrel; and to consent to certain amendments to the existing indenture. The agreement with the noteholders further provides for thetermination of its provisions in the event that the Kestrel unit purchase agreement is no longer in effect. The understandings and agreementscontemplated by these transactions will terminate if the transaction does not close prior to April 30, 2006. We believe the proposed recapitalization would substantially strengthen our balance sheet and thereby assist us in meeting our liquidity and capitalrequirements, which we believe would improve our future financial performance and as a result enhance unitholder value. In addition to enhancingunitholder value, we believe we will be able to operate more efficiently going forward with less long-term debt. As part of the recapitalization transaction, we have entered into a definitive unit purchase agreement with Kestrel and its affiliates, which provides for,among other things: the receipt by us of $50 million in new equity financing through the issuance to Kestrel’s affiliates of 7,500,000 common units at$2.00 per unit for an aggregate of $15 million and the issuance of an additional 17,500,000 common units in a rights offering to our commonunitholders at an exercise price of $2.00 per unit for an aggregate of $35 million. The rights will be non-transferable, and an affiliate of Kestrel hasagreed to buy any common units not subscribed for in the rights offering. Under the terms of the unit purchase agreement, Kestrel Heat, LLC, or KestrelHeat, a wholly owned subsidiary of Kestrel, will become our new general partner and Star Gas LLC, our current general partner, will receive noconsideration for its removal as general partner. 30 Table of ContentsIn addition, the unit purchase agreement provides for the adoption of a second amended and restated agreement of limited partnership that will, amongother matters: • provide for the mandatory conversion of each outstanding senior subordinated unit and junior subordinated unit into one commonunit; • change the minimum quarterly distribution to the common units from $0.575 per quarter, or $2.30 per year, to $0.0675 per unit, or$0.27 per year, which shall commence accruing October 1, 2008; and, eliminate all previously accrued cumulative distributionarrearages which aggregated $92.5 million at November 30, 2005; • suspend all distributions of available cash by us through the fiscal quarter ending September 30, 2008; • reallocate the incentive distribution rights so that, commencing October 1, 2008, the new general partner units in the aggregate will beentitled to receive 10% of the available cash distributed once $.0675 per quarter, or $0.27 per year, has been distributed to commonunits and general partner units and 20% of the available cash distributed in excess of $0.1125 per quarter, or $.45 per year, providedthere are no arrearages in minimum quarterly distributions at the time of such distribution (under our current partnership agreement ifquarterly distributions of available cash exceed certain target levels, the senior subordinated units, junior subordinated units andgeneral partner units would receive an increased percentage of distributions, resulting in their receiving a greater amount on a per unitbasis than the common units). The recapitalization is subject to certain closing conditions including, the approval of our unitholders, approval of the lenders under our revolvingcredit facility, and the successful completion of the tender offer for our Senior Notes. As a result of the challenging financial and operating conditions that we have experienced since fiscal 2004, we have not been able to generatesufficient available cash from operations to pay the minimum quarterly distribution of $0.575 per unit on our partnership securities. These conditionsled to the suspension of distributions on our senior subordinated units, junior subordinated units and general partner units on July 29, 2004 and to thesuspension of distributions on the common units on October 18, 2004. We believe that the proposed amendments to our partnership agreement will simplify our capital structure, provide internally generated funds for futureinvestment and align the minimum quarterly distribution more closely with the levels of available cash from operations that we expect to generate inthe future. Kestrel is a private equity investment firm formed by Yorktown Energy Partners VI, L.P., Paul A. Vermylen, Jr. and other investors. Yorktown EnergyPartners VI, L.P. is a New York-based private equity investment partnership, which makes investments in companies engaged in the energy industry.Yorktown affiliates and Mr. Vermylen were investors in Meenan Oil Co. L.P. from 1983 to 2001, during which time Mr. Vermylen served as Presidentof Meenan. Meenan was sold to us in 2001. It is possible that the units purchased as part of the recapitalization transaction or units purchased by one or more than one 5% unitholder would triggeran IRC Section 382 limitation relating to certain net operating loss carryforwards. An ownership change occurs for purposes of Section 382 when thereis a direct or indirect sale or exchange of more than 50% by one or more than one 5% shareholders. If an ownership change has occurred in accordancewith Section 382, future limitations in the utilization of net operating losses could be significant. It is possible that the Partnership’s subsidiary,Star/Petro, Inc., will not be able to use any of its currently existing net income tax loss carry forwards in the future. Business Outlook Fiscal 2006 We expect our business to continue to be affected by the following key trends. Our expectations are based on assumptions made by us, and informationcurrently available to us. To the extent our underlying assumptions about or interpretations of available information prove to be incorrect, our actual resultsmay vary materially from our estimated results. We face numerous challenges in fiscal 2006. In particular, it will be difficult to stem the high attrition rates and continued customer conservation that we arecurrently experiencing, primarily as a result of a volatile and consistently high heating oil commodity market. 31 Table of ContentsBased on our outlook we expect increased global demand for oil and gas in fiscal 2006, particularly as a result of emerging energy consumers such as Chinaand India. This resultant increase in demand may support relatively high heating oil commodity prices. We believe that our efforts to decentralize a portion of our current service operations by redirecting a portion of our customer calls and empowering our localbranches will provide benefits in stemming attrition rates in 2006. In addition, we believe our cost control programs coupled with our increasing discipline inhedging rising commodity price risk for our customer price protected contracts and continued philosophy of maintaining reasonable margins in spite ofcompetitors’ aggressive price tactics should mitigate some of the negative impact associated with the continued high heating oil prices in fiscal 2006. As aresult we anticipate that our per-gallon margin may improve over our margins earned in fiscal 2005. We believe the proposed recapitalization , as described above, if approved by our unitholders and completed, will substantially strengthen our balance sheetand thereby assist us in meeting our liquidity and capital requirements, which we believe will improve our future financial performance and as a resultenhance unitholder value. In addition to enhancing unitholder value, we believe we will be able to operate more efficiently going forward with less long-termdebt. In the latter part of fiscal 2006, we intend to pursue asset acquisitions, to the extent permitted in our credit facility, in demographic areas that will enable us torealize margins we consider reasonable in the face of aggressive localized price competition as one way to replace volume lost through attrition. In addition,we may dispose of operations in markets where we are not able to effectively employ our strategy of maintaining reasonable margins. We anticipate using thiscash flow, in part, to the extent permitted under our credit facility and MLP Notes, to fund anticipated acquisitions. 32 Table of ContentsFiscal Year Ended September 30, 2005 (Fiscal 2005)Compared to Fiscal Year Ended September 30, 2004 (Fiscal 2004)Statements of Operations by Segment Fiscal 2004 (1) Fiscal 2005 (1) (in thousands) Heating Oil Partners &Others Consol. Heating Oil Partners &Others Consol. Statements of Operations Sales: Product $921,443 $— $921,443 $1,071,270 $— $1,071,270 Installations and service 183,648 — 183,648 188,208 — 188,208 Total sales 1,105,091 — 1,105,091 1,259,478 — 1,259,478 Cost and expenses: Cost of product 594,153 — 594,153 786,349 — 786,349 Cost of installations and service 204,902 204,902 197,430 — 197,430 Delivery and branch expenses 232,985 — 232,985 231,581 — 231,581 Depreciation & amortization expenses 37,313 — 37,313 35,480 — 35,480 General and administrative 16,535 3,402 19,937 17,376 26,042 43,418 Goodwill impairment charge — — — 67,000 — 67,000 Operating income (loss) 19,203 (3,402) 15,801 (75,738) (26,042) (101,780)Net interest expense 28,038 8,644 36,682 21,780 10,058 31,838 Amortization of debt issuance costs 2,750 730 3,480 1,718 822 2,540 Loss on redemption of debt — — — 24,192 17,890 42,082 Loss from continuing operations before income taxes (11,585) (12,776) (24,361) (123,428) (54,812) (178,240)Income tax expense (benefit) 1,240 — 1,240 1,756 (1,060) 696 Loss from continuing operations (12,825) (12,776) (25,601) (125,184) (53,752) (178,936)Income (loss) from discontinued operations — 20,276 20,276 — (4,552) (4,552)Gain (loss) on sale of segments, net of taxes — (538) (538) — 157,560 157,560 Net income (loss) $(12,825) $6,962 $(5,863) $(125,184) $99,256 $(25,928) (1)We completed the sale of our TG&E segment during March 2004 and our propane segment as of November 2004. Volume For fiscal 2005, retail volume of home heating oil decreased 64.3 million gallons, or 11.7%, to 487.3 million gallons, as compared to 551.6 million gallonsfor fiscal 2004. Volume of other petroleum products declined by 7.6 million gallons, or 9.3%, to 73.5 million gallons for fiscal 2005, as compared to81.1 million gallons for fiscal 2004. An analysis of the change in retail volume of home heating oil, which is based on management’s estimates, sampling,and other mathematical calculations (as actual customer consumption patters cannot be precisely determined) is found below: (in millions of gallons) Heating OilSegment Volume – Fiscal 2004 551.6 Impact of colder temperatures 4.2 Impact of acquisitions 3.2 Net customer attrition (39.0)Conservation (24.5)Delivery scheduling (6.0)Other (2.2) Change (64.3) Volume – Fiscal 2005 487.3 We believe that the 64.3 million gallon decline in home heating oil volume was due to net customer attrition, which occurred during fiscal 2004 and fiscal2005, conservation, delivery scheduling, and other factors partially offset by acquisitions. Total degree days in the heating oil segment’s geographic areas ofoperations were approximately 0.9% greater in fiscal 2005 than in fiscal 2004 and approximately 0.5% greater than normal, as reported by the NationalOceanic Atmospheric Administration (“NOAA”). Due to the significant increase in the price per gallon of home heating oil during the year, we believe thatcustomers are using less home heating oil given similar temperatures. Indications based on internal studies suggest that our customers have reduced theirconsumption by approximately 4.4%. We cannot determine if conservation is a permanent or temporary phenomenon. In addition, we estimate that 33 Table of Contentsduring fiscal 2005, home heating oil volume was reduced by 6.0 million gallons due to a delivery scheduling variance. We believe that home heating oilvolume sold in fiscal 2006 may be substantially less than in fiscal 2005 due to customer attrition, conservation and other factors such as warmer temperatures. Product Sales For fiscal 2005, product sales increased $149.8 million, or 16.3%, to $1.071 billion, as compared to $921.4 million for fiscal 2004, as increases in sellingprices more than offset a decline in product sales due to lower volume sold. Selling prices during fiscal 2005 were higher due to the increase in wholesalesupply costs. Average wholesale supply costs were $1.40 per gallon for fiscal 2005, as compared to $0.94 per gallon for fiscal 2004. The weighted averageselling price per gallon was $1.91 per gallon in fiscal 2005 compared to $1.46 in fiscal 2004. Installation, Service and Other Sales For fiscal 2005, installation, service and other sales increased $4.6 million, or 2.5%, to $188.2 million compared to $183.6 million in fiscal 2004, as a declinein installation and other sales of $2.8 million was offset by an increase in service revenues of $7.4 million. Over the last several years, the heating oil segmenthas taken proactive measures, such as modifying service plans and billing strategies, in order to maximize service revenue. Cost of Product For fiscal 2005, cost of product increased $192.2 million, or 32.3%, to $786.3 million, compared to $594.2 million for fiscal 2004. This is the result of anincrease in the heating oil segment’s average wholesale product cost of $0.46 per gallon, or 49%, to an average of $1.40 per gallon for fiscal 2005, from anaverage of $0.94 per gallon for fiscal 2004. In an effort to reduce net customer attrition, we delayed increasing our selling price to certain customers whoseprice plan agreements expired during the July to September 2004 time period. This decision negatively impacted gross profit by an estimated $2.8 million infiscal 2005, primarily during the first quarter of fiscal 2005. During fiscal 2005, product cost was adversely impacted by $3.4 million due to a delay in hedging the price of product for certain residential protected pricecustomers due to cash constraints under our previous credit agreement. Cost of product was also adversely impacted by $1.6 million associated with nothedging the price of product for certain residential price protected customers that were incorrectly coded as variable customers. This coding error wascorrected in December 2004. Home heating oil per gallon margins for the year ended September 30, 2005 declined by 1.3 cents per gallon, compared to fiscal2004 due to an increase in the percentage of volume sold to lower margin residential price protected customers, the delay in increasing the selling price tocustomers whose price plans expired during the July to September 2004 time period and the aforementioned hedging issues concerning price protectedcustomers. Gross profit from product sales decreased $38.2 million in fiscal 2005 due to the margins associated with lower sales volume and $4.2 million dueto lower per gallon margins (which includes $2.8 million delay in price increases previously described) for the volume sold in fiscal 2005 compared to fiscal2004. Our customer base is comprised of three types of customers, residential variable, residential protected price and commercial/industrial. The selling price for aresidential variable customer generally has the highest per gallon gross profit margin. In an effort to retain existing customers and attract new customers, wehave offered and currently are offering discounts that negatively impact the average per gallon gross profit margins. Currently, these discounts are beingoffered to residential variable and price protected customers. Over time, we will try to reduce these discounts and increase the per gallon gross profit margin.If we are not successful in reducing these discounts, per gallon gross profit margins may further decline. Due to the greater price sensitivity of residentialprotected price customers, the per gallon margins realized from that customer segment generally are less than variable priced residential customers.Commercial/industrial customers are characterized as large volume users and contribute the lowest per gallon margin. The percentage of home heating oil volume sold to residential protected price customers increased to approximately 48% of total home heating oil volumesales during fiscal 2005, as compared to 43% for fiscal 2004. Accordingly, the percentage of home heating oil volume sold to residential variable customersdecreased to approximately 36% for fiscal 2005, as compared to 40% for fiscal 2004. During fiscal 2005, sales to commercial/industrial customersrepresented approximately 16% of total home heating oil volume sales, unchanged from fiscal 2004. Rising energy costs have increased consumer interest inprice protection. If wholesale supply costs remain volatile and/or at historically high levels, per gallon profit margins and results could continue to beadversely impacted. Cost of Installations and Service For fiscal 2005, cost of installations and service decreased $7.5 million, or 3.6%, to $197.4 million, as compared to $204.9 million for fiscal 2004. Thisreduction was due to a lower level of variable installation costs of $2.0 million attributable to the lower level of installation sales and a $5.5 million declinein service expenses. Service expenses decreased due to a contraction in costs resulting from servicing a smaller customer base, warmer temperatures duringthe peak heating season, which reduced the frequency of service calls, and an improvement in the scheduling of preventative maintenance service calls whichlowered overtime hours. The loss realized from service (including installations) improved by $12.1 million from a $21.3 million loss for fiscal 2004 to a $9.2million loss for fiscal 2005. When measured on a per gallon of home heating oil sold basis, the loss from service improved by 2.0 cents per gallon from 3.9cents per gallon for fiscal 2004 to 1.9 cents for fiscal 2005. 34 Table of ContentsDelivery and Branch Expenses For fiscal 2005, delivery and branch expenses decreased $1.4 million or 0.6% to $231.6 million compared to $233.0 million of expenses incurred in fiscal2004. Bad debt expense, credit card processing fees and collection expenses all increased, primarily due to the increase in product sales dollars. Deliverycosts were also higher due to the rise in vehicle fuel costs. In total, delivery and branch expenses increased by $4.9 million due to the increase in bad debtexpense, credit card processing fees, collection expenses, and fuel costs. Delivery and branch expenses also increased by approximately $5.9 million due towage and benefit increases. These delivery and branch expense increases were offset by a reduction in operating costs due to the variable nature of certaindelivery and operating expenses such as direct delivery expense, which decreased with lower volume. On a cents per gallon basis, operating costs increased5.3 cents per gallon, or 12.6%, from 42.2 cents per gallon for fiscal 2004 to 47.5 cents per gallon for fiscal 2005. The 5.3 cent per gallon increase was due tohigher bad debt and collection expenses, wage and benefit increases, and the inability to reduce certain fixed expenses commensurate with a reduction inhome heating oil volume of 11.7%. Depreciation and Amortization For fiscal 2005, depreciation and amortization expenses declined by $1.8 million, or 4.9%, to $35.5 million, as compared to $37.3 million for fiscal 2004 ascertain assets, which were not replaced, became fully depreciated. General and Administrative Expenses During fiscal 2005, general and administrative expenses increased by $23.5 million, or 117.8%, to $43.4 million, compared to $19.9 million for fiscal 2004.At the partners’ level, general and administrative expenses increased $22.6 million from $3.4 million in fiscal 2004 to $26.0 million in fiscal 2005 due to$7.5 million in bridge financing fees, $4.4 million of legal expenses incurred relating to defending several purported class action lawsuits, legal andprofessional fees associated with exploring several refinancing alternatives, legal expense attributable to inquiries from regulatory agencies, an increase inofficers and directors insurance of $1.1 million, $4.1 million in expenses for compliance with Sarbanes-Oxley, $3.8 million in expense relating to separationagreements entered into with the former Chief Executive Officer, Chief Financial Officer, and Chief Marketing Officer of the Partnership, and $1.7 millionhigher compensation expense associated with unit appreciation rights. (In fiscal 2004 and fiscal 2005, the decline in the unit price for senior subordinatedunits resulted in reversing previously recorded expenses of $3.9 million and $2.2 million, respectively.) The separation agreement with Irik Sevin, the formerCEO ($3.1 million), was fully accrued during fiscal 2005 and will be paid over an extended period of time. At the heating oil segment, general andadministrative expenses increased by $0.8 million, or 5.1%, to $17.4 million for the fiscal 2005, compared to $16.5 million for fiscal 2004. This increase wasdue primarily to $3.4 million of expenses and fees associated with certain bank amendments and waivers on our previous credit facility obtained during thefirst fiscal quarter of 2005, offset in part by lower business process improvement expenses of $1.4 million and a reduction in compensation and benefitexpense of $1.2 million. Goodwill Impairment Charge During the second quarter of fiscal 2005, a number of events occurred that indicated a possible impairment of goodwill might exist. These events includedour determination in February 2005 of significantly lower than expected operating results for fiscal 2005 and a significant decline in the Partnership’s unitprice. As a result of these triggering events and circumstances, we completed an interim SFAS No. 142 impairment review with the assistance of a third partyvaluation firm as of February 28, 2005. This review resulted in a non-cash goodwill impairment charge of approximately $67.0 million, which reduced thecarrying amount of goodwill of the heating oil segment. Operating Income (Loss) For fiscal 2005, operating income decreased $117.6 million to a loss of $101.8 million, compared to $15.8 million in operating income for fiscal 2004. Thedecrease in our operating income in fiscal 2005 is the result of a $67.0 million non-cash goodwill impairment charge, as described above, lower margin fromthe sale of petroleum products of $42.4 million, increases in general and administrative expense totaling $23.5 million offset in part by an increase in serviceprofitability of $12.1 million, decreases in branch and delivery expenses of $1.4 million and depreciation and amortization of $1.8 million. Interest Expense During fiscal 2005, interest expense decreased $3.9 million, or 9.8%, to $36.2 million, compared to $40.1 million for fiscal 2004. This change was due to theimpact of lower average debt outstanding offset by an increase in our weighted average interest rate during fiscal 2005. Total debt outstanding declinedbecause a portion of the proceeds from the propane sale, were used in part to repay debt at the heating oil segment. Average working capital borrowings werehigher in fiscal 2005 due principally to the increase in wholesale product cost. 35 Table of ContentsInterest Income During fiscal 2005, interest income increased by $0.9 million, or 27.3%, to $4.3 million, compared to $3.4 million for fiscal 2004 due principally to higheraverage invested cash balances. Amortization of Debt Issuance Costs For fiscal 2005, amortization of debt issuance costs decreased $0.9 million, or 27.0%, to $2.5 million, compared to $3.5 million for fiscal 2004. Loss on Redemption of Debt During the first quarter of fiscal 2005, we recorded a loss of $42.1 million on the early redemption of certain notes at the heating oil and propane segments.The loss consisted of cash premiums paid of $37.0 million for early redemption, the write-off of previously capitalized net deferred financing costs of $6.1million and legal expenses of $0.7 million, reduced in part by the realization of the unamortized portion of a $1.7 million basis adjustment to the carryingvalue of long-term debt. Income Tax Expense (Benefit) Income tax expense for fiscal 2005 was approximately $0.7 million compared to $1.2 million in fiscal 2004. The decrease of approximately $0.5 million isthe result of increases in state capital taxes of $0.5 million in fiscal 2005 which is more than offset by $1.0 million in tax benefits that were fully utilizedagainst taxes associated with the gain on the sale of the propane segment. Income (Loss) From Continuing Operations For fiscal 2005 the loss from continuing operations increased $153.3 million to a loss of $178.9 million, compared to a loss of $25.6 million for fiscal 2004,as the decline in operating income of $117.6 million and the loss on the redemption of debt of $42.1 million were reduced by lower interest expense of $3.9million, higher interest income of $0.9 million, lower amortization of debt issuance costs of $0.9 million and a decrease in income tax expense of $0.5million. Income (Loss) From Discontinued Operations For fiscal 2005, income from discontinued operations decreased $24.8 million. Income from the discontinued propane segment, which was sold onDecember 17, 2004, generated $19.4 million in net income for fiscal 2004 and a net loss of $4.6 million for fiscal 2005. The discontinued TG&E segment wassold on March 31, 2004 and generated net income of $0.9 million for fiscal 2004. Gain on Sales of Discontinued Operations During fiscal 2005, the purchase price for the TG&E segment was finalized and a positive adjustment of $0.8 million was recorded. In addition, during fiscal2005, we recorded a gain on the sale of the propane segment totaling approximately $156.8 million, which is net of income taxes of $1.3 million. Net loss For fiscal 2005, the net loss increased $20.0 million to a net loss of $25.9 million, compared to a net loss of $5.9 million incurred in fiscal 2004, as thedecline in operating income (loss) from continuing operations of $153.3 million, and the reduction in income from discontinued operations of $24.8 millionwas partially offset by the gain on the sale of the propane segment and TG&E segment of $157.6 million. 36 Table of ContentsEarnings From Continuing Operations Before Interest, Taxes, Depreciation and Amortization (EBITDA) For fiscal 2005, EBITDA decreased $161.5 million to an EBIDTA loss of $108.4 million, as compared to $53.1 million in EBITDA for fiscal 2004. Thisdecrease was due to a non-cash goodwill impairment charge of $67.0 million, the recording of a $42.1 million loss on the redemption of debt, a reduction ingross profit of $42.4 million due to lower sales volume resulting from net customer attrition, conservation and lower gross profit margins from product sales,bridge facility fees, bank amendment fees, and legal fees totaling $15.3 million, $3.8 million in compensation expense relating to severance agreements withformer executives, and $4.1 million for compliance with Sarbanes-Oxley, offset in part by a $12.1 million increase in service profitability and lower branchexpenses and business process improvement costs. EBITDA should not be considered as an alternative to net income (as an indicator of operatingperformance) or as an alternative to cash flow (as a measure of liquidity or ability to service debt obligations), but provides additional information forevaluating our ability to make the minimum quarterly distribution. EBITDA is calculated for the fiscal years ended September 30 as follows: Fiscal Year Ended September 30, (in thousands) 2004 2005 Loss from continuing operations $(25,601) $(178,936)Plus: Income tax expense 1,240 696 Amortization of debt issuance costs 3,480 2,540 Interest expense, net 36,682 31,838 Depreciation and amortization 37,313 35,480 EBITDA 53,114 (108,382)Add/(subtract) Income tax expense (1,240) (696)Interest expense, net (36,682) (31,838)Unit compensation expense (income) (4,382) (2,185)Provision for losses on accounts receivable 7,646 9,817 Gain on sales of fixed assets, net (281) (43)Goodwill impairment charge — 67,000 Loss on redemption of debt — 42,082 Loss on derivative instruments, net 1,673 2,144 Change in operating assets and liabilities (6,179) (32,814) Net cash provided by (used in) operating activities $13,669 $(54,915) 37 Table of ContentsFiscal Year Ended September 30, 2004 (Fiscal 2004)Compared to Fiscal Year Ended September 30, 2003 (Fiscal 2003) Statements of Operations by Segment Fiscal 2003 (1) Fiscal 2004 (1) (in thousands) Heating Oil Partners& Others Consol. Heating Oil Partners& Others Consol. Statements of Operations Sales: Product $934,967 $— $934,967 $921,443 $— $921,443 Installations and service 168,001 — 168,001 183,648 — 183,648 Total sales 1,102,968 — 1,102,968 1,105,091 — 1,105,091 Cost and expenses: Cost of product 598,397 — 598,397 594,153 — 594,153 Cost of installations and service 195,146 — 195,146 204,902 — 204,902 Delivery and branch expenses 217,244 — 217,244 232,985 — 232,985 Depreciation & amortization expenses 35,535 — 35,535 37,313 — 37,313 General and administrative 22,356 17,407 39,763 16,535 3,402 19,937 Operating income (loss) 34,290 (17,407) 16,883 19,203 (3,402) 15,801 Net interest expense 22,760 6,770 29,530 28,038 8,644 36,682 Amortization of debt issuance costs 1,655 383 2,038 2,750 730 3,480 Gain on redemption of debt (212) — (212) — — — Income (loss) from continuing operations before income taxes 10,087 (24,560) (14,473) (11,585) (12,776) (24,361)Income tax expense 1,200 — 1,200 1,240 — 1,240 Income (loss) from continuing operations 8,887 (24,560) (15,673) (12,825) (12,776) (25,601)Income (loss) from discontinued operations — 19,786 19,786 — 20,276 20,276 Loss on sale of segment, net of taxes — — — — (538) (538)Cumulative effect of change in accounting principle for discontinuedoperations adoption of SFAS No. 142 — (3,901) (3,901) — — — Net income (loss) $8,887 $(8,675) $212 $(12,825) $6,962 $(5,863) (1)The Partnership completed the sale of its TG&E segment during March 2004 and its propane segment as of November 2004. See Note 4. Volume For fiscal 2004, retail volume of home heating oil decreased 15.4 million gallons, or 2.7%, to 551.6 million gallons, as compared to 567 million gallons forfiscal 2003. An analysis of the change in retail volume of home heating oil, which is based on management’s estimates, sampling, and other mathematicalcalculations (as actual customer consumption patterns cannot be precisely determined) is found below. (in millions of gallons) Heating OilSegment Volume – Fiscal 2003 567.0 Impact of warmer temperatures (43.9)Impact of acquisitions 36.1 Net customer attrition (18.2)Other 10.6 Change (15.4) Volume – Fiscal 2004 551.6 We believe that this 15.4 million gallon decline at the heating oil segment was due to the impact of warmer temperatures and net customer attrition partiallyoffset by acquisitions and other volume changes. Net customer attrition is the difference between gross customer losses and customers added through internalmarketing efforts. Customers added through acquisitions do not impact the calculation of net attrition. Temperatures in the heating oil segment’s geographicareas of operations were 7.7% warmer in fiscal 2004 than in fiscal 2003 and approximately 0.2% warmer than normal as reported by the NOAA. 38 Table of ContentsAt September 30, 2004, after adjusting for acquisitions, the heating oil segment estimated that it had approximately 6.4% 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 10,900customers (net) as compared to the quarter ended September 30, 2003, in which the heating oil segment lost approximately 900 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. We believe that theunprecedented rise in heating oil prices has increased the competitive pressures facing our heating oil segment. As wholesale prices have risen, many of ourcompetitors have not raised their retail prices to fully offset the wholesale price rise. In an effort to minimize the loss of customers to price competition, wedid not increase our prices to fully offset for the rise in wholesale prices, resulting in reduced margins. Nevertheless, many of our competitors appear to havesucceeded in inducing some of our customers to leave through various price-related strategies. In addition, prior to the 2004 winter heating season, we attempted to develop a competitive advantage in customer service and, as part of that effort, weexperienced difficulties in centralizing our heating equipment service dispatch and engaged a centralized customer care center to respond to telephoneinquiries. The implementation of that initiative has taken longer than we anticipated, impacting customer service. We believe that the rate of customer loss infiscal 2004 was due to a combination of higher energy prices, operational and customer service problems together with the implementation of strictercustomer credit requirements towards the end of fiscal 2004. Product Sales For fiscal 2004, product sales declined by $13.5 million, or 1.4%, to $921.4 million, 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. Sales, Installations and Service For fiscal 2004, installation, service and appliance sales increased $15.6 million, or 9.3%, to $183.6 million, as compared to $168.0 million for fiscal 2003due to acquisitions and measures taken in the last several years to increase service revenues. Cost of Product For fiscal 2004, cost of product declined by $4.2 million, or 0.7%, to $594.2 million, 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. While selling prices and wholesale prices increased on a per gallon basis, the increase in selling prices exceeded the increase in supply costs during the firstnine months of fiscal 2004. At September 30, 2004, heating oil supply costs were approximately 38% higher than at June 30, 2004. During the three monthsended September 30, 2004, we were not able to fully pass these increases on to our respective customers. As a result, per gallon margins for the three monthsended September 30, 2004 declined by 2.3 cents per gallon at the heating oil segment, as compared to the three months ended September 30, 2003, whichpartially offset per gallon margin increases that the heating oil segment experienced earlier in the year. The per gallon margins realized in the heating oilsegment for the three months ended September 30, 2004 were significantly less than expected. For fiscal 2004, per gallon margin increases were realized inthe base business compared to fiscal 2003 (excluding the impact of acquisitions) of 0.8 cents per gallon. Cost of Installations, Service and Appliances For fiscal 2004, 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 millionin fiscal 2003. This change was primarily due to acquisitions and wage and other cost increases. Delivery and Branch Expenses For fiscal 2004, delivery and branch expenses increased $15.7 million, or 7.2%, to $233.0 million, as compared to $217.2 million in fiscal 2003. Thisincrease of $15.7 million was due to a higher level of fixed and variable operating costs attributable to acquisitions, (primarily those completed in easternPennsylvania) of $10.1 million and approximately $6.3 million due to operating and wage increases. These increases in delivery and branch expenses werepartially reduced by cost reductions relating to lower volume delivered due to warmer temperatures and net customer attrition experienced in fiscal 2004.Prior to the 2004 winter heating season, we attempted to develop a competitive advantage in customer service, and as part of that effort centralized ourheating equipment service dispatch functions and engaged a centralized call center to respond to telephone inquiries. Start-up challenges associated with thisinitiative impacted the customer base and unanticipated training and support was required. The expected savings from this initiative were less than expected. 39 Table of ContentsDepreciation and Amortization For fiscal 2004, depreciation and amortization expenses increased approximately $1.8 million, or 5%, to $37.3 million, as compared to $35.5 million forfiscal 2003. This increase was primarily due to a larger depreciable base of assets, as a result of the impact of acquisitions in fiscal 2004 and to increaseddepreciation resulting from the technology investment made by the heating oil segment in centralizing its customer service and dispatcher functions. General and Administrative Expenses For fiscal 2004, general and administrative expenses declined approximately $20 million, or 50%, to $19.9 million, as compared to $39.8 million for fiscal2003. At the partners’ 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 $2.5million reduction in restricted stock awards and a reduction of $1.4 million in bonus compensation expense. For fiscal 2004, partners’ 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 millionfor unit appreciation rights. For fiscal 2003, partners’ expenses totaled $17.4 million, which included $3.4 million in salary and bonus expense, $9.0 millionin unit 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 severance paid and a higher level oflegal and professional expenses. Operating Income (Loss) For fiscal 2004, operating income decreased approximately $1.1 million, or 6.5%, to $15.8 million, as compared to $16.9 million for fiscal 2003. At thepartners’ 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 $10.4million reduction in the accrual for compensation earned for unit appreciation rights on the Partnership’s senior subordinated units, lower restricted stockawards of $2.5 million and lower bonus compensation expense of $1.4 million. At the heating oil segment, operating income declined by $15.1 million, or44.0%, to $19.2 million, as compared to $34.3 million for fiscal 2003. This decline was due to warmer temperatures of 7.7% in the heating oil segment’sgeographic areas of operations in fiscal 2004 than in fiscal 2003, net customer attrition, operating and wage increases and higher depreciation andamortization expense, which were reduced in part by the operating income attributable to acquisitions, an increase in per gallon gross profit margins of thebase business, lower expenses associated with the heating oil segment’s centralized customer service and dispatch project and increased service revenues. Interest Expense For fiscal 2004, interest expense increased $6.7 million, or 20%, to $40 million, as compared to $33.3 million for fiscal 2003. This increase was due to higherprincipal amount of long-term debt outstanding and an increase in the weighted average interest rate during fiscal 2004, as compared to fiscal 2003. Amortization of Debt Issuance Costs For fiscal 2004, amortization of debt issuance costs increased $1.4 million, or 66.7%, to $3.5 million, as compared to $2.1 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 $1.2 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 $9.9 million, to a loss of $25.6 million, as compared to a loss of $15.7 million for fiscal2003. This decline was due to a $21.7 million decrease in income at the heating oil segment offset by $12.9 million in lower losses at the partners’ level.Income (loss) from continuing operations declined as the effects of warmer temperatures, other volume changes, including customer losses, operating andwage increases and an increase in interest expense were partially offset by the positive impacts of acquisitions, improved per gallon gross profit margins onthe base business and lower compensation expenses at the partners’ level of $14.3 million in the form of unit appreciation rights, restricted stock awards andbonus expense. 40 Table of ContentsIncome From Discontinued Operations For fiscal 2004, income from discontinued operations increased $0.5 million from $19.8 million in 2003 to $20.3 million in 2004. This income relates to theoperating results of the TG&E segment that was sold on March 31, 2004 and the propane segment sold on December 17, 2004. Net income attributable to theTG&E segment decreased $0.3 million and net income attributable to the propane segment increased $0.8 million. The TG&E segment includes operationsfor six months of the fiscal year ended September 30, 2004 and the propane segment includes operations for the entire 2004 fiscal year. Propane segmentsales increased approximately $70 million, operating income decreased approximately $1.5 million, and net income increased approximately $0.8 million.The increase in sales is attributable to higher selling prices due to the higher wholesale cost of propane and to a lesser extent an increased customer baseresulting from acquisitions. The decrease in operating income is principally due to higher product costs as a result of the higher wholesale cost of propane. Loss On Sale of TG&E Segment For fiscal 2004, we recorded a $0.5 million loss on the sale of the TG&E segment. TG&E was sold in March 2004. Cumulative Effect of Change in Accounting Principle For fiscal 2003, we recorded a $3.9 million charge arising from the adoption of Statement No. 142 to reflect the impairment of its goodwill for TG&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 $9.9 million decrease in income from continuing operations, a $0.5 million increase in income from discontinued operations and the $0.5 million loss onthe 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. Liquidity and Capital Resources Our ability to satisfy our obligations will depend on our future performance, which will be subject to prevailing economic, financial, business and weatherconditions, the ability to pass on the full impact of high wholesale heating oil prices to customers, the effects of high customer attrition, conservation andother factors, most of which are beyond our control. See “Risk Factors”. Capital requirements, at least in the near term, are expected to be provided by cashflows from operating activities, cash on hand at September 30, 2005 or a combination thereof. To the extent future capital requirements exceed cash flowsfrom operating activities, we anticipate that working capital will be financed by our revolving credit facility as discussed below and repaid from subsequentseasonal reductions in inventory and accounts receivable and the utilization of the Excess Proceeds from the sale of the propane segment for any purposepermitted by its debt instruments. We also believe that we will able to reduce our peak inventory levels, which will positively impact our liquidity. See“Recapitalization” Operating Activities For fiscal 2005, net cash used in operating activities was $54.9 million or $68.6 million less than net cash provided by operating activities of $13.7 millionfor fiscal 2004 due to the following factors. At September 30, 2005, accounts receivable (before the allowance for doubtful accounts) were $13.8 millionhigher than at September 30, 2004 and accounts receivable at September 30, 2004 were $6.1 million higher than at September 30, 2003 due to higher pergallon selling prices resulting from the continuing increase in the wholesale cost of home heating oil throughout this two-year period. As a result of thechange in accounts receivable in fiscal 2005 when compared to fiscal 2004, cash flow from operating activities was reduced by $7.7 million. Higher pergallon wholesale heating oil costs and additional volume on hand resulted in a higher inventory balance as of September 30, 2005 than September 30, 2004and a higher inventory balance as of September 30, 2004 than September 30, 2003. As a result, cash provided by operating activities was reduced by $8.2million in fiscal 2005 when compared to fiscal 2004 due to the change in inventory. Operating activities were adversely impacted by the loss of trade credit.Prior to October 18, 2004, we were able to purchase a portion of our home heating oil under terms extended by suppliers, which averaged approximately twoto three days. Currently, heating oil suppliers are not extending trade credit to the heating oil segment and the heating oil segment must prepay for its supply.The loss of trade credit reduced cash flow from operating activities by $11.1 million in 2005. The decline in operating income of $117.6 million describedelsewhere in this report (which included a non-cash impairment charge of $67.0 million and approximately $19.4 million in costs associated with legal andprofessional fees in connection with class action lawsuits, compliance with Sarbanes-Oxley, bank refinancing and bank fees) contributed to the decline incash from operating activities. 41 Table of ContentsInvesting Activities During fiscal 2005, we completed the sale of the propane segment. The net proceeds, after deducting expenses, were approximately $466.4 million. Inaddition, we also finalized the sale of TG&E and recorded an additional $0.8 million in proceeds. During fiscal 2005, the heating oil segment spent $3.2million for capital expenditures and received proceeds from the sale of certain assets of $3.4 million. As a result, cash flow provided by investing activitieswas $467.4 million. For fiscal 2004, cash flows provided by investing activities were $6.4 million as the heating oil segment received $1.5 million from thesale of certain assets, spent $4.0 million for capital expenditures, completed acquisitions totaling $3.5 million and received $12.5 million in cash from thesale of the TG&E segment. Financing Activities Cash flows used in financing activities were $306.7 million for fiscal 2005. During this period, $292.2 million of cash was provided from borrowings underthe heating oil segment’s new revolving credit facility ($181.2 million) and previous credit facility ($111.0 million), which were used to repay $119.0million borrowed under our previous credit facility and $174.6 million borrowed under our new credit facility. Also during fiscal 2005, we repaid $259.6million in long-term debt, paid $37.7 million in debt prepayment premiums and expenses and $8.0 million in fees and expenses related to refinancing theheating oil segment’s new bank credit facilities. As a result of the above activity and $11.4 million of cash used by discontinued operations, cash increased by $94.5 million, to $99.1 million as ofSeptember 30, 2005. 42 Table of ContentsFinancing and Sources of Liquidity We had $268.2 million of debt outstanding as of September 30, 2005 (excluding working capital borrowings of $6.6 million). The following summarizes ourlong-term debt maturities occurring over the next five years as of September 30, 2005: (in millions)2006 $0.82007 $0.12008 $— 2009 $— 2010 $— Thereafter $267.3 On December 17, 2004, we entered into a $260 million asset based revolving credit facility with a group of lenders led by JP Morgan Chase Bank, which wasamended in November 2005. The revolving credit facility provides the heating oil segment with the ability to borrow up to $260 million for working capitalpurposes (subject to certain borrowing base limitations and coverage ratios) including the issuance of up to $75 million in letters of credit. From Decemberthrough March of each year, the heating oil segment can borrow up to $310.0 million. Obligations under the revolving credit facility are secured by liens onsubstantially all of the assets of the heating oil segment, including accounts receivable, inventory, general intangibles, real property, fixtures and equipment. Under the terms of the revolving credit facility, we must maintain at all times either availability (borrowing base less amounts borrowed and letters of creditissued) of $25.0 million or a fixed charge coverage ratio (as defined in the credit agreement) of not less than 1.1 to 1.0. As of September 30, 2005, availabilitywas $74.6 million and the fixed charge coverage ratio (as defined in the credit agreement) was 0.56 to 1.0. This $25 million represents a reduction inavailability. We do not anticipate maintaining a fixed charge coverage ratio of 1.1 to 1.0 or greater in the foreseeable future. In December 2004, we completed the sale of our propane segment. Pursuant to the terms of the indenture relating to the MLP Notes, we are permitted, within360 days of the sale, to apply the Net Proceeds to a Permitted Use. To the extent there are any Excess Proceeds, the indenture requires the Partnership to makean offer to all holders of MLP Notes to purchase for cash that number of MLP Notes that may be purchased with Excess Proceeds at a purchase price equal to100% of the principal amount of the MLP Notes plus accrued and unpaid interest to the date of purchase. After repayment of certain debt and transaction expenses and estimated taxes paid of $1.0 million, the Net Proceeds from the propane segment sale wereapproximately $156.3 million. As of September 30, 2005, the heating oil segment had utilized $53.1 million of such Net Proceeds to invest in workingcapital assets, purchase capital assets and repay long-term debt, which reduced the amount of Net Proceeds in excess of $10 million not applied toward apermitted use to $93.2 million as of September 30, 2005. At September 30, 2005, the amount of Excess Proceeds totaled $93.2 million. As of December 2,2005 all Excess Proceeds were applied toward a Permitted Use. See “Management’s Discussion and Analysis of Financial Condition on Results of Operations—Summary of Significant Events and Developments—MLP Notes.” As of September 30, 2005 total liquidity resources including proceeds from the sale of the propane segment, were $148.8 million. Total liquidity resourcesreflect the availability of $74.6 million, less minimum availability of $25.0 million, plus cash of $99.2 million, subject to the requirements of the indenturefor the MLP Notes. We expect total liquidity resources to decline through the first and second quarters of fiscal 2006 as we fund working capital requirementsfor the heating oil season. As we have indicated, we are in the process of evaluating our near-term and longer-term liquidity position and capital structure. Availability under our revolving credit facility could be significantly impacted by our current hedging strategy. We enter into various hedging arrangementsto manage the majority of our exposure to market risk related to changes in the current and future market price of home heating oil purchased for resale to ourprotected price customers. Futures contracts are marked to market on a daily basis and require an initial cash margin deposit and potentially require a dailyadjustment to such cash deposit (maintenance margin). For example, assuming 64 million gallons, based on the volume hedged under the fixed price programas of September 30, 2005, a 10 cent per gallon decline in the market value of these hedged instruments would create an additional cash margin requirement ofapproximately $6.4 million, (while a 10 cent per gallon increase in market value would provide $6.4 million in available margin). In this example,availability in the short-term is reduced, as we fund the margin call. This availability reduction should be temporary, as we should be able to purchaseproduct at a later date for 10 cents a gallon less than the anticipated strike price when the agreement with the price-protected customer was entered into. Inaddition, a spike in wholesale heating oil prices could also reduce availability, as we must finance a portion of our inventory and accounts receivable withinternally generated cash as the net advance for eligible accounts receivable is 85% and 40% to 80% of eligible inventory. We may also borrow up to $35million against fixed assets and customer lists, which is reduced by $7.0 million each year over the life of the agreement. In addition, due to our current creditposition, the ability to execute certain over-the-counter hedging strategies, which do not require margin adjustments, has been curtailed. 43 Table of ContentsAt any given time, the volume hedged under our price-protected program will be less than the expected volume to be sold annually under this program as therenewals for this program are staggered throughout the year. For example, the hedged balance remaining at September 30, 2005 for a price protectionarrangement entered into in January 2005 will represent approximately 25% of the customer’s annual consumption. We hedge home heating oil volume forfixed price customers at the time they renew their protected price contract. For example, if a protected price customer’s contract expires in July 2005 and thecustomer does not renew its contract until October 2005, this customer becomes a variable price customer until the time that he/she renews their contract, andas such there would not be a hedge in place at September 30, 2005 for the purchase of this customer’s anticipated volume usage. We would hedge theanticipated volume in October 2005 at the time of the customer’s contract renewal. As of September 30, 2005, the accounts receivable net of allowances totaled $89.7 million, which represents an increase of $5.7 million when compared tothe balance as of September 30, 2004 of $84.0 million. Our ability to collect these receivables over the upcoming months will impact our borrowing baseavailability, as the borrowing base, which is used to measure availability, does not include accounts receivable over 60 days past due. At September 30, 2005accounts receivable over 60 days past due were approximately $19.8 million compared to $18.2 million as of September 30, 2004 or an increase of $1.6million. A component of accounts receivable at September 30, 2005 represent amounts due from customers under a budget payment plan, which permits acustomer to pay their annual consumption ratably over the year. As of September 30, 2005, the aggregate amount due from budget customers over 60 dayspast due whose billings exceeded their payments was $3.5 million, compared to $1.9 million at September 30, 2004. This increase of $1.6 million is primarilydue to the increase in the per-gallon selling price of home heating oil. In addition, we have $4.4 million of accounts over 60 days past due at September 30,2005 for certain commercial accounts, compared to $2.7 million at September 30, 2004. Prior to October 18, 2004, we were generally able to obtain trade credit from home heating oil suppliers of two to three business days. Since October 18,2004, we must now prepay for our heating oil supply by at least two days. The loss of trade credit has reduced availability. Availability is also negativelyimpacted by outstanding letters of credit. As of September 30, 2005, $47.3 million in letters of credit have been issued, primarily for current and futureinsurance reserves. In fiscal 2006, we expect to issue an additional $6.0 million in letters of credit in connection with our insurance renewal. For the majority of our fiscal year, the amount of cash received from customers with a budget payment plan is greater than actual billings. This amount isreflected on the balance sheet under the caption “customer credit balances.” At September 30, 2005, customer credit balances aggregated $65.3 million.Generally, customer credit balances are at their low point after the end of the heating season and peak prior to the beginning of the heating season. AtSeptember 30, 2004, customer credit balances were $53.9 million. During the non-heating season, cash is provided from customer credit balances to fundoperating activities. If net receipts from budget customers are reduced, cash availability in the non-heating season will be reduced and we will need to borrowunder the revolving credit facility to fund operations. Before August 2006, we must implement certain changes to ensure compliance with amended Environmental Protection Agency regulations. We currentlyestimate that the capital required to effectuate these requirements will range from $1.0 to $1.5 million. Annual maintenance capital expenditures areestimated to be approximately $3.0 million, excluding the capital requirements for environmental compliance. In general, the Partnership has distributed to its partners on a quarterly basis, all Available Cash . Available Cash is defined for any of the Partnership’s fiscalquarters, as all cash on hand at the end of that quarter, less the amount of cash reserves that are necessary or appropriate in the reasonable discretion of thegeneral partner to (i) provide for the proper conduct of the business; (ii) comply with applicable law, any of its debt instruments or other agreements; or(iii) provide funds for distributions to the common unitholders and the senior subordinated unitholders during the next four quarters, in some circumstances.On October 18, 2004, we announced that we would not pay a distribution on the common units. We had previously announced the suspension ofdistributions on the senior subordinated units on July 29, 2004. The Partnership did not pay distributions on any of its outstanding units in fiscal 2005. It isunlikely that regular distributions on the common units or senior subordinated units will be resumed in the foreseeable future. While we hope to positionourself to pay some regular distribution on our common units in future years, of which there can be no assurance, it is considerably less likely that regulardistributions will ever resume on the senior subordinated units because of their subordination terms and the existing arrearages on our common units. Therevolving credit facility and the indenture for the MLP Notes both impose certain restrictions on our ability to pay distributions to unitholders. It is unlikelythat regular distributions on the common units or senior subordinated units will be resumed in the foreseeable future. See “Recapitalization” Contractual Obligations and Off-Balance Sheet Arrangements We have no special purpose entities or off balance sheet debt, other than operating leases entered into in the ordinary course of business, as fully disclosed inNote 14 to the consolidated financial statements. 44 Table of ContentsLong-term contractual obligations, except for our long-term debt obligations, are not recorded in our consolidated balance sheet. Non-cancelable purchaseobligations are obligations we incur during the normal course of business, based on projected needs. The table below summarizes the payment schedule of our contractual obligations at September 30, 2005 (in thousands): Payments Due by Year Total Less Than1 Year 1 - 3Years 3 - 5Years More Than5 YearsLong-term debt obligations (a) $267,417 $— $95 $— $267,322Use of Excess Proceeds 93,161 93,161 — — — Operating lease obligations (b) 47,457 9,155 13,205 10,070 15,027Purchase obligations (c) 16,645 9,695 5,449 1,461 40Interest obligations Senior Notes (d) 200,324 27,163 54,325 54,325 64,511 $625,004 $139,174 $73,074 $65,856 $346,900 (a)Excludes current maturities of long-term debt of $0.8 million, which are classified within current liabilities.(b)Represents various operating leases for office space, trucks, vans and other equipment from third parties with lease terms running from one day to 20years.(c)Reflects non-cancelable commitments as of September 30, 2005.(d)Reflects 10 1/4% interest obligations on our $265,000,000 Senior Notes due February 2013. Recent Accounting Pronouncements In December 2004, the FASB issued Statement No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”). SFAS No. 123R, which is effective forthe first annual period beginning after June 15, 2005 SFAS No. 123 requires all share-based payments to employees, including grants of stock options, to berecognized in the financial statements based on their fair values. In addition, two transition alternatives are permitted at the time of adoption of thisstatement. Currently, we account for unit appreciation rights and other unit based compensation arrangements using the intrinsic value method under theprovisions of APB 25. We will be required to adopt SFAS No. 123R effective October 1, 2005. In March 2005, the SEC issued Staff Accounting Bulletin No.107 (“SAB 107”) regarding the SEC’s interpretation of SFAS No. 123R. We are currently evaluating the requirements of SFAS No. 123R and SAB 107. Wehave not yet determined the method of adoption or the effect of adopting SFAS No. 123R. However, we believe that of SFAS No. 123R will not have amaterial adverse effect on our results of operations, financial position or liquidity, upon adoption. In May 2005, the FASB issued Statement No. 154, “Accounting Changes and Error Corrections” (“SFAS No. 154”), which is effective for accounting changesand corrections of errors made in fiscal years beginning after December 15, 2005. We are required to adopt SFAS No. 154 in fiscal 2007. SFAS No. 154provides guidance for and reporting of accounting changes and error corrections. It states that retrospective application, or the latest practicable date, is therequired method for reporting a change in accounting principle and the reporting of a correction of an error. Our results of operations and financial conditionwill only be impacted following the adoption of SFAS No. 154 if we implement changes in accounting principle that are addressed by the standard or correctaccounting errors in future periods. Critical Accounting 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 estimates have been reviewed with the Audit Committee of the Board of Directors. Our significant accounting policies are discussed in Note 3 to the consolidated financial statements. We believe the following are our critical accountingpolicies and estimates: Goodwill and Other Intangible Assets We calculate amortization using the straight-line method over periods ranging from five to ten years for intangible assets with definite useful lives. We useamortization methods and determine asset values based on our best estimates using reasonable and supportable assumptions and projections. We assess theuseful lives of intangible assets based on the estimated period over which we will receive 45 Table of Contentsbenefit from such intangible assets such as historical evidence regarding customer churn rate. In some cases, the estimated useful lives are based oncontractual terms. At September 30, 2005, we had $82.3 million of net intangible assets subject to amortization. If circumstances required a change inestimated useful lives of the assets, it could have a material effect on results of operations. For example, if lives were shortened by one year, we estimate thatamortization for these assets for fiscal 2005 would have increased by approximately $2.7 million. SFAS No. 142 requires goodwill to be assessed at least annually for impairment. These assessments involve management’s estimates of future 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 carrying amount ofgoodwill exceeds its implied fair value and is determined to be impaired, an impairment charge is recorded to write-down goodwill to its fair value. AtSeptember 30, 2005, we had $166.5 million of goodwill. Intangible assets with finite lives must be assessed for impairment whenever changes incircumstances indicate that the assets may be impaired. Similar to goodwill, the assessment for impairment requires estimates of future cash flows related tothe intangible asset. To the extent the carrying value of the assets exceeds its future undiscounted cash flows, an impairment loss is recorded based on the fairvalue of the asset. We test the carrying amount of goodwill annually during the fourth quarter of its fiscal year. During the second quarter of fiscal 2005, anumber of events occurred that indicated a possible impairment of goodwill of the heating oil segment might exist. These events included: the determinationin February 2005 that we could expect to generate significantly lower than expected operating results for the heating oil segment for the year and asignificant decline in the Partnership’s unit price. As a result of these triggering events and circumstances, we completed an interim SFAS No. 142 impairmentreview of the heating oil segment with the assistance of a third party valuation firm as of February 28, 2005. The evaluation utilized both an income andmarket valuation approach and contained reasonable assumptions and reflected management’s best estimate of projected future cash flows. This reviewresulted in a non-cash goodwill impairment charge of approximately $67 million, which reduced the carrying amount of goodwill of the heating oil segment.As of August 31, 2005, we performed our annual goodwill impairment valuation for its heating oil segment, with the assistance of a third party valuation firm.Based upon this analysis, we determined that there is no additional goodwill impairment as of August 31, 2005. 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 40 years. Net property, plant andequipment was $50.0 million at September 30, 2005. If circumstances required a change in estimated useful lives of the assets, it could have a material effecton results of operations. For example, if the remaining estimated useful lives of these assets were shortened by one year, we estimate that depreciation forfiscal 2005 would have increased by approximately $4.2 million. Fair Values Of Derivatives The fair market value of all derivative instruments is recognized as an asset or liability on our balance sheet. The accounting treatment for the changes in fairvalue is dependent upon whether or not a derivative instrument is: (i) a cash flow hedge or (ii) a fair value hedge, and upon whether or not the derivativequalifies as an effective hedge. Changes in the fair value of effective cash flow hedges are recognized in accumulated other comprehensive income until thehedged item is recognized in earnings. For fair value hedges, to the extent the hedge is effective there is no effect on the statement of operations as changes inthe fair value of the derivative instrument offset changes in the fair value of the hedged item. For derivative instruments that do not qualify, or are not treatedas hedge accounting, changes in fair value are recognized currently in earnings. The estimated fair value of our derivative instruments requires judgement on our part. We have established the fair value of our derivative instruments usingestimates determined by our counterparties and subsequently evaluated them internally using established index prices and other sources. These values arebased upon, among other things, future prices, volatility, time-to-maturity value and credit risk. The values we report in our financial statements change asthese estimates are revised to reflect actual results, changes in market conditions, or other factors, many of which are beyond our control. In addition, otherfactors that can impact results of operations each period is our ability to estimate the level of correlation between changes in the fair value of our hedgeinstruments and those transactions being hedged (effectiveness) both at inception and on an on-going basis. The factors underlying our estimates of fair valueand our assessment of correlation of our commodity hedging derivatives are impacted by actual results and changes in conditions, market and otherwise,which may be beyond our control. 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 2005 would have 46 Table of Contentsincreased pension expense by approximately $0.1 million and would have increased the minimum pension liability by another $1.6 million. The discountrate used to determine net periodic pension expense was 5.5% in 2005 and 6.0% in 2003 and 2004. The discount rate used by the Partnership in determiningpension expense and pension obligations reflects the yield of high quality (AA or better rating by a recognized rating agency) corporate bonds whose cashflows are expected to match the timing and amounts of future benefit payments. The discount rates to determine net periodic expense used in each of 2003and 2004 (6.0%) and 2005 (5.50%) reflect the decline in applicable bond yields over the past year. We consider the current and expected asset allocations, as well as historical and expected returns on various categories of plan assets to determine ourexpected long-term rate of return on pension plan assets. The expected long-term rate of return on assets is developed with input from the Partnership’squalified actuaries. The long-term rate of return assumption used for determining net periodic pension expense for fiscals 2004 and 2005 was 8.25%. Afurther 25 basis point decrease in the expected return on assets would have increased pension expense in fiscal 2005 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, 2005,$19.8 million of unrecognized losses remain to be recognized by the plans. These losses may result in increases in future pension expense as they arerecognized. Allowance for Doubtful Accounts We periodically review past due customer accounts receivable balances. After giving consideration to economic conditions, overdue status and other factors,the heating oil segment establishes an allowance for doubtful accounts, which it deems sufficient to cover future potential losses. Actual losses could differfrom management’s estimates; however, based on historical experience, we do not expect our estimate of uncollectible accounts to vary significantly fromactual losses. Insurance Reserves We currently self-insure a portion of workers’ compensation, auto and general liability claims. We establish reserves based upon expectations as to what ourultimate liability may be for outstanding claims using developmental factors based upon historical claim experience. We periodically evaluate the potentialfor changes in loss estimates with the support of qualified actuaries. As of September 30, 2005, we had approximately $33.8 million of insurance reserves.The ultimate resolution of these claims could differ materially from the assumptions used to calculate the reserves, which could have a material adverse effecton results of operations. 47 Table of Contents ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to interest rate risk primarily through our bank credit facilities. We utilize these borrowings to meet our working capital needs. At September 30, 2005, we had outstanding borrowings totaling $274.8 million, of which approximately $6.6 million is subject to variable interest ratesunder our bank credit facilities. In the event that interest rates associated with these facilities were to increase 100 basis points, the impact on future cashflows would be a decrease of less than $0.1 million. We also selectively use derivative financial instruments to manage our exposure to market risk related to changes in the current and future market price ofhome heating oil. The value of market sensitive derivative instruments is subject to change as a result of movements in market prices. Consistent with thenature of hedging activity, associated unrealized gains and losses would be offset by corresponding decreases or increases in the purchase price we would payfor the home heating oil being hedged. Sensitivity analysis is a technique used to evaluate the impact of hypothetical market value changes. Based on ahypothetical ten percent increase in the cost of product at September 30, 2005, the potential impact on our hedging activity would be to increase the fairmarket value of these outstanding derivatives by $20.6 million to a fair market value of $55.7 million; and conversely a hypothetical ten percent decrease inthe cost of product would decrease the fair market value of these outstanding derivatives by $19.8 million to a fair market value of $15.3 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. (b)Management’s Report on Internal Control over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term in defined inExchange Act Rules 13a-15(f). Under the supervision of management and with the participation of our management, including our principal executiveofficer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on theframework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based onour evaluation under the framework in Internal Control – Integrated Framework, our management concluded that our internal control over financialreporting was effective as of September 30, 2005. Our management’s assessment of the effectiveness of our internal control over financial reporting as of September 30, 2005 has been audited by KPMGLLP, an independent registered public accounting firm, as stated in their report which is included herein. (c)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. (d)Other. 48 Table of ContentsThe General Partner and the Partnership believe that a control system, no matter how well designed and operated, can not provide absolute assurancethat the objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances offraud, if any, within the Partnership have been determined. ITEM 9B. OTHER INFORMATION Not Applicable 49 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. On March 7, 2005, the General Partner entered into a voting trust agreement (the “Voting Trust Agreement”) with Irik P. Sevin, in his capacity as a member ofthe General Partner, and Irik P. Sevin, Stephen Russell and Joseph P. Cavanaugh in their capacities as trustees under the Voting Trust Agreement (the “VotingTrustees”). Pursuant to the Voting Trust Agreement, Mr. Sevin transferred all of his membership interests (representing 15.6363% of the membership interests)in the General Partner to a voting trust for his benefit. Under the terms of the voting trust, these interests will be voted in accordance with the decision of amajority of the Voting Trustees. The voting trust created by the Voting Trust Agreement terminates on the earliest of (i) March 4, 2030, unless extended byfurther agreement as provided by law, (ii) at any time upon the agreement of all three of the Voting Trustees and the holders of voting trust certificatesrepresenting all of the interests in the General Partner that are being held in trust pursuant to the Voting Trust Agreement and (iii) the date upon which theVoting Trust Agreement is required to be terminated in order to comply with applicable law. The General Partner oversees the activities of the Partnership. Unitholders do not directly or indirectly participate in the management or operation of thePartnership. The General Partner owes a fiduciary duty to the unitholders. However, the agreement of the Limited Partners contains provisions that allow theGeneral Partner to take into account the interested of parties other than the Limited Partners in resolving conflict of interest, thereby limiting such fiduciaryduty. Notwithstanding any limitation on obligations or duties, the General Partner will be liable, as the general partner of the Partnership, for all debts of thePartnership (to the extent not paid by the Partnership), except to the extent that indebtedness or other obligations incurred by the Partnership are madespecifically 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 Partnership units. In addition, the AuditCommittee reviews the external financial reporting of the Partnership, selects and engages the Partnership’s independent registered public accountants andapproves all non-audit engagements of the independent registered public accountants. With respect to the additional matters, the Audit Committee may acton its own initiative to question the General Partner and, absent the delegation of specific authority by the entire Board of Directors, its recommendationswill 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 General Partner does not directly employ any of the persons responsible for managingor operating the Partnership. 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 12, 2005: Name Age Position with the General PartnerJoseph P. Cavanaugh 68 Chief Executive Officer, DirectorDaniel P. Donovan 59 President and Chief Operating OfficerRichard F. Ambury 48 Chief Financial OfficerPaul Biddelman(a)(b)(c) 59 DirectorWilliam P. Nicoletti(c) 60 Non-Executive Chairman of the BoardStephen Russell(a)(c) 65 DirectorIrik P. Sevin(b) 58 Director(a)Member of the Compensation Committee(b)Member of the Distribution Committee(c)Member of the Audit Committee 50 Table of ContentsJoseph P. Cavanaugh has been Chief Executive Officer and a director of Star Gas LLC since March 2005. From December 2004 to March 2005Mr. Cavanaugh was employed by Inergy, L.P. From March 1999 to December 2004 Mr. Cavanaugh was Chief Executive Officer of the Partnership’s propanesegment. From December 1997 to March 1999, Mr. Cavanaugh served as President and Chief Executive Officer of Star Gas Corporation, the predecessorgeneral partner. From October 1979 to December 1997, Mr. Cavanaugh held various financial and management positions with Petro. Daniel P. Donovan has been President of the heating oil segment since May 2004 and President and Chief Operating Officer of Star Gas LLC since March2005. From January 1980 to May 2004, he held various management positions with Meenan Oil, including Vice President and General Manager. From 1971to 1980, he worked for Mobil Oil. His last position with Mobil Oil was President and General Manger of its heating oil subsidiary in New York City. Richard F. Ambury has been Senior Vice President and Chief Financial Officer of Star Gas LLC since May 2005. From November 2001 to May 2005,Mr. Ambury was Vice President and Treasurer of Star Gas, LLC. From March 1999 to November 2001, Mr. Ambury was Vice President of Star Gas Propane,L.P. From February 1996 to March 1999, Mr. Ambury served as Vice President—Finance of Star Gas Corporation, the predecessor general partner.Mr. Ambury was employed by Petro from June 1983 through February 1996, where he served in various accounting/finance capacities. From 1979 to 1983,Mr. Ambury was employed by a predecessor firm of KPMG, a public accounting firm. Mr. Ambury has been a Certified Public Accountant since 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. William P. Nicoletti has been Non-Executive Chairman of the Board of Star Gas LLC since March 2005. Mr. Nicoletti has been a Director of Star Gas LLCsince March 1999 and was a Director of Star Gas Corporation, the predecessor general partner from November 1995 until March 1999. He is ManagingDirector of Nicoletti & Company, Inc., a private investment banking firm. Mr. Nicoletti was formerly a senior officer and head of Energy Investment Bankingfor E. F. Hutton & Company, Inc., PaineWebber Incorporated and McDonald Investments, Inc. Mr. Nicoletti is a director of MarkWest Energy Partners, L.P.and SPI Petroleum, LLC. 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. Irik P. Sevin has been a Director of Star Gas LLC since March 1999. From March 1999 until March 2005 Mr. Sevin was Chairman of the Board and ChiefExecutive Officer of Star Gas LLC and was President from November 2003 until March 2005. From December 1993 to March 1999, Mr. Sevin served asChairman of the Board of Directors of Star Gas Corporation, the predecessor general partner. Mr. Sevin has been a Director of Petro since its organization inOctober 1979, and Chairman of the Board of Petro since January 1993 and served as President of Petro from 1979 through January 1997. Meetings and Compensation of Directors During fiscal 2005, the Board of Directors met 26 times. All Directors attended each meeting except that Mr. Russell did not attend two meetings. Each non-management Director receives an annual fee of $27,000 plus $1,500 for each regular meeting attended and $750 for each telephonic meeting attended. TheChairman of the Audit Committee receives an annual fee of $12,000 while other Audit Committees members receive an annual fee of $6,000. The Chairmanof the Compensation Committee receives an annual fee of $6,000 while other non-management members of the Compensation Committee and DistributionCommittee receive an annual fee of $3,000. Each member of the Audit Committee receives $1,500 for every regular meeting attended and $750 for everytelephonic meeting attended. Each non-management member of the Compensation Committee and Distribution Committee receives $1,000 for each regularmeeting 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 March 7, 2005 the Non-Executive Chairman of the Boardreceives an annual fee of $120,000. 51 Table of ContentsIn 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 of a Senior Subordinated Unit on the respective vesting dates over the strikeprice of $10.70. The Partnership may elect to deliver senior subordinated units in satisfaction of this payment rather than cash, subject to complying withapplicable securities regulations. These units were granted under the same program as units granted to the Chief Executive Officer and other certain namedexecutives – 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 2005, the audit committee met 11times. 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 Board of Directors has determined that Messrs. Nicoletti, Biddelmanand Russell are independent directors in that they do not have any material relationships with the Partnership (either directly, or as a partner, shareholder orofficer of an organization that has a relationship with the Partnership) and they otherwise meet the independence requirements of the NYSE and the SEC. ThePartnership’s Board of Director’s has determined that Mr. Biddelman, the Chairman of the Audit Committee, meets the definition of an Audit Committeefinancial expert under applicable SEC and NYSE regulations. 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 the Partnership; (ii) the terms of compensation plans and compensation levels for officers of the Partnership; (iii) the salary and bonus ranges forofficers of the Partnership, including the performance criteria and target compensation on all performance-based compensation plans or programs and thespecific amounts 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) the accruals 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 2005, the Distribution Committee did not meet. Special 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. 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. 52 Table of ContentsAdoption 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) 328-7300. Non-Management Directors The non-management directors on the Board of Directors of the general partner are Messrs. Sevin, Biddelman, Nicoletti and Russell. Mr. Nicoletti also servesas the Non-Executive Chairman of the Board. Unitholders interested in contacting the Chairman of the Board or the non-management directors as a groupmay do so by contacting William P. Nicoletti c/o Star Gas L.P., 2187 Atlantic Street, Stamford, CT, 06902. Officer Certification Requirements The Partnership’s chief executive officer submitted to the NYSE the CEO certification required pursuant to Section 303A, 12(a) of the NYSE rules for thefiscal year ended September 30, 2004. This annual report on Form 10-K includes as exhibits the certifications of the Partnership’s chief executive officer and chief financial officer required underSection 302 and Section 906 of the Sarbanes-Oxley Act of 2002 and the rules and regulations promulgated thereunder. ITEM 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, 2003, 2004 and 2005. Name and Principal Position Year Summary Compensation TableAnnual Compensation RestrictedStockAwards Long-TermCompensation Salary Bonus OtherAnnualCompensation SecuritiesUnderlyingUARs AllOtherCompensationIrik P. Sevin, 2005 $345,417 $— $6,560,094(1) $ Director (2) 2004 $650,000 $— $$65,736(3) 77,419 2003 $505,000(4) $985,200(5) 14,600(6) 77,419 Ami Trauber,Chief Financial Officer (8) 2005 $223,430 $— $295,821(7) 2004 $370,800 $— $12,201(6) 46,452 2003 $298,800(4) $272,550(5) $11,762(6) 46,452 Joseph P. Cavanaugh,Chief Executive Officer (11) 2005 $189,000 $1,140,894(9) $9,910(10) 2004 $267,800 $— $494,169(10) 2003 $267,800 $268,060(5) $18,768(10) David A. Shinnebarger,Executive Vice President (12) 2005 $195,983 $— $250,673(7) 2004 $284,375 $— $— 4,500 Daniel P. Donovan,President and Chief Operating Officer (13) 2005 $300,000 $— $21,778(6) 5,000 2004 $253,654 $85,785 $24,614(6) 10,000 Richard F. AmburyChief Financial Officer (14) 2005 $232,988 $100,000 $16,629(6) 9,917 2004 $222,956 $— $10,034(6) 9,917 2003 $207,941(4) $162,550(5) $14,185(6) 9,917 53 Table of Contents(1)The $6.6 million in “Other Annual Compensation” represents the cumulative amount that will be paid to Mr. Sevin over the life of his consultingagreement and retirement package, in connection with his Agreement. On March 7, 2005 (the “Termination Date”), Star Gas LLC and Mr. Irik P. Sevinentered into a letter agreement and general release (the “Agreement”). In accordance with the Agreement, Mr. Sevin confirmed his resignation fromemployment as the Chief Executive Officer and President of Star Gas LLC (and its subsidiaries) under the employment agreement between Mr. Sevinand Star Gas LLC dated as of September 30, 2001. Pursuant to the Agreement, Mr. Sevin is entitled to an annual consulting fee totaling $395,000 for aperiod of five years following the Termination Date. In addition, the Agreement provides for Mr. Sevin to receive a retirement benefit equal to$350,000 per year for a 13-year period beginning with the month following the five-year anniversary of the Termination Date. At March 31, 2005, thePartnership recorded a liability for $4.2 million, representing the present value of the cost of the Agreement. This amount also includes $12,768company paid contributions under Petro’s 401(k) defined contribution retirement plan, $7,610 company paid life insurance premiums, professionalfees totaling $5,185 and $9,531 for personal use of company owned vehicles.(2)Mr. Sevin resigned as the Partnership’s Chairman of the Board, President and Chief Executive Officer, effective as of March 7, 2005.(3)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.(4)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, Ami Trauber– $72,000 and Richard F. Ambury – $15,375.(5)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–$410,000, Joseph P. Cavanaugh– $123,060 and Richard F. Ambury – $102,550.(6)These amounts represent company paid contributions under Petro’s 401(k) defined contribution retirement plan.(7)These amounts represent severance payments in connection with Mr. Trauber’s and Mr. Shinnebarger’s separation agreements of $278,100 and$243,750, respectively. Mr. Trauber and Mr. Shinnebarger also received company paid contributions under Petro’s 401(k) defined contributionretirement plan of $13,901 and $3,250, respectively. In addition, these amounts also include $3,820 and $3,673 for personal use of company ownedvehicles for Mr. Trauber and Mr. Shinnebarger, respectively.(8)Mr. Trauber assumed the position of the Chief Financial Officer effective November 1, 2001 and resigned effective May 6, 2005.(9)In connection with the sale of the propane segment in December 2004, the Partnership paid the segment’s then Chief Executive Officer, JosephCavanaugh, a bonus equal to three times Mr. Cavanaugh’s annual salary and bonus upon the successful completion of the sale.(10)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.(11)Mr. Cavanaugh was appointed as the Chief Executive Officer as of March 7, 2005.(12)Mr. Shinnebarger assumed the position of Executive Vice President effective November 1, 2003 and resigned effective as of May 3, 2005.(13)Mr. Donovan assumed the position of President of the Heating Oil Segment effective May 1, 2004 and President and Chief Operating Officer of thePartnership effective March 7, 2005.(14)Mr. Ambury was appointed the Partnership’s Chief Financial Officer, effective as of May 6, 2005. 54 Table of ContentsAggregated Option/UAR Exercises in Last Fiscal Yearand Fiscal Year End Option/UAR Values Name Units AcquiredExercise of UARs Value Realized Number ofUnexercisedUARs atSeptember 30,2005Exercisable(E)/Unexercisable(U) (1) Value ofIn the MoneyUARsat September 30,2005Irik P. Sevin 102,000(2) $286,963(3) 436,019(U) $— Ami Trauber 44,749(2) $172,182(3) — $— Daniel P. Donovan — $— 5,000(U) $— Richard F. Ambury — $— 6,612 $36,762(1)The UARs listed in the above table represent the right of the grantee to receive payment in cash equal to the excess of the fair market value of a seniorsubordinated unit on the vesting date for such UARs over the respective exercise prices which range from $7.6259 to $20.90 per unit (subject todeferral).(2)Represents senior subordinated units issued upon exercise of UARs.(3)Represents the excess of the fair market value of senior subordinated units, represented by the closing price on the New York Stock Exchange on thevesting date for such UARs over the respective exercise prices. 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 — — 240,000 Total — — 240,000 Employment Contracts and Service Agreements 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 achieving certain performancecriteria. Mr. Donovan is also entitled to receive 10,000 common units annually under a long-term incentive plan that is to be developed by the Partnership.The employment agreement provides for one year’s salary as severance if Mr. Donovan’s employment is terminated without cause or by Mr. Donovan forgood reason. Agreement with Joseph P. Cavanaugh In connection with the sale of the propane segment in December 2004, the Partnership paid the segment’s then Chief Executive Officer, Joseph Cavanaugh, abonus of $1,140,894 equal to three times Mr. Cavanaugh’s annual salary and bonus upon the successful completion of the sale. Upon completion of the sale,Mr. Cavanaugh’s position was terminated by the Partnership. Mr. Cavanaugh was subsequently employed by Inergy, the entity that acquired the propanesegment, from December 2004 to March 2005 as President, of its Star Gas Division. Mr. Cavanaugh was appointed as the Chief Executive Officer of Star Gas,effective as of March 7, 2005, at an annual salary of $275,000. 55 Table of ContentsAgreement with Richard F. Ambury Effective May 4, 2005, Petro entered into an employment agreement with Richard F. Ambury pursuant to which Mr. Ambury will be employed by Petro for athree-year term ending on May 3, 2008. Mr. Ambury will serve as Vice President and Chief Financial Officer of both Petro and the general partner of thePartnership. The agreement provides for an annual base salary of $236,333 and a performance-based bonus of up to 35% of his base salary or such higherpercentage as shall be applicable to Petro’s chief operating officer. In addition to the performance-based bonus, Mr. Ambury will receive a payment of$50,000 on the last day of each 12-month period during the term. If Mr. Ambury’s employment is terminated without cause or Mr. Ambury terminates hisemployment as a result of a material breach of this agreement by Petro, Mr. Ambury will be entitled to the following severance compensation: $858,999, ifthe agreement is terminated prior to April 30, 2006; $572,666 if the agreement is terminated after May 1, 2006 and prior to April 30, 2007; and $286,333, ifthe agreement is terminated after May 1, 2007 and prior to May 3, 2008. Agreement with Irik P. Sevin On March 7, 2005, the General Partner and Mr. Irik P. Sevin entered into a letter agreement and general release (the “Agreement”). In accordance with theAgreement, Mr. Sevin confirmed his resignation as Chairman of the Board of the General Partner and his resignation from employment as the Chief ExecutiveOfficer and President of the General Partner (and its subsidiaries) under the employment agreement between Mr. Sevin and the General Partner dated as ofSeptember 30, 2001, in each case effective immediately. Pursuant to the Agreement, Mr. Sevin will not be eligible for any benefits or compensation, otherthan as specifically provided in the Agreement. Pursuant to the Agreement, for the 13-year period beginning with the month following the five-yearanniversary of the termination date, the General Partner will provide Mr. Sevin with a retirement benefit equal to $350,000 per year. Mr. Sevin continues to be a director of the General Partner and will provide consulting services to the Partnership for a period of five years following thetermination date. Mr. Sevin will be entitled to annual consulting fees of $395,000, payable in equal monthly installments. For a period of two years followingthe termination date, the General Partner will reimburse Mr. Sevin for all reasonable expenses incurred in maintaining an office to provide the consultingservices provided that such expenses shall in no event exceed $50,000 per year. The General Partner will also provide Mr. Sevin with one administrativeassistant at the same level as his current assistant during this two-year period. Mr. Sevin executed a general release in favor of the Partnership, containingcertain exceptions. Agreement with Ami Trauber On July 27, 2005, Star Gas LLC and Mr. Ami Trauber entered into an agreement, effective as July 15, 2005, in connection with the termination of hisemployment agreement dated as of October 15, 2001. Mr. Trauber received a payment of $92,700 representing salary in lieu of the 90 days’ notice plus sixmonths of severance compensation equal to $185,400. In addition, the Partnership will pay the premium for Mr. Trauber’s healthcare coverage for ninemonths. Mr. Trauber received all amounts due and payable to him in accordance with the terms of the unit appreciation rights that were previously granted tohim in 2001 and 2002. Agreement with David Shinnebarger Effective as of May 3, 2005, the employment of Mr. David Shinnebarger, as Chief Marketing Officer of the Partnership, was terminated. Mr. Shinnebarger wasemployed pursuant to an employment agreement dated as of October 17, 2003, by and between, the Partnership and Mr. Shinnebarger. In connection with thetermination of this agreement, Mr. Shinnebarger received a payment of $243,750, representing salary in lieu of the 90 days’ notice plus the six monthsseverance. In addition, the Partnership will pay the premium for Mr. Shinnebarger’s healthcare coverage for nine months. 401(k) Plan Mr. Cavanaugh, Mr. Donovan and Mr. Ambury are covered under a 401(k) defined contribution plan maintained by Petro. Participants in the plan may electto contribute a sum not to exceed the lesser of 17% of a participant’s compensation or the maximum limit under the Internal Revenue Code of 1975, asamended. Under this plan, Petro makes a core contribution from 4% up to a maximum 5.5% of a participant’s compensation up to $205,000 and matches 2/3of each amount that a participant contributes with a maximum employer match of 2%. 56 Table of Contents ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table shows the beneficial ownership as of November 20, 2005 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 33,000 * 300,609(b) 8.8 53,426 15.5 325,729(b) 100 Audrey L. Sevin 6,000 * 42,829(b) 1.3 153,131 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 * — — — — — — Joseph P. Cavanaugh — — — — — — — — Daniel P. Donovan — — — — — — — — Ami Trauber — — 44,749 — — — — — All officers and directors and Star Gas LLC as agroup (9 persons) 41,125 * 377,615 9.8% 206,557 59.8% 325,729 100%Third Point Management Company, LLC(c) 2,000,000 6.2% Dalal Street, Inc. (d) 1,802,926 5.4% Lime Capital Management LLC (e) 1,690,100 5.3% Atticus Capital LLC (f) 1,749,000 5.4% (a)For purpose of this table, the number of General Partner Units is deemed to include the 0.01% equity interest in Star/Petro, Inc.(b)Assumes each of Star Gas LLC’s 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. The membership interests in StarGas LLC are owned by its members in the following proportions: Audrey Sevin -44.2580%; Irik Sevin-15.6363%; and Hanseatic Americas, Inc.-40.1057%. See Item 10 “Directors and Executive Officers of the Registrant” – Partnership Management(c)According to a Schedule 13G filed with the SEC on October 26, 2004, Third Point Management Company LLC (“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.(d)According to a Schedule 13G filed with the SEC on January 10, 2005, Dalal Street, Inc. and Mr. Mohnish Prabai in his capacity as chief executiveofficer of Dalal Street, Inc., have shared the power to vote or to direct the vote and the shared power to dispose or direct the disposition of the CommonUnits owned by the Pabrai Investment Fund II, L.P.; Pabrai Investment Fund 3, Ltd.; Pabrai Investment Fund IV, L.P.; Dalal Street, Inc.; an MohnishPrabai. Their address is 17 Spectrum Point Drive, Suite 503, Lake Forest, CA 92630.(e)According to a Schedule 13G filed with the SEC on April 21, 2005, includes 1,156,050 Common Units beneficially owned by Lime CapitalManagement LLC and 534,050 Common Units beneficially owned by Lime Capital Management Administrators LLC, an affiliate of Lime CapitalManagement LLC, for which Lime Capital Management LLC disclaims beneficial ownership. Lime Capital Management LLC is the investmentmanager and a managing member of Lime Fund LLC. Lime Capital 57 Table of Contents Management Administrators LLC is the investment manager of Lime Overseas Fund Ltd. and a managing member of Lime Fund LLC. Gregory E.Bylinsky and Mark Gorton are the managing members of Lime Capital Management LLC and Lime Capital Management Administrators LLC. Theprincipal business office address of each of Lime Capital Management LLC, Lime Capital Management Administrators LLC, Lime Fund LLC, GregoryE. Bylinsky and Mark Gorton is 377 Broadway, 11th Floor, New York, New York 10013. The principal business office address of Lime Overseas Fund isc/o Meridian Corporate Services Limited, P.O. Box HM 528, 73 Front Street, Hamilton, HM CX, Bermuda.(f)According to a Schedule 13G filed with the SEC on April 28, 2005, Atticus Capital LLC and Timothy R. Barakett share voting and disposition powerwith respect to the common units listed above. Their address is 152 West 57th Street, 45th Floor, New York, NY 10019.*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 2005 all filing requirements applicable to its officers, directors, and greaterthan 10 percent beneficial owners were met in a timely manner, except that Mr. Sevin filed two Form 5’s relating to gifts of 4,067 senior subordinated units inthe aggregate, subsequent to the required filing dates. 58 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. On March 7, 2005, the General Partner and Audrey L. Sevin, a director and the Secretary of Star Gas, LLC, entered into a letter agreement and general release(the “Letter Agreement”). In accordance with the Letter Agreement, Ms. Sevin confirmed her resignation from employment as the Secretary of the GeneralPartner (and its subsidiaries), effective immediately. Pursuant to a separate letter from Ms. Sevin to the Partnership, Ms. Sevin also agreed to resign as amember of the Board of Directors of the General Partner, effective immediately. Pursuant to the Letter Agreement, Ms. Sevin will not be eligible for anybenefits or compensation, other than as specifically provided in the Letter Agreement. The Partnership agreed to pay Ms. Sevin, as severance, 26 weeks of herbase salary, payable in intervals in accordance with the Partnership’s customary payroll practices. Ms. Sevin executed a general release in favor of thePartnership, containing certain exceptions. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The following table represents the aggregate fees for professional audit services rendered by KPMG LLP including fees for the audit of the Partnership’sannual financial statements for the fiscal years 2004 and 2005, and for fees billed for other services rendered by KPMG LLP (in thousands). 2004 2005Audit Fees (1) $900 $1,716Audit-Related Fees (2) 298 139 Audit and Audit-Related Fees 1,198 1,855Tax Fees (3) 261 390 Total Fees $1,459 $2,245 (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. The increase in 2005 fees was primarily related to services in connection withSection 404 of the Sarbanes-Oxley Act of 2002. Audit fees incurred in connection with registration statements were $236,000 and $95,000 for fiscalyears 2004 and 2005, respectively.(2)Audit-related fees were principally for audits of financial statements of certain employee benefit plans, internal controls reviews, other services relatedto financial accounting and reporting standards and preparation for the Partnership’s compliance with Section 404 of the Sarbanes-Oxley Act of 2002.(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. 59 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 61 60 Table of ContentsINDEX 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 First Amendment to Unit Purchase Rights Agreement dated December 2, 2005 (12) 4.7 Amendment No. 2 to Amended and Restated Agreement of Limited Partnership of Star Gas Partners, L.P.(17) 4.8 Amendment No. 3 to Amended and Restated Agreement of Limited Partnership of Star Gas Partners.(20) 4.9 Amendment No. 1 to Amended and Restated Agreement of Limited Partnership of Star Gas Propane.(20) 4.10 Form of Second Amended and Restated Agreement of Limited Partnership (27)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% First MortgageNotes, 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., andthe 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.(16)10.33 Parity debt agreement, dated September 30, 2003, between Star Gas Propane, LP, and the agents, Fleet National Bank, Wachovia Bank, N.A. andJPMorgan Chase Bank(16)10.34 Employment Agreement between Petro Holdings, Inc. and Angelo J. Catania(10)(16)10.35 Credit Agreement dated December 22, 2003, between Petroleum Heat and Power Co., Inc. and the agents, Fleet National Bank, JPMorgan ChaseBank and LaSalle Bank National Association.(18)10.36 First supplemental indenture dated January 22, 2004 to the indenture dated February 6, 2003 for the Partnership’s10- 1/4% Senior Notes due 2013.(18)10.37 Agreement to sell the stock and business of Total Gas & Electric.(19)10.38 Indenture for the 10-1/4% senior notes due February 2013.(2)10.39 Letter Amendment and Waiver No. 2 to Petro Credit Agreement.(21)10.40 Employment Agreement between the Registrant and David Shinnebarger.(21)(10)10.41 Employment Agreement between Petro Holdings, Inc. and Daniel P. Donovan.(21)(10)10.42 Interest Purchase Agreement for the sale of the propane operations(20)10.43 Non-Competition Agreement(20)10.44 Credit Agreement dated December 17, 2004, between Petroleum Heat and Power Co., Inc. and JPMorgan Chase Bank, N.A., Bank of America, N.A.,Wachovia Bank, National Association, General Electric Capital Corporation, Citizens Bank of Massachusetts and J. P. MorganSecurities, Inc.(23)10.45 Amendment, dated as of November 2, 2005, to the Credit Agreement, dated as of December 17, 2004 among Petroleum Heat and Power Co., Inc.and JPMorgan Chase Bank, N.A., Bank of America, N.A., Wachovia Bank, National Association, General Electric Capital Corporation, and CitizensBank of Massachusetts (28)10.46 Letter Agreement and general release dated March 7, 2005 between Star Gas Partners L.P. and Irik P. Sevin (23) 10.47 Agreement between the Registrant and Audrey Sevin dated March 7, 2005 (23)10.48 Voting Trust Agreement dated March 7, 2005 between Star Gas LLC, Irik Sevin, Stephen Russell and Joseph Cavanaugh (23)10.49 Employment Agreement dated May 4, 2005 between the Registrant and Richard F. Ambury(24) (10)10.50 Agreement dated July 15, 2005 between the Registrant and Ami Trauber (26)10.51 Agreement dated May 6, 2005 between the Registrant and David Shinnebarger (1)10.52 Unit Purchase Agreement dated as of December [5], 2005 among Star Gas Partners, L.P., Star Gas LLC, Kestrel Energy Partners, LLC, Kestrel Heat,LLC and KM2, LLC (29)10.53 Form of Noteholder Lock-Up Agreement with MacKay Shields LLC and Lehman Brothers Inc. (29)10.54 Form of Noteholder Lock-Up Agreement with Morgan Asset Management, Inc. and Third Point LLC (29)10.55 Form of Noteholder Lock-Up Agreement with Trilogy Capital, LLC (29)10.56 Form of Noteholder Lock-Up Agreement with Merrill Lynch Investment Managers and certain related entities (29)10.57 Form of Backstop Agreement with MacKay Shields LLC and Lehman Brothers Inc. (29)10.58 Form of new Indenture for the new senior notes (29)10.59 Form of Amended and Restated Indenture for the existing senior notes (29)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 Act of2002(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 Act of2002(1) 61 Table of ContentsINDEX 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 CommissionMarch 17, 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, asamended by Exhibit 4.2 to Form 8-A/A filed with the Commission on December 5, 2005.(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-Q filed with the Commission on April 30, 2002.(17) Incorporated by reference to the same Exhibit to Registrant’s Quarterly Report on Form 10-Q filed with the Commission on August 6, 2003.(18) Incorporated by reference to the same Exhibit to Registrant’s Quarterly Report on Form 10-Q filed with the Commission on January 29, 2004.(19) Incorporated by reference to the same Exhibit to Registrant’s Quarterly Report on Form 10-Q filed with the Commission on April 29, 2004.(16) Incorporated by reference to the same Exhibit to Registrant’s Annual Report on Form 10-K for the fiscal year ended September 30, 2003, filed with theCommission on December 22, 2003.(20) Incorporated by reference to the Registrant’s Current Report on Form 8-K dated November 18, 2004.(21) Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the fiscal year ended September 30, 2004, filed with the Commission onDecember 14, 2004.(22) Incorporated by reference to the same Exhibit to Registrant’s Quarterly Report on Form 10-Q filed with the Commission on February 9, 2005.(23) Incorporated by reference to the Registrant’s Current Report on Form 8-K filed with the Commission on March 8, 2005.(24) Incorporated by reference to the an Exhibit to Registrant’s Quarterly Report on Form 10-Q filed with the Commission on May 6, 2005.(25) Incorporated by reference to an Exhibit to the Registrant’s Registration Statement on Form S-4, File No. 333-103873, filed with the Commission June30, 2005.(26) Incorporated by reference to the Registrant’s Current Report on Form 8-K dated August 1, 2005.(27) Incorporated by reference to the same Exhibit to Registrant’s Quarterly Report on Form 10-Q filed with the Commission on August 9, 2005.(28) Incorporated by reference to the Registrant’s Current Report on Form 8-K dated November 4, 2005.(29) Incorporated by reference to the Registrant’s Current Report on Form 8-K dated December 5, 2005. 62 Table of ContentsSIGNATURE 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/ Joseph P. Cavanaugh Joseph P. Cavanaugh 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/ Joseph P. Cavanaugh Chief Executive Officer and DirectorStar Gas LLC December 12, 2005Joseph P. Cavanaugh /s/ Richard F. Ambury Chief Financial Officer(Principal Financial and Accounting Officer)Star Gas LLC December 12, 2005Richard F. Ambury /s/ William P. Nicoletti Non-Executive Chairman of the Board and DirectorStar Gas LLC December 12, 2005William P. Nicoletti /s/ Paul Biddelman DirectorStar Gas LLC December 12, 2005Paul Biddelman /s/ Stephen Russell DirectorStar Gas LLC December 12, 2005Stephen Russell /s/ Irik. P. Sevin DirectorStar Gas LLC December 12, 2005Irik P. Sevin 63 Table of ContentsSIGNATURE 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/ Joseph P. Cavanaugh Joseph P. Cavanaugh 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/ Joseph P. Cavanaugh Chief Executive Officer and Director(Principle Executive Officer)Star Gas Finance Company December 12, 2005Joseph P. Cavanaugh /s/ Richard F. Ambury Chief Financial Officer(Principal Financial and Accounting Officer)Star Gas Finance Company December 12, 2005Richard F. Ambury 64 Table of ContentsSTAR GAS PARTNERS, L.P. AND SUBSIDIARIESINDEX TO CONSOLIDATED FINANCIAL STATEMENTSAND FINANCIAL STATEMENT SCHEDULE PagePart II Financial Information: Item 8 - Financial Statements Reports of Independent Registered Public Accounting Firm F-2 Consolidated Balance Sheets as of September 30, 2004 and 2005 F-4 Consolidated Statements of Operations for the years ended September 30, 2003, 2004 and 2005 F-5 Consolidated Statements of Comprehensive Income (Loss) for the years ended September 30, 2003, 2004 and 2005 F-6 Consolidated Statements of Partners’ Capital for the years ended September 30, 2003, 2004 and 2005 F-7 Consolidated Statements of Cash Flows for the years ended September 30, 2003, 2004 and 2005 F-8 Notes to Consolidated Financial Statements F-9 - F-33 Schedule for the years ended September 30, 2003, 2004 and 2005 II. Valuation and Qualifying Accounts F-34 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 ContentsSTAR 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 (the “Partnership”) as listed in the accompanying index. Inconnection with our audits of the consolidated financial statements, we have also audited the financial statement schedule as listed in the accompanyingindex. These consolidated financial statements and financial statement schedule are the responsibility of the Partnership’s management. Our responsibility isto express an opinion 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 standards require thatwe plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our auditsprovide 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, 2004 and 2005 and the results of their operations and their cash flows for each of the years in the three-year periodended September 30, 2005, 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. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of thePartnership’s internal control over financial reporting as of September 30, 2005, based on criteria established in Internal Control – Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated December 12, 2005 expressed anunqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting. The accompanying financial statements have been prepared assuming that the Partnership will continue as a going concern. As discussed in Note 2 to theconsolidated financial statements, the Partnership must utilize all or a portion of the excess proceeds (as defined) from the sale of its propane segment to fundits working capital requirements over the next twelve months. Under the terms of the Indenture for the Partnership’s Senior Notes, such excess proceeds (asdefined) are required to be offered to the holders of the Senior Notes by December 12, 2005. It is possible that the holders of the Senior Notes will not permitthe use of such excess proceeds (as defined) by the Partnership to fund its working capital requirements. This factor raises substantial doubt about thePartnership’s ability to continue as a going concern. Management’s plans in regard to these matters are described in Note 21. The consolidated financialstatements do not include any adjustments that might result from the outcome of this uncertainty. As discussed in Notes 3 and 9 to the consolidated financial statements, the Partnership adopted the provisions of Statement of Financial AccountingStandards No. 142, “Goodwill and Other Intangible Assets,” as of October 1, 2002. KPMG, LLPStamford, ConnecticutDecember 12, 2005 F-2 Table of ContentsSTAR GAS PARTNERS, L.P. AND SUBSIDIARIES REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Partners of Star Gas Partners, L.P.: We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting appearingunder Item 9A(b) , that Star Gas Partners, L.P. maintained effective internal control over financial reporting as of September 30, 2005, based on criteriaestablished in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).Management of Star Gas Partners, L.P. is responsible for maintaining effective internal control over financial reporting and for its assessment of theeffectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on theeffectiveness of the Partnership’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all materialrespects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing andevaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances.We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal controlover financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are beingmade only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliancewith the policies or procedures may deteriorate. In our opinion, management’s assessment that Star Gas Partners, L.P. maintained effective internal control over financial reporting as of September 30, 2005,is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). Also, in our opinion, Star Gas Partners, L.P. maintained, in all material respects, effective internalcontrol over financial reporting as of September 30, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committeeof Sponsoring Organizations of the Treadway Commission (COSO). We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheetsof Star Gas Partners, L.P. and Subsidiaries as of September 30, 2004 and 2005, 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, 2005, and our report dated December 12, 2005expressed an unqualified opinion on those consolidated financial statements. Our report contains an explanatory paragraph that the Partnership may not beable to fund its working capital requirements, which raises substantial doubt about the Partnership’s ability to continue as a going concern. The consolidatedfinancial statements do not include any adjustments that might result from the outcome of this uncertainty. KPMG LLPStamford, ConnecticutDecember 12, 2005 F-3 Table of ContentsSTAR GAS PARTNERS, L.P. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS Years Ended September 30, (in thousands) 2004 2005 ASSETS Current assets Cash and cash equivalents $4,692 $99,148 Receivables, net of allowance of $5,622 and $8,433, respectively 84,005 89,703 Inventories 34,213 52,461 Prepaid expenses and other current assets 60,973 70,120 Current assets of discontinued operations 50,288 — Total current assets 234,171 311,432 Property and equipment, net 63,701 50,022 Long-term portion of accounts receivables 5,458 3,788 Goodwill 233,522 166,522 Intangibles, net 103,925 82,345 Deferred charges and other assets, net 13,885 15,152 Long-term assets of discontinued operations 306,314 — Total assets $960,976 $629,261 LIABILITIES AND PARTNERS’ CAPITAL Current liabilities Accounts payable $25,010 $19,780 Working capital facility borrowings 8,000 6,562 Current maturities of long-term debt 24,418 796 Accrued expenses 65,491 56,580 Unearned service contract revenue 35,361 36,602 Customer credit balances 53,927 65,287 Current liabilities of discontinued operations 50,676 — Total current liabilities 262,883 185,607 Long-term debt 503,668 267,417 Other long-term liabilities 24,654 31,129 Partners’ capital (deficit) Common unitholders 167,367 144,312 Subordinated unitholders (6,768) (8,930)General partner (3,702) (3,936)Accumulated other comprehensive income 12,874 13,662 Total partners’ capital 169,771 145,108 Total liabilities and partners’ capital $960,976 $629,261 See accompanying notes to consolidated financial statements. F-4 Table of ContentsSTAR GAS PARTNERS, L.P. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS Years Ended September 30, (in thousands, except per unit data) 2003 2004 2005 Sales: Product $934,967 $921,443 $1,071,270 Installations and service 168,001 183,648 188,208 Total sales 1,102,968 1,105,091 1,259,478 Cost and expenses: Cost of product 598,397 594,153 786,349 Cost of installations and service 195,146 204,902 197,430 Delivery and branch expenses 217,244 232,985 231,581 Depreciation and amortization expenses 35,535 37,313 35,480 General and administrative expenses 39,763 19,937 43,418 Goodwill impairment charge — — 67,000 Operating income (loss) 16,883 15,801 (101,780)Interest expense (33,306) (40,072) (36,152)Interest income 3,776 3,390 4,314 Amortization of debt issuance costs (2,038) (3,480) (2,540)Gain (loss) on redemption of debt 212 — (42,082) Loss from continuing operations before income taxes (14,473) (24,361) (178,240)Income tax expense 1,200 1,240 696 Loss from continuing operations (15,673) (25,601) (178,936)Income (loss) from discontinued operations, net of income taxes 19,786 20,276 (4,552)Gain (loss) on sales of discontinued operations, net of income taxes — (538) 157,560 Cumulative effect of changes in accounting principles for discontinued operations - Adoption of SFASNo. 142 (3,901) — — Net income (loss) $212 $(5,863) $(25,928) General Partner’s interest in net income (loss) $2 $(57) $(234) Limited Partners’ interest in net income (loss) $210 $(5,806) $(25,694) Basic and diluted income (loss) per Limited Partner Unit: Continuing operations $(0.48) $(0.72) $(4.95) Net income (loss) $0.01 $(0.16) $(0.72) Weighted average number of Limited Partner units outstanding: Basic 32,659 35,205 35,821 Diluted 32,767 35,205 35,821 See accompanying notes to consolidated financial statements. F-5 Table of ContentsSTAR GAS PARTNERS, L.P. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) Years Ended September 30, (in thousands) 2003 2004 2005 Net income (loss) $212 $(5,863) $(25,928)Other comprehensive income (loss): Unrealized gain (loss) on derivative instruments (4,930) 27,536 6,128 Unrealized gain (loss) on pension plan obligations (1,469) 1,159 (3,703)Other comprehensive income (loss) from discontinued operations (495) 1,900 (1,637) Other comprehensive income (loss) (6,894) 30,595 788 Comprehensive income (loss) $(6,682) $24,732 $(25,140) Reconciliation of Accumulated Other Comprehensive Income (Loss) (in thousands) Pension PlanObligations DerivativeInstruments Total Balance as of September 30, 2002 $(15,745) $4,918 $(10,827)Reclassification to earnings — (7,745) (7,745)Unrealized loss on pension plan obligations (1,469) — (1,469)Unrealized gain on derivative instruments — 2,815 2,815 Other comprehensive loss from discontinued operations — (495) (495) Other comprehensive loss (1,469) (5,425) (6,894)Balance as of September 30, 2003 (17,214) (507) (17,721)Reclassification to earnings — (10,870) (10,870)Unrealized gain on pension plan obligations 1,159 — 1,159 Unrealized gain on derivative instruments — 38,406 38,406 Other comprehensive income from discontinued operations — 1,900 1,900 Other comprehensive income 1,159 29,436 30,595 Balance as of September 30, 2004 (16,055) 28,929 12,874 Reclassification to earnings — (34,901) (34,901)Unrealized loss on pension plan obligations (3,703) — (3,703)Unrealized gain on derivative instruments — 41,029 41,029 Other comprehensive loss from discontinued operations — (1,637) (1,637) Other comprehensive income (loss) (3,703) 4,491 788 Balance as of September 30, 2005 $(19,758) $33,420 $13,662 See accompanying notes to consolidated financial statements. F-6 Table of ContentsSTAR GAS PARTNERS, L.P. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF PARTNERS’ CAPITALYears Ended September 30, 2003, 2004 and 2005 Number of Units Common Sr.Sub. Jr.Sub. GeneralPartner Accum. OtherComprehensiveIncome (Loss) TotalPartners’Capital (in thousands, except per unit amounts) Common Sr.Sub. Jr.Sub. GeneralPartner 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 204 2,402 2,606 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 76 10 86 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 Issuance of units 147 459 459 Net loss (23,073) (2,373) (248) (234) (25,928)Other comprehensive income, net 788 788 Unit compensation expense 18 18 Balance as of September 30, 2005 32,166 3,392 345 326 $144,312 $(6,403) $(2,527) $(3,936) $13,662 $145,108 See accompanying notes to consolidated financial statements. F-7 Table of ContentsSTAR GAS PARTNERS, L.P. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended September 30, (in thousands) 2003 2004 2005 Cash flows provided by (used in) operating activities: Net income (loss) $212 $(5,863) $(25,928)Deduct: (Income) loss from discontinued operations (19,786) (20,276) 4,552 (Gain) loss on sales of discontinued operations — 538 (157,560)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 35,535 37,313 35,480 Amortization of debt issuance cost 2,038 3,480 2,540 Loss (gain) on redemption of debt (212) — 42,082 Loss on derivative instruments, net 306 1,673 2,144 Unit compensation expense (income) 9,001 (4,382) (2,185)Provision for losses on accounts receivable 6,601 7,646 9,817 Goodwill impairment charge — — 67,000 Gain on sales of fixed assets, net (52) (281) (43)Changes in operating assets and liabilities net of amounts related to acquisitions: Increase in receivables (20,735) (6,178) (13,845)Decrease (increase) in inventories 3,155 (10,067) (18,248)Decrease (increase) in other assets (13,917) 7,627 (7,070)Increase (decrease) in accounts payable 7,923 5,832 (5,230)Increase (decrease) in other current and long-term liabilities 1,395 (3,393) 11,579 Net cash provided by (used in) operating activities 15,365 13,669 (54,915) Cash flows provided by (used in) investing activities: Capital expenditures (12,851) (3,984) (3,153)Proceeds from sales of fixed assets 306 1,462 3,398 Cash proceeds from sale of discontinued operations — 12,495 467,186 Acquisitions (35,850) (3,526) — Net cash provided by (used in) investing activities (48,395) 6,447 467,431 Cash flows provided by (used in) financing activities: Working capital facility borrowings 136,000 128,000 292,200 Working capital facility repayments (153,000) (126,000) (293,638)Acquisition facility borrowings 50,000 3,000 — Acquisition facility repayments (17,000) (36,000) — Proceeds from the issuance of debt 197,333 70,512 — Repayment of debt (119,668) (8,471) (259,559)Debt extinguishment costs — — (37,688)Distributions (72,592) (79,819) — Proceeds from the issuance of common units, net 34,180 34,996 — Increase in deferred charges (7,204) (6,092) (8,009) Net cash provided by (used in) financing activities 48,049 (19,874) (306,694) Net cash provided by (used in) discontinued operations (62,866) 194 (11,366) Net increase (decrease) in cash (47,847) 436 94,456 Cash and equivalent at beginning of period 52,103 4,256 4,692 Cash and equivalent at end of period $4,256 $4,692 $99,148 See accompanying notes to consolidated financial statements. F-8 Table of ContentsSTAR 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 home heating oil distributor and services provider. Star Gas is a master limited partnership, whichat September 30, 2005 had outstanding 32.2 million common units (NYSE: “SGU” representing an 88.8% limited partner interest in Star Gas) and 3.4 millionsenior subordinated units (NYSE: “SGH” representing a 9.4% limited partner interest in Star Gas). Additional Partnership interests include 0.3 million juniorsubordinated units (representing a 0.9% limited partner interest) and 0.3 million general partner units (representing a 0.9% general partner interest). The Partnership is organized as follows: • The general partner of the Partnership is Star Gas LLC, a Delaware limited liability company. The Board of Directors of Star Gas LLC is appointedby its members. The general partner’s interest owned by Star Gas LLC represents approximately a 1% interest in the Partnership. • The Partnership’s heating oil operations (the “heating oil segment”) are conducted through Petro Holdings, Inc. (“Petro”) and its subsidiaries.Petro is a Minnesota corporation that is an indirect wholly owned subsidiary of Star/Petro Inc., which is a 99.99% subsidiary of the Partnership.The remaining .01% equity interest in Star/Petro, Inc. is owned by Star Gas LLC. Petro is a retail distributor of home heating oil as ofSeptember 30, 2005 and serves approximately 480,000 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 10 1/4% 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 in the retail distribution of propane and related supplies and equipment to residential and commercial customers in theMidwest and Northeast regions of the United States and Florida and Georgia (the “propane segment”). In December 2004, the Partnership completed the saleof all of its interests in the propane segment to Inergy Propane, LLC (“Inergy”) for a purchase price of $481.3 million. The Partnership recorded a gain on thissale of approximately $157 million. On March 7, 2005 (“the Termination Date”), Star Gas LLC and Mr. Irik P. Sevin entered into a letter agreement and general release (the “Agreement”). Inaccordance with the Agreement, Mr. Sevin confirmed his resignation from employment as the Chairman and Chief Executive Officer and President of Star GasLLC (and its subsidiaries) under the employment agreement between Mr. Sevin and Star Gas LLC dated as of September 30, 2001. In addition, Mr. Sevintransferred his member interests in Star Gas LLC to a voting trust of which Mr. Sevin is one of three trustees. Under the terms of the voting trust, thoseinterests will be voted in accordance with the decision of a majority of the trustees. Pursuant to the Agreement, Mr. Sevin is entitled to an annual consultingfee totaling $395,000 for a period of five years following the Termination Date. In addition, the Agreement provides for Mr. Sevin to receive a retirementbenefit equal to $350,000 per year for a 13-year period beginning with the month following the five-year anniversary of the Termination Date. OnSeptember 30, 2005, a liability of $4.1 million was reflected in the Partnership’s financial statements, the present value of the remaining cost of theAgreement. For the year ended September 30, 2005, the Partnership paid Mr. Sevin $0.2 million and recorded $3.2 million of general and administrativeexpense relating to the Agreement. The Partnership had previously accrued approximately $1.1 million related to Mr. Sevin’s prior SERP, which was forfeitedin lieu of the new retirement benefit in connection with the Agreement. 2) Use of Excess Proceeds During the year ended September 30, 2005, the Partnership has experienced high customer attrition and declining operating margins. Its loss from continuingoperations totaled $178.9 million and cash flows used in operations totaled $54.9 million. The Partnership anticipates that it will be required to utilize theNet Proceeds from the sale of the propane segment to fund its working capital requirements over the next twelve months. Under the terms of the Indenture forthe Partnership’s Senior Notes, such Net Proceeds to the extent not used for Permitted Uses (as defined) become Excess Proceeds and are required to be offeredto the holders of the Senior Notes by December 12, 2005. It is possible that the holders of the Senior Notes could take the position that use of the NetProceeds to purchase working capital assets was not a Permitted Use. We disagree with that position and have communicated our disagreement with thesenoteholders. However, if our position is challenged and we are not successful in defending our position, this would constitute an event of default if declaredby either the holders of 25% in principal amount of the Senior Notes or by the trustee and in such event, all amounts due under the Senior Notes wouldbecome immediately due and payable which would have a material adverse effect on our ability to continue as a going concern. At September 30, 2005, theamount of Net Proceeds in excess of $10 million not yet applied toward a Permitted Use totaled $93.2 million. As of December 2, 2005 all Excess Proceedswere applied toward a Permitted Use. 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 completed the sale of its propane segment on December 17, 2004 and its TG&E segment on March 31, 2004. As a result of the sale ofTG&E and the propane segment, the results of operations of TG&E and propane segments have been classified as discontinued operations inaccordance 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 heating oil and air conditioning equipment are recognized at the time of delivery of the product to the customer or at the time of sale orinstallation. Revenue from repairs and maintenance service is recognized upon completion of the service. 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. F-10 Table of ContentsInventories 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. On October 1, 2002, the Partnership adopted theprovisions of SFAS No. 142 “Goodwill and Other Intangible Assets.” SFAS No. 142 requires that goodwill and intangible assets with indefinite usefullives no longer be amortized, but instead be tested for impairment at least annually. SFAS No. 142 also requires intangible assets with definite usefullives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment. On October 1, 2002, thePartnership ceased amortization of all goodwill. The Partnership also recorded a non-cash charge of $3.9 million in its first fiscal quarter of 2003 toreduce the carrying value of the discontinued TG&E segment’s goodwill. This charge is reflected as a cumulative effect of change in accountingprinciple in the Partnership’s consolidated statement of operations for the year ended September 30, 2003. The Partnership performs its annualimpairment review during its fiscal fourth quarter or more frequently if events or circumstances indicate that the value of goodwill might be impairedThe Partnership performed such an interim review during its fiscal second quarter which resulted in a writedown of its goodwill by $67 million. SeeNote 9. Customer lists are the names and addresses of the acquired company’s patrons. Based on the historical retention experience of these lists, the heatingoil segment amortizes customer lists on a straight-line basis over seven to ten 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. 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 whether 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. F-11 Table of ContentsDeferred 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 $6.6 million, $6.9 million and $9.2 million in 2003, 2004 and 2005,respectively. Customer Credit Balances Customer credit balances represent payments received in advance from customers pursuant to a budget payment plan (whereby customers pay theirestimated annual usage on a fixed monthly basis) and the payments made have exceeded the charges for heating oil 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 and establishes estimatesbased upon actuarial assumptions 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. The accompanying financial statements are reported on a fiscal year, however, the Partnership and its Corporate subsidiaries file state and Federalincome tax returns on a calendar year. For corporate subsidiaries of the Partnership, a consolidated Federal income tax return is filed. Deferred tax assets and liabilities are recognized for thefuture tax consequences attributable to differences between the financial statement carrying amount of assets and liabilities and their respective taxbases and operating loss carry-forwards. 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-12 Table of ContentsDerivatives 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 purchased for resale to protected-price customers. It is the Partnership’s objective to hedge the cash flow variabilityassociated with forecasted purchases of its inventory held for resale to protected-price customers through the use of derivative instruments whenappropriate. To a lesser extent, the Partnership may hedge the fair value of inventory on hand or firm commitments to purchase inventory. To meetthese objectives, it is the Partnership’s policy to enter into various types of derivative instruments to (i) manage the variability of cash flows resultingfrom the price risk associated with forecasted purchases of home heating oil purchased for resale to protected-price customers, (ii) hedge the downsideprice risk of firm 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. Recent Accounting Pronouncements In December 2004, the FASB issued Statement No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”). SFAS No. 123R, which is effectivefor the first annual period beginning after June 15, 2005. SFAS No. 123R requires all share-based payments to employees, including grants of stockoptions, to be recognized in the financial statements based on their fair values. In addition, two transition alternatives are permitted at the time ofadoption of this statement, restating prior year financial statements or recognizing adjustments to share-based liabilities as the cumulative effect of achange in accounting principle. Currently, the Partnership accounts for unit appreciation rights and other unit based compensation arrangements usingthe intrinsic value method under the provisions of APB 25. The Partnership will be required to adopt SFAS No. 123R effective October 1, 2005. InMarch 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”) regarding the SEC’s interpretation of SFAS No. 123R. The Partnership iscurrently evaluating the requirements of SFAS No. 123R and SAB 107. The Partnership has not yet determined the method of adoption or the effect ofadopting SFAS No. 123R. However, it believes that SFAS No. 123R will not have a material effect on its results of operations financial position orliquidity, upon adoption. In May 2005, the FASB issued Statement No. 154, “Accounting Changes and Error Corrections” (“SFAS No. 154”), which is effective for accountingchanges and corrections of errors made in fiscal years beginning after December 15, 2005. The Partnership is required to adopt SFAS No. 154 in fiscal2007. SFAS No. 154 provides guidance for and reporting of accounting changes and error corrections. It states that retrospective application, or thelatest practicable date, is the required method for reporting a change in accounting principle and the reporting of a correction of an error. ThePartnership’s results of operations and financial condition will only be impacted following the adoption of SFAS No. 154 if it implements changes inaccounting principles that are addressed by the standard or corrects accounting errors in future periods. F-13 Table of Contents4) Discontinued Operations On December 17, 2004, the Partnership completed the sale of all of its interests in its propane segment to Inergy for a net purchase price ofapproximately $481.3 million. The propane segment was the Partnership’s principal distributor of propane and related supplies and equipment toresidential, industrial, agricultural and motor fuel customers. Closing and other settlement costs totaled approximately $14 million and approximately$311 million was used to repay outstanding debt of the propane segment and the heating oil segment. $10 million of the proceeds were used toreimburse the heating oil segment for expenses paid by the heating oil segment on behalf of the Partnership. The remainder of the proceeds werecontributed to the heating oil segment (Petro Holdings, Inc.) as a capital contribution. In accordance with the purchase agreement, the effective date ofthe disposition was November 30, 2004. The Partnership recognized a gain on the sale of the propane segment totaling approximately $157 million netof income taxes of $1.3 million. On March 31, 2004, the Partnership sold the stock and business of its natural gas and electricity segment (“TG&E”) to a private party for a purchaseprice of approximately $13.5 million. TG&E was the Partnership’s energy reseller that marketed natural gas and electricity to approximately 65,000residential customers in deregulated markets in New York, New Jersey, Florida and Maryland. The Partnership realized a gain of approximately $0.2million as a result of this transaction. The components of discontinued operations of the propane and TG&E segments for the years ended September 30, are as follows (in thousands): 2003 2004 2005 TG&E Propane Total TG&E Propane Total TG&E Propane Total Sales $81,480 $279,300 $360,780 $52,413 $348,846 $401,259 $— $58,722 $58,722 Cost of sales 71,789 145,015 216,804 46,867 197,000 243,867 — 38,442 38,442 Delivery and branch expenses — 76,279 76,279 — 92,701 92,701 — 17,796 17,796 Depreciation & amortization expenses 667 16,958 17,625 258 20,030 20,288 — 3,481 3,481 General & administrative expenses 7,780 10,568 18,348 4,255 10,090 14,345 — 2,096 2,096 1,244 30,480 31,724 1,033 29,025 30,058 — (3,093) (3,093)Net interest expense 14 11,037 11,051 — 9,221 9,221 — 1,384 1,384 Other loss — 587 587 — 166 166 — 27 27 Income (loss) from discontinued operations beforeincome taxes and cumulative effect of changesin accounting principles, net of income taxes 1,230 18,856 20,086 1,033 19,638 20,671 — (4,504) (4,504)Income tax expense — 300 300 110 285 395 — 48 48 Income (loss) from discontinued operations beforecumulative effect of changes in accountingprinciples, net of income taxes 1,230 18,556 19,786 923 19,353 20,276 — (4,552) (4,552)Cumulative effect of change in accountingprinciples (3,901) — (3,901) — — — — — — Income (loss) from discontinued operations $(2,671) $18,556 $15,885 $923 $19,353 $20,276 $— $(4,552) $(4,552) 5) Quarterly Distribution of Available Cash (See Note 2.) 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-14 Table of ContentsIn 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. ThePartnership did not pay a distribution on any of its units in fiscal 2005. There are currently five quarterly arrearages on distributions to the commonunits, aggregating $92.5 million. The revolving credit facility and the MLP Notes impose certain restrictions on the Partnership’s ability to paydistributions to unitholders (see Note 10). The Partnership believes it is unlikely that the Partnership will resume distributions on the common units,senior subordinated units, and 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, 2008. 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 consecutive non-overlapping four-quarter periods immediatelypreceding that date; 2)the Adjusted Operating Surplus generated during each of the three consecutive immediately preceding non-overlapping four-quarter periodsequaled or exceeded the sum of the minimum quarterly distributions on all of the outstanding common units, senior subordinated units, juniorsubordinated units and general partner units during those periods on a fully diluted basis for employee options or other employee incentivecompensation. This includes all outstanding units and all common units issuable upon exercise of employee options that have, as of the date ofdetermination, already vested or are scheduled to vest before the end of the quarter immediately following the quarter for which thedetermination is made. It also includes all units that have as of the date of determination been earned by but not yet issued to our managementfor incentive compensation; and 3)there are no arrearages in payment of the minimum quarterly distribution on the common units. F-15 Table of Contents6) Segment Reporting At September 30, 2005, the Partnership had one reportable operating segment: retail distribution of heating oil. The administrative expenses and debtservice costs for the public master limited partnership, Star Gas Partners, have not been allocated to the segment. 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 public Master Limited Partnership (“Partners & Others”) includes the office of the Chief Executive Officer and has the responsibility for, amongother things, maintaining investor relations and investor reporting for the Partnership. The following are the statements of operations and balance sheets for the heating oil segment as of and for the periods indicated. Years Ended September 30, 2003 (1) 2004 (1) 2005 (1) (in thousands) Heating Oil Partners&Others (2) Consol. Heating Oil Partners&Others (2) Consol. Heating Oil Partners&Others (2) Consol. Statements of Operations Sales: Product $934,967 $— $934,967 $921,443 $— $921,443 $1,071,270 $— $1,071,270 Installations and service 168,001 — 168,001 183,648 — 183,648 188,208 — 188,208 Total sales 1,102,968 — 1,102,968 1,105,091 — 1,105,091 1,259,478 — 1,259,478 Cost and expenses: Cost of product 598,397 — 598,397 594,153 — 594,153 786,349 — 786,349 Cost of installations andservice 195,146 — 195,146 204,902 — 204,902 197,430 — 197,430 Delivery and branchexpenses 217,244 — 217,244 232,985 — 232,985 231,581 — 231,581 Depreciation &amortization expenses 35,535 — 35,535 37,313 — 37,313 35,480 — 35,480 General and administrative 22,356 17,407 39,763 16,535 3,402 19,937 17,376 26,042 43,418 Goodwill impairmentcharge — — — — — — 67,000 — 67,000 Operating income(loss) 34,290 (17,407) 16,883 19,203 (3,402) 15,801 (75,738) (26,042) (101,780)Net interest expense 22,760 6,770 29,530 28,038 8,644 36,682 21,780 10,058 31,838 Amortization of debt issuancecosts 1,655 383 2,038 2,750 730 3,480 1,718 822 2,540 (Gain) loss on redemption of debt (212) — (212) — — — 24,192 17,890 42,082 Income (loss) fromcontinuing operationsbefore income taxes 10,087 (24,560) (14,473) (11,585) (12,776) (24,361) (123,428) (54,812) (178,240)Income tax expense (benefit) 1,200 — 1,200 1,240 — 1,240 1,756 (1,060) 696 Income (loss) fromcontinuing operations 8,887 (24,560) (15,673) (12,825) (12,776) (25,601) (125,184) (53,752) (178,936)Income (loss) from discontinuedoperations — 19,786 19,786 — 20,276 20,276 — (4,552) (4,552)Gain (loss) on sale ofdiscontinued operations — — — — (538) (538) — 157,560 157,560 Cumulative effect of change inaccounting principles fordiscontinued operations — (3,901) (3,901) — — — — — — Net income (loss) $8,887 $(8,675) $212 $(12,825) $6,962 $(5,863) $(125,184) $99,256 $(25,928) Capital expenditures $12,851 $— $12,851 $3,984 $— $3,984 $3,153 $— $3,153 Total assets $622,005 $353,605 $975,610 $597,867 $363,109 $960,976 $620,872 $8,389 $629,261 F-16 Table of Contents6) Segment Reporting (continued) September 30, 2004 (1) September 30, 2005 (1)(in thousands) Heating Oil Partners &Other (2) Consol. Heating Oil Partners &Other (2) Consol.Balance Sheets ASSETS Current assets: Cash and cash equivalents $4,561 $131 $4,692 $99,102 $46 $99,148Receivables, net 84,005 — 84,005 89,703 — 89,703Inventories 34,213 — 34,213 52,461 — 52,461Prepaid expenses and other current assets 61,549 (576) 60,973 67,908 2,212 70,120Net current assets of discontinued operations — 50,288 50,288 — — — Total current assets 184,328 49,843 234,171 309,174 2,258 311,432Property and equipment, net 63,701 — 63,701 50,022 — 50,022Long-term portion of accounts receivable 5,458 — 5,458 3,788 — 3,788Goodwill 233,522 — 233,522 166,522 — 166,522Intangibles, net 103,925 — 103,925 82,345 — 82,345Deferred charges & other assets, net 6,933 6,952 13,885 9,021 6,131 15,152Net long-term assets of discontinued operations — 306,314 306,314 — — — Total assets $597,867 $363,109 $960,976 $620,872 $8,389 $629,261 LIABILITIES AND PARTNERS’ CAPITAL Current Liabilities: Accounts payable $25,058 $(48) $25,010 $19,807 $(27) $19,780Working capital facility borrowings 8,000 — 8,000 6,562 — 6,562Current maturities of long-term debt 14,168 10,250 24,418 796 — 796Accrued expenses and other current liabilities 56,272 9,219 65,491 50,348 6,232 56,580Due to affiliates 1,329 (1,329) — (8,667) 8,667 — Unearned service contract revenue 35,361 — 35,361 36,602 — 36,602Customer credit balances 53,927 — 53,927 65,287 — 65,287Net current liabilities of discontinued operations — 50,676 50,676 — — — Total current liabilities 194,115 68,768 262,883 170,735 14,872 185,607Long-term debt 148,045 355,623 503,668 95 267,322 267,417Due to affiliate 165,684 (165,684) — 165,684 (165,684) — Other long-term liabilities 24,654 — 24,654 27,377 3,752 31,129Partners’ Capital: Equity Capital 65,369 104,402 169,771 256,981 (111,873) 145,108 Total liabilities and partners’ capital $597,867 $363,109 $960,976 $620,872 $8,389 $629,261 (1)The Partnership completed the sale of its TG&E segment during March 2004 and its propane segment as of November 2004. See Note 4.(2)The Partner and Other amounts include the balance sheet and statement of operations of the Public Master Limited Partnership and Star Gas FinanceCompany, as well as the necessary consolidation entries to eliminate the investment in Petro Holdings, Inc. F-17 Table of Contents7) Inventories The components of inventory were as follows (in thousands): September 30, 2004 2005Heating oil and other fuels $21,661 $39,858Fuel oil parts and equipment 12,552 12,603 $34,213 $52,461 Heating oil and other fuel inventories were comprised of 15.9 million gallons and 21.3 million gallons on September 30, 2004 and September 30,2005, respectively. Inventory Derivative Instruments The Partnership periodically hedges a portion of its home heating oil 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, 2005 had outstanding 26.2 million gallons of swap contracts to buy heating oil with a notional value of $41.8 millionand a fair value of $13.8 million; 64.0 million gallons of futures contracts to buy heating oil with a notional value of $116.1 million and a fair value of$18.3 million; and 17.6 million gallons of purchased call option contracts to buy heating oil with a notional value of $38.6 million and a fair value of$4.2 million. The contracts expire at various times with no contract expiring later than September 30, 2006. The Partnership recognizes the fair value ofthese derivative instruments as assets. To hedge a substantial portion of the purchase price associated with heating oil gallons anticipated to be sold to its price protected 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 expired at various times with no contract expiring later than September 30, 2005. The Partnership recognizes the fair value ofthese derivative instruments as assets. Given the staggered renewals of price-protected contracts, the derivative instruments associated with price protected customers described in the twoforegoing paragraphs represent a substantial majority of the volume anticipated to be required to satisfy the Partnership’s then established fixed andmaximum price obligations for the twelve months following September 30, 2004 and 2005, respectively For the year ended September 30, 2005, the Partnership recognized the following for derivative instruments designated as cash flow hedges: $46.4million gain in earnings due to instruments which settled or settled or expired during the fiscal year ended September 30, 2005, $33.4 millionunrealized gain in accumulated other comprehensive income due to the effective portion of derivative instruments outstanding at September 30, 2005,and $0.8 million unrealized gain due to hedge ineffectiveness for derivative instruments outstanding at September 30, 2005. For derivative instrumentsaccounted for as fair value hedges, the Partnership recognized a $6.9 million loss in earnings due to instruments which expired or settled during thecurrent year, and a $1.5 million unrealized loss in earnings for the change in fair value of derivative instruments outstanding at September 30, 2005.For derivative instruments not designated as hedging instruments, the Partnership recognized a $1.5 million unrealized loss in earnings for the changein fair value of derivative instruments outstanding at September 30, 2005. For the year ended September 30, 2004, the Partnership recognized the following for derivative instruments designated as cash flow hedges: $20.6million gain in earnings due to instruments expiring or settled during the current year, $27.3 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 $0.1 million loss in earnings due to instruments expiring or settled duringthe current year, and a $2.3 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 $1.9 million unrealized loss in earnings for thechange in fair value of derivative instruments outstanding at September 30, 2004. The Partnership recorded $35.1 million for the fair value of all of its derivative instruments, to other current assets, at September 30, 2005. The balanceof approximately $33.4 million in accumulated other comprehensive income, representing the effective portion of cash flow hedges outstanding, isexpected to be reclassified into 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 (in thousands): September 30, 2004 2005 Useful Estimated LivesLand $11,232 $10,885 — Buildings and leasehold improvements 22,591 21,627 1 -40 yearsFleet and other equipment 36,110 35,249 1 -16 yearsTanks and equipment 7,907 7,438 8 -35 yearsFurniture, fixtures and office equipment 44,663 45,645 3 -12 years Total 122,503 120,844 Less accumulated depreciation 58,802 70,822 Property and equipment, net $63,701 $50,022 Depreciation expense was $14.8 million, $15.3 million and $13.5 million for the fiscal years ended September 30, 2003, 2004 and 2005, respectively. 9) Goodwill and Other Intangible Assets Under SFAS No. 142, goodwill impairment is deemed to exist if the net book value of a reporting unit exceeds its estimated fair value. If goodwill of areporting unit is determined to be impaired, the amount of impairment is measured based on the excess of the net book value of the goodwill over theimplied fair value of the goodwill. The Partnership has one reporting unit, the heating oil segment, see Note 6 – Segment Reporting. The Partnership has selected August 31 of each year to perform its annual impairment review under SFAS No. 142. The evaluations utilize both an incomeand market valuation approach and contain reasonable and supportable assumptions and projections and reflect management’s best estimate of projectedfuture cash flows. If the assumptions and estimates underlying the goodwill impairment evaluation are not achieved, a goodwill impairment charge may benecessary. On August 31, 2004, the Partnership, with the assistance of a third party valuation firm, performed its annual goodwill impairment evaluation forits reporting units and at that time determined that no impairment charge was necessary. During the second fiscal quarter of 2005, a number of eventsoccurred that indicated a possible impairment of goodwill of the heating oil segment might exist. These events included: the Partnership’s determination inFebruary 2005 that the Partnership could expect to generate significantly lower than expected operating results for the heating oil segment for the year and asignificant decline in the Partnership’s unit price. As a result of these triggering events and circumstances, the Partnership completed an additional SFASNo. 142 impairment review of the heating oil segment with the assistance of a third party valuation firm as of February 28, 2005. The evaluation utilized bothan income and market valuation approach and contained reasonable assumptions and reflected management’s best estimate of projected future cash flows.This review resulted in a non-cash goodwill impairment charge of approximately $67 million, which reduced the carrying amount of goodwill of the heatingoil segment. As of August 31, 2005, the Partnership performed its annual goodwill impairment valuation for its heating oil segment, with the assistance of athird party valuation firm. Based upon this analysis, it was determined that there was no additional goodwill impairment as of August 31, 2005. A summary of changes in the Partnership’s goodwill during the fiscal years ended September 30, 2005 and 2004 are as follows (in thousands): Balance as of September 30, 2003 $ 232,602 Fiscal 2004 acquisitions 920 Balance as of September 30, 2004 233,522 Second fiscal quarter 2005 impairment charge (67,000) Balance as of September 30, 2005 $166,522 Intangible assets subject to amortization consist of the following (in thousands): September 30, 2004 September 30, 2005 GrossCarryingAmount Accum.Amortization Net GrossCarryingAmount Accum.Amortization NetCustomer lists $189,559 $86,332 $103,227 $189,559 $107,265 $82,294Covenants not to compete 4,736 4,038 698 4,755 4,704 51 $194,295 $90,370 $103,925 $194,314 $111,969 $82,345 F-19 Table of ContentsAmortization expense for intangible assets was $20.4 million, $21.7 million and $21.6 million for the fiscal years ended September 30, 2003, 2004 and2005, respectively. Total estimated annual amortization expense related to intangible assets subject to amortization, for the year ended September 30,2006 and the four succeeding fiscal years ended September 30, is as follows (in thousands): Amount2006 $20,9582007 $20,3402008 $18,5562009 $11,7062010 $6,418 F-20 Table of Contents10) Long-Term Debt and Bank Facility Borrowings Upon the closing of the sale of the Partnership’s propane segment on December 17, 2004 all the outstanding long-term debt and bank debt of thepropane segment was repaid. The Partnership’s long-term debt at September 30, 2004 and 2005 is as follows (in thousands): September 30, 2004 2005 Partners: 10.25% Senior Notes (a) $267,623 $267,322 8.04% First Mortgage Notes (b) 51,250 — 8.70% First Mortgage Notes (b) 27,500 — 7.89% First Mortgage Notes (b) 17,500 — Parity Debt Facility Borrowings (c) 2,000 — Heating Oil Segment: 7.92% Senior Notes (d) 53,000 — 8.25% Senior Notes (e) 77,000 — 8.96% Senior Notes (f) 30,000 — Working Capital Facility Borrowings (g) 8,000 6,562 Acquisition Notes Payable and other (h) 459 225 Subordinated Debentures (i) 1,754 666 Total debt 536,086 274,775 Less current maturities (24,418) (796)Less working capital facility borrowings (8,000) (6,562) Total long-term portion debt $503,668 $267,417 (a)On February 6, 2003, the Partnership and its wholly owned subsidiary, Star Gas Finance Company, jointly issued $200.0 million face value SeniorNotes due on February 15, 2013. These notes accrue interest at an annual rate of 10.25% and require semi-annual interest payments on February 15 andAugust 15 of each year commencing on August 15, 2003. These notes are redeemable at the option of the Partnership, in whole or in part, from time totime 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 endedSeptember 30, 2003, the Partnership used $169.0 million from the proceeds of the 10.25% Senior Notes to repay existing long-term debt and workingcapital facility borrowings, $17.7 million for acquisitions, $3.0 million for capital expenditures, and recognized a $0.2 million gain on redemption ofdebt. The debt discount related to the issuance of the 10.25% Senior Notes was $3.1 million and will be amortized and included in interest expensethrough February 2013. In January 2004, Star Gas and its wholly owned subsidiary, Star Gas Finance Company, jointly issued $35.0 million of 10.25%Senior Notes, due 2013 in a private placement. These notes were issued at a premium to 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 ina private placement. These notes were issued at a premium to par for total net proceeds of $32.4 million, which includes $1.2 million of accruedinterest. The net proceeds of these two offerings resulted in net cash received of $70.5 million. In connection with the sale of the propane segment and pursuant to the terms of the indenture relating to the Partnership’s 10 1/4% Senior Notes due2013 (“MLP Notes”), the Partnership is permitted, within 360 days of the sale, to apply the net proceeds (“Net Proceeds”) of the sale of the propanesegment either to reduce indebtedness of the Partnership or of a restricted subsidiary, or to make an investment in assets or capital expenditures usefulto the business of the Partnership or any of its subsidiaries as in effect on the issue date of the MLP Notes (the “Issue Date”) or any business related,ancillary or complimentary to any of the businesses of the Partnership on the Issue Date (each a “Permitted Use” and collectively the “Permitted Uses”).To the extent any Net Proceeds that are not so applied exceed $10 million on December 12, 2005 (“Excess Proceeds”), the indenture requires thePartnership to make an offer to all holders of MLP Notes to purchase for cash that number of MLP Notes that may be purchased with Excess Proceeds ata purchase price equal to 100% of the principal amount of the MLP Notes plus accrued and unpaid interest to the date of purchase F-21 Table of Contents (b)In December 1995, Star Gas Propane (the Partnership’s former operating subsidiary which was purchased by Inergy on December 17, 2004 inconnection with the sale of the propane segment) assumed $85.0 million of first mortgage notes (the “First Mortgage Notes”) with an annual interestrate of 8.04% 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. In March2001, Star Gas issued $29.5 million of First Mortgage Notes with an average annual interest rate of 7.89% per year. These notes had a final maturity ofMarch 30, 2015. The balance of these notes, including accrued and unpaid interest were repurchased with the proceeds from the sale of the propanesegment in December, 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 Acquisition Facility andWorking Capital Facility and $2.0 million of borrowings outstanding under its Parity Debt Facility. The facility was to expire on September 30, 2006.The balance of these notes, including accrued and unpaid interest were repurchased with the proceeds from the sale of the propane segment inDecember, 2004. (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 acquisition by thePartnership. These notes were scheduled to mature serially with a final maturity date of April 1, 2014. The balance of these notes, including accruedand unpaid interest were repurchased with the proceeds from the sale of the propane segment in December, 2004. (e)The 8.25% Petro Senior Notes were issued under agreements that are substantially identical to the agreement under which the 7.92% and 8.96% SeniorNotes were issued. These notes were also guaranteed by Star Gas Partners. $55.0 million of these notes had a maturity date of August 1, 2006. Theremaining notes were due in equal installments between August 1, 2009 and August 1, 2013. The balance of these, notes including accrued and unpaidinterest were repurchased with the proceeds from the sale of the propane segment in December 2004. In addition, the balance remaining fromunamortized gains from interest rate swaps was written off at the time of the repurchase. (f)The Petro 8.96% Senior Notes were issued under agreements that are substantially identical to the agreements under which the Partnership’s otherSenior Notes were issued. These notes were also guaranteed by Star Gas Partners. These notes were due in various installments beginning November 1,2004 through November 1, 2010. The balance of these notes including accrued and unpaid interest were repurchased with the proceeds from the sale ofthe propane segment in December, 2004. (g)In December 2003, the heating oil segment entered into a credit agreement consisting of three facilities totaling $235.0 million having a maturity dateof June 30, 2006. These facilities consist of a $150.0 million revolving credit facility, which is to be used for working capital purposes, a $35.0 millionrevolving credit facility, which is to be used for the issuance of standby letters of credit in connection with surety, worker’s compensation and otherfinancial guarantees, and a $50.0 million revolving credit facility, which is to be used to finance or refinance certain acquisitions and capitalexpenditures, for the issuance of letters of credit in connection with acquisitions and, to the extent that there is insufficient availability under theworking capital facility. These facilities refinanced and replaced the existing credit agreements, which totaled $193.0 million. The former facilitiesconsisted of a working capital facility and an insurance letter of credit facility that were due to expire on June 30, 2004. These new facilities alsoreplaced the heating oil segments acquisition facility that was due to convert to a term loan on June 30, 2004. For the year ended September 30, 2004,the weighted average interest rate for borrowings under these facilities was 2.9%. As of September 30, 2004, the interest rate on the borrowingsoutstanding was 4.75%. In December 2004 the heating oil segment executed a new $260 million revolving credit facility agreement with a group of lenders led by JPMorganChase Bank, N.A. The new revolving credit facility provides the heating oil segment with the ability to borrow up to $260 million for working capitalpurposes (subject to certain borrowing base limitations and coverage ratios), including the issuance of up to $75 million in letters of credit. OnNovember 3, 2005, the revolving credit facility was amended to increase the facility size by $50 million to $310 million for the peak winter monthsfrom December through March of each year. The facility expires in December 2009. This facility replaced the existing credit facilities entered into inDecember 2003, which totaled $235 million. The former credit facilities consisted of a working capital facility, a letter of credit facility, and an F-22 Table of Contentsacquisition facility. Obligations under the new revolving credit facility are secured by liens on substantially all of the assets of the heating oil segment,accounts receivable, inventory, general intangibles, and real property. Obligations under the new revolving credit facility are guaranteed by theheating oil segment’s subsidiaries and by the Partnership. The new revolving credit facility imposes certain restrictions on the heating oil segment, including restrictions on its ability to incur additionalindebtedness, to pay distributions, make investments, grant liens, sell assets, make acquisitions and engage in certain other activities. In addition, thefacility imposes certain restrictions on the use of proceeds from the sale of the propane segment. The revolving credit facility also requires the heatingoil segment to maintain certain financial ratios, and contains borrowing conditions and customary events of default, including nonpayment ofprincipal or interest, violation of covenants, inaccuracy of representations and warranties, cross-defaults to other indebtedness, bankruptcy and otherinsolvency events. The occurrence of an event of default or an acceleration under the revolving credit facility would result in the heating oil segment’sinability to obtain further borrowings under that facility, which could adversely affect its results of operations. An acceleration under the revolvingcredit facility would result in a default under the Partnership’s other funded debt. The heating oil segment borrowed an initial $119 million under the new revolving credit facility on December 17, 2004, which it used to repayamounts outstanding under the heating oil segment’s existing credit facilities. The heating oil segment recognized a loss of approximately $3 millionas a result of the early redemption of this debt. For the year ended September 30, 2005, the weighted average interest rate for borrowings under thisfacility was 5.0%. At September 30, 2005, the heating oil segment had approximately $6.6 million outstanding under this credit facility. The averageinterest rate on the borrowings outstanding was approximately 6.0%. On November 3, 2005 the Partnership executed an amendment to this creditfacility which, among other things, increased the availability under the facility from $260 million to $310 million for the four month periodDecember 1, through March 31 of each year. The revolving credit facility requires the Partnership to furnish an unqualified audit report for each fiscal year. On November 30, 2005, this requirementwas waived for fiscal 2005. As of September 30, 2005, the Partnership was in compliance with all remaining debt covenants. Under the terms of the revolving credit facility, the heating oil segment must maintain at all times either availability (borrowing base less amountsborrowed and letters of credit issued) of $25.0 million or a fixed charge coverage ratio (as defined in the credit agreement) of not less than 1.1 to 1.0. Asof September 30, 2005, availability was $74.6 million and the fixed charge coverage ratio (as defined in the credit agreement) was 0.56 to 1.0. (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 8% 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 issued wereamended to eliminate substantially all of the covenants provided by the indentures. As of September 30, 2005, the maturities including working capital borrowings during fiscal years ending September 30, are set forth in the followingtable: (in thousands) 2006 $7,3582007 $952008 $— 2009 $— 2010 $— Thereafter $267,322 F-23 Table of Contents11) Acquisitions During fiscal 2003, the Partnership acquired three retail heating oil dealers. The aggregate purchase price was approximately $35.9 million. During fiscal 2004, the Partnership acquired three retail heating oil dealers. The aggregate purchase price was approximately $3.5 million. The Partnership made no acquisitions in fiscal 2005. The following table indicates the allocation of the aggregate purchase price paid and the respective periods of amortization assigned for fiscal 2003and fiscal 2004 (in thousands): 2003 2004 Useful LivesLand $500 $— — Buildings 4,982 — 30 yearsFurniture and equipment 855 1 10 yearsFleet 4,709 — 1-30 yearsTanks and equipment — 426 5-30 yearsCustomer lists 11,171 2,179 7-10 yearsRestrictive covenants 10 — 1-5 yearsGoodwill 13,570 920 — Working capital 53 — — Total $35,850 $3,526 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 are 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 seven to ten years. The weighted average useful lives ofcustomer lists acquired in fiscal 2003 and fiscal 2004 are 7 years. The following un-audited pro forma information presents the results of operations of the Partnership, including the acquisitions previously described,as if 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) 2003 2004 Sales $1,178,582 $1,110,826 Net income (loss) $13,621 $(4,274)General Partner’s interest in net income (loss) 128 (40) Limited Partners’ interest in net income (loss) $13,493 $(4,234) Basic net income (loss) per limited partner unit $0.38 $(0.12) Diluted net income (loss) per limited partner unit $0.38 $(0.12) F-24 Table of Contents12) Employee Benefit Plans 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 2003, 2004 and 2005 were $5.2 million, $5.4 million and $5.1 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 Meenan OilCompany, Inc. (“Meenan”) acquisition, the Partnership assumed the pension plan obligations and assets for Meenan’s company sponsored plan. Thisplan was frozen and merged into the Partnership’s defined benefit pension for non-union personnel as of January 1, 2002. Since these plans are frozen,the projected benefit obligation and the accumulated benefit obligation are the same. The Partnership’s pension expense for all defined benefit plansduring fiscal 2003, 2004 and 2005 were $1.6 million, $1.0 million and $0.8 million, respectively. 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) 2004 2005 Reconciliation of Benefit Obligations Benefit obligations at beginning of year $62,004 $60,321 Service cost — — Interest cost 3,593 3,501 Actuarial loss 827 5,286 Benefit payments (5,538) (5,627)Settlements (565) — Benefit obligation at end of year $60,321 $63,481 Reconciliation of Fair Value of Plan Assets Fair value of plan assets at beginning of year $52,395 $51,363 Actual return on plan assets 4,486 4,327 Employer contributions 585 19 Benefit payments (5,538) (5,627)Settlements (565) — Fair value of plan assets at end of year $51,363 $50,082 Funded Status Benefit obligation $60,321 $63,481 Fair value of plan assets 51,363 50,082 Amount included in accumulated other comprehensive income (16,055) (19,758)Unrecognized net actuarial loss 16,055 19,758 Accrued benefit cost $8,958 $13,399 Years Ended September 30, (in thousands) 2003 2004 2005 Components of Net Periodic Benefit Cost Interest cost 3,810 3,593 3,501 Expected return on plan assets (3,542) (4,170) (4,062)Net amortization 1,288 1,486 1,393 Settlement loss 4 116 — Net periodic benefit cost $1,560 $1,025 $832 Years Ended September 30, 2003 2004 2005 Weighted-Average Assumptions Used in the Measurement of the Partnership’s BenefitObligation as of the period indicated Discount rate 6.00% 6.00% 5.50%Expected return on plan assets 8.25% 8.25% 8.25%Rate of compensation increase N/A N/A N/A F-25 Table of Contents12) Employee Benefit Plans - (continued) 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’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. The Partnership’s Pension Plan assets by category are as follows (in thousands): Years Ended September 30, 2004 2005Asset Categories: Equity Securities $33,892 $33,228Debt Securities 17,223 16,690Cash Equivalents 248 164 $51,363 $50,082 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 67% domestic equities and33% 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 recorded an additional minimum pension liability for under-funded plans of $16.1 million at September 30, 2004 and $19.8 million atSeptember 30, 2005 representing the excess of unfunded accumulated benefit obligations over plan assets. A corresponding amount is recognized as areduction of the Partnership’s capital through a charge to accumulated other comprehensive income. Expected benefit payments over each of the next five years will total approximately $4.0 million per year. Expected benefit payments for the five yearsthereafter will aggregate approximately $21.8 million. In addition, the heating oil segment made contributions to union-administered pension plans of $6.9 million for fiscal 2003, $7.4 million for fiscal2004 and $7.9 million for fiscal 2005 The discount rate used to determine net periodic pension expense was 5.5% in 2005 and 6.0% in 2003 and 2004. The discount rate used by thePartnership in determining pension expense and pension obligations reflects the yield of high quality (AA or better rating by a recognized ratingagency) corporate bonds whose cash flows are expected to match the timing and amounts of projected future benefit payments. The discount rates todetermine net periodic expense used in each of 2003 and 2004 (6.0%) and 2005 (5.50%) reflect the decline in bond yields over the past year. 13) Income Taxes Income tax expense is comprised of the following for the indicated periods (in thousands): Years Ended September 30, 2003 2004 2005Current: Federal $— $— $— State 1,200 1,240 696Deferred — — — $1,200 $1,240 $696 F-26 Table of ContentsThe sources of the deferred income tax expense and the tax effects are as follows (in thousands): Years Ended September 30, 2003 2004 2005 Depreciation $(1,712) $614 $(3,605)Amortization expense 859 2,155 (14,657)Vacation expense 63 (140) 10 Restructuring expense 41 52 52 Bad debt expense 1,800 1,066 (1,084)Hedge accounting (132) (489) (247)Supplemental benefit expense 127 — — Pension contribution 2,628 (387) (349)Other, net (36) (114) (90)Recognition of tax benefit of net operating loss to the extent of current and previousrecognized temporary differences (4,422) (10,726) (15,620)Change in valuation allowance 784 7,969 35,590 $— $— $— The components of the net deferred taxes and the related valuation allowance for the years ended September 30, 2004 and September 30, 2005 usingcurrent tax rates are as follows (in thousands): Years Ended September 30, 2004 2005 Deferred Tax Assets: Net operating loss carryforwards $57,051 $72,671 Vacation accrual 2,151 2,141 Restructuring accrual 80 28 Bad debt expense 1,725 2,809 Amortization — 12,772 Excess of book over tax hedge accounting 611 858 Other, net 231 321 Total deferred tax assets 61,849 91,600 Valuation allowance (47,469) (83,059) Net deferred tax assets $14,380 $8,541 Deferred Tax Liabilities: Amortization $1,885 $— Depreciation 7,027 3,422 Pension contribution 5,468 5,119 Total deferred tax liabilities $14,380 $8,541 Net deferred taxes $— $— 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, atSeptember 30, 2004 and 2005. F-27 Table of ContentsAt September 30, 2005, the Partnership had net income tax loss carryforwards for Federal income tax reporting purposes of approximately $181.7million 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 2025. It is possible that the units purchased as part of the recapitalization transaction or units purchased by one or more 5% unitholders would trigger an IRCSection 382 limitation related to certain net operating loss carryforwards. An ownership change occurs for purposes of Section 382 when there is adirect or indirect sale or exchange of more than 50% by one or more 5% shareholders. If an ownership change has occurred in accordance withSection 382, future limitations in the utilization of net operating losses could be significant. It is possible that the Partnership’s subsidiary, Star/Petro,Inc., will not be able to use any of its currently existing net income tax loss carry forwards in the future. F-28 Table of Contents14) 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, 2005, under operating leases having an initial or remaining non-cancelable term of one yearor more are as follows (in thousands): 2006 $9,1552007 7,1142008 6,0912009 6,1742010 3,896Thereafter 15,027 Total future minimum lease payments $47,457 The Partnership’s rent expense for the fiscal years ended September 30, 2003, 2004 and 2005 was $11.0 million, $12.8 million and $14.7 million,respectively. 15) Unit Incentive Plans The following table summarizes information concerning common and senior subordinated UARs of the Partnership outstanding at September 30, 2005: Price Number ofUnitsOutstanding Restriction Date $7.63 54,715 December 31, 2005 $7.85 381,304 December 31, 2005 $10.70 23,086 October 1, 2005 $11.00 2,500 July 1, 2006 Total / Weighted Average $7.99 461,605 The Partnership recorded $2.6 million and $0.1 million of general and administrative expense for restricted unit grants during fiscal years endedSeptember 30, 2003 and September 30, 2004, respectively. The Partnership recorded an expense of $6.4 million and income of $4.5 million and $2.2million for unit appreciation rights during fiscal years 2003, 2004 and 2005, respectively. 16) Supplemental Disclosure of Cash Flow Information Years Ended September 30, (in thousands) 2003 2004 2005 Cash paid during the period for: Income taxes, net $945 $1,028 $3,022 Interest, net 28,225 36,459 36,345 Non-cash financing activities: Decrease in other asset for interest rate swaps 748 293 — Decrease in long-term debt - amortization of debt discount (927) (293) 314 Increase (decrease) in interest expense 179 — (314) 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 and varioussubsidiaries and officers and directors in the United States District Court of the District of Connecticut entitled Carter v. Star Gas Partners, L.P., et al, No. 3:04-cv-01766-IBA, et.al. Subsequently, 16 additional class action complaints, alleging the same or substantially similar claims, were filed in the same districtcourt: (1) Feit v. Star Gas, et al. Civil Action No. 04-1832 (filed on 10/29/2004), (2) Lila Gold vs. Star Gas, et al, Civil Action No. 04-1791 (filed on10/22/2004), (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 vs. 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 10/25/2004), (7) Strunk v. Star Gas, et al, Civil Action No. 04-1815 (filed on 10/27/2004), (8) Harriette S. & Charles L. F-29 Table of ContentsTabas Foundation vs. 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 vs. Star Gas et al, Civil Action No. 04-1856 (filed on11/3/2004), (12) Yopp vs. 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 on11/9/2004), (14) Lederman v. Star Gas, et al, Civil Action No. 04-1873 (filed on 11/5/2004), (15) Dinkes v. Star Gas, et al, Civil Action No. 04-1979 (filed11/22/2004) and (16) Gould v. Star Gas, et al, Civil Action No. 04-2133 (filed on 12/17/2004) (including the Carter Complaint, collectively referred to hereinas the “Class Action Complaints”). The class actions have been consolidated into one action entitled In re Star Gas Securities Litigation, No 3:04cv1766(JBA). The class action plaintiffs generally allege that the Partnership violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, andRule 10-b5 promulgated thereunder, by purportedly failing to disclose, among other things: (1) problems with the restructuring of Star Gas’s dispatch systemand customer attrition related thereto; (2) that Star Gas’s heating oil segment’s business process improvement program was not generating the benefitsallegedly claimed; (3) that Star Gas was struggling to maintain its profit margins in its heating oil segment; (4) that Star Gas’s fiscal 2004 second quarterprofit 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 andthat, as a result, its credit rating and ability to obtain future financing was in jeopardy. The class action plaintiffs seek an unspecified amount ofcompensatory damages including interest against the defendants jointly and severally and an award of reasonable costs and expenses. On February 23, 2005,the Court consolidated the Class Action Complaints and heard argument on motions for the appointment of lead plaintiff. On April 8, 2005, the Courtappointed the lead plaintiff. Pursuant to the Court’s order, the lead plaintiff filed a consolidated amended complaint on June 20, 2005 (the “ConsolidatedAmended Complaint”). The Consolidated Amended Complaint named: (a) Star Gas Partners, L.P.; (b) Star Gas LLC; (c) Irik Sevin; (d) Audrey Sevin;(e) Hanseatic Americas, Inc.; (f) Paul Biddelman; (g) Ami Trauber; (h) A.G. Edwards & Sons Inc.; (i) UBS Investment Bank; and (j) RBC Dain Rauscher Inc. asdefendants. The Consolidated Amended Complaint added claims arising out of two registration statements and the same transactions under Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 as well as certain allegations concerning the Partnership’s hedging practices. On September 23, 2005, defendantsfiled motions to dismiss the Consolidated Amended Complaint for failure to state a claim under the federal securities laws and failure to satisfy the applicablepleading requirements of the Private Securities Litigation Reform Act of 1995 (“PSLRA”), and the Federal Rules of Civil Procedure. Plaintiffs filed theirresponse to defendants’ motions to dismiss on or about November 23, 2005 and defendants are scheduled to file their reply briefs on or about December 20,2005. In the interim, discovery in the matter remains stayed pursuant to the mandatory stay provisions of the PSLRA. While no prediction may be made as tothe outcome of litigation, we intend to defend against this class action vigorously. In the event that the above action is decided adversely to the Partnership, it could have a material effect on our results of operations, financial condition andliquidity. 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. As 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 we believe are reasonable and prudent. However,the Partnership cannot assure that this insurance will be adequate to protect it from all material expenses related to potential future claims for personaland property damage or that these levels of insurance will be available in the future at economical prices. In addition, the occurrence of an explosionmay have an adverse effect on the public’s desire to use the Partnership 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. 18) Disclosures About the Fair Value of Financial Instruments Cash, Accounts Receivable, Notes Receivable, Inventory Derivative Instruments, Working Capital Facility Borrowings, and Accounts Payable 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 For fiscal 2004, the fair values of each of the Partnership’s long-term financing instruments, including current maturities are based on the amount offuture cash flows associated with each instrument, discounted using the Partnership’s current borrowing rate for similar instruments of comparablematurity. For fiscal 2005, the fair value is based on open market quotations. F-30 Table of ContentsThe estimated fair value of the Partnership’s long-term debt is summarized as follows (in thousands): At September 30, 2004 At September 30, 2005 CarryingAmount EstimatedFair Value CarryingAmount EstimatedFair ValueLong-term debt $528,086 $557,792 $268,213 $216,866 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.Changes in assumptions could significantly affect the estimates. F-31 Table of Contents19) Earnings Per Limited Partner Units Years Ended September 30, (in thousands, except per unit data) 2003 2004 2005 Loss from continuing operations per Limited Partner unit: Basic $(0.48) $(0.72) $(4.95)Diluted $(0.48) $(0.72) $(4.95)Income (loss) from discontinued operations before cumulative Basic $0.61 $0.57 $(0.13)Diluted $0.61 $0.57 $(0.13)Income (loss) on sale of discontinued operations, net of income taxes per Limited Partner unit: Basic $— $(0.01) $4.36 Diluted $— $(0.01) $4.36 Cumulative effect of change in accounting principle for adoption of SFAS No. 142 fordiscontinued operations per Limited Partner unit: Basic $(0.12) $— $— Diluted $(0.12) $— $— Net income (loss) per Limited Partner unit: Basic $0.01 $(0.16) $(0.72)Diluted $0.01 $(0.16) $(0.72)Basic Earnings Per Unit: Net income (loss) $212 $(5,863) $(25,928)Less: General Partners’ interest in net income (loss) 2 (57) (234) Limited Partner’s interest in net income (loss) $210 $(5,806) $(25,694) Common Units 29,175 31,647 32,166 Senior Subordinated Units 3,139 3,213 3,310 Junior Subordinated Units 345 345 345 Weighted average number of Limited Partner units outstanding 32,659 35,205 35,821 Basic earnings (loss) per unit $0.01 $(0.16) $(0.72) Diluted Earnings Per Unit: Effect of dilutive securities $— $— $— Limited Partners’ interest in net income (loss) $210 $(5,806) $(25,694) Effect of dilutive securities 108 — — Weighted average number of Limited Partner units outstanding 32,767 35,205 35,821 Diluted earnings (loss) per unit $0.01 $(0.16) $(0.72) F-32 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) Dec. 31,2004 Mar. 31,2005 Jun. 30,2005 Sep. 30,2005 Total Sales $350,694 $555,317 $202,768 $150,699 $1,259,478 Operating loss (21,028) (17,341) (23,448) (39,963) (101,780)Loss from continuing operations before income taxes (74,317) (25,950) (31,317) (46,656) (178,240)Gain (loss) on sale of segments, net of income taxes 153,644 2,520 (404) 1,800 157,560 Net income (loss) 74,444 (24,099) (29,321) (46,952) (25,928)Limited Partner interest in net income (loss) 73,772 (23,881) (29,056) (46,529) (25,694)Net income (loss) per Limited Partner unit: Basic and diluted $2.06 $(0.67) $(0.81) $(1.30) $(0.72) Three Months Ended (in thousands - except per unit data) Dec. 31,2003 Mar. 31,2004 Jun. 30,2004 Sep. 30,2004 Total Sales $316,070 $481,768 $179,342 $127,911 $1,105,091 Operating income (loss) 14,281 64,366 (22,806) (40,040) 15,801 Income (loss) from continuing operations before income taxes 4,583 53,967 (32,545) (50,366) (24,361)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)(a)The sum of the quarters do not add-up to the total due to the weighting of Limited Partner Units outstanding. 21) Subsequent Events Recapitalization On December 2, 2005 the board of directors of Star Gas LLC approved a strategic recapitalization of Star Gas Partners, if approved by unitholders andcompleted, would result in a reduction in the outstanding amount of the Partnership’s 10 1/4% Senior Notes due 2013 (or “Senior Notes”), of betweenapproximately $87 million and $100 million. The recapitalization includes a commitment by Kestrel Energy Partners, LLC (or “Kestrel”) and its affiliates to purchase $15 million of new equitycapital and provide a standby commitment in a $35 million rights offering to the Partnership’s common unitholders, at a price of $2.00 per commonunit. The Partnership would utilize the $50 million in new equity financing, together with an additional $10 million from operations, to repurchase atleast $60 million in face amount of its Senior Notes and, at its option, up to approximately $73.1 million of Senior Notes. In addition, certainnoteholders have agreed to convert approximately $26.9 million in face amount of Senior Notes into newly issued common units at a conversion priceof $2.00 per unit in connection with the closing of the recapitalization. The Partnership has entered into agreements with the holders of approximately 94% in principal amount of its Senior Notes which provide that: thenoteholders commit to, and will, tender their Senior Notes at par (i) for a pro rata portion of $60 million or, at our option, up to approximately $73.1million in cash, (ii) in exchange for approximately 13,434,000 new common units at a conversion price of $2.00 per unit (which new units would beacquired by exchanging approximately $26.9 million in face amount of Senior Notes), and (iii) in exchange for new notes representing the remainingface amount of the tendered notes. The principle terms of the new senior notes, such as the term and interest rate are the same as the Senior Notes. Theclosing of the tender offer is conditioned upon the closing of the transactions under the Kestrel unit purchase agreement, which is discussed below.Upon closing the transaction the Partnership will incur a gain or loss on the exchange of Senior Notes of common units based on the differencebetween the $2.00 per unit conversion price and the fair value per unit represented by the per unit price in the open market on the conversion date. Subject to and until the transaction closing, the noteholders have agreed not to accelerate indebtedness due under the Senior Notes or initiate anylitigation or proceeding with respect to the Senior Notes. The noteholders have further agreed to: waive any default under the indenture; not to tenderthe Senior Notes in the change of control offer which will be required to be made following the closing of the transactions under the unit purchaseagreement with Kestrel; and to consent to certain amendments to the existing indenture. The agreement with the noteholders further provides for thetermination of its provisions in the event that the Kestrel unit purchase agreement is no longer in effect. The understandings and agreementscontemplated by these transactions will terminate if the transaction does not close prior to April 30, 2006. The Partnership believes the proposed recapitalization would substantially strengthen its balance sheet and thereby assist in meeting its liquidity andcapital requirements, which it believes would improve its future financial performance and enhance unitholder value. In addition to enhancingunitholder value we believe we will be able to operate more efficiently going forward with less long-term debt. As part of the recapitalization transaction, the Partnership has entered into a definitive unit purchase agreement with Kestrel and its affiliates, whichprovides for, among other things: the receipt by the Partnership of $50 million in new equity financing through the issuance to Kestrel’s affiliates of7,500,000 common units at $2.00 per unit for an aggregate of $15 million and the issuance of an additional 17,500,000 common units in a rightsoffering to the Partnership’s common unitholders at an exercise price of $2.00 per unit for an aggregate of $35 million. The rights will be non-transferable, and an affiliate of Kestrel has agreed to buy any common units not subscribed for in the rights offering. Under the terms of the unitpurchase agreement, Kestrel Heat, LLC, or Kestrel Heat, a wholly owned subsidiary of Kestrel, will become the new general partner and Star Gas LLC, our current general partner, will receive no consideration for its removal as general partner. In addition, the unit purchase agreement provides for the adoption of a second amended and restated agreement of limited partnership that will, amongother matters: • provide for the mandatory conversion of each outstanding senior subordinated unit and junior subordinated unit into one common unit; • change the minimum quarterly distribution to the common units from $0.575 per quarter, or $2.30 per year, to $0.0675 per unit, or $0.27 peryear, which shall commence accruing October 1, 2008; and, eliminate all previously accrued cumulative distribution arrearages whichaggregated $92.5 million at November 30, 2005; • suspend all distributions of available cash by us through the fiscal quarter ending September 30, 2008; • reallocate the incentive distribution rights so that, commencing October 1, 2008, the new general partner units in the aggregate will beentitled to receive 10% of the available cash distributed once $.0675 per quarter, or $0.27 per year, has been distributed to common unitsand general partner units and 20% of the available cash distributed in excess of $0.1125 per quarter, or $.45 per year, provided there are noarrearages in minimum quarterly distributions at the time of such distribution (under the current partnership agreement if quarterlydistributions of available cash exceed certain target levels, the senior subordinated units, junior subordinated units and general partner unitswould receive an increased percentage of distributions, resulting in their receiving a greater amount on a per unit basis than the commonunits). The recapitalization is subject to certain closing conditions including, the approval of our unitholders, approval of the lenders under the Partnership’srevolving credit facility, and the successful completion of the tender offer for the Senior Notes. As a result of the challenging financial and operating conditions that the Partnership has experienced since fiscal 2004, it have not been able togenerate sufficient available cash from operations to pay the minimum quarterly distribution of $0.575 per unit on its securities. These conditions ledto the suspension of distributions on its senior subordinated units, junior subordinated units and general partner units on July 29, 2004 and to thesuspension of distributions on the common units on October 18, 2004. The Partnership believes that the proposed amendments to the Partnership agreement will simplify its capital structure, provide internally generatedfunds for future investment and align the minimum quarterly distribution more closely with the levels of available cash from operations that it expectsto generate in the future. It is possible that the units purchased as part of the recapitalization transaction or units purchased by one or more 5% unitholders would trigger an IRCSection 382 limitation relating to certain net operating loss carryforwards. An ownership change occurs for purposes of Section 382 when there is adirect or indirect sale or exchange of more than 50% by one or more 5% shareholders. If an ownership change has occurred in accordance withSection 382, future limitations in the utilization of net operating losses could be significant. It is possible that the Partnership’s subsidiary, Star/Petro,Inc., will not be able to use any of its currently existing net income tax loss carry forwards in the future. F-33 Table of ContentsSchedule II STAR GAS PARTNERS, L.P. AND SUBSIDIARIESVALUATION AND QUALIFYING ACCOUNTSYears Ended September 30, 2003, 2004 and 2005(in thousands) Year Description Balance atBeginningof Year Chargedto Costs &Expenses OtherChangesAdd (Deduct) Balance atEnd of Year2003 Allowance for doubtful accounts $2,960 $6,601 $ (3,215) (a) $6,3462004 Allowance for doubtful accounts $6,346 $7,646 $ (8,370) (a) $5,6222005 Allowance for doubtful accounts $5,622 $9,817 $ (7,006) (a) $8,433(a)Bad debts written off (net of recoveries). F-34 Exhibit 10.51 AGREEMENT AND GENERAL RELEASE OF ALL CLAIMS This Agreement and General Release of All Claims (“Agreement”) is entered into as of this 6th day of May, 2005 between Star Gas Partners, L.P. and allof its direct and indirect subsidiaries (collectively, the “Company”) and David Anthony Shinnebarger (“Shinnebarger”). WHEREAS, Shinnebarger was employed by the Company as its Executive Vice President of Marketing until the termination of his employmenteffective May 6, 2005 (the “Termination Date”); WHEREAS, the parties to this Agreement wish to provide for a full and final resolution of all claims and potential claims which Shinnebarger mighthave against the Company, its affiliates, successors, assigns, divisions, partners and related and affiliated entities, and any and all of their past and presentpartners, shareholders, officers, directors, agents, representatives and employees (collectively, the “Releasees”), NOW, THEREFORE, in consideration of the mutual promises, covenants, conditions and provisions set forth below, it is agreed as follows: 1. Effective on the Termination Date, Shinnebarger’s employment as the Company’s Executive Vice President - Chief Marketing Officer as set forth inhis October 17, 2003 letter agreement with the Company (the “Employment Agreement”) or otherwise is hereby terminated. Shinnebarger also acknowledgesand agrees that all other offices, positions and fiduciary or business relationships he holds with the Company and any of the Releasees are hereby terminatedon the Termination Date. Shinnebarger acknowledges that he has no right to rehire by, or consideration for future employment with, the Company or theReleasees and that the Company and the Releasees have no obligation to hire him or consider him for employment after the Termination Date. 2. In consideration of the releases and additional promises set forth herein, the Company: a. shall pay to Shinnebarger as severance pay, $243,750.00 (90 days notice plus 6 months severance at his present salary), less applicablewithholdings. Such severance pay shall be made in a single payment to Shinnebarger on the Effective Date (as defined herein); and b. shall pay the cost of Shinnebarger’s monthly premiums for COBRA continuation coverage for a period of nine (9) months after theTermination Date (through and including February 2006). 3. Shinnebarger acknowledges that payments contained in Paragraph 2 herein will fully discharge the Company and all of the Releasees from allliabilities and obligations pursuant to any oral or written agreement between Shinnebarger and the Company, including but not limited to the EmploymentAgreement (and all provisions, terms and promises contained therein) or any other alleged promise or understanding between the Company andShinnebarger, provided however that nothing contained in this Agreement shall limit or alter the terms of coverage of the Company’s Director and Officerinsurance policies so as to affect Shinnebarger’s rights thereunder, if any. Shinnebarger specifically acknowledges that the payment promise contained inParagraph 2 herein includes and is in excess of any amounts due Shinnebarger from the Company in connection with, directly or indirectly, Shinnebarger’s employment with the Company and the termination thereof, including, withoutlimitation, any wages, salary, bonus, vacation pay and any other benefit payment due Shinnebarger from the Company. 4. In consideration of the payments made hereunder, Shinnebarger, for himself, his heirs, dependents, executors, administrators, trustees, representativesand assigns, hereby fully, finally and unconditionally waives and forever releases, discharges and forgives the Releasees from any and all claims, allegations,complaints, proceedings, charges, actions, causes of action, demands, debts, covenants, contracts, liabilities or damages of any nature whatsoever, whethernow known or claimed, to whomever made, which Shinnebarger had, has or may have against any or all of the Releasees for or by reason of any cause, natureor thing whatsoever, up to the date of the execution of this Agreement, including, by way of example and without limiting the broadest application of theforegoing, any actions, causes of action or claims under any contract or any federal, state or local decisional law, statutes, regulations or constitutions, anyclaims for notice or pay in lieu of notice, or for wrongful dismissal, discrimination, retaliation or harassment on the basis of any factor (including, withoutlimitation, any claim arising under the Age Discrimination in Employment Act (including the Older Workers Benefit Protection Act), Title VII of the CivilRights Act of 1964, as amended, the Civil Rights Act of 1991, the Employee Retirement Income and Security Act of 1974, as amended, the Fair LaborStandards Act, the Americans with Disabilities Act, the Family and Medical Leave Act, the Connecticut Fair Employment Practices Act, the New York HumanRights Law, the New York City Civil Rights Law, and any other federal, state or local legislation), and any claims, asserted benefits or rights arising by orunder contract or implied contract, any alleged oral or written contract or agreement for employment or services, any claims arising by or under promissoryestoppel, detrimental reliance, or under any asserted covenant of good faith and fair dealing, and any claims for defamation, fraud, fraudulent inducement,intentional infliction of emotional distress, or any other tortious conduct, including personal injury of any nature and arising from any source or condition orattorney’s fees and costs of whatsoever nature related to any such claim described in this Paragraph 4. 5. As of the date of, and upon execution of this Agreement and its waiver and release of all claims, Shinnebarger covenants, represents and warrants thathe has not asserted and will not assert, threaten or commence any claim, lawsuit, arbitration, complaint, charge or proceeding against the Company or theReleasees by reason of any cause, matter or thing, known or unknown, existing up to the date of his execution of this Agreement (or if any such claim,lawsuit, arbitration, complaint, charge or proceeding is currently pending, Shinnebarger represents and warrants that he will immediately discontinue saidaction(s), or take any necessary steps to otherwise effectuate the dismissal or withdrawal of said action(s), with prejudice). If Shinnebarger should, after theexecution of this Agreement, make, pursue or commence (or threaten to make, pursue or commence) any claim, lawsuit, arbitration, complaint, charge orproceeding against the Company, for or by reason of any cause, matter or thing whatsoever existing up to the date of his execution of this Agreement, thisAgreement may be raised as, and shall constitute, a complete bar to any such claim, lawsuit, arbitration, complaint, charge or proceeding, and the Companyshall be entitled to recover from Shinnebarger all reasonable costs incurred by virtue of defending same, including reasonable attorney’s fees, withoutaltering or diminishing the effectiveness of the release provisions provided under this and the preceding Paragraph. In the event Shinnebarger is permitted bylaw to file or assert any charge or claim, he hereby waives any right to equitable or monetary recovery therefrom; provided, however, that 2 nothing in this Agreement shall limit either Shinnebarger or the Company from enforcing their respective rights under this Agreement. 6. On or before the Termination Date, Shinnebarger shall return to the Company all Company property in his possession or under his control, includingany and all documents and electronic information in any form, any and all copies thereof, any other material containing confidential or proprietary Companyinformation, whether or not specifically designated as such material, and any all keys, passcards, credit cards or other Company property. 7. Shinnebarger shall keep any and all information concerning the Company any of the Releasees, other than information generally available to thepublic (except for information that is or becomes public through Shinnebarger’s breach of this paragraph), including but not limited to this Agreement, itsterms, provisions, and any and all underlying circumstances pertaining thereto (collectively, “Confidential Information”), strictly confidential and shall notdisclose or cause or permit to be disclosed any Confidential Information to any person, party or other entity, other than to Shinnebarger’s immediate family,attorney, tax consultant, or the Internal Revenue Service, or as Shinnebarger may be compelled to disclose by law or formal legal process. In the event thatShinnebarger is requested to reveal the existence and contents of this Agreement to any person or entity other than to the persons identified in this paragraph,he shall immediately notify the Company of any such request (and provide to the Company a copy of any written request), but shall not reveal the amount ofany payment by the Company to Shinnebarger provided for herein, unless required by law or otherwise ordered to do so by a Court of competent jurisdiction.Nothing herein shall prevent Shinnebarger from disclosing the terms and provisions of this Agreement to the extent reasonably necessary to legally enforcethe payments required to be made by the Company pursuant to Paragraph 2. 8. Shinnebarger hereby acknowledges his post-termination restrictions contained in Paragraph 5 of the Employment Agreement (the “RestrictiveCovenants”) and that such Restrictive Covenants survive the termination of his employment with the Company and remain enforceable after the TerminationDate. Shinnebarger further acknowledges that if a court of competent jurisdiction holds that the stated scope, duration or other restriction contained in theRestrictive Covenants are overbroad, unreasonable or otherwise unenforceable for whatever reason, such court shall substitute the maximum reasonablescope, duration and restriction in place of the stated provision. 9. Shinnebarger shall cooperate with the Company and the Releasees in connection with any legal or administrative proceeding, claim, allegation,complaint, charge, action, cause of action or demand against the Company and/or any of the Releasees concerning any alleged measure of damage or liabilityof any nature whatsoever against the Company and/or any of the Releasees or to which the Company and/or any of the Releasees is a party or otherwiseinvolved (“Proceeding”). In connection with the Company’s and or any of the Releasees’ defense against any Proceedings (other than any Proceeding byShinnebarger to enforce this Agreement), Shinnebarger shall use his reasonable best efforts to: (1) respond and provide information (including accuratelystated affidavit(s)) concerning all matters in which he has knowledge (whether or not as a result of his employment or other relationship with the Company orany of the Releasees) to the Company and its representatives; (2) make himself available, upon request by the Company or its representative at reasonabletimes, with at least fourteen (14) days prior notice, for meetings and depositions; (3) make himself available upon reasonable advance notice, to appear as awitness in connection with any Proceeding, irrespective or other commitments or 3 schedule conflicts. The Company will reimburse Shinnebarger for reasonable travel, lodging, meals and other out of pocket expenses he incurs (specificallyexcluding his attorney’s fees and personal or professional time charges) in complying with this Paragraph 9. 10. The parties acknowledge and agree that any material breach of this Agreement by Shinnebarger that is not cured by Shinnebarger within 10 daysafter written notice to him by the Company or any of the Releasees of such material breach of this Agreement shall immediately release the Company from itsobligations hereunder without altering or diminishing the effectiveness of the release provisions provided herein. Furthermore, the parties recognize that anybreach of this Agreement by Shinnebarger may damage the Company irreparably, the specific amount of which will be impossible to ascertain. The partieshereto acknowledge that in the event of any such breach, the Company shall, in addition to such other relief as might be appropriate, be entitled to thefollowing relief against Shinnebarger from a court or competent jurisdiction: (a) liquidated damages in the amount of $100,000.00; (b) injunctive reliefenjoining any such breach; (c) specific performance of Shinnebarger’s obligations hereunder; and (d) the costs incurred by the Company in obtaining suchrelief, including attorney’s fees. 11. Shinnebarger acknowledges that he has been given a period of twenty-one (21) days from the receipt hereof to review and consider this Agreementbefore signing it. 12. Shinnebarger acknowledges that he may revoke this Agreement within seven (7) calendar days following the date of his execution of thisAgreement as set forth on the last page hereof, and that this Agreement shall not become effective or enforceable until such revocation period has expired (the“Effective Date”). No such revocation shall be effective unless it is made in writing, signed by Shinnebarger and delivered to the Company and its attorney,Alan Shapiro, Esq., Phillips Nizer LLP, 666 Fifth Avenue, New York, New York 10103-0084, no later than the close of business on the seventh day followingShinnebarger’s execution of this Agreement. Shinnebarger understands that if he revokes this Agreement, it shall be of no force and effect and he shall haveno right to receive, and the Company shall have no obligation to provide, the consideration described herein. If Shinnebarger does not effectively revoke thisAgreement pursuant to and in accordance with this paragraph, it shall be effective and enforceable as of the expiration of the revocation period described inthis Paragraph 12. 13. Shinnebarger acknowledges that he has been advised to consult with an attorney concerning this Agreement and that he has consulted with anattorney of his choice concerning the Agreement prior to signing this Agreement. 14. Shinnebarger shall not disparage the Company or the Releasees in any manner. 15. This Agreement shall not constitute an admission of any wrongdoing by the Company or the Releasees, or of having caused any injury toShinnebarger by any acts or omissions on the part of the Company or the Releasees, or of a violation of any statutory, regulatory or common law obligationowed to Shinnebarger by the Company or the Releasees. 16. The provisions, sections and paragraphs, and the specific terms set forth therein, of this Agreement are severable. If any provision, section orparagraph, or specific term contained therein, of this Agreement or the application thereof is determined by a court of competent jurisdiction to be illegal,invalid or unenforceable, that provision, section, paragraph or term shall not be a part of this Agreement, and the legality, validity and enforceability of 4 remaining provisions, sections and paragraphs, and all other terms therein, of this Agreement shall not be affected thereby. 17. This Agreement embodies the entire agreement between parties hereto and may not be amended, modified or terminated except by express writtenagreement between the parties. This Agreement shall be interpreted, construed and enforced in accordance with the laws of the State of New York.Shinnebarger hereby consents to the exclusive jurisdiction and venue of the courts of the State of New York, New York County and the State of Connecticut,Fairfield County, for the enforcement of this Agreement and waives any rights he may have to a trial by jury in connection therewith. 18. The Company may withhold from any amounts payable under this Agreement such Federal, state and local taxes as may be required to be withheldpursuant to any applicable law or regulation. 19. This Agreement may be signed in counterparts, each of which shall be an original, with the same effect as if the signatures thereto and hereto wereupon the same instrument. IN SIGNING THIS AGREEMENT, SHINNEBARGER ACKNOWLEDGES THAT HE HAS READ AND UNDERSTANDS THE ENTIRE AGREEMENT;THAT IT INCLUDES A FULL AND FINAL RELEASE OF ANY CLAIM HE MAY HAVE AGAINST THE COMPANY AND THE RELEASEES UNDER THEAGE DISCRIMINATION IN EMPLOYMENT ACT, 29 U.S.C. § 621 ET SEQ; AND THAT HE HAS BEEN ADVISED TO CONSULT WITH AN ATTORNEYAND HAS CONSULTED WITH AN ATTORNEY OF HIS CHOICE CONCERNING THIS AGREEMENT PRIOR TO SIGNING THIS AGREEMENT.SHINNEBARGER FURTHER ACKNOWLEDGES THAT IF HE SIGNS THIS AGREEMENT PRIOR TO THE EXPIRATION OF THE 21-DAY PERIOD SETFORTH IN PARAGRAPH 10 OF THIS AGREEMENT, HE HAS KNOWINGLY AND VOLUNTARILY WAIVED HIS RIGHT TO CONSIDER THE TERMS OFTHIS AGREEMENT FOR THE FULL 21-DAY PERIOD. /s/ DAVID ANTHONY SHINNEBARGER Date: 5/6/05 DAVID ANTHONY SHINNEBARGER STAR GAS LLC Date: 5/6/05 BY: ILLEGIBLE 5 Exhibit 21 A.P. Woodson Company – District of Columbia Columbia Petroleum Transportation, LLC – Delaware Marex Corporation – Maryland Maxwhale Corp. – Minnesota Meenan Holdings of New York, Inc. – New York Meenan Oil Co., Inc. – Delaware Meenan Oil Co., L.P. – Delaware Ortep of Pennsylvania, Inc. – Pennsylvania Petro Holdings, Inc. – Minnesota Petro Plumbing Corporation – New Jersey Petro, Inc. – Delaware Petroleum Heat and Power Co., Inc. – Minnesota RegionOil Plumbing, Heating and Cooling Co., Inc. – New Jersey Richland Partners, LLC – Pennsylvania Star Gas Finance Company – Delaware Star/Petro, Inc. – Minnesota TG&E Service Company, Inc. – Florida Exhibit 23.1 Consent of Independent Registered Public Accounting Firm The Board of DirectorsStar Gas LLC: We consent to the 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 reports dated December 12, 2005, with respect to the consolidated balance sheets ofStar Gas Partners, L.P. as of September 30, 2004 and 2005, 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, 2005, and the related financial statement statement schedule,management’s assessment of the effectiveness of internal control over financial reporting as of September 30, 2005 and the effectiveness of internal controlover financial reporting as of September 30, 2005, which reports appear in the September 30, 2005 annual report on Form 10-K of Star Gas Partners, L.P. Our report dated December 12, 2005 contains an explanatory paragraph that states the Partnership may not be able to fund its working capital requirements,which raises substantial doubt about the Partnership’s ability to continue as a going concern. The consolidated financial statements and financial statementschedule 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. KPMG LLPStamford, ConnecticutDecember 12, 2005 Exhibit 31.1 CERTIFICATIONS I, Joseph P. Cavanaugh, 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)) and internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and15d-15(f)) 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)designed such internal controls over financial reporting, or caused such internal controls over financial reporting to be designed underour supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financialstatements for external purposes in accordance with generally accepted principles; (c)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 (d)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 12, 2005 /s/ Joseph P. CavanaughJoseph P. CavanaughChief Executive OfficerStar Gas Partners, L.P.Star Gas Finance Company Exhibit 31.2 CERTIFICATIONS I, Richard F. Ambury, 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)) and internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and15d-15(f)) 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)designed such internal controls over financial reporting, or caused such internal controls over financial reporting to be designed underour supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financialstatements for external purposes in accordance with generally accepted principles; (c)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 (d)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 12, 2005 /s/ Richard F. AmburyRichard F. AmburyChief 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, 2005 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Joseph P. Cavanaugh, Chief Executive Officerof the Partnership and Star Gas Finance Company, certify to my knowledge pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of theSarbanes-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 12, 2005 By: /s/ Joseph P. Cavanaugh Joseph P. CavanaughChief 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, 2005 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Richard F. Ambury, Chief Financial Officer ofthe Partnership and Star Gas Finance Company, certify to my knowledge pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of theSarbanes-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 12, 2005 By: /s/ Richard F. Ambury Richard F. AmburyChief Financial OfficerStar Gas Partners, L.P.Star Gas Finance Company
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