AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 22, 1998 REGISTRATION NO. 333- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM S-4 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ---------------- STAR GAS PARTNERS, L.P. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) ---------------- 2187 ATLANTIC STREET P.O. BOX 120011 STAMFORD, CT 06912-0011 (203) 328-7300 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES) ---------------- JOSEPH P. CAVANAUGH PRESIDENT STAR GAS CORPORATION 2187 ATLANTIC STREET P.O. BOX 120011 STAMFORD, CT 06912-0011 (203) 328-7300 (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) ---------------- COPIES TO:
DELAWARE 5984 06-1437793 (STATE OR OTHER JURISDICTION (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER OF INCORPORATION OR CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.) ORGANIZATION) ---------------- APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after the effective date of this Registration Statement and upon holding of the meetings of securityholders of the Registrant and Petroleum Heat and Power Co., Inc. described herein. If the securities being registered on this Form are being offered in connection with the formation of a holding company and there is compliance with General Instruction G, check the following box. [_] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] CALCULATION OF REGISTRATION FEE
PHILLIPS NIZER BENJAMIN ANDREWS & KURTH L.L.P. KRIM & BALLON LLP BAKER & BOTTS, L.L.P. 805 THIRD AVENUE 666 FIFTH AVENUE, 28TH FLOOR ONE SHELL PLAZA NEW YORK, NEW YORK 10022 NEW YORK, NEW YORK 10103-0084 910 LOUISIANA (212) 850-2800 (212) 977-9700 HOUSTON, TEXAS 77002-4995 ATTN: MICHAEL ROSENWASSER, ATTN: ALAN SHAPIRO, ESQ. (713) 229-1330 ESQ. ATTN: R. JOEL SWANSON, ESQ. - ------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------
(1) Calculated in accordance with Rule 457(f)(1) based upon the average of the high and low sale prices of the Class A Common Stock of Petroleum Heat and Power Co., Inc. of $0.9844 on October 16, 1998, as reported on the Nasdaq National Market, as divided by the exchange ratio in the Transaction of .13064 for the Senior Subordinated Units and the Common Units. THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT SPECIFICALLY STATING THAT THE REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------PROPOSED AMOUNT MAXIMUM PROPOSED MAXIMUM AMOUNT OF TITLE OF EACH CLASS OF SECURITIES TO BE OFFERING PRICE AGGREGATE REGISTRATION TO BE REGISTERED REGISTERED PER UNIT(1) OFFERING PRICE(1) FEE - ------------------------------------------------------------------------------------------- Senior Subordinated Units of limited part- ner interest 3,676,058 $7.54 $27,717,477 $9,557 - ------------------------------------------------------------------------------------------- Common Units of limited partner interest 102,773 $7.54 $ 774,909 $ 268 - ------------------------------------------------------------------------------------------- Total................... $9,825 - ------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------- STAR GAS PARTNERS, L.P. 2187 ATLANTIC STREET STAMFORD, CONNECTICUT 06902 ACQUISITION PROPOSED -- YOUR VOTE IS VERY IMPORTANT , 1999 Dear Common Unitholder: You are cordially invited to attend a special meeting of the Partnership's Common Unitholders to be held at , New York, New York on , 1999. The formal Notice of Unitholders Meeting and a Proxy Statement relating to that meeting are enclosed. The Unitholders Meeting has been called for you to vote upon the Partnership's acquisition of Petroleum Heat and Power Co., Inc. ("Petro"). We believe that Petro is the nation's largest distributor of home heating oil and the principal consolidator of that highly fragmented industry. The details of the acquisition and several related transactions are described in the enclosed proxy materials. To assist you in understanding the Transaction, a question and answer section appears on pages 1-11. We believe this Transaction is an attractive opportunity for the Partnership. The acquisition has been structured with the intent of providing an increase in the Partnership's cash flow. Based on this expectation, we are increasing the annualized minimum quarterly distribution to our Common Unitholders from $2.20 per unit to $2.30 per unit. As a result of Petro's strong position in the home heating oil industry, we believe that the Transaction will also provide the Partnership with an additional source of acquisition and expansion opportunities. Petro Common Stockholders will be receiving subordinated units on which quarterly payments are permitted only after Common Unitholders have received their full quarterly distributions. We also believe the increased size of the Partnership will improve Common Unit market liquidity, investment community awareness and securities analyst research coverage. In summary, we see this as an opportunity to acquire a company that is expected to significantly increase the Partnership's size and scope of operations, growth prospects and ability to increase its distributions to Unitholders. A Special Committee of our Board of Directors, acting on behalf of the Public Common Unitholders, negotiated the terms of the Transaction. A.G. Edwards & Sons, Inc. was retained by the Special Committee as independent financial advisor, and has rendered an opinion that the Transaction is fair, from a financial point of view, to the Public Common Unitholders. BASED ON THE RECOMMENDATION OF THE SPECIAL COMMITTEE, THE BOARD OF DIRECTORS OF THE GENERAL PARTNER UNANIMOUSLY RECOMMENDS THAT THE COMMON UNITHOLDERS VOTE FOR THE TRANSACTION. Approval of the Transaction will require the AFFIRMATIVE vote of a majority of all Common Units (other than those held by Star Gas and its affiliates). Failure to vote by proxy or in person will have the same effect as a vote against the Transaction. IT IS, THEREFORE, VERY IMPORTANT THAT YOU VOTE. Whether or not you plan to attend the Unitholders Meeting, PLEASE TAKE THE TIME TO VOTE BY COMPLETING AND MAILING THE ENCLOSED PROXY CARD TO US. YOU SHOULD CAREFULLY CONSIDER EACH OF THE FACTORS DESCRIBED UNDER "RISK FACTORS," STARTING ON PAGE 48 OF THE ATTACHED PROXY STATEMENT. THE FACTORS DISCUSSED INCLUDE THE FOLLOWING: . THE PARTNERSHIP IS ACQUIRING AN ENTITY WHICH, BASED ON 1997 REVENUES, IS SEVERAL TIMES ITS SIZE. THEREFORE, THE NATURE OF THE PARTNERSHIP'S BUSINESS WILL BE SIGNIFICANTLY CHANGED. . PETRO HAS A HISTORY OF OPERATIONAL AND FINANCIAL DIFFICULTIES AND ACCOUNTING LOSSES. . THE SUCCESS OF THE TRANSACTION DEPENDS UPON THE PARTNERSHIP'S ABILITY TO --CONTINUE TO MAKE ACQUISITIONS AT ATTRACTIVE PRICES; --CONTINUE TO REDUCE PETRO'S CUSTOMER ATTRITION RATE; AND --CONTINUE TO IMPROVE PETRO'S PROFIT MARGINS ON A PER GALLON BASIS. More detailed information about the Unitholders Meeting is included in the attached Notice of Unitholders Meeting and the Proxy Statement. You are urged to read carefully the Proxy Statement and the Annexes thereto for more detailed information concerning Petro, the Partnership, and the Transaction. If you have any questions or need help in voting your Common Units, please call me directly or Richard F. Ambury, Vice President Finance at (203) 328-7313. Very truly yours, Joseph P. Cavanaugh President, Star Gas Corporation -2- STAR GAS PARTNERS, L.P. NOTICE OF MEETING OF HOLDERS OF COMMON UNITS TO BE HELD ON , 1999 , 1999 TO THE HOLDERS OF COMMON UNITS: NOTICE IS HEREBY GIVEN that a meeting of the holders ("Common Unitholders") of the common units of limited partner interest (the "Common Units") of Star Gas Partners, L.P., a Delaware limited partnership (the "Partnership"), will be held at , New York, New York on , 1999 at a.m., New York City time, and at any adjournment or postponement thereof (the "Unitholders Meeting"), to consider and vote upon matters related to the proposed acquisition by the Partnership of Petroleum Heat and Power Co., Inc., a Minnesota corporation ("Petro"), and related financings as described below. The following proposals are to be presented at the Unitholders Meeting: (a) A proposal (the "Acquisition Proposal") to approve and adopt (i) the Agreement and Plan of Merger dated as of October 22, 1998 attached hereto as Annex A, pursuant to which a wholly-owned subsidiary of the Partnership will be merged with and into Petro (the "Merger"), and Petro Common Stockholders will receive subordinated units of the Partnership; and (ii) the Exchange Agreement dated as of October 17, 1998 attached hereto as Annex B, pursuant to which Petro Common Stockholders considered to be affiliates of Petro will exchange their shares of Petro Common Stock for subordinated units of the Partnership; (b) A proposal to amend the Agreements of Limited Partnership of the Partnership and of the Star Gas Propane, L.P. (the "Operating Partnership") (the "Amendment Proposal"); and (c) A proposal to permit Star Gas Corporation ("Star Gas") to withdraw as the general partner of the Partnership and the Operating Partnership and to approve the substitution of Star Gas LLC as the new general partner (the "General Partner Proposal" and, collectively with the Amendment Proposal and the Acquisition Proposal, the "Star Proposals"). The Unitholders Meeting has been called by Star Gas for the purpose of submitting the Star Proposals to the Common Unitholders for their approval, as well as such other business as may properly come before the meeting. The Board of Directors of Star Gas has fixed the close of business on , 1999 as the record date (the "Star Gas Record Date") for determination of the Unitholders entitled to notice of, and to vote at, the Unitholders Meeting. The AFFIRMATIVE vote of the holders of a majority of the Common Units (other than Common Units held by Star Gas and its affiliates) outstanding on the Star Gas Record Date is required to approve each of the Star Proposals. Common Unitholders do not have dissenters' rights in connection with the Star Proposals to be considered at the Unitholders Meeting. You are invited to attend the Unitholders Meeting in person. An abstention or failure to vote or a failure to give instructions to a broker-nominee will have the same effect as a negative vote. Accordingly, whether or not you currently plan to attend, PLEASE COMPLETE, SIGN AND DATE THE ENCLOSED PROXY CARD AND RETURN IT PROMPTLY IN THE PREPAID RETURN ENVELOPE. An executed proxy card that does not indicate how Common Units are to be voted will be voted FOR all the Star Proposals. Returning your proxy card now will not prevent you from voting in person at the Unitholders Meeting, but will assure that your vote is counted if you are unable to attend. As described in the attached Proxy Statement, a Common Unitholder may revoke a proxy at any time before it has been voted by (a) delivering written notice of revocation to Richard F. Ambury, Vice President of Star Gas, whose address is c/o Star Gas Corporation, 2187 Atlantic Street, Stamford, Connecticut 06902, (b) executing and submitting a proxy card bearing a later date, or (c) attending the Unitholders Meeting and voting in person. If your Common Units are held in the name of a brokerage firm or other nominee, only it can vote your Units. To ensure that your Common Units are voted, follow the voting instructions provided to you by such firm or nominee with the enclosed Proxy Statement or telephone the person responsible for your account today to obtain instructions on how to direct him or her to execute a proxy card on your behalf. We urge you to complete, sign and date the enclosed proxy card and return it promptly in the prepaid return envelope, whether or not you intend to be present at the Unitholders Meeting. By Order of the Board of Directors of the General Partner Audrey L. Sevin Secretary Dated: , 1999 -2- PETROLEUM HEAT AND POWER CO., INC. 2187 ATLANTIC STREET STAMFORD, CONNECTICUT 06902 ACQUISITION PROPOSED--YOUR VOTE IS VERY IMPORTANT , 1999 Dear Common Stockholder: You are cordially invited to attend a special meeting of Common Stockholders to be held at , New York, New York on , 1999. The formal Notice of Stockholders Meeting and a Proxy Statement relating to that meeting are enclosed. The Special Meeting has been called for you to vote upon the acquisition of Petro by Star Gas Partners, L.P. (the "Partnership"). The details of the acquisition and several related transactions are described in the enclosed proxy materials. To assist you in understanding the Transaction, a question and answer section appears on pages 1-11. We think this Transaction is an attractive opportunity for Petro's Common Stockholders. We believe Petro is the largest home heating oil distributor in the U.S. and the principal consolidator of that highly fragmented industry. However, it does not have the financial flexibility to fully capitalize on this position. This Transaction will provide Petro with access to lower cost capital to fund its growth through acquisition strategy and make capital investments necessary to take advantage of its size. In addition, we believe that as part of a publicly traded master limited partnership, Petro will receive a better market valuation and the Partnership will receive more investment community awareness and securities analyst research coverage. Please note that the Partnership generally distributes to its partners the available cash it generates from its operations. We believe that this Transaction will increase the likelihood of a resumption of annual cash distributions to Petro Common Stockholders whose dividends have been suspended. If this Transaction is completed, Public Common Stockholders will receive .13064 of a Senior Subordinated Unit for each share of their Petro Common Stock. The Senior Subordinated Units have been approved for listing on the New York Stock Exchange under the symbol " ". No assurance can be given that an active trading market for the Senior Subordinated Units will develop or at what price the Senior Subordinated Units will trade. If the Partnership generates sufficient available cash, the Minimum Quarterly Distribution with respect to the Senior Subordinated Units will be $0.575 per Unit ($2.30 on an annual basis). Actual distributions will be subject, however, to certain limitations and may not be paid if certain assumptions regarding weather or the Partnership's operations are not realized. Dain Rauscher Wessels, a division of Dain Rauscher Incorporated, was retained by the Board of Directors of Petro and has rendered an opinion that the consideration to be received by the Public Common Stockholders is fair, from a financial point of view, to such holders. Based on a variety of factors, including the opinion of Dain Rauscher Wessels, THE PETRO BOARD UNANIMOUSLY RECOMMENDS THAT THE COMMON STOCKHOLDERS VOTE FOR THE TRANSACTION. Approval of the Transaction will require the AFFIRMATIVE vote of the holders of a majority of the shares of Class A Common Stock (other than the Class A Common Stock owned by the directors and executive officers of Petro and their affiliates). Failure to vote by proxy or in person will have the same effect as a vote against the Transaction. IT IS, THEREFORE, VERY IMPORTANT THAT YOU VOTE. Whether or not you plan to attend the Special Meeting, PLEASE TAKE THE TIME TO VOTE BY COMPLETING AND MAILING THE ENCLOSED PROXY CARD TO US. YOU SHOULD REALIZE THAT THE SENIOR SUBORDINATED UNITS IN THE PARTNERSHIP THAT YOU WOULD RECEIVE IN THE TRANSACTION ARE VERY DIFFERENT FROM THE SHARES OF COMMON STOCK THAT YOU CURRENTLY OWN. YOU SHOULD CAREFULLY CONSIDER EACH OF THE FACTORS DESCRIBED UNDER "RISK FACTORS," STARTING ON PAGE 48 OF THE ATTACHED PROXY STATEMENT. THE FACTORS DISCUSSED INCLUDE THE FOLLOWING: . THE PAYMENT OF CASH DISTRIBUTIONS ON THE SENIOR SUBORDINATED UNITS IS NOT ASSURED AND MAY FLUCTUATE WITH PARTNERSHIP OPERATIONS. DUE TO THE SUBORDINATION PROVISIONS OF THE PARTNERSHIP AND LIMITATIONS ON THE PAYMENT OF DISTRIBUTIONS, DISTRIBUTIONS MAY NOT BE PAID ON THE SENIOR SUBORDINATED UNITS IF CERTAIN ASSUMPTIONS REGARDING WEATHER OR THE PARTNERSHIP'S OPERATIONS ARE NOT REALIZED. . THERE IS NO MARKET FOR THE SENIOR SUBORDINATED UNITS, AND THERE IS UNCERTAINTY AS TO THE PRICE AT WHICH THE SENIOR SUBORDINATED UNITS WILL TRADE OR WHETHER AN ACTIVE MARKET FOR THE SENIOR SUBORDINATED UNITS WILL DEVELOP. . HOLDERS OF SENIOR SUBORDINATED UNITS HAVE SUBSTANTIALLY DIFFERENT, AND PROBABLY FEWER, LEGAL RIGHTS THAN COMMON STOCKHOLDERS. . CERTAIN TYPES OF INVESTORS SUCH AS TAX-EXEMPT ENTITIES, REGULATED INVESTMENT COMPANIES AND FOREIGN TAXPAYERS MAY FACE SPECIAL DISADVANTAGES IN OWNING PARTNERSHIP INTERESTS SUCH AS THE SENIOR SUBORDINATED UNITS. . THE PARTNERSHIP IS SUBJECT TO SIGNIFICANT OPERATING RISKS. More detailed information about the Special Meeting is included in the attached Notice of Special Meeting and the Proxy Statement. You are urged to read carefully the Proxy Statement and the Annexes thereto for more detailed information concerning Petro, the Partnership, and the Transaction. If you have any questions or need help in voting your Common Stock, please call Audrey L. Sevin, Secretary of Petro at (203) 325-5400. Very truly yours, Irik P. Sevin Chairman of the Board and Chief Executive Officer -2- PETROLEUM HEAT AND POWER CO., INC. NOTICE OF SPECIAL MEETING OF HOLDERS OF COMMON STOCK TO BE HELD ON , 1999 TO THE HOLDERS OF COMMON STOCK: NOTICE IS HEREBY GIVEN that a special meeting of the holders (the "Common Stockholders") of Class A Common Stock and Class C Common Stock (collectively, the "Common Stock") of Petroleum Heat and Power Co., Inc., a Minnesota corporation ("Petro"), will be held at , New York, New York on , 1999 at 10:00 a.m., New York City time, and at any adjournment or postponement thereof (the "Special Meeting"), to consider and vote upon a proposal relating to the acquisition of Petro by Star Gas Partners, L.P., a Delaware limited partnership (the "Partnership"), and related financings (the "Transaction"). The following proposal is to be presented at the Special Meeting: A proposal (the "Acquisition Proposal") to approve and adopt (i) the Agreement and Plan of Merger dated as of October 22, 1998, pursuant to which a subsidiary of the Partnership will be merged with and into Petro, and Common Stockholders will receive subordinated units of the Partnership, and (ii) the Exchange Agreement dated as of October 17, 1998, pursuant to which Common Stockholders considered to be affiliates of Petro will exchange their shares of Common Stock for subordinated units of the Partnership. The Special Meeting has been called by Petro for the purpose of submitting the Acquisition Proposal to the Common Stockholders for their approval, as well as such other business as may properly come before the meeting. The Board of Directors of Petro has fixed the close of business on , 1999 as the record date (the "Petro Record Date") for determination of the Common Stockholders entitled to notice of, and to vote at, the Special Meeting. The AFFIRMATIVE vote of a majority of Class A Common Stock (other than Class A Common Stock owned by the directors and executive officers of Petro and their affiliates), and a majority of Class C Common Stock outstanding on the Petro Record Date is required to approve the Acquisition Proposal. If the Transaction is consummated, Common Stockholders who do not vote their shares in favor of the Acquisition Proposal and who strictly comply with the applicable sections of the Minnesota Business Corporation Act (the "Dissenting Stockholders") will be entitled to statutory dissenters' appraisal rights. For a description of the rights of Dissenting Stockholders and of the procedures to be followed by Dissenting Stockholders in order to assert such rights and obtain payment for their shares of Common Stock, see Annex F to the accompanying Proxy Statement, as well as the information set forth under the caption "Dissenters' Rights" in the accompanying Proxy Statement. You are invited to attend the Special Meeting in person. An abstention or failure to vote or a failure to give instructions to a broker-nominee will have the same effect as a negative vote. Accordingly, whether or not you currently plan to attend, PLEASE COMPLETE, SIGN AND DATE THE ENCLOSED PROXY CARD AND RETURN IT PROMPTLY IN THE PREPAID RETURN ENVELOPE. An executed proxy card that does not indicate how Common Stock is to be voted will be voted FOR the Acquisition Proposal. Returning your proxy card now will not prevent you from voting in person at the Special Meeting, but will assure that your vote is counted if you are unable to attend. As described in the attached Proxy Statement, a Common Stockholder may revoke a proxy at any time before it has been voted by (a) delivering written notice of revocation to Audrey L. Sevin, Secretary of Petro, whose address is c/o Petroleum Heat and Power Co., Inc., 2187 Atlantic Street, Stamford, Connecticut 06902, (b) executing and submitting a proxy card bearing a later date, or (c) attending the Special Meeting and voting in person. If your Common Stock is held in the name of a brokerage firm or other nominee, only it can vote your shares. To ensure that your Common Stock is voted, follow the voting instructions provided to you by such firm or nominee with the enclosed Proxy Statement or call the person responsible for your account today to obtain instructions on how to direct him or her to execute a proxy card on your behalf. We urge you to complete, sign and date the enclosed proxy card and return it promptly in the prepaid return envelope, whether or not you intend to be present at the Special Meeting. By Order of the Board of Directors Audrey L. Sevin Secretary Dated: , 1999 -2- ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ + INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A + + REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE + + SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY + + OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT + + BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR + + THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE + + SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE + + UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF + + ANY STATE. + ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ STAR GAS PARTNERS, L.P. AND PETROLEUM HEAT AND POWER CO., INC. JOINT PROXY STATEMENT ----------- STAR GAS PARTNERS, L.P. PROSPECTUS ----------- This Joint Proxy Statement and Prospectus ("Proxy Statement") describes in detail the proposed acquisition by Star Gas Partners, L.P., a Delaware limited partnership (the "Partnership"), of Petroleum Heat and Power Co., Inc., a Minnesota corporation ("Petro"), and certain related transactions (the "Transaction"). If the Transaction is completed, Petro will become a wholly- owned indirect subsidiary of the Partnership and the common stockholders of Petro will become holders of subordinated units of the Partnership. This Proxy Statement is being furnished to the holders (the "Common Unitholders") of common units of limited partner interest ("Common Units") in the Partnership, as of , 1999 (the "Star Gas Record Date"), in connection with the solicitation of proxies by the Board of Directors (the "Star Gas Board") of Star Gas Corporation, the general partner of the Partnership ("Star Gas"), for use at a special meeting of Common Unitholders to be held at , New York, New York on , 1999, at a.m., New York City time, and at any and all adjournments or postponements thereof (the "Unitholders Meeting"). This Proxy Statement is also being furnished to holders (the "Common Stockholders") of Petro Class A Common Stock and Class C Common Stock (collectively, the "Common Stock"), as of , 1999 (the "Petro Record Date"), in connection with the solicitation of proxies by the Board of Directors of Petro (the "Petro Board") for use at a special meeting of Common Stockholders to be held at , New York, New York on , 1999, at 10:00 a.m., New York City time, and at any and all adjournments or postponements thereof (the "Special Meeting," and together with the Unitholders Meeting, the "Meetings"). This Proxy Statement also constitutes the Prospectus of the Partnership in connection with the possible resale by certain persons who may be deemed to be affiliates of Petro of the Partnership Units to be received by them pursuant to the Transaction. The Proxy Statement and the accompanying forms of proxy are first being mailed to the Common Unitholders and the Common Stockholders on or about , 1999. SEE "RISK FACTORS," BEGINNING ON PAGE 48, FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY THE COMMON UNITHOLDERS AND THE COMMON STOCKHOLDERS. NEITHER THIS TRANSACTION NOR THESE SECURITIES HAVE BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION. THE SECURITIES AND EXCHANGE COMMISSION HAS NOT PASSED UPON THE FAIRNESS OR MERITS OF THIS TRANSACTION OR UPON THE ACCURACY OR ADEQUACY OF THIS PROXY STATEMENT. ANY REPRESENTATION TO THE CONTRARY IS UNLAWFUL. The date of this Proxy Statement is , 1999. STATEMENT OF FORWARD-LOOKING DISCLOSURE Some of the information in this Proxy Statement may contain forward-looking statements. Such statements can be identified by the use of forward-looking terminology such as "may," "will," "believe," "expect," "anticipate," "estimate," "continue," or other similar words. These statements discuss future expectations, contain projections of results of operations or of financial condition, or state other "forward-looking" information. When considering such forward-looking statements, you should keep in mind the risk factors and other cautionary statements in this Proxy Statement. The risk factors noted under "Risk Factors" and other factors noted throughout this Proxy Statement, including certain risks and uncertainties, could cause our actual results to differ materially from those contained in any forward-looking statement. CAUTIONARY STATEMENT All information contained in this Proxy Statement with respect to the Partnership, the Operating Partnership and its subsidiary, New Petro, Inc. ("Mergeco"), has been provided by Star Gas. All information contained in this Proxy Statement with respect to Petro and its subsidiaries has been provided by Petro. . You should rely only on the information contained in this document or what we have referred you to. We have not authorized anyone to provide you with information that is different. . We are not offering to sell or seeking your offer to buy these securities in any state where it is illegal to do so. . We are not seeking your proxy in any state where it is illegal to do so. . This information may change after , 1999. ii TABLE OF CONTENTS
STATEMENT OF FORWARD-LOOKING DISCLOSURE.................................... ii CAUTIONARY STATEMENT....................................................... ii QUESTIONS AND ANSWERS...................................................... 1 Questions and Answers About the Acquisition for the Partnership's Common Unitholders....................................................... 1 Questions and Answers About the Transaction for Petro Common Stockholders............................................................. 7 PROXY STATEMENT SUMMARY.................................................... 12 Parties................................................................... 12 Potential Advantages to the Common Unitholders............................ 13 Potential Disadvantages and Risks to the Common Unitholders............... 13 Potential Advantages to the Common Stockholders........................... 14 Potential Disadvantages and Risks to the Common Stockholders.............. 14 Recommendations of the Special Committee and Star Gas Board and Opinion of A.G. Edwards & Sons, Inc................................................. 15 Recommendations of Petro Board and Opinion of Dain Rauscher Wessels....... 16 The Transaction........................................................... 16 The Merger and the Exchange............................................... 17 Related Financing and Refinancing Transactions............................ 17 New General Partner....................................................... 18 Amendment of the Partnership Agreement.................................... 18 Estimated Sources and Uses of Funds of the Equity Offering and Debt Offering................................................................. 20 Outstanding Partnership Units............................................. 20 Captialization............................................................ 21 Interests of Certain Persons in the Transaction; Conflicts of Interest.... 22 Cash Available for Distribution........................................... 23 Description of the Partnership Units...................................... 25 Partnership Structure and Management Following the Transaction............ 32 Summary Selected Historical Financial and Operating Data of the Partnership.............................................................. 35 Summary Selected Historical Financial and Operating Data of Petro......... 37 Selected Unaudited Pro Forma Condensed Consolidated Financial Information.............................................................. 39 iii
Comparative Market Price Information....................................... 41 Certain Federal Income Tax Considerations.................................. 41 Accounting Treatment....................................................... 44 Dissenters' Rights......................................................... 44 The Meetings............................................................... 44 Votes Required; Record Date................................................ 45 Effective Time............................................................. 46 Conditions to the Consummation of the Transaction.......................... 46 Regulatory Matters......................................................... 46 Amendment and Termination of the Merger Agreement.......................... 47 RISK FACTORS................................................................ 48 Risks to the Partnership's Common Unitholders.............................. 48 Tax Risks to Common Unitholders............................................ 54 Risks to Common Stockholders............................................... 55 Tax Risks to Common Stockholders........................................... 62 INTERESTS OF CERTAIN PERSONS IN THE TRANSACTION; CONFLICTS OF INTEREST...... 66 The Partnership............................................................ 66 Petro...................................................................... 66 CONFLICTS OF INTEREST AND FIDUCIARY RESPONSIBILITY OF THE GENERAL PARTNER OF THE PARTNERSHIP......................................................... 67 Conflicts of Interest...................................................... 67 Fiduciary Duties of the General Partner.................................... 70 PARTIES TO THE TRANSACTION.................................................. 72 The Partnership and the Operating Partnership.............................. 72 Petro...................................................................... 73 THE UNITHOLDERS MEETING..................................................... 75 Date, Time and Place....................................................... 75 Purpose.................................................................... 75 Star Gas Record Date....................................................... 75 Recommendations of the Special Committee and the Star Gas Board............ 75 Proxies and Revocability of Proxies........................................ 75 Cost of Solicitation of Proxies............................................ 76 Voting Rights; Vote Required............................................... 76 Quorum; Adjournment........................................................ 77 THE SPECIAL MEETING......................................................... 78 Date, Time and Place....................................................... 78 Purpose.................................................................... 78 Petro Record Date.......................................................... 78
Petro Board Recommendation................................................. 78 Proxies and Revocability of Proxies........................................ 78 Cost of Solicitation of Proxies............................................ 79 Voting Rights; Vote Required............................................... 79 Petro Preferred Stock...................................................... 80 Class B Shares............................................................. 80 Quorum; Adjournment........................................................ 80 THE TRANSACTION............................................................. 81 Description of the Transaction............................................. 81 Description of the Merger and the Exchange................................. 81 Related Financing and Refinancing Transactions.............................................................. 83 Background of and Reasons for the Transaction............................................................... 85 Reasons for the Transaction; Recommendation of the Special Committee....... 96 Opinion of A.G. Edwards.................................................... 98 Reasons for the Transaction; Recommendation of the Petro Board............. 107 Opinion of Dain Rauscher Wessels........................................... 109 Certain Projections of Petro and the Partnership............................................................... 119 Description of the Merger Agreement........................................ 125 Restrictions on Resales by Affiliates...................................... 133 Selling Unitholders........................................................ 133 Plan of Distribution....................................................... 134 Accounting Treatment....................................................... 135 Regulatory Matters......................................................... 135 MANAGEMENT OF THE PARTNERSHIP AFTER THE TRANSACTION......................... 136 General Partner............................................................ 136 Board of Directors of Star Gas LLC......................................... 136 Officers and Employees of the Operating Partnership and Petro.............. 137 Reimbursement of Expenses of the General Partner........................... 137 BENEFICIAL OWNERSHIP OF PRINCIPAL UNITHOLDERS AND MANAGEMENT................ 138 AMENDMENTS TO THE PARTNERSHIP AGREEMENTS.................................... 139 Introduction; Required Vote by Unitholders................................. 139 Summary of Amendments to the Partnership Agreement..................................................... 139 Summary of Amendments to the Operating Partnership Agreement............... 144 THE AMENDED AND RESTATED PARTNERSHIP AGREEMENT...................................................... 145 Organization and Duration.................................................. 145 iv
Purpose................................................................... 145 Power of Attorney......................................................... 145 Restrictions on Authority of the General Partner with Respect to Extraor- dinary Transactions; Lack of Dissenters' Rights.......................... 146 Withdrawal or Removal of the General Partner; Approval of Successor General Partner........................... 146 Transfer of General Partner Interest...................................... 148 Reimbursement for Services................................................ 148 Status as Limited Partner or Assignee..................................... 148 Non-citizen Assignees; Redemption......................................... 149 Issuance of Additional Securities......................................... 149 Limited Call Right........................................................ 150 Amendment of Amended and Restated Partnership Agreement.................................................... 151 Meetings; Voting.......................................................... 152 Indemnification........................................................... 153 Limited Liability......................................................... 154 Books and Reports......................................................... 155 Right to Inspect Partnership Books and Records.................................................................. 156 Termination and Dissolution............................................... 156 Liquidation and Distribution of Proceeds.................................. 156 Registration Rights....................................................... 157 CASH DISTRIBUTION POLICY................................................... 158 General................................................................... 158 Quarterly Distributions of Available Cash................................. 159 Distributions of Available Cash from Operating Surplus During the Subordination Period..................................................... 159 Distributions of Available Cash from Operating Surplus After the Subordination Period..................................................... 161 Incentive Distributions During the Subordination Period..................................................... 161 Incentive Distributions After the Subordination Period..................................................... 162 Distributions from Capital Surplus........................................ 163 Limitation on Distributions on Subordinated Interests..................... 163 Adjustment of Minimum Quarterly Distribution and Target Distribution Lev- els...................................................................... 165 Issuance of Additional Senior Subordinated Units.......................... 165 Distributions of Cash upon Liquidation During the Subordination Period.......................................... 167 Distributions of Cash upon Liquidation After the Subordination Period........................................... 168
CASH AVAILABLE FOR DISTRIBUTION............................................. 170 DESCRIPTION OF THE UNITS.................................................... 171 The Units.................................................................. 171 Transfer Agent and Registrar............................................... 171 Transfer of Units.......................................................... 172 COMPARISON OF SECURITIES.................................................... 174 Taxation................................................................... 174 Distributions and Dividends................................................ 174 Voting Rights.............................................................. 175 Rights to Call Meetings.................................................... 175 Removal of Directors or the General Partner................................ 175 Liquidation Rights......................................................... 176 Conversion Rights.......................................................... 176 Liability of Holders....................................................... 176 Transferability and Listing................................................ 177 Redemption................................................................. 177 Appraisal Rights........................................................... 177 Preemptive Rights.......................................................... 178 Inspection of Books, Records and List of Holders........................... 178 COMPARATIVE SECURITY PRICE AND DISTRIBUTION INFORMATION..................... 179 Partnership Securities..................................................... 179 Petro Capital Stock........................................................ 180 Comparative Per Share/Per Unit Information (Unaudited)..................... 181 CERTAIN FEDERAL INCOME TAX CONSIDERATIONS................................... 182 Tax Consequences of the Merger............................................. 182 Tax Consequences of Unit Ownership......................................... 183 Allocation of Partnership Income, Gain, Loss and Deduction................. 189 Tax Treatment of Operations................................................ 190 Disposition of Units....................................................... 193 Uniformity of Units........................................................ 195 Administrative Matters..................................................... 197 State, Local and Other Tax Considerations.................................. 200 v
DISSENTERS' RIGHTS.......................................................... 202 LEGAL MATTERS............................................................... 206 EXPERTS..................................................................... 206 WHERE YOU CAN FIND MORE INFORMATION......................................... 206 INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE............................. 207 UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION............ 209 Star Gas Partners, L.P. and Subsidiary--Pro Forma Condensed Consolidated Balance Sheet (Unaudited)................................................. 209 Star Gas Partners, L.P. and Subsidiary--Pro Forma Condensed Consolidated Statement of Operations (Unaudited)--Year Ended September 30, 1997........ 210 Star Gas Partners, L.P. and Subsidiary--Pro Forma Condensed Consolidated Statement of Operations (Unaudited)--Nine Months Ended June 30, 1998...... 211 GLOSSARY OF TERMS........................................................... 216 APPENDIX A--Application for Transfer of Units............................... A-1 Annexes A Merger Agreement B Exchange Agreement C Amended and Restated Partnership Agreement D Opinion of A.G. Edwards & Co. Inc. E Opinion of Dain Rauscher Wessels F Copy of Sections 302A.471 and 302A.473 of Minnesota Business Corporation Act G Calculation of Pro Forma Available Cash from Operating Surplus QUESTIONS AND ANSWERS QUESTIONS AND ANSWERS ABOUT THE ACQUISITION FOR THE PARTNERSHIP'S COMMON UNITHOLDERS Q: WHAT IS BEING PROPOSED? WHAT ARE THE REASONS FOR IT? A: You are considering the acquisition by Star Gas Partners, L.P. (the "Partnership") of Petroleum Heat & Power Co., Inc. ("Petro"), in exchange for interests in the Partnership that are subordinated to the Common Units. We believe that Petro is the largest home heating oil distributor in the country. In addition, Petro has been the principal consolidator of that highly fragmented industry, having purchased over 180 retail home heating oil companies since 1979. Competition for acquisitions in the propane industry has intensified, decreasing the opportunities available, and increasing the prices paid, for propane companies. We believe Petro's strong position in the home heating oil industry will provide the Partnership with an additional source of attractive acquisition and expansion opportunities. In addition, the acquisition of Petro has been structured with the intent of providing an increase in the Partnership's cash flow. Based on this expectation, we are increasing the annualized Minimum Quarterly Distribution from $2.20 to $2.30 per Unit. In summary, we see this as an opportunity to acquire a company that is expected to significantly increase the Partnership's size and scope of operations, growth prospects and ability to increase its distributions to Unitholders. Q: WHO IS PETRO? A: . We believe Petro is the nation's largest retail distributor of home heating oil. It sells approximately 400 million gallons of home heating oil annually to approximately 340,000 customers through 24 branch locations located throughout the Northeast and Mid Atlantic regions of the United States, including the major metropolitan areas of Boston, Providence, New Haven, New York City, Long Island, Baltimore and Washington, D.C. . A publicly-traded corporation whose Common Stock is listed on the Nasdaq National Market under the symbol "HEAT." . The current owner of the Partnership's existing general partner, Star Gas, and the owner of all of the Partnership's outstanding Subordinated Units. Q: WHAT ARE THE POTENTIAL BENEFITS TO THE COMMON UNITHOLDERS? A: We believe that the Transaction will offer several potential benefits to Common Unitholders, including: . The Minimum Quarterly Distribution to Unitholders will increase from $2.20 to $2.30 per Unit annually, subject to Available Cash to make such distribution. . The Transaction has been structured with the intent of providing an increase in the Partnership's distributable cash flow per Unit. If this expectation is realized, it will provide greater protection of the Minimum Quarterly Distribution and improve the possibility of future distribution increases. . The acquisition of Petro should improve the Partnership's growth prospects by providing the Partnership with an additional source of attractive acquisition and expansion opportunities. . Petro Common Stockholders will be receiving subordinated units entitling them to receive distributions only after the Partnership's Common Unitholders receive their full Minimum Quarterly Distribution. . The Subordination Period during which the Common Unit distribution is senior to the subordinated units has been extended 18 months to July 1, 2002. . The Transaction will increase the Partnership's market capitalization and should provide greater Common Unit market liquidity, investment community awareness and the ability to attract securities analyst research coverage. Q: WHAT ARE THE POTENTIAL DISADVANTAGES AND RISKS TO COMMON UNITHOLDERS? A: The following are potential disadvantages and risks of the Transaction: . The Partnership is acquiring an entity which, based on 1997 revenues, is several times its size. Therefore, the nature of the Partnership's business will be significantly changed. . Petro has a history of operational and financial difficulties (including high leverage and recent substantial net losses). . The success of the Transaction depends upon the Partnership's ability to - -- Continue to make acquisitions at attractive prices; - -- Continue to reduce Petro's customer attrition rate; and - -- Continue to improve Petro's profit margins on a per gallon basis. . The Partnership is making a large investment in a business which, like the Partnership's propane operations, is negatively affected by warm weather during the winter months. . The home heating oil business is not a growth business as a result of increased competition from alternative energy sources . In the Transaction, the proportion of subordinated units to total Units will decline from 37.5% to 26.0%, and the support to Common Units will therefore be reduced. . The number of Common Units will increase from approximately 3.9 million to 10.3 million, representing potential significant dilution. . The income of Petro, unlike the income from the Partnership's propane operations, will be subject to corporate tax prior to any distributions. . The ratio of taxable income to cash distributions to be made to the existing Common Unitholders will increase over time at a greater rate than if the Transaction does not occur, and dividend income from Petro cannot be offset with past or future losses generated by the Partnership's propane operations. 2 Q: WHAT ARE THE CONFLICTS OF INTEREST IN STRUCTURING THE TRANSACTION? A: Star Gas, the current general partner of the Partnership, is a wholly-owned subsidiary of Petro, and Petro owns all of the outstanding Subordinated Units of the Partnership. All but two of the directors of Star Gas are also directors or officers of Petro. As a result, Star Gas and Petro's representatives on the Star Gas Board have interests that are different from, and in conflict with, the interests of the Common Unitholders. The officers of Star Gas and members of the Star Gas Board, including the members of the Special Committee (discussed below), will be indemnified, to the extent permitted by law, for any and all actions taken in connection with the Transaction. Q: WHAT IS THE SPECIAL COMMITTEE? A: The special committee (the "Special Committee") consists of the two members of the Star Gas Board, who are neither officers, directors nor employees of Petro and who were originally elected to the Star Gas Board by Petro. They were appointed by the Star Gas Board as a Special Committee to negotiate the acquisition on behalf of the public Common Unitholders (the "Public Common Unitholders") of the Partnership, for which they will each receive additional compensation of $40,000. Q: WHAT ARE THE PURPOSES OF THE UNITHOLDERS MEETING? A: A Unitholders Meeting has been called to consider and vote upon several matters, including the Star Proposals (discussed below), which must be approved in order to consummate the acquisition of Petro. The affirmative vote of a majority of the Common Units outstanding (excluding the Common Units owned by Star Gas and its affiliates) on the Star Record Date is required to approve each of the Star Proposals. None of the Star Proposals will be effected unless all of them are approved. Q: WHAT ARE THE STAR PROPOSALS? A: There are three proposals that Public Common Unitholders are being asked to approve: . The Acquisition Proposal. The acquisition consists of an exchange by certain stockholders of Petro who are considered to be affiliates of their Common Stock for subordinated units in the Partnership (the "Exchange") and a merger of a wholly-owned subsidiary of Star Gas into Petro (the "Merger"), in which the remaining Petro Common Stockholders will receive subordinated units in the Partnership; . The Amendment Proposal. Certain amendments to the partnership agreement to facilitate the Transaction; and . The General Partner Proposal. The election of Star Gas LLC as the successor general partner. Q: WHAT ARE THE AMENDMENTS TO THE PARTNERSHIP AGREEMENT? A: The material amendments set forth in the Amended and Restated Partnership Agreement attached hereto as Annex C are as follows: . Increase the Minimum Quarterly Distribution from $0.55 to $0.575 per Unit; . Extend the earliest date upon which the Subordination Period can expire from January 1, 2001 to July 1, 2002; 3 . Authorize the issuance of Senior Subordinated Units and Junior Subordinated Units; . Redesignate the general partner interests as General Partner Units and subordinate the distribution rights of the General Partner Units to the Common Units and the Senior Subordinated Units; . Limit the amount of distributions that the Partnership can make during the Subordination Period on the Senior Subordinated Units, Junior Subordinated Units and General Partner Units; . Authorize the issuance of up to an additional 909,000 Senior Subordinated Units to the holders of the Senior Subordinated Units, Junior Subordinated Units and General Partner Units, but only if Petro satisfies certain financial goals; . Reallocate the incentive distribution rights previously held by the General Partner among the Senior Subordinated Units, Junior Subordinated Units and General Partner Units; . Eliminate the requirement that the General Partner maintain a fixed ownership interest in the Partnership and Operating Partnership; . Eliminate the net worth requirement of the General Partner; . Increase the $6 million basket in the definition of Operating Surplus proportionately with the number of Common Units issued in the Equity Offering; . Authorize the issuance of Common Units in the Equity Offering and increase the number of additional Common Units that may be issued during the Subordination Period without a Unitholder vote from 1,300,000 to 2,500,000; and . Provide the Senior Subordinated Units and Junior Subordinated Units (other than Units held by the General Partner and its affiliates) with a collective class vote on certain matters. Q: WHY IS THERE A NEW GENERAL PARTNER, AND WHO IS IT? A: As a result of the Transaction, Petro and its subsidiary, Star Gas (the current general partner), will become subsidiaries of the Partnership. The Partnership cannot have its own subsidiary serve as its general partner, so a new entity must be formed. The new general partner, Star Gas LLC, will be owned by certain affiliates of Petro. The Board of Directors of Star Gas LLC (the "Star Gas LLC Board") will be identical to the existing Star Gas Board as of the date of this Proxy Statement, except that, at her request, one of the current directors of Star Gas will withdraw as a director upon consummation of the Transaction as a result of additional duties associated with a new job. That director will be replaced by a director selected by the Star Gas LLC Board, and the new director will not be an officer or employee of Star Gas or any of its affiliates. The officers of Star Gas LLC will be certain of the current officers of Star Gas and Petro. Q: WHAT ARE THE TAX CONSEQUENCES OF THE ACQUISITION? A: The Transaction will not be taxable to the Common Unitholders. The Partnership will receive an opinion of counsel to the effect that upon consummation of the acquisition, the Partnership will continue to be classified as a partnership for federal income tax purposes. 4 . The ratio of taxable income to cash distributions to be made to the existing Common Unitholders will increase over time at a greater rate than if the Transaction does not occur, and dividend income from Petro cannot be offset with past or future losses generated by the Partnership's propane operations. The acquisition will have different tax effects on different Common Unitholders, depending on when they purchased their Units. Q: WHAT FINANCINGS WILL OCCUR IN CONNECTION WITH THE TRANSACTION? A: The Partnership intends to raise approximately $140 million through a public offering (the "Equity Offering") of Common Units and approximately $120 million through a debt offering (the "Debt Offering"). The proceeds from such offerings will be used to redeem certain outstanding debt and preferred stock of Petro. Q: WHAT ARE THE CONDITIONS PRECEDENT TO CLOSING THE TRANSACTION? A: In order for the Transaction to occur, the following conditions, among others, must be met: . The holders of a majority of Common Units (other than the Common Units owned by Star Gas and its affiliates) must approve the Star Proposals. . The holders of a majority of the shares of Class A Common Stock (other than Class A Common Stock owned by the directors and executive officers of Petro and their affiliates) and Class C Common Stock, each voting separately as a class, must approve the Acquisition Proposal. . Once the Star Proposals and the Acquisition Proposal are approved, the Equity Offering and Debt Offering must be completed. . The Partnership and Petro must receive all necessary regulatory and third party approvals. . The holders of no more than 10% of the outstanding shares of Common Stock shall have perfected their dissenters' rights. . Petro must meet certain financial tests set forth in the Merger Agreement. Q: WHEN IS THE TRANSACTION EXPECTED TO OCCUR? A: The Partnership and Petro are working towards completing the Transaction as soon as possible. Subject to the conditions set forth above, the Partnership and Petro anticipate completing the Transaction in early 1999. Q: WHAT IF THE TRANSACTION DOES NOT HAPPEN? A: If the required votes to approve each of the Star Proposals and the Acquisition Proposal are not obtained or other conditions are not satisfied, the ownership structures of the Partnership and Petro will continue as they are on the date of this Proxy Statement. Petro will remain the parent of the current general partner, and the Partnership's Common Units will continue to be traded on the New York Stock Exchange under the symbol "SGU". 5 Q: WHAT DO I NEED TO DO RIGHT NOW? A: Just return your signed proxy card in the enclosed return envelope as soon as possible in order for your Units to be represented at the meeting. Based on the recommendation of the Special Committee, the Star Gas Board unanimously recommends that Common Unitholders vote FOR the Star Proposals. Q: WHEN IS THE UNITHOLDERS MEETING? A: The meeting of the Common Unitholders will take place at a.m., New York City time, on , 1999, at , New York, New York. Q: DO I SEND IN MY UNIT CERTIFICATES? A: No. Your Common Units will continue to be listed and traded on the New York Stock Exchange. 6 QUESTIONS AND ANSWERS ABOUT THE TRANSACTION FOR PETRO COMMON STOCKHOLDERS Q: WHAT IS BEING PROPOSED? WHAT ARE THE REASONS FOR IT? A: You are considering the acquisition of Petro by the Partnership, as a result of which you (the "Public Common Stockholders") will receive Senior Subordinated Units of the Partnership that will be listed on the New York Stock Exchange in exchange for your shares of Common Stock. We believe Petro is the largest home heating oil distributor in the U.S. and the principal consolidator of that highly fragmented industry. However, Petro does not have the financial flexibility to fully capitalize upon the acquisition, operating and corporate branding opportunities resulting from this position. This Transaction will recapitalize Petro providing it with access to lower cost capital to better realize these growth opportunities. Q: WHO IS THE PARTNERSHIP? A:. We believe, the eighth largest retail propane distributor in the United States. . A publicly traded master limited partnership ("MLP") whose Common Units are listed on the New York Stock Exchange under the symbol "SGU." . A current subsidiary of Petro. The current general partner of the Partnership, Star Gas, is a wholly-owned subsidiary of Petro and owns all of the outstanding subordinated units of the Partnership. Q: WHAT ARE THE POTENTIAL BENEFITS TO THE COMMON STOCKHOLDERS? A:. This Transaction will provide Petro with the financial structure to implement its growth-through-acquisition strategy and invest in its operating and corporate branding opportunities. . We believe that as part of an MLP, Petro should receive an improved market valuation. Since MLP's are cash flow oriented and are valued primarily on a cash distribution basis, the MLP structure corresponds more closely with Petro's focus on cash flow. We also believe the Partnership will have greater investment community awareness as compared to Petro. As the only public home heating oil company, Petro has had limited securities analyst research coverage. . Although Petro has historically paid cash dividends to its Common Stockholders, these dividends have been suspended. The Partnership generally distributes to its partners the cash it generates from its operations. While there can be no assurance, this should give Common Stockholders an increased probability of a resumption of annual distributions. . You will receive Senior Subordinated Units that must receive their full Minimum Quarterly Distribution prior to any payments being made on the Junior Subordinated Units and the General Partner Units. 7 . The Senior Subordinated Units will be allocated certain incentive distribution rights previously held by the General Partner. To the extent that the Partnership generates cash above certain target distribution levels, the holders of Senior Subordinated Units may receive greater cash distributions than the Common Unitholders. . If Petro meets certain financial goals within the five-year period after closing, the holders of Senior Subordinated Units, Junior Subordinated Units and General Partner Units will receive up to an additional 909,000 Senior Subordinated Units. This enables Common Stockholders to continue to participate in Petro's future performance. Q: WHAT ARE THE POTENTIAL DISADVANTAGES AND RISKS? A: The following are potential disadvantages and risks to the Common Stockholders in the Transaction: . Unitholders in the Partnership have substantially different, and probably fewer, legal rights than Common Stockholders. . There is no current trading market for the Senior Subordinated Units. Although the Senior Subordinated Units have been approved for listing on the New York Stock Exchange, there is no assurance that any active trading market will develop after the closing of the Transaction. It is expected that the Senior Subordinated Units will trade at a lower price than the Common Units. . Distributions on the Senior Subordinated Units, Junior Subordinated Units and General Partner Units are not guaranteed and are subordinated to distributions on the Common Units. Further, distributions on the Senior Subordinated Units, Junior Subordinated Units and General Partner Units are generally limited to distributable cash generated after the closing of the Transaction. Therefore, there is significant uncertainty as to the amount and timing of such distributions. . Star Gas LLC, the new general partner in the Partnership, may have a greater number of conflicts of interest than the directors of Petro. . The Partnership's propane operations, like Petro's home heating oil business, are negatively affected by warm weather during the winter months. . The Partnership may face difficulties in the future in making attractive acquisitions in the propane industry because of the highly competitive nature of such industry. . Common Stockholders that are tax-exempt entities, regulated investment companies or foreign taxpayers may determine that holding an interest in the Partnership may be unattractive from a tax perspective. If certain of these investors sell their Senior Subordinated Units following the Transaction, the market price of the Senior Subordinated Units could fall substantially. Q: WHAT ARE THE CONFLICTS IN STRUCTURING THE TRANSACTION? A: Certain directors of Petro have interests in the Transaction that are different from, and in conflict with, the interests of the Public Common Stockholders, since such directors and their affiliates will receive consideration in the Transaction that is different from that of the Public Common Stockholders. These directors and their 8 affiliates will be exchanging their Common Stock for Junior Subordinated Units and General Partner Units, while the Public Common Stockholders and certain other directors and other affiliates will be receiving Senior Subordinated Units. The Junior Subordinated Units and General Partners Units will not be entitled to distributions until the Senior Subordinated Units receive the Minimum Quarterly Distribution. The Senior Subordinated Units will be publicly traded and have been approved for listing on the New York Stock Exchange. The Junior Subordinated Units and General Partner Units have not been registered and will not be publicly traded. The affiliates exchanging their Common Stock for Junior Subordinated Units and General Partner Units will receive .15909 Junior Subordinated Units or General Partner Units for each share of Common Stock, whereas the remaining Common Stockholders will exchange their shares for Senior Subordinated Units at a ratio of .13064 Senior Subordinated Units for each share of Common Stock. The Transaction has been structured so that the Public Common Stockholders will realize a taxable gain or loss on the Transaction, whereas all affiliates of Petro will exchange their Common Stock without realizing such a taxable gain or loss. This structure was designed to minimize the tax effect of the Transaction on Petro. It was also based on the assumption that certain Petro affiliates have a low tax basis and would prefer not realizing a taxable gain on the Transaction, whereas Public Common Stockholders generally have a higher tax basis and would prefer realizing a tax loss. The officers and directors of Petro will be indemnified, to the extent permitted by law, for any and all actions taken in connection with the Transaction. The officers of Petro will continue to be employed as officers following the Transaction. Q: WHAT IS THE PURPOSE OF THE SPECIAL MEETING? A: The purpose of the Special Meeting is for the holders of each class of Common Stock to consider and vote upon the Acquisition Proposal. Each class of Common Stock is entitled to one vote per share for this purpose. The affirmative vote of a majority of all votes that could be cast by the holders of each class of shares of Common Stock, outstanding as of the Petro Record Date, each voting separately as a class, and the holders of a majority of shares of Class A Common Stock held by the Public Common Stockholders outstanding as of the Petro Record Date, is required to approve the Acquisition Proposal. Q: WHAT ARE THE MERGER AND THE EXCHANGE? A: The Merger and the Exchange are the methods by which the acquisition will be effected. The Merger is the aspect of the acquisition in which Petro becomes a subsidiary of the Partnership. In order to accomplish this, Petro will be merged with a subsidiary of the Partnership. Pursuant to the Merger, the Common Stockholders will receive .13064 Senior Subordinated Units for each outstanding share of Common Stock. Pursuant to the Exchange, affiliated Common Stockholders will contribute their shares of Common Stock to the Partnership in exchange for Senior 9 Subordinated Units, Junior Subordinated Units and General Partner Units. Q: WHICH PARTS OF THE TRANSACTION AM I CONSIDERING? A: The Common Stockholders of Petro are only voting on the acquisition of Petro by the Partnership. Q: WHAT WILL I RECEIVE FOR MY COMMON STOCK IN THE TRANSACTION? A: For each of your shares of Common Stock, you will get .13064 Senior Subordinated Units of limited partner interest in the Partnership. You will receive a check in payment for any fractional units based on the market value of Senior Subordinated Units. For example, if you own 100 shares of Common Stock, you will receive 13 Senior Subordinated Units and a check for your fractional Unit. In addition, each Common Stockholder will receive: incentive distributions in excess of those made to the Common Unitholders if the Partnership generates cash above certain target distribution levels; and a pro rata distribution of up to an additional 909,000 Senior Subordinated Units, but only if Petro meets certain financial goals after the acquisition is consummated. Q: WHEN CAN I EXPECT TO RECEIVE MY FIRST DISTRIBUTION AS A HOLDER OF SENIOR SUBORDINATED UNITS? A: The earliest you could expect to receive your first distribution would be on or about August 15, 1999 for the period from the closing of the Transaction through June 30, 1999. Whether the Partnership will make distributions on the Senior Subordinated Units and the amount of such distributions with respect to any quarter is dependent on a number of factors including the following: . results of operations of the Partnership; . the ability of the Partnership to satisfy certain restrictions on distributions in its debt instruments; . the ability of the Partnership to satisfy certain restrictions on distributions on Senior Subordinated Units under the Amended and Restated Partnership Agreement; and . whether the General Partner determines to distribute available cash to Senior Subordinated Unitholders or reserve such cash for other uses of the Partnership. Q: WHAT ARE THE TAX CONSEQUENCES OF THE MERGER? A: The Merger will be a taxable transaction to Public Common Stockholders, to the extent of the difference, if any, between the value of the Senior Subordinated Units received and the federal income tax basis such holder has in the shares of Common Stock that are exchanged. Q: WHAT FINANCINGS WILL OCCUR IN CONNECTION WITH THE TRANSACTION? A: The Partnership intends to raise approximately $140 million through the Equity Offering and approximately $120 million through the Debt Offering. The proceeds from such offerings will be used to redeem certain outstanding debt and preferred stock of Petro. Q: WHAT ARE THE CONDITIONS PRECEDENT TO CLOSING THE TRANSACTION? A: In order for the Transaction to occur, the following conditions, among others, must be met: . The holders of a majority of the shares of Class A Common Stock (other than Class A Common Stock owned by the 10 directors and executive officers of Petro and their affiliates) and Class C Common Stock, each voting separately as a class, must approve the Acquisition Proposal. . The holders of a majority of Common Units (other than the Common Units owned by Star Gas and its affiliates) must approve the Star Proposals. . Once the Star Proposals and the Acquisition Proposal are approved, the Equity Offering and the Debt Offering must be completed. . The Partnership and Petro must receive all necessary regulatory and third party approvals. . The holders of no more than 10% of the outstanding shares of Common Stock shall have perfected their dissenters' rights. . Petro will meet certain financial tests set forth in the Merger Agreement. Q: WHEN IS THE TRANSACTION EXPECTED TO OCCUR? A: The Partnership and Petro are working towards completing the Transaction as soon as possible. Subject to the conditions set forth above, the Partnership and Petro anticipate completing the Transaction in early 1999. Q: WHAT IF THE TRANSACTION DOES NOT HAPPEN? A: If the required votes to approve each of the Star Proposals and the Acquisition Proposal are not obtained or other conditions are not satisfied, the ownership structures of the Partnership and Petro will continue as they are on the date of this Proxy Statement. Petro will remain the parent of the current General Partner, and its Common Stock will continue to be traded under the symbol "HEAT." Q: WHAT DO I NEED TO DO RIGHT NOW? A: Just return your signed proxy card in the enclosed return envelope as soon as possible in order for your shares of Common Stock to be represented at the meeting. The Petro Board has approved the Transaction and unanimously recommends that Common Stockholders vote FOR the Acquisition Proposal. Q: WHEN IS THE SPECIAL MEETING? A: The Special Meeting of the Common Stockholders will take place at a.m., New York City time, on , 1999, at , New York, New York. Q: DO I SEND IN MY STOCK CERTIFICATES NOW? A: No. After the Transaction is approved, record holders of Common Stock will receive written instructions on how to deliver their Petro stock certificates in exchange for Senior Subordinated Units. 11 PROXY STATEMENT SUMMARY This summary highlights selected information from this document and does not contain all of the information that is important to you. To understand the Star Proposals and the Acquisition Proposal fully, and for a more complete description of the legal terms of the Star Proposals and the Acquisition Proposal, you should read carefully this entire document and the documents to which we have referred you. See "Where You Can Find More Information" (page 206). We have included page references parenthetically to direct you to a more complete description of the topics presented in this summary. Except as the context otherwise requires, references to or descriptions of operations of the Partnership include the operations of the Operating Partnership and any other subsidiary operating partnership or corporation, the Partnership's predecessor, Star Gas, and the propane operations of Petro. All such operations were acquired by the Partnership in December 1995. Common Unitholders and Common Stockholders should carefully read this Proxy Statement in its entirety. For ease of reference, a glossary (the "Glossary") of certain terms used in this Proxy Statement is included herein. Certain capitalized terms used in this summary are defined elsewhere in this Proxy Statement. PARTIES (SEE PAGE 72) The Partnership and the Operating Partnership. The Partnership, through the Operating Partnership, is primarily a retail distributor of propane and related supplies and equipment to residential, commercial, industrial, agricultural and motor fuel customers. Propane is used primarily as fuel for space and water heating and cooking by the Partnership's residential and commercial customers, which customers constitute the largest portion of its customer base. The Partnership believes that it is the eighth largest retail propane distributor in the United States, serving approximately 166,000 customers from 74 branch locations in 13 states in the Midwest and Northeast with total sales of approximately $135 million for the fiscal year ended September 30, 1997. In addition to its retail business, the Partnership serves approximately 50 wholesale customers from its wholesale operation in southern Indiana. The executive offices of the Partnership are located at 2187 Atlantic Street, Stamford, Connecticut 06902. The Partnership's telephone number is (203) 328- 7300. Petro. Petro is primarily a retail distributor of home heating oil in the Northeast and Mid-Atlantic states. Petro believes that it is the largest distributor of home heating oil in the United States. Petro serves approximately 340,000 customers from 24 branch locations in such states, with total sales of approximately $548.1 million for the fiscal year ended December 31, 1997. To a limited extent, Petro also markets other petroleum products, including diesel fuel and gasoline, to commercial customers. In addition to its heating oil business, Petro currently owns a 40.5% equity interest in the Partnership. Star Gas, a wholly-owned subsidiary of Petro, is the general partner of the Partnership and the Operating Partnership. Petro's executive offices are located at 2187 Atlantic Street, Stamford, Connecticut 06902. Petro's telephone number is (203) 325-5400. 12 POTENTIAL ADVANTAGES TO THE COMMON UNITHOLDERS (SEE PAGE 96) The following are the potential advantages of the Transaction to the Common Unitholders: . The Minimum Quarterly Distribution to Unitholders will increase from $2.20 to $2.30 per Unit annually, subject to Available Cash to make such distribution. . The Transaction has been structured with the intent of providing an increase in the Partnership's distributable cash flow per Unit. If this expectation is realized, it will provide greater protection of the Minimum Quarterly Distribution and improves the possibility of future distribution increases. . The acquisition of Petro should improve the Partnership's growth prospects by providing the Partnership with an additional source of attractive acquisition and expansion opportunities. . Common Stockholders will be receiving subordinated units entitling them to receive distributions only after the Partnership's Common Unitholders receive their full Minimum Quarterly Distribution. . The Subordination Period during which the Common Unit distribution is senior to the subordinated units has been extended 18 months to July 1, 2002. . The Transaction will increase the Partnership's market capitalization and should provide greater Common Unit market liquidity, investment community awareness and the ability to attract securities analyst research coverage. POTENTIAL DISADVANTAGES AND RISKS TO THE COMMON UNITHOLDERS (SEE PAGES 48 AND 97) The following are the potential disadvantages and risks of the Transaction to the Common Unitholders: . The Partnership is acquiring an entity which, based on 1997 revenues, is several times its size. Therefore, the nature of the Partnership's business will be significantly changed. . Petro has a history of operational and financial difficulties (including high leverage and recent substantial net losses). . The success of the Transaction depends upon the Partnership's ability to --Continue to make acquisitions at attractive prices; --Continue to reduce Petro's customer attrition rate; and --Continue to improve Petro's profit margins on a per gallon basis. . The Partnership is making a large investment in a business which, like the Partnership's propane operations, is negatively affected by warm weather during the winter months. . The home heating oil business is not a growth business as a result of increased competition from alternative energy sources. . In the Transaction, the proportion of subordinated units to total Units will decline from 37.5% to 26%, and the support to Common Units will therefore be reduced. . The number of Common Units will increase from approximately 3.9 million to 10.3 million, representing potential significant dilution. 13 . The income of Petro, unlike the income from the Partnership's propane operations, will be subject to corporate tax prior to any distributions. . The ratio of taxable income to cash distributions to be made to the existing Common Unitholders will increase over time at a greater rate than if the Transaction does not occur, and dividend income from Petro cannot be offset with past or future losses generated by the Partnership's propane operations. POTENTIAL ADVANTAGES TO THE COMMON STOCKHOLDERS (SEE PAGE 107) The following are the potential advantages of the Transaction to the Common Stockholders: . This Transaction will provide Petro with the financial structure to implement its growth-through-acquisition strategy and invest in its operating and corporate branding opportunities. . We believe that as part of an MLP, Petro should receive an improved market valuation. Since MLP's are cash flow oriented and are valued primarily on a cash distribution basis, the MLP structure corresponds more closely with Petro's focus on cash flow. We also believe the Partnership will have greater investment community awareness as compared to Petro. As the only public home heating oil company, Petro has had limited securities analyst research coverage. . Although Petro has historically paid cash dividends to its Common Stockholders, these dividends have been suspended. The Partnership generally distributes to its partners the cash it generates from its operations. While there can be no assurance, this should give Common Stockholders an increased probability of a resumption of annual distributions. . You will receive Senior Subordinated Units that must receive their full Minimum Quarterly Distribution prior to any payments being made on the Junior Subordinated Units and the General Partner Units. . The Senior Subordinated Units will be allocated certain incentive distribution rights previously held by the General Partner. To the extent that the Partnership generates cash above certain target distribution levels, the holders of Senior Subordinated Units may receive greater cash distributions than the Common Unitholders. . If Petro meets certain financial goals within the five-year period after closing, the holders of Senior Subordinated Units Junior Subordinated Units and General Partner Units will receive up to additional 909,000 Senior Subordinated Units. This enables Common Stockholders to continue to participate in Petro's future performance. POTENTIAL DISADVANTAGES AND RISKS TO THE COMMON STOCKHOLDERS (SEE PAGES 55 AND 108) The following are the potential disadvantages and risks of the Transaction to the Common Stockholders: 14 . Unitholders in the Partnership have substantially different, and probably fewer, legal rights than Common Stockholders. . There is no current trading market for the Senior Subordinated Units. Although the Senior Subordinated Units have been approved for listing on the New York Stock Exchange, there is no assurance that any active trading market will develop after the closing of the Transaction. It is expected that the Senior Subordinated Units will trade at a lower price than the Common Units. . Distributions on the Senior Subordinated Units, Junior Subordinated Units and General Partner Units are not guaranteed and are subordinated to distributions on the Common Units. Further, distributions on the Senior Subordinated Units, Junior Subordinated Units and General Partner Units are generally limited to distributable cash generated after the closing of the Transaction. Therefore, there is significant uncertainty as to the amount and timing of such distributions. . Star Gas LLC, the new general partner in the Partnership, may have a greater number of conflicts of interest than the directors of Petro. . The Partnership's propane operations, like Petro's home heating oil business, are negatively affected by warm weather during the winter months. . The Partnership may face difficulties in the future in making attractive acquisitions in the propane industry because of the highly competitive nature of such industry. . Common Stockholders that are tax-exempt entities, regulated investment companies or foreign taxpayers may determine that holding an interest in the Partnership may be unattractive from a tax perspective. If certain of these investors sell their Senior Subordinated Units following the Transaction, the market price of the Senior Subordinated Units could fall substantially. RECOMMENDATIONS OF THE SPECIAL COMMITTEE AND STAR GAS BOARD AND OPINION OF A.G. EDWARDS & SONS, INC. (SEE PAGES 96 AND 98) All of the directors of Star Gas are also directors or officers of Petro, except for two directors who have no affiliation with Petro and who were originally elected to the Star Gas Board by Petro. Because the directors of Petro who are also directors of Star Gas may be considered to have a conflict of interest when considering this Transaction and because Petro owns all outstanding Subordinated Units of the Partnership, the two non-affiliated directors of Star Gas were appointed as a Special Committee to negotiate the Transaction on behalf of the Public Common Unitholders, for which they will each receive additional compensation of $40,000. The Special Committee was represented by independent legal counsel in such negotiations. A.G. Edwards & Sons, Inc. ("A.G. Edwards") has served as independent financial advisor to the Special Committee in connection with the Transaction and has rendered an opinion to the Special Committee (the "A.G. Edwards Opinion") that the Transaction is fair, from a financial point of view, to the Public Common Unitholders. See "The Transaction--Opinion of A.G. Edwards." The A.G. Edwards Opinion is attached as Annex D to this Proxy 15 Statement. Common Unitholders and Common Stockholders are urged to read such opinion in its entirety for descriptions of the procedures followed, matters considered and limitations on the reviews undertaken in connection therewith. After considering the advice of its independent legal counsel and financial advisor and based upon the A.G. Edwards Opinion, the Special Committee believes that the Transaction is in the best interests of the Public Common Unitholders and has recommended the Transaction to the Star Gas Board. Based on such recommendation, the Star Gas Board unanimously recommends that Common Unitholders vote FOR the Star Proposals. See "The Transaction--Background of and Reasons for the Transaction." RECOMMENDATIONS OF PETRO BOARD AND OPINION OF DAIN RAUSCHER WESSELS (SEE PAGES 107 AND 109) Each of the members of the Petro Board has interests that conflict, or may be perceived to conflict, with the interests of the Public Common Stockholders. As a result, the Petro Board could not establish an independent committee. The Petro Board has determined that the Transaction is fair and in the best interests of the Common Stockholders and has, therefore, approved the Merger Agreement and the Exchange Agreement, and unanimously recommends that Common Stockholders vote FOR the Acquisition Proposal. See "The Transaction-- Background of and Reasons for the Transaction." Dain Rauscher Wessels, a division of Dain Rauscher Incorporated ("Dain Rauscher Wessels"), has rendered an opinion to the Petro Board (the "Dain Rauscher Wessels Opinion") that the consideration to be received in the Merger by the Public Common Stockholders is fair, from a financial point of view, to the Public Common Stockholders. See "The Transaction--Opinion of Dain Rauscher Wessels." The Dain Rauscher Wessels Opinion is attached as Annex E to this Proxy Statement. Common Unitholders and Common Stockholders are urged to read such opinion in its entirety for descriptions of the procedures followed, matters considered and limitations on the reviews undertaken in connection therewith. PaineWebber Incorporated has also acted as a financial advisor to Petro. THE TRANSACTION (SEE PAGE 81) The Transaction can be viewed as having four principal parts. The Merger and Exchange . The acquisition of Petro by the Partnership which is accomplished through (i) a merger involving Petro and a wholly-owned subsidiary of the Partnership, and (ii) an exchange by affiliates of Petro of their Common Stock for Senior Subordinated Units, Junior Subordinated Units and General Partner Units, which together will result in Petro becoming a wholly-owned indirect subsidiary of the Partnership. Related Financing and Refinancing Transactions . Public debt and equity offerings by the Partnership and the redemption or restructuring of the public and private debt and preferred stock of Petro. New General Partner . The substitution of a new general partner for the existing general partner 16 of the Partnership. The new general partner will be owned by certain affiliates of Petro. Amendment of the Partnership Agreement . Amendment of the Partnership Agreement as required by the Merger Agreement. THE MERGER AND THE EXCHANGE The Merger Agreement is attached as Annex A to this Proxy Statement. We encourage you to read the Merger Agreement as it is the legal document that governs the Merger. Under the Merger Agreement, at the Effective Time of the Merger, Mergeco will be merged with and into Petro, with Petro surviving the Merger as a wholly- owned, indirect subsidiary of the Operating Partnership. As a result of the Merger, each outstanding share of Petro Common Stock (other than shares which have been exchanged pursuant to the Exchange Agreement or as to which dissenters' rights have been perfected) will be converted into .13064 Senior Subordinated Units; each outstanding share of junior preferred convertible stock of Petro (the "Junior Preferred Stock") will be converted into .13064 Common Units; and each outstanding share of Series C exchangeable preferred stock due 2009 of Petro (the "Public Preferred Stock") will be converted into the right to receive $23 in cash per share plus accrued and unpaid dividends. There are 11,228 shares of Class B common stock (the "Class B Shares") of Petro currently outstanding, representing less than .01% of the issued and outstanding shares of common stock of Petro, which will remain outstanding following the Effective Time. The Exchange Agreement is attached as Annex B to this Proxy Statement. We encourage you to read the Exchange Agreement as it is the legal document that governs the Exchange. The Exchange will occur immediately prior to the Merger and is comprised of the following elements. (a) Certain Common Stockholders, consisting of Irik P. Sevin, Audrey L. Sevin and an entity affiliated with Wolfgang Traber (the "LLC Owners"), will form Star Gas LLC, to which they will contribute a portion of their shares of Common Stock in exchange for all of the limited liability company interests in Star Gas LLC. Star Gas LLC will contribute such shares to the Partnership in exchange for General Partner Units. In addition, the LLC Owners will contribute their remaining shares of Common Stock to the Partnership in exchange for Junior Subordinated Units. (b) Certain other Common Stockholders who are considered to be affiliates of Petro will contribute shares of Common Stock to the Partnership in exchange for Senior Subordinated Units. RELATED FINANCING AND REFINANCING TRANSACTIONS An integral element of the Transaction is the refinancing of Petro's outstanding debt and preferred stock that will substantially reduce Petro's ongoing borrowing costs. This refinancing will be accomplished through several related transactions, which will close substantially simultaneously with the closing of the Transaction. Key elements in the related financing are a public equity offering by the Partnership and a debt offering by Petro Holdings Inc. ("Petro 17 Holdings"). The Partnership will offer for sale to the public pursuant to the Equity Offering approximately 6.4 million Common Units, the net proceeds of which are estimated to be $132.1 million. Petro Holdings, a wholly-owned indirect subsidiary of the Partnership and the direct parent of Petro following the Transaction, will sell to the public approximately $120.0 million of Notes ("Petro Holdings Senior Subordinated Debt") pursuant to the Debt Offering, the net proceeds of which are estimated to be $115.4 million. It is expected that the Partnership will guarantee the Petro Holdings Senior Subordinated Debt. The net proceeds of the Equity Offering and the Debt Offering will be used to redeem Petro's outstanding public debt and preferred stock and to pay for the expenses of the Transaction. NEW GENERAL PARTNER Since Star Gas is a wholly-owned subsidiary of Petro and will be acquired in the Transaction by the Partnership, it will no longer be able to serve as general partner of the Partnership. The new general partner of the Partnership will be Star Gas LLC, which will be owned by the LLC Owners. Star Gas LLC's business activities will be limited to those related to being a general partner of the Partnership. Star Gas LLC is not expected to have a significant net worth except for its interest in the Partnership. The directors of Star Gas LLC will be identical to the existing Star Gas Board as of the date of this Proxy Statement, except that, at her request, one of the current directors of Star Gas will withdraw as a director upon consummation of the Transaction as a result of additional duties associated with a new job. That director will be replaced by a director selected by the Star Gas LLC Board, and the new director will not be an officer or employee of Star Gas or any of its affiliates. The officers of Star Gas LLC will be certain of the current officers of Star Gas and Petro. AMENDMENT OF THE PARTNERSHIP AGREEMENT In order to consummate the Transaction, certain amendments must be made to the Partnership Agreement and Operating Partnership Agreement. If approved, the Amendment Proposal will, among other matters: . Increase the Minimum Quarterly Distribution from $0.55 to $0.575 per Unit; . Extend the earliest date upon which the Subordination Period can expire from January 1, 2001 to July 1, 2002; . Authorize the issuance of Senior Subordinated Units and Junior Subordinated Units; . Redesignate the general partner interests as General Partner Units and subordinate the distribution rights of the General Partner Units to the Common Units and the Senior Subordinated Units; . Limit the amount of distributions that the Partnership can make during the Subordination Period on the Senior Subordinated Units, Junior Subordinated Units and General Partner Units; . Authorize the issuance of up to an additional 909,000 Senior Subordinated Units to the holders of the Senior Subordinated Units, Junior Subordinated Units and General Partner Units, but only if Petro satisfies certain financial goals; 18 . Reallocate the incentive distribution rights previously held by the General Partner among the Senior Subordinated Units, Junior Subordinated Units and General Partner Units; . Eliminate the requirement that the General Partner maintain a fixed ownership interest in the Partnership and Operating Partnership; . Eliminate the net worth requirement of the General Partner; . Increase the $6 million basket in the definition of Operating Surplus proportionately with the number of Common Units issued in the Equity Offering; . Authorize the issuance of Common Units in the Equity Offering and increase the number of additional Common Units that may be issued during the Subordination Period without a Unitholder vote from 1,300,000 to 2,500,000; and . Provide the Senior Subordinated Units and the Junior Subordinated Units (other than the Units held by the General Partner and its affiliates) with a collective class vote on certain matters. See "Amendments to the Partnership Agreements--Summary of Amendments to the Partnership Agreement" and "The Amended and Restated Partnership Agreement." 19 ESTIMATED SOURCES AND USES OF FUNDS OF THE EQUITY OFFERING AND DEBT OFFERING As a result of the Transaction, the sources and uses of funds are currently anticipated to be as follows: (In thousands) - -------- (1) Assumes the sale of 6.4 million Common Units at $22.00 per Common Unit. Net of underwriting discounts and commissions. (2) Includes prepayment premium of $2,844. Such estimated sources and uses may change, depending on market conditions, the Partnership's and Petro's operations and other factors. OUTSTANDING PARTNERSHIP UNITS The following table sets forth the approximate number of Units outstanding before and after completion of the Transaction:
SOURCES Equity Offering, net(/1/)........................................... $132,100 Debt Offering, net(/1/)............................................. 115,400 -------- $247,500 ======== USES Redeem Petro 10 1/8% Notes.......................................... $ 50,000 Redeem Petro 9 3/8% Debentures...................................... 75,000 Redeem Petro 12 1/4% Debentures(/2/)................................ 84,094 Redeem Petro Public Preferred Stock................................. 27,600 Repurchase Petro 1989 Preferred Stock............................... 4,167 Transaction Fees and Expenses....................................... 6,639 -------- $247,500 ======== - -------- (1) Estimated based on an assumed offering price of $22.00 per Unit. The exact number of Common Units to be issued in the Equity Offering will be based on the public offering price of Common Units at the time of sale. (2) Stated in equivalent units before the Transaction and includes the General Partner's interest in the Operating Partnership. 20
BEFORE TRANSACTION AFTER TRANSACTION -------------------- --------------------- NUMBER PERCENTAGE NUMBER PERCENTAGE --------- ---------- ---------- ---------- COMMON UNITS Existing Common Units............. 3,858,999 60.5% 3,858,999 27.7% Issued to Petro Junior Preferred Stockholders..................... -- -- 102,773 0.7% Issued in Equity Offering(/1/).... -- -- 6,363,636 45.6% --------- ---- ---------- ----- Subtotal........................ 3,858,999 60.5% 10,325,408 74.0% SUBORDINATED UNITS Existing Subordinated Units....... 2,396,078 37.5% -- -- Senior Subordinated Units......... -- -- 2,767,058 19.8% Junior Subordinated Units......... -- -- 577,205 4.2% --------- ---- ---------- ----- Subtotal........................ 2,396,078 37.5% 3,344,263 24.0% GENERAL PARTNER INTERESTS/UNITS(/2/)............... 127,655 2.0% 278,973 2.0% --------- ---- ---------- ----- Total........................... 6,382,732 100% 13,948,644 100.0% ========= ==== ========== ===== CAPITALIZATION The following table sets forth (i) the historical capitalization of the Partnership as of June 30, 1998, (ii) as adjusted to give pro forma effect to the acquisition of Petro and (iii) as further adjusted to give pro forma effect to the closing of the Equity Offering and the Debt Offering and the application by the Partnership of the net proceeds therefrom as described in "Proxy Statement Summary--Sources and Uses of Funds." The table should be read in conjunction with the historical and pro forma financial statements and notes thereto included elsewhere in this Proxy Statement. - -------- (a) See the Unaudited Pro Forma Condensed Consolidated Financial Information of Star Gas Partners, L.P., included elsewhere in this Proxy Statement, for a discussion of the pro forma adjustments. (b) The Petro Public Debt consists of $50.0 million of 10 1/8% Subordinated Notes originally due 2003, $75.0 million of 9 3/8% Subordinated Debentures originally due 2006 and approximately $84.1 million of 12 1/4% Subordinated Debentures originally due 2005. (c) The Petro Private Debt consists of approximately $63.1 million of 9% Senior Notes with a final maturity of 2002, approximately $4.3 million of 10.25% Subordinated and Senior Notes with a final maturity in 2001 and approximately $14.3 million of Notes payable in connection with the purchase of fuel oil dealers maturing at various dates through 2004. 21
JUNE 30, 1998 ------------------------------------- ACTUAL AS ADJUSTED(A) PRO FORMA(A) -------- -------------- ------------ (IN THOUSANDS) Cash....................................... $ 1,551 $ 23,507 $ 20,932 ======== ======== ======== Debt: Star Gas First Mortgage Notes............. $ 96,000 $ 96,000 $ 96,000 Petro Holdings Senior Subordinated Debt... -- -- 120,000 Petro Public Debt(b)...................... -- 209,094 -- Petro Private Debt(c)..................... -- 81,779 81,779 Star Gas Acquisition Facility............. -- 5,000 5,000 -------- -------- -------- Total Long-Term debt................... 96,000 391,873 302,779 -------- -------- -------- Redeemable Preferred Stock: Public Preferred Stock.................... -- 27,600 -- Private Preferred Stock................... -- 4,167 -- Partners' capital: Common Unitholders........................ 63,683 66,574 198,674 Subordinated Unitholders.................. 2,056 -- -- Senior Subordinated Unitholders........... -- 20,153 20,153 Junior Subordinated Unitholders........... -- 3,429 3,429 General Partner........................... 281 1,666 1,666 -------- -------- -------- Total partners' capital................ 66,020 91,822 223,922 -------- -------- -------- Total capitalization................... $162,020 $515,462 $526,701 ======== ======== ======== INTERESTS OF CERTAIN PERSONS IN THE TRANSACTION; CONFLICTS OF INTEREST (SEE PAGE 66) The Partnership Star Gas, the current General Partner of the Partnership, is a wholly-owned subsidiary of Petro, and Petro owns all the outstanding Subordinated Units of the Partnership. All of the directors of Star Gas are also directors or officers of Petro, except the members of the Special Committee. As a result, the members of the Star Gas Board who are also members of the Petro Board have conflicting fiduciary duties to the Common Unitholders, Petro and the Common Stockholders. Therefore, certain members of the Star Gas Board have interests that are different from, and in conflict with, the interests of the Public Common Unitholders. The officers and directors of Star Gas will be indemnified, to the extent permitted by law, for any and all actions taken in connection with the Transaction and are also covered by customary directors' and officers' liability insurance. Each member of the Star Gas Board will be a member of the Star Gas LLC Board following the Transaction except that, at her request, one of the current directors of Star Gas will withdraw as a director upon consummation of the Transaction as a result of additional duties associated with a new job. That director will be replaced by a director selected by the Star Gas LLC Board, and the new director will not be an officer or employee of Star Gas LLC or any of its affiliates. The current officers of Star Gas will be employed as officers of the Operating Partnership following the Transaction. Petro Certain directors of Petro have interests in the Transaction that are different from, and in conflict with, the interests of the Public Common Stockholders, since such directors and their affiliates are receiving consideration in the Transaction that is different from that of the Public Common Stockholders. These directors and their affiliates will be exchanging their Common Stock for Junior Subordinated Units and General Partner Units, while the Public Common Stockholders and certain other directors and other affiliates will be receiving Senior Subordinated Units. The Junior Subordinated Units and General Partners Units will not be entitled to distributions until the Senior Subordinated Units receive the Minimum Quarterly Distribution. The Senior Subordinated Units will be publicly traded and have been approved for listing on the New York Stock Exchange. The Junior Subordinated Units and General Partner Units have not been registered and will not be publicly traded. The affiliates exchanging their Common Stock for Junior Subordinated Units and General Partner Units will receive .15909 Junior Subordinated Units or General Partner Units for each share of Common Stock, whereas the remaining Common Stockholders will exchange their shares for Senior Subordinated Units at a ratio of .13064 Senior Subordinated Units for each share of Common Stock. The Transaction has been structured so that the Public Common Stockholders will realize a taxable gain or loss on the Transaction, whereas all affiliates of Petro will exchange their Common Stock without realizing such a taxable gain or loss. This structure was designed to minimize the tax effect of the Transaction on Petro. It was also based on the assumption that certain Petro affiliates have a low tax basis and would prefer not realizing a taxable gain on the Transaction, whereas Public Common Stockholders generally have a higher tax basis and would prefer realizing a tax loss. 22 Irik P. Sevin is both the Chairman of the Board and Chief Executive Officer of Petro and the Chairman of the Board of Star Gas; Audrey L. Sevin is the Secretary and a director of both Petro and Star Gas; and Messrs. Paul Biddelman, Thomas J. Edelman and Wolfgang Traber are directors of both Petro and Star Gas. Messrs. Sevin, Biddelman, Edelman, Cohen and Traber and Mrs. Sevin are beneficial owners of Class A Common Stock and Class C Common Stock. As a result, the members of the Petro Board who are also members of the Star Gas Board have conflicting fiduciary duties to the Public Common Stockholders and the Public Common Unitholders. Therefore, certain members of the Petro Board have interests that are different from, and in conflict with, the interests of the Public Common Stockholders. The officers and directors of Petro will be indemnified, to the extent permitted by law, for any and all actions taken in connection with the Transaction. The current officers of Petro will continue to be employed as officers following the Transaction. CASH AVAILABLE FOR DISTRIBUTION (SEE PAGE 170) The Partnership believes that it will generate sufficient Available Cash from Operating Surplus for the first full four-quarter period following the Effective Time to cover the full Minimum Quarterly Distribution for such four- quarter period on all then outstanding Units. The Partnership's belief is based on a number of assumptions, including the assumptions that normal weather conditions will prevail in the Partnership's and Petro's operating areas, that the Partnership's and Petro's operating margins will remain constant and that market and overall economic conditions will not change substantially. Although the Partnership believes its assumptions are within a range of reasonableness, most of the assumptions are not within the control of the Partnership and cannot be predicted with any degree of certainty. For example, in any particular year or even series of years, weather may deviate substantially from normal. Therefore, certain of the Partnership's assumptions may prove to be inaccurate. As a result, the Operating Surplus of the Partnership could deviate materially from that currently expected. See "Risk Factors." The amount of Available Cash constituting Operating Surplus needed to pay the Minimum Quarterly Distribution for four quarters on the Common Units, Senior Subordinated Units, Junior Subordinated Units and General Partner Units to be outstanding immediately after the Effective Time (assuming no exercise of the underwriters' overallotment option in the Equity Offering) is approximately $32.1 million ($23.7 million for the Common Units, $6.4 million for the Senior Subordinated Units, $1.3 million for the Junior Subordinated Units and $0.6 million for the General Partner Units). After giving pro forma effect to the Transaction, the amount of pro forma Available Cash constituting Operating Surplus generated during the twelve months ended September 30, 1997 would have been approximately $28.3 million, which excludes non-recurring restructuring, corporate identity and pension curtailment expenses of approximately $7.6 million. The pro forma results for such period also do not reflect certain cost savings that Petro implemented in fiscal 1998. See "--Selected Unaudited Pro Forma Condensed Consolidated Financial Information." 23 The Partnership is required to establish reserves for the future payment of principal and interest on certain of the Partnership's indebtedness. There are other provisions in such agreements that will, under certain circumstances, restrict the Partnership's ability to make distributions to its Unitholders. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Description of Indebtedness" in the Partnership's Annual Report Form 10-K for the fiscal year ended September 30, 1997 and in the Partnership's Quarterly Report on form 10-Q for the quarter ended June 30, 1998, which are incorporated by reference herein. The Petro Holdings Senior Subordinated Debt is expected to have provisions that will, under certain circumstances, similarly restrict the Partnership's ability to make distributions to its Unitholders. Cash distributions with respect to the quarter ended March 31, 1999 will be paid to the Common Unitholders on or about May 15, 1999. No distributions will be paid on such date to the Senior Subordinated Units, Junior Subordinated Units and General Partner Units. The aggregate amount of distributions that may be paid on the Senior Subordinated Units, Junior Subordinated Units and General Partner Units with respect to the quarters ending June 30, 1999 (which, if made, would include a pro rata distribution for the period from the Effective Time through March 31, 1999) and September 30, 1999 will depend on whether the combined results of the Partnership and Petro exceed certain financial benchmarks. Beginning with the distribution for the quarter ending on December 31, 1999, the aggregate distributions to be paid on the Senior Subordinated Units, Junior Subordinated Units and General Partner Units will be limited to the total Operating Surplus generated by the Partnership since October 1, 1999. 24 DESCRIPTION OF THE PARTNERSHIP UNITS (SEE PAGES 139, 145, 158 AND 171) (The following summary gives effect to the adoption of the Amendment Proposal) Distributions of Available Cash.......................... The Partnership distributes all of its Available Cash approximately 45 days after each March 31, June 30, September 30 and December 31, to Unitholders of record on the applicable record date. "Available Cash" for any quarter will consist generally of all cash on hand at the end of such quarter, as adjusted for reserves. The definition of Available Cash is set forth in the Glossary. Available Cash will first be distributed to Common Unitholders, then to Senior Subordinated Unitholders, and then pro rata to Junior Subordinated Unitholders and General Partner Unitholders, until the Minimum Quarterly Distribution has been paid. After the Minimum Quarterly Distribution has been paid, Available Cash will generally be distributed pro rata to all Unitholders, except that if Available Cash exceeds certain Target Distribution Levels above the Minimum Quarterly Distribution, the Senior Subordinated Units, Junior Subordinated Units and General Partner Units will receive, in the aggregate, a percentage of such excess distributions that will increase to up to approximately 49.0% of distributions in excess of the highest Target Distribution Level. While the General Partner has broad discretion in making cash disbursements and establishing reserves, the amended and restated partnership agreement of the Partnership (the "Amended and Restated Partnership Agreement") provides that, beginning with the distribution for the quarter ending on December 31, 1999, the aggregate distributions to be paid on the Senior Subordinated Units, Junior Subordinated Units and General Partner Units, will be limited to the total Operating Surplus generated by the Partnership since October 1, 1999. The aggregate amount of distributions that may be paid on the Senior Subordinated Units, Junior Subordinated Units and General Partner Units during the quarter ending June 30, 1999 and September 30, 1999 will depend on whether the combined results of the Partnership and Petro exceed certain financial benchmarks. Distributions to Unitholders................... The Partnership intends, to the extent there is sufficient Available Cash from Operating Surplus, to distribute to each holder of Units at least the Minimum Quarterly Distribution of $0.575 per Unit ($2.30 per Unit on an annualized basis). With respect to each quarter during the 25 Subordination Period (which will generally not end earlier than July 1, 2002) the Common Units will have the right to receive the Minimum Quarterly Distribution, plus any arrearages thereon, before any distribution is made on the Senior Subordinated Units, the Junior Subordinated Units and the General Partner Units; and the Senior Subordinated Units will have the right to receive the Minimum Quarterly Distribution before any distribution is made on the Junior Subordinated Units and the General Partner Units. Common Units issued in the Equity Offering that are held of record on the record date for a distribution will be entitled to receive the full distribution declared on such record date, regardless of how many days such Common Units have been outstanding. The first distribution permitted to be paid to the holders of the Senior Subordinated Units issued in the Transaction will be paid with respect to the quarter ending June 30, 1999 and will be paid on or about August 15, 1999 to holders of record on or about July 31, 1999. Such distribution, if paid, will include a pro rata distribution for the period between the Effective Time and March 31, 1999. See "Cash Distribution Policy--Adjustment of Minimum Quarterly Distribution and Target Distribution Levels." Senior Subordinated Units, Junior Subordinated Units and General Partner Units will not accrue distribution arrearages. Upon the expiration of the Subordination Period, Common Units will no longer accrue distribution arrearages. See "Cash Distribution Policy." Subordination Period.......... The Subordination Period will generally end the first day of any quarter beginning on or after July 1, 2002 provided that certain financial tests have been satisfied. Generally, such financial tests will be satisfied when (i) distributions of Available Cash from Operating Surplus on all outstanding Units equaled or exceeded the sum of the Minimum Quarterly Distribution on all outstanding Units with respect to each of the three non- overlapping four-quarter periods immediately preceding such date; (ii) the Adjusted Operating Surplus generated during each of the three immediately preceding non-overlapping four-quarter periods equaled or exceeded the sum of the Minimum Quarterly Distribution on all Units that were outstanding during such periods on a fully diluted basis; and (iii) there are no arrearages in payment of the Minimum Quarterly Distribution on the Common Units. Upon expiration of the Subordination Period, all Senior Subordinated Units and 26 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 principal differences between the Class A Common Units and Class B Common Units are that the Class B Common Units will have the right to receive incentive distributions and the right to receive additional Senior Subordinated Units but only if certain financial goals are met. In addition, if the General Partner is removed as the general partner of the Partnership other than for Cause (with certain exceptions), the Subordination Period will end. Incentive Distributions....... If quarterly distributions of Available Cash from Operating Surplus exceed the Target Distribution Levels, the General Partner Units, Senior Subordinated Units and Junior Subordinated Units will receive up to 49% of distributions of Available Cash in excess of such Target Distribution Levels. The Class B Common Units into which the Senior Subordinated Units and Junior Subordinated Units convert at the end of the Subordination Period will include the same rights to receive Incentive Distributions as the Senior Subordinated Units and Junior Subordinated Units. The following table illustrates the percentage of Available Cash from Operating Surplus distributed as the Minimum Quarterly Distribution pro rata to all Unitholders ("Base Distributions") and the percentage of Available Cash distributed to the holders of Senior Subordinated Units, Junior Subordinated Units and General Partner Units as incentive distributions ("Incentive Distributions") at the Target Distribution Levels. The percentages set forth in the table below are the percentage interests of the Unitholders in Available Cash from Operating Surplus distributed up to and including the corresponding amount in the column "Quarterly Distribution Amount Per Common Unit" until Available Cash distributed reaches the next Target Distribution Level, if any. The percentage allocation of Incentive Distributions among Senior Subordinated Units, Junior Subordinated Units and General Partner Units, will change in the future if there are additional non pro rata issuances of such Units. 27
PERCENTAGE OF AVAILABLE CASH DISTRIBUTED AS INCENTIVE DISTRIBUTIONS TO THE SPECIFIED PERCENTAGE OF PERCENTAGE OF UNIT CLASS QUARTERLY AVAILABLE CASH AVAILABLE CASH --------------------------------- DISTRIBUTION DISTRIBUTED AS DISTRIBUTED AS SENIOR JUNIOR GENERAL AMOUNT PER BASE INCENTIVE SUBORDINATED SUBORDINATED PARTNER COMMON UNIT DISTRIBUTIONS DISTRIBUTIONS UNITS UNITS UNITS ------------ -------------- -------------- ------------ ------------ ------- Minimum Quarterly Distribution........... $0.575 100.0% -- -- -- -- First Target Distribution........... 0.604 100.0% -- -- -- -- Second Target Distribution........... 0.711 86.7% 13.3% 10.2% 2.1% 1.0% Third Target Distribution........... 0.926 76.5% 23.5% 18.0% 3.7% 1.8% Thereafter.............. -- 51.0% 49.0% 37.4% 7.8% 3.8% The following table illustrates the distribution of Available Cash per Unit among the Common Units, Senior Subordinated Units, Junior Subordinated Units and General Partner Units at the Target Distribution Levels. The calculations are based on the assumption that the quarterly distribution amounts shown do not include any Cumulative Common Unit Arrearages. Adjustment of Minimum Quarterly Distribution and Target Distribution Levels... The Minimum Quarterly Distribution and the Target Distribution Levels are subject to downward adjustments in the event that Unitholders receive distributions of Available Cash from Capital Surplus (which generally includes cash from transactions such as borrowings (other than working capital borrowings), refinancings, sales of securities or sales or other dispositions of assets constituting a return of capital under the Amended and Restated Partnership Agreement, as distinguished from cash from Partnership operations, or in the event legislation is enacted or existing law is modified or interpreted in a manner that causes the Partnership to be treated as an association taxable as a corporation or otherwise taxable as an entity for federal, state or local income tax purposes. If the Unitholders receive a full return of capital as a result of distributions of Available Cash from Capital Surplus, the Incentive Distributions payable on the Senior Subordinated Units, Junior Subordinated Units and General Partner Units will increase to 49% of all amounts distributed thereafter. See "Cash Distribution Policy--Distributions from Capital Surplus" and "--Adjustment of Minimum Quarterly Distribution and Target Distribution Levels." 28
QUARTERLY DISTRIBUTION AMOUNT ---------------------------------------- SENIOR JUNIOR GENERAL COMMON SUBORDINATED SUBORDINATED PARTNER UNIT UNIT UNIT UNIT ------ ------------ ------------ ------- Minimum Quarterly Distribution........ $0.575 $0.575 $0.575 $0.575 First Target Distribution............. 0.604 0.604 0.604 0.604 Second Target Distribution............ 0.711 0.774 0.774 0.774 Third Target Distribution............. 0.926 1.243 1.243 1.243 Additional Senior Subordinated Units........... The Amended and Restated Partnership Agreement provides that up to an additional 909,000 Senior Subordinated Units will be issued pro rata to holders of Senior Subordinated Units, Junior Subordinated Units and General Partner Units, but only if Petro meets certain financial goals during the five-year period following closing of the Transaction (the "Closing"). See "Cash Distribution Policy." Partnership's Ability to Issue Additional Units....... The Amended and Restated Partnership Agreement authorizes the General Partner to cause the Partnership to issue an unlimited number of additional Units of limited partner interests for such consideration and on such terms as shall be established by the General Partner, in its sole discretion without the approval of the Unitholders. However, prior to the end of the Subordination Period, the Partnership may not issue equity securities ranking senior to the Common Units or more than 2,500,000 additional Common Units (excluding (a) Common Units issued in the Equity Offering, (b) Class B Common Units issued upon conversion of Senior Subordinated Units and Junior Subordinated Units as described herein and (c) Common Units issued in connection with certain acquisitions or to repay certain indebtedness), without the approval of at least a majority of the outstanding Common Units, excluding Common Units owned by the General Partner and its affiliates. See "Risk Factors--The Partnership May Issue Additional Units--Diluting Existing Unitholders Interests" and "The Amended and Restated Partnership Agreement--Issuance of Additional Securities." Limited Call Right............ If at any time not more than 20% of the outstanding limited partner interests of any class are held by persons other than the General Partner and its affiliates, the General Partner may purchase all of the remaining limited partner interests of such class at specified prices. If at any time the Partnership acquires in a twelve-month period more than 66 2/3% of the total Class B Common Units, the Partnership may purchase all of the remaining limited partner interests of such class at specified prices. See 29 "The Amended and Restated Partnership Agreement--Limited Call Right." Limited Voting Rights......... Unitholders have only limited voting rights on matters affecting the Partnership's business. See "The Amended and Restated Partnership Agreement--Meetings; Voting." Removal and Withdrawal of the General Partner.............. Subject to certain conditions, the General Partner may be removed upon the approval of the holders of at least 66 2/3% of the outstanding Units, excluding those Units held by the General Partner and its affiliates. A meeting of Unitholders may be called only by the General Partner or by the holders of 20% or more of the outstanding Units. The General Partner has agreed not to voluntarily withdraw as general partner of the Partnership and the Operating Partnership prior to December 31, 2005, subject to limited exceptions, without obtaining the approval of a Unit Majority and furnishing an Opinion of Counsel. See "The Amended and Restated Partnership Agreement--Withdrawal or Removal of the General Partner; Approval of Successor General Partner" and "--Meetings; Voting." Transfer Restrictions......... All recipients of Senior Subordinated Units and Common Units issued in connection with the Transaction and purchasers of Senior Subordinated Units and Common Units in the open market who wish to become limited partners must deliver an executed Transfer Application (which may be obtained from the Transfer Agent) before the transfer of such Units will be registered and before cash distributions and federal income tax allocations will be made to the transferee. See "Description of the Units--Transfer of Units" and "Comparison of Securities." Liquidation Preference........ In the event of any liquidation of the Partnership during the Subordination Period, the outstanding Common Units will be entitled to receive a distribution out of the net assets of the Partnership, generally in preference to liquidating distributions on the Senior Subordinated Units, the Junior Subordinated Units and General Partner Units, and the outstanding Senior Subordinated Units will be entitled to receive a distribution out of the remaining 30 net assets of the Partnership, generally in preference to liquidating distributions on the Junior Subordinated Units and General Partner Units. Following conversion of the Senior Subordinated Units and the Junior Subordinated Units into Class B Common Units, all Units will generally be (to the extent of the first $22.00 distributed per Unit, subject to adjustment) treated the same upon liquidation of the Partnership. See "Cash Distribution Policy." Comparison of Securities...... The rights of a holder of Senior Subordinated Units differ substantially from the rights of a Common Stockholder. For a summary of these differences, see "Comparison of Securities." Listing....................... The Common Units and the Senior Subordinated Units to be issued in the Transaction have been approved for listing, subject to official notice of issuance, on the NYSE. NYSE Trading Symbols Common Units................ "SGU" Senior Subordinated Units... 31 PARTNERSHIP STRUCTURE AND MANAGEMENT FOLLOWING THE TRANSACTION (SEE PAGE 136) Following the Transaction, the Partnership's activities will be conducted through the Operating Partnership and its corporate subsidiaries, Petro and Stellar Propane Corp. ("Stellar"). Star Gas currently serves as general partner of the Partnership and of the Operating Partnership. At the Effective Time, the general partner of the Partnership and the Operating Partnership will be Star Gas LLC. All of the membership interests in Star Gas LLC are owned by the LLC Owners. The officers of Star Gas LLC will be certain of the current officers of Star Gas and Petro. At the Effective Time, the officers and employees of Star Gas will become officers and employees of the Operating Partnership. In addition, at the Effective Time, the officers and employees of Petro will continue to be officers and employees of Petro. The General Partner does not receive any management fee or other compensation in connection with its management of the Partnership, but the General Partner is reimbursed at cost for all direct and indirect expenses incurred on behalf of the Partnership. The General Partner is also reimbursed for all other necessary or appropriate expenses allocable to the Partnership or otherwise reasonably incurred by the General Partner in connection with the operation of the Partnership's business. Conflicts of interest have arisen and could arise between the General Partner and its affiliates, on the one hand, and the Partnership or any partner thereof, on the other. Star Gas has an audit committee (the "Audit Committee") consisting of the two members of the Star Gas Board who are not officers of the General Partner and are available at the General Partner's discretion to review matters involving conflicts of interest. Star Gas LLC will establish an audit committee to review matters involving conflicts of interest. See "Conflicts of Interest and Fiduciary Responsibility." The first chart below illustrates the organization and ownership of the Partnership, the Operating Partnership and its subsidiary and Star Gas prior to the Transaction. The second chart illustrates the organization and ownership of the Partnership, the Operating Partnership and its subsidiaries and Star Gas LLC immediately following the Transaction (without giving any effect to the issuance of the any additional Senior Subordinated Units). The percentages reflected in the following chart represent the approximate ownership interests in each of the Partnership and the Operating Partnership, individually, and not on an aggregate basis. 32 [Chart displaying immediately prior to closing flow chart] 33 [Chart displaying immediately following transaction flow chart] 34 SUMMARY SELECTED HISTORICAL FINANCIAL AND OPERATING DATA OF THE PARTNERSHIP The following table sets forth for the periods and dates indicated, selected historical financial and operating data of the Partnership. The following selected historical financial data of the Partnership are derived from the consolidated financial statements of the Partnership and should be read in conjunction with "Selected Historical and Operating Data," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements of the Partnership and accompanying notes in the Partnership's Annual Report on Form 10-K and Quarterly Reports on Form 10-Q incorporated herein by reference. See "Incorporation of Certain Documents By Reference." The historical financial data for the nine months ended June 30, 1997 and 1998 and the historical other data are unaudited. The results of operations for the nine months ended June 30, 1997 and 1998 contain all adjustments that are of a normal and recurring nature necessary to present fairly the financial condition and results of operation for such periods. These historical results are not necessarily indicative of the results of operations to be expected in the future. - -------- (a) Reflects the results of operations of the predecessor of the Partnership for the period October 1, 1995 through December 20, 1995 and the results of the Partnership from December 20, 1995 through September 30, 1996. Operating results for the year ended September 30, 1996 were combined to facilitate an analysis of the fundamental operating data. For the actual results of the Partnership from December 20, 1995 through September 30, 1996, see Item 14, page F-4 of the Partnership's 1997 Form 10-K, which is incorporated by reference herein. 35
NINE MONTHS ENDED YEAR ENDED SEPTEMBER 30, JUNE 30, ------------------------------ ----------------- 1995 1996(A) 1997 1997 1998 -------- -------- -------- -------- -------- (IN THOUSANDS, EXCEPT FOR PER UNIT DATA) STATEMENT OF OPERATIONS DATA Sales....................... $104,550 $119,634 $135,159 $117,396 $ 95,971 Gross profit................ 54,890 61,077 62,948 53,818 52,245 Depreciation and amortiza- tion....................... 10,073 9,808 10,405 7,869 8,644 Operating income............ 2,555 9,802 9,003 12,382 10,688 Interest expense, net....... 8,549 7,124 6,966 5,290 5,834 Net income (loss)........... (6,169) 2,593 2,012 7,074 4,835 Net income per Unit(b)...... -- $ 0.11(c) $ 0.37 $ 1.32 $ 0.79 Cash distribution declared per Unit................... -- $ 1.17(c) $ 2.20 $ 1.65 $ 1.65 BALANCE SHEET DATA (END OF PE- RIOD) Current assets.............. $ 14,266 $ 17,842 $ 14,165 $ 18,632 $ 15,408 Total assets................ 155,393 156,913 147,469 153,767 173,265 Long-term debt.............. 1,389 85,000 85,000 85,000 96,000 Due to Petro................ 86,002 -- -- -- -- Predecessor's equity/Partners' capital... 44,305 61,398 51,578 59,598 66,020 OTHER DATA EBITDA(d)................... $ 13,541 $ 19,870 $ 19,703 $ 20,380 $ 19,545 Retail propane gallons sold....................... 89,133 96,294 94,893 80,845 84,780 Total capital expenditures(e)............ $ 7,988 $ 5,332 $ 5,279 $ 4,454 $ 3,825 (b) Net income per Unit is computed by dividing the limited partners' interest in net income by the limited partners' weighted average number of Units outstanding. (c) Represents net income per Unit and cash distributions paid per Unit for the period December 20, 1995 through September 30, 1996. (d) "EBITDA" is defined as operating income plus depreciation, amortization and other non-cash charges, less net gain (loss) on sale of businesses and equipment. EBITDA should not be considered an alternative to net income (as an indicator of operating performance) or as an alternative to cash flow (as a measure of liquidity or ability to service debt obligations), but provides additional information for evaluating the Partnership's ability to make the Minimum Quarterly Distribution. For a discussion of the cash flows provided by (used in) the Partnership's operating, investing and financing activities, see the statements of cash flows in the consolidated financial statements of the Partnership incorporated by reference in this Proxy Statement. (e) The net maintenance capital expenditures for the fiscal years ended September 30, 1996 and 1997 were $2.3 and $3.1 million, respectively. 36 SUMMARY SELECTED HISTORICAL FINANCIAL AND OPERATING DATA OF PETRO The following table sets forth for the periods and dates indicated, selected historical financial and operating data of Petro. The following selected historical financial data of Petro are derived from the consolidated financial statements of Petro and should be read in conjunction with "Selected Historical and Operating Data," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements of Petro and accompanying notes in Petro's Annual Report on Form 10-K and Quarterly Reports on Form 10-Q enclosed herewith. From December 8, 1994 to December 19, 1995 the operations, assets and liabilities of the Partnership were included in the consolidated financial statements of Petro. Since the Partnership's initial public offering in December 1995 it has been accounted for under the equity method of accounting in Petro's financial statements. The historical financial data for the six months ended June 30, 1997 and 1998 and the historical other data are unaudited. The results of operations for the six- month periods ended June 30, 1997 and 1998 contain all adjustments that are of a normal and recurring nature necessary to present fairly the financial condition and results of operations for such periods. These historical results are not necessarily indicative of the results to be expected in the future. 37
SIX MONTHS YEAR ENDED DECEMBER 31, ENDED JUNE 30, ---------------------------- ----------------- 1995 1996 1997 1997 1998 -------- -------- -------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF OPERATIONS DATA Net sales.................... $609,507 $608,161 $548,141 $336,067 $249,366 Gross profit................. 221,682 180,773 168,393 108,004 92,046 Operating expenses........... 164,929 138,703 132,383 67,802 57,668 Restructuring, corporate identity and pension curtailment................. -- 4,366 7,640 3,410 687 Depreciation, amortization and other non-cash costs(a).................... 40,450 30,818 30,311 15,069 14,671 Operating income (loss)...... 16,303 6,886 (1,941) 21,723 19,020 Interest expense-net......... 38,792 32,412 31,668 16,026 15,272 Other income (expense)-net... 218 1,842 11,445 38 116 Share of income (loss) of Star Gas.................... 728 2,283 (235) 549 465 Income (loss) before extraor- dinary item................. (22,043) (21,901) (22,899) 5,934 4,004 Net income (loss)............ $(23,479) $(28,315) $(22,899) $ 5,934 $ 4,004 BASIC AND DILUTED EARNINGS (LOSSES) PER COMMON SHARE(B) Class A and Class C Common Stock....................... $ (1.06) $ (1.20) $ (1.06) $ 0.16 $ 0.06 CASH DIVIDENDS DECLARED PER COMMON SHARE(B) Class A and Class C Common Stock....................... $ 0.60 $ 0.60 $ 0.30 $ 0.15 -- WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING Basic(b) Class A Common Stock......... 22,711 22,983 23,441 23,238 23,958 Class C Common Stock......... 2,598 2,598 2,598 2,598 2,598 Diluted(b) Class A Common Stock......... 23,260 24,153 Class C Common Stock......... 2,598 2,598 - -------- (a) Other non-cash costs include provision for supplemental benefits. (b) For the years ended December 31, 1995, 1996 and 1997 there were 15, 12 and 11 shares of Class B Common Stock outstanding respectively. For the six months ended June 30, 1997 and 1998 there were 11 shares of Class B Common Stock outstanding for both periods. For all periods presented, Class B shares did not receive an allocation of earnings or dividends. (c) "EBITDA" is defined as operating income before depreciation, amortization, non-cash charges relating to the grant of stock options to Petro executives, non-cash charges associated with deferred compensation plans and other non-cash charges of a similar nature, if any. EBITDA should not be considered as an alternative to net income (as an indicator of operating performance) or as an alternative to cash flow (as a measure of liquidity or availability to service debt obligations), but provides additional information for evaluating Petro's financial performance. (d) The year ended December 31, 1995 includes $15.2 million of EBITDA and 84.4 million gallons related to the Partnership. Petro's 1995 results include the operations of the Partnership on a consolidated basis through December 19, 1995. Subsequent to that date, Petro accounted for the Partnership on the equity basis. (e) In 1996, Petro undertook a significant operating restructuring and corporate identity program to improve its efficiency and ultimately reduce operating costs. For the years ended December 31, 1996 and 1997 and for the six months ended June 30, 1997 and 1998, Petro recorded expenditures for these programs of $4.4 million, $7.6 million, $3.4 million and $0.7 million, respectively. (f) The decline in EBITDA for the year ended December 31, 1997, as compared to the year ended December 31, 1996 was largely due to warm weather experienced in 1997. (g) For the six months ended June 30, 1998, home heating oil volume declined by 20.1% versus the six months ended June 30, 1997 primarily due to the abnormally warm temperatures associated with the weather phenomenon generally referred to as "El Nino." While volume declined 20.1%, EBITDA declined only 14.5% due to a reduction in operating costs largely attributable to the effects of the restructuring and cost reduction programs. 38
SIX MONTHS YEAR ENDED DECEMBER 31, ENDED JUNE 30, ------------------------------------ ---------------------- 1995 1996 1997 1997 1998 --------- --------- --------- --------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) BALANCE SHEET DATA (END OF PERIOD) Cash.................. $ 78,285 $ 3,257 $ 2,390 $ 28,172 $ 33,223 Working capital....... 65,408 18,093 12,436 54,179 23,139 Total assets.......... 357,241 275,025 247,846 259,761 229,120 Long-term debt........ 294,429 291,337 288,957 288,956 284,587 Redeemable preferred stock (long-term portion)............. 12,500 8,333 32,489 38,333 32,687 Stockholders' deficiency........... (100,903) (145,733) (177,033) (145,848) (175,066) OTHER DATA EBITDA(c)............. $ 56,753(d) $ 37,704 (e) $ 28,370(e)(f) $ 36,792(e) $ 33,691(e)(g) Heating oil and propane gallons...... 503,610(d) 456,141 410,291 254,289 203,299(g) SELECTED UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION The following table sets forth unaudited pro forma condensed consolidated income statement data and per Unit data for the Partnership and Petro for the twelve month period ended September 30, 1997 and the nine month period ended June 30, 1998 as if the Transaction had been consummated at the beginning of each period presented. Additionally, the balance sheet data below is based on the consolidated unaudited June 30, 1998 balance sheets of the Partnership and Petro. The pro forma amounts included below are based on the purchase method of accounting, a preliminary determination and allocation of the total purchase price and the assumptions described under "Unaudited Pro Forma Condensed Consolidated Financial Statements." The information below is based on and should be read in conjunction with, and is qualified in its entirety by, the consolidated financial statements of the Partnership and Petro and accompanying notes of the Partnership and Petro included in the documents described under "Incorporation of Certain Documents By Reference" and the unaudited pro forma consolidated financial statements of the Partnership and Petro and accompanying discussion and notes set forth under "Unaudited Pro Forma Condensed Consolidated Financial Statements." The unaudited pro forma consolidated amounts below are not necessarily indicative of the financial condition or the results of operations of the Partnership and Petro, on a consolidated basis, that would have actually occurred had the Transaction been consummated at October 1, 1996. The unaudited pro forma amounts are also not necessarily indicative of the future financial condition or future results of operations of the Partnership after giving effect to the Transaction. 39
TWELVE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, 1997 JUNE 30, 1998 ---------------------- ------------------- (IN THOUSANDS, EXCEPT PER UNIT AMOUNTS) STATEMENT OF OPERATIONS DATA Sales.................... $702,338 $510,550 Gross profit............. 239,960 199,013 Depreciation, amortization and other non-cash costs(a)....... 37,012 27,771 Operating income......... 26,214 51,669 Interest expense, net.... 26,009 19,229 Net income (loss)........ $ (320) $ 31,946 Net income per Unit(b)... $ (0.02) $ 2.29 OTHER DATA EBITDA(c)................ $ 60,251 $ 71,662 JUNE 30, 1998 ------------- BALANCE SHEET DATA Current assets........... $100,906 Total assets............. 659,449 Long-term debt........... 302,779 Total partners' capital.. 223,922 - -------- (a) Other non-cash costs include provision for supplemental benefits. (b) Net income per Unit is computed by dividing the limited partners' interest in net income by the limited partners' weighted average number of Units outstanding. (c) "EBITDA" is defined as operating income plus depreciation, amortization, restructuring charges, corporate identity expenses, pension curtailment expense and other non-cash charges (including the impairment of long-lived assets) less net gain (loss) on sale of businesses and equipment. EBITDA should not be considered an alternative to net income (as an indicator of operating performance) or as an alternative to cash flow (as a measure of liquidity or ability to service debt obligations), but provides additional information for evaluating the Partnership's ability to make the Minimum Quarterly Distribution. For a discussion of the cash flows provided by (used in) the Partnership's operating, investing and financing activities, see the statements of cash flows in the consolidated financial statements of the Partnership incorporated by reference in this Proxy Statement. In analyzing the historical results of the Partnership and the pro forma information as provided in the table above, the following matters should be considered. First, the results for the fiscal 1997 pro forma exclude cost savings associated with Petro's restructuring program implemented during 1998. This restructuring program includes reductions in both corporate and field personnel, the consolidation of employee benefits plan and the rationalization of branch facilities. Second, while depreciation and amortization expenses reduce net income, as a non-cash expense, these expenses do not impact distributable cash flow. Third, while the propane and home heating oil businesses are both seasonable businesses, the home heating oil business generates a greater proportion of its profits in the heating season from October 1 through March 31 as compared to the propane business. Conversely, the heating oil business experiences greater losses during the period from April 1 through September 30. 40 COMPARATIVE MARKET PRICE INFORMATION (SEE PAGE 179) The Common Units are listed on the New York Stock Exchange under the symbol "SGU." The shares of Class A Common Stock are listed on the Nasdaq National Market under the symbol "HEAT." On August 13, 1998, the last full trading day prior to the public announcement of the proposed Transaction, the closing sales price of the Common Units was $21.063 on the New York Stock Exchange and the closing sales price of the shares of Class A Common Stock was $1.875 on the Nasdaq National Market. On October 21, 1998, the Common Units closed at $20 and the shares of Class A Common Stock closed at $1.00. See "Comparative Security Price and Distribution Information." CERTAIN FEDERAL INCOME TAX CONSIDERATIONS (SEE PAGE 182) Tax Consequences of the Merger. The Merger will be a taxable transaction to the holders of Petro Common Stock, generally, resulting in gain or loss to each such holder in an amount equal to the difference between the value of the Senior Subordinated Units received by such holder and the federal income tax basis such holder has in the shares of Common Stock exchanged for such Units. Gain or loss will be capital gain or loss if the stock is held by the stockholder as a capital asset and will be long-term gain or loss if such stock has been held for more than one year. Long-term capital gains will be taxed at a maximum rate of 20%. Capital losses can be deducted against capital gains and thereafter can only be deducted against ordinary income to the extent of $3,000 per year for individuals with any unused capital loss being carried forward indefinitely. Net capital gain of foreign holders of Petro Common Stock will generally not be subject to United States federal income tax. The Merger will result in gain to Petro. Petro expects that its net operating losses will generally shelter such gain and that, as a consequence, Petro will incur only minimal federal tax as a consequence of the Transaction. The amount and use of Petro's net operating losses, and therefore, the ability to shelter Petro's gains could be subject to challenge by the Internal Revenue Service (the "IRS"). It is not anticipated by Petro that it or its corporate affiliates (the "Corporate Group") will pay significant federal income tax during the several years immediately following the Transaction; however, over time it is expected that more federal income tax will be paid by the Corporate Group. The Corporate Group's ability to reduce income for federal income tax purposes following the Transaction is dependent on the companies' depreciation deductions and interest deductions with respect to certain debt, all of which is subject to challenge by the IRS. See "Risk Factors" and "Certain Federal Income Tax Considerations." Partnership Status. In the opinion of counsel, based on certain assumptions and representations, the Partnership has been and will continue to be classified for federal income tax purposes as a partnership, and the beneficial owners of Senior Subordinated Units will be considered partners of the Partnership. Accordingly, the Partnership itself (not including the Corporate Group, who will pay federal income taxes) will pay no federal income taxes, and a Senior Subordinated Unitholder will be required to report in his federal income tax return his share of the Partnership's income, gains, losses and deductions without regard to the amount of cash distributed to him. In general, cash distributions to a Senior Subordinated Unitholder will be taxable only if, and to the 41 extent that, they exceed such Unitholder's tax basis in his Senior Subordinated Units. Partnership Allocations and Distributions. In general, annual income and loss of the Partnership will be allocated to the General Partner and the Unitholders for each taxable year in accordance with their respective percentage interests in the Partnership. Such income or loss will be determined annually and prorated on a monthly basis and subsequently apportioned among the General Partner and the Unitholders of record as of the opening of the first business day of the month to which they relate, even though Unitholders may dispose of their Units during the month in question. A Unitholder will be required to take into account, in determining his federal income tax liability, his share of income generated by the Partnership for each taxable year of the Partnership ending with or within the taxable year of the Unitholder, even if cash distributions are not made to him. As a consequence, a Unitholder's share of taxable income of the Partnership (and possibly the income tax payable by him with respect to such income) may exceed the cash, if any, actually distributed to such Unitholder. See "--Ratio of Taxable Income to Distributions." Although it is not expected by Petro that the Corporate Group will pay significant federal income tax for several years, it is possible that the Corporate Group may generate earnings and profits during that time such that distributions from the Corporate Group to the Partnership may result in taxable dividend income to the Partnership and, thus, to the Unitholders. Such dividend income cannot be offset by past or future losses generated by the Partnership's propane activities.To the extent distributions are not taxable, they decrease a Unitholder's basis. As a result, upon the sale of a Unit, the Unitholder could incur tax. Ratio of Taxable Income to Distributions. The Partnership estimates that a Common Stockholder who receives Senior Subordinated Units in the Transaction and holds such Senior Subordinated Units from the Effective Time through December 31, 2001, will be allocated, on a cumulative basis, an amount of federal taxable income for such period that will be less than 15% of the cash distributed with respect to that period. The Partnership further estimates that for taxable years beginning after December 31, 1998, the taxable income allocable to such Unitholders will constitute a significantly higher percentage of cash distributed to them. The foregoing estimates are based upon the assumption that gross income from operations will approximate the amount required to make the Minimum Quarterly Distribution with respect to all Units and other assumptions with respect to capital expenditures, cash flow and anticipated cash distributions. These estimates and assumptions are subject to, among other things, numerous business, economic, regulatory, competitive and political uncertainties beyond the control of the Partnership. Further, the estimates are based on current tax law and certain tax reporting positions that the Partnership has followed and intends to follow and with which the IRS could disagree. Accordingly, no assurance can be given that the estimates will prove to be correct. The actual percentage of distributions that will constitute taxable income could be higher or lower, and any such differences could be material and could materially affect the value of the Senior Subordinated Units. The Transaction will result in an increase in taxable income allocated to the existing Common Unitholders as a percentage of cash expected to be distributed. However, the Transaction will have different tax effects on different Common Unitholders, depending on when they purchased their Units. 42 See "Certain Federal Income Tax Considerations--Tax Consequences of Unit Ownership--Ratio of Taxable Income to Distributions." Basis of Senior Subordinated Units. A Unitholder's initial tax basis for a Senior Subordinated Unit will be the fair market value of the Unit at the Effective Time. A Unitholder's basis is generally increased by his share of Partnership income and decreased by his share of Partnership losses and distributions. Limitations on Deductibility of Partnership Losses. In the case of taxpayers subject to the passive loss limitations of the passive loss rules (generally, individuals and closely held corporations), Partnership losses, if any, will only be available to offset future passive income generated by the Partnership and cannot be used to offset income from other activities, including passive activities or investments and any dividend or interest income generated by the Partnership (such as dividends from the Corporate Group). Any losses unused by virtue of the passive loss rules may be deducted against any income when the Unitholder disposes of all of his Units in a fully taxable transaction with an unrelated party. Section 754 Election. The Partnership has made the election provided for by Section 754 of the Code, which will generally permit a Unitholder to calculate income and deductions by reference to the portion of his purchase price attributable to each asset of the Partnership. The Partnership will provide these calculations to Unitholders. Disposition of Senior Subordinated Units. A Unitholder who sells Senior Subordinated Units will recognize gain or loss equal to the difference between the amount realized and his adjusted basis in such Senior Subordinated Units. Thus, distributions of cash from the Partnership to a Unitholder in excess of the income allocated to him will, in effect, become taxable income if he sells his Units at a price greater than his adjusted tax basis even if the price is less than his original cost. A portion of the amount realized (whether or not representing gain) may be ordinary income. Other Tax Considerations. In addition to federal income taxes, Unitholders will likely be subject to other taxes, such as state and local income taxes, unincorporated business taxes and estate, inheritance or intangible taxes that may be imposed by the various jurisdictions in which a Unitholder resides or in which the Partnership does business or owns property. A Unitholder will likely be required to file state income tax returns and to pay taxes in various states and may be subject to penalties for failure to comply with such requirements. The General Partner anticipates that substantially all of the Partnership's income will be generated in the following states: Connecticut, Indiana, Kentucky, Maine, Massachusetts, Michigan, New Hampshire, New Jersey, New York, Ohio, Pennsylvania, Rhode Island, Texas and West Virginia. Of these states, only Texas does not currently impose a personal income tax. New Hampshire's personal income tax applies only to interest and dividend income. Some of these states may require the Partnership to withhold a percentage of income from amounts to be distributed to a Unitholder who is not a resident of such state. The amount of withholding, which may be more or less than a particular Unitholder's income tax liability owed to the state, may not relieve the nonresident Unitholder from the obligation to file an income tax return. Amounts withheld may be treated as if distributed to Unitholders for purposes of determining the amounts distributed by the Partnership. Based on current law and its 43 estimate of future operations, the Partnership anticipates that any amounts required to be withheld will not be material. It is the responsibility of each prospective Unitholder to investigate the legal and tax consequences, under the laws of pertinent states and localities, of his investment in the Partnership. Accordingly, each prospective Unitholder should consult, and must depend upon, his own tax counsel or other advisor with regard to those matters. Further, it is the responsibility of each Unitholder to file all federal, state and local tax returns that may be required of such Unitholder. Counsel has not rendered an opinion on the state and local tax consequences of ownership or sale of Units. ACCOUNTING TREATMENT (SEE PAGE 135) The Transaction will be treated as a purchase for accounting purposes. See "Unaudited Pro Forma Condensed Consolidated Financial Information." DISSENTERS' RIGHTS (SEE PAGE 202) The Partnership The Common Unitholders do not have dissenters' rights. Petro Under Sections 302A.471 and 302A.473 of the Minnesota Business Corporation Act (the "MBCA"), set forth in full as Annex F to this Proxy Statement, Common Stockholders (other than those who have agreed to vote for the Acquisition Proposal or who have granted irrevocable proxies to Petro to vote for the Acquisition Proposal at the Special Meeting) have the right to dissent, and obtain payment of the "fair value" of their shares, in the event of certain corporate actions such as the Merger. Common Stockholders who wish to exercise dissenters' rights must comply fully with the requirements of Sections 302A.471 and 302A.473 of the MBCA. Accordingly, Common Stockholders wishing to dissent are urged to read carefully "Dissenters' Rights" in this Proxy Statement and Annex F hereto, and to consult their own legal advisors. Among other things, Section 302A-473 requires that a Common Stockholder wishing to exercise dissenters' rights must: (1) file with Petro, before the vote on the Transaction at the Special Meeting, a written notice of intent to demand payment of fair value for such holder's Common Stock (a "Dissent Notice"), and (2) not vote in favor of the Acquisition Proposal. If the Acquisition Proposal is approved at the Special Meeting, Common Stockholders wishing to dissent from the Merger must comply fully thereafter with a series of additional requirements under Section 302A.473 of the MBCA. FAILURE TO FOLLOW THE PROCEDURES SET FORTH IN ANNEX F MAY RESULT IN A TERMINATION OR LOSS OF DISSENTERS' RIGHTS UNDER SECTIONS 302A.471 AND 302A.473 OF THE MBCA. THE MEETINGS (SEE PAGES 75 AND 78) The Partnership. The Unitholders Meeting will be held at a.m., New York City time, on , 1999 at , New York, New York. The purpose of the Unitholders Meeting is to consider and vote upon the Star Proposals. See "The Unitholders Meeting." Petro. The Special Meeting will be held at a.m., New York City time, on , 44 1999 at , New York, New York. The purpose of the Special Meeting is to consider and vote upon the Acquisition Proposal. See "The Special Meeting." VOTES REQUIRED; RECORD DATE (SEE PAGES 75 AND 78) The Partnership. Only Common Unitholders of record at the close of business on , 1999 will be entitled to vote at the Unitholders Meeting. The affirmative vote of the holders of a Unit Majority as of the Star Gas Record Date is required to approve each of the Acquisition Proposal, the Amendment Proposal and the General Partner Proposal. A Unit Majority currently means a majority of the holders of the Common Units outstanding on the Record Date, other than Common Units owned by Star Gas and its affiliates. See "The Unitholders Meeting--Voting Rights; Vote Required." As of the Record Date, there were 3,858,999 Common Units outstanding held by holders of record, of which 60,727 Common Units, or 1.6% of the outstanding Common Units, were beneficially owned by Star Gas and its affiliates (including Petro and executive officers and directors of Star Gas and Petro and their affiliates). Petro. Only holders of record of Petro Common Stock at the close of business on , 1999 will be entitled to vote at the Special Meeting. The affirmative vote of the holders of a majority of all shares of each class of Common Stock outstanding as of the Petro Record Date, voting separately as a class, is required for approval of the Acquisition Proposal. In addition, the approval of the holders of a majority of the shares of Class A Common Stock outstanding as of the Petro Record Date (other than shares held by the directors and executive officers of Petro and their affiliates) is required to approve the Acquisition Proposal. As of the Petro Record Date, there were issued and outstanding 23,964,962 shares of Class A Common Stock held by record holders; and 2,597,519 shares of Class C Common Stock held by 24 record holders. The holders of % of the shares of Class A Common Stock and % of the shares of Class C Common Stock outstanding as of the Petro Record Date have agreed to vote for the Acquisition Proposal at the Special Meeting. The Acquisition Proposal also requires the approval of the holders of a majority of all shares of Petro's Junior Preferred Stock, Public Preferred Stock and Private Preferred Stock (collectively, the "Petro Preferred Stock"), outstanding as of the Petro Record Date, each voting separately as a class. The holders of 100% of the Petro Preferred Stock outstanding as of the Petro Record Date have granted irrevocable proxies to Petro or have agreed to vote their shares in favor of the Acquisition Proposal. The directors and executive officers of Petro and affiliates beneficially owned, as of the Petro Record Date, 11,953,432 shares of Common Stock (excluding all options to purchase shares of Class A Common Stock and Class C Common Stock). As of the Petro Record Date, they owned no shares of Petro Preferred Stock. Directors and executive officers of Star Gas and their affiliates (other than those persons who were also directors or executive officers of Petro) did not beneficially own, as of the Record Date, any shares of Common Stock or Petro Preferred Stock, and no shares of Common Stock or Petro Preferred Stock were owned by the Partnership or Star Gas. 45 EFFECTIVE TIME (SEE PAGE 125) The Merger will become effective (a) on the date that is within three business days after the last of the conditions to the consummation has been satisfied or waived or such later date as the parties to the Merger may have agreed to in writing and (b) (1) at the later of the time a certificate of merger is filed with the Delaware Secretary of State in accordance with the requirements of Delaware law and articles of merger are filed with the Minnesota Department of State in accordance with the requirements of Minnesota law or (2) at such later time as may be specified by agreement of the parties in such certificate of merger and articles of merger (the "Effective Time"). Assuming satisfaction of all conditions to consummation of the Merger, it is expected to become effective on or about , 1999. If the Merger does not occur prior to April 1, 1999, the Merger Agreement will be terminated unless the Petro Board and the Special Committee elect to extend such termination date. See "-- Amendment and Termination of the Merger Agreement" below. CONDITIONS TO THE CONSUMMATION OF THE TRANSACTION (SEE PAGE 131) Consummation of the Transaction is subject to fulfillment of various conditions precedent that have not yet been satisfied, including: --the holders of a majority of Common Units (other than the Common Units owned by Star Gas and its affiliates) must approve the Star Proposals; --the holders of a majority of the shares of Class A Common Stock (other than Class A Common Stock owned by the directors and executive officers of Petro and their affiliates) and Class C Common Stock, each voting separately as a class, must approve the Acquisition Proposal; --once the Star Proposals and Acquisition Proposal are approved, the Equity Offering and Debt Offering must be completed; --the Partnership and Petro must receive all necessary regulatory and third party approvals; and --the holders of no more than 10% of the outstanding shares of Common Stock shall have perfected their dissenters' rights. --Petro must meet certain financial tests set forth in the Merger Agreement. See "The Transaction--Conditions to Consummation of the Merger." REGULATORY MATTERS (SEE PAGE 135) Other than (a) the filing of notice of the proposed Transaction with the United States Department of Justice and the Federal Trade Commission under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSRA") and the lapse of the relevant waiting period prescribed thereunder; (b) registration under the Securities Act of the Senior Subordinated Units and the Common Units to be issued in the Transaction and the Common Units to be offered in the Equity Offering; (c) certain notifications required to be given by Petro to state and county authorities pursuant to provisions of certain licenses and permits; and (d) certain tax filings, no filing with, or approval of any federal or state governmental entity is required in connection with the Transaction. 46 AMENDMENT AND TERMINATION OF THE MERGER AGREEMENT (SEE PAGE 132) The Merger Agreement provides that, except as otherwise required by law and without the approval of Common Unitholders or Common Stockholders prior to the Effective Time, any provision of the Merger Agreement may be waived by the party benefitted by that provision or by both parties, and the Merger Agreement may be modified, amended or terminated on behalf of Petro or the Partnership by action of the Petro Board or the Special Committee, without action by the Common Stockholders and the Common Unitholders and whether before or after the Meetings. The Merger Agreement may be terminated and the Merger abandoned prior to the Effective Time, whether before or after its approval by Common Stockholders and Common Unitholders, by mutual consent of the Petro Board and the Special Committee or by either the Petro Board or Special Committee under certain specified circumstances described under "Amendment, Waiver and Termination." Those circumstances include, among other things, failure of the Common Stockholders or the Common Unitholders to approve the Transaction, a material breach by a party of its representations, warranties or agreements not cured within 30 days following written notice, issuance of a non-appealable judgment, decree or other order precluding consummation of the Transaction, or failure to consummate the Transaction by April 1, 1999, unless the failure to accomplish the Transaction by such time is due to the breach of a representation, warranty or agreement by the party seeking to terminate. See "The Transaction-- Amendment, Waiver and Termination." 47 RISK FACTORS Limited partner interests are inherently different from the capital stock of a corporation, although many of the business risks to which the Partnership will be subject are similar to those that would be faced by a corporation engaged in a similar business. Common Unitholders and Common Stockholders should consider the following factors in evaluating the Transaction. All statements, other than statements of historical facts included in this Proxy Statement, are forward-looking statements, including, without limitation, statements regarding the Partnership's (which includes Petro's) business strategy, plans and objectives of management for future operations and the statements under "Proxy Statement Summary--Cash Available for Distribution" and "--Description of Partnership Units--Distributions of Available Cash" and "-- Distributions to Unitholders;" "Cash Available For Distribution;" and "Cash Distribution Policy." Although the Partnership and Petro believe that the expectations reflected in such forward-looking statements are reasonable, they can give no assurance that such expectations will prove to be correct. Important factors that could cause actual results to differ materially from the expectations of the Partnership and Petro are discussed below and elsewhere in this Proxy Statement. RISKS TO THE PARTNERSHIP'S COMMON UNITHOLDERS In addition to the other information contained in this Proxy Statement, the Star Gas Board urges Common Unitholders to carefully consider each of the factors set forth below. Conflicts of Interest Were Present in Structuring the Transaction Petro and Star Gas developed and structured the Transaction. Star Gas is a wholly-owned subsidiary of Petro. Petro currently owns all the Subordinated Units of the Partnership, and all of the directors of Star Gas, other than the members of the Special Committee, are also directors or officers of Petro. As a result of this and other factors, members of the Petro Board and the Star Gas Board, other than the two members of the Special Committee, have interests that are different from, and in conflict with, the interests of the Common Unitholders. However, the Petro Board originally appointed the two members of the Special Committee, who have each received an additional fee of $40,000 for serving on the Special Committee. See "Interests of Certain Persons in the Transaction; Conflicts of Interest." Investment in Petro Will Substantially Change the Partnership's Business The Transaction involves the acquisition by the Partnership of a business that is substantially larger than the Partnership in terms of assets, liabilities and revenues. See "Selected Historical Financial and Operating Data" included in the Partnership's and Petro's Annual Reports on Form 10-K, which are incorporated by reference herein and/or accompany this Proxy Statement. As a result of the Transaction, the Partnership's primary business will shift from the retail distribution of propane to the distribution of home heating oil. Therefore, the nature of a Common Unitholder's investment will change substantially and a Common Unitholder will be exposed to all the risks inherent in the home heating oil business. Petro Has Significant Recent Net Losses Petro incurred net losses of approximately $23.5 million, $28.3 million and $22.9 million for the years ended December 31, 1995, 1996 and 1997, respectively. These net losses were primarily a 48 result of the amortization expense associated with the large number of acquisitions consummated since 1980 and interest expense. In connection with each acquisition, Petro amortizes, for financial accounting purposes, 90% of the amount allocated to customer lists over a six-year period and the balance over a 25-year period. In addition, Petro depreciates fixed assets, on average, over an eight-year period. The aggregate amortization of customer lists and deferred charges and depreciation and amortization of property and equipment in 1995, 1996 and 1997 amounted to approximately $39 million, $29.9 million and $29.7 million, respectively. Petro's net interest expense for 1995, 1996 and 1997 was $38.8 million, $32.4 million and $31.7 million, respectively. Higher than expected customer attrition, relatively mild recent winters and other operational factors also affected operating results. Management's strategy is to maximize EBITDA, rather than net income, and net losses are likely to continue in the near term. However, continued net losses could adversely affect Petro. No Assurance that the Transaction Will Result in Increased Distributions per Common Unit The Star Gas Board believes that the Partnership's acquisition of Petro will result in an increase in cash available to be distributed per Common Unit. This belief is based, in part, on Petro's anticipated ability (i) to effect a significant and successful program of acquiring home heating oil distributors at attractive prices and (ii) to complete its operational restructuring program, which is designed to reduce customer losses and improve operating margins. There can be no assurance as to these matters. Petro is not currently negotiating any potential acquisitions and is not a party to any binding acquisition agreements. See "--Petro's Ability to Grow Depends on Acquisitions." Moreover, there can be no assurance that Petro's implementation of its operational restructuring program will have the desired effect of reducing customer losses and improving operating margins. Common Unitholders Are Subject to Dilution of Their Interest There are currently 3,858,999 Common Units and 2,396,078 Subordinated Units outstanding, as well as a 2% general partner interest representing approximately 127,655 Units for a total of 6,382, 732 Units. As a result of the Common Units to be issued in the Equity Offering and the Units to be issued in the Merger and the Exchange, upon consummation of the Transaction there are expected to be outstanding approximately 10,325,408 Common Units, 2,767,058 Senior Subordinated Units, 577,205 Junior Subordinated Units and 278,973 General Partner Units for a total of 13,948,644 Units, an increase of approximately 119%. The issuance of these additional Units may be dilutive to the interests of the existing Common Unitholders if the Petro operations do not generate sufficient distributable cash flow. Furthermore, if Petro meets certain financial tests during the five-year period following the Closing up to an additional 909,000 Senior Subordinated Units will be issued to the holders of Senior Subordinated Units, Junior Subordinated Units and General Partner Units. Prior to the Transaction, the Partnership was authorized to issue 1,300,000 additional Common Units or Units on a parity with the Common Units (excluding issuances that are accretive on a per Unit basis) during the Subordination Period without a vote of the Common Unitholders. As a result of the Amendment Proposal, the Partnership will be able to issue 2,500,000 of such Units without a vote, the effect of which may be to dilute the value of the interests of the then-existing holders of Common Units in the net assets of the Partnership, dilute the interests of holders of Common Units in distributions by the Partnership and reduce the support provided by the subordination feature of the Senior Subordinated Units, Junior Subordinated Units and General Partner Units. In addition, 49 holders of Common Units will not have preemptive rights to acquire additional Common Units or other partnership interests that may be issued by the Partnership. As of the date hereof, the existing Subordinated Units represent a 37.5% limited partner interest in the Partnership. After the Transaction, the Senior Subordinated Units, Junior Subordinated Units and General Partner Units will represent only a 26.0% partner interest. Therefore, the amount of support provided by these Units for the payment of the Minimum Quarterly Distribution on the Common Units will decline. The Common Unitholders Will Experience a Reduction in Voting Power After the Transaction, certain transactions that previously required only the consent of a majority of the outstanding Common Units (other than those held by the General Partner and its affiliates) will also require the consent of the holders of a majority of the Senior Subordinated Units and Junior Subordinated Units, voting together as a single class. The matters on which the Senior Subordinated Units and Junior Subordinated Units will have a class vote include the merger, consolidation or sale of substantially all of the assets of the Partnership; the dissolution of the Partnership; certain amendments to the Partnership Agreement; the withdrawal of the General Partner; and the transfer by the General Partner of General Partner Units. Thus, there may be matters that are approved by a majority of the Common Units that are not adopted because a majority of the Senior Subordinated Units and Junior Subordinated Units did not vote to approve. The Partnership's Indebtedness May Affect Its Operations and Limit Its Ability to Make Distributions The Partnership is significantly leveraged and has indebtedness that is substantial in relation to its partners' capital. As a result of the Transaction, the Partnership's consolidated indebtedness will increase. On a pro forma basis as of June 30, 1998 (giving effect to the Transaction), the Partnership's total consolidated indebtedness would have been $302.8 million or 57.5% of total capitalization. Principal and interest payable on such indebtedness will reduce cash available to make distributions on the Common Units. Under certain circumstances, the Partnership consolidated indebtedness will restrict the ability of the Partnership to distribute cash to Common Unitholders and to borrow additional funds. The limitations and restrictions in the new debt to be issued by the Partnership may in effect be more restrictive than those in the Partnership's current indebtedness. Certain of the Partnership's indebtedness is secured by liens on substantially all of the assets of the Operating Partnership. In the case of a continuing default by the Partnership under such indebtedness, the lenders could enforce their liens against the assets of the Operating Partnership. Any such foreclosure or action by the Operating Partnership to stay such foreclosure by seeking to reorganize under the Federal Bankruptcy Code would have a material adverse effect on the Partnership and the Common Unitholders. The Partnership Has Debt With Change of Control Provisions Certain of the Partnership's debt instruments, including the Petro Holdings Senior Subordinated Debt, contain provisions relating to a "change of control." If such provisions are triggered, such outstanding indebtedness may become due. In such event, there is no assurance that the Partnership 50 and/or Petro Holdings would be able to pay the indebtedness, in which case the lenders would have the right to foreclose on the Operating Partnership's and Petro Holdings' assets, which would have a material adverse effect on the Partnership. There is no restriction on the ability of the General Partner to enter into a transaction that would trigger the change of control provisions. Weather Conditions Affect the Demand for Heating Oil Petro's home heating oil operations are more sensitive to temperature levels than the Partnership's operations since substantially all of Petro's sales of heating oil are for heating purposes whereas a portion of the Partnership's sales of propane are for uses other than heating. Accordingly, weather patterns during the winter months can have a material effect on sales of heating oil by Petro. Variations in temperature levels occur from year to year. Warmer than normal weather can adversely affect Petro's results of operations, while colder than normal weather can favorably affect Petro's results of operations. For the year ended December 31, 1997, temperatures were approximately 2.0% warmer (on a heating degree-day basis) than normal in the areas where Petro operates, while for the year ended December 31, 1996, temperatures were approximately 1.6% colder (on a heating degree-day basis) than normal in such areas. "Heating degree-days" measure the amount by which the average of the high and low temperatures on a given day is below or above 65 degrees Fahrenheit. There can be no assurance that average temperatures in future years will not be above the historical average. For example, the average temperatures in the regions in which Petro operates have been warmer over the last five years than they were over the preceding ten years. In addition, in situations of extreme weather conditions, such as prolonged or heavy snow, Petro may incur additional operating costs. Petro Has Experienced Significant Customer Losses Petro's annual net loss of home heating oil customers has been between approximately 5% to 6% per annum over the past five years, excluding additional customers obtained through acquisitions. Net customer losses are the result of various factors, including customers moving, changing suppliers, natural gas conversions and credit problems. There can be no assurance that Petro will be able to maintain or reduce its customer net loss rate in the future. Petro's Ability to Grow Depends upon Acquisitions The home heating oil industry is not a growth industry as a result of increased competition from alternative energy sources. Petro's growth in the past decade has been directly tied to the success of its acquisition program, and its future financial performance will depend on its ability to continue to identify and successfully consummate acquisitions at attractive prices. There is no assurance that Petro will be able to continue to identify attractive acquisition candidates in the future or that it will be able to acquire such candidates on attractive terms or obtain financing on acceptable terms. If Petro is able to make acquisitions there can be no assurance that 51 any such acquisitions will be profitable, or that any additional debt requirements will not offset the cash generated. Petro must comply with certain debt incurrence covenants in certain agreements of Petro and the Partnership that might restrict Petro's (and the Partnership's) ability to incur indebtedness to finance acquisitions in the home heating oil industry. In addition, factors that may adversely affect Petro's operating and financial results may, in turn, limit Petro's access to capital and its acquisition activities. Petro Has Heating Oil Supply Risks Home heating oil is available from numerous sources, including integrated international oil companies, independent refiners and independent wholesalers. While substantially all of Petro's supply in recent years has been from North American sources, there can be no assurance that disruptions in the supply of crude oil from foreign sources would not adversely affect Petro's home heating oil business. Past disruptions of this nature have caused increases in the price to Petro of home heating oil. Petro Has Heating Oil Pricing Risks During periods of sudden and sharp increases in the cost of home heating oil to Petro, such as those experienced during 1996, Petro may be unwilling or unable to pass the entire increase in supply costs on to its customers. This may result in reduced gross profit margin and may adversely affect, in the short term, Petro's operating results. Significant wholesale price increases over an extended period of time could have the effect of reducing demand by encouraging conservation, conversion to alternative energy sources or have the effect of causing certain customers to switch to delivery-only dealers. If demand was reduced and Petro was unable to increase its gross profit margin or reduce its operating expenses, the decrease in volume would adversely affect Petro's operating results. Approximately 25% of Petro's heating oil volume is sold to individual customers under agreements that fix in advance the maximum sales price of oil over a period of up to 12 months. The maximum price at which oil is sold to these "capped-price" customers generally is renegotiated in April of each year in light of then current market conditions. Petro currently enters into forward purchase contracts for most of the oil it sells to "capped-price" customers. This practice permits Petro to purchase oil at a fixed price in advance of its obligations to supply such oil. If events occur after a "capped-price" is negotiated that increase the cost of oil above the amount anticipated, margins for the "capped-price" customers whose oil was not purchased under forward contracts would be lower than expected, while margins for those customers whose oil was purchased under forward contracts would be unaffected. Conversely, if, during this period, the cost of oil decreased below the amount anticipated, margins for the "capped-price" customers whose oil was purchased under forward contracts could be lower than expected, while margins for those customers whose oil was not purchased under forward contracts would be unaffected or higher than expected. In the past few years, the percentage of Petro's customers with "capped-price" arrangements has increased, and the gross profit margin of oil sold to these customers has been lower than that of oil sold to Petro's other retail customers, thereby negatively affecting Petro's operating results. There can be no assurance that this trend will not continue in the future, and thereby continue to negatively affect Petro's financial performance. 52 The Home Heating Oil Business Is Highly Competitive Petro's business is highly competitive. Petro competes with heating oil distributors offering a broad range of services and prices, from full service distributors, like Petro, to those offering delivery only. Competition with other companies in the home heating oil industry is based primarily on customer service and price. Long-standing customer relationships are typical in the industry. Many companies in the industry, including Petro, deliver home heating oil to their customers based upon weather conditions and historical consumption patterns, without the customer making an affirmative purchase decision each time oil is needed. In addition, most companies, including Petro, provide home heating equipment repair service on a 24-hour per day basis. As a result of the factors noted above, among others, it may be difficult for Petro to acquire new retail customers. In addition, in certain instances, homeowners have formed buying cooperatives that seek to purchase fuel oil from distributors at a price lower than individual customers are otherwise able to obtain. Petro also competes for retail customers with suppliers of alternative energy products, principally natural gas. Competition from alternative energy sources has been increasing as a result of reduced regulation of many utilities, including natural gas and electric utilities. Many of these utilities have substantially greater financial resources than the Partnership. Petro Is Subject to Operating and Litigation Risks That May Not Be Insured Petro's operations are subject to operating hazards and risks incidental to the holding, storage and transportation of heating oil, a combustible liquid. As a result, Petro may be a defendant in litigation arising in the ordinary course of business. Petro maintains insurance policies with insurers in such amounts and with such coverages and deductibles as it believes are reasonable and prudent. However, there can be no assurance that such insurance will be adequate to protect Petro from all material expenses related to potential future claims for personal and property damage or that such levels of insurance will be available in the future at economical rates. The occurrence of an event not covered by insurance or indemnification could have a material adverse effect on Petro's business, operating results and financial condition. Petro Is Subject to Governmental Regulation and Could Have Significant Costs With Respect to Environmental and Other Regulatory Matters Petro's business is subject to the jurisdiction of governmental agencies with respect to a wide range of environmental and other regulatory matters. Petro has implemented environmental programs and policies designed to avoid potential liability and cost under applicable environmental laws. There can be no assurance, however, that Petro will not be adversely affected by increased costs due to stricter pollution control requirements or liabilities resulting from non-compliance with operating or other regulatory permits. New environmental regulations might adversely impact Petro's operations, including underground storage and transportation of home heating oil. In addition, the environmental risks inherently associated with Petro's home heating oil operations, such as the risks of accidental releases or spills, are greater than those associated with the Partnership's propane operations. There can be no assurance that material costs and liabilities will not be incurred, including those relating to claims for damages to property and persons. 53 No Dissenters', Appraisal or Similar Rights for Non-consenting Common Unitholders If the Common Unitholders approve the Star Proposals, all Common Unitholders will be bound by such approval even though, individually, they may have voted against them. Under applicable Delaware law and the terms of the Partnership Agreement, Common Unitholders will have no dissenters', appraisal or similar rights in connection with the Transaction, nor will such rights be voluntarily accorded to Common Unitholders by the Partnership. Therefore, Common Unitholders will not be entitled to receive cash payment from the Partnership for the fair value of their Common Units if they dissent and each of the Proposals is approved. See "Dissenters' Rights". TAX RISKS TO COMMON UNITHOLDERS Taxes Payable By Petro Will Reduce Distributions The Merger will result in income to Petro equal to the excess of the value of the Units distributed to Common Stockholders in the Merger plus debt relief in excess of the federal income tax basis of such Units to Petro. It is expected by Petro that its net operating losses ("NOLs") will generally shelter such gains and that, as a consequence, Petro will incur only nominal tax as a consequence of the Transaction. The amount of and use of Petro's NOLs and therefore the ability to shelter Petro's gains could be subject to challenge by the IRS. This could reduce the cash available for distribution by the Partnership. It is not anticipated by the Corporate Group that the Corporate Group will pay significant federal income tax during the several years immediately following the Transaction; however, over time it is expected that more federal income tax will be paid by the Corporate Group, which would reduce the amount of cash that the Partnership could distribute to Unitholders. The Corporate Group's ability to reduce income for federal income tax purposes following the Transaction is dependent on the depreciation and interest deductions with respect to certain debt, all of which is subject to challenge by the IRS. Although it is not expected by Petro that the Corporate Group will pay significant federal income tax for several years, it is possible that the Corporate Group may generate earnings and profits during that time such that distributions from the Corporate Group to the Partnership may result in taxable dividend income to the Partnership and thus, to the Unitholders. Such dividend income cannot be offset by past or future losses generated by the Partnership's propane activities. Ratio of Taxable Income to Distributions Will Increase The ratio of taxable income to cash distributions to existing Common Unitholders will increase over time at a greater rate if the Transaction occurs. For example, the General Partner estimates that a holder of an Initial Common Unit would be allocated, in the aggregate, no net passive income and less than $.05 per Unit per year of portfolio income through December 31, 2004 if the Transaction is not consummated but only through December 31, 2002 if the Transaction is consummated. In either case, the taxable income allocated to a Common Unitholder thereafter will constitute an increasingly higher percentage of cash distributed to him, and distributions in excess of the Minimum Quarterly Distribution will increase the ratio of taxable income to cash distributions to an existing Common Unitholder. See "Certain Federal Income Tax Considerations" for a discussion of assumptions and limitations used in making these estimates. However, the Transaction will have different tax effects on different Common Unitholders, depending on when they purchased their Units. In addition, any 54 dividends from the Corporate Group cannot be offset by past or future losses generated by the Partnership's propane operations. RISKS TO COMMON STOCKHOLDERS In addition to the other information contained in this Proxy Statement, the Star Gas Board and the Petro Board urge Common Stockholders to carefully consider each of the factors set forth below. Conflicts Were Present in Structuring the Transaction Petro and Star Gas developed and structured the Transaction. The directors of Petro have interests in the Transaction which, in most cases, vary significantly from the interests of Public Common Stockholders. As a result of this, certain directors of Petro have interests that are different from, and in conflict with, the interests of the Public Common Stockholders. See "Interests of Certain Persons in the Transaction; Conflicts of Interest." Cash Distributions on Senior Subordinated Units are Subordinated and Otherwise Limited Public Common Stockholders will receive Senior Subordinated Units in exchange for their shares of Common Stock. During the Subordination Period, which will generally not end prior to July 1, 2002, no distributions of cash may be made on the Senior Subordinated Units with respect to any quarter until the Common Units have received the Minimum Quarterly Distribution for such quarter, plus any arrearages thereon. Prior to the quarter ending December 31, 1999, distributions may be made on the Senior Subordinated Units only if the combined results of the Partnership and Petro exceed certain financial benchmarks. For the quarter ending December 31, 1999 and thereafter, distributions on the Senior Subordinated Units will be limited to Operating Surplus generated by the Partnership since October 1, 1999. Senior Subordinated Units will not accrue distribution arrearages. There can be no assurance that the Partnership will generate sufficient Available Cash to make distributions on the Senior Subordinated Units. In addition, there can be no assurance that the Partnership will ever meet the requirements necessary for the Subordination Period to end. Accordingly, there can be no assurance that the Senior Subordinated Units will ever convert to Class B Common Units. Furthermore, there can be no assurance that Petro will meet the financial tests necessary for additional Senior Subordinated Units to be issued to the holders of Senior Subordinated Units. See "Cash Distribution Policy." Cash Distributions are Not Guaranteed and May Fluctuate with Partnership Performance Cash distributions on the Senior Subordinated Units will not be guaranteed and may fluctuate based on the performance of the Partnership. The General Partner may establish reserves that reduce the amount of Available Cash. Because of the seasonal nature of the Partnership's business, the General Partner has, historically, made additions to reserves during certain of the Partnership's fiscal quarters in order to fund operating expenses, interest payments and cash distributions to partners with respect to other fiscal quarters. The Partnership Agreement provides that the General Partner may not establish reserves for distributions on the Senior Subordinated Units unless it has determined in its judgment that the establishment of such reserves will not prevent the Partnership from distributing the full Minimum Quarterly Distribution, plus any arrearages, on the Common Units for the 55 following four quarters. Cash distributions are dependent on cash flow, including from reserves, and not on profitability, which is affected by non- cash items. Therefore, cash distributions may be made during periods when the Partnership records losses, and may not be made during periods when the Partnership records income. As a result of these and other factors, there can be no assurance that the Partnership will be able to distribute the Minimum Quarterly Distribution or any other amount on the Senior Subordinated Units. The amount of Available Cash constituting Operating Surplus needed to pay the Minimum Quarterly Distribution for four quarters on the Common Units, Senior Subordinated Units, Junior Subordinated Units and General Partner Units to be outstanding immediately after the Effective Time is approximately $32.1 million ($23.8 million for the Common Units, $6.4 million for the Senior Subordinated Units, $1.3 million for the Junior Subordinated Units and $0.6 million for the General Partner Units). The amount of pro forma Available Cash from Operating Surplus generated during the twelve months ended September 30, 1997 (which excludes any working capital borrowings) was approximately $28.3 million, which excludes non-recurring restructuring, corporate identity and pension curtailment expenses of approximately $7.6 million. As a result, the Partnership believes that it would have been able to distribute the full Minimum Quarterly Distribution on all Common Units during the twelve months ended September 30, 1997, but would not have been able to distribute the full Minimum Quarterly Distribution on all Senior Subordinated Units, Junior Subordinated Units or General Partner Units. See "Cash Available for Distribution." For the calculation of pro forma Available Cash from Operating Surplus, see Annex G. There Is No Active Trading Market in, and Uncertainty Regarding Market Prices of, Senior Subordinated Units At present there is no trading market for the Senior Subordinated Units. Although an application has been approved to list the Senior Subordinated Units on the NYSE under the trading symbol , there can be no assurance that an active trading market will develop after the Effective Time. While the Petro Board, based on information received from its financial advisors, believes that Senior Subordinated Units will trade at a discount to the price per Common Unit, the actual trading price of the Senior Subordinated Units will depend on a variety of factors, including market conditions for securities of master limited partnerships, the trading price of the Common Units, weather in areas of the Partnership's operations and actual and anticipated amounts of Available Cash generated by the Partnership. There can be no assurance that holders of Senior Subordinated Units will be able to sell their Units at favorable prices or that the Senior Subordinated Units will trade at prices related to the market prices of the Common Units. If, following the Transaction, a number of former Common Stockholders sell Senior Subordinated Units, the trading price of the Senior Subordinated Units could decline significantly. The Partnership Has Substantial Indebtedness Although substantially less leveraged than Petro, following the completion of the Transaction the Partnership will have a substantial amount of indebtedness. The terms of such indebtedness could restrict the amount of cash distributable by the Partnership and limit the amount of additional indebtedness the Partnership might incur to make acquisitions or for other purposes. See "-- Risks to the Partnership's Common Unitholders--The Partnership's Indebtedness May Affect Its Operations 56 and Its Ability to Make Distributions" and "--The Partnership Has Debt with Change of Control Provisions." Holders of Units Have Limited Voting Rights; the General Partner Manages and Operates the Partnership The General Partner manages and operates the Partnership and the Operating Partnership. Unlike the holders of common stock in a corporation, holders of outstanding Units have only limited voting rights on matters affecting the Partnership's business. Unitholders have no right to elect the General Partner on an annual or other continuing basis, and the General Partner generally may not be removed except pursuant to the vote of the holders of not less than 66 2/3% of the outstanding Common Units (excluding those held by the General Partner and its affiliates) and the Senior Subordinated Units and Junior Subordinated Units voting as a single class. As a result, Unitholders have limited influence on matters affecting the operation of the Partnership and third parties may find it difficult to attempt to gain control or influence the activities of the Partnership. Although the Amended and Restated Partnership Agreement provides that the General Partner may not transfer any or all of the General Partner Units to another person or entity prior to December 31, 2005 without the approval of a Unit Majority (subject to certain exceptions), the members of Star Gas LLC may sell or otherwise transfer their limited liability company interests in Star Gas LLC to a third party at any time without the approval of the Unitholders. Unlike the holders of Common Units, the holders of Senior Subordinated Units do not have the right to approve the issuance of additional partnership interests under certain circumstances. Furthermore, the matters on which the Senior Subordinated Units may vote require the approval of a Unit Majority. A Unit Majority means, during the Subordination Period, at least a majority of the Common Units (excluding Common Units held by the General Partner and its affiliates) and at least a majority of the Senior Subordinated Units and Junior Subordinated Units voting as a single class. Thus, there may be matters that are approved by a majority of the Senior Subordinated Units that are not adopted either because an insufficient number of Junior Subordinated Units voted to approve or because a majority of the Common Units did not vote to approve. The Partnership May Issue Additional Units Diluting Existing Unitholders' Interests The Partnership will have the authority under the Amended and Restated Partnership Agreement to issue up to 2,500,000 Common Units and, in certain circumstances, an unlimited number of additional Common Units and an unlimited number of additional Senior Subordinated Units, Junior Subordinated Units or other equity securities for such consideration and on such terms and conditions as are established by the General Partner, in its sole discretion without obtaining the approval of the Unitholders. See "--Risks to the Partnership's Common Unitholders--Common Unitholders Are Subject to Dilution of Their Interest." The Amended and Restated Partnership Agreement Contains Provisions That May Discourage a Change of Management The Amended and Restated Partnership Agreement contains certain provisions that may discourage a person or group from attempting to remove an incumbent general partner or otherwise 57 change the management of the Partnership. The effect of these provisions may be to diminish the price at which the Senior Subordinated Units will trade under certain circumstances. Reimbursement of General Partner Has Priority over Distributions Prior to making any distributions on the Units, the Partnership will reimburse the General Partner and its affiliates (including officers and directors of the General Partner) for all expenses incurred by the General Partner and its affiliates on behalf of the Partnership (including wages, salaries, incentive compensation and the cost of employee benefit plans paid or provided to employees, officers and directors of the General Partner), which expenses will be determined by the General Partner in its sole discretion. In addition, the General Partner and its Affiliates may provide services to the Partnership for which the Partnership will be charged reasonable fees as determined by the General Partner. The reimbursement of such expenses and the payment of any such fees could adversely affect the ability of the Partnership to make distributions. The General Partner and the Partnership Will Have a Limited Call Right with Respect to the Units If, at any time, less than 20% of the then issued and outstanding Units of limited partner interest of any class (including Senior Subordinated Units and Junior Subordinated Units) is held by persons other than the General Partner and its affiliates, the General Partner will have the right to acquire all, but not less than all, of the remaining limited partner interests of such class held by such unaffiliated persons at a price generally equal to the then- current market price of limited partner interests of such class. The General Partner may assign such right to any of its affiliates or the Partnership. As a consequence, a holder of Units may be required to sell his Units at a time when he may not desire to sell them or at a price that is less than the price he would desire to receive upon such sale. Also, upon expiration of the Subordination Period, if the Partnership acquires more than 66 2/3% of the Class B Common Units in a twelve-month period, then the Partnership will have a call right that is similar to that of the General Partner described above. Unitholders May Not Have Limited Liability in Certain Circumstances Under certain circumstances, Unitholders could lose their limited liability and could become liable for amounts improperly distributed to them by the Partnership. See "The Amended and Restated Partnership Agreement--Limited Liability." Petro Common Stockholders Will Have Fewer Ownership Rights If the Transaction is effected, the Common Stockholders will lose the rights they hold as stockholders in a Minnesota corporation, but will gain the rights of limited partners in a Delaware limited partnership. Overall, the Transaction probably will result in a reduction in Common Stockholder's legal rights. For example, while Common Stockholders currently have the right to elect directors, Unitholders do not have the right to elect the directors of the General Partner. A comparison of these changes in rights is set forth under "Comparison of Securities." Weather Conditions Affect the Demand for Propane Weather conditions have a significant impact on the demand for propane for both heating and agricultural purposes. Many customers of the Partnership rely heavily on propane as a heating 58 fuel. Accordingly, the volume of retail propane sold is highest during the six- month peak heating season of October through March and is directly affected by the severity of the winter weather. Approximately 70% to 75% of the Partnership's combined retail propane volume is attributable to sales during the peak heating season from October through March. Actual weather conditions can vary substantially from year to year, significantly affecting the Partnership's results of operations. There can be no assurance that average temperatures in future years will not be above historical averages. For example, the average temperatures in the region in which the Partnership operates have been warmer over the last five years than the preceding ten years. Petro's home heating oil operations are more sensitive to temperature levels than the Partnership's operations since substantially all of Petro's sales of heating oil are for heating purposes whereas a portion of the Partnership's sales of propane are for uses other than heating. The Partnership Is Subject to Propane Pricing Risk The retail propane business is a "margin-based" business in which gross profits depend on the excess of selling prices over propane supply costs. Consequently, the Partnership's profitability is sensitive to changes in wholesale propane prices to the extent they cannot be passed on to its customers. Propane is a commodity, the market price of which is subject to fluctuation (which may be volatile) in response to changes in supply or other market conditions. The Partnership has no control over these market conditions. As rapid increases in the wholesale cost of propane may not be immediately passed on to customers by the Partnership, such increases could reduce the Partnership's gross profits. The Partnership Is Subject to Inventory Risk and Inflation Risk Propane is available from numerous sources, including integrated international oil companies, independent refiners and independent wholesalers. The Partnership purchases propane from a variety of suppliers pursuant to supply contracts and on the spot market. The major portion of propane purchased by the Partnership (approximately 79% in fiscal 1997) is produced domestically. To the extent that the Partnership purchases propane from Canadian sources (approximately 21% in fiscal 1997), its propane business will be subject to risks of disruption in foreign supply. The Partnership attempts to minimize inventory risks by purchasing propane on a short-term basis. During periods of low demand for propane, which generally occur during the summer months, the Partnership has on occasion purchased large volumes of propane at lower-than- market costs for storage in the Partnership's 21 million gallon Indiana underground storage facility for future resale. Because of the potential volatility of propane prices, the market price for propane could fall below the price at which the Partnership purchased propane held in inventory, thereby adversely affecting gross margin or sales or rendering sales from such inventory unprofitable. The Partnership may from time to time engage in transactions (such as options or fixed price contracts to purchase propane) to hedge product costs in an attempt to reduce cost volatility. To date, the level of such activities has not been significant and the Partnership is not currently engaged in any such transactions. Inflation increases the Partnership's operating and administrative costs. The Partnership will attempt to limit the effects of inflation on its results of operations through cost control efforts, productivity improvements and increases in gross profit margins, but it may not be successful. 59 The Partnership Is Dependent on Principal Suppliers During fiscal year 1997, 43% of the Partnership's volume of propane purchases in the Midwest was purchased on the spot market from various Mont Belvieu, Texas sources, and 21% was purchased from three refineries in Illinois and Indiana owned by Amoco Canada Marketing Group. Approximately 47% of purchases from Amoco Canada Marketing Group was made under long-term market-based supply contracts, and the balance was made under short-term supply contracts. Although the Partnership believes that alternative sources of propane are readily available, in the event that the Partnership were unable to purchase propane from either of these sources, the failure to obtain alternate sources of supply at competitive prices and on a timely basis could have a material adverse effect on the Partnership. Substantially all of the Partnership's propane supply for its Northeast retail operations is purchased under annual or longer term supply contracts. Historically, a substantial portion of the propane purchased by the Partnership has originated at the Mont Belvieu, Texas storage facilities and has been shipped to the Partnership through a major common carrier pipeline. Any significant interruption in the service at Mont Belvieu or on the common carrier pipeline could have a material adverse effect on the business of the Partnership. The Retail Propane Business Is Highly Competitive The retail propane distribution business is highly competitive. Many of the Partnership's competitors are larger or have substantially greater financial and operating resources than the Partnership. Generally, competition in the last few years has intensified, partly as a result of warmer-than-normal weather and general economic conditions. The Partnership's ability to compete effectively depends on the reliability of its service, its responsiveness to customers, its ability to maintain competitive retail prices and its ability to acquire propane companies. If a competitor attempts to increase market share by reducing prices, the Partnership's operating results and financial condition could be materially and adversely affected. Competition from alternative energy sources has been increasing as a result of reduced regulation of many utilities, including natural gas and electricity. Many of these utilities have substantially greater financial resources than the Partnership. As a result of long-standing customer relationships, which are typical in the retail home propane industry, the inconvenience of switching tanks and suppliers and the lack of growth in the industry, the Partnership's propane business may experience difficulty in acquiring new retail customers (other than through acquisitions). The Partnership's Ability to Grow Depends Upon Acquisitions The retail propane industry is mature with only limited growth in total demand for propane. The Partnership believes the overall demand for propane has remained relatively constant, with year-to-year industry volumes being affected primarily by weather patterns. Therefore, the ability of the Partnership's propane business to grow depends heavily on its ability to acquire other distributors. In making acquisitions, the Partnership competes with larger and well-financed companies. There can be no assurance that the Partnership will identify attractive acquisition candidates in the future or that it will be able to acquire such candidates or obtain financing for such acquisitions on acceptable terms. If the Partnership is able to make acquisitions, there can be no assurance that 60 such acquisitions will not be dilutive to earnings and distributions to the Unitholders, or that any additional debt incurred to finance acquisitions will not affect the ability of the Partnership to make distributions to the Unitholders. The Partnership is subject to certain debt incurrence covenants in certain agreements governing its indebtedness that might restrict the Partnership's ability to incur indebtedness to finance acquisitions. In addition, to the extent that warm winter weather adversely affects the Partnership's operating results, the Partnership's access to capital and its acquisition activities may be limited. The Partnership Is Subject to Operating and Litigation Risks That May Not Be Insured The Partnership's operations are subject to operating hazards and risks incidental to the handling, storage and transportation of propane, a combustible liquid. As a result, the Partnership may be a defendant in litigation arising in the ordinary course of business. The Partnership maintains insurance policies with insurers in such amounts and with such coverages and deductibles as the General Partner believes are reasonable and prudent. However, there can be no assurance that such insurance will be adequate to protect the Partnership from all material expenses related to potential future claims for personal and property damage or that such levels of insurance will be available in the future at economical rates. The occurrence of an event not covered by insurance or indemnification could have a material adverse effect on the Partnership's business, operating results and financial condition. The General Partner Has Conflicts of Interest and Limited Fiduciary Responsibilities The General Partner and its affiliates may have conflicts of interest with the Partnership and its limited partners. The Amended and Restated Partnership Agreement contains certain provisions that limit the liability and reduce the fiduciary duties of the General Partner to the Unitholders, as well as provisions that may restrict the remedies available to Unitholders for actions that might, without such limitations, constitute breaches of fiduciary duty. Holders of Units are deemed to have consented to certain actions and conflicts of interest that might otherwise be deemed a breach of fiduciary or other duties under applicable state law. Decisions of the General Partner with respect to the amount of and timing of asset purchases and sales, cash expenditures, borrowings, issuances of additional Units and the creation, reduction or increases of reserves in any quarter will affect whether, or the extent to which, there is sufficient Available Cash from Operating Surplus to meet the Minimum Quarterly Distribution and Target Distribution Levels on all Units in a given quarter or in subsequent quarters. Except for Irik P. Sevin, who is subject to an agreement limiting his ability to compete with the Partnership's propane and heating operations, the General Partner's affiliates will not be prohibited from engaging in other businesses or activities, including those that might be in direct competition with the Partnership. There can be no assurance that there will not be competition between the Partnership and affiliates of the General Partner. 61 TAX RISKS TO COMMON STOCKHOLDERS There Are Risks Involving Tax Treatment of the Merger The Merger will be a taxable transaction to Common Stockholders, generally resulting in gain or loss to each such holder in an amount equal to the difference between the value of the Senior Subordinated Units received by him and the federal income tax basis he has in the shares exchanged for such Units. Any gain or loss will be capital gain or loss if the stock is held by the stockholder as a capital asset and will be long term capital gain or loss if such stock has been held for more than one year. Long-term capital gains will generally be taxed at a maximum rate of 20%. Capital losses can be deducted against capital gains and thereafter against ordinary income to the extent of $3,000 per year for individuals with any unused capital loss being carried forward indefinitely. The Merger will also result in income to Petro equal to the excess of the value of the Units distributed to its Common Stockholders in the Merger and any debt relief in excess of the federal income tax basis of such Units to Petro. Although it is expected by Petro that such gain will generally be offset by Petro's NOLs, the NOLs are subject to challenge by the IRS. This could reduce the cash available for distribution by the Partnership. Petro does not anticipate that the Corporate Group will pay significant federal income tax in the first few years; however, over time more federal income tax will be paid by the Corporate Group. The Corporate Group's ability to reduce income for federal income tax purposes is dependent on the depreciation deductions and interest deductions with respect to certain debt, all of which is subject to challenge by the IRS. Counsel has not rendered any opinion with respect to these matters. See "Certain Federal Income Tax Considerations--Tax Consequences of the Merger." Tax Treatment Is Dependent on Partnership Status The availability to a Unitholder of the federal income tax benefits of an investment in the Partnership depends, in large part, on the classification of the Partnership as a partnership for federal income tax purposes. Assuming the accuracy of certain factual matters as to which the General Partner and the Partnership have made representations, counsel is of the opinion that, under current law, the Partnership has been and will be classified as a partnership for federal income tax purposes. No ruling from the IRS as to classification has been or is expected to be requested. Instead, the Partnership intends to rely on such opinion of Counsel, which is not binding on the IRS. Based on the representations of the Partnership and the General Partner and a review of applicable legal authorities, Counsel is also of the opinion that at least 90% of the Partnership's gross income is income derived from the exploration, development, mining or production, processing, refining, transportation or marketing of any mineral or natural resource or other items of "qualifying income," within the meaning of Section 7704 of the Internal Revenue Code of 1986, as amended (the "Code"). Whether the Partnership will continue to be classified as a partnership in part depends, therefore, on the Partnership's ability to meet this qualifying income test in the future. See "Certain Federal Income Tax Considerations--Tax Consequences of Unit Ownership--Partnership Status." If the Partnership were classified as an association taxable as a corporation for federal income tax purposes, the Partnership would pay tax on its income at corporate rates (currently a 35% federal rate), distributions would generally be taxed again to the Unitholders as corporate distributions, and 62 no income, gains, losses and deductions would flow through to the Unitholders. Because a tax would be imposed upon the Partnership as an entity, the cash available for distribution to Unitholders would be substantially reduced. Treatment of the Partnership as an association taxable as a corporation or otherwise as a taxable entity would result in a material reduction in the anticipated cash flow and after-tax return to the Unitholders and thus would likely result in a substantial reduction in the market value of the Units. See "Certain Federal Income Tax Considerations--Tax Consequences of Unit Ownership--Partnership Status." There can be no assurance that the law will not be changed so as to cause the Partnership to be treated as an association taxable as a corporation for federal income tax purposes or otherwise to be subject to entity-level taxation. The Amended and Restated Partnership Agreement provides that, if a law is enacted or existing law is modified or interpreted in a manner that subjects the Partnership to taxation as a corporation or otherwise subjects the Partnership to entity-level taxation for federal, state or local income tax purposes, certain provisions of the Amended and Restated Partnership Agreement will be subject to change, including a decrease in the Minimum Quarterly Distribution and the Target Distribution Levels to reflect the impact of such law on the Partnership. See "Cash Distribution Policy--Adjustment of Minimum Quarterly Distribution and Target Distribution Levels." No IRS Ruling With Respect to Tax Consequences Leaves Uncertainty No ruling has been requested from the IRS with respect to classification of the Partnership as a partnership for federal income tax purposes, whether the Partnership's propane activities generate "qualifying income" under Section 7704 of the Code or any other matter affecting the Partnership. Accordingly, the IRS may adopt positions that differ from Counsel's conclusions expressed herein. It may be necessary to resort to administrative or court proceedings in an effort to sustain some or all of Counsel's conclusions, and some or all of such conclusions ultimately may not be sustained. Any such contest with the IRS may materially and adversely impact the market for the Units and the prices at which Units trade. In addition, the costs of any contest with the IRS will be borne directly or indirectly by some or all of the Unitholders and the General Partner. Risk of Tax Liability Exceeding Cash Distributions; Portfolio Income A Unitholder will be required to pay federal income taxes and, in certain cases, state and local income taxes on his allocable share of the Partnership's income, whether or not he receives cash distributions from the Partnership. There is no assurance that a Unitholder will receive cash distributions equal to his allocable share of taxable income from the Partnership or even the tax liability to him resulting from that income. Further, a holder of Units may incur a tax liability, in excess of the amount of cash received, upon the sale of his Units. See "Certain Federal Income Tax Considerations--Tax Consequences of Unit Ownership" and "--Disposition of Units." Although it is not expected by the Corporate Group that it will pay significant federal income tax for some period of time, it is possible that the Corporate Group may generate earnings and profits during that time such that distributions from the Corporate Group to the Partnership may result in taxable dividend income to the Partnership and, thus, to the Unitholders. Any dividend income from the Corporate Group cannot be offset by past or future losses generated by the Partnership's propane activities. 63 Ownership of Units Raises Issues For Tax-Exempt Organizations and Certain Other Investors Investment in Units by certain tax-exempt entities, regulated investment companies and foreign persons raises issues unique to such persons. For example, virtually all of the taxable income derived by a Unitholder that is an organization exempt from federal income tax (including IRAs and other retirement plans) is expected by the Partnership in the first few years to be unrelated business taxable income and thus taxable to such a Unitholder. A significant portion of the Petro Common Stockholders may, therefore, find it necessary or advisable to sell the Senior Subordinated Units they acquire in the Transaction, possibly driving down the market price of such Units. See "Certain Federal Income Tax Considerations--Uniformity of Units--Tax-Exempt Organizations and Certain Other Investors." There Are Limits On Deductibility of Losses In the case of taxpayers subject to the passive loss rules (generally, individuals and closely held corporations), losses generated by the Partnership will only be available to offset future passive income generated by the Partnership and cannot be used to offset income from other activities, including passive activities or investments or interest and dividend income generated by the Partnership (such as dividend income from the Corporate Group). Passive losses that are not deductible because they exceed the Unitholder's income generated by the Partnership may be deducted in full when the Unitholder disposes of his entire investment in the Partnership to an unrelated party in a fully taxable transaction. Net passive income from the Partnership may be offset by unused Partnership losses carried over from prior years, but not by losses from other passive activities, including losses from other publicly traded companies. See "Certain Federal Income Tax Considerations--Tax Consequences of Unit Ownership--Limitations on Deductibility of Partnership Losses." Tax Shelter Registration Could Increase Risk of Potential IRS Audit The Partnership is registered with the Secretary of the Treasury as a "tax shelter." The IRS has issued the following tax shelter registration number to the Partnership: 96026000016. No assurance can be given that the Partnership will not be audited by the IRS or that tax adjustments will not be made. Any Unitholder owning less than a 1% profit interest in the Partnership has very limited rights to participate in the income tax audit process. Further, any adjustments in the Partnership's tax returns will lead to adjustments in the Unitholders' tax returns and may lead to audits of Unitholders' tax returns and adjustments of items unrelated to the Partnership. Each Unitholder would pay any tax owed as the result of an examination of his personal tax return. There is a Possibility of Loss of Tax Benefits Relating to Non-Uniformity of Units and Non-Conforming Depreciation Covenants Because the Partnership cannot match transferors and transferees of Units, uniformity of the economic and tax characteristics of the Units to a purchaser of Units must be maintained. To maintain uniformity and for other reasons, the Partnership will adopt certain depreciation and amortization conventions that do not conform with all aspects of certain proposed and final Treasury Regulations. A successful challenge to those conventions by the IRS could adversely affect the 64 amount of tax benefits available to a purchaser of Units and could have a negative impact on the value of the Units. See "Certain Federal Income Tax Considerations--Uniformity of Units." Tax Gain or Loss on Disposition of Units Could Be Different Than Expected A Unitholder who sells Units will recognize gain or loss equal to the difference between the amount realized (including his share of Partnership nonrecourse liabilities) and his adjusted tax basis in such Units. Thus, prior Partnership distributions in excess of cumulative net taxable income in respect of a Unit that decreased a Unitholder's tax basis in such Unit will, in effect, become taxable income if the Unit is sold at a price greater than the Unitholder's tax basis in such Unit, even if the price is less than his original cost. A portion of the amount realized (whether or not representing gain) may be ordinary income. Furthermore, should the IRS successfully contest certain conventions to be used by the Partnership, a Unitholder could realize more gain on the sale of Units than would be the case under such conventions, without the benefit of decreased income in prior years. Reporting of Partnership Tax Information Is Complicated and Subject To Audits The Partnership will furnish each Unitholder with a Schedule K-1 that sets forth his allocable share of income, gains, losses and deductions. In preparing these schedules, the Partnership will use various accounting and reporting conventions and adopt various depreciation and amortization methods. There is no assurance that these schedules will yield a result that conforms to statutory or regulatory requirements or to administrative pronouncements of the IRS. Further, the Partnership's tax return may be audited, and any such audit could result in an audit of a partner's individual tax return as well as increased liabilities for taxes because of adjustments resulting from the audit. There Are State, Local and Other Tax Considerations In addition to federal income taxes, Unitholders will likely be subject to other taxes, such as state and local taxes, unincorporated business taxes and estate, inheritance or intangible taxes that are imposed by the various jurisdictions in which the Partnership does business or owns property. A Unitholder will likely be required to file state and local income tax returns and pay state and local income taxes in some or all of the various jurisdictions in which the Partnership does business or owns property and may be subject to penalties for failure to comply with those requirements. The General Partner anticipates that substantially all of the Partnership's income will be generated in the following states: Connecticut, Indiana, Kentucky, Maine, Massachusetts, Michigan, New Hampshire, New Jersey, New York, Ohio, Pennsylvania, Rhode Island, Texas and West Virginia. Of these states, only Texas does not currently impose a personal income tax. New Hampshire's personal income tax applies only to interest and dividend income. It is the responsibility of each Unitholder to file all federal, state and local tax returns that may be required of such Unitholder. Counsel has not rendered an opinion on the state or local tax consequences of ownership or sale of Units. See "Certain Federal Income Tax Considerations--State, Local and Other Tax Considerations." 65 INTERESTS OF CERTAIN PERSONS IN THE TRANSACTION; CONFLICTS OF INTEREST THE PARTNERSHIP Star Gas, the current general partner of the Partnership, is a wholly-owned subsidiary of Petro, and Petro owns all the outstanding Subordinated Units of the Partnership. All of the directors of Star Gas are also directors or officers of Petro, except the members of the Special Committee. As a result the members of the Star Gas Board who are also members of the Petro Board have conflicting fiduciary duties to the Common Unitholders, Petro and the Common Stockholders. Therefore, certain members of the Star Gas Board have interests that are different from, and in conflict with, the interests of the Common Unitholders. The officers and directors of Star Gas will be indemnified, to the extent permitted by law, for any and all actions taken in connection with the Transaction and are also covered by customary directors' and officers' liability insurance. Each member of the Star Gas Board will be a member of the Star Gas LLC Board following the Transaction, except that, at her request, one of the current directors of Star Gas will withdraw as a director upon consummation of the Transaction as a result of additional duties associated with a new job. That director will be replaced by a director selected by the Star Gas LLC Board, and the new director will not be an officer or employee of Star Gas LLC or any of its affiliates. The current officers of Star Gas will be employed as officers of the Operating Partnership following the Transaction. PETRO Certain directors of Petro have interests in the Transaction that are different from, and in conflict with, the interests of the Public Common Stockholders, since certain directors and their affiliates are receiving consideration that is different from that of the Public Common Stockholders. All directors and executive officers of Petro have interests in the Transaction, in addition to their interests as Common Stockholders and they are exchanging their Common Stock in a tax-free exchange whereas the Public Common Stockholders must exchange their shares in a taxable transaction. These directors and their affiliates will be exchanging their Common Stock for Junior Subordinated Units and General Partner Units, while the Public Common Stockholders and certain other directors and other affiliates will be receiving Senior Subordinated Units. The Junior Subordinated Units and General Partner Units will not be entitled to distributions until the Senior Subordinated Units receive the Minimum Quarterly Distribution. The Senior Subordinated Units will be publicly traded and have been approved for listing on the New York Stock Exchange. The Junior Subordinated Units and General Partner Units have not been registered and will not be publicly traded. The affiliates exchanging their Common Stock for Junior Subordinated Units and General Partner Units will receive .15909 Junior Subordinated Units or General Partner Units for each share of Common Stock, whereas the remaining Common Stockholders will exchange their shares for Senior Subordinated Units at a ratio of .13064 Senior Subordinated Units for each share of Common Stock. The Transaction has been structured so that the Public Common Stockholders will realize a taxable gain or loss on the Transaction, whereas all affiliates of Petro will exchange their Common 66 Stock without realizing such a taxable gain or loss. This structure was designed to minimize the tax effect of the Transaction on Petro. It was also based on the assumption that certain Petro affiliates have a low tax basis and would prefer not realizing a taxable gain on the Transaction, whereas Public Common Stockholders generally have a higher tax basis and would prefer realizing a tax loss. Irik P. Sevin is both the Chairman of the Board and Chief Executive Officer of Petro and the Chairman of the Board of Star Gas; Audrey L. Sevin is the Secretary and a director of both Petro and Star Gas; and Messrs. Paul Biddelman, Thomas J. Edelman and Wolfgang Traber are directors of both Petro and Star Gas. Messrs. Sevin, Biddelman, Edelman, Cohen and Traber and Mrs. Sevin are beneficial owners of Class A Common Stock and Class C Common Stock. As a result, the members of the Petro Board who are also members of the Star Gas Board have conflicting fiduciary duties to the Public Common Stockholders and the Public Common Unitholders. Therefore, certain members of the Petro Board have interests that conflict with the interests of the Public Common Stockholders. The officers and directors of Petro will be indemnified, to the extent permitted by law, for any and all actions taken in connection with the Transaction. The current officers of Petro will continue to be employed as officers following the Transaction. CONFLICTS OF INTEREST AND FIDUCIARY RESPONSIBILITY OF THE GENERAL PARTNER OF THE PARTNERSHIP CONFLICTS OF INTEREST Certain conflicts of interest could arise in the future as a result of the General Partner's relationships with its security holders, on the one hand, and the Partnership, on the other hand. The directors and officers of the General Partner have fiduciary duties to manage the General Partner, including its investments in its subsidiaries and affiliates, in a manner beneficial to its members. In general, the General Partner has a fiduciary duty to manage the Partnership in a manner beneficial to the Partnership and the Unitholders. The Amended and Restated Partnership Agreement contains provisions that allow the General Partner to take into account the interests of parties in addition to the Partnership in resolving conflicts of interest, thereby limiting its fiduciary duty to the Unitholders, as well as provisions that may restrict the remedies available to Unitholders for actions taken that might, without such limitations, constitute breaches of fiduciary duty. The duty of the directors and officers of the General Partner to the security holders of the General Partner may, therefore, come into conflict with the duties of the General Partner to the Partnership and the Unitholders. The Audit Committee of the Board of Directors of the General Partner will, at the request of the General Partner, review conflicts of interest that may arise between the General Partner or its affiliates, on the one hand, and the Partnership, on the other. See "Management of the Partnership After the Transaction" and "--Fiduciary Duties of the General Partner." The fiduciary obligations of general partners is a developing area of law. The provisions of the Delaware Revised Uniform Limited Partnership Act (the "DRULPA") that allow the fiduciary duties of a general partner to be waived or restricted by a partnership agreement have not been resolved in a court of law, and the General Partner has not obtained an opinion of counsel covering the provisions set forth in the Amended and Restated Partnership Agreement that purport to waive or 67 restrict fiduciary duties of the General Partner. Common Unitholders should consult their own legal counsel concerning the fiduciary responsibilities of the General Partner and its officers and directors and the remedies available to the Common Unitholders. Conflicts of interest could arise in the situations described below, among others: Certain Actions Taken by the General Partner May Affect the Amount of Cash Available for Distribution to Unitholders or Accelerate the Right to Convert Senior Subordinated Units and Junior Subordinated Units Decisions of the General Partner with respect to the amount and timing of cash expenditures, participation in capital expansions and acquisitions, borrowings, issuance of additional Units and establishment of reserves in any quarter may affect whether, or the extent to which, there is sufficient Available Cash from Operating Surplus to meet the Minimum Quarterly Distribution and Target Distribution Levels on all Units in such quarter or subsequent quarters. The Amended and Restated Partnership Agreement provides that any borrowings by the Partnership or the approval thereof by the General Partner shall not constitute a breach of any duty owed by the General Partner to the Partnership or the Unitholders, including borrowings that have the purpose or effect, directly or indirectly, of enabling the holders of Senior Subordinated Units, Junior Subordinated Units and General Partner Units to receive Incentive Distributions, hasten the expiration of the Subordination Period or the conversion of the Senior Subordinated Units and Junior Subordinated Units into Class B Common Units. The Partnership Agreement provides that the Partnership may borrow funds from the General Partner and its affiliates. The General Partner and its affiliates may not borrow funds from the Partnership. Further, any actions taken by the General Partner consistent with the standards of reasonable discretion set forth in the definitions of Available Cash, Operating Surplus and Capital Surplus will not be deemed to be a breach of any duty of the General Partner to the Partnership or the Unitholders. See "Risk Factors" and "Cash Distribution Policy." The Partnership Reimburses the General Partner and Its Affiliates for Certain Expenses Under the terms of the Amended and Restated Partnership Agreement, the General Partner and its affiliates are reimbursed by the Partnership for certain expenses incurred on behalf of the Partnership, including costs incurred in providing corporate staff and support services to the Partnership. The Amended and Restated Partnership Agreement provides that the General Partner shall determine the expenses that are allocable to the Partnership in any reasonable manner determined by the General Partner in its sole discretion. See "Management of the Partnership After the Transaction--Reimbursement of Expenses of the General Partner." The General Partner Intends to Limit Its Liability with Respect to the Partnership's Obligations Whenever possible, the General Partner intends that the Partnership's liability under contractual arrangements be limited so that the other party has recourse only as to all or particular assets of the Partnership, with no recourse against the General Partner or its assets. The Amended and Restated Partnership Agreement provides that any action by the General Partner in so limiting the liability of the General Partner or that of the Partnership will not be deemed to be a breach of the General Partner's fiduciary duties, even if the Partnership could have obtained more favorable terms without such limitation on liability. 68 Unitholders Have No Right to Enforce Obligations of the General Partner and Its Affiliates Under Agreements with the Partnership The Partnership will acquire or provide certain services from and/or to the General Partner and its affiliates on an ongoing basis. The agreements relating thereto will not grant to the Unitholders, separate and apart from the Partnership, the right to enforce the obligations of the General Partner and its affiliates in favor of the Partnership. Therefore, the General Partner is primarily responsible for enforcing such obligations. Contracts Between the Partnership on the One Hand, and the General Partner and Its Affiliates on the Other Will Not Be the Result of Arm's-Length Negotiations Under the terms of the Amended and Restated Partnership Agreement, the General Partner is not restricted from paying the General Partner or its affiliates for any services rendered (provided such services are rendered on terms that are fair and reasonable to the Partnership) or entering into additional contractual arrangements with any of them on behalf of the Partnership. Neither the Amended and Restated Partnership Agreement nor any of the other agreements, contracts and arrangements between the Partnership, on the one hand, and the General Partner and its affiliates, on the other, are or will be the result of arm's-length negotiations. All of such transactions entered into are required to be on terms that are fair and reasonable to the Partnership, provided that any transaction shall be deemed fair and reasonable if (i) such transaction is approved by the Audit Committee (although no party is obligated to seek such approval), (ii) its terms are no less favorable to the Partnership than those generally being provided to or available from unrelated third parties or (iii) taking into account the totality of the relationships between the parties involved (including other transactions that may be particularly favorable or advantageous to the Partnership), the transaction is fair to the Partnership. The General Partner and its affiliates have no obligation to permit the Partnership to use any facilities or assets of the General Partner and such affiliates, except as may be provided in contracts entered into from time to time specifically dealing with such use, nor is there any obligation of the General Partner and its affiliates to enter into any such contracts. Units Are Subject to the General Partner's Limited Call Right The Partnership Agreement provides that it will not constitute a breach of the General Partner's fiduciary duties if the General Partner exercises its right to call for and purchase Units as provided in the Partnership Agreement or assign this right to its affiliates or to the Partnership. The General Partner thus may use its own discretion, free of fiduciary duty restrictions, in determining whether to exercise such right. As a consequence, a Unitholder may have his Units purchased from him even though he may not desire to sell them, and the price paid may be less than the amount the holder would desire to receive upon sale of his Units. For a description of such right, see "The Amended and Restated Partnership Agreement--Limited Call Right." The General Partner's Affiliates May Compete with the Partnership The General Partner may not engage in any business or activity or incur any debts or liabilities except in connection with or incidental to (i) its performance as general partner of the Partnership or its affiliates or (ii) the acquiring, owning or disposing of debt or equity securities of such entities. In 69 addition, Irik P. Sevin has an agreement with the Partnership which provides that following the consummation of the Transaction he will not engage in the retail propane or retail home heating oil business in the United States so long as he (a) is a director, officer or employee of the General Partner, the Partnership or a subsidiary of the Partnership or (b) has access to information that would put the Partnership at a competitive disadvantage. Further, so long as Mr. Sevin and his mother, Ms. Audrey Sevin, own in the aggregate more than a 10% voting interest in the General Partner, he will not directly or indirectly employ in the retail propane business or the retail home heating oil business a person who was a managerial employee of the General Partner, the Partnership or a subsidiary of the Partnership during the twelve-month period prior to such date of employment. The General Partner Is Not Restricted from Engaging in a Transaction That Would Trigger Change of Control Provisions The Partnership's debt instruments contain provisions relating to change of control. If such change of control provisions are triggered, such outstanding indebtedness may become due. There is no restriction on the ability of the General Partner to enter into a transaction that would trigger such change of control provisions. FIDUCIARY DUTIES OF THE GENERAL PARTNER The General Partner is accountable to the Partnership and the Unitholders as a fiduciary. Consequently, the General Partner must exercise good faith and integrity in handling the assets and affairs of the Partnership. In contrast to the relatively well-developed law concerning fiduciary duties owed by officers and directors to the common stockholders of a corporation, the law concerning the duties owed by general partners to other partners and to partnerships is relatively undeveloped. Neither the DRULPA nor case law defines with particularity the fiduciary duties owed by general partners to limited partners or a limited partnership, but the DRULPA provides that Delaware limited partnerships may, in their partnership agreements, restrict or expand the fiduciary duties that might otherwise be applied by a court in analyzing the standard of duty owed by general partners to limited partners and the partnership. Fiduciary duties are generally considered to include an obligation to act with the highest good faith, fairness and loyalty. Such duty of loyalty, in the absence of a provision in a partnership agreement providing otherwise, would generally prohibit a general partner of a Delaware limited partnership from taking any action or engaging in any transaction as to which it has a conflict of interest. In order to induce the General Partner to manage the business of the Partnership, the Partnership Agreement, as permitted by the DRULPA, contains various provisions intended to have the effect of restricting the fiduciary duties that might otherwise be owed by the General Partner to the Partnership and its partners and waiving or consenting to conduct by the General Partner and its affiliates that might otherwise raise issues as to compliance with fiduciary duties or applicable law. The Partnership Agreement provides that in order to become a limited partner of the Partnership, a Unitholder is required to agree to be bound by the provisions thereof, including the provisions discussed above. This is in accordance with the policy of the DRULPA favoring the 70 principle of freedom of contract and the enforceability of partnership agreements. The DRULPA also provides that a partnership agreement is enforceable even if not signed by a person being admitted as a limited partner or becoming an assignee in accordance with the terms thereof. The Amended and Restated Partnership Agreement provides that whenever a conflict of interest arises between the General Partner or its affiliates, on the one hand, and the Partnership or any other partner, on the other, the General Partner shall resolve such conflict. The General Partner shall not be in breach of its obligations under the Amended and Restated Partnership Agreement or its duties to the Partnership or the Unitholders if the resolution of such conflict is fair and reasonable to the Partnership, and any resolution shall conclusively be deemed to be fair and reasonable to the Partnership if such resolution is (i) approved by the Audit Committee (although no party is obligated to seek such approval and the General Partner may adopt a resolution or course of action that has not received such approval), (ii) on terms no less favorable to the Partnership than those generally being provided to or available from unrelated third parties or (iii) fair to the Partnership, taking into account the totality of the relationships between the parties involved (including other transactions that may be particularly favorable or advantageous to the Partnership). In resolving such conflict, the General Partner may (unless the resolution is specifically provided for in the Amended and Restated Partnership Agreement) consider the relative interests of the parties involved in such conflict or affected by such action, any customary or accepted industry practices or historical dealings with a particular person or entity and, if applicable, generally accepted accounting or engineering practices or principles and such other factors as it deems relevant. Thus, unlike the strict duty of a fiduciary who must act solely in the best interests of his beneficiary, the Amended and Restated Partnership Agreement permits the General Partner to consider the interests of all parties to a conflict of interest, including the interests of the General Partner. In connection with the resolution of any conflict that arises, unless the General Partner has acted in bad faith, the action taken by the General Partner shall not constitute a breach of the Partnership Agreement, any other agreement or any standard of care or duty imposed by the DRULPA or other applicable law. The Amended and Restated Partnership Agreement also provides that in certain circumstances the General Partner may act in its sole discretion, in good faith or pursuant to other appropriate standards. The DRULPA provides that a limited partner may institute legal action on behalf of the partnership (a partnership derivative action) to recover damages from a third party where the general partner has refused to institute the action or where an effort to cause the general partner to do so is not likely to succeed. In addition, the statutory or case law of certain jurisdictions may permit a limited partner to institute legal action on behalf of himself or all other similarly situated limited partners (a class action) to recover damages from a general partner for violations of its fiduciary duties to the limited partners. The Amended and Restated Partnership Agreement also provides that any standard of care and duty imposed thereby or under the DRULPA or any applicable law, rule or regulation will be modified, waived or limited, to the extent permitted by law, as required to permit the General Partner and its officers and directors to act under the Amended and Restated Partnership Agreement or any other agreement contemplated therein and to make any decision pursuant to the authority prescribed in the Amended and Restated Partnership Agreement so long as such action is reasonably believed by the General Partner to be in, or not inconsistent with, the best interests of the Partnership. Further, 71 the Partnership Agreement provides that the General Partner and its officers and directors will not be liable for monetary damages to the Partnership, the limited partners or assignees for errors of judgment or for any acts or omissions if the General Partner and such other persons acted in good faith. In addition, under the terms of the Amended and Restated Partnership Agreement, the Partnership is required to indemnify the General Partner and its officers, directors, employees, Affiliates, partners, agents and trustees, to the fullest extent permitted by law, against liabilities, costs and expenses incurred by the General Partner or other such persons, if the General Partner or such persons acted in good faith and in a manner they reasonably believed to be in, or not opposed to, the best interests of the Partnership and, with respect to any criminal proceedings, had no reasonable cause to believe the conduct was unlawful. See "The Amended and Restated Partnership Agreement-- Indemnification." Thus, the General Partner could be indemnified for its negligent acts if it meets such requirements concerning good faith and the best interests of the Partnership. PARTIES TO THE TRANSACTION THE PARTNERSHIP AND THE OPERATING PARTNERSHIP The Partnership is a publicly-traded Delaware limited partnership formed in 1995 to acquire and operate the propane business of Star Gas and Petro. The Partnership's activities are conducted through the Operating Partnership (and a corporate subsidiary). Except as the context otherwise requires, references to or descriptions of operations of the Partnership include the operations of the Operating Partnership and any other subsidiary operating partnership or corporation, the Partnership's predecessor, Star Gas, and the propane operations of Petro that were acquired from Petro in December 1995. The Partnership is primarily engaged in the retail distribution of propane and related supplies and equipment to residential, commercial, industrial, agricultural and motor fuel customers. The Partnership believes that it is the eighth largest retail propane distributor in the United States, serving approximately 166,000 customers from 74 branch locations in the Midwest and Northeast, with total sales of approximately $135 million for the fiscal year ended September 30, 1997. Propane is used primarily as fuel for space and water heating and cooking by the Partnership's residential and commercial customers, which customers constitute the largest portion of the Partnership's customer base. In the Midwest, the Partnership services customers in Indiana, Kentucky, Michigan, Ohio and West Virginia. In the Northeast, the Partnership services customers in Connecticut, Maine, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania and Rhode Island. In addition to its retail business, the Partnership serves approximately 50 wholesale customers from its wholesale operation in southern Indiana. For the nine months ended June 30, 1998, approximately 79% of the Partnership's sales (by volume of gallons sold) were to retail customers (of which approximately 55%, 19%, 19% and 7% were sales to residential customers, industrial/commercial customers, agricultural customers and motor fuel customers, respectively) and approximately 21% were to wholesale customers. Residential sales have a greater profit margin and a more stable customer base and tend to be less sensitive to price changes than the other markets served by the Partnership. Sales to residential customers for the nine months ended June 30, 1998 accounted for 67% of the 72 Partnership's gross profit on propane sales, reflecting the higher-margin nature of this segment of the retail market. The Partnership's business strategy is to maximize its cash flow and profitability, primarily through (i) internal growth, (ii) controlling operating costs and (iii) acquisitions that have the potential for generating attractive returns on investment. The retail propane industry is mature, experiences only limited growth in total demand for the product and is large and highly fragmented, with approximately 6,000 independently owned and operated distributors. Given these characteristics, the Partnership's acquisition strategy is focused on acquiring smaller to medium-sized local and regional independent propane distributors, particularly those with a relatively large percentage of residential customers, which generate higher margins than other types of customers, and those located in the Midwest and Northeast, where the Partnership believes it can attain higher margins than in other areas of the United States. To facilitate the Partnership's acquisition strategy, the Operating Partnership has bank credit facilities, which consist of a $25 million acquisition facility and a $12 million working capital facility (collectively, the "Bank Credit Facilities"). As of June 30, 1998, $1.0 million was outstanding under these facilities. In addition to borrowings under the Bank Credit Facilities, the Partnership may fund future acquisitions from internal cash flow or from the issuance of additional Partnership interests or debt securities. While the Partnership regularly considers and evaluates acquisitions as part of its ongoing acquisition program, the Partnership does not have any present agreements or commitments with respect to any material acquisition other than the Transaction. The General Partner has broad discretion in making acquisitions and it is expected that the General Partner will not generally seek approval by the Partnership's limited partners of acquisitions. See "Risk Factors." For information concerning weather conditions, and other factors that could adversely affect the Partnership's operations, see "Risk Factors--Risks to Petro Common Stockholders--Weather Conditions Affect the Demand for Propane." Additional information about the Partnership is included in the Partnership's Annual Report on Form 10-K for its fiscal year ended September 30, 1997 and the other documents relating to the Partnership that are incorporated herein by reference. See "Incorporation of Certain Documents By Reference." PETRO Petro is a Minnesota corporation engaged primarily in the retail distribution of home heating oil in the Northeast and Mid-Atlantic states. Petro serves approximately 340,000 customers from 24 branch locations in such states, including metropolitan Boston, New York City, Baltimore, Providence, and Washington, D.C., with total sales of approximately $548.1 million for the year ended December 31, 1997. Petro believes that it is the largest retail distributor of home heating oil in the United States. As an adjunct to its heating oil business, Petro installs and repairs heating equipment. Petro considers such services, which are typically not designed to generate profits, to be an integral part of its basic fuel oil business and generally does not provide service to any person 73 who is not a home heating oil customer. To a limited extent, Petro also markets other petroleum products, including diesel fuel and gasoline, to commercial customers. In addition, through Star Gas Petro has a 40.5% equity interest in the Partnership. The home heating oil industry is large, highly fragmented and undergoing consolidation, with approximately 3,700 independently owned and operated home heating oil distributors in the Northeast. Petro has been the principal consolidator in this industry and, since 1979, when Petro's current management assumed control, has acquired over 180 retail heating oil distributors. Petro acquires distributors in both new and existing markets and integrates them into the existing operations. Economies of scale are realized from these purchases through its centralization of accounting, data processing, fuel oil purchasing, credit and marketing functions. Petro is well known in the heating oil industry and is regularly contacted by potential sellers. As a result of its growth strategy, heating oil sales volume increased from 59.4 million gallons in 1980 to 410.3 million gallons for the year ended December 31, 1997, a compound annual growth rate of 12%. Despite its size, Petro estimates that its customer base represents only approximately 5% of the residential home heating oil customers in the Northeast. Petro has been implementing an operational restructuring program, including a "brand name" identity program to, among other things, reduce customer attrition and improve operating margins. Following the completion of the Transaction, Petro will operate as a wholly- owned indirect subsidiary of the Operating Partnership. Additional information about Petro is included in Petro's Annual Report on Form 10-K for the fiscal year ended December 31, 1997 and other documents relating to Petro that accompany this Proxy Statement. See "Incorporation of Certain Documents By Reference." 74 THE UNITHOLDERS MEETING DATE, TIME AND PLACE The Unitholders Meeting will be held on , 1999, at a.m., New York City time, at New York, New York. PURPOSE The purpose of the Unitholders Meeting is to consider and vote upon the Acquisition Proposal, the Amendment Proposal and the General Partner Proposal. STAR GAS RECORD DATE The close of business on , 1999 has been fixed by the Star Gas Board as the record date (the "Star Gas Record Date") for the determination of Common Unitholders entitled to notice of, and to vote at, the Unitholders Meeting and any adjournment or postponement thereof. On the Star Gas Record Date, there were 3,858,999 Common Units issued and outstanding, held by approximately holders of record. RECOMMENDATIONS OF THE SPECIAL COMMITTEE AND THE STAR GAS BOARD The Special Committee believes that the Transaction is in the best interests of the Public Common Unitholders and has recommended the Transaction to the Star Gas Board. Based on such recommendation, the Star Gas Board unanimously recommends that Common Unitholders vote FOR the Star Proposals. See "The Transaction--Background and Reasons for the Transaction." PROXIES AND REVOCABILITY OF PROXIES A proxy card for voting at the Unitholders Meeting is enclosed with this Proxy Statement, which is being mailed to all holders of Common Units as of the Star Gas Record Date. When a proxy card is returned, properly completed, signed and dated, the Common Units represented thereby will be voted in accordance with the instructions contained on the proxy card. If a Common Unitholder does not attend the Unitholders Meeting and does not return the signed proxy card, such holder's shares will not be voted, and this will have the effect of a vote "AGAINST" the matters to be voted on at the Unitholders Meeting. Common Unitholders are urged to mark the box on the proxy card to indicate how Common Units represented by the proxy card are to be voted. An executed proxy card that does not indicate how Common Units are to be voted will be voted "FOR" all Star Proposals. Star Gas does not intend to bring any matters before the Unitholders Meeting, other than approval of the Star Proposals, and does not know of any other matters sought to be brought before the Unitholders Meeting by others. If any business other than the Star Proposals is brought before the Unitholders Meeting, the Common Units represented by a proxy card will be voted by those persons appointed by Star Gas to vote the Common Units represented by the proxy card according to their best judgment. The proxy card also confers discretionary authority on the persons appointed by Star Gas named on the proxy card to vote the Common Units represented thereby on any other procedural matter that is properly presented for action at the Unitholders Meeting. 75 The execution of a proxy card will not affect a Unitholder's right to attend the Unitholders Meeting and vote in person. A Unitholder who has given a proxy may revoke it at any time before it is exercised at the Unitholders Meeting by (a) delivering a written notice of revocation to the Vice President--Finance of Star Gas, (b) executing and submitting a proxy card bearing a later date or (c) attending the Unitholders Meeting and voting in person. However, the mere presence at the Unitholders Meeting by a person who has given a proxy will not revoke such proxy. Unless the arrangement between the beneficial owner and a broker or other nominee holder provides otherwise, brokers and other nominee holders of Common Units will not have discretionary authorization to vote Common Units on any of the matters to be voted thereon in the absence of instructions from the beneficial owners of such Common Units. Beneficial owners are therefore urged to provide instructions to such brokers or other nominees concerning how they wish their Common Units to be voted. Abstentions and broker non-votes are each included in the determination of the number of Common Units present for quorum purposes. Abstentions and broker non-votes will in effect be votes against the Star Proposals because approval thereof requires the affirmative vote of the holders of a majority of all Common Units. COST OF SOLICITATION OF PROXIES Petro, which has agreed to reimburse the Partnership for the expenses incurred by the Partnership in connection with the Transaction, will bear all costs relating to the solicitation of proxies from the Common Unitholders and will reimburse banks, brokerage houses, custodians, nominees, fiduciaries, and other persons holding Common Units in their names or in the names of their nominees for their reasonable expenses in forwarding proxy material to beneficial owners of Common Units. The Partnership has engaged , a professional proxy solicitation firm (the "Solicitation Agent"), to solicit proxies on behalf of the Partnership. The Partnership will pay such firm a fee of $ , plus expenses, for so acting. An additional fee of $ will be paid to such firm if the Star Proposals are adopted. In addition, certain officers, directors and regular employees of Star Gas may, without additional compensation, solicit proxies by personal interview, telephone, telex, telegram, facsimile or similar means of communication. VOTING RIGHTS; VOTE REQUIRED Except for certain limitations discussed below, each person deemed to be a "Record Holder" of Common Units on the Star Gas Record Date will have a vote according to their percentage interest in the Partnership on such date. Under the Partnership Agreement as currently in effect, a "Record Holder" of Common Units means the person in whose name such Common Units are registered on the books of the transfer agent for the Common Units at the opening of business on the Star Gas Record Date, which includes both persons who have been admitted to the Partnership as limited partners or substitute limited partners and transferees of Common Units who have executed and delivered to such transfer agent a transfer application as required by the Partnership Agreement, but who have not yet been admitted to the Partnership as substitute limited partners. The Partnership Agreement also provides that Common Units held in nominee or street name account will be voted by the broker (or other nominee) pursuant to the instructions of the beneficial 76 owner, unless the arrangement between the beneficial owner and his nominee provides otherwise. The Partnership is entitled to assume that such nominee is acting at the direction of the beneficial owner without further inquiry. The Partnership Agreement requires, in order to approve and adopt each of the Star Proposals to be considered at the Unitholders Meeting, the affirmative vote of at least a Unit Majority. "Unit Majority" is, for this purpose, defined in the Partnership Agreement to mean those persons holding at least a majority of the outstanding Common Units (other than Common Units owned by Star Gas or any of its affiliates). The Transaction cannot be effected without approval of each of the Star Proposals by the Common Unitholders. Holders of Common Units should not send any unit certificates with their proxy cards. QUORUM; ADJOURNMENT The Partnership Agreement provides that the presence at the Unitholders Meeting, either in person or by proxy, of a Unit Majority is necessary to constitute a quorum at the Unitholders Meeting. The Partnership Agreement also provides that, in the absence of a quorum, the Unitholders Meeting may be adjourned from time to time by the affirmative vote of the holders of a majority of the Common Units represented either in person or by proxy. The Partnership Agreement provides that, when a meeting is adjourned to another time or place, notice need not be given of the adjourned meeting and a new record date need not be fixed if the time and place of the adjourned meeting is announced at the meeting at which the adjournment is taken, unless such adjournment is for more than 45 days. At an adjourned meeting, the Partnership may transact any business that might have been transacted at the original meeting. 77 THE SPECIAL MEETING DATE, TIME AND PLACE The Special Meeting will be held on , 1999, at 10:00 a.m., New York City time, at , New York, New York. PURPOSE The purpose of the Special Meeting is to consider and vote upon the Acquisition Proposal. PETRO RECORD DATE The Petro Board has fixed the close of business on , 1999, as the record date (the "Petro Record Date") for the determination of stockholders entitled to notice of, and to vote at, the Special Meeting. Accordingly, only holders of record of shares of Common Stock at the close of business on the Petro Record Date will be entitled to vote at the Special Meeting and any adjournment or postponement thereof. As of the close of business on the Petro Record Date, there were issued and outstanding 23,964,962 shares of Class A Common Stock, held by record holders; and 2,597,519 shares of Class C Common Stock, held by 24 record holders. PETRO BOARD RECOMMENDATION The Petro Board has determined that the Transaction is fair and in the best interests of the Public Common Stockholders and has, therefore, approved the Merger Agreement and the Exchange Agreement, and unanimously recommends that the Common Stockholders vote FOR the Acquisition Proposal. PROXIES AND REVOCABILITY OF PROXIES A proxy card for voting at the Special Meeting is enclosed with this Proxy Statement, which is being mailed to all Common Stockholders of record as of the Petro Record Date. When a proxy card is returned, properly completed, signed and dated, the shares of Common Stock represented thereby will be voted in accordance with the instructions on the proxy card. If a Common Stockholder does not attend the Special Meeting and does not return the signed proxy card, such holder's shares will not be voted, and this will have the effect of a vote "AGAINST" the matters to be voted on at the Special Meeting. Common Stockholders are urged to mark the box on the proxy card to indicate how the shares represented by the proxy card are to be voted. An executed proxy card that does not indicate how the shares of Common Stock is to be voted will be voted "FOR" approval of the Acquisition Proposal. The Petro Board does not intend to bring any matters before the Special Meeting, other than approval of the Acquisition Proposal, and does not know of any other matters sought to be brought before the Special Meeting by others. If any business other than the Acquisition Proposal is brought before the Special Meeting, the shares of Common Stock represented by a proxy card will be voted by those persons appointed by the Petro Board to vote the shares of Common Stock represented by the proxy card according to their best judgment. The proxy card also confers discretionary authority on the persons appointed by the Petro Board named on the proxy card 78 to vote the shares represented thereby on any other procedural matter that is properly presented for action at the Special Meeting. The execution of a proxy card will not affect a Common Stockholder's right to attend the Special Meeting and vote in person. A Common Stockholder who has given a proxy may revoke it at any time before it is exercised at the Special Meeting by (a) delivering a written notice of revocation to the Secretary of Petro, (b) executing and submitting a proxy card bearing a later date, or (c) attending the Special Meeting and voting in person. However, the mere presence at the Special Meeting by a person who has given a proxy will not revoke such proxy. Unless the arrangement between the beneficial owner and a broker or other nominee holder provides otherwise, brokers and other nominee holders of Common Stock will not have discretionary authorization to vote shares of Common Stock on any of the matters to be voted thereon in the absence of instructions from the beneficial owners of such Common Stock. Beneficial owners are therefore urged to provide instructions to such brokers or other nominees concerning how they wish their Common Stock to be voted. Abstentions and broker non-votes are each included in the determination of the number of shares of Common Stock present for quorum purposes. Abstentions and broker non-votes will in effect be votes against the Acquisition Proposal because approval thereof requires the affirmative vote of the holders of a majority of all shares of Common Stock. COST OF SOLICITATION OF PROXIES Petro will bear all costs relating to the solicitation of proxies from Common Stockholders and will reimburse banks, brokerage houses, custodians, nominees, fiduciaries, and other persons holding Common Stock in their names or in the names of their nominees for their reasonable expenses in forwarding proxy material to beneficial owners of Common Stock. Petro has engaged the Solicitation Agent to solicit proxies on behalf of Petro. Petro will pay such firm a fee of $ , plus expenses, for so acting. An additional fee of $ will be paid to such firm if a majority of the Common Stockholders vote in favor of the Acquisition Proposal. In addition, certain officers, directors and regular employees of Petro may, without additional compensation, solicit proxies by personal interview, telephone, telex, telegram, facsimile or similar means of communication. VOTING RIGHTS; VOTE REQUIRED All Common Stockholders of record at the close of business on the Petro Record Date are entitled to vote at the Special Meeting. Holders of each class of Common Stock, voting as a separate class, will have one vote for each share with respect to the Acquisition Proposal. The affirmative vote of the holders of a majority of the Class A Common Stock outstanding as of the Petro Record Date, voting as a class, the affirmative vote of the holders of the Class C Common Stock outstanding as of the Petro Record Date, voting as a class, and the affirmative vote of the holders of a majority of the Class A Common Stock outstanding as of the Petro Record Date (other than shares held by the directors and officers of Petro and their affiliates) is required to approve the Acquisition Proposal. The directors and executive officers of Petro and affiliates beneficially owned, as of the Record Date, 11,953,432 shares of Common Stock (excluding all options to purchase shares of Class A 79 Common Stock and Class C Common Stock). The holders of % of the shares of Class A Common Stock and % of the shares of Class C Common Stock have agreed to vote for the Acquisition Proposal at the Special Meeting. Directors and executive officers of Star Gas and their affiliates (other than those persons who were also directors or executive officers of Petro) did not beneficially own, as of the Petro Record Date, any shares of Common Stock and no shares of Common Stock were owned by the Partnership or Star Gas. The Transaction cannot be effected without approval of the Acquisition Proposal by the Common Stockholders. Holders of Common Stock should not send any stock certificates with their proxy cards. If the Transaction is effected, Common Stockholders will be provided with transmittal materials for the surrender of Petro stock certificates in exchange for certificates representing Senior Subordinated Units of the Partnership or cash payments, as applicable. PETRO PREFERRED STOCK The Acquisition Proposal also requires the approval of the holders of a majority of all shares of Petro's Junior Preferred Stock, Public Preferred Stock and Private Preferred Stock (collectively, the "Petro Preferred Stock"), outstanding as of the Petro Record Date, voting separately as a class. The holders of 100% of the Petro Preferred Stock outstanding as of the Petro Record Date have granted irrevocable proxies to Petro or have agreed to vote their shares for the Acquisition Proposal. As of the Petro Record Date, no shares of Petro Preferred Stock were beneficially owned by any of the directors and executive officers of Petro or Star Gas or any of their affiliates or by the Partnership or Star Gas. CLASS B SHARES There are 11,228 Class B Shares currently outstanding representing less than .1% of the issued and outstanding shares of common stock of Petro, which will remain outstanding following the Effective Time. QUORUM; ADJOURNMENT Petro's Restated Bylaws provide that the presence at the Special Meeting, either in person or by proxy, of a majority of the Common Stockholders is necessary to constitute a quorum at the Special Meeting. Petro's Restated Bylaws also provide that, in the absence of a quorum, the Special Meeting may be adjourned from time to time by the affirmative vote of the holders of a majority of shares of the Common Stock represented either in person or by proxy. Petro's Restated Bylaws provide that, when a meeting is adjourned to another time or place, notice need not be given of the adjourned meeting and a new record date need not be fixed if the time and place of the adjourned meeting is announced at the meeting at which the adjournment is taken. At an adjourned meeting at which a quorum is present, the Partnership may transact any business that might have been transacted at the original meeting. 80 THE TRANSACTION The following discussion includes summaries of the principal provisions of the Merger Agreement and the Exchange Agreement, together with certain additional information. The descriptions of the Merger Agreement and the Exchange Agreement contained in this Proxy Statement do not purport to be complete and are qualified in their entirety by reference to the complete text of the Merger Agreement and the Exchange Agreement, copies of which (excluding the exhibits and schedules thereto) are attached hereto as Annexes A and B, respectively, and incorporated herein by reference. Common Unitholders and Common Stockholders are urged to read the Merger Agreement, the Exchange Agreement and other Annexes in their entirety. DESCRIPTION OF THE TRANSACTION The Transaction can be viewed as having four principal parts: (a) The acquisition of Petro by the Partnership, which will be accomplished through the Exchange and the Merger. In the Exchange, certain affiliates of Petro will exchange 11,953,432 shares of Common Stock for approximately 858,532 Senior Subordinated Units, 577,205 Junior Subordinated Units and 278,973 General Partner Units. In the Merger, Mergeco, a wholly-owned subsidiary of the Partnership, will merge with and into Petro, with Petro surviving the Merger. Pursuant to the Merger, the Public Common Stockholders will exchange their 14,609,049 shares of Common Stock for approximately 1,908,526 Senior Subordinated Units. (b) The Equity Offering, pursuant to which the Partnership expects to sell approximately 6.4 million Common Units, and the Debt Offering, pursuant to which Petro Holdings expects to sell $120 million of Petro Holdings Senior Subordinated Debt. The net proceeds of the Equity Offering and the Debt Offering, which are expected to be approximately $247.5 million (assuming an offering price in the Equity Offering of $22.00 per Common Unit), will be used to redeem certain debt and preferred stock of Petro. (c) The withdrawal of Star Gas as the general partner of the Partnership and the Operating Partnership and the election of Star Gas LLC as the successor general partner. (d) The adoption of certain amendments to the Partnership Agreement and the Operating Partnership Agreement. See "Amendment of the Partnership Agreement." DESCRIPTION OF THE MERGER AND THE EXCHANGE The Merger Upon the terms and subject to the conditions of the Merger Agreement, at the Effective Time, (a) Mergeco will merge with and into Petro, and the separate corporate existence of Mergeco will cease; (b) Petro will survive and continue to exist as a Minnesota corporation and as a wholly-owned indirect subsidiary of the Operating Partnership; (c) each share of the common stock of Mergeco outstanding immediately prior to the Effective Time will be converted into one newly issued, fully paid and non-assessable share of common stock of Petro as the "Surviving Corporation"; (d) each share of Common Stock held by Petro as Treasury Stock or owned by Mergeco will be canceled and retired and no consideration will be issued in exchange therefor; (e) each share of Common Stock held by a dissenting Common Stockholder who has perfected his dissenters' rights under the MBCA 81 will represent only the right to receive "fair value" for such shares, as determined pursuant to the MBCA, unless such dissenting Common Stockholder withdraws his Fair Value Demand (as defined in the MBCA) or loses his dissenters' rights, in which case, such shares will be converted into Senior Subordinated Units as described below in subparagraph (g)(1) below; (f) each outstanding option to purchase shares of Common Stock granted to employees and directors of Petro and its subsidiaries that is vested at the Effective Time or becomes vested by reason of the Merger will cease to represent the right to acquire shares of Common Stock and will be converted into an option to purchase .13064 of a Senior Subordinated Unit at an exercise price equal to the quotient of dividing the original exercise price by .13064, and such options shall thereupon be assumed by the Partnership; and (g) each share of Common Stock outstanding immediately prior to the Effective Time (excluding shares as to which dissenters' rights have been perfected and shares held by Petro or Mergeco) will cease to be outstanding and will be converted as follows: (1) each outstanding share of Common Stock will be converted into .13064 of a Senior Subordinated Unit, with cash being paid in lieu of any fractional Senior Subordinated Unit; (2) each outstanding share of Junior Convertible Preferred Stock will be converted into .13064 of a Common Unit, with cash being paid in lieu of any fractional Common Unit; (3) each outstanding share of Public Preferred Stock will be converted into the right to receive cash in the amount of $23.00 plus accrued and unpaid dividends; and (4) each outstanding Class B Share will remain unchanged. Up to an aggregate of 909,000 additional Senior Subordinated Units may be issued to the holders of Senior Subordinated Units, Junior Subordinated Units and General Partner Units, on a pro rata basis, but only if Petro satisfies certain financial goals during the five-year period following the closing of the Transaction. Subject to the satisfaction or waiver of the conditions set forth in the Merger Agreement and described in "--Conditions to Consummation of the Merger," the Merger will become effective upon the later to occur of (a) the filing of a certificate of merger in the office of the Secretary of State of Delaware and (b) the filing of articles of merger with the Minnesota Department of State, or such later date and time as may be set forth in such certificate of merger and articles of merger (the "Effective Time"). The Merger will have the effects prescribed in the Delaware General Corporation Law (the "DGCL") and the MBCA. Directors of Petro who are also employees of Petro immediately prior to the Effective Time and officers of Petro immediately prior to the Effective Time will be those of Petro following the Effective Time. If the Partnership changes the number of Common Units outstanding prior to the Effective Time by reason of a subdivision, dividend in the form of equity interests, split, reclassification, recapitalization or combination, the foregoing exchange ratios and the average closing prices of Common Units applicable to the payment of cash in lieu of fractional Common Units will be proportionately adjusted. Consummation of the Merger is subject to various conditions. See "-- Conditions to Consummation of the Merger." 82 The Exchange The Exchange will occur immediately prior to the Merger and is comprised of the following elements: (a) The LLC Owners will form Star Gas LLC, to which they will contribute an aggregate of 1,753,546 shares of Common Stock in exchange for all of the limited liability company interests in Star Gas LLC. Star Gas LLC will contribute the shares of Common Stock received in the preceding step to Petro in exchange for 278,973 General Partner Units (representing all of the General Partner Units) in the Partnership. In addition, the LLC Owners will contribute 3,628,146 shares of Common Stock to the Partnership in exchange for 577,205 Junior Subordinated Units. (b) In addition, certain other Common Stockholders of Petro that are parties to a shareholders' agreement with the LLC Owners with respect to the Class C Common Stock will contribute 6,571,740 shares of Common Stock to the Partnership in exchange for 858,532 Senior Subordinated Units. RELATED FINANCING AND REFINANCING TRANSACTIONS An integral element of the Transaction is the refinancing of Petro's outstanding debt and preferred stock in order to substantially reduce Petro's ongoing borrowing costs, which is expected to increase the cash flow of the combined entity. This refinancing will be accomplished through several related transactions that are described below and will close substantially simultaneously with the closing of the Transaction. Public Offerings Key elements in the related financing are the Equity Offering and the Debt Offering by the Partnership. The Partnership will offer for sale to the public approximately 6.4 million Common Units (assuming an offering price of $22.00 per Common Unit) the net proceeds of which are estimated to be $132.1 million. Petro Holdings will sell to the public approximately $120.0 million of Petro Holdings Senior Subordinated Debt, the net proceeds of which are estimated to be $115.4 million. It is expected that the Partnership will guarantee the Petro Holdings Senior Subordinated Debt. The net proceeds of the Equity Offering and the Debt Offering will be used to redeem the Petro public debt and preferred stock and to pay for the expenses of the Transaction. Petro Private Debt and Preferred Stock Petro has entered into agreements (the "Private Debt Agreements") with the holders (the "Private Noteholders") of (i) its outstanding 10.90% Senior Notes due 2002 (the "Senior Notes") in the aggregate principal amount of $60 million; and (ii) its 14.1% Senior and Subordinated Notes due 2001 (the "14.1% Notes" and together with the Senior Notes, the "Petro Private Debt") in the aggregate principal amount of $4.1 million (after payment of the January 1999 installment). 83 Pursuant to the Private Debt Agreements at the Effective Time: (a) the holders of the Senior Notes will exchange such Notes for $63.1 million aggregate principal amount of 9.0% Senior Notes due 2002 of Petro (the "New 9% Notes"); and (b) the holders of the 14.1% Notes will exchange such notes for $2.2 million aggregate principal amount of 10.25% Senior Notes due 2001 of Petro and $2.2 million principal amount of 10.25% Subordinated Notes due 2001 of Petro (collectively, the "New 10.25% Notes"). The New 9% Notes and the New 10.25% Notes will be guaranteed by the Partnership and Petro Holdings. (The New 9% Notes and the New 10.25% Notes are collectively referred to as the "New Private Notes"). Petro has also entered into an agreement with the holder of $4.1 million in face value of its 1989 Preferred Stock to redeem such 1989 Preferred Stock at 100% of face value plus accrued but unpaid dividends immediately prior to the Effective Time. Petro Public Debt and Public Preferred Stock In September 1998, Petro completed an exchange offer (the "Debt Exchange Offer") with the holders of Petro's 10 1/8% Subordinated Notes due 2003 ("10 1/8% Notes"), 12 1/4% Subordinated Debentures due 2005 ("12 1/4% Debentures") and 9 3/8% Subordinated Debentures due 2006 ("9 3/8% Debentures," and together with the 10 1/8% Notes and the 12 1/4% Debentures, the "Old Public Debt") and entered into individually negotiated agreements (the "Preferred Stock Agreements") with the holders of its 12 7/8% Series B exchangeable preferred stock (the "Old Public Preferred Stock," and together with the Old Public Debt, the "Old Securities"). Pursuant to the Debt Exchange Offer and the Preferred Stock Agreements the holders (the "Tendering Holders") of approximately 98.5% in aggregate principal amount and liquidation preference of the Old Securities exchanged the Old Securities for a like principal amount and liquidation preference of New Public Debt and New Public Preferred Stock, the terms of which are in all material respects the same as the terms of the Old Public Debt and the Old Public Preferred Stock, except that (1) the New Public Debt is senior to the Old Public Debt, and (2) the terms of the New Public Debt and the New Public Preferred Stock (collectively, the "New Public Securities") (a) give Petro the right to redeem (the "Redemption Right") the New Securities in connection with the consummation of the Transaction at the following redemption prices: (i) 103.5% of face value for the new 12 1/4% Debentures; (ii) 100% of face value for the new 10 1/8% Notes and the 9 3/8% Debentures; and (iii) $23.00 per share for the new Public Preferred Stock; and 84 (b) eliminate substantially all covenants from the indentures under which the Old Public Debt was issued. The Tendering Holders of the Old Public Preferred Stock have also granted Petro an irrevocable proxy to vote their shares of New Public Preferred Stock in favor of the Acquisition Proposal at the Special Meeting. In connection with the Debt Exchange Offer, Petro issued an aggregate of 786,690 shares of Junior Convertible Preferred Stock (the "Exchange Shares") to the Tendering Holders. At the Effective Time, pursuant to the Merger, the Exchange Shares will be converted into an aggregate of 102,773 Common Units. Holders of Exchange Shares have also granted Petro an irrevocable proxy or have agreed to vote such Exchange Shares in favor of the Acquisition Proposal. BACKGROUND OF AND REASONS FOR THE TRANSACTION Background of the Transaction In May 1997, Mr. Kevin McCarthy, then of Smith Barney Inc., contacted Irik Sevin, Chairman of the Board and Chief Executive Officer of Petro, to determine Petro's interest in a strategic business combination with the Partnership (the "Proposed Transaction"). Mr. McCarthy, who had previously been associated with PaineWebber Incorporated ("PaineWebber"), had provided investment banking services to, and was very familiar with, both Petro and the Partnership. On May 2 and May 7, 1997, Mr. McCarthy and other Smith Barney bankers presented the following concept to Mr. Sevin. In their view, Petro's Common Stock was not fully valued in the public market place due to, in large measure, a lack of research analyst coverage and investor interest resulting from a number of factors. Mr. McCarthy noted that despite Petro's preeminent position in the home heating oil industry, the public market had always had a difficult time valuing its Common Stock due to (i) there being no other comparable publicly traded companies, (ii) its being a cash flow oriented company with no earnings per share, which is a standard measure used to value publicly traded common stocks, and (iii) its small equity market capitalization. Mr. McCarthy went on to note that while Petro was the principal consolidator of the home heating oil industry, its capital structure was limiting its full growth potential. He suggested that converting Petro into an MLP format would address these various issues. He noted that Petro would benefit from the relatively broad research coverage provided the relatively large number of publicly traded MLPs. In addition, these entities were valued on a cash flow basis, similar to Petro's financial orientation, and that the combined Petro/Star MLP would have a significantly increased market capitalization. Also of significance was that the MLP format would give Petro access to lower cost capital and increase its financial flexibility to fund its growth through acquisition strategy. Mr. McCarthy went on to note that he believed that combining the Partnership and Petro could also significantly benefit the Partnership. While the Partnership had been performing relatively well operationally, there had been a significant increase in competition for propane acquisitions, the major source of the Partnership's growth. This not only was impacting the number of acquisitions the Partnership could make but was also increasing the purchase price multiples paid for propane companies. Both of these factors combined to limit the potential growth in the Partnership's annual cash flow from its acquisition program. The combination with Petro could provide an additional source of acquisition opportunities at lower purchase price multiples resulting from Petro's 85 preeminent position in the home heating oil industry and the significantly lower level of competition in that industry for acquisitions. Combining Petro's acquisition opportunities with the Partnership's access to lower cost capital suggested the combination of the two companies made strategic sense. During May and June 1997, Mr. Sevin had several meetings and telephone calls with representatives of Smith Barney and other financial and legal advisors concerning various business, tax and regulatory aspects of the Proposed Transaction. On June 5, 1997, at a Petro Board meeting, Mr. Sevin described the Proposed Transaction and its benefits. In addition to the original benefits outlined by Mr. McCarthy, the Proposed Transaction was now structured to refinance Petro's relatively high cost long-term debt and preferred stock with lower cost Partnership equity and a new issue of debt further increasing the combined entity's distributable cash flow. Mr. Sevin informed the Petro Board that not all aspects of the Proposed Transaction had been fully developed and that he had not made any presentation concerning the combination to the Star Gas Board. After discussing the matter, a consensus was reached that the Proposed Transaction seemed interesting and that Mr. McCarthy should be invited to make a formal presentation to the Petro Board. Mr. McCarthy Presents the Proposed Transaction to the Petro Board On July 24, 1997, the Petro Board met to hear Mr. McCarthy make a formal presentation regarding the Proposed Transaction. Initially, Mr. McCarthy explained that he had terminated his relationship with Smith Barney and had reassociated with PaineWebber as a Managing Director in its Investment Banking Division. Mr. McCarthy then reviewed the overall strategic rationale for the proposed Transaction. Mr. McCarthy went on to describe the Proposed Transaction's structure indicating that it would have two fundamental components. The first was Petro's becoming a wholly-owned subsidiary of the Partnership, by virtue of the Public Common Stockholders and a limited number of affiliated Common Stockholders exchanging their shares for publicly traded Senior Subordinated Units with a certain number of Petro shares being exchanged for Junior Subordinated Units that would not be publicly traded. He indicated that in order to provide the Public Common Stockholders with a publicly traded Partnership unit with sufficient earnings coverage, there needed to be a certain number of Units junior to those securities. The second component of the Transaction was the refinancing of Petro's outstanding, relatively high-cost debt and preferred stock through the sale of lower-cost, new Partnership equity and debt. Mr. McCarthy then enumerated the benefits of the Proposed Transaction to Common Stockholders as well as to the Partnership. Mr. McCarthy briefly outlined the following benefits to the Partnership's Common Unitholders: (i) a significant increase in distributable cash flow, (ii) an increase in the annualized Minimum Quarterly Distribution from $2.20 to $2.30, (iii) improved distribution coverage, (iv) larger equity market capitalization and resulting liquidity to Unitholders and (v) improved growth potential in an otherwise relatively stagnant market. Mr. McCarthy went on to note that the most important considerations in valuing MLPs are their growth, ability to make 86 distributions, and size. The combination of the Partnership and Petro would improve the Partnership's measures in each of these areas. After review and discussion by the Petro Board of this concept, it authorized Mr. Sevin to consult further with PaineWebber concerning the Proposed Transaction, and to present it to the Star Gas Board. In this regard, it was determined that it would be most appropriate to approach the two members of the Star Gas Board who were not officers, directors or employees of Petro to ascertain their views about the Proposed Transaction, since the remaining members of such Board were also directors or officers of Petro. The Petro Board recognized that in light of the potential conflict of interest, the Proposed Transaction should be analyzed and approved by the non-Petro members of the Star Gas Board. The Petro Board also instructed Petro's management to closely monitor the impact of Petro's recently instituted regionalization and product branding programs as it believed that Petro's ability to operate more efficiently and with more customer sensitivity would be an important element to the success of any business combination. PaineWebber Informally Discusses the Proposed Transaction with the Non-Petro Directors of Star Gas On September 2, 1997, at the request of Mr. Sevin, Mr. McCarthy had a meeting with the non-Petro directors of the Star Gas Board, Mr. William Nicoletti and Ms. Elizabeth Lanier, concerning the combination of Petro and the Partnership. Mr. Nicoletti and Ms. Lanier indicated that they had a number of questions concerning the Proposed Transaction, but that they believed that the Partnership would be willing to consider such a combination. Petro Considers Alternative Transactions In December 1997 and January 1998, Petro also began to explore other transactions. Mr. Sevin met with representatives of a large natural gas utility to explore the possibility of forming a joint venture acquisition corporation. However, such discussions did not progress beyond the preliminary stages. In addition, Mr. Sevin met with an investment banking firm which had a relationship with an energy marketing company that was seeking investment opportunities. Mr. Sevin believed that Petro's large customer base would provide this company with cross-marketing potential adding to the attractiveness of forming a joint venture acquisition corporation with Petro. After discussions held in January 1998, this company indicated that it was not interested in forming such a joint venture with Petro. PaineWebber Formally Presents the Proposed Transaction to the Star Gas Board On January 26, 1998, Mr. McCarthy made a formal presentation concerning the Proposed Transaction to the Star Gas Board. He first described the underlying rationale of the Proposed Transaction. Mr. McCarthy then detailed the Proposed Transaction's structure: . Petro would combine with the Partnership, becoming a wholly-owned subsidiary of the Operating Partnership. 87 . The Public Common Stockholders (as well as certain affiliated Common Stockholders) would receive publicly traded Senior Subordinated Units. . Certain affiliated Common Stockholders would be required to exchange their shares for Junior Subordinated Units that would be junior to the Senior Subordinated Units offered the Public Common Stockholders and would not be publicly traded. Mr. McCarthy indicated that this condition was required to provide sufficient earnings coverage of the Senior Subordinated Units to make them sufficiently attractive in the marketplace. . In determining the exchange ratio for Petro's Common Stock and how many Partnership Units would be given to the Common Stockholders, the following values were used: --Petro's Common Stock was being valued at $3.15/share. --The Senior Subordinated Units to be given to the Public Common Stockholders were valued on the basis of their having an 11.5% yield representing an approximately 10% discount from the Common Unit value. --The Junior Subordinated Units and General Partner Units were valued at an assumed 14% yield representing a 250 basis point premium over the Senior Subordinated Units based on their additional level of subordination and illiquidity. . As a result of the anticipated immediate accretion in distributable cash flow resulting from the Transaction, the Partnership would increase its quarterly distributions per unit from $0.55 to $0.575 (from $2.20 per unit or $2.30 per unit annually). . Incentive payments historically provided to the General Partner upon meeting certain performance tests would be reallocated to all Common Stockholders by distributing such rights among the Senior Subordinated Units, Junior Subordinated Units and General Partner Units pro rata. . The general partner of the Partnership would be a newly organized limited liability company that would be owned by affiliates of Petro. . The Senior Subordinated Units and Junior Subordinated Units would be subordinated to the distribution and liquidation rights of the Common Units until such time as the Partnership earned $2.30 per Unit in distributable cash flow for three years, at which time the subordination period would end. Mr. McCarthy then described, as he had done with the Petro Board, the benefits of the Proposed Transaction to the Public Common Unitholders and the Public Common Stockholders. In response to a question from the directors, Mr. McCarthy indicated that, based on a preliminary review, he did not believe that a combined propane/heating oil MLP would have a negative perception in the public market. He considered growth and ability to make distributions the key considerations for valuing an MLP, and Petro's growth potential would more than offset any impact of its having non-propane activities. In addition, he pointed out that several diversified MLPs exist and perform favorably compared to their peers. In response to a question concerning Petro's operating performance, Mr. McCarthy indicated that while the benefits of Petro's regionalization and branding programs had begun to be realized, the 88 implied value has yet to be factored into Petro's stock price. However, these improvements should ultimately benefit the combined entity and its future value. The Star Gas Board Appoints the Special Committee to Consider the Proposed Transaction Based on this presentation and the ensuing discussion, the Star Gas Board believed that there was a consensus to proceed with further consideration of the Proposed Transaction. Because all of the directors of Star Gas were also directors or officers of Petro, other than Mr. Nicoletti and Ms. Lanier, the Board assigned the task of exploring the proposal to them. It was decided they should act as a Special Committee to ensure that the interests of the Public Common Unitholders were independently represented in connection with the Proposed Transaction. Ms. Lanier then proposed that the Special Committee retain independent financial advisors and legal counsel to assist in a review of the Proposed Transaction. The Star Gas Board authorized the Special Committee to retain such independent financial advisor and legal counsel as they deemed appropriate. In January and February 1998, the Special Committee invited A.G. Edwards along with one other investment banking firm to present its qualifications to serve as financial advisor to the Special Committee. Following several meetings and discussions with A.G. Edwards and the other candidate, on March 23, 1998 the Special Committee engaged A.G. Edwards as its financial advisor. The Special Committee had previously retained Baker & Botts, L.L.P. as its legal counsel. On February 4, 1998, Petro's management met with investment bankers at Donaldson Lufkin & Jenrette to discuss the proposed terms for the refinancing or restructuring of Petro's public and private debt and preferred stock in connection with the Proposed Transaction. Mr. Sevin Reviews the Status of the Proposed Transaction with the Petro Board in February 1998 At a February 23, 1998 Petro Board meeting, Mr. Sevin updated the Petro Board on the discussions with the Special Committee regarding the Proposed Transaction, as well as developments with other energy companies. The Petro Board agreed that Mr. Sevin should continue to pursue the Proposed Transaction, as well as other investment alternatives. The Petro Board then asked one of its members to assist Mr. Sevin in structuring such alternatives. In March 1998, Mr. Sevin met with each of Petro's three commercial banks separately to determine if the mergers and acquisitions or utility departments of such institutions could identify any public utility that was seeking to invest in deregulated energy activities or any other party that might be interested in investing in or forming a joint venture with Petro. Petro Commences Discussions with the Special Committee On March 10, 1998, Petro's representatives met with the Special Committee to discuss certain initial questions that had arisen from its discussions with potential financial advisors. Petro's representatives wanted to review with the Special Committee Petro's capitalization structure, the improvement in Petro's customer attrition rate, and its ability to continue to increase its gross profit margins and to acquire new businesses at historic rates. 89 Petro Continues to Pursue Other Investment Alternatives In March and April 1998, Petro continued to pursue other investment alternatives. In April 1998, Petro's management met with representatives of two public utilities to discuss with each a possible joint venture. While one utility indicated that it was not interested in pursuing the matter, a second, which had previously expressed an interest in purchasing Petro's heating oil operations, indicated that it could possibly be interested in a joint venture. However, its conditions to pursuing further discussions of such a venture were determined to be unacceptable and discussions were ended. During May and June 1998, Petro had several discussions and meetings with representatives of a third public utility concerning a proposed investment in Petro either pursuant to a joint venture or the purchase of certain of Petro's operations. However, this utility determined not to proceed with such an investment and Petro indicated it was not interested in divesting of any operations. Petro Retains Dain Rauscher Wessels to Provide a Fairness Opinion to Petro's Public Common Stockholders In April 1998, Petro began a search for an independent investment banking firm with expertise in the area of MLPs which could render an opinion as to the fairness, from a financial point of view, of the consideration to be received by the Public Common Stockholders in the Proposed Transaction. On April 22, 1998, Mr. Sevin met with representatives of Dain Rauscher Wessels. On May 14, 1998, Dain Rauscher Wessels was formally engaged, and, on May 28 and May 29, 1998, Dain Rauscher Wessels met separately with the management of the Partnership and Petro in order to begin its due diligence with respect to the Partnership and Petro. A.G. Edwards Prepares Preliminary Status Report On April 28, 1998, A.G. Edwards met with the Special Committee and members of the Partnership's management to discuss and present the status of A.G. Edwards' due diligence efforts and preliminary conclusions. A.G. Edwards recommended that the Special Committee proceed in its analysis and review of a potential business combination with Petro and recommended that A.G. Edwards begin preparation of a preliminary status report (the "Preliminary Status Report") that could be shared with Petro and PaineWebber. The Preliminary Status Report would include the Special Committee's preliminary views on the structure of a potential transaction as well as its preliminary thoughts on a merger agreement and required changes to the Partnership Agreement. The Special Committee agreed. On May 4, 1998, A.G. Edwards delivered the Preliminary Status Report and an updated and revised preliminary financial analysis to the Special Committee. The Special Committee authorized A.G. Edwards to discuss the Preliminary Status Report with both Petro and PaineWebber. On May 5, 1998, at a meeting of the Board of Directors of Star Gas, the Special Committee advised the Board as to the status of the Preliminary Status Report and indicated A.G. Edwards' preliminary views as to the valuation of Petro. 90 The Special Committee and Petro Meet to Review the Preliminary Status Report and to Negotiate the Proposed Transaction On May 7, 1998, the Special Committee and A.G. Edwards met with Petro and PaineWebber to discuss the Preliminary Status Report and to begin negotiations over a potential combination. The Special Committee took three firm negotiating positions at the May 7 meeting, which were reflected in the Preliminary Status Report. First, the Special Committee required that the Minimum Quarterly Distribution to be paid to Common Unitholders be raised from $2.20 annually to $2.30 annually. Second, the Special Committee took the position that no distributions would be paid to the holders of Senior Subordinated Units, Junior Subordinated Units and General Partner Units following a transaction that were not earned by the actual performance of the combined business following the Transaction. Third, the Special Committee took the position that the $3.15 valuation per Petro share was too high, and that the Special Committee would only look at a combination if the price was in the $2.00 per share range. In support of this third position, A.G. Edwards discussed with Petro and PaineWebber the basis for its analysis of Petro's Common Stock at $2.00 per share. Mr. Sevin responded that he could agree to the revised Minimum Quarterly Distribution of $2.30 and to the proposal that during the Subordination Period holders of Senior Subordinated Units, Junior Subordinated Units and General Partner Units would only receive distributions out of distributable cash generated following the closing of the Transaction. However, he indicated he could not agree to valuing Petro's Common Stock at $2.00 per share, indicating his belief that this valuation was unfairly low. He pointed out that while there are many criteria that could be used in determining the appropriate valuation for Petro's Common Stock, he believed the most important was the accretion to the Partnership resulting from the acquisition of Petro. While Mr. Sevin questioned certain of the assumptions upon which A.G. Edwards views were based, he noted that even using the most conservative assumption, a $2.00 value would (based on the projections available at such time) would result in projected accretion of approximately $.62 per unit, which could grow to over $1.00 per unit. Mr. Sevin indicated that this level of accretion was excessive and unwarranted and that the approximate $.40 per unit projected accretion resulting from a $3.15 per share price was certainly more appropriate and would still make this combination significantly attractive to the Common Unitholders. This was especially true given the greater growth potential provided by Petro which would, over time, increase the accretion to over $1.00 per Unit even at a $3.15 valuation. PaineWebber also indicated to A.G. Edwards that the $3.15 per unit valuation did not represent an excessive premium to market value (the "merger premium") when Petro's average stock performance for the last twelve months was considered. PaineWebber noted that the suspension of Petro's Common Stock dividends following the unusually warm weather of the first quarter of 1998 had lowered the short-term trading prices of Petro's Common Stock despite the significant improvements in Petro's operating results. In addition, PaineWebber asked A.G. Edwards to consider market statistics prepared by PaineWebber that indicated that the merger premiums for stocks priced at less than $5.00 per share were generally greater than the merger premiums for higher priced shares. In an attempt to bridge the valuation gap, the parties discussed having the Partnership issue additional Units to the Common Stockholders after consummation of the Transaction if Petro met certain financial goals. 91 At the conclusion of this meeting, the parties agreed to review their respective positions. On May 19, 1998, representatives of A.G. Edwards met with representatives of PaineWebber and Petro in an attempt to reach an agreement on the appropriate price per share to be used to value the consideration paid to the Common Stockholders. PaineWebber provided A.G. Edwards with information concerning comparable acquisition multiples to demonstrate that a $3.15 per share price was appropriate. In addition, PaineWebber indicated that Petro's first quarter operating performance was better than the budgeted figures originally provided A.G. Edwards, which further suggested that the $3.15 valuation was appropriate. In order to bridge the gap in valuation, the parties began discussing a $2.50 per share value with Petro's ability to obtain additional value through the issuance of additional Senior Subordinated Units after the closing if it met certain earnings criteria. The concept was that Petro would be able to receive an additional total 909,000 Units, at a rate of 303,000 per year in each of three years that Petro provided the Partnership with $.50 per unit of accretion in distributable cash flow over the level the Partnership would earn had it not combined with Petro. It was indicated that these additional Units, if earned, would be issued pro rata to the holders of Senior Subordinated Units, Junior Subordinated Units and General Partner Units. A.G. Edwards Prepares a Preliminary Draft Proposal for the Transaction On May 20, 1998, the Special Committee met by conference telephone call with A.G. Edwards and Baker & Botts to discuss its preliminary analysis (updated by A.G. Edwards) and the status of negotiations. The group also discussed a preliminary draft proposal prepared by A.G. Edwards for submission to Petro. The Special Committee instructed A.G. Edwards to revise the preliminary draft proposal. On May 21, the Special Committee met again by conference telephone call with Baker & Botts to review such proposal. A.G. Edwards submitted a revised preliminary draft proposal to the Special Committee on May 26, 1998 and the Special Committee instructed A.G. Edwards to submit such proposal to Petro. Such proposal dated May 26, 1998 (the "Preliminary Draft Proposal") included the following principal terms: . In exchange for all of Petro's issued and outstanding shares of Common Stock, the Partnership would issue an aggregate of 2,718,000 Senior Subordinated Units, 524,000 Junior Subordinated Units and 289,000 General Partner Units (reflecting a valuation for the Petro Common Stock of $2.50 per share). In conjunction with the issuance of these new Units, the Partnership would in effect cancel the existing 2,396,078 subordinated units and the 2% combined general partner interest, both owned by Petro. . The Partnership would issue up to 303,000 additional Senior Subordinated Units per year (up to a maximum of 909,000 additional Senior Subordinated Units) pro rata to the holders of the Senior Subordinated Units, Junior Subordinated Units and General Partner Units in each year that Petro achieves certain levels of accretion in the future. . The amount of new equity required to be raised by the Partnership and new debt required to be raised by a subsidiary of the Partnership in order to refinance Petro's existing debt and preferred stock could not exceed certain maximum amounts and were subject to certain price and expense limitations. 92 . The Partnership Agreement would be amended to prohibit the payment of distributions to the holders of Senior Subordinated Units, Junior Subordinated Units and the General Partner Units from any source other than distributable cash generated during the last twelve months. . The cost of refinancing Petro's outstanding debt and redeeming Petro's preferred stock could not exceed specified limits. The management of Petro believed that, with some further modifications, the Preliminary Draft Proposal could form the basis of an agreement. With that in mind, Petro began focusing its efforts on reaching an agreement with institutional holders of its long-term debt and preferred stock on a basis that would comply with the terms of the Preliminary Draft Proposal. Petro Negotiates the Refinancing of its Public and Private Debt and Preferred Stock During June and July 1998, representatives of Petro undertook negotiations with institutional holders of its public and private debt and preferred stock to obtain the right to refinance these securities. In August 1998, Petro reached an agreement with institutional holders of $149 million or 63.1% of Petro's Old Public Debt and Old Preferred Stock (including the holders of 100% of the Old Preferred Stock) to permit the redemption of such securities at the closing of the proposed Transaction. This Agreement allows Petro to redeem its 9 3/8% Debentures, 10 1/8% Notes and 12 1/4% Debentures at 100%, 100% and 103.5% of principal amount, respectively, and to redeem its 12 7/8% Preferred Stock at $23 per share. In consideration for this early redemption right, Petro agreed to issue to such holders 3.3732 shares of newly issued Junior Convertible Preferred Stock for each $1,000 in principal amount or liquidation preference of such securities. Petro subsequently offered to the remaining holders of its Old Public Debt the same right of early redemption under the same terms and conditions as agreed to by the consenting holders. This proposal was made through an exchange offer that terminated on September 24, 1998 with an aggregate acceptance rate of more than 95% of the Old Public Debt. Other Activities Undertaken in Connection With The Proposed Transaction On June 3, 1998, following consultation with a number of Petro Board members, the management of Petro entered into a formal financial advisory agreement with PaineWebber. Also, on June 3, 1998, Mr. Sevin met with the representatives of Hanseatic Americas LDC, a Bahamian limited duration company indirectly controlled by Hanseatic Corporation, a majority of the shares of capital stock of which were owned by Wolfgang Traber, a Petro Board member, and in which another Petro Board member, Paul A. Biddelman, acts as President. Hanseatic Americas and Hanseatic Corporation (collectively, "Hanseatic") in the aggregate owned more than 1.9 million shares of Common Stock. The purpose of the meeting was to determine Hanseatic's willingness to exchange its Common Stock for Junior Subordinated Units and General Partner Units, rather than the Senior Subordinated Units being exchanged with the Public Common Stockholders. Certain other affiliates had previously indicated an unwillingness to accept such junior and illiquid securities at the value suggested by PaineWebber. Hanseatic's assent was necessary, so that when combined with the 93 shares that Irik Sevin and Audrey Sevin were prepared to convert into Junior Subordinated Units, and General Partner Units a total of the approximately 5.3 million required by the Partnership's proposal could be accumulated. While Mr. Traber indicated a willingness to undertake such an exchange, in order to accommodate consummation of the Transaction he further wanted the independent assent of Hanseatic's major investors. An agreement was reached that these representatives would support the exchange. On July 27, 1998, at a meeting of the Star Gas Board, Mr. Sevin (on behalf of Petro) and the Special Committee informed the Board of the progress of the discussions and negotiations between PaineWebber on behalf of Petro and A.G. Edwards on behalf of the Special Committee. Mr. Sevin also informed the Star Gas Board of the results of Petro's negotiations with the institutional holders of its public and private debt and preferred stock. Mr. Sevin advised the Star Gas Board that it was his understanding that A.G. Edwards would produce a revised proposal in the form of a draft term sheet (the "Revised Proposal") to reflect such discussions and negotiations. Mr. Sevin also informed the Board that he had received a telephone call from a director of another public propane MLP to inquire as to whether the Partnership would be interested in being acquired by such MLP. The purchase price indicated did not reflect any premium over the current market price of the Common Units and the valuation of Petro's Subordinated Units and general partner interests was not acceptable to Petro. After discussion, it was decided that Mr. Sevin should respond that the Partnership was not interested in such a proposal. A.G. Edwards Prepares and Forwards the Revised Proposal to Petro On July 28, 1998, following additional telephonic discussions with PaineWebber to further refine the terms of the Revised Proposal, A.G. Edwards, on behalf of the Special Committee forwarded the Revised Proposal to the Star Gas Board, the Petro Board and PaineWebber for each of their reviews and consideration. The Revised Proposal clarified that the General Partner Units would be subordinated to both the Common Units and Senior Subordinated Units, but was otherwise similar to the Preliminary Draft Proposal. On July 29, 1998, Dain Rauscher Wessels met with representatives of Petro to review the Revised Proposal and for Dain Rauscher Wessels to undertake further due diligence. The Petro Board Reviews the Revised Proposal On August 3, 1998, at a meeting of the Petro Board, which was attended telephonically by Dain Rauscher Wessels as well as PaineWebber and legal counsel, Mr. Sevin stated that it was important at such time to apprise the directors of all of the details of the Revised Proposal and to answer any questions that they may have, since the matter might be brought to a formal vote within the next week to ten days. The Petro Board then discussed various aspects of the Proposed Transaction as well as the fiduciary obligations of the Petro Board and those of the Petro directors who also serve as directors of Star Gas. In response to questions regarding these responsibilities, Mr. Michael Rosenwasser, of 94 Andrews & Kurth L.L.P., co-counsel to Petro, indicated that the Special Committee would have the overall responsibility for negotiating, reviewing and deciding whether to recommend the Proposed Transaction to the Star Gas Board and to the public Common Unitholders. Mr. Rosenwasser further indicated that the law firms of Phillips Nizer Benjamin Krim & Ballon LLP and Andrews & Kurth would be representing Petro and its Board and that the law firm of Baker & Botts would be representing the Special Committee. A question was raised as to whether it would be advisable to appoint an independent committee of the Petro Board to represent the Public Common Stockholders. After discussion, it was determined that there was doubt as to whether an unquestionably independent committee could be constituted. Instead, the Board determined that Petro would not proceed with the Proposed Transaction without the approval of the holders of a majority of the shares of Petro's Class A Common Stock owned by non-affiliates and unless Petro received a favorable fairness opinion from Dain Rauscher Wessels as to the consideration to be received by the Public Common Stockholders. On August 10, 1998, Petro entered into an agreement with certain affiliated Class C Common Stockholders to approve the transaction. Such approval was required pursuant to a stockholders' agreement among the holders of Petro's Class C Common Stock. The Special Committee Approves the Revised Proposal On August 11, 1998, the Star Gas Board by written consent authorized the Special Committee to assume responsibility for all matters relating to the Proposed Transaction, including the power and authority to negotiate the terms of the transaction subject to such additional actions by the Star Gas Board as may be necessary or advisable under applicable law. Following the grant of such authority, the Special Committee approved the Revised Proposal and transmitted the Revised Proposal to the Petro Board. The Petro Board Approves the Revised Proposal The Petro Board met on August 13, 1998 to consider and vote upon the Revised Proposal. Mr. Sevin reviewed with the Petro Board certain minor changes which had been made to that document subsequent to the August 3, 1998 meeting, and indicated that it had been approved by the Special Committee earlier in the week. After discussion, the Petro Board unanimously approved the Revised Proposal. On August 14, 1998, Petro and the Partnership issued a joint press release announcing that they had reached an agreement-in-principle concerning the Proposed Transaction. During August, September and October 1998, the Special Committee, in conjunction with its legal counsel and financial advisors, negotiated the terms of a definitive Merger Agreement and Exchange Agreement with Petro and its legal counsel and financial advisors. During the course of these negotiations, the Special Committee required, and Petro ultimately agreed, as a condition of the Transaction, that (i) no distributions could be made on any Subordinated Units until August 15, 1999; (ii) certain earnings tests had to be achieved for any distributions to be made on that date or on the next anticipated distribution date of November 15, 1999; and (iii) as of the Closing, Petro had to have certain minimum working capital levels substantially higher than was required in the Preliminary Draft Proposal. 95 The Special Committee Recommends and the Star Gas Board Approves the Definitive Transaction Documents On October 16, 1998 the Special Committee met with its financial advisors and legal counsel to consider the Transaction. At this meeting, A.G. Edwards delivered its oral and written opinion that the Transaction was fair, from a financial point of view, to the Public Common Unitholders. The Special Committee then entered into a full discussion of the financial and legal aspects of the Transaction with its financial and legal advisors. On October 19, 1998, the Special Committee met again with its financial and legal advisors and, after discussion and based on the advice of its advisors and the fairness opinion of A.G. Edwards, unanimously voted to recommend the Transaction to the Star Gas Board for its approval subject to its legal advisors negotiating the last remaining details of the Merger Agreement, none of which were deemed material. On October 19, 1998, based on that recommendation, the Star Gas Board approved the Merger Agreement and Exchange Agreement and authorized the officers of Star Gas to execute and deliver the Merger Agreement and Exchange Agreement. The Petro Board Approves the Definitive Transaction Documents On October 6, 1998, Dain Rauscher Wessels presented to the Petro Board its opinion that the consideration to be provided to the Public Common Stockholders pursuant to the Transaction was fair from a financial point of view. PaineWebber and Petro's legal counsel attended that meeting. On October 19, 1998, the Petro Board held a meeting to consider the Transaction. Based on a variety of factors, including the Dain Rauscher Wessels Opinion, the Petro Board unanimously approved the Merger Agreement and Exchange Agreement and authorized and directed the officers of Petro to execute and deliver the Merger Agreement and Exchange Agreement. REASONS FOR THE TRANSACTION; RECOMMENDATION OF THE SPECIAL COMMITTEE At a meeting of the Special Committee held on October 16, 1998, the Special Committee received presentations concerning, and reviewed the terms of, the Transaction with members of management and its legal counsel and financial advisors. At the meeting, the Special Committee unanimously determined that the Transaction is fair to, and in the best interests of, the Public Common Unitholders. Accordingly, the Special Committee unanimously recommends that the Unitholders vote FOR the Star Proposals at the Unitholders Meeting. Based on the recommendation of the Special Committee, the Board of Directors of Star Gas unanimously recommends that the Common Unitholders vote FOR the Star Proposals at the Unitholders Meeting. See "--Background of the Transaction" and "-- Interests of Certain Persons in the Transaction; Conflicts of Interest." During the course of its deliberations, the Special Committee, with the assistance of management and its legal and financial advisors, considered a number of factors, including the following potential advantages of the Transaction: . The Special Committee believes the acquisition of Petro will increase the Partnership's ability to grow through further acquisitions in the home heating oil business. Petro is the largest retail distributor of home heating oil in the country. In addition, Petro has been the principal 96 consolidator of that highly fragmented industry, having purchased over 180 retail home heating oil companies since 1979. The primary source of growth in the propane industry is acquisitions. Competition for acquisitions in the propane industry has intensified, decreasing the opportunities available, and increasing the prices paid, for propane companies. The Special Committee believes Petro's strong position in the home heating oil industry will provide the Partnership with an additional source of attractive acquisition and expansion opportunities. . The Special Committee believes the Transaction will be accretive to the Partnership's distributable cash flow per Unit. The expected increase in distributable cash flow per Unit resulting from the Transaction will enable the Partnership to raise the Minimum Quarterly Distribution from $0.55 to $0.575 (or from $2.20 to $2.30 on an annual basis). If the expected increase in distributable cash flow is realized, it will provide greater protection of the Minimum Quarterly Distribution and improves the possibility of future distribution increases. . The Transaction will increase the Partnership's market capitalization and should provide greater Common Unit liquidity, investment community awareness and the ability to attract securities analyst research coverage. . Common Stockholders will receive Senior Subordinated Units which are subordinated to the distributions on Common Units for a minimum of three years. The Senior Subordinated Units will remain subordinated to the Common Units until the Partnership has earned and paid the Minimum Quarterly Distribution of $2.30 on all Units for three consecutive four- quarter periods. In addition, the Subordination Period has been extended at least 18 months from January 1, 2001 to July 1, 2002. . During the Subordination Period, distributions on the Senior Subordinated Units, Junior Subordinated Units and General Partner Units will be generally limited to the amount of distributable cash generated after the Transaction is effective after October 1, 1997. . Overall, the Special Committee believes that the Transaction represents an opportunity to acquire a company that is expected to significantly increase the Partnership's size and scope of operations, growth prospects and ability to increase its distributions to Unitholders. During the course of its deliberations, the Special Committee also considered the following potential disadvantages of the Transaction: . The Partnership is acquiring an entity which, based on 1997 revenues, is several times its size. Therefore, the nature of the Partnership's business will be significantly changed. . Petro has a history of operational and financial difficulties (including high leverage and recent substantial net losses). . The success of the acquisition depends upon the Partnership's ability to (i) continue to make acquisitions at attractive prices; (ii) continue to reduce Petro's customer attrition rate; and (iii) continue to improve Petro's profit margins on a per gallon basis. There can be no assurance that each of the three will occur. . The Partnership is making a large investment in a business which, like the Partnership's propane operations, is negatively affected by warm weather during the winter months. 97 . The income of Petro, unlike the income of the Partnership, will be subject to corporate tax prior to distributions and dividend income from Petro cannot be offset with past or future losses generated by the Partnership's propane operations. . The ratio of taxable income to cash distributions to be made to the existing Common Unitholders will increase over time at a greater rate than if the Transaction does not occur. . The home heating oil business is not a growth business as a result of competition from alternative energy sources. . In the Transaction, the proportion of Subordinated Units to total Units will decline from 37.5% to 26%, and the support to Common Units will therefore be reduced. . The number of Common Units will increase from approximately 3.9 million to 10.3 million representing a potential significant dilution. The Special Committee also considered the following factors: . The A.G. Edwards Opinion and the financial analysis prepared by A.G. Edwards in connection therewith (see page 98). . The projections prepared by the Partnership and Petro (see page 119). . The terms of the Exchange Agreement, Merger Agreement and Amendment to the Partnership Agreement (see pages 83, 125 and 139). . The conditions to the consummation of the Transaction (see page 131). . The background which resulted in the development of the structure of the Transaction (see page 85). . The conflicts of interest in structuring the Transaction (see page 66). . Recent trading prices of the Common Units and the Common Stock (see page 179). The foregoing discussion of information and factors considered and given weight by the Special Committee is not intended to be exhaustive. In view of the wide variety of factors considered in connection with its evaluation of the Transaction, the Special Committee did not find it practicable to, and did not, quantify or otherwise attempt to assign relative weights to the specific factors considered in reaching their determination. In addition, individual members of the Special Committee may have given different weights to different factors. THE SPECIAL COMMITTEE UNANIMOUSLY RECOMMENDS THAT THE PUBLIC COMMON UNITHOLDERS VOTE FOR THE STAR PROPOSALS. OPINION OF A.G. EDWARDS On March 23, 1998, the Special Committee engaged A.G. Edwards to serve as its financial advisor and to render an opinion as to the fairness, from a financial point of view, of the Transaction to the Public Common Unitholders. A.G. Edwards, as part of its investment banking business, is regularly engaged in, among other things, the valuation of businesses and their securities in connection with mergers and acquisitions, 98 initial public offerings, secondary distribution of listed and unlisted securities, private placements, and valuations for estate, corporate and other purposes. A.G. Edwards is familiar with the Partnership through acting as exclusive financial advisor and placement agent in the Partnership's private placement of 7.17% First Mortgage Notes due 2010 and through its securities research coverage of the Partnership. A.G. Edwards is not aware of any relationship between A.G. Edwards and the Partnership, the General Partner or Petro, which in its opinion, would affect its ability to render a fair and independent opinion in this matter. On October 16, 1998, A.G. Edwards rendered its written opinion to the Special Committee that, as of such date, the Transaction was fair, from a financial point of view, to the Public Common Unitholders. THE FULL TEXT OF THE A.G. EDWARDS OPINION, WHICH SETS FORTH ITS PRINCIPAL ASSUMPTIONS MADE, PROCEDURES FOLLOWED, MATTERS CONSIDERED AND LIMITATIONS OF THE SCOPE OF THE REVIEW UNDERTAKEN BY A.G. EDWARDS IN RENDERING ITS OPINION, IS ATTACHED AS ANNEX D TO THIS PROXY STATEMENT. THE PUBLIC COMMON UNITHOLDERS ARE URGED TO, AND SHOULD, READ THE A.G. EDWARDS OPINION CAREFULLY AND IN ITS ENTIRETY. THE A.G. EDWARDS OPINION WAS DIRECTED TO THE SPECIAL COMMITTEE AND ADDRESSES ONLY THE FAIRNESS, FROM A FINANCIAL POINT OF VIEW, OF THE TRANSACTION TO THE PUBLIC COMMON UNITHOLDERS, AND DOES NOT CONSTITUTE TAX ADVICE OR A RECOMMENDATION TO ANY PUBLIC COMMON UNITHOLDER AS TO HOW TO VOTE WITH RESPECT TO THE TRANSACTION. THE SUMMARY OF THE A.G. EDWARDS OPINION SET FORTH IN THIS PROXY STATEMENT IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE FULL TEXT OF THE A.G. EDWARDS OPINION. For purposes of the A.G. Edwards Opinion with respect to the Transaction, A.G. Edwards has assumed that the Partnership will be able to complete the Debt Offering and the Equity Offering and the redemption of certain debt and preferred stock of Petro (the "Refinancing Transactions") and understands that the Transaction will not be consummated if the Partnership is unable to complete the Refinancing Transactions in accordance with the terms set forth in the Agreement and Plan of Merger. We have also assumed that the General Partner's withdrawal and the related admission of a successor general partner will have no financial impact on the Public Common Unitholders. In connection with rendering the A.G. Edwards Opinion, A.G. Edwards reviewed (i) the most recently available drafts of the Partnership's Registration Statement on Form S-4 and exhibits thereto, including the Agreement and Plan of Merger, the Exchange Agreement, the Amended and Restated Partnership Agreement and the Conveyance and Contribution Agreements; (ii) certain publicly available historical audited financial statements and certain unaudited interim financial statements of the Partnership and Petro; (iii) certain financial analyses and forecasts of the Partnership prepared by, and reviewed with, management of the General Partner and the views of management of the General Partner regarding the Partnership's past and current business operations, results thereof, financial condition and future prospects, including the impact of the Transaction, as well as information relating to the retail propane distribution industry and the potential strategic, financial and operational benefits and challenges anticipated from the Transaction; (iv) certain financial analyses and forecasts of Petro prepared by, and reviewed with, management of Petro and the views of management of Petro regarding Petro's past and current business operations, results thereof, financial condition and future prospects, including the impact of the Transaction, as well as information relating to the home 99 heating oil distribution industry and the potential strategic, financial and operational benefits and challenges anticipated from the Transaction; (v) the pro forma impact of the Transaction on the Partnership and Petro; (vi) the publicly reported historical price and trading activity for the Common Units and the Class A Common Stock, including a comparison of certain financial and stock market information for the Partnership with similar publicly available information for certain other companies, the securities of which are publicly traded; (vii) the current market environment generally, and the retail propane distribution environment and the home heating oil distribution environment in particular; (viii) information relating to the financial terms of certain transactions, including selected merger and acquisition transactions; and (ix) such other information, financial studies, analyses and investigations, and financial, economic and market criteria that A.G. Edwards considered relevant. In rendering the A.G. Edwards Opinion, A.G. Edwards has assumed that the Transaction will be consummated on the terms contained in the Agreement and Plan of Merger, without any waiver of any material terms or conditions by the Partnership or Petro. In rendering the A.G. Edwards Opinion, A.G. Edwards has relied upon and assumed, without independent verification, the accuracy and completeness of all financial and other information, publicly available, furnished to, or otherwise discussed with A.G. Edwards for the purposes of the A.G. Edwards Opinion. With respect to financial projections and other information provided to or otherwise discussed with A.G. Edwards, A.G. Edwards assumed and was advised by the management of the General Partner and Petro, respectively, that such projections and other information were reasonably prepared on a basis that reflects the best currently available estimates and judgments of the management of the General Partner and Petro, respectively. A.G. Edwards did review numerous sets of Petro's projections and analyzed what it believed were certain of the major assumptions embedded within Petro's projections, which are detailed in "- Certain Projections of Petro and the Partnership." A.G. Edwards requested that Petro make changes to two of its assumptions and furnish A.G. Edwards with the resulting projections based on both 15-year weather ("Adjusted 15-Year Weather Projections for Petro") and 30-year weather ("Adjusted 30-Year Weather Projections for Petro"), collectively referred to as "Adjusted Projections for Petro." The two assumptions that A.G. Edwards requested that Petro change were as follows: (i) A.G. Edwards assumed retail margin growth of $0.01 per gallon in 1999 and $0.005 per gallon thereafter; and (ii) A.G. Edwards assumed that Petro would complete $30.0 million of home heating oil company acquisitions annually at a purchase price of 4.75x the first year earnings before interest expense, income taxes, depreciation and amortization and any non-recurring revenues and expenses ("EBITDA"). The Adjusted 30-Year Weather Projections for Petro resulted in heating oil EBITDA projections that were lower than the heating oil EBITDA projections from Petro's 30-year weather projections by the following percentages for 1999, 2000, 2001 and 2002, respectively: 0.4%, 4.4%, 7.7% and 10.5%. The Adjusted 15-Year Weather Projections for Petro resulted in heating oil EBITDA projections that were higher than the heating oil EBITDA projection from Petro's 15-year weather projections for 1999 by 0.8%, and lower than the heating oil EBITDA projections from Petro's 15-year weather projections by the following percentages for 2000, 2001 and 2002, respectively: 1.4%, 3.4% and 5.2%. The Special Committee did not, however, engage A.G. Edwards to, and therefore A.G. Edwards did not, verify the accuracy or completeness of any such information. A.G. Edwards has relied upon the assurances of the management of the General Partner and Petro that the respective managements 100 are not aware of any facts that would make such information inaccurate or misleading. A.G. Edwards did not conduct a physical inspection of the properties or facilities of the Partnership or Petro nor did it make or obtain any independent evaluation or appraisals of any such properties or facilities or assets and liabilities. A.G. Edwards assumed that the Transaction will be accounted for as a purchase transaction under generally accepted accounting principles. A.G. Edwards also assumed that the final form of the Partnership's Registration Statement on Form S-4, the Agreement and Plan of Merger, the Exchange Agreement, the Amended and Restated Partnership Agreement and the Conveyance and Contribution Agreements would be substantially similar to the last draft reviewed by A.G. Edwards, except for changes requested by the Special Committee. The A.G. Edwards Opinion is necessarily based on economic, market and other conditions as in effect on, and the information made available to A.G. Edwards as of, October 16, 1998. The preparation of a fairness opinion is a complex process and is not readily susceptible to partial analysis or summary description. In rendering the A.G. Edwards Opinion, A.G. Edwards applied its judgment to a variety of complex analyses and assumptions, considered the results of all of its analyses as a whole and did not attribute any particular weight to any analysis or factor considered by it. Furthermore, selecting any portion of its analyses, without considering all analyses, would create an incomplete view of the process underlying the A.G. Edwards Opinion. In addition, A.G. Edwards may have given various analyses and factors more or less weight than other analyses and factors, and may have deemed various assumptions more or less probable than other assumptions, so that the ranges of valuations resulting from any particular analysis described above should not be taken to be A.G. Edwards' view of the actual value of the Partnership or Petro. In performing its analyses, A.G. Edwards made numerous assumptions with respect to industry performance, general business and economic conditions and other matters, many of which are beyond the control of the Partnership or Petro. The assumptions made and judgments applied by A.G. Edwards in rendering the A.G. Edwards Opinion are not readily susceptible to description beyond that set forth in the written text of the A.G. Edwards Opinion itself. Any estimates contained herein are not necessarily indicative of future results or actual values, which may be significantly more or less favorable than those suggested by such estimates. A.G. Edwards does not assume responsibility if future results are different from those projected. The analyses performed were prepared solely as part of A.G. Edwards' analysis of the fairness, from a financial point of view, to Public Common Unitholders of the Transaction and were conducted in connection with the delivery of the A.G. Edwards Opinion. As described above, the A.G. Edwards Opinion to the Special Committee was one of the many factors taken into consideration by the Special Committee in making its determination to recommend the Transaction. The decision to enter into the Transaction was solely that of the Special Committee and the General Partner's Board. The following is a summary of the material analyses performed by A.G. Edwards in arriving at the A.G. Edwards Opinion: Implied Unit Analysis The consideration being paid to the Common Stockholders pursuant to the Transaction will consist of Senior Subordinated Units, Junior Subordinated Units and General Partner Units. As of the date of the A.G. Edwards Opinion, a market price did not exist for such Units; subsequent to 101 the Transaction, a market price will exist only for the Senior Subordinated Units. In A.G. Edwards' judgment, an analysis of the value per unit of each of the Senior Subordinated Units, Junior Subordinated Units and General Partner Units was necessary to evaluate the fairness of the Transaction. In analyzing the value of the Senior Subordinated Units, A.G. Edwards reviewed estimated ranges of discount rates, trading yields and relative valuations compared to the price of the publicly traded Common Units. In determining these estimated ranges, A.G. Edwards considered, among other factors: (i) during the Subordination Period, Common Unitholders will have priority in payment of the full Minimum Quarterly Distribution plus arrearages before any distributions are made to the Senior Subordinated Unitholders; (ii) the earliest date on which the Subordination Period would expire is July 1, 2002; (iii) the Subordination Period would only expire if the Adjusted Operating Surplus generated during each of the three immediately preceding non-overlapping four- quarter periods equaled or exceeded the sum of the increased Minimum Quarterly Distribution of $2.30 on an annualized basis on all outstanding Units during such period; (iv) during the Subordination Period, distributions on the Senior Subordinated Units will be limited to the amount of distributable cash generated; (v) the Senior Subordinated Units will be entitled to receive a pro rata distribution of additional Senior Subordinated Units, but only if Petro achieves certain financial goals during the five year period following the closing of the Transaction; and (vi) the Senior Subordinated Units will receive a pro rata distribution of the rights to receive Incentive Distributions previously held by the General Partner. A.G. Edwards' analysis resulted in an implied valuation range for a Senior Subordinated Unit of $17.04 to $20.00 per unit, of which A.G. Edwards used the midpoint value of $18.52. In analyzing the value of the Junior Subordinated Units and General Partner Units, A.G. Edwards considered, among other factors, certain of the differences between the Senior Subordinated Units, on the one hand, and the Junior Subordinated Units and General Partner Units, on the other hand, including: (i) the lack of marketability of the Junior Subordinated Units and General Partner Units; (ii) the authority given the General Partner under the Amended and Restated Partnership Agreement (and reflected in the General Partner Units) to control the affairs of the Partnership; and (iii) during the Subordination Period, both the Common Units and Senior Subordinated Units will have priority in payment of the full Minimum Quarterly Distribution before any distributions are made on the Junior Subordinated Units and General Partner Units. A.G. Edwards' analysis resulted in an implied valuation range for the Junior Subordinated Units and General Partner Units of $14.38 to $16.43 per unit, of which A.G. Edwards used the midpoint value of $15.41. Based on a value of $18.52 for each Senior Subordinated Unit and $15.41 for each Junior Subordinated Unit and General Partner Unit, A.G. Edwards calculated that the implied consideration paid for each Petro share averaged $2.43. A.G. Edwards did not express an opinion as to what the value of the Senior Subordinated Units, Junior Subordinated Units or General Partner Units will be when issued to the Common Stockholders pursuant to the Transaction, or the price at which the Common Units or Senior Subordinated Units will trade subsequent to the Transaction. Pro Forma Acquisition Analysis A.G. Edwards analyzed the impact of the Transaction on the Partnership's distributable cash flow (EBITDA less interest expense, maintenance capital expenditures and cash taxes) ("DCF") 102 per unit (DCF divided by the total number of Common Units, Senior Subordinated Units, Junior Subordinated Units and General Partner Units), the related accretion, the Partnership's Common Unit coverage (DCF per common unit divided by the annualized Minimum Quarterly Distribution of $2.20, or $2.30 on a pro forma basis) and the Partnership's total unit coverage (DCF per total unit divided by the annualized Minimum Quarterly Distribution of $2.20, or $2.30 on a pro forma basis). Based on the Adjusted 15-Year Weather Projections for Petro and the General Partners' management projections for 15-year weather, as well as other assumptions including certain assumptions regarding the Refinancing Transactions, A.G. Edwards calculated, pro forma for the Transaction, projected DCF per Unit, Common Unit coverage and total unit coverage under three scenarios: (i) adjusted for actual 1998, which was based on historical results of operations through July 31, 1998 and assumed normal weather for the remainder of 1998, (ii) normalized 1998, which was based on the 1998 budget and assumed normal weather and (iii) projected 1999, which assumed normal weather. Under these three scenarios: (i) DCF per unit would increase by $0.26, $0.53 and $0.54, respectively; (ii) Common Unit coverage would decrease from 0.96x to 0.89x, increase from 1.22x to 1.25x and increase from 1.30x to 1.33x, respectively; and (iii) total unit coverage would increase from 0.58x to 0.66x, increase from 0.74x to 0.94x and increase from 0.81x to 1.00x, respectively. Based on the Adjusted 30-Year Weather Projections for Petro and the General Partners' management projections for 30-year weather, as well as other assumptions including certain assumptions regarding the Refinancing Transactions, A.G. Edwards calculated pro forma for the Transaction, projected DCF per Unit, Common Unit coverage and total unit coverage, based on adjusted for actual 1998, normalized 1998 and projected 1999. Under these three scenarios (i) DCF per unit would increase by $0.26, $0.56 and $0.58, respectively; (ii) Common Unit coverage would decrease from 0.96x to 0.89x, increase from 1.38x to 1.39x and remain constant at 1.51x, respectively; and (iii) total unit coverage would increase from 0.58x to 0.66x, increase from 0.84x to 1.05x and increase from 0.92x to 1.13x, respectively. Analysis of Acquisition Premiums to Market Value A.G. Edwards analyzed the premium of the implied consideration to be received by Common Stockholders using the implied consideration of $2.43 for each Petro share to the market value of the Class A Common Stock one day, one week, four weeks, three months and one year prior to August 14, 1998, the day the agreement in principle relating to the Transaction was announced (the "Transaction Premiums"). A.G. Edwards reviewed three groups of selected merger and acquisition transactions of majority or remaining interests involving public companies and compared these transactions with the Transaction. The first group included mergers and corporate transactions announced and completed January 1, 1996 through October 9, 1998 in which the selling company's share price was equal to or greater than $10 per share one week prior to the announcement (the "$10 and Greater Transactions"). The second group included mergers and corporate transactions announced and completed since January 1, 1996 through October 9, 1998 in which the selling company's share price was less than $10 per share but greater than $5 per share one week prior to the announcement (the "Greater than $5 and Less than $10 Transactions"). The third group included mergers and corporate transactions completed since January 1, 1996 through October 9, 1998 in which the selling company's share price was equal to or less than $5 per share one week prior to announcement (the "$5 and Less Transactions"). A.G. Edwards compared the mean values for the $10 and Greater Transactions, the Greater than $5 and Less than $10 Transactions, and the $5 and 103 Less Transactions, respectively, to the Transaction Premiums. The premium to the stock price one day prior to the announcement date was 28.1%, 34.3% and 39.7%, respectively, compared to 29.6% for the Class A Common Stock. The premium to the stock price one week prior to the announcement date was 32.7%, 42.3% and 48.8%, respectively, compared to 38.9% for the Class A Common Stock. The premium to the stock price four weeks prior to the announcement date was 39.6%, 48.5% and 55.4%, respectively, compared to 17.8% for the Class A Common Stock. The premium to the stock price three months prior to the announcement date was 77.9%, 58.0% and 67.1%, compared to 52.5% for the Class A Common Stock. The premium to the stock price one year prior to the announcement date was 53.2%, 45.8% and 53.8%, compared to a discount of 19.0% for the Class A Common Stock. A.G. Edwards observed that the Class A Common Stock price has declined since the announcement of the agreement in principle of the Transaction and that the premium of the implied consideration to be received by Common Stockholders, based on the Class A Common Stock price as of October 14, 1998, was 135.6%. Contribution Analysis A.G. Edwards analyzed the relative pro forma contribution of each of the Partnership and Petro to the ownership of capital in the Partnership pro forma for the Transaction based on the Partnership's and Petro's historical results of operations and the General Partner's management projections and the Adjusted Projections for Petro. For comparative purposes, A.G. Edwards converted Petro's historical December 31 fiscal year-end to a September 30 year-end using Petro's quarterly statements to conform to the Partnership's September 30 year-end. This analysis indicated, among other things, that the Partnership would have contributed 24.3% and 31.3% of gross profit and EBITDA, respectively, in fiscal year 1996, and 29.4% and 39.8% of gross profit and EBITDA, respectively, in fiscal year 1997. The analysis indicated that the Partnership would contribute 28.6% and 31.7% of gross profit and EBITDA, respectively, for 15-year weather and 28.4% and 32.1% of gross profit and EBITDA, respectively, for 30-year weather in normalized 1998 and 29.3% and 33.1% of gross profit and EBITDA, respectively, for 15-year weather and 29.1% and 33.5% of gross profit and EBITDA, respectively, for 30-year weather in projected 1999. A.G. Edwards compared these figures to the percentage of the implied firm value attributable to the Partnership of 37.1%, which was calculated by subtracting the implied aggregate purchase price of Petro's heating oil assets, as described in the Comparable Transactions Analysis, from the pro forma market capitalization of the Partnership (pro forma Common Units multiplied by the market price of the Common Units plus the pro forma Senior Subordinated Units, Junior Subordinated Units and General Partner Units multiplied by their implied values based on the Implied Unit Analysis plus the pro forma book value of debt less pro forma cash) divided by the pro forma market capitalization of the Partnership. Discounted Cash Flow Analyses A.G. Edwards performed discounted cash flow analysis using the Adjusted Projections for Petro (the "Petro Cash Flow Analysis"). In performing the Petro Cash Flow Analysis, A.G. Edwards discounted back to December 31, 1998, using a discount rate range of 13.4% to 13.9% based upon Petro's weighted average cost of capital, the sum of (i) the projected tax-adjusted operating cash flows for 1999 to 2002; and (ii) the terminal value for 2002 (the "Petro Terminal Value"). The Petro 104 Terminal Value was determined based on projected 2002 EBITDA and a terminal EBITDA multiple range of 6.0x to 8.0x. The Petro Cash Flow Analysis indicated a present value of the equity of Petro in the range of $44.8 million to $113.5 million for 15-year weather and $60.1 million to $131.9 million for 30-year weather, respectively. A.G. Edwards compared the results from the Petro Cash Flow Analysis to the equity value being paid for Petro's heating oil business, which A.G. Edwards calculated to be $25.5 million based on the implied consideration being paid to each of the Common Stockholders less the implied value of the Subordinated Units and the general partner interest currently owned by Petro that will be effectively retired as part of this Transaction. A.G. Edwards also performed discounted cash flow analyses of the Partnership based on the General Partner's management projections and the Partnership pro forma for the Transaction based on the General Partner's management projections and the Adjusted Projections for Petro (the "Partnership Cash Flow Analyses"). In performing the Partnership Cash Flow Analyses, A.G. Edwards discounted back to September 30, 1998, using a discount rate range of 6.8% to 7.2% for the Partnership and 7.3% to 7.7% for the Partnership pro forma for the Transaction based upon the weighted average cost of capital for each, respectively, the sum of (i) the projected tax-adjusted operating cash flows for 1999 to 2002; and (ii) the terminal values for 2002 (the "Partnership Terminal Values"). The Partnership Terminal Values were determined based on 2002 projected EBITDAs and a terminal EBITDA multiple range of 9.0x to 11.0x. Based on the Partnership Cash Flow Analyses and the ratio of the Common Units outstanding as of the date of the A.G. Edwards Opinion (the "Original Partnership Common Units") to total Units (including the general partner interest) outstanding as of such date, A.G. Edwards calculated the net present value attributable to the Original Partnership Common Units and compared it to the present value attributable to the Original Partnership Common Units pro forma for the Transaction. The range of values were $90.8 million to $118.3 million for 15-year weather and $101.4 million and $130.7 million for 30-year weather, respectively, for the Partnership and $126.0 million to $161.1 million for 15-year weather and $136.9 million to $173.9 million for 30-year weather, respectively, for the Partnership pro forma for the Transaction. Comparable Transactions Analysis A.G. Edwards noted that, because Petro is the only publicly traded home heating oil distribution company, public disclosure regarding transactions in the home heating oil distribution industry was extremely limited. A.G. Edwards analyzed the financial terms related to divestitures by Petro of three of its heating oil branches and compared them to the implied multiples of the implied aggregate purchase price of Petro's heating oil assets. Petro has sold three branches for a range of 8.0x to 9.8x purchase price to EBITDA multiple. In analyzing the implied EBITDA multiple paid for Petro's heating oil assets, A.G. Edwards considered the following: (i) the implied consideration paid for the Common Stock; (ii) the implied valuation of the Subordinated Units and general partner interest of the Partnership currently owned by Petro; (iii) the redemption value of certain of Petro's indebtedness and preferred stock; (iv) the value of certain of Petro's indebtedness that will remain outstanding subsequent to the Transaction; (v) consent fees paid to certain of Petro's debt holders; (vi) an estimate of all of the transaction costs associated with the Transaction; and (vii) Petro's normalized 1997 EBITDA, normalized 1998 EBITDA and projected 1999 EBITDA based on the Adjusted Projections for Petro. Based on such information, the normalized 1997 EBITDA, 105 normalized 1998 EBITDA and projected 1999 EBITDA implied multiples paid for Petro's heating oil assets were 8.3x, 8.0x and 7.7x for 15-year weather, respectively, and 8.3x, 7.6x and 7.3x for 30-year weather, respectively. Analysis of Selected Publicly Traded Companies A.G. Edwards used publicly-available information to compare selected financial and market trading information for the Partnership to the Partnership pro forma for the Transaction and to a group of selected retail propane distributors, all of which are also master limited partnerships (the "Partnership Comparable Group"). The retail propane distributors in the Partnership Comparable Group were selected by A.G. Edwards based on the similarity of their businesses to that of the Partnership. The Partnership Comparable Group was comprised of: AmeriGas Partners, L.P., Cornerstone Propane Partners, L.P., Ferrellgas Partners, L.P., Heritage Propane Partners, L.P., National Propane Partners, L.P., and Suburban Propane Partners, L.P. No partnership used in A.G. Edwards' analysis is identical to the Partnership. A.G. Edwards' analysis involves complex considerations and judgments concerning differences in the potential financial and operating characteristics of the Partnership Comparable Group and other factors regarding the trading values of the Partnership Comparable Group. The financial information reviewed included, among other things: (i) market capitalization (equity market value (common units plus subordinated units and implied general partner units multiplied by the market price of the common units) plus the book value of debt plus minority interest less cash) to latest twelve month ("LTM") EBITDA and 1999 estimated EBITDA based on currently available research estimates; (ii) equity market value to LTM DCF and 1999 estimated DCF based on currently available research estimates; and (iii) distribution yield. Such analysis for the Partnership and the Partnership pro forma for the Transaction was based on the General Partner's management projections and the Adjusted Projections for Petro. A.G. Edwards compared the market capitalization to LTM EBITDA and 1999 EBITDA of the Partnership of 12.5x and 10.2x for 15-year weather and 12.5x and 9.6x for 30- year weather, respectively, to the Partnership pro forma for the Transaction of 10.0x and 8.1x for 15-year weather and 10.0x and 7.7x for 30-year weather, respectively, and to the range and median of the Partnership Comparable Group of 9.0x to 12.7x with a median of 11.6x, and 8.4x to 11.1x with a median of 9.2x, respectively. A.G. Edwards compared the equity market value to LTM DCF and 1999 DCF of the Partnership of 15.4x and 10.6x for 15-year weather and 15.4x and 9.6x for 30-year weather, respectively, to the Partnership pro forma for the Transaction of 12.5x and 8.1x for 15-year weather and 12.5x and 7.4x for 30-year weather, respectively, and to the range and median of the Partnership Comparable Group of 8.1x to 15.3x with a median of 13.4x, and 4.9x to 12.2x with a median of 9.8x, respectively. Using the closing price of the Partnership's price per Common Unit on October 14, 1998 of $19.56, A.G. Edwards compared the distribution yield of the Partnership, assuming a $2.20 annualized Minimum Quarterly Distribution, of 11.2% to the Partnership pro forma for the Transaction, assuming a $2.30 annualized Minimum Quarterly Distribution, of 11.8% and to the range and median of the Partnership Comparable Group of 9.1% to 22.3% with a median of 10.1%, respectively. Terms of A.G. Edwards' Engagement The terms of the engagement of A.G. Edwards by the Special Committee are set forth in a letter agreement between A.G. Edwards and the Special Committee (the "Engagement Letter"). 106 Pursuant to the terms of the Engagement Letter, as compensation for rendering its financial advisory services and the A.G. Edwards Opinion to the Special Committee, the Partnership agreed to pay A.G. Edwards a fee of $575,000, of which $75,000 has been paid; $250,000 was due upon the delivery of the A.G. Edwards Opinion; and $250,000 will be due upon the closing of the Transaction. The Partnership has agreed to reimburse A.G. Edwards for all travel and out-of- pocket expenses incurred in connection with its engagement. The Partnership has also agreed to indemnify A.G. Edwards against certain liabilities in connection with the engagement of A.G. Edwards. REASONS FOR THE TRANSACTION; RECOMMENDATION OF THE PETRO BOARD At a special meeting of the Petro Board held on October 6, 1998, the Petro Board received presentations concerning, and reviewed the terms of, the Transaction with members of Petro's management and its legal counsel and financial advisors. At a special meeting held on October 19, 1998, the Petro Board unanimously determined that the Transaction is fair to, and in the best interests of, the Public Common Stockholders. Accordingly, the Petro Board has unanimously approved the Merger Agreement and Exchange Agreement and unanimously recommends that the Common Stockholders vote FOR the approval of the Acquisition Proposal at the Special Meeting. See "--Background of the Transaction" and "--Interests of Certain Persons in the Transaction; Conflicts of Interest." During the course of its deliberations, the Petro Board with the assistance of management and its legal and financial advisors, considered the following potential advantages of the Transaction: . Petro is the largest home heating oil distributor in the U.S. and the principal consolidator of that highly fragmented industry. However, Petro does not have the financial flexibility to fully capitalize upon the acquisition, operating and corporate branding opportunities resulting from this position. This Transaction will recapitalize Petro providing it with access to lower cost capital to better realize these growth opportunities. . As part of an MLP, Petro's home heating oil operations should receive an improved market valuation. Due to high financing costs and amortization of customer lists, Petro does not currently generate net income for financial reporting purposes. Since MLP's are cash flow oriented and are valued primarily on a cash distribution basis, the MLP structure corresponds more closely with Petro's focus on cash flow. The Petro Board also believes the Partnership will have greater investment community awareness as compared to Petro. As the only public home heating oil company, Petro has had limited securities analyst research coverage. . Based on information provided by its financial advisors, the Petro Board expects the Common Stockholders to receive partnership units that are expected to trade at an attractive price compared to the recent trading price of the Common Stock. The actual trading price of the Senior Subordinated Units will depend on a variety of factors, including overall market conditions for MLPs, the trading level of the Common Units, the weather in the Partnership's areas of operations and the actual and expected levels of Available Cash generated by the Partnership's activities. . The Petro Board believes that the Transaction has been structured so the Common Stockholders will continue to participate in the expected benefits from Petro's operating 107 and corporate branding opportunities. If Petro meets certain financial goals within the five-year period after closing, the holders of Senior Subordinated Units, Junior Subordinated Units and General Partner Units will receive up to an additional 909,000 Senior Subordinated Units. This enables Common Stockholders to continue to participate in Petro's future performance. While there is no assurance these objectives will be achieved, the Petro Board believes that they are realistic and, if achieved, could provide significant additional value to Common Stockholders. . Although Petro has historically paid cash dividends to its Common Stockholders, these dividends have been suspended. The Partnership generally distributes to its partners the cash it generates from its operations. While there can be no assurance, this should give Common Stockholders an increased probability of a resumption of annual distributions. . The Senior Subordinated Units will be allocated certain Incentive Distribution rights previously held by the General Partner. To the extent that the Partnership generates cash above certain target distribution levels, the holders of Senior Subordinated Units may receive increased cash distributions. . The Public Common Stockholders will receive Senior Subordinated Units that must receive their full Minimum Quarterly Distribution prior to any payments being made on the Junior Subordinated Units and the General Partner Units. During the course of its deliberations, the Petro Board also considered the following potential disadvantages of the proposed Transaction: . Unitholders in the Partnership have substantially different, and probably fewer, legal rights than Common Stockholders. . There is no current trading market for the Senior Subordinated Units and even though they will be listed on the New York Stock Exchange, there are no assurances that any active trading market will exist after the closing of the Transaction. It is expected that the Senior Subordinated Units will trade at a lower price than the Common Units. . Distributions on the Senior Subordinated Units, Junior Subordinated Units and General Partner Units are not guaranteed and are subordinated to distributions on the Common Units. Further, distributions on the Senior Subordinated Units, Junior Subordinated Units and General Partner Units are in general limited to the amount of distributable cash generated after the Transaction. Therefore, there is significant uncertainty as to the amount and timing of such distributions. . Star Gas LLC, the new general partner in the Partnership, may have a greater number of conflicts of interest than the directors of Petro. . The Partnership's propane operations, like Petro's home heating oil business, is negatively affected by warm weather during the winter months. . The Partnership may face difficulties in the future in making attractive acquisitions in the propane industry because of the highly competitive nature of such industry. 108 . Common Stockholders that are tax-exempt entities, regulated investment companies or foreign taxpayers may determine that holding an interest in the Partnership may be unattractive from a tax perspective. If certain of these investors sell their Senior Subordinated Units following the transaction, the market price of the Senior Subordinated Units could fall substantially. The Petro Board also considered the following factors: . The Dain Rauscher Wessels Opinion and the financial analysis prepared by Dain Rauscher Wessels in connection therewith (see page 109). . The projections prepared by the Partnership and Petro (see page 119). . The terms of the Exchange Agreement, Merger Agreement and Amendment to the Partnership Agreement (see pages 83, 125 and 139). . The conditions to the consummation of the Transaction (see page 131). . The background which resulted in the development of the structure of the Transaction (see page 85). . The conflicts of interest in structuring the transaction (see page 66). . Recent trading prices for the Common Units and the Common Stock (see page 179). The foregoing discussion of information and factors considered and given weight by the Petro Board is not intended to be exhaustive. In view of the wide variety of factors considered in connection with its evaluation of the Transaction, the Petro Board did not find it practicable to, and did not, quantify or otherwise attempt to assign relative weights to the specific factors considered in reaching their determination. In addition, individual members of the Petro Board may have given different weights to different factors. THE PETRO BOARD UNANIMOUSLY RECOMMENDS THAT THE COMMON STOCKHOLDERS VOTE FOR THE ACQUISITION PROPOSAL AT THE SPECIAL MEETING. OPINION OF DAIN RAUSCHER WESSELS On May 14, 1998, the Petro Board retained Dain Rauscher Wessels to render an opinion to the Petro Board concerning the fairness, from a financial point of view, of the consideration to be received by the Public Common Stockholders pursuant to the Merger. On October 6, 1998, Dain Rauscher Wessels rendered to the Petro Board the Dain Rauscher Wessels Opinion that, as of the date of the opinion, and based upon and subject to the factors and assumptions set forth therein, the consideration to be received by the Public Common Stockholders pursuant to the Merger was fair, from a financial point of view, to the Public Common Stockholders. The full text of the Dain Rauscher Wessels Opinion, which sets forth the principal assumptions made, matters considered and qualifications and limitations on the review undertaken by Dain Rauscher Wessels in rendering its opinion, is attached as Annex E hereto and is incorporated herein by reference. The summary of the Dain Rauscher Wessels Opinion set forth in this Proxy Statement 109 is qualified in its entirety by reference to the full text of such opinion. Common Stockholders are urged to read such opinion carefully and in its entirety. The Dain Rauscher Wessels Opinion was provided to the Petro Board for its information and is directed only to the fairness from a financial point of view of the consideration to be received by the Public Common Stockholders pursuant to the Merger. The Dain Rauscher Wessels Opinion does not address the merits of the underlying decision by Petro to engage in the Merger and does not constitute a recommendation to any Common Stockholder as to how such holder should vote on the approval and adoption of the Merger Agreement or any matter related thereto. The summary set forth below does not purport to be a complete description of the analyses underlying the Dain Rauscher Wessels Opinion or the presentation made by Dain Rauscher Wessels to the Petro Board. The preparation of a fairness opinion is a complex analytical process involving various determinations as to the most appropriate and relevant methods of financial analysis and the application of those methods to the particular circumstances. Therefore, such an opinion is not readily susceptible to partial analysis or summary description. In arriving at its opinion, Dain Rauscher Wessels did not attribute any particular weight to any analysis or factor considered by it, but rather made qualitative judgments as to the significance and relevance of each analysis and factor. Accordingly, Dain Rauscher Wessels believes that its analyses must be considered as a whole and that selecting portions of its analyses, without considering all of its analyses, would create an incomplete view of the process underlying the Dain Rauscher Wessels Opinion. In performing its analyses, numerous assumptions were made with respect to industry performance, general business, economic, market and financial conditions and other matters, many of which are beyond the control of Dain Rauscher Wessels, Petro or the Partnership. Any estimates contained in the analyses performed by Dain Rauscher Wessels are not necessarily indicative of actual values or future results, which may be significantly more or less favorable than suggested by such analyses. Additionally, estimates of the value of businesses or securities do not purport to be appraisals or to reflect the prices at which such businesses or securities might actually be sold. Accordingly, such analyses and estimates are inherently subject to substantial uncertainty. The Dain Rauscher Wessels Opinion and Dain Rauscher Wessels' presentation to the Petro Board were among several factors taken into consideration by the Petro Board in making its determination to approve the Merger Agreement. Consequently, the Dain Rauscher Wessels' analyses described below should not be viewed as determinative of the decision of the Petro Board or Petro's senior management to engage in the Merger. In arriving at the Dain Rauscher Wessels Opinion, Dain Rauscher Wessels reviewed the most recently available drafts of the Merger Agreement, the Amended and Restated Partnership Agreement, the Proxy Statement of Petro and the Partnership filed as a part of the Registration Statement on Form S-4 of the Partnership, and certain publicly available financial information concerning Petro and the Partnership. In addition, Dain Rauscher Wessels reviewed certain internal analyses, forecasts and other internal information concerning the businesses and operations of Petro and the Partnership prepared by the respective senior managements of Petro and the Partnership. Dain Rauscher Wessels also met with the senior managements of Petro and the Partnership to discuss the businesses, operations and prospects of Petro and the Partnership. Dain Rauscher Wessels also considered certain long-term strategic benefits of the Merger, both operational and financial, that 110 were described to Dain Rauscher Wessels by the senior managements of Petro and the Partnership. Dain Rauscher Wessels reviewed the terms of the Transaction in relation to, among other things, current and historical market prices and trading volume for the Class A Common Stock and the Common Units; the respective companies' cash flow, net income and book value per share/unit; the capitalization and financial condition of Petro and the Partnership; the pro forma financial impact of the Merger on Petro and the Partnership, including the potential relative ownership of various classes of Units of the Partnership after the Merger by the current holders of Common Stock and the current unitholders of the Partnership; and, to the extent publicly available, the terms of recent merger and acquisition transactions involving comparable companies. In addition, Dain Rauscher Wessels reviewed the merger premiums paid in recent stock-for-stock acquisitions of public companies generally, and energy industry companies in particular. Dain Rauscher Wessels also analyzed certain financial, stock market and other publicly available information relating to the business of other companies and partnerships whose operations Dain Rauscher Wessels considered comparable to the respective operations of Petro and the Partnership. In addition to the foregoing, Dain Rauscher Wessels considered such other information, financial studies, analyses and investigations and financial, economic and market criteria as Dain Rauscher Wessels deemed relevant in arriving at the Dain Rauscher Wessels Opinion. In preparing the Dain Rauscher Wessels Opinion, Dain Rauscher Wessels did not independently verify any of the foregoing information, and relied upon such information being complete and accurate in all material respects. Dain Rauscher Wessels assumed, with Petro's consent, that the financial forecasts provided to Dain Rauscher Wessels and discussed with Dain Rauscher Wessels were reasonably prepared on a basis reflecting the best currently available estimates and judgments of the senior managements of Petro and the Partnership as to the respective expected future performance of Petro and the Partnership, and of the combined companies subsequent to the proposed Merger. In addition, Dain Rauscher Wessels did not conduct a physical inspection or make an independent evaluation or appraisal of the assets of Petro or the Partnership, nor was Dain Rauscher Wessels furnished with any such evaluation or appraisal. Dain Rauscher Wessels assumed that the Merger will be accounted for as a purchase transaction under generally accepted accounting principles, and will be a taxable event to the Public Common Stockholders. In rendering the Dain Rauscher Wessels Opinion, Dain Rauscher Wessels assumed that in the course of obtaining the necessary regulatory and governmental approvals for the proposed Merger, no restriction will be imposed that will have a material adverse effect on the contemplated benefits of the proposed Merger. Dain Rauscher Wessels also assumed that the final form of the Merger Agreement would be substantially similar to the last draft reviewed by Dain Rauscher Wessels. The Dain Rauscher Wessels Opinion is based on circumstances as they existed and could be evaluated on, and the information made available to Dain Rauscher Wessels, as of the date of the Dain Rauscher Wessels Opinion. For purposes of rendering the Dain Rauscher Wessels Opinion, Dain Rauscher Wessels assumed, in all respects material to its analyses, that the representations and warranties of each party to the Merger Agreement and all related documents and instruments contemplated thereby were true and correct in all material respects, that each party to such documents will perform all of the covenants and agreements required to be performed by such party under such documents, and that all conditions to the consummation of the Merger will be satisfied without waiver thereof. 111 The following is a brief summary of the material analyses performed by Dain Rauscher Wessels in connection with its preparation of the Dain Rauscher Wessels Opinion. Unit Reference Value Analysis Dain Rauscher Wessels performed a unit reference value analysis to determine ranges of reference values for the Common Units, Senior Subordinated Units and Junior Subordinated Units/ General Partner Units. In Dain Rauscher Wessels' judgment, such an analysis was required because the Senior Subordinated Units and Junior Subordinated Units/General Partner Units are newly-created classes of Units for which no prior market trading data exists. A range of reference values was calculated for the Common Units in order that they could be evaluated on a basis consistent with the other classes of Units. Moreover, the determination of reference values for the Senior Subordinated Units and Junior Subordinated Units/General Partner Units was required in order for Dain Rauscher Wessels to analyze the absolute and relative values of each class of unit, as well as to evaluate the aggregate value of the consideration being received by holders of Common Stock pursuant to the Merger. To determine a reference range of values for each class of unit, Dain Rauscher Wessels employed a discounted distribution model based upon Petro senior management's forecasts for the pro forma combined entity from the year ended September 30, 1998 through the year ended September 30, 2002, assuming 15-year weather ("15-Year Weather Case") and 30-year weather ("30-Year Weather Case"). Dain Rauscher Wessels also examined a case in which distributions per unit remained at $2.30 over the forecast period (the "Downside Case"), and a case in which distributions increased at a slower rate than in the 15-Year Weather Case and the 30-Year Weather Case (the "Dain Rauscher Wessels Case"). Factors examined included the Indicated Distributions (the Minimum Quarterly Distribution and other distributions of Available Cash from Operating Surplus); the additional Senior Subordinated Units to be issued based upon the performance of Petro; and the Incentive Distributions which are to be shared pro rata by the Senior Subordinated Units and Junior Subordinated Units/General Partner Units if distributions of Available Cash exceed Target Distribution Levels. Dain Rauscher Wessels discounted projected distributions for each class of Units to a net present value employing discount rates which, in Dain Rauscher Wessels' professional judgment, reflected (i) prevailing market yields for the Common Units and publicly-traded Units of other propane distribution master limited partnerships; (ii) the structural subordination of the various classes of Units; and (iii) the relative risks associated with the Indicated Distributions, the additional Senior Subordinated Units to be issued based upon the performance of Petro and the Incentive Distributions. For each class of unit, net present terminal values were calculated employing a perpetuity valuation based upon the discount rate employed for a given class of distribution and the amount of the projected distributions in the year ending September 30, 2002. To reflect the lack of marketability of the Junior Subordinated Units/ General Partner Units, Dain Rauscher Wessels considered a range of discounts and applied a discount of 22% to the net present values calculated for the Junior Subordinated Units/General Partner Units. Common Units. For the Common Units, discount rates of 9.0%-11.3% were applied to the projected Indicated Distributions. The calculated reference values for the Downside Case, 15-Year Weather Case, 30-Year Weather Case and Dain Rauscher Wessels Case were $20.75, $26.33, $31.55 and $22.54 per Common Unit, respectively. 112 Senior Subordinated Units. For the Senior Subordinated Units, discount rates of 9.8%-13.3% were applied to the projected Indicated Distributions, discount rates of 12.5%-14.3% were applied to the projected additional Senior Subordinated Units to be issued based upon the performance of Petro and discount rates of 13.0%-14.8% were applied to the projected Incentive Distributions. The calculated reference values for the Downside Case, 15-Year Weather Case, 30-Year Weather Case and Dain Rauscher Wessels Case were $17.74, $26.90, $35.62 and $22.76 per Senior Subordinated Unit, respectively. Junior Subordinated Units / General Partner Units. For the Junior Subordinated Units/General Partner Units, discount rates of 10.5%-14.3% were applied to the projected Indicated Distributions, discount rates of 12.5%-14.3% were applied to the projected additional Senior Subordinated Units to be issued based on the performance of Petro and discount rates of 13.0%-14.8% were applied to the projected Incentive Distributions. The calculated reference values for the Downside Case, 15-Year Weather Case, 30-Year Weather Case and Dain Rauscher Wessels Case were $12.91, $19.53, $26.16 and $16.67 per Junior Subordinated Unit/General Partner Unit, respectively. For purposes of performing its other analyses, Dain Rauscher Wessels employed the unit reference values implied by the Dain Rauscher Wessels Case as reference values for the subject Units. Dain Rauscher Wessels multiplied the exchange ratio of .13064 by the $22.76 reference value for the Senior Subordinated Units to calculate an implied merger value ("Implied Merger Value") of $2.97 per share of Common Stock held by the Public Common Stockholders. Dain Rauscher Wessels calculated that the $2.97 Implied Merger Value was comprised of the sum of net present values of $2.54 attributable to the Indicated Distributions and $0.43 attributable to the additional Senior Subordinated Units to be issued based on the performance of Petro and Incentive Distributions. Dain Rauscher Wessels also multiplied an exchange ratio of .15913 (the ratio of the number of Junior Subordinated Units/General Partner Units to be received by holders of Common Stock other than the Public Common Stockholders ("Affiliate Common Stockholders") to the number of shares of Common Stock to be exchanged by such holders) by the $16.67 reference value for the Junior Subordinated Units/General Partner Units to calculate an Implied Merger Value of $2.65 per share of Common Stock held by the Affiliated Common Stockholders. Dain Rauscher Wessels calculated that the $2.65 Implied Merger Value was comprised of the sum of net present values of $2.24 attributable to the Indicated Distributions and $0.41 attributable to the additional Senior Subordinated Units to be issued based on the performance of Petro and Incentive Distributions. Discounted Cash Flow Analysis Dain Rauscher Wessels performed a discounted cash flow analysis to calculate the implied price per share of Petro Common Stock based upon senior management's projections assuming 15-year weather and 30-year weather from June 30, 1998 through December 31, 2002, and no acquisitions. Using this information, Dain Rauscher Wessels calculated the net present value of Petro's unlevered free cash flows from June 30, 1998 through December 31, 2002 using discount rates ranging from 12.0% to 16.0%. Dain Rauscher Wessels also calculated the net present terminal value of Petro at December 31, 2002 based upon multiples of 6.5x to 8.5x EBITDA (earnings before interest, taxes, depreciation and amortization) in the year ending December 31, 2002, and discount rates ranging from 12.0% to 16.0%. Dain Rauscher Wessels employed the capital asset pricing model to determine 113 a weighted average cost of capital for Petro, and also employed its professional judgment in determining a range of discount rates for use in the analysis. The sum of the net present values of the free cash flows and terminal values, less outstanding debt and preferred stock (net of excess cash), yielded an implied net present value per share of Common Stock ranging from $(1.81) to $2.56. Inherent in any discounted cash flow analysis are the use of a number of assumptions, including the accuracy of management's projections, and the subjective determination of an appropriate terminal value and discount rate to apply to the projected cash flows of the entity under examination. Variations in any of these assumptions or judgments and variables beyond management's control, such as the general and regional economies, worldwide oil and gas prices, adverse weather conditions and the availability of personnel and equipment, could significantly alter the results of a discounted cash flow analysis. Relative Contribution Analysis Dain Rauscher Wessels performed a relative contribution analysis to examine the relationship between the percentage ownership of the Partnership that the Common Stockholders would receive pursuant to the Merger, and the relative contribution of Petro to the distributable cash flow of the Partnership on a pro forma combined basis. In considering the percentage ownership of the Partnership that the Common Stockholders would receive pursuant to the Merger, Dain Rauscher Wessels performed calculations on both a gross Units basis, treating all classes of Units as identical, as well as an adjusted Units basis, in which the number of Units to be received by the Common Stockholders was adjusted to reflect the different values of various classes of Units implied by Dain Rauscher Wessels' Unit Reference Value Analysis. In calculating the relative contributions of Petro and the Partnership to the distributable cash flow of the Partnership on a pro forma combined basis, Dain Rauscher Wessels considered that Petro, as the owner of Star Gas and all of the Partnership's outstanding subordinated units prior to the Merger, was the contributor of the distributable cash flow accruing to that ownership position. Based upon senior management's normalized estimates for fiscal 1998 for Petro and the Partnership, and the 15-Year Weather Case assumptions for the Partnership on a pro forma combined basis for fiscal 1999, Dain Rauscher Wessels calculated that Petro would provide 46.8% and 56.8% of the distributable cash flow of the Partnership on a pro forma combined basis in fiscal 1998 and 1999, respectively. Dain Rauscher Wessels determined that, pursuant to the Merger, the Common Stockholders would receive 48.6% of the ownership of the pro forma combined entity on a gross Units basis, and 47.5% on an adjusted Units basis. Dain Rauscher Wessels also noted that, based on the exchange ratio of .13064 and assuming that (i) the Minimum Quarterly Distribution is $0.575 following the Merger and (ii) the Minimum Quarterly Distribution is paid to holders of Senior Subordinated Units, the Public Common Stockholders who receive Senior Subordinated Units would receive an annual distribution of $0.30 for each share of Common Stock exchanged pursuant to the Merger. Dain Rauscher Wessels noted that Common Stock does not presently pay a dividend. Net Asset Value Analysis Dain Rauscher Wessels performed a net asset value analysis to examine values which might be realized by the Common Stockholders if Petro pursued orderly liquidations of its home heating oil 114 business and investment in the Partnership, and satisfied Petro's obligations to its creditors and preferred stockholders. For purposes of this analysis, Dain Rauscher Wessels selected six criteria for valuing Petro's home heating oil business: (i) the mean EBITDA multiple paid by Petro in its ten largest acquisitions of home heating oil businesses in 1996-1997, adjusted for a 10% size premium; (ii) the mean price per gallon of target annual volume paid by Petro in such acquisitions, adjusted for a 10% size premium; (iii) the mean price per target customer paid by Petro in such acquisitions, adjusted for a 10% size premium; (iv) the mean EBITDA multiple paid by the Partnership in its acquisitions of eleven propane retailers in 1994-1997, adjusted for a 10% size premium; (v) the mean EBITDA multiple paid in the Selected Transactions examined in Dain Rauscher Wessels' Comparable Transactions Analysis; and (vi) a growth rate-adjusted EBITDA multiple implied by an analysis of the public market multiples of companies engaged in consolidating fragmented industries. In each scenario, Dain Rauscher Wessels valued Petro's current investment in the Partnership by multiplying the number of subordinated Units and implied General Partner Units by the most recent Common Unit price, less a 15% discount to reflect structural subordination. Outstanding debt and preferred stock were assumed to be liquidated at par or liquidation value, plus applicable prepayment penalties, and the analysis further assumed $5.0 million of transaction costs. The values per share of Common Stock implied by these analyses ranged from $0.00 to $5.47, with a median of $1.04 and a mean of $1.64. Dain Rauscher Wessels applied its subjective professional judgment in comparing these values to the Implied Merger Value to be received pursuant to the Merger by the Public Common Stockholders. Comparable Company Trading Analysis Using publicly available information, Dain Rauscher Wessels compared, based upon market trading values as of September 25, 1998, multiples of certain financial criteria, including net income, EBITDA, EBIT (earnings before interest and taxes), Cash Flow from Operations (net income plus depreciation and amortization, deferred taxes and other non-cash items, but not including changes in working capital accounts), revenues and the tangible book value of equity of Petro to certain other companies which, in Dain Rauscher Wessels' judgment, were comparable to Petro for purposes of this analysis. Dain Rauscher Wessels noted that Petro is the only publicly-traded company engaged primarily in the distribution of home heating oil. Accordingly, Dain Rauscher Wessels selected for comparison companies engaged to varying degrees in the wholesale and retail marketing and distribution of energy and fuel. Other factors considered by Dain Rauscher Wessels in selecting companies for comparison included size, financial condition and geographic scope of operations. The group of companies used in the comparison included Adams Resources & Energy, Inc., Bay State Gas Company, Halstead Energy Corp., Meteor Industries, Inc., Midcoast Energy Resources, Inc., National Gas & Oil Company, Streicher Mobile Fueling, Inc., TransMontaigne Inc. and World Fuel Services Corporation. For the group of comparable energy and fuel marketing and distribution companies, the range, median and mean for equity market value as a multiple of each of the indicated statistics were as follows: (a) latest twelve months net income--7.6x to 47.4x, with a median of 13.8x and a mean of 20.8x; (b) latest twelve months Cash Flow from Operations--2.8x to 21.9x, with a median of 11.1x and a mean of 11.5x; and (c) tangible book value of common equity--0.3x to 2.5x, with a median of 1.7x and a mean of 1.6x. Net Market Capitalization (defined as equity market value plus the book 115 value of debt and preferred stock, less cash and equivalents in excess of a 1.0 working capital ratio) as a multiple of latest twelve months EBIT ranged from 5.6x-24.1x, with a median of 12.1x and a mean of 14.5x. Dain Rauscher Wessels was unable to calculate meaningful mathematical comparisons between these comparable company multiples and corresponding multiples for Petro because Petro (a) generated negative net income and Cash Flow from Operations for the latest twelve months ended June 30, 1998; (b) generated EBIT for the latest twelve months ended June 30, 1998 at a level which rendered the resultant multiple (478.1x) not meaningful in Dain Rauscher Wessels' judgment; and (c) had a net stockholders' deficiency at June 30, 1998. In addition, Dain Rauscher Wessels examined certain other market valuation criteria for which comparisons could be drawn. The comparable companies' Net Market Capitalization as a multiple of latest twelve months EBITDA ranged from 2.7x-19.7x, with a median of 10.7x and a mean of 11.2x, which compared to 9.8x for Petro. Net Market Capitalization as a multiple of latest twelve months revenues ranged from 0.2x-1.8x, with a median of 0.5x and a mean of 0.7x, which compared to 0.8x for Petro. Dain Rauscher Wessels applied its subjective professional judgment in evaluating Petro's results of operations for the twelve months ended June 30, 1998 in relation to the comparable company trading multiples. In addition, Dain Rauscher Wessels used publicly available information, based upon market trading values as of September 25, 1998, to compare certain financial criteria (including multiples of latest twelve months EBITDA and Cash Flow from Operations, distribution yields and debt to book capitalization ratios), among a group of propane distribution master limited partnerships which Dain Rauscher Wessels considered to be comparable to the Partnership. For purposes of analysis, this group was composed of Amerigas Partners, L.P., Cornerstone Propane Partners, L.P., Ferrellgas Partners, L.P., Heritage Propane Partners, L.P., National Propane Partners, L.P., and Suburban Propane Partners, L.P. Dain Rauscher Wessels calculated an Adjusted Equity Market Value for each propane distribution master limited partnership by valuing the common units of each limited partnership at market value, the subordinated units at 65% of the common unit market value, and the general partner units at 85% of the common unit market value. Dain Rauscher Wessels also calculated an Adjusted Market Capitalization for each limited partnership as the sum of Adjusted Equity Market Value plus the book value of debt, less cash and equivalents in excess of a 1.0 working capital ratio. For the group of propane distribution master limited partnerships, Adjusted Market Capitalization as a multiple of latest twelve months EBITDA ranged from 8.6x-14.0x, with a median of 10.2x and a mean of 10.5x, which compared to 11.9x for the Partnership. Adjusted Equity Market Value as a multiple of latest twelve months Cash Flow from Operations ranged from 7.4x-9.6x, with a median of 9.2x and a mean of 8.7x, which compared to 10.1x for the Partnership. Common unit distribution yields ranged from 8.7%-15.6%, with a median of 10.2% and a mean of 11.0%, which compared to 10.6% for the Partnership. The ratio of debt to book capitalization ranged from 46.3%-96.5%, with a median of 77.5% and a mean of 76.5%, which compared to 65.8% for the Partnership. The comparable company trading analysis is a valuation methodology used by Dain Rauscher Wessels to determine whether Petro and the Partnership were reasonably valued by the public trading market, at existing market prices, in relation to the public trading markets' valuation of similar companies and partnerships. Dain Rauscher Wessels did not establish any specific valuation for Petro or the Partnership in connection with this analysis. 116 No public company utilized as a comparison is identical to Petro, the Partnership or the business segment for which a comparison is being made. An analysis of the results of such a comparison is not mathematical; rather, it involves complex considerations and judgments concerning differences in financial and operating characteristics of the comparable companies and other factors that could affect the public trading value of the comparable companies to which Petro and the Partnership were being compared. Comparable Transactions Analysis Dain Rauscher Wessels conducted a comparable transactions analysis whereby it examined the terms of recent publicly disclosed acquisitions of businesses and assets related to the energy marketing and distribution industry. With respect to the significant majority of these transactions, public disclosure regarding purchase price and target financial results was insufficient to permit Dain Rauscher Wessels to draw conclusions regarding value. Sufficient data did exist with respect to ten transactions (the "Selected Transactions") which Dain Rauscher Wessels considered reasonably comparable to the Merger: (Acquisitor/Target) Valero Energy Corporation/Valero Natural Gas Partners, L.P.; Associated Natural Gas Corporation/Grand Valley Gas Company; K N Energy, Inc./American Oil & Gas Company; Panhandle Eastern Corp./Associated Natural Gas Corporation; Natural Gas Clearinghouse/Trident NGL Holding, Inc.; LG&E Energy Corporation/ Hadson Corporation; El Paso Natural Gas Company/Eastex Energy Inc.; PacifiCorp Holdings, Inc./TPC Corporation; Enron Corp./Enron Global Power & Pipelines, L.L.C.; and Kinder Morgan Energy Partners, L.P./ Santa Fe Pacific Pipeline Partners, L.P. For the Selected Transactions, total consideration paid for the equity of the target company as a multiple of target company net income ranged from 15.4x- 55.3x, with a median of 37.2x and a mean of 36.4x. Equity consideration as a multiple of the target company's tangible book value of equity ranged from 1.4x-4.3x, with a median of 2.5x and a mean of 2.8x. Total transaction value as a multiple of the target company's latest twelve months EBIT ranged from 10.9x- 23.3x, with a median of 16.7x and a mean of 17.1x. Dain Rauscher Wessels was unable to calculate meaningful mathematical comparisons between these comparable transactions multiples and the Implied Merger Value to be received pursuant to the Merger by the Public Common Stockholders because Petro (a) generated a net loss for the latest twelve months period ended June 30, 1998; (b) had a net tangible stockholders' deficiency at June 30, 1998; and (c) generated EBIT for the latest twelve months ended June 30, 1998 at a level which rendered the resultant multiple (515.4x) not meaningful in Dain Rauscher Wessels' judgment. For the Selected Transactions, total transaction value as a multiple of the target company's latest twelve months EBITDA ranged from 7.3x- 14.6x, with a median of 10.9x and a mean of 11.4x, which compared to 10.6x for Petro. Dain Rauscher Wessels applied its subjective professional judgment in evaluating the Implied Merger Value to be received pursuant to the Merger by the Public Common Stockholders in relation to Petro's results of operations for the latest twelve months period. Dain Rauscher Wessels also examined multiples paid by Petro in the acquisitions of retail distributors of home heating oil during 1996-1997. For all Petro acquisitions during such period (excluding the ten largest), transaction value as a multiple of target EBITDA ranged from 3.4x-4.9x, with a median of 3.9x and a mean of 4.1x. Transaction value per target gallon of annual volume 117 ranged from $0.37-$0.87, with a median of $0.55 and a mean of $0.55. Transaction value per target customer ranged from $334-$1,037, with a median of $533 and a mean of $630. To examine the effect of target size on transaction multiples, Dain Rauscher Wessels examined the acquisition multiples paid by Petro in the ten largest acquisitions in the 1996-1997 period. For this group of transactions, transaction value as a multiple of target EBITDA ranged from 3.4x-4.6x, with a median of 4.2x and a mean of 4.2x. Transaction value per target gallon of annual volume ranged from $0.58-$1.02, with a median of $0.89 and a mean of $0.84. Transaction value per target customer ranged from $658- $2,010, with a median of $1,055 and a mean of $1,194. Based upon the Implied Merger Values and certain assumptions regarding the value of Petro's current investment in the Partnership, Dain Rauscher Wessels calculated that the comparable multiples and values for Petro's home heating oil business implied in the Merger were 7.4x EBITDA, $0.87 per gallon and $994 per customer, assuming senior management normalized estimates for fiscal 1998. Dain Rauscher Wessels noted that Petro generally paid higher multiples and values in its larger acquisitions and that Petro's home heating oil business is significantly larger than any similar business acquired by Petro. Merger Premiums Analysis Dain Rauscher Wessels examined percentage premiums paid in all publicly- disclosed stock-for-stock transactions with transaction values of $100-$500 million since January 1, 1998. The analysis indicated median percentage premiums to the target company's stock price one day, one week and four weeks prior to announcement, of 20.2%, 30.2%, and 33.3%, respectively. Dain Rauscher Wessels also examined median percentage premiums paid in all publicly-disclosed stock-for-stock energy industry transactions with transaction values of $100- $500 million since January 1, 1994. This analysis indicated median percentage premiums to the target company's stock price one day, one week and four weeks prior to the announcement, of 13.7%, 17.6%, and 22.6%, respectively. Dain Rauscher Wessels calculated that the Implied Merger Value to be received pursuant to the Merger by the Public Common Stockholders of $2.97 represented premiums to the market price of the Class A Common Stock one day, one week and four weeks prior to announcement of 58.6%, 90.3%, and 64.1%, respectively. Dain Rauscher Wessels further calculated that the portion of the Implied Merger Value attributable to the net present value of the Indicated Distributions, or $2.54, represented premiums to the market price of the Class A Common Stock one day, one week and four weeks prior to announcement of 35.6%, 62.7% and 40.3%, respectively. Dain Rauscher Wessels' Engagement Agreement Dain Rauscher Wessels was retained to render the Dain Rauscher Wessels Opinion on the basis of Dain Rauscher Wessels' experience with mergers and acquisitions in the energy industry, and on the basis of Dain Rauscher Wessels' experience with energy industry master limited partnerships. Dain Rauscher Wessels is a nationally recognized investment banking firm and is regularly engaged in the valuation of businesses and their securities in connection with mergers and acquisitions, corporate restructurings, negotiated underwritings, secondary distributions of listed and unlisted securities, private placements and valuations for corporate and other purposes. In the ordinary course of its business, Dain Rauscher Wessels and its affiliates may actively trade the debt and equity securities of Petro and the Partnership for their own account and for the accounts of customers and, accordingly, may at any time hold a long or short position in such securities. 118 Pursuant to an engagement agreement between Petro and Dain Rauscher Wessels, Petro paid Dain Rauscher Wessels an engagement fee of $50,000 upon the execution of the engagement agreement and $375,000 upon the initial delivery of the written Dain Rauscher Wessels Opinion to the Petro Board. Petro has agreed to reimburse Dain Rauscher Wessels for its out-of-pocket expenses not to exceed $50,000, and to indemnify Dain Rauscher Wessels and its controlling persons against certain liabilities and expenses relating to or arising out of the consummation of the Transaction, including certain liabilities under U.S. federal securities laws. No portion of Dain Rauscher Wessels' fee was contingent upon the closing of the Transaction or whether Dain Rauscher Wessels rendered a favorable opinion with respect to the proposed Merger. The terms of Dain Rauscher Wessels' engagement agreement with Petro, which are customary for transactions of this nature, were negotiated at arm's length between Petro and Dain Rauscher Wessels, and the Petro Board was aware of such terms at the time of its approval of the Merger Agreement. CERTAIN PROJECTIONS OF PETRO AND THE PARTNERSHIP Petro and the Partnership provided A.G. Edwards and Dain Rauscher Wessels (the "Financial Advisors") with certain projected financial data for the years 1999 through 2003 (the "Projections"). The Projections were not prepared with a view to public disclosure or compliance with published guidelines of the Securities and Exchange Commission or the guidelines established by the American Institute of Certified Public Accountants regarding projections. The projections are included in this Proxy Statement only because they were made available to the Financial Advisors. These projections were prepared as of September 30, 1998. Neither the Financial Advisors nor KPMG Peat Marwick, LLP, the Partnership's independent certified public accountants, examined, compiled or applied any procedures with respect to the Projections or expressed any opinion or provided any kind of assurance thereon. None of the Financial Advisors, Petro, the Partnership, the Special Committee nor any of their respective affiliates or advisors assumes any responsibility for the reasonableness or completeness of the Projections. While presented with numerical specificity, the Projections are based on a variety of assumptions relating to the business of Petro and the Partnership that, although considered appropriate by Petro and the Partnership at the time, may not be realized. Moreover, the Projections and the assumptions upon which they are based are subject to significant uncertainties and contingencies, many of which are beyond the control of Petro and the Partnership. Consequently, the Projections and the underlying assumptions are necessarily speculative in nature and inherently imprecise, and there can be no assurance that projected financial results will be realized. It is expected that there will be differences between actual and projected results, and projected results and actual results are likely to vary materially from those shown, and such variance will likely increase over time. None of the Financial Advisors, Petro, the Partnership, the Special Committee nor any of their respective affiliates or advisors intends to update or otherwise revise the Projections. The inclusion of the Projections herein should not be regarded as an indication that the Financial Advisors, Petro, the Partnership, the Special Committee or any of their respective affiliates or advisors considers the Projections likely to be an accurate prediction of future results. Common Unitholders and Common Stockholders are cautioned not to place undue reliance on the Projections, which should be read in conjunction with the information relating to the business, assets and financial condition of the Partnership included herein. 119 The Projections contain forward-looking information and are subject to a number of risks discussed elsewhere in this Proxy Statement. See "Risk Factors." These risks are likely to cause actual results in the future to differ significantly from results expressed or implied in the Projections. The Projections described herein are the most recent versions of numerous projections provided to the Financial Advisors. Petro and the Partnership believe that discussion of earlier versions would not add materially to the information provided herein. Earlier versions have, however, been filed as an exhibit to the Registration Statement. Set forth below is a summary of the Projections prepared by Petro and the Partnership as of September 30, 1998 and provided to the Financial Advisors. Petro Projections on a Stand Alone Basis In order to develop projections for the fiscal years ending December 31, 1999-2003, Petro first began with formulating a revised 1998 budget (the "Normalized 1998 Budget"). The Normalized 1998 Budget made certain assumptions relating to revenues and delivery expenses based on volumes which would be associated with a "normal" winter. In addition, Petro gave full year impact in the Normalized 1998 Budget to $11 million in cost reduction initiatives implemented during 1998. These estimated annual cost reductions include $3.5 million for the elimination of corporate and branch overhead, $3.5 million for the rationalization of branch operating expenses and $4 million in reduced benefit plan, personnel and other operating expenses. For these purposes, Petro ran two cases assuming that "normal" weather ("Weather Normalization") was based on either (a) the historical average temperature of the relevant measurement statistics over the 15-year period from 1983 through 1997 derived from information published by the U.S. Department of Commerce-National Oceanic and Atmospheric Administration ("NOAA") (the "15-Year Case") or (b) the historical average temperature of the relevant measurement statistics as published by the NOAA over the 30-year period from 1961 through 1990 (the "30- Year Case"). The projections for the fiscal years ending December 31, 1999-2003 were based on the Normalized 1998 Budget adjusted for the following: (a) base customer attrition of 4.0% annually, (b) an increase in retail gross margins of $0.01 per gallon annually, (c) an increase in service revenues and expenses (net of the impact of attrition) of 2.0% annually, (d) an increase in net operating costs of 2.0% annually, and (e) no additional acquisitions due to capital constraints. 120 PETRO PROJECTIONS ON A STAND ALONE BASIS--30-YEAR CASE (IN THOUSANDS) PETRO PROJECTIONS ON A STAND ALONE BASIS--15-YEAR CASE (IN THOUSANDS)
FOR THE YEARS ENDING DECEMBER 31, ---------------------------------------------------------- 1998 1999 2000 2001 2002 2003 -------- -------- -------- -------- -------- -------- OPERATING INFORMATION Heating Oil EBITDA...... $ 46,900 $ 45,548 $ 43,867 $ 42,283 $ 40,766 $ 39,288 MLP Distributions(1).... 4,366 4,387 4,965 5,570 5,575 5,579 -------- -------- -------- -------- -------- -------- Total EBITDA............ 51,266 49,935 48,832 47,853 46,341 44,867 Depreciation and Amortization........... 28,710 23,500 19,500 15,500 11,500 8,000 -------- -------- -------- -------- -------- -------- EBIT.................... 22,556 26,435 29,332 32,353 34,841 36,867 Interest Expense........ (31,444) (30,971) (30,675) (28,749) (28,083) (28,035) -------- -------- -------- -------- -------- -------- Pre-Tax Income.......... (8,888) (4,536) (1,343) 3,604 6,758 8,832 Income Taxes............ (500) (500) (500) (500) (500) (500) Equity in Partnership Earnings............... 997 1,291 1,255 1,283 1,375 1,467 MLP Distributions....... (5,684) (4,387) (4,965) (5,570) (5,575) (5,579) -------- -------- -------- -------- -------- -------- Net Income(2)........... $(12,757) $ (8,132) $ (5,553) $ (1,183) $ 2,058 $ 4,220 ======== ======== ======== ======== ======== ======== OTHER INFORMATION Maintenance Capital Expenditures... $ 2,776 $ 3,000 $ 3,000 $ 3,000 $ 3,000 $ 3,000 Net Debt and Preferred Stock (3).............. 287,935 284,816 273,995 262,227 251,305 241,809 - -------- (1) MLP distributions in 1998 represent actual distributions received on the Units and General Partner interest owned by Petro; MLP distributions in 1999-2003 represent expected distributions based on the Partnership's Available Cash, which may be less than the full Minimum Quarterly Distribution. (2) Net Income includes Equity in Partnership Earnings but excludes MLP distributions. (3) Reflects total debt less net working capital plus preferred stock. 121
FOR THE YEARS ENDING DECEMBER 31, ---------------------------------------------------------- 1998 1999 2000 2001 2002 2003 -------- -------- -------- -------- -------- -------- OPERATING INFORMATION Heating Oil EBITDA...... $ 44,749 $ 43,392 $ 41,769 $ 40,237 $ 38,770 $ 37,342 MLP Distributions(1).... 4,366 2,739 2,941 3,220 3,527 3,861 -------- -------- -------- -------- -------- -------- Total EBITDA............ 49,115 46,131 44,710 43,457 42,297 41,203 Depreciation and Amortization........... 28,710 23,500 19,500 15,500 11,500 8,000 -------- -------- -------- -------- -------- -------- EBIT.................... 20,405 22,691 25,210 27,957 30,797 33,203 Interest Expense........ (31,444) (30,971) (30,675) (28,869) (29,283) (29,235) -------- -------- -------- -------- -------- -------- Pre-Tax Income.......... (11,039) (8,340) (5,465) (912) 1,514 3,968 Income Taxes............ (500) (500) (500) (500) (500) (500) Equity in Partnership Earnings............... 442 791 798 799 857 908 MLP Distributions....... (4,366) (2,739) (2,941) (3,220) (3,527) (3,861) -------- -------- -------- -------- -------- -------- Net Income(2)........... $(15,463) $(10,788) $ (8,108) $ (3,833) $ (1,656) $ 515 ======== ======== ======== ======== ======== ======== OTHER INFORMATION Maintenance Capital Expenditures........... $ 2,776 $ 3,000 $ 3,000 $ 3,000 $ 3,000 $ 3,000 Net Debt and Preferred Stock(3)............... 290,086 288,620 281,921 274,669 268,992 264,360 Partnership Projections on a Stand Alone Basis In order to develop projections for the fiscal years ending September 30, 1999-2003, the Partnership first began with formulating a revised 1998 budget (the "Normalized 1998 Budget"). The Normalized 1998 Budget made certain adjustments to revenues and expenses based on the expected increase in volumes which would be associated with a "normal" winter as well as acquisitions completed during fiscal 1998. For these purposes, the Partnership ran two cases assuming that "normal" weather ("Weather Normalization") was based on either (a) the historical average temperature of the relevant measurement statistics over the 15-year period from 1983 through 1997 derived from information published by the NOAA (the "15-Year Case") or (b) the historical average temperature of the relevant measurement statistics as published by the NOAA over the 30-year period from 1961 through 1990 (the "30-Year Case"). The Projections for the fiscal year ending September 30, 1999 through 2003 include the following additional assumptions: (a) $10.0 million of acquisitions are made annually, (b) the acquisitions are made at a purchase price of 6.5x the first year EBITDA of the acquired assets, (c) additional debt is incurred at an annual interest rate of 7.25%, (d) acquisitions are financed with debt and equity such that a pro forma debt to EBITDA ratio of 4.5x is maintained, (e) Common Units are issued at $22.00 per Unit and (f) maintenance capital expenditures on the acquired assets are assumed to be approximately 2.2 cents per retail gallon sold. PARTNERSHIP PROJECTIONS ON A STAND ALONE BASIS--30-YEAR CASE (IN THOUSANDS) 122
FOR THE YEARS ENDING DECEMBER 31, ---------------------------------------------------------- 1998 1999 2000 2001 2002 2003 -------- -------- -------- -------- -------- -------- OPERATING INFORMATION EBITDA.................. $ 23,722 $ 24,491 $ 26,029 $ 27,566 $ 29,104 $ 30,642 Depreciation and Amortization........... 12,079 12,358 13,346 14,224 14,938 15,662 -------- -------- -------- -------- -------- -------- EBIT.................... 11,643 12,133 12,683 13,342 14,166 14,980 Interest Expenses....... (8,498) (8,811) (9,377) (9,878) (10,380) (10,882) -------- -------- -------- -------- -------- -------- Pre-Tax Income.......... 3,145 3,322 3,306 3,464 3,786 4,098 Income Taxes............ (25) (25) (25) (25) (25) (25) -------- -------- -------- -------- -------- -------- Net Income.............. $ 3,120 $ 3,297 $ 3,281 $ 3,439 $ 3,761 $ 4,073 ======== ======== ======== ======== ======== ======== OTHER INFORMATION Maintenance Capital Expenditures........... $ 2,610 $ 2,632 $ 2,679 $ 2,728 $ 2,777 $ 2,827 Total Long Term Debt.... $105,000 $113,668 $120,587 $127,506 $134,425 $141,346 AVERAGE UNITS OUTSTAND- ING Common Units............ 3,859 3,925 4,083 4,253 4,395 4,505 Subordinated Units...... 2,396 2,396 2,396 2,396 2,396 2,396 Implied General Partner Units.................. 128 129 132 136 139 141 -------- -------- -------- -------- -------- -------- Total Units............. 6,383 6,450 6,611 6,785 6,930 7,042 ======== ======== ======== ======== ======== ======== PARTNERSHIP PROJECTIONS ON A STAND ALONE BASIS--15-YEAR CASE (IN THOUSANDS) Star Gas Projections Pro Forma for the Transaction The Partnership ran two cases of projections pro forma for the Transaction. The first case assumes that volumes reflect Weather Normalization based on the historical average temperature of the relevant measurement statistics over the 15-year period from 1983 through 1997 derived from information published by the NOAA (the "15-Year Case"). The second case reflects Weather Normalization based on the historical average temperature of the relevant measurement statistics as published by the NOAA over the 30-year period from 1961 through 1997 (the "30- Year Case"). The pro forma Projections for the fiscal years ended September 30, 1998 through 2003 include the following additional assumptions: (a) the specific terms of the merger as set forth in "The Transaction" included herein, (b) $120 million of new debt issued at 8.50%, (c) the redemption of $206.3 million in senior and subordinated notes, the redemption of $34.2 million in Preferred Stock, and the restructuring of $66.2 million of senior and subordinated notes, (d) issuance of approximately $140.0 million of new Common Units at $22.00 per Common Unit, (e) acquisitions are financed with debt and equity such that a debt to EBITDA ratio of up to 4.5x is maintained at all times, (f) Common Units are issued at annualized yields of 9.5% in 1999 and at 9.0% in 2000 and thereafter, (g) base and projected EBITDA, maintenance capital expenditures, acquisition and operating assumptions for both Petro and the Partnership are the same as previously defined in "Petro Projections on a Stand-Alone Basis" and "Partnership Projections on a Stand-Alone Basis", (h) annual operating synergies associated with the Transaction of $500,000 and (i) transaction expenses net of underwriting discounts and commissions of approximately $8.8 million. 123
FOR THE YEARS ENDING DECEMBER 31, ---------------------------------------------------------- 1998 1999 2000 2001 2002 2003 -------- -------- -------- -------- -------- -------- OPERATING INFORMATION EBITDA.................. $ 22,316 $ 23,032 $ 24,465 $ 25,898 $ 27,331 $ 28,764 Depreciation and Amortization........... 12,079 12,358 13,343 14,217 14,927 15,647 -------- -------- -------- -------- -------- -------- EBIT.................... 10,237 10,674 11,122 11,681 12,404 13,117 Interest Expenses....... (8,498) (8,574) (8,883) (9,351) (9,818) (10,286) -------- -------- -------- -------- -------- -------- Pre-Tax Income.......... 1,739 2,100 2,239 2,330 2,586 2,831 Income Taxes............ (25) (25) (25) (25) (25) (25) -------- -------- -------- -------- -------- -------- Net Income.............. $ 1,714 $ 2,075 $ 2,214 $ 2,305 $ 2,561 $ 2,806 ======== ======== ======== ======== ======== ======== OTHER INFORMATION Maintenance Capital Expenditures........... $ 2,610 $ 2,657 $ 2,705 $ 2,753 $ 2,803 $ 2,853 Total Long Term Debt.... $105,000 $107,104 $113,548 $119,994 $126,443 $132,891 AVERAGE UNITS OUTSTAND- ING Common Units............ 3,859 4,108 4,505 4,795 5,072 5,336 Subordinated Units...... 2,396 2,396 2,396 2,396 2,396 2,396 Implied General Partner Units.................. 128 133 141 147 152 158 -------- -------- -------- -------- -------- -------- Total Units............. 6,383 6,637 7,042 7,338 7,620 7,890 ======== ======== ======== ======== ======== ======== The pro forma Projections include the following assumptions regarding Petro's ability to make acquisitions: (a) $30.0 million of acquisitions are made annually under the 30-Year Case, and $25.0 million of acquisitions are made annually under the 15-Year Case, (b) acquisitions are made at a purchase price of 4.6x the first year EBITDA of the acquired assets, (c) customer attrition associated with acquisitions is 16.2% in year 1, 12.6% in year 2, 6.8% in year 3, and 6.1% in year 4 and thereafter. PARTNERSHIP PROJECTIONS PRO FORMA FOR TRANSACTION--30-YEAR CASE (IN THOUSANDS) 124
FOR THE YEARS ENDING SEPTEMBER 30, ---------------------------------------------------------- 1998 1999 2000 2001 2002 2003 -------- -------- -------- -------- -------- -------- OPERATING INCOME Propane EBITDA.......... $ 23,722 $ 24,491 $ 26,029 $ 27,566 $ 29,104 $ 30,642 Heating Oil EBITDA...... 46,900 48,881 53,535 57,814 61,900 65,791 Synergistic Savings..... 500 500 500 500 500 500 -------- -------- -------- -------- -------- -------- Pro Forma Combined EBITDA................. 71,122 73,872 80,064 85,880 91,504 96,933 Depreciation and Amorti- zation................. 36,097 37,922 41,537 45,047 48,398 51,764 -------- -------- -------- -------- -------- -------- EBIT.................... 35,025 35,950 38,527 40,833 43,106 45,169 Interest Expense........ (27,461) (28,699) (31,028) (33,172) (35,039) (36,842) -------- -------- -------- -------- -------- -------- Pre-Tax Income.......... 7,564 7,252 7,499 7,660 8,067 8,327 Income Taxes............ (525) (525) (625) (675) (725) (775) -------- -------- -------- -------- -------- -------- Net Income.............. $ 7,039 $ 6,727 $ 6,874 $ 6,985 $ 7,342 $ 7,552 ======== ======== ======== ======== ======== ======== OTHER INFORMATION Maintenance Capital Expenditures........... $ 6,110 $ 6,273 $ 6,393 $ 6,516 $ 6,641 $ 6,768 Total Long Term Debt.... $309,154 $342,861 $375,290 $401,458 $426,768 $451,199 AVERAGE UNITS OUTSTANDING Common Units............ 10,326 10,326 10,351 10,523 10,847 11,195 Senior Subordinated Units.................. 2,767 2,767 3,070 3,373 3,676 3,676 Junior Subordinated Units.................. 577 577 577 577 577 577 General Partner Units... 279 279 279 279 279 279 -------- -------- -------- -------- -------- -------- Total Units............. 13,949 13,949 14,277 14,752 15,379 15,727 ======== ======== ======== ======== ======== ======== PARTNERSHIP PROJECTIONS PRO FORMA FOR TRANSACTION--15-YEAR CASE (IN THOUSANDS) DESCRIPTION OF THE MERGER AGREEMENT The description of the Merger Agreement set forth below is qualified by reference to the Merger Agreement itself, which is attached for your review as Annex A. Under the terms of the Merger Agreement, Mergeco will be merged with and into Petro, with Petro surviving as an indirect wholly-owned subsidiary of the Partnership. THE EFFECTIVE TIME; CLOSING The Closing of the Merger shall occur after the day on which the last of the conditions to the Merger have been satisfied or waived (see "--Conditions to Consummation of the Merger" and "--Amendment, Waiver, Termination and Expenses") but in no event prior to February 15, 1999. The Merger shall become effective following the filing of (i) the Certificate of Merger with the Delaware Secretary of State and (ii) the Articles of Merger with the Minnesota Department of State (the "Effective Time"). MERGER CONSIDERATION In the Merger: (i) Each share of outstanding Common Stock held by a Public Common Holder immediately prior to the Effective Time shall be converted into the right to receive .13064 Senior Subordinated Units. 125
FOR THE YEARS ENDING SEPTEMBER 30, ---------------------------------------------------------- 1998 1999 2000 2001 2002 2003 -------- -------- -------- -------- -------- -------- OPERATING INCOME Propane EBITDA.......... $ 22,316 $ 23,032 $ 24,465 $ 25,898 $ 27,331 $ 28,764 Heating Oil EBITDA...... 44,749 46,094 49,605 52,823 55,897 58,821 Synergistic Savings..... 500 500 500 500 500 500 -------- -------- -------- -------- -------- -------- Pro Forma Combined EBITDA................. 67,565 69,626 74,570 79,221 83,728 88,085 Depreciation and Amorti- zation................. 36,097 37,723 40,938 44,047 46,997 49,962 -------- -------- -------- -------- -------- -------- EBIT.................... 31,468 31,903 33,632 35,174 36,731 38,123 Interest Expense........ (27,595) (28,068) (29,398) (30,984) (32,478) (33,924) -------- -------- -------- -------- -------- -------- Pre-Tax Income.......... 3,873 3,834 4,234 4,191 4,253 4,198 Income Taxes............ (525) (525) (525) (525) (525) (525) -------- -------- -------- -------- -------- -------- Net Income.............. $ 3,348 $ 3,309 $ 3,709 $ 3,666 $ 3,728 $ 3,673 ======== ======== ======== ======== ======== ======== OTHER INFORMATION Maintenance Capital Ex- penditures............. $ 6,110 $ 6,298 $ 6,419 $ 6,541 $ 6,667 $ 6,794 Total Long Term Debt.... $309,154 $325,470 $347,719 $368,650 $388,931 $408,537 AVERAGE UNITS OUTSTANDING Common Units............ 10,326 10,673 11,225 11,635 12,063 12,507 Senior Subordinated Units.................. 2,767 2,767 3,070 3,373 3,676 3,676 Junior Subordinated Units.................. 577 577 577 577 577 577 General Partner Units... 279 279 279 279 279 279 -------- -------- -------- -------- -------- -------- Total Units............. 13,949 14,296 15,151 15,864 16,595 17,039 ======== ======== ======== ======== ======== ======== (ii) Each share of outstanding Junior Preferred Stock shall be converted into the right to receive .13064 Common Units. (iii) Each share of outstanding Public Preferred Stock shall be converted into the right to receive $23 in cash plus accrued and unpaid dividends. (iv) Class B Shares shall remain unchanged. (v) Treasury Shares and shares held by Mergeco shall be cancelled for no consideration. NO FRACTIONAL UNITS No fractional Senior Subordinated Units or Common Units are to be issued in the Merger. In lieu thereof, (a) each former holder of Common Stock who would otherwise be entitled to receive a fractional Senior Subordinated Unit will receive an amount in cash, without interest, equal to the product (calculated to the nearest cent) obtained by multiplying such fraction by the closing price of the Senior Subordinated Units on the first day of trading thereof on the New York Stock Exchange, as reported in an authoritative source, and (b) each former holder of Junior Preferred Stock will receive an amount in cash, without interest, equal to the product (calculated to the nearest cent) obtained by multiplying such fraction by the average of the daily last sales prices of Common Units on the New York Stock Exchange, as reported in an authoritative source, for the five consecutive trading days ending on the second trading day preceding the Closing Date. No former holder is entitled to distributions or interest on, or other rights in respect of, any such fraction. Although it is not possible to quantify the aggregate amount to be paid with respect to fractional Units, the total amount is estimated to be less than $ . EXCHANGE OF PETRO STOCK CERTIFICATES FOR PARTNERSHIP UNITS OR CASH At or prior to the Effective Time, the Partnership will deposit, or cause to be deposited, with American Stock Transfer & Trust Company (the "Exchange Agent"), for the benefit of the holders of certificates formerly representing shares of Common Stock, Junior Preferred Stock and Public Preferred Stock ("Old Certificates"), (a) in respect of holders of Common Stock and Junior Preferred Stock, certificates representing Senior Subordinated Units and Common Units ("New Certificates") and an estimated amount of cash payable with respect to fractional Senior Subordinated Units and Common Units and (b) the amount of cash necessary to be distributed to the holders of certificates formerly representing Public Preferred Stock. For holders of Common Stock and Junior Preferred Stock: Promptly after the Effective Time, the Exchange Agent will mail transmittal materials to each holder of record of Common Stock and Junior Preferred Stock outstanding immediately prior to the Effective Time (other than Petro, Mergeco or dissenting Common Stockholders) for use by such Common Stockholder in exchanging Old Certificates for New Certificates. Upon submission to the Exchange Agent of Old Certificates from a former holder of Common Stock or Junior Preferred Stock, together with executed transmittal materials and any other items specified by the letter of transmittal, the Exchange Agent will deliver to such former holder New Certificates representing Senior Subordinated Units or Common Units, as appropriate, together with a check for payment of cash in lieu of any fractional Senior Subordinated Units or Common Units. 126 NOTE: COMMON STOCKHOLDERS SHOULD NOT SEND IN THEIR OLD CERTIFICATES UNTIL THEY RECEIVE TRANSMITTAL MATERIALS FROM THE EXCHANGE AGENT. For holders of Public Preferred Stock: Promptly after the Effective Time, the Exchange Agent will mail transmittal materials to each holder of Public Preferred Stock. Upon submission to the Exchange Agent of Old Certificates from a former holder of Public Preferred Stock, together with executed transmittal materials and any other items specified by the letter of transmittal, the Exchange Agent will deliver a check for the aggregate amount payable to such former holder of Public Preferred Stock. The Exchange Agent may impose reasonable and customary terms and conditions upon the acceptance of Old Certificates in order to effect an orderly exchange. Notwithstanding the foregoing, neither the Exchange Agent nor the Partnership, Mergeco or Petro shall be liable to any former Common Stockholder for any amount properly delivered to a public official pursuant to applicable abandoned property, escheat or similar laws. Holders of record of Common Stock and Junior Preferred Stock immediately prior to the Effective Time will thereafter be entitled, subject to compliance with the certificate exchange procedures, including submission of an executed Transfer Application, to receive distributions from the Partnership in respect of the number of Senior Subordinated Units or Common Units, as the case may be, into which their shares of Common Stock or Junior Preferred Stock have been converted. COVENANTS OF THE PARTNERSHIP AND PETRO Article IV of the Merger Agreement sets forth covenants of Petro and the Partnership, in effect until the Effective Time or until the Merger Agreement is terminated. Petro and the Partnership are required to conduct their business in the ordinary course consistent with past practice, to use reasonable best efforts to preserve their business organizations intact and to maintain their rights, franchises, goodwill and assets, keep available the services of their employees, and preserve their relationships with customers, suppliers and others. Certain Negative Covenants of Petro and the Partnership. Petro and the Partnership have agreed that, unless the prior written consent of the other party is obtained (which consent will not be unreasonably withheld or delayed) and except as expressly contemplated by the Merger Agreement, Petro and the Partnership will not, and will not permit their respective subsidiaries to: (i) Capital Stock. In the case of Petro, issue, sell or otherwise permit to become outstanding, or authorize the creation of, any additional shares of stock, or securities convertible into or exchangeable for shares of stock, or any rights to subscribe for or acquire any shares of stock, or enter into any agreement with respect to the foregoing, or permit any additional shares of stock to become subject to new grants of employee stock options, stock appreciation rights or similar stock-based employee rights, except pursuant to the exercise of stock options disclosed in the Merger Agreement or pursuant to the Petro dividend reinvestment program; (ii) Dividends, distributions. Make, declare or pay any dividends on any of its equity securities (except for regular quarterly dividends on Public Preferred Stock and Private Preferred Stock and regular quarterly distributions of Available Cash on Common Units, Subordinated 127 Units and the general partner interest of the Partnership), split, combine or reclassify any capital stock or issue or authorize or propose the issuance of any other securities in respect of, in lieu of, or in substitution for shares of capital stock, or repurchase, redeem or otherwise acquire any shares of capital stock, except as required by the terms of its securities outstanding on the date of the Merger Agreement or as contemplated by an existing employee benefit plan; (iii) Compensation, Employment Agreements. Enter into or amend any written employment, severance or similar agreements or arrangements with any of its directors, officers or employees, or grant any salary or wage increase or increase any employee benefit (including incentive or bonus payments), except for (a) normal increases in compensation to employees (other than officers and directors) or (b) such other changes as are provided for in the Merger Agreement, as may be required by law or to satisfy contractual obligations existing as of the date of the Merger Agreement or (c) additional grants or awards to newly hired employees consistent with past practice; (iv) Benefit Plans. In the case of Petro, enter into or amend any pension, retirement, stock option, stock purchase, savings, profit sharing, deferred compensation, consulting, bonus, group insurance or other employee benefit, incentive or welfare contract, plan or arrangement, or any trust agreement related thereto, in respect of any directors, officers or other employees, including, without limitation, taking any action that accelerates the vesting or exercise of any benefits payable thereunder; (v) Acquisitions and Dispositions. In the case of Petro, sell, lease, dispose of, or discontinue, any portion of its assets, business or properties material to it and its subsidiaries, or acquire or lease (other than by way of foreclosure or acquisition of control in a bona fide fiduciary capacity or in satisfaction of debts previously contracted in good faith, in each case in the ordinary course of business consistent with past practice) any assets or all or any portion of the business or property of any other entity that, in either case, would be likely to have a material adverse effect on the ability of the parties to the Merger Agreement to consummate the Merger or that would materially delay the Effective Time; (vi) Amendments. In the case of Petro, amend its Articles of Incorporation or By-laws; (vii) Accounting Methods. Implement or adopt any changes in accounting principles, practices or methods, other than as may be required by law or by generally accepted accounting principles; (viii) Insurance. Fail to use reasonable best efforts to maintain, with financially responsible insurance companies, insurance in such amounts and against such risks and losses as has been customarily maintained by it in the past; (ix) Notification. Fail to promptly notify the other party of any material change in its condition (financial or otherwise) or business, any material litigation, governmental proceedings or the breach in a material respect of any of its representations or warranties contained in the Merger Agreement; (x) Taxes. Make or rescind any material express or deemed election relating to taxes, unless it is not reasonable to expect that such action will not materially adversely affect it; settle or compromise any material tax claim, litigation, proceeding investigation or audit, except where 128 such settlement or compromise will not materially adversely affect it; or change in any material respect any of its methods of reporting income or deductions for federal income tax purposes from those employed in the preparation of its federal income tax return for the most recent taxable year for which a return has been filed, except as may be required by applicable law or except for changes that it is not reasonable to expect will materially adversely affect it; (xi) Debt, Capital Expenditures. In the case of Petro, except for its obligation to use reasonable best efforts to accomplish the Refinancing Conditions (as defined), (a) incur any indebtedness for borrowed money (except for working capital under existing credit facilities) or guarantee any such indebtedness of others, (b) enter into any material lease (whether operating or capital), (c) create any material mortgages, liens, security interests or other encumbrances on its property in connection with any pre- existing indebtedness, new indebtedness or lease, or (d) make or commit to make aggregate capital expenditures in excess of $2.0 million over Petro's fiscal 1998 capital expenditure budget; (xii) No Dissolution. Authorize, recommend, propose or announce its intention to adopt a plan of complete or partial liquidation or dissolution; (xiii) Adverse Actions. Knowingly take any action that is intended or is reasonably likely to result in (a) any representations and warranties set forth in the Merger Agreement being or becoming untrue in any material respect at any time prior to the Closing, (b) any of the conditions to the consummation of the Merger set forth in the Merger Agreement not being satisfied, or (c) a material violation of any provision of the Merger Agreement, except, in each case, as may be required by applicable law; (xiv) Agreements. Agree or commit to do anything prohibited by the covenants in the Merger Agreement. REPRESENTATIONS AND WARRANTIES Article V of the Merger Agreement sets forth representations and warranties of the parties, which will terminate immediately after the Effective Time. Pursuant to Section 5.2, with certain exceptions, no representation or warranty of Petro or the Partnership shall be deemed untrue or incorrect, and no party shall be deemed to have committed a breach of representation or warranty, as a consequence of the existence of any fact, circumstance or event, unless such fact, circumstance or event, individually or taken together with all other facts, circumstances or events has had or is reasonably expected to have a Material Adverse Effect (as defined). Petro and the Partnership have made certain representations and warranties as to themselves and their subsidiaries with respect to, among other things: (i) corporate organization or partnership formation, existence, qualifications to do business, permits and authorizations; (ii) capitalization; (iii) subsidiaries and other equity interests; (iv) corporate or partnership power and authority to own its assets, conduct its business and to execute, deliver and perform its obligations under the Merger Agreement; (v) authority of the equityholders to agree to the Merger Agreement, binding nature of the Merger Agreement, and authorization of the Merger Agreement by all necessary corporate action (other than by action of Common Stockholders and Common Unitholders, not yet voted upon); (vi) that execution of the Merger Agreement will not constitute a default under any agreement or 129 judgment; (vii) financial statements and related filings with the Securities Exchange Commission; (viii) absence of undisclosed litigation, claims, proceedings, judgments, orders and decrees;(ix) compliance with applicable laws; (x) absence of undisclosed contracts and defaults under contracts; (xi) absence of undisclosed brokerage or finders' fee claims in connection with the Merger Agreement; (xii) employee compensation and benefit plans and related matters; (xiii) labor matters; (xiv) absence of violations or liabilities under environmental laws; (xv) filing of material tax returns and the payment or provision for payment of all taxes shown to be due on such returns; (xvi) absence of any necessary regulatory approvals as to the Merger, other than pursuant to the HSRA; (xvii) the conduct of business, and the absence of certain materially adverse changes, since December 31, 1997 in the case of Petro, and since September 30, 1997 in the case of the Partnership; (xviii) certain insurance matters; and (xix) the condition and sufficiency of certain tangible assets; and (xx) the ownership and adequacy of certain intellectual property rights. Indemnification of Officers and Directors. The Merger Agreement provides that if an actual or threatened claim, suit, proceeding or investigation in which any person who is, has been at any time prior to the date of the Merger Agreement, or who becomes prior to the Closing under the Merger Agreement, a director, officer or employee of Petro or any of its subsidiaries, including directors of Star Gas (each an "Indemnified Party"), is, or is threatened to be, made a party, based wholly or partially on (i) the fact that he/she is or was a director, officer or employee of Petro or any of its subsidiaries or was prior to the Closing serving at the request of any such party as a director, officer, employee, fiduciary or agent of another entity or enterprise, or (ii) the Merger Agreement or any of the transactions contemplated thereby and all actions taken by an Indemnified Party in connection therewith, whether, in any case, asserted or arising before or after the Closing (each, a "Claim"), the Indemnified Party will cooperate and use his or her best efforts to defend against and respond to any such Claim. In addition, the Partnership has agreed that following the Closing, it will indemnify and hold harmless each Indemnified Party against losses, damages, liabilities, judgments, fines and amounts paid in settlement of any Claim and expenses (including reasonable attorneys' fees and expenses to be paid to each Indemnified Party in advance of the final disposition of a Claim) upon receipt of an undertaking from such Indemnified Party to repay advanced expenses if it is finally determined that such Indemnified Party was not entitled to such indemnification. The Partnership's indemnification obligation continues in effect for a period of six years from the Closing; provided that all rights to indemnification in respect of a Claim asserted or made within such six year period continue until the final disposition of such Claim. The Partnership has also agreed that all rights to indemnification and all limitations of liability existing in favor of an Indemnified Party under the articles of incorporation or by-laws of Petro and its subsidiaries, as in effect on the date of the Merger Agreement, as to matters occurring on or prior to the Closing, will survive the Merger and will continue in effect for a period of six years from the Closing; provided that all rights to indemnification in respect of any Claim asserted or made within such period continue until the final disposition of the Claim. The Partnership has agreed to use its best efforts to cause persons serving as officers and directors of Petro and the General Partner immediately prior to the Closing to be covered for a period of six years from the Closing by the directors' and officers' liability insurance policy maintained by Petro with respect to acts or omissions of such officers and directors in their capacity as such, 130 occurring prior to the Closing, provided that the Partnership will not be required to pay premiums in excess of last annual premium paid by Petro prior to the date of the Merger Agreement, but, in such case, will buy as much coverage as is reasonably practicable for such amount. CONDITIONS TO CONSUMMATION OF THE MERGER Conditions to Each Party's Obligations. Article VII of the Merger Agreement provides that the obligation of each of Petro and the Partnership to consummate the Merger is conditioned upon the accuracy of the other party's representations and warranties and the compliance of the other party with its covenants and the satisfaction at or prior to the Closing of, among other things, the following conditions: (i) Unitholder and Stockholder Vote. Approvals of the Acquisition Proposal by the requisite vote of the Common Stockholders and the Star Proposals by the requisite vote of the Common Unitholders; (ii) Governmental Approvals. Any waiting period under the HSRA shall have expired or terminated and all other filings required to be made prior to the Effective Time with, and all other approvals required to be obtained prior to the Effective Time from, any governmental authority in connection with the execution and delivery of the Merger Agreement shall have been made or obtained, except where the failure to obtain any such approvals would not be reasonably likely to result in a Material Adverse Effect (as defined) on the Partnership or Petro or on the ability of the Partnership or Petro to consummate the transactions contemplated by the Merger Agreement; (iii) No Injunction. No order, decree or injunction of any court or agency of competent jurisdiction shall be in effect, no law or regulation shall have been enacted or adopted which prohibits, enjoins or makes illegal the consummation of any of the transactions contemplated by the Merger Agreement, and no action, proceeding or investigation by any governmental authority with respect to the Merger shall be pending that seeks to enjoin or delay consummation of the Merger or to impose any material restrictions or requirements thereon or on the Partnership or Petro with respect thereto; provided, however, that prior to invoking this condition, each party shall have complied fully with its obligations under the Merger Agreement relating to defending any litigation seeking to enjoin the Merger; (iv) Effective Merger Registration Statement. The registration statement pertaining to the Merger shall have become effective and no stop order and no proceedings for that purpose shall have been initiated or threatened by the Securities Exchange Commission or any other governmental authority; (v) Legal Opinions. The Partnership and Petro will have received (a) an opinion, as to certain limited partnership and tax matters, from Andrews & Kurth L.L.P., special counsel to the Partnership, and (b) an opinion, as to certain corporate matters, from Phillips Nizer Benjamin Krim & Ballon LLP, counsel to Petro; (vi) NYSE Listing. The Senior Subordinated Units and the Common Units issuable in the Merger shall have been approved for listing on the New York Stock Exchange, subject to official notice of issuance; 131 (vii) Fairness Opinion. In the case of the Partnership, the A.G. Edwards Opinion shall not have been withdrawn, and in the case of Petro, the Dain Rauscher Wessels Opinion shall not have been withdrawn; (viii) Public Offerings. The Equity Offering and the Debt Offering shall have been consummated, with a Cost of Capital (as defined in the Merger Agreement) not to exceed $27.5 million on an annual basis, the Special Committee shall not have reasonably objected to the restrictive covenants pertaining to the Petro Holdings Senior Subordinated Debt, and the net proceeds shall be applied to reduce indebtedness; (ix) Refinancing Conditions. Certain conditions with respect to refinancing of debt, cash balances and working capital shall have been met; (x) Dissenters' Rights. The number of shares of Common Stock held by dissenting Common Stockholders shall not exceed 10% of the number of shares of Common Stock outstanding immediately prior to the Effective Time; (xi) Working Capital Loan. Petro shall have entered into a working capital credit facility of not less than $30 million on terms reasonably satisfactory to the Special Committee; (xii) Custody Agreement. All of the members of the Tax Free Group shall have executed a custody agreement (with respect to their shares of Common Stock) on or prior to December 31, 1998. AMENDMENT, WAIVER, TERMINATION AND EXPENSES Amendment and Waiver. The Merger Agreement provides that prior to the Closing, any provision of the Merger Agreement may be (i) waived by the party benefitted by that provision or (ii) modified or amended at any time by a written agreement of Petro and the Partnership if approved by the Petro Board and the Special Committee. The Merger Agreement also provides that prior to submission of the Merger Agreement for approval at the Special Meeting, the Partnership may change the method of effecting the combination of Petro with the Partnership, and Petro has agreed that the Petro Board will approve any amendments to the Merger Agreement resulting from any such action by the Partnership, provided that no such change (x) alters or changes the amount or kind of consideration to be issued to Common Stockholders as provided for in the Merger Agreement (the "Merger Consideration"), or (y) alters the tax treatment of Common Stockholders as a result of receiving the Merger Consideration beyond that which was originally contemplated by the Merger Agreement, or (z) materially impedes or delays consummation of the Merger. Termination. The Merger Agreement may be terminated, and the Merger abandoned, at any time prior to the Effective Time, whether prior to or after approval of the Merger by the Common Unitholders or the Common Stockholders: (a) by the mutual consent of Petro and the Partnership, if the Petro Board and the Special Committee so determine; (b) by the Partnership, if the Special Committee so determines, or by Petro, if the Petro Board so determines, in the event of a material breach by the other party of any representation, 132 warranty or covenant contained in the Merger Agreement that is not cured or curable in the prescribed time; (c) by the Partnership, if the Special Committee so determines, or the Petro Board, if the Petro Board so determines, in the event (i) the approval under the HSRA required for consummation of the Merger shall have been denied by final action of any governmental authority or a court or other governmental authority shall have issued a final order enjoining or otherwise prohibiting the consummation of the Merger, provided that the terminating party shall have observed and performed its covenants contained in the Merger Agreement; or (ii) Common Stockholders fail to approve the Acquisition Proposal at the Special Meeting or the Common Unitholders fail to approve the Star Proposals at the Unitholders Meeting; or (d) by the Partnership, if the Petro Board has, or by Petro, if the Star Gas Board has, withdrawn, modified or changed in a manner adverse to the terminating party its approval or recommendation of the Merger Agreement and the transactions contemplated thereby. Furthermore, the Merger Agreement shall be terminated if the Merger shall not have been consummated on or prior to April 1, 1999 unless the Special Committee and Petro elect to extend such termination date. In the event of termination of the Merger Agreement and the abandonment of the Merger pursuant to the foregoing provisions, neither Petro nor the Partnership will have any liability or further obligation to any other party under the Merger Agreement, except that termination will not relieve a breaching party from liability for any wilful breach of the Merger Agreement giving rise to such termination. Expenses. Petro will bear all expenses incurred in connection with the Merger Agreement and the transactions contemplated thereby. RESTRICTIONS ON RESALES BY AFFILIATES The Common Units and Senior Subordinated Units issuable to Common Stockholders upon consummation of the Transaction have been registered under the Securities Act and may be traded freely without restriction on those Common Stockholders who are not deemed to be "affiliates" (as defined in the rules promulgated under the Securities Act) of the Partnership or Petro. Common Units and Senior Subordinated Units received by those Common Stockholders who are deemed to be affiliates of the Partnership or Petro at the time of the Meetings may be resold without registration under the Securities Act only as permitted by Rule 145 under the Securities Act or as otherwise permitted thereunder. Common Units and Senior Subordinated Units received by persons who are deemed to be "affiliates" of the Partnership may be sold by them only in transactions permitted under the provisions of Rule 144 under the Securities Act, or as otherwise permitted under the Securities Act. SELLING UNITHOLDERS The Registration Statement of which this Proxy Statement forms a part also covers the reoffering and resale (collectively, the "Offering") by the following persons (the "Selling 133 Unitholders") who may be deemed to be "affiliates" of Petro within the meaning of Rule 145 of the following Senior Subordinated Units (the "Resale Units") to be received by the Selling Unitholders in connection with the Transaction. The Partnership will not receive any proceeds from the sale of the Resale Units by the Selling Unitholders. - -------- (1) Assumes all Senior Subordinated Units offered herewith are sold by each Selling Unitholder. PLAN OF DISTRIBUTION The Selling Unitholders may from time to time sell all or a portion of their Resale Units in transactions on the NYSE, in the over-the-counter market, in negotiated transactions, pursuant to Rule 144 or otherwise, at prices then prevailing or related to the then current market price or at negotiated prices. The Resale Units may be sold directly or through brokers or dealers or in a distribution by one or more underwriters on a firm commitment or best efforts basis. The methods by which the Resale Units may be sold include (i) a block trade (which may involve crosses) in which the broker dealer or dealer engaged will attempt to sell the Resale Units as agent but may position and resell a portion of the block as principal to facilitate the transaction, (ii) purchases by a broker or dealer as principal and resales by such broker dealer for its account pursuant to this Proxy Statement, (iii) ordinary brokerage transactions and transactions in which the broker solicits purchasers or to or through marketmakers, (iv) transactions in put or call options or other rights (whether exchange-listed or otherwise) established after the effectiveness of the Registration Statement of which this Proxy Statement is a part and (v) privately negotiated transactions. In addition, any of the Resale Units that qualify for sale pursuant to Rule 145 under the Securities Act may be sold in transactions complying with such Rule, rather than pursuant to this Proxy Statement. In the case of the sale of the Resale Units effected to or through broker- dealers, such broker-dealers may receive compensation in the form of discounts, concessions or commissions from the Selling Unitholders or the purchasers of the Resale Units sold by or through such broker-dealers, or both. The Partnership is not aware as of the date of this Proxy Statement of any agreements between any of the Selling Unitholders and any broker-dealers with respect to the sale of the Resale Units. The Selling Unitholders and any broker-dealers or agents participating in the distribution of the 134
NUMBER OF SENIOR MAXIMUM NUMBER NUMBER OF SENIOR SUBORDINATED UNITS OF SENIOR SUBORDINATED UNITS OWNED BEFORE SUBORDINATED UNITS TO TO BE OWNED AFTER SELLING UNITHOLDER THE OFFERING BE SOLD IN THE OFFERING THE OFFERING ------------------ ------------------ ----------------------- ------------------ Phillip Cohen........... 103,556 103,556 -- Thomas Edelman.......... 102,203 102,203 -- Richard O'Connell....... 186,972 186,972 -- Brentwood Corp. ........ 104,885 104,885 -- Gabes S.A. ............. 94,313 94,313 -- Minneford Corp. ........ 11,188 11,188 -- Fernando Montero........ 4,610 4,610 -- M.M. Warburg & Co. ..... 4,155 4,155 -- Barcel Corp. ........... 98,814 98,814 -- Hubertus Langen......... 96,740 96,740 -- Tortosa GmbH............ 39,024 39,024 -- Paul Biddelman.......... 311 311 -- United Capital Corp. ... 11,758 11,758 -- Resale Units may be deemed to be "underwriters" within the meaning of the Securities Act and any commissions received by any such broker-dealers or agents and profits on any resale of the Resale Units may be deemed to be underwriting commissions under the Securities Act. The commissions received by a broker-dealer or agent may be in excess of customary compensation. The Partnership will receive no part of the proceeds from the sale of any of the shares of the Resale Units by the Selling Unitholders. The Partnership will pay all costs and expenses incurred in connection with the registration under the Securities Act of the Resale Units offered by the Selling Unitholders, including without limitation all registration and filing fees, listing fees, printing expenses, fees and disbursements of counsel and accountants for the Partnership. Each Selling Unitholder will pay all brokerage fees and commissions, if any, incurred in connection with the sale of the Resale Units owned by him. In addition, the Partnership has agreed to indemnify the Selling Unitholders against certain liabilities, including liabilities under the Securities Act. ACCOUNTING TREATMENT The parties anticipate that the Transaction will be accounted for as a purchase for accounting purposes. See "Selected Unaudited Combined Pro Forma Financial Information." REGULATORY MATTERS Other than (a) the filing of notice of the proposed Transaction with the United States Department of Justice and the Federal Trade Commission under the HSRA, and the lapse of the relevant waiting period prescribed thereunder; (b) registration under the Securities Act of the Senior Subordinated Units and the Common Units to be issued in the Transaction and the Common Units to be offered in the Equity Offering; (c) certain notifications required to be given by Petro to state and county authorities pursuant to provisions of certain licenses and permits, and (d) certain tax filings, no filing with, or approval of any federal or state governmental entity is required in connection with the Transaction. 135 MANAGEMENT OF THE PARTNERSHIP AFTER THE TRANSACTION GENERAL PARTNER At the Effective Time, the general partner of the Partnership and the Operating Partnership will be Star Gas LLC. The membership interests in Star Gas LLC are owned by the LLC Owners. The officers of Star Gas LLC will be Irik P. Sevin, Chairman of the Board and Chief Executive; Joseph Cavanaugh, Executive Vice President--Propane and Member of the Office of President; William G. Powers, Jr., Executive Vice President--Heating Oil and Member of the Office of President; George Leibowitz, Treasurer; Richard F. Ambury, Vice President; James Bottiglieri, Vice President; and Audrey L. Sevin, Secretary. The General Partner manages and operates the activities of the Partnership. Unitholders do not directly or indirectly participate in the management or operation of the Partnership. The General Partner owes a fiduciary duty to the Unitholders. See "Conflicts of Interest and Fiduciary Responsibility." Notwithstanding any limitation on obligations or duties, the General Partner is liable, as the general partner of the Partnership, for all debts of the Partnership (to the extent not paid by the Partnership), except to the extent that indebtedness or other obligations incurred by the Partnership are made specifically non-recourse to the general partner. In addition, if the Operating Partnership defaults under the First Mortgage Notes or the Bank Credit Facilities, the General Partner will be liable for any deficiency remaining after foreclosure on the Operating Partnership's assets. BOARD OF DIRECTORS OF STAR GAS LLC At the Effective Time, it is expected that the Star Gas LLC Board will consist of the following persons, all of whom currently serve as directors of Star Gas: Irik P. Sevin (Chairman of the Board), Audrey L. Sevin, William G. Powers, Jr., Thomas J. Edelman, Paul Biddelman, Wolfgang Traber, and William P. Nicoletti. At her request, one of the current directors of Star Gas will withdraw as a director upon consummation of the Transaction as a result of additional duties associated with a new job. That director will be replaced by a director selected by the Star Gas LLC Board, and the new director will not be an officer or employee of Star Gas LLC or any of its affiliates. William P. Nicoletti and an independent director to be selected by the Star Gas LLC Board, who are neither officers nor employees of any affiliates of the General Partner, will serve on the Audit Committee of the Star Gas LLC Board with the authority to review, at the request of the General Partner, specific matters as to which the General Partner believes there 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 the Partnership. Any matters approved by the Audit Committee will be conclusively deemed to be fair and reasonable to the Partnership, approved by all partners of the Partnership and not a breach by the General Partner of any duties it may owe the Partnership or the Unitholders. In addition, the Audit Committee reviews external financial reporting of the Partnership, recommends engagement of the Partnership's independent accountants and reviews the Partnership's procedure for internal auditing and the adequacy of the Partnership's internal accounting controls. With respect to such additional matters, the Audit Committee may act on its own initiative to question the General Partner and, absent the delegation of specific authority by the entire Board of Directors, its recommendations with regard thereto will be advisory. 136 OFFICERS AND EMPLOYEES OF THE OPERATING PARTNERSHIP AND PETRO Operating Partnership. At the Effective Time, the officers and employees of Star Gas who currently manage the operations and business of the Partnership will become officers and employees of the Operating Partnership. It is expected that the following persons who currently comprise Star Gas' executive officers will continue to serve as executive officers of the Operating Partnership: Irik P. Sevin, Chairman of the Board; Joseph P. Cavanaugh, President and Chief Executive Officer; David R. Eastin, Vice President-Operations; Richard F. Ambury, Vice President-Finance; and Audrey L. Sevin, Secretary. Certain information relating to executive compensation, various benefit plans (including unit option plans), voting securities and the principal holders thereof, certain relationships and related transactions and other related matters as to the Partnership and Star Gas is incorporated by reference or set forth in the Partnership's Annual Report on Form 10-K for the fiscal year ended September 30, 1997, and is incorporated herein by reference. Securityholders of the Partnership or Petro desiring copies of such documents may contact the Partnership at its address or telephone number indicated under "Where You Can Find More Information." Petro. At the Effective Time, the officers and employees of Petro will continue to be employed by Petro. It is expected that the following persons who currently comprise Petro's executive officers will continue to serve as executive officers of Petro: Irik P. Sevin, Chairman of the Board and Chief Executive Officer; William G. Powers, Jr., President; C. Justin McCarthy, Senior Vice President-Operations; Audrey L. Sevin, Secretary; George Leibowitz, Treasurer; Vincent De Palma, Vice President and General Manager-New York Region; James J. Bottiglieri, Controller; Matthew J. Ryan, Vice President-Supply; Angelo Catania, Vice President and General Manager-Mid Atlantic Region; John Ryan, Vice-President-Sales and Marketing; and Peter B. Terenzio, Jr., Vice President-Human Resources. Certain information relating to executive compensation, various benefit plans (including stock option plans), voting securities and the principal holders thereof, certain relationships and related transactions and other related matters as to Petro is set forth in Petro's Annual Report on Form 10-K for the year ended December 31, 1997, and is incorporated herein by reference. Securityholders of the Partnership or Petro desiring copies of such documents may contact Petro at its address or telephone number indicated under "Where You Can Find More Information." REIMBURSEMENT OF EXPENSES OF THE GENERAL PARTNER The General Partner does not receive any management fee or other compensation in connection with its management of the Partnership. The General Partner is reimbursed at cost for all expenses incurred on behalf of the Partnership, including the costs of compensation described herein properly allocable to the Partnership. The Partnership Agreement provides that the General Partner shall determine the expenses that are allocable to the Partnership in any reasonable manner determined by the General Partner in its sole discretion. 137 The General Partner will be entitled to distributions on its General Partner Units and will be entitled to Incentive Distributions in respect of such Units, as described under "Cash Distribution Policy." BENEFICIAL OWNERSHIP OF PRINCIPAL UNITHOLDERS AND MANAGEMENT The following table sets forth the beneficial ownership (as of the Record Date) of Common Units, Senior Subordinated Units, Junior Subordinated Units and General Partner Units after giving effect to the Transaction by (i) Star Gas LLC and certain beneficial owners and all of the directors of Star Gas LLC, (ii) each of the named executive officers of Star Gas and Petro, and (iii) all directors and executive officers of Star Gas and Petro as a group. - -------- * Less than 1%. (a) The address of each such person is c/o the Partnership at 2187 Atlantic Street, Stamford, CT 06912-0011. (b) Includes, as deemed General Partner Units, Star Gas LLC's .1% general partner interest in the Operating Partnership. (c) Includes 10,000 Common Units owned by Mr. Traber's wife and 400 Common Units owned by Mr. Traber's daughter as to which he may be deemed to share beneficial ownership. (d) Includes 222,931 Junior Subordinated Units held by Hanseatic Americas LDC, a Bahamian limited duration company in which the sole managing member is Hansabel Partners, LLC, a Delaware limited liability company in which the sole managing member is Hanseatic Corporation, a New York corporation. Messrs. Traber and Biddelman are executive officers of Hanseatic Corporation and Mr. Traber holds in excess of a majority of the shares of capital stock of Hanseatic Corporation. (e) Assumes each member of Star Gas LLC (and Messrs. Traber and Biddelman through their positions with Hanseatic, a member of Star Gas LLC) may be deemed to beneficially own all of Star Gas LLC's General Partner Units, as to which they disclaim beneficial ownership. 138
SENIOR JUNIOR GENERAL PARTNER COMMON UNITS SUBORDINATED UNITS SUBORDINATED UNITS UNITS -------------------- ------------------ --------------------- --------------------- NAME(A) NUMBER PERCENTAGE NUMBER PERCENTAGE NUMBER PERCENTAGE NUMBER PERCENTAGE ------- ------ ---------- ------- ---------- ------- ---------- ------- ---------- Star Gas LLC............ -- --% -- --% -- --% 278,973(b) 100% Irik P. Sevin........... -- -- -- -- 101,041 17.5 278,973(e) 100 Audrey L. Sevin......... -- -- -- -- 252,537 43.8 278,973(e) 100 Wolfgang Traber......... 10,400(c) * 1,181 * 222,931(d) 38.6 278,973(e) 100 Paul Biddelman.......... -- -- 103,556 3.7 222,931(d) 38.6 278,973(e) 100 Thomas Edelman.......... -- -- 102,203 3.7 -- -- -- -- Richard F. Ambury....... 625 * 311 * -- -- -- -- George Leibowitz........ -- -- 46 * -- -- -- -- C. Justin McCarthy...... -- -- -- -- -- -- -- -- Vincent De Palma........ -- -- 1,306 * -- -- -- -- Angelo Catania.......... -- -- 327 * -- -- -- -- David Eastin............ -- -- -- -- -- -- -- -- Joseph G. Cavanaugh..... -- -- 65 * -- -- -- -- William G. Powers....... -- -- -- -- -- -- -- -- All officers and directors and Star Gas LLC as a group (14 persons)........... 11,025 * 207,815 7.5% 577,205 99.9% 278,973 100% AMENDMENTS TO THE PARTNERSHIP AGREEMENTS SET FORTH BELOW IS A SUMMARY OF THE PROPOSED AMENDMENTS TO THE PARTNERSHIP AGREEMENT AND OPERATING PARTNERSHIP AGREEMENT TO BE VOTED UPON BY THE PARTNERSHIP'S COMMON UNITHOLDERS AT THE UNITHOLDERS MEETING. THE FOLLOWING DISCUSSION OF THE AMENDMENTS AND THE RESULTING AMENDED AND RESTATED PARTNERSHIP AGREEMENT IS NOT COMPLETE. FOR A MORE COMPLETE UNDERSTANDING OF THE AMENDMENTS, SEE ANNEX C, WHICH SETS FORTH THE FULL TEXT OF THE PROPOSED AMENDED AND RESTATED PARTNERSHIP AGREEMENT, AND ALSO SHOWS THE PORTIONS OF THE EXISTING PARTNERSHIP AGREEMENT THAT WILL BE DELETED OR CHANGED IF THE AMENDMENT PROPOSAL IS APPROVED AT THE UNITHOLDERS MEETING. INTRODUCTION; REQUIRED VOTE BY UNITHOLDERS Pursuant to the Partnership Agreement, the General Partner proposes the adoption of the amendments to the Partnership Agreement and Operating Partnership Agreement described herein. In order to become effective, the Amendment Proposal must receive the approval of the holders of a Unit Majority. Under the Partnership Agreement, as currently in effect, a Unit Majority means, during the Subordination Period, at least a majority of the Common Units outstanding on the record date (other than Common Units owned by the General Partner or any affiliate). The enclosed proxy affords Unitholders an opportunity to separately vote for or against the Amendment Proposal by marking the appropriate box on their proxy card. HOWEVER, THE TRANSACTION WILL NOT BE EFFECTED UNLESS THE AMENDMENT PROPOSAL IS ADOPTED. SUMMARY OF AMENDMENTS TO THE PARTNERSHIP AGREEMENT Increase of Minimum Quarterly Distribution. The Amendment Proposal will increase the Minimum Quarterly Distribution from $0.55 to $0.575 per quarter ($2.20 to $2.30 on an annualized basis). No changes will be made to the Target Distribution Levels. Extension of the Subordination Period. The Amendment Proposal will extend the earliest date on which the Subordination Period can expire from January 1, 2001 to July 1, 2002. Under the Partnership Agreement, as currently in effect, the Subordination Period will end upon the removal of the General Partner as the general partner of the Partnership upon the requisite vote by limited partners under circumstances where Cause does not exist. The Amendment Proposal provides that the Subordination Period will end upon the removal of the General Partner upon the requisite vote by limited partners under circumstances where Cause does not exist; provided, however, that if the General Partner is removed during the Subordination Period within 12 months after a six-quarter period in which the Minimum Quarterly Distribution was not made on the Common Units with respect to more than one of such quarters (excluding for this purpose the payment of any Common Unit Arrearages) and the first quarter in such six- quarter period that the Minimum Quarterly Distribution on the Common Units is not made occurs after March 31, 2001, then the Subordination Period will not end. If the General Partner is removed and the Subordination Period does not end, the Junior Subordinated Units shall convert into Senior Subordinated Units on a one-for-one basis and the distribution rights on the General Partner Units with respect to the Minimum Quarterly Distribution and to an extent with respect to liquidating distributions will rank pari passu with the Senior Subordinated Units. 139 Issuance of Senior Subordinated Units. The Amendment Proposal will authorize the issuance of Senior Subordinated Units. The Senior Subordinated Units will have distribution rights that are subordinated to all present and future Common Units with respect to the Minimum Quarterly Distribution and arrearages thereon, and to an extent with respect to liquidating distributions. The Senior Subordinated Units will be senior to all present and future Junior Subordinated Units and General Partner Units with respect to the Minimum Quarterly Distribution and to an extent with respect to liquidating distributions. Upon expiration of the Subordination Period, all outstanding Senior Subordinated Units will convert into Class B Common Units on a one-for-one basis and each outstanding Common Unit will be redesignated as a Class A Common Unit (all references herein to Common Units after the expiration of the Subordination Period are deemed to be references to Class A Common Units and Class B Common Units unless otherwise indicated). The only differences between the Class A Common Units and the Class B Common Units is that the Class B Common Units will have the right to receive Incentive Distributions and the right to receive additional Senior Subordinated Units if Petro meets certain financial goals. See "Cash Distribution Policy--Distributions of Available Cash from Operating Surplus During the Subordination Period." Issuance of Junior Subordinated Units. The Amendment Proposal will authorize the issuance of Junior Subordinated Units. The Junior Subordinated Units will have distribution rights that are subordinate to all present and future Common Units and Senior Subordinated Units, and that rank pari passu with all present and future General Partner Units, with respect to the Minimum Quarterly Distribution and to an extent with respect to liquidating distributions. Upon expiration of the Subordination Period, all outstanding Junior Subordinated Units will convert into Class B Common Units on a one-for-one basis. The existing Subordinated Units held by Star Gas will be cancelled in the Transaction. See "Cash Distribution Policy--Distributions of Available Cash from Operating Surplus During the Subordination Period." Subordination of General Partner Interests. The Amendment Proposal will redesignate the general partner interests of the General Partner in the Partnership as General Partner Units and subordinate the distribution rights of the General Partner Units so that they rank pari passu with the Junior Subordinated Units with respect to the Minimum Quarterly Distribution and Liquidation. Currently, the General Partner is entitled to 2% of all payments of the Minimum Quarterly Distribution made on the Common Units and the existing Subordinated Units. The General Partner Units shall not convert into any class of Common Units upon expiration of the Subordination Period; however, at such time they shall no longer be subordinated and shall rank pari passu with the Class A Common Units and the Class B Common Units. See "Cash Distribution Policy--Distributions of Available Cash from Operating Surplus During the Subordination Period" and "--Distributions of Available Cash from Operating Surplus After the Subordination Period." Limitations on Distributions on Subordinated Interests. The Amendment Proposal will limit distributions during the Subordination Period on the Senior Subordinated Units, Junior Subordinated Units and General Partner Units in the following manner: No distributions will be paid on the Senior Subordinated Units, Junior Subordinated Units and General Partner Units with respect to the time period beginning on the Effective Time and ending on March 31, 1999 until the distribution date for the quarter ending on June 30, 1999, which will be on or about August 15, 1999. 140 With respect to the time period beginning on the Effective Time and ending on June 30, 1999, the Partnership may make a distribution of Available Cash on the Senior Subordinated Units, Junior Subordinated Units and General Partner Units in an amount up to the Minimum Quarterly Distribution for such period to the extent the sum of EBITDA less interest, less taxes and less maintenance capital expenditures on a consolidated basis (the Partnership and Petro combined from October 1, 1998 until the Effective Time) ("Adjusted Distributable Cash") for the period beginning October 1, 1998 and ending on June 30, 1999 exceeds the sum of: (i) $57,172,000, plus or minus (ii) the product of (A) $0.60 and (B) the amount by which the number of Common Units outstanding on the record date for the distribution of Available Cash with respect to the quarter ending December 31, 1998, exceeds or is less than 10,544,000, plus or minus (iii) the product of (A) $0.60 and (B) the amount by which the number of Common Units outstanding on the record date for the distribution of Available Cash with respect to the quarter ending March 31, 1999 exceeds or is less than 10,544,000, plus or minus (iv) the product of (A) $0.60 and (B) the amount by which the number of Common Units outstanding on the record date for the distribution of Available Cash with respect to the quarter ending June 30, 1999, exceeds or is less than 10,544,000. With respect to the quarter ending September 30, 1999, the Partnership may make a distribution of Available Cash on the Senior Subordinated Units, Junior Subordinated Units and General Partner Units in an amount up to the Minimum Quarterly Distribution for such period to the extent the Adjusted Distributable Cash for the time period beginning October 1, 1998 and ending on September 30, 1999 exceeds the sum of: (i) $25,307,000 plus or minus (ii) the product of (A) $0.60 and (B) the amount by which the number of Common Units outstanding on the record date for the distribution of Available Cash with respect to the quarter ending December 31, 1998, exceeds or is less than 10,544,000, plus or minus (iii) the product of (A) $0.60 and (B) the amount by which the number of Common Units outstanding on the record date for the distribution of Available Cash with respect to the quarter ending March 31, 1999, exceeds or is less than 10,544,000, plus or minus (iv) the product of (A) $0.60 and (B) the amount by which the number of Common Units outstanding on the record date for the distribution of Available Cash with respect to the quarter ending June 30, 1999, exceeds or is less than 10,544,000, plus or minus (v) the product of (A) $0.60 and (B) the amount by which the number of Common Units outstanding on the record date for the distribution of Available Cash with respect to the quarter ending September 30, 1999, exceeds or is less than 10,544,000. Beginning with the distribution for the quarter ending on December 31, 1999, no distributions will be made on the Senior Subordinated Units, Junior Subordinated Units or General Partner Units, except for distributions from Capital Surplus, unless the aggregate amount of distributions on all 141 Units with respect to all quarters, beginning with the quarter ended December 31, 1999, shall be equal to or less than the total Operating Surplus generated by the Partnership since October 1, 1999 (which does not include the portion of Operating Surplus included in clause (a) (i) of the definition of Operating Surplus). The Amendment Proposal does not prohibit the holders of Senior Subordinated Units, Junior Subordinated Units or General Partner Units from receiving distributions from Capital Surplus in a partial liquidation during the Subordination Period. Issuance of Additional Senior Subordinated Units. The Amendment Proposal authorizes the issuance and distribution to holders of the Senior Subordinated Units, Junior Subordinated Units and General Partner Units of up to an aggregate of 909,000 additional Senior Subordinated Units or Class B Common Units. For each full non-overlapping four-quarter period ending on or after the first anniversary of the Effective Time, but prior to the fifth anniversary of the Effective Time, in which the dollar amount of Petro Adjusted Operating Surplus (as defined hereinafter) per Petro Unit (as defined hereinafter) equals or exceeds $2.90, the Partnership will issue 303,000 Senior Subordinated Units (or 303,000 Class B Common Units if such issuance occurs after the end of the Subordination Period) to the holders of the Senior Subordinated Units, Junior Subordinated Units and the General Partner Units on the record date in respect of the distribution for the final quarter of such four-quarter period, pro rata; provided that the Partnership may not issue more than 909,000 Senior Subordinated Units or Class B Common Units in the aggregate pursuant to this provision; provided, further, that the Partnership may not issue more than 303,000 Senior Subordinated Units or Class B Common Units pursuant to this provision in any 365-day period. See "Cash Distribution Policy--Issuance of Additional Senior Subordinated Units." Reallocation of Incentive Distribution Rights. The Amendment Proposal will reallocate the right to receive Incentive Distributions currently held by the General Partner among the Senior Subordinated Units, Junior Subordinated Units and General Partner Units. As a result, there may be quarters with respect to which the holders of Senior Subordinated Units, Junior Subordinated Units and General Partner Units receive greater distributions than the holders of Common Units. See "Cash Distribution Policy--Incentive Distributions During the Subordination Period" and "--Incentive Distributions After the Subordination Period." Deletion of the Provision Regarding the Net Worth of the General Partner. The Amendment Proposal will delete the prohibition against the General Partner from taking any action that would cause its net worth, independent of its interest in the Partnership and Operating Partnership, to be less than $6.0 million. The primary purpose of the net worth requirement was to ensure that the Partnership would be treated as a partnership and not as an association taxable as a corporation for federal income tax purposes. Counsel has advised the Partnership that the failure of the General Partner to maintain a specific net worth will not result in the Partnership being treated as an association taxable as a corporation for federal income tax purposes under current regulations under the Code. Issuance of Additional Common Units. The Partnership Agreement, as currently in effect, authorizes the Partnership to issue 1,300,000 Common Units or Units ranking on a parity with 142 Common Units (which number does not include Common Units issued in connection with (i) certain capital improvements, (ii) certain acquisitions that are accretive on a per Unit basis, (iii) the repayment of certain indebtedness or (iv) the conversion of the existing Subordinated Units) without the approval of the Unitholders. The Amendment Proposal will increase the number of Common Units or Units ranking on a parity with Common Units without further Unitholder approval to 2,500,000 (which number does not include (a) Common Units issued in (i), (ii) and (iii) above, (b) Class B Common Units issued in connection with the conversion of Senior Subordinated Units and Junior Subordinated Units and (c) the Common Units issued in the Transaction, including the Equity Offering. Approval of this amendment satisfies the requirement under the Partnership Agreement, as currently in effect, that the holders of a Unit Majority approve the issuance of Common Units in the Equity Offering. Unit Majority. Under the Partnership Agreement as currently in effect, certain transactions require the approval of a Unit Majority, which is defined to mean the approval of a majority of the Common Units (other than Common Units held by the General Partner or any of its affiliates). The Amendment Proposal will provide that the Senior Subordinated Units and Junior Subordinated Units have a vote with respect to certain matters by restating the definition of "Unit Majority" as follows: "Unit Majority" means, during the Subordination Period, at least (i) a majority of the outstanding Common Units voting as a class and (ii) a majority of the outstanding Senior Subordinated Units and Junior Subordinated Units voting as a single class, in each case excluding Units owned by the General Partner or any affiliate, and, after the Subordination Period, at least a majority of the outstanding Common Units. Proportionate Increase in Operating Surplus Basket. The Amendment Proposal will increase the basket of $6 million set forth in the definition of "Operating Surplus" in proportion to the additional number of Common Units to be issued in the Equity Offering. In lieu of $6 million, such amount shall be a number equal to the product of (i) $6 million and (ii) a fraction, (x) the numerator of which is the number of outstanding Common Units at the Effective Time (assuming the simultaneous closing of the Equity Offering) and (y) the denominator of which is the number of outstanding Common Units immediately prior to the Effective Time. Assuming the issuance of approximately 6.4 million Common Units in the Equity Offering, the basket will be increased to approximately $16 million. This amendment will keep the dollar amount of the basket per Common Unit the same as it was immediately before the Transaction. Deletion of Provisions Relating to Early Conversion of Subordinated Units. The Amendment Proposal will delete those provisions of the Partnership Agreement that provide that a portion of the Subordinated Units will convert into Common Units prior to the expiration of the Subordination Period if certain levels of Minimum Quarterly Distribution are both earned and distributed. [Based upon the Partnership's inability to satisfy certain tests based on distributions and earnings, the early conversion of certain Subordinated Units is no longer feasible]. General Partner Capital Contribution Requirement. The Amendment Proposal will relieve the General Partner of its obligation to make contributions of capital to the Partnership upon the issuance of additional Units in order to maintain a fixed percentage general partner interest in the Partnership. The General Partner will retain its preemptive right to maintain its existing ownership interest. If the 143 General Partner does not make a contribution of capital upon the issuance of additional Units, its claim on distributions of Available Cash will be proportionately reduced. Additional Capital Contribution Obligation of the General Partner. The Amendment Proposal will delete the Additional Capital Contribution Obligation of the General Partner in order for the Partnership to pay the Minimum Quarterly Distribution on the Common Units. Based upon the satisfaction of certain tests determined by distributions, this obligation of the General Partner has expired. Right to Acquire Units. The Amendment Proposal will provide that if the Partnership acquires, in a twelve-month period through purchase or exchange, 66 2/3% or more of the total Class B Common Units, the Partnership may purchase all, but not less than all, of the remaining Class B Common Units then outstanding during the following twelve-month period. Registration Rights The Amendment Proposal will provide that the Partnership must register for resale under the Securities Act the Common Units and Senior Subordinated Units issued to affiliates of Petro in the Transaction. SUMMARY OF AMENDMENTS TO THE OPERATING PARTNERSHIP AGREEMENT Under the Partnership Agreement, as currently in effect, the General Partner cannot consent to any amendment of the Operating Partnership Agreement that would have a material adverse effect on the Partnership as a partner of the Operating Partnership or cause the Partnership to elect a successor general partner to the Operating Partnership without the approval of the holders of at least a Unit Majority. The General Partner consents to and proposes that the Limited Partners approve (i) the election of Star Gas LLC as successor general partner to the Operating Partnership, (ii) delete allocation of depreciation to the General Partner, (iii) delete the prohibition against the General Partner from taking any action that would cause its net worth to be less than $6 million and (iv) such other amendments to the Operating Partnership Agreement that the General Partner deems necessary in connection with the consummation of the Transaction. CONFORMING CHANGES Certain additional changes will be required to conform the Partnership Agreement and the Operating Partnership Agreement to the foregoing amendments and to facilitate the consummation of the Transaction. It is the good faith opinion of the General Partner that such conforming changes do not adversely affect the Unitholders in any material respect, and thus pursuant to the Partnership Agreement, as currently in effect, the General Partner may make any or all conforming changes without the consent of the Unitholders. 144 THE AMENDED AND RESTATED PARTNERSHIP AGREEMENT IF THE TRANSACTION IS COMPLETED (WHICH WILL NOT OCCUR UNLESS THE ACQUISITION PROPOSAL, THE AMENDMENT PROPOSAL AND THE GENERAL PARTNER PROPOSAL ARE EACH APPROVED), ALL HOLDERS OF THE PARTNERSHIP'S UNITS WILL BE BOUND BY THE PROVISIONS OF THE AMENDED AND RESTATED PARTNERSHIP AGREEMENT, AS IT MAY BE FURTHER AMENDED FROM TIME TO TIME. THE FOLLOWING PARAGRAPHS DISCUSS CERTAIN PROVISIONS OF THE AMENDED AND RESTATED PARTNERSHIP AGREEMENT. SUCH DISCUSSION DOES NOT PURPORT TO BE COMPLETE. FOR A MORE COMPLETE UNDERSTANDING, SEE THE PROPOSED AMENDED AND RESTATED PARTNERSHIP AGREEMENT SET FORTH IN ANNEX C HERETO. Certain provisions of the Amended and Restated Partnership Agreement are summarized elsewhere in this Prospectus under various headings. With regard to various transactions and relationships of the Partnership with the General Partner and its affiliates, see "Conflicts of Interest and Fiduciary Responsibility." With regard to the management of the Partnership, see "Management of the Partnership After the Transaction." With regard to the transfer of Units, see "Description of the Units." With regard to distributions of Available Cash, see "Cash Distribution Policy." With regard to allocations of taxable income and taxable loss, see "Tax Considerations." Prospective investors are urged to review these sections of this Prospectus and the Amended and Restated Partnership Agreement carefully. ORGANIZATION AND DURATION The Partnership and the Operating Partnership were organized in 1995 as Delaware limited partnerships. The Partnership will dissolve on December 31, 2085, unless sooner dissolved pursuant to the terms of the Amended and Restated Partnership Agreement. PURPOSE The purpose of the Partnership is limited to serving as the limited partner of the Operating Partnership and engaging in any other activity approved by the General Partner. The General Partner will have the ability under the Amended and Restated Partnership Agreement to cause the Partnership and the Operating Partnership to engage in activities that may pose a greater risk to investors than the propane marketing business and home heating oil marketing business. The General Partner is authorized in general to perform all acts deemed necessary to carry out such purposes and to conduct the business of the Partnership. The General Partner has the power to cause the Partnership to commence a bankruptcy proceeding under the federal bankruptcy laws. However, the General Partner does not intend to cause the Partnership to commence such a proceeding unless the Partnership is insolvent. POWER OF ATTORNEY Each limited partner, and each person who acquires a Unit from a Unitholder and executes and delivers a Transfer Application with respect thereto, grants to the General Partner and, if a liquidator of the Partnership has been appointed, such liquidator, a power of attorney to, among other things, execute and file certain documents required in connection with the qualification, continuance or dissolution of the Partnership, or the amendment of the Amended and Restated Partnership 145 Agreement in accordance with the terms thereof and to make consents and waivers contained in the Amended and Restated Partnership Agreement. RESTRICTIONS ON AUTHORITY OF THE GENERAL PARTNER WITH RESPECT TO EXTRAORDINARY TRANSACTIONS; LACK OF DISSENTERS' RIGHTS The authority of the General Partner is limited in certain respects under the Amended and Restated Partnership Agreement. The General Partner is prohibited, without the prior approval of holders of record of a Unit Majority, from, among other things, selling, exchanging or otherwise disposing of all or substantially all of the Partnership's assets in a single transaction or a series of related transactions (including by way of merger, consolidation or other combination) or approving on behalf of the Partnership the sale, exchange or other disposition of all or substantially all of the assets of the Operating Partnership; provided that the Partnership may mortgage, pledge, hypothecate or grant a security interest in all or substantially all of the Partnership's assets without such approval. The Partnership may also sell all or substantially all of its assets pursuant to a foreclosure or other realization upon the foregoing encumbrances without such approval. The Unitholders are not entitled to dissenters' rights of appraisal under the Partnership Agreement, as currently in effect, or the Amended and Restated Partnership Agreement or applicable Delaware law in the event of a merger or consolidation of the Partnership or a sale, exchange or other disposition of substantially all of the Partnership's assets or any other event. WITHDRAWAL OR REMOVAL OF THE GENERAL PARTNER; APPROVAL OF SUCCESSOR GENERAL PARTNER The General Partner has agreed not to voluntarily withdraw as general partner of the Partnership and the Operating Partnership prior to December 31, 2005 (with limited exceptions described below), without obtaining the approval of a Unit Majority and furnishing an opinion of counsel that such withdrawal (following the selection of a successor general partner) will not result in the loss of the limited liability of the limited partners of the Partnership or cause the Partnership to be treated as an association taxable as a corporation or otherwise taxed as an entity for federal income tax purposes (an "Opinion of Counsel"). On or after December 31, 2005, the General Partner may withdraw as general partner by giving 90 days' written notice (without first obtaining approval from the Unitholders), and such withdrawal will not constitute a violation of the Amended and Restated Partnership Agreement. Notwithstanding the foregoing, the General Partner may withdraw without Unitholder approval upon 90 days' notice to the limited partners if more than 50% of the outstanding Units are held or controlled by one person and its affiliates (other than the General Partner and its affiliates). In addition, the Amended and Restated Partnership Agreement permits the General Partner (in certain limited instances) to sell all of its general partner interest (which is evidenced by the General Partner Units) in the Partnership. See "--Transfer of General Partner Interest." Upon the withdrawal of the General Partner under any circumstances (other than as a result of a transfer by the General Partner of all or a part of its general partner interest (which is evidenced by the General Partner Units) in the Partnership), the holders of a Unit Majority may select a successor to such withdrawing General Partner. If such a successor is not elected, or is elected but an Opinion of Counsel cannot be obtained, the Partnership will be dissolved, wound up and liquidated, unless within 180 days after such withdrawal a Unit Majority agrees in writing to continue the business of 146 the Partnership and to the appointment of a successor general partner. See "-- Termination and Dissolution." Pursuant to the terms of the Amended and Restated Partnership Agreement, the General Partner may not be removed unless such removal is approved by the vote of the holders of not less than 66 2/3% of the outstanding Units owned by limited partners voting together as a single class (other than Units owned by the General Partner and its affiliates) and the Partnership receives an Opinion of Counsel. Any such removal is also subject to the approval of a successor general partner by the vote of the holders of a Unit Majority. If the General Partner is removed as General Partner other than for Cause, the Subordination Period will end, any then-existing arrearages on the Common Units will be terminated, any Senior Subordinated Units and Junior Subordinated Units held by the General Partner will immediately convert into Class B Common Units and the General Partner Units will no longer be subordinated, provided, however, that if the General Partner is removed during the Subordination Period within 12 months after a six-quarter period in which the Minimum Quarterly Distribution is not made on the Common Units with respect to more than one of such quarters (excluding for this purpose the payment of any Common Unit Arrearages) and the first quarter in such six-quarter period that the Minimum Quarterly Distribution on the Common Units is not made occurs after March 31, 2001, then the Subordination Period will not end. If the General Partner is removed and the Subordination Period does not end, the Junior Subordinated Units shall convert into Senior Subordinated Units on a one-for-one basis and the distribution rights on the General Partner Units with respect to the Minimum Quarterly Distribution and Liquidation will rank pari passu with the Senior Subordinated Units. Removal or withdrawal of the General Partner of the Partnership also constitutes removal or withdrawal, as the case may be, of the General Partner as general partner of the Operating Partnership. In the event of withdrawal of the General Partner where such withdrawal violates the Amended and Restated Partnership Agreement or removal of the General Partner by the limited partners under circumstances where Cause exists, a successor general partner will have the option to purchase the General Partner Units of the departing General Partner (the "Departing Partner") in the Partnership and the Operating Partnership for a cash payment equal to the fair market value of such interest. Under all other circumstances where the General Partner withdraws or is removed by the limited partners, the Departing Partner will have the right to require the successor general partner to purchase the General Partner Units of the Departing Partner for such amount. In each case, such fair market value will be determined by agreement between the Departing Partner and the successor general partner, or if no agreement is reached, by an independent investment banking firm or other independent experts selected by the Departing Partner and the successor general partner (or if no expert can be agreed upon, by the expert chosen by agreement of the experts selected by each of them). In addition, the Partnership will be required to reimburse the Departing Partner for all amounts due the Departing Partner, including, without limitation, all employee-related liabilities, including severance liabilities, incurred in connection with the termination of the employees employed by the Departing Partner for the benefit of the Partnership. If the above-described option is not exercised by either the Departing Partner or the successor general partner, as applicable, the Departing Partner's General Partner Units will be converted into 147 Common Units (or Class A Common Units if any Class B Common Units are then outstanding) equal to the fair market value of such interest as determined by an investment banking firm or other independent expert selected in the manner described in the preceding paragraph. TRANSFER OF GENERAL PARTNER INTEREST Except for a transfer by the General Partner of all, but not less than all, of its general partner interest, which is evidenced by the General Partner Units, in the Partnership to an affiliate or in connection with the merger or consolidation of the General Partner with or into another entity, the General Partner may not transfer any or all of the General Partner Units in the Partnership to another person or entity prior to December 31, 2005, without the approval of holders of a Unit Majority; provided that, in each case such transferee assumes the rights and duties of the General Partner, agrees to be bound by the provisions of the Amended and Restated Partnership Agreement, furnishes an Opinion of Counsel and agrees to purchase all (or the appropriate portion thereof as applicable) of the General Partner's partnership interest in the Operating Partnership. At any time, the members of Star Gas LLC may sell or otherwise transfer their membership interests in Star Gas LLC to a third party without the approval of the Unitholders. REIMBURSEMENT FOR SERVICES The Amended and Restated Partnership Agreement provides that the General Partner is not entitled to receive any compensation for its services as general partner of the Partnership; the General Partner is, however, entitled to be reimbursed on a monthly basis (or such other basis as the General Partner may reasonably determine) for all direct and indirect expenses it incurs or payments it makes on behalf of the Partnership, and all other necessary or appropriate expenses allocable to the Partnership or otherwise reasonably incurred by the General Partner in connection with the operation of the Partnership's business (including expenses allocated to the General Partner by its affiliates). The Amended and Restated Partnership Agreement provides that the General Partner shall determine the expenses that are allocable to the Partnership in any reasonable manner determined by the General Partner in its sole discretion. STATUS AS LIMITED PARTNER OR ASSIGNEE Except as described below under "--Limited Liability," the Units will be fully paid, and Unitholders will not be required to make additional contributions to the Partnership. A person receiving a Common Unit, Senior Subordinated Unit or Junior Subordinated Unit subsequent to executing and delivering a Transfer Application, but pending its admission as a substituted limited partner or additional limited partner, as the case may be, in the Partnership, is entitled to an interest in the Partnership equivalent to that of a limited partner with respect to the right to share in allocations and distributions from the Partnership, including liquidating distributions. The General Partner will vote and exercise other powers attributable to Common Units, Senior Subordinated Units and Junior Subordinated Units owned by such person who has not become a substitute limited partner or additional limited partner, as the case may be, at the written direction of such person. See "--Meetings; Voting." Persons who do not execute and deliver a Transfer Application will be treated neither as assignees nor as record holders of Common Units, Senior 148 Subordinated Units or Junior Subordinated Units, as the case may be, and will not receive cash distributions, federal income tax allocations or reports furnished to record holders of Common Units, Senior Subordinated Units and Junior Subordinated Units. See "Description of the Units--Transfer of Units." NON-CITIZEN ASSIGNEES; REDEMPTION If, because of the nationality, citizenship or other related status of any limited partner or assignee, the Partnership is or becomes subject to federal, state or local laws or regulations that, in the reasonable determination of the General Partner, create a substantial risk of cancellation or forfeiture of any property in which the Partnership has an interest, the Partnership may redeem the Units held by such limited partner or assignee at their Current Market Price. In order to avoid any such cancellation or forfeiture, the General Partner may require each limited partner or assignee to furnish information about his nationality, citizenship, residency or related status. If a limited partner or assignee fails to furnish information about such nationality, citizenship, residency or other related status within 30 days after a request for such information, such limited partner or assignee may be treated as a non-citizen assignee ("Non-citizen Assignee"). In addition to other limitations on the rights of an assignee who is not a substituted limited partner, a Non-citizen Assignee does not have the right to direct the voting of his Units and may not receive distributions in kind upon liquidation of the Partnership. ISSUANCE OF ADDITIONAL SECURITIES The Amended and Restated Partnership Agreement authorizes the General Partner to cause the Partnership to issue an unlimited number of additional limited partner interests and other equity securities of the Partnership for such consideration and on such terms and conditions as shall be established by the General Partner in its sole discretion without the approval of any limited partners, provided that, prior to the end of the Subordination Period, (a) except as provided in clauses (b), (c), (d) and (e) below, during the Subordination Period the Partnership may not issue equity securities of the Partnership ranking prior or senior to the Common Units or an aggregate of more than 2,500,000 additional Common Units or an equivalent amount of securities ranking on a parity with the Common Units (the "Parity Units"), without the approval of at least a majority of the outstanding Common Units (other than Common Units held by the General Partner and its affiliates); (b) the Partnership may issue Common Units pursuant to the Transaction, including those issued in the Equity Offering; (c) the Partnership may issue an unlimited number of additional Common Units or Parity Units without the approval of the Unitholders if such issuance occurs (i) in connection with an Acquisition or a Capital Improvement or (ii) within 365 days of, and the net proceeds from such issuance are used to repay debt incurred in connection with, an Acquisition or a Capital Improvement, in each case, where such Acquisition or Capital Improvement involves assets that would have, if acquired by the Partnership as of the date that is one year prior to the first day of the quarter in which such transaction is to be effected, resulted in an increase in (A) the amount of Adjusted Operating Surplus generated by the Partnership on a per-Unit basis for all outstanding Units with respect to each of the four most recently completed quarters (on a pro forma basis) over (B) the actual amount of Adjusted Operating Surplus generated by the Partnership on a per-Unit basis for all outstanding Units with respect to each of such four quarters; (d) the Partnership may also issue an 149 unlimited number of additional Common Units or parity Units prior to the end of the Subordination Period and without the approval of the Unitholders if the use of proceeds from such issuance is exclusively to repay up to $20 million of indebtedness of the Partnership, the Operating Partnership or any subsidiary thereof; and (e) the Partnership may issue Class B Common Units upon the conversion of the Senior Subordinated Units and Junior Subordinated Units at the end of the Subordination Period. In accordance with Delaware law and the provisions of the Amended and Restated Partnership Agreement, the General Partner in its sole discretion, may cause the Partnership to issue additional partnership interests that may have special voting rights. The General Partner will have the right, which it may from time to time assign in whole or in part to any of its affiliates, to purchase Common Units, Senior Subordinated Units and Junior Subordinated Units or other equity securities of the Partnership from the Partnership whenever, and on the same terms that, the Partnership issues such securities or rights to persons other than the General Partner and its affiliates, to the extent necessary to maintain the percentage interest of the General Partner and its affiliates in the Partnership that existed immediately prior to each such issuance. The holders of Common Units will not have preemptive rights to acquire additional Common Units or other partnership interests that may be issued by the Partnership. Additional issuances of Units, including Senior Subordinated Units and Junior Subordinated Units or other equity securities of the Partnership ranking junior to the Common Units, may reduce the likelihood of, and the amount of, any distributions above the Minimum Quarterly Distribution. LIMITED CALL RIGHT If at any time (a) not more than 20% of the then-issued and outstanding limited partner interests of any class are held by persons other than the General Partner and its affiliates, the General Partner will have the right, which it may assign and transfer in whole or in part to any of its affiliates or to the Partnership, to acquire all, but not less than all, of the remaining limited partner interests of such class held by such unaffiliated persons as of a record date to be selected by the General Partner, on at least 10 but not more than 60 days' notice or (b) after the expiration of the Subordination Period, the Partnership acquires, through purchase or exchange, in a twelve- month period, 66 2/3% or more of the total Class B Common Units, the Partnership shall then have the right, which it may not assign or transfer, exercisable in its sole discretion, to purchase all, but not less than all, of the remaining Units of such class then outstanding during the following twelve- month period. The purchase price in the event of (a) or (b) above shall be the greater of (x) the highest cash price paid by the Partnership, the General Partner or any of its affiliates for any limited partner interests of such class purchased within the 90 days preceding the date on which the Partnership or the General Partner first mails notice of its election to purchase such limited partner interests and (y) the Current Market Price as of the date three days prior to the date such notice is mailed. As a consequence of the Partnership's or the General Partner's right to purchase outstanding limited partner interests (including Senior Subordinated Units and Junior Subordinated Units), a holder of limited partner interests may have his limited partner interests purchased from him even though such holder may not desire to sell them, or the price paid may be less than the amount the holder would desire to receive upon the sale of his limited partner interests. The tax consequences to a Unitholder of the exercise of this call right are 150 the same as a sale by such Unitholder of his Units in the market. See "Certain Federal Income Tax Considerations--Disposition of Units." AMENDMENT OF AMENDED AND RESTATED PARTNERSHIP AGREEMENT Amendments to the Amended and Restated Partnership Agreement may be proposed only by or with the consent of the General Partner. In order to adopt a proposed amendment, the General Partner is required to seek written approval of the holders of the number of Units required to approve such amendment or call a meeting of the limited partners to consider and vote upon the proposed amendment, except as described below. Prohibited Amendments. Proposed amendments (unless otherwise specified) must be approved by holders of at least a Unit Majority except that no amendment may be made that would: (i) enlarge the obligations of any limited partner, without its consent, (ii) enlarge the obligations of, restrict in any way any action by or rights of, or reduce in any way the amounts distributable, reimbursable or otherwise payable to, the General Partner, without its consent, which may be given or withheld in its sole discretion, (iii) change the term of the Partnership, (iv) provide that the Partnership is not dissolved upon expiration of its term or (v) give any person the right to dissolve the Partnership other than the General Partner's right to dissolve the Partnership with the approval of holders of at least a Unit Majority. No Unitholder Approval. The General Partner may make amendments to the Amended and Restated Partnership Agreement without the approval of any limited partner or assignee of the Partnership to reflect: (i) a change in the name of the Partnership, the location of the principal place of business of the Partnership, the registered agent or the registered office of the Partnership, (ii) admission, substitution, withdrawal or removal of partners in accordance with the Partnership Agreement, (iii) a change that, in the sole discretion of the General Partner, is necessary or advisable to qualify or continue the qualification of the Partnership as a partnership in which the limited partners have limited liability or that is necessary or advisable to ensure that the Partnership and the Operating Partnership will not be treated as an association taxable as a corporation or otherwise taxed as an entity for federal income tax purposes, (iv) an amendment that is necessary, in the opinion of counsel to the Partnership, to prevent the Partnership or the General Partner or its respective directors or officers from in any manner being subjected to the provisions of the Investment Company Act of 1940, as amended, the Investment Advisors Act of 1940, as amended, or the "plan asset" regulations adopted under the Employee Retirement Income Security Act of 1974, as amended, whether or not substantially similar to plan asset regulations currently applied or proposed, (v) subject to the limitations on the issuance of additional Class A Common Units, Class B Common Units or other limited or general partner interests described above, an amendment that 151 in the sole discretion of the General Partner is necessary or advisable in connection with the authorization of additional limited or general partner interests, (vi) any amendment expressly permitted in the Amended and Restated Partnership Agreement to be made by the General Partner acting alone, (vii) an amendment effected, necessitated or contemplated by a merger agreement that has been approved pursuant to the terms of the Amended and Restated Partnership Agreement, (viii) any amendment that, in the sole discretion of the General Partner, is necessary or advisable in connection with the formation by the Partnership of, or its investment in, any corporation, partnership or other entity (other than the Operating Partnership) as otherwise permitted by the Amended and Restated Partnership Agreement, (ix) a change in the fiscal year and taxable year of the Partnership and changes related thereto and (x) any other amendments substantially similar to the foregoing. In addition, the General Partner may make amendments to the Amended and Restated Partnership Agreement without the approval of any limited partner or assignee if such amendments: (i) do not adversely affect the limited partners in any material respect, (ii) are necessary or advisable, in the sole discretion of the General Partner to satisfy any requirements, conditions or guidelines contained in any opinion, directive, ruling or regulation of any federal or state agency or judicial authority or contained in any federal or state statute, (iii) are necessary or advisable to facilitate the trading of the Units or to comply with any rule, regulation, guideline or requirement of any securities exchange on which the Units are or will be listed for trading, compliance with any of which the General Partner deems to be in the best interests of the Partnership and the Unitholders or (iv) are required or contemplated by the Amended and Restated Partnership Agreement. Opinion of Counsel and Unitholder Approval. The General Partner will not be required to obtain an Opinion of Counsel in the event of the amendments described in the two immediately preceding paragraphs. No other amendments to the Amended and Restated Partnership Agreement will become effective without the approval of at least 90% of the Units unless the Partnership obtains an Opinion of Counsel to the effect that such amendment will not affect the limited liability of any limited partner in the Partnership or the limited partner of the Operating Partnership. Any amendment that materially and adversely affects the rights or preferences of any type or class of outstanding Units in relation to other classes of Units will require the approval of holders of at least a majority of the outstanding Units so affected (excluding, during the Subordination Period, any Units held by the General Partner and its affiliates). MEETINGS; VOTING Unitholders or assignees who are record holders of Units on the record date set pursuant to the Amended and Restated Partnership Agreement will be entitled to notice of, and to vote at, meetings 152 of limited partners of the Partnership and to act with respect to matters as to which approvals may be solicited. With respect to voting rights attributable to Units that are owned by an assignee who is a record holder but who has not yet been admitted as a limited partner, the General Partner shall be deemed to be the limited partner with respect thereto and shall, in exercising the voting rights in respect of such Units on any matter, vote such Units at the written direction of such record holder. Absent such direction, such Units will not be voted (except that, in the case of Units held by the General Partner on behalf of Non-citizen Assignees, the General Partner shall distribute the votes in respect of such Units in the same ratios as the votes of limited partners in respect of other Units are cast). The General Partner does not anticipate that any meeting of limited partners will be called in the foreseeable future, other than the Unitholders Meeting. Any action that is required or permitted to be taken by the limited partners may be taken either at a meeting of the limited partners or without a meeting if consents in writing setting forth the action so taken are signed by holders of such number of limited partner interests as would be necessary to authorize or take such action at a meeting of all of the limited partners. Meetings of the limited partners of the Partnership may be called by the General Partner or by limited partners owning at least 20% of the outstanding Units of the class for which a meeting is proposed. Limited partners may vote either in person or by proxy at meetings. The holders of a majority of the outstanding Units of the class or classes for which a meeting has been called represented in person or by proxy shall constitute a quorum at a meeting of limited partners of such class or classes, unless any such action by the limited partners requires approval by holders of a greater percentage of such Units, in which case the quorum shall be such greater percentage (excluding, in either case, if such are to be excluded from the vote, outstanding Units owned by the General Partner and its affiliates). Each record holder of a Unit has a vote according to his percentage interest in the Partnership, although additional limited partner interests having special voting rights could be issued by the General Partner. See "--Issuance of Additional Securities." The Amended and Restated Partnership Agreement provides that Units held in nominee or street name account will be voted by the broker (or other nominee) pursuant to the instruction of the beneficial owner unless the arrangement between the beneficial owner and his nominee provides otherwise. Any notice, demand, request, report or proxy material required or permitted to be given or made to record holders of Units (regardless of whether such record holder has been admitted as a limited partner) under the terms of the Amended and Restated Partnership Agreement will be delivered to the record holder by the Partnership or by the Transfer Agent at the request of the Partnership. INDEMNIFICATION The Amended and Restated Partnership Agreement provides that the Partnership will indemnify the General Partner, any Departing Partner, any Person who is or was an affiliate of the General Partner or any Departing Partner, any Person who is or was an officer, director, employee, partner, agent or trustee of the General Partner or any Departing Partner or any affiliate of the General Partner or any Departing Partner, or any Person who is or was serving at the request of the General Partner or any Departing Partner or any affiliate of the General Partner or any Departing Partner as an officer, director, employee, partner, agent or trustee of another Person ("Indemnitees"), to the 153 fullest extent permitted by law, from and against any and all losses, claims, damages, liabilities (joint or several), expenses (including, without limitation, legal fees and expenses), judgments, fines, penalties, interest, settlements and other amounts arising from any and all claims, demands, actions, suits or proceedings, whether civil, criminal, administrative or investigative, in which any Indemnitee may be involved, or is threatened to be involved, as a party or otherwise, by reason of its status as any of the foregoing; provided that in each case the Indemnitee acted in good faith and in a manner that such Indemnitee reasonably believed to be in or not opposed to the best interests of the Partnership and, with respect to any criminal proceeding, had no reasonable cause to believe its conduct was unlawful. Any indemnification under these provisions will only be out of the assets of the Partnership, and the General Partner shall not be personally liable for, or have any obligation to contribute or loan funds or assets to the Partnership to enable it to effectuate, such indemnification. The Partnership is authorized to purchase (or to reimburse the General Partner or its affiliates for the cost of) insurance against liabilities asserted against and expenses incurred by such persons in connection with the Partnership's activities, regardless of whether the Partnership would have the power to indemnify such person against such liabilities under the provisions described above. LIMITED LIABILITY Assuming that a limited partner does not participate in the control of the business of the Partnership within the meaning of the DRULPA and that he otherwise acts in conformity with the provisions of the Amended and Restated Partnership Agreement, his liability under the DRULPA will be limited, subject to certain possible exceptions, to the amount of capital he is obligated to contribute to the Partnership in respect of his Units plus his share of any undistributed profits and assets of the Partnership. If it were determined, however, that the right or exercise of the right by the limited partners as a group to remove or replace the General Partner, to approve certain amendments to the Amended and Restated Partnership Agreement or to take other action pursuant to the Amended and Restated Partnership Agreement constituted "participation in the control" of the Partnership's business for the purposes of the DRULPA, then the limited partners could be held personally liable for the Partnership's obligations under the laws of the State of Delaware to the same extent as the General Partner with respect to persons who transact business with the Partnership reasonably believing, based on the limited partner's conduct, that the limited partner is a general partner. Under the DRULPA, a limited partnership may not make a distribution to a partner to the extent that at the time of the distribution, after giving effect to the distribution, all liabilities of the partnership, other than liabilities to partners on account of their partnership interests and nonrecourse liabilities, exceed the fair value of the assets of the limited partnership. For the purpose of determining the fair value of the assets of a limited partnership, the DRULPA provides that the fair value of property subject to nonrecourse liability shall be included in the assets of the limited partnership only to the extent that the fair value of that property exceeds that nonrecourse liability. The DRULPA provides that a limited partner who receives such a distribution and knew at the time of the distribution that the distribution was in violation of the DRULPA shall be liable to the limited partnership for the amount of the distribution for three years from the date of the distribution. Under the DRULPA, an assignee who becomes a substituted limited partner of a limited partnership is liable for the obligations of his assignor to make contributions to the partnership, except the assignee 154 is not obligated for liabilities unknown to him at the time he became a limited partner and that could not be ascertained from the partnership agreement. The Operating Partnership conducts business in at least 15 states. Maintenance of limited liability may require compliance with legal requirements in such jurisdictions in which the Operating Partnership conducts business, including qualifying the Operating Partnership to do business therein. Limitations on the liability of limited partners for the obligations of a limited partnership have not been clearly established in many jurisdictions. If it were determined that the Partnership was, by virtue of its limited partner interest in the Operating Partnership or otherwise, conducting business in any state without compliance with the applicable limited partnership statute, or that the right or exercise of the right by the limited partners as a group to remove or replace the General Partner, to approve certain amendments to the Amended and Restated Partnership Agreement, or to take other action pursuant to the Amended and Restated Partnership Agreement constituted "participation in the control" of the Partnership's business for the purposes of the statutes of any relevant jurisdiction, then the limited partners could be held personally liable for the Partnership's obligations under the law of such jurisdiction to the same extent as the General Partner under certain circumstances. The Partnership will operate in such manner as the General Partner deems reasonable and necessary or appropriate to preserve the limited liability of Unitholders. BOOKS AND REPORTS The General Partner is required to keep appropriate books of the business of the Partnership at the principal offices of the Partnership. The books will be maintained for both tax and financial reporting purposes on an accrual basis. The fiscal year of the Partnership (for accounting but not for tax purposes) is October 1 to September 30. As soon as practicable, but in no event later than 120 days after the close of each fiscal year, the General Partner will furnish each record holder of Units (as of a record date selected by the General Partner) with an annual report containing audited financial statements of the Partnership for the past fiscal year, prepared in accordance with generally accepted accounting principles. As soon as practicable, but in no event later than 90 days after the close of each quarter (except the last quarter of each fiscal year), the General Partner will furnish each record holder of Units (as of a record date selected by the General Partner) a report containing unaudited financial statements of the Partnership with respect to such quarter and such other information as may be required by law. The General Partner will use all reasonable efforts to furnish each record holder of a Unit with information reasonably required for tax reporting purposes within 90 days after the close of each calendar year in which the Partnership's taxable year ends. Such information is expected to be furnished in summary form so that certain complex calculations normally required of partners can be avoided. The General Partner's ability to furnish such summary information to Unitholders will depend on the cooperation of such Unitholders in supplying certain information to the General Partner. Every Unitholder (without regard to whether he supplies such information to the General Partner) will receive information to assist him in determining his federal and state tax liability and filing his federal and state income tax returns. 155 RIGHT TO INSPECT PARTNERSHIP BOOKS AND RECORDS The Amended and Restated Partnership Agreement provides that a limited partner can, for a purpose reasonably related to such limited partner's interest as a limited partner, upon reasonable demand and at his/her own expense, be furnished with (i) a current list of the name and last known address of each partner, (ii) a copy of the Partnership's tax returns, (iii) information as to the amount of cash, and a description and statement of the net agreed value of any other property or services, contributed or to be contributed by each partner and the date on which each became a partner, (iv) copies of the Amended and Restated Partnership Agreement, the certificate of limited partnership of the Partnership, amendments thereto and powers of attorney pursuant to which the same have been executed, (v) information regarding the status of the Partnership's business and financial condition and (vi) such other information regarding the affairs of the Partnership as is just and reasonable. The General Partner may, and intends to, keep confidential from the limited partners trade secrets or other information the disclosure of which the General Partner believes in good faith is not in the best interests of the Partnership or which the Partnership is required by law or by agreements with third parties to keep confidential. TERMINATION AND DISSOLUTION The Partnership will continue until December 31, 2085, unless sooner terminated pursuant to the Amended and Restated Partnership Agreement. The Partnership will be dissolved upon (i) the election of the General Partner to dissolve the Partnership, if approved by holders of a Unit Majority, (ii) the sale, exchange or other disposition of all or substantially all of the assets and properties of the Partnership and the Operating Partnership, (iii) the entry of a decree of judicial dissolution of the Partnership or (iv) withdrawal or removal of the General Partner or any other event that results in its ceasing to be the General Partner (other than by reason of a transfer of its General Partner Units in accordance with the Amended and Restated Partnership Agreement or withdrawal or removal following approval and admission of a successor). Upon a dissolution pursuant to clause (iv), the holders of at least a majority of the outstanding Units (excluding Units held by the Departing General Partner and its affiliates) may also elect, within certain time limitations, to reconstitute the Partnership and continue its business on the same terms and conditions set forth in the Amended and Restated Partnership Agreement by forming a new limited partnership on terms identical to those set forth in the Amended and Restated Partnership Agreement and having as a general partner a person or entity approved by at least the holders of a majority of the outstanding Units (excluding Units held by the Departing General Partner and its affiliates), subject to receipt by the Partnership of an Opinion of Counsel. LIQUIDATION AND DISTRIBUTION OF PROCEEDS Upon dissolution of the Partnership, unless the Partnership is reconstituted and continued as a new limited partnership, the person authorized to wind up the affairs of the Partnership (the "Liquidator") will, acting with all of the powers of the General Partner that such Liquidator deems necessary or desirable in its good faith judgment in connection therewith, liquidate the Partnership's assets and apply the proceeds of the liquidation as provided in "Cash Distribution Policy--Distributions of Cash upon Liquidation During the Subordination Period" and "--Distributions of Cash upon Liquidation After the Subordination Period." Under certain circumstances and subject to 156 certain limitations, the Liquidator may defer liquidation or distribution of the Partnership's assets for a reasonable period of time or distribute assets to partners in kind if it determines that a sale would be impractical or would cause undue loss to the partners. REGISTRATION RIGHTS Pursuant to the terms of the Amended and Restated Partnership Agreement and subject to certain limitations described therein, the Partnership has agreed (i) to register for resale under the Securities Act and applicable state securities laws any Units proposed to be sold by the General Partner or its affiliates (upon their request) if an exemption from such registration requirements is not otherwise available for such proposed transaction and (ii) to register for resale under the Securities Act and applicable state securities laws the Common Units and Senior Subordinated Units issued to affiliates of Petro in the Transaction (upon their request if an exemption from such registration requirements is not otherwise available for such proposed transaction), and to use its best efforts to keep such registration statement effective for one year, subject to certain exceptions and to such requesting party providing necessary information. The Partnership is obligated to pay all expenses incidental to such registration, excluding underwriting discounts and commissions. 157 CASH DISTRIBUTION POLICY The following discussion gives effect to the adoption of the Amendment Proposal. GENERAL In general, the Partnership distributes to its partners on a quarterly basis, all its Available Cash in the manner described herein. "Available Cash" is defined in the Glossary and generally means, with respect to any fiscal quarter of the Partnership, all cash on hand at the end of such quarter less the amount of cash reserves that are necessary or appropriate in the reasonable discretion of the General Partner to (i) provide for the proper conduct of the Partnership's business, (ii) comply with applicable law or any Partnership debt instrument or other agreement or (iii) in certain circumstances provide funds for distributions to the Common Unitholders and the Senior Subordinated Unitholders during the next four quarters. The General Partner may not establish cash reserves for distributions to the Senior Subordinated Units unless the General Partner has determined that in its judgment the establishment of reserves will not prevent the Partnership from distributing the Minimum Quarterly Distribution on all Common Units and any Common Unit Arrearages thereon with respect to the next four quarters. The restrictions, discussed below, on distributions on Senior Subordinated Units, Junior Subordinated Units and General Partner Units could result in cash that would otherwise be Available Cash being reserved for other purposes. Cash distributions will be characterized as distributions from either Operating Surplus or Capital Surplus. This distinction affects the amounts distributed among different classes of Units. See "--Quarterly Distributions of Available Cash." Operating Surplus as currently defined generally refers to (i) the cash balance of the Partnership on the date the Partnership commenced operations, plus approximately $16 million, plus all cash receipts of the Partnership (excluding cash receipts constituting Capital Surplus), less (ii) all Partnership operating expenses (including expenses of the General Partner incurred on behalf of the Partnership), debt service payments, maintenance capital expenditures and reserves established for future Partnership operations; provided, however, that Operating Surplus is calculated without any reduction for costs or expenses incurred in connection with the Transaction. Capital Surplus will generally be generated only by borrowings (other than for working capital purposes), sales of debt and equity securities and sales or other dispositions of assets for cash (other than inventory, accounts receivable and other assets, all as disposed of in the ordinary course of business). To avoid the difficulty of trying to determine whether Available Cash distributed by the Partnership is from Operating Surplus or Capital Surplus, all Available Cash distributed by the Partnership from any source will be treated as distributed from Operating Surplus until the sum of all Available Cash distributed since the commencement of the Partnership equals the Operating Surplus as of the end of the quarter prior to such distribution. Any excess Available Cash (irrespective of its source) will be deemed to be Capital Surplus and distributed accordingly. If Capital Surplus is distributed in respect of each Initial Common Unit in an aggregate amount per Unit equal to $22.00 per Common Unit (the "Initial Unit Price"), the distinction between 158 Operating Surplus and Capital Surplus will cease, and all distributions will be treated as from Surplus. The General Partner does not expect that there will be significant distributions from Capital Surplus. The Senior Subordinated Units and the Junior Subordinated Units are each a separate class of interests in the Partnership, and the rights of holders of such interests to participate in distributions Operating differ from the rights of the holders of Common Units. When issued, the Class B Common Units will also be a separate class of interests in the Partnership. QUARTERLY DISTRIBUTIONS OF AVAILABLE CASH The Partnership will make distributions to its partners with respect to each fiscal quarter of the Partnership prior to liquidation in an amount equal to all of its Available Cash for such quarter. Distributions will be made approximately 45 days after each March 31, June 30, September 30 and December 31, to holders of record on the applicable record date. If the Partnership meets certain tests set forth in the Amended and Restated Partnership Agreement, the first distribution permitted to be paid to the holders of the Senior Subordinated Units issued in the Transaction will be paid with respect to the quarter ending June 30, 1999 and will be paid on or about August 15, 1999 to holders of record on or about July 31, 1999. Such distribution, if paid, will include a pro rata distribution for the period between the Effective Time and March 31, 1999. The first distribution on the Common Units (including those issued in the Equity Offering) subsequent to the Effective Time will be paid with respect to the quarter ending March 31, 1999 on or about May 15, 1999 to holders of record on or about May 4, 1999 regardless of how many days such Common Units have been outstanding. For a discussion of certain restrictions on distributions to the holders of subordinated interests, see "--Limitation on Distributions of Subordinated Interests." Upon expiration of the Subordination Period, all Senior Subordinated Units and Junior Subordinated Units will be converted (on a one-for-one basis) into Class B Common Units (all references herein to Common Units after the expiration of the Subordination Period are deemed to be references to Class A Common Units and Class B Common Units, collectively, unless otherwise indicated) and distributions on the General Partner Units will no longer be subordinated to distributions on the Common Units. Neither Class A Common Units nor Class B Common Units will accrue arrearages for any quarter after the Subordination Period, and Senior Subordinated Units, Junior Subordinated Units and General Partner Units will not accrue any arrearages with respect to distributions for any quarter. The Minimum Quarterly Distribution and the Target Distribution Levels are subject to adjustment as described below under "--Distributions from Capital Surplus" and "--Adjustment of Minimum Quarterly Distribution and Target Distribution Levels." DISTRIBUTIONS OF AVAILABLE CASH FROM OPERATING SURPLUS DURING THE SUBORDINATION PERIOD The Subordination Period will generally extend until the first day of any quarter beginning on or after July 1, 2002 in respect of which (i) distributions of Available Cash from Operating Surplus on the Common Units, Senior Subordinated Units, Junior Subordinated Units and General Partner Units equaled or exceeded the sum of the Minimum Quarterly Distributions on all of the outstanding 159 Common Units, Senior Subordinated Units, Junior Subordinated Units and General Partner Units with respect to each of the three non-overlapping four-quarter periods immediately preceding such date, (ii) the Adjusted Operating Surplus generated during each of the three immediately preceding non-overlapping four- quarter periods equaled or exceeded the sum of the Minimum Quarterly Distributions on all of the outstanding Common Units, Senior Subordinated Units, Junior Subordinated Units and General Partner Units during such periods on a fully diluted basis with respect to employee options or other employee incentive compensation (i.e., taking into account for purposes of such determination all outstanding Common Units, Senior Subordinated Units, Junior Subordinated Units and General Partner Units and all Common Units issuable upon exercise of employee options that have, as of the date of determination, already vested or are scheduled to vest prior to the end of the quarter immediately following the quarter with respect to which determination is made, and all Units that have as of the date of determination been earned by but not yet issued to management of the Partnership in respect of incentive compensation) and (iii) there are no arrearages in payment of the Minimum Quarterly Distribution on the Common Units. In certain circumstances, if the General Partner is removed other than for Cause, the Subordination Period will end, the existing arrearages on the Common Units will terminate and the Senior Subordinated Units and the Junior Subordinated Units will immediately convert into Class B Common Units and distributions on the General Partner Units will no longer be subordinated. See "The Amended and Restated Partnership Agreement--Withdrawal or Removal of the General Partner; Approval of Successor General Partner." Distributions by the Partnership of Available Cash from Operating Surplus with respect to any quarter during the Subordination Period will be made in the following manner: first, 100% to the Common Units, pro rata, until there has been distributed in respect of each Common Unit an amount equal to the Minimum Quarterly Distribution for such quarter; second, 100% to the Common Units, pro rata, until there has been distributed in respect of each Common Unit an amount equal to any Cumulative Common Unit Arrearages on each Common Unit with respect to any prior quarter; third, 100% to the Senior Subordinated Units, pro rata, until there has been distributed in respect of each Senior Subordinated Unit an amount equal to the Minimum Quarterly Distribution for such quarter; fourth, 100% to the Junior Subordinated Units and General Partner Units, pro rata, until there has been distributed in respect of each Junior Subordinated Unit and General Partner Unit an amount equal to the Minimum Quarterly Distribution for such quarter; and thereafter, in the manner described in "--Incentive Distributions During the Subordination Period" below. At the Effective Time, the General Partner will have a 1.99% general partner interest in the Partnership in the form of General Partner Units and a 0.01% general partner interest in the Operating Partnership. References in this Proxy Statement to distributions on the General Partner Units disregard the General Partners' 0.01% general partner interest in the Operating Partnership. 160 DISTRIBUTIONS OF AVAILABLE CASH FROM OPERATING SURPLUS AFTER THE SUBORDINATION PERIOD Distributions by the Partnership of Available Cash from Operating Surplus with respect to any quarter after the Subordination Period will be made in the following manner: first, 100% to all Units, pro rata, until there has been distributed in respect of each Unit an amount equal to the Minimum Quarterly Distribution for such quarter; and thereafter, in the manner described in "--Incentive Distributions After the Subordination Period" below. INCENTIVE DISTRIBUTIONS DURING THE SUBORDINATION PERIOD For any quarter for which Available Cash from Operating Surplus is distributed in respect of each of the Common Units, Senior Subordinated Units, Junior Subordinated Units and General Partner Units in an amount equal to the Minimum Quarterly Distribution and Available Cash has been distributed on outstanding Common Units in such amount as may be necessary to eliminate any Cumulative Common Unit Arrearages, then any additional Available Cash from Operating Surplus in respect of such quarter will be distributed among the Units in the following manner: first, 100% to all Units, pro rata, until each Unit has received (in addition to any distributions to the Common Units to eliminate any Cumulative Common Unit Arrearages) a total of $0.604 per Unit for such quarter in respect of each Unit (the "First Target Distribution"); second, 86.7% to all Units, pro rata, and 13.3% to all Senior Subordinated Units, Junior Subordinated Units and General Partner Units, pro rata, until the Common Units have received (in addition to any distributions to Common Unitholders to eliminate any Cumulative Common Unit Arrearages) a total of $0.711 per Unit for such quarter in respect of each Common Unit (the "Second Target Distribution"); third, 76.5% to all Units, pro rata, and 23.5% to all Senior Subordinated Units, Junior Subordinated Units and General Partner Units, pro rata, until the Common Units have received (in addition to any distributions to Common Unitholders to eliminate any Cumulative Common Unit Arrearages and) a total of $0.926 per Unit for such quarter in respect of each Common Unit (the "Third Target Distribution"); and thereafter, 51.0% to all Units, pro rata, and 49.0% to all Senior Subordinated Units, Junior Subordinated Units and General Partner Units, pro rata. The Amended and Restated Partnership Agreement may not be amended (including in connection with the issuance of additional partnership securities) in any manner which would increase the aggregate amount of incentive distributions without the approval of a majority of the outstanding Units of the classes that would be adversely affected. The following table illustrates the percentage of Available Cash from Operating Surplus distributed as the Minimum Quarterly Distribution ("Base Distributions") pro rata to all Unitholders and the percentage of Available Cash distributed to the holders of Senior Subordinated Units, Junior Subordinated Units and General Partner Units as incentive distributions ("Incentive Distributions") 161 at the Target Distribution Levels. The percentages set forth in the table below are the percentage interests of the Unitholders in Available Cash from Operating Surplus distributed up to and including the corresponding amount in the column "Quarterly Distribution Amount per Common Unit" until Available Cash distributed reaches the next Target Distribution Level, if any. The percentage allocation of Incentive Distributions among Senior Subordinated Units, Junior Subordinated Units and General Partner Units, will change in the future if there are additional non pro rata issuances of such Units. The following table illustrates the distribution of Available Cash per Unit among the Common Units, Senior Subordinated Units, Junior Subordinated Units and General Partner Units at the Target Distribution Levels. The calculations are based on the assumption that the quarterly distribution amounts shown do not include any Cumulative Common Unit Arrearages.
PERCENTAGE OF AVAILABLE CASH DISTRIBUTED AS INCENTIVE DISTRIBUTIONS TO THE SPECIFIED UNIT CLASS --------------------------------- - PERCENTAGE OF PERCENTAGE OF QUARTERLY AVAILABLE CASH AVAILABLE CASH DISTRIBUTION DISTRIBUTED AS DISTRIBUTED AS SENIOR JUNIOR GENERAL AMOUNT PER BASE INCENTIVE SUBORDINATED SUBORDINATED PARTNER COMMON UNIT DISTRIBUTIONS DISTRIBUTIONS UNITS UNITS UNITS ------------ -------------- -------------- ------------ ------------ ------- Minimum Quarterly Distribution........... $0.575 100.0% -- -- -- -- First Target Distribution........... 0.604 100.0% -- -- -- -- Second Target Distribution........... 0.711 86.7% 13.3% 10.2% 2.1% 1.0% Third Target Distribution........... 0.926 76.5% 23.5% 18.0% 3.7% 1.8% Thereafter.............. -- 51.0% 49.0% 37.4% 7.8% 3.8% INCENTIVE DISTRIBUTIONS AFTER THE SUBORDINATION PERIOD For any quarter for which Available Cash from Operating Surplus is distributed in respect of each of the Class A Common Units, the Class B Common Units and General Partner Units in an amount equal to the Minimum Quarterly Distribution, then any additional Available Cash from Operating Surplus in respect of such quarter will be distributed among the Unitholders in the following manner: first, 100% to all Units, pro rata, until the Units have received the First Target Distribution; second, 86.7% to all Units, pro rata, and 13.3% to all Class B Common Units and General Partner Units, pro rata, until the Class A Common Units have received the Second Target Distribution; third, 76.5% to all Units, pro rata, and 23.5% to all Class B Common Units and General Partner Units, pro rata, until the Class A Common Units have received the Third Target Distribution; and 162
QUARTERLY DISTRIBUTION AMOUNT ---------------------------------------- SENIOR JUNIOR GENERAL COMMON SUBORDINATED SUBORDINATED PARTNER UNIT UNIT UNIT UNIT ------ ------------ ------------ ------- Minimum Quarterly Distribution........ $0.575 $0.575 $0.575 $0.575 First Target Distribution............. 0.604 0.604 0.604 0.604 Second Target Distribution............ 0.711 0.774 0.774 0.774 Third Target Distribution............. 0.926 1.243 1.243 1.243 thereafter, 51% to all Units, pro rata, and 49% to all Class B Common Units and General Partner Units, pro rata. The following table illustrates the distribution of Available Cash per Unit among the Class A Common Units, Class B Common Units and General Partner Units at the Target Distribution Levels. DISTRIBUTIONS FROM CAPITAL SURPLUS Distributions by the Partnership of Available Cash from Capital Surplus will be made 100% on all Units, pro rata, until the Partnership shall have distributed, in respect of each Initial Common Unit, Available Cash from Capital Surplus in an aggregate amount per Initial Common Unit equal to the Initial Unit Price. Thereafter, all distributions from Capital Surplus will be distributed as if they were from Operating Surplus. When a distribution is made from Capital Surplus, it is treated as if it were a repayment of the Initial Unit Price. To reflect such repayment, the Minimum Quarterly Distribution and the Target Distribution Levels will be adjusted downward by multiplying each such amount by a fraction, the numerator of which is the Unrecovered Initial Unit Price immediately after giving effect to such repayment and the denominator of which is the Unrecovered Initial Unit Price immediately prior to such repayment. For example, based on the Unrecovered Initial Unit Price of $22.00 per Unit and assuming Available Cash from Capital Surplus of $11.00 per Unit is distributed on all Initial Common Units (assuming no prior adjustments), then the amount of the Minimum Quarterly Distribution and the Target Distribution Levels would each be reduced to 50% of its initial level. When "payback" of the Initial Unit Price has occurred, i.e., when the Unrecovered Initial Unit Price is zero, then in effect the Minimum Quarterly Distribution and the Target Distribution Levels each will have been reduced to zero. Thereafter, all distributions of Available Cash from all sources will be treated as if they were from Operating Surplus and, because the Minimum Quarterly Distribution and the Target Distribution Levels will have been reduced to zero, the holders of the Incentive Distributions will be entitled with respect to such rights to receive 50% of all distributions of Available Cash after distributions in respect of Cumulative Common Unit Arrearages. Distributions from Capital Surplus will not reduce the Minimum Quarterly Distribution or any of the Target Distribution Levels for the quarter with respect to which they are distributed. LIMITATION ON DISTRIBUTIONS ON SUBORDINATED INTERESTS With respect to the time period beginning on the Effective Time and ending on June 30, 1999, the Partnership may make a distribution of Available Cash on the Senior Subordinated Units, Junior Subordinated Units and General Partner Units in an amount up to the Minimum Quarterly 163
QUARTERLY DISTRIBUTION --------------------- CLASS CLASS A B GENERAL COMMON COMMON PARTNER UNIT UNIT UNIT ------ ------ ------- Minimum Quarterly Distribution............................ $0.575 $0.575 $0.575 First Target.............................................. 0.604 0.604 0.604 Second Target............................................. 0.711 0.774 0.774 Third Target.............................................. 0.926 1.243 1.243 Distribution for such period to the extent the sum of EBITDA, less interest, less taxes and less maintenance capital expenditures consolidated (combined from October 1, 1998 until the Effective Time) for the Partnership and Petro ("Adjusted Distributable Cash") for the time period beginning October 1, 1998 and ending on June 30, 1999 exceeds the sum of (i) $57,172,000, plus or minus (ii) the product of (A) $0.60 and (B) the amount by which the number of Common Units outstanding on the record date for the distribution of Available Cash with respect to the quarter ending December 31, 1998, exceeds or is less than 10,544,000, plus or minus (iii) the product of (A) $0.60 and (B) the amount by which the number of Common Units outstanding on the record date for the distribution of Available Cash with respect to the quarter ending March 31, 1999 exceeds or is less than 10,544,000, plus or minus (iv) the product of (A) $0.60 and (B) the amount by which the number of Common Units outstanding on the record date for the distribution of Available Cash with respect to the quarter ending June 30, 1999, exceeds or is less than 10,544,000. With respect to the quarter ending September 30, 1999, the Partnership may make a distribution of Available Cash on the Senior Subordinated Units, Junior Subordinated Units and General Partner Units to the extent the Adjusted Distributable Cash for the time period beginning October 1, 1998 and ending on September 30, 1999 exceeds the sum of (i) $25,307,000 plus or minus (ii) the product of (A) $0.60 and (B) the amount by which the number of Common Units outstanding on the record date for the distribution of Available Cash with respect to the quarter ending December 31, 1998, exceeds or is less than 10,544,000, plus or minus (iii) the product of (A) $0.60 and (B) the amount by which the number of Common Units outstanding on the record date for the distribution of Available Cash with respect to the quarter ending March 31, 1999, exceeds or is less than 10,544,000, plus or minus (iv) the product of (A) $0.60 and (B) the amount by which the number of Common Units outstanding on the record date for the distribution of Available Cash with respect to the quarter ending June 30, 1999, exceeds or is less than 10,544,000, plus or minus (v) the product of (A) $0.60 and (B) the amount by which the number of Common Units outstanding on the record date for the distribution of Available Cash with respect to the quarter ending September 30, 1999, exceeds or is less than 10,544,000. Beginning with the distribution for the quarter ending on December 31, 1999, no distributions will be made on the Senior Subordinated Units, Junior Subordinated Units or General Partner Units, except for distributions from Capital Surplus, unless the aggregate amount of distributions on all Units with respect to all quarters, beginning with the quarter ended December 31, 1999, shall be equal to or less than the total Operating Surplus generated by the Partnership since October 1, 1999 (which does not include the portion of Operating Surplus included in clause (a) (i) of the definition of Operating Surplus). 164 The holders of the Senior Subordinated Units, Junior Subordinated Units and General Partner Units are not prohibited from receiving distributions from Capital Surplus in a partial liquidation during the Subordination Period. ADJUSTMENT OF MINIMUM QUARTERLY DISTRIBUTION AND TARGET DISTRIBUTION LEVELS In addition to adjustments made upon a distribution of Available Cash from Capital Surplus, the Minimum Quarterly Distribution, the Target Distribution Levels, the Unrecovered Initial Unit Price, the number of additional Common Units issuable during the Subordination Period without a Unitholder vote, the number of Class B Common Units issuable upon conversion of the Senior Subordinated Units and the Junior Subordinated Units and other amounts calculated on a per Unit basis will be proportionately adjusted upward or downward, as appropriate, in the event of any combination or subdivision of Common Units (whether effected by a distribution payable in Common Units or otherwise), but not by reason of the issuance of additional Units for cash or property. For example, in the event of a two-for-one split of the Common Units (assuming no prior adjustments), the Minimum Quarterly Distribution, the Target Distribution Levels and the Unrecovered Initial Unit Price would each be reduced to 50% of its initial level. The Minimum Quarterly Distribution and Target Distribution Levels may also be adjusted if legislation is enacted or if existing law is modified or interpreted by the relevant governmental authority in a manner that causes the Partnership to become taxable as a corporation or otherwise subjects the Partnership to taxation as an entity for federal, state or local income tax purposes. In such event, the Minimum Quarterly Distribution and Target Distribution Levels for each quarter thereafter would be reduced to amounts equal to the product of (i) the respective Minimum Quarterly Distribution or Target Distribution Level multiplied by (ii) one minus the sum of (x) the maximum marginal federal income tax rate to which the Partnership is then subject as an entity plus (y) any increase in the effective overall state and local income tax rate to which the Partnership is subject as a result of the new imposition of the entity level tax (after taking into account the benefit of any deduction allowable for federal income tax purposes with respect to the payment of state and local income taxes). For example, assuming the Partnership was not previously subject to state and local income tax, if the Partnership were to become taxable as an entity for federal income tax purposes and the Partnership became subject to a maximum marginal federal, and effective state and local, income tax rate of 38%, then the Minimum Quarterly Distribution and the Target Distribution Levels would each be reduced to 62% of the amount thereof immediately prior to such adjustment. ISSUANCE OF ADDITIONAL SENIOR SUBORDINATED UNITS The Amended and Restated Partnership Agreement provides that for each full non-overlapping four-quarter period ending on or after the first anniversary of the Effective Time, but prior to the fifth anniversary of the Effective Time, in which the dollar amount of Petro Adjusted Operating Surplus (as defined hereinafter) per Petro Unit (as defined hereinafter) equals or exceeds $2.90, the Partnership will issue 303,000 Senior Subordinated Units (or 303,000 Class B Common Units if such issuance occurs after the end of the Subordination Period) to the holders of the Senior Subordinated Units, Junior Subordinated Units and the General Partner Units on the record date in respect of the distribution for the final quarter of such four-quarter period, pro rata; provided that the Partnership may not issue more than 909,000 Senior Subordinated Units or Class B Common Units in the 165 aggregate pursuant to this provision; provided, further, that the Partnership may not issue more than 303,000 Senior Subordinated Units or Class B Common Units pursuant to this provision in any 365-day period. No fractional Senior Subordinated Units will be issued by the Partnership in connection with the issuance of the additional Units. The Partnership shall pay to each holder who would otherwise be entitled to a fractional Senior Subordinated Unit an amount in cash to be paid in lieu of such fractional Units determined by multiplying such fraction by the Current Market Price of a Senior Subordinated Unit or a Class B Common Unit as the case may be, as of the date three days prior to issuance of the additional Units. On the first day after the record date for distributions with respect to the first quarter ending on or after the fifth anniversary of the Effective Time, the right to receive the additional Units shall lapse and all conversion rights shall cease to exist. "Petro Adjusted Operating Surplus" means, with respect to any four-quarter period, the Adjusted Operating Surplus generated by Petro (which for purposes of this definition includes all subsidiaries of the Partnership primarily engaged in the home heating oil business) during such four quarter period, as determined in good faith by a majority of the members of the Board of Directors of the General Partner (with the concurrence of the Audit Committee). In calculating Petro Adjusted Operating Surplus, (i) debt service (including the payment of principal, interest and premium) on all debt incurred or assumed by Petro or any of its affiliates, the proceeds of which are used by or for the benefit of Petro (including the proceeds from the Debt Offering), shall be included to the extent such debt service is included in the calculation of Operating Surplus, and (ii) debt service (including the payment of principal, interest and premium) on all debt incurred or assumed by Petro or any of its affiliates, the proceeds of which are not used by or for the benefit of Petro, shall be excluded. "Petro Units", with respect to any date, means the sum of (i) the excess of the number of Units outstanding at the Effective Time over the number of Units outstanding immediately prior to the Effective Time (assuming the simultaneous closing of the Equity Offering), (ii) the number of Units issued by the Partnership thereafter to the extent the net proceeds of which are contributed to Petro (which for purposes hereof includes all subsidiaries of the Partnership primarily engaged in the home heating oil business), (iii) the number of Senior Subordinated Units or Class B Common Units issued pursuant to the Amended and Restated Partnership Agreement based on the performance of Petro and (iv) the deemed number of Units outstanding based upon a contribution of capital to Petro by the Partnership or any affiliate thereof after the Effective Time (which contribution is not covered by (ii) above or traceable to debt proceeds), which number of deemed Units is obtained by dividing (A) the amount of such contribution by (B) the Current Market Price of a Common Unit (or of a Class A Common Unit after the termination of the Subordination Period). If Petro pays down debt of Petro or debt allocated to Petro from internally generated funds of Petro and if those internally generated funds exist at Petro only because Petro has not paid dividends up to the Partnership in an amount equal to the distributions that would have been paid on the Petro Units had they been actual outstanding Units of the Partnership, then the amount used to pay down such debt will be treated as if it were contributed to Petro by the Partnership. The distribution per Senior Subordinated Unit of the Partnership shall be the amount that the Partnership would have been deemed to have distributed per Petro Unit had they been actual outstanding Units of the Partnership. For purposes of the number of deemed outstanding Units in (iv) above, such Units shall be deemed to be issued on the date of such Capital Contribution. For this purpose, Common Unit means Class A Common Units upon expiration of the Subordination Period. 166 The terms upon which any of the said additional Units may be issued may not be amended in a manner that would materially adversely affect the rights of the holders thereof without the affirmative vote of the holders of a majority of the outstanding Senior Subordinated Units, Junior Subordinated Units and General Partner Units, voting together as a single class. DISTRIBUTIONS OF CASH UPON LIQUIDATION DURING THE SUBORDINATION PERIOD Following the commencement of the dissolution and liquidation of the Partnership, assets will be sold or otherwise disposed of and the partners' capital account balances will be adjusted to reflect any resulting gain or loss. The proceeds of such liquidation will, first, be applied to the payment of creditors of the Partnership in the order of priority provided in the Amended and Restated Partnership Agreement and by law and, thereafter, be distributed on the Units in accordance with respective capital account balances, as so adjusted. Partners are entitled to liquidation distributions in accordance with capital account balances. Although operating losses are allocated on all Units pro rata, the allocations of gains and losses attributable to liquidation are intended to entitle the holders of outstanding Common Units to a preference over the holders of outstanding Senior Subordinated Units, Junior Subordinated Units and General Partner Units upon the liquidation of the Partnership, to the extent of the Unrecovered Initial Unit Price plus any Cumulative Common Unit Arrearages. However, no assurance can be given that there will be sufficient gain upon liquidation of the Partnership to enable the holders of Common Units to fully recover all of such amounts, even though there may be cash available for distribution to the holders of Senior Subordinated Units and Junior Subordinated Units. The manner of such adjustment is provided in the Amended and Restated Partnership Agreement, which is attached hereto as Annex C. If the liquidation of the Partnership occurs before the end of the Subordination Period, any gain (or unrealized gain attributable to assets distributed in kind) will be allocated to the partners as follows: first, to the Partners that have negative balances in their capital accounts, to the extent of and in proportion to, such negative balances; second, 100% to the Common Units, pro rata, until the capital account for each Common Unit is equal to the Unrecovered Initial Unit Price in respect of such Common Unit (plus the amount of the Minimum Quarterly Distribution for the fiscal quarter during which the dissolution occurs) plus any Cumulative Common Unit Arrearages in respect of such Common Units; third, 100% to the Senior Subordinated Units, pro rata, until the capital account for each Senior Subordinated Unit is equal to the Unrecovered Initial Unit Price (plus the amount of the Minimum Quarterly Distribution for the fiscal quarter during which the dissolution occurs) in respect of a Senior Subordinated Unit; fourth, 100% to the Junior Subordinated Units and General Partner Units, pro rata, until the Capital Account for each Junior Subordinated Unit is equal to the Unrecovered Initial Unit Price (plus the amount of the Minimum Quarterly Distribution for the fiscal quarter during which the dissolution occurs) in respect of a Junior Subordinated Unit; 167 fifth, 100% to all Units, pro rata, until there has been allocated under this clause fifth an amount per Common Unit equal to (a) the excess of the First Target Distribution per Unit over the then effective Minimum Quarterly Distribution per Unit for each quarter of the Partnership's existence, less (b) the amount per Common Unit of any distributions of Available Cash from Operating Surplus in excess of the then effective Minimum Quarterly Distribution per Unit that was distributed 100% to all Units, pro rata, for each quarter of the Partnership's existence; sixth, 86.7% to all Units, pro rata, 13.3% to Senior Subordinated Units, Junior Subordinated Units and General Partner Units, pro rata, until there has been allocated under this clause sixth an amount per Common Unit equal to (a) the excess of the Second Target Distribution per Common Unit over the First Target Distribution per Common Unit for each quarter of the Partnership's existence, less (b) the amount per Common Unit of any distributions of Available Cash from Operating Surplus in excess of the First Target Distribution but not in excess of the Second Target Distribution for each quarter of the Partnership's existence; seventh, 76.5% to all Units, pro rata, and 23.5% to all Senior Subordinated Units, Junior Subordinated Units and General Partner Units, pro rata, until there has been allocated under this clause seventh an amount per Common Unit equal to (a) the excess of the Third Target Distribution per Common Unit over the Second Target Distribution per Common Unit for each quarter of the Partnership's existence, less (b) the amount per Common Unit of any distributions of Available Cash from Operating Surplus in excess of the Second Target Distribution but not in excess of the Third Target Distribution for each quarter of the Partnership's existence; and thereafter, 51.0% to all Units, pro rata, and 49.0% to all Senior Subordinated Units, Junior Subordinated Units and General Partner Units, pro rata. Any loss or unrealized loss will be allocated to the Unitholders as follows: first, 100% to the Junior Subordinated Units and General Partner Units, pro rata, in proportion to the positive balances in their respective capital accounts until the positive balances in their respective capital accounts have been reduced to zero; second, 100% to the Senior Subordinated Units in proportion to the positive balances in their respective capital accounts until the positive balances in their respective capital accounts have been reduced to zero; third, 100% to the Common Units in proportion to the positive balances in their respective capital accounts Units until the positive balances in the respective capital accounts have been reduced to zero; and thereafter, to the General Partner Units. DISTRIBUTIONS OF CASH UPON LIQUIDATION AFTER THE SUBORDINATION PERIOD. If the liquidation of the Partnership occurs after the end of the Subordination Period, any gain (or unrealized gain attributable to assets distributed in kind) will be allocated to the partners as follows: first, to the Partners that have negative balances in their capital accounts to the extent of and in proportion to such negative balances; second, 100% to all Class A Common Units and Class B Common Units, until the capital account for each Class A Common Unit and Class B Common Unit is equal to the Unrecovered Initial Unit Price in respect of such Unit (plus the amount of the Minimum Quarterly Distribution for the fiscal quarter during which the dissolution occurs; 168 third, 100% to all Units, pro rata, until there has been allocated under this clause third an amount per Class A Common Unit equal to (a) the excess of the First Target Distribution per Class A Common Unit over the then effective Minimum Quarterly Distribution for each quarter of the Partnership's existence, less (b) the amount per Class A Common Unit of any distributions of Available Cash from Operating Surplus in excess of the then effective Minimum Quarterly Distribution per Class A Common Unit that was distributed 100% to Units, pro rata, for each quarter of the Partnership's existence; fourth, 86.7% to all Units, pro rata, and 13.3% to Class B Common Units and General Partner Units, pro rata, until there has been allocated under this clause four an amount per Class A Common Unit equal to (a) the excess of the Second Target Distribution per Class A Common Unit over the First Target Distribution per Class A Common Unit for each quarter of the Partnership's existence, less (b) the amount per Class A Common Unit of any distributions of Available Cash from Operating Surplus in excess of the First Target Distribution but not in excess of the Second Target Distribution for each quarter of the Partnership's existence; fifth, 76.5% to all Units, pro rata, and 23.5% to Class B Common Units and General Partner Units, pro rata, until there has been allocated under this clause five an amount per Class A Common Unit equal to (a) the excess of the Third Target Distribution per Class A Common Unit over the Second Target Distribution per Class A Common Unit for each quarter of the Partnership's existence, less (b) the amount per Class A Common Unit of any distributions of Available Cash from Operating Surplus in excess of the Second Target Distribution but not in excess the Third Target Distribution for each quarter of the Partnership's existence; and thereafter, 51.0% to all Units, pro rata, and 49.0% to all Class B Common Units and General Partner Units, pro rata. Any loss or unrealized loss will be allocated to the General Partner Units, the Class A Common Units, Class B Common Units, pro rata, in proportion to the positive balances in their respective capital accounts, until the positive balances in the respective capital accounts have been reduced to zero. Interim adjustments to Capital Accounts will be made at the time the Partnership issues additional interests in the Partnership or makes distributions of property. Such adjustments will be based on the fair market value of the interests issued or the property distributed and any gain or loss resulting therefrom will be allocated to the Unitholders in the same manner as gain or loss is allocated upon liquidation. 169 CASH AVAILABLE FOR DISTRIBUTION The Partnership believes that it will generate sufficient Available Cash from Operating Surplus for the first four-quarter period following the Effective Time to cover the full Minimum Quarterly Distribution for such four-quarter on all then outstanding Units. Even if such amount is generated, the Partnership may, however, not distribute such cash. In particular, the Partnership may distribute less than the Minimum Quarterly Distribution on the Senior Subordinated Units, Junior Subordinated Units and General Partner Units because of the subordination provisions and other limitations on distributions in the Amended and Restated Partnership Agreement. The Partnership's belief about the amount of cash it may generate is based on a number of assumptions, including the assumptions that normal weather conditions will prevail in the Partnership's and Petro's operating areas, that the Partnership's and Petro's operating margins will remain constant and that market and overall economic conditions will not change substantially. Although the Partnership believes its assumptions are within a range of reasonableness, most of the assumptions are not within the control of the Partnership and cannot be predicted with any degree of certainty. For example, in any particular year or even series of years, weather may deviate substantially from normal. Therefore, certain of the Partnership's assumptions may prove to be inaccurate. As a result, the Operating Surplus of the Partnership could deviate from that currently expected. See "Risk Factors." The amount of Available Cash constituting Operating Surplus needed to pay the Minimum Quarterly Distribution for four quarters on the Common Units, Senior Subordinated Units, Junior Subordinated Units and General Partner Units to be outstanding immediately after the Effective Time (assuming no exercise of the underwriters' overallotment option in the Equity Offering) is approximately $32.1 million ($23.8 million for the Common Units, $6.4 million for the Senior Subordinated Units, $1.3 million for the Junior Subordinated Units and $0.6 million for the General Partner Units). After giving pro forma effect to the Transaction, the amount of pro forma Available Cash constituting Operating Surplus generated during the twelve months ended September 30, 1997, would have been approximately $28.3 million, which excludes non-recurring restructuring, corporate identity and pension curtailment expenses of approximately $7.6 million. The pro forma results for such period also do not reflect certain cost savings that Petro implemented in fiscal 1998. See "Unaudited Pro Forma Condensed Consolidated Financial Information." The Partnership is required to establish reserves for the future payment of principal and interest on the First Mortgage Notes and the indebtedness under the Bank Credit Facilities. There are other provisions in such agreements that will, under certain circumstances, restrict the Partnership's ability to make distributions to its partners. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Description of Indebtedness" in the Partnership's Annual Report on Form 10-K for the fiscal year ended September 30, 1997 and in the Partnership's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998 which are incorporated herein by reference. The Petro Holdings Senior Subordinated Debt is expected to have provisions that will, under certain circumstances, similarly restrict the Partnership's ability to make distributions to its Unitholders. 170 DESCRIPTION OF THE UNITS This discussion gives effect to the adoption of the Amendment Proposal. The Common Units and Senior Subordinated Units to be issued in connection with the Transaction have been registered under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and the rules and regulations promulgated thereunder, and the Partnership is subject to the reporting and certain other requirements of the Exchange Act. The Partnership is required to file periodic reports containing financial and other information with the Securities and Exchange Commission ("SEC" or the "Commission"). Common Stockholders who receive Common Units or Senior Subordinated Units in connection with the Transaction and subsequent transferees of Common Units and Senior Subordinated Units (or their brokers, agents or nominees on their behalf) will be required to execute Transfer Applications, the form of which is included as Appendix A to this Proxy Statement and which is also set forth on the reverse side of the certificate representing Common Units and Senior Subordinated Units. Unitholders may hold Common Units and Senior Subordinated Units in nominee accounts, provided that the broker (or other nominee) executes and delivers a Transfer Application and becomes a limited partner. The Partnership will be entitled to treat the nominee holder of a Common Unit or a Senior Subordinated Unit as the absolute owner thereof, and the beneficial owner's rights will be limited solely to those that it has against the nominee holder as a result of or by reason of any understanding or agreement between such beneficial owner and nominee holder. THE UNITS Generally, the Common Units, Senior Subordinated Units and Junior Subordinated Units represent limited partner interests in the Partnership, which entitle the holders thereof to participate in Partnership distributions and exercise the rights or privileges available to limited partners under the Amended and Restated Partnership Agreement. For a description of the relative rights and preferences of holders of Common Units, Senior Subordinated Units and Junior Subordinated Units in and to Partnership distributions, together with a description of the circumstances under which Senior Subordinated Units and Junior Subordinated Units may convert into Class B Common Units, see "Cash Distribution Policy." For a description of the rights and privileges of limited partners under the Amended and Restated Partnership Agreement, see "The Amended and Restated Partnership Agreement." TRANSFER AGENT AND REGISTRAR The Partnership has retained BankBoston N.A. as registrar and transfer agent (the "Transfer Agent") for the Common Units and the Senior Subordinated Units. The Transfer Agent receives a fee from the Partnership for serving in such capacities. All fees charged by the Transfer Agent for transfers of Common Units and Senior Subordinated Units will be borne by the Partnership and not by the holders of Common Units or Senior Subordinated Units, except that fees similar to those customarily paid by stockholders for surety bond premiums to replace lost or stolen certificates, taxes and other governmental charges, special charges for services requested by a holder of a Common Unit or a Senior Subordinated Unit and other similar fees or charges will be borne by the affected 171 holder. There will be no charge to holders for disbursements of the Partnership's cash distributions. The Partnership will indemnify the Transfer Agent, its agents and each of their respective common stockholders, directors, officers and employees against all claims and losses that may arise out of acts performed or omitted in respect of its activities as such, except for any liability due to any negligence, gross negligence, bad faith or intentional misconduct of the indemnified person or entity. The Transfer Agent may at any time resign, by notice to the Partnership, or be removed by the Partnership, such resignation or removal to become effective upon the appointment by the General Partner of a successor transfer agent and registrar and its acceptance of such appointment. If no successor has been appointed and accepted such appointment within 30 days after notice of such resignation or removal, the General Partner is authorized to act as the transfer agent and registrar until a successor is appointed. TRANSFER OF UNITS Until a Common Unit, a Senior Subordinated Unit or a Junior Subordinated Unit has been transferred on the books of the Partnership, the Partnership and the Transfer Agent, notwithstanding any notice to the contrary, may treat the record holder thereof as the absolute owner for all purposes, except as otherwise required by law or stock exchange regulations. Any transfers of a Common Unit or a Senior Subordinated Unit will not be recorded by the Transfer Agent or recognized by the Partnership unless the transferee executes and delivers a Transfer Application. By executing and delivering a Transfer Application, the transferee of Common Units, Senior Subordinated Units or Junior Subordinated Units (i) becomes the record holder of such Units and shall be constituted as an assignee until admitted into the Partnership as a substituted limited partner, (ii) automatically requests admission as a substituted limited partner in the Partnership, (iii) agrees to be bound by the terms and conditions of, and executes, the Amended and Restated Partnership Agreement, (iv) represents that such transferee has the capacity, power and authority to enter into the Amended and Restated Partnership Agreement, (v) grants powers of attorney to the General Partner and any liquidator of the Partnership as specified in the Amended and Restated Partnership Agreement and (vi) makes the consents and waivers contained in the Amended and Restated Partnership Agreement. An assignee will become a substituted limited partner of the Partnership in respect of the transferred Common Units or Senior Subordinated Units upon satisfaction of the following two conditions: the consent of the General Partner, which may be withheld for any reason in its sole discretion, and the recordation of the name of the assignee on the books and records of the Partnership. Common Units and Senior Subordinated Units are securities and are transferable according to the laws governing transfer of securities. In addition to other rights acquired upon transfer, the transferor gives the transferee the right to request admission as a substituted limited partner in the Partnership in respect of the transferred Common Units or Senior Subordinated Units. A purchaser or transferee of Common Units or Senior Subordinated Units who does not execute and deliver a Transfer Application obtains only (a) the right to assign the Common Unit or Senior Subordinated Units to a purchaser or other transferee and (b) the right to transfer the right to seek admission as a substituted limited partner in the Partnership with respect to the transferred Common Units or Senior Subordinated Units. Thus, a purchaser or transferee of Common Units who does not execute and deliver a Transfer Application will not receive cash distributions unless the Common Units or Senior 172 Subordinated Units are held in a nominee or "street name" account and the nominee or broker has executed and delivered a Transfer Application with respect to such Common Units or Senior Subordinated Units, and may not receive certain federal income tax information or reports furnished to record holders of Common Units or Senior Subordinated Units. The transferor of Common Units or Senior Subordinated Units will have a duty to provide such transferee with all information that may be necessary to obtain registration of the transfer of the Common Units or Senior Subordinated Units, but a transferee agrees, by acceptance of the certificate representing Common Units or Senior Subordinated Units, that the transferor will not have a duty to insure the execution of the Transfer Application by the transferee and will have no liability or responsibility if such transferee neglects or chooses not to execute and forward the Transfer Application to the Transfer Agent. See "The Amended and Restated Partnership Agreement--Status as Limited Partner or Assignee." 173 COMPARISON OF SECURITIES The following comparison explains the material differences between the attributes of Class A Common Stock that will be replaced with Senior Subordinated Units. The summary is necessarily incomplete, and reference is hereby made to the Amended and Restated Partnership Agreement, a copy of which is attached hereto as Annex C and to "Certain Federal Income Tax Considerations." TAXATION Class A Common Stock Senior Subordinated Units Taxable income is realized by the The holders of the Senior holders of Class A Common Stock when Subordinated Units will be required Petro makes actual distributions out to report their share of the of current or accumulated earnings Partnership's income, gains, losses or, in other cases, if distributions and deductions in their federal exceed the holder's basis in such income tax return whether or not stock. distributions are made to them. In general, cash distributions on the Senior Subordinated Units will themselves be taxable only if, and to the extent that, they exceed the holder's tax basis in the Senior Subordinated Units. DISTRIBUTIONS AND DIVIDENDS Class A Common Stock Senior Subordinated Units Shares of Class A Common Stock are The Senior Subordinated Units entitled to a pro rata share of any generally are entitled to receive dividends declared by the Petro quarterly distributions from Board to be made from funds legally Available Cash during the available therefor; provided, that Subordination Period after the no dividends may be paid on the Common Units receive the Minimum shares of Class A Common Stock Quarterly Distribution plus any until, with respect to the 1989 arrearages thereon. The Senior Preferred Stock and the New Subordinated Units have the right to Preferred Stock, all dividends have receive the Minimum Quarterly been paid (or declared and set Distribution before any distribution apart) and all mandatory redemption is made on the Junior Subordinated requirements have been satisfied. Units and the General Partner Units. No distribution can be paid on Senior Subordinated Units unless the Partnership meets certain cash generation requirements. In addition, the Senior Subordinated United have the right to receive distributions in addition to the Minimum Quarterly Distribution if quarterly distributions of Available Cash exceed the Target Distribution Levels. 174 VOTING RIGHTS Class A Common Stock Senior Subordinated Units The holders of shares of Class A All Units have limited voting rights Common Stock are entitled to one on matters affecting the vote per share on all matters partnership. The matters that submitted to the Common do require Unitholder approval Stockholders. Generally, for passage generally require the approval of or adoption of actions that require the holders of a Unit Majority, a vote of the Common Stockholders, a which prior to the expiration of the majority of each class of stock Subordination Period, includes the represented at the meeting is approval of a majority of the Senior required. The Petro Restated Subordinated Units and Junior Articles of Incorporation do not Subordinated Units voting together provide for cumulative voting. as a single class as well as the approval of a majority of the Common Units. Unitholders in the Partnership do not elect the directors of the General Partner. RIGHTS TO CALL MEETINGS Class A Common Stock Senior Subordinated Units Petro is required to hold an annual The Partnership does not have annual stockholders meeting each year. meetings. A meeting of Unitholders Special meetings of the stockholders may be called only by the General may be called (and business proposed Partner or by the holders of 20% or at such meetings) by the Chairman more of the outstanding Units of the of the Petro Board or by the class for which the meeting is Secretary upon the written request proposed. of a majority of the total number of Directors that Petro would have if there were no vacancies. REMOVAL OF DIRECTORS OR THE GENERAL PARTNER Class A Common Stock Senior Subordinated Units The business and affairs of Petro The business and affairs of the are managed by or under the Partnership are managed by or under direction of the Petro Board, whose the direction of the General members are elected by a plurality Partner. Subject to certain of the votes cast by stockholders. conditions, the General Partner may Stockholders may remove a director be removed upon the approval of the or the entire Petro Board with or holders of at least 66 2/3% of without cause, and such removal the outstanding Units (excluding requires the affirmative vote of a Units owned by the General Partner majority of the outstanding voting and its affiliates). stock. 175 LIQUIDATION RIGHTS Senior Subordinated Units Class A Common Stock In the event of any liquidation of In the event of any complete the Partnership during the liquidation, dissolution or winding Subordination Period, the Senior up of the business of Petro, each Subordinated Units will be entitled Class B Share would be entitled to a to receive a distribution out of the distribution equal to $5.70 per net assets of the Partnership after share, as adjusted, before any liquidating distributions are made distribution is made with respect to on the Common Units. The Senior any other class of Petro Stock. Subordinated Units will be entitled Thereafter, each share of 1989 to receive a distribution out of the Preferred Stock and each share of net assets of the Partnership in Public Preferred Stock would be preference to liquidating entitled to distributions equal to distributions on the Junior $100 per share and $23 per share, Subordinated Units and General respectively, plus accrued and Partner Units. unpaid dividends. Thereafter, each share of Junior Convertible Preferred Stock would be entitled to a distribution of $0.10 per share. Thereafter, each share of Class A Common Stock, Class B Share, Class C Common Stock and Junior Convertible Preferred Stock would participate equally in all liquidating distributions. CONVERSION RIGHTS Class A Common Stock Senior Subordinated Units The Class A Common Stock is not The Senior Subordinated Units will convertible into any other security. convert into Class B Common Units upon the expiration of the Subordination Period. The Subordination Period will extend until the first day of any quarter beginning July 1, 2002 in respect of which certain amounts of Available Cash were distributed and earned in previous quarters. LIABILITY OF HOLDERS Class A Common Stock Senior Subordinated Units The liability of a holder of Class A So long as a holder of a Senior Common Stock for the debts and Subordinated Unit does not obligations of Class A Common Stock participate in the control of the is limited to such holders' business of the Partnership and acts investment in the stock. All Class A in accordance with the Amended and Common Stock is fully paid and non- Restated Partnership Agreement, assessable. liability is limited to the holder's investment in the Senior Subordinated Units. Except under limited exceptions, all Senior Subordinated Units are fully paid and non-assessable. 176 TRANSFERABILITY AND LISTING Class A Common Stock Senior Subordinated Units Shares of Class A Common Stock are The Senior Subordinated Units are freely transferrable and are quoted freely transferable and listed on on the Nasdaq National Market. the New York Stock Exchange. REDEMPTION Class A Common Stock Senior Subordinated Units There are no redemption rights with If at any time not more than 20% of respect to shares of Class A Common the then issued and outstanding Stock. limited partner interests of any class are held by persons other than the General Partner and its affiliates, the General Partner will have the right, which it may assign to an affiliate or the Partnership, to acquire all, but not less than all, of the remaining limited partner interests of such class. If at any time after the expiration of the Subordination Period the Partnership acquires, through purchase or exchange, in a twelve- month period, 66 2/3% or more of the total Class B Common Units, the Partnership shall have the right, which it may not assign, to purchase all, but not less than all, of the remaining Class B Common Units of such class during the following twelve-month period. APPRAISAL RIGHTS Class A Common Stock Senior Subordinated Units Under Sections 302A.471 and 302A.473 The holders of the Senior of the MBCA, set forth in full as Subordinated Units (as well as the Annex F to this Proxy Statement, holders of all other Units) are not Common Stockholders (other than who entitled to dissenters' rights under have agreed to vote for the the Amended and Restated Partnership Acquisition Proposal or who have Agreement or applicable Delaware law granted irrevocable powers to Petro in the event of a merger or to vote for the Transaction at the consolidation of the Partnership, or Special Meeting) have the right to a sale, exchange or other dissent, and obtain payment of the disposition of substantially all of "fair value" of their shares, in the the Partnership's assets. event of certain corporate actions such as the Transaction. 177 PREEMPTIVE RIGHTS Class A Common Stock Senior Subordinated Units Holders of Class A Common Stock have The holders of the Senior no preemptive rights, rights to Subordinated Units do not have maintain their respective percentage preemptive rights with respect to ownership interests or other rights the issuance of any securities of to subscribe for additional Petro the Partnership. Stock. INSPECTION OF BOOKS, RECORDS AND LIST OF HOLDERS Class A Common Stock Senior Subordinated Units Under Section 302A.461 of the MBCA, So long as there exists a purpose any stockholder, in person or by reasonably related to a limited attorney or other agent, has the partner's interest, the holders of right, upon written demand under Senior Subordinated Units may, upon oath stating the purpose thereof, reasonable demand and at their own during the usual hours of business expense, have furnished to them (i) to inspect for any proper purpose a current list of the name and last the corporation's stock ledger, a known address of each partner, (ii) list of its stockholders, and its a copy of the Partnership's tax other books and records, and to make returns, (iii) certain information copies or extracts therefrom. A with respect to the value of proper purpose means a purpose contributions to the Partnership, reasonably related to such person's (iv) copies of the Amended and interest as a stockholder. Restated Partnership Agreement, certificate of limited partnership and powers of attorney, (v) information regarding the status of the Partnership's business and financial condition and (vi) such other information regarding the affairs of the Partnership as is just and reasonable. 178 COMPARATIVE SECURITY PRICE AND DISTRIBUTION INFORMATION PARTNERSHIP SECURITIES Common Units. Since May 29, 1998, the Common Units have been listed and traded on the New York Stock Exchange under the symbol "SGU." From December 20, 1995 through May 28, 1998, the Common Units were listed on the Nasdaq National Market. The following table sets forth the closing high and low sales prices per Common Unit on the Nasdaq National Market through May 28, 1998 and thereafter on the New York Stock Exchange and the cash distributions declared per Common Unit for the periods indicated. - -------- (a) From October 1, 1998 through October 20, 1998. (b) The General Partner announced on October 21, 1998 its intention to pay Common Unitholders a cash distribution of $0.55 per Unit for the three months ended September 30, 1998 to be paid on November 13, 1998 to Common Unitholders of record as of November 3, 1998. On August 13, 1998, the last full trading day prior to the public announcement of the proposed Transaction, the closing sales price of the Common Units was $21.063 on the NYSE. On October 20, 1998, the closing sales price of the Common Units was $21.000. Subordinated Units. There is no trading market for the Partnership's 2,396,078 Subordinated Units, all of which are held by Star Gas. Senior Subordinated Units. There are no Senior Subordinated Units outstanding as of the date of this Proxy Statement. Junior Subordinated Units. There are no Junior Subordinated Units outstanding as of the date of this Proxy Statement. 179
1999 1998 1997 -------------------------------- -------------------------- -------------------------- FISCAL CASH CASH CASH QUARTER ENDED HIGH LOW DISTRIBUTION HIGH LOW DISTRIBUTION HIGH LOW DISTRIBUTION ------------- --------- --------- ------------ ------ ------ ------------ ------ ------ ------------ December 31,............ $21.00(a) $18.13(a) -- $23.88 $20.50 $0.55 $23.88 $21.75 $0.55 March 31,............... -- -- -- 24.75 21.38 0.55 24.63 20.75 0.55 June 30,................ -- -- -- 23.00 20.50 0.55 21.88 19.00 0.55 September 30,........... -- -- -- 21.00 18.13 0.55(b) 23.50 21.00 0.55 PETRO CAPITAL STOCK Class A Common Stock. Shares of Class A Common Stock are listed and traded on the Nasdaq National Market under the symbol "HEAT". The following table sets forth the last reported high and low sale prices per share of Class A Common Stock and dividends declared on shares of Class A Common Stock for the periods indicated: - -------- (a) From October 1, 1998 through October 20, 1998. (b) Petro declared a dividend of $.075 per share of Class A Common Stock which was paid on January 2, 1998 to holders of record on December 15, 1997. On February 24, 1998, Petro announced that it will suspend its regularly scheduled quarterly common stock dividend and that it did not expect to pay common stock dividends for the remainder of the year. In arriving at this decision, the Petro Board considered the impact of unusually warm winter weather on its earnings and cash flow, as well as a variety of other facts. On August 13, 1998, the last full trading day prior to the public announcement of the proposed Transaction, the closing sales price of the Class A Common Stock was $1.875 on the Nasdaq National Market. The last sale price of the Class A Common Stock on October 20, 1998 was $1.000 per share. As of , 1998, Petro had holders of record of Class A Common Stock. Class C Common Stock. There is no established trading market for Class C Common Stock. As of , 1998, Petro had holders of record of Class C Common Stock. Public Preferred Stock. There is no established trading market for the Public Preferred Stock. As of , 1998, Petro had holders of record of Public Preferred Stock. Private Preferred Stock. There is no established trading market for the Private Preferred Stock. As of , 1998, Petro had holders of record of the Private Preferred Stock. Junior Convertible Preferred Stock. There is no established trading market for the Junior Convertible Preferred Stock. As of , 1998, Petro had holders of record of Junior Convertible Preferred Stock. 180
1998 1997 1996 ------------------------------- ----------------------- ----------------------- FISCAL QUARTER ENDED HIGH LOW DIVIDENDS HIGH LOW DIVIDENDS HIGH LOW DIVIDENDS - -------------------- ------ ------- --------- ------ ------ --------- ------ ------ --------- March 31,............. $ 3 $1 7/16 $0.075(b) $6 3/4 $3 3/8 $0.075 $8 1/4 $6 1/2 $0.15 June 30,.............. 2 1/16 1 1/2 -- 3 7/8 2 1/2 0.075 7 3/4 6 1/2 0.15 September 30,......... 2 1/16 1 5/16 -- 3 1/2 2 5/8 0.075 7 3/4 6 1/4 0.15 December 31,.......... 1 3/8 (a) 15/16 (a) -- 3 1/2 2 1/8 0.075 7 3/4 5 5/8 0.15 COMPARATIVE PER SHARE/PER UNIT INFORMATION (UNAUDITED) The following table sets forth, for Units and shares of Class A Common Stock, certain historical, pro forma and pro forma equivalent per Unit financial information for the latest fiscal years of the Partnership and Petro, the latest interim periods of the Partnership and Petro and the pro forma results as of and for the nine months ended June 30, 1998. The pro forma data do not purport to be indicative of the results of future operations or the results that would have occurred had the Transaction been consummated on October 1, 1997. This information should be read in conjunction with and is qualified in its entirety by the financial statements and accompanying notes of the Partnership and Petro included in the documents described under "Incorporation of Certain Documents By Reference" and the pro forma combined financial statements and accompanying discussion and notes set forth under "Unaudited Pro Forma Condensed Consolidated Financial Statements." - -------- (a) For the fiscal year ended September 30, 1997. (b) For the fiscal year ended December 31, 1997. (c) For the fiscal year ended September 30, 1997. (d) For the nine months ended June 30, 1998. (e) For the six months ended June 30, 1998. (f) For the nine months ended June 30, 1998. (g) As of September 30, 1997. (h) As of December 31, 1997. (i) As of June 30, 1998. (j) Per Unit limited partner interest. (k) Per share of Common Stock. 181
FISCAL YEAR ENDED INTERIM PERIODS ------------------------------------------------ ------------------------------------------------ HISTORICAL PRO FORMA HISTORICAL PRO FORMA PARTNERSHIP(A)(J) PETRO(B)(K) EQUIVALENT(C)(J) PARTNERSHIP(D)(J) PETRO(E)(K) EQUIVALENT(F)(J) ----------------- ----------- ---------------- ----------------- ----------- ---------------- Net Income.............. $0.37 $(1.06) $(0.02) $ 0.79 $ 0.06 $ 2.29 Cash Distributions...... $2.20 $ 0.30 $ 2.20 $ 2.20 $ 0.00 $ 1.65 Book Value.............. $9.59(g) $ (6.76)(h) -- $10.39(i) $(6.61)(i) $16.05(i) CERTAIN FEDERAL INCOME TAX CONSIDERATIONS This section is a summary of material tax considerations that may be relevant to prospective Unitholders and, to the extent set forth below under "Legal Opinions and Advice," expresses the opinion of Andrews & Kurth L.L.P., special counsel to the General Partner and the Partnership ("Counsel"), insofar as it relates to matters of law and legal conclusions. This section is based upon current provisions of the Code, existing and proposed regulations thereunder and current administrative rulings and court decisions, all of which are subject to change with and without retroactive effect. Subsequent changes in such authorities may cause the tax consequences to vary substantially from the consequences described below. Unless the context otherwise requires, references in this section to the Partnership are references to both the Partnership and the Operating Partnership. No attempt has been made in the following discussion to comment on all federal income tax matters affecting the Partnership or the Unitholders. Moreover, the discussion focuses on Unitholders who are individual citizens or residents of the United States and has only limited application to corporations, estates, trusts, non-resident aliens or other Unitholders subject to specialized tax treatment (such as tax-exempt institutions, foreign persons, individual retirement accounts, REITs or mutual funds). Accordingly, each prospective Unitholder should consult, and should depend on, his own tax advisor in analyzing the federal, state, local and foreign tax consequences peculiar to him of the ownership or disposition of Units. TAX CONSEQUENCES OF THE MERGER The Merger will be a taxable transaction to the Petro Common Stockholders generally resulting in gain or loss to each such holder in an amount equal to the difference between the value of the Senior Subordinated Units received by him and the federal income tax basis he has in the shares exchanged for Senior Subordinated Units. The gain or loss will be capital gain or loss if the stock is held by the Common Stockholder as a capital asset and will be long-term gain or loss if such stock has been held for more than one year. Long-term capital gain will generally be taxed at a maximum rate of 20%. Capital losses can be deducted against capital gains and thereafter against ordinary income to the extent of $3,000 per year for individuals with any unused capital loss being carried forward indefinitely. Net capital gain of foreign holders of Common Stock should generally not be subject to United States federal income tax. Common Stockholders participating in the Merger will have a basis in their Senior Subordinated Units equal to the fair market value of such Units at the time of the Merger and their holding period will begin on the day after the Merger. Counsel has not rendered any opinion with respect to these matters. The Merger will also result in gain to Petro equal to the excess of the value of the Senior Subordinated Units distributed to the Common Stockholders in the Merger and any debt relief over the federal income tax basis of such Units to Petro. Although it is expected by Petro that such gain will generally be offset by Petro's NOLs, the NOLs are subject to challenge by the IRS. The Corporate Group does not anticipate that it will pay significant federal income tax at the outset; however, over time more federal income tax will be paid by the Corporate Group. The Corporate Group's ability to reduce income for federal income tax purposes is dependent on depreciation deductions and interest deductions with respect to certain debt, all of which is subject to scrutiny by the IRS. Counsel has not rendered any opinion with respect to these matters. 182 TAX CONSEQUENCES OF UNIT OWNERSHIP Legal Opinions and Advice. Counsel is of the opinion that, based on the representations and subject to the qualifications set forth in the detailed discussion that follows, for federal income tax purposes (i) the Partnership and the Operating Partnership have been and will each be treated as a partnership and (ii) owners of Units (with certain exceptions, as described in "Limited Partner Status" below) will be treated as partners of the Partnership (but not the Operating Partnership). In addition, all statements as to matters of law and legal conclusions contained in this section, unless otherwise noted, reflect the opinion of Counsel. No ruling has been or will be requested from the IRS with respect to classification of the Partnership as a Partnership for federal income tax purposes, whether the Partnership's operations generate "qualifying income" under Section 7704 of the Code or any other matter affecting the Partnership or prospective Unitholders. An opinion of counsel represents only that counsel's best legal judgment and does not bind the IRS or the courts. Thus, no assurance can be provided that the opinions and statements set forth herein would be sustained by a court if contested by the IRS. Any such contest with the IRS may materially and adversely impact the market for the Units and the prices at which Units trade. In addition, the costs of any contest with the IRS will be borne directly or indirectly by the Unitholders and the General Partner. Furthermore, no assurance can be given that the treatment of the Partnership or an investment therein will not be significantly modified by future legislative or administrative changes or court decisions. Any such modifications may or may not be retroactively applied. For the reasons hereinafter described, Counsel has not rendered an opinion with respect to the following specific federal income tax issues: (i) the treatment of a Unitholder whose Units are loaned to a short seller to cover a short sale of Units (see "--Tax Treatment of Operations--Treatment of Short Sales"), (ii) whether a Unitholder acquiring Units in separate transactions must maintain a single aggregate adjusted tax basis in his Units (see "-- Disposition of Units--Recognition of Gain or Loss"), (iii) whether the Partnership's monthly convention for allocating taxable income and losses is permitted by existing Treasury Regulations (see "--Disposition of Units-- Allocations Between Transferors and Transferees"), (iv) whether the Partnership's method for depreciating Section 743 adjustments is sustainable (see "--Tax Treatment of Operations--Section 754 Election") and (v) whether the allocations of recapture income contained in the Partnership Agreement will be respected (see "--Allocation of Partnership Income, Gain, Loss and Deduction"). Tax Rate. The top marginal income tax rate for individuals for 1998 is 39.6%. Net capital gains of an individual are generally subject to a maximum 20% tax rate if the asset was held for more than 12 months at the time of disposition. Partnership Status. A partnership is not a taxable entity and incurs no federal income tax liability. Instead, each partner is required to take into account his allocable share of items of income, gain, loss and deduction of the partnership in computing his federal income tax liability, regardless of whether cash distributions are made. Distributions by a partnership to a partner are generally not taxable unless the amount of cash distributed is in excess of the partner's adjusted basis in his partnership interest. 183 No ruling has been or will be sought from the IRS as to the status of the Partnership or the Operating Partnership as a partnership for federal income tax purposes. Instead, the Partnership has relied on the opinion of Counsel that, based upon the Code, the regulations thereunder, published revenue rulings and court decisions and certain representations set forth below, the Partnership and the Operating Partnership have been and will each be classified as a partnership for federal income tax purposes. In rendering its opinion, Counsel has relied on certain factual representations made by the Partnership and the General Partner. Such factual matters for taxable years beginning before December 31, 1996 are as follows: (a) With respect to the Partnership and the Operating Partnership, the General Partner, at all times while acting as general partner of the relevant partnership, had a net worth, computed on a fair market value basis, excluding its interest in the Partnership and the Operating Partnership and any notes or receivables due from such partnerships, equal to at least $6.0 million; (b) The Partnership has been operated in accordance with (i) all applicable partnership statutes, (ii) the Partnership Agreement and (iii) the description thereof in this Proxy Statement; (c) The Operating Partnership has been operated in accordance with (i) all applicable partnership statutes, (ii) the limited partnership agreement for the Operating Partnership and (iii) the description thereof in this Proxy Statement; (d) The General Partner has at all times acted independently of the Limited Partners; and (e) For each taxable year, less than 10% of the gross income of the Partnership has been derived from sources other than (i) the exploration, development, production, processing, refining, transportation or marketing of any mineral or natural resource, including oil, gas or products thereof, or (ii) other items of qualifying income within the meaning of Section 7704(d) of the Code. Such factual matters for taxable years beginning after December 31, 1996 are as follows: (a) Neither the Partnership nor the Operating Partnership has elected, or will elect, to be treated as an association or corporation; (b) The Partnership has been and will be operated in accordance with (i) all applicable partnership statutes, (ii) the Partnership Agreement, and (iii) the description thereof in this Prospectus; (c) The Operating Partnership has been and will be operated in accordance with (i) all applicable partnership statutes, (ii) the Operating Partnership Agreement, and (iii) the description thereof in this Prospectus; and (d) For each taxable year, more than 90% of the gross income of the Partnership has been and will be (i) derived from the exploration, development, production, processing, refining, transportation or marketing of any mineral or natural resource, including oil, gas or products thereof; or (ii) other items of "qualifying income" within the meaning of Section 7704(d) of the Code. 184 Section 7704 of the Code provides that publicly-traded partnerships will, as a general rule, be taxed as corporations. However, an exception (the "Qualifying Income Exception") exists with respect to publicly-traded partnerships of which 90% or more of the gross income for every taxable year consists of "qualifying income." Qualifying income includes interest (from other than a financial business), dividends and income and gains from the transportation and marketing of crude oil, natural gas, and products thereof, including the retail and wholesale marketing of propane and the transportation of propane and natural gas liquids. Based upon the representations of the Partnership and the General Partner and a review of the applicable legal authorities, Counsel is of the opinion that least 90% of the Partnership's gross income will constitute qualifying income. The Partnership estimates that less than % of its gross income for each taxable year will not constitute qualifying income. If the Partnership fails to meet the Qualifying Income Exception (other than a failure that is determined by the IRS to be inadvertent and is cured within a reasonable time after discovery), the Partnership will be treated as if it had transferred all of its assets (subject to liabilities) to a newly formed corporation (on the first day of the year in which it fails to meet the Qualifying Income Exception) in return for stock in that corporation, and then distributed that stock to the partners in liquidation of their interests in the Partnership. This contribution and liquidation should be tax-free to Unitholders and the Partnership, so long as the Partnership, at that time, does not have liabilities in excess of the tax basis of its assets. Thereafter, the Partnership would be treated as a corporation for federal income tax purposes. If the Partnership or the Operating Partnership were treated as an association taxable as a corporation in any taxable year, either as a result of a failure to meet the Qualifying Income Exception or otherwise, its items of income, gain, loss and deduction would be reflected only on its tax return rather than being passed through to the Unitholders, and its net income would be taxed to the Partnership or the Operating Partnership at corporate rates. In addition, any distribution made to a Unitholder would be treated as either taxable dividend income (to the extent of the Partnership's current or accumulated earnings and profits) or (in the absence of earnings and profits) a nontaxable return of capital (to the extent of the Unitholder's tax basis in his Units) or taxable capital gain (after the Unitholder's tax basis in the Units is reduced to zero). Accordingly, treatment of either the Partnership or the Operating Partnership as an association taxable as a corporation would result in a material reduction in a Unitholder's cash flow and after-tax return and thus would likely result in a substantial reduction of the value of the Units. The discussion below is based on the assumption that the Partnership will be classified as a Partnership for federal income tax purposes. Limited Partner Status. Unitholders who have become limited partners of the Partnership will be treated as partners of the Partnership for federal income tax purposes. Counsel is of the opinion that (a) assignees who have executed and delivered Transfer Applications, and are awaiting admission as limited partners and (b) Unitholders whose Units are held in street name or by a nominee and who have the right to direct the nominee in the exercise of all substantive rights attendant to the ownership of their Units will be treated as partners of the Partnership for federal income tax purposes. As there is no direct authority addressing assignees of Units who are entitled to execute and deliver Transfer Applications and thereby become entitled to direct the exercise of 185 attendant rights, but who fail to execute and deliver Transfer Applications, Counsel's opinion does not extend to these persons. (Furthermore, a purchaser or other transferee of Units who does not execute and deliver a Transfer Application may not receive certain federal income tax information or reports furnished to record holders of Units unless the Units are held in a nominee or street name account and the nominee or broker has executed and delivered a Transfer Application with respect to such Units.) A beneficial owner of Units whose Units have been transferred to a short seller to complete a short sale would appear to lose his status as a partner with respect to such Units for federal income tax purposes. See "--Tax Treatment of Operations--Treatment of Short Sales." Income, gain, deductions or losses would not appear to be reportable by a Unitholder who is not a partner for federal income tax purposes, and any cash distributions received by such a Unitholder would therefore be fully taxable as ordinary income. These holders should consult their own tax advisors with respect to their status as partners in the Partnership for federal income tax purposes. Flow-through of Taxable Income. No federal income tax will be paid by the Partnership. Instead, each Unitholder will be required to report on his income tax return his allocable share of the income, gains, losses and deductions of the Partnership without regard to whether corresponding cash distributions are received by such Unitholder. Consequently, a Unitholder may be allocated income from the Partnership even if he has not received a cash distribution. Each Unitholder will be required to include in income his allocable share of Partnership income, gain, loss and deduction for the taxable year of the Partnership ending with or within the taxable year of the Unitholder. Although Petro Holdings and Petro do not expect that either Petro Holdings or Petro will pay significant federal income tax for some period of time, it is possible that Petro Holdings may generate earnings and profits during that time such that distributions from Petro Holdings to the Partnership may result in taxable dividend income to the Partnership and, thus, to the Unitholders. Counsel has not rendered any opinion with respect to these matters. Treatment of Partnership Distributions. Distributions by the Partnership to a Unitholder generally will not be taxable to the Unitholder for federal income tax purposes to the extent of his tax basis in his Units immediately before the distribution. Cash distributions in excess of a Unitholder's tax basis generally will be considered to be gain from the sale or exchange of the Units, taxable in accordance with the rules described under "Disposition of Units" below. Any reduction in a Unitholder's share of the Partnership's liabilities for which no partner, including the General Partner, bears the economic risk of loss ("nonrecourse liabilities") will be treated as a distribution of cash to that Unitholder. To the extent that Partnership distributions cause a Unitholder's "at risk" amount to be less than zero at the end of any taxable year, he must recapture any losses deducted in previous years. See "-- Limitations on Deductibility of Partnership Losses." A decrease in a Unitholder's percentage interest in the Partnership because of the issuance by the Partnership of additional Units will decrease such Unitholder's share of nonrecourse liabilities of the Partnership, and thus will result in a corresponding deemed distribution of cash. A non-pro rata distribution of money or property may result in ordinary income to a Unitholder, regardless of his tax 186 basis in his Units, if such distribution reduces the Unitholder's share of the Partnership's "unrealized receivables" (including depreciation recapture) and/or substantially appreciated "inventory items" (both as defined in Section 751 of the Code) (collectively, "Section 751 Assets"). To that extent, the Unitholder will be treated as having been distributed his proportionate share of the Section 751 Assets and having exchanged such assets with the Partnership in return for the non-pro rata portion of the actual distribution made to him. This latter deemed exchange will generally result in the Unitholder's realization of ordinary income under Section 751(b) of the Code. Such income will equal the excess of (1) the non-pro rata portion of such distribution over (2) the Unitholder's tax basis for the share of such Section 751 Assets deemed relinquished in the exchange. Ratio of Taxable Income to Distributions. The Partnership estimates that a holder who acquires Units through the Transaction and holds such Units through December 31, 2001, will be allocated, on a cumulative basis, an amount of federal taxable income for such period that will be less than 15% of the cash distributed with respect to that period. The Partnership further estimates that for taxable years after the taxable year ending December 31, 2001, the taxable income allocable to the Unitholders will constitute a significantly higher percentage of cash distributed to Unitholders. The foregoing estimates are based upon the assumption that gross income from operations will approximate the amount required to make the Minimum Quarterly Distribution with respect to all Units and other assumptions with respect to capital expenditures, cash flow and anticipated cash distributions. These estimates and assumptions are subject to, among other things, numerous business, economic, regulatory, competitive and political uncertainties beyond the control of the Partnership. Further, the estimates are based on current tax law and certain tax reporting positions that the Partnership intends to adopt and with which the IRS could disagree. Accordingly, no assurance can be given that the estimates will prove to be correct. The actual percentage could be higher or lower, and any such differences could be material and could materially affect the value of the Units. Consummation of the Transaction and related transactions will result in an increased allocation of taxable income to the Common Unitholders as a percentage of cash being distributed although the Partnership expects that suspended losses will be available to offset such income for some period of time. Counsel has not rendered any opinion with respect to this matter. Basis of Units. A person who acquires his Units pursuant to the Transaction will generally have an initial tax basis for his Units equal to the fair market value of the Units received. A holder's basis will be increased by his share of Partnership income and by any increases in his share of Partnership nonrecourse liabilities. That basis will be decreased (but not below zero) by distributions from the Partnership, by the Unitholder's share of Partnership losses, by any decrease in his share of Partnership nonrecourse liabilities and by his share of expenditures of the Partnership that are not deductible in computing its taxable income and are not required to be capitalized. A limited partner will have no share of Partnership debt which is recourse to the General Partner, but will have a share, generally based on his share of profits, of Partnership nonrecourse liabilities. See "--Disposition of Units--Recognition of Gain or Loss." Limitations on Deductibility of Partnership Losses. The deduction by a Unitholder of his share of Partnership losses will be limited to the tax basis in his Units and, in the case of an individual Unitholder or a corporate Unitholder (if more than 50% of the value of its stock is owned directly or 187 indirectly by five or fewer individuals or certain tax-exempt organizations), to the amount for which the Unitholder is considered to be "at risk" with respect to the Partnership's activities, if that is less than the Unitholder's tax basis. A Unitholder must recapture losses deducted in previous years to the extent that Partnership distributions cause the Unitholder's at risk amount to be less than zero at the end of any taxable year. Losses disallowed to a Unitholder or recaptured as a result of these limitations will carry forward and will be allowable to the extent that the Unitholder's tax basis or "at risk" amount (whichever is the limiting factor) is subsequently increased. Upon the taxable disposition of a Unit, any gain recognized by a Unitholder can be offset by losses that were previously suspended by the at risk limitation but may not be offset by losses suspended by the basis limitation. Any excess loss (above such gain) previously suspended by the at risk or basis limitations is no longer utilizable. In general, a Unitholder will be at risk to the extent of the tax basis of his Units, excluding any portion of that basis attributable to his share of Partnership nonrecourse liabilities, reduced by any amount of money the Unitholder borrows to acquire or hold his Units if the lender of such borrowed funds owns an interest in the Partnership, is related to such a person or can look only to Units for repayment. A Unitholder's at risk amount will increase or decrease as the tax basis of the Unitholder's Units increases or decreases (other than tax basis increases or decreases attributable to increases or decreases in his share of Partnership nonrecourse liabilities). The passive loss limitations generally provide that individuals, estates, trusts and certain closely-held corporations and personal service corporations can deduct losses from passive activities (generally, activities in which the taxpayer does not materially participate) only to the extent of the taxpayer's income from those passive activities. The passive loss limitations are applied separately with respect to each publicly-traded partnership. Consequently, any passive losses generated by the Partnership will only be available to offset future passive income generated by the Partnership and will not be available to offset income from other passive activities or investments (including other publicly-traded companies), interest and dividend income generated by the Partnership, such as dividends from the Corporate Group, or salary or active business income. Passive losses which are not deductible because they exceed a Unitholder's income generated by the Partnership may be deducted in full when he disposes of his entire investment in the Partnership in a fully taxable transaction to an unrelated party. The passive activity loss rules are applied after other applicable limitations on deductions such as the at risk rules and the basis limitation. A Unitholder's share of net income from the Partnership may be offset by any suspended passive losses from the Partnership, but it may not be offset by any other current or carryover losses from other passive activities, including those attributable to other publicly-traded companies. The IRS has announced that Treasury Regulations will be issued that characterize net passive income from a publicly-traded partnership as investment income for purposes of the limitations on the deductibility of investment interest. Limitations on Interest Deductions. The deductibility of a non-corporate taxpayer's "investment interest expense" is generally limited to the amount of such taxpayer's "net investment income." As noted, a Unitholder's net passive income from the Partnership will be treated as investment income for this purpose. In addition, the Unitholder's share of the Partnership's portfolio income will be treated as investment income. Investment interest expense includes (i) interest on 188 indebtedness properly allocable to property held for investment, (ii) the Partnership's interest expense attributed to portfolio income, and (iii) the portion of interest expense incurred to purchase or carry an interest in a passive activity to the extent attributable to portfolio income. The computation of a Unitholder's investment interest expense will take into account interest on any margin account borrowing or other loan incurred to purchase or carry a Unit. Net investment income includes gross income from property held for investment and amounts treated as portfolio income pursuant to the passive loss rules less deductible expenses (other than interest) directly connected with the production of investment income, but generally does not include gains attributable to the disposition of property held for investment. ALLOCATION OF PARTNERSHIP INCOME, GAIN, LOSS AND DEDUCTION In general, if the Partnership has a net profit, items of income, gain, loss and deduction will be allocated among the General Partner and the Unitholders in accordance with their respective percentage interests in the Partnership. At any time that distributions are made to the Common Units and not to the Senior Subordinated Units or Junior Subordinated Units, or that Incentive Distributions are made to holders of Senior Subordinated Units, Junior Subordinated Units or General Partner Units or to holders of Senior Subordinated Units and not to Junior Subordinated Units or General Partner Units, gross income will be allocated to the recipients to the extent of such distributions. If the Partnership has a net loss, items of income, gain, loss and deduction will generally be allocated first, to the General Partner and the Unitholders in accordance with their respective Percentage Interests to the extent of their positive capital accounts (as maintained under the Partnership Agreement) and, second, to the General Partner. As required by Section 704(c) of the Code and as permitted by Regulations thereunder, certain items of Partnership income, deduction, gain and loss will be allocated to account for the difference between the tax basis and fair market value of property contributed or deemed contributed to the Partnership by each of the partners ("Contributed Property"). The effect of these allocations to a Unitholder will be essentially the same as if the tax basis of the Contributed Property were equal to their fair market value at the time of contribution or deemed contribution. In addition, certain items of recapture income will be allocated to the extent possible to the partner allocated the deduction giving rise to the treatment of such gain as recapture income in order to minimize the recognition of ordinary income by some Unitholders. Finally, although the Partnership does not expect that its operations will result in the creation of negative capital accounts, if negative capital accounts nevertheless result, items of Partnership income and gain will be allocated in an amount and manner sufficient to eliminate the negative balance as quickly as possible. Regulations provide that an allocation of items of Partnership income, gain, loss or deduction, other than an allocation required by Section 704(c) of the Code to eliminate the difference between a partner's "book" capital account (credited with the fair market value of Contributed Property) and "tax" capital account (credited with the tax basis of Contributed Property) (the "Book-Tax Disparity"), will generally be given effect for federal income tax purposes in determining a partner's distributive share of an item of income, gain, loss or deduction only if the allocation has substantial economic effect. In any other case, a partner's distributive share of an item will be determined on the basis of the partner's interest in the Partnership, which will be determined by taking into account all the facts and circumstances, including the partner's relative contributions to the Partnership, the 189 interests of the partners in economic profits and losses, the interest of the partners in cash flow and other nonliquidating distributions and rights of the partners to distributions of capital upon liquidation. Counsel is of the opinion that allocations under the Partnership Agreement, with the exception of the allocation of recapture income discussed above, will be given effect for federal income tax purposes in determining a partner's distributive share of an item of income, gain, loss or deduction. TAX TREATMENT OF OPERATIONS Accounting Method and Taxable Year. The Partnership uses the year ending December 31 as its taxable year and has adopted the accrual method of accounting for federal income tax purposes. Each Unitholder will be required to include in income his allocable share of Partnership income, gain, loss and deduction for the taxable year of the Partnership ending within or with the taxable year of the Unitholder. In addition, a Unitholder who has a taxable year ending on a date other than December 31 and who disposes of all of his Units following the close of the Partnership's taxable year but before the close of his taxable year must include his allocable share of Partnership income, gain, loss and deduction in income for his taxable year with the result that he will be required to report in income for his taxable year his distributive share of more than one year of Partnership income, gain, loss and deduction. See "--Disposition of Units--Allocations Between Transferors and Transferees." Initial Tax Basis, Depreciation and Amortization. The tax basis of the assets of the Partnership will be used for purposes of computing depreciation and cost recovery deductions and, ultimately, gain or loss on the disposition of such assets. The federal income tax burden associated with the difference between the fair market value of property contributed and the tax basis established for such property will be borne by the contributors of such property. See "-- Allocation of Partnership Income, Gain, Loss and Deduction." To the extent allowable, the Partnership may elect to use the depreciation and cost recovery methods that will result in the largest deductions in the early years of the Partnership. The Partnership will not be entitled to any amortization deductions with respect to goodwill conveyed to the Partnership on formation. Property subsequently acquired or constructed by the Partnership may be depreciated using accelerated methods permitted by the Code. If the Partnership disposes of depreciable property by sale, foreclosure, or otherwise, all or a portion of any gain (determined by reference to the amount of depreciation previously deducted and the nature of the property) may be subject to the recapture rules and taxed as ordinary income rather than capital gain. Similarly, a partner who has taken cost recovery or depreciation deductions with respect to property owned by the Partnership may be required to recapture such deductions as ordinary income upon a sale of his interest in the Partnership. See "--Allocation of Partnership Income, Gain, Loss and Deduction" and "--Disposition of Units--Recognition of Gain or Loss." Section 754 Election. The Partnership has made the election permitted by Section 754 of the Code, which generally permits the Partnership to adjust a Unit purchaser's tax basis in the Partnership's assets ("inside basis") pursuant to Section 743(b) of the Code to reflect his purchase price. That election is irrevocable without the consent of the IRS. The Section 743(b) adjustment 190 belongs to the purchaser and not to other partners. (For purposes of this discussion, a partner's inside basis in the Partnership's assets will be considered to have two components: (1) his share of the Partnership's tax basis in such assets ("Basis") and (2) his Section 743(b) adjustment to that basis.) Proposed Treasury regulations under Section 743 of the Code require, if the remedial allocation method is adopted (which the Partnership has done), a portion of the Section 743(b) adjustment attributable to recovery property to be depreciated over the remaining cost recovery period for the Section 704(c) built-in gain. Nevertheless, the proposed regulations under Section 197 indicate that the Section 743(b) adjustment attributable to an amortizable Section 197 intangible should be treated as a newly-acquired asset placed in service in the month when the purchaser acquires the Unit. Under Treasury Regulation Section 1.167(c)-1(a)(6), a Section 743(b) adjustment attributable to property subject to depreciation under Section 167 of the Code rather than cost recovery deductions under Section 168 is generally required to be depreciated using either the straight-line method or the 150% declining balance method. Although the proposed regulations under Section 743 will likely eliminate many of the problems if finalized in their current form, the depreciation and amortization methods and useful lives associated with the Section 743(b) adjustment may differ from the methods and useful lives generally used to depreciate the basis in such properties. Pursuant to the Partnership Agreement, the General Partner is authorized to adopt a convention to preserve the uniformity of Units even if such convention is not consistent with Treasury Regulation Section 1.167(c) -1(a)(6) and Proposed Treasury Regulation Section 1.197-2(g)(3). See "--Uniformity of Units." Although Counsel is unable to opine as to the validity of such an approach, the Partnership intends to depreciate the portion of a Section 743(b) adjustment attributable to unrealized appreciation in the value of Contributed Property (to the extent of any unamortized Book-Tax Disparity) using a rate of depreciation or amortization derived from the depreciation or amortization method and useful life applied to the Basis of such property, or treat that portion as non-amortizable to the extent attributable to property the Basis of which is not amortizable. This method is consistent with the proposed regulations under Section 743 but is arguably inconsistent with Treasury Regulation Section 1.167(c)-1(a)(6) and Proposed Treasury Regulation Section 1.197-2(g)(3) (neither of which is expected to directly apply to a material portion of the Partnership's assets). To the extent such Section 743(b) adjustment is attributable to appreciation in value in excess of the unamortized Book-Tax Disparity, the Partnership will apply the rules described in the Regulations and legislative history. If the Partnership determines that such position cannot reasonably be taken, the Partnership may adopt a depreciation or amortization convention under which all purchasers acquiring Units in the same month would receive depreciation or amortization, whether attributable to Basis or Section 743(b) adjustment, based upon the same applicable rate as if they had purchased a direct interest in the Partnership's assets. Such an aggregate approach may result in lower annual depreciation or amortization deductions than would otherwise be allowable to certain Unitholders. See "--Uniformity of Units." The allocation of the Section 743(b) adjustment must be made in accordance with the Code. The IRS may seek to reallocate some or all of any Section 743(b) adjustment not so allocated by the Partnership to goodwill which, as an intangible asset, would be amortizable over a longer period of time than the Partnership's tangible assets. 191 A Section 754 election is advantageous if the transferee's tax basis in his Units is higher than such Units' share of the aggregate tax basis to the Partnership of the Partnership's assets immediately prior to the transfer. In such a case, as a result of the election, the transferee would have a higher tax basis in his share of the Partnership's assets for purposes of calculating, among other items, his depreciation and depletion deductions and his share of any gain or loss on a sale of the Partnership's assets. Conversely, a Section 754 election is disadvantageous if the transferee's tax basis in such Units is lower than such Unit's share of the aggregate tax basis of the Partnership's assets immediately prior to the transfer. Thus, the fair market value of the Units may be affected either favorably or adversely by the election. The calculations involved in the Section 754 election are complex and will be made by the Partnership on the basis of certain assumptions as to the value of Partnership assets and other matters. There is no assurance that the determinations made by the Partnership will not be successfully challenged by the IRS and that the deductions resulting from them will not be reduced or disallowed altogether. Should the IRS require a different basis adjustment to be made, and should, in the Partnership's opinion, the expense of compliance exceed the benefit of the election, the Partnership may seek permission from the IRS to revoke the Section 754 election for the Partnership. If such permission is granted, a subsequent purchaser of Units may be allocated more income than he would have been allocated had the election not been revoked. Alternative Minimum Tax. Although it is not expected that the Partnership will generate significant tax preference items or adjustments, each Unitholder will be required to take into account his distributive share of any items of the Partnership income, gain, deduction, or loss for purposes of the alternative minimum tax. The minimum tax rate for noncorporate taxpayers is 26% on the first $175,000 of alternative minimum taxable income in excess of the exemption amount and 28% on any additional alternative minimum taxable income. Prospective Unitholders should consult with their tax advisors as to the impact of an investment in Units on their liability for the alternative minimum tax. Valuation of Partnership Property and Basis of Properties. The federal income tax consequences of the ownership and disposition of Units will depend in part on estimates by the Partnership of the relative fair market values, and determinations of the initial tax bases, of the assets of the Partnership. Although the Partnership may from time to time consult with professional appraisers with respect to valuation matters, many of the relative fair market value estimates will be made by the Partnership. These estimates and determinations of basis are subject to challenge and will not be binding on the IRS or the courts. If the estimates of fair market value or determinations of basis are subsequently found to be incorrect, the character and amount of items of income, gain, loss or deductions previously reported by Unitholders might change, and Unitholders might be required to adjust their tax liability for prior years. Treatment of Short Sales. A Unitholder whose Units are loaned to a "short seller" to cover a short sale of Units may be considered as having disposed of ownership of those Units. If so, he would no longer be a partner with respect to those Units during the period of the loan and may recognize gain or loss from the disposition. As a result, during this period, any Partnership income, gain, deduction or loss with respect to those Units would not be reportable by the Unitholder, any cash distributions received by the Unitholder with respect to those Units would be fully taxable and all of such distributions would appear to be treated as ordinary income. Unitholders desiring to assure 192 their status as partners and avoid the risk of gain recognition should modify any applicable brokerage account agreements to prohibit their brokers from borrowing their Units. The IRS has announced that it is actively studying issues relating to the tax treatment of short sales of partnership interests. See also "--Disposition of Units--Recognition of Gain or Loss." DISPOSITION OF UNITS Recognition of Gain or Loss. Gain or loss will be recognized on a sale of Units equal to the difference between the amount realized and the Unitholder's tax basis for the Units sold. A Unitholder's amount realized will be measured by the sum of the cash or the fair market value of other property received plus his share of Partnership nonrecourse liabilities. Because the amount realized includes a Unitholder's share of Partnership nonrecourse liabilities, the gain recognized on the sale of Units could result in a tax liability in excess of any cash received from such sale. Prior Partnership distributions in excess of cumulative net taxable income in respect of a Unit that decreased a Unitholder's tax basis in such Unit will, in effect, become taxable income if the Unit is sold at a price greater than the Unitholder's tax basis in such Unit, even if the price is less than his original cost. Should the IRS successfully contest the convention used by the Partnership to amortize only a portion of the Section 743(b) adjustment (described under "-- Tax Treatment of Operations--Section 754 Election") attributable to an amortizable Section 197 intangible after a sale by the General Partner of Units, a Unitholder could realize additional gain from the sale of Units than had such convention been respected. In that case, the Unitholder may have been entitled to additional deductions against income in prior years but may be unable to claim them, with the result to him of greater overall taxable income than appropriate. Counsel is unable to opine as to the validity of the convention but believes such a contest by the IRS to be unlikely because a successful contest could result in substantial additional deductions to other Unitholders. Gain or loss recognized by a Unitholder (other than a "dealer" in Units) on the sale or exchange of a Unit held for more than one year will generally be taxable as capital gain or loss. Capital gain recognized on the sale of Units held more than 12 months will generally be taxed a maximum rate of 20%. A portion of this gain or loss (which could be substantial), however, will be separately computed and taxed as ordinary income or loss under Section 751 of the Code to the extent attributable to assets giving rise to depreciation recapture or other "unrealized receivables" or to "inventory items" owned by the Partnership. The term "unrealized receivables" includes potential recapture items, including depreciation recapture. Ordinary income attributable to unrealized receivables, inventory items and depreciation recapture may exceed net taxable gain realized upon the sale of the Unit and may be recognized even if there is a net taxable loss realized on the sale of the Unit. Thus, a Unitholder may recognize both ordinary income and a capital loss upon a disposition of Units. Net capital loss may offset no more than $3,000 of ordinary income in the case of individuals and may only be used to offset capital gain in the case of corporations. The IRS has ruled that a partner who acquires interests in a Partnership in separate transactions must combine those interests and maintain a single adjusted tax basis. Upon a sale or other disposition of less than all of such interests, a portion of that tax basis must be allocated to the 193 interests sold using an "equitable apportionment" method. The ruling is unclear as to how the holding period of these interests is determined once they are combined. If this ruling is applicable to the holders of Units, a Unitholder will be unable to select high or low basis Units to sell as would be the case with corporate stock. It is not clear whether the ruling applies to the Partnership, because, as is the case with corporate stock, interests in the Partnership are evidenced by separate certificates. Accordingly, Counsel is unable to opine as to the effect such ruling will have on the Unitholders. A Unitholder considering the purchase of additional Units or a sale of Units purchased in separate transactions should consult his tax advisor as to the possible consequences of such ruling. Certain provisions of the Code affect the taxation of certain financial products and securities, including partnership interests, by treating a taxpayer as having sold an "appreciated" partnership interest (one in which gain would be recognized if it were sold, assigned or terminated at its fair market value) if the taxpayer or related persons enters into (i) a short sale of, (ii) an offsetting notional principal contract, or (iii) a futures or forward contract with respect to the partnership interest or substantially identical property. Moreover, if a taxpayer has previously entered into a short sale, an offsetting notional principal contract or a futures or forward contract with respect to a partnership interest, the taxpayer will be treated as having sold such position if the taxpayer or a related party then acquires the partnership interest or substantially identical property. The Secretary of Treasury is also authorized to issue regulations that treat a taxpayer who or that enters into transactions or positions that have substantially the same effect as the preceding transactions as having constructively sold the financial position. Allocations Between Transferors and Transferees. In general, the Partnership's taxable income and losses will be determined annually, will be prorated on a monthly basis and will be subsequently apportioned among the Unitholders in proportion to the number of Units owned by each of them as of the opening of the principal national securities exchange on which the Units are then traded on the first business day of the month (the "Allocation Date"). However, gain or loss realized on a sale or other disposition of Partnership assets other than in the ordinary course of business will be allocated among the Unitholders on the Allocation Date in the month in which that gain or loss is recognized. As a result, a Unitholder transferring Units in the open market may be allocated income, gain, loss and deduction accrued after the date of transfer. The use of this allocation method may not be permitted under existing Treasury Regulations. Accordingly, Counsel is unable to opine on the validity of this method of allocating income and deductions between the transferors and the transferees of Units. If this method is not allowed under the Treasury Regulations (or only applies to transfers of less than all of the Unitholder's interest), taxable income or losses of the Partnership might be reallocated among the Unitholders. The Partnership is authorized to revise its method of allocation between transferors and transferees (as well as among partners whose interests otherwise vary during a taxable period) to conform to a method permitted under future Treasury Regulations. A Unitholder who owns Units any time during a quarter and who disposes of such Units prior to the record date set for a cash distribution with respect to such quarter will be allocated items of Partnership income, gain, loss and deductions attributable to such quarter but will not be entitled to receive that cash distribution. 194 Notification Requirements. A Unitholder who sells or exchanges Units is required to notify the Partnership in writing of that sale or exchange within 30 days after the sale or exchange and in any event by no later than January 15 of the year following the calendar year in which the sale or exchange occurred. The Partnership is required to notify the IRS of that transaction and to furnish certain information to the transferor and transferee. However, these reporting requirements do not apply with respect to a sale by an individual who is a citizen of the United States and who effects the sale or exchange through a broker. Additionally, a transferor and a transferee of a Unit will be required to furnish statements to the IRS, filed with their income tax returns for the taxable year in which the sale or exchange occurred, that set forth the amount of the consideration received for the Unit that is allocated to goodwill or going concern value of the Partnership. Failure to satisfy these reporting obligations may lead to the imposition of substantial penalties. Constructive Termination. The Partnership and the Operating Partnership will be considered to have been terminated if there is a sale or exchange of 50% or more of the total interests in Partnership capital and profits within a 12- month period. Electing large partnerships do not terminate by reason of the sale or exchange of interests in the partnership. A termination of the Partnership will cause a termination of the Operating Partnership. A termination of the Partnership will result in the closing of the Partnership's taxable year for all Unitholders. In the case of a Unitholder reporting on a taxable year other than a fiscal year ending December 31, the closing of the tax year of the Partnership may result in more than 12 months' taxable income or loss of the Partnership being includable in his taxable income for the year of termination. New tax elections required to be made by the Partnership, including a new election under Section 754 of the Code, must be made subsequent to a termination and a termination could result in a deferral of Partnership deductions for depreciation. A termination could also result in penalties if the Partnership were unable to determine that the termination had occurred. Moreover, a termination might either accelerate the application of, or subject the Partnership to, any tax legislation enacted prior to the termination. Entity-Level Collections. If the Partnership is required or elects under applicable law to pay any federal, state or local income tax on behalf of any Unitholder or any General Partner or any former Unitholder, the Partnership is authorized to pay those taxes from Partnership funds. Such payment, if made, will be treated as a distribution of cash to the partner on whose behalf the payment was made. If the payment is made on behalf of a person whose identity cannot be determined, the Partnership is authorized to treat the payment as a distribution to current Unitholders. The Partnership is authorized to amend the Partnership Agreement in the manner necessary to maintain uniformity of intrinsic tax characteristics of Units and to adjust subsequent distributions, so that after giving effect to such distributions, the priority and characterization of distributions otherwise applicable under the Partnership Agreement is maintained as nearly as is practicable. Payments by the Partnership as described above could give rise to an overpayment of tax on behalf of an individual partner in which event the partner could file a claim for credit or refund. UNIFORMITY OF UNITS Because the Partnership cannot match transferors and transferees of Units, uniformity of the economic and tax characteristics of the Units to a purchaser of such Units must be maintained. In the absence of uniformity, compliance with a number of federal income tax requirements, both statutory and regulatory, could be substantially diminished. A lack of uniformity can result from a literal 195 application of Treasury Regulation Section 1.167(c)-1(a)(6) and Proposed Treasury Regulation Section 1.197-2(g)(3). Any non-uniformity could have a negative impact on the value of the Units. See "--Tax Treatment of Operations-- Section 754 Election." The Partnership intends to depreciate the portion of a Section 743(b) adjustment attributable to unrealized appreciation in the value of contributed property or adjusted property (to the extent of any unamortized Book-Tax Disparity) using a rate of depreciation or amortization derived from the depreciation or amortization method and useful life applied to the basis of such property, or treat that portion as nonamortizable, to the extent attributable to property the basis of which is not amortizable consistent with the proposed regulations under Section 743 (but despite its inconsistency with Treasury Regulation Section 1.167(c)-1(a)(6) and Proposed Treasury Regulation Section 1.197-2(g)(3) (neither of which is expected to directly apply to a material portion of the Partnership's assets)). See "--Tax Treatment of Operations--Section 754 Election." To the extent such Section 743(b) adjustment is attributable to appreciation in value in excess of the unamortized Book-Tax Disparity, the Partnership will apply the rules described in the Regulations and legislative history. If the Partnership determines that such a position cannot reasonably be taken, the Partnership may adopt a depreciation and amortization convention under which all purchasers acquiring Units in the same month would receive depreciation and amortization deductions, whether attributable to basis or Section 743(b) basis, based upon the same applicable rate as if they had purchased a direct interest in the Partnership's property. If such an aggregate approach is adopted, it may result in lower annual depreciation and amortization deductions than would otherwise be allowable to certain Unitholders and risk the loss of depreciation and amortization deductions not taken in the year that such deductions are otherwise allowable. This convention will not be adopted if the Partnership determines that the loss of depreciation and amortization deductions will have a material adverse effect on the Unitholders. If the Partnership chooses not to utilize this aggregate method, the Partnership may use any other reasonable depreciation and amortization convention to preserve the uniformity of the intrinsic tax characteristics of any Units that would not have a material adverse effect on the Unitholders. The IRS may challenge any method of depreciating the Section 743(b) adjustment described in this paragraph. If such a challenge were sustained, the uniformity of Units might be affected, and the gain from the sale of Units might be increased without the benefit of additional deductions. See "--Disposition of Units--Recognition of Gain or Loss." Tax-exempt Organizations and Certain Other Investors. Ownership of Units by employee benefit plans, other tax-exempt organizations, nonresident aliens, foreign corporations, other foreign persons and regulated investment companies raises issues unique to such persons and, as described below, may have substantially adverse tax consequences. Employee benefit plans and most other organizations exempt from federal income tax (including individual retirement accounts ("IRAs") and other retirement plans) are subject to federal income tax on unrelated business taxable income. Virtually all of the taxable income derived by such an organization from the ownership of a Unit will be unrelated business taxable income and thus will be taxable to such a Unitholder. A regulated investment company or "mutual fund" is required to derive 90% or more of its gross income from interest, dividends, gains from the sale of stocks or securities or foreign currency or certain related sources. It is not anticipated that any significant amount of the Partnership's gross income will include that type of income. 196 Non-resident aliens and foreign corporations, trusts or estates which hold Units will be considered to be engaged in business in the United States on account of ownership of Units. As a consequence, they will be required to file federal tax returns in respect of their share of Partnership income, gain, loss or deduction and pay federal income tax at regular rates on any net income or gain. Generally, a partnership is required to pay a withholding tax on the portion of the Partnership's income that is effectively connected with the conduct of a United States trade or business and which is allocable to the foreign partners, regardless of whether any actual distributions have been made to such partners. However, under rules applicable to publicly-traded partnerships, the Partnership will withhold (currently at the rate of 39.6%) on actual cash distributions made quarterly to foreign Unitholders. Each foreign Unitholder must obtain a taxpayer identification number from the IRS and submit that number to the Transfer Agent of the Partnership on a Form W-8 in order to obtain credit for the taxes withheld. A change in applicable law may require the Partnership to change these procedures. Because a foreign corporation that owns Units will be treated as engaged in a United States trade or business, such a corporation may be subject to United States branch profits tax a rate of 30%, in addition to regular federal income tax, on its allocable share of the Partnership's income and gain (as adjusted for changes in the foreign corporation's "U.S. net equity") which are effectively connected with the conduct of a United States trade or business. That tax may be reduced or eliminated by an income tax treaty between the United States and the country with respect to which the foreign corporate Unitholder is a "qualified resident." In addition, such a Unitholder is subject to special information reporting requirements under Section 6038C of the Code. Under a ruling of the IRS, a foreign Unitholder who sells or otherwise disposes of a Unit will be subject to federal income tax on gain realized on the disposition of such Unit to the extent that such gain is effectively connected with a United States trade or business of the foreign Unitholder. Apart from the ruling, a foreign Unitholder will not be taxed or subject to withholding upon the disposition of a Unit if that foreign Unitholder has held less than 5% in value of the Units during the five-year period ending on the date of the disposition and if the Units are regularly traded on an established securities market at the time of the disposition. ADMINISTRATIVE MATTERS Partnership Information Returns and Audit Procedures. The Partnership intends to furnish to each Unitholder, within 90 days after the close of each calendar year, certain tax information, including a Schedule K-1, which sets forth each Unitholder's share of the Partnership's income, gain, loss and deduction for the preceding Partnership taxable year. In preparing this information, which will generally not be reviewed by counsel, the Partnership will use various accounting and reporting conventions, some of which have been mentioned in the previous discussion, to determine the Unitholder's share of income, gain, loss and deduction. There is no assurance that any of those conventions will yield a result that conforms to the requirements of the Code, regulations or administrative interpretations of the IRS. The Partnership cannot assure prospective Unitholders that the IRS will not successfully contend in court that such accounting and reporting conventions are impermissible. Any such challenge by the IRS could negatively affect the value of the Units. 197 The federal income tax information returns filed by the Partnership may be audited by the IRS. Adjustments resulting from any such audit may require each Unitholder to adjust a prior year's tax liability, and possibly may result in an audit of the Unitholder's own return. Any audit of a Unitholder's return could result in adjustments of non-Partnership as well as Partnership items. Partnerships generally are treated as separate entities for purposes of federal tax audits, judicial review of administrative adjustments by the IRS and tax settlement proceedings. The tax treatment of Partnership items of income, gain, loss and deduction are determined in a Partnership proceeding rather than in separate proceedings with the partners. The Code provides for one partner to be designated as the "Tax Matters Partner" for these purposes. The Partnership Agreement appoints the General Partner as the Tax Matters Partner of the Partnership. The Tax Matters Partner will make certain elections on behalf of the Partnership and Unitholders and can extend the statute of limitations for assessment of tax deficiencies against Unitholders with respect to Partnership items. The Tax Matters Partner may bind a Unitholder with less than a 1% profits interest in the Partnership to a settlement with the IRS unless that Unitholder elects, by filing a statement with the IRS, not to give such authority to the Tax Matters Partner. The Tax Matters Partner may seek judicial review (by which all the Unitholders are bound) of a final Partnership administrative adjustment and, if the Tax Matters Partner fails to seek judicial review, such review may be sought by any Unitholder having at least a 1% interest in the profits of the Partnership and by the Unitholders having in the aggregate at least a 5% profits interest. However, only one action for judicial review will go forward, and each Unitholder with an interest in the outcome may participate. However, if the Partnership elects to be treated as a large partnership, a partner will not have the right to participate in settlement conferences with the IRS or to seek a refund. A Unitholder must file a statement with the IRS identifying the treatment of any item on his federal income tax return that is not consistent with the treatment of the item on the Partnership's return. Intentional or negligent disregard of the consistency requirement may subject a Unitholder to substantial penalties. However, if the Partnership elects to be treated as a large partnership, its partners would be required to treat all partnership items in a manner consistent with the Partnership return. Each partner in a partnership that elects to be treated as a "large partnership" takes into account separately his share of the following items, determined at the partnership level: (1) taxable income or loss from passive loss limitation activities; (2) taxable income or loss from other activities (such as portfolio income or loss); (3) net capital gains to the extent allocable to passive loss limitation activities and other activities; (4) tax exempt interest; (5) a net alternative minimum tax adjustment separately computed for passive loss limitation activities and other activities; (6) general credits; (7) low-income housing credit; (8) rehabilitation credit; (9) foreign income taxes; (10) credit for producing fuel from a nonconventional source; and (11) any other items the Secretary of Treasury deems appropriate. Moreover, miscellaneous itemized deductions are not passed through to the partners and 30% of such deductions are used at the partnership level. A number of changes have also been made to the tax compliance and administrative rules relating to electing large partnerships. One provision would require that each partner in a large 198 partnership, such as the Partnership, take into account his share of any adjustments to partnership items in the year such adjustments are made. Under prior law, adjustments relating to partnership items for a previous taxable year are taken into account by those persons who were partners in the previous taxable year. Alternatively, a partnership could elect to or, in some circumstances, could be required to directly pay the tax resulting from any such adjustments. In either case, therefore, Unitholders could bear significant economic burdens associated with tax adjustments relating to periods predating their acquisition of Units. It is not expected that the Partnership will elect to have the large partnership provisions apply because of the cost of their application. Nominee Reporting. Persons who hold an interest in the Partnership as a nominee for another person are required to furnish to the Partnership (a) the name, address and taxpayer identification number of the beneficial owner and the nominee; (b) whether the beneficial owner is (i) a person that is not a United States person, (ii) a foreign government, an international organization or any wholly-owned agency or instrumentality of either of the foregoing, or (iii) a tax-exempt entity; (c) the amount and description of Units held, acquired or transferred for the beneficial owner; and (d) certain information including the dates of acquisitions and transfers, means of acquisitions and transfers, and acquisition cost for purchases, as well as the amount of net proceeds from sales. Brokers and financial institutions are required to furnish additional information, including whether they are United States persons and certain information on Units they acquire, hold or transfer for their own account. A penalty of $50 per failure (up to a maximum of $100,000 per calendar year) is imposed by the Code for failure to report such information to the Partnership. The nominee is required to supply the beneficial owner of the Units with the information furnished to the Partnership. Registration as a Tax Shelter. The Code requires that "tax shelters" be registered with the Secretary of the Treasury. The temporary Treasury Regulations interpreting the tax shelter registration provisions of the Code are extremely broad. It is arguable that the Partnership is not subject to the registration requirement on the basis that it will not constitute a tax shelter. However, the General Partner, as a principal organizer of the Partnership, has registered the Partnership as a tax shelter with the Secretary of the Treasury in the absence of assurance that the Partnership will not be subject to tax shelter registration and in light of the substantial penalties which might be imposed if registration is required and not undertaken. The IRS has issued the following tax shelter registration number to the Partnership: 96026000016. ISSUANCE OF THE REGISTRATION NUMBER DOES NOT INDICATE THAT INVESTMENT IN THE PARTNERSHIP OR THE CLAIMED TAX BENEFITS HAVE BEEN REVIEWED, EXAMINED OR APPROVED BY THE IRS. The Partnership must furnish the registration number to the Unitholders, and a Unitholder who sells or otherwise transfers a Unit in a subsequent transaction must furnish the registration number to the transferee. The penalty for failure of the transferor of a Unit to furnish the registration number to the transferee is $100 for each such failure. The Unitholders must disclose the tax shelter registration number of the Partnership on Form 8271 to be attached to the tax return on which any deduction, loss or other benefit generated by the Partnership is claimed or income of the Partnership is included. A Unitholder who fails to disclose the tax shelter registration number on his return, without reasonable cause for that failure, will be subject to a $250 penalty for each failure. Any penalties discussed herein are not deductible for federal income tax purposes. Accuracy-related Penalties. An additional tax equal to 20% of the amount of any portion of an underpayment of tax which is attributable to one or more of certain listed causes, including negligence or disregard of rules or regulations, substantial understatements of income tax and 199 substantial valuation misstatements, is imposed by the Code. No penalty will be imposed, however, with respect to any portion of an underpayment if it is shown that there was a reasonable cause for that portion and that the taxpayer acted in good faith with respect to that portion. A substantial understatement of income tax in any taxable year exists if the amount of the understatement exceeds the greater of 10% of the tax required to be shown on the return for the taxable year or $5,000 ($10,000 for most corporations). The amount of any understatement subject to penalty generally is reduced if any portion is attributable to a position adopted on the return (i) with respect to which there is, or was, "substantial authority" or (ii) as to which there is a reasonable basis and the pertinent facts of such position are disclosed on the return. Certain more stringent rules apply to "tax shelters," a term that in this context does not appear to include the Partnership. If any Partnership item of income, gain, loss or deduction included in the distributive shares of Unitholders might result in such an "understatement" of income for which no "substantial authority" exists, the Partnership must disclose the pertinent facts on its return. In addition, the Partnership will make a reasonable effort to furnish sufficient information for Unitholders to make adequate disclosure on their returns to avoid liability for this penalty. A substantial valuation misstatement exists if the value of any property (or the adjusted basis of any property) claimed on a tax return is 200% or more of the amount determined to be the correct amount of such valuation or adjusted basis. No penalty is imposed unless the portion of the underpayment attributable to a substantial valuation misstatement exceeds $5,000 ($10,000 for most corporations). If the valuation claimed on a return is 400% or more than the correct valuation, the penalty imposed increases to 40%. STATE, LOCAL AND OTHER TAX CONSIDERATIONS In addition to federal income taxes, Unitholders will be subject to other taxes, such as state and local income taxes, unincorporated business taxes, and estate, inheritance or intangible taxes that may be imposed by the various jurisdictions in which the Partnership does business or owns property. Although an analysis of those various taxes is not presented here, each prospective Unitholder should consider their potential impact on his investment in the Partnership. Star Gas believes that substantially all of the Partnership's income will be generated in the following states: Connecticut, Indiana, Kentucky, Maine, Massachusetts, Michigan, New Hampshire, New Jersey, New York, Ohio, Pennsylvania, Rhode Island, Texas and West Virginia. Of these states, only Texas does not currently impose a personal income tax. New Hampshire's personal income tax applies only to interest and dividend income. A Unitholder will be required to file state income tax returns and to pay state income taxes in some or all of these states and may be subject to penalties for failure to comply with those requirements. In certain states, tax losses may not produce a tax benefit in the year incurred (if, for example, the Partnership has no income from sources within that state) and also may not be available to offset income in subsequent taxable years. Some of the states may require the Partnership, or the Partnership may elect, to withhold a percentage of income from amounts to be distributed to a Unitholder who is not a resident of the state. Withholding, the amount of which may be greater or less than a particular Unitholder's income tax liability to the state, generally does not relieve the non-resident Unitholder from the obligation to file an income tax return. Amounts withheld may be treated as if distributed to Unitholders for purposes of determining the amounts 200 distributed by the Partnership. See "--Disposition of Units--Entity-Level Collections." Based on current law and its estimate of future Partnership operations, the General Partner anticipates that any amounts required to be withheld will not be material. IT IS THE RESPONSIBILITY OF EACH UNITHOLDER TO INVESTIGATE THE LEGAL AND TAX CONSEQUENCES, UNDER THE LAWS OF PERTINENT STATES AND LOCALITIES OF HIS INVESTMENT IN THE PARTNERSHIP. ACCORDINGLY, EACH PROSPECTIVE UNITHOLDER SHOULD CONSULT, AND MUST DEPEND UPON, HIS OWN TAX COUNSEL OR OTHER ADVISOR WITH REGARD TO THOSE MATTERS. FURTHER, IT IS THE RESPONSIBILITY OF EACH UNITHOLDER TO FILE ALL STATE AND LOCAL, AS WELL AS U.S. FEDERAL, TAX RETURNS THAT MAY BE REQUIRED OF SUCH UNITHOLDER. COUNSEL HAS NOT RENDERED AN OPINION ON THE STATE OR LOCAL TAX CONSEQUENCES OF AN INVESTMENT IN THE PARTNERSHIP. 201 DISSENTERS' RIGHTS Sections 302A.471 and 302A.473 of the MBCA provide to each Common Stockholder the right to dissent from the Acquisition Proposal and obtain payment for the "fair value" of such Common Stockholder's shares following the consummation of the Transaction. Common Unitholders do not have dissenters' rights under the DRULPA or the Partnership Agreement. The following summary of the applicable provisions of Sections 302A.471 and 302A.473 of the MBCA is not intended to be a complete statement of such provisions and is qualified in its entirety by reference to such sections, the full texts of which are attached as Appendix E to this Proxy Statement. These Sections should be reviewed carefully by any Common Stockholder who wishes to exercise dissenters' rights or who wishes to preserve the right to do so, since failure to comply with the procedures described herein and set forth therein will result in the loss of dissenters' rights. Under the MBCA, Common Stockholders will have the right, by fully complying with the applicable provisions of Sections 302A.471 and 302A.473, to dissent with respect to the Transaction and to receive from Petro payment in cash of the "fair value" of their shares of Common Stock after the Transaction is completed. The term "fair value" means the value of such shares of Common Stock immediately before the Effective Time. Pursuant to the Merger Agreement, the Partnership has agreed to make payment of the fair value of the shares of dissenting Common Stockholders. All references in Sections 302A.471 and 302A.473 of the MBCA to a "shareholder" are to a record holder of shares of Common Stock as to which dissenters' rights are asserted by such Common Stockholder. A person having beneficial ownership of shares of Common Stock that are held of record in the name of another person, such as a broker, nominee, trustee or custodian, must act promptly to cause the record holder to follow the steps summarized below properly and in a timely manner in order to perfect whatever dissenters' rights such beneficial owner may have. Common Stockholders who desire to exercise their dissenters' rights must satisfy all of the following conditions: A written notice of intent to demand fair value (a "Dissent Notice") for his or its shares of Common Stock must be delivered by such a Common Stockholder to Petro at the address specified below before the taking of the vote of shareholders on the Acquisition Proposal. Such Dissent Notice is in addition to and separate from any proxy or vote against the Transaction Proposal. Voting against, abstaining from voting or failing to vote on the Acquisition Proposal does not constitute a Dissent Notice or demand for appraisal within the meaning of the MBCA. Only Common Stockholders of record as of the Record Date, and beneficial owners of Common Stock as of such date who hold through such Common Stockholders, are entitled to exercise dissenters' rights. Holders of Common Stock electing to exercise dissenters' rights under the MBCA must not vote for the Transaction Proposal. A Common Stockholder's failure to vote against the Acquisition Proposal will not constitute a waiver of dissenters' rights. However, if a Common Stockholder returns a signed proxy but does not specify a vote against the Acquisition Proposal or a direction to 202 abstain, the proxy will be voted for the Acquisition Proposal, which will have the effect of waiving that Common Stockholder's dissenters' rights. A Common Stockholder may not assert dissenters' rights as to less than all of the shares of Common Stock registered in such holder's name and/or beneficially owned by such Common Stockholder, except where shares are beneficially owned by another person but registered in such Common Stockholder's name. If a Common Stockholder, such as a broker, nominee, trustee or custodian, wishes to dissent with respect to shares of Common Stock beneficially owned by another person, such Common Stockholder must dissent with respect to all of such shares and must disclose the name and address of the beneficial owner on whose behalf the dissent is made. A beneficial owner of shares of Common Stock who is not the record owner of such shares may assert dissenters' rights as to shares held on such person's behalf, provided that such beneficial owner submits a written consent of the record owner to Petro at or before the time such rights are asserted. A Common Stockholder who elects to exercise dissenters' rights must send a Dissent Notice to Petro at the following address before the taking of the vote on the Acquisition Proposal: Petroleum Heat and Power Co., Inc., P.O. Box 1457, Stamford, CT 06902, Attention: Treasurer. The Dissent Notice should specify the Common Stockholder's name and mailing address, the number of shares of each class of Common Stock owned by such Common Stockholder and that the Common Stockholder intends to demand the fair value of such shares. If the Acquisition Proposal is approved by Common Stockholders at the Special Meeting, Petro will send a written notice to each Common Stockholder (the "Advisory Notice") who filed a Dissent Notice. The Advisory Notice will contain the address to which the Common Stockholder should send a demand for the payment of the fair value of his or its shares of Common Stock (the "Fair Value Demand") and the certificates representing such shares in order to obtain payment and the date by which they must be received by Petro, a form to be used to make such Fair Value Demand and other related information. In order to receive fair value for his or its shares of Common Stock, a dissenting Common Stockholder must, within 30 days after the date the Advisory Notice was given, send his or its stock certificates, a Fair Value Demand and all other information specified in the Advisory Notice from Petro, to the address specified in the Advisory Notice. A dissenting Common Stockholder will retain all rights as a Common Stockholder until the Effective Time. After the later of (1) the date of receipt by Petro of a valid Fair Value Demand and the related stock certificates and other information are received and (2) the Effective Time, the Partnership, on behalf of Petro, will remit to each dissenting Common Stockholder who has complied with the statutory requirements the amount that Petro estimates to be the fair value of such Common Stockholder's shares of Common Stock, with interest commencing five days after the Effective Time at a rate prescribed by statute. Remittance will be accompanied by Petro's balance sheet and statement of operations for a fiscal year ending not more than 16 months before the Effective Time, together with the latest available interim financial data, an estimate of the fair value of such dissenting Common Stockholder's shares of Common Stock and a brief description of the method used to reach such estimate, a brief description of the procedure to be followed if such holder is demanding supplemental payment and copies of Sections 302A.471 and 302A.473 of the MBCA. 203 If the dissenting Common Stockholder believes that the amount remitted by the Partnership, on behalf of Petro, is less than the fair value of such Common Stockholder's shares, plus interest, the dissenting Common Stockholder may give written notice to Petro of such Common Stockholder's own estimate of the fair value of the shares, plus interest, within 30 days after the mailing date of the remittance and demand payment of the difference (a "Supplemental Payment Demand"). Such Supplemental Payment Demand must be given to Petro at the address specified in the Advisory Notice. A Common Stockholder who fails to give such written notice within this time period is entitled only to the amount remitted by the Partnership. Within 60 days after receipt of a Supplemental Payment Demand, Petro must either (1) pay the Common Stockholder the amount demanded or agreed to by such Common Stockholder after discussion with Petro or (2) petition a state court in Hennepin County, Minnesota for the determination of the fair value of the shares, plus interest. The petition must name as parties all Common Stockholders who have demanded supplemental payment and have not reached an agreement with Petro. The court, after determining that the dissenting Common Stockholder or Stockholders in question have complied with all statutory requirements, may use any valuation method or combination of methods it deems appropriate, whether or not used by Petro or the dissenting Common Stockholder, and may appoint appraisers to recommend the amount of the fair value of the class of Common Stock to be valued. The court's determination will be binding on all Common Stockholders who properly exercised dissenters' rights and did not agree with Petro as to the fair value of such shares. Dissenting Common Stockholders are entitled to judgment for the amount by which the court- determined fair value per share, plus interest, exceeds the amount per share, plus interest, remitted to the Common Stockholders by the Partnership. The Common Stockholders will not be liable to Petro or the Partnership for any amounts paid by Petro or the Partnership that exceed the fair value of the shares as determined by the court, plus interest. The costs and expenses of such a proceeding, including the expenses and compensation of any appraisers, will be determined by the court and assessed against Petro, except that the court may, in its discretion, assess part or all of those costs and expenses against any Common Stockholder whose action in demanding supplemental payment is found to be arbitrary, vexatious or not in good faith. The court may award fees and expenses to an attorney for the dissenting Common Stockholders out of the amount, if any, awarded to such Common Stockholders. Fees and expenses of experts or attorneys may also be assessed against any person who acted arbitrarily, vexatiously or not in good faith in bringing the proceeding. The Partnership may withhold the remittance of the estimated fair value, plus interest, for any shares of Common Stock owned by any person who was not a Common Stockholder, or who is dissenting on behalf of a person who was not a beneficial owner, on August 14, 1998, the date on which the proposed Transaction was first announced to the public (the "Public Announcement Date"). Petro will forward to any such dissenting Common Stockholder who has complied with all requirements in exercising dissenters' rights the Advisory Notice and all other materials sent after approval by the Common Stockholders of the Acquisition Proposal to all Common Stockholders who have properly exercised dissenters' rights, together with a statement of the reason for withholding the remittance and an offer to pay the dissenting Common Stockholder the amount listed in the materials, if such Common Stockholder agrees to accept that amount in full satisfaction. A dissenting Common Stockholder may decline such offer and demand payment by following the same procedure as that 204 described for a Supplemental Payment Demand by Common Stockholders who owned their shares as of the Public Announcement Date. Any Common Stockholder who did not own shares on the Public Announcement Date and who fails properly to demand payment will be entitled only to the amount offered by Petro. Upon proper demand by any such Common Stockholder, rules and procedures applicable in connection with receipt by the Partnership of a Supplemental Payment Demand given by a dissenting Common Stockholder who owned shares on the Public Announcement Date will also apply to any Common Stockholder properly giving a demand for payment but who did not own shares of record or beneficially on the Public Announcement Date, except that any such Common Stockholder is not entitled to receive any remittance from Petro or the Partnership until the fair value of the shares, plus interest, has been determined pursuant to such rules and procedures. Common Stockholders considering exercising dissenters' rights should bear in mind that the fair value of their shares determined under Sections 302A.471 and 302A.473 of the MBCA could be more than, the same as or, in certain circumstances, less than the consideration they would receive pursuant to the Acquisition Proposal if they do not seek appraisal of their shares, and that the opinion of any investment banking firm as to fairness, from a financial point of view, is not an opinion as to fair value under Sections 302A.471 and 302A.473. Cash received pursuant to the exercise of dissenters' rights may be subject to federal or state income tax. See "Certain Federal Income Tax Considerations." A COMMON STOCKHOLDER WHO FAILS TO COMPLY FULLY WITH THE STATUTORY PROCEDURE SUMMARIZED ABOVE WILL FORFEIT HIS OR HER RIGHTS OF DISSENT AND WILL RECEIVE THE TRANSACTION CONSIDERATION FOR HIS OR HER SHARES. SEE APPENDIX E. Pursuant to the Merger Agreement, from and after the Effective Time, the Partnership will be responsible for the payment of any and all consideration that may be determined pursuant to Section 320a-473 to be due to the holders of Common Stock who have perfected their rights to receive the fair value of their shares as described above. 205 LEGAL MATTERS The validity of the Common Units and the Senior Subordinated Units to be issued in connection with the Transaction will be passed upon for the Partnership by Phillips Nizer Benjamin Krim & Ballon LLP, New York, New York. Certain tax matters will be passed upon for the Partnership by Andrews & Kurth L.L.P., New York, New York. EXPERTS The consolidated financial statements and schedules of Star Gas Partners, L.P. and its subsidiary and the Star Gas Group (Predecessor) as of September 30, 1996 and 1997 and for the fiscal years ended September 30, 1995, 1996 and 1997, incorporated by reference in this Proxy Statement, have been incorporated by reference in reliance upon the report of KPMG Peat Marwick LLP, independent certified public accountants, given on the authority of that firm as experts in accounting and auditing. The consolidated financial statements and schedules of Petroleum Heat and Power Co., Inc. as of December 31, 1996 and 1997 and for the fiscal years ended December 31, 1995, 1996 and 1997, have been included in this Proxy Statement in reliance upon the report of KPMG Peat Marwick LLP, independent certified public accountants, appearing herein and upon the authority of that firm as experts in accounting and auditing. WHERE YOU CAN FIND MORE INFORMATION The Partnership and Petro file annual, quarterly and special reports, proxy statements (Petro only) and other information with the Commission. You may read and copy any reports, statement or other information that the Partnership and Petro file with the Commission at the Commission's public reference rooms in Washington, D.C., New York, New York and Chicago, Illinois. Please call the Commission at 1-800-SEC-0330 for further information on the public reference rooms. These Commission filings are also available to the public from commercial document retrieval services and at the Internet world wide web site maintained by the Commission at "http://www.sec.gov." Reports and other information concerning the Partnership should also be available for inspection at the offices of the NYSE. The Partnership filed a Registration Statement on Form S-4 (the "Registration Statement") to register with the Commission the Common Units and Senior Subordinated Units to be issued in the Transaction. This Proxy Statement is a part of that Registration Statement and constitutes a prospectus of the Partnership. As allowed by Commission rules, this Proxy Statement does not contain all the information you can find in the Partnership's Registration Statement or the exhibits to the Registration Statement. The Commission allows the Partnership and Petro to "incorporate by reference" information into this Proxy Statement, which means that they can disclose important information to you by referring you to another document filed separately with the Commission. The information incorporated by reference is considered part of this Proxy Statement, except for any information superseded by information contained directly in this Proxy Statement or in later filed documents incorporated by reference in this Proxy Statement. 206 This Proxy Statement includes information required by the Commission to be disclosed pursuant to Rule 13e-3 under the Exchange Act which governs so-called "going private" transactions by certain issuers or their affiliates. In accordance with that rule, Petro filed with the Commission under the Exchange Act, a Schedule 13E-3 with respect to the Transaction. This Proxy Statement does not contain all of the information set forth in the Schedule 13E-3, parts of which are omitted in accordance with the regulations of the Commission. The Schedule 13E-3, and amendments thereto, including exhibits filed with it, will be available for inspection and copying at the offices of the Commission as set forth above. This Proxy Statement incorporates by reference the documents set forth below that the Partnership and Petro have previously filed with the Commission. These documents contain important information about the Partnership and Petro and their finances. You should rely only on the information contained or incorporated by reference in this Proxy Statement. We have not authorized anyone to provide you with information that is different from what is contained in this Proxy Statement. This Proxy Statement is dated . You should not assume that the information contained in this Joint Proxy Statement-Prospectus is accurate as of any date other than the date of the Proxy Statement. Neither the mailing of this Proxy Statement to Securityholders nor the issuance of Units in the Transaction creates any implication to the contrary. 207
THE PARTNERSHIP COMMISSION FILINGS (FILE NO. 33-78490) PERIOD/AS OF DATE ---------------------------------- ----------------- Annual Report on Form 10-K Year ended September 30, 1997 Quarterly Report on Form 10-Q Quarter ended June 30, 1998 PETRO COMMISSION FILINGS (FILE NO. 1-9358) PERIOD/AS OF DATE ------------------------------------------ ----------------- Annual Report on Form 10-K Year ended December 31, 1997 Quarterly Report on Form 10-Q Quarter ended June 30, 1998 Proxy Statement April 30, 1998 INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE The following documents filed by the Partnership with the Commission (File No. 33-98490) are incorporated by reference in this Proxy Statement: (1) the Partnership's Annual Report on Form 10-K for the fiscal year ended September 30, 1997; (2) the Partnership's Quarterly Reports on Form 10-Q for the fiscal quarters ended December 31, 1997, March 31, 1998 and June 30, 1998; and (3) the Partnership's Current Reports on Form 8-K filed on October 22, 1997, as amended on October 30, 1997 and November 24, 1997. In addition, all other reports and documents filed by the Partnership pursuant to Section 13(a), 13(c), 14 or 15(d) of the Exchange Act subsequent to the date hereof and prior to the Unitholders Meeting and the Special Meeting shall be deemed incorporated by reference into this Proxy Statement from the date of filing of such reports and documents. Any statement contained herein or in a document, all or a portion of which is incorporated or deemed to be incorporated by reference herein, shall be deemed to be modified or superseded for purposes of this Proxy Statement to the extent that a statement contained herein (and, in case of any statement in an incorporated document prior to the date of this Proxy Statement), or in any other subsequently filed document which also is or is deemed to be incorporated by reference herein, modifies or supersedes such statement. Any such statement so modified or superseded shall not be deemed, except as so modified or superseded, to constitute a part of this Proxy Statement. The following documents filed by Petro with the Commission are also incorporated by reference in this Proxy Statement: (i) Petro's Annual Report in Form 10-K for the fiscal year ended December 31, 1997, which accompanies this Proxy Statement; and (ii) Petro's Quarterly Reports on Form 10-Q for the fiscal quarters ended March 31, 1998 and June 30, 1998, which accompanies this Proxy Statement. (iii) Petro's Proxy Statement dated April 30, 1998. THIS PROXY STATEMENT INCORPORATES DOCUMENTS BY REFERENCE THAT ARE NOT INCLUDED WITH THIS PROXY STATEMENT. SUCH DOCUMENTS (EXCLUDING EXHIBITS TO SUCH DOCUMENTS) ARE AVAILABLE WITHOUT CHARGE, UPON ORAL OR WRITTEN REQUEST BY ANY PERSON, INCLUDING ANY BENEFICIAL OWNER, TO WHOM THIS PROXY STATEMENT IS DELIVERED. FOR DOCUMENTS RELATING TO THE PARTNERSHIP, CONTACT STAR GAS CORPORATION, 2187 ATLANTIC STREET, STAMFORD, CONNECTICUT 06902, ATTENTION: RICHARD F. AMBURY, VICE PRESIDENT-FINANCE, TELEPHONE (203) 328-7313. FOR DOCUMENTS RELATING TO PETRO, CONTACT PETROLEUM HEAT AND POWER CO., INC., 2187 ATLANTIC AVENUE, STAMFORD, CONNECTICUT 06902, ATTENTION: GEORGE LEIBOWITZ, TREASURER, TELEPHONE (203) 325-5470. TO ENSURE TIMELY DELIVERY OF THE DOCUMENTS, ANY REQUEST SHOULD BE MADE BY , 1999. 208 UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION STAR GAS PARTNERS, L.P. AND SUBSIDIARY PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET (UNAUDITED) JUNE 30, 1998 (IN THOUSANDS) 209
STAR GAS PARTNERS, L.P. STAR GAS PROPANE PETRO PRO FORMA PRO FORMA THE ADJUSTED PARTNERS, L.P. ACQUISITIONS(A) ACQUISITION(B) ADJUSTMENTS COMBINED OFFERINGS PRO FORMA -------------- --------------- -------------- ----------- --------- --------- -------------- ASSETS ------ Current assets: Cash.................. $ 1,551 $ 33,223 $ (4,167)(c) $ 23,507 $ 115,400 (k) $ 20,932 (7,100)(i) 132,100 (l) (250,075)(m) Accounts receivable... 5,041 46,960 52,001 52,001 Inventories........... 7,777 11,063 18,840 18,840 Prepaid expenses and other current assets............... 1,039 8,094 9,133 9,133 -------- --------- -------- -------- --------- -------- Total current assets.. 15,408 99,340 (11,267) 103,481 (2,575) 100,906 -------- --------- -------- -------- --------- -------- Cash collateral account.............. 11,800 11,800 11,800 Property and equipment, net....... 108,298 $2,914 29,964 10,136 (j) 151,312 151,312 Intangible and other assets, net.......... 49,559 2,686 88,016 5,366 (e) 390,831 4,600 (k) 395,431 2,291 (f) 249,450 (g) 1,100 (h) (7,637)(j) -------- ------ --------- -------- -------- --------- -------- Total assets.......... $173,265 $5,600 $ 229,120 $249,439 $657,424 $ 2,025 $659,449 ======== ====== ========= ======== ======== ========= ======== LIABILITIES AND PARTNERS' CAPITAL ----------------- Current liabilities Current debt and preferred stock...... $ 6,558 $ (4,167)(c) $ 2,391 $ 2,391 Bank credit facility borrowings........... $ 950 -- 950 950 Accounts payable...... 2,697 5,688 8,385 8,385 Unearned service contract revenue..... 12,736 12,736 12,736 Accrued expenses and income taxes......... 2,866 30,338 4,600 (h) 37,804 37,804 Accrued interest and dividends............ 2,248 10,557 872 (d) 13,677 (9,214)(m) 4,463 Customer credit balances............. 2,405 10,324 12,729 12,729 -------- --------- -------- -------- --------- -------- Total current liabilities.......... 11,166 76,201 1,305 88,672 (9,214) 79,458 -------- --------- -------- -------- --------- -------- Long-term debt......... 96,000 $5,000 284,587 6,286 (e) 391,873 120,000 (k) 302,779 (209,094)(m) Deferred income taxes.. 46,000 (j) 46,000 46,000 Other long-term liabilities........... 79 10,711 (3,500)(h) 7,290 7,290 Redeemable and exchangeable preferred stock................. 32,687 (920)(e) 31,767 (31,767)(m) -- Partners' capital Common unitholders.... 63,683 600 2,291 (f) 66,574 132,100 (l) 198,674 Subordinated unitholders.......... 2,056 62,030 (g) 23,582 23,582 (40,504)(j) General partner....... 281 4,382 (g) 1,666 1,666 (2,997)(j) Petro's Stockholders' deficiency........... (175,066) (872)(d) -- -- (7,100)(i) 183,038 (g) -------- ------ --------- -------- -------- --------- -------- Total Partners' Capital.............. 66,020 600 (175,066) 200,268 91,822 132,100 223,922 -------- ------ --------- -------- -------- --------- -------- Total Liabilities and Partners' Capital.... $173,265 $5,600 $ 229,120 $249,439 $657,424 $ 2,025 $659,449 ======== ====== ========= ======== ======== ========= ======== STAR GAS PARTNERS, L.P. AND SUBSIDIARY PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (UNAUDITED) YEAR ENDED SEPTEMBER 30, 1997 (IN THOUSANDS, EXCEPT PER UNIT AMOUNTS) 210
STAR GAS STAR GAS PARTNERS, L.P. PARTNERS, L.P. PROPANE PETRO PRO FORMA PRO FORMA THE ADJUSTED ADJUSTED(N) ACQUISITIONS(O) ACQUISITION(P) ADJUSTMENTS COMBINED OFFERINGS PRO FORMA -------------- --------------- -------------- ----------- --------- --------- -------------- Sales................... $149,766 $4,431 $548,141 $702,338 $702,338 Cost of sales........... 80,370 2,260 379,748 462,378 462,378 -------- ------ -------- -------- -------- Gross profit.......... 69,396 2,171 168,393 239,960 239,960 Operating expenses...... 46,408 918 132,383 179,709 179,709 Restructuring charges... 2,850 2,850 2,850 Corporate identity expenses............... 4,136 4,136 4,136 Pension curtailment expense................ 654 654 654 Provision for supplemental benefits.. 565 565 565 Depreciation and amortization........... 11,495 596 29,746 (5,132)(s) 36,705 307 (u) 37,012 Net gain (loss) on sales of assets.............. (265) -- 11,445 11,180 11,180 -------- ------ -------- ------ -------- ------- -------- Operating income...... 11,228 657 9,504 5,132 26,521 (307) 26,214 Interest income (expense), net......... (7,766) (373) (31,668) (39,807) 13,798 (v) (26,009) -------- ------ -------- -------- ------- -------- Income (loss) before income taxes........... 3,462 284 (22,164) 5,132 (13,286) 13,491 205 -------- ------ -------- ------ -------- ------- -------- Income tax expense...... 25 -- 500 525 525 -------- Income (loss) before equity interest in Star Gas.................... -- -- (22,664) -- -- -- -- Share of income (loss) of Star Gas............ -- -- (235) 235 (t) -- -- -- -------- ------ -------- ------ -------- ------- -------- Net income (loss)....... $ 3,437 $ 284 $(22,899) $5,367 $(13,811) $13,491 $ (320) ======== ====== ======== ====== ======== ======= ======== General Partner's interest in net income (loss)................. 69 (508) (6) -------- -------- -------- Limited Partners' interest in net income (loss)................. $ 3,368 (13,303) (314) ======== ======== ======== Net income (loss) per Limited Partner unit... $ 0.54 $ (1.82) $ (0.02) ======== ======== ======== Weighted average number of Limited Partner Units outstanding...... 6,228 27 (a) 103 (f) 2,767 (g) 7,306 6,364 (l) 13,670 577 (g) (2,396)(j) STAR GAS PARTNERS, L.P. AND SUBSIDIARY PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (UNAUDITED) NINE MONTHS ENDED JUNE 30, 1998 (IN THOUSANDS, EXCEPT PER UNIT AMOUNTS) 211
STAR GAS PARTNERS, L.P. STAR GAS PROPANE PETRO PRO FORMA PRO FORMA THE ADJUSTED PARTNERS, L.P. ACQUISITIONS(Q) ACQUISITION(R) ADJUSTMENTS COMBINED OFFERINGS PRO FORMA -------------- --------------- -------------- ----------- --------- --------- -------------- Sales................... $95,971 $3,927 $410,652 $510,550 $510,550 Cost of sales........... 43,726 2,012 265,799 311,537 311,537 ------- ------ -------- -------- -------- Gross profit........... 52,245 1,915 144,853 199,013 199,013 Operating expenses...... 32,700 892 93,759 127,351 127,351 Restructuring charges... 2,085 2,085 2,085 Corporate identity expenses............... 1,100 1,100 1,100 Provision for supplemen- tal benefits........... 320 320 320 Depreciation and amortization 8,644 437 21,998 $(3,538)(s) 27,541 $ 230 (u) 27,771 Net gain (loss) on sales of assets.............. (213) 11,496 11,283 11,283 ------- ------ -------- ------- -------- ------- -------- Operating income....... 10,688 586 37,087 3,538 51,899 (230) 51,669 Interest income(expense), net (5,834) (301) (23,163) (29,298) 10,069 (v) (19,229) ------- ------ -------- ------- -------- ------- -------- Income (loss) before income taxes........... 4,854 285 13,924 3,538 22,601 9,839 32,440 ------- ------ -------- ------- -------- ------- -------- Income tax expense...... 19 -- 475 494 494 -------- Income before equity interest in Star Gas... -- -- 13,449 -- -- -- -- Share of income (loss) of Star Gas............ -- -- 2,038 (2,038)(t) -- -- -- ------- ------ -------- ------- -------- ------- -------- Net income.............. $ 4,835 $ 285 $ 15,487 $ 1,500 $ 22,107 $ 9,839 $ 31,946 ======= ====== ======== ======= ======== ======= ======== General Partner's interest in net income................. 69 813 639 ------- -------- -------- Limited Partners' interest in net income................. $ 4,766 21,294 31,307 ======= ======== ======== Net income per Limited Partner unit........... $ 0.77 $ 2.91 $ 2.29 ======= ======== ======== Weighted average number of Limited Partner Units outstanding...... 6,228 27 (a) 103 (f) 2,767 (g) 7,306 6,364 (m) 13,670 577 (g) (2,396)(j) STAR GAS PARTNERS, L.P. AND SUBSIDIARY NOTES TO PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS The following pro forma adjustments give effect to (i) the acquisition of Petro, (ii) the Debt Offering, and (iii) the Equity Offering, as if each transaction had taken place on June 30, 1998, in the case of the pro forma condensed consolidated balance sheet, or as of October 1, 1996, in the case of the pro forma condensed consolidated statement of operations for the year ended September 30, 1997, or as of October 1, 1997 in the case of the pro forma condensed consolidated statement of operations for the nine months ended June 30, 1998. The condensed consolidated statements of operations for the year ended September 30, 1997 and nine months ended June 30, 1998 each include the results of operations for the three months ended December 31, 1997 of Petro. The pro forma adjustments are based upon currently available information, certain estimates and assumptions and a preliminary determination and allocation of the total purchase price and therefore the actual results may differ from the pro forma results. However, the Partnership's management believes that the assumptions provide a reasonable basis for presenting the significant effects of the transactions as contemplated, and that the pro forma adjustments give appropriate effect to those assumptions and are properly applied in the pro forma financial information. BALANCE SHEET ACQUISITIONS (a) Adjustment to reflect the acquisition and purchase price allocation in connection with three acquisitions by the Partnership in the fourth fiscal quarter of 1998. These acquisitions with an aggregate value of $5.6 million were financed with $5.0 million of borrowings under the Partnership's acquisition line and $0.6 million of Common Units issued to a seller. (b) Represents the actual balance sheet of Petro as of June 30, 1998. TRANSACTION RELATED ADJUSTMENTS (c) Adjustment to reflect the redemption in August 1998 of Petro's 1989 Preferred Stock. (d) Adjustment to reflect the accrued dividends payable on Petro's redeemable and exchangeable preferred stock. (e) Adjustment to carrying values to reflect the negotiated premium of $6.3 million to refinance Petro's Private Debt and Petro's Public Debt and negotiated discount of $0.9 million to redeem Petro's public preferred stock. (f) Reflects the issue of 0.8 million shares of Junior Preferred Stock of Petro, which upon consumption of the Transaction will be converted into 0.1 million Common Units at an assumed value of $22.00 per Unit as consideration to the holders of Petro's 9 3/8% Subordinated Debentures, 10 1/8% Subordinated Notes, and 12 1/4% Subordinated Debentures, and 12 7/8% exchangeable Preferred stock to permit the early redemption of such securities. 212 THE TRANSACTION (MERGER AND EXCHANGE) (g) Represents the exchange of 26.6 million shares of Petro's Class A Common Stock and Class C Common Stock for 2.8 million Senior Subordinated Units, 0.6 million Junior Subordinated Units and 0.3 million General Partner Units. (h) Represents the estimated amount of federal and state taxes to be incurred in connection with the acquisition of certain assets by the Partnership from Petro. (i) Reflects the payment by Petro of legal, professional and advisory fees for costs incurred by Petro and the Partnership as a result of the transaction. (j) The preliminary allocation of the excess of purchase price over the book value of Petro in connection with the Petro acquisition. The allocation of the purchase price was based on the results of a preliminary appraisal of the assets and the business to be acquired. The preliminary allocation is as follows (in thousands): THE DEBT OFFERING AND THE EQUITY OFFERING (k) Reflects the net proceeds to Petro of approximately $115.4 million from the $120.0 million Note Offering, net of underwriting discounts and commissions (estimated to be $3.6 million) and offering expenses (estimated to be $1.0 million). (l) Reflects the net proceeds to the Partnership of approximately $132.1 million from the issuance and sale of 6.4 million Common Units at an assumed offering price of $22.00 per Common Unit, net of underwriting discounts and commissions ($7.0 million) and offering expenses (estimated to be $0.9 million). (m) Reflects the use of the net proceeds from the Equity Offering and the Debt Offering to pay $9.2 million in accrued interest and preferred dividends, to repay $209.1 million of Petro Public Debt, including $2.8 million of premiums and to retire $31.8 million of Petro's exchangeable preferred stock. STATEMENT OF OPERATIONS Estimated expenses of $7.1 million to be incurred by Petro as a direct result of its acquisition by the Partnership, which will be included in Petro's actual statement of operations subsequent to June 30, 1998, have not been included as pro forma operating adjustments to the pro forma condensed consolidated statements of operations for the twelve months and nine months ended September 30, 1997 and June 30, 1998, respectively. 213
Assumed value of Units issued...................................... $ 66,412 Book value of Petro, adjusted for accrued dividends of $872 and transaction costs of $7,100..................................... (183,038) --------- Preliminary excess of purchase price over net book value........... 249,450 Allocation to property, plant and equipment........................ (10,136) Allocation to Subordinated Units, redeemed......................... (43,501) Recognition of current and net deferred tax liabilities incurred in connection with the acquisition....................................................... 47,100 Costs associated with the renegotiation of various debt instruments and preferred stock directly related to the Transaction........... 7,657 --------- Estimated intangibles, including customer lists and goodwill....... $ 250,570 ========= ACQUISITIONS n) Represents the Partnership's previously reported unaudited results for fiscal 1997 adjusted to reflect the Pearl Gas acquisition on October 22, 1997, the December 22, 1997 Common Unit Offering of 0.8 million Units and $11.0 million of debt incurred to finance a portion of the Pearl Gas acquisition as previously disclosed in the Partnership's December 1997 offering on Form S-1. o) Represents the results of certain propane distribution assets acquired by the Partnership subsequent to September 30, 1997 adjusted for: i) Certain cost savings of $0.3 million, primarily salary and benefit expenses relating to selling shareholders. ii) Additional depreciation and amortization of $0.5 million. iii) Additional interest expense of $0.3 million. p) Represents the results of operations of Petro for the twelve months ended December 31, 1997. q) Represents the results of certain propane distributors acquired by the Partnership in fiscal 1998 from October 1, 1997 to their dates of acquisition. Results of such distributors from the dates of acquisition to June 30, 1998 are included in the Partnership's nine months ended June 30, 1998 results adjusted for: i) Certain cost savings of $0.4 million, primarily salary and benefit expenses relating to selling shareholders. ii) Additional depreciation and amortization of $0.1 million. iii) Additional interest expense of $0.3 million. THE TRANSACTION (MERGER AND EXCHANGE) r) Represents the results of Petro for the nine months ended June 30, 1998. s) Adjustment to depreciation and amortization attributable to the Petro acquisition. t) Reflects the elimination of Petro's equity interest in the Partnership. THE OFFERINGS u) Amortization of debt insurance costs attributable to the Debt Offering. v) Reflects the net reduction to interest expense of $13.8 million and $10.1 million for fiscal 1997 and for the nine months ended June 30, 1998, respectively, which reflects interest expense on the $120.0 million Debt Offering at an assumed interest rate of 8.5% ($10.2 million of additional expense annually) offset by an annual reduction in interest expense of $24.0 million due to the repayment of $206.3 million of Petro Public Debt and a reduction in the interest rate/increase in principal on Petro's Private Debt. 214 ANALYSIS OF PRO FORMA RESULTS OF OPERATIONS Overview In analyzing the historical results of the Partnership and the pro forma information as provided, the following matters should be considered. First, the results for the fiscal 1997 pro forma exclude cost savings associated with Petro's restructuring program implemented during 1998. This restructuring program includes reductions in both corporate and field personnel, the consolidation of employee benefits plan and the rationalization of branch facilities. Second, while depreciation and amortization expenses reduce net income, as a non-cash expense, these expenses do not impact distributable cash flow. Third, while the propane and home heating oil businesses are both seasonal businesses, the home heating oil business generates a greater proportion of its profits in the heating season from October 1 through March 31 as compared to the propane business. Conversely, the heating oil business experiences greater losses during the period from April 1 through September 30. The following discussion pertains to pro forma net income per limited partner unit for the year ended September 30, 1997 and the nine months ended June 30, 1998. Year Ended Fiscal 1997 For fiscal 1997, adjusted net income per limited partner unit decreases by $.56 per unit from $0.54 per unit to a loss of $0.02 per unit, on a pro forma basis. This decline is primarily due to a higher level of non-cash charges associated with the Petro acquisition of $0.76 per unit, offset in part by a net non recurring benefit of $0.23 per unit. This net non recurring benefit is due to the gain recorded by Petro associated with the disposal of certain assets, which was reduced by certain one-time non recurring charges associated with Petro's branding, corporate identity and restructuring programs. Nine Months Ended June 30, 1998 For the nine months ended June 30, 1998, net income per limited partner unit increases from $0.77 per limited partner unit to $2.29 per limited partner unit, on a pro-forma basis. This increase during this period was attributable to the net non recurring benefit of $8.0 million or $0.57 per unit, the impact of certain propane acquisitions and the Petro acquisition. This increase is greater than the expected annual increase in net income due to the seasonality of the Petro acquisition. 215 GLOSSARY OF TERMS Acquisition: Any transaction in which any member of the Partnership Group acquires (through an asset acquisition, merger, stock acquisition or other form of investment) control over all or a portion of the assets, properties or business of another person for the purpose of increasing the operating capacity of the Partnership Group over the operating capacity of the Partnership Group existing immediately prior to such transaction. Adjusted Operating Surplus: With respect to any period, Operating Surplus generated during such period as adjusted to (a) decrease Operating Surplus by (i) any net increase in working capital borrowings during such period and (ii) any net reduction in cash reserves for Operating Expenditures during such period not relating to an Operating Expenditure made during such period, and (b) increase Operating Surplus by (i) any net decrease in working capital borrowings during such period and (ii) any net increase in cash reserves for Operating Expenditures during such period required by any debt instrument for the repayment of principal, interest or premium. Adjusted Operating Surplus does not include that portion of Operating Surplus included in clause (a)(i) of the definition of Operating Surplus. Affiliate: With respect to any person, any other person that directly, or indirectly through one or more intermediaries controls, is controlled by or is under common control with, the person in question. As used herein, the term "control" means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through ownership of voting securities, by contract or otherwise. Audit Committee: A committee of the board of directors of the general partner composed entirely of two or more directors who are neither members, officers nor employees of the general partner or members, stockholders (other than holders of Common Units or Senior Subordinated Units), officers, directors or employees of any Affiliate of the general partner. Available Cash: With respect to any quarter prior to liquidation: (a) the sum of (i) all cash and cash equivalents of the Partnership Group on hand at the end of such quarter and (ii) all additional cash and cash equivalents of the Partnership Group on hand on the date of determination of Available Cash with respect to such quarter resulting from Working Capital Borrowings subsequent to the end of such quarter; less (b) the amount of cash reserves that is necessary or appropriate in the reasonable discretion of the general partner to (i) provide for the proper conduct of the business of the Partnership Group (including reserves for future capital expenditures) subsequent to such quarter, (ii) provide funds for Minimum Quarterly Distributions and Cumulative Common Unit Arrearages in respect of any one or more of the next four quarters, or (iii) comply with applicable law or any debt instrument or other agreement or obligation to which any member of the Partnership Group is a party or its assets are subject; provided, however, that the General Partner may not establish cash reserves for distributions to the Senior-Subordinated Units unless the General Partner has determined that in its judgment the establishment of reserves will not prevent the Partnership from distributing the Minimum Quarterly Distribution on all Common Units and any Common Unit Arrearages thereon with respect to the next four quarters; and, 216 provided further, that disbursements made by a Group Member or cash reserves established, increased or reduced after the end of such Quarter but on or before the date of determination of Available Cash with respect to such quarter shall be deemed to have been made, established, increased or reduced, for purposes of determining Available Cash, within such quarter if the General Partner so determines. BTU: British Thermal Unit. The quantity of heat required to raise the temperature of one pound of water by one degree Fahrenheit. Capital Account: The capital account maintained for a Partner pursuant to the Partnership Agreement. The Capital Account in respect of a Common Unit, a Subordinated Unit, a Junior Subordinated Unit, a General Partner Unit or any other specified interest in the Partnership shall be the amount which such Capital Account would be if such Common Unit, Subordinated Unit, Junior Subordinated Unit, General Partner Unit or other interest in the Partnership were the only interest in the Partnership held by a Partner. Capital Improvements: Additions or improvements to the capital assets owned by any member of the Partnership Group or the acquisition of existing or the construction of new capital assets (including retail distribution outlets, propane tanks, pipeline systems, storage facilities and related assets), made to increase the operating capacity of the Partnership Group from the operating capacity of the Partnership Group existing immediately prior to such addition, improvement, acquisition or construction. Capital Surplus: All Available Cash distributed by the Partnership from any source will be treated as distributed from Operating Surplus until the sum of all Available Cash distributed since the commencement of the Partnership equals the Operating Surplus as of the end of the quarter prior to such distribution. Any excess Available Cash will be deemed to be Capital Surplus. Cause: A court of competent jurisdiction has entered a final, non-appealable judgment finding the general partner liable for actual fraud, gross negligence or willful or wanton misconduct in its capacity as a general partner of the Partnership. Class A Common Unit: A Unit representing a fractional part of the Partnership Interests of all Limited Partners and Assignees and having the rights and obligations specified with respect to Class A Common Units in this Agreement; no Class A Common Units shall be outstanding until the expiration of the Subordination Period, at which time all Common Units Outstanding immediately prior to the expiration of the Subordination Period shall be redesignated as Class A Common Units. Class B Common Unit: A Unit representing a fractional part of the Partnership Interests of all Limited Partners and Assignees and having the rights and obligations specified with respect to Class B Common Units in this Agreement; no Class B Common Units shall be outstanding until the expiration of the Subordination Period, at which time each Outstanding Senior Subordinated Unit and Junior Subordinated Unit shall convert into one Class B Common Unit. Common Unit: A Unit representing a fractional part of the partnership interests of all limited partners and assignees and having the rights and obligations specified with respect to Common Units 217 in the Partnership Agreement. All references in the Amended and Restated Partnership Agreement to Common Units after the expiration of the Subordination Period shall be deemed to be references to both Class A Common Units and Class B Common Units, unless otherwise indicated. Common Unit Arrearage: With respect to any Common Unit, whenever issued, and as to any quarter within the Subordination Period, the excess, if any, of (a) the Minimum Quarterly Distribution with respect to such Common Unit over (b) the sum of all Available Cash distributed with respect to such Common Unit in respect of such quarter. Cumulative Common Unit Arrearage: With respect to any Common Unit, whenever issued, and as of the end of any quarter, the excess, if any, of (a) the sum resulting from adding together the Common Unit Arrearage as to a Common Unit issued in the Initial Offering for each of the quarters within the Subordination Period ending on or before the last day of such quarter over (b) the sum of any distributions of Operating Surplus theretofore made with respect to such Common Unit (including any distributions to be made in respect of the last of such quarters). Current Market Price: With respect to any class of Units listed or admitted to trading on any national securities exchange as of any date, the average of the daily Closing Prices (as hereinafter defined) for the 20 consecutive Trading Days (as hereinafter defined) immediately prior to such date. "Closing Price" for any day means the last sale price on such day, regular way, or in case no such sale takes place on such day, the average of the closing bid and asked prices on such day, regular way, in either case as reported in the principal consolidated transaction reporting system with respect to securities listed or admitted to trading on the principal national securities exchange on which the Units of such class are listed or admitted to trading or, if the Units of such class are not listed or admitted to trading on any national securities exchange, the last quoted price on such day, or, if not so quoted, the average of the high bid and low asked prices on such day in the over-the- counter market, as reported by the Nasdaq Stock Market or such other system then in use, or if on any such day the Units of such class are not quoted by any such organization, the average of the closing bid and asked prices on such day as furnished by a professional market maker making a market in the Units of such class selected by the Board of Directors of the general partner, or if on any such day no market maker is making a market in the Units of such class, the fair value of such Units on such day as determined reasonably and in good faith by the Board of Directors of the general partner. "Trading Day" means a day on which the principal national securities exchange on which Units of any class are listed or admitted to trading is open for the transaction of business or, if the Units of a class are not listed or admitted to trading on any national securities exchange, a day on which banking institutions in New York City generally are open. Degree Day: Degree days measure the amount by which the average of the high and low temperature on a given day is below 65 degrees Fahrenheit. For example, if the high temperature is 60 degrees and the low temperature is 40 degrees for a National Oceanic and Atmospheric Administration measurement location, the average temperature is 50 degrees and the number of degree days for that day is 15. EBITDA: Operating income plus depreciation, amortization and non-cash charges (excluding expenses related to the consummation of the Merger and the transactions contemplated thereby). As used in this Proxy Statement, EBITDA is not intended to be construed as an alternative to net income 218 as an indicator of operating performance, or as an alternative to cash flow as a measure of liquidity or ability to service debt obligations. General Partner: Star Gas Corporation, a Delaware Corporation, until the Effective Time and Star Gas LLC, a Delaware limited liability company, and its successors, following the Effective Time. General Partner Interest: The ownership interest of the General Partner in the Partnership (in its capacity as a general partner without reference to any Limited Partner Interest held by it) which after the Closing will be evidenced by General Partner Units and includes any and all benefits to which the General Partner is entitled as provided in this Agreement, together with all obligations of the General Partner to comply with the terms and provisions of this Agreement. General Partner Unit: A Unit representing a fractional part of the General Partner Interest and having the rights and obligations specified with respect to the General Partner Interest. Initial Common Units: The Common Units sold in the Initial Offering. Initial Unit Price: With respect to each Common Unit, Senior Subordinated Unit, Junior Subordinated Unit and General Partner Unit, $22.00 or with respect to any other class or series of Units, the price per Unit at which such class or series of Units is initially sold by the Partnership, as determined by the General Partner, in each case adjusted as the General Partner determines to be appropriate to give effect to any distribution, subdivision or combination of Units. Interim Capital Transactions: (a) borrowings, refinancings or refundings of indebtedness and sales of debt securities (other than for working capital purposes and other than for items purchased on open account in the ordinary course of business) by any member of the Partnership Group, (b) sales of equity interests (including Common Units sold to the underwriters pursuant to the exercise of their over-allotment option) by any member of the Partnership Group and (c) sales or other voluntary or involuntary dispositions of any assets of any member of the Partnership Group (other than (i) sales or other dispositions of inventory in the ordinary course of business, (ii) sales or other dispositions of other current assets, including, without limitation, receivables and accounts, in the ordinary course of business and (iii) sales or other dispositions of assets as a part of normal retirements or replacements), in each case prior to the commencement of the dissolution and liquidation of the Partnership. Initial Closing Date: December 20, 1995. Initial Offering: The initial offering and sale of Common Units to the public on December 20, 1995. Junior Subordinated Unit: A Unit representing a fractional part of the Partnership Interests of all Limited Partners and Assignees and having the rights and obligations specified with respect to Junior Subordinated Units in the Amended and Restated Partnership Agreement. Limited Partner Interest: The ownership interest of a Limited Partner in the Partnership which is evidenced by Common Units, Senior Subordinated Units and Junior Subordinated Units or other 219 Partnership Securities and includes any and all benefits to which a Limited Partner is entitled as provided in the Amended and Restated Partnership Agreement, together with all obligations of a Limited Partner to comply with the terms and provisions of the Amended and Restated Partnership Agreement. Minimum Quarterly Distribution: $0.575 per Unit per Quarter; provided, however, the Minimum Quarterly Distribution with respect to the Senior Subordinated Units, Junior Subordinated Units and General Partner Units for the period commencing on the Effective Time and ending on June 30, 1999, shall be equal to the product of $0.575 multiplied by a fraction of which the numerator is the number of days in such period and of which the denominator is 91, subject to adjustment as described in "Cash Distribution Policy--Distributions from Capital Surplus" and "Cash Distribution Policy--Adjustment of Minimum Quarterly Distribution and Target Distribution Levels." Operating Expenditures: All Partnership Group expenditures, including taxes, reimbursements of the general partner, debt service payments, and capital expenditures, subject to the following: (a) Payments (including prepayments) of principal and premium on a debt shall not be an Operating Expenditure if the payment is (i) required in connection with the sale or other disposition of assets or (ii) made in connection with the refinancing or refunding of indebtedness with the proceeds from new indebtedness or from the sale of equity interests. For purposes of the foregoing, at the election and in the reasonable discretion of the general partner, any payment of principal or premium shall be deemed to be refunded or refinanced by any indebtedness incurred or to be incurred by the Partnership Group within 180 days before or after such payment to the extent of the principal amount of such indebtedness. (b) Operating Expenditures shall not include (i) capital expenditures made for Acquisitions or for Capital Improvements (as opposed to capital expenditures made to maintain assets), (ii) payment of transaction expenses relating to Interim Capital Transactions (iii) payment of transaction expenses related to the Merger and the transactions contemplated thereby or (iv) distributions to partners. Where capital expenditures are made in part for Acquisitions or Capital Improvements and in part for other purposes, the general partner's good faith allocation between the amounts paid for each shall be conclusive. Operating Partnership: Star Gas Propane, L.P., a Delaware limited partnership, and any successors thereto. Operating Partnership Agreement: The Amended and Restated Partnership Agreement for the Operating Partnership (the form of which has been filed as an exhibit to the Registration Statement of which this Proxy Statement is a part). Operating Surplus: As to any period prior to liquidation: (a) the sum of (i) $6.0 million plus all cash of the Partnership Group on hand as of the close of business on the Initial Closing Date, (ii) all the cash receipts of the Partnership Group for the period beginning on the Initial Closing Date and ending with the last day of such period, other than cash receipts from Interim Capital Transactions (except to the extent specified in the 220 Amended and Restated Partnership Agreement and (iii) all cash receipts of the Partnership Group after the end of such period but on or before the date of determination of Operating Surplus with respect to such period resulting from borrowings for working capital purposes, less (b) the sum of (i) Operating Expenditures for the period beginning on the Initial Closing Date and ending with the last day of such period and (ii) the amount of cash reserves that is necessary or advisable in the reasonable discretion of the general partner to provide funds for future Operating Expenditures; provided, however, that disbursements made (including contributions to a Group Member or disbursements on behalf of a Group Member) or cash reserves established, increased or reduced after the end of such period but on or before the date of determination of Available Cash with respect to such period shall be deemed to have been made, established, increased or reduced, for purposes of determining Operating Surplus, within such period if the General Partner so determines. Notwithstanding the foregoing, "Operating Surplus" with respect to the Quarter in which the Liquidation Date occurs and any subsequent Quarter shall equal zero. Opinion of Counsel: An opinion of counsel to the effect that the taking of a particular action will not result in the loss of the limited liability of the limited partners of the Partnership or cause the Partnership to be treated as an association taxable as a corporation or otherwise taxed as an entity for federal income tax purposes. Partnership: Star Gas Partners, L.P., a Delaware limited partnership, and any successors thereto. Partnership Agreement: The partnership agreement for the Partnership, as currently in effect, and unless the context requires otherwise, references to the Partnership Agreement constitute references to the Partnership Agreements of the Partnership and of the Operating Partnership, collectively. Partnership Group: The Partnership, the Operating Partnership and any subsidiary of either such entity, treated as a single consolidated entity. Petro Adjusted Operating Surplus: With respect to any four-quarter period, the Adjusted Operating Surplus generated by Petro (which for purposes of this definition includes all subsidiaries of the Partnership primarily engaged in the home heating oil business) during such four-quarter period, as determined in good faith by a majority of the members of the Board of Directors of the General Partner (with the concurrence of the Audit Committee). In calculating Petro Adjusted Operating Surplus, (i) debt service (including the payment of principal, interest and premium) on all debt incurred or assumed by Petro or any of its affiliates, the proceeds of which are used by or for the benefit of Petro (including the proceeds from the Debt Offering), shall be included to the extent such debt service is included in the calculation of Operating Surplus, and (ii) debt service (including the payment of principal, interest and premium) on all debt incurred or assumed by Petro or any of its affiliates, the proceeds of which are not used by or for the benefit of Petro, shall be excluded. Petro Units: With respect to any date, means the sum of (i) the excess of the number of Units outstanding at the Effective Time over the number of Units outstanding immediately prior to the 221 Effective Time (assuming the simultaneous closing of the Equity Offering), (ii) the number of Units issued by the Partnership thereafter to the extent the net proceeds of which are contributed to Petro (which for purposes hereof includes all subsidiaries of the Partnership primarily engaged in the home heating oil business), (iii) the number of additional Senior Subordinated Units or Class B Common Units issued pursuant to the Amended and Restated Partnership Agreement if Petro meets certain financial targets, and (iv) the deemed number of Units outstanding based upon a contribution of capital to Petro by the Partnership or any affiliate thereof after the Effective Time (which contribution is not covered by (ii) above or traceable to debt proceeds), which number of deemed Units is obtained by dividing (A) the amount of such contribution by (B) the Current Market Price of a Common Unit (or of a Class A Common Unit after the termination of the Subordination Period). If Petro pays down debt of Petro or debt allocated to Petro from internally generated funds of Petro and if those internally generated funds exist at Petro only because Petro has not paid dividends up to the Partnership in an amount equal to the distributions that would have been paid on the Petro Units had they been actual outstanding Units of the Partnership, then the amount used to pay down such debt will be treated as if it were contributed to Petro by the Partnership. The distribution per Senior Subordinated Unit of the Partnership shall be the amount that the Partnership would have been deemed to have distributed per Petro Unit had they been actual outstanding Units of the Partnership. For purposes of the number of deemed outstanding Units in (iv) above, such Units shall be deemed to be issued on the date of such Capital Contribution. For this purpose, Common Unit means Class A Common Units upon expiration of the Subordination Period. Senior Subordinated Unit: A Unit representing a fractional part of the Partnership Interests of all Limited Partners and Assignees, and having the rights and obligations specified with respect to Senior Subordinated Units in the Amended and Restated Partnership Agreement. Subordination Period: The Subordination Period will extend from the Initial Closing Date until the first day of any quarter beginning on or after July 1, 2002 in respect of which (i) distributions of Available Cash from Operating Surplus on each of the outstanding Common Units, Senior Subordinated Units, Junior Subordinated Units and General Partner Units equaled or exceeded the sum of the Minimum Quarterly Distribution on all of the outstanding Common Units and Junior Subordinated Units with respect to each of the three non-overlapping four-quarter periods immediately preceding such date, (ii) the Adjusted Operating Surplus, generated during each of the three immediately preceding, non-overlapping four quarter periods equaled or exceeded the sum of Minimum Quarterly Distribution on all of the Common Units, Senior Subordinated Units, Junior Subordinated Units and General Partner Units that were outstanding during such periods on a fully diluted basis with respect to employee options or other employee incentive compensation (i.e., taking into account for purposes of such determination all outstanding Common Units, Senior Subordinated Units, Junior Subordinated Units and General Partner Units and all Common Units issuable upon exercise of employee options that have as of the date of determination, already vested or are scheduled to vest prior to the end of the quarter immediately following the quarter with respect to which determination is made, and all Units that have as of the date of determination been earned by but not yet issued to management of the Partnership in respect of incentive compensation) and (iii) there are no arrearages in payment of the Minimum Quarterly Distribution on the Common Units. Target Distribution Levels: See "Cash Distribution Policy--Incentive Distributions." 222 Transfer Application: An application for transfer of Units in the form set forth on the back of a certificate, substantially in the form included in this Proxy Statement as Appendix A, or in a form substantially to the same effect in a separate instrument. Unit: A Partnership Interest of a Partner or Assignee in the Partnership representing a fractional part of the Partnership Interests of all Partners and Assignees and shall include Common Units (Class A Common Units and Class B Common Units after the expiration of the Subordination Period), Senior Subordinated Units, Junior Subordinated Units and General Partner Units; provided, that each Unit at any time Outstanding shall represent the same fractional part of the Partnership Interests of all Partners and Assignees holding Units as each other Unit. A Unit shall not include a Petro Unit. Unitholders: Holders of Units. Unit Majority: During the Subordination Period, at least (i) a majority of the outstanding Common Units voting as a class and (ii) a majority of the outstanding Senior Subordinated Units and Junior Subordinated Units voting as a single class, in each case excluding Units owned by the General Partner or any Affiliate, and, after the Subordination Period has ended, at least a majority of the outstanding Common Units. Unrecovered Initial Unit Price: At any time, with respect to Common Units, Senior Subordinated Units, Junior Subordinated Units or General Partner Units, the Initial Unit Price less the sum of all distributions constituting Capital Surplus theretofore made in respect of an Initial Common Unit and any distributions of cash (or the Net Agreed Value of any distributions in kind) in connection with the dissolution and liquidation of the Partnership theretofore made in respect of an Initial Common Unit, adjusted as the General Partner determines to be appropriate to give effect to any distribution, subdivision or combination of Units. Working Capital Borrowings: Borrowings pursuant to a facility or other arrangement requiring all borrowings thereunder to be reduced to a relatively small amount each year for an economically meaningful period of time. Borrowings that are not intended exclusively for working capital purposes shall not be treated as Working Capital Borrowings. 223 APPENDIX A No transfer of the Units evidenced hereby will be registered on the books of the Partnership unless the Certificate evidencing the Units to be transferred is surrendered for registration or transfer and an Application for Transfer of Units has been executed by a transferee either (a) on the form set forth below or (b) on a separate application that the Partnership will furnish on request without charge. A transferor of the Units shall have no duty to the transferee with respect to execution of the transfer application in order for such transferee to obtain registration of the transfer of the Units. APPLICATION FOR TRANSFER OF UNITS The undersigned ("Assignee") hereby applies for transfer to the name of the Assignee of the Units evidenced hereby. The Assignee (a) requests admission as a Substituted Limited Partner (evidenced by a credit to the account of the undersigned at The Depository Trust Company in the name of its nominee, Cede & Co.) and agrees to comply with and be bound by, and hereby executes, the Agreement of Limited Partnership of Star Gas Partners, L.P. (the "Partnership"), as amended, supplemented or restated to the date hereof (the "Partnership Agreement") (b) represents and warrants that the Assignee has all right, power and authority and, if an individual, the capacity necessary to enter into the Partnership Agreement, (c) appoints the General Partner and, if a Liquidator shall be appointed, the Liquidator of the Partnership as the Assignee's attorney-in fact to execute, swear to, acknowledge and file any document, including, without limitation, the Partnership Agreement and any amendment thereto and the Certificate of Limited Partnership of the Partnership and any amendment thereto, necessary or appropriate for the Assignee's admission as a Substituted Limited Partner and as a party to the Partnership Agreement, (d) gives the powers of attorney provided for in the Partnership Agreement and (e) makes the waivers and gives the consents and approvals contained in the Partnership Agreement. Capitalized terms not defined herein have the meanings assigned to such terms in the Partnership Agreement. Date: ___________________________ - ------------------------------------- Signature of Assignee - ------------------------------------- Social Security or other identifying number of Assignee - ------------------------------------- - ------------------------------------- - ------------------------------------- A-1 Name and Address of Assignee - ------------------------------------- Purchase Price including commissions, if any Type of Entity (check one): [_] Individual [_] Trust [_] Partnership [_] Other (specify) _______________________________________________ [_] Corporation Nationality (check one): [_] U.S. Citizen, Resident or Domestic Entity [_] Foreign Corporation [_] Non-resident Alien If the U.S. Citizen, Resident or Domestic Entity box is checked, the following certification must be completed. Under Section 1445(e) of the Internal Revenue Code of 1986, as amended (the "Code"), the Partnership must withhold tax with respect to certain transfers of property if a holder of an interest in the Partnership is a foreign person. To inform the Partnership that no withholding is required with respect to the undersigned interestholder's interest in it, the undersigned hereby certifies the following (or, if applicable, certifies the following on behalf of the interestholder). Complete Either A or B: A. Individual Interestholder 1. I am not a non-resident alien for purposes of U.S. income taxation. 2. My U.S. taxpayer identification number (Social Security Number) is _____________________________________________________________________ 3. My home address is ________________________________________________ B. Partnership, Corporation or Other Interestholder 1. (Name of Interestholder) is not a foreign corporation, foreign partnership, foreign trust or foreign estate (as those terms are defined in the Code and Treasury Regulations). 2. The interestholder's U.S. employer identification number is _______ 3. The interestholder's office address and place of incorporation (if applicable) is _________________________________________________________ ------------------------------------------------------------------------ A-2 The interestholder agrees to notify the Partnership within sixty (60) days of the date the interestholder becomes a foreign person. The interestholder understands that this certificate may be disclosed to the Internal Revenue Service by the Partnership and that any false statement contained herein could be punishable by fine, imprisonment or both. Under penalties of perjury, I declare that I have examined this certification and to the best of my knowledge and belief it is true, correct and complete and, if applicable, I further declare that I have authority to sign this document on behalf of (Name of Interestholder) ------------------------- Signature and Date ------------------------- Title (if applicable)------------------------- Note: If the Assignee is a broker, dealer, bank, trust company, clearing corporation, other nominee holder or an agent of any of the foregoing, and is holding for the account of any other person, this application should be completed by an officer thereof or, in the case of a broker or dealer, by a registered representative who is a member of a registered national securities exchange or a member of the National Association of Securities Dealers, Inc., or, in the case of any other nominee holder, a person performing a similar function. If the Assignee is a broker, dealer, bank, trust company, clearing corporation, other nominee owner or an agent of any of the foregoing, the above certification as to any person for whom the Assignee will hold the Units shall be made to the best of the Assignee's knowledge. A-3 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- AGREEMENT AND PLAN OF MERGER BY AND AMONG PETROLEUM HEAT AND POWER CO., INC. STAR GAS PARTNERS L.P. PETRO/MERGECO, INC. AND STAR GAS PROPANE, L.P. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- TABLE OF CONTENTS PAGE ARTICLE I. CERTAIN DEFINITIONS i
1.1. Certain Definitions................................................. 1 ARTICLE II. THE MERGER; EFFECTS OF THE MERGER 2.1. The Merger.......................................................... 11 2.2. Effective Date And Closing.......................................... 12 ARTICLE III. MERGER CONSIDERATION; EXCHANGE PROCEDURES 3.1. Merger Consideration................................................ 12 3.2. Rights As Stockholders; Stock Transfers............................. 13 3.3. Fractional Shares................................................... 13 3.4. Exchange Procedures................................................. 14 3.5. Anti-Dilution Provisions............................................ 16 3.6. Shares of Dissenting Common Holders................................. 16 3.7. Options............................................................. 16 ARTICLE IV. ACTIONS PENDING MERGER 4.1. Ordinary Course..................................................... 17 4.2. Capital Stock....................................................... 17 4.3. Dividends, Distributions............................................ 17 4.4. Compensation; Employment Agreements................................. 18 4.5. Benefit Plans....................................................... 18 4.6. Acquisitions And Dispositions....................................... 18 4.7. Amendments.......................................................... 19 4.8. Accounting Methods.................................................. 19 4.9. Insurance........................................................... 19 4.10. Notification........................................................ 19 4.11. Taxes............................................................... 19 4.12. Debt, Capital Expenditures and the Like............................. 19 4.13. No Dissolution...................................................... 19 4.14. Adverse Actions..................................................... 20 4.15. Agreements.......................................................... 20 ARTICLE V. REPRESENTATIONS AND WARRANT 5.1. Disclosure Schedule................................................. 20 5.2. Standard............................................................ 20 5.3. Representations And Warranties...................................... 20 ARTICLE VI. COVENANTS 6.1. Best Efforts........................................................ 31 6.2. Equityholder Approvals.............................................. 31 6.3. Registration Statements............................................. 32 6.4. Modification of Petro Indentures and Preferred Stock................ 33 ii
6.5. Press Releases..................................................... 34 6.6. Access; Information................................................ 34 6.7. Acquisition Proposals.............................................. 35 6.8. Affiliate Arrangements............................................. 35 6.9. Takeover Laws...................................................... 36 6.10. No Rights Triggered................................................ 36 6.11. Senior Subordinated Units Listed................................... 36 6.12. Third Party Approvals.............................................. 36 6.13. Indemnification; Directors' and Officers' Insurance................ 37 6.14. Benefit Plans...................................................... 39 6.15. Notification Of Certain Matters.................................... 40 6.16. New Director for Star Gas LLC...................................... 40 ARTICLE VII. CONDITIONS TO CONSUMMATION OF THE MERGER 7.1. Shareholder Vote................................................... 40 7.2. Governmental Approvals............................................. 40 7.3. No Injunction...................................................... 40 7.4. Representations, Warranties And Covenants Of Star Partners......... 41 7.5. Representations, Warranties And Covenants Of Petro................. 41 7.6. Effective Merger Registration Statement............................ 41 7.7. Opinion............................................................ 42 7.8. Opinion of Petro's Counsel......................................... 42 7.9. NYSE Listing....................................................... 43 7.10. Affiliate Arrangements............................................. 43 7.11. Fairness Opinion................................................... 43 7.12. Public Offerings................................................... 43 7.13. Refinancing Conditions............................................. 43 7.14. Dissenters' Rights................................................. 45 7.15. Covenant Not to Compete............................................ 45 7.16. Working Capital Loan............................................... 45 7.17. Debt Offering...................................................... 45 7.18. Restructuring Transactions......................................... 45 7.19. Special Committee.................................................. 45 7.20. Custody Agreement.................................................. 45 ARTICLE VIII. TERMINATION 8.1. Termination........................................................ 45 8.2... Effect Of Termination And Abandonment.............................. 46 ARTICLE IX MISCELLANEOUS 9.1. Survival........................................................... 47 9.2. Waiver; Amendment.................................................. 47 9.3. Counterparts....................................................... 47 9.4. Governing Law...................................................... 47 9.5. Expenses........................................................... 47 9.6. Confidentiality.................................................... 47 9.7. Notices............................................................ 47 9.8. Entire Understanding; No Third Party Beneficiaries................. 48 9.9. Headings........................................................... 49 EXHIBITS iii
Exhibit A Amended and Restated Partnership Agreement Exhibit B Amended and Restated Operating Partnership Agreement Exhibit C Petro Conveyance Agreement Exhibit D Star LLC Conveyance Agreement Exhibit E Covenant Not To Compete of Irik P. SevinDISCLOSURE SCHEDULES iv
(S) 4.2 (Petro only) Capital stock; issuance of additional shares (S) 4.4 (Petro only) Compensation; Employment Agreements (S) 4.6 (Petro only) Acquisition and Dispositions (S) 4.12 (Petro only) 1998 Capital Budget Shares; Shares/Units reserved for issuance; (S) 5.3 (b) stock options (S) 5.3 (c) Subsidiaries (S) 5.3 (f) No defaults (S) 5.3 (h) Litigation Compliance with laws (exception for no (S) 5.3 (i) Material Adverse Effect) (S) 5.3 (l) (i) Compensation and Benefit Plans Disclosures concerning pension plans, multi- (S) 5.3 (l) (iv) employer plans Excess of benefit liabilities over current (S) 5.3 (l) (vi) value of assets (S) 5.3 (l) (viii) Golden parachutes, etc. (S) 5.3 (m) Collective bargaining agreement (S) 5.3 (p) Regulatory approval (S) 5.3 (t) Intellectual propertyAGREEMENT AND PLAN OF MERGER, dated as of October 22, 1998 (this "Agreement"), by and among PETROLEUM HEAT AND POWER CO., INC., a Minnesota corporation ("Petro"), STAR GAS PARTNERS, L.P., a Delaware limited partnership ("Star Partners"), STAR GAS PROPANE, L.P., a Delaware limited partnership ("Star Propane"), and PETRO/MERGECO, INC., a Minnesota corporation ("Mergeco") and an indirect, wholly owned subsidiary of Star Partners. WITNESSETH: WHEREAS, the Board of Directors of Petro and the Board of Directors of Star Gas Corporation, the general partner of Star Partners and Star Propane, upon the recommendation of the Special Committee of the Board of Directors of the General Partner, have determined that it is in the best interests of their respective companies and their equity holders to consummate the business combination provided for herein pursuant to which Mergeco will, subject to the terms and conditions set forth herein, merge (the "Merger") with and into Petro, with Petro surviving as an indirect, wholly owned subsidiary of Star Partners; WHEREAS, on or prior to the date hereof, the Tax Free Group (as defined herein) and Star Partners have executed the Exchange Agreement (as defined herein); WHEREAS, the parties desire to make certain representations, warranties and agreements in connection with the Merger and also to prescribe certain conditions to the Merger; NOW, THEREFORE, in consideration of the mutual covenants, representations, warranties and agreements contained herein, and intending to be legally bound hereby, the parties agree as follows: ARTICLE I. CERTAIN DEFINITIONS 1.1. Certain Definitions. As used in this Agreement, the following terms shall have the meanings set forth below: "Affiliate" shall have the meaning set forth in Section 6.8(a). "Agreement" shall have the meaning set forth in the introductory paragraph to this Agreement. "Amended and Restated Operating Partnership Agreement" shall mean the Amended and Restated Operating Partnership Agreement substantially in the form attached hereto as Exhibit B. "Amended and Restated Partnership Agreement" shall mean the Amended and Restated Partnership Agreement substantially in the form attached hereto as Exhibit A. "Articles of Merger" shall have the meaning set forth in Section 2.1(b). "Certificate of Merger" shall have the meaning set forth in Section 2.1(b). "Certificates" shall have the meaning set forth in Section 3.4(b). A-1 "Closing" shall have the meaning set forth in Section 2.2. "Closing Date" shall have the meaning set forth in Section 2.2. "Code" shall mean the Internal Revenue Code of 1986, as amended. "Common Units" shall mean the common units representing limited partner interests of Star Partners having the rights and obligations specified with respect to Common Units in the Amended and Restated Partnership Agreement. "Compensation and Benefit Plans" shall have the meaning set forth in Section 5.3(1). "Cost of Capital" shall mean the sum of (a) the number of Common Units and Subordinated Units issued in the Equity Offering (excluding any Common Units or Subordinated Units issued pursuant to the exercise of an over-allotment option) multiplied by $2.30 and (b) the principal amount of debt issued in the Debt Offering multiplied by the interest rate on such debt. "Custody Agreement" shall mean the Custody Agreement among the members of the Tax Free Group and American Stock Transfer and Trust substantially in the form annexed to the Exchange Agreement. "Dain Rauscher Wessels" shall mean Dain Rauscher Wessels, a division of Dain Rauscher Incorporated. "Debt Offering" shall mean a public offering by a wholly owned subsidiary of Star Propane of nonconvertible debt securities with gross proceeds of not more than $120 million with total underwriting discounts and commissions not to exceed 3% of the aggregate principal amount offered to the public, the proceeds of which shall be used to refinance a portion of the Public Debt. "Debt Registration Statement" shall have the meaning set forth in Section 6.3(a). "Designated Percentage" shall mean a percentage of between 0% and 100% recommended by the Chief Financial Officer of Petro and approved by the Special Committee, not more than 10 business days and not less than two business days before the Closing Date. "DGCL" shall mean the Delaware General Corporation Law. "Disclosure Schedule" shall have the meaning set forth in Section 5.1. "Dissenting Common Holders" shall mean Petro shareholders who comply with all provisions of the MBCA concerning their right to object to and dissent from the Merger and demand "fair value" for their shares. "Effective Time" shall have the meaning set forth in Section 2.1(b). "Environmental Laws" shall mean all applicable local, state and federal environmental, health and safety laws and regulations, including, without limitation, the Resource Conservation and Recovery Act, the Comprehensive Environmental Response, Compensation, and Liability Act, the A-2 Clean Water Act, the Federal Clean Air Act, and the Occupational Safety and Health Act, each as amended, regulations promulgated thereunder, and state counterparts. "Equity Registration Statement" shall have the meaning set forth in Section 6.3(a). "Equity Offering" shall mean a public offering by Star Partners of Common Units or Senior Subordinated Units with gross proceeds of not less than $110 million and not more than $140 million, as determined by Petro (excluding any proceeds received from the exercise of the underwriters' over-allotment option, which will not exceed 15% of the number of Common Units or Senior Subordinated Units initially issued in the public offering), with total underwriting discounts and commissions not to exceed 5% of the aggregate price to the public. "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended. "ERISA Affiliate" shall have the meaning set forth in Section 5.3(1)(iv). "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder. "Exchange Agent" shall mean American Stock Transfer & Trust Company or such other entity as may be selected by Star Partners subject to the reasonable approval of Petro. "Exchange Agreement" shall mean the Exchange Agreement among the members of the Tax Free Group and Star Partners dated as of October 17, 1998. "Exchange Fund" shall have the meaning set forth in Section 3.4(a). "General Partner" shall mean Star Gas Corporation, a Delaware corporation, and its successors and permitted assigns as general partner of Star Partners and Star Propane. "General Partner Units" shall mean the general partner units representing a general partner interest in Star Partners having the rights and obligations specified with respect to General Partner Units in the Amended and Restated Partnership Agreement. "HSRA" shall mean the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and the rules and regulations thereunder. "Indemnified Party" shall have the meaning set forth in Section 6.13(a). "Joint Proxy Statement" shall have the meaning set forth in Section 6.3(a). "Junior Preferred Stock" shall mean Petro's 1998 Junior Convertible Preferred Stock. "Junior Subordinated Units" shall mean the junior subordinated units representing limited partner interests of Star Partners having the rights and obligations specified with respect to Junior Subordinated Units in the Amended and Restated Partnership Agreement. "Lien" shall mean any charge, mortgage, pledge, security interest, restriction, claim, lien, or encumbrance. A-3 "MBCA" shall mean the Minnesota Business Corporation Act. "Material Adverse Effect" shall mean, with respect to either Petro or Star Partners, any effect that (i) is material and adverse to the financial position, results of operations, business or prospects of Petro and its Subsidiaries taken as a whole, or Star Partners and its Subsidiaries taken as a whole, respectively, or (ii) would materially impair the ability of Petro or Star Partners, respectively, to perform its obligations under this Agreement or otherwise materially threaten or materially impede the consummation of the Merger and the other transactions contemplated by this Agreement; provided, however, that Material Adverse Effect shall not be deemed to include the impact of (a) actions or omissions of Petro or Star Partners taken with the prior written consent of Petro or the Special Committee, as applicable, in connection with the transactions contemplated hereby (as long as the material facts known to the requesting party concerning such actions or omissions were disclosed to the consenting party at the time it gave its consent), (b) circumstances affecting home heating oil companies or propane companies generally, and (c) the effects of the Merger and compliance by either party with the provisions of this Agreement on the business, financial condition or results of operations of such party and its Subsidiaries, or the other party and its Subsidiaries, as the case may be. "Meeting" shall have the meaning set forth in Section 6.2. "Merger" shall have the meaning set forth in the recitals to this Agreement and in Section 2.1(a). "Merger Consideration" shall have the meaning set forth in Sections 2.1(a) and 3(1). "Merger Registration Statement" shall have the meaning set forth in Section 6.3(a). "Multiemployer Plans" shall have the meaning set forth in Section 5.3(1)(iii). "New Certificates" shall have the meaning set forth in Section 3.4(a). "Newco" shall mean Petro Holdings Inc., a Minnesota corporation and a wholly owned subsidiary of Parentco." "Non-Compliance Event" shall have the meaning set forth in Section 5(3)(i)(i). "Non-Compliance Notification" shall have the meaning set forth in Section 5(3)(i)(iii). "NYSE" shall mean the New York Stock Exchange. "Old Subordinated Units" shall mean the subordinated units representing limited partner interests of Star Partners having the rights and obligations specified with respect to Subordinated Units in the Partnership Agreement. "Operating Partnership Agreement" shall mean the Agreement of Limited Partnership of Star Propane, as in effect immediately prior to the Effective Time. "Operating Partnership Agreement Amendments" shall mean the amendments to the Operating Partnership Agreement effected in the Amended and Restated Operating Partnership Agreement. A-4 "Parentco" shall mean Star/Petro, Inc., a Minnesota corporation and a wholly owned subsidiary of the Star Propane. "Partnership Agreement" shall mean the Agreement of Limited Partnership of Star Partners, as in effect immediately prior to the Effective Time. "Partnership Agreement Amendments" shall mean the amendments to the Partnership Agreement effected in the Amended and Restated Partnership Agreement. "Pension Plan" shall have the meaning set forth in Section 5.3(1)(iii). "Permitting Violation" shall have the meaning set forth in Section 5(3)(i)(ii). "Person" or "person" shall mean any individual, bank, corporation, partnership, limited liability company, association, joint-stock company, business trust or unincorporated organization. "Petro Class A Common Stock" means the Class A Common Stock, par value $.10 per share of Petro. "Petro Class B Common Stock" means the Class B common Stock, par value $.10 per share of Petro. "Petro Class C Common Stock" means the Class C Common Stock, par value $.10 per share of Petro. "Petro Common Stock" shall mean shares of Petro Class A Common Stock and Class C Common Stock without distinction as to class. "Petro Conveyance Agreement" shall mean the Conveyance and Contribution Agreement among Petro, Star Partners and Star Propane to be entered into as of the Closing Date substantially in the form of Exhibit C. "Petro Directors" shall mean the members of the Board of Directors of Petro. "Petro's Disclosure Schedule" shall mean the Disclosure Schedule delivered by Petro pursuant to Section 5.1. "Petro Insiders" shall mean Irik P. Sevin, Audrey L. Sevin, Phillip Ean Cohen, Thomas J. Edelman, Richard O'Connell, Brentwood Corp., Gabes S.A., Minneford Corp., Fernando Montero, M.M. Warburg & Co., Hanseatic Corp., Hanseatic Americas LDC, Barcel Corp., Hubertus Langen, Tortosa GmbH, Paul Biddelman and United Capital Corp. "Petro Meeting" shall have the meaning set forth in Section 6.2. "Petro Preferred Stock" shall mean collectively the Junior Preferred Stock, the Private Preferred Stock and the Public Preferred Stock. "Petro Stock Option" shall have the meaning set forth in Section 3.7. A-5