AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 22, 1998 REGISTRATION NO. 333-66005 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 AMENDMENT NO. 1 TO 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 OF INCORPORATION OR (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.) ---------------- 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. [_] 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. - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
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, ESQ. ATTN: ALAN SHAPIRO, ESQ. (713) 229-1330 ATTN: R. JOEL SWANSON, ESQ. STAR GAS PARTNERS, L.P. 2187 ATLANTIC STREET STAMFORD, CONNECTICUT 06902 ACQUISITION PROPOSED -- YOUR VOTE IS VERY IMPORTANT , 1999 Dear Unitholder: You are cordially invited to attend a meeting of common unitholders to be held at , New York, New York on , 1999. We have called this meeting so that you may vote upon our acquisition of Petroleum Heat and Power Co., Inc. and related matters. We believe the transaction is an attractive opportunity for Star Gas Partners, L.P. The transaction has been structured with the intent to provide an increase in our cash flow. Based on this expectation, we will increase the minimum quarterly distribution to our unitholders from $0.55 to $0.575 per unit, or from $2.20 to $2.30 on an annualized basis, upon completion of 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 Corporation and its affiliates). If you fail to vote by proxy or in person, it 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 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 OF THE PROXY STATEMENT. More detailed information about the meeting is included in the proxy statement. If you have any questions or need help in voting, please call me or Richard F. Ambury, Vice President-Finance at (203) 328-7300. Very truly yours, Joseph P. Cavanaugh President, Star Gas Corporation PETROLEUM HEAT AND POWER CO., INC. 2187 ATLANTIC STREET STAMFORD, CONNECTICUT 06902 ACQUISITION PROPOSED--YOUR VOTE IS VERY IMPORTANT , 1999 Dear Stockholder: You are cordially invited to attend a special meeting to be held at , New York, New York on , 1999. We have called this special meeting so that you may vote upon Star Gas Partners, L.P.'s acquisition of the company. This letter constitutes the notice of the special meeting required under Minnesota law. We think the transaction is an attractive opportunity for you because it will result in your ownership of equity in a financially stronger company with growth opportunities. When the transaction is completed, you will receive .13064 of a senior subordinated unit representing limited partner interests in Star Gas Partners, L.P. for each of your shares of common stock. The senior subordinated units have been approved for listing on the New York Stock Exchange under the symbol " ". However, no assurance can be given that an active trading market for the senior subordinated units will develop or at what price they will trade. Approval of this transaction will require the AFFIRMATIVE vote of a majority of the shares of Class A Common Stock (other than those owned by our directors and executive officers and their affiliates). If you fail to vote by proxy or in person, it will have the same effect as a vote against this 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. If this transaction is completed, common stockholders who do not vote their shares in favor of the transaction and who strictly comply with the applicable sections of the Minnesota Business Corporation Act will be entitled to statutory dissenters' appraisal rights. YOU SHOULD CAREFULLY CONSIDER EACH OF THE FACTORS DESCRIBED UNDER "RISK FACTORS," STARTING ON PAGE OF THE PROXY STATEMENT. More detailed information about the special meeting is included in the proxy statement. 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 ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ + + +THE INFORMATION IN THIS JOINT PROXY STATEMENT/PROSPECTUS IS NOT COMPLETE AND + +MAY BE CHANGED. WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION + +STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. + +THIS JOINT PROXY STATEMENT/PROSPECTUS IS NOT AN OFFER TO SELL THESE + +SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY + +STATE WHERE THE OFFER OR SALE IS NOT PERMITTED. + + + ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ SUBJECT TO COMPLETION, DATED DECEMBER 22, 1998 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 describes in detail Star Gas Partners, L.P.'s proposed acquisition of Petroleum Heat and Power Co., Inc., and related matters. If the transaction is completed, Petroleum Heat and Power Co., Inc. will be a subsidiary of Star Gas Partners, L.P., and the common stockholders will receive subordinated limited partner interests in Star Gas Partners, L.P. This proxy statement is furnished to the holders of common units in Star Gas Partners, L.P., as of , 1999, for the solicitation of proxies by the board of directors of Star Gas Corporation, its general partner. The proxies are for use at a meeting 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 of the meeting. This proxy statement is also furnished to holders of common stock of Petroleum Heat & Power Co., Inc., as of , 1999, for the solicitation of proxies by the board of directors of Petroleum Heat and Power Co., Inc. The proxies are for use at a special meeting 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 of the special meeting. This proxy statement is also the prospectus of Star Gas Partners, L.P. for the resale of limited partner interests received in the transaction by persons who may be deemed affiliates of Petroleum Heat and Power Co., Inc. YOU SHOULD CAREFULLY CONSIDER EACH OF THE FACTORS DESCRIBED UNDER "RISK FACTORS," STARTING ON PAGE OF THIS PROXY STATEMENT. 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 JOINT PROXY STATEMENT/PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS UNLAWFUL. Joint proxy statement/prospectus dated , 1999, and first mailed to unitholders/stockholders on , 1999. CAUTIONARY STATEMENT Star Gas Corporation provided all information in this proxy statement about the Partnership, Star Gas Propane, L.P. and its subsidiaries involved in propane operations, and Petro/Mergeco, Inc. Petro provided all information in this proxy statement about Petro and its subsidiaries in the home heating oil business. . You should rely only on the information contained in this document or to which we refer you. 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
CAUTIONARY STATEMENT....................................................... ii QUESTIONS AND ANSWERS...................................................... 1 Questions and Answers for the Partnership's Common Unitholders............ 1 Questions and Answers for Petro's Common Stockholders...................................................... 3 PROXY STATEMENT SUMMARY.................................................... 5 Parties................................................................... 5 Special Factors........................................................... 6 The Transaction........................................................... 10 Description of the Partnership Units...................................... 11 Financial Information..................................................... 13 RISK FACTORS............................................................... 20 Risks to the Partnership's Common Unitholders............................. 20 Tax Risks to Common Unitholders........................................... 24 Risks to Common Stockholders.............................................. 25 Tax Risks to Common Stockholders.......................................... 31 PARTIES AND CONFLICTS...................................................... 35 Parties to the Transaction................................................ 35 Conflicts of Interest..................................................... 37 PROXY SOLICITATIONS........................................................ 44 The Unitholders Meeting................................................... 44 The Special Meeting....................................................... 46 SPECIAL FACTORS............................................................ 50 Background of the Transaction............................................. 50 Reasons for the Transaction that the Special Committee Considered; Recom- mendation of the Special Committee....................................... 61 Opinion of A.G. Edwards................................................... 63 Reasons for the Transaction that the Petro Board Considered; Recommenda- tion of the Petro Board.................................................. Opinion of Dain Rauscher Wessels.......................................... 75 Certain Projections of Petro and the Partnership.......................... 84 THE TRANSACTION............................................................ 92 Description of the Transaction............................................ 92 Description of the Merger and the Exchange................................ 92 Related Financing and Refinancing Transactions............................................................. 94 Description of the Merger Agreement....................................... 96 Restrictions on Resales of Senior Subordinated Units by Non-Affiliates and Affiliates...................... 104 Selling Unitholders....................................................... 104 Plan of Distribution for the Resale Units................................. 105 Accounting Treatment of the Transaction................................... 105 iii
Regulatory Matters Associated with the Transaction........................ 106 MANAGEMENT OF THE PARTNERSHIP AFTER THE TRANSACTION........................ 107 General Partner........................................................... 107 Board of Directors of Star Gas LLC........................................ 107 Officers and Employees of the Operating Partnership and Petro............. 108 Reimbursement of Expenses of the General Partner.......................................................... 108 Partnership Structure..................................................... 109 BENEFICIAL OWNERSHIP OF PRINCIPAL UNITHOLDERS AND MANAGEMENT............... 112 AMENDMENTS TO THE PARTNERSHIP AGREEMENTS................................... 113 Introduction; Vote Required by Unitholders in order to Amend the Partnership Agreement.................................................... 113 Summary of Amendments to the Partnership Agreement.................................................... 113 Summary of Amendments to the Operating Partnership Agreement.............. 118 Conforming Changes........................................................ 118 THE AMENDED AND RESTATED PARTNERSHIP AGREEMENT..................................................... 119 Organization and Duration................................................. 119 Purpose................................................................... 119 Power of Attorney......................................................... 119 Restrictions on Authority of the General Partner with Respect to Extraor- dinary Transactions; Lack of Dissenters' Rights.......................... 120 Withdrawal or Removal of the General Partner; Approval of Successor General Partner........................... 120 Restriction on Transfer of General Partner Interest....................... 122 Reimbursement for Services of the General Partner.......................................................... 122 Rights and Status as Limited Partner or Assignee Upon Transfer of Interest....................................... 122 Limitations on the Rights of Non-citizen Assignees and Redemption Rights of the Partnership....................... 122 Issuance of Additional Securities by the Partnership...................... 123 Limited Call Right on Outstanding Limited Partner Interests............... 124 Amendment of the Amended and Restated Partnership Agreement............... 125
Meetings of Limited Partners and Voting Rights............................ 126 Indemnification Obligations of the Partnership.............................................................. 127 Potential Loss of Limited Liability by Unitholders........................ 128 Obligations of the General Partner to Provide Books and Reports to Limited Partners............................ 129 Limited Partners' Right to Inspect Partnership Books and Records.................................................................. 129 Description of Termination and Dissolution of the Partnership............. 130 Liquidation of the Partnership and Distribution of Proceeds................................................. 130 Registration Rights of the General Partner or its Affiliates.............. 130 CASH DISTRIBUTION POLICY................................................... 132 General Description of the Partnership's Cash Distribution................ 132 Quarterly Distributions of Available Cash................................. 133 Distributions of Available Cash from Operating Surplus During the Subordination Period..................................................... 133 Distributions of Available Cash from Operating Surplus After the Subordination Period..................................................... 135 Incentive Distributions During the Subordination Period..................................................... 135 Incentive Distributions After the Subordination Period..................................................... 136 Distributions from Capital Surplus........................................ 137 Limitation on Distributions on Subordinated Interests..................... 138 Adjustment of Minimum Quarterly Distribution and Target Distribution Lev- els...................................................................... 139 Issuance of Additional Senior Subordinated Units.......................... 139 Distributions of Cash upon Liquidation During the Subordination Period.......................................... 141 Distributions of Cash upon Liquidation After the Subordination Period........................................... 142 CASH AVAILABLE FOR DISTRIBUTION............................................ 144 DESCRIPTION OF THE UNITS................................................... 145 The Rights of Unitholders................................................. 145 Transfer Agent and Registrar.............................................. 145 Obligations and Procedures for the Transfer of Units...................... 146 COMPARISON OF SECURITIES................................................... 148 Taxation.................................................................. 148 iv
Distributions and Dividends.............................................. 148 Voting Rights............................................................ 149 Rights to Call Meetings.................................................. 149 Removal of Directors or the General Partner ........................................................ 149 Liquidation Rights....................................................... 150 Conversion Rights........................................................ 150 Liability of Holders..................................................... 150 Transferability and Listing.............................................. 151 Redemption............................................................... 151 Appraisal Rights......................................................... 151 Preemptive Rights........................................................ 152 Inspection of Books, Records and List of Holders......................... 152 COMPARATIVE SECURITY PRICE AND DISTRIBUTION INFORMATION................... 153 Partnership Securities................................................... 153 Petro Capital Stock...................................................... 154 Comparative Per Share/Per Unit Information (Unaudited)................................................. 155 CERTAIN FEDERAL INCOME TAX CONSIDERATIONS........................................................... 156 Tax Consequences of the Merger........................................... 156 Tax Consequences of Unit Ownership....................................... 157 Allocation of Our Income, Gain, Loss and Deduction....................... 163 Tax Treatment of Operations.............................................. 164 Disposition of Units..................................................... 166 Uniformity of Units...................................................... 169 Administrative Matters................................................... 171 State, Local and Other Tax Considerations.......................................................... 174 DISSENTERS' RIGHTS........................................................ 175 LEGAL MATTERS............................................................. 179 EXPERTS................................................................... 179 WHERE YOU CAN FIND MORE INFORMATION.............................................................. 179 STATEMENT OF FORWARD-LOOKING DISCLOSURE................................... 180 INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE................................................... 181 UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION.............................................................. 182 Star Gas Partners, L.P. and Subsidiaries--Pro Forma Condensed Consolidated Balance Sheet (Unaudited)................................................ 183 Star Gas Partners, L.P. and Subsidiaries--Pro Forma Condensed Consolidated Statement of Operations (Unaudited)...................................... 184
Star Gas Partners, L.P. And Subsidiaries--Notes to Pro Forma Condensed Consolidated Financial Information..................................... 185 GLOSSARY OF TERMS....................................................... 190 Appendix A--Application for Transfer of Units........................... App-1 v
Annexes A Merger Agreement B Exchange Agreement C Amended and Restated Partnership Agreement D Opinion of A.G. Edwards & Sons 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 FOR THE PARTNERSHIP'S COMMON UNITHOLDERS Q: WHAT IS BEING PROPOSED? A: You are considering the Partnership's acquisition of Petro. Petro's public stockholders will receive senior subordinated units in exchange for their shares of common stock. Q: WHAT ARE THE REASONS FOR IT? A: Petro is the largest home heating oil distributor in the country and has been a principal consolidator of that highly fragmented industry. We believe Petro's strong position in the home heating oil industry will provide the Partnership with 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 will increase the minimum quarterly distribution from $0.55 to $0.575 per unit, or from $2.20 to $2.30 on an annualized basis, upon completion of the transaction. Q: WHAT IS THE PURPOSE OF THE MEETING OF COMMON UNITHOLDERS? A: The meeting is for you to vote upon matters that must be approved in order to complete the acquisition of Petro. Q: WHAT ARE THE PROPOSALS THE COMMON UNITHOLDERS WILL VOTE ON? A: We are asking the common unitholders to approve three proposals: . The proposal to acquire Petro through a merger and an exchange. . The proposal to amend the partnership agreement to facilitate the transaction. . The proposal to elect a new general partner. Q: WHAT ARE THE CONDITIONS TO CLOSING THE TRANSACTION? A: In order for the transaction to occur, several conditions must be met. The following are three key conditions: . A majority of the common stockholders and common unitholders must approve each of the proposals submitted for vote. . An equity offering by the Partnership and a debt offering by Petro must be completed. . Petro must meet the financial tests in the merger agreement. Q: WHEN IS THE TRANSACTION EXPECTED TO OCCUR? A: The Partnership and Petro anticipate completing the transaction in early 1999. Q: WHAT IF THE TRANSACTION DOES NOT HAPPEN? A: The ownership structures of the Partnership and Petro will continue as they are on the date of this proxy statement. 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 a special committee of the Star Gas Corporation board of directors, the Star Gas Corporation board of directors unanimously recommends that you vote FOR each of the proposals. Q: WHO IS ENTITLED TO VOTE? A: Common unitholders of record at the close of business on , 1999. 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. Q:ARE THERE DISSENTERS' RIGHTS? A: No. Common unitholders do not have dissenters' rights. 2 QUESTIONS AND ANSWERS FOR PETRO'S COMMON STOCKHOLDERS Q: WHAT IS BEING PROPOSED? A: You are considering the acquisition of Petro by the Partnership. The Partnership is the eighth largest propane distributor in the United States. You will receive senior subordinated units of the Partnership in exchange for your shares of common stock. The senior subordinated units you will receive will be listed on the New York Stock Exchange. Q: WHAT ARE THE REASONS FOR IT? A: Petro is the largest home heating oil distributor in the U.S. and a 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: WHAT IS THE PURPOSE OF THE SPECIAL MEETING OF COMMON STOCKHOLDERS? A: Petro has called a special meeting for you to consider and vote upon the proposal for the Partnership to acquire Petro. Q: WHICH PARTS OF THE TRANSACTION AM I CONSIDERING? A: You are only voting on the Partnership's acquisition of Petro. Q: WHAT WILL I RECEIVE FOR MY COMMON STOCK IN THE TRANSACTION? A: For each share of common stock, you will receive: . .13064 of a senior subordinated unit of limited partner interests in the Partnership; and . 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 the future, senior subordinated unitholders may receive: . distributions in excess of those made on the common units if the Partnership generates cash above certain target levels; and . a proportionate share of up to an additional 909,000 senior subordinated units, but only if Petro achieves certain financial goals after the acquisition is completed. Q: ARE THERE DISSENTERS' RIGHTS? A: Common stockholders have the right to dissent and obtain payment for the "fair value" of their shares if certain corporate actions such as the merger should occur. 3 Common stockholders who wish to exercise dissenters' rights must comply fully with the requirements of the Minnesota Business Corporation Act. Accordingly Petro urges common stockholders wishing to dissent to read carefully "Proxy Solicitation--The Special Meeting--Dissenters' Rights," in this proxy statement and its attached Annex F, and to consult their own legal advisors. FAILURE TO FOLLOW THE PROCEDURES IN ANNEX F MAY RESULT IN A TERMINATION OR LOSS OF DISSENTERS' RIGHTS UNDER THE MINNESOTA BUSINESS CORPORATION ACT. Q: WHAT ARE THE TAX CONSEQUENCES OF THE MERGER? A: The merger will be a taxable transaction to the extent of the difference between the value of the senior subordinated units you receive and the federal income tax basis that you have in your shares of common stock. Q: WHAT ARE THE CONDITIONS TO CLOSING THE TRANSACTION? A: In order for the transaction to occur, several conditions must be met. The following are three key conditions: . A majority of the common stockholders and common unitholders must approve each of the proposals submitted for vote. . An equity offering by the Partnership and a debt offering by Petro must be completed. . Petro must meet the financial tests in the merger agreement. Q: WHEN IS THE TRANSACTION EXPECTED TO OCCUR? A: The Partnership and Petro anticipate completing the transaction in early 1999. Q: WHAT IF THE TRANSACTION DOES NOT HAPPEN? A: The ownership structures of the Partnership and Petro will continue as they are on the date of this proxy statement. Petro's Class A 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 of directors has approved the transaction and unanimously recommends that common stockholders vote FOR the proposal to be acquired by the Partnership. Q:WHO IS ENTITLED TO VOTE? A: Common stockholders of record at the close of business on , 1999. Q: DO I SEND IN MY STOCK CERTIFICATES NOW? A: No. After the transaction is approved, common stockholders of record will receive written instructions on how to deliver their Petro stock certificates in exchange for senior subordinated units. 4 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 fully understand the transaction, and for a more complete description of legal terms, you should read carefully this entire document and the documents to which we have referred you. See "Where You Can Find More Information" (page 179). A glossary of certain terms used in this proxy statement begins on p. 190. PARTIES The Partnership. The 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 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. For the fiscal year ended September 30, 1998, on a pro forma basis giving effect to the acquisition in fiscal 1998, the Partnership's operations had EBITDA (operating income plus depreciation, amortization and other non-cash charges, less net gain (loss) on sale of business and equipment) of $20.2 million on total sales of approximately $116.1 million. In addition to its retail business, the Partnership serves approximately 30 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 is the largest distributor of home heating oil in the United States and serves approximately 340,000 customers from 24 branch locations. For the twelve months ended September 30, 1998, on a pro forma basis Petro had EBITDA of $30.7 million and total sales of $450.1 million. If certain non-recurring restructuring, corporate identity and transaction expenses were not subtracted from EBITDA, pro forma EBITDA would have been $34.9 million. 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 Corporation, a wholly-owned subsidiary of Petro, is the current general partner of the Partnership. Petro's executive offices are located at 2187 Atlantic Street, Stamford, Connecticut 06902. Petro's telephone number is (203) 325-5400. 5 SPECIAL FACTORS POTENTIAL ADVANTAGES TO THE PARTNERSHIP'S COMMON UNITHOLDERS (SEE PAGE 61) The following are the potential advantages of the transaction to the common unitholders: . The minimum quarterly distribution will increase from $0.55 to $0.575, or $2.20 to $2.30 on an annualized basis, per unit. . The transaction has been structured with the intent to increase the amount of cash available for distribution to unitholders. If this expectation is realized, it will provide unitholders with greater assurance of receiving the minimum quarterly distribution and an improved possibility of future distribution increases. . The acquisition of Petro should improve the Partnership's growth prospects by providing attractive acquisition and expansion opportunities. . Petro common stockholders will receive subordinated limited partner interests which entitle them to receive distributions only after the common unitholders receive their full minimum quarterly distribution. . The period during which the common unit distribution is senior to the subordinated limited partner interests will be extended 21 months to October 1, 2002. . The transaction will increase the Partnership's market capitalization and should provide greater (1) common unit market liquidity, (2) investment community awareness and (3) ability to attract securities analyst research coverage. POTENTIAL DISADVANTAGES AND RISKS TO THE PARTNERSHIP'S COMMON UNITHOLDERS (SEE PAGES 20 AND 62) The following are the potential disadvantages and risks of the transaction to the common unitholders: . The Partnership is acquiring an entity that is several times its size based on 1997 revenues. Therefore, the nature of the Partnership's business will significantly change. . 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 of home heating oil businesses at attractive prices; - -- reduce Petro's customer attrition rate; and - -- increase Petro's profit margins on a per gallon basis. . The Partnership is making a large investment in a business that is more sensitive to temperature levels than its propane operations. This is due to Petro's home heating oil sales being used for heating purposes, while the Partnership's propane sales are often used for uses other than heating. . The home heating oil industry is not a growth industry as a result of increased competition from alternative energy sources. . The proportion of subordinated limited partner interests to total limited partner interests will decline from 37.5% to 6 25.2%, and therefore the support to common units will be reduced. . The number of common units will increase from approximately 3.9 million to 10.8 million, representing potential significant dilution. . Petro's income, 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 and interest income from Petro cannot be offset with past or future losses generated by the Partnership's propane operations. POTENTIAL ADVANTAGES TO PETRO'S COMMON STOCKHOLDERS (SEE PAGE 72) 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 Petro should receive an improved market valuation as part of a publicly-traded limited partnership. Publicly-traded limited partnerships are cash flow oriented and are valued primarily on a cash distribution basis. We believe Petro's focus on cash flow is well suited for that structure.We also believe the Partnership will have greater investment community awareness than Petro. As the only public home heating oil company, Petro has had limited securities analyst research coverage. . You are more likely to receive cash distributions as a holder of a senior subordinated unit in the Partnership than you are to receive dividends as a holder of Petro common stock. . You will receive senior subordinated units that must receive the minimum quarterly distribution prior to any payments being made on the junior subordinated units and the general partner units. . The senior subordinated units will have the right to receive incentive distributions. If the Partnership generates cash above target levels, the holders of senior subordinated units may receive greater cash distributions than the common unitholders. . If Petro achieves 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. POTENTIAL DISADVANTAGES AND RISKS TO PETRO'S COMMON STOCKHOLDERS (SEE PAGES 25 AND 73) The following are the potential disadvantages and risks of the transaction to the common stockholders: . 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 7 Stock Exchange, there is no assurance that any active trading market will develop. 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. The Partnership will make these distributions only after it has made the full minimum quarterly distribution on the common units. Further, distributions on the senior subordinated units, junior subordinated units and general partner units are generally limited to available cash generated after the closing of the transaction. Therefore, there is significant uncertainty as to the amount and timing of these distributions. . Star Gas LLC, the new general partner of the Partnership, will have conflicts of interest typical of a general partner in a publicly-traded limited partnership. These conflicts are different than any conflicts of interest that may exist for the Petro board of directors. . Like Petro's home heating oil operations, the Partnership's propane operations are also 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 the industry. . 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 some 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 CORPORATION BOARD OF DIRECTORS AND OPINION OF A.G. EDWARDS & SONS, INC. (SEE PAGES 37, 61 AND 63) All of the directors of Star Gas Corporation are also directors or officers of Petro, except for two directors who have no affiliation with Petro but who were originally elected to the Star Gas Corporation board of directors by Petro. Because the directors of Petro who are also directors of Star Gas Corporation 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 Corporation were appointed as a special committee to negotiate the transaction on behalf of the public common unitholders. Independent legal counsel represented the special committee in the negotiations. These two directors will each receive additional compensation of $40,000. A.G. Edwards & Sons, Inc. has served as independent financial advisor to the special committee in the transaction. They have rendered an opinion to the special committee that the transaction is fair, from a financial point of view, to the public common unitholders. The A.G. Edwards opinion is attached as Annex D to this proxy statement. Common unitholders and common stockholders are urged to read the opinion in its entirety for descriptions of the procedures followed, matters considered and limitations on the analysis undertaken. 8 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 fair to, and in the best interests of the common unitholders who are not affiliated with Star Gas Corporation. The special committee, therefore, has recommended the transaction to the Star Gas Corporation board of directors. Based on such recommendation, the Star Gas Corporation board of directors unanimously recommends that common unitholders vote FOR each of the proposals. RECOMMENDATIONS OF PETRO BOARD OF DIRECTORS AND OPINION OF DAIN RAUSCHER WESSELS (SEE PAGES 37, 72 AND 75) Each of the members of the Petro board of directors has interests that conflict, or may be perceived to conflict, with the interests of the public common stockholders. As a result, the Petro board of directors could not establish an independent committee. The Petro board of directors has determined that the transaction is fair and in the best interests of the common stockholders and has approved the merger agreement and the exchange agreement. The Petro board of directors, therefore, unanimously recommends that common stockholders vote FOR the proposal to be acquired by the Partnership. Dain Rauscher Wessels, a division of Dain Rauscher Incorporated, has rendered an opinion to the Petro board of directors that the consideration to be received in the merger by the common stockholders not affiliated with Star Gas Corporation is fair, from a financial point of view, to unaffiliated common stockholders. The Dain Rauscher Wessels opinion is attached as Annex E to this proxy statement. Common unitholders and common stockholders are urged to read the opinion in its entirety for descriptions of the procedures followed, matters considered and limitations on the analysis undertaken. PaineWebber Incorporated has also acted as a financial advisor to Petro. 9 THE TRANSACTION The transaction has four principal parts. THE MERGER AND THE EXCHANGE (SEE PAGE 92) As a result of the merger, in general, . Each outstanding share of Petro public common stock will be converted into .13064 of a senior subordinated unit. . Each outstanding share of junior preferred convertible stock of Petro will be converted into .13064 of a common unit. . Each outstanding share of Series C exchangeable preferred stock due 2009 of Petro will be converted into the right to receive $23 in cash plus accrued and unpaid dividends. As a result of the exchange, in general, . Irik P. Sevin, Audrey L. Sevin, Hanseatic Corp. and Hanseatic Americas LDC will contribute some of their common stock to Star Gas LLC in exchange for the ownership of Star Gas LLC. . Star Gas LLC will contribute these shares to the Partnership in exchange for general partner units. . The owners of Star Gas LLC will contribute their remaining shares of common stock to the Partnership in exchange for junior subordinated units. . 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. FINANCINGS AND REFINANCINGS (SEE PAGE 94) 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. . The Partnership will offer for sale to the public approximately 6.8 million common units, the net proceeds of which are estimated to be $128.3 million. . Petro will sell approximately $120.0 million of notes, the net proceeds of which are estimated to be $115.4 million. It is expected that the Partnership and a subsidiary of Petro will guarantee the notes. NEW GENERAL PARTNER (SEE PAGE 107) The new general partner of the Partnership will be Star Gas LLC. The directors of Star Gas LLC will be identical to the existing Star Gas Corporation directors as of the date of this proxy statement, except that, at her request, one of the current directors will withdraw as a director after 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 of directors. The new director will not be an officer or employee of Star Gas LLC or any of its affiliates. AMENDMENT OF THE PARTNERSHIP AGREEMENT (SEE PAGE 113) In order to complete the transaction, the partnership agreement must be amended. These amendments will substantially change the terms of the partnership agreement. 10 DESCRIPTION OF THE PARTNERSHIP UNITS This summary assumes that the partnership agreement will be amended. Distributions of available cash........................ . The Partnership intends to distribute, (See page 132) to the extent there is sufficient available cash, at least a minimum quarterly distribution of $0.575 per unit ($2.30 per unit on a yearly basis). . "Available cash" for any quarter consists generally of all cash on hand at the end of that quarter, as adjusted for reserves. The general partner has broad discretion in establishing reserves. . In general, available cash will be distributed per quarter based on the following priorities: First, to the common units until each has received $0.575 plus any arrearages from prior quarters. Second, to the senior subordinated units until each has received $0.575. Third, to the junior subordinated units and general partner units until each has received $0.575. Finally, after each unit has received $0.575, available cash will be distributed proportionately to all units until target levels are met. . If distributions of available cash exceed target levels greater than $0.604, the senior subordinated units, junior subordinated units and general partner units will receive incentive distributions as described below. Limitations on certain distributions............... . The aggregate amount of distributions (See page 138) that may be paid on the senior subordinated units, junior subordinated units and general partner units for the quarters ending June 30, 1999 and September 30, 1999 depends on whether the combined results of the Partnership and Petro exceed certain financial benchmarks. . Beginning with the quarter ending on December 31, 1999, the aggregate distributions paid on the senior subordinated units, junior subordinated units and general partner units depend upon the amount of available cash generated by the Partnership after October 1, 1999. Timing of distributions...... . The Partnership makes distributions (See page 133) approximately 45 days after each March 31, June 30, September 30 and December 31, to unitholders on the applicable record date. 11 . Common units issued in the equity offering are entitled to receive the full distribution with respect to the quarter ending March 31, 1999. . The first possible distribution on the senior subordinated units may be paid for the quarter ending June 30, 1999 on approximately August 14, 1999 to holders of record on approximately August 3, 1999. If paid, this will include a proportionate distribution for the period between the completion of the transaction and March 31, 1999. Subordination period.......... . The subordination period will generally (See page 133) end once the Partnership meets certain financial tests, but it cannot end prior to October 1, 2002. However in certain instances, if the general partner is removed, the subordination period will end. . When the subordination period ends, all senior subordinated units and junior subordinated units will convert into Class B common units on a one-for-one basis, and each common unit will be redesignated as a Class A common unit. . The main 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 as described below and the right to receive additional units. Incentive distributions....... If quarterly distributions of available (See page 135) cash exceed target levels, the senior subordinated units, junior subordinated units and general partner units will receive an increased percentage of distributions, resulting in their receiving a greater amount on a per unit basis than the common units. Additional senior Up to an additional 909,000 senior subordinated units........... subordinated units will be issued (See page 139) proportionately to holders of senior subordinated units, junior subordinated units and general partner units, but only if Petro achieves certain financial goals during the five-year period following completion of the transaction. NYSE Trading Symbols: Common Units.................. "SGU" Senior Subordinated Units..... 12 FINANCIAL INFORMATION 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) -------- (a) Assumes the sale of 6.8 million common units at $20.00 per common unit, net of underwriting discounts and commissions and expenses. The exact number of common units will increase or decrease inversely in relation to the public offering price of the common units. (b) Net of underwriting discounts and commissions and expenses. (c) Includes prepayment premium of $2.8 million. (d) The amounts across from the Petro 12 1/4% Senior Subordinated Debentures, the Petro 10 1/8% Senior Subordinated Notes, and the Petro 9 3/8% Senior Subordinated Debentures (1) include certain subordinated debt that was in Petro's October 1998 exchange offer under which this senior subordinated debt was issued and (2) assume that Petro will redeem or otherwise repurchase 100% of these securities. Upon completion of the transaction, Petro has the right to redeem up to an aggregate 98.5% of the principal amount of these securities. The Partnership intends to seek to purchase the remaining securities on comparable terms. (e) Does not include reserves for dissenters' rights which may be exercised by former Petro stockholders. (f) Petro will pay an additional $3.2 million of expenses from its existing cash balances. The 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(a).......................................... $128,300 Debt offering, net(b)............................................ 115,400 -------- 243,700 ======== USES Redeem Petro 12 1/4% Senior Subordinated Debentures due 2005(c)(d)...................................................... $ 84,094 Redeem Petro 10 1/8% Senior Subordinated Notes due 2003(d)....... 50,000 Redeem Petro 9 3/8% Senior Subordinated Debentures due 2006(d)... 75,000 Redeem Petro Public Preferred Stock.............................. 27,600 Repurchase Petro 1989 Preferred Stock............................ 4,167 Transaction fees and expenses(e)(f).............................. 2,839 -------- $243,700 ======== -------- (a) Estimated based on an assumed offering price of $20.00 per common 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. The exact number of common units will increase or decrease inversely in relation to the public offering price of the common units. (b) Stated in equivalent units before the transaction and includes the general partner's interest in Star Gas Propane, L.P. 13
BEFORE TRANSACTION AFTER TRANSACTION -------------------- --------------------- NUMBER PERCENTAGE NUMBER PERCENTAGE --------- ---------- ---------- ---------- COMMON UNITS Existing common units............ 3,858,999 60.5% 3,858,999 26.8% Issued to Petro Junior Preferred Stockholders.................... -- -- 102,773 0.7 Issued in equity offering(a)..... -- -- 6,800,000 47.3 --------- ---- ---------- ----- Subtotal....................... 3,858,999 60.5 10,761,772 74.8 SUBORDINATED UNITS Existing Subordinated Units...... 2,396,078 37.5 -- -- Senior Subordinated Units........ -- -- 2,767,058 19.2 Junior Subordinated Units........ -- -- 568,478 4.0 --------- ---- ---------- ----- Subtotal....................... 2,396,078 37.5 3,335,536 23.2 GENERAL PARTNER INTERESTS/UNITS(B)............... 127,655 2.0 287,700 2.0 --------- ---- ---------- ----- Total.......................... 6,382,732 100% 14,385,008 100.0% ========= ==== ========== ===== CAPITALIZATION The following table shows the Partnership's historical capitalization as of September 30, 1998, (1) actual, (2) as adjusted to give pro forma effect to the acquisition of Petro and (3) as further adjusted to give pro forma effect to the closing of the equity offering and the debt offering and our application of the net proceeds of these offerings as described in "Proxy Statement Summary-- Financial Information." You should read this table together with the historical and pro forma financial statements and notes included and incorporated by reference in this proxy statement. - -------- (a) See "Unaudited Pro Forma Condensed Consolidated Financial Information of Star Gas Partners, L.P.," for a discussion of the pro forma adjustments. This table does not include $4.2 million of the current portion of Petro's 1989 Preferred Stock, which will be paid with the proceeds of this offering. (b) The Petro Public Debt consists of $84.1 million of 12 1/4% Senior Subordinated Debentures due 2005, $50.0 million of 10 1/8% Senior Subordinated Notes due 2003 and $75.0 million of 9 3/8% Senior Subordinated Debentures due 2006. The amounts described (1) include the principal amount of subordinated debt that was not exchanged in Petro's October 1998 exchange offer in which this senior subordinated debt was issued and (2) assume that Petro will redeem or otherwise repurchase 100% of these securities. Upon completion of the transaction, Petro has the right to redeem up to an aggregate of 98.5% of the principal amount of these securities. We intend to purchase the remaining securities on comparable terms. (c) The Petro Private Debt consists of approximately $63.1 million of 9% Senior Notes due 2002, $4.3 million of 10 1/4% Subordinated and Senior Notes due 2001 and $14.3 million of notes payable for the purchase of fuel oil dealers maturing at various dates through 2004. 14
SEPTEMBER 30, 1998 ------------------------------------- PRO FORMA ADJUSTED ACTUAL COMBINED(A) PRO FORMA(A) -------- -------------- ------------ (IN THOUSANDS) Cash..................................... $ 1,115 $ 19,782 $ 16,550 ======== ======== ======== Debt: Star Gas Propane L.P. First Mortgage Notes.................................. $ 96,000 $ 96,000 $ 96,000 Star Gas Propane L.P. Acquisition Facil- ity.................................... 8,308 8,308 8,308 The notes issued in the debt offering... -- -- 120,000 Petro Public Debt(b).................... -- 209,094 -- Petro Private Debt(c)................... -- 76,056 81,686 -------- -------- -------- Total Long-Term debt................. 104,308 389,458 305,994 -------- -------- -------- Redeemable Preferred Stock: Petro Public Preferred Stock............ -- 27,600 -- Partners' capital: Common unitholders...................... 58,686 60,741 189,041 Existing subordinated unitholders....... (1,446) -- -- Senior and Junior subordinated unitholders............................ -- 22,544 22,544 General partner......................... 107 1,666 1,666 -------- -------- -------- Total partners' capital.............. 57,347 84,951 213,251 -------- -------- -------- Total capitalization................. $161,655 $502,009 $519,245 ======== ======== ======== SUMMARY SELECTED HISTORICAL FINANCIAL AND OPERATING DATA OF THE PARTNERSHIP The following table describes for the periods and dates indicated, summary selected historical financial and operating data of the Partnership, which are derived from the consolidated financial statements of the Partnership. The financial data is only a summary and should be read in conjunction with the Partnership's historical financial statements (and related notes) contained in the annual reports and other information that the Partnership has filed with the Commission. See "Incorporation of Certain Documents by Reference." The historical Other Data are unaudited but have been prepared on the same basis as that of the audited consolidated financial statements. These historical results of operations 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 1998 Form 10-K, which is incorporated by reference herein. (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. The definition of EBITDA set forth above is different from the definition of EBITDA used by Petro and may be different from that used by other corporations or partnerships. (e) For purposes of determining the ratio of earnings to fixed charges, earnings are defined as earnings (loss) from continuing operations before income taxes, plus fixed charges. Fixed charges consist of interest expense on all indebtedness, the amortization of deferred debt issuance costs and the portion of operating rental expense that is representative of the interest factor. For the year ended September 30, 1998, earnings were inadequate to cover fixed charges by $1.0 million. (f) Includes net maintenance capital expenditures for the fiscal years ended September 30, 1996, 1997 and 1998 of $2.3 million, $3.1 million and $2.6 million. 15
SEPTEMBER 30, --------------------------------------------- 1996(A) 1997 1998 --------------- ------------- ------------- (IN THOUSANDS, EXCEPT FOR PER UNIT DATA) STATEMENT OF OPERATIONS DATA Sales..................... $ 119,634 $ 135,159 $ 111,685 Gross margin.............. 61,077 62,948 62,187 Depreciation and amortiza- tion..................... 9,680 10,242 11,462 Operating income.......... 9,930 9,166 7,173 Interest expense, net..... 7,124 6,966 7,927 Net income (loss)......... 2,593 2,012 (955) Net income (loss) per unit(b).................. $ 0.11(c) $ 0.37 $ (0.16) Cash distribution declared per unit................. $ 1.17(c) $ 2.20 $ 2.20 BALANCE SHEET DATA (END OF PERIOD) Current assets............ $ 17,842 $ 14,165 $ 17,947 Total assets.............. 156,913 147,469 179,607 Long-term debt............ 85,000 85,000 104,308 Partners' capital......... 61,398 51,578 57,347 SUMMARY CASH FLOW DATA Net cash provided by oper- ating activities......... $ 9,982 $ 18,964 $ 9,264 Net cash provided by (used in) investing activi- ties..................... (6,954) (4,905) (13,276) Net cash provided by (used in) financing activi- ties..................... (2,649) (14,276) 4,238 OTHER DATA Earnings before interest, taxes, depreciation and amortization less net gain (loss) on sales of equipment ("EBITDA")(d).. $ 19,870 $ 19,703 $ 18,906 Retail propane gallons sold..................... 96,294 94,893 98,870 Ratio of earnings to fixed charges(e)............... 1.22x 1.27x -- Total capital expenditures(f).......... $ 5,332 $ 5,279 $ 5,015 SUMMARY SELECTED HISTORICAL FINANCIAL AND OPERATING DATA OF PETRO The following table describes for the periods and dates indicated, summary selected historical financial and operating data of Petro, which are derived from the consolidated financial statements of Petro. The financial data is only summary, and you should read it in conjunction with Petro's historical financial statements (and related notes) contained in the annual reports and other information that Petro has filed with the Commission. See "Incorporation of Certain Documents by Reference." Since the Partnership's initial public offering in December 1995, the Partnership has been accounted for under the equity method of accounting in Petro's financial statements. The historical financial data for the nine months ended September 30, 1997 and 1998 and the historical other data are unaudited. The results of operations for the nine- month periods ended September 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 of operations are not necessarily indicative of the results to be expected in the future. 16
NINE MONTHS YEAR ENDED DECEMBER 31, ENDED SEPTEMBER 30, ------------------------ -------------------- 1996 1997 1997 1998 ----------- ----------- --------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF OPERATIONS DATA Net sales.................... $ 608,161 $ 548,141 $ 386,855 $ 291,479 Gross margin (exclusive of depreciation)............... 180,773 168,393 115,586 99,971 Operating expenses .......... 138,703 132,383 96,292 81,758 Restructuring, corporate identity and pension curtailment................. 4,366 7,640 5,142 1,716 Depreciation, amortization and other non-cash costs(a).................... 28,946 28,847 21,567 20,639 Operating income (loss)...... 8,758 (477) (7,415) (4,142) Interest expense-net......... 32,412 31,668 23,777 22,912 Amortization of debt issuance cost........................ (1,872) (1,464) (1,097) (1,069) Other income (expense)-net... 1,842 11,445 65 127 Share of income (loss) of Star Gas.................... 2,283 (235) (1,808) (1,890) Income (loss) before extraor- dinary item................. (21,901) (22,899) (34,382) (30,211) Net income (loss)............ $ (28,315) $ (22,899) $ (34,382) $ (30,211) BASIC AND DILUTED EARNINGS (LOSSES) PER COMMON SHARE(B) Class A and Class C Common Stock....................... $ (1.20) $ (1.06) $ (1.47) $ (1.29) CASH DIVIDENDS DECLARED PER COMMON SHARE(B) Class A and Class C Common Stock....................... $ 0.60 $ 0.30 $ 0.23 -- WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING Basic(b) Class A Common Stock......... 22,983 23,441 23,339 23,960 Class C Common Stock......... 2,598 2,598 2,598 2,598 Diluted(b) Class A Common Stock......... 23,339 23,960 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, 1996 and 1997 there were 12,000 and 11,000 shares of Class B Common Stock outstanding, respectively. For the nine months ended June 30, 1997 and 1998 there were 11,000 shares of Class B Common Stock outstanding for both periods. For all periods presented, shares of Class B Common Stock did not receive an allocation of earnings or dividends. (c) 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. The definition of EBITDA set forth above is different from the definition of EBITDA used by the Partnership and may be different from that used by other companies. (d) 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 nine months ended September 30, 1997 and 1998, Petro recorded expenditures for these programs of $4.4 million, $7.6 million, $5.1 million and $0.7 million, respectively. (e) The decline in this measurement for the year ended December 31, 1997, as compared to the year ended December 31, 1996 was primarily due to warm weather experienced in 1997. (f) For the nine months ended September 30, 1998, home heating oil volume declined by 19.9% as compared to the nine 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 19.9%, operating income before depreciation, amortization and provision for supplemental benefits (EBITDA) declined only 16.6% due to a reduction in operating costs largely attributable to the effects of the restructuring and cost reduction programs. (g) For purposes of determining the ratio of earnings to fixed charges, earnings are defined as earnings (loss) from continuing operations before income taxes, plus fixed charges. Fixed charges consist of interest expense on all indebtedness and the amortization of deferred debt issuance costs and the portion of operating rental expense that is representative of the interest factor. For the years ended December 31, 1996 and 1997 and for the nine months ended September 30, 1997 and 1998, earnings were inadequate to cover fixed charges by $28.3 million, $22.9 million, $34.3 million and $30.2 million. 17
YEAR ENDED DECEMBER NINE MONTHS 31, ENDED SEPTEMBER 30, ----------------------- ---------------------- 1996 1997 1997 1998 --------- --------- --------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) BALANCE SHEET DATA (END OF PERIOD) Cash.................. $ 3,257 $ 2,390 $ 13,806 $ 13,767 Working capital....... 18,093 12,436 5,414 (7,479) Total assets.......... 275,025 247,846 223,918 198,678 Long-term debt........ 291,337 288,957 288,774 278,864 Redeemable preferred stock (long-term portion)............. 8,333 32,489 34,167 28,555 Stockholders' deficiency........... (145,733) (177,033) (189,361) (209,618) SUMMARY CASH FLOW DATA: Net Cash provided by (used in) operating activities........... $ (3,852) $ 18,644 $ 34,342 $ 28,803 Net Cash provided by (used in) investing activities........... (26,193) (980) (14,059) 1,011 Net Cash provided by (used in) financing activities........... (44,983) (18,531) (9,734) (18,437) OTHER DATA Operating income before depreciation, amortization and provision for supplemental benefits (EBITDA)(c).......... $ 37,704 (d) $ 28,370(d)(e) $ 14,152(d) $ 16,497(d)(f) Heating oil gallons... 456,141 410,291 282,806 226,579(f) Ratio of earnings to fixed charges(g)..... -- -- -- -- SUMMARY SELECTED UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION The following summary selected unaudited pro forma condensed consolidated statement of operations data, other data and balance sheet data as of and for the twelve month period ended September 30, 1998 assume the transaction occurred on October 1, 1997. The pro forma financial information below reflects the purchase method of accounting and is intended to give you a better picture of what our businesses might have looked like had they been combined since October 1, 1997. The companies may have performed differently if they were combined. You should not rely on the pro forma financial information as being indicative of the historical results that we would have had or the future results that we will experience after the transaction. See "Unaudited Pro Forma Condensed Consolidated Financial Statements." - -------- (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 and amortization less net gain (loss) on sale of 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. The definition of EBITDA set forth above is different from the definition of EBITDA used by Petro and may be different from that used by other corporations or partnerships. (d) EBITDA has been reduced by approximately $4.2 million in expenses associated with Petro's corporate identity, restructuring and Transaction expenses. (e) For the pro forma combined and as adjusted pro forma, the earnings were inadequate to cover fixed charges by $28.2 million and $15.0 million, respectively. 18
TWELVE MONTHS ENDED SEPTEMBER 30, 1998 ---------------------------------- (dollars in thousands, except per unit amounts) Pro Forma As adjusted Combined Pro Forma -------- ------------------------ STATEMENT OF OPERATIONS DATA Sales..................................... $566,155 $566,155 Gross margin.............................. 216,683 216,683 Depreciation, amortization and other non- cash costs(a)............................ 37,843 37,843 Operating income.......................... 13,027 13,027 Interest expense, net..................... 39,157 26,859 Net income (loss)......................... (28,238) (14,968) Net income (loss) per unit(b)............. N.A. $ (1.04) OTHER DATA Earnings before interest, taxes, depreciation, amortization less net gain (loss) on sales of equipment ("EBITDA")(c)(d)......................... $ 50,918 $ 50,918 Ratio of earnings to fixed charges(e)..... -- -- Heating oil and propane gallons........... 455,360 455,360 SEPTEMBER 30, 1998 ---------------------------------- BALANCE SHEET DATA Current assets............................ $100,659 $ 97,427 Total assets.............................. 678,592 679,960 Long-term debt............................ 389,458 305,994 Total partners' capital................... 84,951 213,251 In analyzing the historical results of the Partnership and the pro forma information as provided in the table above, the following three important factors 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 benefit plans 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, in fiscal 1998, temperatures were significantly warmer than normal for the areas in which we conduct our propane operations and our home heating oil operations. We believe that overall levels of pro forma available cash from operating surplus were adversely affected during fiscal 1998 due to this abnormally warm weather. 19 RISK FACTORS Limited partner interests are inherently different from the capital stock of a corporation, although the business risks faced by the Partnership are similar to those of a corporation engaged in a similar business. Common unitholders and common stockholders should consider the following factors in evaluating the transaction. RISKS TO THE PARTNERSHIP'S COMMON UNITHOLDERS The Star Gas Corporation board of directors urges common unitholders to carefully consider each of the factors set forth below. Conflicts of Interest Were Present in Structuring the Transaction All of the directors of Star Gas Corporation, other than the members of the special committee, are also directors or officers of Petro. Thus, except for the special committee, members of the Petro board of directors and the Star Gas Corporation board of directors have interests that are different from, and in conflict with, the interests of the common unitholders. The Star Gas Corporation board of directors appointed the two members of the special committee to negotiate the acquisition of Petro on behalf of the common unitholders. Each member of the special committee has received additional compensation of $40,000 for serving on the special committee. The Transaction Substantially Changes the Size and Nature of the Partnership's Business Petro is substantially larger than the Partnership in terms of assets, liabilities and revenues. The Partnership's primary business will therefore shift from the retail distribution of propane to the distribution of home heating oil. 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. These net losses were primarily a result of the amortization expense associated with Petro's many acquisitions since 1980 and interest expense. Higher than expected customer attrition, relatively mild recent winters and other operational factors also affected operating results. Petro's strategy is to maximize EBITDA and thus, net losses are likely to continue in the near term. Increased Distributions per Common Unit Are Not Assured The Star Gas Corporation board of directors structured the transaction based on its belief that it would increase the cash available to be distributed per common unit. The board of directors based this belief on the expectation that the Partnership will be able to (1) successfully acquire home heating oil distributors at attractive prices, (2) complete Petro's restructuring program to reduce customer losses and (3) increase operating margins. There can be no assurance that these expectations will be realized. 20 Common Unitholders Are Subject to Dilution in the Percentage of Their Ownership Interest After the transaction, it is expected that the number of outstanding units will increase by approximately 125%. The issuance of these additional units may dilute the interests of the existing common unitholders since they will own a smaller percentage of the Partnership. Furthermore, up to an additional 909,000 senior subordinated units will be issued to the holders of senior subordinated, junior subordinated and general partner units if Petro achieves certain financial goals during the five-year period following the closing. During the subordination period, the Partnership can issue 2,500,000 additional common units without obtaining any unitholder approval. These additional common units could dilute the interest of then-existing unitholders in the net assets of, and distributions to be made by, the Partnership. In addition, 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. There Will Be Less Support for the Common Units After the Transaction The existing subordinated units now represent a 37.5% limited partner interest in the Partnership. After the transaction, the senior subordinated, junior subordinated and general partner units will represent only a 25.2% 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. Common Unitholders Will Experience a Reduction in Voting Power After the transaction, matters that previously required only the consent of a majority of the outstanding common units will also require the consent of a majority of the senior subordinated and junior subordinated units, voting together as a single class. Thus, there may be matters in the future that the common units approve but are not adopted because a majority of the senior subordinated and junior subordinated units did not approve. The Partnership's Indebtedness May Limit Its Ability to Make Distributions and Affect Its Operations As a result of the transaction, the Partnership will have debt that is substantial compared to its partners' capital. Principal and interest payable on this debt will reduce cash available to make distributions on the common units. Under certain circumstances, the terms of the Partnership's debt instruments, including the senior subordinated notes issued in the debt offering, will limit its ability to distribute cash to common unitholders and to borrow additional funds. The limitations and restrictions in new debt we issue may be more restrictive than those in our current indebtedness. In addition, some of the Partnership's debt is secured by its assets. If the Partnership defaulted on this secured debt, the lenders could institute foreclosure proceedings to seize its assets. Any attempt to stay these foreclosure actions 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 After the completion of the transaction, it is expected that the debt instruments of the Partnership and Petro will contain provisions relating to a "change of control." There is no restriction on either Neither party is restricted from entering a transaction that would trigger the change of control provisions. 21 If these change of control provisions are triggered, some of the outstanding debt may become due. It is possible that the Partnership or Petro will not have sufficient funds at the time of any change of control to make the required payments on its debt or that restrictions in its other debt instruments will not permit those payments. In some instances, lenders would have the right to foreclose on the Partnership's or Petro's assets if debt payments were not made upon a change of control. Weather Conditions Affect the Demand for Heating Oil More than the Demand for Propane Petro's operations are more sensitive to temperature levels than are the Partnership's since Petro's home heating oil sales are for heating purposes, while the Partnership's propane sales are often for uses other than heating. Since sales of home heating oil during the peak heating season from October through March represent 75% to 80% of Petro's annual home heating oil volume, weather conditions during this period can have a material effect on Petro's financial results. It is possible that average temperatures in future years will be above the historical average. Petro Has Experienced Significant Customer Losses Petro's net attrition of home heating oil customers has been between approximately 5% to 6% per year over the past five years. This rate represents an annual gross customer loss rate of about 15% to 16%, offset by customer gains of approximately 10% yearly. Customer losses are the result of various factors, including customer relocations, supplier changes, natural gas conversions and credit problems. There can be no assurance that Petro will be able to maintain or reduce its customer net attrition rate in the future. Petro Cannot Grow Unless It Makes Acquisitions on Economically Acceptable Terms The home heating oil industry is not a growth industry because 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. Its future financial performance will depend on its ability to continue to make acquisitions at attractive prices. There is no assurance that Petro will be able to continue to make acquisitions or to do so on economically acceptable terms. If Petro is able to make acquisitions, there is no assurance that they will be profitable, or that any additional debt will not offset the cash generated. Petro must comply with certain covenants in certain agreements that restrict its ability to incur debt to finance acquisitions. Factors that may adversely affect Petro's operating and financial results may also limit Petro's access to capital and its acquisition activities. Petro Could Experience Oil Price Increases That May Affect Its Operations During periods of sudden and sharp increases in the supply cost of home heating oil, such as those experienced during 1996, Petro may be unwilling or unable to pass the entire increase in costs on to its customers. This may reduce gross profit margins. Price increases that continue over a long period of time may be passed on to customers, which could reduce demand by encouraging conservation or conversion to alternative energy sources. If demand were 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. 22 The Home Heating Oil 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. It is customary in this business for companies to deliver home heating oil to their customers based upon weather conditions and historical consumption patterns, without the customer making an affirmative purchase decision. Most companies provide home heating equipment repair service on a 24-hour per day basis. In some cases, 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. As a result of these factors, it may be difficult for Petro to acquire new retail customers. Petro also competes for customers with suppliers of alternative energy products, principally natural gas. Petro could face additional price competition from alternative heating sources such as electricity and natural gas as a result of deregulation in those industries. Over the past five years, conversions by Petro's customers from heating oil to other sources have averaged approximately 1% per year of the homes it serves. This conversion trend is not entirely within Petro's control, and it may worsen. Petro Is Subject to Operating and Litigation Risks That May Not Be Insured Petro's operations, like those of the Partnership, are subject to all operating hazards and risks incidental to providing customers with combustible liquids such as home heating oil. As a result, in the ordinary course of business, Petro may be a defendant in litigation. Petro maintains insurance policies in the amounts and with coverages and deductibles as it believes are reasonable. However, there can be no assurance that this insurance will be adequate to protect Petro from all expenses related to potential future claims. 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 federal and state laws and regulations related 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. It is possible, however, that Petro will have 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 release or spill, are greater than those associated with the Partnership's propane operations. It is possible that material costs and liabilities will be incurred, including those relating to claims for damages to property and persons. No Dissenters', Appraisal or Similar Rights for Non-consenting Common Unitholders Under applicable Delaware law and the terms of the partnership agreement, common unitholders will have no dissenters', appraisal or similar rights in the transaction, nor will the Partnership 23 voluntarily accord those rights to them. If a majority of common unitholders approve each of the proposals, then all common unitholders will be bound, even if they may have voted against them. Therefore, common unitholders who dissent from the proposals submitted to the common unitholders for approval will not be entitled to receive cash payment from the Partnership for the fair value of their common units. See "Dissenters' Rights". Petro Could Experience Oil Supply Interruptions While substantially all of Petro's home heating oil supply in recent years has been from North American sources, it is possible that disruptions in the supply of crude oil from foreign sources will adversely affect Petro's home heating oil business. TAX RISKS TO COMMON UNITHOLDERS Taxes Payable By Petro Will Reduce Distributions The transaction will result in income to Petro equal to the difference in the value of the units distributed in the merger (including the amount of any debt Petro is relieved of) and the federal income tax basis Petro has in those units. Petro expects that its net operating losses ("NOLs") will generally offset this income and Petro will incur only nominal tax. The IRS could challenge the amount of Petro's net operating losses and the use of the net operating losses to offset income realized in the transaction. A successful challenge could reduce the cash available for distribution by the Partnership. Although Petro and its corporate affiliates do not expect to pay significant federal income tax for several years following the transaction, over time the amount of federal income taxes paid by Petro and its corporate affiliates will increase, and this will also reduce the amount of cash that the Partnership can distribute to unitholders. A successful IRS challenge to the deduction of depreciation or interest on certain debt will increase the Partnership/Petro corporate group's tax liability and this will reduce the Partnership's ability to distribute cash to unitholders. Although Petro believes that the Partnership/Petro corporate group will not pay significant federal income tax for several years, Petro expects the related entities to generate earnings and profits during that time making that a portion of the distributions from the entities to the Partnership taxable dividend income to the unitholders. This 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 portion of the cash distributions that constitute taxable income to unitholders will increase at a greater rate if the transaction occurs. For example, the general partner estimates that a holder of a common unit issued in the initial public offering would be allocated, in the aggregate, no net passive income and less than $0.05 per unit per year of portfolio income through December 31, 2004 if the transaction is not completed. In contrast, if the transaction is completed the general partner estimates that the same holder would instead be allocated, in the aggregate, no net passive income and approximately $.20 per unit per year of portfolio income through December 31, 2002. In either case, the taxable income allocated to a common unitholder after either date will constitute an increasingly higher percentage of cash distributed to him. Furthermore, distributions that are in excess of the minimum quarterly distribution will increase the portion of each cash distribution that 24 constitutes taxable income to an existing common unitholder. However, the transaction will have different tax effects on different common unitholders, depending on when they purchased their units. RISKS TO COMMON STOCKHOLDERS The Petro board of directors urges common stockholders to carefully consider each of the factors set forth below. Conflicts Were Present in Structuring the Transaction Certain directors of Petro have interests that are different from, and in conflict with, the interests of the Petro public common stockholders. Senior Subordinated Unitholders Are Not Assured of Receiving Cash Distributions Petro public common stockholders will receive senior subordinated units in exchange for their shares of common stock. During the subordination period, which generally cannot end before October 1, 2002, no distributions of cash for any quarter may be made on the senior subordinated units until the common units have received the minimum quarterly distribution, plus any arrearages on those common units. In addition to receiving distributions after the common units, the senior subordinated units will not receive distributions unless the Partnership generates sufficient amounts of cash. The amount that may be paid for the quarters ending June 30, 1999 and September 30, 1999 depends on whether the combined results of the Partnership and Petro exceed certain financial benchmarks. Beginning with the quarter ending on December 31, 1999, the amount of distributions depends upon the amount of available cash generated by the Partnership after October 1, 1999. At no time do senior subordinated units accrue distribution arrearages. There can be no assurance that the Partnership will generate sufficient cash to make distributions on the senior subordinated units. In addition, there can be no assurance that the Partnership will ever meet the tests that must be satisfied to end the subordination period. 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. Cash Distributions Are Not Guaranteed and May Fluctuate with Partnership Performance Although generally the Partnership distributes all its available cash to unitholders, there is no assurance regarding the amounts of cash it will generate. Cash distributions on the senior subordinated units will not be guaranteed and may fluctuate based on the performance of the Partnership. The actual amount of cash that is available will depend upon numerous factors, including profitability of operations, required principal and interest payments on debt, the cost of acquisitions, issuance of debt and equity securities, fluctuations in working capital, capital expenditures, adjustments in reserves, prevailing economic conditions and financial, business and other factors. Some of these factors are beyond the control of the general partner. The partnership agreement gives the general partner discretion in establishing reserves for the proper conduct of the Partnership's business. These reserves will also affect the amount of cash available for distribution. The general partner may establish reserves for distributions on the senior 25 subordinated units only if those reserves will not prevent the Partnership from distributing the full minimum quarterly distribution, plus any arrearages, on the common units for the following four quarters. Cash distributions are dependent primarily on cash flow and reserves, and not on profitability, which is affected by non-cash items. Thus, at certain times, cash distributions may be made during periods when the Partnership records losses, and may not be made when the Partnership records profits. In addition, the Partnership is required to establish reserves for the future payment of principal and interest on certain debt instruments. The notes issued in the debt offering by Petro and the guarantee of those notes by the Partnership may have certain restrictions that will require cash reserves. As a result of these and other factors, the Partnership can give no assurance regarding the actual levels of cash distributions. The amount of cash needed to pay the minimum quarterly distribution for four quarters on units outstanding immediately after the transaction is approximately $33.1 million ($24.7 million for the common units, $6.4 million for the senior subordinated units, $1.3 million for the junior subordinated units and $0.7 million for the general partner units). After giving pro forma effect to the transaction, the amount of available cash generated in the twelve months ended September 30, 1998 would have been about $18.7 million. If certain infrequent restructuring, corporate identity and transaction expenses were not taken into effect, pro forma cash available for distribution would have been $22.9 million. 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 there can be no assurance that an active trading market will develop after the transaction. The Petro board of directors believes that senior subordinated units will likely 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 publicly-traded limited partnerships, the trading price of the common units, weather conditions and the 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. After the transaction, if a number of former common stockholders sell their senior subordinated units, the trading price of the senior subordinated units could decline significantly. The Partnership Has Substantial Indebtedness That May Affect its Ability to Make Distributions and Operations Although it has less debt than Petro, after the transaction, the Partnership will have debt that is substantial compared to its partners' capital. Principal and interest payable on this debt will reduce cash available to make distributions on the common units. Under certain circumstances, the terms of the Partnership's debt instruments, including the senior subordinated notes issued in the debt offering, will limit its ability to distribute cash to common unitholders and to borrow additional funds. The limitations and restrictions in new debt we issue may be more restrictive than those in our current indebtedness. In addition, some of the Partnership's debt is secured by its assets. If the Partnership defaulted on this secured debt, the lenders could institute foreclosure proceedings to seize its assets. 26 Any attempt to stay these foreclosure actions 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 After the completion of the transaction, it is expected that the debt instruments of the Partnership and Petro will contain provisions relating to a "change of control." Neither party is restricted from entering a transaction that would trigger the change of control provisions. If these change of control provisions are triggered, some of the outstanding debt may become due. It is possible that the Partnership or Petro will not have sufficient funds at the time of any change of control to make the required payments on its debt or that restrictions in its other debt instruments will not permit those payments. In some instances, lenders would have the right to foreclose on the Partnership's or Petro's assets if debt payments were not made upon a change of control. The General Partner Manages and Operates the Partnership; Holders of Units Have Limited Voting Rights The general partner manages and operates the Partnership and Star Gas Propane, L.P. Unlike the holders of common stock in a corporation, unitholders 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. The general partner generally may not be removed unless approved by the holders of 66 2/3% of the outstanding units voting together as a single class (except those of the general partner and its affiliates). As a result, unitholders have only limited influence on matters affecting the operation of the Partnership, and it would be difficult for third parties to control or influence the Partnership. Although the partnership agreement provides that the general partner may not (with certain exceptions) transfer its general partner units to another person prior to December 31, 2005 unless approved by a unit majority, the members of Star Gas LLC may 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 any circumstances. Furthermore, the matters on which the senior subordinated units may vote require the approval of a unit majority. During the subordination period, a unit majority means at least a majority of the common units (except those of 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 but that are nevertheless not adopted because either too few junior subordinated units approved or a majority of the common units did not approve. The Partnership May Issue Additional Units Diluting the Percentage of Ownership Interest of Existing Unitholders After the transaction, the Partnership will have the authority to issue up to 2,500,000 common units. In certain circumstances, it may also issue an unlimited number of additional common, senior subordinated, and junior subordinated units or other equity securities for the consideration and on the 27 terms and conditions as are established by the general partner, in its sole discretion without obtaining the approval of the unitholders. The issuance of these additional units may dilute the interests of the existing unitholders since they will own a smaller percentage of the Partnership. The Partnership Agreement Contains Provisions That May Discourage a Change of Management The partnership agreement contains certain provisions that may discourage attempts to remove an incumbent general partner or otherwise change the management of the Partnership. These provisions may diminish the price at which the senior subordinated units will trade under certain circumstances. Reimbursement of General Partner Has Priority over Distributions Before any distributions on the units, the Partnership will reimburse the general partner for all expenses it has incurred on behalf of the Partnership. Reimbursable expenses are determined by the general partner in its sole discretion. In addition, the general partner may charge the Partnership reasonable fees for services. The reimbursement of those expenses and the payment of those 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 outstanding units of any class are held by persons other than the general partner and its affiliates, the general partner has the right to acquire all, but not less than all, of those units held by the unaffiliated persons. The price for these units will generally equal the then-current market price of the units. The general partner may assign this acquisition right to any of its affiliates or the Partnership. As a consequence, a holder of units may be required to sell these units at an undesirable time or price. Also, after the subordination period ends, 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 A number of states have not clearly established limitations on the liability of limited partners for the obligations of a limited partnership. If it were determined that the Partnership had been conducting business in any state and had failed to comply with the applicable limited partnership statute, or that the rights or exercise of the rights by the limited partners as a group pursuant to the partnership agreement constituted participation in the "control" of the Partnership, then a unitholder might be held liable to the same extent as the general partner for the Partnership's obligations. Petro Common Stockholders Will Have Fewer Rights as Unitholders After the transaction, the common stockholders will lose their rights 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 described in "Comparison of Securities." 28 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 fuel. Accordingly, retail propane sales are directly affected by the severity of the winter weather. The highest sales occur during the six-month peak heating season from October through March, which period accounts for about 70% to 75% of total retail propane volume. Weather conditions can vary substantially from year to year, significantly affecting the Partnership's results of operations. For the fiscal year ended September 30, 1998, temperatures were significantly warmer than normal for the areas in which the Partnership sells propane. Weather variations also affect demand for propane from agricultural customers, because dry weather during the harvest season reduces demand for propane in crop drying. It is possible that average temperatures in future years will be above historical averages. The Partnership Could Experience Propane Price Increases It Cannot Pass on to Its Customers The retail propane business is a margin-based business in which gross profits depend on sales prices over propane supply costs. Consequently, the Partnership's profitability is sensitive to changes in wholesale and market prices of propane. The Partnership has no control over these market conditions. Thus when there are large or sudden increases in the supply costs of propane, the Partnership may not be able to pass on these increases to its customers through higher sales prices. The Partnership Could Be Unable to Sell Inventory Profitably Due to Market Volatility and/or Inflation 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 under supply contracts and on the spot market. The major portion of propane purchased by the Partnership (approximately 95% in fiscal 1998) is produced domestically. To the extent that the Partnership purchases propane from Canadian sources (approximately 5% in fiscal 1998), 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 it, thereby adversely affecting gross margin or rendering sales from 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 these activities has not been significant, and the Partnership is not currently engaged in any of these transactions. Inflation increases the Partnership's operating and administrative costs. The Partnership attempts to limit the effects of inflation on its operations through cost control efforts, productivity improvement and increases in gross profit margins. 29 The Partnership Is Dependent on Principal Suppliers Historically, a substantial portion of the propane purchased by the Partnership has originated in Mont Belvieu, Texas 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. Although the Partnership believes that alternative sources of propane are readily available, if the Partnership were unable to purchase propane from its usual sources, the failure to obtain alternate sources at competitive prices and on a timely basis could have a material adverse effect on the Partnership. The Retail Propane Business Is Highly Competitive Many of the Partnership's competitors and potential competitors are larger or have substantially greater financial resources than the Partnership, which may provide them with certain advantages. Competition within the propane distribution industry stems primarily from three types of participants: larger, multistate marketers; smaller, local independent marketers; and farm cooperatives. Generally, competition in the past few years has intensified, partly as a result of warmer-than-normal weather and general economic conditions. Most of the Partnership's propane retail branch locations compete with five or more marketers or distributors. Each branch location operates in its own competitive environment, as retail marketers are typically located in close proximity to their customers to lower the cost of providing service. The principal factors influencing competition with other retail marketers are price, reliability and quality of service, responsiveness to customer needs and safety concerns. The Partnership can make no assurances that it will be able to compete successfully on the basis of these factors. If a competitor attempts to increase 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. As a result of long-standing customer relationships that 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 experiences difficulty in acquiring new retail customers (other than through acquisitions). The Partnership Cannot Grow Unless It Makes Acquisitions on Economically Acceptable Terms The propane business is mature and total demand is expected to remain relatively flat or to decline slightly. The Partnership's future financial performance will depend on its ability to make acquisitions at attractive prices. Growth strategy continues to be focused on the acquisition of complementary businesses. The Partnership cannot assure that it will be able to identify attractive acquisition candidates in the future or to acquire them on economically acceptable terms. In particular, competition for acquisitions in the propane business has intensified and become more costly in recent years. Factors that may adversely affect operating and financial results, such as warm weather patterns, may limit the Partnership's access to capital and adversely affect its ability to make acquisitions. Any acquisition will also involve potential risks, including an increase in debt; the inability to integrate the acquired business; excessive expenses of the acquisition; diversion of management's attention; and potential loss of the acquired business' key employees. In addition, 30 acquisitions may be dilutive to earnings and any additional debt incurred to finance acquisitions may affect the Partnership's ability to make distributions to the unitholders. The Partnership Is Subject to Operating and Litigation Risks That May Not Be Insured The Partnership's operations are subject to all operating hazards and risks incidental to providing consumers with combustible liquids such as propane. Thus, in the ordinary course of business, the Partnership may be a defendant in litigation. The Partnership maintains insurance policies in the amounts and with the coverages and deductibles as the general partner believes are reasonable. However, there can be no assurance that this insurance will be adequate to protect the Partnership from all material expenses related to potential future claims. 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 partnership agreement contains provisions that limit the general partner's liability and reduce its fiduciary duties, while also restricting the remedies available to unitholders for actions that might, without the limitations, constitute breaches of fiduciary duty. Unitholders 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. The availability of cash for distributions to unitholders is affected by 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 increase in reserves. Except for Irik P. Sevin, who is subject to a non-compete agreement regarding the Partnership's propane and heating operations, the general partner's affiliates are not be prohibited from engaging in other businesses or activities, including 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. TAX RISKS TO COMMON STOCKHOLDERS There Are Risks Involving Tax Treatment of the Merger The transaction will be taxable to a common stockholder, generally resulting in gain or loss in an amount equal to the difference between the value of the senior subordinated units he receives and the federal income tax basis he has in the shares he exchanges. Any gain or loss will be capital gain or loss if the stock has been held as a capital asset, and will be long-term capital gain or loss if held for more than one year. Long-term capital gains are generally 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. Any unused capital loss can be carried forward indefinitely. The transaction will also result in income to Petro equal to the difference in the value of the units it distributes (including the amount of any debt Petro is relieved of) and the federal income tax basis Petro has in the units. Petro expects that its net operating losses will generally offset this income, however, the IRS could challenge the amount or use of the net operating losses and a successful challenge could reduce the cash available for distribution by the Partnership. 31 Tax Treatment Is Dependent on Partnership Status The federal income tax benefits of an investment in the Partnership depend largely on the Partnership's classification as a partnership for federal income tax purposes. Assuming the accuracy of certain factual matters represented as true by the general partner and the Partnership, counsel is of the opinion that 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 the 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 "qualifying income," within the meaning of Section 7704 of the Internal Revenue Code of 1986, as amended. This means that the Partnership's income is derived from the exploration, development, mining or production, processing, refining, transportation or marketing of any mineral or natural resource or other items. Whether the Partnership will continue to be classified as a partnership depends, at least partly, on the Partnership's ability to continue to meet this qualifying income test in the future. 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 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 that is 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, likely causing a substantial reduction in the market value of the units. There can be no assurance that the law will not change 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 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 income tax purposes, then certain provisions of the partnership agreement are subject to change, including a decrease in distribution to reflect the impact of that law on the Partnership. 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 Internal Revenue Code or any other matter affecting the Partnership. Accordingly, the IRS may adopt positions different from counsel's conclusions expressed herein. It may be necessary to resort to administrative or court proceedings to sustain some or all of counsel's conclusions, and these conclusions may ultimately not be sustained. Any such contest with the IRS might materially and adversely impact the market value of the units. 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. 32 Risk of Tax Liability Exceeding Cash Distributions 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. No assurance can be given that a unitholder will receive cash distributions equal to his allocable share of taxable income of the Partnership or even equal to the actual tax liability that results from this allocable share of income. Further, upon the sale of his units, a unitholder may incur a tax liability in excess of the amount of cash he receives. 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 these persons. For example, for any unitholder that is an organization exempt from federal income tax (including IRAs and other retirement plans), virtually all of the unitholder's allocable share of taxable income in the first few years will constitute unrelated business taxable income and thus will be taxable to this 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 those units. There Are Limits on Deductibility of Losses For any taxpayers who are 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. Passive losses that are not deductible because they exceed the unitholder's share of income of the Partnership may be deducted in full when the unitholder disposes of his entire investment in the Partnership in a fully taxable transaction with an unrelated party. 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. 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. The Partnership cannot assure unitholders that it will not be audited by the IRS or that adjustments to its income or losses 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 is responsible for any tax owed as the result of an examination of his personal tax return. 33 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 and because of other reasons, the Partnership has adopted certain depreciation and amortization conventions that do not conform with all aspects of certain proposed and final Treasury Regulations. A successful IRS challenge to those conventions could adversely affect the amount of tax benefits available to a purchaser of units and could have a negative impact on the value of the 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 these units. Thus, prior Partnership distributions in excess of cumulative net taxable income attributable to a unit that decreased a unitholder's tax basis in this unit will, in effect, become taxable income if the unit is sold at a price greater than the unitholder's tax basis in this 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 used by the Partnership, a unitholder could realize more gain on the sale of units than would be the case if the conventions were used, 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 for each year. 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 audit of this type 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 and West Virginia; however, New Hampshire's tax only applies to interest and dividend income. Each of these states currently imposes a personal income tax. It is the responsibility of each unitholder to file all United States federal, state and local tax returns that may be required of him. Counsel has not rendered an opinion on the state or local tax consequences of ownership or sale of units. 34 PARTIES AND CONFLICTS 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 Corporation ("Star Gas") and Petro. The Partnership's activities are conducted through Star Gas Propane, L.P., a Delaware Corporation (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 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 on a pro forma basis of approximately $116.1 million for the fiscal year ended September 30, 1998. 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 fiscal year ended September 30, 1998, approximately 80% of the Partnership's sales (by volume of gallons sold) were to retail customers (of which approximately 56%, 18%, 19% and 7% were sales to residential customers, industrial/commercial customers, agricultural customers and motor fuel customers, respectively) and approximately 20% 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 fiscal 1998 accounted for 66% of the 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 (1) internal growth, (2) controlling operating costs and (3) 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. 35 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 September 30, 1998, $9.0 million was outstanding under the Acquisition Facility and $14.8 million under the Working Capital Facility. 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 Transactions undertaken to facilitate the acquisition of Petro (the "Transaction"). Star Gas LLC (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 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, 1998 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 including metropolitan Boston, New York City, Baltimore, Providence, and Washington, D.C., with total sales on a pro forma basis of approximately $450.1 million for the twelve months ended September 30, 1998. 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 these 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 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. 36 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." CONFLICTS OF INTEREST Certain Persons Have Interests in the Transaction that Conflict, or May be Perceived to Conflict, with the Interests of Common Stockholders and Common Unitholders Star Gas, the current general partner of the Partnership, is a wholly-owned subsidiary of Petro. Petro also owns all the currently outstanding subordinated units representing limited partner interests ("Subordinated Units") of the Partnership. All of the directors of Star Gas are also directors or officers of Petro, except the members of a special committee (the "Special Committee"), consisting of the two members of the Star Gas Corporation board of directors ("Star Gas Board") who are neither officers, directors, nor employees of Petro. As a result, the members of the Star Gas Board who are also members of the Petro board of directors (the "Petro Board") have conflicting fiduciary duties to the holders ("Common Unitholders") of the common units of limited partner interests (the "Common Units") of the Partnership, Petro and its holders (the "Common Stockholders") of Class A Common Stock and Class C Common Stock (collectively, the "Common Stock"). Certain members of the Star Gas Board have interests that are different from, and in conflict with, the interests of its Common Unitholders. Prior to Petro's acquisition of Star Gas, Star Gas engaged Nicoletti & Company Inc., an investment banking firm owned by William P. Nicoletti, a member of the Special Committee, to perform certain investment banking services for Star Gas. Pursuant to this engagement, Star Gas paid Nicoletti & Company Inc. fees of $40,000, $521,500 and $81,600 for services rendered during 1992, 1993 and 1994, respectively. In 1995, Star Gas paid Nicoletti & Company Inc. $20,000 in advisory fees for a proposed acquisition. In 1997, Star Gas paid Mr. Nicoletti $20,000 for serving on the Special Committee which explored the possible sale or merger of the Partnership. In 1998, Star Gas paid Mr. Nicoletti $40,000 for serving on the Board of Directors Special Committee which explored the business combination with Petro. Elizabeth K. Lanier, a member of the Special Committee, was a partner in the law firm of Frost & Jacobs, in Cincinnati, Ohio until June 1996. Frost & Jacobs has acted as counsel to Star Gas in certain litigation matters. In 1997, Star Gas paid Ms. Lanier $20,000 for serving on the Board of Directors Special Committee which explored the possible sale or merger of the Partnership. In 1998, Star Gas paid Ms. Lanier $40,000 for serving on the Special Committee which explored the business combination with Petro. The officers and directors of Star Gas will be indemnified, to the extent permitted by law, for any and all actions taken in the Transaction and they are also covered by customary directors' and officers' liability insurance. Each member of the Star Gas Board will be a member of the board of directors of Star Gas LLC (the "Star Gas LLC Board") following the Transaction, except that, at her request, one of the current Star Gas directors will withdraw after the Transaction as a result of 37 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. Certain directors of Petro have interests in the Transaction that are different from, and in conflict with, the interests of the Common Stockholders who are not directors, officers or affiliates of Petro (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 of a Junior Subordinated Unit or General Partner Unit for each share of Common Stock, whereas the remaining Common Stockholders will exchange their shares for Senior Subordinated Units at a ratio of .13064 of a Senior Subordinated Unit 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, while substantially all affiliates of Petro will exchange their Common Stock without realizing 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 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 Common Unitholders who are not directors, officers or affiliates of the Partnership (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 the Transaction. The current officers of Petro will continue to be employed as officers following the Transaction. 38 Conflicts of Interest May Arise as a Result of the Publicly-Traded Limited Partnership Structure Certain conflicts of interest have arisen and could arise in the future as a result of relationships between the General Partner and its affiliates, on the one hand, and the Partnership or any of the partners, 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. It also restricts the remedies available to Unitholders for actions taken that without those 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. An audit committee of the Star Gas LLC Board (the "Audit Committee"), consisting of two directors who are not officers 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 Owed to Unitholders by the General Partner as Prescribed by Law and the Partnership." The fiduciary obligations of general partners is a developing area of law. The provisions of the Delaware Revised Uniform Limited Partnership Act (the "Delaware Act") 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. Further, the General Partner has not obtained an opinion of counsel covering the provisions in the Amended and Restated Partnership Agreement that purport to waive or 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. The amount of cash that is available for distribution to Unitholders is affected by decisions of the General Partner regarding matters such as cash expenditures, participation in capital expansions and acquisitions, borrowings, issuance of additional Units and establishment of reserves. In addition, borrowings by the Partnership do not constitute a breach of any duty owed by the General Partner to the Unitholders, including borrowings that have the purpose or effect of causing incentive distributions to be made, hastening the expiration of the Subordination Period or the conversion of the Senior Subordinated 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 although the General Partner and its affiliates may not borrow funds from the Partnership. See "Risk Factors" and "Cash Distribution Policy." Our Borrowings May Enable the General Partner to Permit Distributions on the Senior Subordinated Units, Junior Subordinated Units and General Partner Units. The General Partner generally must act as a fiduciary to us and the Unitholders, and therefore must generally consider our 39 best interests when deciding whether to make capital or operating expenditures or take other steps with respect to our business. It is not a breach of the General Partner's fiduciary duty under the Amended and Restated Partnership Agreement if our borrowings are effected in a manner that, directly or indirectly, enable the General Partner to permit the payment of distributions on the Senior Subordinated Units, Junior Subordinated Units and General Partner Units. The Partnership Reimburses the General Partner and Its Affiliates for Certain Expenses. Under the 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 General Partner determines the expenses that are allocable to the Partnership in any reasonable manner and 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. The General Partner intends to limit the Partnership's liability under contractual arrangements so that the other party has recourse only as to all or particular assets of the Partnership, and not against the General Partner or its assets. The Partnership Agreement provides that any action taken by the General Partner to limit its liability or that of the Partnership is not a breach of the General Partner's fiduciary duties, even if the Partnership could have obtained more favorable terms without the limitation on liability. Unitholders Have No Right to Enforce Obligations of the General Partner and Its Affiliates Under Agreements with the Partnership. The Partnership will acquire services from, or provide certain services to, the General Partner and its affiliates on an ongoing basis. The agreements relating to these arrangements 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 these 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 these 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 these 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 (1) the transaction is approved by the Audit Committee (although no party is obligated to seek approval), (2) its terms are no less favorable to the Partnership than those generally being provided to or available from unrelated third parties or (3) 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 40 the General Partner and those affiliates, except as may be provided in contracts entered into from time to time specifically dealing with that use, nor is there any obligation of the General Partner and its affiliates to enter into any of these contracts. Units Are Subject to the General Partner's Limited Call Right. The General Partner may exercise 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 that 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 this right, see "The Amended and Restated Partnership Agreement--The General Partner Limited Call Right on Outstanding Limited Partner Interests." 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 its duties associated with or incidental to (1) its performance as general partner of the Partnership or its affiliates or (2) the acquiring, owning or disposing of debt or equity securities of these entities. In addition, Irik P. Sevin has an agreement with the Partnership which provides that following the completion 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 that 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 these change of control provisions are triggered, the 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 Owed to Unitholders by the General Partner as Prescribed by Law and the Partnership Agreement 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 Delaware Act nor case law defines with particularity the fiduciary duties owed by general partners to limited partners or a limited partnership, but the Delaware Act 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 41 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 Delaware Act, 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 Delaware Act favoring the principle of freedom of contract and the enforceability of partnership agreements. The Delaware Act 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 this 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 this conflict is fair and reasonable to the Partnership, and any resolution shall conclusively be deemed to be fair and reasonable to the Partnership if the resolution is (1) approved by the Audit Committee (although no party is obligated to seek approval and the General Partner may adopt a resolution or course of action that has not received approval), (2) on terms no less favorable to the Partnership than those generally being provided to or available from unrelated third parties or (3) 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 this 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 the conflict or affected by the 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 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 Delaware Act or other applicable law. The 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 Delaware Act 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 42 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 Partnership Agreement also provides that any standard of care and duty imposed thereby or under the Delaware Act 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 that action is reasonably believed by the General Partner to be in, or not inconsistent with, the best interests of the Partnership. Further, 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 the 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 persons, if the General Partner or those 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 Obligations of the Partnership." Thus, the General Partner could be indemnified for its negligent acts if it meets the requirements concerning good faith and the best interests of the Partnership. 43 PROXY SOLICITATIONS THE UNITHOLDERS MEETING Date, Time and Place. The meeting of Common Unitholders (the "Unitholders 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 Unitholders Meeting is to consider and vote upon the proposal to acquire Petro (the "Acquisition Proposal"), the proposal to amend the partnership agreement ("the Amendment Proposal") and the proposal to change the general partner (the "General Partner Proposal" and, together with the Acquisition Proposal and the Amendment Proposal, the "Star Proposals"). 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 this recommendation, the Star Gas Board unanimously recommends that Common Unitholders vote FOR the Star Proposals. See "Special Factors--Reasons for the Transaction that the Special Committee Considered; Recommendation of the Special Committee." Description of Proxies and Procedures for Voting and Revoking 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 it represents 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, that 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. 44 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 that 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 those Common Units. Beneficial owners are therefore urged to provide instructions to those 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 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 this firm a fee of $ , plus expenses, for so acting. An additional fee of $ will be paid to this 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 that date. Under the Partnership Agreement as currently in effect, a "Record Holder" of Common Units means the person in whose name those 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 that 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 owner, unless the arrangement between the beneficial owner and his nominee provides otherwise. The Partnership is entitled to assume that the 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 45 Majority" is 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 that 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. No Dissenters' Rights. Common Unitholders do not have dissenters' rights for matters to be voted on at the Common Unitholders meeting. THE SPECIAL MEETING Date, Time and Place. A special meeting of Common Stockholders (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 a merger agreement (the "Merger Agreement"), under which Petro will be merged with a subsidiary of the Partnership (the "Merger") and Petro Common Stockholders will receive subordinated units of the Partnership and an exchange agreement (the "Exchange Agreement"), under which Petro Common Stockholders who are affiliates of Petro will exchange their Common Stock for subordinated units of the Partnership (the "Exchange"), and unanimously recommends that the Common Stockholders vote FOR the Acquisition Proposal. 46 Description of Proxies and Procedure for Voting and Revoking 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, that 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 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 that 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 upon in the absence of instructions from the beneficial owners of that Common Stock. Beneficial owners are therefore urged to provide instructions to those 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 that firm a fee of $ , plus expenses, for so acting. An additional fee of $ will be paid to that 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. 47 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 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. Voting Rights of Holders of 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 Will Remain Outstanding. There are 11,228 shares of Class B Common Stock 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 of the Merger (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 48 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. Dissenters' Rights. Under Sections 302A.471 and 302A.473 of the Minnesota Business Corporation Act (the "MBCA"), included in full as Annex F to this Proxy Statement, Common Stockholders (other than those who have agreed to vote for the proposal to acquire Petro or who have granted irrevocable proxies to Petro to vote for the proposal to acquire Petro at the meeting of Common Stockholders) have the right to dissent, and obtain payment for the "fair value" of their shares, if certain corporate actions such as the Merger should occur. 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 its attached Annex F, 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 meeting of Common Stockholders, a written notice of intent to demand payment of fair value for that holder's Common Stock (a "Dissent Notice"), and (2) not vote in favor of the proposal to acquire Petro. If the proposal to acquire Petro is approved at the meeting of Common Stockholders, 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 IN ANNEX F MAY RESULT IN A TERMINATION OR LOSS OF DISSENTERS' RIGHTS UNDER SECTIONS 302A.471 AND 302A.473 OF THE MBCA. 49 SPECIAL FACTORS BACKGROUND OF THE TRANSACTION The Genesis of the Transaction and Related Events 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. The initial contact was made at Mr. McCarthy's initiative based on his perception that the two entities could benefit from a business combination transaction. 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 (1) there being no other comparable publicly traded companies, (2) 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 (3) 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 a publicly-traded limited partnership 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 limited partnership. In addition, these entities were valued on a cash flow basis, similar to Petro's financial orientation, and that the combined Petro/Star publicly-traded limited partnership would have a significantly increased market capitalization. Also of significance was that the publicly-traded limited partnership 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 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. 50 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 and 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 Proposed 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 Unitholders as well as to the Partnership. Mr. McCarthy briefly outlined the following benefits to the Partnership's Common Unitholders: (1) a significant increase in distributable cash flow, (2) an increase in the annualized Minimum Quarterly Distribution from $2.20 to $2.30, (3) improved distribution coverage, (4) larger equity market capitalization and resulting liquidity to Unitholders and (5) 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 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 that Board were also directors or officers of Petro. The Petro Board recognized that in light of the potential conflict of 51 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 CNG Energy Services Corporation, a subsidiary of Consolidated Natural Gas Company, a large natural gas utility to explore the possibility of forming a joint venture acquisition corporation. However, these discussions did not progress beyond the preliminary stages. In addition, Mr. Sevin met with an investment banking firm which had a relationship with Enron Capital and Trade Corp., a subsidiary of Enron Corp., 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 this 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. . 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: 52 --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). . The right to receive incentive payments, which has historically been provided to the General Partner upon meeting certain performance tests, would be reallocated to all Common Stockholders by distributing those 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 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 publicly-traded limited partnership would have a negative perception in the public market. He considered growth and ability to make distributions the key considerations for valuing a publicly-traded limited partnership, 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 publicly-traded limited partnerships 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 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 Star Gas 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 53 were independently represented in 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 an 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 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 these 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 those 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. 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, AllEnergy Marketing Company L.L.C. ("AllEnergy") and Connective Power Delivery ("Connective"), to discuss with each a possible joint venture. While Connective indicated that it was not interested in pursuing the matter, AllEnergy, 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. 54 During May and June 1998, Petro had several discussions and meetings with representatives of Providence Energy Corporation 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 this 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. 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 55 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 the 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 the Transaction if Petro met certain financial goals. 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. 56 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 the 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 the proposal to Petro. The 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. . 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 57 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 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 12 7/8% Series B exchangeable preferred stock (the "Old Public Preferred Stock," and together with the Old Public Debt, the "Old Securities") (including the holders of 100% of the Old Preferred Stock) to permit the redemption of those 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 those 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 Formal Financial Advisory Agreement with PaineWebber. 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. Meeting with Hanseatic on Terms of the Exchange. 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 junior and illiquid securities at the value suggested by PaineWebber. Hanseatic's assent was necessary, so that when combined with the 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 58 Mr. Traber indicated a willingness to undertake an exchange, in order to accommodate completion 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. Meeting with Star Gas Board of Directors on the Status of the Transaction. 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 the discussions and negotiations. Mr. Sevin also informed the Board that he had received a telephone call from a director of Heritage Propane Partners, L.P., another publicly-traded propane limited partnership, to inquire as to whether the Partnership would be interested in being acquired by that publicly-traded limited partnership. 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 the 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 this 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 Andrews & Kurth L.L.P., co-counsel to Petro, indicated that the Special Committee would have the 59 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 those additional actions by the Star Gas Board as may be necessary or advisable under applicable law. Following the grant of that 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 of the Transaction, Petro had to have certain minimum working capital levels substantially higher than was required in the Preliminary Draft Proposal. 60 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 THAT THE SPECIAL COMMITTEE CONSIDERED; 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. All of the directors of Star Gas, except for the members of the Special Committee, are also directors of Petro. These directors have also determined that the Transaction is fair to, and in the best interests of the Public Common Stockholders and have recommended that the Public Common Stockholders vote for the Transaction Proposal at the Stockholders Meeting. See "--Background of the Transaction" and "Parties and Conflicts--Conflicts of Interest--Certain Persons Have Interests in the Transaction that Conflict, or May be Perceived to Conflict, with the Interests of Common Stockholders and Common Unitholders." 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 61 retail distributor of home heating oil 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. 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 21 months from January 1, 2001 to October 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. . 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 heating oil 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. 62 . 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 25%, and the support to Common Units will therefore be reduced. . The number of Common Units will increase from approximately 3.9 million to 10.8 million representing a potential significant dilution. The Special Committee also considered the following factors: . The Special Committee placed significant weight on the A.G. Edwards Opinion, that the Transaction is fair, from a financial point of view, to the Public Common Unitholders. The Special Committee considered valuation methods used by A.G. Edwards in rendering the A.G. Edwards Opinion to be appropriate and relied upon them in reaching their determination as to the fairness of the Transaction to the Public Common Unitholders. The Special Committee did not perform its own financial analysis (see page ). . The projections prepared by the Partnership and Petro (see page ). . The terms of the Exchange Agreement, Merger Agreement and Amendment to the Partnership Agreement (see pages , and ). . The conditions to the completion of the Transaction (see page ). . The background which resulted in the development of the structure of the Transaction (see page ). . The conflicts of interest in structuring the Transaction (see page ). . Recent trading prices of the Common Units and the Common Stock (see page ). The foregoing discussion of information and factors considered and given weight by the Special Committee is not intended to be exhaustive. Except for the A.G. Edwards Opinion on which it placed significant weight, in view of the wide variety of factors considered in 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. 63 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 mergers and acquisitions, 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 (the "First Mortgage Notes") 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, Star Gas 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 that date, the Transaction was fair, from a financial point of view, to the Public Common Unitholders. Subsequent to delivering its opinion, A.G. Edwards was invited to serve as one of seven co-managers of the equity offering. 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 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 on the Transaction, A.G. Edwards has assumed that the Partnership will be able to complete Petro's debt offering (the "Debt Offering"), in which Petro will sell to the public approximately $120.0 million of notes and the Partnership's equity offering (the "Equity Offering"), in which it will offer for sale to the public approximately 6.8 million Common Units and the redemption of certain debt and preferred stock of Petro (the "Refinancing Transactions") and understands that the Transaction will not be completed if the Partnership is unable to complete the Refinancing Transactions in accordance with the terms of the Merger Agreement. We have also assumed that the withdrawal of Star Gas as general partner of the Partnership 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 (1) the most recently available drafts of the Partnership's Registration Statement on Form S-4 and its exhibits including the Merger Agreement, the Exchange Agreement, the Amended and Restated Partnership Agreement and the Conveyance and Contribution Agreements; (2) certain publicly available historical audited financial statements and certain unaudited interim financial statements of the Partnership and Petro; (3) certain financial analyses and forecasts of the Partnership prepared by, and reviewed with, management of Star Gas and the views of management of Star Gas regarding the Partnership's past and current business operations, results thereof, financial condition and future 64 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; (4) 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 heating oil distribution industry and the potential strategic, financial and operational benefits and challenges anticipated from the Transaction; (5) the pro forma impact of the Transaction on the Partnership and Petro; (6) 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; (7) the current market environment generally, and the retail propane distribution environment and the home heating oil distribution environment in particular; (8) information relating to the financial terms of certain transactions, including selected merger and acquisition transactions; and (9) any other information, financial studies, analyses and investigations, and financial, economic and market criteria that A.G. Edwards considered relevant. A.G. Edwards did not perform an analysis related to the net book value or the liquidation value of Petro as it considered these analyses inappropriate under the circumstances of the Transaction. In rendering the A.G. Edwards Opinion, A.G. Edwards has assumed that the Transaction will be completed on the terms contained in the Merger Agreement, 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 Star Gas and Petro, respectively, that the projections and other information were reasonably prepared on a basis that reflects the best currently available estimates and judgments of the management of Star Gas 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: (1) A.G. Edwards assumed retail margin growth of $0.01 per gallon in 1999 and $0.005 per gallon thereafter; and (2) 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 infrequent 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 65 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 information. A.G. Edwards has relied upon the assurances of the management of Star Gas and Petro that the respective managements are not aware of any facts that would make the 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 those 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 in the written text of the A.G. Edwards Opinion itself. Any estimates are not necessarily indicative of future results or actual values, which may be significantly more or less favorable than those suggested by the 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 for 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 Star Gas Board. 66 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 these Units; subsequent to 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: (1) 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; (2) the earliest date on which the Subordination Period would expire is July 1, 2002; (3) 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 that period; (4) during the Subordination Period, distributions on the Senior Subordinated Units will be limited to the amount of distributable cash generated; (5) the Senior Subordinated Units will be entitled to receive a 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 (6) 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: (1) the lack of marketability of the Junior Subordinated Units and General Partner Units; (2) 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 (3) 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. 67 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") 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: (1) 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, (2) normalized 1998, which was based on the 1998 budget and assumed normal weather and (3) projected 1999, which assumed normal weather. Under these three scenarios: (1) DCF per unit would increase by $0.26, $0.53 and $0.54, respectively; (2) 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 (3) 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 Star Gas' 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 (1) DCF per unit would increase by $0.26, $0.56 and $0.58, respectively; (2) 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 (3) 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 domestic public companies, excluding banks, thrifts and trusts, and compared these transactions with the Transaction. The first group included 551 mergers and corporate transactions announced and completed since January 1, 1996 68 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 125 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 91 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 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 69 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 (1) the projected tax-adjusted operating cash flows for 1999 to 2002; and (2) the terminal value for 2002 (the "Petro Terminal Value"). The Petro 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 (1) the projected tax-adjusted operating cash flows for 1999 to 2002; and (2) 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 that 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. The analyzed divestitures were (1) Punderson, a division 70 of Petro located in Springfield, Massachusetts, (2) New Hampshire, a division of Petro located in southern New Hampshire and (3) TLC, a division of Petro's subsidiary Ocennet located in Hartford, Connecticut. 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: (1) the implied consideration paid for the Common Stock; (2) the implied valuation of the Subordinated Units and general partner interest of the Partnership currently owned by Petro; (3) the redemption value of certain of Petro's indebtedness and preferred stock; (4) the value of certain of Petro's indebtedness that will remain outstanding subsequent to the Transaction; (5) consent fees paid to certain of Petro's debt holders; (6) an estimate of all of the transaction costs associated with the Transaction; and (7) Petro's normalized 1997 EBITDA, normalized 1998 EBITDA and projected 1999 EBITDA based on the Adjusted Projections for Petro. Based on this information, the normalized 1997 EBITDA, 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: (1) 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; (2) equity market value to LTM DCF and 1999 estimated DCF based on currently available research estimates; and (3) 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 71 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 described in a letter agreement between A.G. Edwards and the Special Committee (the "Engagement Letter"). 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 its engagement. The Partnership has also agreed to indemnify A.G. Edwards against certain liabilities in the engagement of A.G. Edwards. REASONS FOR THE TRANSACTION THAT THE PETRO BOARD CONSIDERED; 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 "Parties and Conflicts--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 a publicly-traded limited partnership, 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 publicly-traded limited partnerships are cash flow oriented and are valued primarily on a cash distribution basis, the publicly-traded limited partnership 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. 72 . 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 publicly-traded limited partnerships, 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 and corporate branding opportunities. If Petro achieves 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 goals 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 those distributions. 73 . 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 the 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. The Petro Board also considered the following factors: . The Petro Board placed significant weight on the Dain Rauscher Wessels Opinion, that the Transaction is fair, from a financial point of view, to the Public Common Stockholders. The Petro Board considered the valuation methods used by Dain Rauscher Wessels in rendering the Dain Rauscher Wessels Opinion to be appropriate and relied upon them in reaching their determination as to the fairness of the Transaction to the Public Common Stockholders. The Petro Board did not perform its own financial analysis. (see page ). . The projections prepared by the Partnership and Petro (see page ). . The terms of the Exchange Agreement, Merger Agreement and Amendment to the Partnership Agreement (see pages , and ). . The conditions to the completion of the Transaction (see page ). . The background which resulted in the development of the structure of the Transaction (see page ). . The conflicts of interest in structuring the Transaction (see page ). . Recent trading prices for the Common Units and the Common Stock (see page ). 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 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. 74 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 describes 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 to the proxy statement and is incorporated by reference. The summary of the Dain Rauscher Wessels Opinion in this proxy statement is qualified in its entirety by reference to the full text of the opinion. Common Stockholders are urged to read the 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 from 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 that holder should vote on the approval and adoption of the Merger Agreement or any matter related to it. 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, this 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 the analyses. Additionally, estimates of the value of businesses or securities do not purport to be appraisals or to reflect the prices at which those businesses or securities might actually be sold. Accordingly, the analyses and estimates are inherently subject to substantial uncertainty. The Dain 75 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 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 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 the 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 evaluation or appraisal. Dain Rauscher Wessels assumed that the Merger will be accounted for as a purchase transaction under generally accepted accounting principles, and 76 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 by it were true and correct in all material respects, that each party to those documents will perform all of the covenants and agreements required to be performed by that party under such documents, and that all conditions to the Merger will be satisfied without waiver thereof. The following is a brief summary of the material analyses performed by Dain Rauscher Wessels in 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, this 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 77 to a net present value employing discount rates which, in Dain Rauscher Wessels' professional judgment, reflected (1) prevailing market yields for the Common Units and publicly-traded Units of other propane distribution master limited partnerships; (2) the structural subordination of the various classes of Units; and (3) 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. 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 those holders) by the $16.67 reference value for the Junior 78 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 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. 79 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 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: (1) 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; (2) the mean price per gallon of target annual volume paid by Petro in those acquisitions, adjusted for a 10% size premium; (3) the mean price per target customer paid by Petro in those acquisitions, adjusted for a 10% size premium; (4) the mean EBITDA multiple paid by the Partnership in its acquisitions of eleven propane retailers in 1994-1997, adjusted for a 10% size premium; (5) the mean EBITDA multiple paid in the Selected Transactions examined in Dain Rauscher Wessels' Comparable Transactions Analysis; and (6) 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 noted that excluding criteria (3) above, the values per share of Common Stock implied by these analyses ranged from $0.00 to $2.28, with a median of $0.21 and a mean of $0.87. Dain Rauscher Wessels believes that criteria (3) is less reliable as a means of valuing Petro's home heating oil business due to a lack of consistency in the price per target customer paid by Petro in such acquisition. 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, 80 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 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 81 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 this analysis. 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 82 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 that 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 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. 83 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%. 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 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. 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 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 the terms at the time of its approval of the Merger Agreement. It is contemplated that Dain Rauscher Wessels will serve as one of seven co- managers of the Equity Offering. 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, 84 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. 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 that 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. 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 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 here. 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 85 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. 86 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....... (4,366) (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) Publicly-traded limited partnership ("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. 87
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 22,631 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) 88
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 described 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. 89
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 13,346 14,224 14,938 15,662 -------- -------- -------- -------- -------- -------- EBIT.................... 10,237 10,674 11,119 11,674 12,393 13,102 Interest Expenses....... (8,498) (8,573) (8,881) (9,346) (9,811) (10,276) -------- -------- -------- -------- -------- -------- Pre-Tax Income.......... 1,739 2,102 2,238 2,329 2,582 2,826 Income Taxes............ (25) (25) (25) (25) (25) (25) -------- -------- -------- -------- -------- -------- Net Income.............. $ 1,714 $ 2,077 $ 2,213 $ 2,304 $ 2,557 $ 2,801 ======== ======== ======== ======== ======== ======== OTHER INFORMATION Maintenance Capital Expenditures........... $ 2,610 $ 2,632 $ 2,679 $ 2,728 $ 2,777 $ 2,827 Total Long Term Debt.... $105,000 $107,078 $113,494 $119,909 $126,324 $132,737 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) 90
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) 91
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 40,942 44,054 47,008 49,978 -------- -------- -------- -------- -------- -------- EBIT.................... 31,468 31,903 33,628 35,167 36,720 38,107 Interest Expense........ (27,595) (28,068) (29,398) (30,984) (32,478) (33,924) -------- -------- -------- -------- -------- -------- Pre-Tax Income.......... 3,873 3,834 4,230 4,183 4,242 4,183 Income Taxes............ (525) (525) (525) (525) (525) (525) -------- -------- -------- -------- -------- -------- Net Income.............. $ 3,348 $ 3,309 $ 3,705 $ 3,658 $ 3,717 $ 3,658 ======== ======== ======== ======== ======== ======== OTHER INFORMATION Maintenance Capital Ex- penditures............. $ 6,110 $ 6,273 $ 6,393 $ 6,516 $ 6,641 $ 6,768 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 11,223 11,632 12,059 12,502 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 15,149 15,861 16,591 17,034 ======== ======== ======== ======== ======== ======== 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 their exhibits and schedules) are attached as Annexes A and B of this proxy statement and incorporated by reference in this proxy statement. 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 Partnership's acquisition of Petro, 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, 568,478 Junior Subordinated Units and 287,700 General Partner Units. In the Merger, Petro/Mergeco, Inc., 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, in which the Partnership expects to sell approximately 6.8 million Common Units, and the Debt Offering, in which Petro Holdings expects to sell $120 million of notes. The net proceeds of the Equity Offering and the Debt Offering, which are expected to be approximately $243.7 million (assuming an offering price in the Equity Offering of $20.00 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 "Amendments to the Partnership Agreements." 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) Petro/Mergeco, Inc. will merge with and into Petro, and the separate corporate existence of Petro/Mergeco, Inc. 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 Petro/Mergeco, Inc. 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 Petro/Mergeco, Inc. 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 92 has perfected his dissenters' rights under the MBCA will represent only the right to receive "fair value" for those 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, those 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 those 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 Petro/Mergeco, Inc.) 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 share of Class B Common Stock 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 achieves certain financial goals during the five-year period following the closing of the Transaction. Subject to the satisfaction or waiver of the conditions in the Merger Agreement and described in "Description of the Merger Agreement--Conditions to 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 a later date and time as may be described 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. Completion of the Merger is subject to various conditions. See "Description of the Merger Agreement--Conditions to the Merger." 93 The Exchange The Exchange will occur immediately prior to the Merger and is comprised of the following elements: (a) Irik P. Sevin, Audrey L. Sevin, Hanseatic Corp. and Hanseatic Americas LDC (the "LLC Owners") will form Star Gas LLC, to which they will contribute an aggregate of 1,808,400 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 287,700 General Partner Units (representing all of the General Partner Units) in the Partnership. In addition, the LLC Owners will contribute 3,573,290 shares of Common Stock to the Partnership in exchange for 568,478 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 6.8 million Common Units (assuming an offering price of $20.00 per Common Unit) the net proceeds of which are estimated to be $128.3 million. Petro will sell to the public approximately $120.0 million of notes, the net proceeds of which are estimated to be $115.4 million. It is expected that the Partnership and Petro Holdings will guarantee the notes issued in the Debt Offering. 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. Description of Exchange of Petro Private Debt and Redemption of Preferred Stock Petro has entered into agreements (the "Private Debt Agreements") with the holders (the "Private Noteholders") of (1) its outstanding 10.90% Senior Notes due 2002 (the "Senior Notes") in the aggregate principal amount of $60 million; and (2) 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). 94 Pursuant to the Private Debt Agreements at the Effective Time: (a) the holders of the Senior Notes will exchange those 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 those 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 the 1989 Preferred Stock at 100% of face value plus accrued but unpaid dividends immediately prior to the Effective Time. Description of Petro Public Debt and Public Preferred Stock Exchange Offers In September 1998, Petro completed an exchange offer (the "Debt Exchange Offer") with the holders of Petro's Old Public Debt and entered into individually negotiated agreements (the "Preferred Stock Agreements") with the holders of its Old Public Preferred Stock. 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 of the Transaction at the following redemption prices: (1) 103.5% of face value for the new 12 1/4% Debentures; (2) 100% of face value for the new 10 1/8% Notes and the 9 3/8% Debentures; and (3) $23.00 per share for the new Public Preferred Stock; and (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. 95 In 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 the Exchange Shares in favor of the Acquisition Proposal. 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, Petro/Mergeco, Inc. 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 the Merger" and "--Amendment, Waiver and Termination of the Merger Agreement and Provisions for Payment of Expenses") but in no event prior to February 15, 1999. The Effective Time will follow 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. Merger Consideration In the Merger: (1) 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 of a Senior Subordinated Unit. (2) Each share of outstanding Junior Preferred Stock shall be converted into the right to receive .13064 of a Common Unit. (3) Each share of outstanding Public Preferred Stock shall be converted into the right to receive $23 in cash plus accrued and unpaid dividends. (4) Shares of Class B Common Stock shall remain unchanged. (5) Treasury shares and shares held by Petro/Mergeco, Inc. shall be cancelled for no consideration. No Fractional Units will be Issued in the Merger 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 the 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 96 receive an amount in cash, without interest, equal to the product (calculated to the nearest cent) obtained by multiplying the 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 $ . Procedure for, and Description of, the 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, Petro/Mergeco, Inc. or dissenting Common Stockholders) for use by that 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 the 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. 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 the 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, Petro/Mergeco, Inc. 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. 97 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 in the Merger Agreement 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 subsidiaries to: (1) 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; (2) 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 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; (3) 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) 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; 98 (4) 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 to any of the above, 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 under any of the above; (5) 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; (6) Amendments. In the case of Petro, amend its Articles of Incorporation or By-laws; (7) 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; (8) Insurance. Fail to use reasonable best efforts to maintain, with financially responsible insurance companies, insurance in the amounts and against the risks and losses as has been customarily maintained by it in the past; (9) 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; (10) Taxes. Make or rescind any material express or deemed election relating to taxes, unless it is not reasonable to expect that the action will not materially adversely affect it; settle or compromise any material tax claim, litigation, proceeding investigation or audit, except where that 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; (11) 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 the 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 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; 99 (12) No Dissolution. Authorize, recommend, propose or announce its intention to adopt a plan of complete or partial liquidation or dissolution; (13) Adverse Actions. Knowingly take any action that is intended or is reasonably likely to result in (a) any representations and warranties described 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 Merger described 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; (14) Agreements. Agree or commit to do anything prohibited by the covenants in the Merger Agreement. Representations and Warranties Set Forth in the Merger Agreement 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 the 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: (1) corporate organization or partnership formation, existence, qualifications to do business, permits and authorizations; (2) capitalization; (3) subsidiaries and other equity interests; (4) 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; (5) 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); (6) that execution of the Merger Agreement will not constitute a default under any agreement or judgment; (7) financial statements and related filings with the Securities Exchange Commission; (8) absence of undisclosed litigation, claims, proceedings, judgments, orders and decrees;(9) compliance with applicable laws; (10) absence of undisclosed contracts and defaults under contracts; (11) absence of undisclosed brokerage or finders' fee claims in the Merger Agreement; (12) employee compensation and benefit plans and related matters; (13) labor matters; (14) absence of violations or liabilities under environmental laws; (15) filing of material tax returns and the payment or provision for payment of all taxes shown to be due on those returns; (16) absence of any necessary regulatory approvals as to the Merger, other than pursuant to the HSRA; (17) 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; (18) certain insurance matters; and (19) the condition and sufficiency of certain tangible assets; and (20) the ownership and adequacy of certain intellectual property rights. 100 Indemnification of Officers and Directors Provided for in the Merger Agreement 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 (1) 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 of those parties as a director, officer, employee, fiduciary or agent of another entity or enterprise, or (2) the Merger Agreement or any of the transactions contemplated by it and all actions taken by an Indemnified Party in any of those transactions, 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 that 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 the Indemnified Party to repay advanced expenses if it is finally determined that the Indemnified Party was not entitled to 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 the six year period continue until the final disposition of the 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 that 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 those officers and directors in their capacity as officers and directors, 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 that 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: (1) 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; 101 (2) 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 the execution and delivery of the Merger Agreement shall have been made or obtained, except where the failure to obtain those 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; (3) 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 completion 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 completion of the Merger or to impose any material restrictions or requirements on it or on the Partnership or Petro in this matter; 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; (4) 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; (5) 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; (6) 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; (7) 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; (8) Public Offerings. The Equity Offering and the Debt Offering shall have been completed, 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 notes issued in the Debt Offering, and the net proceeds shall be applied to reduce indebtedness; (9) Refinancing Conditions. Certain conditions with respect to refinancing of debt, cash balances and working capital shall have been met; (10) 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; 102 (11) 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; (12) 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 and Termination of the Merger Agreement and Provision for Payment of Expenses Amendment and Waiver. The Merger Agreement provides that prior to the Closing, any provision of the Merger Agreement may be (1) waived by the party benefitted by that provision or (2) 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 that action by the Partnership provided that the change does not (x) alter or change the amount or kind of consideration to be issued to Common Stockholders as provided for in the Merger Agreement (the "Merger Consideration"), or (y) alter 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 impede or delays 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, if a material breach by the other party of any representation, warranty or covenant contained in the Merger Agreement that is not cured or curable in the prescribed time should occur; (c) by the Partnership, if the Special Committee so determines, or the Petro Board, if the Petro Board so determines, if (i) the approval under the HSRA required for completion 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 completion 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 completed on or prior to April 1, 1999 unless the Special Committee and Petro elect to extend the termination date. 103 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 that termination. Expenses. Petro will bear all expenses incurred for the Merger Agreement and its contemplated transactions. RESTRICTIONS ON RESALES OF SENIOR SUBORDINATED UNITS BY NON-AFFILIATES AND AFFILIATES The Common Units and Senior Subordinated Units issuable to Petro stockholders upon completion 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 Petro 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 or as otherwise permitted under the Securities Act. 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 from time to time (collectively, the "Offering") by the following persons (the "Selling 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 the Transaction. The Partnership will not receive any proceeds from the sale of the Resale Units by the Selling Unitholders. - -------- (a) Represents the total number of Senior Subordinated Units owned by each Selling Unitholder prior to the Offering and the maximum number of Senior Subordinated Units which could be sold by each Selling Unitholder in the Offering. (b) Includes 9,929 Senior Subordinated Units owned by Mr. Edelman's wife and trusts for the benefit of his minor children. 104
NUMBER OF SENIOR SELLING UNITHOLDER SUBORDINATED UNITS (A) ------------------ ---------------------- Phillip Cohen............................................ 103,556 Thomas Edelman........................................... 102,203(b) Richard O'Connell........................................ 186,972 Wolfgang Traber.......................................... 1,181 Brentwood Corp. ......................................... 104,885 Gabes S.A. .............................................. 94,313 Minneford Corp. ......................................... 11,188 Fernando Montero......................................... 4,610 M.M. Warburg & Co. ...................................... 4,155 Barcel Corp. ............................................ 98,814 Hubertus Langen.......................................... 96,740 Tortosa GmbH............................................. 39,024 Paul Biddelman........................................... 311 United Capital Corp. .................................... 11,758 PLAN OF DISTRIBUTION FOR THE RESALE UNITS 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 (1) 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, (2) purchases by a broker or dealer as principal and resales by that broker dealer for its account pursuant to this proxy statement, (3) ordinary brokerage transactions and transactions in which the broker solicits purchasers or to or through marketmakers, (4) 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 (5) 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 the Rule, rather than pursuant to this proxy statement. In the case of the sale of the Resale Units effected to or through broker- dealers, the 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 the 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 Resale Units may be deemed to be "underwriters" within the meaning of the Securities Act and any commissions received by the 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 for 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 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 OF THE TRANSACTION The parties anticipate that the Transaction will be accounted for as a purchase for accounting purposes. See "Unaudited Pro Forma Condensed Consolidated Financial Information." 105 REGULATORY MATTERS ASSOCIATED WITH THE TRANSACTION 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 under them; (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 for the Transaction. 106 MANAGEMENT OF THE PARTNERSHIP AFTER THE TRANSACTION GENERAL PARTNER Since Star Gas is a wholly-owned subsidiary of Petro and will become an indirect subsidiary of the Partnership in the Transaction, it will no longer be able to serve as the 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 "Parties and Conflicts--Conflicts of Interest." 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 completion 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 the 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. In these 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 will be advisory. 107 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 their principal holders, certain relationships and related transactions and other related matters as to the Partnership and Star Gas is incorporated by reference or described in the Partnership's Annual Report on Form 10-K for the fiscal year ended September 30, 1998, and is incorporated by reference in this proxy statement. Securityholders of the Partnership or Petro desiring copies of these 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; 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; and Audrey L. Sevin, Secretary. Certain information relating to executive compensation, various benefit plans (including stock option plans), voting securities and their principal holders, certain relationships and related transactions and other related matters as to Petro is described in Petro's Annual Report on Form 10-K for the year ended December 31, 1997, and is incorporated by reference in this proxy statement. Securityholders of the Partnership or Petro desiring copies of these 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 for 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. 108 The General Partner will be entitled to distributions on its General Partner Units and will be entitled to Incentive Distributions in respect of those Units, as described under "Cash Distribution Policy." PARTNERSHIP STRUCTURE 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. 109 [GRAPHIC] 110 [GRAPHIC] 111 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 of these persons 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 220,246 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. (f) Includes 9,929 Senior Subordinated Units owned by Mr. Edelman's wife and trusts for the benefit of his minor children. 112
SENIOR JUNIOR GENERAL PARTNER COMMON UNITS SUBORDINATED UNITS SUBORDINATED UNITS UNITS -------------------- --------------------- --------------------- --------------------- NAME(A) NUMBER PERCENTAGE NUMBER PERCENTAGE NUMBER PERCENTAGE NUMBER PERCENTAGE ------- ------ ---------- ------- ---------- ------- ---------- ------- ---------- Star Gas LLC............ -- --% -- --% -- --% 287,700(b) 100% Irik P. Sevin........... -- -- -- -- 99,514 17.5 287,700(e) 100 Audrey L. Sevin......... -- -- -- -- 248,718 43.8 287,700(e) 100 Wolfgang Traber......... 10,400(c) * 1,181 * 220,246(d) 38.6 287,700(e) 100 Paul Biddelman.......... -- -- 311 * 220,246(d) 38.6 287,700(e) 100 Thomas Edelman.......... -- -- 102,203(f) 3.7 -- -- -- -- Richard F. Ambury....... 625 * 46 * -- -- -- -- George Leibowitz........ -- -- -- * -- -- -- -- 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% 568,475 99.9% 287,700 100% 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. 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; VOTE REQUIRED BY UNITHOLDERS IN ORDER TO AMEND THE PARTNERSHIP AGREEMENT 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 (the "Minimum Quarterly Distribution") ($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 October 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 those quarters (excluding for this purpose the payment of any Common Unit Arrearages) and the first quarter in that 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. 113 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 achieves 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 that 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 approximately August 15, 1999. 114 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 that 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: (1) $57,172,000, plus or minus (2) 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 (3) 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 (4) 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 that 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: (1) $25,307,000 plus or minus (2) 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 (3) 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 (4) 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 (5) 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 115 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 the 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 that four-quarter period, pro rata; provided, however, 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 116 Common Units (which number does not include Common Units issued for (1) certain capital improvements, (2) certain acquisitions that are accretive on a per Unit basis, (3) the repayment of certain indebtedness or (4) 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 (1), (2) and (3) above, (b) Class B Common Units issued in 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. Definition of 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 (1) 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 described 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, the amount shall be a number equal to the product of (1) $6 million and (2) 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 6.8 million Common Units in the Equity Offering, the basket will be increased to approximately $16.7 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 117 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. Partnership's Right to Acquire Units. The Amendment Proposal will provide that if at any time after the expiration of the Subordination Period and the earlier to occur of (A) the fifth anniversary of the Effective Time or (B) the issuance of 909,000 Senior Subordinated Units and Class B Common Units in the aggregate, 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 of Certain Affiliates of Petro. 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 (1) the election of Star Gas LLC as successor general partner to the Operating Partnership, (2) delete allocation of depreciation to the General Partner, (3) delete the prohibition against the General Partner from taking any action that would cause its net worth to be less than $6 million and (4) any other amendments to the Operating Partnership Agreement that the General Partner deems necessary for 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 Transaction. It is the good faith opinion of the General Partner that the 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. 118 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. THIS DISCUSSION DOES NOT PURPORT TO BE COMPLETE. FOR A MORE COMPLETE UNDERSTANDING, SEE THE PROPOSED AMENDED AND RESTATED PARTNERSHIP AGREEMENT IN ANNEX C IN THIS PROXY STATEMENT. 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 "Parties and Conflicts--Conflicts of Interest." 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 "Certain Federal Income 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 other activities as may be approved by the General Partner. The General Partner is authorized in general to perform all acts deemed necessary to carry out those purposes and to conduct the business of the Partnership. 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 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 for that Unit, grants to the General Partner and, if a liquidator of the Partnership has been appointed, that liquidator, a power of attorney to, among other things, execute and file certain documents required for the qualification, continuance or dissolution of the Partnership, or the amendment of the Amended and Restated Partnership Agreement in accordance with the terms thereof and to make consents and waivers contained in the Amended and Restated Partnership Agreement. 119 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. However, the Partnership may mortgage, pledge, hypothecate or grant a security interest in all or substantially all of the Partnership's assets without that 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 that approval. The Unitholders are not entitled to dissenters' rights of appraisal under the current Partnership Agreement, the Amended and Restated Partnership Agreement or applicable Delaware law if a merger or consolidation of the Partnership or the sale, exchange or other disposition of substantially all of the Partnership's assets or any other event should occur. 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 the 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 the 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 "--Restriction on 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 Units, the holders of a Unit Majority may select a successor to the withdrawing General Partner. If the 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 that withdrawal, a Unit Majority agrees in writing to continue the business of the Partnership and to the appointment of a successor general partner. See "-- Description of Termination and Dissolution of the Partnership." Pursuant to the terms of the Amended and Restated Partnership Agreement, the General Partner may not be removed unless removal is approved by the vote of the holders of not less than 120 66 2/3% of the outstanding Units owned by limited partners voting together as a single class (other than those of the General Partner and its affiliates) and the Partnership receives an Opinion of Counsel. 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 has not been made on the Common Units for more than one of those quarters (excluding for this purpose the payment of any Common Unit Arrearages) and the first quarter in that 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 equally 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 the 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 both the Partnership and the Operating Partnership for a cash payment equal to the fair market value of that 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 that amount. In each case, the 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 such as severance liabilities, incurred in the termination of the employees employed for the benefit of the Partnership by the Departing Partner. 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 Common Units (or Class A Common Units if any Class B Common Units are then outstanding) equal to the fair market value of the interest as determined by an investment banking firm or other independent expert selected in the manner described in the preceding paragraph. 121 RESTRICTION ON TRANSFER OF GENERAL PARTNER INTEREST Except for a transfer by the General Partner of all, but not less than all, of its General Partner Units to an affiliate or for 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 to another person or entity prior to December 31, 2005, without the approval of holders of at least a Unit Majority; provided that, in each case the 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 OF THE GENERAL PARTNER 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 for 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. RIGHTS AND STATUS AS LIMITED PARTNER OR ASSIGNEE UPON TRANSFER OF INTEREST 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 or Senior 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, 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, including liquidating distributions. The General Partner will vote and exercise other powers attributable to Common Units or Senior Subordinated Unit owned by that person who has not become a substitute limited partner or additional limited partner, as the case may be, at the written direction of that person. See "--Meetings of Limited Partners and Voting Rights." Persons who do not execute and deliver a Transfer Application will be treated neither as assignees nor as record holders of Common Units or Senior Subordinated Unit 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--Obligations and Procedures for the Transfer of Units." LIMITATIONS ON THE RIGHTS OF NON-CITIZEN ASSIGNEES AND REDEMPTION RIGHTS OF THE PARTNERSHIP 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 122 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 that limited partner or assignee at their Current Market Price. In order to avoid any 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 his nationality, citizenship, residency or other related status within 30 days after a request for the information, that 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 BY THE PARTNERSHIP The General Partner is authorized to cause the Partnership to issue an unlimited number of additional limited partner interests and other equity securities of the Partnership for the consideration and on the terms and conditions established by the General Partner in its sole discretion, without the approval of any limited partners. However, during the Subordination Period, the Partnership may not issue an aggregate of more than 2,500,000 additional limited partner interests (the "Parity Units") without the prior approval of at least a majority of the outstanding Common Units (other than those held by the General Partner and its affiliates). Even during the Subordination Period, the restrictions on issuance of additional limited partner interests are subject to the following exceptions (that is, additional limited partner interests can be made in the following circumstances): (1) the Partnership may issue Common Units pursuant to the Transaction, including those issued in the Equity Offering; (2) the Partnership may issue an unlimited number of additional Common Units or Parity Units without the approval of the Unitholders if the issuance occurs (a) an Acquisition or a Capital Improvement or (b) within 365 days of, and the net proceeds from the issuance are used to repay debt incurred for, an Acquisition or a Capital Improvement, in each case, where that 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 the transaction is to be effected, resulted in an increase in the amount of Adjusted Operating Surplus calculated on a per-Unit basis for all outstanding Units as to each of the four most recently completed quarters (on a pro forma basis); (3) the Partnership may also issue an 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 proceeds from the issuance are used exclusively to repay up to $20 million of indebtedness of the Partnership, the Operating Partnership or any subsidiary thereof; and 123 (4) 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 has the right, which it may assign in whole or in part to any of its affiliates, to purchase any class of Units or other equity securities from the Partnership on the same terms that the Partnership issues the Units or securities to persons other than the General Partner and its affiliates, whenever that purchase is necessary so that the General Partner and its affiliates will maintain the percentage of ownership interest that existed immediately prior to each issuance. The holders of Common Units do not have preemptive rights to acquire additional Common Units or other partnership interests that may be issued by the Partnership. Additional issues 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 and/or amount of, any distributions above the Minimum Quarterly Distribution. LIMITED CALL RIGHT ON OUTSTANDING LIMITED PARTNER INTERESTS 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 that class held by those 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 and the earlier to occur of (A) the fifth anniversary of the Effective Time or (B) the issuance of 909,000 Senior Subordinated Units and Class B Common Units in the aggregate, 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 if (a) or (b) above should occur 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 that 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 those limited partner interests and (y) the Current Market Price as of the date three days prior to the date the 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 that 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 the same as a sale by that Unitholder of his Units in the market. See "Certain Federal Income Tax Considerations--Disposition of Units." 124 AMENDMENT OF THE 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 the 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: (1) enlarge the obligations of any limited partner, without its consent, (2) 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, (3) change the term of the Partnership, (4) provide that the Partnership is not dissolved upon expiration of its term or (5) 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 to reflect: (1) 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, (2) admission, substitution, withdrawal or removal of partners in accordance with the Amended and Restated Partnership Agreement, (3) 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, (4) 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 being subjected in any manner 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, (5) 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 in the sole discretion of the General Partner is necessary or advisable for the authorization of additional limited or general partner interests, (6) any amendment expressly permitted in the Amended and Restated Partnership Agreement to be made by the General Partner acting alone, 125 (7) 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, (8) any amendment that, in the sole discretion of the General Partner, is necessary or advisable for 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, (9) a change in the fiscal year and taxable year of the Partnership and changes related to that change and (10) 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 the amendments: (1) do not adversely affect the limited partners in any material respect, (2) 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, (3) 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 (4) 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 if the amendments described in the two immediately preceding paragraphs should occur. 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 the 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 OF LIMITED PARTNERS AND VOTING RIGHTS 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 of limited partners of the Partnership and to act on matters as to which approvals may be solicited. When Units 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 of those Units and shall, in exercising the voting rights of those Units on any matter, vote the Units at the written direction of that record holder. Absent this direction, those 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 126 shall distribute the votes of these Units in the same ratios as the votes of limited partners on 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 that number of limited partner interests as would be necessary to authorize or take that 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, who are represented in person or by proxy, shall constitute a quorum at a meeting of limited partners of that class or classes, unless the action by the limited partners requires approval by holders of a greater percentage of those Units, in which case the quorum shall be the greater percentage (excluding, in either case, if they 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 Amended and Restated Partnership, although additional limited partner interests having special voting rights could be issued by the General Partner. See "--Issuance of Additional Securities by the Partnership." The Partnership Agreement provides that Units held in a 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 the 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 OBLIGATIONS OF THE PARTNERSHIP The Amended and Restated Partnership Agreement provides that the Partnership will indemnify (1) the General Partner, (2) any Departing Partner, (3) any Person who is or was an affiliate of the General Partner or any Departing Partner, (4) 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 (5) 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"). The Partnership will indemnify these persons to the 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 127 that in each case the Indemnitee acted in good faith and in a manner that the 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, that 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 those persons for the Partnership's activities, regardless of whether the Partnership would have the power to indemnify that person against those liabilities under the provisions described above. POTENTIAL LOSS OF LIMITED LIABILITY BY UNITHOLDERS Assuming that a limited partner does not participate in the control of the business of the Partnership within the meaning of the Delaware Act and that he otherwise acts in conformity with the provisions of the Amended and Restated Partnership Agreement, his liability under the Delaware Act 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 Delaware Act, 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 Delaware Act, 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 Delaware Act 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 Delaware Act provides that a limited partner who receives a distribution and knew at the time of the distribution that the distribution was in violation of the Delaware Act shall be liable to the limited partnership for the amount of the distribution for three years from the date of the distribution. Under the Delaware Act, 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 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 13 states. Maintenance of limited liability may require compliance with legal requirements in those jurisdictions in which the Operating Partnership conducts business, including qualifying the Operating Partnership to do business therein. 128 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 that jurisdiction to the same extent as the General Partner under certain circumstances. The Partnership will operate in the manner as the General Partner deems reasonable and necessary or appropriate to preserve the limited liability of Unitholders. OBLIGATIONS OF THE GENERAL PARTNER TO PROVIDE BOOKS AND REPORTS TO LIMITED PARTNERS 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 that quarter and any 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. This 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 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 this 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. LIMITED PARTNERS' 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 the limited partner's interest as a limited partner, upon reasonable demand and at his/her own expense, be furnished with (1) a current list of the name and last known address of each partner, (2) a copy of the Partnership's tax returns, (3) information as to the amount of cash, and a description and statement of the net agreed value of any other property or services, 129 contributed or to be contributed by each partner and the date on which each became a partner, (4) 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, (5) information regarding the status of the Partnership's business and financial condition and (6) such other information regarding the affairs of the Partnership as is just and reasonable. The General Partner may, and intends to, keep the following 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 that is required by law or by agreements with third parties to be kept confidential. DESCRIPTION OF TERMINATION AND DISSOLUTION OF THE PARTNERSHIP 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 (1) the election of the General Partner to dissolve the Partnership, if approved by holders of a Unit Majority, (2) the sale, exchange or other disposition of all or substantially all of the assets and properties of the Partnership and the Operating Partnership, (3) the entry of a decree of judicial dissolution of the Partnership or (4) 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 (4), 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 in the Amended and Restated Partnership Agreement by forming a new limited partnership on terms identical to those in the 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 OF THE PARTNERSHIP 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 the Liquidator deems necessary or desirable in its good faith judgment, 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 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 OF THE GENERAL PARTNER OR ITS AFFILIATES Pursuant to the terms of the Amended and Restated Partnership Agreement and subject to certain limitations described therein, the Partnership has agreed (1) to register for resale under the 130 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 the registration requirements is not otherwise available for that proposed transaction and (2) 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 the registration requirements is not otherwise available for such proposed transaction), and to use its best efforts to keep that registration statement effective for one year, subject to certain exceptions and to the requesting party providing necessary information. The Partnership is obligated to pay all expenses incidental to that registration, excluding underwriting discounts and commissions. 131 CASH DISTRIBUTION POLICY The following discussion gives effect to the adoption of the Amendment Proposal and is furnished by the Partnership. Thus, references to "we," "us" and "our" are to the Partnership. GENERAL DESCRIPTION OF THE PARTNERSHIP'S CASH DISTRIBUTION In general, we distribute to our partners on a quarterly basis, all of our Available Cash in the manner described herein. "Available Cash" is defined in the Glossary and generally means, with respect to any of our fiscal quarters, all cash on hand at the end of that quarter less the amount of cash reserves that are necessary or appropriate in the reasonable discretion of the General Partner to (i) provide for the proper conduct of the Partnership's business, (ii) comply with applicable law or any of our debt instruments or other agreements or (iii) provide funds for distributions to the Common Unitholders and the Senior Subordinated Unitholders during the next four quarters (in certain circumstances). 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 us from distributing the Minimum Quarterly Distribution on all Common Units and any Common Unit Arrearages thereon with respect to the next four quarters. As discussed below, the restrictions on distributions to 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 we commenced operations, plus approximately $16 million, plus all of our cash receipts of the Partnership (excluding cash receipts from Capital Surplus), less (ii) all of our operating expenses (including expenses of the General Partner incurred on our behalf), 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 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 is distributed from Operating Surplus or Capital Surplus, all Available Cash distributed from any source will be treated as distributed from Operating Surplus until the sum of all Available Cash distributed since our commencement equals the Operating Surplus as of the end of the quarter prior to that 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 132 Operating Surplus and Capital Surplus will cease, and all distributions will be treated as from Operating 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 those interests to participate in distributions 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 We will make distributions to our partners with respect to each of our fiscal quarters prior to liquidation in an amount equal to all of our Available Cash for that 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 described 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 approximately August 14, 1999 to holders of record on approximately August 3, 1999. The 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 approximately May 15, 1999 to holders of record on approximately May 4, 1999 regardless of how many days the Common Units have been outstanding. For a discussion of certain restrictions on distributions to the holders of subordinated interests, see "--Limitation on Distributions on 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 (1) 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 133 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 that date, (2) 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 those periods on a fully diluted basis with respect to employee options or other employee incentive compensation (including all outstanding Units and all Common Units issuable upon exercise of employee options that have, as of the date of determination, already vested or are scheduled to vest 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 (3) there are no arrearages in payment of the Minimum Quarterly Distribution on the Common Units. In certain circumstances, if the General Partner is removed without Cause, the Subordination Period will end, any existing arrearages on the Common Units will be extinguished, the Senior Subordinated Units and 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 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 that 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 that 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 that quarter; and thereafter, in the manner described in "--Incentive Distributions During the Subordination Period" below. Upon completion of the Transaction, 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 Partner's 0.01% general partner interest in the Operating Partnership. 134 DISTRIBUTIONS OF AVAILABLE CASH FROM OPERATING SURPLUS AFTER THE SUBORDINATION PERIOD Distributions 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 that 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 the amount as may be necessary to eliminate any Cumulative Common Unit Arrearages, then any additional Available Cash from Operating Surplus in respect of that quarter will be distributed among the Units in the following manner: first, 100% to all Units, 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 that 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 that 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) a total of $0.926 per Unit for that 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 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 (each class voting separately). The following table illustrates the percentage of Available Cash from Operating Surplus distributed pro rata to all Unitholders ("Base Distributions") pro rata and the percentage of Available Cash distributed to the holders of Senior Subordinated Units, Junior Subordinated Units and General Partner Units only ("Incentive Distributions") 135 at the Target Distribution Levels. The percentages in the table below are the percentage interests of the Unitholders in Available Cash from Operating Surplus distributed as Base Distributions and Incentive Distributions based on the number of Units outstanding immediately after completion of the Transaction. 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 proportional issuances of 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. The amounts set forth below are based on the Units outstanding immediately after completion of the Transaction.
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 17.9 3.7 1.9 Thereafter.............. -- 51.0 49.0 37.4 7.7 3.9 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 that 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 136
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 0.777 0.777 0.777 Third Target Distribution............. 0.926 1.257 1.257 1.257 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. The calculations are based on the assumption that the quarterly distribution amounts shown do not include any Cumulative Common Unit Arrearages. The amounts set forth below are based on the number of Units outstanding immediately after completion of the Transaction. DISTRIBUTIONS FROM CAPITAL SURPLUS Distributions by the Partnership of Available Cash from Capital Surplus will be made 100% on all Units, pro rata, until we 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 repayment, the Minimum Quarterly Distribution and the Target Distribution Levels will be adjusted downward by multiplying each amount by a fraction, the numerator of which is the Unrecovered Initial Unit Price immediately after giving effect to the repayment and the denominator of which is the Unrecovered Initial Unit Price immediately prior to the 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 (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 rights to Incentive Distributions will be entitled to receive 49% 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. 137
QUARTERLY DISTRIBUTION --------------------- CLASS CLASS A B GENERAL COMMON COMMON PARTNER UNIT UNIT UNIT ------ ------ ------- Minimum Quarterly Distribution............................ $0.575 $0.575 $0.575 First Target Distribution................................. 0.604 0.604 0.604 Second Target Distribution................................ 0.711 0.777 0.777 Third Target Distribution................................. 0.926 1.257 1.257 LIMITATION ON DISTRIBUTIONS ON SUBORDINATED INTERESTS With respect to the time period beginning on the completion of the Transaction 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 that period to the extent the sum of EBITDA, less interest, less taxes and less maintenance capital expenditures consolidated (combined from October 1, 1998 until completion of the Transaction) 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 (1) $57,172,000, plus or minus (2) 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 (3) 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 (4) 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 (1) $25,307,000 plus or minus (2) 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 (3) 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 (4) 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 (5) 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 138 equal to or less than the total Operating Surplus generated by us since October 1, 1999 (which does not include the approximately $16.7 million and our cash balance on the date we commenced operations). 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, (1) the Minimum Quarterly Distribution, (2) the Target Distribution Levels, (3) the Unrecovered Initial Unit Price, (4) the number of additional Common Units issuable during the Subordination Period without a Unitholder vote, (5) the number of Class B Common Units issuable upon conversion of the Senior Subordinated Units and (6) Junior Subordinated Units and other amounts calculated on a per Unit basis will be proportionately adjusted upward or downward, as appropriate, if any combination or subdivision of Units should occur (whether effected by a distribution payable in Units or otherwise), but not by reason of the issuance of additional Units for cash or property. For example, if a two-for-one split of the Common Units should occur (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 us to taxation as an entity for federal, state or local income tax purposes. In this event, the Minimum Quarterly Distribution and Target Distribution Levels for each quarter thereafter would be reduced to amounts equal to the product of (1) the respective Minimum Quarterly Distribution or Target Distribution Level multiplied by (2) one minus the sum of (x) the highest marginal federal corporate (or other entity as applicable) income tax rate to which we are then subject as an entity plus (y) any increase in the effective overall state and local income tax rate to which we are 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), but only to the extent of the increase in rates resulting from that legislation or interpretation. For example, assuming we are not previously subject to state and local income tax, if we were to become taxable as an entity for federal income tax purposes and we 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 the 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 completion of the Transaction, but prior to the fifth anniversary of the completion of the Transaction, in which the dollar amount of Petro Adjusted Operating Surplus (as defined hereinafter) per Petro Unit (as defined hereinafter) equals or 139 exceeds $2.90, we will issue 303,000 Senior Subordinated Units (or 303,000 Class B Common Units if the 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 the 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. We will not issue any fractional Senior Subordinated Units or Class B Common Units in the issuance of the additional Units. We will 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 those fractional Units determined by multiplying the 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 completion of the Transaction, 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 that 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 of the Board of Directors of the General Partner consisting of two members of the Board who are not officers of the General Partner (the "Audit Committee")). In calculating Petro Adjusted Operating Surplus, (1) 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 that debt service is included in the calculation of Operating Surplus, and (2) 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 (1) the excess of the number of Units outstanding at completion of the Transaction over the number of Units outstanding immediately prior to the completion of the Transaction (assuming the simultaneous closing of the Equity Offering), (2) the number of Units issued by the Partnership thereafter to the extent the net proceeds of which are contributed to Petro (which for these purposes includes all subsidiaries of the Partnership primarily engaged in the home heating oil business), (3) 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 (4) the deemed number of Units outstanding based upon a contribution of capital to Petro by the Partnership or any of its affiliates after completion of the Transaction (which contribution is not covered by (2) above or traceable to debt proceeds), which number of deemed Units is obtained by dividing (A) the amount of that 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 140 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 that 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 (4) above, those 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. 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, 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 liquidation will, first, be applied to the payment of our creditors 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, 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. If our liquidation 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. 141 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; 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 per Common Unit 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 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 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; 142 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 (plus the amount of the Minimum Quarterly Distribution for the fiscal quarter during which the dissolution occurs); 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 fourth 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. 143 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 period 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 $33.1 million ($24.7 million for the Common Units, $6.4 million for the Senior Subordinated Units, $1.3 million for the Junior Subordinated Units and $0.7 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, 1998, would have been approximately $18.7 million; if certain infrequent restructuring, corporate identity and Transaction expenses were not taken into effect, pro forma Available Cash constituting Operating Surplus would have been $22.9 million. In fiscal 1998, temperatures were significantly warmer than normal for the areas in which the Partnership conducts its propane operations and Petro conducts its home heating oil operations. The Partnership believes that overall levels of both pro forma Available Cash from operating Surplus and EBITDA were adversely affected during fiscal 1998 due to this abnormally warm weather. 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 "Note 9 to Consolidated Financial Statements--Long-Term Debt and Working Capital Borrowings" in the Partnership's Annual Report on Form 10-K for the fiscal year ended September 30, 1998 that is incorporated herein by reference. The notes issued in the Debt Offering are expected to have provisions that will, under certain circumstances, similarly restrict the Partnership's ability to make distributions to its Unitholders. 144 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 the Transaction have been registered under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and its promulgated rules and regulations, 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 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 RIGHTS OF UNITHOLDERS 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 145 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. OBLIGATIONS AND PROCEDURES FOR THE 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 146 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--Rights and Status as Limited Partner or Assignee Upon Transfer of Interest." 147 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 The Senior Subordinated Units Shares of Class A Common Stock are generally are entitled to receive entitled to a pro rata share of any quarterly distributions from dividends declared by the Petro Available Cash during the Board to be made from funds legally Subordination Period after the available therefor; provided, that Common Units receive the Minimum no dividends may be paid on the Quarterly Distribution plus any shares of Class A Common Stock arrearages thereon. The Senior until, with respect to the 1989 Subordinated Units have the right to Preferred Stock and the New receive the Minimum Quarterly Preferred Stock, all dividends have Distribution before any distribution been paid (or declared and set is made on the Junior Subordinated apart) and all mandatory redemption Units and the General Partner Units. requirements have been satisfied. 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. 148 VOTING RIGHTS Class A Common Stock Senior Subordinated Units All Units have limited voting rights The holders of Class A Common Stock on matters affecting the are entitled to one vote per share partnership. The matters that and the holders of Class C Common do require Unitholder approval Stock are entitled to ten votes per generally require the approval of share upon all matters submitted for the holders of a Unit Majority, a vote to the Common Stockholders. which prior to the expiration of the Except when required by Minnesota Subordination Period, includes the law and in certain special approval of a majority of the Senior circumstances described in the Subordinated Units and Junior Restated Articles of Incorporation, Subordinated Units voting together the holders of Class B Shares are as a single class as well as the not entitled to vote. Generally, the approval of a majority of the Common action of the majority of the votes Units. Unitholders in the evidenced by the shares of all Partnership do not elect the classes voting as a single class directors of the General Partner. represented at a meeting of the Common Stockholders and entitled to vote is sufficient for actions that require a vote of the Common Stockholders. 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. 149 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. 150 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, described 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 if a merger or consolidation of the to vote for the Transaction at the Partnership, or a sale, exchange or Special Meeting) have the right to other disposition of substantially dissent, and obtain payment for the all of the Partnership's assets "fair value" of their shares, if should occur. certain corporate actions such as the Transaction should occur. 151 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. 152 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 December 21, 1998. (b) During this period the partnership did not pay a distribution to its subordinated unitholders. 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 $21.06 on the NYSE. On December 21, 1998, the closing sales price of the Common Units was $16.13. 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. 153
FISCAL FISCAL 1999 FISCAL 1998 1997 -------------------------------- -------------------------- -------------------------- FISCAL CASH CASH CASH QUARTER ENDED HIGH LOW DISTRIBUTION HIGH LOW DISTRIBUTION HIGH LOW DISTRIBUTION ------------- --------- --------- ------------ ------ ------ ------------ ------ ------ ------------ December 31,............ $21.81(a) $15.31(a) $0.55(b) $23.38 $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,........... -- -- -- 22.38 20.13 0.55 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 December 18, 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 , 1998 was $ 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. 154
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 29/32 (a) 14/16 (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 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 completed 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, 1998. (b) For the fiscal year ended December 31, 1997. (c) As of September 30, 1998. (d) As of December 31, 1997. (e) Per Unit limited partner interest. (f) Per share of Petro Common Stock. 155
FISCAL YEAR ENDED ------------------------------------------------------------------ HISTORICAL PRO FORMA HISTORICAL PRO FORMA PARTNERSHIP(A)(E) PARTNERSHIP(A)(E) PETRO(B)(F) EQUIVALENT(A)(E) ----------------- ----------------- ----------- ---------------- Net Income.............. $(0.16) $(1.04) $(1.06) $(0.14) Cash Distributions...... $ 2.20 $ 2.30 $ 0.30 $ 0.32 Book Value.............. $ 9.50 (c) $14.82 (c) $(6.76)(d) $ 2.03 (d) 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 its 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. In addition, unless otherwise noted, the following discussion is from the Partnership's perspective and all references to "we," "us" and "our" are to the 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. Petro and its affiliates (the "Corporate Group") do 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. 156 TAX CONSEQUENCES OF UNIT OWNERSHIP Legal Opinions and Advice. Counsel is of the opinion that, based on the representations and subject to the qualifications in the detailed discussion that follows, for federal income tax purposes (1) the Partnership and the Operating Partnership have been and will each be treated as a partnership and (2) 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: (1) 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"), (2) 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"), (3) 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"), (4) whether the Partnership's method for depreciating Section 743 adjustments is sustainable (see "--Tax Treatment of Operations--Section 754 Election") and (5) whether the allocations of recapture income contained in the Partnership Agreement will be respected (see "-- Allocation of Our 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. 157 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, its regulations, 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 (1) all applicable partnership statutes, (2) the Partnership Agreement and (3) the description thereof in this proxy statement; (c) The Operating Partnership has been operated in accordance with (1) all applicable partnership statutes, (2) the limited partnership agreement for the Operating Partnership and (3) 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 (1) the exploration, development, production, processing, refining, transportation or marketing of any mineral or natural resource, including oil, gas or products thereof, or (2) 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 (1) all applicable partnership statutes, (2) the Partnership Agreement, and (3) the description thereof in this Prospectus; (c) The Operating Partnership has been and will be operated in accordance with (1) all applicable partnership statutes, (2) the Operating Partnership Agreement, and (3) 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 (1) derived from the exploration, development, production, processing, refining, transportation or marketing of any mineral or natural resource, including oil, gas or products thereof; or (2) other items of "qualifying income" within the meaning of Section 7704(d) of the Code. 158 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, 90% or more of whose 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 159 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 it is not expected 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 them 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. Treatment of Partnership Distributions. Our distributions by the Partnership to a Unitholder generally will not be taxable to him for federal income tax purposes to the extent of his tax basis in his Units immediately before the distribution. Our 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 our 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 us because of our issuance of additional Units will decrease his share of our nonrecourse liabilities, and 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 basis in his Units, if such distribution reduces his share of our 160 "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, he will be treated as having been distributed his proportionate share of the Section 751 Assets and having exchanged such assets with us in return for the non-pro rata portion of the actual distribution made to him. This latter deemed exchange will generally result in his realization of ordinary income under Section 751(b) of the Code. That income will equal the excess of (1) the non-pro rata portion of such distribution over (2) his tax basis for the share of such Section 751 Assets deemed relinquished in the exchange. Ratio of Taxable Income to Distributions. We estimate 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 a Unitholder will constitute a significantly higher percentage of cash distributed to him. These 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 our control. Further, the estimates are based on current tax law and certain tax reporting positions that we have adopted or intend to adopt and with which the IRS could disagree. Accordingly, no assurance can be given that these estimates will prove to be correct. The actual percentage of distributions that will constitute taxable income could be higher or lower, and any differences could be material and could materially affect the value of the Units. Basis of Units. A Unitholder will generally have an initial tax basis for his Units equal to the fair market value of the Units received. His basis will be increased by his share of our income and by any increases in his share of our nonrecourse liabilities. That basis will be decreased (but not below zero) by distributions from the Partnership, by his share of our losses, by any decrease in his share of our nonrecourse liabilities and by his share of our expenditures that are not deductible in computing our taxable income and are not required to be capitalized. A limited partner will have no share of our debt which is recourse to the General Partner, but will have a share, generally based on his share of profits, of our 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 our 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 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 our activities, if that is less than his tax basis. A Unitholder must recapture losses deducted in previous years to the extent that Partnership distributions made to him by us cause his 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 his 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 161 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 our 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 us, 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 his Units increases or decreases (other than tax basis increases or decreases attributable to increases or decreases in his share of our 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 us will only be available to offset our future passive income generated 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 us, 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 us may be deducted in full when he disposes of his entire investment in us 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 our net income may be offset by any suspended passive losses, 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 share of our net passive income will be treated as investment income for this purpose. In addition, the Unitholder's share of our portfolio income will be treated as investment income. Investment interest expense includes (i) interest on indebtedness properly allocable to property held for investment, (ii) our 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. 162 ALLOCATION OF OUR INCOME, GAIN, LOSS AND DEDUCTION In general, if we have 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 us. 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 we have 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 our Amended and Restated Partnership Agreement) and, second, to the General Partner. As required by Section 704(c) of the Code and as permitted by its Regulations, certain items of our 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 us 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 we do not expect that our operations will result in the creation of negative capital accounts, if negative capital accounts nevertheless result, items of our 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 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 our Amended and Restated 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. 163 TAX TREATMENT OF OPERATIONS Accounting Method and Taxable Year. We use the year ending December 31 as our taxable year and we have adopted the accrual method of accounting for federal income tax purposes. Each Unitholder will be required to include in income his allocable share of our income, gain, loss and deduction for our taxable year ending within or with his 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 our taxable year but before the close of his taxable year must include his allocable share of our 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 share of more than one year of our income, gain, loss and deduction. See "--Disposition of Units--Allocations Between Transferors and Transferees." Initial Tax Basis, Depreciation and Amortization. The tax basis of our assets 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 Our Income, Gain, Loss and Deduction." To the extent allowable, we may elect to use the depreciation and cost recovery methods that will result in the largest deductions in the early years assets are placed in service. We will not be entitled to any amortization deductions with respect to goodwill conveyed to us on formation. Property subsequently acquired or constructed by us may be depreciated using accelerated methods permitted by the Code. If we dispose 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 our property may be required to recapture such deductions as ordinary income upon a sale of his interest in us. See "--Allocation of Our Income, Gain, Loss and Deduction" and "--Disposition of Units--Recognition of Gain or Loss." Section 754 Election. We have made the election permitted by Section 754 of the Code, which generally permits us to adjust a Unit purchaser's tax basis in our 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 belongs to the purchaser and not to other Unitholders. (For purposes of this discussion, a Unitholder's inside basis in our assets will be considered to have two components: (1) his share of our 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 would require, if adopted in their current form, the remedial allocation method is adopted (which we have 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 197 164 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 our Amended and Restated 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 certain Treasury Regulations. See "--Uniformity of Units." Although Counsel is unable to opine as to the validity of such an approach, we intend 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, we will apply the rules described in the Regulations and legislative history. If we determine that such position cannot reasonably be taken, we 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 our 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 us to goodwill which, as an intangible asset, would be amortizable over a longer period of time than our tangible assets. 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 us of our 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 our 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 we will make them on the basis of certain assumptions as to the value of our assets and other matters. There is no assurance 165 that our determinations 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 our opinion, the expense of compliance exceed the benefit of the election, we may seek permission from the IRS to revoke our Section 754 election. 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. Each Unitholder will be required to take into account his distributive share of any items of our income, gain, deduction, or loss for purposes of the alternative minimum tax. The minimum tax rate for non- corporate 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 our estimates of the relative fair market values, and determinations of the initial tax bases, of our assets. Although we may from time to time consult with professional appraisers with respect to valuation matters, we will make many of the relative fair market value estimates. 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 of our 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 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 our nonrecourse liabilities. Because the amount realized includes a Unitholder's share of our 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. 166 Prior distributions from us 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 our convention 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 us. 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 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 us, because, as is the case with corporate stock, interests in us 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 (1) a short sale of, (2) an offsetting notional principal contract, or (3) a futures or forward contract with respect to the partnership 167 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, our 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 our 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), our taxable income or losses might be reallocated among the Unitholders. We are authorized to revise our 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 our income, gain, loss and deductions attributable to such quarter but will not be entitled to receive that cash distribution. 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 our goodwill or going concern value. 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 168 Partnership capital and profits within a 12-month period. 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. 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 we are required or elect 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 our funds. That 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, we are 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 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." We intend 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 169 Book-Tax Disparity, we will apply the rules described in the Regulations and legislative history. If we determine that such a position cannot reasonably be taken, we 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 our 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 we determine 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, we 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 our gross income will include that type of income at least in the next few years. Under current rules applicable to publicly-traded partnerships, we are required to withhold as taxes 39.6% of any cash distributions made to foreign Unitholders. A foreign Unitholder may claim a credit for those taxes. If that tax exceeds the taxes due from the foreign Unitholder, he may claim a refund. Each foreign Unitholder must obtain a taxpayer identification number from the IRS and submit that number to our Transfer Agent on a Form W-8 in order to obtain a credit for the taxes withheld. A change in applicable law may require the Partnership to change these procedures. In addition, non-resident aliens and foreign corporations, trusts or estates which own 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 our income, gain, loss or deduction and pay federal income tax at regular rates on any net income or gain. 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 share of our income and gain (as adjusted for 170 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. Except to the extent the ruling applied (as to which counsel has not opined), a foreign Unitholder will not be taxed or subject to withholding upon the disposition of a Unit if he has owned 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 Information Returns and Audit Procedures. We intend 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 our income, gain, loss and deduction for our preceding taxable year. In preparing this information, which will generally not be reviewed by counsel, we will use various accounting and reporting conventions, some of which have been mentioned earlier, 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. Neither we nor counsel can 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. The IRS may audit our federal income tax information returns. 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 not related to our returns as well as those related to our returns. 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 our behalf and on behalf of Unitholders. In addition, the Tax Matters Partner can extend the statute of limitations for assessment of tax deficiencies against Unitholders with respect to items in our returns. The Tax Matters Partner may bind a Unitholder with less than a 1% profits interest in us 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 171 review, such review may be sought by any Unitholder having at least a 1% interest in profits 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 (which we do not currently intend to do), a Unitholder 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 our return. Intentional or negligent disregard of the consistency requirement may subject a Unitholder to substantial penalties. However, if we elect to be treated as a large partnership (which we do not currently intend to do), its partners would be required to treat all partnership items in a manner consistent with our 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 an electing large 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. Although we are authorized under our Partnership Agreement to do so, we do not expect to elect to have the large partnership provisions apply to us because of the cost of their application. Nominee Reporting. Persons who hold an interest in us as a nominee for another person are required to furnish to us (a) the name, address and taxpayer identification number of the beneficial owner and the nominee; (b) whether the beneficial owner is (1) a person that is not a United States person, (2) a foreign government, an international organization or any wholly-owned agency or instrumentality of either of the foregoing, or (3) 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 172 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 us. 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. Nevertheless, it is arguable that we are not subject to the registration requirement on the basis that it will not constitute a tax shelter. However, the predecessor general partner, as our organizer, has registered us as a tax shelter with the Secretary of the Treasury in the absence of assurance that we 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. We 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 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 (1) with respect to which there is, or was, "substantial authority" or (2) 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 173 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, a Unitholder 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 he or she resides 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. 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 we do business or own property and may be subject to penalties for failure to comply with those requirements. Star Gas 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, and West Virginia. Each of these states currently imposes a personal income tax; however, New Hampshire's tax only applies to interest and dividend incomes. Some of them 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. 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. 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 distributed by us. See "--Disposition of Units--Entity-Level Collections." Based on current law and our estimate of our future operations, we do not anticipate 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 US. 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. COUNSEL HAS NOT RENDERED AN OPINION ON THE STATE OR LOCAL TAX CONSEQUENCES OF AN INVESTMENT IN US. 174 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 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 175 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. 176 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 177 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 to 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 F. 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. 178 LEGAL MATTERS The validity of the Common Units and the Senior Subordinated Units to be issued in 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, 1997 and 1998 and for the fiscal years ended September 30, 1996, 1997 and 1998, 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, incorporated by reference and upon 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 incorporated by reference in this proxy statement in reliance upon the report of KPMG Peat Marwick LLP, independent certified public accountants, incorporated by reference 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. 179 This proxy statement includes information required by the Commission to be disclosed under Rule 13e-3 of 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 in the Schedule 13E-3, parts of which are omitted in accordance with the regulations of the Commission. The Schedule 13E- 3, and its amendments, 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. STATEMENT OF FORWARD-LOOKING DISCLOSURE Some of the information in this proxy statement may contain forward-looking statements. You can identify these statements by our use of "will," "believe," "expect," "anticipate," "estimate," "continue," "think" 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 these 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. 180
THE PARTNERSHIP COMMISSION FILINGS (FILE NO. 33-78490) PERIOD/AS OF DATE ---------------------------------- ----------------- Annual Report on Form 10-K Year ended September 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 September 30, 1998 Proxy Statement April 30, 1998 INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE The following document filed by the Partnership with the Commission (File No. 33-98490) is incorporated by reference in this proxy statement: (1) the Partnership's Annual Report on Form 10-K for the fiscal year ended September 30, 1998. 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: (1) Petro's Annual Report on Form 10-K for the fiscal year ended December 31, 1997, which accompanies this proxy statement; and (2) Petro's Quarterly Reports on Form 10-Q for the fiscal quarters ended March 31, 1998, June 30, 1998 and September 30, 1998, which accompanies this proxy statement. (3) 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. 181 UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION The following unaudited pro forma condensed consolidated financial information gives effect to the acquisition of Petroleum Heat and Power Co., Inc., by Star Gas Partner's, L.P., the Transaction, including the Equity Offering, the Debt Offering and the application of the net proceeds therefrom as described in "Uses of Funds From this Offering and the Debt Offering." The information presented is derived from, should be read in conjunction with, and is qualified in its entirety by reference to the historical financial statements, and notes thereto, appearing elsewhere and incorporated by reference in this prospectus. The unaudited pro forma condensed consolidated balance sheet was prepared as if the Transaction had occurred on September 30, 1998. The unaudited pro forma condensed consolidated statement of operations for the twelve months ended September 30, 1998 was prepared as if the Transaction had occurred on October 1, 1997. The pro forma adjustments are based upon currently available information and certain estimates and assumptions, and therefore, the actual adjustments may differ from the unaudited pro forma adjustments. However, management believes that the assumptions provide a reasonable basis for representing the significant effects of the Transaction as contemplated and that the unaudited pro forma adjustments give appropriate effect to those assumptions and are properly applied in the unaudited pro forma condensed consolidated financial statements. The unaudited pro forma condensed consolidated balance sheet and statement of operations are not necessarily indicative of the financial position or results of operations of the Partnership if the Transaction had actually occurred on the dates indicated above. Likewise, the unaudited pro forma condensed consolidated financial information is not necessarily indicative of future financial combined position or future results of combined operations of the Partnership. 182 STAR GAS PARTNERS, L.P. AND SUBSIDIARIES PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET (UNAUDITED) SEPTEMBER 30, 1998 (IN THOUSANDS) 183
STAR GAS PARTNERS, L.P. STAR GAS PRO FORMA PRO FORMA THE ADJUSTED PARTNERS, L.P. PETRO ADJUSTMENTS COMBINED OFFERINGS PRO FORMA -------------- --------- ----------- --------- --------- -------------- ASSETS Current assets: Cash................... $ 1,115 $ 18,667 $ 19,782 $ 115,400 (g) $ 16,550 128,300 (h) (246,932)(o) Accounts receivable.... 5,279 38,163 43,442 43,442 Inventories............ 10,608 13,997 24,605 24,605 Prepaid expenses and other current assets.. 945 11,885 12,830 12,830 -------- --------- -------- --------- -------- Total current assets... 17,947 82,712 100,659 (3,232) 97,427 -------- --------- -------- --------- -------- Cash collateral account............... 6,900 6,900 6,900 Property and equipment, net................... 110,262 28,799 $ 11,310 (f) 150,371 150,371 Intangible and other assets, net........... 51,398 80,267 288,997 (f) 420,662 4,600 (g) 425,262 -------- --------- -------- -------- --------- -------- Total assets........... $179,607 $ 198,678 $300,307 $678,592 $ 1,368 $679,960 ======== ========= ======== ======== ========= ======== LIABILITIES AND PARTNERS' CAPITAL Current liabilities: Current debt and preferred stock....... $ 692 $ 12,188 $ 12,880 $ (9,797)(o) $ 3,083 Bank credit facility borrowings............ 4,770 -- 4,770 4,770 Accounts payable....... 3,097 6,320 9,417 9,417 Unearned service contract revenue...... 13,599 13,599 13,599 Accrued expenses and income taxes.......... 2,830 29,281 $ 4,600 (d) 42,782 (6,071)(o) 36,711 6,071 (e) Accrued interest and dividends............. 485 -- 583 (a) 1,068 1,068 Customer credit balances.............. 6,038 28,803 34,841 34,841 -------- --------- -------- -------- --------- -------- Total current liabilities........... 17,912 90,191 11,254 119,357 (15,868) 103,489 -------- --------- -------- -------- --------- -------- Long-term debt.......... 104,308 278,864 6,286 (b) 389,458 120,000 (g) 305,994 (203,464)(o) Deferred income taxes... 50,000 (d) 50,000 50,000 Other long-term liabilities............ 40 10,686 (3,500)(d) 7,226 7,226 Redeemable and exchangeable preferred stock.................. 28,555 (955)(b) 27,600 (27,600)(o) Partners' capital Common Unitholders..... 58,686 2,055 (c) 60,741 128,300 (h) 189,041 Subordinated Unitholders........... (1,446) 60,006 (f) 22,544 22,544 (36,016)(f) General partner........ 107 4,434 (f) 1,666 1,666 (2,875)(f) Petro's stockholders' deficiency............ (209,618) (583)(a) (5,331)(b) (2,055)(c) (51,100)(d) (6,071)(e) 274,758 (f) -------- --------- -------- -------- --------- -------- Total Partners' Capital............... 57,347 (209,618) 237,222 84,951 128,300 213,251 -------- --------- -------- -------- --------- -------- Total Liabilities and Partners' Capital..... $179,607 $ 198,678 $300,307 $678,592 $ 1,368 $679,960 ======== ========= ======== ======== ========= ======== STAR GAS PARTNERS, L.P. AND SUBSIDIARIES PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (UNAUDITED) TWELVE MONTHS ENDED SEPTEMBER 30, 1998 (IN THOUSANDS, EXCEPT PER UNIT DATA) 184
STAR GAS COMBINED PARTNERS, L.P. STAR GAS PROPANE PROPANE PRO FORMA PRO FORMA THE ADJUSTED PARTNERS, L.P. ACQUISITIONS(I) OPERATIONS PETRO(J) ADJUSTMENTS COMBINED OFFERINGS PRO FORMA -------------- --------------- ---------- -------- ----------- --------- --------- -------------- Sales.............. $111,685 $4,386 $116,071 $452,765 $(2,681)(k) $566,155 $566,155 Cost of sales (exclusive of depreciation shown separately below)............ 49,498 1,972 51,470 299,987 (1,985)(k) 349,472 349,472 -------- ------ -------- -------- ------- -------- -------- Gross margin..... 62,187 2,414 64,601 152,778 (696)(k) 216,683 216,683 Operating expenses.......... 43,281 1,090 44,371 117,849 (669)(k) 161,551 161,551 Restructuring charges........... 2,085 2,085 2,085 Transaction expenses.......... 1,029 1,029 1,029 Corporate identity expenses.......... 1,100 1,100 1,100 Provision for supplemental benefits.......... 409 409 409 Depreciation and amortization...... 11,462 548 12,010 27,514 (87)(k) 37,434 37,434 (2,003)(l) Net gain (loss) on sales of assets... (271) (271) 11,507 (11,284)(k) (48) (48) -------- ------ -------- -------- ------- -------- ------- -------- Operating income... 7,173 776 7,949 14,299 (9,221) 13,027 13,027 Interest (income) expense, net...... 7,927 427 8,354 30,803 39,157 $12,298 (p) 26,859 Amortization of debt issuance costs............. 176 -- 176 1,432 -- 1,608 (972) (n) 636 -------- ------ -------- -------- ------- -------- ------- -------- Income (loss) before income taxes............. (930) 349 (581) (17,936) (9,221) (27,738) 13,270 (14,468) -------- ------ -------- -------- ------- -------- ------- -------- Income tax expense........... 25 25 475 500 500 -------- Income before equity interest in Star Gas Corporation....... (18,411) Share of income (loss) of Star Gas Corporation....... (317) 317 (m) -- -------- ------ -------- -------- ------- -------- ------- -------- Net income (loss).. $ (955) $ 349 $ (606) $(18,728) $(8,904) $(28,238) $13,270 $(14,968) ======== ====== ======== ======== ======= ======== ======= ======== General Partner's interest in net income (loss)............ (19) (299) ======== ======== Limited Partners' interest in net income (loss)............ $ (936) $(14,669) ======== ======== Basic and diluted net income (loss) per Limited Partner Unit...... $ (0.16) $ (1.04)(q) ======== ======== Weighted average number of Limited Partner Units outstanding....... 6,035 220 6,255 103 (c) 7,297 6,800 (h) 14,097 (q) (2,396)(f) 568 (f) 2,767 (f) STAR GAS PARTNERS, L.P. AND SUBSIDIARIES NOTES TO PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION The following pro forma adjustments give effect to (1) the offering of 809,000 Common Units by the Partnership on December 16, 1997, (2) the acquisition of Petro, (3) the Debt Offering and (4) the Equity Offering, as if each transaction had taken place on September 30, 1998, in the case of the pro forma condensed consolidated balance sheet, or as of October 1, 1997, in the case of the pro forma condensed consolidated statement of operations. 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 for Petro and therefore the actual results may differ from the pro forma results. However, 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. TRANSACTION RELATED ADJUSTMENTS (a) Reflects the accrued dividends payable on Petro's redeemable and exchangeable preferred stock. (b) Reflects the negotiated premium of approximately $6.3 million to refinance Petro's Private Debt and Petro's Public Debt and the negotiated discount of approximately $1.0 million to redeem Petro's public preferred stock. (c) Reflects the issue of 0.8 million shares of Junior Preferred Stock of Petro, which will be converted into 0.1 million Common Units upon completion of the Transaction at an assumed value of $20.00 per Unit. The Junior Preferred Stock was issued 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 as consideration for consenting to the early redemption of such securities. THE TRANSACTION (MERGER AND EXCHANGE) (d) Represents: (1) the estimated amount of current federal and state taxes to be incurred of $4.6 million (2) the estimated amount of deferred federal and state income taxes to be recognized of $50.0 million, and (3) the elimination of the tax liability associated with the Pearl Gas conveyance of $3.5 million. (e) Reflects the estimated additional amount to be recorded by Petro of legal, professional and advisory fees (estimated to be $6.1 million) incurred by Petro and the Partnership in the Transaction. (f) Represents the exchange of 26.6 million shares of Petro's Class A Common Stock and Class C Common Stock valued at $64.4 million for 2.8 million Senior Subordinated Units valued at $51.2 million, 0.6 million Junior Subordinated Units valued at $8.8 million and 0.3 million General Partner Units valued at $4.4 million. The values used to determine the fair market value of Petro's common stock and the Partnership's senior subordinated units were based on a report received from A.G. Edwards & Sons, Inc to the Special Committee. 185 The Partnership's 2.4 subordinated units and General Partner's interest held by Petro were converted into common units and senior subordinated units to facilitate the exchange of Petro's junior preferred and common stock. The table below summarizes the preliminary allocation by the Partnership of the excess of purchase price over book value related to the acquisition of Petro. The allocation of the purchase price is based on the results of a preliminary appraisal of the assets and the liabilities of Petro. The amounts used in this pro forma are based on assets and liabilities as of September 30, 1998. These amounts will change based upon the fair value of assets and liabilities on the closing date. The preliminary allocation is as follows (in thousands):
Consideration given for the exchange of Petro shares................... $64,440
Fair market value of Petro's asset and liabilities as of September 30, 1998: Current assets.................................................... $(82,712) Cash collateral account........................................... (6,900) Property, plant and equipment (1)................................. (40,109) Value of Petro's investment in Star Gas........................... (38,891) Current liabilities............................................... 101,445 Long-term debt.................................................... 285,150 Deferred income taxes............................................. 50,000 Other liabilities................................................. 7,186 Preferred stock................................................... 27,600 Junior preferred stock............................................ 2,055 -------- - -------- (1) Includes fair market value adjustment of $11.3 million. THE DEBT OFFERING AND THE EQUITY OFFERING (g) Reflects the estimated net proceeds to Petro of $115.4 million from the $120.0 million Debt Offering, net of underwriting discounts and commissions (estimated to be $3.6 million) and offering expenses (estimated to be $1.0 million). These costs are being amortized over the term of the related debt which is assumed to be 10 years. (h) Reflects the estimated net proceeds to the Partnership of $128.3 million from the issuance and sale of 6.8 million Common Units in the Equity Offering at an assumed offering price of $20.00 per Common Unit, net of underwriting discounts and commissions (estimated to be $6.8 million) and offering expenses (estimated to be $0.9 million). 186
Subtotal.......................................................... 304,824 -------- Total value assigned to intangibles and other assets.................. 369,264 Carrying amount of intangibles and other assets....................... (80,267) -------- Allocation of excess purchase price to intangibles.................... $288,997 ======== CONSISTING OF: Customer Lists...................................................... $ 95,000 Goodwill............................................................ 273,268 Other assets........................................................ 996 -------- Total Intangibles and Other Assets................................ $369,264 ======== THE PROPANE ACQUISITIONS (i) 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 September 30, 1998 are included in the Partnership's twelve months ended September 30, 1998 results adjusted for: (1) certain cost savings of $0.3 million, primarily executive compensation and legal expenses relating to selling shareholders; (2) additional depreciation and amortization of $0.5 million; and (3) additional interest expense of $0.4 million. THE TRANSACTION (ACQUISITION OF PETRO) (j) Represents the results of operations of Petro for the twelve months ended September 30, 1998. Estimated expenses of $7.1 million to be incurred by Petro as a direct result of its acquisition by the Partnership will be included in Petro's actual statement of operations. For the twelve months ended September 30, 1998, Petro has recorded $1.0 million of these expenses. (k) Adjustment to reflect the disposition of Petro's Hartford, CT operations in November 1997. Petro received cash proceeds of $15.6 million and recorded a gain of $11.3 million. The carrying value of these assets at the time of sale was $4.3 million. (l) Adjustment to depreciation and amortization expense attributable to the acquisition of Petro. The following table summarizes the effect on depreciation and amortization of the acquisition of Petro. (m) Reflects the elimination of Petro's equity interest in the Partnership. 187
AMOUNT PER PETRO'S FINANCIALS AMOUNT PER APPRAISAL DIFFERENCE ----------------------------------- ------------------------------------ ------------ PROPERTY AND EQUIPMENT, NET ASSET LIFE DEPRECIATION ASSET LIFE DEPRECIATION DEPRECIATION - ----------------------- ------- -------------- ------------ -------- -------------- ------------ ------------ Land.................... $ 2,092 $ -- $ 3,300 $ -- $ -- Buildings............... 4,920 20-45 years 419 4,300 30 years 143 (276) Fleet................... 6,342 5 to 7 years 2,866 12,800 6 years 2,135 (731) Leasehold............... 4,353 term of leases 562 5,900 term of leases 457 (105) Computer, furniture and fixtures............... 7,593 5 to 7 years 2,491 9,700 5 to 7 years 1,661 (830) Service & other equipment.............. 3,499 5 to 13 years 692 4,109 5 to 13 years 557 (135) ------- ------- -------- ------- ------- Total Property and equipment............. $28,799 $ 7,030 $ 40,109 $ 4,953 $(2,077) INTANGIBLE AND OTHER ASSETS, NET ASSET LIFE AMORTIZATION ASSET LIFE AMORTIZATION AMORTIZATION - -------------------- ------- -------------- ------------ -------- -------------- ------------ ------------ Customer list........... $56,298 6.5 years $17,380 $ 95,000 10 years $ 9,500 $(7,880) Goodwill................ 9,122 25 years 436 273,268 25 years 10,971 10,535 Covenants not to compete and other acquisition related................ 5,211 5 to 7 years 2,581 -- (2,581) Debt issuance costs..... 8,640 -- Other assets............ 996 996 -- ------- ------- -------- ------- ------- Total intangible and other assets.......... $80,267 $20,397 $369,264 $20,471 $ 74 ------- ------- ------- Totals................. 27,427 $25,424 $(2,003) ======= ======= ======= THE OFFERINGS (n) Net adjustment to amortization of debt issuance costs of $1.0 million attributable to the Debt Offering and the acquisition of Petro. Amortization of debt issuance costs is decreased by $1.4 million relating to the repayment and/or exchange of Petro debt and is increased by $0.5 million relating to the 9.75% Notes. (o) Reflects the use of the net proceeds from the Equity Offering, the Debt Offering and $3.2 million of Petro's cash to repay $84.1 million of Petro's 12 1/4% Senior Subordinated Debentures due 2005 including $2.8 million of premiums, to repay $50.0 million of Petro's 10 1/8% Senior Subordinated Notes due 2003, to repay $75.0 million of Petro's 9 3/8% Senior Subordinated Debentures due 2006, to retire $27.6 million of Petro's 12 7/8% Exchangeable Preferred Stock, to retire $4.1 million of Petro's 14.33% Exchangeable Preferred Stock and to pay $6.1 million of Transaction expenses. In addition, Petro has entered into Private Debt Agreements with the Private Noteholders of: (i) its outstanding Senior Notes in the aggregate principal amount of $60 million; and (ii) its Petro Private Debt in the aggregate principal amount of $4.1 million (after payment of the January 1999 installment). Pursuant to the Private Debt Agreements at the effective time of the Transaction: (i) the holders of the Senior Notes will exchange such Notes for $63.1 million aggregate principal amount of New 9% Notes; and (ii) the holders of the 14.1% Notes will exchange such notes for $4.3 million aggregate principal amount of 10 1/4% Notes. The New Private Notes will be guaranteed by the Partnership and Petro Holdings. (p) Reflects the net reduction to interest expense of $12.3 million for the twelve months ended September 30, 1998. This amount reflects interest expense on the $120.0 million in principal amount of the Notes at an assumed interest rate of 9.75% ($11.7 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 with the proceeds of this offering and the Debt Offering and a reduction in the interest rate attributable to the Private Debt Agreements described above. The following table summarizes the effect on interest expense of the Transaction: 188
INTEREST INTEREST AMOUNT RATE EXPENSE ------- -------- -------- DEBT REPAID OR MODIFIED Petro 12 1/4% Senior Subordinated Debentures......... $84,094 12.25% $9,953 Petro 10 1/8% Senior Subordinated Notes.............. 50,000 10.125% 5,063 Petro 9 3/8% Senior Subordinated Debentures.......... 75,000 9.375% 7,031 Petro 11.96% Notes(1)................................ 60,000 11.96% 7,176 Petro 14.10% Notes(1)................................ 6,884 14.10% 971 Lower letter of credit fees on Acquisition Notes..... 181 ------ Total Reductions to Interest Expense................. 30,375 ------ - -------- (1)Notes to be exchanged under the Private Debt Agreement. (q) The Partnership Agreement provides that for each full non-overlapping four quarter period ending on or after the first anniversary of the completion of the Transaction, but prior to the fifth anniversary of the completion of the Transaction, in which the dollar amount of Petro Adjusted Operating Surplus per Petro Unit 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, 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. If these Senior Subordinated Units are issued and they are converted into Class B Common Units, the Class A Common Units would be diluted in terms of available cash to be used for payment of the quarterly distributions. 189
INTEREST INTEREST AMOUNT RATE EXPENSE -------- -------- -------- NEW DEBT ISSUED OR MODIFIED DEBT AMOUNTS Petro 9.75% Notes due 2010........................ $120,000 9.75% $(11,700) Petro 9.0% Senior Notes(1)........................ 63,126 9.00% (5,680) Petro 10% Senior and Subordinated Notes(1)........ 6,884 10.25% (697) -------- Total Additions to Interest Expense.............. (18,077) -------- Net Reduction to Interest Expense.................. $ 12,298 ======== 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, 190 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. 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 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. 191 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 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 as an indicator of operating performance, or as an alternative to cash flow as a measure of liquidity or ability to service debt obligations. 192 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 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. 193 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 for the sale or other disposition of assets or (ii) made for 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 of its successors. 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) $16.7 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 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 194 (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 of its successors 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 195 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 to occur of the following: (a) the first day of any quarter beginning on or after October 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; and (b) the date on which the General Partner is removed as general partner of the Partnership upon the requisite vote by Limited Partners 196 under circumstances where Cause does not exist; provided, however, that if the General Partner is removed during the Subordination Period within 12 months after the end of 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 of such six-quarter period that the Minimum Quarterly Distribution on Common Units was not made occurs after March 31, 2001, then the Subordination Period will not end. In the event that the General Partner is removed under the circumstances described in the above proviso, 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 will rank equally with the Senior Subordinated Units. 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 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) for 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 of its borrowings 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. 197 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 - ------------------------------------- - ------------------------------------- - ------------------------------------- App-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 _________________________________________________________ ------------------------------------------------------------------------ App-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. App-3 ANNEX A - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 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 "Petro Stock Option Plans" shall have the meaning set forth in Section 3.7. "Plans" shall have the meaning set forth in Section 5(3)(l)(iii). "Previously Disclosed" by a party shall mean information set forth in its Disclosure Schedule. "Private Debt" means Petro's 11.85% Senior Notes due October 1, 2002, Petro's 12.17% Senior Notes due October 1, 2002 and Petro's 12.18% Senior Notes due October 1, 2002. "Private Preferred Stock" shall mean Petro's 1989 Preferred Stock due 1999. "Public Debt" means Petro's 10 1/8% Subordinated Notes due 2003, Petro's 9 3/8% Subordinated Debentures due 2006 and Petro's 12 1/4% Subordinated Debentures due 2005. "Public Preferred Stock" means Petro's 12 7/8% Series B and Series C Exchangeable Preferred Stock due 2009. "Registration Statements" shall have the meaning set forth in Section 6.3. "Regulatory Authorities" shall have the meaning set forth in Section 5.3(h)(ii). "Restructuring Transactions" shall mean the following, collectively: 1. the sale of the Designated Percentage of certain assets (the "Transferred Assets") by Petro or Subsidiaries of Petro to Star Propane in exchange for a note (the "Bridge Note"), as contemplated by the Petro Conveyance Agreement; 2. the sale by the General Partner of its general partnership interests in Star Partners and Star Propane and its subordinated limited partnership interests and common limited partnership interests in Star Partners to Petro for a note in the principal amount of $41,146,000; 3. the contribution by Petro of (i) all of its general partner interest in Star Propane (other than a portion of such interest with a value of approximately $1,000) to Star Partners in exchange for 54,316 newly issued Senior Subordinated Units and (ii) all of its general partner interest in Star Partners (other than a portion of such interest with a value of approximately $1,000) to Star Partners in exchange for 54,316 newly issued Senior Subordinated Units) as contemplated by the Petro Conveyance Agreement; 4. the conversion of all of Petro's Old Subordinated Units into 1,992,673 newly issued Senior Subordinated Units and 42,046 newly issued Common Units; 5. the contribution by certain Petro Insiders of 1,753,546 shares of Class A Common Stock Class C Common Stock (the "Insider Stock") to a newly formed Delaware limited liability company ("Star Gas LLC") in exchange for all the member interests in Star Gas LLC as contemplated in the Exchange Agreement, the formation certificate and operating agreement to be subject in form and substance to the approval of the Special Committee; 6. the contribution by Star Gas LLC of 9,244 of its Class A Common Stock to Star Propane in exchange for a .01% general partner interest in Star Propane as contemplated by the Star LLC Conveyance Agreement; A-6 7. the contribution by Star Gas LLC of 1,744,302 of its Class A and Class C Common Stock to Star Partners in exchange for a 1.99% general partner interest in Star Partners as contemplated by the Star LLC Conveyance Agreement; 8. the contribution by certain members of the Tax Free Group of 8,733,735 their Class A and Class C Common Stock to Star Partners in exchange for 577,205 Junior Subordinated Units and 666,994 Senior Subordinated Units, as contemplated in the Exchange Agreement; 9. the contribution by Star Partners of the Petro Common Stock owned by it to Star Propane; 10. the contribution by Star Propane to Parentco of the Transferred Assets, the stock of Petro and the stock of Stellar Propane Corp. in exchange for all the capital stock of Parentco and the assumption by Parentco of $85 million of Star Propane's 8.04% First Mortgage Notes and $11 million of Star Propane's 7.17% First Mortgage Notes. 11. the contribution by Parentco of the Petro Common Stock and the Transferred Assets owned by it to Newco free of any liability with respect to the outstanding First Mortgage Notes of Star Partners; and 12. the contribution by Newco of the Petro Common Stock owned by it to Mergeco. "Rights" shall mean, with respect to any person, securities or obligations convertible into or exchangeable for, or giving any person any right to subscribe for or acquire, or any options, calls or commitments relating to, equity securities of such person. "SEC" shall mean the Securities and Exchange Commission. "SEC Documents" shall have the meaning set forth in Section 5.3(g). "Securities Act" shall mean the Securities Act of 1933, as amended, and the rules and regulations thereunder. "Senior Subordinated Units" shall mean the senior subordinated units representing limited partner interests of Star Partners having the rights and obligations specified with respect to Senior Subordinated Units in the Amended and Restated Partnership Agreement. "Significant Subsidiaries" shall have the meaning ascribed to such term in Section 1-01(w) of Regulation S-X under the Securities Act. "Special Committee" means the special committee of the Board of Directors of the General Partner consisting of William Nicoletti and Elizabeth Lanier. "Star Gas LLC" shall mean Star Gas LLC, a newly-created Delaware limited liability company that will succeed Star Gas Corporation as the general partner of the partnership. "Star LLC Conveyance Agreement" shall mean the Conveyance and Contribution Agreement among Star Gas LLC, Star Propane and Star Partners to be entered into as of the Closing Date substantially in the form of Exhibit D. A-7 "Star Partners" shall have the meaning set forth in the introductory paragraph to this Agreement. "Star Partners' Disclosure Schedule" shall mean the Disclosure Schedule delivered by Star Partners pursuant to Section 5.1. "Star Partners Meeting" shall have the meaning set forth in Section 6.2. "Star Propane" shall have the meaning set forth in the introductory paragraph to this Agreement. "Star Propane Debt Conditions" shall mean the Holders of Star Propane's 8.04% First Mortgage Notes due 2009 and Star Propane's outstanding bank credit facilities shall have consented to the execution, delivery and performance of this Agreement by Star Propane or shall have entered into amendments permitting the execution, delivery and performance of this Agreement by Star Propane without violation of the terms of such indebtedness and without a requirement that such indebtedness be repurchased (or an offer be made to purchase such indebtedness). "Subsidiary" shall have the meaning ascribed to such term in Rule 1-02 of Regulation S-X under the Securities Act. "Surviving Corporation" shall have the meaning set forth in Section 2.1(a). "Takeover Law" means any "fair price", "moratorium", "control share acquisition" or any other anti-takeover statute or similar statute enacted under state or federal law. "Takeover Proposal" shall mean, with respect to Petro, any tender or exchange offer, proposal for a merger, consolidation or other business combination involving Petro or any of its Subsidiaries or any proposal or offer to acquire in any manner a substantial equity interest in, or a substantial portion of the assets of, Petro or any of its Subsidiaries other than the transactions contemplated or permitted by this Agreement. "Tax Returns" shall have the meaning set forth in Section 5.3(o). "Taxes" shall mean all taxes, charges, fees, levies or other assessments, including, without limitation, all net income, gross income, gross receipts, sales, use, ad valorem, goods and services, capital, transfer, franchise, profits, license, withholding, payroll, employment, employer health, excise, estimated, severance, stamp, occupation, property or other taxes, custom duties, fees, assessments or charges of any kind whatsoever, together with any interest and any penalties, additions to tax or additional amounts imposed by any taxing authority. "Treasury Shares" shall mean shares of Petro Common Stock owned by Petro at the Effective Time. "Working Capital" when applied to Petro, shall mean Petro's current assets minus current liabilities determined in accordance with generally accepted accounting principles applied on a consistent basis provided that (i) restricted cash shall be excluded from current assets to the extent such restricted cash remains restricted immediately following the Effective Time and relates to A-8 indebtedness due in more than one year, (ii) draws under Petro's bank working capital facility shall be included in current liabilities, (iii) the current maturities of all other Petro long-term indebtedness and preferred stock shall be excluded from current liabilities, and (iv) expenses of the type described in Section 7.13(d) shall be included as a current liability to the extent not financed in the Debt Offering or the Equity Offering. ARTICLE II.ARTICLE II. THE MERGER; EFFECTS OF THE MERGER 2.1. The Merger. (a) The Surviving Corporation. Subject to the terms and conditions of this Agreement, at the Effective Time, Mergeco shall merge with and into Petro (the "Merger"), the separate corporate existence of Mergeco shall cease and Petro shall survive and continue to exist as a Minnesota corporation (Petro, as the surviving corporation in the Merger, sometimes being referred to herein as the "Surviving Corporation"). Star Partners, with the consent of the Special Committee, may at any time change the method of effecting the Merger (including, without limitation, the provisions of this Article II) if and to the extent it deems such change to be desirable; provided, however, that no such change shall (A) alter or change the amount or kind of consideration to be issued to holders of Petro Common Stock or Petro Preferred Stock as provided for in this Agreement (the "Merger Consideration"), (B) adversely affect the tax treatment of Petro's stockholders as a result of receiving the Merger Consideration or (C) materially impede or delay consummation of the transactions contemplated by this Agreement. (b) Effectiveness And Effects Of The Merger. Subject to the satisfaction or waiver of the conditions set forth in Article VII in accordance with this Agreement, the Merger shall become effective upon the later to occur of (i) the filing in the office of the Secretary of State of Delaware of a properly executed certificate of merger (the "Certificate of Merger") and (ii) the filing with the Department of State of Minnesota of properly executed articles of merger (the "Articles of Merger"), or such later date and time as may be set forth in the Certificate of Merger and the Articles of Merger (the "Effective Time"), in accordance with the DGCL and the MBCA. The Merger shall have the effects prescribed in DGCL and the MBCA. (c) Certificate Of Incorporation And By-Laws. The certificate of incorporation and by-laws of Petro in effect immediately prior to the Effective Time shall be the certificate of incorporation and bylaws of the Surviving Corporation, until duly amended in accordance with applicable law. (d) Directors of the Surviving Corporation. The directors of Petro who are also employees of Petro immediately prior to the Effective time shall be the directors of the Surviving Corporation as of the Effective Time. (e) Officers of the Surviving Corporation. The officers of Petro immediately prior to the Effective Time shall be the officers of the Surviving Corporation as of the Effective Time. 2.2. Effective Date And Closing. Subject to the satisfaction or waiver of the conditions as set forth in Article VII in accordance with this Agreement, the closing of the Merger and the other A-9 transactions contemplated hereby (the "Closing") shall occur on (a) the third business day to occur after the day on which the last of the conditions set forth in Article VII shall have been satisfied or waived in accordance with the terms of this Agreement provided that such date shall not be earlier than February 15, 1999 or (b) such other date to which the parties may agree in writing. The date on which the Closing occurs is referred to as the "Closing Date." The Closing of the transactions contemplated by this Agreement shall take place at the offices of Phillips Nizer Benjamin Krim & Ballon LLP, 666 Fifth Avenue, New York, New York 10103 at 10:00 a.m. New York City time on the Closing Date. ARTICLE III. MERGER CONSIDERATION; EXCHANGE PROCEDURES 3.1. Merger Consideration. Subject to the provisions of this Agreement, at the Effective Time, by virtue of the Merger and without any action on the part of any holder of capital stock of any party: (a) Each share of the common stock, par value $.01 per share, of Mergeco outstanding immediately prior to the Effective Time shall be converted into and become one fully paid and nonassessable share of Common Stock, par value $.10, of the Surviving Corporation. (b) Each Treasury Share and each share of Petro Common Stock owned by Mergeco shall cease to be outstanding and shall be canceled and retired without payment of any consideration therefor, and no partnership interest of Star Partners or other consideration shall be delivered in exchange therefor. (c) Each share of Petro Common Stock issued and outstanding immediately prior to the Effective Time (other than Treasury Shares, shares held by Mergeco, and shares of Dissenting Common Holders) shall be converted into the right to receive .13064 fully paid and nonassessable Senior Subordinated Units. (d) Each share of Junior Preferred Stock issued and outstanding immediately prior to the Effective Time shall be converted into the right to receive .13064 fully paid and nonassessable Common Units. (e) Each share of Public Preferred Stock issued and outstanding immediately prior to the Effective Time shall be converted into the right to receive $23 in cash plus accrued and unpaid dividends as of the Effective Time. (f) Each share of Petro's Class B Common Stock, $.10 par value, outstanding immediately prior to the Effective Time, shall be unchanged and shall remain outstanding with the same relative rights, preferences and privileges which it had immediately prior to the Effective Time. 3.2. Rights As Stockholders; Stock Transfers. At the Effective Time, holders of Petro Common Stock, Junior Preferred Stock and Public Preferred Stock shall cease to be, and shall have no rights, as stockholders of Petro, other than to receive (a) any dividend or other distribution with respect to such Petro Common Stock, Junior Preferred Stock or Public Preferred Stock with a record A-10 date occurring prior to the Effective Time that may have been declared or made by Petro on such shares of Petro Common Stock, Junior Preferred Stock or Public Preferred Stock in accordance with the terms of this Agreement or prior to the date hereof and which remain unpaid at the Effective Time and (b) the consideration provided under this Article III. After the Effective Time, there shall be no transfers on the stock transfer books of the shares of Petro Common Stock or Petro Preferred Stock. 3.3. Fractional Shares. No certificates or scrip representing fractional Common Units or Senior Subordinated Units shall be issued upon the surrender for exchange of Certificates pursuant to this Article III, and, except as provided in Section 3.2 and this Section 3.3, no dividend or other distribution, stock split or interest shall relate to any such fractional security, and such fractional interests shall not entitle the owner thereof to vote or to any rights of a security holder of Star Partners. In lieu thereof, each holder of shares of Petro Common Stock who would otherwise have been entitled to a fraction of a Senior Subordinated Unit upon surrender of Certificates for exchange pursuant to this Article III will be paid an amount in cash (without interest) equal to the closing price of the Senior Subordinated Units on the first day of trading thereof on the NYSE (as reported in The Wall Street Journal or, if not reported therein, in another authoritative source) multiplied by the fractional interest the holder would otherwise be entitled to receive, and each holder of shares of Junior Preferred Stock who would otherwise have been entitled to a fraction of a Common Unit upon surrender of Certificates for exchange pursuant to this Article III will be paid an amount in cash (without interest) equal to such fraction multiplied by the average of the last sales prices of the Common Units on the New York Stock Exchange Composite Transactions tape (as reported in The Wall Street Journal or, if not reported therein, in another authoritative source) for the five consecutive trading days ending immediately prior to the second trading day prior to the Closing Date. 3.4. Exchange Procedures. (a) At or prior to the Effective Time, Star Partners shall deposit, or shall cause to be deposited, with the Exchange Agent, for the benefit of the holders of the Petro Common Stock and the Junior Preferred Stock for exchange in accordance with this Article III (i) certificates representing the Senior Subordinated Units and Common Units ("New Certificates") issuable pursuant to Section 3.1 in exchange for outstanding shares of Petro Common Stock and Junior Preferred Stock, (ii) the amount of cash necessary to be distributed to the holders of Public Preferred Stock in accordance with the foregoing sections of this Article III and (iii) an amount of cash to be paid in lieu of fractional Senior Subordinated Units and Common Units as provided herein (such cash and New Certificates, together with any dividends or distributions with respect thereto (but without any interest thereon), being hereinafter referred to as the "Exchange Fund"). (b) Promptly after the Effective Time, the Exchange Agent shall mail to each holder of record of a certificate or certificates which, immediately prior to the Effective Time, represented outstanding shares of Petro Common Stock and Junior Preferred Stock (the "Certificates"), which holder's shares of Petro Common Stock or Junior Preferred Stock were converted into the right to receive Senior Subordinated Units or Common Units pursuant to Section 3.1 (i) a letter of transmittal, which shall specify that delivery shall be effected and risk of loss and title to the Certificates shall pass only upon delivery of the Certificates to the Exchange Agent, and shall be in such form and have such other provisions as Star Partners may reasonably specify and (ii) instructions for use in effecting the A-11 surrender of the Certificates in exchange for certificates representing Senior Subordinated Units and Common Units. Upon surrender of a Certificate for cancellation to the Exchange Agent, together with such letter of transmittal, duly executed, and any other required documents, the holder of such Certificate shall be entitled to receive in exchange therefor a New Certificate representing the number of whole Senior Subordinated Units or Common Units that such holder has the right to receive pursuant to this Article III, and cash in lieu of any fractional Senior Subordinated Units or Common Units, as contemplated by Section 3.3, and the Certificate so surrendered shall forthwith be canceled. In the event of a transfer of ownership of Petro Common Stock or Junior Preferred Stock that is not registered in the transfer records of Petro, a certificate representing the proper number of Senior Subordinated Units or Common Units may be issued to a transferee only on the condition that the Certificate formerly representing such shares of Petro Common Stock or Junior Preferred Stock is presented to the Exchange Agent, properly endorsed, and accompanied by all documents required to evidence and effect such transfer and by evidence that any applicable stock transfer taxes have been paid or that no such taxes are applicable. The Exchange Agent shall not be entitled to vote or exercise any rights of ownership with respect to Senior Subordinated Units or Common Units held by it from time to time hereunder, except that it shall receive and hold all dividends or other distributions paid or distributed with respect thereto for the account of persons entitled thereto. (c) If any Certificate shall have been lost, stolen, mislaid or destroyed, upon the making of an affidavit of that fact by the Person claiming such Certificate to be lost, stolen, mislaid or destroyed, and if required by Star Partners, the posting by such Person of a bond in such reasonable amount as Star Partners may direct as indemnity against any claim that may be made against it with respect to such Certificate, the Exchange Agent will issue in exchange for such lost, stolen, mislaid or destroyed Certificate the consideration deliverable in respect thereof as determined in accordance with this Article III. (d) Notwithstanding the foregoing, neither the Exchange Agent nor any party hereto shall be liable to any former holder of Petro Common Stock or Junior Preferred Stock for any amount properly delivered to a public official pursuant to applicable abandoned property, escheat or similar laws. (e) No distributions with respect to the Common Units or Senior Subordinated Units declared or made after the Effective Time with a record date occurring after the Effective Time shall be paid to the holder of any unsurrendered old Certificate, and no cash payment in lieu of fractional Senior Subordinated Units or Common Units shall be paid to any such holder pursuant to Section 3.3 until the holder thereof shall surrender such Certificates in accordance with this Article III. After the surrender of certificates in accordance with this Article III, and subject to the effect of applicable laws, there shall be paid to the holder of Senior Subordinated Units or Common Units issued in exchange therefor, without interest, (i) at the time of such surrender, the amount of distributions with a record date after the Effective Time theretofore payable with respect to such Senior Subordinated Units or Common Units and not paid, less the amount of any withholding taxes which may be required thereon, and (ii) at the appropriate payment date, the amount of distributions with a record date after the Effective Time but prior to surrender and a payment date subsequent to surrender payable with respect to such Senior Subordinated Units or Common Units, less the amount of any withholding taxes which may be required thereon. A-12 (f) Any portion of the Exchange Fund that remains unclaimed by the stockholders of Petro for twelve months after the Closing shall be paid to Star Partners. Any stockholders of Petro who have not theretofore complied with this Article III shall thereafter look only to Star Partners for payment of the Common Units or Senior Subordinated Units, cash in lieu of any fractional Common Units or Senior Subordinated Units and unpaid distributions on the Common Units and the Senior Subordinated Units deliverable in respect of each share of Petro Common Stock and Junior Preferred Stock such stockholder holds as determined pursuant to this Agreement, in each case, without any interest thereon. 3.5. Anti-Dilution Provisions. In the event of any subdivisions, reclassifications, recapitalizations, splits, combinations or dividends in the form of equity interests with respect to the Common Units, and the Petro Common Stock (in each case, as permitted pursuant to Section 4.3) the number of Senior Subordinated Units and Common Units to be issued in the Merger and the average closing sales prices of the Common Units determined in accordance with Section 3.3 will be correspondingly adjusted. 3.6. Shares of Dissenting Common Holders. Any issued and outstanding shares of Petro Common Stock held by Dissenting Common Holders shall not be converted as described in Section 3.1(c) but shall from and after the Effective Time represent only the right to receive such consideration as may be determined to be due to such Dissenting Common Holder pursuant to the MBCA; provided, however, that shares of Petro Common Stock outstanding immediately prior to the Effective Time and held by a Dissenting Common Holder who shall, after the Effective Time, withdraw his demand for fair value or lose his dissenters' rights pursuant to the MBCA, shall be deemed to be converted, as of the Effective Time, into the right to receive Senior Subordinated Units as specified in Section 3.1(c), without interest. 3.7. Options. (a) At the Closing, all employee and director stock options to purchase shares of Petro Common Stock (each, a "Petro Stock Option"), which are then outstanding and unexercised, shall cease to represent a right to acquire shares of Petro Stock. To the extent any such stock option is not vested at the Effective Time and does not become vested by reason of the Merger, such stock option shall be cancelled. To the extent that any stock option is vested as of the Effective Time or becomes vested by reason of the Merger, such stock option to the extent so vested shall be converted automatically into options to purchase .13064 Senior Subordinated Units at a price equal to the original exercise price divided by .13064 and Star Partners shall assume each such Petro Stock Option subject to the terms of any of the stock option plans listed under "Stock Option Plans" in Section 5.3 of Petro's Disclosure Schedule (collectively, the "Petro Stock Option Plans"), and the agreements evidencing grants thereunder, including but not limited to the accelerated vesting of such options which shall occur in connection with and by virtue of the Merger as and to the extent required by such plans and agreements. A-13 ARTICLE IV. ACTIONS PENDING MERGER From the date hereof until the Effective Time, except as expressly contemplated by this Agreement, (a) without the prior written consent of the Special Committee (which consent shall not be unreasonably withheld or delayed) Petro will not, and will cause each of its Subsidiaries not to, and (b) without the prior written consent of Petro (which consent shall not be unreasonably withheld or delayed) Star Partners will not, and will cause each of its Subsidiaries not to: 4.1. Ordinary Course. Conduct the business of it and its Subsidiaries other than in the ordinary and usual course or, to the extent consistent therewith, fail to use reasonable best efforts to preserve intact its business organizations, goodwill and assets and maintain its rights, franchises and existing relations with customers, suppliers, employees and business associates, or take any action that would (a) adversely affect the ability of any party to obtain any approvals required under the HSRA for the transactions contemplated hereby or (b) adversely affect its ability to perform any of its material obligations under this Agreement. 4.2. Capital Stock. In the case of Petro and its Subsidiaries, other than (a) pursuant to stock options Previously Disclosed in its Disclosure Schedule, (b) pursuant to the Petro dividend reinvestment program or (c) as otherwise set forth on Section 4.2 of Petro's Disclosure Schedule, (i) issue, sell or otherwise permit to become outstanding, or authorize the creation of, any additional shares of capital stock, any stock appreciation rights or any Rights, (ii) enter into any agreement with respect to the foregoing or (iii) permit any additional shares of capital stock to become subject to new grants of employee stock options, stock appreciation rights or similar stock-based employee rights. 4.3. Dividends, Distributions. (a) Make, declare or pay any dividend (other than (i) in the case of Star Propane, distributions of Available Cash (as defined in the Operating Partnership Agreement) to its partners, (ii) in the case of Star Partners, regular quarterly cash distributions of Available Cash on the Common Units, Subordinated Units and general partner interest of Star Partners and (iii) in the case of Petro, regular quarterly dividends on the Petro Preferred Stock), in each case in the ordinary course consistent with past practice), on or in respect of, or declare or make any distribution on any shares of its equity securities other than as Previously Disclosed, (b) split, combine or reclassify any of its 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 its capital stock or (c) repurchase, redeem or otherwise acquire, or permit any of its Subsidiaries to purchase, redeem or otherwise acquire any shares of its capital stock, except as required by the terms of its securities outstanding on the date hereof or as contemplated by any existing Compensation and Benefit Plan. 4.4. Compensation; Employment Agreements. In the case of Petro and its Subsidiaries, except as set forth on Section 4.4 of Petro's Disclosure Schedule, 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 individual increases in compensation to employees (other than officers and directors) in the ordinary course of business consistent with past practice or (b) other changes as are provided for herein or as may be required by law or to A-14 satisfy contractual obligations existing as of the date hereof or (c) additional grants of awards to newly hired employees consistent with past practice. 4.5. Benefit Plans. In the case of Petro and its Subsidiaries, except as set forth on Section 4.5 of the Petro Disclosure Schedule, enter into or amend (except as may be required by applicable law, to satisfy contractual obligations existing as of the date hereof or amendments which, either individually or in the aggregate, would not reasonably be expected to result in a material liability to Petro or its Subsidiaries) 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 of its directors, officers or other employees, including, without limitation, taking any action that accelerates the vesting or exercise of any benefits payable thereunder. 4.6. Acquisitions And Dispositions. In the case of Petro and its Subsidiaries, and except for the sale of the Transferred Assets to Star Propane, sell, lease, dispose of or discontinue any portion of its assets, business or properties, which is material to it and its Subsidiaries taken as a whole, or acquire, by merger or otherwise, or lease (other than by way of foreclosures or acquisitions of control in a bona fide fiduciary capacity or in satisfaction of debts previously contracted in good faith, in each case in the ordinary and usual course of business consistent with past practice) any assets or all or any portion of, the business or property of any other entity which, in either case, is material to it and its Subsidiaries taken as a whole, or would be likely to have a Material Adverse Effect on the ability of the parties to consummate the transactions contemplated by this Agreement or to delay materially the Effective Time. In the case of Star Partners, Star Partners will not, and will cause its Subsidiaries not to, make any acquisition or take any other action which would have a Material Adverse Effect on its ability to consummate the transactions contemplated by this Agreement. 4.7. Amendments. In the case of Petro, amend its Articles of Incorporation or By-laws. 4.8. Accounting Methods. Implement or adopt any change in its accounting principles, practices or methods, other than as may be required by law or generally accepted accounting principles. 4.9. 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. 4.10. Notification. Fail to promptly notify the other of any material change in its condition (financial or otherwise) or business or any material litigation or material governmental complaints, investigations or hearings or the breach in any material respect of any of its representations or warranties contained herein. 4.11. Taxes. (a) Make or rescind any material express or deemed election relating to Taxes unless it is reasonably expected that such action will not materially and adversely affect it, including elections for any and all joint ventures, partnerships, limited liability companies, working interests or other investments where it has the capacity to make such binding election, (b) settle or compromise any material claim, action, suit, litigation, proceeding, arbitration, investigation, audit or controversy relating to Taxes, except where such settlement or compromise will not materially and adversely A-15 affect it or (c) 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 such changes that are reasonably expected not to materially adversely affect it. 4.12. Debt, Capital Expenditures and the Like. In the case of Petro, except as provided in Section 6.4, (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 the property of Petro or its Subsidiaries 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 identified in Section 4.12 of the Petro Disclosure Schedule and Previously Disclosed to Star Gas. 4.13. No Dissolution. Authorize, recommend, propose or announce an intention to adopt a plan of complete or partial dissolution or liquidation. 4.14. Adverse Actions. Knowingly take any action that is intended or is reasonably likely to result in (a) any of its representations and warranties set forth in this Agreement being or becoming untrue in any material respect at any time prior to the Closing, (b) any of the conditions to the Merger set forth in Article VII not being satisfied or (c) a material violation of any provision of this Agreement except, in each case, as may be required by applicable law. 4.15. Agreements. Agree or commit to do anything prohibited by Sections 4.1 through 4.14. ARTICLE V. REPRESENTATIONS AND WARRANTIES 5.1. Disclosure Schedule. On or prior to the date hereof, Star Partners has delivered to Petro and Petro has delivered to Star Partners a schedule (respectively, its "Disclosure Schedule") setting forth, among other things, items the disclosure of which is necessary or appropriate in relation to any or all of its representations and warranties; provided, however, that (a) no such item is required to be set forth in a Disclosure Schedule as an exception to a representation or warranty if its absence is not reasonably likely to result in the related representation or warranty being deemed untrue or incorrect under the standard established by Section 5.2, and (b) the mere inclusion of an item in a Disclosure Schedule shall not be deemed an admission by a party that such item represents a material exception or fact, event or circumstance or that such item is reasonably likely to result in a Material Adverse Effect. 5.2. Standard. No representation or warranty of Star Partners or Petro contained in Section 5.3 (except Sections 5.3(b), 5.3(c)(i), 5.3(c)(ii), 5.3(d) and 5.3(e)) shall be deemed untrue or incorrect, and no party hereto shall be deemed to have breached a 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 inconsistent with any paragraph of Section 5.3, has had or is reasonably expected to have a Material Adverse Effect. A-16 5.3. Representations and Warranties. Subject to Sections 5.1 and 5.2 and except as Previously Disclosed, Petro hereby represents and warrants to Star Partners, and Star Partners hereby represents and warrants to Petro, to the extent applicable, in each case with respect to itself and its Subsidiaries, as follows: (a) Organization, Standing and Authority. Such party is a corporation, or in the case of Star Partners and Star Propane, a limited partnership, duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization. Such party (i) is duly qualified to do business and is in good standing in the states of the United States where its ownership or leasing of property or the conduct of its business requires it to be so qualified and (ii) has in effect all federal, state, local, and foreign governmental authorizations and permits necessary for it to own or lease its properties and assets and to carry on its business as it is now conducted. Such party (i) is duly qualified to do business and is in good standing in the states of the United States where its ownership or leasing of property or the conduct of its business requires it to be so qualified and (ii) has in effect all federal, state, local, and foreign governmental authorizations and permits necessary for it to own or lease its properties and assets and to carry on its business as it is now conducted. (b) Shares. (i) In the case of Petro, as of the date hereof, the authorized capital stock of Petro consists solely of 81,909,722 shares of stock, $.10 par value, of which, as of the date hereof, 23,964,962 shares of Class A Common Stock, 11,228 shares of Class B Common Stock, 2,597,519 shares of Class C Common Stock, 41,668 shares of Private Preferred Stock, no more than 797,000 shares of Junior Preferred Stock and 1,200,000 shares of Public Preferred Stock are issued and outstanding. Such outstanding shares were duly authorized and are validly issued and fully paid and non-assessable and are not subject to any preemptive or similar rights (and were not issued in violation of any preemptive or similar rights). The holder of the Petro Private Preferred Stock has consented to the redemption thereof on or prior to the Closing Date at a price equal to $4.167 million plus accrued and unpaid dividends. (ii) In the case of Star Partners, as of the date hereof, there are 3,858,999 Common Units and 2,396,078 Old Subordinated Units issued and outstanding, and all of such Common Units and Old Subordinated Units and the limited partner interests represented thereby were duly authorized and validly issued in accordance with the Partnership Agreement and are fully paid (to the extent required under the Partnership Agreement) and nonassessable (except as such nonassessability may be affected by matters described in the Merger Registration Statement under the caption "Description of the Partnership Agreement--Limited Liability"). As of the date hereof, the General Partner owns a 1% general partner interest in Star Partners, and such general partner interest was duly authorized and validly issued in accordance with the Partnership Agreement. As of the date hereof, Star Partners owns a 98.9899% limited partner interest in Star Propane, and such limited partner interest was duly authorized and validly issued in accordance with the Operating Partnership Agreement and is fully paid (to the extent required under the Operating Partnership Agreement) and nonassessable (except as such nonassessability may be affected by matters described in the Merger Registration Statement under the caption "Description of the Partnership Agreement--Limited Liability"). As of the date hereof, the General Partner owns a 1.0101% general partner interest in Star Propane, and such general A-17 partner interest was duly authorized and validly issued in accordance with the Operating Partnership Agreement. (iii) As of the date hereof, except as Previously Disclosed in Section 5.3(b) of a party's Disclosure Schedule, there are no shares of capital stock (in the case of Petro) or interests (in the case of Star Partners), of such party's equity securities authorized and reserved for issuance, such party does not have any Rights issued or outstanding with respect to its equity securities, and such party does not have any commitment to authorize, issue or sell any such equity securities or Rights, except pursuant to this Agreement. Since December 31, 1997, Petro has not issued any shares of its capital stock or rights in respect thereof or reserved any shares for such purposes except pursuant to plans or commitments Previously Disclosed in Section 5.3(b) of its Disclosure Schedule. (iv) The number of shares of Petro Common Stock which are issuable and reserved for issuance upon exercise of Petro Stock Options as of the date hereof are Previously Disclosed in Section 5.3(b) of Petro's Disclosure Schedule, and the number of Common Units and Subordinated Units that are issuable upon exercise of any employee or director options to purchase Common Units or Subordinated Units as of the date hereof are Previously Disclosed in Section 5.3 of Star Partners' Disclosure Schedule. (c) Subsidiaries. (i) (A) Such party has Previously Disclosed in Section 5.3(c) of its Disclosure Schedule a list of all of its Subsidiaries together with the jurisdiction of organization of each such Subsidiary, (B) it owns, directly or indirectly, all of the equity interests of each of its Subsidiaries, (C) no equity interests of any of its Subsidiaries are or may become required to be issued by reason of any Rights, (D) there are no contracts, commitments, understandings or arrangements by which any of such Subsidiaries is or may be bound to sell or otherwise transfer any equity interests of any such Subsidiaries, (E) there are no contracts, commitments, understandings, or arrangements relating to its rights to vote or to dispose of such equity interests, and (F) all of the equity interests of each such Subsidiary held by it or its Subsidiaries are fully paid and nonassessable and are owned by it or its Subsidiaries free and clear of any Liens. (ii) In the case of the representations and warranties of Petro, other than ownership of its Subsidiaries, Petro does not own beneficially, directly or indirectly, any equity securities or similar interests of any person, or any interest in a partnership or joint venture of any kind. (iii) Each of such party's Subsidiaries has been duly organized and is validly existing in good standing under the laws of the jurisdiction of its organization and (a) is duly qualified to do business and in good standing in the jurisdictions where its ownership or leasing of property or the conduct of its business requires it to be so qualified and (b) has in effect all federal, state, local, and foreign governmental authorizations and permits necessary for it to own or lease its properties and assets and to carry on its business as it is now conducted. (d) Corporate or Partnership Power. Such party and each of its Subsidiaries has the corporate power and authority, or in the case of Star Partners and Star Propane the partnership power and authority to carry on its business as it is now being conducted and to own all its properties and assets; and it has the corporate power and authority or, in the case of Star Partners and Star Propane, the partnership power and authority, to execute, deliver and perform its obligations under this Agreement and to consummate the transactions contemplated hereby. A-18 (e) Equityholder Authority. Subject in the case of this Agreement to approval by the holders of a majority of the shares of Petro Class A and Class C Common Stock and Petro Preferred Stock entitled to vote thereon, voting separately by classes the approval of the holders of a majority of the Petro Class A Common Stock which is not owned by Petro Insiders or Affiliates, and by the holders of a majority of the Common Units of Star Partners, excluding Common Units held by Petro and its Affiliates, this Agreement and the transactions contemplated hereby have been authorized by all necessary corporate action (partnership action in the case of Star Partners and Star Propane), and this Agreement has been duly executed and delivered and is a legal, valid and binding agreement of it, enforceable in accordance with its terms (except as such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, fraudulent transfer and similar laws of general applicability relating to or affecting creditors' rights or by general equity principles). In the case of Petro, the holders of 100% of the Public Preferred Stock, 100% of the Private Preferred Stock and 100% of the Junior Preferred Stock have granted Petro an irrevocable proxy to vote their shares in favor of the Merger. (f) No Defaults. Except as Previously Disclosed, subject to receipt of the HSRA approval, the approval of the holders of the Private Debt and 1998 Preferred Stock, the approval of Petro's bank group, the required filings under federal and state securities laws and the approvals contemplated by Article VII, the execution, delivery and performance of this Agreement and the consummation of the transactions contemplated hereby does not and will not (i) constitute a breach or violation of, or result in a default (or an event that, with notice or lapse of time or both, would become a default) under, or result in the termination or in a right of termination or cancellation of, or accelerate the performance required by, any note, bond, mortgage, indenture, deed of trust, license, franchise, lease, contract, agreement, joint venture or other instrument or obligation to which it or any of its Subsidiaries is a party or by which it or any of its Subsidiaries or properties is subject or bound, (ii) constitute a breach or violation of, or a default under, in the case of Petro its articles of incorporation or by-laws and in the case of Star Partners and Star Propane its Agreement of Limited Partnership, (iii) contravene or conflict with or constitute a violation of any provision of any law, rule, regulation, judgment, order or decree binding upon or applicable to it or any of its Subsidiaries, (iv) result in the creation of any Lien on any of its assets or its Subsidiaries' assets or (v) cause the transactions contemplated by this Agreement to be subject to Takeover Laws. (g) Financial Reports And SEC Documents. Its Annual Report on Form 10-K, for the fiscal year ended December 31, 1997 in the case of Petro and for the fiscal year ended September 30, 1997 in the case of Star Partners, and all other reports, registration statements, definitive proxy statements or information statements filed or to be filed by it or any of its Subsidiaries subsequent to December 31, 1995 under the Securities Act, or under Sections 13(a), 13(c), 14 and 15(d) of the Exchange Act, in the form filed, or to be filed (collectively, its "SEC Documents"), with the SEC (i) complied or will comply in all material respects as to form with the applicable requirements under the Securities Act or the Exchange Act, as the case may be, and (ii) did not and will not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements made therein, in light of the circumstances under which they were made, not misleading; and each of the balance sheets contained in or incorporated by reference into any such SEC Document (including the related notes and schedules thereto) fairly presents the financial position of the entity or entities to which it relates as of its date, and each of the statements of A-19 income and changes in stockholders' equity and cash flows or equivalent statements in the case of Star Partners in such SEC Documents (including any related notes and schedules thereto) fairly presents the results of operations, changes in stockholders' equity and changes in cash flows, as the case may be, of the entity or entities to which it relates for the periods to which it relates, in each case in accordance with generally accepted accounting principles consistently applied during the periods involved, except in each case as may be noted therein, subject to normal year-end audit adjustments in the case of unaudited statements. Except as and to the extent set forth on its balance sheet as of September 30, 1997 (in the case of Star Partners) and December 31, 1997 (in the case of Petro), as of such date, neither it nor any of its Subsidiaries had any liabilities or obligations of any nature (whether accrued, absolute, contingent or otherwise) that would be required to be reflected on, or reserved against in, a balance sheet or in the notes thereto prepared in accordance with generally accepted accounting principles consistently applied. (h) Litigation; Regulatory Action. (i) No litigation, claim or other proceeding before any court or governmental agency is pending against it or any of its Subsidiaries and, to the best of its knowledge, no such litigation, claim or other proceeding has been threatened, other than normal and routine litigation which is either covered by insurance in amounts sufficient to discharge any likely exposure. There are no outstanding judgments, decrees, injunctions, awards or orders against it or any of its Subsidiaries. Section 5.3(h) of its Disclosure Schedule contains, as of the date of this Agreement, an accurate and complete list of all actions, suits and proceedings pending or, to the best of its knowledge, threatened against it, except as to routine law suits arising in the ordinary course of business involving customer complaints or vehicular accidents which are fully covered by insurance (except for deductible amounts under such insurance policies which if required to be paid would not individually or in the aggregate have a Material Adverse Effect). (ii) Except as Previously Disclosed, neither it nor any of its Subsidiaries or properties is a party to or is subject to any order, decree, agreement, memorandum of understanding or similar arrangement with, or a commitment letter or similar submission to, any federal or state governmental agency or court or authority or body or the supervision or regulation of it or any of its Subsidiaries (collectively, the "Regulatory Authorities"). (iii) Neither it nor any of its Subsidiaries has been advised by any Regulatory Authority that such Regulatory Authority is contemplating issuing or requesting (or is considering the appropriateness of issuing or requesting) any such order, decree, agreement, memorandum of understanding, commitment letter or similar submission. (i) Compliance With Laws. Except as set forth in Section 5.3(i) of its Disclosure Schedule, it and each of its Subsidiaries: (i) in the conduct of its business, is in compliance with all applicable federal, state, local and foreign statutes, laws, regulations, ordinances, rules, judgments, orders or decrees applicable thereto or to the employees conducting such businesses, (any instance of failure to so comply is referred to herein as a "Non-Compliance Event"). (ii) has all permits, licenses, authorizations, orders and approvals of, and has made all filings, applications and registrations with, all Regulatory Authorities that are required in order to permit it to conduct its businesses substantially as presently conducted; all such permits, A-20 licenses, certificates of authority, orders and approvals are in full force and effect and, to the best of its knowledge, no suspension or cancellation of any of them is threatened (any instance or failure to obtain any of the foregoing and to maintain them in full force and effect is referred to herein as a ("Permitting Violation"); and (iii) has not received, since December 31, 1994, any notification or communication from any Regulatory Authority asserting that it or any of its Subsidiaries is not in compliance with any of the statutes, regulations, or ordinances which such Regulatory Authority enforces or threatening to revoke any license, franchise, permit, or governmental authorization (nor, to its knowledge, do any grounds for any of the foregoing exist), any instance of the foregoing referred to herein as a "Non-Compliance Notification"; (j) Defaults. Neither it nor any of its Subsidiaries is in default under any contract, agreement, commitment, arrangement, lease, insurance policy, or other instrument to which it is a party, by which its respective assets, business, or operations may be bound or affected, or under which it or its respective assets, business, or operations receives benefits, and there has not occurred any event that, with the lapse of time or the giving of notice or both, would constitute such a default. (k) No Brokers. No action has been taken by it that would give rise to any valid claim against any party hereto for a brokerage commission, finder's fee or other like payment with respect to the transactions contemplated by this Agreement, excluding, in the case of Petro, fees to be paid to PaineWebber Incorporated and Dain Rauscher Wessels, and, in the case of Star Partners, fees to be paid to A.G. Edwards & Sons, Inc., in each case pursuant to letter agreements which have been heretofore disclosed to the other party. (l) Compensation and Benefit Plans. (i) Section 5.3(l)(i) of a party's Disclosure Schedule contains a complete list of all material bonus, vacation, deferred compensation, pension, retirement, profit-sharing, thrift, savings, employee stock ownership, stock bonus, stock purchase, restricted stock and stock option plans, all employment or severance contracts, all medical, dental, disability, health and life insurance plans, all other employee benefit and fringe benefit plans, contracts or arrangements and any applicable "change of control" or similar provisions in any plan, contract or arrangement maintained or contributed to by it or any of its Subsidiaries for the benefit of officers, former officers, employees, former employees, directors, former directors, or the beneficiaries of any of the foregoing, including all "employee benefit plans" as defined in ERISA (collectively, "Compensation and Benefit Plans"). (ii) True and complete copies of its Compensation and Benefit Plans, including, but not limited to, any trust instruments and/or insurance contracts, if any, forming a part thereof, and all amendments thereto and, if applicable, the most recent Form 5500 and annual reports for such plans have been made available to the other party. (iii) Each of its Compensation and Benefit Plans has been administered in all material respects in accordance with the terms thereof. All "employee benefit plans" within the meaning of Section 3(3) of ERISA, other than "multiemployer plans" within the meaning of Section 3(37) of ERISA ("Multiemployer Plans"), covering employees or former employees of it and its Subsidiaries (its "Plans"), to the extent subject to ERISA, are in material compliance with ERISA, the Code, the Age Discrimination in Employment Act and other applicable laws and no A-21 prohibited transaction has occurred with respect to any such employee benefit plan that would result in any such excise tax or other liability under ERISA or the Code. Each Compensation and Benefit Plan of it or its Subsidiaries which is an "employee pension benefit plan" within the meaning of Section 3(2) of ERISA ("Pension Plan") and which is intended to be qualified under Section 401(a) of the Code has received a favorable determination letter from the Internal Revenue Service, and it is not aware of any circumstances reasonably likely to result in the revocation or denial of any such favorable determination letter. There is no pending or, to its knowledge, threatened litigation or governmental audit, examination or investigation relating to the Plans. (iv) Except as Previously Disclosed in Section 5.3(l)(iv) of a Party's Disclosure Schedule, no material liability under Title IV of ERISA has been or is expected to be incurred by it or any of its Subsidiaries with respect to any ongoing, frozen or terminated "single-employer plan", within the meaning of Section 4001(a)(15) of ERISA, currently or formerly maintained by any of them, or the single-employer plan of any entity which is considered one employer with it under Section 4001(a)(15) of ERISA or Section 414 of the Code (an "ERISA Affiliate"). Except as Previously Disclosed in Section 5.3(l)(iv) of a party's Disclosure Schedule, neither it nor any of its Subsidiaries presently contributes to a Multiemployer Plan, nor have they contributed to such a plan within the past five calendar years. No notice of a "reportable event", within the meaning of Section 4043 of ERISA for which the 30-day reporting requirement has not been waived, has been required to be filed for any Pension Plan of it or any of its Subsidiaries or by any ERISA Affiliate within the past 12 months. (v) All contributions, premiums and payments required to be made under the terms of any Compensation and Benefit Plan of it or any of its Subsidiaries have been made. Neither any Pension Plan of it or any of its Subsidiaries nor any single-employer plan of an ERISA Affiliate of it or any of its Subsidiaries has an "accumulated funding deficiency" (whether or not waived) within the meaning of Section 412 of the Code or Section 302 of ERISA. Neither it nor any of its Subsidiaries has provided or is required to provide, security to any Pension Plan or to any single-employer plan of an ERISA Affiliate pursuant to Section 401(a)(29) of the Code. (vi) Except as Previously Disclosed in Section 5.3(l)(vi) of a party's Disclosure Schedule, under each Pension Plan of it or any of its Subsidiaries which is a single-employer plan, as of the last day of the most recent plan year ended prior to the date hereof, the actuarially determined present value of all "benefit liabilities", within the meaning of Section 4001(a)(16) of ERISA (as determined on the basis of the actuarial assumptions contained in the Plan's most recent actuarial valuation) did not exceed the then current value of the assets of such Plan, and there has been no adverse change in the financial condition of such Plan (with respect to either assets or benefits) since the last day of the most recent Plan year. (vii) Neither it nor any of its Subsidiaries has any obligations under any Compensation and Benefit Plans to provide benefits, including death or medical benefits, with respect to employees of it or its Subsidiaries beyond their retirement or other termination of service other than (i) coverage mandated by Part 6 of Title I of ERISA or Section 4980B of the Code, (ii) retirement or death benefits under any employee pension benefit plan (as defined under Section 3(2) of A-22 ERISA), (iii) disability benefits under any employee welfare plan that have been fully provided for by insurance or otherwise, or (iv) benefits in the nature of severance pay. (viii) Except as Previously Disclosed under Section 5.1(l)(viii) of a party's Disclosure Schedule, neither the execution and delivery of this Agreement nor the consummation of the transactions contemplated hereby will (i) result in any payment (including, without limitation, severance, unemployment compensation, golden parachute or otherwise) becoming due to any director or any employee of it or any of its Subsidiaries under any Compensation and Benefit Plan or otherwise from it or any of its Subsidiaries, (ii) increase any benefits otherwise payable under any Compensation and Benefit Plan or (iii) result in any acceleration of the time of payment or vesting of any such benefit. (m) Labor Matters. Except as set forth in Section 5.3(m) of a party's Disclosure Schedule, neither it nor any of its Subsidiaries is a party to, or is bound by, any collective bargaining agreement, contract or other agreement or understanding with a labor union or labor organization, nor is it or any of its Subsidiaries the subject of a proceeding asserting that it or any such Subsidiaries has committed an unfair labor practice (within the meaning of the National Labor Relations Act) or seeking to compel it or such Subsidiaries to bargain with any labor organization as to wages and conditions of employment. (n) Environmental Matters. Neither (a) the past or present conduct nor operation of such party or its Subsidiaries nor any condition of any property or asset presently or previously owned, leased or operated by any of them, including but not limited to on-site or off-site disposal or release of any chemical substance, product or waste, violates or violated Environmental Laws, and no condition has existed or event has occurred with respect to any of them or any such property that, with notice or the passage of time, or both, is reasonably likely to result in liability or obligations for any clean-up, remediation, disposal or corrective action under Environmental Laws or claims for personal injury, property damage or damage to natural resources and (b) such party nor any of its Subsidiaries has received any notice from any person or entity that it or its Subsidiaries or the operation or condition of any property or asset ever owned, leased, operated, held as collateral or held as a fiduciary by any of them is or was in violation of or otherwise are alleged to have liability under any Environmental Law or has entered into any consent decree or order or is subject to any order of any court or governmental authority or tribunal under any Environmental Law or relating to the clean-up of any hazardous materials contamination, including, but not limited to, responsibility (or potential responsibility) for the cleanup or other remediation of any pollutants, contaminants, or hazardous or toxic wastes, substances or materials at, on, beneath, or originating from any such property. (o) Tax Matters. (i) All material returns, declarations, reports, estimates, information returns and statements required to be filed under federal, state, local or any foreign tax laws ("Tax Returns") with respect to it or any of its Subsidiaries, have been timely filed, or requests for extensions have been timely filed and have not expired; (ii) all Tax Returns filed by it are complete and accurate in all material respects; (iii) all Taxes shown to be due on such Tax Returns and all other Taxes, if any, required to be paid by it or its Subsidiaries for all periods ending through the date hereof have been paid or adequate reserves have in accordance with generally accepted accounting principles been established for the payment of such Taxes; and (iv) no material (A) audit or examination or (B) refund litigation with respect to any Tax Return is pending. As of the date hereof, neither it nor any of its Subsidiaries (x) has granted any requests, agreements, consents or A-23 waivers to extend the statutory period of limitations applicable to the assessment of any taxes with respect to any tax returns, (y) is a party to any tax sharing or tax indemnity agreement or (z) is a party to an agreement that provides for the payment of any amount that would constitute a "parachute payment" within the meaning of Section 280G of the Code. (p) Regulatory Approvals. Except as set forth in Section 5.3(p) of a party's Disclosure Schedule, the only approval of any governmental agency necessary to consummate the transactions contemplated by this Agreement (other than filings under the Securities Act) is pursuant to the HSRA. As of the date hereof, neither Petro nor the Star Partners is aware of any reason why the approvals under the HSRA will not be received. (q) No Material Adverse Change. Since September 30, 1997, in the case of Star Partners, and since December 31, 1997, in the case of Petro, except as disclosed in its SEC Documents filed with the SEC on or before the date hereof, (i) it and its Subsidiaries have conducted their respective businesses in the ordinary and usual course (excluding the incurrence of expenses related to this Agreement and the transactions contemplated hereby), (ii) it has not made any material change in its accounting methods, principles or practices or its tax methods, practices or elections and (iii) no event has occurred or circumstance arisen that, individually or taken together with all other facts, circumstances and events is reasonably likely to result in a Material Adverse Effect. (r) Insurance. It has previously delivered to the other party a schedule listing the officers' and directors' liability insurance policies, primary and excess casualty and liability insurance policies providing coverage for bodily injury and property damage maintained by it and its Subsidiaries. It and its Subsidiaries maintain insurance coverage reasonably adequate for the operation of their respective businesses taking into account the cost and availability of such insurance. (s) Condition and Sufficiency of Assets. The vehicles, equipment and other assets used in the business of it and its Subsidiaries are in operating condition and repair consistent with normal industry standards and are adequate for the uses to which they are being put and none of such vehicles, equipment and assets are in need of replacement, maintenance or repairs except for ordinary and routine maintenance and repairs that are not material in nature or cost, except for vehicles and equipment which are not in service and the use of which are not required to conduct the business of it and its Subsidiaries in the ordinary course consistent with past practices. The vehicles, equipment and assets in service are sufficient for the continued conduct of its business after the Closing. (t) Intellectual Property. Except as may be disclosed in Section 5.3(t) of its Disclosure Schedule, it and its Subsidiaries own or possess adequate licenses and other valid rights to use all patents, patent rights, trademarks, trademark rights and proprietary information used or held for use in connection with their respective businesses as currently being conducted, and there are no assertions or claims challenging the validity of any of the foregoing which are likely to have, individually or in the aggregate, a Material Adverse Effect. The computer software operated or licensed by it that is material to its business or its internal operations is capable of providing or is being adapted to provide uninterrupted millennium functionality to record, store, process and present calendar dates falling on or after January 1, 2000 in substantially the same manner and with substantially the same functionality as such software records, stores, processes and presents such calendar dates falling on or before December 31, 1999. The costs of the adaptations referred to in the prior sentence will not have a Material Adverse Effect. A-24 ARTICLE VI. COVENANTS Petro hereby covenants to and agrees with Star Partners, and Star Partners hereby covenants to and agrees with Petro, that: 6.1. Best Efforts. (a) Subject to the terms and conditions of this Agreement, it shall use its commercially reasonable best efforts in good faith to take, or cause to be taken, all actions, and to do, or cause to be done, all things necessary, proper, desirable or advisable under applicable laws, so as to permit consummation of the Merger promptly and otherwise to enable consummation of the transactions contemplated hereby, including, without limitation, obtaining (and cooperating with the other party hereto to obtain) HSRA approval and any other third party approval that is required to be obtained by Petro or Star Partners or any of their respective Subsidiaries in connection with the Merger and the other transactions contemplated by this Agreement, and using reasonable efforts to lift or rescind any injunction or restraining order or other order adversely affecting the ability of the parties to consummate the transactions contemplated hereby, and using reasonable efforts to defend any litigation seeking to enjoin, prevent or delay the consummation of the transactions contemplated hereby or seeking material damages, and each shall cooperate fully with the other parties hereto to that end, and shall furnish to the other party copies of all correspondence, filings and communications between it and its affiliates and any governmental or regulatory authority with respect to the transactions contemplated hereby. In complying with the foregoing, neither it nor its Subsidiaries shall be required to take measures that would have a Material Adverse Effect on it and its Subsidiaries taken as a whole. 6.2. Equityholder Approvals. Each of them shall take, in accordance with applicable law, applicable stock exchange rules and its restated articles or certificate of incorporation and by-laws, in the case of Petro, and Agreement of Limited Partnership, in the case of Star Partners, all action necessary to convene, respectively, an appropriate meeting of the holders of the Common Units of Star Partners to consider and vote upon the approval of the Merger Agreement, the Amended and Restated Partnership Agreement, the Amended and Restated Operating Partnership Agreement, and any other matters required to be approved by them for consummation of the Merger (including any adjournment or postponement, the "Star Partners Meeting"), and an appropriate meeting of stockholders of Petro to consider and vote upon the approval of the Merger and any other matters required to be approved by Petro's stockholders for consummation of the Merger (including any adjournment or postponement, the "Petro Meeting"; and each of the Star Partners Meeting and Petro Meeting, a "Meeting"), respectively, promptly after the date hereof. The Board of Directors of Petro and the Special Committee shall (subject in the case of Petro to compliance with its fiduciary duties as advised by counsel) recommend such approval, and each of Star Partners and Petro shall take all reasonable lawful action to solicit such approval by its respective equityholders. 6.3. Registration Statements. (a) Each of Star Partners and Petro agrees to cooperate in the preparation of (i) a registration statement on Form S-4 (the "Merger Registration Statement") to be filed by Star Partners with the SEC in connection with the issuance of Senior Subordinated Units and Common Units in the Merger and the Junior Subordinated and Senior Subordinated Units to be issued by Star Partners to certain Affiliates of Petro as described under subparagraph 9 of the definition of "Restructuring Transactions" (including the joint proxy statement and prospectus and A-25 other proxy solicitation materials of Star Partners and Petro constituting a part thereof (the "Joint Proxy Statement") and all related documents), (ii) a registration statement on Form S-3 to be filed by Star Partners with the SEC in connection with the Equity Offering (the "Equity Registration Statement") and (iii) a registration statement to be filed by Star Partners or a subsidiary of Star Partners with the SEC in connection with the Debt Offering (the "Debt Registration Statement" and together with the Merger Registration Statement and the Equity Registration Statement, the "Registration Statements"). Provided Petro has cooperated as required above, Star Partners agrees to file the Registration Statements with the SEC as promptly as practicable. Each of Petro and Star Partners agrees to use all reasonable efforts to cause the Registration Statements to be declared effective under the Securities Act as promptly as practicable after filing thereof. Star Partners also agrees to use commercially reasonable efforts to obtain all necessary state securities law or "Blue Sky" permits and approvals required to carry out the transactions contemplated by this Agreement. Petro agrees to furnish to Star Partners all information concerning Petro, its Subsidiaries, officers, directors and stockholders and to take such other action as may be reasonably requested in connection with the foregoing. (b) Each of Petro and Star Partners agrees, as to itself and its Subsidiaries, that (i) none of the information supplied or to be supplied by it for inclusion or incorporation by reference in the Registration Statements will, at the time the Registration Statements and each amendment or supplement thereto, if any, becomes effective under the Securities Act, contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading, and (ii) the Joint Proxy Statement and any amendment or supplement thereto will, at the date of mailing to stockholders and at the times of the Star Partners Meeting and Petro Meeting, not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. Each of Petro and Star Partners further agrees that if it shall become aware prior to the Closing Date of any information that would cause any of the statements in the Registration Statements to be false or misleading with respect to any material fact, or omit to state any material fact necessary to make the statements therein, in light of the circumstances under which they were made, not false or misleading, it will promptly inform the other party thereof and take the necessary steps to correct the Joint Proxy Statement. (c) Star Partners will advise Petro, promptly after Star Partners receives notice thereof, of the time when each of the Registration Statements has become effective or any supplement or amendment has been filed, of the issuance of any stop order or the suspension of the qualification of the Common Units or Senior Subordinated Units for offering or sale in any jurisdiction, of the initiation or threat of any proceeding for any such purpose, or of any request by the SEC for the amendment or supplement of a Registration Statement or for additional information. (d) Each of Star Partners and Petro will use its best efforts to cause the Joint Proxy Statement to be mailed to its unitholders and stockholders, respectively, as soon as practicable after the effective date thereof. 6.4. Modification of Petro Indentures and Preferred Stock. Immediately upon execution of this Agreement, Petro agrees to use its reasonable best efforts in good faith to accomplish the following prior to the Effective Date: A-26 (a) As to the Private Debt. The Private Debt consists of (i) $60.0 million of Notes due 2002 at 11.96% interest per annum which shall be restructured to $63.12 million of Notes due 2002 at 9.0% per annum and (ii) $4.1 million of Notes due 2001 at 14.1% interest per annum to be restructured to $2.2 million of Senior Notes due 2001 at 10.25% interest per annum and $2.2 million of Subordinated Notes due 2001 at 10.25% interest per annum (the "Private Debt Conditions"). (b) As to the 12 7/8% Series B Exchange Preferred Stock. The 12 7/8% Series B Exchangeable Preferred Stock will be repurchased at $22 per share plus accrued and unpaid dividends (the "12 7/8% Preferred Stock Conditions"). (c) As to the Public Debt. At least 90% of (a) Petro's 9 3/8% Subordinated Notes due 2003 and 10 1/8% Subordinated Notes due 2003 will be repurchased at 100% of par plus accrued interest and (b) Petro's 123% Subordinated Notes due 2005 will be repurchased at 103.5% of par plus accrued interest (the "Public Debt Conditions"). (d) As to the 1989 Preferred Stock. The 1989 Preferred Stock will be repurchased for an aggregate of $4.167 million plus accrued and unpaid dividends (the "1989 Preferred Stock Conditions"). (e) As to the outstanding Star Propane Debt. The Holders of Star Propane's 8.04% First Mortgage Notes due 2009, Star Propane's 7.17% First Mortgage Notes due 2010 and Star Propane's outstanding Bank credit facilities shall have consented to the execution, delivery and performance of this Agreement by Star Propane or shall have entered into amendments permitting the execution, delivery and performance of this Agreement by Star Propane without violation of the terms of such indebtedness and without a requirement that such indebtedness be repurchased (or an offer be made to purchase such indebtedness) (the "Star Propane Debt Conditions"). 6.5. Press Releases. It will not, without the prior approval of the other party hereto, issue any press release or written statement for general circulation relating to the transactions contemplated hereby, except as otherwise required by applicable law or regulation or the rules of the NYSE, in which case it will consult with the other party before issuing any such press release or written statement. 6.6. Access; Information. (a) Upon reasonable notice and subject to applicable laws relating to the exchange of information, it shall, and shall cause its Subsidiaries to, afford the other parties and their officers, employees, counsel, accountants and other authorized representatives, access, during normal business hours throughout the period prior to the Effective Date, to all of its properties, books, contracts, commitments and records, and to its officers, employees, accountants, counsel or other representatives, and, during such period, it shall, and shall cause its Subsidiaries to, furnish promptly to such other parties and representatives (i) a copy of each material report, schedule and other document filed by it pursuant to the requirements of federal or state securities law (other than reports or documents that Star Partners or Petro, or their respective Subsidiaries, as the case may be, are not permitted to disclose under applicable law) and (ii) all other information concerning the business, properties and personnel of it as the other may reasonably request. Neither Star Partners nor Petro nor any of its respective Subsidiaries shall be required to provide access to or to disclose A-27 information where such access or disclosure would violate or prejudice the rights of its customers, jeopardize the attorney-client privilege of the institution in possession or control of such information or contravene any law, rule, regulation, order, judgment, decree, fiduciary duty or binding agreement entered into prior to the date of this Agreement. The parties hereto will make appropriate substitute disclosure arrangements under the circumstances in which the restrictions of the preceding sentence apply. (b) It will not use any information obtained pursuant to this Section 6.6 for any purpose unrelated to the consummation of the transactions contemplated by this Agreement and, if this Agreement is terminated, will hold all information and documents obtained pursuant to this paragraph in confidence. No investigation by either party of the business and affairs of the other shall affect or be deemed to modify or waive any representation, warranty, covenant or agreement in this Agreement, or the conditions to either party's obligation to consummate the transactions contemplated by this Agreement. 6.7. Acquisition Proposals. Without the prior written consent of Star Partners, Petro shall not, and shall cause its Subsidiaries and its and its Subsidiaries' officers, directors, agents, advisors and affiliates not to, solicit or encourage inquiries or proposals with respect to, or engage in any negotiations concerning, or provide any confidential information to, or have any discussions with, any such person relating to, any tender offer or exchange offer for, or any proposal for the acquisition of a substantial equity interest in, or a substantial portion of the assets of, or any merger or consolidation with, Petro or any of its Significant Subsidiaries; provided, however, that Petro may, and may authorize and permit its officers, directors, employees or agents to, furnish or cause to be furnished confidential information and may participate in such discussions and negotiations with a person or entity who has made an unsolicited bona fide acquisition proposal for Petro or such assets or Significant Subsidiaries that is superior to the Merger and is reasonably capable of being financed if Petro's Board of Directors, after having consulted with and considered the advice of outside counsel, has determined that the failure to provide such information or participate in such negotiations and discussions could cause the members of such Board of Directors to breach their fiduciary duties under applicable laws. Petro shall promptly (within 24 hours) advise Star Partners of its receipt of any such proposal or inquiry, of the substance thereof, and of the identity of the person making such proposal or inquiry. Nothing in this Section 6.7 shall permit Petro to enter into any agreement with respect to an acquisition proposal during the term of this Agreement other than a confidentiality and standstill agreement in reasonably customary form. 6.8. Affiliate Arrangements. (a) Not later than the 15th day after the mailing of the Joint Proxy Statement, Petro shall deliver to Star Partners a schedule of each person that, to the best of its knowledge, is or is reasonably likely to be, as of the date of the relevant Meeting, deemed to be an "affiliate" of it (an "Affiliate") as that term is used in Rule 145 under the Securities Act. (b) Petro shall use its reasonable best efforts to cause its Affiliates not to sell any securities received under the Merger or Exchange Agreement in violation of the registration requirements Securities Act, including Rule 145 thereunder. 6.9. Takeover Laws. Neither party shall take any action that would cause the transactions contemplated by this Agreement to be subject to requirements imposed by any Takeover Laws, and A-28 each of them shall take all necessary steps within its control to exempt (or ensure the continued exemption of) the transactions contemplated by this Agreement from, or if necessary challenge the validity or applicability of, any shareholder rights plan adopted by such party or any applicable Takeover Law, as now or hereafter in effect, including, without limitation, Takeover Laws of any state that purport to apply to this Agreement. the transactions contemplated hereby. 6.10. No Rights Triggered. Each of Petro and Star Partners shall take all steps necessary to ensure that the entering into of this Agreement and the consummation of the transactions contemplated hereby and any other action or combination of actions, or any other transactions contemplated hereby, do not and will not result in the grant of any Rights to any person (i) in the case of Petro under its articles or certificate of incorporation or by-laws and in the case of Star Partners under its Agreement of Limited Partnership or (ii) under any material agreement to which it or any of its Subsidiaries is a party. 6.11. Senior Subordinated Units Listed. In the case of Star Partners, Star Partners shall use its reasonable best efforts to list, prior to the Closing, on the NYSE, upon official notice of issuance, the Senior Subordinated Units to be issued to the holders of Petro Common Stock in the Merger and to certain Petro Affiliates pursuant to the Exchange Agreement. 6.12. Third Party Approvals. (a) Star Partners and Petro and their respective Subsidiaries shall cooperate and use their respective commercially reasonable best efforts to prepare all documentation, to effect all filings, to obtain all permits, consents, approvals and authorizations of all third parties and HSRA approval necessary to consummate the transactions contemplated by this Agreement and to comply with the terms and conditions of such permits, consents, approvals and authorizations and to cause the Merger to be consummated as expeditiously as practicable. Each of Star Partners and Petro shall have the right to review in advance, and to the extent practicable each will consult with the other, in each case subject to applicable laws relating to the exchange of information, with respect to, all material written information submitted to any third party or any Regulatory Authorities in connection with the transactions contemplated by this Agreement. In exercising the foregoing right, each of the parties hereto agrees to act reasonably and promptly. Each party hereto agrees that it will consult with the other parties hereto with respect to the obtaining of all material permits, consents, approvals and authorizations of all third parties and Regulatory Authorities necessary or advisable to consummate the transactions contemplated by this Agreement, and each party will keep the other parties apprised of the status of material matters relating to completion of the transactions contemplated hereby. (b) Each party agrees, upon request, to furnish the other party with all information concerning itself, its Subsidiaries, directors, officers and stockholders and such other matters as may be reasonably necessary or advisable in connection with the Registration Statement, the Joint Proxy Statement or any filing, notice or application made by or on behalf of such other party or any of its Subsidiaries to any Regulatory Authority in connection with the transactions contemplated hereby. 6.13. Indemnification; Directors' and Officers' Insurance. (a) In the event of any threatened or actual claim, action, suit, proceeding or investigation, whether civil, criminal or administrative, including, without limitation, any such claim, action, suit, proceeding or investigation in which any person who is now, or has been at any time prior to the date of this Agreement, or who becomes A-29 prior to the Closing, a director, officer or employee of Petro or any of its Subsidiaries, including, without limitation, the directors of Star Gas (the "Indemnified Parties" or, individually, an "Indemnified Party") is, or is threatened to be, made a party based in whole or in part on, or arising in whole or in part out of, or pertaining to (i) the fact that he is or was a director, officer or employee of Petro, any of Petro's Subsidiaries or any of their respective predecessors or was prior to the Closing serving at the request of any such party as a director, officer, employee, fiduciary or agent of another corporation, partnership, trust or other enterprise or (ii) this Agreement or any of the transactions contemplated hereby and thereby and all actions taken by an Indemnified Party in connection herewith or therewith, whether in any case asserted or arising before or after the Closing, the parties hereto agree to cooperate and use their best efforts to defend against and respond thereto. It is understood and agreed that after the Closing, Star Partners shall indemnify and hold harmless, as and to the fullest extent permitted by law, each such Indemnified Party against any losses, claims, damages, liabilities, costs, expenses (including reasonable attorney's fees and expenses in advance of the final disposition of any claim, suit, proceeding or investigation to each Indemnified Party to the fullest extent permitted by law upon receipt of an undertaking from such Indemnified Party to repay such advanced expenses if it is finally and unappealably determined that such Indemnified Party was not entitled to indemnification hereunder), judgments, fines and amounts paid in settlement in connection with any such threatened or actual claim, action, suit, proceeding or investigation, and in the event of any such threatened or actual claim, action, suit, proceeding or investigation (whether asserted or arising before or after the Closing), the Indemnified Parties may retain counsel reasonably satisfactory to them after consultation with Star Partners; provided, however, that (1) Star Partners shall have the right to assume the defense thereof and upon such assumption Star Partners shall not be liable to any Indemnified Party for any legal expenses of other counsel or any other expenses subsequently incurred by any Indemnified Party in connection with the defense thereof, except that if Star Partners elects not to assume such defense, or counsel for the Indemnified Parties reasonably advises the Indemnified Parties that there are or may be (whether or not any have yet actually arisen) issues which raise conflicts of interest between Star Partners and the Indemnified Parties, the Indemnified Parties may retain counsel reasonably satisfactory to them, and Star Partners shall pay the reasonable fees and expenses of such counsel for the Indemnified Parties, (2) Star Partners shall be obligated pursuant to this paragraph to pay for only one firm of counsel for all Indemnified Parties, (3) Star Partners shall not be liable for any settlement effected without its prior written consent (which consent shall not be unreasonably withheld) and (4) Star Partners shall have no obligation hereunder to any Indemnified Party when and if a court of competent jurisdiction shall ultimately determine, and such determination shall have become final and nonappealable, that indemnification of such Indemnified Party in the manner contemplated hereby is prohibited by applicable law. Any Indemnified Party wishing to claim indemnification under this Section 6.13, upon learning of any such claim, action, suit, proceeding or investigation, shall notify Star Partners thereof provided that the failure to so notify shall not affect the obligations of Star Partners under this Section 6.13 except (and only) to the extent such failure to notify materially prejudices Star Partners. Star Partners's obligations under this Section 6.10 shall continue in full force and effect for a period of six (6) years from the Closing; provided, however, that all rights to indemnification in respect of any claim (a "Claim") asserted or made within such period shall continue until the final disposition of such Claim. A-30 (b) Without limiting any of the obligations under paragraph (a) of this Section 6.13, Star Partners agrees that all rights to indemnification and all limitations of liability existing in favor of the Indemnified Parties as provided in Petro's Amended and Restated Articles of Incorporation or Bylaws or in the governing documents of any of Petro's Subsidiaries as in effect as of the date of this Agreement with respect to matters occurring on or prior to the Closing shall survive the Merger and shall continue in full force and effect, without any amendment thereto, for a period of six (6) years from the Closing; provided, however, that all rights to indemnification in respect of any Claim asserted or made within such period shall continue until the final disposition of such Claim; provided further, however, that nothing contained in this Section 6.13(b) shall be deemed to preclude the liquidation, consolidation or merger of Petro or any Company Subsidiary, in which case all of such rights to indemnification and limitations on liability shall be deemed to so survive and continue notwithstanding any such liquidation, consolidation or merger and shall constitute rights which may be asserted against Star Partners. Nothing contained in this Section 6.13(b) shall be deemed to preclude any rights to indemnification or limitations on liability provided in Petro's Amended and Restated Articles of Incorporation or Bylaws or the governing documents of any of Petro's Subsidiaries with respect to matters occurring subsequent to the Closing to the extent that the provisions establishing such rights or limitations are not otherwise amended to the contrary. (c) Star Partners shall use its reasonable best efforts to cause the persons serving as officers and directors of Petro and Star Gas immediately prior to the Closing to be covered for a period of six (6) years from the Closing by the directors' and officers' liability insurance policy maintained by Petro (provided that Star Partners may substitute therefor policies of at least the same coverage and amounts containing terms and conditions which are not less advantageous to such directors and officers of Petro than the terms and conditions of such existing policy) with respect to acts or omissions occurring prior to the Closing which were committed by such officers and directors in their capacity as such provided that Star Partners shall not be required to pay annual premiums in excess of the last annual premium paid by Petro prior to the date hereof but in such case shall purchase as much coverage as reasonably practicable for such amount. (d) In the event Star Partners or any of its successors or assigns (i) consolidates with or merges into any other person and shall not be the continuing or surviving corporation or entity of such consolidation or merger or (ii) transfers or conveys all or substantially all of its properties and assets to any person, then, and in each such case, to the extent necessary, proper provision shall be made so that the successors and assigns of Star Partners shall assume the obligations set forth in this Section 6.13. (e) The provisions of this Section 6.13 are intended to be for the benefit of, and shall be enforceable by, each Indemnified Party and his or her heirs and representatives. 6.14. Benefit Plans. The parties agree to take such actions with respect to compensation and employee benefit plans, programs, arrangements and other perquisites as are set forth on Section 6.14 of Petro's Disclosure Schedule. 6.15. Notification Of Certain Matters. Each of Petro and Star Partners shall give prompt notice to the other of any fact, event or circumstance known to it that (i) is reasonably likely, A-31 individually or taken together with all other facts, events and circumstances known to it, to result in any Material Adverse Effect with respect to it or (ii) would cause or constitute a material breach of any of its representations, warranties, covenants or agreements contained herein. 6.16. New Director for Star Gas LLC. As soon as reasonably practicable following the Effective Time, Star Gas LLC will appoint a new independent director to serve on the Audit Committee of Star Gas LLC provided that Star Gas LLC shall not appoint any such director to which William P. Nicoletti shall have reasonably objected. ARTICLE VII. CONDITIONS TO CONSUMMATION OF THE MERGER The obligations of each of the parties to consummate the Merger is conditioned upon the satisfaction at or prior to the Closing of each of the following: 7.1. Shareholder Vote. The Merger, the Partnership Agreement Amendments and the other transactions contemplated hereby shall have been approved and adopted by the affirmative vote of a Unit Majority (as defined in the Partnership Agreement), and the Merger and the other transactions contemplated hereby shall have been approved and adopted by the affirmative vote of the holders of a majority of each class of Petro Common Stock and Petro Preferred Stock and a majority of the Petro Class A Common Stock held by Persons other than Petro and Affiliates of Petro. Holders of at least 100% of the Private Preferred Stock and 90% of the Junior Preferred Stock shall have voted in favor of the Merger. 7.2. Governmental Approvals. Any waiting period (including any extended waiting period arising as a result of a request for additional information by the Federal Trade Commission or the U. S. Department of Justice) under the HSRA shall have expired or been terminated. All other filings required to be made prior to the Effective Time with, and all other consents, approvals, permits and authorizations required to be obtained prior to the Effective Time from, any Regulatory Authority in connection with the execution and delivery of this Agreement and the consummation of the transactions contemplated hereby by the parties hereto or their affiliates shall have been made or obtained, except where the failure to obtain such consents, approvals, permits and authorizations would not be reasonably likely to result in a Material Adverse Effect on Star Partners or Petro or on the ability of Star Partners or Petro to consummate the transactions contemplated by this Agreement. 7.3. No Injunction. No order, decree or injunction of any court or agency of competent jurisdiction shall be in effect, and no law, statute or regulation shall have been enacted or adopted, that enjoins, prohibits or makes illegal consummation of any of the transactions contemplated hereby, and no action, proceeding or investigation by any Regulatory Authority with respect to the Merger or the other transactions contemplated hereby shall be pending that seeks to restrain, enjoin, prohibit or delay consummation of the Merger or such other transaction or to impose any material restrictions or requirements thereon or on Star Partners or Petro with respect thereto; provided, however, that prior to invoking this condition, each party shall have complied fully with its obligations under Section 6.1. 7.4. Representations, Warranties And Covenants Of Star Partners. In the case of Petro's obligation to consummate the Merger (i) each of the representations and warranties contained herein of Star Partners shall be true and correct as of the date of this Agreement and upon the Closing Date A-32 with the same effect as though all such representations and warranties had been made on the Closing Date, except for any such representations and warranties made as of a specified date, which shall be true and correct as of such date, in any case subject to the standard set forth in Section 5.2, (ii) each and all of the agreements and covenants of Star Partners to be performed and complied with pursuant to this Agreement on or prior to the Closing Date shall have been duly performed and complied with in all material respects, and (iii) Petro shall have received a certificate signed by the Chief Financial Officer of the General Partner, dated the Closing Date, to the effect set forth in clauses (i) and (ii) of this Section 7.4. 7.5. Representations, Warranties And Covenants Of Petro. In the case of Star Partners's obligation to consummate the Merger (i) each of the representations and warranties contained herein of Petro shall be true and correct as of the date of this Agreement and upon the Closing Date with the same effect as though all such representations and warranties had been made on the Closing Date, except for any such representations and warranties made as of a specified date, which shall be true and correct as of such date, in any case subject to the standard set forth in Section 5.2, (ii) each and all of the agreements and covenants of Petro to be performed and complied with pursuant to this Agreement on or prior to the Closing Date shall have been duly performed and complied with in all material respects, and (iii) Star Partners shall have received a certificate signed by the Chief Financial Officer of Petro, dated the Closing Date, to the effect set forth in clauses (i) and (ii) of this Section 7.5. 7.6. Effective Merger Registration Statement. The Merger Registration Statement shall have become effective under the Securities Act and no stop order suspending the effectiveness of the Merger Registration Statement shall have been issued and no proceedings for that purpose shall have been initiated or threatened by the SEC or any other Regulatory Authority. 7.7. Opinion of Andrews & Kurth LLP. Star Partners and Petro shall have received an opinion from Andrews & Kurth LLP to the effect that: (a) the Merger and the transactions contemplated by this Agreement will not result in the loss of limited liability of any limited partner of Star Partners or Star Propane, (b) the Merger and the transactions contemplated by this Agreement will not cause Star Partners or Star Propane to be treated as an association taxable as a corporation or otherwise to be taxed as an entity for federal income tax purposes, (c) the Merger Registration Statement accurately sets forth the material federal income tax consequences to the holders of Common Units of the transactions contemplated hereby. 7.8. Opinion of Petro's Counsel. In the case of Star Partner's obligation to consummate the Merger, Star Partners shall have received an opinion from Phillips Nizer Benjamin Krim & Ballon LLP, counsel to Petro, to the effect that: (a) Petro is a corporation duly incorporated, validly existing and in good standing under the laws of the State of Minnesota with all requisite corporate power and authority to own its properties and assets and to carry on its business as presently conducted; A-33 (b) Petro has all requisite corporate power and authority to effect the Merger as contemplated by this Agreement; the Board of Directors and shareholders of Petro have taken all action required by the MBCA and Petro's Articles of Incorporation and Bylaws to authorize the Merger in accordance with the terms of this Agreement; the execution and delivery of this Agreement did not, and the consummation of the Merger will not, violate any provision of Petro's Articles of Incorporation or Bylaws; and upon the filing by the Surviving Corporation of the Articles of Merger with the Secretary of State of the State of Minnesota, the Merger shall become effective under the MBCA. In rendering such opinions, such counsel may require and rely upon representations and covenants including those contained in certificates of officers of Star Partners, Petro and others and opinions of Minnesota counsel, reasonably satisfactory in form and substance to such counsel. 7.9. NYSE Listing. The Senior Subordinated Units and Common Units issuable pursuant to this Agreement and the Exchange Agreement shall have been approved for listing on the NYSE, subject to official notice of issuance. 7.10. Affiliate Arrangements. Petro shall have taken reasonable action to cause its Affiliates not to sell any securities received under the Merger Agreement in violation of the registration requirements of the Securities Act, including Rule 145 thereunder. 7.11. Fairness Opinion. In the case of Star Partner's obligation to consummate the Merger, the Special Committee shall have received an opinion of A.G. Edwards & Sons, Inc. to the effect that, as of the date of the Joint Proxy Statement, the Merger and the transactions contemplated hereby are fair, from a financial point of view, to the holders of Common Units (other than Petro and its affiliates), and the opinion shall not have been withdrawn by A.G. Edwards & Sons, Inc. In the case of Petro's obligation to consummate the Merger, Petro shall have received an opinion of Dain Rauscher Wessels to the effect that, as of the date of the Joint Proxy Statement, the Merger and the transactions contemplated thereby are fair, from a financial point of view, to the non- affiliated, public holders of Petro Common Stock, and the opinion shall not have been withdrawn by Dain Rauscher Wessels. 7.12. Public Offerings. Star Partners shall have consummated the Equity Offering and the Debt Offering, with the Cost of Capital not to exceed $27.5 million on an annual basis, and with the net proceeds therefrom applied to reduce indebtedness of Petro outstanding prior to the Effective Time. 7.13. Refinancing Conditions. Immediately prior to the Restructuring Transactions: (a) The sum of (i) all indebtedness for borrowed money of Petro and its Subsidiaries to be outstanding at the Effective Time except indebtedness outstanding under Petro's working capital bank credit facility and (ii) the repurchase or redemption price (including the value of the Junior Preferred Stock, which shall be deemed to be $2.24 million) of all indebtedness for borrowed money and Petro Preferred Stock to be repurchased or redeemed as provided in the Refinancing Conditions less the amount, if any, by which the Working Capital of Petro as of the most recent date for which internal Petro financial statements are available (but in any event no more than 15 calendar days after the end of the preceding month) shall exceed the amount of Working Capital of Petro required pursuant to Section 7.13(c), shall not exceed $331,367,000; A-34 (b) Petro and its subsidiaries shall have cash balances of not less than $500,000; (c) At the Closing Date, the Working capital of Petro as of the most recent date for which internal Petro financial statements are available (which date or the availability of Petro financial statements shall in any event not be more than 15 calendar days after the end of the preceding month) shall exceed the following amounts:
PETRO WORKING CAPITAL CLOSING DATE REQUIREMENT ------------ -----------