HERITAGE PROPANE PARTNERS L P - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED AUGUST 31, 2001

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the Transition Period from to
---------- -----------

COMMISSION FILE NUMBER 1-11727

HERITAGE PROPANE PARTNERS, L.P.
(Exact name of registrant as specified in its charter)

DELAWARE 73-1493906
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)

8801 SOUTH YALE AVENUE, SUITE 310, TULSA, OKLAHOMA 74137
(Address of principal executive offices and zip code)

(918) 492-7272
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of class Name of each exchange on
which registered
Common Units New York Stock Exchange

Securities registered pursuant to section 12(g) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -------

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]

The aggregate market value as of November 5, 2001, of the registrant's common
units held by nonaffiliates of the registrant, based on the reported closing
price of such units on the New York Stock Exchange on such date, was
approximately $254,792,338.

At November 5, 2001, the registrant had units outstanding as follows:
Heritage Propane Partners, L.P. 14,262,066 Common Units
1,382,514 Class B Subordinated Units

Documents Incorporated by Reference: None

HERITAGE PROPANE PARTNERS, L.P.

2001 FORM 10-K ANNUAL REPORT

TABLE OF CONTENTS

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PART I

FORWARD-LOOKING STATEMENTS

CERTAIN MATTERS DISCUSSED IN THIS REPORT, EXCLUDING HISTORICAL
INFORMATION, AS WELL AS SOME STATEMENTS BY HERITAGE IN PERIODIC PRESS RELEASES
AND SOME ORAL STATEMENTS OF HERITAGE OFFICIALS DURING PRESENTATIONS ABOUT
HERITAGE, INCLUDE CERTAIN "FORWARD-LOOKING" STATEMENTS. ALTHOUGH HERITAGE
BELIEVES SUCH FORWARD-LOOKING STATEMENTS ARE BASED ON REASONABLE ASSUMPTIONS AND
CURRENT EXPECTATIONS AND PROJECTIONS ABOUT FUTURE EVENTS, NO ASSURANCE CAN BE
GIVEN THAT EVERY OBJECTIVE WILL BE REACHED. SUCH STATEMENTS ARE MADE IN RELIANCE
ON THE "SAFE HARBOR" PROTECTIONS PROVIDED UNDER THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995.

AS REQUIRED BY THAT LAW, HERITAGE HEREBY IDENTIFIES THE FOLLOWING
IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM ANY
RESULTS PROJECTED, FORECASTED, ESTIMATED OR BUDGETED BY HERITAGE IN
FORWARD-LOOKING STATEMENTS. THESE INCLUDE:

o CHANGES IN GENERAL ECONOMIC CONDITIONS IN THE UNITED STATES AS
WELL AS CHANGES IN GENERAL ECONOMIC CONDITIONS AND CURRENCIES IN
FOREIGN COUNTRIES;

o WEATHER CONDITIONS THAT VARY SIGNIFICANTLY FROM HISTORICALLY
NORMAL CONDITIONS;

o ITS SUCCESS IN HEDGING ITS POSITIONS;

o THE EFFECTIVENESS OF RISK-MANAGEMENT POLICIES AND PROCEDURES AND
THE ABILITY OF HERITAGE'S LIQUIDS MARKETING COUNTERPARTIES TO
SATISFY THEIR FINANCIAL COMMITMENTS;

o THE GENERAL LEVEL OF PETROLEUM PRODUCT DEMAND, AND THE
AVAILABILITY OF PROPANE SUPPLIES;

o ENERGY PRICES GENERALLY AND SPECIFICALLY, THE PRICE OF PROPANE TO
THE CONSUMER COMPARED TO THE PRICE OF ALTERNATIVE AND COMPETING
FUELS;

o COMPETITION FROM OTHER PROPANE DISTRIBUTORS AND ALTERNATE FUELS;

o THE AVAILABILITY AND COST OF CAPITAL;

o CHANGES IN LAWS AND REGULATIONS TO WHICH HERITAGE IS SUBJECT,
INCLUDING TAX, ENVIRONMENTAL AND EMPLOYMENT REGULATIONS;

o ITS ABILITY TO GENERATE AVAILABLE CASH FOR DISTRIBUTIONS TO
UNITHOLDERS;

o THE COSTS AND EFFECTS OF LEGAL AND ADMINISTRATIVE PROCEEDINGS
AGAINST IT OR WHICH MAY BE BROUGHT AGAINST IT;

o ITS ABILITY TO SUSTAIN HISTORICAL LEVELS OF INTERNAL GROWTH; AND

o ITS ABILITY TO CONTINUE TO LOCATE AND ACQUIRE OTHER PROPANE
COMPANIES AT PURCHASE PRICES THAT ARE ACCRETIVE TO ITS FINANCIAL
RESULTS.

ITEM 1. BUSINESS

BUSINESS OF HERITAGE

Heritage Propane Partners, L.P., (the "Registrant" or "Partnership"), a
publicly traded Delaware limited partnership, was formed in April of 1996. The
general partner of Heritage Propane Partners, L.P. is Heritage

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Holdings, Inc. (Heritage Holdings), which is a wholly owned subsidiary of U.S.
Propane, L.P. (U.S. Propane). U.S. Propane is a joint venture among the
following four publicly traded southeastern utilities: TECO Energy, Inc.; AGL
Resources, Inc.; Piedmont Natural Gas Company, Inc.; and Atmos Energy
Corporation.

o TECO Energy, Inc. (TECO) is a diversified, energy-related holding
company. One of TECO's subsidiaries is Florida's largest natural
gas distributor, serving more than 260,000 customers. Its other
businesses include an electric utility that serves over 550,000
customers and an independent power company that builds, owns and
operates electric generation facilities in the United States and
Central America.

o AGL Resources, Inc. (AGL Resources), is a regional energy holding
company engaged in natural gas distribution, wholesale and retail
energy services and building telecommunications infrastructure.
AGL Resources' principal subsidiary is the second largest pure
natural gas distributor in the United States, serving more than
1.5 million customers in Georgia and portions of Tennessee and
Virginia.

o Piedmont Natural Gas Company, Inc. (Piedmont Natural Gas) is an
energy and services company primarily engaged in the
transportation, distribution and sales of natural gas. Piedmont
Natural Gas is the second largest natural gas distributor in the
Southeast, serving more than 690,000 customers in North Carolina,
South Carolina and Tennessee.

o Atmos Energy Corporation (Atmos), which owned United Cities
Propane Gas, Inc., is an energy and services company primarily
engaged in natural gas distribution and nonregulated energy
management and gas marketing services. Atmos is the fifth largest
natural gas distributor in the United States, serving
approximately 1.4 million customers in 11 states.

In order to simplify the Partnership's obligations under the laws of
several jurisdictions in which it conducts business, its business activities are
conducted through a subsidiary operating partnership, Heritage Operating, L.P.
(the "Operating Partnership"). The Partnership holds a 97.9798% limited partner
interest in the Operating Partnership. In addition, Heritage Holdings holds a
1.0101% general partner interest and U.S. Propane holds a 1.0101% limited
partner interest in the Operating Partnership. The Operating Partnership
accounts for nearly all of the consolidated assets, sales and operating earnings
of the Partnership.

The business of the Partnership starting with the formation of Heritage
Holdings, Inc. in 1989 has grown primarily through acquisitions of retail
propane operations and, to a lesser extent, through internal growth. Since its
inception in 1989 through August 31, 2001, the Partnership has completed 81
acquisitions for a total purchase price of approximately $608 million, including
the transfer by U.S. Propane of its propane operations to the Partnership for
$181.4 million, plus working capital of approximately $12.9 million. The U.S.
Propane transaction combined five of the nation's 50 largest retail propane
operations. Volumes of propane sold to retail customers have increased steadily
from 63.2 million gallons for the Partnership's fiscal year ended August 31,
1992 to 330.2 million gallons for the fiscal year ended August 31, 2001.

U.S. PROPANE MERGER

In August 2000, TECO, Atmos, Piedmont Natural Gas and AGL Resources
contributed each company's propane operations, Peoples Gas Company (Peoples
Gas), United Cities Propane Gas, Inc. (United Cities), Piedmont Propane Company
(Piedmont), and AGL Propane, Inc. (AGL), respectively, to U.S. Propane in
exchange for equity interests in U.S. Propane. The merger was accounted for as
an acquisition using the purchase method of accounting with Peoples Gas being
the accounting acquirer.

In August 2000, U.S. Propane acquired all of the outstanding common
stock of Heritage Holdings for $120 million. By virtue of Heritage Holdings'
general partner and limited partner interests in the Partnership, U.S. Propane
gained control of the Partnership. Simultaneously, U.S. Propane transferred its
propane operations, consisting of its interest in four separate limited
liability companies, AGL Propane, L.L.C., Peoples Gas Company, L.L.C., United
Cities Propane Gas, L.L.C. and Retail Propane Company, L.L.C. (former Piedmont
operations) to the Partnership for $181.4 million plus working capital. The
$181.4 million was payable $139.5 million in cash, $31.8 million of assumed
debt, and the issuance of 372,392 common units of the Partnership valued at $7.3
million and a

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1.0101% limited partner interest in the Operating Partnership valued at $2.7
million. The purchase price and the exchange price for the common units were
approved by an independent committee of the Board of Directors of Heritage
Holdings. The exchange price for the common units was $19.73125 per unit under a
formula based on the average closing price of common units on the New York Stock
Exchange for the twenty (20) day period beginning ten (10) days prior to the
public announcement of the transaction on June 15, 2000 (the "Formula Price").
Subsequent to August 31, 2000, payments totaling approximately $12.9 million
were made for the working capital adjustment, of which $5.0 million was accrued
at August 31, 2000.

Concurrent with the acquisition, the Operating Partnership borrowed
$180 million from several institutional investors and the Partnership sold
1,161,814 common units and 1,382,514 class B subordinated units in a private
placement to the former shareholders of Heritage Holdings based on the Formula
Price resulting in net proceeds of $50.2 million. The total of these proceeds
was utilized to finance the transaction and retire a portion of existing debt.

Heritage Propane Partners, L.P. is the surviving entity for legal
purposes; however, U.S. Propane's propane operations was the acquirer for
accounting purposes. For purposes of the discussion herein, Peoples Gas is
described as the accounting acquirer because Peoples Gas was the acquirer in the
transaction that formed U.S. Propane; the propane operations of Heritage Propane
Partners, L.P. prior to the series of transactions with U.S. Propane are
referred to as Predecessor Heritage; and the combined operations of U.S. Propane
and Predecessor Heritage are described as Heritage. Peoples Gas had a fiscal
year-end of December 31. The eight-month period ended August 31, 2000 was
treated as a transition period under the rules of the Securities and Exchange
Commission. However, the Form 10-K for the year ended August 31, 2000 was not a
transition report as the Registrant continues to have an August 31 fiscal
year-end.

Heritage believes it is presently the fourth largest retail marketer of
propane in the United States (as measured by retail gallons sold). Heritage
currently serves more than 600,000 active residential, commercial, industrial
and agricultural customers located in 28 states. Heritage's operations extend
from coast to coast with concentrations in the western, upper midwestern,
northeastern and southeastern regions of the United States.

GENERAL

At the time of the series of transactions that formed U.S. Propane and
combined the operations of Predecessor Heritage and U.S. Propane, Peoples Gas
was serving more than 70,000 active residential, commercial and wholesale
customers located in the Florida peninsula. Peoples Gas has grown by expanding
existing markets as well as through acquisitions of independent propane
operations located in northeast and southwest Florida. Prior to the series of
transactions, Peoples Gas believed it was among the top 25 independent propane
distributors nationally and was the largest independent propane distributor in
Florida.

Peoples Gas believed it held competitive advantages in both the
residential and commercial markets through its focus on customer service and
product reliability. Following is a summary of the retail sales volumes per
fiscal year. The transition period ended August 31, 2000 represents seven months
of Peoples Gas stand-alone and one month of Heritage.

HERITAGE PROPANE PARTNERS, L.P. (FORMERLY PEOPLES GAS):

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As a result of the implementation of the strategy described below,
Predecessor Heritage achieved the following retail sales volumes per fiscal
year:

Management believes that Heritage's competitive strengths include: (i)
experience in identifying, evaluating and completing acquisitions, (ii)
operations that are focused in areas experiencing higher-than-average population
growth, (iii) a low cost administrative infrastructure and (iv) a decentralized
operating structure and entrepreneurial workforce. These competitive strengths
have enabled Predecessor Heritage and Heritage to achieve levels of EBITDA per
retail propane gallon sold that management believes are among the highest of any
publicly traded propane partnership. Management believes that as a result of
Heritage's geographic diversity and district-level incentive compensation
program, Predecessor Heritage and Heritage have been able to reduce the effect
of adverse weather conditions on EBITDA, including those experienced by
Predecessor Heritage during the warmer-than-normal winters of 1998 - 1999 and
1999 - 2000 recorded as two of the warmest winters of this century. Management
believes that Heritage's concentration in higher-than-average population growth
areas provides a strong economic foundation for expansion through acquisitions
and internal growth. Management does not believe that Heritage is significantly
more vulnerable than its competitors to displacement by natural gas distribution
systems because the majority of Heritage's areas of operations are located in
rural areas in which natural gas is not available.

BUSINESS STRATEGY

Heritage's goal is to increase distributions to the Partnership's
unitholders by being a low-cost, growth oriented retail propane distribution
company. The three critical elements to this strategy are described below.

Acquisitions. Acquisitions will be the principal means of growth for
Heritage, as the retail propane industry is mature and overall demand for
propane is expected to experience limited growth in the foreseeable future.
Management believes that the fragmented nature of the propane industry provides
significant opportunities for growth through acquisition. Industry sources
indicate that there are over 8,000 retail propane operations, of which the 10
largest retailers, including Heritage, account for approximately 45% of the
total retail sales. Heritage follows a disciplined acquisition strategy that
concentrates on companies that (i) are located in geographic areas experiencing
higher-than-average population growth, (ii) provide a high percentage of sales
to residential customers, (iii) have a strong reputation for quality service and
(iv) own a high percentage of the propane tanks used by their customers. In
addition Heritage attempts to capitalize on the reputations of the companies it
acquires by maintaining local brand names, billing practices and employees,
thereby creating a sense of continuity and minimizing customer loss. Management
believes that this strategy has helped to make Heritage an attractive buyer for
many acquisition candidates from the seller's viewpoint.

Through August 9, 2000, Predecessor Heritage had completed 68
acquisitions for a total purchase price of approximately $297 million. Of the 68
companies acquired by Predecessor Heritage, 19 represent "core acquisitions"
with multiple plants in a specific geographic area, with the balance
representing "blend-in companies" or acquisitions of companies that operate in
an existing Heritage region. On August 10, 2000, Predecessor Heritage completed
the merger with U.S. Propane. During the period between August 10, 2000 through
August 31, 2001, Heritage completed 12 additional acquisitions, of which 3
represent core acquisitions. Heritage will focus on acquisition candidates in
its existing areas of operations, but will consider core acquisitions in other
higher-than-average population growth areas in order to further reduce the
impact on Heritage's operations of adverse weather patterns in any one region.
While Heritage is currently evaluating numerous acquisition candidates, there
can be no assurance that Heritage will identify attractive acquisition
candidates in the future, that Heritage will be able to acquire such businesses
on economically acceptable terms or successfully integrate them into existing
operations and make cost-saving changes, that any acquisition will not dilute
earnings and distributions to unitholders or that any additional debt incurred
to finance an acquisition will not adversely affect the ability of Heritage to
make distributions to unitholders.

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In order to facilitate Heritage's acquisition strategy, the Operating
Partnership maintains a Bank Credit Facility with a total of $115 million
available for borrowing. The Bank Credit Facility consists of a $50 million
Acquisition Facility to be used for acquisitions and improvements and a $65
million Working Capital Facility to be used for working capital and other
general partnership purposes. Heritage also has the ability to fund acquisitions
through the issuance of additional partnership interests and through long-term
debt. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations-Description of Indebtedness."

Low Cost, Decentralized Operations. Heritage focuses on controlling
costs at the corporate and district levels. While Predecessor Heritage realized
certain economies of scale as a result of its acquisitions, it attributes its
low operating costs primarily to its decentralized structure, which Heritage
plans to continue. By delegating all customer billing and collection activities
to the district level, Heritage has been able to operate without a large
corporate staff. Of Heritage's 2,340 full-time employees as of August 31, 2001,
only 91, or approximately 4%, were general and administrative. In addition
Heritage's district level incentive compensation program encourages district
employees at all levels to control costs and expand revenues.

Internal Growth. In addition to pursuing expansion through
acquisitions, Heritage has aggressively focused on internal growth at its
existing district locations. Heritage believes that, by concentrating its
operations in areas experiencing higher-than-average population growth, it is
well positioned to achieve internal growth by adding new customers. Heritage
also believes that its decentralized operations foster an entrepreneurial
corporate culture by: (i) having operational decisions made at the district and
regional level, (ii) retaining billing, collection and pricing responsibilities
at the local and regional levels, and (iii) rewarding employees for achieving
financial targets at the local level.

INDUSTRY BACKGROUND AND COMPETITION

Propane, a by-product of natural gas processing and petroleum refining,
is a clean-burning energy source recognized for its transportability and ease of
use relative to alternative forms of stand-alone energy sources. Retail propane
use falls into three broad categories: (i) residential applications, (ii)
industrial, commercial, and agricultural applications and (iii) other retail
applications, including motor fuel sales. Residential customers use propane
primarily for space and water heating. Industrial customers use propane
primarily as fuel for forklifts and stationary engines, to fire furnaces, as a
cutting gas, in mining operations and in other process applications. Commercial
customers, such as restaurants, motels, laundries and commercial buildings, use
propane in a variety of applications, including cooking, heating and drying. In
the agricultural market, propane is primarily used for tobacco curing, crop
drying, poultry brooding and weed control. Other retail uses include motor fuel
for cars and trucks, outdoor cooking and other recreational uses, propane
resales and sales to state and local governments. In its wholesale operations,
Heritage sells propane principally to large industrial end-users and other
propane distributors.

Propane is extracted from natural gas or oil wellhead gas at processing
plants or separated from crude oil during the refining process. Propane is
normally transported and stored in a liquid state under moderate pressure or
refrigeration for ease of handling in shipping and distribution. When the
pressure is released or the temperature is increased, it is usable as a
flammable gas. Propane is colorless and odorless: an odorant is added to allow
its detection. Like natural gas, propane is a clean burning fuel and is
considered an environmentally preferred energy source.

Propane competes with other sources of energy, some of which are less
costly for equivalent energy value. Heritage competes for customers against
suppliers of electricity, natural gas and fuel oil. Competition from alternative
energy sources has been increasing as a result of reduced regulation of many
utilities including natural gas and electricity. Except for certain industrial
and commercial applications, propane is generally not competitive with natural
gas in areas where natural gas pipelines already exist because natural gas is a
significantly less expensive source of energy than propane. The gradual
expansion of the nation's natural gas distribution systems has resulted in the
availability of natural gas in many areas that previously depended upon propane.
Although the extension of natural gas pipelines tends to displace propane
distribution in areas affected, Heritage believes that new opportunities for
propane sales arise as more geographically remote neighborhoods are developed.
Although propane is similar to fuel oil in certain applications and market
demand, propane and fuel oil compete to a lesser extent primarily because

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of the cost of converting from one to another. Based upon information provided
by the Energy Information Agency, propane accounts for approximately three
percent of household energy consumption in the United States.

In addition to competing with alternative energy sources, Heritage
competes with other companies engaged in the retail propane distribution
business. Competition in the propane industry is highly fragmented and generally
occurs on a local basis with other large full-service multi-state propane
marketers, thousands of smaller local independent marketers and farm
cooperatives. Based on industry publications, Heritage believes that the
domestic retail market for propane is approximately 8.8 billion gallons
annually, that the 10 largest retailers, including Heritage, account for
approximately 45% of the total retail sales of propane in the United States, and
that no single marketer has a greater than 10% share of the total retail market
in the United States. Most of Heritage's retail distribution branches compete
with five or more marketers or distributors. Each retail distribution outlet
operates in its own competitive environment because retail marketers tend to
locate in close proximity to customers. The typical retail distribution outlet
generally has an effective marketing radius of approximately 50 miles although
in certain rural areas the marketing radius may be extended by satellite
locations.

The ability to compete effectively further depends on the reliability
of service, responsiveness to customers and the ability to maintain competitive
prices. Heritage believes that its safety programs, policies and procedures are
more comprehensive than many of its smaller, independent competitors and give it
a competitive advantage over such retailers. Heritage also believes that its
service capabilities and customer responsiveness differentiate it from many of
these smaller competitors. Heritage's employees are on call 24-hours-a-day,
7-days-a-week for emergency repairs and deliveries.

The wholesale propane business is highly competitive. For fiscal 2001,
Heritage's domestic wholesale operations (excluding M-P Energy Partnership)
accounted for only 3.7% of total volumes and less than 1% of its gross profit.
Heritage does not emphasize wholesale operations, but it believes that limited
wholesale activities enhance its ability to supply its retail operations.

PRODUCTS, SERVICES AND MARKETING

Heritage distributes propane through a nationwide retail distribution
network consisting of approximately 275 customer service locations in 28 states.
Heritage's operations are concentrated in large part in the western, upper
midwestern, northeastern and southeastern regions of the United States. Heritage
serves almost 600,000 active customers. Historically, approximately two-thirds
of Predecessor Heritage's retail propane volumes and in excess of 80% of its
EBITDA were attributable to sales during the six-month peak-heating season from
October through March, as many customers use propane for heating purposes.
Consequently, sales and operating profits are normally concentrated in the first
and second fiscal quarters. Cash flows from operations however, are generally
greatest during the second and third fiscal quarters when customers pay for
propane purchased during the six-month peak season. To the extent necessary,
Heritage will reserve cash from peak periods for distribution to unitholders
during the warmer seasons.

Typically, district locations are found in suburban and rural areas
where natural gas is not readily available. Generally, such locations consist of
a one to two acre parcel of land, an office, a small warehouse and service
facility, a dispenser and one or more 18,000 to 30,000 gallon storage tanks.
Propane is generally transported from refineries, pipeline terminals, leased
storage facilities and coastal terminals by rail or truck transports to
Heritage's district locations where it is unloaded into storage tanks. In order
to make a retail delivery of propane to a customer, a bobtail truck is loaded
with propane from the storage tank. Propane is then delivered to the customer by
the bobtail truck, which generally holds 2,500 to 3,000 gallons of propane, and
pumped into a stationary storage tank on the customer's premises. The capacity
of these customer tanks ranges from approximately 100 gallons to 1,200 gallons,
with a typical tank having a capacity of 100 to 300 gallons in milder climates
and from 500 to 1,000 gallons in colder climates. Heritage also delivers propane
to retail customers in portable cylinders, which typically have a capacity of 5
to 35 gallons. When these cylinders are delivered to customers, empty cylinders
are picked up for refilling at Heritage's distribution locations or are refilled
in place. Heritage also delivers propane to certain other bulk end users of
propane in tractor-trailers known as transports, which typically have an average
capacity of approximately 10,500 gallons. End users receiving transport
deliveries include industrial customers, large-scale heating accounts, mining
operations, and large agricultural accounts, which use propane for crop drying.

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Heritage encourages its customers whose propane needs are temperature
sensitive to implement a regular delivery schedule by, in some cases, charging
extra for non-scheduled deliveries. Many of Heritage's residential customers
receive their propane supply pursuant to an automatic delivery system which
eliminates the customer's need to make an affirmative purchase decision and
allows for more efficient route scheduling and maximization of volumes
delivered. Heritage also sells, installs and services equipment related to its
propane distribution business, including heating and cooking appliances from its
district locations.

Heritage owns, though its subsidiaries, a 60% interest in M-P Energy
Partnership, a Canadian partnership that supplies Heritage propane as described
below under "Propane Supply and Storage." When it is referred to or information
is given regarding domestic operations, amounts attributable to M-P Energy
Partnership are generally excluded, unless otherwise indicated.

Propane use falls into three broad categories: (i) residential
applications, (ii) industrial, commercial and agricultural applications and
(iii) other retail applications, including motor fuel sales. Approximately 96%
of the domestic gallons sold by Heritage in the fiscal year ended August 31,
2001 were to retail customers and 4% to wholesale customers. Of the retail
gallons sold by Heritage, 57% were to residential customers, 29% were to
industrial, commercial and agricultural customers, and 14% were to other retail
users. Sales to residential customers in the fiscal year ended August 31, 2001
accounted for 55% of total domestic gallons sold inclusive of domestic wholesale
but approximately 71% of Heritage's gross profit from propane sales. Residential
sales have a greater profit margin and a more stable customer base than other
markets served by Heritage. Industrial, commercial and agricultural sales
accounted for 21% of Heritage's gross profit from propane sales for the fiscal
year ended August 31, 2001, with all other retail users accounting for 8%.
Additional volumes sold to wholesale customers contributed less than 1% of gross
profit from propane sales. No single customer accounts for 10% or more of
revenues.

The propane business is very seasonal with weather conditions
significantly affecting demand for propane. Heritage believes that the
geographic diversity of its operations helps to minimize its nationwide exposure
to regional weather. Although overall demand for propane is affected by climate,
changes in price and other factors, Heritage believes its residential and
commercial business to be relatively stable due to the following
characteristics:

o residential and commercial demand for propane has been relatively
unaffected by general economic conditions due to the largely
non-discretionary nature of most propane purchases,

o loss of customers to competing energy sources has been low,

o the tendency of Heritage's customers to remain with Heritage due to
the product being delivered pursuant to a regular delivery schedule
and to Heritage's ownership of over 90% of the storage tanks (verify)
utilized by its customers, and

o the historic ability of Heritage to more than offset customer losses
through internal growth of its customer base in existing markets.

Since home heating usage is the most sensitive to temperature, residential
customers account for the greatest usage variation due to weather. Variations in
the weather in one or more regions in which Heritage operates can significantly
affect the total volumes of propane sold by Heritage and the margins realized
thereon and, consequently, Heritage's results of operations. Heritage believes
that sales to the commercial and industrial markets, while affected by economic
patterns, are not as sensitive to variations in weather conditions as sales to
residential and agricultural markets.

PROPANE SUPPLY AND STORAGE

Supplies of propane from Heritage's sources historically have been
readily available. Heritage purchases from over 50 oil companies and natural gas
processors at numerous supply points located in the United States and Canada. In
the fiscal year ended August 31, 2001, Enterprise Products Operating L.P.
(Enterprise) and Dynegy Liquids Marketing and Trade (Dynegy) provided
approximately 21% and 19% of Heritage's total propane supply, respectively. In
addition, M-P Oils, Ltd., one of our wholly owned subsidiaries, procured 21% of
Heritage's total

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propane supply during the fiscal year ended August 31, 2001. M-P Oils, Ltd.
holds a 60% interest in M-P Energy Partnership, a Canadian partnership that buys
and sells propane for its own account and supplies Heritage propane in the
northern United States.

Heritage believes that, if supplies from Enterprise and Dynegy were
interrupted, it would be able to secure adequate propane supplies from other
sources without a material disruption of its operations. Aside from Enterprise
and Dynegy, no single supplier provided more than 10% of Heritage's total
domestic propane supply during the fiscal year ended August 31, 2001. Heritage
believes that its diversification of suppliers will enable it to purchase all of
its supply needs at market prices if supplies are interrupted from any of the
sources without a material disruption of its operations. Although no assurances
can be given that supplies of propane will be readily available in the future,
Heritage expects a sufficient supply to continue to be available. However,
increased demand for propane in periods of severe cold weather, or otherwise,
could cause future propane supply interruptions or significant volatility in the
price of propane.

Heritage typically enters into one-year supply agreements subject to
annual renewal. The percentage of contract purchases may vary from year to year.
Supply contracts generally provide for pricing in accordance with posted prices
at the time of delivery or the current prices established at major delivery or
storage points, and some contracts include a pricing formula that typically is
based on these market prices. Most of these agreements provide maximum and
minimum seasonal purchase guidelines. Heritage receives its supply of propane
predominately through railroad tank cars and common carrier transport.

Because Heritage's profitability is sensitive to changes in wholesale
propane costs, it generally seeks to pass on increases in the cost of propane to
customers. Heritage has generally been successful in maintaining retail gross
margins on an annual basis despite changes in the wholesale cost of propane, but
there is no assurance that Heritage will always be able to pass on product cost
increases fully, particularly when product costs rise rapidly. Consequently,
Heritage's profitability will be sensitive to changes in wholesale propane
prices. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations-General."

Heritage leases space in storage facilities in Michigan, Mississippi,
South Carolina, Arizona, Missouri and Texas and smaller storage facilities in
other locations and has rights to use storage facilities in additional locations
when it "pre-buys" product from these sources. Heritage believes that it has
adequate third party storage to take advantage of supply purchasing advantages
as they may occur from time to time. Access to storage facilities allows
Heritage to buy and store large quantities of propane during periods of low
demand, which generally occur during the summer months, thereby helping to
ensure a more secure supply of propane during periods of intense demand or price
instability.

PRICING POLICY

Pricing policy is an essential element in the marketing of propane.
Heritage relies on regional management to set prices based on prevailing market
conditions and product cost, as well as local management input. All regional
managers are advised regularly of any changes in the posted price of the
district's propane suppliers. In most situations, Heritage believes that its
pricing methods will permit Heritage to respond to changes in supply costs in a
manner that protects Heritage's gross margins and customer base, to the extent
possible. In some cases, however, Heritage's ability to respond quickly to cost
increases could occasionally cause its retail prices to rise more rapidly than
those of its competitors, possibly resulting in a loss of customers.

BILLING AND COLLECTION PROCEDURES

Customer billing and account collection responsibilities are retained
at the district level. Heritage believes that this decentralized approach is
beneficial for several reasons:

o the customer is billed on a timely basis;

o the customer is more apt to pay a "local" business;

8

o cash payments are received more quickly, and

o local personnel have a current account status available to them at all
times to answer customer inquiries.

GOVERNMENT REGULATION

Heritage is subject to various federal, state and local environmental,
health and safety laws and regulations. Generally, these laws impose limitations
on the discharge of pollutants and establish standards for the handling of solid
and hazardous wastes. These laws include without limitation, the Resource
Conservation and Recovery Act, the Comprehensive Environmental Response,
Compensation and Liability Act ("CERCLA"), the Clean Air Act, the Occupational
Safety and Health Act, the Emergency Planning and Community Right-to-Know Act,
the Clean Water Act, and comparable state statutes. CERCLA, also known as the
"Superfund" law, imposes joint and several liability in most instances, without
regard to fault or the legality of the original conduct on certain classes of
persons that are considered to have contributed to the release or threatened
release of a "hazardous substance" into the environment. Propane is not a
hazardous substance within the meaning of CERCLA. However, certain automotive
waste products generated by Heritage's truck fleet, as well as "hazardous
substances" or "hazardous waste" disposed of during past operations by third
parties on Heritage's properties, could subject Heritage to liability under
CERCLA. Such laws and regulations could result in civil or criminal penalties in
cases of non-compliance and impose liability for remediation costs. In addition,
third parties may make claims against owners or operators of properties for
personal injuries and property damage associated with releases of hazardous or
toxic substances or waste.

In connection with all acquisitions of retail propane businesses that
involve the acquisitions of any interest in real estate, Heritage conducts an
environmental review in an attempt to determine whether any substance other than
propane has been sold from, or stored on, any such real estate prior to its
purchase. Such review includes questioning the seller, obtaining representations
and warranties concerning the seller's compliance with environmental laws and
conducting inspections of the properties. Where warranted, independent
environmental consulting firms are hired to look for evidence of hazardous
substances or the existence of underground storage tanks.

Petroleum-based contamination or environmental wastes are known to be
located on or adjacent to six sites, which Heritage presently or formerly had
operations. These sites were evaluated at the time of their acquisition. In all
cases, remediation operations have been or will be undertaken by others, and in
all six cases, Heritage obtained indemnification for expenses associated with
any remediation from the former owners or related entities. Additionally,
Heritage has been named as a large deminimis generator at one superfund site,
but it believes that its exposure will not be material. Based on information
currently available to Heritage, such projects are not expected to have a
material adverse effect on Heritage's financial condition or results of
operation.

National Fire Protection Association Pamphlets No. 54 and No. 58, which
establish rules and procedures governing the safe handling of propane, or
comparable regulations, have been adopted as the industry standard in all of the
states in which Heritage operates. In some states these laws are administered by
state agencies, and in others they are administered on a municipal level. With
respect to the transportation of propane by truck, Heritage is subject to
regulations promulgated under the Federal Motor Carrier Safety Act. These
regulations cover the transportation of hazardous materials and are administered
by the United States Department of Transportation. Heritage conducts ongoing
training programs to help ensure that its operations are in compliance with
applicable regulations. Heritage maintains various permits that are necessary to
operate some of its facilities, some of which may be material to its operations.
Heritage believes that the procedures currently in effect at all of its
facilities for the handling, storage and distribution of propane are consistent
with industry standards and are in compliance in all material respects with
applicable laws and regulations.

Heritage has implemented environmental programs and policies designed
to avoid potential liability and cost under applicable environmental laws. It is
possible, however, that Heritage will have increased costs due to stricter
pollution control requirements or liabilities resulting from non-compliance with
operating or other regulatory permits. It is not anticipated that Heritage's
compliance with or liabilities under environmental, health and safety laws and
regulations, including CERCLA, will have a material adverse effect on Heritage.
To the extent that there are any environmental liabilities unknown to Heritage
or environmental, health or safety laws or regulations are made more stringent,
there can be no assurance that Heritage's results of operations will not be
materially and adversely affected.

9

EMPLOYEES

As of August 31, 2001, Heritage had 2,340 full time employees, of whom
91 were general and administrative and 2,249 were operational employees. Of its
operational employees 60 are represented by a labor union. Heritage believes
that its relations with its employees are satisfactory. Historically, Heritage
has hired as many as 100 seasonal workers to meet peak winter demands.

ITEM 2. PROPERTIES

Heritage operates bulk storage facilities at approximately 275 customer
service locations. Heritage owns substantially all of these facilities and has
entered into long-term leases for those that it does not own. Heritage believes
that the increasing difficulty associated with obtaining permits for new propane
distribution locations makes its high level of site ownership and control a
competitive advantage. Heritage owns approximately thirty-one million gallons of
above ground storage capacity at its various plant sites and have leased an
aggregate of approximately 50 million gallons of underground storage facilities
in Michigan, Mississippi, South Carolina Arizona, Missouri and Texas. Heritage
does not own or operate any underground storage facilities (excluding customer
and local distribution tanks) or pipeline transportation assets (excluding local
delivery systems).

Heritage also owns 50% of Bi-State Propane, a California general
partnership that conducts business in California and Nevada. Bi-State Propane
operates nine locations that are included on a gross basis in Heritage's site,
customer and other property descriptions contained herein.

The transportation of propane requires specialized equipment. The
trucks and railroad tank cars used for this purpose carry specialized steel
tanks that maintain the propane in a liquefied state. As of August 31, 2001,
Heritage utilized approximately 37 transport truck tractors, 41 transport
trailers, 30 railroad tank cars, 984 bobtails and 1,492 other delivery and
service vehicles, all of which Heritage owns. As of August 31, 2001, Heritage
owned approximately 540,000 customer storage tanks with typical capacities of
120 to 1,000 gallons. These customer storage tanks are collateral to secure the
obligations of Heritage under its borrowings from its banks and note holders.

Heritage believes that it has satisfactory title to or valid rights to
use all of its material properties. Although some of such properties are subject
to liabilities and leases, liens for taxes not yet due and payable, encumbrances
securing payment obligations under non-competition agreements entered in
connection with acquisitions and immaterial encumbrances, easements and
restrictions, Heritage does not believe that any such burdens will materially
interfere with the continued use of such properties by Heritage in its business,
taken as a whole. In addition, Heritage believes that it has, or is in the
process of obtaining, all required material approvals, authorizations, orders,
licenses, permits, franchises and consents of, and has obtained or made all
required material registrations, qualifications and filings with, the various
state and local government and regulatory authorities which relate to ownership
of Heritage's properties or the operations of its business.

Heritage utilizes a variety of trademarks and tradenames that it owns,
including "Heritage Propane." Heritage believes that its strategy of retaining
the names of the companies it has acquired has maintained the local
identification of these companies and has been important to the continued
success of these businesses. Some of Heritage's most significant trade names
include AGL Propane, Balgas, Bi-State Propane, Blue Flame Gas of Charleston,
Blue Flame Gas of Mt. Pleasant, Blue Flame Gas of Vermont, Carolane Propane Gas,
Gas Service Company, EnergyNorth, Gibson Propane, Holton's L. P. Gas, Ikard &
Newsom, Northern Energy, Sawyer Gas, Peoples Gas Company, Piedmont Propane
Company, ProFlame Gas, Rural Bottled Gas and Appliance, ServiGas, TECO Propane
and VGS Propane. Heritage regards its trademarks, tradenames and other
proprietary rights as valuable assets and believes that they have significant
value in the marketing of its products.

10

ITEM 3. LEGAL PROCEEDINGS.

Heritage is threatened with or is named as a defendant in various
personal injury, property damage and product liability suits. In general, these
lawsuits have arisen in the ordinary course of Heritage's business since the
formation of Heritage, and involve claims for actual damages arising from the
alleged negligence of Heritage or as a result of product defects or similar
matters. Of the pending or threatened matters, the suits currently include one
action by Heritage against a seller to Heritage and other suits against Heritage
involving property damage and serious personal injuries. Although any litigation
is inherently uncertain, based on past experience, the information currently
available to it and the availability of insurance coverage, Heritage does not
believe that these pending or threatened litigation matters issues will have a
material adverse effect on its results of operations or its financial condition.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

No matters were submitted to a vote of the security holders of Heritage
Propane Partners, L.P. during the fiscal year ended August 31, 2001.

11

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S UNITS AND RELATED UNITHOLDER MATTERS.

MARKET PRICE OF AND DISTRIBUTIONS ON THE COMMON UNITS AND RELATED UNITHOLDER
MATTERS

The common units representing limited partners interests in the
Partnership ("common units") are listed on the New York Stock Exchange, which is
the principal trading market for such securities, under the symbol "HPG". The
following table sets forth, for the periods indicated, the high and low sales
prices per common unit, as reported on the New York Stock Exchange Composite
Tape, and the amount of cash distributions paid per common unit.

(1) Distributions are shown in the quarter with respect to which they were
declared. For each of the indicated quarters for which distributions have
been made, an identical per unit cash distribution was paid on the
subordinated units.

DESCRIPTION OF UNITS

As of October 1, 2001, there were approximately 573 holders of record
of the Partnership's common units, including common units held in street name
representing over nine thousand individual common unitholders. Common units,
class B subordinated units and class C units represent limited partner interests
in the partnership that entitle the holders to the rights and privileges
specified in the Heritage Propane Partners, L.P. partnership agreement (the
"partnership agreement"). As of November 5, 2001, there were 14,262,066 common
units and 1,382,514 class B subordinated units representing, together with the
1.0101% limited partner interest in the Operating Partnership held by U.S.
Propane, an aggregate 98.9899% limited partner interest in the Partnership.
Except as described below, the common units and class B subordinated units
generally participate pro rata in Heritage's income, gains, losses deductions,
credits and distributions. There are also 1,000,000 class C units outstanding
that are entitled only to participate in any incentive distributions that
Heritage may make that are attributable to amounts received by Heritage in
connection with specified litigation.

Prior to July 6, 2001, the Partnership also had subordinated units
representing limited partner interests that were issued and outstanding, all of
which converted to common units as described below under "-- Subordinated
Units". Prior to converting into common units, and except as described below,
the subordinated units generally participated pro rata with the common units and
the class B subordinated units in Heritage's income, gains, losses, deductions,
credits and distributions.

No person is entitled to preemptive rights in respect of issuances of
securities by the Partnership, except that Heritage Holdings, the general
partner, has the right to purchase sufficient partnership securities to maintain
its equity interest in the Partnership.

12

COMMON UNITS

The Partnership's common units are registered under the Securities
Exchange Act of 1934 and are listed for trading on the New York Stock Exchange.
Each holder of a common unit is entitled to one vote per unit on all matters
presented to the limited partners for a vote. However, if at any time any person
or group (other than the general partner and its affiliates) owns beneficially
20% or more of all common units, any common units owned by that person or group
may not be voted on any matter and are not considered to be outstanding when
sending notices of a meeting of unitholders (unless otherwise required by law),
calculating required votes, determining the presence of a quorum or for other
similar purposes under our partnership agreement. The common units are entitled
to distributions of available cash as described below under "-- Cash
Distribution Policy." As of October 1, 2001 there were approximately 573 holders
of the Heritage's common units, including common units held in street name,
representing over nine thousand individual common unitholders.

SUBORDINATED UNITS

Heritage Holdings, a wholly owned subsidiary of U.S. Propane and the
general partner of the Partnership and the Operating Partnership held all of the
subordinated units. The subordinated units were a separate class of limited
partner interests and the rights of holders of subordinated units to participate
in distributions to partners differed from, and were subordinated to, the rights
of the holders of common units.

Under the partnership agreement, 925,736 subordinated units converted
into common units as of July 7, 1999, 925,736 subordinated units converted into
common units as of July 5, 2000 and the remaining 1,851,471 subordinated units
converted into common units as of July 6, 2001. The conversions of the
subordinated units occurred and the subordination period ended because the
Partnership met specified cash performance and distribution requirements during
successive four-quarter periods commencing with the initial public offering in
June of 1996. As common units issued upon conversion of the subordinated units,
the new common units share equally with other common units in distributions of
available cash.

CLASS B SUBORDINATED UNITS

The class B subordinated units represent a portion of the limited
partner interests issued to certain former stockholders of Heritage Holdings,
who are also members of management, in connection with the transaction with U.S.
Propane. The class B subordinated units have the same voting rights as the
subordinated units outstanding before the end of the subordination period. Each
class B subordinated unit is entitled to one vote on each matter with respect to
which the class B subordinated units are entitled to vote.

In connection with the transaction with U.S. Propane and because the
class B subordinated units are not convertible into common units except by
approval of the common unitholders or a change in the rules of the New York
Stock Exchange, the Partnership agreed to submit to a vote or consent of its
common unitholders a proposal to change the terms of the class B subordinated
units to provide that each class B subordinated unit is convertible into one
common unit. The Partnership intends to submit this proposal to its common
unitholders by December 31, 2001.

The rights of holders of class B subordinated units to participate in
distributions to partners differ from, and are subordinated to, the right of
holders of common units, as described below under "-- Cash distribution Policy".
If the common unitholders approve the conversion of the class B subordinated
units into common units, or if at any time the rules of the New York Stock
Exchange or staff interpretations of such rules are changed, or facts and
circumstances arise so that no vote or consent of the unitholders is required as
a condition to the listing of any common units that may be issued upon such
conversion, each class B subordinated unit will automatically convert into one
common unit. But if the common unitholders do not approve the conversion by
December 31, 2001, the terms of the class B subordinated units will
automatically be changed to provide that the amount allocated or distributed to
each class B subordinated unit will equal 115% of the amount allocated or
distributed to each common unit, except that the common units will have priority
over the class B subordinated units with respect to the minimum quarterly
distributions of $0.50 per common unit and any arrearages on the minimum
quarterly distribution.

The class B subordinated units have rights upon dissolution and
liquidation of the Partnership, including the right to share in any liquidating
distributions that are based on 100% (115% if the conversion of the class B

13

subordinated units is not approved) of the rights of the common units.
Accordingly, the amount of any liquidating distribution to each class B
subordinated unit will equal 100% (115% if the conversion of the class B
subordinated units is not approved) of the amount of such distribution to each
common units, except that the rights of the class B subordinated units will have
the same order of priority relative to the rights of the common units as
subordinated units outstanding before the end of the subordination period.

CLASS C UNITS

In conjunction with the transaction with U.S. Propane and the change of
control of the general partner, the Partnership issued 1,000,000 newly created
class C units to Heritage Holdings in conversion of that portion of its
incentive distribution rights that entitled it to receive any distribution made
by the Partnership attributable to the net amount received by the Partnership in
connection with the settlement, judgment, award or other final nonappealable
resolution of specified litigation filed by Heritage prior to the transaction
with U.S. Propane, which is referred to as the "litigation". The class C units
have zero initial capital account balance and were distributed by Heritage
Holdings to its former stockholders in connection with the transaction with U.S.
Propane. Thus, U.S. Propane will not receive any distributions made with respect
to the litigation.

All decisions of the general partner relating to the litigation will be
determined by a special litigation committee consisting of one or more
independent directors of the general partner. As soon as practicable after the
time, if any, that the Partnership receives the final cash payment as a result
of the resolution of the litigation, the special litigation committee will
determine the aggregate net amount of such proceeds distributable by the
Partnership by deducting from the amounts received all costs and expenses
incurred by the Partnership and its affiliates in connection with the litigation
and such cash reserves as are necessary or appropriate to provide for operating
expenditures. Until the special litigation committee decides to distribute the
distributable proceeds, none of the distributable proceeds will be deemed to be
"available cash" under the partnership agreement. Please read "-- Cash
Distribution Policy - General" below for a discussion of available cash. When
the special litigation committee decides to distribute the distributable
proceeds, the amount of the distribution will be deemed to be available cash and
will be distributed as described below under "-- Cash Distribution Policy,"
provided that the amount of distributable proceeds that would be distributed to
holders of incentive distribution rights will instead be distributed to the
holders of the class C units, pro rata. The Partnership cannot predict whether
it will receive any cash payments as a result of the litigation and, if so, when
such distributions might be received.

Each holder of class C units receiving a distribution of cash in any
taxable year of the partnership will be allocated items of gross income with
respect to such taxable year in an amount equal to the cash distributed to the
holder. The holders of class C units will not be allocated any other items of
income, gain, loss deduction or credit. The class C units do not have any rights
to share in any of the assets or distributions upon dissolution and liquidation
of the partnership, except for the extent that any such distributions consist of
proceeds from the litigation to which the class C unitholders would have
otherwise been entitled. The class C units do not have the privilege of
conversion into any other unit and do not have any voting rights except to the
extent provided by law, in which case the class C units will be entitled to one
vote.

The amount of cash distributions to which the incentive distribution
rights are entitled was not increased by the creation of the class C units;
rather, the class C units are a mechanism for dividing the incentive
distribution rights between Heritage Holdings and its former stockholders.

CASH DISTRIBUTION POLICY

The partnership agreement requires that the Partnership will distribute
all of its "available cash" to its unitholders and its general partner within 45
days following the end of each fiscal quarter. The term "available cash"
generally means, with respect to any fiscal quarter of the Partnership, all cash
on hand at the end of such quarter, plus working capital borrowings after the
end of the quarter, less reserves established by the general partner in its sole
discretion to provide for the proper conduct of the Partnership's business,
comply with applicable law or any Heritage debt instrument or other agreement,
or to provide funds for future distributions to partners with respect to any one
or more of the next four quarters. Available cash is more fully defined in the
partnership agreement previously filed as an exhibit.

14

The subordination period ended as a result of the conversion into
common units of all remaining outstanding subordinated units (but not class B
subordinated units) as described above. Beginning with the fiscal quarter ended
August 31, 2001, and as long as class B subordinated units are outstanding, the
Partnership will distribute available cash, excluding any available cash to be
distributed to the class C unitholders, as follows:

o First, 97% to the holders of common units, pro rata, 1% to U.S.
Propane in respect of its limited partner interest in the
Operating Partnership and 2% to the general partner, until the
holders of common units have received $0.50 per common unit for
such quarter and any prior quarter in which they failed to
receive $0.50 per common unit;

o Second, 97% to the holders of class B subordinated units, pro
rata, 1% to U.S. Propane in respect of its limited partner
interest in the Operating Partnership and 2% to the general
partner, until the holders of class B subordinated units have
received $0.50 per unit for such quarter;

o Third, 97% to all common unitholders and class B subordinated
units, pro rata, 1% to U.S. Propane in respect of its limited
partner interest in the Operating Partnership and 2% to the
general partner, until all common unitholders have received at
least $0.55 per unit for such quarter;

o Fourth, 84% to all common unitholders and class B subordinated
unitholders, 1% to U.S. Propane in respect of its limited partner
interest in the Operating Partnership and 13% to the holders of
incentive distribution rights, pro rata and 2% to the general
partner, until all common unitholders have received at least
$0.635 per unit for such quarter;

o Fifth, 74% to all common unitholders and class B subordinated
unitholders, pro rata, 1% to U.S. Propane in respect of its
limited partner interest in the Operating Partnership, 23% to the
holders of incentive distribution rights, pro rata, and 2% to the
general partner, until all common unitholders have received at
least $0.825 per unit for such quarter; and

o Sixth, thereafter 49% to all common unitholders and class B
subordinated unitholders, pro rata, 1% to U.S. Propane in respect
of its limited partner interest in the Operating Partnership, 48%
to the holders of incentive distribution rights, pro rata, and 2%
to the general partner.

If the common unitholders have not approved the conversion of class B
subordinated units into common units by December 31, 2001, then the amount
distributed to each class B subordinated unit pursuant to the second through
sixth clauses above will be equal to 115% of the amount distributed to each
common unit pursuant to each such clause.

If the conversion of the class B subordinated units is approved, each
class B subordinated unit will be converted into one common unit and will then
participate pro rata with the other common units in distributions of available
cash. After the conversion of the class B subordinated units into common units,
the Partnership will distribute available cash, excluding any available cash to
be distributed to the class C unitholders, as follows:

o First, 97% to all unitholders, pro rata, 1% to U.S. Propane in
respect of its limited partner interest in the Operating
Partnership and 2% to the general partner, until all unitholders
have received $0.50 per unit for such quarter and any prior
quarter;

o Second, 97% to all unitholders, pro rata, 1% to U.S. Propane in
respect of its limited partner interest in the Operating
Partnership and 2% to the general partner, until all unitholders
have received $0.55 per unit for such quarter;

o Third, 84% to all unitholders, pro rata, 1% to U.S. Propane in
respect of its limited partner interest in the Operating
Partnership, 13% to the holders of incentive distribution rights,
pro rata, and 2% to the general partner, until all common
unitholders have received at least $0.635 per unit for such
quarter;

15

o Fourth, 74% to unitholders, pro rata, 1% to U.S. Propane in
respect of its limited partner interest in the Operating
Partnership, 23% to the holders of incentive distribution rights,
pro rata and 2% to the general partner, until all common
unitholders have received at least $0.825 per unit for such
quarter;

o Fifth, thereafter 49% to all unitholders, pro rata, 1% to U.S.
Propane in respect of its limited partner interest in the
Operating Partnership, 48% to the holders of incentive
distribution rights, pro rata, and 2% to the general partner.

RESTRICTIONS ON TRANSFER; REGISTRATION RIGHT

The 1,161,814 common units and the 1,382,514 class B subordinated units
issued to the former stockholders of Heritage Holdings in the U.S. Propane
transaction are subject to certain restrictions on transfer. On November 8,
2000, 473,473 of these class B subordinated units and 624,212 of the common
units became transferable. An additional 266,715 of the class B subordinated
units and 165,700 of the common units became transferable on August 10, 2001. An
additional 266,715 of the class B subordinated units and 165,700 of the common
units become transferable on August 10, 2002, and 375,611 of the class B
subordinated units and 206,202 of the common units become transferable on August
10, 2003. The restrictions on transfer are also subject to exceptions contained
in the employment agreements of certain of the former stockholders and of
Heritage's management.

CHANGES IN SECURITIES AND RECENT SALES OF UNREGISTERED SECURITIES

On July 31, 2001, Heritage sold 2,500,000 common units in an
underwritten public offering at a public offering price of $28.00 per unit.
Heritage used $41 million of the approximate net proceeds of $66 million to
reduce indebtedness under the Senior Revolving Acquisition Facility, which was
incurred in the acquisition of ProFlame, Inc. (ProFlame) and related propane
distribution companies of ProFlame. The remainder of the proceeds was used for
general partnership purposes, including additional acquisitions and repayment of
debt. To effect the transfer of the contribution required by the general partner
to maintain its 1% general partner interest in the Partnership, the general
partner contributed 25,252 common units back to the Partnership and those units
were cancelled.

On August 1, 2001, the Partnership issued 129,901 common units to the
general partner in connection with the assumption of certain liabilities by the
general partner from the acquisition of certain assets of ProFlame. The general
partner was entitled to 158,917 common units as a result of this transaction but
agreed to forego the issuance of 1,638 units and 1,605 units, which represented
its capital contributions to maintain its 1% interest in the Partnership and its
1.0101% interest in the Operating Partnership, respectively, in relation to this
transaction. The general partner also agreed to forego the issuance of an
additional 25,773 common units to which it was entitled in the ProFlame
acquisition to maintain its 1.0101% interest in the Operating Partnership. The
units issued to the general partner were not registered with the Securities and
Exchange Commission under the Securities Act of 1933, as amended, by virtue of
an exemption under Section 4(2) thereof.

During fiscal 2001, Heritage issued 58,000 common units in exchange for
certain assets in connection with the acquisition of a certain propane business,
for a total value of $1.6 million. These units were issued utilizing Heritage's
Registration Statement No. 333-40407 on Form S-4.

ITEM 6. SELECTED HISTORICAL FINANCIAL AND OPERATING DATA

The following table sets forth, for the periods and as of the dates
indicated, selected historical financial and operating data for Heritage Propane
Partners, L.P. (formerly Peoples Gas and surviving legal entity in the series of
transactions with U.S. Propane). The selected historical financial and operating
data should be read in conjunction with the financial statements of Heritage
Propane Partners, L.P. (formerly Peoples Gas Company) included elsewhere in this
Report and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" also included elsewhere in this Report. The amounts in
the table below, except per unit data, are in thousands.

16

HERITAGE PROPANE PARTNERS, L.P. (FORMERLY PEOPLES GAS):

(a) Gross profit is computed by reducing total revenues by the direct cost of
the products sold.

(b) Net income (loss) per unit is computed by dividing the net income by the
weighted average number of units outstanding. Although equity accounts of
Peoples Gas survive the merger, Predecessor Heritage's partnership
structure and partnership units survive. Accordingly, the equity accounts
of Peoples Gas have been restated based on general partner interest and
common units received by Peoples Gas in the merger.

(c) EBITDA is defined as operating income plus non-cash compensation,
depreciation and amortization (including the EBITDA of investees). EBITDA
should not be considered as an alternative to net income (as an indicator
of operating performance) or as an alternative to cash flow (as a measure
of liquidity or ability to service debt obligations), but provides
additional information for evaluating Heritage's ability to make the
Minimum Quarterly Distribution.

(d) Partners' Capital is anticipated to decrease to the extent depreciation and
amortization exceeds maintenance capital expenditure requirements.

(e) Capital expenditures fall generally into three categories: (i) maintenance
capital expenditures, which include expenditures for repairs that extend
the life of the assets and replacement of property, plant and equipment,
(ii) growth capital expenditures, which include expenditures for purchase
of new propane tanks and other equipment to facilitate

17

retail customer base expansion, and (iii) acquisition expenditures which
include expenditures related to the acquisition of retail propane
operations and the portion of the purchase price allocated to intangibles
associated with such acquired businesses.

HERITAGE PROPANE PARTNERS, L.P. (PREDECESSOR HERITAGE):

The following table sets forth, for the periods and as of the dates
indicated, selected historical financial and operating data for Predecessor
Heritage. The selected historical financial and operating data of Predecessor
Heritage should be read in conjunction with the financial statements of Heritage
included elsewhere in this Report and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" also included elsewhere in this
Report. The amounts in the table below, except per unit data, are in thousands.

(a) Gross profit is computed by reducing total revenues by the direct cost of
the products sold.

(b) Net income (loss) per unit is computed by dividing the limited partners'
interest in net income (loss) by the limited partners' weighted average
number of units outstanding.

18

(c) EBITDA is defined as operating income plus non-cash compensation,
depreciation and amortization (including the EBITDA of investees). EBITDA
should not be considered as an alternative to net income (as an indicator
of operating performance) or as an alternative to cash flow (as a measure
of liquidity or ability to service debt obligations), but provides
additional information for evaluating the Partnership's ability to make the
Minimum Quarterly Distribution. The minority interest of MP Energy
Partnership, a majority owned partnership, is deducted from the EBITDA
calculation.

(d) Capital expenditures fall generally into three categories: (i) maintenance
capital expenditures of approximately $5.1 for the period ended August 9,
2000 and $4.6, $3.6 and $2.3 million in fiscal 1999, 1998 and 1997,
respectively, which include expenditures for repairs that extend the life
of the assets and replacement of property, plant and equipment, (ii) growth
capital expenditures, which include expenditures for purchases of new
propane tanks and other equipment to facilitate retail customer base
expansion, and (iii) acquisition capital expenditures, which include
expenditures related to the acquisition of retail propane operations and
the portion of the purchase price allocated to intangibles associated with
such acquired businesses.

(e) Reflects unaudited pro forma information for Predecessor Heritage as if the
Partnership formation had occurred as of the beginning of the period
presented.

(f) Partners' Capital is anticipated to decrease to the extent depreciation and
amortization exceeds maintenance capital expenditure requirements.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.

FORWARD-LOOKING STATEMENTS

CERTAIN MATTERS DISCUSSED IN THIS REPORT, EXCLUDING HISTORICAL
INFORMATION, AS WELL AS SOME STATEMENTS BY HERITAGE IN PERIODIC PRESS RELEASES
AND SOME ORAL STATEMENTS OF HERITAGE OFFICIALS DURING PRESENTATIONS ABOUT THE
PARTNERSHIP, INCLUDE CERTAIN "FORWARD-LOOKING" STATEMENTS. ALTHOUGH HERITAGE
BELIEVES SUCH FORWARD-LOOKING STATEMENTS ARE BASED ON REASONABLE ASSUMPTIONS AND
CURRENT EXPECTATIONS AND PROJECTIONS ABOUT FUTURE EVENTS, NO ASSURANCE CAN BE
GIVEN THAT EVERY OBJECTIVE WILL BE REACHED. SUCH STATEMENTS ARE MADE IN RELIANCE
ON THE "SAFE HARBOR" PROTECTIONS PROVIDED UNDER THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995.

AS REQUIRED BY THAT LAW, HERITAGE HEREBY IDENTIFIES THE FOLLOWING
IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM ANY
RESULTS PROJECTED, FORECASTED, ESTIMATED OR BUDGETED BY HERITAGE IN
FORWARD-LOOKING STATEMENTS. THESE INCLUDE:

o CHANGES IN GENERAL ECONOMIC CONDITIONS IN THE UNITED STATES AS
WELL AS CHANGES IN GENERAL ECONOMIC CONDITIONS AND CURRENCIES IN
FOREIGN COUNTRIES;

o WEATHER CONDITIONS THAT VARY SIGNIFICANTLY FROM HISTORICALLY
NORMAL CONDITIONS;

o ITS SUCCESS IN HEDGING ITS POSITIONS;

o THE EFFECTIVENESS OF RISK-MANAGEMENT POLICIES AND PROCEDURES AND
THE ABILITY OF HERITAGE'S LIQUIDS MARKETING COUNTERPARTIES TO
SATISFY THEIR FINANCIAL COMMITMENTS;

o THE GENERAL LEVEL OF PETROLEUM PRODUCT DEMAND, AND THE
AVAILABILITY OF PROPANE SUPPLIES;

o ENERGY PRICES GENERALLY AND SPECIFICALLY, THE PRICE OF PROPANE TO
THE CONSUMER COMPARED TO THE PRICE OF ALTERNATIVE AND COMPETING
FUELS;

o COMPETITION FROM OTHER PROPANE DISTRIBUTORS AND ALTERNATE FUELS;

19

o THE AVAILABILITY AND COST OF CAPITAL;

o CHANGES IN LAWS AND REGULATIONS TO WHICH HERITAGE IS SUBJECT,
INCLUDING TAX, ENVIRONMENTAL AND EMPLOYMENT REGULATIONS;

o ITS ABILITY TO GENERATE AVAILABLE CASH FOR DISTRIBUTIONS TO
UNITHOLDERS;

o THE COSTS AND EFFECTS OF LEGAL AND ADMINISTRATIVE PROCEEDINGS
AGAINST IT WHICH MAY BE BROUGHT AGAINST IT;

o ITS ABILITY TO SUSTAIN HISTORICAL LEVELS OF INTERNAL GROWTH; AND

o ITS ABILITY TO CONTINUE TO LOCATE AND ACQUIRE OTHER PROPANE
COMPANIES AT PURCHASE PRICES THAT ARE ACCRETIVE TO ITS FINANCIAL
RESULTS.

WEATHER AND SEASONALITY

Heritage's propane distribution business is seasonal and dependent upon
weather conditions in its service areas. Propane sales to residential and
commercial customers are affected by winter heating season requirements. This
generally results in higher operating revenues and net income during the period
from October through March of each year and lower operating revenues and either
net losses or lower net income during the period from April through September of
each year. Sales to industrial and agricultural customers are much less weather
sensitive.

Gross profit margins are not only affected by weather patterns but also
by changes in customer mix. For example, sales to residential customers
ordinarily generate higher margins than sales to other customer groups, such as
commercial or agricultural customers. In addition, gross profit margins vary by
geographic region. Accordingly, gross profit margins could vary significantly
from year to year in a period of identical sales volumes.

HERITAGE PROPANE PARTNERS, L.P. AND SUBSIDIARIES
(FORMERLY PEOPLES GAS COMPANY AND SURVIVING LEGAL ENTITY IN THE SERIES OF
TRANSACTIONS WITH U.S. PROPANE)

GENERAL

The retail propane business is a "margin-based" business in which gross
profits depend on the excess of sales price over propane supply costs. The
market price of propane is often subject to volatile changes as a result of
supply or other market conditions over which Heritage will have no control.
Product supply contracts are one-year agreements subject to annual renewal and
generally permit suppliers to charge posted prices (plus transportation costs)
at the time of delivery or the current prices established at major delivery
points. Since rapid increases in the wholesale cost of propane may not be
immediately passed on to retail customers, such increases could reduce gross
profits. Heritage generally has and Predecessor Heritage generally had attempted
to reduce price risk by purchasing propane on a short-term basis. Heritage has
and Predecessor Heritage had on occasion purchased significant volumes of
propane during periods of low demand, which generally occur during the summer
months, at the then current market price, for storage both at its service
centers and in major storage facilities for future resale.

The retail propane business of Heritage consists principally of
transporting propane purchased in the contract and spot markets, primarily from
major fuel suppliers, to its retail distribution outlets and then to tanks
located on the customers' premises, as well as to portable propane cylinders. In
the residential and commercial markets, propane is primarily used for space
heating, water heating and cooking. In the agricultural market, propane is
primarily used for crop drying, tobacco curing, poultry brooding and weed
control. In addition, propane is used for certain industrial applications,
including use as an engine fuel that burns in internal combustion engines that
power vehicles and forklifts and as a heating source in manufacturing and mining
processes.

Since its formation in 1989, Heritage has grown primarily through
acquisitions of retail propane operations and, to a lesser extent, through
internal growth. Through August 9, 2000, Predecessor Heritage completed 68

20

acquisitions for an aggregate purchase price of approximately $297 million.
Predecessor Heritage completed 40 of these acquisitions since its initial public
offering on June 25, 1996. During the period from August 10, 2000 and August 31,
2001, Heritage completed 12 additional acquisitions, for an aggregate purchase
price of $119.1 million, not including the merger of U.S. Propane and
Predecessor Heritage. On August 1, 2001, Heritage acquired the operations of
ProFlame, Inc. (ProFlame) and related propane distribution companies in
California and Nevada. ProFlame delivered approximately 38 million retail and
wholesale gallons of propane for its fiscal year ended August 31, 2000 to over
32,000 customers. ProFlame's propane distribution network includes 20 customer
service locations throughout California and Nevada, as well as 11 additional
sites that are either railcar terminals and/or storage facilities located in
areas such as the San Francisco Bay, San Joaquin Valley, Redding and Barstow,
California, and in Reno and Las Vegas, Nevada. The general partner believes that
Heritage is the fourth largest retail marketer of propane in the United States,
based on retail gallons sold. As of November 5, 2001, Heritage serves over
600,000 customers through approximately 275 customer service locations in 28
states.

The retail propane distribution business is largely seasonal due to
propane's use as a heating source in residential and commercial buildings.
Historically, approximately two-thirds of Heritage's retail propane volume and
in excess of 80% of Heritage's EBITDA is attributable to sales during the
six-month peak-heating season of October through March. Consequently, sales and
operating profits are concentrated in the first and second fiscal quarters. Cash
flow from operations, however, is generally greatest during the second and third
fiscal quarters when customers pay for propane purchased during the six-month
peak-heating season.

A substantial portion of Heritage's propane is used in the
heating-sensitive residential and commercial markets causing the temperatures
realized in Heritage's areas of operations, particularly during the six-month
peak-heating season, to have a significant effect on its financial performance.
In any given area, sustained warmer-than-normal temperatures will tend to result
in reduced propane use, while sustained colder-than-normal temperatures will
tend to result in greater propane use. Heritage therefore uses information on
normal temperatures in understanding how temperatures that are colder or warmer
than normal affect historical results of operations and in preparing forecasts
of future operations, which assumes that normal weather will prevail in each of
the regions in which it operates.

Gross profit margins vary according to customer mix. For example, sales
to residential customers generate higher margins than sales to certain other
customer groups, such as agricultural customers. Wholesale margins are
substantially lower than retail margins. In addition, gross profit margins vary
by geographical region. Accordingly, a change in customer or geographic mix can
affect gross profit without necessarily affecting total revenues.

Peoples Gas engaged in the sale, distribution and marketing of propane
and other related products. Revenues are derived primarily from the retail
propane marketing business. Peoples Gas believed that prior to the series of
transactions with Atmos, AGL, Piedmont and Predecessor Heritage, it was among
the top 25 retail propane marketers nationally and was the largest independent
propane distributor in Florida. At the time of the merger of U.S. Propane and
Predecessor Heritage, Peoples Gas was serving more than 70,000 residential,
commercial and industrial customers located in the Florida peninsula.

In August 2000, TECO Energy, Inc., Atmos Energy Corporation, Piedmont
Natural Gas Company, Inc. and AGL Resources, Inc. contributed each company's
propane operations, Peoples Gas, United Cities Propane Gas, Inc. (United
Cities), Piedmont Propane Company (Piedmont), and AGL Propane, Inc. (AGL),
respectively, to U.S. Propane, L.P. (U.S. Propane) in exchange for equity
interests in U.S. Propane. The merger was accounted for as an acquisition using
the purchase method of accounting with Peoples Gas being the accounting
acquirer.

In August 2000, U.S. Propane acquired all of the outstanding common
stock of Heritage Holdings, Inc., Heritage Propane Partner, L.P.'s general
partner, for $120 million. By virtue of Heritage Holdings, Inc.'s general
partner and limited partner interests in Heritage Propane Partners, L.P., U.S.
Propane gained control of Heritage Propane Partners, L.P. Simultaneously, U.S.
Propane transferred its propane operations, consisting of its interest in four
separate limited liability companies, AGL Propane, L.L.C., Peoples Gas Company,
L.L.C., United Cities Propane Gas, L.L.C. and Retail Propane Company, L.L.C.
(former Piedmont operations) to Heritage Propane Partners, L.P. for $181.4
million plus working capital. The $181.4 million was payable $139.5 million in
cash, $31.8 million of assumed debt, and the issuance of 372,392 common units of
the Heritage Propane Partners, L.P. valued at $7.3 million and a 1.0101% limited
partner interest in Heritage Operating, L.P. valued at $2.7 million. An
independent committee of the Board of Directors of Heritage Holdings, Inc,
approved the purchase price and the

21

exchange price for the common units. Subsequent to August 31, 2000, additional
payments of approximately $12.9 million were made for working capital. The
exchange price for the common units was $19.73125 per unit under a formula based
on the average closing price of Heritage Propane Partners, L.P.'s common units
on the New York Stock Exchange for the twenty (20) day period beginning ten (10)
days prior to the public announcement of the transaction on June 15, 2000.

ANALYSIS OF HISTORICAL RESULTS OF OPERATIONS - HERITAGE PROPANE PARTNERS, L.P.
(FORMERLY PEOPLES GAS)

The following discussion of the historical financial condition and
results of operations of Heritage Propane Partners, L.P., formerly Peoples Gas,
should be read in conjunction with the Selected Historical Financial and
Operating Data and notes thereto, and the historical financial statements and
notes thereto included elsewhere herein. The formation of U.S. Propane and the
merger with Predecessor Heritage affect the comparability of the fiscal year
ended August 31, 2001 and the eight months ended August 31, 2000, because the
volumes and results of operations of fiscal 2001 include a full year of the
volumes and results of operations of the propane operations of the combined
operations and also the comparability of the results of the eight months ended
August 31, 2000 and August 31, 1999, because the volumes and results of
operations for the period from August 10, 2000 through August 31, 2000 also
include the volumes and results of operations of AGL Propane, United Cities,
Piedmont Propane and Predecessor Heritage. The increases in the line items
discussed below are a result of these transactions. Amounts discussed below
reflect 100% of the results of M-P Energy Partnership during the period from
August 9, 2000 through August 31, 2000 and the fiscal year ended August 31,
2001. M-P Energy Partnership is a general partnership in which Heritage owns a
60% interest. Because M-P Energy Partnership is primarily engaged in
lower-margin wholesale distribution, its contribution to Heritage's net income
is not significant and the minority interest of this partnership is excluded
from the EBITDA calculation.

FISCAL YEAR ENDED AUGUST 31, 2001 COMPARED TO THE EIGHT MONTHS ENDED AUGUST 31,
2000

Volume. Total retail gallons sold in the year ended August 31, 2001
were 330.2 million, an increase of 291.9 million over the 38.3 million gallons
sold in the eight months ended August 31, 2000. Predecessor Heritage sold 170.9
million retail gallons in the approximate 11-month period ended August 9, 2000.
A return to more normal weather during the peak-heating season plus acquisitions
were responsible for the increase.

Heritage sold approximately 101.6 million wholesale gallons during
fiscal 2001 of which 12.7 million were domestic wholesale and 88.9 million were
foreign wholesale. In the eight months ended August 31, 2000, Heritage sold 0.6
million domestic wholesale gallons and 6.2 million foreign wholesale gallons.
The increase in wholesale gallons is attributable to having a full year of the
operations of Predecessor Heritage reported in fiscal 2001, as Peoples Gas did
not have any wholesale gallons that were reported in the eight months ended
August 31, 2000. As a comparison, Predecessor Heritage sold approximately 82.6
million wholesale gallons in the 11-month period ended August 9, 2000 of which
7.1 million were domestic wholesale and 75.5 million were foreign wholesale.

Revenues. Total revenues for the fiscal year ended August 31, 2001 were
$715.5 million an increase of $652.4 million as compared to $63.1 million in the
eight months ended August 31, 2000. Revenues for the propane operations of
Predecessor Heritage for the approximate 11-month period ended August 9, 2000
were $242.5 million. Retail revenues for the fiscal year ended August 31, 2001
were $440.5 million as compared to $43.8 million for the eight months ended
August 31, 2000, an increase of $396.7 million. Predecessor Heritage reported
retail fuel revenues of $178.9 million were in the 11-months ended August 9,
2000. Domestic wholesale revenues were $9.9 million, foreign wholesale revenues
were $50.0 million and other revenues were $42.2 for the fiscal year ended
August 31, 2001. Heritage also had revenues from its liquids marketing of $172.9
million for fiscal 2001, which began operations in June of 2000. For the eight
months ended August 31, 2000, Heritage reported domestic wholesale revenues of
$.4 million, foreign wholesale revenues of $3.4 million and revenues from the
liquids marketing of $12.3 million. A full year of the combined operations of
the propane operations of U.S. Propane, Predecessor Heritage and the additional
acquisitions made by Heritage attributed to the increases in the revenues, along
with the increase in gallons, due to the return of more normal weather patterns,
higher selling prices and the effect of the operations of previous acquisitions
in fiscal 2001 as compared to periods reported last year.

Cost of Products Sold. Total cost of products sold in fiscal 2001
increased $436.5 million to $478.0 million as compared to $41.5 million for the
eight months ended August 31, 2000. Of this increase, $160.0 million is the
result of the liquids marketing due to the increased related revenues. Retail
fuel cost of sales were $238.1 million for

22

the fiscal year ended August 31, 2001, an increase of $212.7 million, as
compared to $25.4 million for the eight months ended August 31, 2000.
Predecessor Heritage reported total cost of sales of $140.8 million in the
11-month period ended August 9, 2000, of which $95.1 million was for retail fuel
cost of sales. Wholesale cost of sales increased $53.4 million of which $44.7
million was related to foreign cost of sales. Other cost of sales increased to
$11.4 million as compared to $1.0 million due to a full year of the combined
operations of the propane operations of U.S. Propane and Predecessor Heritage
coupled with the acquisitions made during fiscal 2001. Fuel cost of sales
increased due to the increases in volumes described above and due to the
significantly higher wholesale cost of propane for fiscal year ended August 31,
2001 as compared to the eight-month period last year.

Gross Profit. Total gross profit increased to $237.4 million in fiscal
2001 as compared to $21.6 million for the eight months ended August 31, 2000.
This increase is due to the aforementioned increases in volumes and revenues,
offset by the increase in product costs. For the fiscal year ended August 31,
2001, retail fuel gross profit was $202.4 million, domestic wholesale was $.8
million, and other gross profit was $30.7 million. Foreign wholesale gross
profit was $2.0 million and liquids marketing gross profit was $1.4 million for
the fiscal year ended August 31, 2001. As a comparison, for the eleven month
period ended August 9, 2000, Predecessor Heritage recorded retail fuel gross
profit of $83.8 million, wholesale fuel gross profit of $.6 million, foreign
gross profit of $1.5 million and other of $15.8 million, for a total gross
profit of $101.7 million.

Operating Expenses. Operating expenses were $126.8 million for fiscal
2001 as compared to $16.6 million for the eight-month period ended August 31,
2000. The increase of $110.2 million is the result of the additional operating
expenses related to a full year of the combined propane operations of U.S.
Propane, Predecessor Heritage and the additional acquisitions made by Heritage.
Predecessor Heritage reported operating expenses of $55.1 million in the
eleven-month period ended August 9, 2000.

Selling, General and Administrative. Selling, general and
administrative expenses were $15.7 million for the fiscal year ended August 31,
2001 as compared to $1.0 million for the eight months ended August 31, 2000.
Peoples Gas did not classify any of its operating expenses as selling, general
and administrative, so as a comparison Predecessor Heritage had selling, general
and administrative, expenses of $6.0 million for the eleven month period ended
August 31, 2000. The increase in selling, general and administrative expenses is
primarily due to the growth of Heritage resulting from the merger of U.S.
Propane and Predecessor Heritage, other acquisitions and the additional
executive compensation that relates to this fiscal year's operating performance.

Depreciation and Amortization. Depreciation and amortization for the
fiscal year ended August 31, 2001 was $40.4 million, an increase of $35.7
millions as compared to $4.7 million in the eight months ended August 31, 2000.
The increase is primarily attributable to the addition of property, plant and
equipment, and intangible assets from the transactions referred to above.

Operating Income (Loss). Heritage reported net income of $54.4 million
in fiscal 2001 as compared to the operating loss of $.7 million for the eight
months ended August 31, 2000. Predecessor Heritage reported operating income of
$23.5 million for the eleven-month period ended August 9, 2000. The increases in
gross profit above, offset by the increases in operating and selling, general
and administrative expenses and depreciation and amortization, attributed to the
increase in operating income.

Provision for Income Taxes. Heritage did not report a provision for
income taxes for fiscal 2001. Heritage is a limited partnership and as a result,
its earnings or loss for federal income tax purposes is included in the tax
returns of the individual partners. Provision for income taxes was $.4 million
in the eight months ended August 31, 2000, which represents the provision for
income taxes incurred prior to the transactions with Predecessor Heritage. Prior
to the transaction with Predecessor Heritage, Peoples Gas filed a consolidated
federal income tax return with TECO and, based on a tax sharing agreement,
included, in its statements of operations, a provision for income taxes
calculated on a separate return basis.

Net Income (Loss). Heritage reported a record net income of $19.7
million, or $1.43 per limited partner unit, for the fiscal year ended August 31,
2001, an increase of $23.5 million over the net loss of $3.8 million for the
eight-month period ended August 31, 2000. Predecessor Heritage reported net
income of $6.5 million or $0.66 per limited partner unit for the eleven-month
period ended August 9, 2000. The increase in net income over the eight-month
period ended August 31, 2000 and the eleven-month period ended August 9, 2000,
was the result of the increase in operating income described above, plus a
nonrecurring gain of $.8 million on the sale of excess property offset by an

23

increase of $33.2 million of interest expense over the interest expense reported
in eight months ended August 31, 2000. Interest expense for fiscal 2001
increased due to the increase of debt incurred in the transaction with U.S.
Propane.

EIGHT MONTHS ENDED AUGUST 31, 2000 COMPARED TO THE EIGHT MONTHS ENDED AUGUST 31,
1999 (UNAUDITED)

Volume. Total retail gallons sold in the eight months ended August 31,
2000 were 38.3 million, an increase of 16.2 million over the 22.1 million
gallons sold in the eight months ended August 31, 1999. Heritage sold 16.3
million retail gallons in the period from August 10, 2000 through August 31,
2000, thus the increase in retail gallons is primarily attributable to the
transactions referred to above.

Revenues. Total revenues for the eight months ended August 31, 2000
were $63.1 million, an increase of $41.3 million as compared to $21.8 million
for the eight months ended August 31, 1999. Revenues for the former propane
operations of Predecessor Heritage for the period from August 10, 2000 through
August 31, 2000 were $36.4 million, of which $11.7 million was due to the
liquids marketing activity conducted through Heritage Energy Resources and the
remainder related to increased volumes. The increase in revenue is primarily
attributable to the transactions referred to above.

Cost of Products Sold. Total cost of products sold increased $33.0
million to $41.5 million for the eight months ended August 31, 2000. Of this
increase, $11.5 million is the result of the liquids marketing activity for the
period from August 10, 2000 through August 31, 2000, with the remainder relating
to the increased volumes described above.

Operating Expenses. Operating expenses were $16.6 million for the
eight-month period ended August 31, 2000 as compared to $8.6 million for the
eight months ended August 31, 1999. The increase of $8.0 million is the result
of the additional operating expense related to the merger.

Depreciation and Amortization. Depreciation and amortization was $4.7
million in the eight months ended August 31, 2000 as compared to $2.0 million in
the eight months ended August 31, 1999. The increase is attributable to the
transactions referred to above.

Operating Income (Loss). Heritage had an operating loss of $.7 million
for the eight months ended August 31, 2000 as compared to operating income of
$2.7 million for the eight months ended August 31, 1999. The decrease is the
result of the additional operating expenses and depreciation and amortization
resulting from the merger.

Provision for Income Taxes. Provision for income taxes decreased $.6
million, to $.4 million for the eight months ended August 31, 2000, as compared
to $1.0 million for the eight months ended August 31, 1999. This decrease is a
result of the decrease in income before provision for income taxes in the
comparable eight-month period of Peoples Gas. Prior to the transaction with
Predecessor Heritage, Peoples Gas filed a consolidated federal income tax return
with TECO and, based on a tax sharing agreement, included, in its statements of
operations, a provision for income taxes calculated on a separate return basis.

Net Income (Loss). For the eight-month period ended August 31, 2000,
Heritage had a net loss of $3.8 million, a decrease of $5.4 million as compared
to net income for the eight months ended August 31, 1999 of $1.6 million. This
decrease is the result of decreased operating income described above.

FISCAL YEAR ENDED DECEMBER 31, 1999 AS COMPARED TO FISCAL YEAR 1998

Volume. Peoples Gas sold 33.6 million gallons in fiscal 1999, an
increase of 2.7 million gallons, or 9% from the 30.9 million gallons sold in
fiscal 1998, primarily as a result of the July 1999 acquisition of Commercial
Propane, Inc. The increase in volumes was net of the effects of unseasonably
warm weather.

Revenues. Total revenues for Peoples Gas increased $3.8 million, or
12.6% to $34.0 million from fiscal 1998's total revenues of $30.2 million. The
increase is primarily the result of increased volumes associated with the July
1999 acquisition of Commercial Propane, Inc. and the effects of higher cost of
fuel.

24

Cost of Products Sold. Total cost of product sold increased $2.5
million, or 20.3% to $14.8 million for fiscal 1999 as compared to $12.3 for
fiscal 1998. The increase is primarily the result of increased volumes
associated with the July 1999 acquisition of Commercial Propane, Inc. and the
effects of higher cost of propane that was passed through to customers.

Operating Expenses. Operating expenses for fiscal 1999 increased $2.1
million, or 18.9% to $13.2 million as compared to $11.1 million in fiscal 1998.
This increase is primarily the result of increased costs related to additional
marketing efforts and costs related to the July 1999 acquisition of Commercial
Propane, Inc.

Depreciation and Amortization. Depreciation and amortization was $3.1
million for fiscal 1999, a $0.2 million increase over fiscal 1998's $2.9
million. This increase is the result of additional depreciation on maintenance
and growth capital expenditures and fixed assets recorded in relation to
acquisitions.

Operating Income. Operating income decreased $1.1 million, or 27.5% to
$2.9 million as compared to $4.0 million in fiscal 1998. The increased revenues
described above were more than offset by the increases in operating expenses,
depreciation and amortization, also described above, which resulted in this
decrease.

Provision for Income Taxes. Provision for income taxes decreased $0.3
million, or 21.4% to $1.1 million as compared to $1.4 million for 1998. This
decrease is a result of the decrease in income before provision for income
taxes.

Net Income. Net income for fiscal year 1999 decreased $0.3 million, or
14.3% to $1.8 million as compared to fiscal 1998's net income of $2.1 million.
This decrease is the result of decreased operating income b