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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-K

(Mark One)

For the fiscal year ended September 30, 2004

OR

For the transition period from                      to                     

Commission File Number: 001-14129

Commission File Number: 333-103873

STAR GAS PARTNERS, L.P.

STAR GAS FINANCE COMPANY

(Exact name of registrants as specified in its charters)

(203) 328-7310

(Registrants’ telephone number, including area code)

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

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 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. ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). x

The aggregate market value of Star Gas Partners, L.P. Common Units held by non-affiliates of Star Gas Partners, L.P. on March 31, 2004 was approximately $820,309,841. As of December 8, 2004, the registrants had units and shares outstanding for each of the issuers classes of common stock as follows:

Documents Incorporated by Reference: None

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STAR GAS PARTNERS, L.P.

2004 FORM 10-K ANNUAL REPORT

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PART I

Structure

Star Gas Partners, L.P. (“Star Gas” or the “Partnership”) is a diversified home energy distributor and services provider, specializing in heating oil and propane. Star Gas is a master limited partnership, which at September 30, 2004 had outstanding 32.2 million common units (NYSE: “SGU” representing an 89.1% limited partner interest in Star Gas) and 3.2 million senior subordinated units (NYSE: “SGH” representing a 9.0% limited partner interest in Star Gas). Additional Partnership interests include 0.3 million junior subordinated units (representing a 1.0% limited partner interest) and 0.3 million general partner units (representing a 0.9% general partner interest).

The Partnership is organized as follows:

The Partnership was formerly engaged as an energy reseller that marketed natural gas and electricity to residential households in deregulated energy markets through Total Gas & Electric, Inc. (“TG&E”), a Florida corporation, that was an indirect wholly-owned subsidiary of Petro. On March 31, 2004, the Partnership sold the stock and business of TG&E in an all-cash transaction to a private party. The Partnership received net proceeds of approximately $12.5 million and recorded a loss of approximately $0.5 million from the sale of TG&E.

The Partnership files annual, quarterly, current and other reports and information with the SEC. These filings can be viewed and downloaded from the internet at the SEC’s website at www.sec.gov. In addition, these SEC filings are available at no cost as soon as reasonably practicable after the filing thereof on the Partnership’s website at www.star-gas.com/Edgar.cfm. These reports are also available to be read and copied at the SEC’s public reference room located at Judiciary Plaza, 450 5th Street, N.W., Washington, D.C. 20549. The public may obtain information on the operation of the public reference room by calling the SEC at 1-800-SEC-0330. You may also obtain copies of these filings and other information at the offices of the New York Stock Exchange located at 11 Wall Street, New York, New York 10005.

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Recent Events

On October 18, 2004, the Partnership announced that it had advised the heating oil segment’s bank lenders that this segment would not be able to make the required representations included in the borrowing certificate under its working capital line. In addition, the Partnership notified such lenders that, for the quarter ending December 31, 2004 and for the foreseeable future thereafter, the heating oil segment will be unlikely to satisfy the drawing condition that requires that the consolidated funded debt of the Partnership not exceed 5.00 times its consolidated operating cash flow. Further, the Partnership advised the lenders that the heating oil segment may not be able to maintain a zero balance under the working capital facility (except for letter of credit obligations) for 45 consecutive days from April 1, 2005 to September 30, 2005, as required by the heating oil segment’s covenants. The Partnership indicated that the source of the problem is a combination of (a) the inability to pass on the full impact of record wholesale heating oil prices to customers and (b) the effects of unusually high customer attrition principally related to the heating oil segment’s operational restructuring undertaken in the past 18 months.

The Partnership also announced that it anticipated that because of the requirements of the Partnership’s current and potential bank lenders, it will not be permitted to make any distributions on its common units.

In addition, the Partnership announced that the heating oil segment’s bank lenders had agreed to permit the heating oil segment to request new working capital advances daily while the Partnership was in discussions with such bank lenders about modifying the terms and conditions of the heating oil segment’s credit agreement. In connection with that understanding the bank lenders requested that the Partnership allow an independent financial advisor to review the heating oil segment’s operations and performance on their behalf.

On November 5, 2004, the Partnership announced that the heating oil segment had entered into a letter amendment and waiver under its credit agreement with Wachovia Bank, N.A. As a result of the amendment, the heating oil segment was able to continue to borrow funds under the credit agreement to support its working capital requirements for the near term. The amendment provides for the waiver, through December 17, 2004, of various terms under the credit agreement. The amendment also amends for the waiver period the financial covenant regarding the Partnership’s consolidated funded debt to cash flow ratio and the financial covenant regarding the heating oil segment’s cash flow to interest expense ratio.

The Partnership also announced that its propane segment had entered into a commitment letter with JPMorgan Securities Inc. and JPMorgan Chase Bank. Under the commitment letter, as amended, JP Morgan Chase Bank committed, subject to certain conditions, to provide a $350 million ($260 million if the propane segment is sold, as discussed below) asset-based senior secured revolving credit facility referred to herein as the revolving credit facility and a $300,000,000 senior secured bridge facility referred to herein as the bridge facility to refinance (the “refinancing transactions”) all of the heating oil segment’s and the propane segment’s (if the propane segment is not sold) working capital facilities and senior secured notes.

On November 18, 2004, the Partnership announced that it had signed an agreement to sell its propane segment, held largely through Star Gas Propane to Inergy Propane LLC (“Inergy”), the operating subsidiary of Inergy, L.P., for $475 million subject to certain adjustments. The Partnership anticipates recognizing a gain in excess of approximately $150 million from the sale of the propane segment. In addition, the Partnership gave notice to holders of the heating oil segment’s secured notes of its optional election to prepay such secured notes, representing an aggregate payment, including principal, interest and estimated premium, of approximately $182 million. The Partnership subsequently gave notice of its optional election to prepay its propane segment’s secured notes involving an aggregate payment including principal, interest and estimated premium, of approximately $114 million. The aggregate amount payable with regard to both sets of secured notes is approximately $296 million. As discussed elsewhere herein, these payments are expected to be made from either the proceeds of the sale of the propane segment or the JP Morgan Chase Bank bridge facility. The partnership expects to recognize a loss of approximately $43 million on the early redemption of this debt in its first quarter of fiscal 2005. For additional information concerning the sale of the propane segment, see Item 1 – Business - “Sale of the Propane Segment; Prepayment of Subsidiaries’ Secured Notes.”

If the sale of the propane segment to Inergy is not consummated for any reason by December 17, 2004, the Partnership’s commitment from JP Morgan Chase will remain unaffected. On that date, the Partnership would expect to draw down JP Morgan Chase’s bridge facility if the propane segment sale has not been consummated. The proceeds from the bridge facility would be used to repay the Partnership’s subsidiaries’ secured notes, which will become due on that date because of the Partnership’s notice of prepayment. The Partnership also would expect to close on that date the asset based revolving credit agreement underwritten by JP Morgan Chase to replace the existing revolving credit agreements of the

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Partnership’s subsidiaries. Therefore, the Partnership will be able to restructure its indebtedness as disclosed in the Partnership’s previous press release dated November 5, 2004, provided that it is able to satisfy the conditions in the JP Morgan Chase commitment. The JP Morgan Chase commitment for the bridge facility and the revolving credit facility is subject to a number of conditions and there can be no assurance that the Partnership will meet those conditions. See “Liquidity and Capital Resources – Financing and Sources of Liquidity, Following Refinancing Transactions.”

If the propane segment is sold (either before or after December 17, 2004), the revolving credit facility will be reduced to $260 million and the liens on all of the assets of the propane segment would be released. If the sale of the propane segment does not close until after the Partnership has drawn down on the bridge facility, the Partnership will use a portion of the sales proceeds to repay the bridge loan. The remaining proceeds will be applied in accordance with the terms of the indenture relating to the Partnership’s 10-1/4% senior notes due 2013 (“MLP Notes”), which is discussed below under “Liquidity and Capital Resources – Financing and Sources of Liquidity, Following Refinancing Transactions.” If the agreement for the sale of the propane segment is terminated, the Partnership will seek to repay the bridge facility through the issuance of senior secured notes issued by the heating oil segment and the propane segment in a public or private offering.

For a further discussion of the refinancing transactions, see “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Sale of the Propane Segment; Prepayment of Subsidiaries’ Secured Notes

Background

On November 18, 2004, the Partnership signed an agreement to sell its propane distribution and services segment, held largely through Star Gas Propane, L.P., to Inergy for $475 million, subject to certain adjustments. Following the Partnership’s press release of October 18, 2004 concerning the heating oil segment’s borrowing problems, the Partnership was approached by Inergy regarding its interest in acquiring the Partnership’s propane segment. In connection with addressing this possibility, the board of directors of the Partnership’s general partner formed a special committee comprised of two independent directors to determine whether a transaction would be fair to the non-affiliated unitholders of the Partnership as a whole. The special committee, in turn, engaged separate financial and legal advisors to assist it. The board monitored the negotiation with Inergy and considered other possible alternatives, including a sale of less than all of the propane segment, a sale of the heating oil segment, a sale of the entire Partnership and delaying any discussion regarding a sale and simply restructuring the debt of the Partnership. The special committee and full board considered the tax impact of the announced transaction and particularly why the sale of the propane segment would generate adverse tax consequences to a number of unitholders, particularly those that had held their units the longest. The special committee and full board considered the likelihood of consummation of the transaction and the specific terms of the purchase agreement with Inergy. The agreement includes a provision permitting the Partnership to terminate the agreement should a superior proposal be made for the propane segment or the Partnership as a whole upon a payment of a breakup fee.

The analyses presented to the special committee and the board indicated that the sale of the propane segment would, by deleveraging the balance sheet of the Partnership, likely advance the time when it would be possible for the Partnership to resume regular distributions on the Partnership’s common units, at some level, although the special committee and full board understood that there could be no assurance that the Partnership would make distributions on the common units, at any level, in the future. The analyses also indicated that, irrespective of the sale of the propane segment, it is unlikely that the Partnership will resume regular distributions to the senior subordinated and junior subordinated units for the foreseeable future.

After considering and partially in reliance on the advice of its advisors, the special committee unanimously determined that the sale of the propane segment to Inergy on the terms described above was fair to the non-affiliated unitholders of the Partnership as a whole. After considering the advice of their advisors and an analysis of the issues, the Audit Committee unanimously determined that the transaction was fair to the Partnership, and the Audit Committee and the full board unanimously approved the execution of the agreement to sell the Partnership’s propane segment to Inergy. The Partnership believes that the sale will improve the Partnership’s financial condition which should have the effect of increasing the heating oil segment’s opportunities.

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Terms of the Agreement.

General description. The agreement with Inergy contemplates that Inergy will purchase the Partnership’s propane segment for $475 million in cash, subject to adjustment without assumption of the propane segment’s indebtedness for borrowed money at the time of sale. The purchase price is subject to certain adjustments including a working capital adjustment. The transaction is expected to close in late December 2004. For purposes of economic effect, the transaction will be effective as of November 30, 2004 and Inergy will assume all profits subsequent to that date.

Upon completion of the sale of the propane segment, the Partnership will restate prior years’ results to include the results of the propane segment and the gain on the disposition as a component of discontinued operations.

No financing condition. The purchaser’s obligation to close is not conditioned on receipt of financing although the purchaser will need financing to complete the purchase.

General conditions. The sale is conditioned on a number of customary closing conditions, including the passage of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, the filing for which was made on November 18, 2004. The agreement provides that the Partnership will enter into a five-year non-competition agreement with respect to the propane segment in certain regions. The agreement also provides for a breakup fee to Inergy in the event that the Partnership terminates the agreement because of a superior offer for the propane segment or the Partnership enters into an agreement providing for the sale of the Partnership in its entirety. The Partnership can terminate the agreement if the transaction does not close by December 20, 2004, and Inergy can terminate the agreement if the transaction does not close by December 31, 2004. There can be no assurance that all of the conditions to closing will be met. The Partnership believes that no unitholder approval is required and none is going to be requested.

Partnership status. Star Gas will continue to be classified as a partnership for federal income tax purposes after the sale of the propane segment. Nonetheless, because the heating oil business is held through a corporate subsidiary, following the sale nearly all of Star Gas’ earnings will be subject to corporate-level income taxes, whereas prior to the sale most of the earnings from the propane business are not subject to entity-level taxation. By virtue of net operating loss carryforwards, the Partnership does not anticipate that the corporate subsidiary will pay substantial federal income taxes for several years.

Use of Proceeds from the Sale of the Propane Segment

Proceeds from the sale of the propane segment will be used to repay $296 million that will be owing with respect to the secured notes at the Partnership’s subsidiaries, to repay outstanding borrowings under the propane segment’s credit facilities, and to pay expenses related to the sale of the propane segment.

Thereafter, pursuant to the terms of the indenture relating to the Partnership’s MLP Notes, the Partnership will be obligated, within 360 days of the sale, to apply the net proceeds of the sale of the propane segment either to reduce indebtedness of the Partnership or of a restricted subsidiary, or to make an investment in assets or capital expenditures useful to the Partnership’s or any subsidiary’s business. To the extent any net proceeds that are not so applied exceed $10 million (“excess proceeds”), the indenture requires the Partnership to make an offer to all holders of MLP Notes to purchase for cash that number of MLP Notes that may be purchased with excess proceeds at a purchase price equal to 100% of the principal amount of MLP Notes plus accrued and unpaid interest to the date of purchase. The Partnership cannot estimate the amount, if any, of excess proceeds that will result from the sale of the propane segment. Accordingly, the Partnership cannot predict the size of any offer to purchase the MLP Notes and whether or to what extent holders of MLP Notes will accept the offer to purchase when made.

Tax Consequences to Unitholders Upon Sale of the Propane Segment

The Partnership’s unitholders will recognize gain or loss associated with the sale of the propane business based on a number of factors, including each individual holder’s basis in the Partnership units held, and the tax consequences of such sale will accrue to the record holders as of the date of the sale. Based on its preliminary calculations, in general the Partnership estimates that, depending on the profile of the unitholder, the gain can be as high as approximately $11 per common unit and loss as high as $4.27. In general, the Partnership anticipates that holders who have held units for a substantial period of time, particularly those who purchased units prior to 2002, and those who purchased units at a low purchase price, will recognize the most gain. A holder’s tax basis in units will be increased by the amount of gain recognized. If a holder sells units prior to the consummation of the sale of the propane business, such holder may recognize substantially less gain than would a holder who continues to hold through the date of consummation of the sale. For additional information concerning the tax consequences to unitholders, see Appendix A.

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Unitholders are encouraged to consult with their own tax advisors with respect to the application of tax laws to their particular situations.

Prepayment of the Partnership’s Subsidiaries’ Secured Notes

On November 18, 2004, the Partnership gave the holders of the heating oil segment’s secured notes notice of prepayment of all of the notes on December 17, 2004. As contemplated by the note purchase agreements relating to the notes, the prepayment amount will be 100% of the principal amount outstanding ($157.2 million), together with interest accrued thereon to the date of prepayment ($3.6 million) and an estimated make-whole amount ($21 million). The Partnership subsequently gave notice of the prepayment of the propane segment’s secured notes. The prepayment amount for the propane segment’s secured notes will be 100% of the outstanding principal amount ($96.3 million), together with accrued interest thereon to the date of prepayment ($1.9 million) and an estimated make-whole amount ($16 million). The aggregate amount payable for the heating oil segment’s notes and the propane segment notes is approximately $296 million. These payments are expected to be made from either the proceeds of the sale of the propane segment or the JP Morgan Bank bridge facility.

Amendments to Partnership Agreements

The Partnership has adopted certain amendments to its amended and restated agreement of limited partnership as well as certain amendments to the amended and restated agreement of limited partnership of Star Gas Propane in order to permit the sale of the propane segment.

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Introduction to Business

Seasonality

The Partnership’s fiscal year ends on September 30. All references to quarters and years in this document are to fiscal quarters and years unless otherwise noted. The seasonal nature of the Partnership’s business results in the sale of approximately 30% of its volume in the first quarter (October through December) and 45% of its volume in the second quarter (January through March) of each year, the peak heating season, because propane and heating oil are primarily used for space heating in residential and commercial buildings. The Partnership generally realizes net income in both of these quarters and net losses during the quarters ending in June and September. The Partnership typically has negative working capital at September 30, due to seasonality. In addition, sales volume typically fluctuates from year to year in response to variations in weather, wholesale energy prices and other factors. Gross profit is not only affected by weather patterns but also by changes in customer mix. For example, sales to residential customers ordinarily 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.

Propane

The propane segment is primarily engaged in the retail distribution of propane and related supplies and equipment to residential, commercial, industrial, agricultural and motor fuel customers. Customers are served from 122 branch locations and 136 satellite storage facilities in the Midwest and Northeast regions and Florida and Georgia. In addition to its retail business, the segment also serves wholesale customers. Based on sales dollars, approximately 96% of propane sales were to retail customers and approximately 4% were to wholesale customers. Retail sales have historically had a greater profit margin, more stable customer base and less price sensitivity as compared to the wholesale business.

Propane, also known as a liquid petroleum gas (lpg) ranks as the fourth most important source of residential heating in the United States, according to the U.S. Department of Energy - Energy Information Administration, 2001 Residential Energy Consumption Survey. Excluding propane gas grills, residential and commercial demand accounts for approximately 45% of all propane used in the United States. Of the 106.9 million households in the United States, 9.3 million households depend on propane. Because 54% of these households rely on propane for their primary heating fuel, sales of propane are highly seasonal. Propane is most commonly used to provide energy to areas not serviced by the natural gas distribution system. Thus, it competes mainly with heating oil and electricity for space heating purposes. Residential customers are typically homeowners, while commercial customers include motels, restaurants, retail stores and laundromats. Industrial users, such as manufacturers, use propane as a heating and energy source in manufacturing and drying processes. In addition, propane is used to supply heat for drying crops and as a fuel source for certain vehicles.

Propane is extracted from natural gas at processing plants or separated from crude oil during the refining process. It is normally transported and stored in 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, propane is usable as a flammable gas. Propane is colorless and odorless; an odorant is added to allow its detection.

Home Heating Oil

Home heating oil customers are served from 19 locations in the Northeast and Mid-Atlantic regions, from which the heating oil segment delivers heating oil and other petroleum products and installs and repairs heating equipment 24 hours a day, seven days a week, 52 weeks a year. These services are an integral part of its basic heating oil business, and are intended to maximize customer satisfaction and loyalty. In fiscal 2004, the heating oil segment’s sales represented approximately 74% of sales from home heating oil; 17% from the installation and repair of heating and air conditioning equipment; and 9% from the sale of other petroleum products, including diesel fuel and gasoline, to commercial customers. In fiscal 2004, sales to residential customers represented 87% of the retail heating oil gallons sold and 92% of heating oil gross profits.

Heating oil can be used for residential and commercial heating purposes, and it is a significant source of fuel used to heat business and residences in the New England and Mid-Atlantic regions. According to the U.S. Department of Energy—Energy Information Administration, 2001 Residential Energy Consumption Survey, these regions account for approximately 77% of the households in the United States where heating oil is the main space-heating fuel. Approximately 31% of the homes in the region use heating oil as their main space-heating fuel. In recent years, demand for home heating oil has been affected by conservation efforts and conversions to natural gas. In addition, as the number of new homes that use oil heat has not been significant, there has been virtually no increase in the customer base due to housing starts.

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Industry Characteristics

The retail propane and home heating oil industries are both mature, with total demand expected to remain relatively flat or to decline slightly. The Partnership believes that these industries are relatively stable and predictable due principally to the non-discretionary nature of propane and home heating oil use. Accordingly, the demand for propane and home heating oil has historically been relatively unaffected by general economic conditions but has been a function of weather conditions. It is common practice in both the propane and home heating oil distribution industries to price products to customers based on a per gallon margin over wholesale costs. As a result, distributors generally seek to maintain their margins by passing wholesale costs through to customers, thus insulating themselves from the volatility in wholesale heating oil and propane prices. However, during periods of sharp price fluctuations in supply costs, distributors may be unable or unwilling to pass the entire product cost increases or decreases through to customers. In these cases, significant increases or decreases in per gallon margins may result. In addition, the timing of cost pass-throughs can significantly affect margins. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The propane and home heating oil distribution industries are highly fragmented, characterized by a large number of relatively small, independently owned and operated local distributors. Each year a significant number of these local distributors have sought to sell their business for reasons that include retirement and estate planning. In addition, the propane and heating oil distribution industries are becoming more complex due to increasing environmental regulations and escalating capital requirements needed to acquire advanced, customer-oriented technologies. Primarily as a result of these factors, both industries are undergoing consolidation, and the propane segment and the heating oil segment have been active consolidators in each of their markets.

Recent Acquisitions

In fiscal 2004, the Partnership completed the purchase of three retail heating oil dealers for an aggregate of $3.5 million and ten retail propane dealers for an aggregate of $14.0 million.

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Propane Segment

As indicated above under “Sale of the Propane Segment; Prepayment of Subsidiaries’ Secured Notes,” the Partnership has signed an agreement for the sale of its propane segment. The following is a description of such business.

Operations

Retail propane operations are located in the following states:

In addition to selling propane, the propane segment also sells home heating oil and installs related equipment, including heating and cooking appliances. Several locations sell bottled water and sell or lease water conditioning equipment. Typical branch locations consist of an office, an appliance showroom and a warehouse and service facility, with one or more 12,000 to 30,000 gallon bulk storage tanks. Satellite facilities typically contain only storage tanks. The distribution of propane at the retail level for the most part involves large numbers of small deliveries averaging 100 to 150 gallons to each customer. Retail deliveries of propane are usually made to customers by means of the propane segment’s fleet of bobtail and rack trucks.

Currently the propane segment owns or leases a total of 746 bobtail, boom and rack trucks. Propane is pumped from a bobtail truck, which generally holds 2,000 to 3,000 gallons, into a storage tank at the customer’s premises. The capacity of these tanks ranges from approximately 24 gallons to approximately 1,000 gallons. The propane segment also delivers propane to retail customers in portable cylinders, which typically are picked up and replenished at distribution locations, then returned to the retail customer. To a lesser extent, the propane segment also delivers propane to certain end-users of propane in larger trucks known as transports. These trucks have an average capacity of approximately 9,000 gallons. End-users receiving transport deliveries include industrial customers, large-scale heating accounts, such as local gas utilities that use propane as a supplemental fuel to meet peak demand requirements, and large agricultural accounts that use propane for crop drying and space heating.

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Customers

During the last fiscal year, the propane segment’s residential volume, excluding the impact of volume obtained through acquisitions, decreased 2.7% due to attrition and other factors including consumer conservation and increased competition from low cost providers. Management expects some degree of attrition to continue in 2005 and perhaps beyond. However, the propane segment has continued to grow through acquisitions and it completed ten acquisitions with approximately 14,000 customers and total annual volumes of 13.7 million gallons during fiscal 2004. Approximately 70% of the propane segment’s retail propane sales are made to residential customers and 30% of retail propane sales are made to commercial and agricultural customers. Sales to residential customers in fiscal 2004 accounted for approximately 75% of propane gross profit on propane sales, reflecting the higher-margins of this segment of the market. In excess of 90% of the propane customers lease their tanks from the propane segment. In most states, due to fire safety regulations, a leased tank may only be refilled by the propane distributor that owns that tank. The inconvenience associated with switching tanks greatly reduces a propane customer’s tendency to change distributors. Over half of the propane segment’s residential customers receive their propane supply under an automatic delivery system. The amount delivered is based on weather and historical consumption patterns. The automatic delivery system eliminates the customer’s need to make affirmative purchase decisions. The propane segment provides emergency service 24 hours a day, seven days a week, 52 weeks a year.

Competition

The propane industry is highly competitive; however, long-standing customer relationships are typical of the retail propane industry. The ability to compete effectively within the propane industry depends on the reliability of service, responsiveness to customers and the ability to maintain competitive prices. The propane segment believes that its superior service capabilities and customer responsiveness differentiates it from many of its competitors. Branch operations offer emergency service 24 hours a day, seven days a week, 52 weeks a year. Competition in the propane industry is highly fragmented and generally occurs on a local basis with other large full-service multi-state propane marketers, smaller local independent marketers and farm cooperatives. According to LP Gas Magazine – February 2003, the ten largest multi-state marketers, including the Partnership’s propane segment, account for approximately 32% of the total retail sales of propane in the United States, and no single marketer has a greater than 10% share of the total retail market in the United States. Most of the propane segment’s branches compete with five or more marketers or distributors. The principal factors influencing competition among propane marketers are price and service. Each branch operates in its own geographic market. While retail marketers locate in close proximity to customers to lower the cost of providing delivery and service, the typical retail distribution outlet has an effective marketing radius of approximately 35 miles.

Propane competes primarily with electricity, natural gas and fuel oil as an energy source on the basis of price, availability and portability. Propane is generally more expensive than natural gas, but serves as an alternative to natural gas in rural and suburban areas where natural gas is unavailable or portability of product is required. The expansion of natural gas into traditional propane markets has historically been inhibited by the capital costs required to expand distribution and pipeline systems. Although the extension of natural gas pipelines tends to displace propane distribution in the areas affected, the Partnership believes that new opportunities for propane sales arise as more geographically remote areas are developed. Although propane is similar to fuel oil in space heating and water heating applications, as well as in market demand and price, propane and fuel oil have generally developed their own distinct geographic markets. Because furnaces that burn propane will not operate on fuel oil, a conversion from one fuel to the other requires the installation of new equipment.

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Home Heating Oil Segment

Operations

The Partnership’s heating oil segment serves over 515,000 customers in the Northeast and Mid-Atlantic regions. In addition to selling home heating oil, the heating oil segment installs, maintains and repairs heating and air conditioning equipment. To a limited extent, it also markets other petroleum products. During the 12 months ended September 30, 2004, the total sales in the heating oil segment were comprised of approximately 74% from sales of home heating oil; 17% from the installation and repair of heating equipment; and 9% from the sale of other petroleum products. The heating oil segment provides home heating equipment repair service 24 hours a day, seven days a week, 52 weeks a year. It also regularly provides various incentives to obtain and retain customers. The heating oil segment is consolidating its operations under two primary brand names, Petro and Meenan, which it is building by employing an upgraded sales force, together with a professionally developed integrated marketing campaign, including broadcast and print advertising media, including direct mail. The heating oil segment has a nationwide toll free telephone number, 1-800-OIL-HEAT, which it believes helps facilitate customer needs.

The heating oil segment is seeking to take advantage of its large size and to utilize modern technology to increase the efficiency and quality of services provided to its customers. The segment is seeking to create a more customer-oriented service approach to significantly differentiate itself from its competitors. A core business process redesign project began in fiscal 2002 with an exhaustive effort to identify customer expectations and document existing business processes. These findings led to a conclusion that improved processes, consolidation of operations, technology investments and selective outsourcing could have a meaningful impact on improving customer services while reducing annual operating costs.

The Partnership believes the technology it employs can improve the efficiency and quality of services provided to its heating oil customers. The heating oil segment has now deployed second generation hand-held devices for the automation of its service workforce. These wireless handheld-data terminals allow service and installation professionals on demand access to customer repair history, data to provide instant part and repair quotations, the ability to invoice at the completion of service and identify customer service issues.

Consolidation of certain heating oil operational activities have been undertaken to create operating efficiencies and cost savings. Service technicians are being dispatched from two consolidated locations rather than 27 local offices which was previously the case. Oil delivery is now being managed from 11 regional locations rather than 27 local offices. The organization continues to adjust to these significant operational changes.

The Partnership has recently completed a transition to outsourcing in the area of customer contact management as both a customer satisfaction and a cost reduction strategy. The Partnership hopes outsourcing customer inquiries through a centralized call center may improve performance, service and leverage the technology to eliminate system redundancy available from third-party service organizations. In addition, an outsourcing partner has greater flexibility to manage extreme seasonal volume. The complexity of customer interactions combined with the Partnership’s goal for service excellence has led to protracted training and implementation efforts.

During fiscal 2004, the heating oil segment experienced startup operational problems with its centralized call center and equipment service dispatch, which the Partnership believes contributed to an increase in customer attrition. The heating oil segment believes that it has made progress in correcting these operational problems. See “Risk Factors.” The heating oil segment operates and markets in the following states:

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Customers

During the 12 months ended September 30, 2004, approximately 87% of the heating oil segment’s heating oil sales were made to homeowners, with the remainder to industrial, commercial and institutional customers. Over the three fiscal years, ended September 30, 2003, the heating oil segment experienced average annual attrition of approximately 1.3%, excluding the impact of acquisitions. During fiscal 2004, the heating oil segment experienced annual customer attrition of 6.6%, excluding the impact of acquisitions. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The Partnership believes this segment’s attrition rate has risen because of greater than normal price competition related to the unprecedented rise in oil prices and because of startup operational problems associated with the business process redesign project, primarily caused by the transition to a centralized call center. Prior to the 2004 winter heating season, the heating oil segment attempted to develop a competitive advantage in customer service, and as part of that effort, centralized its heating equipment service dispatch and engaged a centralized call center to fulfill its telephone requirements. The implementation of this initiative is taking longer and incurring greater difficulties than the heating oil segment had anticipated, which adversely impacted the customer base. In addition, Management’s decision to upgrade the credit quality of its customer base and reduce related bad debt also contributed to the increased customer loss.

While the Partnership believes that the heating oil segment has made progress in correcting the early inefficiencies associated with its centralized customer service, and that it has significantly improved its responsiveness to customer needs, the Partnership expects that customer attrition will likely continue at a rate higher than experienced in each of the three years ended September 30, 2003 into the 2004-2005 winter heating season and the 2004 attrition will adversely impact volume during 2005 and perhaps beyond.

Customer losses are the result of various factors, including customer relocation, price, natural gas conversions, service issues and credit problems. Customer gains are a result of marketing and service programs. While the heating oil segment often loses customers when they move from their homes, it is able to retain a majority of these homes by obtaining the purchaser as a customer. Approximately 90% of the heating oil customers receive their home heating oil under an automatic delivery system without the customer having to make an affirmative purchase decision. These deliveries are scheduled by computer, based upon each customer’s historical consumption patterns and prevailing weather conditions. The heating oil segment delivers home heating oil approximately six times during the year to the average customer. The segment’s practice is to bill customers promptly after delivery. Approximately 32% of its customers are on a budget payment plan, whereby their estimated annual oil purchases and service contract are paid for in a series of equal monthly payments.

On each of September 30, 2004 and September 30, 2003, approximately 48% of the heating oil customers had agreements establishing a fixed or maximum price per gallon over a 12-month period (“price plan customers”). This percentage could increase or decrease during fiscal 2005 based upon market conditions. The fixed or maximum price per gallon at which home heating oil is sold to these price plan customers is generally renegotiated based on current market conditions at the beginning of each heating season. The heating oil segment currently enters into derivative instruments (futures, options, collars and swaps) in order to hedge a majority of the heating oil it expects to sell to price plan customers. The heating oil segment uses these fixed price derivative instruments to mitigate its exposure to changing commodity prices.

Competition

The heating oil segment competes with distributors offering a broad range of services and prices, from full-service distributors, like itself, to those offering delivery only. Long-standing customer relationships are typical in the industry. Like most companies in the home heating oil business, the heating oil segment provides home heating equipment repair service on a 24-hour-a-day, seven days-a-week, 52 weeks-a-year basis. This tends to build customer loyalty. As a result of these factors, it is difficult for the heating oil segment to acquire new retail customers, other than through acquisitions. In some instances homeowners have formed buying cooperatives that seek to purchase fuel oil from distributors at a price lower than individual customers are otherwise able to obtain. The heating oil segment also competes for retail customers with suppliers of alternative energy products, principally natural gas, propane, and electricity. The rate of conversion from the use of home heating oil to natural gas is primarily affected by the relative retail prices of the two products and the cost of replacing an oil fired heating system with one that uses natural gas, in addition to environmental concerns. The Partnership believes that approximately 1% of its home heating oil customer base annually converts from home heating oil to natural gas.

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Suppliers and Supply Arrangements

Propane Segment

The propane segment obtains propane from over 30 sources, including BP Canada Energy Marketing Corp., CHS, Inc., Centennial Gas Liquid, LLC., Dawson Oil Company Ltd., Duke Energy NGL Services, LP, Dynegy Inc., Enterprise Products Partners, Kinetic Resources, U.S.A., Marathon Oil Company, Markwest Hydrocarbons and Transammonia Inc. Supplies from these sources have traditionally been readily available, although there is no assurance that supplies of propane will continue to be readily available.

The majority of the propane supply is purchased under annual or longer term supply contracts that generally provide for pricing in accordance with market prices at the time of delivery. Some of the contracts provide for minimum and maximum amounts of propane to be purchased. The product supplied for the contracts come from refineries, gas processing plants and bulk purchases at the Mont Belvieu trading and storage complex. Most of the bulk purchases at Mont Belvieu are physically moved through the TEPPCO Partners, L.P. pipeline system, to both the Seymour underground storage facility, which the Partnership owns and leases to TEPPCO Partners, L.P. in southern Indiana, and north into the Pennsylvania and New York areas to supplement purchases made by the segment in the Northeast region. This lease agreement provides the propane segment the ability to store at all times throughout the terms of this agreement 21 million gallons of product storage or approximately 11% of the propane segment’s annual supply requirements, along the TEPPCO Partners, L.P. pipeline system. The Seymour facility is located on the TEPPCO Partners, L.P. pipeline system. The pipeline is connected to the Mont Belvieu, Texas storage facilities and is one of the largest conduits of supply for the U.S. propane industry. The Partnership 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 these sources without a material disruption of its operations. The Partnership also believes that relations with its current suppliers are satisfactory.

The propane segment purchases derivative instruments in order to mitigate its exposure to market risk and hedge the cash flow variability associated with forecasted purchases of propane held for resale to price plan customers. At September 30, 2004, the propane segment had outstanding derivative instruments with the following banks and brokers: JPMorgan, Morgan Stanley Dean Witter, Bank of America, Fimat and BP North America Petroleum, a division of BP Products North America, Inc.

Heating Oil Segment

The heating oil segment obtains fuel oil in either barge, pipeline or truckload quantities, and has contracts with over 80 terminals for the right to temporarily store heating oil at facilities it does not own. Purchases are made under supply contracts or on the spot market. The home heating oil segment has market price based contracts for a majority of its petroleum requirements with 12 different suppliers, the majority of which have significant domestic sources for their product, and many of which have been suppliers to the heating oil segment for over ten years. The segment’s current suppliers are: Amerada Hess Corporation, BP North America Petroleum, a division of BP Products North America, Inc., Cargill Inc. Petroleum Trading, Citgo Petroleum Corp., George E. Warren Corp., Global Companies LLC., Inland Fuels Terminals, Inc., Mieco, Inc., Morgan Stanley Capital Group, Inc., Northville Industries, Sprague Energy and Sun Oil Company. Supply contracts typically have terms of 12 months. All of the supply contracts provide for maximum and in certain cases minimum quantities. In most cases the supply contracts do not establish in advance the price of fuel oil. This price is based upon spot market prices at the time of delivery plus a fee ranging from $.0050 to $.0375 per gallon. The Partnership believes that its policy of contracting for substantially all of its supply needs with diverse and reliable sources will enable it to obtain sufficient product should unforeseen shortages develop in worldwide supplies. The Partnership also believes that relations with its current suppliers are satisfactory.

The heating oil segment purchases derivative instruments in order to mitigate its exposure to market risk and hedge the cash flow variability associated with forecasted purchases of home heating oil inventory held for resale to price plan customers. At September 30, 2004 the heating oil segment had outstanding derivative instruments with the following banks or brokers: JPMorgan, Société Genéralé, Royal Bank of Canada, Morgan Stan