EXHIBIT 99.1
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Partners
U.S. Propane, L.P.
We have audited the accompanying consolidated balance sheet of U.S. Propane,
L.P. (a Delaware limited partnership) and subsidiaries as of August 31, 2002.
This financial statement is the responsibility of the Partnership's management.
Our responsibility is to express an opinion on this financial statement based on
our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the balance sheet
is free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the balance sheet. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall balance sheet
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated balance sheet referred to above presents
fairly, in all material respects, the financial position of U.S. Propane, L.P.
and subsidiaries as of August 31, 2002, in conformity with accounting principles
generally accepted in the United States of America.
As explained in Note 2 to the consolidated balance sheet, effective September 1,
2001, the Partnership changed its method of accounting for goodwill and other
intangible assets to adopt the requirements of Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets.
/s/ Grant Thornton LLP
Tulsa, Oklahoma
October 16, 2003 (except for Note 11, as to which the date is November 6, 2003)
U.S. PROPANE, L.P. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(in thousands)
August 31,
2002
----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 7,726
Marketable securities 2,575
Accounts receivable, net of allowance for doubtful accounts 30,906
Inventories 48,187
Assets from liquids marketing 2,301
Prepaid expenses and other 7,230
Deferred taxes 1,456
---------
Total current assets 100,381
PROPERTY, PLANT AND EQUIPMENT, net 400,044
ASSETS HELD IN TRUST 1,048
INVESTMENT IN AFFILIATES 7,858
GOODWILL, net of amortization prior to adoption of SFAS No. 142 155,734
INTANGIBLES AND OTHER ASSETS, net 58,241
---------
Total assets $ 723,306
=========
LIABILITIES AND PARTNERS' CAPITAL
CURRENT LIABILITIES:
Working capital facility $ 30,200
Accounts payable 40,929
Accounts payable to related company 1,646
Accrued and other current liabilities 29,218
Liabilities from liquids marketing 1,818
Current maturities of long-term debt 20,447
---------
Total current liabilities 124,258
LONG-TERM DEBT, less current maturities 420,840
MINORITY INTERESTS 22,307
DEFERRED TAXES 38,651
---------
606,056
---------
COMMITMENTS AND CONTINGENCIES
PARTNERS' CAPITAL:
General partner's capital (2)
Limited partners' capital 117,945
Accumulated other comprehensive loss, net of tax (693)
---------
Total partners' capital 117,250
---------
Total liabilities and partners' capital $ 723,306
=========
The accompanying notes are an integral part of this consolidated balance sheet.
2
U.S. PROPANE, L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED BALANCE SHEET
AUGUST 31, 2002
(Dollars in thousands)
1. OPERATIONS AND ORGANIZATION:
U.S. Propane, L.P. ("U.S. Propane") was formed in August 2000 as a Delaware
limited partnership to acquire, directly and indirectly through Heritage
Holdings, Inc. ("Heritage Holdings"), a controlling interest in Heritage Propane
Partners, L.P. ("Heritage"). U.S. Propane is the General Partner of Heritage.
U.S. Propane, L.L.C. is the General Partner of U.S. Propane with a 0.01% general
partner interest. The members of U.S. Propane, L.L.C. and their respective
membership interests are as follows:
TECO Propane Ventures, L.L.C. 37.98%
AGL Energy Corporation 22.36%
Piedmont Propane Company 20.69%
United Cities Propane Gas, Inc. 18.97%
-------
Total 100.00%
=======
The members of U.S. Propane, L.L.C. or their affiliates also own, in the same
percentages, the limited partner interests in U.S. Propane.
In order to simplify Heritage's obligation under the laws of several
jurisdictions in which Heritage conducts business, Heritage's activities are
conducted through a subsidiary operating partnership Heritage Operating, L.P.
(the "Operating Partnership"). The Operating Partnership sells propane and
propane-related products to more than 600,000 active residential, commercial,
industrial and agricultural customers in 28 states. Heritage is also a wholesale
propane supplier in the southwestern and southeastern United States and in
Canada, the latter through participation in MP Energy Partnership. Heritage owns
a 60% interest in MP Energy Partnership, a Canadian partnership engaged in
supplying the Partnership's northern U.S. locations and in lower-margin
wholesale distribution. U.S. Propane owns a 1% general partner interest in
Heritage and the associated Incentive Distribution Rights, a 1.0101% general
partner interest in the Operating Partnership, and approximately 4.6 million
Common Units of Heritage.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND BALANCE SHEET DETAIL:
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated balance sheet includes the accounts of U.S.
Propane and its subsidiaries ("the Partnership"), including its wholly-owned
subsidiary, Heritage Holdings, and its partially-owned subsidiaries over which
it exercises control including Heritage Propane Partners, L.P., Heritage
Operating, L.P., Heritage Energy Resources, L.L.C. ("Resources") and MP Energy
Partnership. A minority interest liability and minority interest expense is
recorded for all partially owned subsidiaries. The Partnership accounts for its
50% partnership interest in Bi-State Propane, another propane retailer, under
the equity method. All significant intercompany transactions and accounts have
been eliminated in consolidation.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include all cash on hand, demand deposits and
investments with original maturities of three months or less. The Partnership
considers cash equivalents to include short-term, highly liquid investments that
are readily convertible to known amounts of cash and which are subject to an
insignificant risk of changes in value.
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ACCOUNTS RECEIVABLE
The Partnership grants credit to its customers for the purchase of propane and
propane-related products. Accounts receivable consisted of the following at
August 31, 2002:
Accounts receivable $33,410
Less - allowance for doubtful accounts 2,504
-------
Total, net $30,906
=======
INVENTORIES
Inventories are valued at the lower of cost or market. The cost of fuel
inventories is determined using weighted-average cost of fuel delivered to the
retail districts and includes storage fees and inbound freight costs, while the
cost of appliances, parts and fittings is determined by the first-in, first-out
method. Inventories consisted of the following at August 31, 2002:
Fuel $38,523
Appliances, parts and fittings 9,664
-------
Total inventories $48,187
=======
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is stated at cost less accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets. Expenditures for maintenance and repairs are
expensed as incurred. Expenditures to refurbish tanks that either extend the
useful lives of the tanks or prevent environmental contamination are capitalized
and depreciated over the remaining useful life of the tanks. Additionally, the
Partnership capitalizes certain costs directly related to the installation of
company-owned tanks, including internal labor costs. Components and useful lives
of property, plant and equipment were as follows at August 31, 2002:
Land and improvements $ 20,981
Buildings and improvements (10 to 30 years) 29,145
Bulk storage, equipment and facilities (3 to 30 years) 39,908
Tanks and other equipment (5 to 30 years) 298,540
Vehicles (5 to 10 years) 63,755
Furniture and fixtures (5 to 10 years) 10,407
Other (5 to 10 years) 3,442
---------
466,178
Less - Accumulated depreciation (72,822)
---------
393,356
Plus - Construction work-in-process 6,688
---------
Property, plant and equipment, net $ 400,044
=========
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INTANGIBLES AND OTHER ASSETS
Intangibles and other assets are stated at cost, net of amortization computed on
the straight-line method. The Partnership eliminates from its balance sheet any
fully amortized intangibles and the related accumulated amortization. Components
and useful lives of intangibles and other assets were as follows at August 31,
2002:
Gross Carrying Accumulated
Amount Amortization
-------------- ------------
Amortized intangible assets
Noncompete agreements (5 to 15 years) $ 41,994 $(10,924)
Customer lists (15 years) 27,245 (4,160)
Financing costs (3 to 15 years) 4,225 (1,291)
Consulting agreements (2 to 7 years) 618 (390)
-------- --------
Total 74,082 (16,765)
Unamortized intangible assets
Trademarks 865 --
Other assets 59 --
-------- --------
Total intangibles and other assets $ 75,006 $(16,765)
======== ========
GOODWILL
Goodwill is associated with acquisitions made for the Partnership's domestic
retail segment; therefore, all goodwill is recorded in this segment. Of the
$155,734 balance in goodwill, $24,579 is expected to be tax deductible. Goodwill
is tested for impairment at the end of each fiscal year end in accordance with
SFAS 142.
LONG-LIVED ASSETS
The Partnership reviews long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of such assets may
not be recoverable. If such a review should indicate that the carrying amount of
long-lived assets is not recoverable, the Partnership reduces the carrying
amount of such assets to fair value. No impairment of long-lived assets has been
recorded as of August 31, 2002.
ACCRUED AND OTHER CURRENT LIABILITIES
Accrued and other current liabilities consisted of the following at August 31,
2002:
Interest payable $ 4,147
Wages and payroll taxes 6,667
Deferred tank rent 3,585
Advanced budget payments and unearned revenue 8,116
Customer deposits 2,175
Taxes other than income 2,027
Income taxes payable 411
Other 2,090
-------
Accrued and other current liabilities $29,218
=======
INCOME TAXES
U.S. Propane is a limited partnership. As a result, U.S. Propane's earnings or
losses for income tax purposes are included in the tax returns of the individual
partners.
5
Heritage Holdings is a taxable corporation and follows the liability method of
accounting for income taxes in accordance with Statement of Financial Accounting
Standards No. 109, Accounting for Income Taxes (SFAS 109). Under SFAS 109,
deferred income taxes are recorded based upon differences between the financial
reporting and tax bases of assets and liabilities and are measured using the
enacted tax rates and laws that will be in effect when the underlying assets are
received and liabilities settled.
STOCK BASED COMPENSATION PLANS
The Partnership accounts for its Restricted Unit Plan and Long-Term Incentive
Plan using Accounting Principles Board (APB) Opinion No. 25 Accounting for Stock
Issued to Employees. These plans are classified as variable plans so estimates
of compensation are required based on a combination of the fair market value of
the Common Units as of the end of the reporting period and the extent or degree
of compliance with the performance criteria. Heritage follows the disclosure
only provision of Statement of Financial Accounting Standards No. 123,
Accounting for Stock-based Compensation (SFAS 123).
USE OF ESTIMATES
The preparation of the consolidated balance sheet in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosures of contingent assets and liabilities at
the date of the balance sheet. Some of the more significant estimates made by
management include, but are not limited to, allowances for doubtful accounts,
liquids marketing assets and liabilities, and general business and medical
self-insurance reserves. Actual results could differ from those estimates.
FAIR VALUE
The carrying amounts of accounts receivable and accounts payable approximate
their fair value. Based on the estimated borrowing rates currently available to
the Partnership for long-term loans with similar terms and average maturities,
the aggregate fair value and carrying amount of long-term debt at August 31,
2002 was $471,372 and $441,287, respectively.
SFAS 142 GOODWILL AND OTHER INTANGIBLE ASSETS
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
No. 142, Goodwill and Other Intangible Assets (SFAS 142). Under SFAS 142,
goodwill is no longer subject to amortization over its estimated useful life.
Rather, goodwill will be subject to at least an annual assessment for impairment
by applying a fair-value-based test. Additionally, any acquired intangible
assets should be separately recognized if the benefit of the intangible asset is
obtained through contractual or other legal rights, or if the intangible asset
can be sold, transferred, licensed, rented or exchanged, regardless of the
acquirer's intent to do so. Those assets will be amortized over their useful
lives, other than assets that have an indefinite life.
The Partnership adopted SFAS 142 on September 1, 2001 and accordingly has
discontinued the amortization of goodwill existing at the time of adoption.
Under the provisions of SFAS 142, the Partnership was required to perform a
transitional goodwill impairment appraisal within six months from the time of
adoption. Management engaged an independent appraisal firm to perform an
assessment of the fair value of each of the Partnership's operating segments,
which were compared with the carrying value of each segment to determine whether
any impairment existed on the date of adoption. The Partnership has completed
the transitional goodwill impairment appraisal and has determined that based on
the fair value of the Partnership's operating segments, goodwill was not
impaired as of September 1, 2001. Management has determined that a detailed
evaluation of the Partnership's operating segments as of August 31, 2002 is not
necessary based on the fact that there has not been a significant change in the
components of the Partnership's operating segments since the last evaluation,
the previous fair value of the Partnership's operating segments substantially
exceeded the carrying value, and the likelihood that the Partnership's operating
segments current carrying value exceeds its current fair value is remote based
on an analysis of events and circumstances since the Partnership's most recent
evaluation. Accordingly, no impairment of the
6
Partnership's goodwill has been recorded as of August 31, 2002. The Partnership
will continue to test goodwill for impairment as of the end of each fiscal year.
MARKETABLE SECURITIES
The Partnership's marketable securities are classified as available-for-sale
securities and are reflected as a current asset on the consolidated balance
sheet at their fair value. Unrealized holding losses as of August 31, 2002 were
$693, net of minority interest of $2,555 and income taxes of $442. Management
does not consider the decline in market value of the available-for-sale
securities to be other than temporary.
LIQUIDS MARKETING ACTIVITIES
The Partnership buys and sells derivative financial instruments, which are
within the scope of SFAS 133 and that are not designated as accounting hedges.
The Partnership also enters into energy trading contracts, which are not
derivatives, and therefore are not within the scope of SFAS 133. EITF Issue No.
98-10, Accounting for Contracts Involved in Energy Trading and Risk Management
Activities (EITF 98-10), applied to energy trading contracts not within the
scope of SFAS 133 that were entered into prior to October 25, 2002. The types of
contracts the Partnership utilizes in its liquids marketing segment include
energy commodity forward contracts, options, and swaps traded on the
over-the-counter financial markets. In accordance with the provisions of SFAS
133, derivative financial instruments utilized in connection with the
Partnership's liquids marketing activity are accounted for using the
mark-to-market method. Additionally, all energy trading contracts entered into
prior to October 25, 2002 were accounted for using the mark-to-market method in
accordance with the provisions of EITF 98-10. Under the mark-to-market method of
accounting, forwards, swaps, options, and storage contracts are reflected at
fair value, and are shown in the consolidated balance sheet as assets and
liabilities from liquids marketing activities. As of August 31, 2002, the
Partnership adopted the applicable provisions of EITF Issue No. 02-3, Issues
Related to Accounting for Contracts Involved in Energy Trading and Risk
Management Activities (EITF 02-3), which requires that gains and losses on
derivative instruments be shown net in the statement of operations if the
derivative instruments are held for trading purposes. Net realized and
unrealized gains and losses from the financial contracts and the impact of price
movements are recognized in the statement of operations as liquids marketing
revenue. Changes in the assets and liabilities from the liquids marketing
activities result primarily from changes in the market prices, newly originated
transactions, and the timing and settlement of contracts. EITF 02-3 also
rescinds EITF 98-10 for all energy trading contracts entered into after October
25, 2002, and specifies certain disclosure requirements. Consequently, the
Partnership does not apply mark-to-market accounting for any contracts entered
into after October 25, 2002, that are not within the scope of SFAS 133. The
Partnership attempts to balance its contractual portfolio in terms of notional
amounts and timing of performance and delivery obligations. However, net
unbalanced positions can exist or are established based on management's
assessment of anticipated market movements.
The notional amounts and terms of these financial instruments as of August 31,
2002 include fixed price payor for 1,180 barrels of propane, and fixed price
receiver of 1,076 barrels of propane. Notional amounts reflect the volume of the
transactions, but do not represent the amounts exchanged by the parties to the
financial instruments. Accordingly, notional amounts do not accurately measure
the Partnership's exposure to market or credit risks.
The fair value of the financial instruments related to liquids marketing
activities as of August 31, 2002, was assets of $2,301 and liabilities of
$1,818.
Estimates related to Resource's liquids marketing activities are sensitive to
uncertainty and volatility inherent in the energy commodities markets and actual
results could differ from these estimates. A theoretical change of 10% in the
underlying commodity value of the liquids marketing contracts would result in an
approximate $181 change in the market value of the contracts as there were
approximately 4.3 million gallons of net unbalanced positions at August 31,
2002.
Inherent in the resulting contractual portfolio are certain business risks,
including market risk and credit risk. Market risk is the risk that the value of
the portfolio will change, either favorably or unfavorably, in response to
changing market conditions. Credit risk is the risk of loss from nonperformance
by suppliers, customers, or financial counterparties to a contract. The
Partnership and Resources take active roles in managing and controlling market
and credit risk and have established control procedures, which are reviewed on
an ongoing basis. The Partnership monitors market risk through a variety of
techniques, including routine reporting to senior management. The Partnership
attempts to minimize credit risk exposure through credit policies and periodic
monitoring procedures.
The following table summarizes the fair value of Resources' contracts,
aggregated by method of estimating fair value of the contracts as of August 31,
2002 where settlement had not yet occurred. Resources' contracts all have a
maturity of less than 1 year. The market prices used to value these transactions
reflect management's best estimate considering various factors including closing
average spot prices for the current and outer months plus a differential to
consider time value and storage costs.
7
<Table>
<Caption>
August 31,
Source of Fair Value 2002
---------------------------------------------- ----------
Prices actively quoted $ 1,276
Prices based on other valuation methods 1,025
----------
Assets from liquids marketing $ 2,301
==========
Prices actively quoted $ 669
Prices based on other valuation methods 1,149
----------
Liabilities from liquids marketing $ 1,818
==========
Unrealized gains (losses) $ 483
==========
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 2001, the FASB issued Statement No. 143, Accounting for Asset Retirement
Obligations (SFAS 143). SFAS 143 addresses financial accounting and reporting
for obligations associated with the retirement of tangible long-lived assets and
the associated asset retirement costs. This statement requires that the fair
value of a liability for an asset retirement obligation be recognized in the
period in which it is incurred if a reasonable estimate of fair value can be
made. The associated asset retirement costs are capitalized as part of the
carrying amount of the long-lived asset. The Partnership adopted the provisions
of SFAS 143 on September 1, 2002. The adoption of SFAS 143 did not have a
material impact on the Partnership's consolidated financial condition.
In August 2001, the FASB issued Statement No. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets (SFAS 144). SFAS 144 supersedes FASB Statement
No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of (SFAS 121), and the accounting and reporting provisions
of APB Opinion No. 30, Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions. SFAS 144 retains the fundamental
provisions of SFAS 121 for recognition and measurement of the impairment of
long-lived assets to be held and used, and measurement of long-lived assets to
be disposed of by sale. SFAS 144 is effective for financial statements issued
for fiscal years beginning after December 15, 2001 and interim periods within
those fiscal years, with early application encouraged. The Partnership adopted
the provisions of SFAS 144 on September 1, 2002. The adoption of SFAS 144 did
not have a material impact on the Partnership's consolidated financial
condition.
In April 2002, the FASB issued Statement No. 145, Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections
(SFAS 145). SFAS 145 rescinds FASB Statement No. 4, Reporting Gains and Losses
from Extinguishment of Debt, and an amendment of that Statement, FASB Statement
No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. SFAS
145 also rescinds FASB Statement No. 44, Accounting for Intangible Assets of
Motor Carriers, amends FASB Statement No. 13, Accounting for Leases, to
eliminate an inconsistency between the required accounting for sale-leaseback
transactions and the required accounting for certain lease modifications that
have economic effects that are similar to sale-leaseback transactions and also
amends other existing authoritative pronouncements to make various technical
corrections, clarify meanings, or describe their applicability under changed
conditions. SFAS 145 is effective for fiscal years beginning after May 15, 2002
with early application encouraged. The Partnership adopted the provisions of
SFAS 145 on September 1, 2002. The adoption did not have a material impact on
the Partnership's consolidated financial condition.
In October 2002, the EITF of the FASB discussed EITF Issue No. 02-3, Issues
Related to Accounting for Contracts Involved in Energy Trading and Risk
Management Activities (EITF 02-3). The EITF reached a consensus to rescind EITF
Issue No. 98-10, Accounting for Contracts Involved in Energy Trading and Risk
Management Activities (EITF 98-10), the impact of which is to preclude
mark-to-market accounting for energy trading contracts not within the scope of
SFAS 133. The EITF also reached a consensus that gains and losses on derivative
instruments within the scope of SFAS 133 should be shown net in the statement of
operations if the derivative instruments are held for trading purposes and what
disclosure requirements should be. This consensus was effective for financial
statements issued for periods ending after July 15, 2002. The Partnership
adopted EITF 02-03 as of August 31, 2002, and upon application reclassified
comparative financial statements for prior periods to conform to the consensus.
This adoption did not have an impact on the Partnership's financial position.
The consensus regarding the rescission of EITF 98-10 is applicable for fiscal
periods
8
beginning after December 15, 2002. Energy trading contracts not within the scope
of SFAS 133 purchased after October 25, 2002, but prior to the implementation of
the consensus are not permitted to apply mark-to-market accounting. Management
does not expect the adoption of EITF 02-3 as it relates to the rescission of
EITF 98-10 to have a material affect on The Partnership's financial position.
In June 2002, the FASB issued Statement No. 146, Accounting for Costs Associated
with Exit or Disposal Activities (SFAS 146). SFAS 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities
and requires that a liability for a cost associated with an exit or disposal
activity be recognized and measured initially at fair value only when the
liability is incurred. The Partnership adopted the provisions of SFAS 146
effective for exit or disposal activities that are initiated after December 31,
2002. The adoption did not have a material impact on the Partnership's
consolidated financial position.
In November 2002, the FASB issued Financial Interpretation No. 45 "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" (FIN 45). FIN 45 expands the existing
disclosure requirements for guarantees and requires that companies recognize a
liability for guarantees issued after December 31, 2002. The implementation of
FIN 45 did not have a significant impact on the Partnership's financial
position.
In January 2003, the FASB issued Financial Interpretation No. 46 Consolidation
of Variable Interest Entities - An Interpretation of ARB No. 51 (FIN 46). FIN 46
clarifies Accounting Research Bulletin No. 51, Consolidated Financial
Statements. If certain conditions are met, this interpretation requires the
primary beneficiary to consolidate certain variable interest entities in which
equity investors lack the characteristics of a controlling interest or do not
have sufficient equity investment at risk to permit the variable interest entity
to finance its activities without additional subordinated financial support from
other parties. FIN 46 is effective immediately for variable interest entities
created or obtained after January 31, 2003. For variable interest entities
acquired before February 1, 2003, the interpretation is effective for the first
fiscal year or interim period beginning after June 15, 2003. Management does not
believe FIN 46 will have a significant impact on the Partnership's financial
position.
3. ASSETS HELD IN TRUST:
In connection with the initial public offering ("IPO") of Heritage in June 1996,
Heritage Holdings retained proceeds, which were placed in various trusts to be
paid to the noteholders of noncompete agreements entered into prior to the IPO.
The proceeds are disbursed monthly from the trust in accordance with the
noncompete agreements. The Partnership retains all earnings from the trust
assets.
4. ACQUISITIONS:
During the year ended August 31, 2002, the Partnership purchased the stock of
Virginia Gas Propane Company Inc., in Virginia, Mt. Pleasant Propane in
Tennessee and two other smaller companies. The Partnership also acquired
substantially all of the assets of six propane related companies, which included
Tri-County Propane, Inc., located in North Carolina, Franconia Gas Corporation
located in New Hampshire and Quality Gas, Inc. also located in North Carolina.
The aggregate purchase price for these acquisitions totaled $24,915, which
included liabilities assumed and non-compete agreements of $5,173. These
acquisitions were financed primarily with the acquisition facility and were
accounted for by the purchase method.
The Partnership recorded the following intangible assets in conjunction with
these acquisitions:
Customer lists (15 years) $ 1,066
Non-compete agreements (5 to 10 years) 2,800
-------
Total amortized intangible assets 3,866
-------
Trademarks and tradenames 865
Goodwill 6,463
Other assets 96
-------
Total intangible assets acquired $11,290
=======
Goodwill was warranted because these acquisitions enhance the Partnership's
current operations and certain acquisitions are expected to reduce costs through
synergies with existing operations. The Partnership assigned all of the goodwill
acquired to the retail operating segment of the Partnership.
5. WORKING CAPITAL FACILITY AND LONG-TERM DEBT:
Long-term debt consists of the following at August 31, 2002:
1996 8.55% Senior Secured Notes $108,000
1997 Medium Term Note Program:
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7.17% Series A Senior Secured Notes 12,000
7.26% Series B Senior Secured Notes 20,000
6.50% Series C Senior Secured Notes 2,857
6.59% Series D Senior Secured Notes 4,444
6.67% Series E Senior Secured Notes 5,000
2000 and 2001 Senior Secured Promissory Notes:
8.47% Series A Senior Secured Notes 16,000
8.55% Series B Senior Secured Notes 32,000
8.59% Series C Senior Secured Notes 27,000
8.67% Series D Senior Secured Notes 58,000
8.75% Series E Senior Secured Notes 7,000
8.87% Series F Senior Secured Notes 40,000
7.21% Series G Senior Secured Notes 26,500
7.89% Series H Senior Secured Notes 27,500
7.99% Series I Senior Secured Notes 16,000
Senior Revolving Acquisition Facility 14,000
Notes payable on noncompete agreements with interest
imputed at rates averaging 8%, due in installments through
2010, collateralized by a first security lien on certain assets of
the Partnership 22,314
Other 2,672
Current maturities of long-term debt (20,447)
-------
$420,840
========
Maturities of the Senior Secured Notes, the Medium Term Note Program and the
Senior Secured Promissory Notes are as follows:
1996 8.55% Senior Secured Notes:
mature at the rate of $12,000 on June 30 in
each of the years 2002 to and including
2011. Interest is paid semi-annually.
1997 Medium Term Note Program:
Series A Notes: mature at the rate of $2,400 on November 19
in each of the years 2005 to and including
2009. Interest is paid semi-annually.
Series B Notes: mature at the rate of $2,000 on November 19
in each of the years 2003 to and including
2012. Interest is paid semi-annually.
Series C Notes: mature at the rate of $714 on March 13 in
each of the years 2000 to and including
2003, $357 on March 13, 2004, $1,073 on
March 13, 2005, and $357 in each of the
years 2006 and 2007. Interest is paid
semi-annually.
Series D Notes: mature at the rate of $556 on March 13 in
each of the years 2002 to and including
2010. Interest is paid semi-annually.
Series E Notes: mature at the rate of $714 on March 13 in
each of the years 2007 to and including
2013. Interest is paid semi-annually.
2000 and 2001 Senior Secured Promissory Notes:
Series A Notes: mature at the rate of $3,200 on August 15 in
each of the years 2003 to and including
2007. Interest is paid quarterly.
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Series B Notes: mature at the rate of $4,571 on August 15 in
each of the years 2004 to and including
2010. Interest is paid quarterly.
Series C Notes: mature at the rate of $5,750 on August 15 in
each of the years 2006 to and including
2007, $4,000 on August 15, 2008 and $5,750
on August 15, 2009 to and including 2010.
Interest is paid quarterly.
Series D Notes: mature at the rate of $12,450 on August 15
in each of the years 2008 and 2009, $7,700
on August 15, 2010, $12,450 on August 15,
2011 and $12,950 on August 15, 2012.
Interest is paid quarterly.
Series E Notes: mature at the rate of $1,000 on August 15 in
each of the years 2009 to and including
2015. Interest is paid quarterly.
Series F Notes: mature at the rate of $3,636 on August 15 in
each of the years 2010 to and including
2020. Interest is paid quarterly.
Series G Notes: mature at the rate of $5,300 on May 15 in
each of the years 2004 to and including
2008. Interest is paid quarterly.
Series H Notes: mature at the rate of $2,500 on May 15 in
each of the years 2006 to and including
2016. Interest is paid quarterly.
Series I Notes: mature in one payment of $16,000 on May 15,
2013. Interest is paid quarterly.
The Note Agreements for each of the Notes, Medium Term Note Program and Senior
Secured Promissory Notes, and the Bank Credit Facility contain customary
restrictive covenants applicable to the Operating Partnership, including
limitations on the level of additional indebtedness, creation of liens, and sale
of assets. These covenants require the Operating Partnership to maintain ratios
of Consolidated Funded Indebtedness to Consolidated EBITDA (as these terms are
similarly defined in the Bank Credit Facility and the Note Agreements) of not
more than 5.00 to 1 for the Bank Credit Facility and not more than 5.25 to 1 for
the Note Agreements and Consolidated EBITDA to Consolidated Interest Expense (as
these terms are similarly defined in the Bank Credit Facility and the Note
Agreements) of not less than 2.25 to 1. The Consolidated EBITDA used to
determine these ratios is calculated in accordance with these debt agreements.
For purposes of calculating the ratios under the Bank Credit Facility and the
Note Agreements, Consolidated EBITDA is based upon Heritage's most recent
twelve-month EBITDA, as adjusted, and modified to give pro forma effect for
acquisitions and divestitures made during the test period and is compared to
Consolidated Funded Indebtedness as of the test date and the Consolidated
Interest Expense for the most recent twelve months. These debt agreements also
provide that the Operating Partnership may declare, make, or incur a liability
to make, a restricted payment during each fiscal quarter, if: (a) the amount of
such restricted payment, together with all other restricted payments during such
quarter, do not exceed Available Cash with respect to the immediately preceding
quarter; and (b) no default or event of default exists before such restricted
payment and after giving effect thereto. The debt agreements further provide
that Available Cash is required to reflect a reserve equal to 50% of the
interest to be paid on the notes. In addition, in the third, second and first
quarters preceding a quarter in which a scheduled principal payment is to be
made on the notes, Available Cash is required to reflect a reserve equal to 25%,
50%, and 75%, respectively, of the principal amount to be repaid on such payment
dates.
Failure to comply with the various restrictive and affirmative covenants of the
Operating Partnership's Bank Credit Facility and various Note Agreements could
negatively impact the Operating Partnership's ability to incur additional debt
and/or Heritage's ability to pay distributions. The Operating Partnership is
required to measure these financial tests and covenants quarterly and was in
compliance with all requirements, tests, limitations, and covenants related to
the Notes, Medium Term Note Program, Senior Secured Promissory Notes, and Bank
Credit Facility at August 31, 2002. Effective July 16, 2001, the Operating
Partnership entered into the Fifth Amendment to the First Amended and Restated
Credit Agreement. The terms of the Agreement as amended are as follows:
A $65,000 Senior Revolving Working Capital Facility, expiring June 30,
2004 with $30,200 outstanding at August 31, 2002. The interest rate and
interest payment dates vary depending on the terms the Partnership
agrees to when the money is borrowed. The Partnership must be free of
all working capital borrowings for 30 consecutive days each fiscal
year. The weighted average interest rate was 3.675% for the amount
outstanding at August 31, 2002. The maximum commitment fee
11
payable on the unused portion of the facility is 0.50%. All
receivables, contracts, equipment, inventory, general intangibles, cash
concentration accounts, and the capital stock of the Partnership's
subsidiaries secure the Senior Revolving Working Capital Facility.
A $50,000 Senior Revolving Acquisition Facility is available through
December 31, 2003, at which time the outstanding amount must be paid in
ten equal quarterly installments beginning March 31, 2004, with $14,000
outstanding as of August 31, 2002. The interest rate and interest
payment dates vary depending on the terms the Partnership agrees to
when the money is borrowed. The weighted average interest rate was
3.675% for the amount outstanding at August 31, 2002. The maximum
commitment fee payable on the unused portion of the facility is 0.50%.
All receivables, contracts, equipment, inventory, general intangibles,
cash concentration accounts, and the capital stock of the Partnership's
subsidiaries secure the Senior Revolving Acquisition Facility.
Future maturities of long-term debt for each of the next five fiscal years and
thereafter are $20,447 in 2003; $33,653 in 2004; $38,198 in 2005; $47,838 in
2006; $44,261 in 2007, and $256,890 thereafter.
6. INCOME TAXES:
The components of deferred income taxes were as follows at August 31, 2002:
Deferred Tax Assets-
Alternative minimum tax carryforwards $ 2,328
Net operating loss carryforwards (NOLs) 1,239
Accruals, reserves and deferred revenue 1,138
Intangibles 857
Unrealized loss on available for sale securities 442
--------
$ 6,004
========
Deferred Tax Liabilities-
Property, plant and equipment (43,075)
Other (124)
--------
$(43,199)
========
The NOLs of Heritage Holdings generally begin to expire in 2011.
7. COMMITMENTS AND CONTINGENCIES:
Certain property and equipment is leased under noncancelable leases, which
require fixed monthly rental payments and expire at various dates through 2020.
Certain of these leases contain renewal options and also contain escalation
clauses, which are accounted for on a straight-line basis over the minimum lease
term. Fiscal year future minimum lease commitments for such leases are $2,864 in
2003; $1,625 in 2004; $1,274 in 2005; $616 in 2006; $422 in 2007 and $714
thereafter.
The Partnership has entered into employment agreements with seven employees,
(each an "Executive"). One of the Employment Agreements had an initial term of
two years starting August 2000. At the expiration of the term on August 10,
2002, this Employment Agreement became "at will." The Employment Agreements for
the other six Executives have an initial term of three years starting August
2000. However, for each Executive with a three-year Employment Agreement,
beginning on the second anniversary of the effective date and on each day
thereafter the expiration date shall be automatically extended one additional
day unless either party (i) shall give written notice to the other that the Term
shall cease to be so extended beginning immediately after the date of such
notice or (ii) shall give a Notice of Termination to the other by delivering
notice to the Chairman of the Board, or in the event of the employee's death.
The Employment Agreements provide for an annual base salary of $193, $350, $335,
$200, $150, $135, and $135. The Employment Agreements provide for the Executives
to participate in bonus and incentive plans.
12
The Employment Agreements provide that in the event of a change of control of
the ownership of the General Partner or in the event an Executive (i) is
involuntarily terminated (other than for "misconduct" or "disability") or (ii)
voluntarily terminates employment for "good reason" (as defined in the
agreements), such Executive will be entitled to continue receiving his base
salary and to participate in all group health insurance plans and programs that
may be offered to executives of the General Partner for the remainder of the
term of the Employment Agreement or, if earlier, the Executive's death, and the
Executive will vest immediately in the Minimum Award of the number of Common
Units to which the Executive is entitled under the Long-Term Incentive Plan to
the extent not previously awarded, and if the Executive is terminated as a
result of the foregoing, all restrictions on the transferability of the units
purchased by such Executive under the Subscription Agreement dated as of June
15, 2000, shall automatically lapse in full on such date. If such change were to
occur during fiscal year 2003, the Partnership would be required to pay the
remaining portion of $1,305 in base salary for the six Executives whose
employment agreements have the three-year terms and a maximum of 250,000 Common
Units or approximately $6,750 based on a per unit price of $27.00 would be
awarded under the Long-Term Incentive Plan, of which $2,250 has been expensed as
of August 31, 2002. Each Employment Agreement also provides that if any payment
received by an Executive is subject to the 20% federal excise tax under Section
4999(a) of the Code of the Internal Revenue Service, the Payment will be grossed
up to permit the Executive to retain a net amount on an after-tax basis equal to
what he would have received had the excise tax and all other federal and state
taxes on such additional amount not been payable. In addition, each Employment
Agreement contains non-competition and confidentiality provisions.
The Partnership is a party to various legal proceedings incidental to its
business. Certain claims, suits and complaints arising in the ordinary course of
business have been filed or are pending against the Partnership. In the opinion
of management, all such matters are covered by insurance, are without merit or
involve amounts, which, if resolved unfavorably, would not have a significant
effect on the financial position of the Partnership. Once management determines
that information pertaining to a legal proceeding indicates that it is probable
that a liability has been incurred, an accrual is established equal to
management's estimate of the likely exposure. For matters that are covered by
insurance, the Partnership accrues the related deductible. As of August 31,
2002, an accrual of $671 was recorded as accrued and other current liabilities
on the Partnership's consolidated balance sheet.
Petroleum-based contamination or environmental wastes are known to be located on
or adjacent to six sites, which the Partnership 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, the Partnership obtained indemnification for expenses associated
with any remediation from the former owners or related entities. The Partnership
has not been named as a potentially responsible party at any of these sites, nor
has the Partnership's operations contributed to the environmental issues at
these sites. Accordingly, no amounts have been recorded in the Partnership's
August 31, 2002 consolidated balance sheet. Based on information currently
available to the Partnership, such projects are not expected to have a material
adverse effect on the Partnership's financial condition.
In July 2001, the Partnership acquired a company that had previously received a
request for information from the U.S. Environmental Protection Agency (the
"EPA") regarding potential contribution to a widespread groundwater
contamination problem in San Bernardino, California, known as the Newmark
Groundwater Contamination. Although the EPA has indicated that the groundwater
contamination may be attributable to releases of solvents from a former military
base located within the subject area that occurred long before the facility
acquired by the Partnership was constructed, it is possible that the EPA may
seek to recover all or a portion of groundwater remediation costs from private
parties under the Comprehensive Environmental Response, Compensation, and
Liability Act (commonly called "Superfund"). Based upon information currently
available to the Partnership, it is not believed that the Partnership's
liability if such action were to be taken by the EPA would have a material
adverse effect on the Partnership's financial condition.
The Partnership has entered into several purchase and supply commitments with
varying terms as to quantities and prices, which expire at various dates through
March 2003.
13
8. PARTNERS' CAPITAL:
The partnership agreement of Heritage requires that Heritage will distribute all
of its "Available Cash" to its Unitholders and its General Partner within 45
days following the end of each fiscal quarter, subject to the payment of
incentive distributions to the holders of Incentive Distribution Rights to the
extent that certain target levels of cash distributions are achieved. 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
Heritage's business, to comply with applicable laws 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 Amended and Restated Agreement of Limited
Partnership of Heritage Propane Partners, L.P.
Distributions by Heritage in an amount equal to 100% of Available Cash will
generally be made 98% to the Common Unitholders and 2% to U.S. Propane, subject
to the payment of incentive distributions to the holders of Incentive
Distribution Rights to the extent that certain target levels of cash
distributions are achieved.
Heritage currently distributes Available Cash, excluding any Available Cash to
be distributed to the Class C Unitholders as follows:
- First, 98% to all Unitholders, pro rata, and 2% to the U.S. Propane,
until all Unitholders have received $0.50 per unit for such quarter
and any prior quarter;
- Second, 98% to all Unitholders, pro rata, and 2% to the U.S.
Propane, until all Unitholders have received $0.55 per unit for such
quarter;
- Third, 85% to all Unitholders, pro rata, 13% to the holders of
Incentive Distribution Right, pro rata, and 2% to U.S. Propane,
until all Common Unitholders have received at least $0.635 per unit
for such quarter;
- Fourth, 75% to all Unitholders, pro rata, 23% to the holders of
Incentive Distribution Right, pro rata and 2% to U.S. Propane, until
all Common Unitholders have received at least $0.825 per unit for
such quarter;
- Fifth, thereafter 50% to all Unitholders, pro rata, 48% to the
holders of Incentive Distribution Right, pro rata, and 2% to the
U.S. Propane.
- The total amount of distributions for the 2002 fiscal year on Common
Units and other outstanding limited partner interests, the general
partner interests and the Incentive Distribution Rights totaled
$40.3 million, $0.8 million and $0.9 million, respectively. All such
distributions were made from Available Cash from Operating Surplus.
RESTRICTED UNIT PLAN
U.S. Propane has adopted the Amended and Restated Restricted Unit Plan dated
August 10, 2000 (the "Restricted Unit Plan"), for certain directors and key
employees of U.S. Propane and its affiliates. The Restricted Unit Plan covers
rights to acquire 146,000 Common Units of Heritage. The right to acquire the
Common Units under the Restricted Unit Plan, including any forfeiture or lapse
of rights is available for grant to key employees on such terms and conditions
(including vesting conditions) as the Compensation Committee of U.S. Propane
shall determine. Each director shall automatically receive a Director's grant
with respect to 500 Common Units on each September 1 that such person continues
as a director. Newly elected directors are also entitled to receive a grant with
respect to 2,000 Common Units upon election or appointment to the Board.
Directors who are employees of the Members of U.S. Propane, L.L.C. or their
affiliates are not entitled to receive a Director's grant of Common Units.
Generally, the rights to acquire the Common Units will vest upon the later to
occur of (i) the three-year anniversary of the grant date, or (ii) the
conversion of the Subordinated Units to
14
Common Units. Grants made after the conversion of all of the Subordinated Units
to Common Units shall vest on such terms as the Compensation Committee may
establish, which may include the achievement of performance objectives. In the
event of a "change of control" (as defined in the Restricted Unit Plan), all
rights to acquire Common Units pursuant to the Restricted Unit Plan will
immediately vest.
The issuance of the Common Units pursuant to the Restricted Unit Plan is
intended to serve as a means of incentive compensation for performance and not
primarily as an opportunity to participate in the equity appreciation in respect
of the Common Units. Therefore, no consideration will be payable by the plan
participants upon vesting and issuance of the Common Units. As of August 31,
2002, 26,900 restricted units are outstanding and 30,800 are available for
grants to non-employee directors and key employees. Subsequent to August 31,
2002, 500 additional Phantom Units vested pursuant to the vesting rights of the
Restricted Unit Plan and Common Units were issued.
LONG-TERM INCENTIVE PLAN
Effective September 1, 2000, the Partnership adopted a long-term incentive plan
(the Plan) whereby Common Units will be awarded based on achieving certain
targeted levels of Distributed Cash per unit of Heritage. Awards under the Plan
will be made starting in 2003 based upon the average of the prior three years'
Distributed Cash per unit. A minimum of 250,000 Common Units and a maximum of
500,000 Common Units will be awarded.
9. SIGNIFICANT INVESTEE:
Heritage holds a 50% interest in Bi-State Propane, which is accounted for under
the equity method. Heritage's investment in Bi-State Propane totaled $7,485 at
August 31, 2002. On March 1, 2002, the Operating Partnership sold certain assets
acquired in the ProFlame acquisition to Bi-State Propane for approximately
$9,730 plus working capital. There was no gain or loss recorded on the
transaction. This sale was made pursuant to the provision in the Bi-State
Propane partnership agreement that requires each partner to offer to sell any
newly acquired businesses within Bi-State Propane's area of operations to
Bi-State Propane. In conjunction with this sale, the Operating Partnership
guaranteed $5 million of debt incurred by Bi-State Propane to a financial
institution. Based on the current financial condition of Bi-State Propane,
management considers the likelihood of the Partnership incurring a liability
resulting from the guarantee to be remote.
Bi-State Propane's financial position is summarized below as of August 31, 2002:
Current assets $ 3,321
Noncurrent assets 23,105
-------
$26,426
=======
Current liabilities $ 3,344
Long-term debt 9,450
Partners' capital:
Heritage 7,485
Other partner 6,147
-------
$26,426
=======
10. SUPPLEMENTAL INFORMATION:
The following balance sheet of the Partnership includes its investment in
Heritage and Heritage Holdings on an equity basis. Such presentation is included
to provide additional information with respect to the Partnership's financial
position on a stand-alone basis as of August 31, 2002:
15
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 188
Receivable from Heritage 4,887
Prepaid expenses and other 392
---------
Total current assets 5,467
ASSETS HELD IN TRUST 1,048
INVESTMENT IN HERITAGE 45,569
INVESTMENT IN HERITAGE HOLDINGS 83,316
---------
Total assets $ 135,400
=========
LIABILITIES AND PARTNERS' CAPITAL
CURRENT LIABILITIES:
Accounts payable and accrued liabilities $ 4,848
Current maturities of long-term debt 288
---------
Total current liabilities 5,136
LONG-TERM DEBT, less current maturities 819
NOTE PAYABLE TO HERITAGE HOLDINGS 11,539
---------
17,494
---------
PARTNERS' CAPITAL:
General Partner's capital (2)
Limited Partners' capital 117,945
Accumulated other comprehensive loss (37)
---------
Total partners' capital 117,906
---------
Total liabilities and partners' capital $ 135,400
=========
16
U.S. Propane, L.L.C. is the General Partner of U.S. Propane with a 0.01% general
partner interest. The consolidated condensed balance sheet of U.S. Propane,
L.L.C. as of August 31, 2002 is as follows:
CURRENT ASSETS $ 100,381
PROPERTY PLANT AND EQUIPMENT, net 400,044
OTHER NONCURRENT ASSETS 222,881
---------
Total assets $ 723,306
=========
CURRENT LIABILITIES $ 124,258
LONG TERM DEBT, less current maturities 420,840
MINORITY INTERESTS 139,559
DEFERRED TAXES 38,651
---------
$ 723,308
---------
MEMBERS' DEFICIT (2)
---------
Total liabilities and members' deficit $ 723,306
=========
11. SUBSEQUENT EVENTS:
On January 2, 2003, The Partnership purchased the propane assets of V-1 Oil Co.
("V-1") of Idaho Falls, Idaho for total consideration of $34.2 million after
post-closing adjustments. The acquisition price was payable $19.2 million in
cash, with $17.3 million of that amount financed by the Acquisition Facility,
and by the issuance of 551,456 Common Units of Heritage valued at $15.0 million.
V-1's propane distribution network included 35 customer service locations in
Colorado, Idaho, Montana, Oregon, Utah, Washington, and Wyoming.
On May 20, 2003, the Partnership sold 1,610,000 Common Units in an underwritten
public offering at a public offering price of $29.26 per unit. This sale
included the exercise of the underwriters' over-allotment option to purchase an
additional 210,000 Common Units. Heritage used approximately $35.9 million of
the $44.8 million net proceeds from the sale of the Common Units to repay a
portion of the indebtedness outstanding under various tranches of its Senior
Secured Notes. The remainder of the proceeds was used for general partnership
purposes, including repayment of additional debt. The Common Units were issued
utilizing the Partnership's existing shelf registration statement on Form S-3.
To effect the transfer of the contribution required by the General Partner to
maintain its 1% general partner interest in the Partnership and its 1.0101%
general partner interest in the Operating Partnership, the General Partner
contributed 32,692 previously issued Common Units back to the Partnership and
those units were cancelled.
On November 6, 2003, the Partnership signed a definitive agreement with La
Grange Energy, L.P. to purchase substantially all of its midstream natural gas
assets by acquiring La Grange Energy, L.P.'s interests in its subsidiary, La
Grange Acquisition, L.P. whose midstream operations are conducted under the name
Energy Transfer Company, in exchange for approximately $300 million in cash,
repayment of outstanding indebtedness, and a combination of Partnership Common
Units, Class D Units and Special Units. The transaction is valued at
approximately $980 million. The Partnership will also acquire the stock of
Heritage Holdings, Inc., which owns approximately 4.4 million common units of
the Partnership for $100 million. La Grange Energy, L.P. will also purchase U.S.
Propane, L.P., the General Partner of the Partnership, and U.S. Propane, L.L.C.
from subsidiaries of AGL Resources, Atmos Energy Corporation, TECO Energy, Inc.
and Piedmont Natural Gas Company, Inc.
17