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, 2003.
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 of the balance sheet 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, 2003, in conformity with accounting principles
generally accepted in the United States of America.
/s/ Grant Thornton LLP
Tulsa, Oklahoma
October 24, 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)
<Table>
<Caption>
August 31,
2003
-----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 8,140
Marketable securities 3,055
Accounts receivable, net of allowance for doubtful accounts 35,879
Inventories 45,274
Assets from liquids marketing 83
Prepaid expenses and other 4,485
Deferred taxes 1,881
----------
Total current assets 98,797
PROPERTY, PLANT AND EQUIPMENT, net 426,588
ASSETS HELD IN TRUST 724
INVESTMENT IN AFFILIATES 8,694
GOODWILL, net of amortization prior to adoption of SFAS No. 142 218,918
INTANGIBLES AND OTHER ASSETS, net 52,824
----------
Total assets $ 806,545
==========
LIABILITIES AND PARTNERS' CAPITAL
CURRENT LIABILITIES:
Working capital facility $ 26,700
Accounts payable 43,832
Accounts payable to related company 1,471
Accrued and other current liabilities 42,975
Liabilities from liquids marketing 80
Current maturities of long-term debt 38,563
----------
Total current liabilities 153,621
LONG-TERM DEBT, less current maturities 361,327
MINORITY INTERESTS 75,377
DEFERRED TAXES 103,845
----------
694,170
----------
COMMITMENTS AND CONTINGENCIES
PARTNERS' CAPITAL:
General partner's capital (2)
Limited partners' capital 112,525
Accumulated other comprehensive loss, net of tax (148)
----------
Total partners' capital 112,375
----------
Total liabilities and partners' capital $ 806,545
==========
</Table>
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, 2003
(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:
<Table>
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%
=========
</Table>
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 650,000 active residential, commercial,
industrial and agricultural customers in 29 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. ("the Operating Partnership"), Heritage Energy Resources, L.L.C.
("Resources"), Guilford Gas Service, Inc. and MP Energy Partnership. On May 31,
2003, Guilford Gas Service, Inc. was merged into the Operating 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.
3
ACCOUNTS RECEIVABLE
The Partnership grants credit to its customers for the purchase of propane and
propane-related products. Accounts receivable are recorded at amounts billed to
customers less an allowance for doubtful accounts. The allowance for doubtful
accounts is based on management's assessment of the realizability of customer
accounts. Management's assessment is based on the payment history of the
Partnership's customers and any specific disputes. Accounts receivable consisted
of the following at August 31, 2003:
<Table>
Accounts receivable $ 39,383
Less - allowance for doubtful accounts 3,504
-----------
Total, net $ 35,879
===========
</Table>
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, 2003:
<Table>
Fuel $ 34,544
Appliances, parts and fittings 10,730
----------
Total inventories $ 45,274
==========
</Table>
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, 2003:
<Table>
Land and improvements $ 21,937
Buildings and improvements (10 to 30 years) 30,843
Bulk storage, equipment and facilities (3 to 30 years) 43,340
Tanks and other equipment (5 to 30 years) 327,193
Vehicles (5 to 10 years) 76,239
Furniture and fixtures (3 to 10 years) 11,164
Other (5 to 10 years) 3,578
-----------
514,294
Less - Accumulated depreciation (99,563)
-----------
414,731
Plus - Construction work-in-process 11,857
-----------
Property, plant and equipment, net $ 426,588
===========
</Table>
4
INTANGIBLES AND OTHER ASSETS
Intangibles and other assets are stated at cost, net of amortization computed
using 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, 2003:
<Table>
<Caption>
Gross Carrying Accumulated
Amount Amortization
-------------- ------------
Amortized intangible assets:
Noncompete agreements (5 to 15 years) $ 42,742 $ (15,893)
Customer lists (15 years) 28,378 (6,356)
Financing costs (3 to 15 years) 4,225 (1,995)
Consulting agreements (2 to 7 years) 517 (367)
---------- ----------
Total 75,862 (24,611)
Unamortized intangible assets:
Trademarks 1,309 --
Other assets 264 --
---------- ----------
Total intangibles and other assets $ 77,435 $ (24,611)
========== ==========
</Table>
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, 2003.
ACCRUED AND OTHER CURRENT LIABILITIES
Accrued and other current liabilities consisted of the following at August 31,
2003:
<Table>
Interest payable $ 4,517
Wages and payroll taxes 11,886
Deferred tank rent 4,080
Advanced budget payments and unearned revenue 15,417
Customer deposits 2,137
Taxes other than income 2,405
Income taxes payable 500
Other 2,033
----------
Accrued and other current liabilities $ 42,975
==========
</Table>
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.
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.
5
STOCK BASED COMPENSATION PLANS
During the fourth quarter of 2003, the Partnership adopted the fair value
recognition provisions of Statement of Financial Accounting Standards No. 123
Accounting for Stock-Based Compensation (SFAS 123) effective as of September 1,
2002. The Partnership adopted the fair value recognition provisions following
the modified prospective method of adoption described in Statement of Financial
Accounting Standards No. 148, Accounting for Stock-Based Compensation -
Transition and Disclosure (SFAS 148).
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, purchase accounting allocations, and
subsequent realizability of intangible assets, 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,
2003 was $422,398 and $399,890, respectively.
GOODWILL AND OTHER INTANGIBLE ASSETS
The Partnership applies FASB Statement No. 142, Goodwill and Other Intangible
Assets (SFAS 142). Accordingly, 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.
Management has determined that a detailed evaluation of the Partnership's
operating segments as of August 31, 2003 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 Partnership's goodwill was recorded as of ended August 31,
2003.
Goodwill is associated with acquisitions made for the Partnership's domestic
retail segment; therefore, all goodwill is recorded in this segment. Of the
$218,918 balance in goodwill, $23,923 is expected to be tax deductible. Goodwill
is tested for impairment at the end of each fiscal year end in accordance with
SFAS 142.
MARKETABLE SECURITIES
The Partnership's marketable securities are classified as available-for-sale
securities and are reflected as current assets on the consolidated balance sheet
at their fair value.
LIQUIDS MARKETING ACTIVITIES
Heritage buys and sells derivative financial instruments, which are within the
scope of SFAS 133 and that are not designated as accounting hedges. Heritage
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
Heritage 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 Heritage's liquids marketing
activity are
6
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, Heritage
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. Heritage 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,
2003 include fixed price payor for 45 barrels of propane, and fixed price
receiver of 195 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.
Estimates related to Resources' 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 $345 change in the market value of the contracts as there were
approximately 6.3 million gallons of net unbalanced positions at August 31,
2003.
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,
2003 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.
<Table>
<Caption>
Source of Fair Value
Prices actively quoted $ 80
Prices based on other valuation methods 3
--------
Assets from liquids marketing $ 83
========
Prices actively quoted $ 80
Prices based on other valuation methods -
--------
Liabilities from liquids marketing $ 80
========
Unrealized gains (losses) $ 3
========
</Table>
7
RECENTLY ISSUED ACCOUNTING STANDARDS
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.
In April 2003, the FASB issued Statement No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities (SFAS 149). SFAS 149 amends and
clarifies financial accounting and reporting for derivative instruments embedded
in other contracts (collectively referred to as derivatives) and for hedging
activities under SFAS 133. SFAS 149 is effective for contracts entered into or
modified after June 30, 2003, and for hedging relationships designated after
June 30, 2003. The Partnership adopted SFAS 149 as of July 1, 2003. The adoption
of SFAS 149 did not have a material impact on the Partnership's consolidated
financial position.
In May 2003, the FASB issued Statement No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity (SFAS 150). SFAS
150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within the scope
of SFAS 150 as a liability (or an asset in some circumstances). This statement
is effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. The Partnership adopted the provisions of SFAS
150 as of September 1, 2003. The adoption did not have a material impact on the
Partnership's consolidated 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:
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 $35.4 million after
post-closing adjustments. The acquisition price was payable $20.0 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,
and assumed $0.4 million in liabilities. V-1's propane distribution network
included 35 customer service locations in Colorado, Idaho, Montana, Oregon,
Utah, Washington, and Wyoming. The Partnership was able to expand its market
presence in the Northwest and achieve a greater geographical balance through the
transaction with V-1. This acquisition enhanced the
8
Partnership's current operations and reduced costs through synergies with
existing operations in locations in which the Partnership was already conducting
business.
The following table summarizes the estimated fair values of the assets acquired
and liabilities assumed of V-1 as of the date of acquisition:
<Table>
Current assets $ 4,952
Property, plant, & equipment 29,324
Goodwill 20
Customer lists (15 years) 740
Trademarks 370
------------
Total assets acquired $ 35,406
------------
Total liabilities assumed (423)
------------
Net assets acquired $ 34,983
============
</Table>
During the year ended August 31, 2003, the Partnership also acquired
substantially all of the assets of four other companies, which included V-1 Oil
Company of Spokane, Washington, Stegall Petroleum located in North Carolina, 1st
Propane of Boise Idaho, and Love Propane Gas located in South Carolina. The
Partnership also purchased the stock of Tri-Cities Gas Company, Inc. located in
Alabama. The aggregate purchase price for these acquisitions totaled $6.4
million, which included liabilities assumed and non-compete agreements of $1.4
million for periods ranging from five to ten years. These acquisitions were
financed primarily with the acquisition facility and were accounted for by the
purchase method under SFAS 141. The Partnership recorded the following
intangible assets in conjunction with these acquisitions as of August 31, 2003:
<Table>
Customer lists (15 years) $ 1,166
Non-compete agreements (5 to 10 years) 769
----------
Total amortized intangible assets 1,935
Trademarks and tradenames 381
Goodwill 860
----------
Total intangible assets acquired $ 3,176
==========
</Table>
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 its retail operating segment.
5. WORKING CAPITAL FACILITY AND LONG-TERM DEBT:
Long-term debt consists of the following at August 31, 2003:
<Table>
1996 8.55% Senior Secured Notes $ 96,000
1997 Medium Term Note Program:
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 2,143
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
</Table>
9
<Table>
8.87% Series F Senior Secured Notes 40,000
7.21% Series G Senior Secured Notes 19,000
7.89% Series H Senior Secured Notes 8,000
7.99% Series I Senior Secured Notes 16,000
Senior Revolving Acquisition Facility 24,700
Notes Payable on noncompete agreements with interest imputed at rates
averaging 7.38%, due in installments through 2010, collateralized by a first
security lien on certain assets of the Partnership 20,110
Other 1,937
Current maturities of long-term debt (38,563)
------------
$ 361,327
============
</Table>
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.
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.
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 $3,800 on May 15
in each of the years 2004 to and
including 2008. Interest is paid
quarterly. $7.5 million of these notes
were retired during the fiscal year
ended August 31, 2003.
10
Series H Notes: mature at the rate of $727 on May 15 in
each of the years 2006 to and including
2016. Interest is paid quarterly. $19.5
million of these notes were retired
during the fiscal year ended August 31,
2003.
Series I Notes: mature in one payment of $16,000 on May
15, 2013. Interest is paid quarterly.
The Senior Secured Notes, the Medium Term Note Program, and the Senior Secured
Promissory Notes contain restrictive covenants including limitations on
substantial disposition of assets, changes in ownership of the Partnership,
additional indebtedness, and require the maintenance of certain financial
ratios. At August 31, 2003, Heritage was in compliance with these covenants,
or had no continuing defaults. All receivables, contracts, equipment, inventory,
general intangibles, cash concentration accounts, and the capital stock of the
Heritage's subsidiaries secure the notes.
The Note Agreements for each of the Senior Secured 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
EBITDA, as adjusted for the most recent four quarterly periods, 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 the 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 or had no continuing defaults with all requirements, tests,
limitations, and covenants related to the Senior Secured Notes, Medium Term Note
Program and Senior Secured Promissory Notes, and the Bank Credit Facility at
August 31, 2003.
Effective July 16, 2001, the Operating Partnership entered into the Fifth
Amendment to the First Amended and Restated Credit Agreement (Bank Credit
Facility). The terms of the Bank Credit Facility as amended are as follows:
A $65,000 Senior Revolving Working Capital Facility, expiring
June 30, 2004 with $26,700 outstanding at August 31, 2003. 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 2.49125% for the amount outstanding at
August 31, 2003. 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 Heritage'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
11
March 31, 2004, with $24,700 outstanding as of August 31,
2003. 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
2.49125% for the amount outstanding at August 31, 2003. 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 Heritage'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 $38,563 in 2004; $40,565 in 2005; $48,501 in 2006; $38,543 in
2007; $45,255 in 2008, and $188,463 thereafter.
6. INCOME TAXES:
The components of deferred income taxes were as follows at August 31, 2003:
<Table>
Deferred Tax Assets-
Alternative minimum tax carryforwards $ 1,945
Accruals, reserves and deferred revenue 1,696
Unrealized loss on available-for-sale securities 337
---------------
$ 3,978
===============
Deferred Tax Liabilities-
Property, plant and equipment (41,656)
Intangibles (64,134)
Other (152)
---------------
$ (105,942)
===============
</Table>
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 $2,916 in
2004; $1,906 in 2005; $1,325 in 2006; $929 in 2007; $934 in 2008 and $846
thereafter.
The Partnership has employment agreements with seven employees. The employment
agreements provide for total annual base salary of $1,545. The employment
agreements provide for the Executives to participate in bonus and incentive
plans.
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
have occurred on August 31, 2003, the General Partner would be required to pay
the remaining portion of $1,545 in base salary for the executives and a maximum
of 174,993 common units or approximately $5,477 based on a per unit price of
$31.30 would be awarded under the Long-Term Incentive Plan, of which $3,165 has
been expensed as of August 31, 2003. 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
12
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 either 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, 2003
an accrual of $941 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, on which the Partnership presently has, 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, 2003 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 2004.
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
Heritage, 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.
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:
o First, 98% to all Unitholders, pro rata, and 2% to U.S.
Propane, until all Unitholders have received $0.50 per unit
for such quarter and any prior quarter;
13
o Second, 98% to all Unitholders, pro rata, and 2% to U.S.
Propane, until all Unitholders have received $0.55 per unit
for such quarter;
o 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;
o 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;
o Fifth, thereafter 50% to all Unitholders, pro rata, 48% to the
holders of Incentive Distribution Right, pro rata, and 2% to
U.S. Propane.
The total amount of distributions for the 2003 fiscal year on Common Units, the
general partner interests and the Incentive Distribution Rights totaled $43.7
million, $0.9 million and $1.0 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, amended February 4, 2002 as the Second Amended and Restated
Restricted Unit Plan (the "Restricted Unit Plan"), for certain directors and key
employees of the General Partner and its affiliates. The Restricted Unit Plan
covers rights to acquire 146,000 of Heritage's Common Units. 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 the General Partner 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
U.S. Propane, TECO, Atmos Energy, Piedmont Natural Gas or AGL Resources 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) 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,
2003, 39,400 restricted units are outstanding and 15,800 are available for
grants to non-employee directors and key employees. Subsequent to August 31,
2003, 14,800 additional Phantom Units vested pursuant to the vesting rights of
the Restricted Unit Plan and Common Units were issued.
During the fiscal year ended August 31, 2003, 15,000 units were granted under
the Restricted Unit Plan. The units had a weighted-average fair value of $20.24
per unit at the grant date. During fiscal year 2003, 2,500 Phantom Units vested
pursuant to the vesting rights of the Restricted Unit Plan and Common Units were
issued.
14
LONG-TERM INCENTIVE PLAN
Effective September 1, 2000, the Partnership adopted a long-term incentive plan
whereby Heritage Common Units will be awarded based on Heritage achieving
certain targeted levels of Distributed Cash (as defined in the Long-Term
Incentive Plan) per unit. Awards under the program 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 if certain targeted levels are achieved, a
maximum of 500,000 Common Units will be awarded. During the fiscal year ended
August 31, 2003, 66,118 units vested pursuant to the vesting rights of the
Long-Term Incentive Plan and Common Units were issued, and 8,889 units were
forfeited.
9. SIGNIFICANT INVESTEE:
The Partnership holds a 50% interest in Bi-State Propane, which is accounted for
under the equity method. The Partnership's investment in Bi-State Propane
totaled $8,242 at August 31, 2003. The Operating Partnership guarantees $5
million of debt of 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. The Partnership has not recorded a liability on the consolidated
balance sheet as of August 31, 2003 for this guarantee because the guarantee was
in effect prior to the issuance of FIN 45, and there have been no amendments to
the original guarantee.
Bi-State Propane's financial position is summarized below as of August 31, 2003:
<Table>
Current assets $ 3,393
Noncurrent assets 23,187
----------
$ 26,580
==========
Current liabilities $ 3,701
Long-term debt 7,750
Partners' capital:
Heritage 8,242
Other partner 6,887
----------
$ 26,580
==========
</Table>
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, 2003:
<Table>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 52
Receivable from affiliate 5,432
Prepaid expenses and other 324
------------
Total current assets 5,808
ASSETS HELD IN TRUST 724
INVESTMENT IN HERITAGE 45,808
INVESTMENT IN HERITAGE HOLDINGS 79,428
------------
Total assets $ 131,768
============
</Table>
15
<Table>
LIABILITIES AND PARTNERS' CAPITAL
CURRENT LIABILITIES:
Accounts payable and accrued liabilities $ 7,035
Current maturities of long-term debt 254
------------
Total current liabilities 7,289
LONG-TERM DEBT, less current maturities 565
NOTE PAYABLE TO HERITAGE HOLDINGS 11,539
------------
19,393
------------
PARTNERS' CAPITAL:
General Partner's capital (2)
Limited Partners' capital 112,525
Accumulated other comprehensive loss (148)
------------
Total partners' capital 112,375
------------
Total liabilities and partners' capital $ 131,768
============
</Table>
11. SUBSEQUENT EVENT:
On November 6, 2003, the Partnership signed a definitive agreement with Energy
Transfer Company to purchase substantially all of its assets 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 Heritage for $100 million. Energy Transfer Company will
also purchase U.S. Propane, L.P., the General Partner of Heritage, and U.S.
Propane, L.L.C. from subsidiaries of AGL Resources, Atmos Energy Corporation,
TECO Energy, Inc. and Piedmont Natural Gas Company, Inc.
16