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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 001-16405
KANEB SERVICES LLC
(Exact name of registrant as specified in its charter)
Delaware 75-2931295
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
2435 North Central Expressway
Richardson, Texas 75080
- ---------------------------------------- ---------------------
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (972) 699-4062
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
- ------------------- -----------------------------------------
Shares New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Subsection 229.405 of this chapter) is not contained
herein, and will not be contained, to the best of registrant's knowledge, in
definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K. Yes No X
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes X No
Aggregate market value of the voting shares held by non-affiliates of the
registrant: $220,947,360. This figure is estimated as of June 28, 2002, at which
date the closing price of the registrant's shares on the New York Stock Exchange
was $20.00 per share and assumes that only officers and directors of the
registrant were affiliates of the registrant.
Number of Shares of the Registrant outstanding at March 21, 2003:
11,329,851.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III (Items 10, 11, 12 and 13) of Form 10-K
is incorporated by reference from portions of the Registrant's definitive proxy
statement to be filed with the Securities and Exchange Commission not later than
120 days after the close of the fiscal year covered by this Report.
PART I
Item 1. Business
GENERAL
Kaneb Services LLC (the "Company") is a limited liability company organized
under the laws of the State of Delaware. The Company manages and operates a
refined petroleum products and anhydrous ammonia pipeline business and the
terminaling of petroleum products and specialty liquids terminal storage
business through the general partner interest owned by one of its subsidiaries
in Kaneb Pipe Line Partners, L.P., a Delaware limited partnership ("KPP"), which
in turn owns those systems and facilities through its subsidiaries.
KPP is a separate public entity whose limited partner units are traded over
the New York Stock Exchange (NYSE: KPP). The Company's wholly owned subsidiary,
Kaneb Pipe Line Company LLC, a Delaware limited liability company, ("KPL"), owns
the general partner interest and 5.1 million limited partner units of KPP. For
financial statement purposes, the assets, liabilities and earnings of KPP are
included in the Company's consolidated financial statements, with the public
unitholders' interest reflected as interest of outside non-controlling partners
in KPP. For purposes of this report, the business, operations, revenues and
other information about KPP are presented as a whole, even though the Company
does not, directly or indirectly, own 100% of KPP. The Company's product
marketing services are conducted by Martin Oil LLC, a Delaware limited liability
company ("Martin"), a 100% owned subsidiary of KPL and, since KPP's acquisition
of Statia (see "Liquidity and Capital Resources"), by Statia which delivers
bunker fuel to ships in the Caribbean and Nova Scotia, Canada and sells bulk
petroleum products to various commercial interests. Martin provides wholesale
motor fuel marketing services throughout the Great Lakes and Rocky Mountain
regions.
PIPELINE BUSINESS
Introduction
KPP's pipeline business consists primarily of the transportation of refined
petroleum products as a common carrier in Kansas, Nebraska, Iowa, South Dakota,
North Dakota, Colorado, Wyoming and Minnesota. On December 24, 2002, KPP
acquired the Northern Great Plains Product System from Tesoro Refining and
Marketing Company for approximately $100 million. This product pipeline system
is now referred to as KPP's North Pipeline. On November 1, 2002, KPP acquired a
2,000 mile anhydrous ammonia pipeline from Koch Pipeline Company, LP and Koch
Fertilizer Storage and Terminal Company for approximately $139 million. KPP's
three refined petroleum products pipelines and the anhydrous ammonia pipeline
are described below.
East Pipeline
Construction of the East Pipeline commenced in the 1950s with a line from
southern Kansas to Geneva, Nebraska. During subsequent years, the East Pipeline
was extended northward to its present terminus at Jamestown, North Dakota, west
to North Platte, Nebraska and east into the State of Iowa. The East Pipeline,
which moves refined products from south to north, now consists of 2,090 miles of
pipeline ranging in size from 6 inches to 16 inches.
The East Pipeline system also consists of 17 product terminals in Kansas,
Nebraska, Iowa, South Dakota and North Dakota with total storage capacity of
approximately 3.5 million barrels and an additional 23 product tanks with total
storage capacity of approximately 1,118,393 barrels at its tank farm
installations at McPherson and El Dorado, Kansas. The system also has six origin
pump stations in Kansas and 38 booster pump stations throughout the system.
Additionally, the system maintains various office and warehouse facilities, and
an extensive quality control laboratory.
The East Pipeline transports refined petroleum products, including propane,
received from refineries in southeast Kansas and other connecting pipelines to
its terminals along the system and to receiving pipeline connections in Kansas.
Shippers on the East Pipeline obtain refined petroleum products from refineries
connected to the East Pipeline or through other pipelines directly connected to
the pipeline system. Five connecting pipelines can deliver propane for shipment
through the East Pipeline from gas processing plants in Texas, New Mexico,
Oklahoma and Kansas.
Most of the refined petroleum products delivered through the East Pipeline
are ultimately used as fuel for railroads or in agricultural operations,
including fuel for farm equipment, irrigation systems, trucks used for
transporting crops and crop drying facilities. Demand for refined petroleum
products for agricultural use, and the relative mix of products required, is
affected by weather conditions in the markets served by the East Pipeline.
Government agricultural policies and crop prices also affect the agricultural
sector. Although periods of drought suppress agricultural demand for some
refined petroleum products, particularly those used for fueling farm equipment,
the demand for fuel for irrigation systems often increases during such times.
The mix of refined petroleum products delivered varies seasonally, with
gasoline demand peaking in early summer, diesel fuel demand peaking in late
summer and propane demand higher in the fall. In addition, weather conditions in
the areas served by the East Pipeline affect both the demand for and the mix of
the refined petroleum products delivered through the East Pipeline, although
historically any overall impact on the total volumes shipped has been
short-term. Tariffs charged to shippers for transportation of products do not
vary according to the type of product delivered.
West Pipeline
KPP acquired the West Pipeline in February 1995, increasing KPP's pipeline
business in South Dakota and expanding it into Wyoming and Colorado. The West
Pipeline system includes approximately 550 miles of pipeline in Wyoming,
Colorado and South Dakota, four truck-loading terminals and numerous pump
stations situated along the system. The system's four product terminals have a
total storage capacity of over 1.7 million barrels.
The West Pipeline originates near Casper, Wyoming, where it serves as a
connecting point with Sinclair's Little America Refinery and the Seminoe
Pipeline that transports product from Billings, Montana area refineries. At
Douglas, Wyoming, a 6 inch pipeline branches off to serve KPP's Rapid City,
South Dakota terminal approximately 190 miles away. The 6 inch pipeline also
receives product from Wyoming Refining's pipeline at a connection located near
the Wyoming/South Dakota border. From Douglas, KPP's 8 inch pipeline continues
southward through a delivery point at the Burlington Northern junction to
terminals at Cheyenne, Wyoming, the Denver metropolitan area and Fountain,
Colorado.
The West Pipeline system parallels KPP's East Pipeline to the west. The
East Pipeline's North Platte line terminates in western Nebraska, approximately
200 miles east of the West Pipeline's Cheyenne, Wyoming Terminal. The West
Pipeline serves Denver and other eastern Colorado markets and supplies jet fuel
to Ellsworth Air Force Base at Rapid City, South Dakota, as compared to the East
Pipeline's largely agricultural service area. The West Pipeline has a relatively
small number of shippers, who, with few exceptions, are also shippers on KPP's
East Pipeline system.
North Pipeline
The North Pipeline, acquired by KPP in December 2002, runs from west to
east approximately 440 miles from its origin at the Tesoro Refining and
Marketing Company's Mandan, North Dakota refinery to the Minneapolis, Minnesota
area. It has four product terminals, one in North Dakota and three in Minnesota,
with a total tankage capacity of 1.3 million barrels. The North Pipeline crosses
KPP's East Pipeline near Jamestown, North Dakota and the two pipelines will be
connected at that location in the near future. The North Pipeline is presently
supplied exclusively by the Mandan refinery. Once connected to the East
Pipeline, it will be capable of delivering or receiving products to or from the
East Pipeline.
Ammonia Pipeline
On November 1, 2002, KPP acquired the anhydrous ammonia pipeline ("the
"Ammonia Pipeline") from two Koch companies. Anhydrous ammonia is primarily used
as agricultural fertilizer through direct application. Other uses are as a
component of various types of dry fertilizer as well as use as a cleaning agent
in power plant scrubbers. The 2,000 mile pipeline originates in the Louisiana
delta area where it has access to three marine terminals. It moves north through
Louisiana and Arkansas into Missouri, where at Hermann, Missouri, one branch
splits going east into Illinois and Indiana, and the other branch continues
north into Iowa and then turning west into Nebraska. KPP acquired a storage and
loading terminal near Hermann, Missouri but it was leased back to Koch Nitrogen.
The administrative headquarters for the Ammonia Pipeline is located in Hermann,
Missouri. The Ammonia Pipeline is connected to twenty-two other non-Partnership
owned terminals and also has several industrial delivery locations. Product is
primarily supplied to the pipeline from plants in Louisiana and foreign-source
product through the marine terminals.
Other Systems
KPP also owns three single-use pipelines, located near Umatilla, Oregon;
Rawlins, Wyoming and Pasco, Washington, each of which supplies diesel fuel to a
railroad fueling facility. The Oregon and Washington lines are fully automated,
however the Wyoming line utilizes a coordinated startup procedure between the
refinery and the railroad. For the year ended December 31, 2002, these three
systems combined transported a total of 3.5 million barrels of diesel fuel,
representing an aggregate of $1.0 million in revenues.
Pipelines Products and Activities
The revenues for the East Pipeline, West Pipeline, North Pipeline, Ammonia
Pipeline and Other Pipelines (collectively, the "Pipelines") are based upon
volumes and distances of product shipped. The following table reflects the total
volume and barrel miles of refined petroleum products shipped and total
operating revenues earned by the Pipelines for each of the periods indicated,
but does not include any information on the Ammonia Pipeline and North pipeline
systems which were acquired on November 1 and December 24, 2002, respectively:
Year Ended December 31,
------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------- ------------- -------------- ------------- --------------
Volume (1).................. 89,780 92,116 89,192 85,356 77,965
Barrel miles (2)............ 18,275 18,567 17,843 18,440 17,007
Revenues (3)................ $78,240 $74,976 $70,685 $67,607 $63,421
(1) Volumes are expressed in thousands of barrels of refined petroleum product.
(2) Barrel miles are shown in millions. A barrel mile is the movement of one
barrel of refined petroleum product one mile.
(3) Revenues are expressed in thousands of dollars.
The following table sets forth volumes of propane and various types of
other refined petroleum products transported by the Pipelines during each of the
periods indicated:
Year Ended December 31,
(thousands of barrels)
------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------- ------------- -------------- ------------- --------------
Gasoline.................... 45,106 46,268 44,215 41,472 37,983
Diesel and fuel oil......... 40,450 42,354 41,087 40,435 36,237
Propane..................... 4,224 3,494 3,890 3,449 3,745
------------- ------------- -------------- ------------- --------------
Total....................... 89,780 92,116 89,192 85,356 77,965
============= ============= ============== ============= ==============
Diesel and fuel oil are used in farm machinery and equipment, over-the-road
transportation, railroad fueling and residential fuel oil. Gasoline is primarily
used in over-the-road transportation and propane is used for crop drying,
residential heating and to power irrigation equipment. The mix of refined
petroleum products delivered varies seasonally, with gasoline demand peaking in
early summer, diesel fuel demand peaking in late summer and propane demand
higher in the fall. In addition, weather conditions in the areas served by the
East Pipeline affect both the demand for and the mix of the refined petroleum
products delivered through the East Pipeline, although historically any overall
impact on the total volumes shipped has been short-term. Tariffs charged to
shippers for transportation of products do not vary according to the type of
product delivered. Demand on the North Pipeline is anticipated to reflect the
same agricultural nature as the East Pipeline except for the Minneapolis area
terminal which should be more like the Denver metropolitan area demand.
Maintenance and Monitoring
The Pipelines have been constructed and are maintained in a manner
consistent with applicable federal, state and local laws and regulations,
standards prescribed by the American Petroleum Institute and accepted industry
practice. Further, protective measures are taken and routine preventive
maintenance is performed on the Pipelines in order to prolong the useful lives
of the Pipelines. Such measures include cathodic protection to prevent external
corrosion, inhibitors to prevent internal corrosion and periodic inspection of
the Pipelines. Additionally, the Pipelines are patrolled at regular intervals to
identify equipment or activities by third parties that, if left unchecked, could
result in encroachment upon the Pipeline's rights-of-way and possible damage to
the Pipelines.
KPP uses state-of-the-art Supervisory Control and Data Acquisition remote
supervisory control software programs to continuously monitor and control the
Pipelines from the Wichita, Kansas headquarters and from the Roseville,
Minnesota terminal for the North Pipeline. The system monitors quantities of
refined petroleum products injected in and delivered through the Pipelines and
automatically signals the Wichita headquarters or Roseville personnel upon
deviations from normal operations that requires attention.
Pipeline Operations
For pipeline operations, integrity management and public safety, the East
Pipeline, the West Pipeline, the North Pipeline and the Ammonia Pipeline are
subject to federal regulation by one or more of the following governmental
agencies or laws: the Federal Energy Regulatory Commission ("FERC"), the Surface
Transportation Board, the Department of Transportation, the Environmental
Protection Agency, and the Homeland Security Act. Additionally, the operations
and integrity of the Pipelines are subject to the respective state jurisdictions
along the route of the systems. See "Regulation."
Except for the three single-use pipelines and certain ethanol facilities,
all of KPP's pipeline operations constitute common carrier operations and are
subject to federal tariff regulation. In May 1998, KPP was authorized by the
FERC to adopt market-based rates in approximately one-half of its markets on the
East and West systems. Common carrier activities are those under which
transportation through KPP's Pipelines is available at published tariffs filed,
in the case of interstate petroleum product shipments, with the FERC, or in the
case of intrastate petroleum product shipments, in Kansas, Colorado, Wyoming and
North Dakota, with the relevant state authority, to any shipper of refined
petroleum products who requests such services and satisfies the conditions and
specifications for transportation. The Ammonia Pipeline is subject to federal
regulation by the Surface Transportation Board, rather than the FERC.
In general, a shipper on one of KPP's refined petroleum products pipelines
delivers products to the pipeline from refineries or third party pipelines that
connect to the Pipelines. The pipelines' refined petroleum products operations
also include 25 truck-loading terminals through which refined petroleum products
are delivered to storage tanks and then loaded into petroleum transport trucks.
Five of the 25 terminals also receive propane into storage tanks and then load
it into transport trucks. The Ammonia Pipeline receives product from anhydrous
ammonia plants or from the marine terminals for imported product. Tariffs for
transportation are charged to shippers based upon transportation from the
origination point on the pipeline to the point of delivery. Such tariffs also
include charges for terminaling and storage of product at the Pipeline's
terminals. Pipelines are generally the lowest cost method for intermediate and
long-haul overland transportation of refined petroleum products.
Each shipper transporting product on a pipeline is required to supply KPP
with a notice of shipment indicating sources of products and destinations. All
petroleum product shipments are tested or receive refinery certifications to
ensure compliance with KPP's specifications. Shippers are generally invoiced by
KPP immediately upon the product entering one of the Pipelines.
The following table shows the number of tanks owned by KPP at each refined
petroleum product terminal location at December 31, 2002, the storage capacity
in barrels and truck capacity of each terminal location.
Location of Number Tankage Truck
Terminals of Tanks Capacity Capacity(a)
---------------------------- -------- ---------- -----------
Colorado:
Dupont 18 692,000 6
Fountain 13 391,000 5
Iowa:
LeMars 9 103,000 2
Milford(b) 11 172,000 2
Rock Rapids 12 366,000 2
Kansas:
Concordia(c) 7 79,000 2
Hutchinson 9 161,000 2
Salina 10 98,000 3
Minnesota
Moorhead 17 498,000 3
Sauk Centre 11 114,000 2
Roseville 13 594,000 5
Nebraska:
Columbus(d) 12 191,000 2
Geneva 39 678,000 6
Norfolk 16 187,000 4
North Platte 22 197,000 5
Osceola 8 79,000 2
North Dakota:
Jamestown(e) 19 315,000 4
South Dakota:
Aberdeen 12 181,000 2
Mitchell 8 72,000 2
Rapid City 13 256,000 3
Sioux Falls 9 381,000 2
Wolsey 21 149,000 4
Yankton 25 246,000 4
Wyoming:
Cheyenne 15 345,000 2
------ -----------
Totals 349 6,545,000
====== ===========
(a) Number of trucks that may be simultaneously loaded.
(b) This terminal is situated on land leased through August 7, 2007 at an
annual rental of $2,400. KPP has the right to renew the lease upon its
expiration for an additional term of 20 years at the same annual rental
rate.
(c) This terminal is situated on land leased through the year 2060 for a total
rental of $2,000.
(d) Also loads rail tank cars.
(e) Two terminals
The East Pipeline also has intermediate storage facilities consisting of 13
storage tanks at El Dorado, Kansas and 10 storage tanks at McPherson, Kansas,
with aggregate capacities of approximately 584,393 and 534,000 barrels,
respectively. During 2002, approximately 56.8% and 90.1% of the deliveries of
the East Pipeline and the West Pipeline, respectively, were made through their
terminals, and the remainder of the respective deliveries of such lines were
made to other pipelines and customer owned storage tanks.
Storage of product at terminals pending delivery is considered by KPP to be
an integral part of the petroleum product delivery service of the pipelines.
Shippers generally store refined petroleum products for less than one week.
Ancillary services, including injection of shipper-furnished and generic
additives, are available at each terminal.
Demand for and Sources of Refined Petroleum Products
KPP's pipeline business depends in large part on (i) the level of demand
for refined petroleum products in the markets served by the pipelines and (ii)
the ability and willingness of refiners and marketers having access to the
pipelines to supply such demand by deliveries through the pipelines.
Most of the refined petroleum products delivered through the East Pipeline
and the western three terminals on the North Pipeline are ultimately used as
fuel for railroads or in agricultural operations, including fuel for farm
equipment, irrigation systems, trucks used for transporting crops and crop
drying facilities. Demand for refined petroleum products for agricultural use,
and the relative mix of products required, is affected by weather conditions in
the markets served by the East and North Pipeline. The agricultural sector is
also affected by government agricultural policies and crop prices. Although
periods of drought suppress agricultural demand for some refined petroleum
products, particularly those used for fueling farm equipment, the demand for
fuel for irrigation systems often increases during such times.
While there is some agricultural demand for the refined petroleum products
delivered through the West Pipeline, as well as military jet fuel volumes, most
of the demand is centered in the Denver and Colorado Springs area. Because
demand on the West Pipeline and the Minneapolis area terminal of the North
Pipeline is significantly weighted toward urban and suburban areas, the product
mix on the West Pipeline and that terminal includes a substantially higher
percentage of gasoline than the product mix on the East Pipeline.
KPP's refined petroleum products pipelines are also dependent upon adequate
levels of production of refined petroleum products by refineries connected to
the Pipelines, directly or through connecting pipelines. The refineries are, in
turn, dependent upon adequate supplies of suitable grades of crude oil. The
refineries connected directly to the East Pipeline obtain crude oil from
producing fields located primarily in Kansas, Oklahoma and Texas, and, to a much
lesser extent, from other domestic or foreign sources. In addition, refineries
in Kansas, Oklahoma and Texas are also connected to the East Pipeline through
other pipelines. These refineries obtain their supplies of crude oil from a
variety of sources. The refineries connected directly to the West Pipeline are
located in Casper and Cheyenne, Wyoming and Denver, Colorado. Refineries in
Billings and Laurel, Montana are connected to the West Pipeline through other
pipelines. These refineries obtain their supplies of crude oil primarily from
Rocky Mountain sources. The North Pipeline, until the connection to the East
Pipeline is complete, is dependent on the Tesoro Mandan refinery which primarily
operates on North Dakota crude oil although it has the ability to access other
crude oils. If operations at any one refinery were discontinued, KPP believes
(assuming unchanged demand for refined petroleum products in markets served by
the refined petroleum products pipelines) that the effects thereof would be
short-term in nature, and KPP's business would not be materially adversely
affected over the long term because such discontinued production could be
replaced by other refineries or by other sources.
The majority of the refined petroleum product transported through the East
Pipeline in 2002 was produced at three refineries located at McPherson and El
Dorado, Kansas and Ponca City, Oklahoma, and operated by National Cooperative
Refining Association ("NCRA"), Frontier Refining and Conoco, Inc. respectively.
The NCRA and Frontier Refining refineries are connected directly to the East
Pipeline. The McPherson, Kansas refinery operated by NCRA accounted for
approximately 28.9% of the total amount of product shipped over the East
Pipeline in 2002. The East Pipeline also has direct access by third party
pipelines to four other refineries in Kansas, Oklahoma and Texas and to Gulf
Coast supplies of products through connecting pipelines that receive products
from pipelines originating on the Gulf Coast. Five connecting pipelines can
deliver propane from gas processing plants in Texas, New Mexico, Oklahoma and
Kansas to the East Pipeline for shipment.
The majority of the refined petroleum products transported through the West
Pipeline is produced at the Frontier Refinery located at Cheyenne, Wyoming, the
Valero Energy Corporation and Conoco Refineries located at Denver, Colorado, and
Sinclair's Little America Refinery located at Casper, Wyoming, all of which are
connected directly to the West Pipeline. The West Pipeline also has access to
three Billings, Montana, area refineries through a connecting pipeline.
Demand for and Sources of Anhydrous Ammonia
KPP's Ammonia Pipeline business depends on (1) the level of demand for
direct application of anhydrous ammonia as a fertilizer for crop production
("Direct Application" or "DA"); (2) the weather (DA is not effective if the
ground is too wet) and (3) the price of natural gas (the primary component of
anhydrous ammonia).
The Ammonia Pipeline is the largest of three anhydrous ammonia pipelines in
the US and the only one that has the capability of receiving foreign production
directly into the system and transporting anhydrous ammonia into the nation's
corn belt. This ability to receive either domestic or foreign anhydrous ammonia
is a competitive advantage over the next largest ammonia system which originates
in Oklahoma and extends into Iowa.
Corn producers have several fertilizer alternatives such as liquid, dry or
Direct Application. Liquid and dry fertilizers are both upgrades of anhydrous
ammonia and therefore are more costly but are less sensitive to weather
conditions during application. DA is the cheapest method of fertilizer
application but cannot be applied if the ground is too wet or extremely dry.
Principal Customers
KPP had a total of approximately 58 shippers in 2002. The principal
shippers include four integrated oil companies, three refining companies, two
large farm cooperatives and one railroad. Transportation revenues attributable
to the top 10 shippers of the East and West Pipelines were $61.5 million, $51.5
million, and $48.7 million, which accounted for 74%, 69%, and 69% of total
revenues shipped for each of the years 2002, 2001, and 2000, respectively.
Competition and Business Considerations
The East and North Pipelines' major competitor is an independent, regulated
common carrier pipeline system owned by The Williams Companies, Inc.
("Williams") that operates approximately 100 miles east of and parallel to the
East Pipeline and in close proximity to the North Pipeline. The Williams system
is a substantially more extensive system than the East and North Pipelines.
Competition with Williams is based primarily on transportation charges, quality
of customer service and proximity to end users, although refined product pricing
at either the origin or terminal point on a pipeline may outweigh transportation
costs. Twenty-one of the East Pipeline's and all four of the North Pipeline's
delivery terminals are located within 2 to 145 miles of, and in direct
competition with Williams' terminals.
The West Pipeline competes with the truck-loading racks of the Cheyenne and
Denver refineries and the Denver terminals of the Chase Terminal Company and
Phillips Petroleum Company. Valero L.P. terminals in Denver and Colorado
Springs, connected to a Valero L.P. pipeline from their Texas Panhandle
Refinery, are major competitors to the West Pipeline's Denver and Fountain
Terminals, respectively.
Because pipelines are generally the lowest cost method for intermediate and
long-haul movement of refined petroleum products, KPP's Pipelines more
significant competitors are common carrier and proprietary pipelines owned and
operated by major integrated and large independent oil companies and other
companies in the areas where KPP delivers products. Competition between common
carrier pipelines is based primarily on transportation charges, quality of
customer service and proximity to end users. KPP believes high capital costs,
tariff regulation, environmental considerations and problems in acquiring
rights-of-way make it unlikely that other competing pipeline systems comparable
in size and scope to KPP's Pipelines will be built in the near future, provided
KPP's Pipelines have available capacity to satisfy demand and its tariffs remain
at reasonable levels.
The costs associated with transporting products from a loading terminal to
end users limit the geographic size of the market that can be served
economically by any terminal. Transportation to end users from the loading
terminals of KPP is conducted principally by trucking operations of unrelated
third parties. Trucks may competitively deliver products in some of the areas
served by the Pipelines. However, trucking costs render that mode of
transportation not competitive for longer hauls or larger volumes. KPP does not
believe that trucks are, or will be, effective competition to its long-haul
volumes over the long term.
Competitors of the Ammonia Pipeline include another anhydrous ammonia
pipeline which originates in Oklahoma and terminates in Iowa. The competitor
pipeline has the same DA demand and weather issues as the Ammonia Pipeline but
is restricted to domestically produced anhydrous ammonia. Barges and railroads
represent direct competition for smaller niche markets but are not competitive
for larger demand markets.
LIQUIDS TERMINALING BUSINESS
Introduction
KPP's terminaling business is conducted through the Support Terminal
Services operation ("ST Services" or "ST") and Statia Terminals International
N.V. ("Statia"). ST Services is one of the largest independent petroleum
products and specialty liquids terminaling companies in the United States.
Statia, acquired on February 28, 2002 for a purchase price of $178 million (net
of cash acquired), plus the assumption of $107 million of debt, owns and
operates KPP's two largest terminals and provides related value-added services,
including crude oil and petroleum product blending and processing, berthing of
vessels at their marine facilities, and emergency and spill response services.
In addition to its terminaling services, Statia sells bunkers, which is the fuel
marine vessels consume, and bulk petroleum products to various commercial
interests. In January 2001, KPP completed the acquisition of Shore Terminals LLC
for a purchase price of $107 million cash and 1,975,090 limited partnership
units of KPP (valued at $56.5 million at the date of the agreement).
For the year ended December 31, 2002, KPP's terminaling business accounted
for approximately 53% of KPP's revenues. As of December 31, 2002, ST operated 39
facilities in 20 states, with a total storage capacity of approximately 33.3
million barrels. ST also owns and operates six terminals located in the United
Kingdom, having a total capacity of approximately 5.5 million barrels. In
September 2002, ST acquired eight terminals in Australia and New Zealand with a
total capacity of approximately 1.2 million barrels for approximately $47
million in cash. ST Services and its predecessors have a long history in the
terminaling business and handle a wide variety of liquids from petroleum
products to specialty chemicals to edible liquids. At the end of 2002, Statia's
tank capacity was 18.8 million barrels, including an 11.3 million barrel storage
and transshipment facility located on the Netherlands Antilles island of St.
Eustatius, and a 7.5 million barrel storage and transshipment facility located
at Point Tupper, Nova Scotia, Canada.
KPP's terminal facilities provide storage and handling services on a fee
basis for petroleum products, specialty chemicals and other liquids. KPP's six
largest terminal facilities are located on the Island of St. Eustatius,
Netherlands Antilles; in Point Tupper, Nova Scotia, Canada; in Piney Point,
Maryland; in Linden, New Jersey (50% owned joint venture); in Crockett,
California; and in Martinez, California.
Description of Largest Terminal Facilities
St. Eustatius, Netherlands Antilles
Statia owns and operates an 11.3 million barrel petroleum terminaling
facility located on the Netherlands Antilles island of St. Eustatius, which is
located at a point of minimal deviation from major shipping routes. This
facility is capable of handling a wide range of petroleum products, including
crude oil and refined products, and can accommodate the world's largest tankers
for loading and discharging crude oil. A three-berth jetty, a two-berth monopile
with platform and buoy systems, a floating hose station, and an offshore single
point mooring buoy with loading and unloading capabilities serve the terminal's
customers' vessels. The St. Eustatius facility has a total of 51 tanks. The fuel
oil and petroleum product facilities have in-tank and in-line blending
capabilities, while the crude tanks have tank-to-tank blending capability as
well as in-tank mixers. In addition to the storage and blending services at St.
Eustatius, the facility has the flexibility to utilize certain storage capacity
for both feedstock and refined products to support its atmospheric distillation
unit, which is capable of processing up to 15,000 BPD of feedstock, ranging from
condensates to heavy crude oil. Statia owns and operates all of the berthing
facilities at its St. Eustatius terminal and charges vessels a fee for their
use. Vessel owners or charterers may incur separate fees for associated services
such as pilotage, tug assistance, line handling, launch service, emergency
response services, and other ship services.
Point Tupper, Nova Scotia, Canada
Statia owns and operates a 7.5 million barrel terminaling facility located
at Point Tupper on the Strait of Canso, near Port Hawkesbury, Nova Scotia,
Canada, which is located approximately 700 miles from New York City, 850 miles
from Philadelphia and 2,500 miles from Mongstad, Norway. This facility is the
deepest independent, ice-free marine terminal on the North American Atlantic
coast, with access to the East Coast and Canada as well as the Midwestern United
States via the St. Lawrence Seaway and the Great Lakes system. With one of the
premier jetty facilities in North America, the Point Tupper facility can
accommodate substantially all of the world's largest, fully-laden very large
crude carriers and ultra large crude carriers for loading and discharging crude
oil, petroleum products, and petrochemicals. The Point Tupper facility has a
total of 37 tanks. Its butane sphere is one of the largest of its kind in North
America. The facility's tanks were renovated in 1994 to comply with construction
standards that meet or exceed American Petroleum Institute, NFPA, and other
material industry standards. Crude oil and petroleum product movements at the
terminal are fully automated. Separate Statia fees apply for the use of the
jetty facility as well as associated services, including pilotage, tug
assistance, line handling, launch service, spill response services, and other
ship services. Statia also charters tugs, mooring launches, and other vessels to
assist with the movement of vessels through the Strait of Canso and the safe
berthing of vessels at Point Tupper and to provide other services to vessels.
Piney Point, Maryland
The largest domestic terminal currently owned by ST is located on
approximately 400 acres on the Potomac River. The facility was acquired as part
of the purchase of the liquids terminaling assets of Steuart Petroleum Company
and certain of its affiliates (collectively "Steuart") in December 1995. The
Piney Point terminal has approximately 5.4 million barrels of storage capacity
in 28 tanks and is the closest deep-water facility to Washington, D.C. This
terminal competes with other large petroleum terminals in the East Coast
water-borne market extending from New York Harbor to Norfolk, Virginia. The
terminal currently stores petroleum products consisting primarily of fuel oils
and asphalt. The terminal has a dock with a 36-foot draft for tankers and four
berths for barges. It also has truck-loading facilities, product-blending
capabilities and is connected to a pipeline which supplies residual fuel oil to
two power generating stations.
Linden, New Jersey
In October 1998, ST entered into a joint venture relationship with
Northville Industries Corp. ("Northville") to acquire a 50% ownership interest
in and the management of the terminal facility at Linden, New Jersey that was
previously owned by Northville. The 44-acre facility provides ST with deep-water
terminaling capabilities at New York Harbor and primarily stores petroleum
products, including gasoline, jet fuel and fuel oils. The facility has a total
capacity of approximately 3.9 million barrels in 22 tanks, can receive products
via ship, barge and pipeline and delivers product by ship, barge, pipeline and
truck. The terminal owns two docks and leases a third with draft limits of 35,
24 and 24 feet, respectively.
Crockett, California
The Crockett Terminal was acquired in January 2001 as a part of the Shore
acquisition. The terminal has approximately 3 million barrels of tankage and is
located in the San Francisco Bay area. The facility provides deep-water access
for handling petroleum products and gasoline additives such as ethanol. The
terminal offers pipeline connections to various refineries and pipelines. It
receives and delivers product by vessel, barge, pipeline and truck-loading
facilities. The terminal also has railroad tank car unloading capability.
Martinez, California
The Martinez Terminal, also acquired in January 2001 as a part of the Shore
acquisition, is located in the refinery area of San Francisco Bay. It has
approximately 2.8 million barrels of tankage and handles refined petroleum
products as well as crude oil. The terminal is connected to a pipeline and to
area refineries by pipelines and can also receive and deliver products by vessel
or barge. It also has a truck rack for product delivery.
KPP's facilities have been designed with engineered structural measures to
minimize the possibility of the occurrence and the level of damage in the event
of a spill or fire. All loading areas, tanks, pipes and pumping areas are
"contained" to collect any spillage and insure that only properly treated water
is discharged from the site.
Other Terminal Sites
In addition to the four major domestic facilities described above, ST
Services has 35 other terminal facilities located throughout the United States,
six facilities in the United Kingdom, four facilities in Australia and four in
New Zealand. These other facilities primarily store petroleum products for a
variety of customers, with the exception of the facilities in Texas City, Texas,
which handles specialty chemicals; Columbus, Georgia, which handles aviation
gasoline and specialty chemicals; Winona, Minnesota, which handles nitrogen
fertilizer solutions; Savannah, Georgia, which handles chemicals and caustic
solutions, as well as petroleum products; Vancouver, Washington, which handles
chemicals and fertilizer; Eastham, United Kingdom which handles chemicals and
animal fats; and Runcorn, United Kingdom, which handles molten sulphur, and the
Australian and New Zealand terminals which handle chemicals and animal fats and
oil. Overall, these facilities provide ST Services with locations which are
diverse geographically, in products handled and in customers served.
The following table outlines KPP's terminal locations, capacities, tanks
and primary products handled:
Tankage No. of Primary Products
Facility Capacity Tanks Handled
- -----------------------------------------------------------------------------------------------------
Major U. S. Terminals:
Piney Point, MD 5,403,000 28 Petroleum
Linden, NJ(a) 3,884,000 22 Petroleum
Crockett, CA 3,048,000 24 Petroleum
Martinez, CA 2,800,000 16 Petroleum
Jacksonville, FL 2,066,000 30 Petroleum
Texas City, TX 2,002,000 124 Chemicals and Petrochemicals
Other U. S. Terminals:
Montgomery, AL(b) 162,000 7 Petroleum, Jet Fuel
Moundville, AL(b) 310,000 6 Jet Fuel
Tucson, AZ(a) 181,000 7 Petroleum
Los Angeles, CA 597,000 20 Petroleum
Richmond, CA 617,000 25 Petroleum
Stockton, CA 706,000 32 Petroleum
Homestead, FL(b) 72,000 2 Jet Fuel
Augusta, GA 110,000 8 Petroleum
Bremen, GA 180,000 8 Petroleum, Jet Fuel
Brunswick, GA 302,000 3 Fertilizer, Pulp Liquor
Columbus, GA 180,000 25 Petroleum, Chemicals
Macon, GA(b) 307,000 10 Petroleum, Jet Fuel
Savannah, GA 861,000 19 Petroleum, Chemicals
Blue Island, IL 752,000 19 Petroleum
Chillicothe, IL(a) 270,000 6 Petroleum
Peru, IL 221,000 8 Petroleum, Fertilizer
Indianapolis, IN 410,000 18 Petroleum
Westwego, LA 849,000 53 Molasses, Fertilizer, Caustic
Andrews AFB Pipeline, MD(b) 72,000 3 Jet Fuel
Baltimore, MD 832,000 50 Chemicals, Asphalt, Jet Fuel
Salisbury, MD 177,000 14 Petroleum
Winona, MN 229,000 7 Fertilizer
Reno, NV 107,000 7 Petroleum
Paulsboro, NJ 1,580,000 18 Petroleum
Alamogordo, NM(b) 120,000 5 Jet Fuel
Drumright, OK 315,000 4 Petroleum, Jet Fuel
Portland, OR 1,119,000 31 Petroleum
Philadelphia, PA 894,000 11 Petroleum
Dumfries, VA 554,000 16 Petroleum, Asphalt
Virginia Beach, VA(b) 40,000 2 Jet Fuel
Tacoma, WA 377,000 15 Petroleum
Vancouver, WA 166,000 42 Chemicals, Fertilizer
Milwaukee, WI 308,000 7 Petroleum
Tankage No. of Primary Products
Facility Capacity Tanks Handled
- -----------------------------------------------------------------------------------------------------
Foreign Terminals:
St. Eustatius, Netherlands
Antilles. 11,334,000 51 Petroleum, crude oil
Point Tupper, Canada 7,501,000 37 Petroleum, crude oil
Sydney, Australia 330,000 65 Chemicals, fats and oils
Melbourne, Australia 468,000 118 Specialty chemicals
Geelong, Australia 145,000 12 Specialty chemicals
Adelaide, Australia 90,000 24 Chemicals, tallow, petroleum
Auckland, New Zealand (a) 64,000 39 Fats, oils and chemicals
New Plymouth, New Zealand 35,000 10 Fats, oils and chemicals
Mt. Managui, New Zealand 52,000 21 Fats, oils and chemicals
Wellington, New Zealand 50,000 13 Fats, oils and chemicals
Grays, England 1,945,000 53 Petroleum
Eastham, England 2,185,000 162 Chemicals, Petroleum, Animal Fats
Runcorn, England 146,000 4 Molten sulphur
Glasgow, Scotland 344,000 16 Petroleum
Leith, Scotland 459,000 34 Petroleum, Chemicals
Belfast, Northern Ireland 407,000 41 Petroleum
--------------- --------------
58,735,000 1,452
=============== ==============
(a) The terminal is 50% owned by ST.
(b) Facility also includes pipelines to U.S. government military base
locations.
Customers
The storage and transport of jet fuel for the U.S. Department of Defense is
an important part of ST's business. Eleven of ST's terminal sites are involved
in the terminaling or transport (via pipeline) of jet fuel for the Department of
Defense and six of the eleven locations have been utilized solely by the U.S.
Government. One of these locations is presently without government business. Of
the eleven locations, six include pipelines which deliver jet fuel directly to
nearby military bases.
Statia provides terminaling services for crude oil and refined petroleum
products to many of the world's largest producers of crude oil, integrated oil
companies, oil traders, and refiners. Statia's crude oil transshipment customers
include an oil producer that leases and utilizes 5.0 million barrels of storage
at St. Eustatius, and a major international oil company which leases and
utilizes 3.6 million barrels of storage at Point Tupper, both of which have
long-term contracts with Statia. In addition, two different international oil
companies each lease and utilize 1.0 million barrels of clean products storage
at St. Eustatius and Point Tupper, respectively. Also in Canada, a consortium
consisting of major oil companies sends natural gas liquids via pipeline to
certain processing facilities on land leased from Statia. After processing,
certain products are stored at the Point Tupper facility under a long-term
contract. In addition, Statia's blending capabilities have attracted customers
who have leased capacity primarily for blending purposes and who have
contributed to Statia's bunker fuel and bulk product sales.
Competition and Business Considerations
In addition to the terminals owned by independent terminal operators, such
as KPP, many major energy and chemical companies own extensive terminal storage
facilities. Although such terminals often have the same capabilities as
terminals owned by independent operators, they generally do not provide
terminaling services to third parties. In many instances, major energy and
chemical companies that own storage and terminaling facilities are also
significant customers of independent terminal operators, such as KPP. Such
companies typically have strong demand for terminals owned by independent
operators when independent terminals have more cost effective locations near key
transportation links, such as deep-water ports. Major energy and chemical
companies also need independent terminal storage when their owned storage
facilities are inadequate, either because of size constraints, the nature of the
stored material or specialized handling requirements.
Independent terminal owners generally compete on the basis of the location
and versatility of terminals, service and price. A favorably located terminal
will have access to various cost effective transportation modes both to and from
the terminal. Possible transportation modes include waterways, railroads,
roadways and pipelines. Terminals located near deep-water port facilities are
referred to as "deep-water terminals" and terminals without such facilities are
referred to as "inland terminals"; though some inland facilities are served by
barges on navigable rivers.
Terminal versatility is a function of the operator's ability to offer
handling for diverse products with complex handling requirements. The service
function typically provided by the terminal includes, among other things, the
safe storage of the product at specified temperature, moisture and other
conditions, as well as receipt at and delivery from the terminal, all of which
must be in compliance with applicable environmental regulations. A terminal
operator's ability to obtain attractive pricing is often dependent on the
quality, versatility and reputation of the facilities owned by the operator.
Although many products require modest terminal modification, operators with a
greater diversity of terminals with versatile storage capabilities typically
require less modification prior to usage, ultimately making the storage cost to
the customer more attractive.
A few companies offering liquid terminaling facilities have significantly
more capacity than KPP. However, much of KPP's tankage can be described as
"niche" facilities that are equipped to properly handle "specialty" liquids or
provide facilities or services where management believes they enjoy an advantage
over competitors. As a result, many of KPP's terminals compete against other
large petroleum products terminals, rather than specialty liquids facilities.
Such specialty or "niche" tankage is less abundant in the U.S. and "specialty"
liquids typically command higher terminal fees than lower-price bulk terminaling
for petroleum products.
The main competition to crude oil storage at Statia's facilities is from
"lightering" which is the process by which liquid cargo is transferred to
smaller vessels, usually while at sea. The price differential between lightering
and terminaling is primarily driven by the charter rates for vessels of various
sizes. Lightering generally takes significantly longer than discharging at a
terminal. Depending on charter rates, the longer charter period associated with
lightering is generally offset by various costs associated with terminaling,
including storage costs, dock charges, and spill response fees. However,
terminaling is generally safer and reduces the risk of environmental damage
associated with lightering, provides more flexibility in the scheduling of
deliveries, and allows customers of Statia to deliver their products to multiple
locations. Lightering in U.S. territorial waters creates a risk of liability for
owners and shippers of oil under the U.S. Oil Pollution Act of 1990 and other
state and federal legislation. In Canada, similar liability exists under the
Canadian Shipping Act. Terminaling also provides customers with the ability to
access value-added terminal services.
In the bunkering business, Statia competes with ports offering bunker fuels
to which, or from which, each vessel travels or are along the route of travel of
the vessel. Statia also competes with bunker delivery locations around the
world. In the Western Hemisphere, alternative bunker locations include ports on
the U.S. East coast and Gulf coast and in Panama, Puerto Rico, the Bahamas,
Aruba, Curacao, and Halifax. In addition, Statia competes with Rotterdam and
various North Sea locations.
CAPITAL EXPENDITURES
Capital expenditures by KPP relating to its pipelines, including routine
maintenance and expansion expenditures, but excluding acquisitions, were $9.5
million, $4.3 million, and $3.4 million for 2002, 2001, and 2000, respectively.
During these periods, adequate capacity existed on the Pipelines to accommodate
volume growth, and the expenditures required for environmental and safety
improvements were not material in amount. Capital expenditures, including
routine maintenance and expansion expenditures, but excluding acquisitions, by
KPP relating to its terminaling business were $21.0 million, $12.9 million, and
$6.1 million for 2002, 2001, and 2000, respectively.
Capital expenditures of KPP during 2003, including routine maintenance and
expansion expenditures, but excluding acquisitions, are expected to be
approximately $40 million. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity and Capital
Resources." Additional expansion-related capital expenditures will depend on
future opportunities to expand KPP's operations. Such future expenditures,
however, will depend on many factors beyond KPP's control, including, without
limitation, demand for refined petroleum products and terminaling services in
KPP's market areas, local, state and federal governmental regulations, fuel
conservation efforts and the availability of financing on acceptable terms. No
assurance can be given that required capital expenditures will not exceed
anticipated amounts during the year or thereafter or that KPP will have the
ability to finance such expenditures through borrowings or choose to do so.
REGULATION
Interstate Regulation
The interstate common carrier petroleum product pipeline operations of KPP
are subject to rate regulation by FERC under the Interstate Commerce Act. The
Interstate Commerce Act provides, among other things, that to be lawful the
rates of common carrier petroleum pipelines must be "just and reasonable" and
not unduly discriminatory. New and changed rates must be filed with the FERC,
which may investigate their lawfulness on protest or its own motion. The FERC
may suspend the effectiveness of such rates for up to seven months. If the
suspension expires before completion of the investigation, the rates go into
effect, but the pipeline can be required to refund to shippers, with interest,
any difference between the level the FERC determines to be lawful and the filed
rates under investigation. Rates that have become final and effective may be
challenged by a complaint to FERC filed by a shipper or on the FERC's own
initiative. Reparations may be recovered by the party filing the complaint for
the two-year period prior to the complaint, if FERC finds the rate to be
unlawful.
The FERC allows for a rate of return for petroleum products pipelines
determined by adding (i) the product of a rate of return equal to the nominal
cost of debt multiplied by the portion of the rate base that is deemed to be
financed with debt and (ii) the product of a rate of return equal to the real
(i.e., inflation-free) cost of equity multiplied by the portion of the rate base
that is deemed to be financed with equity. The appropriate rate of return for a
petroleum pipeline is determined on a case-by-case basis, taking into account
cost of capital, competitive factors and business and financial risks associated
with pipeline operations.
Under Title XVIII of the Energy Policy Act of 1992 (the "EP Act"), rates
that were in effect on October 24, 1991 that were not subject to a protest,
investigation or complaint are deemed to be just and reasonable. Such rates,
commonly referred to as grandfathered rates, are subject to challenge only for
limited reasons. Any relief granted pursuant to such challenges may be
prospective only. Because KPP's rates that were in effect on October 24, 1991,
were not subject to investigation and protest at that time, those rates could be
deemed to be just and reasonable pursuant to the EP Act. KPP's current rates
became final and effective in July 2000, and KPP believes that its currently
effective tariffs are just and reasonable and would withstand challenge under
the FERC's cost-based rate standards. Because of the complexity of rate making,
however, the lawfulness of any rate is never assured.
On October 22, 1993, the FERC issued Order No. 561 which adopted a
simplified rate making methodology for future oil pipeline rate changes in the
form of indexation. Indexation, which is also known as price cap regulation,
establishes ceiling prices on oil pipeline rates based on application of a
broad-based measure of inflation in the general economy to existing rates. Rate
increases up to the ceiling level are to be discretionary for the pipeline, and,
for such rate increases, there will be no need to file cost-of-service or
supporting data. Moreover, so long as the ceiling is not exceeded, a pipeline
may make a limitless number of rate change filings. This indexing mechanism
calculates a ceiling rate. Rate decreases are required if the indexing mechanism
operates to reduce the ceiling rate below a pipeline's existing rates. The
pipeline may increase its rates to this calculated ceiling rate without filing a
formal cost based justification and with limited risk of shipper protests.
The indexation method is to serve as the principal basis for the
establishment of oil pipeline rate changes in the future. However, the FERC
determined that a pipeline may utilize any one of the following alternative
methodologies to indexing: (i) a cost-of-service methodology may be utilized by
a pipeline to justify a change in a rate if a pipeline can demonstrate that its
increased costs are prudently incurred and that there is a substantial
divergence between such increased costs and the rate that would be produced by
application of the index; and (ii) a pipeline may base its rates upon a
"light-handed" market-based form of regulation if it is able to demonstrate a
lack of significant market power in the relevant markets.
On September 15, 1997, KPP filed an Application for Market Power
Determination with the FERC seeking market based rates for approximately half of
its markets. In May 1998, the FERC granted KPP's application and approximately
half of the markets served by the East and West Pipelines subsequently became
subject to market force regulation.
In the FERC's Lakehead decision issued June 15, 1995, the FERC partially
disallowed Lakehead's inclusion of income taxes in its cost of service.
Specifically, the FERC held that Lakehead was entitled to receive an income tax
allowance with respect to income attributable to its corporate partners, but was
not entitled to receive such an allowance for income attributable to partnership
interests held by individuals. Lakehead's motion for rehearing was denied by the
FERC and Lakehead appealed the decision to the U.S. Court of Appeals.
Subsequently, the case was settled by Lakehead and the appeal was withdrawn. In
another FERC proceeding involving a different oil pipeline limited partnership,
various shippers challenged such pipeline's inclusion of an income tax allowance
in its cost of service. The FERC decided this case on the same basis as its
holding in the Lakehead case. If the FERC were to partially or completely
disallow the income tax allowance in the cost of service of the East and West
Pipelines on the basis set forth in the Lakehead order, KPL believes that KPP's
ability to pay distributions to the holders of the Units would not be impaired;
however, in view of the uncertainties involved in this issue, there can be no
assurance in this regard.
The Ammonia Pipeline rates are regulated by the Surface Transportation
Board (the "STB"). The STB was established in 1996 when the Interstate Commerce
Commission was terminated by the ICC Termination Act of 1995. The STB is headed
by Board Members appointed by the President and confirmed by the Senate and is
authorized to have three members. The STB jurisdiction in general includes
railroad rate and service issues, rail restructuring transactions and labor
matters related thereto; certain trucking company, moving van, and
non-contiguous ocean shipping company rate matters; and certain pipeline matters
not regulated by the FERC. In the performance of its functions, the STB is
charged with promoting, where appropriate, substantive and procedural regulatory
reform in the economic regulation of surface transportation, and with providing
an efficient and effective forum for the resolution of disputes. The STB seeks
to facilitate commerce by providing an effective forum for efficient dispute
resolution and facilitation of appropriate market-based business transactions.
Intrastate Regulation
The intrastate operations of the East Pipeline in Kansas are subject to
regulation by the Kansas Corporation Commission, the intrastate operations of
the West Pipeline in Colorado and Wyoming are subject to regulation by the
Colorado Public Utility Commission and the Wyoming Public Service Commission,
respectively, and the intrastate operations of the North Pipeline are subject to
regulation by the North Dakota Public Utility Commission. Like the FERC, the
state regulatory authorities require that shippers be notified of proposed
intrastate tariff increases and have an opportunity to protest such increases.
KPP also files with such state authorities copies of interstate tariff changes
filed with the FERC. In addition to challenges to new or proposed rates,
challenges to intrastate rates that have already become effective are permitted
by complaint of an interested person or by independent action of the appropriate
regulatory authority.
ENVIRONMENTAL MATTERS
General
The operations of KPP are subject to federal, state and local laws and
regulations relating to the protection of the environment in the United States
and to the environmental laws and regulations of the host countries in regard to
the terminals acquired overseas. Although KPP believes that its operations are
in general compliance with applicable environmental regulations, risks of
substantial costs and liabilities are inherent in pipeline and terminal
operations, and there can be no assurance that significant costs and liabilities
will not be incurred by KPP. Moreover, it is possible that other developments,
such as increasingly strict environmental laws, regulations and enforcement
policies thereunder, and claims for damages to property or persons resulting
from the operations of KPP, past and present, could result in substantial costs
and liabilities to KPP.
See "Item 3 - Legal Proceedings" for information concerning two lawsuits
against certain subsidiaries of KPP involving claims for environmental damages.
Water
The Oil Pollution Act ("OPA") was enacted in 1990 and amends provisions of
the Federal Water Pollution Control Act of 1972 and other statutes as they
pertain to prevention and response to oil spills. The OPA subjects owners of
facilities to strict, joint and potentially unlimited liability for removal
costs and certain other consequences of an oil spill, where such spill is into
navigable waters, along shorelines or in the exclusive economic zone. In the
event of an oil spill into such waters, substantial liabilities could be imposed
upon KPP. Regulations concerning the environment are continually being developed
and revised in ways that may impose additional regulatory burdens on KPP.
Contamination resulting from spills or releases of refined petroleum
products is not unusual within the petroleum pipeline and liquids terminaling
industries. The East Pipeline and ST Services have experienced limited
groundwater contamination at various terminal and pipeline sites resulting from
various causes including activities of previous owners. Remediation projects are
underway or under construction using various remediation techniques. The costs
to remediate contamination at several ST terminal locations are being borne by
the former owners under indemnification agreements. Although no assurances can
be made, KPP believes that the aggregate cost of these remediation efforts will
not be material.
Groundwater remediation efforts are ongoing at all four of the West
Pipeline's terminals and at a Wyoming pump station. Regulatory officials have
been consulted in the development of remediation plans. In connection with the
purchase of the West Pipeline, KPP agreed to implement remediation plans at
these specific sites over the succeeding five years following the acquisition in
return for the payment by the seller, Wyco Pipe Line Company, of $1,312,000 to
KPP to cover the discounted estimated future costs of these remediations.
The EPA has promulgated regulations that may require KPP to apply for
permits to discharge storm water runoff. Storm water discharge permits also may
be required in certain states in which KPP operates. Where such requirements are
applicable, KPP has applied for such permits and, after the permits are
received, will be required to sample storm water effluent before releasing it.
KPP believes that effluent limitations could be met, if necessary, with minor
modifications to existing facilities and operations. Although no assurance in
this regard can be given, KPP believes that the changes will not have a material
effect on KPP's financial condition or results of operations.
Aboveground Storage Tank Acts
A number of the states in which KPP operates in the United States have
passed statutes regulating aboveground tanks containing liquid substances.
Generally, these statutes require that such tanks include secondary containment
systems or that the operators take certain alternative precautions to ensure
that no contamination results from any leaks or spills from the tanks. Although
there is not total federal regulation of all above ground tanks, the DOT has
adopted an industry standard that addresses tank inspection, repair, alteration
and reconstruction. This action requires pipeline companies to comply with the
standard for tank inspection and repair for all tanks regulated by the DOT. KPP
is in substantial compliance with all above ground storage tank laws in the
states with such laws. Although no assurance can be given, KPP believes that the
future implementation of above ground storage tank laws by either additional
states or by the federal government will not have a material adverse effect on
KPP's financial condition or results of operations.
Air Emissions
The operations of KPP are subject to the Federal Clean Air Act and
comparable state and local statutes. KPP believes that the operations of KPP's
pipelines and terminals are in substantial compliance with such statutes in all
states in which they operate.
Amendments to the Federal Clean Air Act enacted in 1990 require or will
require most industrial operations in the United States to incur future capital
expenditures in order to meet the air emission control standards that have been
and are to be developed and implemented by the EPA and state environmental
agencies. Pursuant to these Clean Air Act Amendments, those Partnership
facilities that emit volatile organic compounds ("VOC") or nitrogen oxides are
subject to increasingly stringent regulations, including requirements that
certain sources install maximum or reasonably available control technology. In
addition, the 1999 Federal Clean Air Act Amendments include a new operating
permit for major sources ("Title V Permits"), which applies to some of KPP's
facilities. Additionally, new dockside loading facilities owned or operated by
KPP in the United States will be subject to the New Source Performance Standards
that were proposed in May 1994. These regulations require control of VOC
emissions from the loading and unloading of tank vessels.
Although KPP is in substantial compliance with applicable air pollution
laws, in anticipation of the implementation of stricter air control regulations,
KPP is taking actions to substantially reduce its air emissions. KPP plans to
install bottom loading and vapor recovery equipment on the loading racks at
selected terminal sites along the East Pipeline that do not already have such
emissions control equipment. These modifications will substantially reduce the
total air emissions from each of these facilities. Having begun in 1993, this
project is being phased in over a period of years.
Solid Waste
KPP generates non-hazardous solid waste that is subject to the requirements
of the Federal Resource Conservation and Recovery Act ("RCRA") and comparable
state statutes in the United States. The EPA is considering the adoption of
stricter disposal standards for non-hazardous wastes. RCRA also governs the
disposal of hazardous wastes. At present, KPP is not required to comply with a
substantial portion of the RCRA requirements because KPP's operations generate
minimal quantities of hazardous wastes. However, it is anticipated that
additional wastes, which could include wastes currently generated during
pipeline operations, will in the future be designated as "hazardous wastes".
Hazardous wastes are subject to more rigorous and costly disposal requirements
than are non-hazardous wastes. Such changes in the regulations may result in
additional capital expenditures or operating expenses by KPP.
At the terminal sites at which groundwater contamination is present, there
is also limited soil contamination as a result of the aforementioned spills. KPP
is under no present requirements to remove these contaminated soils, but KPP may
be required to do so in the future. Soil contamination also may be present at
other Partnership facilities at which spills or releases have occurred. Under
certain circumstances, KPP may be required to clean up such contaminated soils.
Although these costs should not have a material adverse effect on KPP, no
assurance can be given in this regard.
Superfund
The Comprehensive Environmental Response, Compensation and Liability Act
("CERCLA" or "Superfund") imposes liability, without regard to fault or the
legality of the original act, on certain classes of persons that contributed to
the release of a "hazardous substance" into the environment. These persons
include the owner or operator of the site and companies that disposed or
arranged for the disposal of the hazardous substances found at the site. CERCLA
also authorizes the EPA and, in some instances, third parties to act in response
to threats to the public health or the environment and to seek to recover from
the responsible classes of persons the costs they incur. In the course of its
ordinary operations, KPP may generate waste that may fall within CERCLA's
definition of a "hazardous substance". KPP may be responsible under CERCLA for
all or part of the costs required to clean up sites at which such wastes have
been disposed.
Environmental Impact Statement
The United States National Environmental Policy Act of 1969 (the "NEPA")
applies to certain extensions or additions to a pipeline system. Under NEPA, if
any project that would significantly affect the quality of the environment
requires a permit or approval from any United States federal agency, a detailed
environmental impact statement must be prepared. The effect of the NEPA may be
to delay or prevent construction of new facilities or to alter their location,
design or method of construction.
Indemnification
KPL has agreed to indemnify KPP against liabilities for damage to the
environment resulting from operations of the East Pipeline prior to October 3,
1989. Such indemnification does not extend to any liabilities that arise after
such date to the extent such liabilities result from change in environmental
laws or regulations. Under such indemnity, KPL is presently liable for the
remediation of contamination at certain East Pipeline sites. In addition, KPP
was wholly or partially indemnified under certain acquisition contracts for some
environmental costs. Most of such contracts contain time and amount limitations
on the indemnities. To the extent that environmental liabilities exceed the
amount of such indemnity, KPP has affirmatively assumed the excess environmental
liabilities.
SAFETY REGULATION
KPP's Pipelines are subject to regulation by the United States Department
of Transportation (the "DOT") under the Hazardous Liquid Pipeline Safety Act of
1979 ("HLPSA") relating to the design, installation, testing, construction,
operation, replacement and management of their pipeline facilities. The HLPSA
covers anhydrous ammonia, petroleum and petroleum products pipelines and
requires any entity that owns or operates pipeline facilities to comply with
such safety regulations and to permit access to and copying of records and to
make certain reports and provide information as required by the Secretary to
Transportation. The Federal Pipeline Safety Act of 1992 amended the HLPSA to
include requirements of the future use of internal inspection devices. KPP does
not believe that it will be required to make any substantial capital
expenditures to comply with the requirements of HLPSA as so amended.
On November 3, 2000, the DOT issued new regulations intended by the DOT to
assess the integrity of hazardous liquid pipeline segments that, in the event of
a leak or failure, could adversely affect highly populated areas, areas
unusually sensitive to environmental impact and commercially navigable
waterways. Under the regulations, an operator is required, among other things,
to conduct baseline integrity assessment tests (such as internal inspections)
within seven years, conduct future integrity tests at typically five-year
intervals and develop and follow a written risk-based integrity management
program covering the designated high consequence areas. KPP does not believe
that any increased costs of compliance with these regulations will materially
affect KPP's results of operations.
KPP is subject to the requirements of the United States Federal
Occupational Safety and Health Act ("OSHA") and comparable state statutes that
regulate the protection of the health and safety of workers. In addition, the
OSHA hazard communication standard requires that certain information be
maintained about hazardous materials used or produced in operations and that
this information be provided to employees, state and local authorities and
citizens. KPP believes that it is in general compliance with OSHA requirements,
including general industry standards, record keeping requirements and monitoring
of occupational exposure to benzene.
The OSHA hazard communication standard, the EPA community right-to-know
regulations under Title III of the Federal Superfund Amendment and
Reauthorization Act, and comparable state statutes require KPP to organize
information about the hazardous materials used in its operations. Certain parts
of this information must be reported to employees, state and local governmental
authorities, and local citizens upon request. In general, KPP expects to
increase its expenditures during the next decade to comply with higher industry
and regulatory safety standards such as those described above. Such expenditures
cannot be accurately estimated at this time, although they are not expected to
have a material adverse impact on KPP.
EMPLOYEES
At December 31, 2002, the Company, and its subsidiaries and affiliates
employed approximately 1,089 persons. Approximately 105 persons at 6 terminal
unit locations in the United States were subject to representation by labor
unions and collective bargaining or similar contracts at that date. The company
considers relations with its employees to be good.
AVAILABLE INFORMATION
The Company files annual, quarterly, and other reports and other
information with the Securities and Exchange Commission ("SEC") under the
Securities Exchange Act of 1934 (the "Exchange Act"). You may read and copy any
materials that the Company files with the SEC at the SEC's Public Reference Room
at 450 Fifth Street, NW, Washington, DC 20549. You may obtain additional
information about the Public Reference Room by calling the SEC at
1-800-SEC-0330. In addition, the SEC maintains an Internet site
(http://www.sec.gov) that contains reports, proxy information statements, and
other information regarding issuers that file electronically with the SEC.
The Company also makes available free of charge on or through the Company's
Internet site (http://www.kaneb.com) the Company's Annual Report on Form 10-K,
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and other
information statements and, if applicable, amendments to those reports filed or
furnished pursuant to Section 13(a) of the Exchange Act as soon as reasonably
practicable after the reports and other information is electronically filed
with, or furnish it to, the SEC.
Item 2. Properties
The properties owned or used by the Company and its subsidiaries are
generally described in Item 1 of this report. Additional information concerning
the obligations of the Company and KPP for lease and rental commitments is
presented under the caption "Commitments and Contingencies" in Note 9 to the
Company's consolidated financial statements. Such descriptions and information
are hereby incorporated by reference into this Item 2.
The properties used in the operations of KPP's Pipelines are owned by KPP,
through its subsidiary entities, except for KPL's operational headquarters,
located in Wichita, Kansas, which is held under a lease that expires in 2004.
Statia's facilities are owned through subsidiaries and the majority of ST's
facilities are owned, while the remainder, including some of its terminal
facilities located in port areas and its operational headquarters, located in
Dallas, Texas, are held pursuant to lease agreements having various expiration
dates, rental rates and other terms.
Item 3. Legal Proceedings
Grace Litigation. Certain subsidiaries of KPP were sued in a Texas state
court in 1997 by Grace Energy Corporation ("Grace"), the entity from which KPP
acquired ST Services in 1993. The lawsuit involves environmental response and
remediation costs allegedly resulting from jet fuel leaks in the early 1970's
from a pipeline. The pipeline, which connected a former Grace terminal with Otis
Air Force Base in Massachusetts (the "Otis pipeline" or the "pipeline"), ceased
operations in 1973 and was abandoned before 1978, when the connecting terminal
was sold to an unrelated entity. Grace alleged that subsidiaries of KPP acquired
the abandoned pipeline, as part of the acquisition of ST Services in 1993 and
assumed responsibility for environmental damages allegedly caused by the jet
fuel leaks. Grace sought a ruling from the Texas court that these subsidiaries
are responsible for all liabilities, including all present and future
remediation expenses, associated with these leaks and that Grace has no
obligation to indemnify these subsidiaries for these expenses. In the lawsuit,
Grace also sought indemnification for expenses of approximately $3.5 million
that it incurred since 1996 for response and remediation required by the State
of Massachusetts and for additional expenses that it expects to incur in the
future. The consistent position of KPP's subsidiaries has been that they did not
acquire the abandoned pipeline as part of the 1993 ST Services transaction, and
therefore did not assume any responsibility for the environmental damage nor any
liability to Grace for the pipeline.
At the end of the trial, the jury returned a verdict including findings
that (1) Grace had breached a provision of the 1993 acquisition agreement by
failing to disclose matters related to the pipeline, and (2) the pipeline was
abandoned before 1978 -- 15 years before KPP's subsidiaries acquired ST
Services. On August 30, 2000, the Judge entered final judgment in the case that
Grace take nothing from the subsidiaries on its claims seeking recovery of
remediation costs. Although KPP's subsidiaries have not incurred any expenses in
connection with the remediation, the court also ruled, in effect, that the
subsidiaries would not be entitled to indemnification from Grace if any such
expenses were incurred in the future. Moreover, the Judge let stand a prior
summary judgment ruling that the pipeline was an asset acquired by KPP's
subsidiaries as part of the 1993 ST Services transaction and that any
liabilities associated with the pipeline would have become liabilities of the
subsidiaries. Based on that ruling, the Massachusetts Department of
Environmental Protection and Samson Hydrocarbons Company (successor to Grace
Petroleum Company) wrote letters to ST Services alleging its responsibility for
the remediation, and ST Services responded denying any liability in connection
with this matter. The Judge also awarded attorney fees to Grace of more than
$1.5 million. Both KPP's subsidiaries and Grace have appealed the trial court's
final judgment to the Texas Court of Appeals in Dallas. In particular, the
subsidiaries have filed an appeal of the judgment finding that the Otis pipeline
and any liabilities associated with the pipeline were transferred to them as
well as the award of attorney fees to Grace.
On April 2, 2001, Grace filed a petition in bankruptcy, which created an
automatic stay against actions against Grace. This automatic stay covers the
appeal of the Dallas litigation, and the Texas Court of Appeals has issued an
order staying all proceedings of the appeal because of the bankruptcy. Once that
stay is lifted, KPP's subsidiaries that are party to the lawsuit intend to
resume vigorous prosecution of the appeal.
The Otis Air Force Base is a part of the Massachusetts Military Reservation
("MMR Site"), which has been declared a Superfund Site pursuant to CERCLA. The
MMR Site contains a number of groundwater contamination plumes, two of which are
allegedly associated with the Otis pipeline, and various other waste management
areas of concern, such as landfills. The United States Department of Defense,
pursuant to a Federal Facilities Agreement, has been responding to the
Government remediation demand for most of the contamination problems at the MMR
Site. Grace and others have also received and responded to formal inquiries from
the United States Government in connection with the environmental damages
allegedly resulting from the jet fuel leaks. KPP's subsidiaries voluntarily
responded to an invitation from the Government to provide information indicating
that they do not own the pipeline. In connection with a court-ordered mediation
between Grace and KPP's subsidiaries, the Government advised the parties in
April 1999 that it has identified two spill areas that it believes to be related
to the pipeline that is the subject of the Grace suit. The Government at that
time advised the parties that it believed it had incurred costs of approximately
$34 million, and expected in the future to incur costs of approximately $55
million, for remediation of one of the spill areas. This amount was not intended
to be a final accounting of costs or to include all categories of costs. The
Government also advised the parties that it could not at that time allocate its
costs attributable to the second spill area.
By letter dated July 26, 2001, the United States Department of Justice
("DOJ") advised ST Services that the Government intends to seek reimbursement
from ST Services under the Massachusetts Oil and Hazardous Material Release
Prevention and Response Act and the Declaratory Judgment Act for the
Government's response costs at the two spill areas discussed above. The DOJ
relied in part on the Texas state court judgment, which in the DOJ's view, held
that ST Services was the current owner of the pipeline and the
successor-in-interest of the prior owner and operator. The Government advised ST
Services that it believes it has incurred costs exceeding $40 million, and
expects to incur future costs exceeding an additional $22 million, for
remediation of the two spill areas. KPP believes that its subsidiaries have
substantial defenses. ST Services responded to the DOJ on September 6, 2001,
contesting the Government's positions and declining to reimburse any response
costs. The DOJ has not filed a lawsuit against ST Services seeking cost recovery
for its environmental investigation and response costs. Representatives of ST
Services have met with representatives of the Government on several occasions
since September 6, 2001 to discuss the Government's claims and to exchange
information related to such claims. Additional exchanges of information are
expected to occur in the future and additional meetings may be held to discuss
possible resolution of the Government's claims without litigation.
PEPCO Litigation. On April 7, 2000, a fuel oil pipeline in Maryland owned
by Potomac Electric Power Company ("PEPCO") ruptured. Work performed with regard
to the pipeline was conducted by a partnership of which ST Services is general
partner. PEPCO has reported that it has incurred total cleanup costs of $70
million to $75 million. PEPCO probably will continue to incur some cleanup
related costs for the foreseeable future, primarily in connection with EPA
requirements for monitoring the condition of some of the impacted areas. Since
May 2000, ST Services has provisionally contributed a minority share of the
cleanup expense, which has been funded by ST Services' insurance carriers. ST
Services and PEPCO have not, however, reached a final agreement regarding ST
Services' proportionate responsibility for this cleanup effort, if any, and
cannot predict the amount, if any, that ultimately may be determined to be ST
Services' share of the remediation expense, but ST believes that such amount
will be covered by insurance and therefore will not materially adversely affect
KPP's financial condition.
As a result of the rupture, purported class actions were filed against
PEPCO and ST Services in federal and state court in Maryland by property and
business owners alleging damages in unspecified amounts under various theories,
including under the Oil Pollution Act ("OPA") and Maryland common law. The
federal court consolidated all of the federal cases in a case styled as In re
Swanson Creek Oil Spill Litigation. A settlement of the consolidated class
action, and a companion state-court class action, was reached and approved by
the federal judge. The settlement involved creation and funding by PEPCO and ST
Services of a $2,250,000 class settlement fund, from which all participating
claimants would be paid according to a court-approved formula, as well as a
court-approved payment to plaintiffs' attorneys. The settlement has been
consummated and the fund, to which PEPCO and ST Services contributed equal
amounts, has been distributed. Participating claimants' claims have been settled
and dismissed with prejudice. A number of class members elected not to
participate in the settlement, i.e., to "opt out," thereby preserving their
claims against PEPCO and ST Services. All non-participant claims except one have
been settled for immaterial amounts with ST Services' portion of such
settlements provided by its insurance carrier. ST Services' insurance carrier
has assumed the defense of the continuing action and ST Services believes that
the carrier would assume the defense of any new litigation by a non-participant
in the settlement, should any such litigation be commenced. While KPP cannot
predict the amount, if any, of any liability it may have in the continuing
action or in other potential suits relating to this matter, it believes that the
current and potential plaintiffs' claims will be covered by insurance and
therefore these actions will not have a material adverse effect on its financial
condition.
PEPCO and ST Services agreed with the federal government and the State of
Maryland to pay costs of assessing natural resource damages arising from the
Swanson Creek oil spill under OPA and of selecting restoration projects. This
process was completed in mid-2002. ST Services' insurer has paid ST Services'
agreed 50 percent share of these assessment costs. In late November 2002, PEPCO
and ST Services entered into a Consent Decree resolving the federal and state
trustees' claims for natural resource damages. The decree required payments by
ST Services and PEPCO of a total of approximately $3 million to fund the
restoration projects and for remaining damage assessment costs. The federal
court entered the Consent Decree as a final judgment on December 31, 2002. PEPCO
and ST have each paid their 50% share and thus fully performed their payment
obligations under the Consent Decree. ST Services' insurance carrier funded ST
Services' payment.
The U.S. Department of Transportation ("DOT") has issued a Notice of
Proposed Violation to PEPCO and ST Services alleging violations over several
years of pipeline safety regulations and proposing a civil penalty of $647,000
jointly against the two companies. ST Services and PEPCO have contested the DOT
allegations and the proposed penalty. A hearing was held before the Office of
Pipeline Safety at the DOT in late 2001. ST Services does not anticipate any
further hearings on the subject and is still awaiting the DOT's ruling.
By letter dated January 4, 2002, the Attorney General's Office for the
State of Maryland advised ST Services that it intended to seek penalties from ST
Services in connection with the April 7, 2000 spill. The State of Maryland
subsequently asserted that it would seek penalties against ST Services and PEPCO
totaling up to $12 million. A settlement of this claim was reached in mid-2002
under which ST Services' insurer will pay a total of slightly more than $1
million in installments over a five year period. PEPCO also reached a settlement
of these claims with the State of Maryland. Accordingly, KPP believes that this
matter will not have a material adverse effect on its financial condition.
On December 13, 2002, ST Services sued PEPCO in the Superior Court,
District of Columbia, seeking, among other causes of action, a declaratory
judgment as to ST Services' legal obligations, if any, to reimburse PEPCO for
costs of the oil spill. On December 16, 2002, PEPCO sued ST Services in the
United States District Court for the District of Maryland, seeking recovery of
all its costs for remediation of the oil spill. Both parties have pending
motions to dismiss the other party's suit. KPP believes that any costs or
damages resulting from these lawsuits will be covered by insurance and therefore
will not materially adversely affect KPP's financial condition.
The Company, primarily KPP, has other contingent liabilities resulting from
litigation, claims and commitments incident to the ordinary course of business.
Management believes, based on the advice of counsel, that the ultimate
resolution of such contingencies will not have a materially adverse effect on
the financial position or results of operations of the Company.
Item 4. Submission of Matters to a Vote of Security Holders
The Company did not hold a meeting of shareholders or otherwise submit any
matter to a vote of security holders in the fourth quarter of 2002.
PART II
Item 5. Market for the Registrant's Shares and Related Shareholder Matters
The Company's shares ("Shares") were listed and began trading on the New
York Stock Exchange (the "NYSE") effective June 29, 2001, under the symbol
"KSL." At March 21, 2003, there were approximately 4,000 shareholders of record
for the Company. Set forth below are prices on the NYSE and cash distributions
for the periods indicated for such Shares.
Share Prices
----------------------- Cash
Year High Low Distributions
------------------------------- --------- -------- -------------
2001:
Third quarter $16.76 $13.87 $ .3625
Fourth quarter 19.72 16.95 .3625
2002:
First quarter 22.35 18.10 .4125
Second quarter 23.98 19.80 .4125
Third quarter 21.25 16.21 .4125
Fourth quarter 21.39 17.51 .4125
2003:
First quarter 20.90 18.20 .4375 (a)
(through March 21, 2003)
(a) The cash distribution with respect to the first quarter of 2003 is payable
May 15, 2003.
Under the terms of its financing agreements, the Company is prohibited from
declaring or paying any distribution if a default exists thereunder.
Item 6. Summary Historical Financial and Operating Data
The following table sets forth, for the periods and at the dates indicated,
certain selected historical consolidated financial data for Kaneb Services LLC
and subsidiaries (the "Company"). The data in the table (in thousands, except
per share amounts) should be read in conjunction with the Company's audited
financial statements. See also "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Year Ended December 31,
--------------------------------------------------------------------------
2002 (a) 2001 (a) 2000 1999 1998
------------ ------------ ------------ ------------ -------------
Income Statement Data:
Revenues.............................. $ 669,828 $ 535,338 $ 537,418 $ 370,326 $ 240,032
============ ============ ============ ============ =============
Operating income...................... $ 106,359 $ 79,791 $ 61,174 $ 64,911 $ 55,197
============ ============ ============ ============ =============
Income before gain on issuance of
units by KPP and income taxes...... $ 24,931 $ 16,051 $ 15,467 $ 17,999 $ 15,303
Income tax benefit (expense) (b)...... (2,585) 2,413 (2,824) 9,494 (1,258)
Gain on issuance of units by KPP (c).. 24,882 9,859 - 16,764 -
------------ ------------ ------------ ------------ -------------
Net income............................ $ 47,228 $ 28,323 $ 12,643 $ 44,257 $ 14,045
============ ============ ============ ============ =============
Per Share Data:
Earnings per common share:
Basic............................ $ 4.13 $ 2.57 $ 1.19 $ 4.22 $ 1.33
============ ============ ============ ============ =============
Diluted.......................... $ 4.02 $ 2.46 $ 1.15 $ 4.06 $ 1.28
============ ============ ============ ============ =============
Cash distributions declared
per share (d)...................... $ 1.65 $ 0.725
============ ============
Balance Sheet Data (at year end):
Property and equipment, net........... $ 1,092,276 $ 481,396 $ 321,448 $ 316,956 $ 268,670
Total assets.......................... 1,244,101 571,767 429,852 427,608 330,517
Long-term debt........................ 718,162 277,302 184,052 167,028 155,852
Shareholders' equity.................. 63,654 33,932 71,369 86,833 37,192
(a) See Note 3 to Consolidated Financial Statements regarding KPP acquisitions.
(b) See Note 4 to Consolidated Financial Statements regarding recognition in
2000 and 1999 of expected benefits from prior years tax losses (change in
valuation allowance) and Note 4 regarding 2001 benefit for change in tax
status.
(c) See Note 2 to Consolidated Financial Statements regarding the 2002 gains on
issuance of units by KPP and Note 3 regarding 2001 gain on issuance of
units by KPP.
(d) The Company makes quarterly distributions of 100% of available cash, as
defined in the limited liability company agreement, to the common
shareholders of record on the applicable record date, within 45 days after
the end of each quarter. Available cash consists generally of all the cash
receipts of the Company, plus the beginning cash balance, less all cash
disbursements and reserves.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This discussion should be read in conjunction with the consolidated
financial statements of the Company and the notes thereto and the summary
historical financial and operating data included elsewhere in this report.
GENERAL
On November 27, 2000, the Board of Directors of Kaneb Services, Inc.
authorized the distribution of its pipeline, terminaling and product marketing
businesses (the "Distribution") to its stockholders in the form of a new limited
liability company, Kaneb Services LLC (the "Company"). On June 29, 2001, the
Distribution was completed, with each shareholder of Kaneb Services, Inc.
receiving one common share of the Company for each three shares of Kaneb
Services, Inc.'s common stock held on June 20, 2001, the record date for the
Distribution, resulting in the distribution of 10.85 million shares of the
Company. On August 7, 2001, the stockholders of Kaneb Services, Inc. approved an
amendment to its certificate of incorporation to change its name to Xanser
Corporation ("Xanser").
In September 1989, Kaneb Pipe Line Company LLC ("KPL"), a wholly-owned
subsidiary of the Company, formed Kaneb Pipe Line Partners, L.P. ("KPP") to own
and operate its refined petroleum products pipeline business. KPL manages and
controls the operations of KPP through its general partner interests and a 20%
(at December 31, 2002) limited partner interest. KPP operates through Kaneb Pipe
Line Operating Partnership, L.P. ("KPOP"), a limited partnership in which KPP
holds a 99% interest as limited partner. KPL owns a 1% interest as general
partner of KPP and a 1% interest as general partner of KPOP.
KPP's petroleum pipeline business consists primarily of the transportation,
as a common carrier, of refined petroleum products in Kansas, Nebraska, Iowa,
South Dakota, North Dakota, Colorado, Wyoming, and Minnesota. Common carrier
activities are those under which transportation through the pipelines is
available at published tariffs filed, in the case of interstate shipments, with
the Federal Energy Regulatory Commission (the "FERC"), or in the case of
intrastate shipments with the relevant state authority, to any shipper of
refined petroleum products who requests such services and satisfies the
conditions and specifications for transportation. The petroleum pipelines
primarily transport gasoline, diesel oil, fuel oil and propane. Substantially
all of the petroleum pipeline operations constitute common carrier operations
that are subject to federal or state tariff regulations. KPP also owns an
approximately 2,000-mile anhydrous ammonia pipeline system acquired from Koch
Pipeline Company, L.P. in November of 2002 (see "Liquidity and Capital
Resources"). The fertilizer pipeline originates in southern Louisiana, proceeds
north through Arkansas and Missouri, and then branches east into Illinois and
Indiana and north and west into Iowa and Nebraska.
KPP's terminaling business is conducted through the Support Terminal
Services operations ("ST Services") and Statia Terminals International N.V.
("Statia"). ST Services is one of the largest independent petroleum products and
specialty liquids terminaling companies in the United States. In the United
States, ST Services operates 39 facilities in 20 states. ST Services also owns
and operates six terminals located in the United Kingdom and eight terminals in
Australia and New Zealand. ST Services and its predecessors have a long history
in the terminaling business and handle a wide variety of liquids from petroleum
products to specialty chemicals to edible liquids. Statia, acquired on February
28, 2002 ("see "Liquidity and Capital Resources"), owns a terminal on the Island
of St. Eustatius, Netherlands Antilles and a terminal at Point Tupper, Nova
Scotia, Canada.
KPL owns a petroleum product marketing business which provides wholesale
motor fuel marketing services in the Great Lakes and Rocky Mountain regions.
KPP's product sales business delivers bunker fuels to ships in the Caribbean and
Nova Scotia, Canada, and sells bulk petroleum products to various commercial
customers at these two locations.
CONSOLIDATED RESULTS OF OPERATIONS
Year Ended December 31,
----------------------------------------
2002 2001 2000
----------- ----------- -----------
(in thousands)
Consolidated revenues.................................................. $ 669,828 $ 535,338 $ 537,418
=========== =========== ===========
Consolidated operating income.......................................... $ 106,359 $ 79,791 $ 61,174
=========== =========== ===========
Consolidated income before gain on issuance of units by KPP
and income taxes.................................................... $ 24,931 $ 16,051 $ 15,467
=========== =========== ===========
Consolidated net income................................................ $ 47,228 $ 28,323 $ 12,643
=========== =========== ===========
For the year ended December 31, 2002, consolidated revenues increased by
$134.5 million, or 25%, when compared to the year ended December 31, 2001, due
to a $73.2 million increase in revenues in the teminaling business, a $53.6
million increase in revenues from the product marketing business and a $7.7
million increase in revenues in the pipeline business. Consolidated operating
income for the year ended December 31, 2002 increased by $26.6 million, or 33%,
when compared to 2001, due primarily to a $19.7 million increase in terminaling
operating income, a $5.3 million increase in product marketing operating income
and a $1.9 million increase in pipeline operating income. See "Liquidity and
Capital Resources" regarding 2002 acquisitions. Consolidated 2002 income, before
gain on issuance of units by KPP and income taxes, increased by $8.9 million, or
55%, when compared to 2001. Consolidated net income for the year ended December
31, 2002 includes $24.9 million in gains on issuance of units by KPP (see
"Liquidity and Capital Resources").
For the year ended December 31, 2001, consolidated revenues decreased by
$2.1 million, or less than 1%, when compared to the year ended December 31,
2000, due to a $53.6 million decrease in product marketing revenues, resulting
from decreases in both volumes sold and sales prices, that were substantially
offset by a $47.3 million increase in terminaling revenues and a $4.3 million
increase in pipeline revenues. Terminaling revenues include the operations of
Shore from the January 3, 2001 acquisition date (see "Liquidity and Capital
Resources"). Consolidated operating income for the year ended December 31, 2001
increased by $18.6 million, or 30%, when compared to the year ended December 31,
2000, due to a $22.0 million increase in terminaling operating income, partially
offset by a $3.1 million decrease in product marketing operating income.
Consolidated December 31, 2001 income before gain on issuance of units by KPP
and income taxes, increased by $0.6 million, or 4%, when compared to the year
ended December 31, 2000, due primarily to an increase in terminaling operating
income, partially offset by a decrease in product marketing operating income.
Consolidated net income for the year ended December 31, 2001 includes a gain of
$9.9 million, before income taxes, from the January 2001 issuance of units by
KPP (see "Liquidity and Capital Resources"). Additionally, effective with the
Distribution, the Company became a pass-through entity with its income, for
federal and state purposes, taxed at the shareholder level instead of the
Company paying such taxes. As a result of the change in tax status of the
Company, all deferred income tax assets and liabilities relating to temporary
differences were eliminated, resulting in a credit to income tax expense in 2001
of $8.6 million. Consolidated net income for the year ended December 31, 2001,
including these items, aggregated $28.3 million, compared to $12.6 million in
2000.
PIPELINE OPERATIONS
Year Ended December 31,
---------------------------------------------------
2002 2001 2000
----------- ----------- -----------
(in thousands)
Revenues............................................. $ 82,698 $ 74,976 $ 70,685
Operating costs...................................... 33,744 28,844 25,223
Depreciation and amortization........................ 6,408 5,478 5,180
General and administrative........................... 3,923 3,881 4,069
----------- ----------- -----------
Operating income..................................... $ 38,623 $ 36,773 $ 36,213
=========== =========== ===========
Pipeline revenues are based on volumes shipped and the distances over which
such volumes are transported. For the year ended December 31, 2002, revenues
increased by $7.7 million, or 10%, compared to 2001, due to higher per barrel
rates realized on volumes shipped on existing pipelines and as a result of the
November and December 2002 pipeline acquisitions (see "Liquidity and Capital
Resources"). Approximately $4.5 million of the 2002 revenue increase was a
result of the pipeline acquisitions. For the year ended December 31, 2001,
revenues increased by $4.3 million, or 6%, compared to 2000, due to increases in
barrel miles shipped and increases in terminaling charges. Because tariff rates
are regulated by the FERC, the pipelines compete primarily on the basis of
quality of service, including delivering products at convenient locations on a
timely basis to meet the needs of its customers. Barrel miles on petroleum
pipelines totaled 18.3 billion, 18.6 billion and 17.8 billion for the years
ended December 31, 2002, 2001 and 2000, respectively.
Operating costs, which include fuel and power costs, materials and
supplies, maintenance and repair costs, salaries, wages and employee benefits,
and property and other taxes, increased by $4.9 million in 2002 and $3.6 million
in 2001. The increase in 2002 was due to the pipeline acquisitions and increases
in expenditures for routine repairs and maintenance. The increase in 2001 was
due to increases in fuel and power costs and expenses from pipeline relocation
projects. For the year ended December 31, 2002, depreciation and amortization
increased by $0.9 million, when compared to 2001, due to the pipeline
acquisitions. General and administrative costs include managerial, accounting
and administrative personnel costs, office rental expense, legal and
professional costs and other non-operating costs.
TERMINALING OPERATIONS
Year Ended December 31,
---------------------------------------------------
2002 2001 2000
----------- ----------- -----------
(in thousands)
Revenues............................................. $ 205,971 $ 132,820 $ 85,547
Operating costs...................................... 94,480 61,788 44,430
Depreciation and amortization........................ 32,368 17,706 11,073
Gain on sale of assets............................... (609) - (1,126)
General and administrative........................... 14,692 8,008 7,812
----------- ----------- -----------
Operating income..................................... $ 65,040 $ 45,318 $ 23,358
=========== =========== ===========
For the year ended December 31, 2002, revenues increased by $73.2 million,
or 55%, compared to 2001, due to 2002 terminal acquisitions (see "Liquidity and
Capital Resources") and overall increases in utilizations at existing locations.
Approximately $63 million of the revenue increase was a result of the terminal
acquisitions. For the year ended December 31, 2001, revenues increased by $47.3
million, or 55%, compared to 2000, due to the Shore acquisition (see "Liquidity
and Capital Resources") and overall increases in utilization at existing
locations. Approximately $36 million of the 2001 revenue increase was a result
of the Shore acquisition. Average annual tankage utilized for the years ended
December 31, 2002, 2001 and 2000 aggregated 46.5 million barrels, 30.1 million
barrels, and 21.0 million barrels, respectively. Average revenues per barrel of
tankage utilized for the years ended December 31, 2002, 2001 and 2000 was $4.43,
$4.41, and $4.12, respectively. The increase in 2001 average revenues per barrel
of tankage utilized was due to more favorable domestic market conditions, when
compared to 2000.
In 2002, operating costs increased by $32.7 million, when compared to 2001,
due to the 2002 terminal acquisitions and increases in volumes stored at
existing locations. In 2001, operating costs increased by $17.4 million, when
compared to 2000, due to the Shore acquisition and increases in volumes stored
at existing locations. For the years ended December 31, 2002 and 2001,
depreciation and amortization increased by $14.7 million and $6.6 million,
respectively, due to the terminal acquisitions. In 2002 and 2000, KPP sold land
and other terminaling business assets for net proceeds of approximately $1.1
million and $2.0 million, respectively, recognizing gains on disposition of
assets of $0.6 million and $1.1 million, respectively. General and
administrative expense increased by $6.7 million in 2002 and by $0.2 million in
2001. The increase in general and administrative expense in 2002, compared to
2001, is due to the 2002 terminal acquisitions and overall increases in
personnel costs. The increase in general and administrative costs in 2001,
compared to 2000, is due to the Shore acquisition, partially offset by
extraordinary high litigation costs in 2000.
PRODUCT MARKETING SERVICES
Year Ended December 31,
----------------------------------------
2002 2001 2000
----------- ----------- -----------
(in thousands)
Revenues............................................................... $ 381,159 $ 327,542 $ 381,186
Cost of products sold.................................................. 367,870 326,230 377,132
----------- ----------- -----------
Gross margin........................................................... $ 13,289 $ 1,312 $ 4,054
=========== =========== ===========
Operating income (loss)................................................ $ 4,692 $ (611) $ 2,472
=========== =========== ===========
For the year ended December 31, 2002, revenues increased by $53.6 million,
or 16%, compared to 2001, due to an increase in sales volumes, partially offset
by a decrease in the average price per gallon received. Total volumes sold and
average sales price per gallon for the year ended December 31, 2002 aggregated
517 million and $0.74, respectively, compared to 364 million and $0.90 for the
year ended December 31, 2001, respectively. The volume increase is due entirely
to the product sales operations acquired with Statia on February 28, 2002 (see
"Liquidity and Capital Resources"). The price decrease was due to decreases in
overall average market prices and changes in product mix resulting from the
Statia acquisition. For the year ended December 31, 2002, gross margin and
operating income increased by $12.0 million and $5.3 million, respectively, due
to the increase in both the volumes sold and favorable product margins.
For the year ended December 31, 2001, product marketing revenues decreased
by $53.6 million, or 14%, compared to 2000, due to a decrease in both volumes
sold and average sales prices. Volumes sold and average sales price decreased to
364 million gallons and $0.90 per gallon for the year ended December 31, 2001,
compared to 408 million gallons and $0.94 per gallon in 2000. Gross margin and
operating income decreased by $2.7 million and $3.1 million, respectively, in
2001, compared to 2000, due to sharp fluctuations in market prices, which more
than offset normal product margins.
Product inventories are maintained at minimum levels to meet customers'
needs; however market prices for petroleum products can fluctuate significantly
in short periods of time.
INTEREST AND OTHER INCOME
In September of 2002, KPOP entered into a treasury lock contract, maturing
on November 4, 2002, for the purpose of locking in the US Treasury interest rate
component on $150 million of anticipated thirty-year public debt offerings. The
treasury lock contract originally qualified as a cash flow hedging instrument
under Statement of Financial Accounting Standards ("SFAS") No. 133. In October
of 2002, KPOP, due to various market factors, elected to defer issuance of the
public debt securities, effectively eliminating the cash flow hedging
designation for the treasury lock contract. On October 29, 2002, the contract
was settled resulting in a net realized gain of $3.0 million, before interest of
outside non-controlling partners in KPP's net income, which was recognized in
the Consolidated Financial Statements as a component of interest and other
income.
In March of 2001, KPOP entered into two contracts for the purpose of
locking in interest rates on $100 million of anticipated ten-year public debt
offerings. As the interest rate locks were not designated as hedging instruments
pursuant to the requirements of SFAS No. 133, increases or decreases in the fair
value of the contracts are included in the Consolidated Financial Statements as
a component of interest and other income. On May 22, 2001, the contracts were
settled resulting in a gain of $3.8 million, before income taxes and interest of
outside non-controlling partners in KPP's net income.
INTEREST EXPENSE
For the year ended December 31, 2002, consolidated interest expense
increased by $13.8 million, compared to the year ended December 31, 2001,
primarily due to increases in debt resulting from KPP's pipeline and terminal
acquisitions (see "Liquidity and Capital Resources"), partially offset by
overall declines in interest rates on variable rate debt. For the year ended
December 31, 2001, consolidated interest expense increased by $2.0 million,
compared to the year ended December 31, 2000, due to increases in KPP debt
resulting from the Shore acquisition (see "Liquidity and Capital Resources"),
partially offset by declines in interest rates on variable rate debt.
INCOME TAXES
Certain KPP operations are conducted through separate taxable wholly-owned
corporate subsidiaries. The income tax expense for these subsidiaries, including
those acquired with Statia (see "Liquidity and Capital Resources"), for the
years ended December 31, 2002, 2001 and 2000 were $4.1 million, $0.3 million and
$0.9 million, respectively.
The Company's income tax expense reported in the consolidated financial
statements prior to the Distribution represents the tax expense of the Company
and its subsidiaries as if they had filed on a separate return basis. As a
result of the Distribution, the Company no longer participates with Xanser in
filing a consolidated federal income tax return. Effective with the
Distribution, the Company became a pass-through entity with its income, for
federal and state purposes, taxed at the shareholder level instead of the
Company paying such taxes. As a result of the change in tax status of the
Company, all deferred income tax assets and liabilities relating to temporary
differences (a net $8.6 million deferred tax liability) were eliminated,
resulting in a credit to income tax expense in 2001.
Prior to the Distribution, the Company maintained a valuation allowance to
adjust the total deferred tax assets to net realizable value in accordance with
SFAS No. 109. For the year ended December 31, 2000, the Company reduced the
valuation allowance as a result of its reevaluation of the realizability of
income tax benefits from future operations by $4.6 million. The Company
considered positive evidence, including the effect of the Distribution, recent
historical levels of taxable income, the scheduled reversal of deferred tax
liabilities, tax planning strategies, revised estimates of future taxable income
growth, and expiration periods of NOLs, among other things, in making this
evaluation and concluding that it is more likely than not that the Company will
realize the benefit of its net deferred tax assets. Upon completion of the
Distribution, all remaining deferred tax assets relating to previously recorded
net operating loss carryforwards ($16.2 million), which were utilized by Xanser
to offset federal income taxes resulting from the Distribution, were charged
directly to shareholders' equity.
Income tax expense for the years ended December 31, 2002 and 2000 includes
benefits of $1.3 million and $0.6 million, respectively, relating to favorable
developments pertaining to the resolution of certain state income tax matters.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities, including the operations of KPP, was
$89.0 million, $103.5 million, and $53.5 million for the years ended December
31, 2002, 2001, and 2000, respectively. The decrease in 2002, compared to 2001,
was due to the payment of personnel-related costs assumed with the Statia
acquisition, initial working capital requirements of the pipeline businesses
acquired in 2002 and changes in working capital components resulting from the
timing of cash receipts and disbursements, partially offset by overall increases
in revenues and operating income. The increase in 2001, compared to 2000, is
primarily the result of increases in terminaling revenues and operating income,
a result of the Shore acquisition and increases in utilization at existing
terminal locations.
Capital expenditures, including routine maintenance and expansion
expenditures, but excluding acquisitions, were $31.1 million, $17.3 million, and
$9.5 million for the years ended December 31, 2002, 2001 and 2000, respectively,
and almost exclusively relate to KPP. The increase in 2002 capital expenditures,
when compared to 2001, is the result of routine maintenance capital expenditures
related to the KPP pipeline and terminaling operations acquired in 2002 and
higher maintenance capital expenditures in the existing pipeline and terminaling
businesses. During all periods, adequate pipeline capacity existed to
accommodate volume growth, and the expenditures required for environmental and
safety improvements were not, and are not expected in the future to be,
significant. Environmental damages are included under KPP's insurance coverages
(subject to deductibles and limits). KPP anticipates that capital expenditures
(including routine maintenance and expansion expenditures, but excluding
acquisitions) will total approximately $40 million in 2003. Such future
expenditures by KPP, however, will depend on many factors beyond KPP's control,
including, without limitation, demand for refined petroleum products and
terminaling services in KPP's market areas, local, state and federal government
regulations, fuel conservation efforts and the availability of financing on
acceptable terms. No assurance can be given that required capital expenditures
will not exceed anticipated amounts during the year or thereafter or that KPP
will have the ability to finance such expenditure through borrowings, or choose
to do so.
The Company makes quarterly distributions of 100% of available cash, as
defined in the limited liability agreement, to the common shareholders of record
on the applicable record date, within 45 days after the end of each quarter.
Available cash consists generally of all the cash receipts of the Company, plus
the beginning cash balance, less all cash disbursements and reserves. Excess
cash flow of the Company's wholly-owned product marketing operations is being
used to reduce working capital borrowings. Distributions of $1.65 per share were
declared and paid to shareholders with respect to 2002. Distributions of $.3625
per share were declared and paid with respect to each of third and fourth
quarters of 2001.
KPP expects to fund its future cash distributions and routine maintenance
capital expenditures (excluding acquisitions) with existing cash and anticipated
cash flows from operations. Expansionary capital expenditures of KPP are
expected to be funded through additional KPP bank borrowings and/or future KPP
public equity or debt offerings.
In July of 2001, the Company entered into an agreement with a bank that
provides for a $50 million revolving credit facility through July 1, 2008. The
credit facility, which bears interest at variable rates, is secured by 4.6
million KPP limited partnership units and has a variable rate commitment fee on
unused amounts. At December 31, 2002, $19.1 million was drawn on the credit
facility, at an average annual interest rate of 2.83%.
The Company's product marketing subsidiary has a credit agreement with a
bank that, as amended, provides for a $20 million revolving credit facility
through April of 2005. The credit facility bears interest at variable rates, has
a commitment fee of 0.25% per annum on unutilized amounts and contains certain
financial and operational covenants. At December 31, 2002, the subsidiary was in
compliance with all covenants. The credit facility, which is without recourse to
the Company, is secured by essentially all of the tangible and intangible assets
of the Company's wholly-owned products marking business and by 500,000 KPP
limited partnership units held by the product marketing subsidiary. At December
31, 2002, $4.7 million was drawn on the facility.
KPP has a credit agreement with a group of banks that, as amended, provides
for a $275 million unsecured revolving credit facility through January 2, 2004.
The credit facility, which is without recourse to the Company, bears interest at
variable rates and has a variable commitment fee on unutilized amounts. The
credit facility contains certain financial and operational covenants, including
limitations on investments, sales of assets and transactions with affiliates
and, absent an event of default, the covenants do not restrict distributions to
the Company or to other partners. At December 31, 2002, KPP was in compliance
with all covenants. At December 31, 2002, $243.0 million was drawn on the
facility, at an average annual interest rate of 2.18%.
On December 24, 2002, KPP entered into a $175 million unsecured bridge loan
agreement with a group of banks in connection with its 2002 pipeline
acquisitions. The bridge loan agreement, as amended, expires in January of 2004
and is without recourse to the Company. The bridge loan agreement bears interest
at variable rates (2.67% at December 31, 2002) and contains certain operational
and financial covenants and, absent an event of default, the covenants do not
restrict distributions to the Company or to other partners. At December 31,
2002, KPP was in compliance with all covenants. KPP expects to repay the bridge
loan with additional KPP bank borrowings and/or public equity or debt offerings.
KPP, through two wholly-owned subsidiaries, has a credit agreement with a
bank that provides for the issuance of term loans in connection with its 1999
United Kingdom terminal acquisition. The term loans ($26.3 million at December
31, 2002), with a fixed rate of 7.25%, are, as amended, due in January of 2004.
The term loans under the credit agreement are unsecured and are pari passu with
the $275 million revolving credit facility. The term loans, which are without
recourse to the Company, also contain certain financial and operational
covenants. At December 31, 2002, KPP was in compliance with all covenants.
In January of 2001, KPP used proceeds from its revolving credit agreement
to repay in full its $128 million of mortgage notes. Under the provisions of the
mortgage notes, KPP incurred a $6.5 million prepayment penalty which, before
interest of outside non-controlling partners in KPP's net income and income
taxes, was recognized in the Consolidated Financial Statements as loss on debt
extinguishment in 2001.
In January of 2001, KPP acquired Shore Terminals LLC ("Shore") for $107
million in cash and 1,975,090 KPP limited partnership units (valued at $56.5
million on the date of agreement and its announcement). Financing for the cash
portion of the purchase price was supplied by KPP's revolving credit facility.
As a result of KPP issuing additional units to unrelated parties, the Company's
share of net assets of KPP increased by $9.9 million. Accordingly, the Company
recognized a $9.9 million gain, before deferred income taxes of $3.8 million, in
2001.
In January of 2002, KPP issued 1,250,000 limited partnership units in a
public offering at $41.65 per unit, generating approximately $49.7 million in
net proceeds. The proceeds were used to reduce the amount of indebtedness
outstanding under KPP's revolving credit agreement. As a result of KPP issuing
additional units to unrelated parties, the Company's share of net assets of KPP
increased by $8.6 million. Accordingly, the Company recognized an $8.6 million
gain in 2002.
In February of 2002, KPOP issued $250 million of 7.75% senior unsecured
notes due February 15, 2012. The net proceeds from the public offering, $248.2
million, were used to repay KPP's revolving credit agreement and to partially
fund the acquisition of all of the liquids terminaling subsidiaries of Statia
Terminals Group NV ("Statia"). Under the note indenture, interest is payable
semi-annually in arrears on February 15 and August 15 of each year. The notes,
which are without recourse to the Company, are redeemable, as a whole or in
part, at the option of KPOP, at any time, at a redemption price equal to the
greater of 100% of the principal amount of the notes, or the sum of the present
value of the remaining scheduled payments of principal and interest, discounted
to the redemption date at the applicable U.S. Treasury rate, as defined in the
indenture, plus 30 basis points. The note indenture contains certain financial
and operational covenants, including certain limitations on investments, sales
of assets and transactions with affiliates and, absent an event of default, such
covenants do not restrict distributions to the Company or to other partners. At
December 31, 2002, KPP was in compliance with all covenants.
On February 28, 2002, KPP acquired Statia for approximately $178 million in
cash (net of acquired cash). The acquired Statia subsidiaries had approximately
$107 million in outstanding debt, including $101 million of 11.75% notes due in
November 2003. The cash portion of the purchase price was funded by KPP's
revolving credit agreement and proceeds from KPOP's February 2002 public debt
offering. In April of 2002, KPP redeemed all of Statia's 11.75% notes at
102.938% of the principal amount, plus accrued interest. The redemption was
funded by KPP's revolving credit facility. Under the provisions of the 11.75%
notes, KPP incurred a $3.0 million prepayment penalty, of which $2.0 million,
before interest of outside non-controlling partners in KPP's net income, was
recognized in the Consolidated Financial Statements as loss on debt
extinguishment in 2002.
In May of 2002, KPP issued 1,565,000 limited partnership units in a public
offering at a price of $39.60 per unit, generating approximately $59.1 million
in net proceeds. A portion of the offering proceeds was used to fund KPP's
September 2002 acquisition of the Australia and New Zealand terminals. As a
result of KPP issuing additional units to unrelated parties, the Company's share
of net assets of KPP increased by $8.8 million. Accordingly, the Company
recognized an $8.8 million gain in 2002.
On September 18, 2002, KPP acquired eight bulk liquid storage terminals in
Australia and New Zealand from Burns Philp & Co. Ltd. for approximately $47
million in cash.
On November 1, 2002, KPP acquired an approximately 2,000-mile anhydrous
ammonia pipeline system from Koch Pipeline Company, L.P. for approximately $139
million in cash. This fertilizer pipeline system originates in southern
Louisiana, proceeds north through Arkansas and Missouri, and then branches east
into Illinois and Indiana and north and west into Iowa and Nebraska. The
acquisition was financed by KPP bank debt maturing in January of 2004.
In November of 2002, KPP issued 2,095,000 limited partnership units in a
public offering at $33.36 per unit, generating approximately $66.7 million in
net proceeds. The offering proceeds were used to reduce KPP's bank borrowings
for the fertilizer pipeline acquisition. As a result of KPP issuing additional
units to unrelated parties, the Company's share of net assets of KPP increased
by $7.5 million. Accordingly, the Company recognized a $7.5 million gain in
2002.
On December 24, 2002, KPP acquired a 400-mile petroleum products pipeline
and four terminals in North Dakota and Minnesota from Tesoro Refining and
Marketing Company for approximately $100 million in cash, subject to normal
post-closing adjustments. The acquisition was funded with KPP bank debt maturing
in January of 2004.
On March 21, 2003, KPP issued 3,000,000 limited partnership units in a
public offering at $36.54 per unit, generating approximately $104.8 million in
net proceeds. The proceeds will be used to reduce the amount of indebtedness
under KPP's bridge facility.
Pursuant to the Distribution, the Company entered into an agreement (the
"Distribution Agreement") with Xanser whereby the Company is obligated to pay
Xanser amounts equal to certain expenses and tax liabilities incurred by Xanser
in connection with the Distribution. In January of 2002, the Company paid Xanser
$10 million for tax liabilities due under the terms of the Distribution
Agreement. The Distribution Agreement also requires the Company to pay Xanser an
amount calculated based on any income tax liability of Xanser that, in the sole
judgement of Xanser, (i) is attributable to increases in income tax from past
years arising out of adjustments required by federal and state tax authorities,
to the extent that such increases are properly allocable to the businesses that
became part of the Company, or (ii) is attributable to the distribution of the
Company's common shares and the operations of the Company's businesses in the
current year and the preceding years. In the event of an examination of Xanser
by federal or state tax authorities, Xanser will have unfettered control over
the examination, administrative appeal, settlement or litigation that may be
involved, notwithstanding that the Company has agreed to pay any additional tax.
See also "Item 1-Environmental Matters" and "Item 3-Legal Proceedings".
CRITICAL ACCOUNTING POLICIES
The preparation of the Company's financial statements 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 financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates. Significant accounting policies are presented in the Notes
to the Consolidated Financial Statements.
Critical accounting policies are those that are most important to the
portrayal to our financial position and results of operations. These policies
require management's most difficult, subjective or complex judgments, often
employing the use of estimates about the effect of matters that are inherently
uncertain. Our most critical accounting policies pertain to impairment of
property and equipment and environmental costs.
The carrying value of KPP's property and equipment is periodically
evaluated using management's estimates of undiscounted future cash flows, or, in
some cases, third-party appraisals, as the basis of determining if impairment
exists under the provisions of SFAS No. 144, "Accounting for the Impairment or
the Disposal of Long-Lived Assets", which was adopted effective January 1, 2002.
To the extent that impairment is indicated to exist, an impairment loss is
recognized by KPP under SFAS No. 144 based on fair value. The application of
SFAS No. 144 did not have a material impact on the results of operations of KPP
for the year ended December 31, 2002. However, future evaluations of carrying
value are dependent on many factors, several of which are out of KPP's control,
including demand for refined petroleum products and terminaling services in
KPP's market areas, and local, state and federal governmental regulations. To
the extent that such factors or conditions change, it is possible that future
impairments might occur, which could have a material effect on the results of
operations of KPP.
KPP environmental expenditures that relate to current operations are
expensed or capitalized, as appropriate. Expenditures that relate to an existing
condition caused by past operations, and which do not contribute to current or
future revenue generation, are expensed. Liabilities are recorded by KPP when
environmental assessments and/or remedial efforts are probable, and the costs
can be reasonably estimated. Generally, the timing of these accruals coincides
with the completion of a feasibility study or KPP's commitment to a formal plan
of action. The application of KPP's environmental accounting policies did not
have a material impact on the results of operations of KPP for the years ended
December 31, 2002, 2001, or 2000. Although KPP believes that its operations are
in general compliance with applicable environmental regulations, risks of
substantial costs and liabilities are inherent in pipeline and terminaling
operations. Moreover, it is possible that other developments, such as
increasingly strict environmental laws, regulations and enforcement policies
thereunder, and legal claims for damages to property or persons resulting from
the operations of KPP could result in substantial costs and liabilities, any of
which could have a material effect on the results of operations of KPP.
RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standard Board (the "FASB") has issued SFAS No.
143 "Accounting for Asset Retirement Obligations", which establishes
requirements for the removal-type costs associated with asset retirements. The
Company is currently assessing the impact of SFAS No. 143, which must be adopted
in the first quarter of 2003.
In April of 2002, the FASB issued SFAS No. 145, which, among other items,
affects the income statement classification of gains and losses from early
extinguishment of debt. Under SFAS No. 145, early extinguishment of debt is
considered a risk management strategy, with resulting gains and losses no longer
classified as an extraordinary item, unless the debt extinguishment meets
certain unusual in nature and infrequency of occurrence criteria, which is
expected to be rare. Effective October 1, 2002, the Company adopted the
provisions of SFAS No. 145 and has reclassified all previously-reported
extraordinary losses on debt extinguishment, before minority interest and income
taxes, to "Loss on debt extinguishment" in the consolidated statements of
income.
In July of 2002, the FASB issued SFAS No. 146 "Accounting for Costs
Associated with Exit or Disposal Activities", which requires all restructurings
initiated after December 31, 2002 be recorded when they are incurred and can be
measured at fair value. The Company is currently assessing the impact of SFAS
No. 146, which must be adopted in the first quarter of 2003.
In November of 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements of Guarantees, Including Indirect
Guarantees of Indebtedness to Others, an interpretation of FASB Statements No.
5, 57, and 107, and a rescission of FASB Interpretation No. 34." This
interpretation elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under guarantees
issued. The interpretation also clarifies that a guarantor is required to
recognize, at inception of a guarantee, a liability for the fair value of the
obligation undertaken. The initial recognition and measurement provisions of the
interpretation are applicable to guarantees issued or modified after December
31, 2002. The disclosure requirements are effective for financial statements of
interim or annual periods ending after December 15, 2002 and have been adopted.
Management of the Company believes that the application of this interpretation
will have no effect on the consolidated financial statements of the Company.
In December of 2002, the FASB issued SFAS No. 148 "Accounting for
Stock-Based Compensation-Transition and Disclosure." SFAS No. 148, which amends
SFAS No. 123, provides for alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation and requires additional disclosures in annual and interim financial
statements regarding the method of accounting for stock-based employee
compensation and the effect of the method used on financial results. The Company
will continue to account for stock-based compensation in accordance with
Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to
Employees" and has provided the required disclosures in its consolidated
financial statements.
In January of 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities, an interpretation of ARB No. 51." This
interpretation addressed the consolidation by business enterprises of variable
interest entities as defined in the interpretation. The interpretation applies
immediately to variable interests in variable interest entities created after
January 31, 2003, and to variable interests in variable interest entities
obtained after January 31, 2003. The interpretation requires certain disclosures
in financial statements issued after January 31, 2003. Management of the Company
believes that the application of this interpretation will have no effect on the
consolidated financial statements of the Company.
Item 7(a). Quantitative and Qualitative Disclosure About Market Risk
The principal market risks (i.e., the risk of loss arising from the adverse
changes in market rates and prices) to which the Company is exposed are interest
rates on the Company's and KPP's debt and investment portfolios. The Company's
investment portfolio consists of cash equivalents; accordingly, the carrying
amounts approximate fair value. The Company's investments are not material to
its financial position or performance. Assuming variable rate debt of $441.8
million (including KPP's debt) at December 31, 2002, a one percent increase in
interest rates would increase annual net interest expense and decrease interest
of outside non-controlling partners in KPP's net income by approximately $4.4
million and $3.3 million, respectively.
Information regarding KPOP's September 2002 interest rate hedging
transaction is included in "Item 7 - Interest and Other Income".
The product market business periodically purchases refined petroleum
products for sales to commercial interests, for resale as bunker fuel and to
maintain an inventory of blendstocks for customers. Such petroleum inventories
are generally held for short periods of time, not exceeding 90 days. As the
Company does not engage in derivative transactions to hedge the value of the
inventory, it is subject to market risk from changes in global oil markets.
Increases or decreases in the market value of inventory, which were not
significant in 2002, are reflected in the product marketing services cost of the
products sold.
Item 8. Financial Statements and Supplementary Data
The financial statements and supplementary data of the Company begin on
page F-1 of this report. Such information is hereby incorporated by reference
into this Item 8.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
PART III
The information required by Part III (Items 10, 11, 12 and 13) of Form 10-K
is incorporated by reference from portions of the Registrant's definitive proxy
statement to be filed with the Securities and Exchange Commission not later than
120 days after the close of the fiscal year covered by this Report.
Item 14. Controls and Procedures.
Included in its recent Release No. 34-46427, effective August 29, 2002, the
Securities and Exchange Commission adopted rules requiring reporting companies
to maintain disclosure controls and procedures to provide reasonable assurance
that a registrant is able to record, process, summarize and report the
information required in the registrant's quarterly and annual reports under the
Securities Exchange Act of 1934 (the "Exchange Act"). While management believes
that the Company's existing disclosure controls and procedures have been
effective to accomplish these objectives, it intends to continue to examine,
refine and formalize the Company's disclosure controls and procedures and to
monitor ongoing developments in this area.
The Company's principal executive officer and principal financial officer,
after evaluating the effectiveness of the Company's disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14(c) and Rule 15d-14(c)) as of
a date within 90 days before the filing date of this Report, have concluded
that, as of such date, the Company's disclosure controls and procedures are
adequate and effective to ensure that material information relating to the
Company and its consolidated subsidiaries would be made known to them by others
within those entities.
There have been no changes in the Company's internal controls or in other
factors known to management that could significantly affect those internal
controls subsequent to the date of the evaluation, nor were there any
significant deficiencies or material weaknesses in the Company's internal
controls. As a result, no corrective actions were required or undertaken.
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)(1) Financial Statements Beginning
Page
Set forth below is a list of financial statements appearing in this report.
Kaneb Services LLC Financial Statements:
Independent Auditors' Report.............................................................. F - 1
Consolidated Statements of Income - Three Years Ended December 31, 2002................... F - 2
Consolidated Balance Sheets - December 31, 2002 and 2001.................................. F - 3
Consolidated Statements of Cash Flows - Three Years Ended December 31, 2002............... F - 4
Consolidated Statements of Shareholders' Equity - Three Years
Ended December 31, 2002................................................................ F - 5
Notes to Consolidated Financial Statements................................................ F - 6
(a)(2) Financial Statement Schedules
Set forth below are the financial statement schedules appearing in this
report.
Schedule I - Kaneb Services LLC (Parent Company) Condensed Financial Statements:
Statements of Income - Year ended December 31, 2002 and
period from June 30, 2001 to December 31, 2001......................................... F - 25
Balance Sheets - December 31, 2002 and 2001............................................... F - 26
Statements of Cash Flows - Year ended December 31, 2002 and
period from June 30, 2001 to December 31, 2001......................................... F - 27
Schedule II - Kaneb Services LLC Valuation and Qualifying Accounts - Years Ended
December 31, 2002, 2001, and 2000......................................................... F - 28
Schedules, other than those listed above, have been omitted because of the
absence of the conditions under which they are required or because the
required information is included in the consolidated financial statements
or related notes thereto. Schedule I information for periods prior to June
30, 2001 has been omitted since the Parent Company was not formed and
capitalized prior to that date.
(a)(3) List of Exhibits
3.01 Amended and Restated Limited Liability Company Agreement of
Registrant, filed as Exhibit 3.1 to the exhibits to Registrant's
Form 10-Q, for the period ended June 30, 2001, which exhibit is
hereby incorporated by reference.
4.01 Specimen Common Share Certificate, filed as Exhibit 4.01 to the
exhibits to Registrant's Form 10/A, dated May 1, 2001, which
exhibit is hereby incorporated by reference.
4.02*Kaneb Services LLC 2001 Incentive Plan, filed as Exhibit 4.2 to
the exhibits to Registrant's Registration Statement on Form S-8
("Form S-8") (S.E.C. File No. 333-65404), which exhibit is hereby
incorporated by reference.
10.1 Distribution Agreement by and between the Registrant and Kaneb
Services, Inc., filed as Exhibit 10.1 to the exhibits to
Registrant's Form 10-Q, for the period ended June 30, 2001, which
exhibit is hereby incorporated by reference.
10.2 Administrative Services Agreement by and between the Registrant
and Kaneb Services, Inc., filed as Exhibit 10.2 to the exhibits
to Registrant's Form 10-Q, for the period ended June 30, 2001,
which exhibit is hereby incorporated by reference.
10.3 Rights Agreement by and between the Registrant and The Chase
Manhattan Bank, filed as Exhibit 10.3 to the exhibits to
Registrant's Form 10-Q, for the period ended June 30, 2001, which
exhibit is hereby incorporated by reference.
10.4*Employee Benefits Agreement by and between the Registrant and
Kaneb Services, Inc., filed as Exhibit 10.04 to the exhibits to
Registrant's Form 10/A, dated May 24, 2001, which exhibit is
hereby incorporated by reference.
10.5 ST Agreement and Plan of Merger dated December 21, 1992 by and
among Grace Energy Corporation, Support Terminal Services, Inc.,
Standard Transpipe Corp., and Kaneb Pipe Line Operating
Partnership, NSTS, Inc. and NSTI, Inc., as amended by Amendment
of STS Merger Agreement dated March 2, 1993, filed as Exhibit
10.1 of the exhibits to Kaneb Pipe Line Partners, L.P.'s Current
Report on Form 8-K, dated March 16, 1993, which exhibit is hereby
incorporated by reference.
10.6 Agreement for Sale and Purchase of Assets between Wyco Pipe Line
Company and Kaneb Pipe Line Operating Partnership, L.P., dated
February 19, 1995, filed as Exhibit 10.1 of the exhibits to the
Kaneb Pipe Line Partners, L.P.'s March 1995 Form 8-K, which
exhibit is hereby incorporated by reference.
10.7 Asset Purchase Agreements between and among Steuart Petroleum
Company, SPC Terminals, Inc., Piney Point Industries, Inc.,
Steuart Investment Company, Support Terminals Operating
Partnership, L.P. and Kaneb Pipe Line Operating Partnership,
L.P., as amended, dated August 27, 1995, filed as Exhibits 10.1,
10.2, 10.3, and 10.4 of the exhibits to Kaneb Pipe Line Partners,
L.P's Current Report on Form 8-K dated January 3, 1996, which
exhibits are hereby incorporated by reference.
10.8 Credit Agreement dated March 25, 1998 between Martin Oil
Corporation and Harris Trust & Savings Bank, filed as Exhibit
10.08 to the exhibits to Registrant's Form 10/A, dated May 1,
2001, which exhibit is hereby incorporated by reference.
10.9 First Amendment to Credit Agreement dated March 18, 1999 between
Martin Oil Corporation and Harris Trust & Savings Bank, filed as
Exhibit 10.09 to the exhibits to Registrant's Form 10/A, dated
May 1, 2001, which exhibit is hereby incorporated by reference.
10.10 Second Amendment to Credit Agreement dated February 11, 2000
between Martin Oil Corporation and Harris Trust & Savings Bank,
filed as Exhibit 10.10 to the exhibits to Registrant's Form 10/A,
dated May 1, 2001, which exhibit is hereby incorporated by
reference.
10.11 Formation and Purchase Agreement, by and among Support Terminal
Operating Partnership, L.P., Northville Industries Corp. and
AFFCO, Corp., dated October 30, 1998, filed as Exhibit 10.9 to
the Kaneb Pipe Line Partners, L.P.'s Form 10-K for the year ended
December 31, 1998, which exhibit is hereby incorporated by
reference.
10.12 Agreement, by and among, GATX Terminals Limited, ST Services
Ltd., ST Eastham, Ltd., GATX Terminals Corporation, Support
Terminals Operating Partnership, L.P. and Kaneb Pipe Line
Partners, L.P., dated January 26, 1999, filed as Exhibit 10.10 to
the Kaneb Pipe Line Partners, L.P.'s Form 10-K for the year ended
December 31, 1998, which exhibit is hereby incorporated by
reference.
10.13 Credit Agreement, by and among, Kaneb Pipe Line Operating
Partnership, L.P., ST Services, Ltd. and SunTrust Bank, Atlanta,
dated January 27, 1999, filed as Exhibit 10.11 to the Kaneb Pipe
Line Partners, L.P.'s Form 10-K for the year ended December 31,
1998, which exhibit is hereby incorporated by reference.
10.14 Revolving Credit Agreement, dated as of December 28, 2000 by and
among Kaneb Pipe Line Operating Partnership, L.P., Kaneb Pipe
Line Partners, L.P., the Lenders party thereto, and SunTrust
Bank, as Administrative Agent, filed as Exhibit 10.11 to Kaneb
Pipe Line Partners, L.P.'s Form 10-K for the year ended December
31, 2000, which exhibit is hereby incorporated by reference.
10.15 Securities Purchase Agreement by and among Shore Terminals LLC,
Kaneb Pipe Line Partners, L.P. and the Sellers Named Therein,
dated as of September 22, 2000, Amendment No. 1 To Securities
Purchase Agreement, dated as of November 28, 2000 and
Registration Rights Agreement, dated as of January 3, 2001, filed
as Exhibits 10.1, 10.2 and 10.3 of the exhibits to Kaneb Pipe
Line Partners, L.P.'s Current Report on Form 8-K dated January 3,
2001, which exhibits are hereby incorporated by reference.
10.16*Kaneb Services LLC 401(k) Savings Plan, filed as Exhibit 10.16
to the exhibits to Registrant's Form 10/A, dated May 24, 2001,
which exhibit is hereby incorporated by reference.
10.17 Credit Agreement by and between the Registrant and Kaneb
Services, Inc., filed as Exhibit 10.5 to the exhibits to
Registrant's Form 10-Q, for the period ended June 30, 2001, which
exhibit is hereby incorporated by reference. This credit
commitment was permanently terminated effective December 10,
2001.
10.18 Loan Agreement by and between the Registrant, Kaneb Pipe Line
Company LLC and the Bank of Scotland, filed as Exhibit 10.6 to
the exhibits to Registrant's Form 10-Q, for the period ended June
30, 2001, which exhibit is hereby incorporated by reference.
21 List of Subsidiaries, filed herewith.
23 Consent of KPMG LLP, filed herewith.
99.1 Certification of Chief Executive Officer, Pursuant to Section
906(a) of the Sarbanes-Oxley Act of 2002, dated as of March 28,
2003, filed herewith.
99.2 Certification of Chief Financial Officer, Pursuant to Section
906(a) of the Sarbanes-Oxley Act of 2002, dated as of March 28,
2003, filed herewith.
* Denotes management contracts.
(b) Reports on Form 8-K
Current Report on Form 8-K filed with the SEC on November 7, 2002.
Current Report on Form 8-K filed with the SEC on November 27, 2002.
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of Kaneb Services LLC
We have audited the accompanying consolidated balance sheets of Kaneb Services
LLC and its subsidiaries (the "Company") as listed in the index appearing in
Item 15(a)(1). In connection with our audits of the consolidated financial
statements, we have also audited the financial statement schedules as listed in
the index appearing under Item 15(a)(2). These consolidated financial statements
and financial statement schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion on the consolidated
financial statements and financial statement schedules based on our audits.
We conducted our audits 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 financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company as of
December 31, 2002 and 2001, and the results of their operations and their cash
flows for each of the years in the three-year period ended December 31, 2002, in
conformity with accounting principles generally accepted in the United States of
America. Also, in our opinion, the related financial statement schedules, when
considered in relation to the basic consolidated financial statements taken as a
whole, present fairly, in all material respects, the information set forth
therein.
KPMG LLP
Dallas, Texas
February 25, 2003, except as to note 14,
which is as of March 21, 2003
F - 1
KANEB SERVICES LLC
CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31,
--------------------------------------------------
2002 2001 2000
--------------- -------------- --------------
Revenues:
Services................................................... $ 288,669,000 $ 207,796,000 $ 156,232,000
Products................................................... 381,159,000 327,542,000 381,186,000
--------------- -------------- --------------
Total revenues.......................................... 669,828,000 535,338,000 537,418,000
--------------- -------------- --------------
Costs and expenses:
Cost of products sold...................................... 367,870,000 326,230,000 377,132,000
Operating costs............................................ 132,269,000 91,704,000 70,399,000
Depreciation and amortization.............................. 39,471,000 23,261,000 16,320,000
Gain on sale of assets..................................... (609,000) - (1,126,000)
General and administrative................................. 24,468,000 14,352,000 13,519,000
--------------- -------------- --------------
Total costs and expenses................................ 563,469,000 455,547,000 476,244,000
--------------- -------------- --------------
Operating income.............................................. 106,359,000 79,791,000 61,174,000
Interest and other income..................................... 3,664,000 4,132,000 332,000
Interest expense.............................................. (29,171,000) (15,381,000) (13,346,000)
Loss on debt extinguishment................................... (3,282,000) (6,540,000) -
--------------- -------------- --------------
Income before gain on issuance of units by
KPP, income taxes and interest of outside
non-controlling partners in KPP's net income............... 77,570,000 62,002,000 48,160,000
Gain on issuance of units by KPP.............................. 24,882,000 9,859,000 -
Income tax benefit (expense).................................. (2,585,000) 2,413,000 (2,824,000)
Interest of outside non-controlling partners in KPP's
net income................................................. (52,639,000) (45,951,000) (32,693,000)
--------------- -------------- --------------
Net income.................................................... $ 47,228,000 $ 28,323,000 $ 12,643,000
=============== ============== ==============
Earnings per share:
Basic...................................................... $ 4.13 $ 2.57 $ 1.19
=============== ============== ==============
Diluted.................................................... $ 4.02 $ 2.46 $ 1.15
=============== ============== ==============
See notes to consolidated financial statements.
F - 2
KANEB SERVICES LLC
CONSOLIDATED BALANCE SHEETS
December 31,
---------------------------------
2002 2001
--------------- --------------
ASSETS
Current Assets:
Cash and cash equivalents.................................................... $ 24,477,000 $ 10,004,000
Accounts receivable (net of allowance for doubtful accounts of
$3,724,000 in 2002 and $653,000 in 2001).................................. 61,835,000 32,890,000
Inventories.................................................................. 12,863,000 8,402,000
Prepaid expenses and other................................................... 10,658,000 3,378,000
--------------- --------------
Total current assets...................................................... 109,833,000 54,674,000
--------------- --------------
Property and equipment.......................................................... 1,288,960,000 639,291,000
Less accumulated depreciation................................................... 196,684,000 157,895,000
--------------- --------------
Net property and equipment................................................ 1,092,276,000 481,396,000
--------------- --------------
Investment in affiliates........................................................ 25,604,000 22,252,000
Excess of cost over fair value of net assets of acquired businesses
and other assets............................................................. 16,388,000 13,445,000
--------------- --------------
$ 1,244,101,000 $ 571,767,000
=============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable............................................................. $ 32,629,000 $ 15,152,000
Accrued expenses............................................................. 38,076,000 18,126,000
Accrued interest payable..................................................... 7,997,000 627,000
Accrued distributions payable to shareholders................................ 4,734,000 4,131,000
Accrued distributions payable to outside non-controlling
partners in KPP's net income.............................................. 15,878,000 11,392,000
Deferred terminaling fees.................................................... 6,246,000 6,515,000
--------------- --------------
Total current liabilities................................................. 105,560,000 55,943,000
--------------- --------------
Long-term debt.................................................................. 718,162,000 277,302,000
Long-term payables and other liabilities........................................ 40,094,000 36,371,000
Interest of outside non-controlling partners in KPP............................. 316,631,000 168,219,000
Commitments and contingencies
Shareholders' equity:
Shareholders' investment..................................................... 63,350,000 34,428,000
Accumulated other comprehensive income (loss)
- foreign currency translation adjustment................................. 304,000 (496,000)
--------------- --------------
Total shareholders' equity................................................ 63,654,000 33,932,000
--------------- --------------
$ 1,244,101,000 $ 571,767,000
=============== ==============
See notes to consolidated financial statements.
F - 3
KANEB SERVICES LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
--------------------------------------------------
2002 2001 2000
--------------- -------------- --------------
Operating activities:
Net income................................................. $ 47,228,000 $ 28,323,000 $12,643,000
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization........................... 39,471,000 23,261,000 16,320,000
Equity in earnings of affiliates, net of distributions.. (3,164,000) (5,000) (154,000)
Interest of outside non-controlling partners in KPP's
net income............................................ 52,639,000 45,951,000 32,693,000
Gain on issuance of units by KPP........................ (24,882,000) (9,859,000) -
Gain on sale of assets ................................. (609,000) - (1,126,000)
Deferred income taxes................................... 3,105,000 (2,414,000) 2,448,000
Other................................................... (559,000) (5,728,000) 1,101,000
Changes in working capital components:
Accounts receivable................................... (16,403,000) 7,617,000 (4,760,000)
Inventories, prepaid expenses and other............... (7,643,000) 8,770,000 (6,759,000)
Accounts payable and accrued expenses................. (165,000) 7,620,000 1,115,000
--------------- -------------- --------------
Net cash provided by operating activities............. 89,018,000 103,536,000 53,521,000
--------------- -------------- --------------
Investing activities:
Acquisitions, net of cash acquired......................... (468,477,000) (111,562,000) (12,264,000)
Capital expenditures....................................... (31,101,000) (17,309,000) (9,533,000)
Proceeds from sale of assets............................... 1,107,000 2,807,000 1,961,000
Other...................................................... 361,000 (2,157,000) (74,000)
--------------- -------------- --------------
Net cash used in investing activities................. (498,110,000) (128,221,000) (19,910,000)
--------------- -------------- --------------
Financing activities:
Issuance of debt........................................... 756,087,000 269,625,000 20,724,000
Payments of debt........................................... (427,493,000) (176,375,000) (3,700,000)
Issuance of common shares upon exercise of stock options... 648,000 2,354,000 -
Distributions to shareholders.............................. (18,351,000) (4,137,000) -
Distributions to outside non-controlling
partners in KPP......................................... (52,827,000) (44,040,000) (37,000,000)
Changes in long-term payables and other liabilities........ (10,026,000) (19,132,000) (13,491,000)
Net proceeds from issuance of units by KPP................. 175,527,000 - -
--------------- -------------- --------------
Net cash provided by (used in) financing activities... 423,565,000 28,295,000 (33,467,000)
--------------- -------------- --------------
Increase in cash and cash equivalents................ 14,473,000 3,610,000 144,000
Cash and cash equivalents at beginning of period.............. 10,004,000 6,394,000 6,250,000
--------------- -------------- --------------
Cash and cash equivalents at end of period.................... $ 24,477,000 $ 10,004,000 $ 6,394,000
=============== ============== ==============
Supplemental cash flow information:
Cash paid for interest..................................... $ 27,070,000 $ 15,044,000 $ 13,529,000
=============== ============== ==============
Non-cash investing and financing activities-
Issuance of units in connection with
acquisition of terminals by KPP....................... $ - $ 56,488,000 $ -
=============== ============== ==============
See notes to consolidated financial statements.
F - 4
KANEB SERVICES LLC
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Accumulated
Other
Shareholders' Comprehensive Comprehensive
Investment Income (Loss) Total Income
------------- -------------- ------------- -------------
Balance at January 1, 2000.................. $ 87,037,000 $ (204,000) $ 86,833,000 -
Net income for the year................ 12,643,000 - 12,643,000 $ 12,643,000
Distributions declared................. 2,094,000 - 2,094,000 -
Dividends.............................. (30,000,000) (30,000,000) -
Foreign currency translation adjustment - (201,000) (201,000) (201,000)
------------- -------------- -------------- --------------
Comprehensive income for the year...... $ 12,442,000
==============
Balance at December 31, 2000................ 71,774,000 (405,000) 71,369,000
Net income for the year................ 28,323,000 - 28,323,000 $ 28,323,000
Capital contributions.................. 328,000 - 328,000 -
Dividends.............................. (61,310,000) - (61,310,000) -
Distributions declared................. (8,268,000) - (8,268,000) -
Issuance of common shares and other.... 3,581,000 - 3,581,000 -
Foreign currency translation adjustment - (91,000) (91,000) (91,000)
------------- -------------- ------------- --------------
Comprehensive income for the year...... $ 28,232,000
==============
Balance at December 31, 2001................ 34,428,000 (496,000) 33,932,000
Net income for the year................ 47,228,000 - 47,228,000 $ 47,228,000
Distributions declared................. (18,954,000) - (18,954,000) -
Issuance of common shares and other.... 648,000 648,000 -
Foreign currency translation adjustment - 800,000 800,000 800,000
------------- -------------- ------------- --------------
Comprehensive income for the year...... $ 48,028,000
==============
Balance at December 31, 2002................ $ 63,350,000 $ 304,000 $ 63,654,000
============= ============== =============
See notes to consolidated financial statements.
F - 5
KANEB SERVICES LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Distribution by Kaneb Services, Inc.
On November 27, 2000, the Board of Directors of Kaneb Services, Inc.
authorized the distribution of its pipeline, terminaling and product marketing
businesses (the "Distribution") to its stockholders in the form of a new limited
liability company, Kaneb Services LLC (the "Company"). On June 29, 2001, the
Distribution was completed, with each shareholder of Kaneb Services, Inc.
receiving one common share of the Company for each three shares of Kaneb
Services, Inc.'s common stock held on June 20, 2001, the record date for the
Distribution, resulting in the distribution of 10.85 million shares of the
Company. On August 7, 2001, the stockholders of Kaneb Services, Inc. approved an
amendment to its certificate of incorporation to change its name to Xanser
Corporation ("Xanser").
In September 1989, Kaneb Pipe Line Company LLC ("KPL"), a wholly-owned
subsidiary of the Company, formed Kaneb Pipe Line Partners, L.P. ("KPP") to own
and operate its refined petroleum products pipeline business. KPL manages and
controls the operations of KPP through its general partner interests and a 20%
(at December 31, 2002) limited partnership interest. KPP operates through Kaneb
Pipe Line Operating Partnership, L.P. ("KPOP"), a limited partnership in which
KPP holds a 99% interest as limited partner. KPL owns a 1% interest as general
partner of KPP and a 1% interest as general partner of KPOP.
Pursuant to the Distribution, the Company entered into an agreement (the
"Distribution Agreement") with Xanser whereby the Company is obligated to pay
Xanser amounts equal to certain expenses and tax liabilities incurred by Xanser
in connection with the Distribution. In January of 2002, the Company paid Xanser
$10 million in tax liabilities due in connection with the Distribution
Agreement. The Distribution Agreement also requires the Company to pay Xanser an
amount calculated based on any income tax liability of Xanser that, in the sole
judgement of Xanser, (i) is attributable to increases in income tax from past
years arising out of adjustments required by federal and state tax authorities,
to the extent that such increases are properly allocable to the businesses that
became part of the Company, or (ii) is attributable to the distribution of the
Company's common shares and the operations of the Company's businesses in the
current year and the preceding years. In the event of an examination of Xanser
by federal or state tax authorities, Xanser will have unfettered control over
the examination, administrative appeal, settlement or litigation that may be
involved, notwithstanding that the Company has agreed to pay any additional tax.
Basis of Presentation
The consolidated financial statements reflect the results of operations of
the Company, which is comprised of the pipeline, terminaling and product
marketing businesses of Xanser that were distributed to the stockholders of
Xanser on June 29, 2001. The consolidated financial statements have been
prepared using the historical bases in the assets and liabilities and historical
results of operations related to these businesses. All significant intercompany
transactions and balances have been eliminated.
Cash and Cash Equivalents
The Company's policy is to invest cash in highly liquid investments with
original maturities of three months or less. Accordingly, uninvested cash
balances are kept at minimum levels. Such investments are valued at cost, which
approximates market, and are classified as cash equivalents.
Inventories
Inventories consist primarily of petroleum products purchased for resale in
the product marketing business and are valued at the lower of cost or market.
Cost is determined using the weighted average cost method.
Property and Equipment
Property and equipment are carried at historical cost. Additions of new
equipment and major renewals and replacements of existing equipment are
capitalized. Repairs and minor replacements that do not materially increase
values or extend useful lives are expensed. Depreciation of property and
equipment is provided on a straight-line basis at rates based upon expected
useful lives of various classes of assets, as discussed in Note 5. The rates
used for pipeline and certain storage facilities, which are subject to
regulation, are the same as those which have been promulgated by the Federal
Energy Regulatory Commission.
Effective January 1, 2002, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets", which addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. The adoption of
SFAS No. 144 did not have a material impact on the consolidated financial
statements of the Company. Under SFAS No. 144, the carrying value of KPP's
property and equipment is periodically evaluated using undiscounted future cash
flows as the basis for determining if impairment exists. To the extent
impairment is indicated to exist, an impairment loss will be recognized by KPP
based on fair value.
Revenue and Income Recognition
The pipeline business provides pipeline transportation of refined petroleum
products, liquified petroleum gases, and anhydrous ammonia fertilizer. Pipeline
revenues are recognized as services are provided. KPP's terminaling services
business provides terminaling and other ancillary services. Storage fees are
billed one month in advance and are reported as deferred income. Terminaling
revenues are recognized in the month services are provided. Revenues for the
product marketing business are recognized when product is sold and title and
risk pass to the customer.
Sales of Securities by Subsidiaries
The Company recognizes gains and losses in the consolidated statements of
income resulting from subsidiary sales of additional equity interest, including
KPP limited partnership units, to unrelated parties.
Foreign Currency Translation
The Company translates the balance sheet of KPP's foreign subsidiaries
using year-end exchange rates and translates income statement amounts using the
average exchange rates in effect during the year. The gains and losses resulting
from the change in exchange rates from year to year have been reported
separately as a component of accumulated other comprehensive income (loss) in
Shareholder's Equity. Gains and losses resulting from foreign currency
transactions are included in the consolidated statements of income.
Excess of Cost Over Fair Value of Net Assets of Acquired Businesses
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and
Other Intangible Assets," which eliminates the amortization for goodwill (excess
of cost over fair value of net assets of acquired businesses) and other
intangible assets with indefinite lives. Under SFAS No. 142, intangible assets
with lives restricted by contractual, legal, or other means will continue to be
amortized over their useful lives. At December 31, 2002, the Company had no
intangible assets subject to amortization under SFAS No. 142. Goodwill and other
intangible assets not subject to amortization are tested for impairment annually
or more frequently if events or changes in circumstances indicate that the
assets might be impaired. SFAS No. 142 requires a two-step process for testing
impairment. First, the fair value of each reporting unit is compared to its
carrying value to determine whether an indication of impairment exists. If an
impairment is indicated, then the fair value of the reporting unit's goodwill is
determined by allocating the unit's fair value to its assets and liabilities
(including any unrecognized intangible assets) as if the reporting unit had been
acquired in a business combination. The amount of impairment for goodwill is
measured as the excess of its carrying value over its fair value. Based on
valuations and analysis performed by the Company at initial adoption date and at
December 31, 2002, the Company determined that the implied fair value of its
goodwill exceeded carrying value and, therefore, no impairment charge was
necessary. Goodwill amortization included in the results of operations of the
Company for the years ended December 31, 2001 and 2000 was not material.
Environmental Matters
KPP environmental expenditures that relate to current operations are
expensed or capitalized, as appropriate. Expenditures that relate to an existing
condition caused by past operations, and which do not contribute to current or
future revenue generation, are expensed. Liabilities are recorded by KPP when
environmental assessments and/or remedial efforts are probable, and the costs
can be reasonably estimated. Generally, the timing of these accruals coincides
with the completion of a feasibility study or KPP's commitment to a formal plan
of action.
Comprehensive Income
The Company follows the provisions of SFAS No. 130, "Reporting
Comprehensive Income", for the reporting and display of comprehensive income and
its components in a full set of general purpose financial statements. SFAS No.
130 only requires additional disclosure and does not affect the Company's
financial position or results of operations.
Accounting for Income Taxes
The accompanying financial statements have been prepared under SFAS No.
109, "Accounting for Income Taxes", assuming the Company were a separate entity.
Under SFAS No. 109, deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. As a result of the Distribution, on June 29, 2001, the
Company became a pass-through entity with its income, for federal and state
purposes, taxed at the shareholder level instead of the Company paying such
taxes. Certain KPP operations are conducted through separate taxable
wholly-owned corporate subsidiaries.
Cash Distributions
The Company makes quarterly distributions of 100% of available cash, as
defined in the limited liability company agreement, to the common shareholders
of record on the applicable record date, within 45 days after the end of each
quarter. Available cash consists generally of all the cash receipts of the
Company, plus the beginning cash balance, less all cash disbursements and
reserves. Excess cash flow of the Company's wholly-owned product marketing
operations is being used to reduce working capital borrowings. Distributions of
$1.65 per share were declared and paid to shareholders with respect to 2002.
Distributions of $.3625 per share were declared and paid with respect to each of
third and fourth quarters of 2001.
Earnings Per Share
Earnings per share has been calculated using basic and diluted weighted
average shares outstanding for each of the periods presented. For periods prior
to the Distribution, the basic weighted average shares were calculated by
adjusting Xanser's historical basic weighted average shares outstanding for the
applicable period to reflect the number of Company shares that would have been
outstanding at the time assuming the distribution of one Company common share
for each three shares of Xanser common stock. The diluted weighted average
shares for such periods reflect an estimate of the potential dilutive effect of
common stock equivalents, based on Xanser's dilutive effect of common stock
equivalents. For the years ended December 31, 2002, 2001, and 2000, basic
weighted average shares outstanding were 11,448,000, 11,014,000, and 10,589,000
and diluted weighted average shares outstanding were 11,775,000, 11,509,000, and
11,029,000, respectively.
Derivative Instruments
Effective January 1, 2001, the Company adopted the provisions of SFAS No.
133, "Accounting For Derivative Instruments and Hedging Activities", which
establishes the accounting and reporting standards for such activities. Under
SFAS No. 133, companies must recognize all derivative instruments on its balance
sheet at fair value. Changes in the value of derivative instruments, which are
considered hedges, are offset against the change in fair value of the hedged
item through earnings, or recognized in other comprehensive income until the
hedged item is recognized in earnings, depending on the nature of the hedge.
SFAS No. 133 requires that unrealized gains and losses on derivatives not
qualifying for hedge accounting be recognized currently in earnings. On January
1, 2001, the Company was not a party to any derivative contracts, and,
accordingly, initial adoption of SFAS No. 133 at that date did not have any
effect on the Company's result of operations or financial position.
In September of 2002, KPOP entered into a treasury lock contract, maturing
on November 4, 2002, for the purpose of locking in the US Treasury interest rate
component on $150 million of anticipated thirty-year public debt offerings. The
treasury lock contract originally qualified as a cash flow hedging instrument
under SFAS No. 133. In October of 2002, KPOP, due to various market factors,
elected to defer issuance of the public debt securities, effectively eliminating
the cash flow hedging designation for the treasury lock contract. On October 29,
2002, the contract was settled resulting in a net realized gain of $3.0 million,
before interest of outside non-controlling partners in KPP's net income, which
was recognized as a component of interest and other income.
In March of 2001, KPOP entered into two contracts for the purpose of
locking in interest rates on $100 million of anticipated ten-year public debt
offerings. As the interest rate locks were not designated as hedging instruments
pursuant to the requirements of SFAS No. 133, increases or decreases in the fair
value of the contracts were included as a component of interest and other
income. On May 22, 2001, the contracts were settled resulting in a gain of $3.8
million, before income taxes and interest of outside non-controlling partners in
KPP's net income.
Stock Option Plans
In December of 2002, the FASB issued SFAS No. 148 "Accounting for
Stock-Based Compensation-Transition and Disclosure." SFAS No. 148, which amends
SFAS No. 123, provides for alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation and requires additional disclosures in annual and interim financial
statements regarding the method of accounting for stock-based employee
compensation and the effect of the method used on financial results.
In accordance with the provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation", the Company applies APB Opinion 25 and related
interpretations in accounting for its stock option plans and, accordingly, does
not recognize compensation cost based on the fair value of the options granted
at grant date as prescribed by SFAS 123. The Black-Scholes option pricing model
has been used to estimate the fair value of stock options issued and the
assumptions in the calculations under such model include stock price variance or
volatility of 3.40% in 2002 and 2.40% in 2001, based on weekly average variances
of KPP's units prior to the Distribution and the Company's common shares after
the Distribution for the ten year period preceding issuance, a risk-free rate of
return of 4.78% in 2002 and 5.39% in 2001, based on the 30-year U.S. treasury
bill rate for the ten-year expected life of the options, and an annual dividend
yield of 8.36% in 2002 and 8.40% in 2001. The following illustrates the effect
on net income and basic and diluted earnings per share if the fair value based
method had been applied:
Year Ended December 31,
--------------------------------------------------
2002 2001 2000
--------------- -------------- --------------
Reported net income..................................... $ 47,228,000 $ 28,323,000 $ 12,643,000
Stock-based employee compensation expense determined
under the fair value based method..................... (49,000) (39,000) -
--------------- -------------- --------------
Pro forma net income.................................... $ 47,179,000 $ 28,284,000 $ 12,643,000
=============== ============== ==============
Earning per share:
Basic - as reported................................... $ 4.13 $ 2.57 $ 1.19
=============== ============== ==============
Basic - pro forma..................................... $ 4.03 $ 2.51 $ 1.19
=============== ============== ==============
Diluted - as reported................................. $ 4.02 $ 2.46 $ 1.15
=============== ============== ==============
Diluted - pro forma................................... $ 3.92 $ 2.41 $ 1.15
=============== ============== ==============
Change in Presentation
Certain prior-year financial statement items have been reclassified to
conform with the 2002 presentation.
Estimates
The preparation of the Company's financial statements 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 financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
Recent Accounting Pronouncements
The FASB has issued SFAS No. 143, "Accounting for Asset Retirement
Obligations", which establishes requirements for the removal-type costs
associated with asset retirements. The Company is currently assessing the impact
of SFAS No. 143, which must be adopted in the first quarter of 2003.
In April of 2002, the FASB issued SFAS No. 145, which, among other items,
affects the income statement classification of gains and losses from early
extinguishment of debt. Under SFAS No. 145, early extinguishment of debt is
considered a risk management strategy, with resulting gains and losses no longer
classified as an extraordinary item, unless the debt extinguishment meets
certain unusual in nature and infrequency of occurrence criteria, which is
expected to be rare. Effective October 1, 2002, the Company adopted the
provisions of SFAS No. 145 and has reclassified all previously-reported
extraordinary losses on debt extinguishment, before minority interest and income
taxes, to "Loss on debt extinguishment" in the accompanying consolidated
statements of income.
In July of 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities", which requires all restructurings
initiated after December 31, 2002 be recorded when they are incurred and can be
measured at fair value. The Company is currently assessing the impact of SFAS
No. 146, which must be adopted in the first quarter of 2003.
In November of 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements of Guarantees, Including Indirect
Guarantees of Indebtedness to Others, an interpretation of FASB Statements No.
5, 57, and 107, and a rescission of FASB Interpretation No. 34." This
interpretation elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under guarantees
issued. The interpretation also clarifies that a guarantor is required to
recognize, at inception of a guarantee, a liability for the fair value of the
obligation undertaken. The initial recognition and measurement provisions of the
interpretation are applicable to guarantees issued or modified after December
31, 2002. The disclosure requirements are effective for financial statements of
interim or annual periods ending after December 15, 2002 and have been adopted.
Management of the Company believes that the application of this interpretation
will have no effect on the consolidated financial statements of the Company.
In January of 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities, an interpretation of ARB No. 51." This
interpretation addressed the consolidation by business enterprises of variable
interest entities as defined in the interpretation. The interpretation applies
immediately to variable interests in variable interest entities created after
January 31, 2003, and to variable interests in variable interest entities
obtained after January 31, 2003. The interpretation requires certain disclosures
in financial statements issued after January 31, 2003. Management of the Company
believes that the application of this interpretation will have no effect on the
consolidated financial statements of the Company.
2. PUBLIC OFFERING OF UNITS BY KPP
In November of 2002, KPP issued 2,095,000 limited partnership units in a
public offering at $33.36 per unit, generating approximately $66.7 million in
net proceeds. The offering proceeds were used to reduce KPP bank borrowings for
the November 2002 fertilizer pipeline acquisition (see Notes 3 and 6). As a
result of KPP issuing additional units to unrelated parties, the Company's share
of net assets of KPP increased by $7.5 million. Accordingly, the Company
recognized a $7.5 million gain in 2002.
In May of 2002, KPP issued 1,565,000 limited partnership units in a public
offering at a price of $39.60 per unit, generating approximately $59.1 million
in net proceeds. A portion of the offering proceeds were used to fund KPP's
September 2002 acquisition of the Australia and New Zealand terminals (see Note
3). As a result of KPP issuing additional units to unrelated parties, the
Company's share of net assets of KPP increased by $8.8 million. Accordingly, the
Company recognized an $8.8 million gain in 2002.
In January of 2002, KPP issued 1,250,000 limited partnership units in a
public offering at $41.65 per unit, generating approximately $49.7 million in
net proceeds. The proceeds were used to reduce the amount of indebtedness
outstanding under KPP's revolving credit agreement (see Note 6). As a result of
KPP issuing additional units to unrelated parties, the Company's share of net
assets of KPP increased by $8.6 million. Accordingly, the Company recognized an
$8.6 million gain in 2002.
3. ACQUISITIONS
On December 24, 2002, KPP acquired a 400-mile petroleum products pipeline
and four terminals in North Dakota and Minnesota from Tesoro Refining and
Marketing Company for approximately $100 million in cash, subject to normal
post-closing adjustments. The acquisition was funded with KPP bank debt maturing
in January of 2004 (see Note 6). The results of operations and cash flows of the
acquired business are included in the consolidated financial statements of the
Company since the date of acquisition. At December 31, 2002, the final valuation
of the acquired assets and liabilities has not been completed and, accordingly,
the Company has recorded a preliminary allocation of the purchase price based on
the estimated fair value. Based on the preliminary purchase price allocation, no
amounts are assigned to goodwill or to other intangible assets.
On November 1, 2002, KPP acquired an approximately 2,000-mile anhydrous
ammonia pipeline system from Koch Pipeline Company, L.P. for approximately $139
million in cash. This fertilizer pipeline system originates in southern
Louisiana, proceeds north through Arkansas and Missouri, and then branches east
into Illinois and Indiana and north and west into Iowa and Nebraska. The
acquisition was funded by KPP bank debt maturing in January of 2004 (see Note
6). The results of operations and cash flows of the acquired business are
included in the consolidated financial statements of the Company since the date
of acquisition. At December 31, 2002, the final valuation of the acquired assets
and liabilities has not been completed and, accordingly, the Company has
recorded a preliminary allocation of the purchase price based on the estimated
fair value. Based on the preliminary purchase price allocation, no amounts are
assigned to goodwill or to other intangible assets.
On September 18, 2002, KPP acquired eight bulk liquid storage terminals in
Australia and New Zealand from Burns Philp & Co. Ltd. for approximately $47
million in cash. The results of operations and cash flows of the acquired
business are included in the consolidated financial statements of the Company
since the date of acquisition. At December 31, 2002, the final valuation of the
acquired assets and liabilities has not been completed and, accordingly, the
Company has recorded a preliminary allocation of the purchase price based on the
estimated fair value. Based on the preliminary purchase price allocation, no
amounts are assigned to goodwill or to other intangible assets.
On February 28, 2002, KPP acquired all of the liquids terminaling
subsidiaries of Statia Terminals Group NV ("Statia") for approximately $178
million in cash (net of acquired cash). The acquired Statia subsidiaries had
approximately $107 million in outstanding debt, including $101 million of 11.75%
notes due in November 2003. The cash portion of the purchase price was funded by
KPP's revolving credit agreement and proceeds from KPOP's February 2002 public
debt offering (see Note 6). In April of 2002, KPP redeemed all of Statia's
11.75% notes at 102.938% of the principal amount, plus accrued interest. The
redemption was funded by KPP's revolving credit facility. Under the provisions
of the 11.75% notes, the Company incurred a $3.0 million prepayment penalty, of
which $2.0 million, before interest of outside non-controlling partners in KPP's
net income, was recognized as loss on debt extinguishment in 2002.
The results of operations and cash flows of Statia are included in the
consolidated financial statements of the Company since the date of acquisition.
Based on the valuations performed, no amounts were assigned to goodwill or to
other tangible assets. A summary of the allocation of the Statia purchase price
is as follows:
Current assets.............................................. $ 10,898,000
Property and equipment...................................... 320,008,000
Other assets................................................ 53,000
Current liabilities......................................... (39,052,000)
Long-term debt.............................................. (107,746,000)
Other liabilities........................................... (5,957,000)
------------
Purchase price.......................................... $178,204,000
============
In connection with the acquisition of Statia, KPP has adopted, and is in
the final stages of implementing, a plan to relocate and integrate Statia's
businesses with KPP's existing operations. The plan, which provides for the
severance and/or relocation of certain administrative and operating employees
and activities, will be fully implemented in early 2003. Costs of $13.9 million
incurred in the implementation of the plan, which are recorded in the allocation
of the Statia purchase price, include employee severance benefits, relocation
costs and lease costs. At December 31, 2002, $7.9 million was accrued by KPP for
such costs.
Assuming the Statia acquisition occurred on January 1, 2001, unaudited pro
forma revenues, net income, basic earnings per share and diluted earnings per
share would have been $694.5 million, $47.0 million, $4.10 and $4.00,
respectively, for the year ended December 31, 2002, and $737.5 million, $28.1
million, $2.55 and $2.44, respectively, for the year ended December 31, 2001.
On January 3, 2001, KPP, through a wholly-owned subsidiary, acquired Shore
Terminals LLC ("Shore") for $107 million in cash and 1,975,090 KPP limited
partnership units (valued at $56.5 million on the date of agreement and its
announcement). Financing for the cash portion of the purchase price was supplied
under KPP's $275 million unsecured revolving credit agreement, with a group of
banks (see Note 6). The acquisition has been accounted for, beginning in January
2001, using the purchase method of accounting. As a result of KPP issuing
additional units to unrelated parties, the Company's share of net assets of KPP
increased by $9.9 million. Accordingly, the Company recognized a $9.9 million
gain, before deferred income taxes of $3.8 million, in 2001.
4. INCOME TAXES
Certain KPP terminaling operations are conducted through separate taxable
wholly-owned corporate subsidiaries. The income before tax expense for these
subsidiaries was $6.3 million, $2.4 million, and $4.1 million for the years
ended December 31, 2002, 2001, and 2000, respectively. The income tax expense
for KPP's taxable subsidiaries for the years ended December 31, 2002, 2001 and
2000 was $4.1 million, $0.3 million and $0.9, respectively. KPP has recorded a
net deferred tax liability of $17.8 million and $6.1 million at December 2002
and 2001, respectively, which is associated with these subsidiaries.
Prior to the Distribution, the Company participated with Xanser in filing a
consolidated federal income tax return. The Company's income tax expense
reported in the consolidated financial statements prior to the Distribution
represents the tax expense of the Company and its subsidiaries as if they had
filed on a separate return basis. Effective with the Distribution, the Company
became a pass-through entity with its income, for federal and state purposes,
taxed at the shareholder level instead of the Company paying such taxes. As a
result of the change in tax status of the Company, all deferred income tax
assets and liabilities relating to temporary differences (a net $8.6 million
deferred tax liability) were eliminated, resulting in a credit to income tax
expense in 2001.
Prior to the Distribution, the Company maintained a valuation allowance to
adjust the total deferred tax assets to net realizable value in accordance with
SFAS No. 109. For the year ended December 31, 2000, the Company reduced the
valuation allowance as a result of its reevaluation of the realizability of
income tax benefits from future operations by $4.6 million. The Company
considered positive evidence, including the effect of the Distribution, recent
historical levels of taxable income, the scheduled reversal of deferred tax
liabilities, tax planning strategies, revised estimates of future taxable income
growth, and expiration periods of NOLs, among other things, in making this
evaluation and concluding that it is more likely than not that the Company will
realize the benefit of its net deferred tax assets. Upon completion of the
Distribution, all remaining deferred tax assets relating to previously recorded
net operating loss carryforwards ($16.2 million), which were utilized by Xanser
to offset federal income taxes resulting from the Distribution, were charged
directly to shareholders' equity.
On June 1, 1989, the governments of the Netherlands Antilles and St.
Eustatius approved a Free Zone and Profit Tax Agreement retroactive to January
1, 1989, which expired on December 31, 2000. This agreement requires a
subsidiary of KPP, which was acquired with Statia on February 28, 2002, to pay a
2% rate on taxable income, as defined, or a minimum payment of 500,000
Netherlands Antilles guilders ($0.3 million) per year. This agreement further
provides that any amounts paid in order to meet the minimum annual payment will
be available to offset future tax liabilities under the agreement to the extent
that the minimum annual payment is greater than 2% of taxable income. During
1999, the subsidiary and representatives appointed by the governments of the
Netherlands Antilles and St. Eustatius completed a draft of a new agreement
applicable to the subsidiary and certain affiliates and submitted the draft for
approval to each government. The draft as submitted called for the new agreement
to be effective retroactively from January 1, 1998, through December 31, 2010,
with extension provisions to 2015. The subsidiary has proposed certain
modifications to the 1999 draft including extension of the expiration of the new
agreement to January 1, 2026 to match certain Netherlands Antilles legislation.
The subsidiary has accrued amounts which may become payable should the new
agreement become effective. On November 1, 2002, the subsidiary received a new
draft agreement submitted on behalf of the government of St. Eustatius only,
which was formally rejected by the subsidiary. The subsidiary is continuing
discussions with representatives of the governments of the Netherlands Antilles
and St. Eustatius, but the ultimate outcome cannot be predicted at this time.
The subsidiary continues to honor the provisions of the expired Free Zone and
Profit Tax Agreement and make payments, as required, under the agreement.
5. PROPERTY AND EQUIPMENT
The cost of property and equipment is summarized as follows:
Estimated
useful December 31,
life -------------------------------------------
(years) 2002 2001
-------------- ----------------- -----------------
Land...................................... -- $ 72,152,000 $ 43,005,000
Buildings................................. 25 - 35 27,574,000 10,849,000
Pipeline and terminaling equipment........ 15 - 40 1,032,914,000 534,292,000
Marine equipment.......................... 15 - 30 84,641,000 -
Machinery and equipment................... 15 - 40 34,880,000 32,750,000
Furniture and fixtures.................... 5 - 16 8,075,000 4,092,000
Transportation equipment.................. 3 - 6 5,414,000 5,092,000
Construction and work-in-progress......... -- 23,310,000 9,211,000
----------------- ------------------
Total property and equipment.............. 1,288,960,000 639,291,000
Less accumulated depreciation............. 196,684,000 157,895,000
----------------- ------------------
Net property and equipment................ $ 1,092,276,000 $ 481,396,000
================= ==================
6. LONG-TERM DEBT
Long-term debt is summarized as follows:
December 31,
-------------------------------------
2002 2001
--------------- ---------------
Revolving credit facility, due in July of 2008................. $ 19,125,000 $ 9,125,000
KPP $275 million revolving credit facility, due in January of 2004 243,000,000 238,900,000
KPP $250 million 7.75% senior unsecured notes,
due in February of 2012...................................... 250,000,000 -
KPP bridge facility, due in January 2004....................... 175,000,000 -
KPP term loan, due in January of 2004.......................... 26,330,000 23,724,000
Revolving credit facility of subsidiary, due in April of 2005.. 4,707,000 5,553,000
--------------- ---------------
Total long-term debt........................................... $ 718,162,000 $ 277,302,000
=============== ===============
In July of 2001, the Company entered into an agreement with a bank that
provides for a $50 million revolving credit facility through July 1, 2008. The
credit facility, which bears interest at variable rates, is secured by 4.6
million KPP limited partnership units and has a variable rate commitment fee on
unused amounts. At December 31, 2002, $19.1 million was drawn on the credit
facility, at an interest rate of 2.83%.
KPP has a credit agreement with a group of banks that, as amended, provides
for a $275 million unsecured revolving credit facility through January 2, 2004.
The credit facility, which is without recourse to the Company, bears interest at
variable rates and has a variable commitment fee on unutilized amounts. The
credit facility contains certain financial and operational covenants, including
limitations on investments, sales of assets and transactions with affiliates,
and, absent an event of default, the covenants do not restrict distributions to
the Company or to other partners. At December 31, 2002, KPP was in compliance
with all covenants. In January 2001, proceeds from the facility were used to
repay in full KPP's $128 million of mortgage notes. Under the provisions of the
mortgage notes, KPP incurred $6.5 million in prepayment penalties which, before
interest of outside non-controlling partners in KPP's net income and income
taxes, was recognized as loss on debt extinguishment in 2001. An additional $107
million was used to finance the cash portion of KPP's 2001 Shore acquisition
(see Note 3). At December 31, 2002, $243.0 million was drawn on the facility at
an interest rate of 2.18%.
On December 24, 2002, KPP entered into a $175 million unsecured bridge loan
agreement with a group of banks in connection with its 2002 pipeline
acquisitions. The bridge loan agreement, as amended, expires in January of 2004
and is without recourse to the Company. The bridge loan agreement bears interest
at variable rates (2.67% at December 31, 2002) and contains certain operational
and financial covenants and, absent an event of default, the covenants do not
restrict distributions to the Company or to other partners. At December 31,
2002, KPP was in compliance with all covenants. KPP expects to repay the bridge
loan with additional KPP bank borrowings and/or public equity or debt offerings.
In February of 2002, KPOP issued $250 million of 7.75% senior unsecured
notes due February 15, 2012. The net proceeds from the public offering, $248.2
million, were used to repay the KPP's revolving credit agreement and to
partially fund the Statia acquisition (see Note 3). Under the note indenture,
interest is payable semi-annually in arrears on February 15 and August 15 of
each year. The notes, which are without recourse to the Company, are redeemable,
as a whole or in part, at the option of KPOP, at any time, at a redemption price
equal to the greater of 100% of the principal amount of the notes, or the sum of
the present value of the remaining scheduled payments of principal and interest,
discounted to the redemption date at the applicable U.S. Treasury rate, as
defined in the indenture, plus 30 basis points. The note indenture contains
certain financial and operational covenants, including certain limitations on
investments, sales of assets and transactions with affiliates and, absent an
event of default, such covenants do not restrict distributions to the Company or
to other partners. At December 31, 2002, KPP was in compliance with all
covenants.
KPP, through two wholly-owned subsidiaries, has a credit agreement with a
bank that provides for the issuance of term loans in connection with its 1999
United Kingdom terminal acquisition. The term loans ($26.3 million at December
31, 2002), with a fixed rate of 7.25%, are, as amended, due in January of 2004.
The term loans under the credit agreement are unsecured and are pari passu with
the $275 million revolving credit facility. The term loans, which are without
recourse to the Company, also contain certain financial and operational
covenants. At December 31, 2002, KPP was in compliance with all covenants.
The Company's product marketing subsidiary has a credit agreement with a
bank that, as amended, provides for a $20 million revolving credit facility
through April of 2005. The credit facility bears interest at variable rates, has
a commitment fee of 0.25% per annum on unutilized amounts and contains certain
financial and operational covenants. At December 31, 2002, the subsidiary was in
compliance with all covenants. The credit facility, which is without recourse to
the Company, is secured by essentially all of the tangible and intangible assets
of the product marketing business and by 500,000 KPP limited partnership units
held by a subsidiary of the Company. At December 31, 2002, $4.7 million was
drawn on the facility.
7. RETIREMENT PLANS
Substantially all of the Company's domestic employees are covered by a
defined contribution plan, which provides for varying levels of employer
matching. Prior to the Distribution, the Company's employees were covered by a
similar defined contribution plan sponsored by Kaneb Services, Inc. The
Company's contributions under these plans were $1.2 million, $1.0 million, and
$0.8 million for 2002, 2001, and 2000, respectively.
8. SHAREHOLDERS' EQUITY
The changes in the number of issued and outstanding common shares of the
Company are summarized as follows:
Common Shares
Issued and
Outstanding
-------------
Balance at June 29, 2001 (Distribution date)............................. 10,864,780
Common shares issued..................................................... 377,966
-----------
Balance at December 31, 2001............................................. 11,242,746
Common shares issued..................................................... 73,091
-----------
Balance at December 31, 2002............................................. 11,315,837
===========
On June 27, 2001, the Board of Directors of the Company declared a
distribution of one right for each of its outstanding common shares to each
shareholder of record on June 27, 2001. Each right entitles the holder, upon the
occurrence of certain events, to purchase from the Company one of its common
shares at a purchase price of $60.00 per common share, subject to adjustment.
The rights will not separate from the common shares or become exercisable until
a person or group either acquires beneficial ownership of 15% or more of the
Company's common shares or commences a tender or exchange offer that would
result in ownership of 20% or more, whichever occurs earlier. The rights, which
expire on June 27, 2011, are redeemable in whole, but not in part, at the
Company's option at any time for a price of $0.01 per right.
The Company has various plans for officers, directors and key employees
under which stock options, deferred stock units and restricted shares may be
issued.
Stock Options
The options granted under the plan generally expire ten years from date of
grant. All options were granted at prices greater than or equal to the market
price at the date of grant.
In connection with the Distribution, the Company issued options in its
common shares to all holders of Kaneb Services, Inc. common stock options in
order to maintain the same intrinsic value for each holder as at the time of the
Distribution. At the Distribution date, the exercise price for each option to
purchase shares of Kaneb Services, Inc. common stock was reduced to an amount
equal to the result of (1) the fair market value of a share of Kaneb Services,
Inc.'s common stock on the ex-dividend date multiplied by (2) a fraction, the
numerator of which was the original exercise price for the option and the
denominator of which was the fair market value of a share of Kaneb Services,
Inc.'s common stock on the last trading date prior to the ex-dividend date. The
number of shares subject to the Kaneb Services, Inc. stock option was not
changed as a result of the Distribution. With regard to options issued for
shares of the Company, the exercise price applicable was that price that created
the same ratio of exercise price to market price as in the adjusted exercise
price applicable to the holders of Kaneb Services, Inc. options. The number of
common shares subject to options issued by the Company was such number necessary
to produce an intrinsic value (determined as of the ex-dividend date) that, when
added to the intrinsic value of the adjusted Kaneb Services, Inc. option
(determined as of the ex-dividend date), equaled the pre-distribution intrinsic
value of the Kaneb Services, Inc. option, if any, (determined as of the last
trading date prior to the ex-dividend date). However options to purchase
fractional common shares of the Company were not granted. The fair market values
of shares of Kaneb Services, Inc.'s common stock and the Company's common shares
were based upon the closing sales price of the stock on the last trading date
prior to the ex-distribution date and the opening sales price of the shares on
the ex-distribution date. All options issued by the Company, excluding the
Company's corporate staff and Xanser's corporate staff, were issued without
restrictions on exercise.
At December 31, 2002, options on 701,286 shares at prices ranging from
$3.27 to $19.73 were outstanding, of which 412,836 were exercisable at prices
ranging from $3.27 to $14.33. At December 31, 2001, options on 669,701 shares at
prices ranging from $3.27 to $14.33 were outstanding, of which 345,653 were
exercisable at prices ranging from $3.27 to $11.28.
Deferred Stock Unit Plans
In 2002, the Company initiated a Deferred Stock Unit Plan (the "DSU Plan"),
pursuant to which key employees of the Company have, from time to time, been
given the opportunity to defer a portion of their compensation for a specified
period toward the purchase of deferred stock units ("DSUs"), an instrument
designed to track the Company's common shares. Under the plan, DSUs are
purchased at a value equal to the closing price of the Company's common shares
on the day by which the employee must elect (if they so desire) to participate
in the DSU Plan; which date is established by the Compensation Committee, from
time to time (the "Election Date"). During a vesting period of one to three
years following the Election Date, a participant's DSUs vest only in an amount
equal to the lesser of the compensation actually deferred to date or the value
(based upon the then-current closing price of the Company's common shares) of
the pro-rata portion (as of such date) of the number of DSUs acquired. After the
expiration of the vesting period, which is typically the same length as the
deferral period, the DSUs become fully vested, but may only be distributed
through the issuance of a like number of shares of the Company's common shares
on a pre-selected date, which is irrevocably selected by the participant on the
Election Date and which is typically at or after the expiration of the vesting
period and no later than ten years after the Election Date, or at the time of a
"change of control" of the Company, if earlier. DSU accounts are unfunded by the
Company. Each person that elects to participate in the DSU Plan is awarded,
under the Company's Share Incentive Plan, an option to purchase a number of
shares ranging from one-half to one and one-half times the number of DSUs
purchased by such person at 100% of the closing price of the Company's common
shares on the Election Date, which options become exercisable over a specified
period after the grant, according to a schedule determined by the Compensation
Committee. At December 31, 2002, no DSUs had vested under the 2002 Plan.
In 1996, Kaneb Services, Inc. implemented a DSU plan whereby officers,
directors and key executives were permitted to defer compensation on a pretax
basis to receive shares of Kaneb Services, Inc. common stock at a predetermined
date after the end of the compensation deferral period. In connection with the
Distribution, the Company agreed to issue DSUs equivalent in price to the
Company's common shares at that time. For every three Kaneb Services, Inc. DSUs
held, the Company issued one DSU, such that the intrinsic value of each holder's
deferred compensation account remained unchanged as a result of the
Distribution. In addition, upon the payment date of any distributions on the
Company's common shares, the Company agreed to credit each deferred account with
the equivalent value of the distribution. Upon the scheduled payment of the
deferred accounts, the Company agreed to issue one common share for each DSU
relative to Company DSUs previously issued and to pay the equivalent of the
accumulated deferred distributions, plus interest, to the previously deferred
account holder. All other terms of the DSU plan remained unchanged. Similarly,
Kaneb Services, Inc. agreed to issue to employees of the Company who hold DSUs,
the number of shares of Kaneb Services, Inc. (now Xanser) common stock subject
to the Kaneb Services, Inc. DSUs held by those employees. At December 31, 2002,
approximately 114,000 common shares of the Company are issuable under this
arrangement.
Restricted Stock
In September 2001, the Company issued an aggregate of 30,000 restricted
common shares to the outside Directors of the Company. All of such shares vest
or become transferable in one-third increments on each anniversary date after
issuance. In conjunction will the issuance and commencement of vesting of the
restricted shares, the Company recognized a total expense of $0.2 million in
2002 and $0.1 million in 2001.
9. COMMITMENTS AND CONTINGENCIES
The following is a schedule by years of future minimum lease payments under
KPP's operating leases as of December 31, 2002:
Year ending December 31:
2003........................................... $ 6,805,000
2004........................................... 3,097,000
2005........................................... 841,000
2006........................................... 612,000
2007........................................... 412,000
Thereafter..................................... 360,000
-------------
Total minimum lease payments $ 12,127,000
=============
Total rent expense under operating leases amounted to $9.5 million, $4.2
million, and $3.2 million for the years ended December 31, 2002, 2001,and 2000,
respectively.
The operations of KPP are subject to federal, state and local laws and
regulations in the United States and the United Kingdom relating to protection
of the environment. Although KPP believes its operations are in general
compliance with applicable environmental regulations, risks of additional costs
and liabilities are inherent in pipeline and terminal operations, and there can
be no assurance that significant costs and liabilities will not be incurred by
KPP. Moreover, it is possible that other developments, such as increasingly
stringent environmental laws, regulations and enforcement policies thereunder,
and claims for damages to property or persons resulting from the operations of
KPP, could result in substantial costs and liabilities to KPP. KPP has recorded
an undiscounted reserve for environmental claims in the amount of $18.7 million
at December 31, 2002, including $12.6 million related to acquisitions of
pipelines and terminals. During 2002 and 2001, respectively, KPP incurred $2.4
million and $5.2 million of costs related to such acquisition reserves and
reduced the liability accordingly.
The asset purchase agreement entered into by a subsidiary of the Company in
connection with the 1998 acquisition of its product marketing business includes
a provision for an earn-out based on annual operating results of the acquired
business for a five-year period ending March 2003. In 2000, $211,000 was paid
under the earn-out provision and included as additional purchase price.
Certain subsidiaries of KPP acquired with Statia (see Note 3) are parties
to a 1996 agreement with Praxair, Inc. ("Praxair") wherein Praxair has agreed to
pay certain environmental costs related to the Point Tupper, Nova Scotia, Canada
facility. Based on investigations conducted and information available to date,
the potential cost for future remediation and compliance for these matters is
estimated at approximately $7.3 million, substantially all of which KPP believes
is the responsibility of Praxair.
Certain subsidiaries of KPP were sued in a Texas state court in 1997 by
Grace Energy Corporation ("Grace"), the entity from which KPP's subsidiaries
acquired ST Services in 1993. The lawsuit involves environmental response and
remediation costs allegedly resulting from jet fuel leaks in the early 1970's
from a pipeline. The pipeline, which connected a former Grace terminal with Otis
Air Force Base in Massachusetts (the "Otis pipeline" or the "pipeline"), ceased
operations in 1973 and was abandoned not later than 1976, when the connecting
terminal was sold to an unrelated entity. Grace alleged that subsidiaries of KPP
acquired the abandoned pipeline, as part of the acquisition of ST Services in
1993 and assumed responsibility for environmental damages allegedly caused by
the jet fuel leaks. Grace sought a ruling from the Texas court that these
subsidiaries are responsible for all liabilities, including all present and
future remediation expenses, associated with these leaks and that Grace has no
obligation to indemnify these subsidiaries for these expenses. In the lawsuit,
Grace also sought indemnification for expenses of approximately $3.5 million
that it incurred since 1996 for response and remediation required by the State
of Massachusetts and for additional expenses that it expects to incur in the
future. The consistent position of KPP's subsidiaries has been that they did not
acquire the abandoned pipeline as part of the 1993 ST Services transaction, and
therefore did not assume any responsibility for the environmental damage nor any
liability to Grace for the pipeline.
At the end of the trial, the jury returned a verdict including findings
that (1) Grace had breached a provision of the 1993 acquisition agreement by
failing to disclose matters related to the pipeline, and (2) the pipeline was
abandoned before 1978 -- 15 years before KPP's subsidiaries acquired ST
Services. On August 30, 2000, the Judge entered final judgment in the case that
Grace take nothing from the subsidiaries on its claims seeking recovery of
remediation costs. Although KPP's subsidiaries have not incurred any expenses in
connection with the remediation, the court also ruled, in effect, that the
subsidiaries would not be entitled to indemnification from Grace if any such
expenses were incurred in the future. Moreover, the Judge let stand a prior
summary judgment ruling that the pipeline was an asset acquired by KPP's
subsidiaries as part of the 1993 ST Services transaction and that any
liabilities associated with the pipeline would have become liabilities of the
subsidiaries. Based on that ruling, the Massachusetts Department of
Environmental Protection and Samson Hydrocarbons Company (successor to Grace
Petroleum Company) wrote letters to ST Services alleging its responsibility for
the remediation, and ST Services responded denying any liability in connection
with this matter. The Judge also awarded attorney fees to Grace of more than
$1.5 million. Both KPP's subsidiaries and Grace have appealed the trial court's
final judgment to the Texas Court of Appeals in Dallas. In particular, the
subsidiaries have filed an appeal of the judgement finding that the Otis
pipeline and any liabilities associated with the pipeline were transferred to
them as well as the award of attorney fees to Grace.
On April 2, 2001, Grace filed a petition in bankruptcy, which created an
automatic stay against actions against Grace. This automatic stay covers the
appeal of the Dallas litigation, and the Texas Court of Appeals has issued an
order staying all proceedings of the appeal because of the bankruptcy. Once that
stay is lifted, KPP's subsidiaries that are party to the lawsuit intend to
resume vigorous prosecution of the appeal.
The Otis Air Force Base is a part of the Massachusetts Military Reservation
("MMR Site"), which has been declared a Superfund Site pursuant to CERCLA. The
MMR Site contains a number of groundwater contamination plumes, two of which are
allegedly associated with the Otis pipeline, and various other waste management
areas of concern, such as landfills. The United States Department of Defense,
pursuant to a Federal Facilities Agreement, has been responding to the
Government remediation demand for most of the contamination problems at the MMR
Site. Grace and others have also received and responded to formal inquiries from
the United States Government in connection with the environmental damages
allegedly resulting from the jet fuel leaks. KPP's subsidiaries voluntarily
responded to an invitation from the Government to provide information indicating
that they do not own the pipeline. In connection with a court-ordered mediation
between Grace and KPP's subsidiaries, the Government advised the parties in
April 1999 that it has identified two spill areas that it believes to be related
to the pipeline that is the subject of the Grace suit. The Government at that
time advised the parties that it believed it had incurred costs of approximately
$34 million, and expected in the future to incur costs of approximately $55
million, for remediation of one of the spill areas. This amount was not intended
to be a final accounting of costs or to include all categories of costs. The
Government also advised the parties that it could not at that time allocate its
costs attributable to the second spill area.
By letter dated July 26, 2001, the United States Department of Justice
("DOJ") advised ST Services that the Government intends to seek reimbursement
from ST Services under the Massachusetts Oil and Hazardous Material Release
Prevention and Response Act and the Declaratory Judgment Act for the
Government's response costs at the two spill areas discussed above. The DOJ
relied in part on the judgment by the Texas state court that, in the view of the
DOJ, held that ST Services was the current owner of the pipeline and the
successor-in-interest of the prior owner and operator. The Government advised ST
Services that it believes it has incurred costs exceeding $40 million, and
expects to incur future costs exceeding an additional $22 million, for
remediation of the two spill areas. KPP believes that its subsidiaries have
substantial defenses. ST Services responded to the DOJ on September 6, 2001,
contesting the Government's positions and declining to reimburse any response
costs. The DOJ has not filed a lawsuit against ST Services seeking cost recovery
for its environmental investigation and response costs. Representatives of ST
Services have met with representatives of the Government on several occasions
since September 6, 2001 to discuss the Government's claims and to exchange
information related to such claims. Additional exchanges of information are
expected to occur in the future and additional meetings may be held to discuss
possible resolution of the Government's claims without litigation.
On April 7, 2000, a fuel oil pipeline in Maryland owned by Potomac Electric
Power Company ("PEPCO") ruptured. Work performed with regard to the pipeline was
conducted by a partnership of which ST Services is general partner. PEPCO has
reported that it has incurred total cleanup costs of $70 million to $75 million.
PEPCO probably will continue to incur some cleanup related costs for the
foreseeable future, primarily in connection with EPA requirements for monitoring
the condition of some of the impacted areas. Since May 2000, ST Services has
provisionally contributed a minority share of the cleanup expense, which has
been funded by ST Services' insurance carriers. ST Services and PEPCO have not,
however, reached a final agreement regarding ST Services' proportionate
responsibility for this cleanup effort, if any, and cannot predict the amount,
if any, that ultimately may be determined to be ST Services' share of the
remediation expense, but ST believes that such amount will be covered by
insurance and therefore will not materially adversely affect KPP's financial
condition.
As a result of the rupture, purported class actions were filed against
PEPCO and ST Services in federal and state court in Maryland by property and
business owners alleging damages in unspecified amounts under various theories,
including under the Oil Pollution Act ("OPA") and Maryland common law. The
federal court consolidated all of the federal cases in a case styled as In re
Swanson Creek Oil Spill Litigation. A settlement of the consolidated class
action, and a companion state-court class action, was reached and approved by
the federal judge. The settlement involved creation and funding by PEPCO and ST
Services of a $2,250,000 class settlement fund, from which all participating
claimants would be paid according to a court-approved formula, as well as a
court-approved payment to plaintiffs' attorneys. The settlement has been
consummated and the fund, to which PEPCO and ST Services contributed equal
amounts, has been distributed. Participating claimants' claims have been settled
and dismissed with prejudice. A number of class members elected not to
participate in the settlement, i.e., to "opt out," thereby preserving their
claims against PEPCO and ST Services. All non-participant claims except one have
been settled for immaterial amounts with ST Services' portion of such
settlements provided by its insurance carrier. ST Services' insurance carrier
has assumed the defense of the continuing action and ST Services believes that
the carrier would assume the defense of any new litigation by a non-participant
in the settlement, should any such litigation be commenced. While KPP cannot
predict the amount, if any, of any liability it may have in the continuing
action or in other potential suits relating to this matter, it believes that the
current and potential plaintiffs' claims will be covered by insurance and
therefore these actions will not have a material adverse effect on its financial
condition.
PEPCO and ST Services agreed with the federal government and the State of
Maryland to pay costs of assessing natural resource damages arising from the
Swanson Creek oil spill under OPA and of selecting restoration projects. This
process was completed in mid-2002. ST Services' insurer has paid ST Services'
agreed 50 percent share of these assessment costs. In late November 2002, PEPCO
and ST Services entered into a Consent Decree resolving the federal and state
trustees' claims for natural resource damages. The decree required payments by
ST Services and PEPCO of a total of approximately $3 million to fund the
restoration projects and for remaining damage assessment costs. The federal
court entered the Consent Decree as a final judgment on December 31, 2002. PEPCO
and ST have each paid their 50% share and thus fully performed their payment
obligations under the Consent Decree. ST Services' insurance carrier funded ST
Services' payment.
The U.S. Department of Transportation ("DOT") has issued a Notice of
Proposed Violation to PEPCO and ST Services alleging violations over several
years of pipeline safety regulations and proposing a civil penalty of $647,000
jointly against the two companies. ST Services and PEPCO have contested the DOT
allegations and the proposed penalty. A hearing was held before the Office of
Pipeline Safety at the DOT in late 2001. ST Services does not anticipate any
further hearings on the subject and is still awaiting the DOT's ruling.
By letter dated January 4, 2002, the Attorney General's Office for the
State of Maryland advised ST Services that it intended to seek penalties from ST
Services in connection with the April 7, 2000 spill. The State of Maryland
subsequently asserted that it would seek penalties against ST Services and PEPCO
totaling up to $12 million. A settlement of this claim was reached in mid-2002
under which ST Services' insurer will pay a total of slightly more than $1
million in installments over a five year period. PEPCO also reached a settlement
of these claims with the State of Maryland. Accordingly, KPP believes that this
matter will not have a material adverse effect on its financial condition.
On December 13, 2002, ST Services sued PEPCO in the Superior Court,
District of Columbia, seeking, among other causes of action, a declaratory
judgment as to ST Services' legal obligations, if any, to reimburse PEPCO for
costs of the oil spill. On December 16, 2002, PEPCO sued ST Services in the
United States District Court for the District of Maryland, seeking recovery of
all its costs for remediation of the oil spill. Both parties have pending
motions to dismiss the other party's suit. KPP believes that any costs or
damages resulting from these lawsuits will be covered by insurance and therefore
will not materially adversely affect KPP's financial condition.
The Company, primarily KPP, has other contingent liabilities resulting from
litigation, claims and commitments incident to the ordinary course of business.
Management believes, based on the advice of counsel, that the ultimate
resolution of such contingencies will not have a materially adverse effect on
the financial position or results of operations of the Company.
10. RELATED PARTY TRANSACTIONS
General and administrative expenses include allocations of actual costs
incurred prior to the Distribution of approximately $0.2 million in 2001 and
$0.8 million in 2000, which were incurred by Kaneb Services, Inc. in providing
services to the Company based on the time devoted to the Company. These services
include accounting, tax, finance, legal, investor relations and employee benefit
services. Such allocation is included in the accompanying consolidated
statements of income as general and administrative expenses and as a capital
contribution.
11. BUSINESS SEGMENT DATA
The Company conducts business through three principal operations: the
"Pipeline Operations," which consists primarily of the transportation of refined
petroleum products and fertilizer in the Midwestern states as a common carrier;
the "Terminaling Operations," which provide storage for petroleum products,
specialty chemicals and other liquids; and the "Product Marketing Operations,"
which provides wholesale motor fuel marketing services throughout the Midwest
and Rocky Mountain regions and, since KPP's acquisition of Statia (see Note 3),
delivers bunker fuel to ships in the Caribbean and Nova Scotia, Canada and sells
bulk petroleum products to various commercial interests. General corporate
includes general and administrative costs, including accounting, tax, finance,
legal, investor relations and employee benefit services. General corporate
assets include cash and other assets not related to the segments.
The Company measures segment profit as operating income. Total assets are
those assets controlled by each reportable segment. Business segment data is as
follows:
Year Ended December 31,
--------------------------------------------------
2002 2001 2000
--------------- -------------- --------------
Business segment revenues:
Pipeline operations................................... $ 82,698,000 $ 74,976,000 $ 70,685,000
Terminaling operations................................ 205,971,000 132,820,000 85,547,000
Product marketing operations.......................... 381,159,000 327,542,000 381,186,000
---------------- -------------- --------------
$ 669,828,000 $ 535,338,000 $ 537,418,000
================ ============== ==============
Year Ended December 31,
--------------------------------------------------
2002 2001 2000
--------------- -------------- --------------
Business segment profit:
Pipeline operations................................... $ 38,623,000 $ 36,773,000 $ 36,213,000
Terminaling operations................................ 65,040,000 45,318,000 23,358,000
Product marketing operations.......................... 4,692,000 (611,000) 2,472,000
General corporate..................................... (1,996,000) (1,689,000) (869,000)
---------------- -------------- --------------
Operating income................................... 106,359,000 79,791,000 61,174,000
Interest and other income ............................ 3,664,000 4,132,000 332,000
Interest expense...................................... (29,171,000) (15,381,000) (13,346,000)
Loss on debt extinguishment........................... (3,282,000) (6,540,000) -
---------------- -------------- --------------
Income before gain on issuance of units by KPP,
income taxes and interest of outside
non-controlling partners in KPP's net income....... $ 77,570,000 $ 62,002,000 $ 48,160,000
================ ============== ==============
Business segment assets:
Depreciation and amortization:
Pipeline operations................................ $ 6,408,000 $ 5,478,000 $ 5,180,000
Terminaling operations............................. 32,368,000 17,706,000 11,073,000
Product marketing operations....................... 695,000 77,000 67,000
---------------- -------------- --------------
$ 39,471,000 $ 23,261,000 $ 16,320,000
================ ============== ==============
Capital expenditures (excluding acquisitions):
Pipeline operations................................ $ 9,469,000 $ 4,309,000 $ 3,439,000
Terminaling operations............................. 20,953,000 12,937,000 6,044,000
Product marketing operations....................... 679,000 63,000 50,000
---------------- -------------- --------------
$ 31,101,000 $ 17,309,000 $ 9,533,000
================ ============== ==============
December 31,
---------------------------------------------------
2002 2001 2000
---------------- -------------- --------------
Total assets:
Pipeline operations................................ $ 352,657,000 $ 105,156,000 $ 102,656,000
Terminaling operations............................. 844,321,000 443,215,000 272,407,000
Product marketing operations....................... 41,297,000 19,313,000 35,364,000
General corporate.................................. 5,826,000 4,083,000 19,425,000
---------------- -------------- --------------
$ 1,244,101,000 $ 571,767,000 $ 429,852,000
================ ============== ==============
The following geographical area data includes revenues and operating income
based on location of the operating segment and net property and equipment based
on physical location.
Year Ended December 31,
---------------------------------------------------
2002 2001 2000
---------------- -------------- --------------
Geographical area revenues:
United States........................................... $ 485,322,000 $ 514,276,000 $ 517,915,000
United Kingdom.......................................... 23,937,000 21,062,000 19,503,000
Netherlands Antilles.................................... 132,387,000 - -
Canada.................................................. 23,207,000 - -
Australia and New Zealand............................... 4,975,000 - -
---------------- -------------- --------------
$ 669,828,000 $ 535,338,000 $ 537,418,000
================ ============== ==============
Geographical area operating income:
United States........................................... $ 83,544,000 $ 74,275,000 $ 56,725,000
United Kingdom.......................................... 7,318,000 5,516,000 4,449,000
Netherlands Antilles.................................... 9,616,000 - -
Canada.................................................. 4,398,000 - -
Australia and New Zealand............................... 1,483,000 - -
---------------- -------------- --------------
$ 106,359,000 $ 79,791,000 $ 61,174,000
================ ============== ==============
December 31,
---------------------------------------------------
2002 2001 2000
---------------- -------------- --------------
Geographical area net property and equipment:
United States........................................... $ 690,262,000 $ 440,226,000 $ 282,778,000
United Kingdom.......................................... 46,543,000 41,170,000 38,670,000
Netherlands Antilles.................................... 224,810,000 - -
Canada.................................................. 78,789,000 - -
Australia and New Zealand............................... 51,872,000 - -
---------------- -------------- --------------
$ 1,092,276,000 $ 481,396,000 $ 321,448,000
================ ============== ==============
12. FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK
The estimated fair value of all debt as of December 31, 2002 and 2001 was
approximately $733 million and $277 million, as compared to the carrying value
of $718 million and $277 million, respectively. These fair values were estimated
using discounted cash flow analysis, based on the Company's current incremental
borrowing rates for similar types of borrowing arrangements. These estimates are
not necessarily indicative of the amounts that would be realized in a current
market exchange. The Company had no derivative financial instruments at December
31, 2002.
The Company markets and sells its services to a broad base of customers and
performs ongoing credit evaluations of its customers. The Company does not
believe that it has a significant concentration of credit risk at December 31,
2002. No customer constituted 10% of the Company's combined revenues in 2002,
2001, or 2000.
13. QUARTERLY FINANCIAL DATA (unaudited)
Quarterly operating results for 2002 and 2001 are summarized as follows:
Quarter Ended
--------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
---------------- ---------------- --------------- --------------
2002:
Revenues........................ $ 122,409,000 $ 179,246,000 $ 184,119,000 $ 184,054,000
================ ================ =============== ==============
Operating income................ $ 23,256,000 $ 28,256,000 $ 28,506,000 $ 26,341,000
================ ================ =============== ==============
Net income...................... $ 13,620,000(a) $ 14,128,000(a) $ 6,673,000 $ 12,807,000(a)
================ ================ =============== ==============
Earnings per share:
Basic........................ $ 1.19 $ 1.23 $ 0.58 $ 1.12
================ ================ =============== ==============
Diluted...................... $ 1.16 $ 1.20 $ 0.57 $ 1.09
================ ================ =============== ==============
2001:
Revenues........................ $ 136,421,000 $ 151,831,000 $ 130,663,000 $ 116,423,000
================ ================ =============== ==============
Operating income................ $ 17,319,000 $ 22,124,000 $ 22,726,000 $ 17,622,000
================ ================ =============== ==============
Net income...................... $ 6,896,000(b) $ 12,217,000(c) $ 5,956,000 $ 3,254,000
================ ================ =============== ==============
Earnings per share:
Basic........................ $ 0.65 $ 1.14 $ 0.55 $ 0.29
================ ================ =============== ==============
Diluted...................... $ 0.61 $ 1.08 $ 0.52 $ 0.28
================ ================ =============== ==============
(a) See Note 2 regarding 2002 gains on issuance of units by KPP.
(b) See Note 3 regarding 2001 gain in issuance of units by KPP.
(c) See Note 4 regarding benefit resulting from change in tax status.
14. SUBSEQUENT EVENT
On March 21, 2003, KPP issued 3,000,000 limited partnership units in a
public offering at $36.54 per unit, generating approximately $104.8 million in
net proceeds. The proceeds will be used to reduce the amount of indebtedness
under KPP's bridge facility.
Schedule I
KANEB SERVICES LLC (PARENT COMPANY)
CONDENSED STATEMENT OF INCOME
Period from
Year Ended June 30, 2001 to
December 31, 2002 December 31, 2001
------------------ --------------------
General and administrative expenses............................... $ (2,036,000) $ (1,053,000)
Interest and other income......................................... 10,000 23,000
Equity in earnings of subsidiaries................................ 49,972,000 10,240,000
Interest expense.................................................. (718,000) -
------------------ ------------------
Net income..................................................... $ 47,228,000 9,210,000
================== ==================
Earnings per share:
Basic.......................................................... $ 4.13 $ 0.84
================== ==================
Diluted........................................................ $ 4.02 $ 0.80
================== ==================
See "Notes to Consolidated Financial Statements" of
Kaneb Services LLC included in this report.
F - 25
Schedule I
(Continued)
KANEB SERVICES LLC (PARENT COMPANY)
CONDENSED BALANCE SHEET
December 31,
--------------------------------------
2002 2001
---------------- ---------------
ASSETS
Current assets:
Cash and cash equivalents............................................... $ 1,695,000 $ 1,369,000
Prepaid expenses and other.............................................. 2,060,000 601,000
---------------- ---------------
Total current assets................................................. 3,755,000 1,970,000
---------------- ---------------
Investments in and advances to subsidiaries................................ 92,316,000 62,358,000
Other assets............................................................... 608,000 719,000
---------------- ---------------
$ 96,679,000 $ 65,047,000
================ ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable...................................................... $ - $ 275,000
Accrued expenses...................................................... 2,325,000 629,000
Accrued distributions payable to shareholders......................... 4,734,000 4,131,000
---------------- ---------------
Total current liabilities.......................................... 7,059,000 5,035,000
---------------- ---------------
Long-term debt........................................................... 19,125,000 9,125,000
Long-term payables and other liabilities................................. 6,841,000 16,955,000
Commitments and contingencies
Shareholders' equity:
Shareholders' investment.............................................. 63,350,000 34,428,000
Accumulated other comprehensive income (loss)
- foreign currency translation adjustment.......................... 304,000 (496,000)
---------------- ---------------
Total shareholders' equity......................................... 63,654,000 33,932,000
---------------- ---------------
$ 96,679,000 $ 65,047,000
================ ===============
See "Notes to Consolidated Financial Statements" of
Kaneb Services LLC included in this report.
F - 26
Schedule I
(Continued)
KANEB SERVICES LLC (PARENT COMPANY)
CONDENSED STATEMENT OF CASH FLOWS
Period from
Year Ended June 30, 2001 to
December 31, 2002 December 31, 2001
-------------------- -------------------
Operating activities:
Net income ........................................................... $ 47,228,000 $ 9,210,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in earnings of subsidiaries, net of distributions......... (29,958,000) (5,370,000)
Changes in current assets and liabilities........................ (38,000) 303,000
----------------- ----------------
Net cash provided by operating activities 17,232,000 4,143,000
----------------- ----------------
Investing activities:
Changes in other assets............................................... 911,000 (719,000)
----------------- ----------------
Net cash provided by (used in) investing activities........... 911,000 (719,000)
----------------- ----------------
Financing activities:
Issuance of debt...................................................... 10,000,000 9,125,000
Issuance of common shares............................................. 648,000 2,354,000
Distributions to shareholders......................................... (18,351,000) (4,137,000)
Changes in long-term payables and other liabilities................... (10,114,000) (9,397,000)
----------------- ----------------
Net cash used in financing activities......................... (17,817,000) (2,055,000)
----------------- ----------------
Increase in cash and cash equivalents.................................... 326,000 1,369,000
Cash and cash equivalents at beginning of period......................... 1,369,000 -
----------------- ----------------
Cash and cash equivalents at end of period............................... $ 1,695,000 $ 1,369,000
================= ================
See "Notes to Consolidated Financial Statements" of
Kaneb Services LLC included in this report.
F - 27
Schedule II
KANEB SERVICES LLC
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
Additions
-------------------------------
Balance at Charged to Charged to Balance at
Beginning of Costs and Other End of
Period Expenses Accounts Deductions Period
------------- ------------- ------------- -------------- -----------
ALLOWANCE DEDUCTED FROM
ASSETS TO WHICH THEY APPLY
Year Ended December 31, 2002:
For doubtful receivables
classified as current assets... $ 653 $ 2,509 $ 841(a) $ (279)(b) $ 3,724
============= ============ ============= ============= ==========
Year Ended December 31, 2001:
For doubtful receivables
classified as current assets... $ 565 $ 184 $ - $ (96)(b) $ 653
============= ============ ============= ============ ==========
Year Ended December 31, 2000:
For doubtful receivables
classified as current assets... $ 533 $ 460 $ - $ (428)(b) $ 565
============= ============= ============= ============ ==========
For deferred tax asset valuation
allowance classified as
noncurrent assets.............. $ 4,550 $ - $ - $ (4,550)(c) $ -
============= ============= ============= ============ ==========
Notes:
(a) Allowance for doubtful receivables from 2002 acquisitions.
(b) Receivable write-offs and reclassifications, net of recoveries.
(c) Reduction in valuation allowance resulting in income tax benefit.
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, Kaneb Services LLC has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
KANEB SERVICES LLC
//s// JOHN R. BARNES
--------------------------------------
By: John R. Barnes
Chairman of the Board and
Chief Executive Officer
Date: March 28, 2003
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of Kaneb
Pipe Line Partners, L.P. and in the capacities with Kaneb Pipe Line Company and
on the date indicated.
Signature Title Date
Principal Executive Officer
//s// JOHN R. BARNES Chairman of the Board March 28, 2003
- ---------------------------------------- and Chief Executive Officer
Principal Accounting Officer
//s// HOWARD C. WADSWORTH Vice President, Treasurer March 28, 2003
- ---------------------------------------- and Secretary
Directors
//s// SANGWOO AHN Director March 28, 2003
- ----------------------------------------
//s// MURRAY R. BILES Director March 28, 2003
- ----------------------------------------
//s// FRANK M. BURKE, JR. Director March 28, 2003
- ----------------------------------------
//s// CHARLES R. COX Director March 28, 2003
- ----------------------------------------
//s// HANS KESSLER Director March 28, 2003
- ----------------------------------------
//s// JAMES R. WHATLEY Director March 28, 2003
- ----------------------------------------
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, John R. Barnes, Chief Executive Officer of Kaneb Services LLC certify that:
1. I have reviewed this annual report on Form 10-K of Kaneb Services LLC;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 28, 2003
//s// JOHN R. BARNES
----------------------------------------
John R. Barnes
President and Chief Executive Officer
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Howard C. Wadsworth, Chief Financial Officer of Kaneb Services LLC certify
that:
1. I have reviewed this annual report on Form 10-K of Kaneb Services LLC;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 28, 2003
//s// HOWARD C. WADSWORTH
----------------------------------------
Howard D. Wadsworth
Vice President, Treasurer and Secretary
Chief Financial Officer