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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 001-16405
KANEB SERVICES LLC
(Exact name of registrant as specified in its charter)
DELAWARE 75-2931295
(State or other jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
2435 North Central Expressway
Richardson, Texas 75080
(Address of principle executive offices, including zip code)
(972) 699-4062
(Registrant's telephone number, including area code)
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 whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes X No
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Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class of Common Shares Outstanding at April 29, 2005
No par value 11,697,353 shares
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KANEB SERVICES LLC AND SUBSIDIARIES
FORM 10-Q
QUARTER ENDED MARCH 31, 2005
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Page No.
Part I. Financial Information
Item 1 (a) (1). Financial Statements (Unaudited)
Consolidated Statements of Income - Three Months Ended
March 31, 2005 and 2004 1
Condensed Consolidated Balance Sheets - March 31, 2005
and December 31, 2004 2
Condensed Consolidated Statements of Cash Flows - Three
Months Ended March 31, 2005 and 2004 3
Notes to Consolidated Financial Statements 4
(a) (2). Financial Statement Schedules (Unaudited)
Schedule I - Kaneb Services LLC (Parent Company)
Condensed Financial Statements:
Statements of Income - Three Months Ended
March 31, 2005 and 2004 14
Balance Sheets - March 31, 2005 and December 31, 2004 15
Statements of Cash Flows - Three Months Ended
March 31, 2005 and 2004 16
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 17
Item 3. Quantitative and Qualitative Disclosure About Market Risk 28
Item 4. Controls and Procedures 28
Part II. Other Information
Item 6. Exhibits 29
KANEB SERVICES LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands -- Except Per Share Amounts)
(Unaudited)
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Three Months Ended
March 31,
----------------------------
2005 2004
------------ -------------
Revenues:
Services $ 99,222 $ 90,698
Products 191,804 142,481
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Total revenues 291,026 233,179
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Costs and expenses:
Cost of products sold 182,997 136,431
Operating costs 46,622 43,424
Depreciation and amortization 14,838 13,907
General and administrative 11,398 6,502
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Total costs and expenses 255,855 200,264
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Operating income 35,171 32,915
Interest and other income 206 32
Interest expense (11,348) (10,629)
------------ -------------
Income before income taxes and interest of outside non-controlling
partners in KPP's net income 24,029 22,318
Income tax expense (1,526) (1,163)
Interest of outside non-controlling partners in KPP's net income (15,854) (15,160)
------------ -------------
Net income $ 6,649 $ 5,995
============ =============
Earnings per share:
Basic $ 0.56 $ 0.51
============ =============
Diluted $ 0.55 $ 0.50
============ =============
See notes to consolidated financial statements.
1
KANEB SERVICES LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands)
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March 31, December 31,
2005 2004
--------------- ----------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 42,432 $ 38,415
Accounts receivable 88,900 85,976
Inventories 17,172 25,448
Prepaid expenses and other 9,840 12,614
--------------- ---------------
Total current assets 158,344 162,453
--------------- ---------------
Property and equipment 1,459,551 1,451,176
Less accumulated depreciation 316,722 302,564
--------------- ---------------
Net property and equipment 1,142,829 1,148,612
--------------- ---------------
Investment in affiliates 26,751 25,939
Excess of cost over fair value of net assets of
acquired business and other assets 19,043 19,884
--------------- ---------------
$ 1,346,967 $ 1,356,888
=============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 53,102 $ 54,280
Accrued expenses 41,129 46,993
Accrued interest payable 8,648 9,374
Accrued distributions payable to shareholders 5,848 5,801
Accrued distributions payable to outside non-controlling
partners in KPP 19,863 19,863
--------------- ---------------
Total current liabilities 128,590 136,311
--------------- ---------------
Long-term debt 692,129 688,985
Other liabilities and deferred taxes 50,902 53,520
Interest of outside non-controlling partners in KPP 393,111 397,717
Commitments and contingencies
Shareholders' equity 82,235 80,355
--------------- ---------------
$ 1,346,967 $ 1,356,888
=============== ===============
See notes to consolidated financial statements.
2
KANEB SERVICES LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
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Three Months Ended
March 31,
----------------------------
2005 2004
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Operating activities:
Net income $ 6,649 $ 5,995
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 14,838 13,907
Equity in earnings of affiliates, net of distributions (812) (1,638)
Interest of outside non-controlling partners in
KPP's net income 15,854 15,160
Deferred income taxes 558 (53)
Changes in working capital components (1,931) (6,520)
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Net cash provided by operating activities 35,156 26,851
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Investing activities:
Capital expenditures (8,743) (7,347)
Other (887) (932)
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Net cash used in investing activities (9,630) (8,279)
------------ -------------
Financing activities:
Issuance of debt 4,080 4,196
Distributions to shareholders (5,801) (5,567)
Distributions to outside non-controlling
partners in KPP (19,863) (19,507)
Other 75 (52)
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Net cash used in financing activities (21,509) (20,930)
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Increase (decrease) in cash and cash equivalents 4,017 (2,358)
Cash and cash equivalents at beginning of period 38,415 43,457
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Cash and cash equivalents at end of period $ 42,432 $ 41,099
============ =============
Supplemental cash flow information - cash paid for interest $ 11,794 $ 10,954
============ =============
See notes to consolidated financial statements.
3
KANEB SERVICES LLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
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1. SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements reflect the results of operations of
Kaneb Services LLC (the "Company"), its wholly-owned subsidiaries and Kaneb
Pipe Line Partners, L.P. ("KPP"). The Company controls the operations of
KPP through its 2% general partner interest and 18% limited partner
interest as of March 31, 2005. All significant intercompany transactions
and balances have been eliminated.
The unaudited condensed consolidated financial statements of the Company
for the three month periods ended March 31, 2005 and 2004, have been
prepared in accordance with accounting principles generally accepted in the
United States of America. Significant accounting policies followed by the
Company are disclosed in the notes to the consolidated financial statements
included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2004. In the opinion of the Company's management, the
accompanying condensed consolidated financial statements contain all of the
adjustments, consisting of normal recurring accruals, necessary to present
fairly the consolidated financial position of the Company and its
consolidated subsidiaries at March 31, 2005, and the consolidated results
of their operations and cash flows for the periods ended March 31, 2005 and
2004. Operating results for the three months ended March 31, 2005 are not
necessarily indicative of the results that may be expected for the year
ending December 31, 2005.
In December of 2004, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 123
(revised 2004), "Share-Based Payment" ("SFAS No. 123R"), which addresses
the accounting for share-based payment transactions in which an enterprise
receives employee services in exchange for equity instruments of the
enterprise, or liabilities that are based on the fair value of the
enterprise's equity instruments or that may be settled by the issuance of
such equity instruments. SFAS No. 123R eliminates the ability to account
for share-based compensation transactions using the intrinsic value method
under Accounting Principles Board ("APB") Opinion 25, "Accounting for Stock
Issued to Employees", and generally requires that such transactions be
accounted for using a fair-value-based method. The Company is currently
evaluating the provisions of SFAS No. 123R to determine which
fair-value-based model and transitional provision to follow upon adoption.
The alternatives for transition include either the modified prospective or
the modified retrospective methods. The modified prospective method
requires that compensation expense be recorded for all unvested stock
options and restricted stock as the requisite service is rendered beginning
with the first quarter of adoption. The modified retrospective method
requires recording compensation expense for stock options and restricted
stock beginning with the first period restated. Under the modified
retrospective method, prior periods may be restated either as of the
beginning of the year of adoption or for all periods presented. SFAS No.
123R will be effective for the Company beginning in the first quarter of
2006. The impact of adoption on the Company's consolidated financial
statements is still being evaluated.
In accordance with the provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation", the Company currently applies the provisions of
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 Company also applies the disclosure provisions of SFAS No.
123, as amended by SFAS No. 148, "Accounting for Stock-based Compensation -
Transition and Disclosure" as if the fair-value-based method had been
applied in measuring compensation expense. The Black-Scholes option pricing
model has been used to estimate the fair value of stock options issued.
The following illustrates the effect on net income and basic and diluted
earnings per share if the fair value based method had been applied:
Three Months Ended
March 31,
--------------------------------
2005 2004
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(in thousands)
Reported net income $ 6,649 $ 5,995
Share-based employee compensation expense determined
under the fair value based method (63) (21)
------------- ------------
Pro forma net income $ 6,586 $ 5,974
============= ============
Earning per share:
Basic - as reported $ 0.56 $ 0.51
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Basic - pro forma $ 0.55 $ 0.51
============= =============
Diluted - as reported $ 0.55 $ 0.50
============= =============
Diluted - pro forma $ 0.54 $ 0.50
============= =============
2. VALERO L.P. MERGER AGREEMENT
On October 31, 2004, Valero L.P. agreed to acquire by merger (the "KSL
Merger") all of the outstanding common shares of the Company for cash.
Under the terms of that agreement, Valero L.P. is offering to purchase all
of the outstanding shares of the Company at $43.31 per share.
In a separate definitive agreement, on October 31, 2004, Valero L.P. and
KPP agreed to merge (the "KPP Merger"). Under the terms of that agreement,
each holder of units of limited partnership interests in KPP will receive a
number of Valero L.P. common units based on an exchange ratio that
fluctuates within a fixed range to provide $61.50 in value of Valero L.P.
units for each unit of KPP. The actual exchange ratio will be determined at
the time of the closing of the proposed merger and is subject to a fixed
value collar of plus or minus five percent of Valero L.P.'s per unit price
of $57.25 as of October 7, 2004. Should Valero L.P.'s per unit price fall
below $54.39 per unit, the exchange ratio will remain fixed at 1.1307
Valero L.P. units for each unit of KPP. Likewise, should Valero L.P.'s per
unit price exceed $60.11 per unit, the exchange ratio will remain fixed at
1.0231 Valero L.P. units for each unit of KPP.
The completion of the KSL Merger is subject to the customary regulatory
approvals including those under the Hart-Scott-Rodino Antitrust
Improvements Act. The completion of the KSL Merger is also subject to
completion of the KPP Merger. All required shareholder and unitholder
approvals have been obtained. Upon completion of the mergers, the general
partner of the combined partnership will be owned by affiliates of Valero
Energy Corporation and the Company and KPP will become wholly owned
subsidiaries of Valero L.P.
3. COMPREHENSIVE INCOME
Comprehensive income for the three months ended March 31, 2005 and 2004, is
as follows:
Three Months Ended
March 31,
--------------------------------
2005 2004
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(in thousands)
Net income $ 6,649 $ 5,995
Foreign currency translation adjustment (153) (49)
KPP interest rate hedging transaction 6 9
------------- --------------
Comprehensive income $ 6,502 $ 5,955
============= ==============
Accumulated other comprehensive income aggregated $3.1 million and $3.2
million at March 31, 2005 and December 31, 2004, respectively.
4. CASH DISTRIBUTIONS
The Company makes quarterly distributions of 100% of its available cash, as
defined in its limited liability company agreement, to 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, less all cash disbursements and reserves. Excess cash flow of
the Company's wholly-owned marketing operations is being used to reduce
working capital borrowings. A cash distribution of $0.495 per share with
respect to the fourth quarter of 2004 was paid on February 14, 2005. A cash
distribution of $0.495 per share with respect to the first quarter of 2005
was declared to holders of record on April 30, 2005 and will be paid on May
13, 2005.
5. EARNINGS PER SHARE
Earnings per share for the three months ended March 31, 2005 and 2004, is
calculated using the Company's basic and diluted weighted average shares
outstanding for the period. For the three months ended March 31, 2005 and
2004, basic weighted average shares outstanding were 11,872,000 and
11,667,000, respectively, and diluted weighted average shares outstanding
were 12,123,000 and 11,921,000, respectively.
6. CONTINGENCIES
The operations of KPP are subject to Federal, state and local laws and
regulations in the United States and various foreign locations 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.
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 had
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 of 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. KPP does not believe this matter will have a materially adverse
effect on its financial condition, although there can be no assurances as
to the ultimate outcome.
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 Services 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 have been settled for
immaterial amounts with ST Services' portion of such settlements provided
by its insurance carrier.
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 Services 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. In June of
2004, the DOT issued a final order reducing the penalty to $256,250 jointly
against ST Services and PEPCO and $74,000 against ST Services. On September
14, 2004, ST Services petitioned for reconsideration of the order which was
subsequently denied.
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 has 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 things, 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 and response to the oil spill. Pursuant
to an agreement between ST Services and PEPCO, ST Services' suit was
dismissed, subject to refiling. ST Services has moved to dismiss PEPCO's
suit. ST Services is vigorously defending against PEPCO's claims and is
pursuing its own counterclaims for return of monies ST Services has
advanced to PEPCO for settlements and cleanup costs. 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 amounts claimed by PEPCO, if recovered, would trigger an
excess insurance policy which has a $600,000 retention, but KPP does not
believe that such retention, if incurred, would materially adversely affect
KPP's financial condition.
In 2003, Exxon Mobil filed a lawsuit in a New Jersey state court against
GATX Corporation, Kinder Morgan Liquid Terminals ("Kinder Morgan"), the
successor in interest to GATX Terminals Corporation ("GATX"), and ST
Services, seeking reimbursement for remediation costs associated with the
Paulsboro, New Jersey terminal. The terminal was owned and operated by
Exxon Mobil from the early 1950's until 1990 when purchased by GATX. ST
Services purchased the terminal in 2000 from GATX. GATX was subsequently
acquired by Kinder Morgan. As a condition to the sale to GATX in 1990,
Exxon Mobil undertook certain remediation obligations with respect to the
site. In the lawsuit, Exxon Mobil is claiming that it has complied with its
remediation and contractual obligations and is entitled to reimbursement
from GATX Corporation, the parent company of GATX, Kinder Morgan, and ST
Services for costs in the amount of $400,000 that it claims are related to
releases at the site subsequent to its sale of the terminal to GATX. It is
also alleging that any remaining remediation requirements are the
responsibility of GATX Corporation, Kinder Morgan, or ST Services. Kinder
Morgan has alleged that it was relieved of any remediation obligations
pursuant to the sale agreement between its predecessor, GATX, and ST
Services. ST Services believes that, except for remediation involving
immaterial amounts, GATX Corporation or Exxon Mobil are responsible for the
remaining remediation of the site. Costs of completing the required
remediation depend on a number of factors and cannot be determined at the
current time.
A subsidiary of KPP purchased the approximately 2,000-mile ammonia pipeline
system from Koch Pipeline Company, L.P. and Koch Fertilizer Storage and
Terminal Company in 2002. The rates of the ammonia pipeline are subject to
regulation by the Surface Transportation Board (the "STB"). The STB had
issued an order in May 2000, prescribing maximum allowable rates KPP's
predecessor could charge for transportation to certain destination points
on the pipeline system. In 2003, KPP instituted a 7% general increase to
pipeline rates. On August 1, 2003, CF Industries, Inc. ("CFI") filed a
complaint with the STB challenging these rate increases. On August 11,
2004, STB ordered KPP to pay reparations to CFI and to return CFI's rates
to the levels permitted under the rate prescription. KPP has complied with
the order. The STB, however, indicated in the order that it would lift the
rate prescription in the event KPP could show "materially changed
circumstances." KPP has submitted evidence of "materially changed
circumstances," which specifically includes its capital investment in the
pipeline. CFI has argued that KPP's acquisition costs should not be
considered by the STB as a measure of KPP's investment base. The STB is
expected to decide the issue within the second quarter of 2005.
Also, on June 16, 2003, Dyno Nobel Inc. ("Dyno") filed a complaint with the
STB challenging the 2003 rate increase on the basis that (i) the rate
increase constitutes a violation of a contract rate, (ii) rates are
discriminatory and (iii) the rates exceed permitted levels. Dyno also
intervened in the CFI proceeding described above. Unlike CFI, Dyno's rates
are not subject to a rate prescription. As of March 31, 2005, Dyno would be
entitled to approximately $2.7 million in rate refunds, should it be
successful. KPP believes, however, that Dyno's claims are without merit.
The Company, primarily through its interest in KPP, has other contingent
liabilities resulting from litigation, claims and commitments incident to
the ordinary course of business. Management believes, after consulting with
counsel, that the ultimate resolution of such contingencies will not have a
materially adverse effect on the financial position, results of operations
or liquidity of the Company.
7. BUSINESS SEGMENT DATA
The Company conducts business through three principal operations: the
"Pipeline Operations" of KPP, which consists primarily of the
transportation of refined petroleum products and fertilizer in the
Midwestern states as a common carrier; the "Terminaling Operations" of KPP,
which provide storage for petroleum products, specialty chemicals and other
liquids; and the "Product Marketing Services," which provides wholesale
motor fuel marketing services throughout the Midwest and Rocky Mountain
regions, delivers bunker fuels to ships in the Caribbean and Nova Scotia,
Canada, and sells bulk petroleum products to various commercial interests.
General corporate includes accounting, tax, finance, legal, investor
relations and other corporate expenses not related to the segments. General
corporate assets include cash, receivables from affiliates of the Company
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:
Three Months Ended
March 31,
--------------------------------
2005 2004
------------- ------------
(in thousands)
Business segment revenues:
Pipeline operations $ 30,092 $ 27,903
Terminaling operations 69,130 62,795
Product marketing operations 191,804 142,481
------------- --------------
$ 291,026 $ 233,179
============= ==============
Business segment profit:
Pipeline operations $ 11,737 $ 11,210
Terminaling operations 18,727 18,484
Product marketing operations 5,567 3,754
General corporate (860) (533)
------------- --------------
Operating income 35,171 32,915
Interest and other income 206 32
Interest expense (11,348) (10,629)
------------- --------------
Income before income taxes and interest of outside
non-controlling partners in KPP's net income $ 24,029 $ 22,318
============= ==============
March 31, December 31,
2005 2004
------------- -------------
(in thousands)
Total assets:
Pipeline operations $ 353,781 $ 351,195
Terminaling operations 895,500 917,966
Product marketing operations 93,934 83,404
General corporate 3,752 4,323
------------- -------------
$ 1,346,967 $ 1,356,888
============= =============
8. RECENT ACCOUNTING PRONOUNCEMENT
In March of 2005, the FASB issued FASB Interpretation No. 47, "Accounting
for Conditional Retirement Obligations" ("FIN 47"), which requires
companies to recognize a liability for the fair value of a legal obligation
to perform asset-retirement activities that are conditional on a future
event, if the amount can be reasonably estimated. FIN 47 must be adopted by
the Company by the end of fiscal 2005. The impact of adoption on the
Company's consolidated financial statements is still being evaluated.
Schedule I
KANEB SERVICES LLC (PARENT COMPANY)
CONDENSED STATEMENTS OF INCOME
(In Thousands - Except Per Share Amounts)
(Unaudited)
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
-----------------------------
2005 2004
------------- -------------
General and administrative expenses $ (822) $ (441)
Interest expense (179) (137)
Interest and other income - 1
Equity in earnings of subsidiaries 7,650 6,572
------------- ------------
Net income $ 6,649 $ 5,995
============= ============
Earnings per share:
Basic $ 0.56 $ 0.51
============= ============
Diluted $ 0.55 $ 0.50
============= ============
See "Notes to Consolidated Financial Statements" of
Kaneb Services LLC included in this report.
14
Schedule I
(Continued)
KANEB SERVICES LLC (PARENT COMPANY)
CONDENSED BALANCE SHEETS
(In Thousands)
- --------------------------------------------------------------------------------
March 31, December 31,
2005 2004
--------------- -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 2,057 $ 1,504
Prepaid expenses and other 115 141
-------------- -------------
Total current assets 2,172 1,645
-------------- -------------
Investments in and advances to subsidiaries 107,678 108,112
Other assets 359 387
-------------- -------------
$ 110,209 $ 110,144
============== =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accrued expenses $ 1,573 $ 2,039
Accrued distributions payable to shareholders 5,848 5,801
-------------- -------------
Total current liabilities 7,421 7,840
-------------- -------------
Long-term debt 14,000 14,000
Long-term payables and other liabilities 6,553 7,949
Commitments and contingencies
Shareholders' equity 82,235 80,355
-------------- -------------
$ 110,209 $ 110,144
============== =============
See "Notes to Consolidated Financial Statements" of
Kaneb Services LLC included in this report.
15
Schedule I
(Continued)
KANEB SERVICES LLC (PARENT COMPANY)
CONDENSED STATEMENT OF CASH FLOWS
(In Thousands)
(Unaudited)
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
-----------------------------
2005 2004
------------ ------------
Operating activities:
Net income $ 6,649 $ 5,995
Adjustments to reconcile net income to net cash provided
by operating activities:
Equity in earnings of subsidiaries, net of distributions 281 (250)
Other 264 -
Changes in current assets and liabilities (440) (455)
------------ ------------
Net cash provided by operating activities 6,754 5,290
------------ ------------
Investing activities:
Changes in other assets 34 27
------------ ------------
Net cash provided by investing activities 34 27
------------ ------------
Financing activities:
Distributions to shareholders (5,801) (5,567)
Changes in long-term payables and other liabilities (509) 53
Other 75 (52)
------------ ------------
Net cash used in financing activities (6,235) (5,566)
------------ ------------
Increase (decrease) in cash and cash equivalents 553 (249)
Cash and cash equivalents at beginning of period 1,504 1,544
------------ ------------
Cash and cash equivalents at end of period $ 2,057 $ 1,295
============ ============
See "Notes to Consolidated Financial Statements" of
Kaneb Services LLC included in this report.
16
KANEB SERVICES LLC AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
- --------------------------------------------------------------------------------
This discussion should be read in conjunction with the condensed
consolidated financial statements of Kaneb Services LLC (the "Company") and
notes thereto included elsewhere in this report. The consolidated financial
information reflects the results of operations of the Company, its
wholly-owned subsidiaries and Kaneb Pipe Line Partners, L.P. ("KPP").
Overview
In September 1989, Kaneb Pipe Line Company LLC ("KPL"), now a wholly owned
subsidiary of the Company, formed KPP to own and operate its refined
petroleum products pipeline business. KPL manages and controls the
operations of KPP through its general partner interest and an 18% (at March
31, 2005) 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.
On October 31, 2004, Valero L.P. agreed to acquire by merger (the "KSL
Merger") all of the outstanding common shares of the Company for cash.
Under the terms of that agreement, Valero L.P. is offering to purchase all
of the outstanding shares of the Company at $43.31 per share.
In a separate definitive agreement, on October 31, 2004, Valero L.P. and
KPP agreed to merge (the "KPP Merger"). Under the terms of that agreement,
each holder of units of limited partnership interests in KPP will receive a
number of Valero L.P. common units based on an exchange ratio that
fluctuates within a fixed range to provide $61.50 in value of Valero L.P.
units for each unit of KPP. The actual exchange ratio will be determined at
the time of the closing of the proposed merger and is subject to a fixed
value collar of plus or minus five percent of Valero L.P.'s per unit price
of $57.25 as of October 7, 2004. Should Valero L.P.'s per unit price fall
below $54.39 per unit, the exchange ratio will remain fixed at 1.1307
Valero L.P. units for each unit of KPP. Likewise, should Valero L.P.'s per
unit price exceed $60.11 per unit, the exchange ratio will remain fixed at
1.0231 Valero L.P. units for each unit of KPP.
The completion of the KSL Merger is subject to the customary regulatory
approvals including those under the Hart-Scott-Rodino Antitrust
Improvements Act. The completion of the KSL Merger is also subject to
completion of the KPP Merger. All required shareholder and unitholder
approvals have been obtained. Upon completion of the mergers, the general
partner of the combined partnership will be owned by affiliates of Valero
Energy Corporation and the Company and KPP will become wholly owned
subsidiaries of Valero L.P.
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. 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 petroleum pipeline business depends on the level of demand
for refined petroleum products in the markets served by the pipelines and
the ability and willingness of refineries and marketers having access to
the pipelines to supply such demand by deliveries through the pipelines.
KPP's pipeline revenues are based on volumes shipped and the distance over
which such volumes are transported.
KPP's terminaling business is one of the largest independent petroleum
products and specialty liquids terminaling companies in the United States.
In the United States, ST Services operates 41 facilities in 20 states. ST
Services also owns and operates seven 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 in 2002, owns a terminal on the Island
of St. Eustatius, Netherlands Antilles, and a terminal at Point Tupper,
Nova Scotia, Canada. Independent terminal owners generally compete on the
basis of the location and versatility of the terminals, service and price.
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 the safe
storage of product at specified temperatures and other conditions, as well
as receipt and delivery from the terminal. The ability to obtain attractive
pricing is dependent largely on the quality, versatility and reputation of
the facility. Terminaling revenues are earned based on fees for the storage
and handling of products.
KPL owns a petroleum product marketing business, which provides wholesale
motor fuel marketing services in the Great Lakes and Rocky Mountain regions
of the United States. 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 those locations. In the
bunkering business, KPP competes with ports offering bunker fuels along the
route of the vessel. Vessel owners or charterers are charged berthing and
other fees for associated services such as pilotage, tug assistance, line
handling, launch service and emergency response services.
Consolidated Results of Operations
Three Months Ended
March 31,
-----------------------------
2005 2004
------------ ------------
(in thousands, except
per share amounts)
Consolidated revenues $ 291,026 $ 233,179
=========== ============
Consolidated operating income $ 35,171 $ 32,915
=========== ============
Consolidated net income $ 6,649 $ 5,995
=========== ============
Earnings per share:
Basic $ 0.56 $ 0.51
=========== ============
Diluted $ 0.55 $ 0.50
=========== ============
Cash distributions declared per share $ 0.495 $ 0.475
=========== ============
Consolidated capital expenditures, excluding acquisitions $ 8,743 $ 7,347
=========== ============
For the three months ended March 31, 2005, consolidated revenues increased
by $57.8 million, or 25%, when compared to the first quarter of 2004, due
to a $49.3 million increase in product marketing revenues (see "Product
Marketing Services" below), a $6.3 million increase in terminaling business
revenues (see "Terminaling Operations" below), and a $2.2 million increase
in pipeline revenues (see "Pipeline Operations" below). Consolidated
operating income for the three months ended March 31, 2005 increased by
$2.3 million, or 7%, when compared to the same period in 2004, due
primarily to a $1.8 million increase in product marketing operating income,
a $0.5 million increase in pipeline operating income, and a $0.3 million
increase in terminaling operating income. Consolidated operating income for
the three months ended March 31, 2005 includes $2.4 million of costs
associated with the Valero L.P. merger agreement. Overall, consolidated net
income for the three months ended March 31, 2005 increased by $0.7 million,
or 11%, when compared to the three months ended March 31, 2004.
Pipeline Operations
Three Months Ended
March 31,
--------------------------------
2005 2004
------------- ------------
(in thousands)
Revenues $ 30,092 $ 27,903
Operating costs 11,499 11,487
Depreciation and amortization 3,792 3,599
General and administrative 3,064 1,607
------------- --------------
Operating income $ 11,737 $ 11,210
============= ==============
The Partnership's pipeline revenues are based on volumes shipped and the
distances over which such volumes are transported. Because tariff rates are
regulated by the FERC or the STB, the pipelines compete primarily on the
basis of quality of service, including delivery of products at convenient
locations on a timely basis to meet the needs of their customers. For the
three month period ended March 31, 2005, revenues increased by $2.2
million, or 8%, when compared to the first quarter of 2004, due to
increases in barrel miles of petroleum products shipped on petroleum
pipelines and increases in the average price received per barrel mile
shipped. Barrel miles on petroleum pipelines totaled 5.2 billion and 5.1
billion for the three months ended March 31, 2005 and 2004, respectively.
Total volumes shipped on the anhydrous ammonia pipeline aggregated 297
thousand tons for each of the three month periods ended March 31, 2005 and
2004.
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, was flat for the three month period
ended March 31, 2005, when compared to the first quarter of 2004. For the
three months ended March 31, 2005, depreciation and amortization increased
by $0.2 million, when compared to the same 2004 period, due primarily to
routine maintenance capital expenditures. General and administrative costs,
which include managerial, accounting and administrative personnel costs,
office rent and expense, legal and professional costs and other
non-operating costs, increased by $1.5 million for the three month period
ended March 31, 2005, when compared to the first quarter of 2004, due
primarily to costs associated with the Valero L.P. merger agreement and
increases in personnel-related costs. Terminaling Operations
Three Months Ended
March 31,
--------------------------------
2005 2004
------------- ------------
(in thousands)
Revenues $ 69,130 $ 62,795
Operating costs 33,360 30,343
Depreciation and amortization 10,824 10,084
General and administrative 6,219 3,884
------------- --------------
Operating income $ 18,727 $ 18,484
============= ==============
For the three month period ended March 31, 2005, terminaling revenues
increased by $6.3 million, or 10%, when compared to the three month period
ended March 31, 2004, due to increases in both the average tankage utilized
and the average price realized per barrel of tankage utilized. Average
tankage utilized for the three month period ended March 31, 2005 was 50.5
million barrels, compared to 48.2 million barrels for the same prior year
period. For the three month period ended March 31, 2005, average annualized
revenues per barrel of tankage utilized increased to $5.55 per barrel,
compared to $5.24 per barrel for the same prior year period, due primarily
to favorable domestic and foreign market conditions.
For the three month period ended March 31, 2005, operating costs increased
by $3.0 million, when compared to the same 2004 period, a result of overall
increases in tank utilization and planned maintenance. For the three months
ended March 31, 2005, depreciation and amortization increased by $0.7
million, when compared to the first quarter of 2004, due to KPP terminal
acquisitions in 2004 and routine maintenance capital expenditures. General
and administrative costs increased by $2.3 million for the three months
ended March 31, 2005, when compared to the first quarter of 2004, due
primarily to costs associated with the Valero L.P. merger agreement and
increases in personnel-related costs.
Product Marketing Services
Three Months Ended
March 31,
--------------------------------
2005 2004
------------- ------------
(in thousands)
Revenues $ 191,804 $ 142,481
Cost of products sold 182,997 136,431
------------- --------------
Gross margin $ 8,807 $ 6,050
============= ==============
Operating income $ 5,567 $ 3,754
============= ==============
For the three month period ended March 31, 2005, revenues for the product
marketing services business increased by $49.3 million, or 35%, when
compared to the same 2004 period, due to increases in volumes sold and an
overall increase in the average sales price realized. Gallons sold totaled
183 million and 162 million, for the three months ended March 31, 2005 and
2004, respectively. For the three month period ended March 31, 2005, the
average price realized per gallon of product sold increased to $1.05 per
gallon, compared to $0.86 per gallon for the same 2004 period. For the
three months ended March 31, 2005, gross margin and operating income
increased by $2.8 million and $1.8 million, respectively, when compared to
the same 2004 period, due to the increase in volumes sold and favorable
variations in prices resulting from the timing of purchases and sales.
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 Expense
For the three months ended March 31, 2005, interest expense increased by
$0.7 million when compared to the same 2004 period, due to overall
increases in KPP debt levels resulting from KPP terminal acquisitions in
2004 and increases in interest rates on variable rate debt.
Income Taxes
KPP's partnership operations are not subject to federal or state income
taxes. However, certain KPP operations are conducted through separate
taxable wholly-owned U.S. and foreign corporate subsidiaries. The income
tax expense for these subsidiaries was $1.5 million and $1.2 million for
the three month periods ended March 31, 2005 and 2004, respectively.
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 in 2002, to
pay a 2% rate on taxable income, as defined therein, or a minimum payment
of 500,000 Netherlands Antilles guilders ($0.3 million) per year. The
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. The subsidiary is currently engaged in
discussions with representatives appointed by the Island Territory of St.
Eustatius regarding the renewal or modification of the agreement, but the
ultimate outcome cannot be predicted at this time. The subsidiary has
accrued amounts assuming a new agreement becomes effective, and continues
to make payments, as required, under the previous agreement.
Liquidity and Capital Resources
Cash provided by operations, including the operations of KPP, was $35.2
million and $26.9 million for the three months ended March 31, 2005 and
2004, respectively. The first quarter 2005 increase was due primarily to
overall increases in consolidated revenues and operating income and changes
in working capital components resulting from the timing of cash receipts
and disbursements, when compared to the first quarter of 2004.
Capital expenditures (related primarily to KPP) were $8.7 million for the
three months ended March 31, 2005, compared to $7.3 million during the same
2004 period. Such expenditures included $7.3 million and $5.7 million in
maintenance and environmental expenditures and $1.4 million and $1.6
million in expansion expenditures for the three months ended March 31, 2005
and 2004, respectively. The increase in first quarter 2005 capital
expenditures, when compared to the same 2004 period, was primarily the
result of increases in planned maintenance capital expenditures related to
KPP's terminaling business. 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 to be,
significant. KPP anticipates that capital expenditures (including routine
maintenance and expansion expenditures, but excluding acquisitions) will
total approximately $40 to $44 million in 2005. Such future expenditures of
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 expenditures
through borrowings, or will choose to do so.
The Company makes quarterly distributions of 100% of its available cash, as
defined in its limited liability company agreement, to 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, less all cash disbursements and reserves. Excess cash flow of
the Company's wholly-owned marketing operations is being used to reduce
working capital borrowings. A cash distribution of $0.495 per share with
respect to the fourth quarter of 2004 was paid on February 14, 2005. A cash
distribution of $0.495 per share with respect to the first quarter of 2005
was declared to holders of record on April 30, 2005, and will be paid on
May 13, 2005.
KPP expects to fund future cash distributions and maintenance capital
expenditures with existing cash and anticipated cash flows from operations.
Expansionary capital expenditures are expected to be funded through
additional KPP bank borrowings and/or future KPP public equity or debt
offerings.
The Company has a credit 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, has a variable rate
commitment fee on unused amounts and contains certain financial and
operational covenants. At March 31, 2005, the Company was in compliance
with all covenants. The credit facility is secured by 4.6 million KPP
limited partnership units. At March 31, 2005, $14.0 million was drawn on
the credit facility.
KPP has a credit agreement with a group of banks that provides for a $400
million unsecured revolving credit facility through April of 2006. The
credit facility, which provides for an increase in the commitment up to an
aggregate of $450 million by mutual agreement between KPP and the banks,
bears interest at variable rates and has a variable commitment fee on
unused amounts. The credit facility is without recourse to the Company and
contains certain financial and operating covenants, including limitations
on investments, sales of assets and transactions with affiliates and,
absent an event of default, does not restrict distributions to the Company
or to other partners. At March 31, 2005, KPP was in compliance with all
covenants. At March 31, 2005, $95.7 million was outstanding under the
credit agreement.
In May of 2003, KPP issued $250 million of 5.875% senior unsecured notes
due June 1, 2013. Under the note indenture, interest is payable
semi-annually in arrears on June 1 and December 1 of each year. The notes
are redeemable, as a whole or in part, at the option of KPP, 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 and other partners.
At March 31, 2005, KPP was in compliance with all covenants.
In February of 2002, KPP issued $250 million of 7.75% senior unsecured
notes due February 15, 2012. 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 KPP, 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 March 31, 2005, KPP
was in compliance with all covenants.
The following is a schedule by period of the Company's, including KPP's,
debt repayment obligations and material contractual commitments as of March
31, 2005:
Less than After
Total 1 year 1 -3 years 4 -5 years 5 years
---------- ------------ ----------- ------------ ---------------
(in thousands)
Debt:
Revolving credit facility $ 14,000 $ - $ - $ 14,000 $ -
Revolving credit facility
of subsidiary 7,113 - - 7,113 -
KPP revolving credit facility 95,669 - 95,669 - -
KPP 7.75% senior unsecured
notes 250,000 - - - 250,000
KPP 5.875% senior unsecured
notes 250,000 - - - 250,000
Other KPP bank debt 75,347 - 75,347 - -
---------- ------------ ----------- ------------ --------------
Debt subtotal 692,129 - 171,016 21,113 500,000
---------- ------------ ----------- ------------ --------------
Contractual commitments -
Operating leases 66,858 11,482 17,164 13,899 24,313
---------- ------------ ----------- ------------ --------------
Total $ 758,987 $ 11,482 $ 188,180 $ 35,012 $ 524,313
========== ============ =========== ============ ==============
Additional information relative to sources and uses of cash is presented in
the consolidated financial statements included in this report.
Off-Balance Sheet Transactions
The Company was not a party to any off-balance sheet transactions at March
31, 2005, or for the three month periods ended March 31, 2005 and 2004.
Critical Accounting Policies and 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. Significant accounting
policies are presented in the Notes to the Consolidated Financial
Statements of the Company's Annual Report on Form 10-K for the year ended
December 31, 2004.
Critical accounting policies are those that are most important to the
portrayal of the Company's 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. The Company's most critical accounting
policies pertain to impairment of KPP's 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 for determining if
impairment exists under the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 144, "Accounting for the Impairment or the Disposal
of Long-Lived Assets". 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 three month periods ended March
31, 2005 and 2004. 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 three month periods ended March 31,
2005 and 2004. 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
In December of 2004, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 123 (revised 2004), "Share-Based Payment" ("SFAS No.
123R"), which addresses the accounting for share-based payment transactions
in which an enterprise receives employee services in exchange for equity
instruments of the enterprise, or liabilities that are based on the fair
value of the enterprise's equity instruments or that may be settled by the
issuance of such equity instruments. SFAS No. 123R eliminates the ability
to account for share-based compensation transactions using the intrinsic
value method under Accounting Principles Board ("APB") Opinion 25,
"Accounting for Stock Issued to Employees", and generally requires that
such transactions be accounted for using a fair-value-based method. The
Company is currently evaluating the provisions of SFAS No. 123R to
determine which fair-value-based model and transitional provision to follow
upon adoption. The alternatives for transition include either the modified
prospective or the modified retrospective methods. The modified prospective
method requires that compensation expense be recorded for all unvested
stock options and restricted stock as the requisite service is rendered
beginning with the first quarter of adoption. The modified retrospective
method requires recording compensation expense for stock options and
restricted stock beginning with the first period restated. Under the
modified retrospective method, prior periods may be restated either as of
the beginning of the year of adoption or for all periods presented. SFAS
No. 123R will be effective for the Company beginning in the first quarter
of 2006. The impact of adoption on the Company's consolidated financial
statements is still being evaluated.
In March of 2005, the FASB issued FASB Interpretation No. 47, "Accounting
for Conditional Retirement Obligations" ("FIN 47"), which requires
companies to recognize a liability for the fair value of a legal obligation
to perform asset-retirement activities that are conditional on a future
event, if the amount can be reasonably estimated. FIN 47 must be adopted by
the Company by the end of fiscal 2005. The impact of adoption on the
Company's consolidated financial statements is still being evaluated
KANEB SERVICES LLC AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Item 3. Quantitative and Qualitative Disclosure About Market Risk
The principal market risks pursuant to this Item (i.e., the risk of loss
arising from 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 and fluctuations in petroleum product prices on inventories held for
sale.
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 $151.9 million (including KPP's debt) at March 31, 2005, a
one percent increase in interest rates would increase annual net interest
expense by approximately $1.5 million.
The product marketing business periodically purchases refined petroleum
products for resale as motor fuel, bunker fuel and sales to commercial
interests. Petroleum inventories are generally held for short periods of time,
not exceeding 90 days. As the Company and KPP do not engage in derivative
transactions to hedge the value of the inventory, they are subject to market
risk from changes in global oil markets.
Item 4. Controls and Procedures
The Company's principal executive officer and principal financial officer,
after evaluating as of March 31, 2005, the effectiveness of the Company's
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
of the Securities Exchange Act of 1934), 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.
During the first quarter of 2005, there have been no changes in the
Company's internal controls over financial reporting that have materially
affected, or are reasonably likely to materially affect, those internal controls
over financial reporting subsequent to the date of the evaluation. As a result,
no corrective actions were required or undertaken.
KANEB SERVICES LLC AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Part II - Other Information
Item 6. Exhibits
(a) Exhibits.
3.1 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.
31.1 Certification of Chief Executive Officer, Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002, dated May 10, 2005.
31.2 Certification of Chief Financial Officer, Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002, dated May 10, 2005.
32.1 Certification of Chief Executive Officer, Pursuant to Section
906(a) of the Sarbanes-Oxley Act of 2002, dated May 10, 2005.
32.2 Certification of Chief Financial Officer, Pursuant to Section
906(a) of the Sarbanes-Oxley Act of 2002, dated May 10, 2005.
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
KANEB SERVICES LLC
(Registrant)
Date: May 10, 2005 //s// HOWARD C. WADSWORTH
--------------------------------------------
Howard C. Wadsworth
Vice President, Treasurer and Secretary
(Principal Financial Officer and
Duly Authorized Officer)
Exhibit 31.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, John R. Barnes, Chief Executive Officer of Kaneb Services LLC, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Kaneb Services LLC;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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
quarterly 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-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, 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 quarterly report is being prepared;
b) designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles;
c) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls and procedures, as
of the end of the period covered by this quarterly report, based on
such evaluation; and
d) disclosed in this quarterly report any change in the registrant's
internal control over financial reporting that occurred during the
registrant's most recent fiscal quarter that has materially affected,
or is reasonably likely to materially affect, the registrant's
internal control over financial reporting; and
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation of internal control over financial reporting to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: May 10, 2005
//s// JOHN R. BARNES
-------------------------------------
John R. Barnes
President and Chief Executive Officer
Exhibit 31.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Howard C. Wadsworth, Chief Financial Officer of Kaneb Services LLC, certify
that:
1. I have reviewed this quarterly report on Form 10-Q of Kaneb Services LLC;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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
quarterly 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-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, 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 quarterly report is being prepared;
b) designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles;
c) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls and procedures, as
of the end of the period covered by this quarterly report, based on
such evaluation; and
d) disclosed in this quarterly report any change in the registrant's
internal control over financial reporting that occurred during the
registrant's most recent fiscal quarter that has materially affected,
or is reasonably likely to materially affect, the registrant's
internal control over financial reporting; and
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation of internal control over financial reporting to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: May 10, 2005
//s// HOWARD C. WADSWORTH
--------------------------------------
Howard C. Wadsworth
Chief Financial Officer
Exhibit 32.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO SECTION 906(A) OF THE SARBANES-OXLEY ACT OF 2002
The undersigned, being the Chief Executive Officer of Kaneb Services LLC (the
"Company"), hereby certifies that, to his knowledge, the Company's Quarterly
Report on Form 10-Q for the three months ended March 31, 2005, filed with the
United States Securities and Exchange Commission pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)), fully
complies with the requirements of Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 and that information contained in such Quarterly Report
fairly presents, in all material respects, the financial condition and results
of operations of the Company.
This written statement is being furnished to the Securities and Exchange
Commission as an exhibit to such Form 10-Q. A signed original of this written
statement required by Section 906 has been provided to Kaneb Services LLC and
will be retained by Kaneb Services LLC and furnished to the Securities and
Exchange Commission or its staff upon request.
Date: May 10, 2005
//s// JOHN R. BARNES
-------------------------------------
John R. Barnes
President and Chief Executive Officer
Exhibit 32.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 906(A) OF THE SARBANES-OXLEY ACT OF 2002
The undersigned, being the Chief Financial Officer of Kaneb Services LLC (the
"Company"), hereby certifies that, to his knowledge, the Company's Quarterly
Report on Form 10-Q for the three months ended March 31, 2005, filed with the
United States Securities and Exchange Commission pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)), fully
complies with the requirements of Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 and that information contained in such Quarterly Report
fairly presents, in all material respects, the financial condition and results
of operations of the Company.
This written statement is being furnished to the Securities and Exchange
Commission as an exhibit to such Form 10-Q. A signed original of this written
statement required by Section 906 has been provided to Kaneb Services LLC and
will be retained by Kaneb Services LLC and furnished to the Securities and
Exchange Commission or its staff upon request.
Date: May 10, 2005
//s// HOWARD C. WADSWORTH
---------------------------------------
Howard C. Wadsworth
Vice President, Treasurer and Secretary
(Chief Financial Officer)