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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended March 31, 2005

OR

For the transition period from              to             

Commission File Number 1-16417

VALERO L.P.

(Exact name of registrant as specified in its charter)

One Valero Way

San Antonio, Texas

(Address of principal executive offices)

78249

(Zip Code)

Telephone number: (210) 345-2000

(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 Rule 12b-2 of the Securities Exchange Act of 1934).    Yes  x    No  ¨

The number of common and subordinated units outstanding as of April 30, 2005 was 13,442,072 and 9,599,322, respectively.

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VALERO L.P. AND SUBSIDIARIES

FORM 10-Q

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PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

VALERO L.P. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Thousands of Dollars, Except Unit Data)

See Condensed Notes to Consolidated Financial Statements.

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VALERO L.P. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited, Thousands of Dollars, Except Unit Data)

See Condensed Notes to Consolidated Financial Statements.

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VALERO L.P. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, Thousands of Dollars)

See Condensed Notes to Consolidated Financial Statements.

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VALERO L.P. AND SUBSIDIARIES

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION, PRINCIPLES OF CONSOLIDATION AND SIGNIFICANT ACCOUNTING POLICIES

As used in this report, the term Valero L.P. may refer, depending on the context, to Valero L.P., Valero Logistics Operations, L.P. (Valero Logistics), the wholly owned subsidiary of Valero L.P., or both of them taken as a whole.

These unaudited consolidated financial statements include the accounts of Valero L.P. and subsidiaries in which it has a controlling interest. Intercompany balances and transactions have been eliminated in consolidation. Investments in 50% or less owned entities are accounted for using the equity method of accounting.

These unaudited consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities Exchange Act of 1934. Accordingly, they do not include all of the information and notes required by GAAP for complete consolidated financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. All such adjustments are of a normal recurring nature unless disclosed otherwise. Financial information for the three months ended March 31, 2005 and 2004 included in these Condensed Notes to Consolidated Financial Statements is derived from Valero L.P.’s unaudited consolidated financial statements. 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.

The consolidated balance sheet as of December 31, 2004 has been derived from the audited consolidated financial statements as of that date. You should read these consolidated financial statements in conjunction with the consolidated financial statements and notes thereto included in Valero L.P.’s Annual Report on Form 10-K for the year ended December 31, 2004.

FASB Interpretation No. 47

In March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (FIN 47). FIN 47 clarifies that the term “conditional asset retirement obligation” as used in FASB Statement No. 143, “Accounting for Asset Retirement Obligations,” refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. Since the obligation to perform the asset retirement activity is unconditional, FIN 47 provides that a liability for the fair value of a conditional asset retirement obligation should be recognized if that fair value can be reasonably estimated, even though uncertainty exists about the timing and/or method of settlement. FIN 47 also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation under FASB Statement No. 143. FIN 47 is effective for fiscal years ending after December 15, 2005, and is not expected to affect Valero L.P.’s financial position or results of operations.

2. PROPOSED TRANSACTION

On October 31, 2004, Valero L.P., Kaneb Services LLC (KSL), and Kaneb Pipe Line Partners, L.P. (KPP) entered into definitive merger agreements whereby Valero L.P. will acquire KSL and KPP (the Kaneb Mergers).

On March 11, 2005, Valero L.P. unitholders holding a majority of Valero L.P.’s outstanding units voted to approve the issuance of Valero L.P. common units to acquire KPP. Also on March 11, 2005, the KPP unitholders and the KSL shareholders (other than Valero L.P., KSL, KPP and their respective affiliates) holding a majority of the outstanding KPP units and KSL shares voted to approve the Kaneb Mergers.

Both of the Kaneb Mergers are contingent upon the completion of the other and are subject to customary regulatory approvals, including those under the Hart-Scott-Rodino Antitrust Improvements Act. Management expects the transaction to close during the second quarter of 2005.

3. LONG-TERM DEBT

$175.0 Million Revolving Credit Facility

As of March 31, 2005, Valero Logistics had outstanding borrowings of $32.0 million under its $175.0 million revolving credit facility with a maturity date of January 15, 2006. The weighted-average interest rate related to outstanding borrowings under the revolving credit facility during the three months ended March 31, 2005 and 2004 was 3.5% and 2.1%, respectively. As of March 31, 2005, Valero Logistics had $143.0 million available under its revolving credit facility.

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VALERO L.P. AND SUBSIDIARIES

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

On December 20, 2004, Valero L.P. entered into a 5-year Revolving Credit Agreement (the “2005 Revolving Credit Agreement”), which is subject to completion of the Kaneb Mergers, with aggregate commitments of $400.0 million and a maturity date five years after the effective date (as defined in the 2005 Revolving Credit Agreement). Once the 2005 Revolving Credit Agreement becomes effective, the amounts outstanding under the $175.0 Million Revolving Credit Agreement will be paid in full and that facility will be terminated.

Interest Rate Swaps

As of March 31, 2005, the weighted-average interest rate for the interest rate swaps was 5.7%. As of March 31, 2005 and December 31, 2004, the aggregate estimated fair value of the interest rate swaps included in other long-term liabilities in the consolidated balance sheets was $4.9 million and $1.2 million, respectively.

Other Long-term Debt

During the three months ended March 31, 2005, Valero Logistics repaid $0.5 million on the note payable to the Port of Corpus Christi Authority of Nueces County, Texas.

4. RELATED PARTY TRANSACTIONS

Valero L.P. has related party transactions with Valero Energy Corporation (Valero Energy) for pipeline tariff, terminalling fee and crude oil storage tank rent and fee revenues, certain employee costs, insurance costs, operating expenses, administrative costs and rent expense. The receivable from Valero Energy represents amounts due for pipeline tariff, terminalling fee and tank rent and fee revenues, and the payable to Valero Energy represents amounts due for employee costs, insurance costs, operating expenses, administrative costs and rent expense.

Under the terms of the amended Services Agreement, Valero L.P. reimburses Valero Energy for payroll costs of employees working on behalf of Valero L.P. Additionally, Valero Energy charges Valero L.P. an administrative services fee.

Valero L.P.’s share of allocated Valero Energy employee benefit plan expenses, excluding compensation expense related to restricted common units and unit options, was $2.9 million and $2.1 million for the three months ended March 31, 2005 and 2004, respectively. These employee benefit plan expenses and the related payroll costs are included in operating expenses and general and administrative expenses.

The following table summarizes the results of transactions with Valero Energy:

5. PARTNERS’ EQUITY

Outstanding Equity

Valero L.P. has identified the general partner interest and the subordinated units as participating securities and uses the two-class method when calculating the net income per unit applicable to limited partners, which is based on the weighted-average number of common and subordinated units outstanding during the period. Net income per unit applicable to limited partners is computed by dividing net income applicable to limited partners, after deducting the general partner’s 2% interest and incentive distributions, by the weighted-average number of limited partnership units outstanding. Basic and diluted net income per unit applicable to limited partners are the same because Valero L.P. has no potentially dilutive securities outstanding.

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VALERO L.P. AND SUBSIDIARIES

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Cash Distributions

On January 27, 2005, Valero L.P. declared a quarterly distribution of $0.80 per unit paid on February 14, 2005 to unitholders of record on February 7, 2005. On April 26, 2005, Valero L.P. declared a quarterly distribution of $0.80 per unit to be paid on May 13, 2005 to unitholders of record on May 6, 2005.

The following table reflects the allocation of total cash distributions to the general and limited partners applicable to the period in which the distributions are earned:

6. SEGMENT INFORMATION

Segment information for Valero L.P.’s four reportable segments was as follows:

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VALERO L.P. AND SUBSIDIARIES

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Total assets by reportable segment were as follows:

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

FORWARD-LOOKING STATEMENTS

This Form 10-Q contains certain estimates, predictions, projections, assumptions and other forward-looking statements that involve various risks and uncertainties. While these forward-looking statements, and any assumptions upon which they are based, are made in good faith and reflect Valero L.P.’s current judgment regarding the direction of its business, actual results will almost always vary, sometimes materially, from any estimates, predictions, projections, assumptions or other future performance suggested in this report. These forward-looking statements can generally be identified by the words “anticipates,” “believes,” “expects,” “plans,” “intends,” “estimates,” “forecasts,” “budgets,” “projects,” “will,” “could,” “should,” “may” and similar expressions. These statements reflect Valero L.P.’s current views with regard to future events and are subject to various risks, uncertainties and assumptions including:

If one or more of these risks or uncertainties materialize, or if the underlying assumptions prove incorrect, Valero L.P.’s actual results may vary materially from those described in any forward-looking statement. Readers are cautioned not to place undue reliance on this forward-looking information, which is as of the date of the Form 10-Q. Valero L.P. does not intend to update these statements unless it is required by the securities laws to do so, and it undertakes no obligation to publicly release the results of any revisions to any such forward-looking statements that may be made to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events.

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Overview

Valero L.P. provides transportation and storage services to Valero Energy and other unrelated customers. Valero L.P. provides these services with its crude oil and refined product pipelines, refined product terminals and crude oil storage tanks located near or connected to nine of Valero Energy’s refineries.

Valero L.P.’s operations are affected by:

Valero L.P.’s profitability and its ability to pay distributions to its limited and general partners are substantially determined by throughput volumes moving through its assets and the tariffs and fees Valero L.P. charges. During the first quarter of 2005, Valero L.P. benefited from higher revenues due to increased throughputs in the crude oil storage segment, strategic acquisitions and capital projects. Offsetting the increases in revenues were higher costs related primarily to the amendment of the Services Agreement with Valero Energy and increased headcount and services. Valero L.P reported net income per unit applicable to limited partners of $0.77 and declared a cash distribution per unit applicable to limited partners of $0.80.

Results of Operations

First Quarter 2005 Compared to First Quarter 2004

Financial Highlights

(Unaudited, Thousands of Dollars)

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Segment Operating Data

Segment Operating Highlights

(Thousands of Dollars, Except Barrel/Day Information)

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General

Net income and net income per unit applicable to the limited partners for the first quarter of 2005 decreased 4% compared to the first quarter of 2004 despite an increase in revenues of 8% for the same period. This decrease was primarily attributable to higher costs as follows:

Revenues were higher primarily due to the following:

Crude Oil Pipelines Segment

Revenues increased 3% due to increased throughputs from the addition of a new supplier to Valero Energy’s Ardmore refinery. Increased revenues were offset by lower throughputs from Valero Energy resulting from an unplanned outage of the alkylation unit at Valero Energy’s McKee refinery.

Operating expenses increased 18% due to higher overhead costs related to the Services Agreement with Valero Energy and increased headcount.

Refined Product Pipelines Segment

Revenues increased 8% due to commencement of operations of the Dos Laredos pipeline system, which began operations on June 1, 2004, and increased throughputs in the Denver pipeline system resulting from higher throughputs from Valero Energy’s McKee refinery to the Denver market and additional volumes from other suppliers.

Operating expenses increased 9% due to higher overhead costs resulting from the amendment to the Services Agreement with Valero Energy and higher environmental expense related to spills on two refined product pipelines. Lower regulatory and maintenance expense and lower chemical expense partially offset the above operating expense increases.

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Refined Product Terminals Segment

Revenues increased 13% primarily due to a full quarter of operations of Royal Trading asphalt terminals and higher additive rates, which became effective April 1, 2004.

Operating expenses increased 4% due to higher payroll and related expenses related to the acquisition of the Royal Trading asphalt terminals and higher overhead costs resulting from the amendment to the Services Agreement with Valero Energy. Partially offsetting those increases were decreased regulatory and maintenance expense due to the timing of regulatory maintenance and decreased ad valorem taxes associated with tax settlements.

Depreciation and amortization expense increased due to the acquisition of the Royal Trading asphalt terminals on February 20, 2004, and the commencement of operations of the Dos Laredos pipeline system.

Crude Oil Storage Tanks Segment

Revenues increased 11% due to increased throughputs at Valero Energy’s Benicia and Texas City refineries. Operating expenses increased primarily due to higher regulatory and maintenance expense due to the timing of regulatory maintenance.

Outlook

In April 2005, two of Valero Energy’s refineries served by Valero L.P. underwent previously announced, plant-wide turnarounds. As a result, throughputs and consequently net income for the quarter ended June 30, 2005 is expected to be slightly lower than for the quarter ended March 31, 2005.

Exclusive of the combined results from the Kaneb Mergers, Valero L.P. expects higher earnings for the second half of the year compared to the first half of the year resulting from increases in pipeline tariffs, which go into effect on July 1, 2005, fewer turnarounds at the Valero Energy refineries served by Valero L.P., and higher throughputs due to increased seasonal demand. Additionally, Valero L.P. expects to increase the quarterly cash distribution per unit applicable to limited partners to $0.855 after the Kaneb Mergers are completed.

Liquidity and Capital Resources

General

Cash generated from operations and borrowings under the Credit Facility are Valero L.P.’s primary sources of liquidity. At March 31, 2005, Valero L.P. had a working capital deficit of $20.5 million and had $143.0 million available under its revolving credit facility. The decrease in working capital from $6.4 million at December 31, 2004 was primarily the result of the classification of $32.0 million of outstanding borrowings under the $175.0 Million Revolving Credit Facility as a current liability due to its maturity date of January 15, 2006. On December 20, 2004, Valero L.P. entered into a 5-year Revolving Credit Agreement (the “2005 Revolving Credit Agreement”), which is subject to completion of the Kaneb Mergers, with aggregate commitments of $400.0 million and a maturity date five years after the effective date (as defined in the 2005 Revolving Credit Agreement). Once the 2005 Revolving Credit Agreement becomes effective, the amounts outstanding under the $175.0 Million Revolving Credit Agreement will be paid in full and that facility will be terminated.

$175.0 Million Revolving Credit Facility

As of March 31, 2005, Valero Logistics had outstanding borrowings of $32.0 million under its $175.0 million revolving credit facility. The weighted-average interest rate related to outstanding borrowings under the revolving credit facility during the three months ended March 31, 2005 and 2004 was 3.5% and 2.1%, respectively.

Cash Flows for the Three Months Ended March 31, 2005 and 2004

Net cash provided by operating activities for the three months ended March 31, 2005 was $15.3 million compared to $13.2 million for the first three months of 2004. The increase in cash generated from operating activities is primarily due to lower working capital requirements due to the changes in the Receivable from Valero Energy and the Payable to Valero Energy partially offset by a reduction in accounts payable and accrued liabilities. Also affecting net cash provided by operating activities were an increase in depreciation expense and a decrease in net income for the reasons previously discussed above under “Results of Operations”.

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The net cash generated by operating activities combined with available cash on hand were used primarily to fund the distributions to the unitholders and the general partner of $19.9 million. Additionally, Valero L.P. used cash from those sources in combination with proceeds from the issuance of long-term debt totaling $4.0 million to fund capital expenditures totaling $4.3 million and pre-acquisition costs associated with the Kaneb Mergers totaling $2.0 million.

As discussed above, net cash provided by operating activities for the first three months of 2004 was $13.2 million. The net cash provided by operations, combined with available cash on hand were used primarily to fund the distribution to the unitholders and the general partner of $18.4 million. Additionally, Valero L.P. used cash from those sources in combination with proceeds from the issuance of long-term debt totaling $43 million to fund $11.6 million of capital expenditures and the acquisition of asphalt terminals from Royal Trading totaling $28.1 million.

Capital Requirements

The petroleum pipeline and terminalling industry is capital-intensive, requiring significant investments to maintain, upgrade or enhance existing operations and to comply with environmental and safety laws and regulations. Valero L.P.’s capital expenditures consist primarily of:

During the first quarter of 2005, Valero L.P. incurred reliability capital expenditures of $1.4 million primarily related to tank and pipeline pump station improvements at numerous locations. Expansion capital expenditures of $2.9 million during the first quarter of 2005 were primarily related to pipeline expansion projects in South Texas.

For 2005, Valero L.P. expects to incur approximately $58.0 million of capital expenditures including approximately $15.0 million for reliability capital expenditures, and approximately $43.0 million for expansion capital expenditures, primarily related to pipeline expansion projects in South Texas. Valero L.P. continuously evaluates its capital budget and makes changes as economic conditions warrant.

Other

Valero L.P. is subject to extensive federal, state and local environmental and safety laws and regulations, including those relating to the discharge of materials into the environment, waste management, pollution prevention measures, pipeline integrity and operator qualifications. Because environmental and safety laws and regulations are becoming more complex and stringent and new environmental and safety laws and regulations are continuously being enacted or proposed, the level of future expenditures required for environmental, health and safety matters is expected to increase. As of March 31, 2005, Valero L.P. has accrued $0.8 million for environmental matters, which is expected to be spent over the next two years.

Valero L.P.’s primary cash requirements are for reliability and expansion capital expenditures, acquisitions, distributions to partners, debt service and normal operating expenses. Valero L.P. believes it typically generates sufficient cash from its current operations to fund day-to-day operating and general and administrative expenses, reliability capital expenditures and its distribution requirements. Valero L.P. also has available borrowing capacity under its existing revolving credit facility and, to the extent necessary, can raise additional funds through equity or debt offerings under its $750.0 million universal shelf registration statement to fund its strategic capital expenditures, as necessary, or other cash requirements not funded from operations. However, there can be no assurance regarding the availability of any future financings or whether such financings can be made available on terms acceptable to Valero L.P.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

The following table provides information about Valero Logistics’ long-term debt and interest rate derivative instruments, all of which are sensitive to changes in interest rates. For long-term debt, principal cash flows and related weighted-average interest rates by expected maturity dates are presented. For interest rate swaps, the table presents notional amounts and weighted-average interest rates by expected (contractual) maturity dates. Notional amounts are used to calculate the contractual payments to be exchanged under the contract. Weighted-average floating rates are based on implied forward rates in the yield curve at the reporting date.