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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 September 30, 2004
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 333-44634
KANEB PIPE LINE OPERATING PARTNERSHIP, L.P.
(Exact name of registrant as specified in its charter)
DELAWARE 75-2287683
(State or other jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
2435 North Central Expressway
Richardson, Texas 75080
(Address of principal 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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KANEB PIPE LINE OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 2004
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Page No.
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
Consolidated Statements of Income - Three and Nine Months Ended
September 30, 2004 and 2003 1
Condensed Consolidated Balance Sheets - September 30, 2004
and December 31, 2003 2
Condensed Consolidated Statements of Cash Flows - Nine
Months Ended September 30, 2004 and 2003 3
Notes to Consolidated Financial Statements 4
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosure About Market Risk 24
Item 4. Controls and Procedures 24
Part II. Other Information
Item 6. Exhibits 25
KANEB PIPE LINE OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands)
(Unaudited)
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Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- -----------------------------
2004 2003 2004 2003
-------------- ------------- ------------- --------------
Revenues:
Services $ 95,898 $ 89,539 $ 280,654 $ 265,694
Products 71,770 50,865 187,385 162,415
-------------- ------------- ------------- -------------
Total revenues 167,668 140,404 468,039 428,109
-------------- ------------- ------------- -------------
Costs and expenses:
Cost of products sold 65,996 46,835 172,202 146,035
Operating costs 46,407 42,366 132,722 125,564
Depreciation and amortization 14,050 13,188 41,677 39,814
General and administrative 7,069 5,999 19,080 18,041
-------------- ------------- ------------- --------------
Total costs and expenses 133,522 108,388 365,681 329,454
-------------- ------------- ------------- --------------
Operating income 34,146 32,016 102,358 98,655
Interest and other income 125 43 165 132
Interest expense (10,719) (10,660) (31,667) (28,178)
-------------- ------------- ------------- --------------
Income before income taxes and cumulative
effect of change in accounting principle 23,552 21,399 70,856 70,609
Income tax expense (1,261) (1,076) (3,055) (3,815)
-------------- ------------- ------------- --------------
Income before cumulative effect of change
in accounting principle 22,291 20,323 67,801 66,794
Cumulative effect of change in accounting
principle - adoption of new accounting
standard for asset retirement obligations - - - (1,593)
-------------- ------------- ------------- --------------
Net income $ 22,291 $ 20,323 $ 67,801 $ 65,201
============== ============= ============= ==============
See notes to consolidated financial statements.
1
KANEB PIPE LINE OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands)
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September 30, December 31,
2004 2003
----------------- ------------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 46,646 $ 38,626
Accounts receivable 63,071 51,864
Inventories 11,291 9,324
Prepaid expenses and other 8,341 9,205
--------------- ---------------
Total current assets 129,349 109,019
--------------- ---------------
Property and equipment 1,421,928 1,360,319
Less accumulated depreciation 286,268 247,349
--------------- ---------------
Net property and equipment 1,135,660 1,112,970
--------------- ---------------
Investment in affiliates 26,277 25,456
Excess of cost over fair value of net assets of
acquired businesses and other assets 18,990 17,237
--------------- ---------------
$ 1,310,276 $ 1,264,682
=============== ===============
LIABILITIES AND PARTNERS' CAPITAL
Current liabilities:
Accounts payable $ 38,830 $ 27,941
Accrued expenses 35,771 35,673
Accrued distributions payable 26,960 26,344
Accrued interest payable 8,716 9,297
Deferred terminaling fees 8,669 7,061
Payable to general partner 4,321 3,630
--------------- ---------------
Total current liabilities 123,267 109,946
--------------- ---------------
Long-term debt 662,191 617,696
Other liabilities and deferred taxes 43,928 43,451
Commitments and contingencies
Partners' capital 480,890 493,589
--------------- ---------------
$ 1,310,276 $ 1,264,682
=============== ===============
See notes to consolidated financial statements.
2
KANEB PIPE LINE OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
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Nine Months Ended
September 30,
----------------------------------------
2004 2003
------------- --------------
Operating activities:
Net income $ 67,801 $ 65,201
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 41,677 39,814
Equity in earnings of affiliates, net of distributions (821) 123
Deferred income taxes 112 2,361
Cumulative effect of change in accounting principle - 1,593
Changes in working capital components 451 5,540
------------- --------------
Net cash provided by operating activities 109,220 114,632
------------- --------------
Investing activities:
Acquisitions, net of cash acquired (41,066) (1,644)
Capital expenditures (25,754) (32,053)
Other (287) (2,242)
------------- --------------
Net cash used in investing activities (67,107) (35,939)
------------- --------------
Financing activities:
Issuance of debt 45,545 286,360
Payment of debt - (382,831)
Distributions (79,638) (71,899)
Net proceeds from issuance of units by KPP - 109,056
------------- --------------
Net cash used in financing activities (34,093) (59,314)
------------- --------------
Increase in cash and cash equivalents 8,020 19,379
Cash and cash equivalents at beginning of period 38,626 22,028
------------- --------------
Cash and cash equivalents at end of period $ 46,646 $ 41,407
============= ==============
Supplemental cash flow information - cash paid for interest $ 31,389 $ 25,891
============= ==============
See notes to consolidated financial statements.
3
KANEB PIPE LINE OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
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1. SIGNIFICANT ACCOUNTING POLICIES
The unaudited condensed consolidated financial statements of Kaneb Pipe
Line Operating Partnership, L.P. and its subsidiaries (the "Partnership")
for the three and nine month periods ended September 30, 2004 and 2003,
have been prepared in accordance with accounting principles generally
accepted in the United States of America. Significant accounting policies
followed by the Partnership are disclosed in the notes to the consolidated
financial statements included in the Partnership's Annual Report on Form
10-K for the year ended December 31, 2003. In the opinion of the
Partnership'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 Partnership and its consolidated subsidiaries at September 30, 2004,
and the consolidated results of their operations and cash flows for the
periods ended September 30, 2004 and 2003. Operating results for the three
and nine months ended September 30, 2004 are not necessarily indicative of
the results that may be expected for the year ending December 31, 2004.
Certain prior year financial statement items have been reclassified to
conform with the 2004 presentation.
2. FINANCINGS
In March of 2003, Kaneb Pipe Line Partners, L.P. ("KPP"), which holds a 99%
interest in the Partnership, issued 3,122,500 limited partnership units in
a public offering at $36.54 per unit, generating approximately $109.1
million in net proceeds. The proceeds were used to reduce the amount of
indebtedness under the Partnership's bridge facility.
In April of 2003, the Partnership entered into 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 the Partnership and the banks, bears interest at variable
rates and has a variable commitment fee on unused amounts. The credit
facility 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 unitholders. At September 30, 2004, the Partnership was in compliance
with all covenants. Initial borrowings on the credit agreement ($324.2
million) were used to repay all amounts outstanding under the Partnership's
$275 million credit agreement and $175 million bridge loan agreement. At
September 30, 2004, $90.7 million was outstanding under the credit
agreement.
On May 19, 2003, the Partnership issued $250 million of 5.875% senior
unsecured notes due June 1, 2013. The net proceeds from the public
offering, $247.6 million, were used to reduce amounts due under the
revolving credit agreement. 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 the Partnership, 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
unitholders. At September 30, 2004, the Partnership was in compliance with
all covenants. In connection with the offering, on May 8, 2003, the
Partnership entered into a treasury lock contract for the purpose of
locking in the US Treasury interest rate component on $100 million of the
debt. The treasury lock contract, which qualified as a cash flow hedging
instrument under Statement of Financial Accounting Standards ("SFAS") No.
133, was settled on May 19, 2003 with a cash payment by the Partnership of
$1.8 million. The settlement cost of the contract has been recorded as a
component of accumulated other comprehensive income and is being amortized,
as interest expense, over the life of the debt.
3. COMPREHENSIVE INCOME
Comprehensive income for the three and nine months ended September 30, 2004
and 2003, is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
(in thousands)
Net income $ 22,291 $ 20,323 $ 67,801 $ 65,201
Foreign currency translation
adjustment 1,888 359 (404) 7,308
Interest rate hedging transactions 53 52 136 (1,737)
----------- ----------- ----------- -----------
Comprehensive income $ 24,232 $ 20,734 $ 67,533 $ 70,772
=========== =========== =========== ===========
Accumulated other comprehensive income aggregated $12.1 million and $12.4
million at September 30, 2004 and December 31, 2003, respectively.
4. CASH DISTRIBUTIONS
The Partnership makes regular cash distributions in accordance with its
partnership agreement within 45 days after the end of each quarter to
holders of limited partner and general partner interests. Aggregate cash
distributions of $79.6 million and $71.9 million were paid to limited
partner and general partner interests for the nine month periods ended
September 30, 2004 and 2003, respectively.
5. CONTINGENCIES
The operations of the Partnership 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 the Partnership
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 the
Partnership. 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 the Partnership, could result in
substantial costs and liabilities to the Partnership.
Certain subsidiaries of the Partnership were sued in a Texas state court in
1997 by Grace Energy Corporation ("Grace"), the entity from which the
Partnership 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 the Partnership
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
the Partnership'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 the Partnership'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 the
Partnership'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
the Partnership'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 the
Partnership'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, the Partnership'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. The Partnership'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 the Partnership'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. The
Partnership 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. The Partnership 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 the
Partnership'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. The DOT
granted ST Services' request to extend the time to file a motion to
reconsider the final order. ST Services has moved for reconsideration of
the order based on facts which were not previously available to the DOT and
ST Services.
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, the Partnership 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. The Partnership
believes that any costs or damages resulting from these lawsuits will be
covered by insurance and therefore will not materially adversely affect the
Partnership's financial condition. The amounts claimed by PEPCO, if
recovered, would trigger an excess insurance policy which has a $600,000
retention, but the Partnership does not believe that such retention, if
incurred, would materially adversely affect the Partnership's financial
condition.
The Partnership has other contingent liabilities resulting from litigation,
claims and commitments incident to the ordinary course of business.
Management of the Partnership 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 Partnership.
6. BUSINESS SEGMENT DATA
The Partnership conducts business through three principal operations: the
"Pipeline Operations," which consists primarily of the transportation of
refined petroleum products and fertilizer in the Midwestern states as a
common carrier; the "Terminaling Operations," which provides storage for
petroleum products, specialty chemicals and other liquids; and the "Product
Sales Operations," which delivers bunker fuels to ships in the Caribbean
and Nova Scotia, Canada, and sells bulk petroleum products to various
commercial interests.
The Partnership measures segment profit as operating income. Total assets
are those controlled by each reportable segment. Business segment data is
as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
(in thousands)
Business segment revenues:
Pipeline operations $ 30,589 $ 31,449 $ 89,102 $ 88,807
Terminaling operations 65,309 58,090 191,552 176,887
Product sales operations 71,770 50,865 187,385 162,415
----------- ----------- ----------- -----------
$ 167,668 $ 140,404 $ 468,039 $ 428,109
=========== =========== =========== ===========
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
(in thousands)
Business segment profit:
Pipeline operations $ 11,569 $ 14,839 $ 34,803 $ 39,036
Terminaling operations 19,181 15,732 58,541 51,567
Product sales operations 3,396 1,445 9,014 8,052
----------- ----------- ----------- -----------
Operating income 34,146 32,016 102,358 98,655
Interest and other income 125 43 165 132
Interest expense (10,719) (10,660) (31,667) (28,178)
----------- ----------- ----------- -----------
Income before income taxes and
cumulative effect of change in
accounting principle $ 23,552 $ 21,399 $ 70,856 $ 70,609
=========== =========== =========== ===========
September 30, December 31,
2004 2003
------------- ---------------
(in thousands)
Total assets:
Pipeline operations $ 358,474 $ 352,901
Terminaling operations 898,600 874,185
Product sales operations 53,202 37,596
------------- -------------
$ 1,310,276 $ 1,264,682
============= =============
7. ADOPTION OF RECENT ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2003, the Partnership adopted SFAS No. 143 "Accounting
for Asset Retirement Obligations", which establishes requirements for the
removal-type costs associated with asset retirements. At the initial
adoption date of SFAS No. 143, the Partnership recorded an asset retirement
obligation of approximately $5.5 million and recognized a cumulative effect
of change in accounting principle of $1.6 million for its legal obligations
to dismantle, dispose of, and restore certain leased pipeline and
terminaling facilities, including petroleum and chemical storage tanks,
terminaling facilities and barges. The Partnership did not record a
retirement obligation for certain of its pipeline and terminaling assets
because sufficient information is presently not available to estimate a
range of potential settlement dates for the obligation. In these cases, the
obligation will be initially recognized in the period in which sufficient
information exists to estimate the obligation. At September 30, 2004, the
Partnership had no assets that were legally restricted for purposes of
settling asset retirement obligations. The application of SFAS No. 143 did
not have a material impact on the results of operations of the Partnership
for the three and nine months ended September 30, 2004 or 2003.
In December 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46 (revised December 2003), "Consolidation of Variable
Interest Entities" ("FIN 46R"), primarily to clarify the required
accounting for interests in variable interest entities ("VIEs"). This
standard replaces FASB Interpretation No. 46, "Consolidation of Variable
Interest Entities," which was issued in January 2003 to address certain
situations in which a company should include in its financial statements
the assets, liabilities and activities of another entity. For the
Partnership, application of FIN 46R is required for interests in certain
VIEs that are commonly referred to as special-purpose entities, or SPEs, as
of December 31, 2003, and for interests in all other types of VIEs as of
March 31, 2004. The application of FIN 46R did not have a material impact
on the consolidated financial statements of the Partnership.
8. SUBSEQUENT EVENT
On October 31, 2004, Valero L.P. and KPP entered into a definitive
agreement to merge (the "KPP Merger") Valero L.P. and KPP. Under the terms
of the 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 of KPP, the exchange ratio
will remain fixed at 1.0231 Valero L.P. units for each unit of KPP.
In a separate definitive agreement, on October 31, 2004, Valero L.P. agreed
to acquire by merger (the "KSL Merger") all of the outstanding common
shares Kaneb Services LLC ("KSL"), the general partner of the Partnership,
for cash. Under the terms of that agreement, Valero L.P. is offering to
purchase all of the outstanding shares of KSL at $43.31 per share.
The completion of the KPP Merger is subject to the approval of the
unitholders of Valero L.P. and KPP, as well as customary regulatory
approvals including those under the Hart-Scott-Rodino Antitrust
Improvements Act. The completion of the KPP Merger is also subject to
completion of the KSL Merger, which requires the approval of its
shareholders. The general partner of the combined partnership will continue
to be owned by affiliates of Valero Energy Corporation. KPP and KSL will
become wholly owned subsidiaries of Valero L.P.
KANEB PIPE LINE OPERATING PARTNERSHIP, L.P. 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 Pipe Line Operating Partnership,
L.P. (the "Partnership") and notes thereto included elsewhere in this
report.
Overview
The Partnership, a limited partnership, is engaged in the refined petroleum
products and anhydrous ammonia pipeline business and the terminaling of
petroleum products and specialty liquids. Kaneb Pipe Line Partners, L.P.
("KPP"), a master limited partnership, holds a 99% interest as limited
partner in the Partnership. Kaneb Pipe Line Company LLC ("KPL"), now a
wholly owned subsidiary of Kaneb Services LLC ("KSL"), manages and controls
the operations of KPP through its general partner interest and an 18% (at
September 30, 2004) limited partner interest. KPL owns a 1% interest as
general partner of the Partnership and a 1% interest as general partner of
KPP.
The Partnership'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. The Partnership 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. The Partnership'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. The Partnership's pipeline
revenues are based on volumes shipped and the distance over which such
volumes are transported.
The Partnership's terminaling business is one of the largest independent
petroleum products and specialty liquids terminaling businesses in the
United States. In the United States, the Partnership operates 37 facilities
in 20 states. The Partnership also owns and operates six terminals located
in the United Kingdom, eight terminals in Australia and New Zealand, 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 functions typically provided by the
terminal include 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.
The Partnership'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,
the Partnership 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 Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
(in thousands)
Revenues $ 167,668 $ 140,404 $ 468,039 $ 428,109
=========== =========== =========== ===========
Operating Income $ 34,146 $ 32,016 $ 102,358 $ 98,655
=========== =========== =========== ===========
Income before cumulative effect of
change in accounting principle $ 22,291 $ 20,323 $ 67,801 $ 66,794
Cumulative effect of change in
accounting principle - - - (1,593)
----------- ----------- ----------- -----------
Net income $ 22,291 $ 20,323 $ 67,801 $ 65,201
=========== =========== =========== ===========
Capital expenditures, excluding
acquisitions $ 8,414 $ 9,541 $ 25,754 $ 32,053
=========== =========== =========== ===========
For the three months ended September 30, 2004, revenues increased by $27.3
million, or 19%, when compared to the third quarter of 2003, due to a $20.9
million increase in product sales revenues and a $7.2 million increase in
terminaling business revenues, partially offset by a $0.9 million decrease
in pipeline revenues. Operating income for the three months ended September
30, 2004 increased by $2.1 million, or 7%, when compared to the same period
in 2003, due to a $3.4 million increase in terminaling operating income and
a $2.0 million increase in product sales operating income, partially offset
by a $3.3 million decrease in pipeline operating income. Overall, net
income for the three months ended September 30, 2004 increased by $2.0
million, or 10%, when compared to the three months ended September 30,
2003.
For the nine months ended September 30, 2004, revenues increased by $39.9
million, or 9%, when compared to the same 2003 period, due to a $25.0
million increase in product sales revenues, a $14.7 million increase in
terminaling business revenues and a $0.3 million increase in pipeline
revenues. Operating income for the nine months ended September 30, 2004
increased by $3.7 million, or 4%, when compared to the same period in 2003,
due to a $7.0 million increase in terminaling operating income and a $1.0
million increase in product sales operating income, partially offset by a
$4.2 million decrease in pipeline operating income. Interest expense for
the nine months ended September 30, 2004 increased by $3.5 million, when
compared to the nine months ended September 30, 2003. Income before
cumulative effect of change in accounting principle for the nine months
ended September 30, 2004 increased by $1.0 million, or 2%, when compared to
the first nine months of 2003. Overall, net income for the nine months
ended September 30, 2004 increased by $2.6 million, when compared to the
nine months ended September 30, 2003, which included a charge of $1.6
million for the cumulative effect of change in accounting
principle-adoption of new accounting standard for asset retirement
obligations.
Pipeline Operations
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
(in thousands)
Revenues $ 30,589 $ 31,449 $ 89,102 $ 88,807
Operating costs 13,534 11,067 38,201 34,374
Depreciation and amortization 3,649 3,540 10,872 10,548
General and administrative 1,837 2,003 5,226 4,849
----------- ----------- ----------- -----------
Operating income $ 11,569 $ 14,839 $ 34,803 $ 39,036
=========== =========== =========== ===========
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 Surface Transportation Board, 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 and nine month periods ended September 30, 2004,
revenues decreased by $0.9 million and increased by $0.3 million,
respectively, when compared to the same 2003 periods. The decrease for the
three months ended September 30, 2004, when compared to the same period in
2003, is due to decreases in both volumes shipped and the price per ton
received on the anhydrous ammonia pipeline, partially offset by increases
in barrel miles of products shipped on petroleum pipelines. The revenue
increase for the nine months ended September 30, 2004, is due to increases
in barrel miles of products shipped on petroleum pipelines, partially
offset by a decrease in volumes shipped on the anhydrous ammonia pipeline.
Barrel miles on petroleum pipelines totaled 5.9 billion and 5.4 billion for
the three months ended September 30, 2004 and 2003, respectively, and 16.7
billion and 15.8 billion for the nine months ended September 30, 2004 and
2003, respectively. Total volumes shipped on the anhydrous ammonia pipeline
aggregated 246 tons and 288 tons for the three months ended September 30,
2004 and 2003, respectively, and 822 tons and 876 tons for the nine months
ended September 30, 2004 and 2003, respectively.
Operating costs, which include fuel and power costs, materials and
supplies, maintenance and repair costs, salaries, wages and employee
benefits, and property and other taxes, increased by $2.5 million and $3.8
million, respectively, for the three and nine month periods ended September
30, 2004, when compared to the same 2003 periods, due to unusually high
expenses relating to preventive and other maintenance and repairs,
including those required by government regulation, and increases in power
and fuel costs. For the three and nine months ended September 30, 2004,
depreciation and amortization increased by $0.1 million and $0.3 million,
respectively, when compared to the same 2003 periods, 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, decreased by $0.2 million and increased by $0.4
million for the three and nine month periods ended September 30, 2004,
respectively, when compared to the same 2003 periods.
Terminaling Operations
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
(in thousands)
Revenues $ 65,309 $ 58,090 $ 191,552 $ 176,887
Operating costs 31,272 29,338 90,213 84,673
Depreciation and amortization 10,182 9,433 30,162 28,533
General and administrative 4,674 3,587 12,636 12,114
----------- ----------- ----------- -----------
Operating income $ 19,181 $ 15,732 $ 58,541 $ 51,567
=========== =========== =========== ===========
For the three and nine month periods ended September 30, 2004, terminaling
revenues increased by $7.2 million, or 12%, and $14.7 million, or 8%,
respectively, when compared to the same 2003 periods, due to increases in
both tankage utilization and the average price realized per barrel of
tankage utilized. Average tankage utilized for the three and nine month
periods ended September 30, 2004 was 48.7 million and 48.2 million,
respectively, compared to 45.9 million and 47.1 million, respectively, for
the same prior year periods. For the three and nine month periods ended
September 30, 2004, average annualized revenues per barrel of tankage
utilized increased to $5.33 per barrel and $5.31 per barrel, respectively,
compared to $5.02 per barrel and $5.02 per barrel, respectively, for the
same prior year periods, due primarily to favorable market conditions
domestically and in Australia and New Zealand.
For the three and nine month periods ended September 30, 2004, operating
costs increased by $1.9 million and $5.5 million, respectively, when
compared to the same 2003 periods, a result of overall increases in planned
terminal maintenance. For the three and nine months ended September 30,
2004, depreciation and amortization increased by $0.7 million and $1.6
million, respectively, when compared to the same 2003 periods, due to
expansion and routine maintenance capital expenditures. General and
administrative costs for the three and nine month periods ended September
30, 2004, increased by $1.1 million and $0.5 million, respectively, when
compared to the same 2003 periods, due primarily to increases in
personnel-related costs.
Product Sales
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
(in thousands)
Revenues $ 71,770 $ 50,865 $ 187,385 $ 162,415
Cost of products sold 65,996 46,835 172,202 146,035
----------- ----------- ----------- -----------
Gross margin $ 5,774 $ 4,030 $ 15,183 $ 16,380
=========== =========== =========== ===========
Operating income $ 3,396 $ 1,445 $ 9,014 $ 8,052
=========== =========== =========== ===========
For the three and nine months ended September 30, 2004, product sales
revenues increased by $20.9 million and $25.0 million, respectively, when
compared to the same 2003 periods, due to a general increase in price, as
well as an overall increase in volumes sold. For the three and nine months
ended September 30, 2004, gross margin increased by $1.7 million and
decreased by $1.2 million, respectively, when compared to the same 2003
periods, due to variations in prices resulting from the timing of purchases
and sales. Operating income for the three and nine months ended September
30, 2004 increased by $2.0 million and $1.0 million, respectively, when
compared to the same 2003 periods, due to the higher sales volumes. Product
inventories are maintained at minimum levels to meet customer's needs;
however, market prices for petroleum products can fluctuate significantly
in short periods of time.
Interest Expense
For the nine months ended September 30, 2004, interest expense increased by
$3.5 million, when compared to the same 2003 period, due to the May 2003
refinancing of variable rate bank debt with $250 million of 5.875% senior
unsecured notes, partially offset by overall declines in debt levels
outstanding due to KPP's March 2003 issuance of limited partnership units
(see "Liquidity and Capital Resources").
Income Taxes
Partnership operations are not subject to federal or state income taxes.
However, certain operations are conducted through separate taxable
wholly-owned U.S. and foreign corporate subsidiaries. The income tax
expense for these subsidiaries was $1.3 million and $1.1 million for the
three month periods ended September 30, 2004 and 2003, respectively, and
$3.1 million and $3.8 million for the nine months ended September 30, 2004
and 2003, 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
required a subsidiary of the Partnership, which was acquired on February
28, 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 provided that any amounts paid in order to meet
the minimum annual payment were 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 was $109.2 million and $114.6 million for the
nine months ended September 30, 2004 and 2003, respectively. The decrease
in operating cash flows for the nine months ended September 30, 2004, when
compared to the same 2003 period, was due primarily to changes in working
capital components resulting from the timing of cash receipts and
disbursements, partially offset by an overall increase in net income.
Capital expenditures were $25.8 million for the nine months ended September
30, 2004, compared to $32.1 million for the same 2003 period. Such
expenditures included $17.4 million and $13.6 million in maintenance and
environmental expenditures and $8.3 million and $18.5 million in expansion
expenditures for the nine months ended September 30, 2004 and 2003,
respectively. The decrease in capital expenditures for the first nine
months of 2004, when compared to the same 2003 period, is primarily the
result of decreases in planned expansion capital expenditures related to
the 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. The Partnership anticipates that capital expenditures
(including routine maintenance and expansion expenditures, but excluding
acquisitions) will total approximately $30 million to $35 million in 2004.
Future capital expenditures, however, will depend on many factors beyond
the Partnership's control, including, without limitation, demand for
refined petroleum products and terminaling services in the Partnership'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 the
Partnership will have the ability to finance such expenditures through
borrowings, or will choose to do so.
The Partnership makes regular cash distributions in accordance with its
partnership agreement within 45 days after the end of each quarter to
holders of limited partner and general partner interests. Aggregate cash
distributions of $79.6 million and $71.9 million were paid to limited
partner and general partner interests for the nine month periods ended
September 30, 2004 and 2003, respectively.
The Partnership 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 Partnership bank borrowings and/or future public debt
offerings or KPP public equity offerings.
In March of 2003, KPP issued 3,122,500 limited partnership units in a
public offering at $36.54 per unit, generating approximately $109.1 million
in net proceeds. The proceeds were used to reduce the amount of
indebtedness under the Partnership's bridge facility.
In April of 2003, the Partnership entered into 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 the Partnership and the banks, bears interest at variable
rates and has a variable commitment fee on unused amounts. The credit
facility 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 unitholders. At September 30, 2004, the Partnership was in compliance
with all covenants. Initial borrowings on the credit agreement ($324.2
million) were used to repay all amounts outstanding under the Partnership's
$275 million credit agreement and $175 million bridge loan agreement. At
September 30, 2004, $90.7 million was outstanding under the credit
agreement.
On May 19, 2003, the Partnership issued $250 million of 5.875% senior
unsecured notes due June 1, 2013. The net proceeds from the public
offering, $247.6 million, were used to reduce amounts due under the
revolving credit agreement. 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 the Partnership, 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
unitholders. At September 30, 2004, the Partnership was in compliance with
all covenants. In connection with the offering, on May 8, 2003, the
Partnership entered into a treasury lock contract for the purpose of
locking in the US Treasury interest rate component on $100 million of the
debt. The treasury lock contract, which qualified as a cash flow hedging
instrument under Statement of Financial Accounting Standards ("SFAS") No.
133, was settled on May 19, 2003 with a cash payment by the Partnership of
$1.8 million. The settlement cost of the contract has been recorded as a
component of accumulated other comprehensive income and is being amortized,
as interest expense, over the life of the debt.
The following is a schedule by period of the Partnership's debt repayment
obligations and material contractual commitments as of September 30, 2004:
Less than After
Total 1 year 1 -3 years 4 -5 years 5 years
---------- ------------ ----------- ------------ ---------------
(in thousands)
Debt:
Revolving credit facility $ 90,669 $ - $ 90,669 $ - $ -
7.75% senior unsecured
notes 250,000 - - - 250,000
5.875% senior unsecured
notes 250,000 - - - 250,000
Other bank debt 71,522 - 71,522 - -
---------- ------------ ----------- ------------ --------------
Debt subtotal 662,191 - 162,191 - 500,000
---------- ------------ ----------- ------------ --------------
Contractual commitments:
Operating leases 16,434 5,665 9,411 1,075 283
---------- ------------ ----------- ------------ --------------
Contractual commitments
subtotal 16,434 5,665 9,411 1,075 283
---------- ------------ ----------- ------------ --------------
Total $ 678,625 $ 5,665 $ 171,602 $ 1,075 $ 500,283
========== ============ =========== ============ ==============
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 Partnership was not a party to any off-balance sheet transactions at
September 30, 2004.
Critical Accounting Policies and Estimates
The preparation of the Partnership'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 included in the Notes to the Consolidated Financial
Statements of the Partnership's Annual Report on Form 10-K for the year
ended December 31, 2003.
Critical accounting policies are those that are most important to the
portrayal of the Partnership'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 Partnership's most critical
accounting policies pertain to impairment of property and equipment and
environmental costs.
The carrying value of 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 SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets", which was adopted effective January 1,
2002. To the extent that impairment is indicated to exist, an impairment
loss is recognized 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 the Partnership for the three and nine month periods ended September 30,
2004 and 2003. However, future evaluations of carrying value are dependent
on many factors, several of which are out of the Partnership's control,
including demand for refined petroleum products and terminaling services in
the Partnership'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 the Partnership.
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 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 the Partnership's
commitment to a formal plan of action. The application of the Partnership's
environmental accounting policies did not have a material impact on the
results of operations of the Partnership for the three and nine month
periods ended September 30, 2004 and 2003. Although the Partnership
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 the
Partnership could result in substantial costs and liabilities, any of which
could have a material effect on the results of operations of the
Partnership.
Recent Accounting Pronouncement
In December 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46 (revised December 2003), "Consolidation of Variable
Interest Entities" ("FIN 46R"), primarily to clarify the required
accounting for interests in variable interest entities ("VIEs"). This
standard replaces FASB Interpretation No. 46, "Consolidation of Variable
Interest Entities," which was issued in January 2003 to address certain
situations in which a company should include in its financial statements
the assets, liabilities and activities of another entity. For the
Partnership, application of FIN 46R is required for interests in certain
VIEs that are commonly referred to as special-purpose entities, or SPEs, as
of December 31, 2003, and for interests in all other types of VIEs as of
March 31, 2004. The application of FIN 46R did not have a material impact
on the consolidated financial statements of the Partnership.
Subsequent Event
On October 31, 2004, Valero L.P. and KPP entered into a definitive
agreement to merge (the "KPP Merger") Valero L.P. and KPP. Under the terms
of the 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 of KPP, the exchange ratio
will remain fixed at 1.0231 Valero L.P. units for each unit of KPP.
In a separate definitive agreement, on October 31, 2004, Valero L.P. agreed
to acquire by merger (the "KSL Merger") all of the outstanding common
shares KSL, for cash. Under the terms of that agreement, Valero L.P. is
offering to purchase all of the outstanding shares of KSL at $43.31 per
share.
The completion of the KPP Merger is subject to the approval of the
unitholders of Valero L.P. and KPP, as well as customary regulatory
approvals including those under the Hart-Scott-Rodino Antitrust
Improvements Act. The completion of the KPP Merger is also subject to
completion of the KSL Merger, which requires the approval of its
shareholders. The general partner of the combined partnership will continue
to be owned by affiliates of Valero Energy Corporation. KPP and KSL will
become wholly owned subsidiaries of Valero L.P.
The above description of KPP's and KSL's definitive agreements with Valero
L.P. does not purport to be a complete statement of the parties' rights and
obligations under that agreement and the transactions contemplated by it.
The above description is qualified in its entirety by reference to the
definitive agreements. A copy of the KPP agreement is attached as Exhibit
2.1 to KPP's Current Report on Form 8-K filed November 1, 2004, and is
incorporated herein by reference. A copy of the KSL agreement is attached
as Exhibit 2.1 to KSL's Current Report on Form 8-K filed November 1, 2004,
and is incorporated herein by reference.
KANEB PIPE LINE OPERATING PARTNERSHIP, L.P. 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 Partnership is
exposed are interest rates on the Partnership's debt and investment portfolios,
fluctuations of petroleum product prices on inventories held for resale and
fluctuations in foreign currency.
The Partnership's investment portfolio consists of cash equivalents;
accordingly, the carrying amounts approximate fair value. The Partnership's
investments are not material to its financial position or performance. Assuming
variable rate debt of $162.2 million at September 30, 2004, a one percent
increase in interest rates would increase annual net interest expense by
approximately $1.6 million.
The product sales business purchases refined petroleum products for resale as
bunker fuel and sales to commercial interests. Petroleum inventories are
generally held for short periods of time, not exceeding 90 days. As the
Partnership does not engage in derivative transactions to hedge the value of the
inventory, it is subject to market risk from changes in global oil markets.
A portion of the terminaling business is exposed to fluctuations in foreign
currency exchange rates. Such fluctuations were not significant for the three
and nine months ended September 30, 2004 or 2003.
Item 4. Controls and Procedures
Kaneb Pipe Line Company LLC's principal executive officer and principal
financial officer, after evaluating, as of September 30, 2004, the effectiveness
of the Partnership'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 Partnership's disclosure controls and procedures are
adequate and effective to ensure that material information relating to the
Partnership and its consolidated subsidiaries would be made known to them by
others within those entities.
During the quarter ended September 30, 2004, there have been no changes in the
Partnership's internal controls over financial reporting that have materially
affected, or are reasonably likely to materially affect, those internal controls
subsequent to the date of the evaluation. As a result, no corrective actions
were required or undertaken.
KANEB PIPE LINE OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Part II - Other Information
Item 6. Exhibits
3.1 Amended and Restated Agreement of Limited Partnership dated September
27, 1989, filed as Exhibit 3.1 to Registrant's Form 10-K for the year
ended December 31, 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 November 8, 2004.
31.2 Certification of Chief Financial Officer, Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002, dated November 8, 2004.
32.1 Certification of Chief Executive Officer, Pursuant to Section 906(a)
of the Sarbanes-Oxley Act of 2002, dated November 8, 2004.
32.2 Certification of Chief Financial Officer, Pursuant to Section 906(a)
of the Sarbanes-Oxley Act of 2002, dated November 8, 2004.
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 PIPE LINE OPERATING
PARTNERSHIP, L.P.
(Registrant)
By KANEB PIPE LINE COMPANY LLC
(General Partner)
Date: November 8, 2004 //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, Edward D. Doherty, Chief Executive Officer of Kaneb Pipe Line Company LLC, as
General Partner for Kaneb Pipe Line Operating Partnership, L.P. certify that:
1. I have reviewed this quarterly report on Form 10-Q of Kaneb Pipe Line
Operating Partnership, L.P.;
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)) 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) [intentionally omitted pursuant to SEC Release No. 34-47986];
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: November 8, 2004
//s// EDWARD D. DOHERTY
-----------------------------------
Edward D. Doherty
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 Pipe Line Company LLC,
as General Partner for Kaneb Pipe Line Operating Partnership, L.P. certify that:
1. I have reviewed this quarterly report on Form 10-Q of Kaneb Pipe Line
Operating Partnership, L.P.;
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)) 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) [intentionally omitted pursuant to SEC Release No. 34-47986];
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: November 8, 2004
//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 Pipe Line Company
LLC, as General Partner of Kaneb Pipe Line Operating Partnership, L.P. (the
"Partnership"), hereby certifies that, to his knowledge, the Partnership's
Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2004,
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 Partnership.
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 Pipe Line Operating
Partnership, L.P. and will be retained by Kaneb Pipe Line Operating Partnership,
L.P. and furnished to the Securities and Exchange Commission or its staff upon
request.
Date: November 8, 2004
//s// EDWARD D. DOHERTY
-----------------------------------
Edward D. Doherty
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 Pipe Line Company
LLC, as General Partner of Kaneb Pipe Line Operating Partnership, L.P. (the
"Partnership"), hereby certifies that, to his knowledge, the Partnership's
Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2004,
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 Partnership.
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 Pipe Line Operating
Partnership, L.P. and will be retained by Kaneb Pipe Line Operating Partnership,
L.P. and furnished to the Securities and Exchange Commission or its staff upon
request.
Date: November 8, 2004
//s// HOWARD C. WADSWORTH
---------------------------------------
Howard C. Wadsworth
Vice President, Treasurer and Secretary
(Chief Financial Officer)