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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 001-16405
KANEB SERVICES LLC
(Exact name of registrant as specified in its charter)
Delaware 75-2931295
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
2435 North Central Expressway
Richardson, Texas 75080
- ---------------------------------------- --------------------------
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (972) 699-4062
Securities registered pursuant to Section
12(b) of the Act:
Title of each class Name of each exchange on which registered
- ------------------------- ----------------------------------------------
Shares New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
X Yes No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Subsection 229.405 of this chapter) is not contained
herein, and will not be contained, to the best of registrant's knowledge, in
definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K.
X Yes No
------ -------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
X Yes No
------ -------
Aggregate market value of the voting shares held by non-affiliates of the
registrant: $318,093,909. This figure is estimated as of June 30, 2003, at which
date the closing price of the registrant's shares on the New York Stock Exchange
was $29.19 per share and assumes that only officers and directors of the
registrant were affiliates of the registrant.
Number of Shares of the Registrant outstanding at March 5, 2004:
11,549,120.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III (Items 10, 11, 12 and 13) of Form 10-K
is incorporated by reference from portions of the Registrant's definitive proxy
statement to be filed with the Securities and Exchange Commission not later than
120 days after the close of the fiscal year covered by this Report.
PART I
Item 1. Business
GENERAL
Kaneb Services LLC (the "Company") is a limited liability company
organized under the laws of the State of Delaware. The Company manages and
operates a refined petroleum products and anhydrous ammonia pipeline business
and the terminaling of petroleum products and specialty liquids terminal storage
business through the general partner interest owned by one of its subsidiaries
in Kaneb Pipe Line Partners, L.P., a Delaware limited partnership ("KPP"), which
in turn owns those systems and facilities through its subsidiaries.
KPP is a separate public entity whose limited partner units are traded
over the New York Stock Exchange (NYSE: KPP). The Company's wholly owned
subsidiary, Kaneb Pipe Line Company LLC, a Delaware limited liability company,
("KPL"), owns the general partner interest and 5.1 million limited partner units
of KPP. For financial statement purposes, the assets, liabilities and earnings
of KPP are included in the Company's consolidated financial statements, with the
public unitholders' interest reflected as interest of outside non-controlling
partners in KPP. For purposes of this report, the business, operations, revenues
and other information about KPP are presented as a whole, even though the
Company does not, directly or indirectly, own 100% of KPP. The Company's product
marketing services are conducted by Martin Oil LLC, a Delaware limited liability
company ("Martin"), a 100% owned subsidiary of KPL and, since KPP's acquisition
of Statia (see "Liquidity and Capital Resources"), by Statia which delivers
bunker fuel to ships in the Caribbean and Nova Scotia, Canada and sells bulk
petroleum products to various commercial interests. Martin provides wholesale
motor fuel marketing services throughout the Great Lakes and Rocky Mountain
regions.
PIPELINE BUSINESS
Introduction
KPP's pipeline business consists primarily of the transportation of
refined petroleum products as a common carrier in Kansas, Nebraska, Iowa, South
Dakota, North Dakota, Colorado, Wyoming and Minnesota. On December 24, 2002, KPP
acquired the Northern Great Plains Product System from Tesoro Refining and
Marketing Company for approximately $100 million. This product pipeline system
is now referred to as KPP's North Pipeline. On November 1, 2002, KPP acquired a
2,000 mile anhydrous ammonia pipeline from Koch Pipeline Company, LP and Koch
Fertilizer Storage and Terminal Company for approximately $139 million. KPP's
three refined petroleum products pipelines and the anhydrous ammonia pipeline
are described below.
East Pipeline
Construction of the East Pipeline commenced in 1953 with a line from
southern Kansas to Geneva, Nebraska. During subsequent years, the East Pipeline
was extended northward to its present terminus at Jamestown, North Dakota, west
to North Platte, Nebraska and east into the State of Iowa. The East Pipeline,
which moves refined products from south to north, now consists of 2,090 miles of
pipeline ranging in size from 6 inches to 16 inches.
The East Pipeline system also consists of 17 product terminals in
Kansas, Nebraska, Iowa, South Dakota and North Dakota with total storage
capacity of approximately 3.5 million barrels and an additional 23 product tanks
with total storage capacity of approximately 1,118,393 barrels at its tank farm
installations at McPherson and El Dorado, Kansas. The system also has six origin
pump stations in Kansas and 38 booster pump stations throughout the system.
Additionally, the system maintains various office and warehouse facilities, and
an extensive quality control laboratory.
The East Pipeline transports refined petroleum products, including
propane, received from refineries in southeast Kansas and other connecting
pipelines to its terminals along the system and to receiving pipeline
connections in Kansas. Shippers on the East Pipeline obtain refined petroleum
products from refineries connected to the East Pipeline or through other
pipelines directly connected to the pipeline system. Five connecting pipelines
can deliver propane for shipment through the East Pipeline from gas processing
plants in Texas, New Mexico, Oklahoma and Kansas.
Much of the refined petroleum products delivered through the East
Pipeline are ultimately used as fuel for railroads or in agricultural
operations, including fuel for farm equipment, irrigation systems, trucks used
for transporting crops and crop drying facilities. Demand for refined petroleum
products for agricultural use, and the relative mix of products required, is
affected by weather conditions in the markets served by the East Pipeline.
Government agricultural policies and crop prices also affect the agricultural
sector. Although periods of drought suppress agricultural demand for some
refined petroleum products, particularly those used for fueling farm equipment,
the demand for fuel for irrigation systems often increases during such times.
The mix of refined petroleum products delivered varies seasonally, with
gasoline demand peaking in early summer, diesel fuel demand peaking in late
summer and propane demand higher in the fall. In addition, weather conditions in
the areas served by the East Pipeline affect both the demand for and the mix of
the refined petroleum products delivered through the East Pipeline, although
historically any impact on total volumes shipped has been short-term. Tariffs
charged to shippers for transportation of products do not vary according to the
type of product delivered.
West Pipeline
KPP acquired the West Pipeline in February 1995, increasing KPP's
pipeline business in South Dakota and expanding it into Wyoming and Colorado.
The West Pipeline system includes approximately 550 miles of pipeline in
Wyoming, Colorado and South Dakota, four truck-loading terminals and numerous
pump stations situated along the system. The system's four product terminals
have a total storage capacity of over 1.7 million barrels.
The West Pipeline originates near Casper, Wyoming, where it serves as a
connecting point with Sinclair's Little America Refinery and the Seminoe
Pipeline which transports product from Billings, Montana area refineries. At
Douglas, Wyoming, a 6 inch pipeline branches off to serve KPP's Rapid City,
South Dakota terminal approximately 190 miles away. The 6 inch pipeline also
receives product from Wyoming Refining's pipeline at a connection located near
the Wyoming/South Dakota border. From Douglas, KPP's pipeline continues
southward through a delivery point at the Burlington Northern junction to
terminals at Cheyenne, Wyoming, the Denver metropolitan area and Fountain,
Colorado.
The West Pipeline system parallels KPP's East Pipeline to the west. The
East Pipeline's North Platte line terminates in western Nebraska, approximately
200 miles east of the West Pipeline's Cheyenne, Wyoming Terminal. The West
Pipeline serves Denver and other eastern Colorado markets and supplies jet fuel
to Ellsworth Air Force Base at Rapid City, South Dakota, as compared to the East
Pipeline's largely agricultural service area. The West Pipeline has a relatively
small number of shippers who, with few exceptions, are also shippers on the
Partnership's East Pipeline system.
North Pipeline
The North Pipeline, acquired by KPP in December 2002, runs from west to
east approximately 440 miles from its origin at the Tesoro Refining and
Marketing Company's Mandan, North Dakota refinery to the Minneapolis, Minnesota
area. It has four product terminals, one in North Dakota and three in Minnesota,
with a total tankage capacity of 1.3 million barrels. The North Pipeline crosses
KPP's East Pipeline near Jamestown, North Dakota where the two pipelines are
connected. The North Pipeline is presently supplied exclusively by the Mandan
refinery, however, it is capable of delivering or receiving products to or from
the East Pipeline.
Ammonia Pipeline
In November 2002, KPP acquired the anhydrous ammonia pipeline (the
"Ammonia Pipeline") from two Koch companies. Anhydrous ammonia is primarily used
as agricultural fertilizer through direct application. Other uses are as a
component of various types of dry fertilizer as well as use as a cleaning agent
in power plant scrubbers. The 2,000 mile pipeline originates in the Louisiana
delta area where it has access to three marine terminals on the Mississippi
River. It moves north through Louisiana and Arkansas into Missouri, where at
Hermann, Missouri, one branch splits going east into Illinois and Indiana, and
the other branch continues north into Iowa and then turning west into Nebraska.
KPP acquired a storage and loading terminal near Hermann, Missouri which was
leased back to Koch Nitrogen. The operations headquarters for the Ammonia
Pipeline is located in Hermann, Missouri. The Ammonia Pipeline is connected to
twenty-two other third party owned terminals and also has several industrial
facility delivery locations. Product is primarily supplied to the pipeline from
plants in Louisiana and foreign-source product delivered through the marine
terminals.
Other Systems
KPP also owns three single-use pipelines, located near Umatilla,
Oregon; Rawlins, Wyoming and Pasco, Washington, each of which supplies diesel
fuel to a railroad fueling facility. The Oregon and Washington lines are fully
automated, however the Wyoming line utilizes a coordinated startup procedure
between the refinery and the railroad. For the year ended December 31, 2003,
these three systems combined transported a total of 3.7 million barrels of
diesel fuel, representing an aggregate of $1.5 million in revenues.
Pipelines Products and Activities
The revenues for the East Pipeline, West Pipeline, North Pipeline,
Ammonia Pipeline and Other Pipelines (collectively, the "Pipelines") are based
upon volumes and distances of product shipped. The following table reflects the
total volume, barrel miles of refined petroleum products shipped and total
operating revenues earned by the Pipelines for each of the periods indicated,
but does not include any information on the Ammonia Pipeline. In addition
information on the North Pipeline system prior to 2003 is not included. During
the year of 2003, the Ammonia Pipeline shipped 1,155,160 tons of ammonia
generating $21.3 million of revenue.
Year Ended December 31,
------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------- ------------- -------------- ------------- --------------
Volume (1).................. 102,928 89,780 92,116 89,192 85,356
Barrel miles (2)............ 21,327 18,275 18,567 17,843 18,440
Revenues (3)................ $98,329 $78,240 $74,976 $70,685 $67,607
(1) Volumes are expressed in thousands of barrels of refined petroleum product.
(2) Barrel miles are shown in millions. A barrel mile is the movement of one
barrel of refined petroleum product one mile.
(3) Revenues are expressed in thousands of dollars.
The following table sets forth volumes of propane and various types of
other refined petroleum products transported by the Pipelines during each of the
periods indicated:
Year Ended December 31,
(thousands of barrels)
------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------- ------------- -------------- ------------- --------------
Gasoline.................... 53,205 45,106 46,268 44,215 41,472
Diesel and fuel oil......... 46,072 40,450 42,354 41,087 40,435
Propane..................... 3,651 4,224 3,494 3,890 3,449
------------- ------------- -------------- ------------- --------------
Total....................... 102,928 89,780 92,116 89,192 85,356
============= ============= ============== ============= ==============
Diesel and fuel oil are used in farm machinery and equipment,
over-the-road transportation, railroad fueling and residential fuel oil.
Gasoline is primarily used in over-the-road transportation and propane is used
for crop drying, residential heating and to power irrigation equipment. The mix
of refined petroleum products delivered varies seasonally, with gasoline demand
peaking in early summer, diesel fuel demand peaking in late summer and propane
demand higher in the fall. In addition, weather conditions in the areas served
by the East Pipeline affect both the demand for and the mix of the refined
petroleum products delivered through the East Pipeline, although historically
any overall impact on the total volumes shipped has been short-term. Tariffs
charged to shippers for transportation of products do not vary according to the
type of product delivered. Demand on the North Pipeline is mainly of the same
agricultural nature as the East Pipeline except for the Minneapolis terminal
area which is more metropolitan.
Maintenance and Monitoring
The Pipelines have been constructed and are maintained in a manner
consistent with applicable federal, state and local laws and regulations,
standards prescribed by the American Petroleum Institute and accepted industry
practice. Further, protective measures are taken and routine preventive
maintenance is performed on the Pipelines in order to prolong their useful
lives. Such measures include cathodic protection to prevent external corrosion,
inhibitors to prevent internal corrosion and periodic inspection of the
Pipelines. Additionally, the Pipelines are patrolled at regular intervals to
identify equipment or activities by third parties that, if left unchecked, could
result in encroachment upon the Pipeline's rights-of-way and possible damage to
the Pipelines.
KPP uses state-of-the-art Supervisory Control and Data Acquisition
remote supervisory control software programs to continuously monitor and control
the Pipelines from the Wichita, Kansas headquarters and from the Roseville,
Minnesota terminal for the North Pipeline. The system monitors quantities of
products injected in and delivered through the Pipelines and automatically
signals the Wichita or Roseville personnel upon deviations from normal
operations that requires attention.
Pipeline Operations
For pipeline operations, integrity management and public safety, the
East Pipeline, the West Pipeline, the North Pipeline and the Ammonia Pipeline
are subject to federal regulation by one or more of the following governmental
agencies or laws: the Federal Energy Regulatory Commission ("FERC"), the Surface
Transportation Board, the Department of Transportation, the Environmental
Protection Agency, and the Homeland Security Act. Additionally, the operations
and integrity of the Pipelines are subject to the respective state jurisdictions
along the route of the systems. See "Regulation."
Except for the three single-use pipelines and certain ethanol
facilities, all of KPP's pipeline operations constitute common carrier
operations and are subject to federal tariff regulation. In May 1998, KPP was
authorized by the FERC to adopt market-based rates in approximately one-half of
its markets on the East and West systems. Common carrier activities are those
for which transportation through KPP's Pipelines is available at published
tariffs filed, in the case of interstate petroleum product shipments, with the
FERC or, in the case of intrastate petroleum product shipments in Kansas,
Colorado, Wyoming and North Dakota, with the relevant state authority, to any
shipper of refined petroleum products who requests such services and satisfies
the conditions and specifications for transportation. The Ammonia Pipeline is
subject to federal regulation by the Surface Transportation Board, rather than
the FERC.
In general, a shipper on one of KPP's refined petroleum products
pipelines delivers products to the pipeline from refineries or third party
pipelines that connect to the Pipelines. The Pipelines' refined petroleum
products operations also include 25 truck-loading terminals through which
refined petroleum products are delivered to storage tanks and then loaded into
petroleum transport trucks. Five of the 25 terminals also receive propane into
storage tanks and then load it into transport trucks. The Ammonia Pipeline
receives product from anhydrous ammonia plants or from the marine terminals for
imported product. Tariffs for transportation are charged to shippers based upon
transportation from the origination point on the pipeline to the point of
delivery. Such tariffs also include charges for terminaling and storage of
product at the Pipeline's terminals. Pipelines are generally the lowest cost
method for intermediate and long-haul overland transportation of refined
petroleum products.
Each shipper transporting product on a pipeline is required to supply
KPP with a notice of shipment indicating sources of products and destinations.
All shipments are tested or receive refinery certifications to ensure compliance
with KPP's specifications. Petroleum shippers are generally invoiced by KPP
immediately upon the product entering one of the Petroleum Pipelines.
The following table shows the number of tanks owned by KPP at each
refined petroleum product terminal location at December 31, 2003, the storage
capacity in barrels and truck capacity of each terminal location.
Location of Number Tankage Truck
Terminals of Tanks Capacity Capacity(a)
- ---------------------------------------- -------- ------------- -----------
Colorado:
Dupont 18 692,000 6
Fountain 13 391,000 5
Iowa:
LeMars 9 103,000 2
Milford(b) 11 172,000 2
Rock Rapids 12 366,000 2
Kansas:
Concordia(c) 7 79,000 2
Hutchinson 9 161,000 2
Salina 10 98,000 3
Minnesota
Moorhead 17 498,000 3
Sauk Centre 11 114,000 2
Roseville 13 594,000 5
Nebraska:
Columbus(d) 12 191,000 2
Geneva 39 678,000 6
Norfolk 16 187,000 4
North Platte 22 197,000 5
Osceola 8 79,000 2
North Dakota:
Jamestown(e) 19 315,000 4
South Dakota:
Aberdeen 12 181,000 2
Mitchell 8 72,000 2
Rapid City 13 256,000 3
Sioux Falls 9 381,000 2
Wolsey 21 149,000 4
Yankton 25 246,000 4
Wyoming:
Cheyenne 15 345,000 2
------ -----------
Totals 349 6,545,000
====== ===========
(a) Number of trucks that may be simultaneously loaded.
(b) This terminal is situated on land leased through August 7, 2007 at an
annual rental of $2,400. KPP has the right to renew the lease upon its
expiration for an additional term of 20 years at the same annual rental
rate.
(c) This terminal is situated on land leased through the year 2060 for a total
rental of $2,000.
(d) Also loads rail tank cars.
(e) Two terminals
The East Pipeline also has intermediate storage facilities consisting
of 13 storage tanks at El Dorado, Kansas and 10 storage tanks at McPherson,
Kansas, with aggregate capacities of approximately 584,393 and 534,000 barrels,
respectively. During 2003, approximately 56.7%, 91.7% and 85.5% of the
deliveries of the East, the West and the North Pipelines, respectively, were
made through their terminals, and the remainder of the respective deliveries of
such lines were made to other pipelines and customer owned storage tanks.
Storage of product at terminals pending delivery is considered by KPP
to be an integral part of the petroleum product delivery service of the
pipelines. Shippers generally store refined petroleum products for less than one
week. Ancillary services, including injection of shipper-furnished and generic
additives, are available at each terminal.
KPP owns 1,500 tons of ammonia storage at the terminal near Hermann,
Missouri. One half of the capacity is leased to Koch Nitrogen to support their
leased terminal obligations.
Demand for and Sources of Refined Petroleum Products
KPP's pipeline business depends in large part on the level of demand
for refined petroleum products in the markets served by the pipelines and the
ability and willingness of refiners and marketers having access to the pipelines
to supply such demand by deliveries through the pipelines.
Much of the refined petroleum products delivered through the East
Pipeline and the western three terminals on the North Pipeline is ultimately
used as fuel for railroads or in agricultural operations, including fuel for
farm equipment, irrigation systems, trucks used for transporting crops and crop
drying facilities. Demand for refined petroleum products for agricultural use,
and the relative mix of products required, is affected by weather conditions in
the markets served by the East and North Pipeline. The agricultural sector is
also affected by government agricultural policies and crop prices. Although
periods of drought suppress agricultural demand for some refined petroleum
products, particularly those used for fueling farm equipment, the demand for
fuel for irrigation systems often increases during such times.
While there is some agricultural demand for the refined petroleum
products delivered through the West Pipeline, as well as military jet fuel
volumes, most of the demand is centered in the Denver and Colorado Springs area.
Because demand on the West Pipeline and the Minneapolis area terminal of the
North Pipeline is significantly weighted toward urban and suburban areas, the
product mix on the West Pipeline and that terminal includes a substantially
higher percentage of gasoline than the product mix on the East Pipeline.
KPP's refined petroleum products pipelines are also dependent upon
adequate levels of production of refined petroleum products by refineries
connected to the Pipelines, directly or through connecting pipelines. The
refineries are, in turn, dependent upon adequate supplies of suitable grades of
crude oil. The refineries connected directly to the East Pipeline obtain crude
oil from producing fields located primarily in Kansas, Oklahoma and Texas, and,
to a much lesser extent, from other domestic or foreign sources. In addition,
refineries in Kansas, Oklahoma and Texas are also connected to the East Pipeline
through other pipelines. These refineries obtain their supplies of crude oil
from a variety of sources. The refineries connected directly to the West
Pipeline are located in Casper and Cheyenne, Wyoming and Denver, Colorado.
Refineries in Billings and Laurel, Montana are connected to the West Pipeline
through other pipelines. These refineries obtain their supplies of crude oil
primarily from Rocky Mountain sources. The North Pipeline is heavily dependent
on the Tesoro Mandan refinery which primarily operates on North Dakota crude oil
although it has the ability to access other crude oils. If operations at any one
refinery were discontinued, KPP believes (assuming unchanged demand for refined
petroleum products in markets served by the refined petroleum products
pipelines) that the effects thereof would be short-term in nature, and KPP's
business would not be materially adversely affected over the long term because
such discontinued production could be replaced by other refineries or by other
sources.
The majority of the refined petroleum product transported through the
East Pipeline in 2003 was produced at three refineries located at McPherson and
El Dorado, Kansas and Ponca City, Oklahoma, and operated by the National
Cooperative Refining Association ("NCRA"), Frontier Refining and
Conoco/Phillips, Inc. respectively. The NCRA and Frontier Refining refineries
are connected directly to the East Pipeline. The McPherson, Kansas refinery
operated by NCRA accounted for approximately 30.1% of the total amount of
product shipped over the East Pipeline in 2003. The East Pipeline also has
direct access by third party pipelines to four other refineries in Kansas,
Oklahoma and Texas and to Gulf Coast supplies of products through connecting
pipelines that receive products from pipelines originating on the Gulf Coast.
Five connecting pipelines can deliver propane from gas processing plants in
Texas, New Mexico, Oklahoma and Kansas to the East Pipeline for shipment.
The majority of the refined petroleum products transported through the
West Pipeline is produced at the Frontier Refinery located at Cheyenne, Wyoming,
the Valero Energy Corporation and Suncor Refineries located at Denver, Colorado,
and Sinclair's Little America Refinery located at Casper, Wyoming, all of which
are connected directly to the West Pipeline. The West Pipeline also has access
to three Billings, Montana, area refineries through a connecting pipeline.
Demand for and Sources of Anhydrous Ammonia
KPP's Ammonia Pipeline business depends on the level of demand for
direct application of anhydrous ammonia as a fertilizer for crop production
("Direct Application" or "DA"), the weather (DA is not effective if the ground
is too wet or too dry) and the price of natural gas (the primary component of
anhydrous ammonia).
The Ammonia Pipeline is the largest of three anhydrous ammonia
pipelines in the United States and the only one that has the capability of
receiving foreign production directly into the system and transporting anhydrous
ammonia into the nation's corn belt. This ability to receive either domestic or
foreign anhydrous ammonia is a competitive advantage over the next largest
ammonia system which originates in Oklahoma and extends into Iowa.
Corn producers have several fertilizer alternatives such as liquid, dry
or Direct Application. Liquid and dry fertilizers are both upgrades of anhydrous
ammonia and therefore are generally more costly but are less sensitive to
weather conditions during application. DA is the cheapest method of fertilizer
application but cannot be applied if the ground is too wet or extremely dry.
Principal Customers
KPP had a total of approximately 55 shippers in 2003. The principal
shippers include four integrated oil companies, four refining companies, three
large farm cooperatives and one railroad. Transportation revenues attributable
to the top 10 shippers were $86.6 million, $61.5 million and $51.5 million,
which accounted for 72%, 74% and 69% of total KPP revenues shipped for each of
the years 2003, 2002 and 2001, respectively.
Competition and Business Considerations
The East and North Pipelines' major competitor is an independent,
regulated common carrier pipeline system owned by Magellan Midstream Partners,
L.P. ("Magellan"), formerly the Williams Companies, Inc., that operates
approximately 100 miles east of and parallel to the East Pipeline and in close
proximity to the North Pipeline. The Magellan system is a substantially more
extensive system than the East and North Pipelines. Competition with Magellan is
based primarily on transportation charges, quality of customer service and
proximity to end users, although refined product pricing at either the origin or
terminal point on a pipeline may outweigh transportation costs. Twenty-one of
the East Pipeline's and all four of the North Pipeline's delivery terminals are
located within 2 to 145 miles of, and in direct competition with Magellan's
terminals.
The West Pipeline competes with the truck-loading racks of the Cheyenne
and Denver refineries and the Denver terminals of the Chase Terminal Company and
Conoco/Phillips. Valero L.P. terminals in Denver and Colorado Springs, connected
to a Valero L.P. pipeline from their Texas Panhandle Refinery, are major
competitors to the West Pipeline's Denver and Fountain Terminals, respectively.
Because pipelines are generally the lowest cost method for intermediate
and long-haul movement of refined petroleum products, KPP's more significant
competitors are common carrier and proprietary pipelines owned and operated by
major integrated and large independent oil companies and other companies in the
areas where KPP delivers products. Competition between common carrier pipelines
is based primarily on transportation charges, quality of customer service and
proximity to end users. KPP believes high capital costs, tariff regulation,
environmental considerations and problems in acquiring rights-of-way make it
unlikely that other competing pipeline systems comparable in size and scope to
KPP's Pipelines will be built in the near future, provided KPP's Pipelines have
available capacity to satisfy demand and its tariffs remain at reasonable
levels.
The costs associated with transporting products from a loading terminal
to end users limit the geographic size of the market that can be served
economically by any terminal. Transportation to end users from the loading
terminals of KPP is conducted principally by trucking operations of unrelated
third parties. Trucks may competitively deliver products in some of the areas
served by KPP's Pipelines. However, trucking costs render that mode of
transportation not competitive for longer hauls or larger volumes. KPP does not
believe that trucks are, or will be, effective competition to its long-haul
volumes over the long term.
Competitors of the Ammonia Pipeline include another anhydrous ammonia
pipeline which originates in Oklahoma and terminates in Iowa. The competitor
pipeline has the same DA demand and weather issues as the Ammonia Pipeline but
is restricted to domestically produced anhydrous ammonia. Barges and railroads
represent other forms of direct competition to the pipeline under certain market
conditions.
LIQUIDS TERMINALING BUSINESS
Introduction
KPP's terminaling business is conducted through the Support Terminal
Services operation ("ST Services" or "ST") and Statia Terminals International
N.V. ("Statia"). ST Services is one of the largest independent petroleum
products and specialty liquids terminaling companies in the United States.
Statia, acquired on February 28, 2002 for a purchase price of $178 million (net
of cash acquired), plus the assumption of $107 million of debt, owns and
operates KPP's two largest terminals and provides related value-added services,
including crude oil and petroleum product blending and processing, berthing of
vessels at their marine facilities, and emergency and spill response services.
In addition to its terminaling services, Statia sells bunkers, which is the fuel
marine vessels consume, and bulk petroleum products to various commercial
interests.
For the year ended December 31, 2003, KPP's terminaling business
accounted for approximately 41% of KPP's revenues. As of December 31, 2003, ST
operated 37 facilities in 20 states, with a total storage capacity of
approximately 33.9 million barrels. ST also owns and operates six terminals
located in the United Kingdom, having a total capacity of approximately 5.5
million barrels. In September 2002, ST acquired eight terminals in Australia and
New Zealand with a total capacity of approximately 1.2 million barrels for
approximately $47 million in cash. ST Services and its predecessors have a long
history in the terminaling business and handle a wide variety of liquids from
petroleum products to specialty chemicals to edible liquids. At the end of 2003,
Statia's tank capacity was 18.8 million barrels, including an 11.3 million
barrel storage and transshipment facility located on the Netherlands Antilles
island of St. Eustatius, and a 7.5 million barrel storage and transshipment
facility located at Point Tupper, Nova Scotia, Canada.
KPP's terminal facilities provide storage and handling services on a
fee basis for petroleum products, specialty chemicals and other liquids. KPP's
six largest terminal facilities are located on the Island of St. Eustatius,
Netherlands Antilles; in Point Tupper, Nova Scotia, Canada; in Piney Point,
Maryland; in Linden, New Jersey (50% owned joint venture); in Crockett,
California; and in Martinez, California.
Description of Largest Terminal Facilities
St. Eustatius, Netherlands Antilles
Statia owns and operates an 11.3 million barrel petroleum terminaling
facility located on the Netherlands Antilles island of St. Eustatius, which is
located at a point of minimal deviation from major shipping routes. This
facility is capable of handling a wide range of petroleum products, including
crude oil and refined products, and can accommodate the world's largest tankers
for loading and discharging crude oil. A two-berth jetty, a two-berth monopile
with platform and buoy systems, a floating hose station, and an offshore single
point mooring buoy with loading and unloading capabilities serve the terminal's
customers' vessels. The St. Eustatius facility has a total of 51 tanks. The fuel
oil and petroleum product facilities have in-tank and in-line blending
capabilities, while the crude tanks have tank-to-tank blending capability as
well as in-tank mixers. In addition to the storage and blending services at St.
Eustatius, the facility has the flexibility to utilize certain storage capacity
for both feedstock and refined products to support its atmospheric distillation
unit, which is capable of processing up to 15,000 BPD of feedstock, ranging from
condensates to heavy crude oil. Statia owns and operates all of the berthing
facilities at its St. Eustatius terminal and charges vessels a fee for their
use. Vessel owners or charterers may incur separate fees for associated services
such as pilotage, tug assistance, line handling, launch service, emergency
response services, and other ship services.
Point Tupper, Nova Scotia, Canada
Statia owns and operates a 7.5 million barrel terminaling facility
located at Point Tupper on the Strait of Canso, near Port Hawkesbury, Nova
Scotia, Canada, which is located approximately 700 miles from New York City, 850
miles from Philadelphia and 2,500 miles from Mongstad, Norway. This facility is
the deepest independent, ice-free marine terminal on the North American Atlantic
coast, with access to the East Coast and Canada as well as the Midwestern United
States via the St. Lawrence Seaway and the Great Lakes system. With one of the
premier jetty facilities in North America, the Point Tupper facility can
accommodate substantially all of the world's largest, fully-laden very large
crude carriers and ultra large crude carriers for loading and discharging crude
oil, petroleum products, and petrochemicals. The Point Tupper facility has a
total of 37 tanks. Its butane sphere is one of the largest of its kind in North
America. The facility's tanks were renovated in 1994 to comply with construction
standards that meet or exceed American Petroleum Institute, NFPA, and other
material industry standards. Crude oil and petroleum product movements at the
terminal are fully automated. Separate Statia fees apply for the use of the
jetty facility as well as associated services, including pilotage, tug
assistance, line handling, launch service, spill response services, and other
ship services. Statia also charters tugs, mooring launches, and other vessels to
assist with the movement of vessels through the Strait of Canso and the safe
berthing of vessels at Point Tupper and to provide other services to vessels.
Piney Point, Maryland
The largest domestic terminal currently owned by ST is located on
approximately 400 acres on the Potomac River. The facility was acquired as part
of the purchase of the liquids terminaling assets of Steuart Petroleum Company
and certain of its affiliates (collectively "Steuart") in December 1995. The
Piney Point terminal has approximately 5.4 million barrels of storage capacity
in 28 tanks and is the closest deep-water facility to Washington, D.C. This
terminal competes with other large petroleum terminals in the East Coast
water-borne market extending from New York Harbor to Norfolk, Virginia. The
terminal currently stores petroleum products consisting primarily of fuel oils
and asphalt. The terminal has a dock with a 36-foot draft for tankers and four
berths for barges. It also has truck-loading facilities, product-blending
capabilities and is connected to a pipeline which supplies residual fuel oil to
two power generating stations.
Linden, New Jersey
In October 1998, ST entered into a joint venture relationship with
Northville Industries Corp. ("Northville") to acquire a 50% ownership interest
in and the management of the terminal facility at Linden, New Jersey that was
previously owned by Northville. The 44-acre facility provides ST with deep-water
terminaling capabilities at New York Harbor and primarily stores petroleum
products, including gasoline, jet fuel and fuel oils. The facility has a total
capacity of approximately 3.9 million barrels in 22 tanks, can receive products
via ship, barge and pipeline and delivers product by ship, barge, pipeline and
truck. The terminal owns two docks and leases a third with draft limits of 35,
24 and 24 feet, respectively.
Crockett, California
The Crockett Terminal was acquired in January 2001 as a part of the
Shore acquisition. The terminal has approximately 3 million barrels of tankage
and is located in the San Francisco Bay area. The facility provides deep-water
access for handling petroleum products and gasoline additives such as ethanol.
The terminal offers pipeline connections to various refineries and pipelines. It
receives and delivers product by vessel, barge, pipeline and truck-loading
facilities. The terminal also has railroad tank car unloading capability.
Martinez, California
The Martinez Terminal, also acquired in January 2001 as a part of the
Shore acquisition, is located in the refinery area of San Francisco Bay. It has
approximately 3.1 million barrels of tankage and handles refined petroleum
products as well as crude oil. The terminal is connected to a pipeline and to
area refineries by pipelines and can also receive and deliver products by vessel
or barge. It also has a truck rack for product delivery.
KPP's facilities have been designed with engineered structural measures
to minimize the possibility of the occurrence and the level of damage in the
event of a spill or fire. All loading areas, tanks, pipes and pumping areas are
"contained" to collect any spillage and insure that only properly treated water
is discharged from the site.
Other Terminal Sites
In addition to the four major domestic facilities described above, ST
Services has 31 other terminal facilities located throughout the United States,
six facilities in the United Kingdom, four facilities in Australia and four in
New Zealand. These other facilities primarily store petroleum products for a
variety of customers, with the exception of the facilities in Texas City, Texas,
which handles specialty chemicals; Columbus, Georgia, which handles aviation
gasoline and specialty chemicals; Winona, Minnesota, which handles nitrogen
fertilizer solutions; Savannah, Georgia, which handles chemicals and caustic
solutions, as well as petroleum products; Vancouver, Washington, which handles
chemicals and fertilizer; Eastham, United Kingdom which handles chemicals and
animal fats; and Runcorn, United Kingdom, which handles molten sulphur, and the
Australian and New Zealand terminals which handle chemicals and animal fats and
oil. Overall, these facilities provide ST Services with locations which are
diverse geographically, in products handled and in customers served.
The following table outlines KPP's terminal locations, capacities,
tanks and primary products handled:
Tankage No. of Primary Products
Facility Capacity Tanks Handled
- ------------------------------ ------------- ------------- ------------------------------
Major U. S. Terminals:
Piney Point, MD 5,403,000 28 Petroleum
Linden, NJ(a) 3,884,000 22 Petroleum
Crockett, CA 3,048,000 24 Petroleum, Ethanol
Martinez, CA 3,106,000 19 Petroleum
Jacksonville, FL 2,069,000 30 Petroleum
Texas City, TX 2,161,000 136 Chemicals, Petrochemicals,
Petroleum
Other U. S. Terminals:
Montgomery, AL(b) 162,000 7 Petroleum, Jet Fuel
Moundville, AL 310,000 6 Jet Fuel
Tucson, AZ(a) 174,000 7 Petroleum
Los Angeles, CA 597,000 20 Petroleum
Richmond, CA 617,000 25 Petroleum, Ethanol
Stockton, CA 706,000 32 Petroleum, Ethanol, Fertilizer
Bremen, GA 182,000 9 Petroleum, Jet Fuel
Brunswick, GA 302,000 3 Fertilizer, Pulp Liquor
Columbus, GA 175,000 24 Petroleum, Chemicals
Macon, GA(b) 307,000 10 Petroleum, Jet Fuel
Savannah, GA 903,000 28 Petroleum, Chemicals
Blue Island, IL 752,000 19 Petroleum, Ethanol
Chillicothe, IL(a) 270,000 6 Petroleum
Peru, IL 221,000 8 Petroleum, Fertilizer
Indianapolis, IN 410,000 18 Petroleum
Westwego, LA 849,000 53 Molasses, Fertilizer, Caustic,
Chemicals
Andrews AFB Pipeline, MD(b) 72,000 3 Jet Fuel
Baltimore, MD 832,000 50 Chemicals, Asphalt, Jet Fuel
Salisbury, MD 177,000 14 Petroleum
Winona, MN 267,000 8 Fertilizer
Reno, NV 107,000 7 Petroleum
Paulsboro, NJ 1,580,000 18 Petroleum
Alamogordo, NM(b) 120,000 5 Jet Fuel
Drumright, OK 315,000 4 Petroleum
Portland, OR 1,119,000 31 Petroleum
Philadelphia, PA 894,000 11 Petroleum
Dumfries, VA 554,000 16 Petroleum, Asphalt
Virginia Beach, VA(b) 40,000 2 Jet Fuel
Tacoma, WA 377,000 15 Petroleum
Vancouver, WA 543,000 55 Chemicals, Fertilizer, Petroleum
Milwaukee, WI 308,000 7 Petroleum
Tankage No. of Primary Products
Facility Capacity Tanks Handled
- ------------------------------ ------------- ------------- ------------------------------
Foreign Terminals:
St. Eustatius, Netherlands
Antilles. 11,350,000 60 Petroleum, crude oil
Point Tupper, Canada 7,514,000 40 Petroleum, crude oil
Sydney, Australia 330,000 65 Chemicals, fats and oils
Melbourne, Australia 468,000 118 Specialty chemicals
Geelong, Australia 145,000 14 Specialty chemicals, petroleum
Adelaide, Australia 90,000 24 Chemicals, tallow, petroleum
Auckland, New Zealand (a) 74,000 44 Fats, oils and chemicals
New Plymouth, New Zealand 35,000 10 Fats, oils and chemicals
Mt. Maunganui, New Zealand 83,000 24 Fats, oils and chemicals
Wellington, New Zealand 50,000 13 Fats, oils and chemicals
Grays, England 1,945,000 53 Petroleum
Eastham, England 2,185,000 162 Chemicals, Petroleum, Animal Fats
Runcorn, England 146,000 4 Molten sulphur
Glasgow, Scotland 344,000 16 Petroleum
Leith, Scotland 459,000 34 Petroleum, Chemicals
Belfast, Northern Ireland 407,000 41 Petroleum
--------------- --------------
59,538,000 1,502
=============== ==============
(a) The terminal is 50% owned by ST.
(b) Facility also includes pipelines to U.S. government military base
locations.
Customers
Statia provides terminaling services for crude oil and refined
petroleum products to many of the world's largest producers of crude oil,
integrated oil companies, oil traders, and refiners. Statia's crude oil
transshipment customers include an oil producer that leases and utilizes 5.0
million barrels of storage at St. Eustatius, and a major international oil
company which leases and utilizes 3.6 million barrels of storage at Point
Tupper, both of which have long-term contracts with Statia. In addition, two
different international oil companies each lease and utilize 1.0 million barrels
of clean products storage at St. Eustatius and Point Tupper, respectively. Also
in Canada, a consortium consisting of major oil companies sends natural gas
liquids via pipeline to certain processing facilities on land leased from
Statia. After processing, certain products are stored at the Point Tupper
facility under a long-term contract. In addition, Statia's blending capabilities
have attracted customers who have leased capacity primarily for blending
purposes and who have contributed to Statia's bunker fuel and bulk product
sales.
The storage and transport of jet fuel for the U.S. Department of
Defense is an important part of ST's business. Eleven of ST's terminal sites are
involved in the terminaling or transport (via pipeline) of jet fuel for the
Department of Defense and four of the eleven locations have been utilized solely
by the U.S. Government. Of the eleven locations, six include pipelines which
deliver jet fuel directly to nearby military bases.
Competition and Business Considerations
In addition to the terminals owned by independent terminal operators,
such as KPP, many major energy and chemical companies own extensive terminal
storage facilities. Although such terminals often have the same capabilities as
terminals owned by independent operators, they generally do not provide
terminaling services to third parties. In many instances, major energy and
chemical companies that own storage and terminaling facilities are also
significant customers of independent terminal operators, such as KPP. Such
companies typically have strong demand for terminals owned by independent
operators when independent terminals have more cost effective locations near key
transportation links, such as deep-water ports. Major energy and chemical
companies also need independent terminal storage when their owned storage
facilities are inadequate, either because of size constraints, the nature of the
stored material or specialized handling requirements.
Independent terminal owners generally compete on the basis of the
location and versatility of terminals, service and price. A favorably located
terminal will have access to various cost effective transportation modes both to
and from the terminal. Transportation modes typically include waterways,
railroads, roadways and pipelines. Terminals located near deep-water port
facilities are referred to as "deep-water terminals" and terminals without such
facilities are referred to as "inland terminals"; although some inland
facilities located on or near navigable rivers are served by barges.
Terminal versatility is a function of the operator's ability to offer
handling for diverse products with complex handling requirements. The service
function typically provided by the terminal includes, among other things, the
safe storage of the product at specified temperature, moisture and other
conditions, as well as receipt at and delivery from the terminal, all of which
must be in compliance with applicable environmental regulations. A terminal
operator's ability to obtain attractive pricing is often dependent on the
quality, versatility and reputation of the facilities owned by the operator.
Although many products require modest terminal modification, operators with
versatile storage capabilities typically require less modification prior to
usage, ultimately making the storage cost to the customer more attractive.
A few companies offering liquid terminaling facilities have
significantly more capacity than KPP. However, much of KPP's tankage can be
described as "niche" facilities that are equipped to properly handle "specialty"
liquids or provide facilities or services where management believes KPP enjoys
an advantage over competitors. As a result, many of KPP's terminals compete
against other large petroleum products terminals, rather than specialty liquids
facilities. Such specialty or "niche" tankage is less abundant in the U.S. and
"specialty" liquids typically command higher terminal fees than lower-price bulk
terminaling for petroleum products.
The main competition to crude oil storage at Statia's facilities is
from "lightering" which is the process by which liquid cargo is transferred to
smaller vessels, usually while at sea. The price differential between lightering
and terminaling is primarily driven by the charter rates for vessels of various
sizes. Lightering generally takes significantly longer than discharging at a
terminal. Depending on charter rates, the longer charter period associated with
lightering is generally offset by various costs associated with terminaling,
including storage costs, dock charges, and spill response fees. However,
terminaling is generally safer and reduces the risk of environmental damage
associated with lightering, provides more flexibility in the scheduling of
deliveries, and allows customers of Statia to deliver their products to multiple
locations. Lightering in U.S. territorial waters creates a risk of liability for
owners and shippers of oil under the U.S. Oil Pollution Act of 1990 and other
state and federal legislation. In Canada, similar liability exists under the
Canadian Shipping Act. Terminaling also provides customers with the ability to
access value-added terminal services.
In the bunkering business, Statia competes with ports offering bunker
fuels to which, or from which, each vessel travels or are along the route of
travel of the vessel. Statia also competes with bunker delivery locations around
the world. In the Western Hemisphere, alternative bunker locations include ports
on the U.S. East coast and Gulf coast and in Panama, Puerto Rico, the Bahamas,
Aruba, Curacao, and Halifax. In addition, Statia competes with Rotterdam and
various North Sea locations.
PRODUCT MARKETING SERVICES
In March 1998, the Company entered the product marketing business
through an acquisition by Martin, one of the Company's wholly owned
subsidiaries. For over 40 years, this operation and its predecessors have
engaged in the business of acquiring quantities of motor fuels and reselling
them at wholesale in smaller lots at truck racks located in terminal storage
facilities along pipelines primarily located throughout Colorado, Illinois,
Indiana, Ohio, Wisconsin and Wyoming. This business does not own any retail
outlets, pipelines or terminals. KPP's product sales, as discussed in "Liquids
Terminaling Business", delivers bunker fuels to ships in the Caribbean and Nova
Scotia, Canada, and sells bulk petroleum products to various commercial
customers at those locations. In the bunkering business, KPP competes with ports
offering bunker fuels along the route of the vessel. Vessel owners or charterers
are charged berthing and other fees for associated services such as pilotage,
tug assistance, line handling, launch service and emergency response services.
For the year ended December 31, 2003, the product marketing segment's revenues,
gross margin and operating income were $511.2 million, $24.9 million and $12.2
million, respectively.
CAPITAL EXPENDITURES
Capital expenditures by KPP relating to its pipelines, including
routine maintenance and expansion expenditures, but excluding acquisitions, were
$9.6 million, $9.5 million and $4.3 million for 2003, 2002 and 2001,
respectively. During these periods, adequate capacity existed on the Pipelines
to accommodate volume growth, and the expenditures required for environmental
and safety improvements were not material in amount. Capital expenditures,
including routine maintenance and expansion expenditures, but excluding
acquisitions, by KPP relating to its terminaling operations were $34.6 million,
$21.0 million and $12.9 million for 2003, 2002 and 2001, respectively.
Capital expenditures of KPP during 2004, including routine maintenance
and expansion expenditures, but excluding acquisitions, are expected to be
approximately $28 million to $32 million. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources." Additional expansion-related capital expenditures will
depend on future opportunities to expand KPP's operations. Such future
expenditures, however, will depend on many factors beyond KPP's control,
including, without limitation, demand for refined petroleum products and
terminaling services in KPP's market areas, local, state and federal
governmental regulations, fuel conservation efforts and the availability of
financing on acceptable terms. No assurance can be given that required capital
expenditures will not exceed anticipated amounts during the year or thereafter
or that KPP will have the ability to finance such expenditures through
borrowings or choose to do so.
REGULATION
Interstate Regulation
The interstate common carrier petroleum product pipeline operations of
KPP are subject to rate regulation by FERC under the Interstate Commerce Act.
The Interstate Commerce Act provides, among other things, that to be lawful the
rates of common carrier petroleum pipelines must be "just and reasonable" and
not unduly discriminatory. New and changed rates must be filed with the FERC,
which may investigate their lawfulness on protest or its own motion. The FERC
may suspend the effectiveness of such rates for up to seven months. If the
suspension expires before completion of the investigation, the rates go into
effect, but the pipeline can be required to refund to shippers, with interest,
any difference between the level the FERC determines to be lawful and the filed
rates under investigation. Rates that have become final and effective may be
challenged by a complaint to FERC filed by a shipper or on the FERC's own
initiative. Reparations may be recovered by the party filing the complaint for
the two-year period prior to the complaint, if FERC finds the rate to be
unlawful.
The FERC allows for a rate of return for petroleum products pipelines
determined by adding (i) the product of a rate of return equal to the nominal
cost of debt multiplied by the portion of the rate base that is deemed to be
financed with debt and (ii) the product of a rate of return equal to the real
(i.e., inflation-free) cost of equity multiplied by the portion of the rate base
that is deemed to be financed with equity. The appropriate rate of return for a
petroleum pipeline is determined on a case-by-case basis, taking into account
cost of capital, competitive factors and business and financial risks associated
with pipeline operations.
Under Title XVIII of the Energy Policy Act of 1992 (the "EP Act"),
rates that were in effect on October 24, 1991 that were not subject to a
protest, investigation or complaint are deemed to be just and reasonable. Such
rates, commonly referred to as grandfathered rates, are subject to challenge
only for limited reasons. Any relief granted pursuant to such challenges may be
prospective only. Because KPP's rates that were in effect on October 24, 1991,
were not subject to investigation and protest at that time, those rates could be
deemed to be just and reasonable pursuant to the EP Act. KPP's current rates
became final and effective in July 2000, and KPP believes that its currently
effective tariffs are just and reasonable and would withstand challenge under
the FERC's cost-based rate standards. Because of the complexity of rate making,
however, the lawfulness of any rate is never assured.
On October 22, 1993, the FERC issued Order No. 561 which adopted a
simplified rate making methodology for future oil pipeline rate changes in the
form of indexation. Indexation, which is also known as price cap regulation,
establishes ceiling prices on oil pipeline rates based on application of a
broad-based measure of inflation in the general economy to existing rates. Rate
increases up to the ceiling level are to be discretionary for the pipeline, and,
for such rate increases, there will be no need to file cost-of-service or
supporting data. Moreover, so long as the ceiling is not exceeded, a pipeline
may make a limitless number of rate change filings. This indexing mechanism
calculates a ceiling rate. Rate decreases are required if the indexing mechanism
operates to reduce the ceiling rate below a pipeline's existing rates. The
pipeline may increase its rates to this calculated ceiling rate without filing a
formal cost based justification and with limited risk of shipper protests.
The indexation method is to serve as the principal basis for the
establishment of oil pipeline rate changes in the future. However, the FERC
determined that a pipeline may utilize any one of the following alternative
methodologies to indexing: (i) a cost-of-service methodology may be utilized by
a pipeline to justify a change in a rate if a pipeline can demonstrate that its
increased costs are prudently incurred and that there is a substantial
divergence between such increased costs and the rate that would be produced by
application of the index; and (ii) a pipeline may base its rates upon a
"light-handed" market-based form of regulation if it is able to demonstrate a
lack of significant market power in the relevant markets.
On September 15, 1997, KPP filed an Application for Market Power
Determination with the FERC seeking market based rates for approximately half of
its markets. In May 1998, the FERC granted KPP's application and approximately
half of the markets served by the East and West Pipelines subsequently became
subject to market force regulation.
In the FERC's Lakehead decision issued June 15, 1995, the FERC
partially disallowed Lakehead's inclusion of income taxes in its cost of
service. Specifically, the FERC held that Lakehead was entitled to receive an
income tax allowance with respect to income attributable to its corporate
partners, but was not entitled to receive such an allowance for income
attributable to partnership interests held by individuals. Lakehead's motion for
rehearing was denied by the FERC and Lakehead appealed the decision to the U.S.
Court of Appeals. Subsequently, the case was settled by Lakehead and the appeal
was withdrawn. In another FERC proceeding involving a different oil pipeline
limited partnership, various shippers challenged such pipeline's inclusion of an
income tax allowance in its cost of service. The FERC decided this case on the
same basis as its holding in the Lakehead case. If the FERC were to partially or
completely disallow the income tax allowance in the cost of service of the East
and West Pipelines on the basis set forth in the Lakehead order, KPL believes
that KPP's ability to pay distributions to the holders of the Units would not be
impaired; however, in view of the uncertainties involved in this issue, there
can be no assurance in this regard.
The Ammonia Pipeline rates are regulated by the Surface Transportation
Board (the "STB"). The STB was established in 1996 when the Interstate Commerce
Commission was terminated by the ICC Termination Act of 1995. The STB is headed
by Board Members appointed by the President and confirmed by the Senate and is
authorized to have three members. The STB jurisdiction generally includes
railroad rate and service issues, rail restructuring transactions and labor
matters related thereto; certain trucking company, moving van, and
non-contiguous ocean shipping company rate matters; and certain pipeline matters
not regulated by the FERC. In the performance of its functions, the STB is
charged with promoting, where appropriate, substantive and procedural regulatory
reform in the economic regulation of surface transportation, and with providing
an efficient and effective forum for the resolution of disputes. The STB seeks
to facilitate commerce by providing an effective forum for efficient dispute
resolution and facilitation of appropriate market-based business transactions.
KPP issued a STB tariff that became effective April 1, 2003. The tariff
filing combined the STB interstate tariff and the Louisiana intrastate tariff
into one document and standardized the tariff regulation between the two
regulatory bodies. The tariff filing modified the capacity allocation procedures
and established a minimum tariff rate of $5.00 per ton. The tariff filing
implemented a 7% tariff increase across all tariff rates. Another modification
was the removal of the "Industrial User" classification which effectively
increases the tariff rates actually paid for transportation to certain shippers
by more than 7%. Dyno Nobel, an industrial user in Missouri, has filed a protest
against the tariff filing. Dyno's protest centered on basically two issues.
First, it questioned KPP's ability to file a tariff without first obtaining
approval from the STB. Second, it questioned the amount of effective increase on
its particular situation on a cost justification basis. CF Industries also filed
a protest questioning KPP's ability to file a tariff without first obtaining
approval from the STB. KPP believes it has regulatory precedent in making the
tariff filing and can cost justify the tariff rate change. Initial data requests
have been submitted and answered, and summary judgment has been requested on the
issue of KPP's ability to file a tariff change. The cost justification portion
of the Dyno protest will go forward after the resolution of the tariff filing
issue.
Intrastate Regulation
The intrastate operations of the East Pipeline in Kansas are subject to
regulation by the Kansas Corporation Commission, the intrastate operations of
the West Pipeline in Colorado and Wyoming are subject to regulation by the
Colorado Public Utility Commission and the Wyoming Public Service Commission,
respectively, and the intrastate operations of the North Pipeline are subject to
regulation by the North Dakota Public Utility Commission. Like the FERC, the
state regulatory authorities require that shippers be notified of proposed
intrastate tariff increases and have an opportunity to protest such increases.
KPP also files with such state authorities copies of interstate tariff changes
filed with the FERC. In addition to challenges to new or proposed rates,
challenges to intrastate rates that have already become effective are permitted
by complaint of an interested person or by independent action of the appropriate
regulatory authority.
The intrastate operations of the Ammonia Pipeline in Louisiana are
subject to regulation by the Louisiana Public Service Commission. Shippers under
the Louisiana intrastate tariff have similar rights as those mentioned in the
paragraph above.
ENVIRONMENTAL MATTERS
General
The operations of KPP are subject to federal, state and local laws and
regulations relating to the protection of the environment in the United States
and to the environmental laws and regulations of the host countries in regard to
the terminals acquired overseas. Although KPP believes that its operations are
in general compliance with applicable environmental regulations, risks of
substantial costs and liabilities are inherent in pipeline and terminal
operations, and there can be no assurance that significant costs and liabilities
will not be incurred by KPP. Moreover, it is possible that other developments,
such as increasingly strict environmental laws, regulations and enforcement
policies thereunder, and claims for damages to property or persons resulting
from the operations of KPP, past and present, could result in substantial costs
and liabilities to KPP.
See "Item 3 - Legal Proceedings" for information concerning two
lawsuits against certain subsidiaries of KPP involving claims for environmental
damages.
Water
The Oil Pollution Act ("OPA") was enacted in 1990 and amends provisions
of the Federal Water Pollution Control Act of 1972 and other statutes as they
pertain to prevention and response to oil spills. The OPA subjects owners of
facilities to strict, joint and potentially unlimited liability for removal
costs and certain other consequences of an oil spill, where such spill is into
navigable waters, along shorelines or in the exclusive economic zone. In the
event of an oil spill into such waters, substantial liabilities could be imposed
upon KPP. Regulations concerning the environment are continually being developed
and revised in ways that may impose additional regulatory burdens on KPP.
Contamination resulting from spills or releases of refined petroleum
products is not unusual within the petroleum pipeline and liquids terminaling
industries. The East Pipeline and ST Services have experienced limited
groundwater contamination at various terminal and pipeline sites resulting from
various causes including activities of previous owners. Remediation projects are
underway or under construction using various remediation techniques. The costs
to remediate contamination at several ST terminal locations are being borne by
the former owners under indemnification agreements. Although no assurances can
be made, KPP believes that the aggregate cost of these remediation efforts will
not be material.
The EPA has promulgated regulations that may require KPP to apply for
permits to discharge storm water runoff. Storm water discharge permits also may
be required in certain states in which KPP operates. Where such requirements are
applicable, KPP has applied for such permits and, after the permits are
received, will be required to sample storm water effluent before releasing it.
KPP believes that effluent limitations could be met, if necessary, with minor
modifications to existing facilities and operations. Although no assurance in
this regard can be given, KPP believes that the changes will not have a material
effect on KPP's financial condition or results of operations.
Aboveground Storage Tank Acts
A number of the states in which KPP operates in the United States have
passed statutes regulating aboveground tanks containing liquid substances.
Generally, these statutes require that such tanks include secondary containment
systems or that the operators take certain alternative precautions to ensure
that no contamination results from any leaks or spills from the tanks. Although
there is not total federal regulation of all above ground tanks, the DOT has
adopted an industry standard that addresses tank inspection, repair, alteration
and reconstruction. This action requires pipeline companies to comply with the
standard for tank inspection and repair for all tanks regulated by the DOT. KPP
is in substantial compliance with all above ground storage tank laws in the
states with such laws. Although no assurance can be given, KPP believes that the
future implementation of above ground storage tank laws by either additional
states or by the federal government will not have a material adverse effect on
KPP's financial condition or results of operations.
Air Emissions
The operations of KPP are subject to the Federal Clean Air Act and
comparable state and local statutes. KPP believes that the operations of KPP's
pipelines and terminals are in substantial compliance with such statutes in all
states in which they operate.
Amendments to the Federal Clean Air Act enacted in 1990 require or will
require most industrial operations in the United States to incur future capital
expenditures in order to meet the air emission control standards that have been
and are to be developed and implemented by the EPA and state environmental
agencies. Pursuant to these Clean Air Act Amendments, those Partnership
facilities that emit volatile organic compounds ("VOC") or nitrogen oxides are
subject to increasingly stringent regulations, including requirements that
certain sources install maximum or reasonably available control technology. In
addition, the 1999 Federal Clean Air Act Amendments include a new operating
permit for major sources ("Title V Permits"), which applies to some of KPP's
facilities. Additionally, new dockside loading facilities owned or operated by
KPP in the United States will be subject to the New Source Performance Standards
that were proposed in May 1994. These regulations require control of VOC
emissions from the loading and unloading of tank vessels.
Although KPP is in substantial compliance with applicable air pollution
laws, in anticipation of the implementation of stricter air control regulations,
KPP is taking actions to substantially reduce its air emissions. KPP plans to
install bottom loading and vapor recovery equipment on the loading racks at
selected terminal sites along the East Pipeline that do not already have such
emissions control equipment. These modifications will substantially reduce the
total air emissions from each of these facilities. Having begun in 1993, this
project is being phased in over a period of years.
Solid Waste
KPP generates non-hazardous solid waste that is subject to the
requirements of the Federal Resource Conservation and Recovery Act ("RCRA") and
comparable state statutes in the United States. The EPA is considering the
adoption of stricter disposal standards for non-hazardous wastes. RCRA also
governs the disposal of hazardous wastes. At present, KPP is not required to
comply with a substantial portion of the RCRA requirements because KPP's
operations generate minimal quantities of hazardous wastes. However, it is
anticipated that additional wastes, which could include wastes currently
generated during pipeline operations, will in the future be designated as
"hazardous wastes". Hazardous wastes are subject to more rigorous and costly
disposal requirements than are non-hazardous wastes. Such changes in the
regulations may result in additional capital expenditures or operating expenses
by KPP.
At the terminal sites at which groundwater contamination is present,
there is also limited soil contamination as a result of the aforementioned
spills. KPP is under no present requirements to remove these contaminated soils,
but KPP may be required to do so in the future. Soil contamination also may be
present at other Partnership facilities at which spills or releases have
occurred. Under certain circumstances, KPP may be required to clean up such
contaminated soils. Although these costs should not have a material adverse
effect on KPP, no assurance can be given in this regard.
Superfund
The Comprehensive Environmental Response, Compensation and Liability
Act ("CERCLA" or "Superfund") imposes liability, without regard to fault or the
legality of the original act, on certain classes of persons that contributed to
the release of a "hazardous substance" into the environment. These persons
include the owner or operator of the site and companies that disposed or
arranged for the disposal of the hazardous substances found at the site. CERCLA
also authorizes the EPA and, in some instances, third parties to act in response
to threats to the public health or the environment and to seek to recover from
the responsible classes of persons the costs they incur. In the course of its
ordinary operations, KPP may generate waste that may fall within CERCLA's
definition of a "hazardous substance". KPP may be responsible under CERCLA for
all or part of the costs required to clean up sites at which such wastes have
been disposed.
Environmental Impact Statement
The United States National Environmental Policy Act of 1969 (the
"NEPA") applies to certain extensions or additions to a pipeline system. Under
NEPA, if any project that would significantly affect the quality of the
environment requires a permit or approval from any United States federal agency,
a detailed environmental impact statement must be prepared. The effect of the
NEPA may be to delay or prevent construction of new facilities or to alter their
location, design or method of construction.
Indemnification
KPL has agreed to indemnify KPP against liabilities for damage to the
environment resulting from operations of the East Pipeline prior to October 3,
1989. Such indemnification does not extend to any liabilities that arise after
such date to the extent such liabilities result from change in environmental
laws or regulations. Under such indemnity, KPL is presently liable for the
remediation of contamination at certain East Pipeline sites. In addition, KPP
was wholly or partially indemnified under certain acquisition contracts for some
environmental costs. Most of such contracts contain time and amount limitations
on the indemnities. To the extent that environmental liabilities exceed the
amount of such indemnity, KPP has affirmatively assumed the excess environmental
liabilities.
SAFETY REGULATION
KPP's Pipelines are subject to regulation by the United States
Department of Transportation (the "DOT") under the Hazardous Liquid Pipeline
Safety Act of 1979 ("HLPSA") relating to the design, installation, testing,
construction, operation, replacement and management of their pipeline
facilities. The HLPSA covers anhydrous ammonia, petroleum and petroleum products
pipelines and requires any entity that owns or operates pipeline facilities to
comply with such safety regulations and to permit access to and copying of
records and to make certain reports and provide information as required by the
Secretary to Transportation. The Federal Pipeline Safety Act of 1992 amended the
HLPSA to include requirements of the future use of internal inspection devices.
KPP does not believe that it will be required to make any substantial capital
expenditures to comply with the requirements of HLPSA as so amended.
On November 3, 2000, the DOT issued new regulations intended by the DOT
to assess the integrity of hazardous liquid pipeline segments that, in the event
of a leak or failure, could adversely affect highly populated areas, areas
unusually sensitive to environmental impact and commercially navigable
waterways. Under the regulations, an operator is required, among other things,
to conduct baseline integrity assessment tests (such as internal inspections)
within seven years, conduct future integrity tests at typically five-year
intervals and develop and follow a written risk-based integrity management
program covering the designated high consequence areas. KPP does not believe
that the increased costs of compliance with these regulations will materially
affect KPP's results of operations.
KPP is subject to the requirements of the United States Federal
Occupational Safety and Health Act ("OSHA") and comparable state statutes that
regulate the protection of the health and safety of workers. In addition, the
OSHA hazard communication standard requires that certain information be
collected regarding hazardous materials used or produced in operations and that
this information be provided to employees, state and local authorities and
citizens. KPP believes that it is in general compliance with OSHA requirements,
including general industry standards, record keeping requirements and monitoring
of occupational exposure to benzene.
The OSHA hazard communication standard, the EPA community right-to-know
regulations under Title III of the Federal Superfund Amendment and
Reauthorization Act, and comparable state statutes require KPP to organize
information about the hazardous materials used in its operations. Certain parts
of this information must be reported to employees, state and local governmental
authorities, and local citizens upon request. In general, KPP expects to
increase its expenditures during the next decade to comply with more stringent
industry and regulatory safety standards such as those described above. Such
expenditures cannot be accurately estimated at this time, although they are not
expected to have a material adverse impact on KPP.
EMPLOYEES
At December 31, 2003, the Company, and its subsidiaries and affiliates
employed approximately 1,078 persons. Approximately 152 persons at seven
terminal locations in the United States and Canada were subject to
representation by labor unions and collective bargaining or similar contracts at
that date. The Company considers relations with its employees to be good.
AVAILABLE INFORMATION
The Company files annual, quarterly, and other reports and other
information with the Securities and Exchange Commission ("SEC") under the
Securities Exchange Act of 1934 (the "Exchange Act"). You may read and copy any
materials that the Company files with the SEC at the SEC's Public Reference Room
at 450 Fifth Street, NW, Washington, DC 20549. You may obtain additional
information about the Public Reference Room by calling the SEC at
1-800-SEC-0330. In addition, the SEC maintains an Internet site
(http://www.sec.gov) that contains reports, proxy information statements, and
other information regarding issuers that file electronically with the SEC.
The Company also makes available free of charge on or through the
Company's Internet site (http://www.kaneb.com) the Company's Annual Report on
Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and
other information statements and, if applicable, amendments to those reports
filed or furnished pursuant to Section 13(a) of the Exchange Act as soon as
reasonably practicable after the reports and other information is electronically
filed with, or furnished to, the SEC.
Item 2. Properties
The properties owned or utilized by the Company and its subsidiaries
are generally described in Item 1 of this Report. Additional information
concerning the obligations of the Company and KPP for lease and rental
commitments is presented under the caption "Commitments and Contingencies" in
Note 9 to the Company's consolidated financial statements. Such descriptions and
information are hereby incorporated by reference into this Item 2.
The properties used in the operations of KPP's Pipelines are owned by
KPP, through its subsidiary entities, except for KPL's operational headquarters,
located in Wichita, Kansas, which is held under a lease that expires in 2009.
Statia's facilities are owned through subsidiaries and the majority of ST's
facilities are owned, while the remainder, including some of its terminal
facilities located in port areas and its operational headquarters, located in
Dallas, Texas, are held pursuant to lease agreements having various expiration
dates, rental rates and other terms.
Item 3. Legal Proceedings
Grace Litigation. Certain subsidiaries of KPP were sued in a Texas
state court in 1997 by Grace Energy Corporation ("Grace"), the entity from which
KPP acquired ST Services in 1993. The lawsuit involves environmental response
and remediation costs allegedly resulting from jet fuel leaks in the early
1970's from a pipeline. The pipeline, which connected a former Grace terminal
with Otis Air Force Base in Massachusetts (the "Otis pipeline" or the
"pipeline"), ceased operations in 1973 and was abandoned before 1978, when the
connecting terminal was sold to an unrelated entity. Grace alleged that
subsidiaries of KPP acquired the abandoned pipeline, as part of the acquisition
of ST Services in 1993 and assumed responsibility for environmental damages
allegedly caused by the jet fuel leaks. Grace sought a ruling from the Texas
court that these subsidiaries are responsible for all liabilities, including all
present and future remediation expenses, associated with these leaks and that
Grace has no obligation to indemnify these subsidiaries for these expenses. In
the lawsuit, Grace also sought indemnification for expenses of approximately
$3.5 million that it incurred since 1996 for response and remediation required
by the State of Massachusetts and for additional expenses that it expects to
incur in the future. The consistent position of KPP's subsidiaries has been that
they did not acquire the abandoned pipeline as part of the 1993 ST Services
transaction, and therefore did not assume any responsibility for the
environmental damage nor any liability to Grace for the pipeline.
At the end of the trial, the jury returned a verdict including findings
that (1) Grace had breached a provision of the 1993 acquisition agreement by
failing to disclose matters related to the pipeline, and (2) the pipeline was
abandoned before 1978 -- 15 years before KPP's subsidiaries acquired ST
Services. On August 30, 2000, the Judge entered final judgment in the case that
Grace take nothing from the subsidiaries on its claims seeking recovery of
remediation costs. Although KPP's subsidiaries have not incurred any expenses in
connection with the remediation, the court also ruled, in effect, that the
subsidiaries would not be entitled to indemnification from Grace if any such
expenses were incurred in the future. Moreover, the Judge let stand a prior
summary judgment ruling that the pipeline was an asset acquired by KPP's
subsidiaries as part of the 1993 ST Services transaction and that any
liabilities associated with the pipeline would have become liabilities of the
subsidiaries. Based on that ruling, the Massachusetts Department of
Environmental Protection and Samson Hydrocarbons Company (successor to Grace
Petroleum Company) wrote letters to ST Services alleging its responsibility for
the remediation, and ST Services responded denying any liability in connection
with this matter. The Judge also awarded attorney fees to Grace of more than
$1.5 million. Both KPP's subsidiaries and Grace have appealed the trial court's
final judgment to the Texas Court of Appeals in Dallas. In particular, the
subsidiaries have filed an appeal of the judgment finding that the Otis pipeline
and any liabilities associated with the pipeline were transferred to them as
well as the award of attorney fees to Grace.
On April 2, 2001, Grace filed a petition in bankruptcy, which created
an automatic stay against actions against Grace. This automatic stay covers the
appeal of the Dallas litigation, and the Texas Court of Appeals has issued an
order staying all proceedings of the appeal because of the bankruptcy. Once that
stay is lifted, KPP's subsidiaries that are party to the lawsuit intend to
resume vigorous prosecution of the appeal.
The Otis Air Force Base is a part of the Massachusetts Military
Reservation ("MMR Site"), which has been declared a Superfund Site pursuant to
CERCLA. The MMR Site contains a number of groundwater contamination plumes, two
of which are allegedly associated with the Otis pipeline, and various other
waste management areas of concern, such as landfills. The United States
Department of Defense, pursuant to a Federal Facilities Agreement, has been
responding to the Government remediation demand for most of the contamination
problems at the MMR Site. Grace and others have also received and responded to
formal inquiries from the United States Government in connection with the
environmental damages allegedly resulting from the jet fuel leaks. KPP's
subsidiaries voluntarily responded to an invitation from the Government to
provide information indicating that they do not own the pipeline. In connection
with a court-ordered mediation between Grace and KPP's subsidiaries, the
Government advised the parties in April 1999 that it has identified two spill
areas that it believes to be related to the pipeline that is the subject of the
Grace suit. The Government at that time advised the parties that it believed it
had incurred costs of approximately $34 million, and expected in the future to
incur costs of approximately $55 million, for remediation of one of the spill
areas. This amount was not intended to be a final accounting of costs or to
include all categories of costs. The Government also advised the parties that it
could not at that time allocate its costs attributable to the second spill area.
By letter dated July 26, 2001, the United States Department of Justice
("DOJ") advised ST Services that the Government intends to seek reimbursement
from ST Services under the Massachusetts Oil and Hazardous Material Release
Prevention and Response Act and the Declaratory Judgment Act for the
Government's response costs at the two spill areas discussed above. The DOJ
relied in part on the Texas state court judgment, which in the DOJ's view, held
that ST Services was the current owner of the pipeline and the
successor-in-interest of the prior owner and operator. The Government advised ST
Services that it believes it has incurred costs exceeding $40 million, and
expects to incur future costs exceeding an additional $22 million, for
remediation of the two spill areas. KPP believes that its subsidiaries have
substantial defenses. ST Services responded to the DOJ on September 6, 2001,
contesting the Government's positions and declining to reimburse any response
costs. The DOJ has not filed a lawsuit against ST Services seeking cost recovery
for its environmental investigation and response costs. Representatives of ST
Services have met with representatives of the Government on several occasions
since September 6, 2001 to discuss the Government's claims and to exchange
information related to such claims. Additional exchanges of information are
expected to occur in the future and additional meetings may be held to discuss
possible resolution of the Government's claims without litigation. KPP does not
believe this matter will have a materially adverse effect on its financial
condition, although there can be no assurances as to the ultimate outcome.
PEPCO Litigation. On April 7, 2000, a fuel oil pipeline in Maryland
owned by Potomac Electric Power Company ("PEPCO") ruptured. Work performed with
regard to the pipeline was conducted by a partnership of which ST Services is
general partner. PEPCO has reported that it has incurred total cleanup costs of
$70 million to $75 million. PEPCO probably will continue to incur some cleanup
related costs for the foreseeable future, primarily in connection with EPA
requirements for monitoring the condition of some of the impacted areas. Since
May 2000, ST Services has provisionally contributed a minority share of the
cleanup expense, which has been funded by ST Services' insurance carriers. ST
Services and PEPCO have not, however, reached a final agreement regarding ST
Services' proportionate responsibility for this cleanup effort, if any, and
cannot predict the amount, if any, that ultimately may be determined to be ST
Services' share of the remediation expense, but ST believes that such amount
will be covered by insurance and therefore will not materially adversely affect
KPP's financial condition.
As a result of the rupture, purported class actions were filed against
PEPCO and ST Services in federal and state court in Maryland by property and
business owners alleging damages in unspecified amounts under various theories,
including under the Oil Pollution Act ("OPA") and Maryland common law. The
federal court consolidated all of the federal cases in a case styled as In re
Swanson Creek Oil Spill Litigation. A settlement of the consolidated class
action, and a companion state-court class action, was reached and approved by
the federal judge. The settlement involved creation and funding by PEPCO and ST
Services of a $2,250,000 class settlement fund, from which all participating
claimants would be paid according to a court-approved formula, as well as a
court-approved payment to plaintiffs' attorneys. The settlement has been
consummated and the fund, to which PEPCO and ST Services contributed equal
amounts, has been distributed. Participating claimants' claims have been settled
and dismissed with prejudice. A number of class members elected not to
participate in the settlement, i.e., to "opt out," thereby preserving their
claims against PEPCO and ST Services. All non-participant claims 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 have each paid their 50% share and thus fully performed their payment
obligations under the Consent Decree. ST Services' insurance carrier funded ST
Services' payment.
The U.S. Department of Transportation ("DOT") has issued a Notice of
Proposed Violation to PEPCO and ST Services alleging violations over several
years of pipeline safety regulations and proposing a civil penalty of $647,000
jointly against the two companies. ST Services and PEPCO have contested the DOT
allegations and the proposed penalty. A hearing was held before the Office of
Pipeline Safety at the DOT in late 2001. ST Services does not anticipate any
further hearings on the subject and is still awaiting the DOT's ruling.
By letter dated January 4, 2002, the Attorney General's Office for the
State of Maryland advised ST Services that it intended to seek penalties from ST
Services in connection with the April 7, 2000 spill. The State of Maryland
subsequently asserted that it would seek penalties against ST Services and PEPCO
totaling up to $12 million. A settlement of this claim was reached in mid-2002
under which ST Services' insurer will pay a total of slightly more than $1
million in installments over a five year period. PEPCO has also reached a
settlement of these claims with the State of Maryland. Accordingly, KPP believes
that this matter will not have a material adverse effect on its financial
condition.
On December 13, 2002, ST Services sued PEPCO in the Superior Court,
District of Columbia, seeking, among things, a declaratory judgment as to ST
Services' legal obligations, if any, to reimburse PEPCO for costs of the oil
spill. On December 16, 2002, PEPCO sued ST Services in the United States
District Court for the District of Maryland, seeking recovery of all its costs
for remediation of and response to the oil spill. Pursuant to an agreement
between ST Services and PEPCO, ST Services' suit was dismissed, subject to
refiling. ST Services has moved to dismiss PEPCO's suit. ST Services is
vigorously defending against PEPCO's claims and is pursuing its own
counterclaims for return of monies ST Services has advanced to PEPCO for
settlements and cleanup costs. KPP believes that any costs or damages resulting
from these lawsuits will be covered by insurance and therefore will not
materially adversely affect KPP's financial condition. The amounts claimed by
PEPCO, if recovered, would trigger an excess insurance policy which has a
$600,000 retention, but KPP does not believe that such retention, if incurred,
would materially adversely affect KPP's financial condition.
The Company, primarily KPP, has other contingent liabilities resulting
from litigation, claims and commitments incident to the ordinary course of
business. Management believes, based on the advice of counsel, that the ultimate
resolution of such contingencies will not have a materially adverse effect on
the financial position, results of operations or liquidity of the Company.
Item 4. Submission of Matters to a Vote of Security Holders
The Company did not hold a meeting of shareholders or otherwise submit
any matter to a vote of security holders in the fourth quarter of 2003.
PART II
Item 5. Market for the Registrant's Shares and Related Shareholder Matters
The Company's shares ("Shares") were listed and began trading on the
New York Stock Exchange (the "NYSE") effective June 29, 2001, under the symbol
"KSL." At March 5, 2004, there were approximately 4,000 shareholders of record
for the Company. Set forth below are prices on the NYSE and cash distributions
for the periods indicated for such Shares.
Share Prices Per Share Cash
Year High Low Distributions
------ ----------------------- -----------------
2002:
First quarter $22.35 $18.10 $.4125
Second quarter 23.98 19.80 .4125
Third quarter 21.25 16.21 .4125
Fourth quarter 21.39 17.51 .4125
2003:
First quarter 21.11 18.35 .4375
Second quarter 29.35 20.90 .4375
Third quarter 29.70 24.99 .475
Fourth quarter 32.31 26.81 .475
2004:
First quarter 33.78 30.77 (a)
(through March 5, 2004)
(a) The cash distribution with respect to the first quarter of 2004 has not yet
been declared.
Under the terms of its financing agreements, the Company is prohibited
from declaring or paying any distribution if a default exists thereunder.
Item 6. Summary Historical Financial and Operating Data
The following table sets forth, for the periods and at the dates
indicated, certain selected historical consolidated financial data for Kaneb
Services LLC and its subsidiaries (the "Company"). The data in the table (in
thousands, except per share amounts) should be read in conjunction with the
Company's audited financial statements. See also "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
Year Ended December 31,
--------------------------------------------------------------------------
2003 2002 (a) 2001 (a) 2000 1999
------------ ------------ ------------ ------------ -------------
Income Statement Data:
Revenues:
Services........................... $ 354,591 $ 288,669 $ 207,796 $ 156,232 $ 158,028
Products........................... 511,200 381,159 327,542 381,186 212,298
------------ ------------ ------------ ------------ -------------
$ 865,791 $ 669,828 $ 535,338 $ 537,418 $ 370,326
============ ============ ============ ============ =============
Operating income...................... $ 128,504 $ 106,359 $ 79,791 $ 61,174 $ 64,911
============ ============ ============ ============ =============
Income before gain on issuance of
units by KPP, income taxes and
cumulative effect of change in
accounting principle............... $ 27,385 $ 24,931 $ 16,051 $ 15,467 $ 17,999
Income tax benefit (expense) (b)...... (4,887) (2,585) 2,413 (2,824) 9,494
Gain on issuance of units by KPP (c).. 10,898 24,882 9,859 - 16,764
------------ ------------ ------------ ------------ -------------
Income before cumulative effect
of change in accounting principle.. 33,396 47,228 28,323 12,643 44,257
Cumulative effect of change in
accounting principle - adoption of
new accounting standard for asset
retirement obligations............. (313) - - - -
------------ ------------ ------------ ------------ -------------
Net income............................ $ 33,083 $ 47,228 $ 28,323 $ 12,643 $ 44,257
============ ============ ============ ============ =============
Per Share Data:
Earnings per share:
Basic:
Before cumulative effect of
change in accounting principle. $ 2.89 $ 4.13 $ 2.57 $ 1.19 $ 4.22
Cumulative effect of change in
accounting principle........... (.03) - - - -
------------ ------------ ------------ ------------ -------------
$ 2.86 $ 4.13 $ 2.57 $ 1.19 $ 4.22
============ ============ ============ ============ =============
Diluted:
Before cumulative effect of
change in accounting principle. $ 2.84 $ 4.02 $ 2.46 $ 1.15 $ 4.06
Cumulative effect of change in
accounting principle........... (.03) - - - -
------------ ------------ ------------ ------------ -------------
$ 2.81 $ 4.02 $ 2.46 $ 1.15 $ 4.06
============ ============ ============ ============ =============
Cash distributions declared
per share (d)...................... $ 1.825 $ 1.65 $ 0.725 $ - $ -
============ ============ ============ ============ =============
Weighted average diluted shares
outstanding........................ 11,792 11,755 11,509 11,029 10,897
============ ============ ============ ============ =============
Year Ended December 31,
--------------------------------------------------------------------------
2003 2002 (a) 2001 (a) 2000 1999
------------ ------------ ------------ ------------ -------------
Balance Sheet Data (at year end):
Property and equipment, net........... $ 1,113,020 $ 1,092,276 $ 481,396 $ 321,448 $ 316,956
Total assets.......................... 1,291,567 1,244,101 571,767 429,852 427,608
Long-term debt........................ 636,308 718,162 277,302 184,052 167,028
Shareholders' equity.................. 77,721 63,654 33,932 71,369 86,833
(a) See Note 3 to Consolidated Financial Statements regarding KPP acquisitions.
(b) See Note 4 to Consolidated Financial Statements regarding 2001 benefit for
change in tax status. Additionally, in 2000 and 1999, the Company
recognized expected benefits from prior years tax losses (change in
valuation allowance) of $4.6 million and $23.3 million, respectively.
(c) See Note 2 to Consolidated Financial Statements regarding the 2003 and 2002
gains on issuance of units by KPP and Note 3 regarding 2001 gain on
issuance of units by KPP.
(d) The Company makes quarterly distributions of 100% of available cash, as
defined in the limited liability company agreement, to the common
shareholders of record on the applicable record date, within 45 days after
the end of each quarter. Available cash consists generally of all the cash
receipts of the Company, less all cash disbursements and reserves.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This discussion should be read in conjunction with the consolidated
financial statements of the Company and the notes thereto and the summary
historical financial and operating data included elsewhere in this report.
GENERAL
On November 27, 2000, the Board of Directors of Kaneb Services, Inc.
authorized the distribution of its pipeline, terminaling and product marketing
businesses (the "Distribution") to its stockholders in the form of a new limited
liability company, Kaneb Services LLC (the "Company"). On June 29, 2001, the
Distribution was completed, with each stockholder of Kaneb Services, Inc.
receiving one common share of the Company for each three shares of Kaneb
Services, Inc.'s common stock held on June 20, 2001, the record date for the
Distribution, resulting in the distribution of 10.85 million shares of the
Company. On August 7, 2001, the stockholders of Kaneb Services, Inc. approved an
amendment to its certificate of incorporation to change its name to Xanser
Corporation ("Xanser").
In September 1989, Kaneb Pipe Line Company LLC ("KPL"), now a wholly
owned subsidiary of the Company, formed Kaneb Pipe Line Partners, L.P. ("KPP")
to own and operate its refined petroleum products pipeline business. KPL manages
and controls the operations of KPP through its general partner interests and an
18% (at December 31, 2003) limited partner interest. KPP operates through Kaneb
Pipe Line Operating Partnership, L.P. ("KPOP"), a limited partnership in which
KPP holds a 99% interest as limited partner. KPL owns a 1% interest as general
partner of KPP and a 1% interest as general partner of KPOP.
KPP's petroleum pipeline business consists primarily of the
transportation, as a common carrier, of refined petroleum products in Kansas,
Nebraska, Iowa, South Dakota, North Dakota, Colorado, Wyoming, and Minnesota.
Common carrier activities are those under which transportation through the
pipelines is available at published tariffs filed, in the case of interstate
shipments, with the Federal Energy Regulatory Commission (the "FERC"), or in the
case of intrastate shipments with the relevant state authority, to any shipper
of refined petroleum products who requests such services and satisfies the
conditions and specifications for transportation. The petroleum pipelines
primarily transport gasoline, diesel oil, fuel oil and propane. Substantially
all of the petroleum pipeline operations constitute common carrier operations
that are subject to federal or state tariff regulations. KPP also owns an
approximately 2,000-mile anhydrous ammonia pipeline system acquired from Koch
Pipeline Company, L.P. in November of 2002 (see "Liquidity and Capital
Resources"). The fertilizer pipeline originates in southern Louisiana, proceeds
north through Arkansas and Missouri, and then branches east into Illinois and
Indiana and north and west into Iowa and Nebraska. KPP's petroleum pipeline
business depends on the level of demand for refined petroleum products in the
markets served by the pipelines and the ability and willingness of refineries
and marketers having access to the pipelines to supply such demand by deliveries
through the pipelines. KPP's pipeline revenues are based on volumes shipped and
the distance over which such volumes are transported.
KPP's terminaling business is conducted through Support Terminal
Services ("ST Services") and Statia Terminals International N.V. ("Statia"). ST
Services is one of the largest independent petroleum products and specialty
liquids terminaling companies in the United States. In the United States, ST
Services operates 37 facilities in 20 states. ST Services also owns and operates
six terminals located in the United Kingdom and eight terminals in Australia and
New Zealand. ST Services and its predecessors have a long history in the
terminaling business and handle a wide variety of liquids from petroleum
products to specialty chemicals to edible liquids. Statia, acquired on February
28, 2002 ("see "Liquidity and Capital Resources"), owns a terminal on the Island
of St. Eustatius, Netherlands Antilles and a terminal at Point Tupper, Nova
Scotia, Canada. Independent terminal owners generally compete on the basis of
the location and versatility of the terminals, service and price. Terminal
versatility is a function of the operator's ability to offer handling for
diverse products with complex handling requirements. The service function
typically provided by the terminal includes the safe storage of product at
specified temperatures and other conditions, as well as receipt and delivery
from the terminal. The ability to obtain attractive pricing is dependent largely
on the quality, versatility and reputation of the facility. Terminaling revenues
are earned based on fees for the storage and handling of products.
KPL owns a petroleum product marketing business which provides
wholesale motor fuel marketing services in the Great Lakes and Rocky Mountain
regions. KPP's product sales business delivers bunker fuels to ships in the
Caribbean and Nova Scotia, Canada, and sells bulk petroleum products to various
commercial customers at those locations. In the bunkering business, KPP competes
with ports offering bunker fuels along the route of the vessel. Vessel owners or
charterers are charged berthing and other fees for associated services such as
pilotage, tug assistance, line handling, launch service and emergency response
services.
OVERVIEW
In 2003, The Company integrated the major acquisitions completed in
2002 and focused on the performance of those operations, as well as its core
business, to generate increased cash flow. The Company's success in this effort
enabled it to increase cash distributions twice in 2003. On an annualized basis,
the Company raised its distributions $0.10 in May 2003 and another $0.15 in
November 2003. The Company had a very strong year as revenues increased 29%,
operating income increased 21% and net income before gain on issuance of units
by KPP, income taxes and cumulative effect of change in accounting principle,
increased 10%. Reflecting the Company's two major assets - the 5.1 million KPP
units it owns and the general partner incentive, the Company's distributions
from KPP increased 17% .
In 2003, KPP completed the financing for the $600 million of
acquisitions it made in 2002, which were financed half with equity and half with
debt. In March 2003, KPP sold approximately three million units - the largest
and most successful equity offering in its history. KPP completed the placement
of its permanent financing in May 2003, and over 85% of that debt is at
favorable fixed rates, thereby limiting its exposure to rising interest rates.
KPP also completed a new revolving credit facility of $400 million, with the
ability to increase it to $450 million.
The Company has a very strong consolidated balance sheet and KPP has
the financial capacity for further expansion. KPP has integrated and assimilated
the substantial acquisitions it made in 2002 and has seen the contribution of
those operations to its results in 2003. The Company, through KPP, now actively
seeks opportunities for strategic and substantial growth.
CONSOLIDATED RESULTS OF OPERATIONS
Year Ended December 31,
----------------------------------------
2003 2002 2001
----------- ----------- -----------
(in thousands, except per share amounts)
Consolidated revenues.................................................. $ 865,791 $ 669,828 $ 535,338
=========== =========== ===========
Consolidated operating income.......................................... $ 128,504 $ 106,359 $ 79,791
=========== =========== ===========
Consolidated income before gain on issuance of units by KPP,
income taxes and cumulative effect of change in accounting
principle........................................................... $ 27,385 $ 24,931 $ 16,051
=========== =========== ===========
Consolidated net income................................................ $ 33,083 $ 47,228 $ 28,323
=========== =========== ===========
Earnings per share:
Basic:
Before cumulative effect of change in accounting principle........ $ 2.89 $ 4.13 $ 2.57
Cumulative effect of change in accounting principle............... (.03) - -
----------- ----------- -----------
$ 2.86 $ 4.13 $ 2.57
=========== =========== ==========
Diluted:
Before cumulative effect of change in accounting principle........ $ 2.84 $ 4.02 $ 2.46
Cumulative effect of change in accounting principle............... (.03) - -
----------- ----------- -----------
$ 2.81 $ 4.02 $ 2.46
=========== =========== ==========
Cash distributions declared per share............................... $ 1.825 $ 1.65 $ 0.725
=========== =========== ===========
Consolidated capital expenditures................................... $ 44,747 $ 31,101 $ 17,309
=========== =========== ===========
For the year ended December 31, 2003, consolidated revenues increased
by $196.0 million, or 29%, when compared to the year ended December 31, 2002,
due to a $36.9 million increase in revenues in the pipeline business, a $29.0
million increase in revenues in the teminaling business and a $130.0 million
increase in revenues from the product marketing business. Consolidated operating
income for the year ended December 31, 2003 increased by $22.1 million, or 21%,
when compared to 2002, due to a $13.2 million increase in pipeline operating
income, a $1.5 million increase in terminaling operating income and a $7.5
million increase in product marketing operating income. See "Liquidity and
Capital Resources" regarding KPP's 2002 acquisitions. Consolidated 2003 income
before gain on issuance of units by KPP, income taxes, and cumulative effect of
change in accounting principle, increased by $2.5 million, or 10%, when compared
to 2002. Consolidated net income for the year ended December 31, 2003 includes a
$10.9 million gain on issuance of units by KPP (see "Liquidity and Capital
Resources") and $0.3 million of expense, net of interest of outside
non-controlling partners in KPP's net income, for the cumulative effect of
change in accounting principle - adoption of new accounting standard for asset
retirement obligations.
For the year ended December 31, 2002, consolidated revenues increased
by $134.5 million, or 25%, when compared to the year ended December 31, 2001,
due to a $73.2 million increase in revenues in the teminaling business, a $53.6
million increase in revenues from the product marketing business and a $7.7
million increase in revenues in the pipeline business. Consolidated operating
income for the year ended December 31, 2002 increased by $26.6 million, or 33%,
when compared to 2001, due primarily to a $19.7 million increase in terminaling
operating income, a $5.3 million increase in product marketing operating income
and a $1.9 million increase in pipeline operating income. See "Liquidity and
Capital Resources" regarding 2002 acquisitions. Consolidated 2002 income, before
gain on issuance of units by KPP and income taxes, increased by $8.9 million, or
55%, when compared to 2001. Consolidated net income for the year ended December
31, 2002 includes $24.9 million of gains on issuance of units by KPP (see
"Liquidity and Capital Resources").
PIPELINE OPERATIONS
Year Ended December 31,
---------------------------------------------------
2003 2002 2001
----------- ----------- -----------
(in thousands)
Revenues............................................. $ 119,633 $ 82,698 $ 74,976
Operating costs...................................... 46,379 33,744 28,844
Depreciation and amortization........................ 14,117 6,408 5,478
General and administrative........................... 7,277 3,923 3,881
----------- ----------- -----------
Operating income..................................... $ 51,860 $ 38,623 $ 36,773
=========== =========== ===========
KPP's pipeline revenues are based on volumes shipped and the distances
over which such volumes are transported. Because tariff rates are regulated by
the FERC or STB, the pipelines compete on the basis of quality of service,
including delivering products at convenient locations on a timely basis to meet
the needs of its customers. For the year ended December 31, 2003, revenues
increased by $36.9 million, or 45%, compared to 2002, due entirely to the
November and December 2002 pipeline acquisitions (see "Liquidity and Capital
Resources"). For the year ended December 31, 2002, revenues increased by $7.7
million, or 10%, compared to 2001, due to higher per barrel rates realized on
volumes shipped on existing pipelines and as a result of the 2002 pipeline
acquisitions. Approximately $4.5 million of the 2002 revenue increase was a
result of the pipeline acquisitions. Barrel miles on petroleum pipelines totaled
21.3 billion (including 4.7 billion for the petroleum pipeline acquired in
December 2002), 18.3 billion and 18.6 billion for the years ended December 31,
2003, 2002 and 2001, 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 $12.6 million in 2003 and $4.9
million in 2002. The increase in 2003 was due to the 2002 pipeline acquisitions
and increases in planned maintenance. The increase in 2002 was due to the
pipeline acquisitions and increases in expenditures for routine repairs and
maintenance. For the years ended December 31, 2003 and 2002, depreciation and
amortization increased by $7.7 million and $0.9 million, respectively, when
compared to the respective prior year, due to the pipeline acquisitions. General
and administrative costs which includes managerial, accounting and
administrative personnel costs, office rental expense, legal and professional
costs and other non-operating costs increased by $3.4 million in 2003, when
compared to 2002, due primarily to the pipeline acquisitions and increases in
personnel-related costs.
TERMINALING OPERATIONS
Year Ended December 31,
---------------------------------------------------
2003 2002 2001
----------- ----------- -----------
(in thousands)
Revenues............................................. $ 234,958 $ 205,971 $ 132,820
Operating costs...................................... 114,030 94,480 61,788
Depreciation and amortization........................ 38,089 32,368 17,706
Gain on sale of assets............................... - (609) -
General and administrative........................... 16,307 14,692 8,008
----------- ----------- -----------
Operating income..................................... $ 66,532 $ 65,040 $ 45,318
=========== =========== ===========
For the year ended December 31, 2003, KPP's terminaling revenues
increased by $29.0 million, or 14%, when compared to 2002, due to the 2002
terminal acquisitions (see "Liquidity and Capital Resources") and overall
increases in the average price realized per barrel of tankage utilized. For the
year ended December 31, 2002, revenues increased by $73.2 million, or 55%,
compared to 2001, due to the terminal acquisitions and overall increases in
utilizations at existing locations. Approximately $25 million of the 2003
revenue increase and $63 million of the 2002 revenue increase was a result of
the terminal acquisitions. Average annual tankage utilized for the years ended
December 31, 2003, 2002 and 2001 aggregated 46.7 million barrels, 46.5 million
barrels and 30.1 million barrels, respectively. Average revenues per barrel of
tankage utilized for the years ended December 31, 2003, 2002 and 2001 was $5.02,
$4.43 and $4.41, respectively. The increase in 2003 average revenues per barrel
of tankage utilized was the result of changes in product mix resulting from the
2002 terminals acquisitions and foreign currency exchange differences. The
increase in 2002 average revenues per barrel of tankage utilized was due to more
favorable domestic market conditions, when compared to 2001.
In 2003, operating costs increased by $19.6 million, when compared to
2002, due to the 2002 terminal acquisitions, repair costs associated with
hurricane Isabel and increases in planned maintenance. In 2002, operating costs
increased by $32.7 million, when compared to 2001, due to the 2002 terminal
acquisitions and increases in volumes stored at existing locations. For the
years ended December 31, 2003 and 2002, depreciation and amortization increased
by $5.7 million and $14.7 million, respectively, due to the terminal
acquisitions. In 2002, KPP sold land and other terminaling business assets for
net proceeds of approximately $1.1 million, recognizing a gain on disposition of
assets of $0.6 million. General and administrative expense increased by $1.6
million in 2003 and by $6.7 million in 2002, due to the terminal acquisitions
and increases in personnel-related costs.
PRODUCT MARKETING SERVICES
Year Ended December 31,
----------------------------------------
2003 2002 2001
----------- ----------- -----------
(in thousands)
Revenues............................................................... $ 511,200 $ 381,159 $ 327,542
Cost of products sold.................................................. 486,310 367,870 326,230
----------- ----------- -----------
Gross margin........................................................... $ 24,890 $ 13,289 $ 1,312
=========== =========== ===========
Operating income (loss)................................................ $ 12,233 $ 4,692 $ (611)
=========== =========== ===========
For the year ended December 31, 2003, revenues increased by $130.0
million, or 34%, compared to 2002, due to an increase in both sales volumes and
the average sales price realized. Total volumes sold and average sales price per
gallon for the year ended December 31, 2003 aggregated 612 million gallons and
$0.84, respectively, compared to 517 million gallons and $0.74 for the year
ended December 31, 2002, respectively. The volume increase was due to the
product sales operations acquired with Statia on February 28, 2002 (see
"Liquidity and Capital Resources"). The price increase was due to increases in
overall average market prices, partially offset by changes in product mix
resulting from the Statia acquisition. For the year ended December 31, 2003,
gross margin and operating income increased by $11.6 million and $7.5 million,
respectively, due to the increase in both the volumes sold and favorable product
margins.
For the year ended December 31, 2002, revenues increased by $53.6
million, or 16%, compared to 2001, due to an increase in sales volumes,
partially offset by a decrease in the average price per gallon received. Total
volumes sold and average sales price per gallon for the year ended December 31,
2002 aggregated 517 million gallons and $0.74, respectively, compared to 364
million gallons and $0.90 for the year ended December 31, 2001, respectively.
The volume increase is due entirely to the product sales operations acquired
with Statia. The price decrease was due to decreases in overall average market
prices and changes in product mix resulting from the Statia acquisition. For the
year ended December 31, 2002, gross margin and operating income increased by
$12.0 million and $5.3 million, respectively, due to the increase in both the
volumes sold and favorable product margins.
Product inventories are maintained at minimum levels to meet customers'
needs; however, market prices for petroleum products can fluctuate significantly
in short periods of time.
INTEREST AND OTHER INCOME
In September of 2002, KPP entered into a treasury lock contract,
maturing on November 4, 2002, for the purpose of locking in the US Treasury
interest rate component on $150 million of anticipated thirty-year public debt
offerings. The treasury lock contract originally qualified as a cash flow
hedging instrument under Statement of Financial Accounting Standards ("SFAS")
No. 133. In October of 2002, KPP, due to various market factors, elected to
defer issuance of the public debt securities, effectively eliminating the cash
flow hedging designation for the treasury lock contract. On October 29, 2002,
the contract was settled resulting in a net realized gain of $3.0 million,
before interest of outside non-controlling partners in KPP's net income, which
was recognized as a component of interest and other income.
In March of 2001, KPP entered into two contracts for the purpose of
locking in interest rates on $100 million of anticipated ten-year public debt
offerings. As the interest rate locks were not designated as hedging instruments
pursuant to the requirements of SFAS No. 133, increases or decreases in the fair
value of the contracts are included as a component of interest and other income.
On May 22, 2001, the contracts were settled resulting in a gain of $3.8 million,
which is included in interest and other income, before income taxes and interest
of outside non-controlling partners in KPP's net income, in 2001.
INTEREST EXPENSE
For the year ended December 31, 2003, consolidated interest expense
increased by $10.4 million, when compared to 2002, due to increases in fixed
rate debt resulting from KPP's 2002 pipeline and terminal acquisitions (see
"Liquidity and Capital Resources"), partially offset by overall declines in
interest rates on variable rate debt.
For the year ended December 31, 2002, consolidated interest expense
increased by $13.8 million, when compared to 2001, due to overall increases in
debt levels resulting from KPP's 2002 acquisitions (see "Liquidity and Capital
Resources"), partially offset by declines in interest rates on variable rate
debt.
INCOME TAXES
KPP's partnership operations are not subject to federal or state income
taxes. However, certain KPP operations are conducted through separate taxable
wholly-owned U.S. and foreign corporate subsidiaries. The income tax expense for
these subsidiaries was $5.2 million, $4.1 million and $0.3 million for the years
ended December 31, 2003, 2002 and 2001, respectively. The 2003 and 2002
increases in income taxes, compared to the respective prior year, were primarily
due to foreign taxes on terminaling operations acquired in 2002 (see "Liquidity
and Capital Resources").
The Company's income tax expense reported in the consolidated financial
statements prior to the Distribution represents the tax expense of the Company
and its subsidiaries as if they had filed on a separate return basis. As a
result of the Distribution, the Company no longer participates with Xanser in
filing a consolidated federal income tax return. Effective with the
Distribution, the Company became a pass-through entity with its income, for
federal and state purposes, taxed at the shareholder level instead of the
Company paying such taxes. As a result of the change in tax status of the
Company, all deferred income tax assets and liabilities relating to temporary
differences (a net $8.6 million deferred tax liability) were eliminated,
resulting in a credit to income tax expense in 2002.
Income tax expense for the year ended December 31, 2002 includes a
benefit of $1.3 million relating to favorable developments pertaining to the
resolution of certain state income tax matters.
On June 1, 1989, the governments of the Netherlands Antilles and St.
Eustatius approved a Free Zone and Profit Tax Agreement retroactive to January
1, 1989, which expired on December 31, 2000. This agreement requires a
subsidiary of the Partnership, which was acquired with Statia 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 provides that any amounts paid in order to meet the minimum
annual payment will be available to offset future tax liabilities under the
agreement to the extent that the minimum annual payment is greater than 2% of
taxable income. The subsidiary is currently engaged in discussions with
representatives appointed by the Island Territory of St. Eustatius regarding the
renewal or modification of the agreement, but the ultimate outcome cannot be
predicted at this time. The subsidiary has accrued amounts assuming a new
agreement becomes effective, and continues to make payments, as required, under
the previous agreement.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities, including the operations of KPP,
was $144.9 million, $89.0 million and $103.5 million for the years ended
December 31, 2003, 2002 and 2001, respectively. The increase in 2003, compared
to 2002, was due to increases in pipeline, terminaling and product marketing
revenues and operating income, primarily a result of the 2002 acquisitions, and
changes in working capital components resulting from the timing of receipts and
disbursements. The 2002 decrease in cash provided by operating activities, when
compared to 2001, was due to the payment of personnel-related costs assumed with
the Statia acquisition, initial working capital requirements of the pipeline
businesses acquired in 2002 and changes in working capital components resulting
from the timing of cash receipts and disbursements, partially offset by overall
increases in revenues and operating income.
Capital expenditures, including routine maintenance and expansion
expenditures, but excluding acquisitions, were $44.7 million, $31.1 million and
$17.3 million for the years ended December 31, 2003, 2002 and 2001,
respectively, and almost exclusively relate to KPP. The increase in 2003 and
2002 capital expenditures, when compared to the respective prior year, is the
result of planned maintenance and expansion capital expenditures related to the
KPP pipeline and terminaling operations acquired in 2002 and higher maintenance
capital expenditures in the existing pipeline and terminaling businesses. During
all periods, adequate pipeline capacity existed to accommodate volume growth,
and the expenditures required for environmental and safety improvements were
not, and are not expected in the future to be, significant. Environmental
damages are included under KPP's insurance coverages (subject to deductibles and
limits). KPP anticipates that capital expenditures (including routine
maintenance and expansion expenditures, but excluding acquisitions) will total
approximately $28 million to $32 million in 2004. Such future expenditures by
KPP, however, will depend on many factors beyond KPP's control, including,
without limitation, demand for refined petroleum products and terminaling
services in KPP's market areas, local, state and federal government regulations,
fuel conservation efforts and the availability of financing on acceptable terms.
No assurance can be given that required capital expenditures will not exceed
anticipated amounts during the year or thereafter or that KPP will have the
ability to finance such expenditures through borrowings, or choose to do so.
The Company makes quarterly distributions of 100% of available cash, as
defined in the limited liability agreement, to the common shareholders of record
on the applicable record date, within 45 days after the end of each quarter.
Available cash consists generally of all the cash receipts of the Company, less
all cash disbursements and reserves. Excess cash flow of the Company's
wholly-owned product marketing operations is being used to reduce working
capital borrowings. Distributions of $1.825 per share were declared and paid to
shareholders with respect to 2003. Distributions of $1.65 per share were
declared and paid to shareholders with respect to 2002. Distributions of $.3625
per share were declared and paid with respect to each of third and fourth
quarters of 2001.
KPP expects to fund its future cash distributions and routine
maintenance capital expenditures (excluding acquisitions) with existing cash and
anticipated cash flows from operations. Expansionary capital expenditures of KPP
are expected to be funded through additional KPP bank borrowings and/or future
KPP public equity or debt offerings.
The Company has an agreement with a bank that provides for a $50
million revolving credit facility through July 1, 2008. The credit facility,
which bears interest at variable rates, is secured by 4.6 million KPP limited
partnership units and has a variable rate commitment fee on unused amounts. At
December 31, 2003, $16.5 million was drawn on the credit facility.
The Company's product marketing subsidiary has a credit agreement with
a bank that, as amended, provides for a $15 million revolving credit facility
through April of 2007. The credit facility bears interest at variable rates, has
a commitment fee of 0.25% per annum on unutilized amounts and contains certain
financial and operational covenants. At December 31, 2003, the subsidiary was in
compliance with all covenants. The credit facility, which is without recourse to
the Company, is secured by essentially all of the tangible and intangible assets
of the Company's wholly-owned products marking business and by 250,000 KPP
limited partnership units held by the product marketing subsidiary. At December
31, 2003, $2.1 million was drawn on the facility.
In January of 2001, KPP used proceeds from its revolving credit
agreement to repay in full its $128 million of mortgage notes. Under the
provisions of the mortgage notes, KPP incurred a $6.5 million prepayment penalty
which, before interest of outside non-controlling partners in KPP's net income
and income taxes, was recognized as loss on debt extinguishment in 2001.
In January of 2001, KPP acquired Shore Terminals LLC ("Shore") for $107
million in cash and 1,975,090 KPP limited partnership units (valued at $56.5
million on the date of agreement and its announcement). Financing for the cash
portion of the purchase price was initially supplied by KPP's revolving credit
facility. As a result of KPP issuing additional units to unrelated parties, the
Company's share of net assets of KPP increased by $9.9 million. Accordingly, the
Company recognized a $9.9 million gain, before deferred income taxes of $3.8
million, in 2001.
In January of 2002, KPP issued 1,250,000 limited partnership units in a
public offering at $41.65 per unit, generating approximately $49.7 million in
net proceeds. The proceeds were used to reduce borrowings under KPP's revolving
credit agreement. As a result of KPP issuing additional units to unrelated
parties, the Company's share of net assets of KPP increased by $8.6 million.
Accordingly, the Company recognized an $8.6 million gain in 2002.
In February of 2002, KPP issued $250 million of 7.75% senior unsecured
notes due February 15, 2012. The net proceeds from the public offering, $248.2
million, were used to repay KPP's revolving credit agreement and to partially
fund the acquisition of all of the liquids terminaling subsidiaries of Statia
Terminals Group NV ("Statia"). Under the note indenture, interest is payable
semi-annually in arrears on February 15 and August 15 of each year. The notes,
which are without recourse to the Company, are redeemable, as a whole or in
part, at the option of KPP, at any time, at a redemption price equal to the
greater of 100% of the principal amount of the notes, or the sum of the present
value of the remaining scheduled payments of principal and interest, discounted
to the redemption date at the applicable U.S. Treasury rate, as defined in the
indenture, plus 30 basis points. The note indenture contains certain financial
and operational covenants, including certain limitations on investments, sales
of assets and transactions with affiliates and, absent an event of default, such
covenants do not restrict distributions to the Company or to other partners. At
December 31, 2003, KPP was in compliance with all covenants.
On February 28, 2002, KPP acquired Statia for approximately $178
million in cash (net of acquired cash). The acquired Statia subsidiaries had
approximately $107 million in outstanding debt, including $101 million of 11.75%
notes due in November 2003. The cash portion of the purchase price was initially
funded by KPP's revolving credit agreement and proceeds from KPP's February 2002
public debt offering. In April of 2002, KPP redeemed all of Statia's 11.75%
notes at 102.938% of the principal amount, plus accrued interest. The redemption
was funded by KPP's revolving credit facility. Under the provisions of the
11.75% notes, KPP incurred a $3.0 million prepayment penalty, of which $2.0
million, before interest of outside non-controlling partners in KPP's net
income, was recognized in the Consolidated Financial Statements as loss on debt
extinguishment in 2002.
In May of 2002, KPP issued 1,565,000 limited partnership units in a
public offering at a price of $39.60 per unit, generating approximately $59.1
million in net proceeds. A portion of the offering proceeds was used to fund
KPP's September 2002 acquisition of the Australia and New Zealand terminals. As
a result of KPP issuing additional units to unrelated parties, the Company's
share of net assets of KPP increased by $8.8 million. Accordingly, the Company
recognized an $8.8 million gain in 2002.
On September 18, 2002, KPP acquired eight bulk liquid storage terminals
in Australia and New Zealand from Burns Philp & Co. Ltd. for approximately $47
million in cash.
On November 1, 2002, KPP acquired an approximately 2,000-mile anhydrous
ammonia pipeline system from Koch Pipeline Company, L.P. for approximately $139
million in cash. This fertilizer pipeline system originates in southern
Louisiana, proceeds north through Arkansas and Missouri, and then branches east
into Illinois and Indiana and north and west into Iowa and Nebraska. The
acquisition was initially financed with KPP bank debt.
In November of 2002, KPP issued 2,095,000 limited partnership units in
a public offering at $33.36 per unit, generating approximately $66.7 million in
net proceeds. The offering proceeds were used to reduce KPP's bank borrowings
for the fertilizer pipeline acquisition. As a result of KPP issuing additional
units to unrelated parties, the Company's share of net assets of KPP increased
by $7.5 million. Accordingly, the Company recognized a $7.5 million gain in
2002.
On December 24, 2002, KPP acquired a 400-mile petroleum products
pipeline and four terminals in North Dakota and Minnesota from Tesoro Refining
and Marketing Company for approximately $100 million in cash, subject to normal
post-closing adjustments. The acquisition was initially funded with KPP bank
debt.
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 bank borrowings. As a result of
KPP issuing additional units to unrelated parties, the Company's share of net
assets of KPP increased by $10.9 million. Accordingly, the Company recognized a
$10.9 million gain in 2003.
In April of 2003, KPP entered into a new credit agreement with a group
of banks that provides for a $400 million unsecured revolving credit facility
through April of 2006. The credit facility, which provides for an increase in
the commitment up to an aggregate of $450 million by mutual agreement between
KPP and the banks, bears interest at variable rates and has a variable
commitment fee on unused amounts. The credit facility is without recourse to the
Company and contains certain financial and operating covenants, including
limitations on investments, sales of assets and transactions with affiliates
and, absent an event of default, does not restrict distributions to the Company
and other partners. At December 31, 2003, KPP was in compliance with all
covenants. Initial borrowings on the credit agreement ($324.2 million) were used
to repay all amounts outstanding under KPP's $275 million credit agreement and
$175 million bridge loan agreement. At December 31, 2003, $54.2 million was
outstanding under the new credit agreement.
On May 19, 2003, KPP 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 2003 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 KPP, at any time, at a redemption price equal
to the greater of 100% of the principal amount of the notes, or the sum of the
present value of the remaining scheduled payments of principal and interest,
discounted to the redemption date at the applicable U.S. Treasury rate, as
defined in the indenture, plus 30 basis points. The note indenture contains
certain financial and operational covenants, including certain limitations on
investments, sales of assets and transactions with affiliates and, absent an
event of default, such covenants do not restrict distributions to the Company or
to other partners. At December 31, 2003, KPP was in compliance with all
covenants. In connection with the offering, on May 8, 2003, KPP 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 SFAS No. 133, was settled on
May 19, 2003 with a cash payment by KPP of $1.8 million. The settlement cost of
the contract, net of interest of outside non-controlling partners in KPP's
accumulated other comprehensive income, has been recorded as a component of
accumulated other comprehensive income and is being amortized, as interest
expense, over the life of the debt.
Pursuant to the Distribution, the Company entered into an agreement
(the "Distribution Agreement") with Xanser whereby the Company is obligated to
pay Xanser amounts equal to certain expenses and tax liabilities incurred by
Xanser in connection with the Distribution. In January of 2002, the Company paid
Xanser $10 million for tax liabilities due under the terms of the Distribution
Agreement. The Distribution Agreement also requires the Company to pay Xanser an
amount calculated based on any income tax liability of Xanser that, in the sole
judgement of Xanser, (i) is attributable to increases in income tax from past
years arising out of adjustments required by federal and state tax authorities,
to the extent that such increases are properly allocable to the businesses that
became part of the Company, or (ii) is attributable to the distribution of the
Company's common shares and the operations of the Company's businesses prior to
the distribution date. In the event of an examination of Xanser by federal or
state tax authorities, Xanser will have unfettered control over the examination,
administrative appeal, settlement or litigation that may be involved,
notwithstanding that the Company has agreed to pay any additional tax.
The following is a schedule by period of the Company's, including
KPP's, debt repayment obligations and material contractual commitments as of
December 31, 2003:
Less than After
Total 1 year 1 -3 years 4 -5 years 5 years
---------- ---------- ---------- ---------- ----------
(in thousands)
Debt:
Revolving credit facility......... $ 16,500 $ - $ - $ 16,500 $ -
Revolving credit facility of
subsidiary...................... 2,112 - - 2,112 -
KPP revolving credit facility..... 54,169 - 54,169 - -
KPP 7.75% senior unsecured
notes........................... 250,000 - - - 250,000
KPP 5.875% senior unsecured
notes........................... 250,000 - - - 250,000
Other KPP bank debt............... 63,527 - 63,527 - -
----------- ----------- --------- ---------- ----------
Debt subtotal.................. 636,308 - 117,696 18,612 500,000
----------- ----------- --------- ---------- ----------
Contractual commitments:
Operating leases.................. 10,809 4,398 3,719 2,350 342
----------- ----------- --------- ---------- ----------
Contractual commitments
subtotal.................... 10,809 4,398 3,719 2,350 342
----------- ----------- --------- ---------- ----------
Total.......................... $ 647,117 $ 4,398 $ 121,415 $ 20,962 $ 500,342
=========== =========== ========= ========== ==========
See also "Item 1 - Environmental Matters" and "Item 3 - Legal
Proceedings".
OFF-BALANCE SHEET TRANSACTIONS
The Company was not a party of any off-balance sheet transactions at
December 31, 2003, or for any of the years ended December 31, 2003, 2002 and
2001.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of the Company's financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates. Significant accounting policies are presented in the Notes
to the Consolidated Financial Statements.
Critical accounting policies are those that are most important to the
portrayal to the Company's financial position and results of operations. These
policies require management's most difficult, subjective or complex judgments,
often employing the use of estimates about the effect of matters that are
inherently uncertain. The Company's most critical accounting policies pertain to
impairment of property and equipment and environmental costs.
The carrying value of KPP's property and equipment is periodically
evaluated using management's estimates of undiscounted future cash flows, or, in
some cases, third-party appraisals, as the basis of determining if impairment
exists under the provisions of SFAS No. 144, "Accounting for the Impairment or
the Disposal of Long-Lived Assets", which was adopted effective January 1, 2002.
To the extent that impairment is indicated to exist, an impairment loss is
recognized by KPP under SFAS No. 144 based on fair value. The application of
SFAS No. 144 did not have a material impact on the results of operations of KPP
for the years ended December 31, 2003 or 2002. However, future evaluations of
carrying value are dependent on many factors, several of which are out of KPP's
control, including demand for refined petroleum products and terminaling
services in KPP's market areas, and local, state and federal governmental
regulations. To the extent that such factors or conditions change, it is
possible that future impairments might occur, which could have a material effect
on the results of operations of KPP.
KPP environmental expenditures that relate to current operations are
expensed or capitalized, as appropriate. Expenditures that relate to an existing
condition caused by past operations, and which do not contribute to current or
future revenue generation, are expensed. Liabilities are recorded by KPP when
environmental assessments and/or remedial efforts are probable, and the costs
can be reasonably estimated. Generally, the timing of these accruals coincides
with the completion of a feasibility study or KPP's commitment to a formal plan
of action. The application of KPP's environmental accounting policies did not
have a material impact on the results of operations of KPP for the years ended
December 31, 2003, 2002 or 2001. Although KPP believes that its operations are
in general compliance with applicable environmental regulations, risks of
substantial costs and liabilities are inherent in pipeline and terminaling
operations. Moreover, it is possible that other developments, such as
increasingly strict environmental laws, regulations and enforcement policies
thereunder, and legal claims for damages to property or persons resulting from
the operations of KPP could result in substantial costs and liabilities, any of
which could have a material effect on the results of operations of KPP.
RECENT ACCOUNTING PRONOUNCEMENT
In December 2003, the 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, that 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
Company, 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 has not and is not expected to have a material impact on
the consolidated financial statements of the Company.
Item 7(a). Quantitative and Qualitative Disclosures About Market Risk
The principal market risks (i.e., the risk of loss arising from the
adverse changes in market rates and prices) to which the Company is exposed are
interest rates on the Company's and KPP's debt and investment portfolios,
fluctuations of petroleum product prices on inventories held for resale, and
fluctuations in foreign currency.
The Company's investment portfolio consists of cash equivalents;
accordingly, the carrying amounts approximate fair value. The Company's
investments are not material to its financial position or performance. Assuming
variable rate debt of $136.3 million (including KPP's debt) at December 31,
2003, a one percent increase in interest rates would increase annual net
interest expense by approximately $1.4 million, before interest of outside
non-controlling partners in KPP's net income. Information regarding KPP's
interest rate hedging transactions was included in "Item 7 -Interest and Other
Income" and "Item 7 - Liquidity and Capital Resources".
The product marketing business periodically purchases refined petroleum
products for resale as motor fuel, bunker fuel and sales to commercial
interests. Petroleum inventories are generally held for short periods of time,
not exceeding 90 days. As the Company 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 significant portion of the terminaling business is exposed to
fluctuations in foreign currency exchange rates. (See "Item 7 - Terminaling
Operations".)
Item 8. Financial Statements and Supplementary Data
The financial statements and supplementary data of the Company begin on
page F-1 of this report. Such information is hereby incorporated by reference
into this Item 8.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
Item 9(a). Controls and Procedures
Kaneb Services LLC's principal executive officer and principal
financial officer, after evaluating as of December 31, 2003, the effectiveness
of the Company's disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934), have concluded
that, as of such date, the Company's disclosure controls and procedures are
adequate and effective to ensure that material information relating to the
Company and its consolidated subsidiaries would be made known to them by others
within those entities.
During the fourth quarter of 2003, there have been no changes in the
Company's internal controls over financial reporting that have materially
affected, or are reasonably likely to materially affect, those internal controls
subsequent to the date of the evaluation. As a result, no corrective actions
were required or undertaken.
PART III
The information required by Part III (Items 10, 11, 12 and 13) of Form
10-K is incorporated by reference from portions of the Registrant's definitive
proxy statement to be filed with the Securities and Exchange Commission not
later than 120 days after the close of the fiscal year covered by this Report.
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) (1)Financial Statements Beginning
Page
----------
Set forth below is a list of financial statements appearing in this
report.
Kaneb Services LLC Financial Statements:
Independent Auditors' Report.............................................................. F - 1
Consolidated Statements of Income - Three Years Ended December 31, 2003................... F - 2
Consolidated Balance Sheets - December 31, 2003 and 2002.................................. F - 3
Consolidated Statements of Cash Flows - Three Years Ended December 31, 2003............... F - 4
Consolidated Statements of Shareholders' Equity - Three Years
Ended December 31, 2003................................................................ F - 5
Notes to Consolidated Financial Statements................................................ F - 6
(a) (2)Financial Statement Schedules
Set forth below are the financial statement schedules appearing in this
report.
Schedule I - Kaneb Services LLC (Parent Company) Condensed Financial Statements:
Statements of Income - Years ended December 31, 2003 and 2002 and period from
June 30, 2001 to December 31, 2001..................................................... F - 24
Balance Sheets - December 31, 2003 and 2002............................................... F - 25
Statements of Cash Flows - Years ended December 31, 2003 and 2002 and period from
June 30, 2001 to December 31, 2001..................................................... F - 26
Schedule II - Kaneb Services LLC Valuation and Qualifying Accounts - Years Ended
December 31, 2003, 2002 and 2001.......................................................... F - 27
Schedules, other than those listed above, have been omitted
because of the absence of the conditions under which they are required
or because the required information is included in the consolidated
financial statements or related notes thereto. Schedule I information
for periods prior to June 30, 2001 has been omitted since the Parent
Company was not formed and capitalized prior to that date.
(a) (3)List of Exhibits
3.01 Amended and Restated Limited Liability Company Agreement of
Registrant, filed as Exhibit 3.1 to the exhibits to
Registrant's Form 10-Q, for the period ended June 30, 2001,
which exhibit is hereby incorporated by reference.
4.01 Specimen Common Share Certificate, filed as Exhibit 4.01 to
the exhibits to Registrant's Form 10/A, dated May 1, 2001,
which exhibit is hereby incorporated by reference.
4.02* Amended and Restated Kaneb Services LLC 2001 Incentive Plan,
filed as Exhibit 10.1 to the exhibits to Registrant's Form
10-Q, for the period ended June 30, 2003, which exhibit is
hereby incorporated by reference.
10.01 Distribution Agreement by and between the Registrant and Kaneb
Services, Inc., filed as Exhibit 10.1 to the exhibits to
Registrant's Form 10-Q, for the period ended June 30, 2001,
which exhibit is hereby incorporated by reference.
10.02 Administrative Services Agreement by and between the
Registrant and Kaneb Services, Inc., filed as Exhibit 10.2 to
the exhibits to Registrant's Form 10-Q, for the period ended
June 30, 2001, which exhibit is hereby incorporated by
reference.
10.03 Rights Agreement by and between the Registrant and The Chase
Manhattan Bank, filed as Exhibit 10.3 to the exhibits to
Registrant's Form 10-Q, for the period ended June 30, 2001,
which exhibit is hereby incorporated by reference.
10.04* Employee Benefits Agreement by and between the Registrant and
Kaneb Services, Inc., filed as Exhibit 10.04 to the exhibits
to Registrant's Form 10/A, dated May 24, 2001, which exhibit
is hereby incorporated by reference.
10.05 ST Agreement and Plan of Merger dated December 21, 1992 by and
among Grace Energy Corporation, Support Terminal Services,
Inc., Standard Transpipe Corp., and Kaneb Pipe Line Operating
Partnership, NSTS, Inc. and NSTI, Inc., as amended by
Amendment of STS Merger Agreement dated March 2, 1993, filed
as Exhibit 10.1 of the exhibits to Kaneb Pipe Line Partners,
L.P.'s Current Report on Form 8-K, dated March 16, 1993, which
exhibit is hereby incorporated by reference.
10.06 Agreement for Sale and Purchase of Assets between Wyco Pipe
Line Company and Kaneb Pipe Line Operating Partnership, L.P.,
dated February 19, 1995, filed as Exhibit 10.1 of the exhibits
to the Kaneb Pipe Line Partners, L.P.'s March 1995 Form 8-K,
which exhibit is hereby incorporated by reference.
10.07 Asset Purchase Agreements between and among Steuart Petroleum
Company, SPC Terminals, Inc., Piney Point Industries, Inc.,
Steuart Investment Company, Support Terminals Operating
Partnership, L.P. and Kaneb Pipe Line Operating Partnership,
L.P., as amended, dated August 27, 1995, filed as Exhibits
10.1, 10.2, 10.3, and 10.4 of the exhibits to Kaneb Pipe Line
Partners, L.P's Current Report on Form 8-K dated January 3,
1996, which exhibits are hereby incorporated by reference.
10.08 Formation and Purchase Agreement, by and among Support
Terminal Operating Partnership, L.P., Northville Industries
Corp. and AFFCO, Corp., dated October 30, 1998, filed as
Exhibit 10.9 to the Kaneb Pipe Line Partners, L.P.'s Form 10-K
for the year ended December 31, 1998, which exhibit is hereby
incorporated by reference.
10.09 Agreement, by and among, GATX Terminals Limited, ST Services
Ltd., ST Eastham, Ltd., GATX Terminals Corporation, Support
Terminals Operating Partnership, L.P. and Kaneb Pipe Line
Partners, L.P., dated January 26, 1999, filed as Exhibit 10.10
to the Kaneb Pipe Line Partners, L.P.'s Form 10-K for the year
ended December 31, 1998, which exhibit is hereby incorporated
by reference.
10.10 Credit Agreement, by and among, Kaneb Pipe Line Operating
Partnership, L.P., ST Services, Ltd. and SunTrust Bank,
Atlanta, dated January 27, 1999, filed as Exhibit 10.11 to the
Kaneb Pipe Line Partners, L.P.'s Form 10-K for the year ended
December 31, 1998, which exhibit is hereby incorporated by
reference.
10.11 Revolving Credit Agreement, dated as of December 28, 2000 by
and among Kaneb Pipe Line Operating Partnership, L.P., Kaneb
Pipe Line Partners, L.P., the Lenders party thereto, and
SunTrust Bank, as Administrative Agent, filed as Exhibit 10.11
to Kaneb Pipe Line Partners, L.P.'s Form 10-K for the year
ended December 31, 2000, which exhibit is hereby incorporated
by reference.
10.12 Securities Purchase Agreement by and among Shore Terminals
LLC, Kaneb Pipe Line Partners, L.P. and the Sellers Named
Therein, dated as of September 22, 2000, Amendment No. 1 To
Securities Purchase Agreement, dated as of November 28, 2000
and Registration Rights Agreement, dated as of January 3,
2001, filed as Exhibits 10.1, 10.2 and 10.3 of the exhibits to
Kaneb Pipe Line Partners, L.P.'s Current Report on Form 8-K
dated January 3, 2001, which exhibits are hereby incorporated
by reference.
10.13* Kaneb Services LLC 401(k) Savings Plan, filed as Exhibit 10.16
to the exhibits to Registrant's Form 10/A, dated May 24, 2001,
which exhibit is hereby incorporated by reference.
10.14 Credit Agreement by and between the Registrant and Kaneb
Services, Inc., filed as Exhibit 10.5 to the exhibits to
Registrant's Form 10-Q, for the period ended June 30, 2001,
which exhibit is hereby incorporated by reference. This credit
commitment was permanently terminated effective December 10,
2001.
10.15 Loan Agreement by and between the Registrant, Kaneb Pipe Line
Company LLC and the Bank of Scotland, filed as Exhibit 10.6 to
the exhibits to Registrant's Form 10-Q, for the period ended
June 30, 2001, which exhibit is hereby incorporated by
reference.
21 List of Subsidiaries, filed herewith.
23 Consent of KPMG LLP, filed herewith.
31.1 Certification of Chief Executive Officer, Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002, dated as of March 12,
2004.
31.2 Certification of Chief Financial Officer, Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002, dated as of March 12,
2004.
32.1 Certification of Chief Executive Officer, Pursuant to Section
906(a) of the Sarbanes-Oxley Act of 2002, dated as of March
12, 2004.
32.2 Certification of Chief Financial Officer, Pursuant to Section
906(a) of the Sarbanes-Oxley Act of 2002, dated as of March
12, 2004.
* Denotes management contracts.
(b) Reports on Form 8-K
Current Report on Form 8-K filed with the SEC on October 30, 2003.
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of Kaneb Services LLC
We have audited the accompanying consolidated financial statements of Kaneb
Services LLC and its subsidiaries (the "Company") as listed in the index
appearing in Item 15(a)(1). In connection with our audits of the consolidated
financial statements, we have also audited the financial statement schedules as
listed in the index appearing under Item 15(a)(2). These consolidated financial
statements and financial statement schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion on the
consolidated financial statements and financial statement schedules based on our
audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company as of
December 31, 2003 and 2002, and the results of their operations and their cash
flows for each of the years in the three-year period ended December 31, 2003, in
conformity with accounting principles generally accepted in the United States of
America. Also, in our opinion, the related financial statement schedules, when
considered in relation to the basic consolidated financial statements taken as a
whole, present fairly, in all material respects, the information set forth
therein.
As described in Note 1, the Company adopted Statement of Financial Accounting
Standards No. 143 "Accounting for Asset Retirement Obligations" in 2003.
KPMG LLP
Dallas, Texas
February 20, 2004
F - 1
KANEB SERVICES LLC
CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31,
--------------------------------------------------
2003 2002 2001
--------------- -------------- --------------
Revenues:
Services................................................... $ 354,591,000 $ 288,669,000 $ 207,796,000
Products................................................... 511,200,000 381,159,000 327,542,000
--------------- -------------- --------------
Total revenues.......................................... 865,791,000 669,828,000 535,338,000
--------------- -------------- --------------
Costs and expenses:
Cost of products sold...................................... 486,310,000 367,870,000 326,230,000
Operating costs............................................ 169,380,000 132,269,000 91,704,000
Depreciation and amortization.............................. 53,195,000 39,471,000 23,261,000
Gain on sale of assets..................................... - (609,000) -
General and administrative................................. 28,402,000 24,468,000 14,352,000
--------------- -------------- --------------
Total costs and expenses................................ 737,287,000 563,469,000 455,547,000
--------------- -------------- --------------
Operating income.............................................. 128,504,000 106,359,000 79,791,000
Interest and other income..................................... 365,000 3,664,000 4,132,000
Interest expense.............................................. (39,576,000) (29,171,000) (15,381,000)
Loss on debt extinguishment................................... - (3,282,000) (6,540,000)
--------------- -------------- --------------
Income before gain on issuance of units by KPP, income
taxes, interest of outside non-controlling partners in
KPP's net income and cumulative effect of change in
accounting principle....................................... 89,293,000 77,570,000 62,002,000
Gain on issuance of units by KPP.............................. 10,898,000 24,882,000 9,859,000
Income tax benefit (expense).................................. (4,887,000) (2,585,000) 2,413,000
Interest of outside non-controlling partners in KPP's
net income................................................. (61,908,000) (52,639,000) (45,951,000)
--------------- -------------- --------------
Income before cumulative effect of change in accounting
principle.................................................. 33,396,000 47,228,000 28,323,000
Cumulative effect of change in accounting principle - adoption
of new accounting standard for asset retirement obligations (313,000) - -
--------------- -------------- --------------
Net income.................................................... $ 33,083,000 $ 47,228,000 $ 28,323,000
=============== ============== ==============
Earnings per share:
Basic:
Before cumulative effect of change in accounting principle $ 2.89 $ 4.13 $ 2.57
Cumulative effect of change in accounting principle..... (.03) - -
--------------- -------------- --------------
$ 2.86 $ 4.13 $ 2.57
=============== ============== ==============
Diluted:
Before cumulative effect of change in accounting principle $ 2.84 $ 4.02 $ 2.46
Cumulative effect of change in accounting principle..... (.03) - -
--------------- -------------- --------------
$ 2.81 $ 4.02 $ 2.46
=============== ============== ==============
See notes to consolidated financial statements.
F - 2
KANEB SERVICES LLC
CONSOLIDATED BALANCE SHEETS
December 31,
---------------------------------
2003 2002
--------------- --------------
ASSETS
Current assets:
Cash and cash equivalents.................................................... $ 43,457,000 $ 24,477,000
Accounts receivable (net of allowance for doubtful accounts of
$3,777,000 in 2003 and $3,724,000 in 2002)................................ 60,684,000 61,835,000
Inventories.................................................................. 18,637,000 12,863,000
Prepaid expenses and other................................................... 9,650,000 10,658,000
--------------- ----------------
Total current assets...................................................... 132,428,000 109,833,000
--------------- ----------------
Property and equipment.......................................................... 1,360,523,000 1,288,960,000
Less accumulated depreciation................................................... 247,503,000 196,684,000
--------------- ----------------
Net property and equipment................................................ 1,113,020,000 1,092,276,000
--------------- ----------------
Investment in affiliates........................................................ 25,456,000 25,604,000
Excess of cost over fair value of net assets of acquired businesses
and other assets............................................................. 20,663,000 16,388,000
--------------- ----------------
$ 1,291,567,000 $ 1,244,101,000
=============== ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable............................................................. $ 36,916,000 $ 32,629,000
Accrued expenses............................................................. 39,307,000 38,076,000
Accrued interest payable..................................................... 9,303,000 7,997,000
Accrued distributions payable to shareholders................................ 5,567,000 4,734,000
Accrued distributions payable to outside non-controlling
partners in KPP's net income.............................................. 19,507,000 15,878,000
Deferred terminaling fees.................................................... 7,061,000 6,246,000
--------------- ----------------
Total current liabilities................................................. 117,661,000 105,560,000
--------------- ----------------
Long-term debt.................................................................. 636,308,000 718,162,000
Other liabilities and deferred taxes............................................ 52,242,000 40,094,000
Interest of outside non-controlling partners in KPP............................. 407,635,000 316,631,000
Commitments and contingencies
Shareholders' equity:
Shareholders' investment..................................................... 75,291,000 63,350,000
Accumulated other comprehensive income....................................... 2,430,000 304,000
--------------- ----------------
Total shareholders' equity................................................ 77,721,000 63,654,000
--------------- ----------------
$ 1,291,567,000 $ 1,244,101,000
=============== ================
See notes to consolidated financial statements
F - 3
KANEB SERVICES LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
--------------------------------------------------
2003 2002 2001
--------------- -------------- --------------
Operating activities:
Net income................................................. $ 33,083,000 $ 47,228,000 $ 28,323,000
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization........................... 53,195,000 39,471,000 23,261,000
Equity in earnings of affiliates, net of distributions.. 148,000 (3,164,000) (5,000)
Interest of outside non-controlling partners in KPP's
net income............................................ 61,908,000 52,639,000 45,951,000
Gain on issuance of units by KPP........................ (10,898,000) (24,882,000) (9,859,000)
Gain on sale of assets ................................. - (609,000) -
Deferred income taxes................................... 1,683,000 3,105,000 (2,414,000)
Cumulative effect of change in accounting principle..... 313,000 - -
Other................................................... 1,468,000 (559,000) (5,728,000)
Changes in working capital components:
Accounts receivable................................... 1,151,000 (16,403,000) 7,617,000
Inventories, prepaid expenses and other............... (4,766,000) (7,643,000) 8,770,000
Accounts payable and accrued expenses................. 7,639,000 (165,000) 7,620,000
--------------- -------------- --------------
Net cash provided by operating activities............. 144,924,000 89,018,000 103,536,000
--------------- -------------- --------------
Investing activities:
Acquisitions, net of cash acquired......................... (1,644,000) (468,477,000) (111,562,000)
Capital expenditures....................................... (44,747,000) (31,101,000) (17,309,000)
Proceeds from sale of assets............................... - 1,107,000 2,807,000
Other...................................................... (1,388,000) 361,000 (2,157,000)
--------------- -------------- --------------
Net cash used in investing activities................. (47,779,000) (498,110,000) (128,221,000)
--------------- -------------- --------------
Financing activities:
Issuance of debt........................................... 291,377,000 756,087,000 269,625,000
Payments of debt........................................... (388,051,000) (427,493,000) (176,375,000)
Distributions to shareholders.............................. (20,473,000) (18,351,000) (4,137,000)
Distributions to outside non-controlling
partners in KPP......................................... (73,004,000) (52,827,000) (44,040,000)
Changes in long-term payables and other liabilities........ - (10,026,000) (19,132,000)
Net proceeds from issuance of units by KPP................. 109,056,000 175,527,000 -
Issuance of common shares upon exercise of stock options... 164,000 648,000 2,354,000
--------------- -------------- --------------
Net cash provided by (used in) financing activities... (80,931,000) 423,565,000 28,295,000
--------------- -------------- --------------
Effect of exchange rate changes on cash....................... 2,766,000 - -
--------------- -------------- --------------
Increase in cash and cash equivalents......................... 18,980,000 14,473,000 3,610,000
Cash and cash equivalents at beginning of period.............. 24,477,000 10,004,000 6,394,000
--------------- -------------- --------------
Cash and cash equivalents at end of period.................... $ 43,457,000 $ 24,477,000 $ 10,004,000
=============== ============== ==============
Supplemental cash flow information:
Cash paid for interest..................................... $ 35,712,000 $ 27,070,000 $ 15,044,000
=============== ============== ==============
Non-cash investing and financing activities-
Issuance of units in connection with
acquisition of terminals by KPP....................... $ - $ - $ 56,488,000
=============== ============== ==============
See notes to consolidated financial statements
F - 4
KANEB SERVICES LLC
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Accumulated
Other
Shareholders' Comprehensive Comprehensive
Investment Income Total Income
------------- -------------- ------------- --------------
Balance at January 1, 2001.................. $ 71,774,000 $ (405,000) $ 71,369,000
Net income for the year................ 28,323,000 - 28,323,000 $ 28,323,000
Capital contributions.................. 328,000 - 328,000 -
Dividends.............................. (61,310,000) - (61,310,000) -
Distributions declared................. (8,268,000) - (8,268,000) -
Issuance of common shares and other.... 3,581,000 - 3,581,000 -
Foreign currency translation adjustment - (91,000) (91,000) (91,000)
------------- -------------- ------------- --------------
Comprehensive income for the year...... $ 28,232,000
==============
Balance at December 31, 2001................ 34,428,000 (496,000) 33,932,000
Net income for the year................ 47,228,000 - 47,228,000 $ 47,228,000
Distributions declared................. (18,954,000) - (18,954,000) -
Issuance of common shares and other.... 648,000 - 648,000 -
Foreign currency translation adjustment - 800,000 800,000 800,000
------------- -------------- ------------- --------------
Comprehensive income for the year...... $ 48,028,000
==============
Balance at December 31, 2002................ 63,350,000 304,000 63,654,000
Net income for the year................ 33,083,000 - 33,083,000 $ 33,083,000
Distributions declared................. (21,306,000) - (21,306,000) -
Issuance of common shares and other.... 164,000 - 164,000 -
Foreign currency translation adjustment - 2,457,000 2,457,000 2,457,000
Interest rate hedging transaction...... - (331,000) (331,000) (331,000)
------------- -------------- ------------- --------------
Comprehensive income for the year...... $ 35,209,000
==============
Balance at December 31, 2003................ $ 75,291,000 $ 2,430,000 $ 77,721,000
============= ============== =============
See notes to consolidated financial statements
F - 5
KANEB SERVICES LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Distribution by Kaneb Services, Inc.
On November 27, 2000, the Board of Directors of Kaneb Services, Inc.
authorized the distribution of its pipeline, terminaling and product marketing
businesses (the "Distribution") to its stockholders in the form of a new limited
liability company, Kaneb Services LLC (the "Company"). On June 29, 2001, the
Distribution was completed, with each stockholder of Kaneb Services, Inc.
receiving one common share of the Company for each three shares of Kaneb
Services, Inc.'s common stock held on June 20, 2001, the record date for the
Distribution, resulting in the distribution of 10.85 million shares of the
Company. On August 7, 2001, the stockholders of Kaneb Services, Inc. approved an
amendment to its certificate of incorporation to change its name to Xanser
Corporation ("Xanser").
In September 1989, Kaneb Pipe Line Company LLC ("KPL"), a wholly owned
subsidiary of the Company, formed Kaneb Pipe Line Partners, L.P. ("KPP") to own
and operate its refined petroleum products pipeline business. KPL manages and
controls the operations of KPP through its general partner interests and a 18%
(at December 31, 2003) limited partnership interest. KPP operates through Kaneb
Pipe Line Operating Partnership, L.P. ("KPOP"), a limited partnership in which
KPP holds a 99% interest as limited partner. KPL owns a 1% interest as general
partner of KPP and a 1% interest as general partner of KPOP.
Pursuant to the Distribution, the Company entered into an agreement (the
"Distribution Agreement") with Xanser whereby the Company is obligated to pay
Xanser amounts equal to certain expenses and tax liabilities incurred by Xanser
in connection with the Distribution. In January of 2002, the Company paid Xanser
$10 million in tax liabilities due in connection with the Distribution
Agreement. The Distribution Agreement also requires the Company to pay Xanser an
amount calculated based on any income tax liability of Xanser that, in the sole
judgement of Xanser, (i) is attributable to increases in income tax from past
years arising out of adjustments required by federal and state tax authorities,
to the extent that such increases are properly allocable to the businesses that
became part of the Company, or (ii) is attributable to the distribution of the
Company's common shares and the operations of the Company's businesses prior to
the distribution date. In the event of an examination of Xanser by federal or
state tax authorities, Xanser will have unfettered control over the examination,
administrative appeal, settlement or litigation that may be involved,
notwithstanding that the Company has agreed to pay any additional tax.
Basis of Presentation
The consolidated financial statements reflect the results of operations
of the Company, which is comprised of the pipeline, terminaling and product
marketing businesses of Xanser that were distributed to the stockholders of
Xanser on June 29, 2001. The consolidated financial statements have been
prepared using the historical bases in the assets and liabilities and historical
results of operations related to these businesses. All significant intercompany
transactions and balances have been eliminated.
Cash and Cash Equivalents
The Company's policy is to invest cash in highly liquid investments with
original maturities of three months or less. Accordingly, uninvested cash
balances are kept at minimum levels. Such investments are valued at cost, which
approximates market, and are classified as cash equivalents.
Inventories
Inventories consist primarily of petroleum products purchased for resale
in the product marketing business and are valued at the lower of cost or market.
Cost is determined by using the weighted-average cost method.
Property and Equipment
Property and equipment are carried at historical cost. Additions of new
equipment and major renewals and replacements of existing equipment are
capitalized. Repairs and minor replacements that do not materially increase
values or extend useful lives are expensed. Depreciation of property and
equipment is provided on a straight-line basis at rates based upon expected
useful lives of various classes of assets, as discussed in Note 5. The rates
used for pipeline and certain storage facilities, which are subject to
regulation, are the same as those which have been promulgated by the Federal
Energy Regulatory Commission. Upon disposal of assets depreciated on an
individual basis, the gains and losses are included in current operating income.
Upon disposal of assets depreciated on a group basis, unless unusual in nature
or amount, residual cost, less salvage, is charged against accumulated
depreciation.
Effective January 1, 2002, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets", which addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. The adoption of
SFAS No. 144 did not have a material impact on the consolidated financial
statements of the Company. Under SFAS No. 144, the carrying value of the
Company's property and equipment is periodically evaluated using undiscounted
future cash flows as the basis for determining if impairment exists. To the
extent impairment is indicated to exist, an impairment loss will be recognized
by the Company based on fair value.
Revenue and Income Recognition
The pipeline business provides pipeline transportation of refined
petroleum products, liquified petroleum gases, and anhydrous ammonia fertilizer.
Pipeline revenues are recognized as services are provided. KPP's terminaling
services business provides terminaling and other ancillary services. Storage
fees are generally billed one month in advance and are reported as deferred
income. Terminaling revenues are recognized in the month services are provided.
Revenues for the product marketing business are recognized when product is sold
and title and risk pass to the customer.
Sales of Securities by Subsidiaries
The Company recognizes gains and losses in the consolidated statements of
income resulting from subsidiary sales of additional equity interest, including
KPP limited partnership units, to unrelated parties.
Foreign Currency Translation
The Company translates the balance sheet of KPP's foreign subsidiaries
using year-end exchange rates and translates income statement amounts using the
average exchange rates in effect during the year. The gains and losses resulting
from the change in exchange rates from year to year have been reported
separately as a component of accumulated other comprehensive income (loss) in
Shareholder's Equity. Gains and losses resulting from foreign currency
transactions are included in the consolidated statements of income. The local
currency is considered to be the functional currency, except in the Netherland
Antilles and Canada, where the U.S. dollar is the functional currency.
Excess of Cost Over Fair Value of Net Assets of Acquired Businesses
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill
and Other Intangible Assets," which eliminates the amortization of goodwill
(excess of cost over fair value of net assets of acquired businesses) and other
intangible assets with indefinite lives. Under SFAS No. 142, intangible assets
with lives restricted by contractual, legal, or other means will continue to be
amortized over their useful lives. At December 31, 2003, the Company had no
intangible assets subject to amortization under SFAS No. 142. Goodwill and other
intangible assets not subject to amortization are tested for impairment annually
or more frequently if events or changes in circumstances indicate that the
assets might be impaired. SFAS No. 142 requires a two-step process for testing
impairment. First, the fair value of each reporting unit is compared to its
carrying value to determine whether an indication of impairment exists. If an
impairment is indicated, then the fair value of the reporting unit's goodwill is
determined by allocating the unit's fair value to its assets and liabilities
(including any unrecognized intangible assets) as if the reporting unit had been
acquired in a business combination. The amount of impairment for goodwill is
measured as the excess of its carrying value over its fair value. Based on
valuations and analysis performed by the Company at initial adoption date and at
December 31, 2003, the Company determined that the implied fair value of its
goodwill exceeded carrying value and, therefore, no impairment charge was
necessary. Goodwill amortization included in the results of operations of the
Company for the year ended December 31, 2001 was not material.
Environmental Matters
KPP environmental expenditures that relate to current operations are
expensed or capitalized, as appropriate. Expenditures that relate to an existing
condition caused by past operations, and which do not contribute to current or
future revenue generation, are expensed. Liabilities are recorded by KPP when
environmental assessments and/or remedial efforts are probable, and the costs
can be reasonably estimated. Generally, the timing of these accruals coincides
with the completion of a feasibility study or KPP's commitment to a formal plan
of action.
Asset Retirement Obligations
Effective January 1, 2003, the Company 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 Company recorded an asset retirement obligation of
approximately $5.5 million and recognized a cumulative effect of change in
accounting principle of $0.3 million, after interest of outside non-controlling
partners in KPP's net income, for its legal obligations to dismantle, dispose
of, and restore certain leased KPP pipeline and terminaling facilities,
including petroleum and chemical storage tanks, terminaling facilities and
barges. The Company did not record a retirement obligation for certain of KPP's
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 December 31,
2003, the Company had no assets which were legally restricted for purposes of
settling asset retirement obligations. The effect of SFAS No. 143, assuming
adoption on January 1, 2001, was not material to the results of operations of
the Company for the years ended December 31, 2003, 2002 and 2001. In 2003,
accretion expense of $0.4 million was included in operating costs.
Comprehensive Income
The Company follows the provisions of SFAS No. 130, "Reporting
Comprehensive Income", for the reporting and display of comprehensive income and
its components in a full set of general purpose financial statements. SFAS No.
130 requires additional disclosure and does not affect the Company's financial
position or results of operations.
Accounting for Income Taxes
Certain KPP operations are conducted through separate taxable
wholly-owned corporate subsidiaries. Prior to the Distribution, the Company
participated with Xanser in filing a consolidated federal income tax return. The
Company's income tax expense reported in the consolidated financial statements
prior to the Distribution represents the tax expense of the Company and its
subsidiaries as if they had filed on a separate return basis. Effective with the
Distribution, the Company became a pass-through entity with its income, for
federal and state purposes, taxed at the shareholder level instead of the
Company paying such taxes.
Cash Distributions
The Company makes quarterly distributions of 100% of available cash, as
defined in the limited liability company agreement, to the common shareholders
of record on the applicable record date, within 45 days after the end of each
quarter. Available cash consists generally of all the cash receipts of the
Company, less all cash disbursements and reserves. Excess cash flow of the
Company's wholly-owned product marketing operations is being used to reduce
working capital borrowings. Distributions of $1.825 per share were declared and
paid to shareholders with respect to 2003. Distributions of $1.65 per share were
declared and paid to shareholders with respect to 2002. Distributions of $0.3625
per share were declared and paid with respect to each of the third and fourth
quarters of 2001.
Earnings Per Share
Earnings per share has been calculated using basic and diluted weighted
average shares outstanding for each of the periods presented. For periods prior
to the Distribution, the basic weighted average shares were calculated by
adjusting Xanser's historical basic weighted average shares outstanding for the
applicable period to reflect the number of Company shares that would have been
outstanding at the time assuming the distribution of one Company common share
for each three shares of Xanser common stock. The diluted weighted average
shares for such periods reflect an estimate of the potential dilutive effect of
common stock equivalents, based on Xanser's dilutive effect of common stock
equivalents. For the years ended December 31, 2003, 2002 and 2001, basic
weighted average shares outstanding were 11,554,000, 11,448,000 and 11,014,000
and diluted weighted average shares outstanding were 11,792,000, 11,755,000 and
11,509,000, respectively.
Derivative Instruments
Effective January 1, 2001, the Company adopted the provisions of SFAS No.
133, "Accounting For Derivative Instruments and Hedging Activities", which
establishes the accounting and reporting standards for such activities. Under
SFAS No. 133, companies must recognize all derivative instruments on their
balance sheet at fair value. Changes in the value of derivative instruments,
which are considered hedges, are offset against the change in fair value of the
hedged item through earnings, or recognized in other comprehensive income until
the hedged item is recognized in earnings, depending on the nature of the hedge.
SFAS No. 133 requires that unrealized gains and losses on derivatives not
qualifying for hedge accounting be recognized currently in earnings. On January
1, 2001, the Company was not a party to any derivative contracts, and,
accordingly, initial adoption of SFAS No. 133 at that date did not have any
effect on the Company's result of operations or financial position.
On May 19, 2003, KPP issued $250 million of 5.875% senior unsecured
notes due June 1, 2013 (see Note 6). In connection with the offering, on May 8,
2003, KPP 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
SFAS No. 133, was settled on May 19, 2003 with a cash payment by KPP of $1.8
million. The settlement cost of the contract, net of interest of outside
non-controlling partners in KPP's accumulated other comprehensive income, has
been recorded as a component of accumulated other comprehensive income and is
being amortized, as interest expense, over the life of the debt. For the year
ended December 31, 2003, $0.1 million of amortization is included in interest
expense.
In September of 2002, KPP entered into a treasury lock contract, maturing
on November 4, 2002, for the purpose of locking in the US Treasury interest rate
component on $150 million of anticipated thirty-year public debt offerings. The
treasury lock contract originally qualified as a cash flow hedging instrument
under SFAS No. 133. In October of 2002, KPP, due to various market factors,
elected to defer issuance of the public debt securities, effectively eliminating
the cash flow hedging designation for the treasury lock contract. On October 29,
2002, the contract was settled resulting in a net realized gain of $3.0 million,
before interest of outside non-controlling partners in KPP's net income, which
was recognized as a component of interest and other income.
In March of 2001, KPP entered into two contracts for the purpose of
locking in interest rates on $100 million of anticipated ten-year public debt
offerings. As the interest rate locks were not designated as hedging instruments
pursuant to the requirements of SFAS No. 133, increases or decreases in the fair
value of the contracts were included as a component of interest and other
income. On May 22, 2001, the contracts were settled resulting in a gain of $3.8
million, which is included in other income, before income taxes and interest of
outside non-controlling partners in KPP's net income, in 2001.
Stock Option Plans
In December of 2002, the FASB issued SFAS No. 148 "Accounting for
Stock-Based Compensation-Transition and Disclosure." SFAS No. 148, which amends
SFAS No. 123, provides for alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation and requires additional disclosures in annual and interim financial
statements regarding the method of accounting for stock-based employee
compensation and the effect of the method used on financial results.
In accordance with the provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation", the Company applies APB Opinion 25 and related
interpretations in accounting for its stock option plans and, accordingly, does
not recognize compensation cost based on the fair value of the options granted
at grant date as prescribed by SFAS 123. The Black-Scholes option pricing model
has been used to estimate the fair value of stock options issued and the
assumptions in the calculations under such model include stock price variance or
volatility ranging from 2.40% to 3.40%, based on weekly average variances of
KPP's units prior to the Distribution and the Company's common shares after the
Distribution for the ten year period preceding issuance, a risk-free rate of
return ranging from 4.78% to 5.39%, based on the 30-year U.S. treasury bill rate
for the ten-year expected life of the options, and an annual dividend yield
ranging from 8.36% to 8.40%.
The following illustrates the effect on net income and basic and diluted
earnings per share if the fair value based method had been applied:
Year Ended December 31,
--------------------------------------------------
2003 2002 2001
--------------- -------------- --------------
Reported net income..................................... $ 33,083,000 $ 47,228,000 $ 28,323,000
Share-based employee compensation expense determined
under the fair value based method..................... (85,000) (49,000) (39,000)
--------------- -------------- --------------
Pro forma net income.................................... $ 32,998,000 $ 47,179,000 $ 28,284,000
=============== ============== ==============
Earning per share:
Basic - as reported................................... $ 2.86 $ 4.13 $ 2.57
=============== ============== ==============
Basic - pro forma..................................... $ 2.86 $ 4.03 $ 2.51
=============== ============== ==============
Diluted - as reported................................. $ 2.81 $ 4.02 $ 2.46
=============== ============== ==============
Diluted - pro forma................................... $ 2.80 $ 3.92 $ 2.41
=============== ============== ==============
Estimates
The preparation of the Company's financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
Recent Accounting Pronouncements
Effective January 1, 2003, the Company adopted SFAS No. 146, "Accounting
for Costs Associated with Exit or Disposal Activities", which requires that all
restructurings initiated after December 31, 2002 be recorded when they are
incurred and can be measured at fair value. The initial adoption of SFAS No. 146
had no effect on the consolidated financial statements of the Company.
The Company has adopted the provisions of FASB Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements of Guarantees, Including
Indirect Guarantees of Indebtedness to Others, an interpretation of FASB
Statements No. 5, 57, and 107, and a rescission of FASB Interpretation No. 34."
This interpretation elaborates on the disclosures to be made by a guarantor in
its interim and annual financial statements about its obligations under
guarantees issued. The interpretation also clarifies that a guarantor is
required to recognize, at inception of a guarantee, a liability for the fair
value of the obligation undertaken. The initial recognition and measurement
provisions of the interpretation are applicable to guarantees issued or modified
after December 31, 2002. The initial application of this interpretation had no
effect on the consolidated financial statements of the Company.
In December 2003, the 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, that 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
Company, 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 has not and is not expected to have a material impact on
the consolidated financial statements of the Company.
The Company has adopted the provisions of SFAS No. 149, "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities", which amends
and clarifies financial accounting and reporting for derivative instruments and
hedging activities. The adoption of SFAS No. 149, which was effective for
derivative contracts and hedging relationships entered into or modified after
June 30, 2003, had no impact on the Company's consolidated financial statements.
On July 1, 2003, the Company adopted SFAS No. 150, "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity", which requires certain financial instruments, which were previously
accounted for as equity, to be classified as liabilities. The adoption of SFAS
No. 150 had no effect on the consolidated financial statements of the Company.
2. PUBLIC OFFERING OF UNITS BY KPP
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 bank borrowings (See Note 6). As
a result of KPP issuing additional units to unrelated parties, the Company's
share of net assets of KPP increased by $10.9 million. Accordingly, the Company
recognized a $10.9 million gain in 2003.
In November of 2002, KPP issued 2,095,000 limited partnership units in a
public offering at $33.36 per unit, generating approximately $66.7 million in
net proceeds. The offering proceeds were used to reduce KPP bank borrowings for
the November 2002 fertilizer pipeline acquisition (see Notes 3 and 6). As a
result of KPP issuing additional units to unrelated parties, the Company's share
of net assets of KPP increased by $7.5 million. Accordingly, the Company
recognized a $7.5 million gain in 2002.
In May of 2002, KPP issued 1,565,000 limited partnership units in a
public offering at a price of $39.60 per unit, generating approximately $59.1
million in net proceeds. A portion of the offering proceeds were used to fund
KPP's September 2002 acquisition of the Australia and New Zealand terminals (see
Note 3). As a result of KPP issuing additional units to unrelated parties, the
Company's share of net assets of KPP increased by $8.8 million. Accordingly, the
Company recognized an $8.8 million gain in 2002.
In January of 2002, KPP issued 1,250,000 limited partnership units in a
public offering at $41.65 per unit, generating approximately $49.7 million in
net proceeds. The proceeds were used to reduce borrowings under KPP's revolving
credit agreement (see Note 6). As a result of KPP issuing additional units to
unrelated parties, the Company's share of net assets of KPP increased by $8.6
million. Accordingly, the Company recognized an $8.6 million gain in 2002.
3. ACQUISITIONS
On December 24, 2002, KPP acquired a 400-mile petroleum products pipeline
and four terminals in North Dakota and Minnesota from Tesoro Refining and
Marketing Company for approximately $100 million in cash, subject to normal
post-closing adjustments. The acquisition was initially funded with KPP bank
debt (see Note 6). The results of operations and cash flows of the acquired
business are included in the consolidated financial statements of the Company
since the date of acquisition. Based on the evaluations performed, no amounts
were assigned to goodwill or to other intangible assets in the purchase price
allocation.
On November 1, 2002, KPP acquired an approximately 2,000-mile anhydrous
ammonia pipeline system from Koch Pipeline Company, L.P. for approximately $139
million in cash. This fertilizer pipeline system originates in southern
Louisiana, proceeds north through Arkansas and Missouri, and then branches east
into Illinois and Indiana and north and west into Iowa and Nebraska. The
acquisition was initially funded with KPP bank debt (see Note 6). The results of
operations and cash flows of the acquired business are included in the
consolidated financial statements of the Company since the date of acquisition.
Based on the evaluations performed, no amounts were assigned to goodwill or to
other intangible assets in the purchase price allocation.
On September 18, 2002, KPP acquired eight bulk liquid storage terminals
in Australia and New Zealand from Burns Philp & Co. Ltd. for approximately $47
million in cash. The results of operations and cash flows of the acquired
business are included in the consolidated financial statements of the Company
since the date of acquisition. Based on the evaluations performed, no amounts
were assigned to goodwill or to other intangible assets in the purchase price
allocation.
On February 28, 2002, KPP acquired all of the liquids terminaling
subsidiaries of Statia Terminals Group NV ("Statia") for approximately $178
million in cash (net of acquired cash). The acquired Statia subsidiaries had
approximately $107 million in outstanding debt, including $101 million of 11.75%
notes due in November 2003. The cash portion of the purchase price was initially
funded by KPP's revolving credit agreement and proceeds from KPP's February 2002
public debt offering (see Note 6). In April of 2002, KPP redeemed all of
Statia's 11.75% notes at 102.938% of the principal amount, plus accrued
interest. The redemption was funded by KPP's revolving credit facility (see Note
6). Under the provisions of the 11.75% notes, the Company incurred a $3.0
million prepayment penalty, of which $2.0 million, before interest of outside
non-controlling partners in KPP's net income, was recognized as loss on debt
extinguishment in 2002.
The results of operations and cash flows of Statia are included in the
consolidated financial statements of the Company since the date of acquisition.
Based on the valuations performed, no amounts were assigned to goodwill or to
other tangible assets. A summary of the allocation of the Statia purchase price,
net of cash acquired, is as follows:
Current assets................................... $ 10,898,000
Property and equipment........................... 320,008,000
Other assets..................................... 53,000
Current liabilities.............................. (39,052,000)
Long-term debt................................... (107,746,000)
Other liabilities................................ (5,957,000)
---------------
Purchase price............................... $ 178,204,000
===============
Assuming the Statia acquisition occurred on January 1, 2001, unaudited
pro forma revenues, net income, basic earnings per share and diluted earnings
per share would have been $694.5 million, $47.0 million, $4.10 and $4.00,
respectively, for the year ended December 31, 2002, and $737.5 million, $28.1
million, $2.55 and $2.44, respectively, for the year ended December 31, 2001.
On January 3, 2001, KPP, through a wholly-owned subsidiary, acquired
Shore Terminals LLC ("Shore") for $107 million in cash and 1,975,090 KPP limited
partnership units (valued at $56.5 million on the date of agreement and its
announcement). Financing for the cash portion of the purchase price was
initially supplied under KPP's revolving credit facility (see Note 6). The
acquisition has been accounted for, beginning in January 2001, using the
purchase method of accounting. As a result of KPP issuing additional units to
unrelated parties, the Company's share of net assets of KPP increased by $9.9
million. Accordingly, the Company recognized a $9.9 million gain, before
deferred income taxes of $3.8 million, in 2001.
4. INCOME TAXES
Certain KPP terminaling operations are conducted through separate taxable
wholly-owned corporate subsidiaries. The income before tax expense for these
subsidiaries was $18.9 million, $6.3 million and $2.4 million for the years
ended December 31, 2003, 2002 and 2001, respectively. The income tax expense for
KPP's taxable subsidiaries for the years ended December 31, 2003, 2002 and 2001
was $5.2 million, $4.1 million and $0.3 million, respectively. KPP has recorded
a net deferred tax liability of $20.6 million and $17.8 million at December 2003
and 2002, respectively, which is associated with these subsidiaries.
Prior to the Distribution, the Company participated with Xanser in filing
a consolidated federal income tax return. The Company's income tax expense
reported in the consolidated financial statements prior to the Distribution
represents the tax expense of the Company and its subsidiaries as if they had
filed on a separate return basis. Effective with the Distribution, the Company
became a pass-through entity with its income, for federal and state purposes,
taxed at the shareholder level instead of the Company paying such taxes. As a
result of the change in tax status of the Company, all deferred income tax
assets and liabilities relating to temporary differences (a net $8.6 million
deferred tax liability) were eliminated, resulting in a credit to income tax
expense in 2001.
On June 1, 1989, the governments of the Netherlands Antilles and St.
Eustatius approved a Free Zone and Profit Tax Agreement retroactive to January
1, 1989, which expired on December 31, 2000. This agreement requires a
subsidiary of the Partnership, which was acquired with Statia on February 28,
2002 (see Note 3), to pay a 2% rate on taxable income, as defined therein, or a
minimum payment of 500,000 Netherlands Antilles guilders ($0.3 million) per
year. The agreement further provides that any amounts paid in order to meet the
minimum annual payment will be available to offset future tax liabilities under
the agreement to the extent that the minimum annual payment is greater than 2%
of taxable income. The subsidiary is currently engaged in discussions with
representatives appointed by the Island Territory of St. Eustatius regarding the
renewal or modification of the agreement, but the ultimate outcome cannot be
predicted at this time. The subsidiary has accrued amounts assuming a new
agreement becomes effective, and continues to make payments, as required, under
the previous agreement.
5. PROPERTY AND EQUIPMENT
The cost of property and equipment is summarized as follows:
Estimated December 31,
useful --------------------------------------------
life (years) 2003 2002
---------------- ----------------- ------------------
Land...................................... -- $ 75,912,000 $ 72,152,000
Buildings................................. 25 - 35 36,244,000 27,574,000
Pipeline and terminaling equipment........ 15 - 40 1,115,458,000 1,067,794,000
Marine equipment.......................... 15 - 30 87,204,000 84,641,000
Furniture and fixtures.................... 5 - 15 11,577,000 8,075,000
Transportation equipment.................. 3 - 6 7,360,000 5,414,000
Construction and work-in-progress......... -- 26,768,000 23,310,000
----------------- ------------------
Total property and equipment.............. 1,360,523,000 1,288,960,000
Less accumulated depreciation............. 247,503,000 196,684,000
----------------- ------------------
Net property and equipment................ $ 1,113,020,000 $ 1,092,276,000
================= ==================
6. LONG-TERM DEBT
Long-term debt is summarized as follows:
December 31,
-------------------------------------
2003 2002
--------------- ---------------
Revolving credit facility, due in July of 2008.................... $ 16,500,000 $ 19,125,000
Revolving credit facility of subsidiary, due in April of 2007.. 2,112,000 4,707,000
KPP $400 million revolving credit facility, due in April of 2006.. 54,169,000 -
KPP $250 million 5.875% senior unsecured notes, due in June
of 2013........................................................ 250,000,000 -
KPP $250 million 7.75% senior unsecured notes, due in February
of 2012........................................................ 250,000,000 250,000,000
KPP $275 million revolving credit facility, repaid in April of 2003 - 243,000,000
KPP bank bridge facility, repaid in April of 2003................. - 175,000,000
KPP term loans, due in April of 2006.............................. 29,243,000 26,330,000
KPP Australian bank facility, due in April of 2006................ 34,284,000 -
--------------- --------------
Total long-term debt........................................... $ 636,308,000 $ 718,162,000
=============== ===============
In July of 2001, the Company entered into an agreement with a bank that
provides for a $50 million revolving credit facility through July 1, 2008. The
credit facility, which bears interest at variable rates, is secured by 4.6
million KPP limited partnership units and has a variable rate commitment fee on
unused amounts. At December 31, 2003, $16.5 million was drawn on the credit
facility.
In April of 2003, KPP entered into a new credit agreement with a group of
banks that provides for a $400 million unsecured revolving credit facility
through April of 2006. The credit facility, which provides for an increase in
the commitment up to an aggregate of $450 million by mutual agreement between
KPP and the banks, bears interest at variable rates and has a variable
commitment fee on unused amounts. The credit facility is without recourse to the
Company and contains certain financial and operating covenants, including
limitations on investments, sales of assets and transactions with affiliates
and, absent an event of default, does not restrict distributions to the Company
or to other partners. At December 31, 2003, KPP was in compliance with all
covenants. Initial borrowings on the credit agreement ($324.2 million) were used
to repay all amounts outstanding under KPP's $275 million credit agreement and
$175 million bridge loan agreement. At December 31, 2003, $54.2 million was
outstanding under the new credit agreement.
On May 19, 2003, KPP 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 KPP's 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 KPP, at any time, at a redemption price equal to the greater of 100%
of the principal amount of the notes, or the sum of the present value of the
remaining scheduled payments of principal and interest, discounted to the
redemption date at the applicable U.S. Treasury rate, as defined in the
indenture, plus 30 basis points. The note indenture contains certain financial
and operational covenants, including certain limitations on investments, sales
of assets and transactions with affiliates and, absent an event of default, such
covenants do not restrict distributions to the Company or to other partners. At
December 31, 2003, KPP was in compliance with all covenants.
In February of 2002, KPP issued $250 million of 7.75% senior unsecured
notes due February 15, 2012. The net proceeds from the public offering, $248.2
million, were used to repay the KPP's revolving credit agreement and to
partially fund the Statia acquisition (see Note 3). Under the note indenture,
interest is payable semi-annually in arrears on February 15 and August 15 of
each year. The notes, which are without recourse to the Company, are redeemable,
as a whole or in part, at the option of KPP, at any time, at a redemption price
equal to the greater of 100% of the principal amount of the notes, or the sum of
the present value of the remaining scheduled payments of principal and interest,
discounted to the redemption date at the applicable U.S. Treasury rate, as
defined in the indenture, plus 30 basis points. The note indenture contains
certain financial and operational covenants, including certain limitations on
investments, sales of assets and transactions with affiliates and, absent an
event of default, such covenants do not restrict distributions to the Company or
to other partners. At December 31, 2003, KPP was in compliance with all
covenants.
The Company's product marketing subsidiary has a credit agreement with a
bank that, as amended, provides for a $15 million revolving credit facility
through April of 2007. The credit facility bears interest at variable rates, has
a commitment fee of 0.25% per annum on unutilized amounts and contains certain
financial and operational covenants. At December 31, 2003, the subsidiary was in
compliance with all covenants. The credit facility, which is without recourse to
the Company, is secured by essentially all of the tangible and intangible assets
of the product marketing business and by 250,000 KPP limited partnership units
held by a subsidiary of the Company. At December 31, 2003, $2.1 million was
drawn on the facility.
In January of 2001, KPP used proceeds from its revolving credit agreement
to repay in full its $128 million of mortgage notes. Under the provisions of the
mortgage notes, KPP incurred a $6.5 million prepayment penalty, which, before
interest of outside non-controlling partners in KPP's net income and income
taxes, was recognized as loss on debt extinguishment in 2001.
7. RETIREMENT PLANS
Substantially all of the Company's domestic employees are covered by a
defined contribution plan, which provides for varying levels of employer
matching. Prior to the Distribution, the Company's employees were covered by a
similar defined contribution plan sponsored by Kaneb Services, Inc. The
Company's contributions under these plans were $1.6 million, $1.2 million and
$1.0 million for 2003, 2002 and 2001, respectively.
8. SHAREHOLDERS' EQUITY
The changes in the number of issued and outstanding common shares of the
Company are summarized as follows:
Common Shares
Issued and
Outstanding
-------------
Balance at June 29, 2001 (distribution date)............. 10,864,780
Common shares issued..................................... 377,966
-----------
Balance at December 31, 2001.............................. 11,242,746
Common shares issued...................................... 73,091
-----------
Balance at December 31, 2002.............................. 11,315,837
Common shares issued...................................... 206,628
-----------
Balance at December 31, 2003.............................. 11,522,465
===========
On June 27, 2001, the Board of Directors of the Company declared a
distribution of one right for each of its outstanding common shares to each
shareholder of record on June 27, 2001. Each right entitles the holder, upon the
occurrence of certain events, to purchase from the Company one of its common
shares at a purchase price of $60.00 per common share, subject to adjustment.
The rights will not separate from the common shares or become exercisable until
a person or group either acquires beneficial ownership of 15% or more of the
Company's common shares or commences a tender or exchange offer that would
result in ownership of 20% or more, whichever occurs earlier. The rights, which
expire on June 27, 2011, are redeemable in whole, but not in part, at the
Company's option at any time for a price of $0.01 per right.
The Company has various plans for officers, directors and key employees
under which stock options, deferred stock units and restricted shares may be
issued.
Stock Options
The options granted under the plan generally expire ten years from date
of grant. All options were granted at prices greater than or equal to the market
price at the date of grant.
In connection with the Distribution, the Company issued options in its
common shares to all holders of Kaneb Services, Inc. common stock options in
order to maintain the same intrinsic value for each holder as at the time of the
Distribution. At the Distribution date, the exercise price for each option to
purchase shares of Kaneb Services, Inc. common stock was reduced to an amount
equal to the result of (1) the fair market value of a share of Kaneb Services,
Inc.'s common stock on the ex-dividend date multiplied by (2) a fraction, the
numerator of which was the original exercise price for the option and the
denominator of which was the fair market value of a share of Kaneb Services,
Inc.'s common stock on the last trading date prior to the ex-dividend date. The
number of shares subject to the Kaneb Services, Inc. stock option was not
changed as a result of the Distribution. With regard to options issued for
shares of the Company, the exercise price applicable was that price that created
the same ratio of exercise price to market price as in the adjusted exercise
price applicable to the holders of Kaneb Services, Inc. options. The number of
common shares subject to options issued by the Company was such number necessary
to produce an intrinsic value (determined as of the ex-dividend date) that, when
added to the intrinsic value of the adjusted Kaneb Services, Inc. option
(determined as of the ex-dividend date), equaled the pre-distribution intrinsic
value of the Kaneb Services, Inc. option, if any, (determined as of the last
trading date prior to the ex-dividend date). However options to purchase
fractional common shares of the Company were not granted. The fair market values
of shares of Kaneb Services, Inc.'s common stock and the Company's common shares
were based upon the closing sales price of the stock on the last trading date
prior to the ex-distribution date and the opening sales price of the shares on
the ex-distribution date. All options issued by the Company, excluding the
Company's corporate staff and Xanser's corporate staff, were issued without
restrictions on exercise.
At December 31, 2003, options on 374,200 shares at prices ranging from
$3.27 to $19.73 were outstanding, of which 195,332 were exercisable at prices
ranging from $3.27 to $19.73. At December 31, 2002, options on 701,286 shares at
prices ranging from $3.27 to $19.73 were outstanding, of which 412,836 were
exercisable at prices ranging from $3.27 to $14.33. At December 31, 2001,
options on 669,701 shares at prices ranging from $3.27 to $14.33 were
outstanding, of which 345,653 were exercisable at prices ranging from $3.27 to
$11.28.
Deferred Stock Unit Plans
In 2002, the Company initiated a Deferred Stock Unit Plan (the "DSU
Plan"), pursuant to which key employees of the Company have, from time to time,
been given the opportunity to defer a portion of their compensation for a
specified period toward the purchase of deferred stock units ("DSUs"), an
instrument designed to track the Company's common shares. Under the plan, DSUs
are purchased at a value equal to the closing price of the Company's common
shares on the day by which the employee must elect (if they so desire) to
participate in the DSU Plan; which date is established by the Compensation
Committee, from time to time (the "Election Date"). During a vesting period of
one to three years following the Election Date, a participant's DSUs vest only
in an amount equal to the lesser of the compensation actually deferred to date
or the value (based upon the then-current closing price of the Company's common
shares) of the pro-rata portion (as of such date) of the number of DSUs
acquired. After the expiration of the vesting period, which is typically the
same length as the deferral period, the DSUs become fully vested, but may only
be distributed through the issuance of a like number of shares of the Company's
common shares on a pre-selected date, which is irrevocably selected by the
participant on the Election Date and which is typically at or after the
expiration of the vesting period and no later than ten years after the Election
Date, or at the time of a "change of control" of the Company, if earlier. DSU
accounts are unfunded by the Company. Each person that elects to participate in
the DSU Plan is awarded, under the Company's Share Incentive Plan, an option to
purchase a number of shares ranging from one-half to one and one-half times the
number of DSUs purchased by such person at 100% of the closing price of the
Company's common shares on the Election Date, which options become exercisable
over a specified period after the grant, according to a schedule determined by
the Compensation Committee. At December 31, 2003, 3,802 DSUs had vested under
the 2002 Plan.
In 1996, Kaneb Services, Inc. implemented a DSU plan whereby officers,
directors and key executives were permitted to defer compensation on a pretax
basis to receive shares of Kaneb Services, Inc. common stock at a predetermined
date after the end of the compensation deferral period. In connection with the
Distribution, the Company agreed to issue DSUs equivalent in price to the
Company's common shares at that time. For every three Kaneb Services, Inc. DSUs
held, the Company issued one DSU, such that the intrinsic value of each holder's
deferred compensation account remained unchanged as a result of the
Distribution. In addition, upon the payment date of any distributions on the
Company's common shares, the Company agreed to credit each deferred account with
the equivalent value of the distribution. Upon the scheduled payment of the
deferred accounts, the Company agreed to issue one common share for each DSU
relative to Company DSUs previously issued and to pay the equivalent of the
accumulated deferred distributions, plus interest, to the previously deferred
account holder. All other terms of the DSU plan remained unchanged. Similarly,
Kaneb Services, Inc. agreed to issue to employees of the Company who hold DSUs,
the number of shares of Kaneb Services, Inc. (now Xanser) common stock subject
to the Kaneb Services, Inc. DSUs held by those employees. At December 31, 2003,
approximately 123,000 common shares of the Company are issuable under this
arrangement.
Restricted Stock
In September 2001, the Company issued an aggregate of 30,000 restricted
common shares to the outside Directors of the Company. All of such shares vest
or become transferable in one-third increments on each anniversary date after
issuance. In conjunction will the issuance and commencement of vesting of the
restricted shares, the Company recognized a total expense of $0.1 million in
2003, $0.2 million in 2002 and $0.1 million in 2001.
9. COMMITMENTS AND CONTINGENCIES
The following is a schedule by years of future minimum lease payments
under the Company's, and KPP's, operating leases as of December 31, 2003:
Year ending December 31:
2004..................................... $ 4,398,000
2005..................................... 2,040,000
2006..................................... 1,679,000
2007..................................... 1,416,000
2008..................................... 934,000
Thereafter............................... 342,000
-------------
Total minimum lease payments $ 10,809,000
=============
Total rent expense under operating leases amounted to $14.6 million, $9.5
million and $4.2 million for the years ended December 31, 2003, 2002 and 2001,
respectively.
The operations of KPP are subject to federal, state and local laws and
regulations in the United States and the United Kingdom relating to protection
of the environment. Although KPP believes its operations are in general
compliance with applicable environmental regulations, risks of additional costs
and liabilities are inherent in pipeline and terminal operations, and there can
be no assurance that significant costs and liabilities will not be incurred by
KPP. Moreover, it is possible that other developments, such as increasingly
stringent environmental laws, regulations and enforcement policies thereunder,
and claims for damages to property or persons resulting from the operations of
KPP, could result in substantial costs and liabilities to KPP. KPP has recorded
an undiscounted reserve for environmental claims in the amount of $28.6 million
at December 31, 2003, including $25.5 million related to acquisitions of
pipelines and terminals. During 2003, 2002 and 2001, respectively, KPP incurred
$2.1 million, $2.4 million and $5.2 million of costs related to such acquisition
reserves and reduced the liability accordingly.
Certain subsidiaries of KPP were sued in a Texas state court in 1997 by
Grace Energy Corporation ("Grace"), the entity from which KPP's subsidiaries
acquired ST Services in 1993. The lawsuit involves environmental response and
remediation costs allegedly resulting from jet fuel leaks in the early 1970's
from a pipeline. The pipeline, which connected a former Grace terminal with Otis
Air Force Base in Massachusetts (the "Otis pipeline" or the "pipeline"), ceased
operations in 1973 and was abandoned before 1978, when the connecting terminal
was sold to an unrelated entity. Grace alleged that subsidiaries of KPP acquired
the abandoned pipeline, as part of the acquisition of ST Services in 1993 and
assumed responsibility for environmental damages allegedly caused by the jet
fuel leaks. Grace sought a ruling from the Texas court that these subsidiaries
are responsible for all liabilities, including all present and future
remediation expenses, associated with these leaks and that Grace has no
obligation to indemnify these subsidiaries for these expenses. In the lawsuit,
Grace also sought indemnification for expenses of approximately $3.5 million
that it incurred since 1996 for response and remediation required by the State
of Massachusetts and for additional expenses that it expects to incur in the
future. The consistent position of KPP's subsidiaries has been that they did not
acquire the abandoned pipeline as part of the 1993 ST Services transaction, and
therefore did not assume any responsibility for the environmental damage nor any
liability to Grace for the pipeline.
At the end of the trial, the jury returned a verdict including findings
that (1) Grace had breached a provision of the 1993 acquisition agreement by
failing to disclose matters related to the pipeline, and (2) the pipeline was
abandoned before 1978 -- 15 years before KPP's subsidiaries acquired ST
Services. On August 30, 2000, the Judge entered final judgment in the case that
Grace take nothing from the subsidiaries on its claims seeking recovery of
remediation costs. Although KPP's subsidiaries have not incurred any expenses in
connection with the remediation, the court also ruled, in effect, that the
subsidiaries would not be entitled to indemnification from Grace if any such
expenses were incurred in the future. Moreover, the Judge let stand a prior
summary judgment ruling that the pipeline was an asset acquired by KPP's
subsidiaries as part of the 1993 ST Services transaction and that any
liabilities associated with the pipeline would have become liabilities of the
subsidiaries. Based on that ruling, the Massachusetts Department of
Environmental Protection and Samson Hydrocarbons Company (successor to Grace
Petroleum Company) wrote letters to ST Services alleging its responsibility for
the remediation, and ST Services responded denying any liability in connection
with this matter. The Judge also awarded attorney fees to Grace of more than
$1.5 million. Both KPP's subsidiaries and Grace have appealed the trial court's
final judgment to the Texas Court of Appeals in Dallas. In particular, the
subsidiaries have filed an appeal of the judgment finding that the Otis pipeline
and any liabilities associated with the pipeline were transferred to them as
well as the award of attorney fees to Grace.
On April 2, 2001, Grace filed a petition in bankruptcy, which created an
automatic stay against actions against Grace. This automatic stay covers the
appeal of the Dallas litigation, and the Texas Court of Appeals has issued an
order staying all proceedings of the appeal because of the bankruptcy. Once that
stay is lifted, KPP's subsidiaries that are party to the lawsuit intend to
resume vigorous prosecution of the appeal.
The Otis Air Force Base is a part of the Massachusetts Military
Reservation ("MMR Site"), which has been declared a Superfund Site pursuant to
CERCLA. The MMR Site contains a number of groundwater contamination plumes, two
of which are allegedly associated with the Otis pipeline, and various other
waste management areas of concern, such as landfills. The United States
Department of Defense, pursuant to a Federal Facilities Agreement, has been
responding to the Government remediation demand for most of the contamination
problems at the MMR Site. Grace and others have also received and responded to
formal inquiries from the United States Government in connection with the
environmental damages allegedly resulting from the jet fuel leaks. KPP's
subsidiaries voluntarily responded to an invitation from the Government to
provide information indicating that they do not own the pipeline. In connection
with a court-ordered mediation between Grace and KPP's subsidiaries, the
Government advised the parties in April 1999 that it has identified two spill
areas that it believes to be related to the pipeline that is the subject of the
Grace suit. The Government at that time advised the parties that it believed it
had incurred costs of approximately $34 million, and expected in the future to
incur costs of approximately $55 million, for remediation of one of the spill
areas. This amount was not intended to be a final accounting of costs or to
include all categories of costs. The Government also advised the parties that it
could not at that time allocate its costs attributable to the second spill area.
By letter dated July 26, 2001, the United States Department of Justice
("DOJ") advised ST Services that the Government intends to seek reimbursement
from ST Services under the Massachusetts Oil and Hazardous Material Release
Prevention and Response Act and the Declaratory Judgment Act for the
Government's response costs at the two spill areas discussed above. The DOJ
relied in part on the Texas state court judgment, which in the DOJ's view, held
that ST Services was the current owner of the pipeline and the
successor-in-interest of the prior owner and operator. The Government advised ST
Services that it believes it has incurred costs exceeding $40 million, and
expects to incur future costs exceeding an additional $22 million, for
remediation of the two spill areas. KPP believes that its subsidiaries have
substantial defenses. ST Services responded to the DOJ on September 6, 2001,
contesting the Government's positions and declining to reimburse any response
costs. The DOJ has not filed a lawsuit against ST Services seeking cost recovery
for its environmental investigation and response costs. Representatives of ST
Services have met with representatives of the Government on several occasions
since September 6, 2001 to discuss the Government's claims and to exchange
information related to such claims. Additional exchanges of information are
expected to occur in the future and additional meetings may be held to discuss
possible resolution of the Government's claims without litigation. KPP does not
believe this matter will have a materially adverse effect on its financial
condition, although there can be no assurances as to the ultimate outcome.
On April 7, 2000, a fuel oil pipeline in Maryland owned by Potomac
Electric Power Company ("PEPCO") ruptured. Work performed with regard to the
pipeline was conducted by a partnership of which ST Services is general partner.
PEPCO has reported that it has incurred total cleanup costs of $70 million to
$75 million. PEPCO probably will continue to incur some cleanup related costs
for the foreseeable future, primarily in connection with EPA requirements for
monitoring the condition of some of the impacted areas. Since May 2000, ST
Services has provisionally contributed a minority share of the cleanup expense,
which has been funded by ST Services' insurance carriers. ST Services and PEPCO
have not, however, reached a final agreement regarding ST Services'
proportionate responsibility for this cleanup effort, if any, and cannot predict
the amount, if any, that ultimately may be determined to be ST Services' share
of the remediation expense, but ST believes that such amount will be covered by
insurance and therefore will not materially adversely affect KPP's financial
condition.
As a result of the rupture, purported class actions were filed against
PEPCO and ST Services in federal and state court in Maryland by property and
business owners alleging damages in unspecified amounts under various theories,
including under the Oil Pollution Act ("OPA") and Maryland common law. The
federal court consolidated all of the federal cases in a case styled as In re
Swanson Creek Oil Spill Litigation. A settlement of the consolidated class
action, and a companion state-court class action, was reached and approved by
the federal judge. The settlement involved creation and funding by PEPCO and ST
Services of a $2,250,000 class settlement fund, from which all participating
claimants would be paid according to a court-approved formula, as well as a
court-approved payment to plaintiffs' attorneys. The settlement has been
consummated and the fund, to which PEPCO and ST Services contributed equal
amounts, has been distributed. Participating claimants' claims have been settled
and dismissed with prejudice. A number of class members elected not to
participate in the settlement, i.e., to "opt out," thereby preserving their
claims against PEPCO and ST Services. All non-participant claims have been
settled for immaterial amounts with ST Services' portion of such settlements
provided by its insurance carrier.
PEPCO and ST Services agreed with the federal government and the State of
Maryland to pay costs of assessing natural resource damages arising from the
Swanson Creek oil spill under OPA and of selecting restoration projects. This
process was completed in mid-2002. ST Services' insurer has paid ST Services'
agreed 50 percent share of these assessment costs. In late November 2002, PEPCO
and ST Services entered into a Consent Decree resolving the federal and state
trustees' claims for natural resource damages. The decree required payments by
ST Services and PEPCO of a total of approximately $3 million to fund the
restoration projects and for remaining damage assessment costs. The federal
court entered the Consent Decree as a final judgment on December 31, 2002. PEPCO
and ST have each paid their 50% share and thus fully performed their payment
obligations under the Consent Decree. ST Services' insurance carrier funded ST
Services' payment.
The U.S. Department of Transportation ("DOT") has issued a Notice of
Proposed Violation to PEPCO and ST Services alleging violations over several
years of pipeline safety regulations and proposing a civil penalty of $647,000
jointly against the two companies. ST Services and PEPCO have contested the DOT
allegations and the proposed penalty. A hearing was held before the Office of
Pipeline Safety at the DOT in late 2001. ST Services does not anticipate any
further hearings on the subject and is still awaiting the DOT's ruling.
By letter dated January 4, 2002, the Attorney General's Office for the
State of Maryland advised ST Services that it intended to seek penalties from ST
Services in connection with the April 7, 2000 spill. The State of Maryland
subsequently asserted that it would seek penalties against ST Services and PEPCO
totaling up to $12 million. A settlement of this claim was reached in mid-2002
under which ST Services' insurer will pay a total of slightly more than $1
million in installments over a five year period. PEPCO has also reached a
settlement of these claims with the State of Maryland. Accordingly, KPP believes
that this matter will not have a material adverse effect on its financial
condition.
On December 13, 2002, ST Services sued PEPCO in the Superior Court,
District of Columbia, seeking, among other things, a declaratory judgment as to
ST Services' legal obligations, if any, to reimburse PEPCO for costs of the oil
spill. On December 16, 2002, PEPCO sued ST Services in the United States
District Court for the District of Maryland, seeking recovery of all its costs
for remediation of and response to the oil spill. Pursuant to an agreement
between ST Services and PEPCO, ST Services' suit was dismissed, subject to
refiling. ST Services has moved to dismiss PEPCO's suit. ST Services is
vigorously defending against PEPCO's claims and is pursuing its own
counterclaims for return of monies ST Services has advanced to PEPCO for
settlements and cleanup costs. KPP believes that any costs or damages resulting
from these lawsuits will be covered by insurance and therefore will not
materially adversely affect KPP's financial condition. The amounts claimed by
PEPCO, if recovered, would trigger an excess insurance policy which has a
$600,000 retention, but KPP does not believe that such retention, if incurred,
would materially adversely affect KPP's financial condition.
The Company, primarily KPP, has other contingent liabilities resulting
from litigation, claims and commitments incident to the ordinary course of
business. Management believes, based on the advice of counsel, that the ultimate
resolution of such contingencies will not have a materially adverse effect on
the financial position, results of operations or liquidity of the Company.
10. BUSINESS SEGMENT DATA
The Company conducts business through three principal operations: the
"Pipeline Operations," which consists primarily of the transportation of refined
petroleum products and fertilizer in the Midwestern states as a common carrier;
the "Terminaling Operations," which provide storage for petroleum products,
specialty chemicals and other liquids; and the "Product Marketing Operations,"
which provides wholesale motor fuel marketing services throughout the Midwest
and Rocky Mountain regions and, since KPP's acquisition of Statia (see Note 3),
delivers bunker fuel to ships in the Caribbean and Nova Scotia, Canada and sells
bulk petroleum products to various commercial interests. General corporate
includes general and administrative costs, including accounting, tax, finance,
legal, investor relations and employee benefit services. General corporate
assets include cash and other assets not related to the segments.
The Company measures segment profit as operating income. Total assets are
those assets controlled by each reportable segment. Business segment data is as
follows:
Year Ended December 31,
--------------------------------------------------
2003 2002 2001
--------------- -------------- --------------
Business segment revenues:
Pipeline operations................................... $ 119,633,000 $ 82,698,000 $ 74,976,000
Terminaling operations................................ 234,958,000 205,971,000 132,820,000
Product marketing operations.......................... 511,200,000 381,159,000 327,542,000
--------------- -------------- --------------
$ 865,791,000 $ 669,828,000 $ 535,338,000
=============== ============== ==============
Business segment profit:
Pipeline operations................................... $ 51,860,000 $ 38,623,000 $ 36,773,000
Terminaling operations................................ 66,532,000 65,040,000 45,318,000
Product marketing operations.......................... 12,233,000 4,692,000 (611,000)
General corporate..................................... (2,121,000) (1,996,000) (1,689,000)
---------------- -------------- --------------
Operating income................................... 128,504,000 106,359,000 79,791,000
Interest and other income ............................ 365,000 3,664,000 4,132,000
Interest expense...................................... (39,576,000) (29,171,000) (15,381,000)
Loss on debt extinguishment........................... - (3,282,000) (6,540,000)
---------------- -------------- --------------
Income before gain on issuance of units by KPP,
income taxes, interest of outside non-controlling
partners in KPP's net income and cumulative effect
of change in accounting principle.................. $ 89,293,000 $ 77,570,000 $ 62,002,000
=============== ============== ==============
Business segment assets:
Depreciation and amortization:
Pipeline operations................................ $ 14,117,000 $ 6,408,000 $ 5,478,000
Terminaling operations............................. 38,089,000 32,368,000 17,706,000
Product marketing operations....................... 989,000 695,000 77,000
---------------- -------------- --------------
$ 53,195,000 $ 39,471,000 $ 23,261,000
================ ============== ==============
Capital expenditures (excluding acquisitions):
Pipeline operations................................ $ 9,584,000 $ 9,469,000 $ 4,309,000
Terminaling operations............................. 34,572,000 20,953,000 12,937,000
Product marketing operations....................... 591,000 679,000 63,000
---------------- -------------- --------------
$ 44,747,000 $ 31,101,000 $ 17,309,000
================ ============== ==============
December 31,
---------------------------------------------------
2003 2002 2001
---------------- --------------- --------------
Total assets:
Pipeline operations................................ $ 352,901,000 $ 352,657,000 $ 105,156,000
Terminaling operations............................. 874,185,000 844,321,000 443,215,000
Product marketing operations....................... 58,161,000 41,297,000 19,313,000
General corporate.................................. 6,320,000 5,826,000 4,083,000
---------------- --------------- --------------
$ 1,291,567,000 $ 1,244,101,000 $ 571,767,000
================ =============== ==============
The following geographical area data includes revenues and operating
income based on location of the operating segment and net property and equipment
based on physical location.
Year Ended December 31,
---------------------------------------------------
2003 2002 2001
---------------- --------------- --------------
Geographical area revenues:
United States........................................... $ 535,895,000 $ 485,322,000 $ 514,276,000
United Kingdom.......................................... 26,392,000 23,937,000 21,062,000
Netherlands Antilles.................................... 241,693,000 132,387,000 -
Canada.................................................. 41,689,000 23,207,000 -
Australia and New Zealand............................... 20,122,000 4,975,000 -
---------------- --------------- --------------
$ 865,791,000 $ 669,828,000 $ 535,338,000
================ =============== ==============
Geographical area operating income:
United States........................................... $ 87,965,000 $ 83,544,000 $ 74,275,000
United Kingdom.......................................... 8,583,000 7,318,000 5,516,000
Netherlands Antilles.................................... 19,223,000 9,616,000 -
Canada.................................................. 6,777,000 4,398,000 -
Australia and New Zealand............................... 5,956,000 1,483,000 -
---------------- --------------- --------------
$ 128,504,000 $ 106,359,000 $ 79,791,000
================ =============== ==============
December 31,
---------------------------------------------------
2003 2002 2001
---------------- --------------- --------------
Geographical area net property and equipment:
United States........................................... $ 693,345,000 $ 690,262,000 $ 440,226,000
United Kingdom.......................................... 51,392,000 46,543,000 41,170,000
Netherlands Antilles.................................... 217,143,000 224,810,000 -
Canada.................................................. 74,995,000 78,789,000 -
Australia and New Zealand............................... 76,145,000 51,872,000 -
---------------- --------------- --------------
$ 1,113,020,000 $ 1,092,276,000 $ 481,396,000
================ =============== ==============
11. FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK
The estimated fair value of all debt as of December 31, 2003 and 2002 was
approximately $654 million and $733 million, as compared to the carrying value
of $636 million and $718 million, respectively. These fair values were estimated
using discounted cash flow analysis, based on the Company's current incremental
borrowing rates for similar types of borrowing arrangements. These estimates are
not necessarily indicative of the amounts that would be realized in a current
market exchange. See Note 1 regarding derivative instruments.
The Company markets and sells its services to a broad base of customers
and performs ongoing credit evaluations of its customers. The Company does not
believe it has a significant concentration of credit risk at December 31, 2003.
No customer constituted 10% of the Company's consolidated revenues in 2003, 2002
or 2001.
12. QUARTERLY FINANCIAL DATA (unaudited)
Quarterly operating results for 2003 and 2002 are summarized as follows:
Quarter Ended
-----------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
---------------- ---------------- --------------- --------------
2003:
Revenues........................ $ 218,469,000 $ 218,654,000 $ 214,592,000 $ 214,076,000
================ ================ =============== ==============
Operating income................ $ 33,724,000 $ 32,705,000 $ 32,251,000 $ 29,824,000
================ ================ =============== ==============
Net income...................... $ 16,559,000(a)(b) $ 5,488,000 $ 5,862,000 $ 5,174,000
================ ================ =============== ==============
Earnings per share:
Basic........................ $ 1.44 $ 0.48 $ 0.50 $ 0.44
================ ================ =============== ==============
Diluted...................... $ 1.41 $ 0.47 $ 0.49 $ 0.43
================ ================ =============== ==============
2002:
Revenues........................ $ 122,409,000 $ 179,246,000 $ 184,119,000 $ 184,054,000
================ ================ =============== ==============
Operating income................ $ 23,256,000 $ 28,256,000 $ 28,506,000 $ 26,341,000
================ ================ =============== ==============
Net income...................... $ 13,620,000(b) $ 14,128,000(b) $ 6,673,000 $ 12,807,000(b)
================ ================ =============== ==============
Earnings per share:
Basic........................ $ 1.19 $ 1.23 $ 0.58 $ 1.12
================ ================ =============== ==============
Diluted...................... $ 1.16 $ 1.20 $ 0.57 $ 1.09
================ ================ =============== ==============
(a) Includes cumulative effect of change in accounting principle - adoption
of new accounting standard for asset retirement obligations of
approximately $0.3 million.
(b) See Note 2 regarding gains on issuance of units by KPP.
Schedule I
KANEB SERVICES LLC (PARENT COMPANY)
CONDENSED STATEMENT OF INCOME
Period from
Year Ended December 31, June 30, 2001
-------------------------------- to December
2003 2002 31, 2001
--------------- -------------- --------------
General and administrative expenses........................... $ (1,983,000) $ (2,036,000) $ (1,053,000)
Interest expense.............................................. (613,000) (718,000) -
Interest and other income..................................... 10,000 10,000 23,000
Equity in earnings of subsidiaries............................ 25,084,000 25,090,000 10,240,000
Equity in earnings of subsidiaries - gain on issuance of
units by KPP............................................... 10,898,000 24,882,000 -
--------------- -------------- ---------------
Income before cumulative effect of change in accounting
principle.................................................. 33,396,000 47,228,000 9,210,000
Cumulative effect of change in accounting principle -
adoption of new accounting standard for asset retirement
obligations................................................ (313,000) - -
--------------- -------------- ---------------
Net income................................................. $ 33,083,000 $ 47,228,000 $ 9,210,000
=============== ============== ===============
Earnings per share:
Basic:
Before cumulative effect of change in accounting
principle............................................. $ 2.89 $ 4.13 $ 0.84
Cumulative effect of change in accounting principle..... (.03) - -
-------------- -------------- --------------
$ 2.86 $ 4.13 $ 0.84
============== ============== ==============
Diluted:
Before cumulative effect of change in accounting
principle............................................. $ 2.84 $ 4.02 $ 0.80
Cumulative effect of change in accounting principle..... (.03) - -
-------------- -------------- --------------
$ 2.81 $ 4.02 $ 0.80
============== ============== ==============
See "Notes to Consolidated Financial Statements" of
Kaneb Services LLC included in this report.
F - 26
Schedule I
(Continued)
KANEB SERVICES LLC (PARENT COMPANY)
CONDENSED BALANCE SHEET
December 31,
--------------------------------------
2003 2002
---------------- ---------------
ASSETS
Current assets:
Cash and cash equivalents............................................... $ 1,544,000 $ 1,695,000
Prepaid expenses and other.............................................. 149,000 2,060,000
---------------- ---------------
Total current assets................................................. 1,693,000 3,755,000
---------------- ---------------
Investments in and advances to subsidiaries................................ 106,068,000 92,316,000
Other assets............................................................... 498,000 608,000
---------------- ---------------
$ 108,259,000 $ 96,679,000
================ ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accrued expenses...................................................... $ 1,112,000 $ 2,325,000
Accrued distributions payable to shareholders......................... 5,567,000 4,734,000
---------------- ---------------
Total current liabilities.......................................... 6,679,000 7,059,000
---------------- ---------------
Long-term debt........................................................... 16,500,000 19,125,000
Long-term payables and other liabilities................................. 7,359,000 6,841,000
Commitments and contingencies
Shareholders' equity:
Shareholders' investment.............................................. 75,291,000 63,350,000
Accumulated other comprehensive income................................ 2,430,000 304,000
---------------- ---------------
Total shareholders' equity......................................... 77,721,000 63,654,000
---------------- ---------------
$ 108,259,000 $ 96,679,000
================ ===============
See "Notes to Consolidated Financial Statements" of
Kaneb Services LLC included in this report.
F - 26
Schedule I
(Continued)
KANEB SERVICES LLC (PARENT COMPANY)
CONDENSED STATEMENT OF CASH FLOWS
Period from
Year Ended December 31, June 30, 2001
-------------------------------- to December
2003 2002 31, 2001
--------------- -------------- --------------
Operating activities:
Net income ............................................... $ 33,083,000 $ 47,228,000 $ 9,210,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in earnings of subsidiaries, net of distributions (11,939,000) (29,958,000) (5,370,000)
Cumulative effect of change in accounting principle.. 313,000 - -
Changes in current assets and liabilities............ 698,000 (38,000) 303,000
-------------- -------------- --------------
Net cash provided by operating activities......... 22,155,000 17,232,000 4,143,000
--------------- -------------- ---------------
Investing activities:
Changes in other assets................................... 110,000 911,000 (719,000)
--------------- -------------- ---------------
Net cash provided by (used in) investing activities 110,000 911,000 (719,000)
--------------- -------------- ---------------
Financing activities:
Issuance of debt.......................................... - 10,000,000 9,125,000
Payments of debt.......................................... (2,625,000) - -
Distributions to shareholders............................. (20,473,000) (18,351,000) (4,137,000)
Changes in long-term payables and other liabilities....... 518,000 (10,114,000) (9,397,000)
Issuance of common shares upon exercise of options........ 164,000 648,000 2,354,000
--------------- -------------- ---------------
Net cash used in financing activities................ (22,416,000) (17,817,000) (2,055,000)
--------------- -------------- ---------------
Increase (decrease) in cash and cash equivalents............. (151,000) 326,000 1,369,000
Cash and cash equivalents at beginning of period............. 1,695,000 1,369,000 -
--------------- -------------- ---------------
Cash and cash equivalents at end of period................... $ 1,544,000 $ 1,695,000 $ 1,369,000
=============== ============== ===============
See "Notes to Consolidated Financial Statements" of
Kaneb Services LLC included in this report.
F - 26
Schedule II
KANEB SERVICES LLC
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
Additions
------------------------------
Balance at Charged to Charged to Balance at
Beginning of Costs and Other End of
Period Expenses Accounts Deductions Period
------------- ------------ -------------- ------------ ----------
ALLOWANCE DEDUCTED FROM
ASSETS TO WHICH THEY APPLY
Year Ended December 31, 2003:
For doubtful receivables
classified as current assets... $ 3,724 $ 526 $ - $ (473)(b) $ 3,777
============= =========== ============= ========= ==========
Year Ended December 31, 2002:
For doubtful receivables
classified as current assets... $ 653 $ 2,509 $ 841(a) $ (279)(b) $ 3,724
============= =========== ============= ========== ==========
Year Ended December 31, 2001:
For doubtful receivables
classified as current assets... $ 565 $ 184 $ - $ (96)(b) $ 653
============= =========== ============= ========== ==========
Notes:
(a) Allowance for doubtful receivables from 2002 acquisitions.
(b) Receivable write-offs and reclassifications, net of recoveries.
See "Notes to Consolidated Financial Statements" of
Kaneb Services LLC included in this report.
F - 26
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, Kaneb Services LLC has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
KANEB SERVICES LLC
By: //s// JOHN R. BARNES
---------------------------------
Chairman of the Board and
Chief Executive Officer
Date: March 12, 2004
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of Kaneb
Services LLC and in the capacities with Kaneb Services LLC and on the date
indicated.
Signature Title Date
- ---------------------------------------- -------------------------- --------------
Principal Executive Officer
//s// JOHN R. BARNES Chairman of the Board March 12, 2004
- ---------------------------------------- and Chief Executive Officer
Principal Accounting Officer
//s// HOWARD C. WADSWORTH Vice President, Treasurer March 12, 2004
- ---------------------------------------- and Secretary
Directors
//s// SANGWOO AHN Director March 12, 2004
- ----------------------------------------
//s// MURRAY R. BILES Director March 12, 2004
- ----------------------------------------
//s// FRANK M. BURKE, JR. Director March 12, 2004
- ----------------------------------------
//s// CHARLES R. COX Director March 12, 2004
- ----------------------------------------
//s// HANS KESSLER Director March 12, 2004
- ----------------------------------------
//s// JAMES R. WHATLEY Director March 12, 2004
- ----------------------------------------
Exhibit 31.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
----------------------------------------
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
---------------------------------------------------------
I, John R. Barnes, Chief Executive Officer of Kaneb Services LLC certify that:
1. I have reviewed this annual report on Form 10-K of Kaneb Services LLC;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-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 annual 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 annual report our conclusions
about the effectiveness of the disclosure controls and procedures, as
of the end of the period covered by this annual report, based on such
evaluation; and
d) disclosed in this annual 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: March 12, 2004
//s// JOHN R. BARNES
-------------------------------------
John R. Barnes
President and Chief Executive Officer
Exhibit 31.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
----------------------------------------
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
---------------------------------------------------------
I, Howard C. Wadsworth, Chief Financial Officer of Kaneb Services LLC certify
that:
1. I have reviewed this annual report on Form 10-K of Kaneb Services LLC;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-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 annual 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 annual report our conclusions
about the effectiveness of the disclosure controls and procedures, as
of the end of the period covered by this annual report, based on such
evaluation; and
d) disclosed in this annual 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: March 12, 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 Services
LLC (the "Company"), hereby certifies that, to his knowledge, the Company's
Annual Report on Form 10-K for the year ended December 31, 2003, 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 Annual Report fairly
presents, in all material respects, the financial condition and results of
operations of the Company.
This written statement is being furnished to the Securities and
Exchange Commission as an exhibit to such Form 10-K. A signed original of this
written statement required by Section 906 has been provided to Kaneb Services
LLC and will be retained by Kaneb Services LLC and furnished to the Securities
and Exchange Commission or its staff upon request.
Date: March 12, 2004
//s// JOHN R. BARNES
-------------------------------------
John R. Barnes
President and Chief Executive Officer
Exhibit 32.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
----------------------------------------
PURSUANT TO SECTION 906(A) OF THE SARBANES-OXLEY ACT OF 2002
------------------------------------------------------------
The undersigned, being the Chief Financial Officer of Kaneb Services
LLC (the "Company"), hereby certifies that, to his knowledge, the Company's
Annual Report on Form 10-K for the year ended December 31, 2003, 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 Annual Report fairly
presents, in all material respects, the financial condition and results of
operations of the Company.
This written statement is being furnished to the Securities and
Exchange Commission as an exhibit to such Form 10-K. A signed original of this
written statement required by Section 906 has been provided to Kaneb Services
LLC and will be retained by Kaneb Services LLC and furnished to the Securities
and Exchange Commission or its staff upon request.
Date: March 12, 2004
//s// HOWARD C. WADSWORTH
-----------------------------------------
Howard C. Wadsworth
Chief Financial Officer