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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 001-16405
KANEB SERVICES LLC
(Exact name of registrant as specified in its charter)
DELAWARE 75-2931295
(State or other jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
2435 North Central Expressway
Richardson, Texas 75080
(Address of principle executive offices, including zip code)
(972) 699-4062
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
---------- ----------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes X No
---------- ----------
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class of Common Shares Outstanding at April 30, 2004
- ---------------------- -----------------------------
No par value 11,554,289 shares
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KANEB SERVICES LLC AND SUBSIDIARIES
FORM 10-Q
QUARTER ENDED MARCH 31, 2004
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Page No.
Part I. Financial Information
Item 1 (a) (1). Financial Statements (Unaudited)
Consolidated Statements of Income - Three Months Ended
March 31, 2004 and 2003 1
Condensed Consolidated Balance Sheets - March 31, 2004
and December 31, 2003 2
Condensed Consolidated Statements of Cash Flows - Three
Months Ended March 31, 2004 and 2003 3
Notes to Consolidated Financial Statements 4
(a) (2). Financial Statement Schedules (Unaudited)
Schedule I - Kaneb Services LLC (Parent Company)
Condensed Financial Statements:
Statements of Income - Three Months Ended
March 31, 2004 and 2003 14
Balance Sheets - March 31, 2004 and December 31, 2003 15
Statements of Cash Flows - Three Months Ended
March 31, 2004 and 2003 16
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 17
Item 3. Quantitative and Qualitative Disclosure About Market Risk 28
Item 4. Controls and Procedures 28
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K 29
KANEB SERVICES LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands -- Except Per Share Amounts)
(Unaudited)
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Three Months Ended
March 31,
----------------------------
2004 2003
------------ -------------
Revenues:
Services $ 90,698 $ 86,694
Products 142,481 131,775
------------ -------------
Total revenues 233,179 218,469
------------ -------------
Costs and expenses:
Cost of products sold 136,431 124,327
Operating costs 43,424 40,674
Depreciation and amortization 13,907 13,032
General and administrative 6,502 6,712
------------ -------------
Total costs and expenses 200,264 184,745
------------ -------------
Operating income 32,915 33,724
Interest and other income 32 109
Interest expense (10,629) (8,844)
------------ -------------
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 22,318 24,989
Gain on issuance of units by KPP - 10,898
Income tax expense (1,163) (1,429)
Interest of outside non-controlling partners in KPP's net income (15,160) (17,586)
------------ -------------
Income before cumulative effect of change in accounting
principle 5,995 16,872
Cumulative effect of change in accounting principle - adoption
of new accounting standard for asset retirement obligations - (313)
------------ -------------
Net income $ 5,995 $ 16,559
============ =============
Earnings per share:
Basic:
Before cumulative effect of change in accounting principle $ 0.51 $ 1.47
Cumulative effect of change in accounting principle - (0.03)
------------ -------------
$ 0.51 $ 1.44
============ ============
Diluted:
Before cumulative effect of change in accounting principle $ 0.50 $ 1.44
Cumulative effect of change in accounting principle - (0.03)
------------ ------------
$ 0.50 $ 1.41
============ ============
See notes to consolidated financial statements.
1
KANEB SERVICES LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands)
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March 31, December 31,
2004 2003
--------------- ------------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 41,099 $ 43,457
Accounts receivable 70,627 60,684
Inventories 18,478 18,637
Prepaid expenses and other 8,023 9,650
--------------- ---------------
Total current assets 138,227 132,428
--------------- ---------------
Property and equipment 1,367,983 1,360,523
Less accumulated depreciation 261,396 247,503
--------------- ---------------
Net property and equipment 1,106,587 1,113,020
--------------- ---------------
Investment in affiliates 27,094 25,456
Excess of cost over fair value of net assets of
acquired business and other assets 20,589 20,663
--------------- ---------------
$ 1,292,497 $ 1,291,567
=============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 37,843 $ 36,916
Accrued expenses 40,591 39,307
Accrued interest payable 8,611 9,303
Accrued distributions payable to shareholders 5,567 5,567
Accrued distributions payable to outside non-controlling
partners in KPP 19,507 19,507
Deferred terminaling fees 7,105 7,061
--------------- ---------------
Total current liabilities 119,224 117,661
--------------- ---------------
Long-term debt 640,386 636,308
Other liabilities and deferred taxes 51,701 52,242
Interest of outside non-controlling partners in KPP 403,138 407,635
Commitments and contingencies
Shareholders' equity 78,048 77,721
--------------- ---------------
$ 1,292,497 $ 1,291,567
=============== ===============
See notes to consolidated financial statements.
2
KANEB SERVICES LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
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Three Months Ended
March 31,
----------------------------
2004 2003
------------ -------------
Operating activities:
Net income $ 5,995 $ 16,559
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 13,907 13,032
Equity in earnings of affiliates, net of distributions (1,638) (297)
Interest of outside non-controlling partners in
KPP's net income 15,160 17,586
Gain on issuance of units by KPP - (10,898)
Deferred income taxes (53) 1,049
Cumulative effect of change in accounting principle - 313
Changes in working capital components (6,520) (4,745)
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Net cash provided by operating activities 26,851 32,599
------------ -------------
Investing activities:
Capital expenditures (7,347) (11,738)
Other (932) 65
------------ -------------
Net cash used in investing activities (8,279) (11,673)
------------ -------------
Financing activities:
Issuance of debt 4,196 14,000
Payments on debt - (105,707)
Distributions to shareholders (5,567) (4,756)
Distributions to outside non-controlling
partners in KPP (19,507) (15,878)
Net proceeds from issuance of units by KPP - 104,770
Other (52) 60
------------ -------------
Net cash used in financing activities (20,930) (7,511)
------------ -------------
Increase (decrease) in cash and cash equivalents (2,358) 13,415
Cash and cash equivalents at beginning of period 43,457 24,477
------------ -------------
Cash and cash equivalents at end of period $ 41,099 $ 37,892
============ =============
Supplemental cash flow information - cash paid for interest $ 10,954 $ 13,455
============ =============
See notes to consolidated financial statements.
3
KANEB SERVICES LLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
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1. SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements reflect the results of operations of
Kaneb Services LLC (the "Company"), its wholly-owned subsidiaries and Kaneb
Pipe Line Partners, L.P. ("KPP"). The Company controls the operations of
KPP through its 2% general partner interest and 18% limited partner
interest as of March 31, 2004. All significant intercompany transactions
and balances have been eliminated.
The unaudited condensed consolidated financial statements of the Company
for the three month periods ended March 31, 2004 and 2003, have been
prepared in accordance with accounting principles generally accepted in the
United States of America. Significant accounting policies followed by the
Company are disclosed in the notes to the consolidated financial statements
included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2003. In the opinion of the Company's management, the
accompanying condensed consolidated financial statements contain all of the
adjustments, consisting of normal recurring accruals, necessary to present
fairly the consolidated financial position of the Company and its
consolidated subsidiaries at March 31, 2004 and the consolidated results of
their operations and cash flows for the periods ended March 31, 2004 and
2003. Operating results for the three months ended March 31, 2004 are not
necessarily indicative of the results that may be expected for the year
ending December 31, 2004.
In December of 2002, the FASB issued Statement of Financial Accounting
Standards ("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, the
Company applies APB Opinion 25 and related interpretations in accounting
for its share 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 share options issued.
The following illustrates the effect on net income and basic and diluted
earnings per share if the fair value based method had been applied:
Three Months Ended
March 31,
--------------------------------
2004 2003
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(in thousands)
Reported net income $ 5,995 $ 16,559
Share-based employee compensation expense determined
under the fair value based method (21) (12)
------------- -------------
Pro forma net income $ 5,974 $ 16,547
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Earning per share:
Basic - as reported $ 0.51 $ 1.44
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Basic - pro forma $ 0.51 $ 1.41
============= =============
Diluted - as reported $ 0.50 $ 1.41
============= =============
Diluted - pro forma $ 0.50 $ 1.38
============= =============
2. KPP FINANCINGS
In March of 2003, KPP issued 3,122,500 limited partnership units in a
public offering at $36.54 per unit, generating approximately $109.1 million
in net proceeds. The proceeds were used to reduce the amount of
indebtedness under KPP's bridge facility. 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 the first quarter of 2003.
In April of 2003, KPP entered into a credit agreement with a group of banks
that provides for a $400 million unsecured revolving credit facility
through April of 2006. The credit facility, which provides for an increase
in the commitment up to an aggregate of $450 million by mutual agreement
between KPP and the banks, bears interest at variable rates and has a
variable commitment fee on unused amounts. The credit facility is without
recourse to the Company and contains certain financial and operating
covenants, including limitations on investments, sales of assets and
transactions with affiliates and, absent an event of default, does not
restrict distributions to the Company or to other partners. At March 31,
2004, 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 March 31, 2004, $54.2 million was outstanding
under the 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 other partners.
At March 31, 2004, 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 has been recorded as a component of accumulated other
comprehensive income and is being amortized, as interest expense, over the
life of the debt.
3. COMPREHENSIVE INCOME
Comprehensive income for the three months ended March 31, 2004 and 2003, is
as follows:
Three Months Ended
March 31,
---------------------------------
2004 2003
------------- --------------
(in thousands)
Net income $ 5,995 $ 16,559
Foreign currency translation adjustment (49) 522
KPP interest rate hedging transaction 9 -
------------- --------------
Comprehensive income $ 5,955 $ 17,081
============= ==============
Accumulated other comprehensive income aggregated $2.4 million at both
March 31, 2004 and December 31, 2003.
4. CASH DISTRIBUTIONS
The Company makes quarterly distributions of 100% of its available cash, as
defined in the limited liability company agreement, to common shareholders
of record on the applicable record date, within 45 days after the end of
each quarter. Available cash consists generally of all the cash receipts of
the Company, less all cash disbursements and reserves. Excess cash flow of
the Company's wholly-owned marketing operations is being used to reduce
working capital borrowings. A cash distribution of $0.475 per share with
respect to the fourth quarter of 2003 was paid on February 13, 2004. A cash
distribution of $0.475 per share with respect to the first quarter of 2004
was declared to holders of record on April 30, 2004 and will be paid on May
14, 2004.
5. EARNINGS PER SHARE
Earnings per share for the three months ended March 31, 2004 and 2003, is
calculated using the Company's basic and diluted weighted average shares
outstanding for the period. For the three months ended March 31, 2004 and
2003, basic weighted average shares outstanding were 11,667,000 and
11,462,000, respectively, and diluted weighted average shares outstanding
were 11,921,000 and 11,760,000, respectively.
6. CONTINGENCIES
The operations of KPP are subject to Federal, state and local laws and
regulations in the United States and various foreign locations relating to
protection of the environment. Although KPP believes its operations are in
general compliance with applicable environmental regulations, risks of
additional costs and liabilities are inherent in pipeline and terminal
operations, and there can be no assurance that significant costs and
liabilities will not be incurred by KPP. Moreover, it is possible that
other developments, such as increasingly stringent environmental laws,
regulations and enforcement policies thereunder, and claims for damages to
property or persons resulting from the operations of KPP, could result in
substantial costs and liabilities to KPP.
Certain subsidiaries of KPP were sued in a Texas state court in 1997 by
Grace Energy Corporation ("Grace"), the entity from which KPP acquired ST
Services in 1993. The lawsuit involves environmental response and
remediation costs allegedly resulting from jet fuel leaks in the early
1970's from a pipeline. The pipeline, which connected a former Grace
terminal with Otis Air Force Base in Massachusetts (the "Otis pipeline" or
the "pipeline"), ceased operations in 1973 and was abandoned before 1978,
when the connecting terminal was sold to an unrelated entity. Grace alleged
that subsidiaries of KPP acquired the abandoned pipeline, as part of the
acquisition of ST Services in 1993 and assumed responsibility for
environmental damages allegedly caused by the jet fuel leaks. Grace sought
a ruling from the Texas court that these subsidiaries are responsible for
all liabilities, including all present and future remediation expenses,
associated with these leaks and that Grace has no obligation to indemnify
these subsidiaries for these expenses. In the lawsuit, Grace also sought
indemnification for expenses of approximately $3.5 million that it had
incurred since 1996 for response and remediation required by the State of
Massachusetts and for additional expenses that it expects to incur in the
future. The consistent position of KPP's subsidiaries has been that they
did not acquire the abandoned pipeline as part of the 1993 ST Services
transaction, and therefore did not assume any responsibility for the
environmental damage nor any liability to Grace for the pipeline.
At the end of the trial, the jury returned a verdict including findings
that (1) Grace had breached a provision of the 1993 acquisition agreement
by failing to disclose matters related to the pipeline, and (2) the
pipeline was abandoned before 1978 -- 15 years before KPP's subsidiaries
acquired ST Services. On August 30, 2000, the Judge entered final judgment
in the case that Grace take nothing from the subsidiaries on its claims
seeking recovery of remediation costs. Although KPP's subsidiaries have not
incurred any expenses in connection with the remediation, the court also
ruled, in effect, that the subsidiaries would not be entitled to
indemnification from Grace if any such expenses were incurred in the
future. Moreover, the Judge let stand a prior summary judgment ruling that
the pipeline was an asset acquired by KPP's subsidiaries as part of the
1993 ST Services transaction and that any liabilities associated with the
pipeline would have become liabilities of the subsidiaries. Based on that
ruling, the Massachusetts Department of Environmental Protection and Samson
Hydrocarbons Company (successor to Grace Petroleum Company) wrote letters
to ST Services alleging its responsibility for the remediation, and ST
Services responded denying any liability in connection with this matter.
The Judge also awarded attorney fees to Grace of more than $1.5 million.
Both KPP's subsidiaries and Grace have appealed the trial court's final
judgment to the Texas Court of Appeals in Dallas. In particular, the
subsidiaries have filed an appeal of the judgment finding that the Otis
pipeline and any liabilities associated with the pipeline were transferred
to them as well as the award of attorney fees to Grace.
On April 2, 2001, Grace filed a petition in bankruptcy, which created an
automatic stay of actions against Grace. This automatic stay covers the
appeal of the Dallas litigation, and the Texas Court of Appeals has issued
an order staying all proceedings of the appeal because of the bankruptcy.
Once that stay is lifted, KPP's subsidiaries that are party to the lawsuit
intend to resume vigorous prosecution of the appeal.
The Otis Air Force Base is a part of the Massachusetts Military Reservation
("MMR Site"), which has been declared a Superfund Site pursuant to CERCLA.
The MMR Site contains a number of groundwater contamination plumes, two of
which are allegedly associated with the Otis pipeline, and various other
waste management areas of concern, such as landfills. The United States
Department of Defense, pursuant to a Federal Facilities Agreement, has been
responding to the Government remediation demand for most of the
contamination problems at the MMR Site. Grace and others have also received
and responded to formal inquiries from the United States Government in
connection with the environmental damages allegedly resulting from the jet
fuel leaks. KPP's subsidiaries voluntarily responded to an invitation from
the Government to provide information indicating that they do not own the
pipeline. In connection with a court-ordered mediation between Grace and
KPP's subsidiaries, the Government advised the parties in April 1999 that
it has identified two spill areas that it believes to be related to the
pipeline that is the subject of the Grace suit. The Government at that time
advised the parties that it believed it had incurred costs of approximately
$34 million, and expected in the future to incur costs of approximately $55
million, for remediation of one of the spill areas. This amount was not
intended to be a final accounting of costs or to include all categories of
costs. The Government also advised the parties that it could not at that
time allocate its costs attributable to the second spill area.
By letter dated July 26, 2001, the United States Department of Justice
("DOJ") advised ST Services that the Government intends to seek
reimbursement from ST Services under the Massachusetts Oil and Hazardous
Material Release Prevention and Response Act and the Declaratory Judgment
Act for the Government's response costs at the two spill areas discussed
above. The DOJ relied in part on the Texas state court judgment, which in
the DOJ's view, held that ST Services was the current owner of the pipeline
and the successor-in-interest of the prior owner and operator. The
Government advised ST Services that it believes it has incurred costs
exceeding $40 million, and expects to incur future costs exceeding an
additional $22 million, for remediation of the two spill areas. KPP
believes that its subsidiaries have substantial defenses. ST Services
responded to the DOJ on September 6, 2001, contesting the Government's
positions and declining to reimburse any response costs. The DOJ has not
filed a lawsuit against ST Services seeking cost recovery for its
environmental investigation and response costs. Representatives of ST
Services have met with representatives of the Government on several
occasions since September 6, 2001 to discuss the Government's claims and to
exchange information related to such claims. Additional exchanges of
information are expected to occur in the future and additional meetings may
be held to discuss possible resolution of the Government's claims without
litigation. KPP does not believe this matter will have a materially adverse
effect on its financial condition, although there can be no assurances as
to the ultimate outcome.
On April 7, 2000, a fuel oil pipeline in Maryland owned by Potomac Electric
Power Company ("PEPCO") ruptured. Work performed with regard to the
pipeline was conducted by a partnership of which ST Services is general
partner. PEPCO has reported that it has incurred total cleanup costs of $70
million to $75 million. PEPCO probably will continue to incur some cleanup
related costs for the foreseeable future, primarily in connection with EPA
requirements for monitoring the condition of some of the impacted areas.
Since May 2000, ST Services has provisionally contributed a minority share
of the cleanup expense, which has been funded by ST Services' insurance
carriers. ST Services and PEPCO have not, however, reached a final
agreement regarding ST Services' proportionate responsibility for this
cleanup effort, if any, and cannot predict the amount, if any, that
ultimately may be determined to be ST Services' share of the remediation
expense, but ST Services believes that such amount will be covered by
insurance and therefore will not materially adversely affect KPP's
financial condition.
As a result of the rupture, purported class actions were filed against
PEPCO and ST Services in federal and state court in Maryland by property
and business owners alleging damages in unspecified amounts under various
theories, including under the Oil Pollution Act ("OPA") and Maryland common
law. The federal court consolidated all of the federal cases in a case
styled as In re Swanson Creek Oil Spill Litigation. A settlement of the
consolidated class action, and a companion state-court class action, was
reached and approved by the federal judge. The settlement involved creation
and funding by PEPCO and ST Services of a $2,250,000 class settlement fund,
from which all participating claimants would be paid according to a
court-approved formula, as well as a court-approved payment to plaintiffs'
attorneys. The settlement has been consummated and the fund, to which PEPCO
and ST Services contributed equal amounts, has been distributed.
Participating claimants' claims have been settled and dismissed with
prejudice. A number of class members elected not to participate in the
settlement, i.e., to "opt out," thereby preserving their claims against
PEPCO and ST Services. All non-participant claims have been settled for
immaterial amounts with ST Services' portion of such settlements provided
by its insurance carrier.
PEPCO and ST Services agreed with the federal government and the State of
Maryland to pay costs of assessing natural resource damages arising from
the Swanson Creek oil spill under OPA and of selecting restoration
projects. This process was completed in mid-2002. ST Services' insurer has
paid ST Services' agreed 50 percent share of these assessment costs. In
late November 2002, PEPCO and ST Services entered into a Consent Decree
resolving the federal and state trustees' claims for natural resource
damages. The decree required payments by ST Services and PEPCO of a total
of approximately $3 million to fund the restoration projects and for
remaining damage assessment costs. The federal court entered the Consent
Decree as a final judgment on December 31, 2002. PEPCO and ST Services have
each paid their 50% share and thus fully performed their payment
obligations under the Consent Decree. ST Services' insurance carrier funded
ST Services' payment.
The U.S. Department of Transportation ("DOT") has issued a Notice of
Proposed Violation to PEPCO and ST Services alleging violations over
several years of pipeline safety regulations and proposing a civil penalty
of $647,000 jointly against the two companies. ST Services and PEPCO have
contested the DOT allegations and the proposed penalty. A hearing was held
before the Office of Pipeline Safety at the DOT in late 2001. 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.
7. BUSINESS SEGMENT DATA
The Company conducts business through three principal operations: the
"Pipeline Operations" of KPP, which consists primarily of the
transportation of refined petroleum products and fertilizer in the
Midwestern states as a common carrier; the "Terminaling Operations" of KPP,
which provide storage for petroleum products, specialty chemicals and other
liquids; and the "Product Marketing Services," which provides wholesale
motor fuel marketing services throughout the Midwest and Rocky Mountain
regions, delivers bunker fuels to ships in the Caribbean and Nova Scotia,
Canada, and sells bulk petroleum products to various commercial interests.
General corporate includes accounting, tax, finance, legal, investor
relations and other corporate expenses not related to the segments. General
corporate assets include cash, receivable from affiliates of the Company
and other assets not related to the segments.
The Company measures segment profit as operating income. Total assets are
those assets controlled by each reportable segment. Business segment data
is as follows:
Three Months Ended
March 31,
---------------------------------
2004 2003
------------- --------------
(in thousands)
Business segment revenues:
Pipeline operations $ 27,903 $ 28,008
Terminaling operations 62,795 58,686
Product marketing operations 142,481 131,775
------------- --------------
$ 233,179 $ 218,469
============= ==============
Business segment profit:
Pipeline operations $ 11,210 $ 11,977
Terminaling operations 18,484 18,040
Product marketing operations 3,754 4,205
General corporate (533) (498)
------------- --------------
Operating income 32,915 33,724
Interest and other income 32 109
Interest expense (10,629) (8,844)
------------- --------------
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 $ 22,318 $ 24,989
============= ==============
March 31, December 31,
2004 2003
------------- -------------
(in thousands)
Total assets:
Pipeline operations $ 357,604 $ 352,901
Terminaling operations 858,523 874,185
Product marketing operations 70,298 58,161
General corporate 6,072 6,320
------------- -------------
$ 1,292,497 $ 1,291,567
============= =============
8. ADOPTION OF RECENT ACCOUNTING PRONOUNCEMENTS
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 March 31, 2004, the Company had no assets which were legally
restricted for purposes of settling asset retirement obligations. The
application of SFAS No. 143 did not have a material impact on the results
of operations of the Company for the three months ended March 31, 2004 or
2003.
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 did not have a material impact
on the consolidated financial statements of the Company.
Schedule I
KANEB SERVICES LLC (PARENT COMPANY)
CONDENSED STATEMENTS OF INCOME
(In Thousands - Except Per Share Amounts)
(Unaudited)
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
-----------------------------
2004 2003
------------- -------------
General and administrative expenses $ (441) $ (462)
Interest expense (137) (168)
Interest and other income 1 2
Equity in earnings of subsidiaries 6,572 6,602
Equity in earnings of subsidiaries - gain on issuance of units by KPP - 10,898
------------- ------------
Income before cumulative effect of change in accounting
principle 5,995 16,872
Cumulative effect of change in accounting principle - adoption
of new accounting standard for asset retirement obligations - (313)
------------- ------------
Net income $ 5,995 $ 16,559
============= ============
Earnings per share:
Basic:
Before cumulative effect of change in accounting principle $ 0.51 $ 1.47
Cumulative effect of change in accounting principle - (0.03)
------------- ------------
$ 0.51 $ 1.44
============= ============
Diluted:
Before cumulative effect of change in accounting principle $ 0.50 $ 1.44
Cumulative effect of change in accounting principle - (0.03)
------------- ------------
$ 0.50 $ 1.41
============= ============
See "Notes to Consolidated Financial Statements" of
Kaneb Services LLC included in this report.
14
Schedule I
(Continued)
KANEB SERVICES LLC (PARENT COMPANY)
CONDENSED BALANCE SHEETS
(In Thousands)
- --------------------------------------------------------------------------------
March 31, December 31,
2004 2003
--------------- -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 1,295 $ 1,544
Prepaid expenses and other 171 149
-------------- -------------
Total current assets 1,466 1,693
-------------- -------------
Investments in and advances to subsidiaries 106,269 106,068
Other assets 471 498
-------------- -------------
$ 108,206 $ 108,259
============== =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accrued expenses $ 679 $ 1,112
Accrued distributions payable to shareholders 5,567 5,567
-------------- -------------
Total current liabilities 6,246 6,679
-------------- -------------
Long-term debt 16,500 16,500
Long-term payables and other liabilities 7,412 7,359
Commitments and contingencies
Shareholders' equity 78,048 77,721
-------------- -------------
$ 108,206 $ 108,259
============== =============
See "Notes to Consolidated Financial Statements" of
Kaneb Services LLC included in this report.
15
Schedule I
(Continued)
KANEB SERVICES LLC (PARENT COMPANY)
CONDENSED STATEMENT OF CASH FLOWS
(In Thousands)
(Unaudited)
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
-----------------------------
2004 2003
------------- ------------
Operating activities:
Net income $ 5,995 $ 16,559
Adjustments to reconcile net income to net cash provided
by operating activities:
Equity in earnings of subsidiaries, net of distributions (250) (12,110)
Cumulative effect of change in accounting principle - 313
Changes in current assets and liabilities (455) (142)
------------ ------------
Net cash provided by operating activities 5,290 4,620
------------ ------------
Investing activities:
Changes in other assets 27 52
------------ ------------
Net cash provided by investing activities 27 52
------------ ------------
Financing activities:
Distributions to shareholders (5,567) (4,756)
Changes in long-term payables and other liabilities 53 117
Other (52) 60
------------ ------------
Net cash used in financing activities (5,566) (4,579)
------------ ------------
Increase (decrease) in cash and cash equivalents (249) 93
Cash and cash equivalents at beginning of period 1,544 1,695
------------ ------------
Cash and cash equivalents at end of period $ 1,295 $ 1,788
============ ============
See "Notes to Consolidated Financial Statements" of
Kaneb Services LLC included in this report.
16
KANEB SERVICES LLC AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
- --------------------------------------------------------------------------------
This discussion should be read in conjunction with the condensed
consolidated financial statements of Kaneb Services LLC (the "Company") and
notes thereto included elsewhere in this report. The consolidated financial
information reflects the results of operations of the Company, its
wholly-owned subsidiaries and Kaneb Pipe Line Partners, L.P. ("KPP"). The
Company controls the operations of KPP through its 2% general partner
interest and 18% limited partner interest at March 31, 2004.
General
In September 1989, Kaneb Pipe Line Company LLC ("KPL"), now a wholly owned
subsidiary of the Company, formed KPP to own and operate its refined
petroleum products pipeline business. KPL manages and controls the
operations of KPP through its general partner interests and an 18% (at
March 31, 2004) 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. The fertilizer pipeline originates in
southern Louisiana, proceeds north through Arkansas and Missouri, and then
branches east into Illinois and Indiana and north and west into Iowa and
Nebraska. KPP's petroleum pipeline business depends on the level of demand
for refined petroleum products in the markets served by the pipelines and
the ability and willingness of refineries and marketers having access to
the pipelines to supply such demand by deliveries through the pipelines.
KPP's pipeline revenues are based on volumes shipped and the distance over
which such volumes are transported.
KPP's terminaling business is one of the largest independent petroleum
products and specialty liquids terminaling businesses in the United States.
In the United States, KPP operates 37 facilities in 20 states. KPP also
owns and operates six terminals located in the United Kingdom, eight
terminals in Australia and New Zealand, a terminal on the Island of St.
Eustatius, Netherlands Antilles and a terminal at Point Tupper, Nova
Scotia, Canada. Independent terminal owners generally compete on the basis
of the location and versatility of the terminals, service and price.
Terminal versatility is a function of the operator's ability to offer
handling for diverse products with complex handling requirements. The
service 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.
Consolidated Results of Operations
Three Months Ended
March 31,
--------------------------------
2004 2003
------------- -------------
(in thousands, except
per share amounts)
Consolidated revenues $ 233,179 $ 218,469
============= =============
Consolidated operating income $ 32,915 $ 33,724
============= =============
Consolidated income before gain on issuance of units
by KPP and cumulative effect of change in
accounting principle $ 5,995 $ 5,974
============= =============
Consolidated net income $ 5,995 $ 16,559
============= =============
Earnings per share:
Basic:
Before cumulative effect of change in accounting
principle $ 0.51 $ 1.47
Cumulative effect of change in accounting
principle - (0.03)
------------- -------------
$ 0.51 $ 1.44
============= =============
Diluted:
Before cumulative effect of change in accounting
principle $ 0.50 $ 1.44
Cumulative effect of change in accounting
principle - (0.03)
-------------- -------------
$ 0.50 $ 1.41
============== =============
Cash distributions declared per share $ 0.475 $ 0.4375
============== =============
Consolidated capital expenditures, excluding acquisitions $ 7,347 $ 11,738
============== =============
For the three months ended March 31, 2004, consolidated revenues increased
by $14.7 million, or 7%, when compared to the first quarter of 2003, due to
a $10.7 million increase in product marketing revenues and a $4.1 million
increase in terminaling business revenues, partially offset by a $0.1
million decrease in pipeline revenues. Consolidated operating income for
the three months ended March 31, 2004 decreased by $0.8 million, or 2%,
when compared to the same period in 2003, due primarily to a $0.8 million
decrease in pipeline operating income and a $0.5 million decrease in
product marketing operating income, partially offset by a $0.4 million
increase in terminaling operating income. Income before gain on issuance of
units by KPP and cumulative effect of change in accounting principle
increased slightly, when compared to the first three months of 2003.
Overall, net income for the three months ended March 31, 2004 decreased by
$10.6 million, when compared the three month period ended March 31, 2003,
which includes a $10.9 million gain on issuance of units by KPP (see
"Liquidity and Capital Resources").
Pipeline Operations
Three Months Ended
March 31,
---------------------------------
2004 2003
------------- --------------
(in thousands)
Revenues $ 27,903 $ 28,008
Operating costs 11,487 11,241
Depreciation and amortization 3,599 3,497
General and administrative 1,607 1,293
------------- --------------
Operating income $ 11,210 $ 11,977
============= ==============
Pipeline revenues are based on volumes shipped and the distances over which
such volumes are transported. Because tariff rates are regulated by the
FERC or the Surface Transportation Board, the pipelines compete primarily
on the basis of quality of service, including delivery of products at
convenient locations on a timely basis to meet the needs of their
customers. For the three month period ended March 31, 2004, revenues
decreased by $0.1 million, when compared to the same 2003 period, due to
decreases in barrel miles of petroleum products shipped. Barrel miles on
petroleum pipelines totaled 5.1 billion and 5.4 billion for the three
months ended March 31, 2004 and 2003, respectively.
Operating costs, which include fuel and power costs, materials and
supplies, maintenance and repair costs, salaries, wages and employee
benefits, and property and other taxes, increased by $0.2 million for the
three month period ended March 31, 2004, when compared to 2003, due to
unusually high expenses relating to maintenance and repairs required by
government regulation and increases in power and fuel costs. For the three
months ended March 31, 2004, depreciation and amortization increased by
$0.1 million, when compared to the same 2003 period, due primarily to
routine maintenance capital expenditures. General and administrative costs,
which include managerial, accounting and administrative personnel costs,
office rent and expense, legal and professional costs and other
non-operating costs, increased by $0.3 million for the three month period
ended March 31, 2004, when compared to the same 2003 period, due primarily
to increases in personnel-related costs.
Terminaling Operations
Three Months Ended
March 31,
---------------------------------
2004 2003
------------- --------------
(in thousands)
Revenues $ 62,795 $ 58,686
Operating costs 30,343 27,277
Depreciation and amortization 10,084 9,244
General and administrative 3,884 4,125
------------- --------------
Operating income $ 18,484 $ 18,040
============= ==============
For the three month period ended March 31, 2004, terminaling revenues
increased by $4.1 million, or 7%, when compared to the same 2003 period,
due to increases in both the average tankage utilized and the average price
realized per barrel of tankage utilized. Average tankage utilized for the
three month period ended March 31, 2004 was 48.2 million, compared to 47.4
million, for the same prior year period. For the three month period ended
March 31, 2004, average annualized revenues per barrel of tankage utilized
increased to $5.24 per barrel, compared to $5.02 per barrel for the same
prior year period, due primarily to favorable domestic market conditions.
For the three month period ended March 31, 2004, operating costs increased
by $3.1 million, when compared to the same 2003 period, a result of overall
increases in tank utilization and planned maintenance. For the three months
ended March 31, 2004, depreciation and amortization increased by $0.8
million, when compared to the same 2003 period, due to expansion and
routine maintenance capital expenditures. General and administrative costs
for the three month period ended March 31, 2004, decreased slightly, when
compared to the same 2003 period.
Product Marketing Services
Three Months Ended
March 31,
---------------------------------
2004 2003
------------- --------------
(in thousands)
Revenues $ 142,481 $ 131,775
Cost of products sold 136,431 124,327
------------- --------------
Gross margin $ 6,050 $ 7,448
============= ==============
Operating income $ 3,754 $ 4,205
============= ==============
For the three month period ended March 31, 2004, revenues for the product
marketing business increased by $10.7 million, or 8%, when compared to the
same 2003 period. The increase in first quarter 2004 revenues, when
compared to the first quarter of 2003, was the result of increase in sales
volumes, partially offset by a decrease in the average sales price
realized. Gallons sold totaled 162 million and 152 million, respectively,
for the three months ended March 31, 2004 and 2003. For the three month
period ended March 31, 2004, the average price realized per gallon of
product sold decreased slightly to $0.86 per gallon, compared to $0.87 per
gallon, for the 2003 period. For the three months ended March 31, 2004,
gross margin and operating income decreased by $1.4 million and $0.5
million, respectively, when compared to the same 2003 period, due to lower
overall product margins, partially offset by the increase in sales volumes.
Product inventories are maintained at minimum levels to meet customers'
needs; however, market prices for petroleum products can fluctuate
significantly in short periods of time.
Interest Expense
For the three months ended March 31, 2004, interest expense increased by
$1.8 million when compared to the same 2003 period, due to KPP's May 2003
refinancing of variable rate bank debt with $250 million of 5.875% senior
unsecured notes, partially offset by overall declines in debt levels
outstanding due to KPP's March 2003 issuance of limited partnership units
(see "Liquidity and Capital Resources").
Income Taxes
KPP's partnership operations are not subject to federal or state income
taxes. However, certain KPP operations are conducted through separate
taxable wholly-owned U.S. and foreign corporate subsidiaries. The income
tax expense for these subsidiaries was $1.2 million and $1.4 million for
the three month periods ended March 31, 2004 and 2003, respectively.
On June 1, 1989, the governments of the Netherlands Antilles and St.
Eustatius approved a Free Zone and Profit Tax Agreement retroactive to
January 1, 1989, which expired on December 31, 2000. This agreement
requires a subsidiary of KPP, which was acquired on February 28, 2002, to
pay a 2% rate on taxable income, as defined therein, or a minimum payment
of 500,000 Netherlands Antilles guilders ($0.3 million) per year. The
agreement further provides that any amounts paid in order to meet the
minimum annual payment will be available to offset future tax liabilities
under the agreement to the extent that the minimum annual payment is
greater than 2% of taxable income. The subsidiary is currently engaged in
discussions with representatives appointed by the Island Territory of St.
Eustatius regarding the renewal or modification of the agreement, but the
ultimate outcome cannot be predicted at this time. The subsidiary has
accrued amounts assuming a new agreement becomes effective, and continues
to make payments, as required, under the previous agreement.
Liquidity and Capital Resources
Cash provided by operations, including the operations of KPP, was $26.9
million and $32.6 million for the three months ended March 31, 2004 and
2003, respectively. The first quarter 2004 decrease was due to changes in
working capital components resulting from the timing of cash receipts and
disbursements, primarily in the Company's product marketing business, and
the overall decrease in first quarter 2004 consolidated operating income.
Capital expenditures (related primarily to KPP) were $7.3 million for the
three months ended March 31, 2004, compared to $11.7 million during the
same 2003 period. Such expenditures included $5.7 million and $6.3 million
in maintenance and environmental expenditures and $1.6 million and $5.4
million in expansion expenditures for the three months ended March 31, 2004
and 2003, respectively. The decrease in first quarter 2004 capital
expenditures, when compared to the same 2003 period, is the result of
decreases in planned maintenance and expansion capital expenditures related
to KPP's terminaling business. During all periods, adequate pipeline
capacity existed to accommodate volume growth, and the expenditures
required for environmental and safety improvements were not, and are not
expected to be, significant. KPP anticipates that capital expenditures
(including routine maintenance and expansion expenditures, but excluding
acquisitions) will total approximately $28 to $32 million in 2004. Such
future expenditures of KPP, however, will depend on many factors beyond
KPP's control, including, without limitation, demand for refined petroleum
products and terminaling services in KPP's market areas, local, state and
federal government regulations, fuel conservation efforts and the
availability of financing on acceptable terms. No assurance can be given
that required capital expenditures will not exceed anticipated amounts
during the year, or thereafter, or that KPP will have the ability to
finance such expenditures through borrowings, or will choose to do so.
The Company makes quarterly distributions of 100% of its available cash, as
defined in the limited liability company agreement, to common shareholders
of record on the applicable record date, within 45 days after the end of
each quarter. Available cash consists generally of all the cash receipts of
the Company, less all cash disbursements and reserves. Excess cash flow of
the Company's wholly-owned marketing operations is being used to reduce
working capital borrowings. A cash distribution of $0.475 per share with
respect to the fourth quarter of 2003 was paid on February 13, 2004. A cash
distribution of $0.475 per share with respect to the first quarter of 2004
was declared to holders of record on April 30, 2004 and will be paid on May
14, 2004.
KPP expects to fund future cash distributions and maintenance capital
expenditures with existing cash and anticipated cash flows from operations.
Expansionary capital expenditures are expected to be funded through
additional KPP bank borrowings and/or future KPP public equity or debt
offerings.
The Company has a credit agreement with a bank that provides for a $50
million revolving credit facility through July 1, 2008. The credit
facility, which bears interest at variable rates, has a variable rate
commitment fee on unused amounts and contains certain financial and
operational covenants. At March 31, 2004, the Company was in compliance
with all covenants. The credit facility is secured by 4.6 million KPP
limited partnership units. At March 31, 2004, $16.5 million was drawn on
the credit facility.
In March of 2003, KPP issued 3,122,500 limited partnership units in a
public offering at $36.54 per unit, generating approximately $109.1 million
in net proceeds. The proceeds were used to reduce the amount of
indebtedness under KPP's bridge facility. 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 the first quarter of 2003.
In April of 2003, KPP entered into a credit agreement with a group of banks
that provides for a $400 million unsecured revolving credit facility
through April of 2006. The credit facility, which provides for an increase
in the commitment up to an aggregate of $450 million by mutual agreement
between KPP and the banks, bears interest at variable rates and has a
variable commitment fee on unused amounts. The credit facility is without
recourse to the Company and contains certain financial and operating
covenants, including limitations on investments, sales of assets and
transactions with affiliates and, absent an event of default, does not
restrict distributions to the Company or to other partners. At March 31,
2004, 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 March 31, 2004, $54.2 million was outstanding
under the 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 and other partners.
At March 31, 2004, 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 Statement of Financial
Accounting Standards ("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
has been recorded as a component of accumulated other comprehensive income
and is being amortized, as interest expense, over the life of the debt.
The following is a schedule by period of the Company's, including KPP's,
debt repayment obligations and material contractual commitments as of March
31, 2004:
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 6,308 - - 6,308 -
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 63,409 - 63,409 - -
---------- ------------ ----------- ------------ --------------
Debt subtotal 640,386 - 117,578 22,808 500,000
---------- ------------ ----------- ------------ --------------
Contractual commitments:
Operating leases 18,960 6,999 9,029 2,590 342
---------- ------------ ----------- ------------ --------------
Contractual commitments
subtotal 18,960 6,999 9,029 2,590 342
---------- ------------ ----------- ------------ --------------
Total $ 659,346 $ 6,999 $ 126,607 $ 25,398 $ 500,342
========== ============ =========== ============ ==============
Additional information relative to sources and uses of cash is presented in
the consolidated financial statements included in this report.
Off-Balance Sheet Transactions
The Company was not a party of any off-balance sheet transactions at March
31, 2004, or for the three month periods ended March 31, 2004 and 2003.
Critical Accounting Policies and Estimates
The preparation of the Company's financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosures of contingent
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Significant accounting
policies are presented in the Notes to the Consolidated Financial
Statements of the Company's Annual Report on Form 10-K for the year ended
December 31, 2003. Critical accounting policies are those that are most
important to the portrayal of the Company's financial position and results
of operations. These policies require management's most difficult,
subjective or complex judgments, often employing the use of estimates about
the effect of matters that are inherently uncertain. The Company's most
critical accounting policies pertain to impairment of KPP's property and
equipment and environmental costs.
The carrying value of KPP's property and equipment is periodically
evaluated using management's estimates of undiscounted future cash flows,
or, in some cases, third-party appraisals, as the basis 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 three month periods ended March
31, 2004 and 2003. However, future evaluations of carrying value are
dependent on many factors, several of which are out of KPP's control,
including demand for refined petroleum products and terminaling services in
KPP's market areas, and local, state and federal governmental regulations.
To the extent that such factors or conditions change, it is possible that
future impairments might occur, which could have a material effect on the
results of operations of KPP.
KPP environmental expenditures that relate to current operations are
expensed or capitalized, as appropriate. Expenditures that relate to an
existing condition caused by past operations, and which do not contribute
to current or future revenue generation, are expensed. Liabilities are
recorded by KPP when environmental assessments and/or remedial efforts are
probable, and the costs can be reasonably estimated. Generally, the timing
of these accruals coincides with the completion of a feasibility study or
KPP's commitment to a formal plan of action. The application of KPP's
environmental accounting policies did not have a material impact on the
results of operations of KPP for the three month periods ended March 31,
2004 and 2003. 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 did not have a material impact
on the consolidated financial statements of the Company.
KANEB SERVICES LLC AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Item 3. Quantitative and Qualitative Disclosure About Market Risk
The principal market risks pursuant to this Item (i.e., the risk of loss arising
from adverse changes in market rates and prices) to which the Company is exposed
are interest rates on the Company's and KPP's debt and investment portfolios,
fluctuations in petroleum product prices on inventories held for sale, 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 $140.4 million (including KPP's debt) at March 31, 2004, a one percent
increase in interest rates would increase annual net interest expense by
approximately $1.4 million.
The product marketing business purchases refined petroleum products for resale
as motor fuel, bunker fuel and sales to commercial interests. Petroleum
inventories are generally held for short periods of time, not exceeding 90 days.
As the Company and KPP do not engage in derivative transactions to hedge the
value of the inventory, they are subject to market risk from changes in global
oil markets.
A portion of KPP's terminaling business is exposed to fluctuations in foreign
currency exchange rates. Such fluctuations were not significant for the three
months ended March 31, 2004.
Item 4. Controls and Procedures
The Company's principal executive officer and principal financial officer, after
evaluating as of March 31, 2004, the effectiveness of the Company's disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the
Securities Exchange Act of 1934), have concluded that, as of such date, the
Company's disclosure controls and procedures are adequate and effective to
ensure that material information relating to the Company and its consolidated
subsidiaries would be made known to them by others within those entities.
During the first quarter of 2004, 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.
KANEB SERVICES LLC AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Part II - Other Information
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
3.1 Amended and Restated Limited Liability Company Agreement of
Registrant, filed as Exhibit 3.1 to the exhibits to Registrant's
Form 10-Q, for the period ended June 30, 2001, which exhibit is
hereby incorporated by reference.
31.1 Certification of Chief Executive Officer, Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002, dated May 6, 2004.
31.2 Certification of Chief Financial Officer, Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002, dated May 6, 2004.
32.1 Certification of Chief Executive Officer, Pursuant to Section
906(a) of the Sarbanes-Oxley Act of 2002, dated May 6, 2004.
32.2 Certification of Chief Financial Officer, Pursuant to Section
906(a) of the Sarbanes-Oxley Act of 2002, dated May 6, 2004.
(b) Reports on Form 8-K
Current Report on Form 8-K, filed February 26, 2004.
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
KANEB SERVICES LLC
(Registrant)
Date: May 6, 2004 //s// HOWARD C. WADSWORTH
----------------------------------------
Howard C. Wadsworth
Vice President, Treasurer and Secretary
Exhibit 31.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, John R. Barnes, Chief Executive Officer of Kaneb Services LLC certify that:
1. I have reviewed this quarterly report on Form 10-Q of Kaneb Services LLC;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this quarterly report is being prepared;
b) [intentionally omitted pursuant to SEC Release No. 34-47986];
c) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls and procedures, as
of the end of the period covered by this quarterly report, based on
such evaluation; and
d) disclosed in this quarterly report any change in the registrant's
internal control over financial reporting that occurred during the
registrant's most recent fiscal quarter that has materially affected,
or is reasonably likely to materially affect, the registrant's
internal control over financial reporting; and
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation of internal control over financial reporting to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: May 6, 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:
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this quarterly report is being prepared;
b) [intentionally omitted pursuant to SEC Release No. 34-47986];
c) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls and procedures, as
of the end of the period covered by this quarterly report, based on
such evaluation; and
d) disclosed in this quarterly report any change in the registrant's
internal control over financial reporting that occurred during the
registrant's most recent fiscal quarter that has materially affected,
or is reasonably likely to materially affect, the registrant's
internal control over financial reporting; and
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation of internal control over financial reporting to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: May 6, 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 Quarterly
Report on Form 10-Q for the three months ended March 31, 2004, filed with the
United States Securities and Exchange Commission pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)), fully
complies with the requirements of Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 and that information contained in such Quarterly Report
fairly presents, in all material respects, the financial condition and results
of operations of the Company.
This written statement is being furnished to the Securities and Exchange
Commission as an exhibit to such Form 10-Q. A signed original of this written
statement required by Section 906 has been provided to Kaneb Services LLC and
will be retained by Kaneb Services LLC and furnished to the Securities and
Exchange Commission or its staff upon request.
Date: May 6, 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 Quarterly
Report on Form 10-Q for the three months ended March 31, 2004, filed with the
United States Securities and Exchange Commission pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)), fully
complies with the requirements of Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 and that information contained in such Quarterly Report
fairly presents, in all material respects, the financial condition and results
of operations of the Company.
This written statement is being furnished to the Securities and Exchange
Commission as an exhibit to such Form 10-Q. A signed original of this written
statement required by Section 906 has been provided to Kaneb Services LLC and
will be retained by Kaneb Services LLC and furnished to the Securities and
Exchange Commission or its staff upon request.
Date: May 6, 2004
//s// HOWARD C. WADSWORTH
------------------------------------------
Howard C. Wadsworth
Vice President, Treasurer and Secretary
Chief Financial Officer