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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, 2004
OR
[X] 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.
Yes X No
-------- --------
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.
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
-------- --------
Aggregate market value of the voting shares held by non-affiliates of the
registrant: $309,666,530. This figure is estimated as of June 30, 2004, at which
date the closing price of the registrant's shares on the New York Stock Exchange
was $28.21 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 4, 2005:
11,696,129.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III (Items 10, 11, 12 and 13) of Form 10-K
is filed herewith.
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.
On October 31, 2004, Valero L.P. agreed to acquire by merger (the "KSL
Merger") all of the outstanding common shares of the Company for cash. Under the
terms of that agreement, Valero L.P. is offering to purchase all of the
outstanding shares of the Company at $43.31 per share.
In a separate definitive agreement, on October 31, 2004, Valero L.P. and
KPP agreed to merge (the "KPP Merger"). Under the terms of that agreement, each
holder of units of limited partnership interests in KPP will receive a number of
Valero L.P. common units based on an exchange ratio that fluctuates within a
fixed range to provide $61.50 in value of Valero L.P. units for each unit of
KPP. The actual exchange ratio will be determined at the time of the closing of
the proposed merger and is subject to a fixed value collar of plus or minus five
percent of Valero L.P.'s per unit price of $57.25 as of October 7, 2004. Should
Valero L.P.'s per unit price fall below $54.39 per unit, the exchange ratio will
remain fixed at 1.1307 Valero L.P. units for each unit of KPP. Likewise, should
Valero L.P.'s per unit price exceed $60.11 per unit, the exchange ratio will
remain fixed at 1.0231 Valero L.P. units for each unit of KPP.
The completion of the KSL Merger is subject to the customary regulatory
approvals including those under the Hart-Scott-Rodino Antitrust Improvements
Act. The completion of the KSL Merger is also subject to completion of the KPP
Merger. All required shareholder and unitholder approvals have been obtained.
Upon completion of the mergers, the general partner of the combined partnership
will be owned by affiliates of Valero Energy Corporation and the Company and KPP
will become wholly owned subsidiaries of Valero L.P.
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 includes 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 1,082,555 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 KPP'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 currently 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 a portion of
which was leased back to Koch Nitrogen. 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, 2004, these three
systems combined transported a total of 3.8 million barrels of diesel fuel,
representing an aggregate of $1.55 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. During 2004 and 2003, the
Ammonia Pipeline shipped 1,122,618 tons and 1,156,549 tons, respectively, of
ammonia generating $19.6 million and $21.3 million, respectively, of revenue.
Year Ended December 31,
------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------- ------------- -------------- ------------- --------------
Volume (1).................. 104,344 102,928 89,780 92,116 89,192
Barrel miles (2)............ 22,243 21,327 18,275 18,567 17,843
Revenues (3)................ $100,241 $98,329 $78,240 $74,976 $70,685
(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)
------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------- ------------- -------------- ------------- --------------
Gasoline.................... 54,745 53,205 45,106 46,268 44,215
Diesel and fuel oil......... 46,223 46,072 40,450 42,354 41,087
Propane..................... 3,376 3,651 4,224 3,494 3,890
------------- ------------- -------------- ------------- --------------
Total....................... 104,344 102,928 89,780 92,116 89,192
============= ============= ============== ============= ==============
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 that of 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 Pipelines' rights-of-way and possible damage to
the Pipelines.
KPP uses 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 "STB"), 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 STB, 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, 2004, 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 12
storage tanks at El Dorado, Kansas and 10 storage tanks at McPherson, Kansas,
with aggregate capacities of approximately 548,555 and 534,000 barrels,
respectively. During 2004, approximately 57.3%, 87.6% and 90.0% 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.
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 Pipelines. 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 2004 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 ConocoPhillips
Company, respectively. The NCRA and Frontier Refining refineries are connected
directly to the East Pipeline. The McPherson, Kansas refinery operated by NCRA
accounted for approximately 31.8% of the total amount of product shipped over
the East Pipeline in 2004. 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 overall nitrogen fertilizer use,
management practice, 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 Texas, then 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 48 shippers in 2004. The principal
shippers include integrated oil companies, refining companies, farm cooperatives
and a railroad. Transportation revenues attributable to the top 10 shippers were
$90.4 million, $86.6 million and $61.5 million, which accounted for 75%, 72% and
74% of total Pipeline revenues shipped for each of the years 2004, 2003 and
2002, 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. Seventeen 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
ConocoPhillips. 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 Texas, 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. Midwest
production 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, 2004, KPP's terminaling business accounted
for approximately 41% of KPP's revenues. As of December 31, 2004, ST operated 41
facilities in 20 states, with a total storage capacity of approximately 34.9
million barrels. ST also owns and operates seven terminals located in the United
Kingdom, having a total capacity of approximately 6.0 million barrels. In May
and September 2004, ST acquired terminals in Philadelphia, Pennsylvania and
Linden, New Jersey from Exxon-Mobil. In September 2004, ST acquired a chemical
and petroleum terminal in Grangemouth, Scotland. 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 2004, 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 barrels per day 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 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. In September 2004, ST, outside of the joint
venture, acquired an adjacent 375,000 barrel terminal from Exxon-Mobil.
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 37 other terminal facilities located throughout the United States,
seven facilities in the United Kingdom, four facilities in Australia and four
facilities 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, lube oils, potash and caustic solutions, as well as petroleum
products; Vancouver, Washington, which handles chemicals and fertilizer;
Eastham, United Kingdom, which handles chemicals and animal fats; Grangemouth,
United Kingdom, which handles chemicals and molasses as well as petroleum
products; 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 2,008,000 124 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,
caustic
Bremen, GA 182,000 9 Petroleum, jet fuel
Brunswick, GA 302,000 3 Fertilizer, pulp liquor
Columbus, GA 175,000 24 Petroleum, chemicals, fertilizers
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 Fertilizer
Indianapolis, IN 410,000 18 Petroleum
Westwego, LA 849,000 53 Molasses, fertilizer, caustic,
chemicals, lube oil
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
Linden, NJ 375,000 11 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
Philadelphia, PA 665,000 11 Petroleum
Texas City, TX 153,000 12 Chemicals, petrochemicals,
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 227,000 49 Chemicals, fertilizer, petroleum
Vancouver, WA 316,000 6 Petroleum, chemicals, fertilizer
Milwaukee, WI 308,000 7 Petroleum, ethanol
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 sulfur
Grangemouth, Scotland 530,000 46 Petroleum, chemicals and molasses
Glasgow, Scotland 344,000 16 Petroleum
Leith, Scotland 459,000 34 Petroleum, chemicals
Belfast, Northern Ireland 407,000 41 Petroleum
--------------- --------------
61,108,000 1,570
=============== ==============
(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, five 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, 2004, the product marketing segment's revenues,
gross margin and operating income were $676.1 million, $28.4 million and $17.3
million, respectively.
CAPITAL EXPENDITURES
Capital expenditures by KPP relating to its pipelines, including routine
maintenance and expansion expenditures, but excluding acquisitions, were $10.3
million, $9.6 million and $9.5 million for 2004, 2003 and 2002, respectively.
During these periods, adequate capacity existed on the Pipelines to accommodate
volume growth, and the expenditures required for environmental matters were not
material in amount. Capital expenditures, including routine maintenance and
expansion expenditures, but excluding acquisitions, by KPP relating to its
terminaling operations were $29.5 million, $34.6 million and $21.0 million for
2004, 2003 and 2002, respectively.
Capital expenditures of KPP during 2005, including routine maintenance and
expansion expenditures, but excluding acquisitions, are expected to be
approximately $40 million to $44 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. On July 20, 2004, the District of Columbia Court
of Appeals vacated the Commission's determination regarding the proper tax
allowance in that case and remanded the income tax allocation issue for further
FERC consideration. FERC has requested and received comments as to the issue. 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 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, and CF Industries
filed protests against the tariff filing. See "Item 3. Legal Proceedings,
Ammonia Pipeline Matters" for a description of those matters.
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 rights similar to 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 several matters
pending 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.
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, 2004, the Company, and its subsidiaries and affiliates
employed approximately 1,133 persons. Approximately 154 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
Richardson, 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 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.
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 Services believes that such
amount will be covered by insurance and therefore will not materially adversely
affect KPP's financial condition.
As a result of the rupture, purported class actions were filed against
PEPCO and ST Services in federal and state court in Maryland by property and
business owners alleging damages in unspecified amounts under various theories,
including under the Oil Pollution Act ("OPA") and Maryland common law. The
federal court consolidated all of the federal cases in a case styled as In re
Swanson Creek Oil Spill Litigation. A settlement of the consolidated class
action, and a companion state-court class action, was reached and approved by
the federal judge. The settlement involved creation and funding by PEPCO and ST
Services of a $2,250,000 class settlement fund, from which all participating
claimants would be paid according to a court-approved formula, as well as a
court-approved payment to plaintiffs' attorneys. The settlement has been
consummated and the fund, to which PEPCO and ST Services contributed equal
amounts, has been distributed. Participating claimants' claims have been settled
and dismissed with prejudice. A number of class members elected not to
participate in the settlement, i.e., to "opt out," thereby preserving their
claims against PEPCO and ST Services. All non-participant claims have been
settled for immaterial amounts with ST Services' portion of such settlements
provided by its insurance carrier.
PEPCO and ST Services agreed with the federal government and the State of
Maryland to pay costs of assessing natural resource damages arising from the
Swanson Creek oil spill under OPA and of selecting restoration projects. This
process was completed in mid-2002. ST Services' insurer has paid ST Services'
agreed 50 percent share of these assessment costs. In late November 2002, PEPCO
and ST Services entered into a Consent Decree resolving the federal and state
trustees' claims for natural resource damages. The decree required payments by
ST Services and PEPCO of a total of approximately $3 million to fund the
restoration projects and for remaining damage assessment costs. The federal
court entered the Consent Decree as a final judgment on December 31, 2002. PEPCO
and ST Services have each paid their 50% share and thus fully performed their
payment obligations under the Consent Decree. ST Services' insurance carrier
funded ST Services' payment.
The U.S. Department of Transportation ("DOT") has issued a Notice of
Proposed Violation to PEPCO and ST Services alleging violations over several
years of pipeline safety regulations and proposing a civil penalty of $647,000
jointly against the two companies. ST Services and PEPCO have contested the DOT
allegations and the proposed penalty. A hearing was held before the Office of
Pipeline Safety at the DOT in late 2001. In June of 2004, the DOT issued a final
order reducing the penalty to $256,250 jointly against ST Services and PEPCO and
$74,000 against ST Services. On September 14, 2004, ST Services petitioned for
reconsideration of the order.
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.
Paulsboro Litigation. In 2003, Exxon Mobil filed a lawsuit in a New Jersey
state court against GATX Corporation, Kinder Morgan Liquid Terminals ("Kinder
Morgan"), the successor in interest to GATX Terminals Corporation ("GATX"), and
the Company's subsidiary, ST Services, seeking reimbursement for remediation
costs associated with the Paulsboro, New Jersey terminal. The terminal was owned
and operated by Exxon Mobil from the early 1950's until 1990 when purchased by
GATX. ST Services purchased the terminal in 2000 from GATX. GATX was
subsequently acquired by Kinder Morgan. As a condition to the sale to GATX in
1990, Exxon Mobil undertook certain remediation obligations with respect to the
site. In the lawsuit, Exxon Mobil is claiming that it has complied with its
remediation and contractual obligations and is entitled to reimbursement from
GATX Corporation, the parent company of GATX, Kinder Morgan, and ST Services for
costs in the amount of $400,000 that it claims are related to releases at the
site subsequent to its sale of the terminal to GATX. It is also alleging that
any remaining remediation requirements are the responsibility of GATX
Corporation, Kinder Morgan, or ST Services. Kinder Morgan has alleged that it
was relieved of any remediation obligations pursuant to the sale agreement
between its predecessor, GATX, and ST Services. ST Services believes that,
except for remediation involving immaterial amounts, GATX Corporation or Exxon
Mobil are responsible for the remaining remediation of the site. Costs of
completing the required remediation depend on a number of factors and cannot be
determined at the current time.
Ammonia Pipeline Matters. A subsidiary of KPP purchased the approximately
2,000-mile ammonia pipeline system from Koch Pipeline Company, L.P. and Koch
Fertilizer Storage and Terminal Company in 2002. The rates of the ammonia
pipeline are subject to regulation by the Surface Transportation Board (the
"STB"). The STB had issued an order in May 2000, prescribing maximum allowable
rates KPP's predecessor could charge for transportation to certain destination
points on the pipeline system. In 2003, KPP instituted a 7% general increase to
pipeline rates. On August 1, 2003, CF Industries, Inc. ("CFI") filed a complaint
with the STB challenging these rate increases. On August 11, 2004, STB ordered
KPP to pay reparations to CFI and to return CFI's rates to the levels permitted
under the rate prescription. KPP has complied with the order. The STB, however,
indicated in the order that it would lift the rate prescription in the event KPP
could show "materially changed circumstances." KPP has submitted evidence of
"materially changed circumstances," which specifically includes its capital
investment in the pipeline. CFI has argued that KPP's acquisition costs should
not be considered by the STB as a measure of KPP's investment base. The STB is
expected to decide the issue within the second quarter of 2005.
Also, on June 16, 2003, Dyno Nobel Inc. ("Dyno") filed a complaint with the
STB challenging the 2003 rate increase on the basis that (i) the rate increase
constitutes a violation of a contract rate, (ii) rates are discriminatory and
(iii) the rates exceed permitted levels. Dyno also intervened in the CFI
proceeding described above. Unlike CFI, Dyno's rates are not subject to a rate
prescription. As of December 31, 2004, Dyno would be entitled to approximately
$2 million in rate refunds, should it be successful. KPP believes, however, that
Dyno's claims are without merit.
The Company, primarily KPP, has other contingent liabilities resulting from
litigation, claims and commitments incident to the ordinary course of business.
Management believes, after consulting with counsel, that the ultimate resolution
of such contingencies will not have a materially adverse effect on the financial
position, results of operations or liquidity of the Company.
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 2004.
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 4, 2005, 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
------------------------------ ---------------------- --------------
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 31.47 28.98 .475
Second quarter 31.17 25.11 .495
Third quarter 31.42 27.28 .495
Fourth quarter 42.91 30.99 .495
2005:
First quarter 43.08 42.61 (a)
(through March 4, 2005)
(a) The cash distribution with respect to the first quarter of 2005 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,
--------------------------------------------------------------------------
2004 2003 2002 (a) 2001 2000
------------ ------------ ------------ ------------ -------------
Income Statement Data:
Revenues:
Services........................... $ 379,155 $ 354,591 $ 288,669 $ 207,796 $ 156,232
Products........................... 676,093 511,200 381,159 327,542 381,186
------------ ------------ ------------ ------------ -------------
$ 1,055,248 $ 865,791 $ 669,828 $ 535,338 $ 537,418
============ ============ ============ ============ =============
Operating income...................... $ 136,779 $ 128,504 $ 106,359 $ 79,791 $ 61,174
============ ============ ============ ============ =============
Income before gain on issuance of
units by KPP, income taxes and
cumulative effect of change in
accounting principle............... $ 27,603 $ 27,385 $ 24,931 $ 16,051 $ 15,467
Income tax benefit (expense) (b)...... (3,251) (4,887) (2,585) 2,413 (2,824)
Gain on issuance of units by KPP (c).. - 10,898 24,882 9,859 -
------------ ------------ ------------ ------------ -------------
Income before cumulative effect
of change in accounting principle.. 24,352 33,396 47,228 28,323 12,643
Cumulative effect of change in
accounting principle - adoption of
new accounting standard for asset
retirement obligations............. - (313) - - -
------------ ------------ ------------ ------------ -------------
Net income............................ $ 24,352 $ 33,083 $ 47,228 $ 28,323 $ 12,643
============ ============ ============ ============ =============
Per Share Data:
Earnings per share:
Basic:
Before cumulative effect of
change in accounting principle. $ 2.07 $ 2.89 $ 4.13 $ 2.57 $ 1.19
Cumulative effect of change in
accounting principle........... - (.03) - - -
------------ ------------ ------------ ------------ -------------
$ 2.07 $ 2.86 $ 4.13 $ 2.57 $ 1.19
============ ============ ============ ============ =============
Diluted:
Before cumulative effect of
change in accounting principle. $ 2.03 $ 2.84 $ 4.02 $ 2.46 $ 1.15
Cumulative effect of change in
accounting principle........... - (.03) - - -
------------ ------------ ------------ ------------ -------------
$ 2.03 $ 2.81 $ 4.02 $ 2.46 $ 1.15
============ ============ ============ ============ =============
Cash distributions declared
per share (d)...................... $ 1.96 $ 1.825 $ 1.65 $ 0.725 $ -
============ ============ ============ ============ =============
Weighted average diluted shares
outstanding........................ 11,981 11,792 11,755 11,509 11,029
============ ============ ============ ============ =============
Year Ended December 31,
--------------------------------------------------------------------------
2004 2003 2002 (a) 2001 2000
------------ ------------ ------------ ------------ -------------
Balance Sheet Data (at year end):
Property and equipment, net........... $ 1,148,612 $ 1,113,020 $ 1,092,276 $ 481,396 $ 321,448
Total assets.......................... 1,356,888 1,291,567 1,244,101 571,767 429,852
Long-term debt........................ 688,935 636,308 718,162 277,302 184,052
Shareholders' equity.................. 80,355 77,721 63,654 33,932 71,369
(a) See Note 4 to Consolidated Financial Statements regarding KPP acquisitions.
(b) Effective with the Distribution (See Note 1 to Consolidated Financial
Statements) 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. Additionally, in 2000 the Company recognized
expected benefits from prior years tax losses (change in valuation
allowance) of $4.6 million.
(c) See Note 3 to Consolidated Financial Statements regarding the 2003 and 2002
gains 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.
OVERVIEW
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, 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.
On October 31, 2004, Valero L.P. agreed to acquire by merger (the "KSL
Merger") all of the outstanding common shares of the Company for cash. Under the
terms of that agreement, Valero L.P. is offering to purchase all of the
outstanding shares of the Company at $43.31 per share.
In a separate definitive agreement, on October 31, 2004, Valero L.P. and
KPP agreed to merge (the "KPP Merger"). Under the terms of that agreement, each
holder of units of limited partnership interests in KPP will receive a number of
Valero L.P. common units based on an exchange ratio that fluctuates within a
fixed range to provide $61.50 in value of Valero L.P. units for each unit of
KPP. The actual exchange ratio will be determined at the time of the closing of
the proposed merger and is subject to a fixed value collar of plus or minus five
percent of Valero L.P.'s per unit price of $57.25 as of October 7, 2004. Should
Valero L.P.'s per unit price fall below $54.39 per unit, the exchange ratio will
remain fixed at 1.1307 Valero L.P. units for each unit of KPP. Likewise, should
Valero L.P.'s per unit price exceed $60.11 per unit, the exchange ratio will
remain fixed at 1.0231 Valero L.P. units for each unit of KPP.
The completion of the KSL Merger is subject to the customary regulatory
approvals including those under the Hart-Scott-Rodino Antitrust Improvements
Act. The completion of the KSL Merger is also subject to completion of the KPP
Merger. All required shareholder and unitholder approvals have been obtained.
Upon completion of the mergers, the general partner of the combined partnership
will be owned by affiliates of Valero Energy Corporation and the Company and KPP
will become wholly owned subsidiaries of Valero L.P.
KPP's petroleum pipeline business consists primarily of the transportation,
as a common carrier, of refined petroleum products in Kansas, Nebraska, Iowa,
South Dakota, North Dakota, Colorado, Wyoming, and Minnesota. Common carrier
activities are those under which transportation through the pipelines is
available at published tariffs filed, in the case of interstate shipments, with
the Federal Energy Regulatory Commission (the "FERC"), or in the case of
intrastate shipments with the relevant state authority, to any shipper of
refined petroleum products who requests such services and satisfies the
conditions and specifications for transportation. The petroleum pipelines
primarily transport gasoline, diesel oil, fuel oil and propane. Substantially
all of the petroleum pipeline operations constitute common carrier operations
that are subject to federal or state tariff regulations. KPP also owns an
approximately 2,000-mile anhydrous ammonia pipeline system acquired from Koch
Pipeline Company, L.P. in November of 2002 (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 one of the largest independent petroleum
products and specialty liquids terminaling companies in the United States. In
the United States, ST Services operates 41 facilities in 20 states. ST Services
also owns and operates seven terminals located in the United Kingdom and eight
terminals in Australia and New Zealand. ST Services and its predecessors have a
long history in the terminaling business and handle a wide variety of liquids
from petroleum products to specialty chemicals to edible liquids. Statia,
acquired 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 of
the United States. KPP's product sales business delivers bunker fuels to ships
in the Caribbean and Nova Scotia, Canada, and sells bulk petroleum products to
various commercial customers at those locations. In the bunkering business, KPP
competes with ports offering bunker fuels along the route of the vessel. Vessel
owners or charterers are charged berthing and other fees for associated services
such as pilotage, tug assistance, line handling, launch service and emergency
response services.
CONSOLIDATED RESULTS OF OPERATIONS
Year Ended December 31,
----------------------------------------
2004 2003 2002
----------- ----------- -----------
(in thousands, except per share amounts)
Consolidated revenues.................................................. $ 1,055,248 $ 865,791 $ 669,828
=========== =========== ===========
Consolidated operating income.......................................... $ 136,779 $ 128,504 $ 106,359
=========== =========== ===========
Consolidated income before gain on issuance of units by KPP, income
taxes and cumulative effect of change in accounting
principle........................................................... $ 27,603 $ 27,385 $ 24,931
=========== =========== ===========
Consolidated net income................................................ $ 24,352 $ 33,083 $ 47,228
=========== =========== ===========
Earnings per share:
Basic:
Before cumulative effect of change in accounting principle........ $ 2.07 $ 2.89 $ 4.13
Cumulative effect of change in accounting principle............... - (.03) -
----------- ----------- -----------
$ 2.07 $ 2.86 $ 4.13
=========== =========== ===========
Diluted:
Before cumulative effect of change in accounting principle........ $ 2.03 $ 2.84 $ 4.02
Cumulative effect of change in accounting principle............... - (.03) -
----------- ----------- -----------
$ 2.03 $ 2.81 $ 4.02
=========== =========== ===========
Cash distributions declared per share............................... $ 1.96 $ 1.825 $ 1.65
=========== =========== ===========
Consolidated capital expenditures................................... $ 42,214 $ 44,747 $ 31,101
=========== =========== ===========
For the year ended December 31, 2004, consolidated revenues increased by
$189.5 million, or 22%, when compared to the year ended December 31, 2003, due
to a $164.9 million increase in revenues in the product marketing business (see
"Product Marketing Services" below), a $24.4 million increase in revenues in the
teminaling business (see "Terminaling Operations" below) and a $0.2 million
increase in revenues from the pipeline business (see "Pipeline Operations"
below). Consolidated operating income for the year ended December 31, 2004
increased by $8.3 million, or 6%, when compared to 2003, due to an $8.1 million
increase in terminaling operating income and a $5.0 million increase in product
marketing operating income, partially offset by a $3.0 million decrease in
pipeline operating income and a $1.9 million increase in corporate general and
administrative expenses. Operating income for 2004 is after $3.9 million of
costs associated with the Valero L.P. merger agreement and compliance with the
Sarbanes-Oxley Act of 2002. Consolidated 2004 income before gain on issuance of
units by KPP, income taxes, and cumulative effect of change in accounting
principle, increased by $0.2 million, when compared to 2003. Overall,
consolidated net income decreased by $8.7 million, or 26%, when compared to
2003, which includes a $10.9 million gain on issuance of units by KPP (see
"Liquidity and Capital Resources").
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.
PIPELINE OPERATIONS
Year Ended December 31,
---------------------------------------------------
2004 2003 2002
----------- ----------- -----------
(in thousands)
Revenues............................................. $ 119,803 $ 119,633 $ 82,698
Operating costs...................................... 48,306 46,379 33,744
Depreciation and amortization........................ 14,538 14,117 6,408
General and administrative........................... 8,106 7,277 3,923
----------- ----------- -----------
Operating income..................................... $ 48,853 $ 51,860 $ 38,623
=========== =========== ===========
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, 2004, revenues increased by
$0.2 million, when compared to 2003, due to increases in barrel miles of
products shipped on petroleum pipelines, substantially offset by lower prices
received for products shipped on the anhydrous ammonia pipeline. For the year
ended December 31, 2003, revenues increased by $36.9 million, or 45%, when
compared to 2002, due entirely to the November and December 2002 pipeline
acquisitions (see "Liquidity and Capital Resources"). Barrel miles on petroleum
pipelines totaled 22.2 billion, 21.3 billion (including 4.7 billion for the
petroleum pipeline acquired in December 2002) and 18.3 billion for the years
ended December 31, 2004, 2003 and 2002, respectively. Total volumes shipped on
the anhydrous ammonia pipeline aggregated 1,123 thousand tons in 2004 and 1,157
thousand tons in 2003.
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 $1.9 million in 2004 and $12.6
million in 2003. The increase in 2004, when compared to 2003, was due to
unusually high expenses relating to preventive and other maintenance and
repairs, including those required by government regulation, and increases in
power and fuel costs. The increase in 2003, when compared to 2002, was due to
the pipeline acquisitions and increases in expenditures for routine repairs and
maintenance. For the year ended December 31, 2004, depreciation and amortization
increased by $0.4 million, when compared to 2003, due primarily to routine
maintenance capital expenditures. For the year ended December 31, 2003,
depreciation and amortization increased by $7.7 million, when compared to 2002,
due to the pipeline acquisitions and routine maintenance capital expenditures.
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 $0.8 million in 2004, when
compared to 2003, due primarily to costs associated with the Valero, L.P. merger
agreement, compliance with the Sarbanes-Oxley Act of 2002 and increases in
personnel-related costs. General and administrative costs for the year ended
December 31, 2003 increased by $3.4 million, when compared to 2002, due to the
pipeline acquisitions and increases in personnel-related costs.
TERMINALING OPERATIONS
Year Ended December 31,
---------------------------------------------------
2004 2003 2002
----------- ----------- -----------
(in thousands)
Revenues............................................. $ 259,352 $ 234,958 $ 205,971
Operating costs...................................... 122,791 114,030 94,480
Depreciation and amortization........................ 41,232 38,089 32,368
Gain on sale of assets............................... - - (609)
General and administrative........................... 20,666 16,307 14,692
----------- ----------- -----------
Operating income..................................... $ 74,663 $ 66,532 $ 65,040
=========== =========== ===========
For the year ended December 31, 2004, KPP's terminaling revenues increased
by $24.4 million, or 10%, when compared to 2003, due to increases in both
tankage utilization and the average price realized per barrel of tankage
utilized. 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.
Approximately $25 million of the 2003 revenue increase was a result of the
terminal acquisitions. Average annual tankage utilized for the years ended
December 31, 2004, 2003 and 2002 aggregated 48.9 million barrels, 46.7 million
barrels and 46.5 million barrels, respectively. Average revenues per barrel of
tankage utilized for the years ended December 31, 2004, 2003 and 2002 was $5.30,
$5.02 and $4.43, respectively. The increase in 2004 average revenues per barrel
of tankage utilized was primarily the result of favorable market conditions
domestically and in Australia and New Zealand and favorable foreign currency
exchange differences. 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 favorable foreign currency exchange differences.
For year ended December 31, 2004, operating costs increased by $8.8
million, when compared to 2003, due to an overall increase in planned terminal
maintenance. 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. For the year ended
December 31, 2004, depreciation and amortization increased by $3.1 million, when
compared to 2003, due to expansion and routine maintenance capital expenditures.
For the year ended December 31, 2003, depreciation and amortization increased by
$5.7 million, when compared to 2002, due to the 2002 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 expenses increased by $4.4 million in 2004,
when compared to 2003, due to increases in personnel-related costs and costs
associated with the Valero L.P. merger agreement and compliance with the
Sarbanes-Oxley Act of 2002. General and administrative expenses increased by
$1.6 million in 2003, when compared to 2002, due to the terminal acquisitions
and increases in personnel-related costs.
PRODUCT MARKETING SERVICES
Year Ended December 31,
----------------------------------------
2004 2003 2002
----------- ----------- -----------
(in thousands)
Revenues............................................................... $ 676,093 $ 511,200 $ 381,159
Cost of products sold.................................................. 647,733 486,310 367,870
----------- ----------- -----------
Gross margin........................................................... $ 28,360 $ 24,890 $ 13,289
=========== =========== ===========
Operating income....................................................... $ 17,262 $ 12,233 $ 4,692
=========== =========== ===========
For the year ended December 31, 2004, revenues increased by $164.9 million,
or 32%, when compared to 2003, due to an increase in both volumes sold and the
overall increase in sales price realized. Total volumes sold and average sales
price per gallon received for the year ended December 31, 2004 aggregated 697
million gallons and $0.97, respectively, compared to 612 million gallons and
$0.84, respectively, for the year ended December 31, 2003. For the year ended
December 31, 2004, gross margin and operating income increased by $3.5 million
and $5.0 million, respectively, when compared to 2003, due to the increase in
volumes sold.
For the year ended December 31, 2003, revenues increased by $130.0 million,
or 34%, when 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, respectively,
for the year ended December 31, 2002. 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.
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.
INTEREST EXPENSE
For the year ended December 31, 2004, interest expense increased by $4.0
million, when compared to 2003, due to KPP's May 2003 refinancing of variable
rate debt with $250 million of 5.875% senior unsecured notes (see "Liquidity and
Capital Resources") and overall increases in interest rates on remaining
variable rate debt.
For the year ended December 31, 2003, interest expense increased by $10.6
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.
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 $3.3 million, $5.2 million and $4.1 million for the years
ended December 31, 2004, 2003 and 2002, respectively.
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 required a
subsidiary of KPP, 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
provided that any amounts paid in order to meet the minimum annual payment were
available to offset future tax liabilities under the agreement to the extent
that the minimum annual payment is greater than 2% of taxable income. The
subsidiary is currently engaged in discussions with representatives appointed by
the Island Territory of St. Eustatius regarding the renewal or modification of
the agreement, but the ultimate outcome cannot be predicted at this time. The
subsidiary has accrued amounts assuming a new agreement becomes effective, and
continues to make payments, as required, under the previous agreement.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities, including the operations of KPP, was
$126.7 million, $144.9 million and $89.0 million for the years ended December
31, 2004, 2003 and 2002, respectively. The decrease in 2004 operating cash
flows, when compared to 2003, was due primarily to changes in working capital
resulting from the timing of cash receipts and disbursements and costs
associated with the Valero L.P. merger agreement and compliance with the
Sarbanes-Oxley Act of 2002, partially offset by overall increases in operating
income. The increase in 2003, when compared to 2002, was due to increase in
pipeline, terminaling and product marketing revenues and operating income,
primarily as a result of the 2002 acquisitions, and changes in working capital
components resulting from the timing of receipts and disbursements.
Capital expenditures, including routine maintenance and expansion
expenditures, but excluding acquisitions, were $42.2 million, $44.7 million and
$31.1 million for the years ended December 31, 2004, 2003 and 2002,
respectively, and almost exclusively relate to KPP. Such expenditures included
$30.8 million and $20.3 million in maintenance and environmental expenditures
and $11.4 million and $24.4 million in expansion expenditures for the years
ended December 31, 2004 and 2003, respectively. The decrease in 2004 capital
expenditures, when compared to 2003, is primarily the result of decreases in
planned expansion capital expenditures related to the terminaling business. The
increase in 2003 capital expenditures, when compared to 2002, is the result of
planned maintenance and expansion capital expenditures related to the KPP
pipeline and terminaling operations acquired in 2002 and planned 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 $40 million to $44 million in 2005. 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 $1.96, $1.825 and $1.65 per share were
declared and paid to shareholders with respect to the years ended December 31,
2004, 2003 and 2002, respectively.
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,
2004, $14.0 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, 2004, 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 marketing business and by 250,000 KPP
limited partnership units held by the product marketing subsidiary. At December
31, 2004, $3.0 million was drawn on the facility.
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, 2004, 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 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, 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 December 31, 2004, $95.7 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 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, 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, 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 at
December 31, 2004:
Less than After
Total 1 year 1 -3 years 4 -5 years 5 years
---------- ---------- ---------- ----------- ----------
(in thousands)
Debt:
Revolving credit facility......... $ 14,000 $ - $ 14,000 $ - $ -
Revolving credit facility of
subsidiary...................... 3,033 - - 3,033 -
KPP revolving credit facility..... 95,669 - 95,669 - -
KPP 7.75% senior unsecured
notes........................... 250,000 - - - 250,000
KPP 5.875% senior unsecured
notes........................... 250,000 - - - 250,000
Other KPP bank debt............... 76,283 - 76,283 - -
----------- ----------- --------- ---------- ----------
Debt subtotal.................. 688,985 - 185,952 3,033 500,000
----------- ----------- --------- ---------- ----------
Contractual commitments -
Operating leases.................. 52,189 9,822 14,831 9,396 18,140
----------- ----------- --------- ---------- ----------
Total.......................... $ 741,174 $ 9,822 $ 200,783 $ 12,429 $ 518,140
=========== =========== ========= ========== ==========
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, 2004, or for any of the years ended December 31, 2004, 2003 or
2002.
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.
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 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, 2004, 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, 2004, 2003 or 2002. 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 of 2004, the Financial Accounting Standards Board (FASB) issued
SFAS No. 123 (revised 2004), "Share-Based Payment" (SFAS No. 123R), which
addresses the accounting for share-based payment transactions in which an
enterprise receives employee services in exchange for equity instruments of the
enterprise, or liabilities that are based on the fair value of the enterprise's
equity instruments or that may be settled by the issuance of such equity
instruments. SFAS No. 123R eliminates the ability to account for share-based
compensation transactions using the intrinsic value method under Accounting
Principles Board (APB) Opinion 25, "Accounting for Stock Issued to Employees",
and generally requires that such transactions be accounted for using a
fair-value-based method. The Company is currently evaluating the provisions of
SFAS No. 123R to determine which fair-value-based model and transitional
provision to follow upon adoption. The alternatives for transition include
either the modified prospective or the modified retrospective methods. The
modified prospective method requires that compensation expense be recorded for
all unvested stock options and restricted stock as the requisite service is
rendered beginning with the first quarter of adoption. The modified
retrospective method requires recording compensation expense for stock options
and restricted stock beginning with the first period restated. Under the
modified retrospective method, prior periods may be restated either as of the
beginning of the year of adoption or for all periods presented. SFAS No. 123R
will be effective for the Company beginning in the third quarter of 2005. The
impact of adoption on the Company's consolidated financial statements is still
being evaluated.
Item 7(a). Quantitative and Qualitative Disclosures About Market Risk
The principal market risks pursuant to this Item (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 $148.2 million (including KPP's debt) at December 31,
2004, a one percent increase in interest rates would increase annual net
interest expense by approximately $1.5 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.
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, 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.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Kaneb Services LLC (the "Company"), is responsible for establishing and
maintaining adequate internal control over financial reporting as defined in
Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934.
Management assessed the effectiveness of the Company's internal control over
financial reporting as of December 31, 2004. In making this assessment,
management used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in Internal Control-Integrated
Framework. Based on management's assessment and those criteria, management
believes that the Company maintained effective internal control over financial
reporting as of December 31, 2004. The Company's independent auditors have
issued an attestation report on management's assessment of the Company's
internal control over financial reporting. That report appears below.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors of Kaneb Services LLC
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control Over Financial Reporting, that Kaneb
Services LLC and subsidiaries (the "Company") maintained effective internal
control over financial reporting as of December 31, 2004, based on criteria
established in Internal Control--Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). The Company's
management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on
management's assessment and an opinion on the effectiveness of the Company's
internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that the Company maintained effective
internal control over financial reporting as of December 31, 2004, is fairly
stated, in all material respects, based on criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Also, in our opinion, the
Company maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2004, based on criteria established in
Internal Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
Kaneb Services LLC and subsidiaries as of December 31, 2004 and 2003, and the
related consolidated statements of income, cash flows and shareholders' equity
for each of the years in the three-year period ended December 31, 2004, and our
report dated March 11, 2005 expressed an unqualified opinion on those
consolidated financial statements.
KPMG LLP
Dallas, Texas
March 11, 2005
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
During the fourth 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.
PART III
Item 10. Directors and Executive Officers of the Registrant
The Company's Amended and Restated Limited Liability Company Agreement (the
"Company Agreement") provides for classifications of its Board of Directors into
three classes, with each class holding office for a three-year term.
Years of Service
Name Age Position with KSL With KSL
--------------------------- ------- ------------------------------------ ---------------------------
John R. Barnes 60 President, Chairman of the Board 3 (a)
and Chief Executive Officer
Howard C. Wadsworth 60 Vice President, Treasurer 3 (b)
and Secretary
Sangwoo Ahn 66 Director 3 (c)
Murray R. Biles 74 Director 3 (d)
Frank M. Burke 65 Director 3 (e)
Charles R. Cox 62 Director 3 (f)
Hans Kessler 55 Director 3 (g)
James R. Whatley 78 Director 3 (h)
(a) Mr. Barnes, Chairman of the Board, President and Chief Executive Officer of
Kaneb Services LLC (the "Company") is also a director of Kaneb Pipe Line
Company LLC ("KPL"). Mr. Barnes also serves as a director of Xanser
Corporation.
(b) Mr. Wadsworth serves as Vice President, Treasurer and Secretary of Kaneb
Services LLC. Mr. Wadsworth joined the Kaneb companies in October 1990.
(c) Mr. Ahn, a director of the Company since the Distribution is also a
director of KPL. Mr. Ahn has served as Chairman of the Board of Quaker
Fabric Corporation since 1993 and currently serves as a director of Xanser
Corporation and PAR Technology Corporation.
(d) Mr. Biles, a director of the Company since the Distribution is also a
director of KPL. Mr. Biles joined KPL in November 1953 and served as
President from January 1985 until his retirement at the close of 1993.
(e) Mr. Burke, a director of the Company since the Distribution is also a
director of KPL. Mr. Burke has been Chairman and Managing General Partner
of Burke, Mayborn Company, Ltd., a private investment company, for more
than the past five years. Mr. Burke also currently serves as a director of
Xanser Corporation, Arch Coal, Inc., Crosstex Energy, Inc., and Crosstex
Energy GP, LLC.
(f) Mr. Cox, a director of the Company since the Distribution is also a
director of KPL. Mr. Cox has been Chairman of the Board and Chief Executive
Officer of WRS Infrastructure and Environment, Inc., a technical services
company, since March 2001. He served as a private business consultant
following his retirement in January 1998, from Fluor Daniel, Inc., where he
served in senior executive level positions during a 29 year career with
that organization. Mr. Cox also currently serves as a director of Xanser
Corporation.
(g) Mr. Kessler, a director of the Company since the Distribution is also a
director of KPL. Mr. Kessler has served as Chairman and Managing Director
of KMB Kessler + Partner GmbH since 1992. He was previously a Managing
Director and Vice President of a European Division of Tyco International
Ltd. Mr. Kessler also currently serves as a director of Xanser Corporation.
(h) Mr. Whatley, a director of the Company since the Distribution is also a
director of KPL. Mr. Whatley served as Chairman of the Board of Directors
of Xanser Corporation (formerly Kaneb Services, Inc.) from February 1981
until April 1989, and continues to serve as a member of the Board.
During 2004, the Board of Directors of the Company held nine meetings and,
with the exception of one meeting which Mr. Whatley was unable to attend, each
director attended 100% of these meetings.
CODE OF ETHICS
The Company has adopted a Code of Ethics applicable to all employees,
including the principal executive officer, principal financial officer and
directors of the General Partner. The Company has also adopted Corporate
Governance Guidelines, which address director qualification standards; director
access to management, and as necessary and appropriate, independent advisors;
director compensation; director orientation and continuing education; management
succession and annual performance evaluation of the board. Copies of the Code of
Ethics and the Corporate Governance Guidelines are available on Kaneb's website
at www.kaneb.com and will be provided without charge by written request to
Investor Relations, 2435 North Central Expressway, Richardson, Texas 75080.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE STATEMENT
Section 16(a) of the Securities Exchange Act of 1934, as amended ("Section
16(a)") requires the Company's executive officers and directors, among others,
to file reports of ownership and changes of ownership in the Partnership's
equity securities with the Securities and Exchange Commission and the New York
Stock Exchange. Such persons are also required by related regulations to furnish
the Company with copies of all Section 16(a) forms that they file.
Based solely on its review of the copies of such forms received by it, the
Company believes that, during the year ended December 31, 2004, its officers and
directors have complied with all applicable filing requirements under Section
16(a).
AUDIT COMMITTEE
The Company's Board has an Audit Committee, which is currently comprised of
Sangwoo Ahn (Chairman), Frank M. Burke and James R. Whatley. Each of the members
of the Audit Committee is independent as defined under the listing standards of
the New York Stock Exchange and the Securities Exchange Act of 1934, and the
Board of Directors of KPL has determined that Frank M. Burke is an "audit
committee financial expert" as defined in the rules of the Securities and
Exchange Commission. Messrs. Ahn and Burke each serve on the audit committee of
more than two public companies other than KPL and KSL. The Audit Committee and
the KPL Board have determined that Mr. Ahn's and Mr. Burke's simultaneous
services on other audit committees will not impair their ability to effectively
serve on the Audit Committee. The Audit Committee held four meetings during 2004
and, with the exception of one meeting which Mr. Whatley was unable to attend,
each committee member attended 100% of these meetings.
The functions of the Audit Committee include the selection of the
independent auditors, the planning of, and fee estimate approval for, the annual
audit of the consolidated financial statements, the review of the results of the
examination by the independent auditors of the consolidated financial
statements, and the approval of any non-audit services performed by the
independent auditors and consideration of the effect of such non-audit services
on the auditors' independence. The Audit Committee has the authority to engage
independent counsel and other advisers as it determines necessary to carry out
its duties. The Audit Committee operates under a written charter adopted by the
Board of Directors of the Company, which is available on Kaneb's website at
www.kaneb.com or in print to any shareholder who sends a written request to
Investor Relations, 2435 North Central Expressway, Richardson, Texas 75080.
The Audit Committee has established procedures for the receipt, retention,
and treatment of complaints received regarding accounting, internal accounting
controls, or auditing matters and the confidential, anonymous submission by
employees of concerns regarding questionable accounting or auditing matters.
Persons wishing to communicate with the Audit Committee may do so by writing in
care of Chairman of the Audit Committee, Kaneb Services LLC, 2435 North Central
Expressway, Suite 700, Richardson, Texas 75080.
COMPENSATION COMMITTEE
The Company has a Compensation Committee comprised of Charles R. Cox, Hans
Kessler and James R. Whatley (Chairman), each of whom is "independent" as
defined under the listing standards of the New York Stock Exchange. The function
of the Compensation Committee is to establish and review the compensation
programs for the Named Executive Officers of Kaneb and its subsidiaries and to
formulate, recommend and implement incentive, share option or other bonus plans
or programs for the officers of Kaneb and its subsidiaries. The Compensation
Committee held four meetings during 2004, which were attended by all committee
members, except for Mr. Whatley, who attended three meetings.
The Compensation Committee operates under a written charter adopted by the
Board of Directors of the Company, which is available on Kaneb's website at
www.kaneb.com.
NYSE CORPORATE GOVERNANCE LISTING STANDARDS
Annual CEO Certification
As the Chief Executive Officer of Kaneb Services LLC and as required by
Section 303A.12(a) of the New York Stock Exchange Listed Company Manual, I
hereby certify that as of the date hereof I am not aware of any violation by the
Company of NYSE's Corporate Governance listing standards, other than has been
notified to the Exchange pursuant to Section 303A.12(b) and disclosed as Exhibit
H to the Company's Section 303A Annual Written Affirmation.
By: //s// JOHN R. BARNES
Print Name: John R. Barnes
Title: Chairman of the Board and
Chief Executive Officer
Date: March 15, 2005
Executive Sessions Of Non-Management Directors
Messrs. Ahn, Biles, Burke, Cox, Kessler and Whatley, who are the
non-management directors of the Company, meet at regularly scheduled executive
sessions without management. Sangwoo Ahn serves as the presiding director at
those executive sessions. Persons wishing to communicate with the non-management
directors may do so by writing Mr. Ahn, Kaneb Services LLC, 2435 North Central
Expressway, Suite 700, Richardson, Texas 75080.
Messrs. Ahn, Biles, Burke, Cox, Kessler and Whatley, who are the
independent non-management directors of the Company, meet at least annually in
executive session without management and the other directors. Sangwoo Ahn serves
as the presiding director at those executive sessions. Persons wishing to
communicate with the Company's independent non-management directors may do so by
by writing Mr. Ahn, Kaneb Services LLC, 2435 North Central Expressway, Suite
700, Richardson, Texas 75080.
Item 11. Executive Compensation
The following table sets forth information concerning the annual and
long-term compensation paid for services to the Company in all capacities for
the fiscal years ended December 31, 2004, 2003 and 2002 to the Chief Executive
Officer and the other executive officer of Kaneb Services LLC (the "Named
Executive Officers").
SUMMARY COMPENSATION TABLE
Annual Compensation (2) Long Term Compensation
----------------------- -----------------------------------------
DSUs Options
Related to Related to Other
Name and Deferred Deferred Share All Other
Principal Position Year Salary Bonus Compensation(3)Compensation Options Compensation (4)
- -------------------- ---- ---------- --------- --------------------------- ----------- ----------------
John R. Barnes (1) 2004 $ 130,000 $ -0- 505 -0- 300,000 $ 2,823
Chairman of the Board 2003 122,917 -0- 547 -0- -0- 2,629
President and Chief 2002 118,760 -0- 9,835 13,970 -0- 2,504
Executive Officer of
the Company
Howard C. Wadsworth(1) 2004 75,750 25,000 98 -0- -0- 2,975
Vice President, 2003 72,375 -0- 109 -0- -0- 2,444
Treasurer and 2002 70,282 -0- 731 855 -0- 2,504
Secretary
(1) Messrs. Barnes and Wadsworth also receive compensation for services
provided to and paid for by Kaneb Pipe Line Partners, L.P., none of which
is included in the foregoing table.
(2) Amounts for 2004, 2003 and 2002, respectively, exclude compensation
voluntarily deferred for the purchase of Deferred Share Units ("DSUs")
pursuant to the Kaneb Deferred Stock Unit Plan by Mr. Barnes ($61,250,
$61,250 and $48,490) and Mr. Wadsworth ($3,750, $3,750 and $2,969) and for
the purchase of DSUs pursuant to the Kaneb Supplement Deferred Compensation
Plan by Mr. Barnes ($8,750, $7,500 and $7,750) and Mr. Wadsworth ($1,695,
$1,500 and $1,750).
(3) Reflects DSUs from salary deferrals and those acquired in connection with
the Supplemental Deferred Compensation Plan.
(4) Includes the amount of the Company's contribution to the Savings Investment
Plan (the "401(k) Plan") and the imputed value of Company-paid group term
life insurance coverage exceeding $50,000.
OPTIONS/SAR'S GRANTED DURING LAST FISCAL YEAR
The following table includes the details of options granted to the Chief
Executive Officer during 2004. All options were priced at 100% of the closing
price of the Company's Common Shares on the date of grant. For illustrative
purposes only, the Black-Scholes option pricing model has been used to estimate
the value of options issued by the Company. The assumptions used in the
calculations under such model include share price variance or volatility based
on weekly average variances of the shares and similar shares for the ten-year
period preceding issuance, a risk-free rate of return based on the 30-year U.S.
Treasury bill rate for the ten-year expected life of the options, and exercise
of the options at the end of their expected life. The actual option value
realized, if such option is exercised, will be based upon the excess of the
market price of the Company's Common Shares over the exercise price of the
option on the date of exercise. There is no relationship between the actual
option value upon exercise and the illustration below.
% of Total Computed Value
Number of Granted Using Black
Options/SAR's To Employees Exercise Price Expiration Scholes Option
Name Granted During Year ($/Share) Date Pricing Model
- ------------------ ---------------- ------------------- --------------- ----------- -----------------
John R. Barnes 300,000 100% $28.75 08/03/2014 $780,000
AGGREGATED OPTION/SAR EXERCISES IN MOST RECENT FISCAL YEAR
AND FISCAL YEAR END OPTION VALUES
Number of Unexercised Value of Unexercised
Options Held at In-the-Money Options
Shares Fiscal Year End at Fiscal Year End
Acquired On Value ---------------------------- ----------------------------
Name Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
- --------------------- ------------- -------- ----------- ------------- ----------- -------------
John R. Barnes -0- $ -0- -0- 300,000 $ -0- $ 4,332,000
Howard C. Wadsworth 1,670 34,097 1,670 3,380 52,033 92,149
EQUITY COMPENSATION PLAN INFORMATION
The following table sets forth information about the Company's equity
compensation plans as of December 31, 2004. Securities to be issued as shown in
the table are the result of options granted and Deferred Share Units purchased
including "Keep Whole Options" granted pursuant to the Distribution.
Number of Securities to Number of Securities
be Issued Upon Exercise Weighted-Average Exercise Remaining Available for
of Outstanding Options, Price of Outstanding Options, Future Issuance Under
Plan Category Warrants and Rights Warrants and Rights Equity Compensation Plans
- ---------------------- -------------------------- ------------------------------ ----------------------------
Equity Compensation
Plans Approved by
Security Holders (1) 506,307 $21.66 287,826
Equity Compensation
Plans Not Approved
By Security Holders - - -
-------------- --------- -------------
Total 506,307 $21.66 287,826
============== ========= =============
(1) All shares utilized for equity compensation are issued under the Kaneb
Services LLC 2001 Incentive Plan, including those Keep-Whole Options
related to Kaneb Services, Inc. options granted up to ten years prior to
the Distribution.
KEEP-WHOLE OPTIONS GRANTED PURSUANT TO THE DISTRIBUTION
In order to preserve the value of options which were outstanding prior to
the Distribution, the Company issued options to purchase shares of its Common
Shares to all holders of Kaneb Services, Inc. common stock options. No value was
created by the grants and the same intrinsic value of options held was
maintained 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.
DESCRIPTION OF OTHER PROGRAMS
Deferred Share Unit Plans
In 1996, Kaneb Services, Inc., now Xanser, implemented a share-based
deferred compensation plan ("Deferred Stock Unit Plan" or "DSU Plan") whereby
officers, directors and key executives were permitted to defer compensation on a
pretax basis in return for common stock of Kaneb Services, Inc. at a
predetermined date after the end of the compensation deferral period. In
connection with the Distribution, the Company agreed to issue Deferred Share
Units ("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 distribution 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 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. common shares subject to
the Kaneb Services, Inc. DSUs held by those employees. In March 2002, the
Company implemented its own Deferred Share Unit Plan with substantially similar
terms as the prior Kaneb Services, Inc. plan for its officers and key employees.
At December 31, 2004, approximately 183,704 Common Shares of the Company are
issuable under the prior Kaneb Services, Inc. plan and the Company's current
plan.
Effective March 10, 2005, the Company terminated its DSU Plan and all
participants were fully vested. All accounts will be distributed to participants
during 2005.
DIRECTOR'S FEES
During 2004, each member of the Company's Board of Directors who was not
also an employee of the Company was paid an annual retainer of $25,000. Members
of the Company Board's Audit Committee, comprised of Sangwoo Ahn (Chairman),
Frank M. Burke and James R. Whatley, received attendance fees of $1,000 per
meeting for the Audit Committee meetings held during 2004. Messrs. Ahn and
Burke, who attended four meetings of the Audit Committee, received $4,000 each
and Mr. Whatley, who attended three meetings, received $3,000. In addition, each
member of the Compensation Committee, comprised of Charles R. Cox, Hans Kessler
and James R. Whatley received attendance fees of $500 per meeting attended.
Messrs. Cox and Kessler each received $2,000 for 2004 for the four meetings
attended during 2004 and Mr. Whatley received $1,500 for the three meetings he
attended.
In August 2004, the Company issued an aggregate of 60,000 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 with the issuance of the restricted shares, the Company
recognized a total expense of $0.4 million in 2004.
Item 12. Security Ownership of Certain Beneficial Owners and Management
BENEFICIAL OWNERSHIP OF COMMON SHARES
BY DIRECTORS AND EXECUTIVE OFFICERS
Number of Common Percent
Shares Beneficially of Out-
Owned at standing
Name Position Held with Company March 4, 2005 (1) Shares
- ------------------------------- --------------------------------------- ------------------- ---------
John R. Barnes Chairman of the Board, President and 390,482 (2) 3.34%
Chief Executive Officer
Sangwoo Ahn Director 97,306 (3) *%
Murray R. Biles Director 15,100 *%
Frank M. Burke Director 63,125 *%
Charles R. Cox Director 78,872 (4) *%
Hans Kessler Director 27,144 *%
James R. Whatley Director 69,353 (5) *%
Howard C. Wadsworth Vice President, Treasurer and Secretary 47,562 (6) *%
All Directors and Executive Officers as a group (8 persons) 788,944 6.75%
* Less than one percent.
(1) Shares listed include those beneficially owned by the person determined in
accordance with Rule 13d-3 under the Exchange Act.
(2) Includes 142,114 shares that Mr. Barnes has the right to acquire, pursuant
to options or otherwise, within 60 days of March 4, 2005, and 248,368
shares for which Mr. Barnes has voting power.
(3) Includes 23,029 shares that Mr. Ahn has the right to acquire, pursuant to
options or otherwise, within 60 days of March 4, 2005.
(4) Includes 31,227 shares that Mr. Cox has the right to acquire, pursuant to
options or otherwise, within 60 days of March 4, 2005.
(5) Includes 16,700 shares that Mr. Whatley has the right to acquire, pursuant
to options or otherwise, within 60 days of March 4, 2005.
(6) Includes 3,380 shares that Mr. Wadsworth has the right to acquire, pursuant
to options or otherwise, within 60 days of March 4, 2005.
Item 13. Certain Relationships and Related Transactions
The Company is entitled to certain reimbursements under the Distribution
Agreement. For additional information regarding the nature and amount of such
reimbursements, see Note 9 to the Partnership's consolidated financial
statements.
Item 14. Principal Accounting Fees and Services
The following table sets forth the aggregate fees billed for professional
services rendered by KPMG LLP, the Company's principal accountant, for the audit
of the Company's financial statements for the years ended December 31, 2004 and
2003, and for fees billed for other services rendered by KPMG LLP during those
periods.
Year Ended December 31,
-------------------------------
2004 2003
------------- -------------
Audit (1)(3) $ 1,232,000 $ 512,000
Audit-related Fees (3) 83,000 -
Tax Fees (2) 30,000 83,000
All Other Fees - -
------------- -------------
$ 1,345,000 $ 595,000
============= =============
(1) Fees for the audit of the Company's annual financial statements,
review of financial statements included in the Company's
Quarterly Reports on Form 10-Q, and services that are normally
provided by KPMG LLP in connection with statutory and regulatory
filings or engagements for the fiscal year shown. Less than 50
percent of the hours expended on KPMG LLP's engagement to audit
the Company's financial statements in 2004 and 2003 were
attributed to work performed by persons other than KPMG LLP's
full-time, permanent employees.
(2) Fees for professional services rendered by KPMG LLP for income
tax return review, income tax consultation and other income tax
compliance work. 2003 amount includes services performed in
connection with acquisitions made in foreign countries.
(3) Audit Fees and Audit-related Fees for 2004 include $625,000 and
$22,800, respectively, for compliance with the Sarbanes-Oxley Act
of 2002.
The Company's Audit Committee must pre-approve all auditing services and
permitted non-audit services (including the fees and terms thereof) to be
performed for the Company by its independent auditor. The Company's Audit
Committee may form and delegate authority to subcommittees consisting of one or
more members when appropriate, including the authority to grant pre-approvals of
audit and permitted non-audit services, provided that decisions of such
subcommittee to grant pre-approvals shall be presented to the full Audit
Committee at its next scheduled meeting. Since May 6, 2003, the effective date
of the SEC rules requiring pre-approval of audit and non-audit services, 100% of
the services identified in the preceding table were approved by the Audit
Committee.
The Audit Committee of the Board of Directors of the Company considered
whether the provision of services other than audit services for 2004 were
compatible with maintaining the principal accountants' independence. The Audit
Committee of the Board of Directors has not yet met to select the principal
accountants to audit the accounts of the Company for the calendar year ending
December 31, 2005.
PART IV
Item 15. Exhibits and Financial Statement Schedules
(a) (1)Financial Statements Beginning Page
Set forth below is a list of financial statements appearing in this
report.
Kaneb Services LLC Financial Statements:
Report of Independent Registered Public Accounting Firm................................... F - 1
Consolidated Statements of Income - Three Years Ended December 31, 2004................... F - 2
Consolidated Balance Sheets - December 31, 2004 and 2003.................................. F - 3
Consolidated Statements of Cash Flows - Three Years Ended December 31, 2004............... F - 4
Consolidated Statements of Shareholders' Equity - Three Years
Ended December 31, 2004................................................................ 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, 2004, 2003 and 2002......................... F - 24
Balance Sheets - December 31, 2004 and 2003............................................... F - 25
Statements of Cash Flows - Years ended December 31, 2004, 2003 and 2002................... F - 26
Schedule II - Kaneb Services LLC Valuation and Qualifying Accounts - Years Ended
December 31, 2004, 2003 and 2002.......................................................... 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.
(a)(3)List of Exhibits
2.1 Agreement and Plan of Merger dated as of October 31, 2004, filed as
Exhibit 2.1 to Registrant's Form 8-K, filed October 31, 2004, which
exhibit is hereby incorporated by reference.
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.
4.1 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.
4.2* 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.
10.1 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.
10.2 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.
10.3 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.
10.4*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.
10.5 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.
10.6 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.
10.7 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.
10.8*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.
10.9 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.
22 Form S-4, as amended and filed January 25, 2005, by Valero L.P., and
incorporated herein by reference.
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 16, 2005.
31.2 Certification of Chief Financial Officer, Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002, dated as of March 16, 2005.
32.1 Certification of Chief Executive Officer, Pursuant to Section 906(a)
of the Sarbanes-Oxley Act of 2002, dated as of March 16, 2005.
32.2 Certification of Chief Financial Officer, Pursuant to Section 906(a)
of the Sarbanes-Oxley Act of 2002, dated as of March 16, 2005.
* Denotes management contracts.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
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 standards of the Public Company
Accounting Standards Board (United States). 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, 2004 and 2003, and the results of its operations and its cash flows
for each of the years in the three-year period ended December 31, 2004, in
conformity with U.S. generally accepted accounting principles. Also, in our
opinion, the related financial statement schedules, when considered in relation
to the basic consolidated financial statements taken as a whole, presents
fairly, in all material respects the information set forth therein.
As described in Note 2, the Company adopted Statement of Financial Accounting
Standards No. 143 "Accounting for Asset Retirement Obligations" in 2003.
We have also audited, in accordance with the Standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Company's
internal control over financial reporting as of December 31, 2004, based on
criteria established in Internal Controls - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our
report dated March 11, 2005 expressed an unqualified opinion on management's
assessment of, and the effective operation of, internal control over financial
reporting.
KPMG LLP
Dallas, Texas
March 11, 2005
F - 1
KANEB SERVICES LLC
CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31,
--------------------------------------------------
2004 2003 2002
--------------- -------------- --------------
Revenues:
Services................................................... $ 379,155,000 $ 354,591,000 $ 288,669,000
Products................................................... 676,093,000 511,200,000 381,159,000
--------------- -------------- --------------
Total revenues.......................................... 1,055,248,000 865,791,000 669,828,000
--------------- -------------- --------------
Costs and expenses:
Cost of products sold...................................... 647,733,000 486,310,000 367,870,000
Operating costs............................................ 177,829,000 169,380,000 132,269,000
Depreciation and amortization.............................. 56,676,000 53,195,000 39,471,000
Gain on sale of assets..................................... - - (609,000)
General and administrative................................. 36,231,000 28,402,000 24,468,000
--------------- -------------- --------------
Total costs and expenses................................ 918,469,000 737,287,000 563,469,000
--------------- -------------- --------------
Operating income.............................................. 136,779,000 128,504,000 106,359,000
Interest and other income..................................... 336,000 365,000 3,664,000
Interest expense.............................................. (43,579,000) (39,576,000) (29,171,000)
Loss on debt extinguishment................................... - - (3,282,000)
--------------- -------------- --------------
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.................................................. 93,536,000 89,293,000 77,570,000
Gain on issuance of units by KPP.............................. - 10,898,000 24,882,000
Income tax expense............................................ (3,251,000) (4,887,000) (2,585,000)
Interest of outside non-controlling partners in KPP's
net income................................................. (65,933,000) (61,908,000) (52,639,000)
--------------- -------------- --------------
Income before cumulative effect of change in accounting
principle.................................................. 24,352,000 33,396,000 47,228,000
Cumulative effect of change in accounting principle -
adoption of new accounting standard for asset retirement
obligations................................................ - (313,000) -
--------------- -------------- --------------
Net income.................................................... $ 24,352,000 $ 33,083,000 $ 47,228,000
=============== ============== ==============
Earnings per share:
Basic:
Before cumulative effect of change in accounting
principle............................................. $ 2.07 $ 2.89 $ 4.13
Cumulative effect of change in accounting principle..... - (.03) -
--------------- -------------- --------------
...................................................... $ 2.07 $ 2.86 $ 4.13
=============== ============== ==============
Diluted:
Before cumulative effect of change in accounting
principle............................................. $ 2.03 $ 2.84 $ 4.02
Cumulative effect of change in accounting principle..... - (.03) -
--------------- -------------- --------------
$ 2.03 $ 2.81 $ 4.02
=============== ============== ==============
See notes to consolidated financial statements.
F - 2
KANEB SERVICES LLC
CONSOLIDATED BALANCE SHEETS
December 31,
---------------------------------
2004 2003
--------------- --------------
ASSETS
Current assets:
Cash and cash equivalents.................................................... $ 38,415,000 $ 43,457,000
Accounts receivable (net of allowance for doubtful accounts of
$2,255,000 in 2004 and $3,777,000 in 2003)................................ 85,976,000 60,684,000
Inventories.................................................................. 25,448,000 18,637,000
Prepaid expenses and other................................................... 12,614,000 9,650,000
--------------- ----------------
Total current assets...................................................... 162,453,000 132,428,000
--------------- ----------------
Property and equipment.......................................................... 1,451,176,000 1,360,523,000
Less accumulated depreciation................................................... 302,564,000 247,503,000
--------------- ----------------
Net property and equipment................................................ 1,148,612,000 1,113,020,000
--------------- ----------------
Investment in affiliates........................................................ 25,939,000 25,456,000
Excess of cost over fair value of net assets of acquired businesses and
other assets................................................................. 19,884,000 20,663,000
--------------- ----------------
$ 1,356,888,000 $ 1,291,567,000
=============== ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable............................................................. $ 54,280,000 $ 36,916,000
Accrued expenses............................................................. 38,142,000 39,307,000
Accrued interest payable..................................................... 9,374,000 9,303,000
Accrued distributions payable to shareholders................................ 5,801,000 5,567,000
Accrued distributions payable to outside non-controlling
partners in KPP's net income.............................................. 19,863,000 19,507,000
Deferred terminaling fees.................................................... 8,851,000 7,061,000
--------------- ----------------
Total current liabilities................................................. 136,311,000 117,661,000
--------------- ----------------
Long-term debt.................................................................. 688,985,000 636,308,000
Other liabilities and deferred taxes............................................ 53,520,000 52,242,000
Interest of outside non-controlling partners in KPP............................. 397,717,000 407,635,000
Commitments and contingencies
Shareholders' equity:
Shareholders' investment..................................................... 77,136,000 75,291,000
Accumulated other comprehensive income....................................... 3,219,000 2,430,000
--------------- ----------------
Total shareholders' equity................................................ 80,355,000 77,721,000
--------------- ----------------
$ 1,356,888,000 $ 1,291,567,000
=============== ================
See notes to consolidated financial statements.
F - 3
KANEB SERVICES LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
--------------------------------------------------
2004 2003 2002
--------------- -------------- --------------
Operating activities:
Net income................................................. $ 24,352,000 $ 33,083,000 $ 47,228,000
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization........................... 56,676,000 53,195,000 39,471,000
Equity in earnings of affiliates, net of distributions.. (483,000) 148,000 (3,164,000)
Interest of outside non-controlling partners in KPP's
net income............................................ 65,933,000 61,908,000 52,639,000
Gain on issuance of units by KPP........................ - (10,898,000) (24,882,000)
Gain on sale of assets ................................. - - (609,000)
Deferred income taxes................................... (671,000) 1,683,000 3,105,000
Cumulative effect of change in accounting principle..... - 313,000 -
Other................................................... (1,191,000) 1,468,000 (559,000)
Changes in working capital components:
Accounts receivable................................... (25,292,000) 1,151,000 (16,403,000)
Inventories, prepaid expenses and other............... (9,775,000) (4,766,000) (7,643,000)
Accounts payable and accrued expenses................. 17,135,000 7,639,000 (165,000)
--------------- -------------- --------------
Net cash provided by operating activities............. 126,684,000 144,924,000 89,018,000
--------------- -------------- --------------
Investing activities:
Acquisitions, net of cash acquired......................... (41,853,000) (1,644,000) (468,477,000)
Capital expenditures....................................... (42,214,000) (44,747,000) (31,101,000)
Proceeds from sale of assets............................... - - 1,107,000
Other, net................................................. 2,684,000 (1,388,000) 361,000
--------------- -------------- --------------
Net cash used in investing activities................. (81,383,000) (47,779,000) (498,110,000)
--------------- -------------- --------------
Financing activities:
Issuance of debt........................................... 52,001,000 291,377,000 756,087,000
Payments of debt........................................... (2,500,000) (388,051,000) (427,493,000)
Distributions to shareholders.............................. (22,860,000) (20,473,000) (18,351,000)
Distributions to outside non-controlling
partners in KPP......................................... (78,732,000) (73,004,000) (52,827,000)
Changes in long-term payables and other liabilities........ - - (10,026,000)
Net proceeds from issuance of units by KPP................. - 109,056,000 175,527,000
Issuance of common shares upon exercise of stock options... 111,000 164,000 648,000
--------------- -------------- --------------
Net cash provided by (used in) financing activities... (51,980,000) (80,931,000) 423,565,000
--------------- -------------- --------------
Effect of exchange rate changes on cash....................... 1,637,000 2,766,000 -
--------------- -------------- --------------
Increase (decrease) in cash and cash equivalents.............. (5,042,000) 18,980,000 14,473,000
Cash and cash equivalents at beginning of period.............. 43,457,000 24,477,000 10,004,000
--------------- -------------- --------------
Cash and cash equivalents at end of period.................... $ 38,415,000 $ 43,457,000 $ 24,477,000
=============== ============== ==============
Supplemental cash flow information - cash paid for interest... $ 42,122,000 $ 35,712,000 $ 27,070,000
=============== ============== ==============
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, 2002.................. $ 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
Net income for the year................ 24,352,000 - 24,352,000 $ 24,352,000
Distributions declared................. (23,094,000) - (23,094,000) -
Issuance of common shares and other.... 587,000 - 587,000 -
Foreign currency translation adjustment - 753,000 753,000 753,000
Interest rate hedging transaction...... - 36,000 36,000 36,000
------------- -------------- ------------- --------------
Comprehensive income for the year...... $ 25,141,000
==============
Balance at December 31, 2004................ $ 77,136,000 $ 3,219,000 $ 80,355,000
============= ============== =============
See notes to consolidated financial statements.
F - 5
KANEB SERVICES LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. COMPANY ORGANIZATION
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 a 18%
(at December 31, 2004) 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.
KPL owns a petroleum product marketing business which provides wholesale
motor fuel marketing services in the Great Lakes and Rocky Mountain regions of
the United States. KPP's product sales business delivers bunker fuels to ships
in the Caribbean and Nova Scotia, Canada, and sells bulk petroleum products to
various commercial customers at those locations. In the bunkering business, KPP
competes with ports offering bunker fuels along the route of the vessel. Vessel
owners or charterers are charged berthing and other fees for associated services
such as pilotage, tug assistance, line handling, launch service and emergency
response services.
Valero L.P. Merger Agreement
On October 31, 2004, Valero L.P. agreed to acquire by merger (the "KSL
Merger") all of the outstanding common shares of the Company for cash. Under the
terms of that agreement, Valero L.P. is offering to purchase all of the
outstanding shares of the Company at $43.31 per share.
In a separate definitive agreement, on October 31, 2004, Valero L.P. and
KPP agreed to merge (the "KPP Merger"). Under the terms of that agreement, each
holder of units of limited partnership interests in KPP will receive a number of
Valero L.P. common units based on an exchange ratio that fluctuates within a
fixed range to provide $61.50 in value of Valero L.P. units for each unit of
KPP. The actual exchange ratio will be determined at the time of the closing of
the proposed merger and is subject to a fixed value collar of plus or minus five
percent of Valero L.P.'s per unit price of $57.25 as of October 7, 2004. Should
Valero L.P.'s per unit price fall below $54.39 per unit, the exchange ratio will
remain fixed at 1.1307 Valero L.P. units for each unit of KPP. Likewise, should
Valero L.P.'s per unit price exceed $60.11 per unit, the exchange ratio will
remain fixed at 1.0231 Valero L.P. units for each unit of KPP.
The completion of the KSL Merger is subject to the customary regulatory
approvals including those under the Hart-Scott-Rodino Antitrust Improvements
Act. The completion of the KSL Merger is also subject to completion of the KPP
Merger. All required shareholder and unitholder approvals have been obtained.
Upon completion of the mergers, the general partner of the combined partnership
will be owned by affiliates of Valero Energy Corporation and the Company and KPP
will become wholly owned subsidiaries of Valero L.P.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following significant accounting policies are followed by the Company
in the preparation of the consolidated financial statements.
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, 2004, 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
each annual evaluation date, including December 31, 2004, the Company determined
that the implied fair value of its goodwill exceeded carrying value and,
therefore, no impairment charge was necessary.
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,
2004, 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, 2002, was not material to the results of operations of
the Company for the years ended December 31, 2004, 2003 and 2002. In 2004 and
2003, accretion expense of $0.2 million and $0.4 million, respectively, 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.
Income Taxes
Limited liability company operations are not subject to federal or state
income taxes. However, certain KPP terminaling operations are conducted through
separate taxable wholly-owned corporate subsidiaries. The income before tax
expense for these subsidiaries was $18.4 million, $18.9 million and $6.3 million
for the years ended December 31, 2004, 2003 and 2002, respectively. The income
tax expense for KPP's taxable subsidiaries for the years ended December 31,
2004, 2003 and 2002 was $3.3 million, $5.2 million and $4.1 million,
respectively. KPP has recorded a net deferred tax liability of $21.5 million and
$20.6 million at December 2004 and 2003, respectively, which is associated with
these subsidiaries.
On June 1, 1989, the governments of the Netherlands Antilles and St.
Eustatius approved a Free Zone and Profit Tax Agreement retroactive to January
1, 1989, which expired on December 31, 2000. This agreement required a
subsidiary of KPP, which was acquired with Statia on February 28, 2002 (see Note
4), to pay a 2% rate on taxable income, as defined therein, or a minimum payment
of 500,000 Netherlands Antilles guilders ($0.3 million) per year. The agreement
further provided that any amounts paid in order to meet the minimum annual
payment were available to offset future tax liabilities under the agreement to
the extent that the minimum annual payment is greater than 2% of taxable income.
The subsidiary is currently engaged in discussions with representatives
appointed by the Island Territory of St. Eustatius regarding the renewal or
modification of the agreement, but the ultimate outcome cannot be predicted at
this time. The subsidiary has accrued amounts assuming a new agreement becomes
effective, and continues to make payments, as required, under the previous
agreement.
Cash Distributions
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 $1.96, $1.825 and $1.65 per share were
declared and paid to shareholders with respect to the years ended December 31,
2004, 2003 and 2002, respectively.
Earnings Per Share
Earnings per share has been calculated using basic and diluted weighted
average shares outstanding for each of the periods presented. For the years
ended December 31, 2004, 2003 and 2002, basic weighted average shares
outstanding were 11,746,000, 11,554,000 and 11,448,000 and diluted weighted
average shares outstanding were 11,981,000, 11,792,000 and 11,755,000,
respectively.
Derivative Instruments
The Company follows 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 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,
2004 and 2003, $0.2 million and $0.1 million, respectively, 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.
Stock Option Plans
In December of 2004, the Financial Accounting Standards Board (FASB) issued
SFAS No. 123 (revised 2004), "Share-Based Payment" (SFAS No. 123R), which
addresses the accounting for share-based payment transactions in which an
enterprise receives employee services in exchange for equity instruments of the
enterprise, or liabilities that are based on the fair value of the enterprise's
equity instruments or that may be settled by the issuance of such equity
instruments. SFAS No. 123R eliminates the ability to account for share-based
compensation transactions using the intrinsic value method under Accounting
Principles Board (APB) Opinion 25, "Accounting for Stock Issued to Employees",
and generally requires that such transactions be accounted for using a
fair-value-based method. The Company is currently evaluating the provisions of
SFAS No. 123R to determine which fair-value-based model and transitional
provision to follow upon adoption. The alternatives for transition include
either the modified prospective or the modified retrospective methods. The
modified prospective method requires that compensation expense be recorded for
all unvested stock options and restricted stock as the requisite service is
rendered beginning with the first quarter of adoption. The modified
retrospective method requires recording compensation expense for stock options
and restricted stock beginning with the first period restated. Under the
modified retrospective method, prior periods may be restated either as of the
beginning of the year of adoption or for all periods presented. SFAS No. 123R
will be effective for the Company beginning in the third quarter of 2005. The
impact of adoption on the Company's consolidated financial statements is still
being evaluated.
In accordance with the provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation", the Company currently applies the provisions of APB
Opinion 25 and related interpretations in accounting for its stock option plans
and, accordingly, does not recognize compensation cost based on the fair value
of the options granted at grant date as prescribed by SFAS 123. The Company also
applies the disclosure provisions of SFAS No. 123, as amended by SFAS No. 148,
"Accounting for Stock-based Compensation - Transition and Disclosure" as if the
fair-value-based method had been applied in measuring compensation expense. The
Black-Scholes option pricing model has been used to estimate the fair value of
stock options issued and the assumptions in the calculations under such model
include stock price variance or volatility ranging from 3.40% to 4.39%, 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 3.75% to 4.78%, 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 6.89% to 8.36%.
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,
--------------------------------------------------
2004 2003 2002
--------------- -------------- --------------
Reported net income..................................... $ 24,352,000 $ 33,083,000 $ 47,228,000
Share-based employee compensation expense determined
under the fair value based method..................... (178,000) (85,000) (49,000)
--------------- -------------- --------------
Pro forma net income.................................... $ 24,174,000 $ 32,998,000 $ 47,179,000
=============== ============== ==============
Earning per share:
Basic - as reported................................... $ 2.07 $ 2.86 $ 4.13
=============== ============== ==============
Basic - pro forma..................................... $ 2.06 $ 2.86 $ 4.03
=============== ============== ==============
Diluted - as reported................................. $ 2.03 $ 2.81 $ 4.02
=============== ============== ==============
Diluted - pro forma................................... $ 2.02 $ 2.80 $ 3.92
=============== ============== ==============
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 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 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.
3. 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 4 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
4). 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.
4. 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
===============
5. PROPERTY AND EQUIPMENT
The cost of property and equipment is summarized as follows:
Estimated December 31,
useful -------------------------------------------
life (years) 2004 2003
------------- ----------------- -----------------
Land...................................... -- $ 84,893,000 $ 75,912,000
Buildings................................. 25 - 35 39,077,000 36,244,000
Pipeline and terminaling equipment........ 15 - 40 1,187,323,000 1,115,458,000
Marine equipment.......................... 15 - 30 87,937,000 87,204,000
Furniture and fixtures.................... 5 - 15 15,390,000 11,577,000
Transportation equipment.................. 3 - 6 7,790,000 7,360,000
Construction and work-in-progress......... -- 28,766,000 26,768,000
----------------- -----------------
Total property and equipment.............. 1,451,176,000 1,360,523,000
Less accumulated depreciation............. 302,564,000 247,503,000
----------------- -----------------
Net property and equipment................ $ 1,148,612,000 $ 1,113,020,000
================= =================
6. LONG-TERM DEBT
Long-term debt is summarized as follows:
December 31,
-------------------------------------
2004 2003
--------------- ---------------
Revolving credit facility, due in July of 2008.................... $ 14,000,000 $ 16,500,000
Revolving credit facility of subsidiary, due in April of 2007..... 3,033,000 2,112,000
KPP $400 million revolving credit facility, due in April of 2006.. 95,669,000 54,169,000
KPP $250 million 5.875% senior unsecured notes, due in June
of 2013........................................................ 250,000,000 250,000,000
KPP $250 million 7.75% senior unsecured notes, due in February
of 2012........................................................ 250,000,000 250,000,000
KPP term loans, due in April of 2006.............................. 40,770,000 29,243,000
KPP Australian bank facility, due in April of 2006................ 35,513,000 34,284,000
--------------- --------------
Total long-term debt.............................................. $ 688,985,000 $ 636,308,000
=============== ===============
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,
2004, $14.0 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, 2004, 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, 2004, $3.0 million was
drawn on the facility.
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 December 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 December 31, 2004, $95.7 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 to other partners. At
December 31, 2004, 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, 2004, KPP was in compliance with all
covenants.
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. The Company's contributions under these plans were $1.6 million, $1.6
million and $1.2 million for 2004, 2003 and 2002, 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 January 1, 2002............................................... 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
Common shares issued..................................................... 169,863
-----------
Balance at December 31, 2004............................................. 11,692,328
===========
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. On October 28,
2004, the rights agreement was amended to generally provide that events referred
to in the Valero L.P. merger agreement (see Note 1) would not cause the rights
to become exercisable.
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.
At December 31, 2004, options on 506,307 shares at prices ranging from
$5.26 to $28.75 were outstanding, of which 137,405 were exercisable at prices
ranging from $5.26 to $19.73. 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.
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, 2004, 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, 2004,
approximately 122,000 common shares of the Company are issuable under this
arrangement.
Restricted Stock
In August 2004 and September 2001, the Company issued 60,000 and 30,000,
respectively, of 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 an
expense of $0.5 million in 2004, $0.1 million in 2003 and $0.2 million in 2002.
9. COMMITMENTS AND CONTINGENCIES
Total rent expense under operating leases amounted to $9.5 million, $14.6
million and $13.5 million for the years ended December 31, 2002, 2003 and 2004,
respectively.
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, 2004:
Year ending December 31:
2005.......................................... $ 9,822,000
2006.......................................... 8,593,000
2007.......................................... 6,238,000
2008.......................................... 5,338,000
2009.......................................... 4,058,000
Thereafter.................................... 18,140,000
-------------
Total minimum lease payments $ 52,189,000
=============
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. KPP has recorded an undiscounted reserve for environmental claims in the
amount of $23.0 million at December 31, 2004, including $16.9 million related to
acquisitions of pipelines and terminals. During 2004, 2003 and 2002,
respectively, KPP incurred $6.7 million, $2.1 million and $2.4 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 acquired ST
Services in 1993. The lawsuit involves environmental response and remediation
costs allegedly resulting from jet fuel leaks in the early 1970's from a
pipeline. The pipeline, which connected a former Grace terminal with Otis Air
Force Base in Massachusetts (the "Otis pipeline" or the "pipeline"), ceased
operations in 1973 and was abandoned before 1978, when the connecting terminal
was sold to an unrelated entity. Grace alleged that subsidiaries of KPP acquired
the abandoned pipeline as part of the acquisition of ST Services in 1993 and
assumed responsibility for environmental damages allegedly caused by the jet
fuel leaks. Grace sought a ruling from the Texas court that these subsidiaries
are responsible for all liabilities, including all present and future
remediation expenses, associated with these leaks and that Grace has no
obligation to indemnify these subsidiaries for these expenses. In the lawsuit,
Grace also sought indemnification for expenses of approximately $3.5 million
that it had incurred since 1996 for response and remediation required by the
State of Massachusetts and for additional expenses that it expects to incur in
the future. The consistent position of KPP's subsidiaries has been that they did
not acquire the abandoned pipeline as part of the 1993 ST Services transaction,
and therefore did not assume any responsibility for the environmental damage nor
any liability to Grace for the pipeline.
At the end of the trial, the jury returned a verdict including findings
that (1) Grace had breached a provision of the 1993 acquisition agreement by
failing to disclose matters related to the pipeline, and (2) the pipeline was
abandoned before 1978 -- 15 years before KPP's subsidiaries acquired ST
Services. On August 30, 2000, the Judge entered final judgment in the case that
Grace take nothing from the subsidiaries on its claims seeking recovery of
remediation costs. Although KPP's subsidiaries have not incurred any expenses in
connection with the remediation, the court also ruled, in effect, that the
subsidiaries would not be entitled to indemnification from Grace if any such
expenses were incurred in the future. Moreover, the Judge let stand a prior
summary judgment ruling that the pipeline was an asset acquired by KPP's
subsidiaries as part of the 1993 ST Services transaction and that any
liabilities associated with the pipeline would have become liabilities of the
subsidiaries. Based on that ruling, the Massachusetts Department of
Environmental Protection and Samson Hydrocarbons Company (successor to Grace
Petroleum Company) wrote letters to ST Services alleging its responsibility for
the remediation, and ST Services responded denying any liability in connection
with this matter. The Judge also awarded attorney fees to Grace of more than
$1.5 million. Both KPP's subsidiaries and Grace have appealed the trial court's
final judgment to the Texas Court of Appeals in Dallas. In particular, the
subsidiaries have filed an appeal of the judgment finding that the Otis pipeline
and any liabilities associated with the pipeline were transferred to them as
well as the award of attorney fees to Grace.
On April 2, 2001, Grace filed a petition in bankruptcy, which created an
automatic stay of actions against Grace. This automatic stay covers the appeal
of the Dallas litigation, and the Texas Court of Appeals has issued an order
staying all proceedings of the appeal because of the bankruptcy. Once that stay
is lifted, KPP's subsidiaries that are party to the lawsuit intend to resume
vigorous prosecution of the appeal.
The Otis Air Force Base is a part of the Massachusetts Military Reservation
("MMR Site"), which has been declared a Superfund Site pursuant to CERCLA. The
MMR Site contains a number of groundwater contamination plumes, two of which are
allegedly associated with the Otis pipeline, and various other waste management
areas of concern, such as landfills. The United States Department of Defense,
pursuant to a Federal Facilities Agreement, has been responding to the
Government remediation demand for most of the contamination problems at the MMR
Site. Grace and others have also received and responded to formal inquiries from
the United States Government in connection with the environmental damages
allegedly resulting from the jet fuel leaks. KPP's subsidiaries voluntarily
responded to an invitation from the Government to provide information indicating
that they do not own the pipeline. In connection with a court-ordered mediation
between Grace and KPP's subsidiaries, the Government advised the parties in
April 1999 that it has identified two spill areas that it believes to be related
to the pipeline that is the subject of the Grace suit. The Government at that
time advised the parties that it believed it had incurred costs of approximately
$34 million, and expected in the future to incur costs of approximately $55
million, for remediation of one of the spill areas. This amount was not intended
to be a final accounting of costs or to include all categories of costs. The
Government also advised the parties that it could not at that time allocate its
costs attributable to the second spill area.
By letter dated July 26, 2001, the United States Department of Justice
("DOJ") advised ST Services that the Government intends to seek reimbursement
from ST Services under the Massachusetts Oil and Hazardous Material Release
Prevention and Response Act and the Declaratory Judgment Act for the
Government's response costs at the two spill areas discussed above. The DOJ
relied in part on the Texas state court judgment, which in the DOJ's view, held
that ST Services was the current owner of the pipeline and the
successor-in-interest of the prior owner and operator. The Government advised ST
Services that it believes it has incurred costs exceeding $40 million, and
expects to incur future costs exceeding an additional $22 million, for
remediation of the two spill areas. KPP believes that its subsidiaries have
substantial defenses. ST Services responded to the DOJ on September 6, 2001,
contesting the Government's positions and declining to reimburse any response
costs. The DOJ has not filed a lawsuit against ST Services seeking cost recovery
for its environmental investigation and response costs. Representatives of ST
Services have met with representatives of the Government on several occasions
since September 6, 2001 to discuss the Government's claims and to exchange
information related to such claims. Additional exchanges of information are
expected to occur in the future and additional meetings may be held to discuss
possible resolution of the Government's claims without litigation. KPP does not
believe this matter will have a materially adverse effect on its financial
condition, although there can be no assurances as to the ultimate outcome.
On April 7, 2000, a fuel oil pipeline in Maryland owned by Potomac Electric
Power Company ("PEPCO") ruptured. Work performed with regard to the pipeline was
conducted by a partnership of which ST Services is general partner. PEPCO has
reported that it has incurred total cleanup costs of $70 million to $75 million.
PEPCO probably will continue to incur some cleanup related costs for the
foreseeable future, primarily in connection with EPA requirements for monitoring
the condition of some of the impacted areas. Since May 2000, ST Services has
provisionally contributed a minority share of the cleanup expense, which has
been funded by ST Services' insurance carriers. ST Services and PEPCO have not,
however, reached a final agreement regarding ST Services' proportionate
responsibility for this cleanup effort, if any, and cannot predict the amount,
if any, that ultimately may be determined to be ST Services' share of the
remediation expense, but ST Services believes that such amount will be covered
by insurance and therefore will not materially adversely affect KPP's financial
condition.
As a result of the rupture, purported class actions were filed against
PEPCO and ST Services in federal and state court in Maryland by property and
business owners alleging damages in unspecified amounts under various theories,
including under the Oil Pollution Act ("OPA") and Maryland common law. The
federal court consolidated all of the federal cases in a case styled as In re
Swanson Creek Oil Spill Litigation. A settlement of the consolidated class
action, and a companion state-court class action, was reached and approved by
the federal judge. The settlement involved creation and funding by PEPCO and ST
Services of a $2,250,000 class settlement fund, from which all participating
claimants would be paid according to a court-approved formula, as well as a
court-approved payment to plaintiffs' attorneys. The settlement has been
consummated and the fund, to which PEPCO and ST Services contributed equal
amounts, has been distributed. Participating claimants' claims have been settled
and dismissed with prejudice. A number of class members elected not to
participate in the settlement, i.e., to "opt out," thereby preserving their
claims against PEPCO and ST Services. All non-participant claims have been
settled for immaterial amounts with ST Services' portion of such settlements
provided by its insurance carrier.
PEPCO and ST Services agreed with the federal government and the State of
Maryland to pay costs of assessing natural resource damages arising from the
Swanson Creek oil spill under OPA and of selecting restoration projects. This
process was completed in mid-2002. ST Services' insurer has paid ST Services'
agreed 50 percent share of these assessment costs. In late November 2002, PEPCO
and ST Services entered into a Consent Decree resolving the federal and state
trustees' claims for natural resource damages. The decree required payments by
ST Services and PEPCO of a total of approximately $3 million to fund the
restoration projects and for remaining damage assessment costs. The federal
court entered the Consent Decree as a final judgment on December 31, 2002. PEPCO
and ST Services have each paid their 50% share and thus fully performed their
payment obligations under the Consent Decree. ST Services' insurance carrier
funded ST Services' payment.
The U.S. Department of Transportation ("DOT") has issued a Notice of
Proposed Violation to PEPCO and ST Services alleging violations over several
years of pipeline safety regulations and proposing a civil penalty of $647,000
jointly against the two companies. ST Services and PEPCO have contested the DOT
allegations and the proposed penalty. A hearing was held before the Office of
Pipeline Safety at the DOT in late 2001. In June of 2004, the DOT issued a final
order reducing the penalty to $256,250 jointly against ST Services and PEPCO and
$74,000 against ST Services. On September 14, 2004, ST Services petitioned for
reconsideration of the order.
By letter dated January 4, 2002, the Attorney General's Office for the
State of Maryland advised ST Services that it intended to seek penalties from ST
Services in connection with the April 7, 2000 spill. The State of Maryland
subsequently asserted that it would seek penalties against ST Services and PEPCO
totaling up to $12 million. A settlement of this claim was reached in mid-2002
under which ST Services' insurer will pay a total of slightly more than $1
million in installments over a five year period. PEPCO has also reached a
settlement of these claims with the State of Maryland. Accordingly, KPP believes
that this matter will not have a material adverse effect on its financial
condition.
On December 13, 2002, ST Services sued PEPCO in the Superior Court,
District of Columbia, seeking, among other things, a declaratory judgment as to
ST Services' legal obligations, if any, to reimburse PEPCO for costs of the oil
spill. On December 16, 2002, PEPCO sued ST Services in the United States
District Court for the District of Maryland, seeking recovery of all its costs
for remediation of and response to the oil spill. Pursuant to an agreement
between ST Services and PEPCO, ST Services' suit was dismissed, subject to
refiling. ST Services has moved to dismiss PEPCO's suit. ST Services is
vigorously defending against PEPCO's claims and is pursuing its own
counterclaims for return of monies ST Services has advanced to PEPCO for
settlements and cleanup costs. KPP believes that any costs or damages resulting
from these lawsuits will be covered by insurance and therefore will not
materially adversely affect KPP's financial condition. The amounts claimed by
PEPCO, if recovered, would trigger an excess insurance policy which has a
$600,000 retention, but KPP does not believe that such retention, if incurred,
would materially adversely affect KPP's financial condition.
In 2003, Exxon Mobil filed a lawsuit in a New Jersey state court against
GATX Corporation, Kinder Morgan Liquid Terminals ("Kinder Morgan"), the
successor in interest to GATX Terminals Corporation ("GATX"), and ST Services,
seeking reimbursement for remediation costs associated with the Paulsboro, New
Jersey terminal. The terminal was owned and operated by Exxon Mobil from the
early 1950's until 1990 when purchased by GATX. ST Services purchased the
terminal in 2000 from GATX. GATX was subsequently acquired by Kinder Morgan. As
a condition to the sale to GATX in 1990, Exxon Mobil undertook certain
remediation obligations with respect to the site. In the lawsuit, Exxon Mobil is
claiming that it has complied with its remediation and contractual obligations
and is entitled to reimbursement from GATX Corporation, the parent company of
GATX, Kinder Morgan, and ST Services for costs in the amount of $400,000 that it
claims are related to releases at the site subsequent to its sale of the
terminal to GATX. It is also alleging that any remaining remediation
requirements are the responsibility of GATX Corporation, Kinder Morgan, or ST
Services. Kinder Morgan has alleged that it was relieved of any remediation
obligations pursuant to the sale agreement between its predecessor, GATX, and ST
Services. ST Services believes that, except for remediation involving immaterial
amounts, GATX Corporation or Exxon Mobil are responsible for the remaining
remediation of the site. Costs of completing the required remediation depend on
a number of factors and cannot be determined at the current time.
A subsidiary of KPP purchased the approximately 2,000-mile ammonia pipeline
system from Koch Pipeline Company, L.P. and Koch Fertilizer Storage and Terminal
Company in 2002. The rates of the ammonia pipeline are subject to regulation by
the Surface Transportation Board (the "STB"). The STB had issued an order in May
2000, prescribing maximum allowable rates KPP's predecessor could charge for
transportation to certain destination points on the pipeline system. In 2003,
KPP instituted a 7% general increase to pipeline rates. On August 1, 2003, CF
Industries, Inc. ("CFI") filed a complaint with the STB challenging these rate
increases. On August 11, 2004, STB ordered KPP to pay reparations to CFI and to
return CFI's rates to the levels permitted under the rate prescription. KPP has
complied with the order. The STB, however, indicated in the order that it would
lift the rate prescription in the event KPP could show "materially changed
circumstances." KPP has submitted evidence of "materially changed
circumstances," which specifically includes its capital investment in the
pipeline. CFI has argued that KPP's acquisition costs should not be considered
by the STB as a measure of KPP's investment base. The STB is expected to decide
the issue within the second quarter of 2005.
Also, on June 16, 2003, Dyno Nobel Inc. ("Dyno") filed a complaint with the
STB challenging the 2003 rate increase on the basis that (i) the rate increase
constitutes a violation of a contract rate, (ii) rates are discriminatory and
(iii) the rates exceed permitted levels. Dyno also intervened in the CFI
proceeding described above. Unlike CFI, Dyno's rates are not subject to a rate
prescription. As of December 31, 2004, Dyno would be entitled to approximately
$2 million in rate refunds, should it be successful. KPP believes, however, that
Dyno's claims are without merit.
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
judgment 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 Company, primarily KPP, has other contingent liabilities resulting from
litigation, claims and commitments incident to the ordinary course of business.
Management believes, after consulting with counsel, that the ultimate resolution
of such contingencies will not have a materially adverse effect on the financial
position, results of operations or liquidity of the Company.
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 4),
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,
--------------------------------------------------
2004 2003 2002
--------------- -------------- ----------------
Business segment revenues:
Pipeline operations................................... $ 119,803,000 $ 119,633,000 $ 82,698,000
Terminaling operations................................ 259,352,000 234,958,000 205,971,000
Product marketing operations.......................... 676,093,000 511,200,000 381,159,000
---------------- -------------- ----------------
$ 1,055,248,000 $ 865,791,000 $ 669,828,000
================ ============== ================
Business segment profit:
Pipeline operations................................... $ 48,853,000 $ 51,860,000 $ 38,623,000
Terminaling operations................................ 74,663,000 66,532,000 65,040,000
Product marketing operations.......................... 17,262,000 12,233,000 4,692,000
General corporate..................................... (3,999,000) (2,121,000) (1,996,000)
---------------- -------------- ----------------
Operating income................................... 136,779,000 128,504,000 106,359,000
Interest and other income ............................ 336,000 365,000 3,664,000
Interest expense...................................... (43,579,000) (39,576,000) (29,171,000)
Loss on debt extinguishment........................... - - (3,282,000)
---------------- -------------- ----------------
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.................. $ 93,536,000 $ 89,293,000 $ 77,570,000
================ ============== ================
Business segment assets:
Depreciation and amortization:
Pipeline operations................................ $ 14,538,000 $ 14,117,000 $ 6,408,000
Terminaling operations............................. 41,232,000 38,089,000 32,368,000
Product marketing operations....................... 906,000 989,000 695,000
---------------- -------------- ----------------
$ 56,676,000 $ 53,195,000 $ 39,471,000
================ ============== ================
Capital expenditures (excluding acquisitions):
Pipeline operations................................ $ 10,334,000 $ 9,584,000 $ 9,469,000
Terminaling operations............................. 29,511,000 34,572,000 20,953,000
Product marketing operations....................... 2,369,000 591,000 679,000
---------------- -------------- ----------------
$ 42,214,000 $ 44,747,000 $ 31,101,000
================ ============== ================
December 31,
---------------------------------------------------
2004 2003 2002
---------------- --------------- ----------------
Total assets:
Pipeline operations................................ $ 351,195,000 $ 352,901,000 $ 352,657,000
Terminaling operations............................. 917,966,000 874,185,000 844,321,000
Product marketing operations....................... 83,404,000 58,161,000 41,297,000
General corporate.................................. 4,323,000 6,320,000 5,826,000
---------------- --------------- ----------------
$ 1,356,888,000 $ 1,291,567,000 $ 1,244,101,000
================ =============== ================
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,
---------------------------------------------------
2004 2003 2002
---------------- --------------- ----------------
Geographical area revenues:
United States........................................... $ 658,814,000 $ 535,895,000 $ 485,322,000
United Kingdom.......................................... 29,540,000 26,392,000 23,937,000
Netherlands Antilles.................................... 298,273,000 241,693,000 132,387,000
Canada.................................................. 43,671,000 41,689,000 23,207,000
Australia and New Zealand............................... 24,950,000 20,122,000 4,975,000
---------------- --------------- ----------------
$ 1,055,248,000 $ 865,791,000 $ 669,828,000
================ =============== ================
Geographical area operating income:
United States........................................... $ 93,954,000 $ 87,965,000 $ 83,544,000
United Kingdom.......................................... 7,704,000 8,583,000 7,318,000
Netherlands Antilles.................................... 22,629,000 19,223,000 9,616,000
Canada.................................................. 5,248,000 6,777,000 4,398,000
Australia and New Zealand............................... 7,244,000 5,956,000 1,483,000
---------------- --------------- ----------------
$ 136,779,000 $ 128,504,000 $ 106,359,000
================ =============== ================
December 31,
---------------------------------------------------
2004 2003 2002
---------------- --------------- ----------------
Geographical area net property and equipment:
United States........................................... $ 718,257,000 $ 693,345,000 $ 690,262,000
United Kingdom.......................................... 63,968,000 51,392,000 46,543,000
Netherlands Antilles.................................... 211,382,000 217,143,000 224,810,000
Canada.................................................. 71,374,000 74,995,000 78,789,000
Australia and New Zealand............................... 83,631,000 76,145,000 51,872,000
---------------- --------------- ----------------
$ 1,148,612,000 $ 1,113,020,000 $ 1,092,276,000
================ =============== ================
11. FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK
The estimated fair value of all debt as of December 31, 2004 and 2003 was
approximately $745 million and $654 million, as compared to the carrying value
of $689 million and $636 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 2 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, 2004.
No customer constituted 10% of the Company's consolidated revenues in 2004, 2003
or 2002.
12. QUARTERLY FINANCIAL DATA (unaudited)
Quarterly operating results for 2004 and 2003 are summarized as follows:
Quarter Ended
-----------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
---------------- ---------------- --------------- --------------
2004:
Revenues........................ $ 233,179,000 $ 254,202,000 $ 272,242,000 $ 295,625,000
================ ================ =============== ==============
Operating income................ $ 32,915,000 $ 36,534,000 $ 34,927,000 $ 32,403,000
================ ================ =============== ==============
Net income...................... $ 5,995,000 $ 7,395,000 $ 6,811,000 $ 4,151,000
================ ================ =============== ==============
Earnings per share:
Basic........................ $ 0.51 $ 0.63 $ 0.58 $ 0.35
================ ================ =============== ==============
Diluted...................... $ 0.50 $ 0.62 $ 0.57 $ 0.34
================ ================ =============== ==============
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
================ ================ =============== ==============
(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 3 regarding gains on issuance of units by KPP.
Schedule I
KANEB SERVICES LLC (PARENT COMPANY)
CONDENSED STATEMENT OF INCOME
Year Ended December 31,
--------------------------------------------------
2004 2003 2002
--------------- -------------- --------------
General and administrative expenses........................... $ (3,951,000) $ (1,983,000) $ (2,036,000)
Interest expense.............................................. (577,000) (613,000) (718,000)
Interest and other income (expense)........................... (12,000) 10,000 10,000
Equity in earnings of subsidiaries............................ 28,892,000 25,084,000 25,090,000
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.................................................. 24,352,000 33,396,000 47,228,000
Cumulative effect of change in accounting principle -
adoption of new accounting standard for asset retirement
obligations................................................ - (313,000) -
--------------- -------------- ---------------
Net income................................................. $ 24,352,000 $ 33,083,000 $ 47,228,000
=============== ============== ===============
Earnings per share:
Basic:
Before cumulative effect of change in accounting
principle............................................. $ 2.07 $ 2.89 $ 4.13
Cumulative effect of change in accounting principle..... - (.03) -
--------------- -------------- --------------
$ 2.07 $ 2.86 $ 4.13
=============== ============== ==============
Diluted:
Before cumulative effect of change in accounting
principle............................................. $ 2.03 $ 2.84 $ 4.02
Cumulative effect of change in accounting principle..... - (.03) -
--------------- -------------- --------------
$ 2.03 $ 2.81 $ 4.02
============== ============== ==============
See "Notes to Consolidated Financial Statements" of
Kaneb Services LLC included in this report.
F - 24
Schedule I
(Continued)
KANEB SERVICES LLC (PARENT COMPANY)
CONDENSED BALANCE SHEET
December 31,
--------------------------------------
2004 2003
---------------- ---------------
ASSETS
Current assets:
Cash and cash equivalents............................................... $ 1,504,000 $ 1,544,000
Prepaid expenses and other.............................................. 141,000 149,000
---------------- ---------------
Total current assets................................................. 1,645,000 1,693,000
---------------- ---------------
Investments in and advances to subsidiaries................................ 108,112,000 106,068,000
Other assets............................................................... 387,000 498,000
---------------- ---------------
$ 110,144,000 $ 108,259,000
================ ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accrued expenses...................................................... $ 2,039,000 $ 1,112,000
Accrued distributions payable to shareholders......................... 5,801,000 5,567,000
---------------- ---------------
Total current liabilities.......................................... 7,840,000 6,679,000
---------------- ---------------
Long-term debt........................................................... 14,000,000 16,500,000
Long-term payables and other liabilities................................. 7,949,000 7,359,000
Commitments and contingencies
Shareholders' equity:
Shareholders' investment.............................................. 77,136,000 75,291,000
Accumulated other comprehensive income................................ 3,219,000 2,430,000
---------------- ---------------
Total shareholders' equity......................................... 80,355,000 77,721,000
---------------- ---------------
$ 110,144,000 $ 108,259,000
================ ===============
See "Notes to Consolidated Financial Statements" of
Kaneb Services LLC included in this report.
F - 25
Schedule I
(Continued)
KANEB SERVICES LLC (PARENT COMPANY)
CONDENSED STATEMENT OF CASH FLOWS
Year Ended December 31,
--------------------------------------------------
2004 2003 2002
--------------- -------------- --------------
Operating activities:
Net income ............................................... $ 24,352,000 $ 33,083,000 $ 47,228,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in earnings of subsidiaries, net of
distributions.................................... (1,254,000) (11,939,000) (29,958,000)
Other ............................................... 475,000 - -
Cumulative effect of change in accounting principle.. - 313,000 -
Changes in current assets and liabilities............ 935,000 698,000 (38,000)
--------------- -------------- ---------------
Net cash provided by operating activities......... 24,508,000 22,155,000 17,232,000
--------------- -------------- ---------------
Investing activities:
Changes in other assets................................... 111,000 110,000 911,000
--------------- -------------- ---------------
Net cash provided by investing activities......... 111,000 110,000 911,000
--------------- -------------- ---------------
Financing activities:
Issuance of debt.......................................... - - 10,000,000
Payments of debt.......................................... (2,500,000) (2,625,000) -
Distributions to shareholders............................. (22,860,000) (20,473,000) (18,351,000)
Changes in long-term payables and other liabilities....... 590,000 518,000 (10,114,000)
Issuance of common shares upon exercise of options........ 111,000 164,000 648,000
--------------- -------------- ---------------
Net cash used in financing activities................ (24,659,000) (22,416,000) (17,817,000)
--------------- -------------- ---------------
Increase (decrease) in cash and cash equivalents............. (40,000) (151,000) 326,000
Cash and cash equivalents at beginning of period............. 1,544,000 1,695,000 1,369,000
--------------- -------------- ---------------
Cash and cash equivalents at end of period................... $ 1,504,000 $ 1,544,000 $ 1,695,000
=============== ============== ===============
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, 2004:
For doubtful receivables
classified as current assets... $ 3,777 $ 990 $ - $ (2,512)(b) $ 2,255
============= =========== ============= ========= ==========
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
============= =========== ============= ========= ==========
Notes:
(a) Allowance for doubtful receivables from 2002 acquisitions.
(b) Receivable write-offs and reclassifications, net of recoveries.
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 16, 2005
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 16, 2005
- ---------------------------------------- and Chief Executive Officer
Principal Accounting Officer
//s// HOWARD C. WADSWORTH Vice President, Treasurer March 16, 2005
- ---------------------------------------- and Secretary
Directors
//s// SANGWOO AHN Director March 16, 2005
- ----------------------------------------
//s// MURRAY R. BILES Director March 16, 2005
- ----------------------------------------
//s// FRANK M. BURKE Director March 16, 2005
- ----------------------------------------
//s// CHARLES R. COX Director March 16, 2005
- ----------------------------------------
//s// HANS KESSLER Director March 16, 2005
- ----------------------------------------
//s// JAMES R. WHATLEY Director March 16, 2005
- ----------------------------------------
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)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this annual report is being prepared;
b) designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles;
c) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this 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 16, 2005
//s// JOHN R. BARNES
-------------------------------------
John R. Barnes
President and Chief Executive Officer
Exhibit 31.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Howard C. Wadsworth, Chief Financial Officer of Kaneb Services LLC certify
that:
1. I have reviewed this 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)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this annual report is being prepared;
b) designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles;
c) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this 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 16, 2005
//s// HOWARD C. WADSWORTH
----------------------------------------
Howard C. Wadsworth
Chief Financial Officer
Exhibit 32.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO SECTION 906(A) OF THE SARBANES-OXLEY ACT OF 2002
The undersigned, being the Chief Executive Officer of Kaneb Services LLC
(the "Company"), hereby certifies that, to his knowledge, the Company's Annual
Report on Form 10-K for the year ended December 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 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 16, 2005
//s// JOHN R. BARNES
----------------------------------------
John R. Barnes
President and Chief Executive Officer
Exhibit 32.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 906(A) OF THE SARBANES-OXLEY ACT OF 2002
The undersigned, being the Chief Financial Officer of Kaneb Services LLC
(the "Company"), hereby certifies that, to his knowledge, the Company's Annual
Report on Form 10-K for the year ended December 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 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 16, 2005
//s// HOWARD C. WADSWORTH
--------------------------------------------
Howard C. Wadsworth
Vice President, Treasurer and Secretary
(Chief Financial Officer)
Exhibit 23
Consent of Independent Registered Public Accounting Firm
The Board of Directors
Kaneb Services LLC:
We consent to the incorporation by reference in the registration statement
(No. 333-65404) on Form S-8 of Kaneb Services LLC of our reports dated March 11,
2005, with respect to the consolidated balance sheets of Kaneb Services LLC and
subsidiaries as of December 31, 2004 and 2003, and the related consolidated
statements of income, shareholders' equity and cash flows for each of the years
in the three-year period ended December 31, 2004, the related financial
statement schedules, management's assessment of the effectiveness of internal
control over financial reporting as of December 31, 2004 and the effectiveness
of internal control over financial reporting as of December 31, 2004, which
reports appear in the December 31, 2004 annual report on Form 10-K of Kaneb
Services LLC. Our report on the consolidated financial statements refers to a
change in accounting for asset retirement obligations in 2003.
KPMG LLP
Dallas, Texas
March 16, 2005