- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 001-16405
KANEB SERVICES LLC
(Exact name of registrant as specified in its charter)
DELAWARE 75-2931295
(State or other jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
2435 North Central Expressway
Richardson, Texas 75080
(Address of principle executive offices, including zip code)
(972) 699-4062
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----------- ----------
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class of Common Shares Outstanding at October 31, 2002
- ---------------------- -------------------------------
No par value 11,314,551 shares
- --------------------------------------------------------------------------------
KANEB SERVICES LLC AND SUBSIDIARIES
FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 2002
- --------------------------------------------------------------------------------
Page No.
Part I. Financial Information
Item 1(a)(1) Financial Statements (Unaudited)
Consolidated Statements of Income - Three and Nine Months
Ended September 30, 2002 and 2001 1
Condensed Consolidated Balance Sheets - September 30, 2002
and December 31, 2001 2
Condensed Consolidated Statements of Cash Flows - Nine
Months Ended September 30, 2002 and 2001 3
Notes to Consolidated Financial Statements 4
(a)(2) Financial Statement Schedules (Unaudited)
Schedule I - Kaneb Services LLC (Parent Company)
Condensed Financial Statements:
Statements of Income - Three and Nine Months
Ended September 30, 2002 15
Balance Sheets - September 30, 2002 and December 31, 2001 16
Statements of Cash Flows - Nine Months Ended
September 30, 2002 17
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 18
Item 3. Quantitative and Qualitative Disclosure About Market Risk 26
Item 4. Controls and Procedures 26
Part II. Other Information
Item 1. Legal Proceedings 26
Item 6. Exhibits and Reports on Form 8-K 27
KANEB SERVICES LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands -- Except Per Share Amounts)
(Unaudited)
- --------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- -----------------------------
2002 2001 2002 2001
-------------- ------------- ------------- --------------
Revenues:
Services $ 75,184 $ 53,403 $ 207,946 $ 154,424
Products 108,935 77,260 277,828 264,491
-------------- ------------- ------------- --------------
Total revenues 184,119 130,663 485,774 418,915
-------------- ------------- ------------- --------------
Costs and expenses:
Cost of products sold 105,059 75,773 268,727 262,296
Operating costs 34,303 23,647 92,555 68,139
Depreciation and amortization 10,313 5,643 27,440 17,382
General and administrative 5,938 2,874 17,034 8,929
-------------- ------------- ------------- --------------
Total costs and expenses 155,613 107,937 405,756 356,746
-------------- ------------- ------------- --------------
Operating income 28,506 22,726 80,018 62,169
Interest and other income 259 123 482 4,230
Interest expense (7,478) (3,560) (20,944) (12,726)
-------------- ------------- ------------- --------------
Income before gain on issuance of units by KPP,
income taxes, interest of outside non-
controlling partners in KPP's net income
and extraordinary item 21,287 19,289 59,556 53,673
Gain on issuance of units by KPP - - 17,332 9,859
Income tax provision (673) (296) (2,113) 800
Interest of outside non-controlling
partners in KPP's net income (13,941) (13,037) (39,852) (38,404)
-------------- ------------- ------------- --------------
Income before extraordinary item 6,673 5,956 34,923 25,928
Extraordinary item - loss on extinguishment of
debt by KPP, net of income taxes and interest
of outside non-controlling partners in KPP's
net income - - (502) (859)
-------------- ------------- ------------- --------------
Net income $ 6,673 $ 5,956 $ 34,421 $ 25,069
============== ============= ============= ==============
Earnings per share:
Basic:
Before extraordinary item $ .58 $ .55 $ 3.05 $ 2.42
Extraordinary item - - (.04) (.08)
-------------- ------------- ------------- -------------
$ .58 $ .55 $ 3.01 $ 2.34
============== ============= ============= =============
Diluted:
Before extraordinary item $ .57 $ .52 $ 2.97 $ 2.29
Extraordinary item - - (.04) (.08)
-------------- ------------- ------------- -------------
$ .57 $ .52 $ 2.93 $ 2.21
============== ============= ============= =============
See notes to consolidated financial statements.
1
KANEB SERVICES LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands)
- --------------------------------------------------------------------------------
September 30, December 31,
2002 2001
------------- -----------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 30,242 $ 10,004
Accounts receivable 50,971 32,890
Inventories 9,861 8,402
Prepaid expenses and other 12,405 3,378
------------- --------------
Total current assets 103,479 54,674
------------- --------------
Property and equipment 1,028,587 639,291
Less accumulated depreciation 185,021 157,895
------------- --------------
Net property and equipment 843,566 481,396
------------- --------------
Investment in affiliates 23,343 22,252
Excess of cost over fair value of net assets
of acquired business and other assets 15,524 13,445
------------- --------------
$ 985,912 $ 571,767
============= ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 27,797 $ 15,152
Accrued expenses 46,098 18,753
Accrued distributions payable to shareholders 4,749 4,131
Accrued distributions payable to outside
non-controlling partners in KPP 14,224 11,392
Deferred terminaling fees 6,616 6,515
------------- --------------
Total current liabilities 99,484 55,943
------------- --------------
Long-term debt 542,580 277,302
Long-term payables and other liabilities 36,929 36,371
Interest of outside non-controlling partners
in KPP 253,142 168,219
Commitments and contingencies
Shareholders' equity 53,777 33,932
------------- --------------
$ 985,912 $ 571,767
============= ==============
See notes to consolidated financial statements.
2
KANEB SERVICES LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
- --------------------------------------------------------------------------------
Nine Months Ended
September 30,
----------------------------------------
2002 2001
------------- --------------
Operating activities:
Net income $ 34,421 $ 25,069
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 27,440 17,382
Equity in earnings of affiliates, net of distributions (1,331) 581
Interest of outside non-controlling partners
in KPP's net income 39,852 38,404
Gain on issuance of units by KPP (17,332) (9,859)
Deferred income taxes 2,323 (1,352)
Extraordinary item 502 859
Changes in working capital components (17,635) 12,835
------------- --------------
Net cash provided by operating activities 68,240 83,919
------------- --------------
Investing activities:
Acquisitions by KPP, net of cash acquired (225,406) (106,810)
Capital expenditures (21,934) (9,645)
Proceeds from sale of assets - 2,807
Other, net 760 (2,254)
------------- --------------
Net cash used in investing activities (246,580) (115,902)
------------- --------------
Financing activities:
Issuance of debt 506,087 266,625
Payment of debt (354,210) (177,381)
Distributions to shareholders (13,602) -
Distributions to outside non-controlling
partners in KPP (38,603) (32,658)
Issuance of common shares 648 1,317
Net proceeds from issuance of units by KPP 108,790 -
Changes in long-term payables and other liabilities (10,532) (18,335)
------------- --------------
Net cash provided by financing activities 198,578 39,568
------------- --------------
Increase in cash and cash equivalents 20,238 7,585
Cash and cash equivalents at beginning of period 10,004 6,394
------------- --------------
Cash and cash equivalents at end of period $ 30,242 $ 13,979
============= ==============
Supplemental cash flow information:
Cash paid for interest $ 20,828 $ 11,883
============= ==============
Non-cash investing and financing activities-
Issuance of units for acquisition of terminals by KPP $ - $ 56,488
============= ==============
See notes to consolidated financial statements.
3
KANEB SERVICES LLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES
On June 29, 2001, Xanser Corporation ("Xanser"), formerly Kaneb Services,
Inc., distributed its Pipeline, Terminaling and Product Marketing
businesses (the "Distribution") to its stockholders in the form of a
limited liability company, Kaneb Services LLC (the "Company"). The
consolidated financial statements reflect the results of operations of the
Company and its subsidiaries and Kaneb Pipe Line Partners, L.P. ("KPP").
The Company controls the operations of KPP through its 2% general partner
interest and 22% limited partner interest at September 30, 2002. All
significant intercompany transactions and balances have been eliminated.
The unaudited condensed consolidated financial statements of the Company
for the three and nine month periods ended September 30, 2002 and 2001,
have been prepared in accordance with accounting principles generally
accepted in the United States of America. Significant accounting policies
followed by the Company are disclosed in the notes to the consolidated
financial statements for the year ended December 31, 2001 and are included
in the Company's Annual Report on From 10-K for the year ended December 31,
2001. In the opinion of the Company's management, the accompanying
condensed consolidated financial statements contain the adjustments,
consisting of normal recurring accruals, necessary to present fairly the
consolidated financial position of the Company and its consolidated
subsidiaries at September 30, 2002 and the consolidated results of their
operations and cash flows for the periods ended September 30, 2002 and
2001. Operating results for the three and nine months ended September 30,
2002 are not necessarily indicative of the results that may be expected for
the year ending December 31, 2002.
2. ACQUISITIONS AND FINANCINGS BY KPP
In January of 2001, KPP used proceeds from its $275 million revolving
credit agreement to repay in full its $128 million of mortgage notes. Under
the provisions of the mortgage notes, KPP incurred a $6.5 million
prepayment penalty which, net of income taxes and interest of outside
non-controlling partners in KPP's net income, was recognized as an
extraordinary expense in the first quarter of 2001.
In January of 2001, KPP, through a wholly-owned subsidiary, acquired Shore
Terminals LLC ("Shore") for $107 million in cash and 1,975,090 KPP limited
partnership units (valued at $56.5 million on the date of agreement and its
announcement). Financing for the cash portion of the purchase price was
supplied under KPP's revolving credit agreement. The acquisition was
accounted for using the purchase method of accounting. As a result of KPP
issuing additional units to unrelated parties, the Company's share of net
assets of KPP increased by $9.9 million. Accordingly, the Company
recognized a $9.9 million gain, before deferred income taxes of $3.8
million, in the first quarter of 2001.
In January of 2002, KPP issued 1,250,000 limited partnership units in a
public offering at $41.65 per unit, generating approximately $49.7 million
in net proceeds. The proceeds were used to reduce the amount of
indebtedness outstanding 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 a $8.6 million gain in the first quarter of 2002.
In February of 2002, Kaneb Pipe Line Operating Partnership, L.P. ("KPOP"),
an operating subsidiary of 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").
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 funded by KPP's revolving credit agreement and proceeds from KPOP's
February 2002 public debt offering. Assuming the acquisition occurred on
January 1, 2001, unaudited pro forma revenues, net income, basic earnings
per share and diluted earnings per share would have been $510.4 million,
$34.2 million, $2.98 and $2.91, respectively, for the nine months ended
September 30, 2002. Unaudited pro forma revenues, net income, basic
earnings per share and diluted earnings per share would have been $181.7
million, $5.9 million, $0.54 and $0.52, respectively, for the three months
ended September 30, 2001 and $574.1 million, $25.3 million, $2.36 and
$2.23, respectively for the nine months ended September 30, 2001.
In connection with the acquisition of Statia, KPP is in the process of
finalizing and implementing a plan to integrate Statia's businesses with
KPP's existing operations. The plan, when finalized, is expected to provide
for the severance and relocation of certain administrative and operating
employees and activities. Costs associated with implementation, which will
be recorded in the final allocation of the Statia purchase price, will
include employee severance benefits, relocation costs and lease costs. The
plan is expected to be finalized and implemented by December 31, 2002. At
September 30, 2002, $4.6 million was accrued by KPP for such costs.
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, net
of interest of outside non-controlling partners in KPP's net income, was
recognized as an extraordinary expense in the second quarter of 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 KPOP'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 a $8.8 million gain in the
second quarter of 2002.
On September 18, 2002, KPOP acquired eight bulk liquid storage terminals in
Australia and New Zealand from Burns Philp & Co. Ltd. for approximately $44
million in cash, subject to adjustment based on a closing date balance
sheet.
On November 1, 2002, KPOP acquired an approximately 2,000 mile anhydrous
ammonia pipeline system from Koch Pipeline Company, L.P. for $140 million
in cash, subject to normal post-closing adjustments. The acquisition was
financed by bank debt maturing in May of 2003.
In November of 2002, KPP issued 2,000,000 limited partnership units in a
public offering at $33.36 per unit, generating approximately $63.7 million
in net proceeds. The offering proceeds were used to reduce bank borrowings
for the Koch pipeline acquisition. As a result of KPP issuing additional
units to unrelated parties, the Company's share of net assets of KPP
increased by $7.3 million. Accordingly, the Company will recognize a $7.3
million gain in the fourth quarter of 2002.
3. COMPREHENSIVE INCOME
Comprehensive income for the three and nine months ended September 30, 2002
and 2001 is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- -----------------------------
2002 2001 2002 2001
---------------- ------------- ------------- --------------
(in thousands)
Net income $ 6,673 $ 5,956 $ 34,421 $ 25,069
Foreign currency translation
adjustment 75 183 280 (52)
Unrealized loss on KPP interest rate
hedging transaction (note 8) (1,240) - (1,240) -
---------------- ------------- ------------- --------------
Comprehensive income $ 5,508 $ 6,139 $ 33,461 $ 25,017
================ ============= ============= ==============
Accumulated other comprehensive income (loss) aggregated ($1.5) million and
($0.5) million at September 30, 2002 and December 31, 2001, respectively.
4. CASH DISTRIBUTIONS
The Company expects to make quarterly distributions of 100% of its
available cash, as defined in its limited liability company agreement, to
common shareholders of record on the applicable record date, within 45 days
after the end of each quarter. Available cash consists generally of all of
the cash receipts of the Company, plus the beginning cash balance less all
of its cash disbursements and reserves. Excess cash flow from the Company's
Product Marketing Operations is being used to reduce working capital
borrowings. Cash distributions of $0.4125 per share with respect to the
first and second quarters of 2002 were paid on May 15, 2002 and August 14,
2002, respectively. A cash distribution of $0.4125 per share with respect
to the third quarter of 2002 will be paid on November 14, 2002.
5. EARNINGS PER SHARE
Earnings per share for the three and nine month periods ended September 30,
2002, has been calculated using the Company's basic and diluted weighted
average shares outstanding for the period. For the periods presented prior
to the Distribution (See Note 1), the basic weighted average shares were
calculated by adjusting Xanser's historical basic weighted average shares
outstanding for the applicable period to reflect the number of the
Company's shares that would have been outstanding at the time assuming the
distribution of one Company common share for each three shares of Xanser
common stock. The diluted weighted average shares used for such periods,
reflect an estimate of the potential dilutive effect of common stock
equivalents, based on Xanser's dilutive effect of common stock equivalents.
For the three and nine month periods ended September 30, 2002, basic and
diluted weighted average shares outstanding were 11,459,000 and 11,751,000,
and 11,446,000 and 11,756,000, respectively. For the three and nine month
periods ended September 30, 2001, basic and diluted weighted average shares
outstanding 10,914,000 and 11,350,000, and 10,730,000 and 11,348,000,
respectively.
6. COMMITMENTS AND CONTINGENCIES
Pursuant to the Distribution, the Company entered into an agreement (the
"Distribution Agreement") with Xanser whereby the Company is obligated to
pay Xanser an amount equal to certain expenses and tax liabilities incurred
by Xanser in connection with the Distribution. The distribution of the
Company's common shares is taxable to Xanser, which will recognize taxable
income to the extent of the excess of the value of the Company's common
shares distributed over the tax basis of the Company's assets in the hands
of Xanser. Xanser will use all of its available net operating loss
carryforwards to reduce that taxable income, but the total amount of
taxable income is expected to exceed such net operating loss carryforwards,
and the Distribution Agreement obligates the Company to pay Xanser amounts
calculated based on whatever tax is due on the net amount of income. The
Company cannot currently determine exactly what this amount will be and
what the tax will be. 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 in the current year and the
preceding years. 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 operations of KPP are subject to Federal, state and local laws and
regulations in the United States and various foreign locations relating to
protection of the environment. Although KPP believes its operations are in
general compliance with applicable environmental regulations, risks of
additional costs and liabilities are inherent in pipeline and terminal
operations, and there can be no assurance that significant costs and
liabilities will not be incurred by KPP. Moreover, it is possible that
other developments, such as increasingly stringent environmental laws,
regulations and enforcement policies thereunder, and claims for damages to
property or persons resulting from the operations of KPP, could result in
substantial costs and liabilities to KPP.
Certain subsidiaries of KPP were sued in a Texas state court in 1997 by
Grace Energy Corporation ("Grace"), the entity from which KPP acquired ST
Services in 1993. The lawsuit involves environmental response and
remediation costs allegedly resulting from jet fuel leaks in the early
1970's from a pipeline. The pipeline, which connected a former Grace
terminal with Otis Air Force Base in Massachusetts (the "Otis pipeline" or
the "pipeline"), ceased operations in 1973 and was abandoned before 1978,
when the connecting terminal was sold to an unrelated entity. Grace alleged
that subsidiaries of KPP acquired the abandoned pipeline, as part of the
acquisition of ST Services in 1993 and assumed responsibility for
environmental damages allegedly caused by the jet fuel leaks. Grace sought
a ruling from the Texas court that these subsidiaries are responsible for
all liabilities, including all present and future remediation expenses,
associated with these leaks and that Grace has no obligation to indemnify
these subsidiaries for these expenses. In the lawsuit, Grace also sought
indemnification for expenses of approximately $3.5 million that it incurred
since 1996 for response and remediation required by the State of
Massachusetts and for additional expenses that it expects to incur in the
future. The consistent position of KPP's subsidiaries has been that they
did not acquire the abandoned pipeline as part of the 1993 ST Services
transaction, and therefore did not assume any responsibility for the
environmental damage nor any liability to Grace for the pipeline.
At the end of the trial, the jury returned a verdict including findings
that (1) Grace had breached a provision of the 1993 acquisition agreement
by failing to disclose matters related to the pipeline, and (2) the
pipeline was abandoned before 1978 -- 15 years before KPP's subsidiaries
acquired ST Services. On August 30, 2000, the Judge entered final judgment
in the case that Grace take nothing from the subsidiaries on its claims
seeking recovery of remediation costs. Although KPP's subsidiaries have not
incurred any expenses in connection with the remediation, the court also
ruled, in effect, that the subsidiaries would not be entitled to
indemnification from Grace if any such expenses were incurred in the
future. Moreover, the Judge let stand a prior summary judgment ruling that
the pipeline was an asset acquired by KPP's subsidiaries as part of the
1993 ST Services transaction and that any liabilities associated with the
pipeline would have become liabilities of the subsidiaries. Based on that
ruling, the Massachusetts Department of Environmental Protection and Samson
Hydrocarbons Company (successor to Grace Petroleum Company) wrote letters
to ST Services alleging its responsibility for the remediation, and ST
Services responded denying any liability in connection with this matter.
The Judge also awarded attorney fees to Grace of more than $1.5 million.
Both KPP's subsidiaries and Grace have appealed the trial court's final
judgment to the Texas Court of Appeals in Dallas. In particular, the
subsidiaries have filed an appeal of the judgment finding that the Otis
pipeline and any liabilities associated with the pipeline were transferred
to them as well as the award of attorney fees to Grace.
On April 2, 2001, Grace filed a petition in bankruptcy, which created an
automatic stay against actions against Grace. This automatic stay covers
the appeal of the Dallas litigation, and the Texas Court of Appeals has
issued an order staying all proceedings of the appeal because of the
bankruptcy. Once that stay is lifted, KPP's subsidiaries that are party to
the lawsuit intend to resume vigorous prosecution of the appeal.
The Otis Air Force Base is a part of the Massachusetts Military Reservation
("MMR Site"), which has been declared a Superfund Site pursuant to CERCLA.
The MMR Site contains nine 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 and the United States Coast Guard, pursuant to a
Federal Facilities Agreement, have 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 two 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.
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 it 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. Those electing not to participate in the settlement
include 23 plaintiffs in a lawsuit in Maryland state court who allege
damage to their property from the oil spill, two individuals who have filed
separate lawsuits alleging damage to their property from the oil spill, as
well as a small number of other individuals who have not filed lawsuits and
whose intentions are currently unknown to ST Services. ST Services'
insurance carrier has assumed the defense of the continuing actions and ST
Services believes that the carrier would assume the defense of any new
litigation by a non-participant in the settlement, should any such
litigation be commenced. While KPP cannot predict the amount, if any, of
any liability it may have in the continuing actions or in other potential
suits relating to this matter, it believes that the current and potential
plaintiffs' claims will be covered by insurance and therefore these actions
will not have a material adverse effect on its financial condition.
PEPCO and ST Services have 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. ST Services' insurer has paid ST
Services' agreed 50 percent share of these assessment costs. The assessment
process is substantially complete and ST Services anticipates that the
federal government and the state of Maryland will conclude that a total of
approximately $2.7 million of compensable natural resource damages occurred
as a result of the oil spill. ST Services has no agreement at this time
with the federal government or the State of Maryland, nor with PEPCO,
concerning payment for natural resource damages or restoration of damaged
resources. KPP believes that both the assessment costs and such damages are
covered by insurance and therefore will not materially adversely affect
KPP's financial condition.
The U.S. Department of Transportation ("DOT") has issued a Notice of
Proposed Violation to PEPCO and ST Services alleging violations over
several years of pipeline safety regulations and proposing a civil penalty
of $647,000 jointly against the two companies. ST Services and PEPCO have
contested the DOT allegations and the proposed penalty. A hearing was held
before the Office of Pipeline Safety at the DOT in late 2001. ST Services
does not anticipate any further hearings on the subject and is still
awaiting the DOJ's ruling.
By letter dated January 4, 2002, the Attorney General's Office for the
State of Maryland advised ST Services that it intended to seek penalties
from ST Services in connection with the April 7, 2000 spill. The State of
Maryland subsequently asserted that it would seek penalties against ST
Services and PEPCO totaling up to $12 million. A settlement of this claim
has been reached in principle 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.
The Company, primarily KPP, has other contingent liabilities resulting from
litigation, claims and commitments incident to the ordinary course of
business. Management believes, based on the advice of counsel, that the
ultimate resolution of such contingencies will not have a materially
adverse effect on the financial position or results of operations of the
Company.
7. BUSINESS SEGMENT DATA
The Company conducts business through three principal segments; the
"Pipeline Operations" of KPP, which consists primarily of the
transportation of refined petroleum products in the Midwestern states as a
common carrier, the "Terminaling Operations" of KPP, which provide storage
for petroleum products, specialty chemicals and other liquids, and the
"Product Marketing Operations," which provides wholesale motor fuel
marketing services throughout the Midwest and Rocky Mountain regions and,
since KPP's acquisition of Statia (see Note 2), delivers bunker fuels to
ships in the Caribbean and Nova Scotia, Canada and sells bulk petroleum
products to various commercial interests. General corporate includes
accounting, tax, finance, legal, investor relations and other corporate
expenses not related to the segments. General corporate assets include
cash, receivables from affiliates of the Company and other assets not
related to the segments.
The Company measures segment profit as operating income. Total assets are
those assets controlled by each reportable segment. Business segment data
is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- -------------------------------
2002 2001 2002 2001
------------- -------------- ------------- --------------
(in thousands)
Business segment revenues:
Pipeline operations $ 20,998 $ 20,195 $ 57,946 $ 55,155
Terminaling operations 54,186 33,208 150,000 99,269
Product marketing operations 108,935 77,260 277,828 264,491
------------- -------------- ------------- --------------
$ 184,119 $ 130,663 $ 485,774 $ 418,915
============= ============== ============= ==============
Business segment profit:
Pipeline operations $ 9,487 $ 9,827 $ 27,421 $ 26,640
Terminaling operations 18,478 12,249 50,962 35,642
Product marketing operations 803 1,013 2,937 749
General corporate (262) (363) (1,302) (862)
------------- -------------- ------------- --------------
Operating income 28,506 22,726 80,018 62,169
Interest and other income 259 123 482 4,230
Interest expense (7,478) (3,560) (20,944) (12,726)
------------- -------------- ------------- --------------
Income before gain on issuance
of units by KPP, income taxes,
interest of outside non-
controlling partners in
KPP's net income and
extraordinary item $ 21,287 $ 19,289 $ 59,556 $ 53,673
============= ============== ============= ==============
September 30, December 31,
2002 2001
------------- --------------
(in thousands)
Total assets:
Pipeline operations $ 112,564 $ 105,156
Terminaling operations 830,413 443,215
Product marketing operations 35,214 19,313
General corporate 7,721 4,083
------------- --------------
$ 985,912 $ 571,767
============= ==============
8. DERIVATIVE INSTRUMENTS
In August of 2000, KPOP filed a shelf registration statement on Form S-3
for the issuance of up to $500 million of public debt securities. At
September 30, 2002, $250 million remained available for issuance under the
shelf registration statement. In September of 2002, KPOP 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
called for a net cash settlement on the maturity date, based on the
difference between the contract's fixed interest rate and the applicable US
Treasury yield on maturity. As the Treasury Lock Contract qualified as a
cash flow hedging instrument under Statement of Financial Accounting
Standards ("SFAS") No. 133, unrealized gains and losses for the applicable
reporting period are recorded in other comprehensive income, along with an
asset or liability in the same amount, based on the fair value of the
contract. Upon completion of the anticipated public debt offering, the gain
or loss realized on the Treasury Lock Contract at settlement date would be
recognized as a component of interest expense over the life of the public
debt instrument. At September 30, 2002, the Company had an unrealized loss
of approximately $5.3 million, before interest of outside non-controlling
partners in KPP's net income of $4.0 million, which was recognized in other
comprehensive income in the third quarter of 2002.
In October of 2002, KPOP, 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 will be recognized as a component of net income in the fourth
quarter of 2002.
9. ADOPTION OF RECENT ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and
Other Intangible Assets" ("SFAS No. 142"), which eliminates the
amortization for goodwill 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. As of September 30, 2002, 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 independent valuation consultants and the Company in
the second quarter of 2002, the Company determined that the implied fair
value of its goodwill exceeded carrying value, and therefore, no impairment
charge was necessary. Goodwill amortization included in the results of
operations of the Company for the three and nine months ended September 30,
2001 was not material.
Additionally, effective January 1, 2002, the Company adopted 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, which superceded SFAS
No. 121, did not have a material impact on the consolidated financial
statements of the Company.
KANEB SERVICES LLC (PARENT COMPANY) Schedule I
CONDENSED STATEMENTS OF INCOME
(In Thousands - Except Per Share Amounts)
(Unaudited)
Three Months Nine Months
Ended Ended
September 30, 2002 September 30, 2002
------------------ ------------------
General and administrative expenses $ (430) $ (1,371)
Interest expense (195) (533)
Interest and other income 2 6
Equity in earnings of subsidiaries 7,296 36,319
------------- ------------
Net income $ 6,673 $ 34,421
============= ============
Earnings per share:
Basic $ .58 $ 3.01
============= ============
Diluted $ .57 $ 2.93
============= ============
See "Notes to Consolidated Financial Statements" of
Kaneb Services LLC included in this report.
15
KANEB SERVICES LLC (PARENT COMPANY) Schedule I
(Continued)
CONDENSED BALANCE SHEETS
(In Thousands)
- --------------------------------------------------------------------------------
September 30, December 31,
2002 2001
------------- ----------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 2,755 $ 1,369
Prepaid expenses and other 3,500 601
------------- -------------
Total current assets 6,255 1,970
------------- -------------
Investments in and advances to subsidiaries 81,344 62,358
Other assets 636 719
------------- -------------
$ 88,235 $ 65,047
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 3,886 $ 904
Accrued distributions payable to shareholders 4,749 4,131
------------- -------------
Total current liabilities 8,635 5,035
------------- -------------
Long-term debt 19,125 9,125
Long-term payables and other liabilities 6,698 16,955
Commitments and contingencies
Shareholders' equity 53,777 33,932
------------- -------------
$ 88,235 $ 65,047
============= =============
See "Notes to Consolidated Financial Statements" of
Kaneb Services LLC included in this report.
16
KANEB SERVICES LLC (PARENT COMPANY) Schedule I
(Continued)
CONDENSED STATEMENT OF CASH FLOWS
(In Thousands)
(Unaudited)
- --------------------------------------------------------------------------------
Nine Months Ended
September 30, 2002
------------------
Operating activities:
Net income $ 34,421
Adjustments to reconcile net income to net cash provided
by operating activities:
Equity in earnings of subsidiaries, net of distributions (20,226)
Changes in current assets and liabilities 83
------------
Net cash provided by operating activities 14,278
------------
Investing activities:
Changes in other assets 83
------------
Net cash provided by investing activities 83
------------
Financing activities:
Issuance of debt 10,000
Issuance of common shares 648
Distributions to shareholders (13,602)
Changes in long-term payables and other liabilities (10,021)
------------
Net cash used in financing activities (12,975)
------------
Increase in cash and cash equivalents 1,386
Cash and cash equivalents at beginning of period 1,369
------------
Cash and cash equivalents at end of period $ 2,755
============
See "Notes to Consolidated Financial Statements" of
Kaneb Services LLC included in this report.
17
KANEB SERVICES LLC AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
- --------------------------------------------------------------------------------
This discussion should be read in conjunction with the consolidated
financial statements of Kaneb Services LLC (the "Company") and notes
thereto included elsewhere in this report.
Operating Results:
Pipeline Operations
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
(in thousands)
Revenues $ 20,998 $ 20,195 $ 57,946 $ 55,155
Operating costs 9,511 8,448 23,602 22,356
Depreciation and amortization 1,385 1,324 4,132 3,937
General and administrative 615 596 2,791 2,222
----------- ----------- ----------- -----------
Operating income $ 9,487 $ 9,827 $ 27,421 $ 26,640
=========== =========== =========== ===========
Pipeline revenues are based on volumes shipped and the distances over which
such volumes are transported. For the three and nine month periods ended
September 30, 2002, revenues increased by 4% and 5%, respectively, compared
to the same 2001 periods, due to higher per barrel rates realized on
volumes shipped. Barrel miles totaled 5.0 billion for each of the three
month periods ended September 30, 2002 and 2001, respectively, and 13.7
billion and 13.9 billion for the nine months ended September 30, 2002 and
2001, respectively.
Operating costs, which include fuel and power costs, materials and
supplies, maintenance and repair costs, salaries, wages and employee
benefits, and property and other taxes, increased by $1.1 million and $1.2
million for the three and nine month periods ended September 30, 2002,
respectively, when compared to 2001, due primarily to expenditures for
routine repairs and maintenance. General and administrative costs, which
include managerial, accounting, and administrative personnel costs, office
rental and expense, legal and professional costs and other non-operating
costs, remained relatively flat for the three month period ended September
30, 2002, and increased by $0.6 million for the nine months ended September
30, 2002, due primarily to first quarter 2002 increases in professional
services and personnel related costs.
18
Terminaling Operations
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
(in thousands)
Revenues $ 54,186 $ 33,208 $ 150,000 $ 99,269
Operating costs 23,445 14,948 65,833 44,977
Depreciation and amortization 8,728 4,300 22,813 13,389
General and administrative 3,535 1,711 10,392 5,261
----------- ----------- ----------- -----------
Operating income $ 18,478 $ 12,249 $ 50,962 $ 35,642
=========== =========== =========== ===========
Terminaling revenues increased by $21.0 million and $50.7 million,
respectively, for the three and nine month periods ended September 30,
2002, compared to the same 2001 periods, due to the Statia acquisition (see
"Liquidity and Capital Resources") and overall increases in utilization at
existing locations. Average annual tankage utilized for the three and nine
month periods ended September 30, 2002 increased to 47.8 million and 45.3
million barrels, respectively, up from 30.0 million and 30.1 million
barrels, respectively, for the comparable prior year periods. For the three
and nine month periods ended September 30, 2002, average annualized
revenues per barrel of tankage utilized increased to $4.50 and $4.43 per
barrel, respectively, compared to $4.40 and $4.42 per barrel, respectively,
for the same prior year periods.
For the three and nine month periods ended September 30, 2002, operating
costs increased by $8.5 million and $20.9 million, respectively, when
compared to the same 2001 periods, the result of the Statia acquisition and
increases in volumes stored. General and administrative costs for the three
and nine month periods ended September 30, 2002, increased by $1.8 million
and $5.1 million, respectively, when compared to the same 2001 periods, due
to the Statia acquisition and overall increases in personnel costs.
Product Marketing Operations
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
(in thousands)
Revenues $ 108,935 $ 77,260 $ 277,828 $ 264,491
Cost of products sold 105,059 75,773 268,727 262,296
----------- ----------- ----------- -----------
Gross margin $ 3,876 $ 1,487 $ 9,101 $ 2,195
=========== =========== =========== ===========
Operating income $ 803 $ 1,013 $ 2,937 $ 749
=========== =========== =========== ===========
For the three and nine month periods ended September 30, 2002, revenues for
the product marketing business increased by $31.7 million and $13.3
million, respectively, when compared to the same 2001 periods. Included in
revenues for the three and nine month periods ended September 30, 2002 is
$28.1 million and $63.7 million, respectively, from the product marketing
business acquired with Statia on February 28, 2002. The increase in
revenues was the result of increases in sales volumes, a result of the
Statia acquisition, partially offset by an overall decrease in the average
price realized per gallon of product sold. Total gallons sold aggregated
140 million and 83 million for the three months ended September 30, 2002
and 2001, respectively, and 385 million and 274 million for the nine months
ended September 30, 2002 and 2001, respectively. For the three and nine
months ended September 30, 2002, the average price realized per gallon of
product sold was $0.78 and $0.72, respectively, compared to $0.93 and
$0.96, respectively, for the same 2001 periods.
Gross margin increased by $2.4 million and $6.9 million for the three and
nine month periods ended September 30, 2002, respectively, when compared to
the same 2001 periods, due to the increase in volumes sold and favorable
product margins. Operating income decreased by $0.2 million for the three
months ended September 30, 2002 and increased by $2.2 million for the nine
months ended September 30, 2002, when compared to the same 2001 periods.
The decrease in third quarter operating income was due to charges resulting
from increases in the allowance for doubtful accounts receivable, partially
offset by increases in volumes sold and the favorable product margins. The
increase in operating income for the nine months ended September 30, 2002
is also due to the increase in volumes sold and favorable product margins,
partially offset by charges resulting from increases to the allowance for
doubtful accounts receivable. 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 March of 2001, a wholly-owned subsidiary of KPP entered into two
contracts for the purpose of locking in interest rates on $100 million of
anticipated ten-year public debt offerings. As the interest rate locks were
not designated as hedging instruments pursuant to the requirements of
Statement of Financial Accounting Standards ("SFAS") No. 133, increases or
decreases in the fair value of the contracts are included as a component of
interest and other income. On May 22, 2001, the contracts were settled
resulting in an aggregate gain of $3.8 million.
Interest Expense
For the three and nine months ended September 30, 2002, interest expense
increased by $3.9 million and $8.2 million, respectively, when compared to
the same 2001 periods, due primarily to increases in KPP debt resulting
from the Statia acquisition, partially offset by overall declines in
variable interest rates.
Income Tax Provision
Tax expense reported in the consolidated financial statements for the nine
months ended September 30, 2001 represents the tax expense of the Company
and its subsidiaries as if they had filed on a separate return basis. As a
result of the Distribution on June 29, 2001 (See "Note 1 to Consolidated
Financial Statements"), the Company no longer participates with Xanser
Corporation in filing a consolidated Federal income tax return. Effective
with the Distribution on June 29, 2001, the Company became a pass-through
entity with its income, for Federal and, generally, for state purposes,
taxed at the shareholder level instead of the Company paying such taxes. As
a result of the change in tax status of the Company, all deferred income
tax assets and liabilities relating to temporary differences (a net $8.6
million deferred tax liability) were eliminated, resulting in a credit to
income tax expense in the second quarter of 2001.
Certain KPP terminaling operations are conducted through separate taxable
wholly-owned corporate subsidiaries. The income tax expense for these
subsidiaries, including those acquired from Statia, for the three months
ended September 30, 2002 and 2001 was $1.4 million and $0.3 million,
respectively. For the nine months ended September 30, 2002 and 2001, income
tax expense for KPP's taxable subsidiaries was $3.0 million and $0.6
million, respectively.
Liquidity and Capital Resources
During the first nine months of 2002, the Company's working capital
requirements for its and KPP's operations and capital expenditures
(excluding acquisitions) were funded through the use of internally
generated funds.
Cash provided by operating activities, including the operations of KPP, was
$68.2 million and $83.9 million for the nine months ended September 30,
2002 and 2001, respectively. The decrease in cash provided by operations
for the nine months ended September 30, 2002, compared to the same 2001
period, was due to changes in working capital components resulting from the
timing of cash receipts and disbursements. Consolidated capital
expenditures (excluding acquisitions) were $21.9 million for the nine
months ended September 30, 2002, compared to $9.6 million during the same
2001 period. The increase in 2002 capital expenditures, when compared to
2001, is the result of higher than normal 2002 maintenance capital
expenditures in both the pipeline and terminaling businesses and
maintenance capital expenditures related to the acquired Statia operations.
In July of 2001, the Company entered into an agreement with a bank that
provides for a $50 million revolving credit facility through July 1, 2008.
The credit facility, which bears interest at variable rates, is secured by
4.6 million KPP limited partnership units and has a variable rate
commitment fee on unused amounts. At September 30, 2002, $19.1 million was
drawn on the credit facility, at an interest rate of 3.03%.
KPP has a credit agreement with a group of banks that provides for a $275
million unsecured revolving credit facility through December 2003. The
credit facility, which is without recourse to the Company, bears interest
at variable rates and has a variable commitment fee on unutilized amounts.
The credit facility contains financial and operational covenants, including
limitations on investments, sales of assets and transactions with
affiliates, and absent an event of default, those covenants do not restrict
distributions to the Company or the other partners. At September 30, 2002,
$243.0 million was drawn on the facility, at an interest rate of 3.12%.
In January of 2001, KPP used proceeds from its $275 million revolving
credit agreement to repay in full its $128 million of mortgage notes. Under
the provisions of the mortgage notes, KPP incurred a $6.5 million
prepayment penalty which, net of income taxes and interest of outside
non-controlling partners in KPP's net income, was recognized as an
extraordinary expense in the first quarter of 2001.
In January of 2001, KPP, through a wholly-owned subsidiary, acquired Shore
Terminals LLC ("Shore") for $107 million in cash and 1,975,090 KPP limited
partnership units (valued at $56.5 million on the date of agreement and its
announcement). Financing for the cash portion of the purchase price was
supplied under KPP's revolving credit agreement. The acquisition was
accounted for using the purchase method of accounting. As a result of KPP
issuing additional units to unrelated parties, the Company's share of net
assets of KPP increased by $9.9 million. Accordingly, the Company
recognized a $9.9 million gain, before deferred income taxes of $3.8
million, in the first quarter of 2001.
In January of 2002, KPP issued 1,250,000 limited partnership units in a
public offering at $41.65 per unit, generating approximately $49.7 million
in net proceeds. The proceeds were used to reduce the amount of
indebtedness outstanding 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 a $8.6 million gain in the first quarter of 2002.
In February of 2002, Kaneb Pipe Line Operating Partnership, L.P. ("KPOP"),
an operating subsidiary of 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").
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 funded by KPP's revolving credit agreement and proceeds from KPOP'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, net
of interest of outside non-controlling partners in KPP's net income, was
recognized as an extraordinary expense in the second quarter of 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 KPOP'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 a $8.8 million gain in the
second quarter of 2002.
On September 18, 2002, KPOP acquired eight bulk liquid storage terminals in
Australia and New Zealand from Burns Philp & Co. Ltd. for approximately $44
million in cash, subject to adjustment based on a closing date balance
sheet.
On November 1, 2002, KPOP acquired an approximately 2,000 mile anhydrous
ammonia pipeline system from Koch Pipeline Company, L.P. for $140 million
in cash, subject to normal post-closing adjustments. The acquisition was
financed by bank debt maturing in May of 2003.
In November of 2002, KPP issued 2,000,000 limited partnership units in a
public offering at $33.36 per unit, generating approximately $63.7 million
in net proceeds. The offering proceeds were used to reduce bank borrowings
for the Koch pipeline acquisition. As a result of KPP issuing additional
units to unrelated parties, the Company's share of net assets of KPP
increased by $7.3 million. Accordingly, the Company will recognize a $7.3
million gain in the fourth quarter of 2002.
In August of 2000, KPOP filed a shelf registration statement on Form S-3
for the issuance of up to $500 million of public debt securities. At
September 30, 2002, $250 million remained available for issuance under the
shelf registration statement. In September of 2002, KPOP 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
called for a net cash settlement on the maturity date, based on the
difference between the contract's fixed interest rate and the applicable US
Treasury yield on maturity. As the Treasury Lock Contract qualified as a
cash flow hedging instrument under SFAS No. 133, unrealized gains and
losses for the applicable reporting period are recorded in other
comprehensive income, along with an asset or liability in the same amount,
based on the fair value of the contract. Upon completion of the anticipated
public debt offering, the gain or loss realized on the Treasury Lock
Contract at settlement date would be recognized as a component of interest
expense over the life of the public debt instrument. At September 30, 2002,
the Company had an unrealized loss of approximately $5.3 million, before
interest of outside non-controlling partners in KPP's net income of $4.0
million, which was recognized in other comprehensive income in the third
quarter of 2002. In October of 2002, KPOP, 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 will be recognized as a component of
net income in the fourth quarter of 2002.
The Company expects to make quarterly distributions of 100% of its
available cash, as defined in its limited liability company agreement, to
common shareholders of record on the applicable record date, within 45 days
after the end of each quarter. Available cash consists generally of all of
the cash receipts of the Company, plus the beginning cash balance less all
of its cash disbursements and reserves. Excess cash flow from the Company's
Product Marketing Operations is being used to reduce working capital
borrowings. Cash distributions of $0.4125 per share with respect to the
first and second quarters of 2002 were paid on May 15, 2002 and August 14,
2002, respectively. A cash distribution of $0.4125 per share with respect
to the third quarter of 2002 will be paid on November 14, 2002.
The Company expects to fund its future cash distributions with existing
cash and anticipated cash flows from operations. KPP expects to fund future
cash distributions and maintenance capital expenditures 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 unit or debt offerings.
Additional information related to the sources and uses of cash is presented
in the financial statements included in this report.
Information regarding the Company's Critical Accounting Policies is
included in Item 7 of the Company's Annual Report on Form 10-K for the year
ended December 31, 2001.
Recent Accounting Pronouncements
The FASB has issued SFAS No. 143 "Accounting for Asset Retirement
Obligations", which establishes requirements for the removal-type costs
associated with asset retirements. The Company is currently assessing the
impact of SFAS No. 143, which must be adopted in the first quarter of 2003.
In April of 2002, the FASB issued SFAS No. 145, which, among other items,
affects the income statement classification of gains and losses from early
extinguishment of debt. Under SFAS No. 145, which must be adopted by the
first quarter of 2003, early extinguishment of debt is now considered a
risk management strategy, with resulting gains and losses no longer
classified an extraordinary item, unless the debt extinguishment meets
certain unusual in nature and infrequency of occurrence criteria, which is
expected to be rare. Upon adoption, companies must reclassify prior items
that do not meet the new extraordinary item classification criteria as a
component of operating income. Had the provisions of SFAS No. 145 been
applied at September 30, 2002, the extraordinary items (before interest of
outside non-controlling partners in KPP's net income and income taxes)
recorded for the nine month periods ended September 30, 2002 and 2001,
respectively, would be reclassified as components of operating income.
Adoption of SFAS No. 145 will have no effect on the net income of the
Company.
In July 2002, the FASB issued SFAS No. 146 "Accounting for Costs Associated
with Exit or Disposal Activities", which requires all restructurings
initiated after December 31, 2002 be recorded when they are incurred and
can be measured at fair value. The Company is currently assessing the
impact of SFAS No. 146, which must be adopted in the first quarter of 2003.
KANEB SERVICES LLC AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Item 3. Quantitative and Qualitative Disclosure About Market Risk
The principal market risks (i.e., the risk of loss arising from the adverse
changes in market rates and prices) to which the Company is exposed are interest
rates on the Company's debt and investment portfolios. 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 $267 million
(including KPP's debt) at September 30, 2002, a one percent increase in interest
rates would increase annual net interest expense by approximately $2.7 million.
Information regarding KPP's September 2002 interest rate hedging transaction is
included in "Liquidity and Capital Resources".
Item 4. Controls and Procedures
In its recent Release No. 34-46427, effective August 29, 2002, the SEC, among
other things, adopted rules requiring reporting companies to maintain disclosure
controls and procedures to provide reasonable assurance that a registrant is
able to record, process, summarize and report the information required in the
registrant's quarterly and annual reports under the Securities Act of 1934 (the
"Exchange Act"). While the Company believes that its disclosure controls and
procedures have been effective to accomplish these objectives, the Company
intends to continue to examine, refine and formalize its disclosure controls and
procedures and to monitor ongoing developments in this area.
The principal executive officer and the principal financial officer of the
Company have informed the Company that, based upon their evaluation within 90
days of the date of this filing of the Company's disclosure controls and
procedures (as defined in Rule 13a-14(c) and Rule 15d-14(c) under the Exchange
Act), they have concluded that those disclosure controls and procedures are
effective.
There have been no changes in the Company's internal controls or in the other
factors known to the Company that could significantly affect these controls
subsequent to their evaluation, nor have any corrective actions with regard to
significant deficiencies and material weaknesses been necessary.
Part II - Other Information
Item 1. Legal Proceedings
The information contained in Note 6 of the Notes to Consolidated Financial
Statements included in this report is hereby incorporated by reference.
26
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
3.01 Amended and Restated Limited Liability Company Agreement of
Registrant, filed as Exhibit 3.1 to the exhibits to Registrant's
Form 10-Q, for the period ended June 30, 2001, which exhibit is
hereby incorporated by reference.
10.01 Distribution Agreement by and between the Registrant and Kaneb
Services, Inc., filed as Exhibit 10.1 to the exhibits to
Registrant's Form 10-Q, for the period ended June 30, 2001, which
exhibit is hereby incorporated by reference.
10.02 Administrative Services Agreement by and between the Registrant
and Kaneb Services, Inc., filed as Exhibit 10.2 to the exhibits
to Registrant's Form 10-Q, for the period ended June 30, 2001,
which exhibit is hereby incorporated by reference.
10.03 Rights Agreement by and between the Registrant and The Chase
Manhattan Bank, filed as Exhibit 10.3 to the exhibits to
Registrant's Form 10-Q, for the period ended June 30, 2001, which
exhibit is hereby incorporated by reference.
10.04 Employee Benefits Agreement by and between the Registrant and
Kaneb Services, Inc., filed as Exhibit 10.04 to the exhibits to
Registrant's Form 10/A, dated May 24, 2001, which exhibit is
hereby incorporated by reference.
10.05 ST Agreement and Plan of Merger dated December 21, 1992 by and
among Grace Energy Corporation, Support Terminal Services, Inc.,
Standard Transpipe Corp., and Kaneb Pipe Line Operating
Partnership, NSTS, Inc. and NSTI, Inc., as amended by Amendment
of STS Merger Agreement dated March 2, 1993, filed as Exhibit
10.1 of the exhibits to Kaneb Pipe Line Partners, L.P.'s Current
Report on Form 8-K, dated March 16, 1993, which exhibit is hereby
incorporated by reference.
10.06 Agreement for Sale and Purchase of Assets between Wyco Pipe Line
Company and Kaneb Pipe Line Operating Partnership, L.P., dated
February 19, 1995, filed as Exhibit 10.1 of the exhibits to the
Kaneb Pipe Line Partners, L.P.'s March 1995 Form 8-K, which
exhibit is hereby incorporated by reference.
10.07 Asset Purchase Agreements between and among Steuart Petroleum
Company, SPC Terminals, Inc., Piney Point Industries, Inc.,
Steuart Investment Company, Support Terminals Operating
Partnership, L.P. and Kaneb Pipe Line Operating Partnership,
L.P., as amended, dated August 27, 1995, filed as Exhibits 10.1,
10.2, 10.3, and 10.4 of the exhibits to Kaneb Pipe Line Partners,
L.P's Current Report on Form 8-K dated January 3, 1996, which
exhibits are hereby incorporated by reference.
10.08 Second Amendment to Credit Agreement dated February 11, 2000
between Martin Oil Corporation and Harris Trust & Savings Bank,
filed as Exhibit 10.10 to the exhibits to Registrant's Form 10/A,
dated May 1, 2001, which exhibit is hereby incorporated by
reference.
10.09 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.
10.10 Agreement, by and among, GATX Terminals Limited, ST Services
Ltd., ST Eastham, Ltd., GATX Terminals Corporation, Support
Terminals Operating Partnership, L.P. and Kaneb Pipe Line
Partners, L.P., dated January 26, 1999, filed as Exhibit 10.10 to
the Kaneb Pipe Line Partners, L.P.'s Form 10-K for the year ended
December 31, 1998, which exhibit is hereby incorporated by
reference.
10.11 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.
10.12 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.
10.13 Securities Purchase Agreement by and among Shore Terminals LLC,
Kaneb Pipe Line Partners, L.P. and the Sellers Named Therein,
dated as of September 22, 2000, Amendment No. 1 To Securities
Purchase Agreement, dated as of November 28, 2000 and
Registration Rights Agreement, dated as of January 3, 2001, filed
as Exhibits 10.1, 10.2 and 10.3 of the exhibits to Kaneb Pipe
Line Partners, L.P.'s Current Report on Form 8-K dated January 3,
2001, which exhibits are hereby incorporated by reference.
10.14 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.
10.15 Credit Agreement by and between the Registrant and Kaneb
Services, Inc., filed as Exhibit 10.5 to the exhibits to
Registrant's Form 10-Q, for the period ended June 30, 2001, which
exhibit is hereby incorporated by reference. This credit
commitment was permanently terminated effective December 10,
2001.
10.16 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.
10.17 Asset Purchase and Sale Agreement, dated as of September 17,
2002, by and between Koch Pipeline Company, L.P., Koch Fertilizer
Storage and Terminal Company and Kaneb Pipe Line Operating
Partnership, L.P., filed as Exhibit 10.2 to the exhibits to
Registrant's Current Report on Form 8-K, dated November 1, 2002,
and incorporated herein by reference.
10.18 First Amendment to Asset Purchase and Sale Agreement, dated as
of October 31, 2002, by and between Koch Pipeline Company, L.P.,
Koch Fertilizer Storage and Terminal Company and Kaneb Pipe Line
Operating Partnership, L.P., filed as Exhibit 10.3 to the
exhibits to Registrant's Current Report on Form 8-K, dated
November 1, 2002, and incorporated herein by reference.
10.19 Bridge Loan Agreement, dated as of November 1, 2002, by and
between Kaneb Operating Partnership, L.P., Kaneb Pipe Line
Partners, L.P., the Lenders and SunTrust Bank as Administrative
Agent, filed as Exhibit 10.4 to the exhibits to Registrant's
Current Report on Form 8-K, dated November 1, 2002, and
incorporated herein by reference.
10.20 Subsidiary Guaranty Agreement, dated as of November 1, 2002,
among each of the Subsidiaries, Kaneb Pipe Line Operating
Partnership, L.P. and SunTrust Bank, filed as Exhibit 10.5 to the
exhibits to Registrant's Current Report on Form 8-K, dated
November 1, 2002, and incorporated herein by reference.
10.21 Amendment No. 1 to Revolving Credit Agreement, dated as of July
31, 2002, by and between Kaneb Operating Partnership, L.P., Kaneb
Pipe Line Partners, L.P., the Lenders and SunTrust Bank as
Administrative Agent, filed as Exhibit 10.6 to the exhibits to
Registrant's Current Report on Form 8-K, dated November 1, 2002,
and incorporated herein by reference.
10.22 Amendment No. 2 to Revolving Credit Agreement, dated as of
October 31, 2002, by and between Kaneb Operating Partnership,
L.P., Kaneb Pipe Line Partners, L.P., the Lenders and SunTrust
Bank as Administrative Agent, filed as Exhibit 10.7 to the
exhibits to Registrant's Current Report on Form 8-K, dated
November 1, 2002, and incorporated herein by reference.
(b) Reports on Form 8-K
None.
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned.
KANEB SERVICES LLC
(Registrant)
Date: November 14, 2002
//s//
------------------------------------------
Howard C. Wadsworth
Vice President, Treasurer and Secretary
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002
I, John R. Barnes, Chief Executive Officer of Kaneb Services LLC certify that:
1. I have reviewed this quarterly report on Form 10-Q of Kaneb Services LLC;
2. Based on my knowledge, this 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
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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 report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures and
internal controls and procedures for financial reporting (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we 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
issuer, including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the period in
which this report is being prepared;
b) Designed such internal controls and procedures for financial
reporting, or caused such internal controls and procedures for
financial reporting to be designed under their supervision, to provide
reasonable assurances that the registrant's financial statements are
fairly presented in conformity with generally accepted accounting
principles;
c) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and internal controls and procedures for financial
reporting as of the end of the period covered by this report
("Evaluation Date");
d) Presented in this report our conclusions about the effectiveness of
the disclosure controls and procedures and internal controls and
procedures for financial reporting based on our evaluation as of the
Evaluation Date;
e) Disclosed to the registrant's auditors and the audit committee of the
board of directors:
(i) All significant deficiencies and material weaknesses in the
design or operation of internal controls and procedures for
financial reporting which could adversely affect the registrant's
ability to record, process, summarize and report financial
information required to be disclosed by the registrant in the
reports that it files or submits under the Act (15 U.S.C. 78a et
seq.), within the time periods specified in the U.S. Securities
and Exchange Commission's rules and forms; and
(ii) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls and procedures for financial reporting; and
f) Indicated in this report any significant changes in the registrant's
internal controls and procedures for financial reporting or in other
factors that could significantly affect internal controls and
procedures for financial reporting made during the period covered by
this report, including any actions taken to correct significant
deficiencies and material weaknesses in the registrant's internal
controls and procedures for financial reporting.
Date: November 14, 2002
//s//
------------------------------------------
John R. Barnes
President and Chief Executive Officer
CERTIFICATION OF CHIEF FINANCIAL OFFICER
Pursuant to Section 302(a) 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 quarterly report on Form 10-Q of Kaneb Services LLC;
2. Based on my knowledge, this 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
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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 report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures and
internal controls and procedures for financial reporting (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we 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
issuer, including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the period in
which this report is being prepared;
b) Designed such internal controls and procedures for financial
reporting, or caused such internal controls and procedures for
financial reporting to be designed under their supervision, to provide
reasonable assurances that the registrant's financial statements are
fairly presented in conformity with generally accepted accounting
principles;
c) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and internal controls and procedures for financial
reporting as of the end of the period covered by this report
("Evaluation Date");
d) Presented in this report our conclusions about the effectiveness of
the disclosure controls and procedures and internal controls and
procedures for financial reporting based on our evaluation as of the
Evaluation Date;
e) Disclosed to the registrant's auditors and the audit committee of the
board of directors:
(i) All significant deficiencies and material weaknesses in the
design or operation of internal controls and procedures for
financial reporting which could adversely affect the registrant's
ability to record, process, summarize and report financial
information required to be disclosed by the registrant in the
reports that it files or submits under the Act (15 U.S.C. 78a et
seq.), within the time periods specified in the U.S. Securities
and Exchange Commission's rules and forms; and
(ii) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls and procedures for financial reporting; and
f) Indicated in this report any significant changes in the registrant's
internal controls and procedures for financial reporting or in other
factors that could significantly affect internal controls and
procedures for financial reporting made during the period covered by
this report, including any actions taken to correct significant
deficiencies and material weaknesses in the registrant's internal
controls and procedures for financial reporting.
Date: November 14, 2002
//s//
------------------------------------------
Howard C. Wadsworth
Vice President, Treasurer and Secretary
(Chief Financial Officer)
CERTIFICATE 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 the Company's Quarterly Report on Form 10-Q for
the quarterly period ended September 30, 2002, filed with the United States
Securities and Exchange Commission pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)), fully complies with
the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of
1934 and that information contained in such Quarterly Report fairly presents, in
all material respects, the financial condition and results of operations of the
Company.
Date: November 14, 2002
//s//
------------------------------------------
John R. Barnes
President and Chief Executive Officer
CERTIFICATE 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 the Company's Quarterly Report on Form 10-Q for
the quarterly period ended September 30, 2002, filed with the United States
Securities and Exchange Commission pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)), fully complies with
the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of
1934 and that information contained in such Quarterly Report fairly presents, in
all material respects, the financial condition and results of operations of the
Company.
Date: November 14, 2002
//s//
------------------------------------------
Howard C. Wadsworth
Vice President, Treasurer and Secretary
(Chief Financial Officer)