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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended September 30, 2003
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
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Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes X No
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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, 2003
- ---------------------- -------------------------------
No par value 11,518,125 shares
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KANEB SERVICES LLC AND SUBSIDIARIES
FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 2003
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Page No.
Part I. Financial Information
Item 1(a)(1). Financial Statements (Unaudited)
Consolidated Statements of Income - Three and Nine Months Ended
September 30, 2003 and 2002 1
Condensed Consolidated Balance Sheets - September 30, 2003
and December 31, 2002 3
Condensed Consolidated Statements of Cash Flows - Nine
Months Ended September 30, 2003 and 2002 4
Notes to Consolidated Financial Statements 5
(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, 2003 and 2002 18
Balance Sheets - September 30, 2003 and December 31, 2002 19
Statements of Cash Flows - Nine Months Ended
September 30, 2003 and 2002 20
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 21
Item 3. Quantitative and Qualitative Disclosure About Market Risk 28
Item 4. Controls and Procedures 28
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K 29
KANEB SERVICES LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands -- Except Per Share Amounts)
(Unaudited)
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Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- -----------------------------
2003 2002 2003 2002
-------------- ------------- ------------- --------------
Revenues:
Services $ 89,539 $ 75,184 $ 265,694 $ 207,946
Products 125,053 108,935 386,021 277,828
-------------- ------------- ------------- --------------
Total revenues 214,592 184,119 651,715 485,774
-------------- ------------- ------------- --------------
Costs and expenses:
Cost of products sold 119,767 105,059 366,531 268,727
Operating costs 42,577 34,303 126,965 92,555
Depreciation and amortization 13,198 10,313 39,845 27,440
General and administrative 6,799 5,938 19,694 17,034
-------------- ------------- ------------- --------------
Total costs and expenses 182,341 155,613 553,035 405,756
-------------- ------------- ------------- --------------
Operating income 32,251 28,506 98,680 80,018
Interest and other income 69 259 208 482
Interest expense (10,855) (7,478) (28,816) (20,944)
Loss on debt extinguishment - - - (2,112)
-------------- ------------- ------------- --------------
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 21,465 21,287 70,072 57,444
Gain on issuance of units by KPP - - 10,898 17,332
Income tax expense (969) (673) (3,597) (2,113)
Interest of outside non-controlling
partners in KPP's net income (14,634) (13,941) (49,151) (38,242)
-------------- ------------- ------------- --------------
Income before cumulative effect of
change in accounting principle 5,862 6,673 28,222 34,421
Cumulative effect of change in accounting
principle - adoption of new accounting
standard for asset retirement obligations - - (313) -
-------------- ------------- ------------- --------------
Net income $ 5,862 $ 6,673 $ 27,909 $ 34,421
============== ============= ============= ==============
See notes to consolidated financial statements.
1
KANEB SERVICES LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME - Continued
(In Thousands -- Except Per Share Amounts)
(Unaudited)
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Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- -----------------------------
2003 2002 2003 2002
-------------- ------------- ------------- --------------
Earnings per share:
Basic:
Before cumulative effect of change
in accounting principle $ .50 $ .58 $ 2.45 $ 3.01
Cumulative effect of change in
accounting principle - - (.03) -
-------------- ------------- ------------- -------------
$ .50 $ .58 $ 2.42 $ 3.01
============== ============= ============= =============
Diluted:
Before cumulative effect of change
in accounting principle $ .49 $ .57 $ 2.41 $ 2.93
Cumulative effect of change in
accounting principle - - (.03) -
-------------- ------------- ------------- -------------
$ .49 $ .57 $ 2.38 $ 2.93
============== ============= ============= =============
See notes to consolidated financial statements.
2
KANEB SERVICES LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands)
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September 30, December 31,
2003 2002
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(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 44,012 $ 24,477
Accounts receivable 64,122 61,835
Inventories 13,219 12,863
Prepaid expenses and other 9,083 10,658
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Total current assets 130,436 109,833
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Property and equipment 1,340,250 1,288,960
Less accumulated depreciation 233,632 196,684
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Net property and equipment 1,106,618 1,092,276
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Investment in affiliates 25,481 25,604
Excess of cost over fair value of net assets
of acquired business and other assets 20,921 16,388
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$ 1,283,456 $ 1,244,101
============= ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 27,143 $ -
Accounts payable 30,430 32,629
Accrued expenses 49,914 38,076
Accrued distributions payable to shareholders 5,559 4,734
Accrued distributions payable to outside
non-controlling partners in KPP 19,507 15,878
Accrued interest payable 8,604 7,997
Deferred terminaling fees 6,735 6,246
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Total current liabilities 147,892 105,560
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Long-term debt, less current portion 599,490 718,162
Other liabilities and deferred taxes 48,977 40,094
Interest of outside non-controlling partners in KPP 410,040 316,631
Commitments and contingencies
Shareholders' equity 77,057 63,654
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$ 1,283,456 $ 1,244,101
============= ==============
See notes to consolidated financial statements.
3
KANEB SERVICES LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
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Nine Months Ended
September 30,
----------------------------------------
2003 2002
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Operating activities:
Net income $ 27,909 $ 34,421
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 39,845 27,440
Equity in earnings of affiliates, net of distributions 123 (1,331)
Interest of outside non-controlling partners
in KPP's net income 49,151 38,242
Gain on issuance of units by KPP (10,898) (17,332)
Deferred income taxes 2,361 2,323
Cumulative effect of change in accounting principle 313 -
Changes in working capital components 6,512 (17,635)
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Net cash provided by operating activities 115,316 66,128
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Investing activities:
Acquisitions by KPP, net of cash acquired (1,644) (225,406)
Capital expenditures (32,059) (21,934)
Other, net (2,196) 760
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Net cash used in investing activities (35,899) (246,580)
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Financing activities:
Issuance of debt 286,360 506,087
Payment of debt (387,055) (352,098)
Distributions to shareholders (14,915) (13,602)
Distributions to outside non-controlling
partners in KPP (53,498) (38,603)
Net proceeds from issuance of units by KPP 109,056 108,790
Changes in long-term payables and other liabilities - (10,532)
Other 170 648
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Net cash provided by (used in) financing activities (59,882) 200,690
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Increase in cash and cash equivalents 19,535 20,238
Cash and cash equivalents at beginning of period 24,477 10,004
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Cash and cash equivalents at end of period $ 44,012 $ 30,242
============= ==============
Supplemental cash flow information:
Cash paid for interest $ 26,489 $ 20,828
============= ==============
See notes to consolidated financial statements.
4
KANEB SERVICES LLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
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1. SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements reflect the results of operations of
Kaneb Services LLC (the "Company"), its wholly-owned subsidiaries and Kaneb
Pipe Line Partners, L.P. ("KPP"). The Company controls the operations of
KPP through its 2% general partner interest and 18% limited partner
interest as of September 30, 2003. 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, 2003 and 2002,
have been prepared in accordance with accounting principles generally
accepted in the United States of America. Significant accounting policies
followed by the Company are disclosed in the notes to the consolidated
financial statements included in the Company's Annual Report on Form 10-K
for the year ended December 31, 2002. In the opinion of the Company's
management, the accompanying condensed consolidated financial statements
contain all of the adjustments, consisting of normal recurring accruals,
necessary to present fairly the consolidated financial position of the
Company and its consolidated subsidiaries at September 30, 2003 and the
consolidated results of their operations and cash flows for the periods
ended September 30, 2003 and 2002. Operating results for the three and nine
months ended September 30, 2003 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2003.
In December of 2002, the FASB issued SFAS No. 148 "Accounting for
Stock-Based Compensation-Transition and Disclosure." SFAS No. 148, which
amends SFAS No. 123, provides for alternative methods of transition for a
voluntary change to the fair value based method of accounting for
stock-based employee compensation and requires additional disclosures in
annual and interim financial statements regarding the method of accounting
for stock-based employee compensation and the effect of the method used on
financial results. In accordance with the provisions of SFAS No. 123, the
Company applies APB Opinion 25 and related interpretations in accounting
for its share option plans and, accordingly, does not recognize
compensation cost based on the fair value of the options granted at grant
date as prescribed by SFAS 123. The Black-Scholes option pricing model has
been used to estimate the fair value of share options issued.
The following illustrates the effect on net income and basic and diluted
earnings per share if the fair value based method had been applied:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- -----------------------------
2003 2002 2003 2002
---------------- ------------- ------------- --------------
(in thousands - except per share data)
Reported net income $ 5,862 $ 6,673 $ 27,909 $ 34,421
Share-based employee compensation
expense determined under the fair
value based method (21) (22) (63) (66)
---------------- ------------ ------------- --------------
Pro forma net income $ 5,841 $ 6,651 $ 27,846 $ 34,355
================ ============ ============= ==============
Earning per share:
Basic - as reported $ .50 $ .58 $ 2.42 $ 3.01
=============== ============ ============= ==============
Basic - pro forma $ .50 $ .58 $ 2.42 $ 3.00
=============== ============ ============= ==============
Diluted - as reported $ .49 $ .57 $ 2.38 $ 2.93
=============== ============ ============= ==============
Diluted - pro forma $ .49 $ .57 $ 2.37 $ 2.93
=============== ============ ============= ==============
2. ACQUISITIONS AND FINANCINGS
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 an $8.6 million gain in the first quarter of 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 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 September 30, 2003, KPP was in
compliance with all covenants.
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 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. Assuming the acquisition occurred on January 1, 2002, unaudited
pro forma revenues, net income, basic earning 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.
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 the
second quarter of 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. 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.
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 financed by KPP bank debt. 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. At September 30, 2003, the final valuation of the acquired
assets and liabilities had not been completed and, accordingly, the Company
has recorded a preliminary allocation of the purchase price based on the
estimated fair value. Based on the preliminary purchase price allocation,
no amounts are assigned to goodwill or to other intangible assets.
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 the fourth quarter of 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. The acquisition
was funded with KPP bank debt. 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. At September 30, 2003, the
final valuation of the acquired assets and liabilities had not been
completed and, accordingly, the Company has recorded a preliminary
allocation of the purchase price based on the estimated fair value. Based
on the preliminary purchase price allocation, no amounts are assigned to
goodwill or to other intangible assets.
In March of 2003, KPP issued 3,122,500 limited partnership units in a
public offering at $36.54 per unit, generating approximately $109.1 million
in net proceeds. The proceeds were used to reduce the amount of
indebtedness under KPP's bridge facility. As a result of KPP issuing
additional units to unrelated parties, the Company's share of net assets of
KPP increased by $10.9 million. Accordingly, the Company recognized a $10.9
million gain in the first quarter of 2003.
In April of 2003, KPP entered into a new credit agreement with a group of
banks that provides for a $400 million unsecured revolving credit facility
through April of 2006. The credit facility, which provides for an increase
in the commitment up to an aggregate of $450 million by mutual agreement
between KPP and the banks, bears interest at variable rates and has a
variable commitment fee on unused amounts. The credit facility is without
recourse to the Company and contains certain financial and operating
covenants, including limitations on investments, sales of assets and
transactions with affiliates and, absent an event of default, does not
restrict distributions to the Company or to other partners. At September
30, 2003, KPP was in compliance with all covenants. Initial borrowings on
the credit agreement ($324.2 million) were used to repay all amounts
outstanding under KPP's $275 million credit agreement and $175 million
bridge loan agreement. At September 30, 2003, $49.2 million was outstanding
under the new credit agreement.
On May 19, 2003, KPP issued $250 million of 5.875% senior unsecured notes
due June 1, 2013. The net proceeds from the public offering, $247.6
million, were used to reduce amounts due under KPP's revolving credit
agreement. Under the note indenture, interest is payable semi-annually in
arrears on June 1 and December 1 of each year. The notes are redeemable, as
a whole or in part, at the option of KPP, at any time, at a redemption
price equal to the greater of 100% of the principal amount of the notes, or
the sum of the present value of the remaining scheduled payments of
principal and interest, discounted to the redemption date at the applicable
U.S. Treasury rate, as defined in the indenture, plus 30 basis points. The
note indenture contains certain financial and operational covenants,
including certain limitations on investments, sales of assets and
transactions with affiliates and, absent an event of default, such
covenants do not restrict distributions to the Company or other partners.
At September 30, 2003, KPP was in compliance with all covenants. In
connection with the offering, on May 8, 2003, KPP entered into a treasury
lock contract for the purpose of locking in the US Treasury interest rate
component on $100 million of the debt. The treasury lock contract, which
qualified as a cash flow hedging instrument under SFAS No. 133, was settled
on May 19, 2003 with a cash payment by KPP of $1.8 million. The settlement
cost of the contract has been recorded as a component of accumulated other
comprehensive income and is being amortized, as interest expense, over the
life of the debt.
3. COMPREHENSIVE INCOME
Comprehensive income for the three and nine months ended September 30, 2003
and 2002 is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- -----------------------------
2003 2002 2003 2002
---------------- ------------- ------------- --------------
(in thousands)
Net income $ 5,862 $ 6,673 $ 27,909 $ 34,421
Foreign currency translation
adjustment 72 75 1,404 280
KPP interest rate hedging transactions 10 (1,240) (341) (1,240)
---------------- ------------- ------------- --------------
Comprehensive income $ 5,944 $ 5,508 $ 28,972 $ 33,461
================ ============= ============= ==============
Accumulated other comprehensive income aggregated $1.4 million and $0.3
million at September 30, 2003 and December 31, 2002, respectively.
4. CASH DISTRIBUTIONS
The Company makes quarterly distributions of 100% of its available cash, as
defined in the limited liability company agreement, to common shareholders
of record on the applicable record date, within 45 days after the end of
each quarter. Available cash consists generally of all the cash receipts of
the Company, less all cash disbursements and reserves. Excess cash flow of
the Company's wholly-owned marketing operations is being used to reduce
working capital borrowings. Cash distributions of $.4375 per share with
respect to the first and second quarters of 2003 were paid on May 15, 2003
and August 14, 2003, respectively. A cash distribution of $.475 per share
with respect to the third quarter of 2003 was declared to holders of record
on November 3, 2003 and will be paid on November 14, 2003.
5. EARNINGS PER SHARE
Earnings per share for the three and nine months ended September 30, 2003
and 2002, is calculated using the Company's basic and diluted weighted
average shares outstanding for the period. For the three months ended
September 30, 2003 and 2002, basic weighted average shares outstanding were
11,635,000 and 11,459,000, respectively, and diluted weighted average
shares outstanding were 11,889,000 and 11,751,000, respectively. For the
nine months ended September 30, 2003 and 2002, basic weighted average
shares outstanding were 11,521,000 and 11,446,000, respectively, and
diluted weighted average shares outstanding were 11,751,000 and 11,756,000,
respectively.
6. CONTINGENCIES
The operations of KPP are subject to Federal, state and local laws and
regulations in the United States and various foreign locations relating to
protection of the environment. Although KPP believes its operations are in
general compliance with applicable environmental regulations, risks of
additional costs and liabilities are inherent in pipeline and terminal
operations, and there can be no assurance that significant costs and
liabilities will not be incurred by KPP. Moreover, it is possible that
other developments, such as increasingly stringent environmental laws,
regulations and enforcement policies thereunder, and claims for damages to
property or persons resulting from the operations of KPP, could result in
substantial costs and liabilities to KPP.
Certain subsidiaries of KPP were sued in a Texas state court in 1997 by
Grace Energy Corporation ("Grace"), the entity from which KPP acquired ST
Services in 1993. The lawsuit involves environmental response and
remediation costs allegedly resulting from jet fuel leaks in the early
1970's from a pipeline. The pipeline, which connected a former Grace
terminal with Otis Air Force Base in Massachusetts (the "Otis pipeline" or
the "pipeline"), ceased operations in 1973 and was abandoned before 1978,
when the connecting terminal was sold to an unrelated entity. Grace alleged
that subsidiaries of KPP acquired the abandoned pipeline, as part of the
acquisition of ST Services in 1993 and assumed responsibility for
environmental damages allegedly caused by the jet fuel leaks. Grace sought
a ruling from the Texas court that these subsidiaries are responsible for
all liabilities, including all present and future remediation expenses,
associated with these leaks and that Grace has no obligation to indemnify
these subsidiaries for these expenses. In the lawsuit, Grace also sought
indemnification for expenses of approximately $3.5 million that it incurred
since 1996 for response and remediation required by the State of
Massachusetts and for additional expenses that it expects to incur in the
future. The consistent position of KPP's subsidiaries has been that they
did not acquire the abandoned pipeline as part of the 1993 ST Services
transaction, and therefore did not assume any responsibility for the
environmental damage nor any liability to Grace for the pipeline.
At the end of the trial, the jury returned a verdict including findings
that (1) Grace had breached a provision of the 1993 acquisition agreement
by failing to disclose matters related to the pipeline, and (2) the
pipeline was abandoned before 1978 -- 15 years before KPP's subsidiaries
acquired ST Services. On August 30, 2000, the Judge entered final judgment
in the case that Grace take nothing from the subsidiaries on its claims
seeking recovery of remediation costs. Although KPP's subsidiaries have not
incurred any expenses in connection with the remediation, the court also
ruled, in effect, that the subsidiaries would not be entitled to
indemnification from Grace if any such expenses were incurred in the
future. Moreover, the Judge let stand a prior summary judgment ruling that
the pipeline was an asset acquired by KPP's subsidiaries as part of the
1993 ST Services transaction and that any liabilities associated with the
pipeline would have become liabilities of the subsidiaries. Based on that
ruling, the Massachusetts Department of Environmental Protection and Samson
Hydrocarbons Company (successor to Grace Petroleum Company) wrote letters
to ST Services alleging its responsibility for the remediation, and ST
Services responded denying any liability in connection with this matter.
The Judge also awarded attorney fees to Grace of more than $1.5 million.
Both KPP's subsidiaries and Grace have appealed the trial court's final
judgment to the Texas Court of Appeals in Dallas. In particular, the
subsidiaries have filed an appeal of the judgment finding that the Otis
pipeline and any liabilities associated with the pipeline were transferred
to them as well as the award of attorney fees to Grace.
On April 2, 2001, Grace filed a petition in bankruptcy, which created an
automatic stay against actions against Grace. This automatic stay covers
the appeal of the Dallas litigation, and the Texas Court of Appeals has
issued an order staying all proceedings of the appeal because of the
bankruptcy. Once that stay is lifted, KPP's subsidiaries that are party to
the lawsuit intend to resume vigorous prosecution of the appeal.
The Otis Air Force Base is a part of the Massachusetts Military Reservation
("MMR Site"), which has been declared a Superfund Site pursuant to CERCLA.
The MMR Site contains a number of groundwater contamination plumes, two of
which are allegedly associated with the Otis pipeline, and various other
waste management areas of concern, such as landfills. The United States
Department of Defense, pursuant to a Federal Facilities Agreement, has been
responding to the Government remediation demand for most of the
contamination problems at the MMR Site. Grace and others have also received
and responded to formal inquiries from the United States Government in
connection with the environmental damages allegedly resulting from the jet
fuel leaks. KPP's subsidiaries voluntarily responded to an invitation from
the Government to provide information indicating that they do not own the
pipeline. In connection with a court-ordered mediation between Grace and
KPP's subsidiaries, the Government advised the parties in April 1999 that
it has identified two spill areas that it believes to be related to the
pipeline that is the subject of the Grace suit. The Government at that time
advised the parties that it believed it had incurred costs of approximately
$34 million, and expected in the future to incur costs of approximately $55
million, for remediation of one of the spill areas. This amount was not
intended to be a final accounting of costs or to include all categories of
costs. The Government also advised the parties that it could not at that
time allocate its costs attributable to the second spill area.
By letter dated July 26, 2001, the United States Department of Justice
("DOJ") advised ST Services that the Government intends to seek
reimbursement from ST Services under the Massachusetts Oil and Hazardous
Material Release Prevention and Response Act and the Declaratory Judgment
Act for the Government's response costs at the two spill areas discussed
above. The DOJ relied in part on the Texas state court judgment which, in
the DOJ's view, held that ST Services was the current owner of the pipeline
and the successor-in-interest of the prior owner and operator. The
Government advised ST Services that it believes it has incurred costs
exceeding $40 million, and expects to incur future costs exceeding an
additional $22 million, for remediation of the two spill areas. KPP
believes that its subsidiaries have substantial defenses. ST Services
responded to the DOJ on September 6, 2001, contesting the Government's
positions and declining to reimburse any response costs. The DOJ has not
filed a lawsuit against ST Services seeking cost recovery for its
environmental investigation and response costs. Representatives of ST
Services have met with representatives of the Government on several
occasions since September 6, 2001 to discuss the Government's claims and to
exchange information related to such claims. Additional exchanges of
information are expected to occur in the future and additional meetings may
be held to discuss possible resolution of the Government's claims without
litigation.
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-related
costs of $70 million to $75 million. PEPCO may continue to incur some
cleanup related costs for the foreseeable future, primarily in connection
with EPA requirements for monitoring the condition of some of the impacted
areas. Since May 2000, ST Services has provisionally contributed a minority
share of the cleanup expense, which has been funded by ST Services'
insurance carriers. ST Services and PEPCO have not, however, reached a
final agreement regarding ST Services' proportionate responsibility for
this cleanup effort, if any, and cannot predict the amount, if any, that
ultimately may be determined to be ST Services' share of the remediation
expense, but ST believes that such amount will be covered by insurance and
therefore will not materially adversely affect KPP's financial condition.
As a result of the rupture, purported class actions were filed against
PEPCO and ST Services in federal and state court in Maryland by property
and business owners alleging damages in unspecified amounts under various
theories, including under the Oil Pollution Act ("OPA") and Maryland common
law. The federal court consolidated all of the federal cases in a case
styled as In re Swanson Creek Oil Spill Litigation. A settlement of the
consolidated class action, and a companion state-court class action, was
reached and approved by the federal judge. The settlement involved creation
and funding by PEPCO and ST Services of a $2,250,000 class settlement fund,
from which all participating claimants would be paid according to a
court-approved formula, as well as a court-approved payment to plaintiffs'
attorneys. The settlement was consummated in 2002 and the fund, to which
PEPCO and ST Services contributed equal amounts, has been distributed.
Participating claimants' claims were 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. ST Services' insurance carrier assumed the defense of
all of these 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 other potential suits
relating to this matter, it believes that such potential plaintiffs' claims
would be covered by insurance and therefore these actions would not have a
material adverse effect on its financial condition.
PEPCO and ST Services agreed with the federal government and the State of
Maryland to pay costs of assessing natural resource damages arising from
the Swanson Creek oil spill under OPA and of selecting restoration
projects. This process was completed in mid-2002. ST Services' insurer has
paid ST Services' agreed 50 percent share of these assessment costs. In
late November 2002, PEPCO and ST Services entered into a Consent Decree
resolving the Federal and State trustees' claims for natural resource
damages. The decree required payments by ST Services and PEPCO of a total
of approximately $3 million to fund the restoration projects and for
remaining damage assessment costs. The federal court entered the Consent
Decree as a final judgment on December 31, 2002. PEPCO and ST have each
paid their 50% share and thus fully performed their payment obligations
under the Consent Decree. ST Services' insurance carrier funded ST
Services' payment.
In 2001 the U.S. Department of Transportation ("DOT") issued a Notice of
Proposed Violation to PEPCO and ST Services alleging violations over
several years of pipeline safety regulations and proposing a civil penalty
of $647,000 jointly against the two companies. ST Services and PEPCO have
contested the DOT allegations and the proposed penalty. A hearing was held
before the Office of Pipeline Safety at the DOT in late 2001. ST Services
does not anticipate any further hearings on the subject and is still
awaiting the DOT's ruling.
By letter dated January 4, 2002, the Attorney General's Office for the
State of Maryland advised ST Services that it intended to seek penalties
from ST Services in connection with the April 7, 2000 spill. The State of
Maryland subsequently asserted that it would seek penalties against ST
Services and PEPCO totaling up to $12 million. A settlement of this claim
was reached in mid-2002 under which ST Services' insurer will pay a total
of slightly more than $1 million in installments over a five year period.
PEPCO 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 causes of action, 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 the oil spill and other
alleged spill-related costs, which PEPCO alleges are in excess of $75
million. Pursuant to a court-approved stipulation between ST Services and
PEPCO, the District of Columbia action has been dismissed without
prejudice, such that the federal case in Maryland is the operative
litigation for resolution of the parties' liabilities to each other. ST
Services' insurer is paying for the cost of defending PEPCO's claims
against ST Services. KPP believes that any costs or damages resulting from
this lawsuit will be covered by insurance and therefore will not materially
adversely affect KPP's financial condition.
The Company, primarily KPP, has other contingent liabilities resulting from
litigation, claims and commitments incident to the ordinary course of
business. Management believes, based on the advice of counsel, that the
ultimate resolution of such other 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 operations: the
"Pipeline Operations" of KPP, which consists primarily of the
transportation of refined petroleum products and fertilizer in the
Midwestern states as a common carrier; the "Terminaling Operations" of KPP,
which provide storage for petroleum products, specialty chemicals and other
liquids; and the "Product Marketing Services," which provides wholesale
motor fuel marketing services throughout the Midwest and Rocky Mountain
regions 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, receivable from affiliates of the Company and other assets
not related to the segments.
The Company measures segment profit as operating income. Total assets are
those assets controlled by each reportable segment. Business segment data
is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- -------------------------------
2003 2002 2003 2002
------------- -------------- ------------- --------------
(in thousands)
Business segment revenues:
Pipeline operations $ 31,449 $ 20,998 $ 88,807 $ 57,946
Terminaling operations 58,090 54,186 176,887 150,000
Product marketing operations 125,053 108,935 386,021 277,828
------------- -------------- ------------- --------------
$ 214,592 $ 184,119 $ 651,715 $ 485,774
============= ============== ============= ==============
Business segment profit:
Pipeline operations $ 14,839 $ 9,487 $ 39,036 $ 27,421
Terminaling operations 15,732 18,478 51,567 50,962
Product marketing operations 2,219 803 9,634 2,937
General corporate (539) (262) (1,557) (1,302)
------------- -------------- ------------- --------------
Operating income 32,251 28,506 98,680 80,018
Interest and other income 69 259 208 482
Interest expense (10,855) (7,478) (28,816) (20,944)
Loss on debt extinguishment - - - (2,112)
------------- -------------- ------------- --------------
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 $ 21,465 $ 21,287 $ 70,072 $ 57,444
============= ============== ============= ==============
September 30, December 31,
2003 2002
------------- -----------------
(in thousands)
Total assets:
Pipeline operations $ 357,480 $ 352,657
Terminaling operations 868,046 844,321
Product marketing operations 53,813 41,297
General corporate 4,117 5,826
------------- --------------
$ 1,283,456 $ 1,244,101
============= ==============
8. ADOPTION OF RECENT ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2003, the Company adopted SFAS No. 143, "Accounting
for Asset Retirement Obligations", which establishes requirements for the
removal-type costs associated with asset retirements. At the initial
adoption date of SFAS No. 143, the Company recorded an asset retirement
obligation of approximately $5.7 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 KPP leased
pipeline and terminaling facilities, including petroleum and chemical
storage tanks, terminaling facilities and barges. At September 30, 2003,
the Company had no assets which were legally restricted for purposes of
settling asset retirement obligations. The effect of SFAS No. 143, assuming
adoption on January 1, 2002, was not material to the results of operations
of the Company for the three and nine month periods ended September 30,
2003 and 2002, respectively.
Effective January 1, 2003, the Company adopted SFAS No. 146, "Accounting
for Costs Associated with Exit or Disposal Activities", which requires that
all restructurings initiated after December 31, 2002 be recorded when they
are incurred and can be measured at fair value. The initial adoption of
SFAS No. 146 had no effect on the consolidated financial statements of the
Company.
The Company has adopted the provisions of FASB Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements of Guarantees,
Including Indirect Guarantees of Indebtedness to Others, an interpretation
of FASB Statements No. 5, 57, and 107, and a rescission of FASB
Interpretation No. 34." This interpretation elaborates on the disclosures
to be made by a guarantor in its interim and annual financial statements
about its obligations under guarantees issued. The interpretation also
clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the fair value of the obligation undertaken. The
initial recognition and measurement provisions of the interpretation are
applicable to guarantees issued or modified after December 31, 2002. The
initial application of this interpretation had no effect on the
consolidated financial statements of the Company.
The Company has adopted the provisions of FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities, an interpretation of ARB No.
51." This interpretation addresses the consolidation by business
enterprises of variable interest entities as defined in the interpretation.
The interpretation applies immediately to variable interests in variable
interest entities created after January 31, 2003, and to variable interests
in variable interest entities obtained after January 31, 2003. The
interpretation requires certain disclosures in financial statements issued
after January 31, 2003. The initial application of this interpretation had
no effect 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. 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.
KANEB SERVICES LLC (PARENT COMPANY) Schedule I
CONDENSED STATEMENTS OF INCOME
(In Thousands - Except Per Share Amounts)
(Unaudited)
- --------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- -----------------------------
2003 2002 2003 2002
-------------- ------------- ------------- --------------
General and administrative expenses $ (509) $ (430) $ (1,462) $ (1,371)
Interest expense (147) (195) (474) (533)
Interest and other income 3 2 9 6
Equity in earnings of subsidiaries 6,515 7,296 19,271 18,987
Equity in earnings of subsidiaries - gain
on issuance of units by KPP - - 10,878 17,332
-------------- -------------- ------------ --------------
Income before cumulative effect of change
in accounting principle 5,862 6,673 28,222 34,421
Cumulative effect of change in accounting
principle - adoption of new accounting
standard for asset retirement obligations - - (313) -
-------------- -------------- ------------ --------------
Net income $ 5,862 $ 6,673 $ 27,909 $ 34,421
============== ============== ============ ==============
Earnings per share:
Basic:
Before cumulative effect of change
in accounting principle $ .50 $ .58 $ 2.45 $ 3.01
Cumulative effect of change in
accounting principle - - (.03) -
-------------- -------------- ------------ --------------
$ .50 $ .58 $ 2.42 $ 3.01
============== ============== ============ ==============
Diluted:
Before cumulative effect of change
in accounting principle $ .49 $ .57 $ 2.41 $ 2.93
Cumulative effect of change in
accounting principle - - (.03) -
-------------- -------------- ------------ --------------
$ .49 $ .57 $ 2.38 $ 2.93
============== ============== ============ ==============
See "Notes to Consolidated Financial Statements" of
Kaneb Services LLC included in this report.
18
KANEB SERVICES LLC (PARENT COMPANY) Schedule I
(Continued)
CONDENSED BALANCE SHEETS
(In Thousands)
- --------------------------------------------------------------------------------
September 30, December 31,
2003 2002
------------- ----------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 1,680 $ 1,695
Prepaid expenses and other 182 2,060
------------- -------------
Total current assets 1,862 3,755
------------- -------------
Investments in and advances to subsidiaries 105,025 92,316
Other assets 525 608
------------- -------------
$ 107,412 $ 96,679
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 1,111 $ 2,325
Accrued distributions payable to shareholders 5,559 4,734
------------- -------------
Total current liabilities 6,670 7,059
------------- -------------
Long-term debt 16,500 19,125
Long-term payables and other liabilities 7,185 6,841
Commitments and contingencies
Shareholders' equity 77,057 63,654
------------- -------------
$ 107,412 $ 96,679
============= =============
See "Notes to Consolidated Financial Statements" of
Kaneb Services LLC included in this report.
19
KANEB SERVICES LLC (PARENT COMPANY) Schedule I
(Continued)
CONDENSED STATEMENT OF CASH FLOWS
(In Thousands)
(Unaudited)
- --------------------------------------------------------------------------------
Nine Months Ended
September 30,
----------------------------------------
2003 2002
------------- --------------
Operating activities:
Net income $ 27,909 $ 34,421
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in earnings of subsidiaries, net of
distributions (11,958) (20,226)
Cumulative effect of change in accounting
principle 313 -
Changes in current assets and liabilities 664 83
------------- --------------
Net cash provided by operating activities 16,928 14,278
------------- --------------
Investing activities:
Changes in other assets 83 83
------------- --------------
Net cash provided by investing activities 83 83
------------- --------------
Financing activities:
Issuance of debt - 10,000
Payments on debt (2,625) -
Distributions to shareholders (14,915) (13,602)
Changes in long-term payables and other liabilities 344 (10,021)
Other 170 648
------------- --------------
Net cash used in financing activities (17,026) (12,975)
------------- --------------
Increase (decrease) in cash and cash equivalents (15) 1,386
Cash and cash equivalents at beginning of period 1,695 1,369
------------- --------------
Cash and cash equivalents at end of period $ 1,680 $ 2,755
============= ==============
See "Notes to Consolidated Financial Statements" of
Kaneb Services LLC included in this report.
20
KANEB SERVICES LLC AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This discussion should be read in conjunction with the condensed
consolidated financial statements of Kaneb Services LLC (the "Company") and
notes thereto included elsewhere in this report. The consolidated financial
information reflects the results of operations of the Company, its
wholly-owned subsidiaries and Kaneb Pipe Line Partners, L.P. ("KPP"). The
Company controls the operations of KPP through its 2% general partner
interest and 18% limited partner interest at September 30, 2003.
Operating Results:
Pipeline Operations
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
(in thousands)
Revenues $ 31,449 $ 20,998 $ 88,807 $ 57,946
Operating costs 11,067 9,511 35,149 23,602
Depreciation and amortization 3,540 1,385 10,548 4,132
General and administrative 2,003 615 4,074 2,791
----------- ----------- ----------- -----------
Operating income $ 14,839 $ 9,487 $ 39,036 $ 27,421
=========== =========== =========== ===========
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, 2003, revenues increased by $10.5 million, or 50%, and $30.9
million, or 53%, respectively, compared to the same 2002 periods, due
primarily to the November and December 2002 pipeline acquisitions (see
"Liquidity and Capital Resources"). Because tariff rates are regulated, the
pipelines compete primarily on the basis of quality of services, including
delivery of products at convenient locations on a timely basis to meet the
needs of its customers. Barrel miles on petroleum pipelines totaled 5.4
billion and 5.0 billion for the three months ended September 30, 2003 and
2002, respectively, and 15.8 billion and 13.7 billion for the nine months
ended September 30, 2003 and 2002, 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 $1.6 million and $11.5
million for the three and nine month periods ended September 30, 2003,
respectively, when compared to 2002, due to the pipeline acquisitions and
increases in planned maintenance. For the three and nine months ended
September 30, 2003, depreciation and amortization increased by $2.2 million
and $6.4 million, respectively, when compared to the same 2002 periods, due
primarily to the pipeline acquisitions. General and administrative costs,
which include managerial, accounting and administrative personnel costs,
office rent and expense, legal and professional costs and other
non-operating costs, increased by $1.4 million and $1.3 million for the
three and nine month periods ended September 30, 2003, when compared to the
same 2002 periods, due to the acquisitions, increases in personnel-related
costs and certain reclassifications from operating expense.
Terminaling Operations
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
(in thousands)
Revenues $ 58,090 $ 54,186 $ 176,887 $ 150,000
Operating costs 29,338 23,445 84,673 65,833
Depreciation and amortization 9,433 8,728 28,533 22,813
General and administrative 3,587 3,535 12,114 10,392
----------- ----------- ----------- -----------
Operating income $ 15,732 $ 18,478 $ 51,567 $ 50,962
=========== =========== =========== ===========
For the three and nine month periods ended September 30, 2003, terminaling
revenues increased by $3.9 million, or 7%, and $26.9 million, or 18%,
respectively, when compared to the same 2002 periods, due to the 2002
terminal acquisitions (see "Liquidity and Capital Resources") and increases
in the average price realized per barrel of tankage utilized. Average
annual tankage utilized for the three and nine month periods ended
September 30, 2003 was 45.9 million and 47.1 million barrels, respectively,
compared to 47.8 million and 45.3 million barrels, respectively, for the
same prior year periods. For the three and nine month periods ended
September 30, 2003, average annualized revenues per barrel of tankage
utilized increased to $5.02 per barrel, compared to $4.50 and $4.43 per
barrel, respectively, for the same prior year periods, due to changes in
product mix resulting from the terminal acquisitions.
For the three and nine month periods ended September 30, 2003, operating
costs increased by $5.9 million and $18.8 million, respectively, when
compared to the same 2002 periods, a result of the terminal acquisitions,
repair costs associated with hurricane Isabel and increases in planned
maintenance. For the three and nine months ended September 30, 2003,
depreciation and amortization increased by $0.7 million and $5.7 million,
respectively, when compared to the same 2002 periods, due also to the
terminal acquisitions. General and administrative costs for the three and
nine month periods ended September 30, 2003, increased by $0.1 million and
$1.7 million, respectively, when compared to the same 2002 period, a result
of the acquisitions and increases in personnel-related costs.
Product Marketing Operations
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
(in thousands)
Revenues $ 125,053 $ 108,935 $ 386,021 $ 277,828
Cost of products sold 119,767 105,059 366,531 268,727
----------- ----------- ----------- -----------
Gross margin $ 5,286 $ 3,876 $ 19,490 $ 9,101
=========== =========== =========== ===========
Operating income $ 2,219 $ 803 $ 9,634 $ 2,937
=========== =========== =========== ===========
For the three and nine month periods ended September 30, 2003, revenues for
the product marketing business increased by $16.1 million, or 15%, and
$108.2 million, or 39%, respectively, when compared to the same 2002
periods. The increase in revenues for the three and nine months ended
September 30, 2003, compared to the same 2002 periods, was the result of
increases in sales volumes and an increase in the average sales price
realized. Included in revenues for the nine month periods ended September
30, 2003 and 2002 is $162.4 million and $63.7 million, respectively, from
the product marketing business acquired with Statia on February 28, 2002
("See Liquidity and Capital Resources"). Gallons sold totaled 151 million
and 140 million, respectively, for the three months ended September 30,
2003 and 2002, and 463 million and 385 million, respectively, for the nine
months ended September 30, 2003 and 2002. For the three and nine month
periods ended September 30, 2003, the average price realized per gallon of
product sold increased to $0.83, compared to $0.78 and $0.72, respectively,
for the 2002 periods. Gross margin and operating income increased by $1.4
million and $1.4 million for the three months ended September 30, 2003,
respectively, and $10.4 million and $6.7 million for the nine months ended
September 30, 2003, respectively, when compared to the same 2002 periods,
due to the increase in 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 Expense
For the three and nine months ended September 30, 2003, interest expense
increased by $3.4 million and $7.9 million, respectively, compared to the
same 2002 periods, due primarily to increases in KPP fixed rate debt
resulting from the 2002 KPP pipeline and terminaling acquisitions (see
"Liquidity and Capital Resources"), partially offset by overall declines in
interest rates on variable rate debt.
Income Taxes
Certain KPP operations are conducted through separate taxable wholly-owned
U.S. and foreign corporate subsidiaries. The income tax expense for these
subsidiaries was $1.1 million and $1.4 million, for the three months ended
September 30, 2003 and 2002, respectively, and $3.8 million and $3.0
million for the nine months ended September 30, 2003 and 2002,
respectively.
Additionally, the Company's income tax expense for the three and nine
months ended September 30, 2002 includes benefits of $0.7 million and $0.9
million, respectively, relating to favorable developments pertaining to the
resolution of certain state income tax matters.
Liquidity and Capital Resources
Cash provided by operations, including the operations of KPP, was $115.3
million and $66.1 million for the nine months ended September 30, 2003 and
2002, respectively. The increase in cash provided by operations for the
nine months ended September 30, 2003, compared to the same 2002 period, was
due to the 2002 KPP pipeline and terminal acquisitions and changes in
working capital components resulting from the timing of cash receipts and
disbursements.
Capital expenditures, including routine maintenance and expansion
expenditures but excluding acquisitions, were $32.1 million for the nine
months ended September 30, 2003, compared to $21.9 million during the same
2002 period, and almost exclusively relate to KPP. The increase in capital
expenditures for the nine months ended September 30, 2003, when compared to
the same 2002 period, is the result of planned maintenance and expansion
capital expenditures related to the KPP pipeline and terminaling operations
acquired in 2002 and higher maintenance capital expenditures in the
existing pipeline and terminaling businesses. During all periods, adequate
pipeline capacity existed to accommodate volume growth, and the
expenditures required for environmental and safety improvements were not,
and are not expected in the future to be, significant. KPP anticipates that
capital expenditures (including routine maintenance and expansion
expenditures, but excluding acquisitions) will total approximately $40 to
$45 million in 2003. Such future expenditures of KPP, however, will depend
on many factors beyond KPP's control, including, without limitation, demand
for refined petroleum products and terminaling services in KPP's market
areas, local, state and federal government regulations, fuel conservation
efforts and the availability of financing on acceptable terms. No assurance
can be given that required capital expenditures will not exceed anticipated
amounts during the year, or thereafter, or that KPP will have the ability
to finance such expenditures through borrowings, or will choose to do so.
The Company makes quarterly distributions of 100% of its available cash, as
defined in the limited liability company agreement, to common shareholders
of record on the applicable record date, within 45 days after the end of
each quarter. Available cash consists generally of all the cash receipts of
the Company, less all cash disbursements and reserves. Excess cash flow of
the Company's wholly-owned marketing operations is being used to reduce
working capital borrowings. Cash distributions of $.4375 per share with
respect to the first and second quarters of 2003 were paid on May 15, 2003
and August 14, 2003, respectively. A cash distribution of $.475 per share
with respect to the third quarter of 2003 was declared to holders of record
on November 3, 2003 and will be paid on November 14, 2003.
KPP expects to fund future cash distributions and maintenance capital
expenditures with existing cash and anticipated cash flows from operations.
Expansionary capital expenditures are expected to be funded through
additional KPP bank borrowings and/or future KPP public equity or debt
offerings.
The Company has a credit agreement with a bank that provides for a $50
million revolving credit facility through July 1, 2008. The credit
facility, which bears interest at variable rates, has a variable rate
commitment fee on unused amounts and contains certain financial and
operational covenants. At September 30, 2003, the Company was in compliance
with all covenants. The credit facility is secured by 4.6 million KPP
limited partnership units. At September 30, 2003, $16.5 million was drawn
on the credit 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 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 an $8.6 million gain in the first quarter of 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 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 September 30, 2003, KPP was in
compliance with all covenants.
On February 28, 2002, KPP acquired Statia for approximately $178 million in
cash (net of acquired cash). The acquired Statia subsidiaries had
approximately $107 million in outstanding debt, including $101 million of
11.75% notes due in November 2003. The cash portion of the purchase price
was funded by KPP's revolving credit agreement and proceeds from its
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.
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 the
second quarter of 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 financed by 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 the fourth quarter of 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. The acquisition
was 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 the amount of
indebtedness under KPP's bridge facility. As a result of KPP issuing
additional units to unrelated parties, the Company's share of net assets of
KPP increased by $10.9 million. Accordingly, the Company recognized a $10.9
million gain in the first quarter of 2003.
In April of 2003, KPP entered into a new credit agreement with a group of
banks that provides for a $400 million unsecured revolving credit facility
through April of 2006. The credit facility, which provides for an increase
in the commitment up to an aggregate of $450 million by mutual agreement
between KPP and the banks, bears interest at variable rates and has a
variable commitment fee on unused amounts. The credit facility is without
recourse to the Company and contains certain financial and operating
covenants, including limitations on investments, sales of assets and
transactions with affiliates and, absent an event of default, does not
restrict distributions to the Company or to other partners. At September
30, 2003, KPP was in compliance with all covenants. Initial borrowings on
the credit agreement ($324.2 million) were used to repay all amounts
outstanding under KPP's $275 million credit agreement and $175 million
bridge loan agreement. At September 30, 2003, $49.2 million was outstanding
under the new credit agreement.
On May 19 2003, KPP issued $250 million of 5.875% senior unsecured notes
due June 1, 2013. The net proceeds from the public offering, $247.6
million, were used to reduce amounts due under KPP's revolving credit
agreement. Under the note indenture, interest is payable semi-annually in
arrears on June 1 and December 1 of each year. The notes are redeemable, as
a whole or in part, at the option of KPP, at any time, at a redemption
price equal to the greater of 100% of the principal amount of the notes, or
the sum of the present value of the remaining scheduled payments of
principal and interest, discounted to the redemption date at the applicable
U.S. Treasury rate, as defined in the indenture, plus 30 basis points. The
note indenture contains certain financial and operational covenants,
including certain limitations on investments, sales of assets and
transactions with affiliates and, absent an event of default, such
covenants do not restrict distributions to the Company and other partners.
At September 30, 2003, KPP was in compliance with all covenants. In
connection with the offering, on May 8, 2003, KPP entered into a treasury
lock contract for the purpose of locking in the US Treasury interest rate
component on $100 million of the debt. The treasury lock contract, which
qualified as a cash flow hedging instrument under SFAS No. 133, was settled
on May 19, 2003 with a cash payment by KPP of $1.8 million. The settlement
cost of the contract has been recorded as a component of accumulated other
comprehensive income and is being amortized, as interest expense, over the
life of the debt.
Additional information relative to 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, 2002.
KANEB SERVICES LLC AND SUBSIDIARIES
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Item 3. Quantitative and Qualitative Disclosure About Market Risk
The principal market risks pursuant to this Item (i.e., the risk of loss arising
from adverse changes in market rates and prices) to which the Company is exposed
are interest rates on the Company's and KPP's debt and investment portfolios and
fluctuations in petroleum product prices on inventories held for sale.
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 $99.5 million (including KPP's debt) at September 30, 2003, a one percent
increase in interest rates would increase annual net interest expense by
approximately $1.0 million.
The product marketing business purchases refined petroleum products for resale
as motor fuel, bunker fuel and sales to commercial interests. Petroleum
inventories are generally held for short periods of time, not exceeding 90 days.
As the Company and KPP do not engage in derivative transactions to hedge the
value of the inventory, they are subject to market risk from changes in global
oil markets.
Item 4. Controls and Procedures.
The Company's principal executive officer and principal financial officer, after
evaluating as of September 30, 2003, the effectiveness of the Company's
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
of the Securities Exchange Act of 1934), have concluded that, as of such date,
the Company's disclosure controls and procedures are adequate and effective to
ensure that material information relating to the Company and its consolidated
subsidiaries would be made known to them by others within those entities.
There have been no changes in the Company's internal controls or in other
factors known to management that could significantly affect those internal
controls subsequent to the date of the evaluation, nor were there any
significant deficiencies or material weaknesses in the Company's internal
controls. As a result, no corrective actions were required or undertaken.
KANEB SERVICES LLC AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Part II - Other Information
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
3.1 Amended and Restated Limited Liability Company Agreement of
Registrant, filed as Exhibit 3.1 to the exhibits to Registrant's
Form 10-Q, for the period ended June 30, 2001, which exhibit is
hereby incorporated by reference.
31.1 Certification of Chief Executive Officer, Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002, dated as of November 13, 2003.
31.2 Certification of Chief Financial Officer, Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002, dated as of November 13, 2003.
32.1 Certification of Chief Executive Officer, Pursuant to Section
906(a) of the Sarbanes-Oxley Act of 2002, dated as of November
13, 2003.
32.2 Certification of Chief Financial Officer, Pursuant to Section
906(a) of the Sarbanes-Oxley Act of 2002, dated as of November
13, 2003.
(b) Reports on Form 8-K
Current Report on Form 8-K, filed August 1, 2003
Current Report on Form 8-K, filed August 1, 2003
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KANEB SERVICES LLC
(Registrant)
Date: November 13, 2003 //s//
---------------------------------------
Howard C. Wadsworth
Vice President, Treasurer and Secretary
Exhibit 31.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, John R. Barnes, Chief Executive Officer of Kaneb Services LLC certify that:
1. I have reviewed this 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 officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) 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 officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: November 13, 2003
//s//
----------------------------------------
John R. Barnes
Chief Executive Officer
Exhibit 31.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Howard C. Wadsworth, Chief Financial Officer of Kaneb Services LLC certify
that:
1. I have reviewed this report on Form 10-Q of Kaneb Serivces 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 officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) 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 officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: November 13, 2003
//s//
----------------------------------------
Howard C. Wadsworth
Chief Financial Officer
Exhibit 32.1
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, 2003, filed with the United States
Securities and Exchange Commission pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)), fully complies with
the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of
1934 and that information contained in such Quarterly Report fairly presents, in
all material respects, the financial condition and results of operations of the
Company.
Date: November 13, 2003
//s//
---------------------------------------------
John R. Barnes
Chief Executive Officer
A signed original of this written statement required by Section 906, or other
document authenticating, acknowledging, or otherwise adopting the signature that
appears in typed form within the electronic version 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.
Exhibit 32.2
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, 2003, filed with the United States
Securities and Exchange Commission pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)), fully complies with
the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of
1934 and that information contained in such Quarterly Report fairly presents, in
all material respects, the financial condition and results of operations of the
Company.
Date: November 13, 2003
//s//
--------------------------------------------
Howard C. Wadsworth
Vice President, Treasurer and Secretary
(Chief Financial Officer)
A signed original of this written statement required by Section 906, or other
document authenticating, acknowledging, or otherwise adopting the signature that
appears in typed form within the electronic version 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.