-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, EZBu8R6WMdFBSaDzd6Cn9DuhVxIi9jESRIz7jRPmsjTwFvg4UjbDfoBrPNcx9g6t FGApOI/Tnhcg6X6s272kiQ== 0000853890-98-000003.txt : 19980326 0000853890-98-000003.hdr.sgml : 19980326 ACCESSION NUMBER: 0000853890-98-000003 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980325 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: KANEB PIPE LINE PARTNERS L P CENTRAL INDEX KEY: 0000853890 STANDARD INDUSTRIAL CLASSIFICATION: PIPE LINES (NO NATURAL GAS) [4610] IRS NUMBER: 752287571 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-10311 FILM NUMBER: 98572634 BUSINESS ADDRESS: STREET 1: P.O. BOX 650283 CITY: DALLAS STATE: TX ZIP: 75265-0283 BUSINESS PHONE: 2146994031 10-K 1 ANNUAL REPORT ON FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 [NO FEE REQUIRED] FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] Commission file number 1-10311 KANEB PIPE LINE PARTNERS, L.P. (Exact name of Registrant as specified in its Charter) Delaware 75-2287571 (State or other jurisdiction (IRS Employer Identification No.) of incorporation or organization) 2435 North Central Expressway Richardson, Texas 75080 (Address of principal executive offices) (zip code) Registrant's telephone number, including area code: (972) 699-4000 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered ---------------------------- -------------------------- Senior Preference Units New York Stock Exchange Preference Units New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Subsection 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.[ ] Aggregate market value of the voting units held by non-affiliates of the registrant: $372,155,103. This figure is estimated as of March 16, 1998, at which date the closing price of the Registrant's Senior Preference Units on the New York Stock Exchange was $35.50 per unit and the closing price of the Registrant's Preference Units on the New York Stock Exchange was $34.25, and assumes that only the General Partner of the Registrant (the "General Partner"), officers and directors of the General Partner and its parent and wholly owned subsidiaries of the General Partner and its parent were affiliates. Number of Senior Preference Units of the Registrant outstanding at March 16, 1998: 7,250,000. Number of Preference Units of the Registrant outstanding at March 16, 1998: 5,650,000. PART I ITEM I. BUSINESS GENERAL The pipeline system of Kaneb Pipe Line Company was initially created in 1953. In September 1989, Kaneb Pipe Line Partners, L.P., a Delaware limited partnership (the "Partnership"), was formed to acquire, own and operate the refined petroleum products pipeline business (the "East Pipeline") previously conducted by Kaneb Pipe Line Company, a Delaware corporation ("KPL" or the "Company"), a wholly owned subsidiary of Kaneb Services, Inc., a Delaware corporation ("Kaneb"). KPL owns a combined 2% interest as general partner of the Partnership and of Kaneb Pipe Line Operating Partnership, L.P., a Delaware limited partnership ("KPOP"). The pipeline operations of the Partnership are conducted through KPOP, of which the Partnership is the sole limited partner and KPL is the sole general partner. The terminaling business of the Partnership is conducted through (i) Support Terminals Operating Partnership, L.P. ("STOP"), (ii) Support Terminal Services, Inc., (iii) StanTrans, Inc., (iv) StanTrans Partners L.P. ("STPP"), and (v) StanTrans Holdings, Inc. KPOP, STOP and STPP are collectively referred to as the "Operating Partnerships". The Partnership is engaged, through its Operating Partnerships, in the refined petroleum products pipeline business and the terminaling of petroleum products and specialty liquids. PRODUCTS PIPELINE BUSINESS Introduction The Partnership's pipeline business consists primarily of the transportation, as a common carrier, of refined petroleum products in Kansas, Nebraska, Iowa, South Dakota, North Dakota, Colorado and Wyoming. The Partnership owns and operates two common carrier pipelines (the "Pipelines") as shown on the map below: [SYSTEM MAP] East Pipeline Construction of the East Pipeline commenced in the 1950s with a line from southern Kansas to Geneva, Nebraska. During the 1960s, the East Pipeline was extended north to its present terminus at Jamestown, North Dakota. In the 1980's, the lines from Geneva, Nebraska to North Platte, Nebraska and the 16" line from McPherson, Kansas to Geneva, Nebraska were built and the Partnership acquired a 6" pipeline from Champlin Oil Company, a portion of which runs south from Shickley, Nebraska through Superior, Nebraska, to Hutchinson, Kansas. In 1997, the Partnership completed construction of a new 6" pipeline from Conway, Kansas to Windom, Kansas (approximately 22 miles north of Hutchinson) that allows the Hutchinson Terminal to be supplied directly from McPherson; a significantly shorter route than was previously used. As a result of this new pipeline becoming operational, the segment of the old Champlin line between Windom and Shickley was shut down, including the Superior terminal. The other end of the line runs northeast approximately 175 miles crossing the main pipeline at Osceola, Nebraska, through a terminal at Columbus, Nebraska, and later crossing and interconnecting with the Partnership's Yankton/Milford line to terminate at Rock Rapids, Iowa. The East Pipeline system also consists of 15 product terminals in Kansas, Nebraska, Iowa, South Dakota and North Dakota (with total storage capacity of approximately 3.1 million barrels) and an additional 23 product tanks with total storage capacity of approximately 922,000 barrels at its tank farm installations at McPherson and El Dorado, Kansas. The system also has six origin pump stations at refineries in Kansas and 38 booster pump stations situated along the system in Kansas, Nebraska, Iowa, South Dakota and North Dakota. Additionally, the system maintains various office and warehouse facilities, and an extensive quality control laboratory. KPOP owns the entire 2,075 mile East Pipeline, except for the 203-mile North Platte line, which is held under a capitalized lease that expires at the end of 1998. KPOP has exercised its option to purchase the North Platte line for approximately $5 million at the end of the lease. KPOP leases office space for its operating headquarters in Wichita, Kansas. The East Pipeline transports refined petroleum products, including propane, received from refineries in southeast Kansas and other connecting pipelines to terminals in Kansas, Nebraska, Iowa, South Dakota and North Dakota and to receiving pipeline connections in Kansas. Shippers on the East Pipeline obtain refined petroleum products from refineries connected to the East Pipeline directly or through other pipelines. These refineries obtain their crude oil primarily from producing areas in Kansas, Oklahoma and Texas. Five connecting pipelines can deliver propane for shipment through the East Pipeline from gas processing plants in Texas, New Mexico, Oklahoma and Kansas. West Pipeline KPOP acquired the West Pipeline in February 1995 through an asset purchase from WYCO Pipe Line Company for a purchase price of $27.1 million. The acquisition of the West Pipeline increased the Partnership's pipeline business in South Dakota and expanded it into Wyoming and Colorado. The West Pipeline system includes approximately 550 miles of underground pipeline in Wyoming, Colorado and South Dakota, four truck loading terminals and numerous pump stations situated along the system. The system's four product terminals have a total storage capacity of over 1.7 million barrels. The West Pipeline originates at Casper, Wyoming and travels east to the Strouds station, which is located in Evansville, Wyoming, where it serves as a connecting point with Sinclair's Little America refinery and the Seminoe pipeline that transports product from Billings, Montana area refineries. From Strouds, the West Pipeline continues easterly through its 8" line to Douglas, Wyoming, where a 6" pipeline branches off to serve the Partnership's Rapid City, South Dakota terminal approximately 190 miles away. The Rapid City terminal has a three bay bottom loading truck rack and storage tank capacity of 256,000 barrels. The 6" pipeline also receives product from Wyoming Refining's pipeline at a connection located near the Wyoming/South Dakota border approximately 30 miles south of Wyoming Refining's Newcastle refinery. From Douglas, the Partnership's 8" pipeline continues southward through a delivery point at the Burlington Northern Junction to the Cheyenne terminal. The Cheyenne terminal has a two bay bottom loading truck rack and storage tank capacity of 345,000 barrels and serves as a receiving point for products from the Frontier refinery, as well as product delivery point to the Cheyenne pipeline. From the Cheyenne terminal, the pipeline extends south into Colorado to the Dupont terminal located in the Denver metropolitan area. The Dupont terminal is the largest terminal on the West Pipeline system, with a six bay bottom loading truck rack and tankage capacity of 692,000 barrels. The 8" pipeline continues to the Commerce City station, where the West Pipeline can receive from and transfer product to the Total Petroleum (now Ultramar Diamond Shamrock) and Conoco refineries and the Phillips Petroleum terminal. From the Commerce City station, a 6" line continues south 90 miles where the system terminates at the Fountain, Colorado terminal serving the Colorado Springs area. The Fountain terminal has a five bay bottom loading truck rack and storage tank capacity of 366,000 barrels. The West Pipeline system parallels the Partnership's East Pipeline to the west. The East Pipeline's North Platte line terminates in western Nebraska, approximately 200 miles east of the West Pipeline's Cheyenne, Wyoming terminal. The small Cheyenne pipeline moves products from west to east from the West Pipeline's Cheyenne terminal to near the East Pipeline's North Platte terminal, although that line has been deactivated from Sidney, Nebraska (approximately 100 miles from Cheyenne) to North Platte. The West Pipeline serves Denver and other eastern Colorado markets and supplies jet fuel to Ellsworth Air Force Base at Rapid City, South Dakota, as compared to the East Pipeline's largely agricultural service area. The West Pipeline has a relatively small number of shippers, who, with a few exceptions, are also shippers on the Partnership's East Pipeline system. Other Systems The Partnership also owns three single-use pipelines, located in Umatilla, Oregon; Rawlins, Wyoming and Pasco, Washington. Each system supplies diesel fuel to a railroad fueling facility under contracts. The Oregon and Washington lines are fully automated and the Wyoming line requires minimal start-up assistance, which is provided by the railroad. For the year ended December 31, 1997, the three systems combined transported a total of 3.5 million barrels of diesel fuel, representing an aggregate of $1.3 million in revenues. Pipelines Products and Activities The Pipelines' revenues are based on volumes and distances of product shipped. The following table reflects the total volume and barrel miles of refined petroleum products shipped and total operating revenues earned by the Pipelines for each of the periods indicated: YEAR ENDED DECEMBER 31, ------------------------------------------------------- 1997 1996 1995(4) 1994 1993 ------- ------- -------- ------- ------- Volume (1) ........... 69,984 73,839 74,965 54,546 56,234 Barrel miles(2)....... 16,144 16,735 16,594 14,460 14,160 Revenues(3) .......... $61,320 $63,441 $60,192 $46,117 $44,107 (1) Volumes are expressed in thousands of barrels of refined petroleum product. (2) Barrel miles are shown in millions. A barrel mile is the movement of one barrel of refined petroleum product one mile. (3) Revenues are expressed in thousands of dollars. (4) Amounts for 1995 and subsequent periods also include amounts attributable to the West Pipeline, acquired by the Partnership in February 1995. The following table sets forth volumes of propane and various types of other refined petroleum products transported by the Pipelines during each of the periods indicated: YEAR ENDED DECEMBER 31, (THOUSANDS OF BARRELS) ------------------------------------------------------ 1997 1996 1995 1994 1993 ------ ------ ------ ------ ------ Gasoline .............. 32,237 36,063 37,348 23,958 25,407 Diesel and fuel oil.... 33,541 32,934 33,411 26,340 25,308 Propane ............... 4,206 4,842 4,146 4,204 4,153 Other ................. -- -- 60 44 1,366 ------ ------ ------ ------ ------ Total ............ 69,984 73,839 74,965 54,546 56,234 ====== ====== ====== ====== ====== Diesel and fuel oil are used in farm machinery and equipment, over-the-road transportation, railroad fueling and residential fuel oil. Gasoline is primarily used in over-the-road transportation and propane is used for crop drying, residential heating and to power irrigation equipment. The mix of refined petroleum products delivered varies seasonally, with gasoline demand peaking in early summer, diesel fuel demand peaking in late summer and propane demand higher in the fall. In addition, weather conditions in the areas served by the East Pipeline affect both the demand for and the mix of the refined petroleum products delivered through the East Pipeline, although historically any overall impact on the total volumes shipped has been short-term. Tariffs charged shippers for transportation do not vary according to the type of product delivered. Maintenance and Monitoring The Pipelines have been constructed and are maintained consistent with applicable Federal, state and local laws and regulations, standards prescribed by the American Petroleum Institute and accepted industry practice. Further, to prolong the useful lives of the Pipelines, protective measures are taken and routine preventive maintenance is performed on the Pipelines. Such measures includes cathodic protection to prevent external corrosion, inhibitors to prevent internal corrosion and periodic inspection of the Pipelines. Additionally, the Pipelines are patrolled at regular intervals to identify equipment or activities by third parties that, if left unchecked, could result in encroachment upon the rights-of-way for the Pipelines and possible damage to the Pipelines. The Partnership uses a state-of-the-art Supervisory Control and Data Acquisition remote supervisory control software program to continuously monitor and control the Pipelines from the Wichita, Kansas headquarters. The system monitors quantities of refined petroleum products injected in and delivered through the Pipelines and automatically signals the Wichita headquarters upon any deviation from normal operations that requires attention. Pipeline Operations Both the East Pipeline and the West Pipeline are interstate pipelines and thus subject to Federal regulation by such governmental agencies as the Federal Energy Regulatory Commission ("FERC") and the Department of Transportation, as well as the Environmental Protection Agency. Additionally, the West Pipeline is subject to state regulation of certain intrastate rates in Colorado and Wyoming and the East Pipeline is subject to state regulation in Kansas. See "Regulation." Except for the three single-use pipelines and certain ethanol facilities, all of the Partnership's pipeline operations constitute common carrier operations and are subject to Federal tariff regulation. Also, certain of its intrastate common carrier operations are subject to state tariff regulation. Common carrier activities are those under which transportation through the Pipelines is available at published tariffs filed with the FERC, in the case of interstate shipments, or the relevant state authority, in the case of intrastate shipments in Kansas, Colorado and Wyoming, to any shipper of refined petroleum products who requests such services and satisfies the conditions and specifications for transportation. In general, a shipper on one of the Pipelines acquires refined petroleum products from refineries connected to such Pipeline, or, if the shipper already owns the refined petroleum products, delivers such products to the Pipeline from those refineries or from pipelines that connect with such Pipeline. Tariffs for transportation are charged to shippers based upon transportation from the origination point on the Pipeline to the point of delivery. Such tariffs also include charges for terminaling and storage of product at the Pipeline's terminals. Pipelines are generally the lowest cost method for intermediate and long-haul overland transportation of refined petroleum products. Each shipper transporting product on a Pipeline is required to supply KPOP with a notice of shipment indicating sources of products and destinations. All shipments are tested or receive refinery certifications to ensure compliance with KPOP's specifications. Shippers are generally invoiced by KPOP immediately upon the product entering one of the Pipelines. The operations of the Pipelines also include 19 truck loading terminals through which refined petroleum products are delivered to storage tanks and then loaded into petroleum transport trucks. The following table shows, with respect to each of such terminals, its location, the number of tanks owned by KPOP, its storage capacity in barrels and truck capacity. Except as indicated, each terminal is owned by KPOP at December 31, 1997. LOCATION OF NUMBER TANKAGE TRUCK TERMINALS OF TANKS CAPACITY CAPACITY(A) ---------------------------- -------- -------- ----------- COLORADO: Dupont 18 692,000 6 Fountain 13 366,000 5 IOWA: LeMars 9 103,000 2 Milford(b) 11 172,000 2 Rock Rapids 12 366,000 2 KANSAS: Concordia(c) 7 79,000 2 Hutchinson 9 162,000 1 NEBRASKA: Columbus(d) 12 191,000 2 Geneva 39 678,000 8 Norfolk 16 187,000 4 North Platte 22 198,000 5 Osceola 8 79,000 2 Superior(e) 11 192,000 1 NORTH DAKOTA: Jamestown 13 188,000 2 SOUTH DAKOTA: Aberdeen 12 181,000 2 Mitchell 8 72,000 2 Rapid City 13 256,000 3 Wolsey 21 149,000 4 Yankton 25 246,000 4 WYOMING: Cheyenne 15 345,000 2 ------ ----------- TOTALS 294 4,902,000 ====== =========== (a) Number of trucks that may be simultaneously loaded. (b) The Milford terminal is situated on land leased through August 7, 2007 at an annual rental of $2,400. KPOP has the right to renew the lease upon its expiration for an additional term of 20 years at the same annual rental rate. (c) The Concordia terminal is situated on land leased through the year 2060 for a total rental of $2,000. (d) Also loads rail tank cars. (e) Out of service as of March 15, 1997. The East Pipeline also has intermediate storage facilities consisting of 13 storage tanks at El Dorado, Kansas and 10 storage tanks at McPherson, Kansas with aggregate capacities of approximately 388,000 and 534,000 barrels, respectively. During 1997, approximately 63% and 89% of the deliveries of the East Pipeline and the West Pipeline, respectively, were made through their terminals, and approximately 37% and 11% the remainder of the respective deliveries of such lines were made to other pipelines and customer owned storage tanks. Storage of product at terminals pending delivery is considered by the Partnership to be an integral part of the product delivery service of the Pipelines. Shippers generally store refined petroleum products for less than one week. Ancillary services, including injection of shipper-furnished and generic additives, are available at each terminal. Demand for and Sources of Refined Petroleum Products The Partnership's pipeline business depends in large part on (i) the level of demand for refined petroleum products in the markets served by the Pipelines and (ii) the ability and willingness of refiners and marketers having access to the Pipelines to supply such demand by deliveries through the Pipelines. Most of the refined petroleum products delivered through the East Pipeline are ultimately used as fuel for railroads or in agricultural operations, including fuel for farm equipment, irrigation systems, trucks transporting crops and crop drying facilities. Demand for refined petroleum products for agricultural use, and the relative mix of products required, is affected by weather conditions in the markets served by the East Pipeline. The agricultural sector is also affected by government agricultural policies and crop prices. Although periods of drought suppress agricultural demand for some refined petroleum products, particularly those used for fueling farm equipment, the demand for fuel for irrigation systems often increases during such times. While there is some agricultural demand for the refined petroleum products delivered through the West Pipeline, as well as military jet fuel volumes, most of the demand is centered in the Denver and Colorado Springs/Fountain areas. Because demand on the West Pipeline is significantly weighted toward urban and suburban areas, the product mix on the West Pipeline includes a substantially higher percentage of gasoline than the product mix on the East Pipeline. The Pipelines are also dependent upon adequate levels of production of refined petroleum products by refineries connected to the Pipelines, directly or through connecting pipelines. The refineries are, in turn, dependent upon adequate supplies of suitable grades of crude oil. The refineries connected directly to the East Pipeline obtain crude oil from producing fields located primarily in Kansas, Oklahoma and Texas, and, to a much lesser extent, from other domestic or foreign sources. Refineries in Kansas, Oklahoma and Texas are connected to the East Pipeline through other pipelines. These refineries obtain their supplies of crude oil from a variety of sources. The refineries connected directly to the West Pipeline are located in Casper and Cheyenne, Wyoming and Denver, Colorado. Refineries in Billings and Laurel, Montana are connected to the West Pipeline through other pipelines. These refineries obtain their supplies of crude oil primarily from Rocky mountain sources. If operations at any one refinery were discontinued, the Partnership believes (assuming unchanged demand for refined petroleum products in markets served by the Pipelines) that the effects thereof would be short-term in nature, and the Partnership's business would not be materially adversely affected over the long term because such discontinued production could be replaced by other refineries or by other sources. The majority of the refined petroleum product transported through the East Pipeline was produced at four refineries located at McPherson, El Dorado and Arkansas City, Kansas and Ponca City, Oklahoma, and operated by National Cooperative Refinery Association ("NCRA"), Texaco, Inc. ("Texaco"), Total Petroleum (now Ultramar Diamond Shamrock) and Conoco, Inc. respectively. The NCRA and Texaco refineries are connected directly to the East Pipeline, as is the Total Petroleum refinery, which was permanently shut down on September 1, 1996. One of such refineries, the McPherson, Kansas refinery operated by NCRA, accounted for approximately 35% of the total amount of product shipped over the East Pipeline in 1997. The East Pipeline also has direct access by third party pipelines to four other refineries in Kansas, Oklahoma and Texas and to Gulf Coast supplies of products through connecting pipelines that receive products from a pipeline originating on the Gulf Coast. Five connecting pipelines can deliver propane from gas processing plants in Texas, New Mexico, Oklahoma and Kansas to the East Pipeline for shipment. The majority of the refined petroleum products transported through the West Pipeline is produced at the Frontier Oil & Refining Company refinery located at Cheyenne, Wyoming, the Total Petroleum (now Ultramar Diamond Shamrock) and Conoco Oil refineries located at Denver, Colorado and Sinclair's Little America refinery located at Casper, Wyoming, all of which are connected directly to the West Pipeline. The West Pipeline also has access to three Billings, Montana area refineries through a connecting pipeline. Principal Customers KPOP had a total of approximately 50 shippers in 1997. The principal shippers include four integrated oil companies, three refining companies, two large farm cooperatives and one railroad. Transportation revenues attributable to the top 10 shippers of the Pipelines were $43.8 million, $46.5 million and $43.7 million, which accounted for 74%, 76% and 75% of total revenues shipped for each of the years 1997, 1996 and 1995, respectively. Competition and Business Considerations The East Pipeline's major competitor is an independent regulated common carrier pipeline system owned by The Williams Companies, Inc. that operates approximately 100 miles east of and parallel to the East Pipeline. The Williams system is a substantially more extensive system than the East Pipeline. Furthermore, Williams and its affiliates have capital and financial resources that are substantially greater than those of the Partnership. Competition with Williams is based primarily on transportation charges, quality of customer service and proximity to end users, although refined product pricing at either the origin or terminal point on a pipeline may outweigh transportation costs. Fourteen of the East Pipeline's 15 delivery terminals are in direct competition with Williams' terminals, as they are located within 2 to 145 miles of one another. The West Pipeline competes with the truck loading racks of the Cheyenne and Denver refineries and the Denver terminals of the Chase Pipeline Company and Phillips Petroleum pipelines. Diamond Shamrock terminals in Denver and Colorado Springs, connected to a Diamond Shamrock pipeline from their Texas Panhandle refinery, are major competitors to the West Pipeline's Denver and Fountain terminals, respectively. Because pipelines are generally the lowest cost method for intermediate and long-haul movement of refined petroleum products, the Pipelines' more significant competitors are common carrier and proprietary pipelines owned and operated by major integrated and large independent oil companies and other companies in the areas where the Pipelines deliver products. Competition between common carrier pipelines is based primarily on transportation charges, quality of customer service and proximity to end users. The Partnership believes high capital costs, tariff regulation, environmental considerations and problems in acquiring rights-of-way make it unlikely that other competing pipeline systems comparable in size and scope to the Pipelines will be built in the near future, provided the Pipelines have available capacity to satisfy demand and its tariffs remain at reasonable levels. The costs associated with transporting products from a loading terminal to end users limit the geographic size of the market that can be served economically by any terminal. Transportation to end users from the loading terminals of the Partnership is conducted principally by trucking operations of unrelated third parties. Trucks may competitively deliver products in some of the areas served by the Pipelines. However, trucking costs render that mode of transportation not competitive for longer hauls or larger volumes. The Partnership does not believe that trucks are, or will be, effective competition to its long-haul volumes over the long term. LIQUIDS TERMINALING Introduction The Partnership's Support Terminal Services operation ("ST") is one of the largest independent petroleum products and specialty liquids terminaling companies in the United States. For the year ended December 31, 1997, the Partnership's terminaling business accounted for approximately 49% of the Partnership's revenues. As of December 31, 1997, ST operated 31 facilities in 16 states and the District of Columbia, with a total storage capacity of approximately 17.2 million barrels. ST and its predecessors have been in the terminaling business for over 40 years and handle a wide variety of liquids from petroleum products to specialty chemicals to edible liquids. ST's terminal facilities provide storage on a fee basis for petroleum products, specialty chemicals and other liquids. ST's five largest terminal facilities are located in Piney Point, Maryland; Jacksonville, Florida; Texas City, Texas; Baltimore, Maryland; and, Westwego, Louisiana. These facilities accounted for approximately 72% of ST's revenues and 65% of its tankage capacity in 1997. Description of Terminals Piney Point, Maryland. The largest terminal currently owned by ST is located on approximately 400 acres on the Potomac River. The facility was acquired as part of the purchase of the liquids terminaling assets of Steuart Petroleum Company and certain of its affiliates (collectively "Steuart") in December 1995. The Piney Point terminal has approximately 5.4 million barrels of storage capacity in 28 tanks and is the closest deep water facility to Washington, D.C. This terminal competes with other large petroleum terminals in the East Coast water-borne market extending from New York Harbor to Norfolk, Virginia. The terminal currently stores petroleum products, consisting primarily of fuel oils, asphalt and caustic soda solution. The terminal has a dock with a 36-foot draft for tankers and four berths for barges. It also has truck loading facilities, product blending capabilities and is connected to a pipeline which supplies residual fuel oil to two power generating stations. Jacksonville, Florida. The Jacksonville terminal, also acquired as part of the Steuart transaction, is located on approximately 86 acres on the St. John's River and consists of a main terminal and two annexes with combined storage capacity of approximately 2.1 million barrels in 30 tanks. The terminal is currently used to store petroleum products including gasoline, No. 2 oil, No. 6 oil, diesel and kerosene. This terminal has a tanker berth with a 38-foot draft and four barge berths and also offers truck and rail car loading facilities and facilities to blend residual fuels for ship bunkering. Texas City, Texas. The Texas City facility is situated on 39 acres of land leased from the Texas City Terminal Railway Company ("TCTRC") with long-term renewal options. It is located on Galveston Bay near the mouth of the Houston Ship Channel, approximately sixteen miles from open water. The eastern end of the Texas City site is adjacent to three deep-water docking facilities, which are also owned by TCTRC. The three deep-water docks include two 36-foot draft docks and a 40-foot draft dock. The docking facilities can accommodate any ship or barge capable of navigating the 40-foot draft of the Houston Ship Channel. ST is charged dockage and wharfage fees on a per vessel and per unit basis, respectively, by TCTRC, which it passes on to its customers. The Texas City facility is designed to accommodate a diverse product mix, including specialty chemicals, such as petrochemicals and has tanks equipped for the specific storage needs of the various products handled; piping and pumping equipment for moving the product between the tanks and the transportation modes; and, an extensive infrastructure of support equipment. The tankage at Texas City is constructed of either mild carbon steel, stainless steel or aluminum. Certain of the tanks, piping and pumping equipment are equipped for special product needs, including among other things, linings and/or equipment that can control temperature, air pressure, air mixture or moisture. ST receives or delivers the majority of the specialty chemicals that it handles via ship or barge at Texas City. ST also receives and delivers liquids via rail tank cars and transport trucks and has direct pipeline connections to refineries in Texas City. The Texas City terminal consists of 124 tanks with a total capacity of approximately 2 million barrels. ST's facility has been designed with engineered structural measures to minimize the possibility of the occurrence and the level of damage in the event of a spill or fire. All loading areas, tanks, pipes and pumping areas are "contained" to collect any spillage and insure that only properly treated water is discharged from the site. Baltimore, Maryland. The Baltimore facility is situated on 18 acres of owned land, located just south of Baltimore near the Harbor Tunnel on the Chesapeake Bay. ST also owns a 700-foot finger pier with a 33-foot draft channel and berth at the facility. The dock gives ST the ability to receive and deliver shipments of product from and to barge and ship. Additionally, the terminal can receive products by pipeline, truck and rail and deliver them via truck and rail. Similar to the Texas City facility, Baltimore is a specialty liquids terminal. The primary products stored at the Baltimore facility include asphalt, fructose, caustic solutions, military jet fuel, latex and other chemicals. The Baltimore tank facility consists of 49 tanks with a total capacity of approximately 821,000 barrels. All of the utilized tanks are dedicated to specific products of customers under contract. The tanks are specifically equipped to handle the requirements of the products they store. Westwego, Louisiana. The Westwego facility is situated on 27 acres of owned land on the west bank of the Mississippi River across from New Orleans. Its dock is capable of handling ocean-going vessels and barges. The terminal has multiple facilities for receiving and shipping by rail and tank truck, as well as vessels and barges. The facility consists of 54 tanks with a total capacity of approximately 858,000 barrels. The facility also includes a blending plant for the formulation of certain molasses-based feeds which has additional smaller tanks for blending and formulation of the liquid feeds. The Westwego terminal historically has been primarily a terminal for molasses and animal and vegetable fats and oils. In recent years, the terminal has broadened its product mix to include fertilizer, herbicides, latex and caustic solutions. The former owner of the facility has contracted with ST until June 1999 for terminaling in five large molasses tanks located at the facility. Other Terminal Sites. In addition to the five major facilities described above, ST has 26 other terminal facilities located throughout the United States. The 26 facilities represented approximately 35% of ST's total tankage capacity and approximately 28% of its total revenue for 1997. With the exception of the facilities in Columbus, Georgia, which handles aviation gasoline and specialty chemicals; Winona, Minnesota, which handles nitrogen fertilizer solutions; and, Savannah, Georgia, which handles chemicals and caustic solutions, these facilities primarily store petroleum products for a variety of customers. These facilities provide ST with a geographically diverse base of customers and revenue. The storage and transport of jet fuel for the U.S. Department of Defense is also an important part of ST's business. Eleven of ST's terminal sites are involved in the terminaling or transport (via pipeline) of jet fuel for the Department of Defense and seven of the eleven locations have been utilized solely by the U.S. Government. Two of these locations are presently without government business. Of the eleven locations, six include pipelines which deliver jet fuel directly to nearby military bases, while another location supplies Andrews Air Force Base, Maryland and consists of a barge receiving dock, an 11.3 mile pipeline, three 24,000 barrel double-bottomed tanks and an administration building located on the base. This facility provides the barge receipt, pipeline transportation and terminaling services for jet fuel to Andrews Air Force Base on a tariff basis for the Defense Fuel Supply Center and has served the base for the past 30 years. The following table outlines ST's terminal locations, capacities, tanks and primary products handled: TANKAGE NO. OF PRIMARY PRODUCTS FACILITY CAPACITY TANKS HANDLED ---------------------- ---------- ------ ------------------------------ PRIMARY TERMINALS: Piney Point, MD 5,403,000 28 Petroleum Jacksonville, FL 2,066,000 30 Petroleum Texas City, TX 2,002,000 124 Chemicals and Petrochemicals Westwego, LA 858,000 54 Molasses, Fertilizer, Caustic Baltimore, MD 821,000 49 Chemicals, Asphalt, Jet Fuel OTHER TERMINALS: Montgomery, AL(a) 162,000 7 Petroleum, Jet Fuel Moundville, AL 310,000 6 Jet Fuel Tuscon, AZ(b) 181,000 7 Petroleum Imperial, CA 124,000 6 Petroleum Stockton, CA 314,000 18 Petroleum Farragut St., DC 176,000 5 Petroleum M Street, DC 133,000 3 Petroleum Homestead, FL(a) 72,000 2 Jet Fuel Augusta, GA 110,000 8 Petroleum Bremen, GA 180,000 8 Petroleum, Jet Fuel Brunswick, GA 302,000 3 Petroleum, Pulp Liquor Columbus, GA 180,000 25 Petroleum, Chemicals Macon, GA(a) 307,000 10 Petroleum, Jet Fuel Savannah, GA 699,000 17 Petroleum, Chemicals Chillicothe, IL 270,000 6 Petroleum Peru, IL 221,000 8 Petroleum, Fertilizer Indianapolis, IN 410,000 18 Petroleum Salina, KS 98,000 10 Petroleum Andrews AFB Pipeline, MD 72,000 3 Jet Fuel Winona, MN 229,000 7 Fertilizer Alamogordo, NM(a) 120,000 5 Jet Fuel Drumright, OK 315,000 4 Jet Fuel San Antonio, TX 207,000 4 Jet Fuel Cockpit Point, VA 554,000 16 Petroleum, Asphalt Virginia Beach, VA(a) 40,000 2 Jet Fuel Milwaukee, WI 308,000 7 Petroleum ----------- ----- 17,244,000 500 =========== ===== (a) Facility also includes pipelines to U.S. government military base locations. (b) The terminal is 50% owned by ST. Competition and Business Considerations In addition to the terminals owned by independent terminal operators, such as ST, many major energy and chemical companies own extensive terminal storage facilities. Although such terminals often have the same capabilities as terminals owned by independent operators, they generally do not provide terminaling services to third parties. In many instances, major energy and chemical companies that own storage and terminaling facilities are also significant customers of independent terminal operators. Such companies typically have strong demand for terminals owned by independent operators when independent terminals have more cost effective locations near key transportation links, such as deep-water ports. Major energy and chemical companies also need independent terminal storage when their owned storage facilities are inadequate, either because of size constraints, the nature of the stored material or specialized handling requirements. Independent terminal owners generally compete on the basis of the location and versatility of terminals, service and price. A favorably located terminal will have access to various cost effective transportation modes both to and from the terminal. Possible transportation modes include waterways, railroads, roadways and pipelines. Terminals located near deep-water port facilities are referred to as "deep-water terminals" and terminals without such facilities are referred to as "inland terminals"; though some inland facilities are served by barges on navigable rivers. Terminal versatility is a function of the operator's ability to offer handling for diverse products with complex handling requirements. The service function typically provided by the terminal includes, among other things, the safe storage of the product at specified temperature, moisture and other conditions, as well as receipt at and delivery from the terminal. An increasingly important aspect of versatility and the service function is an operator's ability to offer product handling and storage in compliance with environmental regulations. A terminal operator's ability to obtain attractive pricing is often dependent on the quality, versatility and reputation of the facilities owned by the operator. Although many products require modest terminal modification, operators with a greater diversity of terminals with versatile storage capabilities typically require less modification prior to usage, ultimately making the storage cost to the customer more attractive. Several companies offering liquid terminaling facilities have significantly more capacity than ST. However, the majority of ST's tankage can be described as "niche" facilities that are equipped to properly handle "specialty" liquids or provide facilities or services where management believes they enjoy an advantage over competitors. Most of the larger operators, including GATX Terminals Corporation, Williams Company, Northville Industries Corporation and Petroleum Fuel & Terminal Company, have facilities used primarily for petroleum related products. As a result, many of ST's terminals compete against other large petroleum products terminals, rather than specialty liquids facilities. Such specialty or "niche" tankage is less abundant in the U.S. and "specialty" liquids typically command higher terminal fees than lower-price bulk terminaling for petroleum products. CAPITAL EXPENDITURES Capital expenditures by the Pipelines, were $4.5 million, $3.4 million and $3.4 million for 1997, 1996 and 1995, respectively. During these periods, adequate capacity existed on the Pipelines to accommodate volume growth and the expenditures required for environmental and safety improvements were not material in amount. Capital expenditures, excluding acquisitions, by ST were $6.1 million, $3.6 million and $5.6 million, for 1997, 1996 and 1995, respectively. Capital expenditures of the Partnership during 1998 are expected to be approximately $7 million to $10 million. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." Additional expansion-related capital expenditures will depend on future opportunities to expand the Partnership's operation. The General Partner intends to finance future expansion capital expenditures primarily through Partnership borrowings. Such future expenditures, however, will depend on many factors beyond the Partnership's control, including, without limitation, demand for refined petroleum products and terminaling services in the Partnership's market areas, local, state and Federal governmental regulations, fuel conservation efforts and the availability of financing on acceptable terms. No assurance can be given that required capital expenditures will not exceed anticipated amounts during the year or thereafter or that the Partnership will have the ability to finance such expenditures through borrowing or choose to do so. REGULATION Interstate Regulation. The interstate common carrier pipeline operations of the Partnership are subject to rate regulation by FERC under the Interstate Commerce Act. The Interstate Commerce Act provides, among other things, that to be lawful the rates of common carrier petroleum pipelines must be "just and reasonable" and not unduly discriminatory. New and changed rates must be filed with the FERC, which may investigate their lawfulness on protest or its own motion. The FERC may suspend the effectiveness of such rates for up to seven months. If the suspension expires before completion of the investigation, the rates go into effect, but the pipeline can be required to refund to shippers, with interest, any difference between the level the FERC determines to be lawful and the filed rates under investigation. Rates that have become final and effective may be challenged by complaint to FERC filed by a shipper or on the FERC's own initiative and reparations may be recovered by the party filing the complaint for the two year period prior to the complaint, if FERC finds the rate to be unlawful. In general, petroleum product pipeline rates are cost-based. Such rates are permitted to generate operating revenues, based on projected volumes, not greater than the total of the following components: (i) operating expenses, (ii) depreciation and amortization, (iii) Federal and state income taxes (determined on a separate company basis and adjusted or "normalized" to avoid year to year variations in rates due to the effect of timing differences between book and tax accounting for certain expenses, primarily depreciation) and (iv) an overall allowed rate of return on the pipeline's "rate base". Generally, the "rate base" is a measure of the investment in, or value of, the common carrier assets of a petroleum products pipeline which should be calculated by the net depreciated "trended original cost" ("TOC") methodology. Under the TOC methodology, after a starting rate base has been determined, a pipeline's rate base is to be (i) increased by property additions at cost plus an amount equal to the equity portion of the rate base multiplied or "trended" by an inflation factor and (ii) decreased by property retirements, depreciation and amortization of rate base write-ups reflecting inflation. The FERC allows for a rate of return for petroleum products pipelines determined by adding (i) the product of a rate of return equal to the nominal cost of debt multiplied by the portion of the rate base that is deemed to be financed with debt and (ii) the product of a rate of return equal to the real (i.e., inflation-free) cost of equity multiplied by the portion of the rate base that is deemed to be financed with equity. The appropriate rate of return for a petroleum pipeline is determined on a case-by-case basis, taking into account cost of capital, competitive factors and business and financial risks associated with pipeline operations. The Partnership has not attempted to depart from cost-based rates. Instead, it has continued to rely on the traditional, cost-based TOC methodology. The TOC methodology has not been subject to judicial review. Under Title XVIII of the Energy Policy Act of 1992 (the "EP Act"), rates that were in effect on October 24, 1991 that were not subject to a protest, investigation or complaint are deemed to be just and reasonable. Such rates are subject to challenge only for limited reasons, relating to (i) substantially changed circumstances in either the economic circumstances of the subject pipeline or the nature of the services, (ii) a contractual bar that prevented the complainant from previously challenging the rates or (iii) a claim that such rates are unduly discriminatory or preferential. Any relief granted pursuant to such challenges may be prospective only. Because the Partnership's rates that were in effect on October 24, 1991, were subject to investigation and protest at that time, its rates were not deemed to be just and reasonable pursuant to the EP Act. The Partnership's current rates became final and effective in April 1994, and the Partnership believes that its currently effective tariffs are just and reasonable and would withstand challenge under the FERC's cost-based rate standards. Because of the complexity of rate making, however, the lawfulness of any rate is never assured. On October 22, 1993, the FERC issued Order No. 561 implementing the EP Act. Order No. 561, among other things, adopted a simplified and generally acceptable rate making methodology for future oil pipeline rate changes in the form of indexation. Indexation, which is also known as price cap regulation, establishes ceiling prices on oil pipeline rates based on application of a broad-based measure of inflation in the general economy to existing rates. Rate increases up to the ceiling level are to be discretionary for the pipeline, and, for such rate increases, there will be no need to file cost-of-service or supporting data. Moreover, so long as the ceiling is not exceeded, a pipeline may make a limitless number of rate change filings. The pipeline rates in effect at December 31, 1994, which are determined to be just and reasonable, become the "Base Rates" for application of the indexing mechanism. This indexing mechanism calculates a ceiling rate. The pipeline may increase its rates to this calculated ceiling rate without filing a formal cost based justification and with limited risk of shipper protests. Shippers may still be permitted to protest pipeline rates, even if the rate change does not exceed the index ceiling, if the shipper can demonstrate that the "increase is so substantially in excess of the actual cost increase incurred by the pipeline" that the proposed rate would be unjust and unreasonable. The index is cumulative, attaching to the applicable ceiling rate and not to the actual rate charged. Thus, a rate that is not increased to the ceiling level in a given year may still be increased to the ceiling level in the following year. The pipeline may be required to decrease the current rate if the rate being charged exceeds the ceiling level. The index underlying Order No. 561 is to serve as the principal basis for the establishment of oil pipeline rate changes in the future. As explained by the FERC in Order Nos. 561 and 561-A, however, there may be circumstances where the indexing mechanism will not apply. Specifically, the FERC determined that a pipeline may utilize any one of the following three alternative methodologies to indexing: (i) a cost-of-service methodology may be utilized by a pipeline to justify a change in a rate if a pipeline can demonstrate that its increased costs are prudently incurred and that there is a substantial divergence between such increased costs and the rate that would be produced by application of the index; (ii) a pipeline may file a rate change as part of a settlement when it secures the agreement of all of its existing shippers; and (iii) a pipeline may base its rates upon a "light-handed" market-based form of regulation if it is able to demonstrate a lack of significant market power in the relevant markets. On October 28, 1994, after hearings and public comment period, the FERC issued Order Nos. 571 and 572, intended as procedural follow-ups to Order No. 561. In Order No. 571, the FERC (i) articulated cost-of-service and reporting requirements to be applicable to pipeline initial rates and to situations where indexing is determined to be inappropriate; (ii) adopted rules for the establishment of revised depreciation rates; and (iii) revised the information required to be reported by pipelines in their Form No. 6, "Annual Report for Oil Pipelines". Order No. 572 establishes the filing requirements and procedures that must be followed when a pipeline seeks to charge market-based rates. On September 15, 1997, the Partnership filed an Application for Market Power Determination with the FERC seeking market based rates for approximately half of its markets. The application is pending before the FERC. In the FERC's Lakehead decision issued June 15, 1995, the FERC partially disallowed Lakehead's inclusion of income taxes in its cost of service. Specifically, the FERC held that Lakehead was entitled to receive an income tax allowance with respect to income attributable to its corporate partners, but was not entitled to receive such an allowance for income attributable to the Partnership interests held by individuals. Lakehead's motion for rehearing was denied by the FERC and Lakehead appealed the decision to the U.S. Court of Appeals. Subsequently the case was settled by Lakehead and the appeal was withdrawn. In another FERC proceeding involving a different oil pipeline limited partnership, various shippers challenged such pipeline's inclusion of an income tax allowance in its cost of service. The FERC Staff also supported the disallowance of income taxes. The FERC recently decided this case on the same basis as the Lakehead case. If the FERC were to disallow the income tax allowance in the cost of service of the Pipelines on the basis set forth in the Lakehead order, the General Partner believes that the Partnership's ability to pay the Minimum Quarterly Distribution to the holders of the Senior Preference Units and Preference Units would not be impaired; however, in view of the uncertainties involved in this issue, there can be no assurance in this regard. Intrastate Regulation. The intrastate operations of the East Pipeline in Kansas are subject to regulation by the Kansas Corporation Commission, and the intrastate operations of the West Pipeline in Colorado and Wyoming are subject to regulation by the Colorado Public Utility Commission and the Wyoming Public Service Commission, respectively. Like the FERC, the state regulatory authorities require that shippers be notified of proposed intrastate tariff increases and have an opportunity to protest such increases. KPOP also files with such state authorities copies of interstate tariff changes filed with the FERC. In addition to challenges to new or proposed rates, challenges to intrastate rates that have already become effective are permitted by complaint of an interested person or by independent action of the appropriate regulatory authority. ENVIRONMENTAL MATTERS General. The operations of the Partnership are subject to Federal, state and local laws and regulations relating to the protection of the environment. Although the Partnership believes that its operations are in general compliance with applicable environmental regulations, risks of substantial costs and liabilities are inherent in pipeline and terminal operations, and there can be no assurance that significant costs and liabilities will not be incurred by the Partnership. Moreover, it is possible that other developments, such as increasingly strict environmental laws, regulations and enforcement policies thereunder, and claims for damages to property or persons resulting from the operations of the Partnership, past and present, could result in substantial costs and liabilities to the Partnership. Water. The Oil Pollution Act ("OPA") was enacted in 1990 and amends provisions of the Federal Water Pollution Control Act of 1972 and other statutes as they pertain to prevention and response to oil spills. The OPA subjects owners of facilities to strict, joint and potentially unlimited liability for removal costs and certain other consequences of an oil spill, where such spill is into navigable waters, along shorelines or in the exclusive economic zone. In the event of an oil spill into such waters, substantial liabilities could be imposed upon the Partnership. Regulations concerning the environment are continually being developed and revised in ways that may impose additional regulatory burdens on the Partnership. Contamination resulting from spills or releases of refined petroleum products are not unusual within the petroleum pipeline industry. The East Pipeline has experienced limited groundwater contamination at five terminal sites (Milford, Iowa; Norfolk and Columbus, Nebraska; and Aberdeen and Yankton, South Dakota) resulting from spills of refined petroleum products. Regulatory authorities have been notified of these findings and remediation projects are underway or under construction using various remediation techniques. The Partnership estimates that $1,084,000 has been expended to date for remediation at these five sites and that ongoing remediation expenses at each site will not have a material effect on the East Pipeline. Groundwater contamination is also known to exist at East Pipeline sites in Augusta, Kansas and in Potwin, Kansas, but no remediation has been required. Although no assurances can be made, if remediation is required, the Partnership believes that the resulting cost would not be material. During January 1994, the East Pipeline experienced a seam rupture of its 8" northbound line in Nebraska and another similar rupture on the same line in April 1994. As a result of these ruptures, KPOP reduced the maximum operating pressure on this line to 60% of the Maximum Allowable Operating Pressure ("MAOP") and, on May 24, 1994, commenced a hydrostatic test to determine the integrity of over 80 miles of that line. The test was completed on the entire 80 miles on May 29, 1994, and the line was authorized to return to approximately 80% of MAOP pending review by the Department of Transportation ("DOT") of the hydrostatic test results. On July 29, 1994, the DOT authorized most of the line to return to the historical MAOP. Approximately 30 miles of the line was authorized to return to slightly less than historical MAOP. Although the Partnership has expended approximately $250,000 to date for remediation at these rupture sites, the total amount of remediation expenses that will be required has not yet been determined. These expenses are not expected to have a material effect upon the results of the Partnership. ST has experienced groundwater contamination at its terminal sites at Baltimore, Maryland, and Alamogordo, New Mexico. Regulatory authorities have been notified of these findings and cleanup is underway using extraction wells and air strippers. Groundwater contamination also exists at the ST terminal site in Stockton, California and in the areas surrounding this site as a result of the past operations of five of the facilities operating in this area. ST has entered into an agreement with three of these other companies to allocate responsibility for the clean up of the contaminated area. Under the current approach, clean up will not be required, however based on risk assessment, the site will continue to be monitored and tested. In addition, ST is responsible for up to two-thirds of the costs associated with existing groundwater contamination at a formerly owned terminal at Marcy, New York, which also is being remediated through extraction wells and air strippers. The Partnership has expended approximately $830,000 through 1997 for remediation at these four sites and estimates that on-going remediation expenses will aggregate approximately $200,000 to $300,000 over the next three years. Groundwater contamination has been identified at ST terminal sites at Montgomery, Alabama and Milwaukee, Wisconsin, but no remediation has taken place. Shell Oil Company has indemnified ST for any contamination at the Milwaukee site prior to ST's acquisition of the facility. Star Enterprises, the former owner of the Montgomery terminal, has indemnified ST for contamination at a portion of the Montgomery site where contamination was identified prior to ST's acquisition of the facility. A remediation system is in place to address groundwater contamination at the ST terminal facility in Augusta, Georgia. Star Enterprises, the former owner of the Augusta terminal, has indemnified ST for this contamination and has retained responsibility for the remediation system. There is also a possibility that groundwater contamination may exist at other facilities. Although no assurance in this regard can be given, the Partnership believes that such contamination, if present, could be remedied with extraction wells and air strippers similar to those that are currently in use and that resulting costs would not be material. In 1991, the Environmental Protection Agency (the "EPA") implemented regulations expanding the definition of hazardous waste. The Toxicity Characteristic Leaching Procedure ("TCLP") has broadened the definition of hazardous waste by including 25 constituents that were not previously included in determining that a waste is hazardous. Water that comes in contact with petroleum may fail the TCLP procedure and require additional treatment prior to its disposal. The Partnership has installed totally enclosed wastewater treatment systems at all East Pipeline terminal sites to treat such petroleum contaminated water, especially tank bottom water. The EPA has also promulgated regulations that may require the Partnership to apply for permits to discharge storm water runoff. Storm water discharge permits also may be required in certain states in which the Partnership operates. Where such requirements are applicable, the Partnership has applied for such permits and, after the permits are received, will be required to sample storm water effluent before releasing it. The Partnership believes that effluent limitations could be met, if necessary, with minor modifications to existing facilities and operations. Although no assurance in this regard can be given, the Partnership believes that the changes will not have a material effect on the Partnership's financial condition or results of operations. Groundwater remediation efforts are ongoing at the West Pipeline's Dupont and Fountain, Colorado terminals and at the Cheyenne, Wyoming terminal and Bear Creek, Wyoming station and will be required at one other West Pipeline terminal. Regulatory officials have been consulted in the development of remediation plans. In the course of acquisition negotiations for this terminal, KPOP's regulatory group and its outside environmental consultants agreed upon the expense and costs of these required remediations. In connection with the purchase of the West Pipeline, KPOP agreed to implement the agreed remediation plans at these specific sites over the succeeding five years following the acquisition in return for the payment by the seller, Wyco Pipe Line Company, of $1,312,000 to KPOP to cover the discounted estimated future costs of these remediations. In conjunction with the acquisition, the Partnership accrued $1.8 million for these future remediation expenses. Groundwater contamination has been experienced at ST's Piney Point, Maryland, Jacksonville, Florida and each of the Washington, D.C. facilities. Foreseeable remediation expenses are estimated not to exceed $1.6 million. In connection with its acquisition of these facilities from Steuart, the Partnership agreed to assume the existing remediation and the costs thereof up to $1.8 million and the Asset Purchase Agreements provided, with respect to unknown environmental damages that are discovered after the closing of the transaction and that were caused by operations conducted by the former owner prior to the closing, that the Partnership and Steuart will share those expenses at a ratio of 20% for the Partnership and 80% for Steuart until a total of $2.5 million has been expended. Thereafter, such expenses will be the Partnership's responsibility. This indemnity will expire in December, 1998. In conjunction with the acquisition, the Partnership accrued $2.3 million for potential environmental liabilities arising from the Steuart acquisition. Aboveground Storage Tank Acts. A number of the states in which the Partnership operates have passed statutes regulating aboveground tanks containing liquid substances. Generally, these statutes require that such tanks include secondary containment systems or that the operators take certain alternative precautions to ensure that no contamination results from any leaks or spills from the tanks. Although there is not currently a Federal statute regulating these above ground tanks, there is a possibility that such a law will be passed within the next couple of years. The Partnership is in substantial compliance with all above ground storage tank laws in the states with such laws. Although no assurance can be given, the Partnership believes that the future implementation of above ground storage tank laws by either additional states or by the Federal government will not have a material adverse effect on the Partnership's financial condition or results of operations. Air Emissions. The operations of the Partnership are subject to the Federal Clean Air Act and comparable state and local statutes. The Partnership believes that the operations of the Pipelines are in substantial compliance with such statues in all states in which they operate. Amendments to the Federal Clean Air Act enacted in 1990 will require most industrial operations in the United States to incur future capital expenditures in order to meet the air emission control standards that have been and are to be developed and implemented by the EPA and state environmental agencies. Pursuant to these Clean Air Act Amendments, those Partnership facilities that emit volatile organic compounds ("VOC") or nitrogen oxides will be subject to increasingly stringent regulations, including requirements that certain sources install maximum or reasonably available control technology. The EPA is also required to promulgate new regulations governing the emissions of hazardous air pollutants. Some of the Partnership's facilities are included within the categories of hazardous air pollutant sources that will be affected by these regulations. Additionally, new dockside loading facilities owned or operated by the Partnership will be subject to the New Source Performance Standards that were proposed in May 1994. These regulations will control VOC emissions from the loading and unloading of tank vessels. Although the Partnership is in substantial compliance with applicable air pollution laws, in anticipation of the implementation of stricter air control regulations, the Partnership is taking actions to substantially reduce its air emissions. The Partnership plans to install bottom loading and vapor recovery equipment on the loading racks at selected terminal sites along the East Pipeline that do not already have such emissions control equipment. These modifications will substantially reduce the total air emissions from each of these facilities. Having begun in 1993, this project is being phased in over a period of years. Solid Waste. The Partnership generates non-hazardous solid waste that is subject to the requirements of the Federal Resource Conservation and Recovery Act ("RCRA") and comparable state statutes. The EPA is considering the adoption of stricter disposal standards for non-hazardous wastes. RCRA also governs the disposal of hazardous wastes. At present, the Partnership is not required to comply with a substantial portion of the RCRA requirements because the Partnership's operations generate minimal quantities of hazardous wastes. However, it is anticipated that additional wastes, which could include wastes currently generated during pipeline operations, will in the future be designated as "hazardous wastes". Hazardous wastes are subject to more rigorous and costly disposal requirements than are non-hazardous wastes. Such changes in the regulations may result in additional capital expenditures or operating expenses by the Partnership. At the terminal sites at which groundwater contamination is present, there is also limited soil contamination as a result of the aforementioned spills. The Partnership is under no present requirements to remove these contaminated soils, but the Partnership may be required to do so in the future. Soil contamination also may be present at other Partnership facilities at which spills or releases have occurred. Under certain circumstances, the Partnership may be required to clean up such contaminated soils. Although these costs should not have a material adverse effect on the Partnership, no assurance can be given in this regard. Superfund. The Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA" or "Superfund") imposes liability, without regard to fault or the legality of the original act, on certain classes of persons that contributed to the release of a "hazardous substance" into the environment. These persons include the owner or operator of the site and companies that disposed or arranged for the disposal of the hazardous substances found at the site. CERCLA also authorizes the EPA and, in some instances, third parties to act in response to threats to the public health or the environment and to seek to recover from the responsible classes of persons the costs they incur. In the course of its ordinary operations, the Partnership may generate waste that may fall within CERCLA's definition of a "hazardous substance". The Partnership may be responsible under CERCLA for all or part of the costs required to clean up sites at which such wastes have been disposed. ST has been named a potentially responsible party for a site located at Elkton, Maryland, operated by Spectron, Inc. until August 1988. This site is presently under the oversight of the EPA and is listed as a Federal "Superfund" site. A small amount of material handled by Spectron was attributed to ST. The Partnership believes that ST will be able to settle its potential obligation in connection with this matter for an aggregate cost of approximately $10,000. However, until a final settlement agreement is signed with the EPA, there is a possibility that the EPA could bring additional claims against ST. Environmental Impact Statement. The National Environmental Policy Act of 1969 (the "NEPA") applies to certain extensions or additions to a pipeline system. Under NEPA, if any project that would significantly affect the quality of the environment requires a permit or approval from any Federal agency, a detailed environmental impact statement must be prepared. The effect of the NEPA may be to delay or prevent construction of new facilities or to alter their location, design or method of construction. Indemnification. KPL has agreed to indemnify the Partnership against liabilities for damage to the environment resulting from operations of the East Pipeline prior to October 3, 1989. Such indemnification does not extend to any liabilities that arise after such date to the extent such liabilities result from change in environmental laws or regulations. Under such indemnity, KPL is presently liable for the remediation of groundwater contamination resulting from three spills and the possible groundwater contamination at a pumping and storage site referred to under "Water" to the standards that are in effect at the time such remediation operations are concluded. In addition, ST's former owner has agreed to indemnify the Partnership against liabilities for damages to the environment from operations conducted by such former owners prior to March 2, 1993. The indemnity, which expired March 1, 1998, is limited in amount to 60% of any claim exceeding $100,000 until an aggregate amount of $10 million has been paid by ST's former owner. In addition, with respect to unknown environmental expenses from operations conducted by Wyco Pipe Line Company prior to the closing of the Partnership's acquisition of the West Pipeline, KPOP has agreed to pay the first $150,000 of such expenses, KPOP and Wyco Pipe Line Company will share, on an equal basis, the next $900,000 of such expenses and Wyco Pipe Line Company will indemnify KPOP for up to $2,950,000 of such expenses thereafter. The indemnity expires in August 1999. To the extent that environmental liabilities exceed the amount of such indemnity, KPOP has affirmatively assumed the excess environmental liabilities. Also, the Steuart terminals Asset Purchase Agreements provide, with respect to unknown environmental damages that are discovered after the closing of the Steuart terminals acquisition and that were caused by operations conducted by Steuart prior to the closing, that the Partnership and Steuart will share expenses associated with such environmental damages at a ratio of 20% for the Partnership and 80% for Steuart until a total of $2.5 million has been expended. Thereafter, such expenses will be the Partnership's responsibility. This indemnity will expire in December 1998. SAFETY REGULATION The Pipelines are subject to regulation by the Department of Transportation under the Hazardous Liquid Pipeline Safety Act of 1979 ("HLPSA") relating to the design, installation, testing, construction, operation, replacement and management of their pipeline facilities. The HLPSA covers petroleum and petroleum products pipelines and requires any entity that owns or operates pipeline facilities to comply with such safety regulations and to permit access to and copying of records and to make certain reports and provide information as required by the Secretary to Transportation. The Federal Pipeline Safety Act of 1992 amended the HLPSA to include requirements of the future use of internal inspection devices. The Partnership does not believe that it will be required to make any substantial capital expenditures to comply with the requirements of HLPSA as so amended. The Partnership is subject to the requirements of the Federal Occupational Safety and Health Act ("OSHA") and comparable state statutes. The Partnership believes that it is in general compliance with OSHA requirements, including general industry standards, record keeping requirements and monitoring of occupational exposure to benzene. The OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of the Federal Superfund Amendment and Reauthorization Act, and comparable state statutes require the Partnership to organize information about the hazardous materials used in its operations. Certain parts of this information must be reported to employees, state and local governmental authorities, and local citizens upon request. In general, the Partnership expects to increase its expenditures during the next decade to comply with higher industry and regulatory safety standards such as those described above. Such expenditures cannot be accurately estimated at this time, although they are not expected to have a material adverse impact on the Partnership. EMPLOYEES The Partnership has no employees. The business of the Partnership is conducted by the General Partner, KPL, which at December 31, 1997, employed 427 persons. Approximately 151 of the persons employed by KPL were subject to representation by unions for collective bargaining purposes; however, only 53 persons employed by the terminal division of KPL were represented by the Oil, Chemical and Atomic Workers International Union AFL-CIO ("OCAW"). The terminal division has agreements with OCAW for 35 and 17 of the above employees, which are in effect through June 28, 1999 and November 1, 2000, respectively. The agreements are subject to automatic renewal for successive one-year periods unless one of the parties serves written notice to terminate such agreement in a timely manner. ITEM 2. PROPERTIES Descriptions of properties owned or utilized by the Partnership are contained in Item 1 of this report and such descriptions are hereby incorporated by reference into this Item 2. Under the caption "Commitments and Contingencies" in Note 6 to the Partnership's financial statements included in Item 8 herein below, additional information is presented concerning obligations for lease and rental commitments. Said additional information is hereby incorporated by reference into this Item 2. ITEM 3. LEGAL PROCEEDINGS The Partnership is a party to several lawsuits arising in the ordinary course of business. Subject to certain deductibles and self-insurance retentions, substantially all the claims made in these lawsuits are covered by insurance policies. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Partnership did not hold a meeting of unitholders or otherwise submit any matter to a vote of security holders in the fourth quarter of 1997. PART II ITEM 5. MARKET FOR THE REGISTRANT'S SENIOR PREFERENCE UNITS AND PREFERENCE UNITS AND RELATED UNITHOLDER MATTERS The Partnership's senior preference limited partner interests ("Senior Preference Units") and Preference Units are listed and traded on the New York Stock Exchange. At March 16, 1998, there were approximately 900 Senior Preference Unitholders of record and approximately 200 Preference Unitholders of record. Set forth below are prices and cash distributions for Senior Preference Units and Preference Units, respectively, on the New York Stock Exchange.
SENIOR PREFERENCE PREFERENCE UNIT PRICES UNIT PRICES CASH ------------------------ ------------------------ DISTRIBUTION YEAR HIGH LOW HIGH LOW DECLARED - ----------------------- ---------- --------- --------- --------- ------------ 1996: First Quarter 26 1/2 23 7/8 24 5/8 22 1/4 $ .55 Second Quarter 26 5/8 24 1/4 24 5/8 23 1/8 .55 Third Quarter 26 5/8 24 3/4 25 7/8 22 7/8 .60 Fourth Quarter 30 25 5/8 28 1/8 25 .60 1997: First Quarter 31 1/4 28 28 5/8 26 1/2 .60 Second Quarter 30 1/4 27 1/8 28 3/8 26 1/4 .60 Third Quarter 31 13/16 29 30 7/8 27 7/8 .65 Fourth Quarter 36 11/16 29 13/16 36 1/2 29 5/8 .65 1998: First Quarter 37 1/2 34 11/16 35 1/2 33 1/4 (through March 16, 1998)
The Partnership has paid the Minimum Quarterly Distribution on each outstanding Senior Preference Unit for each quarter since the Partnership's inception. The Partnership has also paid the Minimum Quarterly Distribution on Preference Units with respect to all quarters since inception of the Partnership, except for distributions in the second, third and fourth quarters of 1991 totaling $9,323,000 which have since been satisfied and no arrearages remain as of December 31, 1997. Prior to 1994, no distributions were paid on the outstanding Common Units, which are not entitled to arrearages in the payment of the Minimum Quarterly Distribution. Distributions paid on the Common Units were $7,742,000; $7,110,000; and $4,582,000 for 1997, 1996 and 1995, respectively. Assuming that distributions of at least $.55 for every Unit are made on May 15 and August 14, 1998, the preference period will end on August 14, 1998 and there will be no distinction thereafter between the Units. Under the terms of its financing agreements, the Partnership is prohibited from declaring or paying any distribution if a default exists thereunder. ITEM 6. SUMMARY HISTORICAL FINANCIAL AND OPERATING DATA The following table sets forth, for the periods and at the dates indicated, selected historical financial and operating data for Kaneb Pipe Line Partners, L.P. and Subsidiaries (the "Partnership"). The data in the table (in thousands, except per unit amounts) is derived from the historical financial statements of the Partnership and should be read in conjunction with the Partnership's audited financial statements. See also "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Year Ended December 31, -------------------------------------------------------------------- 1997 1996 1995(a) 1994 1993(b) ---------- ---------- ---------- ---------- ---------- INCOME STATEMENT DATA: Revenues............................ $ 121,156 $ 117,554 $ 96,928 $ 78,745 $ 69,235 ---------- ---------- --------- ---------- ---------- Operating costs..................... 50,183 49,925 40,617 33,586 29,012 Depreciation and amortization....... 11,711 10,981 8,261 7,257 6,135 General and administrative.......... 5,793 5,259 5,472 4,924 4,673 --------- ---------- --------- ---------- ---------- Total costs and expenses........ 67,687 66,165 54,350 45,767 39,820 --------- ---------- --------- ---------- ---------- Operating income.................... 53,469 51,389 42,578 32,978 29,415 Interest and other income........... 562 776 894 1,299 1,331 Interest expense.................... (11,332) (11,033) (6,437) (3,706) (3,376) Minority interest................... (420) (403) (360) (295) (266) ---------- ----------- ---------- ----------- ----------- Income before income taxes.......... 42,279 40,729 36,675 30,276 27,104 Income taxes (c).................... (718) (822) (627) (818) (450) ---------- ----------- ---------- ----------- ----------- Net income.......................... $ 41,561 $ 39,907 $ 36,048 $ 29,458 $ 26,654 ========== ========== ========= ========== ========== Allocation of net income(d) per: Senior Preference Unit ......... $ 2.55 $ 2.46 $ 2.20 $ 2.20 $ 2.20 ========== ========== ========= ========= ========== Preference Unit................. $ 2.55 $ 2.46 $ 2.20 $ 2.20 $ 2.20 ========== ========== ========= ========= ========== Preference Unit arrearages...... $ - $ - $ - $ - $ 1.20 ========== ========== ========= ========= ========== Cash Distributions declared per: Senior Preference Unit.......... $ 2.50 $ 2.30 $ 2.20 $ 2.20 $ 2.20 ========== ========== ========= ========= ========== Preference Unit................. $ 2.50 $ 2.30 $ 2.20 $ 2.20 $ 2.20 ========== ========== ========= ========= ========== Preference Unit arrearages...... $ - $ - $ - $ - $ 1.20 ========== ========== ========= ========= ========== BALANCE SHEET DATA (AT PERIOD END): Property and equipment, net......... $ 247,132 $ 249,733 $ 246,471 $ 145,646 $ 133,436 Total assets........................ 269,032 274,765 267,787 163,105 162,407 Long-term debt...................... 132,118 139,453 136,489 43,265 41,814 Partners' capital................... 104,196 103,340 100,748 99,754 100,598 (a) Includes the operations of the West Pipeline since its acquisition in February 1995 and the operations of Steuart since its acquisition in December 1995. (b) Includes the operations of ST since its acquisition on March 2, 1993. (c) Subsequent to the acquisition of ST in March 1993, certain operations are conducted in taxable entities. (d) Net income is allocated to the limited partnership units in an amount equal to the cash distributions declared for each reporting period and any remaining income or loss is allocated to any class of units that did not receive the same amount of cash distributions per unit (if any). If the same cash distributions per unit are declared for all classes of units, income or loss is allocated pro rata based on the aggregate amount of distributions declared.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion should be read in conjunction with the consolidated financial statements of Kaneb Pipe Line Partners, L.P. and notes thereto and the summary historical financial and operating data included elsewhere in this report. GENERAL In September 1989, Kaneb Pipe Line Company ("KPL"), a wholly-owned subsidiary of Kaneb Services, Inc. ("Kaneb"), formed the Partnership to own and operate its refined petroleum products pipeline business. The Partnership operates through KPOP, a limited partnership in which the Partnership holds a 99% interest as limited partner and KPL owns a 1% interest as general partner in both the Partnership and KPOP. The Partnership is engaged through operating subsidiaries in the refined petroleum products pipeline business and, since 1993, terminaling and storage of petroleum products and specialty liquids. The Partnership's pipeline business consists primarily of the transportation through the East Pipeline and the West Pipeline, as common carriers, of refined petroleum products. The East Pipeline was constructed by KPL commencing in the 1950s. The Partnership acquired the West Pipeline in February 1995 from Wyco Pipe Line Company, a company jointly owned by GATX Terminals Corporation and Amoco Pipeline Company, for $27.1 million plus transaction costs and the assumption of certain environmental liabilities. The acquisition was financed by the issuance of $27 million of first mortgage notes to a group of insurance companies due February 24, 2002, which bear interest at the rate of 8.37% per annum. The East Pipeline and the West Pipeline are collectively referred to as the "Pipelines." The Pipelines primarily transport gasoline, diesel oil, fuel oil and propane. The products are transported from refineries connected to the Pipeline, directly or through other pipelines, to agricultural users, railroads and wholesale customers in the states in which the Pipelines are located and in portions of other states. Substantially all of the Pipelines' operations constitute common carrier operations that are subject to Federal or state tariff regulations. The Partnership has not engaged, nor does it currently intend to engage, in the merchant function of buying and selling refined petroleum products. The Partnership's business of terminaling petroleum products and specialty liquids is conducted under the name ST Services ("ST"). ST acquired the liquids terminaling assets of Steuart Petroleum Company and certain of its affiliates (collectively, "Steuart") in December 1995 for $68 million plus transaction costs and the assumption of certain environmental liabilities. The acquisition was initially financed with a $68 million bridge loan from a bank. The Partnership refinanced this bridge loan in June 1996 with a series of first mortgage notes (the "Steuart Notes") to a group of insurance companies bearing interest at rates ranging from 7.08% to 7.98% and maturing in varying amounts in June 2001, 2003, 2006 and 2016. The Steuart terminaling assets consist of seven petroleum product terminal facilities located in the District of Columbia, Florida, Georgia, Maryland and Virginia and the pipeline and terminaling facilities serving Andrews Air Force Base in Maryland. The Partnership is the third largest independent liquids terminaling company in the United States. With the acquisition of Steuart, ST operates 31 facilities in 16 states and the District of Columbia with an aggregate tankage capacity of approximately 17.2 million barrels. PIPELINE OPERATIONS Year Ended December 31, ----------------------------------------------- 1997 1996 1995 --------- -------- --------- (in millions) Revenues....................... $61,320 $63,441 $60,192 Operating costs................ 21,696 23,692 22,564 Depreciation and amortization.. 4,885 4,817 4,843 General and administrative..... 2,912 2,711 3,038 ------- ------- ------- Operating income............... $31,827 $32,221 $29,747 ======= ======= ======= Pipelines revenues are based on volumes shipped and the distances over which such volumes are transported. Revenues decreased $2.1 million in 1997 primarily as a result of adverse effects on product demand caused by abnormal weather patterns in the Midwest and shifts in the distribution of product supplies in the Rocky Mountain area. The increase in revenues of $3.2 million in 1996 is primarily due to the acquisition of the West Pipeline in February 1995. Because tariff rates are regulated by the FERC, the Pipelines compete primarily on the basis of quality of service, including delivering products at convenient locations on a timely basis to meet the needs of its customers. Barrel miles totaled 16.1 billion in 1997 compared to 16.7 billion in 1996. 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, decreased $2.0 million in 1997 and increased $1.1 million in 1996. The changes in both years were primarily in materials and supplies, including additives, that are volume related and in outside services. General and administrative costs include managerial, accounting and administrative personnel costs, office rental and expense, legal and professional costs and other non-operating costs. Legal and professional and other non-operating costs were abnormally low in 1996. TERMINALING OPERATIONS Year Ended December 31, --------------------------------------------- 1997 1996 1995 ---------- ---------- ---------- (in millions) Revenues....................... $59,836 $54,113 $36,736 Operating costs ............... 28,487 26,233 18,053 Depreciation and amortization . 6,826 6,164 3,418 General and administrative .... 2,881 2,548 2,434 ------- ------- ------- Operating income............... $21,642 $19,168 $12,831 ======= ======= ======= Revenues increased 11% in 1997 due to terminal acquisitions and increased utilization of existing terminals. The revenue increase of 47% in 1996 was primarily as a result of the acquisition of the former Steuart Petroleum terminals by the Partnership in December 1995. Average annual tankage utilized increased .5 million barrels in 1997 to 12.4 million barrels, compared to 11.9 million barrels in 1996. Average annual revenues per barrel of tankage utilized was $4.83 per barrel in 1997, compared to $4.55 per barrel in 1996. The average revenue per barrel in 1995 was $5.46 per barrel, which was higher than 1996 due to the large proportionate volumes of petroleum products being stored at the former Steuart terminals in 1996 with lower rates per barrel than specialty chemicals with higher rates per barrel that are stored at other terminals. Total tankage capacity (17.2 million barrels at December 31, 1997) has been, and is expected to remain, adequate to meet existing customer storage requirements. Customers consider factors such as location, access to cost effective transportation and quality of service in addition to pricing when selecting terminal storage. Operating costs increased $2.3 million and $8.2 million and depreciation and amortization increased $ .7 million and $2.7 million in 1997 and 1996, respectively, primarily as a result of terminal acquisitions. LIQUIDITY AND CAPITAL RESOURCES The ratio of current assets to current liabilities was 0.9 to 1 at December 31, 1997 and 1.0 to 1 at December 31, 1996. Cash provided by operating activities was $54.8 million, $49.2 million and $44.5 million for the years 1997, 1996 and 1995, respectively. The increase in cash provided by operations in 1997 resulted primarily from overall improvements in revenues and operating income in the terminaling operations. The increase in 1996 was primarily a result of the acquisition of the Steuart terminaling assets. Capital expenditures, excluding expansion capital expenditures, were $10.6 million, $7.1 million and $8.9 million for 1997, 1996 and 1995, respectively. 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, material. Environmental damages caused by sudden and accidental occurrences are included under the Partnership's insurance coverages. Capital expenditures of the Partnership during 1998 are expected to be approximately $7 million to $10 million. The Partnership makes distributions of 100% of its Available Cash to Unitholders and the General Partner. Available Cash consists generally of all the cash receipts less all cash disbursements and reserves. Distributions of $2.50 per unit were declared to Senior Preference Unitholders and Preference Unitholders in 1997, $2.30 per unit was declared in 1996 and $2.20 per unit was declared in 1995. During 1997, 1996 and 1995, the Partnership declared distributions of $7.9 million ($2.50 per unit); $7.3 million ($2.30 per unit); and $6.3 million ($2.00 per unit), respectively, to the holders of Common Units. Most of the software systems used by the Partnership are licensed from third party vendors and are Year 2000 compliant or will be upgraded to Year 2000 compliant releases over the next year. The Partnership does not anticipate that the incremental costs to become fully Year 2000 compliant will be material. The Partnership expects to fund future cash distributions and maintenance capital expenditures with existing cash and cash flows from operating activities. Expansionary capital expenditures are expected to be funded through additional Partnership borrowings. The Partnership has a Credit Agreement with two banks that currently provides a $25 million revolving credit facility for working capital and other partnership purposes. Borrowings under the Credit Agreement bear interest at variable rates and are due and payable in January 2001. The Credit Agreement has a commitment fee of 0.15% per annum of the unused credit facility. No amounts were drawn under this credit facility at December 31, 1997 and $5 million that was outstanding at December 31, 1996 was repaid during 1997. The Partnership acquired the West Pipeline in February 1995 from Wyco Pipe Line Company, a company jointly owned by GATX Terminals Corporation and Amoco Pipeline Company, for $27.1 million. The acquisition was financed by the issuance of $27 million of notes due February 24, 2002, which bear interest at the rate of 8.37% per annum (the "Notes"). The Notes and credit facility are secured by a mortgage on the East Pipeline. The acquisition of the Steuart terminaling assets was initially financed by a $68 million bank bridge loan. The Partnership refinanced this bridge loan in June 1996 with a series of first mortgage notes (the "Steuart Notes") bearing interest at rates ranging from 7.08% to 7.98% and maturing in varying amounts in June 2001, 2003, 2006 and 2016. The Steuart Notes are secured, pari passu with the Notes and credit facility, by a mortgage on the East Pipeline. In the FERC's Lakehead decision issued June 15, 1995, the FERC partially disallowed Lakehead's inclusion of income taxes in its cost of service. Specifically, the FERC held that Lakehead was entitled to receive an income tax allowance with respect to income attributable to its corporate partners, but was not entitled to receive such an allowance for income attributable to the partnership interests held by individuals. Lakehead's motion for rehearing was denied by the FERC and Lakehead appealed the decision to the U. S. Court of Appeals. Subsequently, the case was settled by Lakehead and the appeal was withdrawn. In another FERC proceeding involving a different oil pipeline limited partnership, various shippers challenged such pipeline's inclusion of an income tax allowance in its cost of service. The FERC Staff also supported the disallowance of income taxes. The FERC recently decided the case on the same basis as the Lakehead case. If the FERC were to disallow the income tax allowance in the cost of service of the Pipelines on the basis set forth in the Lakehead order, the General Partner believes that the Partnership's ability to pay the Minimum Quarterly Distribution to the holders of the Senior Preference Units ("SPU"s) and Preference Units ("PU"s) would not be impaired; however, in view of the uncertainties involved in this issue, there can be no assurance in this regard. ALLOCATION OF NET INCOME AND EARNINGS Net income is allocated to the limited partnership units in an amount equal to the cash distributions declared for each reporting period and any remaining income or loss is allocated to any class of units that did not receive the same amount of cash distributions per unit (if any). If the same cash distributions per unit are declared for all classes of units, income or loss is allocated pro rata on the aggregate amount of distributions declared. In 1997, distributions by the Partnership of Available Cash reached the Second Target Distribution, as defined in the Partnership Agreement, which entitled the general partner to receive certain incentive distributions. Earnings per SPU and PU shown on the consolidated statements of income are calculated by dividing the amount of net income, allocated on the above basis with incentives calculated on distributions declared to the SPUs and PUs, by the weighted average number of SPUs and PUs outstanding, respectively. If the allocation of income had been made as if all income had been distributed in cash, earnings per SPU and PU would have been $2.53 for the year ended December 31, 1997. ACCOUNTING PRONOUNCEMENTS In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") 130, "Reporting Comprehensive Income," which establishes standards for the reporting and display of comprehensive income and its components in a full set of general purpose financial statements. The provisions of SFAS 130 must be adopted in fiscal year 1998. The Partnership expects to comply with the provisions of SFAS 130 in the Consolidated Statements of Partners' Capital, when adopted. Also, in June 1997, the FASB issued SFAS 131, "Disclosure About Segments of an Enterprise and Other Information," which requires segment information to be reported on a basis consistent with that used internally for evaluating segment performance and deciding how to allocate resources to segments. The provisions of SFAS 131 must be adopted in fiscal year 1998. The Partnership is evaluating the impact of adopting SFAS 131 on the method it currently uses to report segment information. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements and supplementary data of the Partnership begin on page F-1 of this report. Such information is hereby incorporated by reference into this item 8. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The Partnership is a limited partnership and has no directors. The Partnership is managed by the Company as general partner. Set forth below is certain information concerning the directors and executive officers of the Company. All directors of the Company are elected annually by Kaneb, as its sole stockholder. All officers serve at the discretion of the Board of Directors of the Company.
YEARS OF UNITS BENEFICIALLY OWNED AT MARCH 16, 1998(m) SERVICE ------------------------------------------------------------- POSITION WITH WITH THE SENIOR % OF PREFERENCE % OF COMMON % OF NAME AGE THE COMPANY COMPANY PREFERENCE CLASS UNITS CLASS UNITS CLASS - -------------------- ------- ----------------- ----------- ------------ ------- ------------ ------- ----------- ------- Edward D. Doherty 62 Chairman of 8 (a) 8,326 * 1,300 * 75,000 2.4% the Board and Chief Executive Officer Leon E. Hutchens 63 President 38 (b) 500 * -0- * -0- * Ronald D. Scoggins 43 Senior Vice 1 (c) -0- * 454 * -0- * President Howard C. Wadsworth 53 Vice President 4 (d) -0- * -0- * -0- * Treasurer and Secretary Jimmy L. Harrison 44 Controller 6 (e) -0- * -0- * -0- * John R. Barnes 53 Directr 11 (f) 76,600 1% 60,500 1% 79,000 2.5% Charles R. Cox 55 Director 3 (g) 500 * -0- * -0- * Sangwoo Ahn 59 Director 9 (h) 33,000 * -0- * -0- * Frank M. Burke, Jr. 58 Director 1 (i) -0- * -0- * -0- * James R. Whatley 71 Director 9 (j) 22,400 * -0- * -0- * Hans Kessler 48 Director 1 (k) -0- * -0- * -0- * Murray A. Biles 67 Director 44 (l) 500 * -0- * -0- * All Officers and Directors as a group (12 persons) 141,826 2.0% 62,254 1.1% 154,000 4.9% *Less than one percent (a) Mr. Doherty, Chairman of the Board of the Company since September 1989, is also Senior Vice President of Kaneb. (b) Mr. Hutchens assumed his current position in January 1994, having been with KPL since January 1960. Mr. Hutchens had been Vice President since January 1981. Mr. Hutchens was Manager of Product Movement from July 1976 to January 1981. (c) Mr. Scoggins became an executive officer of the Company in August 1997, prior to which he served in senior level positions for the Company for more than 10 years. (d) Mr. Wadsworth also serves as Vice President, Treasurer and Secretary for Kaneb. Mr. Wadsworth joined Kaneb in October 1990. (e) Mr. Harrison assumed his present position in November 1992, prior to which he served in a variety of financial positions including Assistant Secretary and Treasurer with ARCO Pipe Line Company for approximately 19 years. (f) Mr. Barnes, a director of the Company, is also Chairman of the Board, President and Chief Executive Officer of Kaneb. (g) Mr. Cox, a director of the Company since September 1995, is also a director of Kaneb. Mr. Cox has been a private business consultant since retiring in January 1998 from Fluor Daniel, Inc., an international services company, where he served in senior executive level positions during a 27 year career with that organization. (h) Mr. Ahn, a director of the Company since July 1989, is also a director of Kaneb. Mr. Ahn has been a general partner of Morgan Lewis Githens & Ahn, an investment banking firm, since 1982 and currently serves as a director of Gradall Industries, Inc., ITI Technologies, Inc., PAR Technology Corporation, Quaker Fabric Corporation, and Stuart Entertainment, Inc. (i) Mr. Burke, elected as a director of the Company in January 1997, is also a director of Kaneb. Mr. Burke has been Chairman and Managing General Partner of Burke, Mayborn Company, Ltd., a private investment company, for more than the past five years. He was previously associated with Peat, Marwick, Mitchell & Co. (now KPMG Peat Marwick, LLP), an international firm of certified public accountants, for twenty-four years. (j) Mr. Whatley, a director of the Company since July 1989, is also a director of Kaneb and served as Chairman of the Board of Directors of Kaneb from February 1981 until April 1989. (k) Mr. Kessler was elected to the Board on February 19, 1998 to fill a vacancy. Mr. Kessler has served as Chairman and Managing Director of KMB Kessler + Partner GmbH since 1992. He was previously a Managing Director and Vice President of a European Division of Tyco International Ltd., the largest contractor in the world for the design, manufacturing and installation of fire detection, suppression and sprinkler systems and manufacturer and distributor of flow control products in North America, Europe and Asia-Pacific from 1990 to 1992. He was Managing Director and Executive Vice President of a division of ABB Asea Brown Boveri Ltd., a Zurich, Switzerland based company involved in power generation, power transmission and distribution, and industrial and building systems around the world prior to 1990. (l) Mr. Biles joined the Company in November 1953 and served as President from January 1985 until his retirement at the close of 1993. (m) Units of the Partnership listed are those beneficially owned by the person indicated, his spouse or children living at home and do not include Units in which the person has disclaimed any beneficial interest.
AUDIT COMMITTEE Messrs. Sangwoo Ahn and Frank M. Burke, Jr. serve as the members of the Audit Committee of the Company. Such Committee will, on an annual basis, or more frequently as such Committee may determine to be appropriate, review policies and practices of the Company and the Partnership and deal with various matters as to which conflicts of interest may arise. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Company's Board of Directors does not have a compensation committee or any other committee that performs the equivalent functions. During the fiscal year ended December 31, 1997, none of the Company's officers or employees participated in the deliberations of the Company's Board of Directors concerning executive officer compensation. SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE STATEMENT Section 16(a) of the Securities and Exchange Act of 1934, as amended ("Section 16(a)") requires the Company's officers and directors, among others, to file reports of ownership and changes of ownership in the Partnership's equity securities with the Securities and Exchange Commission and the New York Stock Exchange. Such persons are also required by related regulations to furnish the Company with copies of all Section 16(a) forms that they file. Based solely on its review of the copies of such forms received by it, the Company believes that, since January 1, 1997, its officers and directors have complied with all applicable filing requirements with respect to the Partnership's equity securities. ITEM 11. EXECUTIVE COMPENSATION The Partnership has no executive officers, but is obligated to reimburse the Company for compensation paid to the Company's executive officers in connection with their operation of the Partnership's business. The following table sets forth information with respect to the aggregate compensation paid or accrued by the Company during the fiscal years 1997, 1996 and 1995, to the Chief Executive Officer and each of the other most highly compensated executive officers of the Company.
SUMMARY COMPENSATION TABLE Name and Principal Annual Compensation All Other Position Year Salary Bonus(a) Compensation(b) ------------------------ -------- -------------- --------------- --------------- Edward D. Doherty(c) 1997 $ 208,350 $ 18,420(f) $ 6,541 Chairman of the 1996 200,333(d) 93,040 6,832 Board and Chief 1995 190,833 133,100 6,096 Executive Officer Leon E. Hutchens 1997 180,617 -0- 7,338 President 1996 173,700 15,000 7,051 1995 164,644 30,000 7,278 Ronald D. Scoggins(c) 1997 139,899(e) 9,210(g) 5,003 Senior Vice President Jimmy L. Harrison 1997 110,532 -0- 2,854 Controller 1996 105,532 4,000 3,775 1995 100,670 8,500 5,450 (a) Amounts earned in year shown and paid the following year. (b) Represents the Company's contributions to Kaneb's Savings Investment Plan (a 401(k) plan) and the imputed value of Company-paid group term life insurance. (c) The Compensation for these individuals is paid by Kaneb, which is reimbursed for all or substantially all of such compensation by the Company. (d) Includes deferred compensation of $14,901. (e) Includes $13,608 paid in the form of 454 Partnership Preference Units and 1,566 shares of Kaneb Services, Inc. common stock. (f) Includes deferred compensation of $18,420. (g) Includes deferred compensation of $9,210.
Retirement Plan Effective April 1, 1991, Kaneb established the Savings Investment Plan, a defined contribution 401(k) plan, that permits all full-time employees of the Company who have completed one year of service to contribute 2% to 12% of base compensation, on a pre-tax basis, into participant accounts. In addition to mandatory contribution equal to 2% of base compensation per year for each plan participant, the Company makes matching contributions from 25% to 50% of up to the first 6% of base pay contributed by a plan participant. Employee contributions, together with earnings thereon, are not subject to forfeiture. That portion of a participant's account balance attributable to Company contributions, together with earnings thereon, is vested over a five year period at 20% per year. Participants are credited with their prior years of service for vesting purposes, however, no amounts are accrued for the accounts of participants, including the Company's executive officers, for years of service previous to the plan commencement date. Participants may direct the investment of their contributions into a variety of investments, including Kaneb common stock. Plan assets are held and distributed pursuant to a trust arrangement. Because levels of future compensation, participant contributions and investment yields cannot be reliably predicted over the span of time contemplated by a plan of this nature, it is impractical to estimate the annual benefits payable at retirement to the individuals listed in the Summary Cash Compensation Table above. Director's Fees During 1997, each member of the Company's Board of Directors who was not also an employee of the Company or Kaneb was paid an annual retainer of $10,000 in lieu of all attendance fees. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT At March 16, 1998, the Company owned a combined 2% General Partner interest in the Partnership and the Operating Partnership and, together with its affiliates, owned Preference Units and Common Units representing an aggregate limited partner interest of approximately 31%. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The Company is entitled to certain reimbursements under the Partnership Agreement. For additional information regarding the nature and amount of such reimbursements, see Note 7 to the Partnership's consolidated financial statements. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (A) (1)FINANCIAL STATEMENTS Set forth below is a list of financial statements appearing in this report. Kaneb Pipe Line Partners, L.P. and Subsidiaries Financial Statements: Page Consolidated Statements of Income - Three Years Ended December 31, 1997................... F - 1 Consolidated Balance Sheets - December 31, 1997 and 1996.... F - 2 Consolidated Statements of Cash Flows - Three Years Ended December 31, 1997................... F - 3 Consolidated Statements of Partners' Capital Three Years ended December 31, 1997...................... F - 4 Notes to Consolidated Financial Statements.................... F - 5 Report of Independent Accountants............................. F -13 (A) (2)FINANCIAL STATEMENT SCHEDULES All schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted. (A) (3)LIST OF EXHIBITS 3.1 Amended and Restated Agreement of Limited Partnership dated September 27, 1989, filed as Appendix A to the Registrant's Prospectus, dated September 25, 1989, in connection with the Registrant's Registration Statement on Form S-1 (S.E.C. File No. 33-30330) which exhibit is hereby incorporated by reference. 10.1 ST Agreement and Plan of Merger date December 21, 1992 by and between 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 Registrant's Current Report on Form 8-K, dated March 16, 1993, which exhibit is hereby incorporated by reference. 10.2 Restated Credit Agreement between Kaneb Operating Partnership, L.P. ("KPOP"), Texas Commerce Bank, N.A., ("TCB"), and certain other Lenders, dated December 22, 1994 (the "TCB Loan Agreement"), filed as Exhibit 10.13 of the exhibits to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994, which exhibit is hereby incorporated by reference. 10.3 Amendment to the TCB Loan Agreement, dated January 30, 1998, filed herewith. 10.4 Pledge and Security Agreement between Kaneb Pipe Line Company ("KPL") and TCB, dated October 11, 1993, filed as Exhibit 10.3 of the exhibits to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993, which exhibit is hereby incorporated by reference. 10.5 Note Purchase Agreement, dated December 22, 1994, filed as Exhibit 10.2 of the exhibits to Registrant's Current Report on Form 8-K, dated March 13, 1995 (the "March 1995 Form 8-K"), which exhibit is hereby incorporated by reference. 10.6 Note Purchase Agreements, dated June 27, 1996, filed as Exhibit 10.5 of the exhibits to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996, which exhibit is hereby incorporated by reference. 10.7 Agreement for Sale and Purchase of Assets between Wyco Pipe Line Company and KPOP, dated February 19, 1995, filed as Exhibit 10.1 of the exhibits to the Registrant's March 1995 Form 8-K, which exhibit is hereby incorporated by reference. 10.8 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 KPOP, as amended, dated August 27, 1995, filed as Exhibits 10.1, 10.2, 10.3, and 10.4 of the exhibits to Registrant's Current Report on Form 8-K dated January 3, 1996, which exhibits are hereby incorporated by reference. 21 List of Subsidiaries, filed herewith. 27 Financial Data Schedule, filed herewith. (B) REPORTS ON FORM 8-K - NONE. KANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31, ----------------------------------------------- 1997 1996 1995 ------------- ------------- ------------- Revenues ................................................ $ 121,156,000 $ 117,554,000 $ 96,928,000 ------------- ------------- ------------- Costs and expenses: Operating costs ...................................... 50,183,000 49,925,000 40,617,000 Depreciation and amortization ........................ 11,711,000 10,981,000 8,261,000 General and administrative ........................... 5,793,000 5,259,000 5,472,000 ------------- ------------- ------------- Total costs and expenses .......................... 67,687,000 66,165,000 54,350,000 ------------- ------------- ------------- Operating income ........................................ 53,469,000 51,389,000 42,578,000 Interest and other income ............................... 562,000 776,000 894,000 Interest expense ........................................ (11,332,000) (11,033,000) (6,437,000) ------------- ------------- ------------- Income before minority interest and income taxes ............................ 42,699,000 41,132,000 37,035,000 Minority interest in net income ......................... (420,000) (403,000) (360,000) Income tax provision .................................... (718,000) (822,000) (627,000) ------------- ------------- ------------- Net income .............................................. 41,561,000 39,907,000 36,048,000 General partner's interest in net income ........................................ (560,000) (403,000) (360,000) ------------- ------------- ------------- Limited partners' interest in net income ........................................ $ 41,001,000 $ 39,504,000 $ 35,688,000 ============= ============= ============= Allocation of net income per Senior Preference Unit and Preference Unit as described in Note 2 ............... $ 2.55 $ 2.46 $ 2.20 ============= ============= ============= Weighted average number of Partnership units outstanding: Senior Preference Units .............................. 7,250,000 7,250,000 7,250,000 Preference Units ..................................... 5,650,000 4,650,000 5,400,000
See notes to consolidated financial statements. F - 1 KANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
December 31, ----------------------------------- 1997 1996 ------------- -------------- ASSETS Current assets: Cash and cash equivalents............................................... $ 6,376,000 $ 8,196,000 Accounts receivable..................................................... 11,503,000 11,540,000 Current portion of receivable from general partner...................... - 975,000 Prepaid expenses........................................................ 4,021,000 4,321,000 ------------- -------------- Total current assets................................................. 21,900,000 25,032,000 ------------- -------------- Property and equipment..................................................... 345,802,000 337,202,000 Less accumulated depreciation.............................................. 98,670,000 87,469,000 ------------- -------------- Net property and equipment........................................... 247,132,000 249,733,000 ------------- -------------- $ 269,032,000 $ 274,765,000 ============= ============== LIABILITIES AND PARTNERS' CAPITAL Current liabilities: Current portion of long-term debt....................................... $ 2,335,000 $ 2,036,000 Accounts payable........................................................ 2,400,000 2,764,000 Accrued expenses........................................................ 3,297,000 4,355,000 Accrued distributions payable........................................... 10,725,000 9,833,000 Accrued taxes, other than income taxes.................................. 1,957,000 1,763,000 Deferred terminaling fees............................................... 2,892,000 2,874,000 Payable to general partner.............................................. 1,143,000 711,000 ------------- -------------- Total current liabilities............................................ 24,749,000 24,336,000 ------------- -------------- Long-term debt, less current portion....................................... 132,118,000 139,453,000 Other liabilities and deferred taxes....................................... 6,935,000 6,612,000 Minority interest.......................................................... 1,034,000 1,024,000 Commitments and Contingencies Partners' capital: Senior preference unitholders........................................... 48,830,000 48,446,000 Preference unitholders.................................................. 46,449,000 37,982,000 Preference B unitholders................................................ - 8,168,000 Common unitholders...................................................... 7,888,000 7,720,000 General partner......................................................... 1,029,000 1,024,000 ------------- -------------- Total partners' capital.............................................. 104,196,000 103,340,000 ------------- -------------- $ 269,032,000 $ 274,765,000 ============= ==============
See notes to consolidated financial statements. F - 2 KANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, --------------------------------------------------------- 1997 1996 1995 ------------- ------------- ------------- Operating activities: Net income ........................................ $ 41,561,000 $ 39,907,000 $ 36,048,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization................... 11,711,000 10,981,000 8,261,000 Minority interest in net income................. 420,000 403,000 360,000 Deferred income taxes........................... 651,000 601,000 624,000 Changes in working capital components: Accounts receivable........................... 37,000 (1,330,000) (4,605,000) Prepaid expenses.............................. 300,000 (3,067,000) 670,000 Accounts payable and accrued expenses......... (336,000) 1,697,000 1,943,000 Deferred terminaling fees..................... 18,000 240,000 993,000 Payable to general partner.................... 432,000 (252,000) 177,000 ------------- -------------- -------------- Net cash provided by operating activities.. 54,794,000 49,180,000 44,471,000 ------------- ------------- -------------- Investing activities: Capital expenditures............................... (10,641,000) (7,075,000) (8,946,000) Acquisitions of pipelines and terminals............ - (8,507,000) (97,850,000) Other.............................................. 313,000 (630,000) 2,429,000 ------------- ------------- -------------- Net cash used in investing activities...... (10,328,000) (16,212,000) (104,367,000) ------------- ------------- -------------- Financing activities: Changes in receivable from general partner......... 975,000 2,570,000 2,240,000 Issuance of long-term debt......................... - 73,000,000 96,500,000 Payments of long-term debt......................... (7,036,000) (69,777,000) (3,047,000) Distributions: Senior preference unitholders................... (17,763,000) (16,313,000) (15,950,000) Preference unitholders.......................... (13,842,000) (12,712,000) (12,430,000) Common unitholders.............................. (7,742,000) (7,110,000) (4,582,000) General partner and minority interest........... (878,000) (737,000) (673,000) ------------- ------------- ------------- Net cash provided by (used in) financing activities.............................. (46,286,000) (31,079,000) 62,058,000 ------------- ------------- -------------- Increase (decrease) in cash and cash equivalents...... (1,820,000) 1,889,000 2,162,000 Cash and cash equivalents at beginning of period...... 8,196,000 6,307,000 4,145,000 ------------- ------------- -------------- Cash and cash equivalents at end of period............ $ 6,376,000 $ 8,196,000 $ 6,307,000 ============= ============= ============== Supplemental information - Cash paid for interest..... $ 11,346,000 $ 10,368,000 $ 5,479,000 ============= ============= ==============
See notes to consolidated financial statements. F - 3 KANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL
SENIOR PREFERENCE PREFERENCE PREFERENCE B COMMON GENERAL UNITHOLDERS UNITHOLDERS UNITHOLDERS UNITHOLDERS PARTNER TOTAL ------------- -------------- ------------ ------------ ---------- -------------- Partners' capital at January 1, 1995..........$ 47,288,000 $ 45,247,000 $ - $ 6,227,000 $ 992,000 $ 99,754,000 Unit Conversion............ - (8,008,000) 8,008,000 - - - 1995 income allocation..... 15,950,000 11,880,000 550,000 7,308,000 360,000 36,048,000 Distributions declared..... (15,950,000) (11,880,000) (550,000) (6,320,000) (354,000) (35,054,000) ------------- ------------- ----------- ------------ ----------- ------------- Partners' capital at December 31, 1995........ 47,288,000 37,239,000 8,008,000 7,215,000 998,000 100,748,000 1996 income allocation..... 17,833,000 11,438,000 2,460,000 7,773,000 403,000 39,907,000 Distributions declared..... (16,675,000) (10,695,000) (2,300,000) (7,268,000) (377,000) (37,315,000) ------------- ------------- ----------- ------------ ----------- ------------- Partners' capital at December 31, 1996........ 48,446,000 37,982,000 8,168,000 7,720,000 1,024,000 103,340,000 1997 income allocation..... 18,509,000 12,587,000 1,837,000 8,068,000 560,000 41,561,000 Distributions declared..... (18,125,000) (12,275,000) (1,850,000) (7,900,000) (555,000) (40,705,000) Unit Conversion............ - 8,155,000 (8,155,000) - - - ------------- ------------- ------------ ------------ ----------- ------------ Partners' capital at December 31, 1997........$ 48,830,000 $ 46,449,000 $ - $ 7,888,000 $ 1,029,000 $ 104,196,000 ============= ============= ============ ============ =========== ============= Limited Partnership Units outstanding at January 1, 1995.......... 7,250,000 5,650,000 - 3,160,000 (a) 16,060,000 Unit Conversion in 1995.... - (1,000,000) 1,000,000 - - - ------------- -------------- ----------- ----------- -------------- ----------- Limited Partnership Units outstanding at December 31, 1995 and 1996................. 7,250,000 4,650,000 1,000,000 3,160,000 (a) 16,060,000 Unit Conversion in 1997.... - 1,000,000 (1,000,000) - - - ------------- ------------- ------------ ----------- -------------- ------------ Limited Partnership Units outstanding at December 31, 1997........ 7,250,000(b) 5,650,000 - 3,160,000 (a) 16,060,000 ================ ============= ============ =========== ============== =========== (a) Kaneb Pipe Line Company owns a combined 2% interest in Kaneb Pipe Line Partners, L.P. as General Partner. (b) The Partnership Agreement allows for an additional issuance of up to 7.75 million senior preference units.
F-4 KANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. PARTNERSHIP ORGANIZATION Kaneb Pipe Line Partners, L.P. (the "Partnership"), a master limited partnership, owns and operates a refined petroleum products pipeline business and a petroleum products and specialty liquids storage and terminaling business. The Partnership operates through Kaneb Pipe Line Operating Partnership, L.P. ("KPOP"), a limited partnership in which the Partnership holds a 99% interest as limited partner. Kaneb Pipe Line Company (the "Company"), a wholly-owned subsidiary of Kaneb Services, Inc. ("Kaneb"), as general partner holds a 1% general partner interest in both the Partnership and KPOP. The Company's 1% interest in KPOP is reflected as the minority interest in the financial statements. In September 1995, a subsidiary of the Company sold 3.5 million of the Preference Units ("PU") it held in a public offering and exchanged 1.0 million of its PU's for 1.0 million Preference B Units, which were subordinate to the PU's until September 30, 1997. Effective October 1, 1997, the 1.0 million Preference B Units were exchanged for an equal number of PUs. At December 31, 1997, the Company, together with its affiliates, owns an approximate 31% interest as a limited partner in the form of PU's and Common Units ("CU"), and as a general partner owns a combined 2% interest. The Senior Preference Units ("SPU") represent an approximate 44% interest in the Partnership and the 3.5 million publicly held PU's represent an approximate 21% interest. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The following significant accounting policies are followed by the Partnership in the preparation of the consolidated financial statements. The preparation of the Partnership's financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that effect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS The Partnership's policy is to invest cash in highly liquid investments with maturities of three months or less, upon purchase. Accordingly, uninvested cash balances are kept at minimum levels. Such investments are valued at cost, which approximates market, and are classified as cash equivalents. The Partnership does not have any derivative financial instruments. PROPERTY AND EQUIPMENT Property and equipment are carried at historical cost. Certain leases have been capitalized and the leased assets have been included in property and equipment. Additions of new equipment and major renewals and replacements of existing equipment are capitalized. Repairs and minor replacements that do not materially increase values or extend useful lives are expensed. Depreciation of property and equipment is provided on a straight-line basis at rates based upon expected useful lives of various classes of assets, as disclosed in Note 4. The rates used for pipeline and storage facilities of KPOP are the same as those which have been promulgated by the Federal Energy Regulatory Commission. REVENUE AND INCOME RECOGNITION KPOP provides pipeline transportation of refined petroleum products and liquified petroleum gases. Revenue is recognized upon receipt of the products into the pipeline system. ST provides terminaling and other ancillary services. Storage fees are billed one month in advance and are reported as deferred income. Revenue is recognized in the month services are provided. F-5 KANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ENVIRONMENTAL MATTERS Environmental expenditures that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past operations, and which do not contribute to current or future revenue generation, are expensed. Liabilities are recorded when environmental assessments and/or remedial efforts are probable, and the costs can be reasonably estimated. Generally, the timing of these accruals coincides with the completion of a feasibility study or the Partnership's commitment to a formal plan of action. INCOME TAX CONSIDERATIONS Income before income tax expense is made up of the following components: Year Ended December 31, --------------------------------------- 1997 1996 1995 ----------- ----------- ----------- Partnership operations..... $40,317,000 $37,950,000 $35,269,000 Corporate operations....... 1,962,000 2,779,000 1,406,000 ----------- ----------- ----------- $42,279,000 $40,729,000 $36,675,000 =========== =========== =========== Partnership operations are not subject to Federal or state income taxes. However, certain operations of ST are conducted through wholly-owned corporate subsidiaries which are taxable entities. The provision for income taxes for the periods ended December 31, 1997, 1996 and 1995 consists of deferred U.S. Federal income taxes of $.7 million, $.6 million and $.6 million, respectively, and current Federal income taxes of $.2 million in 1996. The net deferred tax liability of $3.1 million and $2.3 million at December 31, 1997 and 1996, respectively, consists of deferred tax liabilities of $8.2 million and $7.4 million, respectively, and deferred tax assets of $5.2 million and $5.1 million, respectively. The deferred tax liabilities consist primarily of tax depreciation in excess of book depreciation and the deferred tax assets consist primarily of net operating losses. The corporate operations have net operating losses for tax purposes totaling approximately $13.8 million which expire in years 2008 through 2012. Since the income or loss of the operations which are conducted through limited partnerships will be included in the tax returns of the individual partners of the Partnership, no provision for income taxes has been recorded in the accompanying financial statements on these earnings. The tax returns of the Partnership are subject to examination by Federal and state taxing authorities. If any such examination results in adjustments to distributive shares of taxable income or loss, the tax liability of the partners would be adjusted accordingly. F-6 KANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The tax attributes of the Partnership's net assets flow directly to each individual partner. Individual partners will have different investment bases depending upon the timing and prices of acquisition of partnership units. Further, each partner's tax accounting, which is partially dependent upon their individual tax position, may differ from the accounting followed in the financial statements. Accordingly, there could be significant differences between each individual partner's tax basis and their proportionate share of the net assets reported in the financial statements. Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," requires disclosure by a publicly held partnership of the aggregate difference in the basis of its net assets for financial and tax reporting purposes. Management does not believe that, in the Partnership's circumstances, the aggregate difference would be meaningful information. ALLOCATION OF NET INCOME AND EARNINGS Net income is allocated to the limited partnership units in an amount equal to the cash distributions declared for each reporting period and any remaining income or loss is allocated to any class of units that did not receive the same amount of cash distributions per unit (if any). If the same cash distributions per unit are declared for all classes of units, income or loss is allocated pro rata based on the aggregate amount of distributions declared. In 1997, distributions by the Partnership of Available Cash reached the Second Target Distribution, as defined in the Partnership Agreement, which entitled the general partner to certain incentive distributions at different levels of cash distributions. Earnings per SPU and PU shown on the consolidated statements of income are calculated by dividing the amount of net income, allocated on the above basis with incentives calculated on distributions declared to the SPU's and PU's, by the weighted average number of SPU's and PU's outstanding, respectively. If the allocation of income had been made as if all income had been distributed in cash, earnings per SPU and PU would have been $2.53 for the year ended December 31, 1997. CASH DISTRIBUTIONS The Partnership makes quarterly distributions of 100% of its Available Cash, as defined in the Partnership Agreement, to holders of limited partnership units ("Unitholders") and the Company. Available Cash consists generally of all the cash receipts of the Partnership plus the beginning cash balance less all of its cash disbursements and reserves. The Partnership expects to make distributions of Available Cash for each quarter of not less than $.55 per Unit (the "Minimum Quarterly Distribution"), or $2.20 per Unit on an annualized basis, for the foreseeable future, although no assurance is given regarding such distributions. The Partnership expects to make distributions of all Available Cash within 45 days after the end of each quarter to holders of record on the applicable record date. Distributions of $2.50, $2.30 and $2.20 per unit were declared to Senior Preference and Preference Unitholders in 1997, 1996 and 1995, respectively. During 1997, 1996 and 1995, the Partnership declared distributions of $2.50, $2.30 and $1.45, respectively, per unit to the Common Unitholders. As of December 31, 1997, no arrearages existed on any class of partnership interest. Distributions by the Partnership of its Available Cash are made 99% to Unitholders and 1% to the Company, subject to the payment of incentive distributions to the General Partner if certain target levels of cash distributions to the Unitholders are achieved. The distribution of Available Cash for each quarter during the Preference Period, as defined, is subject to the preferential rights of the holders of the SPU's to receive the Minimum Quarterly Distribution for such quarter, plus any arrearages in the payment of the Minimum Quarterly Distribution for prior quarters, before any distribution of Available Cash is made to holders of PU's or CU's for such quarter. In addition, for each quarter within the Preference Period, the distribution of any amounts to holders of CU's was subject to the preferential rights of the holders of the Preference B Units, to the extent outstanding, if any, to receive the Minimum Quarterly Distribution for such quarter, plus any arrearages in the payment of the Minimum Quarterly Distribution for prior quarters. The CU's are not entitled to arrearages in the payment of the Minimum Quarterly Distribution. In general, the Preference Period will continue indefinitely until the Minimum Distribution has been paid to the holders of the SPU's, the PU's, the Preference B Units, to the extent outstanding, and the CU's for twelve consecutive quarters. The Minimum Quarterly Distribution has been paid to all classes of Unitholders for all four quarters in 1997 and 1996 and for the quarters ended September 30 and December 31, 1995. Prior to the end of the Preference Period, up to 2,650,000 of the PU's may be converted into SPU's on a one-for-one basis if the Third Target Distribution, as defined, is paid to all Unitholders for four full consecutive quarters. The Third Target distribution is reached when distributions of Available Cash equals $2.80 per Limited Partner ("LP") Unit on an annualized basis. After the Preference Period ends, all differences and distinctions between the classes of units for the purposes of cash distributions will cease. It is anticipated that the Preference Period will end upon the payment of the twelfth consecutive quarterly distribution on August 14, 1998. F-7 KANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CHANGE IN PRESENTATION Certain financial statement items have been reclassified to conform with 1997 presentation. 3. ACQUISITIONS In February 1995, the Partnership acquired, through KPOP, the refined petroleum product pipeline assets (the "West Pipeline") of Wyco Pipe Line Company for $27.1 million plus transaction costs and the assumption of certain environmental liabilities. The West Pipeline was owned 60% by a subsidiary of GATX Terminals Corporation and 40% by a subsidiary of Amoco Pipe Line Company. The acquisition was financed by the issuance of $27 million of first mortgage notes. In December 1995, the Partnership acquired the liquids terminaling assets of Steuart Petroleum Company and certain of its affiliates (collectively, "Steuart") for $68 million plus transaction costs and the assumption of certain environmental liabilities. The acquisition price was initially financed by the issuance of a $68 million bank bridge loan which was refinanced during 1996 for $68 million of first mortgage notes. The asset purchase agreement includes a provision for an earn-out payment based upon revenues of one of the terminals exceeding a specified amount for a seven-year period beginning in January 1996. No amount was payable under the earn-out provision in 1997 or 1996. The contracts also included a provision for the continuation of all terminaling contracts in place at the time of the acquisition, including those contracts with Steuart. The acquisitions have been accounted for using the purchase method of accounting. The total purchase price has been allocated to the assets and liabilities based on their respective fair values based on valuations and other studies. Assuming the above acquisitions in 1995 occurred as of the beginning of the year ended December 31, 1995, the summarized unaudited pro forma revenues, net income and allocation of net income per SPU and PU for 1995 would be $117.9 million, $35.7 million and $2.20, respectively. 4. PROPERTY AND EQUIPMENT The cost of property and equipment is summarized as follows:
Estimated Useful December 31, Life ------------------------------ (Years) 1997 1996 --------- ------------- -------------- Land ............................... -- $ 18,663,000 $ 18,514,000 Buildings .......................... 35 6,728,000 6,493,000 Furniture and fixtures ............. 16 2,509,000 2,281,000 Transportation equipment ........... 6 3,687,000 3,452,000 Machinery and equipment ............ 20 - 40 28,507,000 28,113,000 Pipeline and terminaling equipment.. 20 - 40 259,467,000 252,319,000 Pipeline equipment under capitalized lease ................ 20 - 40 22,513,000 22,270,000 Construction work-in-progress ...... -- 3,728,000 3,760,000 ------------- ------------- Total property and equipment ....... 345,802,000 337,202,000 Accumulated depreciation ........... (98,670,000) (87,469,000) ------------- ------------- Net property and equipment ......... $ 247,132,000 $ 249,733,000 ============= =============
F-8 KANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. LONG-TERM DEBT Long term debt is summarized as follows:
December 31, ----------------------------- 1997 1996 ------------- ------------- First mortgage notes due 2001 and 2002 ........... $ 60,000,000 $ 60,000,000 First mortgage notes due 2001 through 2016 ....... 68,000,000 68,000,000 Obligation under capital lease ................... 6,453,000 8,489,000 Revolving credit facility ........................ -- 5,000,000 ------------- ------------- Total long-term debt ............................. 134,453,000 141,489,000 Less current portion ............................. 2,335,000 2,036,000 ------------- ------------- Long-term debt, less current portion ............. $ 132,118,000 $ 139,453,000 ============= =============
In 1994, a wholly-owned subsidiary of the Partnership issued $33 million of first mortgage notes ("Notes") to a group of insurance companies. The Notes bear interest at the rate of 8.05% per annum and are due on December 22, 2001. Also in 1994, another wholly-owned subsidiary entered into a Restated Credit Agreement with a group of banks that, as subsequently amended, provides a $25 million revolving credit facility through January 31, 2001. The credit facility bears interest at variable interest rates and has a commitment fee of 0.15% per annum of the unused credit facility. At December 31, 1997, no amounts were drawn under the credit facility. In 1995, the Partnership financed the acquisition of the West Pipeline with the issuance of $27 million of Notes due February 24, 2002 which bear interest at the rate of 8.37% per annum. The Notes and the credit facility are secured by a mortgage on the East Pipeline and contain certain financial and operational covenants. The acquisition of the Steuart terminaling assets was initially financed by a $68 million bridge loan from a bank. In June 1996, the Partnership refinanced this obligation with $68.0 million of new first mortgage notes (the "Steuart notes") bearing interest at rates ranging from 7.08% to 7.98%. $35 million of the Steuart notes is due June 2001, $8.0 million is due June 2003, $10.0 million is due June 2006 and $15.0 million is due June 2016. The loan is secured, pari passu with the existing Notes and credit facility, by a mortgage on the East Pipeline. 6. COMMITMENTS AND CONTINGENCIES The following is a schedule by years of future minimum lease payments under capital and operating leases together with the present value of net minimum lease payments for capital leases as of December 31, 1997: Capital Operating Year ending December 31: Lease (a) Leases ----------------------- ---------- ---------- 1998 ..................................... $3,080,000 $1,578,000 1999 ..................................... 4,118,000 1,017,000 2000 ..................................... -- 940,000 2001 ..................................... -- 824,000 2002 ..................................... -- 785,000 Thereafter ............................... -- 2,576,000 ---------- ---------- Total minimum lease payments ................ 7,198,000 $7,720,000 ========== Less amount representing interest ........... 745,000 ---------- Present value of net minimum lease payments.. $6,453,000 ========== (a) The capital lease is secured by certain pipeline equipment and the Partnership has accrued its obligation to purchase this equipment for approximately $4.1 million at the termination of the lease. F-9 KANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Total rent expense under operating leases amounted to $1.3 million, $1.2 million and $.9 million for each of the years ended December 31, 1997, 1996 and 1995, respectively. The operations of the Partnership are subject to Federal, state and local laws and regulations relating to protection of the environment. Although the Partnership 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 significant costs and liabilities will not be incurred by the Partnership. 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 the Partnership, could result in substantial costs and liabilities to the Partnership. The Partnership has recorded a reserve in other liabilities for environmental claims in the amount of $3.1 million at December 31, 1997, including $2.2 million relating to the acquisitions of the West Pipeline and Steuart. The Company has indemnified the Partnership against liabilities for damage to the environment resulting from operations of the pipeline prior to October 3, 1989 (date of formation of the Partnership). The indemnification does not extend to any liabilities that arise after such date to the extent that the liabilities result from changes in environmental laws and regulations. In addition, ST's former owner has agreed to indemnify the Partnership against liabilities for damages to the environment from operations conducted by the former owner prior to March 2, 1993. The indemnity, which expires March 1, 1998, is limited in amount to 60% of any claim exceeding $0.1 million, up to a maximum of $10 million. The Partnership 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 Partnership. 7. RELATED PARTY TRANSACTIONS The Partnership has no employees and is managed and controlled by the Company. The Company and Kaneb are entitled to reimbursement of all direct and indirect costs related to the business activities of the Partnership. These costs, which totaled $10.8 million, $10.5 million and $9.5 million for the years ended December 31, 1997, 1996 and 1995, respectively, include compensation and benefits paid to officers and employees of the Company and Kaneb, insurance premiums, general and administrative costs, tax information and reporting costs, legal and audit fees. Included in this amount is $9.0 million, $8.4 million and $7.7 million of compensation and benefits, paid to officers and employees of the Company for the periods ended December 31, 1997, 1996 and 1995, respectively, which represent the actual amounts paid by the Company or Kaneb. In addition, the Partnership paid $.2 million during each of these respective periods for an allocable portion of the Company's overhead expenses. At December 31, 1997 and 1996, the Partnership owed the Company $1.1 million and $.7 million, respectively, for these expenses which are due under normal invoice terms. F-10 KANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8. BUSINESS SEGMENT DATA Selected financial data pertaining to the operations of the Partnership's business segments is as follows:
Year Ended December 31, ------------------------------------------------------ 1997 1996 1995 ---------------- --------------- -------------- Revenues: Pipeline operations.................................... $ 61,320,000 $ 63,441,000 $ 60,192,000 Terminaling operations................................. 59,836,000 54,113,000 36,736,000 ---------------- --------------- -------------- $ 121,156,000 $ 117,554,000 $ 96,928,000 ================ =============== ============== Operating Income: Pipeline operations.................................... $ 31,827,000 $ 32,221,000 $ 29,747,000 Terminaling operations................................. 21,642,000 19,168,000 12,831,000 ---------------- --------------- -------------- $ 53,469,000 $ 51,389,000 $ 42,578,000 ================ =============== ============== Depreciation and Amortization: Pipeline operations.................................... $ 4,885,000 $ 4,817,000 $ 4,843,000 Terminaling operations................................. 6,826,000 6,164,000 3,418,000 ---------------- --------------- -------------- $ 11,711,000 $ 10,981,000 $ 8,261,000 ================ =============== ============== Capital Expenditures (including capitalized leases and excluding acquisitions): Pipeline operations.................................... $ 4,496,000 $ 3,446,000 $ 3,381,000 Terminaling operations................................. 6,145,000 3,629,000 5,565,000 ---------------- --------------- -------------- $ 10,641,000 $ 7,075,000 $ 8,946,000 ================ =============== ============== Identifiable Assets: Pipeline operations.................................... $ 97,666,000 $ 102,391,000 $ 105,464,000 Terminaling operations................................. 171,366,000 172,374,000 162,323,000 ---------------- --------------- -------------- $ 269,032,000 $ 274,765,000 $ 267,787,000 ================ =============== ==============
9. FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK The estimated fair value of all long term debt (excluding capital leases) as of December 31, 1997 was approximately $134 million as compared to the carrying value of $128 million. These fair values were estimated using discounted cash flow analysis, based on the Partnership's current incremental borrowing rates for similar types of borrowing arrangements. The Partnership has not determined the fair value of its capital leases as it is not practicable. These estimates are not necessarily indicative of the amounts that would be realized in a current market exchange. The Partnership has no derivative financial instruments. The Partnership markets and sells its services to a broad base of customers and performs ongoing credit evaluations of its customers. The Partnership does not believe it has a significant concentration of credit risk at December 31, 1997. No customer constituted 10 percent or more of consolidated revenues in 1997, 1996 or 1995. F-11 KANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 10. QUARTERLY FINANCIAL DATA (UNAUDITED) Quarterly operating results for 1997 and 1996 are summarized as follows:
Quarter Ended -------------------------------------------------------------------------- March 31, June 30, September 30, December 31, ---------------- ---------------- ---------------- --------------- 1997: Revenues...................... $ 28,579,000 $ 29,793,000 $ 31,465,000 $ 31,319,000 ================ ================ =============== ============== Operating income.............. $ 12,029,000 $ 12,919,000 $ 13,956,000 $ 14,565,000 ================ ================ =============== ============== Net income.................... $ 8,907,000 $ 9,949,000 $ 10,975,000 $ 11,730,000 ================ ================ =============== ============== Allocation of net income per SPU and PU.............. $ .55 $ .61 $ .68 $ .71 ================ ================ =============== ============== 1996: Revenues...................... $ 27,826,000 $ 28,795,000 $ 29,963,000 $ 30,970,000 ================ ================ =============== ============== Operating income.............. $ 11,600,000 $ 12,841,000 $ 12,832,000 $ 14,116,000 ================ ================ =============== ============== Net income.................... $ 8,677,000 $ 10,007,000 $ 9,872,000 $ 11,351,000 ================ ================ =============== ============== Allocation of net income per SPU and PU.............. $ .55 $ .62 $ .61 $ .70 ================ ================ =============== ==============
F-12 REPORT OF INDEPENDENT ACCOUNTANTS To the Partners of Kaneb Pipe Line Partners, L.P. In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) and (2) on page 29 present fairly, in all material respects, the financial position of Kaneb Pipe Line Partners, L.P. and its subsidiaries (the "Partnership") at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Partnership's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP Dallas, Texas February 19, 1998 F-13 SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, Kaneb Pipe Line Partners, L.P. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. KANEB PIPE LINE PARTNERS, L.P. By: Kaneb Pipe Line Company General Partner By: EDWARD D. DOHERTY Chairman of the Board and Chief Executive Officer Date: March 23, 1998 Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of Kaneb Pipe Line Partners, L.P. and in the capacities with Kaneb Pipe Line Company and on the date indicated. SIGNATURE TITLE DATE - ---------------------------- --------------------------- ------------- Principal Executive Officer Chairman of the Board March 23 1998 EDWARD D. DOHERTY and Chief Executive Officer Principal Accounting Officer JIMMY L. HARRISON Controller March 23, 1998 Directors SANGWOO AHN Director March 23, 1998 JOHN R. BARNES Director March 23, 1998 M.R. BILES Director March 23, 1998 FRANK M. BURKE, JR. Director March 23, 1998 CHARLES R. COX Director March 23, 1998 HANS KESSLER Director March 23, 1998 JAMES R. WHATLEY Director March 23, 1998 EXHIBIT INDEX EXHIBIT NUMBER DESCRIPTION - ------- ----------------------------------------------------------------------- 3.1 Amended and Restated Agreement of Limited Partnership dated September 27, 1989, filed as Appendix A to the Registrant's Prospectus, dated September 25, 1989, in connection with the Registrant's Registration Statement on Form S-1 (S.E.C. File No. 33-30330) which exhibit is hereby incorporated by reference. 10.1 ST Agreement and Plan of Merger date December 21, 1992 by and between 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 Registrant's Current Report on Form 8-K, dated March 16, 1993, which exhibit is hereby incorporated by reference. 10.2 Restated Credit Agreement between Kaneb Operating Partnership, L.P. ("KPOP"), Texas Commerce Bank, N.A., ("TCB"), and certain other Lenders, dated December 22, 1994 (the "TCB Loan Agreement"), filed as Exhibit 10.13 of the exhibits to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994, which exhibit is hereby incorporated by reference. 10.3 Amendment to the TCB Loan Agreement, dated January 30, 1998, filed herewith. 10.4 Pledge and Security Agreement between Kaneb Pipe Line Company ("KPL") and TCB, dated October 11, 1993, filed as Exhibit 10.3 of the exhibits to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993, which exhibit is hereby incorporated by reference. 10.5 Note Purchase Agreement, dated December 22, 1994, filed as Exhibit 10.2 of the exhibits to Registrant's Current Report on Form 8-K, dated March 13, 1995 (the "March 1995 Form 8-K"), which exhibit is hereby incorporated by reference. 10.6 Note Purchase Agreements, dated June 27, 1996, filed as Exhibit 10.5 of the exhibits to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996, which exhibit is hereby incorporated by reference. 10.7 Agreement for Sale and Purchase of Assets between Wyco Pipe Line Company and KPOP, dated February 19, 1995, filed as Exhibit 10.1 of the exhibits to the Registrant's March 1995 Form 8-K, which exhibit is hereby incorporated by reference. 10.8 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 KPOP, as amended, dated August 27, 1995, filed as Exhibits 10.1, 10.2, 10.3, and 10.4 of the exhibits to Registrant's Current Report on Form 8-K dated January 3, 1996, which exhibits are hereby incorporated by reference. 21 List of Subsidiaries, filed herewith. 27 Financial Data Schedule, filed herewith. EX-10.3 2 AMENDENT TO CREDIT AGREEMENT THIRD AMENDMENT TO RESTATED CREDIT AGREEMENT THIS DOCUMENT is entered into to be effective as of January 30, 1998, between KANEB PIPE LINE OPERATING PARTNERSHIP, a Delaware limited partnership ('BORROWER'), Lenders, and CHASE BANK OF TEXAS, NATIONAL ASSOCIATION (formerly known as Texas Commerce Bank National Association, ('AGENT') as Agent for Lenders. Borrower, Agent, and Lenders are party to the Restated Credit Agreement (as amended through the date of this document and as further renewed, extended, amended, and restated, the ('CREDIT AGREEMENT') dated as of December 22, 1994 providing for a $15,000,000 revolving credit facility (the 'REVOLVING FACILITY') and the issuance of letters of credit up to an aggregate face amount of $4,118,000. Borrower, Agent, and Lenders have agreed, upon the following terms and conditions, to amend the Credit Agreement to provide for (a) an extension of the stated date of maturity for the Revolving Facility, (b) an increase in the maximum amount available under the Revolving Facility, and (c) modification of certain pricing terms. Accordingly, for adequate and sufficient consideration, Borrower, Agent, and Lenders agree as follows: 1. TERMS AND REFERENCES. Unless otherwise stated in this document, terms defined in the Credit Agreement have the same meanings when used in this document. 2. AMENDMENT TO CREDIT AGREEMENT. The Credit Agreement is amended as follows: (A) CLAUSE (B) in the definition of LIBOR RATE in SECTION 1 is amended as follows: (b) A margin of interest that, for any day, is determined on the basis of the ratio of the KPP Companies consolidated Funded Debt to EBITDA, as follows: RATIO OF FUNDED DEBT TO EBITDA MARGIN 3.00 to 1.00 or more 0.875% Less than 3.00 to 1.00, but 2.50 to 1.00 or more 0.625% Less than 2.50 to 1.00, but 2.00 to 1.00 or more 0.500% Less than 2.00 0.375% For purposes of calculating that ratio, EBITDA is calculated for the KPP Companies' most recently-completed-four-fiscal quarters, and Funded Debt is determined as of the day the margin of interest is determined. EBITDA is determined from the Current Financials and related Compliance Certificate then most recently delivered to Agent, effective as of the date received by Agent. If Borrower fails to timely furnish to Agent any Financial Statements and related Compliance Certificates required by this agreement, then the margin of 1.125% shall apply and remain in effect until Borrower furnishes them to Agent. (B) SECTION 1.1 is further amended by entirely amending the definition of STATED TERMINATION DATE, as follows: STATED TERMINATION DATE means January 31, 2001. (C) SECTION 2.1(B) is entirely amended, as follows: (b) the Principal Debt (other than for payments under LCs) may never exceed $25,000,000, (D) SECTION 4.3 is entirely amended, as follows: 4.3 Commitment Fee. Borrower shall pay to Agent for the account of Lenders (based on their respective Commitment Percentages) a commitment fee, payable as it accrues from the date of this agreement as of the last day of each February, May, August, and November (commencing February 28, 1998), and on the Termination Date, equal to the Applicable Percentage (per annum) of the amount by which (a) the total Commitments exceeds (b) the average-daily Commitment Usage, determined for the calendar quarter (or portion of a calendar quarter commencing on the date of this agreement or ending on the Termination Date) preceding and including the date it is due. For purposes of this SECTION 4.3, the term, 'APPLICABLE PERCENTAGE' means, for any day, a commitment fee percentage subject to adjustment (upwards or downwards, as appropriate), based on the ratio of the KPP Companies' Funded Debt to EBITDA, as follows: RATIO OF FUNDED DEBT TO EBITDA PERCENTAGE Greater than 2.50 to 1.00 0.20% Less than or equal to 2.50 to 1.00 0.15% For purposes of calculating that ratio, EBITDA is calculated for the KPP Companies' most recently-completed-four-fiscal quarters, and Funded Debt is determined as of the day the commitment fee is due. EBITDA is determined from the Current Financials and related Compliance Certificate then most recently delivered to Agent, effective as of the date received by Agent. If Borrower fails to timely furnish to Agent any Financial Statements and related Compliance Certificates required by this agreement, then the percentage of .20% shall apply and remain in effect until Borrower furnishes them to Agent. 3. CANCELLATION OF LC AVAILABILITY. As of the date of this document, the LC Exposure is $0.00. Notwithstanding anything in the Loan Documents to the contrary, Lenders= Commitments with respect to LCs are hereby cancelled, and commencing on the date of this document neither Agent nor any of its Affiliates shall, under any circumstances, issue LCs under the Credit Agreement. 4. CONDITIONS PRECEDENT. Notwithstanding any contrary provision, PARAGRAPH 2 of this document is not effective unless and until (A) the representations and warranties in this document are true and correct and (B) Agent receives (1) counterparts of this document executed by each party named on the signature page or pages of this document, and (2) each item described on ANNEX 1 attached to this document, each in form and substance satisfactory to Agent. 5. RATIFICATIONS. Borrower (A) ratifies and confirms all provisions of the Loan Papers as amended by this document, (B) ratifies and confirms that all guaranties, assurances, and Liens granted, conveyed, or assigned to Agent under the Loan Papers are not released, reduced, or otherwise adversely affected by this document and continue to guarantee, assure, and secure full payment and performance of the present and future Obligation, and (C) agrees to perform such acts and duly authorize, execute, acknowledge, deliver, file, and record such additional documents and certificates as Agent may request in order to create, perfect, preserve, and protect those guaranties, assurances, and Liens. 6. REPRESENTATIONS. Borrower represents and warrants to Agent that as of the date of this document (A) all representations and warranties in the Loan Papers are true and correct in all material respects except to the extent that (1) any of them speak to a different specific date or (2) the facts on which any of them were based have been changed by transactions contemplated or permitted by the Credit Agreement, and (B) no Material Adverse Event, Default or Potential Default exists. 7. EXPENSES. Borrower shall pay all costs, fees, and expenses paid or incurred by Agent incident to this document, including, without limitation, the reasonable fees and expenses of Agent=s counsel in connection with the negotiation, preparation, delivery, and execution of this document and any related documents. 8. MISCELLANEOUS. This document is a 'Loan Paper' referred to in the Credit Agreement, and the provisions relating to Loan Papers in SECTIONS 1 and 14 of the Credit Agreement are incorporated in this document by reference. Unless stated otherwise (A) the singular number includes the plural and vice versa and words of any gender include each other gender, in each case, as appropriate, (B) headings and captions may not be construed in interpreting provisions, (C) this document must be construed, and its performance enforced, under Texas law, (D) if any part of this document is for any reason found to be unenforceable, all other portions of it nevertheless remain enforceable, and (E) this document may be executed in any number of counterparts with the same effect as if all signatories had signed the same document, and all of those counterparts must be construed together to constitute the same document. 9. ENTIRETIES. THIS DOCUMENT REPRESENTS THE FINAL AGREEMENT BETWEEN THE PARTIES ABOUT THE SUBJECT MATTER OF THIS DOCUMENT AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES. 10. PARTIES. This document binds and inures to Borrower, Agent, Lenders, and their respective successors and assigns. THIRD AMENDMENT SIGNATURE PAGE EXECUTED to be effective as of the date first stated above. KANEB PIPE LINE OPERATING CHASE BANK OF TEXAS, NATIONAL ASSOCIATION, PARTNERSHIP, as Borrower formerly known as Texas Commerce Bank N.A., as Agent and Lender By KANEB PIPE LINE COMPANY, General Partner By Edward D. Doherty By Donna German, Senior Vice President BANK OF MONTREAL, as a Lender By Donald G. Skipper, Director, U.S. Corporate Banking To induce Agent and Lenders to enter into this document, the undersigned consent and agree (A) to its execution and delivery, (B) that this document in no way releases, diminishes, impairs, reduces, or otherwise adversely affects any Liens, guaranties, assurances, or other obligations or undertakings of any of the undersigned under any Loan Papers, and (C) waive notice of acceptance of this consent and agreement, which consent and agreement binds the undersigned and their successors and permitted assigns and inures to Agent and their respective successors and permitted assigns. KANEB PIPE LINE PARTNERS, L.P. SUPPORT TERMINALS OPERATING PARTNERSHIP, L.P., as a Guarantor By KANEB PIPE LINE COMPANY, By SUPPORT TERMINAL SERVICES INC. General Partner General Partner By Edward D. Doherty, Chairman By Edward D. Doherty, Chairman STANTRANS, INC., AND SUPPORT STANTRANS PARTNERS, L.P., TERMINAL SERVICES, INC., as Guarantors as a Guarantor By STANTRANS, INC., General Partner By Edward D. Doherty, Chairman By Edward D. Doherty, Chairman of both the above corporations STANTRANS HOLDING, INC., as a Guarantor EX-21 3 SUBSIDIARY LIST LIST OF SUBSIDIARIES KANEB PIPE LINE COMPANY Kaneb Pipe Line Partners, L.P. Kaneb Pipe Line Operating Partnership, L.P. Support Terminal Operating Partnership, L.P. Support Terminal Services, Inc. StanTrans, Inc. StanTrans Holding, Inc. StanTrans Partners, L.P. Kaneb Management Company, Inc. Diamond K Limited Kaneb Management, L.L.C. Martin Oil Corporation EX-27 4 FINANCIAL DATA SCHEDULE
5 1,000 12-MOS DEC-31-1997 JAN-1-1997 DEC-31-1997 6,376 0 11,585 82 0 21,900 345,802 98,670 269,032 24,749 132,118 0 0 0 104,196 269,032 0 121,156 0 67,687 0 0 11,332 42,279 718 41,561 0 0 0 41,561 2.55 2.55
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